Quiz 3: Overview of the Financial System

The main reason for trade in financial assets is A)the desire of holders of bonds to be able to exchange them for shares of common stock. B)the mismatch of income and spending for many individuals and businesses. C)a shortage of money in an economy, making trade in other financial assets necessary. D)the refusal of most modern governments to trade currency for gold or silver.

The primary purpose of the financial system is to A)make it possible for checks written on a bank in one part of the country to clear against an account in a bank in another part of the country. B)allow the government to raise enough money to cover its budget deficit. C)move funds from those who want to spend less than they have available to those with productive investment opportunities. D)facilitate the efficient exchange of goods and services.

The process of matching borrowers and lenders performed by the financial system A)greatly reduces the chances of inflation. B)is plagued by the double coincidence of wants problem. C)increases the economy's ability to produce goods and services. D)occurs only through financial intermediaries.

Borrowers generally demand funds through the financial system in order to A)purchase consumer durables, houses, or business plant and equipment. B)pay taxes or other obligations to the government. C)purchase food, clothing, or other nondurables. D)meet business payrolls or other short-term business obligations.

Why do savers supply funds? A)They are promised to be repaid even more funds in the future. B)They expect to earn higher income in the future. C)They want to accumulate more financial liabilities. D)It's a way to increase current consumption.

All of the following are forms of savings EXCEPT A)purchase of a new car. B)purchase of shares of Google. C)buying shares in a mutual fund. D)opening up a savings account.

Borrowers promise to repay borrowed funds A)by borrowing additional funds in the future. B)based on their expectation of having higher incomes in the future. C)by reducing their costs relative to their revenues. D)by selling other assets.

Promises given by borrowers to lenders are A)recognized as legally enforceable only in some states. B)not subject to federal taxation. C)assets to the borrowers. D)liabilities to the borrowers.

Promises given by borrowers to lenders are A)recognized as legally enforceable only in some states. B)not subject to federal taxation. C)assets to the lenders. D)liabilities to the lenders.

If you purchase a Treasury bond, the Treasury bond is A)an asset to you as well as an asset to the U.S. government. B)an asset to you, but a liability to the U.S. government. C)a liability to you, but an asset to the U.S. government. D)a liability to you as well as a liability to the U.S. government.

If a bank grants you a mortgage, the mortgage is A)an asset to you as well as an asset to the bank. B)an asset to you, but a liability to the bank. C)a liability to you, but an asset to the bank. D)a liability to you as well as a liability to the bank.

If you have a checking account at a bank, the checking account is A)an asset to you as well as an asset to the bank. B)an asset to you, but a liability to the bank. C)a liability to you, but an asset to the bank. D)a liability to you as well as a liability to the bank.

A car loan that a bank grants to you is A)a source of funds to you, but a use of funds to the bank. B)a use of funds to you, but a source of funds to the bank. C)a source of funds to both you and the bank. D)a use of funds to both you and the bank.

Funds flow from lenders to borrowers A)indirectly through financial markets. B)directly through financial intermediaries. C)indirectly through financial intermediaries. D)primarily through government agencies.

Financial markets A)channel funds indirectly between borrowers and lenders. B)issue claims on individual borrowers directly to savers. C)act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers. D)generally provide lenders with lower returns than do financial intermediaries.

Financial intermediaries A)channel funds directly between borrowers and lenders. B)issue claims on individual borrowers directly to savers. C)act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers. D)generally provide lenders with higher returns than do financial markets.

Which of the following is NOT a financial intermediary? A)Mutual fund B)Bank C)Stock exchange D)Insurance company

Which of the following is NOT a key service provided by the financial system? A)Risk sharing B)Tax avoidance C)Liquidity D)Information

The risk involved in owning a financial asset is best thought of as A)equal to the interest received from ownership of the asset. B)the chance that the value of the asset will rise or fall relative to what you expect. C)equal in most instances to the liquidity of the asset. D)the difference between the return on the asset after taxes and the return on a similar tax-free asset.

Fluctuations in the market price of a corporate bond A)are an example of the risk of owning a financial asset. B)happen only very rarely. C)indicate that the firm issuing the bond will soon declare bankruptcy. D)are generally offset by the yield on the bond being very stable.

A financial portfolio A)is a brokerage firm that deals only in common stock. B)measures the risk involved with holding a particular asset. C)is a collection of assets. D)will generally have less liquidity than a nonfinancial portfolio.

Diversification refers to the A)splitting of wealth into many assets. B)difference between the liquidity of an asset and its risk. C)difficulty of converting investments in common stocks into investments in bonds. D)difficulty of selling common stocks in a weak market.

Which of the following represents the most diversification for someone who currently owns share of stock in Intel? A)Buying shares in Dell B)Buying shares in Microsoft C)Buying shares in Advanced Micro Devices D)Buying shares in Disney

The purpose of diversification is to A)increase the liquidity of a financial portfolio. B)reduce the brokerage fees involved in managing a financial portfolio. C)reduce risk. D)reduce tax liability.

Diversification reduces the riskiness of a financial portfolio provided A)the portfolio does not contain too many different assets. B)the returns on the assets in the portfolio do not vary in the same way. C)interest rates are stable. D)at least some tax-free assets are included.

The financial system provides risk sharing by allowing A)borrowers to obtain funds either directly or indirectly. B)savers to earn interest tax-free. C)borrowers to convert liabilities into assets. D)savers to hold many assets.

Financial markets enable individuals to transfer risk by A)effectively prohibiting investments in common stock by unsophisticated investors. B)leading conservative investors to put their money in government bonds. C)ensuring that increased risk is offset by increased liquidity. D)creating instruments that transfer risk from those less willing to bear risk to those more willing to bear risk.

Savers who take advantage of the service of transfer risk offered by the financial system A)often end up paying higher taxes. B)do so by engaging in diversification. C)will incur the cost of a lower return than if they had not taken advantage of the service. D)do so exclusively through the banking system.

Risk sharing A)generally reduces the tax liability of savers. B)increases borrowers' ability to raise funds in the financial system. C)comes at the cost of lower liquidity. D)is sometimes offset by the effects of diversification.

Liquidity A)is the best available measure of the riskiness of an asset. B)is a characteristic of money, and of no other asset. C)is the ease with which an asset can be exchanged for money. D)was declining for many financial assets during the 1990s.

Savers view the liquidity of financial assets as a benefit because A)they want to be able to easily exchange their assets for something else. B)the more liquid an asset is, the higher its rate of return, all else being constant. C)liquid assets incur fewer tax liabilities than do illiquid assets. D)liquid assets are a good means of saving for retirement.

Which of the following assets is the most liquid? A)Money market mutual fund B)Stock C)Treasury bond D)House

Which of the following assets is the least liquid? A)Money market mutual fund B)Stock C)Treasury bond D)House

One value to investors of holding stock or bonds is that A)they are exempt from both state and federal taxes. B)they are very low risk investments. C)they are more liquid than the physical assets of the companies issuing them. D)they are exempt from state taxes, although they are not exempt from federal taxes.

Which of the following statements is true? A)While the financial system creates financial assets, it plays no role in increasing their liquidity. B)While financial assets are not created by the financial system, the financial system provides ways of increasing their liquidity. C)The financial system has little to do with either creating or increasing the liquidity of financial assets. D)The financial system both creates financial assets and provides ways of increasing their liquidity.

Which of the following assets has become significantly more liquid during the past two decades? A)U.S. currency B)U.S. government bonds C)Mortgage loans D)Bonds issued by large corporations

Thirty years ago, banks A)could make mortgage loans, but could not make loans to businesses. B)could make loans to businesses, but could not make mortgage loans. C)sold most loans to investors. D)held most loans until they were paid off.

Increased liquidity during the past two decades has reduced interest rates on which of the following assets (holding constant all other things that affect interest rates)? A)U.S. government bonds B)Bonds issued by large corporations C)Business loans D)Bonds issued by state governments

When borrowers possess information about their opportunities or activities that they don't disclose to lenders or creditors, a problem of A)asymmetric information arises. B)illiquidity arises. C)communication arises. D)undiversified risk arises.

The managers of a firm seek to obtain a loan from a local bank. They tell the bank's loan officer that the loan is intended to finance an expansion in the company, but in reality they intend to use the funds to finance next month's payroll. This incident is an example of A)the problem of asymmetric information. B)the problem of the illiquidity of bank loans. C)banks' failing to charge high enough interest rates on business loans. D)a situation in which direct finance, rather than indirect finance, should have been employed.

You tell the bank loan officer that you would like to borrow money to purchase a car. In reality you intend to use the money to pay off your losing bets on the Super Bowl. This is an example of A)the problem of a double coincidence of wants. B)the problem of asymmetric information. C)high transactions costs. D)the use of financial markets for illicit purposes.

The financial system performs the role of communicating information by A)constantly increasing the liquidity of most assets. B)constantly reducing the riskiness of most assets. C)incorporating all available information into the prices of financial assets. D)providing to investors for a nominal charge all government reports available about a particular company.

Information on financial assets is communicated A)only to borrowers. B)only to savers. C)only to the appropriate agency of the federal government. D)both to borrowers and savers.

The distinguishing feature of a well-functioning financial market is the A)continual increase in the liquidity of most assets. B)continual reduction in the riskiness of most assets. C)increased ease of converting common stocks into bonds. D)incorporation of available information into asset prices.

In a well-functioning financial market, the prices of a company's stocks and bonds will rise A)only after it's reported profits rise. B)if an event boosts its expected future profit. C)only in the presence of asymmetric information. D)when its asset become less liquid.

Financial markets provide arrangements for A)direct finance. B)indirect finance. C)financial intermediation. D)direct finance, indirect finance, and financial intermediation.

Financial markets A)generally deal only with the purchase and sale of government securities. B)directly issue claims on individual borrowers to savers. C)act as intermediaries between borrowers and savers. D)have largely eliminated the risk to savers from holding the bonds of large corporations.

Which of the following would NOT be an example of a financial market transaction? A)You purchase a U.S. government bond. B)You purchase a bond issued by a large corporation. C)You deposit $100 in your bank checking account. D)You give your broker $2000 to purchase shares of stock in General Motors.

A "primary market" is a market A)for government securities. B)in which newly issued claims are sold to buyers by borrowers. C)in which newly issued claims are sold by savers to borrowers. D)for debt by large or "primary" corporations.

Which of the following would be most likely to use a financial market? A)A household with a small amount of funds to lend B)A household wishing to borrow a small amount C)A small business wishing to borrow to expand its operations D)A state government wishing to borrow to finance a highway project

The most commonly used claim in financial markets is A)debt, which is a claim to share in the profits and assets of a firm. B)debt, which requires the borrower to repay the principal of the loan plus interest. C)equity, which is a claim to share in the profits and assets of a firm. D)equity, which requires the borrower to repay the principal of the loan plus interest.

The amount that a borrower borrows is referred to as the A)principal. B)equity. C)maturity. D)lump sum.

Interest is best thought of as A)a rental fee on the principal of a debt. B)compensation for taxes incurred on an investment. C)an example of the exploitation of borrowers by lenders. D)in most cases, equal to the maturity of the debt.

The maturity of a debt instrument refers to A)its interest rate, expressed as a percentage of its principal. B)its interest rate, expressed as an absolute amount. C)the length of time until it expires. D)the length of time until the first interest payment on it is due.

Long-term debt instruments have a maturity of at least A)30 days. B)1 year. C)10 years. D)30 years.

Which of the following is an example of a debt instrument? A)A checking account at a commercial bank B)A share of stock in General Motors C)A life insurance policy D)A bond issued by General Motors

Which of the following is an example of a short-term debt instrument? A)A six-month U.S. Treasury bill B)A ten-year U.S. Treasury note C)A thirty-year U.S. Treasury bond D)A thirty-year corporate bond

An automobile loan is likely to be a(an) A)short-term debt instrument. B)intermediate-term debt instrument. C)long-term debt instrument. D)equity.

When a borrower issues a debt instrument to a lender, A)the lender may receive less than the amount promised, but will not receive more. B)the lender may receive more than the amount promised, but will not receive less. C)the lender will always receive exactly the amount promised. D)the lender may receive more than the amount promised or may receive less than the amount promised.

When economists refer to default risk on a debt instrument, they are referring to A)the interest rate on the instrument minus the tax liability on that interest. B)the risk that borrowers will not repay all or part of their obligations. C)the risk that lenders will insist that borrowers repay the obligation before the maturity date. D)the risk that lenders will insist that borrowers pay more than the agreed upon interest rate.

Which of the following is an example of an equity? A)A thirty-year U.S. government bond B)A thirty-year corporate bond C)A checking account in a commercial bank D)A share of common stock in General Motors

The periodic payments received by owners of equity are referred to as A)interest. B)dividends. C)maturity. D)coupons.

If a business fails to make a profit A)it must still pay a dividend. B)you would probably be better off holding a bond issued by the business than holding stock issued by the business. C)you would probably be better off holding stock issued by the business than holding a bond issued by the business. D)its shareholders may end up being liable for much more than they have invested in the business.

In 2006, the total value of debt instruments was A)roughly equal to the total value of equities. B)roughly half as much as the total value of equities. C)roughly twice as much as the total value of equities. D)roughly one-tenth the total value of equities.

Which of the following is NOT true of stock markets? A)Most of the trading takes place in already issued stock. B)Every time a share of a company's stock changes hands, that company receives a payment. C)The dollar volume of trading is less than the dollar volume of trading on bond markets. D)They help carry out direct finance.

Secondary markets for financial instruments are important because, among other things, A)they are where companies and governments raise new funds. B)taxes on trading in these markets are an important source of revenue for governments. C)they make it easier for investors to hold a diversified portfolio of assets. D)they provide a place where people interested in financial matters can meet.

Trading in capital markets involves A)debt instruments with maturities of more than one year. B)equities. C)debt instruments with maturities of less than one year. D)debt instruments with maturities of more than one year and equities.

Trading in money markets involves A)debt instruments with maturities of more than one year. B)equities. C)debt instruments with maturities of less than one year. D)debt instruments with maturities of more than one year, but less than ten years.

Money markets A)involve trading in debt instruments with maturities of more than one year. B)are used by large corporations to finance inventories. C)involve trading in equities. D)are used by large corporations to finance long-term investments in plant and equipment.

In comparing money market instruments to capital market instruments, we can say that A)money market instruments tend to be less risky and less liquid than capital market instruments. B)money market instruments tend to be more risky, but less liquid than capital market instruments. C)money market instruments tend to be more risky and more liquid than capital market instruments. D)money market instruments tend to be less risky, but more liquid than capital market instruments.

The most common auction markets are A)exchanges. B)over-the-counter markets. C)located in banks or other financial intermediaries. D)engaged in indirect finance.

Which of the following is NOT true of over-the-counter markets? A)Prices are set by competitive bidding by a large number of traders. B)Trading does not take place in one physical location. C)Traders are willing to buy and sell stocks and bonds at a posted price. D)Traders are linked by computer.

In comparing money market and capital market instruments, money market instruments are typically A)riskier than capital market instruments. B)more liquid than capital market instruments. C)less liquid than capital market instruments. D)riskier, but more liquid, than capital market instruments.

Derivative markets exist in order to A)allow for the direct cash sale of common stock. B)allow for the direct cash sale of bonds. C)reduce the risk of exposure to price fluctuations in cash markets. D)overcome some of the information problems involved in trades on the over-the-counter market.

Financial intermediaries A)include banks and other depository institutions. B)include the New York and American Stock exchanges. C)directly issue claims on individual borrowers to savers. D)are owned and operated by the federal government.

When a bank makes a car loan, the loan A)is an asset to the bank. B)is a liability to the bank. C)is an asset to the person taking it out. D)is a money market instrument.

Financial intermediaries pool the funds of A)a few large savers and make loans to many borrowers. B)many small savers and make loans to a few large borrowers. C)many small savers and make loans to many borrowers. D)a few large savers and make loans to a few large borrowers.

Small savers prefer to use financial intermediaries rather than make loans to borrowers directly because A)savers prefer to share risk. B)financial intermediaries offer higher interest rates than could be obtained directly from borrowers. C)savers reduce their tax liability by doing so. D)borrowers dislike dealing with small savers.

Economists believe that the major reason that financial intermediaries move a greater volume of funds between borrowers and lenders than do financial markets is A)the advantage that financial intermediaries have in reducing information costs. B)the tax advantages that financial intermediaries receive from the government. C)the higher interest rates that financial intermediaries are able to offer to lenders. D)the lower interest rates that financial intermediaries are able to offer to borrowers.

In which of the following financial assets did U.S. households have the most invested in 2006? A)U.S. government securities B)Corporate bonds C)Corporate equities D)State and local government securities

In which of the following financial assets in financial intermediaries did U.S. households have the most invested in 2006? A)Bank deposits B)Mutual fund shares C)Life insurance reserves D)Pension fund reserves

Financial innovation A)may reduce the cost of risk sharing to lenders. B)is discouraged by the government because of its adverse impact on tax revenues. C)will generally reduce the liquidity of financial assets. D)has occurred frequently in financial markets, but rarely in financial intermediaries.

Financial integration refers to A)the ability of persons of different races and religions to obtain access to financial services. B)the way in which financial markets are tied together geographically. C)the ability to easily convert investments in common stock into investments in corporate bonds. D)the difference between interest rates offered by commercial banks and those offered by savings and loan associations.

In the early nineteenth century in the United States, A)financial markets were actually more integrated than they are today. B)substantial differences existed in the interest rates charged to borrowers in different parts of the country. C)high-quality investment projects were much easier to finance. D)federal law prohibited the payment of interest on loans.

The decline in the dominance of U.S. financial markets has been the result of A)the rapid post-war growth of Japan and Europe. B)the unwillingness of U.S. financial markets to allow trading in options and futures contracts. C)the difficulties experienced by the U.S. commercial banking system during the 1980s. D)unfair trading practices on the part of Japan and Europe.

Which of the following is NOT an important reason why governments around the world regulate financial markets? A)To ensure that all participants in the financial system have access to information B)To reduce the cost to governments of borrowing funds C)To maintain financial stability D)To advance economic policy by interacting with the financial system

The leading federal regulatory body for financial markets in the United States is the A)Federal Bureau of Investigation. B)Securities and Exchange Commission. C)Federal Financial Market Bureau. D)Investors Protection Agency.

The Securities and Exchange Commission was founded in A)1805. B)1933. C)1965. D)1995.

Trading by managers who own large amounts of a firm's stock or trading by others who have privileged information is known as A)insider trading. B)asymmetric trading. C)arbitrage. D)reverse repurchase trading.

Policy makers are particularly concerned about the financial soundness of financial intermediaries because A)most financial assets are held by intermediaries. B)troubles of intermediaries always receive the most publicity in the media. C)the workings of intermediaries are easier for Congress to understand than are the workings of financial markets. D)federal law applies to intermediaries but does not currently apply to financial markets.

Savings institutions, such as savings-and-loan associations, A)have traditionally made most of their loans in the form of long-term mortgages. B)were greatly helped by the increase in market interest rates during the 1970s and 1980s. C)were spared the difficulties encountered by commercial banks during the 1980s. D)were not included in the deregulation of the financial system during the 1970s and 1980s.

When assessing the effects of regulation of the financial system, we can say that regulation A)sometimes reduces the ability of the financial system to provide risk-sharing, liquidity, and information services. B)has always had the main goal of increasing the ability of the financial system to provide risk-sharing, liquidity, and information services. C)has always been directed toward the maintenance of financial stability. D)has largely been discontinued since 1980.

U.S. Treasury bills A)have the largest trading volume of any money market asset. B)have a default risk slightly greater than that of corporate bonds. C)have a maturity of at least two years. D)may only be purchased directly from the federal government.

Which of the following is a money market asset? A)commercial paper B)stocks C)Treasury bonds D)savings bonds

Which of the following is a capital market asset? A)Commercial paper B)Treasury bills C)Corporate bonds D)Eurodollars

Which of the following money market instruments had the largest amount outstanding in 2006? A)U.S. Treasury bills B)Commercial paper C)Negotiable CDs D)Federal funds

Which of the following statements concerning the Sarbanes-Oxley Act of 2002 is true? A)It strengthened the SEC's ability to prosecute companies that presented misleading accounting data to the public. B)It cracked down on insider trading. C)It established rules for IPOs so average investors would not be at a disadvantage. D)It strengthened the standards for companies which plan to go public.

As a country develops, will businesses become or less likely to borrow in financial markets? Explain.

The financial system allows some savers and borrowers to transfer risk to other savers and borrowers. Why do savers and borrowers differ in their willingness to bear risk?

Suppose you start up an Internet company and, although you are currently not profitable, you are very confident that you will be quite profitable in the near future. Assuming that you are able to issue either debt or equity to raise the funds necessary to expand your business, which would you prefer to issue?

According to the text: "many economists link the severity of the Great Depression of the 1930s to the breakdown in the banking system's ability to provide financial services." The beginning of the Great Depression also coincided with a stock market crash. Why might the problems of the banking system have been more damaging to the economy than the problems on the stock market?