Monetary Theory and Policy
Final Test Solutions
Course Introduction
This course delves into the foundational concepts and contemporary debates in monetary theory and policy. Students will explore the role of money in the economy, how financial institutions and central banks influence money supply, and the tools used to implement monetary policy. Topics include the mechanisms of monetary transmission, the formulation and impact of central bank policy decisions, inflation targeting, interest rate setting, and the interplay between monetary policy and macroeconomic stability. By integrating theoretical models with real-world case studies, the course equips students to critically analyze current monetary policy issues and understand their implications for economic growth and stability.
Recommended Textbook Money Banking and the Financial System 3rd Edition by R. Glenn Hubbard
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18 Chapters
1993 Verified Questions
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Page 2
Chapter 1: Introducing Money and the Financial System
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Q1) What made the recession of 2007-2009 different than any other recession since the Great Depression?
A) The government did not implement a fiscal stimulus.
B) The Fed failed to reduce interest rates.
C) It was accompanied by a financial crisis.
D) The impact was primarily limited to the financial sector.
Answer: C
Q2) Why did some economists and policymakers criticize the Fed and Treasury for arranging the sale of Bear Stearns to JP Morgan Chase in 2008?
Answer: The main concern was with the moral hazard problem,which is the possibility that managers of financial firms such as Bear Stearns might make riskier investments if they believe that the federal government will save them from bankruptcy.
Q3) Which of the following assets is the least liquid?
A) money market mutual fund
B) stock
C) treasury bond
D) house
Answer: D
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Chapter 2: Money and the Payments System
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Q1) All of the following are problems associated with commodity money EXCEPT
A) it is a cumbersome form of payments system.
B) commodities tend to have little value in and of themselves.
C) its value is dependent on its purity.
D) costs are incurred in certifying the purity and weight of commodity money.
Answer: B
Q2) Which of the following is an example of a commodity money?
A) gold coins
B) dollar bills
C) British pound notes
D) Japanese yen notes
Answer: A
Q3) What determines the acceptability of dollar bills as a medium of exchange?
A) our society's willingness to use green paper notes issued by the Federal Reserve as money
B) the willingness of the Federal Reserve to redeem dollar bills for gold
C) the willingness of the U.S. Treasury to redeem dollar bills for gold
D) the public's fear that failing to accept dollar bills will trigger a hyperinflation
Answer: A
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Page 4
Chapter 3: Interest Rates and Rates of Return
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Sample Questions
Q1) An speculator who buys a fifty-year corporate bond
A) must be expecting to still be alive in fifty years.
B) is subject to substantial reinvestment risk.
C) is probably expecting market interest rates to increase in the future.
D) is probably expecting market interest rates to decrease in the future.
Answer: D
Q2) A simple loan involves
A) interest payments from the borrower to the lender periodically during the life of the loan.
B) no payment of interest by the borrower to the lender.
C) payment of interest by the borrower to the lender only at the time the loan matures. D) payment only of principal by the borrower to the lender at maturity.
Answer: C
Q3) Suppose a bond has a coupon of $75,face value of $1,000,and current price of $1,100.What is the coupon rate? What is its current yield? Report a percentage with two decimal places.
Answer: The coupon rate is $75 / $1,000 = 7.50%.The current yield is $75 / $1,100 = 6.82%.
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Page 5
Chapter 4: Determining Interest Rates
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Q1) A one-year discount bond with a face value of $1,000 that is currently selling for $900 has an interest rate of
A) 5.26%.
B) 10%.
C) 11.1%.
D) 100%.
Q2) According to the Fisher effect,an increase in expected inflation results in
A) lower nominal interest rates.
B) higher nominal interest rates.
C) lower real interest rates.
D) higher real interest rates.
Q3) Which best describes the relationship between the cost of acquiring information and return?
A) A high return must compensate for a high cost of acquiring information.
B) A higher cost of information corresponds with a low return.
C) A low cost of acquiring information corresponds with a high return.
D) A higher return results in a lower cost of acquiring information.
Q4) How should a financial plan of an older saver differ from that of a younger saver?
Q5) Explain why the nominal interest rate is the opportunity cost of holding money.
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Q1) In which of the following situations would a lender definitely pay a borrower interest in return for borrowing the lender's money?
A) if the real interest rate was negative
B) if the real interest rate was positive
C) if the nominal interest rate was negative
D) if the nominal interest rate was positive
Q2) Which of the following is TRUE of the segmented markets theory?
A) It assumes that borrowers have particular periods for which they want to borrow.
B) It assumes that lenders always lend for short periods.
C) It provides a good explanation for why yield curves usually slope upward.
D) It assumes that instruments with different maturities are perfect substitutes.
Q3) The risk premium of corporate bonds typically increases
A) when the average price of corporate bonds increases.
B) during a recession.
C) when the interest rates on corporate bonds decreases.
D) when the risk premium on treasury bonds increases.
Q4) How does the liquidity premium theory explain an upward-sloping yield curve during normal economic times?
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Chapter 6: The Stock Market, information, and Financial
Market Efficiency
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Q1) Which of the following is NOT a result of the double taxation of dividends?
A) Because profits that firms distribute to stockholders are taxed a second time, firms have an incentive to retain profits rather than to distribute them to stockholders.
B) The return investors receive from buying stocks is reduced, which reduces the incentive people have to save in the form of stock investments and increases the costs to firms of raising funds.
C) It gives firms an incentive to take on what may be an excessive level of debt rather than issue stock.
D) The decline in retained profits results in increased inefficiency.
Q2) Suppose you plan to hold a stock for one year.You expect that,in one year,it will sell for $30 and pay a dividend of $3 per share.If your required return on equity is 10%,what is the most you should be willing to pay for the share today?
A) $3.30
B) $23
C) $30
D) $33
Q3) What are the effects of the double taxation of dividends?
Q4) What are the differences between common stock and preferred stock?
Page 8
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Chapter 7: Derivatives and Derivative Markets
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Q1) In what ways do futures contracts differ from forward contracts?
Q2) When reading an options listing for a company like Microsoft
A) both call and put options are listed.
B) call options, but not put options, are listed.
C) put options, but not call options, are listed.
D) neither call nor put options are listed.
Q3) A stock option is said to be "out of the money" if the
A) strike price equals the exercise price.
B) stock price equals the strike price.
C) strike price exceeds the stock price.
D) stock price exceeds the strike price.
Q4) A swap is
A) another name for a put option.
B) another name for a call option.
C) an agreement between two or more counterparties to exchange sets of cash flows over some future period.
D) the name for the replacement of a futures contract by an options contract.
Q5) Explain the difference between a credit swap and a credit default swap.
Q6) What are the information costs associated with forward contracts?
Q7) Why may some investors prefer forward contracts to futures?
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Chapter 8: The Market for Foreign Exchange
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Sample Questions
Q1) A depreciating nominal exchange rate results from
A) a depreciating real exchange rate.
B) a low domestic inflation rate relative to the foreign inflation rate.
C) an appreciating real exchange rate.
D) a large government budget deficit.
Q2) What would happen to the value of the dollar if prices in the United States increased more rapidly relative to prices in other countries?
Q3) If the British pound depreciates against the U.S.dollar
A) British businesses gain by an increase in the dollar price of exports to the United States.
B) British consumers gain by a decrease in the pound price of U.S. exports to Britain.
C) British consumers lose by an increase in the pound price of U.S. exports to Britain.
D) U.S. consumers lose by an increase in the dollar price of British exports to the United States.
Q4) Suppose the Federal Reserve reduces interest rates while interest rates in Europe do not change.Make use of a graph of the foreign exchange market to show how this will affect the value of the dollar.
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Page 10
Chapter 9: Transactions Costs, asymmetric Information, and the Structure of the Financial System
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Sample Questions
Q1) Compared to CDs and money market funds,crowdfunding
A) provides higher expected returns with increased safety.
B) provides lower expected returns in exchange for increased safety.
C) is likely to result in lower returns due to higher volatility.
D) provides opportunities for higher returns but also significant losses.
Q2) How does adverse selection affect the willingness of corporations to issue stock?
Q3) In regard to crowdfunding,investors with incomes or net worth of less than $100,000 can buy up to ________ in equity in startups through online crowdfunding sites.
A) $1,000
B) $2,000
C) $25,000
D) Investors must have incomes or net worth of greater that $100,000 to invest in startups through crowdfunding sites.
Q4) How can restrictive covenants help to reduce moral hazard in bond markets?
Q5) How do high interest rates increase the risk of adverse selection in the bond market?
Q6) What are the various ways that financial intermediaries can take advantage of economies of scale?
Page 11
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Chapter 10: The Economics of Banking
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Sample Questions
Q1) Required reserves are
A) the portion of demand deposits and NOW accounts banks must hold.
B) zero on demand deposits.
C) zero on NOW accounts.
D) imposed on all deposits at commercial banks.
Q2) Securities that banks sell and agree to repurchase are known as A) federal funds.
B) discount loans.
C) repurchase agreements.
D) NOW accounts.
Q3) Short-term loans between banks are called A) federal funds.
B) repurchase agreements.
C) repos.
D) discount loans.
Q4) How does moral hazard contribute to high bank leverage?
Q5) What is an important difference between certificates of deposits (CDs)worth less than $100,000 compared to those worth $100,000 or more?
Q6) How can banks measure interest-rate risk?
Q7) What are the different forms of bank borrowings?
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Chapter 11: Beyond Commercial Banks: Shadow Banks and
Nonbank Financial Institutions
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Sample Questions
Q1) Why did Goldman Sachs and Morgan Stanley seek to become financial holding companies in October 2008?
Q2) 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.
Q3) Underwriting involves
A) insuring the life or health of individuals.
B) guaranteeing a price for new capital to the issuing firm.
C) selling stock more cheaply than conventional stockbrokers.
D) issuing stock and using the proceeds to buy bonds.
Q4) How does proprietary trading expose investment banks to interest-rate and credit risk?
Q5) What makes advising on mergers and acquisitions particularly profitable for investment banks relative to other services that they provide?
Q6) How does an investment bank use the results of its research?
Q8) How is the use of leverage a "double-edged sword"? Page 13
Q7) How do defined-contribution plans differ from defined-benefit plans?
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Page 14
Chapter 12: Financial Crises and Financial Regulation
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Sample Questions
Q1) As a part of the Dodd-Frank Act of 2010,Congress amended a portion of the Federal Reserve Act so the Fed could
A) now make loans to individual companies.
B) only make loans to commercial banks.
C) no longer make loans to individual companies.
D) no longer make any loans to private corporations.
Q2) Losses in which holding resulted in BNP Paribas not allowing investors to redeem shares from three of its investment funds?
A) mortgage-backed securities
B) Lehman Brothers
C) Bear Stearns
D) real estate investment trusts
Q3) What happened to consumer prices as measured by the CPI between 1929 and 1933?
A) rose by more than 20%
B) didn't change
C) declined by about 25%
D) declined by about 80%
Q4) How does the relationship between housing prices and rental rates provide evidence for or against the existence of a housing bubble?
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Chapter 13: The Federal Reserve and Central Banking
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Q1) Assuming a required reserve ratio of 8%,interest rate on reserves of 0.5%,and interest rate on loans of 4%,what is the effective cost of the reserve requirement on a $1,000 deposit?
A) 0.05%
B) 0.28%
C) 0.32%
D) 4%
Q2) In 2010,doubts were raised about the debt of all of the following countries EXCEPT A) Ireland.
B) Greece.
C) Poland.
D) Portugal.
Q3) The Fed does NOT have to go through the normal congressional appropriations process because
A) its expenses are very small.
B) it was given enough funds at the time of its founding to provide for its expenses indefinitely.
C) it is self financing.
D) it is not part of the legislative branch of the federal government.
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Page 16
Chapter 14: The Federal Reserves Balance Sheet and the Money
Supply Process
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Q1) Suppose the required reserve ratio is 8% and the Fed purchases $100 million worth of Treasury bills from Wells Fargo.By how much is Wells Fargo able to increase its loans?
A) $8 million
B) $92 million
C) $100 million
D) $1.25 billion
Q2) Suppose that a bank with no excess reserves receives a deposit into a checking account of $10,000 in currency.If the required reserve ratio is 0.20,what is the maximum amount that the bank can lend out?
A) $2,000
B) $8,000
C) $10,000
D) $50,000
Q3) The rapid increase in bank reserves that began in 2008 was a result of A) the Fed printing money.
B) banks making more loans.
C) an increase in the number of commercial banks.
D) the Fed purchasing assets.
Q4) Briefly explain the process of multiple deposit creation.
Page 17
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Chapter 15: Monetary Policy
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Q1) When financial markets and institutions are NOT efficient in matching savers and borrowers
A) interest rates fall, which discourages saving even further.
B) interest rates fall, which discourages investment even further.
C) resources are lost.
D) investment rises.
Q2) All of the following statements about secondary credit are true EXCEPT
A) they are temporary, short-term loans to satisfy seasonal requirements.
B) the secondary credit interest rate is set above the primary credit rate.
C) it is intended for banks not eligible for primary credit.
D) borrowers of secondary credit are less financially healthy.
Q3) The information lag facing the Fed is
A) the difficulty of becoming informed quickly of changes in public opinion about which policy goal is most important.
B) the delay in receiving accurate information about the state of the economy.
C) the delay in Congress and the president communicating their policy goals for the Fed to act on.
D) the time required for monetary policy changes to affect output, employment, and prices.
Q4) What has been the approach of the European Central Bank to monetary targeting?
Page 18
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Chapter 16: The International Financial System and Monetary Policy
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Q1) The main reason central banks engage in foreign-exchange interventions is to
A) stabilize the domestic money supply.
B) stabilize domestic interest rates.
C) stabilize foreign interest rates.
D) stabilize the exchange rate.
Q2) The euro is
A) the currency of all nations in Europe.
B) the rate at which the French central bank makes discount loans.
C) a common currency of many European countries.
D) the name of the European central bank.
Q3) Foreign-exchange market interventions will always
A) lead to a decline in domestic interest rates relative to foreign interest rates.
B) lead to a rise in domestic interest rates relative to foreign interest rates.
C) lead to a decline in the domestic money supply.
D) alter a central bank's holdings of international reserves.
Q4) Why do some economists think a global savings glut contributed to the U.S.running a current account deficit in the 2000s?
Q5) How does a sterilized intervention by the Fed in foreign exchange markets differ from an unsterilized intervention?
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Chapter 17: Monetary Theory I- the Aggregate Demand and Aggregate Supply Model
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Q1) Which of the following is NOT a reason for the weak recovery following the 2007-2009 recession?
A) Recessions started by financial crises are almost always severe.
B) The decline in the automobile industry appeared to be structural.
C) The collapse of the housing market was long lived.
D) The recession was caused by a decline in short-run aggregate supply.
Q2) An increase in the expected price level
A) shifts the short-run aggregate supply curve up and to the left.
B) shifts the short-run aggregate supply curve down and to the right.
C) has no effect on the short-run aggregate supply curve.
D) results in a movement along the short-run aggregate supply curve, rather than a shift in the short-run aggregate supply curve.
Q3) The automatic mechanism can best be described as
A) the process of the economy adjusting back to potential GDP without any action taken by the government.
B) the result of monetary policy implemented by the Fed restoring full employment.
C) how fiscal policy is used to return the economy to its potential.
D) using rule-based policies to stabilize the economy.
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Chapter 18: Monetary Theory Ii: the Is-Mp Model
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Q1) Analysts have attempted to model the impact of monetary policy on net worth by emphasizing
A) the impact of lower interest rates on business spending on fixed investment.
B) the impact of lower interest rates on household spending on housing and durable goods.
C) the liquidity of balance sheet positions as a determinant of business and household spending.
D) the greater variability of business spending compared to household spending.
Q2) In a closed economy,the goods market is in equilibrium when
A) Y = S + I + G.
B) C + S = I + G.
C) C + I = S + G.
D) Y = C + I + G.
Q3) What is the difference between an autonomous change in spending and an induced change in spending?
Q4) In a simple model of the economy,if the MPC is 0.8,the multiplier will equal
A) 0.2.
B) 0.8.
C) 1.25.
D) 5.
Page 21
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