ECO 301 EXAM 1 STUDY GUIDE
Function of Financial Markets (1) - Answers - Perform the essential function of
channeling funds from economic players that have saved surplus funds to those that
have a shortage of funds
Direct Finance - Answers - borrowers borrow funds directly from lenders in financial
markets by selling them securities
Function of Financial Markets (2) - Answers - Promotes economic efficiency by
producing an efficient allocation of capital; which increases production
Function of Financial Markets (3) - Answers - Directly improve the well-being of
consumers by allowing them to time purchases better
Debt and Equity Markets - Answers - debt instruments (maturity)
Equities (dividends)
Primary and Secondary Markets - Answers - Investment Banks underwrite securities in
primary markets
Brokers and dealers work in secondary markets
Exchanges and Over-the-Counter (OTC) Markets - Answers - Exchanges: NYSE,
Chicago Board of Trade
OTC Markets: Foreign exchange, Federal funds
Money and Capital Markets - Answers - Money markets deal in short-term debt
instruments
Capital markets deal in longer-term debt and equity instruments
Foreign Bonds - Answers - sold in a foreign country and denominated in that country's
currency
Eurobond - Answers - bond denominated in a currency other than that of the country in
which it is sold
Eurocurrencies - Answers - foreign currencies deposited in banks outside the home
country
Eurodollars- U.S. dollars deposited in foreign banks outside the U.S. or in foreign
branches of U.S. banks
World Stock Markets - Answers - Helps finance federal government also
, Function of Financial Intermediaries: Indirect Finance (1) - Answers - Lower transaction
costs (time and money spent in carrying out financial transactions)
Economies of Scale
Liquidity services
Function of Financial Intermediaries: Indirect Finance (2) - Answers - Reduce the
exposure of investors to risk
Risk Sharing (Asset Transformation)
Diversification
Function of Financial Intermediaries: Indirect Finance (3) - Answers - Deal with
asymmetric information problems
(before the transaction) Moral Hazard: ensure borrower will not engage in activities that
will prevent him/her to repay the loan
Sign a contract with the restrictive covenants
Function of Financial Intermediaries: Indirect Finance (Conclusion) - Answers -
Financial intermediaries allow "small" savers and borrowers to benefit from the
existence of financial markets
Regulations of the Financial System (1) - Answers - To increase the information
available to investors:
-Reduce adverse selection and moral hazard problems
-Reduce insider trading (SEC)
Regulations of the Financial System - Answers - To ensure the soundness of financial
intermediaries:
-Restrictions on entry (chartering process)
-Disclosure of information
-Restrictions on Assets and Activities (control holding of risky assets)
-Deposit Insurance (avoid bank runs)
-Limits on Competition (mostly in the past):
Branching
Restrictions on Interest Rates
Meaning of Money - Answers - Money (a stock concept) is different from:
Wealth: the total collection of pieces of property that serve to store value
Income: flow of earning per unit of time (a flow concept)
Functions of Money (1) - Answers - Medium of Exchange:
-Eliminates the trouble of finding a double coincidence of needs (reduces transaction
costs)
-Promotes specialization
A medium of exchange must;
-be easily standardized
-be widely accepted
Function of Financial Markets (1) - Answers - Perform the essential function of
channeling funds from economic players that have saved surplus funds to those that
have a shortage of funds
Direct Finance - Answers - borrowers borrow funds directly from lenders in financial
markets by selling them securities
Function of Financial Markets (2) - Answers - Promotes economic efficiency by
producing an efficient allocation of capital; which increases production
Function of Financial Markets (3) - Answers - Directly improve the well-being of
consumers by allowing them to time purchases better
Debt and Equity Markets - Answers - debt instruments (maturity)
Equities (dividends)
Primary and Secondary Markets - Answers - Investment Banks underwrite securities in
primary markets
Brokers and dealers work in secondary markets
Exchanges and Over-the-Counter (OTC) Markets - Answers - Exchanges: NYSE,
Chicago Board of Trade
OTC Markets: Foreign exchange, Federal funds
Money and Capital Markets - Answers - Money markets deal in short-term debt
instruments
Capital markets deal in longer-term debt and equity instruments
Foreign Bonds - Answers - sold in a foreign country and denominated in that country's
currency
Eurobond - Answers - bond denominated in a currency other than that of the country in
which it is sold
Eurocurrencies - Answers - foreign currencies deposited in banks outside the home
country
Eurodollars- U.S. dollars deposited in foreign banks outside the U.S. or in foreign
branches of U.S. banks
World Stock Markets - Answers - Helps finance federal government also
, Function of Financial Intermediaries: Indirect Finance (1) - Answers - Lower transaction
costs (time and money spent in carrying out financial transactions)
Economies of Scale
Liquidity services
Function of Financial Intermediaries: Indirect Finance (2) - Answers - Reduce the
exposure of investors to risk
Risk Sharing (Asset Transformation)
Diversification
Function of Financial Intermediaries: Indirect Finance (3) - Answers - Deal with
asymmetric information problems
(before the transaction) Moral Hazard: ensure borrower will not engage in activities that
will prevent him/her to repay the loan
Sign a contract with the restrictive covenants
Function of Financial Intermediaries: Indirect Finance (Conclusion) - Answers -
Financial intermediaries allow "small" savers and borrowers to benefit from the
existence of financial markets
Regulations of the Financial System (1) - Answers - To increase the information
available to investors:
-Reduce adverse selection and moral hazard problems
-Reduce insider trading (SEC)
Regulations of the Financial System - Answers - To ensure the soundness of financial
intermediaries:
-Restrictions on entry (chartering process)
-Disclosure of information
-Restrictions on Assets and Activities (control holding of risky assets)
-Deposit Insurance (avoid bank runs)
-Limits on Competition (mostly in the past):
Branching
Restrictions on Interest Rates
Meaning of Money - Answers - Money (a stock concept) is different from:
Wealth: the total collection of pieces of property that serve to store value
Income: flow of earning per unit of time (a flow concept)
Functions of Money (1) - Answers - Medium of Exchange:
-Eliminates the trouble of finding a double coincidence of needs (reduces transaction
costs)
-Promotes specialization
A medium of exchange must;
-be easily standardized
-be widely accepted
