Tutorial 2

Question 1

Principal advantage
The principal advantage of the corporate form of business is that the
corporation has limited liability.

The owner of a small family restaurant might be required to personally
guarantee corporate borrowings or purchases. So this advantage might be
eliminated unlimited liability by owner of a small family restaurant, if they set
up a corporation.

The wealthy individual has more at stake and unlimited liability might cause,
one failing business to bring down the other healthy business.

Question 2

Financial market allows of efficient allocation in the flow of savings in an
economy to ultimate users.

Savings from surplus economic units whose savings exceed their
investment in real assets.

The ultimate users are deficit economic units whose investment in real
assets exceeds their savings.

Efficiency is introduced into the process through the use of financial markets.
Since the savings surplus and deficit units are usually different entities,
market serve to channel these funds at the least cost and convenience to both.

As specialization develops, efficiency increases. Loan brokers, secondary
markets and investment bankers all some to expedite this flow from savers to
users.

Question 3

Financial intermediaries provide an indirect channel for the flow of funds
from savers to ultimate users.

These institutions include commercial banks, savings and loan
associations, life insurance companies, pension and profit, sharing funds
and sharing funds and savings banks.






Financial intermediaries perform a vital economic service:

Repackaging finance
Collecting small amounts of finance and repackaging into larger bundles
for specific lending requirement. E.g. bank.

Risk Deduction
Investing sums, on behalf of individual and companies, into larger, well-
diversified investment portfolios. E.g. Pension funds and unit trusts.

Maturity Transformation
Many people and firms want to borrow money for long periods of time
and many depositors want to be able to withdraw their deposits on
demand or at short notice. Financial intermediaries lend for longer
periods of time than they borrow is known as maturity transformation.

Cost reduction and advice
Minimizing transaction costs and provides low costs services to lenders
and borrowers.

Question 4

The prices of goods and service must cover their costs. Costs include labor,
materials and capital.

Capital costs to a borrower include a return to the saver who supplied the
capital plus a markup (called a spread) for the financial intermediary that
brings the savers and the borrower together.

The more efficient the financial system, the lower the costs of intermediation,
the lower the costs to the borrower and the lower the prices of goods and
services to consumers.

Question 5

Stock markets are at the heart of the global financial system.

These exchanges serve as secondary market where in the buyer and seller
meet to exchange shares of companies that are listed on the exchange. These
markets have provided economics of time and scale in the past and have
facilitated exchange among interested parties.








Question 6

A major function of an active market is to provide a mechanism whereby
investors can realize their holdings by selling securities and obviously, for
every seller, there has to the capital market by subscribing to new share
issues is they doubt their ability to find willing buyers as and when they
decided to sell their holdings.

The more liquid the market, the greater its ability to entice firms to make new
share issues and investors to subscribe to item.

Where market liquidity is poor, companies will have to offer much higher
returns making share issue uneconomic.

Question 7

In a well functioning economy, capital will flow efficiently from those who supply
capital to those who demand it. This transfer of capital can take place in three
different ways:

Direct transfers of money and securities occur when a business sells its stock
on bonds directly to savers, without going through any type of financial
institution. The business delivers its securities to savers who in turn give the
firm the money it needs.

Transfer may also go through an investment-banking house, which
underwrites the issue. An underwriter serves as a middleman and facilitates
the issuance of securities. The company sells its stock and bonds to the
investment bank, which in turn sells these same securities to savers. The
businesses securities and the savers money merely pass through the
investment-banking house.

Transfers can also be made through a financial intermediary. Here the
intermediary obtains funds from savers in exchange for its own securities.
The intermediary uses this money to buy and hold businesses securities.
Intermediaries greatly increase the efficiency of money and capital markets.

Question 8

Businesses would be difficult for firms to raise capital.

Capital investment would slow down.
Unemployment would rise.
The output of goods and services would fall.
In general, our standard of living would decline.