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Theory of Financial Structure (Facts of Financial Structure (Stocks (Not…
Theory of Financial Structure
Transaction costs
Ways to reduce transaction costs
economics of scale
Examples: Banks
Effects
Increase costs in economic exchange
Hinder flows of funds
Types
Search and information cost
Bargaining cost
Policing and enforcement cost
Facts of Financial Structure
Stocks
Not the most important source
External Financing
Issuing marketable debt and equity securities
not the primary funding source
Indirect financing
more important source than direct financing
Banks
most important source of external financing
Financial System
most heavily regulated
Only large, well established firms
access to securities markets
Collateral
Prevalent Feature
debt contract
Asymmetric Information
occurs in financial intermediaries
Financial Institutions
Insurance, Takaful
Financial market
effect
Adverse Selection
Tools to help solve
Private production and sale information
Government regulation to increase information
Financial intermediation
Collateral and net worth
Moral Hazard
Agency Problem
Conflict of Interest
Tools to solve
Production of information through monitoring
Government Regulation to Increase Informaton
Financial Intermediation
Moral Hazard in Debt Contract
Tools to solve
Net Worth
Monitoring and Enforcement of Restrictive Covenant
Financial Intermediation
Peach vs. Lemon
The Lemon Problem