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					                         FINA0102 Financial Markets and Institutions
                                 Problem Set for Ch 15, 16


1) Of the following sources of external finance for American nonfinancial businesses, the most
important is
A) loans from banks.
B) stocks.
C) bonds and commercial paper.
D) nonbank loans.

2) With regard to external sources of financing for nonfinancial businesses in the United States,
which of the following are accurate statements?
A) Direct finance is used in less than 5% of the external financing of American businesses.
B) Only large, well-established corporations have access to securities markets to finance their
C) Loans from banks and other financial intermediaries in the United States provide five times
more financing of corporate activities than do stock markets.
D) All of the above.
E) Only A and B of the above.

3) Which of the following is not one of the eight basic facts about financial structure?
A) Debt contracts are typically extremely complicated legal documents that place
substantialrestrictions on the behavior of the borrower.
B) 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
C) Collateral is a prevalent feature of debt contracts for both households and business.
D) New security issues are the most important source of external funds to finance businesses.

4) (I) The total cost of carrying out a transaction in financial markets increases proportionally
with the size of the transaction. (II) Financial intermediaries facilitate diversification when an
investor has only a small sum to invest.
A) (I) is true; (II) is false
B) (I) is false; (II) is true
C) Both (I) and (II) are true
D) Both (I) and (II) are false
5) 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 highest quality of used cars in the market.
B) reflect the lowest quality of used cars in the market.
C) reflect the average quality of used cars in the market.
D) none of the above.

6) 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.

7) The free-rider problem
A) occurs when people do not pay for information take advantage of the information other
people have to pay for.
B) suggests that the private sale of information will only be a partial solution to the lemons
C) prevents the private market from producing enough information to eliminate all the
asymmetric information that leads to adverse selection.
D) all of the above.

8) 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 borrowersʹ undesirable behavior.
B) Covenants require that borrowers keep collateral in good condition.
C) Covenants require periodic accounting statements and income reports.
D) All of the above.
E) Only A and B of the above.

9) Governments in developing countries sometimes adopt policies that retard the efficient
operation of their financial systems. These actions include policies that
A) prevent lenders from foreclosing on borrowers with political clout.
B) nationalize banks and direct credit to politically-favored borrowers.
C) make it costly to collect payments and collateral from defaulting debtors.
D) do all of the above.
E) do only A and B of the above.
10) The principal-agent problem
A) occurs when managers have more incentive to maximize profits than the stockholders-owners
B) would not arise if the owners of the firm had complete information about the activities of the
C) in financial markets helps to explain why equity is a relatively important source of finance for
American business.
D) all of the above.
E) only A and B of the above.

11) 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) occur when adverse selection and moral hazard problems in financial markets become more
C) frequently lead to sharp contractions in economic activity.
D) all of the above.
E) only A and B of the above.

12) A financial institution can achieve cost savings by engaging in multiple activities. These are
called economies of
A) scope.
B) scale.
C) complexity.
D) information.

13) Conflicts of interest pose a problem because they
A) lower the quality of information.
B) increase problems of asymmetric information.
C) make the financial system less efficient.
D) do all of the above.

14) Spinning is the practice of
A) investment banks allowing executives of potential client companies to buy underpriced
initial public offerings of other companies’ securities.
B) investment bank analysts providing misleading information about a company to
encourage more investors to purchase the company’s securities.
C) accounting firms encouraging its audit clients to also purchase its management advisory
D) credit rating agencies providing higher ratings on a company’s securities in order to
develop a long-term relationship with the company.

15) The conflict of interest in credit-rating agencies arises because _________ pay to have
securities rated and, as a result, the agencies’ ratings may be biased _________.
A) security issuers; downward
B) security issuers; upward
C) investors; downward
D) regulators; upward

16) Universal banking refers to combinations of the activities of commercial banking, investment
banking, and
A) auditing.
B) insurance.
C) credit assessment.
D) consulting.

17) The Sarbanes-Oxley Act of 2002 dealt with conflicts of interest in
A) investment banks.
B) accounting firms.
C) credit rating agencies.
D) all of the above.

18) The Global Legal Settlement includes what key element?
A) It directly reduces conflicts of interest.
B) It provides incentives for investment banks not to exploit conflicts of interest.
C) It has measures to improve the quality for information in financial markets.
D) All of the above
MC Answer
1) D
18% - loans from banks.
11% - stocks.
32% - bonds and commercial paper.
38% - nonbank loans.

2) D
(A) is correct according to the textbook
(B) is correct. This is the 6th fact of financial structure
(C) is correct because 18% + 38% > 11% *5

3) D
According to the statistics provided, new security issues are not the most important source of external funds to
finance businesses.

4) B
(I) is incorrect because the total cost should decrease proportionally due to economies of scale

5) C

6) C
(A) is incorrect because the bad borrowers should be the most active ones to seek loans according to adverse
(B) is incorrect. Lenders should be more willing to lend to individuals with high net worth.
(C) is correct.

7) D
(A) is correct.
(B) is correct because other people may still take advantage of the information even if they do not buy the
(C) is correct. Companies that provide information will under-produce because this is not very profitable for selling
information under free-rider problem.
(You can refer to P.372 and 373 of your textbook for the reasoning behind the answer of this question)
8) D
All of them are correct. You can refer to slide 34 of lecture notes CH 15 for more details.

9) D
All of them are correct. You can refer to P.383 and 384 of your textbook for more details.

10) B

11) D

12) A (Textbook P.400)

13) D (Textbook P.401)

14) A (Textbook P.402)

15) B (Textbook P.404)

16) B (Textbook P.405)

17) B (Textbook P.410)

18) D (Textbook P.410)

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