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A snapshot of the summary - Financial Markets and Institutions A European Perspective
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1 Functions of Financial System
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What is the main task of the financial system?It is to channel funds form sectors that have a surplus to sectors that have a shortage of funds
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What does the financial system consist of?All financial intermediaries and financial markets, and their relationship to the flow of funds to- and from households, governments, business firms, and foreigners, as well as the financial infrastructure.
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What is a financial infrastructure?It is a set of institutions that enables effective operation of financial intermediars and finanacial markets, including such elements as payment, credit information bureaus, and collateral registries
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Explain what direct finance is?sectors who are in need of funds borrow from an another sector via a financial market
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What is a financial market?It is a market where participants issue and trade securities
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Explain how asymmetry information arises ex-ante?It arises in a ex-ante because borrowers generally know more about their investment project than lenders. Borrowers most eager to engage in a transaction are the most likely ones to produce an undesirable outcome for lender (adverse selection.
solution:intermediaries reduce information costs and improve resource allocation -
What are the two main functions of the financial system?1. Reducing information- and transactioncosts2. Facilitating the trading diversification, and management risk, to explain why the financial sector may stimulate capital formation and/or technological innovation, two of the driving forces of economic growth
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In what does a financial system help?By overcoming an information asymmetry between borrowers and lenders
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What are the causes of high informations costs?They keep the funds from flowing to their highest productive use.
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Explain the four roles of the government in the FS1) protect property - contracts need to be enforced
2) transparency - info provision can reduce adverse selection & trans. costs
3) soundness - regulation & supervision. Intermediaries take too many risks due to higher possible revenues: too costly for lenders to choose an institution
4) competition policy - to avoid fixed prices and unfair state aid
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