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Testbank finmark - Test bank on Financial Markets by
Fabozzi
Accountancy (STI College)
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Chapter 1 Introduction -1 Financial Assets
1) An asset is a possession that has value in an exchange and can be classified as
________.
A) financial or intangible.
B) financial or variable.
C) tangible or intangible.
D) fixed or variable.
Answer: C
2) The financial asset is referred to as a ________ if the claim is a fixed dollar.
A) debt instrument.
B) common equity instrument.
C) derivative instrument.
D) preferred equity instrument.
Answer: A
3) A basic economic principle is that the price of any financial asset ________ the present
value of its expected cash flow, even if the cash flow is not known with certainty.
A) is greater than
B) is equal to
C) is less than
D) is equal to or greater than
Answer: B
4) A(n) ________ such as plant or equipment purchased by a business entity shares at least
one characteristic with a financial asset: Both are expected to generate future cash flow for
their owner.
A) tangible asset
B) intangible asset
C) balance sheet asset
D) cash asset
5) Financial assets have two principal economic functions. Which of the below is ONE of
these?
A) A principal economic function is to transfer funds from those who have surplus funds to
borrow to those who need funds to invest in intangible assets.
B) A principal economic function is to transfer funds in such a way as to redistribute the
avoidable risk associated with the cash flow generated by intangible assets among those
seeking and those providing the funds.
C) A principal economic function is to transfer funds in such a way as to redistribute the
unavoidable risk associated with the cash flow generated by tangible assets among those
seeking and those providing the funds.
D) A principal economic function is to transfer funds from those who have surplus funds to
invest to those who need funds to invest in intangible assets.
Answer: C
Comment: Financial assets have two principal economic functions.
(1) The first is to transfer funds from those who have surplus funds to invest to those who
need funds to invest in tangible assets.
(2) The second economic function is to transfer funds in such a way as to redistribute the
unavoidable risk associated with the cash flow generated by tangible assets among those
seeking and those providing the funds.
6) A principal economic function to transfer funds from those who have ________ to invest
to those who need funds to invest in ________.
A) deficit funds; tangible assets.
B) surplus funds; intangible assets.
C) deficit funds; intangible assets.
D) surplus funds; tangible assets.
Answer: D
Comment: Financial assets have two principal economic functions.
(1) The first is to transfer funds from those who have surplus funds to invest to those who
need funds to invest in tangible assets.
(2) The second economic function is to transfer funds in such a way as to redistribute the
unavoidable risk associated with the cash flow generated by tangible assets among those
seeking and those providing the funds.
1) Financial markets provide three economic functions. Which of the below is NOT one of
these?
A) The interactions of buyers and sellers in a financial market determine the price of the
traded asset.
B) Financial markets provide a mechanism for an investor to sell a financial asset.
C) Financial markets increases the cost of transacting.
D) The interactions of buyers and sellers in a financial market determine the required return
on a financial asset.
Answer: C
Comment: Financial markets provide three economic functions.
First, the interactions of buyers and sellers in a financial market determine the price of the
traded asset. Or, equivalently, they determine the required return on a financial asset. As the
nducement for firms to acquire funds depends on the required return that investors demand,
it is this feature of financial markets that signals how the funds in the economy should be
allocated among financial assets. This is called the price discovery process.
Second, financial markets provide a mechanism for an investor to sell a financial asset.
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Because of this feature, it is said that a financial market offers liquidity, an attractive feature
when circumstances either force or motivate an investor to sell. If there were not liquidity, the
owner would be forced to hold a debt instrument until it matures and an equity instrument
until the company is either voluntarily or involuntarily liquidated.While all financial markets
provide some form of liquidity, the degree of liquidity is one of the factors that characterize
different markets.
The third economic function of a financial market is that it reduces the cost of transacting.
There are two costs associated with transacting: search costs and information costs.
analyzing financial opportunities.
D) A factor is decreased institutionalization of financial markets.
Answer: D
Comment: The factors that have led to the integration of financial markets are (1)
deregulation or liberalization of markets and the activities of market participants in key
financial centers of the world; (2) technological advances for monitoring world markets,
executing orders, and analyzing financial opportunities; and (3) increased institutionalization
of financial markets.
2) The shifting of the financial markets from dominance by retail investors to institutional
investors is referred to as the ________ of financial markets.
A) globalization
B) institutionalization
C) securitization
D) diversification
Answer: B
2) A factor leading to the integration of financial markets is ________.
A) decreased institutionalization of financial markets.
B) increased monitoring of markets.
C) technological advances for monitoring domestic markets, executing orders, and analyzing
financial opportunities.
D) technological advances for monitoring world markets, executing orders, and disregarding
financial opportunities.
Answer: D
Comment: The factors that have led to the integration of financial markets are (1)
deregulation or liberalization of markets and the activities of market participants in key
financial centers of the world; (2) technological advances for monitoring world markets,
executing orders, and analyzing financial opportunities; and (3) increased institutionalization
of financial markets.
3) Financial markets can be categorized as those dealing with newly issued financial claims
that are called the ________, and those for exchanging financial claims previously issued
that are called the ________.
A) secondary market; primary market.
B) financial market; secondary market.
C) OTC market; NYSE/AMEX market.
D) primary market; secondary market.
Answer: D
4) Business entities include nonfinancial and financial enterprises. ________ manufacture
products such as cars and computers and/or provide nonfinancial services such as
transportation and utilities.
A) Financial enterprises
B) Nonfinancial enterprises
C) Both financial and nonfinancial enterprises
D) None of these
Answer: B
1) Which of the below is NOT a factor that has led to the integration of financial markets?
A) A factor is liberalization of markets and the activities of market participants in key financial
centers of the world.
B) A factor is deregulation of markets and the activities of market participants in key financial
centers of the world.
C) A factor is technological advances for monitoring world markets, executing orders, and
3) From the perspective of a given country, financial markets can be classified as either
internal or external. The internal market is composed of two parts: the domestic market and
the foreign market. The domestic market is ________.
A) where the securities of issuers not domiciled in the country are sold and traded.
B) where issuers domiciled in a country issue securities and where those securities are
subsequently traded.
C) where securities are offered simultaneously to investors in a number of countries.
D) where issuers domiciled in a country issue securities and where those securities are NOT
subsequently traded.
Answer: B
4) A reason for a corporation using ________ is a desire by issuers to diversify their source
of funding so as to reduce reliance on domestic investors.
A) Euromarkets
B) domestic equity markets
C) domestic government markets
D) None of these
Answer: A
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1) The two basic types of derivative instruments are ________ and ________.
A) insurance contracts; options contracts
B) futures/forward contracts; indentures
C) futures/forward contracts; legal contracts
D) futures/forward contracts; options contracts
Answer: D
2) Derivative instruments derive their value from ________.
A) market conditions at time of delivery.
B) market conditions at time of issue.
C) the underlying instruments to which they relate.
D) variations in the future claims conveyed from spot markets.
Answer: C
3) Derivative contracts provide ________.
A) issuers and investors an expensive but efficient way of controlling some major risks.
B) issuers and investors an inexpensive way of controlling some major risks.
C) issuers and investors an inexpensive but inefficient way of controlling all major risks.
D) issuers and investors an expensive way of controlling some minor risks.
Answer: B
4) Derivative markets may have at least three advantages over the corresponding cash
(spot) market for the same financial asset. Which of the below is ONE of these advantages?
A) Transactions typically can be accomplished faster in the derivatives market.
B) It will always cost more to execute a transaction in the derivatives market in order to
adjust the risk exposure of an investors portfolio to new economic information than it would
cost to make that adjustment in the cash market.
C) All derivative markets can absorb a greater dollar transaction without an adverse effect
on the price of the derivative instrument; that is, the derivative market may be more liquid
than the cash market.
D) Some derivative markets can absorb a greater dollar transaction but with an adverse
effect on the price of the derivative instrument; that is, the derivative market may be more
liquid than the cash market.
Answer: A
Comment: Derivative markets may have at least three advantages over the corresponding
cash (spot) market for the same financial asset.
First, depending on the derivative instrument, it may cost less to execute a transaction in the
derivatives market in order to adjust the risk exposure of an investors portfolio to new
economic information than it would cost to make that adjustment in the cash market.
Second, transactions typically can be accomplished faster in the derivatives market.
Third, some derivative markets can absorb a greater dollar transaction without an adverse
effect on the price of the derivative instrument; that is, the derivative market may be more
liquid than the cash market.
1) Which of the following statements is FALSE?
A) Because of the prominent role played by financial markets in economies, governments
have long deemed it necessary to regulate certain aspects of these markets.
B) In their regulatory capacities, governments have had little influence on the development
and evolution of financial markets and institutions.
C) It is important to realize that governments, markets, and institutions tend to behave
interactively and to affect one anothers actions in certain ways.
D) A sense of how the government can affect a market and its participants is important to an
understanding of the numerous markets and securities.
Answer: B
Comment: In their regulatory capacities, governments have greatly influenced the
development and evolution of financial markets and institutions.
2) Which of the below statements is TRUE?
A) Because of differences in culture and history, different countries regulate financial
markets and financial institutions in varying ways, emphasizing some forms of regulation
more than others.
B) The standard explanation or justification for governmental regulation of a market is that
the market, left to itself, will produce its particular goods or services in an efficient manner
and at the lowest possible cost.
C) Governments in most developed economies have created elaborate systems of
regulation for financial markets, in part because the markets themselves are simple and in
part because financial markets are unimportant to the general economies in which they
operate.
D) Financial activity regulation are free of rules about traders of securities and trading on
financial markets.
Answer: A
Comment: The standard explanation or justification for governmental regulation of a market
is that the market, left to itself, will not produce its particular goods or services in an efficient
manner and at the lowest possible cost.
Governments in most developed economies have created elaborate systems of regulation
for financial markets, in part because the markets themselves are complex and in part
because financial markets are so important to the general economies in which they operate.
Financial activity regulation consists of rules about traders of securities and trading on
financial markets.
3) The regulatory structure in the United States is largely the result of ________.
A) the first IPO bubble in the 20th century.
B) the boom in the stock market experienced in the 1990s.
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C) bull markets that have occurred at various times.
D) financial crises that have occurred at various times.
Answer: D
4) The proposal by the U.S. Department of the Treasury, popularly referred to as the
Blueprint for Regulatory Reform or simply Blueprint, would replace the prevailing complex
array of regulators with a regulatory system based on functions. More specifically, there
would be three regulators. Which of the below is NOT one of these?
A) market stability regulator
B) prudential regulator
C) uninhibited regulator
D) business conduct regulator
Answer: C
1) ________ increase the liquidity of markets and the availability of funds by attracting new
investors and offering new opportunities for borrowers.
A) Market-broadening instruments
B) Market-management instruments
C) Risk-management instruments
D) Arbitraging-broadening instruments
Answer: A
Comment: The Economic Council of Canada classifies financial innovations into the
following three broad categories:
(1) market-broadening instruments, which increase the liquidity of markets and the
availability of funds by attracting new investors and offering new opportunities for borrowers
(2) risk-management instruments, which reallocate financial risks to those who are less
averse to them, or who offsetting exposure and thus are presumably better able to should
them
(3) arbitraging instruments and processes, which enable investors and borrowers to take
advantage of differences in costs and returns between markets, and which reflect
differences in the perception of risks, as well as in information, taxation, and regulations
2) The Economic Council of Canada classifies financial innovations into three broad
categories. Which of the below is NOT one of these?
A) market-broadening instruments
B) risk-management instruments
C) risk-broadening instruments
D) arbitraging instruments and processes
Answer: C
Comment: The Economic Council of Canada classifies financial innovations into the
following three broad categories:
(1) market-broadening instruments, which increase the liquidity of markets and the
availability of funds by attracting new investors and offering new opportunities for borrowers
(2) risk-management instruments, which reallocate financial risks to those who are less
averse to them, or who offsetting exposure and thus are presumably better able to should
them
(3) arbitraging instruments and processes, which enable investors and borrowers to take
advantage of differences in costs and returns between markets, and which reflect
differences in the perception of risks, as well as in information, taxation, and regulations
3) There are two extreme views of financial innovation. Which of the below is ONE of these?
A) Some hold that the essence of innovation is the introduction of financial assets that are
less efficient for redistributing risks among market participants.
B) There are some who believe that the minor impetus for innovation has been the endeavor
to circumvent regulations and find loopholes in tax rules.
C) Some hold that the essence of innovation is the introduction of financial instruments that
are more efficient for redistributing risks among market participants.
D) None of these
Answer: C
Comment: There are two extreme views of financial innovation. There are some who believe
that the major impetus for innovation has been the endeavor to circumvent (or arbitrage)
regulations and find loopholes in tax rules. At the other extreme, some hold that the essence
of innovation is the introduction of financial instruments that are more efficient for
redistributing risks among market participants.
4) An ultimate and important cause of financial innovation does not involve ________.
A) incentives to follow existing regulation and and tax laws.
B) increased volatility of interest rates, inflation, equity prices, and exchange rates.
C) changing global patterns of financial wealth.
D) financial intermediary competition.
Answer: A
Comment: It would appear that many of the innovations that have passed the test of time
and have not disappeared have been innovations that provided more efficient mechanisms
for redistributing risk. Other innovations may just represent a more efficient way of doing
things. Indeed, if we consider the ultimate causes of financial innovation, the following
emerge as the most important:
1. Increased volatility of interest rates, inflation, equity prices, and exchange rates.
2. Advances in computer and telecommunication technologies.
3. Greater sophistication and educational training among professional market participants.
4. Financial intermediary competition.
5. Incentives to get around existing regulation and and tax laws.
6. Changing global patterns of financial wealth.
True/False Questions
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1) An equity instrument (also called a residual claim) obligates the issuer of the financial
asset to pay the holder an amount based on earnings, if any, after holders of debt
instruments have been paid.
Answer: TRUE
2) A intangible asset is one whose value depends on particular physical properties such as
buildings, land, or machinery. Tangible assets, by contrast, represent legal claims to some
future benefit.
Answer: FALSE
Comment: A tangible asset is one whose value depends on particular physical properties
such as buildings, land, or machinery. Intangible assets, by contrast, represent legal claims
to some future benefit.
3) Financial assets have two principal economic functions. One function is to transfer funds
from those who have surplus funds to invest to those who need funds to invest in tangible
assets.
Answer: TRUE
1) The three economic functions of financial markets are: to improve the price discovery
process; to lessen liquidity; and, to reduce the cost of transacting.
Answer: FALSE
Comment: The three economic functions of financial markets are: to improve the price
discovery process; to enhance liquidity; and to reduce the cost of transacting.
2) The market participants include households, business entities, national governments,
national government agencies, state and local governments, supranationals, and regulators.
Answer: TRUE
3) One economic function of a financial market is to reduce the cost of transacting. There
are two costs associated with transacting: search costs and information costs.
Answer: TRUE
Comment: The foreign market in any country is the market where the securities of issuers
not domiciled in the country are sold and traded.
3) Global competition has forced governments to exercise control various aspects of their
financial markets so that their financial enterprises can compete effectively around the world.
Answer: FALSE
Comment: Global competition has forced governments to deregulate (or liberalize) various
aspects of their financial markets so that their financial enterprises can compete effectively
around the world.
1) Derivative instruments play a critical role in global financial markets.
Answer: TRUE
2) IBM pension fund owns a portfolio consisting of the common stock of a large number of
companies. Suppose the pension fund knows that two months from now it must sell stock in
its portfolio to pay beneficiaries $20 million. The risk that IBM pension fund faces is that two
months from now when the stocks are sold, the price of most or all stocks may be higher
than they are today.
Answer: FALSE
Comment: IBM pension fund owns a portfolio consisting of the common stock of a large
number of companies. Suppose the pension fund knows that two months from now it must
sell stock in its portfolio to pay beneficiaries $20 million. The risk that IBM pension fund
faces is that two months from now when the stocks are sold, the price of most or all stocks
may be lower than they are today.
3) When the option grants the owner of the option the right to buy a financial asset from the
other party, the option is called a put option.
Answer: FALSE
Comment: When the option grants the owner of the option the right to buy a financial asset
from the other party, the option is called a call option.
5 The Role of the Government in Financial Markets
1) Globalization means the integration of financial markets throughout the world into an
international financial market.
Answer: TRUE
2) The domestic market in any country is the market where the securities of issuers not
domiciled in the
country are sold and traded.
Answer: FALSE
1) The market stability regulator would take on the traditional role of the Federal Reserve by
giving it the responsibility and authority to ensure overall financial market stability.
Answer: TRUE
2) Blueprint regulation is the form of regulation that requires issuers of securities to make
public a large amount of financial information to actual and potential investors.
Answer: FALSE
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Comment: Disclosure regulation is the form of regulation that requires issuers of securities
to make public a large amount of financial information to actual and potential investors.
3) Financial activity regulation is the form of regulation that requires issuers of securities to
make public a large amount of financial information to actual and potential investors.
Answer: FALSE
Comment: Disclosure regulation is the form of regulation that requires issuers of securities
to make public a large amount of financial information to actual and potential investors.
NOTE. Financial activity regulation consists of rules about traders of securities and trading
on
financial markets.
1. Joe Grasso has obtained a license to manufacture Rugrat wristwatches. Joe estimates
that he will need $1 million to purchase plant and equipment to manufacture the watches.
Unfortunately, he has only $200,000 to invest, and that is his life savings, which he does not
want to invest, even though he has confidence that there will be a receptive market for the
watches.
2. Susan Carlson has recently inherited $730,000. She plans to spend $30,000 on some
jewelry, furniture, and a few cruises, and to invest the balance, $700,000.
3. Larry Stein, an up-and-coming attorney with a major New York law firm, has received a
bonus check that after taxes has netted him $250,000. He plans to spend $50,000 on a
BMW and invest the balance, $200,000.
2 Financial Markets
6 Financial Innovation
1) No one holds the extreme view that the essence of innovation is the introduction of
financial instruments that are more efficient for redistributing risks among market
participants.
Answer: FALSE
Comment: Some hold the extreme view that the essence of innovation is the introduction of
financial instruments that are more efficient for redistributing risks among market
participants.
2) Liquidity-generating innovations can increase the liquidity of the market, allow borrowers
to draw upon new sources of funds, and permit market participants to circumvent capital
constraints imposed by regulations.
1) The third economic function of a financial market is that it reduces the cost of transacting.
Name and describe the two costs associated with this economic function.
Answer: There are two costs associated with reducing the cost of transacting: search costs
and information costs.
Search costs represent explicit costs, such as the money spent to advertise ones intention
to sell or purchase a financial asset, and implicit costs, such as the value of time spent in
locating a counterparty. The presence of some form of organized financial market reduces
search costs.
Information costs are costs associated with assessing the investment merits of a financial
asset, that is, the amount and the likelihood of the cash flow expected to be generated. In an
efficient market, prices reflect the aggregate information collected by all market participants.
Answer: TRUE
Essay Questions
1 Financial Assets
1) What are the two principal economic functions of financial assets? Give an illustration.
Answer: Financial assets have two principal economic functions. The first is to transfer funds
from those who have surplus funds to invest to those who need funds to invest in tangible
assets. The second economic function is to transfer funds in such a way as to redistribute
the unavoidable risk associated with the cash flow generated by tangible assets among
those seeking and those providing the funds. However, as we will see, the claims held by
the final wealth holders are generally different from the liabilities issued by the final
demanders of funds because of the activity of financial intermediaries that seek to transform
the final liabilities into the financial assets that the public prefers.
We can illustrate these two economic functions with an example similar to one the below
examples.
2) Name and describe some of the ways to classify financial markets.
Answer: There are many ways to classify financial markets.
(a) One way is by the nature or type of the financial claim, such as debt markets and equity
markets.
(b) Another is by the maturity of the claim, such as short-term and long-term. For example,
there is a financial market for short-term debt instruments, called the money market, and
one for longer-maturity financial assets, called the capital market.
(c) Financial markets can also be categorized as those dealing with financial claims that are
newly issued, called the primary market, and those for exchanging financial claims
previously issued, called the secondary market or the market for seasoned instruments.
NOTE: Other classifications are:
Markets can be classified as either cash or derivative instruments markets and also by their
organizational structure such as an auction market, an over-the-counter market, or an
intermediated market.
3 Globalization of Financial Markets
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1) Describe at least two reasons why a corporation may seek to raise funds outside its
domestic market.
Answer: There are several reasons why a corporation may seek to raise funds outside its
domestic market.
First, in some countries, large corporations seeking to raise a substantial amount of funds
may have no choice but to obtain financing in either the foreign market sector of another
country or the Euromarket. This is because the fund-seeking corporations domestic market
is not fully developed and cannot satisfy its demand for funds on globally competitive terms.
Governments of developing countries have used these markets in seeking funds for
government-owned corporations that they are privatizing.
The second reason is that there may be opportunities for obtaining a lower cost of funding
than is available in the domestic market, although with the integration of capital markets
throughout the world, such opportunities have diminished. Nevertheless, there are still some
imperfections in capital markets throughout the world that may permit a reduced cost of
funds. The causes of these imperfections are discussed throughout the book.
A third reason for using foreign or Euromarkets is a desire by issuers to diversify their source
of funding so as to reduce reliance on domestic investors.
several purposes, which fall into the following categories:
1. To prevent issuers of securities from defrauding investors by concealing relevant
information.
2. To promote competition and fairness in the trading of financial securities.
3. To promote the stability of financial institutions.
4. To restrict the activities of foreign concerns in domestic markets and institutions.
5. To control the level of economic activity.
1) Professor Stephen Ross suggests two classes of financial innovation. List these two
classes.
Answer: Professor Stephen Ross suggests these two classes:
(1) new financial products (financial assets and derivative instruments) better suited to the
circumstances of the time (for example, to inflation) and to the markets in which they trade,
and
(2) strategies that primarily use these financial products.
4 Derivative Markets
Chapter 3 Depository Institutions: Activities and Characteristics
1) The two basic types of derivative instruments are futures/forward contracts and options
contracts. Describe these two basic types.
Answer: A futures or forward contract is an agreement whereby two parties agree to transact
with respect to some financial asset at a predetermined price at a specified future date. One
party agrees to buy the financial asset; the other agrees to sell the financial asset. Both
parties are obligated to perform, and neither party charges a fee.
An options contract gives the owner of the contract the right, but not the obligation, to buy
(or sell) a financial asset at a specified price from (or to) another party. The buyer of the
contract must pay the seller a fee, which is called the option price. When the option grants
the owner of the option the right to buy a financial asset from the other party, the option is
called a call option. If, instead, the option grants the owner of the option the right to sell a
financial asset to the other party, the option is called a put option.
1) Which of the below statements is TRUE?
6 Financial Innovation
A) A depository institution seeks to earn a positive spread between the assets it invests in
(deposits and other sources) and the cost of its funds (loans and securities).
B) Interest rate risk refers to the risk that a borrower will default on a loan obligation to the
depository institution or that the issuer of a security that the depository institution holds will
default on its obligation
C) Regulatory risk is the risk that regulators will change the rules so as to adversely impact
the earnings of the institution.
D) If the spread will be positive, it will cost the depository institution more to finance the
government securities than it will earn on the funds invested in those securities.
Answer: C
5 The Role of the Government in Financial Markets
1) Governments in most developed economies have created elaborate systems of regulation
for financial markets, in part because the markets themselves are complex and in part
because financial markets are so important to the general economies in which they operate.
The numerous rules and regulations are designed to serve several purposes. These rules
and regulations fall into the various categories. Provide at least three of these categories.
Answer: The numerous rules and regulations for financial markets are designed to serve
Comment: A depository institution seeks to earn a positive spread between the assets it
invests in (loans and securities) and the cost of its funds (deposits and other
sources). Credit risk, also called default risk, refers to the risk that a borrower will default on
a loan obligation to the depository institution or that the issuer of a security that the
depository institution holds will default on its obligation. If the spread will be negative, it will
cost the depository institution more to finance the government securities than it will earn on
the funds invested in those securities.
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2) Which of the below statements is FALSE?
A) Absent from any balance sheet of a depository institution is interest rate risk exposure.
B) Managers must be willing to accept some exposure, but they can take various measures
to address the interest rate sensitivity of the institution’s liabilities and its assets.
C) Regulators impose restrictions on the degree of interest rate risk a depository institution
may be exposed to.
D) A depository institution will have an asset/liability committee that is responsible for
monitoring the interest rate risk exposure.
Answer: A
B) Depository institutions are highly regulated because of the important role that they play in
the country’s financial system.
C) Demand deposit accounts are the principal means that individuals and business entities
use for making payments, and government monetary policy is implemented through the
banking system.
D) Securities held for the purpose of satisfying net withdrawals and customer loan demands
are sometimes referred to as secondary reserves.
Answer: A
Comment: At one time, thrifts were not permitted to accept deposits transferable by check
(negotiable), or, as they are more popularly known, checking accounts.
Comment: Inherent in any balance sheet of a depository institution is interest rate risk
exposure.
5) Depository institutions are ________ because of the important role that they play in the
country’s financial system.
3) Which of the below statements is TRUE?
A) Depository institutions do not include commercial banks (or simply banks), savings and
loan associations (S&Ls), savings banks, and credit unions.
B) Since their funds are raised through deposits and other funding sources, depository
institutions cannot make direct loans to various entities or invest in securities.
C) Depository institutions derive their income from two sources: (1) the income generated
from the loans they make and the securities they purchase, and (2) fee income.
D) It is uncommon to refer to S&Ls, savings banks, and credit unions as thrifts, which are
specialized types of depository institutions.
A) lowly regarded
B) highly regulated
C) highly deregulated
D) lowly regulated
Answer: B
6) Because of their important role, ________ are afforded special privileges such as access
to federal deposit insurance and access to a government entity that provides funds for
liquidity or emergency needs..
Answer: C
Comment: Depository institutions include commercial banks (or simply banks), savings and
loan associations (S&Ls), savings banks, and credit unions. All are financial intermediaries
that accept deposits. These deposits represent the liabilities (debt) of the deposit-accepting
institution. With the funds raised through deposits and other funding sources, depository
institutions both make direct loans to various entities and invest in securities. It is common to
refer to S&Ls, savings banks, and credit unions as thrifts, which are specialized types of
depository institutions.
A) NOW accounts
B) repository institutions
C) depository invitations
D) depository institutions
Answer: D
2 Commercial Banks
4) Which of the below statements is FALSE?
1) Prior to 1863, banks were regulated only at the ________ level.
A) At one time, thrifts were permitted to accept deposits transferable by check (negotiable),
or, as they are more popularly known, checking accounts.
A) local
B) state
C) federal
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D) international
Comment: Loans and leasing generate interest income, and other services that banks offer
institutional customers generate fee income.
Answer: B
5) Most global banking activities generate ________ rather than ________.
2) Realizing the need for banks to obtain liquidity during periods of economic stress, the
federal government wanted to establish a banking system that would have an entity that
banks could borrow from. The U.S. Congress accomplished this with the passage of the
________.
A) National Bank Act in 1863
B) Office of the Comptroller of the Currency Act
C) Federal Reserve Act of 1913
D) Financial Institutions Reform, Recovery, and Enforcement Act of 1989
A) dividend income; interest income
B) fee income; dividend income
C) interest income; fee income
D) fee income; interest income
Answer: D
6) The three sources of funds for banks are ________.
Answer: C
3) In our financial system, commercial banks provide numerous services that can be broadly
classified. Which of the below is NOT one of these broadly classified services?
A) individual banking
B) forthright banking
C) institutional banking
D) global banking
A) salaries, nondeposit borrowing, common stock, and retained earnings.
B) deposits, nondeposit borrowing, common stock, and retained earnings.
C) deposits, salaries and wages, common stock, and retained earnings.
D) deposit borrowing, bonds, and retained earnings.
Answer: B
7) Risk-based capital guidelines establish a ________ weight for all assets where a weight
depends on the credit risk associated with each asset.
Answer: B
Comment: The services can be broadly classified as follows: (1) individual banking, (2)
institutional banking, and (3) global banking.
A) commercial bank risk
B) scientific-based
C) credit risk
D) guideline-based
4) Which of the below statements is FALSE?
Answer: C
A) Interest income and fee income are generated from mortgage lending and credit card
financing.
B) Fee income is generated from brokerage services and financial investment services.
C) Loans to nonfinancial corporations, financial corporations, (such as life insurance
companies), and government entities (state and local governments in the United States and
foreign governments) fall into the category of institutional banking.
D) Loans and leasing generate dividend income, and other services that banks offer
institutional customers generate fee income.
8) Which of the below statements is FALSE?
A) Risk-based capital guidelines establish a credit risk weight for all assets where a weight
depends on the credit risk associated with each asset.
B) There are four credit risk classifications for banks: 0%, 20%, 50%, and 100%, arrived at
on no particular scientific basis.
C) The purpose of the Basel I Framework was to improve on the rules as set forth in the
Basel I Framework by bringing risk-based capital requirements more in line with the
underlying risks to which banks are exposed.
Answer: D
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D) The Basel Committee has several subcommittees whose stated purpose is to promote
consistency in its implementation of the guidelines.
Answer: C
Comment: Traditionally, the only assets in which S&Ls were allowed to invest have been
mortgages, mortgage-backed securities, and U.S. government securities. Mortgage loans
include fixed-rate mortgages, adjustable-rate mortgages, and other types of mortgage
designs. While most mortgage loans are for the purchase of homes, S&Ls do make
construction loans.
Comment: The purpose of the Basel II Framework was to improve on the rules as set forth
in the Basel I Framework by bringing risk-based capital requirements more in line with the
underlying risks to which banks are exposed.
4) S&Ls invest in short-term assets for ________.
3 Savings and Loan Associations
A) liquidity and non-regulatory purposes.
B) long-term and regulatory purposes.
C) operational and regulatory purposes.
D) operational and illiquidity purposes.
1) ________ means that there is no stock outstanding, so technically the depositors are the
owners.
Answer: C
A) S&L owned
B) Institutionally owned
C) Corporate stock ownership
D) Mutually owned
Comment: S&Ls invest in short-term assets for operational (liquidity) and regulatory
purposes.
Answer: D
5) The Garn-St. Germain Act, not only granted thrifts the right to offer money market demand
accounts so that S&Ls could compete with money market funds, but also ________ the
types of assets in which S&Ls could invest.
2) As the structures of S&L balance sheets and the consequent maturity mismatch led to
widespread disaster, the Garn-St. Germain Act of 1982 expanded the types of assets in
which S&Ls could invest. The acceptable list of investments now includes ________.
A) consumer loans .
B) nonconsumer loans.
C) municipal securities.
D) All of these
A) limited
B) shortened
C) broadened
D) maintained
Answer: C
6) Which of the below statements is FALSE?
Answer: D
3) Traditionally, the only assets in which S&Ls were allowed to invest include ________.
A) mortgages, mortgage-backed securities, and foreign enterprises
B) mortgages, mortgage-backed securities and U.S. government securities.
C) mortgage-backed securities, non-U.S. government securities and mortgages.
D) mortgages, foreign securities and U.S. government securities.
Answer: B
A) There are two sets of capital adequacy standards for S&Ls as for banks.
B) Until the early 2000s, S&Ls and all other lenders financed housing through traditional
mortgages at interest rates fixed for the life of the loan.
C) For S&Ls, if interest rates rise above the interest rate on the mortgage loan, a negative
spread will result, which must result eventually in insolvency.
D) With the high volatility of interest rates in the 1970s, followed by the historically high level
of interest rates in the early 1980s, all depository institutions began to lose funds to
competitors exempt from ceilings, such as the newly formed money market funds; this
development forced some increase in ceilings.
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Answer: B
Comment: The asset structures of savings banks and S&Ls are similar.
Comment: Until the early 1980s, S&Ls and all other lenders financed housing through
traditional mortgages at interest rates fixed for the life of the loan.
5 Credit Unions
1) Technically, because credit unions are ________ by their members, member deposits are
called ________.
4 Savings Banks
1) ________ are institutions similar to, although much older than, S&Ls.
A) managed; certificates
B) owned; certificates
C) managed; shares
D) owned; shares
A) Federal Reserve Banks
B) Partnerships
C) Corporations
D) Savings banks
Answer: D
Answer: D
2) Credit union assets consist of ________.
Comment: The asset structures of savings banks and S&Ls are similar.
A) small consumer loans, residential mortgage loans, and securities.
B) large consumer loans, residential mortgage loans, and securities.
C) small consumer loans, business mortgage loans, and securities.
D) small consumer loans, residential auto loans, and securities.
2) The principal source of funds for savings banks is ________.
A) government bail-out funds.
B) withdrawals.
C) venture capital.
D) deposits.
Answer: A
3) Since 1970, the shares of all federally chartered credit unions have been insured by the
________.
Answer: D
Comment: The asset structures of savings banks and S&Ls are similar.
3) In comparing savings banks and S&Ls, which of the below comparisons is FALSE?
A) Although the total deposits at savings banks are less than those at S&Ls, savings banks
are typically larger institutions.
B) Asset structures of savings banks are always greater than S&Ls.
C) Because states have permitted more portfolio diversification than was permitted by
federal regulators of S&Ls, savings bank portfolios weathered funding risk far better than
S&Ls.
D) Typically, the ratio of deposits to total assets is greater for savings banks than for S&Ls.
A) Central Liquidity Facility
B) National Credit Union Administration
C) U.S. Central Credit Union
D) National Credit Union Share Insurance Fund
Answer: D
True/False Questions
1 Asset/Liability Problem of Depository Institutions
1) Besides facing credit risk and interest rate risk, a depository institution must be prepared
to satisfy withdrawals of funds by depositors and to provide loans to customers.
Answer: B
Answer: TRUE
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2) A depository institution can accommodate withdrawal and loan demand by attracting
additional deposits and raising short-term funds in the money market.
Answer: TRUE
3) Selling securities that it owns, requires that the depository institution invest a portion of its
funds in securities that are both illiquid and have a lot of price risk.
Answer: TRUE
4) All banks must maintain a specified percentage of their deposits in a non-interest-bearing
account at one of the twelve Federal Reserve Banks. These specified percentages are
called required reserves, and the dollar amounts based on them that are required to be kept
on deposit at a Federal Reserve Bank are called reserve ratios.
Answer: FALSE
Answer: FALSE
Comment: Selling securities that it owns, requires that the depository institution invest a
portion of its funds in securities that are both liquid and have littleprice risk.
4) By interest rate risk, we refer to the prospect that the selling price of the security will be
less than its purchase price, resulting in a loss.
Comment: All banks must maintain a specified percentage of their deposits in a noninterest-bearing account at one of the twelve Federal Reserve Banks. These specified
percentages are called reserve ratios, and the dollar amounts based on them that are
required to be kept on deposit at a Federal Reserve Bank are called required reserves.
5) The market where banks can borrow or lend reserves is called the federal funds market.
The interest rate charged to borrow funds in this market is called the federal funds rate.
Answer: FALSE
Answer: TRUE
Comment: By price risk, we refer to the prospect that the selling price of the security will be
less than its purchase price, resulting in a loss.
3 Savings and Loan Associations
2 Commercial Banks
1) The basic motivation behind creation of S&Ls was the providing of funds for financing the
purchase of a home.
1) Demand deposits pay interest, typically below market interest rates; do not have a
specific maturity; and, usually can be withdrawn upon demand.
Answer: TRUE
Answer: FALSE
Diff: 1
Comment: Savings deposits pay interest, typically below market interest rates, do not have
a specific maturity, and usually can be withdrawn upon demand
2) To increase the ability of S&Ls to expand the sources of funding available to bolster their
capital, legislation facilitated the conversion of mutually owned companies into a corporate
stock ownership structure.
2) Savings deposits (checking accounts) pay no interest and can be withdrawn upon
demand.
Answer: TRUE
Answer: FALSE
Comment: Demand deposits (checking accounts) pay no interest and can be withdrawn
upon demand.
3) Time deposits, also called certificates of deposit, have a fixed maturity date and pay either
a fixed or floating interest rate.
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1) The ________ involves the distribution to investors of newly issued securities by central
governments, its agencies, municipal governments, and corporations
A) A secondary common stock offering is an offering of common stock that had been issued
in the past by the corporation.
A) OTC market B) secondary market C) primary market D) stock market Answer: C
B) For a secondary offering, the range for the gross spread as a percentage of the amount
raised is between 3% and 6%.
2) The participants in the marketplace that work with issuers to distribute newly issued
securities are called investment bankers. Investment banking is performed by two groups:
________.
A) commercial banks and securities houses.
C) For traditional bond offerings, the gross spread as a percentage of the principal is around
100 basis points.
D) The typical underwritten transaction involves so much risk of capital loss that a single
investment banking firm undertaking it alone would be exposed to the danger of losing a
significant portion of its capital.
B) hometown banks and securities houses.
C) commercial banks and bank houses.
Answer: C
D) savings & loans and bank houses.
Comment: For traditional bond offerings, the gross spread as a percentage of the principal is
around 50 basis points.
Answer: A
3) The traditional process in the United States for issuing new securities involves investment
bankers performing up to three functions. Which of the below is NOT one of these
functions?
A) One function is advising the issuer on the terms and the timing of the offering.
1) Underwriting activities are regulated by the ________.
A) Initial Public Offerings Market (IPOM). B) Securities and Exchange Commission (SEC).
C) Investment Banking Industry (IBI). D) Federal Bureau of Investigation (FBI).
Answer: A
B) One function is selling the securities to the issuer.
2) The type of information contained in the registration statement includes ________.
C) One function is distributing the issue to the public.
A) the nature of the business of the issuer and key provisions or features of the security.
D) One function is buying the securities from the issuer.
B) the nature of the investment risks associated with the security and the background of
management.
Answer: B
Comment: The traditional process in the United States for issuing new securities involves
investment bankers performing one or more of the following three functions: (1) advising the
issuer on the terms and the timing of the offering, (2) buying the securities from the issuer,
and (3) distributing the issue to the public.
4) An investment banker may merely act as an advisor and/or distributor of the new security.
The function of buying the securities from the issuer is called ________.
A) advising. B) distributing. C) purchasing. D) underwriting. Answer: D
5) An ________ is a common stock offering issued by companies that have NOT previously
issued common stock to the public.
A) initial private issuance (IPI)
B) seasoned equity offering (SEO)
C) initial public offering (IPO)
D) seasoned offering (SO)
Answer: C
C) the nature of the business of the issuer and the background of management.
D) All of these
Answer: D Comment: The type of information contained in the registration statement is the
nature of the business of the issuer, key provisions or features of the security, the nature of
the investment risks associated with the security, and the background of management.
3.) the registration is actually divided into two parts. Part I is the _________. It is the part
that is typically distributed to the public as an offering of the securities. Part II contains
_________, which is not distributed to the public as part of the offering but is available from
the SEC upon request.
A) registration; additional information
B) prospectus; supplemental information
C supplemental information; registration
6) Which of the below statements is FALSE?
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D) beginning information; prospectus
A) does not provide for penalties in the form of fines and/or imprisonment if the information
provided is inaccurate or material information is omitted.
has encountered. The issuer must remedy any problem by filing an amendment to the
registration statement. If the staff is satisfied, the SEC will issue an order declaring that the
registration statement is “effective”, and the underwriter can solicit sales. The approval of the
SEC, however, does not mean that the securities have investment merit or are properly
priced or that information is accurate. It merely means that the appropriate information
appears to have been disclosed.
B) governs the issuance of securities
6) A red herring is _______.
C) provides that investors who purchase the security are entitled to issuer but not the
underwriter to recover damages if they incur a loss as a result of the misleading information
A) a period of waiting for SEC approval
D) provides that financial statements must be included after the registration statement
C) a preliminary prospectus
ANSWER: B
D) a prospectus printed fully in red ink
The Securities Act of 1933 governs the issuance of securities. The act requires that a
registration statement be filed with the SEC by the issuer of a security. Financial statements
must be included in the registration statement, and they must be certified by an independent
public accountant. The act provides for penalties in the form of fines and/ or imprisonment if
the information provided is inaccurate or material information is omitted. Moreover, investors
who purchase the security are entitled to sue the issuer to recover damages if they incur a
loss as a result of the misleading information. The underwriter may also be sued if it can be
demonstrated that the underwriter did not conduct a reasonable investigation of the
information reported by the issuer. One of the most important duties of an underwriter is to
perform due diligence.
ANSWER C
ANSWER: B
4) The Securities Act of 1933 ______.
B) an amended prospectus
COMMENT: During the waiting period, the SEC does not allow the underwriters to distribute
a preliminary prospectus. Because the prospectus has not become ffective, its cover page
states this in red ink and, as a result, the preliminary prospectus is commonly called a red
herring.
1) Not all deals are underwritten using the traditional syndicate process. For example,
variations in the US, the Euromarkets and foreign markets include ______.
A) the auction process and rights offering for the underwriting of bonds.
B) the bought deal of the Eurostock market
5) Which of the below statements is TRUE?
A) The filing of a registration statement with the SEC means that the security can be offered
to the public.
B) When the SEC declares the registration statement is “effective”, it means that an
amendment to the registration statement can be filed.
C) when the registration statement must be reviewed and approved by the SEC’s Division of
Corporate Finance before a public offering can be made
D) The approval of the SEC means that the securities have investment merit or are properly
priced or that the information is accurate
Answer: C
Comment: The filing of the registration statement with the SEC does not mean that the
security can be offered to the public. The registration statement must be reviewed and
approved by the SEC’s Division of Corporate Finance before a public offering can be made.
Typically, the staff of this division will find a problem with the registration statement. The staff
then sends a “letter of comments” or “deficiency letter” to the issuer explaining the problem it
C) a rights offering for underwriting common stock.
D) All of these
Answer: C
Comment: Not all deals are underwritten using the traditional syndicate process we have
described. Variations in the US, the Euromarkets, and foreign markets include the bought
deal for the underwriting of bonds, the auction process for both stocks and bonds and a
rights offering for underwriting common stock.
2) The mechanics of a bought deal are that _____.
A) the lead manager or a group of managers offers a potential issuer of debt securities a
firm bid to purchase an undetermined amount of the securities with an interest(coupon) rate
and maturity to be announced later
B) the issuer is given a month or more to accept or reject the bid
C) if the bid is rejected, the underwriting firm has bought the deal
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D) the underwriter can sell the securities to other investment banking firms for distribution to
their clients and/ or distribute the securities to its clients
2) Life insurance companies are the major investors in private placements.
ANSWER: D
3) The Securities Act of 1933 does not provide specific guidelines to identify what is a
private offering.
3) A consequence of ________ is that underwriting firms need to expand their capital so that
they can commit greater amounts of funds to such deals.
4) In 1982, the SEC adopted Regulation D, which sets forth the guidelines that determine if
an issue is qualified for exemption from registration
A) accepting auction deals
5) Investment banking firms assist in the private placement of securities by working with the
issuer and potential investors on the design and pricing of the security.
B) rejecting bought deals
6) In April 1990, the SEC Rule 144A became effective and eliminated the two-year holding
period by permitting large institutions to trade securities acquired in a private placement
among themselves without having to register these securities with the SEC.
C) accepting bought deals
D) rejecting auction deals
Answer: C
4) A variation for underwriting securities is the auction process. In this method, _____.
A) the issuer announces the terms of the issue, and interested parties submit bids for part of
the issue
B) the auction form is mandated for certain securities of regulated public utilities but not for
municipal debt obligations
C) the issuer announces the terms of the issue and interested parties submit bids for the
entire issue
D) mandated for many municipal debt obligations but not for certain securities of regulated
public utilities
ANSWER: C
5) In a variant of the auction process, a security is allocated to bidders from the highest bid
price (lowest yield in the case of a bond) to the lower ones (higher yield in the case of a
bond) until the entire issue is allocated.
6) When all the bidders buy the amount allocated to them, then the auction is referred to as
a single-price auction or a Dutch auction.
1) In addition to underwriting securities for distribution to the public, securities may be placed
with the limited number of institutional investors such as ________.
A) insurance companies
B) investment companies
C) pension funds
D) All of these
Answer D
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