You own a house worth $400,000 that is located on a river. If the river floods moderately, the house will be completely destroyed. This happens about once every 50 years. If you build a seawall, the river would have to flood heavily to destroy your house, which only happens about once every 200 years. What would be the annual premium for an insurance policy that offers full insurance? For a policy that only pays 75% of the home value, what are your expected costs with and without a seawall? Do the different policies provide an incentive to be safer (i.e., to build the seawall)?
> In the 1960s and 1970s, the Federal Reserve System lost member banks at a rapid rate. How can the theory of bureaucratic behavior explain the Fed’s campaign for legislation to require all commercial banks to become members? Was the Fed successful in this
> Compare the structure and independence of the Federal Reserve System and the European System of Central Banks.
> Why do bank panics worsen asymmetric information problems in credit markets?
> How can a sovereign debt crisis make an economic contraction more likely?
> Why are more resources not devoted to adequate, prudential supervision of the financial system to limit excessive risk taking, when it is clear that this supervision is needed to prevent financial crises?
> Why is the originate-to-distribute business model subject to the principal–agent problem?
> What is a credit spread? Why do credit spreads rise during financial crises?
> How does a general increase in uncertainty as a result of a failure of a major financial institution lead to an increase in adverse selection and moral hazard problems?
> How does a deterioration in balance sheets of financial institutions cause a decline in economic activity?
> How can a decline in real estate prices cause deleveraging and a decline in lending?
> Why do managers of financial institutions care so much about the activities of the Federal Reserve System?
> How does an unanticipated decline in the price level cause a drop in lending?
> How can a bursting of an asset-price bubble in the stock market help trigger a financial crisis?
> How does the concept of asymmetric information help to define a financial crisis?
> How did the global financial crisis promote a sovereign debt crisis in Europe?
> Why would haircuts on collateral increase sharply during a financial crisis? How would this lead to fire sales on assets?
> What is the shadow banking system, and why was it an important part of the 2007–2009 financial crisis?
> How did a decline in housing prices help trigger the subprime financial crisis starting in 2007?
> True, false, or uncertain: Financial engineering always leads to a more efficient financial system.
> What technological innovations led to the development of the subprime mortgage market?
> Describe two similarities and two differences between the U.S. experiences during the Great Depression and those during the global financial crisis of 2007–2009.
> What types of risks do financial institutions face?
> What role do weak financial regulation and supervision play in causing financial crises?
> How can financial liberalizations lead to financial crises?
> What causes bank panics?
> Why can the provision of several types of financial services by one firm lead to a lower cost of information production?
> “The more collateral there is backing a loan, the less the lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain your answer.
> How does spinning lead to a less efficient financial system?
> How can conflicts of interest make financial service firms less efficient?
> How does the provision of several types of financial services by one firm lead to conflicts of interest?
> Which firms are most likely to use bank financing than to issue bonds or stocks to finance their activities? Why?
> Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or those traded over the counter? Explain.
> Why are financial markets important to the health of the economy?
> How do standard accounting principles help financial markets work more efficiently?
> Would moral hazard and adverse selection still arise in financial markets if information were not asymmetric? Explain.
> Describe two ways in which financial intermediaries help lower transaction costs in the economy.
> How can economies of scale help explain the existence of financial intermediaries?
> Which provisions of the Global Legal Settlement do you think are beneficial, and which are not?
> Which provisions of Sarbanes-Oxley do you think are beneficial, and which are not?
> Describe two conflicts of interest that occur in accounting firms.
> Describe two conflicts of interest that occur when underwriting and research are provided by a single investment firm.
> Explain how the separation of ownership and control in American corporations might lead to poor management.
> How does the free-rider problem aggravate adverse selection and moral hazard problems in financial markets?
> What are the other important financial intermediaries in the economy besides banks?
> Rich people often worry that others will seek to marry them only for their money. Is this a problem of adverse selection?
> Would you be more willing to lend to a friend if she put all of her life savings into her business than you would if she had not done so? Why?
> How can the existence of asymmetric information provide a rationale for government regulation of financial markets?
> You are in the market for a used car. At a used car lot, you know that the blue book value for the cars you are looking at is between $20,000 and $24,000. If you believe the dealer knows as much about the car as you, how much are you willing to pay? Why?
> Now, you believe the dealer knows more about the cars than you. How much are you willing to pay? Why? How can this be resolved in a competitive market?
> You wish to hire Ricky to manage your Dallas operations. The profits from the operations depend partially on how hard Ricky works, as follows. If Ricky is lazy, he will surf the Internet all day, and he views this as a zero cost opportunity. However, R
> Suppose that increases in the money supply lead to a rise in stock prices. Does this mean that when you see that the money supply has had a sharp rise in the past week, you should go out and buy stocks? Why or why not?
> If a forecaster spends hours every day studying data to forecast interest rates, but his expectations are not as accurate as predicting that tomorrow’s interest rates will be identical to today’s interest rates, are his expectations optimal?
> “Whenever it is snowing when Joe Commuter gets up in the morning, he misjudges how long it will take him to drive to work. Otherwise, his expectations of the driving time are perfectly accurate. Considering that it snows only once every 10 years where Jo
> What is the basic activity of banks?
> “Forecasters’ predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be optimal.” Is this statement true, false, or uncertain? Explain your answer.
> “Human fear is the source of stock market crashes, so these crashes indicate that expectations in the stock market cannot be optimal.” Is this statement true, false, or uncertain? Explain your answer.
> If higher money growth is associated with higher future inflation and if announced money growth turns out to be extremely high but is still less than the market expected, what do you think would happen to long-term bond prices?
> “An efficient market is one in which no one ever profits from having better information than the rest.” Is this statement true, false, or uncertain? Explain your answer.
> “If most participants in the stock market do not follow what is happening to the monetary aggregates, prices of common stocks will not fully reflect information about them.” Is this statement true, false, or uncertain? Explain your answer.
> If I read in the Wall Street Journal that the “smart money” on Wall Street expects stock prices to fall, should I follow that lead and sell all my stocks?
> Can a person with optimal expectations expect the price of Google to rise by 10% in the next month?
> If my broker has been right in her five previous buy and sell recommendations, should I continue listening to her advice?
> “If stock prices did not follow a random walk, there would be unexploited profit opportunities in the market.” Is this statement true, false, or uncertain? Explain your answer.
> Can we expect the value of the dollar to rise by 2% next week if our expectations are optimal?
> Looking at Figure 1.3, in what years would you have chosen to visit the Grand Canyon in Arizona rather than the Tower of London? Figure 1.3: Index (March 1973 = 100) 150 135 120 105 90 75 1975 1980 1985 1990 1995 2000 2005 2010
> The following table lists foreign exchange rates between U.S. dollars and British pounds (GBP) during April. Which day would have been the best day to convert $200 into British pounds? Which day would have been the worst day? What would be the differe
> What are the objectives of audit risk assessment, and why is it important in assessing the likelihood that fraud may occur? Explain why risk assessment performed during audit planning sets the tone for the entire audit engagement.
> Assume that a CPA serves as an audit client’s business consultant and performs each of the following services for the client. Identify the threats to independence. Do you believe any safeguards can be employed to reduce the threat to an acceptable level?
> Do you believe that the SEC should prohibit auditors from providing all nonaudit services for audit clients? Use ethical reasoning to support your answer.
> Do you believe the internal audit activity should be independent? Explain.
> How might financial incentives in the form of client services unconsciously introduce auditor bias into the independent audit function? Are there any solutions to the conflict?
> Is independence impaired when an auditor is hired, paid, and fired by the same corporate managers whose activities are the subject of the audit? Does it matter that in most companies the audit committee hires, evaluate, fires (if appropriate), and determ
> It has been said that independence is the cornerstone of the accounting profession. Explain what this means. What does it mean to say that auditors have special and critical gatekeeping duties?
> Explain the safeguards that can be used to reduce or eliminate threats to audit independence.
> Is accounting a trustworthy profession? How would you know whether it is or is not?
> On May 20, 2014, the SEC settled an investigation of James T. Adams, the former chief risk officer at Deloitte, for causing violations of the auditor independence rules. It seems that Adams accepted tens of thousands of casino markers while he was the ad
> Hofstede’s Cultural Dimensions in Exhibit 1.2 indicate that China has a score of only 20 in Individualism, while the U.S. score is 91. How might the differences in scores manifest itself when the public interest is threatened by harmful actions taken by
> In August 2008, EY agreed to pay more than $2.9 million to the SEC to settle charges that it violated ethics rules by co-producing a series of audio CDs with a man who was also a director at three of EY’s audit clients. According to the SEC, EY collabora
> According to SOX rules that mandate auditor rotation, the lead audit partner on an engagement is prohibited from providing those services for a client for greater than five consecutive years. The purpose of the rule is to encourage professional skepticis
> In recent years the move by accounting firms to offshore tax and consulting work has grown and expanded into audit work. What are the ethical concerns that might be raised about the practice of electronically transmitting audit information to offshore ce
> Assume you are the senior in charge of the audit of a client in New York who offers you two tickets to the Super Bowl between the New York Giants and the Denver Broncos. The opportunity to see the Manning brothers square off against each other is appeali
> Explain the threats to professional skepticism that might influence audit judgment.
> Assume that the CPA firm of Packers & Vikings audits Chi Bears Systems. The controller of Chi Bears, a CPA, happens to be a tax expert. During the current tax season, Packers & Vikings gets far behind in reviewing processed tax returns. It does not want
> In January 2008, it was discovered that William Borchard, who handled due diligence for clients of PwC interested in mergers and acquisitions, divulged controversial plans to Gregory Raben, an auditor at the firm, and Raben used the information to buy st
> You were engaged to file the 2015 individual and corporate tax returns for a client. The client provided her records and other tax information on March 1, 2016, to help prepare the 2015 tax return. Your client paid you $12,000 in advance to prepare those
> You previously worked for the Department of Revenue, a governmental agency in your town. You cut all ties with the agency after you left two years ago to start your own tax accounting business. One day you receive a call from the agency asking you to con
> You have decided to leave your CPA firm. Using the AICPA rules as a guide, answer the following questions: (1) Can you post some negative comments about your former employer on Twitter? (2) Can you call your former clients and tell them that you are le
> Your best friend is from another country. One day after a particularly stimulating lecture on the meaning of ethics by your instructor, you and your friend disagree about whether culture plays a role in ethical behavior. You state that good ethics are go
> You’re struggling in your new accounting practice to tap into a potential client base. You have tried traditional advertising and marketing tools to no avail. Your friend tells you to use social media as a tool to reach potential customers. You’re not su
> Andy Simmons is a CPA with his own accounting and tax practice. He occasionally does an audit for small business clients. One day an audit client shows Andy a letter from the local Property Tax Assessor’s office. It seems the client inquired about the pr
> What is the problem with an auditor overrelying on management’s representations on the financial statements?
> Can a CPA auditor be independent without being objective? Can a CPA auditor be objective without being independent? Explain.
> What are the dangers of creeping commercialism in the accounting profession?
> In our discussion of the KPMG professional judgment framework, we pointed out that biased judgments can be made because of judgment tendencies. One such tendency that was not included in the framework is self-serving bias. Explain what you think this mea
> 9. The following questions are about corporate governance and executive compensation. (a) How does agency theory address the issue of executive compensation? (b) How might stakeholder theory argue against the current model of executive compensation in th
> Do you believe that employees who observe more occupational fraud in their organizations are more likely to engage in occupational fraud themselves?
> Explain how “group-think” might lead a person to ignore moral and ethical duty in an organization.
> It has been said that recent graduates from a business school majoring in accounting and just entering the profession are especially vulnerable to ethical missteps because they are often naive and may not see the ethical aspects of situations they confro
> Steroid use in baseball is an important societal issue. Many members of society are concerned that their young sons and daughters may be negatively influenced by what apparently has been done at the major league level to gain an advantage and the possibi
> How do employee perceptions of commitment, integrity, and transparency in the workplace contribute toward creating an ethical corporate culture?
