Question 1

A conflict of interest between providing impartial research about companies issuing securities and selling those same securities arises in

Accepted Answer

Investment banking involves both providing impartial research about companies issuing securities and selling those same securities, which can create a conflict of interest. This is because the investment bank may be more interested in selling the securities to earn a profit rather than providing completely unbiased research.

Question 2

A conflict of interest occurs when

Accepted Answer

A conflict of interest occurs when an individual or organization has multiple interests, and serving one interest could harm the other. In this case, people who are expected to provide reliable information to the public may have incentives not to do so, as it could harm their personal interests or affiliations. This conflict could arise in various fields, such as journalism, politics, or finance.

Question 3

Bad firms

Accepted Answer

Bad firms have an incentive to make themselves look good, so they may slant or manipulate the information they provide to the public to appear more favorable.

Question 4

The conflict of interest in credit-rating agencies arises because ________ pay to have securities rated and,as a result,the agencies' ratings may be biased ________.

Accepted Answer

Credit-rating agencies are paid by security issuers to rate their securities. This gives rise to a conflict of interest because there is a possibility that the ratings may be biased upwards in order to maintain a good relationship with the issuers and secure future business. Therefore, choice B, where biased ratings are directed upwards, is the best choice.

Question 5

Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits.

Accepted Answer

Consulting services became Arthur Andersen's largest source of profits, leading to conflicts of interest, especially when large clients pressured regional office managers to give favorable audits. This situation compromised the firm's objectivity and integrity in its auditing functions.

Question 6

The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can

Accepted Answer

Providing consulting services to audit clients creates a potential conflict of interest because the accounting firm may be hesitant to issue negative audit opinions or provide rigorous review procedures for clients who pay for both services. This conflict of interest can lead to unjustifiably favorable audit reviews for firms that are large clients for its consulting services.

Question 7

An advantage of providing multiple financial services within one financial institution is that it

Accepted Answer

Providing multiple financial services within one financial institution can lower information costs for customers as they do not have to spend time researching and comparing different institutions for different services. This also allows the financial institution to develop broader long-term relationships with customers by meeting multiple needs and increasing customer loyalty.

Question 8

The problem with monitoring as a tool to solve the ________ problem is that it can be expensive in terms of time and money,as reflected in the name economists give it,costly state verification.

Accepted Answer

The costly state verification problem specifically refers to the issue of a principal (such as a company's shareholders) needing to verify that an agent (such as the company's management) is carrying out their duties in accordance with the principal's interests. This is a classic example of a principal-agent problem, and monitoring is one potential tool to address it. Adverse selection, audit, and regulation may also be relevant in different contexts, but they do not specifically relate to the costly state verification problem.

Question 9

Which combination of activities within a single financial institution is least likely to lead to conflicts of interest?

Accepted Answer

Consumer lending and business lending do not involve significant overlap or conflict of interest, as they are two separate types of lending that do not directly compete with one another.

Question 10

Spinning is the practice of

Accepted Answer

Spinning is a practice where investment banks offer executives of potential client companies the opportunity to buy underpriced initial public offerings (IPOs) of other companies' securities. This practice is considered unethical and a conflict of interest since it creates an expectation that the investment bank will provide similar benefits to the executive's own company in the future.

Question 11

A bank

Accepted Answer

A) A bank has access to a lot of information about its customers, which it can use to determine creditworthiness, assess risk, and make informed lending decisions. This information can give the bank a competitive advantage and enable it to generate profits from its activities.
B) By primarily making private loans, a bank can avoid some of the free-rider problems that arise in the market for publicly traded securities. In this way, the bank can better control the risk associated with its loan portfolio.
C) Banks have a lot of experience analyzing financial statements, assessing risk, and identifying good firms from bad firms. This expertise can allow banks to make better lending decisions and avoid losses from defaulting borrowers.

Question 12

A financial institution can achieve cost savings in its credit card operations if it increases the number of cardholders.This is an example of economies of

Accepted Answer

This situation demonstrates economies of scale, as the cost per unit of producing the credit card decreases as the number of cardholders increase.

Question 13

Investment banks are guilty of conflict of interest when they

Accepted Answer

All three options represent situations where investment banks may prioritize the interests of client firms over the interests of investors or the public. By pressuring analysts to produce favorable research or prohibiting negative comments, investment banks may be providing biased information to investors. Allowing client firm executives to alter analysts' research can also lead to the manipulation of information. All of these actions can compromise the integrity and objectivity of investment bank research, and thus represent conflicts of interest.

Question 14

A financial institution can achieve cost savings by engaging in multiple activities.These are called economies of

Accepted Answer

Economies of scope occur when a financial institution can produce multiple products or services at a lower cost per unit than if they were produced separately. Economies of scale occur when a financial institution can produce a larger quantity of a product or service at a lower cost per unit. Both of these factors can lead to cost savings for the institution. Complexity and information are not directly related to achieving cost savings through efficiencies.

Question 15

Conflicts of interest pose a problem because they

Accepted Answer

Conflicts of interest can lower the quality of information, increase problems of asymmetric information, and make the financial system less efficient. Therefore, all the options are correct.

Question 16

Net worth

Accepted Answer

Net worth is the difference between assets and liabilities. This represents the value of an individual's or organization's assets after all debts and obligations have been paid off. It is essentially the amount of equity that a person or company has in their assets. Options A, C, and D are not correct definitions of net worth.

Question 17

Auditors attempt to reduce information asymmetry between a firm's managers and its

Accepted Answer

Auditors attempt to reduce information asymmetry between a firm's managers and its owners by providing an independent and objective assessment of the financial statements. This helps owners make informed decisions about the company's financial health and future prospects.

Question 18

If potential revenues from underwriting greatly exceed brokerage commissions,there is ________ incentive for investment bank analysts to report ________ information about firms issuing securities.

Accepted Answer

When potential revenues from underwriting greatly exceed brokerage commissions, there is a stronger incentive for investment bank analysts to report favorable information about firms issuing securities, as doing so can help secure underwriting deals and generate higher revenues for the investment bank.

Question 19

Investment banks serve two client groups,

Accepted Answer

Investment banks primarily serve issuers of securities, such as corporations and governments, by helping them raise capital through the issuance of stocks and bonds. They also serve investors in those securities by providing research, trading, and other financial services. Home buyers and mortgage lenders, people saving for retirement and pension funds, and mutual funds and investors with relatively small amounts to invest are not typically the main clients of investment banks.

Question 20

Economies of scope refer to cost savings that arise when the

Accepted Answer

Economies of scope occur when a firm produces a variety of products or services together, resulting in cost savings. This is because the same resources can be used for multiple activities, reducing costs compared to producing each product or service separately. Therefore, when the number of different activities undertaken increases, economies of scope can be achieved.

Quiz 7: Why Do Financial Institutions Exist?