Ch 7

72) A conflict of interest between providing impartial research about companies issuing securities and selling those same securities arises in A) investment banking. B) commercial banking. C) accounting firms. D) mutual funds.

A) investment banking.

3) One reason why indirect financing is used is to minimize adverse selection problems.

Answer: TRUE

60) The free-rider problem A) occurs when people who do not pay for information take advantage of the information other people have to pay for. B) suggests that the private sale of information will only be a partial solution to the lemons problem. C) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. D) all of the above.

D) all of the above.

25) The problem of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B) why collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B of the above.

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets.

6) The concept of adverse selection helps to explain why indirect finance is more important than direct finance as a source of business finance.

Answer: TRUE

9) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it makes debt contracts incentive compatible.

Answer: TRUE

80) The conflict of interest in credit-rating agencies arises because ________ pay to have securities rated and, as a result, the agencies' ratings may be biased ________. A) security issuers; downward B) security issuers; upward C) investors; downward D) regulators; upward

B) security issuers; upward

1) Of the following sources of external finance for American nonfinancial businesses, the least important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) nonbank loans.

B) stocks.

32) An audit certifies that A) a firm's loans will be repaid. B) a firm's securities are safe investments. C) a firm abides by standard accounting principles. D) the information reported in a firm's accounting statements is correct.

C) a firm abides by standard accounting principles.

20) Moral hazard is a problem associated with debt and equity contracts arising from A) the borrower's incentive to undertake highly risky investments. B) the owners' inability to ensure that managers will act in the owners' interest. C) the difficulty lenders have in sorting out good credit risks from bad credit risks. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

43) Because managers (________) have less incentive to maximize profits than the stockholders-owners (________) do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities. A) principals; agents B) principals; principals C) agents; agents D) agents; principals

D) agents; principals

87) China is in an early state of development, with a per capita income that is still less than ________, one-fifth of the per capita income in the United States. A) $5,000 B) $10,000 C) $25,000 D) $50,000

B) $10,000

53) A debt contract that specifies that the company can only use the funds to finance certain activities A) is a private loan. B) contains a restrictive covenant. C) increases the problem of adverse selection. D) all of the above. E) only A and B of the above.

B) contains a restrictive covenant.

76) Investment banks serve two client groups, A) home buyers and mortgage lenders. B) people saving for retirement and pension funds. C) issuers of securities and investors in those securities. D) mutual funds and investors with relatively small amounts to invest.

C) issuers of securities and investors in those securities.

35) The pecking order hypothesis predicts that the ________ a corporation is, the more likely it will be to ________. A) smaller and less well known; issue securities B) larger and more well known; borrow from financial intermediaries C) larger and more well known; issue securities D) smaller and less well known; need external financing

C) larger and more well known; issue securities

14) If borrowers take on big risks after obtaining a loan, then lenders face the problem of A) free-riding. B) adverse selection. C) moral hazard. D) costly state verification.

C) moral hazard.

16) In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will A) reflect the highest quality of used cars in the market. B) reflect the lowest quality of used cars in the market. C) reflect the average quality of used cars in the market. D) none of the above.

C) reflect the average quality of used cars in the market.

5) Because of the adverse selection problem, lenders may refuse loans to individuals with low net worth.

Answer: TRUE

8) The concept of adverse selection helps explain why collateral is an important feature of many debt contracts.

Answer: TRUE

74) Spinning is the practice of A) investment banks allowing executives of potential client companies to buy underpriced initial public offerings of other companies' securities. B) investment bank analysts providing misleading information about a company to encourage more investors to purchase the company's securities. C) accounting firms encouraging its audit clients to also purchase its management advisory services. D) credit rating agencies providing higher ratings on a company's securities in order to develop a long-term relationship with the company.

A) investment banks allowing executives of potential client companies to buy underpriced initial public offerings of other companies' securities.

36) Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily A) make private loans. B) acquire a diversified portfolio of stocks. C) buy junk bonds. D) do a balanced combination of A and B of the above.

A) make private loans.

40) Commercial and farm mortgages, in which property is pledged as collateral, account for A) one-quarter of borrowing by nonfinancial businesses. B) one-half of borrowing by nonfinancial businesses. C) one-twentieth of borrowing by nonfinancial businesses. D) two-thirds of borrowing by nonfinancial businesses.

A) one-quarter of borrowing by nonfinancial businesses.

34) The authors' analysis of adverse selection indicates that financial intermediaries A) overcome free-rider problems by holding nontraded loans. B) must buy securities from corporations to diversify the risk that results from holding nontradable loans. C) have not been very successful in dealing with adverse selection problems in financial markets. D) do all of the above. E) do only A and B of the above.

A) overcome free-rider problems by holding nontraded loans.

42) Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. A) principal-agent B) adverse selection C) free-rider D) debt deflation

A) principal-agent

65) The problem with monitoring as a tool to solve the ________ problem is that it can be expensive in terms of time and money, as reflected in the name economists give it,costly state verification. A) principal-agent B) adverse selection C) audit D) regulation

A) principal-agent

50) A debt contract is said to be incentive compatible if A) the borrower's net worth reduces the probability of moral hazard. B) restrictive covenants limit the type of activities that can be undertaken by the borrower. C) both A and B of the above occur. D) neither A nor B of the above occur.

A) the borrower's net worth reduces the probability of moral hazard.

30) A key finding of the economic analysis of financial structure is that A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. B) while free-rider problems limit the extent to which securities markets finance some business activities, the majority of funds going to businesses are channeled through securities markets. C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. D) economists do not have a very good explanation for why securities markets are so heavily regulated

A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses.

26) When an accounting firm conducts an independent audit, the accounting firms certify that A) the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings. B) the firm is adhering to federal regulations with regard to product safety, hiring practices, and environmental regulations. C) the firm's management is qualified to conduct the firm's business in the best interest of share holders. D) All of the above are correct answers.

A) the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings.

19) 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.

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

46) One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the A) venture capital firm. B) money market mutual fund. C) pawn broker. D) savings and loan association.

A) venture capital firm.

17) The Sarbanes-Oxley Act of 2002 was passed in response to scandals in the investment banking industry.

Answer: FALSE

18) The Sarbanes-Oxley Act of 2002 provides for oversight of accounting firms but makes no provisions for increasing the flow of information to financial markets.

Answer: FALSE

14) The financial system is one of the most heavily regulated sectors of the economy.

Answer: TRUE

15) Collateralized debt is also called secured debt.

Answer: TRUE

16) Most legal work in the U.S. involves the writing and enforcement of contracts, not ambulance chasing, criminal law, and frivolous lawsuits.

Answer: TRUE

19) The Sarbanes-Oxley Act of 2002 and the Global Legal Settlement of 2002 both have the potential to reduce economies of scope.

Answer: TRUE

20) The Global Legal Settlement of 2002 arose out of a lawsuit brought by New York Attorney General Eliot Spitzer against the ten largest investment banks.

Answer: TRUE

21) The Sarbanes-Oxley Act of 2002 established a Public Company Accounting Oversight Board (PCAOB), overseen by the SEC, to supervise accounting firms and ensure that audits are independent and controlled for quality.

Answer: TRUE

22) Due to criticisms of rating agencies following the default of many subprime products, the SEC prohibited credit rating agencies from structuring the same products that they rate.

Answer: TRUE

23) China is in an early state of development, with a per capita income that is still less than $10,000, one-fifth of the per capita income in the United States.

Answer: TRUE

12) (I) The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II) Financial intermediaries facilitate diversification when an investor has only a small sum to invest. A) (I) is true; (II) false. B) (I) is false; (II) true. C) Both (I) and (II) are true. D) Both (I) and (II) are false.

B) (I) is false; (II) true.

9) Which of the following is not one of the eight basic facts about financial structure? A) The financial system is among the most heavily regulated sectors of the economy. B) Issuing marketable securities is the primary way businesses finance their operations. C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance in which businesses raise funds directly from lenders in financial markets. D) Financial intermediaries is the most important source of external funds to finance businesses.

B) Issuing marketable securities is the primary way businesses finance their operations.

83) The Sarbanes-Oxley Act of 2002 dealt with conflicts of interest in A) investment banks. B) accounting firms. C) credit-rating agencies. D) all of the above.

B) accounting firms.

13) 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 A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification

B) adverse selection.

28) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. B) are able to prevent potential competitors from free-riding off the information that they provide. C) have failed to solve adverse selection problems in this market because "lemons" continue to be traded. D) do all of the above.

B) are able to prevent potential competitors from free-riding off the information that they provide.

18) A borrower who takes out a loan usually has better information about the potential returns and risks of the investment projects he plans to undertake than the lender does. This inequality of information is called A) moral hazard. B) asymmetric information. C) noncollateralized risk. D) adverse selection.

B) asymmetric information.

59) Adverse selection A) is a problem created by asymmetrical information after the transaction. B) can be solved by eliminating asymmetrical information. C) occurs when people who do not pay for information take advantage of the information other people have to pay for. D) all of the above.

B) can be solved by eliminating asymmetrical information.

57) Economies of scale A) in the financial markets does not explain why financial intermediaries developed and have become such an important part of our financial structure. B) can be used to an advantage by reducing transaction cost. C) both A and B of the above. D) neither A nor B of the above.

B) can be used to an advantage by reducing transaction cost.

15) Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________. A) low; moral hazard B) low; adverse selection C) high; moral hazard D) high; adverse selection

B) low; adverse selection

67) A financial institution can achieve cost savings in its credit card operations if it increases the number of cardholders. This is an example of economies of A) scope. B) scale. C) complexity. D) information.

B) scale.

73) If potential revenues from underwriting greatly exceed brokerage commissions, there is ________ incentive for investment bank analysts to report ________ information about firms issuing securities. A) stronger; unbiased B) stronger; favorable C) weaker; unbiased D) weaker; favorable

B) stronger; favorable

3) Explain how the "lemons" problem could cause financial markets to fail.

Because of asymmetric information and adverse selection, investors cannot distinguish between good and bad firms. Unwilling to pay more than average price. Good companies unwilling to sell at that price, market functions poorly if at all.

3) Of the sources of external funds for nonfinancial businesses in the United States, bonds account for approximately ________ of the total. A) 10% B) 20% C) 30% D) 50%

C) 30%

11) Which of the following best explains the recent decline in the role of financial intermediaries? A) Private production and sale of information B) Government regulation to increase information C) Improvements in information technology D) None of the above can explain the recent decline

C) Improvements in information technology

31) In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A) Federal Corporate Securities Commission. B) Federal Trade Commission. C) Securities and Exchange Commission. D) U.S. Treasury Department. E) Federal Reserve System.

C) Securities and Exchange Commission.

70) An advantage of providing multiple financial services within one financial institution is that it A) lowers information costs. B) develops broader long-term relationships with customers. C) both A and B of the above. D) none of the above.

C) both A and B of the above.

37) Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called A) points. B) interest. C) collateral. D) good faith money.

C) collateral.

39) The majority of household debt in the United States consists of A) credit card debt. B) consumer installment debt. C) collateralized loans. D) unsecured loans, such as student loans.

C) collateralized loans.

23) Because of the adverse selection problem, A) good credit risks are more likely to seek loans, causing lenders to make a disproportionate amount of loans to good credit risks. B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town." C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

C) lenders are reluctant to make loans that are not secured by collateral.

5) What facts about financial structure can be explained by adverse selection?

Can lead to failure of markets. Good companies unwilling to sell at average market price, bad companies are only to happy to sell for more than they are worth. Investors wind up not investing.

13) What conflicts of interest can arise in investment banking?

Conflicts with underwriting and research for bank selling securities and what they will be willing to reveal to buyers. Bank doesn't want research department to say that bond issue is crap.

85) Which of the following provisions of legislation to deal with conflicts of interest does not increase the flow of information in financial markets? A) Requiring a firm's chief officers to certify its financial statements and other disclosures B) Requiring investment banks to make their analysts' recommendations public C) Requiring disclosure of off-balance-sheet transactions D) Increasing resources available to the Securities and Exchange Commission to supervise financial markets

D) Increasing resources available to the Securities and Exchange Commission to supervise financial markets

47) A venture capital firm protects its equity investment from moral hazard through which of the following means? A) It places people on the board of directors to better monitor the borrowing firm's activities. B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It does both A and B of the above. E) It does both A and C of the above.

D) It does both A and B of the above.

8) Which of the following is not one of the eight basic facts about financial structure? A) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. B) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance in which businesses raise funds directly from lenders in financial markets. C) Collateral is a prevalent feature of debt contracts for both households and businesses. D) New security issues is the most important source of external funds to finance businesses.

D) New security issues is the most important source of external funds to finance businesses.

75) Investment banks are guilty of conflict of interest when they A) pressure their analysts to produce research favorable to their client firms. B) permit executives of client firms to alter analysts' research on their firms. C) prohibit analysts from making negative or controversial comments about client firms. D) all of the above

D) all of the above

21) Because of the adverse selection problem, A) lenders may make a disproportionate amount of loans to bad credit risks. B) lenders may refuse loans to individuals with low net worth. C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

D) all of the above.

24) The problem of adverse selection helps to explain A) why banks prefer to make loans secured by collateral. B) why banks have a comparative advantage in raising funds for American businesses. C) why borrowers are willing to offer collateral to secure their promises to repay loans. D) all of the above. E) only A and B of the above.

D) all of the above.

38) Collateral is A) property that is pledged to the lender if a borrower cannot make his or her debt payments. B) a prevalent feature of debt contracts for households. C) a prevalent feature of debt contracts for businesses. D) all of the above. E) only A and C of the above.

D) all of the above.

48) Debt contracts A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. B) have an advantage over equity contracts in that they have a lower cost of state verification. C) are used much more frequently to raise capital than equity contracts. D) all of the above. E) only A and B of the above.

D) all of the above.

62) A bank A) has the ability to profit from the information it produces. B) avoids the free-rider problem by primarily making private loans rather than by purchasing securities that are traded in the open market. C) becomes an expert in determining good firms from bad firms. D) all of the above.

D) all of the above.

29) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) provide information that is valued by consumers of used cars. B) are able to prevent others from free-riding off the information that they provide. C) can profit by becoming experts in determining whether an automobile is a good car or a lemon. D) do all of the above.

D) do all of the above.

56) Governments in developing countries sometimes adopt policies that retard the efficient operation of their financial systems. These actions include policies that A) prevent lenders from foreclosing on borrowers with political clout. B) nationalize banks and direct credit to politically favored borrowers. C) make it costly to collect payments and collateral from defaulting debtors. D) do all of the above. E) do only A and B of the above.

D) do all of the above.

69) Conflicts of interest pose a problem because they A) lower the quality of information. B) increase problems of asymmetric information. C) make the financial system less efficient. D) do all of the above.

D) do all of the above.

2) Of the following sources of external finance for American nonfinancial businesses, the most important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) nonbank loans.

D) nonbank loans.

71) A conflict of interest occurs when A) a financial firm sells a service to its customers for a price that exceeds the cost of producing the service. B) lenders prefer higher interest rates and borrowers prefer lower interest rates. C) riskier borrowers are the ones who are more likely to apply for loans. D) people expected to provide reliable information to the public have incentives not to do so.

D) people expected to provide reliable information to the public have incentives not to do so.

5) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Marketable securities account for a larger share of external business financing in the United States than in most other countries. B) Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households. C) The stock market accounted for the largest share of the financing of American businesses in the 1970-2000 period. D) All of the above. E) Only A and B of the above.

E) Only A and B of the above.

49) Equity contracts account for a small fraction of external funds raised by American businesses because A) costly state verification makes the equity contract less desirable than the debt contract. B) there is greater scope for moral hazard problems under equity contracts, as compared to debt contracts. C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. D) all of the above. E) both A and B of the above.

E) both A and B of the above.

33) The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of nontraded loans), A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance. B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

45) Solutions to the moral hazard problem include A) high net worth. B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

55) Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that A) borrowers may find loopholes that make the covenants ineffective. B) they are costly to monitor and enforce. C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate others' monitoring and enforcement efforts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

10) Because information is scarce, A) equity contracts are used much more frequently to raise capital than are debt contracts. B) monitoring managers gives rise to costly state verification. C) government regulations, such as standard accounting principles, can help reduce moral hazard. D) all of the above are true. E) only B and C of the above are true.

E) only B and C of the above are true.

1) What are economies of scale in financial transactions? How can financial intermediaries achieve these economies?

Economies of scale is the reduction of transaction costs per $ invested as the size of transactions increases. Financial intermediaries can reduce costs by bundling investors funds together. Example- The cost of arranging the purchasing 10K shares is not much greater than cost of arranging purchase of 50 shares.

10) What is the free-rider problem? Describe some situations that this problem creates.

Free rider problem is people using information that others have paid for. Discourages the production and sale of information. You cannot benefit from the information you purchased if everyone else is following your lead (free riders)

11) The U.S. has more lawyers per capita than any other country in the world. It is also among the richest countries in the world. Explain why these two facts may not be mere coincidence.

Legal system involves writing and enforcing contracts and protecting property rights. Anglo Saxon legas system is and advantage of the U.S. Economy.

6) What facts about financial structure can be explained by moral hazard?

Risk of moral hazard leads lenders to require complex contracts with restrictive and prescriptive covenants.

2) How does the U.S. differ from other countries with respect to the source of funding for nonfinancial business?

US is lowest in bank loans, highest in Non-bank loans, bonds and stocks in that order. Germany, Japan, and Canada highest in bank loans, 76%, 78%, 56%

Collateral and net worth are effective tools for solving which asymmetric information problem(s)? - adverse selection - moral hazard in equity contracts -moral hazard in debt contracts - adverse selection and moral hazard in debt contracts are correct - All of these are correct

adverse selection and moral hazard in debt contract are correct

4) Distinguish between adverse selection and moral hazard.

adverse selection before the transaction, moral hazard after

7) What factors usually cause an increase in moral hazard?

asymmetric information

8) What factors usually cause an increase in adverse selection?

asymmetric information

14) What conflicts of interest can arise in accounting firms?

auditing and consulting. Auditors may skew their opinions to win consulting contracts. Arthur Andersen auditors did not want to unfavorable audits to big clients.

9) What is the principal-agent problem?

particular type of moral hazard. Stock holders, "the principals" are not the managers. Managers are "agents" of the principles. Problem is that without close supervision by principles, managers (agents) do not always act in the best interest of the principals.

63) Net worth A) is the difference between current assets and current liabilities. B) is the difference between assets and liabilities. C) is total assets divided by total liabilities. D) is total assets plus total liabilities.

B) is the difference between assets and liabilities.

77) Auditors attempt to reduce information asymmetry between a firm's managers and its A) customers. B) owners. C) employees. D) competitors.

B) owners.

61) Bad firms A) do not have an incentive to make themselves look good. B) will slant the information they are required to transmit to the public. C) both A and B of the above. D) neither A nor B of the above.

B) will slant the information they are required to transmit to the public.

66) A financial institution can achieve cost savings by engaging in multiple activities. These are called economies of A) scope. B) scale. C) complexity. D) information.

A) scope.

1) American businesses get more funds from direct financing than from indirect financing.

Answer: FALSE

13) The principal-agent problem is an example of the adverse selection problem that can result from asymmetric information.

Answer: FALSE

4) Issuing marketable securities is the primary way businesses finance their operations.

Answer: FALSE

7) The problem of adverse selection helps to explain why direct finance is more important than indirect finance as a source of business finance.

Answer: FALSE

10) Net worth is the difference between a firm's assets and its liabilities.

Answer: TRUE

2) American businesses use stock to finance about 10 percent of their external financing.

Answer: TRUE

84) The Global Legal Settlement of 2002 dealt with conflicts of interest in A) accounting firms. B) investment banks. C) credit-rating agencies. D) all of the above.

B) investment banks.

79) The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. D) pressure its clients into paying high fees for both auditing and consulting services.

C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services.

54) Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets? A) Covenants reduce moral hazard by restricting borrowers' undesirable behavior. B) Covenants require that borrowers keep collateral in good condition. C) Covenants require periodic accounting statements and income reports. D) All of the above. E) Only A and B of the above.

D) All of the above.

6) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Direct finance is used in less than 5% of the external financing of American businesses. B) Only large, well-established corporations have access to securities markets to finance their activities. C) Loans from banks and other financial intermediaries in the United States provide five times more financing of corporate activities than do stock markets. D) All of the above. E) Only A and B of the above.

D) All of the above.

86) The Global Legal Settlement includes what key element? A) It directly reduces conflicts of interest. B) It provides incentives for investment banks to not exploit conflicts of interest. C) It has measures to improve the quality for information in financial markets. D) All of the above.

D) All of the above.

41) Because of the moral hazard problem, A) lenders will write debt contracts that restrict certain activities of borrowers. B) lenders will more readily lend to borrowers with high net worth. C) debt contracts are used less frequently to raise capital than equity contracts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

7) (I) In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

A) (I) is true, (II) false.

4) Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately ________ of the total. A) 10% B) 20% C) 30% D) 40%

A) 10%

52) A clause in a mortgage loan contract requiring the borrower to purchase homeowner's insurance is an example of A) a restrictive covenant. B) a collusive agreement between mortgage lenders and insurance companies. C) both A and B of the above. D) neither A nor B of the above.

A) a restrictive covenant.

17) The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________. A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification

A) adverse selection; moral hazard

78) Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits. A) consulting; regional B) consulting; national C) auditing; regional D) auditing; national

A) consulting; regional

22) The ________ problem occurs when people who do not pay for information take advantage of the information that other people have paid for. A) free-rider B) moral hazard C) adverse selection D) lemons

A) free-rider

82) Since firms issuing new securities pay to have these securities rated, the credit-rating agencies have incentive to ________ to attract more business. A) give favorable ratings B) give impartial ratings C) lower the fees they charge D) practice spinning

A) give favorable ratings

58) Liquidity services are services that A) make it easier for customers to conduct transactions. B) conducts transactions for the customer. C) increase transaction costs. D) all of the above.

A) make it easier for customers to conduct transactions.

11) Economies of scale means that the percentage return on a financial transaction rises as the size of the transaction rises.

Answer: FALSE

12) Agency theory focuses on how government agencies regulate financial intermediaries and markets.

Answer: FALSE

44) The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) would not arise if the owners of the firm had complete information about the activities of the managers. C) in financial markets helps to explain why equity is a relatively important source of finance for American businesses. D) all of the above. E) only A and B of the above.

B) would not arise if the owners of the firm had complete information about the activities of the managers.

81) During the 2007-2009 financial crisis, housing prices began to fall and subprime mortgages began to default. Which of the following statements is true about the rating of subprime mortgage products? A) The rating agencies were way ahead of the market, giving many of the subprime products junk ratings from the start. B) Rating agencies were not involved. Subprime mortgages could not be structured, by law. C) Many AAA-rated subprime products had to be downgraded over and over again until they reached junk status. D) None of the above are true.

C) Many AAA-rated subprime products had to be downgraded over and over again until they reached junk status.

64) Economies of scope refer to cost savings that arise when the A) size of financial transactions increase. B) size of financial transactions decrease. C) number of different activities undertaken increases.

C) number of different activities undertaken increases.

51) A debt contract is more likely to be incentive compatible if A) the company must follow standard accounting principles. B) the funds are provided by a venture capital firm. C) owners of the firm have more of their own money in the business. D) all of the above. E) only B and C.

C) owners of the firm have more of their own money in the business.

27) The concept of adverse selection helps to explain A) why collateral is not a common feature of many debt contracts. B) why large, well-established corporations find it so difficult to borrow funds in securities markets. C) why financial markets are among the most heavily regulated sectors of the economy. D) all of the above.

C) why financial markets are among the most heavily regulated sectors of the economy.

68) Which combination of activities within a single financial institution is least likely to lead to conflicts of interest? A) Auditing and management advisory services B) Commercial banking and investment banking C) Assessment of credit quality and consulting D) Consumer lending and business lending

D) Consumer lending and business lending