Financial Institutions

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International Technological University
FINN 918 Financial Institutions
Final Exam: Answers
Textbook: Foundations of Financial Markets and Institutions, 4th Edition, Fabozzi, Modigliani, and Jones, Prentice Hall, 2010,| ISBN –13: 978-0-13613531-9|
ISBN –10: 0-13-613531-5|

1. Indicate whether each of the following instruments trades in the money market or the capital market: a. General Motors Acceptance Corporation issues a financial instrument with four months to maturity. b. The U.S. Treasury issues a security with 10 years to maturity. c. Microsoft Corporation issues common stock.

d. The State of Alaska issues a financial instrument with eight months to maturity. e. GMAC issue trades in the money market.
f. U.S. security trades in the capital market.
g. Microsoft stock trades in the capital market.
h. State of Alaska security trades in the money market.

2. Give three reasons for the trend toward greater integration of financial markets throughout the world. There are several reasons. These include:
a. Deregulation and/or liberalization of financial markets to permit greater participants from other countries; b. Technological innovations to provide globally-available information and to speed transactions; c. Institutionalization -- financial institutions are better able to diversify portfolio and exploit mis-pricings than are individuals.

3 Why does increased volatility in financial markets with respect to the price of financial assets, interest rates, and exchange rates foster financial innovation?

Increased volatility of the prices of financial assets has fostered innovation as investors and institutions seek ways to mitigate financial risk. Among other things, these innovations include the advancement of the modern derivatives markets.

Chapter 2
1. Each year, millions of American investors pour billions of dollars into investment companies, which use those dollars to buy the common stock of other companies. What do the investment companies offer investors who prefer to invest in the investment companies rather than buying the common stock of these other companies directly?

In investing funds with the investment companies, investors are reducing their risk via diversification and the cost of contracting and information. These companies also provide liquidity to the investor.

2. a. Why is the term hedge to describe “hedge funds” misleading? b. Where is the term hedge fund described in the U.S. securities laws?

a. Hedge denotes hedging risk. Many hedge funds, however, do not use hedge as a strategy, and these funds take significant risk in their attempt to achieve abnormal returns. b. The term is not described in US securities laws, and hedge funds are not regulated by the SEC.

3. Some hedge funds will refer to their strategies as “arbitrage strategies.” Why would this be misleading?

Arbitrage means riskless profit. These opportunities are few and fleeting. Hedge funds take great risk. The arbitrage typically taken is where there is a disparity between the risk and the return, such as pricing disparities across markets.

Chapter 3
1. What is the Basel Committee for Bank Supervision?
a. What do the two frameworks, Basel I and Basel II, published by the Basel Committee for Bank Supervision, address regarding banking?

a. It is the organization that plays the primary role in establishing risk and management guidelines for banks throughout the world. b. The frameworks set forth minimum capital requirements and standards.

2. Explain each of the following:
a. reserve ratio
b. required reserves

a. The reserve ratio is the percentage of deposits a bank must keep in a non-interest-bearing account at the Fed. b. Required reserves are the actual dollar amounts based on a given reserve ratio.

3. How did the Glass-Steagall Act impact the operations of a bank?...
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