Question 1

Conflicts of interest pose a problem because they

Accepted Answer

A) lower the quality of information. 
B) increase problems of asymmetric information. 
C) make the financial system less efficient. 
D) do all of the above. 
A) lower the quality of information. 
B) increase problems of asymmetric information. 
C) make the financial system less efficient. 
D) do all of the above.

Question 2

The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can

Accepted Answer

A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. 
B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. 
C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. 
D) pressure its clients into paying high fees for both auditing and consulting services. 
A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. 
B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. 
C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. 
D) pressure its clients into paying high fees for both auditing and consulting services.

Question 3

The principal-agent problem

Accepted Answer

A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. 
B) would not arise if the owners of the firm had complete information about the activities of the managers. 
C) in financial markets helps to explain why equity is a relatively important source of finance for American businesses. 
D) all of the above. 
E) only A and B of the above. 
A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. 
B) would not arise if the owners of the firm had complete information about the activities of the managers. 
C) in financial markets helps to explain why equity is a relatively important source of finance for American businesses. 
D) all of the above. 
E) only A and B of the above.

Question 4

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 5

A financial institution can achieve cost savings by engaging in multiple activities. These are called economies of

Accepted Answer

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

Question 6

The Sarbanes-Oxley Act of 2002 provides for oversight of accounting firms but makes no provisions for increasing the flow of information to financial markets.

Accepted Answer

A) True 
 B)False

Question 7

The problem of adverse selection helps to explain

Accepted Answer

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. 
B) why collateral is an important feature of consumer, but not business, debt contracts. 
C) why direct finance is more important than indirect finance as a source of business finance. 
D) only A and B of the above. 
A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. 
B) why collateral is an important feature of consumer, but not business, debt contracts. 
C) why direct finance is more important than indirect finance as a source of business finance. 
D) only A and B of the above.

Question 8

What facts about financial structure can be explained by adverse selection?

Accepted Answer

The answer of What facts about financial structure can be...

Question 9

American businesses use stock to finance about 10 percent of their external financing.

Accepted Answer

A) True 
 B)False

Question 10

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 11

Auditors attempt to reduce information asymmetry between a firm's managers and its

Accepted Answer

A) customers. 
B) owners. 
C) employees. 
D) competitors. 
A) customers. 
B) owners. 
C) employees. 
D) competitors.

Question 12

The free-rider problem

Accepted Answer

A) occurs when people who do not pay for information take advantage of the information other people have to pay for. 
B) suggests that the private sale of information will only be a partial solution to the lemons problem. 
C) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. 
D) all of the above. 
A) occurs when people who do not pay for information take advantage of the information other people have to pay for. 
B) suggests that the private sale of information will only be a partial solution to the lemons problem. 
C) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. 
D) all of the above.

Question 13

Solutions to the moral hazard problem include

Accepted Answer

A) high net worth. 
B) monitoring and enforcement of restrictive covenants. 
C) greater reliance on equity contracts and less on debt contracts. 
D) all of the above. 
E) only A and B of the above. 
A) high net worth. 
B) monitoring and enforcement of restrictive covenants. 
C) greater reliance on equity contracts and less on debt contracts. 
D) all of the above. 
E) only A and B of the above.

Question 14

One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the

Accepted Answer

A) venture capital firm. 
B) money market mutual fund. 
C) pawn broker. 
D) savings and loan association. 
A) venture capital firm. 
B) money market mutual fund. 
C) pawn broker. 
D) savings and loan association.

Question 15

A bank

Accepted Answer

A) has the ability to profit from the information it produces. 
B) avoids the free-rider problem by primarily making private loans rather than by purchasing securities that are traded in the open market. 
C) becomes an expert in determining good firms from bad firms. 
D) all of the above. 
A) has the ability to profit from the information it produces. 
B) avoids the free-rider problem by primarily making private loans rather than by purchasing securities that are traded in the open market. 
C) becomes an expert in determining good firms from bad firms. 
D) all of the above.

Question 16

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

Accepted Answer

The answer of Explain how the "lemons" problem could cause...

Question 17

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

Accepted Answer

A) principal-agent 
B) adverse selection 
C) free-rider 
D) debt deflation 
A) principal-agent 
B) adverse selection 
C) free-rider 
D) debt deflation

Question 18

Most legal work in the U.S. involves the writing and enforcement of contracts, not ambulance chasing, criminal law, and frivolous lawsuits.

Accepted Answer

A) True 
 B)False

Question 19

With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements?

Accepted Answer

A) Direct finance is used in less than 5% of the external financing of American businesses. 
B) Only large, well-established corporations have access to securities markets to finance their activities. 
C) Loans from banks and other financial intermediaries in the United States provide five times more financing of corporate activities than do stock markets. 
D) All of the above. 
E) Only A and B of the above. 
A) Direct finance is used in less than 5% of the external financing of American businesses. 
B) Only large, well-established corporations have access to securities markets to finance their activities. 
C) Loans from banks and other financial intermediaries in the United States provide five times more financing of corporate activities than do stock markets. 
D) All of the above. 
E) Only A and B of the above.

Question 20

Because information is scarce,

Accepted Answer

A) equity contracts are used much more frequently to raise capital than are debt contracts. 
B) monitoring managers gives rise to costly state verification. 
C) government regulations, such as standard accounting principles, can help reduce moral hazard. 
D) all of the above are true. 
E) only B and C of the above are true. 
A) equity contracts are used much more frequently to raise capital than are debt contracts. 
B) monitoring managers gives rise to costly state verification. 
C) government regulations, such as standard accounting principles, can help reduce moral hazard. 
D) all of the above are true. 
E) only B and C of the above are true.

Exam 7: Why Do Financial Institutions Exist

Conflicts of interest pose a problem because they

The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can

The principal-agent problem

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.

A financial institution can achieve cost savings by engaging in multiple activities. These are called economies of

The Sarbanes-Oxley Act of 2002 provides for oversight of accounting firms but makes no provisions for increasing the flow of information to financial markets.

The problem of adverse selection helps to explain

What facts about financial structure can be explained by adverse selection?

American businesses use stock to finance about 10 percent of their external financing.

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

Auditors attempt to reduce information asymmetry between a firm's managers and its

The free-rider problem

Solutions to the moral hazard problem include

One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the

A bank

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

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

Most legal work in the U.S. involves the writing and enforcement of contracts, not ambulance chasing, criminal law, and frivolous lawsuits.

With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements?

Because information is scarce,

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 Why Are They so Damaging to the Economy

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

Savings Associations and Credit Unions

Finance Companies

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