Assignment # 1

Toufeeq Brothers is a large manufacturing firm in Faisalabad that was created about 35 years ago
by Mr Haji Muhammad Toufeeq. It was initially financed by with an equity investment by the
Toufeeq family and 10 others individuals. Over time, Toufeeq family has obtained substantial
loans from finance companies and commercial banks. The interest rate on the loan is tied to
market interest rate and adjusted every six months. Thus, Toufeeq Brothers cost of borrowing is
sensitive to interest rate movements. It has a credit line with the bank for obtain of funds on
urgent basis. It had purchased Treasury securities that it could sell if it faces any liquidation
problems.

It has assets valued at $10m and generates sales of $20m per year. Some of its growth is
attributed to its acquisition of other firms. Toufeeq Brothers hopes to do so i.e. expansion by
acquiring other businesses. Its expects that it needs substantial long term financing and plans to
borrow additional funds by loans or by bonds. It is also considering issuing of stocks to raise
funds in the next year. Toufeeq Brothers monitors conditions in the financial markets that could
affect its cash inflow and cash outflow and ultimately affects its values.

a. In what ways Toufeeq Brothers a surplus unit

b. If financial markets were perfect how might this have allowed Toufeeq Brothers to
avoid financial institution

c. How Toufeeq Brothers is exposed to moral hazard problem

d. How Toufeeq Brothers is exposed to adverse selection