The function of capital markets is to facilitate an exchange of funds

Question

The function of capital markets is to facilitate an exchange of funds among all participants, and yet in practice we find that certain participants are not on a par with others. Members of society have varying degrees of market strength in terms of information they bring to a transaction, as well as of purchasing power and creditworthiness, as defined by lenders.

For example, within minority communities, capital markets do not properly fulfill their functions; they do not provide access to the aggregate flow of funds in the United States. The financial system does not generate the credit or investment vehicles needed for underwriting economic development in minority areas. The problem underlying this dysfunction is found in a rationing mechanism affecting both the available alternatives for investment and the amount of financial resources. This creates a distributive mechanism penalizing members of minority groups because of their socioeconomic differences from others. The existing system expresses definite socially based investment preferences that result from the previous allocation of income and that influence the allocation of resources for the present and future. The system tends to increase the inequality of income distribution. And, in the United States economy, a greater inequality of income distribution leads to a greater concentration of capital in certain types of investment.

Most traditional financial-market analysis studies ignore financial markets’ deficiencies in allocation because of analysts’ inherent preferences for the simple model of perfect competition. Conventional financial analysis pays limited attention to issues of market structure and dynamics, relative costs of information, and problems of income distribution. Market participants are viewed as acting as entirely independent and homogeneous individuals with perfect foresight about capital-market behavior. Also, it is assumed that each individual in the community at large has the same access to the market and the same opportunity to transact and to express the preference appropriate to his or her individual interest.  Moreover, it is assumed that transaction costs for various types of financial instruments (stocks, bonds, etc.) are equally known and equally divided among all community members.    1 
 1. The main point made by the passage is that

(A) financial markets provide for an optimum allocation of resources among all competing participants by balancing supply and demand
(B) the allocation of financial resources takes place among separate individual participants, each of whom has access to the market
(C) the existence of certain factors adversely affecting members of minority groups shows that financial markets do not function as conventional theory says they function
(D) investments in minority communities can be made by the use of various alternative financial instruments, such as stocks and bonds
(E) since transaction costs for stocks, bonds, and other financial instruments are not equally apportioned among all minority-group members, the financial market is subject to criticism

2 
 2. The passage states that traditional studies of the financial market overlook imbalances in the allocation of financial resources because

(A) an optimum allocation of resources is the final result of competition among participants
(B) those performing the studies choose an oversimplified description of the influences on competition
(C) such imbalances do not appear in the statistics usually compiled to measure the market's behavior
(D) the analysts who study the market are unwilling to accept criticism of their methods as biased
(E) socioeconomic differences form the basis of a rationing mechanism that puts minority groups at a disadvantage

3 
 3. The author’s main point is argued by

(A) giving examples that support a conventional generalization
(B) showing that the view opposite to the author’s is self-contradictory
(C) criticizing the presuppositions of a proposed plan
(D) showing that omissions in a theoretical description make it inapplicable in certain cases
(E) demonstrating that an alternative hypothesis more closely fits the data

4 
 4. A difference in which of the following would be an example of inequality in transaction costs as alluded to in lines 40-43  Moreover, it is assumed that transaction costs for various types of financial instruments (stocks, bonds, etc.) are equally known and equally divided among all community members. ]?

(A) Maximum amounts of loans extended by a bank to businesses in different areas
(B) Fees charged to large and small investors for purchasing stocks
(C) Prices of similar goods offered in large and small stores in an area
(D) Stipends paid to different attorneys for preparing legal suits for damages
(E) Exchange rates in dollars for currencies of different countries

5 
 5. Which of the following can be inferred about minority communities on the basis of the passage?

(A) They provide a significant portion of the funds that become available for investment in the financial market. 
(B) They are penalized by the tax system, which increases the inequality of the distribution of income between investors and wage earners. 
(C) They do not receive the share of the amount of funds available for investment that would be expected according to traditional financial-market analysis. 
(D) They are not granted governmental subsidies to assist in underwriting the cost of economic development 
(E) They provide the same access to alternative sources of credit to finance businesses as do majority communities.

6 
 6. According to the passage, a questionable assumption of the conventional theory about the operation of financial markets is that

(A) creditworthiness as determined by lenders is a factor determining market access
(B) market structure and market dynamics depend on income distribution
(C) a scarcity of alternative sources of funds would result from taking socioeconomic factors into consideration
(D) those who engage in financial-market transactions are perfectly well informed about the market
(E) inequalities in income distribution are increased by the functioning of the financial market

7 
 7. According to the passage, analysts have conventionally tended to view those who participate in financial markets as

(A) judging investment preferences in terms of the good of society as a whole
(B) influencing the allocation of funds through prior ownership of certain kinds of assets
(C) varying in market power with respect to one another
(D) basing judgments about future events mainly on chance
(E) having equal opportunities to engage in transactions

TaN1213 · Accepted Answer

The entire passage talks about the injustice happening to the minority communities. Look for an option that stresses on this point.

276. The main point made by the passage is that

(A)  financial markets provide for an optimum allocation of resources among all competing participants by balancing supply and demand 
Opposite of what author thinks. Financial markets are being criticized here for not treating the minorities fairly.

(B)  the allocation of financial resources takes place among separate individual participants,   each of whom has access to the market  
passage excerpt : "it is assumed that each individual in the community at large has the same access to the market and the same opportunity to transact "

(C)  the existence of certain factors adversely affecting members of minority groups shows that financial markets do not function as conventional theory says they function 
Conventional theory supports the perfect model where everyone has equal access. But in reality the markets are not fair to the minorities, who do not have equal access.   Correct

(D)  investments in minority communities can be made by the use of various alternative financial instruments, such as stocks and bonds 
out of scope
(E)  since transaction costs for stocks, bonds, and other financial instruments are not equally apportioned among all minority-group members, the financial market is subject to criticism  
This is consistent as per passage but only discussed in last paragraph. So, this can not be the main point of the entire passage.

GMATNinja · Answer

Thanks  TaN1213  for the explanation!

Referring to the third paragraph, we are told that most traditional financial-market analysis studies ignore financial markets’ deficiencies in allocation. The second paragraph provides an example of such allocation deficiencies (i.e. those affecting members of minority groups).

The third paragraph then describes assumptions made by the conventional (i.e. traditional) financial analysis. Because of these assumption, the conventional analysis FAILS to address certain allocation deficiencies. For example, the conventional analysis assumes that all individuals have perfect foresight about capital-market behavior, the same access to the market, and the same opportunity to transact and to express the preference appropriate to their individual interests. The conventional analysis also assumes that transaction costs for various types of financial instruments (stocks, bonds, etc.) are equally known and equally divided among all community members.

In making these assumptions, the conventional analysis ignores certain deficiencies in allocation. These deficiencies, as described in the second paragraph, are factors that adversely affect members of minority groups. If the conventional analysis were accurate, the deficiencies described and the adverse effect on minority communities would not be present. However, the deficiencies DO exist, showing that financial markets do not function as conventional theory says they function.

Thanks again  TaN1213 ! Notice that the question says, "A   difference   in which of the following..." If the fees charged to large and small investors were DIFFERENT, it would represent an inequality in transaction costs.

The author's main point, as described in the explanation for 276, is that the existence of allocation deficiencies, such as those that adversely affect minority groups, shows that the conventional analysis is inaccurate. The conventional theory makes certain assumptions (as described in the third paragraph) and, as a result, FAILS to address certain allocation deficiencies. In other words, these allocation deficiencies are not accounted for in the conventional analysis (the conventional analysis IGNORES or OMITS these deficiencies). These omissions make the conventional theory inapplicable in cases where such deficiencies DO exist (i.e. in minority communities).

I hope that helps!

ShashankDave · Answer

All correct. Dense to read but questions were not that confusing. I do have problem with some questions because the elimination was difficult.

278. The author’s main point is argued by

(A) giving examples that support a conventional generalization
(D) showing that omissions in a theoretical description make it inapplicable in certain cases

How to eliminate (A)?

280. Which of the following can be inferred about minority communities on the basis of the passage?

(C) They do no receive the share of the amount of funds available for investment that would be expected according to traditional financial-market analysis. 
(D) They are not granted governmental subsidies to assist in underwriting the cost of economic development

How to eliminate (D)?

dave13 · Answer

Hi everyone

Can anyone shed some light on the question below. I could not answer the question correctly cause i simply couldnt find key information

So why B ? thank you!

279. A difference in which of the following would be an example of inequality in transaction costs as alluded to in lines 40-43 ? (A) Maximum amounts of loans extended by a bank to businesses in different areas (B) Fees charged to large and small investors for purchasing stocks (C) Prices of similar goods offered in large and small stores in an area (D) Stipends paid to different attorneys for preparing legal suits for damages (E) Exchange rates in dollars for currencies of different countries

TaN1213 · Answer

The question explicitly mentions the key you need to look for - financial instruments (stocks, bonds)
Since the answer choice needs to be an example of inequality in stocks or bonds, B can not get easier to spot. 
B rightly shows the inequality in large and small investors in terms of the fees charged while buying stocks.

sambit66 · Answer

I am unable to understand q278. The author???s main point can be found in line 1st para : 
The function of capital markets is to facilitate an exchange of funds among all participants, and yet in practice we find that certain participants are not on a par with others.

How is the Option (D) showing that omissions in a theoretical description make it inapplicable in certain cases related to author's main point. Please help.

Boomshockalocka · Answer

GMATNinja

Hi GMATNinja, could you please explain 278? I chose B but the answer is D.

For B, "The function of capital markets is to facilitate an exchange of funds among all participants, and yet in practice we find that certain participants are not on a par with others." this sentence indicates that the view opposite to the author's is self-contradictory. Doesn't it?

And I don't understand why D is correct. What is the intended "theoretical description"? And what are those "certain cases"?

Very appreciated!

GMATNinja · Answer

In this sentence, the author makes a statement (in practice, certain participants are not on par with others) which contradicts the opposing view. This is a case of one person (the author) contradicting another (anyone who believes conventional financial analysis). This is not a case of  self -contradiction, which would require the opposition to contradict their own logic or their own statements.

The "theoretical description" is that capital markets facilitate an exchange of funds among all participants. This is a conventional view of market participation, and the author disagrees with this conventional view because it omits many cases (i.e. minority communities) wherein capital markets fail to fulfill their functions.

Thinking about this structurally, we see that in the first paragraph, the author declares that the conventional theory about capital markets is inaccurate. In the second paragraph, the author shows cases that are omitted by this conventional theory, and therefore can't be explained by that theory. In the third paragraph, the author explains the assumptions that lead to these cases' being omitted during conventional analysis. This structure matches the language in choice (D), and since we've eliminated every other answer choice, (D) is our best answer.

I hope that helps!

Riya21 · Answer

Hi,

Can someone please explain q. 280? confused between options C and D. Also, question 282

GMATNinja · Answer

Question 5 (book question 280) 
 
The author begins the passage by arguing against the idea that capital markets "facilitate an exchange of funds among all participants," because some participants are at a disadvantage in these markets.

He/she then states that one group of disadvantaged participants are members of  minority communities.  How are these communities disadvantaged? According to the author, the capital markets:
  do not provide minority communities with access to the "aggregate flow of funds," and  
 do not generate credit or investment pathways to fund economic development in minority communities

One  underlying reason  for this dysfunction is that minority communities have a limited amount of financial resources. And finally, one the  effect  of this disadvantage is that it increases income inequality, which in turn makes capital more concentrated in certain types of investment.

Let's take a look at the evidence for (D): 
 
From the above analysis, we know that the  capital market  does not generate credit or investment vehicles to fund economic development in minority communities. However, we are not given any information to confirm whether the government provides  subsidies  to fill this gap. Because we have no idea whether minorities are granted government subsidies, we cannot infer (D). Eliminate this answer choice.

Take a look at (C):
 
That's a long answer choice! (C) tells us that minority communities do not have access to an "expected" amount of funds for investment.

In the last paragraph of the passage, we are told that traditional market analysis studies assume that "each individual in the community at large has  the same  access to the market and the same opportunity to transact and to express the preference appropriate to his or her individual interest."

However, the author argues  against  this notion by stating that capital markets do not provide minority communities access to the flow of fund in the United States.

Because traditional analyses predict equal access to funds, and the funds of minority communities do not have access to the flow of funds, we can infer that these communities do not have access to the "expected" amount of funds for investment.

(C) is the correct answer to question #5.

Question 7 (book question 282) 
 
The author lays out the views of traditional (or conventional) analysts in the last paragraph of the passage. These analysts
  pay little attention to the issues discussed in the preceding paragraph -- namely, how the structure of the market and unequal income distribution impact market activity 
 view people as independent and homogeneous (or identical to one another), and 
 assume that all participants have equal opportunities to transact in the marketplace

This last bullet fits well with (E):
 
(E) is the correct answer to question #7.

I hope that helps!

unraveled · Answer

Para-1: Summary - Author talks about Capital Markets’ function sort of an ideal in nature but it’s not and gives a reason for that.

Para-2: Summary – Author continues his/her idea about the reason behind the shortcoming of function by giving an example. The example takes minority communities into consideration and enumerates what, how and why of the problem. He/she mentions that financial system does not create enough ways so that investment can be generated and gives another reason behind that i.e. rationing system. Thus, existing system is followed which is flawed in itself further increasing the inequality gap thus leading to non-uniform distribution of capital.

Para-3: Summary – In this para author refers to analysis of markets. He/she mentions that studies in general ignore the shortcomings and pay little attention to actors actually affecting capital market and makes assumption that every individual has perfect knowledge of the capital market and has same access/opportunities.

Overall Summary – Capital markets don’t work as they should. They make certain assumptions leading to non uniformity in the market i.e. certain pockets are left out.

1.
276. The main point made by the passage is that

(A) financial markets provide for an optimum allocation of resources among all competing participants by balancing supply and demand – WRONG. Nowhere it is mentioned in the passage that allocation is optimum.
(B) the allocation of financial resources takes place among separate individual participants, each of whom has access to the market – WRONG. Even if this is true it only pertains to a part of the passage
(C) the existence of certain factors adversely affecting members of minority groups shows that financial markets do not function as conventional theory says they function – CORRECT. This matches our summary.
(D) investments in minority communities can be made by the use of various alternative financial instruments, such as stocks and bonds – WRONG. The option covers only a part of scope of passage.
(E) since transaction costs for stocks, bonds, and other financial instruments are not equally apportioned among all minority-group members, the financial market is subject to criticism – WRONG. ‘Apportioned equally among all minority group’s subtly changed from all community members. Covers only a part of scope of passage even if true.

2.
277. The passage states that traditional studies of the financial market overlook imbalances in the allocation of financial resources because

(A) an optimum allocation of resources is the final result of competition among participants – WRONG. If this is true it is causaly wrong.
(B) those performing the studies choose an oversimplified description of the influences on competition – CORRECT. Refer para 3 second line “analysts’ inherent preferences” for the simple model’.
(C) such imbalances do not appear in the statistics usually compiled to measure the market's behavior. – WRONG. No mentioned anywhere in the passage.
(D) the analysts who study the market are unwilling to accept criticism of their methods as biased – WRONG. No mentioned anywhere in the passage.
(E) socioeconomic differences form the basis of a rationing mechanism that puts minority groups at a disadvantage – WRONG. Might be true but this is not the reason behind overlooking.

3.
278. The author’s main point is argued by

(A) giving examples that support a conventional generalization – WRONG. Author is not supporting anything conventional.
(B) showing that the view opposite to the author’s is self-contradictory – WRONG. Opposite view not mentioned anywhere in the passage.
(C) criticizing the presuppositions of a proposed plan – WRONG. Irrelevant.
(D) showing that omissions in a theoretical description make it inapplicable in certain cases – CORRECT. A model with assumptions as proposed by analyst might not work actually n real life.
(E) demonstrating that an alternative hypothesis more closely fits the data – WRONG. Alternative hypothesis is not mentioned anywhere in the passage.

4.
279. A difference in which of the following would be an example of inequality in transaction costs as alluded to in lines 40-43 [Moreover, it is assumed that transaction costs for various types of financial instruments (stocks, bonds, etc.) are equally known and equally divided among all community members.]?

(A) Maximum amounts of loans extended by a bank to businesses in different areas – WRONG. Loans’ amount may vary as much as possible depending on the scale of business.
(B) Fees charged to large and small investors for purchasing stocks – CORRECT. Though this might look straight forward and leads to doubting this option this is correct in the sense that for a single transaction between a large and a small investor both should be charged same. Buying both stocks and bonds then both should be charged same amount. Any difference in the charges would lead to inequality.
(C) Prices of similar goods offered in large and small stores in an area – WRONG. Prices may vary depending on the cost entailed by the stores which customer must be known off.
(D) Stipends paid to different attorneys for preparing legal suits for damages – WRONG. Stipends may differ in that an experienced attorney might have huge compared to a relatively newbie.
(E) Exchange rates in dollars for currencies of different countries – WRONG. Rates may vary for different reasons so can’t be treated as inequality.

5.
280. Which of the following can be inferred about minority communities on the basis of the passage?

(A) They provide a significant portion of the funds that become available for investment in the financial market. – WRONG. Significant proportion is neither mentioned nor can be inferred from the passage.
(B) They are penalized by the tax system, which increases the inequality of the distribution of income between investors and wage earners. – WRONG. This one is closest of being right answer for simply using word penalized but a closer look and understanding shows that it changes the meaning of the passage.
(C) They do not receive the share of the amount of funds available for investment that would be expected according to traditional financial-market analysis. – CORRECT. Since the passage is about inequality among communities this makes sense.
(D) They are not granted governmental subsidies to assist in underwriting the cost of economic development – WRONG. Govt. granting subsidies to minority communities can’t be inferred rather a rationing mechanism is referred here which causes further problems.
(E) They provide the same access to alternative sources of credit to finance businesses as do majority communities. – WRONG. Exactly opposite to what is discussed in the passage even if it is true.

6.
281. According to the passage, a questionable assumption of the conventional theory about the operation of financial markets is that

(A) creditworthiness as determined by lenders is a factor determining market access – WRONG. Creditworthiness is nowhere mentioned in the passage.
(B) market structure and market dynamics depend on income distribution – WRONG. Exactly opposite to what is discussed in the passage.
(C) a scarcity of alternative sources of funds would result from taking socioeconomic factors into consideration – WRONG. Incorrect causual relationship.
(D) those who engage in financial-market transactions are perfectly well informed about the market – CORRECT. Refer para 3 where it is mentioned that every individual has equal access and opportunity in the market which is actually not the case in reality.
(E) inequalities in income distribution are increased by the functioning of the financial market – WRONG. Not an assumption made anywhere rather existing system increases inequalities. Refer Para 2.

7.
282. According to the passage, analysts have conventionally tended to view those who participate in financial markets as

(A) judging investment preferences in terms of the good of society as a whole – WRONG. Irrelevant.
(B) influencing the allocation of funds through prior ownership of certain kinds of assets – WRONG. Irrelevant.
(C) varying in market power with respect to one another – WRONG. Close but passage clearly mentions that every individual has equal access and opportunity.
(D) basing judgments about future events mainly on chance – WRONG. Irrelevant.
(E) having equal opportunities to engage in transactions – CORRECT. Refer para 3.

Completed in 11:36 min. All correct.
I could not believe myself since my RC is not good.

devavrat · Answer

Hi, 
in question 278 i marked option C 
Can someone pls explain why option D is better than option C

Does the author  criticize  the presupposition of the proposed plan or does he show the  omissions ?

GMATNinja · Answer

As I've explained here  — including a full explanation for why we keep choice (D) — the author's main point in this passage is that a conventional view of market participation and the function of capital markets is inaccurate.

This question asks: How does the author argue this point?

If (C) were true, we'd expect to see the author identify a  proposed plan  and then criticize that plan's presuppositions.

However,  there's no evidence of a "proposed plan"  in this passage.

The author describes how traditional financial analysis ignores important issues and deficiencies. But traditional analysis and conventional wisdom are  not  the same as a "proposed plan."

Choice (C) doesn't match up with the passage, so we can eliminate it and move on.

I hope this helps!

psls · Answer

Hi  GMATNinja   egmat   BrightOutlookJenn  ,and others are welcome,

I don't understand why Question 278 asks by using passive voice.
 
This passive voice question seems like asking which choice opposes the author’s main point.
While choice(D) seems like supporting the author's main point that omissions in a theoretical description make it inapplicable in minority communities.

Please clarify my understanding.

BrightOutlookJenn · Answer

Hi  TorGmatGod

Thanks for the tag and question.

Yes, it sounds like you are having a misunderstanding of   argue   here. I think you are including the word or the idea of "against" when you are reading this question.

A person can argue FOR something or AGAINST it. Let's use retaking the GMAT as an example ...

1. She argued for retaking the GMAT.  (She was in favor of retaking the exam) 
2. She argued against retaking the GMAT.  (She was against a retake.) 
3. She argued that the GMAT should be retaken.  (Same meaning as #1, just with a passive construction.)

Let's get this example closer to the question you are considering ...
4. Her main point was that you should retake the GMAT. She argued this point by giving statistics about the average improvement in scores on second attempts.

What does the second sentence in #4 mean?  She argued this point  =  She supported this idea 
 ... and then it goes on to say  how  she supported the idea.

We could make the second sentence in #4 passive and it would be close to the form of Question 278: 
5.  Her point was argued by  giving statistics about the average improvement in scores on second attempts.

(Note that I haven't changed the meaning from #4 to #5; I just switched from active voice to passive voice.)

Question #278 is asking  how the author  supported  their main point .

Does this help? Please let us know.

Prachita123 · Answer

GMATNinja  
Q278... the main point is argued by
I assumed we need to weaken the author's main point. 
Does "argued by" supported by?

Also can you explain in Q280, why C is the right choice.

Thank you in advance.

GMATNinja · Answer

Question 3 (or 278) 
 
Question 3 (or book question 278) is asking us  how  the author argues his/her point. In other words, how does the author make his/her case? So, we don't have to weaken or support the argument -- instead, we have to find the answer choice that best describes the author's way of reaching his/her main point.

In this case, the author argues his/her point by showing that traditional models don't account for imperfections and inequalities in a capitalist marketplace. That's best captured by (D), which is the correct answer to question 3.

For what it's worth: this is a pretty old question, and I can't think of any newer ones that use phrasing like this. So, don't worry too much about this exact issue.

Question 5 (or 280) 
 
The author's overall point is that capital markets aren't perfect, because certain minority groups don't have equal access to information and funds. This is most clearly stated at the beginning of the second paragraph: "Within minority communities, capital markets do not properly fulfill their functions; they do not provide access to the aggregate flow of funds in the United States."

The author goes on to say that "traditional" studies ignore this issue by assuming that "that each individual in the community at large has the same access to the market and the same opportunity to transact and to express the preference appropriate to his or her individual interest." The author's evidence goes  against  this assumption.

From this, we can infer the information in (C):
 
Traditional analyses assume that everyone has equal access, but the evidence in the passage shows otherwise.

(C) is the correct answer to question 5.

I hope that helps!

agrasan · Answer

Hi experts  KarishmaB   GMATNinja   DmitryFarber

277. The passage states that traditional studies of the financial market overlook imbalances in the allocation of financial resources because

(A) an optimum allocation of resources is the final result of competition among participants

In question 277, can we say that option A is wrong as there is  no such causal relationship  given in the passage?

If we look at the relevant lines  "Most traditional financial-market analysis studies ignore financial markets' deficiencies in allocation because of analysts' inherent preferences for the simple model of perfect competition." ,  we don't see anything indicating on:

Competition among participants --> Optimum allocation of resources

Please let me know if my thought process is faltering somewhere.

DmitryFarberMPrep · Answer

That's right. The rest of the passage gives us an outline of the kind of complications that prevent "perfect competition" in real life. It's not about the perfect ("optimum") allocation of resources. It's the ability for everyone to compete equally with full access to the necessary resources and information. Since that doesn't exist, academics are oversimplifying the actual situation.

The function of capital markets is to facilitate an exchange of funds

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GMAT Reading Comprehension (RC) Questions

The function of capital markets is to facilitate an exchange of funds

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