Financial Markets and Institutions, 8e (Mishkin)
Chapter 22 Investment Banks, Security Brokers and Dealers, and Venture Capital Firms
22.1 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) In a ________, new issues of a security are sold to buyers by the corporation or government
agency ultimately using the funds.
A) primary market
B) secondary market
C) capital market
D) money market
3) In a ________, a security is sold between investors, and does not (necessarily) involve the
corporation or government agency ultimately using the funds.
A) primary market
B) secondary market
C) capital market
D) money market
4) 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.
5) During the Depression, about ________ banks failed (about 40% of all commercial banks).
A) 500
B) 1,000
C) 5,000
D) 10,000
6) 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
7) 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.
8) 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.
9) 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
10) 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.
11) 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
12) 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.
13) 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.
14) 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.
15) 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
16) 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
17) Most investment banks are attached to
A) large commercial banks.
B) large brokerage houses.
C) finance companies.
D) large nonfinancial corporations.
18) From an investment banker’s perspective, the best outcome occurs when a new issue is
________.
A) undersubscribed
B) fully subscribed
C) oversubscribed
D) syndicated
19) 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
20) The largest U.S. underwriter of global debt and equity issues, as of 2009, was ________.
A) Merrill Lynch
B) J.P. Morgan
C) Morgan Stanley
D) Goldman Sachs
21) 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
22) 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 efforts
B) brokered
C) private-placement
D) jump-start
23) 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.
24) 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) are only A and B of the above.
25) The most active investment banking firm in the private placement market is ________.
A) Merrill Lynch
B) Lehman Brothers
C) Goldman Sachs
D) Morgan Stanley
26) 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
27) 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
28) 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.
29) 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.
30) 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
31) The best known investment banker involved in mergers and acquisitions, credited with
inventing the junk bond market, is ________.
A) Ivan Boesky
B) Michael Milken
C) James Garner
D) Michael Douglas
32) ________ 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
33) The securities sales, the ________ price is the price that the broker pays for securities they
buy for their inventory.
A) bid
B) ask
C) midpoint
D) transaction
34) The securities sales, the ________ price is the price that the broker receive when they sell the
securities.
A) bid
B) ask
C) midpoint
D) transaction
35) 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
36) 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.
37) 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.
38) 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.
39) 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
40) 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
41) 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
42) 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
43) 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
44) To take advantage of anticipated stock price decreases, an investor would use ________.
A) a market order
B) a limit order
C) a short sell
D) margin credit
45) 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.
46) The largest full-service broker is ________ with about 17,000 financial advisors and $2.2
trillion in client assets.
A) Bank of America Merrill Lynch
B) Charles Schwab Corp.
C) Ameritrade
D) Smith Barney
47) A full-service broker offers its clients all of the following except
A) execution of trades on request.
B) low transaction fees.
C) research and investment advice.
D) development of long-term customer relationships.
48) 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.
49) A securities dealer stands ready to make a market in the security at any time. For this reason,
dealers are also called ________.
A) market makers
B) “brokers and dealers”
C) liquidity traders
D) demand dealers
50) If an investment is liquid, it can be sold ________.
A) quickly
B) anonymously
C) only on “rainy” days
D) through a full-service broker
51) 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
52) 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
53) The first true venture capital firm was ________, established in 1946 by MIT president Karl
Compton and local business leaders.
A) American Research & Development (ARD)
B) Charles River Development
C) Redsocks Capital
D) the MIT Fund
54) Which of the following is the first phase in the life cycle of a venture capital deal?
A) A limited partnership is formed and funds are raised.
B) Funds are invested in start-up companies.
C) The venture firm exits the investment.
D) The venture firm seeks approval from the S.E.C.
55) Which of the following is the second phase in the life cycle of a venture capital deal?
A) A limited partnership is formed and funds are raised.
B) Funds are invested in start-up companies.
C) The venture firm exits the investment.
D) The venture firm seeks approval from the S.E.C.
56) Which of the following is the third and final phase in the life cycle of a venture capital deal?
A) A limited partnership is formed and funds are raised.
B) Funds are invested in start-up companies.
C) The venture firm exits the investment.
D) The venture firm seeks approval from the S.E.C.
57) Venture capital firms are usually organized as ________.
A) closed-end mutual funds
B) limited partnerships
C) corporations
D) nonprofit businesses
58) 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
59) 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
60) 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) done none of the above.
61) 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
62) 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.
63) The 20-year average return of venture capital firms has been about ________.
A) 56%
B) 8%
C) 24%
D) 102%
64) 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
65) 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
66) 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 occur
67) Which of the following 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
subpar companies.
C) Both A and B.
D) Neither A nor B.
68) 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
69) There are ________ risk and ________ returns to investors in private equity buyouts.
A) high; low
B) low; high
C) high; high
D) low; low
70) Which of the following is a description of a public firm acquired by a private equity
investment?
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 are correct.
22.2 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) To help raise the money to finance railroad expansions, J. P. Morgan’s father resided in
London and sold Morgan railroad securities to European investors.
4) 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.
5) Investment banks form syndicates to reduce the risk involved in selling new securities.
6) Resisted takeovers are called hostile.
7) Private placements are more common for the sale of stocks than for bonds.
8) 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.
9) One disadvantage of the private placement of securities issues is the high cost of registering
the issue.
10) Junk bonds are high-risk, high-return equity securities that were used primarily to finance
takeover attempts.
11) The Securities Acts Amendment of 1975 abolished fixed commissions.
12) An investment pool is formed to manipulate the market for a stock by spreading false rumors
about the health of the firm.
13) Venture capital firms reduce risk by investing in only a few companies which can be
carefully monitored and nurtured.
14) Investors in venture capital firms expect to profit quickly from their investment.
15) 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 rate rather than the 35% rate they would suffer if the income
was received as income.
16) In a typical private equity buyout, a partnership is formed and private equity investors are
contacted to pledge participation.
17) Within the broad universe of private equity sectors, the two most common are venture funds
and capital buyouts.
1) Explain how rulings by the courts and regulators have made the markets served by both
commercial and investment banks more competitive.
2) Discuss the difference between full-service and discount brokers.
3) What services do investment bankers provide for firms that are issuing new securities?
4) What is underwriting?
5) How do best efforts agreements and private placements differ from the usual process of
underwriting new securities issues?
6) Explain why private placements of securities are an attractive way of raising funds for some
firms.
7) Describe the differences between securities brokers and securities dealers.
8) What niche in the financial system do venture capital firms fill?
9) Discuss some of the abuses in the market prior to the passage of the securities acts in 1933 and
1934.
10) How do venture capital firms overcome the problem of information asymmetries that
accompany start-up firms?
11) What is the difference between a venture fund and a capital buyout?
12) Discuss the several ways in which venture capitalists reduce asymmetric information.
13) Discuss the advantages of a private equity buyout.
14) Discuss the life cycle of a equity buyout.
15) What ultimately happened to Webvan, the Internet grocer that received more than $1 billion
in venture financing.