Chapter 01: Role of Financial Markets and Institutions

1. Financial market participants who provide funds are called a. Treasury note
a. deficit units. b. municipal bond
b. surplus units. c. mortgage
c. primary units. d. commercial paper
d. secondary units. ANSWER: d
ANSWER: b
8. The creditors in the federal funds market are
2. Which of the following is NOT an issuer of bonds? a. households.
a. households b. depository institutions.
b. corporations c. firms.
c. the U.S. Treasury d. government agencies.
d. government agencies ANSWER: b
ANSWER: a
9. Investors in equity securities may earn a return from
3. Behavioral finance a. coupon payments and the return of principal at
a. applies concepts from sociology and the maturity date.
anthropology to the behavior of market b. coupon payments and a capital gain when they
participants. sell the securities.
b. studies the behavior of financial markets in c. quarterly dividends (if paid) and a capital gain
response to changes in Federal Reserve policy. when they sell the securities.
c. applies psychology to financial decision making. d. quarterly dividends (if paid) and the return of
d. explains why markets are efficient. principal at the maturity date.
ANSWER: c ANSWER: c

4. The financial markets that facilitate the flow of short-term 10. Money market securities generally have ____.
funds are known as a. relatively low liquidity, low expected return, and
a. money markets. a high degree of credit risk
b. capital markets. b. relatively high liquidity, high expected return, and
c. primary markets. a high degree of credit risk
d. secondary markets. c. relatively low liquidity, high expected return, and
a low degree of credit risk
ANSWER: a
d. relatively high liquidity, low expected return, and
5. Funds are provided to the initial issuer of securities in the a low degree of credit risk
a. secondary market. ANSWER: d
b. primary market.
11. If security prices fully reflect all available information,
c. deficit market. the markets for these securities are
d. surplus market. a. efficient.
ANSWER: b b. primary.
c. overvalued.
6. Which of the following is a capital market instrument?
d. undervalued.
a. a six-month certificate of deposit
ANSWER: a
b. a three-month Treasury bill
c. a ten-year bond 12. If markets are ____, investors could use available
d. an agreement for a bank to loan funds directly to information ignored by the market to earn abnormally high
a company for nine months returns.
ANSWER: c a. perfect
b. active
7. Which of the following is a money market security? c. inefficient
Chapter 01: Role of Financial Markets and Institutions

d. in equilibrium a. provide brokerage services

ANSWER: c b. provide underwriting services
c. accept deposits that are insured by the federal
13. If financial markets are efficient, this implies that all government and use the funds to provide loans to
securities should earn the same return. corporations
a. True d. offer advice on mergers and other corporate
b. False restructurings
ANSWER: False ANSWER: c

14. The Securities Act of 1933 19. Without the participation of financial intermediaries in
a. required complete disclosure of relevant financial financial market transactions,
information for publicly offered securities in the a. information and transaction costs would be lower.
primary market. b. transaction costs would be higher but information
b. declared trading strategies to manipulate the costs would be unchanged.
prices of public secondary securities illegal. c. information costs would be higher but transaction
c. imposed heavy penalties for insider trading. costs would be unchanged.
d. required complete disclosure of relevant financial d. information and transaction costs would be
information for securities traded in the secondary higher.
market. ANSWER: d
e. All of these are correct.
ANSWER: a 20. Which of the following is most likely to be described as a
depository institution?
15. The Securities and Exchange Commission (SEC) was a. finance companies
established by the b. securities firms
a. Federal Reserve Act. c. credit unions
b. McFadden Act. d. pension funds
c. Securities Exchange Act of 1934. e. insurance companies
d. Glass-Steagall Act. ANSWER: c
e. None of these are correct.
ANSWER: c 21. In aggregate, ____ are the most dominant depository
institution, with more total assets than other depository
16. Stock issued by a corporation is an example of a(n) institutions.
a. debt security. a. commercial banks
b. money market security. b. savings banks
c. equity security. c. credit unions
d. debt security AND money market security. d. S&Ls
ANSWER: c ANSWER: a

17. If financial markets were ____, all information about any 22. Which of the following is a nondepository financial
securities for sale in primary and secondary markets would institution?
be continuously and freely available to investors. a. savings bank
a. efficient b. commercial bank
b. inefficient c. savings and loan association
c. perfect d. mutual fund
d. imperfect ANSWER: d
ANSWER: c
23. Which of the following distinguishes credit unions from
18. Which of the following is NOT a typical function of commercial banks and savings institutions?
securities firms? a. Credit unions are nonprofit.
Chapter 01: Role of Financial Markets and Institutions

b. Credit unions accept deposits but do not make

loans. 29. ____ securities have a maturity of one year or less; ____
c. Credit unions make loans but do not accept securities generally have relatively high liquidity.
deposits. a. Money market; capital market
d. Savings institutions restrict their business to b. Money market; money market
members who share a common bond. c. Capital market; money market
ANSWER: a d. Capital market; capital market
ANSWER: b
24. When a securities firm acts as a broker, it
a. guarantees the issuer a specific price for newly 30. Which of the following are NOT major investors in
issued securities. stocks?
b. makes a market in specific securities by adjusting a. commercial banks
its own inventory. b. insurance companies
c. executes securities transactions between two c. mutual funds
parties.
d. pension funds
d. purchases securities for its own account.
ANSWER: a
ANSWER: c
31. Which of the following financial intermediaries
25. When a securities firm acts as a(n) ____, it makes a commonly invest in stocks and bonds?
market in specific securities by maintaining an inventory of a. pension funds
those securities.
b. insurance companies
a. adviser
c. mutual funds
b. dealer
d. All of these are correct.
c. broker
ANSWER: d
d. None of these are correct.
ANSWER: b 32. Securities represent a claim on the issuer.
a. True
26. ____ obtain funds by issuing securities and then lend the
funds to individuals and small businesses. b. False
a. Finance companies ANSWER: True
b. Securities firms
33. Debt securities represent debt (borrowed funds) incurred
c. Mutual funds by the issuer.
d. Insurance companies a. True
ANSWER: a b. False
ANSWER: True
27. Households with ____ are served by ____.
a. deficient funds; depository institutions and 34. A five-year security was purchased two years ago by an
finance companies investor who plans to resell it. The investor will sell the
b. deficient funds; finance companies only security in the
c. savings; finance companies only a. secondary market.
d. savings; pension funds and finance companies b. primary market.
ANSWER: a c. deficit market.
d. surplus market.
28. ____ concentrate on mortgage loans. ANSWER: a
a. Finance companies
b. Commercial banks 35. When security prices fully reflect all available
c. Savings institutions information, the markets for these securities are said to be
d. Credit unions efficient.
ANSWER: c a. True
Chapter 01: Role of Financial Markets and Institutions

b. False ANSWER: True

ANSWER: True
44. Money market securities are commonly issued to finance
36. If markets are perfect, securities buyers and sellers do not the purchase of assets such as buildings, equipment, or
have full access to information and cannot always break machinery.
down securities to the precise size they desire. a. True
a. True b. False
b. False ANSWER: False
ANSWER: False
45. The total asset value of savings institutions is larger than
37. A broker executes securities transactions between two that of commercial banks.
parties and charges a commission for the transaction. a. True
a. True b. False
b. False ANSWER: False
ANSWER: True
46. Financial markets facilitating the flow of short-term debt
38. The adoption of the euro by 19 European countries has securities with maturities of one year or less are known as
increased business between those countries and created a a. secondary markets.
more competitive environment in Europe. b. capital markets.
a. True c. primary markets.
b. False d. money markets.
ANSWER: True e. None of these are correct.
ANSWER: d
39. In recent years, financial institutions have consolidated to
capitalize on economies of scale and on economies of scope.
47. Which of the following transactions would NOT be
a. True considered a secondary market transaction?
b. False a. An individual investor purchases some existing
ANSWER: True shares of stock in Apple through her broker.
b. An institutional investor sells some Disney stock
40. Securities represent a claim on the provider of funds. through its broker.
a. True c. A firm that was privately held engages in an
b. False offering of stock to the public.
ANSWER: False d. All of these are correct.
ANSWER: c
41. Debt securities include commercial paper, Treasury
bonds, and corporate bonds. 48. If investors speculate in the underlying asset rather than
a. True in derivative contracts on the underlying asset, they will
b. False probably achieve ____ returns, and they are exposed to
ANSWER: True relatively ____ risk.
a. lower; lower
42. Common types of capital market securities include b. lower; higher
Treasury bills and commercial paper. c. higher; lower
a. True d. higher; higher
b. False ANSWER: a
ANSWER: False
49. ____ maintain a larger amount of assets in aggregate than
43. Common types of money market securities include the other types of nondepository institutions.
negotiable certificates of deposit and Treasury bills. a. Finance companies
a. True b. Mutual funds
b. False c. Life insurance companies
Chapter 01: Role of Financial Markets and Institutions

d. Securities firms b. surplus units.

ANSWER: b c. borrowing units.
d. government units.
50. An asymmetric information problem arises when one ANSWER: b
party to a transaction has information that is not available to
the other party, as when a corporation fails to tell investors
57. Equity securities
the full extent of its losses.
a. have a maturity.
a. True
b. pay interest on a periodic basis.
b. False
c. represent ownership in the issuer.
ANSWER: True
d. repay the principal amount at maturity.
51. Bonds issued by corporations have a ____ expected ANSWER: c
return and ____ risk than Treasury bonds.
a. lower; lower 58. ____ involve(s) decisions such as how much funding to
b. lower; higher obtain and what types of securities to issue when financing
operations.
c. higher; lower
a. Corporate finance
d. higher; higher
b. Investment management
ANSWER: d
c. Financial markets and institutions
52. Systemic risk is the risk that a large decline in one stock’s d. None of these are correct.
price could cause investors to sell their stock in other ANSWER: a
companies.
a. True 59. There is a ____ relationship between the risk of a security
b. False and the expected return from investing in the security.
a. positive
ANSWER: False
b. negative
53. The Sarbanes-Oxley Act requires firms to provide c. indeterminable
complete and accurate financial information and imposes d. None of these are correct.
penalties on key executives of the firm if financial fraud is ANSWER: a
detected.
a. True 60. If a security is undervalued, some investors will capitalize
b. False on this by purchasing that security. As a result, the security's
ANSWER: True price will ____, resulting in a ____ return for those investors.
a. rise; lower
54. Capital market securities are commonly issued in order to b. fall; higher
finance the purchase of assets such as buildings, equipment, c. fall; lower
or machinery.
d. rise; higher
a. True
ANSWER: d
b. False
ANSWER: True 61. The credit crisis in the 2008–2009 period was caused by
weak economies in Asia.
55. Commercial banks in aggregate have more assets than a. True
credit unions.
b. False
a. True
ANSWER: False
b. False
ANSWER: True 62. ____ are classified as depository institutions.
a. Credit unions
56. Those participants who receive more money than they
b. Pension funds
spend are referred to as
a. deficit units. c. Finance companies
Chapter 01: Role of Financial Markets and Institutions

d. Securities firms ANSWER: False

ANSWER: a
70. By requiring full disclosure of information, securities
63. The main reason that depository institutions experienced laws prevent investors from making poor investment
financial problems during the credit crisis was their decisions.
investment in a. True
a. mortgages. b. False
b. money market securities. ANSWER: False
c. stocks.
d. Treasury bonds. 71. When a depository institution offers a loan, it is acting as
a creditor.
ANSWER: a
a. True
64. Those financial markets that facilitate the flow of short- b. False
term funds (with maturities of less than one year) are known ANSWER: True
as capital markets, while those that facilitate the flow of long-
term funds are known as money markets. 72. Savings institutions are a type of nondepository
a. True institution.
b. False a. True
ANSWER: False b. False
ANSWER: False
65. Bonds commonly have maturities of one to three years.
a. True 73. Most mutual funds raise funds by issuing securities and
b. False then lend the funds to individuals and small businesses.
a. True
ANSWER: False
b. False
66. Since markets are efficient, institutional and individual ANSWER: False
investors should ignore the various investment instruments
available. 74. Institutional investors not only provide financial support
a. True to companies but also exercise some degree of corporate
b. False control over them.
a. True
ANSWER: False
b. False
67. Speculating with derivative contracts on an underlying ANSWER: True
asset typically results in both higher risk and higher returns
than speculating in the underlying asset itself. 75. Which of the following is NOT a reason why depository
a. True financial institutions are popular?
b. False a. They offer deposit accounts that can
accommodate the amount and liquidity
ANSWER: True
characteristics desired by most surplus units.
68. When security prices fully reflect all available b. They repackage funds received from deposits to
information, the markets for these securities are said to be provide loans of the size and maturity desired by
perfect. deficit units.
a. True c. They accept the risk on loans that they provide.
b. False d. They use their information resources to act as
brokers, executing securities transactions between
ANSWER: False
two parties.
69. Securities that are not as safe and liquid as other e. They have more expertise than individual surplus
securities are never considered for investment by anyone. units in evaluating the creditworthiness of deficit
units.
a. True
ANSWER: d
b. False
Chapter 01: Role of Financial Markets and Institutions
76. Which of the following are NOT considered money investors.
market securities? a. undervalued
a. Treasury bills b. overvalued
b. mortgage-backed securities c. fairly priced
c. negotiable certificates of deposit d. efficient
d. commercial paper e. None of these are correct.
ANSWER: b ANSWER: b

77. ____ are not considered capital market securities. 82. Which of the following are NOT considered depository
a. Derivative securities financial institutions?
b. Treasury bonds a. finance companies
c. Corporate bonds b. commercial banks
d. Equity securities c. savings institutions
e. Mortgages d. credit unions
ANSWER: a e. All of these are depository financial institutions.
ANSWER: a
78. ____ are long-term debt obligations issued by
corporations and government agencies to support their 83. The main source of funds for ____ is proceeds from
operations. selling securities to households and businesses, while their
a. Common stock main use of funds is providing loans to households and
b. Derivative securities businesses.
c. Bonds a. savings institutions
d. None of these are correct. b. commercial banks
ANSWER: c c. mutual funds
d. finance companies
79. Which of the following is an example of an asymmetric e. pension funds
information problem? ANSWER: d
a. A corporation releases toxic wastes into a river.
b. A corporation relocates to Ireland to take 84. Which of the following statements is incorrect?
advantage of lower corporate tax rates. a. Financial markets attract funds from investors and
c. A stock analyst rates a stock higher than it channel the funds to corporations.
deserves because the securities firm she works for b. Money markets enable corporations to borrow
wants to obtain business from the corporation that funds on a short-term basis so that they can
issued the stock. support their existing operations.
d. A corporation manipulates its financial c. Financial institutions serve solely as
information to avoid disclosing a large loss from intermediaries with the financial markets and
its operations in China. never serve as investors.
ANSWER: d d. Investors seek to invest their funds in the stock of
firms that are presently undervalued and have
80. If investors speculate in derivative contracts rather than in much potential to improve.
the underlying asset, they will probably achieve ____ returns, ANSWER: c
and they are exposed to relatively ____ risk.
a. lower; lower 85. Which of the following facilitates the exchange of
b. lower; higher currencies?
c. higher; lower a. money market
d. higher; higher b. foreign exchange market
ANSWER: d c. New York Stock Exchange
d. federal funds market
81. When particular securities are perceived to be ____ by ANSWER: b
the market, their prices decrease when they are sold by
Chapter 01: Role of Financial Markets and Institutions

c. federal funds market.

86. Debt securities issued by a small firm may be ________, d. federal exchange market.
meaning that _______ investors want to invest in those
securities. ANSWER: c
a. liquid; many
92. Most of the funds that insurance companies receive from
b. liquid; not many premiums are invested in short-run money market securities.
c. illiquid; not many a. True
d. illiquid; many b. False
ANSWER: c ANSWER: False

87. Valuing stocks is easier than valuing debt securities 93. The risk that financial problems could spread among
because stocks promise to provide investors with specific financial institutions and across financial markets, causing a
payments at regular intervals. collapse of the financial system, is known as
a. True a. systemic risk.
b. False b. leverage risk.
ANSWER: False c. financial meltdown risk.
d. credit risk.
88. ____________ applies psychology to financial decisions
and offers an explanation for why markets are not always ANSWER: a
efficient.
a. Psychological marketing 94. Systemic risk exists because
a. there is no government regulation of financial
b. Behavioral finance
markets.
c. Inefficient markets theory
b. financial institutions invest in similar securities
d. Financial psychology and therefore are similarly exposed to large
ANSWER: b declines in prices of those securities.
c. financial institutions borrow using long-term debt
89. International integration of securities markets allows securities but lend their funds for short-term
a. governments and corporations to have easier periods.
access to funding from creditors and investors in d. financial institutions invest heavily in Treasury
other countries. securities and therefore are exposed to the
b. investors and creditors to benefit from investment possibility that the government will default on its
opportunities in other countries. debts.
c. one country’s financial problems to adversely ANSWER: b
affect other countries.
d. All of these are correct.
ANSWER: d

90. The foreign exchange market facilitates the exchange of

a. information between investors in different
countries.
b. debt securities.
c. equity securities.
d. currencies.
ANSWER: d

91. If a depository institution is experiencing more deposits

than it needs to make loans or invest in securities, it can lend
its excess funds to another depository institution through the
a. Federal Reserve’s trading desk.
b. options market.