ECO 301 EXAM 1 UME QUESTIONS AND
COMPLETE ANSWERS
Functions of Financial Markets - answer Channel money from savers to borrowers
Direct Finance - answer a flow of funds from savers to firms through financial markets,
such as the New York Stock Exchange
Indirect Finance - answer A flow of funds from savers to borrowers through financial
intermediaries such as banks. Intermediaries raise funds from savers to lend to firms
(and other borrowers).
Securities - answer All of the investments, including stocks, bonds, mutual funds,
options, and commodities, that are traded.
Structure of Financial Markets - answer -Debt & Equity markets
-Primary & Secondary markets
-Exchanges & over-the-counter markets
-Money & Capital markets
Debt Instrument - answer contractual agreement by the borrower to pay the holder of
the instrument fixed dollar amounts at regular intervals until a specified date
Equity - answer contractual agreement representing claims to a share in the income and
assets of a corporation
Primary Market - answer the market in which new securities are originally sold to
investors
Secondary Market - answer previously issued securities are traded among investors
Secondary Market Functions - answer 1) Provide liquidity
2) Price comparison between new/old assets
Exchange - answer Centralized market where buyers and sellers transact
Over the Counter Market - answer a network of dealers who buy and sell the stocks of
corporations that are not listed on a securities exchange; decentralized
I.e. US treasury bonds, NASDAQ
Money Markets - answer Debt instruments with a maturity of 1yr or less
, Capital Markets - answer The financial markets for stocks and for intermediate- or
long-term debt (one year or longer).
Money Market Instruments - answer Certificate of debt, US T-bills, commercial paper,
repurchase agreements, federal funds, Eurodollars
Capital Market Instruments - answer Mortgages, US Treasury Notes (1yr) and Bonds
(3yr), common stock, other types of loans, state & local govt. bonds
Financial Intermediation - answer 1) Economies of scale and transaction costs
2) Diversification and risk sharing
3) Information Asymmetry
Economies of Scale and Transaction Costs - answer Reduced transaction costs through
economies of scale
Diversification and Risk Sharing - answer Extend a variety of loans
Information Asymmetry - answer situation in which one party is more informed than
another because of the possession of private information
Adverse selection, moral hazard
Adverse Selection - answer the situation in which one party to a transaction takes
advantage of knowing more than the other party to the transaction, risky types are more
likely to borrow prior to loan
Moral Hazard - answer Borrower has incentive to take large risks after loan is given
Money - answer anything generally accepted as a form of payment or for the repayment
of debts
Functions of Money - answer medium of exchange, unit of account, store of value
Medium of Exchange - answer anything that is used to determine value during the
exchange of goods and services; reduces transaction costs
Store of Value - answer an item that people can use to transfer purchasing power from
the present to the future
Unit of Account - answer a means for comparing the values of goods and services
COMPLETE ANSWERS
Functions of Financial Markets - answer Channel money from savers to borrowers
Direct Finance - answer a flow of funds from savers to firms through financial markets,
such as the New York Stock Exchange
Indirect Finance - answer A flow of funds from savers to borrowers through financial
intermediaries such as banks. Intermediaries raise funds from savers to lend to firms
(and other borrowers).
Securities - answer All of the investments, including stocks, bonds, mutual funds,
options, and commodities, that are traded.
Structure of Financial Markets - answer -Debt & Equity markets
-Primary & Secondary markets
-Exchanges & over-the-counter markets
-Money & Capital markets
Debt Instrument - answer contractual agreement by the borrower to pay the holder of
the instrument fixed dollar amounts at regular intervals until a specified date
Equity - answer contractual agreement representing claims to a share in the income and
assets of a corporation
Primary Market - answer the market in which new securities are originally sold to
investors
Secondary Market - answer previously issued securities are traded among investors
Secondary Market Functions - answer 1) Provide liquidity
2) Price comparison between new/old assets
Exchange - answer Centralized market where buyers and sellers transact
Over the Counter Market - answer a network of dealers who buy and sell the stocks of
corporations that are not listed on a securities exchange; decentralized
I.e. US treasury bonds, NASDAQ
Money Markets - answer Debt instruments with a maturity of 1yr or less
, Capital Markets - answer The financial markets for stocks and for intermediate- or
long-term debt (one year or longer).
Money Market Instruments - answer Certificate of debt, US T-bills, commercial paper,
repurchase agreements, federal funds, Eurodollars
Capital Market Instruments - answer Mortgages, US Treasury Notes (1yr) and Bonds
(3yr), common stock, other types of loans, state & local govt. bonds
Financial Intermediation - answer 1) Economies of scale and transaction costs
2) Diversification and risk sharing
3) Information Asymmetry
Economies of Scale and Transaction Costs - answer Reduced transaction costs through
economies of scale
Diversification and Risk Sharing - answer Extend a variety of loans
Information Asymmetry - answer situation in which one party is more informed than
another because of the possession of private information
Adverse selection, moral hazard
Adverse Selection - answer the situation in which one party to a transaction takes
advantage of knowing more than the other party to the transaction, risky types are more
likely to borrow prior to loan
Moral Hazard - answer Borrower has incentive to take large risks after loan is given
Money - answer anything generally accepted as a form of payment or for the repayment
of debts
Functions of Money - answer medium of exchange, unit of account, store of value
Medium of Exchange - answer anything that is used to determine value during the
exchange of goods and services; reduces transaction costs
Store of Value - answer an item that people can use to transfer purchasing power from
the present to the future
Unit of Account - answer a means for comparing the values of goods and services
