Deck 2: An Overview of the Financial System

Question 1

A breakdown of financial markets can result in ________.

A) financial stability
B) rapid economic growth
C) political instability
D) stable prices

Answer 1

C

Question 2

You can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is ________.

A) 25 percent
B) 12.5 percent
C) 10 percent
D) 5 percent

Answer 2

D

Question 3

How do financial intermediaries play an important role in the economy?

Answer 3

Financial intermediaries play an important role in the economy because they provide liquidity services, they lower transaction costs through economies of scale, they reduce the risk exposure of investors through risk sharing, and they solve the asymmetric information problems of adverse selection and moral hazard. By doing this, they allow small savers and borrowers to benefit from the existence of financial markets and its instruments. They also improve economic efficiency because they help financial markets to channel funds from lenders-savers to people with productive investment opportunities.

Question 4

Which of the following is an example of an intermediate-term debt?

A) A thirty-year mortgage
B) A sixty-month car loan
C) A six month loan from a finance company
D) A Treasury bond

Question 5

Every financial market has which of the following characteristics?

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.

Question 6

Financial markets have the basic function of ________.

A) getting people with funds to lend together with 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) providing a risk-free repository of spending power

Question 7

Well-functioning financial markets ________.

A) cause inflation
B) eliminate the need for indirect finance
C) cause financial crises
D) produce an efficient allocation of capital

Question 8

Which of the following statements about the characteristics of debt and equity is false?

A) They can both be long-term financial instruments.
B) They can both be short-term financial instruments.
C) They both involve a claim on the issuer's income.
D) They both enable a corporation to raise funds.

Question 9

Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in Canada?

Question 10

Which of the following statements about the characteristics of debt and equities is true?

A) They can both be long-term financial instruments.
B) Bond holders are residual claimants.
C) The income from bonds is typically more variable than that from equities.
D) Bonds pay dividends.

Question 11

Which of the following can be described as direct finance?

A) You take out a mortgage from your local bank.
B) You borrow $2500 from a friend.
C) You buy shares of common stock in the secondary market.
D) You buy shares in a mutual fund.

Question 12

Financial markets improve economic welfare because ________.

A) they channel funds from investors to savers
B) they allow consumers to time their purchase better
C) they weed out inefficient firms
D) eliminate the need for indirect finance

Question 13

Which of the following statements about financial markets and securities is 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 intermediate term if its maturity is ten years or longer.
D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date.

Question 14

Which of the following can be described as involving direct finance?

A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys a short-term corporate security in a secondary market.
D) People buy shares of common stock in the primary markets.

Question 15

The principal lender-savers are ________.

A) governments
B) businesses
C) households
D) foreigners

Question 16

Which of the following can be described as involving direct finance?

A) A corporation issues new shares of stock.
B) People buy shares in a mutual fund.
C) A pension fund manager buys a short-term corporate security in the secondary market.
D) An insurance company buys shares of common stock in the over-the-counter markets.

Question 17

Securities are ________ for the person who buys them, but are ________ for the individual or firm that issues them.

A) assets; liabilities
B) liabilities; assets
C) negotiable; nonnegotiable
D) nonnegotiable; negotiable

Question 18

Assume that you borrow $2000 at 10 percent annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is ________.

A) $400
B) $201
C) $200
D) $199

Question 19

With ________ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.

A) active
B) determined
C) indirect
D) direct

Question 20

Which of the following can be described as involving indirect finance?

A) You make a loan to your neighbor.
B) A corporation buys a share of common stock issued by another corporation in the primary market.
C) You buy a Canadian Treasury bill from the Bank of Canada.
D) You make a deposit at a bank.

Question 21

If the maturity of a debt instrument is less than one year, the debt is called ________.

A) short-term
B) intermediate-term
C) long-term
D) prima-term

Question 22

When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public.

A) underwrites
B) undertakes
C) overwrites
D) overtakes

Question 23

The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market.

A) more; primary
B) more; secondary
C) less; primary
D) less; secondary

Question 24

An important function of secondary markets is to ________.

A) make it easier to sell financial instruments to raise funds
B) raise funds for corporations through the sale of securities
C) make it easier for governments to raise taxes
D) create a market for newly constructed houses

Question 25

A corporation acquires new funds only when its securities are sold in the ________.

A) primary market by an investment bank
B) primary market by a stock exchange broker
C) secondary market by a securities dealer
D) secondary market by a commercial bank

Question 26

Long-term debt has a maturity that is ________.

A) between one and ten years
B) less than a year
C) between five and ten years
D) ten years or longer

Question 27

Equity instruments are traded in the ________ market.

A) money
B) bond
C) capital
D) commodities

Question 28

A financial market in which only short-term debt instruments are traded is called the ________ market.

A) bond
B) money
C) capital
D) stock

Question 29

Corporations receive funds when their stock is sold in the primary market. Why do corporations pay attention to what is happening to their stock in the secondary market?

Question 30

A liquid asset is ________.

A) an asset that can easily and quickly be sold to raise cash
B) a share of an ocean resort
C) difficult to resell
D) always sold in an over-the-counter market

Question 31

When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors.

A) bonds
B) bills
C) notes
D) stock

Question 32

Which of the following is not a secondary market?

A) Foreign exchange market
B) Futures market
C) Options market
D) Primary market

Question 33

Prices of money market instruments undergo the least price fluctuations because of ________.

A) the short terms to maturity for the securities
B) the heavy regulations in the industry
C) the price ceiling imposed by government regulators
D) the lack of competition in the market

Question 34

Describe the two methods of organizing a secondary market.

Question 35

Describe the difference between the money market and the capital market.

Question 36

________ work in the secondary markets matching buyers with sellers of securities.

A) Dealers
B) Underwriters
C) Brokers
D) Claimants

Question 37

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

Question 38

A financial market in which previously issued securities can be resold is called a ________ market.

A) primary
B) secondary
C) tertiary
D) used securities

Question 39

Which of the following benefit directly from any increase in the corporation's profitability?

A) A bond holder
B) A commercial paper holder
C) A shareholder
D) A T-bill holder

Question 40

Secondary markets make financial instruments more ________.

A) solid
B) vapid
C) liquid
D) risky

Question 41

A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called ________.

A) commercial paper
B) a negotiable certificate of deposit
C) a municipal bond
D) federal funds

Question 42

Which of the following instruments are traded in a money market?

A) Bank commercial loans
B) Commercial paper
C) Provincial government bonds
D) Residential mortgages

Question 43

Overnight funds are ________.

A) funds raised by the federal government in the bond market
B) loans made by the Bank of Canada to banks
C) loans made by banks to the Bank of Canada
D) loans made by banks to each other

Question 44

Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower purchase price than the amount you receive at maturity.

A) premium
B) collateral
C) default
D) discount

Question 45

One reason for the extraordinary growth of foreign financial markets is ________.

A) decreased trade
B) increases in the pool of savings in foreign countries
C) the recent introduction of the foreign bond
D) slower technological innovation in foreign markets

Question 46

A short-term debt instrument issued by well-known corporations is called ________.

A) commercial paper
B) corporate bonds
C) municipal bonds
D) commercial mortgages

Question 47

Which of the following are short-term financial instruments?

A) A repurchase agreement
B) A share of Walt Disney Corporation stock
C) A Treasury note with a maturity of four years
D) A residential mortgage

Question 48

Collateral is ________ the lender receives if the borrower does not pay back the loan.

A) a liability
B) an asset
C) a present
D) an offering

Question 49

Explain why Government of Canada Treasury Bills are considered as a financial instrument with very low risk.

Question 50

Treasury bills are considered the safest of all money market instruments because there is no risk of ________.

A) defeat
B) default
C) desertion
D) demarcation

Question 51

Equity and debt instruments with maturities greater than one year are called ________ market instruments.

A) capital
B) money
C) federal
D) benchmark

Question 52

Bonds issued by corporations are called ________ bonds.

A) corporate
B) Treasury
C) municipal
D) commercial

Question 53

Which of the following instruments are traded in a money market?

A) Provincial government bonds
B) Treasury bills
C) Corporate bonds
D) Government agency securities

Question 54

Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as ________.

A) foreign bonds
B) Eurobonds
C) equity bonds
D) country bonds

Question 55

If Microsoft sells a bond in London and it is denominated in dollars, the bond is a ________.

A) Eurobond
B) foreign bond
C) British bond
D) currency bond

Question 56

Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which it is sold are known as ________.

A) foreign bonds
B) Eurobonds
C) equity bonds
D) country bonds

Question 57

U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks are called ________.

A) Atlantic dollars
B) Eurodollars
C) foreign dollars
D) outside dollars

Question 58

Which of the following instruments is not traded in a money market?

A) Residential mortgages
B) Treasury Bills
C) Negotiable bank certificates of deposit
D) Commercial paper

Question 59

Explain why only the largest and most trustworthy corporations issue the financial instruments known as commercial paper?

Question 60

________ are short-term loans in which Treasury bills serve as collateral.

A) Repurchase agreements
B) Negotiable certificates of deposit
C) Overnight funds
D) Government agency securities

Question 61

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.

A) adverse selection
B) moral hazard
C) risk sharing
D) credit risk

Question 62

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as ________.

A) risk sharing
B) risk aversion
C) risk neutrality
D) risk selling

Question 63

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) the borrower's lack of good options for obtaining funds

Question 64

Risk sharing is profitable for financial institutions due to ________.

A) low transactions costs
B) asymmetric information
C) adverse selection
D) moral hazard

Question 65

The concept of diversification is captured by the statement ________.

A) don't look a gift horse in the mouth
B) don't put all your eggs in one basket
C) it never rains, but it pours
D) make hay while the sun shines

Question 66

If Volkswagen, a German company, sells a euro-denominated bond in London, the bond is a

A) Eurobond.
B) foreign bond.
C) currency bond.
D) Duetsche bond.

Question 67

Distinguish between a foreign bond and a Eurobond.

Question 68

Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. The difference in information is called ________, and it creates the ________ problem.

A) asymmetric information; risk sharing
B) asymmetric information; adverse selection
C) adverse selection; risk sharing
D) moral hazard; adverse selection

Question 69

The countries that have made the least use of securities markets are ________ and ________; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.

A) Germany; Japan
B) Germany; Great Britain
C) Great Britain; Canada
D) Canada; Japan

Question 70

The time and money spent in carrying out financial transactions are called ________.

A) economies of scale
B) financial intermediation
C) liquidity services
D) transaction costs

Question 71

The process of indirect finance using financial intermediaries is called ________.

A) direct lending
B) financial intermediation
C) resource allocation
D) financial liquidation

Question 72

Financial intermediaries provide customers with liquidity services. Liquidity services ________.

A) make it easier for customers to conduct transactions
B) allow customers to have a cup of coffee while waiting in the lobby
C) are a result of the asymmetric information problem
D) are another term for asset transformation

Question 73

Economies of scale enable financial institutions to ________.

A) reduce transactions costs
B) avoid the asymmetric information problem
C) avoid adverse selection problems
D) reduce moral hazard

Question 74

The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________.

A) adverse selection; moral hazard
B) moral hazard; adverse selection
C) costly state verification; free-riding
D) free-riding; costly state verification

Question 75

Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. The difference in information is called ________.

A) moral selection
B) risk sharing
C) asymmetric information
D) adverse hazard

Question 76

The process of asset transformation refers to the conversion of ________.

A) safer assets into risky assets
B) safer assets into safer liabilities
C) risky assets into safer assets
D) risky assets into risky liabilities

Question 77

If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of ________.

A) moral hazard
B) adverse selection
C) free-riding
D) costly state verification

Question 78

Reducing risk through the purchase of assets whose returns do not always move together is ________.

A) diversification
B) intermediation
C) intervention
D) discounting

Question 79

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from ________.

A) government agencies
B) equities markets
C) financial intermediaries
D) bond markets

Question 80

An example of economies of scale in the provision of financial services is ________.

A) investing in a diversified collection of assets
B) providing depositors with a variety of savings certificates
C) spreading the cost of borrowed funds over many customers
D) spreading the cost of writing a standardized contract over many borrowers