Chapter 11 - d Providing Liquidity • Financial...

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Chapter 11 The Economics of Financial Intermediation I. The Role of Financial Intermediaries a. Indirect finance through financial intermediaries is much more important that direct finance though stock and bond markets b. Pooling savings By accepting many small deposits, banks empower themselves to make large loans c. Safekeeping, Payments System Access, and Accounting Payments system: the network that transfers funds from the account of one person or business to the account of another Comparative advantage leads to specialization so that each of us ends up doing just one job and being paid in some form of money Provides accounting services by noting all our transactions Economies of scale: the average cost of producing a good or service falls as the quantity produced increases
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Unformatted text preview: d. Providing Liquidity • Financial intermediaries offer us the ability to transform assets into money at a relatively low cost • Banks structure assets keeping enough funds in short-term liquid financial instruments • Specializes in liquidity management • Must design its balance sheet so that it can sustain sudden withdrawals e. Diversifying Risk • Financial institutions enable us to diversify our investments and reduce risk • Mutual funds f. Collecting of Processing Information • Information asymmetry: borrowers have information that lenders don’t II. Information Asymmetries and Information Costs a. Adverse selection • Before the transaction occurs •...
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