MULTIPLE CHOICE.  Choose the one alternative that best completes the statement or answers the question. 
1) 

Financial enterprises, more popularly referred to as financial institutions, provide a variety of services. Which of the below is NOT one of these? 

1) 

_______ 
A) 

Assist in the creation of financial assets for their customers, and then sell those financial assets to other market participants.  
B) 

Transform financial assets acquired through the market and constituting them into a different, and more widely preferable, type of asset–which becomes their liability.  
C) 

Exchange financial assets on behalf of customers but not for their own accounts. 
D) 

Manage the portfolios of other market participants. 
 
2) 

Financial intermediaries include ________ that acquire the bulk of their funds by offering their liabilities to the public mostly in the form of deposits; insurance companies, pension funds, and finance companies. 

2) 

_______ 
A) 

depository institutions 

B) 

initial public offerings 
C) 

utilities 

D) 

preferred equity instrument. 
 
3) 

Some nonfinancial enterprises have subsidiaries that provide financial services. These financial institutions are called ________. 

3) 

_______ 
A) 

captive investment companies. 
B) 

captive finance companies. 
C) 

free finance companies. 
D) 

captive finance shares. 
 
4) 

Depository institutions  include ________. 

4) 

_______ 
A) 

savings and loan associations. 
B) 

commercial banks. 
C) 

savings banks and credit unions. 
D) 

All of these 
 
5) 

Financial intermediaries get funds by issuing financial claims against themselves to market participants, and then investing those funds. The investments made by financial intermediaries can be in ________. 

5) 

_______ 
A) 

loans but not in securities. 

B) 

loans and/or securities. 
C) 

securities but not in loans. 

D) 

only equity. 
 
6) 

Financial intermediaries play the basic role of transforming financial assets that are less desirable for a large part of the public into other financial assets (their own liabilities) which are more widely preferred by the public. This transformation involves at least one of four economic functions. Which of the below is NOT one of these functions? 

6) 

_______ 
A) 

 providing maturity intermediation 
B) 

enhancing risk via diversification 
C) 

providing a payments mechanism 
D) 

reducing the costs of contracting and information processing 
 
7) 

The commercial bank by issuing its own financial claims transforms a longer-term asset into a shorter-term one by giving the borrower a loan for the length of time sought and the investor/depositor a financial asset for the desired investment horizon. This function of a financial intermediary is called ________. 

7) 

_______ 
A) 

diversification. 
B) 

providing payment mechanisms. 
C) 

information processing costs. 
D) 

maturity intermediation. 
 
8) 

The economic function of financial intermediaries that transforms more risky assets into less risky ones is called ________. 

8) 

_______ 
A) 

maturity intermediation. 
B) 

diversification. 
C) 

providing payment mechanisms. 
D) 

information processing costs. 
 
9) 

The costs of writing loan contracts are referred to as ________. 

9) 

_______ 
A) 

loan costs. 

B) 

asset costs. 
C) 

information processing costs. 

D) 

contracting costs. 
 
10) 

Which of the below statements is FALSE? 

10) 

______ 
A) 

Investors purchasing financial assets should take the time to develop skills necessary to understand how to evaluate an investment and then apply these skills to the analysis of specific financial assets that are candidates for purchase (or subsequent sale). 
B) 

In addition to the opportunity cost of the time to process the information about the financial asset and its issuer, there is the cost of acquiring that information. All these costs are called contracting costs. 
C) 

Investors who want to make a loan to a consumer or business will need to write the loan contract (or hire an attorney to do so). Although there are some people who enjoy devoting leisure time to this task, most prefer to use that time for just that–leisure. 
D) 

One dimension to contracting costs involves the cost of enforcing the terms of the loan agreement. 
 
11) 

To understand the reasons managers of financial institutions invest in particular types of financial assets and the types of investment strategies they use, it is necessary to have a general understanding of the ________ that they face. 

11) 

______ 
A) 

asset/liability problem 
B) 

investment/employee problem 
C) 

risk management /dividend problem 
D) 

shot-term/long-term asset problem 
 
12) 

The objective of a ________ is to earn a positive spread between the assets it invests in (what it has sold the money for) and the costs of its funds (what it has purchased the money for). 

12) 

______ 
A) 

corporation 

B) 

life insurance company 
C) 

depository institution 

D) 

limited partnership 
 
13) 

Which of the below statements is FALSE? 

13) 

______ 
A) 

The nature of the liabilities dictates the investment strategy a financial institution will pursue. 
B) 

Pension funds are in the spread business in that they do not raise funds themselves in the market. 
C) 

The objective of a depository institution is to earn a positive spread between the assets it invests in (what it has sold the money for) and the costs of its funds (what it has purchased the money for). 
D) 

Life insurance companies and, to a certain extent, property and casualty insurance companies are in the spread business. 
 
14) 

Which of the below statements is TRUE? 

14) 

______ 
A) 

For Type-II Liabilities, both the amount and the timing of the liabilities are known with certainty 
B) 

When we refer to a cash outlay as being uncertain, we mean that it cannot be predicted. 
C) 

By the liabilities of a financial institution, we mean the amount and timing of the cash outlays that must be made to satisfy the contractual terms of the obligations issued. 
D) 

Type-I Liabilities, the amount of cash outlay is known, but the timing of the cash outlay is uncertain. 
 
15) 

With this type of liability, the timing of the cash outlay is known, but the amount is uncertain. 

15) 

______ 
A) 

Type-I Liabilities 

B) 

Type-II Liabilities 
C) 

Type-IV Liabilities 

D) 

Type-III Liabilities 
 
16) 

________ is a broadly used term to describe several types of risk. 

16) 

______ 
A) 

Counterparty risk 

B) 

Market risk 
C) 

Credit risk 

D) 

Settlement risk 
 
17) 

________ is the risk that a counterparty in a trade fails to satisfy its obligation. 

17) 

______ 
A) 

Settlement risk 

B) 

Liquidity risk 
C) 

Counterparty risk 

D) 

Market risk 
 
18) 

Because of uncertainty about the timing and/or the amount of the cash outlays, a financial institution must be prepared ________. 

18) 

______ 
A) 

to have sufficient risk to satisfy its obligations. 
B) 

to have sufficient projects to satisfy its capital budget constraints. 
C) 

to have sufficient cash to satisfy its obligations. 
D) 

to have sufficient risk to satisfy its conservative investors. 
 
19) 

________ is the risk to a financial institution's economic well-being that results from an adverse movement in the market price of assets it owns. 

19) 

______ 
A) 

Funding liquidity risk 

B) 

Settlement risk 
C) 

Credit risk 

D) 

Market risk 
 
20) 

________ is the risk that the financial institution will be unable to obtain funding to obtain cash flow necessary to satisfy its obligations. 

20) 

______ 
A) 

Market risk 

B) 

Settlement risk 
C) 

Credit risk 

D) 

Funding liquidity risk 
 
21) 

Which of the following statements is FALSE? 

21) 

______ 
A) 

Asset management firms are either affiliated with some financial institution (such as a commercial bank, insurance company, or investment bank) or are independent companies. 
B) 

Asset management firms manage the funds of individuals, businesses, endowments and foundations, and state and local governments. 
C) 

Asset management firms are ranked semi-annually by Pension & Investments with the ranking based on the number of liabilities under management. 
D) 

Larger institutional clients seeking the services of an asset management firm typically do not allocate all of their assets to one asset management firm. 
 
22) 

________ seeking the services of an asset management firm typically do not allocate all of their assets to one asset management firm firm. 

22) 

______ 
A) 

Depository institutions 

B) 

GIC institutions 
C) 

Smaller institutional clients 

D) 

Larger institutional clients 
 
23) 

Asset management firms receive their compensation ________ from management fees charged based on the market value of the assets managed for clients. 

23) 

______ 
A) 

to a minor extent 

B) 

secondarily 
C) 

totally 

D) 

primarily 
 
24) 

Which of the below is NOT one of the types of funds managed by asset management firms? 

24) 

______ 
A) 

Insurance company funds 
B) 

Separately managed accounts for individuals and institutional investors 
C) 

Deregulated investment companies 
D) 

Pension and hedge funds. 
 
25) 

There is no universally accepted definition to describe the 9,000 privately pooled investment entities in the United States called ________ that invest more than $1.3 trillion in assets. 

25) 

______ 
A) 

hedge funds 

B) 

derivative funds 
C) 

asset/liability funds 

D) 

option funds 
 
26) 

The term hedge fund is associated with common characteristics. Which of the below is NOT one of these common characteristics?  

26) 

______ 
A) 

use a wide variety of trading strategies involving position-taking in a range of markets 
B) 

pay performance fees to their managers; and have an investor base comprising modest-income individuals 
C) 

employ an assortment of trading techniques and instruments, often including short-selling, derivatives and leverage 
D) 

organized as private investment partnerships or offshore investment corporations 
 
27) 

There are various ways to categorize the different types of hedge funds. Mark Anson uses the four broad categories. Which of the below is NOT one of these? 

27) 

______ 
A) 

market directional 

B) 

corporate restructuring 
C) 

divergence buying 

D) 

opportunistic 
 
TRUE/FALSE.  Write 'T' if the statement is true and 'F' if the statement is false. 
28) 

Business entities include nonfinancial and financial enterprises. Nonfinancial enterprises manufacture products (e.g., cars, steel, computers) and/or provide nonfinancial services (e.g., transportation, utilities, computer programming). 

28) 

______ 
 
29) 

A financial institution that provides an underwriting service will only on occasion also provide a brokerage and/or dealer service. 

29) 

______ 
 
30) 

Many large manufacturing firms have subsidiaries that provide financing for the parent company's customer. These financial institutions are called captive finance companies. 

30) 

______ 
 
31) 

People who work for financial intermediaries (such as a commercial bank and an investment company) include investment professionals who are trained to analyze financial assets and manage them. 

31) 

______ 
 
32) 

Most transactions made today are done with cash more so than payments mechanisms that use checks, credit cards, debit cards, and electronic transfers of funds. 

32) 

______ 
 
33) 

Many large manufacturing firms have subsidiaries that provide financing for the parent company's customer. These financial institutions are called free investment companies. 

33) 

______ 
 
34) 

In addition to uncertainty about the timing and amount of the cash outlays, and the potential for the depositor or policyholder to withdraw cash early or borrow against a policy, a financial institution has to be concerned with possible reduction in cash inflows. 

34) 

______ 
 
35) 

Very few regulations and tax considerations influence the investment policies that financial institutions pursue. 

35) 

______ 
 
36) 

For Type-IV Liabilities, both the amount and the timing of the liabilities are known with certainty. 

36) 

______ 
 
37) 

In regards to Type-IV Liabilities, there are numerous insurance products and pension obligations that present uncertainty as to both the amount and the timing of the cash outlay. 

37) 

______ 
 
38) 

Funding liquidity risk is the risk that the financial institution will be unable to obtain funding to obtain cash flow necessary to satisfy its obligations. 

38) 

______ 
 
39) 

Liquidity risk is the risk that a counterparty in a trade fails to satisfy its obligation. 

39) 

______ 
 
40) 

An important risk that is often overlooked but has been the cause of the demise of some major financial institutions is value-at risk. 

40) 

______ 
 
41) 

Liquidity risk in the context of settlement risk means that the counterparty can eventually meet its obligation, but not at the due date. 

41) 

______ 
 
42) 

A market directional hedge fund is one in which the asset manager retains some exposure to "systematic risk." 

42) 

______ 
 
43) 

A convergence trading hedge fund is one in which the asset manager positions the portfolio to capitalize on the anticipated impact of a significant corporate event. 

43) 

______ 
 
44) 

Risk-arbitrage hedge funds have the broadest mandate of all of the four hedge fund categories. 

44) 

______ 
 
45) 

Hedge funds use a wide range of trading strategies and techniques in an attempt to earn superior returns. 

45) 

______ 
 
ESSAY.  Write your answer in the space provided or on a separate sheet of paper. 
46) 

Describe three of the services that can be provided by financial enterprises. 
 
47) 

Describe the difference between direct and indirect investments. Cite an example of how an investor in a financial intermediaries makes an indirect investment in an actual entity or company. 
 
48) 

By the liabilities of a financial institution, we mean the amount and timing of the cash outlays that must be made to satisfy the contractual terms of the obligations issued. The liabilities of any financial institution can be categorized according to four types where the categorization assumes that the entity that must be paid the obligation will not cancel the financial institution's obligation prior to any actual or projected payout date. Using a table format, name and describe these four types. 
 
49) 

The Global Association of Risk Professional (GARP) suggests classifying the major categories of operational risk into five categories according to the cause of the loss event. Name and describe two of these categories. 
 
50) 

There is considerable debate on the role of hedge funds in financial markets because of their size and their impact on financial markets that result from their investment strategies. On the positive side, it has been argued that they provide liquidity to the market.Nonetheless, there is a major concern. Identify and discuss this major concern. 
 
51) 

Name three of the five types of funds managed by asset management firms. 

1) 

C 
2) 

A 
3) 

B 
4) 

D 
5) 

B 
6) 

B 
7) 

D 
8) 

B 
9) 

D 
10) 

B 
11) 

A 
12) 

C 
13) 

B 
14) 

C 
15) 

D 
16) 

C 
17) 

C 
18) 

C 
19) 

D 
20) 

D 
21) 

C 
22) 

D 
23) 

D 
24) 

C 
25) 

A 
26) 

B 
27) 

C 
28) 

TRUE 
29) 

FALSE 
30) 

TRUE 
31) 

TRUE 
32) 

FALSE 
33) 

FALSE 
34) 

TRUE 
35) 

FALSE 
36) 

FALSE 
37) 

TRUE 
38) 

TRUE 
39) 

FALSE 
40) 

FALSE 
41) 

TRUE 
42) 

TRUE 
43) 

FALSE 
44) 

FALSE 
45) 

TRUE 
46) 

Financial enterprises, more popularly referred to as financial institutions, provide services related to one or more of the following 1. Transforming financial assets acquired through the market and constituting them into a different, and more widely preferable, type of asset–which becomes their liability. This is the function performed by financial intermediaries, the most important type of financial institution. 2. Exchanging of financial assets on behalf of customers. 3. Exchanging of financial assets for their own accounts. 4. Assisting in the creation of financial assets for their customers, and then selling those financial assets to other market participants. 5. Providing investment advice to other market participants. 6. Managing the portfolios of other market participants. 
47) 

Financial intermediaries obtain funds by issuing financial claims against themselves to market participants, and then investing those funds. The investments made by financial intermediaries–their assets–can be in loans and/or securities. These investments are referred to as direct investments. Market participants who hold the financial claims issued by financial intermediaries are said to have made indirect investments.
As a first example, consider commercial banks that accept deposits and may use the proceeds to lend funds to consumers and businesses. The deposits represent the IOU of the commercial bank and a financial asset owned by the depositor. The loan represents an IOU of the borrowing entity and a financial asset of the commercial bank. The commercial bank has made a direct investment in the borrowing entity; the depositor (or investor) effectively has made an indirect investment in that borrowing entity.
As a second example, consider an investment company, which is a financial intermediary that pools the funds of market participants and uses those funds to buy a portfolio of securities such as stocks and bonds. Investment companies are more commonly referred to as "mutual funds." Investors providing funds to the investment company receive an equity claim that entitles the investor to a pro rata share of the outcome of the portfolio. The equity claim is issued by the investment company. The portfolio of financial assets acquired by the investment company represents a direct investment that it has made. By owning an equity claim against the investment company, those who invest in the investment company have made an indirect investment in stocks and bonds of actual companies. 
48) 

Liability Type	Amount of Cash Outlay		Timing of Cash Outlay
Type I	Known					Known
Type II	Known					Uncertain
Type III	Uncertain					Known
Type IV	Uncertain					Uncertain 
49) 

The Global Association of Risk Professional (GARP) suggests classifying the major categories of operational risk into five categories according to the cause of the loss event. They are 1. Employee loss events resulting from the actions or inactions of a person who works for a firm. 2. Business Process loss events arising from a firm's execution of business operations. 3. Relationships loss events caused by the connection or contact that a firm has with clients, regulators, or third parties. This category focuses on the interaction between a firm and other entities; relationship risks involve both parties. 4. Technology loss events due to piracy, theft, failure, breakdown, or other disruption in technology, data or information; this category also includes technology that fails to meet the intended business needs. 5. External loss events caused by people or entities outside a firm; the firm cannot control their actions." The five categories above apply to nonfinancial entities as well as financial institutions. 
50) 

The major concern is the risk of a severe financial crisis (i.e., systemic risk) due to the activities and investment strategies of hedge funds, most notably the employment of excess leverage. The best-known example is the collapse of Long-Term Capital Management (LTCM) in September 1998. Studies of LTCM indicate that it used leverage of 50. This means that for every $1 million of capital provided by investors, LTCM was able to borrow $50 million. The reason why LTCM was able to borrow such a large amount was because lenders did not understand or ignored the huge risks associated with that hedge fund''s investment strategies. The loss of LTCM because of bad bets is not a concern per se since the investors in that hedge fund were sophisticated investors who took their chances in the hopes of reaping substantial returns. Rather, the problem was that the real losers of that hedge fund's activities were major commercial banks and investment banking firms that loaned funds to LTCM. In the view of the Federal Reserve, there were potential dire consequences from the potential failure of LTCM and it reacted by organizing a rescue plan for that hedge fund. More recently, in June 2007, there was the collapse of the two hedge funds sponsored by the investment banking firm Bear Stearns the High-Grade Structured Credit Strategies Enhanced Leverage Fund and the High-Grade Structured Credit Strategies Fund. This required the sponsor, Bear Stearns, to bail out the hedge fund. As a result of the LTCM failure, the President's Working Group on Financial Markets made several recommendations for improving the functioning of hedge funds in financial markets. The major recommendation was that commercial banks and investment banks that lend to hedge funds improve their credit risk management practices. 
51) 

Types of funds managed by asset management firms include regulated investment companies; insurance company funds; separately managed accounts for individuals and institutional investors; pension funds; and hedge funds.