Question 1

Because information is scarce,

Accepted Answer

A)  equity contracts are used much more frequently to raise capital than are debt contracts. 
B)  monitoring managers gives rise to costly state verification. 
C)  government regulations, such as standard accounting principles, can help reduce moral hazard. 
D)  all of the above are true. 
E)  only B and C of the above are true.

Question 2

Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called

Accepted Answer

A)  points. 
B)  interest. 
C)  collateral. 
D)  good faith money.

Question 3

The concept of adverse selection helps explain why collateral is an important feature of many debt contracts.

Accepted Answer

A) True 
 B)False

Question 4

What is the principal-agent problem?

Accepted Answer

The answer of What is the principal-agent problem?...

Question 5

The conflict of interest in credit-rating agencies arises because ________ pay to have securities rated and,as a result,the agencies' ratings may be biased ________.

Accepted Answer

A)  security issuers; downward 
B)  security issuers; upward 
C)  investors; downward 
D)  regulators; upward

Question 6

Bad firms

Accepted Answer

A)  do not have an incentive to make themselves look good. 
B)  will slant the information they are required to transmit to the public. 
C)  both A and B of the above. 
D)  neither A nor B of the above.

Question 7

What is the free-rider problem? Describe some situations that this problem creates.

Accepted Answer

The answer of What is the free-rider problem? Describe some...

Question 8

A debt contract that specifies that the company can only use the funds to finance certain activities

Accepted Answer

A)  is a private loan. 
B)  contains a restrictive covenant. 
C)  increases the problem of adverse selection. 
D)  all of the above. 
E)  only A and B of the above.

Question 9

The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can

Accepted Answer

A)  charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. 
B)  charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. 
C)  provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. 
D)  pressure its clients into paying high fees for both auditing and consulting services.

Question 10

During the 2007-2009 financial crisis,housing prices began to fall and subprime mortgages began to default.Which of the following statements is true about the rating of subprime mortgage products?

Accepted Answer

A)  The rating agencies were way ahead of the market, giving many of the subprime products junk ratings from the start. 
B)  Rating agencies were not involved. Subprime mortgages could not be structured, by law. 
C)  Many AAA-rated subprime products had to be downgraded over and over again until they reached junk status. 
D)  None of the above are true.

Question 11

Auditors attempt to reduce information asymmetry between a firm's managers and its

Accepted Answer

A)  customers. 
B)  owners. 
C)  employees. 
D)  competitors.

Question 12

Which of the following provisions of legislation to deal with conflicts of interest does not increase the flow of information in financial markets?

Accepted Answer

A)  Requiring a firm's chief officers to certify its financial statements and other disclosures 
B)  Requiring investment banks to make their analysts' recommendations public 
C)  Requiring disclosure of off-balance-sheet transactions 
D)  Increasing resources available to the Securities and Exchange Commission to supervise financial markets

Question 13

The ________ problem occurs when people who do not pay for information take advantage of the information that other people have paid for.

Accepted Answer

A)  free-rider 
B)  moral hazard 
C)  adverse selection 
D)  lemons

Question 14

One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the

Accepted Answer

A)  venture capital firm. 
B)  money market mutual fund. 
C)  pawn broker. 
D)  savings and loan association.

Question 15

The concept of adverse selection helps to explain

Accepted Answer

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)  all of the above.

Question 16

A conflict of interest occurs when

Accepted Answer

A)  a financial firm sells a service to its customers for a price that exceeds the cost of producing the service. 
B)  lenders prefer higher interest rates and borrowers prefer lower interest rates. 
C)  riskier borrowers are the ones who are more likely to apply for loans. 
D)  people expected to provide reliable information to the public have incentives not to do so.

Question 17

Which of the following is not one of the eight basic facts about financial structure?

Accepted Answer

A)  The financial system is among the most heavily regulated sectors of the economy. 
B)  Issuing marketable securities is 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)  Financial intermediaries is the most important source of external funds to finance businesses.

Question 18

Investment banks are guilty of conflict of interest when they

Accepted Answer

A)  pressure their analysts to produce research favorable to their client firms. 
B)  permit executives of client firms to alter analysts' research on their firms. 
C)  prohibit analysts from making negative or controversial comments about client firms. 
D)  all of the above.

Question 19

A financial institution can achieve cost savings by engaging in multiple activities.These are called economies of

Accepted Answer

A)  scope. 
B)  scale. 
C)  complexity. 
D)  information.

Question 20

Of the following sources of external finance for American nonfinancial businesses,the least important is

Accepted Answer

A)  loans from banks. 
B)  stocks. 
C)  bonds and commercial paper. 
D)  nonbank loans.

Exam 7: Why Do Financial Institutions Exist?