Ch 2 Questions Flashcards
A share of Microsoft common stock is:
an asset for its owner, which Microsoft shows as shareholder equity on its balance sheet.
The share of Microsoft stock is an asset for its owner because it entitles the owner to a share of the earnings and assets of Microsoft. It is counted as shareholder equity on Microsoft’s balance sheet because it is a claim on its earnings and assets by the owner of the share.
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Financial markets perform the basic function of:
matching savers with funds to lend to people who want to borrow funds
Financial markets improve economic welfare because:
they channel funds from savers to investors
&
they allow consumers to time their purchases better
Financial markets allow funds to move from people who lack productive investment opportunities to people who have such opportunities. These markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy. Well-functioning financial markets also directly improve the well-being of consumers by allowing them to time their purchases better. They provide funds to young people to buy what they need and can eventually afford without forcing them to wait until they have saved up the entire purchase price. Financial markets that are operating efficiently improve the economic welfare of everyone in the society.
Which of the following is not a function or service provided by secondary markets
Matching lenders (savers) with borrowers in need of funds
Secondary markets serve two important functions. First, they make it easier and quicker to sell financial instruments to raise cash; that is, they make the financial instruments more liquid. The increased liquidity of these instruments then makes them more desirable and thus easier for the issuing firm to sell in the primary market. Second, they determine the price of the security that the issuing firm sells in the primary market. The investors who buy securities in the primary market will pay the issuing corporation no more than the price they think the secondary market will set for this security. Willingness to pay a particular price will depend on attitudes about the firm’s profitability, solvency, and economic environment in which the firm operates.
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Complete the following table related to the structure of financial markets
Savers: direct finance by buying securities and indirect by making deposits.
Borrowers: direct finance by selling securities and indirect finance by taking out loans.
Financial markets facilitate the purchase of securities (stocks and bonds) by lender-savers and the sale of these same instruments by borrower-spenders. Financial intermediaries accept deposits from lender-savers and make loans to borrower-spenders.
Which of the following is true regarding primary and secondary markets?
Secondary markets sell old issues of securities
The primary markets for securities are not well known to the public because the selling of securities to initial buyers often takes place behind closed doors. On the other hand, the secondary markets, such as the New York Stock Exchange and NASDAQ, are well-known.
Other things being the same, the financial instrument that is the most risky to own is the :
Equity:
Equity holders are residual claimants, so in the event of a bankruptcy, they receive funds only after all of the debt holders have been paid. Short-term debt securities have smaller fluctuations in prices than long-term securities do. Therefore, short-term bonds have the least risk.
Which of the following is NOT true regarding primary and secondary markets?
Primary and secondary markets both sell assets directly form the institution that offers the bonds.
Other things being the same, the financial instrument that is least risky to own is the:
short term (least risky)
Choose the correct description for the following money market instrument.
A short-term debt instrument issued by the United States Gov to cover immediate spending obligations.
One reason for the extraordinary growth of foreign financial markets
the deregulation of foreign financial markets
financial Intermediaries have a role to play in matching savers and borrowers for all of the following reasons except:
Information Symmetries:
On the contrary, the problem in financial markets is not symmetric information, it is asymmetric information. In financial markets, one party often does not know enough about the other party to make accurate decisions. This inequality is called asymmetric information. For example, a borrower who takes out a loan usually has better information about the potential returns and risk associated with the investment projects for which the funds are earmarked than the lender does.
The large size of financial intermediaries allows them to take advantage of economies of scale, the reduction in transaction costs per euro of transactions as the size (scale) of transactions increases.
Which of the following is an example of indirect finance?
You pay life insurance premiums to Franklin Life, and Franklin Life issues a mortgage loan to a homebuyer.
A financial intermediary conducts indirect financing by borrowing funds from the lender-savers and then using these funds to make loans to borrower-spenders.
Individuals may find it efficient to save their funds in a financial intermediary because
they help reduce the exposure of investors to risk.
Financial intermediaries can substantially reduce transaction costs because they have developed expertise in lowering them and because their large size allows them to take advantage of economies of scale. They also help reduce exposure of investors to risk.
When lenders have inferior knowledge relative to borrowers about the potential returns and risks associated with an investment project, it gives rise to the problem known as
Asymmetric information
Lack of information creates problems in the financial system on two fronts: before the transaction is entered into (Adverse Selection) and after (Moral Hazard).
