Macroeconomics: Policy and Practice, 2e (Mishkin)
Chapter 14 The Financial System and Economic Growth
14.1 The Role of the Financial System
1) Firms can acquire access to savings directly ________.
A) by issuing securities
B) through the payment of taxes to the federal government
C) by borrowing from banks
D) through the depositing of funds in depository institutions
2) Firms can acquire access to savings indirectly through ________.
A) issuing securities
B) borrowing from banks
C) the payment of taxes to the federal government
D) the depositing of funds in depository institutions
3) The purpose of a financial sector is ________.
A) to minimize the payments firms make to state and local governments
B) to maximize the payments firms make to state and local governments
C) to channel funds away from households and firms with surplus funds
D) to channel monies into socially acceptable causes
4) The purpose of a financial sector is ________.
A) to enable consumers to make purchases before receiving income
B) to ensure that retirees have a source of income
C) to direct available funds to worthy opportunities
D) to create and to promote the trading of assets
5) If the economy may be likened to a biological organism, then the financial system may be
thought of as the ________.
A) brain
B) stomach
C) lungs
D) feet
6) An asset is ________.
A) equal in value to its corresponding liabilities and net worth
B) a debt for the owner of the asset
C) a net outflow from the revenues of a producing firm
D) anything that can be owned and has value
7) Economic agents can raise money capital by ________.
A) issuing liabilities
B) repaying a loan
C) paying taxes
D) providing a subsidy
8) A financial market where economic agents meet in one central location is known as
________.
A) an over the counter market
B) an exchange
C) a bond market
D) a money market
9) Which of the following is not a financial intermediary?
A) an insurance company
B) a pension fund
C) a commercial bank
D) an organized exchange, e.g. NYSE
10) Which of the following is not a depository institution?
A) a savings & loan association
B) a mutual savings bank
C) an investment bank
D) a credit union
11) Equities is to ________ as bond is to ________.
A) ownership; debt
B) fairness; constraint
C) stock; asset
D) banks; exchanges
12) Nonfinancial businesses may acquire funds by borrowing from a commercial bank or by
________.
A) purchasing short-term assets
B) issuing securities
C) issuing insurance policies
D) trading on an exchange
13) Commercial banks are financial intermediaries, as are ________.
A) household savers
B) state and local governments
C) insurance companies
D) organized exchanges
14) The most important source of funds for nonfinancial businesses is ________.
A) financial intermediaries
B) insurance companies
C) hedge funds
D) state and local governments
15) Approximately 60 percent of the funds flowing to nonfinancial businesses come from
________.
A) hedge funds
B) financial intermediaries
C) organized exchanges, like the New York Stock Exchange
D) insurance companies
16) Which of the following statements is correct?
A) assets plus liabilities equal net worth
B) assets plus net worth equal liabilities
C) assets equal liabilities plus net worth
D) liabilities minus net worth equal assets
17) Hedge funds ________.
A) acquire access to funds by accepting deposits then using these monies to lend to households
and firms
B) raise funds by selling commercial paper then lend these funds to consumers
C) acquire access to monies through the payment of premiums by employees
D) are a special type of mutual fund
18) Credit unions ________.
A) acquire access to funds by accepting deposits then use these monies in lending to households
and firms
B) are a special type of mutual fund
C) raise funds by selling commercial paper then lend these funds to consumers
D) acquire access to monies through the payment of premiums by employees
19) Pension funds ________.
A) acquire access to funds by accepting deposits then using these monies to lend to households
and firms
B) raise funds by selling commercial paper then lend these funds to consumers
C) are a special type of mutual fund
D) acquire access to monies through the payment of premiums by employees
20) Finance companies ________.
A) acquire access to funds by accepting deposits then using these monies to lend to households
and firms
B) raise funds by selling commercial paper then lend these funds to consumers
C) acquire access to monies through the payment of premiums by employees
D) are a special type of mutual fund
21) Mutual funds ________.
A) accept deposits and issue loans
B) sell shares and buy financial instruments
C) are a special type of commercial bank
D) issue policies and receive premiums
22) Financial firms whose loans are often $100 or less operate in ________.
A) the microcredit market
B) the hedge fund industry
C) the macrofinance market
D) the credit union sector
23) Direct finance involves ________.
A) borrowing monies from commercial banks
B) issuing securities in financial markets
C) borrowing from the Federal Reserve System
D) issuing insurance policies
24) The principal buyers in financial markets are ________.
A) financial intermediaries
B) nonfinancial businesses
C) commercial banks
D) individual savers
25) The primary source of funds for finance companies is ________.
A) commercial paper
B) deposits
C) securities
D) the central bank
26) The primary source of funds for commercial banks is ________.
A) securities
B) Federal Reserve Banks
C) loans
D) deposits
14.2 Information Challenges and the Financial System
1) If one economic agent possesses more information than their fellow transactor ________.
A) economic transactions cannot occur
B) the moral hazard problem has been eliminated
C) the adverse section problem has been eliminated
D) asymmetric information exists
2) Asymmetric information discourages the movement of funds from savers to borrowers,
because ________.
A) big risks have high payoffs
B) the safe choice is always preferable to the risky choice
C) taking risks is inefficient
D) the loss arising from a failed project must be borne by the borrower, rather than the lender
3) Suppose you have money to lend, but will do so only if you are compensated for the risk of
default. If you set a high interest rate on your loan, a likely consequence is that ________.
A) safe borrowers will look elsewhere, and only risky borrowers will find your terms attractive
B) risky borrowers will look elsewhere, so your money is more likely to go to a safe borrower
C) competition from other lenders will force you to lower your interest rate
D) you will be prosecuted for predatory lending
4) Adverse selection exists because ________.
A) moral hazard exists
B) asymmetric information exists
C) of government regulation
D) financial innovation continually occurs
5) Which of the following statement is untrue?
A) assets equal liabilities plus net worth
B) households and firms are lenders and borrowers in the flow of funds
C) government regulation is the major cause of asymmetric information problems
D) pension funds and insurance companies are financial intermediaries
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6) Suppose you hear of a great deal on a used car and wonder, “Why is the price so low?” This
might be an instance of ________.
A) tyranny of collateral
B) adverse selection
C) the free rider problem
D) moral hazard
7) Providers of health care insurance require applicants to provide information on their medical
history. The purpose may be to minimize which of the following problems?
A) moral hazard
B) adverse selection
C) government taxes
D) opportunity cost
8) The incentive to collect information is undermined by the ________.
A) opportunity cost of collecting information
B) asymmetric character of information flows
C) free rider problem
D) Willamette effect
9) Which of the following is an example of the free-rider problem?
A) Warren Buffett
B) a stow-away
C) banks that will not lend to anyone they haven’t known for years
D) No one takes out the trash, because everyone expects that someone else will.
10) Assume that the riskiest individuals in a given population are the ones most likely to apply
for health insurance. In this situation a provider of health insurance faces the problem of
________.
A) moral hazard
B) opportunity costs
C) tertiary impedence
D) adverse selection
11) Of all financial intermediaries, which of the following holds the most assets?
A) hedge funds
B) the federal government
C) commercial banks
D) corporations
12) Of all financial intermediaries which holds the most assets?
A) pension funds
B) commercial banks
C) insurance companies
D) hedge funds
13) Suppose that a provider of health insurance is concerned that a policy holder will eat
unhealthy foods during the lifetime of their insurance contract. The insurer faces the problem of
________.
A) Antediluvian intransigence
B) opportunity costs
C) moral hazard
D) adverse selection
14) Which of the following is an example of adverse selection?
A) The foulest-tasting medicine is often the most effective.
B) Having secured a loan, a business manager is more likely to have a lavish office party than to
buy new equipment.
C) The clientele at a low-price restaurant are unlikely to leave generous tips.
D) The shiniest packaging often contains disappointment.
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15) Commercial banks limit the adverse selection problem through ________.
A) monitoring
B) restrictive covenants
C) screening
D) moral hazard
16) Which of the following is used by lenders to reduce the problems that arise from
asymmetries of information?
A) patent contracts
B) collateral
C) decreased interest rates
D) restrictive contents
17) A loan contract that requires the borrower to keep a certain percentage of its assets in cash is
an example of ________.
A) screening
B) monitoring
C) a restrictive covenant
D) a patent contract
18) Moral hazard and adverse selection are the result of ________.
A) prudential supervision
B) any and all government policy
C) excessive price fluctuations
D) asymmetries of information
19) In 2012, U.S. banks held ________.
A) $19.4 million in assets
B) $19.4 million in liabilities
C) $19.4 billion in assets
D) $19.4 trillion in assets
20) Banks are most dominant in the financial markets of ________.
A) Canada and Germany
B) Germany and Japan
C) Japan and the United States
D) the United States and Canada
21) In the United States, commercial banks supply about ________% of total credit to
nonfinancial businesses.
A) 20
B) 75
C) 50
D) 90
22) From the perspective of households and businesses deciding where to deposit their money,
the key advantage of the private loans issued by commercial banks is ________.
A) transparency
B) marketability
C) incentive for the bank to collect information
D) relatively high interest rates
23) Restrictive covenants place constraints on the behavior of ________.
A) borrowers
B) lenders
C) the central bank
D) the executive branch of the federal government
24) When property rights are well defined and inexpensive to enforce, ________.
A) collateral is an efficient solution to asymmetric information problems
B) little or no collateral is needed to secure a loan
C) banks become less dominant among intermediaries
D) poor borrowers are at no disadvantage relative to wealthy borrowers
25) The tyranny of collateral ________.
A) suggests that government tax rates are too high in the United States
B) gives rise to the twin problems of moral hazard and adverse selection
C) implies that when a poor person has a good idea they find it difficult to acquire financing
D) attributes moral hazard to excessive government regulation
26) In economies with effective accounting standards and low-cost, reliable information,
________.
A) banks become less dominant among intermediaries
B) the tyranny of collateral is particularly intense
C) funds are available only for activities involving little or no risk
D) restrictive covenants are difficult to enforce
27) Screening and monitoring are costly activities. Why is it a bad idea to impose these costs on
borrowers?
28) How do commercial banks solve asymmetric information problems?
29) How might asymmetric information cause a well-managed bank to be abandoned by its
depositors?
30) If you invest in an “emerging market fund,” your money is probably going to a commercial
bank, rather than directly to nonfinancial businesses. Why? Why is that probably a good thing?
31) Do you think that information technologies will someday eliminate asymmetric information
problems?
14.3 Government Regulation and Supervision of the Financial Sector
1) Government-backed deposit insurance increases the ________.
A) Willamette torsion effect
B) adverse selection problem
C) moral hazard problem
D) the prudential contagion problem
2) Deposit insurance can lead to ________.
A) an increase in adverse selection
B) a decrease in bank costs
C) a decrease in bank lending rates
D) an increase in risks banks take on
3) Government-backed deposit insurance ________.
A) protects “good” banks from the misdeeds of “bad” banks
B) is intended to encourage banks to pursue high-risk activities
C) is an example of prudential regulation
D) is an example of government-directed credit
4) An example of a government-based approach to improve the quality of information in
financial markets is ________.
A) financial news networks
B) mandatory disclosures
C) government-directed credit
D) government safety nets
5) Information asymmetries may make it difficult for important sectors of the economy to
receive the funding they need to keep the economy growing. In many economies, this problem is
addressed with ________.
A) prudential regulation
B) government-directed credit
C) government-backed deposit insurance
D) adverse selection
6) An inherent weakness of ________ is the absence of the profit incentive.
A) government-directed credit
B) government-backed deposit insurance
C) private loans
D) prudential supervision
7) A key objective of a government safety net for the banking system is to ensure ________.
A) that the poor have access to bank services
B) an efficient allocation of credit
C) bank profitability
D) that depositors always believe that their money is safe in the bank
8) The collapse of one bank might lead easily to the failure of several others, because ________.
A) depositors cannot trust each other to keep their money in the bank
B) deposit insurance renders all banks equally fragile
C) no bank can survive when its competitors cease to operate
D) government regulators will step in to punish any bank suspected of poor management
9) Prudential regulation ________.
A) requires that banks maintain the confidentiality of loan applications
B) is administered by a specific insurance company
C) is necessitated by the government’s safety net for the banking system
D) is an effective substitute for prudential supervision
10) The U.S. Securities and Exchange Commission ________.
A) oversees lending policies at commercial banks
B) directs credit to underserved segments of the financial sector
C) promotes transparency in direct finance transactions
D) advises households and businesses on the best companies in which to invest
11) The collapse of Enron Corporation is a reminder of the importance of ________.
A) moral hazard
B) government-directed credit
C) energy trading
D) transparency
12) Prudential regulation ________.
A) is an example of government-directed credit
B) helps to encourage people to abandon banks that engage in excessively risky behaviors
C) provides banking services to economically-disadvantaged households and businesses
D) is more prominent for direct than for indirect finance
13) Prudential supervision is, in essence, the monitoring of ________.
A) borrowers, to enforce restrictive covenants
B) intermediaries, to direct credit to preferred sectors of the economy
C) holders of an insurance policy, to discourage excessively risky behaviors
D) depositors, to discourage sudden withdrawal of funds
14) Overall, government intervention in the financial system ________.
A) is both essential and imperfect
B) prevents adequate market solutions to market problems
C) is continually improving and expanding
D) is incompatible with an efficient allocation of resources
15) What problem is addressed by a government safety net for the banking system? What
problem is caused by the safety net?
16) How might government-directed credit help poor entrepreneurs to escape the “tyranny of
collateral”? What side-effects might undermine the effectiveness of such a program?
17) When is a firm more likely to engage in excessively risky behaviors, when business is well,
or when it is facing financial distress?
14.4 Financial Development and Economic Growth: The Evidence
1) Financial deepening is synonymous with ________.
A) issuing equities
B) financial development
C) borrowing additional funds from world capital markets
D) holding a well diversified portfolio
2) Evidence suggests that financial deepening is of greatest benefit to ________.
A) industries that are highly dependent on external sources of funds
B) family-owned enterprises
C) established firms, rather than new firms
D) child workers
3) An important consequence of financial deepening is ________.
A) an increase in the number of new firms
B) a sharp increase in levels of saving & investment
C) higher profit rates
D) an expansion of bank loans relative to other funding sources
4) Economic growth in China ________.
A) would have been impossible in the absence of its impressive record of financial development
B) occurred despite limited domestic financial development
C) can continue indefinitely without additional financial development
D) has occurred despite a relatively low domestic saving rate
5) Per capita income in China is approximately ________% of the U.S. level.
A) 17
B) 80
C) 40
D) 5
6) Over the past two decades, the saving rate in China has been approximately ________%.
A) 17
B) 80
C) 40
D) 5
7) China’s recent economic performance is most similar to the experience of ________.
A) the United States in the 1890s
B) Japan in the 1960s & 1970s
C) Cuba in the 1990s
D) the Soviet Union in the 1950s & 1960s
8) The single most important contributor to China’s economic growth has been ________.
A) government-directed credit to key economic sectors
B) strong demand for China’s exports
C) rapid improvements in worker productivity
D) a substantial increase in the utilization of labor and capital inputs
9) ________ is among the ingredients of “a first-rate financial system.”
A) Government-directed credit to key economic sectors
B) Greater efficiency of state-owned banks
C) Legal reform to strengthen financial contracts
D) Saving rates of 20% or more
10) What are the benefits of bankruptcy laws that enable lenders to seize the assets of firms that
default on loan contracts?
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11) How might financial deepening contribute to poverty reduction?