Financial Info Marketplace

Chapter 03 - The Financial Information Marketplace
Chapter 3
The Financial Information Marketplace
Learning Objectives
You will be able to identify the most important sources of information about
the money and capital markets and the financial system.
You will discover why the efficient distribution of information within the
financial system is so important and what can happen when relevant financial
information is not readily available to all market participants.
You will understand how any individual or institution active in financial
marketplace can keep track of the prices of financial assets, interest rates, and
other financial variables.
In an appendix to the chapter you will learn about the Flow of Funds Accounts
of the United States and discover what is meant by social accounting.
Key Topics Outline

The Efficient Markets Hypothesis: Assumptions and Forms.
Insider Trading.
Asymmetric Information.
Problems of Asymmetry: Lemons, Adverse Selection, Moral Hazard.
Remedies for Asymmetry.
Sources of information for Bonds, Notes, and Corporate Stock.
Information on Security Issuers and the Economy.
Appendix: The Flow of Funds Accounts and Social Accounting.
Chapter Outline
3.1. Introduction: The Importance of Information in the Financial
Marketplace
3.2. The Great Debate over Efficient Markets and Asymmetric Information
3.2.1. The Efficient Markets Hypothesis (EMH)
3.2.1.1. What Is an Efficient Market?
3.2.1.2. Different Forms of the EMH
3.2.1.3. Insiders and Insider Trading
3.2.1.4. What Is Insider Trading?
3.2.1.5. When Is Insider Trading Legal or Illegal?
3.2.2. The Asymmetric Information Hypothesis (AIH)
3.2.3. Problems Asymmetries Can Create: Lemons and Plums
3.2.4. Problems Asymmetries Can Create: Adverse Selection
3.2.5. Problems Asymmetries Can Create: Moral Hazard
3.2.6. Asymmetry, Efficiency, and Real-World Markets
3.2.7. Informational Asymmetries and The Law
3.3. Debts Security Prices and Yields: Sources of Information
3.3.1. Bonds and Notes
3.3.2. Bid and Asked Prices and Pricing Information
3.4. Stock Prices and Dividend Yields: Sources of Information
3.4.1. Price and Yield Information
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3.4.2. Stock Price Indexes and Foreign Stock Prices
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3.5. Information on Security Issuers

3.5.1. Moodys and Standard & Poors Reports
3.5.2. Securities and Exchange Commission (SEC) Reports
3.5.3. Company Histories
3.5.4. Dun & Bradstreet Ratings and Risk Management
3.5.5. Financial Institutions
3.5.6. Credit Bureaus
3.6. General Economic and Financial Conditions
3.6.1. The Federal Reserve System
3.6.2. Other Domestic and International Sources of Information
Appendix
Social Accounting and The Flow of Funds in the Financial System
o National Income and Product Accounts
o The Flow of Funds Accounts
Constructing the Flow of Funds Accounts: Sectoring the
Economy
Constructing the Flow of Funds Accounts: Building Sector
Balance Sheets
Sources of Balance Sheet Data
Constructing the Flow of Funds Accounts: Preparing Sources
and Uses of Funds Statements
Balancing Out a Sources and Uses of Funds Statement
Constructing the Flow of Funds Accounts: Building a Flow of
Funds Matrix for the Whole Economy
Limitations and Uses of the Flow of Funds Accounts
Key Terms Appearing in This Chapter

efficient Markets Hypothesis (EMH), note, 68
56 bond, 68
asymmetric information hypothesis bid price, 69
(AIH), 56
ask price, 69
insider trading, 59
stocks, 69
moral hazard, 63
Questions to Help You Study

1. Why is the availability and reliability of financial information important to
both borrowers and lenders of funds? What can happen when relevant
information is missing?
Answer: Borrowers require financial information to determine when to borrow and
what source of funds to use. A borrower will also be interested in financial
information to determine the most efficient maturity of current borrowings and the
cheapest source of funds available. Lenders need information to determine where and
when to invest. Lenders consider the risk factor, the marketability of an investment,
and the expected return.
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2. Can you explain why financial information that is accurate and reliable is of
great significance to government policymakers and regulators within the
financial system?
Answer: Government policymakers need information to ensure the smooth
functioning of the financial markets, to make sufficient credit available to support
business and commerce, to promote full employment, price stability, satisfactory
economic growth, and a satisfactory balance of payments position for the nation.
Because the Federal Reserve makes decisions daily to enter the market for the nation
to buy or sell, so as to influence the availability of credit and interest rates, data on
security prices and yields as well as economic conditions are necessary.
3. Carefully explain what is meant by the term efficient market. Are there
different levels of market efficiency? What are these levels?
Answer: An efficient market exists when all information that is relevant is used to
value or price financial assets. When a market is efficient, no investor can earn excess
returns using the information available to all. Instead, investors should expect to earn
an ordinary or normal return for the degree of risk they take on.
There are three forms of market efficiency. The weak form of the EMH says
that current prices reflect all past prices and trading volume. No single investor can
earn excess profits from using this information. The semi-strong form of the EMH
says that all publicly available information will be reflected in the current price, so no
investor can earn excess profits using this information. The strong form of the EMH
says that all public and private information is relevant to valuing financial assets.
Therefore an investor with private information (insider) can earn excess profits.
4. Explain what is meant by informational asymmetries. What problems can

these asymmetries create for participants in the money and capital markets?
Answer: Informational asymmetries exist when there are pockets of information
available to particular investors. These investors can earn excess profits by using this
information, which is costly for others to obtain. When information asymmetries
exist, both the quality and quantity of information may vary.
The lemons problem and adverse selection are two problems caused by
information asymmetries. The lemons problem exists when buyers and sellers have
different information sets. For example, the used car seller has more information than
the buyer, while the bank borrower has more information than the loan officer. High
quality participants may be driven from the market because prices rise to compensate
the party with less information. The adverse selection problem exists when more
costly market participants choose one financial-service firm for the services they
need, while less costly market participants choose another whose prices are more in
line with their expectations. Securities regulations are one mechanism for addressing
information asymmetries.
5. What does it mean to say a financial asset is temporarily overpriced or

temporarily under-priced? How can such a situation happen? Why is such
overpricing or under-pricing likely to be only temporary?
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Answer: Temporary overpricing means that there is an imbalance between supply

and demand supply is less than demand on a temporary basis. The overpricing is
likely to be temporary since in the long run, substitute products and imports from
overseas will satisfy the unsatisfied demand.
Consider the case of a "brutal four-day freeze" destroying more than a third of
California's annual citrus crop, resulting in half a billion dollars in damage and the
prospect of tripled orange prices in supermarkets. (The New York Times, December
25, 1998, p. A1)
Cold weather damages oranges, reducing their supply. This can be seen in the
following diagram as a shift to the left in the supply curve for oranges. The new
equilibrium price is higher than the old equilibrium price.
Price of S'
Oranges
S
D
Quantity
of
Oranges
On the other hand, rent control in certain areas, such as New York City, leads
to permanent under-pricing of real estate assets for the lucky tenants who have been
the incumbent tenants. (The Boston Globe, April 28, 1997, p. A1.)
6. As you look at the real world around you, do you see examples of what seem to
be efficient markets? Can you detect any real-world examples of what seem to be
informational asymmetries? How did you identify these market situations?
Answer: Waiting lines at the customs at the airport provide a good example of an
efficient market whenever a short line is formed by chance, people will start to
move toward that line, and it doesnt take long to see that that line develops to be as
long as the other lines.
Informational asymmetries exist in the insurance industry. For example,
buyers of health insurance know more about their own health than the insurance
companies. Since less healthy people are more likely to buy health insurance, the
insurance companies, being aware of this, will price health insurance policies to
reflect the cost of a less-healthy-than-average person. As a result, people with average
or better health are at disadvantage when they buy health insurance. Such situations
will occur in real life when one party in a transaction knows more than the other party.
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7. What steps have been taken recently to promote greater accuracy and
reliability of information concerning the financial marketplace and the valuation
of individual assets?
Answer: In the fall of 2000 the U.S. Securities and Exchange Commission passed
Regulation FD (for Fair Disclosure). This required companies to disclose material
financial information broadly rather than only to selected viewers (such as stock
brokers or security dealers). This supposedly gives all possible investors roughly
equal access to market moving information. Even more recently a settlement between
the New York Attorney Generals Office and major brokerage companies in 2003
restricted the exchange of privileged information between security brokers and their
wealthiest clients who often pay large brokerage commissions and expect special
treatment in return. At about the same time the SEC moved to block mutual funds
from releasing inside information about the funds portfolio strategies to hedge funds
and other large investors. Rules such as these help to protect the public by giving
them more equal access to pertinent information as an aid to sound financial decision
making.
While the government regulations and controls recently put in place to
mitigate the damaging effects of asymmetric information may be helpful in improving
the efficiency of the financial markets, many observers think we have a long way to
go in solving asymmetric information problems. They point, for example, to the case
of Enron Corporation, a huge energy firm that filed for bankruptcy in 2001 and whose
alleged insider dealings and questionable accounting practices cost investors billions
in stock market losses and destroyed the retirement savings of many Enron
employees. The accounting practices of major corporations need a closer look today
to make sure that capital-market investors are getting the full amount of reliable and
relevant information they need to make rational buy-sell decisions. The Sarbanes-
Oxley Accounting Practices Act of 2002 makes chief executive officers (CEOs) and
chief financial officers (CFOs) of public companies responsible when their firms
dispense inaccurate or misleading information about the financial condition of the
businesses they manage. Sarbanes-Oxley represents a step toward a more information-
rich and information-reliable financial marketplace, but it is only a step in what is still
a long road to travel.
8. If you needed to gather information for a possible stock or bond purchase,

where would you go to get such information? What are the principal sources to
check?
Answer: Information on the history of each firm, its recent acquisitions/mergers,
recent financial statements, stock prices, dividend yields, and ratings of corporations,
is readily available. Security price information can be gathered from numerous
sources, including The Wall Street Journal, The Value Line Investment Survey, and
S&P Stock Reports. The Stock Price Indexes and Foreign Stock Prices are one of the
other information that reflects price movements in groups of similar quality stocks.
There are many indexes such as the Dow Jones, NASDAQ, S&P, etc.
9. Suppose you wanted to evaluate the financial condition of a business firm.

What major sources exist that could assist you in getting that kind of
information?
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Answer: Two of the most respected sources of information on major security issues
and issuers are Moodys Investor Service and Standard & Poors Corporation.
Moodys offers research studies focusing upon the performance and financial
condition of thousands of businesses, financial institutions, and governmental
authorities in both domestic and foreign markets, provides opinions on economic and
credit trends, etc. Standard & Poors Corporation provides similar services, including
credit research, credit ratings for securities offered in financial marketplace, and
investment portfolio recommendations, etc.
10. Suppose you were planning to take a job with a particular company. What
would you want to know about the company and where could you find that
information?
Answer: You need to know how well the company is performing within the industry,
and you may also want to know if that particular industry is still growing or mature.
Financial newspapers such as Wall Street Journal, Fortune Magazine, and Forbes are
good sources of information. You should also visit the career planning and placement
center at your school to obtain company brochures for the most up-to-date
information. Visit the company's website too!
11. If you wanted to gather information about the state of the U.S. economy,
which information sources would likely be most helpful to you?
Answer:
Board of Governors of the Federal Reserve System - http://www.federalreserve.gov
U.S. Government Printing Office - published statistical information
Project sponsored by the University of California - http://www.access.gpo.gov
The Comptroller of the Currency - http://www.occ.treas.gov/
Federal Reserve Bank of New York - http://www.ny.frb.org/
The International Monetary Fund - http://www.imf.org/
12. Where could you go to gather information about the global economy?
Answer: Visit http://www.economist.com for worldwide economic data. Visit
http://www.finance.yahoo.com/ and http://www.cnnfn.com for additional links to
many different countries.
13. Why would information about the global and domestic economies be of
assistance to investors in stocks, bonds, and other financial assets?
Answer: Because a number of different sources provide market participants with
information on developments in the economy, prevailing trends in the money and
capital markets, and actions by the government that may affect economic and
financial conditions worldwide. Today, all financial markets have been connected
around the world.
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Questions to Help You Study: The Appendix to Chapter 3

A-1. What is meant by the term social accounting? Why is such an accounting
system needed?
Answer: Social Accounting is a system of record keeping that reports transactions
between the principal sectors of the economy (households, financial institutions, and
government agencies). It is used to forecast interest rates and to build econometric
models to simulate future conditions in the financial markets. This information can aid
investors and policymakers.
A-2. Compare and contrast the Flow of Funds Accounts with the National
Income and Product Accounts. What types of information does each system of
accounts provide that could be useful for making financial decisions?
Answer: National Income Accounts (NIA), compiled and issued quarterly by the U.S.
Department of Commerce, present data on the nations production, income flows,
investment spending, consumption, and total savings. NIA provides extensive
information on the level and growth of the nations economic activity, but little data
on financial transactions or about what goes on in the money and capital markets.
The Flow of Funds Accounts (FFA), prepared and published quarterly by the
Board of Governors of the Federal Reserve System, provide data on financial
transactions between economic sectors. FFA traces the flow of savings into purchases
of financial assets; shows how different sectors relate to and interact with each other;
and highlights the interconnections between the financial sector and the rest of the
economy.
A-3. How are the Flow of Funds Accounts constructed?

Answer: The Flow of Funds Accounts are constructed by 4 steps
1. Sectoring the Economy: divide the economy into several broad sectors,
each consisting of economic units (transactors) with similar balance
sheets.
2. Building Sector Balance Sheets: construct the balance sheets for each
sector. Sector balance sheets contain estimates of the assets, liabilities,
and net worth held by each sector at a single point in time.
3. Preparing Sources and Uses of Funds Statements: show changes in net
worth and changes in holdings of financial assets and liabilities taken
from each sectors balance sheet at the beginning and end of a calendar
quarter or year.
4. Building a Flow of Funds Matrix for the Whole Economy: combine the
sources and uses of funds statement for each sector into a flow of funds
matrix for the entire economy.
A-4. What is a sources and uses of funds statement? Why is it important?

Answer: The sources and uses of funds statement shows the changes in net worth and
changes in holdings of financial assets, real assets, and liabilities for each sector.
These are arranged as follows:
Change in Financial Assets Change in Liabilities
Change in Real Assets Change in Net Worth
Change in Total Assets Change in Liabilities and Net Worth
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A-5. Discuss the principal limitations of flow of funds data. Why must a user of
flow of funds information keep these limitations in mind?
Answer: The Flow of Funds Accounts provides a vast amount of information on

trends in the financial system, but these social accounts have a number of limitations
such that:
1. The Flow of Funds Accounts presents no information on transactions
among economic units within each sector.
2. The Flow of Funds Accounts shows only net flows between one point
in time and another point in time.
3. All Flow of Funds data are expressed in terms of current market
values.
Problems and Issues

1. Trading on inside information would not yield excess returns to investors if
the stock market:
(A) were efficient according to the Weak Form of Market Efficiency, but not
efficient according to either the Semi-Strong Form or the Strong Form of
Market Efficiency.
(B) were efficient according to the Weak Form of Market Efficiency and the
Semi-Strong Form of Market Efficiency, but not efficient according to either
the Strong Form of Market Efficiency.
(C) were not efficient according to any of the Weak Form, Semi-Strong
Form, or Strong Form of Market Efficiency.
(D) were efficient according to all of the Weak Form, Semi-Strong Form, or
Strong Form of Market Efficiency.
ANSWER: (D)
2. A manager of Accurate Info, Inc. decides to purchase a golf membership for

the senior executives of his firm. If he does not believe that this decision will
raise shareholder value, then his decision is an example of:
(A) adverse selection, but not an agency problem.
(B) adverse selection and an agency problem.
(C) moral hazard, but not an agency problem.
(D) moral hazard and an agency problem.
ANSWER: (D)
3. Insider trading by corporate executives that yields abnormal profits:

(A) is a violation of the Semi-Strong Form of the Efficient Market Hypothesis
(EMH), and is subject to investigation by the Federal Reserve.
(B) is a violation of the Strong Form of the Efficient Market Hypothesis
(EMH), and is subject to investigation by the Securities and Exchange
Commission (SEC).
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(C) is not a violation of the Semi-Strong Form of the Efficient Market

Hypothesis (EMH), and is subject to investigation by the Federal Reserve.
(D) is not a violation of the Strong Form of the Efficient Market Hypothesis
(EMH), and is subject to investigation by the Securities and Exchange
Commission (SEC).
ANSWER: (B)
EXCEL 4. In the Appendix to this chapter (especially Exhibit A-2) you are given
household balance sheet information relating to the U.S. household sectors financial
assets and liabilities. Households also possess nonfinancial assets, the bulk of which is
housing. Use the information presented below along with the information in Exhibit
A-2 to examine how housing has affected U.S. household wealth since 1980.
U.S. Household Balance Sheet Items

($billions) 1980 1990 2000 2006
Total Household Sector Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Nonfinancial Assets of Households 4,359.70 9,353.00 15,806.80 25,780.40
Value of Housing Assets 2,943.20 6,578.50 11,411.90 19,926.10
a. For each of the years: 1980, 1990, 2000, and 2006, please place into a
spreadsheet the following information: Total Assets, Total Nonfinacial Assets,
Total Housing, Total Liabilities, and Total Mortgages.
ANSWER: Spreadsheet
($billions) 1980 1990 2000 2006
Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Nonfinancial Assets 4,359.70 9,353.00 15,806.80 25,780.40
Total Housing 2,943.20 6,578.50 11,411.90 19,926.10
Total Liabilities 1,453.00 3,719.30 7,356.10 12,198.80
Total Mortgages 932.00 2,504.10 4,770.10 8,943.60
b. For each year, determine what percentage of Total Assets is made up of

Housing.
ANSWER:
($billions) 1980 1990 2000 2006
Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Housing 2,943.20 6,578.50 11,411.90 19,926.10
Total Mortgages 932.00 2,504.10 4,770.10 8,943.60
The percentage of Housing in Total Assets(%) 26.97 27.51 23.40 30.33
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c. For each year, determine what percentage of Total Liabilities is made up of

Mortgages.
ANSWER:
($billions) 1980 1990 2000 2006
Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Housing 2,943.20 6,578.50 11,411.90 19,926.10
Total Mortgages 932.00 2,504.10 4,770.10 8,943.60
The percentage of Mortgages in Total
Liabilities (%) 64.14 67.33 64.85 73.32
d. For each year, compute the net equity that U.S. households have in their
home by subtracting Mortgages (liability) from Housing (asset).
ANSWER:
($billions) 1980 1990 2000 2006
Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Housing 2,943.20 6,578.50 11,411.90 19,926.10
Total Mortgages 932.00 2,504.10 4,770.10 8,943.60
The Net Equity of Housing 2,011.20 4,074.40 6,641.80 10,982.50
e. For each year, compute U.S. households Net Worth = Total Assets Less Total
Liabilities.
ANSWER:
($billions) 1980 1990 2000 2006
Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Housing 2,943.20 6,578.50 11,411.90 19,926.10
Total Mortgages 932.00 2,504.10 4,770.10 8,943.60
The Net Worth 9,461.70 20,196.30 41,416.10 53,507.10
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f. For each year, compute the percentage of households Net Worth that is made
up of net equity in their homes.
ANSWER:
($billions) 1980 1990 2000 2006
Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Housing 2,943.20 6,578.50 11,411.90 19,926.10
Total Mortgages 932.00 2,504.10 4,770.10 8,943.60
The Net Equity of Housing 2,011.20 4,074.40 6,641.80 10,982.50
The Net Worth 9,461.70 20,196.30 41,416.10 53,507.10
The Percentage of Net Equity of Housing
in the Net Worth (%) 21.26 20.17 16.04 20.53
g. Describe the principle trends in the make-up of U.S. households balance

sheet that you observe and try to explain why these trends are occurring.
What role might the development of the financial information marketplace
play in the trends you observe?
ANSWER: The principle trends in the make-up of U.S. households balance sheet are
that the household sector has been the net lender of funds to rest of the economy. The
percentage of the Net worth is increasing and the percentage of net equity of housing
in the net worth is decreasing.
5. The following situations may be covered by insider trading laws in the United
States. Examine each situation described and indicate whether, in your
opinion a violation of insider trading laws might have occurred. If you think
a violation occurred, what kind of violation was it?
a. The chief financial officer of Start Corporation reads an internal

memorandum criticizing the firms recent oil field development investments
and picks up his phone to call his broker, placing an order to sell his holdings
of the firms shares when the market opens in the morning.
ANSWER: Here the CFO, as a company insider, appears to be breaching his
fiduciary duty by attempting to profit from company-proprietary information.
b. Corren Professional Corporation, a CPA firm, assists Selkirk Industrial

Corporation with its quarterly and annual financial reports. Jim Roberts, a
CPA with Corren, after reviewing the latest information provided by
Selkirks CEO, calls a friend and suggests making certain stock and bond
trades involving Selkirks securities. Roberts will not benefit financially from
these suggested trades and refuses to get involved.
ANSWER: Here the CPA, Jim Roberts, would probably be considered a de facto
Company insider. He seems to be misappropriating information about Selkirk,
whether or not he stands to directly profit from his actions.
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c. James Smith works for Cohen and Cooper, a local law firm, and while
browsing in his firms law library, he discovers a new report from a legal
client of his colleague, Roscoe Adams, that predicts serious financial problems
if the client proceeds with its recently drafted strategic plan. Smith
subsequently discovers discreetly that the strategic plan is to be launched
next week. He also learns that Roscoe is selling the clients stock short
through his broker. Smith quietly advises Roscoe not to make the short sale
and lets the matter drop.
ANSWER: Here Adams, as the attorney directly representing the company, (and who,
again, seemingly would be considered a de facto Company insider) seems to be
breaching his fiduciary duty by attempting to profit from company-proprietary
information.
d. Samuel Joule learns from conversations with Sarah Conklin, a bartender at a

local bar, that neighboring Locket Corporation has recently developed a
warning device that may help prevent air collisions and may be worth tens of
millions of dollars once announced to the public. Neither Joule nor Conklin
works for Locket, though he has been dating Miss Conklin. Both of these
individuals decide to purchase 1,000 shares of Lockets stock before Locket
holds a press conference to announce the new air collision device. Joule and
Conklin will use a bank loan to finance the purchase of Lockets shares. A
wedding is planned if the transaction pays off.
ANSWER: Neither of these individuals is an actual or de facto insider of Locket, and
neither seems to bear any fiduciary responsibility to the company, therefore, their
actions seem legal. It remains to be seen whether their actions will be profitable.
6. In this chapter we discussed three different forms or levels of market

efficiency. Refer to the appropriate forms of market efficiency in answering
the following questions:
a. Why is insider trading illegal?
ANSWER: The strong form argues that the current price of a financial asset already
captures all relevant public and private information. However, we do not see the
strong form of market efficiency often and insiders information can be exploited for
profit at the cost of others who do not have the private information.
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Why and how do small investors benefit from efficient markets?

ANSWER: The semi-strong form contends that the current price of a financial asset
already reflects all publicly available and relevant information. In the fall of 2000 the
U.S. Securities and Exchange Commission passed Regulation FD (for Fair
Disclosure). This required companies to disclose material financial information
broadly rather than only to selected viewers (such as stock brokers or security
dealers). This supposedly gives all possible investors roughly equal access to market
moving information. Even more recently a settlement between the New York Attorney
Generals Office and major brokerage companies in 2003 restricted the exchange of
privileged information between security brokers and their wealthiest clients who often
pay large brokerage commissions and expect special treatment in return. At about the
same time the SEC moved to block mutual funds from releasing inside information
about the funds portfolio strategies to hedge funds and other large investors. Rules
such as these help to protect the public by giving them more equal access to pertinent
information as an aid to sound financial decision making.
b. If you were a stock trader and markets were not efficient, how would this
influence your trading activity? What does this tell you about why markets
may be efficient?
ANSWER: If the market is not efficient, then some traders will be able to make profit
by extrapolating the patterns of profitable trading which was achieved by
manipulating the information in a market which is not efficient. However, since such
behavior is profitable, more people will be actively looking for such opportunities and
that will help push the market to be efficient.
c. Consider the case of a day trader who looks only at the past history of stock
prices in conducting his or her trades. How likely would it be for such a
person to beat the market? What does this suggest about investing in the
entire market (such as by purchasing shares in an index fund) rather than
attempting to pick individual stocks?
ANSWER: If a day trader looks only at the past history of stock prices in conducting
his trades, he must be a believer that the market is not even weakly efficient. The
weak form of the EMH argues that the current price of a financial asset already
reflects all its price and trading volume history. Since most markets are at least semi-
efficient, the trader will not be able to make money easily, let alone make easy money.
If somebody invests in an index fund / market fund instead of trying to beat the
market, she believes that the market is at least semi-efficient. The semi-strong form
contends that the current price of a financial asset already reflects all publicly
available and relevant information.
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7. Based on the material in the appendix to this chapter construct sources and
uses of funds statements for each sector and for the whole economy using the
following information:
Banks and Other

Business Financial Governmental
Households Firms Institutions Units
($ billions) ($ billions) ($ billions) ($ billions)
Current Saving $428.8 $280.00 $35.0 -$35.0
Current Real 332.5 350.0 17.5 ---
Investment
Current Financial 306.3 78.8 43.8 8.8
Investment
Current Borrowing 210.0 148.8 26.3 43.8
Assume that the four sectors listed above are the only sectors in the economy
and that there are no international transactions. Is there a statistical
discrepancy? Where? Referring to the discussion in Chapter 2, which
sectors are deficit-budget sectors (DBUs) and which are surplus-budget
sectors (SBUs)? Are there any balanced-budget sectors (BBUs)?
ANSWER:
Households
Uses Sources
Change in Real Assets $332.5 Change in Liabilities $210.0
Changes in Financial Assets 306.3 Change in Net Worth 428.8
Total Uses $638.8 Total Sources $638.8
Business Firms
Uses Sources
Financial Institutions
Uses Sources
Governments
Uses Sources
Change in Real Assets $---- Change in Liabilities $43.8
Changes in Financial Assets 8.8 Change in Net Worth -35.0
Flow of Funds Matrix for the Whole Economy

Uses Sources
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While total uses equal total sources of funds for the economy as a whole, the change
in real assets (net investment) is not equal to the change in net worth (current saving).
Nor is the change in financial assets equal to the change in liabilities as should be the
case in a closed economic and financial system. The discrepancy observed is
approximately equal to the statistical discrepancy normally found in the Flow of
Funds Accounts and usually arises from unreported transactions and differences in
accounting systems.
Deficit budget sectors include business firms and government. These sectors
experience a greater current increase in real assets than net worth and, therefore, a
greater rise in outstanding debt than in holdings of financial assets. Surplus-budget
sectors include households and financial institutions for which the change in net worth
exceeds current growth in real assets, such that the change in financial assets is larger
than the change in outstanding liabilities
Web-Based Problems
1. Go to the Internet and use such Web sources as www.federalreserve.gov,
www.bea.gov, and www.bls.gov in order to obtain the following information:
a. The latest stock price that you can find for IBM
Check: http://finance.yahoo.com/q?s=IBM
From Company Profile (as of 6/29/2007), the Close Price for IBM is
$105.25/share.
b. The average yield on highly-rated long-term bonds
Check: http://www.federalreserve.gov/releases/h15/Current/
Moody's seasoned Aaa (as of 6/22/2007) has a yield of 5.86%
c. The interest rate on 3-month U.S. Treasury bills
The 3-month U.S. Treasury bills (secondary market, as of 6/22/07) have a
yield of 4.59%.
d. The size of the U.S. money supply (measured as M1 and M2)
The seasonally adjusted in billions of dollars (as in May, 2007): M1: 1377.3;
M2: 7226.8. The non-seasonally adjusted in billions of dollars: M1: 1382.0;
M2: 7200.3.
e. The annualized growth rate of the U.S. economy for the most recent
quarter (real GDP)
Check: http://www.bea.gov/national/txt/dpga.txt
Quarterly GDP in billions dollars Annualized Growth Rate
2006q1 13,008.4
2006q2 13,197.3 2.6%
2006q3 13,322.6 2.0%
2006q4 13,458.2 2.5%
2007q1 13,620.2 0.7%
3-16
f. The size of the U.S. budget deficit (or surplus) for the last fiscal year
Check: http://www.whitehouse.gov/omb/budget/fy2005/pdf/hist.pdf (For
Federal Budget in millions of dollars)
Receipts Outlays Surplus or Deficit ()
2007 estimate $2,415,852 $2,770,097 $354,245
g. Total business fixed investment in the U.S. during the last calendar year
Check:http://www.bea.gov/national/FA2004/TableView.asp?
SelectedTable=18&FirstYear=2000&LastYear=2005&Freq=Year in Billions of
dollars; yearend estimates
2004 2005
Private fixed assets 27,192.8 29,343.6
h. Total employment in the nonfarm business sector
Check: http://www.bls.gov/news.release/empsit.nr0.htm
Total employment in the fourth quarter of 2006 is 136,951 in Thousands and
the first quarter of 2007 is 137,447 in Thousands.
i. The inflation rate in the United States for the past year measured in terms
of the growth rate of the CPI
Check: http://www.bls.gov/news.release/cpi.nr0.htm
The May 2007 level of 207.949 (1982-84=100) was 2.7 percent higher than in
May 2006.
2. Track the performance of a stock issued by a company included in the Dow

Jones Industrial Average (DJIA) Index (such as IBM or Microsoft) over the
course of the semester and compare the performance of the stock you have
selected relative to the performance of a broad stock-market index of your
own choosing (such as the S&P 500 Stock Index, the Vanguard Total Stock
Market Index Fund, or the Wilshire 5000 Index). There are a wide variety of
sources for the information you will need, including The Wall Street Journal
(www.wsj.com), the New York Stock Exchange (www.nyse.com) and other
sources mentioned in this chapter.
At the end of each week, find the closing price of your stock and the stock
index you have chosen. Keep a running account of the percentage gains and
losses that you would have experienced had you (a) bought the stock, or (b)
bought the market by buying an index fund representing a whole basket of
stocks (such as an S&P 500 index fund). At the semesters end, compute the
return you would have made had you invested $10,000 in your chosen stock
or in your chosen index fund. Did your stock outperform or under-perform
the index fund? What information can you point to that seems to account for
the over- or under-performance of your stock relative to the market?
3-17

Financial Info Marketplace

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Financial Info Marketplace

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Chapter 03 - The Financial Information Marketplace

Key Topics Outline

3.4.2. Stock Price Indexes and Foreign Stock Prices

3.5. Information on Security Issuers

Key Terms Appearing in This Chapter

Questions to Help You Study

4. Explain what is meant by informational asymmetries. What problems can

5. What does it mean to say a financial asset is temporarily overpriced or

Answer: Temporary overpricing means that there is an imbalance between supply

8. If you needed to gather information for a possible stock or bond purchase,

9. Suppose you wanted to evaluate the financial condition of a business firm.

Questions to Help You Study: The Appendix to Chapter 3

A-3. How are the Flow of Funds Accounts constructed?

A-4. What is a sources and uses of funds statement? Why is it important?

Answer: The Flow of Funds Accounts provides a vast amount of information on

Problems and Issues

2. A manager of Accurate Info, Inc. decides to purchase a golf membership for

3. Insider trading by corporate executives that yields abnormal profits:

(C) is not a violation of the Semi-Strong Form of the Efficient Market

U.S. Household Balance Sheet Items

Total Household Sector Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

b. For each year, determine what percentage of Total Assets is made up of

Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

c. For each year, determine what percentage of Total Liabilities is made up of

Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

Total Assets 10,914.70 23,915.60 48,772.20 65,705.90

g. Describe the principle trends in the make-up of U.S. households balance

a. The chief financial officer of Start Corporation reads an internal

b. Corren Professional Corporation, a CPA firm, assists Selkirk Industrial

d. Samuel Joule learns from conversations with Sarah Conklin, a bartender at a

6. In this chapter we discussed three different forms or levels of market

Why and how do small investors benefit from efficient markets?

Banks and Other

Flow of Funds Matrix for the Whole Economy

2. Track the performance of a stock issued by a company included in the Dow

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