Question 1

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

Accepted Answer

D

Question 2

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

Accepted Answer

C

Question 3

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

Accepted Answer

D

Question 4

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

Accepted Answer

Adverse selection occurs when the lender lacks information about the borrower's potential returns and risks of investment activities, leading to the possibility of lending to high-risk borrowers who are more likely to default. This can result in lower returns for lenders and higher interest rates for borrowers. B and C are not necessarily associated with adverse selection.

Question 5

(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 is the most important source of external funds for nonfinancial businesses in Germany and Japan. Therefore, statement (I) is true and statement (II) is false, making option A the correct answer.

Question 6

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

Accepted Answer

Stocks are typically considered a less important source of external finance for American nonfinancial businesses because they involve giving up ownership and control of the company to shareholders. Loans from banks, bonds and commercial paper, and nonbank loans are generally considered more important sources of external finance as they allow a company to raise capital without diluting ownership or control.

Question 7

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 occurs when the borrowers who are most likely to default are the ones who apply for loans and are approved by financial intermediaries. This puts financial intermediaries at risk of lending to borrowers who are unlikely to pay back their loans, leading to potential losses.

Question 8

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 by asymmetric information before the transaction occurs, where one party has more information than the other and uses it to their advantage. Moral hazard is the problem created after the transaction occurs, where one party takes on more risk because they know the other party bears some of the costs. Costly state verification and free-riding are other types of problems that may arise from asymmetric information, but they are not related to the question asked.

Question 9

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

Accepted Answer

The statement "New security issues is the most important source of external funds to finance businesses" is not one of the eight basic facts about financial structure. The eight basic facts are: (1) excess demanders of funds (borrowers) far outnumber suppliers of funds (lenders); (2) indirect finance, involving financial intermediaries, is much more important than direct finance; (3) financial intermediaries, particularly banks, are the most important source of external funds used to finance businesses; (4) the financial system is heavily regulated; (5) only well-established, financially strong corporations have easy access to securities markets to finance their activities; (6) collateral is a prevalent feature of debt contracts for both households and businesses; (7) debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower; and (8) the use of different types of securities has proliferated and securities markets have become more integrated and globalized.

Question 10

Because information is scarce,

Accepted Answer

Option A is false because when there is scarcity of information, debt contracts are favored over equity contracts as they impose stricter discipline on borrowers. Option D is false because option A is incorrect. Option B is true because when information is scarce, it is expensive to monitor managers, leading to costly state verification. Option C is also true because government regulations, such as standard accounting principles, can help reduce moral hazard by ensuring that firms provide accurate and reliable information to investors. Therefore, option E is the correct choice.

Question 11

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

Accepted Answer

According to the Federal Reserve, stocks account for approximately 10% of the total sources of external funds for nonfinancial businesses in the United States.

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

Option A is accurate since marketable securities (such as stocks and bonds) are widely used for financing nonfinancial businesses in the United States.

Option B is also accurate since most corporate bonds and commercial paper are sold through financial intermediaries rather than directly to households.

Option C is incorrect since the stock market has been a major source of external financing for American businesses, but not necessarily the largest. Other sources such as bank loans and bonds have also played significant roles.

Therefore, the correct answer is E, only option A and B are accurate statements.

Question 13

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 in which one party in a transaction has more or better information than the other party. In this case, the borrower has better information about the potential returns and risks of the investment project than the lender does, which creates an imbalance in information. The other answer choices (moral hazard, noncollateralized risk, and adverse selection) do not accurately describe this situation.

Question 14

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, as many businesses also rely on borrowing from financial intermediaries or receiving funds from venture capitalists or angel investors. The other three statements are basic facts about financial structure.

Question 15

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

Accepted Answer

Moral hazard refers to the problem where borrowers may undertake risky actions after obtaining a loan because they do not bear the full cost of their actions. Lenders face the problem of moral hazard because they cannot observe the actions of borrowers and may not be able to ensure that they are using the loan as intended. This can lead to higher default rates and losses for the lender.

Question 16

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

Accepted Answer

Improvements in information technology have reduced the role of financial intermediaries by enabling borrowers and lenders to directly access financial markets and obtain information about investment opportunities. This has reduced the demand for intermediaries to find and screen potential borrowers or investments.

Question 17

(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 18

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

Accepted Answer

Moral hazard refers to the situation where one party takes more risks knowing that another party will bear the cost of those risks. In the case of debt and equity contracts, the borrower may be incentivized to undertake highly risky investments because they are not fully bearing the cost of those risks. This is option A. Moral hazard can also arise when managers act in their own interest instead of the shareholders' interest, as they may not bear the full cost of their actions. This is captured in option B. Option C is not directly related to moral hazard. Therefore, the correct answer is E, only options A and B capture the problem of moral hazard in debt and equity contracts.

Question 19

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 causes a situation where the quality of the used cars offered for sale is lower than the average quality, leading to adverse selection. This occurs because buyers do not have enough information about the quality of the cars, and sellers have an incentive to hide defects in order to get a higher price. This results in a market where the only sellers willing to sell are those with low-quality cars, making it difficult for buyers to find high-quality cars.

Question 20

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.

Quiz 7: Why Do Financial Institutions Exist

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

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

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

(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.

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

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

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

Because information is scarce,

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

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

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

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

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

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

(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.

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 .

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