1.

The presence of adverse selection problem keeps bond and stock markets from
effectively channelling funds from savers to borrowers. What does statement
mean? Explain briefly.

This statement means that:

- In stock markets, adverse selection happens when high and low quality stock are
difficult to distinguish. This will discourage lenders to enter the markets because they
do not know whether a stock has high profit potential or high risk.

- In bond markets, adverse selection happens when default risk is significant. A firm
may know that its true default risk is higher or lower than the public thinks and then
makes decision whether to issue bonds or securities to maximize its benefits.

2. Why do large corporations find it easier to raise funds in securities markets

while small businesses rely mostly on bank loans?

It is one of eight basic facts that only large, well-established corporations have access
to direct finance, which means large corporations often raise funds by issuing
securities while small businesses often take out bank loans. This is because lenders
lack the information needed to verify the quality of small newly-established
businesses. In contrast, large well-established firms make lenders more confident
about their quality.

3. Would each of the following events increase or decrease the volume of bank
loans? Explain.

a. New regulations make it easier for shareholders to replace company directors.

b. A new law makes it a crime to default on a bank loan.

c. All the economys small firms are bought by large firms.

d. Mutual funds reduce their minimum balances for shareholders.

Xem link: https://www.coursehero.com/file/10294423/BallSMchap07/

4. Suppose you have $1000 to lend and offer it for 10-percent interest. Someone
promises to pay 20 percent if you lend to him. Should you jump at this offer?
Xem link: https://www.coursehero.com/file/p3e4ae9v/Also-the-fact-that-the-worker-
volunteered-to-take-a-lower-salary-may-indicate/

5. Suppose I am a good borrower. I need $10,000 to invest in a project that will

pay a safe 6% rate of return next year. Suppose my neighbour is a bad borrower,
his $10,000 project has very low chance of success but the expected rate of return
is 20%. The local bank charges 10% interest rate on all its loans.

a. Will I be willing to borrow at this rate? Will my neighbour be willing to borrow at

this rate?

I may be unwilling to borrow at this rate because the interest rate is much higher than
my investments rate of return. Meanwhile, my neighbour may be willing to borrow at
this rate because the interest rate is much lower than his projects rate of return. Hay
may gain a lot of profit if his project is successful.

b. Assume all potential borrowers are either like me or like my neighbour. Explain
why the bank will end up issuing no loans and no projects will be funded.

If all potential borrowers are like me, they may be unwilling to take out loans from the
bank because of high interest rate. If all potential borrowers are like my neighbour, the
bank may be unwilling to make loans to them because of their highly risky projects.
As a result, the bank will end up issuing no loans and no projects will be funded.

c. How could the bank reduce with this adverse selection problem?

The bank could reduce this adverse selection problem by require the borrowers to put
up collaterals for the loans. If the borrowers default, the bank will get the collaterals.

6. What kind of moral hazard problems do banks worry about?

The borrowers may not use the loans they receive efficiently. They may invest in
dangerous projects and may be unable to repay the loans to banks. Some measures to
prevent moral hazard are monitoring the borrowers activities and restricting risky
behaviour, requiring collateral, periodic auditing of the borrowers, etc.
7. Suppose an all you can eat buffet costs $10. The buffet discovers that most of
its customers are sumo fighters. Is this a problem of adverse selection or moral
hazard for the restaurant? Explain.

This is a problem of both adverse selection and moral hazard for the restaurant.
Adverse selection happens because the restaurant did not know in advance that most
of its customers would be sumo fighters while they charged only $10 for average
customer. Moral hazard happens because the restaurant cannot know whether the
sumo fighter will eat buffet within the cost of $10 or more. In other words, the
restaurant cannot know they will gain profit or get loss.

8. Why might you be willing to make a loan to your neighbour by putting funds
in a savings account earning a 5% interest rate at the bank and having the bank
lend her the funds at a 10% interest rate rather than lend her the funds yourself?

We will avoid the asymmetric information. Bank is one of the financial institutions
that prevent the lender from risk of borrowers default. In other words, we will not
lose our money when lending our neighbour funds through the banks system. The
bank will help us to monitor the loans and get the collateral from the borrower when
she is not able to pay her debt. We also save an amount of money in legal fees, fees
for a credit check, and so on and always receive the payment at the interval terms.

Non-bank institutions

9. Why do property and casualty insurance companies have large holdings of

municipal bonds but life insurance companies do not?

Because the assets of the property and casualty insurance companies are essentially
reserves against sudden claims, they have to be liquid. Thus, these companies get
more municipal bonds which are have high liquidity.

10. Life insurance companies tend to invest in long-term assets such as loans to
manufacturing firms to build factories or to real estate developers to build
shopping malls and skyscrapers. Automobile insurers tend to invest in short-
term assets such as Treasury bills. What accounts for these differences?

Life insurance companies hold assets of longer maturity than property and casualty
insurance companies. Life insurance companies can calculate liabilities with a fair
degree of accuracy using mortality tables. As a result, they use funds to buy longer
term securities. Automobile insurers generally need to have funds readily available
when a policyholder makes a claim, and Treasury bills are highly liquid.
11. List three types of financial intermediaries, give examples.

These are:

Depository institutions, Ex: commercial banks, saving and loans associations, credit
unions and mutual saving banks

Contractual savings institutions, Ex: life insurance companies, fire and casualty
insurance companies, pension funds

Investment intermediaries, Ex: finance companies, mutual funds

12. What explains the widespread use of deductibles in insurance policies?

The deductible is the amount of expenses that must be paid out buy the policy buyer
before an insurer will pay any expenses. Deductibles are used to discourage the large
number of claims that a policy buyer can be reasonably expected to bear the cost of
the insurance policy it buys. As a result, insurance policy is cheaper when deductibles
are higher.

13. Why might insurance companies restrict the amount of insurance a

policyholder can buy?

The Insurance Companies might restrict the amount of insurance a policyholder can
buy to restrict the amount of risk that insurance company can bear.

14. Explain why shares in closed-end mutual funds typically sell for less than the
market value of the stocks they hold.

A closed-end fund's share price is based on supply and demand among investors.
Market conditions can influence the price of a CEF being above (at a premium to) or
below (at a discount to) it's NAV. Some of the factors that may impact whether a fund
trades at a premium/discount are the fund's performance, yield, or name recognition of
a fund's manager. Discounted closed-end funds offer investors the advantage of
buying the fund's underlying assets at a discount, which can lead to enhanced returns.

15. Will finance companies be replaced by commercial banks?

No. Because their operating processes are different with each other. Finance companies borrow
in large amounts but often lend in small amount, while commercial banks collect deposits in
small amount and then often make large loans. Finance companies have narrow focus, so they
somehow have advantages over banks in which they better control and monitor their customers
creditworthiness and manage risk in case of default.

16. Closed end funds tend to hold stocks that are less liquid than stocks held by open
end funds. Comment on this.

The investment in illiquid stock may be an advantage for closed end funds because it allows the
closed end funds to purchase stocks that are not allowed by most investors. These stocks are
more likely to mispriced than other stock.

It is easier for closed end fund to manage a portfolio of less liquid stocks than it would be for
open end funds because closed end fund do not have to accommodate redemptions, where as
open end funds do. Thus, closed end funds dont have to worry about selling some of their stock
holdings just for the purpose of satisfying redemptions.

17. Is investment banking a good career for someone who is afraid of taking risks? Why
or why not?

Cau nay tui phan van qua, khong biet Yes hay No nua.

Yes. Because an employee in investment bank will have to collect data or information of issuers
and markets, they have to be very careful and merticulous. They also have to provide advice to
firms through the process of research and estimation of the value of the new company a risk-
adverse will be good at this.

No, because sometimes the price at which the investment bank sells the bond or stocks in
financial markets can turn out to be lower than the price guaranteed by the issuing company
there is some risks to underwriting.

18. Should financial institutions be regulated in order to reduce their risk? Offer at least
one argument for regulation and one argument against regulation.

Regulation may be able to reduce failures of financial institutions, which may stabilize the
financial system. The flows of funds into financial institutions will be larger if the people who
provide the funds can trust that the financial institutions may not fail. However, regulation may
restrict competition. In some cases, it results in subsidies to financial institutions that are
performing poorly. Thus, regulation can prevent firms from operating efficiently.

19. When a securities firm serves as an underwriter for an IPO, is the firm working for
the issuer or the institutional investors that may purchase shares? Explain the
dilemma.

This securities firm is working for the issuer (the private company) to ensure that all
regulatory requirements are satisfied. Next, the underwriter contacts a large network of
investment organizations, such as mutual funds and insurance companies, to gauge
investment interest. The amount of interest received by these large institutional investors
helps the underwriter set the IPO price of the company's stock. The underwriter also
guarantees a specific number of shares will be sold at that initial price and will purchase
any surplus.
These securities firms plays the intermediary role between the issuer and the investor
(hieu vay dung khong may che???)

Moi tim duoc key moi chinh xac:

A securities firm attempts to satisfy the issuer of the stock by ensuring that the price is
sufficiently high, but it must also ensure that it can place all the shares. It also wants to
satisfy investors who invest in IPO. If the investors incur losses because they paid too
much for the shares, they may not want to purchase any more stock from that underwriter
in the future.

20. You are thinking up starting your own business, but have no money.
Think of a business that you could start without having to borrow any money.
Now think of a business that you would want to start if you could borrow any amount of
money at the going market interest rate.
What are the risk that you will face in this business?
Where can you get financing for your new business?

Cu ny chc ko cho u ha ??!

21. Splitland is a developing economy with two distinct regions. The northern region has
great investment opportunities, but the people who live there need to consume all of their
income to survive. Those living in the south are better off than their northern counterparts
and save a significant portion of their income. The southern region, however, has few
profitable investment opportunities and so most of the savings remain in shoeboxes and
 under mattresses. Explain how the development of the financial sector could benefit both
regions and promote economic growth in Splitland.

When development of the financial sector happens. The southern region people can use their
savings to invest in the northern region and they can make profits. In the meantime, the northern
region can develop its economy by receiving investment.

22. Discuss the following: Money market funds attract money from investors who do not
know what else to do with their money. Thus money market funds are merely a last resort
when there are no better alternatives for investment. Since they invest only in short term
securities, they do not play a role in financing economic growth.

Money market provides liquidity to investors, which is necessary to investors even when
investors have alternative investments that pay higher return. In addtition, money market
plays a major role in fianancing budget deficit because they invest heavily in treasury
securities. They also channel funds to corporation in the form of commercial paper. Since the
treasury and corporation frequently reissue short-term securities , they are sometimes using
the short-term securities to finance long-term investments.