Central Banking Review Questions
Course Introduction
This course provides an in-depth exploration of the structure, functions, and policy roles of central banks within the modern financial system. Key topics include the formulation and implementation of monetary policy, supervision and regulation of financial institutions, and the role of central banking in maintaining financial stability. The course also examines the tools and strategies utilized by central banks to manage inflation, stimulate economic growth, and respond to financial crises. Through case studies and analysis of global central banks such as the Federal Reserve, European Central Bank, and others, students will gain a comprehensive understanding of central bankings impact on both domestic and international economies.
Recommended Textbook Money Banking and Financial Markets 3rd Edition by Stephen G. Cecchetti
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23 Chapters
2744 Verified Questions
2744 Flashcards
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Chapter 1: An Introduction to Money and the Financial System
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Sample Questions
Q1) Why do banks usually offer higher rates of interest to savers willing to provide their savings to the bank for a longer period of time? To which core principle does this relate?
Answer: It isn't so much that banks want to offer the higher rates, but time has value, and the banks realize that in order to use other people's money for longer periods of time, they must pay them more.
Q2) 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
Answer: C
Q3) 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
Answer: C
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Chapter 2: Money and the Payments System
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Sample Questions
Q1) There are three goods produced in an economy by three individuals: Answer: \(\begin{array} { l l }
{ \text { Good } } & { \text { Producer } } \\
\text { Oranges } & \text { Orchard owner } \\
\text { Bread } & \text { Baker } \\
\text { Chocolate } & \text { Candy Maker } \end{array}\) If the orchard owner likes only bread, the baker likes only chocolate, and the candy maker likes only oranges, will any trade between these three persons take place in a barter economy? Explain.
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 he/she wants; for example, the baker will have to trade bread with the orchard owner to get oranges, to then be able to trade with the candy maker to obtain the chocolate that he/she really wants.
Q2) Why are electronic transactions increasingly taking the place of paper transactions? Answer: Because efficient payments systems continue to evolve and seek easier and cheaper ways to pay for things.
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Sample Questions
Q1) 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
Answer: D
Q2) Financial instruments are different from money because:
A)They can act as a store of value and money cannot
B)They can't be a means of payment but money can
C)They can allow for the transfer of risk
D)They have greater liquidity
Answer: C
Q3) Is the obtaining of a car loan a primary or secondary market transaction?
Answer: The obtaining of a car loan is a primary market transaction since the loan represents a newly-issued instrument by the bank.
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Chapter 4: Future Value, Present Value, and Interest Rates
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Sample Questions
Q1) The price of a coupon bond is determined by:
A)Taking the present value of the bond's final payment and subtracting the coupon payments
B)Taking the present value of the coupon payments and adding this to the face value
C)Taking the present value of all of the bond's payments
D)Estimating its future value
Q2) A coupon bond is a bond that:
A)Always sells at a price that is less than the face value
B)Provides the owner with regular payments
C)Pays the owner the sum of the coupons at the bond's maturity
D)Pays a variable coupon rate depending on the bond's price
Q3) Compound interest means that:
A)You get an interest deduction for paying your loan off early
B)You get interest on interest
C)You get an interest deduction if you take out a loan for longer than one year
D)Interest rates will rise on larger loans
Q4) Explain why an increase in expected inflation will result in an increase in nominal interest rates, holding other factors constant.
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Chapter 5: Understanding Risk
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Sample Questions
Q1) Uncertainty associated with the expected rate of return on an individual stock reflects all of the following except:
A)Idiosyncratic risk
B)Changes in the performance of the individual company relative to others
C)Change in macroeconomic conditions
D)Systematic risk
Q2) Spreading involves:
A)Finding assets whose returns are perfectly negatively correlated
B)Adding assets to a portfolio that move independently
C)Investing in bonds and avoiding stocks during bad times
D)Building a portfolio of assets whose returns move together
Q3) An investment with a large spread between possible payoffs will generally have:
A)A low expected return
B)A high standard deviation
C)A low value at risk
D)Both a low expected return and a low value at risk
Q4) Explain the rapid rise in popularity of mutual funds.
Q5) Discuss how well financial markets would work if people all had the exact same tolerance for risk.
Q6) Why isn't it correct to say that people who are risk averse avoid risk?
Page 7
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Sample Questions
Q1) When the price of a bond equals the face value:
A)The yield to maturity will be above the coupon rate
B)The yield to maturity will be below the coupon rate
C)The current yield is equal to the coupon rate
D)The yield to maturity is greater than the current yield
Q2) Which of the following is not a reason why the yield to maturity can differ from the current yield?
A)Because the yield to maturity considers the capital gain/loss
B)Because the current yield focuses only on the coupon payment and the purchase price
C)Because most bonds are not purchased for face value
D)Because the current yield moves in the opposite direction from price
Q3) The holding period return has relevance because:
A)Most bonds are held by the original purchaser until maturity
B)Most bonds are held by the original purchaser until they mature
C)Bonds are frequently traded
D)Current yields are not that important to bondholders
Q4) Use the example of a consol to show how bond prices and yields are inversely related.
Page 8
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Chapter 7: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) Which of the following statements pertaining to the yield curve is not true?
A) Yield curves usually slope upwards
B) The yield curve shows the difference in default risk between securities
C) The yield curve shows the relationship among bonds with the same risk characteristics but different maturities
D) The yield curve can be flat or downward sloping depending on market conditions
Q2) Most commercial paper is:
A) Issued with maturities exceeding one year
B) Issued with maturities between 50 and 75 days
C) Used exclusively for short-term financing needs
D) Issued by foreign companies doing business in the United States
Q3) Imagine a scandal that finds the officers of bond rating agencies have been taking bribes to inflate the rating of specific bonds. This should:
A) Have no impact on the bond market since bond markets are highly efficient
B) Decrease the demand for all bonds
C) Increase the demand for U.S. Treasury securities and decrease the demand for corporate bonds
D) Decrease the risk spread
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Chapter 8: Stocks, Stock Markets, and Market Efficiency
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Sample Questions
Q1) Stock market bubbles can lead to all of the following except:
A)An efficient allocation of resources.
B)Stock market crashes.
C)Patterns of volatile returns from the stock market.
D)Gaps between actual stock prices and those warranted by the fundamentals.
Q2) The impact from rapid dividend growth on a stock's current price will be:
A)Negative, since the company is paying out profits to stockholders.
B)Positive since rapid dividend growth causes stockholders to expect higher future dividends.
C)Zero; only current dividends are used to determine the current price of a stock.
D)Positive, but only if the corporation does not have any debt.
Q3) Identify the ways in which a bondholder's rights differ from those of a stockholder.In what ways do they differ when a firm is bankrupt?
Q4) Why isn't the actual level of an index, for example the Dow Jones Industrial Average, very useful on its own?
Q5) Discuss whether the economy would be more or less efficient if public corporations issued fewer shares of stock.
Q6) Why must caution be employed in comparing stock indexes across countries?
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Sample Questions
Q1) The primary risk in swaps is that:
A)Interest rates will not change.
B)One of the parties will default.
C)They are highly liquid and the market price will change.
D)High U.S.government deficits will limit the availability of swaps.
Q2) Derivatives are financial instruments that:
A)Present high levels of risk and should only be used by the wealthy.
B)When used correctly can actually lower risk.
C)Should only be used by people seeking high returns from low risk.
D)Represents the outright purchase of a bond.
Q3) Assume we have a stock currently worth $50.We also assume the interest rate is zero, and we can buy options for this stock with a strike price of $50.If the stock can rise or fall by $10 with equal probability over the option period, and the option cannot be exercised until the expiration date, what is the time value of the option?
A)$5
B)$10
C)$50
D)$40
Q4) Explain the difference between American and European options.
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Chapter 10: Foreign Exchange
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Sample Questions
Q1) Considering the dollar-euro market, as a dollar will purchase fewer euros, holding other factors constant:
A)This is represented by a downward movement along the supply of dollars curve
B)This would be represented by a leftward shift in the demand for dollars curve
C)This would be represented by a leftward shift of the supply of dollars curve
D)This is represented by a downward movement along the demand for dollars curve
Q2) Which of the following are reasons to supply dollars on the foreign exchange market?
A)To purchase goods and services produced abroad
B)To get a lower return paid on foreign currencies that is not subject to the risk associated with exchange-rate fluctuations
C)To invest in U.S.assets
D)To take advantage of higher inflation rates in other countries
Q3) Which of the following does not contribute to the failure of the law of one price?
A)Tariffs
B)Transportations costs
C)The fact that all goods can be traded
D)Technical specifications
Q4) Explain why the law of one price may best be applied to financial assets.
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Chapter 11: The Economics of Financial Intermediation
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Sample Questions
Q1) A borrower who obtains funds from a lender to purchase additional inventory but uses the funds to finance a trip to Las Vegas for a weekend of gambling at the opening of a new casino is an example of:
A)The problem of adverse selection
B)The free-rider
C)The moral hazard problem
D)Lax government regulation
Q2) When a bank takes savings from many small savers and lends it to many borrowers, the bank:
A)Decreases the risk to savers through diversification
B)Increases the risk to borrowers through high transaction costs
C)Decreases the risk to savers through economies of scale
D)Decreases the return to savers and increases the cost to borrowers
Q3) Most credit cards charge a relatively high rate of interest, yet many people carry them, including people who would be considered low-risk borrowers.Our discussion of adverse selection said that low-risk borrowers should have been discouraged from these What gives?
Q4) How did information asymmetries in the home mortgage market contribute to the financial crisis of 2007-2009?
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Chapter 12: Depository Institutions: Banks and Bank Management
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Sample Questions
Q1) A bank develops specialized skills in analyzing companies from one specific industry.This contributes significantly to the bank achieving economies of scale because a large portion of its total loan portfolio is made up of companies in this industry.What are the long-run profit prospects for this bank? Explain.
Q2) Considering that, on average, the return on assets is the same for small and large banks, and the return on equity is higher for large banks than small banks, what can be one of the explanations for the trend toward bank mergers?
Q3) Commercial banks differ from credit unions in the following way:
A)Credit unions focus on consumer loans while commercial banks primarily make loans to businesses
B)Credit unions make loans and accept deposits while commercial banks just make loans
C)Commercial banks cannot make auto loans to individuals, just to businesses while credit unions can do both
D)Credit unions do not have to hold reserves while commercial banks do
Q4) Explain why a bank with a high debt-to-equity ratio may be more profitable than a bank with a lower ratio but would also have a higher level of risk.
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Chapter 13: Financial Industry Structure
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Sample Questions
Q1) Explain why the decoding of the human genome has interesting implications for the life insurance industry.
Q2) Which of the following is an example that can help explain increased profits for large financial holding companies?
A)Financial holding companies offer a wide array of services under many brand names
B)Financial holding companies need only one CEO, one Board of Directors, and one computer system regardless of size
C)Financial holding companies are not well diversified and receive a higher return for the higher risk
D)Financial holding companies are exempt from having to pay for FDIC insurance
Q3) Prior to the Civil War most state banks issued their own banknotes.This resulted in all of the following problems except:
A)Their values decreased as the holder moved further from the bank
B)They were worthless if the bank failed
C)They were not efficient as a means of payment if the holder was far from the bank
D)They were usually redeemable in gold
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Chapter 14: Regulating the Financial System
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Sample Questions
Q1) Governments supervise banks mainly to do each of the following, except:
A)Reduce the potential cost to taxpayers of bank failures
B)Be sure the banks are following the regulations set out by banking laws
C)Reduce the moral hazard risk
D)Eliminate all risk faced by investors
Q2) When the Federal Reserve was unable to stem the bank panics of the 1930s, Congress responded by:
A)Taking over the lender of last resort function and assigning this function to the U.S.Treasury
B)Ordering the printing of tens of billions of dollars of additional currency
C)Creating the FDIC and offering deposit insurance
D)Declaring a bank holiday and closing banks for 30 days
Q3) Deposit insurance only seems to be viable at the federal level.This is likely due to the fact that:
A)Only a few state funds are large enough to withstand a run on all banks they insure
B)A run on the banks within a state will always spread countrywide
C)The U.S.Treasury backs the FDIC and can therefore withstand virtually any crisis
D)The cost of state insurance is prohibitively high
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Chapter 15: Central Banks in the World Today
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Sample Questions
Q1) All of the following are true about central bank independence except that it:
A)Is usually given at the pleasure of governments
B)Can be eliminated by governments in a time of crisis
C)Is usually guaranteed by a country's constitution
D)Can be subverted by the actions of fiscal policymakers
Q2) If we look back in history, why has the role of creating money fallen to central banks?
Q3) Chapter 15 discussed the relationship between the level and volatility of growth.What is that relationship and is its causality clear? Explain.
Q4) Which is a function of modern central banks?
A)To control securities markets
B)To control the government's budget
C)To control the availability of money and credit
D)To manage fiscal policy
Q5) Successful monetary policy relies most on:
A)Having an ample supply of highly qualified people
B)Luck
C)The institutional environment
D)Knowledgeable citizens who know how to react to the policy
Q6) What are the operational components of central bank independence?
Page 17
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Chapter 16: The Structure of Central Banks: the Federal
Reserve and the European Central Bank
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Sample Questions
Q1) The Reserve Banks of the Federal Reserve System are owned by:
A)The taxpayers in their districts
B)The U.S.Treasury
C)The Board of Governors
D)The commercial banks in their districts
Q2) The largest of the regional Federal Reserve Banks is located in:
A)Washington D.C
B)San Francisco since it serves almost one-third of the country
C)New York City
D)Kansas City
Q3) The European Central Bank has ensured independence by appointing Executive Board members for:
A)Life
B)Eight-year non-renewable terms
C)Fourteen-year terms
D)Twenty-year terms
Q4) What are the three branches that make up the Federal Reserve System?
Q5) Explain why the decision to join the Euro system presents serious domestic monetary policy issues.
Q6) Why are so few state chartered banks members of the Federal Reserve System? Page 18
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Chapter 17: The Central Bank Balance Sheet and the Money
Supply Process
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Sample Questions
Q1) The most a bank could lend at any time without altering its assets is an amount equal to its:
A)Checkable deposits
B)Reserves
C)Excess reserves
D)Net worth
Q2) As a portion of total assets measured in billions of dollars, the most important asset on the Fed's balance sheet is:
A)Gold
B)Securities
C)Foreign exchange reserves
D)Loans
Q3) A central bank's sale of securities from its portfolio will:
A)Decrease the size of its balance sheet
B)Have no impact at all on the balance sheet
C)Only change the composition of its liabilities
D)Only change the composition of its assets
Q4) Why do most central banks publish their balance sheets so frequently?
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Q5) What is deposit sweeping and how does it affect the amount of required reserves that banks must hold?
Chapter 18: Monetary Policy: Stabilizing the Domestic Economy
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Q1) Consider the objective of flying a jet form New York to Paris.After takeoff, a pilot would certainly check a few times to see if he or she is on course.Using this example, discuss why, at least in theory, intermediate monetary policy targets may be useful.
Q2) When the Fed forecasts a sustained increase in the demand for the monetary base, the staff of the Fed is likely to meet this demand through:
A)Discount loans
B)Repurchase agreements
C)An outright purchase of U.S.Treasury Securities
D)An outright sale of U.S.Treasury Securities
Q3) The Fed's temporary operations involve the use of:
A)Discount loans
B)Repurchase agreements
C)An outright purchase of U.S.Treasury Securities
D)An outright sale of U.S.Treasury Securities
Q4) Discuss the key criteria for success and the advantages of a central bank adopting the framework of inflation targeting.
Q5) How do policy duration commitments influence the economy and inflation?
Page 21
Q6) Explain the three desirable features of a good monetary policy instrument.
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Chapter 19: Exchange-Rate Policy and the Central Bank
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Q1) If capital flows freely between countries and a country has a fixed exchange rate, one thing you know is that the country:
A)Exports more than it imports
B)Must have ample gold reserves
C)Cannot have a domestic monetary policy
D)Must be running large trade deficits
Q2) If the exchange rate between the Canadian dollar and the American dollar was fixed at 1.30 Canadian dollars per U.S.dollar and investors perceived Canadian bonds to be equal in risk to U.S.bonds, if the U.S.bonds are selling for $1,000 and have a 5 percent interest rate, assuming capital flows freely between the two countries what will be the price and the interest rate of the Canadian bonds?
Q3) Describe the automatic stabilizers that are lost to a country that fixes its exchange rate to another currency.
Q4) What were the reasons for selecting the U.S.dollar as the currency to which the other 43 countries agreed to peg their currencies as part of the Bretton Woods System?
Q5) What were the contributing factors that led to Argentina's initial adoption of a currency board and then its subsequent failure?
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Page 22
Chapter 20: Money Growth, Money Demand, and Modern Monetary Policy
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Q1) Irving Fisher derived the quantity theory of money from the equation of exchange.What two assumptions did he make to derive the theory and what is the basic assertion of the theory?
Q2) If we look at the value of money in terms of how many units of a good it takes to buy one dollar, then inflation means:
A)It would take more goods to buy the same dollar
B)It would take fewer goods to buy the same dollar
C)The same number of goods would buy fewer dollars
D)It would take fewer dollars to buy the same goods
Q3) What factors can cause the portfolio demand for money to increase?
Q4) In the late 1970s and early 1980s, the velocity of money increased significantly.The main reason(s) for the increase was:
A)As presidential election years near the velocity of money increases
B)The introduction of stock and bond mutual funds with draft writing privileges and low nominal interest rates
C)High nominal interest rates
D)The introduction of stock and bond mutual funds with draft writing privileges along with high nominal interest rates
Page 23
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Chapter 21: Output, Inflation, and Monetary Policy
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Q1) The slope of the monetary policy reaction curve is determined by:
A)How strongly the economy reacts to changes in the nominal interest rate
B)How strongly the inflation rate impacts peoples' decisions
C)How aggressively policymakers change interest rates in response to deviations between current and target inflation rates
D)People's expectations for inflation
Q2) The monetary policy reaction curve:
A)Is the guideline the Fed publishes in setting their interest rate target
B)Approximates the behavior of central bankers
C)Has remained fairly constant over the years
D)Is set by Congress and given to the Fed as a guideline to follow
Q3) The fact that central bankers tend to respond to higher rates of inflation by increasing the real interest rate is:
A)One reason the dynamic aggregate demand curve shifts left
B)One reason the dynamic aggregate demand curve slopes downward
C)One reason the dynamic aggregate demand curve shifts right
D)Why the monetary policy reaction curve has a negative slope
Q4) Discuss what happens to the monetary policy reaction curve if the Fed were to lower their inflation target and why?
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Chapter 22: Understanding Business Cycle Fluctuations
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Q1) During the Great Moderation experienced in the United States during the 1990s:
A)Output never decreased and inflation fell steadily
B)Output and inflation both fell steadily
C)Output and inflation both increased
D)Output never decreased and inflation rose only slightly
Q2) Possible explanations that have been offered for the Great Moderation experienced in the United States during the 1990s include all of the following except:
A)Good fortune
B)Economies that have become more flexible in absorbing shocks
C)Calm financial markets
D)Better understanding and use of monetary policy
Q3) In the article from the New York Times in Chapter 22, the Fed is described as having a dilemma.What was the dilemma, and what would be the consequences if the Fed chose the wrong course of action?
Q4) Real business cycle theory explains fluctuations in output through:
A)Changes in aggregate demand
B)Changes in productivity
C)Shifts of the short-run aggregate supply curve
D)Changes in monetary policy
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) Stock prices may rise from a reduction in interest rates because:
A)The present value of future earnings will increase
B)Stockholders will expect lower future earnings
C)Financial market participants are less optimistic about future earnings
D)The present value of future earnings will decrease
Q2) The Federal Reserve's surveys of bank loan officers can help the Fed determine whether:
A)A drop in the quantity of loans granted resulted from fewer applications or a tightening of credit standards
B)An increase in the quantity of loans granted resulted from fewer applications or a tightening of credit standards
C)Climbing interest-rate spreads are the result of more borrowers or fewer loans being granted
D)An increase in the quantity of new loans was due to a decrease in supply or an increase in demand
Q3) It has been argued that monetary policy reached its limits in Japan during the late 1990s and early 2000s.What fact created this belief?
Q4) Why should the supply of loans increase as interest rates fall?
Page 26
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