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FIM CH 2 Questions Part 1

FI chapter 2

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14 views9 pages

FIM CH 2 Questions Part 1

FI chapter 2

Uploaded by

gech95465195
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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1. What is one primary role of financial institutions in financial markets?

A. Manufacturing tangible goods

B. Transforming financial assets into a preferable type of liability

C. Providing funding for non-financial enterprises

D. Eliminating market risks entirely

2. Which of the following best defines maturity intermediation?

A. Aligning deposit and loan maturities to the same time frame

B. Offering only short-term deposits and loans

C. Transforming short-term deposits into long-term loans

D. Providing high-interest rates for all deposits

3. What is the main implication of the "lemons problem" in securities markets?

A. Overvaluation of good securities

B. Lack of demand for bad securities

C. Undervaluation of good securities

D. Elimination of market intermediaries

4. Why are banks considered the most important source of external finance?

A. They specialize in direct finance

B. They are less regulated than other financial institutions


C. They provide indirect financing through intermediation

D. They offer non-financial services like consultancy

5. Which economic function of financial intermediaries is most related to investment diversification?

A. Maturity intermediation

B. Reducing risk

C. Providing a payment mechanism

D. Reducing contracting costs

6. What is the primary reason for the free-rider problem in solving adverse selection?

A. Borrowers failing to pledge adequate collateral

B. Lack of transparency in government regulations

C. Shared benefits from privately produced information

D. Inadequate enforcement of restrictive covenants

7. Collateral in debt contracts primarily serves to:

A. Increase the borrower’s equity capital

B. Mitigate moral hazard after the loan is issued

C. Reduce adverse selection before the loan is issued

D. Provide lenders a safeguard against default


8. Adverse selection occurs:

A. When borrowers misuse funds after a transaction

B. Before a transaction when hidden attributes exist

C. When lenders impose restrictive covenants

D. After a borrower defaults

9. Which financial institutions' role directly addresses the issue of asymmetric information?

A. Managing payment mechanisms

B. Assisting in the creation of financial assets

C. Exchanging financial assets for their own accounts

D. Financial intermediation

10. What is a primary limitation of issuing marketable securities for businesses?

A. The securities are only available to small firms

B. High levels of regulation make issuance infeasible

C. It is not the primary source of funding for most businesses

D. They are not allowed for companies with collateral

11. Debt contracts often include restrictive covenants to:

A. Reduce the cost of contracting

B. Prevent adverse selection issues

C. Mitigate moral hazard risks


D. Protect borrowers from default

12. What is the main goal of maturity intermediation?

A. Maximizing short-term borrowing options

B. Offering lower interest rates to long-term borrowers

C. Aligning loan maturities to investor expectations

D. Eliminating the need for interest rates

13. Which method is NOT used to address the lemons problem?

A. Government regulation

B. Pledging collateral

C. Moral hazard monitoring

D. Private production of information

14. Why are smaller firms less likely to issue securities in capital markets?

A. Securities markets cater only to private firms

B. Smaller firms face higher regulatory scrutiny

C. Capital markets favor large, established firms

D. Issuing securities is a form of indirect financing

15. Reducing contracting costs in financial markets relies on:


A. Economies of scale in information processing

B. Eliminating asymmetric information entirely

C. Simplifying debt covenants

D. Increasing maturity mismatches

16. Moral hazard in equity contracts arises from:

A. Borrowers’ incentives to default

B. Managers acting against owners’ interests

C. Asymmetric information before the transaction

D. High costs of collateral

17. The primary role of a payment mechanism is to:

A. Enhance diversification

B. Facilitate non-cash transactions

C. Offer financial advice to customers

D. Monitor restrictive covenants

18. How do financial intermediaries reduce asymmetric information?

A. By providing investment guarantees

B. Through financial intermediation and monitoring

C. By aligning loan maturities to deposits

D. Offering higher interest rates for risky borrowers


19. What is a significant challenge in the private production of information?

A. High costs of collateral requirements

B. Lack of economies of scale in information gathering

C. The free-rider problem

D. The moral hazard issue

20. Why are debt contracts typically more complicated than equity contracts?

A. They lack restrictive covenants

B. They include terms to mitigate adverse selection

C. They contain numerous terms to address moral hazard

D. They are unregulated

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Answers and Explanations:

1. B - Financial institutions transform financial assets into preferred liabilities, a key role in financial
markets.
2. C - Maturity intermediation converts short-term deposits into long-term loans.

3. C - The lemons problem undervalues good securities, discouraging their issuance.

4. C - Banks dominate external finance through their intermediation role.

5. B - Diversification reduces risk by spreading investments across assets.

6. C - The free-rider problem arises because others benefit from private information without paying for
it.

7. D - Collateral provides lenders a safety net in case of default.

8. B - Adverse selection occurs before transactions when one party has hidden attributes.

9. D - Financial intermediation reduces asymmetric information by creating and verifying data.

10. C - Most businesses rely on indirect financing rather than issuing securities.
11. C - Restrictive covenants address moral hazard by regulating borrower actions.

12. B - Maturity intermediation supports long-term loans with lower rates due to successive deposits.

13. C - Moral hazard monitoring relates to post-transaction issues, not lemons problems.

14. C - Capital markets are generally accessible to large, well-established firms.

15. A - Financial intermediaries achieve scale efficiencies in contracting and processing costs.

16. B - Equity contract moral hazard stems from misaligned incentives between managers and owners.

17. B - Payment mechanisms enable seamless non-cash transactions.

18. B - Financial intermediation combats asymmetric information through expertise and monitoring.
19. C - The free-rider problem limits the effectiveness of private information production.

20. C - Debt contracts address moral hazard through complex legal covenants.

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