Chapter2OverviewoftheFinancialSystem1

Chapter2
AnswerstoEndofChapterQuestions

1. TheshareofMicrosoftstockisanassetforitsownerbecauseitentitlestheownertoashareofthe
earningsandassetsofMicrosoft.TheshareisaliabilityforMicrosoftbecauseitisaclaimonits
earningsandassetsbytheowneroftheshare.
2. Yes,Ishouldtakeouttheloan,becauseIwillbebetteroffasaresultofdoingso.Myinterest
paymentwillbe$4,500(90%of$5,000),butasaresult,Iwillearnanadditional$10,000,soIwillbe
aheadofthegameby$5,500.SinceLarrysloansharkingbusinesscanmakesomepeoplebetteroff,
asinthisexample,loansharkingmayhavesocialbenefits.(Oneargumentagainstlegalizingloan
sharking,however,isthatitisfrequentlyaviolentactivity.)
3. Yes,becausetheabsenceoffinancialmarketsmeansthatfundscannotbechanneledtopeople
whohavethemostproductiveuseforthem.Entrepreneursthencannotacquirefundstosetup
businessesthatwouldhelptheeconomygrowrapidly.
4. TheprincipaldebtinstrumentsusedwereforeignbondswhichweresoldinBritainand
denominatedinpounds.TheBritishgainedbecausetheywereabletoearnhigherinterestratesasa
resultoflendingtoAmericans,whiletheAmericansgainedbecausetheynowhadaccesstocapitalto
startupprofitablebusinessessuchasrailroads.
5. Thisstatementisfalse.Pricesinsecondarymarketsdeterminethepricesthatfirmsissuing
securitiesreceiveinprimarymarkets.Inaddition,secondarymarketsmakesecuritiesmoreliquidand
thuseasiertosellintheprimarymarkets.Therefore,secondarymarketsare,ifanything,more
importantthanprimarymarkets.
6. Youwouldratherholdbonds,becausebondholdersarepaidoffbeforeequityholders,whoarethe
residualclaimants.
7. Becauseyouknowyourfamilymemberbetterthanastranger,youknowmoreaboutthe
borrowershonesty,propensityforrisktaking,andothertraits.Thereislessasymmetricinformation
thanwith
astrangerandlesslikelihoodofanadverseselectionproblem,withtheresultthatyouaremorelikely
tolendtothefamilymember.
9. Loansharkscanthreatentheirborrowerswithbodilyharmifborrowerstakeactionsthatmight
jeopardizepayingofftheloan.Henceborrowersfromaloansharkarelesslikelytoengagein
moralhazard.
10. Theymightnotworkhardenoughwhileyouarenotlookingormaystealorcommitfraud.
11. Yes,becauseevenifyouknowthataborroweristakingactionsthatmightjeopardizepayingoffthe
loan,youmuststillstoptheborrowerfromdoingso.Becausethatmaybecostly,youmaynotspend
thetimeandefforttoreducemoralhazard,andsomoralhazardremainsaproblem.
12. True.Iftherearenoinformationortransactionscosts,peoplecouldmakeloanstoeachotheratno
costandwouldthushavenoneedforfinancialintermediaries.
13. Becausethecostsofmakingtheloantoyourneighborarehigh(legalfees,feesforacreditcheck,
andsoon),youwillprobablynotbeabletoearn5%ontheloanafteryourexpenseseventhoughit
hasa10%interestrate.Youarebetteroffdepositingyoursavingswithafinancialintermediaryand
earning5%interest.Inaddition,youarelikelytobearlessriskbydepositingyoursavingsatthebank
ratherthanlendingthemtoyourneighbor.
14. IncreaseddiscussionofforeignfinancialmarketsintheU.S.pressandthegrowthinmarketsfor
internationalfinancialinstrumentssuchasEurodollarsandEurobonds.