Question 1

Financial intermediaries provide customers with liquidity services.Liquidity services ________.
A) make it easier for customers to conduct transactions
B) allow customers to have a cup of coffee while waiting in the lobby
C) are a result of the asymmetric information problem
D) are another term for asset transformation

Accepted Answer

Liquidity services provided by financial intermediaries help customers conduct transactions more easily by providing access to funds or assets quickly and efficiently.

Question 2

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.
A) adverse selection
B) moral hazard
C) risk sharing
D) credit risk

Accepted Answer

Moral hazard refers to the problem of one party taking excessive risks because they do not bear the full cost of those risks. In this scenario, the corporation is using funds raised from selling bonds for purposes other than their original intention, which shows a lack of responsibility and creates a moral hazard.

Question 3

The time and money spent in carrying out financial transactions are called ________.
A) economies of scale
B) financial intermediation
C) liquidity services
D) transaction costs

Accepted Answer

The time and money spent in carrying out financial transactions are referred to as transaction costs.

Question 4

Typically,borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project.The difference in information is called ________,and it creates the ________ problem.
A) asymmetric information; risk sharing
B) asymmetric information; adverse selection
C) adverse selection; risk sharing
D) moral hazard; adverse selection

Accepted Answer

Asymmetric information occurs when one party has more information than the other party in a transaction. In this case, borrowers have more information about the potential risks and returns associated with an investment project. This creates a problem of adverse selection, where lenders may make decisions based on incomplete or inaccurate information.

Question 5

Reducing risk through the purchase of assets whose returns do not always move together is ________.
A) diversification
B) intermediation
C) intervention
D) discounting

Accepted Answer

Diversification involves purchasing assets that have different returns and do not move in the same direction, in order to reduce risk. This strategy helps to minimize the impact of any one investment on an individual's overall portfolio. Intermediation involves connecting buyers and sellers in financial markets, intervention refers to government actions to influence economic activity, and discounting involves reducing the value of future cash flows to their present value.

Question 6

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as ________.
A) risk sharing
B) risk aversion
C) risk neutrality
D) risk selling

Accepted Answer

This process is known as risk sharing, as the intermediaries spread or share the risk across multiple assets. They create low-risk assets (such as deposits) that are sold to investors and use the proceeds to purchase riskier assets (such as loans or securities). This allows them to earn higher returns on the riskier assets while offering a lower risk product to investors.

Question 7

Risk sharing is profitable for financial institutions due to ________.
A) low transactions costs
B) asymmetric information
C) adverse selection
D) moral hazard

Accepted Answer

Risk sharing helps financial institutions spread their risks across a larger pool of individuals or institutions, reducing the likelihood of suffering large losses. This can be done with low transaction costs, as the cost of creating and trading risk-sharing securities is often minimal compared to the potential profit. Asymmetric information, adverse selection, and moral hazard can make it more difficult to create risk-sharing arrangements, but they are not necessarily profitable for financial institutions.

Question 8

Economies of scale enable financial institutions to ________.
A) reduce transactions costs
B) avoid the asymmetric information problem
C) avoid adverse selection problems
D) reduce moral hazard

Accepted Answer

Economies of scale refer to the cost advantages that an organization can achieve by increasing the scale of production. In financial institutions, economies of scale allow for the reduction of transaction costs, as larger quantities of transactions can be handled more efficiently, reducing the per-unit cost. This leads to lower costs for customers, which can help financial institutions to compete effectively in the market.

Question 9

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from ________.
A) government agencies
B) equities markets
C) financial intermediaries
D) bond markets

Accepted Answer

Studies have shown that businesses usually obtain funds from financial intermediaries such as banks or other lending institutions. These intermediaries provide financing in the form of loans or credit to businesses, which allows them to fund their activities and invest in growth opportunities. While businesses can also raise funds through equities markets or bond markets, these avenues are typically more costly and require a higher level of disclosure and transparency than borrowing from financial intermediaries.

Question 10

If bad credit risks are the ones who most actively seek loans and,therefore,receive them from financial intermediaries,then financial intermediaries face the problem of ________.
A) moral hazard
B) adverse selection
C) free-riding
D) costly state verification

Accepted Answer

This situation is a classic example of adverse selection, where the lender is unaware of the borrower's creditworthiness and the borrower may take advantage of the situation. Lenders face the risk of lending to bad credit risks who are actively seeking loans, and this can result in higher default rates and losses for the lenders.

Question 11

The countries that have made the least use of securities markets are ________ and ________; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.
A) Germany; Japan
B) Germany; Great Britain
C) Great Britain; Canada
D) Canada; Japan

Accepted Answer

Germany and Japan have historically relied more on bank financing than on securities markets, with finance from financial intermediaries being significantly greater than that from securities markets.

Question 12

The concept of diversification is captured by the statement ________.
A) don't look a gift horse in the mouth
B) don't put all your eggs in one basket
C) it never rains, but it pours
D) make hay while the sun shines

Accepted Answer

The concept of diversification is all about not putting all your resources, money, or efforts into one thing. Just like not putting all your eggs in one basket, diversification means spreading your investments or efforts across different areas or assets to reduce risk and maximize returns.

Question 13

Although the dominance of ________ over ________ is clear in all countries,the relative importance of bond versus stock markets differs widely.
A) financial intermediaries; securities markets
B) financial intermediaries; government agencies
C) government agencies; financial intermediaries
D) government agencies; securities markets

Accepted Answer

The correct answer is A) financial intermediaries; securities markets. This is because the statement refers to the dominance of one type of financial market entity over another. Financial intermediaries, such as banks and investment companies, often have a more dominant role in the financial system compared to securities markets, which include stock and bond markets. However, the relative importance of bond versus stock markets can vary by country.

Question 14

The process of asset transformation refers to the conversion of ________.
A) safer assets into risky assets
B) safer assets into safer liabilities
C) risky assets into safer assets
D) risky assets into risky liabilities

Accepted Answer

Asset transformation typically involves converting risky assets into safer assets. This is a common practice in financial institutions like banks, where they take in deposits (which are liabilities to the bank but are considered safe to the depositor) and then lend that money out as loans or invest in other assets that are inherently riskier. The process involves managing the risk to ensure that the assets are safer for the bank's stakeholders, including depositors and investors.

Question 15

Because there is an imbalance of information in a lending situation,we must deal with the problems of adverse selection and moral hazard.Define these terms and explain how financial intermediaries can reduce these problems.

Accepted Answer

The answer of Because there is an imbalance of information...

Question 16

Financial institutions that accept deposits and make loans are called ________ institutions.
A) investment
B) contractual savings
C) depository
D) underwriting

Accepted Answer

Depository institutions are financial institutions that accept deposits and make loans. They include commercial banks, credit unions, and savings and loans associations. Investment institutions engage in investment activities such as buying and selling securities, but they do not accept deposits or make loans. Contractual savings institutions collect and invest funds on behalf of their customers, and underwriting institutions help companies issue securities.

Question 17

An example of economies of scale in the provision of financial services is ________.
A) investing in a diversified collection of assets
B) providing depositors with a variety of savings certificates
C) spreading the cost of borrowed funds over many customers
D) spreading the cost of writing a standardized contract over many borrowers

Accepted Answer

Spreading the cost of writing a standardized contract over many borrowers is an example of economies of scale in the provision of financial services. As the number of borrowers increase, the cost per borrower of creating the contract is reduced, which ultimately results in lower costs for both the lender and borrower.

Question 18

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 borrower's lack of good options for obtaining funds

Accepted Answer

Adverse selection occurs when a borrower has more information about the potential risks and returns of their investment activities than the lender. This can lead to the borrower selecting investments that are riskier than what the lender would have approved if they had access to all of the information. This results in higher default rates and losses for lenders.

Question 19

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

Accepted Answer

Adverse selection occurs before a transaction takes place when one party has more information than the other and uses that information to their advantage. Moral hazard occurs after a transaction takes place, when one party has an incentive to take risks that negatively affect the other party because they do not bear the full costs of those risks. Costly state verification and free-riding are both types of moral hazard.

Question 20

Typically,borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project.The difference in information is called ________.
A) moral selection
B) risk sharing
C) asymmetric information
D) adverse hazard

Accepted Answer

Asymmetric information refers to the difference in information between borrowers and lenders about investment projects. This can create a problem of adverse selection and moral hazard, which can lead to market failure.

Quiz 2: An Overview of the Financial System

Financial intermediaries provide customers with liquidity services.Liquidity services ________.

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.

The time and money spent in carrying out financial transactions are called ________.

Typically,borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project.The difference in information is called ,and it creates the problem.

Reducing risk through the purchase of assets whose returns do not always move together is ________.

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as ________.

Risk sharing is profitable for financial institutions due to ________.

Economies of scale enable financial institutions to ________.

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from ________.

If bad credit risks are the ones who most actively seek loans and,therefore,receive them from financial intermediaries,then financial intermediaries face the problem of ________.

The countries that have made the least use of securities markets are and ; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.

The concept of diversification is captured by the statement ________.

Although the dominance of over is clear in all countries,the relative importance of bond versus stock markets differs widely.

The process of asset transformation refers to the conversion of ________.

Because there is an imbalance of information in a lending situation,we must deal with the problems of adverse selection and moral hazard.Define these terms and explain how financial intermediaries can reduce these problems.

Financial institutions that accept deposits and make loans are called ________ institutions.

An example of economies of scale in the provision of financial services is ________.

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

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

Typically,borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project.The difference in information is called ________.