Financial System Quiz

Question 1

How can funds be obtained in the financial market?

Answer 1

1) Issuance of debt instruments
2) Issuance of equities

Question 2

How are secondary markets organized?

Answer 2

1) Centralized exchange
2) OTC market

Question 3

What is the difference between the Money and Capital market?

Answer 3

Short-term instruments are exchanged in the money market, and long-term instruments in the capital market.

Question 4

List the money market instruments

Answer 4

1) US Treasury bills
2) Certificates of deposit
3) Commercial paper
4) Repos
5) Federal Funds

Question 5

US Treasury Bills

Answer 5

Issued by the US government to finance government expenditure + sold at discount prices.

Question 6

Certificates of Deposit

Answer 6

Sold by banks and pays annual interest of a given amount and at maturity pays back face value + must remain untouched for whole period.

Question 7

Commercial Paper

Answer 7

Issued by large banks and well known big corporations (e.g. Microsoft) used by firms to repay short-term liabilities.

Question 8

Repos

Answer 8

Short-term loans for which Treasury bills serve as collateral (firm purchases t-bills from bank, and bank repurchases some time later).

Question 9

Federal Funds

Answer 9

Overnight loans between banks at the Federal Reserve.

Question 10

What is the name of the rate of borrowing costs?

Answer 10

Prime rate

Question 11

List the capital market instruments

Answer 11

1) Stocks
2) Mortgages
3) Corporate bonds
4) Government securities
5) State and local government bonds
6) Consumer & bank commercial loans

Question 12

Stocks

Answer 12

Equity claims on the net income and assets of a corporation.

Question 13

Mortgages

Answer 13

Loans used to purchase structure which becomes collateral for loans.

Question 14

What are mortgage-backed securities?

Answer 14

Debt instruments backed by a bundle of individual mortgages whose interest and payments are paid to the holder of the security.

Question 15

Corporate bonds

Answer 15

Long-term bonds that sends the holder an interest payment twice per year and pays off the face value when the bond matures.

Question 16

What are convertible bonds?

Answer 16

Corporate bonds that are allowed to be converted into a specified number of shares of stock at any time up to the maturity date.

Question 17

What is an attractive characteristic of state and local government bonds?

Answer 17

Interest payments are exempt from federal income tax and state taxes.

Question 18

Foreign bonds

Answer 18

Bonds sold in a foreign country and denominated in that country’s currency.

Question 19

Eurobond

Answer 19

A bond denominated in a currency other than that of the country in which it is sold.

Question 20

Eurocurrency

Answer 20

Foreign currencies deposited in banks outside the home country (e.g. Eurodollars).

Question 21

What is Financial Intermediation?

Answer 21

The process of indirect financing using financial intermediaries.

Question 22

How do Financial Intermediaries reduce transaction costs?

Answer 22

Economies of scale (reduced cost as size of transaction increases) and liquidity services

Question 23

What is risk-sharing?

Answer 23

Process of creating and selling assets with lower risk and using the funds acquired to purchase other assets that have more risk.

Question 24

What processes involve risk-sharing?

Answer 24

Asset transformation + diversification.

Question 25

Moral Hazard

Answer 25

Occurs after the transaction when the lenders have no control on the behavior of the borrower after having received the loan.

Question 26

Asymmetric Information

Answer 26

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

Question 27

How is asymmetric information reduced in the market?

Answer 27

Screening (credit ratings) + monitoring.

Question 28

List the types of depository institutions

Answer 28

1) Commercial banks 2) Savings and loans associations 3) Credit unions

Question 29

List the types of contractual savings institutions

Answer 29

1) Life insurance companies 2) Fire & casualty insurance companies 3) Pension and retirement funds

Question 30

List the types of investment intermediaries

Answer 30

1) Finance companies 2) Mutual funds 3) Hedge funds 4) Investment banks

Question 31

What regulations are used to prevent financial panic?

Answer 31

- Restriction of entry - Disclosure of books - Restriction on assets + activities - Deposit insurance - Limits on competition - Restriction on interest rates

Question 32

What are the key principles of money and banking?

Answer 32

1) Time 2) Risk 3) Information 4) Markets

Question 33

What is the difference between an asset and liability?

Answer 33

An asset is something that is owned; a liability is something that is owed.

Question 34

What is the difference between brokers and dealers?

Answer 34

Brokers match buyers with sellers; dealers buy/sell from buyers and sellers.

Question 35

What are the advantages of Financial Intermediaries?

Answer 35

1) Lower transaction costs 2) Reduce risk 3) Reduce information asymmetry