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Chapter 8
ANSWERS TO QUESTIONS
1. For each of the following countries, identify the single most important (largest) and least
important (smallest) source of external funding: United States; Germany; Japan; Canada.
Comment on the similarities and differences among the countries’ funding sources.
For each country, the largest (most important) is listed first, and smallest (least important) is
2. How can economies of scale help explain the existence of financial intermediaries?
3. Explain why dating can be considered a method to solve the adverse selection problem.
When a couple dates, they are (explicitly or implicitly) extracting information about the
4. Why are financial intermediaries willing to engage in information collection activities when
investors in financial instruments may be unwilling to do so?
Investors in financial instruments who engage in information collection face a free-rider
problem, which means other investors may be able to benefit from their information without
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 114
Copyright © 2019 by Pearson Education, Inc. All rights reserved.
financial intermediaries. However, without proper regulations (i.e., prudential regulation and
supervision) to limit the moral hazard problems associated with a system of deposit
insurance, banks will probably accept more risks than they would otherwise do. This is
obviously not a desired consequence. The increase in moral hazard problems will probably
offset the benefit derived from avoiding bank runs (the most immediate
effect of a system of deposit insurance).
21. Gustavo is a young doctor who lives in a country with a relatively inefficient legal and
financial system. When Gustavo applied for a mortgage, he found that banks usually
required collateral for up to 300% of the amount of the loan. Explain why banks might
require that much collateral in such a financial system. Comment on the consequences of
such a system for economic growth.
ANSWERS TO APPLIED PROBLEMS
For Problems 22–25, use the fact that the expected value of an event is a probability weighted
average, the sum of each possible outcome multiplied by the probability of the event occurring.
22. You are in the market for a used car and decide to visit a used car dealership. You know that
the Blue Book value of the car you are looking at is between $20,000 and $24,000. If you
believe the dealer knows as much about the car as you do, how much are you willing to pay?
Why? Assume that you care only about the expected value of the car you will buy and that the
car values are symmetrically distributed.
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23. Refer to Problem 22. Now you believe the dealer knows more about the car than you do.
How much are you willing to pay? Why? How can this asymmetric information problem be
resolved in a competitive market?
You are willing to pay the average price up front: $22,000. However, the dealer will know
24. You wish to hire Ron to manage your Dallas operations. The profits from the operations
depend partially on how hard Ron works, as follows.
Profit Probabilities
Profit = $10,000
Profit = $50,000
Lazy
60%
40%
Hard worker
20%
80%
If Ron is lazy, he will surf the Internet all day, and he views this as a zero cost opportunity.
However, Ron views working hard as a “personal cost” valued at $1,000. What fixed
percentage of the profits should you offer Ron? Assume Ron cares only about his expected
payment less any “personal cost.”
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ANSWERS TO DATA ANALYSIS PROBLEMS
1. Go to the St. Louis Federal Reserve FRED database and find data on the percent of value of
loans secured by collateral for all commercial and industrial loans (ESANQ) and the net
percentage of domestic banks tightening standards for commercial and industrial loans to
large and middle-market firms (DRTSCILM). Download the data into a spreadsheet.
a. Calculate the average, over the most recent four quarters and the four quarters prior to
that, for the bank standards indicator and the “percent of loans secured by collateral”
indicator. Do these averages behave as you would expect?
See summary table below for the periods of 2016:Q2 to 2017:Q1 and 2015:Q2 to
2016:Q1. There seems to be an direct relationship between percent value of loans
collateralized and net tightening of C&I lending standards. As the percent value of loans
Percent Value of C&I
Loans Collateralized,
Average
Net Tightening of C&I
Lending Standards,
Average
62.0
5.8
55.9
0.8
b. Use the Data Analysis tool in Excel to calculate the correlation coefficient for the two
data series from 1997:Q3 to the most recent quarter of data available. What can you
conclude about the relationship between collateral and bank C&I lending standards? Is
this result consistent with efforts to reduce asymmetric information?