Chapter 2: Financial Intermediation and Financial Markets

1. Which one of the following defines a Type IV liability ?

Both the timing and amount of liability are known. Both the timing and amount of liability are uncertain. The timing of the liability is known but the amount is uncertain. The timing of the liability is unknown but the amount is uncertain.

2. Which one of the following statement is FALSE?

Preference shares are less risky than common shares. Debt holders have preference over equity holders. Debt claims are inherently less risky than equity claims and therefore require a lower expected rate of return. Equity holders are always entitled to an annual dividend.

3. Which one of the following is an example of a primary market transaction?

A bank sells some of its Treasury bond holdings so that it can make more loans. A fund manager sells of its funds shares to a newly formed mutual fund. The UK government sells some Treasury bonds to help finance this year’s fiscal deficit. A 90 day Treasury bill with 10 days to expiration is sold by the holder at a profit to someone that has never owned Treasury bills before.

4. Which of the following is a correct definition of arbitrage?

The simultaneous sale and purchase of a security at the same price. The taking on of risk in the hope of making a profit. The buying of a security that is likely to rise in price and the sale of another security that is likely to fall in price. Exploiting a pricing anomaly to make riskless guaranteed profits.

5. Which of the following is an example of maturity transformation?

A financial intermediary turning short term deposits into longer term loans. A financial intermediary reducing the risk of longer term loans compared to short term deposits. A financial intermediary enabling short term depositors to withdraw their money on demand. A financial intermediary selling short term Treasury bills and using the proceeds to buy long term Treasury bonds.

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