Transaction cost: A fee charged by a financial intermediary such as a bank, broker, or underwriter. Example: communication charges, legal fees, informational cost of finding the price, quality and durability, etc. In sum, transaction costs freeze many small savers and borrowers out of direct involvement with financial markets. Financial intermediaries make profits by reducing transactions costs1) Take advantage of economies of scale (example: mutual funds).2) Develop expertise to lower transaction costs. Information Asymmetries and Information Costs: Asymmetric information is a serious hindrance to the operation of financial markets. It poses two important obstacles to the smooth flow of funds from savers to investors 1) adverse selection arises before the transaction occurs.* Lenders need to know how to distinguish good credit risks from bad.2) Moral hazard occurs after the transaction.* Will borrowers use the money as they claim?. Collateral and Net Worth: 1) Another solution for adverse selection is to make sure lenders are compensated even if borrowers default.*If a loan is insured in some way, then the borrower isnt a bad credit risk.2) Collateral is something of value pledged by a borrower to the lender in the event of the borrowers default.*It is said to back or secure a loan. Ex: Cars, houses.3) Collateral is very prevalent because adverse selection is less of a concern - the lender gets something of equal or greater value if the borrower defaults.4) Unsecured loans, like credit cards, are loans made without collateral.*Because of this they generally have very high interest rates. The net worth is the owners stake in a firm - the value of the firms assets minus the value of its liabilities.* Net worth serves the same purpose as collateral.* If a firm defaults on a loan, the lender can make a claim against the firms net worth.* The importance of net worth in reducing adverse selection is the reason owners of new businesses have so much difficulty borrowing money.* Most small business owners must put up their homes and other property as collateral for their business loans.Twelve Federal Reserve banks: A Federal Reserve Bank is a regional bank of the Federal Reserve System, the central banking system of the United States. The banks are jointly responsible for implementing the monetary policy set forth by the Federal Open Market Committee, and are divided as follows: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, San Francisco. Federal open market committee: The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve controls the three tools of monetary policy--open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. Reserve requirements: The reserve requirement is a central bank regulation employed by most, but not all, of the world's central banks, that sets the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves. These required reserves are normally in the form of cash stored physically in a bank vault or deposits made with a central bank. Twelve Federal Reserve Banks:1) Each of the twelve districts has a main Federal Reserve Bank and at least one branch office.2) The banks are quasi-public.** Owned by member commercial banks in the district.** Member banks elect six directors, while three directors are appointed by the Board of Governors.** Directors represent professional bankers, prominent business leaders, and public interests. Federal Reserve Bank Functions: General: 1) Clear checks.2) Issue new currency and remove damaged currency.3) Evaluate bank mergers and expansions.4) Lender to member banks.5) Liaison between local community and the Federal Reserve System.6) Perform bank examinations.7) Collect and examine data on local business conditions. Federal Reserve Bank Functions: Monetary Policy: 1) Establish the discount rate at which member banks may borrow from the Federal Reserve Bank.2) Determine which bank receive loans. 3) Elect one member to the Federal Advisory Council. 4) Five of the 12 bank presidents vote in the Federal Open Market Committee.