1、Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1-1 ANSWERS TO QUESTIONS FOR CHAPTER 1 (Questions are in bold print followed by answers.) 1. What is the difference between a financial asset and a tangible asset? A tangible asset is one whose value depends upon certain physical pr
2、operties, e.g. land, capital equipment and machines. A financial asset, which is an intangible asset, represents a legal claim to some future benefits or cash flows. The value of a financial asset is not related to the physical form in which the claim is recorded. 2. What is the difference between t
3、he claim of a debtholder of General Motors and an equityholder of General Motors? The claim of the debt holder is established by contract, which specifies the amount and timing of periodic payments in the form of interest as well as term to maturity of the principal. The debt holder stands as a cred
4、itor and in case of default, he has a prior claim on firm assets over the equity-holder. The equity holder has a residual claim to assets and income. He can receive funds only after other claimants are satisfied. Income is in terms of dividends, the amount and timing of which are not certain. 3. Wha
5、t is the basic principle in determining the price of a financial asset? The price of any financial asset is the present value of the expected cash flows or a stream of payments over time. Thus, the basic variables in determining the price are: expected cash flows, discount rate and the timing of the
6、se cash flows. 4. Why is it difficult to determine the cash flow of a financial asset? The estimation and determination of cash flows is difficult because of several reasons. These include accounting measures, possibility of default of the issuer, and embedded options in the security. Interest payme
7、nts can also change over time. There is uncertainty as to the amount and the timing of these payments. 5. Why are the characteristics of an issuer important in determining the price of a financial asset? The characteristics of the issuer are important because these determine the riskiness or uncerta
8、inty of the expected cash flows. These characteristics, which determine the issuers creditworthiness or default risk, have an impact on the required rate of return for that particular financial asset. Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1-2 6. What are the two princip
9、al roles of financial assets? The first role of financial assets is to transfer funds from surplus spending units (i.e. persons or institutions with funds to invest) to deficit spending units (i.e. persons or firms needing funds to invest in tangible assets). The second role is to redistribute risk
10、among persons or institutions seeking and providing funds. Funds providers share the risks of expected cash flows generated by tangible assets. 7. In September 1990, a study by the U.S. Congress, Office of Technology Assessment, entitled “Electronic Bulls 2. “they help to allocate capital toward pro
11、ductive uses” - function 3; 3. “they provide an opportunity for people to increase their savings by investing in them” - functions 1 and 5; 4. “they reveal investors judgments about the potential earning capacity of corporations, thus giving guidance to corporate managers” -function 3; 5. “they gene
12、rate employment and income” - follows from functions 1 and 2 allowing Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1-3 those who need funds to use these funds to create employment and income opportunities. 8. Explain the difference between each of the following: a. money marke
13、t and capital market b. primary market and secondary market c. domestic market and foreign market d. national market and Euromarket a. The money market is a financial market of short-term instruments having a maturity of one year or less. The capital markets contain debt and equity instruments with
14、more than one year to maturity; b. The primary market deals with newly issued financial claims, whereas the secondary market deals with the trading of season issues (ones previously issued in the primary market); c. The domestic market is the national market wherein domestic firms issue securities a
15、nd where such issued securities are traded. Foreign markets are where securities of firms not domiciled in the country are issued and traded; d. In a national market securities are traded in only one country and are subject to the rules of that country. In the Euromarket, securities are issued outsi
16、de of the jurisdiction of any single country. For example, Eurodollars are dollar-denominated financial instruments issued outside the United States. 9. Indicate whether each of the following instruments trades in the money market or the capital market: a. General Motors Acceptance Corporation issue
17、s a financial instrument with four months to maturity. b. The U.S. Treasury issues a security with 10 years to maturity. c. Microsoft Corporation issues common stock. d. The State of Alaska issues a financial instrument with eight months to maturity. a. GMAC issue trades in the money market. b. U.S.
18、 security trades in the capital market. c. Microsoft stock trades in the capital market. d. State of Alaska security trades in the money market. 10. A U.S. investor who purchases the bonds issued by the government of France made the following comment: “Assuming that the French government does not de
19、fault, I know what the cash flow of the bond will be.” Explain why you agree or disagree with this statement. Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1-4 One would tend to disagree with this statement. Even though there is no default risk with French bonds issued by the g
20、overnment, some other risks include price risk and foreign exchange risk. 11. A U.S. investor who purchases the bonds issued by the U.S. government made the following statement: “By buying this debt instrument I am not exposed to default risk or purchasing power risk.” Explain why you agree or disag
21、ree with this statement. This is not true. There is no default (credit) risk of U.S. government securities. However, it is not free of purchasing power or inflation risk. There is also price risk, which is related to maturity of any bond. 12. In January 1992, Atlantic Richfield Corporation, a U.S.-b
22、ased corporation, issued $250 million of bonds in the United States. From the perspective of the U.S. financial market, indicate whether this issue is classified as being issued in the domestic market, the foreign market, or the offshore market. The corporate bonds issued by Atlantic Corporation are
23、 in the domestic market, but the investors can also be from foreign markets. 13. In January 1992, the Korea Development Bank issued $500 million of bonds in the United States. From the perspective of the U.S. financial market, indicate whether this issue is classified as being issued in the domestic
24、 market, the foreign market, or the offshore market. This issue can be classified as a domestic issue. 14. 14. Give three reasons for the trend toward greater integration of financial markets throughout the world. There are several reasons. These include: a. Deregulation and/or liberalization of fin
25、ancial markets to permit greater participants from other countries; b. Technological innovations to provide globally-available information and to speed transactions; c. Institutionalization - financial institutions are better able to diversify portfolio and exploit mis-pricings than are individuals.
26、 15. What is meant by the “institutionalization” of capital markets? The term “institutionalization” refers to the dominance of large institutional investors such as pension funds, investment companies, banks, insurance companies, etc. in the money and capital markets. Copyright 2010 Pearson Educati
27、on, Inc. Publishing as Prentice Hall. 1-5 Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall. 1-6 16.a. What are the two basic types of derivative instruments? b. “Derivative markets are nothing more than legalized gambling casinos and serve no economic function.” Comment on this sta
28、tement. a. The two basic types of derivative instruments are futures and options contracts. They are called derivatives because their values are derived from the values of their underlying stocks or bonds. b. The statement implies that derivative instruments can be used only for speculative purposes
29、. Actually, derivatives serve an important economic function by permitting hedging, which involves shifting risks on those individuals and institutions (speculators) that are willing to bear them. 17. What is the economic rationale for the widespread use of disclosure regulation? The economic ration
30、ale is that disclosure mitigates the potential for fraud by the issuer. Typically, there information asymmetry between the issuer (management) and the investors, and disclosure regulation mitigates the harm to investors that could result from this informational disadvantage. As a result, there is co
31、nfidence in the market and the pricing mechanism of the market. 18. What is meant by market failure? Market failure occurs when the market cannot produce its goods or services efficiently. In the context of financial market failure, it occurs when the pricing mechanism fails and thus the supply and
32、demand equilibrium is disrupted. This results in failure to price securities efficiently and reduced liquidity. 19. What is the major long-term regulatory reform that the U.S. Department of the Treasury has proposed? The long-term proposal is to replace the prevailing complex array of regulators wit
33、h a regulatory system based on functions. Specifically, there would be three regulators: (1) market stability regulator, (2) prudential regulator, (3) business conduct regulator. 20. Why does increased volatility in financial markets with respect to the price of financial assets, interest rates, and
34、 exchange rates foster financial innovation? Increased volatility of the prices of financial assets has fostered innovation as investors and institutions seek ways to mitigate financial risk. Among other things, these innovations include the advancement of the modern derivatives markets. Copyright 2
35、010 Pearson Education, Inc. Publishing as Prentice Hall. 1-7 ANSWERS TO QUESTIONS FOR CHAPTER 2 (Questions are in bold print followed by answers.) 1. Why is the holding of a claim on a financial intermediary by an investor considered an indirect investment in another entity? An individuals account a
36、t a financial intermediary is a direct claim on that intermediary. In turn, the intermediary pools individual accounts and lends to a firm. As a result, the intermediary has a direct contractual claim on that firm for the expected cash flows. Since the individuals funds have in essence been passed t
37、hrough the intermediary to the firm, the individual has an indirect claim on the firm. Two separate contracts exist. Should the individual lend to the firm without the help of an intermediary, he then has a direct claim. 2. The Insightful Management Company sells financial advice to investors. This
38、is the only service provided by the company. Is this company a financial intermediary? Explain your answer. Strictly speaking, the Insightful Management Company is not a financial intermediary, because it lacks the function of deposit taking and creating liabilities. 3. Explain how a financial inter
39、mediary reduces the cost of contracting and information processing. Financial intermediaries can reduce the cost of contracting by its professional staff because investing funds is their normal business. The use of such expertise and economies of scale in contracting about financial assets benefits
40、both the intermediary as well as the borrower of funds. Risk can be reduced through diversification and taking advantage of fund expertise. 4. “All financial intermediaries provide the same economic functions. Therefore, the same investment strategy should be used in the management of all financial
41、intermediaries.” Indicate whether or not you agree or disagree with this statement. Disagree. Although each financial intermediary more or less provides the same economic functions, each has a different asset-liability management problem. Therefore, same investment strategy will not work. 5. A bank
42、issues an obligation to depositors in which it agrees to pay 8% guaranteed for one year. With the funds it obtains, the bank can invest in a wide range of financial assets. What is the risk if the bank uses the funds to invest in common stock? Practically, it is not a valid statement as banks are no
43、t allowed to hold stocks. The bank has a funding risk. On the liability side, amount of cash outlay and timing are known with certainty (Type I). However, on the asset side, both factors are unknown. Thus, there is liquidity risk and price risk. Copyright 2010 Pearson Education, Inc. Publishing as P
44、rentice Hall. 1-8 6. Look at Table 2-1 again. Match the types of liabilities to these four assets that an individual might have: a. car insurance policy b. variable-rate certificate of deposit c. fixed-rate certificate of deposit d. a life insurance policy that allows the holders beneficiary to rece
45、ive $100,000 when the holder dies; however, if the death is accidental, the beneficiary will receive $150,000 a. Car insurance: neither the time nor the amount of payoffs are certain, which is Type IV liability b. Variable rate certificates of deposit: times of payments are certain, the amounts are
46、not, which is Type II liability. c. Fixed-rate certificate of deposit: both times of payments and cash outflows are known, which is Type I liability. d. Life insurance policy: time of payout is not known, but the amount is certain, which is Type III liability. 7. Each year, millions of American inve
47、stors pour billions of dollars into investment companies, which use those dollars to buy the common stock of other companies. What do the investment companies offer investors who prefer to invest in the investment companies rather than buying the common stock of these other companies directly? In in
48、vesting funds with the investment companies, investors are reducing their risk via diversification and the cost of contracting and information. These companies also provide liquidity to the investor. 8. In March 1996, the Committee on Payment and Settlement Systems of the Bank for International Sett
49、lements published a report entitled “Settlement Risk in Foreign Exchange Transactions” that offers a practical approach that banks can employ when dealing with settlement risk. What is meant by settlement risk? Counterparty risk is that risk that a counterparty to a transaction cannot fulfill its obligation. It is related to settlement risk in that counterparty party risk bears on the question of whether settlement can take place or not. 9. The following appeared in the Federal Reserve Bank of San Franciscos Economic Letter, January 25,
