1- What is the effect of interest rates on the economy?

Interest rate: amount of interest due per period as a percentage of the amount rent or borrowed
Many types of interest rates:
(1) Mortgage IR: interest paid by house owners' for a loan of a new house (2) car loan IR (3) Bond IR
Its effect: (1) Increased cost of borrowing: lama el IR btzeed: Interest payments on credit cards and loans are more
expensive so it discourages people to borrow or spend and people who already have loans will have less income because
they spend more on interest payments – other areas of consumption will fall – low economic growth
(2) increase the incentive to save rather than to spend: high IR make it more attractive to save in banks
(3) Rising IR affect both consumers and firms: so the economy is likely to experience falls in consumptions and investment
(4) Reduce confidence: a rise in IR discourages investment as it makes firms and consumers less willing to take out risk
Effect on increase IR:
On Personals: Increase cost of borrowing – increase the incentive of saving – increase the cost of bank loans – could reduce
confidence of borrowers
On economy: imports become cheaper – slow eco growth – unemployment rises

2- How does a decline in the value of U.S dollar affect the American consumers?
It makes foreign goods more expensive and so U.S consumers will buy less foreign goods and more domestic goods.

3- How does a rise in the value of U.S dollar affect the American consumers?
A strong dollar means that U.S goods exported abroad will cost more in foreign countries so foreigners will buy less from
them and it will benefit American consumers' b making foreign goods cheaper

4- What effect might a rise in stock prices have on consumers’ decisions to spend?
It will increase the consumer wealth so they will be more likely to increase their spending and investing

5- What effect might a fall in stock prices have on business investment?

The lower price for a firm's shares means that it raises small amount of funds so Investment will fall

6- What are the other important financial intermediaries in the economy besides banks?
Investment banks – Insurance Companies – Pension funds – mutual funds – investment companies

7- What is the basic function of the financial markets?

Carry funds to individuals and businesses - help to transfer money from lenders to borrowers - Provide means by which
prices are determined (new issued and existed stocks)

8- Securities brokers and dealers are crucial to a well-functioning secondary market. Differentiate between
securities brokers and dealers?

Security broker dealer

An agent goes to a professional broker to trade and invest by A person who trades by his own money
the agent's money
Only makes purchases as per the client's wishes Makes all decisions in respect of purchases
Paid a commission No commission is paid

9- Differentiate between primary market and secondary market?

Primary Secondary
Market where stocks and bonds are newly Where securities are traded after the company has sold them
issued before in the primary market

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 Investors buy stocks directly from the country Investors trade securities among themselves
issuing them
Large institutional investors Involve brokers and dealers
Involve investment banks

10- Because corporations do not actually raise any funds in the secondary markets, they are less important to the
economy than primary markets”. Comment.
This statement is false because the secondary market is important as: (it provides liquidity for the securities and makes it
easy to sell them in the primary market – determine the prices of securities issued in the primary market)

11- What are the differences between foreign bonds, Eurobond and Eurocurrencies?
(1) Foreign bonds: sold in a foreign country and are dominated in that country's currency (Egyptian co. issued us dollar)
(2) Eurobond: a bond dominated in a currency other than that of the country in which it's sold (bond issued in us dollar sold
in London)
(3) Eurocurrencies: foreign currencies deposited in banks outside the home country (bond issued in euro sold in Egypt)

12- Assume an investor want to start a new business that will cost him about 300,000 Egyptian pounds, and will
have a net profit of 100,000 after 2 years. And he is thinking of whether borrowing the money from his friend or
going to an institution to borrow the money. If he borrows money from his friend he will repay the loan after 2 years
with an interest rate of 8 % and this will cost him registration costs of 30,000.

On the other hand if he borrows money from the institution, he will pay 11% interest rate and at the same time the
registration cost of the project will cost him 2,000 Egyptian pounds. And this investor managed to borrow the
money from this institution. Analyze this case with clarifying why does the investor prefer to use this type of
finance? And what kind of finance does the investor acquire? And what are the benefits of this type of finance?
Direct (friend): 300,000 * 8% = 24,000 + 30,000 = 64,000
Indirect (Institution): 300,000 * 11% = 33,000 + 20,000 = 35,000 + Answer Q13

13- Why are financial intermediaries and indirect finance so important in financial markets?
(1) Reduce the transaction cost by providing expertise and knowledge (2) Reduce the customers' exposure to risk
(3) evaluate the profile of borrowers and keep their profile cost-effective
(4) Provide the customers' portfolio with diversification to reduce risk (Low transaction costs allow them to buy a range of
assets)
(5) Reduce the impact of asymmetric info

14- There are three major types of financial intermediaries, Discuss with examples?
(1) Depository Institutions: 1- Commercial Banks: Deposit Accounts and loans
2- Saving & loan Associations: accept saving and lending money
3- credit unions: non-profit organizations owned by its members. Work as a lending and depository services
(2) Contractual saving institutions: 1- Insurance companies: protect individuals and firms from adverse events ( Life
insurance – property & casualty insurance)
2- pension funds: provide retirement income to retired employees
(3) Investment intermediaries: 1- Mutual funds: deals with all types of investment (stock, bond or cash)
2- finance companies: provide loans for individuals and corporations
3- Money&Market mutual funds: provide liquid and short-term securities

15- Explain the problem of adverse selection created by asymmetric flow of info. Use an example to explain your
answer.
The event in which 1 party has relevant and important info about the situation that the other party lacks. It results in wrong
decision, less profit and more risk

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Example: smoker successfully manages to obtain insurance coverage as a non-smoker. Therefore, he pays lower premium
as a non-smoker (because chance of dying is less). By this, the applicant is leading the company to make wrong decision

16- Lisa is planning to purchase a new house and is looking for a home loan that will give her the lowest interest
rate. Discuss how she can be affected by asymmetric information and adverse selection.
Banks naturally has more info and knowledge about the customers and the financial markets than the customers. Banks
developed technologies to overcome the asymmetric info and it determines different interest rates according to the
customer's credit score. So, here she will be affected by both asymmetric info and adverse selection

17- If there were no asymmetry in the information that a borrower and a lender had, could there still be a moral
hazard problem?
Moral Hazard: occurs after the transaction, the borrowers engage in illegal activities, making it hard to pay the loan back.
Yes, Even if the borrowers took the loan at first and there was no asymmetry between the borrower and the bank there
could also be moral hazard problem

18- “Financial intermediaries play a crucial role in an economic crisis–they are responsible for both causing the
market to crash and then helping it recover from the crisis.” Is this statement true? Discuss with an example.
Potential problems of financial intermediaries:
(1) no guarantee as they could spread the risk
(2) there could be economic crisis, so investors lose their money, even if the financial intermediary ensured diversification

19- Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a 5%
interest rate at the bank and having the bank lend her the funds at a 10% interest rate rather than lend her the
funds yourself?
The same answer of Q13

20- How do financial intermediaries solve the problem of adverse selection?

It gathers info about lenders and borrowers so that every party know everything about the another one

21- Distinguish between direct finance and indirect finance

Direct Finance: Borrowing money from friends; borrowing money directly from investors by selling stocks or bonds.
Indirect Finance: Borrowing money from a bank. The bank lends out depositors money to borrowers at a profit.

22- Distinguish between money market and capital market

- Money: a financial market in which only short-term debt (less than 1 year) instruments are traded
- Capital: a market in which longer-term debt (1 year or more) and equity instruments are traded

23- Describe how over-the-counter markets work. What about exchanges? (Types of secondary market)
- dealers at different locations who have an inventory of securities stand ready to buy and sell securities over the counter to
anyone who comes to them and is willing to accept their prices. This market is very competitive
- buyers and sellers of securities meet in 1 central location to conduct trades.

24- Define Security – bond – central bank – monetary policy – financial innovations – transaction costs – economies
of scale – economies of scope – conflict of interest - liquidity services
Security: a claim on the issuer's future income or assets
Bond: a debt security that promises to make payments periodically for a specified period of time
Central bank: responsible for the conduct of monetary policy
monetary policy: involves the mgmt. of IRs and the quantity of money
Financial innovation: the development of new financial products and services
transaction costs: the time and money spent in carrying out financial transactions. FIs make profits by reducing transaction

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costs through taking advantage of economies of scale
Economies of scale: the reduction in transaction costs per dollar of transactions as the size of transactions increase
economies of scope: reducing cost of info production for each service by applying 1 info resource to many different
services
conflict of interest: a type of moral hazard problem that arise when a person or institution has many objectives and, as a
result, has conflict between those objectives.
Liquidity services: services that make it easier for customers to conduct transactions.

25- What's the difference between debt and equity market?

Debt: (1) short-term: maturity <1 year (2) long-term: maturity>10 year (3) Intermediate: between them
Equity: Represents an ownership claim in the firm

26- What are the main reasons for regulation?

Increase Information to Investors (government regulation can reduce adverse selection and moral hazard problems in
financial markets and increase their efficiency by increasing the amount of information available to investors) - Ensure the
Soundness of Financial Intermediaries

27- How does government ensure soundness of FIs (what are government actions to protect the economy from
financial panics? And what is the reason of this regulation?
1- Restrictions on Entry: Regulators have created tight regulations so who want to establish a financial intermediary, must
obtain a charter from the government
2- Disclosure: bookkeeping must follow certain principles - They must make certain info available to the public - periodical
inspection
3- Restrictions on Assets and Activities: restrictions on what financial intermediaries are allowed to do and what assets they
can hold (restrict the financial intermediary from engaging in certain risky activities and from holding certain risky assets)
4- Deposit Insurance: insure people’s deposits to a financial intermediary from any financial loss if the FI should fail
5- Limits on Competition 6- Restrictions on Interest Rates that can be paid on deposits
Reason: improve control over the money supply.