38) Collateral is
A) property that is pledged to the lender if a borrower cannot make his or her debt payments.
B) a prevalent feature of debt contracts for households.
C) a prevalent feature of debt contracts for businesses.
D) all of the above.
E) only A and C of the above.
39) The majority of household debt in the United States consists of
A) credit card debt.
B) consumer installment debt.
C) collateralized loans.
D) unsecured loans, such as student loans.
40) Commercial and farm mortgages, in which property is pledged as collateral, account for
A) one-quarter of borrowing by nonfinancial businesses.
B) one-half of borrowing by nonfinancial businesses.
C) one-twentieth of borrowing by nonfinancial businesses.
D) two-thirds of borrowing by nonfinancial businesses.
41) Because of the moral hazard problem,
A) lenders will write debt contracts that restrict certain activities of borrowers.
B) lenders will more readily lend to borrowers with high net worth.
C) debt contracts are used less frequently to raise capital than equity contracts.
D) all of the above.
E) only A and B of the above.
42) Moral hazard in equity contracts is known as the ________ problem because the manager of
the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.
A) principal-agent
B) adverse selection
C) free-rider
D) debt deflation
43) Because managers (________) have less incentive to maximize profits than the stockholders–
owners (________) do, stockholders find it costly to monitor managers; thus, stockholders are
reluctant to purchase equities.
A) principals; agents
B) principals; principals
C) agents; agents
D) agents; principals
44) The principal-agent problem
A) occurs when managers have more incentive to maximize profits than the stockholders-owners
do.
B) would not arise if the owners of the firm had complete information about the activities of the
managers.
C) in financial markets helps to explain why equity is a relatively important source of finance for
American businesses.
D) all of the above.
E) only A and B of the above.
45) Solutions to the moral hazard problem include
A) high net worth.
B) monitoring and enforcement of restrictive covenants.
C) greater reliance on equity contracts and less on debt contracts.
D) all of the above.
E) only A and B of the above.
46) One financial intermediary in our financial structure that helps to reduce the moral hazard
arising from the principal-agent problem is the
A) venture capital firm.
B) money market mutual fund.
C) pawn broker.
D) savings and loan association.
47) A venture capital firm protects its equity investment from moral hazard through which of the
following means?
A) It places people on the board of directors to better monitor the borrowing firm’s activities.
B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture
capital firm.
C) It prohibits the borrowing firm from replacing its management.
D) It does both A and B of the above.
E) It does both A and C of the above.
48) Debt contracts
A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals.
B) have an advantage over equity contracts in that they have a lower cost of state verification.
C) are used much more frequently to raise capital than equity contracts.
D) all of the above.
E) only A and B of the above.
49) Equity contracts account for a small fraction of external funds raised by American businesses
because
A) costly state verification makes the equity contract less desirable than the debt contract.
B) there is greater scope for moral hazard problems under equity contracts, as compared to debt
contracts.
C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt.
D) all of the above.
E) both A and B of the above.
50) A debt contract is said to be incentive compatible if
A) the borrower’s net worth reduces the probability of moral hazard.
B) restrictive covenants limit the type of activities that can be undertaken by the borrower.
C) both A and B of the above occur.
D) neither A nor B of the above occur.
51) A debt contract is more likely to be incentive compatible if
A) the company must follow standard accounting principles.
B) the funds are provided by a venture capital firm.
C) owners of the firm have more of their own money in the business.
D) all of the above.
E) only B and C.
52) A clause in a mortgage loan contract requiring the borrower to purchase homeowner’s
insurance is an example of
A) a restrictive covenant.
B) a collusive agreement between mortgage lenders and insurance companies.
C) both A and B of the above.
D) neither A nor B of the above.
53) A debt contract that specifies that the company can only use the funds to finance certain
activities
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.
54) Which of the following are accurate statements concerning the role that restrictive covenants
play in reducing moral hazard in financial markets?
A) Covenants reduce moral hazard by restricting borrowers’ undesirable behavior.
B) Covenants require that borrowers keep collateral in good condition.
C) Covenants require periodic accounting statements and income reports.
D) All of the above.
E) Only A and B of the above.
55) Although restrictive covenants can potentially reduce moral hazard, a problem with
restrictive covenants is that
A) borrowers may find loopholes that make the covenants ineffective.
B) they are costly to monitor and enforce.
C) too many resources may be devoted to monitoring and enforcing them, as debtholders
duplicate others’ monitoring and enforcement efforts.
D) all of the above.
E) only A and B of the above.
56) Governments in developing countries sometimes adopt policies that retard the efficient
operation of their financial systems. These actions include policies that
A) prevent lenders from foreclosing on borrowers with political clout.
B) nationalize banks and direct credit to politically favored borrowers.
C) make it costly to collect payments and collateral from defaulting debtors.
D) do all of the above.
E) do only A and B of the above.
57) Economies of scale
A) in the financial markets does not explain why financial intermediaries developed and have
become such an important part of our financial structure.
B) can be used to an advantage by reducing transaction cost.
C) both A and B of the above.
D) neither A nor B of the above.
58) Liquidity services are services that
A) make it easier for customers to conduct transactions.
B) conducts transactions for the customer.
C) increase transaction costs.
D) all of the above.
59) Adverse selection
A) is a problem created by asymmetrical information after the transaction.
B) can be solved by eliminating asymmetrical information.
C) occurs when people who do not pay for information take advantage of the information other
people have to pay for.
D) all of the above.
60) The free-rider problem
A) occurs when people who do not pay for information take advantage of the information other
people have to pay for.
B) suggests that the private sale of information will only be a partial solution to the lemons
problem.
C) prevents the private market from producing enough information to eliminate all the
asymmetric information that leads to adverse selection.
D) all of the above.
61) Bad firms
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.
62) A bank
A) has the ability to profit from the information it produces.
B) avoids the free-rider problem by primarily making private loans rather than by purchasing
securities that are traded in the open market.
C) becomes an expert in determining good firms from bad firms.
D) all of the above.
63) Net worth
A) is the difference between current assets and current liabilities.
B) is the difference between assets and liabilities.
C) is total assets divided by total liabilities.
D) is total assets plus total liabilities.
64) Economies of scope refer to cost savings that arise when the
A) size of financial transactions increase.
B) size of financial transactions decrease.
C) number of different activities undertaken increases.
D) number of different activities undertaken decreases.
65) The problem with monitoring as a tool to solve the ________ problem is that it can be
expensive in terms of time and money, as reflected in the name economists give it,costly state
verification.
A) principal-agent
B) adverse selection
C) audit
D) regulation
66) A financial institution can achieve cost savings by engaging in multiple activities. These are
called economies of
A) scope.
B) scale.
C) complexity.
D) information.
67) A financial institution can achieve cost savings in its credit card operations if it increases the
number of cardholders. This is an example of economies of
A) scope.
B) scale.
C) complexity.
D) information.
68) Which combination of activities within a single financial institution is least likely to lead to
conflicts of interest?
A) Auditing and management advisory services
B) Commercial banking and investment banking
C) Assessment of credit quality and consulting
D) Consumer lending and business lending
69) Conflicts of interest pose a problem because they
A) lower the quality of information.
B) increase problems of asymmetric information.
C) make the financial system less efficient.
D) do all of the above.
70) An advantage of providing multiple financial services within one financial institution is that
it
A) lowers information costs.
B) develops broader long-term relationships with customers.
C) both A and B of the above.
D) none of the above.
71) A conflict of interest occurs when
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.
72) A conflict of interest between providing impartial research about companies issuing
securities and selling those same securities arises in
A) investment banking.
B) commercial banking.
C) accounting firms.
D) mutual funds.
73) If potential revenues from underwriting greatly exceed brokerage commissions, there is
________ incentive for investment bank analysts to report ________ information about firms
issuing securities.
A) stronger; unbiased
B) stronger; favorable
C) weaker; unbiased
D) weaker; favorable