FINS3630 notes wks1-6
FINS3630- Semester 1 2014 Notes
Financial Service and Industry and Specialness of FIs
Financial Intermediaries’ Specialness
Financial intermediaries’ function
Brokerage Function
Agent for investors
Reduce costs (economies of scale)
Asset Transformation
Purchase primary securities by selling financial claims (secondary securities) to households
Secondary securities are more marketable BECAUSE
Less information asymmetry
Less monitoring costs
More liquid
Less risky
Without financial intermediaries, households will find direct investments in corporate securities unattractive due to information/monitoring costs, liquidity cost and price risk. Thus flow was funds are less, little monitoring and risk of investments would increase.
Specialness of financial institutions
General areas (LIP TM)
Liquidity services
Information services
Price- risk reduction services
Transaction cost services
Maturity intermediation services
Institution- specific (McDIP)
Money supply transmission
Credit allocation
Denomination intermediation
Intergenerational transfers
Payment services
Information costs
Agency costs costs relating to the risk that firm owners and managers use savers’ funds not in the best interest of the savers
Financial institutions collect funds from households in order to avoid free- rider problem (incentive for information collection and monitoring), reduce costs of information collection and monitoring and to develop new secondary securities to more effectively monitor borrows.
Liquidity and price risk
Financial intermediaries provide secondary claims to household savers – high liquidity and low price risk and invest in these illiquid and risky sectors
Advantage of financial institutions managing liquidity and price risk
Diversification (due to size of funds)
Development of better risk management techniques
Disadvantage of delegated institutions
Intermediary services are not free
Agency issues
Risk management
Financial Service and Industry and Specialness of FIs
Financial Intermediaries’ Specialness
Financial intermediaries’ function
Brokerage Function
Agent for investors
Reduce costs (economies of scale)
Asset Transformation
Purchase primary securities by selling financial claims (secondary securities) to households
Secondary securities are more marketable BECAUSE
Less information asymmetry
Less monitoring costs
More liquid
Less risky
Without financial intermediaries, households will find direct investments in corporate securities unattractive due to information/monitoring costs, liquidity cost and price risk. Thus flow was funds are less, little monitoring and risk of investments would increase.
Specialness of financial institutions
General areas (LIP TM)
Liquidity services
Information services
Price- risk reduction services
Transaction cost services
Maturity intermediation services
Institution- specific (McDIP)
Money supply transmission
Credit allocation
Denomination intermediation
Intergenerational transfers
Payment services
Information costs
Agency costs costs relating to the risk that firm owners and managers use savers’ funds not in the best interest of the savers
Financial institutions collect funds from households in order to avoid free- rider problem (incentive for information collection and monitoring), reduce costs of information collection and monitoring and to develop new secondary securities to more effectively monitor borrows.
Liquidity and price risk
Financial intermediaries provide secondary claims to household savers – high liquidity and low price risk and invest in these illiquid and risky sectors
Advantage of financial institutions managing liquidity and price risk
Diversification (due to size of funds)
Development of better risk management techniques
Disadvantage of delegated institutions
Intermediary services are not free
Agency issues
Risk management