Chapter 8  An Economic Analysis of Financial Structure

 

 

1)   American businesses get their external funds primarily from

A) bank loans.                                             B)  bonds and commercial paper issues.

C) stock issues.                                           D)  other loans.

 

Answer: A

 

5)   Of the sources of external funds for nonfinancial businesses in the United States, corporate bonds and commercial paper account for approximately _____ of the total.

A) 5% B)  10% C)  30% D)  50%

 

Answer: C

 

10) Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true?

A) Bonds are a far more important source of finance than are stocks.

B) Stocks and bonds, combined, supply less than one-third of the external funds.

C) Financial intermediaries such as banks are the most important source of external funds.

D) All of the above.

E) Only (a) and (b) of the above.

 

Answer: D

 

15) Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true?

A) In the mid- to late 1980s, American corporations in the aggregate did not issued shares to finance their activities.

B) Issuing marketable securities is the primary way businesses finance their operations.

C) Direct finance is twice as important as indirect finance as a source of external funds to business.

D) Direct finance is fifty percent more important than indirect finance as a source of external funds to business.

 

Answer: A

 

20) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements?

A) Marketable securities account for a larger share of external business financing in the United States than in most other countries.

B) In the period 1970-1985, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households.

C) The stock market accounted for a sizeable fraction of the financing of American businesses in the 1970-1985 period.

D) All of the above.

E) Only (a) and (b) of the above.

 

Answer: E

 

25) The predominant form of household debt contract is

A) consumer installment debt.                      B)  collateralized debt.

C) unsecured debt.                                      D)  none of the above.

 

Answer: B

 

30) If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of

A) moral hazard.                                         B)  adverse selection.

C) free-riding.                                             D)  costly state verification.

 

Answer: B

 

35) Because of the adverse selection problem,

A) good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks.

B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town."

C) lenders are reluctant to make loans that are not secured by collateral.

D) all of the above.

 

Answer: C

 

40) In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the

A) Federal Communications Commission.

B) Federal Trade Commission.

C) Securities and Exchange Commission.

D) U.S. Treasury Department.

E) Federal Reserve System.

 

Answer: C

 

45) The concept of adverse selection helps to explain

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets.

B) why indirect finance is more important than direct finance as a source of business finance.

C) why direct finance is more important than indirect finance as a source of business finance.

D) only (a) and (b) of the above.

E) only (a) and (c) of the above.

 

Answer: D

 

50) Mishkin's analysis of adverse selection indicates that financial intermediaries

A) overcome free-rider problems by holding non-traded loans.

B) must buy securities from corporations to diversify the risk that results from holding non-tradable loans.

C) have not been very successful in dealing with adverse selection problems in financial markets.

D) do all of the above.

E) do only (a) and (b) of the above.

 

Answer: A

 

55) The concept of adverse selection helps to explain

A) why financial markets are among the most heavily regulated sectors of the economy.

B) why only large, well-established corporations have access to securities markets.

C) why collateral is an important feature of debt contracts.

D) all of the above.

E) only (a) and (b) of the above.

 

Answer: D

 

60) Government regulations designed to reduce the moral hazard problem include

A) laws that force firms to adhere to standard accounting principles.

B) stiff criminal penalties for those who commit fraud.

C) state verification subsidies.

D) all of the above.

E) only (a) and (b) of the above.

 

Answer: E

 

65) Equity contracts account for a small fraction of external funds raised by American businesses because

A) costly state verification makes the equity contract less desirable than the debt contract.

B) of the greater scope for moral hazard problems under equity contracts, as compared to debt contracts.

C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt.

D) of all of the above.

E) of both (a) and (b) of the above.

 

Answer: E

 

70) Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets?

A) Covenants reduce moral hazard by restricting borrowers' undesirable behavior.

B) Covenants require that borrowers keep collateral in good condition.

C) Covenants require that borrowers maintain high net worth.

D) All of the above.

E) Only (a) and (b) of the above.

 

Answer: D

 

75) Financial intermediaries and, particularly, banks have the ability to avoid the free-rider problem as long as they primarily

A) make private loans.

B) acquire a diversified portfolio of stocks.

C) buy junk bonds.

D) do a balanced combination of (a) and (b) of the above.

 

Answer: A

 

80) Factors that lead to worsening conditions in financial markets include:

A) declining interest rates.

B) unanticipated increases in the price level.

C) the deterioration in banks' balance sheets.

D) only (a) and (c) of the above.

E) only (b) and (c) of the above.

 

Answer: C

 

85) If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

A) Increase in interest rates                                     B)  Bank panic

C) Stock market decline                               D)  Increase in uncertainty

 

Answer: B

 

90) Moral hazard in equity contracts is known as the _____ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

A) principal-agent                                        B)  adverse selection

C) free-rider                                               D)  debt deflation

 

Answer: A

 

95) Which of the following is not one of the eight basic puzzles about financial structure?

A) The financial system is among the most heavily regulated sectors of the economy.

B) Issuing marketable securities is the primary way businesses finance their operations.

C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.

D) Banks are the most important source of external funds to finance businesses.

 

Answer: B

 

100)   Which of the following are true statements concerning financial structure in the United States?

A) Issuing marketable securities is not the primary way businesses finance their operations.

B) Bonds are a far more important source of finance than are stocks in the United States.

C) Together, bonds and stocks supply less than one-third of the external funds that corporations use to finance their activities.

D) All of the above are true statements.

 

Answer: D

 

105)   Because managers (_____) have less incentive to maximize profits than the stockholders-owners (_____) do, stockholders find it costly to monitor managers; thus, they are reluctant to purchase equities.

A) principals; agents                                 B)  principals; principals

C) agents; agents                                                 D)  agents; principals

 

Answer: D

 

110)   Because information is scarce,

A) helps explain why equity contracts are used so much more frequently to raise capital than are debt contracts.

B) monitoring managers gives rise to costly state verification.

C) government regulations, such as standard accounting principles, can help reduce moral hazard.

D) all of the above are true.

E) only (b) and (c) of the above are true.

 

Answer: E

 

115)   Most financial crises in the United States have begun with

A) a sharp rise in interest rates.

B) a steep stock market decline.

C) an increase in uncertainty resulting from the failure of a major firm.

D) all of the above.

E) only (a) and (b) of the above.

 

Answer: D

 

120)   Factors that lead to worsening conditions in financial markets include

A)    bankers' lack of expertise in screening and monitoring borrowers.         

B)     declining stock prices.

C)     declining interest rates.          

D)    only (a) and (b) of the above.

E)     only (b) and (c) of the above.

 

Answer: D

 

125)  Factors that lead to worsening conditions in Mexico's 1994-1995 financial markets include

A) failure of the Mexican oil monopoly.

B)  the ratification of the North American Free Trade Agreement.

C)  the failure to ratify the North American Free Trade Agreement.

D)  all of the above.

E)  only (a) and (b) of the above.

 

Answer: C