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Money Banking And Financial Markets 4Th Edition By Stephen G. Cecchetti - Solution Manual
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Money Banking And Financial Markets 4Th Edition By Stephen G. Cecchetti - Solution Manual
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,Chapter 01 - An Introduction to Money and the Financial SystemChapter 1
An Introduction to Money and the Financial System
Problems
1. List the financial transactions you have engaged in over the past week. How might
each one have been carried out 50 years ago? (LO1)
Answer: Commercial purchases that you made likely used credit cards and debit
cards. Fifty years ago they would have all used cash. Payment of utilities (if you do
it) might have been done by electronic transfer, rather than a check (which would
have been the method 50 years ago).
2. How were you, your family or your friends affected by the recent failure of the
financial system to function normally during the financial crisis of 2007-2009? (LO1)
Answer: It is likely that you or someone you know had an account with one of the
many financial institutions that folded during the crisis, or that someone you know
was refused a business loan or a mortgage or had a bank foreclose on their house.
3. List three items you used to buy with cash but you now purchase with a debit card.
(LO1)
Answer: Among the possibilities: purchases of cappuccino at the local coffee shop,
gasoline for your car, and groceries for the week.
4. Various financial instruments usually serve one of two distinct purposes: to store
value or to transfer risk. Name a financial instrument used for each purpose. (LO1)
Answer: Financial instruments used to store value include bank accounts, stocks and
bonds. Instruments used to transfer risk include car insurance and life insurance.
5. Financial innovation has reduced individuals’ need to carry cash. Explain how. (LO1)
Answer: Everyone has a number of alternative methods of payment. Electronic
forms, like credit and debit cards, are the primary ones that have reduced need to
carry cash.
6. * Many people believe that, despite ongoing financial innovations, cash will always
be with us to some degree as a form of money. What Core Principle could justify this
view? (LO2)
Answer: Core Principle 3 – information is the basis for decisions. When cash is used
to settle a transaction, it is a final payment, not some form of a promise to pay. No
1-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
,Chapter 01 - An Introduction to Money and the Financial System
information is needed about the payer once cash has been handed over to settle a
transaction. This has obvious advantages to the recipient, as the information costs are
negligible. In some circumstances, one or both parties to a transaction may wish to
preserve their anonymity, and cash allows this.
7. When you apply for a loan, you are required to answer lots of questions. Why? Why
is the set of questions you must answer standardized? (LO2)
Answer: The questions are aimed at figuring out how likely you are to repay the loan.
They are standardized to reduce the cost of making the loan.
8. Name two distinct financial markets and describe the kind of asset traded in each.
(LO1)
Answer: Among the best-known financial markets are those for stocks and for bonds.
In the stock markets, equities or ownership shares in companies are bought and sold.
In the bond market, debt issues of government units or companies are traded.
9. * Why do you think the financial system has become more globally integrated over
time? Can you think of any downside to this increased integration? (LO1)
Answer: Technological progress is one obvious reason. According to Core Principle
3, information is the basis for decisions. Improvements in technology have allowed
for huge volumes of information to be collected and disseminated quickly and
cheaply on a global basis, facilitating long distance financial transactions. Increased
integration allows for problems that arise in the financial system of one country to
spread more quickly and easily to other countries, as we saw during the financial
crisis of 2007-2009.
10. The government is heavily involved in the financial system. Explain why. (LO1)
Answer: For markets to work there have to be rules. And the rules need to be
enforced. The government both makes the rules and enforces them so that we all trust
the markets to work as they should. Without the government to monitor the financial
system, ensuring that people behave themselves, the system would collapse.
11. If offered the choice of receiving $1,000 today or $1,000 in one year’s time, which
option would you choose, and why? (LO2)
Answer: Core Principle 1 states that time has value, so you should choose option 1.
By receiving the $1000 today, you can immediately put the money to use. Perhaps
you buy a new computer or put the money in the bank to earn interest. Regardless of
what you do with the money, waiting a year to receive the money involves an
opportunity cost.
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
, Chapter 01 - An Introduction to Money and the Financial System
12. If time has value, why are financial institutions often willing to extend you a 30-year
mortgage at a lower annual interest rate than they would charge for a one-year loan?
(LO2)
Answer: With a mortgage, the house you purchase acts as collateral for the loan. In
the event you default, the bank can sell the house and recoup its funds. The existence
of collateral reduces the risk associated with the loan and so reduces the
compensation the bank requires.
13. Using Core Principle 2, under what circumstances would you expect a job applicant
to accept an offer of a low base salary and an opportunity to earn commission over
one with a higher base salary and no commission potential? (LO2)
Answer: The applicant would have to expect to earn a higher total salary working for
a low base and commission, as they require compensation for the risk they assume
due to the uncertainty about the level of commission earnings.
14. Suppose medical research confirms earlier speculation that red wine is good for you.
Why would banks be willing to lend to vineyards that produce red wine at a lower
interest rate than before? (LO2)
Answer: The future prospects for the vineyards have improved, reducing the risk
involved in lending to them. The banks require less compensation than before.
15. * If the U.S. Securities and Exchange Commission eliminated its requirement for
public companies to disclose information about their finances, what would you expect
to happen to the stock prices for these companies? (LO2)
Answer: You should expect the stock prices to fall. Gathering sufficient information
upon which to make an informed investment decision would become much more
costly for investors, reducing the demand for the stock at a given price.
16. If 2 percent growth is your break-even point for an investment project, under which
outlook for the economy would you be more inclined to go ahead with the
investment: (1) A forecast for economic growth that ranges from 0 to 4 percent, or (2)
a forecast of 2 percent growth for sure, assuming the forecasts are equally reliable?
What Core Principle does this illustrate? (LO2)
Answer: You would be more inclined to invest in the project if you knew for sure that
growth would be 2%. Uncertainty about the future makes investment less attractive,
as you run the risk of losing out if the lower end of the forecast is realized. This
illustrates core principle 5 – stability improves welfare.
17. * Why are large, publicly listed companies much more likely than small businesses to
sell financial instruments such as bonds directly to the market, while small businesses
get their financing from financial institutions such as banks? (LO2)
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
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