Money and Banking
Chapter Exam Questions
Course Introduction
This course provides an in-depth examination of the role of money and financial institutions in the modern economy. Topics include the nature and functions of money, the structure and operation of the banking system, central bank policies, the creation and control of money supply, and the impact of monetary policy on economic activity. Students will explore the relationship among financial markets, interest rates, and macroeconomic stability, gaining an understanding of how banks and other financial intermediaries support economic growth and respond to regulatory environments. The course combines theoretical concepts with real-world examples to prepare students for advanced study or careers in finance, banking, and public policy.
Recommended Textbook
Money Banking and Financial Markets 5th Edition by Stephen Cecchetti
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Chapter 1: An Introduction to Money and the Financial System
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Sample Questions
Q1) Most financial markets in the United States operate under a system:
A) without any formal rules or regulation.
B) with many rules and regulation to ensure a fair market.
C) where it depends on which state where the financial market is located since some states do not have any regulations.
D) that is totally controlled by the federal government.
Answer: B
Q2) How do financial institutions evaluate the creditworthiness of potential borrowers?
A) They offer high interest rates because only the best borrowers will be able to afford them.
B) They gather information regarding the borrowers' finances.
C) They do not evaluate creditworthiness because everyone is treated the same.
D) They do not evaluate the creditworthiness because they know the borrower will honor his/her obligation to repay the loan.
Answer: B
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Chapter 2: Money and the Payments System
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Q1) Which of the following statements is not true?
A) For most of history gold has been the most common commodity money.
B) The most common form of money in the U.S. is not a commodity money.
C) Gold is an example of a fiat money.
D) U.S. currency is legal tender.
Answer: C
Q2) Suppose there is an economy that has 100 people each of whom makes a different good, and that they use a barter system for exchange. How many relative prices will there be?
Answer: The general formula for the number of prices is n (n-1)/2; where n = the number of goods. Since we have 100 people each producing one good, we have 100 goods, so n = 100. Plugging this into our formula, we obtain: 100(99)/2 = 4,950; so there will be 4,950 relative prices.
Q3) Which of the following could not be commodity money?
A) Gold coins
B) Cigarettes
C) U.S. Currency
D) Silk
Answer: C
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Sample Questions
Q1) Which of the following is likely to be a primary financial market transaction?
A) You cash the check your grandmother sent you for your birthday.
B) You call a broker and purchase bonds for your retirement fund.
C) A city issues bonds to finance new road construction.
D) A supermarket needs to borrow the funds for a second location and takes out a loan from a commercial bank to pay for it.
Answer: C
Q2) Standard & Poor's sells information to investors; this is their primary business. Is this an example of a financial intermediary? Explain.
Answer: No. A financial intermediary is involved indirectly in a financial transaction. It matches up the ultimate lenders (savers) with the ultimate spenders (borrowers). The funds flow through the intermediary which is acting as a "middleman." That is not the case with Standard & Poor's.
Q3) Financial instruments used primarily as stores of value do not include:
A) asset backed securities.
B) U.S. Treasury bonds.
C) a car insurance policy.
D) a bank loan.
Answer: C
Page 5
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Chapter 4: Future Value, Present Value and Interest Rates
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Q1) Considering the concept of compounding, explain why in determining the future value of a
$100 investment at 5 percent annual interest, you can't simply multiply $100 by (1.10) and get the correct answer.
Q2) The coupon rate for a coupon bond is equal to the:
A) annual coupon payment divided by the face value of the bond.
B) annual coupon payment divided by the purchase price of the bond.
C) purchase price of the bond divided by the coupon payment.
D) annual coupon payment divided by the selling price of the bond.
Q3) Which investment plan will provide the highest future value: $500 invested at 5 percent annually for four years and then that balance invested at 7 percent annually for an additional three years, or $500 invested at 6 percent annually for seven years?
Q4) The rule of 72 says that at 6% interest $100 should become $200 in about:
A) 72 months
B) 100 months
C) 12 years
D) 7.2 years
Q5) Explain why, if real interest rates are so important, we see most interest rates quoted in nominal terms.
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Chapter 5: Understanding Risk
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Q1) You study horse racing avidly and discover for this year's Kentucky Derby you think you have the field pretty well figured out. In fact, you calculate the expected return and it is the same as the expected return you are getting from the stock market. Is this investment in the race valuable to you?
Q2) An investor puts $1,000 into an investment that will return $1,250 one-half of the time and $900 the remainder of the time. The expected return for this investor is:
A) $1,075
B) 5.0%
C) 7.5%
D) 15.0%
Q3) What is the expected value of a $100 bet on a flip of a fair coin, where heads pays double and tails pays zero?
Q4) The variance of a portfolio containing n assets with independent returns:
A) increases as n increases. B) decreases as n increases. C) is constant for any n greater than two. D) does not change in a predictable way when n increases.
Q5) Explain the rapid rise in popularity of mutual funds.
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Q1) If the federal government were to offer larger tax breaks on the purchase of new equipment for businesses, all other factors constant, we would expect to see the:
A) bond demand curve shift right.
B) bond supply curve shift left.
C) bond supply curve shift right.
D) bond demand curve shift left.
Q2) Suppose a family member approaches you to borrow $2,000 for the down payment on an automobile. You have the cash available in a savings account that currently earns 5% annual interest. You and the family member consider the following repayment options:
(i) Borrower repays $259 each year over the next ten years
(ii) Borrower repays $300 each year over the next five years, plus a lump-sum payment of $895 in the fifth year.
(iii) Borrower repays you $2,100 at the end of one year. For each of the options above, show that the present values of each option are approximately equal. Then, relate each of the options above to the four types of bonds, indicating which option is equivalent to which type of bond. Explain why.
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Chapter 7: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) The yield on a tax-exempt bond:
A) equals the taxable bond yield times one minus the tax rate.
B) is equal to the yield on a U.S. 30-year bond.
C) is called the risk-free yield.
D) only applies to foreign bonds because they are exempt from U.S. income taxes.
Q2) A flight to quality should result in the:
A) price of U.S. Treasury Securities rising and the price of corporate bonds rising.
B) yield on U.S. Treasury Securities falling and the price of corporate bonds rising.
C) yield on corporate bonds falling and the price of U.S. Treasury Securities rising.
D) yield on U.S. Treasury securities falling and the price of corporate bonds falling.
Q3) Which of the following is true?
A) Long-term bond yields move together but short-term yields do not.
B) Short-term bond yields move together but long-term yields do not.
C) U.S. Treasury Bill yields are lower than the yields on commercial paper.
D) Long-term bond yields are usually the same as short-term yields.
Q4) Briefly describe the two different types of junk bonds (high-yield bonds).
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Chapter 8: Stocks, Stock Markets and Market Efficiency
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Q1) Which of the following will cause an increase in the current price of a stock? \( \mathrm{P}_{\text {today }}=\frac{\mathrm{D}_{\text {today }}(1+g)}{r f+r p-g} \)
A) A decrease in the risk-free return
B) A decrease in the current dividend
C) A decrease in the dividend growth rate
D) Both an increase in the risk-free return or an increase in the current dividend
Q2) Discuss whether the economy would be more or less efficient if public corporations issued fewer shares of stock.
Q3) The dividend-discount model of stock valuation:
A) is an application of the net present value formula.
B) takes the net present value of expected dividends and add it to the future sale price of the stock.
C) takes the net present value of the expected future price of the stock and adds the annual dividend.
D) takes the annual dividend, adds it to the expected future selling price and divides by the number of years to get the current price.
Q4) Explain why being a residual claimant can increase the risk from owning stocks.
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Q1) The right to buy a given quantity of an underlying asset at a predetermined price on or before a specific date is called a(n):
A) put option.
B) option writer.
C) call option.
D) arbitrage contract.
Q2) Imagine a baker who has the opportunity to bid on a contract to supply a local military base with bread for an entire year. The problem is the baker must commit to a price today and hold to that price for the entire year. Identify the risk faced by the baker, and explain how the use of a futures contract could transfer the risk.
Q3) What would be the value of an option on a stock that sells at a fixed price with a standard deviation of zero? Explain.
Q4) The main difference between European and American options is:
A) holders of European options have more options than holders of American options.
B) American option holders have more options than European option holders.
C) European option holders can exercise the option prior to expiration.
D) European options cannot be resold.
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Chapter 10: Foreign Exchange
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Q1) The government of a country that is experiencing strong currency appreciation might find itself under pressure from some of its own citizens. Who would be likely to be bringing pressure and why?
Q2) Explain why the changes we observe in nominal exchange rates in the short run must be due primarily to changes in the real exchange rate in countries with low inflation.
Q3) When a country's current account balance is added to its capital account balance, the sum should be:
A) twice the current account.
B) zero.
C) positive.
D) negative.
Q4) The annual volume of foreign exchange transactions:
A) is small relative to most financial markets.
B) is one-eighth the world GDP.
C) is three times the world trade volume.
D) is more than 18 times larger than world GDP.
Q5) Explain why the law of one price may best be applied to financial assets.
Q6) Briefly describe the foreign exchange market.
Q7) Explain why an appreciating U.S. dollar does not benefit everyone in the U.S.
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Chapter 11: The Economics of Financial Intermediation
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Q1) If financial intermediaries did not have the ability to pool the resources of small savers:
A) borrowers needing large amounts of money would find it more costly to obtain the funds.
B) the economy would grow faster.
C) people would likely save more.
D) the risk associated with lending would decrease.
Q2) Assume there are two companies. Both issue stock, but one is high quality and the other low quality. If potential investors cannot distinguish the quality of the company:
A) the shares of the low quality firm will disappear from the market.
B) the shares of both companies will trade on the market.
C) the shares of the high quality firm will disappear from the market.
D) this is an example of moral hazard and the shares of both companies will cease to trade.
Q3) If a lender faces a potential loan applicant pool made up of equal amounts of low risks and high risks, will charging an average interest rate provide the average (expected) return? Explain.
Q4) Explain why deflation can be so troubling to borrowers and lenders.
Q5) What are the five functions performed by financial intermediaries?
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Chapter 12:Depository Institutions: Banks and Bank Management
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Sample Questions
Q1) Which of the following is a bank liability?
A) Mortgage loans
B) Demand deposits
C) Reserves
D) U.S. Treasury securities
Q2) A bank's assets tend to be long-term while its liabilities are short-term. Therefore, when interest rates rise, the value of the bank's assets:
A) increases by more than the value of its liabilities.
B) will decrease by more than the value of its liabilities.
C) increases and the value of its liabilities decreases.
D) decreases and the value of its liabilities increases.
Q3) If bank with $100 million in assets and $10 million in equity increases its assets by adding $1 to capital for every $1 added to assets:
A) the debt-to-equity ratio will increase.
B) the debt-to-equity ratio will remain constant.
C) the debt-to-equity ratio will decrease.
D) the answer cannot be determined from the information in the question.
Q4) Why are U.S. banks prohibited from owning stocks?
Q5) What is the equation that reflects a bank's balance sheet?
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Chapter 13:Financial Industry Structure
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Sample Questions
Q1) Explain why a large equipment provider that sells to many of its commercial customers on account may use a finance company.
Q2) Evaluate the pros and cons of the repeal of the Glass-Steagall Act of 1933.
Q3) Many insurance companies sell group policies that cover all of the employees at a particular firm, or all of the members of a particular organization. How could this policy help to overcome the problem of adverse selection?
Q4) Which of the following statements most accurately describes the state of banking in the U.S.?
A) A large number of large banks and a small number of small banks
B) A large number of large and small banks
C) A small number of large and small banks
D) A large number of small banks and a small number of large banks
Q5) The number of banks in the U.S. has fallen almost by half in the past twenty years or so. Was this the result of bank failures or were some due to another cause? Explain.
Q6) Explain why the decoding of the human genome has interesting implications for the life insurance industry.
Q7) Why do you think Congress and the President are reluctant to fix the problems (identified in the text) with the Social Security System?
Page 15
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Chapter 14: Regulating the Financial System
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Sample Questions
Q1) Deflation can cause widespread bank crises for all of the following reasons except: A) a decline in the value of borrowers' net worth but not their liabilities.
B) borrowers' default rates increase.
C) bank balance sheets deteriorate as the level of economic activity decreases.
D) information asymmetry problems decrease during deflationary periods.
Q2) It is difficult for depositors to know the true health of banks because:
A) regulations prohibit banks making their financial statements publicly available. B) the financial statements of banks are too difficult for most people to understand. C) most of the information on bank loans is private and based on sophisticated models. D) banking is competitive and financial records of banks are not divulged to prevent competitor banks from having an advantage.
Q3) Besides regulating banks, the government also regulates nondepository financial institutions, such as insurance companies. Consider a property casualty insurance company; why would the government need to regulate them?
Q4) Why might there be a trade-off between a bank's profitability and its safety?
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Chapter 15: Central Banks in the World Today
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Q1) What do you think is meant by the statement that "successful monetary policy requires competent people and the right institutional environment"?
Q2) To be independent, a central bank must have:
A) its policies overturned only by the president.
B) control of its own budget.
C) the board members appointed for very short terms.
D) the chairperson serve as a member of the President's cabinet.
Q3) Setting an explicit numerical inflation target is most associated with the goal(s) of: A) transparency.
B) accountability.
C) both transparency and accountability.
D) neither transparency nor accountability; it's about moral hazard.
Q4) Explain why inflation degrades the information content of prices.
Q5) Explain why it is correct to say the Federal Reserve functions as the government's bank but it is incorrect to say it controls the government's budget.
Q6) How do the specific goals of interest rate and exchange rate stability differ in importance from the other specific goals mentioned for central bankers?
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Chapter 16: The Structure of Central Banks: The Federal Reserve
and the European Central Bank
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Q1) Member countries of the Eurosystem agree to:
A) pursue independent domestic monetary policies based on what is best for their own country, but not all member countries have adopted the euro as their currency.
B) share a common monetary policy and fiscal policy.
C) use the euro as their currency, but each country still pursues an independent monetary policy.
D) share a common monetary policy and use the euro as their currency.
Q2) In its role as bank for the U.S. government, the Federal Reserve performs all of the following services, except:
A) issuing new currency.
B) making discount loans.
C) maintaining the U.S. Treasury's bank account.
D) managing U.S. Treasury borrowings.
Q3) Which of the books used at the FOMC meetings can be characterized as less quantitative than the other two?
A) The Tealbook
B) The Beigebook
C) The Greenbook
D) The white paper released to the press
Page 18
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Chapter 17: The Central Bank Balance Sheet and the Money Supply Process
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Q1) Why do most central banks publish their balance sheets so frequently?
Q2) If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in what change in loans?
A) No change
B) A decrease of $1 million
C) An increase of $10 million
D) An increase of $1 million
Q3) Vault cash is not included in the central bank's liability category of currency because:
A) only non-bank currency is in the liability category of currency.
B) vault cash really is only electronic funds.
C) vault cash is in the asset category of reserves.
D) it is the liability of the U.S. Treasury.
Q4) A central bank's balance sheet will categorize the following as liabilities:
A) currency.
B) loans.
C) securities.
D) foreign exchange reserves.
Page 19
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Chapter 18:Monetary Policy: Stabilizing the Domestic Economy
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Q1) What are the advantages from the 2002 change in the Fed's lending policy?
Q2) Over the years most monetary policy experts would agree with each of the following statements, except: ?
A) the reserve requirement is not useful as an operational instrument.?
B) central bank lending is necessary to ensure financial stability.?
C) short-term interest rates are the best tool to use to stabilize short-term fluctuations in prices and output.?
D) transparency in policy making hinders accountability.
Q3) Why does the Federal Funds rate face a zero bound?
Q4) Inflation targeting does all of the following except: ?
A) increase policymakers' credibility.?
B) increase policymakers' accountability.?
C) communicate policymakers' objectives clearly and openly.?
D) hinder economic growth.
Q5) The Fed can _____ in the economy. ?
A) change interest rates, but not the supply of money?
B) change the supply of money, but not the interest rates
C) change both interest rates and the supply of money?
Page 20
D) change neither interest rates nor the supply of money
Q6) How does policy forward guidance influence the economy and inflation?
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Chapter 19:Exchange Rate Policy and the Central Bank
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Q1) A foreign exchange intervention that does not alter the domestic monetary base is:
A) sterilized.
B) unsterilized.
C) likely to change domestic interest rates.
D) impossible.
Q2) Which of the following statements best completes the following sentence; "Prior to World War I, when the U.S. was on the gold standard, inflation in the U.S ."?
A) averaged 3.5 percent per year but was highly variable.
B) averaged less than one percent per year and was highly variable.
C) averaged less than one percent per year and was stable.
D) averaged 3.5 percent per year and was stable.
Q3) What were the contributing factors that led to Argentina's initial adoption of a currency board and then its subsequent failure?
Q4) What should be the impact on the U.S. interest rates if the Fed undertakes a sterilized foreign exchange intervention? Be sure to explain your answer.
Q5) What are the risks to a country of fixing its exchange rate to that of another country?
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Chapter 20:Money Growth, Money Demand and Modern Monetary Policy
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Q1) Between 1970 and 2000, if the Fed had tried to hit the money growth targets:
A) the economy would have likely experienced very high inflation.
B) the federal funds rate would have changed often and by large amounts.
C) the interest rates would have likely been more stable.
D) the economy would have likely experienced very high inflation but the interest rates would have likely been more stable.
Q2) People have a portfolio demand for money in part because:
A) money is part of a well-diversified financial portfolio.
B) the return on money is often higher than other financial assets.
C) money is needed to pay brokerage commissions.
D) there is no cost to holding money which gives it a relatively high return.
Q3) Why do people hold money? Explain the reasons.
Q4) If the price of money is determined by supply and demand, what impact should a decrease in the supply of money (given steady money demand) have on the price of money and the rate of inflation?
Q5) Equilibrium in the money market would be expressed by which of the following?
A) Ms = (1/V)Y
B) Ms =Md
C) Ms = (1/V)P
D) Md = (1/V)P
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Chapter 21:Output, Inflation, and Monetary Policy
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Q1) In the long run the inflation rate equals the level implied by:
A) the rate of money growth.
B) aggregate demand.
C) the exchange rate.
D) fiscal policy.
Q2) In the long run, if we ignore changes in velocity, inflation will:
A) be zero.
B) equal the rate of money growth.
C) equal money growth less the growth in potential output.
D) equal money growth plus the growth in potential output.
Q3) A decrease in the inflation target by the central bank would:
A) have no impact on the positioning of the dynamic aggregate demand curve.
B) cause the dynamic aggregate demand curve to shift to the left.
C) cause the dynamic aggregate demand curve to shift to the right.
D) be reflected by a movement down and along the existing dynamic aggregate demand curve.
Q4) Can central bankers set short-term interest rate targets and still control inflation in the long run or are these goals mutually impossible? Explain.
Q5) What are the conditions for long-run equilibrium?
Q6) Explain why the short-run aggregate supply curve has a positive slope.
Page 24
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Chapter 22:Understanding Business Cycle Fluctuations
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Q1) Stabilization policy refers to the use of:
A) only fiscal policy.
B) only monetary policy.
C) either fiscal or monetary policy.
D) policy to shift the long-run aggregate supply curve.
Q2) If the economy's output response to changes in current inflation is small, the slope of the dynamic aggregate demand curve will be:
A) flat.
B) steep.
C) positive.
D) zero.
Q3) Policymakers can stabilize the economy by shifting:
A) the short-run aggregate supply curve.
B) the dynamic aggregate demand curve.
C) the long-run aggregate supply curve.
D) neither the short-run aggregate supply curve nor the dynamic aggregate supply curve.
Q4) What explanations have been offered to account for the Great Moderation?
Q5) Explain how globalization impacts inflation in both the short run and the long run.
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) Decreases in the real interest rate will result in a(n):
A) increase in net exports because it will lead to a depreciation of the dollar.
B) decrease in net exports because it will lead to a depreciation of the dollar.
C) increase in net exports because it will lead to an appreciation of the dollar.
D) decrease in net exports because it will lead to an appreciation of the dollar.
Q2) When central bankers are acting preemptively they are:
A) letting markets work and taking a wait and see approach.
B) aggressively trying to hit a zero inflation target.
C) usually focused on reducing expansionary gaps.
D) taking bold steps to stabilize the economy.
Q3) The challenges facing policymakers today include each of the following, except:
A) the economy's sustainable growth rate is highly stable.
B) nominal interest rates cannot fall below the effective lower bound (somewhat below zero).
C) stock and property values are subject to booms and busts.
D) the structure of the economy and financial system continues to evolve.
Q4) What are the unconventional policy options that central bankers can use if the traditional target interest rate hits the lower bound?
Page 26
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