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Multiple Choice
Which of the following is a reason why savers work through financial institutions to lend money to investors?
A
Financial institutions guarantee higher returns than direct lending.
B
Financial institutions eliminate all transaction costs for savers.
C
Financial institutions require no regulatory oversight.
D
Financial institutions help reduce the risk of lending by diversifying investments.
Verified step by step guidance
1
Understand the role of financial institutions: Financial institutions act as intermediaries between savers and investors, helping to allocate funds efficiently and reduce risks.
Recognize the concept of risk diversification: Financial institutions pool funds from multiple savers and invest in a variety of assets, which reduces the impact of any single investment's poor performance.
Eliminate incorrect options: Review each option provided in the problem and identify why it is not correct. For example, financial institutions do not guarantee higher returns, eliminate all transaction costs, or operate without regulatory oversight.
Focus on the correct reasoning: Financial institutions help reduce the risk of lending by diversifying investments, which is a key benefit for savers who might otherwise face higher risks in direct lending.
Conclude with the importance of diversification: Diversification is a fundamental principle in financial management, as it spreads risk across multiple investments, making financial institutions a safer option for savers.