Q&A Hero

Q: A problem for equity contracts is a particular type of ________ called the ________ problem. A) adverse selection; principal-agent B) moral hazard; principal-agent C) adverse selection; free-rider D) moral hazard; free-rider

Q: Equity contracts A) are claims to a share in the profits and assets of a business. B) have the advantage over debt contracts of a lower costly state verification. C) are used much more frequently to raise capital than are debt contracts. D) are not subject to the moral hazard problem.

Q: How does collateral help to reduce the adverse selection problem in credit market?

Q: Tools to help solve the adverse selection problem in financial markets include all of the following EXCEPT A) diversification. B) government regulations to increase information. C) the use of financial intermediaries. D) the private production and sale of information.

Q: The concept of adverse selection helps to explain A. why collateral is not a common feature of many debt contracts. B. why large, well-established corporations find it so difficult to borrow funds in securities markets. C. why financial markets are among the most heavily regulated sectors of the economy. D. why stocks are the most important source of external financing for businesses.

Q: The problem of adverse selection helps to explain A. why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B. why collateral is an important feature of consumer, but not business, debt contracts. C. why direct finance is more important than indirect finance as a source of business finance. D. why lenders refuse loans to individuals with high net worth.

Q: Net worth can perform a similar role to A. diversification. B. collateral. C. intermediation. D. economies of scale.

Q: Because of the adverse selection problem A. good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks. B. lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town." C. lenders are reluctant to make loans that are not secured by collateral. D. lenders will write debt contracts that restrict certain activities of borrowers.

Q: That only large, well-established corporations have access to securities markets A. explains why indirect finance is such an important source of external funds for businesses. B. can be explained by the problem of moral hazard. C. can be explained by government regulations that prohibit small firms from acquiring funds in securities markets. D. explains why newer and smaller corporations rely so heavily on the new issues market for funds.

Q: External financing by ________ should be more important in developing countries than in industrialized countries because information about private firms is more difficult to collect in developing countries. A. financial intermediaries B. bonds C. stock D. direct lending

Q: As information technology improves, the lending role of financial institutions such as banks should A. increase somewhat. B. decrease. C. stay the same. D. increase significantly.

Q: The concept of adverse selection helps to explain all of the following EXCEPT A. why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets. B. why indirect finance is more important than direct finance as a source of business finance. C. why direct finance is more important than indirect finance as a source of business finance. D. why the financial system is so heavily regulated.

Q: Analysis of adverse selection indicates that financial intermediaries, especially banks A. have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance. B. despite their success in overcoming free-rider problems, nevertheless play a minor role in moving funds to corporations. C. provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds. D. must buy securities from corporations to diversify the risk that results from holding non-tradable loans.

Q: That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A. have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. B. are able to prevent potential competitors from free-riding off the information that they provide. C. have failed to solve adverse selection problems in this market because "lemons" continue to be traded. D. have solved the moral hazard problem by providing valuable information to their customers.

Q: A lesson of the Enron collapse is that government regulation A. always fails. B. can reduce but not eliminate asymmetric information. C. increases the problem of asymmetric information. D. should be reduced.

Q: Government regulations require publicly traded firms to provide information, reducing A. transactions costs. B. the need for diversification. C. the adverse selection problem. D. economies of scale.

Q: In the United States, the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A. Federal Communications Commission. B. Federal Trade Commission. C. Securities and Exchange Commission. D. Federal Reserve System.

Q: The free-rider problem occurs because A. people who pay for information use it freely. B. people who do not pay for information use it. C. information can never be sold at any price. D. it is never profitable to produce information.

Q: The ________ problem helps to explain why the private production and sale of information cannot eliminate ________. A. free-rider; adverse selection B. free-rider; moral hazard C. principal-agent; adverse selection D. principal-agent; moral hazard

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

Q: Because of the "lemons problem" the price a buyer of a used car pays is A. equal to the price of a lemon. B. less than the price of a lemon. C. equal to the price of a peach. D. between the price of a lemon and a peach.

Q: The "lemons problem" exists because of A. transactions costs. B. economies of scale. C. rational expectations. D. asymmetric information.

Q: The analysis of how asymmetric information problems affect economic behavior is called ________ theory. A. uneven B. parallel C. principal D. agency

Q: An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds. A. moral hazard B. adverse selection C. costly state verification D. agency

Q: The problem faced by the lender that the borrower may take on additional risk after receiving the loan is called A. adverse selection. B. moral hazard. C. transactions costs. D) diversification.

Q: If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of A. moral hazard. B. adverse selection. C. free-riding. D. costly state verification.

Q: The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A. noncollateralized risk B. free-riding C. asymmetric information D. costly state verification

Q: A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called A. moral hazard. B. asymmetric information. C. noncollateralized risk. D. adverse selection.

Q: How does a mutual fund lower transactions costs through economies of scale?

Q: Financial intermediaries' low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions. A. liquidity B. conduction C. transcendental D. equitable

Q: Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs. A. expertise B. diversification C. regulations D. equity

Q: Which of the following is NOT a benefit to an individual purchasing a mutual fund? A. reduced risk B. lower transactions costs C. free-riding D. diversification

Q: By bundling share purchases of many investors together mutual funds can take advantage of economies of scale and thereby lower A. adverse selection. B. moral hazard. C. transactions costs. D. diversification.

Q: The reduction in transactions costs per dollar of investment as the size of transactions increases is A. discounting. B. economies of scale. C. economies of trade. D. diversification.

Q: The current structure of financial markets can be best understood as the result of attempts by financial market participants to A. adapt to continually changing government regulations. B. deal with the great number of small firms in the United States. C. reduce transaction costs. D. cartelize the provision of financial services.

Q: Which of the following is NOT one of the eight basic puzzles about financial structure? A. Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. B. Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets. C. Collateral is a prevalent feature of debt contracts for both households and business. D. There is very little regulation of the financial system.

Q: Which of the following is NOT one of the eight basic puzzles about financial structure? A. Stocks are the most important source of finance for American businesses. B. Issuing marketable securities is not the primary way businesses finance their operations. C. Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets. D. Banks are the most important source of external funds to finance businesses.

Q: A clause in a mortgage loan contract requiring the borrower to purchase homeowner's insurance is an example of a A. proscriptive covenant. B. prescriptive covenant. C. restrictive covenant. D. constraint-imposed covenant.

Q: A ________ is a provision that restricts or specifies certain activities that a borrower can engage in. A. residual claimant B. risk hedge C. restrictive barrier D. restrictive covenant

Q: Commercial and farm mortgages, in which property is pledged as collateral, account for A. one-quarter of borrowing by nonfinancial businesses. B. one-half of borrowing by nonfinancial businesses. C. one-twentieth of borrowing by nonfinancial businesses. D. two-thirds of borrowing by nonfinancial businesses.

Q: If you default on your auto loan, your car will be repossessed because it has been pledged as ________ for the loan. A. interest B. collateral C. dividend D. commodity

Q: The predominant form of household debt is A. consumer installment debt. B. collateralized debt. C. unsecured debt. D. unrestricted debt.

Q: Credit card debt is A. secured debt. B. unsecured debt. C. restricted debt. D. unrestricted debt.

Q: Collateralized debt is also know as A. unsecured debt. B. secured debt. C. unrestricted debt. D. promissory debt.

Q: Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called A. collateral. B. points. C. interest. D. good faith money.

Q: One purpose of regulation of financial markets is to A. limit the profits of financial institutions. B. increase competition among financial institutions. C. promote the provision of information to shareholders, depositors and the public. D. guarantee that the maximum rates of interest are paid on deposits.

Q: Regulation of the financial system A. occurs only in the United States. B. protects the jobs of employees of financial institutions. C. protects the wealth of owners of financial institutions. D. ensures the stability of the financial system.

Q: Direct finance involves the sale to ________ of marketable securities such as stocks and bonds. A. households B. insurance companies C. pension funds D. financial intermediaries

Q: As a source of funds for nonfinancial businesses, stocks are relatively more important in A. the United States. B. Germany. C. Japan. D. Canada.

Q: Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds A. by issuing stock. B. by issuing bonds. C. from nonbank loans. D. from bank loans.

Q: With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A. Marketable securities account for a larger share of external business financing in the United States than in Germany and Japan. B. Since 1970, most of the newly issued corporate bonds and commercial paper have been sold directly to American households. C. Direct finance accounts for more than 50 percent of the external financing of American businesses. D. Smaller businesses almost always raise funds by issuing marketable securities.

Q: Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE? A. Issuing marketable securities is the primary way that they finance their activities. B. Bonds are the least important source of external funds to finance their activities. C. Stocks are a relatively unimportant source of finance for their activities. D. Selling bonds directly to the American household is a major source of funding for American businesses.

Q: Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE? A. Stocks are a far more important source of finance than are bonds. B. Stocks and bonds, combined, supply less than one-half of the external funds. C. Financial intermediaries are the least important source of external funds for businesses. D. Since 1970, more than half of the new issues of stock have been sold to American households.

Q: Of the four sources of external funding for nonfinancial businesses, the least often used in the U.S. is A. bank loans. B. nonbank loans. C. bonds. D. stock.

Q: Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately ________ of the total. A. 2% B. 11% C. 20% D. 40%

Q: Of the following sources of external finance for American nonfinancial businesses, the least important is A. loans from banks. B. stocks. C. bonds and commercial paper. D. loans from other financial intermediaries.

Q: Of the sources of external funds for nonfinancial businesses in the United States, corporate bonds and commercial paper account for approximately ________ of the total. A. 5% B. 10% C. 32% D. 50%

Q: Of the sources of external funds for nonfinancial businesses in the United States, loans from banks and other financial intermediaries account for approximately ________ of the total. A) 6% B) 40% C) 56% D) 60%

Q: American businesses get their external funds primarily from A. bank loans. B. bonds and commercial paper issues. C. stock issues. D. loans from nonbank financial intermediaries.

Q: You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn A. above average returns since you will share in the higher profits. B. above average returns since your stock price will definitely appreciate as higher profits are earned. C. below average returns since computer makers have low profit rates. D. a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.

Q: Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is A. clearly inconsistent with the efficient markets hypothesis. B. consistent with the efficient markets hypothesis if the earnings were not as high as anticipated. C. consistent with the efficient markets hypothesis if the earnings were not as low as anticipated. D. consistent with the efficient markets hypothesis if the favorable earnings were expected.

Q: Which of the following types of information most likely allows the exploitation of a profit opportunity? A. financial analysts' published recommendations B. technical analysis C. hot tips from a stockbroker D. insider information

Q: You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor A. may or may not be better than the other forecasts. Past performance is no guarantee of the future. B. will always be the best of the group. C. will definitely be worse in the future. What goes up must come down. D. will be worse in the near future, but improve over time.

Q: According to the efficient markets hypothesis, purchasing the reports of financial analysts A. is likely to increase one's returns by an average of 10%. B. is likely to increase one's returns by about 3 to 5%. C. is not likely to be an effective strategy for increasing financial returns. D. is likely to increase one's returns by an average of about 2 to 3%.

Q: The efficient markets hypothesis implies that future changes in exchange rates should for all practical purposes be A. unpredictable. B. set by each country. C. increasing. D. pegged to a standard such as the U.S. dollar or the Euro.

Q: When we describe stock prices as following a random walk, we mean that future changes in stock prices are A. unpredictable. B. increasing. C. decreasing. D. constant.

Q: If future changes in stock prices are unpredictable, then we say that the stock prices follow a A. random walk. B. straight and narrow path. C. meandering path. D. generalized walk.

Q: The elimination of unexploited profit opportunities requires that ________ market participants be well informed. A. all B. a few C. zero D. many

Q: Financial markets quickly eliminate unexploited profit opportunities through changes in A. dividend payments. B. tax laws. C. asset prices. D. monetary policy.

Q: The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient market A. it will tend to go unnoticed for some time. B. it will be quickly eliminated. C. financial analysts are your best source of this information. D. all profits will be eliminated through taxation.

Q: ________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity. A. Arbitrage B. Mediation C. Asset capitalization D. Market intercession

Q: Another way to state the efficient markets hypothesis is: in an efficient market A. unexploited profit opportunities will be quickly eliminated. B. unexploited profit opportunities will never exist. C. all prices can be accurately predicted. D. every financial market participant must be well informed about securities.

Q: If the optimal forecast of the return on a security exceeds the equilibrium return, then A. the market is inefficient. B. no unexploited profit opportunities exist. C. the market is in equilibrium. D. the market is myopic.

Q: According to the efficient markets hypothesis, the current price of a financial security A. is the discounted net present value of future interest payments. B. is determined by the lowest successful bidder. C. fully reflects all available relevant information. D. is a result of none of the above.

Q: The theory of rational expectations, when applied to financial markets, is known as A. monetarism. B. the efficient markets hypothesis. C. the theory of strict liability. D. the theory of impossibility.

Q: Suppose Barbara looks out in the morning and sees a clear sky so decides that a picnic for lunch is a good idea. Last night the weather forecast included a 100% chance of rain by midday but Barbara did not watch the local news program. Is Barbara's prediction of good weather at lunch time rational? Why or why not?

Q: According to rational expectations A. expectations of inflation are viewed as being an average of past inflation rates. B. expectations of inflation are viewed as being an average of expected future inflation rates. C. expectations formation indicates that changes in expectations occur slowly over time as past data change. D. expectations will not differ from optimal forecasts using all available information.

Q: If market participants notice that a variable behaves differently now than in the past, then, according to rational expectations theory, we can expect market participants to A. change the way they form expectations about future values of the variable. B. begin to make systematic mistakes. C. no longer pay close attention to movements in this variable. D. give up trying to forecast this variable.

Q: People have a strong incentive to form rational expectations because A. they are guaranteed of success in the stock market. B. it is costly not to do so. C. it is costly to do so. D. everyone wants to be rational.

Q: When using rational expectations, forecast errors will, on average, be ________ and ________ be predicted ahead of time. A. positive; can B. positive; cannot C. negative; can D. zero; cannot