Chapter 1

The standardization of many FI products is evidence of the inefficient institutionalization by financial markets and the mechanisms through which these products trade

False

The asset transformation function of an FI is to issue primary financial claims to corporations while purchasing primary claims issued by households and other investors

False, FIs purchase primary financial claims from corporations (lend) and issue (sell) primary financial claims to households (borrow)

The goal of credit allocation is the encouragement of FIs to diversity the composition of their assets

False, credit allocation refers to FIs enabling markets that have a hard time getting credit to be able to get credit

Time intermediation involves the investment of small amounts by investors into mutual funds that invest in long-term securities such as stocks and bonds

False, denomination intermediation

Credit allocation regulations are typically designed to benefit customers as well as the financial institution that must implement the guidlines

False, designed support FIs lending to certain markets. Designed for social welfare purposes, but can have negative impacts on FIs.

The ability of savers to transfer wealth between youth and old age and across generations is called maturity intermediation

False, it is called time intermediation

In an attempt to enhance the net social welfare benefits of the services provided by financial intermediaries, safety and soundness regulation requires a DI to hold a minimum level of cash reserves against deposits

False, requires 5 layers of protective mechanisms

An FI is exposed to liquidity risk because the average maturity of assets and the average maturity of liabilities are often different on the FIs balance sheet

False, risk that FIs will not have enough funds to cover to meet borrower and depositor demand

Commercial banks and finance companies have traditionally served the needs of the residential real estate market

False, savings banks and savings associations have

Secondary securities are securities that serve as collateral for primary securities

False, secondary securities are collateralized by primary securities.

When an FI functions as a broker, they are selling a financial asset that they have created and will continue to hold on their balance sheet

False, someone else creates that asset in the case of the FI being the broker

The more costly it is to supervise the use of funds by a borrower, the less likely a saver will encounter agency costs

False, the more costly it is to supervise a borrower the more likely agency problems are to occur

FIs typically provide secondary claims to household savers that have inferior liquidity then primary securities of corporations such as equity and bonds

False, they have superior liquidity

The risk that the sale price of an asset will be less than the purchase price of an asset is called liquidity risk

False, this is price risk

The federal reserve mandates reserve requirements for depository institutions so that DIs may provide payment services for the US economy

False, to minimize liquidity risk

The qualified thrift lender test is utilized to determine whether an institution can serve as an FI

False, utilized to whether a FI can retain a thrift lender status

Depository financial institutions

Include: -commercial banks -savings banks -credit unions Do not include: -investment banks -insurance companies -mutual funds -finance companies -securities firms

Nondepository financial institutions

Include: -insurance companies -mutual funds -finance companies -securities firms -investment banks Do not include: -credit unions -commercial banks -savings banks -credit unions

Globalization

The evolution of markets and institutions so that geographic boundaries do not restrict financial transactions

Why is the failure of a large bank more detrimental to the economy than the failure of a large steel manufacturer

The large bank failure reduces credit availability throughout the economy

An FI acting as an agent in matching savers and borrowers of funds can attain economies of scale and provide this service more efficiently than either the saver or borrower could on their own

True

As a delegated monitor, an FIs actions reduce agency costs

True

As an asset transformer, the FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations

True

Because of changes in regulatory barriers, technology, and financial innovation, a single financial service firm may now be able to offer a full set of financial services.

True

Depository institutions serve as the primary conduit through which monetary policy actions impact the economy

True

FIs are subject to economies of scale in the collection of information

True

Failure to monitor the actions of firms in a timely and complete fashion after purchasing securities in the firm exposes the investor to agency costs

True

Financial institutions act as intermediaries between suppliers and demanders of money

True

If a household invests in corporate securities and does not supervise how the funds are invested or used by the corporation, the risk of not earning the desired return or not having the funds returned increase

True

If not done by financial institutions, the process of monitoring the actions of borrowers would reduce the attractiveness and increase the risk of investing in corporate debt and equity by individuals

True

In most countries, cash is required to be held in reserve against deposits

True

In recent years, the proportion of savings and demand deposits have decreased and the proportion of pension funds have increased in the financial assets held by US households

True

One reason for the increasing proportion of total financial assets controlled by pension funds and investment companies is that these intermediaries exploit the comparative advantages of size and diversification

True

Regulation of FIs is an attempt to enhance the social welfare benefits and mitigate the social costs of providing FI services

True

Savers increasingly favor investments that closely imitate diversified investments in the direct securities markets over the transformed financial claims offered by traditional FIs

True

Services provided by depository institutions have become relatively less significant as a portion of all services provided by FIs

True

Small investors in mutual funds are often able to realize larger returns than they would receive from bank deposits

True

The adverse effects on the economy that can occur because of major disturbances to the special functions or services provided by financial institutions are negative externalities

True

The efficiency with which FIs provide payment services directly benefits the economy

True

The internet has allowed individual investors to purchase securities while benefiting from decreased transaction costs

True

The liabilities of depository institutions are significant components of the money supply

True

Unfairly excluding some potential service consumers from the financial services marketplace is a reason why FIs must absorb net regulatory burden

True

FIs are independent market entities that create financial assets whose value is the transformation of financial risk

True, they are the third party to transactions between lenders and borrowers. Their value added is in the form of risk mitigation.

The ability of diversification to eliminate much of the risk from the asset side of the balance sheet of an FI is the result of choosing assets that are less than perfectly positively correlated

True, this means that when one ship sinks other stay afloat

Major functions of Financial Intermediaries

-Brokerage services -Asset transformation services -Information production -Administration of payments mechanism Not major function: -Management of the nation's money supply

Which function of an Fi reduces transaction and information costs between a corporation and individual which may encourage a high rate of savings

Brokerage services

Depository institutions (DIs) play an important role in transmission of monetary policy from the Federal Reserve to the rest of the economy primarily because

DI deposits are a major portion of the money supply

Financial intermediaries

Do: -specializes in the production of information -reduces its risk exposure by pooling its assets -benefits society by providing a mechanism for payments -may act a broker to bring together funds deficit and funds surplus units Do not: -act as lenders of last resort

What distinguishes Financial intermediaries from industrial firms

FI balance sheets are almost totally comprised of financial assets while commercial firms hold substantial amounts of real assets

Which of the following repealed the 1933 Glass-Steagall barriers between commercial banking, insurance, and investment banking

FSMA( financial services modernization act) 1999

Because bank loans have a shorter maturity than most debt contracts, FIs (financial institutions) typically exercise less monitoring power and control over the borrower

False

Pension and mutual funds have a lower correlation between the maturities of their assets and liabilities than do commercial banks and thrifts

False

The proportion of financial assets controlled by depository institutions has been increasing in recent years

False

In a world without FIs, households will be less willing to invest in corporate securities because they

-are not able to monitor the activities of the corporation more closely than FIs -tend to prefer shorter, more liquid securities -are subject to price risk when corporate securities are sold -may not have enough funds to purchase corporate securities

The reason FIs can offer highly liquid, low price-risk contracts to savers while investing in relatively illiquid and higher risk assets is

-because diversification allows an FI to predict more accurately the expected returns on its asset portfolio -significant amounts of portfolio risk are diversified away by investing in assets that have correlations between returns that are less than perfectly positive -because individual savers cannot benefit from risk diversification -because FIs have a cost advantage in monitoring their portfolios

The federal government has traditionally extended safety nets to DIs consisting of

-deposit insurance and discount window borrowing

investment companies are successful in attracting business away from banks and insurance companies primarily because they

-give savers cheaper access to the direct securities markets

Charter values of FIs will be higher if regulators

-increase the cost of entry by requiring more capital -restrict the number of FIs that can operate in a given market

In as delegated monitor, an FI

-keeps track of required interest and principal payments on loads it originates -works with financially distressed borrowers in danger of defaulting on their loans -holds portfolios of loans that they continue to service -maintains contact with borrowers to ensure that loan proceeds are utilized for intended purposes

The housing bubble that began building in 2001 was primarily the result of

-low interest rates and increased liquidity provided by the Federal Reserve

Many households place funds with financial institutions because many FI accounts provide

-lower denominations than other securities -flexible maturities verses other interest-earning securities -better liquidity than directly negotiated debt contracts -less price risk if interest rates change

Advantages of depositing funds into a typical bank account instead of directly buying corporate securities

-monitoring done by the bank on your behalf -increased liquidity if funds are needed quickly -less price risk when funds are needed -better diversification of deposited funds

A significant recent trend in the provision of financial services is that households increasingly prefer denomination intermediation and information services provided by

-mutual funds and money market mutual funds

FIs perform their intermediary function in two ways

-they specialize as brokers between savers and borrowers -they serve as asset transformers by purchasing primary securities and issuing secondary securities

Why do households prefer to use FIs as intermediaries to invest their surplus funds

-transaction costs are low to the household since FIs are more efficient in monitoring and gathering investment information -to receive the benefits of diversification the households may not be able to achieve on their own -The FI can benefit from combining funds and negotiating lower asset prices and transaction costs -The FI can provide insurance at relatively low cost that will protect funds under management

refers to the possibility that a firm's owners or managers will take actions contrary to the promises contained in the covenants of the securities the firm issues to raise funds

agency costs

The asset transformation function of FIs typically involves

altering the liquidity and maturity features of funds sources used to finance the FIs asset portfolio Does not involve: -receipt of securities through electronic payments systems -granting loans to transform funds deficit units into funds surplus units -investing short-term funds in off-balance sheet activities -transferring funds from one generation to another

Traditionally, regulation of FIS in the US has been

extensive, as a result of the importance of FI to the economy

Maturity intermediation

mismatching the maturities of assets and liabilities

Financial intermediaries are

neither funds surplus nor deficit units

The origination of a home mortgage loan is considered to be a

primary security, because the mortgage not is a newly created security