c2 Financial Markets and Institutions يط

FIC001 Financial Markets and Institutions Final Practice Exam Fall2014
FIC001 Financial Markets and Institutions

Final Practice Exam, Fall, 2014
I. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers
the question. (86points)
1. The analysis of how asymmetric information problems affect economic behavior is called ________
theory.
A) uneven B) principal C) agency D) parallel
2. The concept of adverse selection helps to explain

A) why financial markets are among the most heavily regulated sectors of the economy.
B) why stocks are the most important source of external financing for businesses.
C) why collateral is not a common feature of many debt contracts.
D) why large, well-established corporations find it so difficult to borrow funds in securities markets.
3. A clause in a debt contract requiring that the borrower purchase insurance against loss of the asset
financed with the loan is called a
A) collateral-insurance clause. B) proscription covenant.
C) prescription covenant. D) restrictive covenant.
4. When a new depositor opens a checking account at the First National Bank, the bank's assets ________
and its liabilities ________.
A) decrease; increase B) increase; increase
C) decrease; decrease D) increase; decrease
5. ________ means people are more unhappy when they suffer losses than they are happy when they achieve
gains.
A) Loss cycle B) Loss fundamentals
C) Loss aversion D) Loss leader
6. A serious consequence of a financial crisis is

A) a contraction in economic activity. B) financial globalization.
C) financial engineering. D) an increase in asset prices.
7. The problem created by asymmetric information before the transaction occurs is called ________, while
the problem created after the transaction occurs is called ________.
A) moral hazard; adverse selection B) costly state verification; free-riding
C) adverse selection; moral hazard D) free-riding; costly state verification
8. ________ is a process of bundling together smaller loans (like mortgages) into standard debt securities.
A) Origination B) Distribution C) Securitization D) Debt
deflation
9. In emerging market countries, the deterioration in bank's balance sheets has more ________ effects on
lending and economic activity than in advanced countries.
A) affirming B) positive C) advancing D) negative
10. The difference of rate-sensitive liabilities and rate-sensitive assets is known as the
A) gap. B) duration. C) rate-risk index. D) interest-sensitivity index.
11. With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount
New Bank could lend is
A) $110. B) $90. C) $10. D) $100.
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12. To prevent bank runs and the consequent bank failures, the United States established the ________ in
1934 to provide deposit insurance.
A) SEC B) Federal Reserve C) ATM D)
FDIC
13. Which of the following bonds are considered to be default-risk free?

A) Municipal bonds B) Junk bonds C) U.S. Treasury bonds D) Investment-
grade bonds
14. When yield curves are flat,
A) short-term interest rates are about the same as long-term interest rates.
B) medium-term interest rates are above both short-term and long-term interest rates.
C) long-term interest rates are above short-term interest rates.
D) short-term interest rates are above long-term interest rates.
15. If the FDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring
that ________ depositors will suffer losses.
A) payoff; no B) payoff; large
C) purchase and assumption; no D) purchase and assumption; large
16. A decrease in the liquidity of corporate bonds will ________ the price of corporate bonds and ________
the yield of Treasury bonds, everything else held constant.
A) decrease; decrease B) increase; decrease
C) decrease; increase D) increase; increase
17. According to rational expectations,

A) expectations will not differ from optimal forecasts using all available information.
B) expectations formation indicates that changes in expectations occur slowly over time as past data change.
C) expectations of inflation are viewed as being an average of expected future inflation rates.
D) expectations of inflation are viewed as being an average of past inflation rates.
18. The reduction in transactions costs per dollar of investment as the size of transactions increases is
A) economies of trade. B) discounting. C) diversification. D) economies of scale.
19. Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects,
banks face the
A) lemon problem. B) adverse selection problem.
C) adverse credit risk problem. D) moral hazard problem.
20. Increased uncertainty resulting from the global financial crisis ________ the required return on
investment in equity.
A) had no impact on B) lowered C) decreased D) raised
21. The primary difference between the "payoff" and the "purchase and assumption" methods of handling
failed banks is
A) that the FDIC is more likely to use the "payoff" method when the bank is large and it fears that depositor
losses may spur business bankruptcies and other bank failures.
B) that the FDIC guarantees all deposits when it uses the "payoff" method.
C) that the FDIC is more likely to use the purchase and assumption method for small institutions because it
will be easier to find a purchaser for them compared to large institutions.
D) that the FDIC guarantees all deposits when it uses the "purchase and assumption" method.
22. When the yield curve is flat or downward-sloping, it suggest that the economy is more likely to enter
A) a period of increasing output. B) a boom time.
C) an expansion. D) a recession.
23. If in an efficient market all prices are correct and reflect market fundamentals, which of the following is
a false statement?
A) One investment is as good as any other because the securities' prices are correct.
B) Security prices can be used by managers to assess their cost of capital accurately.
C) A stock that has done poorly in the past is more likely to do well in the future.
D) A security's price reflects all available information about the intrinsic value of the security.
24. Managers (________) may act in their own interest rather than in the interest of the stockholder-owners
(________) because the managers have less incentive to maximize profits than the stockholder-owners do.
A) agents; agents B) agents; principals
C) principals; agents D) principals; principals
25. Factors likely to cause a financial crisis in emerging market countries include
A) severe fiscal imbalances. B) a foreign exchange crisis.
C) too strong oversight of the financial industry. D) decreases in foreign interest rates.
26. A financial crisis occurs when an increase in asymmetric information from a disruption in the financial
system
A) increases economic activity.
B) allows for a more efficient use of funds.
C) causes severe adverse selection and moral hazard problems that make financial markets incapable of
channeling funds efficiently.
D) reduces uncertainty in the economy and increases market efficiency.
27. Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the
A) contagion effect. B) adverse selection problem.
C) too-big-to-fail effect. D) moral hazard problem.
28. In the one-period valuation model, an increase in the required return on investments in equity
A) increases the current price of a stock. B) increases the expected sales price of a
stock.
C) reduces the expected sales price of a stock. D) reduces the current price of a stock.
29. If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4
percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is
the one with a maturity of
A) two years. B) three years. C) four years. D) five years.
30. The ________ problem helps to explain why the private production and sale of information cannot
eliminate ________.
A) free-rider; moral hazard B) principal-agent; moral hazard
C) free-rider; adverse selection D) principal-agent; adverse selection
31. People have a strong incentive to form rational expectations because

A) it is costly not to do so. B) everyone wants to be rational.
C) they are guaranteed of success in the stock market. D) it is costly to do so.
32. Which of the following statements is false?

A) A bank's assets are its uses of funds.
B) A bank issues liabilities to acquire funds.
C) Bank capital is recorded as an asset on the bank balance sheet.
D) The bank's assets provide the bank with income.
33. Which of the following bonds would have the highest default risk?
A) U.S. Treasury bonds B) Municipal bonds
C) Investment-grade bonds D) Junk bonds
34. When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in
A) an economic boom. B) an increased opportunity for growth.
C) a call for government regulation. D) a contraction of economic activity.
35. With ________, firms value assets on their balance sheet at what they would sell for in the market.
A) off-balance sheet accounting B) book-value accounting
C) mark-to-market accounting D) historical-cost accounting
36. As "haircuts" increased during 2007-2009, financial institutions found that to borrow the same loan
amount now required ________ collateral.
A) no B) default-free C) more D) less
37. The view that expectations change relatively slowly over time in response to new information is known
in economics as
A) rational expectations. B) irrational expectations.
C) adaptive expectations. D) slow-response expectations.
38. Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is
called
A) points. B) interest. C) good faith money. D) collateral.
39. The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same
capital requirement is known as
A) depositor supervision. B) a dual banking system.
C) regulatory arbitrage. D) competition in laxity.
40. Examples of off-balance-sheet activities include

A) borrowing from other banks. B) extending loans to depositors.
C) loan sales. D) selling negotiable CDs.
41. You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The
merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you
can expect to earn
A) below average returns since computer makers have low profit rates.
B) a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.
C) above average returns since you will share in the higher profits.
D) above average returns since your stock price will definitely appreciate as higher profits are earned.
42. When bad drivers line up to purchase collision insurance, automobile insurers are subject to the
A) ill queue problem. B) adverse selection problem.
C) assigned risk problem. D) moral hazard problem.
43. The spread between the interest rates on bonds with default risk and default-free bonds is called the
A) bond margin. B) risk premium. C) junk margin. D) default premium.
I. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the
question. Use the following format with answers in the provided answer sheet. (86 points)
1 2 3 4 5 6 7 8 9 10
11 12 13 14 15 16 17 18 19 20
21 22 23 24 25 26 27 28 29 30
31 32 33 34 35 36 37 38 39 40
41 42 43
II. ESSAY. Write your answer in the space provided or on a separate sheet of paper. (20 points)
1. Your bank has the following balance sheet:
Assets Liabilities
Reserves $ 50 million Checkable deposits $200 million
Securities 50 million
Loans 150 million Bank capital 50 million
If the required reserve ratio is 10%, what actions should the bank manager take if there is an unexpected
deposit outflow of $50 million? (10 points)
2. If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $40,000
in reserves, what is the maximum deposit outflow it can sustain without altering its balance sheet? (10
points)
1. C
2. A
3. D
4. B
5. C
6. A
7. C
8. C
9. D
10. A
11. B
12. D
13. C
14. A
15. C
16. A
17. A
18. D
19. D
20. D
21. D
22. D
23. C
24. B
25. A
26. C
27. A
28. D
29. D
30. C
31. A
32. C
33. D
34. D
35. C
36. C
37. C
38. D
39. C
40. C
41. B
42. B
43. B
1. After the deposit outflow, the bank will have a reserve shortfall of $15 million. The bank manager could try to
borrow in the Federal Funds market, take out a discount loan from the Federal Reserve, sell $15 million of the
securities the bank owns, sell off $15 million of the loans the bank owns , or lastly call-in $15 million of loans. All of
the actions will be costly to the bank. The bank manager should try to acquire the funds with the least costly
method.
2. $25,000.
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FIC001 Financial Markets and Institutions Final Practice Exam Fall2014

FIC001 Financial Markets and Institutions

2. The concept of adverse selection helps to explain

6. A serious consequence of a financial crisis is

13. Which of the following bonds are considered to be default-risk free?

17. According to rational expectations,

31. People have a strong incentive to form rational expectations because

32. Which of the following statements is false?

40. Examples of off-balance-sheet activities include

1. Your bank has the following balance sheet:

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