ECON 131 CH 2
Equity and debt instruments with maturities greater than one year are called ___ market instruments.
Capital
Equity instruments are traded in the ___ market.
Capital
A short-term debt instrument issued by well-known corporations is called
Commercial paper
Which of the following instruments are traded in a money market?
Commercial paper
Adverse selection is a problem associated with equity and debt contracts arising from
The lender's relative lack of information about the borrower's potential returns and risks of his investment activities
Which of the following statements about financial markets and securities is TRUE?
The maturity of a debt instrument is the number of years(term) to that instrument's expiration date.
When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called an
exchange
A liquid asset
is an asset that can easily and quickly be sold to raise cash
Thrift institutions include
savings and loan associations, mutual savings banks, and credit unions.
Every financial market has the following characteristic:
It channels funds from lenders-savers to borrowers-spenders
Describe the two methods of organizing a secondary market.
1) Where buyers and sellers meet in one central location to conduct trades like the NYSE 2) Over-the-counter market, where dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices like federal funds market.
Long term debt has a maturity that is
10+ years
Which of the following is an example of an intermediate-term debt?
A 60 month car loan
Which of the following is a long-term financial instrument?
A U.S. treasury bond
A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called
A certificate of deposit
Which of the following instruments are traded in a capital market?
A corporate bond
Which of the following can be described as indirect finance?
A corporation issues new shares of stock
Which of the following is a depository institution?
A credit union
Which of the following financial intermediaries is NOT a depository institution?
A finance company
Distinguish between a foreign bond and a Eurobond.
A foreign bond is sold in a foreign country and priced in that country's currency. A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency.
Which of the following is a contractual savings institution?
A life insurance company
Which of the following is a depository institution?
A mutual savings bank
Which of the following are short-term financial instruments?
A repurchase agreement
If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of
Adverse selection
Because there is an imbalance of information in a lending situation, we must deal with the problems of adverse selection and moral hazard. Define these terms and explain how financial intermediaries can reduce these problems.
Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately. Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower.
Increasing the amount of information available to investors helps to reduce the problems of ________ and ________ in the financial markets.
Adverse selection; moral hazard
The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________.
Adverse selection; moral hazard
Well-functioning financial markets
Allow the economy to operate more efficiently
Collateral is ________ the lender receives if the borrower does not pay back the loan.
Asset
Securities are ___ for the person who buys them, but are ___ for the individual or firm that issues them.
Assets; liabilities
A goal of the Securities and Exchange Commission is to reduce problems arising from
Asymmetric information
Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. The difference in information is called
Asymmetric information
___ work in the secondary markets matching buyers with sellers of securities.
Brokers
U.S. Treasury bills are considered the safest of all money market instruments because there is a low probability of
Default
Financial institutions that accept deposits and make loans are called ________ institutions.
Depository
The primary liabilities of a commercial bank are
Deposits
With ___ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.
Direct
U.S. Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower purchase price than the amount you receive at maturity.
Discount
Reducing risk through the purchase of assets whose returns do not always move together is
Diversification
If Microsoft sells a bond in London and it is denominated in dollars, the bond is a
Eurobond
Bonds that are sold in a foreign country and are denominated in a currency OTHER than that of the country in which it is sold are known as
Eurobonds
US dollar deposits in foreign banks outside the US or in foreign branches of US banks are called
Eurodollars
The regulatory agency that sets reserve requirements for all banks is
Federal Reserve System
Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from
Financial intermediaries
In the United States, loans from ________ are far ________ important for corporate finance than are securities markets.
Financial intermediaries; more
If Toyota sells a $1000 bond in the United States, the bond is a
Foreign bond
Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as
Foreign bonds
Financial markets have the basic function of
Getting people with no funds to lend together with people who want to borrow funds
Which of the following is NOT a secondary market?
IPO market
The purpose of the disclosure requirements of the Securities and Exchange Commission is to
Increase the info available to investors
One reason for extraordinary growth of foreign financial markets is
Increases in the pool of savings in foreign countries
An important financial institution that assists in the initial sale of securities in the primary market is the
Investment bank
Secondary markets make financial instruments more
Liquid
Federal funds are
Loans made by banks to each other
Risk sharing is profitable for financial institutions due to
Low transaction costs
An important function of secondary markets is to
Make it easier to sell financial instruments to raise funds
Which of the following statements about financial markets and securities is TRUE?
Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as NYSE.
A financial market in which only short-term debt instruments are traded is called the ___ market.
Money
Because these securities are more liquid and generally have smaller price fluctuations, corporations and banks use the ___ securities to earn interest on temporary surplus funds.
Money market
An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.
Moral hazard
Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services.
Moral hazard
The higher a security's price in the secondary market the ___ funds a firm can raise by selling securities in the ___ market.
More; primary
Bonds issues by state and local governments are called ___ bonds.
Municipal
Which of the following are investment intermediaries?
Mutual funds
An important source of short-term funds for commercial banks are ________ which can be resold on the secondary market.
Negotiable CDs
In a(n) ___ market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices.
Over-the-counter
In order to reduce risk and increase the safety of financial institutions, commercial banks and other depository institutions are prohibited from
Owning common stock
Which of the following can be described as indirect finance?
People buy shares in a mutual fund
A corporation acquires new funds only when its securities are sold in the
Primary market by an investment bank
Economies of scale enable financial institutions to
Reduce transaction costs
How do regulators help to ensure the soundness of financial intermediaries?
Regulators restrict who can set up a financial intermediary, conduct regular examinations, restrict assets, and provide insurance to help ensure the soundness of financial intermediaries.
Which of the following are NOT traded in a capital market?
Repurchase agreements
Which of the following instruments is NOT traded in a money market?
Residential mortgages
Equity holders are a corporation's ___. That means the corporation must pay all of its debt holders before it pays its equity holders.
Residual claimants
The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as
Risk sharing
The process of asset transformation refers to the conversion of
Risky assets into safer assets
With direct finance, funds are channeled through the financial market from the ___ directly to the ___.
Savers; spenders
A financial market in which previously issued securities can be resold is called a ________ market.
Secondary
Benefits directly from any increase in the corporation's profitability:
Shareholder
If the maturity of a debt instrument is less than one year, the debt is called
Short-term
When I purchase ___, I own a portion of a firm and have the right to vote on issues important.
Stock
Corporations receive funds when their stock is sold in the primary market. Why do corporations pay attention to what is happening to their stock in the secondary market?
The existence of the secondary market makes their stock more liquid and the price in the secondary market sets the price that the corporation would receive if they choose to sell more stock in the primary market.
Prices of money market instruments undergo the least price fluctuations because of
The short terms to maturity for the securities
Financial markets improve economic welfare because
They allow consumers to time their purchase better
Which of the following statements about the characteristics of debt and equity is FALSE?
They can be both short-term financial instruments
Which of the following statements about the characteristics of debt and equity is TRUE?
They can both be long-term financial instruments
Government regulations to reduce the possibility of financial panic include all of the following EXCEPT
Transaction costs
The time and money spent in carrying out financial transactions are called
Transaction costs
Which of the following instruments are traded in a capital market?
U.S. government agency securities
Which of the following instruments are traded in a money market?
U.S. treasury bills
The most liquid securities traded in the capital market are
U.S. treasury bonds
Equity of US companies can be purchased by
US citizens and foreign citizens
When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public.
Underwrites
An investment bank purchases securities from a corporation at a predetermined price and then resells them in the market. This process is called
Underwriting
Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in the United States?
With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in the U.S.
Which of the following can be described as direct finance?
You borrow $2500 from a friend.
Which of the following can be described as indirect finance?
You buy shares in a mutual fund
Which of the following can be described as indirect finance?
You make a deposit at a bank
