Introduction to Financial Systems
Textbook Exam Questions
Course Introduction
Introduction to Financial Systems provides a comprehensive overview of the fundamental structures and functions that underpin modern financial markets and institutions. The course explores the roles of banks, non-bank financial intermediaries, stock and bond markets, and regulatory bodies in facilitating the flow of funds and allocation of resources within an economy. Students will gain insight into core concepts such as money, credit, payment systems, risk management, and financial innovation, while analyzing the impacts of technology and globalization on financial systems. By the end of the course, learners will understand the critical importance of sound financial systems in supporting economic growth and stability.
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 represent returns to savers EXCEPT:
A)dividends on stocks
B)fees on loans
C)interest on deposits
D)coupon payments on bonds
Answer: B
Q2) The financial system is primarily a means by which
A)funds are transferred from savers to borrowers.
B)money is put into circulation.
C)the government puts into operation its plans for the economy.
D)business firms distribute their goods.
Answer: A
Q3) Which president said, "Prosperity is just around the corner"?
A)Herbert Hoover near the start of the Great Depression
B)Franklin Delano Roosevelt near the start of the Great Depression
C)George W. Bush near the start of the Great Recession
D)Barack Obama near the start of the Great Recession
Answer: A
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Chapter 2: Money and the Payments System
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Q1) As of October 2012, the amount of money as measured by M2 was about
A)$880 billion.
B)$1700 billion.
C)$10.2 trillion.
D)$14 trillion.
Answer: C
Q2) The most important economic benefit from specialization is that it
A)makes it possible for an economy to begin using money.
B)leads to an increase in the standard of living in an economy.
C)makes barter possible.
D)eliminates the need for financial markets.
Answer: B
Q3) Which of the following is the largest measure of money in the United States?
A)Federal Reserve notes
B)definitive money
C)M1
D)M2
Answer: D
Q4) In what way are other assets less liquid than money?
Answer: You incur transactions costs when you exchange other assets for money.
Page 4
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Chapter 3: Interest Rates and Rates of Return
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Sample Questions
Q1) What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now?
A)6%
B)6)38%
C)5)3%
D)Not enough information has been provided to determine the answer.
Answer: A
Q2) If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years?
A)$625
B)$392
C)$638
D)$550
Answer: C
Q3) What are three reasons that banks charge interest on loans?
Answer: Banks charge interest on loans to compensate for inflation, to compensate for default risk, and to compensate for the opportunity cost of waiting to spend your money.
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Chapter 4: Determining Interest Rates
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Q1) If there is an excess demand for bonds at a given price of bonds, then
A)the interest rate will fall.
B)the interest rate will rise.
C)the price of bonds will fall.
D)the interest rate may rise or the interest rate may fall depending upon the reasons for the excess demand for bonds.
Q2) If the expected gains on stocks rise, while the expected returns on bonds do not change, then
A)the demand curve for bonds will shift to the left.
B)the supply curve for loanable funds will shift to the right.
C)the demand curve for loanable funds will shift to the left.
D)the equilibrium interest rate will fall.
Q3) In recent decades, the United States
A)was essentially a closed economy.
B)was generally a net borrower of foreign funds.
C)was generally a net lender abroad.
D)experienced a net outflow of savings.
Q4) What impact do savings rates in Belgium have on the real interest rate that businesses in Belgium must pay to obtain the funds to finance their spending on plant and equipment?
Page 6
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Q1) When the yield curve is downward-sloping,
A)short-term yields are higher than long-term yields.
B)long-term yields are higher than short-term yields.
C)the bond market is anticipating the U.S. Treasury may default on its obligations.
D)the inflation rate is expected to rise.
Q2) Which of the following is a single statistic that summarizes a rating agency's view of the issuer's likely ability to make the required payments on its bonds?
A)grade
B)bond rating
C)speculation
D)yield
Q3) Currently, a three-year Treasury note pays 4.75%. Assuming that your tax rate is 20%, what is the minimum interest rate that you would you need to earn on a tax-free municipal bond in order to buy it instead?
A)0)95%
B)3)8%
C)5)7%
D)15.25%
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Chapter 6: The Stock Market, Information, and Financial
Market Efficiency
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Q1) Momentum investing can be described as
A)consistent with the efficient markets hypothesis.
B)similar to mean reversion.
C)follow the picks of investors who have been successful in the past.
D)the trend is your friend.
Q2) Which of the following is NOT a popular stock market index?
A)Dow Jones Industrial Average
B)NASDAQ
C)S&P 500
D)Moody's Market Index
Q3) In what way can the stock market affect the overall economy?
A)It's an important source of funds for corporations.
B)It can affect consumer and business sentiment.
C)It is an important factor affecting consumer wealth and thus consumer spending.
D)All of the above
Q4) Explain how a bubble can develop in the market for an asset.
Q5) Explain what is meant by the "double taxation of dividends"?
8
Q6) What are the differences between common stock and preferred stock?
Q7) What is the difference between adaptive expectations and rational expectations?
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Chapter 7: Derivatives and Derivative Markets
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Q1) Which of the following is NOT an advantage of a futures contract over a forward contract?
A)reduced counterparty risk
B)increased flexibility
C)lower information cost
D)increased liquidity
Q2) 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.
Q3) Which of the following statements is NOT true of the VIX?
A)It is calculated based on prices of call and put options of the S&P 500.
B)Investors who want to hedge against stock market volatility can sell VIX options.
C)A VIX of 10 indicates investors expect the S&P 500 to fluctuate by 10% at an annual rate over the next 30 days.
D)The VIX is a measure of fear in the stock market.
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Chapter 8: The Market for Foreign Exchange
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Q1) What would happen in the foreign exchange market if the European Central Bank raises European interest rates?
A)There will be a decline in the value of the euro.
B)There will be a decline in the value of the dollar.
C)There will be an increase in the value of the dollar.
D)U)S. interest rates will decline.
Q2) What real-world complications keep purchasing power parity from being a complete explanation of exchange rates ?
Q3) When a country's real exchange rate appreciates,
A)its nominal exchange rate must also have appreciated.
B)its nominal exchange rate must have depreciated.
C)it can trade its goods for fewer units of foreign goods.
D)it can trade its goods for more units of foreign goods.
Q4) When a country's nominal exchange rate depreciates, the price of
A)that country's goods abroad increases.
B)that country's goods abroad decreases.
C)foreign goods sold in the country decreases.
D)that country's goods produced and sold at home decreases.
Q5) What are three reasons that the interest-rate parity condition may not always hold?
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Chapter 9: Transactions Costs, Asymmetric Information, and the Structure of the Financial System
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Q1) The presence of information and transactions cost result in all of the following EXCEPT:
A)reduced efficiency of financial markets.
B)higher returns for savers
C)some funds not being lent at all
D)borrowers need to pay more for funds
Q2) Which of the following is NOT a company that collects information on individual borrowers and sells it to savers?
A)Moody's Investor Service
B)Value Line
C)NASDAQ
D)Dun and Bradstreet
Q3) Which of the following agencies has established standardized accounting principles for reporting corporate earnings?
A)The Securities and Exchange Commission
B)The Federal Trade Commission
C)The National Accounting Board
D)The Fair Reporting Commission
Q4) How are financial intermediaries able to reduce transactions costs?
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Q5) How does the principal-agent problem increase the possibility of moral hazard?
Chapter 10: The Economics of Banking
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Q1) In order to reduce the likelihood of excessive leverage in the banking system, governments have traditionally
A)imposed capital requirements on commercial banks.
B)imposed capital requirement on investment banks.
C)imposed capital requirements on both commercial and investment banks.
D)imposed asset requirements on all banks.
Q2) During a banking panic, a lender of last resort will
A)purchase banks which are having difficulty but appear sound.
B)make loans to solvent but temporality illiquid banks.
C)make loans to insolvent but liquid banks.
D)make loans to any banks which request them.
Q3) The difference between a savings deposit and a time deposit is
A)time deposits pay no interest.
B)savings deposits pay no interest.
C)time deposits have specified maturities.
D)savings deposits have specified maturities.
Q4) How can banks measure interest-rate risk?
Q5) How does moral hazard contribute to high bank leverage?
Q6) Compare the characteristics of loans and marketable securities in terms of liquidity, risk, and information costs.
Page 12
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Chapter 11: Investment Banks, Mutual Funds, Hedge Funds, and the Shadow Banking System
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Q1) Sales finance companies
A)purchase accounts receivable of small firms at a discount.
B)sell commercial paper and buy long-term corporate bonds.
C)take in deposits from savers and buy corporate commercial paper.
D)are affiliated with companies which manufacture or sell goods.
Q2) Which of the following groups is an investment bank NOT likely to visit during a "road show"?
A)institutional investors
B)individual investors
C)university endowments
D)mutual funds
Q3) All of the following are types of finance companies EXCEPT
A)government finance.
B)consumer finance.
C)sales finance.
D)business finance.
Q4) How do defined-contribution plans differ from defined-benefit plans?
Q5) Compare and contrast hedge funds and mutual funds in terms of the benefits and drawbacks of each.
Q6) How is the use of leverage a "double-edged sword"? Page 13
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Chapter 12: Financial Crises and Financial Regulation
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Q1) A stress test of banks, such as that undertaken in the Spring of 2009, is designed to:
A)ensure that banks have followed proper accounting standards
B)make sure that banks are properly managed
C)gauge how well banks would fare if the economy worsens
D)estimate the impact of a bank panic on the overall economy
Q2) Why might a nation seek to maintain a pegged exchange rate?
A)It makes business planning easier for firms involved in the global economy.
B)It removes the need to intervene in the foreign exchange market.
C)It ensures that the exchange rate will remain at its equilibrium.
D)It makes their currency more attractive on the foreign exchange market.
Q3) Which of the following is NOT an accurate description of the recession that accompanied the financial crisis of 2007-2009?
A)GDP declined by more than twice the rate of the average recession.
B)Inflation rose at nearly twice the rate as the average recession.
C)It lasted just under twice as long as the typical recession.
D)Peak unemployment was about one-third higher than usual.
Q4) What are the two most common reasons for a sovereign debt crisis?
Q5) What are the likely effects of a sovereign debt crisis in terms of the government's ability to finance its debt?
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Chapter 13: The Federal Reserve and Central Banking
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Q1) How does the Fed reach its target for the federal funds rate?
A)by changing the discount rate
B)by changing reserve requirements
C)by adjusting the level of reserves
D)by directly setting the federal funds rate
Q2) 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
Q3) The original intent of the Federal Reserve Act of 1913 was to provide the Fed with what role?
A)regulator of the banking system
B)lender of last resort
C)manage the exchange rate
D)maintain a balanced budget
Q4) In what ways is the Fed independent of the political process?
Q5) What was the original intent of the Federal Reserve Act of 1913?
Q6) How are the operations of the Federal Reserve financed?
Page 16
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Chapter 14: The Federal Reserves Balance Sheet and the Money
Supply Process
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Q1) Suppose the banking system holds no excess reserves. If the required reserve ratio is 0.10 and the money multiplier is 2.5, what is the value of the currency-deposit ratio?
Q2) Why did banks increase their holdings of excess reserves during the Financial Crisis of 2007-2009?
Q3) As of October 2012, which of the following was true?
A)deposits of foreign governments and international organizations > bank reserves > currency in circulation
B)currency in circulation > bank reserves > deposits of foreign governments and international organizations
C)bank reserves > currency in circulation > deposits of foreign government and international organizations
D)currency in circulation > deposits of foreign governments and international organizations > bank reserves
Q4) Suppose the required reserve ratio is 8%, excess reserve-to-deposit ratio is 2%, and the currency-to-deposit ratio is 10%. What is the value of the money multiplier?
Q5) Briefly explain the process of multiple deposit creation.
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Chapter 15: Monetary Policy
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Q1) Under which chair did the Fed implement the policy of inflation targeting?
A)Volcker
B)Bernanke
C)Greenspan
D)Geithner
Q2) 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?
Q3) Dynamic open market operations
A)are aimed at achieving changes in monetary policy.
B)are used much more frequently than defensive open market transactions.
C)are used to offset disturbances to the monetary base.
D)make it easy to deduce the Fed's intentions for monetary policy.
Q4) Defensive open market transactions
A)are aimed at achieving changes in monetary policy.
B)are used much less frequently than dynamic open market transactions.
C)are used to offset disturbances to the supply or demand for reserves.
D)make it easy to deduce the Fed's intentions for monetary policy.
Q5) What has been the approach of the European Central Bank to monetary targeting?
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Chapter 16: The International Financial System and Monetary Policy
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Q1) In what sense does the IMF act as a lender of last resort? How might the IMF's actions during the Mexican crisis of the mid-1990s have contributed to the Asian currency crisis a few years later?
Q2) The current account balance plus the financial account balance
A)equals the trade balance.
B)equals the net outflow of currency from the domestic economy.
C)will be negative during economic expansions and positive during economic contractions.
D)equals zero.
Q3) The speculative attack on the German mark in 1971 resulted in
A)a large increase in the German monetary base.
B)a decline in the value of the mark relative to the dollar.
C)a decision to end the floating of the mark against the dollar.
D)a large decrease in the German monetary base.
Q4) Why may a central bank intervene in the foreign exchange market when its currency is depreciating?
A)concerns about the country's exports becoming less competitive
B)concerns about inflation
C)concerns about deflation
D)to sterilize the effects on the domestic economy
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Chapter 17: Monetary Theory I: The Aggregate Demand and Aggregate Supply Model
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Q1) 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
Q2) The proposition of monetary neutrality states that changes in the money supply have:
A)no impact on output in the short run
B)no impact on output in the long run
C)no impact on the price level in the short run
D)no impact on the price level in the long run
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) According to New Keynesians, why can firms increase output in the short run in response to higher prices?
Q5) How does an increase in the price level lead to a higher interest rate?
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Chapter 18: Monetary Theory II: The IS-MP Model
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Q1) Which of the following statements about potential GDP is false?
A)The Fed's goal is to have equilibrium GDP close to potential GDP.
B)When GDP is at potential, cyclical unemployment is zero.
C)It occurs when firms are producing at their maximum level of output.
D)It occurs when firms are producing with a workforce of normal size working normal hours.
Q2) How is the economy likely to respond when AE (sales)exceed production?
Q3) Which interest rates is most relevant in determining aggregate expenditures?
A)federal funds rate
B)short-term real interest rate
C)long-term nominal interest rate
D)long-term real interest rate
Q4) An autonomous expenditure is one that does not depend on:
A)government policy
B)the automobile sector
C)interest rates
D)GDP
Q5) What three parts of the economy are represented in the IS-MP model?
Q6) What is potential GDP? What happens to unemployment when GDP is at its potential?
Page 21
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