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Chapter 03
Financial Instruments, Financial Markets, and Financial Institutions
Multiple-Choice Questions
1. A financial intermediary:
a. is an agency that guarantees a loan.
b. is a third-party that facilitates a transaction between a borrower and a lender.
c. would be used in direct finance.
d. must be a depository institution.
2. Most individuals borrow:
a. directly without the use of a financial intermediary.
b. using a financial intermediary because it lowers the cost of borrowing.
c. using a financial intermediary, but would save money if they financed directly.
d. without using financial intermediaries, preferring credit cards.
3. Tom obtains a car loan from Old Town Bank.
a. The car loan is Tom’s asset and the bank’s liability.
b. The car loan is Tom‘s asset, but the liability belongs to the bank’s depositors.
c. The car loan is Tom’s liability and an asset for Old Town Bank.
d. The car loan is Tom‘s liability and a liability of the bank until Tom pays it off.
4. The ultimate role of the financial system of a country is to:
a. provide a place for wealthy households to save.
b. be a low-cost source of funds for government.
c. facilitate production, employment, and consumption.
d. provide jobs in the financial sector.
5. Loans made between borrowers and lenders are:
a. liabilities to the lenders and assets to the borrowers since the borrower obtains the funds.
b. assets to the lenders and liabilities of the borrowers since the promises are made to the lenders.
c. not part of either parties’ assets or liabilities until the loans are repaid.
d. liabilities to both the lenders and the borrowers.
6. Financial instruments are used to channel funds from:
a. savers to borrowers in financial markets and via financial institutions.
b. savers to borrowers in financial markets but not through financial institutions.
c. borrowers to savers in financial markets but not through financial institutions.
d. borrowers to savers through financial institutions, but not in financial markets.
7. Loans made between borrowers and lenders are:
a. usually not taxable at the federal level.
b. legal only in the state of origination.
c. assets of the lenders.
d. assets of the borrowers.
8. Loans made between lenders and borrowers are:
a. assets to the borrowers.
b. liabilities of the lenders.
c. not taxable in the state of origination.
d. liabilities of the borrowers.
9. The process of financial intermediation:
a. creates a net cost to an economy.
b. increases the economy’s ability to produce.
c. is always used when a borrower needs to obtain funds.
d. is used primarily in underdeveloped countries.
10. Which of the following statements is most correct?
a. Financial intermediaries are banks.
b. A bank is a financial intermediary.
c. Financial intermediaries are insurance companies.
d. Financial intermediaries are essential to direct finance.
11. Which of the following statements is most correct?
a. All banks are financial intermediaries, but not all financial intermediaries are banks.
b. Financial intermediaries must be public corporations.
c. All financial intermediaries are insurance companies.
d. Financial intermediaries are government agencies.
12. Which of the following is not a financial intermediary?
a. A bank
b. An insurance company
c. The New York Stock Exchange
d. A mutual fund
13. Mary purchases a U.S. Treasury bond; the bond is a(n):
a. asset of the U.S. government as well as an asset for Mary.
b. liability of the U.S. government and an asset for Mary.
c. asset for Mary but not a liability of the U.S. Government.
d. asset for the government but a liability for Mary.
14. A financial instrument would include:
a. only a written obligation and a transfer of value.
b. only a written obligation and a specified date.
c. a written obligation, a transfer of value, a future date, and certain conditions.
d. a written obligation, a transfer of value, a specific date for payment, uncertain conditions.
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15. Which of the following is not a financial instrument?
a. A share of Microsoft stock
b. A U.S. Treasury Bond
c. An electric bill
d. A life insurance policy
16. Sue has a checking account at the First National Bank; her checking account is a(n):
a. asset to the bank and a liability to Sue.
b. asset to Sue and a liability to the bank.
c. asset to Sue but actually a liability to the Federal Reserve.
d. liability to Sue until she spends the funds.
17. Financial instruments and money share which of the following characteristics?
a. Both can function as a means of payment and a store of value.
b. Both can function as a store of value and allow for trading of risk.
c. Both can function by acting as a means of payment and allow for trading of risk.
d. Both can function as a store of value even though they do not allow for trading of risk.
18. Financial instruments are different from money because they:
a. can act as a store of value and money cannot.
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b. can’t be a means of payment but money can.
c. can allow for the transfer of risk.
d. have greater liquidity.
19. Juan purchases automobile insurance; the insurance contract is a:
a. financial instrument.
b. form of money.
c. transfer of risk from the insurance company to Juan.
d. financial intermediary.
20. A bank is a financial intermediary. Which of the following statements is most accurate?
a. The bank’s depositors are the ultimate lenders and the bank is the ultimate borrower.
b. People seeking loans from the bank are the ultimate spenders while the bank is the ultimate
lender.
c. The bank’s depositors are the ultimate lenders, while those seeking loans from the bank are the
ultimate spenders.
d. Those seeking loans from the bank are the ultimate spenders; the bank’s stockholders are the
ultimate lenders.
21. Which of the following statements is most correct?
a. When a risk is difficult to predict, financial instruments are created to transfer these risks.
b. Financial instruments are created to transfer risks that are relatively easy to predict.
c. Financial instruments require certainty of an event to be able to transfer risk.
d. Financial instruments eliminate the risk from uncertainty, they do not transfer it.
22. Standardization of financial instruments has occurred as a result of:
a. the rule of 70.
b. the law of demand.
c. economies of scale.
d. the law of supply.
23. More detailed financial instruments tend to be:
a. less costly because all possible contingencies are covered.
b. more costly because it will cost more to create.
c. more desirable than less detailed ones, no matter what the price.
d. less costly because they can be standardized more easily.
24. Many financial instruments are standardized because:
a. it is believed that most parties to a contract do not read them anyway.
b. complexity is costly, the more complex a contract, the more it costs to create.
c. the standardization of contracts makes them harder to understand.
d. it is required by the government.
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25. A share of Ford Motor Company stock is an example of:
a. a non-standardized financial instrument.
b. a standardized financial instrument.
c. a non-standardized financial instrument since their prices can differ over time.
d. a financial instrument without risk.
26. A counterparty to a financial instrument is always the:
a. issuer of the financial instrument.
b. government agency guaranteeing the value of the instrument.
c. person or institution that purchases the financial instrument.
d. person or institution that is on the other side of the financial contract.
27. The information concerning the issuer of a financial instrument:
a. needs to be complete and closely monitored by the buyers of the instrument for change.
b. is somewhat non-standardized to minimize the cost of the instrument.
c. is usually standardized to the essential information required by the buyers.
d. is closely monitored by the buyers of these instruments for change.
28. Asymmetric information in financial markets is a potential problem usually resulting from:
a. borrowers having more information than the lenders.
b. lenders having more information than borrowers.
c. the fact that people are basically dishonest.
d. the uncertainty about Federal Reserve monetary policy.
29. Agencies exist which rate bonds based on characteristics of the borrower. Such bond rating
agencies are an example of a financial market response designed to:
a. increase information asymmetry.
b. decrease the real return to bondholders.
c. provide a lower cost solution to the high cost of information.
d. transfer risk from the buyer to the rating agency.
30. The better the information provided to financial markets the:
a. less the amount of funds transferred between savers and borrowers.
b. greater the amount of funds transferred between savers and borrowers, though risk increases.
c. higher the return required by lenders.
d. greater will be the flow of funds in these markets.
31. Financial markets enable the transfer of risk by:
a. requiring that risk-averse investors have access to U.S. Treasury bond markets.
b. allowing individuals and firms less willing to bear risk to transfer risk to other individuals and
firms more willing to bear risk.
c. making sure that higher default risk is offset by greater liquidity.
d. enabling even unsophisticated investors to purchase highly complex financial instruments.
32. A borrower has information that is not available to a prospective lender; this is an example
of:
a. a wise borrower and an unwise lender.
b. a transfer of risk.
c. information asymmetry.
d. liquidity risk.
33. Disability income insurance is:
a. insurance borrowers can take out in case the company they invest in defaults.
b. insurance that makes payments of wages to workers when the company they work for is
disabled due to a natural disaster.
c. insurance that makes payments to workers when they are unable to work due to an injury.
d. only available through the government as part of the Social Security System.
34. The owner of a small business applies for a bank loan and tells the loan officer that the funds
will be used to expand inventory for the upcoming holiday season. The small business finds itself
in need of additional funds to meet the monthly rent for the next quarter and the owner uses the
loan proceeds to pay the rent. This is an example of:
a. liquidity risk.
b. default risk.
c. a lack of diversification for the bank.
d. information asymmetry.
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35. A share of Microsoft stock would best be described as which of the following?
a. A derivative instrument
b. A means of payment
c. An underlying instrument
d. A debt instrument
36. A derivative instrument:
a. comes into existence after the underlying instrument is in default.
b. is a low-risk financial instrument used by highly risk-averse savers.
c. gets its value and payoff from the performance of the underlying instrument. d.
should be purchased prior to purchasing the underlying security.
37. A futures contract is an example of:
a. a derivative instrument.
b. an instrument used solely by financial institutions.
c. a high-risk security that will only have value if certain events occur.
d. a contract that is traded but is not a financial instrument.
38. The primary use of derivative contracts is:
a. for IRA and other pension plans since they only have value well into the future.
b. to shift risk among investors.
c. for investors seeking a greater return by taking greater risk.
d. to add to the profits an investor obtains through information asymmetry.
39. Considering the value of a financial instrument, the bigger the size of the promised payment
the:
a. less valuable the financial instrument because risk must be greater.
b. longer an investor has to wait for the payment.
c. more valuable the financial instrument.
d. greater the risk.
40. Considering the value of a financial instrument, the sooner the promised payment is made:
a. the less valuable is the promise to make it since time is valuable.
b. the greater the risk, therefore the promise has greater value.
c. the more valuable is the promise to make it.
d. the less relevant is the likelihood that the payment will be made.
41. Considering the value of a financial instrument, the more likely it is the payment will be
made:
a. the more valuable the financial instrument.
b. the less valuable is the instrument because risk is lower.
c. the less valuable is the financial instrument because it is highly liquid.
d. the greater the uncertainty; therefore the less valuable is the financial instrument.
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42. Considering the value of a financial instrument, the circumstances under which the payment
is to be made influence the value because:
a. we like uncertain payoffs because this adds to the return.
b. payments that are made when we need them the most are more valuable.
c. the sooner the payment is to be made the better.
d. we know when certain events are going to occur and that is when we want the payment.
43. The fundamental characteristics influencing the value of a financial instrument include each
of the following except:
a. the size of the payment promised.
b. when the promised payment will be made.
c. where the instrument is traded.
d. the likelihood of payment.
44. The value of a financial instrument rises as:
a. the size of the payment promised decreases.
b. the promised payment is made sooner rather than later.
c. it is less likely the payment will be made.
d. the payments are made when the prospective investor needs them least.
45. Consider the price paid for debt issued by the State of California. Which of the following
would lead to a decrease in the value of State of California bonds?
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a. The State of California bonds are in small dollar amounts.
b. The State of California bonds have a shorter maturity.
c. The State of California experiences a fiscal crisis that makes it less likely it will be able to
honor its interest payments.
d. The State of California pays back its previous bonds ahead of schedule.
46. Financial instruments used primarily as stores of value include each of the following,
except:
a. bonds.
b. futures contracts.
c. stocks.
d. home mortgages.
47. Financial instruments used primarily as stores of value would not include:
a. a car insurance policy.
b. a U.S. Treasury bond.
c. shares of General Motors stock.
d. a home mortgage.
48. Financial instruments used primarily to transfer risk would include all of the following,
except:
a. an insurance contract.
b. a futures contract.
c. options.
d. a bank loan.
49. Financial instruments used primarily to transfer risk would not include:
a. a bank loan.
b. options.
c. an insurance policy.
d. home mortgages.
50. Which of the following financial instruments is used mainly to transfer risk?
a. Asset-backed securities
b. Bonds
c. Options
d. Stocks
51. Financial instruments used primarily as stores of value do not include:
a. asset backed securities.
b. U.S. Treasury bonds.
c. a car insurance policy.
d. a bank loan.
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52. The most prominent of asset-backed securities is:
a. shares of stock in corporations since stockholders own the assets.
b. securities backed by home mortgages.
c. U.S. Treasury bonds since they are backed by all public assets.
d. movie box-office receipts.
53. Roles served by financial markets include the following, except:
a. eliminating risk.
b. providing liquidity.
c. pooling and communicating information.
d. sharing of risk.
54. If financial markets didn’t exist:
a. required returns would be lower since fewer instruments would trade.
b. liquidity would diminish and returns would be lower.
c. more funds would flow directly between borrowers and savers.
d. liquidity would diminish, reducing the flow of funds between borrowers and savers.
55. The high volume of shares of stock that are traded on a normal day on stock markets
reflects the:
a. high transaction costs associated with these financial markets.
b. low transaction costs and high liquidity associated with these markets.
c. low transaction costs and low liquidity associated with these markets.
d. high transactions costs and low liquidity associated with these markets.
56. The pool of information collected by financial markets is usually:
a. only available to lenders.
b. summarized in the form of a price.
c. valuable and not made available until the parties pay for it.
d. more than a borrower needs to make a loan.
57. Financial markets:
a. enable buyers and sellers to exchange financial instruments but not risk.
b. enable buyers and sellers to exchange risk by buying and selling financial instruments.
c. only allow the transfer of risk through derivative securities.
d. do not allow for the transfer of risk but do help reduce it.
58. Commissions paid to a stock broker are an example of:
a. risk transfer.
b. transaction costs.
c. information asymmetry.
d. liquidity.
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59. Brokerage commissions:
a. are set by government regulators so they cannot vary across firms for the same services.
b. can vary but typically don’t because firms tend to set them at the same levels.
c. can differ reflecting the different services being offered.
d. are always a percentage of the amount of the trade.
60. A primary financial market is:
a. a market just for corporate stocks.
b. a market only for AAA rated Securities. c.
the New York Stock Exchange.
d. one in which newly issued securities are sold.
61. A primary financial market is:
a. located only in New York, London, and Tokyo but can handle transactions anywhere in the
world.
b. one where the borrower obtains funds directly from the lender for newly issued securities.
c. a market where U.S. Treasury bonds are traded.
d. one that can only deal in the highest investment grade securities.
62. Newly issued U.S. Treasury Securities are sold in:
a. the primary financial market.
b. only to the Federal Reserve who then resells them.