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Goals
Understand
Chapter 3 • Transaction cost, Assymetric Information
• Business Financial Structure
Assymetric
Information & The Analyse:
Role of Financial • Tools to solve information assymetry
Intermediaries • 8 basic characteristics of financial structure
Explain the role of financial
intermediaries
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3.1 Definition
3.1.1Transaction cost
3.1.1 Transaction costs
• Economics: The cost
associated with
• In finance, transaction costs are all fees and
exchange of goods or
commissions paid when buying or selling
services. Transaction
securities, such as search costs, cost of
costs cover a wide
distributing securities to investors, cost of
range: communication
SEC registration, and the time and hassle of
charges, legal fees,
the financial transaction.
informational cost of
finding the price, quality, • Include: search cost, negotiation –
and durability, etc., and implementation cost, monitoring cost
may also include (Dahlman, 1979)
transportation costs.
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3.1.1 Transaction
Minicase – Transaction cost
cost
• Ton y, the Thu y Cung c offee shop o wner, learns that the
• In general, the greater the transaction bank is willing to loan him the $25 ,000 ; ho wever, he thinks
cost, the more likely it is that a financial that the 9 percent loan rate is to o h igh. T hus, To ny seek s an
intermediary will provide the financial individua l in vestor who might offer a lower loan rate.
service. Why and How? • Sup pose that y ou have mone y to inve st and are look ing for
some inves tmen t op portu nities. Yo u do not kno w Tony
personally, but you have frequented the coffee shop when
you were in college. You are currently a bus ines s
consultant but not a f inancial ex pert. To keep the examp le
simple, we as su me the loan is for 1 year and your profits
are earned from the gro ss interest rate spread, wh ich is
$1,00 0 ($25 ,000 x 0. 04).
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Minicase – Transaction cost 3.1.1 Transaction cost
• 1. Discussion about transaction costs to • Economies of scale
make the transaction between (Tony and
you) happen. Similar for the transaction
between Tony and the bank
• 2. So, how do the banks or financial
intermediaries reduce transaction cost?
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3.1.1 Transaction cost 3.1.1 Transaction cost
• Expertise Technology
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3.1.2 Information Assymetry 3.1.2 Information Asymmetry
• In financial markets, one party often does
not know enough about the other party to
make accurate decisions. This inequality is
called asymmetric information.
• Asymmetric information occurs when
buyers and sellers do not have access to the
same information; sellers usually have
more information than buyers
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3.1.3. Asymmetric Information:
3.1.2 Asymmetric Information Adverse Selection & Moral Hazard
TThe problems which are created by
Securities Labor asymmetric information include:
Ngân market,
hàng
Banking investment market
Real Adverse Selection Moral hazard
estate,
Insurance second -occur after the transaction
hand § Occurs when one party in
market a transaction has better (loan) takes place, when one
information than the other party has an incentive to behave
party differently once an agreement is
§Before transaction occurs made between parties
§Potential borrowers most -occur if borrowers engage in
likely to produce adverse activities that increase the
Asymmetric Information occurs in any field outcome are ones most probability that the borrower
likely to seek loan and be will default
selected
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Problems of Information Problems of Information
Asymmetry - Example Asymmetry
• the owner of a woodworking shop goes • Let’s say that the bank made the loan.
to a local bank for a business loan. The Rather than using the money for working
capital, however, the owner takes half the
company is in financial trouble and money and invest in real estate market!.
may fold unless the owner is able to
• Why would a business owner take on
secure a loan for working capital. What additional risk that would increase the firm’s
is the owner to say when asked if he probability of default?
can repay the loan?
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The Principal-Agent Problem/
The Principal-Agent Problem
Agency problem
• Ownership & control: “the large corporation • The bulk of the dividends go to outside
is owned by so many shareholders that no shareholders.
single shareholder owns a significant • All the major decisions are taken by the
proportion of the outside stock. Therefore corporate officers.
no single shareholder has the power to
• The outside shareholders are unable to
really control the actions of the officers of
control the corporate officers.
the corporation”.
• The interests of the shareholders and the
• Result of separation of ownership by
corporate officers diverge significantly.
stockholders (principals) from control by
managers (agents)
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Tools to Help Solve Adverse
The Principal-Agent Problem
Selection (Lemons) Problems
• Shareholders: PROFIT 1. Private Production and Sale of Information
─ Free-rider problem interferes with this solution
• Corporate Officers: POWER, PRESTIGE, 2. Government Regulation to Increase
PERSONAL WEALTH Information (explains Fact # 5)
─ For example, annual audits of public
corporations
• Senior managers may be in a position to
enrich themselves at the expense of the
shareholders.
• Moral hazard problem
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Tools to Help Solve Adverse Moral Hazard in Equity Contracts
Selection (Lemons) Problems QUIZ
§ Define the Principal-Agen t Problem
3. Financial Intermediation
§ Why does the Principal-Agent Problem make
─ Used car dealers analogy for lemons problem
debt more attractive than equity to
─ Avoid free-rider problem by making private loans investors?
(explains Fact # 3 and # 4)
─ Also explains fact #6—large firms are more likely
to use direct financing.
4. Collateral and Net Worth
─ Explains Fact # 7
liquidate collateral: phát mãi tài sản thế chấp cho khoản
nợ khi người vay mất khả năng cho vay ( default)
networth= assets - liabilities: tìa sản ròng
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How Moral Hazard Affects the How Moral Hazard Influences
Choice Between Debt and Equity Financial Structure in Debt
Contracts Markets
§ Tools to Help Solve the Principal-Agent • Tools to Help Solve Moral Hazard in
Problem Debt Contracts
[Link] of Information: costly monitoring 1. Net Worth and Collateral
makes equity less desirable than debt 2. Monitoring and Enforcement of Restrictive
[Link] Regulation to Increase Covenants.
Information 3. Financial Intermediation—banks and other
[Link] Intermediation (e.g, venture capital) intermediaries have special advantages
[Link] Contracts in monitoring
• Explains Facts # 1–4
§ Explains Fact # 1: Why debt is used more
than equity
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chủ nợ giám sát công ty hơn cổ đông: vì ko muốn công ty đầu tư 4 loại restrictive covenants:
mạo hiểm. ví dụ: ko cho công ty vay nợ ngân hàng khác, ko cho - encourage desirable -> buying life insurance.
mua những cái khác vớ vẩn ( phải cam kết trong hợp đồng), ( cam - discourage undesirable behaving borrower
kết) ko cho đầu tư mạo hiểm,….. - maintain the value of collateral ( nếu tài sản thế chấp giảm thì
ohair nạp thêm tiền )
- provide information cho lender.
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Tools to solve agency problem Two decades of CEO pay
-Stockholders, bondholders,
- Financial Press
- - SEC and other government
Monitoring regulators
- Outside auditors
- Provide a
-Trannsparent Agency compensation
responsibility system Create a
- Business code of
problem package to managers
strong that try to induce
ethics) manage Incentives them to act in
ment stockholders’ interest
system - Usually this is
performance (or
value) based
incentives à Stock
options
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Summary
Financial Intermediaries
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Flows of Funds Through the Sources of Foreign
Financial System External Finance
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deposist - short-term
chứng khoán đầu tư: ngân hàng nắm goverment bonds nhiều
nhất - nắm chứng khoán an toàn và thanh khoản cao nhất ( đẻ
bán chứng khoán nhanh để thu hồi)
Bảo hiểm: lấy tiền từ phí bảo hiểm( long-term và ổn định) ->
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nắm tiền chứng khoán ( long-term hơn ngân hàng)
Câu 3: ngân hàng lấy công cụ giải quyết - tools
giải quyết vấn đề “chênh lệch thông tin” và “rủi ro đạo đức”
->
ko phân biệt chênh vs đào để đỡ chi phí giao dịch và chi phí
lương-> mua hết cả chênh và đào.
Công ty tài chính = bảo hiểm
3.4 Financial intermediary
Facts of Financial Structure
definition
1. Stocks are not the most important source of finance for v Financial institution (such as a bank, credit union,
businesses. bonds - loan finance company, insurance company, stock
2. Issuing marketable securities is not the primary funding exchange, brokerage company) which acts as the
source for businesses. 'middleman' between those who want to lend and
3. Indirect finance (financial intermediation) is far more those who want to borrow.
important than direct finance.
4. Banks are the most important source of external finance. v Classify financial institutions into: Bank and non-
5. The financial sector is among the most heavily regulated. bank financial institutions/ depository and non-
6. Only large, well established firms have access to depository institution/ Depository institutions,
securities markets. contractual savings institutions and investment
7. Collateral is a prevalent feature of debt contracts. intermediaries
8. Debt contracts are typically extremely complicated legal
documents with restrictive covenants.
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Dùng chi phí chuyển đổi, chênh lệch thông tin để giải thích 8 facts này
The Economics of Financial Reasons for Financial
Intermediation Intermediation
• In a world of perfect financial markets there • Transaction costs
would be no need for financial – Cost of bringing lender/borrower together
– Reduced when financial intermediation is used
intermediaries (middlemen) in the process
– Relevant to smaller lenders/borrowers
of lending and/or borrowing
• Portfolio Diversification
– Costless transactions – Spread investments over larger number of securities and
– Securities can be purchased in any denomination reduce risk exposure
– Perfect information about the quality of financial – Option not available to small investors with limited funds
instruments – Mutual Funds—pooling of funds from many investors and
purchase a portfolio of many different securities
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Reasons for Financial
Depository institutions
Intermediation
• Gathering of Information • Accept deposits from individuals and
– Intermediaries are efficient at obtaining institutions and make loans.
information, evaluating credit risks, and are
specialists in production of information • Include commercial banks and the so-called
• Asymmetric Information thrift institutions (thrifts): savings and loan
– Adverse Selection associations, mutual saving banks, and
– Moral Hazard credit unions
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Balance Sheets of Depository Depository institution:
Institutions Commercial banks
• Raise funds by issuing checkable deposits,
savings deposits, time deposits
• All have deposits on the right-hand side
of balance sheet • Use funds to make commercial, consumer
and mortgage loans and to buy government
• Investments in assets tend to be short
securities/ municipal bonds
term in maturity
• Gather small amounts of money from
• Do face credit risk because they invest
households and make (bigger) loans
heavily in nontraded private loans
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Depository institution: Savings Depository institution: Credit
and Loan Associations / Mutual Unions
Savings Banks
• Small cooperative lending institutions
• Obtain funds through savings deposits, time
organized around a particular group: union
and checkable deposits. members, employees of a particular firm,...
• Use funds to make mortgage loans and • Acquire funds from deposits (called shares)
commercial loans (often for small
and make consumer loans
businesses)
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Balance Sheets of Non-
Contractual savings institutions
depository Financial
Intermediaries • Are financial intermediaries that acquire
• Some experience credit risk associated funds at periodic intervals on a contractual
with nontraded financial claims basis
• Asset maturities reflect the maturity of • Include insurance companies and pension
liabilities funds
– Insurance and pension funds have long-term • Predic accurately how much they will have
policies and annuities—invest in long-term to pay out in benefits à not worry as much
instruments as depository institutions about losing funds
– Consumer and commercial finance companies quickly à liquidity of assets is not as
have assets in short-term nontraded loans—
important consideration à invest in long-
raise funds by issuing short-term debt
term securities
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Contractual savings institutions: Contractual savings institutions: Fire
Life insurance companies and Casualty insurance companies
• Insure people against financial hazards • Insure people against loss from theft, fire
following a death and sell annuities (annual and accidents.
income payments upon retirement) • Acquire funds from the premiums that
• Acquire funds from the premiums that people pay for the insurance contract and
people pay for the insurance contract and use funds to buy municipal bonds (largest),
use funds to buy corporate bonds, corporate bonds and stocks, government
mortgages, and stock (restricted in the securities
amount they can hold). • Have a greater possibility of loss of funds if
major disasters occur à buy more liquid
assets than life insurance compnaies
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Contractual savings institutions: Investment Intermediaris:
Pension funds and government Finance Companies
retirement funds
• Raise funds by selling commercial paper and
• Provide retirement income in the form of by issuing stock and bonds
annuities to employees who are covered by • Lend funds to consumers and to small
a pension plan. business.
• Acquire funds from contributions from
• Gather big amounts of money and then lend
employers and employees (automatically small amounts to consumers & SMEs
deducted from paychecks or contribute
voluntarily).
• Use funds to buy corporate bonds and
stocks
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Investment Intermediaris: Investment Intermediaries:
Mutual Funds Money market mutual funds
• Acquire funds by selling shares to many • Similar to mutual fund but also function as a
individuals depoitory institution
• Use funds to purchase diversified portfolios • Sell shares to acquire funds and use to buy
of stocks and bonds. money market instruments
• Investments in mutual funds can be risky • Shareholders can write checks against the
value of their shareholding
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Investment Intermediaries:
Investment banks
• Not take in deposit and lend them out.
• Help a corporation issue securities:
• Which type of securities to issue
• Help sell (underwrite) the securities by
purchasing them from corporation at a
predetermined price and resell in the
market.
• Act as deal makers and earn fees by helping
corporations in M&A deals
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