The special role played by financial intermediaries in the economy. Here, it describes how financial intermediaries take advantage of economies of scale to reduce trans- action costs, how financial institutions assist in the process of risk sharing and diversification, and how financial institutions overcome the problems of adverse selection and more hazard.
The major types of financial intermediaries, including depository institutions banks , contractual savings institutions, and investment intermediaries. As we go along, we can always refer back to this overview to recall how a particular type of financial instrument works or what a particular type of financial intermediary does.
Households Funds 1. Businesses 2. Governments 3. Households 4. Foreigners 4. Examples: Government and corporate bonds. Example: Corporate stock. May pay regular dividends. Have no maturity date; hence are considered long-term securities.
A key feature distinguishing equity from debt is that the equity holders are the residual claimants: the firm must make payments to its debt holders before making payments to its equity holders. Advantage to holders of equities: Receive larger payments when the business becomes more profitable or the value of its assets rises. Disadvantage to holders of equities: Receive smaller payments when the business becomes less profitable or the value of its assets falls.
Note that the originally issuer or borrower receives funds only when its securities are first sold in the primary market; the issuer does not receive funds when its securities are traded in the secondary market. Nevertheless, secondary markets perform two essential functions: They allow the original buyers of securities to sell them before the maturity date, if necessary. That is, they make the securities more liquid. They allow participants in the primary markets to make judgements about the value of newly-issued securities by looking at the prices of similar, existing securities that are traded in the secondary markets.
Example: New York Stock Exchange. Currently issued with maturities of 1, 3, and 6 months. Make no regular interest payments, but sell at a discount. Trade on a very active secondary market. Are the safest of all money market instruments, since it is very unlikely that the US Government will go bankrupt. Make regular interest payments until maturity. At maturity, return the original purchase price. Commercial Paper: Short-term debt issued by corporations.. Make no interest payments, but sell at a discount.
Trade on a secondary market. Often arise in the process of international trade. Repurchase Agreements: Very short-term loans, often overnight, with Treasury bills as collateral, between a non-bank corporation as the lender and a bank as the borrower. Non-bank corporation buys the Treasury bill from the bank. Federal Funds: Overnight loans between banks of deposits at the Federal Reserve.
Interest rate on these loans is called the federal funds rate. Eurodollars: US dollar deposits at foreign banks. Corporate Stocks: Equity claims to the income and assets of corporations. Mortgages Residential, Commercial, and Farm : Loans to individuals and firms used to purchase land, houses, and other structures.
The land or structure then serves as collateral. The mortgage market is the biggest debt market in the US. Secondary markets for mortgages first developed in the s and s and are now quite large and active. Usually make regular interest payments twice per year. Return a fixed amount face value at maturity. Make regular interest payments twice per year and return a fixed amount at maturity. State and Local Government Municipal Bonds: Intermediate and long-term debt issued by state and local governments.
Interest payments are exempt from federal income taxes, making municipal bonds especially attractive to some investors. Commercial and Consumer Loans: Loans, originally made by banks, to businesses and households. The role of the Reserve Bank of Australia in managing monetary policy during the crisis is reviewed. Higher interest meant it was more expensive to borrow money to buy. MyEconLab is an online homework, tutorial, and assessment program designed to work with this text to engage students and improve results.
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