Roles and Major Components of the Financial System Financial system:
What is the role of the financial system, and what are the two major components of the financial system?
Roles and Major Components of the Financial System Answer
The critical role of the financial system in the economy is to gather money from households, businesses, and governments with a surplus of funds to invest and channel that money to those who need it. The two major components of the financial system are financial markets and financial institutions.
- Financial system: What is the difference between saver-lenders and borrower-spenders, and who are the major representatives of each group?
Answer: The difference between a saver-lender and a borrower-spender is that a saver-lender is someone whose income exceeds their spending and a borrower spending is someone who’s spending exceeds their incoming. Households are saver-lenders while businesses are borrower spenders.
- Financial markets: Suppose you own security that you know can be easily sold in the secondary market, but the security will sell at a lower price than you paid for it. What does this imply for the security’s marketability and liquidity?
Answer: This implies the lower the transaction cost the greater the marketability is as it can be sold into cash faster. Liquidity implies that when the security is sold there is no loss of value when converted to cash.
Roles and Major Components of the Financial System
- Financial markets: Trader Inc. is a $300 million company, as measured by asset value, and Horst Corp. is a $35 million company. Both are privately held corporations. Explain which firm is more likely to go public and register with the SEC, and why. Answer: Trader, Inc is more likely to go public because of its larger size. Though the cost of SEC registration and compliance is very high, larger firms can offset these costs by the lower funding cost in public markets. Smaller companies find the cost prohibitive for the dollar amount of the securities they are likely to sell.
- Primary market: Identify whether the following transactions are the primary market or secondary market transactions.
(a) Jim Hendry bought 300 shares of IBM through his brokerage account.
Roles and Major Components of the Financial System Answer: Secondary
(b) Peggy Jones bought $5,000 of General Motors bonds from another investor.
Answer: Secondary
(c) Hathaway Insurance Company bought 500,000 shares of Trigen Corp. when the company issued stock.
Roles and Major Components of the Financial System Answer: Primary
- Investment banking: Cranjet Inc. is issuing 10,000 bonds, and its investment banker has guaranteed a price of $985 per bond. If the investment banker sells the entire issue to investors for $10,150,000.
(a) What is the underwriting spread for this issue?
Answer: $300,000
(b) What does the percentage underwriting cost?
Answer: 3.05%
(c) How much will Cranjet raise?
Answer: $9,850,000
(Parrino, 713)
- Financial institutions: How do financial institutions act as intermediaries to provide services to small businesses?
Answer: Financial institutions act as intermediaries by converting financial securities with one set of characteristics into securities with another set of characteristics. (Parrino, 36)
- Market efficiency: Describe the informational differences that distinguish the three forms of market efficiency.
Answer: The strong form of market efficiency states that all information is reflected in the securities price. In other words, there is no private or inside information that if released would potentially change the price. The semi-strong form of market efficiency holds that all public information available to investors is reflected in the securities price. Therefore insiders with access to private information could potentially profit from trading on this information before it becomes public. Finally, the weak form of market efficiency holds that there Is bother public and private information that is not reflected in the securities price and having access to it can enable an investor to earn abnormal profits.(Parrino, 714)
- Financial markets: What are the major differences between public and private markets?
Answer: Public markets are organized financial markets where the public buys and sells securities through their stockbrokers or other brokers or dealers. The SEC regulates public securities markets in the US. In contrast, private markets involve direct transactions between two parties. These transactions lack SEC regulation. (Parrino, 714)
Roles and Major Components of the Financial System
- Interest rates: Your parents have given you $1,000 a year before your graduation so that you can take a trip when you graduate. You wisely decide to invest the money in a bank CD that pays 6.75 percent interest. You know that the trip costs $1,025 right now and that inflation for the year is predicted to be 4 percent. Will you have enough money in a year to purchase the trip?
Answer: Yes you will earn $1067.50 on the CD and the trip will cost $1066. I times 1000×6.75 percent for the Cd and 1025×4 percent for the inflation.
We can write this or a similar paper for you! Simply fill the order form!
