ACCO 340 Lecture Notes - Lecture 6: Adverse Selection, Insider Trading, Efficient-Market Hypothesis

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bronzemammoth297

2 Feb 2017

School

Concordia University

Department

Accountancy

Course

ACCO 340

Professor

Elizabeth Peltier- Wagner

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Document Summary

When one type of participant in the market will know something about the asset being traded and that another type of participant does not know. Two types: adverse selection (inside information) & moral hazard (managerial shirking). "lemon problem"": in the used car market, the owner of the car will know more about its true condition, and hence its future stream of benefits, than would a potential buyer. This creates an adverse selection problem, since the owner may try to take advantage of this inside information by bringing a "lemon"" to market, hoping to get more than it is worth. However, buyers will be aware of this temptation and since they don"t have the information to distinguish between lemons and good cars, they will lower the price they are willing to pay for any used car. As a result, the good cars will have a market value that is less than the real value of their future stream of benefits.

Related Questions

Mini-Case #2

Financial crisis, Home Mortgages, Credit Markets,Financial Institutions, Moral Hazard, Adverseselections,

CONCEPTS IN THIS CASE:

Mortgage defaults
sub-prime mortgages
mortgage-backed security
defaults
write off
wealth effect
moral hazard
adverse selection

You have been hired to manage a depository institution, such asa bank. The top management team is very concerned to avoid thesimilar massive defaults on home mortgages as in 2007. You arebeing asked to explain factors behind the financial crisis andexplain the role of government in minimizing the adverse impact ofthe crisis on the financial system.

You start with some background information on how a wave ofdefaults on home mortgages threatened the health of any financialinstitutions that had invested in home mortgages either directly orindirectly through investment in mortgage-backed securities.Mortgage-backed securities were perceived to be sound investmentsas they were rated by legitimate rating agencies. Before the crisishappened, banks had mistakenly believed that an innovation andsecuritization of their long-term assets could eliminate theirexposure to mortgage defaults and minimize their interest rate riskand even make them more profitable. When the mortgages started togo bad, many investment funds âblew upâ and couldnât repay theloans they had taken from the banks. The banks had to âwrite offâthe loans they had made to the investors. Doing so reduced theirreserves and lending powers. This was a major factor affectingprofitability and soundness of depository institutions.

To the management team, the lending standard was a crucialfactor to see if asymmetric information was a factor. You explainedthat a relaxed standard on mortgage lending was anothercontributing factor. According to the Federal Housing FinanceBoard, the average fee on a mortgage loan fell from around 1% ofthe amount of the loan in 1998 to less than .5% from 2002 to 2007.Mortgage lenders who were willing to lower their standards gainedmarket share. Other mortgage lenders either had to lower theirstandards or lose market share.

The bursting of any housing bubble would be expected to have anegative effect on the economy for two reasons. First, homeconstruction is an important economic activity and the decline inhome construction would reduce GDP. Second, the decrease in homeprices would also reduce household consumption due to the wealtheffect. But the bursting of this housing bubble caused more severeand widespread harm than would be predicted from just these tworeasons. As mentioned previously, most of the losses were sufferedby the financial system, not by the homeowners. The bursting of thehousing bubble sent a shock through the entire financial system,increasing the perceived credit risk throughout the economy.

Due to government interventions and a Federal Reserve increasein the money supply, the economy stabilized gradually.

How can financial innovations lead to financial crisis? Explainspecifically the role of securitization of the mortgage market.

How were adverse selection and moral hazard contributing factorsin this crisis?

Did the unprecedented level of government intervention in theeconomy prevent an even more severe economic downturn than whatactually occurred? Is this affecting a moral hazard problem in thefuture?

What will be the long-term impact of the governmentâsintervention, particularly the ballooning of the national debt?

Please make it minimum of 2 pages thanks.

rubyspider287

7. If a survey is to be conducted to determine businessesâselection criterion for choosing PC and network communicationsproducts, which survey method should be used and why?

8. Design a questionnaire for determining businessesâ selectioncriterion for choosing PC and network communications products.

INTEL: Building Blocks Inside Out

The Intel Corporation (www.intel.com) was founded in 1968 tobuild semiconductor memory products. It introduced the worldâsfirst microprocessor in 1971. Microprocessors, also referred to ascentral processing units (CPUs), often are described as the âbrainâof a computer. Today, Intel supplies the building blocks for thecomputing and communications industries worldwide. These buildingblocks include chips, boards, systems, and software, and they areused in computers, servers, and networking/communications products.Most of Intelâs customers fall into two separate groups: theoriginal equipment manufacturers (OEMs) and the PC and networkcommunications products users. The OEMs manufacture computersystems, cellular handsets and handheld computing devices,telecommunications and networking communications equipment, andperipherals. The PC and network communications products usersinclude individuals, large and small businesses, and serviceproviders, who buy Intelâs PC enhancements, networking products,and business communications products through reseller, retail,e-business, and OEM channels. Intel is an increasingly globalcompany. Only 35 percent of its revenues are from North America,whereas Asia and Europe comprise 31 percent and 25 percent,respectively. Revenues for fiscal year 2010 amounted to $43.62billion. Intel has shown phenomenal growth as a company. Much ofIntelâs success can be attributed to innovation within itsmarketing department. This innovation was required to overcomeseveral obstacles. The main problem Intel faced was trying to sellan ingredient brand, which is a component of a larger product.Thus, the difficulty is in reaching consumers that will never seeyour product and might not even know what it does or why it isthere. Intel began marketing research in the 1980s because it washaving difficulty with its customers not upgrading from the 286 tothe 386 microprocessor. Marketing research showed that this was dueto a lack of customer awareness, and Intel set out to change that.It conducted a small but effective advertising campaign. In fact,in the process it realized that it had inadvertently created abrand in Intel. Because of the success of this small campaign,Intel began to realize the importance of marketing and marketingresearch and started to focus more effort and money on these areas.Marketing research revealed that in order to be effective in itsoverall marketing campaign, Intel would have to reach the consumersand convince them that what was inside the computer was asimportant as what was on the outside. This became the key elementof the âIntel Insideâ campaign conducted during the early 1990s.This slogan helped Intel put a name with its products, and ithelped it encompass several of its products under one title.Furthermore, marketing research showed that it would be mosteffective to cross-market with its technology partners. This wouldhelp consumers understand the products that Intel helped make up.It did this by including the âIntel Insideâ logo in its partnersâads. It also helped fund these advertisements. A problem withincluding its slogan in other ads is that Intel did not want tointrude on the commercials. It decided to help make the small logosink in by accompanying it with a jingle every time it wasdisplayed. This jingle has become extremely recognizable andsynonymous with Intelâs slogan. All of this helped Intel realizeits goal of increased consumer awareness. Longitudinal measurementof advertising effectiveness via marketing research revealed thatthe âIntel Insideâ campaign was very effective. Intelâs next ideawas to come up with a name for its microprocessor. This would helpit to avoid using the numbering scheme, which was nonpatentable,and to find a name that consumers could identify their processorswith. After extensive marketing research, Intel chose the nameâPentium,â which it found generated positive reactions with itsconsumers. Intel has been marketing its processors under this nameever since. Between 1990 and 1993, Intel invested $500 million inadvertising to build its brand equity. By 1993, 80 percent ofpeople in the United States recognized Intel and 75 percent hadpositive feelings about the brand. Most important, 50 percent ofconsumers looked for the brand when they were shopping. By 1994,Intel had captured 95 percent of the microprocessor market, due inlarge part to its marketing efforts. Intelâs market share formicroprocessors slipped to about 80 percent in 2005 as a result ofincreased competition from its main competitor, AMD. On December30, 2005, Intel announced a major overhaul of its corporate andproduct branding, a move designed to symbolize the chip makerâstransformation into a supplier for products beyond personalcomputers. The changes included a new version of the companyâs bluelogoâwithout the lowered âeâ that had long been a part of Intelâsbrandingâalong with a new tagline, âLeap Ahead.â As of 2006, Intelno longer used the well-known âIntel Insideâ logo. In 2009 tobetter align major product groups around the core competencies ofIntel architecture and manufacturing operations, Intel reorganizeditself into nine operating segments. The increased competitionmakes Intelâs marketing research efforts more important than everas it attempts to preserve its dominant place in the market. Intelhas been able to be very successful because of its focus ontechnology, brand image, and brand equity. Intel still faces futurechallenges, including increased competition, the opening of newmarkets, and the development of new products. Intel will continueto rely on marketing research to meet these challenges. ConclusionMarketing research has played a critical role in Intelâs phenomenalgrowth. Marketing research was instrumental in developing the Intelbrand, designing the âIntel Insideâ campaign, and crafting the newlogo with the âLeap Aheadâ tag line. Continued reliance onmarketing research will enable Intel to enhance its image as apreeminent building block supplier inside out.

peachgnu627

Peter Schultz IV, president of Schultz Quality Furniture, takespride in carrying on a tradition of manufacturing custom qualityfurniture, a skill that was started by his great-grandfather insouthern Germany almost 100 years ago. In the 1930, Peter'sgrandfather immigrated to the Unites States and settled inPennsylvania where he incorporated the furniture business.

Throughout its existence, the company has focused on the highend of the furniture line and remained relatively small. They werenot interested in getting into the mass production of lesserquality items. Their workmanship and quality of product haveattracted a loyal following of customers and clients who arewilling to pay a premium for Schultz furnishings.

Over the years, Schultz has changed their focus and emphasis tomeet changing consumer preferences and desires, however, some ofthe original designs are still being manufactured in certainpieces. While the core business has remained strong and fairlyconsistent, the company will sometimes venture off into some othermarkets and specialties.

Just two years ago, Peter Schultz IV purchased the controllinginterest in Garden Patios Deluxe. This is a small company whichspecialized in making high-end patio and outdoor garden typefurniture. The furniture is sturdy, rust resistant and uses qualitymaterials which resist weathering and fading for a number of years.Peter thought this line of furniture would be a good compliment tohis company since Garden Patios Deluxe concentrate on the superiorquality furniture, have a relatively small operation, and support aloyal customer base. Also, with the general trend of the populationnow entertaining more and enjoying the outdoors, there seemed to bea sustainable market for patio furniture of this type.

So far, the operation of Garden Patios Deluxe has been asuccess. The company is bringing in a profit, but it has been alittle harder to attract a market than Peter first imagined. Thenorthern climate can tend to limit the outdoor season, and itseemed that people did not want to pay a lot of money for patiofurniture that would have to be in storage for half the year.

As a matter of course, Peter likes to review the manufacturingprocess for the different furniture lines about every eighteenmonths. He was interested in getting a detailed breakdown on theproduction cost and methods used to make the patio tables andchairs.

The material is a specially developed compound of structurallysound polymers, which is molded and heat treated by a supplier. Thecompound comes in four basic colors of beige, forest green, grayand white. The furniture pieces are constructed at the GardenPatios plant and parts like the fabric seats, glass inlays, andother decorative features are assembled.

The plant used in this manufacturing capacity is operating atabout 90% of capacity, although there are some seasonalfluctuations. The busy season is from November through May prior tothe outdoor entertainment season. In the summer, much time is spentin redesign and testing of new models or experimenting onvariations in existing product lines.

One of the most popular pieces made by Garden Patios Deluxe is asimple armchair. The chair has a molded frame that comes in about 4pieces along with a contoured fabric seat. The chairs can beretailed in a set with a table or sold separately. They areextremely comfortable and lightweight.

Peter wanted to know the actual cost of manufacturing a singlechair. The following unit cost are identified. The total costs arebased on a normal annual volume of 40,000 chairs. The currentselling price of the chairs is $75 each.

Item	Costs/Unit	Costs/Unit	Total Costs
Materials
Main Frame	9.00		$360,000
Chair Arm	2 @ $1.75 = 3.50		140,000
Stand	4.50		180,000
Fabric Seat and Back	5.00		200,000
Related Supplies	2.00		80,000
Total Materials		$24.00	960,000
Labor
Fabric Labor	30 min @ $10 = 5.00		200,000
Assembly Labor	20 min @ $12 = 4.00		160,000
Total Labor		9.00	360,000
Fixed Overhead
Manufacturing	150% of Labor = 13.50		540,000
Administrative	25% of Material = 6.00		240,000
Total Fixed Overhead		19.50	780,000
Total Manufacturing Cost		$52.50	$2,100,000

Required: (please show your work)

1. If Schultz QualityFurniture sells all 40,000 chairs, how much will the company makeon the chairs?

2. If the company is ableto produce and sell 44,000 chairs, how much will the company makeon the chairs?

3. What is the marginalcost of making one additional chair?

4. During the off season,a special order for 3,000 chairs has come in from an overseesgovernment agency. However, because of the currency exchange rate,this company is only willing to pay $50.00 per chair, but Schultzwill have to pay a shipping and tariff cost of $5 per chair. ShouldSchultz Quality Furniture accept this order? How much money willthe company make or lose on this order?

5. The supplier whoprovides the special polymer material for the chairs has introduceda proposal to ship the chairs to Schultz fully assembled for $50.00per chair, which is less than the current manufacturing cost toSchultz of $52.50. All Schultz would have to do is send the chairsout to their customers. Should Schultz accept the offer? How muchmoney will the company make or lose on this offer?

6. The marketing managerbelieves that the customer base for chairs is pretty strong andthat a price increase to $80 per chair would only reduce demand by2,000 chairs. Should Schultz implement a price increase? If theactual price per chair were increased to $80, how far could theannual demand for chairs decline before Schultz would beindifferent between the $75 price and the $80 price?

7. What nonfinancialissues should be considered before decisions are made regarding theproduction and sale of these chairs?

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ACCO 340 Lecture Notes - Lecture 6: Adverse Selection, Insider Trading, Efficient-Market Hypothesis

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