Solution Manual For Financial Markets and Institutions, 10th Edition By Jeff Madura Chapter 1-25
Chapter 1 Role of Financial Markets and Institutions Outline Role of Financial Markets Accommodating Investment Needs Accommodating Corporate Finance Needs Primary Versus Secondary Markets
Securities Traded in Financial Markets Money Market Securities Capital Market Securities Derivative Securities Valuation of Securities Securities Regulations International Securities Transactions
Role of Financial Institutions Role of Depository Institutions © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Role of Nondepository Financial Institutions Comparison of Roles among Financial Institutions Relative Importance of Financial Institutions Consolidation of Financial Institutions
Credit Crisis for Financial Institutions Systemic Risk During the Credit Crisis Government Response to the Credit Crisis Key Concepts
1. Explain the role of financial intermediaries in transferring funds from surplus units to deficit units.
2. Introduce the types of financial markets available and their functions.
3. Introduce the various financial institutions that facilitate the flow of funds.
4. Provide a preview of the course outline. Emphasize the linkages between the various sections of the course.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
POINT/COUNTER-POINT: Will Computer Technology Cause Financial Intermediaries to Become Extinct? POINT: Yes. Financial intermediaries benefit from access to information. As information becomes more accessible, individuals will have the information they need before investing or borrowing funds. They will not need financial intermediaries to make their decisions. COUNTER-POINT: No. Individuals rely not only on information, but also on expertise. Some financial intermediaries specialize in credit analysis so that they can make loans. Surplus units will continue to provide funds to financial intermediaries rather than make direct loans, because they are not capable of credit analysis, even if more information about prospective borrowers is available. Some financial intermediaries no longer have physical buildings for customer service, but they still require agents who have the expertise to assess the creditworthiness of prospective borrowers. WHO IS CORRECT? Use the Internet to learn more about this issue and then formulate your own opinion.
ANSWER: Computer technology may reduce the need for some types of financial intermediaries such as brokerage firms, because individuals can make transactions on their own (if they prefer to do so). However, loans will still require financial intermediaries because of the credit assessment that is needed.
Questions 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.
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ANSWER: Surplus units provide funds to the financial markets while deficit units obtain funds from the financial markets. Surplus units include households with savings, while deficit units include firms or government agencies that borrow funds.
This exercise allows students to realize that they constantly interact with financial institutions, and that they often play the role of a deficit unit (on car loans, tuition loans, etc.).
2. Types of Markets. Distinguish between primary and secondary markets. Distinguish between money and capital markets.
ANSWER: Primary markets are used for the issuance of new securities while secondary markets are used for the trading of existing securities.
Money markets facilitate the trading of short-term (money market) instruments while capital markets facilitate the trading of long-term (capital market) instruments.
3. Imperfect Markets. Distinguish between perfect and imperfect security markets. Explain why the existence of imperfect markets creates a need for financial intermediaries.
ANSWER: With perfect financial markets, all information about any securities for sale would be freely available to investors, information about surplus and deficit units would be freely available, and all securities could be unbundled into any size desired. In reality, markets are imperfect, so that surplus and deficit units do not have free access to information, and securities cannot be unbundled as desired.
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Financial intermediaries are needed to facilitate the exchange of funds between surplus and deficit units. They have the information to provide this service and can even repackage deposits to provide the amount of funds that borrowers desire.
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.
ANSWER: If markets are efficient then prices of securities available in these markets properly reflect all information. We should expect markets to be efficient because if they weren’t, investors would capitalize on the discrepancy between what prices are and what they should be. This action would force market prices to represent the appropriate prices as perceived by the market.
Efficiency is often defined with regard to publicly available information. In this case, markets can be efficient, but investors with inside information could possibly outperform the market on a consistent basis. A stronger version of efficiency would hypothesize that even access to inside information will not consistently outperform the market.
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.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.