Question 1

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

Accepted Answer

Adverse selection is the problem created before the transaction occurs, where one party has more information about the quality of the product or service being offered than the other party. Moral hazard, on the other hand, is the problem created after the transaction occurs, where one party has an incentive to take excessive risks or engage in unethical behavior because they do not bear the full consequences of their actions. The other choices, costly state verification and free-riding, are not directly related to the problem of asymmetric information.

Question 2

Moral hazard is a problem associated with debt and equity contracts arising from

Accepted Answer

Moral hazard refers to the incentive for one party to take greater risks because they are shielded from the negative consequences of those risks. In the context of debt and equity contracts, both the borrower and the managers have an incentive to take unnecessary risks because they do not bear the full consequences of their actions. Therefore, both A and B are correct, while C is not directly related to the problem of moral hazard.

Question 3

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________.

Accepted Answer

The lemons problem in the used car market results in a higher proportion of low-quality used cars being offered for sale. This is due to adverse selection because sellers of high-quality used cars are less likely to put their cars on the market, as they can usually earn more by keeping them or trading them in. Therefore, buyers are more likely to encounter low-quality used cars with hidden problems, which leads to the problem of adverse selection where the higher risk of buying a lemon leads to lower prices and a further thinning of the market.

Question 4

Which of the following best explains the recent decline in the role of financial intermediaries?

Accepted Answer

Improvements in information technology have allowed individuals and businesses to access and share financial information directly, reducing the need for financial intermediaries.

Question 5

Of the sources of external funds for nonfinancial businesses in the United States, bonds account for approximately ________ of the total.

Accepted Answer

Bonds account for approximately 30% of the total external funds for nonfinancial businesses in the United States. This reflects the significant but not dominant role of bond financing in the capital structure of these businesses.

Question 6

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

Accepted Answer

Adverse selection refers to the problem that arises when borrowers with the highest credit risk are the ones who are most likely to seek out and receive loans from financial intermediaries. Thus, financial intermediaries are faced with the problem of potentially lending to borrowers who are more likely to default on their loans.

Question 7

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

Accepted Answer

New security issues is not one of the eight basic facts about financial structure. The eight basic facts are: (1) Debt contracts are important. (2) Debt contracts are not standardized. (3) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. (4) Debt is not the only way to finance. (5) 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. (6) Collateral is a prevalent feature of debt contracts for both households and businesses. (7) Debt contracts are typically less important for small businesses than for large businesses. (8) The stock market is not the most important source of external funds to finance businesses.

Question 8

Of the following sources of external finance for American nonfinancial businesses, the most important is

Accepted Answer

The answer of Of the following sources of external finance...

Question 9

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

Accepted Answer

Adverse selection occurs when the lender (or investor) is unaware of the borrower's potential risk and return for their investment activities. This lack of information can lead to a mispricing of the loan, which can result in a higher risk of default. Therefore, option A is the correct answer. Option B discusses collateral, which is associated with a different problem known as moral hazard. Option C is incorrect because borrowers may still seek loans for highly risky investments despite the potential risk involved. Option D is incorrect as adverse selection is a well-known problem in the field of finance.

Question 10

Because information is scarce,

Accepted Answer

Option A is not true since equity contracts are not used more frequently than debt contracts because of scarce information. Option B is true because in the absence of complete information, lenders must rely on costly verification mechanisms to ensure that borrowers do not expropriate their wealth. Option C is also true because government regulations such as standard accounting principles can help reduce the information asymmetry between lenders and borrowers. Therefore, option E is the best choice as only options B and C are true.

Question 11

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

Accepted Answer

Asymmetric information refers to the situation where one party, in this case the borrower, has more or better information than the other party, the lender. This can lead to problems such as adverse selection and moral hazard. Adverse selection refers to the tendency of the party with the better information to take actions that are unfavorable to the other party, while moral hazard refers to the tendency of the party with less information to take greater risks that could potentially harm the other party.

Question 12

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

Accepted Answer

A is true, as marketable securities (such as stocks and bonds) account for a larger share of external business financing in the United States than in most other countries.

B is true, as less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households since 1970.

C is false, as the stock market accounted for a large but not the largest share of the financing of American businesses in the 1970-2000 period. Bank loans and other forms of debt financing were also significant sources of external financing during that time.

Question 13

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

Accepted Answer

According to data from the Federal Reserve, stocks account for approximately 10% of the total external funds for nonfinancial businesses in the United States. The majority of external funding for these businesses comes from debt financing, such as loans and bonds.

Question 14

In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

Accepted Answer

The answer of In the used car market, asymmetric information...

Question 15

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

Accepted Answer

The answer of With regard to external sources of financing...

Question 16

(I)In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II)In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses.

Accepted Answer

According to the statement, nonbank loans are the most important source of external funds for nonfinancial businesses in the United States, while issuing stocks and bonds are the most important source of external funds for nonfinancial businesses in Germany and Japan. Therefore, statement (I) is true while statement (II) is false. Option A is the correct answer.

Question 17

If borrowers take on big risks after obtaining a loan, then lenders face the problem of

Accepted Answer

Moral hazard occurs when the borrower takes on more risks because they know the lender will bear the consequences. This can lead to a situation where the borrower does not act in the best interest of the lender, causing losses or defaults.

Question 18

(I)The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II)Financial intermediaries facilitate diversification when an investor has only a small sum to invest.

Accepted Answer

The total cost of carrying out a transaction in financial markets does not necessarily increase proportionally with the size of the transaction, as there are fixed costs and variable costs involved. Financial intermediaries, such as mutual funds, indeed facilitate diversification for investors with small sums to invest by pooling resources from many investors to buy a diversified portfolio of assets.

Question 19

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

Accepted Answer

Issuing marketable securities is not the primary way businesses finance their operations. While it is an important source of external funding, businesses also rely on loans and other forms of direct and indirect finance. The other three options are basic facts about financial structure.

Question 20

Of the following sources of external finance for American nonfinancial businesses, the least important is

Accepted Answer

While stocks are still an important source of external finance for American nonfinancial businesses, they are typically a less important source than loans from banks, bonds and commercial paper, and nonbank loans. Stocks represent ownership in the company and involve sharing of profits and control, while loans and bonds represent debt that must be repaid with interest. Therefore, stocks are considered a riskier source of external finance for businesses compared to other options.

Quiz 7: Why Do Financial Institutions Exist

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

Moral hazard is a problem associated with debt and equity contracts arising from

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be , which gives rise to the problem of .

Which of the following best explains the recent decline in the role of financial intermediaries?

Of the sources of external funds for nonfinancial businesses in the United States, bonds account for approximately ________ of the total.

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

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

Of the following sources of external finance for American nonfinancial businesses, the most important is

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

Because information is scarce,

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

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

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

In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

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

(I) In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses.

If borrowers take on big risks after obtaining a loan, then lenders face the problem of

(I) The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II) Financial intermediaries facilitate diversification when an investor has only a small sum to invest.

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

Of the following sources of external finance for American nonfinancial businesses, the least important is