MT481 Financial Markets

Chapter 1 & 2

Prof. D. Weaver

By Ivan Rivera

Chapter 1 Questions and Application: 4,10 and 14 pg. 23-24

4. Efficient Markets Explain the meaning of efficient markets. Why might we expect
markets to be efficient most of the time? In recent years, several securities
firms have been guilty of using inside information when purchasing securities, thereby
achieving returns well above the norm (even when accounting for risk). Does this
suggest that the security markets are not efficient? Explain.

( Answer )
Efficient markets refer to a market condition where consumers and market participants
have complete and accurate info about the market. This helps for good business there
is no insider trading happening. Most of us expect the markets to be efficient and
accurate most of the time as the rules and regulations prohibit insider trading and
support fair play but the consequences are not clear and accountability is unfair naming
one individual only when it could have been a group or the company itself. In recent
years, several securities firms have been guilty of using inside information when
purchasing securities, thereby achieving returns well above the norm (even when
accounting for risk). This definitely does suggest that there are some illegal practices
that jeopardize the efficient markets. Nevertheless when these practices are
successfully curbed it leads to efficient markets, otherwise there is some amount of
inefficiency in the market due to insider training. In this way the efficiency of the market
may be reduced through insider training.

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 10. Marketability Commercial banks use some funds to purchase securities and other
funds to make loans. Why are the securities more marketable than loans in the
secondary market?

( Answer )

Securities tend to be more marketable because of the following reasons, Securities are
traded in the secondary market at lower values then loans could be obtained, Securities
are also trade multiple times a day by regular people and by companies internationally,
Loans are given for exchange of credit which means background checks and
verification of multiple documents which could be an extensive process. Securities also
don’t have to face multiple fees for processing and lock down or buy down of rates.

14. Mutual Funds What is the function of a mutual fund? Why are mutual funds popular
among investors? How does a money market mutual fund differ from a stock or bond
mutual fund?

ANSWER:

Mutual funds means that many companies or many investors combine their money into
one account in a collective effort to purchase stocks. Funds are managed by
professional and experienced managers who can reduce the risk and diversify the
investments. Money market mutual funds invest in treasury bills, notes, call options and
other securities. Stock Bond mutual funds mainly invest in bond and stocks in the
primary and secondary market
.

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 Financial Markets MT481
Chapter 2 Question and App 4, and 6 pg. 45

4. Impact of a Recession Explain why interest rates tend to decrease during

recessionary periods. Review historical interest rates to determine how they reacted to
recessionary periods. Explain this reaction.

ANSWER:

During a recession periods in the 1970’s, mid 1990,2000 and now, firms and consumers reduce
their amount of borrowing due to low jobs and consumer phsyche is nervous about the
economy. The demand for loans and funds decreases and interest rates decrease as a result.
We face that situation now and since people don’t know when rates might go up, or jobs then
they tend to save money there is less movement in the banking industry and because less is
being spent then more jobs get affected.

6. Impact of the Money Supply Should increasing money supply growth place upward or
downward pressure on interest rates?

ANSWER:

If one believes that higher money supply growth will not cause inflationary expectations, the
additional supply of funds places downward pressure on interest rates. However, if one believes
that inflation expectations do erupt as a result, demand for loans will also increase, and interest
rates could increase.

Chapter 2 Problem – Prob: 1 and 2 pg. 47

1. Nominal Rate of Interest Suppose the real interest rate is 6 percent and the expected
inflation rate is 2 percent. What would you expect the nominal rate of interest to be?

i = E(INF) + ik ------>> i = 2% + 6% = 8%

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 2. Real Interest Rate Suppose that Treasury bills are currently paying 9 percent and the
expected inflation rate is 3 percent. What is the real interest rate?

i = E(INF) + ik

ik = i – E(INF)

ik = 9% – 3% = 6%

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