Course Introduction
Financial Economics
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Financial Economics explores the principles and models that underpin financial markets and decision-making. The course examines how individuals, firms, and institutions allocate resources over time under conditions of uncertainty, focusing on topics such as asset pricing, risk management, portfolio theory, and the functioning of capital markets. Students will analyze the behavior of financial instruments including stocks, bonds, and derivatives, and learn how economic theory informs financial policy and strategy. Through theoretical frameworks and practical applications, the course provides insights into the impact of financial systems on the broader economy.
Recommended Textbook
MandB 3 3rd Edition by Dean Croushore
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Page 2
Chapter 1: Money and the Financial System
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Sample Questions
Q1) More than half of all U.S.dollars can be found
A)in foreign countries.
B)in the United States.
C)in the underground economy.
D)in bank vaults.
Answer: A
Q2) Americans should not worry about all the dollars held by foreigners because
A)most of the currency is reinvested into America.
B)taxes are lower as a result.
C)interest rates are lower as a result.
D)stock prices are higher as a result.
Answer: B
Q3) Interest rates on long-term loans are generally _____than interest rates on short-term loans, partly because______loans are riskier.
A)lower; short-term
B)lower; long-term
C)higher; long-term
D)higher; short-term
Answer: C
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Page 3
Chapter 2: The Financial System and the Economy
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Sample Questions
Q1) When a household borrows using credit cards and by taking out loans for large purchases (such as automobiles), the resulting security is known as
A)a discount bond.
B)a Treasury bill.
C)mortgage debt.
D)consumer credit.
Answer: D
Q2) Mobi's is a new company that manufactures premium apparel for men.It needs fund for expanding its production units and is planing to issue the first lot of shares.These shares will be traded in the .
A)primary market
B)secondary market
C)tertiary market
D)closed market
Answer: A
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Chapter 3: Money and Payments
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Q1) In an economy, the amount of money held in currency and coins is $3,500, the amount of money held as traveler's check is $1,000, the amount of money held as checkable deposits is $2,000, the amount of money held in savings deposit is $4,000, and the amount of money held with retailed money market mutual funds is $700.M1 in the economy equals
A)$3,500.
B)$6,500.
C)$10,500.
D)$11,300.
Answer: B
Q2) Under the fiat money system, the revenue that the government makes on every coin issued is referred to as A)fiat revenue.
B)fullbodied revenue.
C)money tax.
D)seignorage revenue.
Answer: D
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Page 5
Chapter 4: Present Value
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Sample Questions
Q1) If the present value of $3,000 to be received after a year is $2,795, the annual rate of discount must be
A)5.65%.
B)7.33%.
C)9%.
D)11.11%.
Q2) Consider a fixed-payment security that pays $250 at the end of every year for eight years.If the annual rate of discount is 3 percent, calculate the present value of the bond.
Q3) Consider a three-year fixed-payment security that has a present value of $1,000.If the annual rate of discount is 7 percent, the payment made at the end of each year is
A)$70.00.
B)$107.00.
C)$142.86.
D)$381.05.
Q4) Consider a one-year discount bond that has a present value of $3,000.If the annual rate of discount is 5 percent, calculate the future value of the bond (the amount the bond pays in one year).
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6
Chapter 5: The Structure of Interest Rates
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Q1) If the interest rate on three-month Treasury securities is 5 percent and the interest rate on ten-year Treasury securities is 6 percent, then the odds of a recession are
A)less than 15 percent.
B)about 25 percent.
C)about 40 percent.
D)about 80 percent.
Q2) What does an upward-sloping yield curve imply, according to the expectations theory of the term structure of interest rates?
A)Investors expect long-term interest rates to fall in the future.
B)Investors expect future short-term interest rates to be lower than the current short-term interest rate.
C)Investors expect future short-term interest rates to be the same as the current short-term interest rate.
D)Investors expect future short-term interest rates to be higher than the current short-term interest rate.
Q3) What do steep upward-sloping yield curves indicate about the business cycle?
Q4) What is the reason for a low rated security to generate a high yield to maturity?
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7
Chapter 6: Real Interest Rates
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Sample Questions
Q1) In recessions, the short-term expected real interest rate usually
A)rises by about 4 percentage points.
B)rises by about 2 percentage points.
C)declines by about 2 percentage points.
D)declines by about 4 percentage points.
Q2) Suppose you buy an inflation-indexed bond that will adjust with inflation and thus pay you $2,500 in real (inflation- adjusted) terms each year for the next five years, plus your real principal of $100,000 at the end of the fifth year.The nominal interest rate is 4 percent and the expected inflation rate is 1 percent.What is the present value of the bond? Show your work.
Q3) The hypothesis that an increase in the expected inflation rate will cause the nominal interest rate to rise and the real interest rate to remain unchanged is the
A)Fisher hypothesis.
B)rational-expectations theory.
C)Okun's hypothesis.
D)Keynesian hypothesis.
Q4) How can the expected inflation rate be measured?
Q5) Explain why inflation risk is a problem for investors.
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Chapter 7: Stocks and Other Assets
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Sample Questions
Q1) An index of thirty major U.S.industrial companies is the
A)NASDAQ index.
B)NYSE index.
C)Dow Jones Industrial Average.
D)S&P 500.
Q2) In the CAPM, if a stock has a beta coefficient near one, then
A)the stock's return is less volatile than the market's average return.
B)the stock's return is about as volatile as the market's average return.
C)the stock's return is more volatile than the market's average return.
D)the stock's risk is greater than its expected return.
Q3) Consider two stocks: A and B.The price of stock A is $400, while the price of stock B is $600.If the fundamental value of both stocks is $500,
A)stock A is overvalued and stock B is undervalued.
B)stock A is undervalued and stock B is overvalued.
C)both stocks are undervalued.
D)both stocks are overvalued.
Q4) Write a formula for the equity premium.
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9
Chapter 8: How Banks Work
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Sample Questions
Q1) In which of the following ways can a bank increase its reserves?
A)Give out more loans
B)Sell securities
C)Reduce interest rate on time deposits
D)Increase service charges for safety vault facility
Q2) A bank offers credit cards with a 25 percent interest rate, when its competitors' cards have just a 15 percent interest rate.Despite the high rate, the bank finds itself losing money because many of its customers fail to repay the balances on their cards.The bank's losses are most likely to have occurred because of
A)bad management.
B)the lock-in effect.
C)redlining.
D)adverse selection.
Q3) The possibility that a bank's loan customers might not repay their loans is known as A)withdrawal risk.
B)default risk.
C)interest-rate risk.
D)foreign-exchange risk.
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10
Chapter 9: Governments Role in Banking
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Q1) From which of the following agencies does a national bank obtain its charter?
A)The Federal Deposit Insurance corporation
B)The Federal Reserve
C)The Office of the Comptroller of the Currency
D)National Credit Union Administration
Q2) The document that a bank must fill out quarterly, reporting its assets, liabilities, and profits to the government, is called a
A)balance-sheet analysis.
B)P&L statement.
C)white paper.
D)call report.
Q3) Which of the following is a reason for the government to regulate banks?
A)To prevent bank runs
B)To prevent the situation of contagion
C)To help a bank grow in size
D)To allow for the situation of a bank run
Q4) Prior to the passage of the McFadden Act in 1927, what characterized a national bank?
Q5) What is the Basel III Accord?
Q6) Describe the moral hazard problem of deposit insurance.
Page 11
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Chapter 10: Economics Growth and Business Cycles
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Sample Questions
Q1) Suppose a country has a population of 76 million, of which 53 million are in the working-age population.Of those, 3 million are unemployed and 46 million are employed.
a.Calculate the number of people who are in the labor force.
b.Calculate the number of people who are not in the labor force.
c.Calculate the labor-force participation rate.
d.Calculate the unemployment rate.
Q2) Which of the following is likely to happen according to monetarists if money supply increases?
A)Unemployment will increase
B)Output will increase
C)Consumption will fall
D)Investment will fall
Q3) If the working-age population in a country is 215 million, the labor force is 145 million, and the number of employed people is 137 million, then the labor-force participation rate in the country is
A)2.5 percent.
B)67.4 percent.
C)45.3 percent.
D)94.5 percent.
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Chapter 11: Modeling Money
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Sample Questions
Q1) A variable that is determined within a model is called
A)a dynamic variable.
B)a static variable.
C)an endogenous variable.
D)an exogenous variable.
Q2) A partial-equilibrium model is a model in which
A)all key macroeconomic variables are endogenous.
B)some key macroeconomic variables are exogenous.
C)all key macroeconomic variables are discrete random variables.
D)none of the key macroeconomic variables are endogenous.
Q3) In the dynamic model of money, an increase in the price level causes an increase in money demand, thus leading to a higher nominal interest rate.This effect is referred to as the
A)price-level effect.
B)income effect.
C)liquidity effect.
D)inflationary effect.
Q4) Describe the standard equation used to describe the demand for money.In that equation, what would happen to the demand for money if prices were to double?
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Chapter 12: The Aggregate-Demandaggregate-Supply
Model
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Q1) The aggregate-demand curve shows the combinations of_____and____that are consistent with equilibrium in the market for goods and services and the market for money.
A)the price level; output
B)the price level; the real interest rate
C)the real interest rate; the money supply
D)the money supply; output and
Q2) The total amount of physical capital in all firms and households is called the A)human capital.
B)capital stock.
C)household income.
D)physical product.
Q3) With the price level measured on the vertical axis and output measured on the horizontal axis, the long-run aggregate-supply curve
A)is vertical.
B)is upward-sloping.
C)is horizontal.
D)is downward-sloping.
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Chapter 13: Modern Macroeconomic Models
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Sample Questions
Q1) In the two-period model, suppose a household's income in the first period is $40,000, income in the second period is $50,000, and the real interest rate is 25 percent.What is the maximum amount that the household would be able to spend in the first period?
A)$40,000
B)$50,000
C)$80,000
D)$100,000
Q2) In a two-period model, a household has an income of $20,000 in period one and an income of $25,000 in period two. The household faces an interest rate of 50 percent.What is the present value of the household's income if the income in period one increases to $30,000?
A)$39,000
B)$46,666.66
C)$40,555.65
D)$50,000
Q3) Can VARs be used to analyze the effects of monetary policy?
Q4) What are the advantages and disadvantages of VAR models?
Q5) Describe the new neoclassical synthesis.
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Chapter 14: Economic Interdependence
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Q1) If three bushels of rice produced in Japan trade for 2 bushels of rice produced in Guatemala, the _____is equal to 1.5.
A)inflation rate
B)interest rate
C)nominal exchange rate
D)real exchange rate
Q2) Assume that the only good traded between Mexico, the U.S., and Canada is chicken, which is produced by all three countries.If the cost of producing a pound of chicken is 5 pesos in Mexico, 1 U.S.dollar in the U.S., and 2 Canadian dollars in Canada, and if the law of one price holds, what are each of the exchange rates between the three countries?
Q3) In recessions, the dollar usually
A)appreciates.
B)depreciates.
C)remains unaffected.
D)follows no consistent pattern.
Q4) How should a country respond when foreign investors withdraw investments from that country?
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Chapter 15: The Federal Reserve System
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Q1) Which of the following statements is true?
A)The Fed does not need to rely on the Government for its operating funds.
B)Open market operations can be used by the Fed only to tighten monetary policy and not to ease it.
C)The Board of Governors of the Fed is headed by the President of the United States.
D)The operations of the Fed are deeply dependent on the actions of the ruling political power.
Q2) Each Federal Reserve Bank is
A)a corporation.
B)a government owned enterprise.
C)a publicly traded company.
D)a government-sponsored enterprise.
Q3) Which of the following statements is true?
A)If the Fed wants to decrease money supply, it sells government securities.
B)If the Fed wants to increase money supply, it sells government securities.
C)If the Fed wants to decrease money demand, it sells government securities.
D)If the Fed wants to increase money demand, it sells government securities.
Q4) Why are the deliberations of the FOMC kept secret?
Q5) Comment on the success of various Fed chairmen in reducing inflation.
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Chapter 16: Monetary Control
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Q1) The supply curve of reserves in an economy is horizontal when
A)the federal funds rate is greater than the seasonal credit discount rate.
B)the federal funds rate is less than the secondary credit discount rate.
C)the federal funds rate equals the primary credit discount rate.
D)the federal funds rate is less than the primary credit discount rate.
Q2) Consider a bank that has $10 million as reserves, $5million as securities, and $100 million as transaction accounts.If a customer, who is a government securities dealer, sells $2 million in securities to the Fed
A)the bank's transaction accounts reduce to $98 million.
B)the bank's securities reduce by $4 million.
C)the bank's reserves increase to $12 million.
D)the bank's loans reduce by $2 million.
Q3) The supply curve of reserves in an economy is _____when the federal funds rate is less than the primary credit discount rate.
A)downward-sloping
B)upward-sloping
C)horizontal
D)vertical when the federal funds rate is less than the primary credit
Q4) Since the 2008 financial crisis, what has happened to the M1 and M2 multipliers?
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Chapter 17: Monetary Policy: Goals and Tradeoffs
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Q1) If the equation for the Phillips curve is ? = ?<sup>e</sup> ? 0.5(U ? 5), Then the natural rate of unemployment is
A)10 percent.
B)5 percent.
C)2.5 percent.
D)0.5 percent.
Q2) In comparison to when monetary policy is not expansionary, under an expansionary monetary policy, the unemployment rate is ____and the inflation rate is_____ over time.
A)higher; higher
B)higher; lower
C)lower; lower
D)lower; higher
Q3) The lag between when a change in policy is decided and when it is put into action is referred to as the _____lag.
A)implementation
B)recognition
C)effectiveness
D)decision
Q4) Why is there an effectiveness lag for monetary policy?
Page 19
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Chapter 18: Rules for Monetary Policy
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Q1) Which of the following best describes the reason why policymakers do not generally like to commit to following a rule for monetary policy?
A)Because changes to the economy's structure will prevent any rule from working well for long
B)Because rules do not effectively prevent time-inconsistency
C)Because rules without credibility are worse than discretion
D)Because central bankers like to feel important
Q2) Suppose the economy is thought to be 2 percent above potential (i.e., the output gap is 2 percent), when potential output grows 4 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 2 percent over the past year.The federal funds rate is currently 3 percent.The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The inflation target is 1 percent.
a.Is the fed funds rate currently too high or too low? By how much? Show your work.
b. Suppose a year has gone by, output is now just 1 percent above potential, and inflation rate was 1.5 percent over the year.What federal funds rate should the Fed now set (assuming the inflation target does not change)?
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