Fim(Solution)

7. What are five general areas of FI specialness that are caused by providing various services to sectors of the economy?

The first function is the brokerage function. When acting as a pure broker, an FI acts an agent for saver by providing information and transaction services.

The second function is the asset-transformation function. In acting as an asset transformer, the FI issues financial claims that are far more attractive to household savers than the claims directly issued by corporations. FIs are independent market parties that create financial products whose value added to their clients is the transformation.

Third, FIs collect and process information more efficiently than individual savers. the large FI now has a much greater incentive to collect information and monitor actions of the firm because it has far more at stake than does any small individual household.

Fourth, FIs such as depository institutions can offer highly liquid and low price-risk contracts to savers on the liability side of their balance sheets while investing in relatively illiquid and higher price-risk securities issued by corporations on the asset side. FIs diversify away significant amounts of portfolio risk—especially the risk specific to the individual firm issuing any given security.

Finally, FLs Reduce Transaction Costs. Just as FIs provide potential economies of scale in information collection, they also provide potential economies of scale in transaction costs. FIs offer maturity intermediation services to the rest of the economy.

8. How do FIs solve the information and related agency costs when household savers invest directly in securities issued by corporations? What are agency costs?

Household savers must monitor the actions of firms in a timely and complete fashion after purchasing securities. Failure to monitor exposes investors to agency costs, that is, the risk that the firm’s owners or managers will take actions with the saver’s...