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Chapter 4: FI exists to reduce/ solve market imperfections, to solve…
Chapter 4: FI exists to reduce/ solve market imperfections, to solve problems such as differences in preferences of shares, transaction cost, shocks in consumers consumption and asymmetric information which results in AS/MH
Asset transformation theory: FI satisfies both borrowers and lenders needs
- Reconcile the conflicting differences of both parties
- Transform primary securities issued by firms into indirect securities needed by lenders
- Usually, issue ST, Low risk, high risk low liquidity claims
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Transaction cost: presence of T costs are incurred due to time and money invested in performing financial transaction
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3 ways to reduce t costs
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Expertise to lower tranaction cost, expertise, IT
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Asymmetric information: one party of the transaction has less information than the other party and therefore cannot make accurate decisions
Eg: potential investor has less info than mangers of the firm he/she like to invest in, thus unable to accurately evaluate risk and returns
- insurance companies dk exact health of policy holder
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Moral Hazards
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Operate in the equity market, avoid MHP