ECON-310 Chapter 11

COLLATERAL

Assets pledged to pay for a loan in the event that the borrower doesn't make the required payments.

The text showed in an exhibit that the United States, the United Kingdom, Germany, and Japan all fund the majority of their business finance through a. Internal funds b. Financial markets c. Financial intermediaries d. The government

Internal funds

Which of the following nations receives the highest percentage of business financing from financial intermediaries? a. Japan b. U.S. c. U.K. d. Germany

Japan

The reason financial intermediaries play such an important role in economies has to do with all of the following except: a. transaction costs b. information costs c. the composition of GDP d. complexity of a lot of financial transactions

the composition of GDP

A home mortgage is a good example of: a. a high risk loan b. the problem of adverse selection c. an unsecured loan d. a secured loan

a secured loan

If a bank has 1,000 depositors, each of whom deposits $1,000 in the bank, and the bank makes loans of $10,000 each, then each depositor has contributed: a. $1 to each loan. b. $1000 to each loan. c. $100 to each loan. d. $10 to each loan.

$10 to each loan

Unsecured Loans

A loan that is not guaranteed by collateral.

Asymmetric information poses two important obstacles to the smooth flow of funds from savers to investors. The are: a. Adverse selection, which arises before the transaction occurs, and moral hazard, which occurs after the transaction b. Moral hazard, which arises before the transaction occurs, and adverse selection, which occurs after the transaction. c. Adverse selection and moral hazard, both of which occur before the transaction. d. Adverse selection and moral hazard, both of which occur after the transaction

Adverse selection, which arises before the transaction occurs, and moral hazard, which occurs after the transaction.

The scandals involving Enron, World Com, Global Crossing and other large firms: a. Have resulted in a cry for less government regulation of public corporations b. Are examples of asymmetric information and have led, at least temporarily, to a less well functioning stock market c. Demonstrate that the government should be responsible for collecting and distributing financial information on firms d. Is what should have been expected on the part of investors, that is why there is risk premium.

Are examples of asymmetric information and have led, at least temporarily, to a less well functioning stock market

Which of the following is true about banks as a source of funding? a. Banks have alway been a dominant source of funding, and that importance has only grown over time. b. Banks are not as dominant a source of funding as they once were, but they are still quite important c. Bank were not a dominant source of funding in the past, but they are increasingly important today. d. Banks were once the dominant source of funding, but they are of very little importance today.

Banks are not as dominant a source of funding as they once were, but they are still quite important.

If financial intermediaries did not have the ability to pool the resources of small savers: a. people would likely save more b. the risk associated with lending would decrease c. borrowers needing large amounts of money would find it more costly to obtain the funds d. the economy would grow faster

Borrowers needing large amounts of money would find it more costly to obtain the funds.

Lending and borrowing involve _____ costs; the text credits financial intermediaries' skill in lowering _____ costs with their continued importance. a. Only information; information b. Only transactions; transactions c. Both transactions and information; information d. Both transactions and information; transactions

Both transactions and information; transactions

Liquidity for a bank means a. Bank loans can be called in at any time. b. Depositors have easy access to funds. c. Customer deposits are kept only in the form of cash. d. Banks make as few loans as possible.

Depositors have easy access to funds

Consider a $100,000 loan made by a bank. The bank would be most likely to provide risk diversification by a. forming the loan from small amounts - say, $100 each - from many deposits. b. forming the loan from $100,00 from a single, safe account of more than $100,000 - say, $1 million. c. Making up most of the loan from the bank's own cash account. d. Forming the loan from the entirety of a single, safe account of exactly $100,000.

Forming the loan from small amounts - say $100,000.

Moral hazard problems occur in stock transactions when a. Funds are used for reasons that benefit managers instead of owners b. Buyers pay too much for a given share of stock c. Brokers and dealers spend too much money on information services from research firms d. The stock buyer requests stock from one firm but his broker buys from another

Funds are used for reasons that benefit managers instead of owners

The original bankers were _____. a. Brokers and dealers b. Goldsmiths c. The government d. Loan sharks

Goldsmiths

When the amount of direct and indirect financing are summed, the result is usually: a. equal to GDP b. less than GDP c. approximately 50% of GDP d. greater than 100% of GDP

Greater than 100% of GDP

Financial intermediaries can reduce adverse selection problems in lending by a. Asking borrowers to report their credit scores directly b. Directly monitoring borrowers after loans are made c. Having access to borrower credit info and account history d. Helping small and medium sized businesses issue securities.

Having access to borrower credit info and account history.

The screening process a bank follows for a loan applicant: a. Is based on just public information b. Uses only confidential information c. Uses information that anyone can obtain, the bank can usually obtain it cheaper. d. Includes information that can be available to other firms, as well as proprietary information that only the bank would have.

Includes information that can be available to other firms, as well as proprietary information that only the bank would have.

Which of the following best summarizes the information available when a loan is made? a. Information is asymmetric (uneven) because the lender knows more than the borrower. b. Information is asymmetric (uneven) because the borrower knows more than the lender c. Information is symmetric (even) because the borrower knows more than the lender d. Information is symmetric (even) because the lender knows more than the borrower.

Information is asymmetric because the borrower knows more than the lender.

A measure of the ease and cost with which an asset can be turned into the means of payment refers to ____; a highly ____ asset can be transformed into money quickly, easily, and at low cost. a. Liquidity; illiquid b. Profitability; profitable c. Liquidity; liquid d. Profitability; unprofitable

Liquidity; liquid

Which of the following is true? a. Moral hazard and adverse selection are two obstacles presented by asymmetric information. b. Adverse selection and asymmetric information are two obstacles presented by moral hazard. c. Moral hazard and asymmetric information are two obstacles presented by adverse selection.

Moral hazard and adverse selection are two obstacles presented by asymmetric information.

Financial intermediation is: a. The same thing as finance through stock and bond markets b. Only a little more important than direct finance in the U.S. c. Far less important than direct finance through stock and bond markets d. Much more important than direct finance through stock and bond markets

Much more important than direct finance through stock and bond markets.

Financial intermediaries pool the resources of many small savers so that they can: a. Obtain the funds necessary to make loans to borrowers seeking large amounts b. Lower their transaction costs of obtaining funds c. Charge fees to these small savers and earn substantial income d. avoid paying any interest to obtain funds to lend.

Obtain the funds necessary to make loans to borrowers seeking large amounts

Mutual Funds a. Are not meant for "small savers" like families and individuals b. Have extremely high costs c. Have a minimum buy-in of at least $20,000 d. Offer a low-cost way for savers to diversify

Offer a low-cost way for savers to diversify.

The network that transfers funds from one account to another is called the _____. a. Exchange system b. Central bank c. Barter system d. Payments system

Payments system

Services offered by banks include a. Providing internet access to bank information and ATM machines b. Controlling the payments system and making loans to other banks c. Setting interest rates and making loans d. Making discount loans and providing monthly bank statements

Providing internet access to bank information and ATM machines

Which of the following is a key role played by financial intermediaries, according to the text? a. Providing liquidity b. Helping firms issue new stock c. Keeping unemployment low d. Setting interest rates

Providing liquidity

Today, banks make depositors feel that their deposited funds will be safe in part by a. Advertising how much money they print each day b. Setting interest rates at hight levels c. Having large vaults in plain view of customers d. Relying on their strong reputations

Relying on their strong reputations

One way to help with adverse selection problems in financial markets is to a. Lower interest rates on unsecured loans. b. Make companies publish more information about them c. Require more collateral from borrowers d. Encourage more free riders.

Require more collateral from borrowers.

Adverse selection: a. Results in fewer market transactions b. Increases the efficiency of most markets c. Makes it easier for all customers to find what they want. d. Usually causes prices to adjust faster than they otherwise would

Results in fewer market transactions

Banks must lessen asymmetric information problems because when loans are made a. The lender knows more than the borrower b. Both the borrower and the lender know more than the bank c. Banks know more than the borrower and less than the lender d. The borrower knows more than the lender

The borrower knows more than the lender

Net Worth

The difference between a firm's or household's assets and liabilities.

The concept of moral hazard originated in _____. a. The insurance industry b. Bond markets c. The stock market d. Banking

The insurance industry

Which of the following is true about solving principal-agent problems in debt and equity markets? a. The problem may be reduced if covenants force firm managers to pledge their own personal assets toward firm success or failure. b. In the last few years, firms have had great success in reducing moral hazard problems by tying manager compensation to firm performance. c. The problem may be reduced if firm managers share more in the upside of risk. d. The problem may be reduced if managers report more directly to owners.

The problem may be reduced if managers report more directly to owners.

One reason lenders usually require a lot of information from loan applicants is to avoid: a. charges of discrimination in lending b. the problems of moral hazard c. the problem of adverse selection d. being harmed by symmetric information

The problem of adverse selection

ADVERSE SELECTION

The problem of distinguishing a good risk from a bad one before making a loan or providing insurance; it is caused by asymmetric information.

MORAL HAZARD

The risk that a borrower or someone who is insured will behave in a way that is not in the interest of the lender or insurer, it is caused by asymmetric information.

Assume there are two companies. Both issue stock, but one is high quality and the other low quality. If potential investors cannot distinguish the quality of the company a. The shares of both companies will trade on the market b. This is an example of moral hazard and the shares of both companies will cease to trade. c. The shares of the high quality firm will disappear from the market d. The shares of the low quality firm will disappear from the market

The shares of the high quality firm will disappear from the market

Financial intermediation exists, in part, because: a. Direct finance through stocks and bonds is the dominant form of financing. b. Financial markets work so well c. Transaction costs of financial intermediation is always higher than direct finance. d. The transaction costs associated with direct finance can at times be prohibitive.

The transaction costs associated with direct finance can at times be prohibitive

Figure 11.1 in the textbook, which plots the availability of domestic credit against per-capita real GDP, indicates that ____. a. There is a strong positive relationship between a nation's financial development and its per-capita real GDP b. There is a strong negative relationship between a nation's financial development and its per-capita real GDP c. There is a weak positive relationship between a nation's financial development and its per-capita real GDP d. There is a weak negative relationship between a nation's financial development and its per-capita real GDP.

There is a strong positive relationship between a nation's financial development and its per-capita real GDP.

Which of the following is true about adverse selection and loan contracts? a. Net worth and collateral serve very different functions. b. Unsecured contracts tend to have higher interest rates. c. Adverse selection problems are less severe with unsecured loans. d. The higher the firm's net worth, the higher the chance of adverse selection problems.

Unsecured contracts tend to have higher interest rates.

Emerging market economies, compared to industrialized economies have financial markets that: a. differ in composition and size b. are similar in composition and size c. differ in composition but not in size d. are the sam in composition but differ in size

differ in composition and size

Which of the following is not a role of a financial institution acting as a financial intermediary? a. formulating oversight regulations b. providing ways to diversify risk c. pooling the resources of small savers d. supplying liquidity

formulating oversight regulations

Financial institutions, acting as financial intermediaries, perform all of the following, except: a. pooling resources of small savers. b. provide safekeeping and accounting services. c. increase transaction costs d. provide ways to diversify risk

increase transaction costs

Tom borrows $100,000 from his local bank to purchase inventory for his store for the upcoming holiday season. Tom's neighbor tells him about a get-rich-quick scheme that can take this $100,000 and triple it in a month. Tom decides to buy into this scheme figuring he can repay the bank and still have plenty left for inventory. This is an example of: a. diversification b. adverse selection c. sound risk analysis on Tom's part d. moral hazard

moral hazard

Two problems that arise from asymmetric information are: a. adverse selection and diseconomies of scale b. moral hazard and adverse selection c. moral hazard and the free-rider problem d. the free-rider problem and adverse selection

moral hazard and adverse selection

Examples of economies of scale are: a. the decrease in overall transaction costs that occur as volume increases b. the additional fees financial intermediaries charge on small accounts c. the reduction in the cost per transaction that occurs as the number of transactions increase d. the decrease in overall information costs that occurs as more transactions are handled

the reduction in the cost per transaction that occurs as the number of transactions increase