Money and Banking Chapter 2

________ occurs when an informed party takes a hidden (unobserved) action that harms the less-informed party. A) Adverse selection B) Moral hazard C) Risk sharing D) Credit risk

B) Moral hazard

Which of the following statements about the characteristics of debt and equity is FALSE? A) They can both be long-term financial instruments. B) They can both be short-term financial instruments. C) They both involve a claim on the issuer's income. D) They both enable a corporation to raise funds.

B) They can both be short-term financial instruments.

Which of the following instruments are traded in a money market? A) state and local government bonds B) U.S. Treasury bills C) corporate bonds D) U.S. government agency securities

B) U.S. Treasury bills

Which of the following can be described as direct finance? A) You take out a mortgage from your local bank. B) You borrow $2,500 from a friend. C) You buy shares of common stock in the secondary market. D) You buy shares in a mutual fund.

B) You borrow $2,500 from a friend.

If the maturity of a debt instrument is less than one year, the debt is called A) short-term. B) intermediate-term. C) long-term. D) prima-term.

A) short-term.

Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) You buy shares in a mutual fund. C) You buy a U.S. Treasury bill from the U.S. Treasury at Treasury Direct.gov. D) You purchase shares in an initial public offering by a corporation in the primary market.

B) You buy shares in a mutual fund.

U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks are called A) Atlantic dollars. B) Eurodollars. C) foreign dollars. D) outside dollars.

B) Eurodollars.

Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as A) foreign bonds. B) Eurobonds. C) equity bonds. D) country bonds.

A) foreign bonds.

Which of the following can be described as involving direct finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys a short-term corporate security in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets.

A) A corporation issues new shares of stock.

________ bonds allow the holder to change them into a specific number of shares of stock at any time up to the maturity date. A) Convertible B) Treasury C) Municipal D) Commercial

A) Convertible

Financial markets have the basic function of A) getting people with funds to lend together with people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) providing a risk-free repository of spending power.

A) getting people with funds to lend together with people who want to borrow funds.

An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house.

A) investment bank.

Risk sharing is profitable for financial institutions due to A) low transactions costs. B) asymmetric information. C) adverse selection. D) moral hazard.

A) low transactions costs.

Financial intermediaries provide customers with liquidity services. Liquidity services A) make it easier for customers to conduct transactions. B) allow customers to have a cup of coffee while waiting in the lobby. C) are a result of the asymmetric information problem. D) are another term for asset transformation.

A) make it easier for customers to conduct transactions.

Assume that you borrow $2,000 at 10% annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is A) $400. B) $201. C) $200. D) $199.

B) $201.

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 A) foreign bonds. B) Eurobonds. C) equity bonds. D) country bonds.

B) Eurobonds.

________ work in the secondary markets matching buyers with sellers of securities. A) Dealers B) Underwriters C) Brokers D) Claimants

C) Brokers

The most liquid securities traded in the capital market are A) corporate bonds. B) municipal bonds. C) U.S. Treasury bonds. D) mortgage-backed securities.

C) U.S. Treasury bonds.

Equity of U.S. companies can be purchased by A) U.S. citizens only. B) foreign citizens only. C) U.S. citizens and foreign citizens. D) U.S. mutual funds only.

C) U.S. citizens and foreign citizens.

Forty or so dealers establish a "market" in these securities by standing ready to buy and sell them. A) secondary stocks B) surplus stocks C) U.S. government bonds D) common stocks

C) U.S. government bonds

Which of the following is a long-term financial instrument? A) a negotiable certificate of deposit B) a repurchase agreement C) a U.S. Treasury bond D) a U.S. Treasury bill

C) a U.S. Treasury bond

Which of the following benefits directly from any increase in the corporation's profitability? A) a bond holder B) a commercial paper holder C) a shareholder D) a T-bill holder

C) a shareholder

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 A) moral selection. B) risk sharing. C) asymmetric information. D) adverse hazard.

C) asymmetric information.

Equity instruments are traded in the ________ market. A) money B) bond C) capital D) commodities

C) capital

In the United States, loans from ________ are far ________ important for corporate finance than are securities markets. A) government agencies; more B) government agencies; less C) financial intermediaries; more D) financial intermediaries; less

C) financial intermediaries; more

You can borrow $5,000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is A) 25%. B) 12.5%. C) 10%. D) 5%.

D) 5%.

Which of the following is NOT a secondary market? A) foreign exchange market B) futures market C) options market D) IPO market

D) IPO market

Every financial market has the following characteristic. A) It determines the level of interest rates. B) It allows common stock to be traded. C) It allows loans to be made. D) It channels funds from lenders-savers to borrowers-spenders.

D) It channels funds from lenders-savers to borrowers-spenders.

Which of the following can be described as involving direct finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys a short-term corporate security in a secondary market. D) People buy shares of common stock in the primary markets.

D) People buy shares of common stock in the primary markets.

Which of the following statements about financial markets and securities is TRUE? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is intermediate term if its maturity is ten years or longer. D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date.

D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date.

Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) A corporation buys a share of common stock issued by another corporation in the primary market. C) You buy a U.S. Treasury bill from the U.S. Treasury at TreasuryDirect.gov. D) You make a deposit at a bank.

D) You make a deposit at a bank.

Well-functioning financial markets A) cause inflation. B) eliminate the need for indirect finance. C) cause financial crises. D) allow the economy to operate more efficiently.

D) allow the economy to operate more efficiently.

With ________ finance, borrowers obtain funds from lenders by selling them securities in the financial markets. A) active B) determined C) indirect D) direct

D) 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. A) premium B) collateral C) default D) discount

D) discount

Federal funds are A) funds raised by the federal government in the bond market. B) loans made by the Federal Reserve System to banks. C) loans made by banks to the Federal Reserve System. D) loans made by banks to each other.

D) loans made by banks to each other.

An example of economies of scale in the provision of financial services is A) investing in a diversified collection of assets. B) providing depositors with a variety of savings certificates. C) hiring more support staff so that customers don't have to wait so long for assistance. D) spreading the cost of writing a standardized contract over many borrowers.

D) spreading the cost of writing a standardized contract over many borrowers.

Securities are ________ for the person who buys them, but are ________ for the individual or firm that issues them. A) assets; liabilities B) liabilities; assets C) negotiable; nonnegotiable D) nonnegotiable; negotiable

A) assets; liabilities

If Microsoft sells a bond in London and it is denominated in dollars, the bond is a A) Eurobond. B) foreign bond. C) British bond. D) currency bond.

A) Eurobond.

If Volkswagen, a German company, sells a euro-denominated bond in London, the bond is a A) Eurobond. B) foreign bond. C) currency bond. D) Duetsche bond.

A) Eurobond.

Which of the following statements about financial markets and securities is TRUE? A) Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as the New York Stock Exchange. B) As a corporation gets a share of the broker's commission, a corporation acquires new funds whenever its securities are sold. C) Capital market securities are usually more widely traded than shorter-term securities and so tend to be more liquid. D) Prices of capital market securities are usually more stable than prices of money market securities, and so are often used to hold temporary surplus funds of corporations.

A) Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as the New York Stock Exchange.

________ are short-term loans in which Treasury bills serve as collateral. A) Repurchase agreements B) Negotiable certificates of deposit C) Federal funds D) U.S. government agency securities

A) Repurchase agreements

Which of the following statements about the characteristics of debt and equities is TRUE? A) They can both be long-term financial instruments. B) Bond holders are residual claimants. C) The income from bonds is typically more variable than that from equities. D) Bonds pay dividends.

A) They can both be long-term financial instruments.

Which of the following instruments are traded in a capital market? A) U.S. Government agency securities B) negotiable bank CDs C) repurchase agreements D) U.S. Treasury bills

A) U.S. Government agency securities

Which of the following are short-term financial instruments? A) a repurchase agreement B) a share of Walt Disney Corporation stock C) a Treasury note with a maturity of four years D) a residential mortgage

A) a repurchase agreement

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) adverse selection; moral hazard

A liquid asset is A) an asset that can easily and quickly be sold to raise cash. B) a share of an ocean resort. C) difficult to resell. D) always sold in an over-the-counter market.

A) an asset that can easily and quickly be sold to raise cash.

Mortgage-backed securities are similar to ________ but the interest and principal payments are backed by the individual mortgages within the security. A) bonds B) stock C) repurchase agreements D) negotiable CDs

A) bonds

Equity and debt instruments with maturities greater than one year are called ________ market instruments. A) capital B) money C) federal D) benchmark

A) capital

A short-term debt instrument issued by well-known corporations is called A) commercial paper. B) corporate bonds. C) municipal bonds. D) commercial mortgages.

A) commercial paper.

Well functioning financial markets benefit ________ by allowing them to time their purchases more efficiently. A) consumers B) lenders C) creditors D) cashiers

A) consumers

Which of the following instruments are traded in a capital market? A) corporate bonds B) U.S. Treasury bills C) negotiable bank CDs D) repurchase agreements

A) corporate bonds

Reducing risk through the purchase of assets whose returns do not always move together is A) diversification. B) intermediation. C) intervention. D) discounting.

A) diversification.

A Japanese firm issues foreign bonds in the United State. The firm will pay bond payments in A) dollars. B) yen. C) either dollars or yen. D) a currency that the firm decides.

A) dollars.

If Microsoft issues eurobonds in Japan, it will pay bond payments in A) dollars. B) yen. C) either dollars or yen. D) a currency that the firm decides.

A) dollars.

When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called a(n) A) exchange. B) over-the-counter market. C) common market. D) barter market.

A) exchange.

If Toyota (headquarters in Japan) sells a $1,000 bond in the United States, the bond is a A) foreign bond. B) Eurobond. C) Tokyo bond. D) currency bond.

A) foreign bond.

An important function of secondary markets is to A) make it easier to sell financial instruments to raise funds. B) raise funds for corporations through the sale of securities. C) make it easier for governments to raise taxes. D) create a market for newly constructed houses.

A) make it easier to sell financial instruments to raise funds.

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. A) money market B) capital market C) bond market D) stock market

A) money market

U.S. Treasury bills are traded in the A) money market B) stock market C) capital market D) equity market

A) money market

The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market. A) more; primary B) more; secondary C) less; primary D) less; secondary

A) more; primary

An important source of short-term funds for commercial banks are ________ which can be resold on the secondary market. A) negotiable CDs B) commercial paper C) mortgage-backed securities D) municipal bonds

A) negotiable CDs

A corporation acquires new funds only when its securities are sold in the A) primary market by an investment bank. B) primary market by a stock exchange broker. C) secondary market by a securities dealer. D) secondary market by a commercial bank.

A) primary market by an investment bank.

Economies of scale enable financial institutions to A) reduce transactions costs. B) avoid the asymmetric information problem. C) avoid adverse selection problems. D) reduce moral hazard.

A) reduce transactions costs.

Which of the following instruments is NOT traded in a money market? A) residential mortgages B) U.S. Treasury Bills C) negotiable bank certificates of deposit D) commercial paper

A) residential mortgages

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as A) risk sharing. B) risk aversion. C) risk neutrality. D) risk selling.

A) risk sharing.

With direct finance, funds are channeled through the financial market from the ________ directly to the ________. A) savers; spenders B) spenders; investors C) borrowers; savers D) investors; savers

A) savers; spenders

Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) the borrower's lack of good options for obtaining funds.

A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.

Prices of money market instruments undergo the least price fluctuations because of A) the short terms to maturity for the securities. B) the heavy regulations in the industry. C) the price ceiling imposed by government regulators. D) the lack of competition in the market.

A) the short terms to maturity for the securities.

When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public. A) underwrites B) undertakes C) overwrites D) overtakes

A) underwrites

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) commercial paper. B) a certificate of deposit. C) a municipal bond. D) federal funds.

B) a certificate of deposit.

Which of the following is an example of an intermediate-term debt? A) a fifteen-year mortgage B) a sixty-month car loan C) a six-month loan from a finance company D) a thirty-year U.S. Treasury bond

B) a sixty-month car loan

If the bad credit risks actively seek out a loan and are thus more likely to be selected, then financial intermediaries face the problem of A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification.

B) adverse selection.

Collateral is ________ the lender receives if the borrower does not pay back the loan. A) a liability B) an asset C) a present D) an offering

B) an asset

U.S. 30-year Treasury bonds are traded in the A) money market B) capital market C) stock market D) equity market

B) capital market

Which of the following instruments are traded in a money market? A) bank commercial loans B) commercial paper C) state and local government bonds D) residential mortgages

B) commercial paper

U.S. Treasury bills are considered the safest of all money market instruments because there is a low probability of A) defeat. B) default. C) desertion. D) demarcation.

B) default.

The concept of diversification is captured by the statement A) don't look a gift horse in the mouth. B) don't put all your eggs in one basket. C) it never rains, but it pours. D) make hay while the sun shines.

B) don't put all your eggs in one basket.

The process of indirect finance using financial intermediaries is called A) direct lending. B) financial intermediation. C) resource allocation. D) financial liquidation.

B) financial intermediation.

One reason for the extraordinary growth of foreign financial markets is A) decreased trade. B) increases in the pool of savings in foreign countries. C) the recent introduction of the foreign bond. D) slower technological innovation in foreign markets.

B) increases in the pool of savings in foreign countries.

A financial market in which only short-term debt instruments are traded is called the ________ market. A) bond B) money C) capital D) stock

B) money

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. A) adverse selection B) moral hazard C) risk sharing D) credit risk

B) moral hazard

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. A) exchange B) over-the-counter C) common D) barter

B) over-the-counter

A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank.

B) primary market by an investment bank.

A financial market in which previously issued securities can be resold is called a ________ market. A) primary B) secondary C) tertiary D) used securities

B) secondary

Financial markets improve economic welfare because A) they channel funds from investors to savers. B) they allow consumers to time their purchase better. C) they weed out inefficient firms. D) they eliminate the need for indirect finance.

B) they allow consumers to time their purchase better.

A Japanese firm issues eurobonds in the United State. The firm will pay bond payments in A) dollars. B) yen. C) either dollars or yen. D) euros.

B) yen.

If Microsoft issues foreign bonds in Japan, it will pay bond payments in A) dollars. B) yen. C) either dollars or yen. D) euros.

B) yen.

Since the value of Argentine peso is much more volatile than that of the U.S. dollar, to successfully raise funds in the United States, an Argentinian company would issue ________ in the U.S. A) eurodollars B) eurobonds C) foreign bonds D) europesos

C) foreign bonds

The principal lender-savers are A) governments. B) businesses. C) households. D) foreigners.

C) households.

Secondary markets make financial instruments more A) solid. B) vapid. C) liquid. D) risky.

C) liquid.

Bonds issued by state and local governments are called ________ bonds. A) corporate B) Treasury C) municipal D) commercial

C) municipal

A breakdown of financial markets can result in A) financial stability. B) rapid economic growth. C) political instability. D) stable prices.

C) political instability.

Microsoft raises funds by selling bonds to an investment company in the ________ market. This is an example of ________ finance. A) secondary; direct B) primary; direct C) primary; indirect D) secondary; indirect

C) primary; indirect

Which of the following are NOT traded in a capital market? A) U.S. government agency securities B) state and local government bonds C) repurchase agreements D) corporate bonds

C) repurchase agreements

Equity holders are a corporation's ________. That means the corporation must pay all of its debt holders before it pays its equity holders. A) debtors B) brokers C) residual claimants D) underwriters

C) residual claimants

The process of asset transformation refers to the conversion of A) safer assets into risky assets. B) safer assets into safer liabilities. C) risky assets into safer assets. D) risky assets into risky liabilities.

C) risky assets into safer assets.

New York Stock Exchange (NYSE) is a ________ market as well as a ________ market. A) primary; money B) secondary; money C) secondary; capital D) primary; capital

C) secondary; capital

When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors. A) bonds B) bills C) notes D) stock

D) stock

Long-term debt has a maturity that is A) between one and ten years. B) less than a year. C) between five and ten years. D) ten years or longer.

D) ten years or longer.

The time and money spent in carrying out financial transactions are called A) economies of scale. B) financial intermediation. C) liquidity services. D) transaction costs.

D) transaction costs.