Week One

Question 1

What is direct finance

Answer 1

• Raising funds directly from financial markets rather than from intermediaries like banks. This can involve issuing stocks or bonds directly to investors. It’s a method for companies or governments to obtain funding without going through traditional lending channels.

Question 2

What is indirect finance

Answer 2

An institution stands between lender and borrower.
- We get a loan from a bank or from a finance company to buy a car

Question 3

What is an asset

Answer 3

Something of value you own

Question 4

What is a liability

Answer 4

Something you owe

Question 5

Who are the users of the financial system (2)

Answer 5

• ultimate lenders
• ultimate borrowers

Question 6

What is an ultimate lender

Answer 6

Agents whose excess of income over expenditure creates a
financial surplus which they are willing to lend

Question 7

What is an ultimate borrower

Answer 7

Agents whose excess of expenditure over income creates
a financial deficit which they wish to meet by borrowing

Question 8

Why do borrowers and lenders have conflicting preferences

Answer 8

• borrowers :
  Low liquidity
  Minimum cost
  Minimum risk
  Minimum transaction costs

lenders:
- high liquidity
- maximum return
- minimum risk
- minimum transaction costs

Question 9

What are the functions of money (3)

Answer 9

• means of payment : used in exchange for goods and servives
• It is a unit of account: used to quote prices.
• It is a store of value: used to transfer purchasing power into the future

Question 10

What is liquidity

Answer 10

a measure of the ease with which an asset can be turned into a means of payment

Question 11

What are the different types of liquidity (2)

Answer 11

• market liquidity : is the ability to sell assets
• funding liquidity: is the ability to borrow money

Question 12

What is the inflation and inflation rate

Answer 12

The process of rising prices and inflation rate is the measurement of the process

Question 13

How does inflation link to the basket of goods

Answer 13

If inflation rises you need more money to buy the same basket of goods

Question 14

What is M1

Answer 14

Narrow money - the sum of currency in circulation and overnight deposits.

Question 15

What is M2

Answer 15

Intermediate money - the sum of M1, short-term time deposits (i.e. with an agreed
maturity of up to 2-year) and deposits redeemable at notice of up to 3
months.

Question 16

What is m3

Answer 16

Broad money - is the sum of M2 and long-term time deposits.

Question 17

What is CPI

Answer 17

How much more would it cost for people to purchase today
the same basket of goods and services that they actually bought at some fixed time in the past

Question 18

How to calculate cpi

Answer 18

X
- survey to see what’s they bought
- Figure out what it would cost to buy the same basket of goods and
services today
- Compute the percentage change in the cost of the basket of goods:
CPI =
Cost of the basket in current year /
Cost of the basket in base year ∗ 100

Question 19

What are financial instruments

Answer 19

Assets that can be traded such as stocks, bonds, derivatives, commodities, currencies, and mutual funds. They represent a claim to future cash flows or a right to receive something of valu

Question 20

What are the different types of assets (2)

Answer 20

Tangible assets - value based on physical properties
Intangible assets - Claim to future income generated (ultimately) by tangible asset(s)

Question 21

What are two fundamental classes of financial instruments

Answer 21

Underlying and derivative instruments

Question 22

What are the three principle economic functions of financial assets

Answer 22

• act as mean of payment - employees take stock options as payment for working
• act as a store of value - Claim to future income generated (ultimately) by tangible asset(s)
• allow for the transfer of risk - Futures and insurance contracts allow one person to transfer risk to
  another

Question 23

What financial instruments are a store of value

Answer 23

Bank loans
Bonds
Home morgatges
Stocks

Question 24

What financial instruments are used to transfer risk

Answer 24

Insurance contracts
Future contracts
Options

Question 25

What are financial markets

Answer 25

Places where financial instruments are bought and sold

Question 26

What are the economic functions of financial markets

Answer 26

Market liquidity + ensure that owners of financial instruments can buy and sell them cheaply and easily. Information - Pool and communicate information about the issuer of a financial instrument Risk sharing - Provide individuals a place to buy and sell risk

Question 27

What are different types of financial intermediaries (2)

Answer 27

Deposit takers - retail bank - commercial bank Non deposit taker - insurance companies - pension funds - Securities firms (brokers, investment banks, mutual funds, private equity and venture capital firms) - Finance companies

Question 28

What are the role of financial intermediaries (5)

Answer 28

- Pooling the resources of small savers. -Providing safekeeping and accounting services, as well as access to payments system - Supplying liquidity by converting savers’ balances directly into a means of payment whenever needed - providing ways to diversify risk - Collecting and processing information in ways that reduce information costs

Question 29

How do banks pool savings

Answer 29

By accepting many small deposits banks empower themselves to more large loans - must attract substantial numbers of savers - must convince potential depositors of the institutions soundness

Question 30

How do banks provide safekeeping payment systems access and accounting

Answer 30

- provide reliable and inexpensive payments systems - manage our finances - provide us with bookkeeping and accounting service - These force financial intermediaries to write legal contracts - but one can be written and used over and over again - reducing the cost of each Take advantage of economies of scales

Question 31

What does providing liquidity look like for banks (6)

Answer 31

- Liquidity is a measure of the ease and cost with which an asset can be turned into a means of payment. - Financial intermediaries offer us the ability to transform assets into money at relatively low cost - ATMs, for example. - Banks can structure their assets accordingly, keeping enough funds in short-term, liquid financial instruments to satisfy the few people who will need them and lending out the rest. - By collecting funds from a large number of small investors, the bank can reduce the cost of their combined investment, offering each individual investor both liquidity and high rates of return. - Intermediaries offer both individuals and businesses lines of credit, which provides customers with access to liquidity. - A financial intermediary must specialise in liquidity management, designing its balance sheet to sustain sudden withdrawals.

Question 32

What does diversifying risk look like

Answer 32

-Financial institutions enable us to diversify our investments and reduce risk - Banks take deposits from thousands of individuals and make thousands of loans with them. Thus, each depositor has a very small stake in each one of the loans - All financial intermediaries provide a low-cost way for individuals to diversify their investments.

Question 33

How do banks collect and process information

Answer 33

-The fact that the borrower knows whether he or she is trustworthy, while the lender faces substantial costs to obtain that information, results in an information asymmetry. - Borrowers have information that lenders do not have -By collecting and processing standardized information, financial intermediaries reduce the problems that information asymmetries create

Question 34

What is information asymmetries

Answer 34

- Information plays a central role in the structure of financial markets and financial institutions - markets require a sophisticated information to work well - if the cost of information is too high the markets cease to function - Issuers of financial instruments know more about their business prospects and willingness to work than potential lenders/investors

Question 35

What is asymmetric information (2)

Answer 35

One party lacks crucial information about another party, impacting decision-making - adverse selection - before transactions - moral hazard - after transactions

Question 36

What are solutions for adverse selection

Answer 36

- goverment require information disclosure - private collection of info - Pledging of collateral to insure lenders against the borrower’s default - Requiring borrowers to invest substantial resources of their ow

Question 37

What are thr solutions of moral hazard

Answer 37

Requires mangers to report to owners Requiring mangers to invest substantial resources of their own - covenants that restrict what borrowers can do with borrowed funds