Ch.8 Flashcards
Since they require less monitoring of firms, ________ contracts are used more frequently than ________ contracts to raise capital.
A. debt; equity
B. equity; stock
C. debt; loan
D. equity; debt
A
High net worth helps to diminish the problem of moral hazard problem by:
A. making the debt contract incentive compatible.
B. requiring the state to verify the debt contract.
C. collateralizing the debt contract.
D. giving the debt contract characteristics of equity contracts.
A
A venture capital firm protects its equity investment from moral hazard through which of the following means?
A. It requires a 50% stake in the company.
B. It prohibits the borrowing firm from replacing its management.
C. It places people on the board of directors to better monitor the borrowing firm’s activities.
D. It writes contracts that prohibit the sale of an equity investment to the venture capital firm.
C
A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called
A. moral hazard.
B. noncollateralized risk.
C. adverse selection.
D. asymmetric information.
D
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 restrict the borrower from changing his behavior once given a loan
C. the lender’s inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults.
D. the borrower’s lack of incentive to seek a loan for highly risky investments
A
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. moral hazard
B. adverse selection
C. agency
D. costly state verification
A
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
In the United States, the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the
A. Federal Communications Commission.
B. Federal Reserve System.
C. Federal Trade Commission.
D. Securities and Exchange Commission.
D
Solutions to the moral hazard problem include
A. monitoring and enforcement of restrictive covenants.
B. greater reliance on debt contracts than financial intermediaries.
C. low net worth.
D. greater reliance on equity contracts and less on debt contracts.
A
That most used cars are sold by intermediaries provides evidence that these intermediaries
A. have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars.
B. have failed to solve adverse selection problems in this market because “lemons” continue to be traded.
C. are able to prevent potential competitors from free-riding off the information that they provide.
D. have solved the moral hazard problem by providing valuable information to their customers.
C
A clause in a debt contract requiring that the borrower purchase insurance against loss of the asset financed with the loan is called a
A. proscription covenant.
B. restrictive covenant.
C. collateral-insurance clause.
D. prescription covenant.
B
Which of the following is NOT one of the eight basic puzzles about financial structure?
A. Collateral is a prevalent feature of debt contracts for both households and business.
B. Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower.
C. 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.
D. There is very little regulation of the financial system.
D
The reduction in transactions costs per dollar of investment as the size of transactions increases is
A. economies of scale.
B. economies of trade.
C. diversification.
D. discounting.
A
The “lemons problem” exists because of
A. economies of scale.
B. asymmetric information.
C. transactions costs.
D. rational expectations.
B
By bundling share purchases of many investors together mutual funds can take advantage of economies of scale and thereby lower
A. moral hazard.
B. adverse selection.
C. diversification.
D. transactions costs.
D
