Well, in the first introductory episode, we claimed that if the market would be perfect, then there would be no problem and this course would be sort of irrelevant. However, the reality is different. And in this small episode, l will draw a simple, maybe even a funny picture that will really show us, Do these problems come from and how they can be treated and coped with. Well, let's start with the following. The picture is such, well, capital market can be represented as, first of all huge crowd of ultimate savers that are sometimes nicely labelled investors. So these are the people. We have some cash saved, you, me and the majority of people in this world. Now, we are all fine. But we cannot produce more money from these small bags. There is another part. These are businesses. So these are old way businesses. These are sort of modern businesses. That have a magic feature if they have some money swallowed. Then they do something inside of them. They produce more money, more cash from that. So obviously, these black houses or black computers they have the money of their own. But if they can take other people's money, so the money from these small or sometimes large through bags, then they can produce even more. So you can see that there is a huge demand and natural demand for other people's money. And we can start with thinking about some contracts between these people so that, let's say I lend money to the business and we draw a contract on which the business says well I'll pay you back that much and of course with a certain schedule and so on and so forth. Now, in the perfect capital market world, that scheme is nice and working and no problem occurs. However, the existence of private information and unobservability mainly, these guys do not observe what these guys do with their money, what projects they choose. And we are not here talking about fraud or theft, or any other criminal activity. We talk about normal business situations in which people make their choice based on their own benefit. It can be shown, and we will do it in quite some detail, that in this world in the existence of private information, We can see the emergence of a diverse incentives that often times force these people to behave in a way that is exposed harmful to these people. And these problems are plentiful. Corporate finance week six, episode one is called moral hazard and the other is called adverse selection and we'll study them in some greater detail this weekend later. But for now, the important thing is that, what can be done in general? Well, the result is that the demand for the services of financial intermediaries is born. So now we can see another player. This is a red skyscraper that serves an intermediary and works like this. And although sometimes in general you can say that intermediaries cost money and it is not quite clear that the existence of these guys, is better than their absence. But we will show quite clearly that they actually do alleviate the most egregious problems caused by private information and they play a fundamentally positive role. Now, this set up that is put here in such a funny way has been recognized ever since capital markets were born, or people recognized their existence and that counts hundreds of years. You can think about the first banks in Florence or Geneva or Venice maybe as early as 700 years plus ago. But in the existence of some problems of that would occur without them has also been recognized for quite a long time, but it was not until the 1970s that the study of this market took a certain, let's say systemic way. It can be traced back to the original works of George Akerlof, and then later Joseph Stiglitz. Both of them later won Nobel Prizes in economics, and many other authors who actually produced first general and then more advanced models of private information that allowed them to arrive at certain very important conclusions that were used as a basis for a system of measures to alleviate these problems. Now, starting from the next episode, we will build a general model of private information that will allow us to study all these problems in some greater detail and using some very simple arithmetic.
