Economics of Money, Banking, and Financial Markets, 12e (Mishkin)
Chapter 8 An Economic Analysis of Financial Structure
8.1 Basic Facts About Financial Structure Throughout the World
1) American businesses get their external funds primarily from
A) bank loans.
B) bonds and commercial paper issues.
C) stock issues.
D) loans from nonbank financial intermediaries.
2) Of the sources of external funds for nonfinancial businesses in the United States, loans from
banks and other financial intermediaries account for approximately ________ of the total.
A) 6%
B) 40%
C) 56%
D) 60%
3) Of the sources of external funds for nonfinancial businesses in the United States, corporate
bonds and commercial paper account for approximately ________ of the total.
A) 5%
B) 10%
C) 32%
D) 50%
4) Of the following sources of external finance for American nonfinancial businesses, the least
important is
A) loans from banks.
B) stocks.
C) bonds and commercial paper.
D) loans from other financial intermediaries.
5) Of the sources of external funds for nonfinancial businesses in the United States, stocks
account for approximately ________ of the total.
A) 2%
B) 11%
C) 20%
D) 40%
6) Of the four sources of external funding for nonfinancial businesses, the least often used in the
U.S. is
A) bank loans.
B) nonbank loans.
C) bonds.
D) stock.
7) Which of the following statements concerning external sources of financing for nonfinancial
businesses in the United States are TRUE?
A) Stocks are a far more important source of finance than are bonds.
B) Stocks and bonds, combined, supply less than one-half of the external funds.
C) Financial intermediaries are the least important source of external funds for businesses.
D) Since 1970, more than half of the new issues of stock have been sold to American
households.
8) Which of the following statements concerning external sources of financing for nonfinancial
businesses in the United States are TRUE?
A) Issuing marketable securities is the primary way that they finance their activities.
B) Bonds are the least important source of external funds to finance their activities.
C) Stocks are a relatively unimportant source of finance for their activities.
D) Selling bonds directly to the American household is a major source of funding for American
businesses.
9) With regard to external sources of financing for nonfinancial businesses in the United States,
which of the following are accurate statements?
A) Marketable securities account for a larger share of external business financing in the United
States than in Germany and Japan.
B) Since 1970, most of the newly issued corporate bonds and commercial paper have been sold
directly to American households.
C) Direct finance accounts for more than 50 percent of the external financing of American
businesses.
D) Smaller businesses almost always raise funds by issuing marketable securities.
10) Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds
A) by issuing stock.
B) by issuing bonds.
C) from nonbank loans.
D) from bank loans.
11) As a source of funds for nonfinancial businesses, stocks are relatively more important in
A) the United States.
B) Germany.
C) Japan.
D) Canada.
12) Direct finance involves the sale to ________ of marketable securities such as stocks and
bonds.
A) households
B) insurance companies
C) pension funds
D) financial intermediaries
13) Regulation of the financial system
A) occurs only in the United States.
B) protects the jobs of employees of financial institutions.
C) protects the wealth of owners of financial institutions.
D) ensures the stability of the financial system.
14) One purpose of regulation of financial markets is to
A) limit the profits of financial institutions.
B) increase competition among financial institutions.
C) promote the provision of information to shareholders, depositors and the public.
D) guarantee that the maximum rates of interest are paid on deposits.
15) Property that is pledged to the lender in the event that a borrower cannot make his or her debt
payment is called
A) collateral.
B) points.
C) interest.
D) good faith money.
16) Collateralized debt is also know as
A) unsecured debt.
B) secured debt.
C) unrestricted debt.
D) promissory debt.
17) Credit card debt is
A) secured debt.
B) unsecured debt.
C) restricted debt.
D) unrestricted debt.
18) The predominant form of household debt is
A) consumer installment debt.
B) collateralized debt.
C) unsecured debt.
D) unrestricted debt.
19) If you default on your auto loan, your car will be repossessed because it has been pledged as
________ for the loan.
A) interest
B) collateral
C) dividend
D) commodity
20) 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.
21) A ________ is a provision that restricts or specifies certain activities that a borrower can
engage in.
A) residual claimant
B) risk hedge
C) restrictive barrier
D) restrictive covenant
22) A clause in a mortgage loan contract requiring the borrower to purchase homeowner’s
insurance is an example of a
A) proscriptive covenant.
B) prescriptive covenant.
C) restrictive covenant.
D) constraint-imposed covenant.
23) Which of the following is NOT one of the eight basic puzzles about financial structure?
A) Stocks are the most important source of finance for American businesses.
B) Issuing marketable securities is not 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) Banks are the most important source of external funds to finance businesses.
24) Which of the following is NOT one of the eight basic puzzles about financial structure?
A) Debt contracts are typically extremely complicated legal documents that place substantial
restrictions on the behavior of the borrower.
B) 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.
C) Collateral is a prevalent feature of debt contracts for both households and business.
D) There is very little regulation of the financial system.
1) The current structure of financial markets can be best understood as the result of attempts by
financial market participants to
A) adapt to continually changing government regulations.
B) deal with the great number of small firms in the United States.
C) reduce transaction costs.
D) cartelize the provision of financial services.
2) The reduction in transactions costs per dollar of investment as the size of transactions
increases is
A) discounting.
B) economies of scale.
C) economies of trade.
D) diversification.
3) By bundling share purchases of many investors together mutual funds can take advantage of
economies of scale and thereby lower
A) adverse selection.
B) moral hazard.
C) transactions costs.
D) diversification.
4) Which of the following is NOT a benefit to an individual purchasing a mutual fund?
A) reduced risk
B) lower transactions costs
C) free-riding
D) diversification
5) Financial intermediaries develop ________ in things such as computer technology which
allows them to lower transactions costs.
A) expertise
B) diversification
C) regulations
D) equity
6) Financial intermediaries’ low transaction costs allow them to provide ________ services that
make it easier for customers to conduct transactions.
A) liquidity
B) conduction
C) transcendental
D) equitable
7) How does a mutual fund lower transactions costs through economies of scale?
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8.3 Asymmetric Information: Adverse Selection and Moral Hazard
1) A borrower who takes out a loan usually has better information about the potential returns and
risk of the investment projects he plans to undertake than does the lender. This inequality of
information is called
A) moral hazard.
B) asymmetric information.
C) noncollateralized risk.
D) adverse selection.
2) The presence of ________ in financial markets leads to adverse selection and moral hazard
problems that interfere with the efficient functioning of financial markets.
A) noncollateralized risk
B) free-riding
C) asymmetric information
D) costly state verification
3) The problem created by asymmetric information before the transaction occurs is called
________, while the problem created after the transaction occurs is called ________.
A) adverse selection; moral hazard
B) moral hazard; adverse selection
C) costly state verification; free-riding
D) free-riding; costly state verification
4) If bad credit risks are the ones who most actively seek loans then financial intermediaries face
the problem of
A) moral hazard.
B) adverse selection.
C) free-riding.
D) costly state verification.
5) The problem faced by the lender that the borrower may take on additional risk after receiving
the loan is called
A) adverse selection.
B) moral hazard.
C) transactions costs.
D) diversification.
6) An example of the ________ problem would be if Brian borrowed money from Sean in order
to purchase a used car and instead took a trip to Atlantic City using those funds.
A) moral hazard
B) adverse selection
C) costly state verification
D) agency
7) The analysis of how asymmetric information problems affect economic behavior is called
________ theory.
A) uneven
B) parallel
C) principal
D) agency
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8.4 The Lemons Problem: How Adverse Selection Influences Financial Structure
1) The “lemons problem” exists because of
A) transactions costs.
B) economies of scale.
C) rational expectations.
D) asymmetric information.
2) Because of the “lemons problem” the price a buyer of a used car pays is
A) equal to the price of a lemon.
B) less than the price of a lemon.
C) equal to the price of a peach.
D) between the price of a lemon and a peach.
3) Adverse selection is a problem associated with equity and debt contracts arising from
A) the lender’s relative lack of information about the borrower’s potential returns and risks of his
investment activities.
B) the lender’s inability to legally require sufficient collateral to cover a 100% loss if the
borrower defaults.
C) the borrower’s lack of incentive to seek a loan for highly risky investments.
D) the lender’s inability to restrict the borrower from changing his behavior once given a loan.
4) The ________ problem helps to explain why the private production and sale of information
cannot eliminate ________.
A) free-rider; adverse selection
B) free-rider; moral hazard
C) principal-agent; adverse selection
D) principal-agent; moral hazard
5) The free-rider problem occurs because
A) people who pay for information use it freely.
B) people who do not pay for information use it.
C) information can never be sold at any price.
D) it is never profitable to produce information.
6) In the United States, the government agency requiring that firms that sell securities in public
markets adhere to standard accounting principles and disclose information about their sales,
assets, and earnings is the
A) Federal Communications Commission.
B) Federal Trade Commission.
C) Securities and Exchange Commission.
D) Federal Reserve System.
7) Government regulations require publicly traded firms to provide information, reducing
A) transactions costs.
B) the need for diversification.
C) the adverse selection problem.
D) economies of scale.
8) A lesson of the Enron collapse is that government regulation
A) always fails.
B) can reduce but not eliminate asymmetric information problems.
C) increases the problem of asymmetric information.
D) should be reduced.