Economics of Money, Banking & Financial Markets, 7e (Mishkin)
Chapter 2 An Overview of the Financial System
2.1 Function of Financial Markets
1) Every financial market has which of the following characteristics?
A) It determines the level of interest rates.
B) It allows common stock to be traded.
C) It allows loans to be made.
D) It channels funds from lenders-savers to borrowers-spenders.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
2) Financial markets have the basic function of ________.
A) getting people with funds to lend together with people who want to borrow funds
B) assuring that the swings in the business cycle are less pronounced
C) assuring that governments need never resort to printing money
D) providing a risk-free repository of spending power
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
3) Financial markets improve economic welfare because ________.
A) they channel funds from investors to savers
B) they allow consumers to time their purchase better
C) they weed out inefficient firms
D) eliminate the need for indirect finance
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
4) Well-functioning financial markets ________.
A) cause inflation
B) eliminate the need for indirect finance
C) cause financial crises
D) produce an efficient allocation of capital
Answer: D
Diff: 3 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
1
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,5) A breakdown of financial markets can result in ________.
A) financial stability
B) rapid economic growth
C) political instability
D) stable prices
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
6) The principal lender-savers are ________.
A) governments
B) businesses
C) households
D) foreigners
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
7) Which of the following can be described as direct finance?
A) You take out a mortgage from your local bank.
B) You borrow $2500 from a friend.
C) You buy shares of common stock in the secondary market.
D) You buy shares in a mutual fund.
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
8) Assume that you borrow $2000 at 10 percent annual interest to finance a new business
project. For this loan to be profitable, the minimum amount this project must generate in annual
earnings is ________.
A) $400
B) $201
C) $200
D) $199
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
2
Copyright © 2020 Pearson Canada, Inc.
,9) You can borrow $5000 to finance a new business venture. This new venture will generate
annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds
and still increase your income is ________.
A) 25 percent
B) 12.5 percent
C) 10 percent
D) 5 percent
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
10) Which of the following can be described as involving direct finance?
A) A corporation issues new shares of stock.
B) People buy shares in a mutual fund.
C) A pension fund manager buys a short-term corporate security in the secondary market.
D) An insurance company buys shares of common stock in the over-the-counter markets.
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
11) Which of the following can be described as involving direct finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys a short-term corporate security in a secondary market.
D) People buy shares of common stock in the primary markets.
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
12) Which of the following can be described as involving indirect finance?
A) You make a loan to your neighbor.
B) A corporation buys a share of common stock issued by another corporation in the primary
market.
C) You buy a Canadian Treasury bill from the Bank of Canada.
D) You make a deposit at a bank.
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
3
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, 13) Securities are ________ for the person who buys them, but are ________ for the individual
or firm that issues them.
A) assets; liabilities
B) liabilities; assets
C) negotiable; nonnegotiable
D) nonnegotiable; negotiable
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
14) With ________ finance, borrowers obtain funds from lenders by selling them securities in
the financial markets.
A) active
B) determined
C) indirect
D) direct
Answer: D
Diff: 2 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
15) How do financial intermediaries play an important role in the economy?
Answer: Financial intermediaries play an important role in the economy because they provide
liquidity services, they lower transaction costs through economies of scale, they reduce the risk
exposure of investors through risk sharing, and they solve the asymmetric information
problems of adverse selection and moral hazard. By doing this, they allow small savers and
borrowers to benefit from the existence of financial markets and its instruments. They also
improve economic efficiency because they help financial markets to channel funds from
lenders-savers to people with productive investment opportunities.
Diff: 3 Type: ES
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
16) Distinguish between direct finance and indirect finance. Which of these is the most important
source of funds for corporations in Canada?
Answer: With direct finance, funds flow directly from the lender/saver to the borrower. With
indirect finance, funds flow from the lender/saver to a financial intermediary who then channels
the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major
source of funds for corporations in Canada.
Diff: 3 Type: ES
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
4
Copyright © 2020 Pearson Canada, Inc.
Chapter 2 An Overview of the Financial System
2.1 Function of Financial Markets
1) Every financial market has which of the following characteristics?
A) It determines the level of interest rates.
B) It allows common stock to be traded.
C) It allows loans to be made.
D) It channels funds from lenders-savers to borrowers-spenders.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
2) Financial markets have the basic function of ________.
A) getting people with funds to lend together with people who want to borrow funds
B) assuring that the swings in the business cycle are less pronounced
C) assuring that governments need never resort to printing money
D) providing a risk-free repository of spending power
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
3) Financial markets improve economic welfare because ________.
A) they channel funds from investors to savers
B) they allow consumers to time their purchase better
C) they weed out inefficient firms
D) eliminate the need for indirect finance
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
4) Well-functioning financial markets ________.
A) cause inflation
B) eliminate the need for indirect finance
C) cause financial crises
D) produce an efficient allocation of capital
Answer: D
Diff: 3 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
1
Copyright © 2020 Pearson Canada, Inc.
,5) A breakdown of financial markets can result in ________.
A) financial stability
B) rapid economic growth
C) political instability
D) stable prices
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
6) The principal lender-savers are ________.
A) governments
B) businesses
C) households
D) foreigners
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
7) Which of the following can be described as direct finance?
A) You take out a mortgage from your local bank.
B) You borrow $2500 from a friend.
C) You buy shares of common stock in the secondary market.
D) You buy shares in a mutual fund.
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
8) Assume that you borrow $2000 at 10 percent annual interest to finance a new business
project. For this loan to be profitable, the minimum amount this project must generate in annual
earnings is ________.
A) $400
B) $201
C) $200
D) $199
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
2
Copyright © 2020 Pearson Canada, Inc.
,9) You can borrow $5000 to finance a new business venture. This new venture will generate
annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds
and still increase your income is ________.
A) 25 percent
B) 12.5 percent
C) 10 percent
D) 5 percent
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
10) Which of the following can be described as involving direct finance?
A) A corporation issues new shares of stock.
B) People buy shares in a mutual fund.
C) A pension fund manager buys a short-term corporate security in the secondary market.
D) An insurance company buys shares of common stock in the over-the-counter markets.
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
11) Which of the following can be described as involving direct finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys a short-term corporate security in a secondary market.
D) People buy shares of common stock in the primary markets.
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
12) Which of the following can be described as involving indirect finance?
A) You make a loan to your neighbor.
B) A corporation buys a share of common stock issued by another corporation in the primary
market.
C) You buy a Canadian Treasury bill from the Bank of Canada.
D) You make a deposit at a bank.
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
3
Copyright © 2020 Pearson Canada, Inc.
, 13) Securities are ________ for the person who buys them, but are ________ for the individual
or firm that issues them.
A) assets; liabilities
B) liabilities; assets
C) negotiable; nonnegotiable
D) nonnegotiable; negotiable
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
14) With ________ finance, borrowers obtain funds from lenders by selling them securities in
the financial markets.
A) active
B) determined
C) indirect
D) direct
Answer: D
Diff: 2 Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
15) How do financial intermediaries play an important role in the economy?
Answer: Financial intermediaries play an important role in the economy because they provide
liquidity services, they lower transaction costs through economies of scale, they reduce the risk
exposure of investors through risk sharing, and they solve the asymmetric information
problems of adverse selection and moral hazard. By doing this, they allow small savers and
borrowers to benefit from the existence of financial markets and its instruments. They also
improve economic efficiency because they help financial markets to channel funds from
lenders-savers to people with productive investment opportunities.
Diff: 3 Type: ES
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
16) Distinguish between direct finance and indirect finance. Which of these is the most important
source of funds for corporations in Canada?
Answer: With direct finance, funds flow directly from the lender/saver to the borrower. With
indirect finance, funds flow from the lender/saver to a financial intermediary who then channels
the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major
source of funds for corporations in Canada.
Diff: 3 Type: ES
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
4
Copyright © 2020 Pearson Canada, Inc.
