Chapter1_PractiseQs - CHAPTER 1 PRACTISE QUESTIONS 1 Any...

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Unformatted text preview: CHAPTER 1 PRACTISE QUESTIONS 1 Any asset may be regarded as a package of attributes. Which of the following contains the greatest number of such attributes? A) return, risk, time pattern of cash flows B) yield, liquidity, tax effectiveness, time pattern of cash flows C) return, risk, liquidity, time pattern of cash flows Feedback: Assets can be regarded as having four main characteristics that are important to the owner or to a D) consumption, (or yield), risk, risk, liquidity potential buyer. These are: return return, flexibility, liquidity and the time-pattern of the cash flows (or returns) that the asset is expected to provide. Only C contains all four of these characteristics, making it the answer. See page 7. 2 The typical person is assumed to: A) like return, liquidity and risk B) like return and liquidity but refuse to accept risk C) like return, dislike risk and have no concern about liquidity Feedback: Return and liquidity are both asset characteristics that will generally be preferred by investors who D) like return and liquidity but dislike risk are also assumed to be risk averse. Risk aversion does not mean that a person will refuse to accept risk. It does mean that a person will take on risk only if it is accompanied by compensation, usually in the form of a higher expected return. Only D is consistent with these assumptions. See page 7. 3 Which of the following is not an important function of an efficient financial system? A) providing a wide range of financial instruments with characteristics that suit the needs of investors B) providing economic and financial information to market participants C) facilitating economic growth by encouraging savings D) allowing companies to produce goods Feedback: When a company provides goods or services and services regardless of the profits and therefore its and that are in high demand, its demand for these goods services s hare price will be higher than otherwise. The higher share price and positive outlook will make it easier for the company to raise more capital and invest to increase its output. Thus the statement in D is not applicable to an efficient financial system, making it the answer. See page 8. 4 Debt may be either secured or unsecured. Which of the following is correct? A) secured debt is debt that can be traded in the capital market B) the promise that secured debt will be repaid is supported by a claim over specified assets Feedback: Secured debt is less risky for lenders than unsecured debt because the borrower’s promise to repay C) secured debt is more risky for the lender than unsecured debt the loan is supported by a claim over certain assets or a guarantee from a third party. This means that if the D) the risks of secured and unsecured have been pledged as security and sell them. Secured borrower defaults the lender can seize the assets thatdebt are essentially the same debt may be marketable but this is not necessarily the case. In summary, A, C and D are and B is the only answer. See page 13. 5 Financial instruments may be divided into three broad categories: equity, debt and derivatives. There are also hybrid instruments, which may be most accurately described as: in a corporation A) a form of equity that provides limited ownership rights B) financial instruments that entitle the holder to a claim that ranks ahead of shareholders C) financial instruments that entitle the holder to a claim over specified assets Feedback: Most, but not all, financial instruments fit into one of the three categories: debt, equity and derivatives. HybridD) financial instruments that incorporate characteristics of both because equity instruments do not fit neatly into any of these categories debt and they combine the characteristics of two of the underlying categories; typically, some of the characteristics of equity and debt. Accordingly, D is the answer. See page 12. 6 There are many types of debt instrument. Which of the following types of debt may a non-financial corporation use toV A) I, II, III, raise borrowed funds? I debentures II certificates of deposit III promissory notes IV Treasury notes V unsecured notes VI term loans B) III, IV, V, VI Feedback: Debentures, promissory notes and unsecured notes are all marketable debt securities that can be C) I, III, V, VI issued by a non-financial corporation. A corporation can also borrow by obtaining a term loan from a bank or D) I, III, However, a non-financial corporation cannot issue certificates of deposit or Treasury other financial institution.IV, V notes. Certificates of deposit are issued by authorised deposit-taking institutions and Treasury notes are issued by the government. Therefore, A, B and D are all but C is . See page 13. 7 A non-negotiable financial instrument is one where: A) ownership of the instrument cannot legally be transferred B) the terms of the instrument cannot be varied after it has been issued C) Feedback: The term ‘negotiable’ refers to something that can be sold or transferred to another party, which the terms of the instrument can be varied by agreement between the issuer and holder corresponds to the meaning in A. Alternatives B, C and D refer to changes that might be negotiated between two D) the term to maturity of the instrument contracts that are parties. (This flexibility may be present in the context of cannot be extended private agreements between two parties and cannot be transferred to anyone else. In contrast, negotiable (or marketable) instruments have terms that are (i) clearly stated at the time they are issued and (ii) not easily changed at any later time.) See page 13. 8 Which of the following statements about derivatives contracts is correct? A) futures contracts are standardised and traded on an exchange B) forward contracts differ from futures contracts only in that forward contracts are standardised C) an option contract gives the buyer both rights and obligations Feedback: As stated in A, futures contracts are standardised and traded on an organised exchange but the s tatements in B, CD) a currency swap errors. Specifically, forward contracts are not standardised; an option gives and D all contain fixes the interest rate for a loan denominated in a foreign currency the buyer rights but not obligations and a currency swap fixes an exchange rate rather than an interest rate. See page 14. 9 Which of the following statements is correct? A) secondary markets in financial instruments are irrelevant to the companies that issued those instruments in the primary market B) secondary markets are directly involved in channelling funds from investors to borrowers C) secondary markets do encourage both savings and investment D) Feedback: Funds areprimary andnot secondary markets lead to greater investment by the issuers thefinancial assets raised but new securities are issued in the primary market. However, of existence of s econdary markets in which investors can sell those securities again if their needs change does encourage them to invest through primary markets so C is the answer. See page 16. 10 Secondary market transactions in shares: A) involve additional shares being issued by companies B) allow companies to borrow more heavily Feedback: A secondary market transaction is one where securities are bought and sold after their original C) only involve transfers of ownership between existing shareholders issuance in the primary market. The proceeds of a secondary market transaction go to the investor who sells the securities, not D) involve changes in security. Thus, A and B shares is inaccurate through inclusion of the word to the issuer of the the ownership of existing are . C ‘only’ (there is also a transfer of funds) and because the buyer need not be an ‘existing shareholder’. D is . See page 16. 11 The flow of funds in the primary market may be direct or indirect. Which of the following is correct? A) direct finance is provided by financial institutions such as banks B) direct finance is provided by brokers and dealers C) indirect finance is provided by brokers and dealers D) brokers by financial intermediaries such provision flows indirectly Feedback: Finance providedacting as agents often facilitate the as banksof direct finance from savers to borrowers s o A and C are both . Direct finance is provided by savers not by brokers and dealers, but brokers are often involved in these transactions as agents so D is the answer. See page 17. 12 Intermediated finance differs fundamentally from direct finance in that: A) in contrast to a broker who may arrange direct finance, the intermediary acts as a principal and is exposed to default risk Feedback: A crucial difference between directbroker who brings together savers and borrowers B) the intermediary acts as a and intermediated finance relates to the obligations of the parties. For example, direct finance may involve a broker who plays an important role in bringing the parties together C) intermediated finance is generally less costly than direct finance but the broker never has ownership of any securities that are issued. In contrast, a financial intermediary is an D) bank, that accepts deposits and makes loans. Importantly, the institution, such as adirect lenders are exposed to default risk but intermediaries are not deposits are a liability of the bank and must be repaid even if some borrowers fail to repay their loans. In summary, A is accurate while B, C and D are not, so A is the answer. See page 19. 13 Which of the following statements about the disadvantages of direct financing is not correct? A) direct financing can involve difficulties in matching the preferences of the suppliers and users of funds B) not all of the financial instruments issued by users of funds have an active secondary market C) the transaction costs associated with a direct issue of securities are usually insignificant D) investors may find it difficult to assess the default risk of securities issued directly by a borrower Feedback: An issue of securities can involve costs that are quite significant, such as the costs of preparing a prospectus, so the statement in C is wrong, making it the answer. See page 19. 14 Feedback: There are many benefits ofintermediation include combining funds from many small deposits to The benefits of financial financial intermediation. Which of the following are valid benefits? I asset transformation II transformation’) and using short-term deposits to provide long-term V credit risk provide large loans (‘assetincreased market profile III maturity transformation IV liability managementloans (‘maturity A) I, II, V, VI diversification VI lower scale costs for lenders and borrowers transformation’). Because of V search of their operations, financial intermediaries are able to diversify credit B) I, III, IV, the risk more effectively I, III, IV, VI individual investors and the ready availability of deposits with, and loans from, C) than most intermediaries should result in lower search costs for lenders and borrowers. In summary, I, III, V and VI are D) I, III, V, VI benefits of financial intermediation relative to direct finance. Direct borrowing may increase a company’s market profile and the need for liability management increases the cost of intermediation, so II and IV are not benefits of intermediation. See page 20. 15 The domestic economy can be divided into four sectors: business corporations, financial corporations, government and household sectors. The flow of funds between sectors varies but some generalisations are A) possible. In general, which of theusually a deficit sector and the household sector is a surplus sector the business sector is following is correct? B) the business and household sectors are usually deficit sectors Feedback: The business sector usually has a deficit each year as funds are raised to finance investment in C) the financial corporations and government sectors are usually surplus sectors additional assets and the household sector usually has a surplus. The financial corporations sector is often D) tends to have a small deficit sectors are usually deficit sectors close to balanced or the household and government whilethe government sector may have either a surplus or a deficit depending largely on the commonwealth government’s budgetary position. Consequently, A is but B, C and D are all . See page 31. 16 Wholesale market transactions are most accurately described as: A) transactions where non-bank institutions deposit surplus funds with banks B) direct transactions between institutional investors and borrowers C) direct transactions between large corporations and merchant banks Feedback: The classification of financial transactions as either ‘wholesale’ or ‘retail’ is based mainly on the size D) (value) of the transaction. Transactions in the wholesale market are large and generally involve financial transactions of more than $1 million government corporations and financial intermediaries institutions dealing directly with large corporations or between largeauthorities. The transactions referred to in A, C and D are examples of wholesale transactions but such transactions are not limited to the types of institutions mentioned. The description in B is more general, making it the answer. See page 22. 17 A company that issues promissory notes is: A) raising funds in the commercial paper market B) issuing discount securities C) usually raising funds on an unsecured basis D) all of the above Feedback: Promissory notes are short-term, money market securities, which differ from bills in that they are unsecured. See page 26. 18 Bills of exchange are discount securities. An important feature of discount securities is: A) the term to maturity is long B) the issue price is usually greater than face value C) the holder receives regular interest payments from the issuer D) holders obtain their return on investment from the difference between the price they pay for the security and the price at less it is face Feedback: Discount securities are issued at whichthansold value and redeemed at face value. Thus, they do not involve interest payments and, while the term to maturity is often short, there are also longer term zero-coupon bonds with the same cash flow pattern. Therefore, A, B and C are all and D is the answer. See page 26. 19 XYZ Enterprises Limited needs to raise additional funding to expand its manufacturing operations. Management decidesmarket $10 million in corporate bonds over the next three months. These securities A) wholesale to issue will be issued in the: B) secondary market C) money market Feedback: A new issue is a primary rather than secondary market transaction and since bonds are long-term s ecurities they areD) capital market traded in the capital market rather than the money market. An issue of $10 million in one parcel would be regarded as a ‘wholesale’ transaction but the information provided leaves open the possibility that the bonds will be issued in smaller, ‘retail’ parcels. In summary, B, C and A are all , but D is . See page 26. 20 The essential characteristic of equity is: A) ordinary shares are issued only by public companies B) equity provides both short- and long-term funding C) the equity investor obtains an ownership interest D) equity finance can be raised only by companies with shares listed holders exchange Feedback: The most common form of equity is the ordinary share, which provideson a stockwith an ownership interest in the issuing company, so C is . Ordinary shares are issued by private and unlisted companies as well as listed public companies, so A and D are both . Shares have no maturity date so B is also . See page 27. 21 Banks and other financial intermediaries typically use standardised documentation for their contracts, including deposits and loans. Which of the following benefits of financial intermediation applies in this case? A) asset transformation B) economies of scale C) liquidity transformation Feedback: Standardisation lowers costs in financial intermediation because once a contract has been drawn up the same contract D) credituseddiversification can be risk for many transactions. Therefore, the fixed costs of preparing the contract are s pread over many ‘units of output’, lowering the cost per unit which is the concept known as economies of s cale. See page 22. 22 Users of the foreign exchange market may be concerned about foreign exchange risk. This risk is: A) the risk that interest rates in overseas markets may change B) the risk that the exchange rate between currencies may alter C) the risk that an overseas borrower may default D) the risk that particular foreign currency may not be available when it is required Feedback: Currencies are tradedain the foreign exchange market and an exchange rate is the price of one currency in terms of another. Accordingly, foreign exchange risk arises from changes in exchange rates, so B is the answer. See page 29. 23 In the context of the capital market, the derivatives market is important because: A) derivatives allow borrowers to raise long-term funds B) derivatives allow the risks associated with capital market transactions to be managed C) securities with options attached to them are attractive to investors Feedback: Derivatives are financial instruments whose value is linked to (derived from) the value of some D) derivatives are very secure low-risk A change in underlying (‘physical’) asset such as a bond or share. investments the price of the underlying asset will result in a price change for any related derivatives so it follows that they can be used to manage risks as stated in B. See page 29. 24 Financial institutions whose liabilities are mainly contracts that specify that, in return for the periodic payment of fundsA) money market corporations will make payments if and when a specified event occurs are: to the institution, the institution B) unit trusts C) contractual savings institutions Feedback: Financial institutions that are obliged to make payment(s) if and when a specified event occurs D) financial general insurers and superannuation funds. The contracts between these include life insurance offices,intermediaries institutions and their policyholders require payment of regular premiums or contributions (the policyholder agrees to save) so they are classified as contractual savings institutions, making C the answer. See page 9. 25 Institutions that mainly provide off-balance-sheet advisory or fee-based services while also providing some loans are: finance companies A) B) investment banks and merchant banks Feedback: Depository financial institutions such as commercial banks accept deposits and make loans, earning C) commercial banks a return from the spread between the interest rates on loans and deposits, both of which are on-balance sheet. D) depository financial way. Investment banks and merchant banks focus instead on offFinance companies operate in a similarinstitutions balance-sheet business, such as underwriting and providing advice on valuations and acquisitions, which generates income through fees. In summary, A, C and D are all and B is the answer. See pages 9–11. 26 Financial systems evolve in response to various ‘drivers of change’. These drivers of change have been groupedA) the ageing of the populationis regulatory change. Examples of regulatory change include: into categories, one of which in many countries B) expansion of ATM and EFTPOS networks C) the floating of exchange rates and authorising foreign banks to operate within a country D) Feedback: The Wallis report grouped the factors that drive change in a financial system into four categories: blurring of traditional roles as financial institutions offer a wider range of products changing changing customer needs (answer A), changes in technology (B), changes in regulation and the and services financial landscape (D). The items mentioned in C involve decisions by governments and are therefore examples of regulatory change. See page 38. 27 The matching principle: A) applies to corporations that hold real assets but not to financial institutions B) contends that assets should be funded with an equal amount of liabilities C) contends that short-term assets should be financed with short-term liabilities and longer-term assets should be financed with longer-term sources of funds D) contends that, in Feedback: The matching principle is general, assets should be financed by short-term sources befunds that by using based on the idea that risk and transaction costs can of reduced can be rolled over to provide that match the economic lives of the assets being acquired. For s ources of finance with terms to maturitylonger term finance example, long-term assets should be financed with equity and perhaps long-term debt rather than short-term debt. Clearly C is the only answer that is consistent with the matching principle. See page 15. 28 A financial crisis that affected several Asian countries in the late 1990s began when the value of the Thai baht fellA) excessive after it was floated. Which of the following factors were later identified as being common significantly bank credit encouraged over-investment in assets such as office buildings to the countries affected by this crisis? B) reliance on external borrowing that was not hedged against foreign exchange risk C) significant capital outflows when the confidence of external investors fell D) for International Feedback: The Bank all of the above Settlements identified several weaknesses that were common to the countries that were worst affected by the Asian financial crisis of the late 1990s. These weaknesses included all the items listed in A, B and C making D the answer. See page 40. 1hapter 01no C 0 4070140898 1256361 qu 1 INCORRECT Any asset may be regarded as a package of attributes. Which of the following contains the greatest number of such attributes? A) return, risk, time pattern of cash flows B) yield, liquidity, tax effectiveness, time pattern of cash flows C) return, risk, liquidity, time pattern of cash flows Feedback: Assets can be regarded as having four main characteristics that are important to the owner or to a D) consumption, (or yield), risk, risk, liquidity potential buyer. These are: return return, flexibility, liquidity and the time-pattern of the cash flows (or returns) that the asset is expected to provide. Only C contains all four of these characteristics, making it the correct answer. See page 7. 2 4 2 INCORRECT The typical person is assumed to: A) like return, liquidity and risk B) like return and liquidity but refuse to accept risk C) like return, dislike risk and have no concern about liquidity Feedback: Return and liquidity are both asset characteristics that will generally be preferred by investors who D) like return and liquidity but dislike risk are also assumed to be risk averse. Risk aversion does not mean that a person will refuse to accept risk. It does mean that a person will take on risk only if it is accompanied by compensation, usually in the form of a higher expected return. Only D is consistent with these assumptions. See page 7. 3 4 3 INCORRECT Which of the following is not an important function of an efficient financial system? A) providing a wide range of financial instruments with characteristics that suit the needs of investors B) providing economic and financial information to market participants C) facilitating economic growth by encouraging savings D) allowing companies to produce goods Feedback: When a company provides goods or services and services regardless of the profits and therefore its and that are in high demand, its demand for these goods services s hare price will be higher than otherwise. The higher share price and positive outlook will make it easier for the company to raise more capital and invest to increase its output. Thus the statement in D is not applicable to an efficient financial system, making it the correct answer. See page 8. 4 4 4 INCORRECT Debt may be either secured or unsecured. Which of the following is correct? A) secured debt is debt that can be traded in the capital market B) the promise that secured debt will be repaid is supported by a claim over specified assets Feedback: Secured debt is less risky for risky for the lender than unsecured debt the borrower’s promise to repay C) secured debt is more lenders than unsecured debt because the loan is supported by a claim over certain assets or a guarantee from a third party. This means that if the D) the risks of secured and unsecured have been pledged as security and sell them. Secured borrower defaults the lender can seize the assets thatdebt are essentially the same debt may be marketable but this is not necessarily the case. In summary, A, C and D are incorrect and B is the only correct answer. See page 13. 5 4 5 INCORRECT Financial instruments may be divided into three broad categories: equity, debt and derivatives. There are also hybrid instruments, which may be most accurately described as: in a corporation A) a form of equity that provides limited ownership rights B) financial instruments that entitle the holder to a claim that ranks ahead of shareholders C) financial instruments that entitle the holder to a claim over specified assets Feedback: Most, but not all, financial instruments fit into one of the three categories: debt, equity and derivatives. HybridD) financial instruments that incorporate characteristics of both because equity instruments do not fit neatly into any of these categories debt and they combine the characteristics of two of the underlying categories; typically, some of the characteristics of equity and debt. Accordingly, D is the correct answer. See page 12. 6 4 6 INCORRECT There are many types of debt instrument. Which of the following types of debt may a non-financial corporation use toV A) I, II, III, raise borrowed funds? I debentures II certificates of deposit III promissory notes IV Treasury notes V unsecured notes VI term loans B) III, IV, V, VI Feedback: Debentures, promissory notes and unsecured notes are all marketable debt securities that can be C) I, III, V, VI issued by a non-financial corporation. A corporation can also borrow by obtaining a term loan from a bank or D) I, III, However, a non-financial corporation cannot issue certificates of deposit or Treasury other financial institution.IV, V notes. Certificates of deposit are issued by authorised deposit-taking institutions and Treasury notes are issued by the government. Therefore, A, B and D are all incorrect but C is correct. See page 13. 7 4 7 CORRECT A non-negotiable financial instrument is one where: A) ownership of the instrument cannot legally be transferred B) the terms of the instrument cannot be varied after it has been issued C) Feedback: The term ‘negotiable’ refers to something that can be sold or transferred to another party, which the terms of the instrument can be varied by agreement between the issuer and holder corresponds to the meaning in A. Alternatives B, C and D refer to changes that might be negotiated between two D) the term to maturity of the instrument contracts that are parties. (This flexibility may be present in the context of cannot be extended private agreements between two parties and cannot be transferred to anyone else. In contrast, negotiable (or marketable) instruments have terms that are (i) clearly stated at the time they are issued and (ii) not easily changed at any later time.) See page 13. 8 4 8 CORRECT Which of the following statements about derivatives contracts is correct? A) futures contracts are standardised and traded on an exchange B) forward contracts differ from futures contracts only in that forward contracts are standardised C) an option contract gives the buyer both rights and obligations Feedback: As stated in A, futures contracts are standardised and traded on an organised exchange but the s tatements in B, CD) a currency swap errors. Specifically, forward contracts are not standardised; an option gives and D all contain fixes the interest rate for a loan denominated in a foreign currency the buyer rights but not obligations and a currency swap fixes an exchange rate rather than an interest rate. See page 14. 9 4 9 INCORRECT Which of the following statements is correct? A) secondary markets in financial instruments are irrelevant to the companies that issued those instruments in the primary market B) secondary markets are directly involved in channelling funds from investors to borrowers C) secondary markets do encourage both savings and investment D) Feedback: Funds areprimary andnot secondary markets lead to greater investment by the issuers thefinancial assets raised but new securities are issued in the primary market. However, of existence of s econdary markets in which investors can sell those securities again if their needs change does encourage them to invest through primary markets so C is the correct answer. See page 16. 10 4 10 INCORRECT Secondary market transactions in shares: A) involve additional shares being issued by companies B) allow companies to borrow more heavily Feedback: A secondary market transaction is one where securities are bought and sold after their original C) only involve transfers of ownership between existing shareholders issuance in the primary market. The proceeds of a secondary market transaction go to the investor who sells the securities, not D) involve changes in security. Thus, A and B shares to the issuer of the the ownership of existing are incorrect. C is inaccurate through inclusion of the word ‘only’ (there is also a transfer of funds) and because the buyer need not be an ‘existing shareholder’. D is correct. See page 16. 11 4 11 INCORRECT The flow of funds in the primary market may be direct or indirect. Which of the following is correct? A) direct finance is provided by financial institutions such as banks B) direct finance is provided by brokers and dealers C) indirect finance is provided by brokers and dealers D) brokers by financial intermediaries such provision flows indirectly Feedback: Finance providedacting as agents often facilitate the as banksof direct finance from savers to borrowers s o A and C are both incorrect. Direct finance is provided by savers not by brokers and dealers, but brokers are often involved in these transactions as agents so D is the correct answer. See page 17. 12 4 12 CORRECT Intermediated finance differs fundamentally from direct finance in that: A) in contrast to a broker who may arrange direct finance, the intermediary acts as a principal and is exposed to default risk Feedback: A crucial difference between directbroker who brings together savers and borrowers B) the intermediary acts as a and intermediated finance relates to the obligations of the parties. For example, direct finance may involve ais generally less costly than direct finance bringing the parties together C) intermediated finance broker who plays an important role in but the broker never has ownership of any securities that are issued. In contrast, a financial intermediary is an D) bank, that accepts deposits and makes loans. Importantly, the institution, such as adirect lenders are exposed to default risk but intermediaries are not deposits are a liability of the bank and must be repaid even if some borrowers fail to repay their loans. In summary, A is accurate while B, C and D are not, so A is the correct answer. See page 19. 13 4 13 INCORRECT Which of the following statements about the disadvantages of direct financing is not correct? A) direct financing can involve difficulties in matching the preferences of the suppliers and users of funds B) not all of the financial instruments issued by users of funds have an active secondary market C) the transaction costs associated with a direct issue of securities are usually insignificant D) investors may find it difficult to assess the default risk of securities issued directly by a borrower Feedback: An issue of securities can involve costs that are quite significant, such as the costs of preparing a prospectus, so the statement in C is wrong, making it the correct answer. See page 19. 14 4 14 INCORRECT Feedback: There are many benefits ofintermediation include combining funds from many small deposits to The benefits of financial financial intermediation. Which of the following are valid benefits? I asset transformation II transformation’) and using short-term deposits to provide long-term V credit risk provide large loans (‘assetincreased market profile III maturity transformation IV liability managementloans (‘maturity A) I, II, V, VI diversification VI lower scale costs for lenders and borrowers transformation’). Because of V search of their operations, financial intermediaries are able to diversify credit B) I, III, IV, the risk more effectively than most individual investors and the ready availability of deposits with, and loans from, C) I, III, IV, VI intermediaries should result in lower search costs for lenders and borrowers. In summary, I, III, V and VI are D) I, III, V, VI benefits of financial intermediation relative to direct finance. Direct borrowing may increase a company’s market profile and the need for liability management increases the cost of intermediation, so II and IV are not benefits of intermediation. See page 20. 15 4 15 CORRECT The domestic economy can be divided into four sectors: business corporations, financial corporations, government and household sectors. The flow of funds between sectors varies but some generalisations are A) possible. In general, which of the following is correct? the business sector is usually a deficit sector and the household sector is a surplus sector B) the business and household sectors are usually deficit sectors Feedback: The businessfinancialusually has a deficit each year as funds are raised to finance investment in C) the sector corporations and government sectors are usually surplus sectors additional assets and the household sector usually has a surplus. The financial corporations sector is often D) tends to have a small deficit sectors are usually deficit sectors close to balanced or the household and government whilethe government sector may have either a surplus or a deficit depending largely on the commonwealth government’s budgetary position. Consequently, A is correct but B, C and D are all incorrect. See page 31. 16 4 16 INCORRECT Wholesale market transactions are most accurately described as: A) transactions where non-bank institutions deposit surplus funds with banks B) direct transactions between institutional investors and borrowers C) direct transactions between large corporations and merchant banks Feedback: The classification of financial transactions as either ‘wholesale’ or ‘retail’ is based mainly on the size D) (value) of the transaction. Transactions in the wholesale market are large and generally involve financial transactions of more than $1 million government corporations and financial intermediaries institutions dealing directly with large corporations or between largeauthorities. The transactions referred to in A, C and D are examples of wholesale transactions but such transactions are not limited to the types of institutions mentioned. The description in B is more general, making it the correct answer. See page 22. 17 4 17 INCORRECT A company that issues promissory notes is: A) raising funds in the commercial paper market B) issuing discount securities C) usually raising funds on an unsecured basis D) all of the above Feedback: Promissory notes are short-term, money market securities, which differ from bills in that they are unsecured. See page 26. 18 4 18 INCORRECT Bills of exchange are discount securities. An important feature of discount securities is: A) the term to maturity is long B) the issue price is usually greater than face value C) the holder receives regular interest payments from the issuer D) holders obtain their return on Feedback: Discount securities are issued at lessinvestment value and redeemed at face value. Thus,pay for the than face from the difference between the price they they do not security and the the at which it is sold involve interest payments and, whileprice term to maturity is often short, there are also longer term zero-coupon bonds with the same cash flow pattern. Therefore, A, B and C are all incorrect and D is the correct answer. See page 26. 19 4 19 INCORRECT XYZ Enterprises Limited needs to raise additional funding to expand its manufacturing operations. Management decidesmarket $10 million in corporate bonds over the next three months. These securities A) wholesale to issue will be issued in the: market B) secondary Feedback: A new issue is a primary rather than secondary market transaction and since bonds are long-term C) money market s ecurities they are traded in the capital market rather than the money market. An issue of $10 million in one D) capital market parcel would be regarded as a ‘wholesale’ transaction but the information provided leaves open the possibility that the bonds will be issued in smaller, ‘retail’ parcels. In summary, B, C and A are all incorrect, but D is correct. See page 26. 20 4 20 INCORRECT The essential characteristic of equity is: A) ordinary shares are issued only by public companies B) equity provides both short- and long-term funding C) the equity investor obtains an ownership interest Feedback: The most common form of equity is the ordinary share, which provides holders with an ownership D) equity finance can be raised only by companies are shares by private and exchange interest in the issuing company, so C is correct. Ordinary shares with issued listed on a stockunlisted companies as well as listed public companies, so A and D are both incorrect. Shares have no maturity date so B is also incorrect. See page 27. 21 4 21 INCORRECT Banks and other financial intermediaries typically use standardised documentation for their contracts, including deposits and loans. Which of the following benefits of financial intermediation applies in this case? A) asset transformation B) economies of scale C) liquidity transformation Feedback: Standardisation lowers costs in financial intermediation because once a contract has been drawn up the same contract D) credituseddiversification can be risk for many transactions. Therefore, the fixed costs of preparing the contract are s pread over many ‘units of output’, lowering the cost per unit which is the concept known as economies of s cale. See page 22. 22 4 22 INCORRECT Users of the foreign exchange market may be concerned about foreign exchange risk. This risk is: A) the risk that interest rates in overseas markets may change B) the risk that the exchange rate between currencies may alter C) the risk that an overseas borrower may default D) the risk that particular foreign currency may not be available when it is required Feedback: Currencies are tradedain the foreign exchange market and an exchange rate is the price of one currency in terms of another. Accordingly, foreign exchange risk arises from changes in exchange rates, so B is the correct answer. See page 29. 23 4 23 INCORRECT In the context of the capital market, the derivatives market is important because: A) derivatives allow borrowers to raise long-term funds B) derivatives allow the risks associated with capital market transactions to be managed C) securities with options attached to them are attractive to investors Feedback: Derivatives are financial instruments whose value is linked to (derived from) the value of some D) derivatives are very secure low-risk A change in underlying (‘physical’) asset such as a bond or share. investments the price of the underlying asset will result in a price change for any related derivatives so it follows that they can be used to manage risks as stated in B. See page 29. 24 4 24 INCORRECT Financial institutions whose liabilities are mainly contracts that specify that, in return for the periodic payment of fundsA) money market corporations will make payments if and when a specified event occurs are: to the institution, the institution B) unit trusts Feedback: Financial institutions that are obliged to make payment(s) if and when a specified event occurs C) contractual savings institutions include life insurance offices, general insurers and superannuation funds. The contracts between these D) policyholders require institutions and theirfinancial intermediaries payment of regular premiums or contributions (the policyholder agrees to save) so they are classified as contractual savings institutions, making C the correct answer. See page 9. 25 4 25 INCORRECT Institutions that mainly provide off-balance-sheet advisory or fee-based services while also providing some loans are: finance companies A) Feedback: Depository financial banks and merchant banks B) investment institutions such as commercial banks accept deposits and make loans, earning a return from the spread between the interest rates on loans and deposits, both of which are on-balance sheet. C) commercial banks Finance companies operate in a similar way. Investment banks and merchant banks focus instead on offD) depository financial institutions balance-sheet business, such as underwriting and providing advice on valuations and acquisitions, which generates income through fees. In summary, A, C and D are all incorrect and B is the correct answer. See pages 9–11. 26 4 26 INCORRECT Financial systems evolve in response to various ‘drivers of change’. These drivers of change have been groupedA) the ageing of the populationis regulatory change. Examples of regulatory change include: into categories, one of which in many countries B) expansion of ATM and EFTPOS networks C) the floating of exchange rates and authorising foreign banks to operate within a country D) Feedback: The Wallis report grouped the factors that drive change in a financial system into four categories: blurring of traditional roles as financial institutions offer a wider range of products changing changing customer needs (answer A), changes in technology (B), changes in regulation and the and services financial landscape (D). The items mentioned in C involve decisions by governments and are therefore examples of regulatory change. See page 38. 27 4 27 INCORRECT The matching principle: A) applies to corporations that hold real assets but not to financial institutions B) contends that assets should be funded with an equal amount of liabilities C) contends that short-term assets should be financed with short-term liabilities and longer-term assets should be financed with longer-term sources of funds D) contends that, in Feedback: The matching principle is general, assets should be financed by short-term sources befunds that by using based on the idea that risk and transaction costs can of reduced can be rolled over to provide that match the economic lives of the assets being acquired. For s ources of finance with terms to maturitylonger term finance example, long-term assets should be financed with equity and perhaps long-term debt rather than short-term debt. Clearly C is the only answer that is consistent with the matching principle. See page 15. 28 4 28 INCORRECT A financial crisis that affected several Asian countries in the late 1990s began when the value of the Thai baht fellA) excessive after it was floated. Which of the following factors were later identified as being common significantly bank credit encouraged over-investment in assets such as office buildings to the countries affected by this crisis? that was not hedged against foreign exchange risk B) reliance on external borrowing C) significant capital outflows when the confidence of external investors fell D) for International Feedback: The Bank all of the above Settlements identified several weaknesses that were common to the countries that were worst affected by the Asian financial crisis of the late 1990s. These weaknesses included all the items listed in A, B and C making D the correct answer. See page 40. no Results epor < 1table ¶style= 4256361R ...
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This note was uploaded on 03/26/2012 for the course FIN 1612 at University of New South Wales.

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