Homework 2 Flashcards
Given the following business plan information:
I need to borrow $5,000 for a car because it enables me to get a job as a traveling anvil seller. Larry the Loan Shark will loan me the $5,000 at an interest rate of 90%. Principle and interest are due in exactly 12 months. With the car, I will be able to earn $10,000 in extra income over the next 12 months. What is the net cash flow by taking out the loan?
The net cash flow is…?
(Interest = Principal * interest rate)
(Total loan cost = interest + principal)
(Net cash flow = Earnings - loan payment)
$500
In which of the following situations do financial markets allow consumers to better time their purchases? (Select all that apply.)
A. Purchasing a car or furniture.
B. Paying the cost of repairing a flooded basement.
C. Paying for tuition
D. Buying groceries.
A. Purchasing a car or furniture.
B. Paying the cost of repairing a flooded basement.
C. Paying for tuition
Match (by number) each financial market with its description:
Primary market
Capital market
Money market
Secondary market
Debt market
1.) A financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded.
2.) A financial market in which securities that have been previously issued can be resold.
3.) A financial market in which new issues of a security, such as a bond or a stock, are sold to initial buyers by the corporation or government agency borrowing the funds.
4.) A market in which longer-term debt (generally those with original maturity of one year or greater) and equity instruments are traded.
5.) A market where bonds or mortgages, which are contractual agreements by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date when a final payment is made, are traded.
6.) A market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their price.
3,4,1,2,5
What is the difference between a mortgage and a mortgage-backed security?
Mortgages are loans, whereas mortgage-backed securities are bond-like debt instruments.
Match (by number) each capital market instrument with its description:
Government Security
Stocks
Agency Securities
Corporate Bonds
Mortgages
1.) These long-term bonds are issued by institutions such as Ginnie Mae, the Federal Farm Credit Bank, and the TVA. Many of these securities are guaranteed by the federal government.
2.) These long-term debt instruments are issued by the U.S. Treasury to finance the deficits of the federal government.
3.) These are loans to households or firms to purchase housing, land, or other real structures, where the structure or land itself serves as collateral for the loans.
4.) These are equity claims on the net income and assets of a corporation.
5.) State and local bonds are long-term debt instruments issued by state and local governments to finance expenditures on schools, roads, and other large programs.
6.) These long-term bonds are issued by corporations with very strong credit ratings.
2,4,2,6,3
Match (by number) each international financial instrument with its description.
Foreign bonds
Eurocurrency
Eurodollars
Eurobonds
1.) A common currency used in the Euro-zone for buying and selling goods or for investments.
2.) US dollars deposited in foreign banks outside the United States or in foreign branches of US banks.
3.) Bonds sold in a foreign country and denominated in that country’s currency.
4.) A bond denominated in a currency other than that of the country in which it is soldlong dashfor example, a bond denominated in US dollars sold in London.
5.) Foreign currencies deposited in banks outside the home country.
3,5,2,4
Suppose that you buy, and one year later sell, a foreign (British) bond under the following circumstances:
When you buy the bond the exchange rate is $1.50 = 1 pound.
You pay 45 pounds ($67.50) for the British bond.
You sell the bond for 50 pounds. No interest payment was expected or received.
When you sell the bond, the exchange rate is $1.75 = 1 pound.
What is your gain or loss in dollars?
$20
How do financial intermediaries benefit by providing risk-sharing services?
They are able to earn a profit on the spread between the returns they earn on risky assets and the payments they make on the assets they have sold
Financial intermediaries have a role to play in matching savers and borrowers for all of the following reasons except:
Risk sharing
Economies of scale
Minimising transaction costs
Information symmetries
Information symmetries
How do conflicts of interest make the asymmetric information problem worse?
Competing interests may lead a financial institution to conceal information or disseminate misleading information, which prevents financial markets from channeling funds into the most productive investment opportunities.
Match (by number) each concept with its description:
Adverse selection
Asymmetric information
Moral hazard
1.) A situation where the borrower might engage in activities that are undesirable from the lender’s point of view, because they make it less likely that the loan will be paid back.
2.) Investing in a collection (portfolio) of assets whose returns do not always move together, with the result that overall risk is lower than for individual assets.
3.) Occurs when the potential borrowers who are the most likely to produce an undesirable (adverse) outcomelong dashthe bad credit riskslong dashare the ones who most actively seek out a loan and are thus most likely to be selected.
4.) A situation where one party often does not know enough about the other party to make accurate decisions.
5.) A process of borrowing funds from the lender-savers
and then using these funds to make loans to borrower-spenders.
3,4,1
Why would a life insurance company be concerned about the financial stability of major corporations or the health of the housing market?
Most life insurance companies hold large amounts of corporate bonds and mortgage assets.
Match (by number) each financial intermediary with its description:
Commercial bank
Savings and Loan
Credit Union
Mutual Fund
1.) These financial institutions are very small cooperative lending institutions organized around a particular group: union members, employees of a firm, and so forth. They acquire funds from deposits called shares and primarily make consumer loans.
2.) These intermediaries raise funds by selling commercial paper (a short-term debt instrument) and by issuing stocks and bonds. They lend these funds to consumers and to small businesses.
3.) These financial intermediaries raise funds primarily by issuing checkable deposits, savings deposits, and time deposits. They then use these funds to make commercial, consumer, and mortgage loans and to buy U.S. government securities and municipal bonds.
4.) These depository institutions obtain funds primarily through savings deposits (often called shares) and time and checkable deposits. In the past, these institutions were constrained in their activities and mostly made mortgage loans for residential housing.
5.) These financial intermediaries acquire funds by selling shares to many individuals and use the proceeds to purchase diversified portfolios of stocks and bonds.
3,4,1,5
Match (by number) each regulatory agency with its description:
Federal Reserve
FDIC
Office of Thrift Supervision
Comptroller of the Currency
SEC
1.) Examines the books of savings and loan associations and imposes restrictions on assets they can hold.
2.) Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold.
3.) Examines the books of commercial banks that are members of the Federal Reserve System and sets reserve requirements for all banks.
4.) Provides insurance of at $250,000 for each depositor at a bank, examines the books of insured banks, and imposes restrictions on assets they can hold.
5.) Requires disclosure of information of financial instruments traded in organized exchanges.
6.) Regulates procedures for trading in futures markets.
3,4,1,2,5
In 2008, as a financial crisis began to unfold in the United States, the FDIC raised the limit on insured losses to bank depositors from $100,000 per account to $250,000 per account. How would this help stabilize the financial system?
It would reassure depositors that their money was safe in banks and prevent a possible bank panic.
