lecture 1

52 Questions

Which type of financial intermediary has the largest financial portfolio and the most diversified portfolios?

Commercial Banks

What type of financial intermediary issues deposits as shares, which are owned collectively by depositors?

Credit Unions

In which year did Lehman Brothers file for bankruptcy, causing a domino effect on many stakeholders?

2008

Which financial intermediary primarily gives out mostly mortgage and consumer loans?

Savings and Loan Associations (S&L)

What is the primary way that commercial banks make money?

Through the spread in loan rate and deposit rate

Which type of financial intermediary is specific to a certain group, such as employees of a particular company or members of a labor union?

Credit Unions

What are the primary activities of individuals borrowing from financial intermediaries?

Education and big expenses

What are the primary activities of firms borrowing from financial intermediaries?

Executing ideas and saving

Which type of financial intermediary raises funds by issuing checkable time deposits and savings used to make commercial, consumer, and mortgage loans?

Commercial Banks

What is the main role of financial intermediaries in reducing costs for transferring funds from lenders to borrowers?

To facilitate efficient allocation of capital

What is the function of financial intermediaries in indirect finance?

Transfer funds to borrowers or in financial markets

What is the concept of asset transformation in the context of financial intermediaries?

Transforming risky assets into safer assets for investors

What is the primary incentive for a bank to engage in asset transformation?

Increased scope for profits

What is the key challenge addressed by financial intermediaries in the context of adverse selection?

Identifying potential borrowers most likely to produce adverse outcomes

What is the primary concern addressed by the Diamond-Dybvig Model?

Moral hazard and liquidity issues in banking

In the Diamond-Dybvig Model, what is the utility of an impatient depositor receiving money tomorrow instead of today?

Small

What is the primary role of banks in the Diamond-Dybvig Model?

Converting short term deposits into long term loans

What is the return on short term investment (reserves) in the Diamond-Dybvig Model?

What is the primary source of outflows of currency and inflation in the context of emerging market bonds?

US increasing their interest rates

What is the alternative source of funds provided by Yen bond issuance in the UK Eurocurrency Market?

Foreign currency deposited outside of home nation

Which type of institution invests in riskier assets due to their ability to predict payments?

Life insurance companies

What type of funds invest in liquid short-term debt assets and are relatively safe?

Money market mutual funds

Which regulatory agency in the USA is responsible for ensuring soundness of intermediaries?

Office of the Controller of the Currency

What do finance companies do to raise funds for lending to consumers and small businesses?

Issue bonds and stocks

Which type of institution collects money through shares and invests in securities with investing managers?

Mutual funds

What is the primary function of investment banks?

Advise firms on securities

What are the main components of financial markets according to the text?

Debt and equity markets

Which type of institution funds are based on scheduled contracts and predictable payout requirements?

Pension and government retirement funds

What is the main focus of regulatory measures according to the text?

Increase investor information

Which type of insurance companies invest in safer securities due to the unpredictability of payouts from tragedies?

Fire and casualty insurance companies

Explain the role of financial intermediaries in reducing the costs of transferring funds from lenders to borrowers, and provide an example of a financial intermediary.

Financial intermediaries reduce the costs of transferring funds by pooling resources from multiple lenders and providing them to borrowers at a lower cost. An example of a financial intermediary is a commercial bank.

Discuss the potential consequences of the failure of financial intermediaries, using the example of the 2008/9 Lehman Brothers bankruptcy.

The failure of financial intermediaries can lead to a domino effect on many stakeholders, as seen in the case of the 2008/9 Lehman Brothers bankruptcy. This can disrupt the flow of funds in the financial system and impact the broader economy.

Compare the primary activities of individuals borrowing from financial intermediaries with the activities of firms borrowing from financial intermediaries.

Individuals borrow for education and big expenses, as well as save for retirement, while firms borrow to execute ideas and also save for various purposes.

Explain the function of mutual savings banks and credit unions in issuing deposits as shares, and discuss the ownership structure of these deposits.

Mutual savings banks and credit unions issue deposits as shares, which are collectively owned by the depositors. This collective ownership structure distinguishes them from traditional deposit accounts in other financial intermediaries.

What types of securities do life insurance companies typically invest in?

Life insurance companies typically invest in liquid securities and mortgages.

What type of assets do fire and casualty insurance companies typically invest in, and why?

Fire and casualty insurance companies typically invest in safer securities due to the unpredictability of payouts from tragedies.

What is the primary source of funding for pension and government retirement funds, and how do they utilize these funds?

Pension and government retirement funds are funded by workers and invest in securities to provide retirement income.

How do finance companies raise funds, and what is the purpose of these funds?

Finance companies raise funds through issuing bonds and stocks to lend to consumers and small businesses, increasing revenue for the firm.

What is the primary investment strategy of mutual funds?

Mutual funds collect money through shares and invest in securities with investing managers.

What types of assets do money market mutual funds typically invest in, and how safe are these investments?

Money market mutual funds invest in liquid short-term debt assets and are relatively safe.

What are the key functions of investment banks in the financial market?

Investment banks provide various financial services such as advising firms on securities and acting as dealers in markets.

What are some regulatory agencies in the USA, and what are their responsibilities?

Regulatory agencies in the USA include the SEC, Office of the Controller of the Currency, FDIC, and the Federal Reserve System. They aim to increase investor information, ensure soundness of intermediaries, and prevent financial panics.

What are the critical roles of financial markets in the economy?

Financial markets are critical for efficient capital allocation, improving consumer well-being, and channeling funds from lenders to borrowers.

What are the key components of financial markets mentioned in the overview?

Debt and equity markets, interest rate patterns, stock market performance, and the primary and secondary markets are key components of financial markets.

Explain the difference between direct finance and indirect finance in the context of borrowers and lenders.

Direct finance involves borrowers borrowing directly from lenders, while indirect finance involves borrowers borrowing from lenders via financial intermediaries.

Describe the concept of adverse selection and moral hazard in the context of financial transactions.

Adverse selection occurs before a transaction, where potential borrowers most likely to produce adverse outcomes are the most likely to seek a loan. Moral hazard occurs after a transaction, where borrowers have an incentive to engage in undesirable activities, making it more likely to default.

Explain the main idea and assumptions of the Diamond-Dybvig Model (1983) in the context of banks and depositors.

The Diamond-Dybvig Model addresses the challenges of moral hazard and liquidity issues in financial transactions. It assumes that firms demand for long-term borrowings and households demand short-term investments for flexibility.

Discuss the utility considerations for depositors and the investment opportunities for banks in the Diamond-Dybvig Model.

Depositors either need the money today (impatient) or tomorrow (patient), with utility considerations based on their need for money. Banks have two investment opportunities - short-term investment (reserves) and long-term investment (illiquid).

Explain the role of financial intermediaries in providing liquidity services and reducing exposure to risk through risk sharing.

Financial intermediaries provide liquidity services by enabling depositors to have checking accounts and earn interest, as well as reducing exposure to risk through risk sharing by creating/selling lower risk assets to buy greater risk assets.

Describe the concept of asset transformation and its significance for financial intermediaries.

Asset transformation involves financial intermediaries transforming risky assets into safer assets for investors, as well as transforming magnitude and maturity. This is significant as it allows for risk sharing and diversification, and provides incentives for banks through increased scope for profits.

Discuss the impact of foreign currency deposits on the local currency and the implications of issuing bonds in foreign currency for emerging economies.

Foreign currency deposits outside of the home nation provide an alternative source for citizens, impacting the power of the local currency. Issuing bonds in foreign currency by emerging economies leads to outflows of currency and inflation, especially due to changes in US interest rates.

Explain the primary reasons why financial intermediation is important, including transaction costs, risk sharing, and asymmetric information.

Financial intermediation is important due to its role in reducing transaction costs, facilitating risk sharing through asset transformation, and addressing asymmetric information between borrowers and lenders.

Study Notes

Financial Institutions and Markets Overview

Contractual savings institutions (CSIs) receive funds based on scheduled contracts and predictable payout requirements.
Life insurance companies invest in liquid securities and mortgages and can predict payments, allowing them to invest in riskier assets.
Fire and casualty insurance companies invest in safer securities due to the unpredictability of payouts from tragedies.
Pension and government retirement funds are funded by workers and invest in securities to provide retirement income.
Finance companies raise funds through issuing bonds and stocks to lend to consumers and small businesses, increasing revenue for the firm.
Mutual funds collect money through shares and invest in securities with investing managers.
Money market mutual funds invest in liquid short-term debt assets and are relatively safe.
Investment banks provide various financial services such as advising firms on securities and acting as dealers in markets.
Regulatory agencies in the USA include the SEC, Office of the Controller of the Currency, FDIC, and the Federal Reserve System.
Regulatory measures aim to increase investor information, ensure soundness of intermediaries, and prevent financial panics.
Financial markets are critical for efficient capital allocation, improving consumer well-being, and channeling funds from lenders to borrowers.
Debt and equity markets, interest rate patterns, stock market performance, and the primary and secondary markets are key components of financial markets.