Deck 1: Why Are Financial Institutions Special

Question 1

As an asset transformer, the FI issues financial claims that are more attractive to household savers than the claims directly issued by corporations.

Answer 1

True

Question 2

Financial institutions act as intermediaries between suppliers and users of money.

Answer 2

True

Question 3

Secondary securities are securities that serve as collateral for primary securities.

Answer 3

False

Question 4

Currently (2015) J. P. Morgan Chase is the largest bank holding company in the world and operations in 60 countries.

Question 5

FIs are independent market entities that create financial assets whose value is the transformation of financial risk.

Question 6

Financial institutions are subject to economies of scale in the collection of information.

Question 7

As a delegated monitor, an FI's actions reduce agency costs.

Question 8

FIs typically provide secondary claims to household savers that have inferior liquidity than primary securities of corporations such as equity and bonds.

Question 9

Because bank loans have a shorter maturity than most debt contracts, FIs typically exercise less monitoring power and control over the borrower.

Question 10

If a household invests in corporate securities and does not supervise how the funds are invested or used by the corporation, the risk of not earning the desired return or not having the funds returned increase.

Question 11

If not done by FIs, the process of monitoring the actions of borrowers would reduce the attractiveness and increase the risk of investing in corporate debt and equity by individuals.

Question 12

The more costly it is to supervise the use of funds by a borrower, the less likely a saver will encounter agency costs.

Question 13

The risk that the sale price of an asset will be less than the purchase price of an asset is called liquidity risk.

Question 14

An FI is exposed to liquidity risk because the average maturity of assets and the average maturity of liabilities are often different on the FIs balance sheet.

Question 15

As of 2015, U.S. FIs held assets totaling over $29 trillion.

Question 16

Compared to households, FIs often have economies of scale when purchasing or selling securities issued by businesses and governments.

Question 17

The asset transformation function of an FI is to issue primary financial claims to corporations while purchasing secondary claims issued by households and other investors.

Question 18

Failure to monitor the actions of firms in a timely and complete fashion after purchasing securities in that firm exposes the investor to agency costs.

Question 19

When an FI functions as a broker, they are selling a financial asset that they have created and will continue to hold on their balance sheet.

Question 20

An FI acting as an agent in matching savers and borrowers of funds can attain economies of scale and provide this service more efficiently than either the saver or borrower could on their own.

Question 21

The qualified thrift lender test is used to determine whether an institution is classified as a Savings Institution (Thrift).

Question 22

Time intermediation involves the investment of small amounts by investors into mutual funds that invest in long-term securities such as stocks and bonds.

Question 23

Credit allocation regulations are typically designed to benefit customers as well as the financial institution that must implement the guidelines.

Question 24

The goal of credit allocation is the encouragement of FIs to diversity the composition of their assets.

Question 25

The liabilities of depository institutions are significant components of the money supply.

Question 26

The Federal Reserve mandates reserve requirements for depository institutions so that the DIs may provide payment services for the U.S. economy.

Question 27

By diversifying investments, an FI is able to more accurately predict the expected return on its asset portfolio.

Question 28

Regulation of FIs is an attempt to enhance the social welfare benefits and mitigate the social costs of providing FI services.

Question 29

The adverse effects on the economy that can occur because of major disturbances to the special functions or services provided by financial institutions are negative externalities.

Question 30

Commercial banks and finance companies have traditionally served the needs of the residential real estate market.

Question 31

Unfairly excluding some potential financial service consumers from the financial services marketplace is a reason why FIs must absorb net regulatory burden.

Question 32

Research shows that there is a significant reduction in risk achieved by investing in as few as 6 different securities.

Question 33

In an attempt to enhance the net social welfare benefits of the services provided by financial intermediaries, safety and soundness regulation requires a DI to hold a minimum level of cash reserves against deposits.

Question 34

The part of the money supply produced by depository institutions is referred to outside money because it is produced outside of the government.

Question 35

Because FIs remove imperfections between households and corporations, households tend to save more than they would if FIs did not exist.

Question 36

The ability of diversification to eliminate much of the risk from the asset side of the balance sheet of an FI is the result of choosing assets that are less than perfectly positively correlated.

Question 37

Depository institutions serve as the primary conduit through which monetary policy actions impact the economy.

Question 38

Because of changes in regulatory barriers, technology, and financial innovation, a single financial service firm may now be able to offer a full set of financial services.

Question 39

The ability of savers to transfer wealth between youth and old age and across generations is called maturity intermediation.

Question 40

The efficiency with which FIs provide payment services directly benefits the economy.

Question 41

As a result of adopting an enterprise risk management approach, an FI will invest heavily in advanced risk measurement and management systems and practices.

Question 42

Pension and mutual funds have a lower correlation between the maturities of their assets and liabilities than do commercial banks and thrifts.

Question 43

The passage of legislation to prevent discrimination in lending is an example of regulation to protect investors.

Question 44

The Internet has allowed individual investors to purchase securities while benefiting from decreased transactions costs.

Question 45

The standardization of many FI products is evidence of the inefficient institutionalization by financial markets and the mechanisms through which these products trade.

Question 46

Nondepository financial institutions are represented by all of the following EXCEPT

A) insurance companies.
B) mutual funds.
C) finance companies.
D) credit unions.
E) securities firms.

Question 47

Firms in industries that have low costs of entry tend to enjoy larger profits than firms in industries with high costs of entry.

Question 48

Economic collapse during the 1930s, the banking system in the U.S. performed directly or indirectly all financial services. Those functions included all of the following EXCEPT

A) commercial banking.
B) money market funds.
C) investment banking.
D) stock investing.
E) insurance services.

Question 49

Services provided by depository institutions have become relatively less significant as a portion of all services provided by FIs.

Question 50

Small investors in mutual funds are often able to realize larger returns than they would receive from bank deposits.

Question 51

Depository financial institutions include all of the following EXCEPT

A) commercial banks.
B) savings banks.
C) investment banks.
D) credit unions.
E) all of the options are depository institutions.

Question 52

One reason for the increasing proportion of total financial assets controlled by pension funds and investment companies is that these intermediaries exploit the comparative advantages of size and diversification.

Question 53

The purpose of guaranty funds in safety and soundness regulation is to protect claim-holders when an FI collapses or fails.

Question 54

The passage of legislation to ensure that FIs are meeting the needs of their local communities is an example of entry regulation.

Question 55

The concept of enterprise risk management encourages FIs to manage all of the risks to which they are exposed as a portfolio, rather than managing each risk individually.

Question 56

The proportion of financial assets controlled by depository institutions has been increasing in recent years.

Question 57

In recent years, the proportion of savings and demand deposits have decreased and the proportion of pension funds have increased in the financial assets held by U.S. households.

Question 58

Which of the following statements is FALSE?

A) A financial intermediary specializes in the production of information.
B) A financial intermediary reduces its risk exposure by pooling its assets.
C) A financial intermediary benefits society by providing a mechanism for payments.
D) A financial intermediary may act as a broker to bring together funds deficit and funds surplus units.
E) A financial intermediary acts as a lender of last resort.

Question 59

Savers increasingly favor investments that closely imitate diversified investments in the direct securities markets over the transformed financial claims offered by traditional FIs.

Question 60

In most countries, cash is required to be held in reserve against deposits.

Question 61

Advantages of depositing funds into a typical bank account instead of directly buying corporate securities include all of the following EXCEPT

A) monitoring done by the bank on your behalf.
B) increased liquidity if funds are needed quickly.
C) increased transactions costs.
D) less price risk when funds are needed.
E) better diversification of deposited funds.

Question 62

What distinguishes financial intermediaries from industrial firms?

A) FI balance sheets are almost totally comprised of financial assets while commercial firms hold substantial amounts of real assets.
B) Industrial firms are the customers of FIs, but FIs cannot be customers of industrial firms.
C) FIs deal exclusively in primary securities, but industrial firms specialize in secondary securities.
D) Industrial firms produce real goods or services while FIs only produce money.
E) Industrial firms are unregulated while FIs are heavily regulated.

Question 63

Which of the following is NOT a major function of financial intermediaries?

A) Brokerage services.
B) Asset transformation services.
C) Information production.
D) Management of the nation's money supply.
E) Administration of the payments mechanism.

Question 64

How have the innovations of global financial networks and computerized money and information transfer systems changed financial intermediation?

A) Financial intermediation has become riskier because it is more difficult to stay informed about worldwide events.
B) Financial intermediation has become more costly because it is necessary to invest in high cost technology.
C) Financial intermediation has been unaffected.
D) Financial intermediation has become more costly as global firms exploit economies of scale and scope.
E) Financial intermediation has become less risky as firms become adept at maintaining zero gap positions.

Question 65

Financial intermediaries are

A) funds surplus units, because they exist to make money.
B) funds deficit units, because they must pay heavy regulatory fees and taxes.
C) funds surplus units, because they hold large portfolios of financial securities.
D) funds deficit units, because they must comply with minimum capital requirements.
E) neither funds surplus nor deficit units.

Question 66

The reason FIs can offer highly liquid, low price-risk contracts to savers while investing in relatively illiquid and higher risk assets is

A) because diversification allows an FI to predict more accurately the expected returns on its asset portfolio.
B) significant amounts of portfolio risk are diversified away by investing in assets that have correlations between returns that are less than perfectly positive.
C) because individual savers cannot benefit from risk diversification.
D) because FIs have a cost advantage in monitoring their portfolios.
E) All of the options.

Question 67

Many households place funds with financial institutions because many FI accounts provide

A) lower denominations than other securities.
B) flexible maturities verses other interest-earning securities.
C) better liquidity than directly negotiated debt contracts.
D) less price risk if interest rates change.
E) All of the options.

Question 68

Traditionally, regulation of FIs in the U.S. has been

A) minimal, as evidenced by the recent financial crisis.
B) extensive, as a result of the importance of FI to the economy.
C) minimal, because the free market is allowed to allocate financial resources.
D) extensive, because banks have monopoly power.
E) no different from regulation of nonfinancial firms.

Question 69

The charter values of FIs will be higher if regulators

A) increase the cost of entry by requiring more capital.
B) restrict the number of activities permitted by FIs, thereby increasing potential profits.
C) restrict the number of FIs that can operate in a given market.
D) increase the cost of entry by requiring more capital and restrict the number of activities permitted by FIs, thereby increasing potential profits.
E) increase the cost of entry by requiring more capital and restrict the number of FIs that can operate in a given market.

Question 70

The asset transformation function of FIs typically involves

A) receipt of securities through electronic payments systems.
B) altering the liquidity and maturity features of funds sources used to finance the FI's asset portfolio.
C) granting loans to transform funds deficit units into funds surplus units.
D) investing short-term funds in off-balance sheet activities.
E) transferring of funds from one generation to another.

Question 71

Net regulatory burden for FIs is higher because regulators may require the FI to

A) hold more capital than what would be held without regulation.
B) produce less information than would be produced without regulation.
C) hold more debt than what would be held without regulation.
D) hold fewer reserves than they would without regulation.
E) All of the options.

Question 72

The federal government has traditionally extended safety nets to DIs consisting of

A) deposit insurance, discount window borrowing, and reserve requirements.
B) deposit insurance and discount window borrowing.
C) deposit insurance, unemployment insurance, and discount window borrowing.
D) deposit insurance, open market operations, and discount window borrowing.
E) deposit insurance protection.

Question 73

Why is the failure of a large bank more detrimental to the economy than the failure of a large steel manufacturer?

A) The bank failure usually leads to a government bailout.
B) There are fewer steel manufacturers than there are banks.
C) The large bank failure reduces credit availability throughout the economy.
D) Since the steel company's assets are tangible, they are more easily reallocated than the intangible bank assets.
E) Everyone needs money, but not everyone needs steel.

Question 74

In its role as a delegated monitor, an FI

A) keeps track of required interest and principal payments on loans it originates.
B) works with financially distressed borrowers in danger of defaulting on their loans.
C) holds portfolios of loans that they continue to service.
D) maintains contact with borrowers to ensure that loan proceeds are utilized for intended purposes.
E) All of the options.

Question 75

FIs perform their intermediary function in two ways

A) they specialize as brokers between savers and users.
B) they serve as asset transformers by purchasing primary securities and issuing secondary securities.
C) they serve as asset transformers by purchasing secondary securities and issuing primary securities.
D) they specialize as brokers between savers and users and they serve as asset transformers by purchasing primary securities and issuing secondary securities.
E) they specialize as brokers between savers and users and they serve as asset transformers by purchasing secondary securities and issuing primary securities.

Question 76

The origination of a home mortgage loan is considered to be a

A) primary transaction, because this is the FI's primary source of business.
B) secondary transaction, because mortgages are typically resold in the secondary market.
C) primary transaction, because the mortgage note is a newly created financial asset.
D) secondary transaction if the sale is for an existing home and a primary transaction if it is for a new home.
E) derivative transaction because the value of the mortgage note depends on the underlying value of the home.

Question 77

Depository institutions (DIs) play an important role in the transmission of monetary policy from the Federal Reserve to the rest of the economy primarily because

A) loans to corporations are part of the money supply.
B) bank loans are highly regulated.
C) savings institutions provide a large amount of credit to finance residential real estate.
D) DI deposits are a major portion of the money supply.
E) U.S. DIs compete with foreign financial institutions.

Question 78

Which function of an FI reduces transaction and information costs between a corporation and individual which may encourage a higher rate of savings?

A) Brokerage services.
B) Asset transformation services.
C) Information production services.
D) Money supply management.
E) Administration of the payments mechanism.

Question 79

Negative externalities exist in the depository sector when

A) the fear of DI insolvency leads to bank deposit runs.
B) lending activity is impaired or constrained.
C) there are delays in disbursements from insolvent DIs.
D) banks that are healthy suffer when another bank nears insolvency.
E) All of the options.

Question 80

Which of the following measures the difference between the private costs of regulations and the private benefits of those regulations for the producers of financial services?

A) Capital adequacy.
B) Agency costs.
C) Net regulatory burden.
D) Charter value.
E) Liquidity risk.