N Answers to End-Of-Chapter 19 Questions

LECTURE 8 - Tutorial

 Answers to End-of-Chapter 19 Questions

1. Regulators felt that investment banking was riskier and had led to bank failures during the Great Depression.

2. The Glass Steagall Act.

3. When an offering is underwritten, the investment banker purchases the issue at a pre- specified price. In a best-efforts issue, the investment bankers does not take ownership.

4. Investment bankers offer advice, help with filing documents, and assistance with marketing the issue.

5. No, an SEC review simply determines if the proper documents have been filed.

6. By forming a syndicate the risk of the issue is spread among many different firms and more brokers will be attempting to sell the securities.

7. It is better to be fully subscribed because oversubscription indicates that the investment bankers priced the security too low.

 Answers to End-of-Chapter 20 Questions

1. Yes. By warning borrowers that they will not be able to get future loans if they engage in risky activities, borrowers will be less likely to engage in these activities in order to have access to loans in the future. 2. Secured loans are an important method of lending for financial institutions because if the borrower defaults, the financial institution can take title to the collateral, sell it off, and use the proceeds to offset any losses on the loan. Thus the financial institution can worry less about the adverse selection problem because it has some protection even if the borrower was a bad credit risk. 3. Uncertain. In some cases, raising rates may generate more income and thus increase profits. However, the higher interest rates do increase adverse selection in which the risk-prone borrowers are more likely to seek out the loans. Thus the rate of default might go up and bank profits could suffer. 4. To reduce adverse selection, a banker needs to screen out bad credit risks by learning as much as possible about potential borrowers. Similarly, to minimize moral hazard, the banker must continually monitor borrowers to see that they are complying with restrictive loan covenants. Hence it pays for the banker to by nosy. 5. Compensating balances can act as collateral. They also help establish long-term customer relationships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem. Compensating balances help the bank monitor the activities of a borrowing firm, so that it can prevent the firm from taking on too much risk, thereby not acting in the interest of the bank.