FIN 390 ch1

The charter values of FIs will be higher if regulators

- increase the cost of entry by requiring more capital. - restrict the number of FIs that can operate in a given market.

FIs perform their intermediary function in two ways

1. they specialize as brokers between savers and users. 2. they serve as asset transformers by purchasing primary securities and issuing secondary securities.

In what year did housing prices begin to deteriorate leading to a jump in defaults in the subprime mortgage markets and the onset of the recent financial crisis?

2006

Which function of an FI reduces transaction and information costs between a corporation and individual which may encourage a higher rate of savings? A. Brokerage services. B. Asset transformation services. C. Information production services. D. Money supply management. E. Administration of the payments mechanism.

A. Brokerage Services

Which of the following refers to the possibility that a firm's owners or managers will take actions contrary to the promises contained in the covenants of the securities the firm issues to raise funds?

Agency Cost

In a world without FIs, households will be less willing to invest in corporate securities because they A. are not able to monitor the activities of the corporation more closely than FIs. B. tend to prefer shorter, more liquid securities. C. are subject to price risk when corporate securities are sold. D. may not have enough funds to purchase corporate securities. E. All of the above.

All of above

Many households place funds with financial institutions because many FI accounts provide A. lower denominations than other securities. B. flexible maturities verses other interest-earning securities. C. better liquidity than directly negotiated debt contracts. D. less price risk if interest rates change. E. All of the above.

All of above

Negative externalities exist in the depository sector when A. the fear of DI insolvency leads to bank deposit runs. B. lending activity is impaired or constrained. C. there are delays in disbursements from insolvent DIs. D. banks that are healthy suffer when another bank nears insolvency. E. All of the above.

All of above.

Why do households prefer to use FIs as intermediaries to invest their surplus funds? A. Transaction costs are low to the household since FIs are more efficient in monitoring and gathering investment information. B. To receive the benefits of diversification that households may not be able to achieve on their own. C. The FI has can benefit from combining funds and negotiating lower asset prices and transactions costs. D. The FI can provide insurance at relatively low cost that will protect funds under management. E. All of the above.

All of above.

Which of the following is NOT a major function of financial intermediaries? A. Brokerage services. B. Asset transformation services. C. Information production. D. Management of the nation's money supply. E. Administration of the payments mechanism.

D. Management of the nation's money supply.

Depository institutions (DIs) play an important role in the transmission of monetary policy from the Federal Reserve to the rest of the economy primarily because

DI deposits are a major portion of the money supply.

Which of the following statements is FALSE? A. A financial intermediary specializes in the production of information. B. A financial intermediary reduces its risk exposure by pooling its assets. C. A financial intermediary benefits society by providing a mechanism for payments. D. A financial intermediary may act as a broker to bring together funds deficit and funds surplus units. E. A financial intermediary acts as a lender of last resort.

E. A financial intermediary acts as a lender of last resort.

In its role as a delegated monitor, an FI A. keeps track of required interest and principal payments on loans it originates. B. works with financially distressed borrowers in danger of defaulting on their loans. C. holds portfolios of loans that they continue to service. D. maintains contact with borrowers to ensure that loan proceeds are utilized for intended purposes. E. All of the above.

E. All of above

What distinguishes financial intermediaries from industrial firms?

FI balance sheets are almost totally comprised of financial assets while commercial firms hold substantial amounts of real assets.

An FI is exposed to liquidity risk because the average maturity of assets and the average maturity of liabilities are often different on the FIs balance sheet.

False

Because bank loans have a shorter maturity than most debt contracts, FIs typically exercise less monitoring power and control over the borrower.

False

Commercial banks and finance companies have traditionally served the needs of the residential real estate market.

False

Credit allocation regulations are typically designed to benefit customers as well as the financial institution that must implement the guidelines.

False

FIs typically provide secondary claims to household savers that have inferior liquidity than primary securities of corporations such as equity and bonds.

False

Firms in industries that have low costs of entry tend to enjoy larger profits than firms in industries with high costs of entry.

False

In an attempt to enhance the net social welfare benefits of the services provided by financial intermediaries, safety and soundness regulation requires a DI to hold a minimum level of cash reserves against deposits.

False

Pension and mutual funds have a lower correlation between the maturities of their assets and liabilities than do commercial banks and thrifts.

False

Research shows that there is a significant reduction in risk achieved by investing in as few as 8 different securities.

False

Secondary securities are securities that serve as collateral for primary securities.

False

The Federal Reserve mandates reserve requirements for depository institutions so that the DIs may provide payment services for the U.S. economy.

False

The ability of savers to transfer wealth between youth and old age and across generations is called maturity intermediation.

False

The asset transformation function of an FI is to issue primary financial claims to corporations while purchasing primary claims issued by households and other investors.

False

The goal of credit allocation is the encouragement of FIs to diversity the composition of their assets.

False

The more costly it is to supervise the use of funds by a borrower, the less likely a saver will encounter agency costs.

False

The passage of legislation to ensure that FIs are meeting the needs of their local communities is an example of entry regulation.

False

The passage of legislation to prevent discrimination in lending is an example of regulation to protect investors.

False

The proportion of financial assets controlled by depository institutions has been increasing in recent years.

False

The qualified thrift lender test is utilized to determine whether an institution can serve as an FI.

False

The risk that the sale price of an asset will be less than the purchase price of an asset is called liquidity risk.

False

The standardization of many FI products is evidence of the inefficient institutionalization by financial markets and the mechanisms through which these products trade.

False

Time intermediation involves the investment of small amounts by investors into mutual funds that invest in long-term securities such as stocks and bonds.

False

When an FI functions as a broker, they are selling a financial asset that they have created and will continue to hold on their balance sheet.

False

Which of the following groups of FIs have experienced the highest percentage growth in assets in the U.S. financial services industry during the past sixty years?

Investment Companies

Which of the following is closely associated with credit allocation regulation?

Support the FI's lending to socially important sectors.

What is globalization?

The evolution of markets and institutions so that geographic boundaries do not restrict financial transactions.

Why is the failure of a large bank more detrimental to the economy than the failure of a large steel manufacturer?

The large bank failure reduces credit availability throughout the economy.

Which of the following is true of secondary securities?

They are securities that back primary securities.

An FI acting as an agent in matching savers and borrowers of funds can attain economies of scale and provide this service more efficiently than either the saver or borrower could on their own

True

As a delegated monitor, an FI's actions reduce agency costs.

True

As an asset transformer, the FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations.

True

Because of changes in regulatory barriers, technology, and financial innovation, a single financial service firm may now be able to offer a full set of financial services.

True

Depository institutions serve as the primary conduit through which monetary policy actions impact the economy.

True

FIs are independent market entities that create financial assets whose value is the transformation of financial risk.

True

Failure to monitor the actions of firms in a timely and complete fashion after purchasing securities in that firm exposes the investor to agency costs.

True

Financial institutions act as intermediaries between suppliers and demanders of money.

True

Financial institutions are subject to economies of scale in the collection of information.

True

If a household invests in corporate securities and does not supervise how the funds are invested or used by the corporation, the risk of not earning the desired return or not having the funds returned increase.

True

If not done by FIs, the process of monitoring the actions of borrowers would reduce the attractiveness and increase the risk of investing in corporate debt and equity by individuals.

True

In most countries, cash is required to be held in reserve against deposits

True

In recent years, the proportion of savings and demand deposits have decreased and the proportion of pension funds have increased in the financial assets held by U.S. households.

True

One reason for the increasing proportion of total financial assets controlled by pension funds and investment companies is that these intermediaries exploit the comparative advantages of size and diversification.

True

Regulation of FIs is an attempt to enhance the social welfare benefits and mitigate the social costs of providing FI services.

True

Savers increasingly favor investments that closely imitate diversified investments in the direct securities markets over the transformed financial claims offered by traditional FIs.

True

Services provided by depository institutions have become relatively less significant as a portion of all services provided by FIs

True

Small investors in mutual funds are often able to realize larger returns than they would receive from bank deposits.

True

The Internet has allowed individual investors to purchase securities while benefiting from decreased transactions costs.

True

The ability of diversification to eliminate much of the risk from the asset side of the balance sheet of an FI is the result of choosing assets that are less than perfectly positively correlated.

True

The adverse effects on the economy that can occur because of major disturbances to the special functions or services provided by financial institutions are negative externalities.

True

The efficiency with which FIs provide payment services directly benefits the economy.

True

The liabilities of depository institutions are significant components of the money supply.

True

The purpose of guaranty funds in safety and soundness regulation is to protect claim-holders when an FI collapses or fails.

True

Unfairly excluding some potential financial service consumers from the financial services marketplace is a reason why FIs must absorb net regulatory burden.

True

The asset transformation function of FIs typically involves

altering the liquidity and maturity features of funds sources used to finance the FI's asset portfolio.

The Community Reinvestment Act and the Home Mortgage Disclosure Act were both passed to provide incentives to comply with

consumer protection regulation.

Price and quantity restrictions in regulation are usually aimed at determining whether an FI is meeting certain

credit allocation guidelines

When a DI makes a shift from an "originate-to-hold" banking model to an "originate-to-distribute" model, the change is likely to result in

decreased monitoring costs

The federal government has traditionally extended safety nets to DIs consisting of

deposit insurance and discount window borrowing.

The following are protective mechanisms that have been developed by regulators to promote the safety and soundness of the banking system EXCEPT

encouraging banks to rely more on deposits rather than debt or capital as a cushion against failure.

Traditionally, regulation of FIs in the U.S. has been

extensive, as a result of the importance of FI to the economy.

Investment companies are successful in attracting business away from banks and insurance companies primarily because they

give savers cheaper access to the direct securities markets.

Net regulatory burden for FIs is higher because regulators may require the FI to

hold more capital than what would be held without regulation.

Advantages of depositing funds into a typical bank account instead of directly buying corporate securities include all of the following EXCEPT A. monitoring done by the bank on your behalf. B. increased liquidity if funds are needed quickly. C. increased transactions costs. D. less price risk when funds are needed. E. better diversification of deposited funds.

increased transactions costs.

Each of the following is a special function performed by FIs at a macro level EXCEPT

interbank lending and investing.

The housing bubble that began building in 2001 was primarily the result of

low interest rates and increased liquidity provided by the Federal Reserve.

A significant recent trend in the provision of financial services is that households increasingly prefer denomination intermediation and information services provided by

mutual funds and money market mutual funds.

Financial intermediaries are

neither funds surplus nor deficit units.

The origination of a home mortgage loan is considered to be a

primary security, because the mortgage note is a newly created security.

The recent financial crisis highlighted, in retrospect, how heavily households and businesses had come to rely on FIs to act as specialists in

risk measurement and management.

Verifying the minimum level of capital or equity that must be held to fund the operations of an FI is part of the goal of

safety and soundness regulation.

Safety and soundness regulations include all of the following layers of protection EXCEPT

the creation of money for those FIs in financial trouble.

As DIs made a shift from an "originate-to-hold" banking model to an "originate-to-distribute" model over the last decade,

there was a dramatic increase in systematic risk of the financial system.

Which of the following observations is true?

Bulk of the money supply consists of inside money.

Depository financial institutions include all of the following EXCEPT A. commercial banks. B. savings banks. C. investment banks. D. credit unions. E. all of the above are depository institutions.

C. investment banks.

All of the following are examples of participants in the shadow banking system EXCEPT

Credit Unions.

Nondepository financial institutions are represented by all of the following EXCEPT A. insurance companies. B. mutual funds. C. finance companies. D. credit unions. E. securities firms.

D. Credit Union

The reason FIs can offer highly liquid, low price-risk contracts to savers while investing in relatively illiquid and higher risk assets is A. because diversification allows an FI to predict more accurately the expected returns on its asset portfolio. B. significant amounts of portfolio risk are diversified away by investing in assets that have correlations between returns that are less than perfectly positive. C. because individual savers cannot benefit from risk diversification. D. because FIs have a cost advantage in monitoring their portfolios. E. All of the above.

All of the above

Economic collapse during the 1930s, the banking system in the U.S. performed directly or indirectly all financial services. Those functions included all of the following EXCEPT A. commercial banking. B. money market funds. C. investment banking. D. stock investing. E. insurance services.

B. money market funds.

Which of the following repealed the 1933 Glass-Steagall barriers between commercial banking, insurance, and investment banking?

Financial Services Modernization Act (1999).

How have the innovations of global financial networks and computerized money and information transfer systems changed financial intermediation?

Financial intermediation has become more costly because it is necessary to invest in high cost technology

Which of the following refers to the term "maturity intermediation"?

Mismatching the maturities of assets and liabilities.

Which of the following measures the difference between the private costs of regulations and the private benefits of those regulations for the producers of financial services?

Net regulatory burden.