Money and Banking

1278 Words6 Pages
2) How can economies of scale help explain the existence of financial intermediaries? Transaction costs might freeze numerous smaller savers and borrowers out of the possibility of direct involvement inside the financial markets. In addition, transaction costs allow individuals with low volumes to take short positions and to broaden their options (diversify). Financial intermediaries group together the funds from numerous investors together and take advantage of economies of scale (the reduction in transaction costs per dollar of investment as the volume of transactions increases). As an example, mutual funds are able to take advantage of smaller commissions because of the scale of their purchases is higher than that of an individual. On the other hand, bank’s sizeable amount of transactions allows them to keep legal and computing costs for each transaction low. Additionally, a high number of transactions help to diversify and reduce associated risk. Economies of scale, which are crucial in aiding financial intermediaries reduce transactions costs, explains why financial intermediaries exist and are so important to the economy. 5) Suppose you go to a bank, intending to buy a certificate of deposit with your savings. Explain why you would not offer a loan to the next individual who applies for a car loan at your bank at a higher interest rate than the bank pays on certificates of deposit (but lower than the rate the bank charges for car loans). Below are the 4 main reasons as to why not to offer a loan 1. Trust. The simple matter of comparing a person that I have no knowledge about, with a bank (especially if it’s an established bank) that inspires more trust, should be explanatory enough 2. Asymmetric information. There would be a lack of sufficient information about the person and there is a possibility that he could be a potential credit risk as he
Open Document