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financial markets institutions
Questions and Answers of
Financial Markets Institutions
An investment costs $23,958 and will generate cash flow of $6,000 annually for five years. The firm’s cost of capital is 6 percent.a. What is the investment’s internal rate of return? Based on
A firm has two possible investments with the following cash inflows. Each investment costs $480, and the cost of capital is ten percent.a. Based only on visual inspection, which investment is to be
You are given the following information concerning a firm:Assets required for operation: ............................$5,000,000Revenues:
Three investments cost $5,000 each and have the following cash flows. Rank them on the basis of their payback periods. Does the ranking make intuitive sense? Year A $2,000 $3,000 2 1,000 1,000 3,000
Fill in the table using the following information.Assets required for operation: $10,000Firm A uses only equity financingFirm B uses 30% debt with a 6% interest rate and 70% equityFirm C uses 50%
Fill in the table using the following information.Assets required for operation: $4,000Case Afirm uses only equity financingCase Bfirm uses 30% debt with an 8% interest rate
Who issues commercial paper? What types of financial institutions issue commercial paper? Why do some firms create a department that can directly place commercial paper? What criteria affect the
What is a bond indenture? What is the function of a trustee, with respect to the bond indenture?
Why is the relationship between interest rates and bond prices important to financial institutions?
If a bond’s coupon rate were above its required rate of return, would its price be above or below its par value? Explain.
Describe the shared-appreciation mortgage.
Describe how collateralized mortgage obligations (CMOs) are used and why they have been popular.
Explain why the rescue of Fannie Mae and Freddie Mac improves the ability of mortgage companies to originate mortgages.
As a portfolio manager of a financial institution, you are invited to numerous road shows at which firms that are going public promote themselves, and the lead underwriter invites you to invest in
Discuss the concept of asymmetric information. Explain why it may motivate firms to repurchase some of their stock.
Explain expert networks. How can expert networks affect the trading of specific stocks?
How does the money market deposit account differ from other bank sources of funds?
Explain how the Financial Reform Act resolved some problems during the credit crisis.
What changes to reserve requirements were added by The Wall Street Reform and Consumer Protection Act (also called the Dodd-Frank Act) of 2010?
What criteria are used by regulators to examine a thrift institution?
Explain how the credit crisis in the 2008-2009 period affected some savings institutions. Compare the causes of the credit crisis to the causes of the savings institution crisis in the late
Explain how the default risk of finance companies differs from that of other lending financial institutions.
Explain the role of the SEC, the NASD, and the stock exchanges in regulating the securities industry.
What is a best-efforts agreement?
What is reinsurance?
What is the NAIC and what is its purpose?
In 2012, some economists suggested that U.S. interest rates are dictated by the weak economic conditions in Europe. Use the loanable funds framework to explain how European economic conditions might
Distinguish between primary and secondary markets. Distinguish between money and capital markets.
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.
European debt markets have become integrated over time, so that institutional investors (such as commercial banks) commonly purchase debt issued in other European countries. When the government of
Recall that Carson Company has obtained substantial loans from finance companies and commercial banks. The interest rate on the loans is tied to market interest rates, and is adjusted every six
A war tends to cause significant reactions in financial markets. Why would a war in Iraq place upward pressure on U.S. interest rates? Why might some investors expect a war like this to place
If ti1 > ti2 what is the market consensus forecast about the one-year forward rate one year from now? Is this rate above or below today’s one-year interest rate? Explain.
Explain the liquidity premium theory.
Explain how credit raters have changed their process following criticism of their ratings during the credit crisis.
What are the main goals of the Federal Open Market Committee? How does it attempt to achieve these goals?
How has the Fed used mortgage-backed securities in recent years, and what has it been trying to accomplish?
Assess the economic situation today. Is the administration more concerned with reducing unemployment or inflation? Does the Fed have a similar opinion? If not, is the administration publicly
Individual credit unions are very small in size. If there is going to be increased competition in the consumer credit market, and greater regulatory equalization among competing institutions, how do
Discuss the debt instruments used in liability management. What are the common characteristics of these debt instruments and what type of bank is most likely to issue them?
How do banks decide on the proper amount of primary and secondary reserves to hold?
Assume you are the manager of a bank with the balance sheet as shown below. Determine the maturity GAP and duration GAP for the bank. What will happen to the value or net income for the bank if
Distinguish between the credit risk of individual loans and the credit risk of loan portfolios. How are they related? Which is more important?
How do financial institutions identify problem loans?
Describe what banks do when they identify a problem loan.
Describe how internal credit risk ratings can be used to allocate funds to different types of loans.
Describe how credit default swaps can be used to manage credit risk exposure.
Explain what happens to the cash flows or market value of a typical bank when interest rates decline. What happens if interest rates increase?
Suppose a financial institution holds a portfolio of bonds with a value of $50,000,000 and duration of 3.5. The portfolio currently yields 4 percent and you don’t anticipate any changes in the
Explain how financial futures are used to reduce bank interest rate risk. How does the value of a futures contract change when interest rates change?
Explain how one can use options on financial futures to manage interest rate risk.
A bank economist projects that interest rates in the future are expected to decline. What is the bank's proper funds management strategy? Why?
Liquidity management can be practiced on either side of the balance sheet. How are asset and liability management similar and how do they differ? Why do smaller banks have limited access to liability
What are the two ways a bank can fail? Explain how these two conditions cause failure. Give examples of times when we have had the two different types of failures.
Explain the profitability versus solvency and liquidity dilemma facing bank management.
What is a REIT? How did REITs perform during the most recent U.S. real estate bubble and crash?
Explain how a hedge fund differs from a mutual fund.
Give examples from this chapter to illustrate how different forms of financial institutions may either grow rapidly or decline as economic and regulatory conditions change.
Why are money market funds included in the broader measures of the money supply (M2 and M3) that the Federal Reserve introduced in 1980?
Why have ETFs grown so popular so quickly? What advantages do ETFs have over open-end index funds?
What is the major difference between open-end and closed-end investment companies? Why have open-end companies been more popular?
(a) If you earned 3 percent per year in a tax-free money market fund and you were in the 31 percent federal income tax bracket and were fortunate enough to live in a state that had no state income
If you invested $10,000 in an index fund that matched the market return of 10 percent per year for ten years, and levied a 0.25 percent management fee and no other fees, how much would you have at
If you invested $10,000 in a closed-end fund that invested in stocks that matched the market return of 10 percent for 10 years, levied a management fee of 2 percent of net assets per year, and sold
If you invested $10,000 in a mutual fund that charged a 1 percent of net assets management advisory fee and a 1 percent 12b-1 fee, and the fund matched the stock market’s return of 10 percent per
What type of fund would you want to buy if you believed that stock markets were always fully efficient?Explain why. Why do you think people don’t all buy the same kinds of funds?
How can the pricing of closed-end funds possibly indicate that market inefficiencies exist? What are the pros and cons of that argument? If market inefficiencies exist, how can they be exploited to
Assume a venture capitalist requires a 40% rate of return per year. If the venture capitalist thinks that a company will be worth $50 million in five years, what percentage of ownership in the
What are the two primary categories of private equity? How do they differ?
How does private equity differ from public equity?
What is prime brokerage?
What is proprietary trading?
What does a broker-dealer do? How does a broker-dealer make money?
What is the difference between an IPO and a seasoned offering?
How does a private placement differ from a public offering?
Explain why there were no large independent investment banks left in the United States at the end of 2008.
Explain each of the following parts of bringing a new issue to market: origination, underwriting, and distribution.
Explain why underwriting new securities issues can be a risky business.
What are the major business activities of investment banks?
Granite Insurance Company’s combined ratio two years ago was 1.035. A review of that year’s financial statements showed the company paid $4.5 million in income taxes. Why was the company
Granite Insurance Company had claims and expenses of $425 million last year. The company’s premium income was $450 million. What was the company’s combined ratio?
Assume it was determined that the insurer in Question 17 had overestimated its loss reserves by $20 million. If the loss reserve estimate was corrected, what is the impact on policyholders’
An insurance company’s total assets were $400 million. Its total liabilities were $340 million. What was the insured policyholder surplus?
Differentiate between defined benefit and defined contribution pension plans. Who bears the investment risk under each of these alternatives? Which type of plan is easier to fund and manage?
How are Social Security old-age benefits funded? What is the age for full retirement benefits for those retiring under Social Security today? What is the age under current law for full retirement
What are the major similarities between the balance sheets of life insurance companies and property and liability insurance companies? What are the major differences?
What are the advantages of purchasing a package policy versus purchasing the same coverage included in a package policy separately?
Why is the liability risk much more difficult to gauge than the property risk?
What is the relationship between the level of policy loans taken by policy owners and the level of interest rates in the general economy?
Why are annuities and life insurance often described as opposites? If they are opposites, when why do insurance companies marketing life insurance also commonly market life annuities?
Why did universal life insurance become popular in the 1980s? What explains the popularity of variable life insurance in the 1990s?
Term insurance becomes cost prohibitive for older in dividuals. However, the same insurance companies that do not offer term policies at advanced ages sell whole life insurance. How are these
What is meant by the phrase “adverse selection” in insurance? Although discussed in this chapter in connection with term insurance, adverse selection is a problem in all insurance markets. What
What are the primary sources of insurance regulation? What areas are regulated?
What problem is likely to develop for a stock life insurance company that issues participating policies?
To what extent do(1) The risk of unemployment(2) The risk of war satisfy the requirements of privatelyinsurable risks?
According to the law of large numbers, as the number of insureds increases, risk is reduced. However, as an insurance company writes more policies, it exposes itself to the potential for greater
What is the difference between pure risk and speculative risk? Provide an example of each of these types of risk.
Throughout this chapter, the role of insurance companies and pension funds as financial intermediaries was stressed. Discuss the financial intermediation process as it applies to insurance companies
What is the U.S. Central Credit Union? Why is it important to the future development of the credit union industry?
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