Transcript mishkin_money_3ce_ch02

Chapter 2
An Overview of
the Financial
System
2.1
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An Overview of the
Financial System
Primary Function of the Financial System
is Financial Intermediation
The channeling of funds from households, firms
and governments who have surplus funds (savers)
to those who have a shortage of funds (borrowers).
2.2
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An Overview of the
Financial System
2.3
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Classifications of
Financial Markets
Debt Markets
• Short-term (maturity < 1 year) – the
Money Market
• Long-term (maturity > 10 year) – the
Capital Market
• Medium-term (maturity >1 and < 10
years)
2.4
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Classifications of
Financial Markets
Equity Markets - Common stocks
• Primary Market - New security issues sold to
initial buyers
• Secondary Market - Securities previously
issued are bought and sold
2.5
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Classifications of
Financial Markets (Cont’d)
Secondary Markets
Exchanges
• Trades conducted in central locations (e.g.,
Toronto Stock Exchange and New York Stock
Exchange)
Over-the-Counter Markets
• Dealers at different locations buy and sell
2.6
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Financial Market
Instruments
2.7
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Financial Market
Instruments (Cont’d)
Other Money Market Instruments
• Certificates of deposit
• Repurchase agreements
• Overnight funds
2.8
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Financial Market
Instruments (Cont’d)
2.9
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Financial Market
Instruments (Cont’d)
Other Capital Market Instruments
• Canada savings bonds
• Provincial and municipal bonds
• Government agencies securities
2.10
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Internationalization of
Financial Markets
International Bond Market
• Foreign bonds - sold in a foreign country and
denominated in that country
• Eurobonds – denominated in a currency other than
the country in which it is sold
• Eurocurrencies – foreign currencies deposited in
banks outside the home country
2.11
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World Stock Markets
2.12
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Function of Financial
Intermediaries
Financial Intermediaries
• Engage in process of indirect finance
• Are needed because of transactions costs and
asymmetric information
2.13
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Function of Financial
Intermediaries (Cont’d)
Transactions Costs
1. Financial intermediaries make profits by
reducing transactions costs.
2. They reduce transactions costs by developing
expertise and taking advantage of
economies of scale.
2.14
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Function of Financial
Intermediaries (Cont’d)
Risk Sharing
• Create and sell assets with low risk characteristics
and then use the funds to buy assets with more risk
(also called asset transformation)
• Lower risk by helping people to diversify portfolios
2.15
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Asymmetric Information
Adverse Selection
• Before transaction occurs
• Potential borrowers most likely to produce adverse
outcomes are ones most likely to seek loans and
be selected
2.16
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Asymmetric Information
(Cont’d)
Moral Hazard
• After transaction occurs
• Hazard that borrower has incentives to engage in
undesirable activities making it more likely that loan
won’t be paid back
2.17
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Financial Intermediaries
2.18
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Size of Financial
Intermediaries
2.19
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Regulation of Financial
Markets
2.20
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Regulation of Financial
Markets
Primary Reasons for Regulation
1. Increase information to investors
- Decreases adverse selection and moral hazard
-
2.21
problems
Securities commissions force corporations to
disclose information
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Regulation of Financial
Markets (Cont’d)
Primary Reasons for Regulation
(continued)
2. Ensuring the soundness of intermediaries
- Prevents financial panics
- Restrictions on entry/assets/activities, disclosure,
deposit insurance, limits on competition
2.22
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