Question

Respond to the reading below the course name is money and banking.

Chapter 1, Page 19

2. What effect might a fall in stock prices have on business investments?

Any new stock the company issues at the time of falling stock prices reduces the new revenue the firm can acquire through sales of stock. This in turn might lead to a decrease in the firm’s investments. A falling stock price also reduces a firm’s ability to acquire other firms, as such buyouts often include offers of the acquiring firm’s shares in exchange (at a set ratio) for those of the firm to be acquired.

4. Why are financial markets important to the health of the economy?

Purchases and selling of stocks, bonds, and foreign currencies make financial transactions that fund investments made by firms, governments, banks, and consumers. The activities enabled by these funds make the generation of the goods and services desired by consumers. Their financial instruments also serve as stores of wealth for those seeking to accumulate further wealth and are converted to other forms of wealth (such as money) to enable their purchasing of goods and services.

Chapter 2

7. What is the difference between a mortgage and a mortgage-backed security?

According to our text, a mortgage is a form of debt instrument in which is created “a contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals (interest and principal payments) until a specified date (the maturity date), when a final payment is made.” The purpose of this borrowing is to allow borrowers to purchase land, housing, or other real structures. On the other hand, mortgage-backed securities are financial instruments created by institutions through the bundling of multiple mortgages into a single instrument, in a manner similar to that of a mutual fund consisting of a collection of shares of stock from a variety of corporations.

10. How does risk sharing benefit both financial intermediaries and private investors?

Risk sharing is a process by which financial intermediaries purchase large amounts of low risk securities in large volumes and at corresponding lower transaction costs/share than a small investor could afford to purchase and sell these to private investors for a profit. This benefits the private investor by transferring to them instruments with low risk at a price lower than the individual investor could obtain on his own. The large amount of funds generated by these sales of low-risk securities enabled the financial intermediaries to purchase smaller values of higher risk instruments than they would otherwise have been able to safely purchase (if some of the high-risk instruments decrease in value/price, they financial intermediary does not become insolvent, as they have not converted all of their profit from selling low-risk instruments into high-risk instruments, it is money they can now afford to lose for the possibility of making rates of return on their higher-risk investments). The financial intermediary is now in possession of higher-risk instruments that they can sell to individual investors able and willing to tolerate greater risk in exchange for the possibility of higher rates of growth (asset transformation from low-risk to high-risk instruments). Financial intermediaries are also capable of repackaging/bundling mixtures of high and low-risk securities from different sectors of the economy so as to create new financial instruments that a spectrum of risk and potential growth rates to appeal to individual investors with a wide variation in appetites for risk (diversifying the investments of individual investors).

Answer 1

alll the answers you have given are correct, but in Question 4, u can add more on fianncial market

financial market are important for economy because -

1.Price Determination: Demand and supply of an asset in a financial market help to determine their price. Investors are the supplier of the funds, while the industries are in need of the funds. Thus, the interaction between these two participants and other market forces helps to determine the price.

2. Mobilization of savings: For an economy to be successful it is crucial that the money does not sit idle. Thus, a financial market helps in connecting those with money with those who require money.

3. Saves time and money: Financial markets serve as a platform where buyers and sellers can easily find each other without making too much efforts or wasting time. Also, since these markets handle so many transactions it helps them to achieve economies of scale. This results in lower transaction cost and fees for the investors.

4. Provide liquidity to financial assets: Assets that buyers and sellers trade in the financial market have high liquidity. It means that investors can easily sell those assets and convert them into cash whenever they want. Liquidity is an important reason for investors to participate in trade.

5. Increase in Trade and Business

6. Higher Growth rate