Question 1

Why do higher interest rates increase adverse selection problems in the loan market?

Accepted Answer

A) Higher interest rates reduce the gains from economies of scale. 
B) As interest rates rise, the creditworthiness of the average loan applicant declines. 
C) Higher interest rates reduce information problems in the loan market. 
D) At higher interest rates fewer investment projects are profitable. 
A) Higher interest rates reduce the gains from economies of scale. 
B) As interest rates rise, the creditworthiness of the average loan applicant declines. 
C) Higher interest rates reduce information problems in the loan market. 
D) At higher interest rates fewer investment projects are profitable. B

Question 2

The assumption of asymmetric information means that

Accepted Answer

A) borrowers and lenders have the same information. 
B) borrowers and lenders have perfect information. 
C) borrowers know more than lenders. 
D) lenders know more than borrowers. 
A) borrowers and lenders have the same information. 
B) borrowers and lenders have perfect information. 
C) borrowers know more than lenders. 
D) lenders know more than borrowers. C

Question 3

Financial intermediaries reduce transactions costs by

Accepted Answer

A) charging fees to small savers. 
B) charging fees to small investors. 
C) taking advantage of economies of scale. 
D) avoiding risky investments. 
A) charging fees to small savers. 
B) charging fees to small investors. 
C) taking advantage of economies of scale. 
D) avoiding risky investments. C

Question 4

Venture capital firms attempt to overcome the principal-agent problem by

Accepted Answer

A) investing only in industries with high profit rates. 
B) charging high interest rates on loans. 
C) holding large equity stakes in the firms they invest in. 
D) avoiding investing in common stock. 
A) investing only in industries with high profit rates. 
B) charging high interest rates on loans. 
C) holding large equity stakes in the firms they invest in. 
D) avoiding investing in common stock.

Question 5

Which of the following is NOT true of moral hazard?

Accepted Answer

A) It would not exist in a world of perfect information. 
B) It arises because borrowers typically know more than lenders. 
C) It describes a lender's problem of distinguishing the good-risk applicants from the bad-risk applicants. 
D) It describes a lender's problem in verifying borrowers are using their funds as intended. 
A) It would not exist in a world of perfect information. 
B) It arises because borrowers typically know more than lenders. 
C) It describes a lender's problem of distinguishing the good-risk applicants from the bad-risk applicants. 
D) It describes a lender's problem in verifying borrowers are using their funds as intended.

Question 6

Recent research has shown that

Accepted Answer

A) countries with investor protection, such as the United States and the United Kingdom, have less well-developed financial markets. 
B) countries with strong investor protection, such as France and Spain, have comparatively well-developed financial markets. 
C) there is a strong relationship across countries between investor protection and the development of financial markets. 
D) there is no consistent relationship across countries between investor protection and the development of financial markets. 
A) countries with investor protection, such as the United States and the United Kingdom, have less well-developed financial markets. 
B) countries with strong investor protection, such as France and Spain, have comparatively well-developed financial markets. 
C) there is a strong relationship across countries between investor protection and the development of financial markets. 
D) there is no consistent relationship across countries between investor protection and the development of financial markets.

Question 7

Use the analysis presented in this chapter to provide a possible explanation for the large increase in issuances of bonds relative to issuances of stock by corporations during the 1980s.

Accepted Answer

The moral hazard problem is greater for

Question 8

Small savers face

Accepted Answer

A) high transactions costs in financial markets. 
B) low transactions costs in financial markets. 
C) high transactions costs in financial intermediaries. 
D) high information costs in financial intermediaries. 
A) high transactions costs in financial markets. 
B) low transactions costs in financial markets. 
C) high transactions costs in financial intermediaries. 
D) high information costs in financial intermediaries.

Question 9

Credit rationing refers to

Accepted Answer

A) the increase in the interest rate that occurs when the demand for credit increases. 
B) the increase in the interest rate that occurs when the supply of credit increases. 
C) the increase in the interest rate that occurs when the supply of credit decreases. 
D) a restriction in the availability of credit. 
A) the increase in the interest rate that occurs when the demand for credit increases. 
B) the increase in the interest rate that occurs when the supply of credit increases. 
C) the increase in the interest rate that occurs when the supply of credit decreases. 
D) a restriction in the availability of credit.

Question 10

The "lemons problem" exists in the market for goods because

Accepted Answer

A) sellers tend to try to take advantage of buyers. 
B) buyers tend to try to take advantage of sellers. 
C) differences in the quality of the goods being exchanged. 
D) of moral hazard. 
A) sellers tend to try to take advantage of buyers. 
B) buyers tend to try to take advantage of sellers. 
C) differences in the quality of the goods being exchanged. 
D) of moral hazard.

Question 11

Which of the following is an example of adverse selection?

Accepted Answer

A) A homeowner with a large fire insurance policy allows the wiring in her house to deteriorate. 
B) A woman with a large life insurance policy takes up sky diving. 
C) Your brother-in-law borrows $20,000 from you to open a pizza parlor, but spends it gambling at the racetrack instead. 
D) A man with a bad heart condition buys a large life insurance policy. 
A) A homeowner with a large fire insurance policy allows the wiring in her house to deteriorate. 
B) A woman with a large life insurance policy takes up sky diving. 
C) Your brother-in-law borrows $20,000 from you to open a pizza parlor, but spends it gambling at the racetrack instead. 
D) A man with a bad heart condition buys a large life insurance policy.

Question 12

The main reason why banks are the leading source of external finance for businesses is

Accepted Answer

A) the interest rates on bank loans are usually lower than interest rates on corporate bonds. 
B) banks have an information-cost advantage in reducing adverse selection problems. 
C) interest paid on bank loans is deductible against the corporate income tax, whereas interest paid on corporate bonds is not. 
D) government regulators encourage small businesses to obtain funding from banks. 
A) the interest rates on bank loans are usually lower than interest rates on corporate bonds. 
B) banks have an information-cost advantage in reducing adverse selection problems. 
C) interest paid on bank loans is deductible against the corporate income tax, whereas interest paid on corporate bonds is not. 
D) government regulators encourage small businesses to obtain funding from banks.

Question 13

A number of companies exist that specialize in "payday loans." Payday loans are small loans often for a few hundred dollars or less that are made to low-income borrowers. Often these borrowers have poor credit histories and few assets and would have difficulty in qualifying for loans from other sources. The interest rates on these loans are often very high and some commentators have suggested that ceilings should be enforced on these loans. If such interest rate ceilings were imposed, what would be the likely effect?

Accepted Answer

Given the severe adverse selection probl

Question 14

Which of the following is NOT true of restrictive covenants?

Accepted Answer

A) They sometimes require borrowers to maintain the value of collateral offered to the lender. 
B) They increase the marketability and liquidity of loans. 
C) They sometimes require a borrower to maintain a certain minimum level of net worth. 
D) They sometimes limit a borrower's risk taking. 
A) They sometimes require borrowers to maintain the value of collateral offered to the lender. 
B) They increase the marketability and liquidity of loans. 
C) They sometimes require a borrower to maintain a certain minimum level of net worth. 
D) They sometimes limit a borrower's risk taking.

Question 15

Which of the following is NOT true of debt deflation?

Accepted Answer

A) It can exacerbate adverse selection problems. 
B) It can exacerbate moral hazard problems 
C) It results in a decline in a firm's net worth. 
D) It results in a decline in the real value of a firm's outstanding debt. 
A) It can exacerbate adverse selection problems. 
B) It can exacerbate moral hazard problems 
C) It results in a decline in a firm's net worth. 
D) It results in a decline in the real value of a firm's outstanding debt.

Question 16

The best known example of debt deflation came during

Accepted Answer

A) the Great Depression. 
B) the 1970s. 
C) the 1980s. 
D) the 1990s. 
A) the Great Depression. 
B) the 1970s. 
C) the 1980s. 
D) the 1990s.

Question 17

A firm's agents are its

Accepted Answer

A) shareholders. 
B) management. 
C) marketing department. 
D) customers. 
A) shareholders. 
B) management. 
C) marketing department. 
D) customers.

Question 18

Which of the following is NOT an example of adverse selection?

Accepted Answer

A) A family with a home ten feet from a large river buys flood insurance. 
B) A company uses the proceeds of a new stock sale to build an unnecessarily luxurious new headquarters. 
C) A terminal cancer patient buys life insurance. 
D) A company in serious financial trouble offers to pay you 30% on a loan. 
A) A family with a home ten feet from a large river buys flood insurance. 
B) A company uses the proceeds of a new stock sale to build an unnecessarily luxurious new headquarters. 
C) A terminal cancer patient buys life insurance. 
D) A company in serious financial trouble offers to pay you 30% on a loan.

Question 19

Which economist is credited with having been the first to discuss the "lemons problem"?

Accepted Answer

A) George Akerlof 
B) Milton Friedman 
C) Robert Shiller 
D) James Tobin 
A) George Akerlof 
B) Milton Friedman 
C) Robert Shiller 
D) James Tobin

Question 20

Why is adverse selection more likely in financial markets when interest rates rise?

Accepted Answer

A) The remaining borrowers are more likely to be risky. 
B) Higher interest rates are likely to hurt the economy. 
C) If firms have to pay higher interest rates, they may choose to use the funds differently than they first intended. 
D) Banks eliminate risky borrowers by raising interest rates. 
A) The remaining borrowers are more likely to be risky. 
B) Higher interest rates are likely to hurt the economy. 
C) If firms have to pay higher interest rates, they may choose to use the funds differently than they first intended. 
D) Banks eliminate risky borrowers by raising interest rates.

Exam 11: Reducing Transactions Costs and Information Costs

Why do higher interest rates increase adverse selection problems in the loan market?

The assumption of asymmetric information means that

Financial intermediaries reduce transactions costs by

Venture capital firms attempt to overcome the principal-agent problem by

Which of the following is NOT true of moral hazard?

Recent research has shown that

Use the analysis presented in this chapter to provide a possible explanation for the large increase in issuances of bonds relative to issuances of stock by corporations during the 1980s.

Small savers face

Credit rationing refers to

The "lemons problem" exists in the market for goods because

Which of the following is an example of adverse selection?

The main reason why banks are the leading source of external finance for businesses is

Which of the following is NOT true of restrictive covenants?

Which of the following is NOT true of debt deflation?

The best known example of debt deflation came during

A firm's agents are its

Which of the following is NOT an example of adverse selection?

Which economist is credited with having been the first to discuss the "lemons problem"?

Why is adverse selection more likely in financial markets when interest rates rise?

Introducing Money and the Financial System

Money and the Payments System

Overview of the Financial System

Interest Rates and Rates of Return

The Theory of Portfolio Allocation

Determining Market Interest Rates

Risk Structure and Term Structure of Interest Rates

The Foreign-Exchange Market and Exchange Rates

Derivative Securities and Derivative Markets

Information and Financial Market Efficiency

What Financial Institutions Do

The Business of Banking

The Banking Industry

Banking Regulation: Crisis and Response

Banking in the International Economy

The Money Supply Process

Changes in the Monetary Base

Organization of Central Banks

Monetary Policy Tools

The Conduct of Monetary Policy

The International Financial System and Monetary Policy

The Demand for Money

Linking the Financial System and the Economy: the Is-Lm-Fe Model

Aggregate Demand and Aggregate Supply

Money and Output in the Short Run

Information Problems and Channels for Monetary Policy

Inflation: Causes and Consequences

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