Chapter 8

Question 1

Answer 1

Question 2

Indirect Finance: … (investors) are indirectly linked by ….

Answer 2

Indirect Finance: borrowers and lenders (investors) are indirectly linked by Financial Intermediaries.

Question 3

Function of Financial Intermediaries

(the process of … using f.. is called…: the primary route for moving funds from …to …).

• • 1. 2. M
          *

Answer 3

Function of Financial Intermediaries

(the process of indirect financing using financial intermediaries is called financial intermediation: the primary route for moving funds from lenders to borrowers).

• Reducing Transaction Costs: transaction costs is the time and money spend in carrying our financial transactions.
  
  • Economies of scale: the reduction in transaction costs per dollar of transactions as the size of transactions increases (e.g. mutual fund)
  • Liquidity services: services that make it easier for customers to conduct transactions.
• Risk sharing: e.g. through asset transformation and diversification, etc.
• Helping reduce Problems due to asymmetric information: ADVERSE SELECTION and MORAL HAZARD
  
  1. ​​ADVERSE SELECTION is the problem created by asymmetric information before the transaction occurs. Adverse selection in financial markets occurs when the potential borrowers who are the most likely to produce an undesirable (adverse) outcome – the bad credit risks – are the ones who most actively seek out a loan and are thus most likely to be selected. (typical adverse selection problem: Lemon’s problem)​
  2. MORAL HAZARD is the problem created by asymmetric information after the transaction occurs. Moral hazard in financial markets is the risk (hazard) that the borrower might engage in activities that are undesirable (immoral) from the lender’s point of view, because they make it less likely that the loan will be paid back. ( Change of borrower’s behavior) (typical moral hazard problem: principal-agency problem)​
• Economies of Scope

Question 4

Direct Finance:

…

Securities:

A. Structure of Financial Markets:​

​B. Financial Market Instruments

• a.
  
• b
  
• C. Other instruments:
  *

Answer 4

Direct Finance:

borrowers borrow funds directly from lenders in financial markets by selling the lenders securities (financial instruments), which are claims on the borrowers’ future income or assets.

Securities: are assets for the person who buys them but liabilities for the individual or firm that sells (issues) them.

A. Structure of Financial Markets:​

• Debt vs. Equity markets
• Primary vs. Secondary Markets
• Exchanges vs. Over-the Counter
• Markets Money vs. Capital Markets

B. Financial Market Instruments

• a. Money Market Instruments:
  
  • Treasury bills and Short-term paper
  • Certificates of Deposit
  • Commercial Paper
  • Repurchase Agreements
  • Overnight Funds
• b. Capital Market Instruments:
  
  • Stocks
  • Mortgages and Mortgage-Backed Securities
  • Corporate Bonds
  • Government bonds
  • Canada Savings Bond Provincial and Municipal Government Bonds
  • Government Agency Securities
  • Consumer and Bank Commercial Loans
• C. Other instruments:
  
  • Foreign bonds, Eurobond, Eurocurrencies