ECON 131 CH 2

Equity and debt instruments with maturities greater than one year are called ___ market instruments.

Capital

Equity instruments are traded in the ___ market.

Capital

A short-term debt instrument issued by well-known corporations is called

Commercial paper

Which of the following instruments are traded in a money market?

Commercial paper

Adverse selection is a problem associated with equity and debt contracts arising from

The lender's relative lack of information about the borrower's potential returns and risks of his investment activities

Which of the following statements about financial markets and securities is TRUE?

The maturity of a debt instrument is the number of years(term) to that instrument's expiration date.

When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called an

exchange

A liquid asset

is an asset that can easily and quickly be sold to raise cash

Thrift institutions include

savings and loan associations, mutual savings banks, and credit unions.

Every financial market has the following characteristic:

It channels funds from lenders-savers to borrowers-spenders

Describe the two methods of organizing a secondary market.

1) Where buyers and sellers meet in one central location to conduct trades like the NYSE 2) Over-the-counter market, where dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices like federal funds market.

Long term debt has a maturity that is

10+ years

Which of the following is an example of an intermediate-term debt?

A 60 month car loan

Which of the following is a long-term financial instrument?

A U.S. treasury bond

A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called

A certificate of deposit

Which of the following instruments are traded in a capital market?

A corporate bond

Which of the following can be described as indirect finance?

A corporation issues new shares of stock

Which of the following is a depository institution?

A credit union

Which of the following financial intermediaries is NOT a depository institution?

A finance company

Distinguish between a foreign bond and a Eurobond.

A foreign bond is sold in a foreign country and priced in that country's currency. A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency.

Which of the following is a contractual savings institution?

A life insurance company

Which of the following is a depository institution?

A mutual savings bank

Which of the following are short-term financial instruments?

A repurchase agreement

If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of

Adverse selection

Because there is an imbalance of information in a lending situation, we must deal with the problems of adverse selection and moral hazard. Define these terms and explain how financial intermediaries can reduce these problems.

Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately. Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower.

Increasing the amount of information available to investors helps to reduce the problems of ________ and ________ in the financial markets.

Adverse selection; moral hazard

The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________.

Adverse selection; moral hazard

Well-functioning financial markets

Allow the economy to operate more efficiently

Collateral is ________ the lender receives if the borrower does not pay back the loan.

Asset

Securities are ___ for the person who buys them, but are ___ for the individual or firm that issues them.

Assets; liabilities

A goal of the Securities and Exchange Commission is to reduce problems arising from

Asymmetric information

Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. The difference in information is called

Asymmetric information

___ work in the secondary markets matching buyers with sellers of securities.

Brokers

U.S. Treasury bills are considered the safest of all money market instruments because there is a low probability of

Default

Financial institutions that accept deposits and make loans are called ________ institutions.

Depository

The primary liabilities of a commercial bank are

Deposits

With ___ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.

Direct

U.S. Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower purchase price than the amount you receive at maturity.

Discount

Reducing risk through the purchase of assets whose returns do not always move together is

Diversification

If Microsoft sells a bond in London and it is denominated in dollars, the bond is a

Eurobond

Bonds that are sold in a foreign country and are denominated in a currency OTHER than that of the country in which it is sold are known as

Eurobonds

US dollar deposits in foreign banks outside the US or in foreign branches of US banks are called

Eurodollars

The regulatory agency that sets reserve requirements for all banks is

Federal Reserve System

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from

Financial intermediaries

In the United States, loans from ________ are far ________ important for corporate finance than are securities markets.

Financial intermediaries; more

If Toyota sells a $1000 bond in the United States, the bond is a

Foreign bond

Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as

Foreign bonds

Financial markets have the basic function of

Getting people with no funds to lend together with people who want to borrow funds

Which of the following is NOT a secondary market?

IPO market

The purpose of the disclosure requirements of the Securities and Exchange Commission is to

Increase the info available to investors

One reason for extraordinary growth of foreign financial markets is

Increases in the pool of savings in foreign countries

An important financial institution that assists in the initial sale of securities in the primary market is the

Investment bank

Secondary markets make financial instruments more

Liquid

Federal funds are

Loans made by banks to each other

Risk sharing is profitable for financial institutions due to

Low transaction costs

An important function of secondary markets is to

Make it easier to sell financial instruments to raise funds

Which of the following statements about financial markets and securities is TRUE?

Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as NYSE.

A financial market in which only short-term debt instruments are traded is called the ___ market.

Money

Because these securities are more liquid and generally have smaller price fluctuations, corporations and banks use the ___ securities to earn interest on temporary surplus funds.

Money market

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.

Moral hazard

Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services.

Moral hazard

The higher a security's price in the secondary market the ___ funds a firm can raise by selling securities in the ___ market.

More; primary

Bonds issues by state and local governments are called ___ bonds.

Municipal

Which of the following are investment intermediaries?

Mutual funds

An important source of short-term funds for commercial banks are ________ which can be resold on the secondary market.

Negotiable CDs

In a(n) ___ market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices.

Over-the-counter

In order to reduce risk and increase the safety of financial institutions, commercial banks and other depository institutions are prohibited from

Owning common stock

Which of the following can be described as indirect finance?

People buy shares in a mutual fund

A corporation acquires new funds only when its securities are sold in the

Primary market by an investment bank

Economies of scale enable financial institutions to

Reduce transaction costs

How do regulators help to ensure the soundness of financial intermediaries?

Regulators restrict who can set up a financial intermediary, conduct regular examinations, restrict assets, and provide insurance to help ensure the soundness of financial intermediaries.

Which of the following are NOT traded in a capital market?

Repurchase agreements

Which of the following instruments is NOT traded in a money market?

Residential mortgages

Equity holders are a corporation's ___. That means the corporation must pay all of its debt holders before it pays its equity holders.

Residual claimants

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as

Risk sharing

The process of asset transformation refers to the conversion of

Risky assets into safer assets

With direct finance, funds are channeled through the financial market from the ___ directly to the ___.

Savers; spenders

A financial market in which previously issued securities can be resold is called a ________ market.

Secondary

Benefits directly from any increase in the corporation's profitability:

Shareholder

If the maturity of a debt instrument is less than one year, the debt is called

Short-term

When I purchase ___, I own a portion of a firm and have the right to vote on issues important.

Stock

Corporations receive funds when their stock is sold in the primary market. Why do corporations pay attention to what is happening to their stock in the secondary market?

The existence of the secondary market makes their stock more liquid and the price in the secondary market sets the price that the corporation would receive if they choose to sell more stock in the primary market.

Prices of money market instruments undergo the least price fluctuations because of

The short terms to maturity for the securities

Financial markets improve economic welfare because

They allow consumers to time their purchase better

Which of the following statements about the characteristics of debt and equity is FALSE?

They can be both short-term financial instruments

Which of the following statements about the characteristics of debt and equity is TRUE?

They can both be long-term financial instruments

Government regulations to reduce the possibility of financial panic include all of the following EXCEPT

Transaction costs

The time and money spent in carrying out financial transactions are called

Transaction costs

Which of the following instruments are traded in a capital market?

U.S. government agency securities

Which of the following instruments are traded in a money market?

U.S. treasury bills

The most liquid securities traded in the capital market are

U.S. treasury bonds

Equity of US companies can be purchased by

US citizens and foreign citizens

When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public.

Underwrites

An investment bank purchases securities from a corporation at a predetermined price and then resells them in the market. This process is called

Underwriting

Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in the United States?

With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in the U.S.

Which of the following can be described as direct finance?

You borrow $2500 from a friend.

Which of the following can be described as indirect finance?

You buy shares in a mutual fund

Which of the following can be described as indirect finance?

You make a deposit at a bank