An Overview of the Financial System

Question: How can the adverse selection problem explain why you are more likely to make a loan to a family member than to a stranger? Answer: The stock prices are directly linked with the capacity of the business to make investment in the business. The lower the share price for a firm that means the amount of funds raised would be less as the total collection from the investors will fall and thus the investment in the assets such as plant and equipment will fall and there will be a decrease in the funds cycle of the company. But it will be noticed that if the company has good fundamentals then the effect on the prices will not hamper the investment as the investors jump to buy at a lower price and the quantity would go up leading to the balancing property.The rise in the interest rates would surely effect the decisions of the business houses as well as the consumers as they will be more aware of the spending that are to be done from the borrowed funds. The business houses will decrease their investments plans and would try to cut down their investment expenditure during the phase of higher interest rates as well as the con sumers would be less likely to buy cars and houses because the cost of finance would be higher for them and hence they will not go for such investments. The rise of interest rates affects people in an opposite manner and all are not worse off with this rise. The payers are worried and the receivers are happy. So the ones that have an obligation to pay would be worse off as they have to pay at a higher rate but the ones that save are benefited as they will get higher rates for the same. Therefore it is a mixed effect on people due to the rising interest rates and not only worse off. If the dollar is costlier than the other currencies it implies that the buyers of the countries other than US will have to pay in dollars for which the foreign currency value will be much more and they have to pay higher of their local currency for the jeans so it will be costlier for them and hence they will prefer to buy the foreign jeans rather than the American jeans as it will be costlier to buy the American jeans for them. The US companies that manufactures jeans would be targeting the foreign customers and hence they will wish for weak dollars so that the buyers would find it cheap to buy the US jeans and if the dollar is strong it will impact the pockets of the buyers in a negative may and will not be suitable for them The company that import jeans into US from other countries would wish that the dollar remains strong so that it has to pay less of US dollars for importing the goods. If the dollar would be strong the outflow would be less and the imports would be cheaper. If there is a suspicion that the company will be bankrupt in the times to come then the investors would be interested to hold the bonds before the equity shares because the bonds would be redeemed prior to any other equity or capital. The equity holders are mostly paid the residues left paying off the other liabilities for the company. This statement is false. Prices in secondary markets determine the prices that firms issuing securities receive in primary markets. In addition, secondary markets make securities more liquid and thus easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important than primary markets for the firms and there is no such thing that the secondary markets are irrelevant for the business houses. The allotment of loans plays a very important role in the credit rating system of the lenders. The adverse selection problems arise in the case of the people that are unknown to us and that are not in the case of unknown people. This is because you know your family member better than a stranger, you know more about the borrowers honesty, propensity for risk taking, and other traits. There is less asymmetric information than with a stranger and less likelihood of an adverse selection problem, with the result that you are more likely to lend to the family member. The rise of the limits of the amount of the loans that would be given to the customers for the insured loans would help the security to be sure for the amount of money lend by the banks as during the time of recession if the banks fail then it will be a loss so to insure that the customers bankruptcy does not affect bank the insured amounts were increased by the US government Answers 14 Year Cash flow PV (10%) 1 1100 1000 2 1210 1000 3 1331 1000 PV 3000 15 Years To Maturity 5 Yield To Maturity 6% FV of Bond 1000 $ 747.26 16 Year Cash flow PV(10%) 0 2000000 2000000 1 2000000 1886792.453 2 2000000 1779992.88 3 2000000 1502629.602 4 2000000 1366026.911 PV $ 85,35,441.85