Part 1 - Introduction to financial markets

What are the main functions / purposes of financial markets?

• Capital allocation: channel surplus savings to those needing funds

• Price discovery: markets aggregate information and set asset prices

• Liquidity provision: allow investors to buy/sell assets efficiently

• Risk transfer: instruments like derivatives allow redistribution of risk

• Support business expansion, infrastructure, innovation, and economic growth

What is the difference between direct and indirect financing? (2023)

Direct finance (40% of total financing):

NO intermediary → Borrowers obtain funds directly from lenders by issuing financial instruments such as shares or bonds

Indirect finance (60% of total financing):

WITH intermediary (bank, investment fund, insurance company etc.) → process where intermediaries collect funds from surplus units (savers) to lend to deficit units (borrowers) through lending or investment management

What is Information Asymmetry in financial markets and what is its consequence? (2020 + 2021)

IA = one party in a financial transaction has more or better information than the other, the consequences of this imbalance are:

• Adverse Selection (AS) → PRE-transaction, where lenders are unable to distinguish between high- and low-risk borrowers

• Moral Hazard (MH) → POST-transaction, where borrower takes hidden risks once financing is provided

Provide 5 reasons why bank lending is not growing fast in Europe? (2022)

Bank lending in Europe is slow because of

• low profits,

• strict regulations,

• fear of risk,

• competition from non-banks, and

• more firms using direct market finance.

What are the sources of funding for large companies vs. smaller companies and how do they differ? (2020 + 2024)

Large companies: use direct market financing (stocks/bonds)

Small companies: rely on bank loans and private funding due to limited market access