Question 1

An FI is exposed to liquidity risk because the average maturity of assets and the average maturity of liabilities are often different on the FIs balance sheet.

Accepted Answer

False

Question 2

FIs are independent market entities that create financial assets whose value is the transformation of financial risk.

Accepted Answer

This is true. Financial institutions (FIs) often create financial assets such as bonds, stocks, derivatives, etc., by transforming financial risk from one party to another. This is one of the key functions of FIs.

Question 3

The risk that the sale price of an asset will be less than the purchase price of an asset is called liquidity risk.

Accepted Answer

The risk that the sale price of an asset will be less than the purchase price of an asset is called market risk. Liquidity risk refers to the risk of not being able to quickly and easily sell an asset for cash without significantly affecting its price.

Question 4

As of 2012, U.S. FIs held assets totaling over $27 trillion

Accepted Answer

This is true according to data from the Federal Reserve as of June 2012.

Question 5

Financial institutions act as intermediaries between suppliers and demanders of money.

Accepted Answer

Financial institutions such as banks, insurance companies, and investment firms facilitate the transfer of funds between those who have excess funds (suppliers) and those who need funds (demanders).

Question 6

Currently (2012) J.P. Morgan Chase is the largest bank holding company in the world and operations in 60 countries.

Accepted Answer

In 2012, J.P. Morgan Chase was one of the largest bank holding companies, but not necessarily the largest in the world. The title of the largest bank by assets has often shifted among various banks globally.

Question 7

As an asset transformer, the FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations.

Accepted Answer

As an asset transformer, the financial intermediary can issue financial claims that are more attractive to household savers, such as deposits or mutual funds, which are typically seen as safer and more familiar than direct claims issued by corporations. This intermediation process helps to match the needs of savers and borrowers, promoting financial intermediation and ultimately supporting economic growth.

Question 8

Financial institutions are subject to economies of scale in the collection of information.

Accepted Answer

Financial institutions can benefit from economies of scale in the collection of information as they can spread the fixed costs of data gathering and processing over a larger volume of transactions or clients. This can lead to cost savings and improved efficiency in identifying credit risks, fraud, and compliance issues.

Question 9

If a household invests in corporate securities and does not supervise how the funds are invested or used by the corporation, the risk of not earning the desired return or not having the funds returned increase.

Accepted Answer

If a household invests in corporate securities without supervising how the funds are used, they are leaving the fate of their investment entirely in the hands of the corporation. Without oversight, there is a greater risk that the funds may be mismanaged, resulting in a lower return or a failure to return the funds at all.

Question 10

The asset transformation function of an FI is to issue primary financial claims to corporations while purchasing primary claims issued by households and other investors.

Accepted Answer

The asset transformation function of a financial intermediary (FI) involves issuing secondary financial claims to households and other investors while purchasing primary claims issued by corporations.

Question 11

Because bank loans have a shorter maturity than most debt contracts, FIs typically exercise less monitoring power and control over the borrower.

Accepted Answer

Bank loans often have covenants and terms that allow banks significant monitoring power and control over the borrower, more so than many longer-term debt contracts which might be more standardized and less closely monitored.

Question 12

As a delegated monitor, an FI's actions reduce agency costs.

Accepted Answer

As a delegated monitor, an FI is responsible for monitoring and ensuring that the funds entrusted to them are used appropriately. By doing so, they reduce the agency costs that arise due to the principals (investors) not having complete control over their funds. Therefore, the statement is true.

Question 13

Failure to monitor the actions of firms in a timely and complete fashion after purchasing securities in that firm exposes the investor to agency costs.

Accepted Answer

Agency costs arise when there is a conflict between the interests of a principal (investor) and an agent (firm management). Failure to monitor the actions of firms after investing in them can allow management to pursue self-interest at the expense of shareholder wealth. Timely and complete monitoring is necessary to minimize agency costs.

Question 14

FIs typically provide secondary claims to household savers that have inferior liquidity than primary securities of corporations such as equity and bonds.

Accepted Answer

The answer of FIs typically provide secondary claims to household...

Question 15

An FI acting as an agent in matching savers and borrowers of funds can attain economies of scale and provide this service more efficiently than either the saver or borrower could on their own.

Accepted Answer

An FI has access to a larger network of potential savers and borrowers, allowing them to match them more effectively and efficiently. Additionally, they have the expertise and resources to conduct credit analysis and risk management, further improving the efficiency of the process. This can result in lower transaction costs and better terms for both savers and borrowers.

Question 16

The ability of diversification to eliminate much of the risk from the asset side of the balance sheet of an FI is the result of choosing assets that are less than perfectly positively correlated.

Accepted Answer

Diversification involves investing in a variety of assets that are not perfectly positively correlated, which helps to reduce the overall risk of the asset side of the balance sheet. By choosing assets that have different return patterns, an FI can mitigate the impact of negative events affecting any one asset. Consequently, diversification is an important risk management tool for FIs.

Question 17

If not done by FIs, the process of monitoring the actions of borrowers would reduce the attractiveness and increase the risk of investing in corporate debt and equity by individuals.

Accepted Answer

If individuals are not provided with information about the actions of borrowers, it would be difficult for them to assess the creditworthiness and reliability of the borrowers. This would increase the risk of investing in corporate debt and equity for individuals, as they would not have access to the same level of information and analysis that FIs have. Therefore, monitoring the actions of borrowers is important for reducing the risk and increasing the attractiveness of investing in corporate debt and equity by individuals.

Question 18

The more costly it is to supervise the use of funds by a borrower, the less likely a saver will encounter agency costs.

Accepted Answer

The more costly it is to supervise the use of funds by a borrower, the more likely a saver will encounter agency costs. High supervision costs may lead to a lack of monitoring by the lender, resulting in inefficient use of funds by the borrower and potential conflicts of interest.

Question 19

Secondary securities are securities that serve as collateral for primary securities.

Accepted Answer

Secondary securities are those traded in the secondary market, which means they are bought and sold after the original issuance in the primary market, not serving as collateral for primary securities.

Question 20

When an FI functions as a broker, they are selling a financial asset that they have created and will continue to hold on their balance sheet.

Accepted Answer

When an FI functions as a broker, they are acting as an intermediary between buyers and sellers of financial assets, but they are not selling assets that they have created and continue to hold on their balance sheet. Instead, they are facilitating transactions between parties who are buying and selling existing financial assets.

Quiz 1: Why Are Financial Institutions Special