Coursework Financial Questions and Answers

1. Describe the Sarbanes-Oxley Act, and explain which section(s) you find to be the most important.

The Sarbanes-Oxley Act became law in July of 2002 and brought some very drastic changes to the policing of corporations and financial practices. The Securities and Exchange Commission notes that corporate and accounting fraud was largely responsible for the introduction of this act because of the massive amount of money lost by investors, the drastic changes in share prices and the corruption and loss of assurance in the securities markets. In terms of necessity the most important are sections 302, 401, 404, 409, 802 and 906. The 906 section of the Sarbanes-Oxley Act seemed to be one of the most important aspects because transparency that is required among heads of the company makes it much easier for other levels of management to adhere to acceptable standards of ethics in business.

2. What are the three stages found within a financial crisis for the United States?

The first stage found within a financial crisis for the United States is the formation of a bubble. A great example of this was the real estate market. The second stage is the bursting of the bubble. Once again in the case of the real estate market, the bubble eventually got too big and burst. There was too much fraud that the illusion of houses being worth their listing prices was dashed and the market crashed. The third stage is the dispersion of that particular bubble’s damage to other sectors in the financial system as a whole. After the bubble burst and the damage began to spread, it was like dominos to other sectors until the entire financial system was impacted by the original bubble of stage one.

3. What are the issues that are involved with the idea of adverse selection?

Adverse selection involves doing business with dishonest people. Adverse selection can be especially problematic when there is an imbalance of information between the seller and the buyer in an insurance deal. For insurance, there is a reduction in the chance of profit because the buyer may have a better understanding of their risks than the seller does. When adverse selection occurs, the buyer of an insurance policy knows they are of higher risk for claiming than the average group of people. This creates a problem with the overall setting of premiums because there are outliers in the system that are not accounted for. As a result, the insurance industry loses money and increasing the premium will not resolve the problem because that would make the insurance too expensive.

4. What are the three-stages found within a financial crisis for Emerging Markets?

The initiation stage starts with the mismanagement of finances through leniency. When an increase in lending accompanies the leniency of regulation, this creates the initial disaster. Stage 2, the currency crisis, follows. Governments and banks have to engage in a delicate balance to try and keep interest rates and profit in healthy ranges. An increase in interest rates puts pressure on an already fragile system but not increasing interest makes currency value topple. Stage 3, the full-fledged financial crisis is when new markets collide with currency devaluations.

5. What are the eight basic facts that support the reason for having financial institutions?

Financial institutions deliver consumers and other clients numerous services and banking products, this is especially true when the market explodes and when it crashes. The lending of money is a very important role that financial institutions play and as a result, the government made it easier in the 20th century for this process. Financial institutions act as intercessors for both investors and borrowers. Financial institutions also offer a variety of insurance options. Financial institutions provide a balance so that no one entity is so powerful that it can cause a financial meltdown.

6. What are some of the products and services created from technological advances in the banking system?

For the customer, the first of many advances is the self-inquiry facility. This allows a customer to view transactions within their account. Remote banking, another service, allows banking business to be conducted conveniently. ATMs have offered quick and easy ways for customers to access funds. For the bank, there is a substantial increase in response time to inquiries. There is also a much faster system of information transfers and the interconnection of branches and offices. For the employees, there is accurate computation, automation for busy work tasks, signature retrieval and the avoidance of mistakes such as duplication.

7. How has the banking system evolved into a “dual banking system”, and what does this mean?

The banking system began as a charter system. These banks were overseen by the market itself and banknote movement was almost always conducted on the state level. Free banking came next because of a massive amount of bank failures in 1837. Banknote discounting was typical in this system. National banking followed. This form of banking was created largely through the National Bank Act of 1863. Just one year later, Congress passed an amendment that started the taxation of state banknotes. As a result, state bank numbers fell from over 1,000 to about 250 in just a decade. Dual banking promotes competition which helps lessen regulation and because of this financial innovation is allowed to thrive.

8. What are some of the ways that moral hazard and adverse selection are limited for insurance products?

One way to limit moral hazard and adverse selection is to ensure both sides of the transaction, buyers and sellers, divulge information so that one side does not have more information than the other. A second way would be to make sure there are adequate screening methods to avoid risk manipulation. A third way is to offer a variety of choices in policy for varying risk types. A fourth way is to invest in increased monitoring. A fifth way is to use deductibles and experience rates. The final way is to ask potential and current buyers to prove insurable interest.

9. Describe the idea of “national banking.” How is the system evolving today (and into the future)?

National banking has a couple of definitions. The first of two applies to developing countries and banks owned by the state. The second is a typical private bank that conducts business on a national level, not on a local, regional or international level. Although the term national bank has been used in conjunction with central bank, this is not the case today. The term national bank means the bank is monitored by the Office of Comptroller of the Currency (OCC) in accordance with the National Bank Act and that national banks do not have to adhere to state usury laws, only the federal government Truth in Lending Act. National banking is evolving, in many ways it possesses the same qualities as a central bank but national banking still does a lot of jobs that central banks undertake. Through evolving it is crucial that national banking update their traditional systems to modern ones in order to keep up with the competitive financial system.