Question 1

The problem created by asymmetric information before the transaction occurs is called ________,while the problem created after the transaction occurs is called ________.
A)adverse selection;moral hazard
B)moral hazard;adverse selection
C)costly state verification;free-riding
D)free-riding;costly state verification

Accepted Answer

Adverse selection refers to the problem created by asymmetric information before the transaction occurs, where one party has more information than the other and may use that information to their advantage. Moral hazard refers to the problem created after the transaction occurs, where one party takes risks because they are no longer fully responsible for the consequences. Choice A correctly identifies both problems and their timing. Choice B and D switch the timing of the problems, and choice C refers to a different problem altogether.

Question 2

Banks can lower the cost of information production by applying one information resource to many different services.This process is called
A)economies of scale.
B)asset transformation.
C)economies of scope.
D)asymmetric information.

Accepted Answer

Economies of scope refer to a situation where a firm can use one information resource to produce different services at a lower cost. In the case of banks, they can use customer data to offer a variety of services such as loans, credit cards, savings accounts, etc. at a lower cost, hence reducing the cost of production. This process is achieved by cross-selling and bundling different products to customers. Therefore, option C is the best choice.

Question 3

Typically,borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project.The difference in information is called
A)moral selection.
B)risk sharing.
C)asymmetric information.
D)adverse hazard.

Accepted Answer

Asymmetric information refers to a situation where one party in a transaction has more or better information than the other party. In this case, borrowers have superior information about the potential returns and risks associated with an investment project, while lenders do not have access to this information. This can lead to adverse selection and moral hazard problems in lending markets.

Question 4

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.
A)adverse selection
B)moral hazard
C)risk sharing
D)credit risk

Accepted Answer

The problem described in the example is moral hazard, where the corporation is taking risks with the funds raised from bond sales that are not in the best interest of the bondholders who lent the money. This creates a situation where the corporation has a perverse incentive to undertake activities that are not in the best interest of the investors who have lent them money.

Question 5

The countries that have made the least use of securities markets are ________ and ________;in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.
A)Germany;Japan
B)Germany;Great Britain
C)Great Britain;Canada
D)Canada;Japan

Accepted Answer

Germany and Japan have historically relied more on bank financing than on securities markets, with finance from financial intermediaries being significantly greater than that from securities markets.

Question 6

Because there is an imbalance of information in a lending situation,we must deal with the problems of adverse selection and moral hazard.Define these terms and explain how financial intermediaries can reduce these problems.

Accepted Answer

The answer of Because there is an imbalance of information...

Question 7

Although the dominance of ________ over ________ is clear in all countries,the relative importance of bond versus stock markets differs widely.
A)financial intermediaries;securities markets
B)financial intermediaries;government agencies
C)government agencies;financial intermediaries
D)government agencies;securities markets

Accepted Answer

The correct answer is A) financial intermediaries; securities markets. This is because the statement refers to the dominance of one type of financial market entity over another. Financial intermediaries, such as banks and investment companies, often have a more dominant role in the financial system compared to securities markets, which include stock and bond markets. However, the relative importance of bond versus stock markets can vary by country.

Question 8

Reducing risk through the purchase of assets whose returns do not always move together is
A)diversification.
B)intermediation.
C)intervention.
D)discounting.

Accepted Answer

Diversification means purchasing different types of assets that have low correlations with each other. This reduces the overall risk of the portfolio because when some assets are performing poorly, others may be performing well, thus balancing out the overall returns. Intermediation refers to the process of financial intermediaries, such as banks and investment firms, facilitating transactions between buyers and sellers. Intervention refers to government intervention in the economy, such as through regulation or stimulus measures. Discounting refers to the process of determining the present value of future cash flows.

Question 9

Financial intermediaries provide customers with liquidity services.Liquidity services
A)make it easier for customers to conduct transactions.
B)allow customers to have a cup of coffee while waiting in the lobby.
C)are a result of the asymmetric information problem.
D)are another term for asset transformation.

Accepted Answer

Liquidity services provided by financial intermediaries make it easier for customers to conduct transactions by providing them with easy access to funds and other forms of liquidity, such as credit lines and overdraft facilities. This allows customers to quickly and easily settle transactions and pay bills, without having to worry about liquidity constraints.

Question 10

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as
A)risk sharing.
B)risk aversion.
C)risk neutrality.
D)risk selling.

Accepted Answer

This process is commonly known as "asset transformation" and it refers to the practice of financial intermediaries, such as banks or investment funds, using deposits or other low-risk sources of funding to purchase higher-risk assets, such as stocks, bonds or other securities. By doing so, they are able to "share" the risk with investors who are looking for higher returns but are not necessarily willing to take on the full risk associated with these types of assets. This process helps to allocate risk more efficiently throughout the financial system and can lead to increased economic growth and wealth creation.

Question 11

Risk sharing is profitable for financial institutions due to
A)low transactions costs.
B)asymmetric information.
C)adverse selection.
D)moral hazard.

Accepted Answer

Risk sharing reduces the risk of losses for financial institutions by spreading it among multiple parties, which in turn reduces the need for costly risk management measures. This is especially true when transactions costs are low, making it more feasible for financial institutions to enter into risk sharing agreements. Asymmetric information, adverse selection, and moral hazard are all potential challenges to risk sharing, but they do not necessarily make it less profitable for financial institutions.

Question 12

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from
A)government agencies.
B)equities markets.
C)financial intermediaries.
D)bond markets.

Accepted Answer

Studies have shown that businesses in major developed countries usually obtain funding from financial intermediaries such as banks, credit unions, and other financial institutions. These intermediaries offer various types of loans to businesses, including working capital loans, trade finance, and equipment finance. While equity and bond markets can also be sources of funding, they tend to be less commonly used by businesses, especially smaller ones. Government agencies may provide certain types of funding or support for businesses, but they are not typically the primary source of funds.

Question 13

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
A)moral hazard.
B)adverse selection.
C)free-riding.
D)costly state verification.

Accepted Answer

Adverse selection is the problem faced by financial intermediaries when bad credit risks actively seek loans and are more likely to receive them, leading to a potential imbalance in the loan portfolio. This can result in higher risks and potentially lead to defaults and losses for the intermediary. The other choices do not accurately reflect the problem faced in this situation.

Question 14

The process of asset transformation refers to the conversion of
A)safer assets into risky assets.
B)safer assets into safer liabilities.
C)risky assets into safer assets.
D)risky assets into risky liabilities.

Accepted Answer

Asset transformation typically involves converting risky assets into safer assets. This is a common practice in financial institutions like banks, where they take in deposits (which are liabilities to the bank but are considered safe to the depositor) and then lend that money out as loans or invest in other assets that are inherently riskier. The process involves managing the risk to ensure that the assets are safer for the bank's stakeholders, including depositors and investors.

Question 15

Thrift institutions include
A)banks,mutual funds,and insurance companies.
B)savings and loan associations,mutual savings banks,and credit unions.
C)finance companies,mutual funds,and money market funds.
D)pension funds,mutual funds,and banks.

Accepted Answer

Thrift institutions are financial institutions that primarily focus on accepting deposits and providing mortgages and other consumer loans. Savings and loan associations, mutual savings banks, and credit unions are all examples of thrift institutions because they prioritize the collection of savings from their members or depositors.

Question 16

Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services.
A)adverse selection
B)free-riding
C)discounting
D)moral hazard

Accepted Answer

The answer of Conflicts of interest are a type of...

Question 17

Adverse selection is a problem associated with equity and debt contracts arising from
A)the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.
B)the lender's inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults.
C)the borrower's lack of incentive to seek a loan for highly risky investments.
D)the borrower's lack of good options for obtaining funds.

Accepted Answer

Adverse selection is a situation in which the borrower has better information about the risks and potential returns of an investment activity than the lender. This creates a problem for the lender because they are not able to accurately assess the likelihood of the borrower defaulting on the loan. As a result, the lender may end up with a pool of borrowers who are more likely to default, leading to higher default rates and lower returns for the lender.

Question 18

Financial institutions that accept deposits and make loans are called ________ institutions.
A)investment
B)contractual savings
C)depository
D)underwriting

Accepted Answer

Depository institutions are those that take deposits from customers and use those funds to make loans to other customers. Examples of depository institutions include banks, credit unions, and savings and loans associations. Investment institutions primarily deal in securities such as stocks and bonds, while contractual savings institutions offer insurance and pension products. Underwriting institutions help companies issue new securities.

Question 19

The concept of diversification is captured by the statement
A)don't look a gift horse in the mouth.
B)don't put all your eggs in one basket.
C)it never rains,but it pours.
D)make hay while the sun shines.

Accepted Answer

The phrase "don't put all your eggs in one basket" refers to the idea of spreading out one's resources or investments to reduce the risk of losing everything in one fell swoop. This is a key concept in diversification, which involves investing in a variety of different assets or sectors to create a balanced portfolio.

Question 20

Which of the following is a depository institution?
A)a life insurance company
B)a credit union
C)a pension fund
D)a mutual fund

Accepted Answer

A depository institution is a financial institution that takes deposits from customers and holds them in accounts such as checking, savings, and money market accounts. Credit unions are depository institutions because they offer these types of accounts to their members. Life insurance companies, pension funds, and mutual funds are not depository institutions because they do not offer deposit accounts to customers.

Quiz 2: An Overview of the Financial System

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

Banks can lower the cost of information production by applying one information resource to many different services.This process is called

Typically,borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project.The difference in information is called

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.

The countries that have made the least use of securities markets are and ;in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.

Because there is an imbalance of information in a lending situation,we must deal with the problems of adverse selection and moral hazard.Define these terms and explain how financial intermediaries can reduce these problems.

Although the dominance of over is clear in all countries,the relative importance of bond versus stock markets differs widely.

Reducing risk through the purchase of assets whose returns do not always move together is

Financial intermediaries provide customers with liquidity services.Liquidity services

The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as

Risk sharing is profitable for financial institutions due to

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from

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 process of asset transformation refers to the conversion of

Thrift institutions include

Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services.

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

Financial institutions that accept deposits and make loans are called ________ institutions.

The concept of diversification is captured by the statement

Which of the following is a depository institution?