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slides02 - Class #2: Financial and Monetary Institutions...

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[Notes on Mishkin Ch.2 - P.1] Class #2: Financial and Monetary Institutions Financial system. Money. Federal Reserve. The Financial System (Mishkin ch.2) • Role of the Financial System. • Financial Markets – overview. • Financial Intermediaries – overview. • Financial Innovation and Regulation: systemic problems and current issues.
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[Notes on Mishkin Ch.2 - P.2] The Role of the Financial System 1. Channel funds from lenders/savers to borrowers/spenders 2. Facilitate payments from buyers to sellers => Money (ch.3)
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[Notes on Mishkin Ch.2 - P.3] Economic Question: Why is the Financial System important? 1. Economic growth requires investment – investment needs financing. - History of financial crises: Subprime mortgage crisis 2007-08; The Great Depression; Japan in the 1990s; Mexico 1995. - Normal times: Don’t take efficient financing for granted. - History of credit controls, allocations, regulations. 2. Payment system is vital to production – sensitive to disruption. 3. Personal finance – mistakes are costly.
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[Notes on Mishkin Ch.2 - P.4] Key Distinctions • Debt Markets vs. Equity Markets: Definitions? Examples? • Primary Markets vs. Secondary Markets: Definitions? Examples? – Importance for Demand: Flows << Outstanding quantities. • Money Markets vs. Capital Markets: Definitions? Examples? – Where is the “Market for Money”? • Exchanges vs. Over-the-Counter Markets: Definitions? Examples? • Direct vs. Indirect Finance (sometimes blurred).
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[Notes on Mishkin Ch.2 - P.5] Money Markets
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[Notes on Mishkin Ch.2 - P.6] Capital Markets
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[Notes on Mishkin Ch.2 - P.7] Financial Intermediaries
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[Notes on Mishkin Ch.2 - P.8] Economic Question: Who cares about Financial Intermediaries? • Good question! Much of intermediation is similar to transactions that could be done on markets. Possible answers: 1. Transactions Cost . Examples: Mutual funds, ETFs. Convenient but not essential – do these institutions “matter”? 2. Risk sharing . Example: Diversification—in loans, credit cards etc. Known risks can be transferred to markets (pre-2007: CLO, CDO, ABS) 3. Asymmetric information. Types: moral hazard and adverse selection . Problem: Someone must have incentives to produce reliable information. • Intermediaries = answer to asymmetric information: collect information about borrowers; make loan decisions; profit from bearing credit risks. - Strong incentives to screen borrowers – mitigate adverse selection. - Strong incentives to monitor borrowers – mitigate moral hazard. • Securitization: Transfer default risk to markets. Create liquidity. - What about incentives: Credit ratings? Reputation? Gov. guarantees?
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[Notes on Mishkin Ch.2 - P.9] Financial Innovation • The Financial System is always changing. When you study current institutions, study them as examples that teach
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This note was uploaded on 12/26/2011 for the course ECON 135 taught by Professor Bohn,h during the Fall '08 term at UCSB.

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slides02 - Class #2: Financial and Monetary Institutions...

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