Chapter 3

Financial Instruments, Markets, and Institutions

D2Interpretive
1. Financial markets serve as the A) primary source of funds for financial intermediaries. B) means of converting cash into tangible assets. C) transmission mechanism between savers and borrowers. D) economic system s ultimate source of funds. Answer! C

D2Factual
". An indirect flow of funds occurs when A) funds flow from saver#lenders to borrower#spenders through financial intermediaries. B) funds flow from saver#lenders to borrower#spenders through financial markets. C) funds flow to saver#lenders from borrower#spenders through financial intermediaries. D) funds flow to saver#lenders from borrower#spenders through financial markets. Answer! A

D1Applied
$. An e%ample of direct finance would be when A) a person purchases a certificate of deposit from a bank. B) a person buys a life insurance policy. C) a person buys 1&& shares of stock from a corporation. D) a bank makes a loan to a customer. Answer! C

D2Interpretive
'. (hich of the following statements is not true) A) Financial and intermediated markets are conduits through which funds are channeled. B) Borrower#spenders tend to benefit because they earn interest or dividends on their funds. C) (ithout financial and intermediated markets* savers would have no choice but to hoard their e%cess money. D) (hen funds flow through intermediaries* the process is indirect. Answer! B

21

22+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D1Factual
0. 1he largest group of saver#lenders in the financial system is A) businesses. B) government. C) households. D) financial intermediaries. Answer! C

D2Factual
2. 3ost borrower#spenders in the financial system are A) businesses and governments. B) banks and thrift institutions. C) households and foreigners. D) governments and financial institutions. Answer! A

D2Factual
4. 555555555555555555 are never borrower#spenders. A) 6overnmental bodies B) Business firms C) 7ouseholds D) All of the above can be borrower#spenders. Answer! D

D1Interpretive
8. An important role of financial institutions is to A) provide borrowers with low interest rates. B) provide information to lenders about the 9uality of financial claims issued. C) buy primary securities. D) control the money supply. Answer! B

D2Interpretive
:. An efficient financial system A) must disseminate information to lenders about the 9uality of financial claims issued. B) provides minimal information about financial markets. C) provides perfect information regarding investment opportunities to savers. D) does not provide any information to borrowers. Answer! A

D1Factual
1&. (hen borrower#spenders raise funds in financial markets* they issue new securities in the A) primary market. B) secondary market. C) third market. D) fourth market. Answer! A

Chapter $Financial ;nstruments* 3arkets* and ;nstitutions 23

D2Applied
11. (hich of the following is a primary market transaction) A) -ally (ither purchases 1&& shares of ;B3 through her broker. B) <old Co. issues 1 million new shares through 3organ -tanley. C) Bob 7ill sells 1*&&& shares of Disney directly to his friend. D) <ip =eters sells 1*&&& shares of Dush* ;nc.* which he bought in an ;=> last month* through his broker. Answer! B

D1Factual
1". A secondary market is one in which A) new securities are issued. B) financial intermediaries make loans. C) savers place funds in financial intermediaries. D) e%isting securities can be bought and sold. Answer! D

D1Factual
1$. 1he most prominent financial market is A) the ?ew @ork -tock /%change. B) the American -tock /%change. C) the ?asda9. D) the over#the#counter market. Answer! A

D1Factual
1'. ;nvestment banks specialiAe in information regarding A) commodities. B) certificates of deposit. C) demand deposits. D) primary securities. Answer! D

D1Factual
10. 1he issuer of a bond is a A) borrower. B) creditor. C) saver. D) lender. Answer! A

D1Factual
12. 555555555555555555 is not a cash flow associated with a bond. A) =ayment to purchase a bond B) =eriodic interest payments C) =eriodic dividend payments D) +epayment of the face value when the bond matures Answer! C

24+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D1Factual
14. 1raditionally* bonds have been issued with coupons that bondholders redeem every A) year. B) 9uarter. C) si% months. D) month. Answer! C

D1Factual
18. Bonds without a maturity date are called A) Aero#coupon bonds. B) preferred bonds. C) common bonds. D) consols. Answer! D

D1Factual
1:. Bonds that pay no interest are A) Aero#coupon bonds. B) coupon securities. C) perpetuities. D) ta%#e%empts. Answer! A

D1Factual
"&. (hich of the following bonds are called ta%#e%empts) A) 3unicipal bonds B) ..-. savings bonds C) ..-. 1reasury bonds D) Consols Answer! A

D1Interpretive
"1. 1o the stockholder* corporate stock represents A) a source of fi%ed interest income. B) a loan. C) ownership. D) a guaranteed return of principal. Answer! C

D2Interpretive
"". A maBor difference between stocks and bonds is that A) bonds pay their owners dividends while stocks pay interest. B) bonds pay their owners interest while stocks pay dividends. C) the interest on a bond depends on the earnings of the corporation and is not guaranteed while dividends on stock are legally re9uired. D) bonds represent ownership while stock represent debt. Answer! B

Chapter $Financial ;nstruments* 3arkets* and ;nstitutions 25

D3Interpretive
"$. (hich of the following statements is true) A) Convertible preferred stockholders receive 9uarterly interest payments. B) Common stockholders receive a fi%ed dividend* and they are entitled to it before preferred stockholders get anything. C) Convertible preferred stock can be converted into preferred stock at a predetermined price. D) 3any buyers of common stock are more interest in capital gains than in dividends. Answer! D

D1Factual
"'. (hich of the following investments offers fi%ed dividend payments) A) Consols B) Cero#coupon bonds C) =referred stock D) Convertible stock Answer! C

D2Factual
"0. (hich of the following investments does not make interest payments annually but is sold at a discount* with the face value of the security paid at maturity) A) =referred stock B) =referred bonds C) Cero#coupon bonds D) Convertible preferred stock Answer! C

D2Factual
"2. All financial securities share the characteristic that they represent a claim to future A) interest income. B) ownership. C) cash flows. D) dividend payments. Answer! C

D1Factual
"4. 1he most popular and widely followed stock inde% is the A) ?ew @ork -tock /%change Composite ;nde%. B) -D= 0&& ;nde%. C) Dow Eones ;ndustrial Average. D) ?asda9 Composite ;nde%. Answer! C

26+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D1Factual
"8. A market in which stock prices are rising is called a A) bull market. B) bear market. C) pig market. D) primary market. Answer! A

D2Interpretive
":. (hich of the following is not true regarding mortgages) A) 1hey are debt instruments. B) F7A#FA mortgages are insured by government agencies. C) 1hey always have a fi%ed mortgage rate. D) 1hey often have maturities between "0 and $& years. Answer! C

D2Factual
$&. 3ortgages carry an uncertain flow of cash because A) borrowers often default on home loans. B) mortgages are short#term debt instruments. C) homeowners often prepay their mortgage loans. D) lenders cannot legally fi% interest rates. Answer! C

D2Interpretive
$1. F7A#FA mortgages differ from conventional mortgages in that A) the mortgaged land and building are collateral for conventional mortgages but not for F7A# FA mortgages. B) F7A#FA mortgages are insured by the federal government* while conventional mortgages are not. C) F7A#FA mortgages involve real estate* while conventional mortgages may or may not involve real estate. D) conventional mortgages run for "0#$& years* but F7A#FA are considerably shorter in duration. Answer! B

D3Factual
$". >ne of the most popular types of mortgage pools is insured by the A) Federal Deposit ;nsurance Corporation. B) Federal -avings and Goan ;nsurance Corporation. C) Federal 7ome Goan Bank Board. D) ..-. Department of 7ousing and .rban Development. Answer! D

Chapter $Financial ;nstruments* 3arkets* and ;nstitutions 27

D2Factual
$$. 3ortgage pools are often referred to as A) municipal securities. B) pass#through securities. C) preferred mortgages. D) common securities. Answer! B

D2Factual
$'. Funds that used to flow through intermediated markets and now flow through financial markets are A) intermediated. B) indirectly financed. C) securitiAed. D) saved. Answer! C

D2Factual
$0. An e%ample of a derivative financial instrument is aHn) A) corporate bond. B) option contract on ..-. 1reasury bonds. C) variable#rate mortgage. D) preferred stock. Answer! B

D3Applied
$2. An investor who anticipates that interest rates will rise should A) buy a variable#rate bond. B) buy preferred corporate stock. C) buy a bond futures contract. D) sell a bond futures contract. Answer! D

D2Factual
$4. A put option gives the owner the A) right to sell the underlying asset at a fi%ed price. B) right to buy the underlying asset at a fi%ed price. C) obligation to sell the underlying asset at a fi%ed price. D) obligation to buy the underlying asset at a fi%ed price. Answer! A

D2Factual
$8. A call option gives the owner the A) right to sell the underlying asset at a fi%ed price. B) right to buy the underlying asset at a fi%ed price. C) obligation to sell the underlying asset at a fi%ed price. D) obligation to buy the underlying asset at a fi%ed price. Answer! B

28+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D3Applied
$:. =eter Gemmings purchased a call option on I@C -tock with a strike price pf J0&. A) =eter will e%ercise the option if the price of I@C -tock at e%piration is J$&. B) =eter will e%ercise the option if the price of I@C -tock at e%piration is above J0&. C) =eter will let the option e%pire if the price of I@C -tock at e%piration is J2&. D) =eter will buy a put option to close out his position if the price of I@C -tock at e%piration is above J2&. Answer! B

D1Factual
'&. 1hat segment of the market for securities which have original maturities of more than one year is called the A) stock market. B) derivative securities market. C) money market. D) capital market. Answer! D

D1Factual
'1. 1hat segment of the market for securities which have original maturities of less than one year is called the A) stock market. B) derivative securities market. C) money market. D) capital market. Answer! C

D2Applied
'". An e%ample of a financial instrument in the capital market is A) commercial paper. B) a corporate bond. C) a negotiable bank CD. D) a ..-. 1reasury bill. Answer! B

D2Applied
'$. An e%ample of a financial instrument in the money market is a A) residential mortgage. B) corporate bond. C) negotiable bank CD. D) ..-. government agency security. Answer! C

Chapter $Financial ;nstruments* 3arkets* and ;nstitutions 29

D2Interpretive
''. Besides differences in maturities* the characteristic that distinguishes financial assets in the capital market from those in the money market is the level of A) activity. B) li9uidity. C) velocity. D) intermediation. Answer! B

D2Interpretive
'0. 1he best strategy for an investor who believes that interest rates will fall in the near future would be to purchase A) commercial paper. B) negotiable bank CDs. C) short#term ..-. 1reasury bills. D) long#term ..-. 1reasury bonds. Answer! D

D2Interpretive
'2. A business firm that has temporary surplus funds is most likely to buy A) ..-. 1reasury bills. B) ..-. 1reasury bonds. C) corporate stock. D) corporate bonds. Answer! A

D3Applied
'4. (hich of the following securities is least likely to be guaranteed by the full faith and credit of the federal government) A) A bond issued by a Federal Gand Bank B) A bond issued by the .nited -tates =ostal -ervice C) A note issued by the Federal ?ational 3ortgage Association D) A security issued by a Federal 7ome Goan Bank Answer! B

D2Interpretive
'8. Commercial banks participate in the money markets as A) lenders only. B) borrowers only. C) both lenders and borrowers. D) trustees only. Answer! C

30+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D1Factual
':. Commercial paper represents the A) capital assets of business firms. B) short#term liabilities of the most creditworthy business firms and finance companies. C) long#term liabilities of investment banks. D) short#term liabilities of commercial banks. Answer! B

D2Applied
0&. Commercial paper is mostly held by A) corporations. B) commercial banks. C) bond mutual funds. D) money market mutual funds. Answer! D

D2Applied
01. (hich of the following will suffer the smallest decrease in value as a result of rising interest rates) A) A ..-. 1reasury bond B) A corporate bond C) A negotiable CD D) A commercial mortgage pool Answer! C

D2Applied
0". (hich of the following will suffer the largest loss in value from rising interest rates) A) A ..-. 1reasury bill B) Commercial paper C) A negotiable CD D) A corporate bond Answer! D

D2Interpretive
0$. All financial intermediaries ac9uire funds by A) selling bonds. B) selling stocks. C) issuing their own liabilities. D) charging interest. Answer! C

D1Interpretive
0'. (hich of the following is not a maBor purpose of financial intermediaries) A) 1ransaction costs B) Diversification C) ;nformation D) All of the above are maBor purposes of financial intermediaries. Answer! D

Chapter $Financial ;nstruments* 3arkets* and ;nstitutions 31

D2Interpretive
00. .nlike most companies* financial intermediaries A) carry financial instruments only on the liabilities side of their balance sheet. B) carry financial instruments only on the asset side of their balance sheet. C) carry financial instruments on both sides of the balance sheet. D) have no debt. Answer! C

D3Applied
02. ;f an individual sells a ..-. 1reasury bill and uses the funds to open a money market deposit account* it is an e%ample of A) consumption. B) direct finance. C) ta% avoidance. D) financial intermediation. Answer! D

D3Interpretive
04. ;f financial intermediation were substantially reduced* the likely initial effect on individual investors would be A) higher inflation. B) a shift to a barter economy. C) a reduction in disintermediation. D) increased risk. Answer! D

D2Interpretive
08. -aver#lenders often choose to invest in financial intermediaries because the intermediaries A) reduce transactions costs for saver#lenders. B) increase risk by diversification. C) produce information on saver#lenders. D) engage in direct finance. Answer! A

D2Factual
0:. An inde% fund A) is a bond fund that provides diversification. B) is a mutual fund that buys the stocks that compose a well#known inde%. C) is a growth fund that reduces transaction costs. D) produces information on the securities it invests in. Answer! B

32+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D1Interpretive
2&. Financial institutions are Bust like other firms in that they attempt to ma%imiAe A) total assets. B) total liabilities. C) capital. D) profits. Answer! D

D2Interpretive
21. (hich of these financial institutions is the most likely to have a portfolio very similar to those of life insurance companies) A) 3oney market mutual funds B) 3utual savings banks C) =rivate noninsured pension funds D) =roperty and casualty insurance companies Answer! C

D2Interpretive
2". (hich of these institutions has the greatest degree of certainty regarding the timing of liability payouts) A) Gife insurance companies B) =roperty and casualty insurance companies C) 3oney market mutual funds D) Credit unions Answer! A

D2Interpretive
2$. 3utual funds usually do not invest in A) the stock market. B) the municipal bond market. C) the residential mortgage market. D) 3utual funds invest in all of the above. Answer! D

D2Interpretive
2'. Assets on the balance sheet of a money market mutual fund typically include A) commercial mortgages. B) high#grade commercial paper. C) ..-. 1reasury bonds. D) municipal bonds. Answer! B

Chapter $Financial ;nstruments* 3arkets* and ;nstitutions 33

D2Interpretive
20. Garge#siAe bank CDs are most likely to appear on the balance sheet of a A) pension fund. B) life insurance company. C) mutual fund. D) money market mutual fund. Answer! D

D1Factual
22. 1raditionally* the largest asset held by savings#and#loan associations has been A) ?>( deposits. B) business loans. C) residential mortgages. D) consumer loans. Answer! C

D2Factual
24. 555555555555555555 are concentrated on the /ast Coast and have a relatively long history of making nonmortgage consumer loans. A) -avings and loan associations H-DGs) B) Commercial banks C) Credit unions D) -avings banks Answer! D

D2Interpretive
28. Consumer finance companies get their funds primarily from A) the federal government. B) selling stock. C) selling commercial paper. D) issuing long term bonds. Answer! C

D1Factual
2:. Consumer finance companies specialiAe in A) consumer loans. B) residential mortgages. C) corporate stock. D) financial disintermediation. Answer! A

D1Factual
4&. A 555555555555555555 is a Kthrift institution.L A) credit union B) commercial bank C) consumer finance company D) life insurance company Answer! A

34+itter,-ilber,.dell Money, Banking, and Financial Markets * /leventh /dition

D1Factual
41. Checking accounts can be offered by A) pension funds. B) life insurance companies. C) consumer finance companies. D) savings and loan associations. Answer! D

D1Factual
4". -avings banks are very similar to A) finance companies. B) savings and loan associations H-DGs). C) bond mutual funds. D) money market mutual funds. Answer! B