Ch. 8

Question 1

Stocks ARE/ARE NOT the most important source of external financing for businesses?

Answer 1

ARE NOT

Question 2

Issuing marketable debt and equity securities IS/IS NOT the primary way in which businesses finance their operations.

Answer 2

IS NOT

Question 3

True or False: 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.

Answer 3

TRUE

Question 4

TRUE OR FALSE: Financial Intermediaries , particularly banks, are the most important source of external funds used to finance businesses.

Answer 4

TRUE

Question 5

Only LARGE/SMALL corporations have easy access to securities markets to finance their activities.

Answer 5

LARGE, well established corporations.

Question 6

TRUE/FALSE: The financial system is does not have many regulations.

Answer 6

FALSE it is among the most heavily regulated sectors of the economy.

Question 7

TRUE/FALSE: Collateral is a prevalent feature of debt contracts for both households and businesses.

Answer 7

TRUE

Question 8

Collateral

Answer 8

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

Question 9

secured debt vs unsecured debt

Answer 9

secured debt uses collateral; unsecured debt does not have collateral and includes credit card debt. Unsecured debt is the predominant form of borrowing in households and in businesses.

Question 10

Debt contracts typically are extremely complicated legal documents that place substantial _____________ on the behavior of the borrower.

Answer 10

restrictions

Question 11

restrictive covenants

Answer 11

restrictions and specify certain activities that the borrower can engage in

Question 12

How do financial intermediaries reduce transaction costs?

Answer 12

Economies of Scale and Expertise

Question 13

Economies of scale allow for the __________ reduction in transaction cost per dollar invested. Economies of scale also allow for increased _________ in the portfolio, to reduce risk.

Answer 13

reduction; diversity

Question 14

the analysis of how asymmetric information problems affect economic behavior is called _____ ______.

Answer 14

agency theory

Question 15

The presence of _______ problems keeps securities markets from being effective in channeling funds from savers to borrowers.

Answer 15

lemon

Question 16

One strategy to reduce adverse selection problems is to use private companies that collect and product information on good firms and bad firms such as _________, _______, ________.

Answer 16

S&P, Moody’s, and Value Line

Question 17

free-rider program

Answer 17

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

Question 18

government _____________ help to increase information available; reducing the problem of adverse selection (and assymetric information)

Answer 18

regulations

Question 19

TRUE/FALSE: Regulations encourage firms to reveal honest information about themselves so that investors can determine how good or bad the firms are.

Answer 19

true

Question 20

net worth

Answer 20

aka equity capital - the difference between a arms assets and its liabilities

Question 21

TRUE/FALSE: collateral and high net worth can reduce adverse selection problems

Answer 21

True

Question 22

Principal-Agent Problem

Answer 22

When managers own only a small fraction of the firm they work for the stockholders who now most of the firm’s equity are the owners. – Managers in control (the agents) may act in their own interest rather that in the interest of the stockholder-owners (principals) because the mangers have less incentive to maximize profits than the stockholder-owners do.

Question 23

costly state verification

Answer 23

A moral hazard issue where audits by stockholders on firms - can be very expensive in terms of time and money

Question 24

governments everywhere have laws to force firms to adhere to standard accounting principles that make profit verification easier and pass laws to impost stiff penalties for fraud of hiding and stealing profits. These regulations help protect and reduct moral _______ problems.

Answer 24

hazard

Question 25

venture capital firm

Answer 25

pool the resources of their partners and use the funds to help budding entrepreneurs stat new businesses. will typically have board of directors that include investors so they can monitor the firms decisions.

Question 26

debt contracts help to reduce moral hazard how?

Answer 26

the investor doesn’t care about the ongoing supervision of firm, as long as they are getting their payments on time.

Question 27

restrictive convenants

Answer 27

provisions in debt contract that restrict the firms activities. Helps reduce moral hazard problems.

Question 28

4 types of restrictive covenants

Answer 28

1. to discourage undesirable behavior
2. to encourage desirable behavior
3. to keep collateral valuable
4. to provide information