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Chapter 2

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Money and Financial Systems (Econ 3020)

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Economics of Money, Banking, and Financial Markets, 11e (Mishkin) Chapter 2 An Overview of the Financial System

2 Function of Financial Markets

  1. Every financial market has the following characteristic. A) It determines the level of interest rates. B) It allows common stock to be traded. C) It allows loans to be made. D) It channels funds from lenders-savers to borrowers-spenders. Answer: D AACSB: Reflective Thinking

  2. Financial markets have the basic function of A) getting people with funds to lend together with people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) providing a risk-free repository of spending power. Answer: A AACSB: Reflective Thinking

  3. Financial markets improve economic welfare because A) they channel funds from investors to savers. B) they allow consumers to time their purchase better. C) they weed out inefficient firms. D) they eliminate the need for indirect finance. Answer: B AACSB: Reflective Thinking

  4. Well-functioning financial markets A) cause inflation. B) eliminate the need for indirect finance. C) cause financial crises. D) allow the economy to operate more efficiently. Answer: D AACSB: Reflective Thinking

  5. A breakdown of financial markets can result in A) financial stability. B) rapid economic growth. C) political instability. D) stable prices. Answer: C AACSB: Reflective Thinking

1

  1. The principal lender-savers are A) governments. B) businesses. C) households. D) foreigners. Answer: C AACSB: Application of Knowledge

  2. Which of the following can be described as direct finance? A) You take out a mortgage from your local bank. B) You borrow $2500 from a friend. C) You buy shares of common stock in the secondary market. D) You buy shares in a mutual fund. Answer: B AACSB: Analytical Thinking

  3. Assume that you borrow $2000 at 10% annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is A) $400. B) $201. C) $200. D) $199. Answer: B AACSB: Analytical Thinking

  4. You can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is A) 25%. B) 12%. C) 10%. D) 5%. Answer: D AACSB: Analytical Thinking

  5. Which of the following can be described as involving direct finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys a short-term corporate security in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets. Answer: A AACSB: Analytical Thinking

2

  1. With direct finance, funds are channeled through the financial market from the ________ directly to the ________. A) savers, spenders B) spenders, investors C) borrowers, savers D) investors, savers Answer: A AACSB: Reflective Thinking

  2. Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in the United States? Answer: With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in the U. AACSB: Reflective Thinking

2 Structure of Financial Markets

  1. Which of the following statements about the characteristics of debt and equity is FALSE? A) They can both be long-term financial instruments. B) They can both be short-term financial instruments. C) They both involve a claim on the issuer's income. D) They both enable a corporation to raise funds. Answer: B AACSB: Reflective Thinking

  2. Which of the following statements about the characteristics of debt and equities is TRUE? A) They can both be long-term financial instruments. B) Bond holders are residual claimants. C) The income from bonds is typically more variable than that from equities. D) Bonds pay dividends. Answer: A AACSB: Reflective Thinking

  3. Which of the following statements about financial markets and securities is TRUE? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is intermediate term if its maturity is ten years or longer. D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date. Answer: D AACSB: Reflective Thinking

4

  1. Which of the following is an example of an intermediate-term debt? A) a fifteen-year mortgage B) a sixty-month car loan C) a six-month loan from a finance company D) a thirty-year U. Treasury bond Answer: B AACSB: Analytical Thinking

  2. If the maturity of a debt instrument is less than one year, the debt is called A) short-term. B) intermediate-term. C) long-term. D) prima-term. Answer: A AACSB: Application of Knowledge

  3. Long-term debt has a maturity that is A) between one and ten years. B) less than a year. C) between five and ten years. D) ten years or longer. Answer: D AACSB: Application of Knowledge

  4. When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors. A) bonds B) bills C) notes D) stock Answer: D AACSB: Application of Knowledge

  5. Equity holders are a corporation's ________. That means the corporation must pay all of its debt holders before it pays its equity holders. A) debtors B) brokers C) residual claimants D) underwriters Answer: C AACSB: Reflective Thinking

5

  1. ________ work in the secondary markets matching buyers with sellers of securities. A) Dealers B) Underwriters C) Brokers D) Claimants Answer: C AACSB: Application of Knowledge

  2. A corporation acquires new funds only when its securities are sold in the A) primary market by an investment bank. B) primary market by a stock exchange broker. C) secondary market by a securities dealer. D) secondary market by a commercial bank. Answer: A AACSB: Reflective Thinking

  3. A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank. Answer: B AACSB: Reflective Thinking

  4. An important function of secondary markets is to A) make it easier to sell financial instruments to raise funds. B) raise funds for corporations through the sale of securities. C) make it easier for governments to raise taxes. D) create a market for newly constructed houses. Answer: A AACSB: Reflective Thinking

  5. Secondary markets make financial instruments more A) solid. B) vapid. C) liquid. D) risky. Answer: C AACSB: Reflective Thinking

  6. A liquid asset is A) an asset that can easily and quickly be sold to raise cash. B) a share of an ocean resort. C) difficult to resell. D) always sold in an over-the-counter market. Answer: A AACSB: Reflective Thinking

7

  1. The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market. A) more; primary B) more; secondary C) less; primary D) less; secondary Answer: A AACSB: Reflective Thinking

  2. When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called a(n) A) exchange. B) over-the-counter market. C) common market. D) barter market. Answer: A AACSB: Application of Knowledge

  3. In a(n) ________ market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices. A) exchange B) over-the-counter C) common D) barter Answer: B AACSB: Application of Knowledge

  4. Forty or so dealers establish a "market" in these securities by standing ready to buy and sell them. A) secondary stocks B) surplus stocks C) U. government bonds D) common stocks Answer: C AACSB: Application of Knowledge

8

  1. Describe the two methods of organizing a secondary market. Answer: A secondary market can be organized as an exchange where buyers and sellers meet in one central location to conduct trades. An example of an exchange is the New York Stock Exchange. A secondary market can also be organized as an over-the-counter market. In this type of market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices. An example of an over-the-counter market is the federal funds market. AACSB: Reflective Thinking

2 Financial Market Instruments

  1. Prices of money market instruments undergo the least price fluctuations because of A) the short terms to maturity for the securities. B) the heavy regulations in the industry. C) the price ceiling imposed by government regulators. D) the lack of competition in the market. Answer: A AACSB: Reflective Thinking

  2. U. Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower purchase price than the amount you receive at maturity. A) premium B) collateral C) default D) discount Answer: D AACSB: Analytical Thinking

  3. U. Treasury bills are considered the safest of all money market instruments because there is a low probability of A) defeat. B) default. C) desertion. D) demarcation. Answer: B AACSB: Analytical Thinking

  4. A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called A) commercial paper. B) a certificate of deposit. C) a municipal bond. D) federal funds. Answer: B AACSB: Analytical Thinking

10

  1. A short-term debt instrument issued by well-known corporations is called A) commercial paper. B) corporate bonds. C) municipal bonds. D) commercial mortgages. Answer: A AACSB: Analytical Thinking

  2. ________ are short-term loans in which Treasury bills serve as collateral. A) Repurchase agreements B) Negotiable certificates of deposit C) Federal funds D) U. government agency securities Answer: A AACSB: Analytical Thinking

  3. Collateral is ________ the lender receives if the borrower does not pay back the loan. A) a liability B) an asset C) a present D) an offering Answer: B AACSB: Analytical Thinking

  4. Federal funds are A) funds raised by the federal government in the bond market. B) loans made by the Federal Reserve System to banks. C) loans made by banks to the Federal Reserve System. D) loans made by banks to each other. Answer: D AACSB: Analytical Thinking

  5. An important source of short-term funds for commercial banks are ________ which can be resold on the secondary market. A) negotiable CDs B) commercial paper C) mortgage-backed securities D) municipal bonds Answer: A AACSB: Application of Knowledge

11

  1. Equity and debt instruments with maturities greater than one year are called ________ market instruments. A) capital B) money C) federal D) benchmark Answer: A AACSB: Application of Knowledge

  2. Which of the following is a long-term financial instrument? A) a negotiable certificate of deposit B) a repurchase agreement C) a U. Treasury bond D) a U. Treasury bill Answer: C AACSB: Analytical Thinking

  3. Which of the following instruments are traded in a capital market? A) U. Government agency securities B) negotiable bank CDs C) repurchase agreements D) U. Treasury bills Answer: A AACSB: Analytical Thinking

  4. Which of the following instruments are traded in a capital market? A) corporate bonds B) U. Treasury bills C) negotiable bank CDs D) repurchase agreements Answer: A AACSB: Analytical Thinking

  5. Which of the following are NOT traded in a capital market? A) U. government agency securities B) state and local government bonds C) repurchase agreements D) corporate bonds Answer: C AACSB: Analytical Thinking

13

  1. The most liquid securities traded in the capital market are A) corporate bonds. B) municipal bonds. C) U. Treasury bonds. D) mortgage-backed securities. Answer: C AACSB: Reflective Thinking

  2. Mortgage-backed securities are similar to ________ but the interest and principal payments are backed by the individual mortgages within the security. A) bonds B) stock C) repurchase agreements D) negotiable CDs Answer: A AACSB: Application of Knowledge

2 Internationalization of Financial Markets

  1. Equity of U. companies can be purchased by A) U. citizens only. B) foreign citizens only. C) U. citizens and foreign citizens. D) U. mutual funds only. Answer: C AACSB: Diverse and multicultural work environments

  2. One reason for the extraordinary growth of foreign financial markets is A) decreased trade. B) increases in the pool of savings in foreign countries. C) the recent introduction of the foreign bond. D) slower technological innovation in foreign markets. Answer: B AACSB: Diverse and multicultural work environments

  3. Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as A) foreign bonds. B) Eurobonds. C) equity bonds. D) country bonds. Answer: A AACSB: Application of Knowledge

14

2 Function of Financial Intermediaries: Indirect Finance

  1. The process of indirect finance using financial intermediaries is called A) direct lending. B) financial intermediation. C) resource allocation. D) financial liquidation. Answer: B AACSB: Reflective Thinking

  2. In the United States, loans from ________ are far ________ important for corporate finance than are securities markets. A) government agencies; more B) government agencies; less C) financial intermediaries; more D) financial intermediaries; less Answer: C AACSB: Reflective Thinking

  3. The time and money spent in carrying out financial transactions are called A) economies of scale. B) financial intermediation. C) liquidity services. D) transaction costs. Answer: D AACSB: Application of Knowledge

  4. Economies of scale enable financial institutions to A) reduce transactions costs. B) avoid the asymmetric information problem. C) avoid adverse selection problems. D) reduce moral hazard. Answer: A AACSB: Reflective Thinking

  5. An example of economies of scale in the provision of financial services is A) investing in a diversified collection of assets. B) providing depositors with a variety of savings certificates. C) hiring more support staff so that customers don't have to wait so long for assistance. D) spreading the cost of writing a standardized contract over many borrowers. Answer: D AACSB: Reflective Thinking

16

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

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

  3. The process of asset transformation refers to the conversion of A) safer assets into risky assets. B) safer assets into safer liabilities. C) risky assets into safer assets. D) risky assets into risky liabilities. Answer: C AACSB: Analytical Thinking

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

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

17

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

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

  3. Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services. A) adverse selection B) free-riding C) discounting D) moral hazard Answer: D AACSB: Ethical understanding and reasoning abilities

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

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

19

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

  2. Because there is an imbalance of information in a lending situation, we must deal with the problems of adverse selection and moral hazard. Define these terms and explain how financial intermediaries can reduce these problems. Answer: Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately. Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower. AACSB: Reflective Thinking

2 Types of Financial Intermediaries

  1. Financial institutions that accept deposits and make loans are called ________ institutions. A) investment B) contractual savings C) depository D) underwriting Answer: C AACSB: Application of Knowledge

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

  3. Which of the following is a depository institution? A) a life insurance company B) a credit union C) a pension fund D) a mutual fund Answer: B AACSB: Analytical Thinking

20

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Chapter 2

Course: Money and Financial Systems (Econ 3020)

8 Documents
Students shared 8 documents in this course

University: Millsaps College

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Economics of Money, Banking, and Financial Markets, 11e (Mishkin)
Chapter 2 An Overview of the Financial System
2.1 Function of Financial Markets
1) Every financial market has the following characteristic.
A) It determines the level of interest rates.
B) It allows common stock to be traded.
C) It allows loans to be made.
D) It channels funds from lenders-savers to borrowers-spenders.
Answer: D
AACSB: Reflective Thinking
2) Financial markets have the basic function of
A) getting people with funds to lend together with people who want to borrow funds.
B) assuring that the swings in the business cycle are less pronounced.
C) assuring that governments need never resort to printing money.
D) providing a risk-free repository of spending power.
Answer: A
AACSB: Reflective Thinking
3) Financial markets improve economic welfare because
A) they channel funds from investors to savers.
B) they allow consumers to time their purchase better.
C) they weed out inefficient firms.
D) they eliminate the need for indirect finance.
Answer: B
AACSB: Reflective Thinking
4) Well-functioning financial markets
A) cause inflation.
B) eliminate the need for indirect finance.
C) cause financial crises.
D) allow the economy to operate more efficiently.
Answer: D
AACSB: Reflective Thinking
5) A breakdown of financial markets can result in
A) financial stability.
B) rapid economic growth.
C) political instability.
D) stable prices.
Answer: C
AACSB: Reflective Thinking
1
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