International Project Financing Flashcards
What is the typical relationship among interest rates on threemonth Treasury bills, long-term Treasury bonds, and Baa corporate bonds?
The interest rate on three-month Treasury bills fluctuates more than the other interest rates and is lower on average. The interest rate on Baa corporate bonds is higher on average than the other interest rates.
What effect might a fall in stock prices have on business
investment?
The lower price for a firm’s shares means that it can raise a smaller amount of funds, so investment in facilities and equipment will fall.
Explain the main difference between a bond and a common stock.
A bond is a debt instrument, which entitles the owner to receive periodic amounts of money (predetermined by the characteristics of the bond) until its maturity date.
A common stock represents a share of ownership in the institution that has issued the stock.
Explain the link between well-performing financial markets and
economic growth. Name one channel through which financial
markets might affect economic growth and poverty.
Well performing financial markets tend to allocate funds to its more efficient use, thereby allowing the best investment opportunities to be undertaken.
The improvement in the allocation of funds results in a more efficient economy, which stimulates economic growth (and thereby poverty reduction).
Can you think of a reason why people in general
do not lend money to one another to buy a house or
a car? How would your answer explain the existence
of banks?
In general, people do not lend large amounts of money to
one another because of several information problems. In
particular, people do not know about the capacity of
other people of repaying their debts, or the effort they
will provide to repay their debts.
Financial intermediaries, in particular commercial banks,
tend to solve these problems by acquiring information
about potential borrowers and writing and enforcing
contracts that encourage lenders to repay their debt
When interest rates decrease, how might
businesses and consumers change their economic
behavior?
Businesses would increase investment spending
because the cost of financing this spending is
now lower,
and consumers would be more likely to
purchase a house or a car because the cost of
financing their purchase is lower.
Is everybody worse off when interest rates rise?
No. It is true that people who borrow to purchase a house or a car are worse off because it costs them more to finance their purchase; however, savers benefit because they can earn higher interest rates on their savings.
Why do managers of financial institutions care so
much about the activities of the Federal Reserve
System?
Because the Federal Reserve affects interest rates, inflation, and business cycles, all of which have an important impact on the profitability of financial institutions.
If I can buy a car today for $5,000 and it is worth
$10,000 in extra income to me next year because
it enables me to get a job as a traveling salesman,
should I take out a loan from Larry the Loan Shark
at a 90% interest rate if no one else will give me a
loan?
Will I be better or worse off as a result of taking
out this loan?
Yes, I should take out the loan, because I will be
better off as a result of doing so. My interest
payment will be $4,500 (90% of $5,000), but as a
result, I will earn an additional $10,000 extra
income, so my gain (G) will be:
G = 10.000 - 4.500 = 5.500
Since Larry’s loan-sharking business can make some people better off, as in this example, loan sharking may have social benefits.
Can you make a case for legalizing loan sharking?
?
Some economists suspect that one of the reasons economies in developing countries grow so slowly is that they do not have welldeveloped financial markets. Does this argument make sense?
Yes, because the absence of financial markets means that funds cannot be channeled to people who have the most productive use for them.
• In developing countries: Entrepreneurs cannot acquire funds to set up businesses that would help the economy grow rapidly.
Give at least three examples of a situation in which financial markets allow consumers to better time their purchases.
Examples of how financial markets allow consumers to better time their purchases include
1. The purchase of a durable good, like a car or
furniture.
2. Paying for tuition.
3. Paying the cost of repairing a roof.
• In all three cases, consumers were able to pay for a good or service (education or the reparation of a roof) without having to wait to save enough and only then being able to afford such goods and services.
Describe who issues each of the following money market instruments: – Treasury bills – Certificates of deposit – Commercial paper – Repurchase agreement – Fed funds
• Treasury bills are short-term debt instruments
issued by the US government to cover
immediate spending obligations, i.e. finance
deficit spending.
• Certificates of deposit (CD) are issued by
banks and sold to depositors.
• Corporations and large banks issue
commercial paper as a method of short-term
funding in debt markets.
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