Valerie Bodden K.

(10-0014) Financial Markets and Institutions (UNIBE) Professor Bairan September 8, 2011 Chapter 1 Review Questions 1) What is the difference between a financial asset and a tangible asset? The difference between a tangible asset and a financial asset is that a tangible asset is basically one whose value depends on a physical property, while a financial asset, considered an intangible asset, represents a legal claim of some future benefits or cash flows. 2) What is the difference between the claim of a debt holder of general Motors and an equity holder of General Motors? When a debt holder establishes a claim, he establishes it by contract that specifies the amount and timing of periodic payment in the form of interest, as well as the maturity. The debt holder plays the part of an creditor. In the case of a default he would have a prior claim on firm assets over the equity-holder. The equity holder has a Residencial claim to assets and income. 3) What is the basic principle in determining the cash flow of a financial asset? The present value of the expected cash flow is the price of any financial asset. The basic variables when determining the price of an asset are: expected cash flows, timing of cash flows and discount rates. 4) Why is it difficult to determine the cash flow of a financial asset? It is difficult to determine the cash flow of a financial asset because of several accounting measures, the existing possibility of default of the issuer, and the embedded options in the security. 5) Why are the characteristics of an issuer important in determining the price of a financial asset?

The characteristics of an issuer are important when determining the price of a financial asset because they determine the issuers creditworthiness and they have an impact on the required rate of return for that asset. 6) What are the two principal roles of financial assets? 1. To transfer funds from surplus spending units to deficit spending units. 2. To redistribute risk among people or institutions that seek to provide funds. Fund providers share the risks of expected cash flow generated by tangible assets. 7) In September 1990, a study by the US Congress Office of Technology Assessment, entitled electric Bulls and Bears: US Securities Markets and Information Technology included this statement: a. Securities markets have five basic functions in a capitalistic economy: a. They make it possible for corporations and governmental units to raise capital b. They help to allocate capital towards productive uses c. They provide an opportunity for people to increase their savings by investing in them d. They reveal investors judgments about the potential earning capacity of corporations this giving guidance to corporate managers. e. They generate employment and income For each of these functions cited above, explain how financial markets perform each function. a. Transferring funds from those who have surplus funds to invest to those who need funds b. Transferring funds in a way that redistributes the unavoidable risk associated with the cash flow generated by tangible assets. c. Determining the price of financial assets d. Providing a mechanism for an investor to sell a financial asset 8) Explain the difference between each of the following: a. Money market and capital market

b. Primary market and secondary market c. Domestic market and foreign market d. National market and Euromarkets a. The money market is a financial market of short-term instruments (1 year) while capital market are for long term debts (1+ year). b. The primary market deals with newly issued financial claims, on the other hand, secondary market deals with the trading of season issues. c. The domestic market is the national market, where foreign deals with international securities and their trade. d. In a national market, securities are traded in one country and must follow the rules of that country in specific. 9) Indicate whether each of the following instruments trade I the money market or the capital market. a. General Motors Acceptance Corporation issues a financial instrument with four months to maturity. b. The U.S. Treasury issues a security with 10 years to maturity c. Microsoft Corporation issuers common stock d. The State of Alaska issues a financial instrument with eight months to maturity. a. GMAC issues trades in the money market b. US 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 default, I know what the cash flow of the bond will be. Explain why you agree or disagree with this statement. I would disagree with this statement.

11) A U.S. investor who purchases the bonds issued by the U.S. government made the following statement: By buying this debt instrumental I am not exposed to default risk or purchasing power risk. Explain why you agree or disagree with this statement. This is false, because there is no credit risk of US government securities. Although, it is not free of purchasing power or inflation risk. There is also price risk. 12) In January 1992, Atlantic Richfield Corporation, a U.S.-based corporation, issued $250 million of bonds in the U.S. From the perspective of the U.S. financial market, indicate whether this issue is classified as being issued n the domestic market, the foreign market or offshore market. Corporate bonds issued by A.C. are in the domestic market. On the other hand, investors can be foreign markets. 13) In January 1992, the Korea Development Bank issued $500 million of bonds in the U.S. From the perspective of the U.S. financial markets, issued whether this issue is classified as being issued in the domestic market, the foreign market, or the offshore market. It is a domestic issue. 14) Give three reasons for the trend toward greater integration of financial markets throughout the world. a. Deregulation of financial markets to permit greater participants from other different countries b. Technological innovations to provide globally-available information and to speed transactions c. Institutionalization 15) What is meant by the institutionalization of capital markets? Institutionalization means the dominance of large institutional investors such as pension funds, investment companies. 16) a. What are the two basic types of derivative instruments? Futures and option contracts

b. Derivative markets are nothing more than legalized gambling casinos and serve no economic function. Comment on this statement. Derivatives serve an important economic function that permit hedging. 17) What is the economic rationale for the widespread use of disclosure regulation? Disclosure mitigate the potential for fraud by the issuer. 18) What is meant by market failure? Market failure is when market cannot produce its goods or services efficiently. 19) What is the major long-term regulatory reform that the U.S. department of the Treasure has proposed? The proposal is to replace the prevailing complex array of regulators with a regulatory system based on functions. 20) Why does increased volatility in financial markets with respect to the price of financial assets, interest rates, and exchange rates foster financial innovation? Increased volatility of the prices of financial assets has fostered innovation as investors and institutions.