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 refers to the process in which a borrower-spender obtains funds directly from a lender-saver without any intermediary, such as a financial institution. In this scenario, the borrower-spender is typically a company or government that needs capital for various purposes, such as expansion, research, or other operational costs. The lender-saver is usually an individual or institution that has surplus funds and is willing to lend these funds in exchange for a return, such as interest.
In this direct process, the borrower-spender can issue financial instruments like bonds or promissory notes to raise capital. The lender-saver, in return, invests in these instruments. Unlike indirect financing, where financial institutions like banks mediate between borrowers and lenders by collecting deposits and issuing loans, direct financing allows borrowers and lenders to interact more directly.
For example, a company might issue bonds directly to the public. Investors who purchase these bonds are essentially lending money to the company. There are no intermediaries involved in the transaction. The bonds are a form of direct financing, where the company (borrower-spender) gets the funds it needs, and the investors (lender-savers) expect to receive interest payments in return.
This method of financing can benefit borrowers by potentially reducing costs related to intermediaries and providing direct access to capital. However, it also involves more risk, as borrowers must be able to convince investors of their creditworthiness. Similarly, lenders take on the risk of default, as they rely on the borrower’s ability to repay the loan.
In short, direct financing is a key tool in modern financial markets, offering both borrowers and lenders a more direct way of meeting their capital and investment needs.