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Section 1: Choose the correct answer (20pts - 1pt/correct answer)

1. Which of the following can be described as involving indirect finance?
A) You make a loan to your neighbor.
B) You buy shares in a mutual fund.
C) You buy a U.S. Treasury bill from the U.S. Treasury.
D) A corporation buys a short-term security issued by another corporation in the primary
2. In the early 1980s, a particular bank in Oklahoma developed a reputation of readily
providing loans to borrowers for the purpose of exploring for oil deposits. Many of these
loans were never repaid, because this bank failed to address the
A) adverse selection problem.
B) regulatory avoidance problem.
C) free-rider problem.
D) risk-sharing problem.
3. A professional baseball player may be contractually restricted from skiing. The team
owner includes this clause in the players contract to protect against
A) risk sharing.
B) moral hazard.
C) adverse selection.
D) regulatory circumvention.
4. Because of the lemons problem the price a buyer of a used car pays is
A) equal to the price of a lemon.
B) less than the price of a lemon.
C) equal to the price of a peach.
D) between the price of a lemon and a peach.
5. The process where financial intermediaries create and sell low-risk assets and use the

proceeds to purchase riskier assets is known as

A) risk sharing.
B) risk aversion.
C) risk neutrality.
D) risk selling.
6. Which of the following are transaction deposits?
A) Savings accounts
B) Small-denomination time deposits
C) Negotiable order of withdraw accounts
D) Certificates of deposit
7. Bank capital is listed on the ________ side of the banks balance sheet because it
represents a ________ of funds.
A) liability; use
B) liability; source
C) asset; use
D) asset; source
8. Long-term customer relationships ________ the cost of information collection and make
it easier to ________ credit risks.
A) reduce; screen
B) increase; screen
C) reduce; increase
D) increase; increase
9. Property promised to the lender as compensation if the borrower defaults is called
A) collateral
B) deductibles

C) restrictive covenants
D) contingencies
10. Measuring the sensitivity of bank profits to changes in interest rates by multiplying the
gap times the change in the interest rate is called
A) basic duration analysis.
B) basic gap analysis.
C) interest-exposure analysis.
D) gap-exposure analysis.
11. Secondary markets make financial instruments more
A) solid.
B) vapid.
C) liquid.
D) risky.
12. A financial market in which only short-term debt instruments are traded is called the
________ market.
A) bond
B) money
C) capital
D) stock
13. An increase in stock prices ________ the size of peoples wealth and may ________ their
willingness to spend, everything else held constant.
A) increases; increase
B) increases; decrease
C) decreases; increase
D) decreases; decrease
14. American farmers who sell beef to Europe benefit most from

A) a decrease in the dollar price of euros.

B) an increase in the dollar price of euros.
C) a constant dollar price for euros.
D) a European ban on imports of American beef.
15. The money market instruments that were created to assist in carrying out international
trade are called ________.
A) negotiable CDs.
B) bankers acceptances.
C) repurchase agreements.
D) federal funds.
16. Bonds issued by state and local governments are called ________ bonds.
A) corporate
B) Treasury
C) municipal
D) commercial
17. Examples of off-balance-sheet activities include
A) loan sales.
B) extending loans to depositors.
C) borrowing from other banks.
D) selling negotiable CDs.
18. A bank is insolvent when
A) its liabilities exceed its assets.
B) its assets exceed its liabilities.
C) its capital exceeds its liabilities.
D) its assets increase in value.
19. The countries that have made the least use of securities markets are ________ and

________; in these two countries finance from financial intermediaries has been almost
ten times greater than that from securities markets.
A) Germany; Japan
B) Germany; Great Britain
C) Great Britain; Canada
D) Canada; Japan
20. The delivery of financial services electronically is called ________.
A) e-business
B) e-commerce
C) e-finance
D) e-possible
Section 2: Decide whether the statements are true (T) or false (F) (20pts -2pts/correct
21. When a countrys currency depreciates, its goods abroad become
more expensive and foreign goods in that country become cheaper.

22. If a bank is to make a profit, it can put that to productive use through
investing in bonds and making loans.
23. In market-based financial systems, loans from financial
intermediaries are more important for corporate finance than
marketable securities, but at a higher extent than in other financial
24. Generally, increasing interest rates from the banks encourages
individuals from lending.
25. Loans represent the most important source of finance in terms of
funds raised externally in most cases.
26. Treasury Bonds typically have the original maturity of less than 1
27. Municipal Governments and Corporations can issue stocks.

Answer: cheaper,
more expensive
Answer: lower
Answer: 10 - 30 years
Answer: Corporations

28. A bond is a debt security that promises to make payments

periodically for a specified period of time.

29. The organization responsible for the conduct of monetary policy in

the United States is the U.S. Treasury.

Answer: Federal
Reserve System

30. Call provision is a chareacteristic of Corporate Bonds. It gives the

issuer the right to force the holder to sell the bond back.

Section 3: Fill in the gaps (30pts - 3pts/correct answer)

par value



coupon rate












- (31)______________ accept deposits to make loans and to buy government securities. Deposits
are broad in range, including (32)______________ deposits (deposits on which cheques can be
written), (33)______________ deposits (deposits that are payable on demand, but do not allow
depositors to write cheques), (34)______________ deposits (deposits with a fixed term to
maturity). Loans include consumer, commercial and (35)______________ loans. (5)
- A bond has three main components: the (36)______________, or the stated interest on the debt;
the (37)______________, or the life of the bond; and the (38)______________, the principal or
the total amount initially borrowed that must be repaid to the lender at maturity.
- Themajordifferencebetweentheprimaryandsecondarymarketsisthe(39)______________
asset, investors know that the asset can be liquidated fairly quickly and without (40)______________,otherthanthefeesforhandlingthetransaction.
31. commercial banks

32. checkable

33. savings

34. time

35. mortgage

36. coupon rate

37. maturity

38. par value

39. liquidity

40. penalty

Section 4: Answer the questions (30pts - 6pts/correct answer)

41. How does collateral help to reduce the adverse selection problem in credit market?

Answer: Collateral is property that is promised to the lender if the borrower defaults thus
reducing the lenders losses. Lenders are more willing to make loans when there is collateral that
can be sold if the borrower defaults.
42. Would you be more willing to lend to a friend if she put all of her life savings into her

business than you would if she had not done so? Why?
Answer: Yes. The person who is putting her life savings into her business has more to lose if she
takes on too much risk or engages in personally beneficial activities that dont lead to higher
profits. So she will act more in the interest of the lender, making it more likely that the loan will
be paid off.
43. If Mexicans go on a spending spree and buy twice as much French perfume, Japanese
TVs, English sweaters, Swiss watches and Italian wine, what will happen to the value
of the Mexican Peso.
Answer: The peso will depreciate. Consider Mexico to be the domestic country. An increased
demand for imports would lower the expected future exchange rate and result in a lower
expected appreciation of the peso. The resulting lower expected return on peso assets at any
given exchange rate would then shift the demand curve to the left, leading to a fall in the peso
exchange rate.
44. If the president of a bank told you that the bank was so well run that it never had to
call in loans, sell securities or borrow as a result of a deposit outflow, would you be
willing to buy stock in that bank? Why or why not?
Answer: No, because the bank president is not managing the bank well. The fact that the bank
has never incurred costs as a result of a deposit outflow means that the bank is holding a lot of
reserves that do not earn any interest. Thus the banks profits are low, and stock in the bank is not
a good investment.
45. Bank managers should always seek the highest return possible on their assets. Is
this statement true, false or uncertain? Explain your answer.
Answer: False. If an asset has a lot of risk, a bank manager might not want to hold it even if it
has a higher return than other assets. Thus a bank manager has to consider risk as well as the
expected return when deciding to hold an asset.