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Question : 8.4   The Lemons Problem:  How Adverse Selection Influences Financial Structure 1) : 1373699

Economics

 

8.4   The Lemons Problem:  How Adverse Selection Influences Financial Structure

 

1) The “lemons problem” exists because of

A) transactions costs.

B) economies of scale.

C) rational expectations.

D) asymmetric information.

2) Because of the “lemons problem” the price a buyer of a used car pays is

A) equal to the price of a lemon.

B) less than the price of a lemon.

C) equal to the price of a peach.

D) between the price of a lemon and a peach.

 

3) Adverse selection is a problem associated with equity and debt contracts arising from

A) the lender’s relative lack of information about the borrower’s potential returns and risks of his investment activities.

B) the lender’s inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults.

C) the borrower’s lack of incentive to seek a loan for highly risky investments.

D) the lender’s inability to restrict the borrower from changing his behavior once given a loan.

 

4) The ________ problem helps to explain why the private production and sale of information cannot eliminate ________.

A) free-rider; adverse selection

B) free-rider; moral hazard

C) principal-agent; adverse selection

D) principal-agent; moral hazard

 

5) The free-rider problem occurs because

A) people who pay for information use it freely.

B) people who do not pay for information use it.

C) information can never be sold at any price.

D) it is never profitable to produce information.

 

6) In the United States, the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the

A) Federal Communications Commission.

B) Federal Trade Commission.

C) Securities and Exchange Commission.

D) Federal Reserve System.

7) Government regulations require publicly traded firms to provide information, reducing

A) transactions costs.

B) the need for diversification.

C) the adverse selection problem.

D) economies of scale.

 

8) A lesson of the Enron collapse is that government regulation

A) always fails.

B) can reduce but not eliminate asymmetric information.

C) increases the problem of asymmetric information.

D) should be reduced.

 

9) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries

A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars.

B) are able to prevent potential competitors from free-riding off the information that they provide.

C) have failed to solve adverse selection problems in this market because “lemons” continue to be traded.

D) have solved the moral hazard problem by providing valuable information to their customers.

 

10) Analysis of adverse selection indicates that financial intermediaries, especially banks,

A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance.

B) despite their success in overcoming free-rider problems, nevertheless play a minor role in moving funds to corporations.

C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds.

D) must buy securities from corporations to diversify the risk that results from holding non-tradable loans.

 

 

 

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July 1, 2023
    

 

101. On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount. The journal entry to record the first interest payment is: 

A. Debit Bond Interest Expense $14,000; credit Cash $14,000.

B. Debit Bond Interest Expense $28,000; credit Cash $28,000.

C. Debit Bond Interest Expense $14,200; credit Cash $14,000; credit Discount on Bonds Payable $200.

D. Debit Bond Interest Expense $13,800; debit Discount on Bonds Payable $200; credit Cash $14,000.

E. Debit Bond Interest Expense $14,000; debit Discount on Bonds Payable $200; credit Cash $14,200.

102. A company issued 5-year, 7% bonds with a par value of $100,000. The company received $97,947 for the bonds. Using the straight-line method, the amount of interest expense for the first semiannual interest period is: 

A. $3,294.70.

B. $3,500.00.

C. $3,705.30.

D. $7,000.00.

E. $7,410.60.

103. The effective interest amortization method: 

A. Allocates bond interest expense over the bond's life using a changing interest rate.

B. Allocates bond interest expense over the bond's life using a constant interest rate.

C. Allocates a decreasing amount of interest over the life of a discounted bond.

D. Allocates bond interest expense using the current market rate for each interest period.

E. Is not allowed by the FASB.

104. A company issued 7%, 5-year bonds with a par value of $100,000. The market rate when the bonds were issued was 7.5%. The company received $97,947 cash for the bonds. Using the effective interest method, the amount of interest expense for the first semiannual interest period is: 

A. $3,500.00.

B. $3,673.01.

C. $3,705.30.

D. $7,000.00.

E. $7,346.03.

105. The market value of a bond is equal to: 

A. The present value of all future cash payments provided by a bond.

B. The present value of all future interest payments provided by a bond.

C. The present value of the principal for an interest-bearing bond.

D. The future value of all future cash payments provided by a bond.

E. The future value of all future interest payments provided by a bond.

106. The Premium on Bonds Payable account is a(n): 

A. Revenue account.

B. Adjunct or accretion liability account.

C. Contra revenue account.

D. Contra asset account.

E. Contra liability account.

107. Adidas issued 10-year, 8% bonds with a par value of $200,000. Interest is paid semiannually. The market rate on the issue date was 7.5%. Adidas received $206,948 in cash proceeds. Which of the following statements is True? 

A. Adidas must pay $200,000 at maturity and no interest payments.

B. Adidas must pay $206,948 at maturity and no interest payments.

C. Adidas must pay $200,000 at maturity plus 20 interest payments of $8,000 each.

D. Adidas must pay $206,948 at maturity plus 20 interest payments of $8,000 each.

E. Adidas must pay $200,000 at maturity plus 20 interest payments of $7,500 each.

108. A company received cash proceeds of $206,948 on a bond issue with a par value of $200,000. The difference between par value and issue price for this bond is recorded as a: 

A. Credit to Interest Income.

B. Credit to Premium on Bonds Payable.

C. Credit to Discount on Bonds Payable.

D. Debit to Premium on Bonds Payable.

E. Debit to Discount on Bonds Payable.

109. If an issuer sells bonds at a date other than an interest payment date: 

A. This means the bonds sell at a premium.

B. This means the bonds sell at a discount.

C. The issuing company will report a loss on the sale of the bonds.

D. The issuing company will report a gain on the sale of the bonds.

E. The buyers normally pay the issuer the purchase price plus any interest accrued since the prior interest payment date.

110. A company issues at par 9% bonds with a par value of $100,000 on April 1, which is 4 months after the most recent interest date. The cash received for accrued interest on April 1 by the bond issuer is: 

A. $750.

B. $5,250.

C. $1,500.

D. $3,000.

E. $6,000.

 

default image
July 1, 2023
    

 

101. On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount. The journal entry to record the first interest payment is: 

A. Debit Bond Interest Expense $14,000; credit Cash $14,000.

B. Debit Bond Interest Expense $28,000; credit Cash $28,000.

C. Debit Bond Interest Expense $14,200; credit Cash $14,000; credit Discount on Bonds Payable $200.

D. Debit Bond Interest Expense $13,800; debit Discount on Bonds Payable $200; credit Cash $14,000.

E. Debit Bond Interest Expense $14,000; debit Discount on Bonds Payable $200; credit Cash $14,200.

102. A company issued 5-year, 7% bonds with a par value of $100,000. The company received $97,947 for the bonds. Using the straight-line method, the amount of interest expense for the first semiannual interest period is: 

A. $3,294.70.

B. $3,500.00.

C. $3,705.30.

D. $7,000.00.

E. $7,410.60.

103. The effective interest amortization method: 

A. Allocates bond interest expense over the bond's life using a changing interest rate.

B. Allocates bond interest expense over the bond's life using a constant interest rate.

C. Allocates a decreasing amount of interest over the life of a discounted bond.

D. Allocates bond interest expense using the current market rate for each interest period.

E. Is not allowed by the FASB.

104. A company issued 7%, 5-year bonds with a par value of $100,000. The market rate when the bonds were issued was 7.5%. The company received $97,947 cash for the bonds. Using the effective interest method, the amount of interest expense for the first semiannual interest period is: 

A. $3,500.00.

B. $3,673.01.

C. $3,705.30.

D. $7,000.00.

E. $7,346.03.

105. The market value of a bond is equal to: 

A. The present value of all future cash payments provided by a bond.

B. The present value of all future interest payments provided by a bond.

C. The present value of the principal for an interest-bearing bond.

D. The future value of all future cash payments provided by a bond.

E. The future value of all future interest payments provided by a bond.

106. The Premium on Bonds Payable account is a(n): 

A. Revenue account.

B. Adjunct or accretion liability account.

C. Contra revenue account.

D. Contra asset account.

E. Contra liability account.

107. Adidas issued 10-year, 8% bonds with a par value of $200,000. Interest is paid semiannually. The market rate on the issue date was 7.5%. Adidas received $206,948 in cash proceeds. Which of the following statements is True? 

A. Adidas must pay $200,000 at maturity and no interest payments.

B. Adidas must pay $206,948 at maturity and no interest payments.

C. Adidas must pay $200,000 at maturity plus 20 interest payments of $8,000 each.

D. Adidas must pay $206,948 at maturity plus 20 interest payments of $8,000 each.

E. Adidas must pay $200,000 at maturity plus 20 interest payments of $7,500 each.

108. A company received cash proceeds of $206,948 on a bond issue with a par value of $200,000. The difference between par value and issue price for this bond is recorded as a: 

A. Credit to Interest Income.

B. Credit to Premium on Bonds Payable.

C. Credit to Discount on Bonds Payable.

D. Debit to Premium on Bonds Payable.

E. Debit to Discount on Bonds Payable.

109. If an issuer sells bonds at a date other than an interest payment date: 

A. This means the bonds sell at a premium.

B. This means the bonds sell at a discount.

C. The issuing company will report a loss on the sale of the bonds.

D. The issuing company will report a gain on the sale of the bonds.

E. The buyers normally pay the issuer the purchase price plus any interest accrued since the prior interest payment date.

110. A company issues at par 9% bonds with a par value of $100,000 on April 1, which is 4 months after the most recent interest date. The cash received for accrued interest on April 1 by the bond issuer is: 

A. $750.

B. $5,250.

C. $1,500.

D. $3,000.

E. $6,000.

 

default image
July 1, 2023
    

 

101. On January 1, a company issued and sold a $400,000, 7%, 10-year bond payable, and received proceeds of $396,000. Interest is payable each June 30 and December 31. The company uses the straight-line method to amortize the discount. The journal entry to record the first interest payment is: 

A. Debit Bond Interest Expense $14,000; credit Cash $14,000.

B. Debit Bond Interest Expense $28,000; credit Cash $28,000.

C. Debit Bond Interest Expense $14,200; credit Cash $14,000; credit Discount on Bonds Payable $200.

D. Debit Bond Interest Expense $13,800; debit Discount on Bonds Payable $200; credit Cash $14,000.

E. Debit Bond Interest Expense $14,000; debit Discount on Bonds Payable $200; credit Cash $14,200.

102. A company issued 5-year, 7% bonds with a par value of $100,000. The company received $97,947 for the bonds. Using the straight-line method, the amount of interest expense for the first semiannual interest period is: 

A. $3,294.70.

B. $3,500.00.

C. $3,705.30.

D. $7,000.00.

E. $7,410.60.

103. The effective interest amortization method: 

A. Allocates bond interest expense over the bond's life using a changing interest rate.

B. Allocates bond interest expense over the bond's life using a constant interest rate.

C. Allocates a decreasing amount of interest over the life of a discounted bond.

D. Allocates bond interest expense using the current market rate for each interest period.

E. Is not allowed by the FASB.

104. A company issued 7%, 5-year bonds with a par value of $100,000. The market rate when the bonds were issued was 7.5%. The company received $97,947 cash for the bonds. Using the effective interest method, the amount of interest expense for the first semiannual interest period is: 

A. $3,500.00.

B. $3,673.01.

C. $3,705.30.

D. $7,000.00.

E. $7,346.03.

105. The market value of a bond is equal to: 

A. The present value of all future cash payments provided by a bond.

B. The present value of all future interest payments provided by a bond.

C. The present value of the principal for an interest-bearing bond.

D. The future value of all future cash payments provided by a bond.

E. The future value of all future interest payments provided by a bond.

106. The Premium on Bonds Payable account is a(n): 

A. Revenue account.

B. Adjunct or accretion liability account.

C. Contra revenue account.

D. Contra asset account.

E. Contra liability account.

107. Adidas issued 10-year, 8% bonds with a par value of $200,000. Interest is paid semiannually. The market rate on the issue date was 7.5%. Adidas received $206,948 in cash proceeds. Which of the following statements is True? 

A. Adidas must pay $200,000 at maturity and no interest payments.

B. Adidas must pay $206,948 at maturity and no interest payments.

C. Adidas must pay $200,000 at maturity plus 20 interest payments of $8,000 each.

D. Adidas must pay $206,948 at maturity plus 20 interest payments of $8,000 each.

E. Adidas must pay $200,000 at maturity plus 20 interest payments of $7,500 each.

108. A company received cash proceeds of $206,948 on a bond issue with a par value of $200,000. The difference between par value and issue price for this bond is recorded as a: 

A. Credit to Interest Income.

B. Credit to Premium on Bonds Payable.

C. Credit to Discount on Bonds Payable.

D. Debit to Premium on Bonds Payable.

E. Debit to Discount on Bonds Payable.

109. If an issuer sells bonds at a date other than an interest payment date: 

A. This means the bonds sell at a premium.

B. This means the bonds sell at a discount.

C. The issuing company will report a loss on the sale of the bonds.

D. The issuing company will report a gain on the sale of the bonds.

E. The buyers normally pay the issuer the purchase price plus any interest accrued since the prior interest payment date.

110. A company issues at par 9% bonds with a par value of $100,000 on April 1, which is 4 months after the most recent interest date. The cash received for accrued interest on April 1 by the bond issuer is: 

A. $750.

B. $5,250.

C. $1,500.

D. $3,000.

E. $6,000.

 

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