Financial Economics
Final Exam
Course Introduction
Financial Economics explores the principles and models underlying financial markets and instruments, focusing on how individuals and institutions make investment, financing, and risk management decisions. The course examines the behavior of asset prices, market efficiency, portfolio theory, and the valuation of equities, bonds, and derivatives. Students will analyze the impact of macroeconomic factors on financial systems, understand the role of financial intermediaries, and evaluate the effects of government policies and regulations on financial stability. The course combines theoretical frameworks with practical applications, preparing students to comprehend and analyze complex financial phenomena in a global context.
Recommended Textbook
Economics of Money Banking and Financial Markets 12th Edition by Frederic S. Mishkin
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Chapter 1: Why Study Money, banking, and Financial Markets
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Sample Questions
Q1) Everything else held constant,an increase in interest rates on student loans
A)increases the cost of a college education.
B)reduces the cost of a college education.
C)has no effect on educational costs.
D)increases costs for students with no loans.
Answer: A
Q2) The gross domestic product is the
A)the value of all wealth in an economy.
B)the value of all goods and services sold to other nations in a year.
C)the market value of all final goods and services produced in an economy in a year.
D)the market value of all intermediate goods and services produced in an economy in a year.
Answer: C
Q3) What crucial role do financial intermediaries perform in an economy?
Answer: Financial intermediaries borrow funds from people who have saved and make loans to other individuals and businesses and thus improve the efficiency of the economy.
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Chapter 2: An Overview of the Financial System
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Sample Questions
Q1) Risk sharing is profitable for financial institutions due to A)low transactions costs.
B)asymmetric information.
C)adverse selection.
D)moral hazard.
Answer: A
Q2) Which of the following are short-term financial instruments?
A)a repurchase agreement
B)a share of Walt Disney Corporation stock
C)a Treasury note with a maturity of four years
D)a residential mortgage
Answer: A
Q3) How do regulators help to ensure the soundness of financial intermediaries?
Answer: Regulators restrict who can set up a financial intermediary,conduct regular examinations,restrict assets,and provide insurance to help ensure the soundness of financial intermediaries.
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Chapter 3: What Is Money
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Sample Questions
Q1) Small-denomination time deposits refer to certificates of deposit with a denomination of less than
A)$1,000.
B)$10,000.
C)$100,000.
D)$1,000,000.
Answer: C
Q2) A feature of Bitcoin,a new type of electronic money,that make it attractive as a medium of exchange is
A)anonymous transactions.
B)volatility of value.
C)heavy regulations by the central bank.
D)wide acceptance by businesses.
Answer: A
Q3) Why are most of the U.S. dollars held outside of the United States?
Answer: Concern about high inflation eroding the value of their own currency causes many people in foreign countries to hold U.S. dollars as a hedge against inflation risk.
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Page 5
Chapter 4: The Meaning of Interest Rates
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Sample Questions
Q1) A discount bond
A)pays the bondholder a fixed amount every period and the face value at maturity.
B)pays the bondholder the face value at maturity.
C)pays all interest and the face value at maturity.
D)pays the face value at maturity plus any capital gain.
Q2) 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
Q3) A bond that is bought at a price below its face value and the face value is repaid at a maturity date is called a
A)simple loan.
B)fixed-payment loan.
C)coupon bond.
D)discount bond.
Q4) Your favorite uncle advises you to purchase long-term bonds because their interest rate is 10%. Should you follow his advice?
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Chapter 5: The Behavior of Interest Rates
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Sample Questions
Q1) Everything else held constant,if the expected return on U.S. Treasury bonds falls from 10 to 5 percent and the expected return on GE stock rises from 7 to 8 percent,then the expected return of holding GE stock ________ relative to U.S. Treasury bonds and the demand for GE stock ________.
A)rises;rises
B)rises;falls
C)falls;rises
D)falls;falls
Q2) Everything else held constant,an increase in the liquidity of bonds results in a ________ in demand for bonds and the demand curve shifts to the ________.
A)rise;right
B)rise;left
C)fall;right
D)fall;left
Q3) The demand for houses decreases,all else equal,when
A)wealth increases.
B)real estate prices are expected to increase.
C)stock prices become more volatile.
D)gold prices are expected to increase.
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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) When yield curves are steeply upward sloping
A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.
Q3) The expectations theory and the segmented markets theory do not explain the facts very well,but they provide the groundwork for the most widely accepted theory of the term structure of interest rates
A)the Keynesian theory.
B)the separable markets theory.
C)the liquidity premium theory.
D)the asset market approach.
Q4) If a higher inflation is expected,what would you expect to happen to the shape of the yield curve? Why?
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Sample Questions
Q1) Suppose Barbara looks out in the morning and sees a clear sky so decides that a picnic for lunch is a good idea. Last night the weather forecast included a 100% chance of rain by midday but Barbara did not watch the local news program. Is Barbara's prediction of good weather at lunch time rational? Why or why not?
Q2) 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.
Q3) The global financial crisis lead to a decline in stock prices because
A)of a lowered expected dividend growth rate.
B)of a lowered required return on investment in equity.
C)higher expected future stock prices.
D)higher current dividends.
Q4) The theory of rational expectations,when applied to financial markets,is known as A)monetarism.
B)the efficient markets hypothesis.
C)the theory of strict liability.
D)the theory of impossibility.
Page 9
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called
A)moral hazard.
B)asymmetric information.
C)noncollateralized risk.
D)adverse selection.
Q2) Nonfinancial businesses in Germany,Japan,and Canada raise most of their funds
A)by issuing stock.
B)by issuing bonds.
C)from nonbank loans.
D)from bank loans.
Q3) One reason financial systems in developing and transition countries are underdeveloped is
A)they have weak links to their governments.
B)they make loans only to nonprofit entities.
C)the legal system may be poor making it difficult to enforce restrictive covenants.
D)the accounting standards are too stringent for the banks to meet.
Q4) Explain the principal-agent problem as it pertains to equity contracts.
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Chapter 9: Banking and the Management of Financial Institutions
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Sample Questions
Q1) A reason why rogue traders have bankrupt their banks is due to
A)the separation of trading activities from the bookkeepers.
B)stringent supervision of trading activities by bank management.
C)accounting errors.
D)a failure to maintain proper internal controls.
Q2) Secondary reserves are so called because
A)they can be converted into cash with low transactions costs.
B)they are not easily converted into cash,and are,therefore,of secondary importance to banking firms.
C)50% of these assets count toward meeting required reserves.
D)they rank second to bank vault cash in importance of bank holdings.
Q3) Examples of off-balance-sheet activities include
A)trading activities.
B)extending loans to depositors.
C)borrowing from other banks.
D)selling negotiable CDs.
Q4) Using T-accounts show what happens to reserves at Security National Bank if one individual deposits $1,000 in cash into her checking account and another individual withdraws $750 in cash from her checking account.
Page 11
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Chapter 10: Economic Analysis of Financial Regulation
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Sample Questions
Q1) When one party to a transaction has incentives to engage in activities detrimental to the other party,there exists a problem of
A)moral hazard.
B)split incentives.
C)ex ante shirking.
D)pre-contractual opportunism.
Q2) The ability to use the too-big-to-fail policy was curtailed by the passage of the FDICIA. To use this action today,the FDIC must get approval of a two-thirds majority of both the Board of Governors of the Federal Reserve and the directors of the FDIC and also the approval of the
A)Secretary of the Treasury.
B)Senate Finance Committee Chairperson.
C)President of the United States.
D)governor of the state in which the failed bank is located.
Q3) How did the increase in the interest rates in the early 80s contribute to the S&L crisis?
Q4) The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.
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Chapter 11: Banking Industry: Structure and Competition
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Sample Questions
Q1) The process in which people seeking higher yielding securities take their funds out of the banking system thus restricting the amount of funds banks can lend is called
A)capital mobility.
B)loophole mining.
C)disintermediation.
D)deposit jumping.
Q2) ATMs were developed because of breakthroughs in technology and as a A)means of avoiding restrictive branching regulations.
B)means of avoiding paying interest to corporate customers.
C)way of concealing transactions from the SEC.
D)increasing the competition from foreign banks.
Q3) Adjustable rate mortgages
A)reduce the interest-rate risk for financial institutions.
B)benefit homeowners when interest rates rise.
C)generally have higher initial interest rates than conventional fixed-rate mortgages.
D)allow borrowers to avoid paying interest on portions of their mortgage loans.
Q4) Discuss three ways in which U.S. banks can become involved in international banking.
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Chapter 12: Financial Crises
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Sample Questions
Q1) Financial crises in advanced economies might start from a A)debt deflation.
B)currency crisis.
C)mismanagement of financial innovations.
D)currency mismatch.
Q2) When the value of loans begins to drop,the net worth of financial institutions falls causing them to cut back on lending in a process called A)deleveraging.
B)releveraging.
C)capitulation.
D)deflation.
Q3) When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a A)credit boom.
B)credit bust.
C)deleveraging.
D)market race.
Q4) Typically,the economy recovers fairly quickly from a recession. Why did this NOT happen in the United States during the Great Depression?
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Chapter 13: Central Banks and the Federal Reserve System
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Sample Questions
Q1) The case for Federal Reserve independence does NOT include the idea that A)political pressure would impart an inflationary bias to monetary policy.
B)a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.
C)policy is always performed better by an elite group such as the Fed.
D)a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.
Q2) Why does the Federal Reserve Bank of New York play a special role within the Federal Reserve System?
Q3) The president from which Federal Reserve Bank always has a vote in the Federal Open Market Committee?
A)Philadelphia
B)Boston
C)San Francisco
D)New York
Q4) Make the case for and against an independent Federal Reserve.
Q5) Explain the similarities and differences between the European System of Central Banks and the Federal Reserve System.
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Chapter 14: The Money Supply Process
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Sample Questions
Q1) Everything else held constant,an increase in wealth will cause the holdings of checkable deposits to the holdings of currency to ________ and the currency ratio will
A)increase;increase
B)increase;decrease
C)decrease;increase
D)decrease;decrease
Q2) Which of the following are NOT liabilities on the Fed's balance sheet?
A)discount loans
B)bank deposits
C)deferred availability cash items
D)U)S. Treasury deposits
Q3) A bank has excess reserves of $6,000 and demand deposit liabilities of $100,000 when the required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent,the bank's excess reserves will be
A)-$5,000.
B)-$1,000.
C)$1,000.
D)$5,000.
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Page 16
Chapter 15: Tools of Monetary Policy
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Sample Questions
Q1) If float is predicted to increase because of bad weather,the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A)defensive;inject
B)defensive;drain
C)dynamic;inject
D)dynamic;drain
Q2) To lower interest rates on residential mortgages to stimulate the housing market,the Fed extended its open market operations to purchase
A)mortgage-backed securities.
B)commercial papers.
C)long-term Treasuries.
D)Treasury bills and Treasury notes.
Q3) When bad storms slow the check-clearing process,float tends to ________ causing the Fed to initiate ________ open market ________.
A)decrease;defensive;sales
B)decrease;dynamic;purchases
C)increase;defensive;sales
D)increase;dynamic;purchases
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Chapter 16: The Conduct of Monetary Policy: Strategy and Tactics
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Sample Questions
Q1) Unemployment resulting from a mismatch of workers' skills and job requirements is called
A)frictional unemployment.
B)structural unemployment.
C)seasonal unemployment.
D)cyclical unemployment.
Q2) Which of the following is not an element of inflation targeting?
A)a public announcement of medium-term numerical targets for inflation
B)an institutional commitment to price stability as the primary long-run goal
C)an information-inclusive approach in which only monetary aggregates are used in making decisions about monetary policy
D)increased accountability of the central bank for attaining its inflation objectives
Q3) Which of the following is NOT a requirement in selecting a policy instrument?
A)measurability
B)controllability
C)flexibility
D)predictability
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Chapter 17: The Foreign Exchange Market
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Sample Questions
Q1) If one U.S. dollar is traded on the foreign exchange market for about 0.89 euros,then one euro can purchase about ________ U.S. dollars.
A)0.75
B)0.89
C)1.12
D)1.75
Q2) When Americans or foreigners expect the return on ________ assets to be high relative to the return on ________ assets,there is a ________ demand for dollar assets,everything else held constant.
A)dollar;foreign;constant
B)dollar;foreign;higher
C)foreign;dollar;higher
D)foreign;dollar;constant
Q3) Everything else held constant,if a factor decreases the demand for ________ goods relative to ________ goods,the domestic currency will depreciate.
A)foreign;domestic
B)foreign;foreign
C)domestic;domestic
D)domestic;foreign
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Chapter 18: The International Financial System
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Sample Questions
Q1) Under an exchange-rate targeting rule for monetary policy,a crawling peg
A)fixes the value of the domestic currency to a commodity such as gold.
B)fixes the value of the domestic currency to that of a large,low-inflation country.
C)allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be higher than that of the anchor country.
D)allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be lower than that of the anchor country.
Q2) An advantage to exchange-rate targeting is it helps keep inflation under control by tying the inflation rate for ________ traded goods to what is found in the ________ country.
A)domestically;anchor
B)domestically;domestic
C)internationally;anchor
D)internationally;domestic
Q3) Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed exchange rate system. What alternative policies are available to eliminate the overvaluation of the exchange rate?
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Page 20
Chapter 19: Quantity Theory, inflation and the Demand for Money
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Sample Questions
Q1) 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.
Q2) If people expect nominal interest rates to be lower in the future,the expected return to bonds ________,and the demand for money ________.
A)increases;increases
B)increases;decreases
C)decreases;increases
D)decreases;decreases
Q3) If initially the money supply is $2 trillion,velocity is 5,the price level is 2,and real GDP is $5 trillion,a fall in the money supply to $1 trillion
A)reduces real GDP to $2.5 trillion.
B)causes velocity to rise to 10.
C)decreases the price level to 1.
D)decreases the price level to 1 and decreases velocity to 2.5.
Q4) Describe what the liquidity trap is. Explain how it can be problematic for monetary policymakers.
Page 21
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Chapter 20: The Is Curve
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Sample Questions
Q1) Everything else held constant,if disposable income increases by 200 and consumption expenditure increases by 150,the mpc is
A)0.
B)0.15.
C)0.5.
D)0.75.
Q2) If aggregate demand falls short of current output,business firms will ________ production to ________ inventories.
A)cut;keep from accumulating
B)expand;keep from accumulating C)cut;build up
D)expand;build up
Q3) The negative relation between investment spending and the interest rate is what gives the ________ curve its ________ slope.
A)IS;upward
B)IS;downward
C)LM;downward
D)LM;upward
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Chapter 21: The Monetary Policy and Aggregate Demand
Curves
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Sample Questions
Q1) Everything else held constant,an autonomous easing of monetary policy will cause
A)the quantity of aggregate demand to increase.
B)the quantity of aggregate demand to decrease.
C)aggregate demand to decrease.
D)aggregate demand to increase.
Q2) Because prices are sticky in the short-run,when the Federal Reserve raises the federal funds rate
A)nominal interest rates fall.
B)real interest rates rise.
C)inflation falls.
D)real interest rates fall.
Q3) The monetary policy (MP)curve indicates the relationship between
A)the Federal Funds Rate and the real interest rate.
B)the Federal Funds Rate and the inflation rate.
C)the inflation rate and the expected inflation rate.
D)the real interest rate the central bank sets and the inflation rate.
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Chapter 22: Aggregate Demand and Supply Analysis
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Q1) 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 inflation in the short run.
A)an increase;an increase
B)a decrease;a decrease
C)a decrease;an increase
D)no change;no change
Q2) The long-run rate of unemployment to which an economy always gravitates is the
A)normal rate of unemployment.
B)natural rate of unemployment.
C)neutral rate of unemployment.
D)inflationary rate of unemployment.
Q3) Everything else held constant,a change in workers' expectations about inflation will cause ________ to change.
A)aggregate demand
B)short-run aggregate supply
C)the production function
D)long-run aggregate supply
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Chapter 23: Monetary Policy Theory
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Q1) Nonactivists of policies contend that a policy of shifting the aggregate ________ curve will be costly because it produces ________ volatility in both the price level and output.
A)supply;less B)supply;more C)demand;less D)demand;more
Q2) When output is below potential and the policy rate has hit the floor of zero,the resulting fall in inflation leads to ________ real interest rates,which ________ output further,which causes inflation to fall further.
A)lower;increase B)higher;depress
C)higher;increase D)lower;depress
Q3) To say that inflation is a monetary phenomenon seems to beg the question
A)Why does inflationary monetary policy occur?
B)Why do politicians seek reelection?
C)Why is the Fed independent?
D)Why does the U.S. Treasury print so much money?
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Chapter 24: The Role of Expectations in Monetary Policy
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Q1) Suppose that there is a negative aggregate supply shock and the central bank commits to an inflation rate target.
A)If the commitment is credible,the public's expected inflation will remain unchanged.
B)Credible policy produces better outcomes on both inflation and output in the short run.
C)Policies that are not credible produce worse economic contraction.
D)all of the above.
E)both A and C.
Q2) Lucas argues that when policies change,expectations will change thereby
A)changing the relationships in econometric models.
B)causing the government to abandon its discretionary stance.
C)forcing the Fed to keep its deliberations secret.
D)making it easier to predict the effects of policy changes.
Q3) Approaches to establishing central bank credibility include
A)inflation targeting.
B)exchange rate targeting.
C)central bank independence.
D)appointment of a more conservative central banker.
E)all of the above.
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Page 26
Chapter 25: Transmission Mechanisms of Monetary Policy
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Sample Questions
Q1) The monetarist-Keynesian debate on the importance of monetary policy is unresolved because monetarists and Keynesians focus on two different types of evidence that generate conflicting conclusions. Monetarists tend to focus on
A)structural-model evidence,while Keynesians focus on reduced-form evidence.
B)reduced-form evidence,while Keynesians focus on structural-model evidence.
C)reduced-form evidence,while Keynesians focus on direct-model evidence.
D)structural-model evidence,while Keynesians focus on direct-model evidence.
Q2) During the Great Depression,Tobin's q
A)rose dramatically,as did real interest rates.
B)fell to unprecedentedly low levels.
C)stayed fairly constant,in contrast to most other economic measures.
D)rose only slightly,in spite of Hoover's attempts to prop it up.
Q3) An expansionary monetary policy increases net exports by ________ interest rates and ________ the value of the dollar.
A)lowering nominal;decreasing
B)lowering real;decreasing
C)raising nominal;increasing
D)raising real;increasing
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Chapter 26: Financial Crises in Emerging Market Economies
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Sample Questions
Q1) The mismanagement of financial liberalization in emerging market countries can be understood as a severe
A)principal/agent problem.
B)asymmetric information problem.
C)lemons problem.
D)free-rider problem.
Q2) The two key factors that trigger speculative attacks on emerging market currencies are
A)deterioration in bank balance sheets and severe fiscal imbalances.
B)deterioration in bank balance sheets and low interest rates abroad.
C)low interest rates abroad and severe fiscal imbalances.
D)low interest rates abroad and rising asset prices.
Q3) 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 include
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)stock market decline.
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28
Chapter 27: The ISLM Model
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Q1) Which of the followings does NOT describe the goods market in the ISLM model?
A)consumption function
B)investment function
C)government spending and tax
D)money demand function
Q2) In the long-run ISLM model and with everything else held constant,the long-run effect of an expansionary fiscal policy is to ________ real output and ________ the interest rate.
A)increase;increase
B)not change;not change
C)increase;not change
D)not change;increase
Q3) If the economy is on the LM curve,but is to the right of the IS curve,then the ________ market is in equilibrium,but aggregate ________ exceeds aggregate
A)goods;output;demand
B)goods;demand;output
C)money;output;demand
D)money;demand;output
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