Chapter 3 (Financial Markets, Institutions and Instruments)

1. If higher leverage is associated with greater risk, explain why the process of
deleveraging (reducing leverage or debt) can be destabilizing for instance during
the financial crisis?

2. Suppose you need to take out a personal loan with a bank. Explain how you
could be affected by problems in the interbank lending market such as those
seen during the 2007-2009 financial crisis

3. Commercial banks, insurance companies, investment banks, and pension funds are all
examples of financial intermediaries. For each of these, give an example of a source of
their funds and an example of their use of funds.

4. Joe and Mike purchase identical houses for $200,000. Joe makes a down payment of
$40,000 while Mike only puts down $10,000; for each individual, the down payment is the
total of his net worth. Assuming everything else equal, who is more highly leveraged? If
house prices in the neighbourhood immediately fall by 10 percent (before any mortgage
payments are made), what would happen to Joe’s and Mike’s net worth?

5. Splitland is a developing economy with two distinct regions. The northern region has
great investment opportunities, but the people who live there need to consume all of
their income to survive. Those living in the south are better off than their northern
counterparts and save a significant portion of their income. The southern region,
however, has few profitable investment opportunities and so most of the savings remain
in shoeboxes and under mattresses. Explain how the development of the financial sector
could benefit both regions and promote economic growth in Splitland.

6. For each pair of instruments below, use the criteria for valuing a financial instrument to
choose the one with the highest value. (LO1)
a. A U.S. Treasury bill that pays $1,000 in six months or a U.S. Treasury bill that pays
$1,000 in three months.
b. A U.S. government Treasury bill that pays $1,000 in three months or commercial
paper issued by a private corporation that pays $1,000 in three months.

Chapter 6 – Are Financial Markets Efficient

7. Describe Random Walk Behaviour of Stock Market?

8. Describe what would happen to the stock if investors foresee that optimal
Forecast Return is greater than the Equilibrium Return in an Efficient Market?
9. Describe two types of Arbitrage? Provide an example of Arbitrage?
10. What does the book says about the performance of mutual funds as
compared to performance of the market as a whole?
11. Why it was said using technical analysis is a waste of time to predict stock
price?