Question 1

The principal-agent problem is an example of the adverse selection problem that can result from asymmetric information.

Accepted Answer

A) True 
 B)False

Question 2

A financial institution can achieve cost savings in its credit card operations if it increases the number of cardholders.This is an example of economies of

Accepted Answer

A)  scope. 
B)  scale. 
C)  complexity. 
D)  information. 
A)  scope. 
B)  scale. 
C)  complexity. 
D)  information.

Question 3

The majority of household debt in the United States consists of

Accepted Answer

A)  credit card debt. 
B)  consumer installment debt. 
C)  collateralized loans. 
D)  unsecured loans, such as student loans. 
A)  credit card debt. 
B)  consumer installment debt. 
C)  collateralized loans. 
D)  unsecured loans, such as student loans.

Question 4

What facts about financial structure can be explained by moral hazard?

Accepted Answer

Moral hazard refers to a situation where

Question 5

A debt contract is said to be incentive compatible if

Accepted Answer

A)  the borrower's net worth reduces the probability of moral hazard. 
B)  restrictive covenants limit the type of activities that can be undertaken by the borrower. 
C)  both A and B of the above occur. 
D)  neither A nor B of the above occur. 
A)  the borrower's net worth reduces the probability of moral hazard. 
B)  restrictive covenants limit the type of activities that can be undertaken by the borrower. 
C)  both A and B of the above occur. 
D)  neither A nor B of the above occur.

Question 6

Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets?

Accepted Answer

A)  Covenants reduce moral hazard by restricting borrowers' undesirable behavior. 
B)  Covenants require that borrowers keep collateral in good condition. 
C)  Covenants require periodic accounting statements and income reports. 
D)  All of the above. 
E)  Only A and B of the above. 
A)  Covenants reduce moral hazard by restricting borrowers' undesirable behavior. 
B)  Covenants require that borrowers keep collateral in good condition. 
C)  Covenants require periodic accounting statements and income reports. 
D)  All of the above. 
E)  Only A and B of the above.

Question 7

A venture capital firm protects its equity investment from moral hazard through which of the following means?

Accepted Answer

A)  It places people on the board of directors to better monitor the borrowing firm's activities. 
B)  It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. 
C)  It prohibits the borrowing firm from replacing its management. 
D)  It does both A and B of the above. 
E)  It does both A and C of the above. 
A)  It places people on the board of directors to better monitor the borrowing firm's activities. 
B)  It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. 
C)  It prohibits the borrowing firm from replacing its management. 
D)  It does both A and B of the above. 
E)  It does both A and C of the above.

Question 8

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries

Accepted Answer

A)  provide information that is valued by consumers of used cars. 
B)  are able to prevent others from free-riding off the information that they provide. 
C)  can profit by becoming experts in determining whether an automobile is a good car or a lemon. 
D)  do all of the above. 
A)  provide information that is valued by consumers of used cars. 
B)  are able to prevent others from free-riding off the information that they provide. 
C)  can profit by becoming experts in determining whether an automobile is a good car or a lemon. 
D)  do all of the above.

Question 9

(I)In the United States,nonbank loans are the most important source of external funds for nonfinancial businesses.
(II)In Germany and Japan,issuing stocks and bonds is the most important source of external for nonfinancial businesses.

Accepted Answer

A)  (I) is true, (II) false. 
B)  (I) is false, (II) true. 
C)  Both are true. 
D)  Both are false. 
A)  (I) is true, (II) false. 
B)  (I) is false, (II) true. 
C)  Both are true. 
D)  Both are false.

Question 10

The problem of adverse selection helps to explain why direct finance is more important than indirect finance as a source of business finance.

Accepted Answer

A) True 
 B)False

Question 11

A key finding of the economic analysis of financial structure is that

Accepted Answer

A)  the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. 
B)  while free-rider problems limit the extent to which securities markets finance some business activities, the majority of funds going to businesses are channeled through securities markets. 
C)  given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. 
D)  economists do not have a very good explanation for why securities markets are so heavily regulated. 
A)  the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. 
B)  while free-rider problems limit the extent to which securities markets finance some business activities, the majority of funds going to businesses are channeled through securities markets. 
C)  given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. 
D)  economists do not have a very good explanation for why securities markets are so heavily regulated.

Question 12

The Sarbanes-Oxley Act of 2002 and the Global Legal Settlement of 2002 both have the potential to reduce economies of scope.

Accepted Answer

A) True 
 B)False

Question 13

Explain how the "lemons" problem could cause financial markets to fail.

Accepted Answer

This is a result of information asymmetr

Question 14

Economies of scope refer to cost savings that arise when the

Accepted Answer

A)  size of financial transactions increase. 
B)  size of financial transactions decrease. 
C)  number of different activities undertaken increases. 
D)  number of different activities undertaken decreases. 
A)  size of financial transactions increase. 
B)  size of financial transactions decrease. 
C)  number of different activities undertaken increases. 
D)  number of different activities undertaken decreases.

Question 15

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries

Accepted Answer

A)  have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. 
B)  are able to prevent potential competitors from free-riding off the information that they provide. 
C)  have failed to solve adverse selection problems in this market because "lemons" continue to be traded. 
D)  do all of the above. 
A)  have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. 
B)  are able to prevent potential competitors from free-riding off the information that they provide. 
C)  have failed to solve adverse selection problems in this market because "lemons" continue to be traded. 
D)  do all of the above.

Question 16

Which combination of activities within a single financial institution is least likely to lead to conflicts of interest?

Accepted Answer

A)  Auditing and management advisory services 
B)  Commercial banking and investment banking 
C)  Assessment of credit quality and consulting 
D)  Consumer lending and business lending 
A)  Auditing and management advisory services 
B)  Commercial banking and investment banking 
C)  Assessment of credit quality and consulting 
D)  Consumer lending and business lending

Question 17

One way of describing the solution that high net worth provides to the moral hazard problem is to say that it makes debt contracts incentive compatible.

Accepted Answer

A) True 
 B)False

Question 18

What are economies of scale in financial transactions? How can financial intermediaries achieve these economies?

Accepted Answer

Economies of scale

Financial intermedia

Question 19

Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits.

Accepted Answer

A)  consulting; regional 
B)  consulting; national 
C)  auditing; regional 
D)  auditing; national 
A)  consulting; regional 
B)  consulting; national 
C)  auditing; regional 
D)  auditing; national

Question 20

Of the sources of external funds for nonfinancial businesses in the United States,stocks account for approximately ________ of the total.

Accepted Answer

A)  10% 
B)  20% 
C)  30% 
D)  40% 
A)  10% 
B)  20% 
C)  30% 
D)  40%

Exam 7: Why Do Financial Institutions Exist?

The principal-agent problem is an example of the adverse selection problem that can result from asymmetric information.

A financial institution can achieve cost savings in its credit card operations if it increases the number of cardholders.This is an example of economies of

The majority of household debt in the United States consists of

What facts about financial structure can be explained by moral hazard?

A debt contract is said to be incentive compatible if

Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets?

A venture capital firm protects its equity investment from moral hazard through which of the following means?

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries

(I)In the United States,nonbank loans are the most important source of external funds for nonfinancial businesses. (II)In Germany and Japan,issuing stocks and bonds is the most important source of external for nonfinancial businesses.

The problem of adverse selection helps to explain why direct finance is more important than indirect finance as a source of business finance.

A key finding of the economic analysis of financial structure is that

The Sarbanes-Oxley Act of 2002 and the Global Legal Settlement of 2002 both have the potential to reduce economies of scope.

Explain how the "lemons" problem could cause financial markets to fail.

Economies of scope refer to cost savings that arise when the

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries

Which combination of activities within a single financial institution is least likely to lead to conflicts of interest?

One way of describing the solution that high net worth provides to the moral hazard problem is to say that it makes debt contracts incentive compatible.

What are economies of scale in financial transactions? How can financial intermediaries achieve these economies?

Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits.

Of the sources of external funds for nonfinancial businesses in the United States,stocks account for approximately ________ of the total.

Why Study Financial Markets and Institutions?

Overview of the Financial System

What Do Interest Rates Mean and What Is Their Role in Valuation?

Why Do Interest Rates Change?

How Do Risk and Term Structure Affect Interest Rates?

Are Financial Markets Efficient?

Why Do Financial Crises Occur and

Central Banks and the Federal Reserve System

Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics

The Money Markets

The Bond Market

The Stock Market

The Mortgage Markets

The Foreign Exchange Market

The International Financial System

Banking and the Management of Financial Institutions

Financial Regulation

Banking Industry: Structure and Competition

The Mutual Fund Industry

Insurance Companies and Pension Funds

Investment Banks, Security Brokers and Dealers, and Venture Capital Firms

Risk Management in Financial Institutions

Hedging with Financial Derivatives

Financial Crises In Emerging Market Economies

Savings Associations and Credit Unions

Finance Companies

Filters

Conflicts of interest in the Arthur Andersen accounting firm intensified when became the firm's largest source of profits and large clients pressured office managers to give favorable audits.