Solutions to Chapter 2 Financial Markets and Institutions.doc

Solutions to Chapter 2 Financial Markets and Institutions The story of Apple Computer provides three examples of financing sources: equity investments by the founders of the company, trade credit from suppliers and investments by venture capitalists. Other sources include reinvested earnings of the company and loans from banks and other financial institutions. Yes. When the corporation retains cash and reinvests in the firm’s operations, that cash is saved and invested on behalf of the firm’s shareholders. The reinvested cash could have been paid out to the shareholders. By not taking the cash, these investors have reinvested their savings in the corporation. Individuals can also save and invest in a corporation by lending to, or buying shares in, a financial intermediary such as a bank or mutual fund that subsequently invests in the corporation. Separation of ownership and control for public corporations means that the ultimate owners of the corporation are not its managers. These same managers will consider their own interest as well as shareholders when making decisions. This creates agency problems. Money markets, where short-term debt instruments are bought and sold. Foreign-exchange markets. Most trading takes place in over-the-counter transactions between the major international banks. Commodities markets for agricultural commodities, fuels (including crude oil and natural gas) and metals (such as gold, silver and platinum). Derivatives markets, where options and other derivative instruments are traded. Buy shares in a mutual fund. Mutual funds pool savings from many individual investors and then invest in a diversified portfolio of securities. Each individual investor then owns a proportionate share of the mutual fund’s portfolio. Defined contribution pension plans provide three key advantages as vehicles for retirement savings: Professional management. Diversification at low cost. Pension plan contributions are tax-deductible,