Deck 11: The Nature of Financial Intermediation

Question 1

A perfect market would have all but which of the following characteristics?

A) Infinitely divisible securities
B) Asymmetric information
C) Buyers and sellers of financial instruments would know the true quality of what they are buying and selling.
D) Buyers and sellers could transact with each other without cost (no transactions costs).

Answer 1

B

Question 2

If financial markets were perfect, financial intermediaries would

A) be illegal.
B) handle roughly half of all finance.
C) be the conduit of all finance.
D) probably not exist.

Answer 2

D

Question 3

It is virtua+B78:F145lly impossible to save or lend nowadays without __________ being involved.

A) traded securities
B) financial intermediaries
C) direct finance
D) disintermediation

Answer 3

B

Question 4

Another term for "don't put all your eggs in one basket" is

A) moral hazard.
B) indirect finance.
C) asymmetric information.
D) portfolio diversification.

Question 5

Which of the following is not a characteristic of "perfect" markets?

A) Buyers and sellers can transact with each other directly if transaction costs are set at an appropriate level.
B) Securities are infinitely divisible.
C) Buyers and sellers know the true quality of what they are buying and selling.
D) All of the above are characteristics of perfect markets.

Question 6

Asymmetric information occurs when

A) buyers and sellers are not equally informed about the true quality of what they are buying and selling.
B) banks face an adverse selection problem with their borrowers.
C) borrowers covertly engage in activities that increase the probability of poor performance.
D) All of the above.

Question 7

In the context of portfolio diversification,

A) investors are compensated for diversifiable risk in the portfolio.
B) prudent investors should hold about three to five stocks in their portfolio.
C) a stock index mutual fund is a financial intermediary that offers small investors a way to participate in the performance of the stock market as a whole.
D) financial intermediaries make it more difficult to be diversified.

Question 8

A major reason for the existence of financial intermediaries is

A) transactions costs that would be incurred without their existence.
B) the fees charged by dealers and brokers in direct finance are so high.
C) the problem of symmetric information.
D) to assist borrowers in buying securities in financial markets.

Question 9

The problem of "asymmetric information" is that the

A) lender knows more than the borrower.
B) borrower knows more than the lender.
C) borrower and lender have different goals.
D) borrower and lender know the future much less than they do the present.

Question 10

If a banker lacks enough information to determine exactly which applicants for a loan are good risks and which are bad risks, then he faces a(n)__________ problem.

A) moral hazard
B) adverse selection
C) market failure
D) disintermediation

Question 11

"Information Problematic" borrowers are generally

A) municipal governments.
B) small businesses and individuals.
C) large businesses.
D) federal government.

Question 12

If the problem of asymmetric information is so serious that a lender chooses not to lend to any potential small business borrower, then the problem is

A) moral hazard.
B) adverse selection.
C) market failure.
D) disintermediation.

Question 13

Financial intermediaries are specialists in the production of

A) market failure.
B) information.
C) traded assets.
D) commercial paper.

Question 14

Adverse selection is a problem

A) unique to direct finance.
B) unique to indirect finance.
C) arising before a transaction is consummated.
D) arising after a transaction is consummated.

Question 15

Which of the following statements is not true?

A) Without financial intermediaries, small savers and small borrowers would often face expensive transaction costs.
B) Banks and other financial intermediaries reduce transaction costs.
C) The existence of financial intermediaries can be attributed to market imperfections.
D) Because of financial intermediaries, securities in financial markets are infinitely divisible.

Question 16

Moral hazard is a problem

A) peculiar to direct finance.
B) peculiar to mutual funds.
C) arising before a transaction is consummated.
D) arising after a transaction is consummated.

Question 17

In actual financial markets, securities are __________ divisible, which __________ a type of market imperfection.

A) perfectly, is
B) perfectly, is not
C) imperfectly, is
D) imperfectly, is not

Question 18

Lenders must be concerned that borrowers may do risky unauthorized things with the funds they are lent. This is the __________ problem.

A) moral hazard
B) nondivisibility
C) adverse selection
D) None of the above.

Question 19

Non-traded securities are part of

A) direct but not indirect finance.
B) indirect but not direct finance.
C) direct and indirect finance.
D) neither direct nor indirect finance.

Question 20

__________ make(s)it easy for small savers to diversify their portfolios.

A) Direct finance
B) Traded securities
C) Regulation Q
D) Financial intermediaries

Question 21

In the early 1980s, rising interest rates caused a tremendous __________ in the value of savings-and-loan __________.

A) inflow; liabilities
B) inflow; assets
C) outflow; liabilities
D) outflow; assets

Question 22

Economies of scale in information production are enjoyed by

A) small borrowers.
B) small lenders.
C) large borrowers.
D) large lenders.

Question 23

Which of the following statements is incorrect?

A) Regulation Q was eliminated as a result of DIDMCA and the Garn-St. Germain Act.
B) S&Ls in the early 1980s were primarily invested in deposits.
C) The rate spread between the average yield on assets and the average cost of funds for S&Ls in the early 1980s was negative.
D) In the early 1980s, the value of S&L assets fell below the value of S&L liabilities.

Question 24

Regulation Q was repealed in the __________ by the __________.

A) early 1970s; Garn-St. Germain Act
B) late 1970s; Depository Institutions Deregulation and Monetary Control Act
C) late 1980s; Reigle-Neil Act
D) early 1980s; Depository Institutions Deregulation and Monetary Control Act

Question 25

One type of financial intermediary now falling in relative importance is

A) money market mutual funds.
B) pension funds.
C) thrift institutions.
D) mutual funds.

Question 26

In the 1980s, banks responded to the loss of loans to the commercial paper market by increasing loans to all the following except

A) less creditworthy businesses.
B) commercial real estate loans.
C) loans to less-developed countries.
D) large corporations.

Question 27

Regulation Q put a ceiling on

A) bank loan rates.
B) loan rates at all depository institutions.
C) deposit rates.
D) the proportion of a savings-and-loan's assets made up of loans other than mortgages.

Question 28

Which of the following is not true with respect to money market mutual funds?

A) They allow small savers to pool their funds to buy a diversified portfolio of money market instruments.
B) They often include securities such as Treasury bills, Treasury bonds, commercial paper, and negotiable CDs.
C) They charge a small management fee.
D) Most funds offer limited withdrawal by check.

Question 29

Regulation Q was rendered ineffective by the invention of

A) negotiable CDs.
B) commercial paper.
C) 401(k) plans.
D) money market mutual funds.

Question 30

Repealing Regulation Q still left savings-and-loan associations with a problem: most of their __________ were still at __________ interest rates.

A) assets; low
B) assets; high
C) deposits; low
D) deposits; high

Question 31

After the repeal of Regulation Q, a problem for savings-and-loan associations (S&Ls)was that most of their assets were at __________ interest rates while their deposits were at __________ interest rates.

A) low; low
B) low; high
C) high; low
D) high; high

Question 32

In the 1960s, banks started issuing negotiable CDs in order to

A) offer higher interest rates than they were allowed to on deposits.
B) lower information costs.
C) appeal more to the small borrower.
D) lend in the direct finance market.

Question 33

"Institutionalization" refers to the fact that a(n)__________ percentage of funds in the United States are flowing __________ the financial markets through financial intermediaries

A) increasing; indirectly into
B) decreasing; indirectly into
C) increasing; indirectly out of
D) decreasing; directly out of

Question 34

"Information problematic" borrowers must usually go the __________ finance route and issue __________ securities.

A) direct; traded
B) direct; nontraded
C) indirect; traded
D) indirect; nontraded

Question 35

Most bank loans are __________ maturity by the bank because of the __________ in monitoring how the borrower maintains his obligations.

A) held to; ease
B) held to; difficulty
C) sold before; ease
D) sold before; difficulty

Question 36

One type of financial intermediary now rising in relative importance is

A) pension funds.
B) banks.
C) savings-and-loan associations (S&Ls).
D) life insurance companies.

Question 37

Which of the following are not thrift institutions?

A) Savings and loan associations (S&Ls)
B) Mutual savings banks
C) Money market mutual funds
D) Credit unions

Question 38

Nontraded securities are part of

A) direct, but not indirect finance.
B) indirect, but not direct finance.
C) direct and indirect finance.
D) neither direct nor indirect finance.

Question 39

As Regulation Q was repealed, most of the assets of savings-and-loans were in the form of

A) business loans.
B) consumer loans.
C) mortgages.
D) savings deposits.

Question 40

The increase in interest rates that shook depository institutions began in the

A) 1950s.
B) 1960s.
C) 1970s.
D) 1980s.

Question 41

Banks still have a strong comparative advantage in extending __________ to __________ businesses.

A) traded securities; small
B) non-traded loans; small
C) traded securities; large
D) non-traded loans; large

Question 42

In the 1980s, banks lost many of their __________ borrowers, because these borrowers were able to sell their commercial paper to __________.

A) small; savings-and-loan associations
B) small; money market mutual funds
C) large; savings-and-loan associations
D) large; money market mutual funds

Question 43

Which of the following statements is incorrect with respect to the 1980s?

A) Corporate financing migrated from the short-term bank loan market to the commercial paper market.
B) Money market funds could offer transactions services coupled with a diversified money market investment vehicle at very low costs because of advances in computer technology.
C) Specialized monitoring services of commercial banks became more important because of new asset valuation models.
D) Innovations in information technology made some small borrowers more "bankable."

Question 44

The advent of money market mutual funds is __________ the trend of "institutionalization," in which a __________ percentage of financial assets are directly owned by individuals.

A) part of; growing
B) part of; shrinking
C) not a part of; growing
D) not a part of; shrinking

Question 45

Pension plans, because of the __________-term nature of their liabilities, prefer to hold __________-term assets.

A) long; long
B) long; short
C) short; long
D) short; short

Question 46

In 1981, the combined net worth of the entire savings-and-loan industry in the United States was estimated by economists to be

A) $150 billion.
B) close to zero.
C) -$20 billion.
D) -$150 billion.

Question 47

In the 1980s, banks __________ the amount of highly speculative loans they were holding due to __________ deposit rates.

A) increased; rising
B) increased; falling
C) decreasing; rising
D) decreased; falling

Question 48

In a __________ plan, employees may choose __________.

A) defined benefit; the assets they invest in
B) defined benefit; the benefits received during retirement
C) defined contribution; the assets they invest in
D) defined contribution; the benefits received during retirement

Question 49

A rise in deposit rates, all else constant, __________ a bank's __________ risk.

A) lowers; credit
B) lowers; interest rate
C) raises; credit
D) raises; interest rate

Question 50

There is __________ "institutionalization" in U.S. financial markets, meaning a greater relative use of __________ finance.

A) increasing; indirect
B) increasing; direct
C) decreasing; indirect
D) decreasing; direct

Question 51

The Financial Services Modernization Act

A) effectively repealed the Glass-Steagall Act of 1933.
B) increased restrictions on cross-ownership of different types of financial institutions.
C) allowed mergers between commercial banks and investment banks, but not between commercial banks and insurance companies.
D) All of the above.

Question 52

In the early 1980s, many savings-and-loan associations pretended to be solvent by

A) valuing their assets on a historical cost basis.
B) underreporting the amount of their liabilities.
C) including the impact of high interest rates on the value of their assets.
D) counting "goodwill" as an asset.

Question 53

To avoid maturity mismatches, most financial intermediaries tend to

A) have assets whose maturities on average exceed the maturities of their liabilities.
B) have assets whose maturities on average are less than the maturities of their liabilities.
C) have assets whose maturities on average mirror the maturities of their liabilities.
D) hold primarily real assets.

Question 54

A wave of bank failures in the United States

A) occurred in the 1970s.
B) occurred from the early 1980s to the early 1990s.
C) occurred from late 1980s to the mid 1990s.
D) has been ongoing since the late 1980s.

Question 55

A bank that mismatches its asset and liability maturities is

A) trying to reduce credit risk.
B) willingly accepting greater credit risk.
C) essentially engaging in interest-rate speculation.
D) trying to protect itself against interest rate movements.

Question 56

If a bank has a lot of long-term loans, it will probably want to reduce interest rate risk by encouraging __________-term deposits, especially of interest rates are expected to __________ in the future.

A) long; rise
B) long; fall
C) short; rise
D) short; fall

Question 57

A drop in deposit rates, all else constant, __________ a bank's __________ risk.

A) lowers; credit
B) lowers; interest rate
C) raises; credit
D) raises; interest rate

Question 58

The general perception in the early 1980s was the S&Ls were not in serious trouble, partly because S&Ls were insured by the

A) Securities and Exchange Commission (SEC).
B) U.S. Treasury.
C) Federal Deposit Insurance Corporation.
D) Federal Savings and Loan Insurance Corporation (FSLI

Question 59

When a financial intermediary purchases a nontraded claim of either a business or an individual, its main concern is with

A) interest rate risk.
B) credit risk.
C) reinvestment rate risk.
D) None of the above.

Question 60

Pension fund growth has been spurred by the recent development of "defined __________ plans," such as the __________ plan.

A) benefit; 401(k)
B) benefit; Keogh
C) contribution; 401(k)
D) contribution; Keogh

Question 61

Consumer finance companies, because of the __________-term nature of their liabilities, prefer to hold __________-term assets.

A) long; long
B) long; short
C) short; long
D) short; short

Question 62

Life insurance companies, because of the __________-term nature of their liabilities, prefer to hold __________-term assets.

A) long; long
B) long; short
C) short; long
D) short; short