Deck 3: Overview of the Financial System

Question 1

All of the following are forms of savings EXCEPT

A)purchase of a new car.
B)purchase of shares of Google.
C)buying shares in a mutual fund.
D)opening up a savings account.

Answer 1

purchase of a new car.

Question 2

A car loan that a bank grants to you is

A)a source of funds to you, but a use of funds to the bank.
B)a use of funds to you, but a source of funds to the bank.
C)a source of funds to both you and the bank.
D)a use of funds to both you and the bank.

Answer 2

a source of funds to you, but a use of funds to the bank.

Question 3

Financial intermediaries

A)channel funds directly between borrowers and lenders.
B)issue claims on individual borrowers directly to savers.
C)act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers.
D)generally provide lenders with higher returns than do financial markets.

Answer 3

act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers.

Question 4

Which of the following is NOT a key service provided by the financial system?

A)Risk sharing
B)Tax avoidance
C)Liquidity
D)Information

Question 5

Which of the following is NOT a financial intermediary?

A)Mutual fund
B)Bank
C)Stock exchange
D)Insurance company

Question 6

The process of matching borrowers and lenders performed by the financial system

A)greatly reduces the chances of inflation.
B)is plagued by the double coincidence of wants problem.
C)increases the economy's ability to produce goods and services.
D)occurs only through financial intermediaries.

Question 7

Fluctuations in the market price of a corporate bond

A)are an example of the risk of owning a financial asset.
B)happen only very rarely.
C)indicate that the firm issuing the bond will soon declare bankruptcy.
D)are generally offset by the yield on the bond being very stable.

Question 8

The primary purpose of the financial system is to

A)make it possible for checks written on a bank in one part of the country to clear against an account in a bank in another part of the country.
B)allow the government to raise enough money to cover its budget deficit.
C)move funds from those who want to spend less than they have available to those with productive investment opportunities.
D)facilitate the efficient exchange of goods and services.

Question 9

Why do savers supply funds?

A)They are promised to be repaid even more funds in the future.
B)They expect to earn higher income in the future.
C)They want to accumulate more financial liabilities.
D)It's a way to increase current consumption.

Question 10

Promises given by borrowers to lenders are

A)recognized as legally enforceable only in some states.
B)not subject to federal taxation.
C)assets to the borrowers.
D)liabilities to the borrowers.

Question 11

If you have a checking account at a bank, the checking account is

A)an asset to you as well as an asset to the bank.
B)an asset to you, but a liability to the bank.
C)a liability to you, but an asset to the bank.
D)a liability to you as well as a liability to the bank.

Question 12

The risk involved in owning a financial asset is best thought of as

A)equal to the interest received from ownership of the asset.
B)the chance that the value of the asset will rise or fall relative to what you expect.
C)equal in most instances to the liquidity of the asset.
D)the difference between the return on the asset after taxes and the return on a similar tax-free asset.

Question 13

Borrowers generally demand funds through the financial system in order to

A)purchase consumer durables, houses, or business plant and equipment.
B)pay taxes or other obligations to the government.
C)purchase food, clothing, or other nondurables.
D)meet business payrolls or other short-term business obligations.

Question 14

If a bank grants you a mortgage, the mortgage is

A)an asset to you as well as an asset to the bank.
B)an asset to you, but a liability to the bank.
C)a liability to you, but an asset to the bank.
D)a liability to you as well as a liability to the bank.

Question 15

The main reason for trade in financial assets is

A)the desire of holders of bonds to be able to exchange them for shares of common stock.
B)the mismatch of income and spending for many individuals and businesses.
C)a shortage of money in an economy, making trade in other financial assets necessary.
D)the refusal of most modern governments to trade currency for gold or silver.

Question 16

Promises given by borrowers to lenders are

A)recognized as legally enforceable only in some states.
B)not subject to federal taxation.
C)assets to the lenders.
D)liabilities to the lenders.

Question 17

If you purchase a Treasury bond, the Treasury bond is

A)an asset to you as well as an asset to the U.S. government.
B)an asset to you, but a liability to the U.S. government.
C)a liability to you, but an asset to the U.S. government.
D)a liability to you as well as a liability to the U.S. government.

Question 18

Financial markets

A)channel funds indirectly between borrowers and lenders.
B)issue claims on individual borrowers directly to savers.
C)act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers.
D)generally provide lenders with lower returns than do financial intermediaries.

Question 19

Borrowers promise to repay borrowed funds

A)by borrowing additional funds in the future.
B)based on their expectation of having higher incomes in the future.
C)by reducing their costs relative to their revenues.
D)by selling other assets.

Question 20

Funds flow from lenders to borrowers

A)indirectly through financial markets.
B)directly through financial intermediaries.
C)indirectly through financial intermediaries.
D)primarily through government agencies.

Question 21

Which of the following assets is the most liquid?

A)Money market mutual fund
B)Stock
C)Treasury bond
D)House

Question 22

The financial system provides risk sharing by allowing

A)borrowers to obtain funds either directly or indirectly.
B)savers to earn interest tax-free.
C)borrowers to convert liabilities into assets.
D)savers to hold many assets.

Question 23

Financial markets enable individuals to transfer risk by

A)effectively prohibiting investments in common stock by unsophisticated investors.
B)leading conservative investors to put their money in government bonds.
C)ensuring that increased risk is offset by increased liquidity.
D)creating instruments that transfer risk from those less willing to bear risk to those more willing to bear risk.

Question 24

Which of the following assets has become significantly more liquid during the past two decades?

A)U.S. currency
B)U.S. government bonds
C)Mortgage loans
D)Bonds issued by large corporations

Question 25

A financial portfolio

A)is a brokerage firm that deals only in common stock.
B)measures the risk involved with holding a particular asset.
C)is a collection of assets.
D)will generally have less liquidity than a nonfinancial portfolio.

Question 26

Which of the following represents the most diversification for someone who currently owns share of stock in Intel?

A)Buying shares in Dell
B)Buying shares in Microsoft
C)Buying shares in Advanced Micro Devices
D)Buying shares in Disney

Question 27

Liquidity

A)is the best available measure of the riskiness of an asset.
B)is a characteristic of money, and of no other asset.
C)is the ease with which an asset can be exchanged for money.
D)was declining for many financial assets during the 1990s.

Question 28

Increased liquidity during the past two decades has reduced interest rates on which of the following assets (holding constant all other things that affect interest rates)?

A)U.S. government bonds
B)Bonds issued by large corporations
C)Business loans
D)Bonds issued by state governments

Question 29

When borrowers possess information about their opportunities or activities that they don't disclose to lenders or creditors, a problem of

A)asymmetric information arises.
B)illiquidity arises.
C)communication arises.
D)undiversified risk arises.

Question 30

Which of the following statements is true?

A)While the financial system creates financial assets, it plays no role in increasing their liquidity.
B)While financial assets are not created by the financial system, the financial system provides ways of increasing their liquidity.
C)The financial system has little to do with either creating or increasing the liquidity of financial assets.
D)The financial system both creates financial assets and provides ways of increasing their liquidity.

Question 31

One value to investors of holding stock or bonds is that

A)they are exempt from both state and federal taxes.
B)they are very low risk investments.
C)they are more liquid than the physical assets of the companies issuing them.
D)they are exempt from state taxes, although they are not exempt from federal taxes.

Question 32

Savers view the liquidity of financial assets as a benefit because

A)they want to be able to easily exchange their assets for something else.
B)the more liquid an asset is, the higher its rate of return, all else being constant.
C)liquid assets incur fewer tax liabilities than do illiquid assets.
D)liquid assets are a good means of saving for retirement.

Question 33

The purpose of diversification is to

A)increase the liquidity of a financial portfolio.
B)reduce the brokerage fees involved in managing a financial portfolio.
C)reduce risk.
D)reduce tax liability.

Question 34

Which of the following assets is the least liquid?

A)Money market mutual fund
B)Stock
C)Treasury bond
D)House

Question 35

Diversification refers to the

A)splitting of wealth into many assets.
B)difference between the liquidity of an asset and its risk.
C)difficulty of converting investments in common stocks into investments in bonds.
D)difficulty of selling common stocks in a weak market.

Question 36

Risk sharing

A)generally reduces the tax liability of savers.
B)increases borrowers' ability to raise funds in the financial system.
C)comes at the cost of lower liquidity.
D)is sometimes offset by the effects of diversification.

Question 37

Diversification reduces the riskiness of a financial portfolio provided

A)the portfolio does not contain too many different assets.
B)the returns on the assets in the portfolio do not vary in the same way.
C)interest rates are stable.
D)at least some tax-free assets are included.

Question 38

Thirty years ago, banks

A)could make mortgage loans, but could not make loans to businesses.
B)could make loans to businesses, but could not make mortgage loans.
C)sold most loans to investors.
D)held most loans until they were paid off.

Question 39

The managers of a firm seek to obtain a loan from a local bank. They tell the bank's loan officer that the loan is intended to finance an expansion in the company, but in reality they intend to use the funds to finance next month's payroll. This incident is an example of

A)the problem of asymmetric information.
B)the problem of the illiquidity of bank loans.
C)banks' failing to charge high enough interest rates on business loans.
D)a situation in which direct finance, rather than indirect finance, should have been employed.

Question 40

Savers who take advantage of the service of transfer risk offered by the financial system

A)often end up paying higher taxes.
B)do so by engaging in diversification.
C)will incur the cost of a lower return than if they had not taken advantage of the service.
D)do so exclusively through the banking system.

Question 41

When economists refer to default risk on a debt instrument, they are referring to

A)the interest rate on the instrument minus the tax liability on that interest.
B)the risk that borrowers will not repay all or part of their obligations.
C)the risk that lenders will insist that borrowers repay the obligation before the maturity date.
D)the risk that lenders will insist that borrowers pay more than the agreed upon interest rate.

Question 42

A "primary market" is a market

A)for government securities.
B)in which newly issued claims are sold to buyers by borrowers.
C)in which newly issued claims are sold by savers to borrowers.
D)for debt by large or "primary" corporations.

Question 43

The maturity of a debt instrument refers to

A)its interest rate, expressed as a percentage of its principal.
B)its interest rate, expressed as an absolute amount.
C)the length of time until it expires.
D)the length of time until the first interest payment on it is due.

Question 44

Which of the following would NOT be an example of a financial market transaction?

A)You purchase a U.S. government bond.
B)You purchase a bond issued by a large corporation.
C)You deposit $100 in your bank checking account.
D)You give your broker $2000 to purchase shares of stock in General Motors.

Question 45

The distinguishing feature of a well-functioning financial market is the

A)continual increase in the liquidity of most assets.
B)continual reduction in the riskiness of most assets.
C)increased ease of converting common stocks into bonds.
D)incorporation of available information into asset prices.

Question 46

The most commonly used claim in financial markets is

A)debt, which is a claim to share in the profits and assets of a firm.
B)debt, which requires the borrower to repay the principal of the loan plus interest.
C)equity, which is a claim to share in the profits and assets of a firm.
D)equity, which requires the borrower to repay the principal of the loan plus interest.

Question 47

Long-term debt instruments have a maturity of at least

A)30 days.
B)1 year.
C)10 years.
D)30 years.

Question 48

The financial system performs the role of communicating information by

A)constantly increasing the liquidity of most assets.
B)constantly reducing the riskiness of most assets.
C)incorporating all available information into the prices of financial assets.
D)providing to investors for a nominal charge all government reports available about a particular company.

Question 49

In a well-functioning financial market, the prices of a company's stocks and bonds will rise

A)only after it's reported profits rise.
B)if an event boosts its expected future profit.
C)only in the presence of asymmetric information.
D)when its asset become less liquid.

Question 50

When a borrower issues a debt instrument to a lender,

A)the lender may receive less than the amount promised, but will not receive more.
B)the lender may receive more than the amount promised, but will not receive less.
C)the lender will always receive exactly the amount promised.
D)the lender may receive more than the amount promised or may receive less than the amount promised.

Question 51

Which of the following is an example of a debt instrument?

A)A checking account at a commercial bank
B)A share of stock in General Motors
C)A life insurance policy
D)A bond issued by General Motors

Question 52

Which of the following would be most likely to use a financial market?

A)A household with a small amount of funds to lend
B)A household wishing to borrow a small amount
C)A small business wishing to borrow to expand its operations
D)A state government wishing to borrow to finance a highway project

Question 53

The amount that a borrower borrows is referred to as the

A)principal.
B)equity.
C)maturity.
D)lump sum.

Question 54

You tell the bank loan officer that you would like to borrow money to purchase a car. In reality you intend to use the money to pay off your losing bets on the Super Bowl. This is an example of

A)the problem of a double coincidence of wants.
B)the problem of asymmetric information.
C)high transactions costs.
D)the use of financial markets for illicit purposes.

Question 55

Financial markets

A)generally deal only with the purchase and sale of government securities.
B)directly issue claims on individual borrowers to savers.
C)act as intermediaries between borrowers and savers.
D)have largely eliminated the risk to savers from holding the bonds of large corporations.

Question 56

An automobile loan is likely to be a(an)

A)short-term debt instrument.
B)intermediate-term debt instrument.
C)long-term debt instrument.
D)equity.

Question 57

Financial markets provide arrangements for

A)direct finance.
B)indirect finance.
C)financial intermediation.
D)direct finance, indirect finance, and financial intermediation.

Question 58

Which of the following is an example of a short-term debt instrument?

A)A six-month U.S. Treasury bill
B)A ten-year U.S. Treasury note
C)A thirty-year U.S. Treasury bond
D)A thirty-year corporate bond

Question 59

Interest is best thought of as

A)a rental fee on the principal of a debt.
B)compensation for taxes incurred on an investment.
C)an example of the exploitation of borrowers by lenders.
D)in most cases, equal to the maturity of the debt.

Question 60

Information on financial assets is communicated

A)only to borrowers.
B)only to savers.
C)only to the appropriate agency of the federal government.
D)both to borrowers and savers.

Question 61

The most common auction markets are

A)exchanges.
B)over-the-counter markets.
C)located in banks or other financial intermediaries.
D)engaged in indirect finance.

Question 62

The periodic payments received by owners of equity are referred to as

A)interest.
B)dividends.
C)maturity.
D)coupons.

Question 63

Derivative markets exist in order to

A)allow for the direct cash sale of common stock.
B)allow for the direct cash sale of bonds.
C)reduce the risk of exposure to price fluctuations in cash markets.
D)overcome some of the information problems involved in trades on the over-the-counter market.

Question 64

If a business fails to make a profit

A)it must still pay a dividend.
B)you would probably be better off holding a bond issued by the business than holding stock issued by the business.
C)you would probably be better off holding stock issued by the business than holding a bond issued by the business.
D)its shareholders may end up being liable for much more than they have invested in the business.

Question 65

Financial intermediaries pool the funds of

A)a few large savers and make loans to many borrowers.
B)many small savers and make loans to a few large borrowers.
C)many small savers and make loans to many borrowers.
D)a few large savers and make loans to a few large borrowers.

Question 66

Financial intermediaries

A)include banks and other depository institutions.
B)include the New York and American Stock exchanges.
C)directly issue claims on individual borrowers to savers.
D)are owned and operated by the federal government.

Question 67

Which of the following is an example of an equity?

A)A thirty-year U.S. government bond
B)A thirty-year corporate bond
C)A checking account in a commercial bank
D)A share of common stock in General Motors

Question 68

When a bank makes a car loan, the loan

A)is an asset to the bank.
B)is a liability to the bank.
C)is an asset to the person taking it out.
D)is a money market instrument.

Question 69

Trading in capital markets involves

A)debt instruments with maturities of more than one year.
B)equities.
C)debt instruments with maturities of less than one year.
D)debt instruments with maturities of more than one year and equities.

Question 70

Trading in money markets involves

A)debt instruments with maturities of more than one year.
B)equities.
C)debt instruments with maturities of less than one year.
D)debt instruments with maturities of more than one year, but less than ten years.

Question 71

Small savers prefer to use financial intermediaries rather than make loans to borrowers directly because

A)savers prefer to share risk.
B)financial intermediaries offer higher interest rates than could be obtained directly from borrowers.
C)savers reduce their tax liability by doing so.
D)borrowers dislike dealing with small savers.

Question 72

In 2006, the total value of debt instruments was

A)roughly equal to the total value of equities.
B)roughly half as much as the total value of equities.
C)roughly twice as much as the total value of equities.
D)roughly one-tenth the total value of equities.

Question 73

Money markets

A)involve trading in debt instruments with maturities of more than one year.
B)are used by large corporations to finance inventories.
C)involve trading in equities.
D)are used by large corporations to finance long-term investments in plant and equipment.

Question 74

Which of the following is NOT true of stock markets?

A)Most of the trading takes place in already issued stock.
B)Every time a share of a company's stock changes hands, that company receives a payment.
C)The dollar volume of trading is less than the dollar volume of trading on bond markets.
D)They help carry out direct finance.

Question 75

In comparing money market and capital market instruments, money market instruments are typically

A)riskier than capital market instruments.
B)more liquid than capital market instruments.
C)less liquid than capital market instruments.
D)riskier, but more liquid, than capital market instruments.

Question 76

Which of the following is NOT true of over-the-counter markets?

A)Prices are set by competitive bidding by a large number of traders.
B)Trading does not take place in one physical location.
C)Traders are willing to buy and sell stocks and bonds at a posted price.
D)Traders are linked by computer.

Question 77

In which of the following financial assets did U.S. households have the most invested in 2006?

A)U.S. government securities
B)Corporate bonds
C)Corporate equities
D)State and local government securities

Question 78

Secondary markets for financial instruments are important because, among other things,

A)they are where companies and governments raise new funds.
B)taxes on trading in these markets are an important source of revenue for governments.
C)they make it easier for investors to hold a diversified portfolio of assets.
D)they provide a place where people interested in financial matters can meet.

Question 79

In comparing money market instruments to capital market instruments, we can say that

A)money market instruments tend to be less risky and less liquid than capital market instruments.
B)money market instruments tend to be more risky, but less liquid than capital market instruments.
C)money market instruments tend to be more risky and more liquid than capital market instruments.
D)money market instruments tend to be less risky, but more liquid than capital market instruments.

Question 80

Economists believe that the major reason that financial intermediaries move a greater volume of funds between borrowers and lenders than do financial markets is

A)the advantage that financial intermediaries have in reducing information costs.
B)the tax advantages that financial intermediaries receive from the government.
C)the higher interest rates that financial intermediaries are able to offer to lenders.
D)the lower interest rates that financial intermediaries are able to offer to borrowers.