FINC 3700 Ch7

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1) Adverse selection and moral hazard problems increased in magnitude during the early years of the Great Depression as

A) stock prices declined to 10 percent of their level in 1929. B) the aggregate price level declined. C) banks failed. D) a result of all of the above.
E) a result of A and B of the above.

2) Financial crises in the United States and Mexico

A) were different because in Mexico speculative attacks in the foreign exchange market played a key role. B) were similar in being precipitated by an increase in interest rates abroad. C) were similar in being preceded by stock market declines. D) all of the above. E) only A and C.

3) 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.

4) Because of the adverse selection problem,

A) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip
town." B) good credit risks are more likely to seek loans, causing lenders to make a disproportionate amount of
loans to good credit risks. C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

5) One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the

A) pawn broker. B) savings and loan association. C) money market mutual fund. D) venture capital firm.

6) In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will

A) reflect the lowest quality of used cars in the market. B) reflect the average quality of used cars in the market. C) reflect the highest quality of used cars in the market. D) none of the above.

7) Of the following sources of external finance for American nonfinancial businesses, the least important is

A) bonds and commercial paper. B) nonbank loans. C) stocks.
D) loans from banks.

8) The authors' analysis of adverse selection indicates that financial intermediaries

A) must buy securities from corporations to diversify the risk that results from holding non-tradable loans. B) overcome free-rider problems by holding non-traded 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.

9) Which of the following factors led up to the Mexican financial crisis of 1994?

A) Speculative attacks on the peso and a rise in actual and expected inflation. B) A rise in foreign interest rates and domestic stock market declines. C) A rise in domestic interest rates and a deterioration in bank balance sheets. D) all of the above. E) only B and C.

10) Solutions to the moral hazard problem include

A) high net worth.
B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) all of the above. E) only A and B of the above.

11) Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be _________, which gives rise to the problem of _________.

A) high; adverse selection B) low; moral hazard C) high; moral hazard D) low; adverse selection

12) 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) Since 1970, less than 5 percent of newly issued corporate bonds and commercial paper have been sold directly to American households.
C) The stock market accounted for the largest share of the financing of American businesses in the 1970-2000 period.
D) All of the above. E) Only A and B of the above.

13) Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately _________ of the total.

A) 30 percent B) 20 percent C) 40 percent D) 10 percent

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

A) bank panics.
B) unanticipated increases in the price level. C) declining interest rates. D) only A and C of the above. E) only B and C of the above.

15) Stock market declines preceded a full blown financial crisis

A) in Indonesia in 1997.
B) in Thailand in 1997. C) in the United States in 1987. D) all of the above. E) only B and C.

16) The concept of adverse selection helps to explain

A) why collateral is not a common feature of many debt contracts. B) why financial markets are among the most heavily regulated sectors of the economy. C) why large, well-established corporations find it so difficult to borrow funds in securities markets. D) all of the above.

17) Argentina's 2001-2002 financial crisis was precipitated by

A) a weak and poorly supervised banking system. B) difficulty financing a large budget deficit. C) a decline in interest rates.
D) a lending boom that fueled a stock market bubble.

18) 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) Stock market decline B) Increase in interest rates C) Increase in uncertainty D) Bank panic

19) Moral hazard is a problem associated with debt and equity contracts arising from

A) the borrower's incentive to undertake highly risky investments. B) the owners' inability to ensure that managers will act in the owners' interest. C) the difficulty lenders have in sorting out good credit risks from bad credit risks. D) all of the above.
E) only A and B of the above.

20) The pecking order hypothesis predicts that the _________ a corporation is, the more likely it will be to _________.

A) smaller and less well known; need external financing B) larger and more well known; issue securities C) larger and more well known; borrow from financial intermediaries D) smaller and less well known; issue securities

21) Debt contracts

A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. B) are used much more frequently to raise capital than are equity contracts. C) have an advantage over equity contracts in that they have a lower cost of state verification. D) all of the above. E) only A and B of the above.

22) Financial crises

A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the
failures of many financial and nonfinancial firms. B) frequently lead to sharp contractions in economic activity. C) occur when adverse selection and moral hazard problems in financial markets become more significant. D) all of the above. E) only A and B of the above.

23) The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of non-traded loans),

A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance.
B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem.
C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds.
D) all of the above. E) only A and B of the above.

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

A) increasing uncertainty in financial markets. B) declining stock prices. C) increases in interest rates.
D) all of the above. E) only A and B of the above.

25) Of the following sources of external finance for American nonfinancial businesses, the most important is

A) bonds and commercial paper. B) loans from banks. C) stocks.
D) nonbank loans.

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