QUESTIONS You will find the answers to the questions marked with this statement true, false, or uncertain? Explain your an asterisk in the Textbook Resources section of your answer. MyEconlab. 11. How does the free-rider problem aggravate adverse 1. How can economies of scale help explain the exis- selection and moral hazard problems in financial tence of financial intermediaries? markets *2. Describe two ways in which financial intermediaries #12. Explain how the separation of ownership and con- help lower transaction costs in the economy. trol in Canadian corporations might lead to poor 3. Would moral hazard and adverse selection still arise management. in financial markets if information were not asym- 13. Why can the provision of several types of financial metric? Explain. services by one firm lead to a lower cost of informa- *4. How do standard accounting principles help finan- tion production? cial markets work more efficiently? "14. How does the provision of several types of financial 5. Do you think the lemons problem would be more services by one firm lead to conflicts of interest? severe for stocks traded on the Toronto Stock 15. How can conflicts of interest make financial service Exchange or those traded over the counter? Explain. firms less efficient? "6 Which firms are most likely to use bank financing 16. Describe two conflicts of interest that occur when rather than to issue bonds or stocks to finance their underwriting and research are provided by a single activities? Why? investment firm. 7. How can the existence of asymmetric information 17. How does spinning lead to a less efficient financial provide a rationale for government regulation of System? financial markets "18 Describe two conflicts of interest that can occur in *8 Would you be more willing to lend to a friend if she accounting firms. put all of her life savings into her business than you 19. Which provisions of Sarbanes- Oxley do you think would if she had not done so? Why? are beneficial, and which do you think are not 9. Rich people often worry that others will seek to 20. Which provisions of the Global Legal Seulement do marry them only for their money. Is this a problem you think are beneficial, and which do you think of adverse selection? are not? *10. The more collateral there is backing a loan, the less the lender has to worry about adverse selection. Is(b) Direct regulation, or "command-and-control policies", have been pop- ular with regulators and also (relatively speaking) with the regulated firms. However, economist have long pointed out that they have certain drawbacks compared to alternative solutions to an environ- mental problem. Discuss the drawbacks with comman-and-control policies.E1. You are an A quality borrower, and you pay 10 percent on a five-year loan with one final amortization at the end. This is 1 percent above the spread paid by an AAA borrower. What will be the up-front fee for which your bank should be willing to lower the rate by 1 percent?1. Explain why it is difficult to estimate the value people place on environmental goods, the benefits they receive from cleaner air and other services of nature. 2. Why is there a trade-off between environmental quality and other forms of consumption (p. 290)? Also, what is the difference between other public goods such as national defense and wilderness (p. 291)? 3. Define marginal willingness to pay for clean air (p. 292). Also, distinguish between marginal willingness to pay and total willingness to pay (p. 293). 4. Distinguish between use and non-use value (p. 295-296). 5. What is the difference between an ordinary demand curve and a compensated demand curve (p. 298-301)? Define an expenditure function (p. 301-302). What does the area under a compensated demand curve measure (p. 302)? 6. What do we mean by restricted demand curve or a restricted expenditure function (p. 305-306)? Explain how we can use a restricted demand curve to estimate the marginal willingness to pay for an improvement in air quality (p. 306). (This question is important.) 7. Distinguish between the equivalent surplus and a compensating surplus associated with an increase in the quality or quantity of the environment. 8. Chapter 16: Hedonic Price Methods. We did not deal with much of the first part of this chapter. However, you should know that changes in land values following an improvement in environmental improvement accurately measure the benefits associated with environmental quality only under very special circumstances (see p. 315 for an example). 9. You should know what is to know about the effects of climate on land values (p. 317 and 321). 10. The important point about hedonic price theory is that the measured market relationship between the price of land and air quality represents a series of equilibriums between the demand for housing at a particular location and the supply of housing at a particular location (p. 324-327). As p. 329 indicates the hedonic price function is not a demand function. It simply indicates how housing prices change when characteristics change. You should be able to explain how investigators went about estimating a demand curve or the willingness to pay for air quality in Boston. This consists of a two-stage procedure described on p. 328-329. For the results, see p. 292. 11. Page 330 discusses how the value of a statistical life is estimated. You should know this. 12. Household Production. One example of this approach to measuring benefit is by measuring defensive expenditures (see example on p. 337-381). The basic idea is quite simple. If external noise is present, I will undertake defensive expenditures to maintain a tolerable noise level inside. If the external noise outside increases and I increase my defensive expenditures so as to maintain the indoor noise level at the same level, the increase in expenditure is a true measure of the cost of an increase in external noises. But see the discussion on why the individual will in general allow the internal noise level to deteriorate a bit following an increase in external noise.2. {i} (ii) (iii) Explain the concept of opportunity loss, and show that the minimum opportunity loss is equal to the Expected Value of Perfect Information. The failure rate in a particular examination is estimated to be 40%. Construct a table showing the probabilities of l}, I, 2 . . . 5 students failing in a sample of ve. 150 graduate entrants are due to take their rst professional accounting exam at the Institute of Certiahle Accountants. The probability distribution for the failure rate is mtimated in the following table: Failure rate Probability 0.1 {1.1 0.2 {1.2 {1.3 {1.3 [1.4 0.3 [15 0.11 Each failing student is entitled to a 10 refund on professional fees. The Institute's senior tutor is condent that she could ensure a failure rate of [1.1 by holding an intensive revision course, at a cost to the Institute of Bill]. Advise the Institute on whether the revision course should take place. A tutorial test of ve students resulted in no failures. Use this information to revise the failure rate probability distribution, and hence reassess the revision course. 3. 1Illespite being a small local shopkeeper I can always heat the price that Woolworths charge for the same product. Woolworths must pay rent on its store while I own my shop and have no rent to pay.' Discuss. 4. A rm keeps a record of sales and prices over the past seven months, resulting in the following table: Prim {'tonj Sales (tons) Nov. 1935 v.5 34.5 Dec. 3.0 32.0 Jan. 1930 3.0 34.0 Feb. 12 92A] March 1.0 95.0 April 3.0 92.0 May 3.5 91.5 Use these observations to estimate demand as a linear function of both price and time. Utilise this function to estimate demand for the following month. on the assumption that: (a) price remains unchanged, (h) price increases to when. E8. The six- and nine-month interest rates are 10 percent and 1 1 percent p.a., respectively. (a) What is the current six-to-nine forward interest rate? (b) What is the forward price of a six-month (= 71) forward contract on a nine-month (= T,) CD? (c) What is the futures quote (ignoring effects of marking to market)? (d) If the underlying CD has a face value of USD 10,000, what is the marking-to-market cash flow when the six- and nine-month interest rates both increase by 0.5 percent