Econ 308 Chapter 2

Assume that you borrow $2000 at 10% annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is

$201.

_________ are short-term loans in which Treasury bills serve as collateral.

Repurchase agreements

Which of the following is an example of an intermediate-term debt? A) a fifteen-year mortgage B) a sixty-month car loan C) a six-month loan from a finance company D) a thirty-year U.S. Treasury bond

B) A sixty-month car loan

Every financial market has the following characteristic.

It channels funds from lenders-savers to borrowers-spenders.

When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called an

exchange.

Financial markets have the basic function of

getting people with funds to lend together with people who want to borrow funds.

The principal lender-savers are

households.

You can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is

5%.

Describe two methods in the secondary market.

A secondary market can be organized as an exchange where buyers and sellers meet in one central location to conduct trades. An example of an exchange is the New York Stock Exchange. A secondary market can also be organized as an over-the-counter market. In this type of market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices. An example of an over-the-counter market is the federal funds market.

Which of the following can be described as involving direct finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys a short-term corporate security in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets

A) A corporation issues new shares of stock.

Which of the following statements about financial markets and securities is TRUE?A) Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as the New York Stock Exchange. B) As a corporation gets a share of the broker's commission, a corporation acquires new funds whenever its securities are sold. C) Capital market securities are usually more widely traded than shorter-term securities and so tend to be more liquid. D) Prices of capital market securities are usually more stable than prices of money market securities, and so are often used to hold temporary surplus funds of corporations.

A) Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as the New York Stock Exchange.

Which of the following statements about the characteristics of debt and equities is TRUE? A) They can both be long-term financial instruments. B) Bond holders are residual claimants. C) The income from bonds is typically more variable than that from equities. D) Bonds pay dividends.

A) They can both be long-term financial

If the maturity of a debt instrument is less than one year, the debt is called

A) short-term.

Which of the following can be described as direct finance? A) You take out a mortgage from your local bank. B) You borrow $2500 from a friend. C) You buy shares of common stock in the secondary market. D) You buy shares in a mutual fund.

B

Which of the following statements about the characteristics of debt and equity is FALSE? A) They can both be long-term financial instruments. B) They can both be short-term financial instruments. C) They both involve a claim on the issuer's income. D) They both enable a corporation to raise funds.

B) They can both be short-term financial instruments.

Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) You buy shares in a mutual fund. C) You buy a U.S. Treasury bill from the U.S. Treasury at Treasury Direct.gov. D) You purchase shares in an initial public offering by a corporation in the primary market.

B) You buy shares in a mutual fund.

__________ work in the secondary markets matching buyers with sellers of securities.

Brokers

Which of the following is NOT a secondary market? A) foreign exchange market B) futures market C) options market D) IPO market

D) IPO market

Which of the following can be described as involving direct finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys a short-term corporate security in a secondary market. D) People buy shares of common stock in the primary markets.

D) People buy shares of common stock in the primary markets.

Which of the following statements about financial markets and securities is TRUE? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is intermediate term if its maturity is ten years or longer. D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date.

D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date.

Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) A corporation buys a share of common stock issued by another corporation in the primary market. C) You buy a U.S. Treasury bill from the U.S. Treasury at TreasuryDirect.gov. D) You make a deposit at a bank.

D) You make a deposit at a bank.

Corporations receive funds when their stock is sold in the primary market. Why do corporations pay attention to what is happening to their stock in the secondary market?

The existence of the secondary market makes their stock more liquid and the price in the secondary market sets the price that the corporation would receive if they choose to sell more stock in the primary market.

Forty or so dealers establish a "market" in these securities by standing ready to buy and sell them.

U.S. government bonds

Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in the United States?

With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in the U.S.

A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called

a certificate of deposit.

Which of the following benefits directly from any increase in the corporation's profitability?

a shareholder

Well-functioning financial markets

allow the economy to operate.

Collateral is _______ the lender receives if the borrower does not pay back the loan.

an asset

A liquid asset is

an asset that can easily and quickly be sold to raise cash.

Securities are __________ for the person who buys them, but are ___________ for he individuals or firm that issues them.

assets; liabilities

Equity instruments are traded in the __________ market

capital

A short-term debt instrument issued by well-known corporations is called

commercial paper.

U.S. Treasury bills are considered the safest of all money market instruments because there is a low probability of

default.

With _________ finance, borrowers obtain funds from lenders by selling them securities in the financial market.

direct

U.S. Treasury bills pay no interest buy are sold at a ____________. That is, you will pay a lower purchase price than the amount you receive at maturity.

discount

An important financial institution that assists in the initial sale of securities in the primary market is the

investment bank.

Secondary markets make financial instruments more

liquid.

Federal funds are

loans made by banks to each other.

An important function of secondary markets is to

make it easier to sell financial instruments to raise funds.

A financial market in which only short-term debt instruments are traded is called the __________ market.

money

Because these securities are more liquid and generally have smaller price fluctuations, corporations and banks use the __________ securities to earn interest on temporary surplus.

money market

The higher a security's price in the secondary market the _______ funds a firm can raise by selling securities in the ________ market.

more; primary

In an ____________ market, dealer in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices.

over-the-counter

A breakdown of financial markets can result in

political instability.

A corporation acquires new funds only when its securities are sold in the

primary market by an investment bank.

Equity holders are a corporation's __________. That means that corporation must pay all of its debt holders before it pays its equity holders.

residual claimants

With direct finance, funds are channeled through the financial market from the ___________ directly to the __________.

savers; spenders

A financial market in which previously issued securities can be resold is called a __________ market.

secondary

When I purchase ___________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors.

stock

Long-term debt has a maturity than is

ten years or longer.

Prices of money market instruments undergo the least price fluctuation because of

the short terms to maturity for the securities.

Financial markets improve economic welfare because

they allow consumers to time their purchase better.

When an investment bank _________ securities, it guarantees a price for a corporation's securities and then sells them to the public.

underwrites