Financial Market Tutorial

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Tutorial 1

1. Ice breaking session

2. General overview of financial markets and institutions module

3. Group project briefing

4. Mid semester and final examination

5. Other relevant matters

Tutorial 2 : Financial Intermediation

1. Why is financial intermediation important in the economy? Because they channel funds from those who do not have a productive use for them (surplus sector) to those who do (deficit sector), thereby resulting in higher economic efficiency.

2. Explain why a higher interest rates will lead to lower economic growth?

Businesses would cut investment spending because the cost of financing this spending is now

higher, and consumers would be less likely to purchase a house or a car because the cost of

financing their purchase is higher.

3. Explain the impact of interest rates on cost of funds and asset valuation like stocks and bonds.

• A change in interest rates affects the cost of acquiring funds for financial institution

• In addition, changes in interest rates affect the price of assets such as stock and bonds that the financial institution owns which can lead to profits or losses.

• High interest affects profitability of company, thus stock prices drop

• High interest lead to lower bond price

4. Why firms do not normally raise fund when the stock market is weak?

The lower price for a firm’s shares means that it can raise a smaller amount of funds, and so

investment in plant and equipment will fall.

5. Explain the impact of a bullish stock market on consumption and economy

Higher stock prices mean that consumers’ wealth is higher and so they will be more likely to

increase their spending.

Tutorial 3 : Financial Intermediation

1. Why do you still want to deposit your money with a bank that pays 5% although you can lend

it directly to a borrower at 10%?

Because the costs of making the loan to your neighbor are high (legal fees, monitoring costs, fee for a credit check, and so on), you will probably not be able to earn 5% on the loan after your expenses even though it has a 10% interest rate. You are better off depositing your savings with a financial intermediary and earning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bank rather than lending them to your neighbor. Banks have economic of scale and information

2. Is it possible to eliminate financial intermediation?

If there are no information or transactions costs and no need to monitor, people could make loans to each other at no cost

and would thus have no need for financial intermediaries.

3. Explain how standard accounting principle can reduce adverse selection and moral hazard problems in the financial markets

Standard accounting principles make profit verification easier, thereby reducing adverse selection

and moral hazard problems in financial markets and hence making them operate better. Standard

accounting principles make it easier for investors to screen out good firms from bad firms,

thereby reducing the adverse selection problem in financial markets. In addition, they make it

harder for managers to understate profits, thereby reducing the principal-agent (moral hazard)

problem.

4. Explain why lemons problem is less severe for firms listed on the NYSE

The lemons problem would be less severe for firms listed on the New York Stock Exchange because they are typically larger corporations which are better known in the market place. Therefore it is easier for investors to get information about them and figure out whether the firm is of good quality or is a lemon. This makes the adverse selection-lemons problem less severe.

5. Explain the causes of principal agent problem

The separation of ownership and control creates a principal-agent problem. The managers...
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