Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following is the primary source of external funds used by American businesses to finance their activities? 1) A) Bank loans B) Bonds and commercial paper C) Other loans D) Stock 2) Of the following sources of external finance for American nonfinancial businesses, the most important is 2) A) bonds and commercial paper. B) loans from other financial intermediaries. C) loans from banks. D) stocks. 3) Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true? 3) A) Financial intermediaries such as banks are the most important source of external funds. B) Bonds are a far more important source of finance than are stocks. C) Stocks and bonds, combined, supply less than one-fifth of the external funds. D) Only A and B of the above. E) Only A and C of the above. 4) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? 4) A) Only large, well-established corporations have access to securities markets to finance their activities. B) Bank loans in the United States provide over four times more financing of corporate activities than do stock markets. C) Direct finance is used in less than 5% of the external financing of American businesses. D) All of the above. E) Only A and B of the above. 1
5) Which of the following is not one of the eight basic puzzles about financial structure? A) Collateral is a prevalent feature of debt contracts for both households and business. B) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. C) Only large, well-established corporations have access to securities markets to finance their activities. D) The financial system is among the most heavily regulated sectors of the economy. E) Direct finance, in which businesses raise funds directly from lenders in financial markets, is many times more important than indirect finance, which involves the activities of financial intermediaries. 5) 6) The reduction in transactions costs per dollar of investment as the size of transactions increases is A) economies of scale. B) discounting. C) economies of trade. D) diversification. E) both A and B of the above. 6) 7) Because of the "lemons problem" the price a buyer of a used car pays is A) less than the price of a lemon. B) equal to the price of a peach. C) between the price of a lemon and a peach. D) greater than the price of a peach. E) equal to the price of a lemon. 7) 8) Because of the adverse selection problem, A) lenders may make a disproportionate amount of loans to bad credit risks. B) lenders are reluctant to make loans that are not secured by collateral. C) lenders may refuse loans to individuals with low net worth. 8) 9) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries 9) A) provide information that is valued by consumers of used cars. B) help solve the adverse selection problem. C) are able to prevent others from free-riding off the information that they provide. D) do all of the above. 2
10) Analysis of adverse selection indicates that financial intermediaries, especially banks, A) despite their success in overcoming free-rider problems, nevertheless play a minor role in moving funds to corporations. B) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds. C) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance. E) only A and B of the above. 10) 11) The fact that the largest, most established corporations are the most likely to raise funds by issuing securities is know as 11) A) the "too-big-to-fail" hypothesis. B) the efficient markets hypothesis. C) the "larger is better" hypothesis. D) the "only those that don't need the money can borrow" hypothesis. E) the pecking order hypothesis. 12) The principal-agent problem arises because A) monitoring agents' activities is costly. B) agents have more information about their activities than do the principals. C) principals have incentives to free-ride off the monitoring expenditures of other principals. D) of all of the above. E) of only A and B of the above. 12) 13) The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) only A and B of the above. C) in financial markets helps to explain why equity is a relatively important source of finance for American business. E) would not arise if the owners of the firm had complete information about the activities of the managers. 13) 3
14) A venture capital firm protects its equity investment from moral hazard through which of the following means? 14) A) It places people on the board of directors to better monitor the borrowing firm's activities. B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It does both A and B of the above. E) It does both A and C of the above. 15) Equity contracts account for a small fraction of external funds raised by American businesses because 15) A) costly state verification makes the equity contract less desirable than the debt contract. B) of the greater scope for moral hazard problems under equity contracts, as compared to debt contracts. C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. D) of all of the above. E) of both A and B of the above. 16) A debt contract is said to be incentive compatible if A) restrictive covenants limit the type of activities that can be undertaken by the borrower. B) the borrower's net worth reduces the probability of moral hazard. C) both A and B of the above occur. D) neither A nor B of the above occur. 16) 17) Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that 17) A) borrowers may find loopholes that make the covenants ineffective. B) too few resources may be devoted to monitoring and enforcing them, as debtholders free-ride on others' monitoring and enforcement efforts. C) they are costly to monitor and enforce. E) only A and B of the above. 18) A reason that many developing and transition economies remain poor is A) overly stringent accounting standards. B) lack of government direction in the allocation of credit. C) nationalization of banks. D) excessive government regulation of financial markets. E) all of the above. 18) 4
19) Factors that lead to worsening conditions in financial markets include: A) weak supervision by bank regulators. B) the deterioration in banks' balance sheets. C) bankers' lack of expertise in screening and monitoring borrowers. E) only B and C of the above. 19) 20) Factors that led to worsening conditions in Mexico's 1994-1995 financial markets include A) the ratification of the North American Free Trade Agreement. B) increased uncertainty from political shocks. C) failure of the Mexican oil monopoly. E) only A and B of the above. 20) 5
Answer Key Testname: PRACTICE_CH08 1) A 2) C 3) D 4) D 5) E 6) A 7) C 8) D 9) D 10) C 11) E 12) D 13) E 14) D 15) E 16) B 17) D 18) C 19) D 20) B 6