Economics of Banking
Final Exam Questions
Course Introduction
Economics of Banking explores the fundamental principles and economic functions of the banking sector within the broader financial system. The course examines the role of banks as financial intermediaries, the mechanisms of credit creation, and the ways banks manage risks related to liquidity, interest rates, and default. Students analyze the impacts of regulation and monetary policy on banking operations, the reasons behind banking crises, and the outcome of recent developments such as fintech and digital currencies. Emphasis is placed on understanding how banks contribute to economic growth, stability, and policy transmission, using both theoretical models and real-world case studies.
Recommended Textbook
The Economics of Money Banking and Financial Markets 6th Canadian Edition by Frederic S. Mishkin
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Chapter 1: Why Study Money, Banking, and Financial Markets
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Q1) Financial crises are characterized by ________.
A)surging employment
B)hyperinflation
C)decline in asset prices
D)high profits in the financial sector
Answer: C
Q2) What is the aggregate income? How is the aggregate income related to the gross domestic product?
Answer: Aggregate income is the total income of factors of production. It is equal to aggregate output.
Q3) Compared to interest rates on long-term bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average.
A)more; lower
B)less; lower
C)more; higher
D)less; higher
Answer: A
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Chapter 2: An Overview of the Financial System
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Q1) ________ are short-term loans in which Treasury bills serve as collateral.
A)Repurchase agreements
B)Negotiable certificates of deposit
C)Overnight funds
D)Government agency securities
Answer: A
Q2) Which of the following statements about the characteristics of debt and equities is true?
A)They can both be long-term financial instruments.
B)Bond holders are residual claimants.
C)The income from bonds is typically more variable than that from equities.
D)Bonds pay dividends.
Answer: A
Q3) Long-term debt has a maturity that is ________.
A)between one and ten years
B)less than a year
C)between five and ten years
D)ten years or longer
Answer: D
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Page 4
Chapter 3: What Is Money
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Q1) As a store of value, money ________.
A)does not earn interest
B)cannot be a durable asset
C)must be currency
D)is a way of saving for future purchases
Answer: D
Q2) Which of the following statements best explains how the use of money in an economy increases economic efficiency?
A)Money increases economic efficiency because it is costless to produce.
B)Money increases economic efficiency because it discourages specialization.
C)Money increases economic efficiency because it decreases transactions costs.
D)Money cannot have an effect on economic efficiency.
Answer: C
Q3) If the price level doubles, the value of money ________.
A)doubles
B)more than doubles, due to scale economies
C)rises but does not double, due to diminishing returns
D)falls by half
Answer: D
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Page 5
Chapter 4: Understanding Interest Rates
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Q1) Duration is ________.
A)an asset's term to maturity
B)the time until the next interest payment for a coupon bond
C)the average lifetime of a debt security's stream of payments
D)the time between interest payments for a coupon bond
Q2) Comparing a discount bond and a coupon bond with the same maturity, ________.
A)the coupon bond has the greater effective maturity
B)the discount bond has the greater effective maturity
C)the effective maturity cannot be calculated for a coupon bond
D)the effective maturity cannot be calculated for a discount bond
Q3) Your friend tells you that she bought a 10-year to maturity discount bond that she plans to hold until maturity in order to finance her daughter's university education. She also tells you that she is worried that due to interest-rate-risk she may suffer significant capital losses if interest rates increase. Are her fears justified?
Q4) An asset's interest rate risk ________ as the duration of the asset ________.
A)increases; decreases
B)decreases; decreases
C)decreases; increases
D)remains constant; increases
Page 6
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Chapter 5: The Behaviour of Interest Rates
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Q1) Everything else held constant, if the expected return on ABC stock rises from 5 to 10 percent and the expected return on CBS stock is unchanged, then the expected return of holding CBS stock ________ relative to ABC stock and the demand for CBS stock
A)rises; rises B)rises; falls C)falls; rises D)falls; falls
Q2) If brokerage commissions on bond sales decrease, then, other things equal, the demand for bonds will ________ and the demand for real estate will ________.
A)increase; increase B)increase; decrease C)decrease; decrease D)decrease; increase
Q3) The demand for silver decreases, other things equal, when ________.
A)the gold market is expected to boom
B)the market for silver becomes more liquid C)wealth grows rapidly
D)interest rates are expected to rise
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Chapter 6: The Risk and Term Structure of Interest Rates
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Q1) The mound-shaped yield curve in the figure above indicates that short-term interest rates are expected to ________.
A)rise in the near-term and fall later on B)fall moderately in the near-term and rise later on C)fall sharply in the near-term and rise later on D)remain unchanged in the near-term and fall later on
Q2) As default risk increases and bond prices adjust, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant.
A)increases; less B)increases; more C)decreases; less D)decreases; more
Q3) As their relative riskiness ________, the equilibrium price of corporate bonds ________ relative to the expected return on default-free bonds, everything else held constant.
A)increases; increases B)increases; decreases C)decreases; decreases D)decreases; does not change
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Q1) According to rational expectations theory, forecast errors of expectations
A)are more likely to be negative than positive
B)are more likely to be positive than negative
C)tend to be persistently high or low
D)are unpredictable
Q2) An increase in uncertainty for the economy will ________.
A)increase stock prices due to a higher required return
B)not affect stock prices
C)increase stock prices due to a lower required return
D)depress stock prices due to a higher required return
Q3) The advantage of a "buy-and-hold strategy" is that ________.
A)net profits will tend to be higher because there will be fewer brokerage commissions
B)losses will eventually be eliminated
C)the longer a stock is held, the higher will be its price
D)profits are guaranteed
Q4) Explain the Gordon growth model of stock pricing. Explain how changes in each component affect the current stock price. On what assumptions is the model based?
Page 9
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Chapter 8: An Economic Analysis of Financial Structure
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Q1) If all the students in your class pool their money in order to buy one bond and share its return accordingly, in order to eliminate transaction costs, this is an example of
A)economies of scale
B)cooperative game
C)risk sharing
D)moral hazard
Q2) Because of the adverse selection problem, ________.
A)good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks
B)lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town"
C)lenders are reluctant to make loans that are not secured by collateral
D)lenders will write debt contracts that restrict certain activities of borrowers
Q3) Explain the difference between net worth and collateral.
Q4) Explain the four tools that can help solve the principal-agent problem.
Q5) Explain how high net worth and collateral reduce the problem of moral hazard.
Q6) Explain the principal-agent problem as it pertains to equity contracts.
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Chapter 9: Financial Crises
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Q1) Financial innovations that emerged after 2000 in the mortgage markets included all of the following except ________.
A)adjustable-rate mortgages
B)subprime mortgages
C)Alt-A mortgages
D)mortgage-backed securities
Q2) Agency problems in the subprime mortgage market included all of the following except ________.
A)homeowners could refinance their houses with larger loans when their homes appreciated in value
B)mortgage originators had little incentives to make sure that the mortgage is a good credit risk
C)underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back
D)the evaluators of securities, the credit rating agencies, were subject to conflicts of interest
Q3) How do increases in interest rates play a role in promoting financial crises?
Q4) What triggered the ABCP saga in Canada?
Q5) Describe the declining phase of the leverage cycle.
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Chapter 10: Economic Analysis of Financial Regulation
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Q1) Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions except ________.
A)forgiving tax debt
B)lending from the central bank
C)lending directly from the government's treasury department
D)nationalizing and guaranteeing that all creditors will be repaid their loans in full
Q2) Deposit insurance covers deposits up to $100,000, but as part of a doctrine called "too-big-to-fail" the CDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the CDIC does this, it uses the ________.
A)"payoff" method
B)"purchase and assumption" method
C)"inequity" method
D)"Basel" method
Q3) What are the three pillars that Basel 2 is based on?
Q4) Banking crises have occurred throughout the world. What similarities do we find when we look at the different countries?
Q5) Describe how the CDIC premiums have evolved over the past years.
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Page 12
Chapter 11: Banking Industry: Structure and Competition
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Q1) The experience of disintermediation in the banking industry illustrates that
A)more regulation of financial markets may avoid such problems in the future
B)banks are unable to remain competitive with other financial intermediaries
C)consumers no longer desire the services that banks provide
D)markets invent alternatives to costly regulations
Q2) The primary reason for the recent reduction in the number of financial institutions is ________.
A)financial failures
B)re-regulation of banking
C)restrictions on branching
D)financial consolidation
Q3) Describe some of the major implications of the 2001 Bank Act Reform.
Q4) A debit card differs from a credit card in that ________.
A)a debit card is a loan while for a credit card purchase, payment is made immediately
B)a debit card is a long-term loan while a credit card is a short-term loan
C)a credit card is a loan while for a debit card purchase, payment is made immediately
D)a credit card is a long-term loan while a debit card is a short-term loan
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Page 13
Chapter 12: Banking and the Management of Financial Institutions
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Q1) Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the bank's assets to increase their rate sensitivity or, alternatively, ________ the duration of the bank's liabilities.
A)shortening; lengthening
B)shortening; shortening
C)lengthening; lengthening
D)lengthening; shortening
Q2) Banks hold excess and secondary reserves to ________.
A)reduce the interest-rate risk problem
B)provide for deposit outflows
C)satisfy margin requirements
D)achieve higher earnings than they can with loans
Q3) Unanticipated moral hazard contingencies can be reduced by ________.
A)screening
B)long-term customer relationships
C)specialization in lending
D)credit rationing
Q4) What are the main items in a bank's asset side of the balance sheet? Discuss them briefly.
Page 14
Q5) What is a loan sale and how does it work?
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Chapter 13: Risk Management With Financial Derivatives
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Q1) If you buy a European call option on Canada bonds with a strike price of 115 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 120, you will ________ the option in order to make a profit of $________.
A)not exercise; 5000
B)not exercise; 5
C)exercise; 5000
D)exercise; 5
Q2) If you sell in March a bond future contract for 125 that matures on June 30 of the same year, and at the maturity date the same future sells for 135, you have a ________ of $________.
A)loss; 10000
B)loss; 10
C)profit; 10000
D)profit; 10
Q3) Financial derivatives include ________.
A)stocks
B)bonds
C)futures
D)foreign exchange
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Page 15
Chapter 14: Central Banks and the Bank of Canada
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Q1) According to the performance of the Canadian economy, and the evolution of economic theory, what is the most important goal of monetary policy?
A)Currency stability
B)Price stability
C)GDP growth
D)Employment growth
Q2) Unemployment rates in Canada after the Great Depression rose close to
A)20 percent
B)25 percent
C)30 percent
D)10 percent
Q3) Which of the following functions are not performed by the Bank of Canada in its role as the federal government's fiscal agent?
A)Advising on federal government borrowings
B)Managing new debt offerings by the federal government
C)Setting interest rates payable on time deposits
D)Servicing the federal government's outstanding debt
Q4) What is the theory of bureaucratic behavior and how can it be used to explain the behavior of the Bank of Canada?
Page 16
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Chapter 15: The Money Supply Process
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Q1) Everything else held constant, an increase in the time deposit ratio will result in ________ in the M1+ money multiplier and ________ in the M2+ money multiplier.
A)an increase; an increase
B)no change; an increase
C)a decrease; a decrease
D)no change; a decrease
Q2) Which of the following are not assets on the Bank of Canada's balance sheet?
A)Advances to banks
B)Government of Canada deposits
C)Securities
D)Foreign deposits
Q3) Individuals that lend funds to a bank by opening a chequing account are called
A)policyholders
B)partners
C)depositors
D)debt holders
Q4) Explain why the simple deposit multiplier overstates the true deposit multiplier.
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Chapter 16: Tools of Monetary Policy
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Q1) To keep inflation from falling below the target range, the Bank of Canada
A)decreases the target for the overnight rate which causes the dollar to go down
B)decreases the target for the overnight rate which causes the dollar to go up
C)increases the target for the overnight rate which causes the dollar to go down
D)increases the target for the overnight rate which causes the dollar to go up
Q2) The quantity of reserves demanded rises when the ________.
A)bank rate rises
B)bank rate falls
C)overnight funds rate rises
D)overnight rate falls
Q3) If the Bank of Canada wants to alleviate undesired downward pressure on the overnight financing rate it will enter into a ________.
A)Special Purchase and Resale Agreement
B)Sale and Repurchase Agreement
C)Swap
D)Repo
Q4) What are the advantages and disadvantages of the Bank's lending policy?
Q5) Explain why the bank rate is an upper limit for the overnight rate.
Q6) What is the operating band for the overnight interest rate?
Page 18
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Chapter 17: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) Define the two types of asset-price bubbles and explain why one of these is more is more problematic for the economy.
Q2) Price stability is often the primary goal of central banks. Describe the five other goals of monetary policy
Q3) In the 1975-1981 period, the Bank of Canada selected an interest rate as an operating target than a reserve aggregate primarily because it ________.
A)had no interest in targeting a monetary aggregate, as evidenced by its unwillingness to target a reserve aggregate
B)was still very concerned with interest rate stability
C)was committed to the real bills doctrine
D)was committed to keeping the foreign exchange and domestic bonds markets functioning smoothly
E)None of the above
Q4) Explain the Taylor rule, including the formula for setting the overnight rate target, and the components of the formula. If the Bank of Canada were to use this rule, how many goals would it use to set monetary policy?
Q5) Why might a policy of low interest rates encourage excessive risk taking?
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Chapter 18: The Foreign Exchange Market
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Q1) In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the price is the ________.
A)spot exchange rate
B)money exchange rate
C)forward exchange rate
D)fixed exchange rate
Q2) Everything else held constant, when the current value of the domestic exchange rate increases, the ________ of domestic assets ________.
A)quantity supplied; does not change
B)supply; decreases
C)quantity supplied; increases
D)supply; increases
Q3) When the effects of the subprime crisis started to spread more quickly throughout the rest of the world, the U.S. dollar ________ because demand for U.S. assets
A)appreciated; increased
B)depreciated; increased
C)appreciated; decreased
D)depreciated; decreased
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Chapter 19: The International Financial System
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Q1) An international lender of last resort creates a serious ________ problem because depositors and other creditors of banking institutions expect that they will be protected if a crisis occurs.
A)moral hazard
B)adverse selection
C)public choice
D)strategic choice
Q2) Under the Bretton Woods system, the IMF could encourage deficit countries to pursue contractionary monetary policies that would ________ their currency or eliminate their balance of payment ________.
A)strengthen; surpluses
B)strengthen; deficits
C)weaken; surpluses
D)weaken; deficits
Q3) Which of the following appears in the capital account part of the balance of payments?
A)A gift to a Canadian from his English aunt
B)A purchase by the Honda corporation of a Canadian Treasury bill
C)A purchase by the Bank of England of a Canadian Treasury bill
D)Income earned by the Honda corporation on its automobile plant in Ontario
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Chapter 20: Quantity Theory, Inflation, and the Demand for Money
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Q1) In one of the earliest studies on the link between interest rates and money demand using United States data, James Tobin concluded that the demand for money is
A)sensitive to interest rates
B)not sensitive to interest rates
C)not sensitive to changes in income
D)not sensitive to changes in bond values
Q2) In the equation of exchange, the concept that provides the link between M and PY is called ________.
A)the velocity of money
B)aggregate demand
C)aggregate supply
D)the money multiplier
Q3) If people expect nominal interest rates to be lower in the future, the expected return on bonds ________, and the demand for money ________.
A)increases; increases
B)increases; decreases
C)decreases; increases
D)decreases; decreases
22
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Chapter 21: The Is Curve
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Q1) An increase in interest rates ________.
A)increases the value of the dollar, net exports, and equilibrium output
B)increases the value of the dollar, reducing net exports and equilibrium output
C)reduces the value of the dollar, net exports, and equilibrium output
D)reduces the value of the dollar, increasing net exports and equilibrium output
Q2) If the consumption function is expressed as C = a + mpc × YD, then "a" represents ________.
A)autonomous consumer expenditure
B)the marginal propensity to consume
C)the expenditure multiplier
D)disposable income
Q3) In the Keynesian framework, as long as output is above the equilibrium level, unplanned inventory investment will remain ________ and firms will continue to ________ production.
A)negative; lower
B)negative; raise
C)positive; lower
D)positive; raise
Q4) What is the marginal propensity to consume according to Keynes's consumption theory? provide an example.
Page 23
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Chapter 22: The Monetary Policy and Aggregate Demand
Curves
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Q1) Suppose the aggregate demand curve is given by Y = 12 - r then, if inflation increases by 1 percent ________.
A)aggregate output is unchanged
B)aggregate output increases
C)the nominal interest changes
D)the real interest rate falls
Q2) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.
A)up; left
B)up; right
C)down; left
D)down; right
Q3) Higher inflation results from higher interest rates due to ________.
A)the Taylor principle
B)the Taylor rule
C)the slope of the monetary policy curve
D)the Fisher equation
Q4) Describe how the Bank of Canada would apply the Taylor principle.
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Chapter 23: Aggregate Demand and Supply Analysis
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Q1) A theory of aggregate economic fluctuations called real business cycle theory holds that ________.
A)changes in the real money supply are the only demand shocks that affect the natural rate of output
B)aggregate demand shocks do affect the natural rate of output
C)aggregate supply shocks do affect the natural rate of output
D)changes in net exports are the only demand shocks that affect the natural rate of output
Q2) Suppose the economy is producing at the natural rate of output and the government passes legislation that severely restricts a company's ability to reduce production costs via outsourcing. Everything else held constant, this policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run.
A)an increase; an increase
B)a decrease; a decrease
C)a decrease; an increase
D)no change; no change
Q3) Enumerate the four implications for aggregate output from algebraic expression of the aggregate demand curve.
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Chapter 24: Monetary Policy Theory
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Q1) Explain and show graphically why continuous monetary growth is needed to generate inflation. Describe how the inflation process is generated.
Q2) Non-activists believe that that expectations are ________ formed and that wages and prices are ________ with respect to the expected price level.
A)adaptively; completely flexible
B)adaptively; sticky
C)rationally; completely flexible
D)rationally; sticky
Q3) "How do we prevent the inflationary fire from igniting again and stop the roller coaster ride in the inflation rate of the last 40 years?" Milton Friedman's famous proposition suggests the simple solution: ________.
A)reduce the number of terms that politicians are allowed to serve
B)reduce the growth rate of the money supply
C)reduce the marginal tax rate on low-income wage earners
D)increase the marginal tax rates on businesses that hike prices in excess of 5 percent per year
Q4) What are the objectives of quantitative easing?
Q5) What three forms does non-conventional monetary policy take?
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Chapter 25: The Role of Expectations in Monetary Policy
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Q1) Some economists contend that a policy of shifting the aggregate demand curve will be costly because it produces more volatility in both the price level and output. These economists likely are advocates of ________ policy.
A)supply-side
B)discretionary
C)demand-management
D)nondiscretionary
Q2) The Lucas critique indicates that ________.
A)advocates of discretionary policies' criticisms of rational expectations models are well-founded
B)advocates of discretionary policies' criticisms of rational expectations models are not well-founded
C)expectations are important in determining the outcome of a discretionary policy
D)expectations are not important in determining the outcome of a discretionary policy
Q3) How did Canada win the battle against inflation?
Q4) Describe the two main benefits of a credible nominal anchor.
Q5) Provide some alternate approaches to establishing credibility.
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Chapter 26: Transmission Mechanisms of Monetary Policy
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Q1) A disadvantage of ________ evidence is that it cannot rule out ________.
A)reduced-form; reverse causation
B)reduced-form; adverse selection
C)structural model; reverse causation
D)structural model; adverse selection
Q2) Early Keynesians believed that monetary policy ________.
A)affected aggregate demand solely through its effect on nominal interest rates
B)did not affect aggregate demand through nominal interest rates
C)affected aggregate demand through many channels
D)affected real output directly
Q3) According to Tobin's q theory, ________ policy can affect ________ spending through its effect on the prices of common stock.
A)fiscal; consumption
B)fiscal; investment
C)monetary; consumption
D)monetary; investment
Q4) What are the advantages of structural model evidence if the structure is correct?
Q5) Explain what we call structural model evidence in describing the transmission mechanism of monetary policy.
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Chapter 27: Financial Crises in Emerging Markets
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Q1) Financial crises in emerging-market economies generally develop along two basic paths: ________.
A)mismanagement of financial liberalization/globalization and severe fiscal imbalances
B)stock market declines and severe fiscal imbalances
C)mismanagement of financial liberalization/globalization and stock market declines
D)stock market declines and unanticipated declines in the value of the domestic currency
Q2) What is the relationship between fiscal imbalances in emerging-market economies and financial crises?
Q3) List four things that emerging market economies can do to prevent financial crises.
Q4) Argentina's financial crisis was due to ________.
A)poor supervision of the banking system
B)a lending boom prior to the crisis
C)fiscal imbalances
D)lack of expertise in screening and monitoring borrowers at banking institutions
Q5) What is a currency mismatch and why does it create risks?
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Chapter 28: The ISLM Model
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107 Verified Questions
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Sample Questions
Q1) If the economy is on the IS curve, but is to the left of the LM curve, aggregate output will ________ and the interest rate will ________.
A)rise; rise
B)rise; fall
C)fall; rise
D)fall; fall
Q2) A contractionary monetary policy shifts the LM curve to the ________, reducing ________, everything else held constant.
A)left; output and increasing interest rates
B)left; both real output and interest rates
C)right; both interest rates and real output
D)right; interest rates and increasing real output
Q3) Everything else held constant, if aggregate output is to the ________ of the LM curve, then there is an excess supply of money which will cause the interest rate to
A)right; fall
B)right; rise
C)left; fall
D)left; rise
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Chapter 29: Non-Bank Finance
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Sample Questions
Q1) The institutions that assist in the trading of securities in the secondary market are called ________.
A)investors
B)stockholders
C)auditors
D)dealers
Q2) Examples of crown finance companies are ________.
A)the Bank of Canada and the Office of the Superintendent of Financial Institutions Canada
B)the Bank of Canada and Canada Deposit Insurance Corporation
C)Farm Credit Canada and Export Development Canada
D)A and B only
Q3) Permanent insurance is also known as ________.
A)endowment insurance
B)term insurance
C)group insurance
D)individual insurance
Q4) How does the economic concept of adverse selection apply to the lending activities of insurers? Provide an example.
Q5) How do sovereign wealth funds raise national security issues?
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