Finance 4000

Money and Capital Markets

Ninth class

• Financial Structure of Economies

  
  
  
  
  

  • Why are financial contracts written as they are?

    
    
    
    
    

  • Why do more funds flow to borrowers from financial intermediaries than from financial markets?

    
    
    
    
    

  • Why do financial crises occur and why do they matter?

• Basic Aspects of Financial Markets

  
  
  

  • Transactions costs
    • Transactions costs are costs of buying or selling something or assessing the quality of the good

      
      
      
      
      

  • Risk
    • Risk is the chance of danger, loss or injury or other adverse consequences

      
      
      
      
      

  • Asymmetric information
    • Asymmetric information is an inequality of information in which one party to a transaction has information about himself or herself that the other party does not have

      
      
      

    • Adverse selection occurs when those least desirable from the point of view of party making loan or insurance are the ones attracted by the offered contract

• • • Moral hazard is the set of actions taken because a person has a loan, contract or insurance

      
      
      

• Observations about financial aspects of economies

  
  
  

  • Loans from financial intermediaries are the most important source of external financing for businesses

    
    
    

    • Issuing stock is not the most important source of external financing for businesses

      
      
      

    • Issuing marketable debt and equity securities is not the most important source of external financing for businesses

      
      
      

    • Direct finance, in which borrowers deal directly with savers, is relatively unimportant

      
      
      

    • Banks are the largest single source of external financing for businesses

      
      
      

    • Only relatively large, established firms obtain external financing through financial markets

      
      
      

  • Financial markets and intermediaries are heavily regulated

    
    
    

  • Debt contracts often involve collateral and restrictive covenants

• Transactions costs

  
  
  

  • explain why savers use financial intermediaries to allocate their saving

    
    
    

    • Actual payments necessary to buy and sell

      
      
      

    • Economies of scale in payments and diversifying

      
      
      
      
      

• Tools to help reduce costs associated with adverse selection

  
  
  

  • Government regulation

    
    
    

  • Private production and sale of information

    
    
    

  • Financial intermediation

    
    
    

  • Restrictions on behavior of recipient of funds

    
    
    

    • Collateral

      
      
      

    • Restrictive covenants

• Tools to reduce costs associated with moral hazard

  
  
  

  • Government regulation to increase information

    
    
    

  • Contractual restrictions

    
    
    

  • Monitoring

    
    
    

    • Financial intermediaries

      
      
      

• Financial crises

  
  
  

  • Large decreases in the prices of assets associated with failures of nonfinancial and financial firms

    
    
    

  • Causes of financial crises

    
    
    

    • Increases in interest rates

      
      
      

    • Increases in uncertainty

      
      
      

    • Asset market effects on balance sheets

      
      
      

      • Really effect of decrease in asset values

• Banking panics

  
  
  

  • Run on banking system

    
    
    

  • Sudden withdrawal of a substantial amount of deposits by many depositors

    
    
    

  • If worried that a bank will not be able to pay everyone, get there first

    
    
    

  • Not necessarily panic in the sense of unreasoning fear

    
    
    

  • If worried that others will run on the bank, get there first

    
    
    

  • Problem of liquidity versus solvency

    
    
    

  • Disruption of financial arrangements

    
    
    

  • Decrease in the money supply

    
    
    

    • Spending

      
      
      

    • Employment and output

      
      
      
      
      
      
      

• Banking panics are part of the reason that banks are heavily regulated

  
  
  

  • Depression

    
    
    

  • Historically, many different rules applied to banks

    
    
    

    • Asymmetric information between depositors and banks