Homework Assignment – Week 1

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Chapter 1
1- Why are financial markets important to the health of the economy? Because they channel funds from those who do not have a productive use for them to those who do, thereby resulting in higher economic efficiency. 2- When interest rates rise, how might businesses and consumers change their economic behavior? 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- How can a change in interest rates affect the profitability of financial institutions? A change in interest rates affects the cost of acquiring funds for financial institution as well as changes the income on assets such as loans, both of which affect profits. In addition, changes in interest rates affect the price of assets such as stock and bonds that the financial institution owns that can lead to profits or losses. 4- Is everybody worse off when interest rates rise?

No. People who borrow to purchase a house or a car are worse off because it costs them more to finance their purchase; however, savers benefit because they can earn higher interest rates on their savings. 5- What effect might a fall in stock prices have on business investment? 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. 6- What effect might a rise in stock prices have on consumers’ decisions to spend? Higher stock prices mean that consumers’ wealth is higher and so they will be more likely to increase their spending. 7- How does a decline in the value of pound sterling affect British consumers? It makes foreign goods more expensive and so British consumers will buy less foreign goods and more domestic goods. 8- How does an increase in the value of the pound sterling affect American businesses? It makes British goods more expensive relative to American goods. American businesses will find it easier to sell their goods in the United States and abroad, and the demand for their products will rise. If, however, an American business depends on supplies/parts from British companies these products will increase their costs. 9- How can changes in foreign exchange rates affect the profitability of financial institutions? Changes in foreign exchange rates change the value of assets held by financial institutions and thus lead to gains and losses on these assets. Also changes in foreign exchange rates affect the profits made by traders in foreign exchange who work for financial institutions. 10- Using www.bloomberg.com find a chart of the US dollar vs. British Pound exchange rate for the past 5 years. In what year would an American have found it cheapest to visit London? In what year would an English citizen have found it cheapest to visit the Grand Canyon? The exchange rate chart can be found at: http://www.bloomberg.com/quote/GBPUSD:CUR/chart. The Pound was the weakest in 2009 and this would have been the cheapest time for an American to visit London. The Pound was strongest in November 2007 and this would have been the time when an English Citizen would have found the US the cheapest. 11- What is the basic activity of banks?

Banks accept deposits and then use the resulting funds to make loans. 12- What are other important financial intermediaries in the economy besides banks? Savings and loan associations, mutual savings banks, credit unions, insurance companies, mutual funds, pension funds, and finance companies 13- Can you think of any financial innovation in the past 10 years that has affected you personally? Has it made you better or worse off? In what way? 14- What types of risks do financial institutions face?

The profitability of financial institutions is affected by changes in interest rates, stock prices, and foreign exchange rates; fluctuations in these variables expose these...
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