Money and Banking Test 2, Chapter 8

With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Marketable securities account for a larger share of external business financing in the United States than in Germany and Japan. B) Since 1970, most of the newly issued corporate bonds and commercial paper have been sold directly to American households. C) Direct finance accounts for more than 50 percent of the external financing of American businesses. D) Smaller businesses almost always raise funds by issuing marketable securities.

A

A conflict of interest arises in investment banking because the banks are attempting to simultaneously serve two client groups A) the security-issuing firms and the security-buying investors. B) the government and the stockholders. C) the government and the security-issuing firms. D) the security-issuing firms and the lawyers.

A

A conflict of interest can occur for accounting firms when the firms both A) provide auditing services and nonaudit consulting services. B) provide nonaudit services and tax advice. C) enter data and record data. D) monitor data and underwrite securities.

A

A debt contract is incentive compatible A) if the borrower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the borrowerʹs net worth in the business. B) if the borrowerʹs net worth is sufficiently low so that the lenderʹs risk of moral hazard is significantly reduced. C) if the debt contract is treated like an equity. D) if the lender has the incentive to behave in the way that the borrower expects and desires.

A

A key finding of the economic analysis of financial structure is that A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. B) while free-rider problems limit the extent to which securities markets finance some business activities, nevertheless the majority of funds going to businesses are channeled through securities markets. C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. D) economists do not have a very good explanation for why securities markets are so heavily regulated.

A

A venture capital firm protects its equity investment from moral hazard through which of the following means? A) It places people on the board of directors to better monitor the borrowing firmʹs activities. B) It writes contracts that prohibit the sale of an equity investment to the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It requires a 50% stake in the company.

A

Adverse selection is a problem associated with equity and debt contracts arising from A) the lenderʹs relative lack of information about the borrowerʹs potential returns and risks of his investment activities. B) the lenderʹs inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults. C) the borrowerʹs lack of incentive to seek a loan for highly risky investments. D) the lenderʹs inability to restrict the borrower from changing his behavior once given a loan.

A

All of the following are credit-rating agency reforms proposed by the SEC in 2008 except A) prohibit credit-rating agencies from structuring the same products that they rate. B) disclose historical ratings performance. C) differentiate the ratings on structured products from those issued on bonds. D) sever links between research and securities underwriting.

A

Although debt contracts require less monitoring than equity contracts, debt contracts are still subject to ________ since borrowers have an incentive to take on more risk than the lender would like. A) moral hazard B) agency theory C) diversification D) the ʺlemonsʺ problem

A

Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that A) borrowers may find loopholes that make the covenants ineffective. B) they are inexpensive to monitor and enforce. C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate othersʹ monitoring and enforcement efforts. D) they reduce the value of the debt contract.

A

An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds. A) moral hazard B) adverse selection C) costly state verification D) agency

A

Analysis of adverse selection indicates that financial intermediaries, especially banks, A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance. B) despite their success in overcoming free-rider problems, nevertheless play a minor role in moving funds to corporations. C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds. D) must buy securities from corporations to diversify the risk that results from holding non-tradable loans.

A

Because conflicts of interest increase asymmetric information problems A) the economy will not operate as efficiently. B) loans will not be made. C) banks will not be able to make a profit. D) the financial markets will operate more smoothly.

A

Commercial and farm mortgages, in which property is pledged as collateral, account for A) one-quarter of borrowing by nonfinancial businesses. B) one-half of borrowing by nonfinancial businesses. C) one-twentieth of borrowing by nonfinancial businesses. D) two-thirds of borrowing by nonfinancial businesses.

A

Credit-rating agencies may face a conflict of interest because they A) both advise clients on how to structure debt issues and determine the creditworthiness of the debt issues. B) underwrite securities and advise clients on how to structure debt issues. C) underwrite securities and determine the creditworthiness of the debt issues. D) both advise clients on how to structure debt issues and write restrictive covenants.

A

Debt contracts A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. B) have a higher cost of state verification than equity contracts. C) are used less frequently to raise capital than are equity contracts. D) never result in a loss for the lender.

A

Direct finance involves the sale to ________ of marketable securities such as stocks and bonds. A) households B) insurance companies C) pension funds D) financial intermediaries

A

Equity contracts A) are claims to a share in the profits and assets of a business. B) have the advantage over debt contracts of a lower costly state verification. C) are used much more frequently to raise capital than are debt contracts. D) are not subject to the moral hazard problem.

A

Equity contracts account for a small fraction of external funds raised by American businesses because A) costly state verification makes the equity contract less desirable than the debt contract. B) of the reduced scope for moral hazard problems under equity contracts, as compared to debt contracts. C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. D) there is no moral hazard problem when using a debt contract.

A

Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs. A) expertise B) diversification C) regulations D) equity

A

Financial intermediariesʹ low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions. A) liquidity B) conduction C) transcendental D) equitable

A

For restrictive covenants to help reduce the moral hazard problem they must be ________ by the lender. A) monitored and enforced B) written in all capitals C) easily changed D) impossible to remove

A

Government regulations designed to reduce the moral hazard problem include A) laws that force firms to adhere to standard accounting principles. B) light sentences for those who commit the fraud of hiding and stealing profits. C) state verification subsidies. D) state licensing restrictions.

A

Investment banks ________ companies issuing securities and ________ these securities by selling them to the public on behalf of the issuing companies. A) research; underwrite B) research; monitor C) monitor; underwrite D) monitor; manipulate

A

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. A) principal-agent B) adverse selection C) free-rider D) debt deflation

A

One financial intermediary in our financial structure that helps to reduce the moral hazard from arising from the principal-agent problem is the A) venture capital firm. B) money market mutual fund. C) pawn broker. D) savings and loan association.

A

One reason China has been able to grow so rapidly even though its financial development is still in its early stages is A) the high savings rate of around 40%. B) the shift of labor to the agricultural sector. C) the stringent enforcement of financial contracts. D) the ease of obtaining high-quality information about creditors

A

Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called A) collateral. B) points. C) interest. D) good faith money.

A

Since they require less monitoring of firms, ________ contracts are used more frequently than ________ contracts to raise capital. A) debt; equity B) equity; debt C) debt; loan D) equity; stock

A

That only large, well-established corporations have access to securities markets A) explains why indirect finance is such an important source of external funds for businesses. B) can be explained by the problem of moral hazard. C) can be explained by government regulations that prohibit small firms from acquiring funds in securities markets. D) explains why newer and smaller corporations rely so heavily on the new issues market for funds.

A

The Global Legal Settlement of 2002 required investment banks to separate ________ and ________. A) research; securities underwriting B) deposits; securities underwriting C) research; legal analysis D) deposits; legal analysis

A

The ________ problem helps to explain why the private production and sale of information cannot eliminate ________. A) free-rider; adverse selection B) free-rider; moral hazard C) principal-agent; adverse selection D) principal-agent; moral hazard

A

The fact that the credit-rating agencies both advised clients on how to structure the financial instruments that paid out cash flows from subprime mortgages and also rated these financial instruments contributed to the A) subprime financial crisis that began in 2007. B) Enron collapse. C) demise of Arthur Andersen. D) technology bust.

A

The name economists give the process by which stockholders gather information by frequent monitoring of the firmʹs activities is A) costly state verification. B) the free-rider problem. C) costly avoidance. D) debt intermediation.

A

The presence of economies of scope may benefit financial institutions but may create potential costs from ________. A) conflicts of interest B) multiple profitable enterprises C) economies of scale D) unsecured debt

A

The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________. A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification

A

The problem of adverse selection helps to explain A) why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B) why collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) why lenders refuse loans to individuals with high net worth.

A

Which of the following is not one of the eight basic puzzles about financial structure? A) Stocks are the most important source of finance for American businesses. B) Issuing marketable securities is not the primary way businesses finance their operations. C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets. D) Banks are the most important source of external funds to finance businesses.

A

While Sarbanes-Oxley is designed to reduce the problems caused by conflicts of interest critics say that it might diminish economies of scope and A) reduce information in financial markets. B) encourage IPOs in the U.S. C) encourage smaller firms to list on the U.S. financial markets. D) increase U.S. capital markets relative to those abroad.

A

A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called A) moral hazard. B) asymmetric information. C) noncollateralized risk. D) adverse selection.

B

A lesson of the Enron collapse is that government regulation A) always fails. B) can reduce but not eliminate asymmetric information. C) increases the problem of asymmetric information. D) should be reduced.

B

A problem for equity contracts is a particular type of ________ called the ________ problem. A) adverse selection; principal-agent B) moral hazard; principal-agent C) adverse selection; free-rider D) moral hazard; free-rider

B

As information technology improves, the lending role of financial institutions such as banks should ________. A) increase somewhat B) decrease C) stay the same D) increase significantly

B

Because information is scarce A) helps explain why equity contracts are used so much more frequently to raise capital than are debt contracts. B) monitoring managers gives rise to costly state verification. C) government regulations, such as standard accounting principles, have no impact on problems such as moral hazard. D) developing nations do not rely heavily on banks for business financing.

B

Collateralized debt is also know as A) unsecured debt. B) secured debt. C) unrestricted debt. D) promissory debt.

B

Credit card debt is A) secured debt. B) unsecured debt. C) restricted debt. D) unrestricted debt

B

If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification.

B

If you default on your auto loan, your car will be repossessed because it has been pledged as ________ for the loan. A) interest B) collateral C) dividend D) commodity

B

Net worth can perform a similar role to ________. A) diversification B) collateral C) intermediation D) economies of scale

B

Of the following sources of external finance for American nonfinancial businesses, the least important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) loans from other financial intermediaries.

B

Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately ________ of the total. A) 2% B) 11% C) 20% D) 40%

B

One way of describing the solution that high net worth provides to the moral hazard problem is to say that it A) collateralizes the debt contract. B) makes the debt contract incentive compatible. C) state verifies the debt contract. D) removes all of the risk in the debt contract

B

Solutions to the moral hazard problem include A) low net worth. B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) greater reliance on debt contracts than financial intermediaries.

B

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. B) are able to prevent potential competitors from free-riding off the information that they provide. C) have failed to solve adverse selection problems in this market because ʺlemonsʺ continue to be traded. D) have solved the moral hazard problem by providing valuable information to their customers.

B

The Sarbanes-Oxley Act of 2002 increased supervisory oversight by A) giving the FDIC the authority to review independent audits. B) increasing the SECʹs budget to supervise securities markets. C) creating a new Department of Conflict Resolution. D) reducing the penalties for obstruction of an official investigation.

B

The free-rider problem occurs because A) people who pay for information use it freely. B) people who do not pay for information use it. C) information can never be sold at any price. D) it is never profitable to produce information.

B

The practice of ________ is allocating initially underpriced initial public offerings to executives in companies the investment bank hopes to do underwriting business with in the future. A) discounting B) spinning C) peppering D) wiring

B

The predominant form of household debt is A) consumer installment debt. B) collateralized debt. C) unsecured debt. D) unrestricted debt.

B

The reduction in transactions costs per dollar of investment as the size of transactions increases is A) discounting. B) economies of scale. C) economies of trade. D) diversification.

B

Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true? A) Stocks are a far more important source of finance than are bonds. B) Stocks and bonds, combined, supply less than one-half of the external funds. C) Financial intermediaries are the least important source of external funds for businesses. D) Since 1970, more than half of the new issues of stock have been sold to American households.

B

2) Of the sources of external funds for nonfinancial businesses in the United States, loans from banks and other financial intermediaries account for approximately ________ of the total. A) 6% B) 40% C) 56% D) 60%

C

A clause in a debt contract requiring that the borrower purchase insurance against loss of the asset financed with the loan is called a A) collateral-insurance clause. B) prescription covenant. C) restrictive covenant. D) proscription covenant.

C

A clause in a mortgage loan contract requiring the borrower to purchase homeownerʹs insurance is an example of a A) proscriptive covenant. B) prescriptive covenant. C) restrictive covenant. D) constraint-imposed covenant.

C

Because of the adverse selection problem, A) good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks. B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to ʺskip town.ʺ C) lenders are reluctant to make loans that are not secured by collateral. D) lenders will write debt contracts that restrict certain activities of borrowers.

C

Government regulations require publicly traded firms to provide information, reducing A) transactions costs. B) the need for diversification. C) the adverse selection problem. D) economies of scale.

C

High net worth helps to diminish the problem of moral hazard problem by A) requiring the state to verify the debt contract. B) collateralizing the debt contract. C) making the debt contract incentive compatible. D) giving the debt contract characteristics of equity contracts.

C

In the United States, the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A) Federal Communications Commission. B) Federal Trade Commission. C) Securities and Exchange Commission. D) Federal Reserve System.

C

Of the sources of external funds for nonfinancial businesses in the United States, corporate bonds and commercial paper account for approximately ________ of the total. A) 5% B) 10% C) 32% D) 50%

C

One purpose of regulation of financial markets is to A) limit the profits of financial institutions. B) increase competition among financial institutions. C) promote the provision of information to shareholders, depositors and the public. D) guarantee that the maximum rates of interest are paid on deposits.

C

One reason financial systems in developing and transition countries are underdeveloped is A) they have weak links to their governments. B) they make loans only to nonprofit entities. C) the legal system may be poor making it difficult to enforce restrictive covenants. D) the accounting standards are too stringent for the banks to meet.

C

Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are A) limited-liability clauses. B) risk insurance. C) restrictive covenants. D) illegal.

C

The concept of adverse selection helps to explain A) why collateral is not a common feature of many debt contracts. B) why large, well-established corporations find it so difficult to borrow funds in securities markets. C) why financial markets are among the most heavily regulated sectors of the economy. D) why stocks are the most important source of external financing for businesses.

C

The current structure of financial markets can be best understood as the result of attempts by financial market participants to A) adapt to continually changing government regulations. B) deal with the great number of small firms in the United States. C) reduce transaction costs. D) cartelize the provision of financial services.

C

The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A) noncollateralized risk B) free-riding C) asymmetric information D) costly state verification

C

The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) in financial markets helps to explain why equity is a relatively important source of finance for American business. C) would not arise if the owners of the firm had complete information about the activities of the managers. D) explains why direct finance is more important than indirect finance as a source of business finance.

C

The recent Enron and Tyco scandals are an example of A) the free-rider problem. B) the adverse selection problem. C) the principal-agent problem. D) the ʺlemons problem.ʺ

C

Which of the following is not a benefit to an individual purchasing a mutual fund? A) reduced risk B) lower transactions costs C) free-riding D) diversification

C

Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true? A) Issuing marketable securities is the primary way that they finance their activities. B) Bonds are the least important source of external funds to finance their activities. C) Stocks are a relatively unimportant source of finance for their activities. D) Selling bonds directly to the American household is a major source of funding for American businesses.

C

A ________ is a provision that restricts or specifies certain activities that a borrower can engage in. A) residual claimant B) risk hedge C) restrictive barrier D) restrictive covenant

D

American businesses get their external funds primarily from A) bank loans. B) bonds and commercial paper issues. C) stock issues. D) loans from nonbank financial intermediaries.

D

As a source of funds for nonfinancial businesses, stocks are relatively more important in A) the United States. B) Germany. C) Japan. D) Canada.

D

Because of the ʺlemons problemʺ the price a buyer of a used car pays is A) equal to the price of a lemon. B) less than the price of a lemon. C) equal to the price of a peach. D) between the price of a lemon and a peach.

D

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do. A) principals; agents B) principals; principals C) agents; agents D) agents; principals

D

Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds A) by issuing stock. B) by issuing bonds. C) from nonbank loans. D) from bank loans.

D

Regulation of the financial system A) occurs only in the United States. B) protects the jobs of employees of financial institutions. C) protects the wealth of owners of financial institutions. D) ensures the stability of the financial system.

D

The analysis of how asymmetric information problems affect economic behavior is called ________ theory. A) uneven B) parallel C) principal D) agency

D

The ʺlemons problemʺ exists because of A) transactions costs. B) economies of scale. C) rational expectations. D) asymmetric information.

D

Which of the following is not one of the eight basic puzzles about financial structure? A) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. B) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets. C) Collateral is a prevalent feature of debt contracts for both households and business. D) There is very little regulation of the financial system.

D