Deck 15: Introduction to the Financial System

Question 1

A stock is:

A)a loan to a corporation.
B)a fixed-payment asset.
C)an ownership share in a corporation.
D)an ownership share in the government.

Answer 1

an ownership share in a corporation.

Question 2

Corporations issue stocks to:

A)write off taxes on profits.
B)raise funds for investment.
C)enrich the owners of the corporations.
D)engage in trading activities.

Answer 2

raise funds for investment.

Question 3

A bond is an example of a:

A)fixed income security.
B)constant asset.
C)flexible income security.
D)security with an unknown payment.

Answer 3

fixed income security.

Question 4

A zero coupon bond pays:

A)a stream of coupon payments only.
B)its face value and coupon payments.
C)only the face value.
D)There is not enough information provided to Answer the question.

Question 5

Interest is best defined as:

A)the payment for using funds.
B)the amount of a loan.
C)insurance against future disaster.
D)the receipt of principal.

Question 6

If the issuer of a bond does not pay its promised payments, the issuer:

A)defaults.
B)diversifies.
C)depreciates.
D)divests.

Question 7

Which of the following institutions is least likely to issue bonds?

A)the Federal government
B)corporations
C)local governments
D)small businesses.

Question 8

Financial markets contain people and firms that buy and sell two kinds of assets: and .

A)travelers checks; insurance policies
B)currency; securities
C)dollars; euros
D)bonds; stocks

Question 9

The principle function of financial markets is to:

A)maximize profits earned by financial institutions.
B)allocate factors of production.
C)redistribute resources from poor households to wealthy households.
D)funds from savers to investors.

Question 10

If a bond's face value plus all coupon payments exceeds the price a buyer pays, the bond pays:

A)a discount rate.
B)interest.
C)a premium.
D)the rate of inflation.

Question 11

A stock entitles you to:

A)charge interest to a corporation.
B)a fixed payment forever.
C)a percentage of a firm's total profits.
D)a coupon payment

Question 12

Which of the following arranges bond issuers from least risky to most risky (left to right)?

A)large corporations-government-small corporations
B)small corporations-large corporations-government
C)government-small corporations-large corporations
D)government-large corporations-small corporations

Question 13

A stock entitles you to:

A)a percentage of a firm's total profits.
B)one dollar for each of a firm's share you own.
C)a fixed payment forever.
D)a fixed face value payment at the time of maturity.

Question 14

Which of the following institutions is least likely to issue bonds?

A)foreign governments
B)corporations
C)government agencies
D)households.

Question 15

To attract of a zero coupon bond, the seller must the bond at a price its face value.

A)buyers; sell; less than
B)buyers; sell; greater than
C)sellers; buy; less than

Question 16

Consider a bond you buy for $5,000, which pays you $250 a year for 5 years, and then pays back the $5,000. The face value of the bond is , the is $250, and the maturity is .

A)$250; coupon payment; 5 years
B)$5,000; coupon payment; 5 years
C)$5,000; face value; 1 year
D)$5,000; coupon payment; 1 year

Question 17

Financial markets are made up of people and firms that assets.

A)buy
B)sell
C)print
D)buy and sell

Question 18

A security is a claim on income.

A)a future flow of
B)current
C)a past flow of
D)perpetual

Question 19

Which of the following best defines a security?

A)It is a claim on the past flow of income.
B)It is a claim on the depreciation of income.
C)It is a fixed payment.
D)It is a claim on the future flow of income.

Question 20

A bond pays its at the time of .

A)present value; purchase
B)future value; purchase
C)face value; maturity
D)present value; maturity

Question 21

Which of the following definitions does the text use?

A)Savers are people who spend less than they earn.
B)Investors are people who make risky purchases of paper assets.
C)Savers are people who spend more than they earn.
D)Investors are people who purchase stocks and bonds.

Question 22

The difference in interest rates between savings accounts and loans can be explained, in part, by the:

A)cost of gathering information on potential borrowers.
B)risk associated with making loans.
C)cost of monitoring borrowers once the loan has been made.
D)All of the Answer s are correct.

Question 23

Diversification is defined as:

A)spending less than is earned.
B)the distribution of wealth among different assets.
C)increasing the productive capacity of the economy.
D)the general rising level of prices.

Question 24

The problem of moral hazard arises when the owners of a security have:

A)an incentive to give potential buyers bad information.
B)little incentive to behave prudently after selling its asset.
C)a disincentive to give potential buyers bad information.
D)an incentive to behave according to expectations.

Question 25

Which of the following definitions is correct?

A)Savers are people who spend less than they earn.
B)Investors are people who spend more than they earn.
C)Investors are people who spend less than they earn.
D)Savers are people who put all their excess income in savings accounts.

Question 26

Banks reduce by .

A)adverse selection; requiring covenants
B)moral hazard; diversification
C)adverse selection; risk sharing
D)moral hazard; monitoring borrower behavior

Question 27

Firms that have a majority of their own stock in their employee 401(k) plans include:

A)General Electric.
B)Pfizer.
C)Procter and Gamble.
D)All of the Answer s are correct.

Question 28

To minimize the problem of moral hazard when making a loan, a bank requires borrowers to:

A)sign a covenant.
B)use their car as collateral.
C)make the bank the majority owner of the firm.
D)allow themselves to be monitored by the FDIC.

Question 29

Is defined as when savers deposit money in banks, which then lend to investors, while arises when savers provide funds to investors by buying securities in financial markets.

A)Lending; borrowing
B)Indirect finance; direct finance
C)Borrowing; direct finance
D)Direct finance; indirect finance

Question 30

A firm that helps channel funds from to is called a .

A)savers; investors; financial institution
B)savers; investors; government agency
C)investors; savers; financial institution
D)the government; investors; bank

Question 31

Economists call the situation in which one side of an economic transaction has more information than the other:

A)a negative externality.
B)a fixed cost.
C)a lack of diversification.
D)asymmetric information.

Question 32

A mutual fund is an institution that:

A)holds a diversified set of assets and sells shares to savers.
B)holds a diversified set of assets and buys shares directly from the government.
C)holds a single share and sells shares to savers.
D)buys physical capital for investors.

Question 33

The problem of adverse selection arises when the owners of a security have a(n):

A)incentive to misbehave after an asset purchase.
B)incentive to behave according to expectations.
C)incentive to give potential buyers bad information.
D)disincentive to give potential buyers bad information.

Question 34

Employees of Enron got in trouble because:

A)they could only buy Enron stock for retirement.
B)the majority of the 401(k) fund they saved in was devoted to Enron stock.
C)the majority of the 401(k) fund they saved in was devoted to US Treasury bills.
D)the majority of the 401(k) fund they saved in was devoted to Microsoft stock.

Question 35

Banks reduce by screening .

A)moral hazard; potential borrowers
B)adverse selection; savers
C)adverse selection; potential borrowers
D)irrational exuberance; depositors

Question 36

Which of the following best defines a financial institution?

A)A financial institution is an institution that only makes loans.
B)A financial institution is a firm that prints money.
C)A financial institution is a firm that helps channel funds from savers to investors.
D)A financial institution is a government agency that gives away funds to investors.

Question 37

Which of the following explain(s) the importance of financial markets? I. They help channel funds from savers to investors with productive uses for the funds. II. They help people and firms share risks.
III) They allow the rich to get richer.

A)I only
B)II only
C)I and II
D)I, II, and III

Question 38

Diversification allows to earn healthy returns from securities while minimizing .

A)savers; risk
B)bond issuers; risk
C)savers; deposits
D)bond issuers; loans

Question 39

Moral hazard and adverse selection are examples of:

A)irrational exuberance.
B)asymmetric information.
C)adaptive expectations.
D)default risk.

Question 40

By requiring borrowers to sign a covenant when getting a loan, a bank is trying to minimize:

A)high unexpected inflation.
B)moral hazard.
C)adverse selection.
D)irrational exuberance.

Question 41

Describe the problem that the employees of Enron had when the company went bankrupt.

Question 42

The restriction that requires that banks operate in no more than one state is called:

A)asymmetric information.
B)unit banking.
C)moral hazard.
D)a negative externality.

Question 43

In 2007-2008, the U.S. financial system required substantial help from the U.S. central bank (the Fed). Explain how bailing out these financial institutions may contribute to moral hazard.

Question 44

Empirical evidence shows a positive correlation between and .

A)inflation; financial development
B)deflation; economic growth
C)high rates of money growth; economic growth.
D)economic growth; financial development

Question 45

An economy run by a government that completely decides what goods and services to produce, who receives them, and which investment projects to undertake, is called a:

A)command economy.
B)economy.
C)mixed economy.
D)capitalistic economy.

Question 46

Banks are the main source of funding for mainly because of and .

A)bond holders; risk; asymmetric information
B)governments; adverse selection; uncertainty about the future
C)small firms; adverse selection; moral hazard
D)big firms; adverse selection; moral hazard

Question 47

Economic historians have pointed to which of the following to explain the demise of the Soviet Union?
I. Managers were evaluated based on profits rather than production quotas.
II. There was misallocation of investment, with "prestige" sectors chosen over less productive ones.
III. Planners emphasized the short run over the long run.

A)I only
B)II only
C)III only
D)II and III

Question 48

Microfinance institutions get around the problem of moral hazard and high default rates by:

A)lending to groups rather than individuals.
B)lending only to proven borrowers.
C)lending only to large businesses.
D)charging usurious interest rates.

Question 49

Explain how strong financial markets contribute to economic growth.

Question 50

List, and explain, the basic functions of a bank.

Question 51

Researchers found that countries with in the 1960s had faster .

A)strong financial systems; economic growth during the 1960s
B)strong financial systems; economic growth in the decades after the 1960s
C)weaker financial systems; inflation in the decades after the 1960s
D)strong financial systems; inflation before the 1960s

Question 52

Explain the key differences between a bond and a stock.

Question 53

Which of the following are arguments against unit banking? I. Unit banking decreases economies of scale. II. Unit banking increases bank risk.
III) Unit banking allows for more competition.

A)I only II
B)only III
C)only I
D)and II

Question 54

One explanation for high long-run economic growth rates is:

A)high savings rates.
B)high consumption rates. low
C)productivity of capital. high
D)rates of unemployment.

Question 55

Banks in developing economies are less willing to lend to small firms because:

A)of higher loan default rates.
B)interest rates charged cover transaction costs.
C)of lower adverse selection.
D)of lower moral hazard.

Question 56

The prohibition of branches in a unit banking system results in banks that are typically:

A)larger and more efficient.
B)larger and more diversified.
C)smaller and more competitive.
D)smaller and less efficient.

Question 57

Arguments against unit banking include the contentions that unit banking the costs of banking services and the risk of bank failures.

A)increases; decreases
B)increases; increases
C)decreases; increases
D)decreases; decreases