Finance Chapter on Transaction Costs and Asymmetric Info
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Questions and Answers

Which of the following is NOT a type of security?

  • Debt Securities
  • Equity Securities
  • Real Estate Securities (correct)
  • Derivative Securities

    • Stocks provide a fixed return through interest payments.

    False

    What is the primary purpose of trading securities in financial markets?

    To address a need or desire, such as saving for retirement.

    Bonds represent a claim on _______ future income or assets.

    <p>debt</p> Signup and view all the answers

    Match the types of securities with their characteristics:

    <p>Equity Securities = Share of ownership Debt Securities = Fixed maturity Derivative Securities = Contractual agreement based on an asset Currencies = Medium of exchange</p> Signup and view all the answers

    Which market is referred to when trading currencies like the US Dollar or Euro?

    <p>Foreign Exchange Market (Forex)</p> Signup and view all the answers

    Financial markets have no impact on personal wealth.

    <p>False</p> Signup and view all the answers

    Securities can be broadly categorized into four types: Equity Securities, Debt Securities, Derivative Securities, and _______.

    <p>Currencies</p> Signup and view all the answers

    What is one way financial intermediaries reduce transaction costs?

    <p>By offering liquidity services</p> Signup and view all the answers

    Financial intermediaries eliminate the risk associated with transactions.

    <p>False</p> Signup and view all the answers

    What is adverse selection in the context of financial transactions?

    <p>A situation where potential borrowers likely to produce a bad outcome are the ones seeking loans.</p> Signup and view all the answers

    After a transaction is established, the borrower may engage in _____ activities due to moral hazard.

    <p>undesirable</p> Signup and view all the answers

    Match the terms with their definitions:

    <p>Adverse Selection = Risk of loss when potential borrowers are likely to be high-risk Moral Hazard = Risk of a borrower taking risky actions after receiving a loan Liquidity Services = Services that enable easy conversion of deposits into goods Risk Sharing = Process where financial intermediaries spread risk among parties</p> Signup and view all the answers

    Which problem is associated with the situation where unhealthy individuals seek insurance for pre-existing conditions?

    <p>Adverse Selection</p> Signup and view all the answers

    Risk sharing allows investors to handle greater risks by acquiring riskier assets.

    <p>True</p> Signup and view all the answers

    How do financial intermediaries provide liquidity to customers?

    <p>By offering checking and savings accounts that allow easy access to funds.</p> Signup and view all the answers

    What is the primary purpose of an initial public offering (IPO)?

    <p>To raise funds for the company</p> Signup and view all the answers

    Equity securities represent a loan made to a company.

    <p>False</p> Signup and view all the answers

    What are the two main types of equity securities?

    <p>Common stocks and preferred stocks</p> Signup and view all the answers

    The distinction between primary and secondary markets is valid for all __________.

    <p>securities</p> Signup and view all the answers

    Which of the following best describes asset transformation?

    <p>Changing risky assets into safer assets for investors</p> Signup and view all the answers

    Stockholders receive dividends regardless of a company’s earnings.

    <p>False</p> Signup and view all the answers

    Match the following types of markets with their correct descriptions:

    <p>Primary market = Market for new stock issues Secondary market = Market for trading previously issued stocks Centralized exchanges = Organized markets for trading securities OTC = Broker-dealer networks for trading securities</p> Signup and view all the answers

    What factors primarily determine the price of a stock in the secondary market?

    <p>Supply and demand</p> Signup and view all the answers

    Study Notes

    Types of Securities

    • Stocks do not provide a fixed return through interest payments.
    • Bonds represent a claim on future income or assets.
    • Securities can be broadly categorized into four types: Equity Securities, Debt Securities, Derivative Securities, and Money Market Instruments.

    Financial Markets

    • The primary purpose of trading securities in financial markets is to facilitate the flow of funds from savers to borrowers.
    • The foreign exchange market is referred to when trading currencies.
    • Financial markets significantly impact personal wealth by providing avenues for investment and wealth creation.
    • Financial intermediaries reduce transaction costs by providing a platform for buyers and sellers to meet.
    • Financial intermediaries do not eliminate risk associated with transactions.

    Financial Intermediaries

    • Adverse selection in the context of financial transactions occurs when one party in a transaction has more information than the other, leading to an imbalance in the deal.
    • After a transaction is established, the borrower may engage in riskier activities due to moral hazard.

    Risks and Problems in Markets

    • Adverse selection is a problem associated with the situation where unhealthy individuals seek insurance for pre-existing conditions.
    • Risk sharing allows investors to handle greater risks by acquiring riskier assets.

    Liquidity and Intermediation

    • Financial intermediaries provide liquidity to customers by buying and selling assets, connecting buyers and sellers, and facilitating transactions.
    • The primary purpose of an initial public offering (IPO) is to raise capital for a company by selling shares to the public.

    Equity Securities

    • Equity securities represent ownership in a company, not a loan.
    • The two main types of equity securities are common stock and preferred stock.

    Primary and Secondary Markets

    • The distinction between primary and secondary markets is valid for all securities.
    • Asset transformation is the process of converting assets into different forms, for example, by a bank taking deposits and using them to make loans.

    Stock Prices and Markets

    • Supply and demand, company profitability, and investor expectations primarily determine the price of a stock in the secondary market.
    • Stockholders do not receive dividends regardless of a company’s earnings.

    Market Types

    • Money markets trade short-term debt instruments with maturities of less than a year.
    • Capital markets trade long-term debt instruments and equity securities.
    • Primary markets are where new securities are issued and sold for the first time.
    • Secondary markets are where existing securities are bought and sold.

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    Description

    This quiz covers key concepts in finance related to reducing transaction costs and the implications of asymmetric information in transactions. Explore important topics like financial intermediaries, adverse selection, and moral hazard as you test your understanding of these core principles. Understand how these elements impact the financial landscape and decision-making processes.

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