TUTORIAL 1

AN OVERVIEW OF THE FINANCIAL SYSTEM

I. Review questions

1. What is the main function of financial markets?

2. Classify financial markets

3. List and distinguish the differences among financial instruments

4. Identify the differences among types of financial intermediaries (in terms of primary liabilities and

assets).

II. Multiple-choice questions

1. Economists group commercial banks, saving and loans associations, credit unions, mutual funds,

mutual savings banks, insurance companies, pension funds and finance companies under the

heading financial intermediaries. Financial intermediaries:

A. produce nothing of value and therefore a drain on society’s resources

B. provide a channel for linking between those who want to save and those who want to spend

C. can hurt the performance of the economy

D. have been a source of slow and resistant financial innovation

2. What is the basic activity of banks?

A. To sell shares of corporations to the general public

B. To facilitate the transfer of money from savers to borrowers

C. To represent the interest of insurance companies

D. To ensure everyone who wants a loan gets one

E. To equate future consumption with current consumption

3. Banks, savings and loans associations, mutual savings banks and credit unions

A. are no longer important players in financial intermediation

B. have been adept at innovating in response to changes in regulatory environment

D. since deregulation now provide services only to small depositors

4. Why are financial markets important to the health of the economy?

A. They channel funds from investors to savers

B. They identify and shut down inefficient firms

C. They eliminate the needs for financial intermediaries

D. They allow consumers to time their purchase better

5. These financial institutions are very small cooperative lending institutions organized around a

particular group: union members, employees of a firm and so forth. They acquire funds from deposits

called shares and primarily make consumer loans. They are:

A. Credit unions

B. Commercial banks

C. Savings and loan associations

D. Mutual fund

6. These financial intermediaries raise funds primarily by issuing checkable deposits, savings

deposits and time deposits. They then use these funds to make commercial, consumer and mortgage

loans, and to buy US government securities and municipal bonds. They are

A. Credit union

B. Commercial bank

C. Savings and loan

D. Mutual fund

7. These instruments are typically overnight loans between banks of their deposits at Federal

Reserve.

A. Commercial paper

B. Treasury bills

C. Repurchase agreement
 D. Federal Funds

E. Banker’s acceptances

8. Short-term debt instruments issued by large banks and well-known corporations

A. Commercial paper

B. Treasury bills

C. Repurchase agreement

D. Federal Funds

E. Banker’s acceptances

9. These instruments are effectively short-term loans (usually with maturity of less than two

weeks) for which Treasury bills serve as collateral, which the lender receives if the borrower does not

pay back the loan.

A. Commercial paper

B. Treasury bills

C. Repurchase agreement

D. Federal Funds

E. Banker’s acceptances

10. A share of Microsoft common stock is:

A. a liability to the shareholder because it must be sold to realize a capital gain

B. an asset of Microsoft because it allows Microsoft to invest in capital equipment or other

companies

C. identical to a bond issued by Microsoft

D. an asset for its owner and a liability for Microsoft.

11. A share of common stock is a claim on a corporationʹs

A) debt.

B) liabilities.

C) expenses.
 D) earnings and assets.

12. ___________ occurs when the potential borrowers who are the most likely to produce an

undesirable (adverse) outcome – the bad credit risks – are the ones who most actively seek out a

loan and are thus most likely to be selected.

A. Adverse selection

B. Asymmetric information

C. Moral hazard

D. Credit ratings

13. A situation where one party often does not know enough about the other party to make

accurate decisions

A. Adverse selection

B. Asymmetric information

C. Moral hazard

D. Credit ratings

14. A situation where the borrower might engage in activities that are undesirable from the lender’s

point of view because they make it less likely that the loan will be paid back.

A. Adverse selection

B. Asymmetric information

C. Moral hazard

D. Credit ratings

15. Equity holders are a corporationʹs ________. That means the corporation must pay

all of its debt holders before it pays its equity holders.

A) debtors

B) brokers

C) residual claimants

D) underwriters
 16. A corporation acquires new funds only when its securities are sold in the

A) secondary market by an investment bank.

B) primary market by an investment bank.

C) secondary market by a stock exchange broker.

D) secondary market by a commercial bank.

17.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 brokerʹs 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) Because of their short term to maturity, the prices of money market instruments tend to fluctuate

widely.

III. Practice exercises

Questions taken and adapted from chapter 2 (Mishkin, 2019)

1. Give at least three examples of a situation in which financial markets allow consumers to better

time their purchases.

2. If you suspect that a company will go bankrupt next year, which would you rather hold, bonds

issued by the company or equities issued by the company? Why?

3. Describe who issues each of the following money market instruments:

a. Treasury bills

b. Certificates of deposit
 c. Commercial paper

d. Repurchase agreement

e. Fed funds

a. Treasury bills:
Treasury bills, also known as T-bills, are issued by the U.S. Department of the Treasury on behalf of the
federal government. They are short-term debt instruments with maturities of less than one year,
typically ranging from a few days to 52 weeks. Treasury bills are considered to be one of the safest
money market instruments available due to the creditworthiness of the U.S. government.

b. Certificates of deposit:
Certificates of deposit (CDs) are issued by commercial banks, credit unions, and thrift institutions.
These financial institutions offer CDs to raise funds from depositors. A CD is a time deposit with a
fixed term and fixed interest rate. The maturity period can range from a few days to several years. CDs
typically offer higher interest rates compared to regular savings accounts, with the condition that the
funds are locked in for the duration of the term.

c. Commercial paper:
Commercial paper is issued by large corporations and financial institutions to meet their short-term
financing needs. It represents an unsecured promissory note, typically with a maturity period of less
than 270 days. The issuers of commercial paper have strong creditworthiness, and the instruments are
usually backed by the assets of the issuing organization.

d. Repurchase agreement:
A repurchase agreement, also known as a repo, is a transaction where one party sells securities
(usually government securities) with a commitment to repurchase them at a later date. The party
selling the securities is either a financial institution or a government-backed entity, such as the Federal
Reserve. Repos are commonly used as a short-term borrowing and lending tool in the money market,
and they provide collateralized funding.

e. Fed funds:
Fed funds refer to funds held by banks at the Federal Reserve. Banks maintain required reserves at the
Federal Reserve to meet regulatory requirements. Banks with excess funds can lend the money to
other banks with temporary liquidity needs. These short-term loans between banks are known as
federal funds transactions. The Federal Reserve sets the target range for the federal funds rate, which
influences the interest rates in the money market.

4. How does risk sharing benefit both financial intermediaries and private investors?

4. How does risk sharing benefit both financial intermediaries and private investors?

Risk sharing benefits both financial intermediaries and private investors in several ways:

1. Reduced Risk Exposure: Risk sharing allows financial intermediaries to diversify their
investment portfolios and spread risk across a wide range of investments. By pooling funds from
various investors, they can invest in a diverse set of assets. This reduces the impact of any individual
investment's performance on the overall portfolio and helps mitigate risk for both the intermediaries
and investors.
2. Increased Opportunities: Risk sharing enables financial intermediaries to access a larger pool
of investment opportunities. They can invest in a variety of assets, including those that may require a
larger capital base or have higher risk levels. Private investors benefit by gaining exposure to a wider
range of investment options that they might not have access to individually.
3. Professional Management: Financial intermediaries have expertise in managing portfolios and
assessing investment risks. By entrusting their funds to intermediaries, private investors can benefit
from professional management skills. These intermediaries can conduct thorough due diligence,
monitor market conditions, and make well-informed investment decisions. This provides peace of
mind for private investors, who may lack the time or knowledge to manage investments effectively
themselves.
4. Cost Efficiency: Risk sharing can lead to cost savings for both financial intermediaries and
private investors. Financial intermediaries benefit from economies of scale. They can negotiate better
pricing on investment opportunities, achieve lower transaction costs, and access better research and
analysis resources. These cost efficiencies can then be passed on to private investors in the form of
lower fees or expenses, enhancing their investment returns.
5. Access to Liquidity: Risk sharing through financial intermediaries provides private investors
with increased liquidity. They can buy and sell shares or units of pooled investment vehicles, such as
mutual funds or exchange-traded funds (ETFs), at market prices. This liquidity allows investors to easily
enter or exit investments, providing flexibility and convenience compared to directly investing in
illiquid assets.

Overall, risk sharing through financial intermediaries facilitates efficient allocation of capital,
diversification of risk, access to professional management, cost savings, and increased liquidity. These
benefits help both intermediaries and private investors achieve their financial goals while managing
risk effectively.
HT
4. Việc chia sẻ rủi ro mang lại lợi ích như thế nào cho cả các trung gian tài chính và nhà đầu tư tư
nhân?

Chia sẻ rủi ro mang lại lợi ích cho cả các trung gian tài chính và nhà đầu tư tư nhân như sau:

1. Giảm khả năng chịu rủi ro: Chia sẻ rủi ro cho phép các trung gian tài chính phân tán rủi ro
trên nhiều khoản đầu tư. Bằng cách huy động vốn từ các nhà đầu tư khác nhau, các trung gian có thể
đầu tư vào nhiều tài sản khác nhau. Điều này giảm tác động của hiệu suất đầu tư của từng khoản đầu
tư riêng lẻ đối với tổng thể danh mục và giúp giảm thiểu rủi ro cho cả trung gian tài chính và nhà đầu
tư.
2. Tạo ra cơ hội đầu tư đa dạng: Chia sẻ rủi ro cho phép các trung gian tài chính tiếp cận với
một nguồn lực đầu tư lớn hơn. Họ có thể đầu tư vào nhiều tài sản, bao gồm cả những tài sản yêu cầu
quỹ vốn lớn hơn hoặc có mức độ rủi ro cao hơn. Người đầu tư tư nhân cũng hưởng lợi khi có cơ hội
tiếp cận với nhiều lựa chọn đầu tư mà họ có thể không thể tiếp cận khi đầu tư độc lập.
3. Quản lý chuyên nghiệp: Các trung gian tài chính có kiến thức và kinh nghiệm trong quản lý
danh mục và đánh giá rủi ro đầu tư. Bằng cách gửi tiền cho các trung gian, nhà đầu tư tư nhân có thể
hưởng lợi từ kỹ năng quản lý chuyên nghiệp. Các trung gian có thể tiến hành nghiên cứu kỹ lưỡng,
theo dõi tình hình thị trường và đưa ra quyết định đầu tư dựa trên thông tin chính xác. Điều này mang
lại an tâm cho nhà đầu tư tư nhân, những người có thể không có thời gian hoặc kiến thức để quản lý
đầu tư hiệu quả.
4. Hiệu quả chi phí: Chia sẻ rủi ro có thể dẫn đến tiết kiệm chi phí cho cả các trung gian tài chính
và nhà đầu tư tư nhân. Các trung gian tài chính có lợi từ quy mô kinh tế. Họ có thể đàm phán giá tốt
hơn đối với các cơ hội đầu tư, giảm chi phí giao dịch và tiếp cận nguồn lực nghiên cứu và phân tích
tốt hơn. Các hiệu quả chi phí này sau đó có thể được truyền đến nhà đầu tư tư nhân dưới dạng giảm
phí hoặc chi phí, tăng cường lợi nhuận đầu tư của họ.
5. Tiếp cận dòng tiền: Chia sẻ rủi ro thông qua các trung gian tài chính cung cấp cho nhà đầu tư
tư nhân tính thanh khoản cao hơn. Họ có thể mua bán cổ phiếu hoặc đơn vị trong các công cụ đầu tư
hợp nhất như quỹ mở hoặc quỹ giao dịch (ETF) với giá thị trường. Tính thanh khoản này giúp nhà đầu
tư dễ dàng tham gia hoặc rút ra khỏi đầu tư, mang lại sự linh hoạt và tiện lợi hơn so với việc đầu tư
trực tiếp vào tài sản không dễ chuyển đổi.

Tổng quát, chia sẻ rủi ro thông qua các trung gian tài chính tạo điều kiện cho việc phân bổ vốn hiệu
quả, phân tán rủi ro, tiếp cận quản lý chuyên nghiệp, tiết kiệm chi phí và tăng cường thanh khoản.
Những lợi ích này giúp cả trung gian tài chính và nhà đầu tư tư nhân đạt được mục tiêu tài chính của
họ trong khi quản lý rủi ro hiệu quả.

5. You have just purchased a 10-year, $1,000 par value bond. The coupon rate on this bond is 8

percent annually, with interest being paid each 6 months. If you expect to earn a 10 percent yield

on this bond, how much did you pay for it?

6. Callaghan Motors ‘bonds have 10 years remaining to maturity. Interest is paid annually, they have

a $1,000 par value, the coupon interest rate is 8%, and the yield to maturity is 9%. What is the

bond’s current market price?

7. A bond has a $1,000 par value, 10 years to maturity, and a 7% annual coupon and sells for $985.

a. What is its yield to maturity (YTM)?

b. Assume that the yield to maturity remains constant for the next 3 years. What will the price

be 3 years from today?