ECON 2035 Chapter 2

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

depository

The primary liabilities of a commercial bank are

deposits.

The primary liabilities of depository institutions are

deposits.

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

direct

US 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

The concept of diversification is captured by the statement:

don't put all your eggs in one basket

Banks can lower the cost of information production by applying one information resource to many different services. This process is called

economies of scope.

The process of indirect finance using financial intermediaries is called:

financial intermediation

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 funds to lend together with people who want to borrow funds

The principal lender-savers are:

households

One reason for the extraordinary growth of foreign financial markets is:

increases in the pool of savings in foreign countries

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 negotiable certificate of deposit

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

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

The primary assets of credit unions are

consumer loans.

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

corporate bonds

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

investment bank

Every financial market has the following characteristic:

it channels funds from lenders- savers to borrowers- spenders

Contractual savings institutions include

life insurance companies.

Forty or so dealers establish a "market" in these securities by standing ready to buy and sell them.

US government bonds

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

US treasury bills

Which of the following is a long term financial instrument?

a US treasury bond

Which of the following can be described as involving direct finance?

a corporation issues new shares of stock

Which of the following are short-term financial instruments?

a repurchase agreement

Which of the following benefit directly from any increase in the corporation's profitability?

a shareholder

When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called a(n):

exchange

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

The process of asset transformation refers to the conversion of:

risky assets into safer assets

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

the can both be short term financial instruments

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

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

the short terms to maturity for the securities

The British Banker's Association average of interbank rates for dollar deposits in the London market is called the:

libor rate

Secondary markets make financial instruments more:

liquid

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

Eurobond

Assume that you borrow $2000 at 10% annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is:

$201

You can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is:

5%

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

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

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

Brokers

________ institutions are financial intermediaries that acquire funds at periodic intervals on a contractual basis.

Contractual savings

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:

Eurodollards

Which of the following is not a secondary market?

IPO market

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 the New York Stock Exchange

_____ are short - term loans in which Treasury bills serve as collateral.

Repurchase agreements

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

US Government agency securities

The most liquid securities traded in the capital market are:

US Treasury bonds

Internationalization of Financial Markets:

US citizens and foreign citizens

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

an asset

A liquid asset is:

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

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

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

capital

Equity instruments are traded in the ____ market.

capital

Federal funds are:

loans made by banks to each other

Risk sharing is profitable for financial institutions due to:

low transactions costs

Financial intermediaries provide customers with liquidity services. Liquidity services:

make it easier for customers to conduct transactions

An important function of secondary markets is to:

make it easier to sell financial instruments to raise funds

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

Bonds issued by state and local governments are called _____ bonds.

municipal

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

Which of the following can be described as involving direct finance?

people buy shares of common stock in the primary markets

A breakdown of financial markets can result in:

political instability

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

primary market by an investment bank

Well functioning financial markets:

produce an efficient allocation of capital

Economies of scale enable financial institutions to:

reduce transactions costs

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

Thrift institutions include

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

A financial market in which previously issues securities can be resold is called a ______ market.

secondary

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

short term

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

sixty month car loan

An example of economies of scale in the provision of financial services is:

spreading the cost of writing a standardized contract over many borrowers

When I purchase ______, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors.

stock

Long-term debt has a maturity that is:

ten years or longer

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 true?

they can both be long term financial instruments

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

transaction costs

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

underwrites

Which of the following can be described as direct finance?

you borrow $3500 from a friend

Which of the following can be described as involving indirect finance?

you buy shares in a mutual funds

Which of the following can be described as involving indirect finance?

you make a deposit at a bank

The countries that have made the least use of securities markets are ________ and ________; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.

- Germany - Japan

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

Securities are _____ for the person who buys them, but are ____ for the individual of firm that issues them.

- assets - liabilities

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

- financial intermediaries - more

Although the dominance of ________ over ________ is clear in all countries, the relative importance of bond versus stock markets differs widely.

- financial intermediaries - securities markets

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

- more - primary

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

- savers - spenders

US Treasury bills are considered the safest of all money market instruments because there is almost no risk of:

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