Scribd
Upload
35 views3 pages

Money and Banking Chapter 8

The document provides information on the global financial system and how businesses are financed. It discusses: 1) Financial intermediaries like banks are the most important source of external funds for businesses. Indirect finance through intermediaries is much more significant than direct finance from markets. 2) Only large, established corporations have easy access to securities markets to finance activities. Smaller businesses rely more on loans that typically include complicated legal documents and restrictions. 3) Collateral is commonly used in debt contracts for both households and businesses to guarantee loans in case of default.

Uploaded by

Gene's
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
35 views3 pages

Money and Banking Chapter 8

The document provides information on the global financial system and how businesses are financed. It discusses: 1) Financial intermediaries like banks are the most important source of external funds for businesses. Indirect finance through intermediaries is much more significant than direct finance from markets. 2) Only large, established corporations have easy access to securities markets to finance activities. Smaller businesses rely more on loans that typically include complicated legal documents and restrictions. 3) Collateral is commonly used in debt contracts for both households and businesses to guarantee loans in case of default.

Uploaded by

Gene's
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 3

Identify eight basic facts about the global financial system. 1.

Stocks are not the most important


source of external financing for businesses.

2. Issuing marketable debt and equity securities is not the primary way in which businesses
finance their operations

3. Indirect finance, which involves the activities of financial intermediaries, is many times more
important than direct finance, in which businesses raise funds directly from lenders in financial
markets.

4. Financial intermediaries, particularly banks, are the most important source of external funds
used to finance businesses.

5. The financial system is among the most heavily regulated sectors of the economy.

6. Only large, well-established corporations have easy access to securities markets to finance
their activities.

7 .Collateral is a prevalent feature of debt contracts for both households and businesses

8. Debt contracts typically are extremely complicated legal documents that place substantial
restrictions on the behavior of the borrower.

How do American banks financed their activities using external funds? They use bank loans,
non-bank loans, bonds, and stocks.

Bank loans made it up of loans from depository institutions

Non-Bank loans loans from financial intermediaries

Bonds marketable debt securities such as corporate bonds and commercial paper

Stocks new issue of equity

Collateral property pledge to a lender to guarantee payment in case the borrower defaults on
payment

Unsecured Debt not backed by collateral

Secured Debt debt guaranteed by collateral

How transaction costs affect financial intermediaries. High transaction costs deter
investments as most of the money set aside for investing for example, $5000, will be give to
broker. Also because money is usually limited for most Americans, you're not able to properly
diversify you portfolio leading on to take higher risk.
Economies of scale as a solution to high transaction costs bundle the funds of many investors
together so that they can take advantage of economies of scale, the reduction in transaction costs
per dollar of investment as the size (scale) of transactions increases.

Mutual Fund a financial intermediary that sells shares to individuals and then invests the
proceeds in bonds or stocks.

Expertise as a solution to high transaction costs better able to develop expertise that can be
used to lower transaction costs.Low transaction costs enable financial intermediaries to provide
their customers with liquidity services, which are services that make it easier for customers to
conduct transactions.

Why does asymmetric information leads to adverse selection and moral hazard. a situation that
arises when one party's insufficient knowledge about the other party involved in a transaction
makes it impossible for the first party to make accurate decisions when conducting the
transaction

Assymetric information one party's insufficient knowledge about the other party involved
in a transaction

Adverse Selection asymmetric information problem that occurs before the transaction

Moral Hazard asymmetric information that happens after the transaction. Lender thinks funds
are going to be used unwisely.

Agency theorythe analysis of how asymmetric information problems affect economic behavior

How do financial intermediaries reduce transaction costs? through economies of scale and
expertise

What is one way to solve the asymmetric information problem give the people who are
supplying the funds with more information about the firms they are trying to invest in. There are
companies that collects this information and then sell it ton saver-lenders. The private sale of
information is only half the solution for the lemon problems. It does not account for the free rider
problem

free rider problem when people who did not pay for information take advantage of the
information that other people did pay for. The increased demand for the undervalued good
securities causes their low price to be bid up immediately to reflect the securities' true value.

Can government regulate information about firms? The government can distribute information
about firms free of charge, but this idea tend to create a conflict of interest where the government
promotes and demotes based on their own judgment. The government does however, use the
SEC to regulate information by making sure each firm reports accurate information about their
company.
New worth or equity capital The difference between a firm's asset and liability

True or False

An equity capital can be used as a collateral True

Principal agent problem This separation of ownership and control involves moral hazard, in
that the managers in control (the agents) may act in their own interest rather than in the interest
of the stockholder-owners (the principals) because the managers have less incentive to maximize
profits than the stockholder-owners do.

Tools to solve principal agent problem monitoring

government regulation

financial intermediaries

debt contracts

venture capital firms companies that invest in start-up businesses with high growth potential in
exchange for a share of ownership

True or False

It doesn't matter the borrowers net worth, they will invest in riskier venture if they have the loan
amount False, if the borrower's net worth is high of the collateral to the lender is valuable,
their is reduce risk that the borrower will undergo risky ventures. This is called incentive-
compatible

What are some functions of restrictive covenants 1. discourage bad behavior

2. encourage good behavior

3. Keep collateral valuable

4. provide information

incentive-compatible aligns the incentives of the borrower with those of the lender

You might also like