Principles of Microeconomics for AP® Courses

Steven A. Greenlaw, David Shapiro, Timothy Taylor

Chapter 17

Financial Markets - all with Video Answers

Educators

MH

Chapter Questions

Problem 1

Answer these three questions about early-stage corporate finance:
a. Why do very small companies tend to raise money from private investors instead of through an IPO?
b. Why do small, young companies often prefer an IPO to borrowing from a bank or issuing bonds?
c. Who has better information about whether a small firm is likely to earn profits, a venture capitalist or a
potential bondholder, and why?

Riham Bassal

Riham Bassal

Numerade Educator

Problem 2

From a firm’s point of view, how is a bond similar to a bank loan? How are they different?

Mihir Nayar

Numerade Educator

Problem 3

Calculate the equity each of these people has in his or her home:
a. Fred just bought a house for $200,000 by putting 10% as a down payment and borrowing the rest from the bank.
b. Freda bought a house for $150,000 in cash, but if she were to sell it now, it would sell for $250,000.
c. Frank bought a house for $100,000. He put 20% down and borrowed the rest from the bank. However, the value of the house has now increased to $160,000 and he has paid off $20,000 of the bank loan.

Prathmesh Gupta

Prathmesh Gupta

Numerade Educator

Problem 4

Which has a higher average return over time: stocks, bonds, or a savings account? Explain your answer.

Mihir Nayar

Numerade Educator

Problem 5

Investors sometimes fear that a high-risk investment is especially likely to have low returns. Is this fear true? Does a high risk mean the return must be low?

Amrita Bhasin

Numerade Educator

Problem 6

What is the total amount of interest from a $5,000 loan after three years with a simple interest rate of 6%?

Mihir Nayar

Numerade Educator

Problem 7

If your receive $500 in simple interest on a loan that you made for $10,000 for five years, what was the interest rate you charged?

Prathmesh Gupta

Prathmesh Gupta

Numerade Educator

Problem 8

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Mihir Nayar

Numerade Educator

Problem 9

What are the most common ways for start-up firms to raise financial capital?

Amrita Bhasin

Numerade Educator

Problem 10

Why can firms not just use their own profits for financial capital, with no need for outside investors?

Mihir Nayar

Numerade Educator

Problem 11

Why are banks more willing to lend to well-established firms?

Amrita Bhasin

Numerade Educator

Problem 12

What is a bond?

Mihir Nayar

Numerade Educator

Problem 13

What does a share of stock represent?

Amrita Bhasin

Numerade Educator

Problem 14

When do firms receive money from a stock sale in their firm and when do they not receive money?

Mihir Nayar

Numerade Educator

Problem 15

What is a dividend?

Amrita Bhasin

Numerade Educator

Problem 16

What is a capital gain?

Mihir Nayar

Numerade Educator

Problem 17

What is the difference between a private company and a public company?

Amrita Bhasin

Numerade Educator

Problem 18

How do the shareholders who own a company choose the actual company managers?

Mihir Nayar

Numerade Educator

Problem 19

Why are banks called “financial intermediaries”?

MH

Mauri Hall

Numerade Educator

Problem 20

Name several different kinds of bank account. How are they different?

Mihir Nayar

Numerade Educator

Problem 21

Why are bonds somewhat risky to buy, even though they make predetermined payments based on a fixed rate of interest?

Amrita Bhasin

Numerade Educator

Problem 22

Why should a financial investor care about diversification?

Mihir Nayar

Numerade Educator

Problem 23

What is a mutual fund?

Amrita Bhasin

Numerade Educator

Problem 24

What is an index fund?

Mihir Nayar

Numerade Educator

Problem 25

How is buying a house to live in a type of financial investment?

Amrita Bhasin

Numerade Educator

Problem 26

Why is it hard to forecast future movements in stock prices?

Mihir Nayar

Numerade Educator

Problem 27

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Amrita Bhasin

Numerade Educator

Problem 28

Is investing in housing always a very safe investment?

Mihir Nayar

Numerade Educator

Problem 29

If you owned a small firm that had become somewhat established, but you needed a surge of financial capital to carry out a major expansion, would you prefer to raise the funds through borrowing or by
issuing stock? Explain your choice.

Amrita Bhasin

Numerade Educator

Problem 30

Explain how a company can fail when the safeguards that should be in place fail.

Amrita Bhasin

Numerade Educator

Problem 31

What are some reasons why the investment strategy of a 30-year-old might differ from the investment
strategy of a 65-year-old?

Amrita Bhasin

Numerade Educator

Problem 32

Explain why a financial investor in stocks cannot earn high capital gains simply by buying companies with a demonstrated record of high profits.

Amrita Bhasin

Numerade Educator

Problem 33

Explain what happens in an economy when the financial markets limit access to capital. How does this
affect economic growth and employment?

Amrita Bhasin

Numerade Educator

Problem 34

You and your friend have opened an account on E-Trade and have each decided to select five similar
companies in which to invest. You are diligent in monitoring your selections, tracking prices, current
events, and actions the company has taken. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the performance for each of your portfolios at the end of the year.

Amrita Bhasin

Numerade Educator

Problem 35

How do bank failures cause the economy to go into recession?

Amrita Bhasin

Numerade Educator

Problem 36

The Darkroom Windowshade Company has 100,000 shares of stock outstanding. The investors in the
firm own the following numbers of shares: investor 1 has 20,000 shares; investor 2 has 18,000 shares; investor 3 has 15,000 shares; investor 4 has 10,000 shares; investor 5 has 7,000 shares; and investors 6 through 11 have 5,000 shares each. What is the minimum number of investors it would take to vote to change the company's top management? If investors 1 and 2 agree to vote together, can they be certain of always getting their way in how the company will be run?

Mihir Nayar

Numerade Educator

Problem 37

Imagine that a local water company issued $10,000 ten-year bond at an interest rate of 6%. You are thinking about buying this bond one year before the end of the ten years, but interest rates are now 9%.
a. Given the change in interest rates, would you expect to pay more or less than $10,000 for the bond?
b. Calculate what you would actually be willing to pay for this bond.

Amrita Bhasin

Numerade Educator

Problem 38

Suppose Ford Motor Company issues a five year bond with a face value of $5,000 that pays an annual
coupon payment of $150.
a. What is the interest rate Ford is paying on the borrowed funds?
b. Suppose the market interest rate rises from 3% to 4% a year after Ford issues the bonds. Will the value of the bond increase or decrease?

Mihir Nayar

Numerade Educator

Problem 39

How much money do you have to put into a bank account that pays 10% interest compounded annually to have $10,000 in ten years?

Amrita Bhasin

Numerade Educator

Problem 40

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $5,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns 4.75%. After 30 years, how much more will Alexx have than Spenser?

Mihir Nayar

Numerade Educator