How can the provision of several types of financial services by one firm be both beneficial and problematic?

Answer all the following questions, the words limit are suggested words count for each question.


Question 1: How can the provision of several types of financial services by one firm be both beneficial and problematic? (5marks, 100 words)


Question 2: How does risk-sharing benefit both financial intermediaries and private investors? (5marks, 100 words)

Question 3: Suppose you have just inherited $10,400 and are considering the following options for investing the money to maximize your return:

Option 1: Put the money in an interest-bearing checking account that earns 3%. The FDIC insures the account against bank failure.

Option 2: Invest the money in a corporate bond with a stated return of 6%, although there is a 10% chance the company could go bankrupt.

Option 3: Loan the money to one of your friend’s roommates, Ayesha, at an agreed-upon interest rate of 7%, but you believe there is a 7% chance that she will leave town without repaying you.

Option 4: Hold the money in cash and earn zero return.

  1. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return? (Hint: To calculate the expected return of an outcome, multiply the probability that an event will occur by the outcome of that event and then add them up. (6 marks, 120 words)
  2. Assume that Option 3 and Option 4 are your only choices. If you could pay your friend $50 to find out extra information about Ayesha that would indicate with certainty whether she will leave town without paying, would you pay the $50? What does this say about the value of better information regarding risk? (15 marks, 300 words)


Question 4: Suppose your bank has the following balance sheet:

Assets Liabilities
Reserves $ 50 million Checkable deposits     $200 million
Securities $ 50 million  
Loans $150 million Bank capital $ 50 million



If the required reserve ratio on deposits is 10%, what actions should the bank manager take if there is an unexpected deposit outflow of $50 million in U.S. market? (5 marks, 100 words)



Question 5: If the president of a bank told you that the bank was so well run that it has never had to call in loans, sell securities, or borrow as a result of a deposit outflow, would you be willing to buy stock in that bank? Why or why not? (5 marks, 100 words)


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