Tutorial 3 Q&A - q&a PDF

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1. How can economies of scale help explain the existence of financial intermediaries? High transaction cost greatly affect the average American because they don't have the money to diversify their investing* money. Which intermediaries are cheaper to invest because of economies of scale? 2. Describe two ways in which financial intermediaries help lower transaction cost in the economy. 

Economies of Scale - 3 ways to lower costs. A) Bundle Investors. B) Mutual Funds; selling shares to individuals; then proceed in bonds or stocks. C) Telecommunications system for transactions is easier and cheaper.

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Expertise - A) Having an expert using a computer quickly and efficiently to help customers, with, figuring out how well their investment is doing with a toll-free number. B) Liquidity Services - easier for a customer to conduct a transaction.

3. Would moral hazard and adverse selection still arise in financial markets if information were not asymmetric? Explain. No. Asymmetric information is the inability of knowing the borrowers exact intentions. A) Whether its adverse selection (Before transaction) where crooks try to take out loans and never repay. Or B) whether its moral hazard (After Transaction) where the borrower will take the higher risk route since it’s not their money they're playing with. NO LEMON PROBLEM HERE! 4. Which firms are most likely to use bank financing rather than to issue bonds or stocks to finance their activities? Why? Smaller firms. Bigger firms are well known and can easily sell bonds and stocks. Smaller firms are better off to finance through the bank.

5. How can the existence of asymmetric information provide a rationale for gov't regulation of financial markets? Bringing savers to burrowers... Firms are highly regulated by the gov't because asymmetric information gives uncertainty to people to want to purchase bonds or securities. This will drop the financial market, thus, the government regulates it to create more certainty so more cash flows. 6. Would you be more willing to lend to a friend if she put all of her life savings into her business than you would if she had not done so? Why? I would be willing to do so. Her intentions on this business would always be for a profitable cause and she wouldn't take high risk, thus, you are more likely to get your money back. 7. The more collateral there is backing a loan, the less the lender has to worry about adverse selection. Is this statement true, false, or uncertain? Explain. True. When an individual has a lot of collateral on a loan, the more he will act in the lenders favor because he has much at risk too. 8. How does the free-rider problem aggravate adverse selection and moral hazard problems in financial markets? Adverse Selection - Stock Market; purchasing information to better yourself on your investment that a private company provides will cost a lot of money. That cost will be given freely too many others that follow your lead. Moral Hazard - Security Market; Spending time and money monitoring the business. Other people will know and allow you to do all the monitoring, while they sit back and save that monitoring money.

9. How do standard accounting principles help financial markets work more efficiently? By disclosing accurate info about Sales, Assets, and Earnings. Causes it to give more additional info about the company for investors to make wiser decisions. Disclosing requirements wasn't so great (Enron Ex.). It lessens the Lemon problem, but doesn't eliminate. Firms could lie on their Balance Sheets about their substantial amounts of debt and taking off financial contracts, what Enron did. 10. Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or those traded over-the-counter? Explain. Over-the-counter. A lemon problem is the idea that there isn't enough information about something and a buyer is only seeking to purchase at an average price. Which, the willingness to pay for a "peach" isn't enough and would not be sold. NYSE would have a lot more info than over-the-counter. 11. Wealthy people often worry that others will seek to marry them only for their money. Is this a problem of adverse selection? Maybe? That woman can be a crook and who only seeks for the death of the significant other and take all his money upon death? 12. Explain how the separation of ownership and control in American corporations might lead to poor management. All these regulations are causing higher prices. Especially Has Sarbanes-Oxley and Global Legal Settlement of 2002. These cost are driving out corporations and reducing US capital or poorer management is hired so they make up for their losses.

13. Why can the provision of several types of financial services by one firm lead to a lower cost of information production? This is known as economies of scope. Financial institutions are always collecting, producing, and distributing information. Re-using this information can lead to lower cost of info pro. 14. How does the provision of several types of financial services by one firm lead to conflicts of interest? Moral Hazard problems are created. 1) Underwriting and Research in Investment Banking 2) Auditing and Consulting in Accounting Firms 3) Credit Assessment and Consulting in CreditRating Agencies. 15. How can conflicts of interest make financial service firms less efficient? The information that the firms give off isn't provided correctly. 16. Describe two conflicts of interest that occur when underwriting and research are provided by a single investment firm. 1) When underwriting greatly exceed the brokerage commissions from selling, the bank will have a strong incentive to alter the info to favor the issuing firm's needs or else they will lose that business. 2) Spinning occurs to attract other executives from companies' to their investment bank. 17. How does spinning lead to a less efficient financial system? Diminishes the capital market. Why? Because an investment bank allocates hot. Initial Public Offerings is a share of newly issued stock to other companies in response for them to transfer to their banks, which the newly stock goes up in price. Since the new company comes over, they sell their shares with this new bank investment, which would not be the highest price for the company's securities.

18. Describe two conflicts of interest that occur in accounting firms. Auditors may skew things to win consulting business from same clients. Or may audit info systems or tax and financial plans and put it in their non- audit counterparts and may criticize the systems or advice. 19. Which provisions of Sarbanes-Oxley do you think are beneficial, and which are not? Beneficial- Created PCAOB public acc. oversight board overseen by the SEC to supervise acc. firms. AND made it illegal to provide any non- audit service to a client. AND increased criminal charges. Not Beneficial- Increased SEC's budget. AND increased cost for businesses are causing smaller business to list abroad. AND causing US capital to drop. 20. Which provisions of the Global Legal Settlement do you think are beneficial, and which are not? Beneficial- Requires investment banks to sever the links between research and securities underwriting. AND banned Spinning AND increased charges AND investment banks to make their analysts’ recommendations public. Not Beneficial-...