Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
99. Provide examples of direct and indirect finance and a brief explanation of the difference
between the two.
100. Stacy needs $5,000 to help with her tuition fees this semester. She is considering two
ways to raise the funds she needs. First, she is considering going to her parents for the loan.
Second, she could go to a bank for the loan. Discuss these options in the context of direct
versus indirect finance. In what sense might her parents pay for the loan either way?
101. What is the relationship between financial market development and economic growth?
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
102. What are the four characteristics of a financial instrument?
103. Briefly explain one function of financial instruments that can make them very different
from money.
104. Explain why most financial instruments are fairly complex, while at the same time quite
standardized.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
105. Credit cards usually charge higher rates of interest than most other forms of lending. In
terms of information, collateral and monitoring, how might these higher rates be explained?
106. Why might a life insurance company insist on an individual having a physical exam
before agreeing to provide life insurance to the individual?
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
107. An annuity is a contract that makes monthly payments as long as someone lives. Explain
why an individual would want to purchase such a contract. What risk is being transferred?
108. Why are options referred to as derivative instruments?
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
109. What are the four fundamental characteristics that determine the value of a financial
instrument?
110. A high school basketball player decides to bypass college and go right into the NBA (the
National Basketball Association). Describe the risk the individual is taking and a contract that
might transfer the risk.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
111. Describe what is likely to happen to the average price of a share of stock if the stock
markets decide to close every Friday and Monday to provide workers at the exchanges with
longer weekends.
112. What evidence is there that the transaction costs involved with the buying and selling of
stocks is low?
113. Standard & Poor’s sells information to investors; this is their primary business. Is this an
example of a financial intermediary? Explain.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
114. Consider a typical individual who owns the following financial instruments: A life
insurance policy for $250,000; a certificate of deposit for $10,000; homeowner’s and auto
insurance policies; $50,000 in a mutual fund, and $150,000 in her pension fund at work.
Which of these are instruments used primarily as stores of value and which are being used to
transfer risk?
115. Explain how the introduction of asset-backed securities has allowed investors to take
advantage of higher returns from loans that most investors could never make on their own.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
116. How do financial markets pool and communicate the information regarding issuers of
financial instruments in a convenient way?
117. How do financial markets contribute to the process of risk transfer?
118. Can a financial instrument be bought and sold in both a primary and secondary financial
market? Explain.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
119. Is the obtaining of a car loan a primary or secondary market transaction?
120. Where would you expect prices to be more volatile, on instruments traded in the money
market or instruments traded in the bond market? Explain.
121. Why didn’t the over-the-counter (OTC) exchanges suffer the disruption of service that
the New York Stock Exchange did after the terrorist attacks of September 11, 2001?
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
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122. What is the primary distinction between debt/equity markets and derivative markets?
123. From the savers’ perspective, what are the benefits of going to a depository institution to
obtain accounts in which to hold a portion of wealth, instead of buying securities directly
from financial markets?
124. What is meant by the “paradox of leverage?”
Essay Questions
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
125. As we saw in the chapter, some financial instruments are used primarily to transfer risk.
Explain how a bread maker can use a financial instrument to transfer the following risk: The
bread maker has the opportunity to provide bread to a local army base. The base figures they
will need 10,000 loaves of bread each week, or roughly 500,000 for a year. The problem is the
baker must quote a price for the entire year. The baker would really like to have this contract
but he realizes that fluctuating input prices (specifically wheat) could result in significant
losses.
126. Suppose that an Internet-based program, Novus, wants to raise $10 million to expand its
business operations. Describe how Novus can raise these funds directly through each of the
follow options: issuing stock, issuing bonds, or obtaining a bank loan. Compare and contrast
these three options.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
127. Many countries of the former Soviet Union are finding the transformation to a market-
based economy to be quite difficult and economic growth rates for many of these countries
are quite low. Explain what role the lack of financial market development may play in these
countries.
128. Explain the various ways that financial intermediaries increase the efficiency of an
economy.
Chapter 03 – Financial Instruments, Financial Markets, and Financial Institutions
129. Compare and contrast financial institutions that act as brokers to those that transform
assets. In what sense are both types of institutions financial intermediaries? Provide one
example of each type and describe how each functions as a financial intermediary.