Chapter 11 – The Economics of Financial Intermediation
Multiple Choice Questions
1. Financial intermediation is:
A. Far less important than direct finance through stock and bond markets
2. Financial intermediation exists, in part, because:
A. Financial markets work so well
3. When the amount of direct and indirect financing are summed, the result is usually:
D. Approximately 50% of GDP
Chapter 11 – The Economics of Financial Intermediation
4. Emerging market economies, compared to industrialized economies, have financial markets
that:
A. Differ in composition and size
5. The reason financial intermediaries play such an important role in economies has to do with
all of the following except:
A. Information costs
6. Which of the following is not a role of a financial institution acting as a financial
intermediary?
D. Supplying liquidity
Chapter 11 – The Economics of Financial Intermediation
7. Financial institutions, acting as financial intermediaries, perform all of the following,
except:
A. Provide ways to diversify risk
8. Financial intermediaries pool the resources of many small savers so that they can:
D. Avoid paying any interest to obtain funds to lend
9. If financial intermediaries did not have the ability to pool the resources of small savers:
D. The risk associated with lending would decrease
Chapter 11 – The Economics of Financial Intermediation
10. Financial intermediaries:
A. Increase the cost of financial transactions but offset these higher costs by providing
safekeeping of customer funds
11. Financial intermediaries, through their ability to lower transaction costs:
D. Reduce the number of financial transactions that occur
D. Make collecting and processing information easier
Chapter 11 – The Economics of Financial Intermediation
13. The fact that a financial intermediary can hire a lawyer to write one contract that works
for many customers is an example of:
D. The law of demand
14. The fact that financial intermediaries employ experts to carry out particular activities and
so lower transactions costs is usually associated with the following economic concept:
A. The law of demand
15. Economies of scale associated with financial intermediaries means:
D. The cost per transaction decreases regardless of the size of the transaction
Chapter 11 – The Economics of Financial Intermediation
16. Examples of economies of scale are:
17. One reason financial intermediaries earn profits is because:
A. Individuals are not aware of the true cost of using an intermediary
18. The reduction in transaction costs provided by financial intermediaries benefit:
D. Small borrowers but not small savers
Chapter 11 – The Economics of Financial Intermediation
19. Automated teller machines provided by financial intermediaries are an example of:
20. The function of providing liquidity by financial intermediaries:
A. Includes depositors withdrawing funds but not borrowers
Chapter 11 – The Economics of Financial Intermediation
21. Since one function of financial intermediaries is to provide liquidity:
A. They must keep all of their funds in short-term securities
22. A bank can usually offer a saver a higher return for the same risk for all of the following
reasons except:
A. The bank can usually purchase assets at a lower cost than any one saver
Chapter 11 – The Economics of Financial Intermediation
23. Lines of credit provided by financial intermediaries:
D. Require deposits in the intermediary that equal or exceed the amount of the line of credit
24. When a bank takes savings from many small savers and lends it to many borrowers, the
bank:
D. Decreases the return to savers and increases the cost to borrowers
25. If a bank has 1,000 depositors, each of whom deposits $1,000 in the bank, and the bank
makes 100 loans of $10,000 each, then each depositor has contributed:
A. $100 to each loan
Chapter 11 – The Economics of Financial Intermediation
26. Mutual funds offer investors:
A. A greater return for greater risk than what an investor can earn on his own
27. Mutual funds are attractive because:
D. They usually have inside information because they run most of the companies they invest
in
28. A bank has 10,000 depositors, each of whom deposits $100 in the bank. If the bank makes
1000 loans for $1,000 each then each depositor has contributed:
A. $1 to each loan
Chapter 11 – The Economics of Financial Intermediation
29. A lender usually knows less about the creditworthiness of a borrower than the borrower
does. This is an example of:
A. Opportunistic behavior
30. Most individuals save at banks rather than lend directly because:
A. The bank creates information asymmetry
31. Financial intermediaries reduce the problems in lending associated with information
asymmetries by all of the following except:
A. Collecting and processing standardized information
Chapter 11 – The Economics of Financial Intermediation
32. Asymmetric information poses two important obstacles to the smooth flow of funds from
savers to investors. They are:
D. Adverse selection and moral hazard, both of which occur before the transaction
33. Financial markets do not function as well as they could due to:
D. Fluctuations in the inflation rate
34. The usual situation in banking regarding asymmetric information is:
D. Lenders and borrowers have perfect information
Chapter 11 – The Economics of Financial Intermediation
35. If information in a financial market is symmetric, this means:
A. Borrowers and lenders have perfect information
36. Mom’s Pizzeria goes out of business due to a dramatic decrease in sales from a local
newspaper article highlighting the fact that Mom’s Pizzeria has been purchasing expired meat
from a distributor at cut rate prices for years. The decrease in business also results in Mom’s
defaulting on the loan they have with the bank. This is an example of:
A. Symmetric information in the financial markets
37. Mom’s Bakery goes out of business due to decreasing sales resulting from the dramatic
increase in people on low carbohydrate diets. The decrease in business also results in Mom’s
defaulting on the loan they have with the bank. This is an example of:
D. Symmetric information in financial markets
Chapter 11 – The Economics of Financial Intermediation
38. Often times we see companies offering money back guarantees to customers if they are
not satisfied. These guarantees are a way to treat the problem of:
D. Adverse selection
39. Which of the following is not true of adverse selection?
D. It arises if lenders try to charge an average price to all applicants
40. In a financial market where information is symmetric:
A. All information would be known by both parties in a transaction
Chapter 11 – The Economics of Financial Intermediation
41. In a financial market where information is symmetric:
D. Information is not free
42. Two problems that arise from asymmetric information are:
A. Adverse selection and diseconomies of scale
43. Which of the following is a problem of adverse selection?
D. Individuals use more medical services as a result of their purchase of a health insurance
plan
Chapter 11 – The Economics of Financial Intermediation
44. Which of the following is a problem of moral hazard?
D. An auto insurance company charges higher premiums to younger drivers than what they
charge to older drivers
45. One of the conclusions from Akerlof’s paper titled “The Market for Lemons” was:
A. High quality goods will drive low quality goods out of the market
Chapter 11 – The Economics of Financial Intermediation
46. Mary Jones is the president of a local bank. She knows that half of the loan applicants in
town she would classify as high risk and the other half as low risk. She observes that the other
banks in town charge two different interest rates, a lower rate for low risk borrowers and the
higher rate for high risk borrowers. She decides that to have an advantage over the other
banks she will offer an average rate to everyone. The likely result will be:
A. Mary’s bank will be highly successful as this will provide the bank with a large
competitive advantage
47. One lesson that Akerlof’s Lemons model provides is:
D. Moral hazard is unavoidable
48. A firm that has a well-earned reputation for providing high quality:
A. Has found a way to treat the free-rider problem
Chapter 11 – The Economics of Financial Intermediation
49. The interest rates charged on most credit cards is:
D. Lower than they should be given the problem of adverse selection
50. If the market prices the shares of stock of two companies, one of high quality and the
other of lower quality, are the same average price and potential buyers cannot distinguish the
prospects of the companies:
A. The shares of the low quality firm will disappear from the market
51. The publication, Consumer’s Reports, is one tool designed to treat:
D. Symmetric information
Chapter 11 – The Economics of Financial Intermediation
52. In the bond market, the assigning of a risk premium is a tool designed to address the
problem of:
D. Moral hazard
D. Adverse selection problem of buyers preferring new versus used cars
54. Adverse selection:
Chapter 11 – The Economics of Financial Intermediation
55. Which of the following statements is true?
D. Moral hazard is a problem that occurs before a transaction
56. Which of the following statements is true?
A. Adverse selection is a problem that occurs after a transaction
57. One reason lenders usually require a lot of information from loan applicants is to avoid:
D. Charges of discrimination in lending