Deck 2: The Financial System and the Level of Interest Rates

Question 1

The nominal rate of interest is the rate of interest that is adjusted for inflation.

Answer 1

False

Question 2

The law that prohibited commercial banks from engaging investment banking activities is the Financial Services Modernization Act of 1999.

Answer 2

False

Question 3

An active secondary market for a security will help to enhance the price of that particular security in the primary market.

Answer 3

True

Question 4

Governments are the principal lender-savers in the economy.

Question 5

Real rates of interest are perfectly observable in the financial markets.

Question 6

The role of the financial system is to gather money from people, businesses and government that have funds to invest and to channel that money to those who need it.

Question 7

A primary market is any financial market in which owners of outstanding securities can resell them to other investors.

Question 8

The term money market reflects the idea that the instruments traded in the money market are highly marketable and easily converted into cash.

Question 9

Direct financial markets could be broadly labeled as wholesale markets for funding.

Question 10

The downside to a private placement transaction is that, it does not require the fees and expenses associated with an SEC registration.

Question 11

A privately held corporation who borrows from a regional commercial bank is an example of a direct market transaction.

Question 12

Today, major money center banks in U.S have been allowed back to provide investment banking services.

Question 13

The financial system is nothing more than a collection of financial markets.

Question 14

Without a financial market, purchasing a house would require a cash purchase.

Question 15

Business finance companies obtain the majority of their funds by selling equity.

Question 16

Equities with maturity of greater than one year generally are traded in the capital market.

Question 17

Most companies use indirect market funding from financial institutions to obtain financing.

Question 18

Most securities sales on the New York Stock Exchange are secondary market transactions.

Question 19

Brokers are market specialists who do not bear the risk of owning securities.

Question 20

Businesses are the principal borrower-spenders in the economy.

Question 21

Which of the following is a process by which investment bankers purchase new securities directly from the issuing company and resell them to the investors?

A) Agency marketing.
B) Underwriting.
C) Distribution.
D) Private placement.

Question 22

Savings by _____ in small dollar amounts is the origin of much of the money that funds business loans in an economy.

A) households
B) the U.S. government
C) small businesses
D) none of the above

Question 23

Which of the following is a major participant in the direct financial market?

A) Large corporations.
B) Wealthy individuals.
C) Investment banks.
D) All of the above.

Question 24

If you just purchased a share of IBM through a New York Stock Exchange-based transaction, you participated in:

A) a primary market transaction.
B) a secondary market transaction.
C) a futures market transaction.
D) none of the above.

Question 25

It is difficult for individuals to participate in the direct financial markets for the following reason:

A) The direct financial markets re retail markets with a typical minimum transaction size of $1 million.
B) The direct financial markets are wholesale markets with a typical minimum transaction size of $1 million.
C) Major buyers and sellers of securities in indirect financial markets include commercial banks, large corporations, the federal government, hedge funds, and some wealthy individuals.
D) Major buyers and sellers of securities in direct financial markets do not include commercial banks, large corporations, the federal government, hedge funds, and some wealthy individuals.

Question 26

Financial markets and financial institutions are both part of:

A) the U.S. Treasury.
B) the financial system.
C) the SEC.
D) none of the above.

Question 27

Which of the following is responsible for rolling back many of the rules against commercial banks offering investment banking activities?

A) The Securities Act of 1933.
B) The Securities Exchange Act of 1934.
C) The Glass-Steagall Act of 1933.
D) The Financial Services Modernization Act of 1999.

Question 28

An important function of financial intermediation is:

A) To convert financial securities with one set of characteristics into securities with another set of characteristics.
B) To direct the money from lenders to borrowers
C) To direct the money from borrowers to savers.
D) For commercial banks to use consumer CD deposits to make deposits to small businesses.

Question 29

A financial system's primary function is funneling money from:

A) wealthy individuals to non-wealthy individuals.
B) lender-savers to borrower-spenders.
C) borrower-spenders to lender-savers.
D) the government to wealthy individuals.

Question 30

The major players in the direct financial markets are:

A) investment banks.
B) money center banks.
C) regional banks.
D) both A and B.

Question 31

Direct financing occurs when:

A) a lender-savers borrows directly from a borrower-spenders.
B) a borrower-spenders borrows directly from a lender-savers.
C) a lender-savers borrows from the federal government.
D) a borrower-spenders borrows from the federal government.

Question 32

Stocks that are traded in the _____ are typically those of smaller and less known firms.

A) National Stock Exchange
B) New York Stock Exchange
C) American Stock Exchange
D) over-the-counter market

Question 33

It is impossible for the nominal rate of interest to be less than real rate of interest.

Question 34

What is the typical minimum denominated transaction size in the direct financial markets?

A) $10,000.
B) $100,000.
C) $1,000,000.
D) $10,000,000.

Question 35

The ease with which a security can be sold and converted into cash is called:

A) convertibility.
B) liquidity.
C) marketability.
D) none of the above.

Question 36

The financial market where a new security is sold for the first time is:

A) a primary market.
B) a secondary market.
C) an indirect financial market.
D) none of the above.

Question 37

_____ are the principal lender-savers in the economy.

A) Households
B) Investment banks
C) State governments
D) Businesses

Question 38

Secondary financial markets are similar to:

A) direct auction markets.
B) new-car markets.
C) used-car markets.
D) direct financial market.

Question 39

An economy with a large flow of funds requires:

A) a lot of gold reserves.
B) a frictionless market.
C) an efficient financial system.
D) all of the above.

Question 40

An important function of the financial system is:

A) to direct money to the best investment opportunities in the economy.
B) to allow the federal government to view all financial transactions.
C) to help state governments to coordinate state tax levies.
D) to direct the money from borrower-lenders to lender-savers.

Question 41

Money market instruments are generally issued by:

A) firms in dire need of cash to maintain their credit rating.
B) firms of the highest credit rating.
C) firms of the lower credit ratings.
D) all of the above.

Question 42

The NYSE is an example of:

A) an over-the-counter market exchange.
B) an organized exchange.
C) a commodities exchange.
D) all of the above.

Question 43

The term money market is used because:

A) firms that issue securities in this market are in dire need of cash.
B) it is a market where stocks are converted into money.
C) the instruments traded in this market are close substitutes for cash.
D) none of the above.

Question 44

The presence of a financial market increases the marketability of a financial security by:

A) insuring the price of the security.
B) reducing the transaction costs for selling the security.
C) guaranteeing the accuracy of information produced by the issuer of the security.
D) none of the above.

Question 45

The process of converting financial securities with one set of characteristics into securities with another set of characteristics is called:

A) financial bundling.
B) financial intermediation.
C) financial disintermediation.
D) none of the above.

Question 46

One of the main services offered by investment banks to companies is:

A) helping companies sell new debt or equity issues in the security markets.
B) making loans to companies.
C) taking deposits from companies.
D) all of the above.

Question 47

A highly liquid financial instrument with a maturity of 90 days would be traded in:

A) the money market.
B) the bond market.
C) the stock market.
D) none of the above.

Question 48

Casualty insurance companies sell:

A) protection against loss of income in the event of the death of the insured.
B) protection against loss of property from fire, theft, accidents, and other predictable causes.
C) protection against a loss of pension revenue for retirees.
D) all of the above.

Question 49

The most common reason that corporate firms use the futures and options markets is:

A) to hedge risk.
B) to take risk.
C) to make deposits.
D) none of the above.

Question 50

Large firms are most likely to use money markets for the following reason:

A) To finance long term investments
B) To adjust their liquidity position.
C) To make long term investments.
D) To buy commercial paper at lower interest rates than it could sell through a bank

Question 51

If your firm obtains most of its financing from commercial banks, then it primarily accesses the capital markets through:

A) direct financing.
B) indirect financing.
C) a legal loophole that allows all commercial banks the ability to underwrite securities.
D) none of the above.

Question 52

Which of the following theories states that security prices reflect all public information, but not all private information?

A) Weak-form efficiency.
B) Semistrong-form efficiency.
C) Strong-form efficiency.
D) Nominal-form efficiency.

Question 53

Which of the following theories states that security prices reflect all information, whether public or private?

A) Weak-form efficiency.
B) Semistrong-form efficiency.
C) Strong-form efficiency.
D) Nominal-form efficiency.

Question 54

A line of credit to a corporation is like _____ to an individual.

A) a term loan
B) a bond
C) a credit card
D) a debit card

Question 55

Which of the following would not make up a major part of a pension fund's investment portfolio?

A) Commercial paper.
B) Long-term corporate bonds.
C) Stocks.
D) None of the above.

Question 56

If a firm needs to finance a new corporate headquarters building, then it would most likely seek the funds in the:

A) money market.
B) capital market.
C) futures market.
D) all of the above.

Question 57

Which of the following is a primary investment vehicle for the funds in which life insurance companies must invest?

A) CDs.
B) Equity securities.
C) Long-term corporate bonds.
D) Both B and C.

Question 58

If a firm needs to adjust its liquidity position, then it would participate in:

A) the money market.
B) the bond market.
C) the stock market.
D) the auction market.

Question 59

A mutual fund is an example of:

A) a line of credit.
B) an endowment fund.
C) an investment fund.
D) a pension fund.

Question 60

Which of the following markets has no central trading location?

A) A futures exchange.
B) An over-the-counter market.
C) An auction market.
D) None of the above.

Question 61

You loaned $100 to a friend for one year at a nominal rate of interest of 5 percent. Inflation during that year was 8 percent. How much did the purchasing power of your money change (an increase is positive and a decrease is negative)?

A) increase by around 3 percent.
B) decrease by around 3 percent.
C) increase by around 13 percent.
D) decrease by around 13 percent.

Question 62

If inflation is anticipated to be 6 percent during the next year, while the real rate of interest for a one-year loan is 5 percent, then what should the nominal rate of interest be for a risk-free one-year loan?

A) 6%
B) 11%
C) 5%
D) 12%

Question 63

The general level of interest rates tends to follow:

A) deflation.
B) the business cycle.
C) the default cycle.
D) all of the above.

Question 64

In the United States, the real rate of interest has historically been around:

A) 1 percent.
B) 3 percent.
C) 5 percent.
D) 7 percent.

Question 65

Which of the following is when a firm sells common stock to the public for the very first time?

A) an underwriting
B) an initial public offering
C) a financial intermediation
D) an origination

Question 66

The nominal rate of interest is made up of:

A) the real rate of interest.
B) compensation for inflation.
C) a commodity cross-index return.
D) both A and B .

Question 67

If inflation is anticipated to be 5 percent during the next year, while the real rate of interest for a one-year loan is 5 percent, then what should the nominal rate of interest be for a risk-free one-year loan?

A) 5 percent.
B) 10 percent.
C) 25 percent.
D) None of the above.

Question 68

If you are a borrower, which would you prefer to occur during the life of your loan?

A) A level of inflation that is higher than that anticipated at the outset of the loan.
B) A level of inflation that is lower than that anticipated at the outset of the loan.
C) A level of inflation that is exactly as anticipated at the outset of the loan.
D) No inflation at all

Question 69

If a small business chooses not to borrow funds from a commercial bank, then what will probably be its next best alternative?

A) An insurance company.
B) A pension.
C) An investment fund.
D) A business finance company.

Question 70

The real rate of return can be justified, at a basic level, by:

A) compensation for inflation.
B) compensation for deferring consumption.
C) compensation for the level of international borrowing.
D) all of the above.

Question 71

During an economic expansion, we would expect:

A) interest rates to increase.
B) interest rates to decrease.
C) interest rates to remain the same.
D) the cost of money to decrease.

Question 72

You loaned $100 to a friend for one year at a nominal rate of interest of 3 percent. Inflation during that year was 2 percent. How much did the purchasing power of your money change (an increase is positive and a decrease is negative)?

A) increased by 1 percent.
B) decreased by 1 percent.
C) increased by 5 percent.
D) decreased by 5 percent.

Question 73

If the supply of loanable funds decreases relative to the demand for those funds, then we would expect:

A) interest rates to remain unchanged.
B) interest rates to increase.
C) interest rates to decrease.
D) the cost of money to remain unchanged.

Question 74

The cost of borrowing money is called:

A) inflation.
B) return.
C) interest.
D) all of the above.

Question 75

Why do interest rates follow the business cycle?

A) Typically, the Fed tightens credit to stimulate the economy, which puts further downward pressure on interest rates.
B) Interest rates tend rise during economic expansion and decline during recessions.
C) During an expansion, there is downward pressure on interest rates as businesses begin to grow and borrow more money.
D) During a recession, the demand for goods and services is lower, businesses borrow more, and as a result the economy slows down and the interest rates decline.

Question 76

Explain why secondary markets are so important to businesses that need to raise capital?