Financial Intermediation Study Guide Questions
Course Introduction
Financial Intermediation explores the role of financial institutions such as banks, insurance companies, and investment firms in channeling funds from savers to borrowers. The course examines the structure and function of financial markets, the process of credit creation, risk management practices, and the regulatory environment governing intermediaries. Students will analyze how intermediaries reduce transaction and information costs, facilitate liquidity, and contribute to economic stability, alongside discussions of recent developments and challenges in the global financial system.
Recommended Textbook
Financial Markets and Institutions 7th Edition by Frederic S. Mishkin
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Page 2
Chapter 1: Why Study Financial Markets and Institutions
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Q1) Different interest rates have a tendency to move in unison.
A)True
B)False
Answer: True
Q2) (I)Debt markets are often referred to generically as the bond market. (II)A bond is a security that is a claim on the earnings and assets of a corporation.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Answer: A
Q3) Interest rates are important to financial institutions since an interest rate increase ________ the cost of acquiring funds and ________ the income from assets.
A)decreases; decreases
B)increases; increases
C)decreases; increases
D)increases; decreases
Answer: B
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3
Chapter 2: Overview of the Financial System
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Q1) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as
A)foreign bonds.
B)Eurobonds.
C)Eurocurrencies.
D)Eurodollars.
Answer: B
Q2) Which of the following can be described as involving indirect finance?
A)A bank buys a U.S. Treasury bill from one of its depositors.
B)A corporation buys commercial paper issued by another corporation.
C)A pension fund manager buys commercial paper in the primary market.
D)Both A and C of the above.
Answer: D
Q3) Which of the following are primary markets?
A)The New York Stock Exchange
B)The U.S. government bond market
C)The over-the-counter stock market
D)The options markets
E)None of the above
Answer: E
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Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation
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Q1) For simple loans, the simple interest rate is ________ the yield to maturity. A)greater than B)less than C)equal to D)not comparable to
Answer: C
Q2) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of A)5 percent.
B)8 percent.
C)10 percent.
D)40 percent.
Answer: A
Q3) Which of the following are true of coupon bonds?
A)The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid.
B)U)S. Treasury bonds and notes are examples of coupon bonds.
C)Corporate bonds are examples of coupon bonds.
D)All of the above.
E)Only A and B of the above.
Answer: D
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Chapter 4: Why Do Interest Rates Change
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Q1) What is the expected return on a bond if the return is 9% two-thirds of the time and 3% one-third of the time? What is the standard deviation of the returns on this bond? Would you prefer this bond or one with an identical expected return and a standard deviation of 4.5? Why?
Q2) If investors perceive greater interest rate risk, what will happen to the equilibrium interest rate in the bond market? Explain using the bond demand and supply framework.
Q3) When stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________.
A)right; rises
B)right; falls
C)left; falls
D)left; rises
Q4) When prices in the stock market become more uncertain, the demand curve for bonds shifts to the ________ and the interest rate ________.
A)right; rises
B)right; falls
C)left; falls
D)left; rises
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates
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Q1) When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A)right; right
B)right; left
C)left; left
D)left; right
Q2) The liquidity premium theory of the term structure
A)assumes investors tend to prefer short-term bonds because they have less interest-rate risk.
B)assumes that interest rates on the long-term bond respond to demand and supply conditions for that bond.
C)assumes that an average of expected short-term rates is an important component of interest rates on long-term bonds.
D)assumes all of the above.
E)assumes none of the above.
Q3) What do credit-rating agencies do and why is this work important?
Q4) How would a severe recession affect the risk premium on corporate bonds?
Q5) What is meant by the risk structure of interest rates?
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Chapter 6: Are Financial Markets Efficient
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Q1) How is it possible that a firm can announce a record-breaking loss, yet its stock price rises when the announcement is made?
Q2) The elimination of a riskless profit opportunity in a market is called A)the efficient market hypothesis.
B)random walk. C)arbitrage.
D)market fundamentals.
Q3) The evidence suggests technical analysts are not superior stock pickers. A)True B)False
Q4) Technical analysts look at historical prices for information to project future prices. A)True B)False
Q5) Loss aversion means the unhappiness a person feels when he or she suffers a monetary loss exceeds the happiness the same person experiences from receiving a monetary gain of the same amount. A)True B)False
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Chapter 7: Why Do Financial Institutions Exist
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Q1) The pecking order hypothesis predicts that the ________ a corporation is, the more likely it will be to ________.
A)smaller and less well known; issue securities
B)larger and more well known; borrow from financial intermediaries
C)larger and more well known; issue securities
D)smaller and less well known; need external financing
Q2) Explain how the "lemons" problem could cause financial markets to fail.
Q3) (I)In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II)In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q4) Collateralized debt is also called secured debt.
A)True
B)False
Q5) What is the principal-agent problem?
Q6) What factors usually cause an increase in moral hazard and adverse selection?
Page 9
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Chapter 8: Why Do Financial Crises Occur and Why Are
They so Damaging to the Economy
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Q1) In an emerging market economy, a lending boom and crash are not inevitable outcomes of financial liberalization and globalization. Discuss when a boom and crash will occur, and how it can be avoided.
Q2) In addition to having a direct effect on increasing adverse selection problems, increases in interest rates also promote financial crises by ________ firms' and households' interest payments, thereby ________ their cash flow.
A)increasing; increasing
B)increasing; decreasing C)decreasing; increasing D)decreasing; decreasing
Q3) Factors that can lead to worsening conditions in financial markets include increasing interest rates and asset price booms.
A)True
B)False
Q4) In the second stage of a financial crisis in an emerging economy, a speculative currency attack begins. Why can't the government defend itself from such an attack?
Q5) Discuss why some view the Fed as a culprit in the U.S. housing bubble during the 2000s.
Page 10
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Chapter 9: Central Banks and the Federal Reserve System
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Q1) The unusual structure of the Federal Reserve System is perhaps best explained by
A)Americans' fear of centralized power.
B)the traditional American distrust of moneyed interests.
C)Americans' desire to remove control of the money supply from the U.S. Treasury.
D)all of the above.
E)only A and B of the above.
Q2) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress because
A)Congress can pass legislation that would restrict the Fed's independence.
B)Congress can withhold the Fed's budget requests.
C)Congress can remove members of the Board of Governors whose views on policy differ from those of key members of Congress.
D)All of the above.
Q3) The Federal Reserve banks act as liaisons between the business community and the Federal Reserve System.
A)True
B)False
Q4) What are the factors that promote the independence of the Federal Reserve?
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Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Q1) If the Fed increases reserve requirements, the demand for reserves ________ and the equilibrium federal funds rate ________.
A)increases; drops
B)decreases; rises
C)decreases; drops
D)increases; rises
Q2) Inflation targeting makes the central bank less accountable.
A)True
B)False
Q3) What goals are continually mentioned by central bank officials when discussing the objectives of monetary policy?
A)High unemployment
B)Instability in foreign exchange markets
C)Interest-rate stability
D)All of the above
Q4) Can the Fed control the money supply? Has it done so? What evidence can you provide to support your answer to each question?
Q5) Discuss how the monetary policy of the European Central Bank is similar to the U.S. How are they different?
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Chapter 11: The Money Markets
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Q1) Money market securities have all the following characteristics except they are not A)short term.
B)money.
C)low risk.
D)very liquid.
Q2) Government securities dealers frequently engage in repos to
A)manage liquidity.
B)take advantage of anticipated changes in interest rates.
C)lend or borrow for a day or two with what is essentially a collateralized loan.
D)do all of the above.
E)do only A and B of the above.
Q3) What are the major types of securities and who are the major participants in the money markets?
Q4) What are the main characteristics of money market securities?
Q5) The main purpose of federal funds is to provide banks with an immediate infusion of reserves should they be short.
A)True
B)False
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Chapter 12: The Bond Market
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Q1) The nearer a bond's price is to its par value and the longer the maturity of the bond, the more closely the ________ approximates the ________.
A)current yield; yield to maturity
B)current yield; coupon rate
C)yield to maturity; current yield
D)yield to maturity; coupon rate
Q2) (I)The primary issuers of capital market securities are financial institutions. (II)The largest purchasers of capital market securities are corporations.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q3) Most corporate bonds have a face value of $1,000, are sold at a discount, and can only be redeemed at the maturity date.
A)True
B)False
Q4) What types of risks should bondholders be aware of and how do these affect bond prices and yields?
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Chapter 13: The Stock Market
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Q1) Which of the following is not an objective of the Securities and Exchange Commission?
A)maintain integrity of the securities markets
B)advise investors about which particular stocks are good buys
C)require firms to provide specific information to investors
D)regulate major participants in securities markets
Q2) The Enron financial scandal increased uncertainty about the quality of accounting information and as a result, increased required return on investment in stocks.
A)True
B)False
Q3) What is the primary disadvantage of an ETF?
A)ETFs tend to have lower management fees than comparable index mutual bonds.
B)ETFs usually have no minimum investment amount.
C)Investors have to pay a broker commission each time they buy or sell shares.
D)None of the above are disadvantages of an ETF.
Q4) Why would a crisis in the subprime mortgage market lead to declining prices in the U.S. equity markets?
Q5) What is the role of the required return on equity investments in stock valuation models?
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Chapter 14: The Mortgage Markets
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Q1) Which of the following are true of mortgages?
A)A mortgage is a long-term loan secured by real estate.
B)A borrower pays off a mortgage in a combination of principal and interest payments that result in full payment of the debt by maturity.
C)Over 80 percent of mortgage loans finance residential home purchases.
D)All of the above are true of mortgages.
E)Only A and B of the above are true of mortgages.
Q2) The share of the mortgage market held by commercial banks is approximately A)50 percent.
B)25 percent.
C)15 percent.
D)5 percent.
Q3) Adjustable-rate mortgages generally have lower initial interest rates than fixed-rate mortgages.
A)True
B)False
Q4) How has the modern mortgage market changed over recent years?
Q5) Nearly half the funds for mortgage lending comes from mortgage pools and trusts.
A)True
B)False
16
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Chapter 15: The Foreign Exchange Market
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Q1) A decrease in the foreign interest rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to appreciate.
A)domestic; right
B)domestic; left
C)foreign; right
D)foreign; left
Q2) The theory of purchasing power parity cannot fully explain exchange rate movements because
A)all goods are identical even if produced in different countries.
B)monetary policy differs across countries.
C)some goods are not traded between countries.
D)fiscal policy differs across countries.
Q3) According to the interest parity condition, if the domestic interest rate is 12 percent and the foreign interest rate is 10 percent, then the expected appreciation of the foreign currency must be 2 percent.
A)True
B)False
Q4) What are some of the long-run determinants of the exchange rate?
Q5) Explain the theory of purchasing power parity.
17
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Chapter 16: The International Financial System
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Q1) If the current account balance shows a surplus, and capital account receipts exceed capital account payments, then the net change in government international reserves must be ________, indicating a(n)________ in U.S. international reserves.
A)positive; increase
B)negative; increase
C)negative; decrease
D)positive; decrease
Q2) By the end of 2010, China had accumulated more than $2 trillion of international reserves.
A)True
B)False
Q3) The official reserve transactions balance
A)equals the current account balance plus the items in the capital account.
B)tells us the net amount of international reserves that must move between central banks in order to finance international transactions.
C)has an important impact on the money supply.
D)is all of the above.
Q4) How does a fixed exchange rate regime differ from a system of floating exchange rates?
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Chapter 17: Banking and the Management of Financial Institutions
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Q1) Checkable deposits and money market deposit accounts are
A)payable on demand.
B)liabilities of the banks.
C)assets of the banks.
D)only A and B of the above.
E)only A and C of the above.
Q2) Banks can protect themselves from the disruption caused by deposit outflows by
A)holding excess reserves.
B)selling securities.
C)"calling in" loans.
D)doing all of the above.
E)doing only A and B of the above.
Q3) If a bank has $200,000 of deposits, a required reserve ratio of 20 percent, and $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is
A)$50,000.
B)$40,000.
C)$30,000.
D)$25,000.
Q4) What are a bank's major sources and uses of funds?
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Chapter 18: Financial Regulation
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Q1) "Truth in lending" was mandated under the Consumer Protection Act of 1969 and requires all lenders to reveal the annual percentage rate, or APR, on loans.
A)True
B)False
Q2) Ways in which bank regulations reduce the adverse selection and moral hazard problems in banking include
A)a chartering process designed to prevent crooks from getting control of a bank.
B)restrictions that prevent banks from acquiring certain risky assets, such as common stocks.
C)high bank capital requirements to increase the cost of bank failure to the owners.
D)all of the above.
E)only A and B of the above.
Q3) The Depository Institutions Deregulation and Monetary Control Act of 1980
A)approved NOW accounts nationwide.
B)restricted the use of ATS accounts.
C)imposed interest rate ceilings on bank loans.
D)did all of the above.
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Chapter 19: Banking Industry: Structure and Competition
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Q1) Since the late 1970s, thrift institutions' importance as a source of funds for borrowers has shrunk markedly, from above ________ percent of total credit advanced to below ________ percent today.
A)30; 20
B)30; 15
C)40; 5
D)20; 10
Q2) As a result of shared electronic banking facilities,
A)barriers to branching have become less burdensome.
B)banking has become less competitive.
C)both of the above have occurred.
D)neither of the above has occurred.
Q3) Which of the following is not a financial innovation stimulated by information technology?
A)credit card
B)debit card
C)adjustable-rate mortgage
D)electronic banking
Q4) Explain what happened to the large, free-standing investment banks as a result of the 2007-2009 financial crisis.
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Chapter 20: The Mutual Fund Industry
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Q1) Hedge funds are
A)low risk because they are market-neutral.
B)low risk if they buy Treasury bonds.
C)low risk because they hedge their investments.
D)high risk because they are market-neutral.
E)high risk, even though they may be market-neutral.
Q2) Which of the following is an advantage to investors of an open-end mutual fund?
A)Once all the shares have been sold, the investor does not have to put in more money.
B)The investors can sell their shares in the over-the-counter market with low transaction fees.
C)The fund agrees to redeem shares at any time.
D)The market value of the fund's shares may be higher than the value of the assets held by the fund.
Q3) The increase in the number of defined contribution pension funds has slowed the growth of mutual funds.
A)True
B)False
Q4) What benefits do mutual funds offer investors?
Q5) Discuss the four primary classes of mutual funds available to investors.
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Chapter 21: Insurance Companies and Pension Funds
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Q1) Keogh plans and IRAs are
A)individual pension plans.
B)government pension plans.
C)corporate pension plans.
D)public pension plans.
Q2) Private pension plan assets are invested mainly in ________.
A)government securities
B)corporate bonds
C)stock
D)certificates of deposit
Q3) Privatization of Social Security
A)would transform the program from an unfunded pay-as-you-go system to a fully funded pension plan.
B)would mean that workers' current contributions to Social Security would no longer be available to pay benefits to current retirees.
C)receives less public support when the stock market declines.
D)all of the above
E)none of the above
Q4) Distinguish between different types of life insurance.
Q5) Why must insurance companies screen applicants so carefully?
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Chapter 22: Investment Banks, Security Brokers and
Dealers, and Venture Capital Firms
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Q1) Private placements are more common for the sale of stocks than for bonds.
A)True
B)False
Q2) An instruction to a securities agent to purchase a stock as long as its price does not exceed a specified level is a ________.
A)short sell
B)market order
C)limit order
D)stop loss order
Q3) Often investment bankers will form a group, each one buying only a portion of the new securities to be issued. Such a group is called an underwriting ________.
A)alliance
B)syndicate
C)association
D)guild
Q4) Resisted takeovers are called hostile.
A)True
B)False
Page 24
Q5) Describe the differences between securities brokers and securities dealers.
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Chapter 23: Risk Management in Financial Institutions
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Q1) The difference between rate-sensitive liabilities and rate-sensitive assets is known as the ________.
A)duration
B)interest-sensitivity index
C)interest-rate risk index
D)gap
Q2) How do the concepts of adverse selection and moral hazard explain the credit risk management principles that banks adopt?
Q3) Developing and maintaining long-term customer relationships help to reduce banks' costs of screening and monitoring borrowers.
A)True
B)False
Q4) Explain how banks benefit from long-term customer relationships.
Q5) Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the
A)adverse selection problem.
B)lemon problem.
C)adverse credit risk problem.
D)moral hazard problem.
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Chapter 24: Hedging With Financial Derivatives
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Q1) As compared to a default on the notional principle, a default on a swap
A)is more costly.
B)is about as costly.
C)is less costly.
D)may cost more or less than default on the notional principle.
Q2) A call option gives the owner the ________ to ________ the underlying security.
A)right; sell
B)obligation; sell
C)right; buy
D)obligation; buy
Q3) Explain how a long hedge could be used to protect a bank from the risk that interest rates could rise before a loan is funded.
Q4) Discuss the advantages of using swaps to protect against interest-rate risk rather than restructuring the balance sheet.
Q5) Futures contracts are standardized.
A)True
B)False
Q6) Explain how a swap could be used to reduce interest-rate risk for a bank with more rate-sensitive assets than rate-sensitive liabilities.
Page 26
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Chapter 25: Savings Associations and Credit Unions
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Q1) Credit unions are owned by stockholders.
A)True
B)False
Q2) The Competitive Equality in Banking Act of 1987
A)provided insufficient funds to the FSLIC to close down insolvent S&Ls.
B)actually directed S&L regulators to continue to pursue regulatory forbearance, further delaying the closing of insolvent S&Ls.
C)created a new agency, the Resolution Trust Corporation, to manage insolvent thrifts.
D)did all of the above.
E)did only A and B of the above.
Q3) Listing large amounts of goodwill as an asset is another way that savings and loans are able to hide the fact that they are insolvent.
A)True
B)False
Q4) Why have commercial banks gone to court in an effort to limit the activities of credit unions?
Q5) Why did the Competitive Equality in Banking Act of 1987 fail to solve the problems in the thrift industry?
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Chapter 26: Finance Companies
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Q1) In the early 1900s, banks did not offer loans to purchase automobiles. This is because
A)banks could not make a profit on car loans.
B)only finance companies were permitted to offer car loans.
C)banks could not repossess a car if the loan defaulted.
D)banks did not view a car as a productive asset.
Q2) Like the consumer finance market, finance companies face many regulations in the business loan market.
A)True
B)False
Q3) What are the various types of finance companies?
Q4) Lease financing is an example of a business financing need not served by most banks.
A)True
B)False
Q5) Finance companies are ________ market intermediaries.
A)stock
B)bond
C)FX
D)money
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