Financial Markets and Institutions
Final Test Solutions
Course Introduction
This course provides a comprehensive overview of the structure, functions, and operations of financial markets and institutions. Students will examine the various types of financial markets including money and capital markets and the roles of key institutions such as banks, investment firms, insurance companies, and central banks. The course explores topics such as financial instruments, interest rate determination, regulation, risk management, and the impact of monetary policy on the economy. Emphasis is placed on understanding the interrelationships between financial markets and institutions, and their significance in facilitating economic growth and stability both domestically and globally.
Recommended Textbook
Economics of Money Banking and Financial Markets 12th Edition by Frederic S. Mishkin
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27 Chapters
2796 Verified Questions
2796 Flashcards
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Chapter 1: Why Study Money, banking, and Financial Markets
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109 Verified Questions
109 Flashcards
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Sample Questions
Q1) From 2002 to 2011,the dollar depreciated substantially against other currencies. This drop in value most likely benefitted
A)European citizens traveling in the U.S.
B)U)S. citizens traveling in Europe.
C)U)S. manufacturers importing parts from abroad.
D)U)S. citizens purchasing foreign-made automobiles.
Answer: A
Q2) A rising stock market index due to higher share prices
A)increases people's wealth,but is unlikely to increase their willingness to spend.
B)increases people's wealth and as a result may increase their willingness to spend.
C)decreases the amount of funds that business firms can raise by selling newly-issued stock.
D)decreases people's wealth,but is unlikely to increase their willingness to spend.
Answer: B
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Chapter 2: An Overview of the Financial System
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Sample Questions
Q1) Which of the following are short-term financial instruments?
A)a repurchase agreement
B)a share of Walt Disney Corporation stock
C)a Treasury note with a maturity of four years
D)a residential mortgage
Answer: A
Q2) Economies of scale enable financial institutions to
A)reduce transactions costs.
B)avoid the asymmetric information problem.
C)avoid adverse selection problems.
D)reduce moral hazard.
Answer: A
Q3) Distinguish between a foreign bond and a Eurobond.
Answer: A foreign bond is sold in a foreign country and priced in that country's currency. A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency.
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Chapter 3: What Is Money
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Sample Questions
Q1) All of the following are necessary criteria for a commodity to function as money EXCEPT
A)it must deteriorate quickly.
B)it must be divisible.
C)it must be easy to carry.
D)it must be widely accepted.
Answer: A
Q2) Which of the following statements accurately describes the two measures of the money supply?
A)The two measures do not move together,so they cannot be used interchangeably by policymakers.
B)The two measures' movements closely parallel each other,even on a month-to-month basis.
C)Short-run movements in the money supply are extremely reliable.
D)M2 is the narrowest measure the Fed reports.
Answer: A
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Chapter 4: The Meaning of Interest Rates
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Sample Questions
Q1) There is ________ for any bond whose time to maturity matches the holding period.
A)no interest-rate risk
B)a large interest-rate risk
C)rate-of-return risk
D)yield-to-maturity risk
Q2) Another name for a consol is a ________ because it is a bond with no maturity date. The owner receives fixed coupon payments forever.
A)perpetuity
B)discount bond
C)municipality
D)high-yield bond
Q3) The nominal interest rate minus the expected rate of inflation
A)defines the real interest rate.
B)is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate.
C)is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate.
D)defines the discount rate.
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Page 6
Chapter 5: The Behavior of Interest Rates
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Sample Questions
Q1) If brokerage commissions on bond sales decrease,then,other things equal,the demand for bonds will ________ and the demand for real estate will ________.
A)increase;increase
B)increase;decrease
C)decrease;decrease
D)decrease;increase
Q2) The reduction of brokerage commissions for trading common stocks that occurred in 1975 caused the demand for bonds to ________ and the demand curve to shift to the ________.
A)fall;right
B)fall;left
C)rise;right
D)rise;left
Q3) A movement along the bond demand or supply curve occurs when ________ changes.
A)bond price
B)income
C)wealth
D)expected return
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Chapter 6: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) According to the liquidity premium theory of the term structure,a slightly upward sloping yield curve indicates that short-term interest rates are expected to A)rise in the future.
B)remain unchanged in the future.
C)decline moderately in the future. D)decline sharply in the future.
Q2) As default risk decreases,the expected return on corporate bonds ________,and the return becomes ________ uncertain,everything else held constant. A)increases;less B)increases;more C)decreases;less D)decreases;more
Q3) Corporate bonds are not as liquid as government bonds because A)fewer corporate bonds for any one corporation are traded,making them more costly to sell.
B)the corporate bond rating must be calculated each time they are traded. C)corporate bonds are not callable. D)corporate bonds cannot be resold.
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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) In a one-period valuation model,a decrease in the required return on investments in equity causes a(n)________ in the ________ price of a stock.
A)increase;current
B)increase;expected sales
C)decrease;current
D)decrease;expected sales
Q2) Using the Gordon growth model,a stock's current price decreases when
A)the dividend growth rate increases.
B)the required return on equity decreases.
C)the expected dividend payment increases.
D)the growth rate of dividends decreases.
Q3) The small-firm effect refers to the
A)negative returns earned by small firms.
B)returns equal to large firms earned by small firms.
C)abnormally high returns earned by small firms.
D)low returns after adjusting for risk earned by small firms.
Q4) Your best friend calls and gives you the latest stock market "hot tip" that he heard at the health club. Should you act on this information? Why or why not?
Q5) What rights does ownership interest give stockholders?
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) The principal-agent problem would not occur if ________ of a firm had complete information about actions of the ________.
A)owners;customers
B)owners;managers
C)managers;customers
D)managers;owners
Q2) One reason financial systems in developing and transition countries are underdeveloped is
A)they have weak links to their governments.
B)they make loans only to nonprofit entities.
C)the legal system may be poor making it difficult to enforce restrictive covenants.
D)the accounting standards are too stringent for the banks to meet.
Q3) Tools to help solve the adverse selection problem in financial markets include all of the following EXCEPT
A)diversification.
B)government regulations to increase information.
C)the use of financial intermediaries.
D)the private production and sale of information.
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Chapter 9: Banking and the Management of Financial Institutions
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Sample Questions
Q1) Of the following methods that banks might use to reduce moral hazard problems,the one not legally permitted in the United States is the
A)requirement that firms keep compensating balances at the banks from which they obtain their loans.
B)requirement that firms place on their board of directors an officer from the bank.
C)inclusion of restrictive covenants in loan contracts.
D)requirement that individuals provide detailed credit histories to bank loan officers.
Q2) Which of the following statements is FALSE?
A)Checkable deposits are usually the lowest cost source of bank funds.
B)Checkable deposits are the primary source of bank funds.
C)Checkable deposits are payable on demand.
D)Checkable deposits include NOW accounts.
Q3) The most important category of assets on a bank's balance sheet is
A)other assets.
B)securities.
C)loans.
D)cash items in the process of collection.
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Page 11
Chapter 10: Economic Analysis of Financial Regulation
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Sample Questions
Q1) Deposit insurance has not worked well in countries with A)a weak institutional environment.
B)strong supervision and regulation.
C)a tradition of the rule of law.
D)few opportunities for corruption.
Q2) Banks engage in regulatory arbitrage by
A)keeping high-risk assets on their books while removing low-risk assets with the same capital requirement.
B)keeping low-risk assets on their books while removing high-risk assets with the same capital requirement.
C)hiding risky assets from regulators.
D)buying risky assets from arbitragers.
Q3) Competition between banks
A)encourages greater risk taking.
B)encourages conservative bank management.
C)increases bank profitability.
D)eliminates the need for government regulation.
Q4) The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.
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Chapter 11: Banking Industry: Structure and Competition
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Sample Questions
Q1) Prior to 2008,bank managers looked on reserve requirements
A)as a tax on deposits.
B)as a subsidy on deposits.
C)as a subsidy on loans.
D)as a tax on loans.
Q2) Currency circulated by banks that could be redeemed for gold was called A)junk bonds.
B)banknotes.
C)gold bills.
D)state money.
Q3) The FHLBS gives loans to S&Ls and thus performs a function similar to the ________ for commercial banks.
A)Federal Reserve
B)U)S. Treasury
C)Office of the Comptroller of the Currency
D)U)S. Mint
Q4) Discuss three ways in which U.S. banks can become involved in international banking.
Q5) What financial innovations helped banks to get around the bank branching restrictions of the McFadden Act?
13
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Chapter 12: Financial Crises
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Sample Questions
Q1) A serious consequence of a financial crisis is
A)a contraction in economic activity.
B)an increase in asset prices.
C)financial engineering.
D)financial globalization.
Q2) When housing prices began to decline after their peak in 2006,many subprime borrowers found that their mortgages were "underwater." This meant that
A)the value of the house fell below the amount of the mortgage.
B)the basement flooded since they could not afford to fix the leaky plumbing.
C)the roof leaked during a rainstorm.
D)the amount that they owed on their mortgage was less than the value of their house.
Q3) When asset prices rise above their fundamental economic values,a(n)________ occurs.
A)asset-price bubble
B)liability war
C)decline in lending
D)decrease in moral hazard
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Chapter 13: Central Banks and the Federal Reserve System
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Sample Questions
Q1) Banks subject to reserve requirements set by the Federal Reserve System include A)only nationally chartered banks.
B)only banks with assets less than $100 million.
C)only banks with assets less than $500 million.
D)all banks whether or not they are members of the Federal Reserve System.
Q2) Member commercial banks have purchased stock in their district Fed banks;the dividend paid by that stock is limited by law to ________ percent annually.
A)four
B)five
C)six
D)eight
Q3) 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
Q4) Make the case for and against an independent Federal Reserve.
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Chapter 14: The Money Supply Process
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Sample Questions
Q1) Which of the following are NOT liabilities on the Fed's balance sheet?
A)discount loans
B)bank deposits
C)deferred availability cash items
D)U)S. Treasury deposits
Q2) If a bank has excess reserves of $5,000 and demand deposit liabilities of $80,000,and if the reserve requirement is 20 percent,then the bank has actual reserves of A)$11,000.
B)$20,000.
C)$21,000.
D)$26,000.
Q3) Decisions by depositors to increase their holdings of ________,or of banks to hold ________ will result in a smaller expansion of deposits than the simple model predicts.
A)deposits;required reserves
B)deposits;excess reserves
C)currency;required reserves
D)currency;excess reserves
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16
Chapter 15: Tools of Monetary Policy
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Sample Questions
Q1) Everything else held constant,the vertical section of the supply curve of reserves is shortened when the
A)discount rate increases.
B)discount rate decreases.
C)federal funds rate rises.
D)federal funds rate falls.
Q2) The equivalent to the Federal Reserve's discount rate in the European System of Central Banks is the
A)federal funds rate.
B)marginal lending rate.
C)deposit facility rate.
D)lombard rate.
Q3) The two types of open market operations are
A)offensive and defensive.
B)dynamic and reactionary.
C)active and passive.
D)dynamic and defensive.
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) Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in nonborrowed reserves.
Q2) During the 1950s,Fed monetary policy targeted
A)the monetary base.
B)the exchange rate.
C)discount loans.
D)interest rates.
Q3) The strengthening of the dollar between 1980 and 1985 contributed to a ________ in American competitiveness,putting pressure on the Fed to pursue a more ________ monetary policy.
A)decrease;contractionary
B)increase;expansionary
C)increase;contractionary
D)decrease;expansionary
Q4) The Fed accidentally discovered open market operations in the early
A)1920s.
B)1910s.
C)1900s.
D)1890s.
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and
Chapter 17: The Foreign Exchange Market
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Sample Questions
Q1) Anything that increases the demand for foreign goods relative to domestic goods tends to ________ the domestic currency because domestic goods will only continue to sell well if the value of the domestic currency is ________,everything else held constant.
A)depreciate;lower B)depreciate;higher C)appreciate;lower D)appreciate;higher
Q2) A decrease in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to ________,everything else held constant. A)increase;appreciate B)increase;depreciate C)decrease;appreciate D)decrease;depreciate
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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19
Chapter 18: The International Financial System
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Sample Questions
Q1) Explain an additional disadvantage for a country undergoing dollarization compared to a currency board or other exchange-rate targeting regimes.
Q2) Two reasons for an industrialized country to adopt an exchange-rate targeting regime are if the country ________ conduct successful monetary policy on its own,and if the country wants to ________ integration of the domestic economy with its neighbors.
A)cannot;encourage B)cannot;discourage C)can;encourage D)can;discourage
Q3) An advantage to exchange-rate targeting is it helps keep inflation under control by tying the inflation rate for ________ traded goods to what is found in the ________ country.
A)domestically;anchor
B)domestically;domestic
C)internationally;anchor
D)internationally;domestic
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Page 20
Chapter 19: Quantity Theory, inflation and the Demand for Money
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Sample Questions
Q1) The Keynesian theory of money demand predicts that people will increase their money holdings if they believe that
A)interest rates are about to fall.
B)bond prices are about to rise.
C)expected inflation is about to fall.
D)bond prices are about to fall.
Q2) The Keynesian demand for real balances can be expressed as A)M = f(i,Y).
B)M /P = f(i).
C)M /P = f(Y).
D)M /P = f(i,Y).
Q3) If the money supply is $600 and nominal income is $3,600,the velocity of money is A)1/60.
B)1/6.
C)6.
D)60.
Q4) What factors determine the demand for money in the Baumol-Tobin analysis of transactions demand for money? How does a change in each factor affect the quantity of money demanded?
Page 21
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Chapter 20: The Is Curve
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Sample Questions
Q1) 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
Q2) Everything else held constant,a shift in tastes in the U.S. toward Mexican goods will ________ net exports in the U.S. and cause the quantity of aggregate output demanded to ________ in Mexico.
A)decrease;rise B)decrease;fall C)increase;rise D)increase;fall
Q3) A decline in taxes ________ consumer expenditure and shifts the ________ curve to the ________,everything else held constant.
A)raises;LM;right
B)lowers;IS;left
C)raises;IS;right
D)lowers;LM;left
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Page 22
Chapter 21: The Monetary Policy and Aggregate Demand
Curves
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Sample Questions
Q1) The Fed's policy actions of reacting to higher inflation by raising the real interest rate during 2004-2006 were
A)upward movements along the monetary policy curve.
B)downward movement along the monetary policy curve.
C)upward shifts of the monetary policy curve.
D)downward shifts of the monetary policy curve.
Q2) Everything else held constant,a decrease 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
Q3) Based on the Taylor Principle,a central bank's endogenous response of decreasing interest rates when inflation falls
A)causes an upward movement along the monetary policy curve.
B)causes a downward movement along the monetary policy curve.
C)shifts the monetary policy curve upward.
D)shifts the monetary policy curve downward.
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Chapter 22: Aggregate Demand and Supply Analysis
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Sample Questions
Q1) Explain and demonstrate graphically the effects of a negative supply shock in both the short-run and long-run.
Q2) Everything else held constant,an increase in the cost of production ________ aggregate ________.
A)increases;demand B)decreases;demand C)increases;supply D)decreases;supply
Q3) Everything else held constant,when output is ________ the natural rate level,wages will begin to ________,decreasing short-run aggregate supply.
A)above;fall
B)above;rise
C)below;fall
D)below;rise
Q4) Which of the followings does NOT shift the short-run aggregate supply curve?
A)supply shocks.
B)persistent positive output gap. C)changes in expected inflation. D)an increase in output gap.
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Chapter 23: Monetary Policy Theory
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Sample Questions
Q1) Nonactivists of the policies believe that
A)wages and prices are very flexible.
B)the self-correcting mechanism is very rapid.
C)government action is unnecessary.
D)all of the above.
Q2) When the economy suffers a permanent negative supply shock and the central bank does not respond by changing the autonomous component of monetary policy,then
A)inflation will be higher.
B)output will be at its potential.
C)output will be unchanged.
D)inflation will be unchanged.
E)both A and B.
Q3) To say that inflation is a monetary phenomenon seems to beg the question
A)Why does inflationary monetary policy occur?
B)Why do politicians seek reelection?
C)Why is the Fed independent?
D)Why does the U.S. Treasury print so much money?
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25
Chapter 24: The Role of Expectations in Monetary Policy
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Q1) Arguments for discretionary policies include
A)policy rules can be too rigid because they cannot foresee every contingency.
B)the time-inconsistency problem can lead to poor economic outcomes.
C)discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run.
D)all of the above.
Q2) Approaches to establishing central bank credibility include
A)continued success at keeping inflation under control.
B)central bank independence.
C)appointment of a more conservative central banker.
D)all of the above.
Q3) Ending the "Great Inflation" era in the 1970s is an example of A)inflation targeting.
B)exchange rate targeting.
C)central bank independence.
D)appointment of a more conservative central banker.
E)all of the above.
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26
Chapter 25: Transmission Mechanisms of Monetary Policy
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Q1) From the earlier 1990s until 2012,the Japanese monetary was ________ and stock and real estate prices were ________.
A)tight;rising
B)easy;rising
C)tight;falling
D)easy;falling
Q2) Because of the presence of asymmetric information problems in credit markets,an expansionary monetary policy causes a ________ in net worth,which ________ the adverse selection problem,thereby ________ increased lending to finance investment spending.
A)decline;increases;encouraging B)rise;increases;discouraging C)rise;reduces;encouraging D)decline;reduces;discouraging
Q3) Monetarists' preference for reduced-form models is based on their belief that A)reverse causation is a problem.
B)structural models may understate money's effect on economic activity.
C)money supply changes are always endogenous.
D)monetary policy affects only investment spending.
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Page 27
Chapter 26: Financial Crises in Emerging Market Economies
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Q1) 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.
Q2) Factors likely to cause a financial crisis in emerging market countries include
A)severe fiscal imbalances.
B)decreases in foreign interest rates.
C)a foreign exchange crisis.
D)too strong oversight of the financial industry.
Q3) Financial crises generally develop along two basic paths
A)mismanagement of financial liberalization/globalization and severe fiscal imbalances.
B)stock market declines and severe fiscal imbalances.
C)mismanagement of financial liberalization/globalization and stock market declines.
D)stock market declines and unanticipated declines in the value of the domestic currency.
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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 fall.
A)right;supply
B)right;demand
C)left;supply
D)left;demand
Q2) In the money market,a condition of excess demand for money can be eliminated by a ________ in aggregate output or a ________ in the interest rate,everything else held constant.
A)rise;rise
B)rise;fall
C)fall;rise
D)fall;fall
Q3) In the basic closed-economy ISLM model,the IS curve can be described by an equation where
A)output is a function of consumption.
B)money is a function of interest rates.
C)output is a function of money.
D)output is a function of interest rates.
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