Financial Markets and Institutions, 6e (Mishkin/Eakins)
Chapter 23 Investment Banks, Security Brokers and Dealers, and Venture Capital
Firms
23.1 Multiple Choice
1) An investment bank is a financial institution that
A) bundles small deposits into larger loans.
B) helps corporations raise funds.
C) holds most of its assets in commercial paper.
D) does all of the above.
E) does only A and B of the above.
2) The Glass–Steagall Act
A) separated commercial and investment banking.
B) made it illegal for a commercial bank to buy or sell securities on behalf of its customers.
C) made it illegal for investment banks to engage in the underwriting of corporate
securities.
D) did all of the above.
E) did only A and B of the above.
3) Investment banks sell _________ securities to the public, and brokerage firms sell _________
securities to the public.
A) new; existing
B) new and existing; existing
C) existing; new
D) existing; new and existing
4) The primary function of investment banks is
A) the bundling of deposits into loans.
B) extending long–term credit to other financial institutions.
C) helping corporations raise funds.
D) providing credit to firms engaged in international trade.
5) The primary function of investment banks is to
A) extend credit to stock brokers and dealers.
B) extend credit to investors.
C) extend credit to corporations.
D) help corporations issue new securities.
6) Which is not an activity of investment banks?
A) Underwriting new issues of corporate stocks and bonds.
B) Acting as deal–makers in mergers.
C) Acting as intermediaries in the buying and selling of businesses or parts of businesses.
D) Underwriting new issues of federal government bonds.
7) Tasks that investment bankers perform when acting as underwriters to sell securities to the
public include:
A) pricing the security.
B) preparing the filings required by the Securities and Exchange Commission.
C) arranging for the security to be rated.
D) all of the above.
E) only A and B of the above.
8) Investment banks find it less difficult to price securities if the firm has prior issues currently
selling in the market, called
A) secondary issues.
B) seasoned issues.
C) outstanding issues.
D) experienced issues.
9) The process of underwriting a stock or bond issue requires that the investment bank
A) assure investors that the issue will provide them a high return.
B) purchase the entire issue at a predetermined price if the quantity demanded by
consumers is insufficient at the predetermined price.
C) purchase the entire issue at a predetermined price and then resell it in the market.
D) do both A and B of the above.
10) The registration statement the securities underwriter files with the SEC contains information
about
A) the firm’s financial condition, management, competition, industry, and experience.
B) how the funds will be used.
C) management’s assessment of the risk of the securities.
D) all of the above.
E) only A and B of the above.
11) SEC registration is
A) required for all securities.
B) required if less than $1.5 million in securities are issued per year.
C) not required for securities that are sold through a private placement.
D) required if the securities mature in less than one year.
E) not required if securities are underwritten by a reputable investment bank.
12) By law, investors must be given a portion of the registration statement before they can invest
in a new security. This document is called a
A) prospectus.
B) proxy statement.
C) fiduciary warrant.
D) debenture.
13) Investment banks advertise upcoming securities offerings with block ads in the Wall Street
Journal. Such an ad is called a
A) tombstone.
B) marker.
C) prospectus.
D) registration statement.
14) Most investment banks are attached to
A) large commercial banks.
B) large brokerage houses.
C) finance companies.
D) large nonfinancial corporations.
15) From an investment banker’s perspective, the best outcome occurs when a new issue is
A) undersubscribed.
B) fully subscribed.
C) oversubscribed.
D) syndicated.
16) Investment banks may lose _________ if new securities issues are _________.
A) large amounts of money; oversubscribed
B) large amounts of money; fully subscribed
C) future business; oversubscribed
D) future business; undersubscribed
17) The largest U.S. underwriter of global debt and equity issues, as of 2003, was
A) Merrill Lynch.
B) Citigroup.
C) Morgan Stanley.
D) Goldman Sachs.
18) Often investment bankers will form a group, each one buying only a portion of the new
securities to be issued. Such a group is called an underwriting
A) alliance.
B) syndicate.
C) association.
D) guild.
19) In a _________ agreement, the investment banker makes no guarantee regarding the price
the issuing firm will receive, but agrees to sell the securities on a commission basis.
A) best–effort
B) brokered
C) private–placement
D) jump–start
20) Under best–efforts underwriting, the underwriter
A) pays for the entire security issue.
B) sells the security on a commission basis.
C) spreads the risk among different brokerage houses.
D) makes a special appeal to the Securities and Exchange Commission to delay the issue.
21) Private placements
A) do not require the services of investment bankers.
B) need not be registered with the SEC.
C) are more common in the sale of stocks than for bonds.
D) all of the above.
E) only A and B of the above.
22) The most active investment banking firm in the private placement market is
A) Merrill Lynch.
B) Lehman Brothers.
C) Goldman Sachs.
D) Morgan Stanley.
23) The buyers of private placement issues are most likely to be
A) insurance companies.
B) pension funds.
C) investment banks.
D) all of the above.
E) only A and B of the above.
24) The buyers of private placement securities are most likely to be
A) insurance companies.
B) pension funds and mutual funds.
C) commercial banks.
D) all of the above.
E) only A and B of the above.
25) Which of the following statements about private placements are true?
A) Private placements are more common for the sale of bonds than for stocks.
B) Investment bankers, though not required for a private placement, often facilitate the
transaction.
C) Investment bankers help the issuing firm file the paperwork required by the SEC.
D) All of the above are true.
E) Only A and B of the above are true.
26) Investment bankers have been active in the mergers and acquisitions market since the 1960s.
Their contributions have included
A) helping firms that want to acquire another firm locate a firm to pursue.
B) helping would–be acquirers solicit shareholders through a tender offer.
C) helping target firms ward off undesired takeover attempts.
D) all of the above.
E) only A and B of the above.
27) Which of the following is not a step in the process by which an investment bank assists in
the sale of a company or corporate division?
A) Preparation of a confidential memorandum
B) Negotiation of a letter of intent
C) Preparation of a definitive agreement
D) Forming a syndicate of purchasers
28) The best known investment banker involved in mergers and acquisitions, credited with
inventing the junk bond market, is
A) Ivan Boskey.
B) Michael Milken.
C) James Garner.
D) Michael Douglas.
29) _________ perform their main function in the primary market for securities and _________
perform their main function in the secondary market.
A) Investment banks; securities brokers and dealers
B) Securities brokers and dealers; investment banks
C) Securities brokers; securities dealers
D) Securities dealers; securities brokers
30) In a primary market, _________ sell new issues of securities; in a secondary market,
_________ assist in trading previously issued securities.
A) securities dealers; securities brokers
B) securities brokers; securities dealers
C) investment banks; securities brokers and dealers
D) securities brokers and dealers; investment banks
31) Which of the following best explains the difference between brokers and dealers?
A) Brokers are pure middlemen; dealers make markets by standing ready to buy and sell
at given prices.
B) Dealers are pure middlemen; brokers make markets by standing ready to buy and sell
at given prices.
C) Dealers link up buyers and sellers, but do not stand ready to buy and sell from their
inventories of securities; brokers stand ready to buy and sell from their inventories of
securities.
D) There is no difference between brokers and dealers.
32) Securities dealers
A) hold inventories of securities, which they sell to customers who want to buy.
B) hold securities that they have purchased from customers who wanted to sell.
C) are called market takers, as they have significantly cut into the market that brokers
used to dominate.
D) do all of the above.
E) do only A and B of the above.
33) Securities dealers
A) sell securities out of their inventories to customers who want to buy.
B) buy securities, which they add to their inventories, from customers who want to sell.
C) are largely responsible for the health and growth of small businesses in the United
States.
D) do all of the above.
E) do only A and B of the above.
34) By making a market in thinly traded stocks, securities dealers solve the _________ trading
problem, which is of particular benefit to _________ businesses.
A) synchronous; large
B) synchronous; small
C) nonsynchronous; large
D) nonsynchronous; small
35) Which of the following is not a service securities brokers offer their clients?
A) Holding customers’ stock for safekeeping
B) Providing insurance against loss of the securities
C) Providing insurance against loss of value of the securities
D) Extending margin credit
36) An instruction to a securities agent to buy or sell the security at the current market price is
called a
A) limit order.
B) market order.
C) stop loss order.
D) margin order.
37) An instruction to a securities agent to sell a stock when it reaches a specific price is a
A) short sell.
B) market order.
C) limit order.
D) stop loss order.
38) An instruction to a securities agent to purchase a stock as long as its price does not exceed a
specified level is a
A) short sell.
B) market order.
C) limit order.
D) stop loss order.
39) To take advantage of anticipated stock price decreases, an investor would use a
A) a market order.
B) a limit order.
C) a short sell.
D) margin credit.
40) Which of the following statements about cash management accounts (CMAs) are true?
A) The cash management account was developed in 1977 by Merrill Lynch.
B) The advantage of brokerage–based cash management accounts is that they make it
easier to buy and sell securities.
C) As a result of CMAs, the distinction between banking activities and the activities of
nonbank financial institutions has become more clearly defined.
D) All of the above are true.
E) Only A and B of the above are true.
41) The largest full–service broker is
A) Merrill Lynch.
B) Charles Schwab & Company.
C) Ameritrade.
D) Smith Barney.
42) A full–service broker offers its clients all of the following except
A) execution of trades on request.
B) low transactions fees.
C) research and investment advice.
D) development of long–term customer relationships.
43) An investment pool is formed to
A) manipulate the market by spreading false rumors.
B) lower brokerage fees by combining security purchases.
C) share investment advice among member investors.
D) take advantage of tax breaks introduced by the 1933 and 1934 securities acts.
44) A _________ is a specialized firm that finances young, start–up companies.
A) venture capital firm
B) finance company
C) small–business finance company
D) capital–creation company
45) Which of the following provides funds to companies not yet ready to sell securities to the
public?
A) Investment banks
B) Securities brokers and dealers
C) Venture capital firms
D) None of the above
46) Venture capital firms are usually organized as
A) closed–end mutual funds.
B) limited partnerships.
C) corporations.
D) nonprofit businesses.
47) Which of the following is not a characteristic feature of venture capital firms?
A) Funding just one or a small number of firms
B) Holding equity in the firms that are funded
C) Having a long–term investment horizon
D) Providing advice and assistance to the firms that are funded
48) Which of the following is a characteristic feature of venture capital firms?
A) Developing a portfolio of companies
B) Holding debt in the firms that are funded
C) Allowing firms to use the funds as they see fit
D) Having a short–term investment horizon
49) The sources of venture capital funding have
A) shifted from wealthy individuals to pension funds and corporations.
B) shifted from pension funds and corporations to wealthy individuals.
C) decreased since 1990.
D) none of the above.
50) A typical venture capital firm has a _________ number of investors who each contribute a
_________ amount of money to the fund.
A) large; small
B) small; large
C) large; large
D) small; small
51) In 2000 the bulk of venture capital funds were used for
A) seed investing.
B) early stage investing.
C) later stage investing.
D) final stage investing.
52) Which of the following statements about venture capital funding is not correct?
A) Exiting an investment can occur through an initial public offering or by merger or
acquisition.
B) Venture capital investing is highly risky.
C) Venture capital firms may focus on a limited geographic area or on specific industries
to facilitate monitoring their investments.
D) Firms hope to exit a start–up firm in 3–5 years.
53) The 20–year average return of venture capital firms has been about _________.
A) 50%
B) 8%
C) 20%
D) 100%
54) Since the stock market decline in 2000, the number of companies funded and the total funds
invested by venture capital firms have
A) held steady.
B) declined.
C) increased slightly.
D) increased sharply.
55) The ______ of the volume handled by brokers and dealers is in the publicly held securities.
A) vast majority
B) low percentage
C) total amount
D) none of the above.
56) With private investing
A) capital is raised by selling securities to the public.
B) capital is raised by issuing new shares of stock.
C) a limited partnership is formed that raises money from a small number of high–wealth
investors.
D) all of the above.
57) Which is an advantage to a private equity buyout?
A) They are subject to the controversial regulations included in the 2002 Sarbanes–Oxley
Act.
B) The CEOs frequently have more time and flexibility to enact changes need to turn
around sub–par companies.
C) both A and B.
D) neither A nor B.
58) When taking a particular course of action for a private equity firm, the CEO of a privately
held company needs to convince _________ that it is a good decision.
A) the shareholders
B) the managing partners
C) no one
D) both (a) and (b)
59) There are _________ risk and _________ returns to investors in private equity buyouts.
A) high; low
B) low; high
C) high;high
D) low; low
60) Which is a description of a private equity firm?
A) Public shares are retired.
B) A public company goes private.
C) The firm is no longer subject to controls and oversight required of publicly held
companies.
D) All of the above.
23.2 True/False
1) The Glass–Steagall Act made it illegal for an investment bank to buy or sell securities on
behalf of its customers.
2) When a firm issues stock for the first time in an initial public offering, it is difficult for an
investment bank to determine what the correct price should be.
3) An undersubscribed issue occurs when sales agents have been unable to generate sufficient
interest among their customers to sell all the securities by the issue date.
4) Investment banks form syndicates to reduce the risk involved in selling new securities.
5) Resisted takeovers are called hostile.
6) Private placements are more common for the sale of stocks than for bonds.
7) Investment bankers perform a number of tasks required to sell securities to the public,
among them pricing the security, preparing the filings required by the SEC, arranging for
the security to be rated, and marketing the security through their contacts with brokerage
houses.
8) One disadvantage of the private placement of securities issues is the high cost of registering
the issue.
9) Junk bonds are high–risk, high–return equity securities that were used primarily to finance
takeover attempts.
10) The Securities Acts Amendment of 1975 abolished fixed commissions.
11) An investment pool is formed to manipulate the market for a stock by spreading false
rumors about the health of the firm.
12) Venture capital firms reduce risk by investing in only a few companies which can be
carefully monitored and nurtured.
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13) Investors in venture capital firms expect to profit quickly from their investment.
14) An additional perk of a private equity firm is that the profits for both CEOs and the partners
are taxed at the 15% capital gains rather than the 35% rate they would suffer if the income
was received as income.
15) In a typical private equity buyout, a partnership is formed and private equity investors are
contacted to pledge participation.
16) Within the broad universe of private equity sectors, the two most common are venture funds
and capital buyouts.
23.3 Essay
1) Explain how rulings by the courts and regulators have made the markets served by both
commercial and investment banks more competitive.
2) What services do investment bankers provide for firms that are issuing new securities?
3) What is underwriting?
4) How do best efforts agreements and private placements differ from the usual process of
underwiriting new securities issues?
5) Explain why private placements of securities are an attractive way of raising funds for some
firms.
6) Describe the differences between securities brokers and securities dealers.
7) What niche in the financial system do venture capital firms fill?
8) How do venture capital firms overcome the problem of information asymmetries that
accompany start–up firms?
9) Discuss the advantages of a private equity buyout.