Overview of the Financial System
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Questions and Answers

What is a financial system?

  • A system that includes only financial intermediaries
  • A system that includes only financial markets
  • A system for tracking personal finances
  • A system that consists of financial markets and intermediaries (correct)

    • Name the two ways of financing.

    Direct finance and indirect finance

    What is direct finance?

    Funds are transferred directly from lenders to borrowers by sale of securities.

    What is indirect finance?

    <p>Funds are channeled through financial intermediaries such as banks.</p> Signup and view all the answers

    What is a financial market?

    <p>A market for funds where people with a shortage can borrow from people with a surplus.</p> Signup and view all the answers

    In a financial market, who is a saver?

    <p>A lender is a saver.</p> Signup and view all the answers

    In a financial market, who is a borrower?

    <p>A borrower is a spender.</p> Signup and view all the answers

    What is a security or financial instrument?

    <p>A tradable asset that gives the owner a claim on future income or assets.</p> Signup and view all the answers

    What are the two types of securities?

    <p>Debt security and equity</p> Signup and view all the answers

    What is a debt security?

    <p>A type of security requiring repayment of borrowed money.</p> Signup and view all the answers

    What is equity?

    <p>A kind of security that provides ownership claim to the holder.</p> Signup and view all the answers

    What do stocks represent?

    <p>A claim on the earnings and assets of the issuing corporation.</p> Signup and view all the answers

    What are bonds?

    <p>A debt security that promises periodic payments.</p> Signup and view all the answers

    Why are financial markets important?

    <p>They promote economic activity and efficiency and increase consumer well-being.</p> Signup and view all the answers

    How do financial markets promote economic activity?

    <p>By providing investment opportunities to savers.</p> Signup and view all the answers

    How do financial markets promote economic efficiency?

    <p>By efficiently allocating capital, leading to increased production.</p> Signup and view all the answers

    How do financial markets increase the well-being of consumers?

    <p>Allow for buying items today and paying later or in installments.</p> Signup and view all the answers

    Firms can raise funds by issuing what?

    <p>A debt instrument or equities.</p> Signup and view all the answers

    Debt instruments can be divided based on what?

    <p>Their maturity date.</p> Signup and view all the answers

    What is a maturity date?

    <p>Number of years until the instrument expires.</p> Signup and view all the answers

    What is classified as short-term in maturity?

    <p>Maturity less than 1 year.</p> Signup and view all the answers

    What is classified as intermediate-term in maturity?

    <p>Maturity between one and ten years.</p> Signup and view all the answers

    What is classified as long-term in maturity?

    <p>Maturity of 10 years or longer.</p> Signup and view all the answers

    What is a money market?

    <p>The financial market for short-term debt instruments.</p> Signup and view all the answers

    What is a capital market?

    <p>The financial market for longer-term debt instruments and equity instruments.</p> Signup and view all the answers

    What is the most common method of raising funds for firms?

    <p>Issuing debt instruments.</p> Signup and view all the answers

    The debt or bond market is much larger than the?

    <p>Equity/stock market.</p> Signup and view all the answers

    What does it mean that equity holders have a residual claim?

    <p>Debt holders must be paid before equity holders.</p> Signup and view all the answers

    What is the primary market?

    <p>Where new issues of securities are traded.</p> Signup and view all the answers

    What do investment banks do in primary markets?

    <p>They underwrite securities and guarantee a price.</p> Signup and view all the answers

    What is a secondary market?

    <p>Where previously issued securities are resold.</p> Signup and view all the answers

    Where do brokers and dealers work?

    <p>In secondary markets.</p> Signup and view all the answers

    What do brokers do?

    <p>Match buyers with sellers of securities.</p> Signup and view all the answers

    What do dealers do?

    <p>Facilitate the sale of securities by trading.</p> Signup and view all the answers

    Study Notes

    Overview of the Financial System

    • A financial system connects lenders who have surplus funds with borrowers who need financing.
    • Financial markets and intermediaries facilitate this interaction.

    Types of Financing

    • Direct finance involves direct transfer of funds through the sale of securities.
    • Indirect finance channels funds through intermediaries like banks and credit unions.

    Financial Markets

    • A venue for borrowing and lending where those with a fund shortage can obtain funds from savers.

    Role of Savers and Borrowers

    • Savers are lenders in the financial market.
    • Borrowers, also known as spenders, utilize funds for various expenditures.

    Securities

    • Securities are tradable assets that grant the buyer future claims on the issuer’s income or assets.
    • Two main types of securities are debt securities and equity.

    Debt Securities

    • Require the issuer to repay borrowed funds, detailing the interest rate and maturity dates.

    Equity

    • Represents ownership in a firm, with stocks serving as a common form of equity.

    Importance of Financial Markets

    • Encourage economic activity and efficiency, enhancing consumer well-being.

    Promotion of Economic Activity

    • Financial markets create investment opportunities for savers and provide financing for business ideas.

    Promotion of Economic Efficiency

    • Efficient capital allocation leads to increased production levels.

    Enhancement of Consumer Well-Being

    • Financial markets allow consumers to purchase goods like cars and homes through installment payments.

    Fundraising Methods for Firms

    • Companies can raise funds by issuing debt instruments or equities, predominantly favoring debt instruments.

    Debt Market Structure

    • The debt (bond) market far exceeds the equity (stock) market in size.
    • Equity holders possess a residual claim, meaning they receive payments only after debt holders are paid.

    Market Types

    • Primary Market: where new securities are issued; often not publicized.
    • Secondary Market: where previously issued securities are bought and sold, ensuring liquidity.

    Role of Investment Banks

    • Underwrite securities in primary markets by guaranteeing a price for securities before public sales.

    Brokers and Dealers in the Secondary Market

    • Brokers connect buyers with sellers of securities.
    • Dealers facilitate transactions by buying securities to resell them at set prices.

    Significance of Secondary Markets

    • Provide liquidity, making it easier for investors to buy and sell assets, thus aiding in price discovery.

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    Description

    This quiz covers the fundamental concepts of the financial system, including the roles of savers and borrowers, types of financing, and the nature of securities. Dive into the distinctions between direct and indirect finance and understand the functioning of financial markets. Perfect for students looking to strengthen their financial literacy.

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