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some third party content may be suppressed from the eBook and/or eChapters. Financial Markets and Institutions 11th Edition Jeff Madura Senior Vice Treasury bonds are perceived to be free from default risk because they qualify for prime mortgages or who are unable to make a down payment. edition madura test bank solutions completed download financial markets and madura pdf - read online now personal finance 5th edition jeff madura ebook pdf jeff madura pdf file for free from our online library pdf file: personal finance 5th. Financial Markets and Institutions, 11 edition PDF Book, By Jeff Madura, ISBN: Author: Jeff Madura Download Ebook, Read Now, File Type, Upload Date.
Jeff Madura. Financial Markets and Institutions 5th Edition. Read more. European Financial Markets and Institutions. Financial Institutions and Markets:
Current Issues in Financial Markets. The Financial Crisis: An Early Retrospective. Understanding Financial Statements 9th Edition. Risk Management and Financial Institutions 1st Edition. The origins and development of financial markets and institutions. Economists and the financial markets. Capital Markets and Financial Intermediation. Economists and the Financial Markets. Financial Markets and Corporate Strategy. Financial markets and corporate strategy. In this way they finance the needs of deficit units and thus serve as important financial intermediaries.
Their overall performance is linked to the performance of the stocks and bonds in which they invest. Pension Funds Many corporations and government agencies offer pension plans to their employees. The employees and their employers or both periodically contribute funds to the plan. Pension funds provide an efficient way for individuals to save for their retirement. The pension funds manage the money until the individuals with draw the funds from their retirement accounts.
The money that is contributed to individual WEB finance. Thus pension funds are important financial intermediaries that finance the needs of deficit units.
Surplus units are shown on the left side of the exhibit and deficit units are shown on the right. Three different flows of funds from surplus units to deficit units are shown in the exhibit.
One set of flows repre- sents deposits from surplus units that are transformed by depository institutions into loans for deficit units. A second set of flows represents purchases of securities commercial paper issued by finance companies that are transformed into finance company loans for deficit units.
A third set of flows reflects the purchases of shares issued by mutual funds which are used by the mutual funds to purchase debt and equity securities of deficit units.
The deficit units also receive funding from insurance companies and pension funds. Because insurance companies and pension funds purchase massive amounts of stocks and bonds they finance much of the expenditures made by large deficit units such as corpora- tions and government agencies.
Financial institutions such as commercial banks insurance companies mutual funds and pension funds serve the role of investing funds that they have received from surplus units so they are often referred to as institutional investors.
Securities firms are not shown in Exhibit 1. Many of the transactions between the financial institutions and Exhibit 1.
Furthermore some funds flow directly from surplus units to deficit units as a result of security transactions with securities firms serving as brokers. Because insurance companies pension funds and some mutual funds are major investors in stocks they can influence the management of publicly traded firms.
In recent years many large institutional investors have publicly criticized the management of specific firms which has resulted in corporate restructuring or even the firing of executives in some cases. Thus institutional investors not only provide financial support to companies but also exercise some degree of corporate control over them.
By serving as activist shareholders they can help ensure that managers of publicly held cor- porations are making decisions that are in the best interests of the shareholders. Some commercial banks have been created solely as online entities. Because they have lower costs they can offer higher interest rates on deposits and lower rates on loans. Other banks and depository institutions also offer online services which can reduce costs increase efficiency and intensify competition.
Many mutual funds allow their shareholders to execute buy or sell transactions online. Some insurance companies conduct much of their business online which reduces their operating costs and forces other insurance companies to price their services competitively.
Some brokerage firms conduct much of their business online which reduces their operating costs because these firms can lower the fees they charge they force other brokerage firms to price their services competitively.
Com- mercial banks hold the most assets of any depository institution with about 12 trillion in aggregate. Mutual funds hold the largest amount of assets of any nondepository insti- tution with about 11 trillion in aggregate.
Exhibit 1. Households with savings are served by depository institutions. Households with deficient funds are served by depository institutions and finance companies. Large corporations and governments that issue securities obtain financing from all types of financial institutions.
Several agencies regulate the various types of financial institutions and the various regulations may give some financial institutions a comparative advantage over others.
By increasing the volume of services produced the average cost of providing the services such as loans can be reduced. Savings institutions have consolidated to achieve economies of scale for their mortgage lending business. Insurance companies have consolidated so that they can reduce the average cost of providing insurance services.
During the last 10 years different types of financial institutions were allowed by regu- lators to expand the types of services they offer and capitalize on economies of scope.
Commercial banks merged with savings institutions securities firms finance companies mutual funds and insurance companies. Although the operations of each type of finan- cial institution are commonly managed separately a financial conglomerate offers advan- tages to customers who prefer to obtain all of their financial services from a single financial institution.
Because a financial conglomerate is more diversified it may be less exposed to a possible decline in customer demand for any single financial service. It originally focused on com- mercial banking but has expanded its nonbank services to include mortgages small business loans consumer loans real estate brokerage investment banking online financial services and insur- ance. In a recent annual report Wells Fargo stated: Financial Services. This helps us weather downturns that inevita- bly affect any one segment of our industry.
Historically each of the financial services such as banking mortgages brokerage and insurance had significant barriers to entry so only a limited number of firms competed in that industry.
The bar- riers prevented most firms from offering a wide variety of these services. In recent years the barriers to entry have been reduced allowing firms that had specialized in one ser- vice to expand more easily into other financial services. Many firms expanded by acquir- ing other financial services firms. Thus many financial conglomerates are composed of various financial institutions that were originally independent but are now units or subsidiaries of the conglomerate.
Impact of Consolidation on Competition As financial institutions spread into other financial services the competition for customers desiring the various types of finan- cial services increased. Prices of financial services declined in response to the competition. In addition consolidation has provided more convenience. Individual customers can rely on the financial conglomerate for convenient access to life and health insurance brokerage mutual funds investment advice and financial planning bank deposits and personal loans.
A corporate customer can turn to the financial conglomerate for property and casualty insurance health insurance plans for employees business loans advice on restructuring its businesses issuing new debt or equity securities and management of its pension plan.
Financial Markets and Institutions, 11 edition
Commercial banks insur- ance companies and securities firms have expanded through international mergers. An international merger between financial institutions enables the merged company to offer the services of both entities to its entire customer base. For example a U. A merger between the two entities allows the U. By combining specialized skills and customer bases the merged financial institu- tions can offer more services to clients and have an international customer base. The adoption of the euro by 17 European countries has increased business between those countries and created a more competitive environment in Europe.
European financial institutions which had primarily competed with other financial institutions based in their own country recognized that they would now face more competition from financial institutions in other countries.
Many financial institutions have attempted to benefit from opportunities in emerging markets. For example some large securities firms have expanded into many countries Exhibit 1. The need for this ser- vice has increased most dramatically in countries where businesses have been privatized. In addition commercial banks have expanded into emerging markets to provide loans.
Although this allows them to capitalize on opportunities in these countries it also exposes them to financial problems in these countries. Some financial institutions especially commercial banks and savings institutions aggressively attempted to expand their mortgage business in order to capitalize on the strong housing market.
Home prices were expected to continue rising over time so financial institutions presumed incorrectly that the underlying value of the homes would pro- vide adequate collateral to back the mortgage if homeowners could not make their mortgage payments. In the — period mortgage defaults increased and there was an excess of unoccupied homes as homeowners who could not pay the mortgage left their homes.
As a result home prices plummeted and the value of the property collateral backing many mortgages was less than the outstanding mortgage amount. By January at least 10 percent of all American homeowners were either behind on their mortgage payments or had defaulted on their mortgage. Many of the financial institutions that originated mortgages suffered major losses. Systemic risk is defined as the spread of financial problems among financial institutions and across financial markets that could cause a collapse in the financial system.
It exists because financial institutions invest their funds in similar types of securities and therefore have similar exposure to large declines in the prices of these securities. In this case mortgage defaults affected financial institutions in sev- eral ways. First many financial institutions that originated mortgages shortly before the crisis sold them to other financial institutions i.
Second many other financial institutions that invested in mortgage-backed securities and promised payments on mortgages were exposed to the crisis.
Third some financial institutions especially securities firms relied heavily on short-term debt to finance their operations and used their holdings of mortgage-backed securities as collateral. But when the prices of mortgage-backed securities plummeted large securities firms such as Bear Stearns and Lehman Brothers could not issue new short-term debt to pay off the princi- pal on maturing debt.
Furthermore the decline in home building activity caused a decrease in the demand for many related businesses such as air-conditioning services roofing and landscaping. In addition the loss of income by workers in these industries caused a decline in Chapter 1: The weak economy also created more concerns about the potential default on debt securities causing further declines in bond prices.
The financial markets were filled with sellers who wanted to dump debt securities but there were not many buyers willing to buy securities. Consequently the prices of debt securities plunged. Systemic risk was a major concern during the credit crisis because the prices of most equity securities declined substantially since the operating performance of most firms declined when the economy weakened.
Financial Markets and Institutions, 11 edition - PDF Book
Thus most financial institutions experienced large losses on their investments during the credit crisis even if they invested solely inequity securities. Emergency Economic Stabilization Act On October 3 Congress enacted the Emergency Economic Stabilization Act of also referred to as the bail- out act which was intended to resolve the liquidity problems of financial institutions and to restore the confidence of the investors who invest in them. The act directed the Treasury to inject billion into the financial system primarily by investing money into the banking system by purchasing the preferred stock of financial institutions.
In this way the Treasury provided large commercial banks with capital to cushion their losses thereby reducing the likelihood that the banks would fail. Federal Reserve Actions In some large securities firms such as Bear Stearns and Lehman Brothers experienced severe financial problems.
Morgan Chase in order to calm the financial markets.
However when Lehman Brothers was failing six months later it was not rescued by the government and this caused much paranoia in financial markets. At this time the Fed also provided emergency loans to many other securities firms that were not subject to its regulation. Some major securities firms such as Merrill Lynch were acquired by commercial banks while others Goldman Sachs and Morgan Stanley were converted into commercial banks.
These actions resulted in the consolida- tion of financial institutions and also subjected more financial institutions to Federal Reserve regulations. The provisions of the act are frequently discussed in this text when they apply to specific financial markets or financial institutions. One of the key provisions of the Financial Reform Act of is that mortgage len- ders verify the income job status and credit history of mortgage applicants before approving mortgage applications.
This provision is intended to prevent applicants from receiving mortgages unless they are creditworthy. In addition the Financial Reform Act called for the creation of the Financial Stability Oversight Council which is responsible for identifying risks to financial stability in the United States and makes regulatory recommendations that could reduce any risks to the financial system. Furthermore the act established the Consumer Financial Protection Bureau housed within the Federal Reserve to regulate specific financial services for consumers including online banking checking accounts credit cards and student loans.
This bureau can set rules to ensure that information regarding endorsements of specific financial products is accurate and to prevent deceptive practices.
Since financial institutions serve as intermediaries for financial markets the tougher regulations on financial institutions can stabilize the finan- cial markets and encourage more participation by surplus and deficit units in these markets. Because funding needs vary among deficit units various financial markets have been established. The primary market allows for the issuance of new securities and the secondary market allows for the sale of existing securities.
Common capital market securities include bonds mortgages mortgage-backed securities and stocks. The valuation of a security represents the present value of future cash flows that it is expected to generate. New information that indi- cates a change in expected cash flows or degree of uncertainty affects prices of securities in financial markets.
The main deposi- tory institutions are commercial banks savings insti- tutions and credit unions. The main nondepository institutions are finance companies mutual funds pension funds and insurance companies. Many financial institutions have been consolidated due to mergers into financial conglomerates where they serve as subsidiaries of the conglomerate while con- ducting their specialized services.
Thus some finan- cial conglomerates are able to provide all types of financialservices. Those institutions that were heavily involved in originating or invest- ing in mortgages suffered major losses. Many inves- tors were concerned that the institutions might fail and therefore avoided them which disrupted the ability of financial institutions to facilitate the flow of funds. The credit crisis led to concerns about sys- temic risk as financial problems spread among financial institutions that were heavily exposed to mortgages.
Financial intermediaries benefit from access to information. As information becomes more accessible individuals will have the information they need before investing or borrowing funds.
They will not need financial intermediaries to make their decisions. Counter-Point No. Individuals rely not only on information but also on expertise. Some financial intermediaries specialize in credit analysis so that they can make loans. Surplus units will continue to provide funds to financial intermediaries rather than make direct loans because they are not capable of credit analysis even if more information about prospective borrowers is available. Some financial intermediaries no longer have physical buildings for customer service but they still require agents who have the expertise to assess the creditworthiness of prospective borrowers.
Who Is Correct Use the Internet to learn more about this issue and then formulate your own opinion. Surplus and Deficit Units Explain the meaning of surplus units and deficit units.
Provide an example of each. Which types of financial institutions do you deal with Explain whether you are acting as a surplus unit or a deficit unit in your relationship with each financial institution. Types of Markets Distinguish between primary and secondary markets. Distinguish between money and capital markets. Imperfect Markets Distinguish between perfect and imperfect security markets. Explain why the existence of imperfect markets creates a need for financial intermediaries.
Efficient Markets Explain the meaning of effi- cient 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 infor- mation 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. Securities Laws What was the purpose of the Securities Act of What was the purpose of the Securities Exchange Act of Do these laws prevent investors from making poor investment decisions Explain.
International FlowofFunds In what way could the international flow of funds cause a decline in interest rates 8. Securities Firms What are the functions of securities firms Many securities firms employ brokers and dealers. Distinguish between the functions of a broker and those of a dealer and explain how each is compensated. Standardized Securities Why do you think securities are commonly standardized Explain why some financial flows of funds cannot occur through the sale of standardized securities.
If securities were not standardized how would this affect the volume of financial transactions conducted by brokers 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 Depository Institutions Explain the primary use of funds by commercial banks versus savings institutions.
Credit Unions With regard to the profit motive how are credit unions different from other financial institutions Nondepository Institutions Compare the main sources and uses of funds for finance companies insurance companies and pension funds. 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 Impact of Privatization on Financial Markets Explain how the privatization of companies in Europe can lead to the development of new securities markets.
Advanced Questions Comparing Financial Institutions Classify the types of financial institutions mentioned in this chapter 22 Part 1: Explain the general difference between depository and nondeposi- tory institution sources of funds. It is often said that all types of financial institutions have begun to offer ser- vices that were previously offered only by certain types. Consequently the operations of many financial institutions are becoming more similar.
Nevertheless performance levels still differ significantly among types of financial institutions. Why Financial Intermediation Look in a business periodical for news about a recent financial transaction involving two financial institutions.
For this transac- tion determine the following: Will either institution receive immediate income from the transaction c. Who is the ultimate user of funds d. Who is the ultimate source of funds Role of Accounting in Financial Markets Integrate the roles of accounting regulation and financial market participation.
That is explain how financial market participants rely on accounting and why regulatory oversight of the accounting process is necessary. Impact of Credit Crisis on Liquidity Explain why the credit crisis caused a lack of liquidity in the secondary markets for many types of debt securities. Explain how such a lack of liquidity would affect the prices of the debt securities in the secondary markets. ImpactofCreditCrisisonInstitutions Explain whymortgage defaults during the credit crisisadversely affected financial institutions that did not originate the mortgages.
What role did these institutions play in financing the mortgages Regulation of Financial Institutions Financial institutions are subject to regulation to ensure that they do not take excessive risk and can safely facilitate the flow of funds through financial markets.
Nevertheless during the credit crisis individualswere concerned about using financial institutions to facilitate their financial transactions. Why do you think the existing regulations were ineffective at ensuring a safe financial system Impact of the Greece Debt Crisis European debt markets have become integrated over time so that institutional investors such as commercial banks commonly purchase debt issued in other European countries.
When the government of Greece experi- enced problems in meeting its debt obligations in some investors became concerned that the crisis would spread to other European countries. Explain why inte- grated European financial markets might allow a debt crisis in one European country to spread to other countries in Europe. Global Financial Market Regulations Assume that countries A and B are of similar size that they have similar economies and that the government debt levels of both countries are within reasonable limits.
Assume that the regulations in country A require complete dis- closure of financial reporting by issuers of debt in that country but that regulations in country B do not require much disclosure of financial reporting. Explain why the government of country A is able to issue debt at a lower cost than the government of country B. Influence of Financial Markets Some countries do not have well-established markets for debt securities or equity securities.
Why do you think this can limit the development of the country business expansion and growth in national income in these countries Impact of Systemic Risk Different types of financial institutions commonly interact. They provide loans to each other and take opposite positions on many different types of financial agreements whereby one will owe the other based on a specific financial outcome.
Explain why their relationships cause con- cerns about systemic risk. Interpret the following statements. What are the most likely ways in which you can borrow 70 million b. Assuming that you decide to issue debt securities describe the types of financial institutions that may purchase these securities.
It illustrates how financial markets and institutions are integrated and facilitate the flow of funds in the business and financial environment. At the end of every chapter this exercise provides a list of questions about Carson Company that requires the application of concepts presented in the chapter as they relate to the flow of funds. Carson Company is a large manufacturing firm in California that was created 20 years ago by the Carson family.
It was initially financed with an equity invest- ment by the Carson family and 10 other individuals. Over time Carson Company obtained substantial loans from finance companies and commercial banks. The interest rate on the loans is tied to market interest rates and is adjusted every six months. It has a credit line with a bank in case it suddenly needs additional funds for a temporary period. It has purchased Treasury securities that it could sell if it experiences any liquidity problems.
CarsonCompanyhasassetsvaluedatabout50mil- lion and generates sales of about million per year. Some of its growth is attributed to its acquisitions of other firms. Because of its expectations of a strong U. It expects that it will need substantial long-term financing and plans to borrow additional funds either through loans or by issuing bonds. It is also consider- ing issuing stock to raise funds in the next year.
Carson closely monitors conditions in financial markets that could affect its cash inflows and cash outflows and thereby affect its value. In what way is Carson a surplus unit b. In what way is Carson a deficit unit c. Why might Carson have limited access to addi- tional debt financing during its growth phase f. How might Carson use the primary market to facilitate its expansion h.
How might it use the secondary market i. If financial markets were perfect how might this have allowed Carson to avoid financial institutions j. Review the information for the common stock of IBM using the website finance. Review the data that are shown for IBM stock. Compare the price of IBM based on its last trade with the price range for the year. Is the price near its high or low price What is the total value of IBM stock market capitalization What is the average daily 24 Part 1: At what points was the stock price the highest and lowest 2.
Explain whether each of these tables is focused on the primary or secondary markets. If your class has an online component your profes- sor may ask you to post your summary of the article there and provide a link to the article so that other students can access it. If your class is live your profes- sor may ask you to summarize your application of the article in class.
Your professor may assign specific stu- dents to complete this assignment or may allow any students to do the assignment on a volunteer basis. For recent online articles and real-world examples related to this chapter consider using the following search terms be sure to include the prevailing year as a search term to ensure that the online articles are recent: Term Paper on the Credit Crisis Write a term paper on one of the following topics or on a topic assigned by your profes- sor.
Details such as the due date and the length of the paper will be provided by your professor. Each of the topics listed below can be easily researched because considerable media attention has been devoted to the subject. Although this text offers a brief summary of each topic much more information is available at online sources that you can find by using a search engine and inserting a few key terms or phrases.
Impact of the Credit Crisis on Financial Market Liquidity Explain the link between the credit crisis and the lack of liquidity in the debt markets. Offer some insight as to why the debt markets became inactive. How were interest rates affected What happened to initial public offering IPO activity during the credit crisis Why 3. Transparency of Financial Institutions during the Credit Crisis Select a financial institution that had serious financial problems as a result of the credit crisis.
Review the media stories about this institution during the six months before its financial problems were publicized. Were there any clues that the financial institution was having problems At what point do you think that the institution recognized that it was having financial difficulties Did its previous annual report indicate serious problems Did it announce its problems or did another media source reveal the problems 4. Cause of Problems for Financial Institutions during the Credit Crisis Select a financial institution that had serious financial problems as a result of the credit crisis.
Determine the main underlying causes of the problems experienced by that financial institution. Explain how these problems might have been avoided.
Mortgage-Backed Securities and Risk Taking by Financial Institutions Do you think that institutional investors that purchased mortgage-backed securities con- taining subprime mortgages were following reasonable investment guidelines Address this issue for various types of financial institutions such as pension funds commercial banks insurance companies and mutual funds your answer might differ with the type 26 Copyright Cengage Learning.
If financial institutions are taking on too much risk how should regulations be changed to limit such excessive risk taking 6. Do you think that municipal pension funds that purchased commercial paper and other debt securities issued by Lehman Brothers were following reasonable investment guidelines If a pension fund is taking on too much risk how should regulations be changed to limit such excessive risk taking 7. Identify some advantages and disadvantages of this method and propose a solution that would be fair to both commercial banks and regulators.
Future Structure of Fannie Mae Fannie Mae plays an important role in the mortgage market but it suffered major problems during the credit crisis. Discuss the underlying causes of the problems at Fannie Mae beyond what has been discussed in the text.
Should Fannie Mae be owned completely by the government Should it be priva- tized Offer your opinion on a structure for Fannie Mae that would avoid its previous problems and enable it to serve the mortgage market. Future Structure of Ratings Agencies Rating agencies rated the so-called tranches of mortgage-backed securities that were sold to institutional investors. Explain why the performance of these agencies was criticized and then defend against this criti- cism on behalf of the agencies.
Was the criticism of the agencies justified How could rating agencies be structured or regulated in a different manner in order to prevent the problems that occurred during the credit crisis Future Structure of Credit Default Swaps Explain how credit default swaps maybe partially responsible for the credit crisis. Offer a proposal for how they could be structured in the future to ensure that they are used to enhance the safety of the financial system. Sale of Bear Stearns Review the arguments that have been made for the government-orchestrated sale of Bear Stearns.
If AIG had been allowed to fail what types of financial institutions would have been adversely affected That is who benefited from the bailout of AIG Do you think AIG should have been allowed to fail Explain your opinion.
Executive Compensation at Financial Institutions Discuss the compensation received by executives at some financial institutions that experienced financial problems e. Should these executives be allowed to retain the bonuses that they received in the — period Should executive compensation at financial institutions be capped Discuss the reasons for the adverse effects on commercial banks and securities firms and explain why the reasons were different.
Treasury and the Federal Reserve intervened to resolve the credit crisis. Discuss the pros and cons of their interventions. Offer your own opinion regarding whether they should have intervened. Since interest rates change over time so does the rate earned by creditors who provide loans or the rate paid by borrowers who obtain loans.
Interest rate movements have a direct influence on the market values of debt securities such as money market securities bonds and mortgages. They have an indirect influence on equity security values because they can affect the return by investors who invest in equity securities. Thus participants in financial markets attempt to anticipate interest rate movements when restructuring their investment or loan positions.
Interest rate movements also affect the value of most financial institutions. They influence the cost of funds to depository institutions and the interest received on some loans by financial institutions. Since many financial institutions invest in securities such as bonds the market value of their investments is affected by interest rate movements. Thus managers of financial institutions attempt to anticipate interest rate movements and commonly restructure their assets and liabilities to capitalize on their expectations.
Individuals attempt to anticipate interest rate movements so that they can monitor the potential cost of borrowing or the potential return from investing in various debt securities. The theory is especially useful for explaining movements in the general level of interest rates for a particular country. Furthermore it can be used along with other concepts to explain why interest rates among some debt securities of a given country vary which is the focus of the next chapter.
Finally the demand and supply concepts are integrated to explain interest rate movements. In addi- tion they finance the purchases of automobiles and household items which results in installment debt. As the aggregate level of household income rises so does installment debt. The level of installment debt as a percentage of disposable income has been increasing over time although it is generally lower in recessionary periods.
If households could be surveyed at any given time to indicate the quantity of loanable funds they would demand at various interest rate levels the results would reveal an inverse relationship between the interest rate and the quantity of loanable funds demanded. This simply means that at any moment in time households would demand a greater quantity of loanable funds at lower rates of interest in other words they are willing to borrow more money in aggregate at lower rates of interest.
Various events can cause household borrowing preferences to change and thereby shift the demand curve.
For example if tax rates on household income are expected to decrease significantly in the future households might believe that they can more easily afford future loan repayments and thus be willing to borrow more funds. For any interest rate the quantity of loan- able funds demanded by households would be greater as a result of the tax rate change.
This repre- sents an outward shift to the right in the demand curve. The quantity of funds demanded by businesses depends on the number of business projects to be implemented. Businesses evaluate a project by comparing the present value of its cash flows to its initial investment as follows: The required return to implement a given project will be lower if interest rates are lower because the cost of borrowing funds to support the project will be lower.
Hence more projects will have positive NPVs and businesses will need a greater amount of financing. This implies that all else being equal businesses will demand a greater quantity of loanable funds when interest rates are lower this rela- tion is illustrated in Exhibit 2. In addition to long-term assets businesses also need funds to invest in their short-term assets such as accounts receivable and inventory in order to support ongoing operations.
Any demand for funds resulting from this type of investment is positively related to the number of projects implemented and thus is inversely related to the interest rate. The opportunity cost of investing in short-term assets is higher when interest rates are higher.
Therefore firms generally attempt to support ongoing operations with fewer funds during periods of high interest rates. Although the demand for loan- able funds by some businesses may be more sensitive to interest rates than others all businesses are likely to demand more funds when interest rates are lower. Shifts in the Demand for Loanable Funds The business demand-for-loanable- funds schedule as reflected by the demand curveinExhibit2.
If economic conditions become more favorable the expected cash flows on various proposed projects will increase. More pro- posed projects will then have expected returns that exceed a particular required rate of return sometimes called the hurdle rate.
Additional projects will be acceptable as a result of more favorable economic forecasts causing an increased demand for loanable funds.
The increase in demand will result in an outward shift to the right in the demand curve. Exhibit 2. Chapter 2: Municipal state and local governments issue municipal bonds to obtain funds the federal govern- ment and its agencies issue Treasury securities and federal agency securities. These securities constitute government debt. In contrast municipal governments sometimes postpone proposed expenditures if the cost of financing is too high implying that their demand for loanable funds is somewhat sensitive to interest rates.
Like household and business demand government demand for loanable funds can shift in response to various events. Courses that emphasize financial markets should focus on the first five parts Chapters 1 through 16 ; however, some chapters in the section on commercial banking are also relevant.
Courses that emphasize financial institutions and financial services should focus on Parts 1, 2, 6, and 7, although some background on securities markets Parts 3, 4, and 5 may be helpful. Do you like this book? Please share with your friends, let's read it!! Free ebook download XooBooks is the biggest community for free ebook download, audio books, tutorials download, with format pdf, epub, mobi,…and more.
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