Financial Economics
Test Questions
Course Introduction
Financial Economics explores the principles and mechanisms that underpin financial markets, instruments, and institutions. The course examines how financial decisions are made by individuals, firms, and governments, emphasizing concepts such as risk and return, portfolio theory, asset pricing models, market efficiency, and the role of financial intermediaries. Students will also analyze the impact of financial policies and regulations, delve into capital markets and financial derivatives, and apply economic theories to understand real-world financial issues and strategies.
Recommended Textbook
Economics of Money Banking and Financial Markets The Business School Edition 4th Edition by Frederic
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Page 2
Chapter 1: Why Study Money,banking,and Financial Markets
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Sample Questions
Q1) Everything else held constant,a decrease in the value of the dollar relative to all foreign currencies means that the price of foreign goods purchased by Americans
A)increases
B)decreases.
C)remains unchanged.
D)either increases,decreases,or remains unchanged.
Answer: A
Q2) Poorly performing financial markets can be the cause of A)wealth.
B)poverty.
C)financial stability.
D)financial expansion.
Answer: B
Q3) From 1980-1985,the dollar strengthened in value against other currencies.Who was helped and who was hurt by this strong dollar?
Answer: American consumers benefitted because imports were cheaper and consumers could purchase more.American businesses and workers in those businesses were hurt as domestic and foreign sales of American products fell.
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3
Chapter 2: An Overview of the Financial System
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Sample Questions
Q1) Which of the following instruments are traded in a capital market?
A)corporate bonds
B)U.S.Treasury bills
C)negotiable bank CDs
D)repurchase agreements
Answer: A
Q2) Because these securities are more liquid and generally have smaller price fluctuations,corporations and banks use the ________ securities to earn interest on temporary surplus funds.
A)money market
B)capital market
C)bond market
D)stock market
Answer: A
Q3) Secondary markets make financial instruments more
A)solid.
B)vapid.
C)liquid.
D)risky.
Answer: C
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Chapter 3: What Is Money
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Sample Questions
Q1) Compared to an electronic payments system,a payments system based on checks has the major drawback that
A)checks are less costly to process.
B)checks take longer to process,meaning that it may take several days before the depositor can get her cash.
C)fraud may be more difficult to commit when paper receipts are eliminated.
D)legal liability is more clearly defined.
Answer: B
Q2) Of the following,the largest is
A)money market deposit accounts.
B)demand deposits.
C)M1.
D)M2.
Answer: D
Q3) The currency component includes paper money and coins held in A)bank vaults.
B)ATMs.
C)the hands of the nonbank public.
D)the central bank.
Answer: C
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Chapter 4: The Meaning of Interest Rates
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Sample Questions
Q1) A coupon bond that has no maturity date and no repayment of principal is called a A)consol.
B)cabinet.
C)Treasury bill.
D)Treasury note.
Q2) What is the present value of $500.00 to be paid in two years if the interest rate is 5 percent?
A)$453.51
B)$500.00
C)$476.25
D)$550.00
Q3) If the nominal rate of interest is 2 percent,and the expected inflation rate is -10 percent,the real rate of interest is
A)2 percent.
B)8 percent.
C)10 percent.
D)12 percent.
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Chapter 5: The Behavior of Interest Rates
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Sample Questions
Q1) Of the four effects on interest rates from an increase in the money supply,the one that works in the opposite direction of the other three is the
A)liquidity effect.
B)income effect.
C)price level effect.
D)expected inflation effect.
Q2) If there is an excess demand for money,individuals ________ bonds,causing interest rates to ________.
A)sell;rise
B)sell;fall
C)buy;rise
D)buy;fall
Q3) The opportunity cost of holding money is
A)the level of income.
B)the price level.
C)the interest rate.
D)the discount rate.
Q4) Using the liquidity preference framework,show what happens to interest rates during a business cycle recession.
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Chapter 6: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) Other things being equal,a decrease in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds to the ________.
A)right;right
B)right;left
C)left;right
D)left;left
Q2) The risk structure of interest rates is
A)the structure of how interest rates move over time.
B)the relationship among interest rates of different bonds with the same maturity.
C)the relationship among the term to maturity of different bonds.
D)the relationship among interest rates on bonds with different maturities.
Q3) According to the liquidity premium theory,a yield curve that is flat means that
A)bond purchasers expect interest rates to rise in the future.
B)bond purchasers expect interest rates to stay the same.
C)bond purchasers expect interest rates to fall in the future.
D)the yield curve has nothing to do with expectations of bond purchasers.
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) The view that expectations change relatively slowly over time in response to new information is known in economics as
A)rational expectations.
B)irrational expectations.
C)slow-response expectations.
D)adaptive expectations.
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) In the one-period valuation model,the current stock price increases if
A)the expected sales price increases.
B)the expected sales price falls.
C)the required return increases.
D)dividends are cut.
Q4) You believe that a corporation's dividends will grow 5% on average into the foreseeable future.If the company's last dividend payment was $5 what should be the current price of the stock assuming a 12% required return?
Page 9
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) Solutions to the moral hazard in equity contracts include all of the following EXCEPT
A)government regulations to increase information.
B)the use of financial intermediaries.
C)the use of debt contracts.
D)government ownership of resources.
Q2) Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs.
A)expertise
B)diversification
C)regulations
D)equity
Q3) The analysis of how asymmetric information problems affect economic behavior is called ________ theory.
A)uneven
B)parallel
C)principal
D)agency
Q4) How does collateral help to reduce the adverse selection problem in credit market?
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Chapter 9: Banking and the Management of Financial Institutions
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Sample Questions
Q1) Banks hold excess and secondary reserves to
A)reduce the interest-rate risk problem.
B)provide for unexpected deposit outflows.
C)satisfy margin requirements.
D)achieve higher earnings than they can with loans.
Q2) If a bank's liabilities are more sensitive to interest rate movements than are its assets,then
A)an increase in interest rates will reduce bank profits.
B)a decrease in interest rates will reduce bank profits.
C)interest rates changes will not impact bank profits.
D)an increase in interest rates will increase bank profits.
Q3) When $1 million is deposited at a bank,the required reserve ratio is 20 percent,and the bank chooses not to make any loans but to hold excess reserves instead,then,in the bank's final balance sheet
A)the assets at the bank increase by $1 million.
B)the liabilities of the bank decrease by $1 million.
C)reserves increase by $200,000.
D)liabilities increase by $200,000.
Q4) How can specializing in lending help to reduce the adverse selection problem in lending?
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Chapter 10: Economic Analysis of Financial Regulation
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Sample Questions
Q1) Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities,income and dividends,and so forth.
A)call reports
B)balance reports
C)regulatory sheets
D)examiner updates
Q2) An analysis of the political economy of the savings and loan crisis helps one to understand
A)why politicians aided the efforts of thrift regulators,raising regulatory appropriations and encouraging closing of insolvent thrifts.
B)why thrift regulators were so quick to inform Congress of the problems that existed in the thrift industry.
C)why thrift regulators willingly acceded to pressures placed upon them by members of Congress.
D)why politicians listened so closely to the taxpayers they represented.
Q3) 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 National Bank Act of 1863,and subsequent amendments to it
A)created a banking system of state-chartered banks.
B)established the Office of the Comptroller of the Currency.
C)broadened the regulatory powers of the Federal Reserve.
D)created insurance on deposit accounts.
Q2) The regulatory system that has evolved in the United States whereby banks are regulated at the state level,the national level,or both,is known as a
A)bilateral regulatory system.
B)tiered regulatory system.
C)two-tiered regulatory system.
D)dual banking system.
Q3) In a ________ banking system,commercial banks provide a full range of banking,securities,and insurance services,all within a single legal entity.
A)universal
B)severable
C)barrier-free
D)dividerless
Q4) What financial innovations helped banks to get around the bank branching restrictions of the McFadden Act?
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Chapter 12: Financial Crises
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Sample Questions
Q1) If a borrower takes out a $200 million loan in a repo agreement and is asked to post $220 million of mortgage-backed securities as collateral,the "haircut" is A)5%.
B)10%.
C)20%.
D)50%.
Q2) The Dodd-Frank legislation of 2010 permanently increased the federal deposit insurance to
A)$40,000.
B)$100,000.
C)$200,000.
D)$250,000.
Q3) Microprudential supervision does all of the following EXCEPT
A)checking capital ratios of a bank.
B)checking a bank's compliance with disclosure requirements.
C)assessing the riskiness of an individual bank's activities.
D)focusing on financial system liquidity.
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: Nonbank Finance
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Sample Questions
Q1) Privatization of Social Security involves
A)tax reductions.
B)benefit reductions.
C)increasing the retirement age.
D)investing portions of the trust fund in corporate securities.
Q2) Fraudulent practices and other abuses of private pension funds led Congress to enact the
A)FDIC Act.
B)Federal Reserve Act.
C)FHLBS.
D)Employee Retirement Income Security Act.
Q3) ________ assist in the initial sale of securities in the primary market;________ assist in the trading of securities in the secondary markets.
A)Investment banks;mutual funds
B)Commercial banks;mutual funds
C)Investment banks;securities brokers and dealers
D)Commercial banks;securities brokers and dealers
Q4) Explain why the Social Security system faces problems.Discuss the possible solutions to these problems.
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Chapter 14: Financial Derivatives
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Sample Questions
Q1) An option allowing the owner to sell an asset at a future date is a A)put option.
B)call option.
C)futures contract.
D)forward contract.
Q2) An option that can be exercised at any time up to maturity is called
A)a swap.
B)a stock option.
C)an European option.
D)an American option.
Q3) A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is
A)an interest-rate swap.
B)a currency swap.
C)a swaption.
D)an international swap.
Q4) Show graphically and explain the profits and losses of buying futures relative to buying call options.
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Chapter 15: Conflicts of Interest in the Financial Industry
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Sample Questions
Q1) One problem with conflicts of interest is that they can reduce the ________ in financial markets,thereby increasing ________.
A)quantity of information;financial institutions' profits
B)quantity of information;asymmetric information
C)quality of information;asymmetric information
D)quality of information;financial institutions' profits
Q2) Conflicts of interest is a type of ________ problem that occurs when a person or institution has multiple objectives that are in conflict with each other.
A)moral hazard
B)adverse selection
C)risk sharing
D)spinning
Q3) Under the Global Legal Settlement of 2002,the provision that requires investment banking firms to make their analysts' recommendations public is an example of A)regulate for transparency.
B)supervisory oversight.
C)separation of functions.
D)socialization of information production.
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Chapter 16: Central Banks and the Federal Reserve System
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Sample Questions
Q1) Recent research indicates that inflation performance (low inflation)has been found to be best in countries with
A)the most independent central banks.
B)political control of monetary policy.
C)money financing of budget deficits.
D)a policy of always keeping interest rates low.
Q2) The Depository Institutions Deregulation and Monetary Control Act of 1980
A)established higher reserve requirements for nonmember than for member banks.
B)established higher reserve requirements for member than for nonmember banks.
C)abolished reserve requirements.
D)established uniform reserve requirements for all banks.
Q3) The research document given to the Federal Open Market Committee that contains information on the state of the economy in each Federal Reserve district is called the A)beige book.
B)green book.
C)blue book.
D)black book.
Q4) Why does the Federal Reserve Bank of New York play a special role within the Federal Reserve System?
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Chapter 17: The Money Supply Process
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Sample Questions
Q1) When the Fed supplies the banking system with an extra dollar of reserves,deposits increase by more than one dollar-a process called
A)extra deposit creation.
B)multiple deposit creation.
C)expansionary deposit creation.
D)stimulative deposit creation.
Q2) Suppose that from a new checkable deposit,First National Bank holds two million dollars in vault cash,nine million dollars in excess reserves,and faces a required reserve ratio of ten percent.Given this information,we can say First National Bank has ________ million dollars on deposit with the Federal Reserve.
A)one
B)two
C)eight
D)ten
Q3) Factors causing an increase in currency holdings include
A)an increase in the interest rates paid on checkable deposits.
B)an increase in the cost of acquiring currency.
C)a decrease in bank panics.
D)an increase in illegal activity.
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Chapter 18: Tools of Monetary Policy
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Sample Questions
Q1) The most important advantage of discount policy is that the Fed can use it to A)precisely control the monetary base.
B)perform its role as lender of last resort.
C)control the money supply.
D)punish banks that have deficient reserves.
Q2) The interest rate for primary credit is usually set ________ basis points ________ the federal funds rate.In March 2008,this gap was changed to ________ basis points. A)50;below;100
B)100;above;25
C)100;below;50
D)50;above;25
Q3) The Federal Open Market Committee makes the Fed's decisions on the purchase or sale of government securities,but these purchases or sales are executed by the Federal Reserve Bank of A)Chicago.
B)Boston.
C)New York.
D)San Francisco.
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20
Chapter 19: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) The European Central Bank (ECB)pursues a hybrid monetary policy strategy that has elements in common with the -targeting strategy previously used by the Bundesbank but also includes some elements of targeting.
A)monetary;inflation
B)inflation;monetary
C)monetary;exchange rate
D)monetary;nominal GDP
Q2) When asset prices increase above their fundamental values it is called an
A)asset-price bubble.
B)irrational bubble.
C)asset-price spike.
D)irrational spike.
Q3) During World War II,whenever interest rates would ________ and the price of bonds would begin to ________,the Fed would make open market purchases.
A)rise;rise
B)rise;fall
C)fall;rise
D)fall;fall
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Chapter 20: The Foreign Exchange Market
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Sample Questions
Q1) Everything else held constant,when a country's currency appreciates,the country's goods abroad become ________ expensive and foreign goods in that country become ________ expensive.
A)more;less
B)more;more
C)less;less
D)less;more
Q2) If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollar-denominated assets,and if the dollar is expected to appreciate at a 4 percent rate,the expected return on ________-denominated assets in terms of ________ percent.
A)dollar;euros is 3
B)euro;dollars is 1
C)dollar;euros is 9
D)euro;dollars is 11
Q3) Explain the law of one price and the theory of purchasing power parity.Why doesn't purchasing power parity explain all exchange rate movements in the short run? What factors determine long-run exchange rates?
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Chapter 21: The International Financial System
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Q1) To keep from running out of international reserves under the Bretton Woods system,a country had to implement ________ monetary policy to ________ its currency.
A)expansionary;strengthen
B)expansionary;weaken
C)contractionary;strengthen
D)contractionary;weaken
Q2) Which of the following appears in the capital account part of the balance of payments?
A)a gift to an American from his English aunt
B)a purchase by the Honda corporation of a U.S.Treasury bill
C)a purchase by the Bank of England of a U.S.Treasury bill
D)income earned by the Honda corporation on its automobile plant in Ohio
Q3) Hong Kong chooses to have ________ and ________ and therefore,cannot have an independent monetary policy at the same time.
A)capital control;a fixed exchange rate
B)free capital mobility;a fixed exchange rate
C)free capital mobility;a flexible exchange rate
D)capital control;a flexible exchange rate
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Chapter 22: Quantity Theory, inflation and the Demand for Money
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Q1) In the Baumol-Tobin analysis of the demand for money,either an increase in ________ or an increase in ________ increases money demand.
A)income;interest rates
B)brokerage fees;interest rates
C)interest rates;the price level
D)brokerage fees;income
Q2) The finance of government spending through a Treasury sale of bonds which are then purchased by the Fed
A)causes both reserves and the monetary base to rise.
B)causes both reserves and the monetary base to decline.
C)causes reserves to rise,but the monetary base to decline.
D)has no net effect on the monetary base.
Q3) Keynes argued that the precautionary component of the demand for money was primarily determined by the level of people's ________,which he believed were proportional to ________.
A)incomes;wealth
B)incomes;age
C)transactions;income
D)transactions;age
Page 24
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Chapter 23: Aggregate Demand and Supply Analysis
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Q1) Suppose the economy is producing below the natural rate of output and the government is suffering from large budget deficits.To deal with the deficit problem,suppose the government takes a policy action to reduce the size of the deficits.This policy action will cause ________ in the unemployment rate 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)a decrease;an increase
D)an increase;a decrease
Q2) If firms and households form their expectations about inflation by looking at past inflation,this form of expectations formation is known as ________ expectations.
A)adaptive
B)forward-looking
C)rational
D)perfect
Q3) 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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Chapter 24: Monetary Policy Theory
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Q1) The combination of a successful wage push by workers and the government's commitment to high employment leads to
A)demand-pull inflation.
B)supply-side inflation.
C)supply-shock inflation.
D)cost-push inflation.
Q2) Because policies in the United States were too expansionary from 1965 through 1973,the U.S.suffered
A)demand-pull inflation.
B)cost-push inflation,as workers sought higher wages in order to keep up with inflation.
C)both demand-pull and cost-push inflation.
D)neither demand-pull nor cost-push inflation.
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 25: Transmission Mechanisms of Monetary Policy
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Q1) When Keynesians argue that "correlation does not necessarily imply causation," they are probably criticizing
A)structural-model evidence.
B)reduced-form evidence.
C)indirect-model evidence.
D)black-box evidence.
Q2) The channels through which monetary policy affects economic activity are called the ________ of monetary policy.
A)transmission mechanisms
B)flow mechanisms
C)distribution mechanisms
D)allocational mechanisms
Q3) Early Keynesians felt that ________ policy was ________,so they stressed the importance of ________ policy.
A)fiscal;ineffective;monetary
B)monetary;ineffective;fiscal
C)monetary;potent;monetary
D)fiscal;too potent;monetary
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Chapter 26: Financial Crises in Emerging Market Economies
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Q1) A sharp depreciation of the domestic currency after a currency crisis leads to
A)higher inflation.
B)lower import prices.
C)lower interest rates.
D)decrease in the value of foreign currency-denominated liabilities.
Q2) All of the following might create problems from financial liberalization in emerging countries EXCEPT
A)ineffective screening of borrowers.
B)limits on risk-taking.
C)lax government supervision of banks.
D)lenders failure to monitor borrowers.
Q3) In emerging market countries,the deterioration in bank's balance sheets has more ________ effects on lending and economic activity than in advanced countries.
A)negative
B)positive
C)affirming
D)advancing
Q4) What two key factors trigger speculative attacks leading to currency cries in emerging market countries?
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Chapter 27: The IS Curve
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Q1) In the Keynesian cross diagram,a decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________,the equilibrium level of aggregate output to fall,and the IS curve to shift to the ________,everything else held constant.
A)up;left
B)up;right
C)down;left
D)down;right
Q2) Keynes believed that changes in autonomous spending were dominated by unstable fluctuations in ________,which are influenced by emotional waves of optimism and pessimism-factors he referred to as "animal spirits."
A)unplanned investment spending
B)actual investment spending
C)planned investment spending
D)autonomous consumer expenditures
Q3) Keynes believed that unstable investment caused the Great Depression.Using the simple Keynesian model,explain how a fall in investment affects equilibrium output.
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Chapter 28: The Monetary Policy and Aggregate Demand
Curves
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Q1) Everything else held constant,an increase in government spending will cause
A)aggregate demand to increase.
B)aggregate demand to decrease.
C)the quantity of aggregate demand to increase.
D)the quantity of aggregate demand to decrease.
Q2) Everything else held constant,an appreciation of the domestic currency 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,an increase in net taxes 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 30
Chapter 29: 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) 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.
Q3) The interest rate thought to have the most important impact on aggregate demand is the
A)short-term interest rate.
B)T-bill rate.
C)rate on 90-day CDs.
D)long-term interest rate.
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Page 31
Chapter 30: The ISLM Model
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99 Verified Questions
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Sample
Questions
Q1) As aggregate output rises,the demand for money ________ and the interest rate ________,so that money demanded equals money supplied and the money market is in equilibrium.
A)increases;rises
B)increases;falls
C)decreases;rises
D)decreases;falls
Q2) An expansionary 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) In the long-run the ISLM model predicts that ________ can change real output.
A)only monetary policy
B)only fiscal policy
C)both monetary and fiscal policy
D)neither monetary nor fiscal policy
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