Deck 11: The Economics of Financial Intermediation

Question 1

Emerging market economies, compared to industrialized economies, have financial markets that:

A)Differ in composition and size
B)Differ in composition but not in size
C)Are the same in composition but differ in size
D)Are similar in composition and size

Answer 1

C

Question 2

The function of providing liquidity by financial intermediaries:

A)Includes depositors withdrawing funds but not borrowers
B)Only considers people who borrow on a short-term basis, but not depositors
C)Affects people who need to borrow and depositors who withdraw their funds
D)Only affects customers with savings accounts

Answer 2

C

Question 3

Which of the following is not a role of a financial institution acting as a financial intermediary?

A)Pooling the resources of small savers
B)Formulating oversight regulations
C)Providing ways to diversify risk
D)Supplying liquidity

Answer 3

B

Question 4

Financial intermediaries pool the resources of many small savers so that they can:

A)Charge fees to these small savers and earn substantial income
B)Obtain the funds necessary to make loans to borrowers seeking large amounts
C)Lower their transaction costs of obtaining funds
D)Avoid paying any interest to obtain funds to lend

Question 5

Financial intermediation is:

A)Far less important than direct finance through stock and bond markets
B)Only a little more important than direct finance in the United States
C)Much more important than direct finance through stock and bond markets
D)The same thing as finance through stock and bond markets

Question 6

Economies of scale associated with financial intermediaries means:

A)The total cost of handling transactions falls as more transactions are handled
B)The cost per transaction falls as a larger volume of similar transactions are handled
C)The cost per transaction increases as more transactions are handled
D)The cost per transaction decreases regardless of the size of the transaction

Question 7

Automated teller machines provided by financial intermediaries are an example of:

A)High transactions costs associated with financial intermediaries
B)Diseconomies of scale
C)The ability of financial intermediaries to provide liquidity
D)The ability of financial intermediaries to earn profits by raising transaction costs above the norm

Question 8

Financial intermediaries, through their ability to lower transaction costs:

A)Allow for people to be more self-sufficient
B)Increase the amount of trading that occurs in an economy
C)Take people away from their comparative advantage
D)Reduce the number of financial transactions that occur

Question 9

The fact that financial intermediaries employ experts to carry out particular activities and so lower transactions costs is usually associated with the following economic concept:

A)The law of demand
B)Economies of scale
C)Comparative advantage
D)Information costs

Question 10

The fact that a financial intermediary can hire a lawyer to write one contract that works for many customers is an example of:

A)Economies of scale
B)The law of diminishing marginal returns
C)The law of increasing opportunity cost
D)The law of demand

Question 11

Financial intermediaries, through their ability to lower transaction costs:

A)Allow people to specialize in what they do at the lowest opportunity cost
B)Decrease the efficiency of an economy
C)Allow for people to be more self-sufficient
D)Make collecting and processing information easier

Question 12

Financial intermediaries:

A)Increase the cost of financial transactions but offset these higher costs by providing safekeeping of customer funds
B)Provide handling of payments but usually less efficiently than other firms
C)Reduce the cost of financial transactions
D)Provide safety of resources, but only for the large borrowing customers who can afford it

Question 13

Financial institutions, acting as financial intermediaries, perform all of the following, except:

A)Provide ways to diversify risk
B)Pooling resources of small savers
C)Increase transactions costs
D)Provide safekeeping and accounting services

Question 14

When the amount of direct and indirect financing are summed, the result is usually:

A)Greater than 100% of GDP
B)Equal to GDP
C)Less than GDP
D)Approximately 50% of GDP

Question 15

The reduction in transaction costs provided by financial intermediaries benefit:

A)Small borrowers and small savers
B)Large borrowers but not small savers
C)Society in the net, but small savers bear much of the cost
D)Small borrowers but not small savers

Question 16

Financial intermediation exists, in part, because:

A)Financial markets work so well
B)Direct finance through stocks and bonds is the dominant form of financing
C)Transaction costs of financial intermediation is always higher than direct finance
D)The transaction costs associated with direct finance can at times be prohibitive

Question 17

If financial intermediaries did not have the ability to pool the resources of small savers:

A)Borrowers needing large amounts of money would find it more costly to obtain the funds
B)The economy would grow faster
C)People would likely save more
D)The risk associated with lending would decrease

Question 18

The reason financial intermediaries play such an important role in economies has to do with all of the following except:

A)Information costs
B)High transaction costs
C)Complexity of a lot of financial transactions
D)The composition of GDP

Question 19

Examples of economies of scale are:

A)The additional fees financial intermediaries charge on small accounts
B)The decrease in overall transaction costs that occur as volume increases
C)The reduction in the cost per transaction that occurs as the number of transactions increase
D)The decrease in overall information costs that occurs as more transactions are handled

Question 20

One reason financial intermediaries earn profits is because:

A)Individuals are not aware of the true cost of using an intermediary
B)Financial intermediaries are charging for services people do not value
C)Individuals are willing to pay for the reduction in transaction costs financial intermediaries provide
D)They raise the cost of transactions and pass these higher costs on to customers

Question 21

When a bank takes savings from many small savers and lends it to many borrowers, the bank:

A)Decreases the risk to savers through diversification
B)Increases the risk to borrowers through high transaction costs
C)Decreases the risk to savers through economies of scale
D)Decreases the return to savers and increases the cost to borrowers

Question 22

The usual situation in banking regarding asymmetric information is:

A)Borrowers know more than lenders
B)Lenders know more than borrowers
C)Borrowers and lenders have the same information
D)Lenders and borrowers have perfect information

Question 23

Lines of credit provided by financial intermediaries:

A)Decrease liquidity for customers but increase income for the intermediary
B)Are pre-approved loans that can increase liquidity and lowering transaction costs
C)Are costly for intermediaries to provide so are only available to large commercial customers
D)Require deposits in the intermediary that equal or exceed the amount of the line of credit

Question 24

Most individuals save at banks rather than lend directly because:

A)The bank creates information asymmetry
B)Moral hazard exists only when individuals make loans directly to borrowers, it does not occur when banks issue loans
C)Banks through economies of scale can reduce the cost of information asymmetry
D)Information asymmetry is a problem for individuals but not for banks

Question 25

Mutual funds are attractive because:

A)They provide high returns from purchasing the financial securities of a few select companies
B)They provide the investor with greater diversification at a lower cost than what most investors could obtain individually
C)They have inside information that is not available to other investors
D)They usually have inside information because they run most of the companies they invest in

Question 26

Mutual funds offer investors:

A)A greater return for greater risk than what an investor can earn on his own
B)A lower return for more risk than what the investor could earn on his own
C)A lower return for less risk than what the investor could earn on his own
D)A way for individuals to eliminate the idiosyncratic risk associated with any single investment

Question 27

Financial markets do not function as well as they could due to:

A)The fact that banking is highly monopolized
B)The cost of obtaining information can be high
C)Regulation by governments
D)Fluctuations in the inflation rate

Question 28

A bank can usually offer a saver a higher return for the same risk for all of the following reasons except:

A)The bank can usually purchase assets at a lower cost than any one saver
B)The bank can pool the resources of small savers and purchase higher valued assets
C)Economies of scale can also be applied by the bank in its purchase of assets
D)Savers do not have good enough information to know if the return is sufficient

Question 29

If a bank has 1,000 depositors, each of whom deposits $1,000 in the bank, and the bank makes 100 loans of $10,000 each, then each depositor has contributed:

A)$100 to each loan
B)$1 to each loan
C)$10 to each loan
D)$1000 to each loan

Question 30

Asymmetric information poses two important obstacles to the smooth flow of funds from savers to investors.They are:

A)Adverse selection, which arises before the transaction occurs, and moral hazard, which occurs after the transaction
B)Moral hazard, which arises before the transaction occurs, and adverse selection, which occurs after the transaction
C)Adverse selection and moral hazard, both of which occur after the transaction
D)Adverse selection and moral hazard, both of which occur before the transaction

Question 31

Often times we see companies offering money back guarantees to customers if they are not satisfied.These guarantees are a way to treat the problem of:

A)Buyers having more information about the product than the seller
B)The seller having more information about the product than the buyer
C)Symmetric information
D)Adverse selection

Question 32

A bank has 10,000 depositors, each of whom deposits $100 in the bank.If the bank makes 1000 loans for $1,000 each then each depositor has contributed:

A)$1 to each loan
B)$100 to each loan
C)$0.10 to each loan
D)$10 to each loan

Question 33

Mom's Pizzeria goes out of business due to a dramatic decrease in sales from a local newspaper article highlighting the fact that Mom's Pizzeria has been purchasing expired meat from a distributor at cut rate prices for years.The decrease in business also results in Mom's defaulting on the loan they have with the bank.This is an example of:

A)Symmetric information in the financial markets
B)Perfect information in the financial markets
C)Asymmetric information in the financial markets
D)Perfect information in the pizza market

Question 34

Since one function of financial intermediaries is to provide liquidity:

A)They must keep all of their funds in short-term securities
B)They keep almost all of their funds in cash
C)They must know approximately how much liquidity their customers will need each day and have these funds available
D)Regulations require financial intermediaries to keep 50% of their assets in cash

Question 35

Which of the following is not true of adverse selection?

A)It exists because information is perfect
B)It describes the problem a lender faces in identifying loan applicants as good or bad risk borrowers
C)It arises because borrowers have more information than lenders regarding their creditworthiness
D)It arises if lenders try to charge an average price to all applicants

Question 36

Financial intermediaries reduce the problems in lending associated with information asymmetries by all of the following except:

A)Collecting and processing standardized information
B)Screening applicants to be sure they are creditworthy
C)Monitoring loan recipients to be sure the funds are used properly
D)Charging interest rates high enough to discourage undesirable borrowers

Question 37

A lender usually knows less about the creditworthiness of a borrower than the borrower does.This is an example of:

A)Opportunistic behavior
B)Economies of scale
C)Diminishing marginal returns
D)Information asymmetry

Question 38

In a financial market where information is symmetric:

A)All information would be known by both parties in a transaction
B)One party to a transaction knows information the other party does not
C)The ability to obtain information is available to only one party
D)There would be no adverse selection

Question 39

Mom's Bakery goes out of business due to decreasing sales resulting from the dramatic increase in people on low carbohydrate diets.The decrease in business also results in Mom's defaulting on the loan they have with the bank.This is an example of:

A)Lack of perfect information in financial markets
B)Asymmetric information in financial markets
C)Moral hazard in financial markets
D)Symmetric information in financial markets

Question 40

If information in a financial market is symmetric, this means:

A)Borrowers and lenders have perfect information
B)Borrowers would have more information than lenders
C)Borrowers and lenders have the same information
D)Lenders have more information than borrowers

Question 41

In the bond market, the assigning of a risk premium is a tool designed to address the problem of:

A)Adverse selection
B)Information asymmetry
C)The free-rider
D)Moral hazard

Question 42

The interest rates charged on most credit cards is:

A)High due to the problem of adverse selection
B)High because Visa and MasterCard have a virtual monopoly on this business
C)High due to diseconomies of scale that exist in this market
D)Lower than they should be given the problem of adverse selection

Question 43

A lender who wants to avoid the problem of adverse selection could:

A)Charge a very high interest rate and assume all loan applicants are high risk
B)Charge the same average interest rate to all borrowers
C)Charge a low interest rate and make the applicant prove they warrant the low rate by providing information
D)Only lend by issuing credit cards

Question 44

The publication, Consumer's Reports, is one tool designed to treat:

A)Adverse selection
B)Moral hazard
C)The free-rider problem
D)Symmetric information

Question 45

If the market prices the shares of stock of two companies, one of high quality and the other of lower quality, are the same average price and potential buyers cannot distinguish the prospects of the companies:

A)The shares of the low quality firm will disappear from the market
B)The shares of both companies will trade on the market
C)The shares of the high quality firm will disappear from the market
D)This is an example of moral hazard and the shares of both companies will cease to trade

Question 46

Mary Jones is the president of a local bank.She knows that half of the loan applicants in town she would classify as high risk and the other half as low risk.She observes that the other banks in town charge two different interest rates, a lower rate for low risk borrowers and the higher rate for high risk borrowers.She decides that to have an advantage over the other banks she will offer an average rate to everyone.The likely result will be:

A)Mary's bank will be highly successful as this will provide the bank with a large competitive advantage
B)Mary's bank is likely to see a dramatic increase in both types of borrowers
C)Mary's bank will experience adverse selection and have a disproportionate number of low risk borrowers
D)Mary's bank will experience adverse selection and have a disproportionate number of high risk borrowers

Question 47

Which of the following is a problem of adverse selection?

A)The lender has a problem of distinguishing good risk from bad risk borrowers
B)The lender has a problem determining that the proceeds from a loan are being used as the borrower stated
C)A person takes up the hobby of bungee jumping after purchasing health insurance
D)Individuals use more medical services as a result of their purchase of a health insurance plan

Question 48

One reason the government requires public corporations to disclose so much information is to:

A)Minimize the monopoly profits some corporations earn
B)Give small corporations a better chance of competing against large corporations
C)Address the potential harm from asymmetric information
D)Discourage risk-taking by investors

Question 49

Which of the following statements is true?

A)Adverse selection is a problem of monopoly and moral hazard is a problem of information asymmetry
B)Adverse selection and moral hazard are problems stemming from asymmetric information
C)Adverse selection is a problem that occurs after a transaction
D)Moral hazard is a problem that occurs before a transaction

Question 50

Adverse selection:

A)Increases the efficiency of most markets
B)Usually causes prices to adjust faster than they otherwise would
C)Makes it easier for all customers to find what they want
D)Results in fewer market transactions

Question 51

Used car dealers that provide warranties on the cars they sell are treating the:

A)Lemons problem
B)Monopoly problem
C)Problem of people preferring foreign cars
D)Adverse selection problem of buyers preferring new versus used cars

Question 52

In a financial market where information is symmetric:

A)The information known by both parties in a transaction is the same
B)All information is known by both parties in a transaction
C)The ability to obtain information is available to only one party in a transaction
D)Information is not free

Question 53

Which of the following statements is true?

A)Adverse selection is a problem that occurs after a transaction
B)Moral hazard is a problem that occurs before a transaction
C)Adverse selection is a problem stemming from asymmetric information
D)Both adverse selection and moral hazard occur before a transaction

Question 54

The First Bank of Podunk has recently suffered some extraordinary losses on its loan portfolio due to the closing of the largest employer in town.As a result, the bank's management decides to raise the interest rate to new loan applicants.This move is likely to:

A)Increase the profitability of the bank
B)Cause even greater losses
C)Significantly increase both loan applicants and profits
D)Treat the problem of adverse selection that contributed to the losses the bank is experiencing

Question 55

One of the conclusions from Akerlof's paper titled "The Market for Lemons" was:

A)High quality goods will drive low quality goods out of the market
B)Lacking the ability to distinguish high from low quality, the quality the market will end up offering will be the average quality
C)Lacking the ability to distinguish high from low quality, low quality may drive high quality out of the market
D)High quality is always demanded by consumers over low quality

Question 56

Two problems that arise from asymmetric information are:

A)Adverse selection and diseconomies of scale
B)Moral hazard and the free-rider problem
C)Moral hazard and adverse selection
D)The free-rider problem and adverse selection

Question 57

Which of the following is a problem of moral hazard?

A)A lender cannot distinguish good risk from bad risk borrowers
B)An individual who purchases auto insurance begins to leave his or her keys in the car while running into a store
C)Life insurance companies offer an average premium to smokers and non-smokers so they do not have to have two different premiums
D)An auto insurance company charges higher premiums to younger drivers than what they charge to older drivers

Question 58

A firm that has a well-earned reputation for providing high quality:

A)Has found a way to treat the free-rider problem
B)Has found a way to treat the moral hazard problem
C)Has found a way to treat the problem of adverse selection
D)Will not survive in a market if low quality is provided at a lower price

Question 59

One lesson that Akerlof's Lemons model provides is:

A)That for high quality providers to survive they must provide a way that customers can distinguish high quality from low quality
B)Low quality will not survive in a market
C)People always prefer high quality to low quality goods
D)Moral hazard is unavoidable

Question 60

One reason lenders usually require a lot of information from loan applicants is to avoid:

A)The problems of moral hazard
B)The problem of adverse selection
C)Being harmed by symmetric information
D)Charges of discrimination in lending

Question 61

Which of the following statements is true?

A)Unsecured loans generally involve very high interest rates as a result of the free-rider problem
B)Unsecured loans generally involve very high interest rates as a result of adverse selection
C)Unsecured loans are no longer made; all loans now must have some form of collateral
D)Unsecured loans are only made to individuals with very high net worth because it is the only way to limit the risk

Question 62

An unsecured loan is:

A)A loan where the applicant does not have any net worth
B)A loan where the applicant does not post any collateral
C)Another name for a mortgage loan
D)Usually a low-risk loan

Question 63

Requiring that borrowers put up collateral to obtain a loan is a tool designed to treat:

A)The Lemons Problem
B)The problem of adverse selection
C)The problem of moral hazard
D)The free-rider problem

Question 64

The principal-agent problem is quite common in large public corporations due to:

A)The fact that large corporations generate large sales volumes
B)The fact that large companies employ many people
C)Too little regulation by government
D)The fact that the people making the operational decisions are usually not the owners

Question 65

The principal-agent problem is:

A)A form of adverse selection
B)When stockholders are not acting in the best interest of managers
C)A form of moral hazard
D)Due to managers not being able to monitor stockholder behavior

Question 66

The scandals involving Enron, World Com, Global Crossing and other large firms:

A)Are examples of asymmetric information and have led, at least temporarily, to a less well functioning stock market
B)Is what should have been expected on the part of investors, that is why there is a risk premium
C)Have resulted in a cry for less government regulation of public corporations
D)Demonstrate that the government should be responsible for collecting and distributing financial information on firms

Question 67

A home mortgage is a good example of:

A)An unsecured loan
B)A secured loan
C)A high risk loan
D)The problem of adverse selection

Question 68

Recent history has shown that the government regulations requiring the disclosure of information from public corporations have:

A)All but eliminated the problems from asymmetric information
B)Reduced but not eliminated the problems from asymmetric information
C)Just about eliminated the market for information services
D)Resulted in symmetric information

Question 69

Moody's, Value Line, and Dun and Bradstreet are examples of companies that:

A)Provide information free to investors but charge the companies for the ratings provided on the company
B)Provide information free to investors but recoup expenses through advertising done by the companies being rated
C)Charge investors who subscribe to the services for the information
D)Duplicate information that is available to investors at no cost

Question 70

Credit may dry up at the start of an economic downturn because of all of the following except:

A)Lenders require information and accurate information is more difficult to obtain
B)It becomes more difficult for lenders to determine the creditworthiness of borrowers
C)Lenders see greater risk in making loans to borrowers
D)The free-rider problem worsens during a downturn

Question 71

A borrower who obtains funds from a lender to purchase additional inventory but uses the funds to finance a trip to Las Vegas for a weekend of gambling at the opening of a new casino is an example of:

A)The problem of adverse selection
B)The free-rider
C)The moral hazard problem
D)Lax government regulation

Question 72

Which of the following statements is not true?

A)Home mortgage loans are secured loans
B)Credit card loans are secured
C)Most automobile loans are secured loans
D)Secured loans usually carry less risk than unsecured loans

Question 73

The problem of adverse selection created the opportunity for:

A)Lenders to profit significantly at the expense of borrowers
B)Significant deregulation of financial markets
C)A new market in the trading of information
D)Stock prices for many years to be much lower than what they should have been

Question 74

Requiring a large net worth on the part of an applicant is one way lenders treat the problem of:

A)Free-riders
B)Adverse selection
C)Moral hazard
D)The Lemons market

Question 75

Requiring a home buyer to have a large down payment reduces the risk to a mortgage lender because:

A)If the price of the home falls the buyer is still likely to stay
B)The buyer is less likely to sell the house
C)It means the buyer likely underpaid when she bought the house
D)It means there is more information available on the buyer

Question 76

Deflation compounds information problems because it:

A)Increases a company's net worth
B)Tends to understate a company's assets and overstate their liabilities
C)Reduces the dollar value of assets while the dollar value of liabilities stays constant
D)Always harms lenders

Question 77

Private mortgage insurance is usually required in situations where:

A)The lender feels the buyers have overpaid for the house
B)The buyers have no down payment
C)The buyers have a down payment less than 20 percent of the purchase price
D)In the lenders' view the buyers do not have adequate monthly income to handle the mortgage payment

Question 78

The fact that many companies employ supervisors to oversee the actions of workers is a way to treat:

A)Moral hazard
B)Adverse selection
C)The law of diminishing returns
D)The free-rider problem

Question 79

The price for private information is likely higher than it should be and the number of subscribers is lower than users due to the problem of:

A)Adverse selection
B)Free-riders
C)The government regulations regarding information
D)Moral hazard

Question 80

Which of the following could be the lemons problem, applied to financial markets? Explain

A)Lenders seeing a disproportionate share of high quality loan applicants
B)An average interest rate that is too high for the actual risk obtained
C)Profits for many lenders increasing significantly
D)High quality potential borrowers relying more on internally generated funds to finance investment