The Economics of Money, Banking, and Financial Markets solution
PART THREE
Answers
to End-of-Chapter
Problems
Chapter 1
Why Study Money, Banking, and Financial Markets?
2. The data in Figures 1, 2, 3, and 4 suggest that real output, the inflation rate, and interest rates would
all fail.
4. You might be more likely to buy a house or a car because the cost of financing them would fall, or
you might be less likely to save because you earn less on your savings.
6. No. It is true that people who borrow to purchase a house or a car are worse off because it costs them
more to finance their purchase; however, savers benefit because they can earn higher interest rates on
their savings.
7. The basic activity of banks is to accept deposits and make loans.
8. They channel funds from people who do not have a productive use for them to people who do,
thereby resulting in higher economic efficiency.
9. The interest rate on three-month Treasury bills fluctuates more than the other interest rates and is
lower on average. The interest rate on Baa corporate bonds is higher on average than the other
interest rates.
10. The lower price for a firm’s shares means that it can raise a smaller amount of funds, so investment in
facilities and equipment will fall.
11. Higher stock prices means that consumers’ wealth is higher, and they will be more likely to increase
their spending.
12. It makes foreign goods more expensive, so British consumers will buy fewer foreign goods and more
domestic goods.
13. It makes British goods more expensive relative to American goods. Thus American businesses will
, find it easier to sell their goods in the United States and abroad, and the demand for their products
will rise.
14. In the mid- to late 1970s and in the late 1980s and early 1990s, the value of the dollar was low,
making travel abroad relatively more expensive; thus it was a good time to vacation in the United
States and see the Grand Canyon. With the rise in the dollar’s value in the early 1980s, travel abroad
became relatively cheaper, making it a good time to visit the Tower of London.
15. When the dollar increases in value, foreign goods become less expensive relative to American goods;
thus you are more likely to buy French-made jeans than American-made jeans. The resulting drop in
demand for American-made jeans because of the strong dollar hurts American jeans manufacturers.
On the other hand, the American company that imports jeans into the United States now finds that the
demand for its product has risen, so it is better off when the dollar is strong.
55
,56 Mishkin • The Economics of Money, Banking, and Financial Markets, Ninth Edition
Chapter 2
An Overview of the Financial System
1. The share of Microsoft stock is an asset for its owner, because it entitles the owner to a share of the
earnings and assets of Microsoft. The share is a liability for Microsoft, because it is a claim on its
earnings and assets by the owner of the share.
2. Yes, I should take out the loan, because I will be better off as a result of doing so. My interest
payment will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will
be ahead of the game by $5,500. Since Larry’s loan-sharking business can make some people better
off, as in this example, loan sharking may have social benefits. (One argument against legalizing loan
sharking, however, is that it is frequently a violent activity.)
3. Yes, because the absence of financial markets means that funds cannot be channeled to people who
have the most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses
that would help the economy grow rapidly.
4. The principal debt instruments used were foreign bonds which were sold in Britain and denominated
in pounds. The British gained because they were able to earn higher interest rates as a result of
lending to Americans, while the Americans gained because they now had access to capital to start up
profitable businesses such as railroads.
5. This statement is false. Prices in secondary markets determine the prices that firms issuing securities
receive in primary markets. In addition, secondary markets make securities more liquid and thus
easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important
than primary markets.
6. You would rather hold bonds, because bondholders are paid off before equity holders, who are the
residual claimants.
7. Because you know your family member better than a stranger, you know more about the borrower’s
honesty, propensity for risk taking, and other traits. There is less asymmetric information than with a
stranger and less likelihood of an adverse selection problem, with the result that you are more likely
to lend to the family member.
9. Loan sharks can threaten their borrowers with bodily harm if borrowers take actions that might
jeopardize their paying off the loan. Hence borrowers from a loan shark are less likely to increase
moral hazard.
10. They might not work hard enough while you are not looking or may steal or commit fraud.
11. Yes, because even if you know that a borrower is taking actions that might jeopardize paying off the
loan, you must still stop the borrower from doing so. Because that may be costly, you may not spend
the time and effort to reduce moral hazard, and so the problem of moral hazard still exists.
, Part Three: Answers to End-of-Chapter Problems 57
12. True. If there are no information or transactions costs, people could make loans to each other at no
cost and would thus have no need for financial intermediaries.
13. Because the costs of making the loan to your neighbor are high (legal fees, fees for a credit check,
and so on), you will probably not be able earn 5% on the loan after your expenses even though it has
a 10% interest rate. You are better off depositing your savings with a financial intermediary and
earning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bank
rather than lending them to your neighbor.
14. A ranking from most liquid to least liquid is (a), (b), (c), and (d). The ranking is similar for the most
safe to the least safe.
15. Increased discussion of foreign financial markets in the U.S. press and the growth in markets for
international financial instruments such as Eurodollars and Eurobonds.
PART THREE
Answers
to End-of-Chapter
Problems
Chapter 1
Why Study Money, Banking, and Financial Markets?
2. The data in Figures 1, 2, 3, and 4 suggest that real output, the inflation rate, and interest rates would
all fail.
4. You might be more likely to buy a house or a car because the cost of financing them would fall, or
you might be less likely to save because you earn less on your savings.
6. No. It is true that people who borrow to purchase a house or a car are worse off because it costs them
more to finance their purchase; however, savers benefit because they can earn higher interest rates on
their savings.
7. The basic activity of banks is to accept deposits and make loans.
8. They channel funds from people who do not have a productive use for them to people who do,
thereby resulting in higher economic efficiency.
9. The interest rate on three-month Treasury bills fluctuates more than the other interest rates and is
lower on average. The interest rate on Baa corporate bonds is higher on average than the other
interest rates.
10. The lower price for a firm’s shares means that it can raise a smaller amount of funds, so investment in
facilities and equipment will fall.
11. Higher stock prices means that consumers’ wealth is higher, and they will be more likely to increase
their spending.
12. It makes foreign goods more expensive, so British consumers will buy fewer foreign goods and more
domestic goods.
13. It makes British goods more expensive relative to American goods. Thus American businesses will
, find it easier to sell their goods in the United States and abroad, and the demand for their products
will rise.
14. In the mid- to late 1970s and in the late 1980s and early 1990s, the value of the dollar was low,
making travel abroad relatively more expensive; thus it was a good time to vacation in the United
States and see the Grand Canyon. With the rise in the dollar’s value in the early 1980s, travel abroad
became relatively cheaper, making it a good time to visit the Tower of London.
15. When the dollar increases in value, foreign goods become less expensive relative to American goods;
thus you are more likely to buy French-made jeans than American-made jeans. The resulting drop in
demand for American-made jeans because of the strong dollar hurts American jeans manufacturers.
On the other hand, the American company that imports jeans into the United States now finds that the
demand for its product has risen, so it is better off when the dollar is strong.
55
,56 Mishkin • The Economics of Money, Banking, and Financial Markets, Ninth Edition
Chapter 2
An Overview of the Financial System
1. The share of Microsoft stock is an asset for its owner, because it entitles the owner to a share of the
earnings and assets of Microsoft. The share is a liability for Microsoft, because it is a claim on its
earnings and assets by the owner of the share.
2. Yes, I should take out the loan, because I will be better off as a result of doing so. My interest
payment will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will
be ahead of the game by $5,500. Since Larry’s loan-sharking business can make some people better
off, as in this example, loan sharking may have social benefits. (One argument against legalizing loan
sharking, however, is that it is frequently a violent activity.)
3. Yes, because the absence of financial markets means that funds cannot be channeled to people who
have the most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses
that would help the economy grow rapidly.
4. The principal debt instruments used were foreign bonds which were sold in Britain and denominated
in pounds. The British gained because they were able to earn higher interest rates as a result of
lending to Americans, while the Americans gained because they now had access to capital to start up
profitable businesses such as railroads.
5. This statement is false. Prices in secondary markets determine the prices that firms issuing securities
receive in primary markets. In addition, secondary markets make securities more liquid and thus
easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important
than primary markets.
6. You would rather hold bonds, because bondholders are paid off before equity holders, who are the
residual claimants.
7. Because you know your family member better than a stranger, you know more about the borrower’s
honesty, propensity for risk taking, and other traits. There is less asymmetric information than with a
stranger and less likelihood of an adverse selection problem, with the result that you are more likely
to lend to the family member.
9. Loan sharks can threaten their borrowers with bodily harm if borrowers take actions that might
jeopardize their paying off the loan. Hence borrowers from a loan shark are less likely to increase
moral hazard.
10. They might not work hard enough while you are not looking or may steal or commit fraud.
11. Yes, because even if you know that a borrower is taking actions that might jeopardize paying off the
loan, you must still stop the borrower from doing so. Because that may be costly, you may not spend
the time and effort to reduce moral hazard, and so the problem of moral hazard still exists.
, Part Three: Answers to End-of-Chapter Problems 57
12. True. If there are no information or transactions costs, people could make loans to each other at no
cost and would thus have no need for financial intermediaries.
13. Because the costs of making the loan to your neighbor are high (legal fees, fees for a credit check,
and so on), you will probably not be able earn 5% on the loan after your expenses even though it has
a 10% interest rate. You are better off depositing your savings with a financial intermediary and
earning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bank
rather than lending them to your neighbor.
14. A ranking from most liquid to least liquid is (a), (b), (c), and (d). The ranking is similar for the most
safe to the least safe.
15. Increased discussion of foreign financial markets in the U.S. press and the growth in markets for
international financial instruments such as Eurodollars and Eurobonds.
