This Document Contains Chapters 1 to 2 Chapter 1 Why Study Money, Banking, and Financial Markets? 1.1 Why Study Financial Markets? 1) Financial markets promote economic efficiency by A) channeling funds from investors to savers. B) creating inflation. C) channeling funds from savers to investors. D) reducing investment. Answer: C 2) Financial markets promote greater economic efficiency by channeling funds from ________ to ________. A) investors; savers B) borrowers; savers C) savers; borrowers D) savers; lenders Answer: C 3) Well-functioning financial markets promote A) inflation. B) deflation. C) unemployment. D) growth. Answer: D 4) A key factor in producing high economic growth is A) eliminating foreign trade. B) well-functioning financial markets. C) high interest rates. D) stock market volatility. Answer: B 5) Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called A) commodity markets. B) fund-available markets. C) derivative exchange markets. D) financial markets. Answer: D 6) ________ markets transfer funds from people who have an excess of available funds to people who have a shortage. A) Commodity B) Fund-available C) Financial D) Derivative exchange Answer: C 7) Poorly performing financial markets can be the cause of A) wealth. B) poverty. C) financial stability. D) financial expansion. Answer: B 8) The bond markets are important because they are A) easily the most widely followed financial markets in the United States. B) the markets where foreign exchange rates are determined. C) the markets where interest rates are determined. D) the markets where all borrowers get their funds. Answer: C 9) The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of $100 per year) is commonly referred to as the A) inflation rate. B) exchange rate. C) interest rate. D) aggregate price level. Answer: C 10) Compared to interest rates on long-term U.S. government bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average. A) more; lower B) less; lower C) more; higher D) less; higher Answer: A 11) The interest rate on Baa (medium quality) corporate bonds is ________, on average, than other interest rates, and the spread between it and other rates became ________ in the 1970s. A) lower; smaller B) lower; larger C) higher; smaller D) higher; larger Answer: D 12) Everything else held constant, a decline in interest rates will cause spending on housing to A) fall. B) remain unchanged. C) either rise, fall, or remain the same. D) rise. Answer: D 13) High interest rates might ________ purchasing a house or car but at the same time high interest rates might ________ saving. A) discourage; encourage B) discourage; discourage C) encourage; encourage D) encourage; discourage Answer: A 14) An increase in interest rates might ________ saving because more can be earned in interest income. A) encourage B) discourage C) disallow D) invalidate Answer: A 15) Everything else held constant, an increase in interest rates on student loans A) increases the cost of a college education. B) reduces the cost of a college education. C) has no effect on educational costs. D) increases costs for students with no loans. Answer: A 16) High interest rates might cause a corporation to ________ building a new plant that would provide more jobs. A) complete B) consider C) postpone D) contemplate Answer: C 17) The stock market is important because it is A) where interest rates are determined. B) the most widely followed financial market in the United States. C) where foreign exchange rates are determined. D) the market where most borrowers get their funds. Answer: B 18) Stock prices are A) relatively stable trending upward at a steady pace. B) relatively stable trending downward at a moderate rate. C) extremely volatile. D) unstable trending downward at a moderate rate. Answer: C 19) A rising stock market index due to higher share prices A) increases people's wealth, but is unlikely to increase their willingness to spend. B) increases people's wealth and as a result may increase their willingness to spend. C) decreases the amount of funds that business firms can raise by selling newly-issued stock. D) decreases people's wealth, but is unlikely to increase their willingness to spend. Answer: B 20) When stock prices fall A) an individual's wealth is not affected nor is their willingness to spend. B) a business firm will be more likely to sell stock to finance investment spending. C) an individual's wealth may decrease but their willingness to spend is not affected. D) an individual's wealth may decrease and their willingness to spend may decrease. Answer: D 21) Changes in stock prices A) do not affect people's wealth and their willingness to spend. B) affect firms' decisions to sell stock to finance investment spending. C) occur in regular patterns. D) are unimportant to decision makers. Answer: B 22) An increase in stock prices ________ the size of people's wealth and may ________ their willingness to spend, everything else held constant. A) increases; increase B) increases; decrease C) decreases; increase D) decreases; decrease Answer: A 23) Low stock market prices might ________ consumers willingness to spend and might ________ businesses willingness to undertake investment projects. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: C 24) Fear of a major recession causes stock prices to fall, everything else held constant, which in turn causes consumer spending to A) increase. B) remain unchanged. C) decrease. D) cannot be determined. Answer: C 25) A share of common stock is a claim on a corporation's A) debt. B) liabilities. C) expenses. D) earnings and assets. Answer: D 26) On ________, October 19, 1987, the market experienced its worst one-day drop in its entire history with the DIJA falling by more than 500 points. A) "Terrible Tuesday" B) "Woeful Wednesday" C) "Freaky Friday" D) "Black Monday" Answer: D 27) The decline in stock prices from 2000 through 2002 A) increased individuals' willingness to spend. B) had no effect on individual spending. C) reduced individuals' willingness to spend. D) increased individual wealth. Answer: C 28) The Dow reached a peak of over 11,000 before the collapse of the ________ bubble in 2000. A) housing B) manufacturing C) high-tech D) banking Answer: C 29) What is a stock? How do stocks affect the economy? Answer: A stock represents a share of ownership of a corporation, or a claim on a firm's earnings/assets. Stocks are part of wealth, and changes in their value affect people's willingness to spend. Changes in stock prices affect a firm's ability to raise funds, and thus their investment. 30) Why is it important to understand the bond market? Answer: The bond market supports economic activity by enabling the government and corporations to borrow to undertake their projects and it is the market where interest rates are determined. 1.2 Why Study Financial Institutions and Banking? 1) Channeling funds from individuals with surplus funds to those desiring funds when the saver does not purchase the borrower's security is known as A) barter. B) redistribution. C) financial intermediation. D) taxation. Answer: C 2) A financial crisis is A) not possible in the modern financial environment. B) a major disruption in the financial markets. C) a feature of developing economies only. D) typically followed by an economic boom. Answer: B 3) Banks are important to the study of money and the economy because they A) channel funds from investors to savers. B) have been a source of rapid financial innovation. C) are the only important financial institution in the U.S. economy. D) create inflation. Answer: B 4) Financial intermediaries A) provide a channel for linking those who want to save with those who want to invest. B) produce nothing of value and are therefore a drain on society's resources. C) can hurt the performance of the economy. D) hold very little of the average American's wealth. Answer: A 5) Banks, savings and loan associations, mutual savings banks, and credit unions A) are no longer important players in financial intermediation. B) since deregulation now provide services only to small depositors. C) have been adept at innovating in response to changes in the regulatory environment. D) produce nothing of value and are therefore a drain on society's resources. Answer: C 6) Financial institutions search for ________ has resulted in many financial innovations. A) higher profits B) regulations C) respect D) higher risk Answer: A 7) Banks and other financial institutions engage in financial intermediation, which A) can hurt the performance of the economy. B) can benefit economic performance. C) has no effect on economic performance. D) involves borrowing from investors and lending to savers. Answer: B 8) Financial institutions that accept deposits and make loans are called ________. A) exchanges B) banks C) over-the-counter markets D) finance companies Answer: B 9) The financial intermediaries that the average person interacts with most frequently are ________. A) exchanges B) over-the-counter markets C) finance companies D) banks Answer: D 10) Which of the following is not a financial institution? A) a life insurance company B) a pension fund C) a credit union D) a business college Answer: D 11) The delivery of financial services electronically is called ________. A) e-business B) e-commerce C) e-finance D) e-possible Answer: C 12) What crucial role do financial intermediaries perform in an economy? Answer: Financial intermediaries borrow funds from people who have saved and make loans to other individuals and businesses and thus improve the efficiency of the economy. 1.3 Why Study Money and Monetary Policy? 1) Money is defined as A) bills of exchange. B) anything that is generally accepted in payment for goods and services or in the repayment of debt. C) a risk-free repository of spending power. D) the unrecognized liability of governments. Answer: B 2) The upward and downward movement of aggregate output produced in the economy is referred to as the ________. A) roller coaster B) see saw C) business cycle D) shock wave Answer: C 3) Sustained downward movements in the business cycle are referred to as A) inflation. B) recessions. C) economic recoveries. D) expansions. Answer: B 4) During a recession, output declines resulting in A) lower unemployment in the economy. B) higher unemployment in the economy. C) no impact on the unemployment in the economy. D) higher wages for the workers. Answer: B 5) Prior to all recessions since 1900, there has been a drop in A) inflation. B) the money stock. C) the growth rate of the money stock. D) interest rates. Answer: C 6) Evidence from business cycle fluctuations in the United States indicates that A) a negative relationship between money growth and general economic activity exists. B) recessions have been preceded by declines in share prices on the stock exchange. C) recessions have been preceded by dollar depreciation. D) recessions have been preceded by a decline in the growth rate of money. Answer: D 7) ________ theory relates changes in the quantity of money to changes in aggregate economic activity and the price level. A) Monetary B) Fiscal C) Financial D) Systemic Answer: A 8) A sharp increase in the growth of the money supply is likely followed by A) a recession. B) a depression. C) an increase in the inflation rate. D) no change in the economy. Answer: C 9) It is true that inflation is a A) continuous increase in the money supply. B) continuous fall in prices. C) decline in interest rates. D) continually rising price level. Answer: D 10) Which of the following is a true statement? A) Money or the money supply is defined as Federal Reserve notes. B) The average price of goods and services in an economy is called the aggregate price level. C) The inflation rate is measured as the rate of change in the federal government budget deficit. D) The aggregate price level is measured as the rate of change in the inflation rate. Answer: B 11) If ten years ago the prices of the items bought last month by the average consumer would have been much higher, then one can likely conclude that A) the aggregate price level has declined during this ten-year period. B) the average inflation rate for this ten-year period has been positive. C) the average rate of money growth for this ten-year period has been positive. D) the aggregate price level has risen during this ten-year period. Answer: A 12) From 1950-2008 the price level in the United States increased more than ________. A) twofold B) threefold C) sixfold D) ninefold Answer: C 13) Complete Milton Friedman's famous statement, "Inflation is always and everywhere a ________ phenomenon." A) recessionary B) discretionary C) repressionary D) monetary Answer: D 14) There is a ________ association between inflation and the growth rate of money ________. A) positive; demand B) positive; supply C) negative; demand D) negative; supply Answer: B 15) Evidence from the United States and other foreign countries indicates that A) there is a strong positive association between inflation and growth rate of money over long periods of time. B) there is little support for the assertion that "inflation is always and everywhere a monetary phenomenon." C) countries with low monetary growth rates tend to experience higher rates of inflation, all else being constant. D) money growth is clearly unrelated to inflation. Answer: A 16) Countries that experience very high rates of inflation may also have A) balanced budgets. B) rapidly growing money supplies. C) falling money supplies. D) constant money supplies. Answer: B 17) Between 1950 and 1980 in the U.S., interest rates trended upward. During this same time period, A) the rate of money growth declined. B) the rate of money growth increased. C) the government budget deficit (expressed as a percentage of GNP) trended downward. D) the aggregate price level declined quite dramatically. Answer: B 18) The management of money and interest rates is called ________ policy and is conducted by a nation's ________ bank. A) monetary; superior B) fiscal; superior C) fiscal; central D) monetary; central Answer: D 19) The organization responsible for the conduct of monetary policy in the United States is the A) Comptroller of the Currency. B) U.S. Treasury. C) Federal Reserve System. D) Bureau of Monetary Affairs. Answer: C 20) ________ policy involves decisions about government spending and taxation. A) Monetary B) Fiscal C) Financial D) Systemic Answer: B 21) When tax revenues are greater than government expenditures, the government has a budget ________. A) crisis B) deficit C) surplus D) revision Answer: C 22) A budget ________ occurs when government expenditures exceed tax revenues for a particular time period. A) deficit B) surplus C) surge D) surfeit Answer: A 23) Budgets deficits can be a concern because they might A) ultimately lead to higher inflation. B) lead to lower interest rates. C) lead to a slower rate of money growth. D) lead to higher bond prices. Answer: A 24) Budget deficits are important because deficits A) cause bank failures. B) always cause interest rates to fall. C) can result in higher rates of monetary growth. D) always cause prices to fall. Answer: C 25) What happens to economic growth and unemployment during a business cycle recession? What is the relationship between the money growth rate and a business cycle recession? Answer: During a recession, output declines and unemployment increases. Prior to every recession in the U.S. the money growth rate has declined, however, not every decline is followed by a recession. 1.4 Why Study International Finance? 1) American companies can borrow funds A) only in U.S. financial markets. B) only in foreign financial markets. C) in both U.S. and foreign financial markets. D) only from the U.S. government. Answer: C 2) The price of one country's currency in terms of another country's currency is called the A) exchange rate. B) interest rate. C) Dow Jones industrial average. D) prime rate. Answer: A 3) The market where one currency is converted into another currency is called the ________ market. A) stock B) bond C) derivatives D) foreign exchange Answer: D 4) Everything else constant, a stronger dollar will mean that A) vacationing in England becomes more expensive. B) vacationing in England becomes less expensive. C) French cheese becomes more expensive. D) Japanese cars become more expensive. Answer: B 5) Which of the following is most likely to result from a stronger dollar? A) U.S. goods exported aboard will cost less in foreign countries, and so foreigners will buy more of them. B) U.S. goods exported aboard will cost more in foreign countries and so foreigners will buy more of them. C) U.S. goods exported abroad will cost more in foreign countries, and so foreigners will buy fewer of them. D) Americans will purchase fewer foreign goods. Answer: C 6) Everything else held constant, a weaker dollar will likely hurt A) textile exporters in South Carolina. B) wheat farmers in Montana that sell domestically. C) automobile manufacturers in Michigan that use domestically produced inputs. D) furniture importers in California. Answer: D 7) Everything else held constant, a stronger dollar benefits ________ and hurts ________. A) American businesses; American consumers B) American businesses; foreign businesses C) American consumers; American businesses D) foreign businesses; American consumers Answer: C 8) From 1980 to early 1985 the dollar ________ in value, thereby benefiting American ________. A) appreciated; consumers B) appreciated, businesses C) depreciated; consumers D) depreciated, businesses Answer: A 9) From 1980 to 1985 the dollar appreciated relative to the British pound. Holding everything else constant, one would expect that, when compared to 1980, A) fewer Britons traveled to the United States in 1985. B) Britons imported more wine from California in 1985. C) Americans exported more wheat to England in 1985. D) more Britons traveled to the United States in 1985. Answer: A 10) When in 1985 a British pound cost approximately $1.30, a Shetland sweater that cost 100 British pounds would have cost $130. With a weaker dollar, the same Shetland sweater would have cost A) less than $130. B) more than $130. C) $130, since the exchange rate does not affect the prices that American consumers pay for foreign goods. D) $130, since the demand for Shetland sweaters will decrease to prevent an increase in price due to the stronger dollar. Answer: B 11) Everything else held constant, a decrease in the value of the dollar relative to all foreign currencies means that the price of foreign goods purchased by Americans A) increases B) decreases. C) remains unchanged. D) either increases, decreases, or remains unchanged. Answer: A 12) American farmers who sell beef to Europe benefit most from A) a decrease in the dollar price of euros. B) an increase in the dollar price of euros. C) a constant dollar price for euros. D) a European ban on imports of American beef. Answer: B 13) If the price of a euro (the European currency) increases from $1.00 to $1.10, then, everything else held constant, A) a European vacation becomes less expensive. B) a European vacation becomes more expensive. C) the cost of a European vacation is not affected. D) foreign travel becomes impossible. Answer: B 14) Everything else held constant, Americans who love French wine benefit most from A) a decrease in the dollar price of euros. B) an increase in the dollar price of euros. C) a constant dollar price for euros. D) a ban on imports from Europe. Answer: A 15) From 1980-1985, the dollar strengthened in value against other currencies. Who was helped and who was hurt by this strong dollar? Answer: American consumers benefitted because imports were cheaper and consumers could purchase more. American businesses and workers in those businesses were hurt as domestic and foreign sales of American products fell. 1.5 Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation Rate 1) The most comprehensive measure of aggregate output is A) gross domestic product. B) net national product. C) the stock value of the industrial 500. D) national income. Answer: A 2) The gross domestic product is the A) the value of all wealth in an economy. B) the value of all goods and services sold to other nations in a year. C) the market value of all final goods and services produced in an economy in a year. D) the market value of all intermediate goods and services produced in an economy in a year. Answer: C 3) Which of the following items are not counted in U.S. GDP? A) your purchase of a new Ford Mustang B) your purchase of new tires for your old car C) GM's purchase of tires for new cars D) a foreign consumer's purchase of a new Ford Mustang Answer: C 4) If an economy has aggregate output of $20 trillion, then aggregate income is A) $10 trillion. B) $20 trillion. C) $30 trillion. D) $40 trillion. Answer: B 5) When the total value of final goods and services is calculated using current prices, the resulting measure is referred to as A) real GDP. B) the GDP deflator. C) nominal GDP. D) the index of leading indicators. Answer: C 6) Nominal GDP is output measured in ________ prices while real GDP is output measured in ________ prices. A) current; current B) current; fixed C) fixed; fixed D) fixed; current Answer: B 7) GDP measured with constant prices is referred to as A) real GDP. B) nominal GDP. C) the GDP deflator. D) industrial production. Answer: A 8) If your nominal income in 2002 was $50,000, and prices doubled between 2002 and 2008, to have the same real income, your nominal income in 2008 must be A) $50,000. B) $75,000. C) $90,000. D) $100,000. Answer: D 9) If your nominal income in 1998 is $50,000, and prices increase by 50% between 1998 and 2008, then to have the same real income, your nominal income in 2008 must be A) $50,000. B) $75,000. C) $100,000. D) $150,000. Answer: B 10) To convert a nominal GDP to a real GDP, you would use A) the PCE deflator. B) the CPI measure. C) the GDP deflator. D) the PPI measure. Answer: C 11) If nominal GDP in 2001 is $9 trillion, and 2001 real GDP in 1996 prices is $6 trillion, the GDP deflator price index is A) 7. B) 100. C) 150. D) 200. Answer: C 12) When prices are measured in terms of fixed (base-year) prices they are called ________ prices. A) nominal B) real C) inflated D) aggregate Answer: B 13) The measure of the aggregate price level that is most frequently reported in the media is the ________. A) GDP deflator B) producer price index C) consumer price index D) household price index Answer: C 14) To calculate the growth rate of a variable, you will A) calculate the percentage change from one time period to the next. B) calculate the difference between the two variables. C) add the ending value to the beginning value. D) divide the increase by the number of time periods. Answer: A 15) If real GDP grows from $10 trillion in 2002 to $10.5 trillion in 2003, the growth rate for real GDP is A) 5%. B) 10%. C) 50%. D) 0.5%. Answer: A 16) If real GDP in 2002 is $10 trillion, and in 2003 real GDP is $9.5 trillion, then real GDP growth from 2002 to 2003 is A) 0.5%. B) 5%. C) 0%. D) -5%. Answer: D 17) If the aggregate price level at time t is denoted by Pt, the inflation rate from time t - 1 to t is defined as A) πt = (Pt - Pt - 1)/Pt - 1. B) πt = (Pt + 1 - Pt - 1)/Pt - 1. C) πt = (Pt + 1 - Pt)/Pt. D) πt = (Pt - Pt - 1)/Pt. Answer: A 18) If the price level increases from 200 in year 1 to 220 in year 2, the rate of inflation from year 1 to year 2 is A) 20%. B) 10%. C) 11%. D) 120%. Answer: B 19) If the CPI is 120 in 1996 and 180 in 2002, then between 1996 and 2002, prices have increased by A) 180%. B) 80%. C) 60%. D) 50%. Answer: D 20) If the CPI in 2004 is 200, and in 2005 the CPI is 180, the rate of inflation from 2004 to 2005 is A) 20%. B) 10%. C) 0%. D) -10%. Answer: D Chapter 2 An Overview of the Financial System 2.1 Function of Financial Markets 1) Every financial market has the following characteristic: A) It determines the level of interest rates. B) It allows common stock to be traded. C) It allows loans to be made. D) It channels funds from lenders-savers to borrowers-spenders. Answer: D 2) Financial markets have the basic function of A) getting people with funds to lend together with people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) providing a risk-free repository of spending power. Answer: A 3) Financial markets improve economic welfare because A) they channel funds from investors to savers. B) they allow consumers to time their purchase better. C) they weed out inefficient firms. D) eliminate the need for indirect finance. Answer: B 4) Well-functioning financial markets A) cause inflation. B) eliminate the need for indirect finance. C) cause financial crises. D) produce an efficient allocation of capital. Answer: D 5) A breakdown of financial markets can result in A) financial stability. B) rapid economic growth. C) political instability. D) stable prices. Answer: C 6) The principal lender-savers are A) governments. B) businesses. C) households. D) foreigners. Answer: C 7) Which of the following can be described as direct finance? A) You take out a mortgage from your local bank. B) You borrow $2500 from a friend. C) You buy shares of common stock in the secondary market. D) You buy shares in a mutual fund. Answer: B 8) Assume that you borrow $2000 at 10% annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is A) $400. B) $201. C) $200. D) $199. Answer: B 9) You can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is A) 25%. B) 12.5%. C) 10%. D) 5%. Answer: D 10) Which of the following can be described as involving direct finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys a short-term corporate security in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets. Answer: A 11) Which of the following can be described as involving direct finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys a short-term corporate security in a secondary market. D) People buy shares of common stock in the primary markets. Answer: D 12) Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) A corporation buys a share of common stock issued by another corporation in the primary market. C) You buy a U.S. Treasury bill from the U.S. Treasury. D) You make a deposit at a bank. Answer: D 13) Which of the following can be described as involving indirect finance? A) You make a loan to your neighbor. B) You buy shares in a mutual fund. C) You buy a U.S. Treasury bill from the U.S. Treasury. D) A corporation buys a short-term security issued by another corporation in the primary market. Answer: B 14) Securities are ________ for the person who buys them, but are ________ for the individual or firm that issues them. A) assets; liabilities B) liabilities; assets C) negotiable; nonnegotiable D) nonnegotiable; negotiable Answer: A 15) With ________ finance, borrowers obtain funds from lenders by selling them securities in the financial markets. A) active B) determined C) indirect D) direct Answer: D 16) With direct finance funds are channeled through the financial market from the ________ directly to the ________. A) savers, spenders B) spenders, investors C) borrowers, savers D) investors, savers Answer: A 17) Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in the United States? Answer: With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in the U.S. 2.2 Structure of Financial Markets 1) Which of the following statements about the characteristics of debt and equity is false? A) They can both be long-term financial instruments. B) They can both be short-term financial instruments. C) They both involve a claim on the issuer's income. D) They both enable a corporation to raise funds. Answer: B 2) Which of the following statements about the characteristics of debt and equities is true? A) They can both be long-term financial instruments. B) Bond holders are residual claimants. C) The income from bonds is typically more variable than that from equities. D) Bonds pay dividends. Answer: A 3) Which of the following statements about financial markets and securities is true? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is intermediate term if its maturity is ten years or longer. D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date. Answer: D 4) Which of the following is an example of an intermediate-term debt? A) A thirty-year mortgage. B) A sixty-month car loan. C) A six month loan from a finance company. D) A Treasury bond. Answer: B 5) If the maturity of a debt instrument is less than one year, the debt is called ________. A) short-term B) intermediate-term C) long-term D) prima-term Answer: A 6) Long-term debt has a maturity that is ________. A) between one and ten years. B) less than a year. C) between five and ten years. D) ten years or longer. Answer: D 7) When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors. A) bonds B) bills C) notes D) stock Answer: D 8) Equity holders are a corporation's ________. That means the corporation must pay all of its debt holders before it pays its equity holders. A) debtors B) brokers C) residual claimants D) underwriters Answer: C 9) Which of the following benefit directly from any increase in the corporation's profitability? A) a bond holder B) a commercial paper holder C) a shareholder D) a T-bill holder Answer: C 10) A financial market in which previously issued securities can be resold is called a ________ market. A) primary B) secondary C) tertiary D) used securities Answer: B 11) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house. Answer: A 12) When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public. A) underwrites B) undertakes C) overwrites D) overtakes Answer: A 13) Which of the following is not a secondary market? A) foreign exchange market B) futures market C) options market D) IPO market Answer: D 14) ________ work in the secondary markets matching buyers with sellers of securities. A) Dealers B) Underwriters C) Brokers D) Claimants Answer: C 15) A corporation acquires new funds only when its securities are sold in the A) primary market by an investment bank. B) primary market by a stock exchange broker. C) secondary market by a securities dealer. D) secondary market by a commercial bank. Answer: A 16) A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank. Answer: B 17) An important function of secondary markets is to A) make it easier to sell financial instruments to raise funds. B) raise funds for corporations through the sale of securities. C) make it easier for governments to raise taxes. D) create a market for newly constructed houses. Answer: A 18) Secondary markets make financial instruments more A) solid. B) vapid. C) liquid. D) risky. Answer: C 19) A liquid asset is A) an asset that can easily and quickly be sold to raise cash. B) a share of an ocean resort. C) difficult to resell. D) always sold in an over-the-counter market. Answer: A 20) The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market. A) more; primary B) more; secondary C) less; primary D) less; secondary Answer: A 21) When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called a(n) A) exchange. B) over-the-counter market. C) common market. D) barter market. Answer: A 22) Forty or so dealers establish a "market" in these securities by standing ready to buy and sell them. A) Secondary stocks B) Surplus stocks C) U.S. government bonds D) Common stocks Answer: C 23) Which of the following statements about financial markets and securities is true? A) Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as the New York Stock Exchange. B) As a corporation gets a share of the broker's commission, a corporation acquires new funds whenever its securities are sold. C) Capital market securities are usually more widely traded than shorter-term securities and so tend to be more liquid. D) Because of their short-terms to maturity, the prices of money market instruments tend to fluctuate wildly. Answer: A 24) A financial market in which only short-term debt instruments are traded is called the ________ market. A) bond B) money C) capital D) stock Answer: B 25) Equity instruments are traded in the ________ market. A) money B) bond C) capital D) commodities Answer: C 26) Corporations receive funds when their stock is sold in the primary market. Why do corporations pay attention to what is happening to their stock in the secondary market? Answer: The existence of the secondary market makes their stock more liquid and the price in the secondary market sets the price that the corporation would receive if they choose to sell more stock in the primary market. 27) Describe the two methods of organizing a secondary market. Answer: A secondary market can be organized as an exchange where buyers and sellers meet in one central location to conduct trades. An example of an exchange is the New York Stock Exchange. A secondary market can also be organized as an over-the-counter market. In this type of market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices. An example of an over-the-counter market is the federal funds market. 2.3 Financial Market Instruments 1) Prices of money market instruments undergo the least price fluctuations because of A) the short terms to maturity for the securities. B) the heavy regulations in the industry. C) the price ceiling imposed by government regulators. D) the lack of competition in the market. Answer: A 2) U.S. Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower purchase price than the amount you receive at maturity. A) premium B) collateral C) default D) discount Answer: D 3) U.S. Treasury bills are considered the safest of all money market instruments because there is no risk of ________. A) defeat B) default C) desertion D) demarcation Answer: B 4) A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called A) commercial paper. B) a negotiable certificate of deposit. C) a municipal bond. D) federal funds. Answer: B 5) A short-term debt instrument issued by well-known corporations is called A) commercial paper. B) corporate bonds. C) municipal bonds. D) commercial mortgages. Answer: A 6) ________ are short-term loans in which Treasury bills serve as collateral. A) Repurchase agreements B) Negotiable certificates of deposit C) Federal funds D) U.S. government agency securities Answer: A 7) Collateral is ________ the lender receives if the borrower does not pay back the loan. A) a liability B) an asset C) a present D) an offering Answer: B 8) Federal funds are A) funds raised by the federal government in the bond market. B) loans made by the Federal Reserve System to banks. C) loans made by banks to the Federal Reserve System. D) loans made by banks to each other. Answer: D 9) The British Banker's Association average of interbank rates for dollar deposits in the London market is called the A) Libor rate. B) federal funds rate. C) prime rate. D) Treasury Bill rate. Answer: A 10) Which of the following are short-term financial instruments? A) A repurchase agreement. B) A share of Walt Disney Corporation stock. C) A Treasury note with a maturity of four years. D) A residential mortgage. Answer: A 11) Which of the following instruments are traded in a money market? A) State and local government bonds. B) U.S. Treasury bills. C) Corporate bonds. D) U.S. government agency securities. Answer: B 12) Which of the following instruments are traded in a money market? A) Bank commercial loans. B) Commercial paper. C) State and local government bonds. D) Residential mortgages. Answer: B 13) Which of the following instruments is not traded in a money market? A) Residential mortgages. B) U.S. Treasury Bills. C) Negotiable bank certificates of deposit. D) Commercial paper. Answer: A 14) Bonds issued by state and local governments are called ________ bonds. A) corporate B) Treasury C) municipal D) commercial Answer: C 15) Equity and debt instruments with maturities greater than one year are called ________ market instruments. A) capital B) money C) federal D) benchmark Answer: A 16) Which of the following is a long-term financial instrument? A) A negotiable certificate of deposit. B) A repurchase agreement. C) A U.S. Treasury bond. D) A U.S. Treasury bill. Answer: C 17) Which of the following instruments are traded in a capital market? A) U.S. Government agency securities. B) Negotiable bank CDs. C) Repurchase agreements. D) U.S. Treasury bills. Answer: A 18) Which of the following instruments are traded in a capital market? A) Corporate bonds. B) U.S. Treasury bills. C) Negotiable bank CDs. D) Repurchase agreements. Answer: A 19) Which of the following are not traded in a capital market? A) U.S. government agency securities. B) State and local government bonds. C) Repurchase agreements. D) Corporate bonds. Answer: C 2.4 Internationalization of Financial Markets 1) Equity of U.S. companies can be purchased by A) U.S. citizens only. B) foreign citizens only. C) U.S. citizens and foreign citizens. D) U.S. mutual funds only. Answer: C 2) One reason for the extraordinary growth of foreign financial markets is A) decreased trade. B) increases in the pool of savings in foreign countries. C) the recent introduction of the foreign bond. D) slower technological innovation in foreign markets. Answer: B 3) Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as A) foreign bonds. B) Eurobonds. C) equity bonds. D) country bonds. Answer: A 4) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which it is sold are known as A) foreign bonds. B) Eurobonds. C) equity bonds. D) country bonds. Answer: B 5) If Microsoft sells a bond in London and it is denominated in dollars, the bond is a ________. A) Eurobond B) foreign bond C) British bond D) currency bond Answer: A 6) U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks are called ________. A) Atlantic dollars B) Eurodollars C) foreign dollars D) outside dollars Answer: B 7) Distinguish between a foreign bond and a Eurobond. Answer: A foreign bond is sold in a foreign country and priced in that country's currency. A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency. 2.5 Function of Financial Intermediaries: Indirect Finance 1) The process of indirect finance using financial intermediaries is called A) direct lending. B) financial intermediation. C) resource allocation. D) financial liquidation. Answer: B 2) In the United States, loans from ________ are far ________ important for corporate finance than are securities markets. A) government agencies; more B) government agencies; less C) financial intermediaries; more D) financial intermediaries; less Answer: C 3) The time and money spent in carrying out financial transactions are called A) economies of scale. B) financial intermediation. C) liquidity services. D) transaction costs. Answer: D 4) Economies of scale enable financial institutions to A) reduce transactions costs. B) avoid the asymmetric information problem. C) avoid adverse selection problems. D) reduce moral hazard. Answer: A 5) An example of economies of scale in the provision of financial services is A) investing in a diversified collection of assets. B) providing depositors with a variety of savings certificates. C) spreading the cost of borrowed funds over many customers. D) spreading the cost of writing a standardized contract over many borrowers. Answer: D 6) 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. Answer: A 7) 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. Answer: A 8) 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. Answer: C 9) Reducing risk through the purchase of assets whose returns do not always move together is A) diversification. B) intermediation. C) intervention. D) discounting. Answer: A 10) 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. Answer: B 11) Risk sharing is profitable for financial institutions due to A) low transactions costs. B) asymmetric information. C) adverse selection. D) moral hazard. Answer: A 12) 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 Answer: C 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. Answer: B 14) 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 Answer: A 15) 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. Answer: A 16) 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 Answer: B 17) 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. Answer: C 18) 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 Answer: A 19) 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 Answer: A 20) 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. Answer: Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately. Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower. 2.6 Types of Financial Intermediaries 1) Financial institutions that accept deposits and make loans are called ________ institutions. A) investment B) contractual savings C) depository D) underwriting Answer: C 2) 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. Answer: B 3) 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 Answer: B 4) Which of the following is a depository institution? A) A life insurance company B) A mutual savings bank C) A pension fund D) A finance company Answer: B 5) Which of the following financial intermediaries is not a depository institution? A) A savings and loan association B) A commercial bank C) A credit union D) A finance company Answer: D 6) The primary assets of credit unions are A) municipal bonds. B) business loans. C) consumer loans. D) mortgages. Answer: C 7) The primary liabilities of a commercial bank are A) bonds. B) mortgages. C) deposits. D) commercial paper. Answer: C 8) The primary liabilities of depository institutions are A) premiums from policies. B) shares. C) deposits. D) bonds. Answer: C 9) ________ institutions are financial intermediaries that acquire funds at periodic intervals on a contractual basis. A) Investment B) Contractual savings C) Thrift D) Depository Answer: B 10) Which of the following is a contractual savings institution? A) A life insurance company B) A credit union C) A savings and loan association D) A mutual fund Answer: A 11) Contractual savings institutions include A) mutual savings banks. B) money market mutual funds. C) commercial banks. D) life insurance companies. Answer: D 12) Which of the following are not contractual savings institutions? A) Life insurance companies B) Credit unions C) Pension funds D) State and local government retirement funds Answer: B 13) Which of the following is not a contractual savings institution? A) A life insurance company B) A pension fund C) A savings and loan association D) A fire and casualty insurance company Answer: C 14) The primary assets of a pension fund are A) money market instruments. B) corporate bonds and stock. C) consumer and business loans. D) mortgages. Answer: B 15) Which of the following are investment intermediaries? A) Life insurance companies B) Mutual funds C) Pension funds D) State and local government retirement funds Answer: B 16) An investment intermediary that lends funds to consumers is A) a finance company. B) an investment bank. C) a finance fund. D) a consumer company. Answer: A 17) The primary assets of a finance company are A) municipal bonds. B) corporate stocks and bonds. C) consumer and business loans. D) mortgages. Answer: C 18) ________ are financial intermediaries that acquire funds by selling shares to many individuals and using the proceeds to purchase diversified portfolios of stocks and bonds. A) Mutual funds B) Investment banks C) Finance companies D) Credit unions Answer: A 19) Money market mutual fund shares function like A) checking accounts that pay interest. B) bonds. C) stocks. D) currency. Answer: A 20) An important feature of money market mutual fund shares is A) deposit insurance. B) the ability to write checks against shareholdings. C) the ability to borrow against shareholdings. D) claims on shares of corporate stock. Answer: B 21) The primary assets of money market mutual funds are A) stocks. B) bonds. C) money market instruments. D) deposits. Answer: C 22) An investment bank helps ________ issue securities. A) a corporation B) the United States government C) the SEC D) foreign governments Answer: A 23) An investment bank purchases securities from a corporation at a predetermined price and then resells them in the market. This process is called A) underwriting. B) underhanded. C) understanding. D) undertaking. Answer: A 2.7 Regulation of the Financial System 1) Which of the following is not a goal of financial regulation? A) Ensuring the soundness of the financial system B) Reducing moral hazard C) Reducing adverse selection D) Ensuring that investors never suffer losses Answer: D 2) Increasing the amount of information available to investors helps to reduce the problems of ________ and ________ in the financial markets. A) adverse selection; moral hazard B) adverse selection; risk sharing C) moral hazard; transactions costs D) adverse selection; economies of scale Answer: A 3) A goal of the Securities and Exchange Commission is to reduce problems arising from A) competition. B) banking panics. C) risk. D) asymmetric information. Answer: D 4) The purpose of the disclosure requirements of the Securities and Exchange Commission is to A) increase the information available to investors. B) prevent bank panics. C) improve monetary control. D) protect investors against financial losses. Answer: A 5) Government regulations to reduce the possibility of financial panic include all of the following except A) transactions costs. B) restrictions on assets and activities. C) disclosure. D) deposit insurance. Answer: A 6) Which of the following do not provide charters? A) The Office of the Comptroller of the Currency B) The Federal Reserve System C) The National Credit Union Administration D) State banking and insurance commissions Answer: B 7) A restriction on bank activities that was repealed in 1999 was A) the prohibition of the payment of interest on checking deposits. B) restrictions on credit terms. C) minimum down payments on loans to purchase securities. D) separation of commercial banking from the securities industries. Answer: D 8) In order to reduce risk and increase the safety of financial institutions, commercial banks and other depository institutions are prohibited from A) owning municipal bonds. B) making real estate loans. C) making personal loans. D) owning common stock. Answer: D 9) The primary purpose of deposit insurance is to A) improve the flow of information to investors. B) prevent banking panics. C) protect bank shareholders against losses. D) protect bank employees from unemployment. Answer: B 10) The agency that was created to protect depositors after the banking failures of 1930-1933 is the A) Federal Reserve System. B) Federal Deposit Insurance Corporation. C) Treasury Department. D) Office of the Comptroller of the Currency. Answer: B 11) Savings and loan associations are regulated by the A) Federal Reserve System. B) Securities and Exchange Commission. C) Office of the Comptroller of the Currency. D) Office of Thrift Supervision. Answer: D 12) The regulatory agency that sets reserve requirements for all banks is A) the Federal Reserve System. B) the Federal Deposit Insurance Corporation. C) the Office of Thrift Supervision. D) the Securities and Exchange Commission. Answer: A 13) Asymmetric information is a universal problem. This would suggest that financial regulations A) in industrial countries are an unqualified failure. B) differ significantly around the world. C) in industrialized nations are similar. D) are unnecessary. Answer: C 14) How do regulators help to ensure the soundness of financial intermediaries? Answer: Regulators restrict who can set up a financial intermediary, conduct regular examinations, restrict assets, and provide insurance to help ensure the soundness of financial intermediaries. Test Bank for The Economics of Money, Banking and Financial Markets Frederic S. Mishkin 9780321599797, 9780134734200, 9780133836790, 9780134734606, 9780134733821
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