People will normally invest in various financial assets, including bonds. Meanwhile, they hold money to facilitate...

People will normally invest in various financial assets, including bonds. Meanwhile, they hold money to facilitate transactions.

(a) The rights and obligations of holding financial assets are specified in financial contracts. Now, legal experts discover a major shortcoming in these contracts, which implies asset holders will suffer from higher risks. What is the impact on money demand upon announcement of the finding? Briefly explain.

b) How the LM curve will be affected, assuming a fixed money supply? Draw a diagram to illustrate. You should also draw the diagram for the money market.

Expert Solution

Answer.(a) The purest form of financial assets is cash and cash equivalents—checking accounts, savings accounts, and money market accounts. Liquid accounts are easily turned into funds for paying bills and covering financial emergencies or pressing demands.

Other varieties of financial assets might not be as liquid. Liquidity is the ability to change a financial asset into cash quickly. For stocks, it is the ability of an investor to buy or sell holdings from a ready market. Liquid markets are those where there are plenty of buyers and plenty of sellers and no extended lag-time in trying to execute a trade.

In the case of equities like stocks and bonds, an investor has to sell and wait for the settlement date to receive their money—usually two business days. Other financial assets have varying lengths of settlement.

Maintaining funds in liquid financial assets can result in greater preservation of capital. Money in bank checking, savings, and CD accounts are insured against loss of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) for credit union accounts. If for some reason the bank fails, your account has dollar-for-dollar coverage up to $250,000. However, since FDIC covers each financial institution individually, an investor with brokered CDs totaling over $250,000 in one bank faces losses if the bank becomes insolvent

Rahul Sunny answered 1 year ago

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