Chapter 11

The Nature of Financial Intermediation

D1Interpretive
1. It is virtually impossible to save or lend nowadays without __________________ being involved. A) traded securities B) financial intermediaries C) direct finance D) disintermediation Answer B

D2Interpretive
!. If financial mar"ets 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 e$ist. Answer D

D2Interpretive
%. &hich of the following is not a characteristic of 'perfect( mar"ets) A) Buyers and sellers can transact with each other directly if transaction costs are set at an appropriate level. B) *ecurities are infinitely divisible. C) Buyers and sellers "now the true +uality of what they are buying and selling. D) All of the above are characteristics of perfect mar"ets. Answer A

D2Interpretive
,. In actual financial mar"ets# securities are __________________ divisible# which __________________ a type of mar"et imperfection. A) perfectly# is B) perfectly# is not C) imperfectly# is D) imperfectly# is not Answer C

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D2Interpretive
1. &hich of the following statements is not true) A) &ithout financial intermediaries# small savers and small borrowers would often face e$pensive transaction costs. B) Ban"s and other financial intermediaries reduce transaction costs. C) 2he e$istence of financial intermediaries can be attributed to mar"et imperfections. D) Because of financial intermediaries# securities in financial mar"ets are infinitely divisible. Answer D

D1Factual
3. Another term for 'don4t put all your eggs in one bas"et( is A) moral ha5ard. B) indirect finance. C) asymmetric information. D) portfolio diversification. Answer D

D2Interpretive
6. In the conte$t of portfolio diversification# A) investors are compensated for diversifiable ris" in the portfolio. B) prudent investors should hold about three to five stoc"s in their portfolio. C) a stoc" inde$ mutual fund is a financial intermediary that offers small investors a way to participate in the performance of the stoc" mar"et as a whole. D) financial intermediaries ma"e it more difficult to be diversified. Answer C

D1Factual
7. 2he problem of 'asymmetric information( is that the A) lender "nows more than the borrower. B) borrower "nows more than the lender. C) borrower and lender have different goals. D) borrower and lender "now the future much less than they do the present. Answer B

D1Interpretive
8. __________________ ma"e9s) it easy for small savers to diversify their portfolios. A) Direct finance B) 2raded securities C) -egulation : D) ;inancial intermediaries Answer D

Chapter 112he <atur e of ;inancial Inter m e di a tion 126

D1Factual
1=. Adverse selection is a problem A) uni+ue to direct finance. B) uni+ue to indirect finance. C) arising before a transaction is consummated. D) arising after a transaction is consummated. Answer C

D2Factual
11. Asymmetric information occurs when A) buyers and sellers are not e+ually informed about the true +uality of what they are buying and selling. B) ban"s 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 Answer D

D1Factual
1!. >enders must be concerned that borrowers may do ris"y unauthori5ed things with the funds they are lent. 2his is the __________________ problem. A) moral ha5ard B) nondivisibility C) adverse selection D) <one of the above Answer A

D1Factual
1%. ?oral ha5ard 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. Answer D

D1Interpretive
1,. ;inancial intermediaries are specialists in the production of A) downside potential. B) information. C) traded assets. D) commercial paper. Answer B

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D1Factual
11. 0conomies of scale in information production are en@oyed by A) small borrowers. B) small lenders. C) large borrowers. D) large lenders. Answer D

D2Factual
13. ?ost ban" loans are __________________ maturity by the ban" because of the __________________ in monitoring how the borrower maintains his obligations. A) held toA ease B) held toA difficulty C) sold beforeA ease D) sold beforeA difficulty Answer B

D2Factual
16. <ontraded 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. Answer B

D2Factual
17. 'Information problematic( borrowers must usually go the __________________ finance route and issue __________________ securities. A) directA traded B) directA nontraded C) indirectA traded D) indirectA nontraded Answer D

D1Factual
18. Bne type of financial intermediary now falling in relative importance is A) money mar"et mutual funds. B) pension funds. C) thrift institutions. D) mutual funds. Answer C

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D1Factual
!=. Bne type of financial intermediary now rising in relative importance is A) pension funds. B) ban"s. C) savingsCandCloan associations 9*D>s). D) life insurance companies. Answer A

D1Factual
!1. &hich of the following are not thrift institutions) A) *avings and loan associations 9*D>s) B) ?utual savings ban"s C) ?oney mar"et mutual funds D) Credit unions Answer C

D1Factual
!!. 2he increase in interest rates that shoo" depository institutions began in the A) 181=s. B) 183=s. C) 186=s. D) 187=s. Answer B

D1Factual
!%. -egulation : put a ceiling on A) ban" loan rates. B) loan rates at all depository institutions. C) deposit rates. D) the proportion of a savingsCandCloan4s assets made up of loans other than mortgages. Answer C

D1Factual
!,. In the 183=s# ban"s 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 mar"et. Answer A

D1Factual
!1. -egulation : was rendered ineffective by the invention of A) negotiable CDs. B) commercial paper. C) ,=19") plans. D) money mar"et mutual funds. Answer D

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D2Factual
!3. &hich of the following is not true with respect to money mar"et mutual funds) A) 2hey allow small savers to pool their funds to buy a diversified portfolio of money mar"et instruments. B) 2hey often include securities such as 2reasury bills# 2reasury bonds# commercial paper# and negotiable CDs. C) 2hey charge a small management fee. D) ?ost funds offer limited withdrawal by chec". Answer B

D2Factual
!6. -egulation : was repealed in the __________________ by the __________________. A) early 186=sA EarnC*t. Eermain Act B) late 186=sA Depository Institutions Deregulation and ?onetary Control Act C) late 187=sA -eigleC<eil Act D) early 187=sA Depository Institutions Deregulation and ?onetary Control Act Answer D

D2Interpretive
!7. -epealing -egulation : still left savingsCandCloan associations with a problem most of their __________________ were still at __________________ interest rates. A) assetsA low B) assetsA high C) depositsA low D) depositsA high Answer A

D2Interpretive
!8. As -egulation : was repealed# most of the assets of savingsCandCloans were in the form of A) business loans. B) consumer loans. C) mortgages. D) savings deposits. Answer C

D2Interpretive
%=. &hich of the following statements is incorrect) A) -egulation : was eliminated as a result of DID?CA and the EarnC*t. Eermain Act. B) *D>s in the early 187=s were primarily invested in deposits. C) 2he rate spread between the average yield on assets and the average cost of funds for *D>s in the early 187=s was negative. D) In the early 187=s# the value of *D> assets fell below the value of *D> liabilities. Answer B

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D2Interpretive
%1. In the early 187=s# rising interest rates caused a tremendous __________________ in the value of savingsCandCloan __________________. A) inflowA liabilities B) inflowA assets C) outflowA liabilities D) outflowA assets Answer D

D1Factual
%!. In 1871# the combined net worth of the entire savingsCandCloan industry in the /.*. was estimated by economists to be A) F11= billion. B) close to 5ero. C) GF!= billion. D) GF11= billion. Answer D

D2Factual
%%. In the early 187=s# many savingsCandCloan 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. Answer A

D1Factual
%,. In the 187=s# ban"s lost many of their __________________ borrowers# because these borrowers were able to sell their commercial paper to __________________. A) smallA savingsCandCloan associations B) smallA money mar"et mutual funds C) largeA savingsCandCloan associations D) largeA money mar"et mutual funds Answer D

D2Factual
%1. 2he general perception in the early 187=s was the *D>s were not in serious trouble# partly because *D>s were insured by the A) *ecurities and 0$change Commission 9*0C). B) /.*. 2reasury. C) ;ederal Deposit Insurance Corporation. D) ;ederal *avings and >oan Insurance Corporation 9;*>IC). Answer D

131-itter.*ilber./dell Money, Banking, and Financial Markets # 0leventh 0dition

D3Interpretive
%3. &hich of the following statements is incorrect with respect to the 187=s) A) Corporate financing migrated from the shortCterm ban" loan mar"et to the commercial paper mar"et. B) ?oney mar"et funds could offer transactions services coupled with a diversified money mar"et investment vehicle at very low costs because of advances in computer technology. C) *peciali5ed monitoring services of commercial ban"s became more important because of new asset valuation models. D) Innovations in information technology made some small borrowers more 'ban"able.( Answer C

D2Factual
%6. 2here is __________________ 'institutionali5ation( in /.*. financial mar"ets# meaning a greater relative use of __________________ finance. A) increasingA indirect B) increasingA direct C) decreasingA indirect D) decreasingA direct Answer A

D2Factual
%7. 2he advent of money mar"et mutual funds is __________________ the trend of 'institutionali5ation#( in which a __________________ percentage of financial assets are directly owned by individuals. A) part ofA growing B) part ofA shrin"ing C) not a part ofA growing D) not a part ofA shrin"ing Answer B

D2Factual
%8. Hension fund growth has been spurred by the recent development of 'defined __________________ plans#( such as the __________________ plan. A) benefitA ,=19") B) benefitA Ieogh C) contributionA ,=19") D) contributionA Ieogh Answer C

D2Factual
,=. In a __________________ plan# employees may choose __________________. A) defined benefitA the assets they invest in B) defined benefitA the benefits received during retirement C) defined contributionA the assets they invest in D) defined contributionA the benefits received during retirement Answer C

Chapter 112he <atur e of ;inancial Inter m e di a tion 132

D2Interpretive
,1. In the 187=s# ban"s __________________ the amount of highly speculative loans they were holding due to __________________ deposit rates. A) increasedA rising B) increasedA falling C) decreasingA rising D) decreasedA falling Answer A

D2Factual
,!. Ban"s still have a strong comparative advantage in e$tending __________________ to __________________ businesses. A) traded securitiesA small B) nonCtraded loansA small C) traded securitiesA large D) nonCtraded loansA large Answer B

D1Factual
,%. A wave of ban" failures in the /nited *tates A) occurred in the 186=s. B) occurred from the early 187=s to the early 188=s. C) occurred from late 187=s to the mid 188=s. D) has been ongoing since the late 187=s. Answer B

D1Interpretive
,,. A rise in deposit rates# all else constant# __________________ a ban"4s __________________ ris". A) lowersA credit B) lowersA interest rate C) raisesA credit D) raisesA interest rate Answer D

D2Factual
,1. 2he ;inancial *ervices ?oderni5ation Act A) effectively repealed the ElassC*teagall Act of 18%%. B) increased restrictions on crossCownership of different types of financial institutions. C) allowed mergers between commercial ban"s and investment ban"s# but not between commercial ban"s and insurance companies. D) All of the above Answer A

133-itter.*ilber./dell Money, Banking, and Financial Markets # 0leventh 0dition

D1Interpretive
,3. &hen a financial intermediary purchases a nontraded claim of either a business or an individual# its main concern is with A) interest rate ris". B) credit ris". C) reinvestment rate ris". D) <one of the above Answer B

D1Interpretive
,6. A drop in deposit rates# all else constant# __________________ a ban"4s __________________ ris". A) lowersA credit B) lowersA interest rate C) raisesA credit D) raisesA interest rate Answer B

D2Interpretive
,7. 2o avoid maturity mismatches# most financial intermediaries tend to A) have assets whose maturities on average e$ceed 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. Answer C

D2Interpretive
,8. A ban" that mismatches its asset and liability maturities is A) trying to reduce credit ris". B) willingly accepting greater credit ris". C) essentially engaging in interestCrate speculation. D) trying to protect itself against interest rate movements. Answer C

D2Interpretive
1=. If a ban" has a lot of longCterm loans# it will probably want to reduce interest rate ris" by encouraging __________________Cterm deposits# especially of interest rates are e$pected to __________________ in the future. A) longA rise B) longA fall C) shortA rise D) shortA fall Answer A

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D1Factual
11. >ife insurance companies# because of the __________________Cterm nature of their liabilities# prefer to hold __________________Cterm assets. A) longA long B) longA short C) shortA long D) shortA short Answer A

D1Factual
1!. Hension plans# because of the __________________Cterm nature of their liabilities# prefer to hold __________________Cterm assets. A) longA long B) longA short C) shortA long D) shortA short Answer A

D1Factual
1%. Consumer finance companies# because of the __________________Cterm nature of their liabilities# prefer to hold __________________Cterm assets. A) longA long B) longA short C) shortA long D) shortA short Answer D

D2Factual
1,. A ma@or reason for the e$istence of financial intermediaries is A) transactions costs that would be incurred without their e$istence. B) the fees charged by dealers and bro"ers in direct finance are so high. C) the problem of symmetric information. D) to assist borrowers in buying securities in financial mar"ets. Answer A

D1Factual
11. A perfect mar"et would have all but which of the following characteristics) A) Infinitely divisible securities B) Asymmetric information C) Buyers and sellers of financial instruments would "now the true +uality of what they are buying and selling D) Buyers and sellers could transact with each other without cost 9no transactions costs) Answer B

135-itter.*ilber./dell Money, Banking, and Financial Markets # 0leventh 0dition

D2Factual
13. If a ban"er lac"s enough information to determine e$actly which applicants for a loan are good ris"s and which are bad ris"s# then he faces a9n) __________________ problem. A) moral ha5ard B) adverse selection C) mar"et failure D) disintermediation Answer B

D2Factual
16. 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 ha5ard. B) adverse selection. C) mar"et failure. D) disintermediation. Answer C

D1Factual
17. 'Information Hroblematic( borrowers are generally A) municipal governments. B) small businesses and individuals. C) large businesses. D) federal government. Answer B

D1Factual
18. <onCtraded 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. Answer A

D2Factual
3=. After the repeal of -egulation :# a problem for savingsCandCloan associations 9*D>s) was that most of their assets were at __________________ interest rates while their deposits were at __________________ interest rates. A) lowA low B) lowA high C) highA low D) highA high Answer B

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D2Factual
31. In the 187=s# ban"s responded to the loss of loans to the commercial paper mar"et by increasing loans to all the following e$cept A) less creditworthy businesses. B) commercial real estate loans. C) loans to lessCdeveloped countries. D) large corporations. Answer D

D2Factual
3!. 'Institutionali5ation( refers to the fact that a9n) __________________ percentage of funds in the /nited *tates are flowing __________________ the financial mar"ets through financial intermediaries A) increasingA indirectly into B) decreasingA indirectly into C) increasingA indirectly out of D) decreasingA directly out of Answer B