Chapter One
Why Are Financial Institutions Special?
True/False
1-1 Prior to the financial crisis of 2007-2008, J.P. Morgan Chase was the largest bank
holding company in the world and operations in 60 countries.
Answer: F
1-2 As of 2009, U.S. FIs held assets totaling over $35 trillion
Answer: T
1-3 Financial institutions act as intermediaries between suppliers and demanders of
money.
Answer: T
1-4 If a household invests in corporate securities and does not supervise how the
funds are invested or used by the corporation, the risk of not earning the desired
return or not having the funds returned increase.
Answer: T
1-5 If not done by FIs, the process of monitoring the actions of borrowers would
reduce the attractiveness and increase the risk of investing in corporate debt and
equity by individuals.
Answer: T
1-6 Failure to monitor the actions of firms in a timely and complete fashion after
purchasing securities in that firm exposes the investor to agency costs.
,Answer: T
1-7 The risk that the sale price of an asset will be less than the purchase price of an
asset is called liquidity risk.
Answer: F
1-8 Because bank loans have a shorter maturity than most debt contracts, FIs typically
exercise less monitoring power and control over the borrower.
Answer: F
1-9 FIs typically provide secondary claims to household savers that have inferior
liquidity than primary securities of corporations such as equity and bonds.
Answer: F
1-10 Because the average maturity of assets and the average maturity of liabilities are
often different on an FIs balance sheet, the FI is exposed to liquidity risk.
Answer: F
1-11 When an FI functions as a broker, they are selling a financial asset that they have
created and will continue to hold on their balance sheet.
Answer: F
1-12 An FI acting as an agent in matching savers and borrowers of funds can attain
economies of scale and provide this service more efficiently than either the saver
or borrower could on their own.
Answer: T
,1-13 Financial institutions are subject to economies of scale in the collection of
information.
Answer: T
1-14 As an asset transformer, the FI issues financial claims that are more attractive to
household savers than the claims directly issued by corporations.
Answer: T
1-15 The asset transformation function of an FI is to issue primary financial claims to
corporations while purchasing primary claims issued by households and other
investors.
Answer: F
1-16 Secondary securities are securities that serve as collateral for primary securities.
Answer: F
1-17 FIs are independent market entities that create financial assets whose value is the
transformation of financial risk.
Answer: T
1-18 The more costly it is to supervise the use of funds by a borrower, the less likely a
saver will encounter agency costs.
Answer: F
1-19 As a delegated monitor, an FI’s actions reduce agency costs.
Answer: T
, 1-20 The ability of diversification to eliminate much of the risk from the asset side of
the balance sheet of an FI is the result of choosing assets that are less than
perfectly positively correlated.
Answer: T
1-21 Research shows that there is a significant reduction in risk achieved by investing
in as few as 8 different securities.
Answer: F
1-22 Depository institutions serve as the primary conduit through which monetary
policy actions impact the economy.
Answer: T
1-23 The liabilities of depository institutions are significant components of the money
supply.
Answer: T
1-24 The goal of credit allocation is the encouragement of FIs to diversity the
composition of their assets.
Answer: F
1-25 Credit allocation regulations are typically designed to benefit customers as well as
the financial institution that must implement the guidelines.
Answer: F
1-26 The qualified thrift lender test is utilized to determine whether an institution can
serve as an FI.
Why Are Financial Institutions Special?
True/False
1-1 Prior to the financial crisis of 2007-2008, J.P. Morgan Chase was the largest bank
holding company in the world and operations in 60 countries.
Answer: F
1-2 As of 2009, U.S. FIs held assets totaling over $35 trillion
Answer: T
1-3 Financial institutions act as intermediaries between suppliers and demanders of
money.
Answer: T
1-4 If a household invests in corporate securities and does not supervise how the
funds are invested or used by the corporation, the risk of not earning the desired
return or not having the funds returned increase.
Answer: T
1-5 If not done by FIs, the process of monitoring the actions of borrowers would
reduce the attractiveness and increase the risk of investing in corporate debt and
equity by individuals.
Answer: T
1-6 Failure to monitor the actions of firms in a timely and complete fashion after
purchasing securities in that firm exposes the investor to agency costs.
,Answer: T
1-7 The risk that the sale price of an asset will be less than the purchase price of an
asset is called liquidity risk.
Answer: F
1-8 Because bank loans have a shorter maturity than most debt contracts, FIs typically
exercise less monitoring power and control over the borrower.
Answer: F
1-9 FIs typically provide secondary claims to household savers that have inferior
liquidity than primary securities of corporations such as equity and bonds.
Answer: F
1-10 Because the average maturity of assets and the average maturity of liabilities are
often different on an FIs balance sheet, the FI is exposed to liquidity risk.
Answer: F
1-11 When an FI functions as a broker, they are selling a financial asset that they have
created and will continue to hold on their balance sheet.
Answer: F
1-12 An FI acting as an agent in matching savers and borrowers of funds can attain
economies of scale and provide this service more efficiently than either the saver
or borrower could on their own.
Answer: T
,1-13 Financial institutions are subject to economies of scale in the collection of
information.
Answer: T
1-14 As an asset transformer, the FI issues financial claims that are more attractive to
household savers than the claims directly issued by corporations.
Answer: T
1-15 The asset transformation function of an FI is to issue primary financial claims to
corporations while purchasing primary claims issued by households and other
investors.
Answer: F
1-16 Secondary securities are securities that serve as collateral for primary securities.
Answer: F
1-17 FIs are independent market entities that create financial assets whose value is the
transformation of financial risk.
Answer: T
1-18 The more costly it is to supervise the use of funds by a borrower, the less likely a
saver will encounter agency costs.
Answer: F
1-19 As a delegated monitor, an FI’s actions reduce agency costs.
Answer: T
, 1-20 The ability of diversification to eliminate much of the risk from the asset side of
the balance sheet of an FI is the result of choosing assets that are less than
perfectly positively correlated.
Answer: T
1-21 Research shows that there is a significant reduction in risk achieved by investing
in as few as 8 different securities.
Answer: F
1-22 Depository institutions serve as the primary conduit through which monetary
policy actions impact the economy.
Answer: T
1-23 The liabilities of depository institutions are significant components of the money
supply.
Answer: T
1-24 The goal of credit allocation is the encouragement of FIs to diversity the
composition of their assets.
Answer: F
1-25 Credit allocation regulations are typically designed to benefit customers as well as
the financial institution that must implement the guidelines.
Answer: F
1-26 The qualified thrift lender test is utilized to determine whether an institution can
serve as an FI.
