Solutions to Online Mini-Cases
Chapter 2 Mini-Case
1. Moral hazard is the problem created by asymmetric information after the transaction occurs. In the
2. Moral hazard can be reduced by monitoring, higher collateral, restrictive covenants, and more capital
requirement for the risk activities that companies are involved in.
4. Unequal information between two parties; one has more knowledge on a given activity than the other
party.
5. Yes, that is the reason behind the regulation of the financial institutions. Government regulation of
financial institutions is done for two main reasons: to increase the information available to the investors
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2. $840.00
4. a. 10.75%
5. a. 12.25%
6. a. −3.28%
7. a. $968.30
e. 4.06%
f. 9.39%
8. a. 400
f. 14.01% = {[(1,452 − 930.50)/930.50] × 100} ÷ 4
g. Because earning interest on interest affects total return on the investment.
Solutions to Online Mini-Cases 165
Chapter 4 Mini-Case
b. 17.65%
d. 5.26%
2. $833.33
3. Wealth
4. Expected profitability of investment opportunities
6. The loanable funds framework provides a theory of how interest rates are determined by examining
7. Note: Various predictions are possible in some of the following statements, leading to in-class
discussions. Consider the following possible initial responses:
a. If supply curve shifts more than demand, equilibrium interest rates rise.
b. With other economic variables constant, interest rates rise.
166 Mishkin/Eakins • Financial Markets and Institutions, Seventh Edition
Chapter 5 Mini-Case
1. Use your favorite search engine to find such key words/phrases as: “Yield Curve,” “Expectations
2. Obtain the most recent yield curve information from Internet site. (Note: Consider the most recent
site at www.bloomberg.com).
3. Plot U.S. Treasury Yield Curve.
Note: Plot is provided at the Bloomberg site.
a. Pure expectations theory views long-term interest rates as equaling the average of future short-
4. Given the information in responses 1, 2, and 3 above, use the pure expectations theory to determine
and predict interest rates as follows:
a. If the one-year interest rate is expected to be the same as the current yield curve over the next three
years, what interest rate is expected on a two-year bond? Note: Answer varies based on current
Internet search. Use Chapter 5 equation for calculating the interest rate on a two-year bond.
b. What interest rate is expected on a three-year bond? Note: Answer varies based on current
5. After describing the current yield curve and forecasting interest rates, using the pure expectations
hypothesis:
Solutions to Online Mini-Cases 167
Chapter 6 Mini-Case
2. Forecast errors may occur since people may find it takes too much effort to make their expectation
the best guess, and/or people might be unaware of some relevant information.
3. The rational expectations theory leads to the efficient markets implications that (1) a change in the
4. a. 8%
6. Current prices will be set so that the optimal forecast of a security’s return using all available
information equals the security’s equilibrium return.
8. Past performance success does not indicate that an investment adviser or a mutual fund will perform
well in the future.
10. Evaluations of technical analysis rules indicate that this approach does not outperform the market,
11. a. Research shows that small firms earn abnormally higher risk-adjusted returns.
b. Over the long run, stock prices tend to rise abnormally from December to January.
12. Exchange rates should approximately follow random walks since people would immediately bid up
(or down) currency prices to match predictions, stopping only when the predictable change in the
168 Mishkin/Eakins • Financial Markets and Institutions, Seventh Edition
Chapter 8 Mini-Case
1. Financial innovation without many regulations could increase risk taking. Government has incentive
to try to reduce the moral hazard problem created by asymmetric information. When there is any
product in the market that investors don’t know enough about, then asymmetric information is higher
and this can contribute to more risk taking, and if it is broad, it could lead to a financial crisis.
2. Loans were given to people without adequate income-adverse selection and also too much risk taking
3. Yes, without government intervention, the Recession could probably be deeper, employment could be
higher, and the extent of the global crisis could be more adverse.
4. More government spending can contribute to greater national debt, which is $14.1 trillion, and by
Chapter 10 Mini-Case
1. Lower interest rates can increase borrowing to finance durable goods items. Also, lower interest
rates can increase the value of financial securities, and cause an increase in consumption through
wealth effects. Capital investment can increase as businesses can borrow more money and issue more
2. In the 1920s, capital began flowing from Massachusetts to North Carolina, a process that continued
until after World War II as textile mills migrated to the South from New England. Beginning in the
1950s capital moved again as textile manufacturing moved to Mexico, India, and Malaysia. Capital
has long moved to where it can be used most productively, and by and large, that has been a good
Solutions to Online Mini-Cases 169
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of history, the major capital flows have been from rich countries to poorer ones. England financed
canals in this country and railroads in Australia and India. That’s no longer the case. The most notable
importer of capital in recent times has been the United States. Australia, Spain, and the United Kingdom
have also been importers of capital. Germany, Japan, China, and Switzerland have been significant
exporters of capital. Over the past 10 years, oil-exporting countries have been exporters of capital.
These facts are collectively referred to as “global imbalances.”
3. The standard view in policy circles is that they represent a serious threat to economic stability rather
than a sensible market reallocation of capital. In the standard view, such imbalances are
4. There are several reasons:
a. The dollar is the de facto international reserve currency. Speculations that other currencies
will replace the dollar in the near future are simply not credible. China could create a basket
of currencies to peg the yuan to instead of pegging to the dollar, but that is not a practical
5. As soon as foreign funds find alternatives to investment in other places, funds can be redirected to
6. Problems in the U.S. are domestic ones; we spend beyond our limit, we don’t save enough, we cannot
170 Mishkin/Eakins • Financial Markets and Institutions, Seventh Edition
Chapter 11 Mini-Case
1. a. U.S. Treasury Department
Federal Reserve System
Commercial banks
b. Treasury bills
Federal funds
2. The question should include weights from instructor, e.g. 20% in commercial paper, 20% in
negotiable certificates of deposit, 20% in treasury bills, and 40% in money market mutual funds.
Assuming the following findings from Internet resources:
Expected Rates
Assumed Weights 1 yr 6 months
CDs 20.00% 5.42% 5.19%
Tbills 20.00% 5.36% 5.12%
c. 5.00%
d. It depends on the data students collect.
Solutions to Online Mini-Cases 171
Chapter 12 Mini-Case
1. a. A financial market in which longer-term debt and equity instruments are traded
b. The largest organized security exchange in the U.S., trading about 2,675 firms
c. The second-largest security exchange in the U.S., trading about 2,500 firms
d. Security exchange made up of computer networks called NASDAQ
2. Guideline responses from this question depend upon research findings of the students. After finding
current rates, they are asked to calculate weighted average returns and compare this to the money
market portfolio from Chapter 9.
Assuming the following findings from Internet resources:
Equal
Weights
Assumed
Beg Rates
a. T-Notes 2 yr 12.5% 5.75%
i. Weighted average return = 8.41%
172 Mishkin/Eakins • Financial Markets and Institutions, Seventh Edition
Chapter 13 Mini-Case
Each student will have different value for beta depending on what stock they choose.
1. Stocks are valued as PV of the dividends. Unfortunately, some stocks (newer companies) don’t pay
dividends, and also we don’t have a precise estimate of what these dividends will be if and when they
2. Total risk will be less as the number of securities increases.
3. If the market decreases by 20%, the value of this stock will decrease by more than 20% since this is a
4. Beta of less than one means it is a defensive stock, as when the market changes, this stock value will