Question 1

Commercial paper has a minimum maturity of
A) one day.
B) seven days.
C) 30 days.
D) 270 days.

Accepted Answer

Commercial paper is a short-term debt instrument issued by corporations and has a minimum maturity of one day, making option A the correct choice. Options B, C, and D are incorrect as they have longer minimum maturity periods than commercial paper.

Question 2

"Medium term notes" have a maturity ranging up to
A) one year.
B) two years.
C) five years.
D) ten years.

Accepted Answer

Medium term notes (MTNs) typically have a maturity range of 5 years or less, making option C the correct choice. Options A and B are too short, as short-term debt typically matures within a year, while option D is too long, as notes with a maturity exceeding 10 years are considered long-term debt.

Question 3

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.

Accepted Answer

A borrower's willingness to sign a personal guarantee is a signal of a high-quality borrower. Personal guarantees show lenders that borrowers are confident in their ability to repay the loan and are willing to put their personal assets at risk if necessary, indicating that they are less likely to default on the loan. Therefore, they are considered less risky and higher quality borrowers.

Question 4

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

Accepted Answer

The answer of A bank that maintains low NSF fees...

Question 5

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

Accepted Answer

Limited-liability ownership is a practice that allows the borrower to limit their personal liability to the amount invested in the business but it does not necessarily prevent them from shifting risk. Placing liens on collateral, personal guarantees, and restrictive covenants are all practices that discourage risk-shifting by holding the borrower accountable for their actions and ensuring they have a stake in the success of the loan.

Question 6

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.

Accepted Answer

Putting up outside collateral, such as a property or other valuable asset, can serve as a signal of a high-quality borrower. This is because borrowers who are confident in their ability to repay the loan are more likely to offer collateral to secure the loan. In this sense, offering collateral can be seen as a form of self-selection, where high-quality borrowers are more likely to offer collateral than low-quality borrowers. Therefore, option (C) is the most appropriate choice.

Question 7

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

Accepted Answer

Underwriting spreads on equity issues are larger than on debt issues because the pricing and sale of equity (stocks) involve greater risk and volatility compared to debt (bonds), which are generally more stable. This increased risk and volatility in stock prices necessitate higher compensation for underwriters.

Question 8

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

Accepted Answer

Public debt financing typically requires a larger minimum size of the borrower compared to mezzanine funds, venture capital funds, and public equity. This is because public debt typically involves issuing bonds or other debt securities to a large number of investors, who typically require a certain level of creditworthiness and financial stability from the borrower.

Question 9

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

Accepted Answer

Short-term commercial bank loans typically have lower minimum size requirements compared to other forms of financing. This is because these loans are mainly intended to finance the day-to-day operations of businesses, and therefore the loan amounts needed can be relatively small. Commercial paper, mezzanine funds, and venture capital funds typically require larger minimum loan amounts, making them less accessible for small borrowers.

Question 10

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.

Accepted Answer

Moral hazard is the situation where one party to a transaction has an incentive to take undue risks because the cost of those risks will be borne, at least in part, by the other party. It typically occurs after a transaction is consummated, as it involves actions taken by one party that the other party cannot observe or control, leading to an imbalance in information and incentives.

Question 11

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

Accepted Answer

Signaling techniques cannot completely overcome the moral hazard problem in small borrower cases, leading to generally short-term loans to mitigate risk.

Question 12

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

Accepted Answer

Liens ease the moral hazard problem because they restrict the borrower's ability to sell the affected assets, thus reducing the risk of the borrower engaging in risky behavior that could jeopardize the lender's interest.

Question 13

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.

Accepted Answer

The moral hazard problem refers to the possibility that a borrower might act in a way that is detrimental to the lender's interests after obtaining a loan or other credit. This might include actions such as failing to make required payments, misusing funds, or engaging in risky behavior that could lead to default. The moral hazard problem arises from the fact that borrowers may have an incentive to take such actions since they are not personally liable for the full amount of the loan, while lenders bear most of the risk. Adverse selection, on the other hand, refers to the problem of selecting which borrowers to lend to in the first place, and is not directly related to the borrower breaking promises. Outside collateral refers to assets that are not used as security for a loan, while inside collateral refers to assets that are pledged as security. Neither of these terms is directly related to the borrower's behavior after obtaining a loan.

Question 14

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

Accepted Answer

Asymmetric information is more problematic for small firms or those with only a recent relationship with a lending institution because these firms are less known to lenders, making it harder for lenders to assess their creditworthiness.

Question 15

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

Accepted Answer

A large business has greater financial resources than a small business, so it may find it easier to pursue a high-risk investment secretly. However, the larger business has more to lose if the investment fails, and its creditors may be less likely to extend future loans if it violates its loan agreements. Therefore, the large business is less beset by the moral hazard problem than a small business.

Question 16

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

Accepted Answer

Moral hazard arises when lenders bear a disproportionate share of the downside risk, as borrowers may take on riskier projects knowing that the lender will absorb most of the losses if things go wrong.

Question 17

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.

Accepted Answer

The answer of Adverse selection is, in general, the asymmetric...

Question 18

Commercial paper has a maximum maturity of
A) one day.
B) seven days.
C) 30 days.
D) 270 days.

Accepted Answer

Commercial paper is a short-term unsecured promissory note issued by corporations, typically used for the financing of accounts receivable, inventories, and meeting short-term liabilities. It has a maximum maturity of 270 days, which helps issuers avoid the need for SEC registration.

Question 19

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.

Accepted Answer

The existence of a "bought deal" in public offerings of bonds came about as a result of shelf registration. Shelf registration allows companies to register securities with the SEC and offer them for sale later, generally within two years, without filing additional documents. This allows investment banks to efficiently underwrite large offerings and sell the securities to investors quickly through a "bought deal" without significant market risk.

Question 20

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

Accepted Answer

High NSF (Non-Sufficient Funds) fees can deter riskier financial behavior, suggesting the bank aims to attract safer-than-average borrowers. Offering low loan rates can be part of this strategy, making banking with them more appealing to financially stable customers.

Quiz 14: Understanding Financial Contracts

Commercial paper has a minimum maturity of

"Medium term notes" have a maturity ranging up to

A borrower's willingness to sign a personal guarantee is

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

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

The putting up of outside collateral is

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

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

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

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

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.

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

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

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

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.

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

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

Commercial paper has a maximum maturity of

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

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