Your Go To Finance Exam About Money And Banking

Financial markets play a crucial role in improving efficiency by facilitating the transfer of funds from individuals or entities that have surplus funds to those who need them for productive investments. This process ensures that funds are allocated to their most productive uses, allowing businesses and individuals with investment opportunities to access the necessary capital. As a result, financial markets contribute to economic growth and development by promoting efficient allocation of resources. Therefore, the statement is true.

The explanation for the given correct answer is that the primary market is indeed where new issues of securities are sold, such as initial public offerings (IPOs), while the secondary market is where previously issued securities are resold, such as through stock exchanges. In the primary market, companies raise capital by selling new securities to investors, while in the secondary market, investors trade already issued securities among themselves. Therefore, the statement that the primary market is where new issues of securities are sold, and the secondary market is where previously issued securities are resold is true.

The government heavily regulates the financial system in order to increase the information available to investors and to ensure the soundness of the financial system. This regulation helps to protect investors from fraudulent activities and provides them with accurate and reliable information to make informed investment decisions. Additionally, regulation helps to maintain the stability and integrity of the financial system, preventing financial crises and promoting economic growth. Therefore, the statement that the government heavily regulates the financial system to increase information available to investors and insure the soundness of the financial system is true.

Financial intermediaries, such as banks or credit unions, can offer lower transaction costs when making loans compared to individuals. This is because financial intermediaries have economies of scale, meaning they can spread their fixed costs over a larger number of loans. As a result, they can offer lower interest rates and fees to borrowers. This makes it more efficient for individuals to save their funds in a financial intermediary, as they can potentially earn higher returns on their savings and have access to lower-cost loans when needed.

Eurodollars are indeed dollars denominated deposits in foreign banks that are outside the United States or in foreign branches of U.S. banks. This means that they are not subject to U.S. banking regulations and can be held and traded internationally.

Asymmetric information in financial markets refers to a situation where one party has more information than the other. In this case, borrowers have more information about the true likelihood of loan repayment compared to lenders. This is because borrowers have access to their own financial situation, credit history, and ability to repay the loan, while lenders have limited information about the borrower's creditworthiness. As a result, lenders may face higher risks and uncertainty when lending money, leading to the existence of asymmetric information in financial markets. Therefore, the statement that borrowers know more about the true likelihood of loan repayment than lenders is true.

Mutual funds do indeed sell shares to investors and use the funds obtained to purchase a diversified portfolio of stocks and bonds. This allows investors to pool their money together and have it professionally managed by the fund's investment team. By investing in a variety of assets, mutual funds aim to reduce risk and potentially generate returns for their shareholders. Therefore, the statement "Mutual funds sell shares and use the funds to buy diversified portfolios of stocks and bonds" is true.

The statement is incorrect. Bonds are actually sold in the debt market, while stocks are sold in the equity market. Bonds represent debt obligations issued by companies or governments, while stocks represent ownership shares in a company. Therefore, the correct answer is false.

Direct finance occurs when borrowers sell securities directly to lenders. This means that borrowers bypass financial intermediaries and directly access funds from lenders by issuing securities such as stocks or bonds. This allows borrowers to raise capital efficiently and at a lower cost compared to indirect finance, where financial intermediaries are involved. By selling securities directly to lenders, borrowers can tailor the terms and conditions of the securities to meet their specific needs. This statement accurately describes the concept of direct finance.

Stocks are actually considered to be riskier investments compared to bonds. This is because stockholders are not guaranteed fixed returns like bondholders. Instead, stockholders are residual claimants, meaning they are the last in line to receive any profits or assets if a company goes bankrupt. Bondholders, on the other hand, have a higher priority in receiving payments and are more likely to receive fixed interest payments even if the company faces financial difficulties. Therefore, the statement that stocks are less risky than bonds is false.

The correct answer is "You pay life insurance premiums to Franklin Life, and Franklin Life makes a mortgage to a homebuyer." This is an example of indirect finance because the funds are being channeled from the savers (those paying the life insurance premiums) to the ultimate borrowers (the homebuyer) through an intermediary (Franklin Life). In this case, Franklin Life is acting as a financial intermediary by using the funds received from the life insurance premiums to provide a mortgage loan to the homebuyer.

Indirect finance refers to the process where a financial intermediary, like a bank, borrows money from one person (savers) and lends it to another person (borrowers). In this case, the bank acts as an intermediary between the savers and borrowers, facilitating the flow of funds in the economy. This allows savers to earn interest on their savings while borrowers can access the funds they need for various purposes. Therefore, the correct answer is indirect finance.

Primary markets are where new issues of securities are sold while secondary markets are where previously issued securities are resold. This means that primary markets are where companies sell their stocks or bonds for the first time to raise capital, while secondary markets are where investors buy and sell these securities among themselves after they have been issued.

Equity holders are residual claimants means that they have the right to claim any remaining assets or profits after all other obligations, including debt payments, have been fulfilled. This characteristic distinguishes equity holders from bond holders, who receive fixed interest payments and do not have the same residual claim on the firm's assets. The other options are incorrect because bond holders do not receive dividends, equity securities are not considered short term, and a bond is a liability to the firm that issues it, not an asset.

Asymmetric information refers to a situation where one party involved in a transaction has more information or knowledge than the other party. In the context of lenders and borrowers, it means that borrowers have more information about the potential returns and risks of an investment project than the lenders. This can lead to problems in financial intermediation, as lenders may be hesitant to provide funds or may charge higher interest rates due to the uncertainty and potential risks involved. Therefore, the correct answer is asymmetric information.

Mutual funds sell shares to investors and use the money obtained from the sales to buy a diversified portfolio of stocks and bonds. This allows investors to pool their money together and have a professional fund manager make investment decisions on their behalf. By investing in a variety of assets, mutual funds aim to reduce risk and maximize returns for their investors.

Securities are financial instruments that represent ownership or debt in a company or government entity. When someone buys securities, they are considered assets because they represent a financial claim or investment. On the other hand, the individual or company that issues securities considers them as liabilities because they are obligated to repay the buyers or provide them with returns. Therefore, the statement that securities are liabilities for the person that buys them, but assets for the individual or company that issues them is incorrect. Securities are assets for both the buyer and the issuer.

Buying a bond issued by General Electric through a broker at Smith Barney is considered direct finance because it involves the direct transfer of funds from the buyer (individual) to the issuer (General Electric) through a financial intermediary (broker). This transaction bypasses the need for a third party, such as a bank, to intermediate the flow of funds. In contrast, the other options involve either the payment of premiums to an insurance company or the depositing of funds in a bank, which are not direct forms of finance.

A credit union is considered a depository institution because it is a financial institution that accepts deposits from its members and provides them with various banking services, such as savings accounts, checking accounts, and loans. Unlike traditional banks, credit unions are member-owned and operated, with the goal of serving their members' financial needs rather than making a profit. Therefore, credit unions meet the criteria of being a depository institution by accepting deposits and providing banking services to their members.

Regulation Q, prior to 1986, restricted competition between banks by placing a limit or ceiling on the interest rates that banks could offer on savings deposits. This means that banks were not allowed to offer higher interest rates to attract customers, thereby limiting competition in the banking industry.

Commercial paper is not considered to be the most liquid money market instrument. Treasury bills are generally considered to be the most liquid money market instrument because they are backed by the government and have a very active secondary market. Commercial paper, on the other hand, is a short-term debt instrument issued by corporations to finance their short-term borrowing needs. While commercial paper is still considered to be a relatively liquid investment, it is not as liquid as treasury bills.

Financial intermediaries achieve all of the above. They reduce transaction costs for lender-savers and borrower-spenders by efficiently matching the needs of both parties. They also allow for risk sharing by pooling funds from multiple lenders and spreading the risk across different investments. Additionally, financial intermediaries solve some of the problems caused by asymmetric information by conducting due diligence and providing information to both lenders and borrowers. Overall, financial intermediaries play a crucial role in facilitating efficient and effective financial transactions.

Savings and loan associations hold mortgages as their primary asset. This is because they are financial institutions that specialize in accepting savings deposits and providing mortgage loans. Unlike banks, which offer a wide range of financial services, savings and loan associations primarily focus on mortgage lending. They obtain funds from depositors and use these funds to provide loans for individuals and businesses to purchase real estate properties. Thus, savings and loan associations have mortgages as their primary asset.

Banks screen their prospective loan customers to avoid the problem of adverse selection. Adverse selection refers to the situation where the borrower has more information about their own creditworthiness than the lender. This can lead to the lender being more likely to select borrowers who are more likely to default on their loans, resulting in higher risk for the bank. By screening their customers, banks aim to minimize this risk and select borrowers who are more likely to repay their loans.

This scenario demonstrates moral hazard because Rick Smith, after receiving the auto loan, decides to use the money for gambling instead of its intended purpose of buying a car. This behavior indicates a lack of responsibility and an increased risk for the lender, as Rick's actions show a disregard for the consequences of his decisions and the potential negative impact it could have on his ability to repay the loan.

Corporations raise the greatest amount of funds through corporate bonds. Corporate bonds are debt securities issued by corporations to raise capital. They are typically used to finance long-term projects or investments. Unlike stocks, which represent ownership in a company, corporate bonds represent a loan made by an investor to a corporation. This loan is then repaid with interest over a specified period of time. Commercial paper is a short-term debt instrument, while repurchase agreements involve the sale and repurchase of securities. Therefore, corporate bonds are the most common instrument for corporations to raise funds.

A U.S. government treasury bill with 6 months to mature is an example of a money market instrument. Money market instruments are short-term debt securities with high liquidity and low risk. Treasury bills are issued by the U.S. government and have a maturity of less than one year. They are considered one of the safest investments and are commonly used by investors to preserve capital and maintain liquidity.

The statement is false because life insurance companies are not the largest financial intermediaries in the United States when measured by the size of their assets. Other financial institutions such as banks and investment firms typically have larger asset sizes compared to life insurance companies.

A bond denominated in dollars that is sold in Great Britain is known as a Eurobond. Eurobonds are issued and traded in a currency that is different from the currency of the country where it is issued. In this case, the bond is denominated in dollars but sold in Great Britain, making it a Eurobond. Eurobonds are popular because they allow issuers to tap into international markets and investors to diversify their portfolios.

A short-term bond is likely to generate the least risk to the purchaser because it has a shorter maturity period. This means that the purchaser will receive their principal investment back sooner, reducing the risk of potential losses. Additionally, short-term bonds generally have lower interest rate risk compared to long-term bonds, as they are less affected by fluctuations in interest rates. Therefore, investing in a short-term bond is a safer option compared to a 30-year mortgage, a share of stock in IBM, or a long-term bond.

The correct answer is the Federal Deposit Insurance Corporation (FDIC). This regulatory agency protects depositors from bank failures by guaranteeing repayment of deposits up to $100,000 per depositor at a bank. The FDIC was established in 1933 in response to the widespread bank failures during the Great Depression. Its main purpose is to maintain stability and public confidence in the banking system by insuring deposits and promoting safe and sound banking practices.

The given statement is false. Moral hazard occurs when individuals take on more risk because they know they will not bear the full consequences of their actions. In the context of loans, moral hazard would suggest that individuals who are more likely to default on their loans are the ones who actively seek them, as they have less to lose. However, the statement suggests that risky individuals are least likely to repay their loans and have the most to gain, which is contradictory to the concept of moral hazard.

The statement is false because more funds flow to corporations through financial intermediaries such as banks, mutual funds, and pension funds, rather than through the corporate bond market. Financial intermediaries play a crucial role in channeling funds from savers to borrowers, including corporations, by collecting deposits and investing them in various financial instruments. The corporate bond market, on the other hand, is a smaller segment of the overall financial market where corporations issue debt securities to raise capital directly from investors.

This statement is false because when an individual buys a bond issued by General Motors through a Merrill Lynch bond dealer, it is an example of direct finance, not indirect finance. Indirect finance refers to when funds are channeled from savers to borrowers through financial intermediaries such as banks or mutual funds. In this case, the individual is directly purchasing the bond from the bond dealer, bypassing any intermediaries.

Investment banks facilitate the sale of securities in the primary market. In the primary market, newly issued securities are sold directly by the issuer to investors. This is where companies raise capital by issuing stocks or bonds for the first time. Investment banks play a crucial role in underwriting and distributing these securities to potential buyers. They help in determining the offering price, marketing the securities, and ensuring regulatory compliance. The primary market is different from the secondary market, where already issued securities are traded among investors, and the over-the-counter market, which is a decentralized market for trading securities directly between parties without a centralized exchange.