Question

Which of the following is a correctly explained key feature of the financial​ system? ​(Check all that​ apply.)

a. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce moral hazard.

b. The bond market is a less important source of external funds to corporations than is the stock market. This is because there is less moral hazard involved with stocks than with bonds.

c. Trade credit is the most important external source of funds for​ small- to​ medium-sized firms. Trade credit can reduce the transaction costs of borrowing for small firms.

d. The stock market is a less important source of external funds to corporations than is the bond market. This is because there is less moral hazard involved with bonds than with stocks.

e. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce adverse selection.

f. Loans from financial intermediaries are the most important external source of funds for​ small- to​ medium-sized firms. Financial intermediaries can reduce the transaction costs of borrowing for small firms.

Answer 1

The correct options are A,D,F

a. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce moral hazard.

d. The stock market is a less important source of external funds to corporations than is the bond market. This is because there is less moral hazard involved with bonds than with stocks.

f. Loans from financial intermediaries are the most important external source of funds for​ small- to​ medium-sized firms. Financial intermediaries can reduce the transaction costs of borrowing for small firms.

One of the biggest problems for any economy is to figure out is how to get money from people who want to save to people who want to borrow. Finance is the answer to that problem. If you think of the economy as a body, finance would be the heart, pumping money from pension funds in Iowa to construction sites in Madrid. In economic terms, the financial system is responsible for a lot of the world’s resource allocation. It decides which investments get funded and which ones do not. This makes it quite important and quite powerful.