Introduction

Introduction - mortgage portfolio for each bank is solvent....

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Key Macroeconomic Issues: 1. What determines long run growth? 2. What causes business cycles? What is the role of financial markets in answering questions 1 and 2?
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Financial markets 1. Match borrowers and savers 2. Primary vs Secondary markets - secondary markets provide liquidity 3. Investment project: project with highest expected payoff pays highest returns 4. Asset transformation: most investment projects are long term, say houses - mortgages or plant - stock issue whereas savings are short term - corporate paper (6 months), savings accounts or deposits 5. Financial markets facilitate risk sharing.
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Example: secondary market in mortgages: Suppose 100 mortgages and 100 banks. Assume 5% of mortgages go bankrupt. I If 1 bank holds 1 mortgage, then 5 banks bear all of bankruptcy risk and 5 banks go bankrupt. Those 5 banks bear all of risk. I If pool 100 mortgages (a security) and have 100 banks hold 1/100th of pooled security, then each bank holds 1/100th of each mortgage. Although 5% of mortgages default, 95% of
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Unformatted text preview: mortgage portfolio for each bank is solvent. Ecient risk sharing. Financing investment: I Internal - through retained earnings or own net worth I External nance I Indirect nance through a nancial intermediary I Direct nance: stock or bond Direct Finance: 1. Bond: a security that is a claim on the issuers income or an asset. A bond is a debt security promising xed payments at specied time interval. The bond is an IOU and there are two outcomes: 1.1 Solvent: as long as the issuer is solvent the payments to the bond holder do not vary with the prots of the rm 1.2 Insolvent: bond holders have certain rights in bankruptcy proceedings. 2. Stock: 2.1 Share of ownership in a corporation 2.2 Pays a dividend only if there are prots 2.3 Shareholder is a residual claimant 2.4 Separation of management and ownership 2.5 Limited liability...
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Introduction - mortgage portfolio for each bank is solvent....

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