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Lecture 1

Economics 2154A/B Lecture 1: Econ 2154 – Textbook Notes

12 Pages

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Economics 2154A/B
Desmond Mc Keon

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Econ 2154 Textbook Notes Chapter 2 An Overview of the Financial System Direct Finance Borrowers borrow funds directly from leaders in financial markets oBy selling them securities (financial Instruments) oClaims on the borrowers future income or assets oSecurities are assets for the person who buys them, but liabilities for the individual or firm that sells them Debt and Market equities oShort term Less than a year oLong Term 10 years or longer oIntermediate Term Between 1 and 10 years Primary Market oNew issues are sold to initial buyers oInitial sells to usually investment banks oUnderwrites the security, by stating a price it would pay for it Secondary market oA financial market in which securities that have been previously issued can be resold oBrokers are agents of investors who match buyers with sellers oDealers link buyers and sellers by buying and selling securities at stated prices OTC Exchange oOver the Counter exchange, dealers at different locations who have an inventory of securities stand ready to buy and sell securities Over the Counter Money Market oA financial Market in which only shortterm debt instruments are traded Capital Market oIs the market in which longerterm debt and equity instruments are traded Treasury Bills oShortterm debt instruments, issued in 1,2,6,12 Month maturities with almost no possibility of default Certificate of Deposit oSame thing as a GIC Commercial Paper oUnsecured shortterm debt instruments issued by large banks and well known corporations or large banks Repurchase AgreementsoEffectively short term loans for which Tbills Serve as collateral Overnight Funds oOvernight loans by banks to other banks Mortgages oLoans to households or firms to purchase housing, land or real structures Mortgage backed securities oA bondlike debt instrument which is backed by a bundle of individual mortgages Corporate bond oLongterm bonds issued by corporations with very strong credit ratings Foreign Bonds oForeign bonds are sold in a foreign country and are denominated in that countries currency Eurobond oA bond denominated in a currency other than that of the country in which it is sold (ex. Bond issued by a Canadian Corporation, denominated in Japanese Yen, Sold in Germany Eurocurrencies oForeign Currency deposited in Banks outside the home country Eurodollars oUS dollars deposited in foreign banks outside the US or in foreign branches of US banks Asymmetric Information oOne party often does not know enough about the other party to make accurate decisions Adverse Selection oThe problem created by asymmetric information before the transaction occurs Moral Hazard othe problem is created by asymmetric information after the transaction occurs Economies of Scope oCan lower the cost of information production for each service by applying one information resource to many different services Financial Panic oAsymmetric information can lead to the widespread collapse of financial intermediaries oProviders of funds may not be able to asses whether the institutions holding their funds are sound or not
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