Chapter 2

Question 1

Every financial market performs the following function:
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.

Answer 1

D

Question 2

Financial markets have the basic function of
A) bringing together people with funds to lend and 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) both A and B of the above.
E) both B and C of the above.

Answer 2

A

Question 3

Which of the following can be described as involving direct finance?
A) A corporation’s stock is traded in an over-the-counter market.
B) People buy shares in a mutual fund.
C) A pension fund manager buys commercial paper in the secondary market.
D) An insurance company buys shares of common stock in the over-the-counter markets.
E) None of the above.

Answer 3

E

Question 4

Which of the following can be described as involving direct finance?
A) A corporation’s stock is traded in an over-the-counter market.
B) A corporation buys commercial paper issued by another corporation.
C) A pension fund manager buys commercial paper from the issuing corporation.
D) Both A and B of the above.
E) Both B and C of the above.

Answer 4

B

Question 5

Which of the following can be described as involving indirect finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys commercial paper in a secondary market.
D) All of the above.
E) Only A and B of the above.

Answer 5

E

Question 6

Which of the following can be described as involving indirect finance?
A) A bank buys a U.S. Treasury bill from one of its depositors.
B) A corporation buys commercial paper issued by another corporation.
C) A pension fund manager buys commercial paper in the primary market.
D) Both A and C of the above.

Answer 6

D

Question 7

Financial markets improve economic welfare because
A) they allow funds to move from those without productive investment opportunities to those who have such opportunities.
B) they allow consumers to time their purchases better.
C) they weed out inefficient firms.
D) they do all of the above.
E) they do A and B of the above.

Answer 7

E

Question 8

A country whose financial markets function poorly is likely to
A) efficiently allocate its capital resources.
B) enjoy high productivity.
C) experience economic hardship and financial crises.
D) increase its standard of living.

Answer 8

C

Question 9

Which of the following are securities?
A) A certificate of deposit
B) A share of Texaco common stock
C) A Treasury bill
D) All of the above
E) Only A and B of the above

Answer 9

D

Question 10

Which of the following statements about the characteristics of debt and equity are true?
A) They both can be long-term financial instruments.
B) They both involve a claim on the issuer’s income.
C) They both enable a corporation to raise funds.
D) All of the above.
E) Only A and B of the above.

Answer 10

D

Question 11

The money market is the market in which \_\_\_\_\_\_\_\_ are traded.
A) new issues of securities
B) previously issued securities
C) short-term debt instruments
D) long-term debt and equity instruments

Answer 11

C

Question 12

Long-term debt and equity instruments are traded in the \_\_\_\_\_\_\_\_ market.
A) primary
B) secondary
C) capital
D) money

Answer 12

C

Question 13

Which of the following are primary markets?
A) The New York Stock Exchange
B) The U.S. government bond market
C) The over-the-counter stock market
D) The options markets
E) None of the above

Answer 13

E

Question 14

Which of the following are secondary markets?
A) The New York Stock Exchange
B) The U.S. government bond market
C) The over-the-counter stock market
D) The options markets
E) All of the above

Answer 14

E

Question 15

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.

Answer 15

B

Question 16

Intermediaries who are agents of investors and match buyers with sellers of securities are called
A) investment bankers.
B) traders.
C) brokers.
D) dealers.
E) none of the above.

Answer 16

C

Question 17

Intermediaries who link buyers and sellers by buying and selling securities at stated prices are called
A) investment bankers.
B) traders.
C) brokers.
D) dealers.
E) none of the above.

Answer 17

D

Question 18

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.

Answer 18

A

Question 19

Which of the following statements about financial markets and securities are true?
A) Most common stocks are traded over-the-counter, although the largest corporations have their shares traded at organized stock exchanges such as the New York Stock Exchange.
B) A corporation acquires new funds only when its securities are sold in the primary market.
C) Money market securities are usually more widely traded than longer-term securities and so tend to be more liquid.
D) All of the above are true.
E) Only A and B of the above are true.

Answer 19

D

Question 20

Which of the following statements about financial markets and securities are 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 long term if its maturity is ten years or longer.
D) The maturity of a debt instrument is the time (term) that has elapsed since it was issued.

Answer 20

C

Question 21

Which of the following statements about financial markets and securities are true?
A) Few common stocks are traded over-the-counter, although the over-the-counter markets have grown in recent years.
B) A corporation acquires new funds only when its securities are sold in the primary market.
C) Capital market securities are usually more widely traded than longer-term securities and so tend to be more liquid.
D) All of the above are true.
E) Only A and B of the above are true.

Answer 21

B

Question 22

Which of the following markets is sometimes organized as an over-the-counter market?
A) The stock market
B) The bond market
C) The foreign exchange market
D) The federal funds market
E) all of the above

Answer 22

E

Question 23

Bonds that are sold in a foreign country and are denominated in that country's currency are known as
A) foreign bonds.
B) Eurobonds.
C) Eurocurrencies.
D) Eurodollars.

Answer 23

A

Question 24

Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as
A) foreign bonds.
B) Eurobonds.
C) Eurocurrencies.
D) Eurodollars.

Answer 24

B

Question 25

Financial intermediaries
A) exist because there are substantial information and transaction costs in the economy.
B) improve the lot of the small saver.
C) are involved in the process of indirect finance.
D) do all of the above.
E) do only A and B of the above.

Answer 25

D

Question 26

The main sources of financing for businesses, in order of importance, are
A) financial intermediaries, issuing bonds, issuing stocks.
B) issuing bonds, issuing stocks, financial intermediaries.
C) issuing stocks, issuing bonds, financial intermediaries.
D) issuing stocks, financial intermediaries, issuing bonds.

Answer 26

A

Question 27

The presence of transaction costs in financial markets explains, in part, why
A) financial intermediaries and indirect finance play such an important role in financial markets.
B) equity and bond financing play such an important role in financial markets.
C) corporations get more funds through equity financing than they get from financial intermediaries.
D) direct financing is more important than indirect financing as a source of funds.

Answer 27

A

Question 28

Financial intermediaries can substantially reduce transaction costs per dollar of transactions because their large size allows them to take advantage of
A) poorly informed consumers.
B) standardization.
C) economies of scale.
D) their market power.

Answer 28

C

Question 29

The purpose of diversification is to
A) reduce the volatility of a portfolio’s return.
B) raise the volatility of a portfolio’s return.
C) reduce the average return on a portfolio.
D) raise the average return on a portfolio.

Answer 29

A

Question 30

An investor who puts all her funds into one asset \_\_\_\_\_\_\_\_ her portfolio's \_\_\_\_\_\_\_\_.
A) increases; diversification
B) decreases; diversification
C) increases; average return
D) decreases; average return

Answer 30

B

Question 31

Through risk-sharing activities, a financial intermediary \_\_\_\_\_\_\_\_ its own risk and \_\_\_\_\_\_\_\_ the risks of its customers.
A) reduces; increases
B) increases; reduces
C) reduces; reduces
D) increases; increases

Answer 31

B

Question 32

The presence of \_\_\_\_\_\_\_\_ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets.
A) noncollateralized risk
B) free-riding
C) asymmetric information
D) costly state verification

Answer 32

C

Question 33

When the lender and the borrower have different amounts of information regarding a transaction, \_\_\_\_\_\_\_\_ is said to exist.
A) asymmetric information
B) adverse selection
C) moral hazard
D) fraud

Answer 33

A

Question 34

When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, \_\_\_\_\_\_\_\_ is said to exist.
A) asymmetric information
B) adverse selection
C) moral hazard
D) fraud

Answer 34

B

Question 35

When the borrower engages in activities that make it less likely that the loan will be repaid, \_\_\_\_\_\_\_\_ is said to exist.
A) asymmetric information
B) adverse selection
C) moral hazard
D) fraud

Answer 35

C

Question 36

The concept of adverse selection helps to explain
A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets.
B) why indirect finance is more important than direct finance as a source of business finance.
C) why direct finance is more important than indirect finance as a source of business finance.
D) only A and B of the above.
E) only A and C of the above.

Answer 36

D

Question 37

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 percent loss if the borrower defaults.
C) the borrower’s lack of incentive to seek a loan for highly risky investments.
D) none of the above.

Answer 37

A

Question 38

When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the
A) moral hazard problem.
B) adverse selection problem.
C) shirking problem.
D) free-rider problem.
E) principal-agent problem.

Answer 38

B

Question 39

Successful financial intermediaries have higher earnings on their investments because they are better equipped than individuals to screen out good from bad risks, thereby reducing losses due to
A) moral hazard.
B) adverse selection.
C) bad luck.
D) financial panics.

Answer 39

B

Question 40

In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called
A) comparative informational disadvantage.
B) asymmetric information.
C) variant information.
D) caveat venditor.

Answer 40

B

Question 41

Which of the following financial intermediaries are depository institutions?
A) A savings and loan association
B) A commercial bank
C) A credit union
D) All of the above
E) Only A and C of the above

Answer 41

D

Question 42

Which of the following is a contractual savings institution?
A) A life insurance company
B) A credit union
C) A savings and loan association
D) A mutual fund

Answer 42

A

Question 43

Which of the following are not investment intermediaries?
A) A life insurance company
B) A pension fund
C) A mutual fund
D) Only A and B of the above

Answer 43

D

Question 44

Which of the following are investment intermediaries?
A) Finance companies
B) Mutual funds
C) Pension funds
D) All of the above
E) Only A and B of the above

Answer 44

E

Question 45

The government regulates financial markets for two main reasons:
A) to ensure soundness of the financial system and to increase the information available to investors.
B) to improve control of monetary policy and to increase the information available to investors.
C) to ensure that financial intermediaries do not earn more than the normal rate of return and to improve control of monetary policy.
D) to ensure soundness of financial intermediaries and to prevent financial intermediaries from earning less than the normal rate of return.

Answer 45

A

Question 46

Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a
A) bank holiday.
B) financial panic.
C) financial disintermediation.
D) financial collapse.

Answer 46

B

Question 47

Foreign currencies that are deposited in banks outside the home country are known as 
A) foreign bonds.	
B) Eurobond.
C) Eurocurrencies.
D) Eurodollars.

Answer 47

C

Question 48

U.S. dollars deposited in foreign banks outside the United States or in foreign branches of U.S. are referred to as
A) Eurodollars.
B) Eurocurrencies.	
C) Eurobonds.
D) foreign bonds.

Answer 48

A

Question 49

Banks providing depositors with checking accounts that enable them to pay their bills easily is known as
A) liquidity services.
B) asset transformation.
C) risk sharing.
D) transaction costs.

Answer 49

A

Question 50

A \_\_\_\_\_\_\_\_ is when one party in a financial contract has incentives to act in its own interest rather than in the interests of the other party. 
A) moral hazard
B) risk
C) conflict of interest
D) financial panic

Answer 50

C

Question 51

Fire and casualty insurance companies are what type of intermediary?
A) Contractual savings institution
B) Depository institutions
C) Investment intermediaries
D) None of the above

Answer 51

A

Question 52

The country whose banks are the most restricted in the range of assets they may hold is 
A) Japan.	
B) Canada.
C) Germany.
D) the United States.

Answer 52

D

Question 53

The largest depository institution (value of assets) at the end of 2009 was
A) commercial banks.
B) pension funds.
C) credit unions.
D) mutual funds.

Answer 53

A