Financial Economics
Final Exam Questions
Course Introduction
Financial Economics explores the principles and methodologies used to analyze financial markets, instruments, and institutions. The course covers topics such as asset pricing, risk and return, portfolio theory, market efficiency, and the role of financial intermediaries. Students will examine how financial markets operate, how information and incentives affect market outcomes, and the impact of monetary policy and regulation on financial systems. Emphasis is placed on both theoretical models and empirical applications, providing a comprehensive understanding of how economic forces shape financial decision-making in both domestic and international contexts.
Recommended Textbook
Financial Markets and Institutions Global 7th Edition by Frederic S Mishkin
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Page 2
Chapter 1: Why Study Financial Markets and Institutions
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Sample Questions
Q1) If you are planning a vacation to Europe, do you prefer a strong dollar or weak dollar relative to the euro? Why?
Answer: not answered
Q2) Interest rates can be accurately described as the rental price of money.
A)True
B)False
Answer: True
Q3) Interest rates are determined in the bond markets.
A)True
B)False
Answer: True
Q4) Have interest rates been more or less volatile in recent years? Why?
Answer: not answered
Q5) In a bull market stock prices are rising, on average.
A)True
B)False
Answer: True
Q6) What are financial intermediaries and what do they do?
Answer: not answered
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Chapter 2: Overview of the Financial System
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Sample Questions
Q1) Financial markets have the basic function of
A)bringing together people with funds to lend and people who want to borrow funds.
B)assuring that the swings in the business cycle are less pronounced.
C)assuring that governments need never resort to printing money.
D)both A and B of the above.
E)both B and C of the above.
Answer: A
Q2) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the
A)moral hazard problem.
B)adverse selection problem.
C)shirking problem.
D)free-rider problem.
E)principal-agent problem.
Answer: B
Q3) American investors pay attention to only the Dow Jones Industrial Average. A)True
B)False
Answer: False
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Page 4
Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation
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Q1) How is a bond's current yield calculated? Why is current yield a more accurate approximation of yield to maturity for a long-term bond than for a short-term bond?
Answer: not answered
Q2) The current yield on a coupon bond is the bond's ________ divided by its ________.
A)annual coupon payment; price
B)annual coupon payment; face value
C)annual return; price
D)annual return; face value
Answer: A
Q3) The current yield is the best measure of an investor's return from holding a bond.
A)True
B)False
Answer: False
Q4) Changes in interest rates make investments in long-term bonds risky.
A)True
B)False
Answer: True
Page 5
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Chapter 4: Why Do Interest Rates Change
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Sample Questions
Q1) A movement along the demand (or supply)curve occurs when the quantity demanded (or supplied)changes at each given price (or interest rate)of the bond in response to a change in some other factor besides the bond's price or interest rate.
A)True
B)False
Q2) A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________
A)decrease; right.
B)decrease; left.
C)increase; right.
D)increase; left.
Q3) When the growth rate of the money supply is increased, interest rates will rise immediately if the liquidity effect is ________ than the other effects and if there is ________ adjustment of expected inflation.
A)larger; rapid
B)larger; slow
C)smaller; slow
D)smaller; rapid
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates
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Sample Questions
Q1) What do credit-rating agencies do and why is this work important?
Q2) Economists' attempts to explain the term structure of interest rates
A)illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.
B)illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.
C)prove that the real world is a special case that tends to get short shrift in theoretical models.
D)have proved entirely unsatisfactory to date.
Q3) (I)If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest rate to rise. (II)If a corporate bond becomes less liquid, the demand for Treasury bonds does not change.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q4) Explain why a flight to quality occurred following the subprime collapse and how this affected the interest rates on lower-quality corporate bonds and Treasury bonds.
Page 7
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Chapter 6: Are Financial Markets Efficient
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Sample Questions
Q1) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is
A)clearly inconsistent with the efficient market hypothesis.
B)consistent with the efficient market hypothesis if the earnings were not as high as anticipated.
C)consistent with the efficient market hypothesis if the earnings were not as low as anticipated.
D)the result of none of the above.
Q2) An investor gains from short selling by ________ and then later ________.
A)buying a stock; selling it at a higher price
B)selling a stock; buying it back at a lower price
C)buying a stock; selling it at a lower price
D)selling a stock; buying it back at a higher price
Q3) Technical analysts look at historical prices for information to project future prices.
A)True
B)False
Q4) Why are expectations important in understanding how financial instruments are valued?
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Chapter 7: Why Do Financial Institutions Exist
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Sample Questions
Q1) One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the
A)venture capital firm.
B)money market mutual fund.
C)pawn broker.
D)savings and loan association.
Q2) The problem of adverse selection helps to explain why direct finance is more important than indirect finance as a source of business finance.
A)True
B)False
Q3) A debt contract that specifies that the company can only use the funds to finance certain activities
A)is a private loan.
B)contains a restrictive covenant.
C)increases the problem of adverse selection.
D)all of the above.
E)only A and B of the above.
Q4) What is the free-rider problem? Describe some situations that this problem creates.
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9
Chapter 8: Why Do Financial Crises Occur and Why Are
They so Damaging to the Economy
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Sample Questions
Q1) Discuss some of the financial innovations in mortgage markets that led to the U.S. financial crisis in 2007.
Q2) Factors that lead to worsening conditions in financial markets include
A)declining interest rates.
B)anticipated increases in the price level.
C)bank panics.
D)only A and C of the above.
E)only B and C of the above.
Q3) Discuss the difference in Stage Two of a financial crisis between an advanced economy and an emerging market economy.
Q4) In addition to having a direct effect on increasing adverse selection problems, increases in interest rates also promote financial crises by ________ firms' and households' interest payments, thereby ________ their cash flow.
A)increasing; increasing
B)increasing; decreasing
C)decreasing; increasing
D)decreasing; decreasing
Q5) What does the "twin crises" in an emerging economy financial crisis refer to?
Page 10
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Chapter 9: Central Banks and the Federal Reserve System
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Sample Questions
Q1) Each member of the seven-member Board is appointed by the president and confirmed by the Senate to serve 14-year terms.
A)True
B)False
Q2) Which of the following is not an entity of the Federal Reserve System?
A)Federal Reserve banks
B)The FDIC
C)The Board of Governors
D)The Federal Advisory Council
E)Member commercial banks
Q3) What are the factors that promote the independence of the Federal Reserve?
Q4) The Board of Governors
A)establishes, within limits, reserve requirements.
B)effectively sets the discount rate.
C)sets margin requirements.
D)does all of the above.
E)does only A and B of the above.
Q5) All nationally chartered banks are required to be members of the Fed. A)True
B)False
11
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Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Sample Questions
Q1) Which of the following is a potential operating target for the Fed?
A)Nonborrowed reserves
B)The federal funds rate
C)The monetary base
D)All of the above
Q2) The type of open market operation intended to offset movements in other factors that affect reserves and the monetary base is
A)the dynamic open market operations.
B)the defensive open market operations.
C)the reserve requirements.
D)market equilibrium.
Q3) If the desired intermediate target is an interest rate, then the preferred operating target will be a(n)________ variable like the ________.
A)interest rate; three-month Treasury bill rate
B)interest rate; federal funds rate
C)reserve aggregate; monetary base
D)reserve aggregate; nonborrowed base
Q4) Why does the Fed use open market operations to a greater extent than reserve requirements in its conduct of monetary policy?
Page 12
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Chapter 11: The Money Markets
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Sample Questions
Q1) Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over banks in attracting funds because the brokerage firms
A)were not subject to deposit reserve requirements.
B)were not subject to the deposit interest rate ceilings.
C)were not limited in how much they could borrow from depositors.
D)had the advantage of all the above.
E)had the advantage of only A and B of the above.
Q2) The size of the asset-backed commercial paper market nearly doubled between 2004 and 2007 to about $1 trillion.
A)True
B)False
Q3) Explain why money market interest rates move so closely together over time.
Q4) In general, money market instruments are low-risk, high-yield securities.
A)True
B)False
Q5) The market for U.S. Treasury bills is a shallow market because so few individual investors buy T-bills.
A)True
B)False
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Chapter 12: The Bond Market
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Sample Questions
Q1) The ________ value of a bond is the amount that the issuer must pay at maturity.
A)market
B)present
C)discounted
D)face
Q2) Most of the time, the interest rate on Treasury notes and bonds is ________ that on money market securities because of ________ risk.
A)above; interest-rate
B)above; default
C)below; interest-rate
D)below; default
Q3) Bonds
A)are securities that represent a debt owed by the issuer to the investor.
B)obligate the issuer to pay a specified amount at a given date, generally without periodic interest payments.
C)both A and B of the above.
D)none of the above.
Q4) What is the purpose of the capital market? How do capital market securities differ from money market securities in their general characteristics?
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Chapter 13: The Stock Market
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Sample Questions
Q1) The Enron financial scandal increased uncertainty about the quality of accounting information and as a result, increased required return on investment in stocks.
A)True
B)False
Q2) What are the objectives of the Securities and Exchange Commission?
Q3) A high price earnings ratio (PE)gives what interpretation?
A)The market expects earnings to fall in the future.
B)The market feels the firm's earnings are very high risk and are willing to pay a premium for them.
C)The market expects the earnings to rise in the future.
D)The firm is not paying a dividend.
Q4) Which of the following is not an objective of the Securities and Exchange Commission?
A)maintain integrity of the securities markets
B)advise investors about which particular stocks are good buys
C)require firms to provide specific information to investors
D)regulate major participants in securities markets
Q5) How do over-the-counter markets differ from organized exchanges?
Q6) How do corporate stocks differ from bonds?
Page 15
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Chapter 14: The Mortgage Markets
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Sample Questions
Q1) Which of the following are true of mortgage interest rates?
A)Interest rates on mortgage loans are determined by three factors: current long-term market rates, the term of the mortgage, and the number of discount points paid.
B)Mortgage interest rates tend to track along with Treasury bond rates.
C)The interest rate on 15-year mortgages is lower than the rate on 30-year mortgages, all else the same.
D)All of the above are true.
E)Only A and B of the above are true.
Q2) During the early years of an amortizing mortgage loan, the lender applies
A)most of the monthly payment to the outstanding principal balance.
B)all of the monthly payment to the outstanding principal balance.
C)most of the monthly payment to interest on the loan.
D)all of the monthly payment to interest on the loan.
E)the monthly payment equally to interest on the loan and the outstanding principal balance.
Q3) An option ARM mortgage gives the borrower the option to reduce the monthly interest being charged on the mortgage.
A)True
B)False
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Page 16
Chapter 15: The Foreign Exchange Market
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Sample Questions
Q1) When the exchange rate for the euro changes from $0.90 to $0.85, then holding everything else constant, the euro has depreciated and American wheat sold in Germany becomes more expensive.
A)True
B)False
Q2) If the exchange rate between the dollar and the Swiss franc changes from 1.8 to 1.5 francs per dollar, the franc depreciates and the dollar appreciates.
A)True
B)False
Q3) According to the interest parity condition, if the domestic interest rate is 10 percent and the foreign interest rate is 12 percent, then the expected ________ of the foreign currency must be ________ percent.
A)appreciation; 4
B)appreciation; 2
C)depreciation; 2
D)depreciation; 4
Q4) There are two kinds of exchange rate transactions.
A)True
B)False
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Chapter 16: The International Financial System
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Sample Questions
Q1) A disadvantage of dollarization is that it
A)prevents a central bank from creating inflation.
B)avoids the possibility of a speculative attack on the domestic currency.
C)does not allow a country to pursue its own independent monetary policy.
D)is a strong commitment to exchange rate stability.
Q2) By the end of 2010, China had accumulated more than $2 trillion of international reserves.
A)True
B)False
Q3) Holding other factors constant, which of the following would decrease the size of the U.S. current account deficit?
A)an increase in the amount of services purchased from foreigners
B)an increase in the amount of goods purchases from foreigners
C)an increase in the amount of goods sold to foreigners
D)only A and B of the above
Q4) Revaluation of a currency's value occurs when
A)a floating exchange rate adjusts upward.
B)a floating exchange rate adjusts downward.
C)a fixed exchange rate is adjusted upward.
D)a fixed exchange rate is adjusted downward.
Page 18
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Chapter 17: Banking and the Management of Financial Institutions
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Q1) With large banks beginning to explore ways in which the liabilities on their balance sheets could provide them with reserves and liquidity, this led to
A)the expansion of overnight loan markets.
B)the development of negotiable CDs.
C)the ability of money center banks to acquire funds quickly.
D)all of the above occurring.
Q2) Which of the following statements is false?
A)A bank's assets are its uses of funds.
B)A bank issues liabilities to acquire funds.
C)A bank's assets provide the bank with income.
D)Bank capital is an asset on the bank balance sheet.
Q3) Which of the following are reported as assets on a bank's balance sheet?
A)discount loans from the Fed
B)loans
C)borrowings
D)only A and B of the above
Q4) What is the major focus of each of the following bank management concerns: asset management, liability management, liquidity management, and capital adequacy management?
Page 19
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Chapter 18: Financial Regulation
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Sample Questions
Q1) Regulators attempt to reduce the riskiness of banks' asset portfolios by
A)limiting the amount of loans in particular categories or to individual borrowers.
B)prohibiting banks from holding risky assets such as common stocks.
C)establishing a minimum interest rate floor that banks can earn on certain assets.
D)doing all of the above.
E)doing only A and B of the above.
Q2) Why did the United States experience a banking crisis in the 1980s?
Q3) The Federal Deposit Insurance Corporation Improvement Act of 1991
A)instructed the FDIC to come up with risk-based deposit insurance premiums.
B)expanded the FDIC's ability to use the "too-big-to-fail" policy.
C)instructed the FDIC to wait longer before intervening when a bank gets into trouble.
D)did all of the above.
Q4) A better capitalized bank has more to lose when it fails and is less likely to take less risk.
A)True
B)False
Q5) Discuss the role of NINJA loans in the 2007-2009 financial crisis.
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Page 20
Chapter 19: Banking Industry: Structure and Competition
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Sample Questions
Q1) Which of the following are important factors in determining the degree and timing of financial innovation?
A)changes in technology
B)changes in financial market conditions
C)changes in regulation
D)all of the above
E)only A and B of the above
Q2) With the creation of the Federal Deposit Insurance Corporation,
A)member banks of the Federal Reserve System were given the option to purchase FDIC insurance for their depositors, while nonmember commercial banks were required to buy deposit insurance.
B)member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors, while nonmember commercial banks could choose to buy deposit insurance.
C)both member and nonmember banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors.
D)both member and nonmember banks of the Federal Reserve System could choose, but were not required, to purchase FDIC insurance for their depositors.
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Chapter 20: The Mutual Fund Industry
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Sample Questions
Q1) The largest share of assets held by money market mutual funds is
A)Treasury bills.
B)certificates of deposit.
C)commercial paper.
D)repurchase agreements.
Q2) Retirement funds account for about 31% Of all mutual fund assets.
A)True
B)False
Q3) The near collapse of Long Term Capital Management was caused by
A)the high management fees charged by the fund's two Nobel Prize winners.
B)the fund's high leverage ratio of 20 to 1.
C)a sharp decrease in the spread between corporate bonds and Treasury bonds.
D)a sharp increase in the spread between corporate bonds and Treasury bonds.
E)the fund's shift away from a market-neutral investment strategy.
Q4) All ________ are open-end investment funds that invest only in money market securities.
A)Stock funds
B)Bond funds
C)Money market mutual funds
D)all of the above
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Chapter 21: Insurance Companies and Pension Funds
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Q1) Which of the following is not a feature of the Terrorism Risk Insurance Act of 2002?
A)Losses that exceed $100 billion are not covered.
B)The law does not apply to acts of international terrorism when losses are less than $5 million.
C)Government pays 50 percent of losses in excess of $100 billion.
D)Government pays 90 percent of the losses.
Q2) The Social Security system is an example of a public pension plan that is ________.
A)underfunded
B)fully funded
C)overfunded
D)none of the above
Q3) Insurance management tools that give policyholders incentives to avoid accidents insured against include ________.
A)deductibles
B)risk-based premiums
C)coinsurance
D)all of the above
Q4) Distinguish between different types of life insurance.
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Chapter 22: Investment Banks, Security Brokers and Dealers,
and Venture Capital Firms
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Q1) In a ________ agreement, the investment banker makes no guarantee regarding the price the issuing firm will receive, but agrees to sell the securities on a commission basis.
A)best efforts
B)brokered
C)private-placement
D)jump-start
Q2) Which of the following is an advantage to a private equity buyout?
A)They are subject to the controversial regulations included in the 2002 Sarbanes-Oxley Act.
B)The CEOs frequently have more time and flexibility to enact changes need to turn around subpar companies.
C)both A and B.
D)neither A nor B.
Q3) Junk bonds are high-risk, high-return equity securities that were used primarily to finance takeover attempts.
A)True
B)False
Q4) Describe the differences between securities brokers and securities dealers.
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Chapter 23: Risk Management in Financial Institutions
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Q1) The difference between rate-sensitive liabilities and rate-sensitive assets is known as the ________.
A)duration
B)interest-sensitivity index
C)interest-rate risk index
D)gap
Q2) What steps do banks take to reduce their exposure to credit risk?
Q3) Which of the following are not generally rate-sensitive assets?
A)securities with a maturity of less than one year
B)variable-rate mortgages
C)fixed-rate mortgages
D)all of the above are rate-sensitive assets
E)none of the above are rate-sensitive assets
Q4) Referring to Table 23.1, First National Bank has a gap of ________.
A)-30
B)+30
C)60
D)0
Q5) How do the concepts of adverse selection and moral hazard explain the credit risk management principles that banks adopt?
25
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Chapter 24: Hedging With Financial Derivatives
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Q1) The seller of an option has the ________ to buy or sell the underlying asset, while the purchaser of an option has the ________ to buy or sell the asset.
A)obligation; right
B)right; obligation
C)obligation; obligation
D)right; right
Q2) A contract that requires the investor to buy securities on a future date is called a ________.
A)short contract
B)long contract
C)hedge
D)cross
Q3) How would a firm use exchange rate futures to lock in current exchange rates?
Q4) If you sell a short contract on financial futures, you hope interest rates will
A)rise
B)fall
C)not change
D)fluctuate
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Chapter 25: Savings Associations and Credit Unions
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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 selection
C)regulatory stringency; moral hazard
D)regulatory stringency; adverse selection
Q2) The Competitive Equality in Banking Act of 1987
A)discouraged regulators from pursuing regulatory forbearance.
B)directed regulators to close "zombie S&Ls" as quickly as administratively possible.
C)encouraged regulators to continue their policy of regulatory forbearance.
D)did both A and B of the above.
Q3) Politicians have ________ incentives to act in their own interests rather than in the interests of taxpayers.
A)no
B)strong
C)weak
D)low
Q4) How has the thrift industry been transformed since FIRREA?
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Chapter 26: Finance Companies
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Questions
Q1) Many retailers established finance companies to provide financing for their customers. Although these finance subsidiaries did increase sales, the subsidiary was typically unprofitable.
A)True
B)False
Q2) Finance companies are ________ market intermediaries.
A)stock
B)bond
C)FX
D)money
Q3) In the early 1900s, banks did not offer loans to purchase automobiles. This is because A)banks could not make a profit on car loans.
B)only finance companies were permitted to offer car loans.
C)banks could not repossess a car if the loan defaulted.
D)banks did not view a car as a productive asset.
Q4) Finance companies essentially sell commercial paper and use the proceeds to make loans.
A)True B)False
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