Financial Markets and Institutions
Practice Questions
Course Introduction
Financial Markets and Institutions explores the structure, function, and roles of various financial markets and the institutions that operate within them. The course examines how financial instruments are traded, the mechanisms of market regulation, and the critical role of financial intermediaries such as banks, insurance companies, and investment firms. It covers topics including interest rate determination, risk management, asset pricing, and the impact of monetary policy on financial systems. Students gain an understanding of how financial markets facilitate capital flows, support economic growth, and respond to domestic and global economic events.
Recommended Textbook
Economics of Money Banking and Financial Markets The Business School Edition 4th Edition by Frederic
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Chapter 1: Why Study Money,banking,and Financial Markets
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Q1) If an economy has aggregate output of $20 trillion,then aggregate income is
A)$10 trillion.
B)$20 trillion.
C)$30 trillion.
D)$40 trillion.
Answer: B
Q2) Stock prices are
A)relatively stable trending upward at a steady pace.
B)relatively stable trending downward at a moderate rate.
C)extremely volatile.
D)unstable trending downward at a moderate rate.
Answer: C
Q3) The most comprehensive measure of aggregate output is
A)gross domestic product.
B)net national product.
C)the stock value of the industrial 500.
D)national income.
Answer: A
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3
Chapter 2: An Overview of the Financial System
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Q1) Which of the following can be described as direct finance?
A)You take out a mortgage from your local bank.
B)You borrow $2500 from a friend.
C)You buy shares of common stock in the secondary market.
D)You buy shares in a mutual fund.
Answer: B
Q2) The process of indirect finance using financial intermediaries is called
A)direct lending.
B)financial intermediation.
C)resource allocation.
D)financial liquidation.
Answer: B
Q3) Although the dominance of ________ over ________ is clear in all countries,the relative importance of bond versus stock markets differs widely.
A)financial intermediaries;securities markets
B)financial intermediaries;government agencies
C)government agencies;financial intermediaries
D)government agencies;securities markets
Answer: A
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Page 4
Chapter 3: What Is Money
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Sample Questions
Q1) The components of the U.S.M1 money supply are demand and checkable deposits plus A)currency.
B)currency plus savings deposits.
C)currency plus travelers checks.
D)currency plus travelers checks plus money market deposits.
Answer: C
Q2) From 2004 to 2007,the growth rates of M1 and M2
A)were identical.
B)both increased but at different rates.
C)both decreased but at different rates.
D)moved in opposite directions.
Answer: D
Q3) People hold money even during inflationary episodes when other assets prove to be better stores of value.This can be explained by the fact that money is A)extremely liquid.
B)a unique good for which there are no substitutes.
C)the only thing accepted in economic exchange.
D)backed by gold.
Answer: A
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Chapter 4: The Meaning of Interest Rates
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Sample Questions
Q1) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent.If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year,what is the yearly return on the bond you are holding?
A)5 percent
B)10 percent
C)15 percent
D)20 percent
Q2) 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
Q3) The interest rate that equates the present value of payments received from a debt instrument with its value today is the
A)simple interest rate.
B)current yield.
C)yield to maturity.
D)real interest rate.
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Chapter 5: The Behavior of Interest Rates
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Q1) When the interest rate on a bond is ________ the equilibrium interest rate,in the bond market there is excess ________ and the interest rate will ________.
A)above;demand;rise
B)above;demand;fall
C)below;supply;fall
D)above;supply;rise
Q2) Everything else held constant,if the expected return on RST stock declines from 12 to 9 percent and the expected return on XYZ stock declines from 8 to 7 percent,then the expected return of holding RST stock ________ relative to XYZ stock and demand for XYZ stock ________.
A)rises;rises
B)rises;falls
C)falls;rises
D)falls;falls
Q3) Keynes assumed that money has ________ rate of return.
A)a positive
B)a negative
C)a zero
D)an increasing
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Chapter 6: The Risk and Term Structure of Interest Rates
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Q1) An increase in default risk on corporate bonds ________ the demand for these bonds,but ________ the demand for default-free bonds,everything else held constant.
A)increases;lowers
B)lowers;increases
C)does not change;greatly increases
D)moderately lowers;does not change
Q2) Which of the following long-term bonds has the highest interest rate?
A)corporate Baa bonds
B)U.S.Treasury bonds
C)corporate Aaa bonds
D)municipal bonds
Q3) The ________ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short-term interest rates that individuals expect to occur over the life of the long-term bond,and investors have no preference for short-term bonds relative to long-term bonds.
A)segmented markets theory
B)expectations theory
C)liquidity premium theory
D)separable markets theory
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Q1) The efficient markets hypothesis implies that future changes in exchange rates should for all practical purposes be
A)unpredictable.
B)set by each country.
C)increasing.
D)pegged to a standard such as the U.S.dollar or the Euro.
Q2) The elimination of unexploited profit opportunities requires that ________ market participants be well informed.
A)all
B)a few
C)zero
D)many
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?
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it
A)collateralizes the debt contract.
B)makes the debt contract incentive compatible.
C)state verifies the debt contract.
D)removes all of the risk in the debt contract.
Q2) Of the four sources of external funding for nonfinancial businesses,the least often used in the U.S.is
A)bank loans.
B)nonbank loans.
C)bonds.
D)stock.
Q3) How does collateral help to reduce the adverse selection problem in credit market?
Q4) Solutions to the moral hazard problem include
A)low net worth.
B)monitoring and enforcement of restrictive covenants.
C)greater reliance on equity contracts and less on debt contracts.
D)greater reliance on debt contracts than financial intermediaries.
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) If a bank has excess reserves greater than the amount of a deposit outflow,the outflow will result in equal reductions in
A)deposits and reserves.
B)deposits and loans.
C)capital and reserves.
D)capital and loans.
Q2) If a bank needs to acquire funds quickly to meet an unexpected deposit outflow,the bank could
A)borrow from another bank in the federal funds market.
B)buy U.S.Treasury bills.
C)increase loans.
D)buy corporate bonds.
Q3) If a bank has ________ rate-sensitive assets than liabilities,then ________ in interest rates will increase bank profits.
A)more;a decline
B)more;an increase
C)fewer;an increase
D)fewer;a surge
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Chapter 10: Economic Analysis of Financial Regulation
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Q1) All of the following are common to banking crises in different countries EXCEPT
A)financial liberalization or innovation.
B)weak bank regulatory systems.
C)a government safety net.
D)a dual banking system.
Q2) The current supervisory practice toward risk management
A)focuses on the quality of a bank's balance sheet.
B)determines whether capital requirements have been met.
C)evaluates the soundness of a bank's risk-management process.
D)focuses on eliminating all risk.
Q3) In May 1991,the FDIC announced that it would sell the government's final 26% stake in Continental Illinois,ending government ownership of the bank that it had rescued in 1984.The FDIC took control of the bank,rather than liquidate it,because it believed that Continental Illinois
A)was a good investment opportunity for the government.
B)could be the Chicago branch of a new governmentally-owned interstate banking system.
C)was too big to fail.
D)would become the center of the new midwest region central bank system.
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Page 12
Chapter 11: Banking Industry: Structure and Competition
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Sample Questions
Q1) If a foreign bank operates a subsidiary bank in the U.S. ,the subsidiary bank is A)subject to the same regulations as a U.S.owned bank.
B)only subject to the regulations of the country in which the foreign bank is chartered.
C)restricted to making loans to only foreign citizens in the U.S.
D)restricted to accepting deposits from foreign citizens living in the U.S.
Q2) Financial innovations occur because of financial institutions search for A)profits.
B)fame.
C)stability.
D)recognition.
Q3) Mutual savings banks are primarily regulated by A)the states in which they are located. B)the Federal Reserve.
C)the FDIC.
D)the National Credit Union Administration.
Q4) Why did the interest rate volatility of the 1970s spur financial innovation?
Q5) Discuss three ways in which U.S.banks can become involved in international banking.
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Chapter 12: Financial Crises
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Sample Questions
Q1) In order to ensure that borrowers have an ability to repay residential mortgages,the new consumer protection legislation requires lenders to do all of the following EXCEPT
A)verify the income of the borrower.
B)verify the borrower's job status.
C)check the credit history of the borrower.
D)verify that the borrower can read and understand a loan contract.
Q2) The growth of the subprime mortgage market led to
A)increased demand for houses and helped fuel the boom in housing prices.
B)a decline in the housing industry because of higher default risk.
C)a decrease in home ownership as investors chose other assets over housing.
D)decreased demand for houses as the less credit-worthy borrowers could not obtain residential mortgages.
Q3) 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.
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Chapter 13: Nonbank Finance
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Q1) Mutual funds in which a fixed number of nonredeemable shares are sold at an initial offering and are then traded in the over-the-counter market,like shares of common stock,are called
A)open-end funds.
B)close-end funds.
C)OTC funds.
D)primary-issue funds.
Q2) Which of the following was the fastest-growing financial intermediary of the 1970s?
A)commercial banks
B)credit unions
C)finance companies
D)money market mutual funds
Q3) The Pension Benefit Guarantee Corporation performs a role similar to that of A)the Federal Reserve System.
B)the Comptroller of the Currency.
C)the FDIC.
D)the Office of Thrift Supervision.
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) If,for a $1000 premium,you buy a $100,000 put option on bond futures with a strike price of 114,and at the expiration date the price is 110,your ________ is ________.
A)profit;$4000
B)loss;$4000
C)profit;$3000
D)loss;$3000
Q2) By taking the long position on a futures contract of $100,000 at a price of 96 you are agreeing to ________ a ________ face value security for ________.
A)sell;$100,000;$96,000.
B)sell;$96,000;$100,000.
C)buy;$100,000;$96,000.
D)buy;$96,000;$100,000.
Q3) Which of the following is not a financial derivative?
A)stock
B)futures
C)options
D)forward contracts
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Chapter 15: Conflicts of Interest in the Financial Industry
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Q1) Which of the following policy measures authorized investors to bring lawsuits against credit-rating agencies for a reckless failure to get the facts when providing a credit rating?
A)the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
B)Sarbanes-Oxley Act of 2002
C)Global Legal Settlement of 2002
D)Gramm-Leach-Bliley Act of 1999
E)Riegle-Neal Act of 1994
Q2) In investment banking,a conflict usually is present between the issuers of securities,who ________,and investors,who ________.
A)benefit from unbiased auditing;desire unbiased consulting
B)desire unbiased research;benefit from optimistic research
C)benefit from optimistic research;desire unbiased research
D)desire unbiased consulting;benefit from unbiased auditing
Q3) The incentive for analysts in investment banks to distort research increases when
A)revenues from brokerage commissions increase.
B)the potential revenues from underwriting greatly exceed brokerage commissions.
C)the potential brokerage commissions greatly exceed revenues from underwriting.
D)revenues from underwriting decrease.
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Chapter 16: Central Banks and the Federal Reserve System
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Sample Questions
Q1) There are ________ members of the Board of Governors of the Federal Reserve System.
A)5
B)7
C)12
D)19
Q2) The trend in recent years is that more and more governments
A)have been granting greater independence to their central banks.
B)have been reducing the independence of their central banks to make them more accountable for poor economic performance.
C)have mandated that their central banks focus on controlling inflation.
D)have required their central banks to cooperate more with their Ministers of Finance.
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
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Chapter 17: The Money Supply Process
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Q1) If reserves in the banking system increase by $100,then checkable deposits will increase by $100 in the simple model of deposit creation when the required reserve ratio is
A)0.01.
B)0.10.
C)0.20.
D)1.00.
Q2) The money multiplier is
A)negatively related to high-powered money.
B)positively related to the excess reserves ratio.
C)negatively related to the required reserve ratio.
D)positively related to holdings of excess reserves.
Q3) U.S.Treasury deposits at the Fed are ________ for the Fed but ________ for the Treasury.Thus an increase in U.S.Treasury deposits ________ the monetary base.
A)a liability;an asset;increases
B)a liability;an asset;decreases
C)an asset;a liability;increases
D)an asset;a liability;decreases
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Chapter 18: Tools of Monetary Policy
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Q1) Much of the credit for prevention of a financial market meltdown after "Black Monday" (October 19,1987)must be given to the Federal Reserve System and then-chairman
A)Paul Volcker.
B)Alan Blinder.
C)Arthur Burns.
D)Alan Greenspan.
Q2) In the market for reserves,if the federal funds rate is between the discount rate and the interest rate paid on excess reserves,a ________ in the reserve requirement decreases the demand for reserves,________ the federal funds interest rate,everything else held constant.
A)rise;lowering
B)decline;raising
C)decline;lowering
D)rise;raising
Q3) The most common type of discount lending that the Fed extends to banks is called A)seasonal credit.
B)secondary credit.
C)primary credit.
D)installment credit.
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Chapter 19: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) Which of the following is not a disadvantage of of the Fed's "just do it" approach to monetary policy?
A)There is low transparency of policy.
B)There is low accountability for central bankers.
C)This type of policy make the Fed more susceptible to the time-inconsistency problem.
D)It relies on a stable money-inflation relationship.
Q2) Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in nonborrowed reserves.
Q3) The rate of inflation tends to remain constant when
A)the unemployment rate is above the NAIRU.
B)the unemployment rate equals the NAIRU.
C)the unemployment rate is below the NAIRU.
D)the unemployment rate increases faster than the NAIRU increases.
Q4) The most common definition that monetary policymakers use for price stability is
A)low and stable deflation.
B)an inflation rate of zero percent.
C)high and stable inflation.
D)low and stable inflation.
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Chapter 20: The Foreign Exchange Market
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Q1) ________ in the expected future domestic exchange rate causes the demand for domestic assets to decrease and the domestic currency to ________,everything else held constant.
A)An increase;appreciate
B)An increase;depreciate
C)A decrease;appreciate
D)A decrease;depreciate
Q2) The theory of PPP suggests that if one country's price level rises relative to another's,its currency should
A)depreciate.
B)appreciate.
C)float.
D)do none of the above.
Q3) When the value of the dollar changes from £0.75 to £0.5,then the British pound has ________ and the U.S.dollar has ________.
A)appreciated;appreciated
B)depreciated;appreciated
C)appreciated;depreciated
D)depreciated;depreciated
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Chapter 21: The International Financial System
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Q1) Under a fixed exchange rate regime,a country that depletes its international reserves in an attempt to keep its currency from ________ will be forced to ________ its currency.
A)depreciating;revalue
B)depreciating;devalue
C)appreciating;revalue
D)appreciating;devalue
Q2) Under a fixed exchange rate regime,a central bank that does not want to acquire international reserves to keep its currency from ________ will decide to ________ its currency.
A)depreciating;revalue
B)depreciating;devalue
C)appreciating;revalue
D)appreciating;devalue
Q3) The monetary policy strategy that directly ties down the price of internationally traded goods is
A)exchange-rate targeting.
B)monetary targeting.
C)inflation targeting.
D)the implicit nominal anchor.
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Chapter 22: Quantity Theory, inflation and the Demand for Money
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Q1) Because interest rates have substantial fluctuations,the ________ theory of the demand for money indicates that velocity has substantial fluctuations as well.
A)classical
B)Cambridge
C)liquidity preference
D)Pigouvian
Q2) In the liquidity trap,the money demand curve
A)is horizontal.
B)is vertical.
C)is negatively sloped.
D)is positively sloped.
Q3) Empirical evidence shows that the quantity theory of money is a good theory of inflation
A)in the long run,but not in the short run.
B)in the short run,but not in the longrun.
C)in both the long run and the short run.
D)not in either the long run nor the short run.
Q4) Describe what the liquidity trap is.Explain how it can be problematic for monetary policymakers.
24
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Chapter 23: Aggregate Demand and Supply Analysis
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Q1) In the long run,following a combination of a negative demand shock and a temporary negative supply shock,
A)both inflation and output return to the original long-run equilibrium values.
B)inflation is permanently increased,while output returns to potential output.
C)output returns to potential output,while inflation may be higher or lower than its initial value.
D)inflation is permanently reduced,while output returns to potential output.
E)None of the above.
Q2) The long-run rate of unemployment to which an economy always gravitates is the
A)normal rate of unemployment.
B)natural rate of unemployment.
C)neutral rate of unemployment.
D)inflationary rate of unemployment.
Q3) An autonomous easing of monetary policy results in a ________ level of equilibrium output,shifting the aggregate demand curve to the ________.
A)higher;right
B)lower;right
C)higher;left
D)lower;left
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Chapter 24: Monetary Policy Theory
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Q1) The existence of lags prevents the instantaneous adjustment of the economy to policies changing aggregate demand,thereby strengthening the case for
A)supply-side policy.
B)nonactivists.
C)activists.
D)demand-management policy.
Q2) With the policy rate set at zero,the rise in expected inflation will lead to a ________ in the real interest rate,which will cause investment spending and aggregate output to
A)fall;rise
B)fall;fall
C)rise;rise
D)rise;fall
Q3) In the period 1965 through the 1970s,policymakers pursued ________ policies in order to achieve ________.
A)expansionary;high employment
B)expansionary;low inflation
C)contractionary;high employment
D)contractionary;low inflation
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Chapter 25: Transmission Mechanisms of Monetary Policy
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Q1) According to the traditional interest-rate channel,expansionary monetary policy lowers the real interest rate,thereby raising expenditure on
A)business fixed investment.
B)government expenditure.
C)consumer nondurables.
D)net exports.
Q2) According to the household liquidity effect,higher stock prices lead to increased consumption expenditures because consumers
A)feel more secure about their financial position.
B)want to sell stocks and spend the proceeds before stock prices fall.
C)believe that their wages will increase due to increased profitability of firms.
D)can now afford more expensive imports.
Q3) Periods of price deflation,such as the Great Depression,are characterized by
A)low nominal rates but high real rates of interest.
B)low nominal and real interest rates.
C)real rates of interest lower than the nominal rate of interest.
D)high nominal and real rates of interest.
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Chapter 26: Financial Crises in Emerging Market Economies
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Q1) The mismanagement of financial liberalization in emerging market countries can be understood as a severe
A)principal/agent problem.
B)asymmetric information problem.
C)lemons problem.
D)free-rider problem.
Q2) What two key factors trigger speculative attacks leading to currency cries in emerging market countries?
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) 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.
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Chapter 27: The IS Curve
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Q1) If actual output is less than equilibrium output,firms will ________ output to keep from ________ inventories.
A)increase;accumulating B)increase;depleting C)decrease;depleting D)decrease;accumulating
Q2) Everything else held constant,if aggregate output is to the ________ of the IS curve,then there is an excess ________ of goods which will cause aggregate output to fall.
A)right;supply B)right;demand C)left;supply D)left;demand
Q3) If aggregate demand falls short of current output,business firms will ________ production to ________ inventories.
A)cut;keep from accumulating B)expand;keep from accumulating C)cut;build up D)expand;build up
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Chapter 28: The Monetary Policy and Aggregate Demand
Curves
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Sample Questions
Q1) In deriving the aggregate demand curve a ________ inflation rate leads the central bank to ________ real interest rates,thereby ________ the level of equilibrium aggregate output.
A)higher;raise;lowering B)lower;raise;lowering C)higher;lower;lowering D)higher;lower;raising
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) Everything else held constant,a depreciation 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
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Chapter 29: The Role of Expectations in Monetary Policy
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Q1) According to the Lucas critique,if past increases in the short-term interest rate have always been temporary,then
A)the term-structure relationship using past data will then show only a weak effect of changes in the short-term interest rate on the long-term rate.
B)the term-structure relationship using past data will show no effect of changes in the short-term interest rate on the long-term rate.
C)one cannot predict the term-structure relationship as it depends on expectations.
D)the term-structure relationship using past data will nevertheless show a strong effect of changes in the short-term interest rate on the long-term rate because of a change in the way expectations are formed.
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.
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Chapter 30: The ISLM Model
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Q1) The money market is in equilibrium
A)at any point on the IS curve.
B)at any point on the LM curve.
C)at only one point on the LM curve.
D)only at the intersection of the IS and LM curves.
Q2) In the basic closed-economy ISLM model,the goods market can be described by the
A)consumption function.
B)investment function.
C)government spending and tax.
D)goods market equilibrium condition.
E)all of the above.
Q3) If an economy experiences high interest rates and high unemployment,the ISLM framework predicts that ________ policy has been too ________.
A)fiscal;expansionary
B)fiscal;contractionary
C)monetary;expansionary
D)monetary;contractionary
Q4) Using the ISLM model,show graphically and explain the effects of a monetary contraction.What is the effect on the equilibrium interest rate and level of output?
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