Chapter 14

Understanding Financial Contracts

D1Factual
1. The Federal Reserve considers any business with less than __________________ employees to be small. A) 10 ) 100 !) "00 #) 1"00 Answer$ !

D1Factual
%. The te&tboo' de(ines any business with less than __________________ in assets to be small. A) )100*000*000 ) )10*000*000 !) )1*000*000 #) )"00*000 Answer$

D1Factual
+. The ma,ority o( small businesses A) are privately owned. ) are mana-ed by pro(essional mana-ers. !) raise (unds in (inancial mar'ets. #) are sel(.(inancin-. Answer$ A

D1Interpretive
/. A ris'y small business stands the best chance o( (indin- e&ternal (inancin- (rom A) a commercial (inance company. ) a commercial ban'. !) an investment ban'. #) trade credit. Answer$ A

162

163Ritter01ilber02dell Money, Banking, and Financial Markets * 3leventh 3dition

D1Factual
". Financin- accounts receivable and inventory is 'nown as A) capital (inancin-. ) wor'in- capital (inancin-. !) lon-.term (inancin-. #) e4uity (inancin-. Answer$

D2Interpretive
5. Firms with a continuous need (or wor'in- capital (inancin- will probably want to have __________________ with a ban'. A) trade credit ) individually ne-otiated loans !) repurchase a-reements #) a line o( credit Answer$ #

D1Factual
6. A (irm that can borrow (rom a ban' any amount it wishes up to a certain limit* and at any time up to a certain date* is said to have a A) repurchase a-reement. ) trade credit. !) a line o( credit. #) internal (inancin-. Answer$ !

D2Interpretive
7. The steps in the process o( commercial ban' lendin- in order are A) borrower ban' search* credit analysis* borrower.ban' ne-otiation* and ban' (undin-. ) borrower ban' search* borrower.ban' ne-otiation* credit analysis* and ban' (undin-. !) credit analysis* borrower ban' search* borrower.ban' ne-otiation* and ban' (undin-. #) borrower.ban' ne-otiation* borrower ban' search* credit analysis* and ban' (undin-. Answer$ A

D1Factual
8. A small (irm9s __________________ usually has the tas' o( -ettin- to 'now the loan o((icers o( local ban's. A) accountant ) owner !) production mana-er #) ta& attorney Answer$ A

!hapter 1/2nderstandin- Financial !ontract s 164

D1Factual
10. an'ers have an advanta-e in developin- a relationship with their business borrowers because A) ban's provide a menu o( services which allows them to learn about a company. ) ban's have access to hi-her 4uality credit reports. !) ban's are better at -ettin- owners to pled-e collateral than are other lenders. #) loans to small businesses are usually less than " years thus allowin- encoura-in- borrowers to return more (re4uently (or evaluation. Answer$ A

D1Factual
11. Are ban' lines o( credit to small (irms collaterali:ed; A) All o( them are ) 1ome o( them are* especially i( the (irm is ris'y !) 1ome o( them are* especially i( the (irm is sa(e #) <one o( them are Answer$

D2Factual
1%. An unsecured loan is one A) with no stated collateral. ) that is pendin- approval by a ban' loan committee. !) which has collateral. #) in which the borrower is delin4uent in loan payments but has not (ormally de(aulted on. Answer$ A

D2Factual
1+. A secured loan is one A) with no stated collateral. ) that is pendin- approval by a ban' loan committee. !) which has collateral. #) in which the borrower is delin4uent in loan payments but has not (ormally de(aulted on. Answer$ !

D2Interpretive
1/. The distinction between a secured lender and an unsecured lender is that in the event o( the ban'ruptcy o( the borrower A) the unsecured lender has (irst claim on collateral. ) the secured lender has (irst claim on collateral. !) the secured lender has a (irst claim on all o( the assets o( the ban'rupt borrower. #) the unsecured lender has a (irst claim on all o( the assets o( the ban'rupt borrower. Answer$

165Ritter01ilber02dell Money, Banking, and Financial Markets * 3leventh 3dition

D2Factual
1". =t is __________________ in the 2nited 1tates (or a ban' to re4uire a business owner to put up some o( his personal assets as __________________ collateral (or a loan to his business. A) le-al> inside ) le-al> outside !) ille-al> inside #) ille-al> outside Answer$

D1Factual
15. A -uaranteed business loan is one A) made under a line o( credit. ) bac'ed up by outside collateral. !) bac'ed up by inside collateral. #) the business owner is personally liable (or repayin-. Answer$ #

D1Interpretive
16. A clause in a loan contract disallowin- the borrower (rom ac4uirin- other companies durin- the term o( the loan is an e&ample o( a A) -uarantee. ) collateral a-reement. !) restrictive covenant. #) moral ha:ard. Answer$ !

D2Factual
17. ecause audited (inancial statements are __________________ to prepare* restrictive covenants rarely appear in loan contracts to companies with __________________ than )1 million in assets. A) ine&pensive> more ) ine&pensive> less !) e&pensive> more #) e&pensive> less Answer$ #

D2Interpretive
18. A __________________ may a-ree to waive a restrictive covenant* especially i( doin- so appears to ma'e the loan __________________. A) borrower> no ris'ier ) borrower> ris'ier !) lender> no ris'ier #) lender> ris'ier Answer$ !

!hapter 1/2nderstandin- Financial !ontract s 166

D2Factual
%0. ?id.si:e (irms may issue publicly.traded __________________ and they usually turn to commercial ban's (or __________________.term debt (inancin-. A) bonds> lon) bonds> short !) e4uity> lon#) e4uity> short Answer$ #

D1Factual
%1. A mid.si:e (irm may have a __________________ line o( credit* meanin- all or part o( it can be converted into an intermediate.term loan. A) revolvin) secured !) -uaranteed #) me::anine Answer$ A

D2Factual
%%. @on-.term debt (inancin- to midsi:e companies at the smaller end o( the midsi:e ran-e is provided by A) commercial ban's. ) individual investors. !) mutual (unds. #) me::anine debt (unds. Answer$ #

D1Factual
%+. Arivate placements avoid A) restrictive a-reements. ) 13! re-istration costs. !) the need (or collateral. #) the primary mar'et. Answer$

D1Factual
%/. Arivate placements avoid A) restrictive a-reements. ) public disclosure o( (inancial in(ormation that is re4uired o( securities that are re-istered with the 13!. !) the need (or collateral. #) the primary mar'et. Answer$

167Ritter01ilber02dell Money, Banking, and Financial Markets * 3leventh 3dition

D1Factual
%". =n the private placement mar'et the term due dili-ence means A) an investor (indin- an honest a-ent (rom whom to buy a bond. ) a borrower (indin- an honest a-ent to sell its bonds. !) conductin- a credit analysis o( the borrower. #) an a-ent tailorin- terms o( the placement to meet investor needs. Answer$ !

D1Factual
%5. Arivate placements are a particularly important type o( (inancin- (or __________________ (irms. A) very small ) small !) mid.si:e #) lar-e Answer$ !

D1Factual
%6. !ommercial ban's A) buy private placements (or their own port(olio o( assets. ) help (irms sell private placements. !) sell their own private placements. #) have nothin- to do with private placements. Answer$

D1Factual
%7. =nsurance companies A) are the ma,or buyers o( private placements (or their own port(olio o( assets. ) help (irms sell private placements. !) sell their own private placements. #) have nothin- to do with private placements. Answer$ A

D1Factual
%8. The te&tboo' de(ines a lar-e business as havin- assets in e&cess o( A) )"0 million. ) )1"0 million. !) )"00 million. #) )1 billion. Answer$

!hapter 1/2nderstandin- Financial !ontract s 168

D2Interpretive
+0. Bnly lar-e (irms are able to sell __________________ securities* with __________________ yields than the securities the small and mid.si:e (irms can sell. A) li4uid> lower ) li4uid> hi-her !) illi4uid> lower #) illi4uid> hi-her Answer$ A

D1Interpretive
+1. ?inimi:in- per.dollar distribution costs (avors issuin- bonds __________________ (or issue si:es above appro&imately __________________. A) privately> )10*000*000 ) privately> )100*000*000 !) publicly> )10*000*000 #) publicly> )100*000*000 Answer$ #

D1Factual
+%. A re-istration statement is drawn up in the process o( A) preparin- a private placement. ) re4uestin- the waivin- o( a restrictive covenant. !) underwritin- publicly.sold securities. #) listin- the collateral on a loan. Answer$ !

D1Interpretive
++. #o underwriters normally run any 'ind o( ris'; A) They ris' bein- unable to sell the bonds they underwrite ) They ris' receivin- a lower price than the commitment price to the bond issuer !) They ris' de(ault on the bonds #) <o* their operations are -enerally ris'.(ree Answer$

D1Factual
+/. Chat is the underwritin- spread; A) The avera-e percenta-e o( the total bond issue handled by a member o( an underwritinsyndicate ) The di((erence between the price the underwriters receive and the price they pay the borrower !) The len-th o( time the underwriter a-rees to withhold the bonds (rom the primary mar'et #) The number o( (inancial institutions in the underwritin- syndicate Answer$

169Ritter01ilber02dell Money, Banking, and Financial Markets * 3leventh 3dition

D1Factual
+". 2nli'e private placements* publicly.sold securities lac' A) any 'ind o( statement o( the (inancial condition o( the borrower. ) a secondary mar'et. !) a de(inite maturity date. #) restrictive covenants. Answer$ #

D1Factual
+5. 2nder __________________ a borrower -ets advance approval (rom the 13! to issue securities up to a certain amount at an unspeci(ied time in the (uture. A) advance re-istration ) pre.re-istration !) -uaranteed re-istration #) shel( re-istration Answer$ #

D2Factual
+6. An important di((erence between o((erin- prospectus in a public bond issue and the o((erinmemorandum in a private placement is A) all relevant (actual in(ormation about the (irm and its (inancin- is re4uired in the prospectus but not in the o((erin- memorandum. ) evidence o( due dili-ence is re4uired in the o((erin- memorandum but not in the prospectus. !) the prospectus may not contain any pro,ections about the company9s (uture while an o((erinmemorandum has no such restriction. #) There are no di((erences between these two documents. Answer$ !

D1Interpretive
+7. @ar-e companies with -ood credit ratin-s tend to rely on __________________ (or short.term (inancin-. A) the commercial paper mar'et ) private placements !) (inance companies #) e4uity Answer$ A

D1Factual
+8. !ommercial paper has a minimum maturity o( A) one day. ) seven days. !) +0 days. #) %60 days. Answer$ A

!hapter 1/2nderstandin- Financial !ontract s 170

D1Factual
/0. !ommercial paper has a ma&imum maturity o( A) one day. ) seven days. !) +0 days. #) %60 days. Answer$ #

D3Interpretive
/1. The e&istence o( a bou-ht deal in public o((erin-s o( bonds came about as a result o( A) shel( re-istration. ) a narrow underwritin- spread. !) the need o( investment ban's to (orm syndicates be(ore underwritin- an issue. #) the need by underwriters to avoid as much ris' as possible. Answer$ A

D1Factual
/%. ?edium term notes have a maturity ran-in- up to A) one year. ) two years. !) (ive years. #) ten years. Answer$ !

D2Interpretive
/+. 2nderwritin- spreads on e4uity issues are much __________________ than on debt issues because stoc' prices are so __________________ relative to bond prices. A) smaller> steady ) smaller> volatile !) lar-er> steady #) lar-er> volatile Answer$ #

D1Factual
//. ?oral ha:ard is* in -eneral* the asymmetric in(ormation problem that occurs A) a(ter a transaction is consummated. ) due to a si:e di((erence in the parties to a transaction. !) with e4uity (inancin-. #) be(ore a transaction is consummated. Answer$ A

D1Factual
/". Adverse selection is* in -eneral* the asymmetric in(ormation problem that occurs A) a(ter a transaction is consummated. ) due to a si:e di((erence in the parties to a transaction. !) with e4uity (inancin-. #) be(ore a transaction is consummated. Answer$

171Ritter01ilber02dell Money, Banking, and Financial Markets * 3leventh 3dition

D2Interpretive
/5. A ban' that maintains low <1F (ees mi-ht also have relatively __________________ loan rates* both parts o( a strate-y to attract __________________.than.avera-e borrowers. A) low> sa(er ) low> ris'ier !) hi-h> sa(er #) hi-h> ris'ier Answer$ #

D2Interpretive
/6. A ban' that maintains hi-h <1F (ees mi-ht also have relatively __________________ loan rates* both part o( a strate-y to attract __________________.than.avera-e borrowers. A) low> sa(er ) low> ris'ier !) hi-h> sa(er #) hi-h> ris'ier Answer$ A

D2Interpretive
/7. Asymmetric in(ormation is a particular problem (or __________________ (irms or (irms with __________________ relationship with a particular lendin- institution. A) small> a lon-standin) small> only a recent !) lar-e> a lon-standin#) lar-e> only a recent Answer$

D1Interpretive
/8. The puttin- up o( outside collateral is A) one (orm o( the moral ha:ard problem. ) one (orm o( the adverse selection problem. !) a si-nal o( a hi-h.4uality borrower. #) a si-nal o( a low.4uality borrower. Answer$ !

D2Interpretive
"0. A borrowerDs willin-ness to si-n a personal -uarantee is A) one (orm o( the moral ha:ard problem. ) one (orm o( the adverse selection problem. !) a si-nal o( a hi-h.4uality borrower. #) a si-nal o( a low.4uality borrower. Answer$ !

!hapter 1/2nderstandin- Financial !ontract s 172

D2Factual
"1. The possibility that a borrower will brea' a promise made to the lender a(ter the loan is made is one (orm o( A) the moral ha:ard problem. ) the adverse selection problem. !) outside collateral. #) inside collateral. Answer$ A

D2Interpretive
"%. ?oral ha:ard can be a problem in lendin- since lenders share __________________ in the __________________ ris'. A) proportionately> upside ) proportionately> downside !) disproportionately> upside #) disproportionately> downside Answer$ #

D2Interpretive
"+. A lar-e business (inds it __________________ than a small business to pursue secretly a hi-h. ris' investment in violation o( the terms o( its loan a-reement* and so the lar-e business is __________________ beset by the moral ha:ard problem. A) more di((icult> more ) more di((icult> less !) easier> more #) easier> less Answer$

D2Interpretive
"/. @iens __________________ the moral ha:ard problem since the borrower is then __________________ to sell the a((ected assets at its discretion. A) worsen> able ) worsen> unable !) ease> able #) ease> unable Answer$ #

D1Factual
"". Chich o( the (ollowin- is <BT a practice that prevents ris'.shi(tin- by a borrower; A) @imited.liability ownership ) Alacin- liens on collateral !) Aersonal -uarantees #) Restrictive covenants Answer$ A

173Ritter01ilber02dell Money, Banking, and Financial Markets * 3leventh 3dition

D2Interpretive
"5. The various si-nalin- techni4ues __________________ completely overcome the moral ha:ard problem in the case o( the small borrower* so that small business loans are -enerally __________________.term. A) can> lon) can> short !) cannot> lon#) cannot> short Answer$ #

D1Interpretive
"6. Chich type o( (inancin- re4uires the lar-est minimum si:e o( the borrower; A) ?e::anine (unds ) Aublic debt !) Eenture capital (unds #) Aublic e4uity Answer$

D1Factual
"7. Chich o( these (orms o( (inancin- re4uires the smallest minimum si:e o( the borrower; A) 1hort.term commercial ban' loans ) !ommercial paper !) ?e::anine (unds #) Eenture capital (unds Answer$ A

D1Interpretive
"8. Chich o( these (orms o( (inancin- is -enerally not employed by very lar-e (irms; A) !ommercial paper ) ?edium.term notes !) Aublic debt #) ?e::anine (unds Answer$ #

D2Applied
50. Chen you -et a car loan* the lendin- institution usually sends a chec' directly to the car dealer. 1uch a practice A) helps (orestall moral ha:ard. ) helps (orestall adverse selection. !) -ives rise to moral ha:ard. #) -ives rise to adverse selection. Answer$ A

!hapter 1/2nderstandin- Financial !ontract s 174

D2Interpretive
51. =n consumer lendin-* asymmetric in(ormation A) is not a problem that comes up. ) cannot be dealt with usin- the same techni4ues as in business lendin-. !) can be partly o((set usin- the same techni4ues as in business lendin-. #) may be virtually eliminated as a problem by ,ust a collateral re4uirement. Answer$ #

D2Factual
5%. ecause consumer loans are rather __________________* they have been relatively __________________ to securiti:e. A) standardi:ed> easy ) standardi:ed> di((icult !) not standardi:ed> easy #) not standardi:ed> di((icult Answer$ A

D2Factual
5+. ecause loans to small and midsi:ed businesses are rather __________________* they have been relatively __________________ to securiti:e. A) standardi:ed> easy ) standardi:ed> di((icult !) not standardi:ed> easy #) not standardi:ed> di((icult Answer$ #