BANKING EXAM 2 (TEST BANK FOR
CORRECTION) QUESTIONS AND
ANSWERS
In what ways is the market for rental apartments like the market for used cars? -
Answer-In both markets, the owner knows more than the potential renter or buyer.
In what ways is it different? - Answer-The landlord is not selling the apartment,
merely renting it, while the buyer of a used car makes an irreversible deal.
An article in the Economist magazine observes:
"Insurance companies often suspect the only people who buy insurance are the ones
most likely to collect."
Source: "The Money Talks," Economist, December 5, 2008.
What do economists call the problem being described here? - Answer-Adverse
selection.
If insurance companies are correct in their suspicion, it will
increase
the price of insurance. - Answer-increase
An article in the Wall Street Journal discussed the fact that the Chinese government
often intervenes to keep banks that make many bad loans from failing. The result
was "moral hazard, or risk-taking based on the belief that someone else will pick up
the tab if things go wrong."
Do you agree with the article's definition of moral hazard in this context?
This
is an example
of moral hazard because the article mentions that the government often intervenes
to bail out banks making bad loans, therefore, banks are
taking risks knowing they will not bear the entire burden when loans fail - Answer-is
an example, taking risks knowing they will not bear the entire burden when loans fail
If the article is correct about what was happening in the Chinese banking system,
what problems might arise as a result? - Answer-Banks will make riskier and riskier
loans over time.
What is the most important source of funds for small to medium-sized firms? -
Answer-The owners' personal funds and profits
What is the most important source of external funds for these firms? - Answer-Loans
from financial intermediaries
Decades ago, many bank records were written by hand in ledgers.
, At the time, banks achieved little economies of scale as the amount of labor required
to maintain such records was the same for every transaction, regardless of the size
of the bank.
The shift to keeping all records on computers has increased the opportunities to
achieve economies of scale by replacing labor costs with technology costs. -
Answer-little, the same, regardless, increased, labor, technology
The author of a newspaper article providing advice to renters observes that
"landlords will always know more than you do."
Source: Marc Santora, "How to Be a Brainy Renter," New York Times, June 3, 2010.
Do you agree with this statement? If so, what do landlords know that potential
renters might not? - Answer-Agree; Landlords know more about the quality of the
property, and hence its true value, than renters.
If the statement is correct, what are the implications for the market for rental
apartments? - Answer-Landlords will attempt to charge a higher price than they
otherwise would receive in the absence of this information asymmetry
Why don't these firms rely on external funds to the same extent as large firms do -
Answer-Transactions costs and information costs are much higher for smaller firms.
What is the most important method of debt financing for corporations? - Answer-The
bond market.
Which of the following is a correctly explained key feature of the financial system?
(Check all that apply.) - Answer-Loans from financial intermediaries are the most
important external source of funds for small- to medium-sized firms. Financial
intermediaries can reduce the transaction costs of borrowing for small firms.
The stock market is a less important source of external funds to corporations than is
the bond market. This is because there is less moral hazard involved with bonds
than with stocks.
Debt contracts usually require collateral or restrictive covenants. The purpose of the
collateral is to reduce moral hazard.
Consider the possibility of income insurance. With income insurance, if a person
loses his job or doesn't get as big a raise as anticipated, he would be compensated
under his insurance coverage. Why don't insurance companies offer income
insurance of this type? (Check all that apply.) - Answer-The problem is adverse
selection (people who are more likely to be fired or get low raises would be more
likely to buy such insurance).
The problem is moral hazard (once insured, you won't work as hard).
If everyone were perfectly honest, would there be a role for financial intermediaries?
- Answer-Yes
Describe some of the information problems in the financial system that lead firms to
rely more heavily on internal funds than external funds to finance their growth. Do
these information problems imply that firms are able to spend less on expansion than
is economically optimal? - Answer-Asymmetric information makes information costs
CORRECTION) QUESTIONS AND
ANSWERS
In what ways is the market for rental apartments like the market for used cars? -
Answer-In both markets, the owner knows more than the potential renter or buyer.
In what ways is it different? - Answer-The landlord is not selling the apartment,
merely renting it, while the buyer of a used car makes an irreversible deal.
An article in the Economist magazine observes:
"Insurance companies often suspect the only people who buy insurance are the ones
most likely to collect."
Source: "The Money Talks," Economist, December 5, 2008.
What do economists call the problem being described here? - Answer-Adverse
selection.
If insurance companies are correct in their suspicion, it will
increase
the price of insurance. - Answer-increase
An article in the Wall Street Journal discussed the fact that the Chinese government
often intervenes to keep banks that make many bad loans from failing. The result
was "moral hazard, or risk-taking based on the belief that someone else will pick up
the tab if things go wrong."
Do you agree with the article's definition of moral hazard in this context?
This
is an example
of moral hazard because the article mentions that the government often intervenes
to bail out banks making bad loans, therefore, banks are
taking risks knowing they will not bear the entire burden when loans fail - Answer-is
an example, taking risks knowing they will not bear the entire burden when loans fail
If the article is correct about what was happening in the Chinese banking system,
what problems might arise as a result? - Answer-Banks will make riskier and riskier
loans over time.
What is the most important source of funds for small to medium-sized firms? -
Answer-The owners' personal funds and profits
What is the most important source of external funds for these firms? - Answer-Loans
from financial intermediaries
Decades ago, many bank records were written by hand in ledgers.
, At the time, banks achieved little economies of scale as the amount of labor required
to maintain such records was the same for every transaction, regardless of the size
of the bank.
The shift to keeping all records on computers has increased the opportunities to
achieve economies of scale by replacing labor costs with technology costs. -
Answer-little, the same, regardless, increased, labor, technology
The author of a newspaper article providing advice to renters observes that
"landlords will always know more than you do."
Source: Marc Santora, "How to Be a Brainy Renter," New York Times, June 3, 2010.
Do you agree with this statement? If so, what do landlords know that potential
renters might not? - Answer-Agree; Landlords know more about the quality of the
property, and hence its true value, than renters.
If the statement is correct, what are the implications for the market for rental
apartments? - Answer-Landlords will attempt to charge a higher price than they
otherwise would receive in the absence of this information asymmetry
Why don't these firms rely on external funds to the same extent as large firms do -
Answer-Transactions costs and information costs are much higher for smaller firms.
What is the most important method of debt financing for corporations? - Answer-The
bond market.
Which of the following is a correctly explained key feature of the financial system?
(Check all that apply.) - Answer-Loans from financial intermediaries are the most
important external source of funds for small- to medium-sized firms. Financial
intermediaries can reduce the transaction costs of borrowing for small firms.
The stock market is a less important source of external funds to corporations than is
the bond market. This is because there is less moral hazard involved with bonds
than with stocks.
Debt contracts usually require collateral or restrictive covenants. The purpose of the
collateral is to reduce moral hazard.
Consider the possibility of income insurance. With income insurance, if a person
loses his job or doesn't get as big a raise as anticipated, he would be compensated
under his insurance coverage. Why don't insurance companies offer income
insurance of this type? (Check all that apply.) - Answer-The problem is adverse
selection (people who are more likely to be fired or get low raises would be more
likely to buy such insurance).
The problem is moral hazard (once insured, you won't work as hard).
If everyone were perfectly honest, would there be a role for financial intermediaries?
- Answer-Yes
Describe some of the information problems in the financial system that lead firms to
rely more heavily on internal funds than external funds to finance their growth. Do
these information problems imply that firms are able to spend less on expansion than
is economically optimal? - Answer-Asymmetric information makes information costs
