c. the secondary market since bonds cannot be sold in the primary market.
d. secondary markets but only using registered bond dealers.
63. Most of the buying and selling in primary markets:
a. is in the public view.
b. is highly transparent and closely monitored by the SEC.
c. involve an investment bank.
d. is done by the Federal Reserve.
64. Secondary financial markets:
a. are financial markets for all financial instruments rated less than investment grade.
b. are financial markets where existing securities are bought and sold.
c. eliminate the transaction costs for buyers and sellers.
d. are only for stock.
65. A collection of assets is known as a(n):
a. asset-backed security.
b. derivative.
c. futures contract.
d. portfolio.
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66. Which of the following would not be an example of a secondary financial market
transaction?
a. You call a broker and purchase 100 shares of McDonalds Corp. stock.
b. You go to the bank and purchase a $5,000 certificate of deposit.
c. You call a broker and purchase a U.S. Treasury bond.
d. You call a broker and purchase a bond issued by General Motors.
67. Which of the following is likely to be a primary financial market transaction?
a. You cash the check your grandmother sent you for your birthday.
b. You call a broker and purchase bonds for your retirement fund.
c. A city issues bonds to finance new road construction.
d. A supermarket needs to borrow the funds for a second location and takes out a loan from a
commercial bank to pay for it.
68. An over-the-counter (OTC) market is:
a. made up of dealers who only sell government bonds.
b. an example of a centralized market.
c. made up of dealer who buy and sell only for their own accounts.
d. made up of dealers who buy and sell for their customers and for their own accounts.
69. The New York Stock Exchange (NYSE) originated as:
a. a decentralized electronic market made up of dealers all over the world.
b. an example of a centralized exchange.
c. a financial market where nearly 100 million shares of stock are traded every business day.
d. the only centralized stock exchange in the world.
70. Over-the-counter (OTC) markets:
a. employ specialists to minimize price volatility.
b. are centralized exchanges but you must be a dealer to be part of an exchange.
c. only deal in the stocks of companies with over $100 million in capital.
d. are networks of security dealers linked electronically.
71. Which of the following is not true of over-the-counter markets?
a. Traders are linked by computer.
b. Dealers buy and sell only for their customers.
c. Trading does not take place in one physical location.
d. Traders are willing to buy and sell stocks and bonds at posted prices.
72. Equity markets are markets:
a. of U.S. Treasury bonds.
b. for AAA rated bonds.
c. for stocks.
d. for either stocks or bonds.
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73. Debt instruments that have maturities less than one year are traded in the:
a. primary market exclusively.
b. bond markets exclusively.
c. bond market if they are already in existence.
d. money market.
74. Money markets are where trades occur for:
a. stocks.
b. bonds of all maturities.
c. derivatives.
d. short-term bonds issued by both governments and private companies.
75. Well-run financial markets:
a. keep transactions costs high to benefit brokers
b. prevent the widespread pooling of information
c. ensure that resources are allocated efficiently
d. are usually the result of little or no government regulation
76. Countries that lack well-defined property laws and legal structures:
a. have large secondary financial markets because the primary markets do not exist.
b. will not develop as fast economically as counties with clear property rights and a formal legal
system.
c. will have much lower transaction costs associated with any level of lending.
d. will not have any financial markets at all.
77. Financial institutions:
a. raise the level of transaction costs relating to borrowing/lending.
b. can lower the information asymmetry involved with
borrowing/lending. c. decrease the liquidity to savers.
d. are required for all financial transactions.
78. An insurance company is an example of a financial institution that:
a. transfers risk.
b. acts as a broker.
c. serves as a depository institution.
d. sells derivative securities.
79. All of the following are depository institutions, except:
a. commercial banks.
b. credit unions.
c. insurance companies.
d. savings banks.
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80. Which of the following are depository institutions?
a. Credit unions
b. Mutual funds
c. Pension funds
d. Insurance companies
81. Nondepository institutions:
a. do not serve as intermediaries.
b. only serve as brokers.
c. only transform assets.
d. do not accept deposits.
82. Non-depository institutions would include all of the following except:
a. finance companies.
b. pension funds.
c. insurance companies.
d. credit unions.
83. Small savers would rather use financial institutions than lend directly to borrowers because:
a. financial institutions will offer the savers higher interest rates than the savers could obtain
directly from borrowers.
b. lenders wouldn’t want to deal with small savers.
c. it allows them to diversify risk.
d. the liquidity is lower with financial institutions but the return is higher.
84. Financial intermediaries pool funds of:
a. many small savers and provide it to a few large borrowers.
b. few large savers and provide it to many small borrowers.
c. few large savers a few large borrowers.
d. many small savers and provide it to many borrowers.
85. Financial intermediaries handle a larger flow of funds than do primary markets primarily
because financial intermediaries:
a. have a government-provided monopoly.
b. have government-regulated prices, so there is little competition.
c. can lower transaction costs and increase liquidity for savers.
d. do not have to worry about information asymmetry.
86. Derivative markets exist to allow for:
a. allow for the transfer of risk.
b. direct transfers of common stocks for bonds.
c. cash receipts from the sale of bonds.
d. reduced information asymmetry.
87. Financial intermediaries include each of the following, except:
a. the New York Stock Exchange.
b. credit unions.
c. savings banks.
d. commercial banks.
88. Which of the following is not considered to be a shadow bank?
a. Credit unions
b. Brokerages
c. Insurers
d. Money–market mutual funds
89. Today the primary distinction between direct and indirect finance is in:
a. direct finance the asset holder has a claim on a financial institution while in indirect finance
the asset holder has a direct claim on the borrower.
b. indirect finance the lender has a direct claim on the borrower while in direct finance the lender
has a claim on a financial institution.
c. direct finance the asset holder has a direct claim on the borrower while in indirect finance the
asset holder has a claim on a financial institution.
d. indirect finance the asset holder has a claim on the government while in direct finance the asset
holder has a direct claim on a private sector corporation.
90. Derivatives would include all of the following except:
a. options.
b. U.S. Treasury securities.
c. swaps.
d. futures.
91. Reasons for the rapid structural change in financial markets in recent years include all of the
following except:
a. globalization.
b. technological advances in computing.
c. technological advances in communication.
d. high real interest rates.
Short Answer Questions
92. What is the relationship between financial market development and economic growth?
94. What are the four characteristics of a financial instrument?
95. Briefly explain one function of financial instruments that can make them very different
from money.
96. Explain why most financial instruments are fairly complex, while at the same time quite
standardized.
97. Credit cards usually charge higher rates of interest than most other forms of lending. In
terms of information, collateral and monitoring, how might these higher rates be explained?
98. Why might a life insurance company insist on an individual having a physical exam before
agreeing to provide life insurance to the individual?
99. An annuity is a contract that makes monthly payments as long as someone lives. Explain
why an individual would want to purchase such a contract. What risk is being transferred?
100. Why are options referred to as derivative instruments?
101. What are the four fundamental characteristics that determine the value of a financial
instrument?
102. A high school basketball player decides to bypass college and go right into the NBA, (the
National Basketball Association). Describe the risk the individual is taking and a contract that
might transfer the risk.
103. Describe what is likely to happen to the average price of a share of stock if the stock
markets decide to close every Friday and Monday to provide workers at the exchanges with
longer weekends.
104. What evidence is there that the transaction costs involved with the buying and selling of
stocks is low?
105. Standard & Poor’s sells information to investors; this is their primary business. Is this an
example of a financial intermediary? Explain.
106. Consider a typical individual who owns the following financial instruments: A life
insurance policy for $250,000; a certificate of deposit for $10,000; homeowner’s and auto
insurance policies; $50,000 in a mutual fund, and $150,000 in her pension fund at work. Which
of these are instruments used primarily as stores of value and which are being used to transfer
risk?
107. Explain how the introduction of asset-backed securities has allowed investors to take
advantage of higher returns from loans that most investors could never make on their own.
108. How do financial markets pool and communicate the information regarding issuers of
financial instruments in a convenient way?
109. Can a financial instrument be bought and sold in both a primary and secondary financial
market? Explain.
110. Is the obtaining of a car loan a primary or secondary market transaction?
111. Why didn’t the over-the-counter (OTC) exchanges suffer the disruption of service that the
New York Stock Exchange did after the terrorist attacks of September 11, 2001?
112. What is the primary distinction between debt/equity markets and derivative markets?
113. What is meant by the “paradox of leverage?”
114. Why has the pace of structural change in financial markets accelerated in recent years?
115. What are some of the advantages of trading in decentralized electronic exchanges?
Essay Questions
116. As we saw in the chapter, some financial instruments are used primarily to transfer risk.
Explain how a bread maker can use a financial instrument to transfer the following risk: the bread
maker has the opportunity to provide bread to a local army base. The base figures they will need
10,000 loaves of bread each week, or roughly 500,000 for a year. The problem is the baker must
quote a price for the entire year. The baker would really like to have this contract but he realizes
that fluctuating input prices (specifically wheat) could result in significant losses.
117. Suppose that an internet-based program, Novus, wants to raise $10 million to expand its
business operations. Describe how Novus can raise these funds directly through each of the
follow options: issuing stock, issuing bonds, or obtaining a bank loan. Compare and contrast
these three options.
118. Explain the various ways that financial intermediaries increase the efficiency of an
economy.
119. Compare and contrast financial institutions that act as brokers to those that transform
assets. In what sense are both types of institutions financial intermediaries? Provide one example
of each type and describe how each functions as a financial intermediary.
120. Trading in electronic exchanges has grown tremendously in recent years, what are some of
the disadvantages of trading in decentralized electronic exchanges?