ECON 343 Chapters 8-9

The "lemons problem" exists because of a) asymmetric information b) transactions costs c) economies of scales d) rational expectations

a) asymmetric information

Banks that actively manage liabilities will most likely meet a reserve shortfall by a) borrowing federal funds b) seeking new deposits c) selling municipal bonds d) calling in loans

a) borrowing federal funds

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) 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

A debt contract is incentive compatible a) if the borrower has the incentive to behave in a way that the lender expects and desires, since doing otherwise jeopardizes the borrower's net worth in the business b) if the borrower's net worth is sufficiently low so that the lender's 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) if the borrower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the borrower's net worth in the business

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

a) monitoring manager gives rise to costly state verification

Traders working for banks are subject to the a) principal-agent problem b) free-rider problem c) exchange-risk problem d) double-jeopardy problem

a) principal-agent problem

One purpose of regulation of financial markets is to a) promote the provision of information to shareholders, depositors, and the public b) increase competition among financial institutions c) limit the profits of financial institutions d) guarantee that the maximum rates of interest are paid on deposits

a) promote the provision of information to shareholders, depositors, and the public

Banks acquire the funds that they use to purchase income-earning assets from such sources as a) savings accounts b) reserves c) cash items in the process of collection d) deposits at other banks

a) savings accounts

Government regulations require publicly traded firms to provide information, reducing a) the adverse selection problem b) the need for diversification c) economies of scale d) transactions costs

a) the adverse selection problem

When $1 million is deposited at a bank, the requires reserve ratio is 20 percent, and the bank chooses not to make any loans but to hold excess reserves instead, then, in the bank's final balance sheet a) the assets at the bank increase by $1 million b) the liabilities of the bank decrease by $1 million c) reserves increase by $200,000 d) liabilities increase by $200,000

a) the assets at the bank increase by $1 million

Credit card debt is a) unsecured debt b) unrestricted debt c) restricted debt d) secured debt

a) unsecured debt

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

b) are claims to a share in the profits and assets of a business

Which of the following are transaction deposits? a) savings accounts b) checkable deposits c) certificates of deposit d) small-denomination time deposits

b) checkable deposits

When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in a) coercive bargaining b) credit rationing c) strategic holding out d) collusive behavior

b) credit rationing

Banks may borrow from or lend to another bank in the Federal Fund market. A loan of excess reserves from one bank to another bank is recorded as a(n) ___ for the borrowing bank and a(n) ___ for the lending bank a) asset; liability b) liability; asset c) asset; asset d) liability; liability

b) liability; asset

Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Fed, and borrowings from other banks to deal with deposit outflows is an example of a) liability management b) liquidity management c) managing credit risk d) managing interest rate risk

b) liquidity management

The problem faced by the lender that the borrower may take on additional risk after receiving the loan is called a) transactions costs b) moral hazard c) diversification d) adverse selection

b) moral hazard

The amount of checkable deposits that banks are required by regulation to hold are the a) total reserves b) required reserves c) vault cash d) excess reserves

b) required reserves

Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called a) return on assets b) return on equity c) return on capital d) return on investment

b) return on equity

Which of the following statements concerning external sources of financing for non financial businesses in the United States are true? a) selling bonds directly to the American household is a major source of funding for American businesses b) stocks are a relatively unimportant source of finance for their activities c) bonds are the least important source of external funds to finance their activities d) issuing marketable securities is the primary way that they finance their activities

b) stocks are a relatively unimportant source of finance for their activities

Which of the following is not one of the eight basic puzzles about financial structure? a) 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 b) stocks are the most important source of finance for American businesses c) banks are the most important source of external funds to finance businesses d) issuing marketable securities is not the primary way businesses finance their operations

b) stocks are the most important source of finance for American businesses

When banks calculate the losses the institution would incur if an unusual combination of bad events happened, the bank is using the ____ approach a) value-at-risk b) stress-test c) trading-loss d) maximum value

b) stress-test

In the absence of regulation, banks would probably hold a) too much capital, reducing the probability of banks b) too little capital c) too much capital, making to more difficult to obtain loans d) too much capital, reducing the efficiency of the payments system

b) too little capital

Examples of off-balance sheet activities include a) selling negotiable CDs b) trading activities c) borrowing from other banks d) extending loans to depositors

b) trading activities

All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ________ in interest rates will ________ bank profits a) a decline; not affect b) a decline; reduce c) an increase; reduce d) an increase; increase

c) an increase; reduce

The presence of ____ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets a) costly state verification b) free-riding c) asymmetric information d) noncollateralized risk

c) asymmetric information

Which of the following statements is FALSE? a) the bank's assets provide the bank with income b) a bank issues liabilities to acquire funds c) bank capital is recorded as an asset on the bank balance sheet d) a bank's assets are its uses of funds

c) bank capital is recorded as an asset on the bank balance sheet

In general, banks would prefer to acquire funds quickly by ___ rather than ___ a) reducing loans; borrowing from the Fed b) "calling in" loans; selling securities c) borrowing from the Fed; reducing loans d) reducing loans; selling securities

c) borrowing from the Fed; reducing loans

Asset transformation can be described as a) borrowing and lending only for the short term b) borrowing long and lending short c) borrowing short and lending long d) borrowing and lending for the long term

c) borrowing short and lending long

A lesson of the Enron collapse is that government regulation a) should be reduced b) always fail c) can reduce but not eliminate asymmetric information d) increases the problem of asymmetric information

c) can reduce but not eliminate asymmetric information

Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds a) by issuing stock b) by issuing bonds c) from bank loans d) from nonbank loans

c) from bank loans

Banks earn profits by selling ___ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy ___ with a different set of characteristics a) assets; liabilities b) loans; deposits c) liabilities; assets d) securities; deposits

c) liabilities; assets

A ____ is a provision that restricts or specifies certain activities that a borrower can engage in a) restrictive barrier b) risk hedge c) restrictive covenant d) residual claimant

c) restrictive covenant

Collateralized debt is also known as a) unsecured debt b) promissory debt c) secured debt d) unrestricted debt

c) secured debt

Of the four sources of external funding for non financial businesses, the least often used in the U.S. is a) bonds b) bank loans c) stock d) nonbank loans

c) stock

One reason financial systems in developing and transition countries are underdeveloped is a) they make loans only to nonprofit entities b) they have weak links to their governments 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) the legal system may be poor making it difficult to enforce restrictive covenants

By bundling share purchases of many investors together, mutual funds can take advantage of economies of scale and thereby lower a) adverse selection b) moral hazard c) transactions costs d) diversification

c) transactions costs

With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is a) $10 b) $100 c) $110 d) $90

d) $90

Since they require less monitoring of firms, ________ contracts are used more frequently than ________ contracts to raise capital a) equity; stock b) equity; debt c) debt; loan d) debt; equity

d) debt; equity

The _____ problem helps to explain why the private production and sale of information cannot eliminate _____ a) free-rider; moral hazard b) principal-agent; moral hazard c) principal-agent; adverse selection d) free-rider; adverse selection

d) free-rider; adverse selection

Off-balance sheet activities involving guarantees of securities and back-up credit lines a) greatly reduce the risk a bank faces b) slightly reduce the risk a bank faces c) have no impact on the risk a bank faces d) increase the risk a bank faces

d) increase the risk a bank faces

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) costly state verification b) agency c) adverse selection d) moral hazard

d) moral hazard

The goals of bank asset management include a) maximizing risk b) lending at high interest rates regardless of risk c) minimizing liquidity d) purchasing securities with high returns and low risk

d) purchasing securities with returns and low risk