20 points total.  Each question is worth 4 points.

1.   [Chapter 2, Question 4]  Consider the following statement: “ All financial intermediaries provide the same economic functions.  Therefore, the same investment strategy should be used in the management of all financial intermediaries.”  Is this statement true or false?

This statement is false.  While financial intermediaries have the same general functions, financial intermediaries (like insurance companies, banks or mutual funds) hold different liabilities whose timing and amount may or may not be predictable.  They are also subject to differing regulations and tax treatments.  All of this differences translate into different asset portfolios, i.e. investments for these institutions.  For example, an intermediary with unpredicatable liabilities will need to hold more liquid assets than an intermediary with predictable liabilities.

2.   [Based on Chapter 2, Question 7]  Each Year, millions of American investors pour billions of dollar into mutual funds, which use those dollars to buy the common stock of other companies.  What do the mutual funds offer investors with this indirect investment, relative to directly investing in the common stock of companies?.

Equity mutual funds allow small investors to diversify their stock holdings across many companies.  This could not be done directly without a large amount of investment capital.  Furthermore, mutual funds, by managing a large portfolio owned by many, will have lower per unit transactions and information costs.  Mutual funds also offer professional management to those without any expertise in stock investing.

3.  [Based on Chapter 1, Question 11].  Do U.S. Treasury securities carry any risk?  Explain your answer.

Yes.  U.S. Treasury do not carry default risk.  However, this is only one type of risk.  The purchasing power of the future cash flows is subject to inflation risk.  The value of Treasuries is inversely related to interest rates.  Foreign owners will be subject to exchange rate risk as well.

4.  Explain the problems associated with the McFadden Act and Glass Steagall Act which led their repeal in the 1990s

The McMadden Act, by limiting interstate branching for banks, resulted in banks that were inefficiently small and unable to take advantages of economies of scale in banking services.  The Glass Steagall Act limited banks from taking advantage of economies of scale in financial services in general beyond banking.  It also resulting in less diversfication across assets and liability types for banks.  U.S. banks were at a disadvantage globally since other countries did not have these restrictions.

5.  Consider the risk-based capital requirement described in chapter 4.   Consider the assets held by the two banks in the tables below.

Bank 1                                                                                                                                              Bank 2

Asset	Value (millions)	wt.	Asset	Value (millions)
U.S. Treasury Securities	$200	0%	U.S. Treasury Securities	$100
Residential Mortgages	$400	50%	Residential Mortgages	$600
Commercial Loans	$500	100%	Commercial Loans	$200
Corporate Bonds	$100	100%/50%	Municipal Revenue Bonds	$100
risk-weighted assets	$800			$550
required capital	$800 x .08 = $64			$550 x .08 = $44

Suppose the total capital requirement is 8% on risk-weighted assets.  Calculate the amount of required total capital for each bank, using the weights  on page 55. What is the general relationship between required capital and the risk of the asset portfolio?
 
The higher the risk of the asset portfolio, the higher the amount of capital required.