Economics of Financial Institutions
Test Bank
Course Introduction
This course explores the economic principles underlying the operation and regulation of financial institutions, including banks, insurance companies, and investment firms. Students will analyze the roles these institutions play in the allocation of capital, risk management, and the facilitation of payments within the broader financial system. The course covers topics such as the structure and function of financial markets, asset transformation, regulatory frameworks, and the effects of financial innovation and crises on institutions and systemic stability. By examining real-world examples and policy issues, students develop a comprehensive understanding of how financial institutions influence economic outcomes at both the microeconomic and macroeconomic levels.
Recommended Textbook Money Banking and the Financial System 3rd Edition by R. Glenn Hubbard
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18 Chapters
1993 Verified Questions
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Page 2
Chapter 1: Introducing Money and the Financial System
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Q1) Increased liquidity in recent decades has reduced interest rates on which of the following assets (holding constant all other things that affect interest rates)?
A) U.S. government bonds
B) bonds issued by large corporations
C) business loans
D) bonds issued by state governments
Answer: C
Q2) Which of the following assets is the least liquid?
A) money market mutual fund
B) stock
C) treasury bond
D) house
Answer: D
Q3) Briefly explain the difference in how banks and peer-to-peer lenders make profits on loans.
Answer: Banks have traditionally earned profits on loans by paying a lower interest rate to depositors than they charge to borrowers.Peer-to-peer lenders make profits by charging borrowers a one-time fee and charging the people providing funds a fee for collecting the payments from borrowers.
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Page 3
Chapter 2: Money and the Payments System
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Sample Questions
Q1) What are four inefficiencies of a barter system?
Answer: Under a barter system,there are several inefficiencies.First,there must be a double coincidence of wants,resulting in high transaction costs.Second,there will be many prices for each good; one for each good for which it can be traded.Third,there is a lack of standardization in terms of the goods to be exchanged.Fourth,it will be difficult to accumulate wealth.
Q2) Suppose the GDP implicit price deflator was 112.7 in 2015 and 116.0 in 2016.Therefore,the inflation rate in 2016 would be
A) 2.8%.
B) 2.9%.
C) 3.3%.
D) 16%.
Answer: B
Q3) According to the equation of exchange,if nominal GDP increases then A) the quantity of money must also increase.
B) the velocity of money must also increase.
C) both the quantity of money and the velocity of money must also increase. D) either the quantity of money and/or the velocity of money must also increase.
Answer: D
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Page 4
Chapter 3: Interest Rates and Rates of Return
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Sample Questions
Q1) If the current price of a bond is equal to its face value
A) there is no capital gain or loss from holding the bond until maturity.
B) the yield to maturity must be greater than the current yield.
C) the current yield must be greater than the coupon rate.
D) the coupon rate must be greater than the yield to maturity.
Answer: A
Q2) A discount bond involves
A) interest payments from the borrower to the lender periodically during the life of the loan.
B) payment by the borrower to the lender of the face value of the loan at maturity.
C) no payment of principal by the borrower to the lender.
D) payment of interest by the borrower to the lender every six months during the life of the loan.
Answer: B
Q3) How do payments on a fixed-payment loan differ from a coupon bond?
Answer: Borrowers that use a coupon bond make interest payments at regular intervals and repay the face value when the bond reaches maturity.Those that borrow using a fixed-payment loan makes periodic payments that are equal and include both interest and principal.
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Page 5
Chapter 4: Determining Interest Rates
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Sample Questions
Q1) The formula for the yield to maturity,i,on a discount bond is
A) i = (Face value - Price)/Price.
B) i = (Price - Face value)/Price.
C) i = (Face value - Price)/Face value.
D) i = (Price - Face value)/Face value.
Q2) According to the Fisher effect,an increase in expected inflation results in
A) lower nominal interest rates.
B) higher nominal interest rates.
C) lower real interest rates.
D) higher real interest rates.
Q3) If the federal government decreases its spending and doesn't decrease taxes,the bond supply shifts to the
A) left and the equilibrium interest rate rises.
B) left and the equilibrium interest rate falls.
C) right and the equilibrium interest rate rises.
D) right and the equilibrium interest rate falls.
Q4) In July 2016,concern was raised about Puerto Rico's sovereign debt.Make use of a graph of the bond market to show how this would affect the price of Puerto Rican bonds.
Q5) How can diversification reduce idiosyncratic risk but not systematic risk?
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Q1) A one-year bond currently pays 5% interest.It's expected that it will pay 4.5% next year and 4% the following year.The two-year term premium is 0.2% while the three-year term premium is 0.35%.What is the interest rate on a three-year bond according to the liquidity premium theory?
A) 4.5%
B) 4.68%
C) 4.85%
D) 5.05%
Q2) Financial instruments with high information costs
A) will usually be more liquid than similar instruments with low information costs.
B) will have lower yields than U.S. Treasury securities.
C) may not be offered for sale in some states.
D) will have lower prices than similar instruments with low information costs.
Q3) Discuss what happened to the market prices on corporate securities relative to government securities during the Great Recession.
Q4) Describe the facts found in the bond market about the relationship between interest rates on bonds of different maturities.
Q5) How do ratings agencies earn income?
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Chapter 6: The Stock Market, information, and Financial
Market Efficiency
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Sample Questions
Q1) If a corporation pays a dividend,which group receives priority in receiving the dividend?
A) bond holders
B) holders of common stock
C) holders of preferred stock
D) Dividends are evenly divided by holders of common and preferred stock.
Q2) According to the Gordon growth model,what is the value of a stock with a dividend of $2,required return on equity of 8% and expected growth rate of dividends of 4%?
A) $25
B) $26
C) $50
D) $52
Q3) Under the efficient markets hypothesis,what would be the price per share of a company whose current dividend is $10.00 and whose dividends are expected to grow by 3% per year (assume the risk-adjusted interest rate is 10%)?
A) $74.62
B) $79.23
C) $142.86
D) $147.14
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Chapter 7: Derivatives and Derivative Markets
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Sample Questions
Q1) Derivative instruments are
A) assets such as bonds or common stock that derive their value from the value of the companies which issue them.
B) assets whose rates of returns must be derived from information published in financial tables.
C) assets which derive their value from underlying assets.
D) computers which display real-time financial information.
Q2) An order from an exchange for a seller to add enough funds to meet the minimum balance in a margin account is called a
A) maintenance margin.
B) margin option.
C) margin call.
D) margin put.
Q3) When reading an options listing for a company like Microsoft
A) both call and put options are listed.
B) call options, but not put options, are listed.
C) put options, but not call options, are listed.
D) neither call nor put options are listed.
Q4) Why may some investors prefer forward contracts to futures?
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Chapter 8: The Market for Foreign Exchange
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Q1) If pepperoni pizzas sell for $10 in Berkeley,California,and £10 in London,England,and the exchange rate is $1.35 = £1
A) the law of one price has been violated.
B) either the British government or the American government must be interfering with the market determination of the exchange rate.
C) the value of the dollar versus the pound is likely to rise.
D) there is no contradiction in the information given because pizza is not a tradeable good.
Q2) If oranges sell for $100 per crate in the United States and 4,000 pesos per crate in Mexico,the law of one price indicates that you should be able to exchange $1 for A) 0.025 peso.
B) 4 pesos.
C) 40 pesos.
D) 400 pesos.
Q3) What is an advantage of using options instead of forward contracts when hedging against exchange-rate risk?
Q4) What is an advantage of using forward contracts instead of options to hedge against exchange-rate risk?
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Page 10
Chapter 9: Transactions Costs, asymmetric Information, and the Structure of the Financial System
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Sample Questions
Q1) In effect,banks are able to charge
A) depositors for banks' superior information about borrowers.
B) borrowers for banks' superior information about depositors.
C) the government for banks' superior information about borrowers and depositors.
D) interest rates that are in fact above those legally allowed.
Q2) Compared to CDs and money market funds,crowdfunding
A) provides higher expected returns with increased safety.
B) provides lower expected returns in exchange for increased safety.
C) is likely to result in lower returns due to higher volatility.
D) provides opportunities for higher returns but also significant losses.
Q3) Transactions costs are
A) zero in financial markets.
B) zero in financial intermediaries.
C) the costs of direct financial transactions.
D) equal to the taxes imposed on financial transactions.
Q4) How does adverse selection affect the economic efficiency of the used car market?
Q5) How do car dealers help reduce adverse selection?
Page 11
Q6) How does the principal-agent problem increase the possibility of moral hazard?
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Chapter 10: The Economics of Banking
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Q1) Which of the following is NOT considered a cash item by banks?
A) U.S. Treasury bills
B) deposits at other banks
C) deposits at the Federal Reserve
D) vault cash
Q2) The process by which banks screen potential applicants by eliminating bad risks and to obtain a pool of creditworthy borrowers is called
A) gap analysis.
B) duration analysis.
C) credit-risk analysis.
D) liquidity analysis.
Q3) Credit risk is the risk that
A) an insufficient number of borrowers will apply for loans or credit.
B) interest rates will rise after a loan has been granted.
C) interest rates will fall after a loan has been granted.
D) borrowers might default on their loans.
Q4) Suppose a bank has $10 million in capital,$100 million in assets,and after-tax profit of $2 million.what is its return on assets? What is its return on equity?
Q5) In what ways does a certificate of deposit (CD)differ from a savings deposit?
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Chapter 11: Beyond Commercial Banks: Shadow Banks and
Nonbank Financial Institutions
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Sample Questions
Q1) Charging drivers with good records lower premiums than drivers with bad records is an example of an attempt by insurance companies to deal with the problem of A) moral hazard.
B) adverse selection.
C) drunk driving.
D) failure of policyholders to keep paying their premiums.
Q2) What is the name of the pension plan under which employees can make tax-deductible contributions through regular payroll deductions?
A) 401(k) plan
B) Social Security plan
C) early retirement plan
D) 486(b) plan
Q3) When investment banks buy or sell securities on their own account,it's called A) financial engineering.
B) proprietary trading.
C) underwriting.
D) factoring.
Q4) How do defined-contribution plans differ from defined-benefit plans?
Q5) What type of economic research do analysts at investment banks conduct?
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Chapter 12: Financial Crises and Financial Regulation
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Q1) The creation of a lender of last resort in the United States
A) occurred in response to banking panics.
B) was mandated in the U.S. Constitution.
C) occurred in response to the S&L crisis of the 1980s.
D) has been recommended by the Treasury in its report of late 1992.
Q2) Disintermediation refers to the
A) failure of financial intermediaries due to moral hazard problems.
B) failure of financial intermediaries due to adverse selection problems.
C) movement of savers and borrowers from banks to financial markets.
D) removal of government regulations of financial intermediaries.
Q3) What happened to consumer prices as measured by the CPI between 1929 and 1933?
A) rose by more than 20%
B) didn't change
C) declined by about 25%
D) declined by about 80%
Q4) The Franklin National Bank Crisis had its greatest impact on the market for A) commercial paper.
B) commodity futures.
C) negotiable certificates of deposit.
D) Eurodollars.
Page 14
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Chapter 13: The Federal Reserve and Central Banking
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Q1) What is the main reason the Fed operates in a political arena?
A) It lacks a constitutional mandate.
B) The members of the Board of Governors must run for reelection every fourteen years.
C) The members of the Board of Governors are typically prominent politicians.
D) It is under the direct control of Congress.
Q2) Why might Congress benefit from the Fed being self-financed?
A) Self-financing increases Congressional control over the Fed.
B) Self-financing reduces the Fed's exposure to external pressures.
C) Self-financing gives the Fed an incentive to expand the money supply, which ultimately results in Congress having additional funds to spend.
D) Congress does not benefit from the Fed being self-financed; Congress is obliged by the Constitution to allow the Fed to be self-financed.
Q3) What was the dilemma that faced the European Central Bank in response to the sovereign debt crisis of 2010?
Q4) How did the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 affect the Fed?
Q5) What are the limitations to the Fed's independence?
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Page 15
Chapter 14: The Federal Reserves Balance Sheet and the
Money Supply Process
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Q1) If the Fed sells securities worth $10 million to a commercial bank,the Fed's balance sheet will show
A) an increase in securities held of $10 million and an increase in bank reserves of $10 million.
B) an increase in securities held of $10 million and a decrease in bank reserves of $10 million.
C) a decrease in securities held of $10 million and an increase in bank reserves of $10 million.
D) a decrease in securities held of $10 million and a decrease in bank reserves of $10 million.
Q2) A $10 million open market sale will decrease the monetary base by A) $10 million.
B) $10 million times the money multiplier.
C) $10 million divided by the money multiplier.
D) an amount between $0 and $10 million, depending on the fraction of the purchase the public wishes to hold as currency.
Q3) Suppose the required reserve ratio is 8% and banks do not hold excess reserves.Illustrate on a bank's balance sheet what happens if the Fed buys $250,000 worth of securities from a bank.
Page 16
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Chapter 15: Monetary Policy
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Q1) In 2016,the Bank of Japan
A) started paying interest on bank reserves in an effort to lower inflation.
B) raised the target interest rate to double digits for the first time in over 10 years.
C) implemented a reverse quantitative easing program, where it sold long-term Treasury securities and mortgage-backed securities to raise long-term interest rates.
D) instituted a negative interest rate on deposits it receives from Japanese banks, effectively requiring banks to pay the Bank of Japan for keeping their deposits.
Q2) If the Fed desired to reduce the federal funds rate
A) it would conduct an open market sale, reducing reserve supply.
B) it would conduct an open market purchase, increasing reserve supply.
C) it would conduct an open market sale, increasing reserve demand.
D) it would conduct an open market purchase, reducing reserve demand.
Q3) Increases in interest rates are often blamed on
A) Congress.
B) the President.
C) the Fed.
D) the U.S. Treasury.
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Page 17
Chapter 16: The International Financial System and Monetary Policy
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Q1) If the U.S.current account balance is negative,
A) its financial account is likely to be positive.
B) its financial account is likely to be negative.
C) it must use official settlements to balance its payments.
D) its balance of payments cannot be zero.
Q2) What was the approximate value of the U.S.current account balance in 2015?
A) $79 billion
B) $10 billion
C) -$380 billion
D) -$463 billion
Q3) When the Fed allows the monetary base to respond to the purchase or sale of domestic currency in the foreign exchange market,the process is called
A) open market operations.
B) hedging.
C) sterilized intervention.
D) unsterilized intervention.
Q4) Make use of a T-account to show the effect of the Fed's sale of $500 million worth of foreign government securities on the Fed's balance sheet.(assume the Fed receives a check from the sale of securities).
Page 18
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Chapter 17: Monetary Theory I- the Aggregate Demand and Aggregate Supply Model
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Q1) If the economy experiences simultaneous negative aggregate demand and aggregate supply shocks,and the Fed decides NOT to intervene with expansionary policy.Short-run aggregate supply will eventually shift back to the right,which will eventually bring the economy
A) back to potential GDP at a lower price level.
B) back to potential GDP at a higher price level.
C) back to the original equilibrium price at a lower level of aggregate output.
D) back to the original equilibrium price at a higher level of aggregate output.
Q2) Productivity growth occurs when
A) there are more inputs.
B) firms can produce more output per unit of input.
C) more output is produced.
D) employees work extra hours.
Q3) The result of the supply shocks of 1973-1974 was to
A) reduce aggregate output and raise the price level.
B) reduce the price level and raise aggregate output.
C) reduce both aggregate output and the price level.
D) raise both aggregate output and the price level.
Q4) What is the principal source of change in productivity growth?
Q5) How does an increase in the price level lead to a higher interest rate?
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Chapter 18: Monetary Theory Ii: the Is-Mp Model
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Q1) The capacity of a firm can best be described as A) when a firm is producing maximum output.
B) a firm's production when operating normal hours using a normal sized workforce. C) when a firm makes full use of all the space available in its factory or building.
D) when all of the firm's workers are producing at their maximum potential.
Q2) The ways in which monetary policy affect output and prices are known as A) channels.
B) stations.
C) vehicles.
D) means.
Q3) What is the multiplier effect?
Q4) How is the economy likely to respond when AE (sales)exceeds production?
Q5) According to the Phillips Curve,which of the following may have taken place if both the unemployment rate and inflation have risen?
A) a negative supply shock
B) an increase in expected inflation
C) a severe recession
D) a negative demand shock
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Page 20