FNAN 321 Problem_set_1_Summer_2016_6_29_2016(1)

FNAN 321 Problem_set_1_Summer_2016_6_29_2016(1) - Andrea...

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Andrea Villazon FNAN 321: Financial Institutions Summer 2016 Problem Set 1 Question 1: make the case for “specialness” as discussed in the textbook. Financial institutions (FIs) are an important factor in the economy, because they bring together those that have money to lend and they are willing to take risk to earn an interest return with those individuals who wants to borrow money for different reasons. Therefore, an economy without FIs, the level of fund between the household savers and the corporate sector is likely to be low. (Saunder & Cornett p. 3). In other words, the specialness of FIs is the result of the followings: *Lower Monitoring Cost: FIs are the ones who is in charge of monitoring the action of the firm/household saver whom the money is lent, because this actions are very expensive and difficult to achieve. Also, the lack of monitoring will increase the risk of investing in corporate debts and equity, which is way likely that the household saver will prefer leave the monitoring to the FIs. *Liquidity Cost: Securities are relatively long termed which produce a lack of secondary market to be able to sell them later on. It is more likely, that the household prefer to hold cash as liquidity
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