Banking Chapter 11 2 The First Bank of Podunk has recently suffered some extraordinary losses on its loan portfolio due to the closing of the largest employer in town

Chapter 11 – The Economics of Financial Intermediation

58. One reason the government requires public corporations to disclose so much information

is to:

A. Minimize the monopoly profits some corporations earn

59. A lender who wants to avoid the problem of adverse selection could:

A. Charge a very high interest rate and assume all loan applicants are high risk

60. The First Bank of Podunk has recently suffered some extraordinary losses on its loan

portfolio due to the closing of the largest employer in town. As a result, the bank’s

management decides to raise the interest rate to new loan applicants. This move is likely to:

D. Treat the problem of adverse selection that contributed to the losses the bank is

experiencing

Chapter 11 – The Economics of Financial Intermediation

61. The problem of adverse selection created the opportunity for:

A. Lenders to profit significantly at the expense of borrowers

62. Recent history has shown that the government regulations requiring the disclosure of

information from public corporations have:

D. Resulted in symmetric information

63. The price for private information is likely higher than it should be and the number of

subscribers is lower than users due to the problem of:

D. Moral hazard

Chapter 11 – The Economics of Financial Intermediation

64. Moody’s, Value Line, and Dun and Bradstreet are examples of companies that:

A. Provide information free to investors but charge the companies for the ratings provided on

the company

65. The scandals involving Enron, World Com, Global Crossing and other large firms:

D. Demonstrate that the government should be responsible for collecting and distributing

financial information on firms

66. Requiring that borrowers put up collateral to obtain a loan is a tool designed to treat:

Chapter 11 – The Economics of Financial Intermediation

67. Which of the following could be the lemons problem, applied to financial markets?

Explain

A. Lenders seeing a disproportionate share of high quality loan applicants

68. Private mortgage insurance is usually required in situations where:

A. The lender feels the buyers have overpaid for the house

69. An unsecured loan is:

D. Usually a low-risk loan

Chapter 11 – The Economics of Financial Intermediation

70. A home mortgage is a good example of:

D. The problem of adverse selection

71. Requiring a large net worth on the part of an applicant is one way lenders treat the

problem of:

A. Free-riders

72. Requiring a home buyer to have a large down payment reduces the risk to a mortgage

lender because:

D. It means there is more information available on the buyer

Chapter 11 – The Economics of Financial Intermediation

73. Which of the following statements is not true?

D. Secured loans usually carry less risk than unsecured loans

74. Which of the following statements is true?

D. Unsecured loans are only made to individuals with very high net worth because it is the

only way to limit the risk

75. Deflation compounds information problems because it:

A. Increases a company’s net worth

Chapter 11 – The Economics of Financial Intermediation

76. A borrower who obtains funds from a lender to purchase additional inventory but uses the

funds to finance a trip to Las Vegas for a weekend of gambling at the opening of a new casino

is an example of:

A. The problem of adverse selection

77. Credit may dry up at the start of an economic downturn because of all of the following

except:

A. Lenders require information and accurate information is more difficult to obtain

78. The principal-agent problem is:

A. A form of adverse selection

Chapter 11 – The Economics of Financial Intermediation

79. The principal-agent problem is quite common in large public corporations due to:

A. The fact that large corporations generate large sales volumes

80. The fact that many companies employ supervisors to oversee the actions of workers is a

way to treat:

D. The free-rider problem

81. Tom borrows $100,000 from his local bank to purchase inventory for his store for the

upcoming holiday season. Tom’s neighbor tells him about a get-rich-quick scheme that can

take this $100,000 and triple it in a month. Tom decides to buy into this scheme figuring he

can repay the bank and still have plenty left for inventory. This is an example of:

A. Adverse selection

Chapter 11 – The Economics of Financial Intermediation

82. A bank usually treats the moral hazard problem by using all of the following, except:

D. Restrictive covenants

83. Moral hazard problems arise because:

D. Lenders charge interest rates that are too low

84. One reason lenders may require a large net worth before making a loan is because:

A. Then the borrower does not need the funds

Chapter 11 – The Economics of Financial Intermediation

85. Providing stock options to corporate managers was an idea designed to:

D. Treat the free-rider problem

86. The moral hazard that can result from debt financing is mainly due to the:

A. Borrower not working as hard once he or she obtains the loan

87. Each of the following is an example of a restrictive covenant on a mortgage loan, except:

A. Net worth requirements

Chapter 11 – The Economics of Financial Intermediation

88. One reason that financial intermediaries exist is that they:

D. Earn high returns from lending their own funds

89. The screening process a bank follows for a loan applicant:

D. Uses only confidential information

90. Large companies seeking to raise funds often will use a well-known investment bank

because:

D. This minimizes moral hazard

Chapter 11 – The Economics of Financial Intermediation

11–32

91. Often a bank will require a loan officer to make personal visits on customers with loans

outstanding. This is encouraged because:

A. The bank worries about another bank trying to steal their customers

92. In looking at the figure showing the sources of business finance, the largest source in the

D. Foreign sources

AACSB: Analytic

BLOOM’S: Remember

Difficulty: Easy

Topic: Financial Intermediaries and Information Costs

Chapter 11 – The Economics of Financial Intermediation

93. A friend of yours tells you she has an idea for a new product. She believes that once the

prototype is built she can sell the rights to the product for $250,000. The problem is she needs

$20,000 to build the prototype and she only has $5,000. She asks you to invest $15,000 in the

idea and she will give you 75% of whatever amount she obtains when she sells the rights. You

have the money available but should be reluctant to provide the money. Why?

94. Please explain how financial intermediaries contribute to increasing the output of an

economy.