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Ch2 Solns - Financial Markets and Institutions Answers to...

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Chapter 2 Financial Markets and Institutions Answers to End-of-Chapter Questions 2-1 The prices of goods and services must cover their costs.  Costs include labor, materials, and  capital.  Capital costs to a borrower include a return to the saver who supplied the capital, plus a  mark-up (called a “spread”) for the financial intermediary that brings the saver and the borrower  together.  The more efficient the financial system, the lower the costs of intermediation, the lower  the costs to the borrower, and, hence, the lower the prices of goods and services to consumers. 2-2 In a well-functioning economy, capital will flow efficiently from those who supply capital to those who  demand it.  This transfer of capital can take place in three different ways: 1. Direct transfers of money and securities occur when a business sells its stocks or bonds directly  to savers, without going through any type of financial institution.  The business delivers its  securities to savers, who in turn give the firm the money it needs. 2. Transfers may also go through an investment banking house which underwrites the issue.  An  underwriter serves as a middleman and facilitates the issuance of securities.  The company  sells its stocks or bonds to the investment bank, which in turn sells these same securities to  savers.  The businesses’ securities and the savers’ money merely “pass through” the  investment banking house. 3. Transfers can also be made through a financial intermediary.  Here the intermediary obtains  funds from savers in exchange for its own securities.  The intermediary uses this money to buy  and hold businesses’ securities.  Intermediaries literally create new forms of capital.  The  existence of intermediaries greatly increases the efficiency of money and capital markets. 2-3 A primary market is the market in which corporations raise capital by issuing new securities.  An  initial public offering is a stock issue in which privately held firms go public.  Therefore, an IPO  would be an example of a primary market transaction.
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