Question 1

The problem with spinning is that it may ________ the cost of capital to a firm and thus ________ the efficiency of the capital market.

Accepted Answer

Spinning, which involves investment bankers allocating hot IPO shares to executives in exchange for future investment banking business, can increase the cost of capital to a firm by creating a conflict of interest between the executives and shareholders. This can lead to inefficiencies in the capital market as investors may view the company as being less trustworthy and may demand higher returns to compensate for the increased risk. Therefore, spinning can both increase the cost of capital and decrease the efficiency of the capital market.

Question 2

Evidence suggests that the market ________ take into account the credibility of analyst's recommendations of IPOs that were underwritten at the analyst's investment bank because the performance of these recommendations was about 50% ________ compared to recommendations made by other analysts at different investment banks.

Accepted Answer

The sentence states that the performance of recommendations made by analysts at the same investment bank as the IPOs being underwritten was about 50% worse than recommendations made by analysts at different investment banks. This suggests that the market does not take into account the credibility of these recommendations, as they are not performing as well as recommendations from independent analysts.

Question 3

Which of the following is not a conflict of interest in accounting firms?

Accepted Answer

A

Question 4

Conflicts of interest may arise within the credit rating agencies because

Accepted Answer

Conflicts of interest may arise within the credit rating agencies if the issuers of debt securities pay them for ratings because the agencies may feel pressure to provide favorable ratings in order to maintain their business relationships with the issuers. This was a contributing factor to the 2008 financial crisis when credit rating agencies gave high ratings to mortgage-backed securities that ultimately proved to be risky assets. Investors relied on these ratings when making investment decisions, which led to significant losses when the securities defaulted.

Question 5

When financial institutions are able to reduce the costs of information for each service they offer by applying the same information source to each service,we say that the financial institution is realizing

Accepted Answer

Economies of scope refer to the cost savings achieved by a firm by producing two or more products using the same inputs or sharing common resources. In this case, by using the same information source for multiple services, the financial institution is able to reduce the costs of information for each service. This is an example of economies of scope, not economies of scale, which refer to the cost savings achieved by a firm by increasing the scale of production. Increasing returns and diminishing marginal returns refer to the relationship between inputs and outputs, and are not relevant to this scenario.

Question 6

A type of ________ problem that occurs when a person or institution has multiple objectives that conflict with each other is called ________.

Accepted Answer

Conflicts of interest occur when a person or institution has multiple objectives that conflict with each other, which is a type of moral hazard problem.

Question 7

Conflicts of interest arising from management advisory services brought down ________ in 2002.

Accepted Answer

Conflicts of interest arising from management advisory services provided by Arthur Andersen were a significant factor in the accounting scandals that led to the collapse of Enron in 2002. Andersen also faced legal issues over its auditing of other companies, including WorldCom and Global Crossing, but Enron was the most high-profile case.

Question 8

The incentive for analysts in investment banks to distort research increases when

Accepted Answer

When potential revenues from underwriting greatly exceed brokerage commissions, there is a higher incentive for analysts to distort research in order to attract clients for underwriting services, which can lead to higher revenues for the investment bank.

Question 9

Conflicts of interest is a type of ________ problem that occurs when a person or institution has multiple objectives that are in conflict with each other.

Accepted Answer

Conflicts of interest arise when a person or institution has multiple objectives that are at odds with one another. This may cause them to act in a manner that is not in the best interest of one or more of the objectives they are supposed to serve, leading to moral hazard. Adverse selection occurs when one party has more information than the other, while risk sharing refers to spreading the risk among multiple parties. Spinning is a practice where investment banks allocate shares of a new issue IPO to their high-profile clients, instead of selling them on the open market. None of these concepts are relevant to conflicts of interest.

Question 10

Not surprisingly,when financial institutions have consolidated more services under one roof,the amount of conflicts of interest has ________,which has led to ________ in unethical behavior.

Accepted Answer

Consolidating more services under one roof leads to increased conflicts of interest, as different services may have competing interests. This has, in turn, led to an increase in unethical behavior.

Question 11

In investment banking,a conflict usually is present between the issuers of securities,who ________,and investors,who ________.

Accepted Answer

Issuers of securities usually benefit from optimistic research as it helps to attract investors to buy their securities while investors desire unbiased research to make informed decisions about investing in the securities. There is no mention of auditing or consulting in the context of the conflict.

Question 12

Describe what is meant by economies of scope and explain how financial institutions' realizing economies of scope has led to an increase in conflicts of interest.

Accepted Answer

The answer of Describe what is meant by economies of...

Question 13

One problem with conflicts of interest is that they can reduce the ________ in financial markets,thereby increasing ________.

Accepted Answer

Conflicts of interest can lead to biased or incomplete information being presented in financial markets, which increases the level of asymmetric information. This ultimately reduces the overall quality of information in financial markets. However, conflicts of interest do not have a direct impact on financial institutions' profits.

Question 14

Which of the following is an example of a bank realizing economies of scope?

Accepted Answer

Economies of scope occur when a company can reduce costs by offering a variety of products or services. In this case, the bank uses information from one service (corporate analysis) to facilitate another service (selling bonds), thus realizing economies of scope.

Question 15

Reputational rents refer to

Accepted Answer

Reputational rents are the economic benefits that a firm gains solely based on its reputation and credibility in the market. These benefits can include higher sales, increased customer loyalty, and the ability to charge a premium price for its products or services. They are distinct from actual economic profits earned through operational efficiencies or cost savings.

Question 16

When the Glass-Steagall Act was repealed in 1999,potential conflicts of interest arose with

Accepted Answer

The repeal of the Glass-Steagall Act allowed for the development of universal banking, where commercial banks could also engage in investment banking activities. This led to potential conflicts of interest as banks could prioritize their own investment activities over their clients' interests.

Question 17

Explain the type of conflicts of interest that can arise from the development of universal banking.

Accepted Answer

The answer of Explain the type of conflicts of interest...

Question 18

When investment banks allocate shares of a popular but underpriced IPO to executives of other firms in order to attract their business,it is called

Accepted Answer

This practice is known as spinning, where investment banks allocate shares of an underpriced IPO to executives of other firms in order to attract their business. It is considered an unethical practice as it's a way of bribing potential clients.

Question 19

Evidence suggests that credit-rating agencies ________ exploited conflicts of interest because ________.

Accepted Answer

The answer of Evidence suggests that credit-rating agencies ________ exploited...

Question 20

Advice on taxes,accounting or management information systems,and business strategies are commonly referred to as ________ services.

Accepted Answer

The term "management advisory" specifically refers to advice on taxes, accounting or management information systems, and business strategies. Accounting audit refers specifically to the auditing of financial statements, while seller and managing underwriter refer more specifically to roles in finance and investment banking.

Quiz 30: Web 5:conflicts of Interest in the Financial Services Industry

The problem with spinning is that it may the cost of capital to a firm and thus the efficiency of the capital market.