Deck 8: An Economic Analysis of Financial Structure

Question 1

As a source of funds for nonfinancial businesses, bonds are relatively more important than stocks in ________.

A) Canada
B) Germany
C) Japan
D) the US

Answer 1

D

Question 2

Of the sources of external funds for nonfinancial businesses in Canada, loans from banks and other financial intermediaries account for ________ of the total.

A) 6 percent
B) 40 percent
C) 56 percent
D) over 70 percent

Answer 2

D

Question 3

Credit card debt is ________.

A) secured debt
B) unsecured debt
C) restricted debt
D) unrestricted debt

Answer 3

B

Question 4

Which of the following statements concerning external sources of financing for nonfinancial businesses in Canada is true?

A) Stocks are a far more important source of finance than are bonds.
B) Stocks and bonds, combined, supply less than one-half of the external funds.
C) Financial intermediaries are the least important source of external funds for businesses.
D) Since 1970, more than half of the new issues of stock have been sold to Canadian households.

Question 5

One purpose of regulation of financial markets is to ________.

A) limit the profits of financial institutions
B) increase competition among financial institutions
C) promote the provision of information to shareholders, depositors and the public
D) guarantee that the maximum rates of interest are paid on deposits

Question 6

Collateralized debt is also know as ________.

A) unsecured debt
B) secured debt
C) unrestricted debt
D) promissory debt

Question 7

Canadian businesses get their external funds primarily from ________.

A) bank loans
B) bonds and commercial paper issues
C) stock issues
D) loans from nonbank financial intermediaries

Question 8

Direct finance involves the sale to ________ of marketable securities such as stocks and bonds.

A) households
B) insurance companies
C) pension funds
D) financial intermediaries

Question 9

Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds ________.

A) by issuing stock
B) by issuing bonds
C) from nonbank loans
D) from bank loans

Question 10

The predominant form of household debt is ________.

A) consumer installment debt
B) collateralized debt
C) unsecured debt
D) unrestricted debt

Question 11

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

A) 2 percent
B) 12 percent
C) 20 percent
D) 40 percent

Question 12

If you default on your auto loan, your car will be repossessed because it has been pledged as ________ for the loan.

A) interest
B) collateral
C) dividend
D) commodity

Question 13

Of the following sources of external finance for Canadian nonfinancial businesses, the least important is ________.

A) loans from banks
B) stocks
C) bonds and commercial paper
D) loans from other financial intermediaries

Question 14

Of the sources of external funds for nonfinancial businesses in Canada, corporate bonds and commercial paper account for approximately ________ of the total.

A) 5 percent
B) 10 percent
C) 15 percent
D) 50 percent

Question 15

Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called ________.

A) collateral
B) points
C) interest
D) good faith money

Question 16

The financial system includes all but the following type of institutions.

A) Banks
B) Insurance companies
C) Mutual funds
D) Public relations firms

Question 17

Canadian businesses used stocks for external financing ________ percent over the 1970-2000 period.

A) 2
B) 12
C) 22
D) 0.2

Question 18

Which of the following statements concerning external sources of financing for nonfinancial businesses in Canada is true?

A) Issuing marketable securities is the primary way that they finance their activities.
B) Bonds are the least important source of external funds to finance their activities.
C) Stocks are a relatively unimportant source of finance for their activities.
D) Selling bonds directly to the Canadian household is a major source of funding for Canadian businesses.

Question 19

Stocks and bonds supply less than ________ of the external funds for Canadian corporations need to finance their activities.

A) one-third
B) one-quarter
C) one-half
D) two-thirds

Question 20

Regulation of the financial system ________.

A) occurs only in Canada
B) protects the jobs of employees of financial institutions
C) protects the wealth of owners of financial institutions
D) ensures the stability of the financial system

Question 21

Financial intermediaries' low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions.

A) liquidity
B) conduction
C) transcendental
D) equitable

Question 22

Which of the following is not a benefit to an individual purchasing a mutual fund?

A) Reduced risk
B) Lower transactions costs
C) Free-riding
D) Diversification

Question 23

If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of ________.

A) moral hazard
B) adverse selection
C) free-riding
D) costly state verification

Question 24

A clause in a mortgage loan contract requiring the borrower to purchase homeowner's insurance is an example of a ________.

A) proscriptive covenant
B) prescriptive covenant
C) restrictive covenant
D) constraint-imposed covenant

Question 25

A ________ is a provision that restricts or specifies certain activities that a borrower can engage in.

A) residual claimant
B) risk hedge
C) restrictive barrier
D) restrictive covenant

Question 26

The two ways financial intermediaries can reduce transactions costs are ________ and ________.

A) economies of scale; expertise
B) moral hazard; adverse selection
C) direct finance; indirect finance
D) stocks; bonds

Question 27

How does a mutual fund lower transactions costs through economies of scale?

Question 28

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

A) moral hazard
B) asymmetric information
C) noncollateralized risk
D) adverse selection

Question 29

A solution to the high transaction costs is to bundle the funds of many investors so that they can take advantage of ________.

A) economies of scale
B) high interest rates
C) high rates of return
D) lower risk

Question 30

The current structure of financial markets can be best understood as the result of attempts by financial market participants to ________.

A) adapt to continually changing government regulations
B) deal with the great number of small firms in the United States
C) reduce transaction costs
D) cartelize the provision of financial services

Question 31

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

A) adverse selection; moral hazard
B) moral hazard; adverse selection
C) costly state verification; free-riding
D) free-riding; costly state verification

Question 32

The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets.

A) noncollateralized risk
B) free-riding
C) asymmetric information
D) costly state verification

Question 33

Commercial and farm mortgages, in which property is pledged as collateral, account for ________.

A) one-quarter of borrowing by nonfinancial businesses
B) one-half of borrowing by nonfinancial businesses
C) one-twentieth of borrowing by nonfinancial businesses
D) two-thirds of borrowing by nonfinancial businesses

Question 34

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

A) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower.
B) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.
C) Collateral is a prevalent feature of debt contracts for both households and business.
D) There is very little regulation of the financial system.

Question 35

If all the students in your class pool their money in order to buy one bond and share its return accordingly, in order to eliminate transaction costs, this is an example of ________.

A) economies of scale
B) cooperative game
C) risk sharing
D) moral hazard

Question 36

Financial intermediaries are able to reduce transaction costs through ________ and ________.

A) economies of scale; expertise
B) restrictive covenants; unsecured debts
C) moral hazard; adverse selection
D) economies of scale; regulation

Question 37

Liquidity service offered by financial intermediary make it ________.

A) easier for customers to conduct transactions
B) more difficult to undertake indirect financial transactions
C) easier to monitor restrictive covenants
D) more difficult to conduct transactions

Question 38

The reduction in transactions costs per dollar of investment as the size of transactions increases is known as ________.

A) discounting
B) economies of scale
C) economies of trade
D) diversification

Question 39

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

A) Stocks are the most important source of finance for Canadian businesses.
B) Issuing marketable securities is not the primary way businesses finance their operations.
C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.
D) Banks are the most important source of external funds to finance businesses.

Question 40

Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs.

A) expertise
B) diversification
C) regulations
D) equity

Question 41

Because of the "lemons problem" the price a buyer of a used car pays is ________.

A) equal to the price of a lemon
B) less than the price of a lemon
C) equal to the price of a peach
D) between the price of a lemon and a peach

Question 42

Explain the problem of asymmetric information, adverse selection and moral hazard, and why these problems are important for the financial system.

Question 43

Nobel prize winner George Akerlof is associated with the "________ problem."

A) lemons
B) efficient markets
C) riskiness
D) volatility

Question 44

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

A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities
B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults
C) the borrower's lack of incentive to seek a loan for highly risky investments
D) the lender's inability to restrict the borrower from changing his behavior once given a loan

Question 45

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries ________.

A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars
B) are able to prevent potential competitors from free-riding off the information that they provide
C) have failed to solve adverse selection problems in this market because "lemons" continue to be traded
D) have solved the moral hazard problem by providing valuable information to their customers

Question 46

The "lemons problem" exists because of ________.

A) transactions costs
B) economies of scale
C) rational expectations
D) asymmetric information

Question 47

The remedies for the adverse selection include all but the following.

A) Private production and sale of information
B) Free-riding
C) Government regulation
D) Financial intermediation

Question 48

Government agencies require that firms that sell securities in public markets adhere to have ________.

A) intermediation
B) nondisclosure
C) independent audits
D) collateral

Question 49

Adverse selection ________.

A) is a problem of symmetric information
B) occurs after the transaction
C) is not important in financial markets
D) why large firms are more likely to obtain funds from securities markets

Question 50

The free-rider problem occurs because ________.

A) people who pay for information use it freely
B) people who do not pay for information use it
C) information can never be sold at any price
D) it is never profitable to produce information

Question 51

In the absence of asymmetric information, the lemons problem ________.

A) goes away
B) becomes worse
C) is not important
D) remains the same

Question 52

The ________ problem helps to explain why the private production and sale of information cannot eliminate ________.

A) free-rider; adverse selection
B) free-rider; moral hazard
C) principal-agent; adverse selection
D) principal-agent; moral hazard

Question 53

Government regulations require publicly traded firms to provide information, reducing ________.

A) transactions costs
B) the need for diversification
C) the adverse selection problem
D) economies of scale

Question 54

The analysis of how asymmetric information problems affect economic behavior is called ________ theory.

A) uneven
B) parallel
C) principal
D) agency

Question 55

A lesson of the Enron collapse is that government regulation ________.

A) always fails
B) can reduce but not eliminate asymmetric information
C) increases the problem of asymmetric information
D) should be reduced

Question 56

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

A) Direct finance accounts for a larger share of external business financing in Canada than indirect finance.
B) Since 1970, most of the newly issued corporate bonds and commercial paper have been sold directly to Canadian households.
C) Indirect finance accounts for a larger share of external business financing in Canada than direct finance.
D) Smaller businesses almost always raise funds by issuing marketable securities.

Question 57

The solution to the adverse selection problem in financial markets is to ________.

A) supply lenders with full details on the borrowers
B) supply borrowers with full details on the lenders
C) supply governmental agencies with financial information
D) produce more free riders

Question 58

An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds.

A) moral hazard
B) adverse selection
C) costly state verification
D) agency

Question 59

Bundling investors funds together ________.

A) increases transactions costs per dollar of investment
B) reduces transaction costs per dollar of investment
C) increases moral hazard
D) explains why stocks are the most import means of external financing for Canadian businesses

Question 60

The "lemons problem" is a term used to describe the ________.

A) moral hazard problem
B) adverse selection problem
C) free-rider problem
D) the diversification problem

Question 61

Explain the "lemons problem" as it applies to the used-car market. Why does this problem exist? How does this market resolve this problem?

Question 62

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do.

A) principals; agents
B) principals; principals
C) agents; agents
D) agents; principals

Question 63

The concept of adverse selection helps to explain all of the following except ________.

A) why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets
B) why indirect finance is more important than direct finance as a source of business finance
C) why direct finance is more important than indirect finance as a source of business finance
D) why the financial system is so heavily regulated

Question 64

The problem of adverse selection helps to explain ________.

A) why banks prefer to make loans unsecured
B) why banks do not have advantage in raising funds for businesses
C) why borrowers are willing to offer collateral to secure their promises to repay loans
D) why the financial system is so heavily regulated

Question 65

Government regulations require publicly traded firms to provide information, reducing ________.

A) transactions costs
B) the need for diversification
C) the adverse selection problem
D) free-riders

Question 66

Analysis of adverse selection indicates that financial intermediaries, especially banks, ________.

A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance
B) despite their success in overcoming free-rider problems, nevertheless play a minor role in moving funds to corporations
C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds
D) must buy securities from corporations to diversify the risk that results from holding non-tradable loans

Question 67

The principal-agent problem ________.

A) occurs when managers have more incentive to maximize profits than the stockholders-owners do
B) in financial markets helps to explain why equity is a relatively important source of finance for Canadian business
C) would not arise if the owners of the firm had complete information about the activities of the managers
D) explains why direct finance is more important than indirect finance as a source of business finance

Question 68

The concept of adverse selection helps to explain ________.

A) why collateral is not a common feature of many debt contracts
B) why large, well-established corporations find it so difficult to borrow funds in securities markets
C) why financial markets are among the most heavily regulated sectors of the economy
D) why stocks are the most important source of external financing for businesses

Question 69

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

A) principal-agent
B) adverse selection
C) free-rider
D) debt deflation

Question 70

The problem of adverse selection helps to explain ________.

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets
B) why direct finance is more important than indirect finance as a source of business finance
C) why collateral is not an important feature of debt contracts
D) why banks prefer to make loans unsecured

Question 71

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries ________.

A) have solved the moral hazard problem created by the consumers of used cars
B) are not able to prevent others from free-riding off the information that they provide
C) help solve the adverse selection problem
D) only sell "lemons"

Question 72

Equity contracts ________.

A) are claims to a share in the profits and assets of a business
B) have the advantage over debt contracts of a lower costly state verification
C) are used much more frequently to raise capital than are debt contracts
D) are not subject to the moral hazard problem

Question 73

Net worth can perform a similar role to ________.

A) diversification
B) collateral
C) intermediation
D) economies of scale

Question 74

As information technology improves, the lending role of financial institutions such as banks should ________.

A) increase somewhat
B) decrease
C) stay the same
D) increase significantly

Question 75

That only large, well-established corporations have access to securities markets ________.

A) explains why indirect finance is such an important source of external funds for businesses
B) can be explained by the problem of moral hazard
C) can be explained by government regulations that prohibit small firms from acquiring funds in securities markets
D) explains why newer and smaller corporations rely so heavily on the new issues market for funds

Question 76

A problem for equity contracts is a particular type of ________ called the ________ problem.

A) adverse selection; principal-agent
B) moral hazard; principal-agent
C) adverse selection; free-rider
D) moral hazard; free-rider

Question 77

How does collateral help to reduce the adverse selection problem in credit market?

Question 78

Because of the adverse selection problem, ________.

A) good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks
B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town"
C) lenders are reluctant to make loans that are not secured by collateral
D) lenders will write debt contracts that restrict certain activities of borrowers

Question 79

The principal-agent problem ________.

A) arises because principals have incentives to free-ride off of the monitoring expenditures of other principals
B) arises because principals find it simple to monitor agents' activities
C) arises because agents' incentives are always compatible with those of the principals
D) arises because principals' incentives are always compatible with those of the agents

Question 80

Explain how government regulation can lessen asymmetric information problems but not eliminate them using Enron as an example.