Summary Financial markets and corporate strategy Book cover image

Summary Financial markets and corporate strategy

- David Hillier, et al
ISBN-10 0077129423 ISBN-13 9780077129422
82 Flashcards & Notes
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A snapshot of the summary - Financial markets and corporate strategy Author: David Hillier Mark Grinblatt Sheridan Titman ISBN: 9780077129422

  • 2 Week 2

  • Why do formal lenders ration credit rather than raise interest rates?
    This is possible if the expected return of a bank loan is not a monotonic function of the nominal interest rate
    Cause: asymmetric information › Consequence: formal credit institutions shy away since raising interest rates can exacerbate incentive problems
  • What is the difference between formal and informal markets. and how should we link them?
    Formal markets have funds, lack information
    informal markets have info, lack funds.

    linking by using moneylenders as agents and increase supply of funds into local markets

    Problems:
    could lead to collusion
    moneylender per borrower ^ -- MC^ -- R^-- Moneylenders^-- more alternative lenders -- lower repayment incentives -- R^
  • Mention the advantages and disadvantages of ROSCAS:
    + Except for last one everyone gains
    + disciplined way to accumulate savings
    + get money out of household

    - drop out after early pot
    - little flexibility
    - no outside funds
  • What are the advantages of group lending?
    - Joint liabibility: information assymetries down
    - only ''good'' borrowers
    - self selection and screening: adverse selection down
    - monitoring: moral hazard down
  • What are limitations of group lending:
    - How credible is threat of social sanctions (friends)
    - attending meetings is costly
    - sometimes difficult to tranfer responsibilities
  • What are the differences between credit cooperatives and ROSCA
    - CC more formal
    - CC members do not have to wait term
    - CC size of loan can vary
    - CC storage of money/collateral
  • Derive interest rate in ex ante moral hazard situation
    net return with effort          (Y-R)-C
    Net return without effort     p(Y-R) 
    (Y-r)-C > P(Y-R)

    R < y -(c/1-p) then firms will exert effort
  • Show that group lending leads to higher R (reduces moral hazard) in 2 persons group
    2Y - 2R- 2C  if effort
    P^2 (2Y-2R) if no effort

    (2y-2r)-2c > p^2(2Y-2R)

    (2Y-2r)  = 2C / (1-P^2)

    y-R = C / (1-P^2) --> R = Y-((C / (1-P^2))

    Since P^2 < P ... R will be higher before no effort. group lending therefore bettter for lender.   
    MAKES IT HARDER TO FREE RIDE
  • 3 Week 3

  • Derive the interest rate with adverse selection.
    Safe borrowers: P=1 so total is p*q = q
    Risky borrowers: (1-q)p

    Lending cost K.
    for safe Rs = K // for risky Rr = k/p

    [Q+(1-Q)p] R = K -->> R = [ K / (q+(1-Q)p ]
     
    So Rr>R>Rs   , so contract is more attractive for Risky than safe therefore adverse selection
  • Derive interest rates with assymetric information and group lending
    Safe will group with safe: •
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