ECON 2035 LSU Chap 2

U.S. Treasury bills are considered the safest of all money market instruments because there is almost no risk of

default

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

depository

The primary liabilities of depository institutions are

deposits

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

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

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

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

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 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

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

Residential mortgages

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

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

a shareholder

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

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

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

commercial paper

The primary assets of credit unions are

consumer loans

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

contractual savings

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

Which of the following is a contractual savings institution?

a life insurance company

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

savers, spenders

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

A corporation issues new shares of stock.

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

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

*A) 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.* B) As a corporation gets a share of the broker's commission, a corporation acquires new funds whenever its securities are sold. C) Capital market securities are usually more widely traded than shorter-term securities and so tend to be more liquid. D) Because of their short-terms to maturity, the prices of money market instruments tend to fluctuate wildly. Answer: A

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 long-term financial instrument?

A U.S. Treasury bond

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 depository institution?

A mutual savings bank

Which of the following are short-term financial instruments?

A repurchase agreement

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

A sixty-month car loan

________ work in the secondary markets matching buyers with sellers of securities

Brokers

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

Commercial paper

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

Corporate bonds

Which of the following are not contractual savings institutions?

Credit Unions

U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks are called

Eurodollars

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

Which of the following is not a secondary market?

IPO market

Every financial market has the following characteristic:

It channels funds from lenders-savers to borrowers-spenders

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

Libor rate

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

People buy shares of common stock in the primary markets

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

Repurchase agreements

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

Repurchase agreements

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.

Which of the following statements about the characteristics of debt and equities is true?

They can both be long-term financial instruments

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

They can both be short-term financial instruments

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

U.S. Government Bonds

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 U.S. companies can be purchased by

U.S. citizens and foreign citizens

Which of the following can be described as direct finance?

You borrow $2500 from a friend

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

You buy shares in a mutual fund

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

You make a deposit at a bank

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

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

assets; liabilities

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

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 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

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

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

Thrift institutions include

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

A financial market in which previously issued 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

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

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

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

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