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PARTTHREEAnswerstoEnd-of-ChapterProblems55Chapter1WhyStudyMoney,Banking,andFinancialMarkets?2.ThedatainFigures1,2,3,and4suggestthatrealoutput,theinflationrate,andinterestrateswouldallfail.4.Youmightbemorelikelytobuyahouseoracarbecausethecostoffinancingthemwouldfall,oryoumightbelesslikelytosavebecauseyouearnlessonyoursavings.6.No.Itistruethatpeoplewhoborrowtopurchaseahouseoracarareworseoffbecauseitcoststhemmoretofinancetheirpurchase;however,saversbenefitbecausetheycanearnhigherinterestratesontheirsavings.7.Thebasicactivityofbanksistoacceptdepositsandmakeloans.8.Theychannelfundsfrompeoplewhodonothaveaproductiveuseforthemtopeoplewhodo,therebyresultinginhighereconomicefficiency.9.Theinterestrateonthree-monthTreasurybillsfluctuatesmorethantheotherinterestratesandisloweronaverage.TheinterestrateonBaacorporatebondsishigheronaveragethantheotherinterestrates.10.Thelowerpriceforafirm’ssharesmeansthatitcanraiseasmalleramountoffunds,soinvestmentinfacilitiesandequipmentwillfall.11.Higherstockpricesmeansthatconsumers’wealthishigher,andtheywillbemorelikelytoincreasetheirspending.12.Itmakesforeigngoodsmoreexpensive,soBritishconsumerswillbuyfewerforeigngoodsandmoredomesticgoods.13.ItmakesBritishgoodsmoreexpensiverelativetoAmericangoods.ThusAmericanbusinesseswillfinditeasiertoselltheirgoodsintheUnitedStatesandabroad,andthedemandfortheirproductswillrise.14.Inthemid-tolate1970sandinthelate1980sandearly1990s,thevalueofthedollarwaslow,makingtravelabroadrelativelymoreexpensive;thusitwasagoodtimetovacationintheUnitedStatesandseetheGrandCanyon.Withtheriseinthedollar’svalueintheearly1980s,travelabroadbecamerelativelycheaper,makingitagoodtimetovisittheTowerofLondon.15.Whenthedollarincreasesinvalue,foreigngoodsbecomelessexpensiverelativetoAmericangoods;thusyouaremorelikelytobuyFrench-madejeansthanAmerican-madejeans.TheresultingdropindemandforAmerican-madejeansbecauseofthestrongdollarhurtsAmericanjeansmanufacturers.Ontheotherhand,theAmericancompanythatimportsjeansintotheUnitedStatesnowfindsthatthedemandforitsproducthasrisen,soitisbetteroffwhenthedollarisstrong.56Mishkin�TheEconomicsofMoney,Banking,andFinancialMarkets,NinthEditionChapter2AnOverviewoftheFinancialSystem1.TheshareofMicrosoftstockisanassetforitsowner,becauseitentitlestheownertoashareoftheearningsandassetsofMicrosoft.TheshareisaliabilityforMicrosoft,becauseitisaclaimonitsearningsandassetsbytheowneroftheshare.2.Yes,Ishouldtakeouttheloan,becauseIwillbebetteroffasaresultofdoingso.Myinterestpaymentwillbe$4,500(90%of$5,000),butasaresult,Iwillearnanadditional$10,000,soIwillbeaheadofthegameby$5,500.SinceLarry’sloan-sharkingbusinesscanmakesomepeoplebetteroff,asinthisexample,loansharkingmayhavesocialbenefits.(Oneargumentagainstlegalizingloansharking,however,isthatitisfrequentlyaviolentactivity.)3.Yes,becausetheabsenceoffinancialmarketsmeansthatfundscannotbechanneledtopeoplewhohavethemostproductiveuseforthem.Entrepreneursthencannotacquirefundstosetupbusinessesthatwouldhelptheeconomygrowrapidly.4.TheprincipaldebtinstrumentsusedwereforeignbondswhichweresoldinBritainanddenominatedinpounds.TheBritishgainedbecausetheywereabletoearnhigherinterestratesasaresultoflendingtoAmericans,whiletheAmericansgainedbecausetheynowhadaccesstocapitaltostartupprofitablebusinessessuchasrailroads.5.Thisstatementisfalse.Pricesinsecondarymarketsdeterminethepricesthatfirmsissuingsecuritiesreceiveinprimarymarkets.Inaddition,secondarymarketsmakesecuritiesmoreliquidandthuseasiertosellintheprimarymarkets.Therefore,secondarymarketsare,ifanything,moreimportantthanprimarymarkets.6.Youwouldratherholdbonds,becausebondholdersarepaidoffbeforeequityholders,whoaretheresidualclaimants.7.Becauseyouknowyourfamilymemberbetterthanastranger,youknowmoreabouttheborrower’shonesty,propensityforrisktaking,andothertraits.Thereislessasymmetricinformationthanwithastrangerandlesslikelihoodofanadverseselectionproblem,withtheresultthatyouaremorelikelytolendtothefamilymember.9.Loansharkscanthreatentheirborrowerswithbodilyharmifborrowerstakeactionsthatmightjeopardizetheirpayingofftheloan.Henceborrowersfromaloansharkarelesslikelytoincreasemoralhazard.10.Theymightnotworkhardenoughwhileyouarenotlookingormaystealorcommitfraud.11.Yes,becauseevenifyouknowthataborroweristakingactionsthatmightjeopardizepayingofftheloan,youmuststillstoptheborrowerfromdoingso.Becausethatmaybecostly,youmaynotspendthetimeandefforttoreducemoralhazard,andsotheproblemofmoralhazardstillexists.PartThree:AnswerstoEnd-of-ChapterProblems5712.True.Iftherearenoinformationortransactionscosts,peoplecouldmakeloanstoeachotheratnocostandwouldthushavenoneedforfinancialintermediaries.13.Becausethecostsofmakingtheloantoyourneighborarehigh(legalfees,feesforacreditcheck,andsoon),youwillprobablynotbeableearn5%ontheloanafteryourexpenseseventhoughithasa10%interestrate.Youarebetteroffdepositingyoursavingswithafinancialintermediaryandearning5%interest.Inaddition,youarelikelytobearlessriskbydepositingyoursavingsatthebankratherthanlendingthemtoyourneighbor.14.Arankingfrommostliquidtoleastliquidis(a