Gordon_Answers11e_ch13 - 144 Gordon Macroeconomics,...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
144 Gordon • Macroeconomics, Eleventh Edition ± Answers to Questions in Textbook 1. Financial markets are exchanges where securities or financial instruments, such as stocks and bonds, are bought and sold. So borrowers obtain funds directly from savers in financial markets. Financial intermediaries are institutions which issue liabilities, such as deposits in a bank, to savers and lend those funds to borrowers. Thus, financial intermediaries indirectly provide the link between savers and borrowers. Financial intermediaries exist for two reasons. For a saver with a small amount of funds, a financial intermediary can spread the risk of lending among a large number of borrowers. As an example, consider a person who has $5,000 in a savings account at a bank which has 10,000 outstanding loans. The person is in essence lending 0.50 to each borrower, thereby considerably reducing the risk of any one borrower defaulting on the loan. Furthermore, it is unlikely that the saver would be able to find 10,000 people needing to borrow 0.50 each, and the cost of negotiating that many loans is likely to outweigh the interest generated by the loans. A second reason why financial intermediaries exist is that they are large enough to hire specialists who can evaluate the risks involved in making loans to individual borrowers, something an individual saver cannot do. For example, a loan officer at a bank is likely to have more information than depositors concerning not only the general business conditions in an area, but also specific information with respect to the ability of a particular borrower to repay a loan. Borrowers in financial markets need to be large enough to either be widely known for repaying loans and/or being able to pay the costs of providing the information that is legally required to sell securities in financial markets. On the other hand, people and businesses who obtain funds from financial intermediaries tend to either be too small to be able to afford to provide the information legally required to use financial markets, or their reputations for repayment may only be known to people at the financial intermediaries. 2. Despository institutions consist of commercial banks and thrift institutions. Commercial banks get their deposits from both households and businesses and make loans to both groups. Thrift institutions obtain funds mainly from the savings accounts of households, although they also obtain funds from deposits into checking accounts. Traditionally, thrift institutions made real estate loans; they continue to do so, but since deregulation, they have broadened their lending activities into other areas. Contractual savings institutions receive retirement savings from people and their employers. The institutions invest these funds in financial markets and use the proceeds to pay out retirement benefits. Investment intermediaries differ in how they obtain funds. Finance companies obtain funds in
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 09/04/2010 for the course ECON 311 taught by Professor Gordon during the Spring '08 term at Northwestern.

Page1 / 7

Gordon_Answers11e_ch13 - 144 Gordon Macroeconomics,...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online