Direct financing occurs when:
A a borrower-spender borrows directly from a lender-savers.
B a lender-saver borrows from the federal government.
C a lender-saver borrows directly from a borrower-spenders.
D a borrower-spender borrows from the federal government.
The correct answer and explanation is:
The correct answer is A) a borrower-spender borrows directly from a lender-saver.
Explanation:
Direct financing occurs when a borrower (usually a spender, such as an individual or business) borrows funds directly from a lender (often a saver, such as an individual or institutional investor). In this arrangement, the intermediary (like a bank or financial institution) is not involved in the transaction. Instead, the lender-saver provides funds directly to the borrower-spender, which can be in the form of loans, bonds, or other financial instruments.
In this model, the lender-saver earns interest or returns on the money they lend, while the borrower-spender gets the necessary funds for consumption, investment, or other needs. This arrangement allows the lender to avoid the fees or risks associated with intermediaries. It is common in capital markets where companies or governments issue bonds directly to investors, or individuals take personal loans or mortgages from other private lenders, bypassing traditional banks.
This system contrasts with indirect financing, where financial institutions act as intermediaries between lenders and borrowers. In that case, banks collect deposits from savers and then lend out those funds to borrowers, taking on the role of a middleman.
In direct financing, both the borrower and lender negotiate terms directly, such as the interest rate, repayment schedule, and any collateral if applicable. The simplicity of this process makes it attractive for some borrowers and lenders, although it can involve higher risks for both parties since there is no institution to help mitigate those risks.