THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 343

CHAPTER 12
6. Private equity funds make long-term investments in
companies that are not traded publicly and are of
two types: venture capital funds, which make investments in startups, and capital buyout funds, which
make investments in established companies, often
taking publicly traded firms private.

Nonbank Financial Institutions

311

federally sponsored agencies that function as private
corporations with close ties to the government.
Because the government provides an implicit guarantee for GSE debt, market discipline to limit excessive risk-taking by GSEs is weak. The resulting moral
hazard problem has led to major taxpayer bailouts,
especially the recent bailout of Fannie Mae and
Freddie Mac, which involved US$200 billion of government funds.

7. To provide credit to residential housing and agriculture, the U.S. government has created a number of
government agencies. Particularly important are government-sponsored enterprises (GSEs), which are

KEY TERMS
government-sponsored enterprises
(GSE), p. 308

permanent life insurance, p. 289

brokerage firms, p. 301
carried interest, p. 307

group life insurance, p. 289

private equity fund, p. 307

capital buyout fund, p. 307

hedge fund, p. 305

private pension plans, p. 297

closed-end fund, p. 303

individual life insurance, p. 289

reinsurance, p. 291

credit default swap (CDS), p. 291

institutional investors, p. 303

seasoned issue, p. 300

deductible, p. 295

leveraged buyout (LBO), p. 307

sovereign wealth funds, p. 303

defined-benefit plan, p. 296

load funds, p. 303

specialist, p. 302

defined-contribution plan, p. 296

monoline insurance companies,
p. 291

temporary life insurance, p. 290

annuities, p. 290

demutualization, p. 289
endowment insurance, p. 290
fully funded, p. 296

no-load funds, p. 303
open-end fund, p. 303

personal pension plans, p. 299

underfunded, p. 296
underwriters, p. 301
venture capital funds, p. 307

QUESTIONS
You will find the answers to the questions marked with
an asterisk in the Textbook Resources section of your
MyEconLab.
*1. If death rates were to become less predictable than

they are, how would life insurance companies
change the types of assets they hold?
2. Why do property and casualty insurance companies
have large holdings of liquid assets but life insurance companies do not?
*3. Why are all defined contribution pension plans fully
funded?

8. Why are restrictive provisions a necessary part of
insurance policies?
*9. If you needed to take out a loan, why might you
first go to your local bank rather than to a finance
company?
10. Explain why shares in closed-end mutual funds typically sell for less than the market value of the stocks
they hold.
*11. Why might you buy a no-load mutual fund instead
of a load fund?

4. How can favourable tax treatment of pension plans
encourage saving?

12. Why can a money market mutual fund allow its
shareholders to redeem shares at a fixed price but
other mutual funds cannot?

*5. In contrast to private pension plans, government
pension plans are rarely underfunded. Is this statement true, false, or uncertain? Explain your answer.

*13. Why might government loan guarantees be a highcost way for the government to subsidize certain
activities?

6. What explains the widespread use of deductibles in
insurance policies?

14. If you like to take risks, would you rather be a
dealer, a broker, or a specialist? Why?

*7. Why might insurance companies restrict the amount
of insurance a policyholder can buy?

*15. Is investment banking a good career for someone
who is afraid of taking risks? Why or why not?