lOMoARcPSD|27085979

Chp 1 mcqs

Finance (Shanghai Finance University)

Scan to open on Studocu

Studocu is not sponsored or endorsed by any college or university

Downloaded by technologys video ([email protected])
 lOMoARcPSD|27085979

Financial Markets and Institutions, 7e (Saunders)

Chapter 1 Introduction

1) Primary markets are markets in which users of funds raise cash by selling securities to funds
suppliers.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

2) Secondary markets are markets used by corporations to raise cash by issuing securities for a
short time period.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

3) Corporate security issuers are always directly involved in funds transfers in the secondary
market.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

4) The NYSE is an example of a secondary market.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

1
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

5) Central governments sometimes indirectly intervene in foreign exchange markets by affecting

foreign exchange rates through raising or lowering interest rates.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

6) Money markets are the markets for securities with an original maturity of one year or less.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

7) Financial intermediaries rather than financial systems are the most common agents to channel
funds from the suppliers to the users of funds.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

8) There are three types of major financial markets today: primary, secondary, and derivatives
markets. The NYSE and NASDAQ are both examples of derivatives markets.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.; 01-04 Understand
what derivative security markets are.
Accessibility: Keyboard Navigation

2
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

9) Asset transformation by financial intermediaries involves increasing the risk attributes of

securities such as mortgages, bonds, and stocks.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.; 01-07 Know the risks
financial institutions face.
Accessibility: Keyboard Navigation

10) One of the factors responsible for globalization of financial markets and institutions is
deregulation.

Answer: TRUE
Difficulty: 1 Easy
Topic: Globalization of Financial Markets and Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-09 Recognize that financial markets are becoming increasingly global.
Accessibility: Keyboard Navigation

11) The average cost incurred by financial institutions to collect information is larger than that of
individuals.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

12) The Volcker Rule prohibits U.S. depository institutions from engaging in proprietary trading.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-04 Understand what derivative security markets are.
Accessibility: Keyboard Navigation

3
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

13) Financial intermediation provides direct transfer of funds to the users.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-05 Distinguish between the different types of financial institutions.
Accessibility: Keyboard Navigation

14) In the United States the SEC provides deposit insurance for $250,000 per person per bank.

Answer: FALSE
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-08 Appreciate why financial institutions are regulated.
Accessibility: Keyboard Navigation

15) Enterprise Risk Management (ERM) system is responsible for managing the totality of a
firm's risk exposures.

Answer: TRUE
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-08 Appreciate why financial institutions are regulated.
Accessibility: Keyboard Navigation

4
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

16) What factors are encouraging financial institutions to offer overlapping financial services
such as banking, investment banking, brokerage, etc.?

I. Regulatory changes allowing institutions to offer more services

II. Technological improvements reducing the cost of providing financial services
III. Increasing competition from full-service global financial institutions
IV. Reduction in the need to manage risk at financial institutions

A) I only
B) II and III only
C) I, II, and III only
D) I, II, and IV only
E) I, II, III, and IV

Answer: C
Difficulty: 1 Easy
Topic: Overview of Financial Institutions
Bloom's: Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-08 Appreciate why financial institutions are regulated.
Accessibility: Keyboard Navigation

17) IBM creates and sells additional stock to the investment banker Morgan Stanley. Morgan
Stanley then resells the issue to the U.S. public through its mutual funds. This transaction is an
example of a(n)
A) primary market transaction.
B) asset transformation by Morgan Stanley.
C) money market transaction.
D) foreign exchange transaction.
E) forward transaction.

Answer: A
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

5
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

18) IBM creates and sells additional stock to the investment banker Morgan Stanley. Morgan
Stanley then resells the issue to the U.S. public through its mutual funds.

Morgan Stanley is acting as a(n)

A) asset transformer.
B) asset broker.
C) government regulator.
D) foreign service representative.
E) derivatives trader.

Answer: A
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

19) A corporation seeking to sell new equity securities to the public for the first time in order to
raise cash for capital investment would most likely
A) conduct an IPO with the assistance of an investment banker.
B) engage in a secondary market sale of equity.
C) conduct a private placement to a large number of potential buyers.
D) place an ad in the Wall Street Journal soliciting retail suppliers of funds.
E) issue bonds with the assistance of a dealer.

Answer: A
Difficulty: 2 Medium
Topic: Overview of Financial Markets
Bloom's: Evaluate
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.; 01-02
Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

6
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

20) The largest capital market security outstanding in 2016 measured by market value was
A) securitized mortgages.
B) corporate bonds.
C) municipal bonds.
D) Treasury bonds.
E) corporate stocks.

Answer: E
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

21) The diagram below is a diagram of the

A) secondary markets.
B) primary markets.
C) money markets.
D) derivatives markets.
E) commodities markets.

Answer: B
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Understand
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

7
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

22) ________ and ________ allow a financial intermediary to offer safe liquid liabilities such as
deposits while investing the depositors' money in riskier illiquid assets.
A) Diversification; high equity returns
B) Price risk; collateral
C) Free riders; regulations
D) Monitoring; diversification
E) Primary markets; foreign exchange markets

Answer: D
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.; 01-07 Know the risks
financial institutions face.
Accessibility: Keyboard Navigation

23) Depository institutions include

A) banks.
B) thrifts.
C) finance companies.
D) all of these choices are correct.
E) banks and thrifts.

Answer: E
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-05 Distinguish between the different types of financial institutions.
Accessibility: Keyboard Navigation

8
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

24) Match the intermediary with the characteristic that best describes its function.

I. Provide protection from adverse events.

II. Pool funds of small savers and invest in either money or capital markets.
III. Provide consumer loans and real estate loans funded by deposits.
IV. Accumulate and transfer wealth from work period to retirement period.
V. Underwrite and trade securities and provide brokerage services.

1. Thrifts
2. Insurers
3. Pension funds
4. Securities firms and investment banks
5. Mutual funds

A) 1, 3, 2, 5, 4
B) 4, 2, 3, 5, 1
C) 2, 5, 1, 3, 4
D) 2, 4, 5, 3, 1
E) 5, 1, 3, 2, 4

Answer: C
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Understand; Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-06 Know the services financial institutions perform.; 01-05 Distinguish
between the different types of financial institutions.
Accessibility: Keyboard Navigation

9
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

25) Secondary markets help support primary markets because secondary markets

I. offer primary market purchasers liquidity for their holdings.

II. update the price or value of the primary market claims.
III. reduce the cost of trading the primary market claims.

A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III

Answer: E
Difficulty: 2 Medium
Topic: Overview of Financial Markets
Bloom's: Understand; Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

26) Financial intermediaries (FIs) can offer savers a safer, more liquid investment than a capital
market security, even though the intermediary invests in risky illiquid instruments because
A) FIs can diversify away some of their risk.
B) FIs closely monitor the riskiness of their assets.
C) the federal government requires them to do so.
D) FIs can diversify away some of their risk and closely monitor the riskiness of their assets.
E) FIs can diversify away some of their risk and the federal government requires them to do so.

Answer: D
Difficulty: 1 Easy
Topic: Overview of Financial Markets; Overview of Financial Institutions
Bloom's: Evaluate
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.; 01-06 Know the
services financial institutions perform.
Accessibility: Keyboard Navigation

10
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

27) Households are increasingly likely to both directly purchase securities (perhaps via a broker)
and also place some money with a bank or thrift to meet different needs. Match up the given
investor's desire with the appropriate intermediary or direct security.

I. Money likely to be needed within six months

II. Money to be set aside for college in 10 years
III. Money to provide supplemental retirement income
IV. Money to be used to provide for children in the event of death

1. Depository institutions
2. Insurer
3. Pension fund
4. Stocks or bonds

A) 2, 3, 4, 1
B) 1, 4, 2, 3
C) 3, 2, 1, 4
D) 1, 4, 3, 2
E) 4, 2, 1, 3

Answer: D
Difficulty: 2 Medium
Topic: Overview of Financial Markets; Overview of Financial Institutions
Bloom's: Evaluate; Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.; 01-02
Differentiate between money and capital markets.; 01-06 Know the services financial institutions
perform.; 01-05 Distinguish between the different types of financial institutions.
Accessibility: Keyboard Navigation

28) As of 2016, which one of the following derivatives instruments had the greatest amount of
notional principal outstanding?
A) Futures
B) Swaps
C) Options
D) Bonds
E) Forwards

Answer: B
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-04 Understand what derivative security markets are.
Accessibility: Keyboard Navigation

11
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

29) Which of the following is/are money market instrument(s)?

A) Negotiable CDs
B) Common stock
C) T-bonds
D) 4-year maturity corporate bond
E) Negotiable CDs, common stock, and T-bonds

Answer: A
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

30) The Securities Exchange Commission (SEC) does not

A) decide whether a public issue is fairly priced.
B) decide whether a firm making a public issue has provided enough information for investors to
decide whether the issue is fairly priced.
C) require exchanges to monitor trading to prevent insider trading.
D) attempt to reduce excessive price fluctuations.
E) monitor the major securities exchanges.

Answer: A
Difficulty: 2 Medium
Topic: Overview of Financial Institutions Markets
Bloom's: Understand
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-08 Appreciate why financial institutions are regulated.
Accessibility: Keyboard Navigation

31) The most diversified type of depository institutions is

A) credit unions.
B) savings associations.
C) commercial banks.
D) finance companies.
E) mutual funds.

Answer: C
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-06 Know the services financial institutions perform.; 01-05 Distinguish
between the different types of financial institutions.
Accessibility: Keyboard Navigation

12
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

32) Insolvency risk at a financial intermediary (FI) is the risk

A) that promised cash flows from loans and securities held by FIs may not be paid in full.
B) incurred by an FI when the maturities of its assets and liabilities do not match.
C) that a sudden surge in liability withdrawals may require an FI to liquidate assets quickly at
fire sale prices.
D) incurred by an FI when its investments in technology do not result in cost savings or revenue
growth.
E) risk that an FI may not have enough capital to offset a sudden decline in the value of its assets.

Answer: E
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-07 Know the risks financial institutions face.
Accessibility: Keyboard Navigation

33) Depository institutions (DIs) play an important role in the transmission of monetary policy
from the Federal Reserve to the rest of the economy because
A) loans to corporations are part of the money supply.
B) bank and thrift loans are tightly regulated.
C) U.S. DIs compete with foreign financial institutions.
D) DI deposits are a major portion of the money supply.
E) thrifts provide a large amount of credit to finance residential real estate.

Answer: D
Difficulty: 3 Hard
Topic: Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

13
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

34) Liquidity risk at a financial intermediary (FI) is the risk

A) that promised cash flows from loans and securities held by FIs may not be paid in full.
B) incurred by an FI when the maturities of its assets and liabilities do not match.
C) that a sudden surge in liability withdrawals may require an FI to liquidate assets quickly at
fire sale prices.
D) incurred by an FI when its investments in technology do not result in cost savings or revenue
growth.
E) risk that an FI may not have enough capital to offset a sudden decline in the value of its assets.

Answer: C
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

35) Money markets trade securities that

I. mature in one year or less.

II. have little chance of loss of principal.
III. must be guaranteed by the federal government.

A) I only
B) II only
C) I and II only
D) I and III only
E) I, II, and III

Answer: C
Difficulty: 2 Medium
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

14
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

36) Which of the following are capital market instruments?

A) 10-year corporate bonds
B) 30-year mortgages
C) 20-year Treasury bonds
D) 15-year U.S. government agency bonds
E) All of these choices are correct

Answer: E
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

37) Commercial paper is

A) a time draft payable to a seller of goods, with payment guaranteed by a bank.
B) a loan to an individual or business to purchase a home, land, or other real property.
C) short-term funds transferred between financial institutions usually for no more than one day.
D) a marketable bank-issued time deposit that specifies the interest rate earned and a fixed
maturity date.
E) a short-term unsecured promissory note issued by a company to raise funds for a short time
period.

Answer: E
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

15
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

38) A negotiable CD is
A) a time draft payable to a seller of goods, with payment guaranteed by a bank.
B) a loan to an individual or business to purchase a home, land, or other real property.
C) a short-term fund transferred between financial institutions usually for no more than one day.
D) a marketable bank-issued time deposit that specifies the interest rate earned and a fixed
maturity date.
E) a short-term unsecured promissory note issued by a company to raise funds for a short time
period.

Answer: D
Difficulty: 1 Easy
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

39) Financial intermediaries' ability to reduce the average cost of collecting information because
of their efficient operations allows them to take advantage of
A) asset transformation.
B) economies of scale.
C) economies of scope.
D) transformational trading.
E) standardization.

Answer: B
Difficulty: 2 Medium
Topic: Overview of Financial Markets
Bloom's: Remember
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.
Accessibility: Keyboard Navigation

40) Discuss how secondary markets benefit issuers and investors.

Answer: The secondary markets provide liquidity to investors after their initial purchase of the
security. This liquidity encourages them to purchase the security at the initial offer. The current
market price also reflects current prospects for the firm and the competitiveness of the issue
relative to similar securities. Corporate treasurers follow their stocks' price closely because the
stock price reflects how well their firm and the market are performing. The current security price
also provides information about the cost of obtaining any additional funds.
Difficulty: 2 Medium
Topic: Overview of Financial Markets
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation
16
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

41) How can brokers and dealers make money? Which activity is riskier? Why?

Answer: An asset broker assists buyers and sellers of securities by providing a mechanism for
buyers or sellers to process their orders. If the broker simply assists one party in finding another
party, the broker charges a small fee called a commission. An asset dealer buys the security for
his or her own account at the bid price and then sells the security at a higher ask price. The dealer
profits by earning the bid-ask spread or the difference between the buy and sell price. The
dealer's function is riskier because the dealer must maintain an inventory of the asset and honor
quotes to buy and sell. If the security is risky, the value of the inventory can fluctuate with
market prices. The broker takes less risk because he or she does not own the security.
Difficulty: 3 Hard
Topic: Overview of Financial Markets
Bloom's: Understand; Evaluate
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.
Accessibility: Keyboard Navigation

42) What does an asset transformer do? Why is asset transformation a risky activity?

Answer: An asset transformer buys one security from a customer and makes or creates a
separate claim in order to raise funds. For example, a bank accepts deposits and uses them to
make loans. This is normally a risky activity because the asset acquired will be riskier than the
security (or deposit) used to raise funds because the intermediary hopes to profit on the spread
between the rate earned on the asset claim and the rate paid on the liability claim. In order for
this spread to be positive, generally speaking, the asset must be riskier than the liability.
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Understand; Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

17
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

43) How can using indirect finance rather than direct finance reduce agency costs associated with
monitoring funds demanders?

Answer: A large FI has a greater incentive to monitor the behavior of funds demanders in
indirect financing. The FI supposedly hires and trains experts who know how to collect
information about a funds demander and evaluate whether the funds demander is acting
appropriately. In direct finance, a funds demander sells claims to the public at large. In this case
there is little incentive for an individual claim holder to monitor and attempt to enforce good
behavior on the part of the funds user. The benefit of monitoring and enforcement is shared
among all claim holders, but the cost would be borne by the sole individual. This is termed the
"free-rider" problem. If there is improved monitoring of borrower behavior, the problem of
agency costs is likely to be reduced.
Difficulty: 3 Hard
Topic: Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-05 Distinguish between the different types of financial institutions.
Accessibility: Keyboard Navigation

44) What have been the major factors contributing to growth in the foreign financial markets?

Answer:
1. The amount of savings available for investment in foreign countries has increased.
2. International investors have looked to the United States for better investment opportunities.
3. The Internet has helped provide additional information on foreign markets and overseas
investment opportunities.
4. Specialized intermediaries such as country-specific mutual funds and ADRs have been
developed to facilitate overseas investments.
5. The euro has had a notable impact on the global financial system by being an important
currency for international transactions.
6. Deregulation of foreign markets has allowed many new investors to participate in international
investing.
Difficulty: 2 Medium
Topic: Globalization of Financial Markets and Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-09 Recognize that financial markets are becoming increasingly global.
Accessibility: Keyboard Navigation

18
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

45) You are a corporate treasurer seeking to raise funds for your firm. What are some advantages
of raising funds via a financial intermediary (FI) rather than by selling securities to the public?

Answer: Advantages include

 Speed: Funds can normally be raised more quickly through FIs.

 Registration process/cost: The registration process can be quite costly and time-
consuming in terms of workers' hours, audit fees, and fees to investment bankers.
Raising funds via a FI can be less expensive, particularly for smaller capital needs
or when funds are needed for only a short time period. (Maturities of 270 days or
less do not require registration, nor do private placements.)
 Nonstandard terms can be negotiated with FIs but are difficult to sell to the public.
For example, if a borrower can only begin paying interest after two years, he or
she would have a difficult time selling bonds to the public.
 There is a greater ability to renegotiate terms if necessary. Terms of public issue
generally cannot be changed outside of court.
 Less information is made public.
Difficulty: 3 Hard
Topic: Overview of Financial Markets; Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.; 01-06 Know the
services financial institutions perform.
Accessibility: Keyboard Navigation

19
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

46) How can a depository intermediary afford to purchase long-term risky direct claims from
funds demanders and finance these purchases with safe, liquid, short-term, low-denomination
deposits? What can go wrong in this process?

Answer: DIs can afford to do so because the rate they must pay to attract funds is lower than the
rate they can charge on their riskier assets. A lot can go wrong however.

 If the money lent is not repaid, the DI may not be able to repay its depositors on
demand (credit and liquidity risk). Diversification of the credit risk is a key way
DIs limit credit risk.
 The difference between the rate earned on assets and the rate paid on liabilities is
called the Net Interest Margin (NIM). The NIM can turn negative if interest rates
rise or if the rates on long-term securities fall below the interest rates risk on
short-term securities (after adjusting for risk).
 Because the assets and liabilities are different claims, it is possible for the value of
the assets to drop resulting in an insolvent institution (insolvency risk). Because
the assets are primarily financial, their value can be quite volatile. As a result, risk
management is crucial at today's financial institution.
 DIs attract many savers with a small amount of funds. DIs then invest the bulk of
these savings in investments that cannot be immediately liquidated. If the savers
lose confidence in the DI, they will seek to withdraw their money, which can
precipitate a liquidity crisis and cause insolvency.
Difficulty: 3 Hard
Topic: Overview of Financial Institutions
Bloom's: Understand; Create
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.
Accessibility: Keyboard Navigation

20
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

47) Discuss the benefits to funds suppliers of using a financial intermediary asset transformer in
place of directly purchasing claims such as stocks or bonds. What is the major disadvantage?

What is the downside of putting your money in an intermediary?

Answer: Potential benefits to funds suppliers (SSUs) are as follows:

 Professional risk managers to assess risk of borrowers' (DSUs) claim and help
decide the correct price to pay.
 Risk reduction via

 insurance.
 additional diversification.
 more frequent monitoring.
 additional cushion of FI equity.
 improved liquidity of SSU claim on FI.

 Denomination intermediation.
 Maturity intermediation.

 Forego potentially higher returns if you do not purchase the more risky direct
claims.
Difficulty: 2 Medium
Topic: Overview of Financial Markets; Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-01 Differentiate between primary and secondary markets.; 01-06 Know the
services financial institutions perform.
Accessibility: Keyboard Navigation

21
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

48) Discuss the major macro benefits of financial intermediaries. What role does the government
have in the credit allocation process?
Answer:
 Money supply transmission: Depository institutions affect the level of money
supply growth in the economy. The money supply is increased when the Fed
increases money available to banks, but the extent of money supply growth is
affected by banks' decisions to lend the increased supply of funds. If the banks do
not lend the increased money, the given increase in funds by the Fed will result in
only a small change in the total money supply in the economy.
 Credit Allocation: FIs price risk and allocate capital to users who they believe can
generate a high enough rate of return to compensate the lender for the risk the
lender bears in loaning the money. FIs also monitor the borrower's condition after
the loan is made. A well-functioning economy must have sound mechanisms for
allocating capital. In capitalist countries, FIs and markets allocate capital to its
highest valued uses, thereby maximizing economic growth. The role of
government is to ensure disclosure of risks and fair practices of all involved. In
communist and some socialist countries, governments allocate capital according
to a current political agenda and strong, lasting economic growth is rarely, if ever,
seen in these countries. As the text indicates, the government can also channel
credit to socially deserving areas such as housing, farms, and small business
development.
 Intergenerational wealth transfers and risk shifting: Pension funds and insurance
firms allow investors to transfer wealth through time, while avoiding taxation,
and/or allow investors the ability to choose which risks in their life they will bear
and which they will insure.
 Payment services: The ability to store and quickly move large sums of money (or
many small sums) at low cost with little risk encourages greater investment by
market participants and, thus, lowers the overall cost of funds in our economy.
Difficulty: 3 Hard
Topic: Overview of Financial Institutions; Globalization of Financial Markets and Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-07 Know the risks financial institutions face.; 01-09 Recognize that financial
markets are becoming increasingly global.; 01-08 Appreciate why financial institutions are
regulated.
Accessibility: Keyboard Navigation

22
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])

 lOMoARcPSD|27085979

49) What determines the price of financial instruments? Which are riskier, capital market
instruments or money market instruments? Why?

Answer: The price of any financial instrument is the present value of future cash flows
discounted at an appropriate rate. A small change in interest rates causes a large change in
present value of distant cash flows. Hence, the prices of long-term capital market instruments are
more sensitive to changes in interest rates than prices of short-term instruments. In addition,
distant cash flows for stocks are not known with certainty. Changing economic prospects can
cause very large changes in current stock values. Money market instruments have predictable
cash flows and mature in one year or less, so they are much less risky.
Difficulty: 2 Medium
Topic: Overview of Financial Institutions
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-06 Know the services financial institutions perform.; 01-05 Distinguish
between the different types of financial institutions.
Accessibility: Keyboard Navigation

50) Explain how the credit crunch originating in the mortgage markets hurt financial
intermediaries' attempts to use diversification and monitoring to limit the riskiness of their loans
and investments while offering more liquid claims to savers.

Answer: Financial intermediaries' (FIs) attempts to diversify away from specific risk failed
when large portions of the debt markets "seized up" and stopped functioning. At that point many
security prices declined all at once, regardless of historical correlations among security prices.
This is a failure of diversification to reduce risk. FIs exploit diversification principles and
economies of scale to allow the FI to invest large amounts of money. They also must closely
monitor the riskiness of their loans and securities, and many FIs are also regulated by the
government to ensure they manage the riskiness of their assets. Some would argue that FIs failed
to monitor the riskiness of many of their mortgage investments as well, leading to large numbers
of poor investments.
Difficulty: 3 Hard
Topic: Overview of Financial Markets
Bloom's: Understand
AACSB: Reflective Thinking
Learning Goal: 01-02 Differentiate between money and capital markets.; 01-08 Appreciate why
financial institutions are regulated.
Accessibility: Keyboard Navigation

23
Copyright ©2019 McGraw-Hill

Downloaded by technologys video ([email protected])