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TEST BANK for Money, Banking, and Financial Markets, 6th Edition by Cecchetti, Schoenholtz CHAPTER 1 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Identify which item is not one of the six parts of the financial system. A) financial markets B) central banks C) credit cards D) financial institutions

2) The current mission of which one of the six parts of the financial system involves serving the public at large? A) financial markets B) central banks C) credit cards D) financial institutions

Which one of the following is the central bank of the United States? A) the Bank of America B) the Federal Reserve System C) the U.S. Treasury D) Citibank

An important way that central banks have changed over time is to provide more A) risk. B) money. C) transparency. D) regional reserve banks.

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More of which one of the following is an important key to the financial system? A) risk B) information C) asymmetric trading D) money

Banks and insurance companies are examples of A) central banks. B) regulatory agencies. C) financial institutions. D) financial instruments.

7) Which part of the financial system is used to transfer risk to those who are best equipped to bear it? A) central banks B) regulatory agencies C) financial institutions D) financial instruments

Which part of the financial system provides oversight through enforcement of rules? A) central banks B) regulatory agencies C) financial institutions D) financial instruments

Which of the following is not one of the five core principles of money and banking?

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A) Risk requires compensation. B) Time has value. C) Information is the basis for decisions. D) Stability creates risk.

10)

Investing in financial instruments in today's economy: A) is an activity practiced only by the wealthy. B) involves costly transactions. C) requires a sum of money larger than $100,000 to invest. D) is made easier by the use of mutual funds.

11)

Which of the following is an example of a financial market? A) a local coffeehouse where people regularly buy and sell financial instruments. B) a bank that only accepts deposits and issues loans. C) an electronic network used for buying and selling textbooks. D) a central bank used for raising taxes and borrowing on behalf of the government.

12) Why would a new home buyer be required to purchase fire insurance before a broker transfers funds to the seller? A) Risk requires compensation. B) This provides information to the lender increasing the likelihood that the loan will be repaid. C) Well-developed financial markets promote economic growth. D) Increasing the use of banking services provides stability in the macroeconomy.

13)

The statement "risk requires compensation" implies that people

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A) do not take risk. B) only accept risk when they absolutely have to. C) will only accept risk when they are rewarded for doing so. D) avoid risk at all cost.

14)

Mutual funds have A) been created for very wealthy individuals with a lot of money to invest. B) increased the risks associated with constructing a portfolio. C) reduced the costs associated with gathering information on stocks and bonds. D) increased the transactions costs associated with participating in financial markets.

15) Which one of the following types of action by a central bank could improve the welfare of a society? A) serving the interests of government rather than the public at large B) promoting regulations to slow economic growth C) controlling prices to allocate resources in support of government objectives D) helping to reduce the volatility of business cycles

16)

In the United States, control of the quantity of money is given to the A) president. B) Federal Reserve System. C) Bureau of Printing and Engraving. D) Department of the Treasury.

17)

Financial instruments can transfer

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A) neither resources nor risk between people. B) resources between people but not risk. C) both resources and risk between people. D) risk but not resources between people.

18)

Financial markets

A) lower the cost and increase the speed of buying and selling financial instruments. B) increase the speed of buying and selling, but they also increase the cost since people are earning fees for these transactions. C) are a good example of unregulated markets. D) today offer fewer instruments than they did in the past.

19) Which one of the following parts of the financial system is responsible for making sure that the elements of the system operate in a safe and reliable manner? A) financial markets B) money C) financial institutions D) regulatory agencies

20)

The New York Stock Exchange is an example of a A) financial instrument. B) financial institution. C) financial market. D) bank.

21) When an individual obtains a car loan and makes all of the regular monthly payments, the sum of the payments made will exceed the purchase price of the car. This is due primarily to which core principle? Version 1

A) Risk requires compensation. B) Information is the basis for decisions. C) Markets determine prices and allocate resources. D) Time has value.

22) Car insurance shelters drivers from the possibility of losing all their wealth in the event that they cause an accident in which someone is seriously injured. This best illustrates which core principle? A) Risk requires compensation. B) Information is the basis for decisions. C) Markets determine prices and allocate resources. D) Time has value.

23) A central bank’s pursuit of policies that control inflation and reduce business cycle fluctuations best illustrates which core principle? A) Risk requires compensation. B) Stability improves welfare. C) Markets determine prices and allocate resources. D) Time has value.

24) Which one of the following provides an economy with a foundation for economic efficiency and economic growth? A) high levels of risk in investing B) healthy and constantly evolving financial system C) government that regulates output markets D) tax structure that redistributes income

25)

Most financial markets in the United States operate under a system

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A) without any formal rules or regulations. B) with many rules and regulations to ensure a fair market. C) where the rules and regulations depend on the state in which the financial market is located. D) that is totally controlled by the federal government.

26)

How do financial institutions evaluate the creditworthiness of potential borrowers? A) They offer high interest rates because only the best borrowers will be able to afford

them. B) They gather information regarding the borrowers' finances. C) They do not evaluate creditworthiness because everyone is treated the same. D) They do not evaluate the creditworthiness because they know the borrower will honor his/her obligation to repay the loan.

27)

Stock prices are A) set by the company issuing the stock. B) set by the central bank. C) determined by market transactions. D) unrelated to the value of the company issuing the stock.

28)

The primary function of central banks is to

A) increase risk and volatility to increase compensation. B) control inflation, as well as help reduce the size and frequency of business cycle fluctuations. C) increase the uncertainty that firms face in making investment decisions. D) eliminate the need for banks to collect financial information.

29)

The goal of U.S. monetary policy is best described as

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A) keeping inflation low and stable and growth high and stable. B) determining the denominations of a country's currency. C) one of the most important functions of Congress. D) attempting to keep inflation constant at 0 percent.

30)

Studying money and banking through five core principles is helpful because A) studies have shown students have a difficult time remembering more than five topics. B) everything in economics can be reduced to five core principles. C) money and banking can undergo drastic changes overtime, but the five principles do

not. D) these five principles are understood by everyone.

31) The large regulatory change in U.S. financial markets that followed the Great Recession is known as A) Basel III. B) the Glass-Steagall Act. C) the Gramm-Leach-Bliley Act. D) the Dodd-Frank Act.

32) In 2010, regulators of many nations agreed on a major update of internationally active banks known as

A) Basel III. B) the Glass-Steagall Act. C) the Gramm-Leach-Bliley Act. D) the Dodd-Frank Act.

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 33) Identify the five core principles of Money and Banking.

34)

Identify the six parts of the financial system.

35) How do the primary functions of financial institutions and regulatory agencies differ in the U.S. financial system?

36) If the U.S. Supreme Court ruled that states could no longer require people to have auto insurance, do you think most people would cancel their policies? Use one of the five core principles to explain your answer.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 37) How do central banks, like the U.S. Federal Reserve, contribute to the welfare of a society?

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38) Which core principle(s) could you use to explain why credit card issuers charge such high rates of interest?

39) Suppose that IBM considers expanding its operations. The expansion will require $400 million for two new factories which the corporation plans to raise by selling stock and bonds. Which of the core principles will come into play as investors decide whether or not to buy the stock and the bonds?

40) A borrower seeking a mortgage today is often presented with the choice between a mortgage with aninterest rate and monthly payment that stays fixed for the duration of the loan, or a mortgage with aninterest rate and monthly payment that can change as other interest rates change. Typically the interest rate on the fixed-rate mortgage is higher. Having learned the five core principles, does this make sense?

41)

Why don’t large financial markets arise by themselves?

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Answer Key Test name: Chap 01_6e 1) C 2) B 3) B 4) C 5) B 6) C 7) D 8) B 9) D 10) D 11) A 12) B 13) C 14) C 15) D 16) B 17) C 18) A 19) D 20) C 21) D 22) A 23) B 24) B 25) B 26) B Version 1

27) C 28) B 29) A 30) C 31) D 32) A 33) (1) Time has value. (2) Risk requires compensation. (3) Information is the basis for decisions. (4) Markets determine prices and allocate resources. (5) Stability improves welfare. 34) They are: money, financial markets, financial instruments, financial institutions, government regulatory agencies, and central banks. 35) Financial institutions, such as banks, securities firms, and insurance companies, provide a myriad of services, including access to the financial markets andcollection of information about prospective borrowers to ensure they are creditworthy. Regulatory agencies provide wide-ranging financial regulation—rules for the operation of financial institutions and markets, and supervision—oversight through examination and enforcement. 36) Probably not. Auto insurance falls under the principle that risk requires compensation. For most people the additional risk they would face of driving without insurance exceeds the cost of the insurance, so they are better off purchasing auto insurance to reduce their risk.

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37) One of the core principles is that stability improves welfare (primarily by reducing risk). One of the functions of a central bank is to try to get rid of the risk that people cannot get rid of on their own, like the risk that comes from economic fluctuations, volatile price level changes or volatility in economic growth. To whatever degree the central bank can smooth these fluctuations, risk can be reduced and the overall welfare of a society can be improved. 38) You could explain the high rates of interest from three principles. First, risk requires compensation, and certainly the credit card issuers are taking a risk when they let people use the cards. There is a risk that some users may not repay the credit card company. Second, you can also justify it from the principle that time has value. The borrowers are using the issuer's funds, and the issuer needs to be compensated for letting the borrower use these funds. Some borrowers do not repay for considerable periods of time. Third, you could also invoke the principle that people use information in making their decisions. Credit card issuers need to acquire information on each applicant before a card is issued and this process is costly. Unfortunately, the applicants who are denied do not get the card, but those who are approved must help cover the information costs.

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39) The five core principles are: (1) Time has value. (2) Risk requires compensation. (3) Information is the basis for decisions. (4) Markets determine prices and allocate resources. (5) Stability improves welfare. Investors considering buying IBM's stock and bonds would surely have principle #2 in mind; they would assess the risk involved in IBM's expansion and want to be compensated for it. This would clearly involve information (principle #3). Principle #1 would come into play with the bonds; are they 1-year bonds? 5-year bonds? The longer the time period involved, everything else constant, the greater the return investors would require. Principles #4 and #5 are not totally irrelevant here, as investors will rely on markets to price the stocks and bonds and will judge IBM's expansion based on the outlook for the economy as a whole (stability). 40) Yes. The lender is shifting risk to the borrower. The risk here is that the lender agrees to a mortgage at (for example) 6% but then over the life of the loan (which can be 10, 25, even 30 years) interest rates in the market go up, putting the lender in the position of being "stuck" with the 6%. If the rate on the mortgage would change with market rates the lender would not have the risk. But remember, risk requires compensation, so to entice the borrower to take on the added risk the lender provides an inducement in the lower rate. A smart borrower will make the decision about whether or not the lower but changeable rate is a good decision based on information about interest rates (information, stability), and the decision may also depend on how long the borrower plans to live in the house (time).

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41) Large financial markets like the New York Stock Exchange, for example, require rules in order to work properly, as well as authorities to police them. Billions of shares of stock change hands every day, and the markets will not function properly without rules and enforcement. For people to be willing to participate in a market, they must perceive it as fair. This creates an important role for the government. Regulators andsupervisors of the financial system make and enforce the rules, punishing people who violate them. When the government protects investors, financial markets work well andhelp promote economic growth.

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CHAPTER 2 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which one of the following is not a necessarycharacteristic of money? A) It is a store of value. B) It is a means of payment. C) It has intrinsic value. D) It is a unit of account.

A system of barter A) does not permit the exchange goods and services. B) requires that people do everything for themselves. C) requires exchange of goods and services without money. D) is efficient since people are self-sufficient.

A society without any money A) would have to rely on barter. B) would have no exchange of goods and services. C) would have individuals doing everything for themselves. D) would be more efficient due to more self-sufficiency.

The use of money makes an economy more efficient because A) people spend more time trading and more time producing. B) people can specialize in what they do well. C) with money, people will borrow less. D) money increases in value over time.

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The unit of account characteristic of money A) makes it difficult to compare the relative prices of goods and services. B) refers to how we use money to transfer purchasing power over time. C) means prices are expressed in terms of money. D) means that money finalizes payments.

Without the use of money, workers in an economy would A) become more specialized. B) have to spend a lot less time trading. C) probably specialize less. D) be far more productive.

As an economy without money produces more different types of goods, A) it is more difficult to quote prices. B) the number of relative prices decreases. C) a unit of account is easier to define. D) buyers are more likely to have full information about sellers.

The store of value characteristic of money refers to the fact that A) people save most of their money. B) money allows people to shift purchasing power into the future. C) money is not valuable unless it is stored. D) money is the only way people have to store value.

Stocks and bonds that are held as wealth fulfill which one of the functions of money?

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A) means of payment B) store of value C) unit of account D) medium of exchange

10)

Which best describes money as a means of payment? A) Money provides an immediate double coincidence of wants. B) Money makes sure a double coincidence of wants never occurs. C) Money requires at least two transactions to obtain the double coincidence of wants. D) To obtain a double coincidence of wants without money is impossible.

11) When comparing the exchange of goods and services in a barter economy and an economy that uses money, A) a double coincidence of wants is necessary in the barter economy. B) a double coincidence of wants is more likely to occur in the barter economy. C) transactions are likely to be smoother in the barter economy because goods and services are exchanged directly. D) the money economy requires that sellers have more information about buyers' wants.

12)

In a barter system, people A) have to specialize in order to have goods to trade. B) cannot specialize because they never know what goods will be desired. C) are less likely to specialize as extensively as they would in a monetary economy. D) must be self-sufficient.

13) In a barter economy, prices are stated in terms of relative prices. How many relative prices are in a barter economy where the only goods are oranges, rafts, and flower necklaces?

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A) 3 B) 5 C) 6 D) 9

14) In a barter economy, prices are stated in terms of relative prices. How many prices would a trader of a particular good need to know in a barter economy with 5 goods? A) 5 B) 10 C) 20 D) 50

15) In a barter economy, prices are stated in terms of relative prices. How many prices would a trader of a particular good need to know in a barter economy with 20 goods? A) 190 B) 100 C) 20 D) 40

16) In a barter economy, where prices are stated in terms of relative prices, with n number of goods there will always be A) exactly n relative prices. B) fewer than n relative prices. C) at least n relative prices. D) n/2 relative prices.

17) Which one of the following is the primary source of the high transaction costs associated with a barter system? Version 1

A) The fact that, often times, these exchanges are taxed by governments B) The risk associated with having to carry an inventory of goods to trade C) The high cost associated with finding someone with whom to exchange D) The cost of drawing up complete contracts

18) Suppose that in a barter economy Tom bakes bread and Hans produces chocolates. Tom wants chocolates but Hans doesn't like bread, so Hans is unwilling to trade with Tom. Tom's problem is an example of which problem associated with a barter system? A) too much specialization B) not enough prices C) the law of diminishing returns D) the double coincidence of wants problem

19) Specialization usually increases the output of a country; however, effective specialization requires A) that everyone in the country produce the same thing. B) that workers have very similar skills. C) an effective low-cost means to exchange goods and services. D) a large stock of capital.

20)

Which one of the following is an example of bartering? A) Sue trading candles with Tom for his bread B) Mary paying for her new shoes with her credit card C) John cutting his neighbor's grass in return for a cash payment D) Mrs. Smith giving each of the neighbor children $5.00 after they helped clean up her

yard

21)

Money eliminates the need for

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A) a search for a double coincidence of wants. B) government regulation. C) specialization of labor. D) financial intermediaries.

22)

Money that is used as a means of payment must be A) actual currency. B) coins and currency. C) coins, currency and credit cards. D) anything that is generally accepted as payment for goods and services.

23)

While money is an asset, not all assets are money because A) only money stores value. B) money must work as a means of payment. C) only money is a good asset to hold during times of inflation. D) money must be legal tender.

24)

An advantage that money has over other assets is that it A) increases in value over time. B) has lower transaction costs to use as a means of payment than other assets. C) provides a higher return to the owner. D) is a safer asset to hold during times of inflation.

25)

An individual who stores wealth in art rather than money will find that they

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A) suffer larger real losses during periods of high inflation. B) have far more liquidity than most savers. C) will incur higher transaction costs when they ultimately make purchases. D) will have to resort to barter exchanging the art for desired goods.

26)

Which one of the following best describes how money and wealth are related?

A) Money is wealth but not all wealth is money. B) Money is a means of payment but is not part of wealth. C) Assets that are part of wealth always havea positive return while money does not. D) Wealth is a store of value and a means of payment while money is only a means of payment.

27)

Which one of the following is an example of fiat money? A) silk in China B) butter in Norway C) gold in Venice D) U.S. currency

28) For most of human history, which one of the following has been the most common commodity money? A) silk B) butter C) gold D) U.S. currency

29)

Gold would be a superior commodity money compared to wheat because

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A) wheat has a high value relative to weight, which gold does not. B) it is easier to divide wheat into small units. C) wheat has more practical uses than gold. D) wheat is perishable.

30)

The fact that U.S. currency is legal tender means

A) U.S. currency is good anywhere in the world. B) the only money the government will accept for settlement of debts is U.S. currency. C) private businesses in the U.S. and the U.S. government must accept currency for payment. D) it cannot be backed by gold or other metals.

31)

In comparing money to a U.S. Treasury bond held by an individual, A) the Treasury bond is an asset but money is not. B) money is an asset but the U.S. Treasury bond is a liability of the individual. C) both are stores of value. D) money is a store of value but the U.S. Treasury bond is not.

32)

In comparing money to a U.S. Treasury bond held by an individual, we can say A) both are legal tender. B) both are units of account. C) only the bond is legal tender since it is an obligation of the U.S. government. D) both are stores of value.

33)

In comparing money to a share of Microsoft stock held by an individual, we can say

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A) the share of stock is an asset, but money is a liability. B) only the money is a means of payment, but both are stores of value. C) only the money is a means of payment, but both are units of account. D) both the Microsoft stock and the money are liabilities.

34)

Comparing checks and currency, we can say A) both are money but only currency is legal tender. B) only checks are both money and legal tender. C) a check isn't money but currency is. D) both are money and legal tender.

35) When the Continental Congress issued currency to finance the Revolutionary War, the Continental Congress A) issued too many Continentals, eventually making the currency worthless. B) tied the value of the Continental to gold. C) tied the value of the Continental to French assignats. D) issued too few Continentals which kept them from being widely accepted.

36) During the Civil War, the North issued currency, known as greenbacks. These greenbacks A) are still legal tender in the United States. B) were tied to the value of gold and silver. C) were used by the South to pay for salaries and supplies. D) are a historical example of commodity money.

37)

Most of the non-cash retail payments made each year in the United States are made by

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A) check. B) credit card. C) debit card. D) electronic funds transfers.

38)

All of the following are true about electronic funds transfers except they A) sometimes involve the Federal Reserve sending electronic images of checks to

banks. B) occur when banks or individuals deposit/withdraw from one bank account to another electronically. C) include automated clearinghouse transactions (ACH). D) include credit card payments made online.

39) Carlos pays his cable bill using his bank's internet banking web site to withdraw funds from his checking account. This transaction is a(n) A) automated clearinghouse transaction (ACH). B) digitized-check transaction. C) e-money transaction. D) Fedwire transaction.

40) Consider the path of a paper check as it travels through the check-clearing system. Which step in the process uses money? A) when the consumer hands the check to the merchant B) when the merchant’s bank sends an electronic image of the check to the local Federal Reserve Bank C) when the Federal Reserve credits the merchant’s bank’s reserve account and debits the consumer’s bank’s reserve account D) when the consumer’s bank debits the consumer’s checking account by the amount of the check

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41)

The value of fiat money A) comes from its intrinsic value. B) is worth more as a commodity than its value as money. C) comes from government decree. D) means that it is more desirable than currency.

42)

U.S. currency is A) a commodity money. B) fiat money. C) tied to the value of gold at a fixed rate. D) the only store of value.

43)

One major difference between a debit card and a credit card is that A) only the debit card helps you to build a credit history. B) the debit card has lower minimum monthly payments. C) you do not need to actually have the funds in your account when you use a debit

card. D) debit cards have no late fees.

44)

One major difference between a debit and credit card is A) you can build a credit history with the credit card but not with the debit card. B) you have to pay interest on your purchases if you use a credit card. C) credit cards are money and the debit card is not. D) debit cards charge late fees.

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45)

An asset that is highly liquid

A) physically takes a liquid form, like oil. B) can easily be converted into a means of payment without loss of value. C) is any asset that can be sold. D) must be U.S. currency.

46)

One advantage of using checks over a debit card is that

A) checks can be replaced if lost or stolen, a debit card cannot. B) the bank is responsible if someone steals your checks and uses them; this isn't the case with debit cards. C) a cancelled paper check is the only generally accepted proof of payment. D) the person has "float," meaning time between writing the check and depositing funds to cover it.

47)

Checks and currency function similarly, except that A) currency is a more effective means of payment. B) carrying currency entails greater risk because it cannot be replaced if lost or stolen. C) currency is a better store of value than checking deposits. D) checks are not included in measures of money, whereas currency is.

48)

Apps and smartphone infrastructure such as Apple Pay, Google Pay, PayPal, and Venmo A) reduce the costs and decrease the speed of payments and transfers. B) reduce the costs and increase the speed of payments and transfers. C) increase the costs and decrease the speed of payments and transfers. D) increase the costs and increase the speed of payments and transfers.

49)

Money aggregates can best be defined as a set of measures of the amount of

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A) money that exists at a particular point in time. B) money the Federal Reserve has on deposit as reserves. C) money available to the economy over a year. D) U.S. currency the Bureau of Printing and Engraving has produced.

50)

The money aggregate M1 includes each of the following, except A) currency in the hands of the public. B) other checkable deposits. C) savings deposits. D) demand deposits at commercial banks.

51)

Which one of the following is the largest category of M1? A) currency in the hands of the public B) other checkable deposits C) savings deposits D) demand deposits at commercial banks

52)

The money aggregate M2 includes A) large denomination time deposits. B) stock and bond mutual fund shares. C) institutional money market funds. D) M1.

53)

An automobile is an asset, but it is not liquid because

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A) the owner may need the automobile for transportation. B) the owner may still be making payments on the loan. C) the automobile may not be in good repair. D) the automobile cannot be easily converted into a means of payment without a loss in value.

54)

With inflation, A) you need less money to buy the same basket of goods you bought a month or a year

ago. B) money is more valuable. C) there is too little money in circulation. D) prices, in general, are increasing over time.

55)

Which one of the following lists correctly orders assets from most liquid to least liquid? A) stocks, house, paper currency, savings deposits B) stocks, paper currency, house, savings deposits C) savings deposits, paper currency, house, stocks D) paper currency, savings deposits, stocks, house

56)

Which one of the following assets is the most liquid? A) art B) demand deposits C) houses D) stocks

57)

Which one of the following assets is least liquid?

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A) common stock B) houses C) art D) checking account deposits.

58)

Considering the roughly $1.6 trillion in U.S. currency held by the public, A) over 90 percent of the amount is held in the form of $1 bills. B) more than three-fourths is held in the form of $100 bills. C) over half of the currency held in the form of $20 bills. D) the Federal Reserve distributes the amount equally across all denominations of bills.

59) Ava buys a $2,000 computer using a paper check. At which step does $2,000 get recorded in M1? A) when Ava hands the $2,000 check to the computer merchant B) once the $2,000 is credited to the merchant bank's reserve account and is debited from Ava's bank account C) once the Federal Reserve sends the paper check (or an electronic image) to Ava's bank D) The check is never M1. The $2,000 is M1 both in Ava's bank account and, later, in the merchant's account. It is the deposit balance that is counted.

60) Which statement best summarizes how monetary aggregates are used to understand inflation? A) Economists and policymakers use M1 to understand inflation today. B) M1 and M2 move together so both are good measures to use for understanding inflation. C) In recent years, growth in M2 has stopped being a useful tool for forecasting inflation. D) Especially when inflation is low, M2 is useful for understanding inflation.

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61)

Gross Domestic Product in the United States is roughly A) equal to M1. B) twice as large as M2. C) equal to M2. D) more than five times M1.

62)

M1 is

A) about one-tenth of GDP B) equal to GDP. C) about four times larger than GDP. D) about one fourth the amount of GDP.

63)

Which of the following statements regarding M1 is true?

A) M1 is a more useful measure of the relationship between the money supply and inflation because it includes the most liquid assets. B) M1 is the money supply the Federal Reserve pays the most attention to in conducting monetary policy. C) Beginning in the early 1980s, M1 became less useful than M2 for understanding inflation. D) M1 is the fastest growing of all of the money aggregates.

64)

M1 has decreased in its usefulness in understanding inflation due to

A) the increased use of checks in the economy. B) the introduction of money market mutual fund shares and similar checking substitutes. C) more reliance on the use of currency. D) the increased use of electronic payments.

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65) The introduction of money market substitutes for basic checking accounts was fueled partially by the A) relatively high rates of inflation that existed in the late 1970s and early 1980s. B) reluctance of many retailers to accept checks. C) high number of bank failures that were occurring in the 1970s. D) higher interest rates banks had to pay on checking accounts.

66) A cross-country analysis of money growth supports the conclusion that the correlation between A) the growth rate of the quantity of money and the rate of inflation does not exist. B) the money growth rate and inflation in most countries was positive but very small. C) inflation and money growth in most industrialized countries was actually negative. D) inflation and the money growth rate was positive and relatively strong.

67) A cross-country analysis of money growth shows that the growth rate in the money supply was A) lower in countries with lower inflation rates. B) higher in countries with lower inflation rates. C) lower in countries with higher inflation rates. D) the same whether the countries had high or low inflation rates.

68)

The Consumer Price Index (CPI) is

A) an example of an index that uses variable expenditure weights. B) a fixed-expenditure-weight index used to measure changes in the GDP Deflator. C) a fixed-expenditure weight-index used to measure changes in purchasing power for households. D) the least commonly used measure of inflation.

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69)

The Consumer Price Index (CPI) A) tends to understate the impact of price changes. B) tends to overstate the impact of price changes due to substitution bias. C) is more accurate than the GDP deflator. D) assumes that consumers substitute away from cheaper goods.

70) Assume that people spend 30 percent of their income on food, 45 percent on housing, and 25 percent on transportation. Assume that 2020 is the base year, and use the table below to compute the Consumer Price Index (CPI) for 2021: Year 2020 2021

Price of Food $100 $120

Price of Housing $200 $210

Price of Transportation $100 $150

Cost of the Basket $145 $168

A) 23 B) 100 C) 116 D) 156.5

71)

The Consumer Price Index (CPI)

A) is calculated using a basket of goods and services adjusted annually by government statisticians. B) answers the question, "How much more does it cost today to buy the same basket of goods and services that were purchased at some fixed time in the past?" C) does not suffer from substitution bias because the basket used to measure prices changes every year. D) understates the impact of price changes.

72)

Economists study the link between money and inflation because

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A) they want to understand how to keep inflation low and stable. B) they believe that inflation in the 3–6 percent range is healthy for an economy. C) as prices increase money becomes more valuable. D) the Fed needs to increase the money supply as prices increase.

73)

Inflation refers to growth in an economy’s A) Gross Domestic Product (GDP). B) interest rates. C) money. D) prices.

74)

When the price level increases, the purchasing power of money A) increases by a similar amount. B) stays the same since the purchasing power of money is not impacted by price levels. C) decreases. D) first increases and then decreases as people get used to higher prices.

75)

The purchasing power of money A) rises when inflation rises. B) decreases as the price level decreases. C) decreases with inflation. D) is not impacted by inflation, only by monetary policy.

76)

If you can buy the same goods this year as you bought last year

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A) with less money there must have been deflation. B) with the same amount of money, prices are unstable. C) but it requires more money, there must have been price instability. D) with the same money there must have been deflation.

77) According to the World Bank, in 2017, what fraction of the world’s adults do not have an account at a bank or a mobile money operator? A) zero B) about one-third C) about one-half D) between one-half and two-thirds

78)

In countries with low inflation, A) M2 growth is a very strong forecaster of inflation. B) there tends to be a greater reliance on checks than electronic payments. C) M2 growth is a poor forecaster of inflation. D) money stocks are a larger percentage of GDP.

79)

Sue uses a credit card to purchase a new pair of jeans. Sue is A) using money to buy her jeans. B) creating a liability that she will ultimately have to pay with money. C) using an electronic payment form of money. D) using a form of money included in M2.

80)

The value of money as a means of payment

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A) is independent of changes in the amount of money in the economy. B) is fixed once relative prices are set. C) depends on the amount of money in the economy, among other things. D) depends on whether the majority of M1 is in currency or demand deposits.

81)

The primary concern of current critics of fiat money is that A) fiat money is too costly to produce. B) governments issue too much money, threatening its value. C) fiat money is too easy to counterfeit. D) governments will issue too little, threatening economic growth.

82)

Why would current critics of fiat money urge governments to return to a gold standard? A) They fear that governments will issue too much money. B) They fear that central banks will start making currency out of plastic. C) They believe that politicians need more discretion to make policy time consistent. D) They worry that governments will stop accepting the currency it has issued.

83)

Which function of money has already undergone big changes as technology has evolved? A) means of payment B) store of value C) unit of account D) store of deferred payment

84)

What makes critics of cryptocurrencies say that this is not money?

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A) Users can remain anonymous while making payments. B) Electronic payments are efficient. C) They lack the three key characteristics of money. D) Their value can be undermined by government fiat.

85)

Which one of the following is a drawback to the use of blockchain technology? A) less efficient B) lack of oversight C) less costly D) innovative

86)

A policy is time consistent when A) policymakers have incentives to adhere to a policy decision made today, in the

future. B) policymakers have incentives to make policy decisions in a time-sensitive fashion. C) policymakers consider the future when making current policies. D) the timing of a policy is irrelevant.

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 87) Consider the following: there are two countries, A and B. Each country has the same resources, and produces the same goods. The residents of country A use money while the residents of country B rely on bartering of goods. Will each country produce the same quantity of output? Explain.

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88) Consider an island where people use sand dollars (shells) as currency. For simplicity, assume that the people consume only one good: fish. a. Currently, there are 400 sand dollars in circulation and there are 200 fish purchased each year. Based on this information, what is the price of fish? b. Suppose that a change in climate leads to new sand dollars washing ashore, leaving a total of 500 sand dollars in the economy. If there are still 200 fish purchased each year, what is the new price of fish? In order to prevent inflation, what would have to happen to the amount of fish purchased each year?

89)

What does it mean to say that an asset is "liquid"?

90)

There are three goods produced in an economy by three individuals. Good apples bread chocolate

Producer orchard owner baker candy maker

If the orchard owner likes only bread, the baker likes only chocolate, and the candy maker likes only apples, will any trade between these three persons take place in a barter economy? Explain.

91) Many college campuses use student ID cards as a way for students to pay for on-campus expenses such as books, photocopies, and food. For convenience, some students will maintain a balance on their ID cards. Are these balances a means of payment? Are they a store of value? Explain why or why not.

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92) Use the information in the table below to answer the questions that follow. Assume that 2020 is the base year and that the market basket includes 5 units of Good A, 15 units of Good B, and 40 units of Good C. Year 2020

Price of Good A $100

Price of Good B $80

Price of Cost of Market Consumer Price Good C Basket Index $240

2021

$150

$80

$300

2022

$200

$120

$360

a. Find the cost of the market basket for each year and fill in the column in the table. b. Find the CPI for each year and fill in the column in the table.

93) Explain why the following statement is true, "money is an asset but not all assets are money."

94)

Explain how money solves the problem of the "double coincidence of wants."

95) Suppose there is an economy that has 100 people each of whom makes a different good, and they use a barter system for exchange. How many relative prices will there be?

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96) Is the characteristic that distinguishes money from other assets its ability to be a store of value?

97)

What distinguishes commodity money from fiat money?

98) During the U.S. Civil War the Confederate government had to resort to printing currency to obtain the goods they needed. Comment on what you think happened to both prices and the value of this currency at the end of the war.

99) You purchase a good by writing a check for $1,000. Considering the financial payments system this check follows, when is the check money? Explain.

100) Explain why credit cards are not considered money even though people seem to use them like money.

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101)

Explain the difference(s) between a debit card and a credit card.

102) Rank the following assets from most liquid to least liquid. a) common stock b) houses c) currency d) art e) savings accounts f) checking account deposits.

103) During what period was money a better store of value: 1960–1980 or 1990–2009? Explain.

104)

What is included in M2 that is not included in M1?

105)

Have the growth rates of M1 and M2 moved together over time? Explain.

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106)

How useful is M2 in tracking inflation? Explain.

107)

Has M2 always been a useful tool for forecasting inflation? Explain.

108) Why do economists claim the Consumer Price Index (CPI) tends to overstate the actual rate of inflation?

109)

What does a CPI of 240 mean?

110) How has the Bureau of Labor Statistics (BLS) changed the calculation of the CPI in order to take substitution bias into account?

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111) What was the double liquidity shock that occurred in the U.S financial system in the summer of 2007?

112)

Why are electronic transactions increasingly taking the place of paper transactions?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 113) Consider two barter economies: Duos and Varietas. Duos produces two different goods, whereas Varietas produces 80 different goods. Both countries have the same number of people. In which barter economy is it more likely that the means of payment and the units of account would be efficient? How many relative prices are there in Duos compared with Varietas? Which economy would benefit more from adopting money?

114) After the Revolutionary War, the United States monetary system was based on gold. Historically, why did the United States adopt the use of gold as a currency? How does this compare with the currency used today?

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115) Historically, some governments have relied on the revenue generated from printing currency to finance government spending. Give two examples of government's relying on paper currency to finance wartime expenditures. What do you expect happened to inflation rates during these historical episodes?

116) In the chapter you read that it costs the U.S. Treasury's Bureau of Engraving and Printing around 5.5 cents to print a $1 bill, 10.5 cents to print a $20 bill, and a bit over 13 cents to print a $100 bill. It seems the Treasury could generate a nice profit for the government by simply printing currency and using this currency to purchase the goods and services the government needs. In fact, this seems to be a way to eliminate the problem of budget deficits for the U.S. government. Comment on this idea.

117) A famous American has been visiting the same tropical island for 15 years for vacations. When she goes she pays for everything by writing checks drawn on her U.S. bank. The currency the natives use is not U.S. dollars; they use a currency called a fungo. The natives never cash her checks. She is so well known on the island that the natives simply trade her checks among themselves. The question you need to answer, complete with an explanation, is: Who is paying for her vacation? (You can assume her bank would honor the checks if presented for payment even after a considerable period of time has passed.)

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Answer Key Test name: Chap 02_6e 1) C 2) C 3) A 4) B 5) C 6) C 7) A 8) B 9) B 10) A 11) A 12) C 13) A 14) B 15) A 16) C 17) C 18) D 19) C 20) A 21) A 22) D 23) B 24) B 25) C 26) A Version 1

27) D 28) C 29) D 30) C 31) C 32) D 33) B 34) C 35) A 36) A 37) D 38) A 39) A 40) C 41) C 42) B 43) D 44) A 45) B 46) D 47) B 48) B 49) A 50) C 51) A 52) D 53) D 54) D 55) D 56) B Version 1

57) C 58) B 59) D 60) C 61) D 62) A 63) C 64) B 65) A 66) D 67) A 68) C 69) B 70) C 71) B 72) A 73) D 74) C 75) C 76) A 77) B 78) C 79) B 80) C 81) B 82) A 83) A 84) C 85) B 86) A Version 1

87) No, the residents of Country B will definitely spend more of their time transacting, trying to create a double coincidence of wants, and may have to rely on multiple trades to do so. They will also likely specialize less, reducing the gains to the country from specialization. In Country A the residents will be able to transact immediately using money, and will also be able to specialize in what they do well, creating a more efficient economy. 88) a. When there are 400 sand dollars and 200 fish purchased in a year, this implies that each fish costs 2 sand dollars (= 400/200). b. When the number of sand dollars increases to 500, the price of fish will increase to 2.5 sand dollars per fish (= 500/200). In order to prevent this inflation in fish prices, the number of fish would have to be increased to 250. That is, if there are 500 sand dollars and 250 fish, the price of fish would go back to 2 sand dollars per fish (= 500/250). 89) An asset is liquid when it can be converted into a means of payment, quickly, without suffering a loss in value. 90) Yes, but this is a good example of the high transaction costs that can occur in a barter economy due to the double coincidence of wants problem. Any one of the individuals will have to make two trades to get what they want; for example, the baker will have to trade bread with the orchard owner to get apples, to then be able to trade with the candy maker to obtain the chocolate that they really want. 91) The balances on the cards serve as both a means of payment and a store of value. Using the student ID card in this way is an example of a stored-value card, similar to a gift card for a store, or a card used to pay for public transportation. While these stored value cards are not included in the money supply, they are used as a means of payment and a store of value.

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92) a. Cost of Market Basket in 2020 = 100(5) + 80(15) + 240(40) = 11,300 Cost of Market Basket in 2021 = 150(5) + 80(15) + 300(40) = 13,950 Cost of Market Basket in 2022 = 200(5) + 120(15) + 360(40) = 17,200 b. CPI in 2020 = 100 since it is the base year. CPI in 2021 = 13,950/11,300 × 100 = 123 CPI in 2022 = 17,200/11,300 × 100 = 152 Year 2020 2021 2022

Price of Good A $100 $150 $200

Price of Good B $80 $80 $120

Price of Good C $240 $300 $360

Cost of Market Basket $11,300 $13,950 $17,200

Consumer Price Index 100 123 152

93) Money is an asset because it represents something of value to the owner. But not all assets can be used as an immediate means of payment. 94) In an economy that does not rely on the use of money, if people are going to specialize at all they have to resort to barter, which is the exchange of one good or service for another. In the situation of barter, it may be likely that the individual who has what the other person wants will not want what the other person has. In this case multiple trades may be necessary to ultimately obtain what is desired. With the use of money, since everyone generally accepts it, one exchange will suffice. In reality you can say that money creates an immediate double coincidence of wants.

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95) The general formula for the number of prices is n ( n − 1)/2 where n = the number of goods. Since we have 100 people each producing one good, we have 100 goods, so n = 100. Plugging this into our formula, we obtain: 100(99)/2 = 4,950.Therefore, there will be 4,950 relative prices. 96) No; there are many assets that fall into the category of financial assets that are good stores of value, these include bonds and stocks. What distinguishes money is that it is liquid, meaning it can immediately serve as a means of payment. This is not true of other assets, which must be converted to spendable form. Moreover, it can be costly to turn a bond or stock into a means of payment, especially if it must be done on short notice. 97) Commodity money, such as gold or silver, has value even if it is not used as money. For example, gold coins could be melted down and converted to jewelry. Fiat money, such as U.S. paper currency, really has no value other than its use as money. Its value derives from the fact that it is deemed to be legal tender by the U.S. government, along with people's willingness to accept it. 98) While the Confederate government was printing this currency in increasing amounts, the prices in the South undoubtedly were rising. Any time currency is made increasingly available the eventual result will be higher prices. In addition, when the war ended and the Confederate states lost, the currency was basically worthless since there was no government that could guarantee its value. It was probably the case that as it was becoming clearer to people living in Confederate states that the outcome of the war was not going to be in their favor, it would not have been surprising if the people relied less on the currency and more on barter.

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99) The check itself is never money; rather it is the balances on deposit that represent money. Therefore the $1,000 was money when it was in your checking account and that $1,000 will be money again when the Federal Reserve credits the reserve account of the bank receiving the check (and debits your bank's reserve account). 100) A credit card isn't money for a few reasons. One, it is not an asset. The use of a credit card actually creates a liability for the user. A credit card is a promise by a bank to lend the cardholder money with which to make purchases. The store supplying the goods being purchased receives money, but the money that is used does not belong to the buyer. The credit card provides the cardholder with access to someone else's money. 101) A debit card works the same way as a check, in that it provides the bank with instructions to transfer funds from the cardholder's account to the merchant's account. The debit cardholder must have adequate funds in their checking account to cover the purchase. A credit card is a promise by a bank to lend the cardholder money with which to make purchases. The store supplying the goods being purchased receives money, but the money that is used does not belong to the buyer, the credit card provides the cardholder with access to someone else's money. 102) Ranked from most liquid to least liquid: (1) currency; (2) checking account deposits; (3) savings accounts; (4) common Stock; (5) houses; (6) art. 103) The period 1990–2009. During the period 1960–1980, inflation often rose to more than 5 percent; during the period 1990–2000, it rarely did. 104) small denomination time deposits, plus savings deposits and money market deposit accounts and retail money market mutual fund shares

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105) From 1960 to 1980 the growth rates of the two money measures did move together. After 1980 M1 behaved very differently than M2. The main reason for this seems to be the high rates of inflation that began in the late 1970s and fostered innovation into other types of accounts that people could hold to earn a higher return and yet were relatively liquid, such as money market accounts. 106) Empirical research mentioned in the chapter shows that across many countries, high rates of growth in M2 were associated with high rates of inflation and relatively low growth rates in M2 in many countries also were associated with low rates of inflation. For this reason many economists believe that, at least for moderate inflation rates, controlling inflation means controlling the money growth. 107) From 1960 to 1980 it seemed that the growth of M2 was a good tool to forecast inflation, with a two-year lag; in fact the correlation was over 0.5. For the years 1990 to 2016 this does not seem to be the case, in fact the correlation was 0. There is no clear explanation for why the growth of M2 has ceased being a good forecast tool for inflation, but there are some ideas economists are researching. 108) The CPI is measured using a fixed-expenditure-weight index. As a result, when the price of a good included in the index increases, the assumption is that people continue to purchase the same quantity of this item when in reality many consumers (to whatever degree possible) may stop purchasing this item and select a lower-priced substitute. This substitution toward a lower-priced good is not reflected in the reported CPI.

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109) The CPI is designed to answer the following question: How much more would it cost for people to purchase today the same basket of goods and services they bought at some fixed time in the past? A CPI of 240 means that it takes $240 today to buy the market basket that cost $100 in the base year. 110) Substitution bias is an overstatement of inflation by the CPI that comes from the fact that the calculation of the index is based on the assumption of an unchanging market basket of goods and services. Since prices do not all rise at the same rate (and some may not rise or may even fall), people can avoid some inflation by changing their spending pattern, that is, substituting lower-priced goods in place of those whose prices have risen. In order to take this into account, the BLS now changes the weights used in the CPI every two years, and today's CPI is a much more accurate measure of inflation. 111) Investors began to doubt the value of a wide class of securities so market liquidity for those instruments disappeared and financial institutions that held them faced large losses. In turn, funding liquidity for these institutions dried up as the potential losses caused their lenders to be worried about their safety. 112) This is occurring because efficient payments systems continue to evolve and seek easier and cheaper ways to pay for things.

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113) Payments would be far easier and efficient in Duos. With fewer goods to be traded, the likelihood of reaching a double coincidence of wants would be greater. Also, with fewer goods being produced, the need for specialization is not as great as it would be in Varietas. With 80 different goods, people in Varietas are likely to be specialized. Also, with many different goods, the need for information is much greater in Varietas. Duos would have one relative price, 1 = 2(2 − 1)/2. Varietas would have thousands of relative prices: 3,160 = 80(80 − 1)/2. This suggests that quoting prices and recording debts would be easier in Duos. Varietas would benefit more from adopting money, for the reasons cited above. 114) Historically, the United States adopted the use of gold as a currency (or as a way to back paper notes) because people had grown suspicious of the use of fiat money. During the Revolutionary War, the Continental Congress issued Continentals that became worthless with rising inflation. Using gold to back currency gave the public trust in the government's ability and desire to protect its value (e.g., to prevent rising inflation). Today, the currency printed by the United States Treasury Bureau of Engraving and Printing is fiat money. That is, it has little or no intrinsic value. The general public is willing to use this fiat money because it trusts the government's promise to protect its value. People have an expectation that they will be able to use the existing currency to pay for goods and services. 115) The Continental Congress issued continentals in 1775 to finance the Revolutionary War. The French Revolutionary Government issued assignats in 1793. The inflation rates during both historical episodes increased. The money supply is linked to the economy's inflation rate. As the money supply grows at a faster rate, the inflation rate rises.

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116) At first it seems the Treasury could buy one hundred dollars’ worth of goods for an actual cost of less than fourteen cents, the cost of printing the note. Plus the Treasury can avoid having to borrow to finance the difference between tax receipts and expenditures. But what may be profitable for the Treasury can be very harmful to the economy. The printing of this additional currency can have many serious consequences. The additional currency will increase the money supply, which can fuel higher prices, lowering the real purchasing power of money. If the problem becomes large enough it can actually make people reluctant to accept the currency as a means of payment and they would revert to increased use of barter which can make the economy less efficient. 117) Obviously neither the famous American nor her bank is paying for the vacation since the checks are never presented for payment. On the other hand, the famous American is providing the people on the island with additional money, which they seem very comfortable using. As a result, the money supply on the island has increased by the amount of these checks. One result of the added money will be inflation, so islanders will see the real purchasing power of their money decrease, thus their loss in real purchasing power has been used to pay for the famous American's vacations.

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CHAPTER 3 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A financial intermediary A) is an agency that guarantees a loan. B) is a third party that facilitates a transaction between a borrower and a lender. C) would be used in direct finance. D) must be a depository institution.

Most individuals borrow A) directly without the use of a financial intermediary. B) using a financial intermediary because it lowers the cost of borrowing. C) using a financial intermediary, but would save money if they financed directly. D) without using financial intermediaries, preferring credit cards.

Tom obtains a car loan from Old Town Bank. The car loan is Tom’s A) asset and the bank's liability. B) asset, but the liability belongs to the bank's depositors. C) liability and an asset for Old Town Bank. D) liability and a liability of the bank until Tom pays it off.

The ultimate role of the financial system of a country is to A) provide a place for wealthy households to save. B) be a low-cost source of funds for government. C) facilitate production, employment, and consumption. D) provide jobs in the financial sector.

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5) Susie buys a share of Alphabet stock through her broker, Mr. Diaz, who works for Acme Investing and purchases the stock at the New York Stock Exchange. In this transaction, __________ is a financial instrument, __________ is a financial institution, and __________ represents a financial market. A) Financial Instrument Alphabet stock

Financial Institution Acme Investing

Financial Market New York Stock Exchange

Financial Institution New York Stock Exchange

Financial Market Alphabet stock

Financial Institution New York Stock Exchange

Financial Market Acme Investing

Financial Institution Alphabet stock

Financial Market New York Stock Exchange

B) Financial Instrument Acme Investing

C) Financial Instrument Alphabet stock

D) Financial Instrument Acme Investing

Loans made between borrowers and lenders are A) liabilities to the lenders and assets to the borrowers since the borrower obtains the

funds. B) assets to the lenders and liabilities of the borrowers since the promises are made to the lenders. C) not part of either parties' assets or liabilities until the loans are repaid. D) liabilities to both the lenders and the borrowers.

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Financial instruments are used to channel funds from A) savers to borrowers in financial markets and via financial institutions. B) savers to borrowers in financial markets but not through financial institutions. C) borrowers to savers in financial markets but not through financial institutions. D) borrowers to savers through financial institutions, but not in financial markets.

Loans made between borrowers and lenders are A) usually not taxable at the federal level. B) legal only in the state of origination. C) assets of the lenders. D) assets of the borrowers.

Loans made between lenders and borrowers are A) assets to the borrowers. B) liabilities of the lenders. C) not taxable in the state of origination. D) liabilities of the borrowers.

10)

The process of financial intermediation A) creates a net cost to an economy. B) increases the economy's ability to produce. C) is always used when a borrower needs to obtain funds. D) is used primarily in underdeveloped countries.

11)

Financial intermediaries are

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A) banks. B) firms that provide access to the financial markets. C) insurance companies. D) essential to direct finance.

12)

Financial intermediaries A) can be banks, but not all financial intermediaries are banks. B) must be public corporations. C) are insurance companies. D) are government agencies.

13)

Which one of the following is not a financial intermediary? A) a bank B) an insurance company C) the New York Stock Exchange D) a mutual fund

14)

Mary purchases a U.S. Treasury bond. The bond is a(n) A) asset of the U.S. government as well as an asset for Mary. B) liability of the U.S. government and an asset for Mary. C) liability of the U.S. government as well as a liability for Mary. D) asset for the government but a liability for Mary.

15)

A financial instrument would include

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A) only a written obligation and a transfer of value. B) only a written obligation and a specified date. C) a written obligation, a transfer of value, a future date, and certain conditions. D) a written obligation, a transfer of value, a specific date for payment, and undefined conditions.

16)

Which one of the following is not a financial instrument? A) a share of Microsoft stock B) a U.S. Treasury bond C) an electric bill D) a life insurance policy

17)

Sue has a checking account at the First National Bank. Her checking account is a(n) A) asset to the bank and a liability to Sue. B) asset to Sue and a liability to the bank. C) asset to Sue but actually a liability to the Federal Reserve. D) liability to Sue until she spends the funds.

18)

Financial instruments and money both can function A) as a means of payment and a store of value. B) as a store of value and allow for trading of risk. C) by acting as a means of payment and allow for trading of risk. D) as a store of value even though they do not allow for trading of risk.

19)

Financial instruments are different from money because they

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A) can act as a store of value and money cannot. B) can't be a means of payment but money can. C) can allow for the transfer of risk. D) have greater liquidity.

20)

Juan purchases automobile insurance. The insurance contract is a A) financial instrument. B) form of money. C) transfer of risk from the insurance company to Juan. D) financial intermediary.

21) The listed concepts relate most closely to which part of the financial system? counterparty, asymmetric information, bank loans, options, mortgages, stock A) types of money B) financial instruments C) financial markets D) financial institutions

22) The listed concepts relate most closely to which part of the financial system? risk sharing, centralized exchanges or markets, electronic communication networks, bid price, collateral, ask price A) types of money B) financial instruments C) financial markets D) financial institutions

23) The listed concepts relate most closely to which part of the financial system? insurance companies, pension funds, securities firms, finance companies, direct finance, assets

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A) types of money B) financial instruments C) financial markets D) financial institutions

24) A bank is a financial intermediary that, at a fundamental level, facilitates borrowing and lending between which parties? A) The bank’s depositors are lenders and the bank is the borrower. B) People seeking loans from the bank are the borrowers while the bank is the lender. C) The bank's depositors are the lenders, while those seeking loans from the bank are the borrowers. D) Those seeking loans from the bank are the borrowers while the bank's stockholders are the lenders.

25)

Financial instruments A) are created to transfer risks that are difficult to predict. B) are created to transfer risks that are relatively easy to predict. C) require certainty of an event to be able to transfer risk. D) eliminate the risk from uncertainty, they do not transfer it.

26) Which one of the following has contributed to the standardization of financial instruments? A) rule of 70. B) law of demand. C) economies of scale. D) law of supply.

27)

More detailed financial instruments tend to be

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A) less costly because all possible contingencies are covered. B) more costly because they will cost more to create. C) more desirable than less detailed ones, no matter what the price. D) less costly because they can be standardized more easily.

28)

Many financial instruments are standardized because A) it is believed that most parties to a contract do not read them anyway. B) complexity is costly, the more complex a contract, the more it costs to create. C) the standardization of contracts makes them harder to understand. D) it is required by the government.

29)

A share of Ford Motor Company stock is an example of A) a nonstandardized financial instrument. B) a standardized financial instrument. C) a debt-based financial instrument. D) a financial instrument without risk.

30)

A counterparty to a financial instrument is always the A) issuer of the financial instrument. B) government agency guaranteeing the value of the instrument. C) person or institution that purchases the financial instrument. D) person or institution that is on the other side of the financial contract.

31)

Any entity on the other side of a financial transaction is

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A) the counterparty. B) the borrower. C) assuming all of the risk. D) responsible for providing full information.

32)

The information concerning the issuer of a financial instrument

A) needs to be complete and closely monitored by the buyers of the instrument for change. B) is somewhat non-standardized to minimize the cost of the instrument. C) is usually standardized to the essential information required by the buyers. D) is closely monitored by the buyers of these instruments for change.

33) from

Asymmetric information in financial markets is a potential problem usually resulting

A) borrowers having more information than the lenders. B) lenders having more information than borrowers. C) the fact that people are basically dishonest. D) the uncertainty about Federal Reserve monetary policy.

34) Bond rating agencies rate bonds based on characteristics of the borrower. These agencies are an example of a financial market response designed to A) increase information asymmetry. B) decrease the real return to bondholders. C) provide a lower cost solution to the high cost of information. D) transfer risk from the buyer to the rating agency.

35)

The better the information provided to financial markets, the

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A) less the amount of funds transferred between savers and borrowers. B) greater the amount of funds transferred between savers and borrowers, though risk increases. C) higher the return required by lenders. D) greater will be the flow of funds in these markets.

36)

Financial markets enable the transfer of risk by

A) requiring that risk-averse investors have access to U.S. Treasury bond markets. B) allowing individuals and firms less willing to bear risk to transfer risk to other individuals and firms more willing to bear risk. C) making sure that higher default risk is offset by greater liquidity. D) enabling even unsophisticated investors to purchase highly complex financial instruments.

37)

If a borrower has information that is not available to a prospective lender, there is A) a trading algorithm. B) a transfer of risk. C) information asymmetry. D) liquidity risk.

38)

Disability income insurance is insurance that

A) borrowers can take out in case the company they invest in defaults. B) makes payments of wages to workers when the company they work for is disabled due to a natural disaster. C) makes payments to workers when they are unable to work due to an injury. D) is only available through the government as part of the Social Security System.

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39) The owner of a small business applies for a bank loan and tells the loan officer that the funds will be used to expand inventory for the upcoming holiday season. The small business finds itself in need of additional funds to meet the monthly rent for the next quarter, and the owner uses the loan proceeds to pay the rent. This is an example of A) liquidity risk. B) default risk. C) a lack of diversification for the bank. D) information asymmetry.

40)

A share of Microsoft stock would best be described as which one of the following? A) a derivative instrument B) a means of payment C) an underlying instrument D) a debt instrument

41)

A derivative instrument A) comes into existence after the underlying instrument is in default. B) is a low-risk financial instrument used by highly risk-averse savers. C) gets its value and payoff from the performance of the underlying instrument. D) should be purchased prior to purchasing the underlying security.

42)

A futures contract is an example of A) a derivative instrument. B) an instrument used solely by financial institutions. C) a high-risk security that will only have value if certain events occur. D) a contract that is traded but is not a financial instrument.

43)

The primary use of derivative contracts is

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A) for IRA and other pension plans since they only have value well into the future. B) to shift risk among investors. C) for investors seeking a greater return by taking greater risk. D) to add to the profits an investor obtains through information asymmetry.

44) Considering the value of a financial instrument, the bigger the size of the promised payment the A) less valuable the financial instrument because risk must be greater. B) longer an investor has to wait for the payment. C) more valuable the financial instrument. D) greater the risk.

45) the

Considering the value of a financial instrument, the sooner the promised payment is made

A) less valuable is the promise to make it since time is valuable. B) greater the risk, therefore the promise has greater value. C) more valuable is the promise to make it. D) less relevant is the likelihood that the payment will be made.

46) Considering the value of a financial instrument, the more likely it is the payment will be made the A) more valuable the financial instrument. B) less valuable is the instrument because risk is lower. C) less valuable is the financial instrument because it is highly liquid. D) greater the uncertainty; therefore the less valuable is the financial instrument.

47) Considering the value of a financial instrument, the circumstances under which the payment is to be made influence the value because Version 1

A) we like uncertain payoffs because this adds to the return. B) payments that are made when we need them the most are more valuable. C) the sooner the payment is to be made the better. D) we know when certain events are going to occur and that is when we want the payment.

48) The fundamental characteristics influencing the value of a financial instrument include each of the following except A) the size of the payment promised. B) when the promised payment will be made. C) where the instrument is traded. D) the likelihood of payment.

49)

The value of a financial instrument rises as A) the size of the payment promised decreases. B) the promised payment is made sooner rather than later. C) it is less likely the payment will be made. D) the payments are made when the prospective investor needs them least.

50) Consider the price paid for debt issued by the State of California. Which one of the following would lead to a decrease in the value of State of California bonds? A) The State of California bonds are in small dollar amounts. B) The State of California bonds have a shorter maturity. C) The State of California experiences a fiscal crisis that makes it less likely it will be able to honor its interest payments. D) The State of California pays back its previous bonds ahead of schedule.

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51) Financial instruments used primarily as stores of value include each of the following, except A) bonds. B) futures contracts. C) stocks. D) home mortgages.

52)

Financial instruments used primarily as stores of value would not include A) a car insurance policy. B) a U.S. Treasury bond. C) shares of General Motors stock. D) a home mortgage.

53) Financial instruments used primarily to transfer risk would include all of the following, except A) an insurance contract. B) a futures contract. C) options. D) a bank loan.

54)

Financial instruments used primarily to transfer risk would not include A) a bank loan. B) options. C) an insurance policy. D) home mortgages.

55)

Which type of financial instrument is used mainly to transfer risk?

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A) asset-backed securities B) bonds C) options D) stocks

56)

Financial instruments used primarily as stores of value do not include A) asset backed securities. B) U.S. Treasury bonds. C) a car insurance policy. D) a bank loan.

57)

Which one of the following is a familiar type of asset-backed security? A) shares of stock in corporations B) securities backed by home mortgages C) U.S. Treasury bonds D) movie box-office receipts

58)

Financial markets contribute to all of the following except which one? A) elimination of risk B) providing liquidity C) pooling and communicating information D) sharing of risk

59)

If financial markets did not exist

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A) required returns would be lower since fewer instruments would trade. B) liquidity would diminish and returns would be lower. C) more funds would flow directly between borrowers and savers. D) liquidity would diminish, reducing the flow of funds between borrowers and savers.

60) The high volume of shares of stock that are traded on a normal day on stock markets reflects the A) high transaction costs associated with these financial markets. B) low transaction costs and high liquidity associated with these markets. C) low transaction costs and low liquidity associated with these markets. D) high transactions costs and low liquidity associated with these markets.

61)

The pool of information collected by financial markets is usually A) only available to lenders. B) summarized in the form of a price. C) valuable and not made available until the parties pay for it. D) more than a borrower needs to make a loan.

62)

Financial markets

A) enable buyers and sellers to exchange financial instruments but not risk. B) enable buyers and sellers to exchange risk by buying and selling financial instruments. C) allow the transfer of risk only through derivative securities. D) do not allow for the transfer of risk but do help reduce it.

63)

Commissions paid to a stock broker are an example of

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A) risk transfer. B) transaction costs. C) information asymmetry. D) liquidity.

64)

Brokerage commissions

A) are set by government regulators so they cannot vary across firms for the same services. B) can vary but typically don't because firms tend to set them at the same levels. C) can differ reflecting the different services being offered. D) are always a percentage of the amount of the trade.

65)

A primary financial market is A) a market just for corporate stocks. B) a market only for AAA rated Securities. C) the New York Stock Exchange. D) one in which newly issued securities are sold.

66)

A primary financial market is

A) located only in New York, London, and Tokyo but can handle transactions anywhere in the world. B) one where the borrower obtains funds directly from the lender for newly issued securities. C) a market where U.S. Treasury bonds are traded. D) one that can only deal in the highest investment grade securities.

67)

Newly issued U.S. Treasury Securities are sold

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A) in the primary financial market. B) only to the Federal Reserve who then resells them. C) in the secondary market since bonds cannot be sold in the primary market. D) in secondary markets but only using registered bond dealers.

68) The figure shown here illustrates the flow of funds through financial institutions. The labels for the types of financial institutions and the major actors in this process are missing. Choose the option that identifies the correct labels for the types of financial institutions and where these labels go in the figure.

A) 1. Saver-Lenders and 3. Spender-Borrowers B) 2. Spender-Borrowers and 4. Saver-Lenders C) 1. those that act as Brokers and 3. those that transform Assets D) 2. those that transform Assets and 4. those that act as Brokers

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69) The figure shown here illustrates the flow of funds through financial institutions. The labels for the types of financial institutions and the major actors in this process are missing. Choose the option that identifies the correct labels for the major actors in this process and where these labels go in the figure.

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70) The figure shown here illustrates the flow of funds through financial institutions. The labels for the types of financial institutions and the major actors in this process are missing. Consider the flows of funds and financial instruments in the figure. What is the difference between financial institutions that act as brokers and those that transform assets?

A) Broker institutions facilitate indirect finance while institutions that transform assets facilitate direct finance. B) Broker institutions facilitate direct finance while institutions that transform assets facilitate indirect finance. C) Broker institutions sell stocks, bonds, and insurance policies while institutions that transform assets sell real estate. D) Broker institutions sell real estate while institutions that transform assets sell stocks, bonds, and insurance policies.

71)

Most of the buying and selling in primary markets

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A) is in the public view. B) is highly transparent and closely monitored by the SEC. C) involves an investment bank. D) is done by the Federal Reserve.

72)

Secondary financial markets A) are financial markets for all financial instruments rated less than investment grade. B) are financial markets where existing securities are bought and sold. C) eliminate the transaction costs for buyers and sellers. D) are only for stock.

73)

A collection of assets is known as a(n) A) asset-backed security. B) derivative. C) futures contract. D) portfolio.

74) Which one of the following would not be an example of a secondary financial market transaction? A) You call a broker and purchase 100 shares of McDonald's Corp. stock. B) You go to the bank and purchase a $5,000 certificate of deposit. C) You call a broker and purchase a U.S. Treasury bond. D) You call a broker and purchase a bond issued by General Motors.

75)

Which one of the following is likely to be a primary financial market transaction?

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A) You cash the check your grandmother sent you for your birthday. B) You call a broker and purchase bonds for your retirement fund. C) A city issues bonds to finance new road construction. D) A supermarket needs to borrow the funds for a second location and takes out a loan from a commercial bank to pay for it.

76)

An over-the-counter (OTC) market is A) made up of dealers who only sell government bonds. B) an example of a centralized market. C) made up of dealer who buy and sell only for their own accounts. D) made up of dealers who buy and sell for their customers and for their own accounts.

77)

The New York Stock Exchange (NYSE) originated as A) a decentralized electronic market made up of dealers all over the world. B) an example of a centralized exchange. C) a financial market where nearly 100 million shares of stock are traded every business

day. D) the only centralized stock exchange in the world.

78)

Over-the-counter (OTC) markets A) employ specialists to minimize price volatility. B) are centralized exchanges but you must be a dealer to be part of an exchange. C) only deal in the stocks of companies with over $100 million in capital. D) are networks of security dealers linked electronically.

79)

Which one of the following is not true of over-the-counter markets?

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A) Traders are linked by computer. B) Dealers buy and sell only for their customers. C) Trading does not take place in one physical location. D) Traders are willing to buy and sell stocks and bonds at posted prices.

80)

Equity markets are markets A) of U.S. Treasury bonds. B) for AAA rated bonds. C) for stocks. D) for either stocks or bonds.

81)

Debt instruments that have maturities less than one year are traded in the A) primary market exclusively. B) bond markets exclusively. C) bond market if they are already in existence. D) money market.

82)

Money markets are where trades occur for A) stocks. B) bonds of all maturities. C) derivatives. D) short-term bonds issued by both governments and private companies.

83) All of the following are examples of the types of problems that can exist when trading on decentralized electronic exchanges, except which one?

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A) Customer orders are not executed quickly. B) Not all bid and offer prices are available prior to the trade. C) Systemic fragility and the presence of high frequency traders may reduce liquidity. D) Trading algorithms can inadvertently lead to price volatility.

84)

Well-run financial markets A) keep transactions costs high to benefit brokers. B) prevent the widespread pooling of information. C) ensure that resources are allocated efficiently. D) are usually the result of little or no government regulation.

85)

Countries that lack well-defined property laws and legal structures

A) have large secondary financial markets because the primary markets do not exist. B) will not develop as fast economically as counties with clear property rights and a formal legal system. C) will have much lower transaction costs associated with any level of lending. D) will not have any financial markets at all.

86)

Financial institutions A) raise the level of transaction costs relating to borrowing/lending. B) can lower the information asymmetry involved with borrowing/lending. C) decrease the liquidity to savers. D) are required for all financial transactions.

87)

An insurance company is an example of a financial institution that

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A) transfers risk. B) acts as a broker. C) serves as a depository institution. D) sells derivative securities.

88)

All of the following are depository institutions, except A) commercial banks. B) credit unions. C) insurance companies. D) savings banks.

89)

Which of the following are depository institutions? A) credit unions B) mutual funds C) pension funds D) insurance companies

90)

Nondepository institutions A) do not serve as intermediaries. B) only serve as brokers. C) only transform assets. D) do not accept deposits.

91)

Nondepository institutions would include all of the following except

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A) finance companies. B) pension funds. C) insurance companies. D) credit unions.

92) Small savers would rather use financial institutions than lend directly to borrowers because A) financial institutions will offer the savers higher interest rates than the savers could obtain directly from borrowers. B) lenders wouldn't want to deal with small savers. C) it allows them to diversify risk. D) the liquidity is lower with financial institutions but the return is higher.

93)

Financial intermediaries pool funds of A) many small savers and provide it to a few large borrowers. B) few large savers and provide it to many small borrowers. C) few large savers a few large borrowers. D) many small savers and provide it to many borrowers.

94) Financial intermediaries handle a larger flow of funds than do primary markets mainly because financial intermediaries A) have a government-provided monopoly. B) have government-regulated prices, so there is little competition. C) can lower transaction costs and increase liquidity for savers. D) do not have to worry about information asymmetry.

95)

Derivative markets exist to allow for

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A) the transfer of risk. B) direct transfers of common stocks for bonds. C) cash receipts from the sale of bonds. D) reduced information asymmetry.

96)

Financial intermediaries include each of the following, except A) the New York Stock Exchange. B) credit unions. C) savings banks. D) commercial banks.

97)

Which of the following is not considered to be a shadow bank? A) credit unions B) brokerages C) insurers D) money-market mutual funds

98) As the historical gap between direct and indirect finance has narrowed, the primary distinction between direct and indirect finance today is in who owns the underlying asset. In direct finance, A) the asset holder has a claim on a financial institution while in indirect finance the asset holder has a direct claim on the borrower. B) the lender has a claim on a financial institution while in indirect finance the lender has a direct claim on the borrower. C) the asset holder has a direct claim on the borrower while in indirect finance the asset holder has a claim on a financial institution. D) asset holder has a direct claim on a private sector corporation while in indirect finance the asset holder has a claim on the government.

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99)

Derivatives would include all of the following except A) options. B) U.S. Treasury securities. C) swaps. D) futures.

100) Reasons for the rapid structural change in financial markets in recent years include all of the following except A) globalization. B) technological advances in computing. C) technological advances in communication. D) high real interest rates.

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 101) How are financial market development and economic growth related?

102)

What are the four characteristics of a financial instrument?

103) Briefly explain one function of financial instruments that can make them very different from money.

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104) Explain why most financial instruments are fairly complex, while at the same time quite standardized.

105) Credit cards usually charge higher rates of interest than most other forms of lending. In terms of information, collateral, and monitoring, how might these higher rates be explained?

106) Why might a life insurance company insist on an individual having a physical exam before agreeing to provide life insurance to the individual?

107) An annuity is a contract that makes monthly payments as long as someone lives. Explain why an individual would want to purchase such a contract. What risk is being transferred?

108)

Why are options referred to as derivative instruments?

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109) What are the four fundamental characteristics that determine the value of a financial instrument?

110) Ceteris paribus, how would each of the four fundamental characteristics that determine the value of a financial instrument need to change to increase the value of a financial instrument?

111) A high-school basketball player decides to bypass college and go right into the NBA (the National Basketball Association). Describe the risk the individual is taking and describe a contract that might transfer the risk.

112) Describe what is likely to happen to the average price of a share of stock if the stock markets decide to close every Friday and Monday to provide workers at the exchanges with longer weekends.

113) Consider a typical individual who owns the following financial instruments: A life insurance policy for $250,000; a certificate of deposit for $10,000; homeowner's and auto insurance policies; $50,000 in a mutual fund, and $150,000 in her pension fund at work. Which of these are instruments used primarily as stores of value and which are being used to transfer risk?

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114) The primary business of Standard & Poor's is the selling of information to investors. Is this an example of a financial intermediary? Explain.

115) Consider a typical individual who owns the following financial instruments: A life insurance policy for $250,000; a certificate of deposit for $10,000; homeowner's and auto insurance policies; $50,000 in a mutual fund, and $150,000 in her pension fund at work. Which of these are instruments used primarily as stores of value and which are being used to transfer risk?

116) Explain how the introduction of asset-backed securities has allowed investors to take advantage of higher returns from loans that most investors could never make on their own.

117) How do financial markets pool and communicate the information regarding issuers of financial instruments in a convenient way?

118) Can a financial instrument be bought and sold in both a primary and secondary financial market? Explain. Version 1

119)

What is the primary distinction between debt/equity markets and derivative markets?

120) Why didn't the over-the-counter (OTC) exchanges suffer the disruption of service that the New York Stock Exchange did after the terrorist attacks of September 11, 2001?

121)

What is the primary distinction between debt/equity markets and derivative markets?

122)

What are some of the advantages of trading in decentralized electronic exchanges?

123)

Why has the pace of structural change in financial markets accelerated in recent years?

124)

What are some of the advantages of trading in decentralized electronic exchanges?

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125) As we saw in the chapter, some financial instruments are used primarily to transfer risk. Explain how a bread maker can use a financial instrument to transfer the following risk: the bread maker has the opportunity to provide bread to a local army base. The base figures they will need 10,000 loaves of bread each week, or roughly 500,000 for a year. The problem is the baker must quote a price for the entire year. The baker would really like to have this contract but he realizes that fluctuating input prices (specifically wheat) could result in significant losses.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 126) Suppose that an internet-based program, Novus, wants to raise $10 million to expand its business operations. Describe how Novus can raise these funds directly through each of the follow options: issuing stock, issuing bonds, or obtaining a bank loan. Compare and contrast these three options.

127) Explain the various ways that financial intermediaries increase the efficiency of an economy.

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128) Compare and contrast financial institutions that act as brokers to those that transform assets. In what sense are both types of institutions financial intermediaries? Provide one example of each type and describe how each functions as a financial intermediary.

129) Trading in electronic exchanges has grown tremendously in recent years. What are some of the disadvantages of trading in decentralized electronic exchanges?

130) Uniqua wants to buy a camper to use when visiting national parks this summer. Her cousin Tyrone recently earned a windfall profit in a business venture with a partner, and Uniqua asked him if she could borrow $5,000 for a down payment on the camper. She proposed paying him 4% interest and paying the loan back over the next two years. Discuss the advantages and disadvantages to Tyrone of choosing to make the loan to Uniqua as opposed to loaning the money to Spectrum Communications, Inc. by buying a $5,000 corporate bond that pays the same amount of interest over that same time period.

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Answer Key Test name: Chap 03_6e 1) B 2) B 3) C 4) C 5) A 6) B 7) A 8) C 9) D 10) B 11) B 12) A 13) C 14) B 15) C 16) C 17) B 18) A 19) C 20) A 21) B 22) C 23) D 24) C 25) B 26) C Version 1

27) B 28) B 29) B 30) D 31) A 32) C 33) A 34) C 35) D 36) B 37) C 38) C 39) D 40) C 41) C 42) A 43) B 44) C 45) C 46) A 47) B 48) C 49) B 50) C 51) B 52) A 53) D 54) A 55) C 56) C Version 1

57) B 58) A 59) D 60) B 61) B 62) B 63) B 64) C 65) D 66) B 67) A 68) C 69) C 70) B 71) C 72) B 73) D 74) B 75) C 76) D 77) B 78) D 79) B 80) C 81) D 82) D 83) A 84) C 85) B 86) B Version 1

87) A 88) C 89) A 90) D 91) D 92) C 93) D 94) C 95) A 96) A 97) A 98) C 99) B 100) D 101) A country's economic growth is linked to financial market development. As the text points out, a country's financial system has to grow as its level of economic activity rises, or the country will stagnate. Economic research has shown that there is strong positive correlation between financial market development and economic growth across countries. 102) (1) A financial instrument is a written legal obligation; (2) a financial instrument transfers something of value to another party; (3) a financial instrument specifies some future date for this transfer to occur; and (4) a financial instrument specifies certain conditions under which payment will be made.

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