Answers for Tutorial Homework due Week 3

Answers for Tutorial Homework due Week 3 - Answers for...

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Answers for Tutorial Homework due Week 3 1.4. What are some problems with direct financing that make indirect financing a more attractive alternative? Direct financing requires a more or less exact match between the characteristics of the financial claims DSUs wish to sell and those the SSUs want to buy. Direct financing can thus involve a costly search and negotiation process, often complicated by information asymmetries concerning ultimate credit risk of the DSU. Intermediaries transform direct claims sold by DSUs and make them more attractive to SSUs, helping DSUs find financing and SSUs find appropriate investments. 1.7. What are the three sources of comparative advantage that financial institutions have over others in producing financial products? (1) Economies of scale —large volumes of similar transactions; (2) Transaction cost control—finding and negotiating direct investments less expensively; and (3) Risk management expertise—bridging the “information gap” about DSUs’ creditworthiness. 1.13. Explain the statement, ‘A financial claim is someone’s asset and someone else’s liability.’ There are always two sides to debt. To the issuer of the debt, it is a liability. To the owner of the debt, it is an asset. A financial asset always appears on two balance sheets; a real asset on just one. 1.14. Discuss three forms of financial market efficiency. Why is it important financial markets are efficient? There are three forms of market efficiency: allocational efficiency, informational efficiency, and operational efficiency. Allocational efficiency is a form of economic efficiency that implies that funds will be allocated to (i.e., invested in) their highest valued use (the funds could not have been allocated in any other way that would have made society better off). This is important as it promotes investment in the projects offering the highest risk-adjusted rates of return and that households invest in direct or indirect financial claims offering the highest yields for given levels of risk. Informational efficiency relates to the ability of investors to obtain accurate information about the relative values of different financial claims (or securities). In an informationally efficient market, securities’ prices are the best indicators of relative
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value because market prices reflect all relevant information about the securities. This is important as it allows investors to determine which investments are the most valuable and ensures that the financial markets are allocationally efficient because households or business firms can get the information they need to make intelligent investment decisions.
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Answers for Tutorial Homework due Week 3 - Answers for...

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