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PBF_Ch2
PBF Chapter 2 concepts
| Question | Answer |
|---|---|
| What is the essential role of financial system? | Financial systems perform the essential economic function of channelling funds from units who have saved surplus funds to units who have a shortage of funds. |
| What is lender-savers? | lender-savers:The units who have saved can lend funds. example: households. |
| Borrower-spender | borrower-spenders: The units with a shortage of funds must borrow funds to finance their spending. typical borrower-spenders: firms and the government. |
| Why channelling of fund is important? (reason 1) | 1) lender-savers (with excess of available funds) do not frequently have profitable investment opportunities, while borrower-spenders have investment opportunities but lack of funds. |
| Why channeling of fund is important? (reason 2) | 2, borrower-spenders may want to invest in excess of their current income or to adjust the composition of their wealth (reconciliation of the preferences for current versus future consumption). |
| Direct finance | borrower-spenders borrow funds directly from lenders in the financial markets by selling them securities. |
| Indirect finance | a financial intermediary stands between the lender-savers and the borrower-spenders: the intermediary helps to transfer funds from one to the other. |
| What are the relationship between direct and indirect finance? which one is more important | They are alternatives that perform more or less the same function but in different ways The process of indirect finance (financial intermediation) is the most important way of transferring funds from lenders to borrowers. |
| What are the 4 functions of a financial system? | 1) chanelling of funds from saver-lender to borrower-lender through direct or indirect finance. 2) enable wealth holders to adjust the composition of their portfolios 3) provide payment mechanisms 4) provide mechanisms for risk transfer |
| What is monetary function? | introduction of money into the economy 1) enables savers and spenders to separate the act of sale from the act of purchase 2) allows them to overcome the main problem of barter (‘double coincidence of wants’). |
| double coincidence of wants | each of the two parties involved in a transaction has to want simultaneously the good the other party is offering to exchange. |
| Example of payment mechanism | cheques, debit cards and credit cards to enable one party to pay another. |
| What is Risk transfer mechanism? Give an example | Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). Risk transfer is shifting risk from one party to another; For example: insurance contracts |
| Use insurance contract to illustrate risk transfer | * allow a party to transfer the risk of loss of wealth to another party. * pay a fee (insurance premium) for this transfer. * insurance company, (large no. of contracts) ** better able to manage the risk **obtain benefits of pooling & diversification |
| What are the 3 entities that compose the financial system (structural view)? | financial markets, securities and financial intermediaries. |
| What is financial market? | Financial markets are markets in which funds are moved from people who have an excess of available funds (and lack of investment opportunities) to people who have investment opportunities (and lack of funds). |
| What are the impact of financial market to the economy? | They also have direct effects on personal wealth, and the behaviours of businesses and consumers. Therefore, they contribute to * increase the production and * the efficiency in the overall economy. |
| What is financial securities? | Financial securities (also called financial instruments) are financial claims on the issuer’s future income or assets. represent financial liability (or asset) for seller (or buyer). |
| Can the amount of financial assets differ from the amount of financial liabilities? | No. By definition, the sum of financial assets in existence will exactly equal the sum of liabilities. |
| What is bond? | Bonds are securities that promise to make periodic payments of a sum of money for a specified period of time. |
| What is stock? | Stocks are securities that represent a share of ownership in the firm. |
| How can government or corporations raise fund in the market? | Governments and corporations raise funds to finance their activities by issuing debt instruments (bonds) and equity instruments (shares, known in the USA as stocks). |
| What are financial intermediaries? | Financial intermediaries are economic agents who specialise in the activities of buying and selling (at the same time) financial contracts (loans and deposits) and securities (bonds and stocks). |
| What are the marketability of securities and contracts? | financial securities are easily marketable, while financial contracts cannot be easily sold (marketed). |
| What is bank? | Banks * largest financial institution in our economy. * accept deposits (loans by individuals or firms to banks) * make loans (sums of money lent by banks to individuals or firms) |
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