Financial Markets and Institutions
8th Edition
by Anthony Saunders
Complete Chapter Solutions Manual
are included (Ch 1 to 25)
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** All Chapters included
** Excel Solutions
,Answers to Chapter 1
Questions:
1. a. primary
b. primary
c. secondary
d. secondary
e. secondary
2. a. money market
b. money market
c. capital market
d. capital market
e. capital market
f. money market
g. money market
h. money market
i. capital market
j. money market
3. The capital markets are more likely to be characterized by actual physical locations such as the New York Stock
Exchange. Money market transactions are more likely to occur via telephone, wire transfers, and computer trading.
4. According to Figure 1-4, federal funds and repurchase agreements, followed by Treasury bills, negotiable CDs,
and commercial paper, had the largest amounts outstanding in 2019.
5. The major instruments traded in capital markets are corporate stocks, mortgages, corporate bonds, Treasury notes
and bonds, state and local government bonds, U.S. government owned and sponsored agencies, and bank and
consumer loans.
6. According to Figure 1-4, corporate stocks represent the largest capital market instrument in 2019, followed by
mortgages, Treasury securities, and corporate bonds.
7. The bank would be most concerned about a depreciation of the yen against the dollar.
8. Financial institutions consist of:
Commercial banks - depository institutions whose major assets are loans and major liabilities are deposits.
Commercial banks’ loans are broader in range, including consumer, commercial, and real estate loans, than other
depository institutions. Commercial banks’ liabilities include more nondeposit sources of funds, such as subordinate
notes and debentures, than other depository institutions.
Thrifts - depository institutions in the form of savings and loans, savings banks, and credit unions. Thrifts generally
perform services similar to commercial banks, but they tend to concentrate their loans in one segment, such as real
estate loans or consumer loans.
Insurance companies - financial institutions that protect individuals and corporations (policyholders) from adverse
events. Life insurance companies provide protection in the event of untimely death, illness, and retirement. Property
casualty insurance protects against personal injury and liability due to accidents, theft, fire, etc.
Securities firms and investment banks - financial institutions that underwrite securities and engage in related
activities such as securities brokerage, securities trading, and making a market in which securities can trade.
Finance companies - financial intermediaries that make loans to both individual and businesses. Unlike depository
institutions, finance companies do not accept deposits but instead rely on short- and long-term debt for funding.
, Mutual funds and hedge funds - financial institutions that pool financial resources of individuals and companies and
invest those resources in diversified portfolios of asset.
Pension funds - financial institutions that offer savings plans through which fund participants accumulated savings
during their working years before withdrawing them during their retirement years. Funds originally invested in and
accumulated in pension funds are exempt from current taxation.
9. If there were no FIs then the users of funds, such as corporations in the economy, would have to approach the
savers of funds, such as households, directly in order to fund their investment projects and fill their borrowing needs.
This would be extremely costly because of the up-front information costs faced by potential lenders. These include
costs associated with identifying potential borrowers, pooling small savings into loans of sufficient size to finance
corporate activities, and assessing risk and investment opportunities. Moreover, lenders would have to monitor the
activities of borrowers over each loan's life span, which is compounded by the free rider problem. The net result is
an imperfect allocation of resources in an economy.
10. There are at least three reasons for this. First, once they have lent money in exchange for financial claims,
suppliers of funds need to monitor or check the use of their funds. They must be sure that the user of funds neither
absconds with nor wastes the funds on projects that have low or negative returns. Such monitoring actions are often
extremely costly for any given fund supplier because they require considerable time, expense, and effort to collect
this information relative to the size of the average fund supplier’s investment.
Second, the relatively long-term nature of some financial claims (e.g., mortgages, corporate stock, and bonds)
creates a second disincentive for suppliers of funds to hold the direct financial claims issued by users of funds.
Specifically, given the choice between holding cash and long-term securities, fund suppliers may well choose to
hold cash for liquidity reasons, especially if they plan to use savings to finance consumption expenditures in the near
future and financial markets are not very deep in terms of active buyers and sellers.
Third, even though real-world financial markets provide some liquidity services, by allowing fund suppliers to trade
financial securities among themselves, fund suppliers face a price risk upon the sale of securities. That is, the price
at which investors can sell a security on secondary markets such as the New York Stock Exchange (NYSE) may
well differ from the price they initially paid for the security either because investors change their valuation of the
security between the time it was bought and when it was sold and/or because dealers, acting as intermediaries
between buyers and sellers, charge transaction costs for completing a trade.
11. A suppler of funds who directly invests in a fund user’s financial claims faces a high cost of monitoring the fund
user’s actions in a timely and complete fashion after purchasing securities. One solution to this problem is for a large
number of small investors to place their funds with a single FI serving as a broker between the two parties. The FI
groups the fund suppliers’ funds together and invests them in the direct or primary financial claims issued by fund
users. This aggregation of funds resolves a number of problems. First, the “large” FI now has a much greater
incentive to hire employees with superior skills and training in monitoring. This expertise can be used to collect
information and monitor the ultimate fund user’s actions because the FI has far more at stake than any small
individual fund supplier. Second, the monitoring function performed by the FI alleviates the “free-rider” problem
that exists when small fund suppliers leave it to each other to collect information and monitor a fund user. In an
economic sense, fund suppliers have appointed the financial institution as a delegated monitor to act on their behalf.
For example, full-service securities firms such as Morgan Stanley carry out investment research on new issues and
make investment recommendations for their retail clients (or investors), while commercial banks collect deposits
from fund suppliers and lend these funds to ultimate users such as corporations.
12. In addition to information costs, FIs help small savers alleviate liquidity and price risk. Often claims issued by
financial institutions have liquidity attributes that are superior to those of primary securities. For example, banks and
thrift institutions (e.g., savings associations) issue transaction account deposit contracts with a fixed principal value
and often a guaranteed interest rate that can be withdrawn immediately, on demand, by investors. Money market
mutual funds issue shares to household savers that allow them to enjoy almost fixed principal (depositlike) contracts
while earning higher interest rates than on bank deposits, and that can be withdrawn immediately. Even life
insurance companies allow policyholders to borrow against their policies held with the company at very short notice.
Notice that in reducing the liquidity risk of investing funds for fund suppliers, the FI transfers this risk to its own
