Financial Markets and Institutions 8th Edition Mishkin Eakins Solutions Manual

Financial Markets and Institutions 8th edition Mishkin Eakins Solutions

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Chapter 1
Why Study Financial Markets
and Institutions?
Why Study Financial Markets?
Debt Markets and Interest Rates
The Stock Market
The Foreign Exchange Market
Why Study Financial Institutions?
Structure of the Financial System
Financial Crises
Central Banks and the Conduct of Monetary Policy
The International Financial System
Banks and Other Financial Institutions
Financial Innovation
Managing Risk in Financial Institutions
Applied Managerial Perspective
How We Will Study Financial Markets and Institutions
Exploring the Web
Collecting and Graphing Data
Web Exercise
Concluding Remarks

 Overview and Teaching Tips

Before embarking on a study of financial markets and institutions, the student must be convinced that this
subject is worth studying. Chapter 1 pursues this goal by showing the student that financial markets and
institutions is an exciting field because it focuses on phenomena that affect everyday life. An additional
purpose of Chapter 1 is to provide an overview for the entire book, previewing the topics that will be
covered in later chapters. The chapter also provides the students with a guide as to how they will be studying
financial markets and institutions with a unifying, analytic framework and an applied managerial perspective.
In teaching this chapter, the most important goal should be to get the student excited about the material. I have
found that talking about the data presented in the figures helps achieve this goal by showing the students that
 Chapter 1: Why Study Financial Markets and Institutions? 3

the subject matter of financial markets and institutions has real-world implications that they should care about.
In addition, it is important to emphasize to the students that the course will have an applied managerial
perspective, which they will find useful latter in their careers. Going through the web exercise is also a way of
encouraging the students to use the web to further their understanding of financial markets and institutions.

 Answers to End-of-Chapter Questions

1. Because they channel funds from those who do not have a productive use for them to those who do,
thereby resulting in higher economic efficiency.

2. Businesses would cut investment spending because the cost of financing this spending is now higher,
and consumers would be less likely to purchase a house or a car because the cost of financing their
purchase is higher.

3. A change in interest rates affects the cost of acquiring funds for financial institution as well as
changes the income on assets such as loans, both of which affect profits. In addition, changes in
interest rates affect the price of assets such as stock and bonds that the financial institution owns
which can lead to profits or losses.

4. No. People who borrow to purchase a house or a car are worse off because it costs them more to finance
their purchase; however, savers benefit because they can earn higher interest rates on their savings.

5. The lower price for a firm’s shares means that it can raise a smaller amount of funds, and so investment
in plant and equipment will fall.

6. Higher stock prices mean that consumers’ wealth is higher and so they will be more likely to increase
their spending.

7. It makes foreign goods more expensive and so British consumers will buy less foreign goods and
more domestic goods.

8. It makes British goods more expensive relative to American goods. American businesses will find it
easier to sell their goods in the United States and abroad, and the demand for their products will rise.

9. Changes in foreign exchange rates change the value of assets held by financial institutions and thus
lead to gains and losses on these assets. Also changes in foreign exchange rates affect the profits
made by traders in foreign exchange who work for financial institutions.

10. In the mid to late 1970s and the late 1980s and early 1990s, the value of the dollar was low, making
travel abroad relatively more expensive; that would have been a good time to vacation in the United
States and see the Grand Canyon. As the dollar’s value rose in the early 1980s, travel abroad became
relatively cheaper, making it a good time to visit the Tower of London.

11. Banks accept deposits and then use the resulting funds to make loans.

12. Savings and loan associations, mutual savings banks, credit unions, insurance companies, mutual
funds, pension funds, and finance companies.

13. Answers will vary.

4 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition

14. The profitability of financial institutions is affected by changes in interest rates, stock prices, and
foreign exchange rates; fluctuations in these variables expose these institutions to risk.

15. Because the Federal Reserve affects interest rates, inflation, and business cycles, all of which have
an important impact on the profitability of financial institutions.

 Quantitative Problems
1. The following table lists foreign exchange rates between U.S. dollars and British pounds during April:

Date U.S. Dollars per GBP Date U.S. Dollars per GBP
4/1 1.9564 4/18 1.7504
4/4 1.9293 4/19 1.7255
4/5 1.914 4/20 1.6914
4/6 1.9374 4/21 1.672
4/7 1.961 4/22 1.6684
4/8 1.8925 4/25 1.6674
4/11 1.8822 4/26 1.6857
4/12 1.8558 4/27 1.6925
4/13 1.796 4/28 1.7201
4/14 1.7902 4/29 1.7512
4/15 1.7785

Which day would have been the best day to convert $200 into British pounds?
Which day would have been the worst day? What would be the difference in pounds?
Solution: The best day is 4/25. At a rate of $1.6674/pound, you would have £119.95. The worst
day is 4/7. At $1.961/pound, you would have £101.99, or a difference of £17.96.

Chapter 2
Overview of the Financial System

Function of Financial Markets

Structure of Financial Markets
Debt and Equity Markets
Primary and Secondary Markets
Exchanges and Over-the-Counter Markets
Money and Capital Markets
 Chapter 1: Why Study Financial Markets and Institutions? 5

Internationalization of Financial Markets

International Bond Market, Eurobonds, and Eurocurrencies
Global Box: Are U.S. Capital Markets Losing Their Edge?
World Stock Markets
Function of Financial Intermediaries: Indirect Finance
Transaction Costs
Following the Financial News: Foreign Stock Market Indexes
Global Box: The Importance of Financial Intermediaries Relative to Securities
Markets: An International Comparison
Risk Sharing
Asymmetric Information: Adverse Selection and Moral Hazard
Economies of Scope and Conflicts of Interest
Types of Financial Intermediaries
Depository Institutions
Contractual Savings Institutions
Investment Intermediaries
Regulation of the Financial System
Increasing Information Available to Investors
Ensuring the Soundness of Financial Intermediaries
Financial Regulation Abroad
6 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition

 Overview and Teaching Tips

Chapter 2 is an introductory chapter that contains the background information on the structure and operation
of financial markets that is needed in later chapters of the book. This chapter allows the instructor to branch
out to various choices of later chapters, thus allowing different degrees of coverage of financial markets
and institutions.

The most important point to transmit to the student is that financial markets and financial intermediaries
are crucial to a well-functioning economy because they channel funds from those who do not have a
productive use for them to those who do. Some instructors will want to teach this chapter in detail, and
those who focus on international issues will want to spend some time on the section “Internationalization
of Financial Markets.” However, those who slant their course to public policy issues may want to give this
chapter a more cursory treatment. No matter how much class time is devoted to this chapter, I have found
that it is a good reference chapter for students. You might want to tell them that if in later chapters they do
not recall what particular financial intermediaries do and who regulates them, they can refer back to this
chapter, especially to tables, such as Tables 2.1 and 2.3.

 Answers to End-of-Chapter Questions

1. The share of Microsoft stock is an asset for its owner because it entitles the owner to a share of the
earnings and assets of Microsoft. The share is a liability for Microsoft because it is a claim on its
earnings and assets by the owner of the share.

2. Yes, I should take out the loan, because I will be better off as a result of doing so. My interest payment
will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will be ahead of
the game by $5,500. Since Larry’s loan-sharking business can make some people better off, as in this
example, loan sharking may have social benefits. (One argument against legalizing loan sharking,
however, is that it is frequently a violent activity.)

3. Yes, because the absence of financial markets means that funds cannot be channeled to people who
have the most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses
that would help the economy grow rapidly.

4. The principal debt instruments used were foreign bonds which were sold in Britain and denominated
in pounds. The British gained because they were able to earn higher interest rates as a result of
lending to Americans, while the Americans gained because they now had access to capital to start up
profitable businesses such as railroads.

5. This statement is false. Prices in secondary markets determine the prices that firms issuing securities
receive in primary markets. In addition, secondary markets make securities more liquid and thus
easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important
than primary markets.

6. You would rather hold bonds, because bondholders are paid off before equity holders, who are the
residual claimants.
 Chapter 1: Why Study Financial Markets and Institutions? 7

7. Because you know your family member better than a stranger, you know more about the borrower’s
honesty, propensity for risk taking, and other traits. There is less asymmetric information than with
a stranger and less likelihood of an adverse selection problem, with the result that you are more likely
to lend to the family member.

9. Loan sharks can threaten their borrowers with bodily harm if borrowers take actions that might
jeopardize paying off the loan. Hence borrowers from a loan shark are less likely to engage in
moral hazard.

10. They might not work hard enough while you are not looking or may steal or commit fraud.

11. Yes, because even if you know that a borrower is taking actions that might jeopardize paying off the
loan, you must still stop the borrower from doing so. Because that may be costly, you may not spend
the time and effort to reduce moral hazard, and so moral hazard remains a problem.

12. True. If there are no information or transaction costs, people could make loans to each other at no
cost and would thus have no need for financial intermediaries.

13. Because the costs of making the loan to your neighbor are high (legal fees, fees for a credit check,
and so on), you will probably not be able to earn 5% on the loan after your expenses even though it
has a 10% interest rate. You are better off depositing your savings with a financial intermediary and
earning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bank
rather than lending them to your neighbor.

14. Financial intermediaries benefit because they can earn profits on the spreads between the returns they
earn on risky assets and they payments they make on the assets they have sold. Households and firms
benefit because they can now own assets that have lower risk.

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