Financial markets, and

Insurance (1)

Dr. Dalia Reda

 Financial markets
●Financial markets: All institutions
and procedures for bringing buyers
and sellers of financial instruments
together.
 The Purpose of Financial
Markets
●In the economy as a whole, savings-surplus units
(those whose savings exceed their investment in real
assets) provide funds to savings-deficit units (those
whose investments in real assets exceed their savings).
●- This exchange of funds is evidenced by investment
instruments, or securities, representing financial assets
to the holders and financial liabilities to the issuers.
 Financial Markets

●Financial markets are not so much physical places as they

are mechanisms for channeling savings to the ultimate
investors in real assets.
●Figure 1 illustrates the role of financial markets and
financial institutions in moving funds from the savings
sector (savings-surplus units) to the investment sector
(savings-deficit units). From the figure we can also note the
prominent position held by certain financial institutions in
channeling the flow of funds in the economy. The secondary
market, financial intermediaries, and financial brokers are
the key institutions that enhance funds flows.
Figure 1: Flow of funds in the
economy and the
mechanism that
financial markets
provide for channeling
savings to the
ultimate investors
in real assets
 Figure 1:
The secondary market
●A market for existing (used) securities
rather than new issues.
Figure 1: Financial intermediaries
●Financial intermediaries:
Are financial institutions that accept money from
savers and use those funds to make loans and other
financial investments in their own name, They include:
●commercial banks,
●savings institutions,
●insurance companies,
●pension funds,
●finance companies,
●and mutual funds.
 Figure 1:Financial
brokers,
●Financial brokers, such as investment
bankers and mortgage bankers, bring together parties
who need funds with those who have savings.
●These brokers are not performing a direct lending
function but rather are acting as matchmakers, or
middlemen.
Insurance Economies
The following part will
explain insurance
economies since
insurance companies
are financial
Intermediaries
Introduction:

●The Problem of Asymmetric

Information and Perfect Information:
●Asymmetric information - a situation where
the seller or the buyer has more information
than the other regarding the quality of the item
for sale.
●Imperfect information - a situation where
either the buyer or the seller, or both, are
uncertain about the qualities of what they are
buying and selling.
The Problem of Imperfect
Information and Asymmetric Information

Imperfect information refers to the situation

where buyers and/or sellers do not have all of
the necessary information to make an
informed decision about the product's price
or quality.
The term imperfect information simply means
that the buyers and/or sellers do not have all
the information necessary to make an
informed decision.
The Problem of Imperfect
Information and Asymmetric Information

Imperfect Information….
Example: Second- hand car salesman…
. The more problems the sellers disclose, the
lower the used car’s selling price.
First, the buyer needs to understand that even
with imperfect information, prices still reflect
information.
Typically, used cars are more expensive on
some dealer lots because the dealers have a
trustworthy reputation to uphold.
In sum, cheaper prices do carry more risk, ….
Similar problems with imperfect information
arise in labor and financial capital markets….,ex,
interview with new workers…
How Imperfect Information Can Affect
Equilibrium Price and Quantity
● The presence of imperfect information can discourage both
buyers and sellers from participating in the market.

● Buyers become reluctant to participate because they cannot

determine the product's quality.

● Sellers of high-quality or medium-quality goods may be reluctant

to participate, because it is difficult to demonstrate the quality of
their goods to buyers.
• Buyers are unwilling to pay a higher price for such goods.

● A market with few buyers and few sellers is a thin market.

When Price Mixes with Imperfect
Information About Quality
● A buyer confronted with imperfect information will often believe
that the price reveals something about the product's quality.

● When buyers use the market price to draw inferences about the
products' quality, then markets may have trouble reaching an
equilibrium price and quantity.

● The idea that higher prices might cause a greater quantity

demanded, and that lower prices might cause a lower quantity
demanded, runs exactly counter to the basic model of demand
and supply.
Mechanisms to Reduce the Risk of
Imperfect Information

● We cannot eliminate imperfect information, but we can often

manage it.
● Buyers and sellers in the goods market rely on reputation as
well as guarantees, warranties, and service contracts to assure
product quality.

● The labor market uses occupational licenses and certifications to

assure competency.

● The financial capital market uses cosigners and collateral as

insurance against unforeseen detrimental events.
Reducing the Risk of
Imperfect Information, Definitions

● Money-back guarantee - a promise that the seller will refund the

buyer’s money under certain conditions, ex, by mail, tele,…

● Warranty - a promise to fix or replace the good, at least for a

certain time period.

● Service contract - the buyer pays an extra amount and the seller
agrees to fix anything that goes wrong for a set time period, ex,
cars…
Reducing the Risk of
Imperfect Information, Definitions

● Occupational license - licenses issued by government agencies,

which indicate that a worker has completed a certain type of
education or passed a certain test. (Barrier to entry…)
● Advertisers and imperfect information… Untrue facts are not
permitted…

● Cosigner - another person or firm who legally pledges to repay

some or all of the money if the original borrower does not do so.

● Collateral - something valuable, often property or equipment, that

a lender would have a right to seize and sell if the buyer does not
repay the loan.
Next Lecture:

• Insurance and Imperfect

Information