Fin 370

Week 2
Individual Assignment
Chap. 14 Questions 14-1, 14-3, 14-4
Chap. 15 Questions 15-12A, 15-13A

Question 14-1
What are financial markets? What function do they perform? How would an economy be worse off
without them?
Financial markets report price for each good; they are institutions and procedures that facilitate
transactions in all types of financial claims (securities). They exist in order to allocate the supply of
savings from those economic units with a surplus to those with a deficit.
Each financial market has a different function that they perform. For example, the stock markets
primary function is to provide a platform for investors to buy shares of ownership of a public
corporation which are sold to investors to allow the companies to raise a lot of cash at once. The
investors profit when the companies increase their earnings which keeps the United States economy
growing.
With mutual funds give you the ability to buy a lot of stocks at once. In a way this makes them an
easier tool to invest in than individual stocks. By reducing stock market volatility, they have also
had a calming effect on the United States economy.
In commodities, such as oil, the price is determined in the commodities futures market. The futures
market are a way to pay for something today that is delivered tomorrow, which helps to remove
some of the volatility in the United States economy. However, futures also increase the traders
leverage by allowing him to borrow the money to purchase the commodity.
Hedge funds are supposed have higher returns for high-end investors. Since hedge funds invest
heavily in futures, some argue that they have decreased the volatility of the stock market and the
United States economy.
Bonds also provide some of the liquidity that helps keep the United States economy lubricated.
However, when stock prices go up the bond prices go down.
The economy would suffer without a developed financial market system because the wealth of the
economy would be less without them. Rate of capital formation would not be as high, followed by
the slowed rate of stock contribution to (1) dwellings, (2) productive plant and equipment, (3)
inventory, and (4) consumer durables. Normal business activities would be funded slowly or not at
all.
Business firms in the aggregate usually spend more during a specific period than they earn.
Households in the aggregate spend less on current consumption than they earn. As a result, some
mechanism is needed to facilitate the transfer of savings from those economic units with a surplus
to those with a deficit. That is precisely the function of financial markets. Financial markets exist in
order to allocate the supply of savings in the economy to the demanders of those savings. The

central characteristic of a financial market is that it acts as the vehicle through which the forces of
demand and supply for a specific type of financial claim are brought together. If, specifically, the
United States did not have a financial market then there would not be a way for the economy to
move money around to facilitate progress and profit.

Question 14-3
Distinguish between the money and capital markets.
Money Markets facilitates transactions using short-term financial instruments; whereas, Capital
Markets facilitates transactions using long-term financial instruments.
A money market is a market for short term debt securities such as bankers acceptances, commercial
paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less
and often 30 days or less. Money market securities are generally very safe investment which returns
a relatively low interest rate that is most appropriate for temporary cash storage or short-term time
horizons. A capital market is where debt or equity securities are traded.

Question 14-4
What major benefits do corporations and investors enjoy because of the existence of organized
security exchanges?
(a) continuous market price volatility reduced
(b) establishing & publicizing fair security prices objective auction-type determination of
price
(c) helping business raise new capital new firms have a place to publicize security
offerings whose price will be subjected to a competitive determinant rather than having
to assign prices

Question 15-12 A
You are a hard-working analyst in the office of financial operations for a manufacturing firm that
produces a single product. You have developed the following cost structure information for this
company. All of it pertains to an output level of 10 million units. Using this information, find the
break-even point in units of output for the firm.
Return on operating assets
Operating asset turnover
Operating assets

= 25%
= 5 times
= $20
million
Degree of operating leverage = 4 times

1) Compute the operating profit margin:

(Margin) x (Turnover) = Return on operating assets
(M) x (5) = 0.25
M = .05
2) Compute the sales level associated with the given output
level:
Sales
5
$20, 000, 000
Sales $20, 000, 000 5
= $100,000,000
3) Compute EBIT:
(.05) ($100,000,000)
= $5,000,000
4) Compute revenue before fixed costs. Since the degree of operating leverage is 4 times,
revenue before fixed costs (RBF) is 4 times EBIT as follows:
RBF = (4) ($5,000,000) = $20,000,000
5) Compute total variable costs:
(Sales) - (Total variable costs) = $20,000,000
$100,000,000 - (Total variable costs) = $20,000,000
Total variable costs = $80,000,000
6) Compute total fixed costs:
RBF - Fixed costs = $5,000,000
$20,000,000 - fixed costs = $5,000,000
Fixed costs = $15,000,000
7) Find the selling price per unit, and the variable cost per unit:
P

$100, 000, 000

10, 000, 000

= $10

$80, 000,000
10, 000, 000

= $8
8) Compute the breakeven point:
F
P V
$15, 000, 000

$10 $8

QB

= 7,500,000 Units

Question 15-13 A
Allison Radios manufactures a complete line of radio and communication equipment for law
enforcement agencies. The average selling price of its finished product is $180 per unit. The
variable cost for these same units is $126. Allison Radios incurs fixed costs of $540,000 per year.
a. What is the break-even point in units for the company?

$540, 000
$180 $126
F
QB
P V

= 10,000 units
b. What is the dollar sales volume the firm must achieve in order to reach the break-even point?
= 10,000 $180
= $1,800,000
c. What would be the firm's profit or loss at the following units of production sold: 12,000 units?
15,000 units? 20,000 units?

Unit
Total
Sales Price
Sales
12000 $180 $2,160,000
15000 $180 $2,700,000
20000 $180 $3,600,000

Allison Radios
Fixed
Unit
Total
Total
Costs Variable Cost Variable Costs
Costs
$540,000
$126
$1,512,000
$2,052,000
$540,000
$126
$1,890,000
$2,430,000
$540,000
$126
$2,520,000
$3,060,000

Total Profit (Loss)

$108,000
$270,000
$540,000

d. Find the degree of operating leverage for the production and sales levels given in part c.

Units
12000
15000
20000

Contribution Margin
$648,000
$810,000
$1,080,000

EBIT
$108,000
$270,000
$540,000

DOL
6
3
2