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1、Chapter 8An Economic Analysis of Financial Structure 2005 Pearson Education Canada Inc.Sources of External Finance in Canada2 2005 Pearson Education Canada Inc.Sources of Foreign External Finance3 2005 Pearson Education Canada Inc.Puzzles of Financial Structure1.Stocks are not most important source
2、of external finance for businesses2.Issuing marketable securities not primary funding source for businesses3.Indirect finance(financial intermediation)is far more important than direct finance4.Banks are most important source of external finance5.Financial system is among most heavily regulated sect
3、ors of economy6.Only large,well established firms have access to securities markets7.Collateral is prevalent feature of debt contracts8.Debt contracts are typically extremely complicated legal documents with restrictive covenants4 2005 Pearson Education Canada Inc.Transaction Costs and Financial Str
4、uctureTransaction costs hinder flow of funds to people with productive investment opportunitiesFinancial intermediaries make profits by reducing transaction costs1.Take advantage of economies of scaleExample:Mutual Funds2.Develop expertise to lower transaction costsExplains Puzzle 35 2005 Pearson Ed
5、ucation Canada Inc.Adverse Selection and Moral Hazard:DefinitionsAdverse Selection:1.Before transaction occurs2.Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selectedMoral Hazard:1.After transaction occurs2.Hazard that borrower has incentives t
6、o engage in undesirable(immoral)activities making it more likely that wont pay loan back6 2005 Pearson Education Canada Inc.Adverse Selection and Financial StructureLemons Problem in Securities Markets1.If cant distinguish between good and bad securities,willing to pay only average of good and bad s
7、ecurities values.2.Result:Good securities undervalued and firms wont issue them;bad securities overvalued,so too many issued.3.Investors wont want to buy bad securities,so market wont function well.Explains Puzzle 2 and Puzzle 1.Also explains Puzzle 6:Less asymmetric information for well known firms
8、,so smaller lemons problem7 2005 Pearson Education Canada Inc.Tools to Help Solve Adverse Selection(Lemons)Problem1.Private Production and Sale of InformationFree-rider problem interferes with this solution2.Government Regulation to Increase InformationExplains Puzzle 53.Financial IntermediationA.An
9、alogy to solution to lemons problem provided by used-car dealersB.Avoid free-rider problem by making private loansExplains Puzzles 3 and 44.Collateral and Net WorthExplains Puzzle 78 2005 Pearson Education Canada Inc.Moral Hazard:Debt versus EquityMoral Hazard in Equity:Principal-Agent Problem1.Resu
10、lt of separation of ownership by stockholders(principals)from control by managers(agents)2.Managers act in own rather than stockholders interestTools to Help Solve the Principal-Agent Problem1.Monitoring:production of information2.Government regulation to increase information3.Financial intermediati
11、on4.Debt contractsExplains Puzzle 1:Why debt used more than equity9 2005 Pearson Education Canada Inc.Moral Hazard and Debt MarketsMoral hazard:borrower wants to take on too much riskTools to Help Solve Moral Hazard1.Net worth2.Monitoring and enforcement of restrictive covenants3.Financial intermedi
12、ationBanks and other intermediaries have special advantages in monitoringExplains Puzzles 14.10 2005 Pearson Education Canada Inc.Summary:Asymmetric Information Problems and Tools to Solve Them11 2005 Pearson Education Canada Inc.Financial Development and Economic GrowthFinancial Repression Leads to
13、 Low Growth:Why?1.Poor legal system2.Weak accounting standards3.Government directs credit4.Financial institutions nationalized5.Inadequate government regulation12 2005 Pearson Education Canada Inc.Financial CrisesFactors Causing Financial Crises1.Increase in interest rates2.Increases in uncertainty3
14、.Asset market effects on balance sheetsStock market effects on net worthUnanticipated deflationCash flow effects4.Bank panics5.Government fiscal imbalances13 2005 Pearson Education Canada Inc.Events in Financial Crises in Canada14 2005 Pearson Education Canada Inc.Events in Mexican,East Asian,and Argentine Financial Crises15 2005 Pearson Education Canada Inc.