Solutions for E nd-of-Chapter Q uestions and Problems: C hapter O ne 1. What are five risks common to financial institutions?

Default or credit risk of assets, interest rate risk caused bymaturity mismatches between assets and liabilities, liability withdrawal or liquidity risk, underwriting risk, and operating cost risks. 2. Explain how economic transactions between household savers of fundsand corporate users of funds would occur in a world without financial intermediaries.

In a world without FIs the users of corporate funds in the economy would have to directly approach thehousehold savers of funds in order to satisfy their borrowing needs. This process would be extremely costly because of the up-front information costs faced by potential lenders. Cost inefficiencies wouldarise with the identification of potential borrowers, the pooling of small savings into loans of sufficient size to finance corporate activities, and the assessment of risk and investment opportunities.Moreover, lenders would have to monitor the activities of borrowers over each loan's life span. The net result would be an imperfect allocation of resources in an economy. 3. Identify and explainthree economic disincentives that probably would dampen the flow of funds between household savers of funds and corporate users of funds in an economic world without financial intermediaries.

Investorsgenerally are averse to directly purchasing securities because of (a) monitoring costs, (b) liquidity costs, and (c) price risk. (a) Monitoring the activities of borrowers requires extensive time,expense, and expertise. As a result, households would prefer to leave this activity to others, and by definition, the resulting lack of monitoring would increase the riskiness of investing in corporatedebt and equity markets. (b) The long-term nature of corporate equity and debt securities would likely eliminate at least a portion of those households willing to lend money, as the preference of... [à continuer]

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