MGEC71H3 Lecture Notes - Lecture 10: Fiat Money, Interest Rate Risk, Zero-Coupon Bond
22 Jun 2014
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Document Summary
A financial intermediary"s low transaction costs mean that it can provide its customers with liquidity services (depositors can earn interest on both chequing and saving accounts and yet still convert them into goods and services whenever necessary). By making loans these institutions help households and firms to overcome liquidity constraints so that they can buy the homes or cars etc or undertake the investment/business plans they desire. The process of risk sharing is sometimes referred to as asset transformation when risky assets are turned into safer assets for investors. Successful financial intermediaries have higher earnings on their investments than small savers because they are better equipped than individuals to screen out good from bad credit risks, thereby reducing losses due to adverse selection. Also, they tend to have higher earnings because they develop expertise in monitoring the parties they lend to, thus reducing losses due to moral hazard.
