Overview of the Financial System Part 2

44) An investor who puts all her funds into one asset ________ her portfolio's ________. A) increases; diversification B) decreases; diversification C) increases; average return D) decreases; average return Answer: B Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 45) Through risk-sharing activities, a financial intermediary ________ its own risk and ________ the risks of its customers. A) reduces; increases B) increases; reduces C) reduces; reduces D) increases; increases Answer: B Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 46) The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A) noncollateralized risk B) free-riding C) asymmetric information D) costly state verification Answer: C Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 47) When the lender and the borrower have different amounts of information regarding a transaction, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: A Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 11 48) When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: B Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 49) When the borrower engages in activities that make it less likely that the loan will be repaid, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: C Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 50) The concept of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets. B) why indirect finance is more important than direct finance as a source of business finance. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B of the above. E) only A and C of the above. Answer: D Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 51) Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) none of the above. Answer: A Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 12 52) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the A) moral hazard problem. B) adverse selection problem. C) shirking problem. D) free-rider problem. E) principal-agent problem. Answer: B Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 53) Successful financial intermediaries have higher earnings on their investments because they are better equipped than individuals to screen out good from bad risks, thereby reducing losses due to A) moral hazard. B) adverse selection. C) bad luck. D) financial panics. Answer: B Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 54) In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called A) comparative informational disadvantage. B) asymmetric information. C) variant information. D) caveat venditor. Answer: B Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 55) A ________ is when one party in a financial contract has incentives to act in its own interest rather than in the interests of the other party. A) moral hazard B) risk C) conflict of interest D) financial panic Answer: C Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 13 56) Fire and casualty insurance companies are what type of intermediary? A) Contractual savings institution B) Depository institutions C) Investment intermediaries D) None of the above Answer: A Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 57) Which of the following financial intermediaries are depository institutions? A) A savings and loan association B) A commercial bank C) A credit union D) All of the above E) Only A and C of the above Answer: D Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 58) Which of the following is a contractual savings institution? A) A life insurance company B) A credit union C) A savings and loan association D) A mutual fund Answer: A Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 59) The largest depository institution (value of assets) at the end of 2012 was A) commercial banks. B) pension funds. C) credit unions. D) mutual funds. Answer: A Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 60) Which of the following are not investment intermediaries? A) A life insurance company B) A pension fund C) A mutual fund D) Only A and B of the above Answer: D Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 14 61) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house. Answer: A Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 62) Which of the following are investment intermediaries? A) Finance companies B) Mutual funds C) Pension funds D) All of the above E) Only A and B of the above Answer: E Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 63) The government regulates financial markets for two main reasons: A) to ensure soundness of the financial system and to increase the information available to investors. B) to improve control of monetary policy and to increase the information available to investors. C) to ensure that financial intermediaries do not earn more than the normal rate of return and to improve control of monetary policy. D) to ensure soundness of financial intermediaries and to prevent financial intermediaries from earning less than the normal rate of return. Answer: A Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 64) Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a A) bank holiday. B) financial panic. C) financial disintermediation. D) financial collapse. Answer: B Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 15 65) Which of the following is not a regulator of part of the U.S. financial system? A) National Credit Union Administration B) Securities and Exchange Commission C) Federal Reserve System D) Federal Deposit Insurance Corporation E) All of the above are regulators. Answer: E Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 66) Asymmetric information can lead to the widespread collapse of financial intermediaries, referred as financial A) panic. B) bubble. C) asset. D) transaction. Answer: A Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 67) The SEC restricts trading by the largest stockholders (known as ________) in corporations issuing securities. A) insiders B) members of the board C) hedge funds D) intermediaries Answer: A Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 68) The Federal Deposit Insurance Corporation (FDIC) insures each depositor at a commercial bank, savings and loan association, or mutual savings bank up to a loss of ________ per account. A) $100,000 B) $250,000 C) $500,000 D) $1,000,000 Answer: B Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 16 69) The major differences between financial regulation in the United States and abroad relate to bank regulation. Specifically, in the past, the U.S. was the only industrialized country to subject banks to restrictions on A) branching. B) lending. C) assets they may hold. D) the size they could grow to. Answer: A Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 2.2 True/False 1) Every financial market allows loans to be made. Answer: FALSE Topic: Chapter 2.1 Function of Financial Markets Question Status: Previous Edition 2) Most people's involvement with the financial system is through financial intermediaries rather than financial markets. Answer: TRUE Topic: Chapter 2.1 Function of Financial Markets Question Status: Previous Edition 3) A critical function of financial markets is an efficient allocation of capital. Answer: TRUE Topic: Chapter 2.1 Function of Financial Markets Question Status: New Question 4) The New York Stock Exchange is an example of a primary market. Answer: FALSE Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 5) Equity represents an ownership interest in a firm and entitles the holder to the residual cash flows. Answer: TRUE Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 6) The capital market is a financial market in which only short-term debt instruments (generally those with an original maturity of less than one year) are traded. Answer: FALSE Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 17 7) Many common stocks are traded over the counter, although a majority of the largest corporations have their shares traded at organized stock exchanges. Answer: TRUE Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 8) Many common stocks are traded at organized exchanges, although a majority of the largest corporations have their shares traded over the counter. Answer: FALSE Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 9) Corporations that issue new securities to raise capital now conduct more of this business in financial markets in Europe and Asia than in the U.S. Answer: TRUE Topic: Chapter 2.3 Internationalization of Financial Markets Question Status: Previous Edition 10) Currently, over 80% of the new issues in the international bond market are Eurobonds. Answer: TRUE Topic: Chapter 2.3 Internationalization of Financial Markets Question Status: Previous Edition 11) American investors pay attention to only the Dow Jones Industrial Average. Answer: FALSE Topic: Chapter 2.3 Internationalization of Financial Markets Question Status: Previous Edition 12) A bond denominated in euros and issued in a country that uses the euro as its currency is an example of a Eurobond. Answer: FALSE Topic: Chapter 2.3 Internationalization of Financial Markets Question Status: Previous Edition 13) An example of direct financing is if you were to lend money to your neighbor. Answer: TRUE Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 14) Liquidity services are services that make it easier for customers to conduct financial transactions. Answer: TRUE Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: New Question 18 15) A financial intermediary's risk-sharing activities are also referred to as asset transformation. Answer: TRUE Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 16) The process of financial intermediation is also known as direct finance. Answer: FALSE Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 17) Through economies of scale, financial intermediaries can lower the cost of information production for each service by applying one information resource to many different services. Answer: FALSE Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: New Question 18) Adverse selection refers to those with high credit risks, being most aggressive in their search for funds. Answer: TRUE Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 19) A mutual fund is not a depository institution. Answer: TRUE Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 20) A pension fund is not a contractual savings institution. Answer: FALSE Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 21) "Thrift institutions" include savings and loan associations, mutual savings banks, and credit unions. Answer: TRUE Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: New Question 22) The government agency that insures each depositor at a commercial bank, savings and loan association, or mutual savings bank up to a loss of $100,000 per account ($250,000 for individual retirement accounts) is the Securities and Exchange Commission (SEC). Answer: FALSE Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 19 23) In the U.S., financial intermediaries are restricted in what they are allowed to do and what assets they can hold. Answer: TRUE Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 24) Unlike regulations in other countries, there are very few federal regulations governing who is allowed to set up a financial intermediary. Answer: FALSE Topic: Chapter 2.6 Regulation of the Financial System Question Status: Previous Edition 2.3 Essay 1) Distinguish between direct financing and indirect financing. Topic: Chapter 2.1 Function of Financial Markets Question Status: Previous Edition 2) Why is it so important for an economy to have fully developed financial markets? Topic: Chapter 2.1 Function of Financial Markets Question Status: Previous Edition 3) Distinguish between primary markets and secondary markets. Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 4) Distinguish between money markets and capital markets. Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 5) Describe how over-the-counter markets work. Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 6) What are some of the differences between an organized exchange and an over-the-counter market? Topic: Chapter 2.2 Structure of Financial Markets Question Status: Previous Edition 7) Why do corporations that issue new securities to raise capital now conduct more of this business in financial markets in Europe and Asia than in the United States? Topic: Chapter 2.3 Internationalization of Financial Markets Question Status: Previous Edition 20 8) What are some of the major foreign stock exchanges? Is following their returns important to U.S. investors? Why or why not? Topic: Chapter 2.3 Internationalization of Financial Markets Question Status: Previous Edition 9) Why are financial intermediaries so important to an economy? Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 10) What are adverse selection and moral hazard? Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 11) Why can a financial intermediary's risk-sharing activities be described as asset transformation? Topic: Chapter 2.4 Function of Financial Intermediaries: Indirect Finance Question Status: Previous Edition 12) Discuss the differences between depository institutions, contractual savings institutions, and investment intermediaries. Topic: Chapter 2.5 Types of Financial Intermediaries Question Status: Previous Edition 13) List some of the regulatory agencies of the U.S. and their primary role. Topic: Chapter 2.6 Regulation of the Financial System Question Status: New Question 21