Assigment 1

Problem 1
a)
“The fact that firms so heavily rely on their internal capital market as a source of financing is strong evidence that internal markets are more efficient than external markets.” Firms use internal capital because it is much easier for managers to use profits from previous years to finance their investments, management don´t have to prove their investment decisions to investors. If management would need to finance investment with external capital, the cost of the capital would much higher than using internal capital. Issues would cause direct costs for (järjestämisestä) and take time and effort from the management. Indirect costs could also (accure) when management would need to underprice the issue to make sure it would succeed.

Firms rely on their internal capital because it is easier and cheaper way to finance investments. It does not mean that external markets are more unefficent than internal and the (väite) is false.

b)
“When underwriting equity or bond issues, investment banks are merely acting as financial intermediaries without taking any risk of their own. Therefore, they are charging unrealistically high fees for their services.”

Underwriters act in three different roles. Firstly, they provide financial advisory and make careful analysis what the issue is likely to be worth. Underwriters also have dialogies with the potential investors to find out how high the demand is with different prices. Secondly, underwriters will buy the issue and carry the market risk. Thirdly, underwriters reoffer the issue to the public. If there is not enough demand with the selected price underwriters will cause the losses.

The reason why underwriters charges ”high fees” for their services is that they carry all the risks that is involved with the issue. Underwriters put also their reputation on the line because they will need