This is termed the "free-rider" problem. If there is improved monitoring of borrower behavior, the
problem of agency costs is likely to be reduced.
References
Short Answer Difficulty: 3 Hard
What have been the major factors contributing to growth in the foreign financial markets?
1. The amount of savings available for investment in foreign countries has increased.
2. International investors have looked to the United States and other markets for better investment
opportunities.
3. The Internet has helped provide additional information on foreign markets and overseas
investment opportunities.
4. Specialized intermediaries such as country-specific mutual funds have been developed to
facilitate overseas investments.
5. The euro has had a notable impact on the global financial system by being an important
currency for international transactions.
6. Deregulation of foreign markets has allowed many new investors to participate in international
investing.
References
Short Answer Difficulty: 2 Medium
45.
Award: 10.00 points
You are a corporate treasurer seeking to raise funds for your firm. What are some advantages of
raising funds via a financial intermediary (FI) rather than by selling securities to the public?
Advantages include:
Speed: Funds can normally be raised more quickly through FIs.
Registration process/cost: The registration process can be quite costly and time-consuming in terms
of workers' hours, audit fees, and fees to investment bankers. Raising funds via an FI can be less
expensive, particularly for smaller capital needs or when funds are needed for only a short time
period. (Maturities of 270 days or less do not require registration, nor do private placements.)
Flexible terms: Nonstandard terms can be negotiated with FIs but are difficult to sell to the public.
For example, if a borrower can only begin paying interest after two years, he or she would have a
difficult time selling bonds to the public.
Ability to change terms: There is a greater ability to renegotiate terms if necessary. Terms of public
issue generally cannot be changed outside of court.
Privacy: Less information is made public.
References
Short Answer Difficulty: 3 Hard
46.
Award: 10.00 points
How can a depository intermediary (DI) afford to purchase long-term risky direct claims from users
of funds and finance these purchases with safe, liquid, short-term, low-denomination deposits? What
can go wrong in this process?
DIs can afford to do so because the rate they must pay to attract funds is lower than the rate they
can charge on their riskier assets. A lot can go wrong, however, including:
If the money lent is not repaid, the DI may not be able to repay its depositors on demand (credit and
liquidity risk). Diversification of the credit risk is a key way DIs limit credit risk.
The difference between the rate earned on assets and the rate paid on liabilities is called the Net
Interest Margin (NIM). The NIM can turn negative if interest rates rise or if the rates on long-term
securities fall below the interest rate risk on short-term securities (after adjusting for risk).
Because the assets and liabilities are different claims, it is possible for the value of the assets to
drop resulting in an insolvent institution (insolvency risk). Because the assets are primarily financial,
their value can be quite volatile. As a result, risk management is crucial at today's financial
institution.
DIs attract many savers with a small amount of funds. DIs then invest the bulk of these savings in
investments that cannot be immediately liquidated. If the savers lose confidence in the DI, they will
seek to withdraw their money, which can precipitate a liquidity crisis and cause insolvency.
References
Short Answer Difficulty: 3 Hard
47.
Award: 10.00 points
Discuss the benefits to funds suppliers of using a financial intermediary asset transformer in place of
directly purchasing claims such as stocks or bonds. What is the major disadvantage?
Potential benefits to funds suppliers are as follows:
Professional risk managers to assess risk of borrower's claim and help decide the correct price to
pay.
Risk reduction via:
insurance.
additional diversification.
more frequent monitoring.
additional cushion of FI equity.
improved liquidity of funds supplier’s claim on FI.
Denomination intermediation.
Maturity intermediation.
The major disadvantage is that you may forego potentially higher returns if you do not purchase the
riskier direct claims.
References
Short Answer Difficulty: 2 Medium
48.
Award: 10.00 points
Discuss the major macro benefits of financial intermediaries. What role does the government have