Chapter 15 Money and Banking 1. Any object can serve as money if it is portable, divisible, durable, and stable. Answer: True Explanation: These characteristics make money able to be used for trade instead of bartering with actual goods. 2. The M-2 money supply includes everything that is in the M-1 money supply. Answer: True Explanation: The M-2 definition of money is broader than the M-1 definition. 3. In mutual savings banks, all depositors are considered owners of the bank. Answer: True Explanation: All profits are divided proportionately among depositors, who receive dividends. 4. A banker's acceptance requires payment by a specified date. Answer: True Explanation: Banks can draw up a banker's acceptance, which promises that the bank will pay some specified amount at a future date. 5. Through the Federal Deposit Insurance Corporation, a deposit in a member bank is currently insured up to $50,000. Answer: False Explanation: They are actually insured up to $250,000. 6. As the government's bank, the Fed produces the nation's paper currency and lends money to the government. Answer: True Explanation: It also lends money to the government by buying bonds issued by the Treasury Department to help finance the national deficit. 7. Like most of the federal government, the governors of the Federal Reserve System are democratically elected by the citizens of the United States. Answer: False Explanation: The governors of the Federal Reserve System are appointed by government officials. 8. The divisibility characteristic of money is illustrated by a financial company's ability to divide its monetary assets among several investments. Answer: True Explanation: Divisibility refers to the ability to divide money into smaller parts; for example, a dollar bill can be divided into ten dimes or four quarters. 9. The reason why a savings account is not considered a component of the M-1 money supply is that it bears interest. Answer: False Explanation: It is not considered as a component because M-1 includes only the most liquid forms of money—cash, checks, and checking accounts. 10. The prime rate of a particular bank is the average interest rate of the commercial loans currently being paid by borrowers from that bank. Answer: False Explanation: The prime rate is set by the respective states in which the banks do business. 11. In order to save money on transactional costs, the U.S. Treasury is moving to electronic fund transfers for payments rather than issuing checks. Answer: True Explanation: The U.S. Treasury reports that it costs $1.03 to issue a check payment, but only $0.105 to issue an EFT payment. 12. Savings and loan associations began primarily to loan money to small to medium-sized businesses. Answer: False Explanation: Traditionally, S&Ls loaned money primarily for home mortgages; many have now ventured into other areas of investments. 13. Individual retirement accounts can be opened only by self-employed people such as doctors, small business owners, and consultants. Answer: False Explanation: Individual retirement accounts are tax-deferred pension funds that any wage earners and their spouses can set up to supplement their retirement income. 14. Banks create money through contracts with the government to mint bills and coins. Answer: False Explanation: Banks create money by taking in deposits and making loans. 15. One of the daily responsibilities of the Federal Reserve System is to regulate the current federal funds rate. Answer: False Explanation: The Federal Reserve System has no direct control over the interest rate charged between banks in lending reserves to each other. 16. Open-market operations is often a more effective method for the Federal Reserve System to expand the money supply than is minting more dollars and coins. Answer: True Explanation: Buying securities from banks is quicker and easier than minting money—and the banks involved have immediately available cash for lending. 17. The Federal Reserve Bank has the responsibility of ensuring the reasonableness of the interest rates for business and personal loans within the United States. Answer: False Explanation: The Fed has no direct control over how individual banks conduct their loans. 18. Banks are subject to prosecution when they fail to maintain systems for identifying and reporting suspicious activities. Answer: True Explanation: Banks need to be able to report suspicious activities such as large cash deposits. 19. An example of a point-of-sale (POS) terminal is when you go to the grocery store and the system transfers funds from your account to the store's account. Answer: True Explanation: POS sales often take the form of debit card purchases. 20. Due to privacy issues, anti-terrorist policies enacted in the early 2000s have had few significant repercussions on banking practices. Answer: False Explanation: Anti-terrorist policies have had significant impact on banking practices. 21. The Federal Reserve System has been instrumental in providing interbank clearing of electronic payments for the nation's financial institutions. Answer: False Explanation: This is actually regulated by NACHA, an independent association. 22. Since late 2008, investors of certain banks have been prevented from having complete control over the sale of their banks' stocks. Answer: True Explanation: The Troubled Asset Recovery Program has given the U.S. Treasury significant control over which stocks of the bailed-out banks can be sold and to whom. 23. The international payments process that moves money between buyers and sellers on different continents is subject to worldwide policy systems. Answer: False Explanation: The international payments process that moves money between buyers and sellers on different continents is not subject to any worldwide policy system beyond loosely structured agreements among countries. 24. In international payments, equal money inflows and outflows can result in no money being transferred between countries. Answer: True Explanation: If trade between any two countries is in balance, money does not flow between the two countries. 25. The one area that the Federal Reserve System has very little control over is the strength of the U.S. dollar against other currencies. Answer: False Explanation: Federal interest rate policies contribute to the strength of the U.S. dollar. 26. The International Monetary Fund seeks to promote stable exchange rates. Answer: True Explanation: The IMF is a UN agency made up of 150 countries that promote exchange rate stability, provide short-term loans to member countries, build cooperation on monetary issues, and develop a system of international payments. 27. A very strong euro in comparison to the U.S. dollar would benefit American businesses more than European businesses in the global economy. Answer: True Explanation: A weak dollar means that more American goods would in general be sought after and bought over European goods, which would necessarily be more expensive. 28. The overall value of the U.S. M-2 has grown considerably since 1979 due primarily to the increased use of credit cards and debit cards. Answer: False Explanation: Credit cards are not considered in the calculation for M-2, and thus increased use of them has had no direct bearing on the exponential growth of M-2. 29. The Federal Deposit Insurance Corporation is the government agency that regulates American banks. Answer: True Explanation: Up to 99 percent of American banks are regulated through the FDIC. Some states regulate their local banks. 30. A single dollar deposited into a commercial bank has the potential of creating up to $3.50 in the overall money supply. Answer: True Explanation: The interest created by loans increases the money supply. 31. The increased activity of the financial market in the past five years has resulted in a severe drop in the required premiums for commercial banks to be members of the Federal Deposit Insurance Corporation. Answer: False Explanation: In recent years, the FDIC has raised the premiums charged to member banks to keep up with losses incurred by failed banks. 32. At any given time, there may be up to 15 different discount rates set by the Federal Reserve System for loaning money to commercial banks. Answer: False Explanation: The Federal Reserve consists of 12 banking districts. So there would be at most 12 different discount rates. 33. An overly large decrease in the reserve requirement by the Federal Reserve System could result in inflation. Answer: False Explanation: A decrease in the reserve requirement reduces the amount of deposits that each bank has to keep on hand; therefore, a decrease in the reserve requirement increases money supply. But if the requirement is too low, there may end up being a larger money supply than demand for goods, leading to deflation. 34. Which of the following has a fixed term? A) demand deposits B) time deposits C) money market mutual funds D) credit card accounts E) savings accounts Answer: B Explanation: B) Time deposits are intended to be held until maturity. 35. Which of the following financial institutions is considered a thrift institution? A) pension fund B) credit union C) commercial bank D) savings and loan association E) securities investment firms Answer: B Explanation: B) Credit unions formed to help certain groups of people manage their money with more thrift. 36. The Norton County Bank performs such tasks as making monthly bill payments, managing investment portfolios, and managing the estates of deceased persons. What are such services called? A) special banker's services B) financial advice services C) public services D) trust services E) amalgamation services Answer: D Explanation: D) For a fee, a bank's trust department will perform all of these functions. 37. Which of the following agencies guarantees the safety of all of its members' bank accounts? A) Internal Revenue Service B) Federal Open Market Committee C) Federal Reserve Bank D) Federal Deposit Insurance Corporation E) Federal Exchange Commission Answer: D Explanation: D) This is the primary responsibility of this agency. 38. Which of the following terms refers to the percentage of its deposits a bank must hold, in cash or on deposit, with a Federal Reserve bank? A) discount rate B) key rate C) prime rate D) federal insurance premium E) reserve requirement Answer: E Explanation: E) This is controlled by the Fed. 39. Which of the following terms refers to the interest level at which member banks can borrow money from the Federal Reserve System? A) discount rate B) key rate C) prime rate D) federal insurance premium E) reserve requirement Answer: A Explanation: A) This is one of the many interest controls that the Fed has at its disposal. 40. Which of the following terms refers to the interest level at which commercial banks lend reserves to each other, usually overnight? A) discount rate B) key rate C) prime rate D) federal insurance premium E) reserve requirement Answer: B Explanation: B) The Fed has no direct control over this. 41. Which of the following best describes what is called the "open-market operations" of the Federal Reserve System? A) the development of new financial opportunities for banks B) the minting of new money to disperse into the money market C) the control of interest rates among banks D) the maintenance of a well-functioning lending system among banks E) the buying and selling of securities Answer: E Explanation: E) This allows the Fed to ensure an active market. 42. Which of the following indices indicates the relative strength of the currencies of two countries? A) trade rate B) exchange rate C) trade balance D) relative gross national products E) international loan rate Answer: B Explanation: B) This is the ratio of one currency against the other. 43. Toyota, based in Japan, would like to build a new factory and a new retail distribution center. Both or either of these may be built in the United States and in Canada. Currently, the U.S. dollar is weak compared to the Canadian dollar. Which of the following would be in Toyota's best interest? A) build the cars in Canada and sell them in the United States B) build the cars in the United States and sell them in Canada C) build the cars in Canada and sell them in both countries D) build the cars in the United States and sell them in both countries E) build the cars in both countries and sell them in both countries Answer: B Explanation: B) Since transportation costs would be negligible here, it would behoove Toyota to build the cars where it would be cheaper to build them and to sell them where they could get the higher price. 44. Which of the following best describes the portability characteristic of money? A) It neither dies nor spoils and if it wears out, it can be replaced. B) Units of money can be matched with the value of goods. C) It can be exchanged across national borders. D) It allows people to measure the relative value of goods and services. E) It is light and easy to handle. Answer: E Explanation: E) Money is easy to carry, which makes it easy to use. 45. Which of the following is a consequence of the divisibility characteristic of money? A) Units of money do not expire after a certain time limit. B) Units of money can be accurately matched with the value of goods. C) Units of money are easily carried. D) Units of money have relatively stable value. E) Units of money of different nations are easily converted to other units of money. Answer: B Explanation: B) Modern currency is easily divisible into smaller parts, each with a fixed value; one dollar can be exchanged for 10 dimes. Thus, the actual value of goods can be approximated very well by units of money. 46. Which of the following affects the value of money? A) how much currency is in circulation B) how many units the currency can be divided into C) how portable the form of currency is D) how durable the form of currency is E) how much currency has been saved Answer: A Explanation: A) If there is too much money in circulation, we end up with inflation. If there is too little, everyone starves. 47. Which of the following best describes the durability characteristic of money? A) Units of money do not expire after a certain time limit. B) Units of money can be matched with the value of goods. C) Units of money allow people to measure the relative value of goods and services. D) Units of money of different nations are easily converted to other units of money. E) Units of money have lasting value. Answer: A Explanation: A) In addition, currency is difficult to counterfeit. 48. Which of the following best describes the stability characteristic of money? A) Units of money do not expire after a certain time limit. B) Units of money of different nations are easily converted to other units of money. C) Units of money can be matched with the value of goods. D) Units of money allow people to measure the relative value of goods and services. E) Units of money have relatively constant value. Answer: E Explanation: E) The value of currency fluctuates a little, though its value is related to what we can buy with it. 49. Money frees society from a system of barter. In doing so, money is performing which of the following functions? A) store of value B) measure of worth C) unit of account D) determination factor E) medium of exchange Answer: E Explanation: E) We use money as a way of buying and selling things; without money, we would all be involved in a system of barter. 50. Which of the following is NOT part of the M-1 supply? A) currency at hand B) currency amount of written checks C) currency available through a debit card D) currency in checking accounts E) currency value of time deposits Answer: E Explanation: E) M-1 includes only the most liquid forms of money: cash, checks, and checking accounts. 51. Which of the following is NOT part of the M-2 money supply? A) debit card account B) time deposits C) money market mutual funds D) savings account E) credit card account Answer: E Explanation: E) The major components of M-2 are M-1, time deposits, money market mutual funds, and savings accounts. 52. Which of the following financial institutions earn profits from loans taken from the funds in each of its depositors' accounts? A) securities investment firms B) pension funds C) credit unions D) commercial banks E) mutual savings banks Answer: D Explanation: D) This is one of the primary ways that commercial banks earn a profit. 53. Which of the following statements is true? A) Since insurance companies generate the vast majority of revenue from investments of premium payments, market fluctuations will not affect one's health care benefits. B) Since insurance companies generate the vast majority of revenue from premium payments, market fluctuations generally do not affect one's health insurance premium. C) Since insurance companies also generate revenue from investments of premium payments, market fluctuations may affect one's health insurance premium. D) Since insurance companies also generate revenue from investments of premium payments, market fluctuations may affect one's health care benefits. E) Since insurance companies generate revenue from both premium payments and investments thereof, market fluctuations will not generally affect one's health insurance benefits. Answer: C Explanation: C) Insurance premiums are set to make a profit, not simply to have an expected break-even value (as they were originally meant to do). Thus, if market fluctuations get too erratic, premiums might be set higher to compensate for this. 54. Which of the following financial institutions are considered to be owned by their depositors? A) commercial banks and savings and loan associations B) savings and loan associations and mutual savings banks C) mutual savings banks and credit unions D) credit unions and pension funds E) pension funds and savings institutions Answer: C Explanation: C) These are the co-owned institutions. The others are owned by the investors. 55. When buying from a supplier in France, LTD, based in Cleveland, Ohio, has arranged for its bank to pay the supplier the cost of the desired material when it has passed customs in the United States. Which of the following terms is this type of bank promise called? A) banker's acceptance B) bank trust service C) certified check D) letter of credit E) currency exchange agreement Answer: D Explanation: D) A letter of credit is payable only after certain conditions are met. 56. David has a savings account and a home mortgage with a financial institution. Each year, this institution sends him a dividend check based on his accounts. Which of the following financial institutions is David using here? A) commercial bank B) savings institution C) credit union D) savings and loan association E) mutual savings bank Answer: E Explanation: E) In mutual savings banks, all depositors are considered owners of the bank; all profits are divided proportionately among depositors, who receive dividends. 57. Which of the following actions can the Federal Deposit Insurance Company take in the event of a failure of one of its insured banks? A) The FDIC can seize the assets of the bank and its investors and settle the bank's debts. B) The FDIC can allow the bank to stay afloat by granting a loan of federal money. C) The FDIC can conduct an inquiry into the investors' assets and actions to determine if there was any malfeasance that caused the bank failure. D) The FDIC can allow another bank to take responsibility for the failed bank's liabilities through sale of the failed bank. E) The FDIC can settle the bank's debts through its insurance deposit fund and regulate the bank's transactions more strictly. Answer: D Explanation: D) The FDIC can do one of two actions: sell the failed bank or pay off its debts by seizure of its assets (and not those of the investors). 58. Which of the following statements best explains how financial institutions create money? A) By opening new checking accounts and giving more people access to readily available cash, financial institutions expand the money supply. B) By issuing money through government contracts, financial institutions expand the money supply. C) By taking deposits and loaning out these funds, financial institutions expand the money supply. D) By collecting interest on its accounts through investments, financial institutions expand the money supply. E) By giving interest from its accounts to its clients, financial institutions expand the money supply. Answer: C Explanation: C) Further, the money supply expands because banks are allowed to loan out most (although not all) of the money they take in from deposits. 59. Which of the following political bodies appoints the members of the board of governors for the Federal Reserve System? A) the Senate B) the House of Representatives C) the President of the United States D) the Council of American Governors E) the people of the United States Answer: C Explanation: C) The Fed's board of governors consists of seven members appointed by the President for overlapping terms of fourteen years. 60. How are the individual Federal Reserve Banks organized? A) by size of financial institution members—small, medium, large, etc. B) by type of financial institution members—commercial banks, credit unions, etc. C) by geographical region—Southeast, Northeast, West, etc. D) by financial purpose—buying, lending, interest controlling, etc. E) by legislative districts—10th District of Massachusetts, 1st District of Colorado, etc. Answer: C Explanation: C) There are a total of 12 districts. 61. Which of the following best describes two of the three primary functions of the Federal Reserve System? A) developing new financial markets and aiding banks in conducting their business B) aiding banks in conducting business and managing the U.S. money supply and interest rates C) managing the U.S. money supply and interest rates and monitoring interbank relationships D) monitoring interbank relationships and acting as a bank for the federal government E) acting as a bank for the federal government and developing new financial markets Answer: B Explanation: B) In addition, the Fed also clears checks—about 56 million each day—for commercial banks. 62. Which of the following is NOT a primary tool for controlling the money supply? A) taxation B) reserve requirements C) discount rate controls D) credit controls E) open-market operations Answer: A Explanation: A) The Fed uses four primary tools for controlling the money supply: reserve requirements, discount rate controls, open-market operations, and selective credit controls. 63. Which of the following statements best describes why U.S. Treasury securities have always been considered risk-free investments? A) They are backed by the U.S. government. B) They have a guaranteed rate of return. C) They are easily sold. D) They are readily available for purchase. E) They earn a great profit on the international money market. Answer: A Explanation: A) The other reasons here are all true because of the backing of the U.S. government. 64. Which of the following laws has had significant effects in maintaining bank identity records? A) the Check Clearing for the 21st Century Act B) the USA Patriot Act C) the Bank Secrecy Act D) the Federal Reserve Act E) the Emergency Economic Stabilization Act Answer: B Explanation: B) The CIP is a part of this law. 65. Which of the following federal laws made transactions between banks significantly more efficient? A) the Check Clearing for the 21st Century Act B) the Bank Secrecy Act C) the USA Patriot Act D) the Federal Reserve Act E) the Economic Emergency Recovery Act Answer: A Explanation: A) It made electronic clearing of checks legal. 66. Which of the following statements best describes how the Automated Clearing House Network (ACH) maintains its integrity as a processor of electronic payments? A) The ACH network is an institution within the Federal Bank System and is regulated by strict government standards. B) The ACH network is a for-profit company and is regulated by its need to make a profit, which it can only do by strictly regulating itself. C) The ACH network is a financial institution and is thus regulated by its obligations to its investors. D) The ACH network is a not-for-profit association and is regulated by its independence from outside interests. E) The ACH network is a professional organization to which all financial institutions are obligated to contribute resources and is regulated by the interests of these institutions. Answer: D Explanation: D) It is no longer a part of NACHA, but as a non-profit, it cannot be swayed by the personal interests of the investors and other institutions. 67. Which of the following financial institutions was taken over by the Federal House Finance Agency in 2008 as a part of the Emergency Economic Recovery Act? A) Lehman Brothers Holdings B) Bear Stearns Companies C) Federal Home Loan Mortgage Corporation D) Federal Home Loan Banks System E) Federal Agricultural Mortgage Corporation Answer: C Explanation: C) The Federal Home Loan Mortgage Corporation was taken over by the government in order to ensure that no more subprime loans and other abuses were made. 68. Which of the following transactions is not included among Automated Clearing House payments? A) ATM deposits B) business-to-business electronic payments C) checks D) Internet-initiated debit card payments E) local tax payments Answer: A Explanation: A) This is handled by the individual banks. 69. Which of the following pieces of information is not required by the USA Patriot Act for banks to collect for every customer? A) name B) address C) date of birth D) place of birth E) tax identification number Answer: D Explanation: D) This is the only one not necessary to be collected. 70. Which of the following institutions most helps simplify transactions made among buyers and sellers in different countries? A) the U.S. State Department B) the International Monetary Fund C) the World Bank D) commercial banks E) the Internet Answer: D Explanation: D) If money inflows and outflows are equal for two countries, money does not have to flow between them; if inflows and outflows are not equal, a flow of money is made to cover the difference. 71. Which of the following is the main justification for the World Bank to fund national improvements by making loans to build roads and hospitals? A) The resulting improvements will help stabilize the political situation, and hence the international trade, of certain developing countries. B) The resulting improvements will help increase the productive capacity, and hence the international trade, of certain developing countries. C) The resulting improvements will help increase the population morale, and hence the international trade, of certain developing countries. D) The resulting improvements will help increase the overall quality of life, and hence the international trade, of certain developing countries. E) The resulting improvements will help increase the value of the currency, and hence the international trade, of certain developing countries. Answer: B Explanation: B) The World Bank provides only a very limited scope of services; the resulting improvements, however, eventually enable borrowing countries to increase productive capacity and international trade. 72. Which of the following describes the requirements that the International Monetary Fund has made on certain developing countries? A) that the government decrease spending in order to bring inflation under control B) that private industries decrease prices in order to bring inflation under control C) that the government increase loans in order to create more money in the local markets D) that the local banks increase loans in order to create more money in the local markets E) that the government and private industries partner in creating more jobs in the region Answer: A Explanation: A) The IMF likes austerity in governments, but not private industries. 73. David is saving $25 a week toward getting a new truck. Which function of money does this illustrate? A) stabilization of value B) foundation of banking C) medium of exchange D) store of value E) measure of worth Answer: D Explanation: D) In the form of currency, money can be used for future purchases and thus "stores" value. 74. A jeweler assesses the value of a flawless white diamond as considerably more than that of a rhinestone. Which function of money does this illustrate? A) foundation of banking B) medium of exchange C) store of value D) measure of worth E) stabilization of value Answer: D Explanation: D) Money lets us measure the value of goods and services. 75. In which of the following financial institutions would all of the people who allow it to hold their funds be able to participate in major decision-making? A) commercial bank B) savings and loan association C) savings institutions D) credit union E) pension fund Answer: D Explanation: D) A credit union is a nonprofit institution owned and run by its members. 76. Which of the following reasons is the primary motivator for a commercial bank to acquire new depositors? A) A new deposit account will make more funds available to pay the interest on other deposit accounts. B) A new deposit account will make more funds available to pay the bank's employees. C) A new deposit account will make more funds available to give out in loans. D) A new deposit account will make more funds available to give out in dividends to its investors. E) A new deposit account will make more funds available to facilitate brokerage transactions. Answer: C Explanation: C) A commercial bank makes its profits from investments and loans derived from its depositors' cash. 77. Suppose a list of all American deposit institutions were created and a name chosen randomly from this list. Which of the following would the chosen institution most likely be? A) a commercial bank B) a savings institution C) a savings and loan association D) a mutual savings bank E) a credit union Answer: A Explanation: A) Despite the plethora of possible deposit financial institutions, the overwhelming majority of them are commercial banks. 78. Which of the following statements best describes why a decrease in reserve requirements often results in an increase in the money supply? A) A decrease in reserve requirements gives banks more money to better determine their interest rates. B) A decrease in reserve requirements gives banks more money to pay off their debts. C) A decrease in reserve requirements gives banks more money to lend out. D) A decrease in reserve requirements gives banks more money to offer in dividend payments to their clients. E) A decrease in reserve requirements gives banks more money to reward their employees for meritorious financial ventures. Answer: C Explanation: C) A decrease in the reserve requirement "frees up" extra money that can be distributed in the form of loans, for example. 79. Which of the following statements best describes why an increase in the discount rate often results in a decrease in the money supply? A) An increase in the discount rate will lower the overall values of loans from the Federal Reserve Banks to individual banks. B) An increase in the discount rate will lower the overall values of loans from individual banks to other financial institutions. C) An increase in the discount rate will lower the overall number of banks issuing loans to individuals. D) An increase in the discount rate will lower the overall number of loans from the Federal Reserve Banks to individual banks. E) An increase in the discount rate will lower the overall number of loans from the Federal Reserve Banks to individuals. Answer: D Explanation: D) An increase in the discount rate increases the amount of money each local bank will pay to the Federal Reserve bank to borrow money, for example; this tightens money supply. 80. Under which of the following circumstances would the Federal Reserve System want to increase the money supply by increasing the discount rate? A) The economy is experiencing severe inflation, and market activity is very low. Yet the financial institutions have a great deal of M-1 resources at their disposal that they are not investing. B) The economy is experiencing severe inflation, and most financial institutions have low M-1 resources at their disposal. Yet there is a great deal of market activity. C) The economy is experiencing severe deflation, and market activity is very low. Yet the financial institutions have a great deal of M-1 resources at their disposal that they are not investing. D) The economy is experiencing severe deflation, and most financial institutions have low M-1 resources at their disposal. Yet there is a great deal of market activity. E) The economy is experiencing wild fluctuations, and most financial institutions have low M-1 resources at their disposal. Answer: A Explanation: A) The Fed helps counteract inflation by decreasing the money supply. By increasing the discount rate, the Fed is discouraging further loans from itself and encouraging the institutions to use their own funds for investment. 81. Under which of the following circumstances would the Federal Reserve System want to decrease the money supply by increasing the reserve requirement? A) The economy is experiencing severe inflation, and market activity is very low. Yet the financial institutions have a great deal of M-1 resources at their disposal that they are not investing. B) The economy is experiencing severe inflation, yet market activity has been extremely high and erratic. C) The economy is experiencing severe deflation, and market activity is very low. Yet the financial institutions have a great deal of M-1 resources at their disposal that they are not investing. D) The economy is experiencing severe deflation, yet market activity has been extremely high and erratic. E) The economy is experiencing severe deflation, market activity is very low, and most financial institutions are low on M-1 resources. Answer: B Explanation: B) The Fed helps counteract inflation by decreasing the money supply. Here the market needs to be stabilized. By increasing the reserve requirement, the Fed will lower the amount of investments made by the financial institutions. 82. Which of the following recent events represents the two most significant impacts on changes in the money and banking system since 2000? A) the rise in government intervention in helping to stabilize the U.S. financial system and the increasingly strict regulation of the mortgage industry B) the increasingly strict regulation of the mortgage industry and the enactment of anti-terrorist policies C) the enactment of anti-terrorist policies and the rise of electronic technologies D) the rise of electronic technologies in banking and the rise in government intervention in helping to stabilize the U.S. financial system E) the rise in government intervention in helping to stabilize the U.S. financial system and the enactment of anti-terrorist policies Answer: D Explanation: D) These changes have been the most far-reaching in banking practices. 83. Regarding the international payments process, which statement is true? A) In international trade, money will flow from the country with the strongest currency to that of the weakest. B) The World Bank monitors the trade of its members to insure that money is flowing properly between the various countries. C) The World Bank monitors the national banks of its members to insure that money is flowing properly between the various countries. D) By international law, international trade must involve money flowing between two countries. E) Money does not actually have to flow between two countries. Answer: E Explanation: E) If trade between the two countries is in balance, meaning that money inflows and outflows are equal for both countries, money does not have to flow between the two countries. 84. What are the components of the M-1 money supply? Answer: The M-1 money supply is made up of currency (cash), checks, and checking accounts (demand deposits). Explanation: The oldest and most basic measure of the supply of money, M-1 counts only the most liquid, or spendable, forms of money. 85. What are the components of the M-2 money supply? Answer: The M-2 money supply includes everything that is in the M-1 money supply (currency, checks, and checking accounts); in addition, M-2 includes time deposits, money market mutual funds, and savings accounts. Explanation: M-2 includes everything in M-1 plus other forms of money that are not quite as liquid. 86. What is the difference between a public pension fund and a private pension fund? Answer: A public pension fund includes Social Security and nearly $3 trillion in retirement programs for state and local government employees. In contrast, a private pension fund is operated by employers, unions, and other private groups. Explanation: A pension fund is a pool of funds that is managed to provide retirement income for its members. Private pension funds cover about 43 million people and have total assets of $13 trillion, down from $15 trillion before the recent recession. 87. What is a debit card? Answer: Debit cards allow only the transfer of money between accounts. They do not increase the funds at an individual's disposal. They can, however, be used to make retail purchases. Explanation: Debit cards are used more than credit cards as payment for U.S. consumer transactions. 88. What is the difference between a credit card and a debit card? Answer: Credit cards allow users to borrow money and pay the money back over time. Unlike credit cards, debit cards allow only the transfer of money between accounts. Explanation: The risk of financial loss is greater for debit cards compared to credit cards. Federal law limits the credit card user's liability to $50 for stolen or fraudulent use. Protection against debit card losses can be higher—ranging up to $500—depending on how quickly the lost card is reported. 89. Why are savings accounts not considered a component of M-1, whereas checking accounts are? Answer: M-1 comprises all currency in circulation and immediately available for circulation. This includes checks, since it makes the currency in a checking account immediately useable. On the other hand, currency in a savings account is not available for immediate use, since it needs to be withdrawn physically from the bank in order to enter circulation. Explanation: Like time deposits and money market mutual funds, savings deposits are not quite as liquid as checks and other M1 forms of money. 90. Which of the three functions of money does a time deposit account most exemplify? Answer: By definition, a time deposit account has a fixed term, at the end of which it is has accrued a much higher value than the original investment. Thus, investment in a time deposit is a method to store (and gain) value. Explanation: A time deposit less exemplifies the other two main functions of money, as a medium of exchange and a measure of worth. 91. What is Check 21? Answer: Check 21 allows banks to present a substitute check for payment instead of the original check; the receiving bank makes an electronic image of the paper check and sends the image to the paying bank for instant payment. Explanation: Check 21 is shorthand for the Check Clearing for the 21st Century Act, which became federal law in 2004. More banks are adopting check image processing and benefitting from its speed and cost efficiency: less paper handling, reduced reliance on physical transportation, faster collection times, and elimination of expensive float. 92. Why might nations decline International Monetary Fund funds? Answer: Such nations may not want to accept the economic changes proposed by the IMF; further, these nations may reject the IMF's requirement that they cut back social programs to bring inflation under control, for example. Explanation: The IMF may impose various conditions when it makes loans to nations suffering from temporary negative trade balances. 93. Explain how current financial institutions can create $342 out of a deposit of $200. Answer: After the $200 is deposited into a bank, that bank can use up to 90 percent ($180. to lend out. That loan is then deposited into some other account, 90 percent ($162. of which can then be lent out by the bank. Thus, through loans, $342 = $180 + $162 has been brought into the money supply. Explanation: Financial institutions can create money not by printing bills and minting coins, but by taking in deposits and making loans. This expands the money supply because they are allowed to loan out most (although not all) of the money they take in from deposits. 94. Explain the need for requiring banks to be able to lend out only 90 percent of its deposit funds. Answer: If banks were allowed to lend out of all its deposit money, it would be possible to create as much money as any bank or pair of banks would desire, leading to massive inflation. Furthermore, a string of defaults would cause a system-wide panic as more and more customers realize that their deposits are no longer in physical possession of their banks—or even never really existed in the first place. Explanation: Holding a reserve, even if it's only 10 percent of the loan amount, is a government regulatory tool as well as a way to help safeguard the depositors' funds. 95. How does the Fed's monetary policy influence banks' willingness to loan money? Answer: Monetary policy is the management of the nation's economic growth through money supply and interest rates; by controlling these factors, the Fed influences banks' ability and willingness to loan money. Explanation: For example, in 2009, the Fed launched its most aggressive buying of long-term Treasury bonds in history—$300 billion—to fight the recession. The purchases were intended to push up market prices for Treasuries and thereby drive down interest rates. As long-term Treasury rates fell, other interest rates soon followed, including rates for home mortgages, business loans, and consumer loans. 96. What happens to demand and price during times of inflation? Answer: Demand for goods and services increases, and prices increase during times of inflation; this results directly from too much money in an economic system. Explanation: In contrast, deflation occurs when the supply of goods outpaces the supply of money, so demand for goods and services falls. Peter Gavin, a Minnesota native, has recently been elected to the U.S. House of Representatives. Although a professor in education elected on a platform of educational reform, he was appointed to the Joint Economic and Financial Services Committee. Thus, Gavin has come to rely on his aides to learn the intricacies of the U.S. financial system. 97. During hearings about the effects of the Troubled Assets Relief Program, Gavin's committee comes to learn that several of the bailed-out banks gave their top officers very high bonuses shortly after the government loaned the banks enough money to keep afloat. Several of Gavin's constituents were quite upset about this. Why would this have been a concern for them? Answer: The bailout money came directly from taxes. Since the bailout was viewed as only necessary to keep the economy from plunging into depression rather than a way to help fellow citizens out of a financial jam, these bonuses were seen as unnecessary and even unethical, since it was rewarding the very companies who got the economy into this mess in the first place. Explanation: TARP support included $235 billion in direct investments to some 600 banks to encourage lending. It was unclear to many in the public how paying huge executive bonuses worked to encourage lending. 98. During these same hearings, several executives from the bailed-out banks testified that such financial perks as these bonuses were necessary to get the economy rolling again. What arguments might they have used? Answer: Not everyone who received bonuses were those responsible for the economic meltdown. In fact, many of these executives made the necessary decisions to halt teetering banks from failing. Additionally, innovative and risk-taking decisions need to be made by the leaders of these banks in order to get them out of the current economic doldrums. This can only be done through the proper merit-based compensation. Explanation: Arguments for merit-based compensation can backfire when the public perception is that there is more blame than merit involved. 99. An inquiry into the possibly unethical relationship between a prominent commercial bank and a little-known insurance company has begun. Gavin is surprised to find that insurance companies are involved with corporate investments. How would his aides explain how insurance companies use investments? Answer: Insurance companies collect premium payments not only to earn profits and pay for insured losses but also to invest in stocks, real estate, and other assets in order to earn profits and generate the needed funds for insured losses. Explanation: Earnings pay for insured losses, such as death benefits, automobile damage, and health care expenses. 100. The inquiry has discovered that the bank involved has been selling its riskiest mortgage accounts to the insurance company, which in turn has been selling these accounts packaged with other more stable loans at a sharply discounted price to other banks. Gavin asks his aides why this would be a beneficial relationship between the two institutions. What would his aides say? Answer: By selling the risky loans out, the commercial banks are able to gain an initial profit from these loans and then reduce the loss from the probable defaults of the loans. The insurance company on the other hand can earn a profit through selling more lucrative loan packages to other banks with the risky loans outweighed by the price of the more stable ones. Explanation: Unlike commercial banks, insurance companies and other non-deposit institutions use inflowing funds for purposes other than earning interest for depositors. 101. There is discussion of a bill raising insurance on bank deposits. Why would these premiums need to be raised? Answer: The Federal Deposit Insurance Corporation, through its Bank Insurance Fund (BIF), insures the accounts of depositors in its member banks. If there are a great number of bank failures, then more and more funds will need to be drawn from the BIF, which would then have fewer banks from which to supply itself. Hence, the need to raise premiums among the insured banks that are left. Explanation: More than 99 percent of the nation's commercial banks and savings institutions pay fees for membership in the FDIC. In return, the FDIC guarantees the safety of all accounts—checking, savings, and certificates of deposit (CDs)—of every account owner up to the current maximum of $250,000. 102. Gavin's district, like many others, is showing severe signs of inflation. What might his committee recommend to the Federal Reserve System in order to curb the current trend? Answer: Inflation occurs when prices increase dramatically throughout an economic system due to an overabundance of money supply. The Committee might recommend that either the reserve requirement or the discount rate be raised slightly to decrease the overall supply of money. Explanation: The Fed, with its goal of economic stability, uses the money supply to avoid extreme inflation or deflation. Because commercial banks are the main creators of money, much of the Fed's management of the money supply takes the form of regulating the supply of money through commercial banks. 103. Gavin's committee is reviewing the current monetary policies of the Federal Reserve System, particularly with regard to a weak or strong U.S. dollar. The economy of Gavin's district is currently based primarily on manufacturing but is starting to see more and more factory closures due to international competition. Would a weak or strong dollar be in the best interests of Gavin's constituents? Explain. Answer: In this case, a weaker dollar would be more beneficial. A weaker dollar would mean that it would be cheaper to manufacture products in the United States (in Gavin's district, in particular) than in other regions of the world, thus keeping the manufacturing sector of his district healthy. Explanation: A weaker dollar makes U.S. goods cheaper and more attractive on the world's markets, thus increasing U.S. export sales. At the same time, the weaker dollar makes foreign imports more expensive, so U.S. consumers can afford fewer imported products, many of which are available only from foreign manufacturers. 104. A recent report to the House reveals that unemployment continues to be high and that the economy is "sluggish." At the same time, the discount rate is very close to zero, and the reserve requirement for banks was recently lowered to an all-time low. What actions might the Federal Reserve System do in order stimulate the economy? Answer: Given the two main tools for controlling the money supply and stimulating the economy—discount rate and reserve requirement—are incredibly low with no discernible effect, the Federal Reserve System would probably choose to buy bonds through open-market operations more actively. This would free up more cash for investment in the economy—and hopefully start reducing unemployment. Explanation: While some claim such bond purchases are essential for economic recovery, critics fear they may stimulate destructive spiraling inflation. 105. Gavin has asked one of aides to investigate whether the International Monetary Fund would be able to provide his district with a loan to foster international trade with the products made within his district. What would his aide most likely say? Answer: The IMF generally gives loans to nations, not parts of nations such as a political district. Furthermore, it only gives loans to nations suffering from negative trade balances in order to foster international trade with those nations. If the nation involved (the United States, in this case) is already heavily involved with international trade, it is very unlikely that the IMF would see the need to get involved. Explanation: IMF funds are often accompanied by conditions, such as the country must cut back social programs and spending in order to bring inflation under control. A political district would not be able to deal with such conditions. StarMart is a large, respected retail chain with more than 120 stores spread across the country. The company is keen to enter into a co-branding agreement with Axiom Financial Services. Under this agreement, Star's customers will be provided with an Axiom-Star Credit Card entitling them to reward points every time they swipe their credit cards at StarMart. Cardholders will be able to redeem points for special discounts, free merchandise, and exclusive services. StarMart is planning on a targeted direct marketing campaign using StarMart's knowledge of consumer buying patterns and Axiom's access to financial information. 106. A senior manager argues that the negative perception associated with mounting credit card debt will affect StarMart. Which of the following would be the most effective measure StarMart could take to address this potential problem? A) offering to forgive all debt more than 90 days old B) making it clear that StarMart is a different entity than Axiom-Star C) pointing out the records and practices of the worst-behaved credit companies D) extending the expiration date of StarMart reward points E) extending credit only to those who are very likely to be able to pay their bills Answer: E Explanation: E) Getting into the credit business is a risky proposition when credit card companies are unpopular. Having fair policies is a good step toward dealing with the potential for negative feedback. Extending credit only to those who are capable of paying their bills, Choice E, is a good way to avoid making the problem of mounting debt even worse. Choice A would be an invitation to run up large bills and then ignore them. Choices B and C attempt to shift the blame elsewhere, but this would just make StarMart look less ethical. Choice D might make more people sign up for the card, but it wouldn't help address the issue of mounting credit card debt. 107. A senior manager argues that the negative perception associated with mounting credit card debt will affect StarMart. Which of the following would be the LEAST effective measure StarMart could take to address this potential problem? A) publicizing the company's policies in clear and easy-to-understand language B) charging no more than the typical interest rate for month-to-month debt C) ensuring that fees for exceeding credit limits are no higher than necessary D) increasing the value of the promotional items that attract new credit card customers E) offering free debt counseling to Axiom-Star customers Answer: D Explanation: D) All of the choices are reasonable ways for StarMart to help consumers avoid excessive debt except Choice D, which would encourage customers to spend themselves into deep credit card debt. This might yield short-term profits, but it would not be a good response to the manager's concern. Subprime loans have higher interest rates than conventional loans. Subprime loans are designed for borrowers with low credit scores who would not qualify for conventional loans. The borrower pays a higher rate to compensate the lender for the greater risk of a default. Subprime loans typically have adjustable rates, meaning that the interest rate can change over the life of the loan. Borrowers who take out adjustable subprime loans usually try to keep the rate as low as possible at the start of the loan, even when doing so would lead to higher payments over the entire life of the loan. After a large number of people defaulted on their subprime loans, research revealed that the majority of people who took out subprime loans could have qualified for conventional loans. 108. The statements above most strongly suggest that if all subprime loan borrowers had taken out the loan that was most appropriate for their needs, then what would have been the outcome? A) None of them would have taken out an adjustable loan. B) None of them would have taken out a subprime loan. C) Most of them would have paid less in interest. D) Most of them would have taken out a conventional loan to cover any expenses not covered by a subprime loan. E) Most of them would have paid money at the start of the loan in order to get a reduced interest rate over the life of the loan. Answer: C Explanation: C) Subprime loans cost more than conventional loans, but most people who took out subprime loans could have gotten conventional loans. So if everyone had gotten the most appropriate loan, most of the people who took out subprime loans would have gotten lower rates and therefore paid less in interest, Choice C. Choices A and B go too far. There might have been some people who were better off with these loans. Choices D and E are possible events, but there's no evidence that either would have happened most of the time. 109. Taking out a subprime loan to buy a house is most likely to be a reasonable financial decision when which of the following is true? A) Qualifying for a conventional loan is impossible. B) Owning a home is an important life goal for the borrower. C) Adjustable rates are likely to be higher than fixed rates. D) The borrower reasonably expects to have greater financial means in the near future. E) The previous owner of the house took out a subprime loan. Answer: D Explanation: D) Can a subprime loan ever be a good idea? Sure. If you need a subprime loan because you can't qualify for a conventional one, then you're probably a high-risk buyer. But if you're about to come into more money in the near future, Choice D, then it might be worth getting a bad rate now if you reasonably think you'll be able to afford it later. Choice A: Not being able to get a regular loan doesn't mean that a subprime loan is a good idea. Maybe you really can't afford it. Choice B: Wanting a house desperately isn't a reason to take out a high-interest loan. Choices C and E tell us nothing about the buyer and his or her ability to pay. Domino Grace is a financial services company. It has started using scientific principles of management to analyze the compensation system for its financial advisors. Under the current system, revenue goals are based on the financial advisors' performances in the previous year. Domino Grace management believes that the financial advisors could generate much more revenue if they were encouraged to offer derivatives, a complex but potentially profitable investment product. 110. Which of the following, if true, would strengthen the argument of Domino Grace's management? A) Higher revenues would lead to higher profits for Domino Grace. B) If the derivative investments perform poorly, managers at Domino Grace will not pay any financial penalties. C) Domino Grace financial advisors are well-trained in handling complicated investment options. D) Many other investment firms have offered derivatives. E) Derivative investments are so complicated that most investors will not understand what they are buying. Answer: C Explanation: C) Derivatives might sound like a good idea, but they are complex. Can Domino Grace's employees handle them? If Choice C is true, the answer is more likely to be "yes, they can" and so Choice C strengthens the argument. Choice A says that higher revenues would be good, but that adds nothing. The question here is how to get higher revenues. Choice B weakens the argument slightly by suggesting that management might have a financial interest in doing something risky. Choice D doesn't help because the issue at hand is Domino Grace. Choice E is a reason to avoid derivatives. 111. Which of the following, if true, would weaken the argument of Domino Grace's management? A) Competitors of Domino Grace have lured new customers by offering access to exotic new investment options. B) A new political administration is expected to pass new financial regulations affecting derivative investments. C) Derivative investments are similar to most investments in that when a trade is made a gain on one side is mirrored by a loss on the other. D) Many of the investors who are interested in derivative investments are also interested in traditional investments. E) The opinions of Domino Grace stockholders are representative of the opinions of the investment community in general. Answer: B Explanation: B) Derivative investments sound like a pretty good idea, but the possibility of new government regulation in Choice B makes them sound less promising. Choice A makes it sound as though Domino Grace will need to offer derivatives (or something else complex and exotic) to keep up. Choice C points out a similarity between derivatives and traditional investments. There's nothing in there that makes derivatives sound worse than what Domino Grace is doing now. Choice D makes a transition to derivatives sound easier. Choice E doesn't help because we don't know what those opinions are or what difference they would make. 112. Suppose that investments in derivatives generated $5 million of revenue for Domino Grace during this calendar year. The managers who proposed offering derivatives contend that this statistic demonstrates that offering derivatives increased Domino Grace revenues this calendar year by $5 million. Which of the following points out a flaw in this argument? A) It assumes that offering derivatives could not have generated less than $5 million. B) It claims without warrant that offering derivatives will generate high revenues in future years. C) It fails to demonstrate that offering derivatives generated more money than any alternative would generate. D) It fails to account for the revenues that could have been generated by alternative uses of the resources that went into offering derivatives. E) It ignores the possibility that some investors lost money by investing in derivatives through Domino Grace. Answer: D Explanation: D) The investments generated money, but it must have taken some effort and resources to generate that money. If those efforts and resources had been devoted to some other project, then that project could have made some money, too. The managers ignore this and so commit this flaw in Choice D. Choices A and B would have been bogus claims, but the managers don't make those claims. Choice C goes too far. Choice E doesn't describe a flaw because the statistic describes what Domino Grace earned and not what the investors made on these investments. Gizmo Sprockets is a successful U.S. distributor of home appliance parts. Having been in business for more than ten years, it has contracts with thousands of retailers and repair shops throughout the country. The CEO wants Gizmo to go international, opening some locations in large economies such Brazil and India. He thinks that since the principles of how people do business in a free market are essentially the same anywhere, the expansion of Gizmo's business into other countries should be fairly straightforward. In other words, because the company has been successful in the United States, it will also be successful in international markets. 113. Gizmo's marketing director argues that because the global economy is interconnected, if Gizmo continues to be profitable in the United States, it should be able to invest that money to do well internationally. Which of the following, if true, would most weaken her argument? A) Gizmo's existing products can be used in other countries. B) The currency exchange rate between countries can fluctuate. C) Current Gizmo employees will need some cultural training to do business effectively in other countries. D) Investors will not be willing to put money into Gizmo's foreign business expansion without a business plan. E) Marketing strategies that are successful in the United States are not always successful overseas. Answer: B Explanation: B) The marketing director is neglecting the fact that the currency exchange rate between countries fluctuates. This means that if the U.S. dollar becomes weak against the local currency, finances in U.S. currency will not go as far in that country. Choice A would strengthen the marketing director's argument, because Gizmo could set up the same production methods overseas as it uses in the United States. Choices C, D, and E are incorrect because Gizmo could implement special cultural training, develop a detailed business plan, and plan specialized marketing strategies, respectively, and still parlay its domestic financial success to international success. Douglas & Reynolds, an American financial firm, has recently fallen on hard times. Its CEO notes that the firm has lost money for three straight years. Over the same period, the euro has lost 15 percent of its value while the Chinese yuan has increased its value by 15 percent. He therefore concludes that the company should discontinue its foreign currency investments in the euro in favor of the yuan in order to increase its profits. 114. Which of the following, if true, most weakens the CEO's argument? A) Over the last ten years, investments in the yuan have only marginally outperformed investments in the euro. B) Research shows that a vast majority of American voters approve of European governments and disapprove of the Chinese government. C) The amount of capital the company currently has invested in the euro is significantly larger than the amount invested in the yuan. D) In the past six months, Europe has shown signs of recovering from a financial crisis while China has shown signs of entering one. E) A competing firm recorded record profits after shifting its investments from Japanese yen to U.S. dollars. Answer: D Explanation: D) Since the CEO bases his argument on trends from the past three years, new information suggesting that earlier trends may no longer apply to the current economic environment weakens his argument. Choice A slightly strengthens the CEO's argument as it suggests that the yuan has been a better investment over the long term, albeit only a slightly better one. It's not known whether American public approval of foreign governments, Choice B, will affect the company's determination to increase its profits. Choice C is irrelevant, as the relative amounts of money currently invested do not have an impact on future investment strategies. Choice E is only tangentially related to the CEO's argument, as it is unreasonable to assume that the mere act of shifting investments between markets will always cause similar profit increases, or that what works for a competing firm will also work for Douglas & Reynolds. The Greenmax beverage company has built a successful business in the United States, having secured a small but consistent slice of the energy drink market. The company is preparing to go global with its brand and market its product overseas. 115. Greenmax's Chief Financial Officer likes the idea of expanding into markets in the southern hemisphere because he argues that this will help the company generate a consistent year-round cash flow. Which of the following, if true, would strengthen the CFO's argument? A) Energy drinks are popular in many different parts of the world. B) Demand for energy drinks is much greater in developed countries than in emerging markets. C) Greenmax has tapped about as much of the energy drink market share in the United States as it can get. D) The energy drink market in the southern hemisphere is dominated by the biggest name brands. E) Demand for energy drinks is heavily seasonal, with products selling much better at the hottest times of the year than others. Answer: E Explanation: E) Since the southern hemisphere has its hottest months during the times of the year when it is coolest in the northern hemisphere, selling Greenmax products to countries in both hemispheres would help generate even levels of sales revenue year-round. Choice A would support the idea that international markets can generate increased revenue, but not consistent year-round cash flow. Choice B argues against expanding into the southern hemisphere, since broadly speaking, most of the world's developed countries are in the northern hemisphere. Choice C says that the U.S. market is tapped but doesn't address the issue of whether expanding to the southern hemisphere would help, whereas Choice D suggests that Greenmax would face an uphill climb as it took on established brands there. Munschausen is a German-based appliance company that is preparing to begin international operations, wherein it plans to open several production facilities and sales centers abroad. The company needs a substantial amount of capital to start its international operations and needs to decide whether it should pursue debt financing by acquiring loans, or whether it can get equity financing from investors. 116. Which of the following, if true, would strengthen the case for Munschausen's seeking to acquire capital by debt financing? A) Munschausen will have very slim profit margins in its international sales. B) Munschausen will hire many new salespeople to work internationally. C) Munschausen will have a steady stream of revenue from its international sales. D) Munschausen will be launching several new product lines soon. E) Munschausen will have to specially train its employees to work internationally. Answer: C Explanation: C) A steady stream of revenue will help Munschausen to repay its debt financing according to a consistent schedule. Choice A would weaken the case for debt financing of Munschausen's international operations, because it would mean that the company would have little room to repay the debt. Choices B, D, and E would mean that Munschausen will have significant expenses, which would make it difficult to pay back debts. 117. Which of the following, if true, would weaken the case for Munschausen's seeking to acquire capital by debt financing? A) Munschausen has several marketing managers with international experience. B) Munschausen projects rapid growth into international markets that it targets. C) Munschausen plans to sell its products only in the most advanced economies. D) Munschausen will grow its business only slowly for its first several years. E) Munschausen gets its engineering talent from all over the world. Answer: D Explanation: D) If Munschausen's business grows only slowly, this will make it very difficult to repay debts. Choices A and E are human resource issues that are not relevant to whether the company should seek to acquire capital by debt financing. Choices B and C would tend to strengthen the case for debt financing, since rapid growth or steady sources of revenue from selling its products in economies where consumers have strong purchasing power both would suggest that Munschausen could easily repay the debts. 118. Which of the following, if true, would strengthen the case for Munschausen's seeking to acquire capital by equity financing? A) Most investors are not currently expressing interest in German companies. B) Munschausen is not sure whether its international sales will be profitable. C) Munschausen employs some of the best engineers in Germany. D) Munschausen will get savings through economies of scale by producing in greater quantity. E) Several venture capitalists are interested in investing in Munschausen. Answer: E Explanation: E) Financing by equity is preferable to debt financing because of the liability involved in indebtedness, so if Munschausen can get equity financing from investors, this would be a good option. Choices A and B would weaken the case that Munschausen could successfully acquire equity financing. Choices C and D are not relevant to whether Munschausen could or should acquire capital by equity financing. 119. Which of the following, if true, would weaken the case for Munschausen's seeking to acquire capital by equity financing? A) The equity capital market in Europe is currently very strong. B) Equity financiers expect a consistent return on their investments. C) Many of the companies in Germany get financing from equity capital. D) Only the largest companies are listed on Germany's public stock exchange. E) Most of the companies in Germany are listed on its stock exchange. Answer: D Explanation: D) This would mean that Munschausen would not be able to get capital through its stock, and it would also decrease the chances that it would be able to get investment capital by other means. Choices A, C, and E would strengthen the case that Munschausen could acquire capital by equity financing. Choice B would weaken the case only if Munschausen could not provide a consistent return on investments. Test Bank for Business Essentials US Edition Ronald J. Ebert, Ricky W. Griffin 9780133034028, 9780273766599, 9780136070764
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