An Overview of the Financial System
Autor: Maryam • February 4, 2018 • 1,037 Words (5 Pages) • 556 Views
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3. The problems of asymmetric information affect a loan transaction both before and after the loan is made. Before the loan is made, adverse selection may occur because risky borrowers have the greatest incentive to borrow. After the loan has been made, moral hazard occurs if borrowers use the borrowed money in a riskier fashion that was agreed to in the loan contract. To avoid this problem, banks screen and monitor borrowers.
Let’s Try!
Direct Finance
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(1) A market where securities are traded directed between two parties
Indirect Finance
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(2) A financial market where short-term securities are traded
Bond/Debt/Fixed Income Market
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(3) A method for borrowers to borrow funds directly from financial markets
Stock/Equity Market
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(4) A financial market where new issuance of securities are sold
Primary Market
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(5) A financial market where securities that have been previously issued are traded
Secondary Market
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(6) A market platform for central trading of securities
Exchange
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(7) A method for borrowers to borrow funds from indirect means such as through a financial intermediary
OTC(Over-the-counter) Market
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(8) A financial market where long-term securities are traded
Money Market
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(9) A financial market where people buy and sell debt securities such as bonds
Capital Market
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(10) A financial market where people buy and sell company stocks and financial derivatives
Let’s Discuss!
What can you do in a common
- retail bank;
- commercial bank;
- investment bank?
Also, think of a few examples of such banks.
Let’s Discuss!
Your grandmother dies and bequeaths to you $10,000. When you receive the check, your best friend accompanies you to the bank in which you plan to deposit the money. Once inside the bank, your friend notices that the rate the bank pays on savings deposits is 3% while the rate the bank charges on auto loans is 9%. Your friend suggests, “Why don’t you just stand by the door to the auto loan office and offer the next auto loan customer a loan directly from you? You could charge much more than the 3% you would get on your deposit and cut out the middleman.”
1. Explain why it would likely be unprofitable for you to make such a loan?
2. Why is it more likely that the bank is able to make the loan profitably?
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