Study Guide for Chapter 9 - Money and Banking

Definitions:
Adverse Selection
Moral hazard
Principal
Agent
Principal-agent problem
Restrictive covenant
Incentive-compatible
Secured debt
Unsecured debt
Indirect finance
Shirking
Financial intermediation
Horizontal merger
Conglomerate merger
Sinking fund
Double taxation of corporate income

T-F-U, explain
1. Secured debt has a higher interest rate than unsecured debt, ceteris paribus.

Essays
1. Explain the principal-agent problem between
a) shareholders and managers,
b) shareholders and bondholders,
c) banks and firms that borrow money from banks, and
d) mortgage companies and homeowners with mortgages,
e) insurance companies and insured parties,
f) landlords and tenants,
g) real estate agents and homebuyers,
h) real estate agents and homesellers, and
i) lawyers and clients.

2. Explain some of the ways that the principal-agent problem can be minimized or eliminated.

3. Explain the role of hostile takeovers in the economy, using the concepts of principal- agent, shirking, and moral hazard.

4. Explain how deposit insurance for savings & loans led to moral hazard and bank failures.

5. Why is bank financing the largest source of capital for private companies?

6. How do outsourcing and downsizing solve the principal-agent problem?

7. Explain the following puzzles:
a. Debt is many times more significant as a source of external financing for U.S. corporations.
b. Indirect finance is many times more important than direct finance.
c. Unmarketable securities are much more common than marketable securities.

8. How do taxes affect the decision by a firm to use debt or external equity to finance expansion?

9. Explain how institutional investors can monitor the actions of corporations more effectively than individual shareholders.