Deck 11: Investment Banks, mutual Funds, hedge Funds, and the Shadow Banking System

Question 1

Which of the following activities is NOT a primary concern of investment banks?

A) taking in deposits and making loans
B) providing advice and financing for mergers and acquisitions
C) underwriting new security issues
D) providing advice on new security issues

Answer 1

A

Question 2

The risk that increased market interest rates will cause a decline in the value of an investment bank's holdings of long-term securities is known as

A) credit risk.
B) interest-rate risk.
C) currency risk.
D) security risk.

Answer 2

B

Question 3

Investment banks

A) lease machinery and equipment to business firms.
B) acquire deposits from savers and lend them to borrowers.
C) assist business firms in raising new capital in primary markets.
D) aid the government to raise funds to cover the budget deficit.

Answer 3

C

Question 4

During the financial crisis,which type of risk was the biggest problem faced by investment banks?

A) interest-rate risk
B) currency risk
C) hedging risk
D) credit risk

Question 5

What information is typically included in a prospectus?

Question 6

What does it mean for an investment bank conducts a "road show"?

A) It involves an investment bank marketing its services to firms considering new issues.
B) It is when an investment bank goes to the SEC to seek approval for a new issue.
C) It is when firms seeking an underwriter consider alternative investment banks.
D) It involves visits to institutional investors who might want to buy the security issue.

Question 7

Which of the following was NOT a result of the passage of the Gramm-Leach-Bliley Act?

A) It repealed the Glass-Steagall Act.
B) It allowed commercial banks to participate in securities, insurance, and real estate activities.
C) It authorized new financial holding companies which permitted securities and investment firms to own commercial banks.
D) It increased the capital requirements for commercial banks.

Question 8

Investment banks are vulnerable because

A) the maturity of their liabilities is less than the maturity of their assets.
B) the maturity of their assets is less than the maturity of their liabilities.
C) they tend to be underleveraged.
D) they tend to primarily hold short-term assets.

Question 9

The due diligence process is

A) the process by which a firm chooses an investment bank.
B) when an investment bank researches a firm's value.
C) how an investment bank underwrites large issues.
D) the review of a prospectus by the SEC.

Question 10

The development of new financial securities or investment strategies using sophisticated models is known as

A) underwriting.
B) factoring.
C) financial engineering.
D) hedging.

Question 11

Suppose an investment bank has a leverage ratio of 10 and the value of its securities decline by 10%.What happens to its return on equity investment?

A) declines by 1%
B) increases by 1%
C) declines by 100%
D) increases by 100%

Question 12

When investment banks buy or sell securities on their own account,it's called

A) financial engineering.
B) proprietary trading.
C) underwriting.
D) factoring.

Question 13

The Glass-Steagall Act was designed to

A) legally separate investment banking from commercial banking.
B) promote mergers in the banking industry.
C) impose high capital ratios on investment banks.
D) promote the interests of community banks.

Question 14

What are the risks and reward for investment banks involved in underwriting a new security issue?

Question 15

What is the book value of a firm?

A) the market value of its existing shares of stocks
B) the current value of its retained earnings
C) the difference between the value of a firm's assets and the value of its liabilities
D) its accumulated earnings over time

Question 16

The risk that the party on the other side of a financial transaction fails to meet its obligation is called

A) credit risk.
B) currency risk.
C) counterparty risk.
D) leverage.

Question 17

The most important service provided by underwriters is

A) lowering of information costs.
B) dealing with problems of moral hazard.
C) insuring firms against loss from fire.
D) insuring firms against loss from employee theft.

Question 18

Underwriting involves

A) insuring the life or health of individuals.
B) guaranteeing a price for new capital to the issuing firm.
C) selling stock more cheaply than conventional stockbrokers.
D) issuing stock and using the proceeds to buy bonds.

Question 19

A syndicate is

A) a group of brokers illegally making use of insider information.
B) a group of commercial banks that agrees to accept the checks of each other's depositors.
C) a group of investment banks underwriting a large security issue.
D) a group of dealers that markets a government bond issue.

Question 20

In investment banking the "spread" is the difference between

A) the value of a firm's assets and the value of its liabilities.
B) the bid and asked prices on a bond.
C) the price of new capital guaranteed to the issuing firm and the price that can be obtained in the market.
D) the price of a new stock issue and the price of an equivalent new bond issue.

Question 21

Suppose an investment bank buys $100 million worth of mortgage-backed securities.It finances the purchase by borrowing $90 million and using $10 million from its equity.If the value of holdings of mortgage-backed securities declines by 5%,what is its return on equity investment?

Question 22

Mutual funds

A) take in deposits from savers and make loans to borrowers.
B) sell shares to savers and purchase assets with the funds.
C) take in deposits from savers and purchase assets with the funds.
D) bring together small savers and small borrowers.

Question 23

Business finance companies

A) purchase accounts receivable of small firms at a discount.
B) sell commercial paper and buy long-term corporate bonds.
C) take in deposits from savers and buy corporate commercial paper.
D) are strictly regulated by state governments.

Question 24

How does proprietary trading expose investment banks to interest-rate and credit risk?

Question 25

Factoring

A) involves selling stocks and using the proceeds to buy bonds.
B) is purchasing accounts receivable at a discount.
C) is calculating the optimal par values of stocks and bonds.
D) has been declared illegal under the Factoring Reform Act of 1994.

Question 26

How is the use of leverage a "double-edged sword"?

Question 27

Money market mutual funds

A) hold portfolios of stocks.
B) hold portfolios of short-term assets.
C) are always load funds.
D) hold only U.S. Treasury securities.

Question 28

All of the following are types of finance companies EXCEPT

A) government finance.
B) consumer finance.
C) sales finance.
D) business finance.

Question 29

In what year did the mutual fund industry in the United States begin?

A) 1812
B) 1924
C) 1974
D) 1990

Question 30

A load fund

A) charges a commission for purchases or sales.
B) is not obligated to redeem shares issued.
C) earns income only from management fees.
D) issues shares that may sell at a discount to the market value of the underlying assets.

Question 31

Finance companies

A) issue stock and use the proceeds to purchase bonds.
B) raise funds in financial markets to lend to households and firms.
C) raise funds from banks to lend to households and firms.
D) issue bonds and use the proceeds to purchase stock.

Question 32

Finance companies

A) take in deposits from savers and make loans to borrowers.
B) sell commercial paper and securities and make loans to borrowers with the funds.
C) take in deposits from savers and purchase assets with the funds.
D) bring together small savers and large borrowers.

Question 33

Sales finance companies

A) purchase accounts receivable of small firms at a discount.
B) sell commercial paper and buy long-term corporate bonds.
C) take in deposits from savers and buy corporate commercial paper.
D) are affiliated with companies which manufacture or sell goods.

Question 34

Why did Goldman Sachs and Morgan Stanley seek to become financial holding companies in October 2008?

Question 35

Which of the following statements is NOT true of consumer finance companies?

A) Their borrowers have higher default risk than bank customers.
B) They charge higher interest rates than banks do on similar loans.
C) They lend primarily to consumers.
D) They are strictly regulated by state governments.

Question 36

What makes advising on mergers and acquisitions particularly profitable for investment banks relative to other services that they provide?

Question 37

How do investment banks use the results of their research?

Question 38

What type of economic research do analysts at investment banks conduct?

Question 39

The portfolios that mutual funds offer to savers are

A) usually made up of bonds.
B) usually made up of common stocks.
C) tax free in most states.
D) usually more liquid than the underlying assets.

Question 40

Which of the following is an investment institution?

A) The New York Stock Exchange
B) Greater Illinois Savings and Loan
C) Prudential Insurance Company
D) Fidelity Magellan Mutual Fund

Question 41

Vesting refers to

A) the right of the holder of an insurance policy to collect for an insurable event.
B) the shielding of returns on whole life policies from taxation.
C) the length of service required of an employee before he or she is eligible for a pension.
D) the payments made by an employee into a pension plan.

Question 42

In a defined contribution pension plan,

A) pension income varies depending on how well the plan's investments have done.
B) the employee is promised an assigned benefit based on earnings and years of service.
C) if the funds in the pension plan exceed the amount promised, the excess accrues to the issuing firm or institution.
D) all earnings are taxable as regular income.

Question 43

Property and casualty insurers hold

A) more short-term assets than do life insurance companies.
B) fewer short-term assets than do life insurance companies.
C) roughly the same amount of short-term assets as do life insurance companies.
D) only long-term assets.

Question 44

What do many economists see finance companies as having an advantage in?

A) in purchasing commercial paper
B) in selling long-term securities
C) in monitoring the value of collateral
D) in charging consumers particularly low interest rates

Question 45

Charging drivers with good records lower premiums than drivers with bad records is an example of an attempt by insurance companies to deal with the problem of

A) moral hazard.
B) adverse selection.
C) drunk driving.
D) failure of policyholders to keep paying their premiums.

Question 46

What services are finance companies able to offer consumers and businesses that banks do not offer?

Question 47

In which of the following have pension funds invested the most?

A) corporate equities and mutual fund shares
B) government securities
C) corporate bonds
D) mortgages

Question 48

The use of deductibles and coinsurance are examples of attempts by insurance companies to deal with the problem of

A) moral hazard.
B) adverse selection.
C) failure of policyholders to keep paying their premiums.
D) excessive government regulation.

Question 49

When an insurance company makes a direct loan to a firm,the loan is known as

A) a private placement.
B) a commercial paper.
C) an account receivable.
D) an account payable.

Question 50

Modern hedge funds typically make investments that involve

A) hedging.
B) speculating.
C) acquiring safe, short-term assets.
D) focus on stocks instead of bonds.

Question 51

A defined benefits plan

A) is always fully funded.
B) may be underfunded but cannot be overfunded.
C) may be overfunded but cannot be underfunded.
D) may be either underfunded or overfunded.

Question 52

How did the financial crisis of 2007-2009 reveal that market participants underestimated two sources of risk from using commercial paper?

Question 53

What are some reasons that hedge funds have become controversial?

Question 54

All of the following are differences between hedge funds and mutual funds EXCEPT

A) hedge funds are largely unregulated.
B) hedge funds consist of a relatively number of wealthy investors.
C) hedge funds make risky investments that mutual funds cannot make.
D) hedge funds use money collected from savers to make investments.

Question 55

Hedge funds have been criticized for

A) their heavy use of short selling.
B) their inability to mobilize a large amount of funds.
C) forcing quick price changes that reduce market inefficiencies.
D) excessive use of hedging strategies.

Question 56

An insurance premium is a

A) payment made by an insurance company to a policyholder after the occurrence of an insurable event.
B) payment made by an insurance company to a policyholder following a period in which the policyholder has filed no claims against the company.
C) fee paid by policyholders to insurance companies as payment for coverage.
D) fee paid by policyholders to insurance companies in exchange for special considerations, such as a particularly large policy.

Question 57

Blood tests administered to applicants for medical insurance are an example of an attempt by insurance companies to deal with the problem of

A) moral hazard.
B) the drug abuse problems currently plaguing the country.
C) adverse selection.
D) failure of policyholders to keep paying their premiums.

Question 58

Which of the following is a contractual saving institution?

A) The New York Stock Exchange
B) Greater Illinois Savings and Loan
C) Prudential Insurance Company
D) Fidelity Magellan Mutual Fund

Question 59

The law of large numbers allows insurance companies to

A) hold capital market instruments as assets without fearing overly large numbers of defaults.
B) hold money market instruments as assets without fearing overly large numbers of defaults.
C) predict the average number of occurrences of insurable events in a large population of policyholders.
D) charge higher premiums than necessary, knowing that large numbers of individuals will pay them.

Question 60

The largest institutional participants in capital markets are

A) pension funds.
B) insurance companies.
C) consumer finance companies.
D) business finance companies.

Question 61

Which of the following was the main reason for increased counterparty risk in the shadow banking system prior to the financial crisis of 2007-2009?

A) increased leverage
B) government insuring money market deposits
C) many firms borrowing long term for short-term investments
D) trading of derivatives on exchanges

Question 62

What regulatory change did Congress approve in 2010 to reduce counterparty risk in the shadow banking system?

A) push more trading of derivatives onto exchanges
B) required investment banks to follow the same rules on leverage as commercial banks
C) require increased collateral for those trading derivatives
D) banned trading of mortgage-backed securities

Question 63

What are three reasons that employees may prefer to save through pensions provided by employers rather than through savings accounts?

Question 64

Which government agency regulates futures markets?

A) SEC
B) Commodity Futures Trading Commission
C) Board of Trade
D) the Federal Futures Agency

Question 65

Which of the following is NOT a form of a short-term loan in the shadow banking system?

A) repurchase agreements
B) commercial paper
C) money market mutual fund shares
D) bank deposits

Question 66

What was the primary reason that Congress initiated deposit insurance in the 1930s?

A) protect the deposits of individual savers
B) provide more of an incentive for depositors to monitor bank activities
C) reduce systemic risk to the financial system
D) reduce information problems in the banking system

Question 67

How do defined-contribution plans differ from defined-benefit plans?

Question 68

Which of the following is NOT a reason that firms in the shadow banking system were more vulnerable than commercial banks during the financial crisis of 2007-2009?

A) They could invest in riskier assets.
B) Investors had no insurance against loss of principal.
C) They made investments that would lose value if housing prices decline.
D) They were more heavily regulated than commercial banks, making them less able to adjust to changing market conditions.

Question 69

What is the name of the pension plan under which employees can make tax-deductible contributions through regular payroll deductions?

A) 401(k) plans
B) Social Security plans
C) Early retirement plans
D) 486(b) plans

Question 70

The shadow banking system refers to

A) commercial banks.
B) community banks.
C) pawn shops and institutions that offer payday loans.
D) nonbank financial institutions such as investment banks, hedge funds, and money market mutual funds.

Question 71

Which agency did Congress create in the 1930s to reduce information costs in financial markets?

A) FDIC
B) SEC
C) Federal Reserve
D) Consumer Financial Protection Agency

Question 72

To deal with difficulties in administering pension funds,Congress in 1974 passed the

A) Corrupt Pension Fund Reform Act.
B) Securities and Exchange Act.
C) Employee Retirement Income Security Act.
D) Social Security Act.

Question 73

Which of the following is likely to be more of a problem after the introduction of deposit insurance?

A) moral hazard
B) adverse selection
C) contagion
D) bank runs

Question 74

what were the two main rationale for exempting nonbanks from restrictions on assets and degrees of leverage?