Financial Economics
Solved Exam Questions
Course Introduction
Financial Economics explores the principles and theoretical frameworks that drive financial markets, institutions, and instruments. This course analyzes how financial decisions are made under conditions of risk and uncertainty, examining the roles of interest rates, asset pricing, portfolio selection, and market efficiency. Students will delve into topics such as the valuation of securities, the functioning of capital and derivatives markets, and the impact of financial policy decisions on the economy. Emphasis is placed on both the microeconomic foundations of financial behavior and the broader macroeconomic implications, preparing students to understand and analyze financial systems and strategies in both domestic and international contexts.
Recommended Textbook
Economics of Money Banking and Financial Markets 12th Edition by Frederic S. Mishkin
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27 Chapters
2796 Verified Questions
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Chapter 1: Why Study Money, banking, and Financial Markets
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109 Verified Questions
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Sample Questions
Q1) A financial crisis is
A)not possible in the modern financial environment.
B)a major disruption in the financial markets.
C)a feature of developing economies only.
D)typically followed by an economic boom.
Answer: B
Q2) The management of money and interest rates is called ________ policy and is conducted by a nation's ________ bank.
A)monetary;superior
B)fiscal;superior
C)fiscal;central
D)monetary;central
Answer: D
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.
Page 3
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Chapter 2: An Overview of the Financial System
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Sample Questions
Q1) Conflicts of interest are a type of ________ problem that can happen when an institution provides multiple services.
A)adverse selection
B)free-riding
C)discounting
D)moral hazard
Answer: D
Q2) Banks can lower the cost of information production by applying one information resource to many different services. This process is called
A)economies of scale.
B)asset transformation.
C)economies of scope.
D)asymmetric information.
Answer: C
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Page 4
Chapter 3: What Is Money
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Sample Questions
Q1) The payments system is
A)the method of conducting transactions in the economy.
B)used by union officials to set salary caps.
C)an illegal method of rewarding contracts.
D)used by your employer to determine salary increases.
Answer: A
Q2) If an individual moves money from a money market deposit account to currency
A)M1 increases and M2 stays the same.
B)M1 stays the same and M2 increases.
C)M1 stays the same and M2 stays the same.
D)M1 increases and M2 decreases.
Answer: A
Q3) What factors have slowed down the movement to a system where all payments are made electronically?
Answer: The equipment necessary to set up the system is expensive,security of the information,and privacy concerns are issues that need to be addressed before an electronic payments system will be widely accepted.
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Page 5
Chapter 4: The Meaning of Interest Rates
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Sample Questions
Q1) For simple loans,the simple interest rate is ________ the yield to maturity.
A)greater than
B)less than
C)equal to
D)not comparable to
Q2) When talking about a coupon bond,face value and ________ mean the same thing.
A)par value
B)coupon value
C)amortized value
D)discount value
Q3) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year,which bond would you prefer to have been holding?
A)a bond with one year to maturity
B)a bond with five years to maturity
C)a bond with ten years to maturity
D)a bond with twenty years to maturity
Q4) If the interest rate is 5%,what is the present value of a security that pays you $1,050 next year and $1,102.50 two years from now? If this security sold for $2,200,is the yield to maturity greater or less than 5%? Why?
Page 6
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Chapter 5: The Behavior of Interest Rates
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Sample Questions
Q1) Discovery of new gold in Alaska will ________ the ________ of gold,________ its price,everything else held constant.
A)increase;demand;increasing
B)decrease;demand;decreasing
C)decrease;supply;increasing
D)increase;supply;decreasing
Q2) You would be less willing to purchase U.S. Treasury bonds,other things equal,if
A)you inherit $1 million from your Uncle Harry.
B)you expect interest rates to fall.
C)gold becomes more liquid.
D)stock prices are expected to fall.
Q3) If stock prices are expected to drop dramatically,then,other things equal,the demand for stocks will ________ and that of Treasury bills will ________.
A)increase;increase
B)increase;decrease
C)decrease;decrease
D)decrease;increase
Q4) Using the liquidity preference framework,what will happen to interest rates if the Fed increases the money supply?
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Chapter 6: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) If the yield curve has a mild upward slope,the liquidity premium theory (assuming a mild preference for shorter-term bonds)indicates that the market is predicting
A)a rise in short-term interest rates in the near future and a decline further out in the future.
B)constant short-term interest rates in the near future and further out in the future.
C)a decline in short-term interest rates in the near future and a rise further out in the future.
D)a decline in short-term interest rates in the near future and an even steeper decline further out in the future.
Q2) According to the liquidity premium theory of the term structure
A)bonds of different maturities are not substitutes.
B)if yield curves are downward sloping,then short-term interest rates are expected to fall by so much that,even when the positive term premium is added,long-term rates fall below short-term rates.
C)yield curves should never slope downward.
D)interest rates on bonds of different maturities do not move together over time.
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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) According to the efficient markets hypothesis,the current price of a financial security
A)is the discounted net present value of future interest payments.
B)is determined by the lowest successful bidder.
C)fully reflects all available relevant information.
D)is a result of none of the above.
Q2) 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.
Q3) You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor
A)may or may not be better than the other forecasts. Past performance is no guarantee of the future.
B)will always be the best of the group.
C)will definitely be worse in the future. What goes up must come down.
D)will be worse in the near future,but improve over time.
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) Government regulations require publicly traded firms to provide information,reducing
A)transactions costs.
B)the need for diversification.
C)the adverse selection problem.
D)economies of scale.
Q2) External financing by ________ should be more important in developing countries than in industrialized countries because information about private firms is more difficult to collect in developing countries.
A)financial intermediaries
B)bonds
C)stock
D)direct lending
Q3) Because of the "lemons problem" the price a buyer of a used car pays is
A)equal to the price of a lemon.
B)less than the price of a lemon.
C)equal to the price of a peach.
D)between the price of a lemon and a peach.
Q4) How does a mutual fund lower transactions costs through economies of scale?
Q5) 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) Of the following,which would be the last choice for a bank facing a reserve deficiency?
A)Call in loans.
B)Borrow from the Fed.
C)Sell securities.
D)Borrow from other banks.
Q2) Interest income minus interest expenses divided by assets is a measure of bank performance known as the A)operating income.
B)net interest margin.
C)return on assets.
D)return on equity.
Q3) Which of the following would NOT be a way to increase the return on equity?
A)Buy back bank stock.
B)Pay higher dividends.
C)Acquire new funds by selling negotiable CDs and increase assets with them.
D)Sell more bank stock.
Q4) How can specializing in lending help to reduce the adverse selection problem in lending?
11
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Chapter 10: Economic Analysis of Financial Regulation
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Sample Questions
Q1) An important factor in producing the global financial crisis was A)lax consumer protection regulation.
B)onerous rules placed on mortgage originators.
C)weak incentives for mortgage brokers to use complicated mortgage products.
D)strong incentives for the mortgage brokers to verify income information.
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) Which of the following is NOT a reason financial regulation and supervision is difficult in real life?
A)Financial institutions have strong incentives to avoid existing regulations.
B)Unintended consequences may happen if details in the regulations are not precise.
C)Regulated firms lobby politicians to lean on regulators to ease the rules.
D)Financial institutions are not required to follow the rules.
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Page 12
Chapter 11: Banking Industry: Structure and Competition
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Sample Questions
Q1) So-called fallen angels differ from junk bonds in that
A)junk bonds refer to newly issued bonds with low credit ratings,whereas fallen angels refer to previously issued bonds that have had their credit ratings fall below Baa.
B)junk bonds refer to previously issued bonds that have had their credit ratings fall below Baa,whereas fallen angels refer to newly issued bonds with low credit ratings.
C)junk bonds have ratings below Baa,whereas fallen angels have ratings below C.
D)fallen angels have ratings below Baa,whereas junk bonds have ratings below C.
Q2) Sweep accounts which were created to avoid reserve requirements became possible because of a change in
A)deposit ceilings.
B)technology.
C)government rules.
D)bank mergers.
Q3) Uncertainty about interest-rate movements and returns is called A)market potential.
B)interest-rate irregularities.
C)interest-rate risk.
D)financial creativity.
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Chapter 12: Financial Crises
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Sample Questions
Q1) The global financial crisis of 2007-2009 not only led to a worldwide recession,but also a ________ in the European nations that use the euro currency.
A)currency devaluation
B)budget surplus
C)sovereign debt crisis
D)tax cut
Q2) The Volcker Rule addresses the off-balance-sheet problem involving
A)trading risks.
B)selling loans.
C)loan guarantees.
D)interest rate risks.
Q3) A possible sequence for the three stages of a financial crisis might be ________ leads to ________ leads to ________.
A)asset price declines;banking crises;unanticipated decline in price level
B)unanticipated decline in price level;banking crises;increase in interest rates
C)banking crises;increase in interest rates;unanticipated decline in price level
D)banking crises;increase in uncertainty;increase in interest rates
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Chapter 13: Central Banks and the Federal Reserve System
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Sample Questions
Q1) The three largest Federal Reserve banks (New York,Chicago,and San Francisco)combined hold more than ________ percent of the assets of the Federal Reserve System.
A)25
B)33
C)50
D)67
Q2) The public's fear of centralized power and distrust of moneyed interests led to the demise of the first two experiments in central banking,otherwise known as
A)the First Bank of the United States and the Second Bank of the United States.
B)the First Bank of the United States and the Central Bank of the United States.
C)the First Central Bank of the United States and the Second Central Bank of the United States.
D)the First Bank of North America and the Second Bank of North America.
Q3) In the Governing Council,the decision of what policy to implement is made by
A)majority vote of the Executive Board members.
B)majority vote of the heads of the National Banks.
C)consensus.
D)majority vote of all members of the Governing Council.
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Page 15
Chapter 14: The Money Supply Process
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Sample Questions
Q1) Assuming initially that the required reserve ratio = 10%,the currency-deposit ratio = 75%,and the excess reserve ratio = 156%,an increase in the required reserve ratio to 15% causes the M1 money multiplier to ________,everything else held constant.
A)increase from 0.15 to 0.33
B)increase from 0.54 to 0.67
C)decrease from 0.73 to 0.71
D)decrease from 1.67 to 1.54
Q2) If the required reserve ratio is 5 percent,currency in circulation is $400 billion,checkable deposits are $800 billion,and excess reserves total $0.8 billion,then the M1 money multiplier is
A)2.5.
B)2.72.
C)2.3.
D)0.551.
Q3) Reserves are equal to the sum of
A)required reserves and excess reserves.
B)required reserves and vault cash reserves.
C)excess reserves and vault cash reserves.
D)vault cash reserves and total reserves.
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Page 16
Chapter 15: Tools of Monetary Policy
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Sample Questions
Q1) A decrease in ________ increases the money supply since it causes the ________ to rise.
A)reserve requirements;monetary base
B)reserve requirements;money multiplier
C)margin requirements;monetary base
D)margin requirements;money multiplier
Q2) When the European System of Central Banks uses main refinancing operations,it is similar to the Federal Reserve using
A)dynamic open market operations.
B)defensive open market operations.
C)discount policy.
D)reserve requirements.
Q3) The actual execution of open market operations is done at
A)the Board of Governors in Washington,D.C.
B)the Federal Reserve Bank of New York.
C)the Federal Reserve Bank of Philadelphia.
D)the Federal Reserve Bank of Boston.
Q4) Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?
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Chapter 16: The Conduct of Monetary Policy: Strategy and Tactics
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Sample Questions
Q1) If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand are prevalent
A)fluctuations of nonborrowed reserves will be small.
B)fluctuations of nonborrowed reserves will be large.
C)the Fed will probably quickly abandon this policy,as it did in the 1960s.
D)the Fed will probably quickly abandon this policy,as it did in the 1950s.
Q2) Large fluctuations in money supply growth and smaller fluctuations in the federal funds rate between October 1982 and the early 1990s indicate that the Fed had shifted to ________ as an operating target.
A)borrowed reserves
B)nonborrowed reserves
C)excess reserves
D)required reserves
Q3) Which of the following is not a disadvantage to inflation targeting?
A)There is a delayed signal about achievement of the target.
B)Inflation targets could impose a rigid rule on policymakers.
C)There is potential for larger output fluctuations.
D)There is a lack of transparency.
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Chapter 17: The Foreign Exchange Market
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Sample Questions
Q1) According to the purchasing power parity theory,a rise in the United States price level of 5 percent,and a rise in the Mexican price level of 6 percent cause
A)the dollar to appreciate 1 percent relative to the peso.
B)the dollar to depreciate 1 percent relative to the peso.
C)the dollar to depreciate 5 percent relative to the peso.
D)the dollar to appreciate 5 percent relative to the peso.
Q2) Suppose that the latest Consumer Price Index (CPI)release shows a higher inflation rate in the U.S. than was expected. Everything else held constant,the release of the CPI report would immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________.
A)increase;appreciate
B)increase;depreciate
C)decrease;appreciate
D)decrease;depreciate
Q3) When domestic real interest rates rise,the domestic currency ________.
A)appreciates
B)depreciates
C)appreciates or depreciates depending on the change in nominal interest rates
D)does not change
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Page 19
Chapter 18: The International Financial System
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Sample Questions
Q1) Policymakers in a country with a balance of payments surplus may not want to see their country's currency appreciate because this would
A)hurt consumers in their country by making foreign goods more expensive.
B)hurt domestic businesses by making foreign goods cheaper in their country.
C)increase inflation in their country.
D)decrease the wealth of the country.
Q2) Under a fixed exchange rate regime,if a country has an overvalued exchange rate,then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.
A)depreciating;gain
B)depreciating;loss
C)appreciating;gain
D)appreciating;loss
Q3) The revenue a government gains from issuing money is A)interest.
B)rent.
C)seignorage.
D)the national dividend.
E)the inflation tax.
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Chapter 19: Quantity Theory, inflation and the Demand for Money
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Sample Questions
Q1) The demand for money as a cushion against unexpected contingencies is called the A)transactions motive.
B)precautionary motive.
C)insurance motive.
D)speculative motive.
Q2) This method of financing government spending is frequently called printing money because high-powered money (the monetary base)is created in the process.
A)financing government spending with taxes
B)financing government spending through a Treasury sale of bonds that are then purchased by the Fed
C)financing government spending by selling bonds to the public,which pays for the bonds with currency
D)financing government spending by selling bonds to the public,which pays for the bonds with checks
Q3) Keynes's theory of the demand for money is consistent with A)countercyclical movements in velocity.
B)a constant velocity.
C)procyclical movements in velocity.
D)a relatively stable velocity.
21
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Chapter 20: The Is Curve
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Sample Questions
Q1) Assume equilibrium at full employment for an economy characterized by the simple Keynesian model. If the government raises taxes to eliminate a budget deficit,then
A)the rate of unemployment will increase.
B)the level of aggregate output will increase.
C)the price level will increase.
D)the rate of interest will fall.
Q2) If aggregated demand is less than actual output,unplanned inventory ________ will cause output to ________.
A)accumulation;rise
B)depletion;fall
C)depletion;rise
D)accumulation;fall
Q3) Keynes reasoned that consumer expenditure is most closely related to A)the level of interest rates.
B)the price level.
C)disposable income.
D)the marginal tax rate.
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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) Everything else held constant,a decrease in autonomous consumer spending will cause the IS curve to shift to the ________ and aggregate demand will ________.
A)right;increase
B)right;decrease
C)left;increase
D)left;decrease
Q3) Everything else held constant,a decrease in government spending will cause the IS curve to shift to the ________ and aggregate demand will ________.
A)right;increase
B)right;decrease
C)left;increase
D)left;decrease
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Page 23
Chapter 22: Aggregate Demand and Supply Analysis
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Sample Questions
Q1) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause ________ in real GDP in the short run and ________ in inflation in the short run,everything else held constant.
A)an increase;an increase
B)a decrease;a decrease
C)no change;an increase
D)no change;a decrease
Q2) The fact that an economy always returns to the natural rate level of output is known as
A)the excess demand hypothesis.
B)the price-adjustment mechanism.
C)the self-correcting mechanism.
D)the natural rate of unemployment.
Q3) Explain and demonstrate graphically the effects of a negative supply shock in both the short-run and long-run.
Q4) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the inflation rate. Be sure to discuss two channels through which changes in inflation rates affect demand.
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Page 24
Chapter 23: Monetary Policy Theory
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Sample Questions
Q1) Which of the following is least likely to lead to inflationary monetary policy?
A)rising unemployment
B)expanding federal budget deficits
C)declining oil prices
D)conflict in the Middle East
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) The time it takes to pass legislation to implement a particular policy is called
A)the data lag.
B)the recognition lag.
C)the legislative lag.
D)the implementation lag.
E)the effectiveness lag.
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Chapter 24: The Role of Expectations in Monetary Policy
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Sample Questions
Q1) 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.
Q2) The U.S. government can play an important role in establishing the credibility of anti-inflation policy by
A)demonstrating fiscal responsibility.
B)monitoring the Fed.
C)conducting fiscal policy.
D)all of the above.
Q3) The Lucas critique indicates that
A)advocates of discretionary policies' criticisms of rational expectations models are well-founded.
B)advocates of discretionary policies' criticisms of rational expectations models are not well-founded.
C)expectations are important in determining the outcome of a discretionary policy.
D)expectations are not important in determining the outcome of a discretionary policy.
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Chapter 25: Transmission Mechanisms of Monetary Policy
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Sample Questions
Q1) Explain the traditional interest-rate channel for expansionary monetary policy. Explain how a tight monetary policy affects the economy through this channel.
Q2) If a contractionary monetary policy lowers the price level by more than expected,it raises the real value of consumer debt. This reduces consumer expenditure through A)the bank lending channel.
B)Tobin's q.
C)the traditional interest-rate channel.
D)the household liquidity effect.
Q3) Real business cycle theory states that the most important cause of business cycles is
A)shocks to the money supply.
B)interest rate shocks.
C)Federal Reserve policy decisions.
D)shocks to tastes and technology.
Q4) Discuss three channels by which monetary policy affects stock prices and aggregate spending.
Q5) Explain how expansionary and contractionary monetary policies affect aggregate demand through the exchange rate channel.
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Chapter 26: Financial Crises in Emerging Market Economies
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Q1) Factors that led to worsening financial market conditions in East Asia in 1997-1998 include
A)weak supervision by bank regulators.
B)a rise in interest rates abroad.
C)unanticipated increases in the price level.
D)increased uncertainty from political shocks.
Q2) Severe fiscal imbalances can directly trigger a currency crisis since
A)investors fear that the government may not be able to pay back the debt and so begin to sell domestic currency.
B)the government may stop printing money.
C)the government may have to cut back on spending.
D)the currency must surely increase in value.
Q3) The key factor leading to the financial crises in Mexico and the East Asian countries was
A)a deterioration in banks' balance sheets because of increasing loan losses.
B)severe fiscal imbalances.
C)a sharp increase in the stock market.
D)a sharp decline in interest rates.
Q4) What two key factors trigger speculative attacks leading to currency cries in emerging market countries?
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Chapter 27: The ISLM Model
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Sample Questions
Q1) Everything else held constant,if aggregate output is to the ________ of the LM curve,then there is an excess ________ of money which will cause the interest rate to rise.
A)right;supply
B)right;demand
C)left;supply
D)left;demand
Q2) A contractionary monetary policy shifts the LM curve to the ________,reducing ________,everything else held constant.
A)left;output and increasing interest rates
B)left;both real output and interest rates
C)right;both interest rates and real output
D)right;interest rates and increasing real output
Q3) If the economy is on the IS curve,but is to the left of the LM curve,then the ________ market is in equilibrium,but the interest rate is ________ the equilibrium level.
A)goods;below
B)goods;above
C)money;below
D)money;above
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