Fi 412

A financial crisis occurs​ when:

a particularly large disruption to information flows occurs in financial markets.

The largest source of external finance for U.S. businesses is

banks and nonbank loans

Prior to​ 1986, Regulation Q gave the Federal Reserve the power to

limit competition between banks by placing a ceiling on the interest rates banks could pay on savings deposits.

Easily converted into cash

liquid

The relative ease and speed with which an asset can be converted into cash

liquidity

Suppose there is an increase in the growth rate of the money supply. If the liquidity effect is smaller than the​ income, price-level, and expected inflation​ effects, and if inflationary expectations adjust​ slowly, then in the short​ run, interest rates

fall

You would be _____ willing to buy a share of Microsoft stock if you expect gold to appreciate in value because

less, the return on gold relative to stocks has improved

You would be ____ willing to buy a house if you expect housing prices to fall because

less, the return on your house will actually be negative

You would be _____ willing to buy a house if you expect Microsoft stock to double in value next year because

less, the stock will earn you a very large return

You would be _____ willing to buy a share of Microsoft stock if the bond market becomes more liquid because

less, you can now sell bonds easier than stocks

A secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their prices

Over-the-counter (OTC) market

A major disruption in financial markets, characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms

financial crisis

Debt not guaranteed by collateral

unsecured debt

When the Federal Reserve decreases the growth rate of the money​ supply, the income effect causes the interest rate to _____ while the liquidity effect drives the interest rate _____

fall, up

With reference to a debt instrument, having a maturity of 10 years or more.

Long-term

Determine if the bond if long term, short term, intermediate term A 30-year corporate bond A money-market instrument with a maturity of 6 months A treasury note with a maturity of 5 or 10 years A 90-day Treasury Bill

Long-term Short-term Intermediate-term Short-term

A financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded

Money Market

A financial market in which only short term debt instruments are traded

Money market

______ is wealth that is used to produce more wealth

Capital

The development of new financial products and services

financial innovation

All resources owned by an individual, including all assets

wealth

Prime Maximum Safety (A,AA,AAA,B,D)

AAA

A collection of assets

Portfolio

Requires disclosures of information of financial instruments traded in organized exchanges

SEC

The interest rate that equates the present value of payments received from a credit market instrument with its value today

yield to maturity

Upper Medium Grade (A,AA,AAA,B,D)

A

What is the reason for the principal-agent problem?

A manager does not have sufficient incentive to maximize the​ company's profits

In which of the following ways could a financial intermediary promote risk​ sharing? ​(Check all that apply​.) A. Asset transformation B. ​All-eggs-in-one-basket approach C. Diversification of portfolio D. Liquidity services

A. Asset transformation C. Diversification of portfolio

In recent​ years, the dominance of U.S. markets has been disappearing because of​ _____ ​(Check all that apply.​) A. The deregulation of foreign financial markets. B. The large increase in the pool of savings in foreign financial markets. C. The strict regulation of foreign financial markets. D. The significant decrease in the pool of savings in foreign financial markets.

A. The deregulation of foreign financial markets. B. The large increase in the pool of savings in foreign financial markets.

Which of the following is true about techniques used to reduce asymmetric information​ problems? A. Screening is used before the​ transaction; monitoring is used after the transaction. B. Monitoring is used before the​ transaction; screening is used after the transaction. C. Both screening and monitoring are used after the transaction. D. Both screening and monitoring are used before the transaction.

A. Screening is used before the transaction; monitoring is used after the transaction

Which of the following is a tool used to reduce the​ principal-agent problem? A. Venture capital firms provide firms to new firms in exchange for equity and membership on the board of directors B. Stockholders reject plans for costly state verification C. Governments avoid regulating firms D. Firms issue equity instead of debt because the princpal-agent problem is smaller with equity

A. Venture capital firms provide firms to new firms in exchange for equity and membership on the board of directors

The government employs the following types of regulations in an attempt to ensure the soundness of our financial intermediaries except A. bolstering competition . B. disclosure C. restrictions on interest rates. D. restrictions on entry.

A. bolstering competition

High grade high quality (A,AA,AAA,B,D)

AA

The problem created by asymmetric information before the transaction occurs: The people who are the most undesirable from the other party's point of view are the ones who are most likely to want to engage in the financial transaction.

Adverse Selection

The analysis of how asymmetric information problems affect economic behavior

Agency theory

Gustavo is a young doctor who lives in a country with a relatively inefficient legal and financial system. When Gustavo applied for a​ mortgage, he found that banks usually required collateral for up to​ 300% of the amount of the loan. Why might banks require that much collateral in a financial system like​ Gustavo's country? As a​ result, when compared to other​ countries, we would expect​ Gustavo's nation to​ have:

An inefficient legal system implies weak property​ rights, and collateral helps banks recoup some of their loan if the borrower defaults. less investment and slower economic growth.

The process by which financial intermediaries turn risky assets into safer assets for investors by creating and selling assets with risk characteristics that people are comfortable with and then use the funds they acquire by selling these assets to purchase other assets that may have far more risk.

Asset transformation

An increase in asset price that are driven above their fundamental economic values by investor psychology

Asset-price bubble

The inequality of knowledge that each party to a transaction has about the other party.

Asymmetric Information

Certification by accounting firms that a business is adhering to standard accounting principles

Audits

Speculative (A,AA,AAA,B,D)

B

Which of the following demonstrates adverse​ selection? A. A borrower takes the funds from a loan to a casino and gambles. B. A builder obtained a loan to build a neighborhood comprised of houses that may sell for much lower than the originally posted price. C. A scientist applies for a loan but decides to scratch the original idea and proceeds to research a possible cure for cancer with a low probability of success but a high payoff if successful. D. A corporate officer uses the funds from the sale of securities to buy art for his office.

B. A builder obtained a loan to build a neighborhood comprised of houses that may sell for much lower than the originally posted price

Why do small savers find it beneficial to lend their funds to a financial​ intermediary? ​(Check all that apply.​) A. A financial intermediary operates on a no​ profit-no loss principle. B. A financial intermediary is better equipped to filter bad credit risks from good ones. C. A financial intermediary never faces any problems. D. A financial intermediary is competent in monitoring its lenders.

B. A financial intermediary is better equipped to filter bad credit risks from good ones. D. A financial intermediary is competent in monitoring its lenders.

Which of the following can be considered as an impact of the internationalization of financial​ markets? ​(Check all that apply.​) A. Foreign corporations and banks never raise funds from Americans. B. Foreigners provide funds to corporations in the United States and also help to finance the federal government. C. It leads to a less integrated world economy. D. American investors often seek investment opportunities abroad.

B. Foreigners provide funds to corporations in the United States and also help to finance the federal government. D. American investors often seek investment opportunities abroad.

Which of the following statements is​ true? A. Only a perpetuity can have a negative nominal interest rate. B. Only a coupon bond can have a negative nominal interest rate. C. Both a coupon bond and a perpetuity can have a negative nominal interest rate. D. Neither a coupon bond nor a perpetuity can have a negative nominal interest rate.

B. Only a coupon bond can have a negative nominal interest rate.

Which of the following reduces both adverse selection and moral hazard in a loan​ arrangement? A. monitoring the borrower closely after the loan is made. B. requiring that the borrower have high net worth C. asking the minimum wage worker to work harder to increase the profits of a store. D. asking for the​ borrower's credit history

B. requiring that the borrower have high net worth

In the theory of portfolio​ choice, which of the following will increase the quantity demanded of an​ asset? A. A decrease in the expected return on the asset relative to alternative assets B. An increase in the liquidity of the asset relative to alternative assets C. An increase in the risk of the asset relative to alternative assets D. A decrease in the wealth of the buyer

B. An increase in the liquidity of the asset relative to alternative assets

Which of the following is not true regarding primary and secondary markets? A. Primary markets and secondary markets are different markets B. Primary and secondary markets both sell assets directly from the institution that offers the bonds. C. Primary markets sell new issues of securities D. Secondary markets sell old issues of securities

B. Primary and secondary markets both sell assets directly from the institution that offers the bonds.

The tool to solve adverse selection problems are the following except A. financial intermediation B. monitoring of activities of the risky party after the transaction C. government regulation to increase information D. private production and sale of information

B. monitoring of activities of the risky party after the transaction

Which of the following is an investment​ intermediary? A. Pension funds B. Mutual funds C. A credit union D. Life insurance companies

B. mutual funds

The simultaneous failure of many banks, as during a financial crisis

Bank panic

Agents for investors who match buyers with sellers

Brokers

What do savers do in direct finance? What do borrowers do in indirect finance? What do savers do in direct finance? What do borrowers do indirect finance?

Buy securities Make deposits Sell securities Take out loans

Which of the following effects of the​ Sarbanes-Oxley Act discourages the foreign firms to list their companies in U.S. capital​ markets? A. The separation in audit and​ non-audit services B. An increase in severity of legal actions C. A rise in compliance cost D. Improved accounting standards

C. A rise in compliance cost

The​ principal-agent problem arises because of many reasons except the statement that indicates that A. Principals have incentives to free ride off the monitoring expenditures of other principals B. Principals find it difficult and costly to monitor agents' activities C. Agents incentives are always compatible with those of the principals D. Agents have information not readily available to the principal

C. Agents incentives are always compatible with those of the principals

Which of the following correctly lists a procedure used to reduce asymmetric information problems as well as the type of asymmetric information problem it​ reduces? A. Screening is used to reduce moral hazard. B. Monitoring is used to reduce adverse selection. C. Covenants are used to reduce moral hazard. D. All of the above correctly list a procedure and the type of problem it reduces.

C. Covenants are used to reduce moral hazard

The​ principal-agent problem arises because of many reasons except the statement that indicates that A. principals have incentives to free ride off the monitoring expenditures of other principals.principals have incentives to free ride off the monitoring expenditures of other principals. B. principals find it difficult and costly to monitor​ agents' activities. C. agents' incentives are always compatible with those of the principals.agents' incentives are always compatible with those of the principals. D. agents have information not readily available to the principal.

C. agents' incentives are always compatible with those of the principals.agents' incentives are always compatible with those of the principals.

Which of the following is an example of a restrictive covenant in a debt​ contract? A. allowing firms to opt out of periodic accounting reports B. encouraging borrowers to keep their collateral valuable C. requiring borrowers to have life insurance D. requiring borrowers to pay a high interest rate

C. requiring borrowers to have life insurance

Wealth, either financial or physical, that is employed to produce more wealth

Capital

A financial market in which longer-term debt (maturity of greater than one year) and equity instruments are traded

Capital Market

A market in which longer-term debt (generally those with original maturity of one year or greater) and equity instruments are traded

Capital Market

Property that is pledged to the lender to guarantee payment in the event that the borrower should be unable to make debt payments

Collateral

_____ is property that is pledged to a lender to guarantee payment in the event that the borrower is unable to make debt payments.

Collateral

Securities that pay out cash flows from subprime mortgage-backed securities

Collateralized debt obligation (CDO)

These financial intermediaries raise funds primarily by issuing checkable​ deposits, savings​ deposits, and time deposits. They then use these funds to make​ commercial, consumer, and mortgage loans and to buy U.S. government securities and municipal bonds.

Commercial Bank

Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold

Comptroller of the Currency

A manifestation of moral hazard in which one party in a financial contract has incentives to act in its own interest, rather than in the interests of the other party

Conflicts of interest

A manifestation of moral hazard in which one party in a financial contract has incentives to act in its own interest, rather than in the interests of the other party

Conflicts on Interest

Monitoring a firm's activities, an expensive process in both time and money

Costly state verification

These financial institutions are very small cooperative lending institutions organized around a particular​ group: union​ members, employees of a​ firm, and so forth. They acquire funds from deposits called shares and primarily make consumer loans.

Credit Unions

Why do credit spreads rise during financial​ crises?

Credit spreads rise because asymmetric information problems​ increase, making it more difficult to judge the risk of potential borrowers.

Investment advisory firms that rate the quality of corporate and municipal bonds in terms of the probability of default

Credit-rating agencies

Highly Speculative (A,AA,AAA,B,D)

D

Which of the following statements regarding direct finance is true​? A. Securities are assets for the firm that issues them and liabilities for the individual that buys them. B. In the United States, more funds flow through the direct financial channels than through indirect financial channels C. Direct finance requires the use of financial intermediaries D. Direct finance occurs when borrowers sell securities directly to lenders

D. Direct finance occurs when borrowers sell securities directly to lenders

Which of the following statements is true? A. Stocks and bonds are the largest source of external funds to businesses B. Firms raise more funds with bonds than with banks loans. C. Direct finance is much more important than indirect finance as a source of external funds to businesses D. Firms raise more funds with bonds than with stocks.

D. Firms raise more funds with bonds than with stocks.

The financial institutions providing multiple services develop a​ long-term relationship with their clients. Which of the following could not be a result of the​ same? A. The economy becomes less efficient B. Increase in asymmetric information problems C. Benefits to the financial institution D. Increase in the cost of producing information.

D. Increase in the cost of producing information

A market where bonds or mortgages, which are contractual agreements by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date when a final payment is made, are traded

Debt Market

Which of the following is associated with asymmetric information in a financial​ crisis? A. There is a lack of information about one or more of the parties involved in a transaction. B. Moral hazard could occur when only borrowers know if the funds will be used to finance​ high-risk activities. C. Adverse selection can occur if lenders must select from a pool of bad credit risks. D. All of the above are correct.

D. all of the above are correct

The following statements are NOT true except the ones that indicates that A. in the United States, bonds are a less important source of extreme funds than stocks B. Stocks are the most important source of external funds for businesses in the United States C. over 90% of American households own securities D. although banks are the most important source of external funds to businesses worldwide, their role is shrinking slightly over time.

D. although banks are the most important source of external funds to businesses worldwide, their role is shrinking slightly over time.

Financial markets improve economic welfare​ because: A. they allow consumers to time their purchases better B. they channel funds from savers to investors C. they eliminate the need for financial intermediaries D. both A and B are correct E. all of the above are correct

D. both a and b are correct

Extremely complicated legal documents that place restrictions on the borrower

Debt contracts

Which of the following plays the primary role in moving funds from lenders to​ borrowers? A. Securities market B. Debt market C. Stock market D. Financial intermediaries

D. financial intermediaries

A situation in which a substantial decline in the price level sets in, leading to a further deterioration in firms' net worth because of the increased burden of indebtedness

Debt deflation

The following are reasons why the yield to maturity can be less than than the return of a bond except that A. interest rates fluctuate over time. B. the time to maturity and the holding period are not the same. C. the price of the bond experiences sizable fluctuations that produce substantial capital gains or losses. D. the coupon payment over the purchase price remains the same.

D. the coupon payment over the purchase price remains the same

People who link buyers with sellers by buying and selling securities at stated prices

Dealers

A situation in which the party issuing a debt instrument is unable to make interest payments or pay off the amount owed when the instrument matures

Default

Bonds with no default risk, such as U.S. government bonds

Default-free bonds

When financial institutions cut back on their lending because they have less capital

Deleveraging

Investing in a collection (portfolio) of assets whose returns do not always move together, with the result that overall risk is lower than for individual assets

Diversification

The risk that one party to a transaction will engage in behavior that is undesirable from the other party's point of view

Moral Hazard

Your parents loan you money to pay your​ tuition, and you use the money to play online poker instead. This is an example of

Moral Hazard

A model whose equations are estimated using statistical procedures

Econometric model

Claims to share in the net income and assets of a corporation (such as common stock)

Equities

Bonds denominated in a currency other than that of the country in which they are sold

Eurobonds

Bonds issued by Axis bank in Germany that are denominated in U.S. dollars are _____

Eurobonds

Foreign currencies deposited in banks outside the home country

Eurocurrencies

US dollars that are deposited in foreign banks outside of the United States or in foreign branches of U.S. banks

Eurodollars

Who is the regulatory agency of Comptroller of the Currency?

Federally chartered commercial banks

Secondary markets in which buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades

Exchanges

The interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond.

Expectations Theory

The return on an asset expected over the next period

Expected Return

T/F: All the bonds denominated in euros are called Eurobonds

FALSE

T/F: Eurodollars are U.S. dollars deposited in U.S. banks.

FALSE

T/F: Financial intermediaries can increase transaction costs because they have developed expertise in​ it

FALSE

T/F: For a financial​ intermediary, there is a direct relationship between the transaction costs and the size​ (scale) of​ transactions:

FALSE

Provides Insurance of at $250,000 for each depositor at a bank, examines the books of insured banks, and imposes restrictions on assets they can hold

FDIC

Regulates agencies such as mutual savings banks and savings and loan associates

FDIC

T/F: According to the​ Sarbanes-Oxley Act, an accounting firm cannot provide consultancy on business strategy and advice on accounting to the same​ firm:

False

T/F: In regards to foreign stock market, American investors would pay attention exclusively to the Dow Jones Industrial​ Average

False

T/F: Publishing the​ analysts' recommendation for bonds and other products to the general public and investor as per the Global Legal Settlement will cause a decline in U.S. capital​ markets:

False

Examines the books of commercial banks that are members of the Federal Reserve System and sets reserve requirements for all banks.

Federal Reserve

____ are the most important source of external funds to finance businesses.

Financial Intermediaries

The process of indirect finance whereby financial intermediaries link lender-savers and borrower-spenders

Financial Intermediation

How can economies of scale help explain the existence of financial intermediaries?

Financial intermediaries are able to operate with lower transaction costs relative to individual lenders or borrowers

The elimination of restrictions on financial markets

Financial liberalization

The widespread collapse of financial markets and intermediaries in an economy

Financial panic

The outcome that when expected inflation occurs, interest rates will rise; named after economist Irving Fisher

Fisher effect

A credit market instrument that provides a borrower with an amount of money that is repaid by making a fixed payment periodically (usually monthly) for a set number of years

Fixed-payment loan

The specified final amount repaid at the maturity date of a coupon bond (also called par value)

face value

Bonds sold in a foreign country and denominated in that country's currency

Foreign bonds

The interest rate predicted by pure expectations theory of the term structure of interest rates to prevail in the future

Forward rate

____ is an issue that occurs when people who do not pay for information take advantage of the information that other people have paid for.

Free rider problem

The problem that occurs when people who do not pay for information take advantage of the information that other people have paid for

Free-rider problem

Who's the regulatory agency of Commodities Futures Trading Commission?

Futures market exchanges

A corporation's first sale of securities to the public

Initial public offering (IPO)

What effect would reducing income tax rates have on the interest rates of municipal​ bonds?

Interest rates would rise because the reduction in income tax rates would make the​ tax-exempt privilege for municipal bonds less valuable and reduce the demand for municipal bonds.

With reference to a debt instrument, having a maturity of between 1 and 10 years

Intermediate-term

A yield curve that is downward sloping

Inverted Yield Curve

List the type of financial institution: Finance Companies Commercial Banks Life Insurance Companies Savings and Loans Associations Credit Unions Mutual Funds Investment Banks Pension Funds

Investment Intermediary Depository Institution Contractual Savings Institution Depository Institution Depository Institution Investment Intermediary Investment Intermediary Contractual Savings Institution

A securities dealer who facilitates the transfer of securities from the original issuer to the public

Investment bank

Bonds rated lower than BBB by bond-rating agencies, not investment grade and are considered speculative, and usually have a high yield to compensate investors for their high risk

Junk bonds

IOUs or debts

Liabilites

_____ are debts or financial obligations that must be repaid.

Liabilities

The theory that the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a positive term premium

Liquidity premium theory

A theory of the term structure that sees markets for different maturity bonds as completely separated and segmented such that the interest rate for bonds of a given maturity is determined solely by supply and demand for bonds of that maturity

Market Segmentation Theory

A situation occurring when the quantity that people are willing to buy (demand) equals the quantity that people are willing to sell (supply)

Market equilibrium

A securities that is collateralized by a pool of mortgage loans

Mortgaged-backed security (securitized mortgage)

These financial intermediaries acquire funds by selling shares to many individuals and use the proceeds to purchase diversified portfolios of stocks and bonds.

Mutual Fund

Since the customer will be paying more than you are​ receiving, would it make sense for you to offer a loan to that individual at a higher rate than you will receive on your certificate of funds​ (but still competitively lower than the rate currently offered to the car loan​ borrower)?

No, the bank is more efficient than you at dealing with asymmetric information problems.

An interest rate that is not adjusted for inflation

Nominal interest rate

Examines the books of savings and loan associations and imposes restrictions on assets they can hold

Office of Thrift Supervision

Who is the regulatory agency of the SEC?

Organized exchanges and financial markets

A business model in which the mortgage is originated by a separate party, typically a mortgage broker, and then distributed to an investor as an underlying asset in a security

Originate-to-distribute model

What might lead to poor management when control and ownership are​ separate, like in many American​ corporations?

Principal-Agent Problem

Suppose the interest rate​ (and therefore the yield to​ maturity) increases by the same amount on Treasury bills and bonds. Between a​ one-year Treasury​ bill, and a​ twenty-year Treasury​ bond, an investor would prefer a

One-year Treasury Bill

A perpetual bond with no maturity date and no repayment of principal that makes periodic fixed payments forever

Perpetuity

The interest rate on a​ long-term bond will equal an average of​ short-term interest rates expected to occur over the life of the​ long-term bond plus a liquidity premium​ (also referred to as a term​ premium) that responds to supply and demand conditions for that bond.

Preferred habitat

A theory that assumes that investors have a preference for bonds of one maturity over another, a particular bond maturity (preferred habitat) in which they prefer to invest

Preferred habitat theory

_____ is based on the notion that a dollar paid in the future is less valuable than a dollar paid today

Present Discounted Value

Based on the commonsense notion that a dollar of cash flow paid to you one year from now is less valuable to you than a dollar paid to you today

Present value

A financial market in which new issues of a security are sold to initial buyers

Primary Market

A financial market in which new issues of a security, such as a bond or stock, are sold to initial buyers by the corporation or government agency borrowing the funds

Primary Market

The change in a security's price relative to the initial purchase price

Rate of capital gain

The spread between the interest rate on bonds with default risk and the interest rate on default-free bonds

Risk premium

The process by which financial intermediaries create and sell assets with risk characteristics that people are comfortable with and then use the funds they acquire bu selling these assets to purchase other assets that may have far more risk

Risk sharing

The relationship among the various interest rates on bonds with the same term to maturity

Risk structure of interest rates

The _____ made it a mandate for the credit rating agencies to disclose the method of research they used to rate the various products.

SEC

These depository institutions obtain funds primarily through savings deposits​ (often called​ shares) and time and checkable deposits. In the​ past, these institutions were constrained in their activities and mostly made mortgage loans for residential housing.

Savings and Loans

Who is the regulatory agency of Office of Thrift Supervision?

Savings and loan associations

A financial market in which securities that have been previously issued can be resold

Secondary Market

A financial market in which securities that have previously been issued can be resold.

Secondary market

The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities

Segmented Markets

Suppose the interest rates on​ one-, five-, and​ ten-year U.S. Treasury bonds are currently​ 3%, 6%, and​ 6%, respectively. Investor A chooses to hold only​ one-year bonds, and Investor B is indifferent with regard to holding​ five- and​ ten-year bonds. Which theories best explain the behavior of Investors A and​ B? Investor A's preference are best explained by the _____ theory, while Investor B's are best explained by the ____ theory.

Segmented markets, expectations

A system in which bank lending is replaced by lending via the securities market

Shadow banking system

A credit market instrument providing the borrower with an amount of funds that must be repaid to the lender at the maturity date along with an additional payment (interest)

Simple loan

Because of transaction costs in financial​ markets, we can say that

Some investors may find it more profitable to invest in something else other than financial markets

The top finance executive of a public listed company prefers investment bank A compared to investment bank B for its future business because of the previous personal equity gains from an IPO through investment bank A. This could be a result of

Spinning

A statistical indicator of an asset's risk

Standard deviation

Securities that are derived from cash flows of underlying assets and are tailored to have particular risk characteristics that appeal to investors with different preferences

Structures credit products

A curve depicting the relationship between quantity supplied and price when all other economic variables are held constant

Supply curve

T/F: Eurocurrencies are similar to​ short-term Eurobonds.

TRUE

T/F: Low transaction costs enable a financial intermediary to provide its customers with liquidity services.

TRUE

T/F: The large size of financial intermediaries allows them to take advantage of economies of​ scale:

TRUE

The hypothesis that the larger and more established is a corporation , the more likely it will be to issue securities to raise funds

pecking order hypothesis

What could be the fundamental reason for the downgrade of the reputation of the credit rating agencies in the​ 2007-2009 financial​ crisis?

The products rated least risky by the credit rating agencies defaulted.

Why does a financial crisis ultimately cause a substantial reduction in economic​ activity?

The resulting credit crash severely reduces investment for productive activities.

Describe two ways in which financial intermediaries help lower transaction costs in the economy.

They pool many small deposits together and specialize in loan risk assessment and other forms of expertise.

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

Thrift Institutions

_______ are savings and​ loans, mutual savings​ banks, and credit unions

Thrift Institutions

The time and money spent trying to exchange financial assets, goods, or services

Transaction costs

T/F: Foreign stock market growth has led to the development of mutual funds in the U.S. that specialize in foreign​ stocks

True

Guaranteeing prices on securities to corporations and then selling the securities to the public

Underwriting

n which country among the United​ States, Germany,​ Japan, and Canada do firms use bonds to the greatest degree when compared to the firms of the other​ countries?

United States

An institution in our financial structure that helps reduce the moral hazard arising from the​ principal-agent problem is​ the:

Venture capital firm

A plot of the interest rates for particular types of bond with different terms to maturity

Yield Curve

When bad credit risks have the most to gain from a loan so they most actively seek a​ loan, we have a demonstration of

adverse selection

_______ is an asymmetric information problem that occurs before the transaction.

adverse selection

When the funds are lent to those among potential borrowers who are actually the bad credit​ risks, it is the problem of _______ it occurs _____ the transaction

adverse selection, before

Regardless of the original source of the financial​ crisis, all credit booms end in a credit crash because of

an increase in adverse selection and moral hazard in the loan market.

Debt​ contracts:

are used more frequently to raise capital than are equity contracts

A financial claim or piece of property that is a store of value

asset

Determining asset prices using stocks of assets rather than flows

asset market approach

Both moral hazard and adverse selection are caused due to

asymmetric information

The inequality of information between borrowers and lenders in financial markets is broadly known​ as:

asymmetric information

The types of problems that occur when _____ arises are Moral Hazard and Adverse Selection.

asymmetric information

Relatively smaller companies are more likely than large, well-know to acquire funds through

banks

The difference between cash receipts and cash expenditures

cash flow

A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date, when a specified final amount is paid

coupon bond

The dollar amount of the yearly coupon payment expressed as a percentage of the face value of a coupon bond

coupon rate

A lending spree when financial institutions expand their lending at a rapid pace

credit boom

A transaction in which one party who wants to hedge credit risk pays a fixed payment on a regular basis, in return for a contingent payment that is triggered by a credit event such as the bankruptcy of a particular firm or the downgrading of the firm's credit rating by a credit rating agency

credit default swap

The difference between interest rates on loans to households and businesses and interest rates on completely safe assets such as U.S. Treasury bonds.

credit spread

The risk premium: the interest rate on bonds with default risks relative to the interest rate on default-free bonds like U.S. Treasury bonds

credit spread

A discount bond will have a negative nominal interest rate when​ the

current bond price is greater than its face value.

An approximation of the yield to maturity that equals the yearly coupon payment divided by the price of the coupon bond

current yield

A situation in which a substantial decline in the price level sets in, leading to a further deterioration in firms' net worth because of the increased burden of indebtedness

debt deflation

With higher losses on​ loans, financial institutions undergo ________ , the process of cutting back their lending to​ borrower-spenders.

deleveraging

Rising defaults from subprime mortgages led to a weakening of balance sheets of banks and other financial institutions. With less capital​ available, these financial institutions sold off assets and limited the availability of credit to households and businesses. This process is referred to​ as:

delveraging

A curve depicting the relationship between quantity demanded and price when all other economic variables are held constant

demand curve

Establishing a divide in research and underwriting services for investment banks and a separation of audit and​ non-audit services for the public accounting firm are measures to

directly reduce conflicts of interest

A credit market instrument that is bought at a price below its face value and whose face value is repaid at the maturity date; it does not make any interest payments (also know as a zero-coupon bond)

discount bond

Periodic payments made by equities to shareholders

dividends

The average lifetime of a debt security's stream of payments

duration

One solution to the problem of high transaction costs is to bundle the funds of many investors to take advantage of

economies of scale

Savings that can be achieved through increased size

economies of scale

Increased business that can be achieved by offering many products in one easy-to-reach location

economies of scope

Other things being the same, the financial instrument that is the most risky to own is the _______

equity

A drop in interest rates can mean that a bond has been​ a/an ____ investment

excellent

A situation in which quantity demanded is greater than quantity supplied

excess demand

A situation in which quantity supplied is greater than quantity demanded

excess supply

The theory that the interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond

expectations theory

Instruments that have payoffs that are linked to previously issued securities and are extremely useful risk-reduction tools

financial derivatives

The process of researching and developing new financial products and services that would meet customer needs and prove profitable

financial engineering

Asymmetric information problems that act as a barrier to financial markets channeling funds efficiently from savers to households and firms with productive investment opportunities

financial frictions

The seeds of a financial crisis are often sown when an economy introduces new types of financial products​, an event known as

financial innovation

The seeds of a financial crisis are often sown when an economy eliminates restrictions on financial markets and institutions, an event known as

financial liberalization

The quick sale of assets to raise necessary funds

fire sales

Bonds issued by Volkswagen in the United States that are denominated in U.S. dollars are _____

foreign bonds

The values of assets based on realistic expectations of the assets' future income streams

fundamental economic values

Requirements that borrowers have more collateral than the amount of the loan

haircuts

The government heavily regulates the financial system by

insuring the soundness of the financial system.

Suppose you go to a​ bank, intending to buy a certificate of deposit with your savings. Assume that the bank offers to pay you​ 2% interest on this certificate of deposit. A customer who comes into the same bank for a car loan is likely to be charged an interest rate ______ the​ 2% that you will receive.

higher than

Aligning the incentives of both parties to a contract

incentive-compatible

The two major policy measures of​ Sarbanes-Oxley Act and Global Legal Settlement of increased criminal charges on accounting firms and fines on investment banks were meant to

incentivize the investment banks not to derive benefits from conflicts of interest.

In the long​ run, if the​ output, price-level, and expected inflation effects outweigh the liquidity​ effect, to raise interest rates the Federal Reserve should

increase the growth rate of the money supply

Bonds whose interest and principal payments are adjusted for changes in the price level and whose interest rate thus provides a direct measure of a real interest rate

indexed bonds

The possible reduction in returns that is associated with changes in interest rates

interest-rate risk

Due to moral hazard and adverse selection,

lenders may decide not to make any loans

You would be ____willing to buy a share of Microsoft stock if your wealth falls because _____

less, you have less money to spend on all of your potential assets

Services that make it easier for customers to conduct transactions

liquidity services

Restrictive covenants

make debt contracts more incentive compatible.

Banks reduce the​ free-rider problem in information production by

making private, non-traded loans so other lenders cannot benefit from the information they have collected about the borrower.

Financial markets perform the basic function​ of:

matching savers with funds to lend to people who want to borrow funds

time to the expiration date of a debt instrument

maturity

The​ principal-agent problem causes

moral hazard

When borrowers engage in activities that reduce the probability of loans being paid back to​ lenders, it is the problem of _______ it occurs _______ the transaction

moral hazard, after

Problems created by asymmetric information after the transaction occurs is called​ ________, while the problem created before a transaction occurs is called​ ________.

moral​ hazard; adverse selection

You would be _____ willing to buy a house if prices in the stock market become more volatile because

more, stocks have become relatively more risky

You would be ____ willing to buy a share of Microsoft stock if prices in the bond market become more volatile because

more, stocks have become relatively safer than bonds

You would be _____ willing to buy a share of Microsoft stock if you expect the stock to appreciate in value because

more, you believe the amount of the return on your investment will be positive

You would be _____ willing to buy a house if you just inherited​ $100,000 because

more, you now have more wealth to spend on all assets

Because it buys large blocks of stocks or​ bonds, a ______ can take advantage of lower transaction costs.

mutual fund

sell shares and use the proceeds to buy diversified portfolios of stocks and bonds

mutual funds

The difference between a firm's assets (what it owns or owed) and its liabilities (what it owes)

net worth (equity capital)

​Defaults:

occur when a borrower cannot make his loan payments.

Financial crises

occur when information flows in financial markets experience a particularly large disruption.

A moral hazard problem that occurs when the managers in control (the agents) act in their own interest rather than in the interest of the owners (the principals) due to differing sets of incentives

principal-agent problem

The interest rate adjusted for expected changes in the price level (inflation) so that it more accurately reflects the true cost of borrowing

real interest rate

Terms reflecting actual goods and services on can buy

real terms

The interest-rate risk associated with the fact that the proceeds of a short-term investments must be reinvested at a future interest rate that is uncertain

reinvestment risk

A form of loan in which the borrower simultaneously contracts to sells securities and contracts to repurchase them, either on demand or on a specified date

repurchase agreement (repos)

Debt guaranteed by collateral

secured debt

Provisions that specify certain activities that a borrower can and cannot engage in

restrictive covenants

The payments to the owner of a security plus the change in the security's value, expressed as a fraction of its purchase price

return (rate of return)

Suppose there is​ a/an increase in the growth rate of the money supply. If the liquidity effect is smaller than the​ output, price-level, and expected inflation​ effects, then in the long​ run, interest rates

rise when compared to their initial value

Continuing on the same train of​ thought, when the Fed increases the growth rate of the money​ supply, the price level effect drives the interest rate _____ while the expected inflation rate pushes the interest rate to _____

rise, rise

The degree of uncertainty associated with the return on an asset

risk

A financial intermediary borrows funds from the ________ and then uses these funds to make loans to ________ It is an _____ way of finance.

savers, spenders indirect

The process of transforming illiquid financial assets into marketable capital market instruments

securitization

With reference to a debt instrument, having a maturity of one year or less

short-term

Mortgage loans made to borrowers who do not qualify for loans at the usual rate of interest due to a poor credit history

subprime mortgages

A​ well-functioning financial​ system:

solves asymmetric information problems.

When an investment bank allocates hot, but underpriced, initial public offerings, shares of newly issued stock, to executives of other companies in return for their companies' future business with the investment banks

spinning

The interest rate at a given moment

spot rate

Banks that are owned by governments

state-owned banks

Financial intermediaries

take advantage of expertise in computer technology

An increase in adverse selection and moral hazard in credit markets _______ bank lending.

tends to decrease

The relationship among interest rates on bonds with different terms to maturity

term structure of interest rates

The​ "lemons problem" applies to financial markets for many reasons except that

the market is large and efficient

You go into an electronics store to buy a​ big-screen television. A salesperson rudely tells you that​ he's too busy to help you now. He says​ you'll just have to wait. Then you watch him get a cup of coffee and take his break.​ You've just seen a demonstration of

the principal-agent problem

The theory that tells how much of an asset people want to hold in their portfolio

theory of portfolio choice

A financial intermediary that pools the resources of its partners and uses the funds to help entrepreneurs start up new businesses

venture capital firm

The financial intermediary that helps reduce the moral hazard arising from the​ principal-agent problem is known as

venture capital firm

Would interest rates of Treasury securities be affected by the tax rate​ change?

​Yes, because the reduction in the​ tax-exempt privilege in municipal bonds would raise the relative value of Treasury​ securities, making Treasury securities more desirable.