Question 1

In the United States,the government agency requiring that firms,which sell securities in public markets,adhere to standard accounting principles and disclose information about their sales,assets,and earnings is the
A) Federal Corporate Securities Commission.
B) Federal Trade Commission.
C) Securities and Exchange Commission.
D) U.S. Treasury Department.
E) Federal Reserve System.

Accepted Answer

The Securities and Exchange Commission (SEC) is the government agency responsible for regulating the public securities markets and ensuring that companies disclose accurate and transparent financial information. The Federal Corporate Securities Commission, Federal Trade Commission, U.S. Treasury Department, and Federal Reserve System do not have specific oversight over securities markets and disclosure requirements like the SEC does.

Question 2

That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries
A) provide information that is valued by consumers of used cars.
B) are able to prevent others from free-riding off the information that they provide.
C) can profit by becoming experts in determining whether an automobile is a good car or a lemon.
D) do all of the above.

Accepted Answer

The fact that most used cars are sold by intermediaries suggests that these intermediaries provide valuable information to consumers, which is why consumers are willing to pay for their services. Additionally, intermediaries are able to prevent free-riding off of this information by charging a fee for their services. Finally, intermediaries can profit by becoming experts in determining whether a car is a good purchase or a lemon. Therefore, all of the above statements are true.

Question 3

The majority of household debt in the United States consists of
A) credit card debt.
B) consumer installment debt.
C) collateralized loans.
D) unsecured loans, such as student loans.

Accepted Answer

The majority of household debt in the United States consists of collateralized loans, such as mortgages and auto loans, which are secured by the value of the item being purchased.

Question 4

The problem of adverse selection helps to explain
A) why banks prefer to make loans secured by collateral.
B) why banks have a comparative advantage in raising funds for American businesses.
C) why borrowers are willing to offer collateral to secure their promises to repay loans.
D) all of the above.
E) only A and B of the above.

Accepted Answer

Adverse selection refers to the problem where the party in a transaction has information that the other party does not have, leading to potentially risky decisions. This concept explains why banks prefer loans secured by collateral (to mitigate the risk of lending to bad credit risks), why banks have a comparative advantage in raising funds (as they develop expertise in assessing credit risk), and why borrowers offer collateral (to signal their creditworthiness and reduce the interest rate they must pay). Thus, all of the options provided (A, B, and C) are explained by the problem of adverse selection.

Question 5

When an accounting firm conducts on independent audit,the accounting firms certify that
A) the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings.
B) the firm is adhering to federal regulations with regard to product safety, hiring practices, and environmental regulations.
C) the firm's management is qualified to conduct the firm's business in the best interest of share holders.
D) All of the above are correct answers.

Accepted Answer

When an accounting firm conducts an independent audit, their primary responsibility is to ensure that the financial statements are prepared in accordance with standard accounting principles and that the information presented is accurate and reliable. The audit does not involve assessing the management's qualifications or evaluating the firm's compliance with federal regulations unrelated to financial reporting. Therefore, Option A is the correct answer.

Question 6

A key finding of the economic analysis of financial structure is that
A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses.
B) while free-rider problems limit the extent to which securities markets finance some business activities, the majority of funds going to businesses are channeled through securities markets.
C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets.
D) economists do not have a very good explanation for why securities markets are so heavily regulated.

Accepted Answer

The free-rider problem in traded securities makes it difficult for investors to profit from paying for information about securities, leading to underproduction of this information. Banks, by privately gathering and acting on information, can overcome this problem, explaining their significant role in business financing.

Question 7

The ________ problem occurs when people who do not pay for information take advantage of the information that other people have paid for.
A) free-rider
B) moral hazard
C) adverse selection
D) lemons

Accepted Answer

Free-rider problem refers to situations where individuals consume (or benefit from) a good without paying for it. In the context of information, the free-rider problem occurs when individuals obtain information that others have paid for, without contributing to the cost of producing that information. This can be a problem because it reduces the incentives for people to produce and share information, which can lead to overall lower levels of information availability and quality. The other choices (B, C, and D) are different concepts that refer to specific problems in economics and are not directly related to the issue of free-riding with information.

Question 8

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) all of the above.

Accepted Answer

Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In the context of financial markets, this can lead to market failure as bad credit risks are more likely to seek loans than good credit risks, prompting lenders to protect themselves. This problem is a key reason financial markets are heavily regulated, to ensure information is as symmetrical as possible and to protect against market failure.

Question 9

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 collateral is an important feature of consumer, but not business, debt contracts.
C) why direct finance is more important than indirect finance as a source of business finance.
D) only A and B of the above.

Accepted Answer

Adverse selection refers to the problem where lenders cannot differentiate between high-risk and low-risk borrowers before providing a loan. Financial intermediaries like banks are better equipped to assess and manage this risk compared to securities markets, making them more likely to provide funds to firms.

Question 10

Because of the adverse selection problem,
A) lenders may make a disproportionate amount of loans to bad credit risks.
B) lenders may refuse loans to individuals with low net worth.
C) lenders are reluctant to make loans that are not secured by collateral.
D) all of the above.

Accepted Answer

Adverse selection refers to the problem where lenders cannot perfectly distinguish between high-risk and low-risk borrowers. This leads to a situation where lenders may end up giving more loans to bad credit risks (A), may refuse loans to individuals who appear to be low net worth due to lack of information (B), and may be reluctant to offer unsecured loans, preferring those backed by collateral to mitigate risk (C).

Question 11

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) do all of the above.

Accepted Answer

Intermediaries like used car dealers play a crucial role in the market by providing valuable information and services that facilitate transactions between buyers and sellers. They help in preventing potential competitors from free-riding off the information they provide, ensuring that the market functions more efficiently. This is because they invest in gathering, verifying, and presenting information about the cars, which would be difficult and costly for individual buyers and sellers to replicate on their own.

Question 12

The authors' analysis of adverse selection indicates that financial intermediaries
A) overcome free-rider problems by holding nontraded loans.
B) must buy securities from corporations to diversify the risk that results from holding nontradable loans.
C) have not been very successful in dealing with adverse selection problems in financial markets.
D) do all of the above.
E) do only A and B of the above.

Accepted Answer

Financial intermediaries overcome free-rider problems by holding nontraded loans, which allows them to mitigate adverse selection by directly monitoring borrowers and retaining the benefits of this monitoring, rather than these benefits being diluted among many investors as would happen with traded securities.

Question 13

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) all of the above.

Accepted Answer

Adverse selection refers to the problem where lenders have difficulty distinguishing between high-risk and low-risk borrowers. As a result, they may become more cautious and prefer to make loans that are secured by collateral to mitigate the risk of default. This does not necessarily mean that good credit risks are more likely to seek loans or that lenders refuse loans to individuals with high net worth for fear they will "skip town."

Question 14

An audit certifies that
A) a firm's loans will be repaid.
B) a firm's securities are safe investments.
C) a firm abides by standard accounting principles.
D) the information reported in a firm's accounting statements is correct.

Accepted Answer

An audit certifies that a firm abides by standard accounting principles, ensuring that the financial statements are prepared according to accepted accounting standards.

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

Accepted Answer

Collateral is property that is pledged as security for a loan. In the event that the borrower cannot make their debt payment, the lender can take possession of the collateral to recoup their losses. Points and interest are terms used to describe the costs associated with borrowing money, and good faith money is a deposit made by the borrower to show their commitment to the transaction.

Question 16

The authors' analysis of adverse selection indicates that financial intermediaries in general,and banks in particular (because they hold a large fraction of nontraded loans),
A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance.
B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem.
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) all of the above.
E) only A and B of the above.

Accepted Answer

The authors' analysis suggests that financial intermediaries, especially banks, are better at overcoming adverse selection and the free-rider problem, allowing them to play a more significant role in moving funds to corporations compared to securities markets. This advantage of financial intermediaries helps explain why indirect finance is a more important source of business finance than direct finance. However, the authors do not provide evidence to support the idea that banks provide a higher percentage of external funds to larger and better-known corporations compared to smaller and newer corporations, or that newer and smaller corporations rely more on the new issues market for funds. Therefore, option C is incorrect.

Question 17

The pecking order hypothesis predicts that the ________ a corporation is,the more likely it will be to ________.
A) smaller and less well known; issue securities
B) larger and more well known; borrow from financial intermediaries
C) larger and more well known; issue securities
D) smaller and less well known; need external financing

Accepted Answer

The pecking order hypothesis states that companies prefer internal financing over external financing, and if external financing is needed, they will first choose to issue securities rather than borrow from financial intermediaries. This is because larger and more well-known corporations typically have easier access to issuing securities and can do so at lower costs, whereas smaller and less well-known corporations may struggle to find buyers for their securities.

Question 18

Financial intermediaries (banks in particular)have the ability to avoid the free-rider problem as long as they primarily
A) make private loans.
B) acquire a diversified portfolio of stocks.
C) buy junk bonds.
D) do a balanced combination of A and B of the above.

Accepted Answer

Financial intermediaries can avoid the free-rider problem by primarily making private loans. In the case of private loans, the bank can have direct communication and contract with the borrower, ensuring that they will receive a return on their investment. The free-rider problem exists when investors can benefit from the investment without contributing anything to it. When banks acquire a diversified portfolio of stocks or buy junk bonds, they are exposed to the risk of not being able to recover their investment and are more vulnerable to the free-rider problem.

Question 19

Collateral is
A) property that is pledged to the lender if a borrower cannot make his or her debt payments.
B) a prevalent feature of debt contracts for households.
C) a prevalent feature of debt contracts for businesses.
D) all of the above.
E) only A and C of the above.

Accepted Answer

Collateral is a prevalent feature of both household and business debt contracts. It is property that is pledged to the lender in case the borrower cannot make their debt payments. Therefore, option D is the correct answer.

Question 20

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.

Accepted Answer

Commercial and farm mortgages account for one-quarter of borrowing by nonfinancial businesses. This reflects the significant but not dominant role that real estate plays in the financing structure of these entities.

Quiz 7: Why Do Financial Institutions Exist?

In the United States,the government agency requiring that firms,which sell securities in public markets,adhere to standard accounting principles and disclose information about their sales,assets,and earnings is the

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

The majority of household debt in the United States consists of

The problem of adverse selection helps to explain

When an accounting firm conducts on independent audit,the accounting firms certify that

A key finding of the economic analysis of financial structure is that

The ________ problem occurs when people who do not pay for information take advantage of the information that other people have paid for.

The concept of adverse selection helps to explain

The problem of adverse selection helps to explain

Because of the adverse selection problem,

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

The authors' analysis of adverse selection indicates that financial intermediaries

Because of the adverse selection problem,

An audit certifies that

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

The authors' analysis of adverse selection indicates that financial intermediaries in general,and banks in particular (because they hold a large fraction of nontraded loans) ,

The pecking order hypothesis predicts that the a corporation is,the more likely it will be to .

Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily

Collateral is

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