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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% GUARANTEED
, 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 are integral to understanding financial structures across the world.
Here’s a breakdown of how they play a role:
1. Collateral in Financial Structure
Definition: Collateral refers to assets pledged by a borrower to secure a loan, serving as
protection for the lender. If the borrower defaults, the lender can seize the collateral to
recover losses.
Reduction of Risk: By requiring collateral, lenders reduce their exposure to the risk of
borrower default. This makes them more willing to extend credit, especially to borrowers
with less established credit histories or higher risk.
Prevalence: Collateral is widely used in both developed and developing countries. It is a
key factor in loans for housing (mortgages), businesses, and even consumer credit.
Lower Interest Rates: Collateralized loans generally come with lower interest rates, as
the lender has security. This encourages borrowing and investment, which in turn fuels
economic growth.
Mitigation of Information Asymmetry: In financial markets, there is often an
information asymmetry between lenders and borrowers, where the lender knows less
about the borrower’s ability to repay. Collateral helps mitigate this issue by providing a
safety net for lenders.
2. Indirect Finance
Definition: Indirect finance involves funds being channeled from savers to borrowers
through intermediaries, such as banks, rather than directly from lender to borrower.
Banks collect deposits from savers and then lend these funds to individuals and
businesses.
Role of Financial Intermediaries: Financial intermediaries, like banks and insurance
companies, play a crucial role in indirect finance. They assess the creditworthiness of
borrowers, pool risks, and allocate capital efficiently, which fosters economic stability
and growth.
Reduction of Transaction Costs: Indirect finance reduces the transaction costs for both
borrowers and lenders. Financial intermediaries have the expertise and infrastructure to
efficiently assess and manage loans, reducing the time and cost it would take individuals
to do so.
Risk Management: Financial intermediaries also help in risk management through
diversification. By pooling funds from many savers, they can spread the risk of loan
defaults across a larger portfolio.
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