The Economics Of Financial Intermediation Exam Prep Ch.11

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1) A friend of yours tells you she has an idea for a new product. She believes that once the prototype is built she can sell the rights to the product for $250,000. The problem is she needs $20,000 to build the prototype and she only has $5,000. She asks you to invest $15,000 in the idea and she will give you 75% of whatever amount she obtains when she sells the rights. You have the money available but should be reluctant to provide the money. Why?

2) Explain how financial intermediaries contribute to increasing the output of an economy.

3) What is the difference between economies of scale and economies of scope? Provide an example of each that pertains to financial institutions.

4) Read the scenarios in the following table and, for each one, determine whether it illustrates a problem of adverse selection or moral hazard. Write your answer in the last column.

5) Is the conflict between a lender to a firm and the borrower/owner an example of adverse selection or moral hazard? Explain.

6) If a lender faces a potential loan applicant pool made up of equal amounts of low risks and high risks, will charging an average interest rate provide the average (expected) return? Explain.

7) Explain how Federal Deposit Insurance (FDIC) could potentially create a moral hazard for the managers of deposit institutions.

8) Why are financial intermediaries so important in most economies?

9) What are the five functions performed by financial intermediaries?

10) Provide an example of how a bank achieves lower costs in making a large loan to a company than could be achieved without the bank.

11) If diversification is such a good idea for a saver, why do so many people put a lot of their savings in the same bank?

12) Explain how mutual funds offer small investors a low-cost way to achieve diversification.

13) Explain what will happen to the market for used cars if buyers cannot distinguish a good used car, worth $15,000, from a "lemon," worth $5,000.

14) A bank advertises a very competitive loan interest rate. Explain what measures the bank can take to address adverse selection.

15) Discuss the role that companies like Standard & Poor's, Dun & Bradstreet, and Moody's play in solving the problem of adverse selection.

16) Respond to the following: "If it takes a significant period of time to uncover accounting manipulations by individuals in a major corporation, honesty may be the best policy but dishonesty can be a lot more profitable!"

17) Explain the difference between a secured loan and an unsecured loan, and the interest rate you would expect to see charged on each (all other factors equal).

18) Explain what is likely to happen to the rate of mortgage loan default given the following: "For years home values across the country have increased, on average, 3 to 4% each year. Mortgage lenders have come to expect this to always be the case and so begin to offer mortgages with little to nothing down and no requirement for PMI insurance. Then an economic slowdown occurs, hitting a few areas of the country harder than others. Home values across the country begin to decrease with some areas seeing decreases of as much as 10%."

19) Explain why deflation can be so troubling to borrowers and lenders.

20) Life insurance companies usually offer a lower premium to nonsmokers than the premium charged to smokers. Discuss first the potential for adverse selection and moral hazard and then ways the company can seek to reduce or eliminate these problems.

21) You have a friend that has run up a pretty large balance on his credit card. He mentions to you that he has missed a few payments but doesn't think it is that big of a deal since all it cost him is a little more interest on his balance. You tell him it may end up costing him a lot more than that. He presses you for an explanation. Explain to him how his handling of this debt can impact what he pays for future debt.

22) It is not uncommon to read about highly successful mutual fund managers that spend considerable amounts of time visiting the companies with which they have placed their clients' funds. What might be the motive(s) behind these visits?

23) Explain how the threat of a leveraged buyout or a takeover can actually address the problem of moral hazard.

24) The United States, the United Kingdom, Germany, and Japan are all developed countries with highly developed and efficient financial markets. However, in all four countries the main source of business finance is internal funding. Why is this so?

25) Use examples to describe at least two possible solutions to the problem of adverse selection.

26) Use examples to describe at least two possible solutions to the problem of moral hazard.

27) Most credit cards charge a relatively high rate of interest, yet many people carry them, including people who would be considered low-risk borrowers. The concept of adverse selection suggests that low-risk borrowers would be less likely to use these. Why is that not the case?

28) A friend who is taking her first class in investments asks you why the regulatory bodies place so much emphasis on minimizing insider information if many of the potential problems associated with financial transactions stem from information asymmetry or a lack of information. How would you respond?

29) Explain how problems of adverse selection and moral hazard make securities finance expensive and difficult to get. Use examples to support your explanations.

30) How did information asymmetries in the home mortgage market contribute to the financial crisis of 2007–2009?

31) Financial intermediation is

A) far less important than direct finance through stock and bond markets.
B) only a little more important than direct finance in the United States.
C) much more important than direct finance through stock and bond markets.
D) the same thing as finance through stock and bond markets.

32) Financial intermediation exists, in part, because

A) financial markets work so well.
B) direct finance through stocks and bonds is the dominant form of financing.
C) transaction costs of financial intermediation is always higher than direct finance.
D) the transaction costs associated with direct finance can at times be prohibitive.

33) When the amount of direct and indirect financing are summed, the result is usually

A) greater than 100% of GDP.
B) equal to GDP.
C) less than GDP.
D) approximately 50% of GDP.

34) Emerging market economies, compared to industrialized economies, have financial markets that

A) differ in composition and size.
B) differ in composition but not in size.
C) are the same in composition but differ in size.
D) are similar in composition and size.

35) All of the following except which one are reasons why financial intermediaries play such an important role in economies?

A) information costs
B) transaction costs
C) complexity of financial transactions
D) composition of GDP

36) Which one of the following is not a role of a financial institution acting as a financial intermediary?

A) pooling the resources of small savers
B) formulating oversight regulations
C) providing ways to diversify risk
D) supplying liquidity

37) Financial institutions, acting as financial intermediaries, perform all of the following, except which one?

A) provide ways to diversify risk
B) pool resources of small savers
C) increase transactions costs
D) provide safekeeping and accounting services

38) Financial intermediaries pool the resources of many small savers so that they can

A) charge fees to these small savers and earn substantial income.
B) obtain the funds necessary to make loans to borrowers seeking large amounts.
C) lower their transaction costs of obtaining funds.
D) avoid paying any interest to obtain funds to lend.

39) If financial intermediaries did not have the ability to pool the resources of small savers,

A) borrowers needing large amounts of money would find it more costly to obtain the funds.
B) the economy would grow faster.
C) people would likely save more.
D) the risk associated with lending would decrease.

40) Financial intermediaries

A) increase the cost of financial transactions but offset these higher costs by providing safekeeping of customer funds.
B) provide handling of payments but usually less efficiently than other firms.
C) reduce the cost of financial transactions.
D) provide safety of resources only for the large borrowing customers who can afford it.

41) Financial intermediaries, through their ability to lower transaction costs,

A) allow for people to be more self-sufficient.
B) increase the amount of trading that occurs in an economy.
C) take people away from their comparative advantage.
D) reduce the number of financial transactions that occur.

42) Financial intermediaries, through their ability to lower transaction costs,

A) reduce the opportunity cost of specialization.
B) decrease the efficiency of an economy.
C) allow for people to be more self-sufficient.
D) make collecting and processing information unprofitable.

43) The fact that a financial intermediary can hire a lawyer to write one contract that works for many customers is an example of

A) economies of scale.
B) the law of diminishing marginal returns.
C) the law of increasing opportunity cost.
D) the law of demand.

44) The fact that financial intermediaries employ experts to carry out particular activities and, therefore, reduce transactions costs is an example of which one of the following economic concepts?

A) law of demand
B) economies of scale
C) comparative advantage
D) information costs

45) Economies of scale associated with financial intermediaries are realized when the

A) total cost of handling transactions falls as more transactions of different kinds are handled.
B) cost per transaction falls as a larger volume of similar transactions are handled.
C) cost per transaction increases as more transactions are handled.
D) cost per transaction decreases regardless of the number of transactions.

46) Examples of economies of scale include the

A) additional fees financial intermediaries charge on small accounts.
B) decrease in overall transaction costs that occur as volume increases.
C) reduction in the cost per transaction that occurs as the number of transactions increase.
D) decrease in overall information costs that occurs as more transactions are handled.

47) The reduction in transaction costs provided by financial intermediaries benefit

A) small borrowers and small savers.
B) large borrowers but not small savers.
C) society in the net, but small savers bear much of the cost.
D) small borrowers but not small savers.

48) Automated teller machines provided by financial intermediaries are an example of

A) high transactions costs associated with financial intermediaries.
B) diseconomies of scale.
C) the ability of financial intermediaries to provide liquidity.
D) the ability of financial intermediaries to earn profits by raising transaction costs above the norm.

49) The function of providing liquidity by financial intermediaries

A) includes depositors withdrawing funds but not borrowers.
B) only considers people who borrow on a short-term basis, but not depositors.
C) affects people who need to borrow and depositors who withdraw their funds.
D) only affects customers with savings accounts.

50) Since one function of financial intermediaries is to provide liquidity,

A) they must keep all of their funds in short-term securities.
B) they keep almost all of their funds in cash.
C) they must know approximately how much liquidity their customers will need each day and have these funds available.
D) regulations require financial intermediaries to keep 50% of their assets in cash.

51) A bank can usually offer a saver a higher return for the same risk for all of the following reasons except

A) the bank can usually purchase assets at a lower cost than any one saver.
B) the bank can pool the resources of small savers and purchase higher valued assets.
C) economies of scale can also be applied by the bank in its purchase of assets.
D) savers do not have good enough information to know if the return is sufficient.

52) Lines of credit provided by financial intermediaries

A) decrease liquidity for customers but increase income for the intermediary.
B) are pre-approved loans that can increase liquidity and lower transaction costs.
C) are costly for intermediaries to provide so are only available to large commercial customers.
D) require deposits in the intermediary that equal or exceed the amount of the line of credit.

53) When a bank takes savings from many small savers and lends it to many borrowers, the bank

A) decreases the risk to savers through diversification.
B) increases the risk to borrowers through high transaction costs.
C) decreases the risk to savers through economies of scale.
D) decreases the return to savers and increases the cost to borrowers.

54) If a bank has 1,000 depositors, each of whom deposits $1,000 in the bank, and the bank makes loans of $10,000 each, then each depositor has contributed

A) $100 to each loan.
B) $1 to each loan.
C) $10 to each loan.
D) $1000 to each loan.

55) Mutual funds offer investors

A) a greater return for greater risk than what an investor can earn on his own.
B) a lower return for more risk than what the investor could earn on his own.
C) a lower return for less risk than what the investor could earn on his own.
D) a way for individuals to eliminate the idiosyncratic risk associated with any single investment.

56) Mutual funds are attractive because they

A) provide high returns from purchasing the financial securities of a few select companies.
B) provide the investor with greater diversification at a lower cost than what most investors could obtain individually.
C) have inside information that is not available to other investors.
D) routinely obtain inside information because they run most of the companies they invest in.

57) A bank has 10,000 depositors, each of whom deposits $100 in the bank. If the bank makes 1000 loans for $1,000 each then each depositor has contributed

A) $1 to each loan.
B) $100 to each loan.
C) $0.10 to each loan.
D) $10 to each loan.

58) A lender usually knows less about the creditworthiness of a borrower than the borrower does. This is an example of

A) opportunistic behavior.
B) economies of scale.
C) diminishing marginal returns.
D) information asymmetry.

59) Most individuals save at banks rather than lend directly because

A) the bank creates information asymmetry.
B) moral hazard exists only when individuals make loans directly to borrowers, it does not occur when banks issue loans.
C) banks can reduce the cost of information asymmetry.
D) information asymmetry is a problem for individuals but not for banks.

60) Financial intermediaries reduce the problems in lending associated with information asymmetries by all of the following except which one?

A) collecting and processing standardized information
B) screening applicants to be sure they are creditworthy
C) monitoring loan recipients to be sure the funds are used properly
D) charging interest rates high enough to discourage undesirable borrowers

61) Asymmetric information poses two important obstacles to the smooth flow of funds from savers to investors. They are

A) adverse selection, which arises before the transaction occurs, and moral hazard, which occurs after the transaction.
B) moral hazard, which arises before the transaction occurs, and adverse selection, which occurs after the transaction.
C) adverse selection and moral hazard, both of which occur after the transaction.
D) adverse selection and moral hazard, both of which occur before the transaction.

62) Financial markets do not function as well as they could due to

A) the fact that banking is highly monopolized.
B) the cost of obtaining information, which can be high.
C) regulation by governments.
D) fluctuations in the inflation rate.

63) The usual situation in banking regarding asymmetric information is that

A) borrowers know more than lenders.
B) lenders know more than borrowers.
C) borrowers and lenders have the same information.
D) lenders and borrowers have perfect information.

64) Guillaume moves from an hourly job where he is paid per unit of output produced to a salaried position where his income is not dependent on his output. He begins to take longer breaks and skip unpleasant tasks. This is an example of what type of information asymmetry?

A) moral hazard
B) adverse selection
C) economies of scale
D) increased diversification

65) Ping-Hsin is a 25-year-old woman who purchases health insurance after she begins to feel fatigued. It is soon discovered that she has an autoimmune disorder that will require expensive monitoring and medication for the rest of her life. If this information was not revealed prior to the purchase of the insurance, this is an example of what type of information asymmetry?

A) moral hazard
B) adverse selection
C) economies of scale
D) increased diversification

66) Mom's Pizzeria goes out of business due to a dramatic decrease in sales from a local newspaper article highlighting the fact that Mom's Pizzeria has been purchasing expired meat from a distributor at cut-rate prices for years. The decrease in business also results in Mom's defaulting on the loan they have with the bank. This is an example of

A) symmetric information in the financial markets.
B) perfect information in the financial markets.
C) asymmetric information in the financial markets.
D) perfect information in the pizza market.

67) Mom's Bakery goes out of business due to decreasing sales resulting from the dramatic increase in people on low-carbohydrate diets. The decrease in business also results in Mom's defaulting on the loan they have with the bank. This is an example of

A) lack of perfect information in financial markets.
B) asymmetric information in financial markets.
C) moral hazard in financial markets.
D) symmetric information in financial markets.

68) We often see companies offering money-back guarantees to customers if they are not satisfied. These guarantees are a way to treat the problem of

A) buyers having more information about the product than the seller.
B) the seller having more information about the product than the buyer.
C) symmetric information.
D) adverse selection.

69) Which one of the following is not true of adverse selection?

A) It exists because information is perfect.
B) It describes the problem a lender faces in identifying loan applicants as good or bad risk borrowers.
C) It arises because borrowers have more information than lenders regarding their creditworthiness.
D) It arises if lenders try to charge an average price to all applicants.

70) In a financial market where information is symmetric,

A) there would be moral hazard.
B) one party to a transaction knows information the other party does not.
C) the ability to obtain information is available to only one party.
D) there would be no adverse selection.

71) Two problems that arise from asymmetric information are

A) adverse selection and diseconomies of scale.
B) moral hazard and the free-rider problem.
C) moral hazard and adverse selection.
D) the free-rider problem and adverse selection.

72) Which one of the following is a problem of adverse selection?

A) The lender has a problem of distinguishing good risk from bad risk borrowers.
B) The lender has a problem determining that the proceeds from a loan are being used as the borrower stated.
C) A person takes up the hobby of bungee jumping after purchasing health insurance.
D) Individuals use more medical services as a result of their purchase of a health insurance plan.

73) Which one of the following is a problem of moral hazard?

A) A lender cannot distinguish good risk from bad risk borrowers.
B) An individual who purchases auto insurance begins to leave his or her keys in the car while running into a store.
C) Life insurance companies offer an average premium to smokers and non-smokers so they do not have to have two different premiums.
D) An auto insurance company charges higher premiums to younger drivers than what they charge to older drivers.

74) One of the conclusions from Akerlof's paper titled "The Market for Lemons" was

A) high quality goods will drive low quality goods out of the market.
B) lacking the ability to distinguish high from low quality, the market will end up offering only average quality.
C) lacking the ability to distinguish high from low quality, low quality may drive high quality out of the market.
D) high quality is always demanded by consumers over low quality.

75) Mary Jones is the president of a local bank. She knows that half of the loan applicants in town she would classify as high risk and the other half as low risk. She observes that the other banks in town charge two different interest rates, a lower rate for low risk borrowers and the higher rate for high risk borrowers. She decides that to have an advantage over the other banks, she will offer an average rate to everyone. The likely result will be that Mary’s bank

A) will be highly successful as this will provide the bank with a large competitive advantage.
B) is likely to see a dramatic increase in both types of borrowers.
C) will experience adverse selection and have a disproportionate number of low risk borrowers.
D) will experience adverse selection and have a disproportionate number of high risk borrowers.

76) One lesson that Akerlof's Lemons model provides is that

A) for high quality providers to survive, they must provide a way for customers to distinguish high quality from low quality.
B) low quality will not survive in a market.
C) people always prefer high quality to low quality goods.
D) moral hazard is unavoidable.

77) A firm that has a well-earned reputation for providing high quality has found a way to address the

A) free-rider problem.
B) moral hazard problem.
C) problem of adverse selection.
D) problem of economies of scale.

78) The interest rates charged on most credit cards are

A) high due to the problem of adverse selection.
B) high because Visa and MasterCard have a virtual monopoly on this business.
C) high due to diseconomies of scale that exist in this market.
D) lower than they should be given the problem of adverse selection.

79) Assume there are two companies that issue stock, but one is high quality and the other is low quality. If potential investors cannot distinguish the quality of the company,

A) the shares of the low quality firm will disappear from the market.
B) the shares of both companies will trade on the market.
C) the shares of the high quality firm will disappear from the market.
D) this is an example of moral hazard and the shares of both companies will cease to trade.

80) The publication Consumer's Reports is one tool designed to address

A) adverse selection.
B) moral hazard.
C) the free-rider problem.
D) symmetric information.

81) In the bond market, the assigning of a risk premium is a tool designed to address the problem of

A) adverse selection.
B) information asymmetry.
C) the free-rider.
D) moral hazard.

82) Used car dealers that provide warranties on the cars they sell are addressing the

A) lemons problem.
B) monopoly problem.
C) problem of people preferring foreign cars.
D) free rider problem of buyers preferring new versus used cars.

83) Adverse selection

A) increases the efficiency of most markets.
B) usually causes prices to adjust faster than they otherwise would.
C) makes it easier for all customers to find what they want.
D) results in fewer market transactions.

84) Which one of the following statements is true?

A) Adverse selection is a problem of monopoly and moral hazard is a problem of information asymmetry.
B) Adverse selection and moral hazard are problems stemming from asymmetric information.
C) Adverse selection is a problem that occurs after a transaction.
D) Moral hazard is a problem that occurs before a transaction.

85) Which one of the following statements is true?

A) Adverse selection is a problem that occurs after a transaction.
B) Moral hazard is a problem that occurs before a transaction.
C) Adverse selection is a problem stemming from asymmetric information.
D) Both adverse selection and moral hazard occur before a transaction.

86) One reason lenders usually require a lot of information from loan applicants is to avoid

A) the problem of moral hazard.
B) the problem of adverse selection.
C) being harmed by symmetric information.
D) charges of discrimination in lending.

87) One reason the government requires public corporations to disclose so much information is to

A) minimize the monopoly profits some corporations earn.
B) give small corporations a better chance of competing against large corporations.
C) address the potential harm from asymmetric information.
D) discourage risk-taking by investors.

88) A lender who wants to avoid the problem of adverse selection could

A) charge a very high interest rate and assume all loan applicants are high risk.
B) charge the same average interest rate to all borrowers.
C) charge a low interest rate and make the applicant prove they warrant the low rate by providing information.
D) only lend by issuing credit cards.

89) The First Bank of Podunk has recently suffered some extraordinary losses on its loan portfolio due to the closing of the largest employer in town. As a result, the bank's management decides to raise the interest rate to new loan applicants. This move is likely to

A) increase the profitability of the bank.
B) cause even greater losses.
C) significantly increase both loan applicants and profits.
D) treat the problem of adverse selection that contributed to the losses the bank is experiencing.

90) The problem of adverse selection created the opportunity for

A) lenders to profit significantly at the expense of borrowers.
B) significant deregulation of financial markets.
C) a new market in the trading of information.
D) stock prices for many years to be much lower than what they should have been.

91) Recent history has shown that the government regulations requiring the disclosure of information from public corporations have

A) all but eliminated the problems of asymmetric information.
B) reduced but not eliminated the problems of asymmetric information.
C) just about eliminated the market for information services.
D) resulted in symmetric information.

92) The price for private information is likely higher than it should be due to the problem of

A) adverse selection.
B) free-riders.
C) the government regulations regarding information.
D) moral hazard.

93) Moody's, Value Line, and Dun and Bradstreet are examples of companies that

A) provide information free to investors but charge the companies for the ratings provided on the company.
B) provide information free to investors but recoup expenses through advertising done by the companies being rated.
C) charge investors who subscribe to the services for the information.
D) duplicate information that is available to investors at no cost.

94) The scandals involving Enron, World Com, Global Crossing, and other large firms

A) are examples of asymmetric information and led, at least temporarily, to a less well-functioning stock market.
B) should have been expected on the part of investors since that is why there is a risk premium.
C) have resulted in a cry for less government regulation of public corporations.
D) demonstrate that the government should be responsible for collecting and distributing financial information on firms.

95) Requiring that borrowers put up collateral to obtain a loan is a tool designed to treat the

A) lemons problem.
B) problem of adverse selection.
C) problem of moral hazard.
D) free-rider problem.

96) Which one of the following could the lemons problem, applied to financial markets, explain?

A) lenders seeing a disproportionate share of high quality loan applicants
B) an average interest rate that is too high for the actual risk obtained
C) profits for many lenders increasing significantly
D) high quality potential borrowers relying more on internally generated funds to finance investment

97) An unsecured loan is

A) a loan where the applicant does not have any net worth.
B) a loan where the applicant does not post any collateral.
C) another name for a mortgage loan.
D) usually a low-risk loan.

98) A home mortgage is a good example of

A) an unsecured loan.
B) a secured loan.
C) a high risk loan.
D) the problem of adverse selection.

99) Requiring a large net worth on the part of an applicant is one way lenders treat the problem of

A) free-riders.
B) adverse selection.
C) moral hazard.
D) the lemons market.

100) Requiring a home buyer to have a large down payment reduces risk to a mortgage lender because it means that

A) if the price of the house falls, the owner suffers the loss.
B) the buyer is less likely to sell the house.
C) the buyer likely underpaid when she bought the house.
D) there is more information available on the buyer.

101) Which one of the following statements is false?

A) Home mortgage loans are secured loans.
B) Credit card loans are secured.
C) Most automobile loans are secured loans.
D) Secured loans usually carry less risk than unsecured loans.

102) Unsecured loans

A) generally involve very high interest rates as a result of the free-rider problem.
B) generally involve very high interest rates as a result of adverse selection.
C) are no longer made; all loans now must have some form of collateral.
D) are only made to individuals with very high net worth because it is the only way to limit the risk.

103) Deflation compounds information problems because it

A) increases a company's net worth.
B) tends to understate a company's assets and overstate their liabilities.
C) reduces the dollar value of assets while the dollar value of liabilities stays constant.
D) always harms lenders.

104) A borrower who obtains funds from a lender to purchase additional inventory but uses the funds to finance a trip to Las Vegas for a weekend of gambling at the opening of a new casino is an example of

A) the problem of adverse selection.
B) the free-rider.
C) the moral hazard problem.
D) lax government regulation.

105) Credit may dry up at the start of an economic downturn because of all of the following except which one?

A) Lenders require information and accurate information is more difficult to obtain.
B) It becomes more difficult for lenders to determine the creditworthiness of borrowers.
C) Lenders see greater risk in making loans to borrowers.
D) The free-rider problem worsens during a downturn.

106) The principal-agent problem is

A) a form of adverse selection.
B) when stockholders are not acting in the best interest of managers.
C) a form of moral hazard.
D) due to managers not being able to monitor stockholder behavior.

107) The principal-agent problem is quite common in large public corporations due to that fact that

A) large corporations generate large sales volumes.
B) large companies employ many people.
C) there is too little regulation by government.
D) the people making the operational decisions are usually not the owners.

108) The fact that many companies employ supervisors to oversee the actions of workers is a way to treat

A) moral hazard.
B) adverse selection.
C) the law of diminishing returns.
D) the free-rider problem.

109) Tom borrows $100,000 from his local bank to purchase inventory for his store for the upcoming holiday season. Tom's neighbor tells him about a get-rich-quick scheme that can take this $100,000 and triple it in a month. Tom decides to buy into this scheme figuring he can repay the bank and still have plenty left for inventory. This is an example of

A) adverse selection.
B) sound risk analysis on Tom's part.
C) diversification.
D) moral hazard.

110) A bank usually treats the moral hazard problem by using all of the following, except which one?

A) not making loans
B) requiring collateral
C) requiring down payments
D) restrictive covenants

111) Moral hazard problems arise because

A) lenders cannot distinguish good risks from bad risks.
B) borrowers have incentives to act in ways that do not reflect the lender's interest.
C) firms hire incompetent employees.
D) lenders charge interest rates that are too low.

112) One reason lenders may require a large net worth before making a loan is because

A) then the borrower does not need the funds.
B) it tells the lender the firm has good employees.
C) it is one way to treat the problem of moral hazard.
D) banking laws require that firms have significant net worth before a bank can make a loan.

113) Providing stock options to corporate managers was an idea designed to

A) hide increases in pay of corporate executives from stockholders.
B) align managers' interest with the stockholders' interest.
C) treat adverse selection.
D) treat the free-rider problem.

114) The moral hazard that can result from debt financing is mainly due to the borrower

A) not working as hard once he or she obtains the loan.
B) wanting to refinance the loan.
C) taking greater risk in hopes of obtaining a larger return.
D) defaulting because the economy turned sour.

115) Each of the following is an example of a restrictive covenant on a mortgage loan, except which one?

A) net worth requirements
B) requiring that the borrower reside in a home for which he or she receives a mortgage
C) insisting the borrower carry physical damage insurance on the property securing the loan
D) requiring the borrower to obtain comprehensive health insurance

116) One reason that financial intermediaries exist is that they

A) are required by government regulation.
B) have developed low-cost methods to obtain information.
C) are the only way to obtain information.
D) earn high returns from lending their own funds.

117) The screening process a bank follows for a loan applicant

A) uses information that anyone can obtain, but the bank can usually obtain it cheaper.
B) includes information that can be available to other firms, as well as proprietary information that only the bank would have.
C) is based only on public information.
D) uses only confidential information.

118) Large companies seeking to raise funds often will use a well-known investment bank because

A) the investment bank's reputation identifies the company as being credit worthy.
B) they are required to do so by government regulation.
C) the investment bank is paying the company for the publicity and goodwill it will generate.
D) this minimizes moral hazard.

119) Often a bank will require a loan officer to make personal visits on customers with loans outstanding. This is encouraged because

A) the bank worries about another bank trying to steal their customers.
B) the bank wants to make sure the business is busy.
C) this is an effective monitoring technique and should reduce moral hazard.
D) the bank has excess funds available and hopes to make another loan to the business.

120) If the threat of a takeover increases the likelihood that managers will act in the interests of stockholders or bondholders, what type of asymmetric information problem is eliminated?

A) moral hazard
B) adverse selection
C) economies of scale
D) increased diversification

121) Suppose that a study of compensation data for CEOs of large firms shows that, ceteris paribus, an increase in the annual probability of a takeover is accompanied by a decrease in the typical CEO’s annual total compensation. This suggests that tying these two variables together can help decrease what type of asymmetric information problem?

A) moral hazard
B) adverse selection
C) economies of scale
D) increased diversification

122) Venture capital firms and private equity firms are types of financial intermediaries that can help reduce problems of

A) moral hazard.
B) adverse selection.
C) a prisoners’ dilemma.
D) limited liability.