Deck 14: Understanding Financial Contracts

Question 1

The U.S. financial system is a(n)__________ system.

A) markets-oriented
B) angel financing
C) banking-oriented
D) loan committee

Answer 1

A

Question 2

The textbook defines any business with less than __________ in assets to be "small."

A) $100,000,000
B) $10,000,000
C) $1,000,000
D) $500,000

Answer 2

B

Question 3

Firms with a continuous need for working capital financing will probably want to have __________ with a bank.

A) credit rationing
B) individually negotiated loans
C) repurchase agreements
D) a line of credit

Answer 3

D

Question 4

The steps in the process of commercial bank lending in order are

A) borrower bank search, credit analysis, borrower-bank negotiation, bank funding.
B) borrower bank search, borrower-bank negotiation, credit analysis, bank funding.
C) credit analysis, borrower bank search, borrower-bank negotiation, bank funding.
D) borrower-bank negotiation, borrower bank search, credit analysis, bank funding.

Question 5

A risky small business stands the best chance of finding external financing from

A) a commercial finance company.
B) a commercial bank.
C) an investment bank.
D) trade credit.

Question 6

A small firm's __________ usually has the task of getting to know the loan officers of local banks.

A) accountant
B) owner
C) production manager
D) tax attorney

Question 7

A __________ may agree to waive a restrictive covenant, especially if doing so appears to make the loan __________.

A) borrower; no riskier
B) borrower; riskier
C) lender; no riskier
D) lender; riskier

Question 8

Bankers have an advantage in developing a relationship with their business borrowers because

A) banks provide a menu of services which allows them to learn about a company.
B) banks have access to higher quality credit reports.
C) banks are better at getting owners to pledge collateral than are other lenders.
D) loans to small businesses are usually less than 5 years thus allowing encouraging borrowers to return more frequently for evaluation.

Question 9

The distinction between a "secured" lender and an "unsecured" lender is that in the event of the bankruptcy of the borrower

A) the unsecured lender has first claim on collateral.
B) the secured lender has first claim on collateral.
C) the secured lender has a first claim on all of the assets of the bankrupt borrower.
D) the unsecured lender has a first claim on all of the assets of the bankrupt borrower.

Question 10

It is __________ in the United States for a bank to require a business owner to put up some of his personal assets as "__________" collateral for a loan to his business.

A) legal; inside
B) legal; outside
C) illegal; inside
D) illegal; outside

Question 11

A clause in a loan contract disallowing the borrower from acquiring other companies during the term of the loan is an example of a

A) guarantee.
B) collateral agreement.
C) restrictive covenant.
D) moral hazard.

Question 12

An "unsecured" loan is one

A) with no stated collateral.
B) that is pending approval by a bank loan committee.
C) which has collateral.
D) in which the borrower is delinquent in loan payments but has not formally defaulted on.

Question 13

The majority of small businesses

A) are privately owned.
B) are managed by professional managers.
C) raise funds in financial markets.
D) are self-financing.

Question 14

A "guaranteed" business loan is one

A) made under a line of credit.
B) backed up by outside collateral.
C) backed up by inside collateral.
D) the business owner is personally liable for repaying.

Question 15

Financing accounts receivable and inventory is known as

A) capital financing.
B) working capital financing.
C) long-term financing.
D) equity financing.

Question 16

Are bank lines of credit to small firms collateralized?

A) All of them are.
B) Some of them are, especially if the firm is risky.
C) Some of them are, especially if the firm is safe.
D) None of them are.

Question 17

The Federal Reserve considers any business with less than __________ employees to be "small."

A) 10
B) 100
C) 500
D) 1500

Question 18

A firm that can borrow from a bank any amount it wishes up to a certain limit, and at any time up to a certain date, is said to have a

A) repurchase agreement.
B) trade credit.
C) a line of credit.
D) internal financing.

Question 19

Because audited financial statements are __________ to prepare, restrictive covenants rarely appear in loan contracts to companies with __________ than $1 million in assets.

A) inexpensive; more
B) inexpensive; less
C) expensive; more
D) expensive; less

Question 20

A "secured" loan is one

A) with no stated collateral.
B) that is pending approval by a bank loan committee.
C) which has collateral.
D) in which the borrower is delinquent in loan payments but has not formally defaulted on.

Question 21

"Mid-size" firms may issue publicly-traded __________ and they usually turn to commercial banks for __________-term debt financing.

A) bonds; long
B) bonds; short
C) equity; long
D) equity; short

Question 22

Large companies with good credit ratings tend to rely on __________ for short-term financing.

A) the commercial paper market
B) private placements
C) finance companies
D) equity

Question 23

The textbook defines a "large" business as having assets in excess of

A) $50 million.
B) $150 million.
C) $500 million.
D) $1 billion.

Question 24

What is the "underwriting spread?"

A) the average percentage of the total bond issue handled by a member of an underwriting syndicate
B) the difference between the price the underwriters receive and the price they pay the borrower
C) the length of time the underwriter agrees to withhold the bonds from the primary market
D) the number of financial institutions in the underwriting syndicate

Question 25

Minimizing per-dollar distribution costs favors issuing bonds __________ for issue sizes above approximately __________.

A) privately; $10,000,000
B) privately; $100,000,000
C) publicly; $10,000,000
D) publicly; $100,000,000

Question 26

In the private placement market the term "due diligence" means

A) an investor finding an honest agent from whom to buy a bond.
B) a borrower finding an honest agent to sell its bonds.
C) conducting a credit analysis of the borrower.
D) an agent tailoring terms of the placement to meet investor needs.

Question 27

An important difference between offering prospectus in a public bond issue and the offering memorandum in a private placement is

A) all relevant factual information about the firm and its financing is required in the prospectus but not in the offering memorandum.
B) evidence of due diligence is required in the offering memorandum but not in the prospectus.
C) the prospectus may not contain any projections about the company's future while an offering memorandum has no such restriction.
D) There are no differences between these two documents.

Question 28

A "registration statement" is drawn up in the process of

A) preparing a private placement.
B) requesting the waiving of a restrictive covenant.
C) underwriting publicly-sold securities.
D) listing the collateral on a loan.

Question 29

Commercial banks

A) buy private placements for their own portfolio of assets.
B) help firms sell private placements.
C) sell their own private placements.
D) have nothing to do with private placements.

Question 30

A mid-size firm may have a "__________" line of credit, meaning all or part of it can be converted into an intermediate-term loan.

A) revolving
B) secured
C) guaranteed
D) mezzanine

Question 31

Only "large" firms are able to sell __________ securities, with __________ yields than the securities the small and mid-size firms can sell.

A) liquid; lower
B) liquid; higher
C) illiquid; lower
D) illiquid; higher

Question 32

Under __________ a borrower gets advance approval from the SEC to issue securities up to a certain amount at an unspecified time in the future.

A) advance registration
B) pre-registration
C) guaranteed registration
D) shelf registration

Question 33

In a private placement, a(n)__________ and __________ are sent to prospective investors.

A) offering memorandum, term sheet
B) registration statement, term sheet
C) registration statement, offering prospectus
D) offering memorandum, offering prospectus

Question 34

Private placements avoid

A) restrictive agreements.
B) SEC registration costs.
C) the need for collateral.
D) the primary market.

Question 35

Insurance companies

A) are the major buyers of private placements for their own portfolio of assets.
B) help firms sell private placements.
C) sell their own private placements.
D) have nothing to do with private placements.

Question 36

Do underwriters normally run any kind of risk?

A) They risk being unable to sell the bonds they underwrite.
B) They risk receiving a lower price than the commitment price to the bond issuer.
C) They risk default on the bonds.
D) No, their operations are generally risk-free.

Question 37

Private placements are a particularly important type of financing for __________ firms.

A) very small
B) small
C) mid-size
D) large

Question 38

Long-term debt financing to midsize companies at the smaller end of the midsize range is provided by

A) commercial banks.
B) individual investors.
C) mutual funds.
D) mezzanine debt funds.

Question 39

Private placements avoid

A) restrictive agreements.
B) public disclosure of financial information that is required of securities that are registered with the SEC.
C) the need for collateral.
D) the primary market.

Question 40

Unlike private placements, publicly-sold securities lack

A) any kind of statement of the financial condition of the borrower.
B) a secondary market.
C) a definite maturity date.
D) restrictive covenants.

Question 41

Commercial paper has a minimum maturity of

A) one day.
B) seven days.
C) 30 days.
D) 270 days.

Question 42

"Medium term notes" have a maturity ranging up to

A) one year.
B) two years.
C) five years.
D) ten years.

Question 43

A borrower's willingness to sign a personal guarantee is

A) one form of the moral hazard problem.
B) one form of the adverse selection problem.
C) a signal of a high-quality borrower.
D) a signal of a low-quality borrower.

Question 44

A bank that maintains low NSF fees might also have relatively __________ loan rates, both parts of a strategy to attract __________-than-average borrowers.

A) low; safer
B) low; riskier
C) high; safer
D) high; riskier

Question 45

Which of the following is NOT a practice that prevents risk-shifting by a borrower?

A) limited-liability ownership
B) placing liens on collateral
C) personal guarantees
D) restrictive covenants

Question 46

The putting up of outside collateral is

A) one form of the moral hazard problem.
B) one form of the adverse selection problem.
C) a signal of a high-quality borrower.
D) a signal of a low-quality borrower.

Question 47

Underwriting spreads on equity issues are much __________ than on debt issues because stock prices are so __________ relative to bond prices.

A) smaller; steady
B) smaller; volatile
C) larger; steady
D) larger; volatile

Question 48

Which type of financing requires the largest minimum size of the borrower?

A) mezzanine funds
B) public debt
C) venture capital funds
D) public equity

Question 49

Which of these forms of financing requires the smallest minimum size of the borrower?

A) short-term commercial bank loans
B) commercial paper
C) mezzanine funds
D) venture capital funds

Question 50

Moral hazard is, in general, the asymmetric information problem that occurs

A) after a transaction is consummated.
B) due to a size difference in the parties to a transaction.
C) with equity financing.
D) before a transaction is consummated.

Question 51

The various signaling techniques __________ completely overcome the moral hazard problem in the case of the small borrower, so that small business loans are generally __________-term.

A) can; long
B) can; short
C) cannot; long
D) cannot; short

Question 52

Liens __________ the moral hazard problem since the borrower is then __________ to sell the affected assets at its discretion.

A) worsen; able
B) worsen; unable
C) ease; able
D) ease; unable

Question 53

The possibility that a borrower will break a promise made to the lender after the loan is made is one form of

A) the moral hazard problem.
B) the adverse selection problem.
C) outside collateral.
D) inside collateral.

Question 54

Asymmetric information is a particular problem for __________ firms or firms with __________ relationship with a particular lending institution.

A) small; a longstanding
B) small; only a recent
C) large; a longstanding
D) large; only a recent

Question 55

A large business finds it __________ than a small business to pursue secretly a high-risk investment in violation of the terms of its loan agreement, and so the large business is __________ beset by the moral hazard problem.

A) more difficult; more
B) more difficult; less
C) easier; more
D) easier; less

Question 56

Moral hazard can be a problem in lending since lenders share __________ in the __________ risk.

A) proportionately; upside
B) proportionately; downside
C) disproportionately; upside
D) disproportionately; downside

Question 57

Adverse selection is, in general, the asymmetric information problem that occurs

A) after a transaction is consummated.
B) due to a size difference in the parties to a transaction.
C) with securitization.
D) before a transaction is consummated.

Question 58

Commercial paper has a maximum maturity of

A) one day.
B) seven days.
C) 30 days.
D) 270 days.

Question 59

The existence of a "bought deal" in public offerings of bonds came about as a result of

A) shelf registration.
B) a narrow underwriting spread.
C) the need of investment banks to form syndicates before underwriting an issue.
D) the need by underwriters to avoid as much risk as possible.

Question 60

A bank that maintains high NSF fees might also have relatively __________ loan rates, both part of a strategy to attract __________-than-average borrowers.

A) low; safer
B) low; riskier
C) high; safer
D) high; riskier

Question 61

In consumer lending, asymmetric information

A) happens only with securitization.
B) cannot be dealt with using the same techniques as in business lending.
C) can be partly offset using the same techniques as in business lending.
D) may be virtually eliminated as a problem by just a collateral requirement.

Question 62

Because consumer loans are rather __________, they have been relatively __________ to securitize.

A) standardized; easy
B) standardized; difficult
C) not standardized; easy
D) not standardized; difficult

Question 63

Because loans to small and midsized businesses are rather __________, they have been relatively __________ to securitize.

A) standardized; easy
B) standardized; difficult
C) not standardized; easy
D) not standardized; difficult

Question 64

When you get a car loan, the lending institution usually sends a check directly to the car dealer. Such a practice

A) helps forestall moral hazard.
B) helps forestall adverse selection.
C) gives rise to moral hazard.
D) gives rise to adverse selection.

Question 65

Which of these forms of financing is generally not employed by very large firms?

A) commercial paper
B) medium-term notes
C) public debt
D) mezzanine funds