Financial Markets

1. How can economies of scale help explain the existence of financial intermediaries? Does mutual fund lower transaction costs? How? Explain

Economies of scale bring with it high transaction costs. High transaction costs have a relative effect in the level of individual investment. Most individuals and business startups have insufficient funds to enlarge their investment fund. However, financial intermediaries provide a platform for cheap investment. Mutual fund does not lower transaction cost. This is so because these costs are dependent on turnover ratio. High ratio and non-liquid investments drive up transaction costs.

2. How does collateral help reduce the adverse selection problem in credit market? Explain

Most lenders consider the amount of collateral before giving out a loan. With increased level of collateral, a lender is left in an advantageous position to extend a given loan as he has less to lose in case of default and vice versa. Therefore, a sufficient level of collateral helps reduce the allocation and allocation problem in a credit market.

3. Rich people often worry that other will seek to marry them only for their money. Do you agree or disagree? Give reasons for your answer.

Largely, I agree. With the tough economic times most individuals enter in a relationship with a financially stable partner with an expectation of financial fortune in case of an uncertainty i.e. divorce or death.

4. What is a free-rider problem? How does this problem occur in the debt market? Explain

A free rider problem is a situation where a client of a business establishment benefits from the use of a given product without necessarily using his/her income/capital. Without stringent measures to guide the debt market, clients may access securities without a pay and later selling the share for a profit. This immoral act of making a fortune by free riding on securities is a threat to fair competition in the debt market.

5. What is conflict of interest? Describe three examples of conflict of interest in financial markets.

A conflict of interest is a situation that occurs when a firm undertaking a number of interests where one of the undertakings may limit or derail the execution of an act in the other interest. Conflict of interest in a financial market leads to a situation where information disseminated to other parties is incorrect or largely biased. The aforementioned can be experienced in a case where a financial firm is dealing with Underwriting and investment banking, Auditing and doing credit assessment. In accordance to its operations, a financial institution might alter crucial information in favor of issuing companies to avoid losses in cases where an underwriting exceeds banks expectation.