Solutions to Chapter 2
Financial Markets and Institutions
1. The story of Apple Computer provides three examples of financing sources: equity
investments by the founders of the company, trade credit from suppliers, and
2. Money markets: where short-term debt instruments are bought and sold.
Foreign-exchange markets: where currencies are traded; most trading takes place in
Commodities markets: where agricultural commodities, fuels (including crude oil and
Derivatives markets: where options and other derivative instruments are traded.
3. a. False. Financing could flow through an intermediary, for example.
4. a. Investor A buys shares in a mutual fund, which buys part of a new stock issue
b. Investor B buys shares issued by the Bank of New York, which lends money to a
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c. Investor C buys part of a new stock issue by the Regional Life Insurance Company,
5. Buy shares in a mutual fund. Mutual funds pool savings from many individual
6. Yes, an insurance company is a financial intermediary. Insurance companies sell
7.
a. Equities. As a percentage of all investors, households are the largest investor in equities.
b. Pension funds. Banks own almost no corporate equities, but instead rely on fixed-
c. Commercial banks. In contrast, investment banks raise money for corporations.
8. NASDAQ and The Chicago Mercantile Exchange are financial markets.
9.
a. False. Exchange traded funds (ETFs) are portfolios of
b. False. Hedge funds may provide diversification, but usually
c. True. Insurance policy premiums are used to pay claims,
d. True. The size of the pension investment is variable,
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10. Liquidity is important because investors want to be able to convert their
investments into cash quickly and easily when it becomes necessary or desirable to
Liquidity is also important to mutual funds. When the mutual fund’s shareholders
want to redeem their shares, the mutual fund is often forced to sell its securities. In
11. The key to the bank’s ability to provide liquidity to depositors is the bank’s ability
to pool relatively small deposits from many investors into large, illiquid loans to
12. Commercial banks accept deposits and provide financing primarily for businesses.
Investment banks do not accept deposits and do not loan money to businesses and
13. Mutual funds collect money from small investors and invest the money in corporate
stocks or bonds, thus channeling savings from investors to corporations. For
14. Financial markets and financial intermediaries channel savings to real investments. They
also channel money from individuals who want to save for the future to those who need
cash to spend today. A third function of financial markets is to allow individuals and
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15. The major functions of financial markets and institutions in a modern financial
system are:
Channeling savings to real investment: The savings of individual investors are
Transporting cash across time: Savers can save money now to be withdrawn
Risk transfer and diversification: Insurance companies allow individuals and
Liquidity: Financial markets and institutions provide investors with the ability
Payment mechanism: Financial institutions provide alternatives to cash
Information provided by financial markets: Financial markets reveal
16. The market price of gold can be observed from transactions in commodity markets.
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17. Financial markets provide extensive data that can be useful to financial managers.
Examples include:
Prices for agricultural commodities, metals, and fuels.
Interest rates for a wide array of loans and securities, including money market
Foreign exchange rates.
Stock prices and overall market values for publicly listed corporations, as
18.
a. 178.5 × $90 = $16.065 billion
b. 3.03 %
c. The farmer sells cattle since he raises them. The meat packer buys cattle because he
19.
a. False. The financial crisis had its roots in an easy monetary policy that provided
b. False. Subprime mortgages are for residential properties.
c. True. Most subprime mortgages were packaged together to be resold as
d. False. The government arranged for Bank of America to take over Merrill but did
e. False. Though the massive bailout of Greece calmed the markets somewhat,
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