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Questions and Answers
What part of the financial system is responsible for securing the money supply and liquidity of the economy?
What part of the financial system is responsible for securing the money supply and liquidity of the economy?
Which function is NOT associated with the financial markets?
Which function is NOT associated with the financial markets?
Which of the following accurately describes money markets?
Which of the following accurately describes money markets?
What is a primary characteristic of financial markets?
What is a primary characteristic of financial markets?
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What distinguishes capital markets from money markets?
What distinguishes capital markets from money markets?
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What role do savers play in the financial markets?
What role do savers play in the financial markets?
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Which of the following is a component of the financial system that reallocates incomes among economic actors?
Which of the following is a component of the financial system that reallocates incomes among economic actors?
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Which statement about the demand side of financial markets is true?
Which statement about the demand side of financial markets is true?
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What characterizes capital markets compared to other types of markets?
What characterizes capital markets compared to other types of markets?
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What is a primary market concerned with?
What is a primary market concerned with?
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How does an active secondary market benefit the financial system?
How does an active secondary market benefit the financial system?
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What distinguishes stock exchanges from OTC markets?
What distinguishes stock exchanges from OTC markets?
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What is the primary feature of spot markets?
What is the primary feature of spot markets?
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What impact do firms on the stock exchange have on secondary market trading?
What impact do firms on the stock exchange have on secondary market trading?
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Which of the following best describes a future/forward market?
Which of the following best describes a future/forward market?
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Which of the following is typical for securities traded on OTC markets?
Which of the following is typical for securities traded on OTC markets?
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What risk do savers face when they directly lend money to borrowers?
What risk do savers face when they directly lend money to borrowers?
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Which of these is a common problem associated with direct funding?
Which of these is a common problem associated with direct funding?
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The process of diversification is important in financial intermediation because it:
The process of diversification is important in financial intermediation because it:
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Which issue arises from savers and borrowers planning for different time periods?
Which issue arises from savers and borrowers planning for different time periods?
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What is a key characteristic of the direct funding method?
What is a key characteristic of the direct funding method?
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What can increase the risk and uncertainty associated with direct funding?
What can increase the risk and uncertainty associated with direct funding?
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Which of the following best describes high searching costs in direct funding?
Which of the following best describes high searching costs in direct funding?
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Why might savers be cautious about directly funding a borrower?
Why might savers be cautious about directly funding a borrower?
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What is the primary function of financial intermediaries?
What is the primary function of financial intermediaries?
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Which of the following is NOT considered a financial intermediary?
Which of the following is NOT considered a financial intermediary?
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How do financial intermediaries provide returns to their savers?
How do financial intermediaries provide returns to their savers?
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What type of funding does financial intermediation primarily encompass?
What type of funding does financial intermediation primarily encompass?
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What role does a bank play in the relationship between savers and borrowers?
What role does a bank play in the relationship between savers and borrowers?
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What do financial intermediaries primarily collect at their own risk?
What do financial intermediaries primarily collect at their own risk?
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Which indirect funding method involves private placement?
Which indirect funding method involves private placement?
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What is a characteristic of the services provided by financial intermediaries to savers?
What is a characteristic of the services provided by financial intermediaries to savers?
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What is one of the main roles of financial intermediaries in relation to savers and borrowers?
What is one of the main roles of financial intermediaries in relation to savers and borrowers?
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How does indirect funding manage risk for savers compared to direct funding?
How does indirect funding manage risk for savers compared to direct funding?
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Which method is NOT mentioned as a way financial intermediaries reduce risks?
Which method is NOT mentioned as a way financial intermediaries reduce risks?
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What primary advantage do financial intermediaries offer in terms of size transformation?
What primary advantage do financial intermediaries offer in terms of size transformation?
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What is a fundamental difference between savers and borrowers regarding their planning for savings and capital needs?
What is a fundamental difference between savers and borrowers regarding their planning for savings and capital needs?
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How do financial intermediaries assist in transforming maturity for savers and borrowers?
How do financial intermediaries assist in transforming maturity for savers and borrowers?
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Why are financial intermediaries considered more efficient in managing risks than individual savers?
Why are financial intermediaries considered more efficient in managing risks than individual savers?
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What challenge do savers face regarding information when lending to borrowers directly?
What challenge do savers face regarding information when lending to borrowers directly?
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Study Notes
Introduction to Finance - Chapter 6: Financial Markets
- Financial system is a crucial part of the whole economic system
- It ensures the economy's money supply and liquidity.
- It maintains, regulates and operates the payment system.
- It allocates savings from savers to borrowers.
- It reallocates income across economic actors over time.
Financial System Functions
- Monetary system: Secures money supply and liquidity.
- Supervising system: Maintains, regulates, and operates the payment system.
- Financial markets, financial intermediaries: Allocate savings to borrowers.
- Fiscal system: Reallocates income across economic actors.
Financial Markets
- Definition: A platform for exchanging financial instruments and money.
- This is where borrowers get funds from savers.
Primary Function of Financial Markets
- Connect savers and borrowers.
- Demand side: Borrowers need funds for liquidity issues or investments.
- Supply side: Savers with excess funds looking for returns.
- Money gets exchanged for financial instruments.
Segments of Financial Markets
- Term (money or capital markets): Based on terms (e.g., less than a year vs. more than a year).
- Geographic scope (domestic or international): Domestic or international transactions.
- Standardization (unique or standardized): Standardized financial instruments are easier for trade
- Time of settlement (spot or futures/forwards): Immediate vs. future settlement of trades.
- Function of trade (primary or secondary): Primary for new issuance vs. secondary for existing securities.
- Type of trade (private or public): Private for bespoke deals; public for regulated transactions
- Platform of trade (stock exchange or OTC): Regulated vs. over-the-counter markets.
Money vs. Capital Markets
- Money markets deal with securities less than a year out, often with lower risk and return. (e.g. Treasury Bills)
- Capital markets deal with securities more than a year out, often with higher risk and return (e.g. stocks, bonds).
Primary vs. Secondary Markets
- Primary markets: Where firms raise capital from savers (e.g. initial public offerings).
- Secondary markets: Where investors can trade existing securities (e.g stock exchange trading).
Stock Exchange vs. OTC
- Stock exchanges (or organised exchanges): Centralized platforms where standardized trading occurs.
- OTC (Over The Counter): Decentralized markets where trading takes place through banks and other financial institutions for non-standardized products.
Spot vs. Future/Forward Markets
- Spot market: The trade is settled within a day.
- Future/forward market: Contracts for trades that settle at a later date. Terms and conditions are agreed in advance, but the exchange itself is in the future.
Financial Intermediation
- Direct funding: Savers give funds directly to borrowers - High risk to savers due to information asymmetry and uncertainty about the borrower
- Financial intermediaries: Intermediaries help in channeling savings to borrowers and manage risks.
- Financial Intermediaries offer the following services to both parties:
- Gathering information
- Assessing creditworthiness
- Managing and reducing risk
- Pooling small deposits of savers
- Transforming maturity needs
- Minimising transaction costs and information asymmetry
Financial Intermediaries - Definition
- Collect savings at their own risk and lend/invest accordingly.
- Provide returns and services for their savers.
- Intermediation mainly for indirect funding (indirect funding is when funds are transferred through an intermediary)
Types of Financial Intermediaries
- Monetary intermediaries: Collect deposits (e.g., banks, credit institutions, money markets funds)
- Non-monetary intermediaries: Do not collect deposits (e.g., investment funds, insurance companies)
Functions of Financial Intermediation - Intermediating Information and Knowledge
- Savers and borrowers lack enough information about each other and their creditworthiness.
- Intermediaries mitigate these problems by gathering and evaluating information, and managing risks.
Functions of Financial Intermediation - Risk Transformation
- Direct funding: Savers bear all the investment risk.
- Indirect funding: Reduces the risk for savers by separating the risk from the borrower. Intermediaries diversify the risk of individual assets to reduce the overall risk of the investments.
Functions of Financial Intermediation - Size Transformation
- Savers and borrowers have differing needs for the sizes of investments
- Intermediation pools smaller amounts into larger, and larger amounts are broken down into smaller investments helping to match investment needs..
Functions of Financial Intermediation - Maturity Transformation
- Savers and borrowers need funds for differing lengths of time.
- Intermediation facilitates harmonization between these differing needs.
- Allows intermediaries to maintain liquidity.
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Description
Explore the essential functions of financial markets in this chapter of Introduction to Finance. Understand how the financial system manages money supply and liquidity, supervises payment systems, and connects savers with borrowers. Learn about the primary roles of financial markets and how they impact the economy.
