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ECS3701 Assignment 2 (COMPLETE ANSWERS) Semester 2 2024 (833935) - DUE 27 September 2024
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ECS3701 Assignment 2(COMPLETE ANSWERS)
Semester 2 2024 (833935) - DUE
27 September 2024
100% GUARANTEEED
, ECS3701 Assignment 2 (COMPLETE ANSWERS)
Semester 2 2024 (833935) - DUE 27 September 2024
2.01 Discuss how collateral and indirect finance are used
in explaining the basic facts about financial structure
around the world. [10]
Collateral and Indirect Finance in Explaining Financial Structure
Financial structure refers to how financial systems are organized, including how funds are raised
and allocated across an economy. Collateral and indirect finance play significant roles in
understanding financial structures around the world, particularly in explaining how financial
institutions and markets function to allocate capital.
1. Collateral in Financial Structure
Definition: Collateral refers to assets that borrowers pledge to lenders to secure a loan. If
the borrower defaults, the lender can seize the collateral to recover their losses.
Risk Mitigation: Collateral reduces the risk faced by lenders, making them more willing
to lend. It provides a form of security that mitigates the potential for moral hazard, where
the borrower might take excessive risks after securing funds.
Facilitates Lending: By offering collateral, borrowers—especially those with weaker
credit histories—can gain access to finance. This is particularly important for small
businesses and individuals in developing countries where credit histories may be
unreliable or hard to verify.
Importance in Developing Markets: In countries where legal enforcement of contracts
may be weak, the presence of collateral can be critical in ensuring the lender's rights. This
helps explain why asset-backed lending is a dominant practice in many financial systems,
especially in economies with underdeveloped financial markets.
Global Practice: Around the world, the use of collateral is widespread, particularly in
bank-based financial systems, such as those in Europe, where banks play a significant
role in financing through secured loans.
2. Indirect Finance in Financial Structure
Definition: Indirect finance involves the flow of funds from savers to borrowers through
financial intermediaries, such as banks, rather than through direct capital markets like
stocks or bonds.
Financial Intermediation: Banks and other financial intermediaries act as middlemen
between savers and borrowers. They collect deposits from individuals and businesses,
pool these funds, and lend them out to those in need of financing.
Risk Sharing and Liquidity: Financial intermediaries help reduce transaction costs and
manage risks better than individuals or firms can on their own. They also provide
liquidity, allowing savers to withdraw their funds when needed while still keeping money
circulating in the economy.
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