Introduction to Finance
Chapter Exam Questions
Course Introduction
Introduction to Finance provides students with a foundational understanding of financial principles and practices, exploring key concepts such as time value of money, risk and return, financial markets, and the basics of investing, capital budgeting, and financial analysis. The course is designed to equip students with the analytical tools needed to make informed financial decisions, understand company financial statements, and appreciate the crucial role finance plays in both personal and business contexts. By the end of the course, students will have developed a framework for understanding financial decision-making processes and the various factors that influence financial outcomes in organizations and markets.
Recommended Textbook Money Banking and the Financial System 2nd Edition by Glenn P. Hubbard
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Chapter 1: Introducing Money and the Financial System
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Q1) All of the following took place during the economic crisis that began in 2007 EXCEPT:
A)the financial system was disrupted
B)large portions of the U.S. economy were cut off from the funds they needed to thrive
C)there was a devastating decline in the production of goods and services throughout the economy
D)unlike households, most businesses still had easy access to funds
Answer: D
Q2) If you buy a bond issued by Intel, the bond is a(n):
A)liability to Intel and an asset to you.
B)liability to you and an asset to Intel.
C)liability to both you and Intel.
D)asset to both you and Intel.
Answer: A
Q3) Briefly explain the process of securitizing mortgages.
Answer: The mortgage lender sells the loan to a government-sponsored enterprise or financial firm that bundle the mortgage with mortgages from other lenders, providing the basis for a mortgage-backed security.
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Chapter 2: Money and the Payments System
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Q1) If fiat money has no value apart from its use as money, how can it be used as a medium of exchange?
Answer: The most important reason paper currency circulates as a medium of exchange is the confidence of consumers and firms that if they accept paper currency they will be able to pass it along when they need to buy goods and services. Also, the federal government has designated it to be legal tender, meaning the government accepts it in payment of taxes and requires it to be accepted in payment of debts.
Q2) The introduction of money to an economy results in:
A)higher incomes
B)higher productivity
C)increased specialization
D)a more efficient barter system
Answer: D
Q3) Which function of money allows for specialization to take place?
A)medium of exchange
B)unit of account
C)store of value
D)standard of deferred payment
Answer: A
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Chapter 3: Interest Rates and Rates of Return
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Q1) How are TIPS adjusted for inflation?
A)The interest rate is adjusted for inflation during each period.
B)The principal is adjusted once the bond reaches maturity.
C)The principal is adjusted for inflation each period.
D)The interest rate is adjusted once the bond reaches maturity.
Answer: C
Q2) Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that
A)interest on simple loans and discount bonds is taxable, while interest on coupon bonds and fixed-payment loans is not.
B)interest on coupon bonds and fixed-payment loans is taxable, while interest on simple loans and discount bonds is not.
C)interest rates on simple loans and discount bonds are generally higher than interest rates on comparable coupon bonds and fixed-payment loans.
D)interest on simple loans and discount bonds is paid in a single payment, while issuers of coupon bonds and fixed-payment loans make multiple payments of interest and principal.
Answer: D
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Chapter 4: Determining Interest Rates
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Q1) Economists believe that as a saver's wealth increases, the saver will generally
A)increase his or her holdings of all assets proportionately.
B)increase the fraction of wealth held as cash.
C)increase the fraction of wealth held as common stock.
D)decrease the fraction held as corporate bonds.
Q2) Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. What is the expected rate of return on the stock?
A)-40%
B)-20%
C)8%
D)16%
Q3) The supply curve for loanable funds would decline due to
A)an increase in wealth.
B)an increase in the expected return on bonds.
C)an increase in expected inflation.
D)a decrease in the riskiness of bonds relative to other assets.
Q4) Suppose you are risk neutral and you are deciding between two investments. One has a guaranteed return of 2% while the second has a 60% chance of a 10% return and a 40% chance of a -5% return. Which investment would you choose? Why?
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Q1) Default risk arises from the fact that
A)borrowers differ in their ability to repay in full the principal and interest required by a loan agreement.
B)the bond price drops when interest rates rise.
C)it is inherently riskier to wait for a capital gain than to receive an immediate interest payment.
D)interest rates are far more likely to go up than to go down.
Q2) Under the liquidity premium theory the shape of the yield curve depends on A)the relative return of investments in common stocks versus investments in corporate bonds.
B)the size of the federal government's budget deficit.
C)government tax treatment of long-term versus short-term bonds.
D)the expected pattern of future short-term rates and the size of the term premium at each maturity.
Q3) Which of the following is considered a default-risk-free instrument?
A)a three-month commercial paper issued by GE
B)a share of stock issued by Google
C)a three-month Treasury bill
D)a ten-year bond issued by Intel
Page 7
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Chapter 6: The Stock Market, Information, and Financial
Market Efficiency
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Q1) An asset's fundamental value equals
A)its face value.
B)its maturity value.
C)the market's best guess of the present value of the asset's expected future returns.
D)the weighted sum of its market price over the recent past.
Q2) According to the efficient markets hypothesis, who is most likely to benefit from frequently moving funds from one asset to another?
A)your broker
B)small investors
C)big investors
D)only those who consistently beat the market
Q3) When market participants have rational expectations,
A)they use all information available to them.
B)they only slowly adjust their expectations to news which could affect prices or returns.
C)they are less likely to make accurate forecasts than if they have adaptive expectations.
D)they are able to forecast interest rates more accurately than inflation rates.
Q4) Explain how a bubble can develop in the market for an asset.
Page 8
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Chapter 7: Derivatives and Derivative Markets
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Q1) Options traded on exchanges are known as:
A)listed options
B)exchange traded options
C)call options
D)put options
Q2) A speculator who believes strongly that interest rates will fall would be likely to
A)buy futures contracts on Treasury bills.
B)sell futures contracts on Treasury bills.
C)sell Treasury bonds in the spot market.
D)decrease now the amount of money which he lends.
Q3) The existence of counterparty risk
A)has no effect on the contracting parties.
B)is disallowed under current government regulations.
C)results in information costs for buyers and sellers when analyzing the potential creditworthiness of potential trading partners.
D)reduces the risk introduced by forward contracts.
Q4) What are the steps involved in using options for a short sale of a stock?
Q5) What are the information costs associated with forward contracts?
Q6) What does it mean to "cover a short"?
Page 9
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Chapter 8: The Market for Foreign Exchange
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Q1) A change in the dollar value of the British pound from $1.60 to $1.50 represents
A)an increase in the pound price of British goods.
B)an appreciation of the dollar relative to the pound.
C)an appreciation of the pound relative to the dollar.
D)an increase in the dollar price of British goods.
Q2) The currency premium in foreign-exchange markets
A)helps to offset anticipated declines in exchange rates.
B)helps to offset anticipated increases in exchange rates.
C)indicates investors' collective preference for financial instruments denominated in one currency relative to those denominated in another.
D)rises as domestic interest rates fall.
Q3) What action did many Japanese car manufacturers take in response to the stronger yen following the 2007-2009 financial crisis?
A)They only accepted payments in the form of yen.
B)They chose to target China as the primary market for exports.
C)They abandoned the market in the United States.
D)They moved their production to the United States.
Q4) What real-world complications keep purchasing power parity from being a complete explanation of exchange rates ?
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Chapter 9: Transactions Costs, Asymmetric Information, and the Structure of the Financial System
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Q1) How does the principal-agent problem increase the possibility of moral hazard?
Q2) Lenders prefer to lend to firms with high net worth because
A)such firms are usually willing to pay higher interest rates.
B)the owners of such firms have more to lose if the firm defaults on a loan.
C)the government requires most bank loans to be made to such firms.
D)such firms usually are unable to raise funds directly through financial markets.
Q3) All of the following are consequences of adverse selection on good firms EXCEPT
A)the cost of external financing increases.
B)firms need to rely more on internal funds.
C)firms need to rely more on accumulated profits.
D)firms will only be able to attain financing from the government.
Q4) Financial intermediaries are able to exploit economies of scale since
A)the equipment or expertise necessary for one transaction can be applied to other transactions.
B)they have special licenses needed to perform financial transactions.
C)financial markets fail to do so.
D)they can reduce transactions cost, but not information costs.
Q5) How does adverse selection affect the economic efficiency of the used car market?
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Chapter 10: The Economics of Banking
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Q1) National banks are chartered by the
A)Office of the Comptroller of the Currency.
B)Office of Bank Supervision.
C)Securities and Exchange Commission.
D)Office of Management and the Budget.
Q2) What is a repurchase agreement?
Q3) In banking, the spread refers to the difference between the
A)interest rate on long-term bonds and the interest rate on short-term bonds.
B)interest rate on car loans and the interest rate on home mortgages.
C)average interest rate earned on assets and the average interest rate paid on liabilities.
D)bid and asked prices on a bond.
Q4) Compare the characteristics of loans and marketable securities in terms of liquidity, risk, and information costs.
Q5) As of 2012, the bank portion of TARP:
A)earned a profit of $21 billion
B)earned a profit of $245 billion
C)cost $266 billion
D)cost $700 billion
Q6) What are the advantages of bank deposits compared to other types of assets?
Page 12
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Chapter 11: Investment Banks, Mutual Funds, Hedge Funds, and the Shadow Banking System
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Q1) Which of the following are statisticians who compile statistics to predict the risk of an event occurring in the population?
A)rocket scientists
B)quants
C)actuaries
D)risk analysts
Q2) The Glass-Steagall Act was designed to
A)legally separate investment banking from commercial banking.
B)promote mergers in the banking industry.
C)impose high capital ratios on investment banks.
D)promote the interests of community banks.
Q3) A syndicate is
A)a group of brokers illegally making use of insider information.
B)a group of commercial banks that agrees to accept the checks of each other's depositors.
C)a group of investment banks underwriting a large security issue.
D)a group of dealers that markets a government bond issue.
Q4) How is the use of leverage a "double-edged sword"?
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Q5) What services are finance companies able to offer consumers and businesses that banks do not offer?
Chapter 12: Financial Crises and Financial Regulation
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Q1) The Franklin National Bank Crisis had its greatest impact on the market for A)commercial paper.
B)commodity futures.
C)negotiable certificates of deposit.
D)Eurodollars.
Q2) Banks have a maturity mismatch since
A)they borrow long term, but lend short term.
B)they borrow short term, but lend long term.
C)some of their loans are short term while others are long term.
D)some of their borrowings are short term while others are long term.
Q3) The Consumer Financial Protection Bureau is part of the
A)Treasury Department
B)Federal Reserve System
C)Justice Department
D)Commerce Department
Q4) What is meant by senior debt?
A)debt that has been around for the longest period of time
B)debt that must be paid before junior debt is paid
C)debt owed to the federal government
D)debt issued by the federal government as opposed to states or corporations
Page 14
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Chapter 13: The Federal Reserve and Central Banking
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Q1) Who owns the Federal Reserve banks?
A)the private commercial banks in each district which are members of the Federal Reserve System
B)those households which have purchased stock in Federal Reserve System
C)the federal government
D)the governments of the states in which the banks are located
Q2) All of the following help make the Fed independent of the political process EXCEPT
A)financial independence.
B)chair of Fed receives a lifetime appointment.
C)Board members receive a long, nonrenewable appointment.
D)Board members' terms expire at different times, reducing the possible number of appointees by any one president.
Q3) Congress authorized a second Bank of the United States partly in response to:
A)difficulty in funding the American Revolution
B)difficulty in funding the War of 1812
C)difficulty in funding the Industrial Revolution
D)difficulty in funding the Civil War
Q4) What are the three books to which the FOMC has access and what information is included in each?
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Chapter 14: The Federal Reserves Balance Sheet and the
Money Supply Process
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Q1) Between late 2007 and 2012, the Fed's balance sheet:
A)remained about the same
B)more than doubled
C)more than tripled
D)rose tenfold
Q2) Which of the following accurately describes the relationship between excess reserves and checkable deposits following the financial crisis of 2007-2009?
A)Excess reserves declined as the excess reserve ratio returned to near zero.
B)Excess reserves rose to nearly one-third of checkable deposits.
C)Excess reserves approached the same level as checkable deposits.
D)Excess reserves exceeded checkable deposits.
Q3) If currency outstanding equals $500 million, checkable deposits equal $2 billion, reserves equal $200 million, and the required reserve ratio is 0.10, the money multiplier equals
A)1)14.
B)3)57.
C)4)35.
D)5)
Q4) Briefly explain the process of multiple deposit creation.
Page 16
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Chapter 15: Monetary Policy
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Q1) The original Federal Reserve Act
A)specified open market operations as the Fed's main policy tool.
B)specified open market operations as one of several Fed policy tools.
C)specified that open market operations be employed by the Fed only in circumstances where discount loans were ineffective.
D)did not specifically mention open market operations.
Q2) The Fed was created
A)after financial panics in the late 1800s and early 1900s.
B)after the stock market crash of 1929.
C)to help finance government expenditures during World War II.
D)to help channel funds to the residential mortgage market.
Q3) Most macroeconomic policy consists of:
A)monetary policy
B)fiscal policy
C)exchange-rate policy
D)regulatory policy
Q4) According to the Taylor rule, what should the federal funds rate target be if inflation is 5%, the target rate of inflation is 2%, the equilibrium real federal funds rate is 2%, full-employment real GDP is $9 trillion, and current real GDP is $8.55 trillion?
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Chapter 16: The International Financial System and Monetary Policy
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Q1) Assets denominated in foreign currency and use in international transactions are referred to as:
A)foreign money
B)international reserves
C)international monetary base
D)foreign exchange
Q2) Why do restrictions on capital inflows receive more support from some economists than restrictions of capital outflows?
Q3) If the Japanese central bank performed a sterilized intervention to reduce the value of the yen, the most likely result is:
A)a lower value of the yen due to an increase in the monetary base in Japan.
B)a lower value of the yen due to a decrease in Japanese interest rates.
C)a higher value of the yen since the intervention was sterilized.
D)no change in the value of the yen since neither the monetary base nor Japanese interest rates would be affected.
Q4) Make use of a T-account to show the effect of the Fed's sale of $500 million worth of government securities on the Fed's balance sheet. (assume the Fed receives a check from the sale of securities)
Page 18
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Chapter 17: Monetary Theory I: The Aggregate Demand and Aggregate Supply Model
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Q1) Why are many economists skeptical of the Fed's ability to fine tune the economy?
A)Monetary policy only affects output in the long run.
B)Lags in policy make it difficult to properly time policy.
C)Fiscal policy can be implemented more quickly than monetary policy.
D)Monetary policy does not have any effect on output.
Q2) How is a monopolistically competitive firm likely to respond to fluctuations in demand in the short run?
A)by selling more or less at the posted price
B)by changing prices
C)by reducing menu costs
D)by increasing menu costs
Q3) Most economists believe that the short-run aggregate supply curve
A)slopes down.
B)slopes up.
C)is a vertical line.
D)is a horizontal line.
Q4) Why is the short-term nominal interest rate the opportunity cost of holding money?
Q5) What are the principal sources of change in productivity growth?
Q6) How does an increase in interest rates affect net exports?
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Chapter 18: Monetary Theory II: The IS-MP Model
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Q1) For the goods market to be in equilibrium in a closed economy, which of the following must be true?
A)Y = S + I + G
B)S + I = C + G
C)S + G = Y + C
D)S = I
Q2) How does an expansionary monetary policy affect aggregate expenditures according to the bank lending channel?
Q3) The aggregate expenditure line is upward sloping since as GDP increases,
A)consumption increases
B)investment increases
C)government purchases increase
D)net exports increase
Q4) Which of the following is NOT a reason given by economists for the failure of Okun's law to account for the rise in unemployment during the recession of 2007-2009?
A)increased willingness among firms to lay off workers during recessions
B)a surge in productivity during the recession
C)the unusual severity of the recession
D)it does not take into account the effect of the stimulus
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