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The process where financial intermediaries create and sell lowrisk assets and use the proceeds to purchase riskier assets

risk sharing

The time and money spent in carrying out financial transactions are called

transaction costs

Government regulations to reduce the possibility of financial panic include all of the following except

transactions costs

One reason for the extraordinary growth of foreign financial markets is

increases in the pool of savings in foreign countries

Which of the following is a depository institution

A mutual savings bank

The problem created by asymmetric information before the transaction occurs is called _, while the problem created after the transaction occurs is called _

adverse selection; moral hazard

Which of the following can be described as involving indirect finance

You make a deposit at a bank

The agency that was created to protect depositors after the banking failures of is the

Federal Deposit Insurance Corporation

An important financial institution that assists in the initial sale of securities in the primary market is the

investment bank

Distinguish between a foreign bond and a Eurobond

A foreign bond is sold in a foreign country and priced in that country's currency A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency

An important function of secondary markets is to

make it easier to sell financial instruments to raise funds

Financial markets have the basic function of

getting people with funds to lend together with people who want to borrow funds

Which of the following are investment intermediaries

Mutual funds

Which of the following financial intermediaries is not a depository institution

A finance company

Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as

foreign bonds

Securities are _ for the person who buys them, but are _ for the individual or firm that issues them

assets; liabilities

Which of the following are shortterm financial instruments

A repurchase agreement

US Treasury bills pay no interest but are sold at a _ That is, you will pay a lower purchase price than the amount you receive at maturity


_ are shortterm loans in which Treasury bills serve as collateral

Repurchase agreements

Which of the following are not contractual savings institutions

Credit unions

The countries that have made the least use of securities markets are _ and _; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets

Germany; Japan

Savings and loan associations are regulated by the

Office of Thrift Supervision

A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called

a negotiable certificate of deposit

Every financial market has the following characteristic

It channels funds from lenderssavers to borrowersspenders

Which of the following instruments are traded in a money market

US Treasury bills

Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project The difference in information is called

asymmetric information

Risk sharing is profitable for financial institutions due to

low transactions costs

Increasing the amount of information available to investors helps to reduce the problems of _ and _ in the financial markets

adverse selection; moral hazard

The regulatory agency that sets reserve requirements for all banks is

the Federal Reserve System

_ institutions are financial intermediaries that acquire funds at periodic intervals on a contractual basis

Contractual savings

Which of the following instruments are traded in a money market

Commercial paper

Assume that you borrow $ at % annual interest to finance a new business project For this loan to be profitable, the minimum amount this project must generate in annual earnings is


Which of the following is not a goal of financial regulation

Ensuring that investors never suffer losses

Which of the following benefit directly from any increase in the corporation's profitability

a shareholder

In the United States, loans from _ are far _ important for corporate finance than are securities markets

financial intermediaries; more

An investment bank helps _ issue securities

a corporation

The purpose of the disclosure requirements of the Securities and Exchange Commission is to

increase the information available to investors

Which of the following is a contractual savings institution

A life insurance company

A liquid asset is

an asset that can easily and quickly be sold to raise cash

A financial market in which previously issued securities can be resold is called a _ market


Equity of US companies can be purchased by

US citizens and foreign citizens

Adverse selection is a problem associated with equity and debt contracts arising from

the lender's relative lack of information about the borrower's potential returns and risks of his investment activities

Collateral is _ the lender receives if the borrower does not pay back the loan

an asset

Which of the following is a longterm financial instrument

A US Treasury bond

_ work in the secondary markets matching buyers with sellers of securities


If the maturity of a debt instrument is less than one year, the debt is called _


The primary liabilities of depository institutions are


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

adverse selection

Bonds issued by state and local governments are called _ bonds


The primary assets of credit unions are

consumer loans

Wellfunctioning financial markets

produce an efficient allocation of capital

_ are financial intermediaries that acquire funds by selling shares to many individuals and using the proceeds to purchase diversified portfolios of stocks and bonds

Mutual funds

Federal funds are

loans made by banks to each other

The process of asset transformation refers to the conversion of

risky assets into safer assets

When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called a(n


Which of the following is not a contractual savings institution

A savings and loan association

Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from

financial intermediaries

Which of the following instruments are traded in a capital market

Corporate bonds

A breakdown of financial markets can result in

political instability

The primary assets of money market mutual funds are

money market instruments

An example of the problem of _ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families

moral hazard

Which of the following is not a secondary market

IPO market

The process of indirect finance using financial intermediaries is called

financial intermediation

The principal lendersavers are


Secondary markets make financial instruments more


A restriction on bank activities that was repealed in was

separation of commercial banking from the securities industries

All of the following are necessary criteria for a commodity to function as money except

it must deteriorate quickly

A hyperinflation is

a period of extreme inflation generally greater than % per month

If an individual moves money from a savings deposit account to a money market deposit account,

M stays the same and M stays the same

If an individual redeems a US savings bond for currency

M increases and M increases

Defining money becomes _ difficult as the pace of financial innovation _

more; quickens

An individual's annual salary is her


Which of the following statements accurately describes the two measures of the money supply

The two measures do not move together, so they cannot be used interchangeably by policymakers

When we say that money is a stock variable, we mean that

the quantity of money is measured at a given point in time

The evolution of the payments system from barter to precious metals, then to fiat money, then to checks can best be understood as a consequence of

innovations that reduced the costs of exchanging goods and services

When economists say that money promotes _, they mean that money encourages specialization and the division of labor


Because inflation in Germany after World War I sometimes exceeded , % per month, one can conclude that the German economy suffered from


Which of the following is not included in the measure of M

Savings deposits

Monetary aggregates are

measures of the money supply reported by the Federal Reserve

Explain how cigarettes could be called "money" in prisonerofwar camps of World War II

The cigarettes performed the three functions of money They served as the medium of exchange because individuals did exchange items for cigarettes They served as a unit of account because prices were quoted in terms of the number of cigarettes required for the exchange They served as a store of value because an individual would be willing to save their cigarettes even if they did not smoke because they believed that they could exchange the cigarettes for something that they did want at some time in the future

Recent financial innovation makes the Federal Reserve's job of conducting monetary policy

more difficult, since the Fed no longer knows what to consider money

Which of the following sequences accurately describes the evolution of the payments system

Barter, coins made of precious metals, paper currency, checks, electronic funds transfers

_ is the narrowest monetary aggregate that the Fed reports


Paper currency that has been declared legal tender but is not convertible into coins or precious metals is called _ money


Compared to an economy that uses a medium of exchange, in a barter economy

transaction costs are higher

During hyperinflations,

money no longer functions as a good store of value and people may resort to barter transactions on a much larger scale

The increase in holiday spending is not the same every year causing the Fed's adjustment for _ to be revised as more data becomes available

seasonal variation

Patrick places his pocket change into his savings bank on his desk each evening By his actions, Patrick indicates that he believes that money is a

store of value

Which of the following is included in M but not in M

Money market mutual fund shares (retail

If there are five goods in a barter economy, one needs to know ten prices in order to exchange one good for another If, however, there are ten goods in a barter economy, then one needs to know _ prices in order to exchange one good for another


The total collection of pieces of property that serve to store value is a person's


The conversion of a barter economy to one that uses money

increases efficiency by reducing transactions costs

As a store of value, money

is a way of saving for future purchases

_ is the relative ease and speed with which an asset can be converted into a medium of exchange


When money prices are used to facilitate comparisons of value, money is said to function as a

unit of account

For a commodity to function effectively as money it must be

easily standardized, making it easy to ascertain its value

If an individual moves money from a demand deposit account to a money market deposit account,

M decreases and M stays the same

The decade during which the growth rates of monetary aggregates diverged the most is

the s

Which of the following statements uses the economists' definition of money

I hope that I have enough money to buy my lunch today

A disadvantage of _ is that it is very heavy and hard to transport from one place to another

commodity money

Compared to checks, paper currency and coins have the major drawbacks that they

are easily stolen

If the price level doubles, the value of money

falls by percent

The M measure of money includes

traveler's checks

_ is a flow of earnings per unit of time


Of money's three functions, the one that distinguishes money from other assets is its function as a

medium of exchange

Which of the following is not included in the M measure of money but is included in the M measure of money

Smalldenomination time deposits

Money is

anything that is generally accepted in payment for goods and services or in the repayment of debt

Which of the following is not a form of emoney

a credit card

The evolution of the payments system from barter to precious metals, then to fiat money, then to checks can best be understood as a consequence of the fact that

precious metals were difficult to carry and transport

Increasing transactions costs of selling an asset make the asset

less liquid

The difference between money and income is that

money is a stock and income is a flow

What factors have slowed down the movement to a system where all payments are made electronically

The equipment necessary to set up the system is expensive, security of the information, and privacy concerns are issues that need to be addressed before an electronic payments system will be widely accepted

A problem with barter exchange when there are many goods is that in a barter system

there exists a multiple number of prices for each good

If peanuts serve as a medium of exchange, a unit of account, and a store of value, then peanuts are


During the past two decades an important characteristic of the modern payments system has been the rapidly increasing use of

electronic fund transfers

A person's house is part of her


In explaining the evolution of money

new forms of money evolve to lower transaction costs

Of the following assets, the least liquid is

a house

Because it is a unit of account, money

reduces the number of prices that need to be calculated

An electronic payments system has not completely replaced the paper payments system because of all of the following reasons except

transportation costs

As the payments system evolves from barter to a monetary system,

commodity money is likely to precede the use of paper currency

Which of the following is not included in the monetary aggregate M

Savings bonds

Of the following, the largest is


Introduction of checks into the payments system reduced the costs of exchanging goods and services Another advantage of checks is that

they provide convenient receipts for purchases

The components of the US M money supply are demand and checkable deposits plus

currency plus travelers checks

Whatever a society uses as money, the distinguishing characteristic is that it must

be generally acceptable as payment for goods and services or in the repayment of debt

If you default on your auto loan, your car will be repossessed because it has been pledged as _ for the loan


That most used cars are sold by intermediaries (ie, used car dealers provides evidence that these intermediaries

are able to prevent potential competitors from freeriding off the information that they provide

How does collateral help to reduce the adverse selection problem in credit market

Collateral is property that is promised to the lender if the borrower defaults thus reducing the lender's losses Lenders are more willing to make loans when there is collateral that can be sold if the borrower defaults

Regulation of the financial system

ensures the stability of the financial system

A lesson of the Enron collapse is that government regulation

can reduce but not eliminate asymmetric information

That only large, wellestablished corporations have access to securities markets

explains why indirect finance is such an important source of external funds for businesses

How does a mutual fund lower transactions costs through economies of scale

The mutual fund takes the funds of the individuals who have purchased shares and uses them to purchase bonds or stocks Because the mutual fund will be purchasing large blocks of stocks or bonds they will be able to obtain them at lower transactions costs than the individual purchases of smaller amounts could

Government regulations designed to reduce the moral hazard problem include

laws that force firms to adhere to standard accounting principles

The "lemons problem" exists because of

asymmetric information

The current structure of financial markets can be best understood as the result of attempts by financial market participants to

reduce transaction costs

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

Stocks are a relatively unimportant source of finance for their activities

An example of the _ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds

moral hazard

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

Securities and Exchange Commission

Because of the "lemons problem" the price a buyer of a used car pays is

between the price of a lemon and a peach

For restrictive covenants to help reduce the moral hazard problem they must be _ by the lender

monitored and enforced

Credit card debt is

unsecured debt

Analysis of adverse selection indicates that financial intermediaries, especially banks,

have advantages in overcoming the freerider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance

Why does the freerider problem occur in the debt market

Restrictive covenants can reduce moral hazard but they must be monitored and enforced to be effective If bondholders know that other bondholders are monitoring and enforcing the restrictive covenants, they can free ride Other bondholders will follow suit resulting in not enough resources devoted to monitoring and enforcing restrictive covenants

If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of

adverse selection

As a source of funds for nonfinancial businesses, stocks are relatively more important in


Equity contracts

are claims to a share in the profits and assets of a business

The concept of adverse selection helps to explain all of the following except

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

The _ problem helps to explain why the private production and sale of information cannot eliminate _

freerider; adverse selection

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