Financial Markets Quiz: Intermediaries and Investment Banks

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Questions and Answers

What was a primary reason financial institutions were unable to provide credit to companies with investment projects?

High demand for credit by consumers

Pressure to hold liquid assets (correct)

Increased competition from non-bank institutions

Insufficient financial backing from governments

What action did governments take to mitigate the impact of failing financial institutions?

Borrowing funds to bail out financial institutions (correct)

Encouraging private investments in banks

Increasing taxes on high-income earners

Lowering interest rates

How have collective investment schemes affected the role of banks in financial intermediation?

Banks now provide higher returns than collective investments.

Banks have been responsible for a declining share of total funds intermediated. (correct)

Banks have increased their market share significantly.

Banks have become the sole providers of credit.

What is a notable phenomenon resulting from the growing efficiency of stock markets?

Higher competitive pressure on banks Signup and view all the answers

Which institutions have increasingly taken over the credit intermediation role traditionally performed by banks?

Shadow banks and special purpose vehicles Signup and view all the answers

What has been a long-term effect on government solvency in Europe following the financial crisis?

Constant scrutiny by investors Signup and view all the answers

Why have banks increasingly relied on financial markets?

To reduce their reliance on customer deposits Signup and view all the answers

What defines 'shadow banks' compared to traditional banks?

They provide loans and saving options without being deposit-taking institutions. Signup and view all the answers

What role does an investment bank play as a counterparty in a derivatives arrangement?

It may enter into a currency swap to manage risks. Signup and view all the answers

How does proprietary trading differ from market making?

Market making involves buying and selling at different prices. Signup and view all the answers

What has replaced physical trading floors in recent decades?

Computerized systems and automated trading. Signup and view all the answers

What is the primary purpose of investment banks in secondary trading?

To act as market makers and provide liquidity. Signup and view all the answers

What do liquidity services providers compete with exchanges for?

The supply of liquidity services. Signup and view all the answers

What characterizes 'pure' proprietary trading compared to market making?

It involves speculation without providing market liquidity. Signup and view all the answers

What is a key function of brokers in secondary trading?

They assist in matching buyers and sellers. Signup and view all the answers

Which of the following best describes asset managers?

They invest retail investors' assets in publicly traded securities. Signup and view all the answers

What is the primary role of credit rating agencies?

To evaluate the financial soundness of issuers of securities. Signup and view all the answers

Which agency is NOT one of the big credit rating agencies mentioned?

Goldman Sachs Signup and view all the answers

What distinguishes buy-side analysts from sell-side analysts?

Buy-side analysts work independently while sell-side analysts work for banks. Signup and view all the answers

What is the significance of credit ratings for investors?

They are used to assess the credit risk of debt issuers. Signup and view all the answers

What is one of the main functions of an investment bank?

To facilitate the issuance of new securities through IPOs. Signup and view all the answers

How do credit ratings influence capital requirements for financial investors?

They help determine acceptable levels of credit risk. Signup and view all the answers

Which statement correctly describes equity analysts?

They provide recommendations to buy, sell, or hold stock. Signup and view all the answers

What scale is commonly used by credit rating agencies to denote credit risk?

AAA to D Signup and view all the answers

What function do money market funds perform in relation to traditional banks?

They provide similar savings and transaction functions without lending. Signup and view all the answers

Which statement accurately describes the role of shadow banks?

They extend services to borrowers and savers, enhancing market competition. Signup and view all the answers

What is one of the main weaknesses of financial systems as described?

They are prone to opportunistic behavior and fraud. Signup and view all the answers

How is the value of financial instruments ideally determined?

Through the expected present value of future earnings. Signup and view all the answers

What difficulty arises when establishing the value of future dividends?

Forecasts of future earnings can be complex and error-prone. Signup and view all the answers

In what manner do financial markets typically transmit risks and disturbances?

Through established interrelations that can facilitate risk transmission. Signup and view all the answers

What do shadow banks allow traditional banks to do?

Delegate certain lending activities, such as mortgage lending. Signup and view all the answers

Which characteristic of financial systems can lead to their failure?

The sophisticated nature of financial contracts. Signup and view all the answers

What was the average percentage of internal finance for corporations in the US from 1970 to 1998?

96.1% Signup and view all the answers

Which external source of finance was the least utilized by corporations in Germany?

New equity Signup and view all the answers

In which country was bank finance the highest, according to average data from 1970 to 1998?

Japan Signup and view all the answers

What percentage of finance for UK corporations was contributed by trade credit?

0.9% Signup and view all the answers

What was a notable feature of financing trends in the UK and US regarding new equity?

New equity had negative figures reflecting repurchases Signup and view all the answers

Which of the following is true regarding bond financing in North America?

It has been increasing since the end of the 1990s. Signup and view all the answers

What was the percentage contribution of capital transfers to US financing?

0% Signup and view all the answers

How did the average percentage of bonds as a source of finance for US corporations compare to that of UK corporations?

Bonds were more significant in the US. Signup and view all the answers

Study Notes

Intermediaries in Financial Markets

Equity analysts and credit rating agencies (CRAs) play pivotal roles in price formation for equities and bonds.
CRAs assess the financial health of companies and governments issuing bonds, giving ratings from AAA (high credit quality) to D (default).
Examples of major CRAs include Standard & Poor’s (S&P), Moody’s, and Fitch Ratings, with S&P recognized as a Nationally Recognized Statistical Rating Organization (NRSRO).
Equity analysts provide investment recommendations (buy, sell, hold) and often focus on specific market sectors, categorized as buy-side or sell-side.

Investment Banks

Investment banks help companies raise funds through initial public offerings (IPOs) and seasoned equity issues.
They act as market makers, providing liquidity by simultaneously buying and selling securities at different prices (bid and ask).
Investment banks engage in proprietary trading and may offer services like derivatives to help clients manage risk, including currency swaps.

Trading Mechanisms

Secondary trading involves matching buyers and sellers, traditionally done on physical trading floors but now primarily via computer systems.
Liquidity services providers, alternative trading systems, and clearing organizations enhance secondary market operations.

Asset Management

Certain intermediaries manage retail investors’ assets by investing in publicly traded securities, reflecting a significant growth in collective investment schemes.

Corporate Financing Sources

In average periods from 1970-1998, corporations in various countries primarily relied on internal financing, with significant differences in external financing sources.
Germany, Japan, the UK, and the US show different reliance on bank finance, bonds, and new equity as sources of corporate funding.
Negative figures in new equity indicate companies frequently repurchase shares or acquire other firms, notably in the UK and US markets.

Financial System Dynamics

Increasingly, banks have had to adapt to competitive pressures from non-bank financial institutions, such as shadow banks, which perform similar functions but lack regulatory oversight.
Shadow banks, such as money market funds and finance companies, expand market services and enhance competition.

Risks in Financial Systems

Financial markets are not perfect in aggregating and disseminating information, leading to potential opportunistic behavior and fraud.
Due to complex financial contracts, the interconnected risks between investors and firms can trigger systemic failures.
Valuation of financial instruments relies on complex forecasting and discounting future earnings, making them inherently susceptible to inaccuracies.

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Description

This quiz explores the critical roles of intermediaries in financial markets, including equity analysts and credit rating agencies (CRAs). It covers how investment banks facilitate fundraising and provide market liquidity through their services. Test your understanding of these fundamental concepts in finance.