Foundations of Financial Markets and Institutions, 4e (Fabozzi/Modigliani/Jones) Chapter 1 Introduction Multiple Choice Questions 1 Financial Assets 1) An asset is a possession

that has value in an exchange and can be classified as ________. A) financial or intangible. B) financial or variable. C) tangible or intangible. D) fixed or variable. Answer C Diff ! "opic 1.1 #inancial Assets $b%ective 1.& the various wa's to classif' financial (ar)ets !) "he financial asset is referred to as a ________ if the clai( is a fixed dollar. A) debt instru(ent. B) co((on e*uit' instru(ent. C) derivative instru(ent. D) preferred e*uit' instru(ent. Answer A Diff ! "opic 1.1 #inancial Assets $b%ective 1.+ the distinction between debt instru(ents and e*uit' instru(ents ,) A basic econo(ic principle is that the price of an' financial asset ________ the present value of its expected cash flow- even if the cash flow is not )nown with certaint'. A) is greater than B) is e*ual to C) is less than D) is e*ual to or greater than Answer B Diff ! "opic 1.1 #inancial Assets $b%ective 1.1 what a financial asset is and the principal econo(ic functions of financial assets

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+) A4n) ________ such as plant or e*uip(ent purchased b' a business entit' shares at least one characteristic with a financial asset Both are expected to generate future cash flow for their owner. A) tangible asset B) intangible asset C) balance sheet asset D) cash asset Answer A Diff 1 "opic 1.1 #inancial Assets $b%ective 1.! the distinction between financial assets and tangible assets &) #inancial assets have two principal econo(ic functions. 5hich of the below is $61 of these7 A) A principal econo(ic function is to transfer funds fro( those who have surplus funds to borrow to those who need funds to invest in intangible assets. B) A principal econo(ic function is to transfer funds in such a wa' as to redistribute the avoidable ris) associated with the cash flow generated b' intangible assets a(ong those see)ing and those providing the funds. C) A principal econo(ic function is to transfer funds in such a wa' as to redistribute the unavoidable ris) associated with the cash flow generated b' tangible assets a(ong those see)ing and those providing the funds. D) A principal econo(ic function is to transfer funds fro( those who have surplus funds to invest to those who need funds to invest in intangible assets. Answer C Co((ent #inancial assets have two principal econo(ic functions. 41) "he first is to transfer funds fro( those who have surplus funds to invest to those who need funds to invest in tangible assets. 4!) "he second econo(ic function is to transfer funds in such a wa' as to redistribute the unavoidable ris) associated with the cash flow generated b' tangible assets a(ong those see)ing and those providing the funds. Diff , "opic 1.1 #inancial Assets $b%ective 1.1 what a financial asset is and the principal econo(ic functions of financial assets

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8) A principal econo(ic function to transfer funds fro( those who have ________ to invest to those who need funds to invest in ________. A) deficit funds9 tangible assets. B) surplus funds9 intangible assets. C) deficit funds9 intangible assets. D) surplus funds9 tangible assets. Answer D Co((ent #inancial assets have two principal econo(ic functions. 41) "he first is to transfer funds fro( those who have surplus funds to invest to those who need funds to invest in tangible assets. 4!) "he second econo(ic function is to transfer funds in such a wa' as to redistribute the unavoidable ris) associated with the cash flow generated b' tangible assets a(ong those see)ing and those providing the funds. Diff ! "opic 1.1 #inancial Assets $b%ective 1.1 what a financial asset is and the principal econo(ic functions of financial assets 2 Financial Mar ets 1) #inancial (ar)ets provide three econo(ic functions. 5hich of the below is 6$" one of these7 A) "he interactions of bu'ers and sellers in a financial (ar)et deter(ine the price of the traded asset. B) #inancial (ar)ets provide a (echanis( for an investor to sell a financial asset. C) #inancial (ar)ets increases the cost of transacting. D) "he interactions of bu'ers and sellers in a financial (ar)et deter(ine the re*uired return on a financial asset. Answer C Co((ent #inancial (ar)ets provide three econo(ic functions. First! the interactions of bu'ers and sellers in a financial (ar)et deter(ine the price of the traded asset. $r- e*uivalentl'- the' deter(ine the re*uired return on a financial asset. As the nduce(ent for fir(s to ac*uire funds depends on the re*uired return that investors de(and- it is this feature of financial (ar)ets that signals how the funds in the econo(' should be allocated a(ong financial assets. "his is called the price discover' process. "econd- financial (ar)ets provide a (echanis( for an investor to sell a financial asset. Because of this feature- it is said that a financial (ar)et offers li*uidit'- an attractive feature when circu(stances either force or (otivate an investor to sell. 2f there were not li*uidit'- the owner would be forced to hold a debt instru(ent until it (atures and an e*uit' instru(ent until the co(pan' is either voluntaril' or involuntaril' li*uidated.5hile all financial (ar)ets provide so(e for( of li*uidit'- the degree of li*uidit' is one of the factors that characteri:e different (ar)ets. "he third econo(ic function of a financial (ar)et is that it reduces the cost of transacting. "here are two costs associated with transacting search costs and infor(ation costs. Diff , "opic 1.! #inancial Mar)ets $b%ective 1., what a financial (ar)et is and the principal econo(ic functions it perfor(s ,
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!) "he shifting of the financial (ar)ets fro( do(inance b' retail investors to institutional investors is referred to as the ________ of financial (ar)ets. A) globali:ation B) institutionali:ation C) securiti:ation D) diversification Answer B Diff ! "opic 1.! #inancial Mar)ets $b%ective 1.& the various wa's to classif' financial (ar)ets ,) #inancial (ar)ets can be categori:ed as those dealing with newl' issued financial clai(s that are called the ________- and those for exchanging financial clai(s previousl' issued that are called the ________. A) secondar' (ar)et9 pri(ar' (ar)et. B) financial (ar)et9 secondar' (ar)et. C) $"C (ar)et9 6;<1=AM1> (ar)et. D) pri(ar' (ar)et9 secondar' (ar)et. Answer D Diff ! "opic 1.! #inancial Mar)ets $b%ective 1.8 the differences between the pri(ar' and secondar' (ar)ets +) Business entities include nonfinancial and financial enterprises. ________ (anufacture products such as cars and co(puters and=or provide nonfinancial services such as transportation and utilities. A) #inancial enterprises B) 6onfinancial enterprises C) Both financial and nonfinancial enterprises D) 6one of these Answer B Diff 1 "opic 1.! #inancial Mar)ets $b%ective 1.? the participants in financial (ar)ets

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# $lobalization of Financial Mar ets 1) 5hich of the below is 6$" a factor that has led to the integration of financial (ar)ets7 A) A factor is liberali:ation of (ar)ets and the activities of (ar)et participants in )e' financial centers of the world. B) A factor is deregulation of (ar)ets and the activities of (ar)et participants in )e' financial centers of the world. C) A factor is technological advances for (onitoring world (ar)ets- executing orders- and anal':ing financial opportunities. D) A factor is decreased institutionali:ation of financial (ar)ets. Answer D Co((ent "he factors that have led to the integration of financial (ar)ets are 41) deregulation or liberali:ation of (ar)ets and the activities of (ar)et participants in )e' financial centers of the world9 4!) technological advances for (onitoring world (ar)ets- executing orders- and anal':ing financial opportunities9 and 4,) increased institutionali:ation of financial (ar)ets. Diff , "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.A reasons for the globali:ation of financial (ar)ets !) A factor leading to the integration of financial (ar)ets is ________. A) decreased institutionali:ation of financial (ar)ets. B) increased (onitoring of (ar)ets. C) technological advances for (onitoring do(estic (ar)ets- executing orders- and anal':ing financial opportunities. D) technological advances for (onitoring world (ar)ets- executing orders- and disregarding financial opportunities. Answer D Co((ent "he factors that have led to the integration of financial (ar)ets are 41) deregulation or liberali:ation of (ar)ets and the activities of (ar)et participants in )e' financial centers of the world9 4!) technological advances for (onitoring %orld (ar)ets- executing orders- and anal&zing financial opportunities9 and 4,) increased institutionali:ation of financial (ar)ets. Diff ! "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.A reasons for the globali:ation of financial (ar)ets

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,) #ro( the perspective of a given countr'- financial (ar)ets can be classified as either internal or external. "he internal (ar)et is co(posed of two parts the do(estic (ar)et and the foreign (ar)et. "he do(estic (ar)et is ________. A) where the securities of issuers not do(iciled in the countr' are sold and traded. B) where issuers do(iciled in a countr' issue securities and where those securities are subse*uentl' traded. C) where securities are offered si(ultaneousl' to investors in a nu(ber of countries. D) where issuers do(iciled in a countr' issue securities and where those securities are 6$" subse*uentl' traded. Answer B Diff ! "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.1/ the distinction between a do(estic (ar)et- a foreign (ar)et- and the 1uro(ar)et +) A reason for a corporation using ________ is a desire b' issuers to diversif' their source of funding so as to reduce reliance on do(estic investors. A) 1uro(ar)ets B) do(estic e*uit' (ar)ets C) do(estic govern(ent (ar)ets D) 6one of these Answer A Diff 1 "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.11 the reasons wh' entities use foreign (ar)ets and 1uro(ar)ets ' (erivative Mar ets 1) "he two basic t'pes of derivative instru(ents are ________ and ________. A) insurance contracts9 options contracts B) futures=forward contracts9 indentures C) futures=forward contracts9 legal contracts D) futures=forward contracts9 options contracts Answer D Diff ! "opic 1.+ Derivative Mar)ets $b%ective 1.1! what a derivative instru(ent is and the two basic t'pes of derivative instru(ents

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!) Derivative instru(ents derive their value fro( ________. A) (ar)et conditions at ti(e of deliver'. B) (ar)et conditions at ti(e of issue. C) the underl'ing instru(ents to which the' relate. D) variations in the future clai(s conve'ed fro( spot (ar)ets. Answer C Diff ! "opic 1.+ Derivative Mar)ets $b%ective 1.1, the role of derivative instru(ents ,) Derivative contracts provide ________. A) issuers and investors an expensive but efficient wa' of controlling so(e (a%or ris)s. B) issuers and investors an inexpensive wa' of controlling so(e (a%or ris)s. C) issuers and investors an inexpensive but inefficient wa' of controlling all (a%or ris)s. D) issuers and investors an expensive wa' of controlling so(e (inor ris)s. Answer B Diff 1 "opic 1.+ Derivative Mar)ets $b%ective 1.1, the role of derivative instru(ents +) Derivative (ar)ets (a' have at least three advantages over the corresponding cash 4spot) (ar)et for the sa(e financial asset. 5hich of the below is $61 of these advantages7 A) "ransactions t'picall' can be acco(plished faster in the derivatives (ar)et. B) 2t will alwa's cost (ore to execute a transaction in the derivatives (ar)et in order to ad%ust the ris) exposure of an investorBs portfolio to new econo(ic infor(ation than it would cost to (a)e that ad%ust(ent in the cash (ar)et. C) All derivative (ar)ets can absorb a greater dollar transaction without an adverse effect on the price of the derivative instru(ent9 that is- the derivative (ar)et (a' be (ore li*uid than the cash (ar)et. D) <o(e derivative (ar)ets can absorb a greater dollar transaction but with an adverse effect on the price of the derivative instru(ent9 that is- the derivative (ar)et (a' be (ore li*uid than the cash (ar)et. Answer A Co((ent Derivative (ar)ets (a' have at least three advantages over the corresponding cash 4spot) (ar)et for the sa(e financial asset. First- depending on the derivative instru(ent- it )a& cost less to execute a transaction in the derivatives (ar)et in order to ad%ust the ris) exposure of an investorCCs portfolio to new econo(ic infor(ation than it would cost to (a)e that ad%ust(ent in the cash (ar)et. "econd- transactions t'picall' can be acco(plished faster in the derivatives (ar)et. *hird- so)e derivative (ar)ets can absorb a greater dollar transaction %ithout an adverse effect on the price of the derivative instru(ent9 that is- the derivative (ar)et (a' be (ore li*uid than the cash (ar)et. Diff , "opic 1.+ Derivative Mar)ets $b%ective 1.1, the role of derivative instru(ents

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+ *he ,ole of the $overn)ent in Financial Mar ets 1) 5hich of the following state(ents is #AD<17 A) Because of the pro(inent role pla'ed b' financial (ar)ets in econo(ies- govern(ents have long dee(ed it necessar' to regulate certain aspects of these (ar)ets. B) 2n their regulator' capacities- govern(ents have had little influence on the develop(ent and evolution of financial (ar)ets and institutions. C) 2t is i(portant to reali:e that govern(ents- (ar)ets- and institutions tend to behave interactivel' and to affect one anotherBs actions in certain wa's. D) A sense of how the govern(ent can affect a (ar)et and its participants is i(portant to an understanding of the nu(erous (ar)ets and securities. Answer B Co((ent 2n their regulator' capacities- govern(ents have greatl& influenced the develop(ent and evolution of financial (ar)ets and institutions. Diff ! "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.1& the different wa's that govern(ents regulate (ar)ets- including disclosure regulation- financial activit' regulation- financial institution regulation- regulation of foreign fir( participation- and regulation of the (onetar' s'ste( !) 5hich of the below state(ents is "EF17 A) Because of differences in culture and histor'- different countries regulate financial (ar)ets and financial institutions in var'ing wa's- e(phasi:ing so(e for(s of regulation (ore than others. B) "he standard explanation or %ustification for govern(ental regulation of a (ar)et is that the (ar)et- left to itself- will produce its particular goods or services in an efficient (anner and at the lowest possible cost. C) @overn(ents in (ost developed econo(ies have created elaborate s'ste(s of regulation for financial (ar)ets- in part because the (ar)ets the(selves are si(ple and in part because financial (ar)ets are uni(portant to the general econo(ies in which the' operate. D) #inancial activit' regulation are free of rules about traders of securities and trading on financial (ar)ets. Answer A Co((ent "he standard explanation or %ustification for govern(ental regulation of a (ar)et is that the (ar)et- left to itself- will not produce its particular goods or services in an efficient (anner and at the lowest possible cost. @overn(ents in (ost developed econo(ies have created elaborate s'ste(s of regulation for financial (ar)ets- in part because the (ar)ets the(selves are co)ple- and in part because financial (ar)ets are so i)portant to the general econo(ies in which the' operate. #inancial activit' regulation consists of rules about traders of securities and trading on financial (ar)ets. Diff , "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.1+ the t'pical %ustification for govern(ental regulation of (ar)ets

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,) "he regulator' structure in the Fnited <tates is largel' the result of ________. A) the first 20$ bubble in the !/th centur'. B) the boo( in the stoc) (ar)et experienced in the 1GG/s. C) bull (ar)ets that have occurred at various ti(es. D) financial crises that have occurred at various ti(es. Answer D Diff 1 "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.18 the F.<. Depart(ent of the "reasur'Bs proposed plan for regulator' refor( +) "he proposal b' the F.<. Depart(ent of the "reasur'- popularl' referred to as the HBlueprint for Eegulator' Eefor(H or si(pl' Blueprint- would replace the prevailing co(plex arra' of regulators with a regulator' s'ste( based on functions. More specificall'- there would be three regulators. 5hich of the below is 6$" one of these7 A) (ar)et stabilit' regulator B) prudential regulator C) uninhibited regulator D) business conduct regulator Answer C Diff ! "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.1& the different wa's that govern(ents regulate (ar)ets- including disclosure regulation- financial activit' regulation- financial institution regulation- regulation of foreign fir( participation- and regulation of the (onetar' s'ste( . Financial Innovation 1) ________ increase the li*uidit' of (ar)ets and the availabilit' of funds b' attracting new investors and offering new opportunities for borrowers. A) Mar)etIbroadening instru(ents B) Mar)etI(anage(ent instru(ents C) Eis)I(anage(ent instru(ents D) ArbitragingIbroadening instru(ents Answer A Co((ent "he 1cono(ic Council of Canada classifies financial innovations into the following three broad categories 41) )ar et/broadening instru)ents- which increase the li*uidit' of (ar)ets and the availabilit' of funds b' attracting new investors and offering new opportunities for borrowers 4!) ris /)anage)ent instru)ents- which reallocate financial ris)s to those who are less averse to the(- or who offsetting exposure and thus are presu(abl' better able to should the( 4,) arbitraging instru)ents and processes- which enable investors and borrowers to ta)e advantage of differences in costs and returns between (ar)ets- and which reflect differences in the perception of ris)s- as well as in infor(ation- taxation- and regulations Diff ! "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation G
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!) "he 1cono(ic Council of Canada classifies financial innovations into three broad categories. 5hich of the below is 6$" one of these7 A) (ar)etIbroadening instru(ents B) ris)I(anage(ent instru(ents C) ris)Ibroadening instru(ents D) arbitraging instru(ents and processes Answer C Co((ent "he 1cono(ic Council of Canada classifies financial innovations into the following three broad categories 41) )ar et/broadening instru)ents- which increase the li*uidit' of (ar)ets and the availabilit' of funds b' attracting new investors and offering new opportunities for borrowers 4!) ris /)anage)ent instru)ents- which reallocate financial ris)s to those who are less averse to the(- or who offsetting exposure and thus are presu(abl' better able to should the( 4,) arbitraging instru)ents and processes- which enable investors and borrowers to ta)e advantage of differences in costs and returns between (ar)ets- and which reflect differences in the perception of ris)s- as well as in infor(ation- taxation- and regulations Diff ! "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation ,) "here are two extre(e views of financial innovation. 5hich of the below is $61 of these7 A) <o(e hold that the essence of innovation is the introduction of financial assets that are less efficient for redistributing ris)s a(ong (ar)et participants. B) "here are so(e who believe that the (inor i(petus for innovation has been the endeavor to circu(vent regulations and find loopholes in tax rules. C) <o(e hold that the essence of innovation is the introduction of financial instru(ents that are (ore efficient for redistributing ris)s a(ong (ar)et participants. D) 6one of these Answer C Co((ent "here are two extre(e views of financial innovation. "here are so(e who believe that the )a0or i(petus for innovation has been the endeavor to circu(vent 4or arbitrage) regulations and find loopholes in tax rules. At the other extre(e- so(e hold that the essence of innovation is the introduction of financial instru(ents that are )ore efficient for redistributing ris)s a(ong (ar)et participants. Diff ! "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation

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+) An ulti(ate and i(portant cause of financial innovation does not involve ________. A) incentives to follow existing regulation and and tax laws. B) increased volatilit' of interest rates- inflation- e*uit' prices- and exchange rates. C) changing global patterns of financial wealth. D) financial inter(ediar' co(petition. Answer A Co((ent 2t would appear that (an' of the innovations that have passed the test of ti(e and have not disappeared have been innovations that provided (ore efficient (echanis(s for redistributing ris). $ther innovations (a' %ust represent a (ore efficient wa' of doing things. 2ndeed- if we consider the ulti(ate causes of financial innovation- the following e(erge as the (ost i(portant 11 2ncreased volatilit' of interest rates- inflation- e*uit' prices- and exchange rates. 21 Advances in co(puter and teleco((unication technologies. #1 @reater sophistication and educational training a(ong professional (ar)et participants. '1 #inancial inter(ediar' co(petition. +1 2ncentives to get around existing regulation and and tax laws. .1 Changing global patterns of financial wealth. Diff ! "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation "rue=#alse Questions 1 Financial Assets 1) An e*uit' instru(ent 4also called a residual clai() obligates the issuer of the financial asset to pa' the holder an a(ount based on earnings- if an'- after holders of debt instru(ents have been paid. Answer "EF1 Diff 1 "opic 1.1 #inancial Assets $b%ective 1.+ the distinction between debt instru(ents and e*uit' instru(ents !) A intangible asset is one whose value depends on particular ph'sical properties such as buildings- land- or (achiner'. "angible assets- b' contrast- represent legal clai(s to so(e future benefit. Answer #AD<1 Co((ent A tangible asset is one whose value depends on particular ph'sical properties such as buildings- land- or (achiner'. Intangible assets- b' contrast- represent legal clai(s to so(e future benefit. Diff 1 "opic 1.1 #inancial Assets $b%ective 1.! the distinction between financial assets and tangible assets

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,) #inancial assets have two principal econo(ic functions. $ne function is to transfer funds fro( those who have surplus funds to invest to those who need funds to invest in tangible assets. Answer "EF1 Diff 1 "opic 1.1 #inancial Assets $b%ective 1.1 what a financial asset is and the principal econo(ic functions of financial assets 2 Financial Mar ets 1) "he three econo(ic functions of financial (ar)ets are to i(prove the price discover' process9 to lessen li*uidit'9 and- to reduce the cost of transacting. Answer #AD<1 Co((ent "he three econo(ic functions of financial (ar)ets are to i(prove the price discover' process9 to enhance li*uidit'9 and to reduce the cost of transacting. Diff ! "opic 1.! #inancial Mar)ets $b%ective 1., what a financial (ar)et is and the principal econo(ic functions it perfor(s !) "he (ar)et participants include households- business entities- national govern(ents- national govern(ent agencies- state and local govern(ents- supranationals- and regulators. Answer "EF1 Diff 1 "opic 1.! #inancial Mar)ets $b%ective 1., what a financial (ar)et is and the principal econo(ic functions it perfor(s ,) $ne econo(ic function of a financial (ar)et is to reduce the cost of transacting. "here are two costs associated with transacting search costs and infor(ation costs. Answer "EF1 Diff 1 "opic 1.! #inancial Mar)ets $b%ective 1., what a financial (ar)et is and the principal econo(ic functions it perfor(s # $lobalization of Financial Mar ets 1) @lobali:ation (eans the integration of financial (ar)ets throughout the world into an international financial (ar)et. Answer "EF1 Diff 1 "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.A reasons for the globali:ation of financial (ar)ets

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!) "he do(estic (ar)et in an' countr' is the (ar)et where the securities of issuers not do(iciled in the countr' are sold and traded. Answer #AD<1 Co((ent "he foreign (ar)et in an' countr' is the (ar)et where the securities of issuers not do(iciled in the countr' are sold and traded. Diff 1 "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.1/ the distinction between a do(estic (ar)et- a foreign (ar)et- and the 1uro(ar)et ,) @lobal co(petition has forced govern(ents to exercise control various aspects of their financial (ar)ets so that their financial enterprises can co(pete effectivel' around the world. Answer #AD<1 Co((ent @lobal co(petition has forced govern(ents to deregulate (or liberalize) various aspects of their financial (ar)ets so that their financial enterprises can co(pete effectivel' around the world. Diff 1 "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.A reasons for the globali:ation of financial (ar)ets ' (erivative Mar ets 1) Derivative instru(ents pla' a critical role in global financial (ar)ets. Answer "EF1 Diff 1 "opic 1.+ Derivative Mar)ets $b%ective 1.1, the role of derivative instru(ents !) 2BM pension fund owns a portfolio consisting of the co((on stoc) of a large nu(ber of co(panies. <uppose the pension fund )nows that two (onths fro( now it (ust sell stoc) in its portfolio to pa' beneficiaries J!/ (illion. "he ris) that 2BM pension fund faces is that two (onths fro( now when the stoc)s are sold- the price of (ost or all stoc)s (a' be higher than the' are toda'. Answer #AD<1 Co((ent 2BM pension fund owns a portfolio consisting of the co((on stoc) of a large nu(ber of co(panies. <uppose the pension fund )nows that two (onths fro( now it (ust sell stoc) in its portfolio to pa' beneficiaries J!/ (illion. "he ris) that 2BM pension fund faces is that two (onths fro( now when the stoc)s are sold- the price of (ost or all stoc)s (a' be lo%er than the' are toda'. Diff ! "opic 1.+ Derivative Mar)ets $b%ective 1.1, the role of derivative instru(ents

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,) 5hen the option grants the owner of the option the right to bu' a financial asset fro( the other part'- the option is called a put option. Answer #AD<1 Co((ent 5hen the option grants the owner of the option the right to bu' a financial asset fro( the other part'- the option is called a call option. Diff ! "opic 1.+ Derivative Mar)ets $b%ective 1.1, the role of derivative instru(ents + *he ,ole of the $overn)ent in Financial Mar ets 1) "he (ar)et stabilit' regulator would ta)e on the traditional role of the #ederal Eeserve b' giving it the responsibilit' and authorit' to ensure overall financial (ar)et stabilit'. Answer "EF1 Diff 1 "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.1& the different wa's that govern(ents regulate (ar)ets- including disclosure regulation- financial activit' regulation- financial institution regulation- regulation of foreign fir( participation- and regulation of the (onetar' s'ste( !) Blueprint regulation is the for( of regulation that re*uires issuers of securities to (a)e public a large a(ount of financial infor(ation to actual and potential investors. Answer #AD<1 Co((ent (isclosure regulation is the for( of regulation that re*uires issuers of securities to (a)e public a large a(ount of financial infor(ation to actual and potential investors. Diff 1 "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.18 the F.<. Depart(ent of the "reasur'Bs proposed plan for regulator' refor( ,) #inancial activit' regulation is the for( of regulation that re*uires issuers of securities to (a)e public a large a(ount of financial infor(ation to actual and potential investors. Answer #AD<1 Co((ent (isclosure regulation is the for( of regulation that re*uires issuers of securities to (a)e public a large a(ount of financial infor(ation to actual and potential investors. 6$"1. Financial activit& regulation consists of rules about traders of securities and trading on financial (ar)ets. Diff 1 "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.1+ the t'pical %ustification for govern(ental regulation of (ar)ets

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. Financial Innovation 1) 6o one holds the extre(e view that the essence of innovation is the introduction of financial instru(ents that are (ore efficient for redistributing ris)s a(ong (ar)et participants. Answer #AD<1 Co((ent "o)e hold the extre(e view that the essence of innovation is the introduction of financial instru(ents that are (ore efficient for redistributing ris)s a(ong (ar)et participants. Diff 1 "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation !) Di*uidit'Igenerating innovations can increase the li*uidit' of the (ar)et- allow borrowers to draw upon new sources of funds- and per(it (ar)et participants to circu(vent capital constraints i(posed b' regulations. Answer "EF1 Diff ! "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation 1ssa' Questions 1 Financial Assets 1) 5hat are the two principal econo(ic functions of financial assets7 @ive an illustration. Answer #inancial assets have two principal econo(ic functions. "he first is to transfer funds fro( those who have surplus funds to invest to those who need funds to invest in tangible assets. "he second econo(ic function is to transfer funds in such a wa' as to redistribute the unavoidable ris) associated with the cash flow generated b' tangible assets a(ong those see)ing and those providing the funds. 3owever- as we will see- the clai(s held b' the final wealth holders are generall' different fro( the liabilities issued b' the final de(anders of funds because of the activit' of financial inter(ediaries that see) to transfor( the final liabilities into the financial assets that the public prefers. 5e can illustrate these two econo(ic functions with an exa(ple si(ilar to one the below exa(ples. 11 Koe @rasso has obtained a license to (anufacture Eugrat wristwatches. Koe esti(ates that he will need J1 (illion to purchase plant and e*uip(ent to (anufacture the watches. Fnfortunatel'he has onl' J!//-/// to invest- and that is his life savings- which he does not want to investeven though he has confidence that there will be a receptive (ar)et for the watches. 21 <usan Carlson has recentl' inherited J?,/-///. <he plans to spend J,/-/// on so(e %ewelr'furniture- and a few cruises- and to invest the balance- J?//-///. #1 Darr' <tein- an upIandIco(ing attorne' with a (a%or 6ew ;or) law fir(- has received a bonus chec) that after taxes has netted hi( J!&/-///. 3e plans to spend J&/-/// on a BM5 and invest the balance- J!//-///. Diff , "opic 1.1 #inancial Assets $b%ective 1.1 what a financial asset is and the principal econo(ic functions of financial assets

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2 Financial Mar ets 1) "he third econo(ic function of a financial (ar)et is that it reduces the cost of transacting. 6a(e and describe the two costs associated with this econo(ic function. Answer "here are two costs associated with reducing the cost of transacting search costs and infor)ation costs. "earch costs represent explicit costs- such as the (one' spent to advertise oneBs intention to sell or purchase a financial asset- and i(plicit costs- such as the value of ti(e spent in locating a counterpart'. "he presence of so(e for( of organi:ed financial (ar)et reduces search costs. Infor)ation costs are costs associated with assessing the invest(ent (erits of a financial assetthat is- the a(ount and the li)elihood of the cash flow expected to be generated. 2n an efficient (ar)et- prices reflect the aggregate infor(ation collected b' all (ar)et participants. Diff , "opic 1.! #inancial Mar)ets $b%ective 1., what a financial (ar)et is and the principal econo(ic functions it perfor(s !) 6a(e and describe so(e of the wa's to classif' financial (ar)ets. Answer "here are (an' wa's to classif' financial (ar)ets. (a) $ne wa' is b' the nature or t'pe of the financial clai(- such as debt )ar ets and e2uit& )ar ets. (b) Another is b' the (aturit' of the clai(- such as short/ter) and long/ter). #or exa(plethere is a financial (ar)et for shortIter( debt instru(ents- called the (one' (ar)et- and one for longerI(aturit' financial assets- called the capital (ar)et. (c) #inancial (ar)ets can also be categori:ed as those dealing with financial clai(s that are newl' issued- called the pri)ar& )ar et- and those for exchanging financial clai(s previousl' issued- called the secondar& )ar et or the (ar)et for seasoned instru(ents. 6$"1 $ther classifications are Mar)ets can be classified as either cash or derivative instru)ents (ar)ets and also b' their organi:ational structure such as an auction )ar et- an over/the/counter )ar et- or an inter)ediated )ar et. Diff , "opic 1.! #inancial Mar)ets $b%ective 1.& the various wa's to classif' financial (ar)ets

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# $lobalization of Financial Mar ets 1) Describe at least two reasons wh' a corporation (a' see) to raise funds outside its do(estic (ar)et. Answer "here are several reasons wh' a corporation (a' see) to raise funds outside its do(estic (ar)et. First- in so(e countries- large corporations see)ing to raise a substantial a(ount of funds (a' have no choice but to obtain financing in either the foreign (ar)et sector of another countr' or the 1uro(ar)et. "his is because the fundIsee)ing corporationBs do(estic (ar)et is not full' developed and cannot satisf' its de(and for funds on globall' co(petitive ter(s. @overn(ents of developing countries have used these (ar)ets in see)ing funds for govern(entIowned corporations that the' are privati:ing. "he second reason is that there (a' be opportunities for obtaining a lower cost of funding than is available in the do(estic (ar)et- although with the integration of capital (ar)ets throughout the world- such opportunities have di(inished. 6evertheless- there are still so(e i(perfections in capital (ar)ets throughout the world that (a' per(it a reduced cost of funds. "he causes of these i(perfections are discussed throughout the boo). A third reason for using foreign or 1uro(ar)ets is a desire b' issuers to diversif' their source of funding so as to reduce reliance on do(estic investors. Diff , "opic 1., @lobali:ation of #inancial Mar)ets $b%ective 1.11 the reasons wh' entities use foreign (ar)ets and 1uro(ar)ets ' (erivative Mar ets 1) "he two basic t'pes of derivative instru(ents are futures=forward contracts and options contracts. Describe these two basic t'pes. Answer A futures or for%ard contract is an agree(ent whereb' two parties agree to transact with respect to so(e financial asset at a predeter(ined price at a specified future date. $ne part' agrees to bu' the financial asset9 the other agrees to sell the financial asset. Both parties are obligated to perfor(- and neither part' charges a fee. An options contract gives the owner of the contract the right- but not the obligation- to bu' 4or sell) a financial asset at a specified price fro( 4or to) another part'. "he bu'er of the contract (ust pa' the seller a fee- which is called the option price. 5hen the option grants the owner of the option the right to bu' a financial asset fro( the other part'- the option is called a call option. 2f- instead- the option grants the owner of the option the right to sell a financial asset to the other part'- the option is called a put option. Diff ! "opic 1.+ Derivative Mar)ets $b%ective 1.1! what a derivative instru(ent is and the two basic t'pes of derivative instru(ents

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+ *he ,ole of the $overn)ent in Financial Mar ets 1) @overn(ents in (ost developed econo(ies have created elaborate s'ste(s of regulation for financial (ar)ets- in part because the (ar)ets the(selves are co(plex and in part because financial (ar)ets are so i(portant to the general econo(ies in which the' operate. "he nu(erous rules and regulations are designed to serve several purposes. "hese rules and regulations fall into the various categories. 0rovide at least three of these categories. Answer "he nu(erous rules and regulations for financial (ar)ets are designed to serve several purposes- which fall into the following categories 11 "o prevent issuers of securities fro( defrauding investors b' concealing relevant infor(ation. 21 "o pro(ote co(petition and fairness in the trading of financial securities. #1 "o pro(ote the stabilit' of financial institutions. '1 "o restrict the activities of foreign concerns in do(estic (ar)ets and institutions. +1 "o control the level of econo(ic activit'. Diff , "opic 1.& "he Eole of the @overn(ent in #inancial Mar)ets $b%ective 1.1& the different wa's that govern(ents regulate (ar)ets- including disclosure regulation- financial activit' regulation- financial institution regulation- regulation of foreign fir( participation- and regulation of the (onetar' s'ste( . Financial Innovation 1) 0rofessor <tephen Eoss suggests two classes of financial innovation. Dist these two classes. Answer 0rofessor <tephen Eoss suggests these two classes 41) new financial products 4financial assets and derivative instru(ents) better suited to the circu(stances of the ti(e 4for exa(ple- to inflation) and to the (ar)ets in which the' trade- and 4!) strategies that pri(aril' use these financial products. Diff ! "opic 1.8 #inancial 2nnovation $b%ective 1.1? the pri(ar' reasons for financial innovation

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