FIN 310 ACTUAL STUDY GUIDE QUESTIONS AND
ANSWERS SURE A+
✔✔Role of Accounting in Financial Markets - ✔✔financial market participants rely on
financial information provided by firms
financial statements provided by firms must be audited to ensure that they are correctly
stated and accurately represent the financial condition of the firm
However, the accounting standards are loose (think of Ritta Crundwell), so financial
market participants can benefit from strong accounting skills that may allow them to
more properly interpret financial statements.
✔✔What factors influence liquidity? - ✔✔debt securities with shorter maturities are more
liquid. Debt securities and stocks with a more active secondary market are more liquid.
✔✔Impact of Credit Crisis on Institutions - ✔✔Some financial institutions participated by
issuing mortgage-backed securities that represented mortgages originated by mortgage
companies.
Mortgage-backed securities performed poorly during the credit crisis in 2008 because of
the high default rate on mortgages.
Some financial institutions that held a large amount of mortgage-backed securities
suffered major losses at this time.
✔✔Impact of Fraudulent Financial Reporting on Market Liquidity - ✔✔If companies are
allowed to engage in fraudulent financial reporting by exaggerating earnings or hiding
debt, this could cause investors to overpay when purchasing securities issued by those
companies.
If investors recognize that they cannot trust financial disclosure by companies, they may
be unwilling to participate in financial markets.
,The lack of trust can cause markets to be less liquid, because of very limited investor
participation.
✔✔Impact of a Country's Laws on its Market Liquidity - ✔✔Some financial markets are
more developed in some countries than in others
each country has its own laws regarding shareholder rights, rights against or for taking
civil action towards a firm, own level of enforcement with securities laws
investors may be more willing to participate in their local country's financial markets if
they believe that their local government enforces the securities laws that are imposed in
that country.
✔✔Global Financial Market Regulations: Not disclosing financial information - ✔✔If a
company does not disclose its financial information, investors cannot assess the
financial condition and ability of the government to cover its payments owed on its debt.
Thus, they are less willing to invest in debt securities issued by such country, so such
country will have to offer a higher yield to entice investors.
✔✔Influence of Financial Markets: When some countries do not have well established
debt or equity securities - ✔✔Businesses rely on financial markets to expand. If they
cannot issue debt or equity securities, they cannot obtain funding to expand. Local
investors who have money to invest will likely invest their money in other countries if the
financial markets are not developed in their home market. Thus, they will essentially
help other countries grow instead of helping their own country grow.
✔✔Concerns with Systemic Risk - ✔✔when financial institutions interact through
transactions, the failure of one financial institution can cause financial problems for
others. As one financial institution fails, it defaults on payments owed on financial
agreements with other financial institutions. Those institutions may have been relying on
those payments to cover other obligations to another set of financial institutions. Thus,
many financial institutions might be unable to cover their obligations, and this spreads
fear that the financial system might collapse.
✔✔Uncertainty surrounding stock price - ✔✔Different valuations by different investors
can lead to uncertainty of a firm's stock price
The value of a company is based on the present value its future cash flows. Investors
may attempt to use financial statements to predict future cash flows. But even when
investors are presented with information value your company's stock, they may interpret
the information in different ways. They commonly derive different interpretations of the
same information, which leads to different valuations of the firm, reflects uncertainty
surrounding the firm's stock price.
,✔✔Financial Intermediaries and how they work depending upon the financial institution:
- ✔✔Depository Institutions: Deposits from surplus units are transformed by depository
institutions into loans for deficit units
Finance Companies: Purchases of securities (commercial paper) issued by finance
companies that are transformed into finance company loans for deficit unit
Mutual Funds: Purchases of shares issued by mutual funds are used to purchase debt
and equity securities of deficit units
Insurance Companies and Pension Funds: large amounts of stocks and bonds used to
finance much of the expenditures made by large deficit units, such as corporations and
government agencies
✔✔Impact of a Financial Crisis on market liquidity: - ✔✔Even if the market prices reflect
existing conditions, a crisis can cause fear that prices will decline substantially. While
this might allow the possibility for large profits from pronounced changes in the prices of
securities, many market participants may be uncomfortable in a market in which they
could lose 30% or more of their investment in a short period of time.
Fear of a decrease in prices also results in less people acting as surplus units
✔✔Who commonly purchases debt securities? - ✔✔Financial institutions such as
mutual funds, pension funds, and insurance companies commonly purchase debt
securities that are issued by firms. Other financial institutions such as commercial banks
and savings institutions may also purchase debt securities.
✔✔How do individuals indirectly provide the financing for your firm when they maintain
deposits at depository institutions, invest in mutual funds, purchase insurance policies,
or invest in pensions? - ✔✔Individuals provide funds to financial institutions in the form
of bank deposits, investment in mutual funds, purchases of insurance policies, or
investment in pensions. The financial institutions may channel the funds toward the
purchase of debt securities (and even equity securities) that were issued by large
corporations, such as the one where you work.
✔✔Example of being a surplus unit - ✔✔Investing in treasury securities:
- providing funds to the treasury- issuer of those securities
✔✔Example of being a deficit unit - ✔✔borrowing funds from financial institutions
✔✔Using the primary market to facilitate expansion of a project- when in need of
funding - ✔✔issue new stock or bonds to obtain funds
✔✔Using the secondary market to obtain funds example - ✔✔Sell its holding of treasury
securities in the secondary market
, ✔✔Perfect Financial Market example - ✔✔It would have been able to obtain loans
directly from surplus units. It would have been able to assess potential targets for
acquisitions without the advice of investment securities firms. It would be able to engage
in a new issuance of stock or bonds without the help of a securities firm.
✔✔Receiving bank's approval before pursuing a large project is due to: - ✔✔to prevent
default on loans of large projects, prevent excessive risks being taken, preferring funds
being used in a more conservative manner
✔✔What are the results of a large fiscal budget deficit? - ✔✔- low interest rates: crisis in
2008 had a large budget deficit and low interest rates
- when government borrows large amount of funds, crowding out of other potential
borrowers takes place and the interest rates are bid up by deficit units
- large demand for funds and upward pressure on interest rates takes place; unless
there are offsetting forces
✔✔Interest Elasticity of Supply - ✔✔Interest elasticity of supply represents a change in
the quantity of loanable funds supplied in response to a change in interest rates.
✔✔Interest Elasticity of Demand - ✔✔Interest elasticity of demand represents a change
in the quantity of loanable funds demanded in response to a change in interest rates.
✔✔Demand for federal loanable funds vs. household or consumer demand for loanable
funds - ✔✔The federal government demand for loanable funds should be less interest
elastic than the consumer demand for loanable funds, because the government's
planned borrowings will likely occur regardless of the interest rate. Conversely, the
quantity of loanable funds by consumers is more responsive to the interest rate level.
✔✔Impact of Government Spending- like with expanding a program or needing funds
for a project - ✔✔- force federal government to increase its budget deficit
- force firms involved in such programs to borrow more funds
- greater demand for loanable funds
- could cause higher income and additional saving (not as likely)
- upward pressure on interest rates (more likely)
✔✔Impact of a Recession - ✔✔During a recession, firms and consumers reduce their
amount of borrowing. The demand for loanable funds decreases and interest rates
decrease as a result.
✔✔Impact of the Economy - ✔✔The interest rate in the future should increase if
economic growth and inflation are expected to rise or decrease if economic growth and
inflation are expected to decline.
ANSWERS SURE A+
✔✔Role of Accounting in Financial Markets - ✔✔financial market participants rely on
financial information provided by firms
financial statements provided by firms must be audited to ensure that they are correctly
stated and accurately represent the financial condition of the firm
However, the accounting standards are loose (think of Ritta Crundwell), so financial
market participants can benefit from strong accounting skills that may allow them to
more properly interpret financial statements.
✔✔What factors influence liquidity? - ✔✔debt securities with shorter maturities are more
liquid. Debt securities and stocks with a more active secondary market are more liquid.
✔✔Impact of Credit Crisis on Institutions - ✔✔Some financial institutions participated by
issuing mortgage-backed securities that represented mortgages originated by mortgage
companies.
Mortgage-backed securities performed poorly during the credit crisis in 2008 because of
the high default rate on mortgages.
Some financial institutions that held a large amount of mortgage-backed securities
suffered major losses at this time.
✔✔Impact of Fraudulent Financial Reporting on Market Liquidity - ✔✔If companies are
allowed to engage in fraudulent financial reporting by exaggerating earnings or hiding
debt, this could cause investors to overpay when purchasing securities issued by those
companies.
If investors recognize that they cannot trust financial disclosure by companies, they may
be unwilling to participate in financial markets.
,The lack of trust can cause markets to be less liquid, because of very limited investor
participation.
✔✔Impact of a Country's Laws on its Market Liquidity - ✔✔Some financial markets are
more developed in some countries than in others
each country has its own laws regarding shareholder rights, rights against or for taking
civil action towards a firm, own level of enforcement with securities laws
investors may be more willing to participate in their local country's financial markets if
they believe that their local government enforces the securities laws that are imposed in
that country.
✔✔Global Financial Market Regulations: Not disclosing financial information - ✔✔If a
company does not disclose its financial information, investors cannot assess the
financial condition and ability of the government to cover its payments owed on its debt.
Thus, they are less willing to invest in debt securities issued by such country, so such
country will have to offer a higher yield to entice investors.
✔✔Influence of Financial Markets: When some countries do not have well established
debt or equity securities - ✔✔Businesses rely on financial markets to expand. If they
cannot issue debt or equity securities, they cannot obtain funding to expand. Local
investors who have money to invest will likely invest their money in other countries if the
financial markets are not developed in their home market. Thus, they will essentially
help other countries grow instead of helping their own country grow.
✔✔Concerns with Systemic Risk - ✔✔when financial institutions interact through
transactions, the failure of one financial institution can cause financial problems for
others. As one financial institution fails, it defaults on payments owed on financial
agreements with other financial institutions. Those institutions may have been relying on
those payments to cover other obligations to another set of financial institutions. Thus,
many financial institutions might be unable to cover their obligations, and this spreads
fear that the financial system might collapse.
✔✔Uncertainty surrounding stock price - ✔✔Different valuations by different investors
can lead to uncertainty of a firm's stock price
The value of a company is based on the present value its future cash flows. Investors
may attempt to use financial statements to predict future cash flows. But even when
investors are presented with information value your company's stock, they may interpret
the information in different ways. They commonly derive different interpretations of the
same information, which leads to different valuations of the firm, reflects uncertainty
surrounding the firm's stock price.
,✔✔Financial Intermediaries and how they work depending upon the financial institution:
- ✔✔Depository Institutions: Deposits from surplus units are transformed by depository
institutions into loans for deficit units
Finance Companies: Purchases of securities (commercial paper) issued by finance
companies that are transformed into finance company loans for deficit unit
Mutual Funds: Purchases of shares issued by mutual funds are used to purchase debt
and equity securities of deficit units
Insurance Companies and Pension Funds: large amounts of stocks and bonds used to
finance much of the expenditures made by large deficit units, such as corporations and
government agencies
✔✔Impact of a Financial Crisis on market liquidity: - ✔✔Even if the market prices reflect
existing conditions, a crisis can cause fear that prices will decline substantially. While
this might allow the possibility for large profits from pronounced changes in the prices of
securities, many market participants may be uncomfortable in a market in which they
could lose 30% or more of their investment in a short period of time.
Fear of a decrease in prices also results in less people acting as surplus units
✔✔Who commonly purchases debt securities? - ✔✔Financial institutions such as
mutual funds, pension funds, and insurance companies commonly purchase debt
securities that are issued by firms. Other financial institutions such as commercial banks
and savings institutions may also purchase debt securities.
✔✔How do individuals indirectly provide the financing for your firm when they maintain
deposits at depository institutions, invest in mutual funds, purchase insurance policies,
or invest in pensions? - ✔✔Individuals provide funds to financial institutions in the form
of bank deposits, investment in mutual funds, purchases of insurance policies, or
investment in pensions. The financial institutions may channel the funds toward the
purchase of debt securities (and even equity securities) that were issued by large
corporations, such as the one where you work.
✔✔Example of being a surplus unit - ✔✔Investing in treasury securities:
- providing funds to the treasury- issuer of those securities
✔✔Example of being a deficit unit - ✔✔borrowing funds from financial institutions
✔✔Using the primary market to facilitate expansion of a project- when in need of
funding - ✔✔issue new stock or bonds to obtain funds
✔✔Using the secondary market to obtain funds example - ✔✔Sell its holding of treasury
securities in the secondary market
, ✔✔Perfect Financial Market example - ✔✔It would have been able to obtain loans
directly from surplus units. It would have been able to assess potential targets for
acquisitions without the advice of investment securities firms. It would be able to engage
in a new issuance of stock or bonds without the help of a securities firm.
✔✔Receiving bank's approval before pursuing a large project is due to: - ✔✔to prevent
default on loans of large projects, prevent excessive risks being taken, preferring funds
being used in a more conservative manner
✔✔What are the results of a large fiscal budget deficit? - ✔✔- low interest rates: crisis in
2008 had a large budget deficit and low interest rates
- when government borrows large amount of funds, crowding out of other potential
borrowers takes place and the interest rates are bid up by deficit units
- large demand for funds and upward pressure on interest rates takes place; unless
there are offsetting forces
✔✔Interest Elasticity of Supply - ✔✔Interest elasticity of supply represents a change in
the quantity of loanable funds supplied in response to a change in interest rates.
✔✔Interest Elasticity of Demand - ✔✔Interest elasticity of demand represents a change
in the quantity of loanable funds demanded in response to a change in interest rates.
✔✔Demand for federal loanable funds vs. household or consumer demand for loanable
funds - ✔✔The federal government demand for loanable funds should be less interest
elastic than the consumer demand for loanable funds, because the government's
planned borrowings will likely occur regardless of the interest rate. Conversely, the
quantity of loanable funds by consumers is more responsive to the interest rate level.
✔✔Impact of Government Spending- like with expanding a program or needing funds
for a project - ✔✔- force federal government to increase its budget deficit
- force firms involved in such programs to borrow more funds
- greater demand for loanable funds
- could cause higher income and additional saving (not as likely)
- upward pressure on interest rates (more likely)
✔✔Impact of a Recession - ✔✔During a recession, firms and consumers reduce their
amount of borrowing. The demand for loanable funds decreases and interest rates
decrease as a result.
✔✔Impact of the Economy - ✔✔The interest rate in the future should increase if
economic growth and inflation are expected to rise or decrease if economic growth and
inflation are expected to decline.
