Monetary Theory and Policy
Pre-Test Questions
Course Introduction
This course examines the fundamental principles and frameworks underlying modern monetary theory and policy. Students will explore the roles of money, financial institutions, and central banks in the economy. Key topics include the demand and supply of money, monetary transmission mechanisms, the design and implementation of monetary policy, and the interaction between monetary policy and macroeconomic outcomes such as inflation, output, and employment. The course also addresses contemporary debates, such as the effectiveness of unconventional monetary policies and the challenges faced by central banks in various economic environments. Through theoretical models and real-world case studies, students will gain a comprehensive understanding of how monetary policy is formulated and its impact on both domestic and global economies.
Recommended Textbook
Money Banking and the Financial System 1st Edition by R. Glenn Hubbard
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Page 2
Chapter 1: Introducing Money and the Financial System
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Q1) Alt-A borrowers were those who
A) used mortgages to purchase apartments.
B) chose adjustable-rate mortgages instead of fixed-rate mortgages.
C) borrowed using "interest-only" mortgages.
D) did not provide documentation of their income when applying for a mortgage.
Answer: D
Q2) 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.
Q3) Which of the following is NOT a financial intermediary?
A) NASDAQ
B) Allstate Insurance Company
C) Bank of America
D) Vanguard Total Stock Market Index Fund
Answer: A
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3
Chapter 2: Money and the Payments System
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Q1) In what way are other assets less liquid than money?
Answer: You incur transactions costs when you exchange other assets for money.
Q2) When economists refer to the role of money as a store of value,they mean that
A) money never loses its value, unlike other assets.
B) money allows value to be stored easily.
C) the value of money falls only when the quantity of money in circulation falls.
D) the value of money falls only when the quantity of money in circulation rises.
Answer: B
Q3) When prices rise,the purchasing power of money
A) rises.
B) falls.
C) is unaffected.
D) may rise, fall, or be unaffected depending upon circumstances.
Answer: B
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Chapter 3: Interest Rates and Rates of Return
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Q1) Issuers of coupon bonds
A) make a single payment of principal when the bonds matures, but multiple payments of interest over the life of the bond.
B) make a single payment of interest and principal.
C) make multiple payments of principal, but a single payment of interest.
D) make a single payment of principal at the time the bond is issued and multiple payments of interest over the life of the bond.
Answer: A
Q2) The concept of present value
A) reveals that discount bonds have higher interest rates than coupon bonds.
B) reveals that fixed payment loans have higher interest rates than discount bonds.
C) is useful in comparing interest rates for different financial instruments.
D) limits the comparability of returns on different types of bonds.
Answer: C
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Chapter 4: Determining Interest Rates
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Q1) A small open economy
A) is unable to affect the world real interest rate by its borrowing and lending decisions.
B) will always be a net borrower from abroad.
C) will always be a net lender abroad.
D) is almost never able to borrow abroad.
Q2) 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.
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) How can diversification reduce idiosyncratic risk but not systematic risk?
Q5) Suppose that businesses in Japan reduce their spending on plant and equipment.What will be the effect on spending on plant and equipment by businesses in the United States?
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Q1) Under the expectations theory if market participants expect that future short-term rates will be higher than current short-term rates,the yield curve will
A) slope upward.
B) slope downward.
C) be flat.
D) slope upward, slope downward, or be flat, depending on risk, liquidity, cost of information, and tax considerations.
Q2) If the expected path of interest rates on one-year bonds over the next five years is 2%,4%,3%,2%,and 1%,the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of
A) one year.
B) two years.
C) three years.
D) five years.
Q3) Discuss what happened to the market prices on corporate securities relative to government securities during the Great Depression.
Q4) What are the economic implications of an inverted yield curve?
Q5) How do ratings agencies earn income?
Page 7
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Chapter 6: The Stock Market, information, and Financial
Market Efficiency
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Q1) As of 2009,which of the following was the largest stock exchange in terms of total value traded?
A) the New York Stock Exchange
B) London Stock Exchange
C) Shanghai Stock Exchange
D) Tokyo Stock Exchange
Q2) 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.
Q3) Suppose you buy a stock that sells for $20.It's expected annual dividend is $2 and you expect its price to be $25 in one year.What is your expected rate of return on the stock?
Q4) Explain how a bubble can develop in the market for an asset.
Q5) What are the differences between common stock and preferred stock?
Page 8
Q6) What are the effects of the double taxation of dividends?
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Chapter 7: Derivatives and Derivative Markets
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Q1) Which best describes a credit default swap?
A) It is designed to reduce interest-rate risk.
B) The issuer receives payments from the buyer in return for agreeing to make payments to the buyer if the security goes into default.
C) Issuers are taking out insurance in case of default.
D) It represents a way for the issuer to establish its creditworthiness.
Q2) One benefit of a swap compared to futures and options is that they A) promote liquidity.
B) reduce the risk for both the buyer and seller.
C) can be better tailored to meet the needs of market participants. D) can involve financial instruments and not just commodities.
Q3) In an options contract,another name for the strike price is the A) market price.
B) exercise price.
C) equilibrium price.
D) fixed price.
Q4) Why may some investors prefer forward contracts to futures?
Q5) Suppose you purchase a call option with a strike price of $85 for an options price of $10 How much profit will you earn if you exercise it when the price is $100?
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Chapter 8: The Market for Foreign Exchange
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Questions
Q1) Suppose that you expect during the next year the dollar will appreciate against the pound from 0.5 pound to the dollar to 0.75 pound to the dollar.How much will you expect to make on an investment of $10,000 in British government securities that will mature in one year and pay interest of 8%?
A) -59.5%
B) -28%
C) 8%
D) 28%
Q2) Suppose that the one-year Treasury bill rate in the United States is 6%,the one-year government bond rate in Canada is 4%,and investors expect the U.S.dollar to depreciate against the Canadian dollar by 4% over the coming year.Is the nominal interest rate parity condition violated?
Q3) About what percentage of the goods and services purchased by U.S.consumers,businesses,and governments in 2010 were produced by foreigners?
A) 1%
B) 12%
C) 15%
D) 40%
Q4) What is a dollar liquidity swap line?
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Chapter 9: Transactions Costs, asymmetric Information, and the Structure of the Financial System
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Q1) How can restrictive covenants help to reduce moral hazard in bond markets?
Q2) How does adverse selection affect the participation of small- and medium-sized firms in the stock market?
Q3) Which of the following is NOT an example of transactions costs?
A) High interest rates
B) Lawyers' fees
C) Brokerage commissions
D) Minimum investment requirements
Q4) Symmetric information
A) is the same as perfect information.
B) holds under the assumption of rational expectations.
C) is true only in efficient markets.
D) means that savers and borrowers have the same information.
Q5) The presence of transactions costs and information costs
A) lowers the cost of funds to borrowers.
B) raises the cost of funds to borrowers.
C) raises the expected return to lenders.
D) increases the efficiency of the financial system.
Q6) What are the information costs faced by savers?
Q7) How are financial intermediaries able to reduce transactions costs? Page 11
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Chapter 10: The Economics of Banking
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Sample Questions
Q1) A bank's remaining value after it has met all its liabilities is known as a
A) bank's assets.
B) bank's liabilities.
C) bank capital.
D) bank's income.
Q2) Banks use credit rationing rather than simply raising the interest rate charged borrowers with higher default risks because
A) of fear of adverse selection problems.
B) of interest rate ceilings in many states.
C) of fear of offending the loan applicants.
D) use of credit rationing is encouraged by the Federal Reserve.
Q3) A bank run involves
A) a failure by a bank to get the maximum return on its investments.
B) large numbers of depositors withdrawing their deposits within a short period of time.
C) a bank being forced out of business.
D) fraud on the part of a bank's managers.
Q4) Suppose a bank has assets of $500 million and capital of $100 million.Its return on assets is -3%.What is its leverage ratio? What is its return on equity?
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Page 13
Chapter 11: Investment Banks, mutual Funds, hedge Funds, and the Shadow Banking System
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Q1) During the financial crisis,which type of risk was the biggest problem faced by investment banks?
A) interest-rate risk
B) currency risk
C) hedging risk
D) credit risk
Q2) How is the use of leverage a "double-edged sword"?
Q3) Factoring
A) involves selling stocks and using the proceeds to buy bonds.
B) is purchasing accounts receivable at a discount.
C) is calculating the optimal par values of stocks and bonds.
D) has been declared illegal under the Factoring Reform Act of 1994.
Q4) Blood tests administered to applicants for medical insurance are an example of an attempt by insurance companies to deal with the problem of A) moral hazard.
B) the drug abuse problems currently plaguing the country.
C) adverse selection.
D) failure of policyholders to keep paying their premiums.
Page 14
Q5) What are some reasons that hedge funds have become controversial?
Q6) How do investment banks use the results of their research?
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Page 15
Chapter 12: Financial Crises and Financial Regulation
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Q1) In what year did the economy return to normal conditions following the Great Depression?
A) 1933
B) 1937
C) 1941
D) 1945
Q2) The second stage in the regulatory process is
A) a crisis.
B) regulation.
C) response by the financial system.
D) regulatory response.
Q3) In late 1998 the Fed averted a possible financial panic by
A) lowering interest rates.
B) raising interest rates.
C) using its influence to bring together the creditors of Long-Term Capital Management.
D) using its influence to encourage banks to make loans to broker-dealers in the securities industry.
Q4) What are the primary reasons for and against a policy of "too big to fail."
Q5) How does deflation affect those with debt?
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Chapter 13: The Federal Reserve and Central Banking
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Q1) The issue of Fed independence is most often raised by A) disagreement over the role the Fed should play in managing monetary policy.
B) the Fed's refusal to carry out the wishes of the President.
C) the Fed's refusal to carry out the wishes of Congress.
D) the public's negative reaction to Fed policy.
Q2) 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.
Q3) In what ways is the Fed independent of the political process?
Q4) Which of the following statements is correct?
A) Federal Reserve district banks are owned by the government.
B) Member banks receive no return on the stock they own in Federal district banks.
C) Federal Reserve district banks pay dividends on their earnings to member banks.
D) The boards of directors of the district banks are all local bankers.
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Chapter 14: The Federal Reserves Balance Sheet and the
Money Supply Process
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Q1) Open market operations involve
A) the Fed making discount loans to depository institutions.
B) the Fed buying and selling common stock in order to affect the liquidity of the stock market.
C) the Fed buying and selling U.S. government securities.
D) private investors buying and selling securities directly on exchanges, rather than through brokers.
Q2) The interest rate the Fed charges on loans to depository institutions is known as A) the federal funds rate.
B) the Fed loan rate.
C) the discount rate.
D) the interbank clearing rate.
Q3) In July 2010,the largest liability of the Fed was
A) currency in circulation.
B) reserves.
C) discount loans to banks.
D) vault cash.
Q4) Illustrate the effect of the Fed purchasing $50 million worth of mortgage-backed securities on the Fed's balance sheet.
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Chapter 15: Monetary Policy
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Q1) How does the Open Market Trading Desk conduct its operations?
A) directly with private securities dealers on the floor of the New York Stock Exchange
B) directly with private securities dealers on the floor of the Federal Reserve Bank of New York
C) over-the-counter electronically with private securities dealers
D) by sending its buy and sell orders to the U.S. Treasury for execution
Q2) How did the federal funds rate compare to that suggested by Taylor's rule following the 2001 recession and during the Financial Crisis of 2007-2009? How would proponents of Taylor's rule evaluate monetary policy in each period.
Q3) What is a matched sale-purchase transaction (also known as a reverse repo)?
Q4) 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.
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Chapter 16: The International Financial System and Monetary Policy
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Q1) Which of the following statements is correct?
A) A devaluation of the British pound would result in more dollars to the pound.
B) A revaluation of the British pound would raise the prices of U.S. goods in Britain.
C) A devaluation of the British pound would lower the prices of British goods in the United States.
D) Revaluations and devaluations of a country's currency were not allowed under the Bretton Woods system.
Q2) An unsterilized foreign-exchange intervention occurs
A) whenever a central bank purchases or sells domestic currency.
B) whenever a central bank purchases or sells foreign currency.
C) whenever a central bank allows the monetary base to respond to the sale or purchase of domestic currency.
D) whenever a central bank fails to reduce its holdings of gold by the amount of a foreign-exchange purchase.
Q3) 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?
Q4) Discuss the problems associated with the imposition of capital controls.
Page 20
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Chapter 17: Monetary Theory I: the Aggregate Demand and Aggregate Supply Model
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Q1) What are the principal sources of change in productivity growth?
Q2) If the coefficient a in the new classical expression for short-run aggregate supply were equal to zero,
A) aggregate output would always be at its full-employment level.
B) the short-run aggregate supply curve would slope down.
C) the short-run aggregate supply curve would be a horizontal line.
D) aggregate output would only differ from its full-employment level if the actual price level did not equal the expected price level.
Q3) In the aggregate demand-aggregate supply model,if the Federal Reserve decides to decrease the nominal money supply,
A) current output will fall, but the price level will rise.
B) current output will rise, but the price level will fall.
C) current output and the price level will both rise.
D) current output and the price level will both fall.
Q4) Monetary neutrality refers to the fact that changes in the money supply
A) affect output more in the long run than in the short run.
B) have no effect on output in the long run.
C) affect only output in the long run.
D) have a greater effect on prices in the short run than in the long run.
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Chapter 18: Monetary Theory Ii: the Is-Mp Model
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Q1) Which of the following does NOT lead to an increase in potential GDP?
A) labor force grows
B) technological change takes place
C) new machinery and equipment are installed
D) aggregate expenditures increase
Q2) What is the multiplier? If MPC =0.75,what is the value of the multiplier in the simple model of the economy?
Q3) The graph of the short-run relationship between the unemployment rate and inflation is called a(n)
A) MP curve.
B) LM curve.
C) IS curve.
D) Phillips curve.
Q4) The series of induced changes in consumption spending that result from an initial change in autonomous expenditure is called the
A) induced effect.
B) autonomous effect.
C) multiplier effect.
D) consumption effect
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