Economics of Financial Markets
Test Preparation
Course Introduction
This course explores the fundamental principles and dynamics of financial markets, analyzing the behavior and interaction of key participants such as investors, financial institutions, and regulatory bodies. Students will examine the structure, function, and efficiency of various markets, including equity, bond, and derivatives markets. The course covers essential economic concepts related to asset valuation, risk and return, market microstructure, and the impact of information and expectations. Emphasis is placed on understanding how financial markets contribute to resource allocation, economic stability, and growth, as well as how they respond to policy interventions and global economic events.
Recommended Textbook
Financial Markets and Institutions 8th Edition by Frederic Mishkin
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27 Chapters
2334 Verified Questions
2334 Flashcards
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Chapter 1: Why Study Financial Markets and Institutions?
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67 Verified Questions
67 Flashcards
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Sample Questions
Q1) Financial innovation has provided more options to both investors and borrowers.
A)True
B)False
Answer: True
Q2) A financial intermediary borrows funds from people who have saved.
A)True
B)False
Answer: True
Q3) The government organization responsible for the conduct of monetary policy in the United States is the U.S.Treasury.
A)True
B)False
Answer: False
Q4) The central bank of the United States is
A) Citicorp.
B) The Fed.
C) Bank of America.
D) The Treasury.
E) none of the above.
Answer: B
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Chapter 2: Overview of the Financial System
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Sample Questions
Q1) Bonds that are sold in a foreign country and are denominated in that country's currency are known as
A) foreign bonds.
B) Eurobonds.
C) Eurocurrencies.
D) Eurodollars.
Answer: A
Q2) Which of the following is not a regulator of part of the U.S.financial system?
A) National Credit Union Administration
B) Securities and Exchange Commission
C) Federal Reserve System
D) Federal Deposit Insurance Corporation
E) All of the above are regulators.
Answer: E
Q3) A corporation acquires new funds only when its securities are sold in the
A) secondary market by an investment bank.
B) primary market by an investment bank.
C) secondary market by a stock exchange broker.
D) secondary market by a commercial bank.
Answer: B
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Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation?
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106 Verified Questions
106 Flashcards
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Sample Questions
Q1) A bond's current market value is equal to the present value of the coupon payments plus the present value of the face amount.
A)True
B)False
Answer: True
Q2) Dollars received in the future are worth ________ than dollars received today.The process of calculating what dollars received in the future are worth today is called ________.
A) more; discounting
B) less; discounting
C) more; inflating
D) less; inflating
Answer: B
Q3) A $10,000,8 percent coupon bond that sells for $10,100 has a yield to maturity
A) equal to 8 percent
B) greater than 8 percent
C) less than 8 perfect
D) that cannot be calculated
Answer: C
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Chapter 4: Why Do Interest Rates Change?
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Sample Questions
Q1) Milton Friedman contends that it is entirely possible that when the money supply rises,interest rates may ________ if the ________ effect is more than offset by changes in income,the price level,and expected inflation.
A) fall; liquidity
B) fall; risk
C) rise; liquidity
D) rise; risk
Q2) A lower level of income causes the demand for money to ________ and the interest rate to ________.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
Q3) When bond prices become more volatile,the demand for bonds ________ and the interest rate ________.
A) increases; rises
B) increases; falls
C) decreases; falls
D) decreases; rises
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates?
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107 Flashcards
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Sample Questions
Q1) What effect did the Bush Tax Cut have on bond interest rates?
Q2) The risk premium on corporate bonds becomes smaller as the liquidity of the bonds falls.
A)True
B)False
Q3) Explain why a flight to quality occurred following the subprime collapse and how this affected the interest rates on lower-quality corporate bonds and Treasury bonds.
Q4) When the default risk on corporate bonds decreases,other things equal,the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right
Q5) A bond rating of Aa or AA would mean that the quality of the bond is A) the highest.
B) high.
C) medium grade.
D) speculative.
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Chapter 6: Are Financial Markets Efficient?
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Sample Questions
Q1) What is a rational bubble?
Q2) Although the verdict is not yet in,the available evidence indicates that,for many purposes,the efficient market hypothesis is
A) a good starting point for analyzing expectations.
B) not a good starting point for analyzing expectations.
C) too general to be a useful tool for analyzing expectations.
D) none of the above.
Q3) How expectations are formed is important because expectations influence A) the demand for assets.
B) bond prices.
C) the risk structure of interest rates.
D) the term structure of interest rates.
E) all of the above.
Q4) Technical analysis is a popular technique used to predict stock prices by studying past stock price data and searching for patterns such as trends and regular cycles. A)True
B)False
Q5) Give evidence both for and against market efficiency.
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Chapter 7: Why Do Financial Institutions Exist?
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Sample Questions
Q1) A conflict of interest between providing impartial research about companies issuing securities and selling those same securities arises in
A) investment banking.
B) commercial banking.
C) accounting firms.
D) mutual funds.
Q2) Governments in developing countries sometimes adopt policies that retard the efficient operation of their financial systems.These actions include policies that
A) prevent lenders from foreclosing on borrowers with political clout.
B) nationalize banks and direct credit to politically favored borrowers.
C) make it costly to collect payments and collateral from defaulting debtors.
D) do all of the above.
E) do only A and B of the above.
Q3) Net worth is the difference between a firm's assets and its liabilities.
A)True
B)False
Q4) What factors usually cause an increase in adverse selection?
Q5) What conflicts of interest can arise in investment banking?
Q6) Distinguish between adverse selection and moral hazard.
Page 9
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Chapter 8: Why Do Financial Crises Occur and
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Sample Questions
Q1) Describe the sequence of events in a financial crisis in an advanced economy and explain why they can cause economic activity to decline.
Q2) In an advanced economy,a financial crisis can begin in several ways,including
A) mismanagement of financial liberalization or innovation.
B) asset pricing booms and busts.
C) an increase in uncertainty caused by failure of financial institutions.
D) all of the above.
Q3) Which of the following led to the U.S.financial crisis of 2007-2009?
A) Financial innovation in mortgage markets
B) Agency problems in mortgage markets
C) An increase in moral hazard at credit rating agencies
D) All of the above
E) only A and B of the above
Q4) The failure of Ohio Life Insurance and Trust in 1857 did not signal the start of a recession due to prompt actions by the Fed.
A)True
B)False
Q5) Discuss some of the financial innovations in mortgage markets that led to the U.S.financial crisis in 2007.
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Chapter 9: Central Banks and the Federal Reserve System
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Sample Questions
Q1) The Federal Advisory Council has ________ member(s)from each district.
A) one
B) two
C) three
D) can have any number of
Q2) Each member of the seven-member Board of Governors is appointed by the president and confirmed by the Senate to serve
A) 4-year terms.
B) 6-year terms.
C) 14-year terms.
D) as long as the appointing president remains in office.
Q3) Federal Reserve monetary policy decisions must be approved by the Secretary of the Treasury before they may be implemented.
A)True
B)False
Q4) The FOMC is an element of the Federal Reserve System.
A)True
B)False
Q5) What factors limit the independence of the Federal Reserve?
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Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Sample Questions
Q1) Regulations making it obligatory for depository institutions to keep a certain fraction of their deposits in accounts with the Fed are
A) open market operations.
B) federal funds rate.
C) required reserve ratio.
D) reserve requirements.
Q2) An open market sale leads to an expansion of reserves and deposits in the banking system and hence to a decline in the monetary base and the money supply.
A)True
B)False
Q3) When there is a mismatch between job requirements and the skills of available workers,the resulting unemployment is called
A) structural unemployment.
B) frictional unemployment.
C) cyclical unemployment.
D) underemployment.
Q4) List and describe the various assets and liabilities making up the consolidated balance sheet of the Federal Reserve System.
Page 12
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Chapter 11: The Money Markets
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Sample Questions
Q1) Money market securities are short-term instruments with an original maturity of less than one year.
A)True
B)False
Q2) Treasury bills do not
A) pay interest.
B) have a maturity date.
C) have a face amount.
D) have an active secondary market.
Q3) The primary function of large diversified brokerage firms in the money market is to
A) sell money market securities to the Federal Reserve for its open market operations.
B) make a market for money market securities by maintaining an inventory from which to buy or sell.
C) buy money market securities from corporations that need liquidity.
D) buy T-bills from the U.S. Treasury Department.
Q4) Commercial paper has been used in various forms since the 1930s.
A)True
B)False
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Chapter 12: The Bond Market
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90 Flashcards
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Sample Questions
Q1) Why don't federal,state,and local governments issue equity claims?
Q2) What are Treasury STRIPS?
Q3) What types of risks should bondholders be aware of and how do these affect bond prices and yields?
Q4) (I)Securities that have an original maturity greater than one year are traded in money markets.
(II)The best known money market securities are stocks and bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Q5) The secondary market is where new issues of stocks and bonds are introduced. A)True
B)False
Q6) The Commodity Futures Modernization Act (2000)removed derivative securities,such as credit default swaps,from regulatory oversight.
A)True
B)False
Q7) Distinguish between general obligation and revenue municipal bonds.
Page 14
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Chapter 13: The Stock Market
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Sample Questions
Q1) More stock trading in the U.S.occurs in over-the-counter markets rather than on organized exchanges.
A)True
B)False
Q2) (I)The market price of a security at a given time is the highest value any investor puts on the security.
(II)Superior information about a security increases its value by reducing its risk.
A) (I) is true, (II) is false.
B) (I) is false, (II) is true.
C) Both are true.
D) Both are false.
Q3) A ________ PE may indicate that the market feels the firm's earnings are very ________ risk and is therefore willing to pay a ________ for them.
A) high; low; premium
B) high; high; discount
C) low; low; discount
D) high; high; premium
Q4) What is the role of specialists on a stock exchange?
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Page 15
Chapter 14: The Mortgage Markets
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74 Flashcards
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Sample Questions
Q1) Which of the following are useful for home buyers who expect their income to fall in the future?
A) GPMs
B) RAMs
C) GEMs
D) Only A and B are useful.
E) Only A and C are useful.
Q2) Which of the following terms are found in mortgage loan contracts to protect the lender from financial loss?
A) Collateral
B) Down payment
C) Private mortgage insurance
D) All of the above
Q3) Which of the following are useful for home buyers who expect their income to rise in the future?
A) GPMs
B) RAMs
C) GEMs
D) Only A and B are useful.
E) Only A and C are useful.
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Chapter 15: The Foreign Exchange Market
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Sample Questions
Q1) If the demand for ________ goods decreases relative to ________ goods,the domestic currency will depreciate.
A) foreign; domestic
B) foreign; foreign
C) domestic; domestic
D) domestic; foreign
Q2) According to the interest parity condition,the domestic interest rate is equal to the foreign interest rate
A) plus the expected appreciation of the domestic currency.
B) less the expected appreciation of the domestic currency.
C) less the expected depreciation of the domestic currency.
D) less the expected depreciation of the domestic currency weighted by the domestic interest rate.
Q3) If the dollar appreciates from 0.8 euros per dollar to 1.2 euros per dollar,the euro depreciates from ________ dollars to ________ dollars per euro.
A) 1.25; 0.83
B) 0.83; 1.25
C) 0.67; 1.50
D) 1.50; 0.67
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Page 17
Chapter 16: The International Financial System
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Sample Questions
Q1) Revaluation of a currency's value occurs when
A) a floating exchange rate adjusts upward.
B) a floating exchange rate adjusts downward.
C) a fixed exchange rate is adjusted upward.
D) a fixed exchange rate is adjusted downward.
Q2) ________ is when the domestic currency is backed 100% by a foreign currency and in which the note-issuing authority establishes a fixed exchange rate to this foreign currency and stands ready to exchange domestic currency for the foreign currency at this rate whenever the public requests it.
A) dollarization
B) currency board
C) devaluation
D) revaluation
Q3) A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called
A) an unsterilized foreign exchange intervention.
B) a sterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money-neutral foreign exchange intervention.
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Page 18
Chapter 17: Banking and the Management of Financial
Institutions
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Sample Questions
Q1) Holding all else constant,when a bank receives the funds for a deposited check,
A) cash items in process of collection fall by the amount of the check.
B) bank assets remain unchanged.
C) bank liabilities decrease by the amount of the check.
D) all of the above occur.
E) only A and B of the above occur.
Q2) Deposits that banks keep in accounts at the Federal Reserve less vault cash is called reserves.
A)True
B)False
Q3) Examples of off-balance-sheet activities include
A) loan sales.
B) extending loans to depositors.
C) borrowing from other banks.
D) all of the above.
Q4) Since a bank's assets exceed its equity capital,the return on assets always exceeds the return on equity.
A)True
B)False
Q5) How did liability management change during the 1960s?
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Chapter 18: Financial Regulation
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Sample Questions
Q1) In the years just prior to the global financial crisis,mortgage loans were issued to borrowers with no income or employment.
A)True
B)False
Q2) Just prior to the global financial crisis,mortgage loans known as NINJA loans were issued to borrowers.What is a NINJA loan?
A) A loan issued by a Japanese bank, thus avoiding U.S. regulation.
B) A loan document originated by a mortgage banker named Bruce Lee.
C) A loan issued to borrowers with no income, employment, nor assets to speak of.
D) A loan issued with a "martial arts" clause.
Q3) Because asymmetric information problems in the banking industry are a fact of life throughout the world,bank regulation in other countries is similar to that in the United States.
A)True
B)False
Q4) Describe 2 of the 5 different categories of regulation found in the Dodd-Frank legislation of 2010.
Q5) Discuss the role of NINJA loans in the global financial crisis.
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Page 20
Chapter 19: Banking Industry: Structure and Competition
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Sample Questions
Q1) A major controversy involving the U.S.banking industry in its early years was
A) whether banks should both accept deposits and make loans or whether these functions should be separated into different institutions.
B) whether the federal government or the states should charter banks.
C) what percent of deposits banks should hold as fractional reserves.
D) whether banks should be allowed to issue their own bank notes.
Q2) The process in which people seeking higher interest rates take their money out of financial institutions is called ________.
A) capital mobility
B) loophole mining
C) disintermediation
D) deposit jumping
Q3) The modern commercial banking system began in America when the
A) Bank of the United States was chartered in New York in 1801.
B) Bank of North America was chartered in Philadelphia in 1782.
C) Bank of the United States was chartered in Philadelphia in 1801.
D) Bank of North America was chartered in New York in 1782.
Q4) What are the reasons for the decline of traditional banking?
Q5) What financial innovations are best explained as attempts to avoid regulations?
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Chapter 20: The Mutual Fund Industry
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Sample Questions
Q1) How did money market mutual funds originate and why did they become especially popular in the late 1970s and early 1980s?
Q2) ________ means the investors can convert their investment into cash quickly at a low cost.
A) Liquidity intermediation
B) Denomination intermediation
C) Diversification
D) Managerial expertise
Q3) Open-end mutual funds are more common than closed-end funds.
A)True
B)False
Q4) A mutual fund's board of directors picks the securities that will be held and makes buy and sell decisions.
A)True
B)False
Q5) Measured by assets,the most popular type of bond fund is the ________ bond fund.
A) state municipal
B) strategic income
C) government
D) high-yield
Page 22
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Chapter 21: Insurance Companies and Pension Funds
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Sample Questions
Q1) Demographic trends and changes in retirement patterns suggest that Social Security funding problems will ease over the next few decades.
A)True
B)False
Q2) Keogh plans and IRAs are
A) individual pension plans.
B) government pension plans.
C) corporate pension plans.
D) public pension plans.
Q3) Why will Social Security funding problems rise in the coming decades? Identify and evaluate the proposals that have been suggested to ease or reverse these problems.
Q4) Vesting refers to the length of time that a person must be enrolled in a pension plan before being entitled to receive benefits.
A)True
B)False
Q5) Why must insurance companies screen applicants so carefully?
Q6) Who has the strongest incentive to monitor the performance of individual pension plans such as Keoghs and IRAs? Explain.
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Chapter 22: Investment Banks, Security Brokers and
Dealers, and Venture Capital Firms
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Sample Questions
Q1) Which of the following best explains the difference between brokers and dealers?
A) Brokers are pure middlemen; dealers make markets by standing ready to buy and sell at given prices.
B) Dealers are pure middlemen; brokers make markets by standing ready to buy and sell at given prices.
C) Dealers link up buyers and sellers, but do not stand ready to buy and sell from their inventories of securities; brokers stand ready to buy and sell from their inventories of securities.
D) There is no difference between brokers and dealers.
Q2) From an investment banker's perspective,the best outcome occurs when a new issue is ________.
A) undersubscribed
B) fully subscribed
C) oversubscribed
D) syndicated
Q3) An investment pool is formed to manipulate the market for a stock by spreading false rumors about the health of the firm.
A)True
B)False
Page 24
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Chapter 23: Risk Management in Financial Institutions
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Sample Questions
Q1) Compensating balances
A) are a particular form of collateral commonly required on commercial loans.
B) are a required minimum amount of funds that a borrower (i.e., a firm receiving a loan) must keep in a checking account at the bank.
C) allow banks to monitor firms' check payment practices, which can yield information about their borrowers' financial conditions.
D) are all of the above.
Q2) Effective screening and information collection together form an important principle of credit risk management.
A)True
B)False
Q3) Banks face the problem of adverse selection in loan markets because bad credit risks are the ones most likely to seek bank loans.
A)True
B)False
Q4) What is gap analysis and why is it important to a bank?
Q5) What steps do banks take to reduce their exposure to credit risk?
Q6) What is the difference between income gap analysis and duration gap analysis?
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Chapter 24: Hedging with Financial Derivatives
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Sample Questions
Q1) By selling short a futures contract of $100,000 at a price of 96,you are agreeing to deliver ________ face value securities for ________.
A) $100,000; $104,167
B) $96,000; $100,000
C) $100,000; $96,000
D) $100,000; $100,000
Q2) By buying a long $100,000 futures contract for 115,you agree to pay ________ for ________ face value securities.
A) $100,000; $115,000
B) $115,000; $100,000
C) $86,956; $100,000
D) $86,956; $115,000
Q3) An option that can be exercised only at maturity is called a(n)________.
A) swap
B) stock option
C) European option
D) American option
Q4) Explain the advantages of protecting against interest-rate risk using options rather than futures contracts.
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Chapter 25: Financial Crises In Emerging Market Economies
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Sample Questions
Q1) For both emerging market economies and advanced economies,Stage Two of a financial crisis is the same - a banking crisis.
A)True
B)False
Q2) Financial crises
A) cause failures of financial intermediaries and leave only securities markets to channel funds from savers to borrowers.
B) are a recent phenomenon that occur only in developing countries.
C) invariably lead to debt deflation.
D) all of the above.
E) none of the above.
Q3) In contrast to most advanced economies that typically denominate debt in domestic currency,emerging market economies denominate many debt contracts in foreign currency.
A)True
B)False
Q4) Describe the differences in the evolution of the financial crises in South Korea (1997-1998)and Argentina (2001-2002).
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Chapter 26: Savings Associations and Credit Unions
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Sample Questions
Q1) Mutual savings banks
A) are heavily concentrated in mortgages.
B) have more flexibility in their investing practices.
C) are both A and B of the above.
D) are neither A nor B of the above.
Q2) Charles Keating
A) was allowed to acquire Lincoln Savings and Loan of Irvine, California, even though he had been accused of fraud by the SEC only four-and-a-half years earlier.
B) fired Lincoln's conservative lending officers and internal auditors, even though he had promised regulators he would keep them.
C) enlisted the help of five senators to delay the seizure of Lincoln's assets.
D) did all of the above.
Q3) In the early stages of the banking crisis in the 1980s,financial institutions were especially harmed by
A) declining interest rates from late 1979 until 1981.
B) the severe recession in 1981-82.
C) the disinflation from mid-1980 to early 1983.
D) all of the above.
Q4) Explain why thrift regulators engaged in regulatory forbearance in the 1980s.
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Chapter 27: Finance Companies
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Sample Questions
Q1) What are the various types of finance companies?
Q2) In which industry is factoring a common practice?
A) Automobile
B) Tech services
C) Entertainment
D) Apparel
Q3) Finance companies are ________ market intermediaries.
A) stock
B) bond
C) FX
D) money
Q4) In a lease financing arrangement,a finance company will purchase equipment,which it then leases to a company for a set period.
A)True
B)False
Q5) What are the three main types of finance companies?
A) Sales, lease, and buyback
B) Business, sales, and consumer
C) Factor, lease, and floor plan
D) None of the above are correct.
Page 29
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