Economics of Financial Markets
Exam Solutions
Course Introduction
Economics of Financial Markets examines the structure, function, and dynamics of financial markets and institutions. The course explores the theory of asset pricing, the role of financial intermediaries, and the effects of financial regulation. Students will analyze the behavior of investors and firms, the process of financial innovation, and the transmission of financial shocks throughout the economy. Topics such as market efficiency, risk management, asymmetric information, and international financial markets are also covered to provide a comprehensive understanding of the economic forces that shape contemporary financial systems.
Recommended Textbook
The Economics of Money Banking and Financial Markets 6th Canadian Edition by Frederic S. Mishkin
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29 Chapters
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Page 2
Chapter 1: Why Study Money, Banking, and Financial Markets
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Sample Questions
Q1) Everything else held constant, a stronger Canadian dollar benefits ________ and hurts ________.
A)Canadian businesses; Canadian consumers
B)Canadian businesses; foreign businesses
C)Canadian consumers; Canadian businesses
D)foreign businesses; Canadian consumers
Answer: C
Q2) Canadian farmers who sell beef to Europe benefit most from ________.
A)a decrease in the Canadian dollar price of euros
B)an increase in the Canadian dollar price of euros
C)a constant Canadian dollar price for euros
D)a European ban on imports of Canadian beef
Answer: B
Q3) Everything else held constant, a weaker Canadian dollar will likely hurt ________.
A)textile exporters in Quebec
B)wheat farmers in Saskatchewan that sell domestically
C)automobile manufacturers in Ontario that use domestically produced inputs
D)furniture importers in British Columbia
Answer: D
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Chapter 2: An Overview of the Financial System
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Sample Questions
Q1) How do financial intermediaries play an important role in the economy?
Answer: Financial intermediaries play an important role in the economy because they provide liquidity services, they lower transaction costs through economies of scale, they reduce the risk exposure of investors through risk sharing, and they solve the asymmetric information problems of adverse selection and moral hazard. By doing this, they allow small savers and borrowers to benefit from the existence of financial markets and its instruments. They also improve economic efficiency because they help financial markets to channel funds from lenders-savers to people with productive investment opportunities.
Q2) The liquidity of assets in contractual savings institutions ________.
A)is an important consideration
B)is not an important consideration
C)is restricted
D)is an undertaking
Answer: B
Q3) How do regulators help to ensure the soundness of financial intermediaries?
Answer: Regulators restrict who can set up as a financial intermediary, conduct regular examinations, restrict assets, and provide insurance to help ensure the soundness of financial intermediaries.
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Page 4
Chapter 3: What Is Money
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Sample Questions
Q1) An individual's annual salary is her ________.
A)money
B)income
C)wealth
D)liabilities
Answer: B
Q2) In the country of Moneyland the law allows you to repay mortgage in rocks. Thus, ________.
A)Moneyland is a poor country
B)rocks in this country are considered as money
C)money is scarce
D)Moneyland is a developing country
Answer: B
Q3) Because it is a unit of account, money ________.
A)increases transaction costs
B)reduces the number of prices that need to be calculated
C)does not earn interest
D)discourages specialization
Answer: B
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Page 5
Chapter 4: Understanding Interest Rates
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Sample Questions
Q1) In which of the following situations would you prefer to be the borrower?
A)The interest rate is 9 percent and the expected inflation rate is 7 percent.
B)The interest rate is 4 percent and the expected inflation rate is 1 percent.
C)The interest rate is 13 percent and the expected inflation rate is 15 percent.
D)The interest rate is 25 percent and the expected inflation rate is 50 percent.
Q2) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________.
A)-5 percent
B)-2 percent
C)2 percent
D)12 percent
Q3) Explain why the current bond prices and interest rates are negatively related.
Q4) To claim that a lottery winner who is to receive $1 million per year for twenty years has won $20 million ignores the process of ________.
A)face value
B)par value
C)deflation
D)discounting the future
Q5) What is a coupon bond? Describe its basic properties.
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Chapter 5: The Behaviour of Interest Rates
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Q1) The figure above illustrates the effect of an increased rate of money supply growth at time period T . From the figure, one can conclude that the ________.
A)liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation
B)liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation
C)liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation
D)liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation
Q2) When the inflation rate is expected to increase, the ________ for bonds falls, while the ________ curve shifts to the right, everything else held constant.
A)demand; demand
B)demand; supply
C)supply; demand
D)supply; supply
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Chapter 6: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) Bonds with no default risk are called ________.
A)flower bonds
B)no-risk bonds
C)default-free bonds
D)zero-risk bonds
Q2) The spread between interest rates on low quality corporate bonds and Canada bonds ________.
A)widens significantly during recessions
B)narrows significantly during recessions
C)narrows moderately during recessions
D)does not change during recessions
Q3) According to the liquidity premium theory of the term structure ________.
A)bonds of different maturities are not substitutes
B)if yield curves are downward sloping, then short-term interest rates are expected to fall by so much that, even when the positive term premium is added, long-term rates fall below short-term rates
C)yield curves should never slope downward
D)interest rates on bonds of different maturities do not move together over time
Q4) If a higher inflation is expected, what would you expect to happen to the shape of the yield curve? Why?
Page 8
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Q1) General Electric announces that it is going to cut its dividends by $0.02 per share in the future. This, everything else remaining the same, will cause its current stock price to ________.
A)increase
B)decrease
C)remain the same D)fluctuate
Q2) The number and availability of discount brokers has grown rapidly since the mid-1970s. The efficient markets hypothesis predicts that people who use discount brokers ________.
A)will likely earn lower returns than those who use full-service brokers
B)will likely earn about the same as those who use full-service brokers, but will net more after brokerage commissions
C)are going against evidence suggesting that full-service brokers can help outperform the market
D)are likely to outperform the market by a wide margin
Q3) What rights does ownership interest give stockholders?
Q4) What is a recommended strategy for a small investor and how it is associated with the efficient market hypothesis?
Page 9
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) The analysis of how asymmetric information problems affect economic behavior is called ________ theory.
A)uneven
B)parallel
C)principal
D)agency
Q2) Of the sources of external funds for nonfinancial businesses in Canada, corporate bonds and commercial paper account for approximately ________ of the total.
A)5 percent
B)10 percent
C)15 percent
D)50 percent
Q3) Explain the "lemons problem" as it applies to the used-car market. Why does this problem exist? How does this market resolve this problem?
Q4) Explain the principal-agent problem as it pertains to equity contracts.
Q5) How do restrictive covenants reduce moral hazard in debt contracts?
Q6) Explain the problem of asymmetric information, adverse selection and moral hazard, and why these problems are important for the financial system.
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Chapter 9: Financial Crises
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Sample Questions
Q1) Increased complexity of structured products can ________.
A)destroy information and improve adverse selection problems
B)increase information and worsen adverse selection problems
C)make asymmetric information better in the financial system
D)make asymmetric information worse in the financial system
Q2) The Dodd-Frank Act of 2010 requires financial institutions to ________.
A)lend to all individuals who need loans
B)require verification of a borrowers job status but not credit history and income
C)require verification of a borrowers income and job status but not their credit history
D)require verification of a borrowers income, credit history and job status
Q3) Explain why the too-big-to-fail problem is a moral hazard problem.
Q4) Which investment bank filed for bankruptcy on September 15, 2008 making it the largest bankruptcy filing in U.S. history?
A)Lehman Brothers
B)Merrill Lynch
C)Bear Stearns
D)Goldman Sachs
Q5) What is debt deflation?
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Chapter 10: Economic Analysis of Financial Regulation
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Sample Questions
Q1) The policy of ________ exacerbated ________ problems as savings and loans took on increasingly huge levels of risk on the slim chance of returning to solvency.
A)regulatory forbearance; moral hazard
B)regulatory forbearance; adverse hazard
C)regulatory agnosticism; moral hazard
D)regulatory agnosticism; adverse hazard
Q2) The chartering process is similar to ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets.
A)screening; restrictive covenants
B)screening; branching restrictions
C)identifying; branching restrictions
D)identifying; credit rationing
Q3) Bank failures in Canada arose due to historical accident, including ________ and
A)sharp increase in interest rates; severe recession
B)sharp increase in interest rates; a housing boom
C)sharp decrease in interest rates; severe recession
D)sharp decrease in interest rates; a housing bubble
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Page 12
Chapter 11: Banking Industry: Structure and Competition
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Sample Questions
Q1) An essential characteristic of credit unions is that ________.
A)they are typically large
B)branching is prohibited
C)their lending is primarily for mortgage loans
D)they are organized for individuals with a common bond
Q2) Prior to 2008, a U.S. bank's cost of holding reserves equaled ________.
A)the interest paid on deposits times the amount of reserves
B)the interest paid on deposits times the amount of deposits
C)the interest earned on loans times the amount of loans
D)the interest earned on loans times the amount on reserves
Q3) Credit cards date back to ________.
A)prior to the second World War
B)just after the second World War
C)the early 1950s
D)the late 1950s
Q4) Bank consolidation will likely result in ________.
A)less competition
B)the elimination of credit unions
C)more competition
D)a shift in assets from larger banks to smaller banks
Page 13
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Chapter 12: Banking and the Management of Financial Institutions
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Sample Questions
Q1) Banks that suffered significant losses in the 1980s made the mistake of ________.
A)holding too many liquid assets
B)minimizing default risk
C)failing to diversify their loan portfolio
D)holding only safe securities
Q2) Assuming that the average duration of its assets is five years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to decline by ________ of the total original asset value.
A)5 percent
B)10 percent
C)15 percent
D)25 percent
Q3) Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called ________.
A)proscription bonds
B)restrictive covenants
C)due-on-sale clauses
D)liens
Page 14
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Chapter 13: Risk Management With Financial Derivatives
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Sample Questions
Q1) What are options? What are their differences from futures contracts?
Q2) If a firm is due to be paid in euros in two months, to hedge against exchange rate risk the firm should ________.
A)sell foreign exchange futures short
B)buy foreign exchange futures long
C)stay out of the exchange futures market
D)buy foreign exchange forward contracts long
Q3) A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is a(n)________.
A)interest rate swap
B)currency swap
C)swaption
D)national swap
Q4) A put option gives the seller ________.
A)the right to sell the underlying security
B)the obligation to sell the underlying security
C)the right to buy the underlying security
D)the obligation to buy the underlying security
Q5) Where are financial futures traded? Describe that market.
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Chapter 14: Central Banks and the Bank of Canada
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Q1) The Bank of Canada assumed the monopoly of issuing bank notes in ________.
A)1945
B)1939
C)1940
D)1949
Q2) From 1929 to 1933 the Canadian real GDP fell by almost ________.
A)30 percent
B)40 percent
C)50 percent
D)20 percent
Q3) Which of the following are entities of the Eurosystem?
A)The European Central Bank
B)National finance ministries in each country
C)The Governing Council of the European Central Bank
D)A and C only
Q4) Which of the following is a responsibility of the Bank of Canada?
A)Funds management
B)Fiscal policy
C)Equalization payments
D)Foreign policy
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Chapter 15: The Money Supply Process
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Sample Questions
Q1) The Bank does not tightly control the monetary base because it does not completely control ________.
A)open market purchases
B)open market sales
C)borrowed reserves
D)the rate
Q2) In the simple deposit expansion model, a decline in chequable deposits of $500 when the desired reserve ratio is equal to 20 percent implies that the Bank of Canada
A)sold $250 in government bonds
B)sold $100 in government bonds
C)sold $50 in government bonds
D)purchased $100 in government bonds
Q3) If the desired reserve ratio is 20 percent, the simple deposit multiplier is ________.
A)5)0
B)2)5
C)4)0
D)10.0
Q4) Who are the three players in the money supply process? Describe their roles.
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Chapter 16: Tools of Monetary Policy
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Sample Questions
Q1) If government deposits at the Bank of Canada are predicted to decrease, the Bank will offset the transaction through government deposit auctions to ________ settlement balances.
A)decrease
B)increase
C)inject
D)resupply
Q2) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent then the bank rate is ________.
A)4 percent
B)3)75 percent
C)3)25 percent
D)4)5 percent
Q3) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent then the operating target of the Bank's monetary policy is ________.
A)3)75 percent
B)4 percent
C)3)25 percent
D)3 percent
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Chapter 17: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) High unemployment ________.
A)results in lower GDP
B)leads to increased human misery
C)cannot be a target of monetary policy
D)A and B only
Q2) Which of the following is disadvantage of inflation targeting?
A)There is simplicity and clarity of the target.
B)Inflation targeting does not rely on a stable money-inflation relationship.
C)It may lead to larger output fluctuations.
D)Inflation targeting reduces the effects of inflation shocks.
Q3) The midpoint of the Bank of Canada's inflation target range is ________.
A)3 percent
B)2 percent
C)1 percent
D)None of the above.
Q4) Why might a policy of low interest rates encourage excessive risk taking?
Q5) Give five reasons why central banks should not try to prick an asset-price bubble.
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Q6) Define the two types of asset-price bubbles and explain why one of these is more is more problematic for the economy.
Chapter 18: The Foreign Exchange Market
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Q1) Explain how productivity affects exchange rates in the long-run
Q2) When the exchange rate for the Mexican peso changes from 9 pesos to the Canadian dollar to 10 pesos to the Canadian dollar, then the Mexican peso has ________ and the Canadian dollar has ________.
A)appreciated; appreciated
B)depreciated; appreciated
C)appreciated; depreciated
D)depreciated; depreciated
Q3) ________ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to appreciate, everything else held constant.
A)An increase; increase
B)An increase; decrease
C)A decrease; increase
D)A decrease; decrease
Q4) Why are exchange rates so volatile?
Q5) In the model of the demand and supply of dollar assets use a graph to explain how a change in the domestic interest rate affects the equilibrium exchange rate.
Q6) What are the factors that affect exchange rates in the long-run?
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Chapter 19: The International Financial System
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Q1) A capital ________ can promote financial instability in an emerging-market country because it is what forces a country to ________ its currency.
A)inflow; devalue
B)inflow; revalue
C)outflow; devalue
D)outflow; revalue
Q2) The seignorage for a government is greater for ________ than for ________. A)dollarization; a currency board
B)dollarization; exchange-rate targeting C)dollarization; monetary targeting D)dollarization; inflation targeting
E)exchange-rate targeting; dollarization
Q3) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from appreciating will result in a ________ of international reserves.
A)undervalued; gain
B)undervalued; loss
C)overvalued; gain
D)overvalued; loss
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21
Chapter 20: Quantity Theory, Inflation, and the Demand for Money
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Q1) Irving Fisher took the view that the institutional features of the economy which affect velocity change ________ over time so that velocity will be fairly ________ in the short run.
A)rapidly; erratic
B)rapidly; stable
C)slowly; stable
D)slowly; erratic
Q2) Budget deficits can be an important source of ________ monetary policy.
A)inflationary
B)recessionary
C)federal
D)fiscal
Q3) The classical economists believed that if the quantity of money doubled, ________.
A)output would double
B)prices would fall
C)prices would double
D)prices would remain constant
Q4) Explain how financing a persistent deficit by money creation will lead to a sustained inflation.
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Chapter 21: The Is Curve
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Q1) A decline in autonomous planned investment spending causes the equilibrium level of aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.
A)rise; LM; right
B)rise; IS; right
C)fall; IS; left
D)fall; LM; left
Q2) Points on the IS curve satisfy ________ market equilibrium.
A)money
B)goods
C)stock
D)bond
Q3) Assume that disposable income equals $1000 and the mpc equals 0.6. If total consumption equal $800, then autonomous consumption is equal to ________.
A)$0
B)$200
C)$800
D)$1000
Q4) What are the factors that can shift the IS curve to the right?
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Chapter 22: The Monetary Policy and Aggregate Demand
Curves
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Q1) An expansionary monetary policy shifts the MP 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
Q2) Higher interest rates lead to reductions in the aggregate output due to ________.
A)reductions in autonomous consumer expenditure
B)reductions in planned investment expenditure
C)higher expected inflation
D)higher employment
Q3) If the central bank did not follow the Taylor principle ________.
A)inflation would spiral out of control
B)it could rely on autonomous monetary policy changes
C)it could rely on non-conventional monetary policy tools
D)B and C only
Q4) Explain the difference between autonomous changes in monetary policy and the Taylor principle.
Q5) 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) The long-run aggregate supply curve is ________.
A)a vertical line through the non-inflationary rate of output
B)a vertical line through the current level of output
C)a vertical line through the natural rate level of output
D)a horizontal line through the current level of output
Q2) Demand shocks are based on the ________ based factors that can shift the aggregate demand curve.
A)seven
B)six
C)five D)eight
Q3) According to aggregate demand and supply analysis, the rising oil prices coupled with the subprime financial crisis in 2007-2008 caused the unemployment rate to ________ and the level of real aggregate output to ________.
A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease
Q4) Explain why the short-run aggregate supply curve has a positive slope.
Q5) What are the factors that can shift the aggregate demand curve to the right?
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Chapter 24: Monetary Policy Theory
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Q1) Which of the following is most likely to lead to inflationary monetary policy?
A)Declining oil prices
B)Resolution of conflict in the Middle East
C)The enactment of a free-trade agreement with Mexico
D)Rising unemployment
Q2) When nominal interest rates are are zero, the AD curve has a ________ slope because when aggregate output decreases the monetary authorities ________ lower the nominal interest rate. As inflation rises the real interest rate _______which will ________ investment and aggregate output.
A)negative; can; increases; decrease
B)negative; cannot; decrease; increase
C)positive; cannot; increases; decrease
D)positive; can; decreases; decrease
Q3) The MP curve is drawn on a graph with the ________ on the horizontal axis and the ________ on the vertical axis.
A)inflation rate, aggregate output
B)nominal interest rate, inflation rate
C)real interest rate, aggregate output
D)inflation rate, real interest rate
Q4) What are the objectives of quantitative easing?
Page 26
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Chapter 25: The Role of Expectations in Monetary Policy
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Q1) An example of a negative supply shock is ________.
A)carbon cap-and-trade program
B)a rapid increase in energy costs
C)a fall in the price of oil
D)the shale gas revolution
Q2) One of the drawbacks of rules based monetary policy is ________.
A)it is subject to the Lucas critique
B)they are too complicated for the general public to understand C)these types of programs are difficult to implement in practice
D)none of the above
Q3) If a negative aggregate supply shock occurs and monetary policy is not credible then ________.
A)inflation will higher and output lower than with credible policy
B)the equilibrium interest rate will fall
C)there will be a corresponding autonomous decrease in aggregate supply
D)none of the above
Q4) Explain why the Bank of Canada had a credibility problem during the 1970s.
Q5) Explain the difference in how the Canadian economy responding during the three oil shocks and the role monetary policy credibility played.
Page 27
Q6) Describe the two main benefits of a credible nominal anchor.
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Chapter 26: Transmission Mechanisms of Monetary Policy
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Q1) In a period of deflation, when there is a declining price level, low nominal interest rates do not necessarily indicate that the cost of borrowing is ________ or that monetary policy is ________.
A)low; tight
B)low; easy
C)high; tight
D)high; easy
Q2) The ________ held the view that monetary policy does not matter at all for movements in aggregate output.
A)new Keynesian economists
B)early Keynesians
C)early monetarists
D)early classical economists
Q3) Most Keynesians currently believe that ________.
A)monetary policy does matter
B)monetary policy is irrelevant
C)fiscal policy does matter
D)A and C only
Q4) What are the advantages of reduced-form evidence?
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Chapter 27: Financial Crises in Emerging Markets
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Q1) Factors that led to worsening conditions in Mexico's 1994-1995 financial markets included ________.
A)strong supervision by bank regulators
B)bankers' lack of expertise in screening and monitoring borrowers
C)improvement of banks' balance sheets because of decreasing loan losses
D)decrease in interest rates
Q2) Severe fiscal imbalances can directly trigger a currency crisis since ________.
A)the government may stop printing money
B)the government may have to cut back on spending
C)the currency must surely increase in value
D)investors fear that the government may not be able to pay back the debt and so begin to sell domestic currency
Q3) Explain what is meant by prudential regulation.
Q4) Factors that led to worsening conditions in Mexico's 1994-1995 financial markets, but did not lead to worsening financial market conditions in East Asia in 1997-1998 included ________.
A)rise in interest rates abroad
B)bankers' lack of expertise in screening and monitoring borrowers
C)deterioration of banks' balance sheets because of increasing loan losses
D)unanticipated increases in the price level
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Chapter 28: The ISLM Model
Available Study Resources on Quizplus for this Chatper
107 Verified Questions
107 Flashcards
Source URL: https://quizplus.com/quiz/36566
Sample Questions
Q1) When is the targeting of the money supply preferred to the interest-rate target? support your answer with the appropriate diagram.
Q2) The LM curve will be vertical and fiscal policy ineffective when ________.
A)the demand for money is unaffected by changes in the interest rate
B)the demand for money is unaffected by changes in income
C)investment is unaffected by changes in the interest rate
D)investment is unaffected by changes in income
Q3) An increase in spending that results from expansionary ________ policy causes the interest rate to ________, everything else held constant.
A)fiscal; rise
B)fiscal; fall
C)incomes; rise
D)incomes; fall
Q4) Describe the key assumption that drives Keynes's ISLM model.
Q5) The money market is in equilibrium ________.
A)at any point on the IS curve
B)at any point on the LM curve
C)at only one point on the LM curve
D)only at the intersection of the IS and LM curves
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Chapter 29: Non-Bank Finance
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109 Verified Questions
109 Flashcards
Source URL: https://quizplus.com/quiz/36567
Sample Questions
Q1) ________ are financial intermediaries that pool the resources of many small investors by selling them shares and using the proceeds to buy securities.
A)Pension funds
B)Investment banks
C)Mutual funds
D)Credit unions
Q2) The Federal Reserve Board set up a ________ credit facility to provide liquidity to AIG.
A)$85 billion
B)$8.5 billion
C)$85 million
D)$8.5 million
Q3) 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
Q4) What are three suggestions given for privatizing public pension plans?
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