Short Answer - Short Answer Chapter 1 Introduction Short...

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Short Answer Chapter 1 Introduction Short Ancwer Questions 33. Discuss how secondary markets benefit funds issuers. Answer: The secondary markets provide liquidity to investors after their initial purchase of the security. This liquidity encourages them to purchase the security at the initial offer. The current market price also reflects current prospects for the firm and the competitiveness of the issue relative to similar securities. Corporate treasurers follow their stock's price closely because the stock price reflects how well their firm and the market is performing. The current security price also provides information about the cost of obtaining any additional funds. Page: 5-6 Level: Medium 34. How can brokers and dealers make money? Which activity is riskier? Why? Answer: An asset broker assists buyers and sellers of securities by providing a mechanism for a buyer or seller to process their order. If the broker simply assists one party in finding another party, the broker charges a small fee called a commission. An asset dealer buys (sells) the security for their own account at the bid price and then sells (buys) the security at a higher ask price. The dealer profits by earning the bid-ask spread or the difference between the buy and sell price. The dealer function is riskier because the dealer must maintain an inventory of the asset and honor quotes posted to buy and sell. If the security is risky the value of the inventory can fluctuate with market prices. The broker takes less risk because they do not own the security. Page: 14 Level: Difficult 35. What does an asset transformer do? Why is this a risky activity? Answer: An asset transformer buys one security from a customer or makes and creates a separate claim in order to raise funds. This is normally a risky activity because the asset acquired will be riskier than the security (or deposit) used to raise funds because the intermediary hopes to profit on the spread between the rate earned on the asset claim and the rate paid on the liability claim. In order for this spread to be positive, generally speaking the asset must be riskier than the liability. Page: 16 Level: Medium 36. How can using indirect finance rather than direct finance reduce agency costs associated with monitoring funds demanders? Answer: A large FI has a greater incentive to monitor the behavior of funds demanders in an indirect financing. The FI supposedly hires and trains experts who know how to collect information about a funds demander and evaluate whether the funds demander is acting appropriately. In direct finance, a funds demander sells claims to the public at large. In this case there is little incentive for an individual claim holder to monitor and attempt to enforce good behavior on the part of the funds user. The benefit of monitoring
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and enforcement is shared among all claimholders, but the cost would be borne by only the sole individual. This is termed the free rider problem. If there is improved monitoring of borrower behavior, the problem of agency costs is likely to be reduced. Page: 15
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This note was uploaded on 12/05/2011 for the course ECON 3311 taught by Professor L during the Spring '11 term at University of Texas at Dallas, Richardson.

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Short Answer - Short Answer Chapter 1 Introduction Short...

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