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Park University Week 1 Homework

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2. When interest rates rise, how might businesses and consumers change their economic behavior?

An interest rate is the cost of borrowing or the price paid for the rental of funds. A couple examples are interest paid on mortgages and car loans. A high interest rate and deter consumers from buying a house, car or other items because the cost of financing would be high. High interest rates could also encourage you to save because you can earn more interest on savings accounts. High interest rates can effect businesses investment decisions. High rates can cause a corporation to postpone expansions, resulting in a loss of future jobs.

14. What types of risks do financial institutions face?

Financial institutions have to deal with the way interest rates have been fluctuating wildly in the resent economic environment. The stock markets crashing both here and overseas creates another risk factor. Speculation has happened in the foreign exchange markets and failures of financial institutions have reached high levels. Given that there are many risk factors, financial institutions must be able to cope with the increased risks.

2. If I can buy a car today for $5000 and it is worth $10000 in extra income next year to me because it enables me to get a job as a traveling anvil seller, should I take out a loan from Larry the loan shark at a 90% interest rate if no one else will give me a loan? Will I be better or worse off as a result of taking out this loan? Can you make a case for legalizing loan-sharking?

Yes you should take out the loan because you will benefit as a result. Your interest payment will be $4,500 (90% of 5,000). Having a vehicle will earn you an additional $10,000. So you will be ahead of the game by $5,500. This is a clear example for the benefits of loan-sharking. Loan-sharking can have some social benefits.

5. Because corporations do not actually raise any funds in secondary markets, they are less important to the economy than primary markets. Comment

Secondary markets make the financial instruments more liquid, which is more desirable. They determine the price of the security that the issuing firm sells in the primary market.

14. How does risk sharing benefit both financial intermediaries and private investors?

Intermediaries create and sell assets that fit each investors risk tolerance. The use the funds to purchase other assets that may have more risk. Intermediaries also have a lower transaction cost than a single private investor.

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