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Money & Banking study guide

Traditional instruments in the international bond

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: traditional instruments in the international bond market; sold in foreign Eurobond : a bond denominated in a currency other than that of the country in which it is sold Eurocurrencies : foreign currencies deposited in banks outside the home country Eurodollars : US dollars deposited in foreign banks outside the US or in foreign branches of US banks Many international countries help financial Fed Gov’t; w/o them, US economy would grow less rapidly Indirect Finance – involves a financial intermediary that stands b/t the lender-savers and the borrower-spenders & helps transfer funds from one to the other; borrows funds from the lender-savers and then uses these funds to make loans to borrower-spenders Financial intermediation : process of indirect finance using financial intermediaries; primary route for moving funds from lenders to borrowers Transaction costs : time and money spent in carrying out financial transactions; major problem for people who have excess funds to lend – people being uncertain of if it’s a worthwhile investment (hire people, which reduces gains) – financial intermediaries can reduce transaction costs Economies of scale : reduction in transportation costs per dollar of transactions as the size (scale of transactions increases) A financial intermediary’s low transaction costs mean that it can provide its customers with liquidity services : services that make it easier for customers to conduct transactions Financial institutions also reduce the exposure of investors to risk; allow fin intermediaries share risk at low costs, so they can earn a profit Risk : uncertainty about the returns investors will earn on assets; done thru Risk sharing : create & sell assets with risk characteristics that people are comfortable with, and the intermediaries then use the funds they acquire by selling these assets to
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purchase other assets that may have far more risk; process of risk sharing is sometimes called asset transformation : risky assets are turned into safer assets for investors Diversification : entails investing in a collection of assets whose returns don’t always move together, with the result that overall risk is lower than for individual assets Portfolio : a collection of assets Don’t put all your eggs in one basket Asymmetric Information: Adverse Selection and Moral Hazard Asymmetric information : one party doesn’t know enough about other party Adverse selection : the bad decision made w/ the poor information; BEFORE transaction occurs Moral hazard : problem created by asymmetric info AFTER transaction occurs; the risk that the borrower might engage in activities that are undesirable from the lender’s POV b/c they make it less likely that the loan will be paid back Financial intermediaries provide liquidity services, promote risk sharing, and solve information problems Economies of scope : they can lower the cost of information production for each service by applying one information resource to many different services Although economies of scope may substantially benefit financial institutions, they also
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