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5 for commercial banks the ratio is 94284805 0011 for

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5. For commercial banks, the ratio is: $94.2/$8,480.5 = 0.011 For non-financial firms, the ratio is: $10,973/$21,851 = 0.502 The difference should be expected primarily because the bulk of the business of financial institutions is to make loans that are financial assets. 6. a. Primary-market transaction b. Derivative assets. c. Investors who wish to hold gold without the complication and cost of physical storage. 7. a. A fixed salary means that compensation is (at least in the short run) independent of the firm's success. This salary structure does not tie the manager’s immediate compensation to the success of the firm. However, the manager might view this as the safest compensation structure and therefore value it more highly. b. A salary that is paid in the form of stock in the firm means that the manager earns the most when the shareholders’ wealth is maximized. This structure is therefore most likely to align the interests of managers and shareholders. If stock compensation is overdone, however, the manager might view it as overly risky since the manager’s career is already linked to the firm, and this undiversified exposure would be exacerbated with a large stock position in the firm. 1-2
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c. Call options on shares of the firm create great incentives for managers to contribute to the firm’s success. In some cases, however, stock options can lead to other agency problems. For example, a manager with numerous call options might be tempted to take on a very risky investment project, reasoning that if the project succeeds the payoff will be huge, while if it fails, the losses are limited to the lost value of the options. Shareholders, in contrast, bear the losses as well as the gains on the project, and might be less willing to assume that risk. 8. Even if an individual shareholder could monitor and improve managers’ performance, and thereby increase the value of the firm, the payoff would be small, since the ownership share in a large corporation would be very small. For example, if you own $10,000 of GM stock and can increase the value of the firm by 5%, a very ambitious goal, you benefit by only: 0.05 × $10,000 = $500. In contrast, a bank that has a multimillion-dollar loan outstanding to the firm has a big stake in making sure that the firm can repay the loan. It is clearly worthwhile for the bank to spend considerable resources to monitor the firm. 9. Securitization requires access to a large number of potential investors. To attract these investors, the capital market needs: (1) a safe system of business laws and low probability of confiscatory taxation/regulation; (2) a well-developed investment banking industry; (3) a well-developed system of brokerage and financial transactions, and; (4) well-developed media, particularly financial reporting. These characteristics are found in (indeed make for) a well-developed financial
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5 For commercial banks the ratio is 94284805 0011 For non...

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