FIN 501: FUNDAMENTALS OF FINANCE

TUTORIAL 2 SOLUTION

1. Match the following financial instruments and securities with their issuers.

Instruments/Securities Issuers
a. corporate stocks [#2] 1. commercial banks
b. Treasury bonds [#3] 2. corporations
c. municipal bonds [#4] 3. U.S. government
d. negotiable certificates of deposit [#1] 4. state/local governments

2. Match the following financial instruments and securities with their typical maturities.

Instruments/Securities Maturities
a. corporate stocks [#2] 1. less than one year
b. Treasury bills [#4] 2. no maturity
c. mortgages [#3] 3. up to about 30 years
d. commercial paper [#1] 4. up to one year

3. List and briefly describe the economic policy objectives of the nation.
The nation’s economic policy objectives are four-fold, as follows:
a. Economic growth: This encompasses not only growth of total output but also growth
on a per capita basis.
b. High and stable levels of employment: It is a stated objective of the government to
promote stability of employment and production at levels close to the nation’s total
potential.
c. Price stability: Inflation causes inequities and discourages investment. Consistently
stable prices help create an environment in which the other economic objectives are
achieved more easily.
d. International financial equilibrium: The increasing importance of international trade
and of the flow of funds in the international capital markets imposes a strong
incentive for maintaining international financial equilibrium.
4. What is meant by the savings-investment process?
The savings-investment process involves the direct or indirect transfer of individual
savings to business firms in exchange for their securities. A broader view of the savings-
investment process could include the exchange of pooled individual savings for
mortgages or other loans, as well as to purchase and hold government debt securities.

5. Define personal saving. Also, differentiate between voluntary and contractual savings.
Personal saving is the savings of individuals and equals personal income less personal
current taxes less personal outlays. Financial savings are the accumulation of cash and
other financial assets such as savings accounts, corporate securities, and savings and
loan shares. Voluntary savings are financial assets set aside for future use. Contractual
savings are disciplined by previous commitments and include such things as the
accumulation of reserves in insurance and pension funds.
6. How and why do corporations save?
 Savings are the financial assets retained by the corporation out of funds generated
through business operations that are neither paid out in dividends nor invested in
operating assets of the business. Corporations have short-term saving for working
capital purposes and long-term saving to meet future expenditures for equipment, major
maintenance, and the like.

7. Describe the principal factors that influence the level of savings by individuals.
The principal factors that influence the levels of savings by individuals are: (a) levels of
income; (b) economic expectations; (c) economic cycles; and (d) the life stage of the
individual saver.
8. What are the life cycle stages of corporations and other business firms? Explain how
financial savings generated by a business are a function of its life cycle?
The life cycle stages of a successful business firm are:
(a) Start-up stage –the development of the business idea takes place, the firm spends
cash rather than builds it
(b) Survival stage – the business continues to spend cash
(c) Rapid growth stage – here the business begins to build surplus or free cash flow
and increases the firm’s value
(d) Maturity stage – here the growth slows down to a long-run sustainable growth
rate. This stage can almost last in definitely as long as the firm remains
competitive in its industry. Sometimes a firm’s products or services are no longer
competitive or needed by consumers and the firm again starts consuming more
cash than it brings in. such firms will eventually cease to exist.

9. What are real assets and what are financial assets?

Real assets are physical or tangible assets that provide value or wealth to their owners.
Examples are the direct ownerships of land, buildings or homes, equipment,
inventories, etc. Financial Assets include cash and bank accounts plus securities and
investment accounts that can be readily converted into cash.

10. Following are data relating to a nation’s operations last year.

Capital consumption allowances $150 million

Undistributed corporate profits 40 million
Personal consumption expenditures 450 million
Personal savings 50 million
Corporate inventory valuation adjustment -5 million
Federal government deficit -30 million
Government purchases of goods and services 10 million
State and local governments surplus 1 million
Net exports of goods and services -2 million
Gross private domestic investment 200 million

a. Determine the nation’s gross domestic product (GDP).

Personal consumption expenditures (PCE) $450 million

Gross private domestic investment (GPDI) 200 million
 Government purchases of goods & services (GP) 10 million
Net exports (NE) [exports – imports] -2 million
Gross domestic product (GDP) $658 million

b. How would your answer change in (a) if exports of goods and services were $5
million and imports were 80 percent of exports?
Personal consumption expenditures (PCE) $450 million
Gross private domestic investment (GPDI) 200 million
Government purchases of goods & services (GP) 10 million
Net exports (NE) [exports – imports] 1 million
Gross domestic product (GDP) $661 million

11. Personal income amounted to $17 million last year. Personal current taxes amounted to
$4 million and personal outlays for consumption expenditures, non-mortgage interest,
and so forth were $12 million.

Personal income
Less: taxes and other payments
Equals: disposable personal income
Less: personal outlays
Equals: personal savings
Savings Rate = (Personal Savings)/ (Disposable Personal Income)

a. What was the amount of disposable personal income last year?

Disposable personal income (DPI) = personal income – personal current taxes
DPI = $17 million - $4 million = $13 million

b. What was the amount of personal saving last year?

Personal savings (PS) = disposable personal income – personal outlays
PS = $13 million - $12 million = $1 million

c. Calculate personal saving as a percentage of disposable personal income.

Savings rate = $1 million/$13 million = 7.69%

12. A country in Southeast Asia states its gross domestic product in terms of yen. Last year
its GDP was 50 billion yen when one U.S. dollar could be exchanged into 120 yen.
a. Determine the country’s GDP in terms of U.S. dollars for last year.
(50 billion yen)/120 yen = $416.7 million
b. Assume the GDP increases to 55 billion yen for this year. However, the dollar
value of one yen is now $0.01. Determine the country’s GDP in terms of U.S.
dollars for this year.
(55 billion yen) × $.01 = $550 million
c. Show how your answer in (b) would change if one U.S. dollar could be exchanged
for 110 yen.
(55 billion yen)/110 yen = $500 million
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