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ECS3701 ASSIGNMENT 2 SEMESTER 2 2024 (POSSIBLE SOLUTION)
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ECS3701 ASSIGNMENT 2 SEMESTER 2 2024 (POSSIBLE SOLUTION)
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ECS 3701ASSIGNMENT 2
SEMESTER 2
DUE DATE 27
SEPTEMBER 2024
, 2.1.
Financial Structure's Foundation: Collateral and Indirect Finance
The global financial system is based on two core ideas: collateral and indirect
finance. They are essential in promoting economic activity, controlling risk, and
forming the general framework of the financial markets.
Collateral: The Basis of Credibility
Definition: Assets that a borrower pledges to a lender as security for a loan are
referred to as collateral. The collateral may be seized by the lender to cover their
losses in the event that the borrower defaults on the loan.
Part in Risk Reduction: Lenders' exposure to credit risk is decreased by collateral,
which acts as a safety net. Having physical assets as a safety net makes lenders
more inclined to offer borrowing on advantageous conditions.
Types of Collateral: There are many different kinds of collateral, such as securities,
commodities, real estate, and even intellectual property. The loan conditions are
influenced by the collateral's value and liquidity.
The definition of "indirect finance" is "the role of financial intermediaries," such as
banks, who collect money from savers and lend it to borrowers. By serving as
middlemen, these intermediaries connect lenders and borrowers.
Important Roles of Middlemen:
Information Gathering: By obtaining information on borrowers and their
creditworthiness, intermediaries lessen the asymmetry of information.
Risk management: By using portfolio management strategies, they combine and
diversify risks.
Liquidity Provision: By enabling savers to take out money whenever they choose,
intermediaries provide liquidity to their clients.
Reduction of Transaction Costs: By streamlining the loan and borrowing process,
they lower transaction costs.
The Relationship Between Indirect Finance and Collateral
Intermediary as a Catalyst: Borrowers can often get better deals on loans from
financial intermediaries when they have collateral. Borrowers demonstrate their
creditworthiness and lower the lender's risk by offering assets as security.
Collateral Market Development and Indirect financing: Indirect financing is essential
to the growth of collateral markets. Intermediaries add to the efficiency and liquidity
of these markets by making it easier for collateralized securities to be traded.
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