Money and Banking Chapter 2

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4) 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 A) foreign bonds. B) Eurobonds. C) equity bonds. D) country bonds.

B AACSB: Application of Knowledge

11) Which of the following instruments are traded in a money market? A) state and local government bonds B) U.S. Treasury bills C) corporate bonds D) U.S. government agency securities

B AACSB: Analytical Thinking

12) Which of the following instruments are traded in a money market? A) bank commercial loans B) commercial paper C) state and local government bonds D) residential mortgages

B AACSB: Analytical Thinking

2) Thrift institutions include A) banks, mutual funds, and insurance companies. B) savings and loan associations, mutual savings banks, and credit unions. C) finance companies, mutual funds, and money market funds. D) pension funds, mutual funds, and banks.

B AACSB: Analytical Thinking

1) Financial institutions that accept deposits and make loans are called ________ institutions. A) investment B) contractual savings C) depository D) underwriting

C AACSB: Application of Knowledge

14) Bonds issued by state and local governments are called ________ bonds. A) corporate B) Treasury C) municipal D) commercial

C AACSB: Application of Knowledge

14) ________ work in the secondary markets matching buyers with sellers of securities. A) Dealers B) Underwriters C) Brokers D) Claimants

C AACSB: Application of Knowledge

7) Which of the following can be described as direct finance? A) You take out a mortgage from your local bank. B) You borrow $2500 from a friend. C) You buy shares of common stock in the secondary market. D) You buy shares in a mutual fund.

8) 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 A) $400. B) $201. C) $200. D) $199.

4) Well-functioning financial markets A) cause inflation. B) eliminate the need for indirect finance. C) cause financial crises. D) allow the economy to operate more efficiently.

1) The process of indirect finance using financial intermediaries is called A) direct lending. B) financial intermediation. C) resource allocation. D) financial liquidation.

B AACSB: Reflective Thinking

1) Which of the following statements about the characteristics of debt and equity is FALSE? A) They can both be long-term financial instruments. B) They can both be short-term financial instruments. C) They both involve a claim on the issuer's income. D) They both enable a corporation to raise funds.

B AACSB: Reflective Thinking

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 AACSB: Reflective Thinking

2) Which of the following statements about the characteristics of debt and equities is TRUE? A) They can both be long-term financial instruments. B) Bond holders are residual claimants. C) The income from bonds is typically more variable than that from equities. D) Bonds pay dividends.

A AACSB: Reflective Thinking

2.3 Financial Market Instruments 1) Prices of money market instruments undergo the least price fluctuations because of A) the short terms to maturity for the securities. B) the heavy regulations in the industry. C) the price ceiling imposed by government regulators. D) the lack of competition in the market.

A AACSB: Reflective Thinking

20) The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market. A) more, primary B) more, secondary C) less, primary D) less, secondary

A AACSB: Reflective Thinking

21) Although the dominance of ________ over ________ is clear in all countries, the relative importance of bond versus stock markets differs widely. A) financial intermediaries, securities markets B) financial intermediaries,government agencies C) government agencies, financial intermediaries D) government agencies, securities markets

A AACSB: Reflective Thinking

27) 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. A) money market B) capital market C) bond market D) stock market

A AACSB: Reflective Thinking

4) Economies of scale enable financial institutions to A) reduce transactions costs. B) avoid the asymmetric information problem. C) avoid adverse selection problems. D) reduce moral hazard.

A AACSB: Reflective Thinking

22) Because there is an imbalance of information in a lending situation, we must deal with the problems of adverse selection and moral hazard. Define these terms and explain how financial intermediaries can reduce these problems.

Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately. Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower. AACSB: Reflective Thinking

13) Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) You buy shares in a mutual fund. C) You buy a U.S. Treasury bill from the U.S. Treasury at Treasury Direct.gov. D) You purchase shares in an initial public offering by a corporation in the primary market.

3) Financial markets improve economic welfare because A) they channel funds from investors to savers. B) they allow consumers to time their purchase better. C) they weed out inefficient firms. D) they eliminate the need for indirect finance.

6) U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks are called A) Atlantic dollars. B) Eurodollars. C) foreign dollars. D) outside dollars.

B AACSB: Application of Knowledge

2) One reason for the extraordinary growth of foreign financial markets is A) decreased trade. B) increases in the pool of savings in foreign countries. C) the recent introduction of the foreign bond. D) slower technological innovation in foreign markets.

B AACSB: Diverse and multicultural work environments

16) 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. A) adverse selection B) moral hazard C) risk sharing D) credit risk

B AACSB: Ethical understanding and reasoning abilities

6) The principal lender-savers are A) governments. B) businesses. C) households. D) foreigners.

12) 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 A) moral selection. B) risk sharing. C) asymmetric information. D) adverse hazard.

C AACSB: Analytical Thinking

16) Which of the following is a long-term financial instrument? A) a negotiable certificate of deposit B) a repurchase agreement C) a U.S. Treasury bond D) a U.S. Treasury bill

C AACSB: Analytical Thinking

19) Which of the following are NOT traded in a capital market? A) U.S. government agency securities B) state and local government bonds C) repurchase agreements D) corporate bonds

C AACSB: Analytical Thinking

1) Every financial market has the following characteristic. A) It determines the level of interest rates. B) It allows common stock to be traded. C) It allows loans to be made. D) It channels funds from lenders-savers to borrowers-spenders.

28) Corporations receive funds when their stock is sold in the primary market. Why do corporations pay attention to what is happening to their stock in the secondary market?

The existence of the secondary market makes their stock more liquid and the price in the secondary market sets the price that the corporation would receive if they choose to sell more stock in the primary market. AACSB: Reflective Thinking

17) Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in the United States?

With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in the U.S. AACSB: Reflective Thinking

15) 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% loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) the borrower's lack of good options for obtaining funds.

A AACSB: Reflective Thinking

24) 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) Prices of capital market securities are usually more stable than prices of money market securities, and so are often used to hold temporary surplus funds of corporations.

A AACSB: Reflective Thinking

5) If Microsoft sells a bond in London and it is denominated in dollars, the bond is a A) Eurobond. B) foreign bond. C) British bond. D) currency bond.

A AACSB: Reflective Thinking

3) Which of the following is a depository institution? A) a life insurance company B) a credit union C) a pension fund D) a mutual fund

B AACSB: Analytical Thinking

4) 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) commercial paper. B) a certificate of deposit. C) a municipal bond. D) federal funds.

B AACSB: Analytical Thinking

4) Which of the following is an example of an intermediate-term debt? A) a fifteen-year mortgage B) a sixty-month car loan C) a six-month loan from a finance company D) a thirty-year U.S. Treasury bond

B AACSB: Analytical Thinking

7) Collateral is ________ the lender receives if the borrower does not pay back the loan. A) a liability B) an asset C) a present D) an offering

B AACSB: Analytical Thinking

10) A financial market in which previously issued securities can be resold is called a ________ market. A) primary B) secondary C) tertiary D) used securities

B AACSB: Application of Knowledge

22) 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. A) exchange B) over-the-counter C) common D) barter

B AACSB: Application of Knowledge

10) The concept of diversification is captured by the statement A) don't look a gift horse in the mouth. B) don't put all your eggs in one basket. C) it never rains, but it pours. D) make hay while the sun shines.

B AACSB: Reflective Thinking

16) A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank.

B AACSB: Reflective Thinking

5) A breakdown of financial markets can result in A) financial stability. B) rapid economic growth. C) political instability. D) stable prices.

26) Equity instruments are traded in the ________ market. A) money B) bond C) capital D) commodities

C AACSB: Analytical Thinking

8) The process of asset transformation refers to the conversion of A) safer assets into risky assets. B) safer assets into safer liabilities. C) risky assets into safer assets. D) risky assets into risky liabilities.

C AACSB: Analytical Thinking

2) 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. A) premium B) collateral C) default D) discount

D AACSB: Analytical Thinking

8) Federal funds are A) funds raised by the federal government in the bond market. B) loans made by the Federal Reserve System to banks. C) loans made by banks to the Federal Reserve System. D) loans made by banks to each other.

D AACSB: Analytical Thinking

3) The time and money spent in carrying out financial transactions are called A) economies of scale. B) financial intermediation. C) liquidity services. D) transaction costs.

D AACSB: Application of Knowledge

6) Long-term debt has a maturity that is A) between one and ten years. B) less than a year. C) between five and ten years. D) ten years or longer.

D AACSB: Application of Knowledge

7) 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. A) bonds B) bills C) notes D) stock

D AACSB: Application of Knowledge

18) Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services. A) adverse selection B) free-riding C) discounting D) moral hazard

D AACSB: Ethical understanding and reasoning abilities

13) Which of the following is NOT a secondary market? A) foreign exchange market B) futures market C) options market D) IPO market

D AACSB: Reflective Thinking

3) Which of the following statements about financial markets and securities is TRUE? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is intermediate term if its maturity is ten years or longer. D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date.

D AACSB: Reflective Thinking

5) An example of economies of scale in the provision of financial services is A) investing in a diversified collection of assets. B) providing depositors with a variety of savings certificates. C) hiring more support staff so that customers don't have to wait so long for assistance. D) spreading the cost of writing a standardized contract over many borrowers.

D AACSB: Reflective Thinking

10) Which of the following can be described as involving direct finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys a short-term corporate security in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets.

14) Securities are ________ for the person who buys them, but are ________ for the individual or firm that issues them. A) assets, liabilities B) liabilities, assets C) negotiable, nonnegotiable D) nonnegotiable, negotiable

2) Financial markets have the basic function of A) getting people with funds to lend together with people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) providing a risk-free repository of spending power.

10) Which of the following are short-term financial instruments? A) a repurchase agreement B) a share of Walt Disney Corporation stock C) a Treasury note with a maturity of four years D) a residential mortgage

A AACSB: Analytical Thinking

13) Which of the following instruments is NOT traded in a money market? A) residential mortgages B) U.S. Treasury Bills C) negotiable bank certificates of deposit D) commercial paper

A AACSB: Analytical Thinking

17) Which of the following instruments are traded in a capital market? A) U.S. Government agency securities B) negotiable bank CDs C) repurchase agreements D) U.S. Treasury bills

A AACSB: Analytical Thinking

18) Which of the following instruments are traded in a capital market? A) corporate bonds B) U.S. Treasury bills C) negotiable bank CDs D) repurchase agreements

A AACSB: Analytical Thinking

5) A short-term debt instrument issued by well-known corporations is called A) commercial paper. B) corporate bonds. C) municipal bonds. D) commercial mortgages.

A AACSB: Analytical Thinking

6) ________ are short-term loans in which Treasury bills serve as collateral. A) Repurchase agreements B) Negotiable certificates of deposit C) Federal funds D) U.S. government agency securities

A AACSB: Analytical Thinking

7) The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as A) risk sharing. B) risk aversion. C) risk neutrality. D) risk selling.

A AACSB: Analytical Thinking

9) Reducing risk through the purchase of assets whose returns do not always move together is A) diversification. B) intermediation. C) intervention. D) discounting.

A AACSB: Analytical Thinking

11) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house.