CHAPTER 3

QUESTIONS

3-1 A financial market is a mechanism by which borrowers and lenders get together. The primary role of financial markets is to bring borrowers and lenders together.

3-2 It would be difficult for firms to raise capital. Thus, capital investment would slow down, unemployment would rise, the output of goods and services would fall, and, in general, our standard of living would decline.

3-3 The prices of goods and services must cover their costs. Costs include labor, materials, and capital. Capital costs to a borrower include a return to the saver who supplied the capital, plus a mark-up (called a “spread”) for the financial intermediary that brings the saver and the borrower together. The more efficient the financial system, the lower the costs of intermediation, the lower the costs to the borrower, and, hence, the lower the prices of goods and services to consumers.

3-4 No, the real value of a security is determined by the equilibrium forces of an efficient market. Assuming that the information provided on newly issued securities is accurate, the market will establish the value of a security regardless of the opinions rendered by the SEC, or, for that matter, opinions offered by any advisory service or analyst.

3-5 a. Listing a stock on a physical stock exchange would increase name recognition and prestige and therefore probably increase a company's ability to attract capital. Flotation costs might decrease as the ability to float an issue easily increases. It should be remembered that listing will only be done if the company is big enough to make this worthwhile and big enough to qualify.

b. For the same reasons as in part a, going public would tend to make attracting capital easier and to decrease flotation costs.

c. The increasing institutionalization of the "buy side" of the stock and bond markets should increase a firm's ability to attract capital and should reduce flotation costs.

d. Financial conglomerates can offer a variety of financial services and types of investments, thus it seems a company's ability to attract capital would increase and flotation costs would decrease.

e. The introduction of shelf registrations has sped up SEC review time and lowered the costs of floating each new issue. Thus, the company's ability to attract new capital has increased.

3-6 Investment bankers must investigate the firms whose securities they sell, simply because, if an issue is overvalued and suffers marked price declines after the issue, the banker will find it increasingly difficult to dispose of the new issue. In other words, reputation is very important in the investment banking industry. Further, if the investment banker doesn't fully understand the situation, then large sums of money can be lost by underwriting, or buying out, a company's initial public issue.

3-7 A firm would desire a wider distribution of its stock for the following reasons:(1) To increase the size of its market for future stock issues.

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Chapter 3(2) To increase the number of shareholders, thus improving the feasibility of management

control or control by a group with 5 to 10 percent of the company's stock.(3) To meet organized security exchange's requirements of a wide geographic distribution of

stockholders throughout the country.(4) To gain potential customers, as stockholders will be favorably disposed to patronize the

firm.

3-8 The principal advantages to listing on an organized exchange include: (1) the publicity and prestige associated with being listed and (2) the marketability that continuous trading activity offers. In addition, many believe that “listing” is beneficial in that it increases sales and decreases the rate of return required by investors because firms are required to provide large amounts of information to investors.

3-9 First, remember that the Nasdaq market is an “electronic” marketplace rather than a physical location like the New York Stock Exchange (NYSE). Both Microsoft and Intel manufacture products that are important to efficiently carry out trades in such markets; thus, it is a “natural fit” for these two companies to be listed on the Nasdaq. In Addition, both companies have significant name recognition and international appeal, hence they do not need to be listed on the NYSE to achieve recognition and to improve their ability to raise funds.

3-10 Generally, companies decide to “go public” because they need to finance their expansion/growth plans, and the funds cannot be raised from existing sources. When a firm goes public, it offers its stock to a larger number, as well as a greater variety, of investors—the potential funding sources are much greater for public firms than for private firms.

3-11 Financial intermediaries are business organizations that receive funds in one form and repackage them for use by those who need funds. Through financial intermediation, resources are allocated more effectively, and the real output of the economy is thereby increased.

3-12 Intermediaries create a variety of financial instruments for lower costs than individuals can. Without intermediaries, the costs associated with both borrowing and investing would be considerably higher. In addition, intermediaries provide investors with the ability to diversify risk and with some degree of financial flexibility. Therefore, intermediaries increase the efficiency of the financial markets, which contributes to a higher standard of living in general.

3-13 a. S&Ls would be better off with a "normal" yield curve. In this situation their liabilities (deposits), which are short-term, would have a lower cost than the returns being generated by their assets (mortgages), which are long-term. Thus they would have a positive "spread."

b. It depends on the situation. A sharp increase in inflation would increase interest rates along the entire yield curve. If the increase was large, short-term interest rates might be boosted above the long-term interest rates that prevailed prior to the inflation increase. Then, because the bulk of the fixed-rate mortgages was initiated when interest rates were lower, the deposits (liabilities) of the S&Ls would cost more than the return being provided on the assets. If this situation continued for any length of time, the equity (reserves) of the S&Ls would be drained to the point that only a "bailout" would prevent bankruptcy. This has indeed happened in the United States. Thus, in this situation the S&L industry would be better off selling their mortgages to federal agencies and collecting servicing fees rather than holding the mortgages they originated.

3-14 The financial intermediaries described in the text include:

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Chapter 3(1) Commercial banks, which originally were established to service businesses, or commerce.

These types of institutions traditionally handled the checking function and loaned funds to businesses.

(2) Thrift institutions, such as savings and loan associations, were created to help individuals purchase homes and related properties and to provide a place for individuals to save their excess funds.

(3) Credit unions originally were “financial pools” established by individuals with some common bond, such as religion or occupation, to provide credit to neighbors who suffered losses due to crop failure, catastrophes, and so forth.

(6) Mutual funds are investment companies that were set up so that individual investors could pool their funds to achieve greater efficiencies in the investment process; that is, reduce risk through diversification and lower costs by achieving economies of scale.

(5) Whole life insurance companies provide policies to protect beneficiaries/dependents from financial ruin in the event of the untimely death of a family “bread winner.” Generally a whole life insurance policy builds up a cash value in the early years of the insured’s life.

(6) Pension funds were established to provide investors a means to save for their retirement years.

3-15 The primary change that is evident from the deregulation of the financial services industry is that

the differences that previously existed among the various financial institutions are disappearing. Now commercial banks offer mortgage loans and thrift institutions offer commercial loans. In addition, intermediaries now are allowed to venture into areas of business that were previously “off limits” to them, and they can conduct business nationally rather than just in their native state. If this trend continues, there will be fewer, but larger financial intermediaries in the United States in the future.

3-16 Even with recent deregulation, the banking industry in the United States is very heavily regulated. U.S. banks are prohibited from many activities that banks in other countries are not, such as owning the stocks of corporations. In addition, U.S. banks are not as free as foreign banks to conduct business nationally—banking in the United States is still mostly fragmented from state to state as the result of the interstate banking restrictions that existed for most of the twentieth century. For these reasons, there are many more (and much smaller) banks in the United States than in other countries.

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PROBLEMS

3-1 a. $7.50 per share

Gross proceeds = (3,000,000)($7.50) = $22,500,000

Net profit = $22,500,000 - $21,000,000 - $450,000 = $1,050,000

b. $9 per share

Gross proceeds = (3,000,000)($9) = $27,000,000

Net profit = $27,000,000 - $21,000,000 - $450,000 = $5,550,000

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Chapter 3c. $6 per share

Gross proceeds = (3,000,000)($6) = $18,000,000

Net profit=$18,000,000 - $21,000,000 - $450,000 = ($3,450,000)

3-2 Net proceeds per share = $27.53(1 - 0.07) = $25.60.

3-3

3-4

If the firm issues 77,784 bonds, the amount it will be able to use is

Proceeds = 77,784($1,000) – 77,784($1,000)(0.03) - $450,000 = $75,000,480

3-5 a. Flotation costs = $39,000,000(0.07) = $2,730,000

b. Net proceeds = $39,000,000(1 – 0.07) = $39,000,000 - $2,730,000= $36,270,000

c. To compute the amount of debt that needs to be issued to net the company $39,000,000, we can solve the following:

Net proceeds = Amount issued x (1 – F)$39,000,000 = Amount issued x (1 – 0.07)

3-6 a. Net proceeds from IBA = $11,000,000 –($11,000,000 x 0.05 + $125,000) = $11,000,000 – ($550,000 + $125,000) = $10,325,000

b. Net proceeds = $10,325,000 - $240,000 = $10,085,000

3-7 a. Flotation costs (equity) = $100,000,000(0.042) = $4,200,000

b. Flotation costs (debt) = $100,000,000(0.023) = $2,300,000

c. Debt has a lower flotation cost. However, debt increases the risk that the firm might be forced into bankruptcy. In addition, generally debt contains restrictions with regard to the firm’s financial position—for example, the firm might have to maintain the times-interest-earned (TIE) ratio above a certain level, dividend payments might be limited, and so forth.

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Chapter 3

3-8 a. Net proceeds = $42,000,000(1 – 0.15 – 0.01) = $35,280,000

b. If the firm needs $42 million for growth, the amount of stock it will have to issue is

The number of shares that must be issued is

c. If 10 million shares are issued, a total of 20 million shares will be outstanding after the IPO. The founders will own 50 percent of the shares (10 million).

d. The founders might decide to issue non-voting shares of stock.

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Chapter 3INTEGRATIVE PROBLEM

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3-9 KAMPFIRE, INC., A VERY SUCCESSFUL MANUFACTURER OF CAMPING EQUIPMENT, IS CONSIDERING “GOING PUBLIC” NEXT MONTH TO RAISE FUNDS TO HELP FINANCE FUTURE EXPECTED GROWTH. THE FINANCIAL MANAGER OF KAMPFIRE HAS APPROACHED THE INVESTMENT BANKING FIRM WHERE YOU WORK SEEKING HELP WITH ITS DECISION. YOUR BOSS ASKED YOU TO EXPLAIN THE NATURE OF THE U.S. FINANCIAL MARKETS AND THE PROCESS OF ISSUING EQUITY TO THE FINANCIAL MANAGER. TO HELP WITH THIS TASK, YOUR BOSS HAS ASKED YOU TO ANSWER THE FOLLOWING QUESTIONS IN EXPLAINING THE U.S. FINANCIAL SYSTEM TO THE FINANCIAL MANAGER.

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A. WHAT IS A FINANCIAL MARKET? HOW ARE FINANCIAL MARKETS DIFFERENTIATED FROM MARKETS FOR PHYSICAL ASSETS?

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ANSWER: A financial market is one in which financial assets are bought and sold. There are many different types of financial markets, each one deals with a different type of financial asset, serves a different set of customers, or operates in a different part of the country. Financial markets differ from physical asset markets in that real, or tangible assets such as machinery, real estate, and agricultural products are traded in the physical asset markets, but financial securities representing claims on assets are traded in the financial markets.

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B. DIFFERENTIATE BETWEEN MONEY MARKETS AND CAPITAL MARKETS.└─────────────────────────────────────────────────────────────────────────────┘

ANSWER: Money markets are the markets in which debt securities with maturities of less than one year are traded. New York, London, and Tokyo are major money market centers. Longer-term securities, including stocks and bonds, are traded in the capital markets. The New York Stock Exchange is an example of a capital market, whereas the New York commercial paper and Treasury bill markets are money markets.

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C. DIFFERENTIATE BETWEEN A PRIMARY MARKET AND A SECONDARY MARKET. IF MICROSOFT DECIDED TO ISSUE ADDITIONAL COMMON STOCK, AND AN

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Chapter 3INVESTOR PURCHASED 100 SHARES OF THIS STOCK FROM MERRILL LYNCH, THE UNDERWRITER, WOULD THIS TRANSACTION BE A PRIMARY MARKET TRANSACTION OR A SECONDARY MARKET TRANSACTION? WOULD IT MAKE A DIFFERENCE IF THE INVESTOR PURCHASED PREVIOUSLY OUTSTANDING MICROSOFT STOCK IN THE NASDAQ MARKET?

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ANSWER: A primary market is one in which companies raise capital by selling newly issued securities, whereas already outstanding securities are traded among investors in the secondary markets. If an investor purchased newly issued Microsoft stock, this would constitute a primary market transaction, with Merrill Lynch acting as an investment banker in the transaction. If an investor purchased “used” stock, then the transaction would be in the secondary market. ┌─────────────────────────────────────────────────────────────────────────────┐

D. DESCRIBE THE THREE PRIMARY WAYS IN WHICH CAPITAL IS TRANSFERRED BETWEEN SAVERS AND BORROWERS.

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ANSWER: Transfers of capital can be made (1) by direct transfer of money and securities, (2) through an investment banker, or (3) through a financial intermediary. In a direct transfer, a business sells its stocks or bonds directly to investors (savers), without going through any type of institution. The business borrower receives dollars from the savers, and the savers receive securities (bonds or stock) in return.

If the transfer is made through an investment banking house, the investment bank serves as a middleman. The business sells its securities to the investment bank, which in turn sells the securities to the savers. Although the securities are sold twice, the two sales constitute one complete transaction in the primary market.

If the transfer is made through a financial intermediary, savers invest funds with the intermediary, which then issues its own securities in exchange. Banks are one type of intermediary, receiving dollars from many small savers and then lending these dollars to borrowers to purchase homes, automobiles, vacations, and so on, and also to businesses and government units. The savers receive a certificate of deposit or some other instrument in exchange for the funds deposited with the bank. Mutual funds, insurance companies, and pension funds are other types of intermediaries.

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E. SECURITIES CAN BE TRADED ON PHYSICAL STOCK EXCHANGES OR IN THE OVER-THE-COUNTER MARKET. DEFINE EACH OF THESE MARKETS, AND DESCRIBE HOW STOCKS ARE TRADED IN EACH ONE.

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ANSWER: The physical, or organized security exchanges are formal organizations that have tangible, physical locations and trade in designated securities. There are exchanges for stocks, bonds, commodities, futures, and options. Two well-known exchanges in the United States are the New York Stock Exchange and the American Stock Exchange. The physical exchanges are conducted as auction markets with securities going to the highest bidder. Buyers and sellers place orders with their brokers who then execute those orders by matching buyers and sellers, although specialists assist in providing continuity to the markets.

The over-the-counter (OTC) market is made up of hundreds of brokers and dealers around the country who are connected electronically by telephones and computers. The OTC market facilitates

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Chapter 3trading of securities that are not listed with an organized, physical exchange. This market consists of (1) the dealers who hold inventories of over-the-counter securities, (2) the brokers who act as agents in bringing together dealers and investors, and (3) the computers, terminals, and electronic networks that facilitate communications between dealers and brokers. Dealers continuously post a price at which they are willing to buy the stock (the bid price) and a price at which they are willing to sell the stock (the asked price). The asked price is always higher than the bid price, and the difference (or “spread”) represents the dealer’s profit.

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F. DESCRIBE THE INVESTMENT BANKING PROCESS AS IT RELATES TO INTITIAL PUBLIC OFFERINGS.

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ANSWER: The basic process is essentially the same as for established firms that are publicly traded. Stage I decisions include those that the firms make concerning the size of the issue, the type of securities to be issued, and the selection of an investment banker. Stage II decisions include those made with the advice of the investment banker—that is, reevaluating the Stage I decisions, determining how the issue will be handled by the investment banker (underwritten or best efforts), negotiating the issuance costs, and determining the issuing price. When a firm is going public for the first time, however, there is no established price for its stock. As a result, its investment banker will have to compare the firm to other firms of similar size and product line. The banker will try to determine a price range for the firm’s stock by applying the price/earnings ratios, price/dividends ratios, and price/book value ratios of similar firms to the IPO firm’s earnings, dividends, and book value data. The banker also will determine the price at which the firm’s stock would have to sell to earn the same rate of return as other firms in its industry. On the basis of all these factors, the investment bankers will determine a ballpark price. This price probably will be lowered somewhat to increase the demand for the stock and to ensure that the stock will sell. Note that the investment banker has an incentive to set a low price, both to make its brokerage customers happy and also to make it easy to sell the issue, whereas the IPO firm would like to set as high a price as possible. Thus, there is an inherent conflict of interests, and the actual price is set by bargaining.

Once the stock is issued, the investment banker generally remains active in the market to help ensure that the stock price remains close to its equilibrium.

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G. KAMPFIRE ESTIMATES THAT IT NEEDS $25 MILLION TO SUPPORT EXPECTED GROWTH. THE UNDERWRITING FEES CHARGED BY THE INVESTMENT BANKING FIRM WHERE YOU WORK ARE BASED ON THE SCHEDULE GIVEN IN TABLE 3-2. IN ADDITION, IT IS ESTIMATED THAT KAMPFIRE WILL INCUR $245,000 IN OTHER EXPENSES RELATED TO THE IPO. IF YOUR ANALYSIS INDICATES THAT KAMPFIRE’S STOCK CAN BE SOLD FOR $8.20 PER SHARE, HOW MANY SHARES MUST BE ISSUED TO NET THE COMPANY THE $25 MILLION IT NEEDS?

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ANSWER: To net the firm $25 million, the amount of the IPO must be

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Chapter 3

The number shares that must be issued is

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3-10 ASSUME YOU RECENTLY GRADUATED WITH A DEGREE IN FINANCE AND HAVE JUST REPORTED TO WORK AS AN INVESTMENT ADVISOR AT THE FIRM OF BALIK AND KIEFER INC. YOUR FIRST ASSIGNMENT IS TO EXPLAIN THE ROLES OF FINANCIAL INTERMEDIARIES PLAY IN THE U.S. BANKING SYSTEM TO MICHELLE DELATORRE, A PROFESSIONAL TENNIS PLAYER WHO HAS JUST COME TO THE UNITED STATES FROM CHILE. DELATORRE IS A HIGHLY RANKED TENNIS PLAYER WHO EXPECTS TO INVEST SUBTANTIAL AMOUNTS OF MONEY THROUGH BALIK AND KIEFER. SHE IS ALSO VERY BRIGHT AND, THEREFORE, SHE WOULD LIKE TO UNDERSTAND IN GENERAL TERMS WHAT WILL HAPPEN TO HER MONEY. YOUR BOSS HAS DEVELOPED THE FOLLOWING QUESTIONS, WHICH YOU MUST ANSWER TO HELP EXPLAIN THE NATURE OF FINANCIAL INTERMEDIARIES IN THE U.S. BANKING SYSTEM TO MS. DELATORRE.

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A. WHAT IS A FINANCIAL INTERMEDIARY? WHAT IS THE FINANCIAL INTERMEDIATION PROCESS?

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ANSWER: A financial intermediary is an organization that facilitates the indirect transfer of funds from savers to borrowers by issuing liabilities to savers in the form of savings accounts, mutual funds, and pension plans, and by offering credit to borrowers in the form of credit cards, mortgages, commercial loans, and so forth. Financial intermediation refers to the process by which financial intermediaries transform funds provided by savers into funds used by borrowers.

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B. WHAT ROLES DO FINANCIAL INTERMEDIARIES FULFILL? HOW HAVE INTERMEDIARIES HELPED IMPROVE OUR STANDARD OF LIVING AS WELL AS THE EFFICIENCY OF THE FINANCIAL MARKETS?

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ANSWER: The primary role of financial intermediaries is to provide a means by which the funds of surplus units are made available to deficit units—that is, financial intermediaries help match the funds

9

Chapter 3made available by savers with the needs of borrowers. Financial intermediaries help lower the costs associated with the investment/savings process, which permits investors/savers to earn greater returns, hence increasing the standard of living that otherwise is attainable. More specifically, financial intermediaries offer the following benefits: reduced borrowing and lending costs; opportunities to diversify risk because loan portfolios generally are large and well diversified; ability to form loans of any size through the “pooling” of customers’ funds, which allows smaller savers to become a part of large loans; financial flexibility, which is attained through the variety of financial instruments that are offered by various financial intermediaries; and, related services, such as check clearing and life insurance, offered by many financial intermediaries.

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C. WHAT ARE THE DIFFERENT TYPES OF FINANCIAL INTERMEDIARIES? GIVE SOME CHARACTERISTICS THAT DIFFERENTIATE THE VARIOUS TYPES OF INTERMEDIARIES.

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ANSWER: Commercial banks are the traditional “department stores” of finance because they offer a variety of products and services to a variety of customers. Even though their customers traditionally have been businesses, commercial banks offer checking and savings instruments and loans to both businesses and individuals. Credit unions are owned by the depositors, who generally have a common bond, such as religion, occupation, and so on. Credit unions primarily service individuals by offering consumer loans used for automobile purchases, home equity improvements, and so forth. Thrift institutions are organizations that cater to individuals who have relatively small amounts of savings or who wish to purchase homes. Thrifts have traditionally been viewed as institutions that provide real estate mortgages and safe savings instruments for individuals. Mutual funds are investment companies that accept funds from savers and then use these funds to purchase various investment instruments, including stocks, corporate bonds, and so on. Because mutual funds offer well-diversified investment pools, they permit individuals the ability to indirectly invest small amounts in corporate stocks and bonds, as well as other instruments, and to achieve good investment diversification. Whole life insurance companies offer two services: protection to beneficiaries against financial distress that results from premature death of a “bread winner” and savings that accrue because the premiums paid early in life exceed the amounts needed to cover the insured. Pension funds are retirement plans funded by corporations or government agencies for their employees. Both insurance companies and pension funds have cash demands that are fairly predictable, thus most of the assets are long-term investments.

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D. HOW DO U.S. FINANCIAL INREMDEIARIES DIFFER FROM FINANCIAL INTERMEDIARIES IN OTHER COUNTRIES?

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ANSWER: Financial intermediaries in other countries are characterized by significantly fewer independent organizations than exist in the United States. For example, most other countries have fewer than 100 independent banks, whereas there are more than 8,000 independent banks in the United States. The principal reason other countries have fewer banks is because they have few, if any, restrictions on nationwide branch banking. In addition, most foreign countries have much less restrictive regulations and other limitations on banking activities than we have in the untied states. For example, foreign banks often are allowed to own the stocks of corporations, to participate in stock issues, and to engage in other business activities that U.S. banks are prohibited from participation.

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Chapter 3

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E. HOW HAVE U.S. FINANCIAL INTERMEDIARIES CHANGED IN RECENT YEARS? WHAT ARE THE ARGUMENTS FOR SUCH CHANGES? WHAT CHANGES ARE EXPECTED IN THE FUTURE?

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ANSWER: The U.S. financial system has experienced significant deregulation during the past couple of decades. Much of the deregulation has been aimed toward “evening the playing field” for U.S. banks and intermediaries in the international markets. For example, branch banking restrictions have been substantially relaxed, banking organization have been allowed to participate in more, and a wider variety of, financial-related business activities. In the future, we should see many more changes that will help U.S. banks and financial intermediaries better compete worldwide. As the financial services industry becomes more stable, we should also see greater deregulation. But, in unstable times, we might see a push by legislators for re-regulation.

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F. HOW CAN MS. DELATORRE UTILIZE THE SERVICES PROVIDED BY FINANCIAL INTERMEDIARIES?

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ANSWER: Ms. Delatorre should view financial intermediaries as specialists that can provide her with instruments for saving/investing excess funds she might have and for borrowing when funds are needed. In addition, Ms. Delatorre might need some of the other services provided by financial institutions, including check clearing, retirement planning, and life insurance.

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Chapter 3ETHICAL DILEMMA

ANYTHING FOR (A) BUC?

Ethical dilemma:

Mr. Charles, the CEO of the Bank of Universal City (BUC), is concerned that the company’s growth this year will be below what is needed to achieve growth projections during the next five years. Mr. Charles believes that Univest, the investment management division of BUC, can increase its sales so that the entire organization can meet the projected growth for the year and keep the firm on track to meet its future growth expectations. To help, Mr. Charles has given the VP of Univest, who is your boss, some “leads” to contact for possible new accounts. One of the most promising leads is a religious organization with a shady reputation—Righteous Freedom Choice (RFC). It has been rumored that RFC is involved, either directly or indirectly, in unsavory activities, including sponsoring terrorism in other parts of the world, and the funds it receives come from organizations involved in similar illicit activities. Although the rumors are just that—rumors—there are indications that they might be true. A colleague of yours provided you with much of this information, which was relayed to her by a couple of prominent businesspersons. The validity of the information is questionable, however, because the persons who provided the information are not on friendly terms with the head of RFC, Mr. Radcliff. Should BUC pursue RFC as a potential customer? It appears that RFC will be moving its funds to a new investment management firms soon. Even if the rumors prove to be correct, is there a problem with BUC managing RFC’s money?

Discussion questions:

● What is the ethical dilemma?

In this case, it appears that the ethical dilemma is whether it is appropriate to do business with customers that have bad reputations or are involved with unacceptable activities. But, if RFC is indeed financially supporting terrorist activity around the world, it would actually be committing an illegal act. If this is the case, then it is clear that BUC should not pursue RFC as a client. If RFC is not involved in illegal activities, however, then BUC must make a decision as to whether it wants to (should) take on RFC as a customer.

● Should BUC try to attract RFC’s business?

If RFC is involved in unethical activities and BUC gets its business, other customers might take their business elsewhere. Although it appears that RFC would bring significant funds for BUC to manage, if a large number of existing customers move their business to other investment management companies, the decision to take on RFC as a new customer might prove to be financially disastrous to BUC. On the other hand, if the rumors about RFC are not true, then BUC could lose a “golden” opportunity by not pursuing RFC’s business. Managing RFC’s investment funds would provide a

12

Chapter 3significant boost to BUC’s financial position, both int the current period and in future periods.

● What decision should BUC make?

Ask the students what they would do if they were the assistant to the vice president in charge of Univest. Undoubtedly, students will argue for one of two decisions: (1) Try to attract RFC as a customer, or (2) stay away from RFC. If the rumors relayed to “you” (the vice president’s assistant) by a colleague are correct, it probably would be disastrous for BUC to accept RFC’s business. On the other hand, if the rumors prove to be incorrect, BUC will be passing up a potential “gold mine.” Remember that the source of the rumors that were passed on by a colleague presumably originated from businesspersons who are not on friendly terms with Mr. Radcliff, the head of RFC. Because the rumors have not been confirmed and cannot be confirmed any time soon, it might be wise to for Univest to slow down and take its time making a decision about RFC. Such a delay will most certainly affect the commissions and bonuses of those who work in the Univest division of BUC. If “you” gather more information to determine the legitimacy of the rumors about RFC, then you should make a correct decision. However, if RFC is not pursued soon, it is possible that the company will take its business elsewhere. Although gathering additional information will delay the decision, which will delay any financial effects (positive or negative) associated with the decision, in this case, it probably is better to be “safe than sorry.” If the rumors are proven false, and BUC ultimately gets RFC’s business, the timing of the monetary reward will be the same; it will simple be received later.

References:

The following articles might be assigned for background material:

Nathan Vardi, “Hezbollah’s Hoard,” Forbes, August 14, 2006, p. 46-47.

Vernon Silver, “Citigroup Did Manage Arafat Funds,” The Wall Street Journal, December 31, 2004, Money Sense 8.

Glenn R. Simpson, “U.S. Indictment of Texas Charity Cites Additional Ties to Hamas,” The Wall Street Journal Online, July 28, 2004. (http://online.wsj.com/)

Farnaz Fassihi, “Where Did Arafat Stash the Money?,” “The Wall Street Journal Online, November 24, 2004. (http://online.wsj.com/)

Glenn Simpson and David S. Cloud, “Immigration Case in Virginia May Complicate Saudi-U.S. Ties, “The Wall Street Journal Online, August 12, 2003. (http://online.wsj.com/)

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