Question 1

Moral hazard is a problem associated with debt and equity contracts arising from

Accepted Answer

A) the borrower's incentive to undertake highly risky investments. 
B) the owners' inability to ensure that managers will act in the owners' interest. 
C) the difficulty lenders have in sorting out good credit risks from bad credit risks. 
D) all of the above. 
E) only A and B of the above. 
A) the borrower's incentive to undertake highly risky investments. 
B) the owners' inability to ensure that managers will act in the owners' interest. 
C) the difficulty lenders have in sorting out good credit risks from bad credit risks. 
D) all of the above. 
E) only A and B of the above.

Question 2

The Global Legal Settlement of 2002 arose out of a lawsuit brought by New York Attorney General Eliot Spitzer against the ten largest investment banks.

Accepted Answer

A) True 
 B)False

Question 3

The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of nontraded loans),

Accepted Answer

A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance. 
B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. 
C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds. 
D) all of the above. 
E) only A and B of the above. 
A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance. 
B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. 
C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds. 
D) all of the above. 
E) only A and B of the above.

Question 4

What conflicts of interest can arise in accounting firms?

Accepted Answer

Conflicts of interest in accounting firm

Question 5

Which of the following is not one of the eight basic facts about financial structure?

Accepted Answer

A) The financial system is among the most heavily regulated sectors of the economy. 
B) Issuing marketable securities is the primary way businesses finance their operations. 
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) Financial intermediaries is the most important source of external funds to finance businesses. 
A) The financial system is among the most heavily regulated sectors of the economy. 
B) Issuing marketable securities is the primary way businesses finance their operations. 
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) Financial intermediaries is the most important source of external funds to finance businesses.

Question 6

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 7

In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

Accepted Answer

A) reflect the highest quality of used cars in the market. 
B) reflect the lowest quality of used cars in the market. 
C) reflect the average quality of used cars in the market. 
D) none of the above. 
A) reflect the highest quality of used cars in the market. 
B) reflect the lowest quality of used cars in the market. 
C) reflect the average quality of used cars in the market. 
D) none of the above.

Question 8

Because managers (________)have less incentive to maximize profits than the stockholders-owners (________)do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities.

Accepted Answer

A) principals; agents 
B) principals; principals 
C) agents; agents 
D) agents; principals 
A) principals; agents 
B) principals; principals 
C) agents; agents 
D) agents; principals

Question 9

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 10

Because of the adverse selection problem, lenders may refuse loans to individuals with low net worth.

Accepted Answer

A) True 
 B)False

Question 11

The financial system is one of the most heavily regulated sectors of the economy.

Accepted Answer

A) True 
 B)False

Question 12

(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 13

Bad firms

Accepted Answer

A) do not have an incentive to make themselves look good. 
B) will slant the information they are required to transmit to the public. 
C) both A and B of the above. 
D) neither A nor B of the above. 
A) do not have an incentive to make themselves look good. 
B) will slant the information they are required to transmit to the public. 
C) both A and B of the above. 
D) neither A nor B of the above.

Question 14

The concept of adverse selection helps explain why collateral is an important feature of many debt contracts.

Accepted Answer

A) True 
 B)False

Question 15

Collateral is

Accepted Answer

A) property that is pledged to the lender if a borrower cannot make his or her debt payments. 
B) a prevalent feature of debt contracts for households. 
C) a prevalent feature of debt contracts for businesses. 
D) all of the above. 
E) only A and C of the above. 
A) property that is pledged to the lender if a borrower cannot make his or her debt payments. 
B) a prevalent feature of debt contracts for households. 
C) a prevalent feature of debt contracts for businesses. 
D) all of the above. 
E) only A and C of the above.

Question 16

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 17

Because of the moral hazard problem,

Accepted Answer

A) lenders will write debt contracts that restrict certain activities of borrowers. 
B) lenders will more readily lend to borrowers with high net worth. 
C) debt contracts are used less frequently to raise capital than equity contracts. 
D) all of the above. 
E) only A and B of the above. 
A) lenders will write debt contracts that restrict certain activities of borrowers. 
B) lenders will more readily lend to borrowers with high net worth. 
C) debt contracts are used less frequently to raise capital than equity contracts. 
D) all of the above. 
E) only A and B of the above.

Question 18

What factors usually cause an increase in moral hazard and adverse selection?

Accepted Answer

There are several factors that can contr

Question 19

A conflict of interest occurs when

Accepted Answer

A) a financial firm sells a service to its customers for a price that exceeds the cost of producing the service. 
B) lenders prefer higher interest rates and borrowers prefer lower interest rates. 
C) riskier borrowers are the ones who are more likely to apply for loans. 
D) people expected to provide reliable information to the public have incentives not to do so. 
A) a financial firm sells a service to its customers for a price that exceeds the cost of producing the service. 
B) lenders prefer higher interest rates and borrowers prefer lower interest rates. 
C) riskier borrowers are the ones who are more likely to apply for loans. 
D) people expected to provide reliable information to the public have incentives not to do so.

Question 20

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

Exam 7: Why Do Financial Institutions Exist

Moral hazard is a problem associated with debt and equity contracts arising from

The Global Legal Settlement of 2002 arose out of a lawsuit brought by New York Attorney General Eliot Spitzer against the ten largest investment banks.

The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of nontraded loans),

What conflicts of interest can arise in accounting firms?

Which of the following is not one of the eight basic facts about financial structure?

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

In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

Because managers (________)have less incentive to maximize profits than the stockholders-owners (________)do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities.

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

Because of the adverse selection problem, lenders may refuse loans to individuals with low net worth.

The financial system is one of the most heavily regulated sectors of the economy.

(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.

Bad firms

The concept of adverse selection helps explain why collateral is an important feature of many debt contracts.

Collateral is

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

Because of the moral hazard problem,

What factors usually cause an increase in moral hazard and adverse selection?

A conflict of interest occurs when

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.

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

Filters

Because managers ()have less incentive to maximize profits than the stockholders-owners ()do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities.