Question 1

1-2 As of 2009,U.S.FIs held assets totaling over $35 trillion

Accepted Answer

According to data from the Federal Reserve, U.S. financial institutions (including banks, investment firms, insurance companies, etc.) held assets totaling over $35 trillion as of 2009.

Question 2

1-1 Prior to the financial crisis of 2007-2008,J.P.Morgan Chase was the largest bank holding company in the world and operations in 60 countries.

Accepted Answer

J.P. Morgan Chase was not the largest bank holding company in the world prior to the 2007-2008 financial crisis; it was one of the largest, but HSBC was the largest at that time.

Question 3

1-13 Financial institutions are subject to economies of scale in the collection of information.

Accepted Answer

Financial institutions can spread the fixed costs of collecting information over a larger number of customers, resulting in lower average costs as they grow in size. This is an example of economies of scale.

Question 4

1-9 FIs typically provide secondary claims to household savers that have inferior liquidity than primary securities of corporations such as equity and bonds.

Accepted Answer

Financial intermediaries (FIs) typically provide secondary claims, such as deposits, that have superior liquidity compared to primary securities like equity and bonds.

Question 5

1-12 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 operating as an intermediary can reduce transaction costs and information asymmetry, leading to more efficient allocation of capital between savers and borrowers. This results in economies of scale, as the FI can handle a large volume of transactions at a lower cost per unit compared to savers or borrowers acting individually.

Question 6

1-6 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

Failure to monitor the actions of firms in a timely and complete fashion after purchasing securities in that firm can lead to agency costs, which are costs incurred due to the divergence of interests between the investor and the management of the firm. Therefore, it is important to monitor the actions of firms to mitigate these costs.

Question 7

1-15 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 8

1-14 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, financial institutions (FI) issue financial claims, such as deposits, that are more attractive to household savers due to their low-risk nature and government insurance protection, compared to the claims directly issued by corporations that may carry higher risk.

Question 9

1-18 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

Higher supervision costs typically increase agency costs, as they represent additional expenses incurred to ensure that borrowers use funds appropriately.

Question 10

1-20 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 allows an FI to reduce its overall risk by investing in assets that are not perfectly correlated with each other. This means that if one asset performs poorly, the others may perform well, reducing the overall impact of any single asset on the FI's balance sheet.

Question 11

1-11 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 selling financial assets that they do not hold on their balance sheet. Instead, they act as an intermediary between buyers and sellers of financial assets.

Question 12

1-16 Secondary securities are securities that serve as collateral for primary securities.

Accepted Answer

Secondary securities are not collateral for primary securities; they are financial instruments derived from primary securities, such as options or futures.

Question 13

1-5 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

Monitoring the actions of borrowers is an important part of risk management in corporate lending. Without such monitoring, individual investors may be less likely to invest in these securities due to increased risk.

Question 14

1-3 Financial institutions act as intermediaries between suppliers and demanders of money.

Accepted Answer

Financial institutions such as banks, credit unions, and investment firms act as intermediaries between individuals and businesses who need money (demanders) and those who have money to lend or invest (suppliers).

Question 15

1-4 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 does not supervise how the funds are invested or used by a corporation, they run the risk of not earning their desired return or not having their funds returned. This is because they have no control over how the corporation operates and uses their invested funds. Therefore, there is a higher risk of financial loss.

Question 16

1-7 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 actually market risk. Liquidity risk refers to the risk of not being able to sell an asset quickly enough or at a fair price.

Question 17

1-19 As a delegated monitor,an FI's actions reduce agency costs.

Accepted Answer

As a delegated monitor, the financial institution's actions can help reduce agency costs by monitoring and controlling the actions of the agent (borrower) to ensure that they act in the best interest of the principal (lender).

Question 18

1-10 Because the average maturity of assets and the average maturity of liabilities are often different on an FIs balance sheet,the FI is exposed to liquidity risk.

Accepted Answer

The answer of 1-10 Because the average maturity of assets...

Question 19

1-17 FIs are independent market entities that create financial assets whose value is the transformation of financial risk.

Accepted Answer

Financial institutions (FIs) are entities that create financial assets through the transformation of financial risk. They operate independently in the market and are involved in activities such as accepting deposits from savers, providing loans to borrowers, and investing in securities. The value of their financial assets is based on their ability to manage risk and generate returns for their clients.

Question 20

1-8 Because bank loans have a shorter maturity than most debt contracts,FIs typically exercise less monitoring power and control over the borrower.

Accepted Answer

Financial institutions (FIs) often exercise more monitoring power and control over borrowers with shorter maturity loans to manage risk and ensure repayment.

Quiz 1: Why Are Financial Institutions Special