Chapter 2

Question 1

Adverse Selection

Answer 1

the problem created by asymmetric information before a transaction occurs: the people who are the most undesirable from the other party’s point of view are the ones who are most likely to want to engage in the financial transaction

Question 2

Asset Transformation

Answer 2

the process of turning risky assets into safer assets for investors by creating and selling assets with risk characteristics that people are comfortable with and then using the funds acquired by selling these assets to purchase other assets that may have far more risk

Question 3

Asymmetric Information

Answer 3

the unequal knowledge that each party to a transaction has about the other party

Question 4

Brokers

Answer 4

agents for investors; they match buyers with sellers

Question 5

Capital

Answer 5

wealth, either financial or physical, that is employed to produce more wealth

Question 6

Capital Market

Answer 6

a financial market in which longer-term debt (generally with original maturity of greater than one year) and equity instruments are traded

Question 7

Conflicts of Interest

Answer 7

a manifestation of the moral hazard problem, particularly when a financial institution provides multiple services and the potentially competing interest of those services may lead to a concealment of information or dissemination of misleading information

Question 8

Currency

Answer 8

paper money (such as dollar bills) and coins

Question 9

Dealers

Answer 9

people who link buyers with sellers by buying and selling securities at stated prices

Question 10

Default

Answer 10

a situation in which the party issuing a debt instrument is unable to make interest payments or pay off the amount owed when the instrument matures

Question 11

Diversification

Answer 11

investing in a collection (portfolio) of assets whose returns do not always move together, with the result that overall risk is lower than for individual assets-

Question 12

Dividends

Answer 12

periodic payments made by equities to shareholders

Question 13

Economies of Scale

Answer 13

the reduction in transaction costs per dollar of transaction as the size (scale) of transactions increases

Question 14

Economies of Scope

Answer 14

the ability to use one resource to provide many different products and services

Question 15

Equities

Answer 15

claims to share in the net income and assets of a corporation (such as common stock)

Question 16

Eurobond

Answer 16

bonds denominated in a currency other than that of the country in which they are sold

Question 17

Eurocurrencies

Answer 17

a variant of the Eurobond; foreign currencies deposited in banks outside the home country

Question 18

Eurodollars

Answer 18

US dollars that are deposited in foreign banks outside the US or in foreign branches of US banks

Question 19

Exchanges

Answer 19

secondary markets in which buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trade

Question 20

Federal Fund Rate

Answer 20

the interest rate on overnight loans of deposits at the Fed

Question 21

Financial Intermediaries

Answer 21

institutions (such as banks, insurance companies, mutual funds, pension funds, and finance companies) that borrow funds from people who have saved and then make loans to others

Question 22

Financial Panic

Answer 22

the widespread collapse of financial markets and intermediaries in an economy

Question 23

Foreign Bond

Answer 23

bonds sold in a foreign country and denominated in that country’s currency

Question 24

Intermediate Term

Answer 24

with reference to a debt instrument, having a maturity of between one and ten years

Question 25

Investment Bank

Answer 25

firms that assist in the initial sale of securities in the primary market

Question 26

Liabilities

Answer 26

IOUs or debts

Question 27

Liquid

Answer 27

easily converted into cash

Question 28

Liquidity Services

Answer 28

services financial intermediaries provide to their customers to make it easier for them to conduct their transactions

Question 29

Long-Term

Answer 29

with reference to a debt instrument, having a maturity of ten years or more

Question 30

Maturity

Answer 30

time to the expiration date (maturity date) of a debt instrument

Question 31

Money Market

Answer 31

a financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded

Question 32

Moral Hazard

Answer 32

the risk that one party to a transaction will engage in behavior that is undesirable from the other party’s point of view

Question 33

Mortgages

Answer 33

loans to household or firms to purchase housing, lands, or other real structures, in which the structure or land itself serves as collateral for the loans

Question 34

Mortgage Backed Securities

Answer 34

securities that cheaply bundle and quantify the default risk of the underlying high-risk mortgages

Question 35

Over-the-Counter (OTC) Market

Answer 35

a secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities “over the counter” to anyone who comes to them and is willing to accept their prices

Question 36

Portfolio

Answer 36

a collection or group of assets

Question 37

Primary Market

Answer 37

a financial market in which new issues of a security are sold to initial buyers

Question 38

Risk

Answer 38

the degree of uncertainty associated with the return on an asset

Question 39

Risk Sharing

Answer 39

the process of creating and selling assets with risk characteristics that people are comfortable with and then using the funds acquired by selling these assets to purchase other assets that may have far more risk

Question 40

Secondary Market

Answer 40

a financial market in which securities that have previously been issued (and are thus second-hand) can be resold

Question 41

Short-Term

Answer 41

with reference to a debt instrument, having a maturity of one year or less

Question 42

Thrift Institutions

Answer 42

savings and loan associations, mutual savings banks, and credit unions

Question 43

Transaction Costs

Answer 43

the time and money spent trying to exchange financial assets, goods, or services

Question 44

Underwrite

Answer 44

purchase securities from a corporation at a predetermined price and the n resell them in the market