Financial Markets and Institutions
Practice Questions
Course Introduction
This course provides an in-depth overview of the structure, functions, and operations of financial markets and institutions. Students will explore the mechanisms that facilitate the flow of funds within the economy, examining both money and capital markets, and the various financial instruments traded within them. The course covers the roles of key financial institutions such as banks, insurance companies, mutual funds, and investment firms, as well as regulatory frameworks that oversee financial activities. Emphasis is placed on understanding how these markets and institutions impact economic stability, influence interest rates, manage risk, and support economic development at both national and global levels.
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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Sample Questions
Q1) Banks are important to the study of money and the economy because they
A)channel funds from investors to savers.
B)have been a source of rapid financial innovation.
C)are the only important financial institution in the U.S.economy.
D)create inflation.
Answer: B
Q2) If real GDP grows from $10 trillion in 2002 to $10.5 trillion in 2003,the growth rate for real GDP is A)5%.
B)10%.
C)50%.
D)0.5%.
Answer: A
Q3) A share of common stock is a claim on a corporation's A)debt.
B)liabilities.
C)expenses.
D)earnings and assets.
Answer: D
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Chapter 2: An Overview of the Financial System
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Sample Questions
Q1) Which of the following can be described as involving indirect finance?
A)You make a loan to your neighbor.
B)You buy shares in a mutual fund.
C)You buy a U.S.Treasury bill from the U.S.Treasury at Treasury Direct.gov.
D)You purchase shares in an initial public offering by a corporation in the primary market.
Answer: B
Q2) An example of economies of scale in the provision of financial services is
A)investing in a diversified collection of assets.
B)providing depositors with a variety of savings certificates.
C)hiring more support staff so that customers don't have to wait so long for assistance.
D)spreading the cost of writing a standardized contract over many borrowers.
Answer: D
Q3) Contractual savings institutions include
A)mutual savings banks.
B)money market mutual funds.
C)commercial banks.
D)life insurance companies.
Answer: D
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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) All but the most primitive societies use money as a medium of exchange,implying that
A)the use of money is economically efficient.
B)barter exchange is economically efficient.
C)barter exchange cannot work outside the family.
D)inflation is not a concern.
Answer: A
Q3) Of money's three functions,the one that distinguishes money from other assets is its function as a
A)store of value.
B)unit of account.
C)standard of deferred payment.
D)medium of exchange.
Answer: D
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Chapter 4: The Meaning of Interest Rates
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Sample Questions
Q1) Economists consider the ________ to be the most accurate measure of interest rates.
A)simple interest rate.
B)current yield.
C)yield to maturity.
D)real interest rate.
Q2) An increase in the time to the promised future payment ________ the present value of the payment.
A)decreases
B)increases
C)has no effect on
D)is irrelevant to
Q3) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 next year?
A)5 percent
B)10 percent
C)-5 percent
D)25 percent
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Chapter 5: The Behavior of Interest Rates
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Sample Questions
Q1) When the price level falls,the ________ curve for nominal money ________,and interest rates ________,everything else held constant.
A)demand;decreases;fall
B)demand;increases;rise
C)supply;increases;rise
D)supply;decreases;fall
Q2) If the Fed wants to permanently lower interest rates,then it should raise the rate of money growth if
A)there is fast adjustment of expected inflation.
B)there is slow adjustment of expected inflation.
C)the liquidity effect is smaller than the expected inflation effect.
D)the liquidity effect is larger than the other effects.
Q3) If wealth increases,the demand for stocks ________ and that of long-term bonds ________,everything else held constant.
A)increases;increases
B)increases;decreases
C)decreases;decreases
D)decreases;increases
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Chapter 6: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) The steeply upward sloping yield curve in the figure above indicates that ________ interest rates are expected to ________ in the future.
A)short-term;rise
B)short-term;fall moderately
C)short-term;remain unchanged
D)long-term;fall moderately
Q2) 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.
Q3) According to the expectations theory of the term structure
A)the interest rate on long-term bonds will exceed the average of short-term interest rates that people expect to occur over the life of the long-term bonds,because of their preference for short-term securities.
B)interest rates on bonds of different maturities move together over time.
C)buyers of bonds prefer short-term to long-term bonds.
D)buyers require an additional incentive to hold long-term bonds.
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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) If the optimal forecast of the return on a security exceeds the equilibrium return,then
A)the market is inefficient.
B)no unexploited profit opportunities exist.
C)the market is in equilibrium.
D)the market is myopic.
Q2) Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period usually
A)beat the market in the next time period.
B)beat the market in the next two subsequent time periods.
C)beat the market in the next three subsequent time periods.
D)do not beat the market in the next time period.
Q3) Using the Gordon growth model,if D is $.50,k is 7%,and g is 5%,then the present value of the stock is
A)$2.50.
B)$25.
C)$50.
D)$46.73.
Q4) What rights does ownership interest give stockholders?
Page 9
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Chapter 8: An Economic Analysis of Financial Structure
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Sample Questions
Q1) Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE?
A)Issuing marketable securities is the primary way that they finance their activities.
B)Bonds are the least important source of external funds to finance their activities.
C)Stocks are a relatively unimportant source of finance for their activities.
D)Selling bonds directly to the American household is a major source of funding for American businesses.
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) How does collateral help to reduce the adverse selection problem in credit market?
Q4) How does a mutual fund lower transactions costs through economies of scale?
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Chapter 9: Banking and the Management of Financial
Institutions
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Sample Questions
Q1) When Jane Brown writes a $100 check to her nephew and he cashes the check,Ms.Brown's bank ________ assets of $100 and ________ liabilities of $100.
A)gains;gains
B)gains;loses
C)loses;gains
D)loses;loses
Q2) If the First National Bank has a gap equal to a negative $30 million,then a 5 percentage point increase in interest rates will cause profits to
A)increase by $15 million.
B)increase by $1.5 million.
C)decline by $15 million.
D)decline by $1.5 million.
Q3) Banks earn profits by selling ________ with attractive combinations of liquidity,risk,and return,and using the proceeds to buy ________ with a different set of characteristics.
A)loans;deposits
B)securities;deposits
C)liabilities;assets
D)assets;liabilities
Page 11
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Chapter 10: Economic Analysis of Financial Regulation
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Sample Questions
Q1) One of the problems experienced by the savings and loan industry during the 1980s was
A)managers lack of expertise to manage risk in new lines of business.
B)heavy regulations in the new areas open to S&Ls.
C)slow growth in lending.
D)close monitoring by the FSLIC.
Q2) A well-capitalized financial institution has ________ to lose if it fails and thus is ________ likely to pursue risky activities.
A)more;more
B)more;less
C)less;more
D)less;less
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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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) Discuss three ways in which U.S.banks can become involved in international banking.
Q3) The process of transforming otherwise illiquid financial assets into marketable capital market instruments is known as
A)securitization.
B)internationalization.
C)arbitrage.
D)program trading.
Q4) Under the Gramm-Leach-Bliley Act states retain regulatory authority over A)bank holding companies.
B)securities activities.
C)insurance activities.
D)bank subsidiaries engaged in securities underwriting.
Q5) Why did the interest rate volatility of the 1970s spur financial innovation?
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Chapter 12: Financial Crises
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Sample Questions
Q1) ________ are asymmetric information problems that act as a barrier to efficient allocation of capital.
A)Asset prices
B)Credit imbalances
C)Financial frictions
D)Financial derivatives
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 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: Nonbank Finance
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Sample Questions
Q1) The federal agency that ensures that potential security purchasers are well informed is the
A)FCC.
B)FTC.
C)NRC.
D)SEC.
Q2) An example of permanent insurance is ________ insurance,and an example of temporary insurance is ________ insurance.
A)term;variable life
B)whole life;variable life
C)whole life;term
D)term;whole life
Q3) In financial markets,when a firm issues stock for the first time it is called an A)investment portfolio option.
B)initial public offering.
C)initial portfolio offering.
D)investment portfolio offering.
Q4) Explain the problems that necessitate insurance management,and three methods insurance companies use to address these problems.Identify the problem that each practice addresses.
Page 15
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Chapter 14: Financial Derivatives
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Sample Questions
Q1) On the expiration date of a futures contract,the price of the contract converges to the
A)purchase price of the contract.
B)average price over the life of the contract.
C)price of the underlying asset.
D)average of the purchase price and the price of the underlying asset.
Q2) 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.
Q3) If,for a $1000 premium,you buy a $100,000 put option on bond futures with a strike price of 110,and at the expiration date the price is 114,your ________ is ________.
A)profit;$1000
B)loss;$1000
C)profit;$3000
D)loss;$3000
Q4) Explain the margin requirement for financial futures and how marking to market affects the margin account.
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Chapter 15: Conflicts of Interest in the Financial Industry
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Sample Questions
Q1) When financial institutions are able to reduce the costs of information for each service they offer by applying the same information source to each service,we say that the financial institution is realizing
A)economies of scope.
B)economies of scale.
C)increasing returns.
D)diminishing marginal returns.
Q2) Which policy measure bans spinning?
A)Sarbanes-Oxley Act of 2002
B)Global Legal Settlement of 2002
C)Gramm-Leach-Bliley Act of 1999
D)Riegle-Neal Act of 1994
Q3) Which policy measure increases the punishment for white-collar crime and obstruction of official investigations?
A)Sarbanes-Oxley Act of 2002
B)Global Legal Settlement of 2002
C)Gramm-Leach-Bliley Act of 1999
D)Riegle-Neal Act of 1994
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Chapter 16: Central Banks and the Federal Reserve System
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Sample Questions
Q1) An important function of the regional Federal Reserve Banks is A)setting reserve requirements.
B)clearing checks.
C)determining monetary policy.
D)setting margin requirements.
Q2) On paper,the Bank of Canada has ________ instrument independence and ________ goal independence when compared to the Federal Reserve System.
A)less;less
B)less;more
C)more;less
D)more;more
Q3) There are ________ members of the Board of Governors of the Federal Reserve System.
A)5
B)7
C)12
D)19
Q4) Make the case for and against an independent Federal Reserve.
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Chapter 17: The Money Supply Process
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Q1) Assuming initially that the required reserve ratio = 10%,the currency-deposit ratio = 40%,and the excess reserve ratio = 0,an decrease in the currency-deposit ratio to 30% causes the M1 money multiplier to ________,everything else held constant.
A)increase from 2.8 to 3.25
B)decrease from 3.25 to 2.8
C)increase from 2.8 to 3.5
D)decrease from 3.5 to 2.8
Q2) If a bank has excess reserves of $7,000 and demand deposit liabilities of $100,000,and if the reserve requirement is 10 percent,then the bank has actual reserves of
A)$14,000.
B)$17,000.
C)$22,000.
D)$27,000.
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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Q1) Open market operations intended to offset movements in noncontrollable factors (such as float)that affect reserves and the monetary base are called
A)defensive open market operations.
B)dynamic open market operations.
C)offensive open market operations.
D)reactionary open market operations.
Q2) The primary indicator of the Fed's stance on monetary policy is
A)the discount rate.
B)the federal funds rate.
C)the growth rate of the monetary base.
D)the growth rate of M2.
Q3) The policy tool of changing reserve requirements is
A)the most widely used.
B)the preferred tool from the bank's perspective.
C)no longer used.
D)still used,even with its disadvantages.
Q4) Explain dynamic and defensive open market operations.What is the purpose of each type? Describe two situations when defensive open market operations are used.How are defensive open market operations typically conducted?
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Chapter 19: The Conduct of Monetary Policy: Strategy and Tactics
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Sample Questions
Q1) 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.
Q2) A central bank has ________ chance to identify a credit-driven bubble compared to an irrational exuberance bubble.
A)a greater
B)less of a
C)about the same level of a
D)a greater,less or about the same level of a
Q3) Using Taylor's rule,when the equilibrium real federal funds rate is 3 percent,the positive output gap is 2 percent,the target inflation rate is 1 percent,and the actual inflation rate is 2 percent,the nominal federal funds rate target should be A)5 percent.
B)5.5 percent.
C)6 percent.
D)6.5 percent.
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Chapter 20: The Foreign Exchange Market
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Q1) According to the interest parity condition,if the domestic interest rate is 10 percent and the foreign interest rate is 12 percent,then the expected ________ of the foreign currency must be ________ percent.
A)appreciation;4
B)appreciation;2
C)depreciation;2
D)depreciation;4
Q2) 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.
Q3) Higher tariffs and quotas cause a country's currency to ________ in the ________ run,everything else held constant.
A)depreciate;short
B)appreciate;short
C)depreciate;long
D)appreciate;long
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Page 22
Chapter 21: The International Financial System
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Q1) When the central bank allows the purchase or sale of domestic currency to have an effect on the monetary base,it is called
A)an unsterilized foreign exchange intervention.
B)a sterilized foreign exchange intervention.
C)an exchange rate feedback rule.
D)a money neutral foreign exchange intervention.
Q2) Under the current managed float exchange rate regime,countries with ________ in their balance of payments frequently do not want to see their currencies ________ because it makes their goods more expensive abroad and foreign goods cheaper in their countries.
A)surpluses;depreciate
B)deficits;depreciate
C)surpluses;appreciate
D)deficits;appreciate
Q3) The seignorage for a government is greater for ________ than for ________.
A)dollarization;a currency board
B)dollarization;exchange-rate targeting
C)dollarization;monetary targeting
D)dollarization;inflation targeting
E)exchange-rate targeting;dollarization
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Chapter 22: Quantity Theory, inflation and the Demand for Money
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Q1) Keynes argued that when interest rates were low relative to some normal value,people would expect bond prices to ________ so the quantity of money demanded would ________.
A)increase;increase
B)increase;decrease
C)decrease;increase D)decrease;decrease
Q2) Tobin's model of the speculative demand for money improves on Keynes's analysis by showing that
A)the speculative demand for money is interest insensitive.
B)the transactions demand for money is interest insensitive.
C)people will hold a diversified portfolio.
D)people will hold money or bonds but not both.
Q3) Keynes's liquidity preference theory indicates that the demand for money is A)constant.
B)positively related to interest rates.
C)negatively related to interest rates.
D)negatively related to bond values.
Q4) Describe what the liquidity trap is.Explain how it can be problematic for monetary policymakers.
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Chapter 23: Aggregate Demand and Supply Analysis
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Q1) A decrease in the availability of raw materials that increases the price level is called a ________ shock
A)negative demand
B)positive demand
C)negative supply
D)positive supply
Q2) positive spending shocks lead to ________ real interest rates ________.
A)higher;in both the short and long runs
B)higher;in the short run but not in the long run
C)lower;in both the short and long runs
D)lower;in the short run but not in the long run
Q3) Suppose the U.S.economy is producing at the natural rate of output.A depreciation of the U.S.dollar will cause ________ in real GDP in the short run and ________ in inflation in the long run,everything else held constant.(Assume the depreciation causes no effects in the supply side of the economy. )
A)an increase;an increase
B)a decrease;a decrease
C)no change;an increase
D)no change;a decrease
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Chapter 24: Monetary Policy Theory
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Q1) If workers believe that government policymakers will increase aggregate demand to avoid a politically unpopular increase in unemployment when workers demand higher wages,then workers will not fear higher unemployment and their wage demands will result in
A)demand-pull inflation.
B)hyperinflation.
C)deflation.
D)cost-push inflation.
Q2) When the economy suffers a temporary negative supply shock,the central bank's autonomous monetary policy to keep inflation at the target inflation rate leads to A)more stable economic activities.
B)a large deviation of output from its potential.
C)divine coincidence.
D)both B and C.
Q3) 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
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Chapter 25: Transmission Mechanisms of Monetary Policy
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Q1) Economic theory suggests that ________ interest rates are ________ important than ________ interest rates in explaining investment behavior.
A)nominal;more;real
B)real;less;nominal
C)real;more;nominal
D)market;more;real
Q2) According to Tobin's q theory,________ policy can affect ________ spending through its effect on the prices of common stock.
A)fiscal;consumption
B)fiscal;investment
C)monetary;consumption
D)monetary;investment
Q3) Since Regulation Q has been abolished,there have been doubts raised about the size of the effect of the ________ channel.
A)balance sheet
B)bank lending
C)cash flow
D)unanticipated price level
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Chapter 26: Financial Crises in Emerging Market Economies
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Q1) In emerging market countries,many firms have debt denominated in foreign currency like the dollar or yen.A depreciation of the domestic currency
A)results in increases in the firm's indebtedness in domestic currency terms,even though the value of their assets remains unchanged.
B)results in an increase in the value of the firm's assets.
C)means that the firm does not owe as much on their foreign debt.
D)strengthens their balance sheet in terms of the domestic currency.
Q2) The chaebols encouraged the Korean government to open up Korean financial markets to foreign capital.The Korean government responded by
A)allowing unlimited short-term foreign borrowing but maintained quantity restrictions on long-term foreign borrowing by financial institutions.
B)allowing unlimited short-term and long-term foreign borrowing by financial institutions.
C)maintaining quantity restrictions on short-term foreign borrowing but allowing unlimited long-term foreign borrowing by financial institutions.
D)not allowing any foreign borrowing by financial institutions.
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Chapter 27: The IS Curve
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Sample Questions
Q1) Using the information contained in Situation 20-1,if autonomous consumption increases by $100,then equilibrium aggregate output will change by
A)-$1,000.
B)-$100.
C)$100.
D)$1,000.
Q2) Economists define investment as the purchase of
A)a new physical asset such as a new machine or a new house.
B)any physical asset,whether new or not,used by business to increase production.
C)any physical asset used by business to increase production and the repurchase of common stock.
D)business spending on capital and household spending on durable goods.
Q3) When interest rates rise in the United States (with the price level fixed),the value of the dollar ________,domestic goods become ________ expensive,and net exports
A)falls;less;fall
B)falls;more;rise
C)rises;more;fall
D)rises;less;fall
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Page 29
Chapter 28: The Monetary Policy and Aggregate Demand
Curves
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Sample Questions
Q1) Based on the Taylor Principle,a central bank's endogenous response of raising interest rates when inflation rises
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.
Q2) 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.
Q3) The Taylor Principle states that central banks raise nominal rates by ________ than any rise in expected inflation so that real interest rates ________ when there is a rise in inflation.
A)less;rise
B)more;fall
C)less;fall
D)more;rise
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Chapter 29: The Role of Expectations in Monetary Policy
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31 Verified Questions
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Sample Questions
Q1) Approaches to establishing central bank credibility include
A)continued success at keeping inflation under control.
B)inflation targeting.
C)exchange rate targeting.
D)all of the above.
Q2) Potential weaknesses of nominal GDP targeting include
A)it requires accurate estimates of potential GDP growth,which are not easy to achieve.
B)real GDP growth that is below potential or inflation that is below the inflation objective will encourage more expansionary monetary policy.
C)it is more complicated to explain to the public than inflation targeting and thus the public might be confused about the objectives of the central bank.
D)both A and C.
Q3) Approaches to establishing central bank credibility include
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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Chapter 30: The ISLM Model
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Q1) If the ________ curve is relatively more unstable than the ________ curve,a money supply target is preferred.
A)IS;IS
B)IS;LM
C)LM;IS
D)LM;LM
Q2) A decline in the money ________ shifts the LM curve to the ________,causing the interest rate to rise and output to fall,everything else held constant.
A)demand;right
B)demand;left
C)supply;right
D)supply;left
Q3) Everything else held constant,a monetary contraction is characterized by ________ output and ________ interest rates.
A)rising;rising
B)rising;falling
C)falling;rising
D)falling;falling
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