Question 1

(I)The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction.
(II)Financial intermediaries facilitate diversification when an investor has only a small sum to invest.

Accepted Answer

The total cost of carrying out a transaction in financial markets does not necessarily increase proportionally with the size of the transaction, as there are fixed costs and variable costs involved. Financial intermediaries, such as mutual funds, indeed facilitate diversification for investors with small sums to invest by pooling resources from many investors to buy a diversified portfolio of assets.

Question 2

Because information is scarce,

Accepted Answer

When information is scarce, there is a higher possibility of moral hazard. This makes it difficult for investors to distinguish between good and bad investments leading to a higher cost of state verification. Therefore, monitoring managers becomes expensive. The government can reduce moral hazard by introducing regulations such as standard accounting principles. However, since equity contracts do not require promised payments as in the case of debt contracts, they do not carry the risk of default, which makes them more favourable in situations where information is scarce. Therefore, A is not true.

Question 3

With regard to external sources of financing for nonfinancial businesses in the United States,which of the following are accurate statements?

Accepted Answer

Direct finance is indeed a small portion of external financing, large corporations primarily access securities markets, and loans from intermediaries are a significant source of financing compared to stock markets.

Question 4

Which of the following is not one of the eight basic facts about financial structure?

Accepted Answer

New security issues are not one of the eight basic facts about financial structure. The eight basic facts are: (1) Debt contracts are legal documents that place substantial restrictions on the behavior of the borrower, (2) Debt contracts are complicated, (3) Indirect finance is many times more important than direct finance, (4) The financial system is composed of many different institutions, (5) Financial intermediaries, such as banks and insurance companies, are the most important source of external funds, (6) Collateral is a prevalent feature of debt contracts, (7) Debt contracts are very important source of funds for corporations, and (8) The stock market is a relatively minor source of external funds for corporations.

Question 5

Of the sources of external funds for nonfinancial businesses in the United States,bonds account for approximately ________ of the total.

Accepted Answer

Bonds account for approximately 30% of the total external funds for nonfinancial businesses in the United States. This reflects the significant but not dominant role of bond financing in the capital structure of these businesses.

Question 6

Adverse selection is a problem associated with equity and debt contracts arising from

Accepted Answer

Adverse selection occurs when one party to a contract has more information than the other party and uses that information to their advantage. In the case of equity and debt contracts, the lender may have limited information about the borrower's potential returns and risks associated with their investments, which can lead to adverse selection. This can result in borrowers who are riskier than the lender anticipates, increasing the likelihood of default and resulting in losses for the lender.

Question 7

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

Accepted Answer

Adverse selection refers to the problem that financial intermediaries face when they are more likely to lend to borrowers with high credit risk who actively seek loans, while borrowers with low credit risk may not apply for loans. This creates a higher probability of loan defaults and losses for the financial intermediaries.

Question 8

If borrowers take on big risks after obtaining a loan,then lenders face the problem of

Accepted Answer

The situation described in the question is an example of moral hazard. When borrowers take on big risks after obtaining a loan, they may not have the same incentive to avoid default or maximize profits as they did before obtaining the loan, since they may feel that the risk is now the responsibility of the lender. This creates a moral hazard problem for the lender, who may face losses as a result of the borrower's actions.

Question 9

Moral hazard is a problem associated with debt and equity contracts arising from

Accepted Answer

Moral hazard refers to the risk that one party may take excessive risks when they have protection against losses. In the context of debt and equity contracts, moral hazard arises when the borrower (or management, in the case of equity) has an incentive to undertake highly risky investments that may benefit the borrower themselves, but may not necessarily benefit the lender (or owners). This can happen because the borrower (or management) may not bear the full cost of losses if the investments do not pay off.

Both choices A and B capture different aspects of this problem - choice A highlights the borrower's incentive to take excessive risks, while choice B refers to the difficulty that owners have in ensuring that management acts in the owners' interest. Therefore, the correct answer is E, only A and B of the above.

Choice C refers to adverse selection, which is a related but distinct problem that arises when lenders cannot tell good credit risks from bad ones. Therefore, it is not directly connected to the problem of moral hazard.

Question 10

Which of the following best explains the recent decline in the role of financial intermediaries?

Accepted Answer

Improvements in information technology have made it easier for buyers and sellers to directly access information and trade without the need for financial intermediaries.

Question 11

Of the following sources of external finance for American nonfinancial businesses,the most important is

Accepted Answer

The answer of Of the following sources of external finance...

Question 12

With regard to external sources of financing for nonfinancial businesses in the United States,which of the following are accurate statements?

Accepted Answer

Choice A is accurate as marketable securities, such as stocks and bonds, account for a larger share of external business financing in the United States than in most other countries.
Choice B is accurate as most newly issued corporate bonds and commercial paper are sold indirectly to American households through intermediaries such as mutual funds, rather than directly to households.
Choice C is not accurate as the stock market did not account for the largest share of financing for American businesses in the 1970-2000 period. Therefore, only choices A and B are accurate, making E the best choice.

Question 13

Which of the following is not one of the eight basic facts about financial structure?

Accepted Answer

Issuing marketable securities is not the primary way businesses finance their operations. This statement is incorrect as businesses also borrow directly from financial intermediaries or financial markets. The other three options are valid basic facts about financial structure.

Question 14

(I)In the United States,nonbank loans are the most important source of external funds for nonfinancial businesses.
(II)In Germany and Japan,issuing stocks and bonds is the most important source of external for nonfinancial businesses.

Accepted Answer

According to the statement, in the United States, nonbank loans are the most important source of external funds for nonfinancial businesses, which makes statement (I) true. On the other hand, in Germany and Japan, issuing stocks and bonds is the most important source of external funds for nonfinancial businesses, which makes statement (II) false. Therefore, the best choice is A) (I) is true, (II) false.

Question 15

Of the sources of external funds for nonfinancial businesses in the United States,stocks account for approximately ________ of the total.

Accepted Answer

Stocks account for approximately 10% of the total external funds for nonfinancial businesses in the United States. The majority of external financing comes from sources other than stock issuance, such as loans and bonds.

Question 16

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________.

Accepted Answer

The lemons problem refers to the fact that buyers of used cars cannot determine the quality of the car before purchase, leading to adverse selection where only lower quality cars are willing to be sold at the same price as higher quality cars. Therefore, the average quality of the used cars offered for sale will be low. Moral hazard refers to a situation where one party takes additional risk because another party has agreed to bear the consequences of that risk, but this is not directly related to the lemons problem in the used car market.

Question 17

Of the following sources of external finance for American nonfinancial businesses,the least important is

Accepted Answer

While stocks are an important source of finance for some businesses, they are not as commonly used as loans from banks, bonds and commercial paper, and nonbank loans. Therefore, option B is the least important source of external finance among the given options.

Question 18

In the used car market,asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

Accepted Answer

Asymmetric information in the used car market means buyers cannot distinguish between high-quality and low-quality cars ("lemons"). Therefore, they are only willing to pay a price that reflects the average quality, which can drive high-quality cars out of the market.

Question 19

A borrower who takes out a loan usually has better information about the potential returns and risks of the investment projects he plans to undertake than the lender does.This inequality of information is called

Accepted Answer

Asymmetric information is the unequal distribution of knowledge between two parties involved in a transaction. In this case, the borrower has more information about the investment projects than the lender, creating an asymmetric information problem. Adverse selection refers to a situation where one party has more information than the other before entering into a contract. Moral hazard refers to a situation where a party takes risks because they do not bear the full consequences of the outcome. Noncollateralized risk is not a term commonly used in finance and economics.

Question 20

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

Accepted Answer

The problem created by asymmetric information before the transaction occurs is adverse selection, which refers to the situation where the buyer or the seller has private information about the quality of the product or service being traded. The problem created after the transaction occurs is moral hazard, which refers to the situation where either the buyer or the seller has an incentive to behave in an opportunistic way after the deal has been made. Options C and D refer to other types of market failures caused by asymmetric information.

Quiz 7: Why Do Financial Institutions Exist?

(I) The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II) Financial intermediaries facilitate diversification when an investor has only a small sum to invest.

Because information is scarce,

With regard to external sources of financing for nonfinancial businesses in the United States,which of the following are accurate statements?

Which of the following is not one of the eight basic facts about financial structure?

Of the sources of external funds for nonfinancial businesses in the United States,bonds account for approximately ________ of the total.

Adverse selection is a problem associated with equity and debt contracts arising from

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

If borrowers take on big risks after obtaining a loan,then lenders face the problem of

Moral hazard is a problem associated with debt and equity contracts arising from

Which of the following best explains the recent decline in the role of financial intermediaries?

Of the following sources of external finance for American nonfinancial businesses,the most important is

With regard to external sources of financing for nonfinancial businesses in the United States,which of the following are accurate statements?

Which of the following is not one of the eight basic facts about financial structure?

(I) In the United States,nonbank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan,issuing stocks and bonds is the most important source of external for nonfinancial businesses.

Of the sources of external funds for nonfinancial businesses in the United States,stocks account for approximately ________ of the total.

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be , which gives rise to the problem of .

Of the following sources of external finance for American nonfinancial businesses,the least important is

In the used car market,asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

A borrower who takes out a loan usually has better information about the potential returns and risks of the investment projects he plans to undertake than the lender does.This inequality of information is called

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