CHAPTER 2

Overview of Market Participants and Financial Innovation

Assignment
Questions

1. Explain how the household sector participates as both a borrower and lender of funds in the
financial market.
2. What entities are included in the nonfinancial business sector of the financial market?
3. Explain why some subsidiaries of a nonfinancial business may be classified as financial
businesses
4. Why were government agencies created in the United States?
5. The European investment bank was established by the European Economic Community and
charged with the role of promoting balanced regional development, serving the common
interest of member states, and furthering industrial modernization. The member states
include certain European countries. Would the European Investment Bank be classified as a
municipal government of a financial business entity? If neither, how would it be classified?
6. a. Explain why an individual’s account at a financial intermediary may be called an indirect
investment in a firm that has borrowed money from the intermediary
b. Explain why the intermediary’s loan to the firm is a direct investment.
7. Referring to Table 2-2, match the types of liabilities to these four assets that an individual
might own:
a. Car insurance policy
b. Variable rate certificate of deposit
c. Fixed rate certificate of deposit
d. A life insurance policy that allows the holder’s beneficiary to receives $100,000 when
the holder dies or $150,000 for accidental death.
8. A bank issues an obligation to depositors in which it agrees to pay 8% guaranteed for 1 year.
With the funds it obtains, the bank can invest in a wide range of financial assets. What is the
risk the bank uses the funds to invest in common stock?
9. Explain how financial intermediaries provide maturity intermediation.
10. How do financial intermediaries reduce the cost of contracting?
11. a. What is the economic rationale for the widespread use of “disclosure regulation?”
b. Why do some economists believe that a disclosure regulation is unnecessary?
12. What is meant by financial activity regulation?
13. A 1989 study entitled “Globalization and Canada’s Financial Markets,” a research report
prepared for the Economic Council of Canada, reported the following:
issuance of, and trading in, securities such as bonds or stocks- as opposed to “financial
intermediation,” in which the financial institution raises funds by issuing a claim on itself and
provides funds in the form of loans.
 a. Commercial banks are financial institutions that raise funds by issuing claims against
themselves and then use the funds to provide loans. What do you think are the
implications of the shift from financial intermediation to market intermediation for
commercial banks
b. What do you think some of the obstacles are in market intermediation?
14. a. What is the difference between a financial innovation process and a financial innovation
product?
b. Give an example of how a financial innovation process can lead to a financial innovation
product.
15. The term “securitization” can be used in a general way to describe a process and in a specific
way. Explain the two ways.
16. With automobile leases, a major risk to the lessor (the party form whom the car is leased? Is
that the market value of the car when the lease term expires is less than the expected value
of the car when the lease was negotiated. Consider Toyota Motor Credit Corporation’s
tuition as a lessor. It was concerned that the 260,000 1998 motor vehicles (cars and light
duty trucks) it leased to customers would decline in value if the used-car market weakened.
To protect itself, Toyota issued a cat bond that inured against a loss in market value of the
fleet of leased motor vehicles.
a. Explain what as cat bond is.
b. Explain how Toyota Motor Credit Corporation was able to use the public marketto
insure against the risk that the market price of the leased vehicles would decline.
Test Questions

1. Government raises funds by issuance of security referred to as corporate securities. F

2. Government are also investors of securities T
3. Nonprofit organization’s operations are subject to tax. F
4. Managers of a foundation’s funds invest in long-term asset with the primary goal of
safeguarding the principal of the fund.T
5. In Debit card, a bill is sent to the cardholder periodically requests payment for the transaction
made. F
6. In type I liabilities both the amount of timing of the liabilities are known with certainty. T

Test. II
1. A major participant in the financial markets is the
a. Private Corporations c. government-sponsored enterprises e. captive finance companies
b. High net worth individuals d. Insurance companies
2. These corporations have subsidiaries that are involved in the same activities as financial corporation,
they participate in the lending funds referred to as
a. Private Corporations c. government-sponsored enterprises e. captive finance companies
b. High net worth individuals d. Insurance companies
3. They sell protection against the occurrence of future events such as death or fire to a resident or
commercial properties
a. Private Corporations c. government-sponsored enterprises e. captive finance companies
b. High net worth individuals d. Insurance companies
4. The following are nonprofit organization except:
a. endowment c. pension funds
b. foundation d. associations
5. Supranational institutions are the international banks which for construction and development.
a. world bank c. Development bank of the Phillipines
b. International Monetary fund d. American Bank
6.These are financial intermediaries except:
a. depository institutions c. endowment
b. insurance companies d. pension funds
7. The following are economic functions of financial intermediaries
a. Providing maturity intermediation c. comply with legal laws
b. risk reduction via diversification d. provide payment mechanism
8. Life insurance policy is an example of
a. Type I liability c. type III liabilities
b. Type II liability d. Type IV Liabilities
CHAPTER 2 -

____1. Government raises funds by issuance of security referred to as

a. Mortgage securities b. national securities c. Local securities d. Treasury securities
20.It is a market in which existing securities are resold or traded.
a. Over the counter b. Stock Exchange c. Primary Market d. Secondary Market
___2. They make direct loans to individuals, nonfinancial and financial business, and state and local
government.
a. Insurance companies c. depository institutions
b. asset management firms d. investment banks
___ 3. An investment banking firms can be a subsidiary of a commercial bank or an insurance company.
A. true b. false
___ 4.Non-profit organization are not motivated any monetary gain but have as their primary objective
financially supporting and/or actively engaging in activities that will benefit the organization.
A. true b. false
___5. Nonprofit organization are referred to as
a. Commercial enterprise c. Profit free organization.
b. Advocacy organization d. endowment
___6. Nonprofit organization are referred to as
a. Commercial enterprise c. Profit free organization.
b. Advocacy organization d. endowment
___ 7. The mangers of a foundation’s fund invest in short-term asset with the primary goal of
safeguarding the principal of the fund. A. true b. FALSE
___ 8. A central bank participates by buying and selling financial assets in the financial market in order
to either stabilize their currency relative to U.S dollar or as an investment vehicle.
A, true b. false
9.play the basic role of transforming financial assets that are less desirable for a large part of the public
into other financial assets.
A. Investment institutions c. financial intermediaries
b. depository institutions d. government owned corporation
10. Which is not true about pension funds
a. They are in the spread business in that they do not raise funds themselves in the market.
b. They seek to cover the cost of pension obligations at a minimum cost that is borne by the sponsor of
the pension plan.
c. They invest to increase its value.
11. Investors with a small sum to invest would find it difficult to achieve some degree of diversification
because of their lack of sufficient funds to buy shares of a large number of companies. A. true b. false
____12. The following are nonprofit organization except:
a. endowment c. pension funds
b. foundation d. associations
____13. Supranational institutions are the international banks which for construction and development.
a. world bank c. Development bank of the Phillipines
b. International Monetary fund d. American Bank
____15. The following are economic functions of financial intermediaries, except:
a. Providing maturity intermediation c. comply with legal laws
b. risk reduction via diversification d. provide payment mechanism

____17. Life insurance policy is an example of

a. Type I liability c. type III liabilities
b. Type II liability d. Type IV Liabilities
_____ 18. _____19. The two sources of income for insurance companies
a. initial underwriting income c. spread income
b. investment income that occurs over time d. commission income

20. It is the form of regulation where government do monitoring that restricts these institutions’
activities in the vital areas of lending, borrowing, and funding.
a. disclosure regulation c. regulation of financial institutions
b. financial activity regulation d. law implementation