CH 1

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Chapter One

Why Are Financial Institutions Special?


Multiple-Choice
1. Depository financial institutions include all of the following EXCEPT
a. commercial banks.
b. savings banks
c. investment banks.
d. credit unions.
e. all of the above are depository institutions.
Answer: C

2. Nondepository financial institutions are represented by all of the following EXCEPT


a. insurance companies.
b. mutual funds.
c. finance companies.
d. credit unions.
e. securities firms.
Answer: D

3. Which of the following statements is FALSE?


a. A financial intermediary specializes in the production of information.
b. A financial intermediary reduces its risk exposure by pooling its assets.
c. A financial intermediary benefits society by providing a mechanism for payments.
d. A financial intermediary may act as a broker to bring together funds deficit and funds surplus
units.
e. A financial intermediary acts as a lender of last resort.
Answer: E

4. Which function of an FI reduces transaction and information costs between a corporation and
individual which may encourage a higher rate of savings?
a. Brokerage services.
b. Asset transformation services.
c. Information production services.
d. Money supply management.
e. Administration of the payments mechanism.
Answer: A

5. In its role as a delegated monitor, an FI


a. keeps track of required interest and principal payments on loans it originates.
b. works with financially distressed borrowers in danger of defaulting on their loans.
c. holds portfolios of loans that they continue to service.
d. maintains contact with borrowers to ensure that loan proceeds are utilized for intended purposes.
e. All of the above.
Answer: E

6. Which of the following is NOT a major function of financial intermediaries?


a. Brokerage services.
b. Asset transformation services.
c. Information production.
d. Management of the nation's money supply.
e. Administration of the payments mechanism.
Answer: D

7. Advantages of depositing funds into a typical bank account instead of directly buying corporate
securities include all of the following EXCEPT
a. monitoring done by the bank on your behalf.
b. increased liquidity if funds are needed quickly.
c. increased transactions costs.
d. less price risk when funds are needed.
e. better diversification of deposited funds.
Answer: C

8. Many households place funds with financial institutions because many FI accounts provide
a. lower denominations than other securities.
b. flexible maturities verses other interest-earning securities.
c. better liquidity than directly negotiated debt contracts.
d. less price risk if interest rates change.
e. All of the above.
Answer: E

9. Which of the following refers to the possibility that a firm’s owners or managers will take actions
contrary to the promises contained in the covenants of the securities the firm issues to raise funds?
a. Liquidity risk.
b. Price risk.
c. Credit risk.
d. Intermediation.
e. Agency costs.
Answer: E

10. Depository institutions (DIs) play an important role in the transmission of monetary policy from the
Federal Reserve to the rest of the economy primarily because
a. loans to corporations are part of the money supply.
b. bank loans are highly regulated.
c. savings institutions provide a large amount of credit to finance residential real estate.
d. DI deposits are a major portion of the money supply.
e. U.S. DIs compete with foreign financial institutions.
Answer: D

11. Which of the following measures the difference between the private costs of regulations and the private
benefits of those regulations for the producers of financial services?
a. Capital adequacy.
b. Agency costs.
c. Net regulatory burden.
d. Charter value.
e. Liquidity risk.
Answer: C

12. Which of the following is the term used when a banker refuses to make loans to residents living within
certain geographic boundaries?
a. Credit allocation.
b. Redlining.
c. Intermediation.
d. Externalization.
e. Spinning.
Answer: B

13. Why is the failure of a large bank more detrimental to the economy than the failure of a large steel
manufacturer?
a. The bank failure usually leads to a government bailout.
b. There are fewer steel manufacturers than there are banks.
c. The large bank failure reduces credit availability throughout the economy.
d. Since the steel company's assets are tangible, they are more easily reallocated than the intangible
bank assets.
e. Everyone needs money, but not everyone needs steel.
Answer: C

14. Why do households prefer to use FIs as intermediaries to invest their surplus funds?
a. Transaction costs are low to the household since FIs are more efficient in monitoring and
gathering investment information.
b. To receive the benefits of diversification that households may not be able to achieve on their
own.
c. The FI has can benefit from combining funds and negotiating lower asset prices and
transactions costs.
d. The FI can provide insurance at relatively low cost that will protect funds under management.
e. All of the above.
Answer: E
15. Financial intermediaries are
a. funds surplus units, because they exist to make money.
b. funds deficit units, because they must pay heavy regulatory fees and taxes.
c. funds surplus units, because they hold large portfolios of financial securities.
d. funds deficit units, because they must comply with minimum capital requirements.
e. neither funds surplus nor deficit units.
Answer: E

16. Net regulatory burden for FIs is higher because regulators may require the FI to
a. to hold more capital than what would be held without regulation.
b. to produce less information than would be produced without regulation.
c. to hold more debt than what would be held without regulation.
d. hold fewer reserves than they would without regulation.
e. All of the above.
Answer: A

17. In a world without FIs, households will be less willing to invest in corporate securities because they
a. are not able to monitor the activities of the corporation more closely than FIs.
b. tend to prefer shorter, more liquid securities.
c. are subject to price risk when corporate securities are sold.
d. may not have enough funds to purchase corporate securities.
e. All of the above.
Answer: E

18. Which of the following is true of secondary securities?


a. They include equities, bonds, and other debt claims.
b. They are backed by the real assets of corporations issuing them.
c. They are securities that back primary securities.
d. They are securities issued by FIs.
e. They must be placed in a separate account on order for primary securities to be offered.
Answer: C

19. The following are protective mechanisms that have been developed by regulators to promote the safety
and soundness of the banking system EXCEPT
a. encouraging banks to rely more on deposits rather than debt or capital as a cushion against
failure.
b. encouraging banks to limit lending to a single customer to no more than 10% of capital.
c. the provision of deposit insurance.
d. the periodic monitoring of banks.
e. encouraging banks to produce timely accounting statements and reports.
Answer: A
20. Safety and soundness regulations include all of the following layers of protection EXCEPT
a. the provision of guaranty funds.
b. requirements encouraging diversification of assets.
c. the creation of money for those FIs in financial trouble.
d. requiring minimum levels of capital.
e. monitoring and surveillance.
Answer: C

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