Chapter 20 Venture Capital Firms, Finance Companies,

and Financial Conglomerates

20.1 Multiple Choice
1) A ______ is a specialized firm that finances young, start-up companies.
A) venture capital firm
B) finance company
C) small-business finance company
D) capital-creation company
Answer: A
2) Venture capital firms are usually organized as
A) closed-end mutual funds
B) limited partnerships
C) corporations
D) nonprofit businesses
Answer: B
3) Which of the following is not a characteristic feature of venture capital firms?
A) Funding just one or a small number of firms.
B) Holding equity in the firms that are funded.
C) Having a long-term investment horizon.
D) Providing advice and assistance to the firms that are funded.
Answer: A
4) Which of the following is a characteristic feature of venture capital firms?
A) Developing a portfolio of companies.
B) Holding debt in the firms that are funded.
C) Allowing firms to use the funds as they see fit.
D) Having a short-term investment horizon.
Answer: A
5) The largest industry group receiving venture capital funding is
A) computer software.
B) medical/health.
C) computer hardware.
D) none of the above.
Answer: D
6) The source of venture capital funding has
A) shifted from wealthy individuals to pension funds and corporations.
B) shifted from pension funds and corporations to wealthy individuals.
C) decreased since 1990.
D) none of the above.
Answer: A
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7) A typical venture capital firm has a ______ number of investors who each
contribute a ______ amount of money to the fund.
A) large; small
B) small; large

C) large; large
D) small; small
Answer: B
8) The 20-year average return of venture capital firms has been about ______.
A) 50 percent
B) 8 percent
C) 20 percent
D) 100 percent
Answer: C
9) The earliest examples of finance companies date back to the beginning of the 1800s
when retailers offered
A) installment credit to customers.
B) balloon loans to customers.
C) zero-interest loans to customers.
D) all of the above to customers.
Answer: A
10) Most automobile financing is provided by
A) commercial banks.
B) thrifts.
C) finance companies owned by automobile companies.
D) finance companies owned by real estate brokers.
Answer: C
11) Finance companies
A) are money market intermediaries.
B) borrow in large amounts, but lend in small amounts.
C) are virtually unregulated.
D) are all of the above.
E) are only (A) and (B) of the above.
Answer: D
12) Consumer finance companies can be distinguished from commercial banks
because
consumer finance companies
A) often accept loans with much higher default risk than banks would.
B) are often wholly owned by a manufacturer that might be willing to offer
favorable credit terms to sell products.
C) typically offer lower interest rates to its loan customers than do banks.
D) do all of the above.
E) do only (A) and (B) of the above.
Answer: E
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13) Which of the following statements about finance companies are true?
A) Finance company delinquency rates are usually higher than those for banks or
thrifts.
B) Finance companies charge higher interest rates than do commercial banks.

C) Interest-rate risk is a more serious problem for finance companies than for
banks and thrifts.
D) All of the above are true.
E) Only (A) and (B) of the above are true.
Answer: E
14) The three types of finance companies are
A) business, consumer, and retail.
B) business, sales, and consumer.
C) retail, wholesale, and consumer.
D) retail, business, and sales.
Answer: B
15) Of the types of loans made by finance companies,
A) consumer loans account for about 50 percent of all loans.
B) real estate loans account for about 40 percent of all loans.
C) business loans account for about 55 percent of all loans.
D) consumer and real estate loans account for about 55 percent of all loans.
Answer: C
16) Which of the following statements about finance companies are true?
A) Finance companies offered loans secured by accounts receivable before
commercial banks did.
B) Finance companies gained a reputation for being more innovative than banks at
finding ways to finance small businesses.
C) Loans secured by motor vehicles, which include loans to buy autos for
business use and for resale, are the second most common type of finance
company loan.
D) All of the above are true.
E) Only (A) and (B) of the above.
Answer: D
17) Which of the following statements about finance companies are true?
A) Finance companies have gained a reputation for being more innovative than
banks at finding ways to finance small businesses.
B) Loans secured by automobiles are the most common type of finance company
loan.
C) Because finance companies are virtually unregulated, they charge lower
interest rates than do commercial banks.
D) All of the above are true.
E) Only (A) and (B) of the above are true.
Answer: A
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18) Business finance companies provide specialized forms of credit to businesses by
making loans and purchasing accounts receivable at a discount; this provision of
credit is called
A) discounting.
B) factoring.

C) refinancing
D) sparking.
Answer: B
19) Firms might sell accounts receivable to finance companies
A) to obtain quick cash.
B) to avoid the cost of funding a credit department.
C) because they dont want to spoil their relationships with customers over bill
collection hassles.
D) for all of the above reasons.
Answer: D
20) Business finance companies specialize in leasing because
A) it makes repossession of an asset easier.
B) the lessee is often not required to make as large an up-front payment as is
usually required on a loan to purchase.
C) the finance company might capture tax benefits if the firm leasing the asset
does not have income to offset with depreciation.
D) of all of the above.
E) of only (A) and (B) of the above.
Answer: D
21) Business finance companies provide
A) factoring.
B) equipment that can be leased.
C) checking accounts.
D) all of the above.
E) only (A) and (B) of the above.
Answer: E
22) In a _____ arrangement, the finance company pays for the car dealerships
inventory of cars received from the manufacturer and puts a lien on each car
financed.
A) factoring
B) floor plan
C) roll over leasing
Answer: B
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23) Consumer finance companies
A) make loans to consumers who cannot obtain credit from other sources.
B) are owned by separate corporations or banks.
C) charge high interest rates because their loans are high risk.
D) do all of the above.
Answer: D
24) Consumer finance companies
A) charge low interest rates on consumer loans.
B) make relatively safe loans because finance companies require high levels of
collateral.

C) provide small retailers with private label credit card services.

D) do all of the above.
E) do only (A) and (B) of the above.
Answer: C
25) Finance companies that make loans to purchase items from a particular retailer or
manufacturer are called
A) retail finance companies.
B) sales finance companies.
C) consumer finance companies.
D) corporate finance companies.
Answer: B
26) GMAC is an example of a
A) captive finance company.
B) corporate finance company.
C) floor plan finance company.
D) business finance company.
Answer: A
27) Finance companies are far less regulated than banks and thrifts because
A) its depositors are exclusively large institutional investors.
B) there are no regulations on subsidiaries of a bank holding company.
C) there are no depositors to protect.
D) there are few cases of finance companies failing.
E) the capital-to-total-assets ratio of finance companies is relatively strong
compared to that of banks and thrifts.
Answer: C
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28) Usury statutes
A) allow consumers to declare bankruptcy while still retaining ownership of many
of their assets.
B) require finance companies to disclose the annual percentage rate charged on
loans.
C) impose restrictions on finance companies ability to collect on delinquent
loans.
D) set a ceiling on interest rates that can be charged on finance company loans.
E) only (A) and (B) of the above.
Answer: D
29) Finance companies are required by truth in lending regulations to disclose the
annual percentage rate charged on loans. This regulation is known as
A) Regulation Q.
B) Regulation Z.
C) Regulation T.
D) Regulation C.
Answer: B
30) Regulations designed to protect consumers in their dealings with finance

companies
include
A) truth in lending legislation.
B) usury statutes.
C) bankruptcy statutes.
D) all of the above.
E) only (A) and (B) of the above.
Answer: D
31) The primary asset of a typical finance company is its
A) commercial paper.
B) reserves for loan losses.
C) loan portfolio.
D) bank loans.
Answer: C
32) On average, finance companies have a _____ capital-to-assets ratio.
A) 12 percent
B) 10 percent
C) 9 percent
D) 8 percent
Answer: A
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33) The primary source of income for finance companies is
A) interest income from its loan portfolio.
B) income from leasing cars and trucks.
C) interest income from commercial paper.
D) income from loan origination fees.
Answer: A
34) Finance companies total assets have shown steady growth except in the
A) early 1980s, when interest rates increased sharply.
B) mid 1980s, when defaults on consumer debt rose sharply.
C) late 1980s, when legislation that supported the revival of the commercial
banking industry was passed.
D) early 1990s, when a recession caused a dip in business loans.
E) mid and late 1990s, when growth in the assets of commercial banks was very
strong.
Answer: A
35) Financial conglomerates began
A) when Prudential Insurance Company acquired Bache Securities.
B) when Merrill Lynch made a cash management account available to its
customers.
C) when Citicorp merged with the Travelers Group.
D) when Sears added Coldwell Banker Real Estate and Dean Witter to its
holdings of Allstate Insurance Company and Allstate Life Insurance Company.
E) when Travelers Insurance merged with Salomon Smith Barney.

Answer: B
36) One goal of creating a financial conglomerate is to achieve economies of scope,
which reflect
A) savings achieved through increased size.
B) savings that come from cutting jobs.
C) savings that come from larger issues of bonds and stocks to finance operations.
D) revenues that come from offering a product in many locations.
E) revenues that come from offering many products in one location.
Answer: E
37) An exception to the rule that financial conglomerates tend to fail is
A) General Electric Capital Services.
B) Sears.
C) Citigroup.
D) Travelers.
E) Xerox.
Answer: A
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38) General Electric Capital Services does not own
A) one of the major investment banks.
B) one of the largest commercial banks.
C) one of the leading suppliers of private-label credit cards.
D) one of the largest property and casualty reinsurers.
Answer: B

20.2 True/False
1) Venture capital firms reduce risk by investing in only a few companies which can
be
carefully monitored and nurtured.
Answer: FALSE
2) Investors in venture capital firms expect to profit quickly from their investment.
Answer: FALSE
3) A balloon loan requires the borrower to make a single large payment at the loans
maturity to retire the debt.
Answer: TRUE
4) Finance companies face several types of risk. The greatest is liquidity risk.
Answer: FALSE
5) Not until the Great Depression did commercial banks begin competing for loans
secured by accounts receivable.
Answer: TRUE
6) When finance companies provide credit to business firms by purchasing their
accounts receivable at a discount, the credit is referred to as a floor plan.
Answer: FALSE
7) Sales finance companies make loans to consumers to purchase items from a
particular retailer or manufacturer.
Answer: TRUE

8) A sales finance company, also called a captive finance company, is owned by the
manufacturer to make loans to consumers to help finance the purchase of the
manufacturers products.
Answer: TRUE
9) Captive finance companies often offer interest rates below those of banks to
increase sales.
Answer: TRUE
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10) Compared to commercial banks and thrifts, finance companies are heavily
regulated.
Answer: FALSE
11) Finance companies allocate a portion of their income each period to an account to
be used to offset losses, called the reserve for loan losses.
Answer: TRUE
12) Financial conglomerates are firms offering a variety of financial services under
one
umbrella.
Answer: TRUE

20.3 Essay
1) What niche in the financial system do venture capital firms fill?
2) How do venture capital firms overcome the problem of information asymmetries
that accompany start-up firms?
3) Explain why sales finance companies might offer loans at below market interest
rates.
4) Why have finance companies been more innovative than commercial banks and
thrifts?
5) Explain the advantages to both firms and finance companies when finance
companies lease business equipment to firms.
6) Explain how economies of both scale and scope confer advantages that financial
conglomerates might enjoy.
7) What types of risk do finance companies face that commercial banks do not? What
types of risk do commercial banks face that finance companies do not?
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