Deck 1: Why Are Financial Institutions Special

Question 1

The part of the money supply produced by the private banking system is called:

A)inside money.
B)outside money.
C)indirect money.
D)The private banking system does not produce part of the money supply.

Answer 1

A

Question 2

Which of the following statements is true?

A)In a world without financial intermediaries the level of fund flows between household savers and the corporate sector is likely to be as high as it is with financial intermediaries.
B)In a world without financial intermediaries funds would directly flow from surplus units to deficit units.
C)In a world without financial intermediaries lenders (household) would need to monitor the actions of the firms to which they have lent their funds.
D)In a world without financial intermediaries funds would directly flow from surplus units to deficit units and lenders (household) would need to monitor the actions of the firms to which they have lent their funds.

Answer 2

D

Question 3

The following are protective mechanisms that have been developed by regulators to promote the safety and soundness of the banking system except:

A)encouraging banks to rely more on deposits rather than debt or capital as a cushion against failure.
B)encouraging banks to limit lending to a single customer to no more than 10 per cent of capital.
C)the provision of deposit insurance.
D)the periodic monitoring of banks.

Answer 3

A

Question 4

Which of the following is an adequate definition of an asset transformer?

A)A corporation that issues financial claims that are more attractive to household savers than the claims issued by other corporations.
B)An FI that issues financial claims that are more attractive to household savers than the claims issued by other FIs.
C)A corporation that issues financial claims that are more attractive to household savers than the claims directly issued by FIs.
D)An FI that issues financial claims that are more attractive to household savers than the claims directly issued by corporations.

Question 5

In the traditional 'originate-to-hold' banking model, where a DI takes short-term deposits and uses them to make loans, the bank usually holds these loans until maturity.This exposes the bank to increased:

A)operating costs.
B)interest rate and liquidity risk.
C)increased monitoring costs
D)All of the listed options are correct.

Question 6

A loan covenant is:

A)a legal clause in a borrowing contract that requires the lender to avoid certain actions.
B)a legal clause in a borrowing contract that requires the lender to take certain actions.
C)a legal clause in a borrowing contract that requires the borrower to take certain actions.
D)a legal clause in a borrowing contract that requires the borrower to either take certain actions or avoid certain actions.

Question 7

Which of the following statements is true?

A)Agency costs arise whenever economic agents enter into a contract in a world of incomplete information.
B)Monitoring costs are part of overall agency costs.
C)The more difficult and costly it is to collect information, the more likely it is that contracts will be broken.
D)Agency costs arise whenever economic agents enter into a contract in a world of incomplete information, monitoring costs are part of overall agency costs and the more difficult and costly it is to collect information, the more likely it is that contracts will be broken.

Question 8

Economies of scale is the concept that:

A)a cost reduction in trading and other transaction services results from increased efficiency when FIs perform these services.
B)a profitability increase in trading and other transaction services results from increased efficiency when FIs perform these services.
C)a cost reduction in trading and other transaction services results from stable efficiency when FIs perform these services.
D)None of the listed options are correct.

Question 9

The ability of an economic agent to reduce risk by holding a number of securities in a portfolio is called:

A)asset management.
B)efficiency.
C)arbitrage.
D)diversification.

Question 10

When a DI makes a shift from an 'originate-to-hold' banking model to an 'originate-to-distribute' banking model, the change is likely to result in:

A)increased operating costs.
B)increased interest rate and liquidity risk.
C)decreased monitoring costs.
D)decreased fee income.

Question 11

Price risk refers to:

A)the risk that the sale price of an asset will be lower than the purchase price of that asset.
B)the risk that the purchase price of an asset will be lower than the sale price of that asset.
C)the risk that the sale price of an asset will be higher than the purchase price of that asset.
D)None of the listed options are correct.

Question 12

Which of the following statements is true?

A)Primary securities are securities issued by corporations and backed by the real assets of those corporations.
B)Secondary securities are securities issued by corporations and backed by the real assets of those corporations.
C)Dominant securities are securities issued by corporations and backed by the real assets of those corporations.
D)Preliminary securities are securities issued by corporations and backed by the real assets of those corporations.

Question 13

Net regulatory burden is defined as the difference between the:

A)private costs of regulations and the private benefits for the producers of financial services.
B)public costs of regulations and the public benefits for the producers of financial services.
C)private costs of regulations and the public benefits for the producers of financial services.
D)public costs of regulations and the private benefits for the producers of financial services.

Question 14

Which of the following is an adequate definition of a delegated monitor?

A)An economic agent appointed to act on behalf of large groups of agents in collecting information and/or investing funds.
B)An economic agent appointed to act on behalf of large groups of principals in collecting information and/or investing funds.
C)An economic agent appointed to act on behalf of smaller agents in collecting information and/or investing funds.
D)An economic agent appointed to act on behalf of smaller principals in collecting information and/or investing funds.

Question 15

Which of the following are reasons for the specialness of financial intermediaries?

A)Higher average information costs.
B)Lower price risk and superior liquidity attributes for financial claims to household savers.
C)Higher average transaction costs.
D)All of the listed options are correct.

Question 16

An action by an economic agent that imposes costs on other economic agents is referred to as:

A)negative endogenous reaction.
B)positive endogenous reaction.
C)positive externality.
D)negative externality.

Question 17

Which of the following statements is true?

A)Household savers are likely to be attracted to direct investments in corporate securities because of lower monitoring costs compared to using financial intermediaries.
B)Household savers are likely to be attracted to direct investments in corporate securities because of lower liquidity costs compared to using financial intermediaries.
C)Household savers are likely to be attracted to direct investments in corporate securities because of lower price risk compared to using financial intermediaries.
D)None of the listed options are correct.

Question 18

FIs perform their intermediary function in two ways:

A)They specialise 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 specialise as brokers between savers and users and they serve as asset transformers by purchasing primary securities and issuing secondary securities.

Question 19

Secondary securities are securities issued by FIs and backed by:

A)the real assets of the FI.
B)primary securities.
C)guarantees.
D)any type of collateral.

Question 20

The part of the money supply directly produced by the government or central bank is called:

A)inside money.
B)outside money.
C)direct money.
D)indirect money.

Question 21

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

A)Brokerage services.
B)Asset transformation services.
C)Information production services.
D)Money supply management.

Question 22

The following are protective mechanisms that have been developed by regulators to promote the safety and soundness of the banking system except:

A)encouraging banks to rely more on deposits rather than debt or capital as a cushion against failure.
B)encouraging banks to limit lending to a single customer to no more than 10 per cent of capital.
C)the provision of deposit insurance.
D)the periodic monitoring of banks.

Question 23

Why do households prefer to use FIs as intermediaries to invest their surplus funds?

A)Transaction costs are low to the household since FIs are more efficient in monitoring and gathering investment information.
B)To receive the benefits of diversification that households may not be able to achieve on their own.
C)The FI can benefit from combining funds and negotiating lower asset prices and transaction costs.
D)All of the listed options are correct.

Question 24

Which of the following statements is false?

A)A financial intermediary specialises 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 acts as a lender of last resort.

Question 25

Which of the following statements is true?

A)Secondary claims often have inferior liquidity attributes compared to primary securities.
B)Secondary claims often have superior liquidity attributes compared to primary securities.
C)Secondary claims and primary claims often have the same liquidity attributes.
D)There is no general relationship between the liquidity attributes of primary and secondary claims.

Question 26

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.

Question 27

Which of the following is an adequate definition of broad money?

A)Currency plus bank current deposits of the private non-bank sector.
B)'M1' plus borrowings from the private sector by non-bank financial institutions less the latter's holdings of currency ad bank deposits.
C)'M3' plus borrowings from the private sector by non-bank financial institutions.
D)None of the listed options are correct.

Question 28

Which of the following statements is true?

A)The RBA controls outside money, while inside money is determined by the private banking system.
B)The RBA controls inside money, while outside money is determined by the private banking system.
C)The RBA controls both inside and outside money.
D)The private banking system controls both inside and outside money.

Question 29

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)All of the listed options are correct.

Question 30

Which of the following statements is true?

A)FI losses are borne by equity holders last; hence they are junior claimants to an FI's assets.
B)FI losses are borne by equity holders last; hence they are senior claimants to an FI's assets.
C)FI losses are borne by equity holders first; hence they are junior claimants to an FI's assets.
D)FI losses are borne by equity holders first; hence they are senior claimants to an FI's assets.

Question 31

What does APCA and APRA stand for?

A)Australian Payments Clearing Association; Australian Prudential Regulatory Association.
B)Australian Payments and Cheques Association; Australian Payments and Regulatory Authority.
C)Australian Payments Cheques Association; Australian Prudential Regulatory Association.
D)Australian Payments Clearing Association; Australian Prudential Regulatory Authority.

Question 32

Which of the following statements is true?

A)Bank loans that represent more than 5 per cent of a banking group's capital must be reported quarterly to APRA.
B)Bank loans that represent more than 10 per cent of a banking group's capital must be reported quarterly to APRA.
C)Bank loans that represent more than 5 per cent of a banking group's liabilities must be reported quarterly to APRA.
D)Bank loans that represent more than 10 per cent of a banking group's liabilities must be reported quarterly to APRA.

Question 33

Safety and soundness regulations include all of the following layers of protection except:

A)the provision of guaranty funds.
B)requirements encouraging diversification of assets.
C)the creation of money for those FIs in financial trouble.
D)requiring minimum levels of capital.

Question 34

Which of the following are areas of institution-specific specialness?

A)money supply transmission
B)payment services
C)intergenerational transfers
D)All of the listed options are correct.

Question 35

Which of the following statements is true?

A)Bank failures may destroy household savings and restrict a firm's access to credit.
B)Bank failures may create doubts in savers' minds regarding the stability and solvency of financial intermediaries in general.
C)Bank failures may threaten the stability of the financial system.
D)All of the listed options are correct.

Question 36

Which of the following statements is true in the context of diversification?

A)As long as the return on different investments is not perfectly positively correlated, financial intermediaries can diversify away significant amounts of portfolio risk.
B)As long as the return on different investments is not perfectly negatively correlated, financial intermediaries can diversify away significant amounts of portfolio risk.
C)As long as the return on different investments is perfectly positively correlated, financial intermediaries can diversify away significant amounts of portfolio risk.
D)None of the listed options are correct.

Question 37

Which of the following statements is true?

A)Loan contracts are bank debt contracts that generally have longer term to maturity than bond contracts.
B)The longer term nature of loans allows the financial intermediary to exercise more monitoring power and control over the borrower.
C)When bank loan contracts are sufficiently long term, the banker almost becomes like an insider to the firm.
D)None of the listed options are correct.

Question 38

Which of the following are types of regulation that seek to enhance the net social welfare benefits of financial intermediaries' services?

A)exit regulation
B)issuer protection regulation
C)credit allocation regulation
D)All of the listed options are correct.

Question 39

Which of the following statements is true?

A)The more diversified a financial intermediary, the higher the probability that it will default on its obligations and the more risky and illiquid the claims.
B)The less diversified a financial intermediary, the higher the probability that it will default on its obligations and the more risky and illiquid the claims.
C)The more diversified a financial intermediary, the lower the probability that it will default on its obligations and the more risky but also the more liquid the claims.
D)The more diversified a financial intermediary, the higher the probability that it will default on its obligations and the more risky but also the more liquid the claims.

Question 40

Which of the following statements is true?

A)The lower the net regulatory burden on FIs, the more inefficiently they produce any given set of financial services from a private (FI) owner's perspective.
B)The higher the net regulatory burden on FIs, the more inefficiently they produce any given set of financial services from a private (FI) owner's perspective.
C)The higher the net regulatory burden on FIs, the less inefficiently they produce any given set of financial services from a private (FI) owner's perspective.
D)None of the listed options are correct.

Question 41

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.

Question 42

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.

Question 43

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)All of the listed options are correct.

Question 44

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.

Question 45

Due to the costs of monitoring, liquidity and price risk savers often prefer to hold the financial claims issued by FIs rather than those issued by corporations.

Question 46

In the principal-agent relationship between savers and a borrowing firm the savers are the agents and the borrowing firm is the principal.

Question 47

Which of the following refers to the possibility that a firm's owners or managers will take actions contrary to the promises contained in the covenants of the securities the firm issues to raise funds?

A)Liquidity risk.
B)Price risk.
C)Credit risk.
D)Agency costs.

Question 48

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)All of the listed options are correct.

Question 49

Which of the following refers to the term 'maturity intermediation'?

A)Creation of a secondary market mature enough to withstand volatility.
B)Overcoming constraints to buying assets imposed by large minimum denomination size.
C)Mismatching the maturities of assets and liabilities.
D)Reducing information costs or imperfections between households and corporations.

Question 50

In most countries regulators require financial intermediaries to hold a minimum level of cash reserves against their deposits.There is no such regulation in Australia.

Question 51

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

Question 52

By acting as a delegated monitor, financial intermediaries reduce the degree of information imperfection and asymmetry between the ultimate suppliers and users of funds.

Question 53

Agency costs are costs relating to the risk that the owners and managers of firms that receive savers' funds will take action with those funds contrary to the best interests of the saver.

Question 54

Depository institutions (DIs) play an important role in the transmission of monetary policy from the central bank (Reserve Bank of Australia) 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)depository institutions provide a large amount of credit to finance residential real estate.
D)DI deposits are a major portion of the money supply.

Question 55

An example of negative externality is the costs faced by small businesses in a one-bank town if the local bank fails.

Question 56

FIs play a significant role in the transmission of monetary policy.

Question 57

FIs are better able to manage the risk of mismatching maturities of assets and liabilities than household savers.

Question 58

Which of the following statements is true regarding the percentage share of assets of financial institutions in Australia as of end June 2005?

A)The largest percentage of assets is held by money market corporations.
B)The largest percentage of assets is held by credit unions.
C)The largest percentage of assets is held by permanent building societies.
D)The largest percentage of assets is held by banks.

Question 59

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)All of the given answers.

Question 60

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

Question 61

Because the average maturity of assets and the average maturity of liabilities are often different on an FI's balance sheet, the FI is exposed to liquidity risk.

Question 62

Why are financial institutions special? Give three concrete examples.

Question 63

What are the entry costs for the financial intermediation sector in Australia? Would you consider entry to be easy or difficult? Explain.

Question 64

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

Question 65

Explain the causes of the global financial crisis (GFC) and outline how and why the Australian government implemented the Financial Claims Scheme.

Question 66

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.