quiz N1.pdf

CH1 1. Surplus and Deficit Units Explain the meaning of surplus units and deficit units. Provide an example of each. Which types of financial institutions do you deal with? Explain whether you are acting as a surplus unit or a deficit unit in your rel...

CH1 1. Surplus and Deficit Units Explain the meaning of surplus units and deficit units. Provide an example of each. Which types of financial institutions do you deal with? Explain whether you are acting as a surplus unit or a deficit unit in your relationship with each financial institution. Surplus and Deficit Units: Surplus units are entities or individuals that have more income than expenditure and are able to save money. Examples of surplus units are individuals who have high paying jobs, corporations that have a high profit margin, or governments that have a budget surplus. Financial institutions that deal with surplus units include banks, credit unions, and insurance companies. In my relationship with these financial institutions, I would be acting as a surplus unit since I have excess funds to save and invest. Deficit units are entities or individuals that have more expenditure than income and need to borrow money. Examples of deficit units are individuals who have low paying jobs, corporations that are not profitable, or governments that have a budget deficit. Financial institutions that deal with deficit units include banks, credit card companies, and payday lenders. In my relationship with these financial institutions, I would be acting as a deficit unit if I needed to borrow money. 2. Types of Markets Distinguish between primary and secondary markets. Distinguish between money and capital markets. Types of Markets: The primary market is where new securities are issued for the first time, and the proceeds go to the issuer. Examples include initial public offerings (IPOs) and new bond issues. The secondary market is where securities that have already been issued are traded among investors. Examples include stock exchanges and over-the-counter markets. Money markets deal with short-term debt instruments, such as Treasury bills, while capital markets deal with longer-term debt and equity instruments, such as bonds and stocks. 3. Imperfect Markets Distinguish between perfect and imperfect security markets. Explain why the existence of imperfect markets creates a need for financial intermediaries.  Imperfect Markets: Perfect security markets are those in which all investors have access to all information at the same time, and the prices of securities fully reflect all available information. Imperfect markets are those in which some investors have better access to information than others, resulting in some investors making profits at the expense of others. Imperfect markets create a need for financial intermediaries because they can pool resources from many investors, thereby reducing the information advantage of any one investor. 4. Efficient Markets Explain the meaning of efficient markets. Why might we expect markets to be efficient most of the time? In recent years, several securities firms have been guilty of using inside information when purchasing securities, thereby achieving returns well above the norm (even when accounting for risk). Does this suggest that the security markets are not efficient? Explain. Efficient Markets: Efficient markets are those in which prices fully reflect all available information. We might expect markets to be efficient most of the time because there are many investors and traders competing to find and act on any available information. However, the fact that some securities firms have been guilty of using inside information suggests that the security markets are not always efficient. 5. Securities Laws What was the purpose of the Securities Act of 1933? What was the purpose of the Securities Exchange Act of 1934? Do these laws prevent investors from making poor investment decisions? Explain. Securities Laws: The Securities Act of 1933 was designed to protect investors by requiring companies to provide full and fair disclosure of all relevant information about securities offered for sale to the public. The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) to regulate securities markets and protect investors from fraud and manipulation. These laws do not prevent investors from making poor investment decisions, but they do provide investors with the information they need to make informed decisions. 6. International Barriers Discuss why many financial institutions have expanded internationally in recent years. What advantages can be obtained through an international merger of financial institutions? Financial institutions have expanded internationally in recent years to take advantage of new markets, diversify their risks, and reduce their costs. By expanding internationally, financial institutions can reduce their  dependence on a single market, which can help them to reduce their exposure to risk. Additionally, expanding internationally can allow financial institutions to take advantage of differences in interest rates and exchange rates between countries, which can help them to increase their profits. international mergers can allow financial institutions to expand their customer base, access new technologies, and reduce costs through economies of scale. 7. Stock Valuation What type of information do investors rely on when determining the proper value of stocks? When investors are determining the proper value of stocks, they rely on a variety of information, including financial statements, economic indicators, news and events, and market trends. Investors may also consider the company's management team, the competitive landscape, and any legal or regulatory factors that may impact the company's performance. Ultimately, investors aim to estimate the company's future earnings potential and to determine whether the current stock price is undervalued or overvalued. 8. Securities Firms What are the functions of securities firms? Many securities firms employ brokers and dealers. Distinguish between the functions of a broker and those of a dealer, and explain how each type of professional is compensated. Securities firms play a variety of functions, including underwriting, trading, and investment banking. Securities firms may also provide research and analysis to help investors make informed decisions about their investments. Brokers are professionals who facilitate the purchase and sale of securities on behalf of their clients. Brokers earn a commission on each transaction, which is based on the size of the transaction. Dealers, on the other hand, buy and sell securities on their own behalf, with the intention of making a profit on the spread between the buy and sell price. Dealers may also earn a commission for executing trades on behalf of their clients. 9. Mis-valued Marijuana Stocks Explain why some stocks in the marijuana industry were mis-valued when several states legalized the recreational use of marijuana. Some stocks in the marijuana industry were mis-valued when several states legalized the recreational use of marijuana because of the lack of reliable information about the market and the companies operating within it. Many of these companies were small start-ups with limited financial histories, which made it difficult for investors to accurately value their stocks. Additionally, the marijuana industry was subject to significant legal  and regulatory uncertainty, which further complicated investors' ability to assess the potential risks and rewards of investing in these companies. 10. Marketability Commercial banks use some funds to purchase securities and other funds to make loans. Why are the securities more marketable than the loans in the secondary market? Securities are more marketable than loans in the secondary market because they are more standardized and easier to trade. Securities such as stocks and bonds are typically traded on organized exchanges, where buyers and sellers can easily exchange these assets. Additionally, securities are typically more liquid than loans, which means that they can be bought and sold more quickly and easily. Loans, on the other hand, are typically more difficult to trade because they are customized for each borrower and lender, and they may have unique terms and conditions that are difficult to value. 11. Depository Institutions Explain the primary use of funds by commercial banks versus savings institutions. Commercial banks primarily use funds to make loans to individuals and businesses, while savings institutions primarily use funds to invest in mortgages and other fixed-income securities. 12. Credit Unions With regard to the profit motive, how are credit unions different from other financial institutions? Credit unions are not-for-profit financial cooperatives owned by their members, while other financial institutions aim to generate profits for shareholders. 13. Nondepository Institutions Compare the main sources and uses of funds for finance companies, insurance companies, and pension funds. Finance companies primarily obtain funds from issuing debt securities and use the funds to make loans to consumers and small businesses. Insurance companies primarily use premiums collected from policyholders to invest in a variety of securities. Pension funds receive contributions from employees and employers and invest the funds to generate returns and provide retirement benefits. 14. Mutual Funds What is the function of a mutual fund? Why are mutual funds popular among investors? How does a money market mutual fund differ from a stock or bond mutual fund? A mutual fund pools money from investors and uses it to purchase a diversified portfolio of securities. Mutual funds are popular among investors because they offer diversification, professional management, and liquidity. A money market mutual fund invests in short-term, low-risk securities, while a stock or bond mutual fund invests in stocks or bonds. 15. Secondary Market for Debt Securities. Why is it important for long-term debt securities to have an active secondary market? Advanced Questions An active secondary market for debt securities is important because it provides investors with liquidity and price transparency, which reduces risk and encourages investment in debt securities. It also enables issuers to borrow at lower rates, as investors are more willing to purchase securities knowing they can sell them if necessary. 16. Explain the general difference between depository and nondepository institutions as sources of funds. It is often said that all types of financial institutions have begun to offer services that were previously offered only by certain types. Consequently, the operations of many financial institutions are becoming more similar. Nevertheless, performance levels still differ significantly among types of financial institutions. Why? Depository Institutions are those that accept deposits from customers, while Nondepository Institutions are those that do not. Depository institutions rely on deposits to fund their activities, while nondepository institutions rely on other sources of funds. Although financial institutions are becoming more similar in the services they offer, performance levels still differ because of differences in management, risk-taking, and other factors. 17. Financial Intermediation Look in a business periodical for news about a recent financial transaction involving two financial institutions. For this transaction,  determine the following: a. How will each institution’s balance sheet be affected? b. Will either institution receive immediate income from the transaction? c. Who is the ultimate user of funds? d. Who is the ultimate source of funds? The effects of a financial transaction on the balance sheets of two financial institutions depend on the type of transaction. The institution that sells securities will experience an increase in cash and a decrease in securities, while the institution that buys securities will experience a decrease in cash and an increase in securities. Income from the transaction may be received immediately, depending on the terms of the transaction. The ultimate user and source of funds will depend on the purpose of the transaction. 18. Role of Accounting in Financial Markets Integrate the roles of accounting, regulation, and financial market participation. That is, explain how financial market participants rely on accounting and why regulatory oversight of the accounting process is necessary Accounting plays an essential role in financial markets because it provides investors with the information they need to make informed decisions about where to invest their money. Financial market participants rely on accounting information to evaluate the financial health of companies, and regulatory oversight of the accounting process is necessary to ensure that companies are providing accurate and transparent information to investors. 19. Factors That Influence Liquidity Which factors influence a security’s liquidity? Factors that influence a security's liquidity include the size of the market, the level of trading activity, the ease of buying and selling the security, the availability of information about the security, and the level of risk associated with the security. Securities that are more liquid are easier to buy and sell, and they generally command higher prices than less liquid securities. 20. Impact of Credit Crisis on Institutions Explain why mortgage defaults during the credit crisis in 2008 and 2009 adversely affected financial institutions that did not originate the mortgages. What role did these institutions play in financing the mortgages? During the credit crisis of 2008 and 2009, financial institutions that did not originate mortgages were adversely affected because they had invested in securities that were backed by the mortgages. These securities became worthless as mortgage defaults increased, and the institutions that held  them suffered significant losses. These institutions played a role in financing the mortgages because they purchased the securities that were created from the mortgages. 21. Impact of Fraudulent Financial Reporting on Market Liquidity Explain why financial markets may be less liquid if companies are not forced to provide accurate financial reports. Financial markets may be less liquid if companies are not forced to provide accurate financial reports because investors may be hesitant to invest in companies whose financial reports are not transparent or reliable. Fraudulent financial reporting can erode investor confidence and lead to market instability, which can ultimately harm the overall economy. 22. Impact of a Country’s Laws on Its Market Liquidity Describe how a country’s laws can influence the degree of its financial market liquidity. A country's laws can influence the degree of its financial market liquidity in several ways, such as by regulating the level of disclosure required for financial reporting, enforcing investor protections, and ensuring the legal enforceability of contracts. 23. Global Financial Market Regulations Assume that countries A and B are of similar size, that they have similar economies, and that the government debt levels of both countries are within reasonable limits. Assume that the regulations in country A require complete disclosure of financial reporting by issuers of debt in that country, whereas regulations in country B do not require much disclosure of financial reporting. Explain why the government of country A is able to issue debt at a lower cost than the government of country B. The government of country A is able to issue debt at a lower cost than the government of country B because complete disclosure of financial reporting by issuers of debt in country A increases transparency and reduces information asymmetry, leading to greater investor confidence and lower borrowing costs. 24. Influence of Financial Markets Some countries do not have well-established markets for debt securities or equity securities. Why do you think this can limit the development of the country, business expansion, and growth in national income in these countries? The absence of well-established markets for debt securities or equity securities can limit the development of a country, business expansion, and  growth in national income by restricting access to capital and hindering investment. 25. Impact of Systemic Risk Different types of financial institutions commonly interact. Specifically, they may provide loans to each other and take opposite positions on many different types of financial agreements, whereby one will owe the other based on a specific financial outcome. Explain why these kinds of relationships create concerns about systemic risk. Relationships between different types of financial institutions, such as providing loans to each other and taking opposite positions on financial agreements, can create concerns about systemic risk because the failure of one institution can have a cascading effect on others. 26. Uncertainty Surrounding Stock Price Assume that your publicly traded company attempts to be completely transparent about its financial condition, and provides thorough information about its debt, sales, and earnings every quarter. Explain why there still may be much uncertainty surrounding your company’s stock price. Despite a company's attempts to be transparent about its financial condition, uncertainty surrounding its stock price can arise due to market factors, such as changes in interest rates, inflation, or investor sentiment, that are beyond the company's control. 27. Financial Institutions’ Roles as Intermediaries Explain how each type of financial institution serves as a financial intermediary. Each type of financial institution serves as a financial intermediary by matching savers and borrowers, managing risk, providing liquidity, and offering financial services to clients. 28. Systemic Risk During a Financial Crisis Explain why financial institutions are highly exposed to systemic risk during a financial crisis? Financial institutions are highly exposed to systemic risk during a financial crisis because their interconnectedness can amplify the impact of a single institution's failure, leading to a domino effect on the entire financial system. Interpreting Financial News a. “The price of Apple stock will not be affected by the announcement that its earnings have increased as expected.” The earnings level was anticipated by investors, so that Apple’s stock price already reflected this anticipation b. “The lending operations at Bank of America should benefit from strong economic growth.” High economic growth encourages expansion by firms which result in a strong demand for loans provided by Bank of America c. “The brokerage and underwriting performance at Goldman Sachs should benefit from strong economic growth.” High economic growth may result in a large volume of stock transactions in which Goldman Sachs may serve as a broker. Also, Goldman underwrites new securities that are issued when firms raise funds to support expansion; firms are more willing to issue new securities to expand during periods of high economic growth. Managing in Financial Markets Utilizing Financial Markets As a financial man ager of a large firm, you plan to borrow $70 million over the next year. a) What are the most likely ways in which you can borrow $70 million? You could attempt to borrow 70M from commercial banks, savings institutions, of finance companies in the form of commercial loans. Alternatively, you may issue debt securities. b) Assuming that you decide to issue debt securities, describe the types of financial institutions that may purchase these securities. Mutual funds, pension funds, insurance companies commonly purchase debt securities that are issued by firms. Other financial institutions such as commercial banks and savings institutions may also purchase debt securities. c) How do individuals indirectly provide the financing for your firm when they maintain deposits at depository institutions, invest in mutual funds, pur chase insurance policies, or invest in pensions? Individuals provide funds to financial institutions in the form of bank deposits, investment in mutual funds, purchases of insurance policies, or investment in pensions. The financial institutionsmay channel the funds toward the purchase of debt securities (even equity securities) that were issued by large corporations, such as the one where you work.