Economics of Money and Banking Study Guide Questions
Course Introduction
Economics of Money and Banking explores the fundamental roles of money, financial institutions, and central banks in modern economies. The course examines how money is created, the functioning and regulation of commercial and central banks, and the impact of monetary policy on inflation, employment, and economic growth. Students study the structure and operations of financial markets and instruments, the transmission mechanisms of monetary policy, and the interconnectedness of global banking systems. Real-world case studies and recent financial crises are analyzed to provide a practical understanding of contemporary banking challenges and regulatory responses.
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Money Banking and Financial Markets 3rd Edition by
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Page 2
Stephen G. Cecchetti
Chapter 1: An Introduction to Money and the Financial System
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Q1) If the U.S.Supreme Court ruled that states could no longer require people to have auto insurance, do you think most people would cancel their policies? Explain.
Answer: Probably not.Auto insurance falls under the principle that risk requires compensation.For most people the additional risk they would face of driving without insurance exceeds the cost of the insurance, so they are better off purchasing auto insurance to reduce their risk.
Q2) Which of the following statements best describes financial instruments?
A)All financial instruments are a means of payment
B)Financial instruments can transfer resources between people but not risk
C)Financial instruments can transfer resources and risk between people
D)Financial instruments can transfer risk but not resources between people
Answer: C
Q3) The amount of information an individual would seek before making a decision:
A)Is about the same across all individuals
B)Varies directly with the importance of the decision
C)Is the same across all decisions but varies across individuals
D)Depends on how much time it will take to get the information regardless of the decision
Answer: B
Page 3
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Chapter 2: Money and the Payments System
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Q1) In comparing money to a U.S.Treasury bond held by an individual, we can say:
A)Both are legal tender
B)Both are units of account
C)Only the bond is legal tender since it is an obligation of the U.S.Government
D)Both are stores of value
Answer: D
Q2) The store of value characteristic of money refers to the fact that:
A)People save most of their money
B)Sellers are less likely to accept perishable goods in exchange for goods they sell
C)Money is not valuable unless it is stored
D)Money is the only way people have to store value
Answer: B
Q3) The most commonly quoted monetary aggregate is:
A)Money-market mutual fund shares
B)M1 since it is the most liquid
C)Public currency
D)M2 since its movement is most closely related to interest rates and economic growth
Answer: D
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Q1) What evidence is there that the transaction costs involved with the buying and selling of stocks is low?
Answer: Probably the best evidence is the volume of trading that occurs on an average day.As an example, on an average day billions of shares of stock may trade in the U.S.alone, and while most of these trades are undertaken using brokers, the fee the broker requires is usually a very small percentage of the overall value of the instruments traded.The volume of trades and the low fees for these trades would not result if transaction costs were high.
Q2) Which of the following is not a financial instrument?
A)A share of Microsoft stock
B)A U.S.Treasury Bond
C)An electric bill
D)A life insurance policy
Answer: C
Q3) A counterparty to a financial instrument is always:
A)The issuer of the financial instrument
B)The government agency guaranteeing the value of the instrument
C)The person or institution that purchases the financial instrument
D)The person or institution that is on the other side of the financial contract
Answer: D
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Chapter 4: Future Value, Present Value, and Interest Rates
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Q1) Higher savings usually requires higher interest rates because:
A)Everyone prefers to save more instead of consuming
B)Saving requires sacrifice and people must be compensated for this sacrifice
C)Higher savings means we expect interest rates to decrease
D)Of the rule of 72
Q2) Which of the following best expresses the future value of $100 left in a savings account earning 3.5% for three and a half years?
A)$100(1.035)3.5
B)$100(0.35)3.5
C)$100 x 3.5 x (1.035)
D)$100(1.035)3/2
Q3) A promise of a $100 payment to be received one year from today is:
A)More valuable than receiving the payment today
B)Less valuable than receiving the payment six months from now
C)Equally valuable as a payment received today if the interest rate is zero
D)Not enough information is provided to answer the question
Q4) Explain why, if real interest rates are so important, we see most interest rates quoted in nominal terms.
Q5) How has Islamic banking redefined lending to deal with Islam's prohibition of usury?
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Chapter 5: Understanding Risk
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Q1) If there are 1,000 people, each of whom owns a $100,000 house, and they each stand a 1/1,000 chance each year of suffering a fire that will totally destroy their house, what is the minimum that they would have to pay annually for fire insurance?
E.L.= 0.001 ($100,000) + 0.999($0) = $100.00.Since the expected loss for each individual is $100 per year, the minimum that each would have to pay is $100.00 a year, in fact, given the probability of 1 in a 1000 homeowners in this group suffering a fire each year, at $100 each, on average, there should be just enough to compensate the person suffering the fire.
Q2) How are the decisions of government policy makers, such as the Federal Reserve, related to risk and an individual investor's portfolio?
Q3) High oil prices tend to harm the auto industry and benefit oil companies; therefore, high oil prices are an example of:
A)Systematic risk
B)Idiosyncratic risk
C)Neither systematic nor idiosyncratic risk
D)Both systematic and idiosyncratic risk
Q4) Explain why returns on assets compensate for systematic risk but not for idiosyncratic risk.
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Q1) A decrease in the nation's wealth, all other factors constant:
A)Would cause the bond demand curve to shift left
B)Would cause bond prices to rise
C)Would cause interest rates to decrease
D)Would cause the bond supply curve to shift left
Q2) During economic recessions, interest rates may decrease or increase.This question asks you to analyze two recent U.S.recessions:
(i) 1990-91 recession (interest rates increased)
(ii) 2001 recession (interest rates decreased)
What happened to bond prices during each of these recession? What do the interest rate data from these two recessions reveal about the shifts in bond demand and bond supply?
Q3) The relationship between the price and the interest rate for a zero coupon bond is best described as:
A)Volatile
B)Fluctuating
C)Inverse
D)Non-existent
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Chapter 7: The Risk and Term Structure of Interest Rates
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Q1) A yield curve that slopes upward says each of the following, except:
A) Short-term rates are expected to decrease
B) People may be expecting short-term rates will be higher in the future
C) Short-term rates could be expected to remain constant
D) Long-term interest rates are higher than current short-term rates
Q2) The risk spread is:
A) The difference between a bond's purchase price and selling price
B) The difference between the bond's yield and the yield on a U.S. Treasury bond of the same maturity
C) Less than 0 (zero) for a U.S. Treasury bond
D) Assigned by a bond-rating agency
Q3) Any theory of the term structure of interest rates needs to explain each of the following, except:
A) The upward slope of the yield curve
B) Why the yields of different maturities tend to move together
C) Why short-term yields are usually higher than long-term yields
D) Why long-term yields are usually higher than short-term yields
Q4) What is the main purpose (function) of bond rating services?
Q5) What role did rating agencies play in the financial crisis of 2007-2009?
Q6) What is meant by a subprime mortgage?
Page 9
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Chapter 8: Stocks, Stock Markets, and Market Efficiency
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Q1) Which of the following will cause an increase in the current price of a stock?
A)A decrease in the risk-free return
B)A decrease in the current dividend
C)A decrease in the dividend growth rate
D)Both an increase in the risk-free return or an increase in the current dividend
Q2) Which of the following is not a feature of common stock?
A)Stockholders receive regular fixed payments on their shares
B)Stockholders have limited liability
C)Stock holders are residual claimants
D)Stockholders have voting rights
Q3) Considering the return an investor requires from a stock, what are the two components that make up that return? Briefly explain each of these components.
Q4) Mutual funds are characterized by the fact that the all:
A)Have the same management fee set by regulation.
B)Require the same minimum investment of $10,000.
C)Provide some degree of diversification.
D)Provide the same degree of liquidity.
Q5) Compare/contrast the Nasdaq Composite Index with the Dow Jones Industrial Average.
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Q1) The intrinsic value of an option:
A)Is the amount the investor believes the option will be worth on the expiration date.
B)Is the amount the option is worth if it is exercised immediately.
C)Is equal to price of the underlying asset.
D)Cannot be determined without knowing the future price of the underlying asset.
Q2) Considering a put option, an increase in the strike price:
A)Causes the intrinsic value of the option to decrease.
B)Causes the intrinsic value of the option to increase.
C)Causes the value of the option to decrease.
D)Makes the option worthless.
Q3) What would be the value of an option on a stock that sells at a fixed price with a standard deviation of zero? Explain.
Q4) Describe the condition that would have a call option in the money.Now describe the condition that has a put option out of the money.
Q5) Explain why for speculation, the purchase of an option may be more attractive than a futures contract or the outright purchase of the underlying asset.
Q6) Identify four factors that will cause the value of call options to increase.
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Chapter 10: Foreign Exchange
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Q1) Explain why a real exchange rate that does not equal one implies purchasing power parity does not hold.
Q2) When a currency is described as undervalued, this implies:
A)It is undervalued relative to what the describer believes purchasing power parity to be
B)It is undervalued relative to the exchange rate set by the nation's central bank
C)The exchange rate is greater than one
D)The exchange rate is lower than one year previous
Q3) If the current exchange rate is 1 /1$U.S.and bagels cost 1 in France and 1$ in the U.S.and the current exchange rate for bagels is 0.74 European bagel/1U.S.bagel and if the bagels are identical:
A)U.S.bagels are less expensive than French bagels
B)U.S.and French bagels are the same price
C)French bagels are less expensive than U.S.bagels
D)Americans should import French bagels
Q4) In looking at the foreign exchange rates in the Wall Street Journal you notice the dollar-euro spot rate is 1.085 /$ and the six-month forward rate is 1.098 /$.What does this imply?
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Chapter 11: The Economics of Financial Intermediation
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Q1) One reason the government requires public corporations to disclose so much information is to:
A)Minimize the monopoly profits some corporations earn
B)Give small corporations a better chance of competing against large corporations
C)Address the potential harm from asymmetric information
D)Discourage risk-taking by investors
Q2) If information in a financial market is symmetric, this means:
A)Borrowers and lenders have perfect information
B)Borrowers would have more information than lenders
C)Borrowers and lenders have the same information
D)Lenders have more information than borrowers
Q3) Which of the following is not a role of a financial institution acting as a financial intermediary?
A)Pooling the resources of small savers
B)Formulating oversight regulations
C)Providing ways to diversify risk
D)Supplying liquidity
Q4) Explain how mutual funds offer small investors a low-cost way to achieve diversification.
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Chapter 12: Depository Institutions: Banks and Bank Management
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Q1) A repurchase agreement is:
A)An asset that represents the value of all collateral repossessed by the bank and held for sale
B)A long-term collateralized loan
C)An agreement where the parties agree to reverse the transaction on a specific day
D)Only made between two or more banks
Q2) The federal funds market:
A)Is the term used for bank borrowing from the Federal Reserve System
B)Is the lending to banks by the U.S.treasury when banks face liquidity emergencies
C)Is the inter-bank market where excess reserves from one bank can be loaned to another bank
D)Is the borrowing by American banks from foreign lenders
Q3) Which of the following bank assets would be categorized as secondary reserves?
A)U.S.Treasury bills
B)Cash
C)Mortgage loans
D)Deposits at the Federal Reserve
Q4) What is the equation that reflects a bank's balance sheet?
Page 14
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Chapter 13: Financial Industry Structure
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Q1) Why do you think most health insurance policies require the first $100 or so of every claim and a percentage of the bill after that to be paid by the insured?
Q2) Explain why the decoding of the human genome has interesting implications for the life insurance industry.
Q3) Explain why a domestic bank in the U.S.might create a subsidiary bank in a foreign location like the Cayman Islands.
Q4) From a transaction cost perspective, discuss why a firm may contract with an investment bank to underwrite or place an issue.
Q5) Explain the difference between a pension fund that is a defined-contribution plan from one that is a defined-benefit.
Q6) Often Eurodollar deposits earn higher returns than U.S.bank deposits for all of the following reasons except:
A)Eurodollar deposits are not subject to U.S.reserve requirements
B)The bank does not have to pay deposit insurance premiums on these deposits
C)Regulatory compliance may be more costly for a foreign bank than a U.S.bank
D)Taxes on the profits at foreign banks may be lower than those for U.S.banks, allowing for higher returns
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Chapter 14: Regulating the Financial System
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Q1) The government provides deposit insurance; this insurance protects:
A)Large corporate deposit accounts, but only the amounts that exceed the $250,000 deductible
B)Depositors for up to $250,000 should a bank fail
C)The deposits of banks in their Federal Reserve accounts
D)The deposits that people have, but only for federally chartered banks
Q2) The fact that banks often make loans to other banks means:
A)One bank failing will not have a large impact on the financial industry
B)The banking industry is really self-regulating
C)One bank's failure can be contagious and spread to other banks
D)The liquidity problem banks face is reduced
Q3) What three strategies are employed by government officials to ensure that the risks created by the government safety net are contained?
Q4) Commercial banks are regulated by a combination of agencies including each of the following, except:
A)The Federal Reserve
B)The Office of Thrift Supervision
C)State authorities
D)The Federal Deposit Insurance Corporation
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Chapter 15: Central Banks in the World Today
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Q1) The correlation between high rates of inflation and economic growth is:
A)Direct; one brings about the other
B)Inverse; high inflation usually means low economic growth
C)There is no correlation between these measures
D)Is direct at low rates of economic growth and inverse at high rates
Q2) The central bank in the United States is:
A)The Bank of America
B)The Federal Reserve
C)The U.S.Treasury
D)The Bank of the United States
Q3) The goals of central banks are to:
A)Reduce the idiosyncratic risk that impacts specific investments
B)Reduce systematic risk
C)Keep stock and bond prices high
D)Keep inflation rates high
Q4) Monetary policy in the United States is under the control of:
A)The U.S.Treasury
B)The President
C)The Federal Reserve
D)The U.S.Senate
17
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Chapter 16: The Structure of Central Banks: the Federal
Reserve and the European Central Bank
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Q1) The primary purpose of meetings of the FOMC is to:
A)Set the required reserve rate
B)Set the discount rate
C)Decide on the target interest rate
D)Set the prime rate
Q2) Why is it technically incorrect to say that the board of directors of the regional Fed banks set the discount rate that each bank charges?
Q3) The make-up of the Governing Council of the European Central Bank and the methods used to calculate price stability for the monetary system can potentially result in:
A)Small countries having undue influence on the decisions of the Council
B)Monetary policy that is well suited for some countries but ill suited for others
C)A policy for the median country rather than a policy well suited for any country
D)All of the results listed are possible
Q4) What are the three criteria that are used to judge a central bank's independence and how does the Fed stack up to each of these criteria?
Q5) Why are so few state chartered banks members of the Federal Reserve System?
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Chapter 17: The Central Bank Balance Sheet and the Money Supply Process
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Q1) If banks never held any excess reserves and if the currency holdings of the public never changed, do you think the Fed would still focus on an interest-rate target?
Q2) You receive a $1,000 gift from your grandmother when you graduate from college.Your grandmother withdrew the $1,000 from her checking account and gave you ten $100 bills.You deposit the ten bills into your checking account.Discuss the impact of these transactions on your grandmother's balance sheet, your balance sheet, and the Fed's balance sheet.
Q3) If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then C + D would equal: A)M B)m C)MB D)ER/RR
Q4) You are given the following information: Reserves (R) in the banking system amount to $48 billion, of which $45.8 billion are required.Currency in the hands of the public amounts to $692.5 billion while checkable deposits amount to $650 billion.Calculate the money multiplier.
Page 19
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Chapter 18: Monetary Policy: Stabilizing the Domestic Economy
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Q1) The focus for most central banks today is:
A)The quantity of M1
B)Interest rates
C)The quantity of M2
D)Controlling the size of the money multiplier
Q2) Which of the following statements is most correct?
A)The FOMC is more successful at keeping the market rate closer to the target rate than the ECB
B)The FOMC is more successful than the ECB at keeping the market rate within a 100 basis point band of the target rate
C)The ECB has kept the market rate within a 100 basis point band of the target rate; the FOMC cannot make this claim
D)The ECB seldom has the market rate within 100 basis points of the target rate
Q3) The European equivalent of the U.S.'s market federal funds rate is called the:
A)Overnight cash rate
B)Target refinancing rate
C)European discount rate
D)Overnight repurchase rate
Q4) How does credit easing alter the outlook for the economy and inflation?
Page 20
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Chapter 19: Exchange-Rate Policy and the Central Bank
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Q1) A sterilized intervention is actually a combination of two transactions.What are they and what is the effect on the monetary base?
Q2) The impact on the foreign exchange market for dollars resulting from the Fed selling euros will be:
A)A decrease in the demand for dollars
B)A decrease in the supply of dollars
C)An increase in the supply of dollars
D)A decrease in the interest rate in the U.S.
Q3) Which of the following statements is incorrect?
A)A foreign exchange intervention affects the value of a country's currency by changing domestic interest rates
B)Any central bank policy that influences the domestic interest rate will affect the exchange rate
C)Higher U.S.interest rates would likely result in an appreciation of the U.S.dollar
D)Changes in foreign exchange reserves always affect a country's monetary base
Q4) Compare the monetary policy of the 50 states that make up the United States to the exchange rate regime of dollarization.
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Chapter 20: Money Growth, Money Demand, and Modern Monetary Policy
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Q1) Key assumptions behind the quantity theory of money include:
A)The money supply is fixed
B)The velocity of money is constant
C)The percentage change in the price level equals the percentage change in real GDP
D)The change in nominal GDP is zero
Q2) To say that the relationship between the velocity of money and the opportunity cost of holding money is not stable is the same as saying:
A)The supply of money is not stable
B)The money market is always in disequilibrium
C)Money demand is stable
D)Money demand is not stable
Q3) Why did a decline in mortgage rates in the 1990s cause the velocity of M2 to fluctuate?
Q4) When the former Soviet Union collapsed in 1990, most of the countries that made up the union experienced extremely high rate of inflation? What was the source of the high inflation and why did it happen?
Q5) Explain why "free" checking accounts are not really free.
Page 22
Q6) What factors can cause the portfolio demand for money to increase?
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Chapter 21: Output, Inflation, and Monetary Policy
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Q1) If current output deviates from potential output, the short-run aggregate supply curve may shift because:
A)Aggregate demand has to shift
B)Potential output will have to shift
C)Inflation adjusts
D)The economy's long-run growth rate will have to adjust
Q2) Is the monetary policy reaction curve applicable only to central banks that have an explicit inflation target? Explain.
Q3) Which of the following statements is incorrect?
A)The point where the short-run and long-run supply curves intersect corresponds to the potential level of output
B)Any point on the short-run aggregate supply curve reflects current inflation equals actual inflation
C)Inflation and output are unrelated in the long run
D)In the long run, inflation is determined by monetary policy
Q4) Why would central bankers have to pay attention to forecasts regarding consumer sentiment and expectations of business owners and managers?
Q5) What are the determinants of the potential output for an economy?
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Chapter 22: Understanding Business Cycle Fluctuations
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Q1) Why do negative supply shocks pose a particularly difficult dilemma for monetary policymakers?
Q2) If the monetary policy reaction curve has a relatively steep slope, the dynamic aggregate demand curve is likely to have a:
A)Relatively steep slope
B)Relatively flat slope
C)Positive slope
D)Zero slope
Q3) Describe the immediate short-run effect to the economy from an increase in government purchases, as well as the self-correcting mechanism that will restore long-run equilibrium.
Q4) Policymakers could neutralize all of the following except:
A)An increase in federal government spending on defense
B)An increase in the price of oil
C)A trade deficit
D)A decrease in business confidence
Q5) If monetary policymakers do not want the current inflation rate to increase, yet they observe increasing aggregate demand from higher government purchases, will they have to accept a higher inflation target? Explain.
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) The importance of the bank-lending channel of monetary policy transmission:
A)Becomes more important the more important banks are as a source of funds for firms and individuals
B)Is likely to become more important with the growth of loan brokers and asset-backed securities
C)Has become more important as technology has solved the problems of information and moral hazard
D)None of the answers given is correct
Q2) As interest rates rise the supply of loans may decrease because:
A)Borrowers net worth rises
B)Demand for loans falls
C)Lenders are increasingly on the lookout for adverse selection
D)All of the answers given are correct
Q3) Will an open market sale by the Federal Reserve increase banks' willingness to make loans? Explain.
Q4) What are the arguments for and against monetary policymakers intervening to address equity and property price bubbles?
Q5) Why should the supply of loans increase as interest rates fall?
Q6) Why can't the nominal interest rate be negative?
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