Part 1: Multiple-Choice Questions (30 points)

• 15 multiple-choice questions are posted on OWL under the section of quizzes/test “Assignment 1-MCQs” . (2 points for each question)

Part 2: Short Answer Questions (70 points)

Q1. (35 points) Flow of Funds Exercise in “Chapter 1 Role of Financial Markets and Institutions” (on page 22, with 10 sub questions from a to j).

Carson Company is a large manufacturing firm in California that was created 20 years ago by the Carson family. It was initially financed with an equity investment by the Carson family    and 10 other individuals. Over time, Carson Company obtained substantial loans from            finance companies and commercial banks. The interest rates on those loans are tied to market interest rates and are adjusted every six months. Thus, Carson’s cost of obtaining funds is      sensitive to interest rate movements.

The company has a credit line with a bank in case it suddenly needs additional funds for a   temporary period. It has purchased Treasury securities that it could sell if it experiences any liquidity problems.

Carson Company has assets valued at approximately $50 million and generates sales of         nearly $100 million per year. Some of its growth is attributed to its acquisitions of other         firms. Because it expects the U.S. economy to be strong in the future, Carson plans to grow   by expanding its business and by making more acquisitions. It expects that it will need           substantial long-term financing and plans to borrow additional funds either through obtaining loans or by issuing bonds. It is also considering issuing stock to raise funds in the next year.  Carson closely monitors conditions in financial markets that could affect its cash inflows and cash outflows and thereby affect its value.

a. In what way is Carson a surplus unit?

b. In what way is Carson a deficit unit?

c. How might finance companies facilitate Carson’s expansion?

d. How might commercial banks facilitate Carson’s expansion?

e. Why might Carson have limited access to additional debt financing during its growth phase?

f.  How might securities firms facilitate Carson’s expansion?

g. How might Carson use the primary market to facilitate its expansion?

h. How might it use the secondary market?

i. If financial markets were perfect, how might this factor have allowed Carson to avoid financial institutions?

j. The loans that Carson has obtained from commercial banks stipulate that Carson must    receive the bank’s approval before pursuing any large projects. What is the purpose of this

condition? Does this condition benefit the owners of the company?

Q2. (35 points) Forecasting interest rate

A.  Look for the following prevailing economic conditions in Canada:

a.   inflation (including oil prices). What has been the inflation rate in Canada in the past two years? What is your expectation for the inflation rate over the next year?

b.   Economic growth. What has been the economic growth rate in Canada? What is your expectation of Canada’s future economic growth over the next year?

c.   Monetary policy by the Bank of Canada. Do you expect the Bank of Canada to affect the existing supply of loanable funds over the next year?

d.   Fiscal policy by the federal government. Do you expect the federal government to increase or cut its spending, increase or reduce taxes over the next year?

Given the information you find and your expectations on the economic conditions, access how the demand for and the supply of loanable funds would be affected, if at all, and predict the future direction of interest rates in Canada.

B.  Assume that you are the treasurer of a manufacturing company. Your company can obtain a one-year loan at a fixed rate of 8 percent or a floating-rate loan that is currently at 8 percent but for which the interest rate would be revised every month in accordance with general interest rate movements. Which type of loan is more appropriate based on your analysis in question A?

C.  Assume that US interest rates have abruptly risen just as you have completed your