Money and Banking Exam Preparation Guide
Course Introduction
This course explores the fundamental principles of money, banking, and financial institutions and their roles in the modern economy. Students will examine the functions and types of money, how banks operate and create credit, and the structure and regulation of the banking system. The course delves into the central banks role in monetary policy, the tools it uses to influence the economy, and the impact of financial markets and institutions on economic growth, stability, and crises. Through the analysis of real-world examples and current events, students gain insight into the interconnectedness of money, banks, and broader macroeconomic outcomes.
Recommended Textbook Financial Markets and Institutions Global 7th Edition by Frederic S Mishkin
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Chapter 1: Why Study Financial Markets and Institutions
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Sample Questions
Q1) Banks, savings and loan associations, mutual savings banks, and credit unions
A)are no longer important players in financial intermediation.
B)have been providing services only to small depositors since deregulation.
C)have been adept at innovating in response to changes in the regulatory environment.
D)all of the above.
E)only A and C of the above.
Answer: C
Q2) The central bank of the United States is A)Citicorp.
B)The Fed. C)Bank of America.
D)The Treasury.
E)none of the above.
Answer: B
Q3) Financial innovation has provided more options to both investors and borrowers. A)True
B)False
Answer: True
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Chapter 2: Overview of the Financial System
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Sample Questions
Q1) Describe how over-the-counter markets work.
Answer: not answered
Q2) The government agency that insures each depositor at a commercial bank, savings and loan association, or mutual savings bank up to a loss of $100,000 per account ($250,000 for individual retirement accounts)is the Securities and Exchange Commission (SEC).
A)True
B)False
Answer: False
Q3) In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called
A)comparative informational disadvantage.
B)asymmetric information.
C)variant information.
D)caveat venditor.
Answer: B
Q4) Why is it so important for an economy to have fully developed financial markets?
Answer: not answered
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Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation
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Sample Questions
Q1) With an interest rate of 5 percent, the present value of $100 received one year from now is approximately
A)$100.
B)$105.
C)$95.
D)$90.
Answer: C
Q2) Reinvestment risk is the risk that
A)a bond's value may fall in the future.
B)a bond's future coupon payments may have to be invested at a rate lower than the bond's yield to maturity.
C)an investor's holding period will be short and equal in length to the maturity of the bonds he or she holds.
D)a bond's issuer may fail to make the future coupon payments and the investor will have no cash to reinvest.
Answer: B
Q3) Why may a bond's rate of return differ from its yield to maturity?
Answer: not answered
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Chapter 4: Why Do Interest Rates Change
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Q1) When bond prices become less volatile, the demand for bonds ________ and the interest rate ________.
A)increases; rises
B)increases; falls
C)decreases; falls
D)decreases; rises
Q2) When the growth rate of the money supply decreases, interest rates end up being permanently lower if
A)the liquidity effect is larger than the other effects.
B)there is fast adjustment of expected inflation.
C)there is slow adjustment of expected inflation.
D)the expected inflation effect is larger than the liquidity effect.
Q3) The higher the standard deviation of returns on an asset, the ________ the asset's ________.
A)greater; risk
B)smaller; risk
C)greater; expected return
D)smaller; expected return
Q4) Use the bond demand and supply framework to explain the Fisher effect and why it occurs.
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates
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Q1) Explain why the liquidity premium theory is so widely accepted.
Q2) If a bond has a favorable tax treatment, its required interest rate (all else equal)
A)will be higher.
B)will not be affected.
C)will be lower.
D)all of the above could happen.
Q3) According to the expectations theory of the term structure,
A)when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.
B)when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future.
C)buyers of bonds prefer short-term to long-term bonds.
D)all of the above.
E)only A and B of the above.
Q4) How would a severe recession affect the risk premium on corporate bonds?
Q5) The interest rates on bonds of different maturities tend to move together over time.
A)True
B)False
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Chapter 6: Are Financial Markets Efficient
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Q1) It is probably a good use of an investor's time to watch as many shows featuring technical analysts as possible.
A)True
B)False
Q2) To say that stock prices follow a "random walk" is to argue that
A)stock prices rise, then fall, then rise again.
B)stock prices rise, then fall in a predictable fashion.
C)stock prices tend to follow trends.
D)stock prices cannot be predicted based on past trends.
Q3) According to the January effect, stock prices
A)experience an abnormal price rise from December to January.
B)experience an abnormal price decline from December to January.
C)follow a random walk during January.
D)set the pattern for the entire year in January.
Q4) Give evidence both for and against market efficiency.
Q5) How is it possible that a firm can announce a record-breaking loss, yet its stock price rises when the announcement is made?
Q6) The evidence suggests technical analysts are not superior stock pickers.
A)True
B)False
Page 8
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Chapter 7: Why Do Financial Institutions Exist
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Sample Questions
Q1) The Sarbanes-Oxley Act of 2002 provides for oversight of accounting firms but makes no provisions for increasing the flow of information to financial markets.
A)True
B)False
Q2) In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A)Federal Corporate Securities Commission.
B)Federal Trade Commission.
C)Securities and Exchange Commission.
D)U)S. Treasury Department.
E)Federal Reserve System.
Q3) The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called
A)adverse selection; moral hazard
B)moral hazard; adverse selection
C)costly state verification; free-riding
D)free-riding; costly state verification
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Chapter 8: Why Do Financial Crises Occur and Why Are
They so Damaging to the Economy
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Q1) In an emerging market economy, a financial crisis generally begins with A)mismanagement of financial liberalization or innovation.
B)asset pricing booms and busts.
C)an increase in uncertainty caused by failure of financial institutions.
D)all of the above.
Q2) Discuss the difference in Stage Two of a financial crisis between an advanced economy and an emerging market economy.
Q3) Most financial crises in the United States have begun with
A)a steep stock market decline.
B)an increase in uncertainty resulting from the failure of a major firm.
C)a steep decline in interest rates.
D)all of the above.
E)only A and B of the above.
Q4) Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.
A)currency
B)stock market
C)banking
D)commodities
Q5) What does the "twin crises" in an emerging economy financial crisis refer to?
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Chapter 9: Central Banks and the Federal Reserve System
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Q1) The Board of Governors of the Federal Reserve System
A)appoint three directors to each Federal Reserve Bank.
B)elect six members to member commercial banks.
C)both of the above.
D)none of the above.
Q2) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would
A)impart an inflationary bias to monetary policy.
B)force monetary authorities to sacrifice the long-run objective of price stability.
C)make the so-called political business cycle even more pronounced.
D)do all of the above.
E)do only A and B of the above.
Q3) Members of the Board of Governors are
A)chosen by the Federal Reserve Bank presidents.
B)appointed by the newly elected president of the United States, as are cabinet positions.
C)appointed by the president of the United States and confirmed by the Senate as members resign.
D)never allowed to serve more than seven-year terms.
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Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Sample Questions
Q1) Flexibility is a requirement in selecting an intermediate target.
A)True
B)False
Q2) Describe an asset-price bubble.
Q3) If the Federal Reserve wants to expand reserves in the banking system, it will
A)purchase government securities.
B)raise the discount rate.
C)sell government securities.
D)raise reserve requirements.
Q4) Discuss how the monetary policy of the European Central Bank is similar to the U.S. How are they different?
Q5) Why does the Fed use open market operations to a greater extent than reserve requirements in its conduct of monetary policy?
Q6) The monetary base consists of
A)currency in circulation and reserves.
B)government securities held by the Fed and discount loans.
C)government securities held by the Fed and currency in circulation.
D)discount loans and reserves.
Q7) Compare the advantages and disadvantages of monetary targeting and inflation targeting. Page 12
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Chapter 11: The Money Markets
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Sample Questions
Q1) If the Fed wants to lower the federal funds interest rate, it will ________ the banking system by ________ securities.
A)add reserves to; selling
B)add reserves to; buying
C)remove reserves from; selling
D)remove reserves from; buying
Q2) Money market instruments
A)are usually sold in large denominations.
B)have low default risk.
C)mature in one year or less.
D)are characterized by all of the above.
E)are characterized by only A and B of the above.
Q3) The Federal Reserve can influence the federal funds interest rate by buying securities, which ________ reserves, thereby ________ the federal funds rate.
A)adds; raising
B)removes; lowering
C)adds; lowering
D)removes; raising
Q4) How are Treasury bills sold? How do competitive and noncompetitive bids differ?
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Chapter 12: The Bond Market
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Sample Questions
Q1) Governments never issue stock because
A)they cannot sell ownership claims.
B)the Constitution expressly forbids it.
C)both A and B of the above.
D)neither A nor B of the above.
Q2) What is a callable bond? How does the callability feature affect the bond's price and interest rate?
Q3) (I)Capital market securities fall into two categories: bonds and stocks. (II)Long-term bonds include government bonds and long-term notes, municipal bonds, and corporate bonds.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q4) The ________ rate is the rate of interest that the issuer must pay.
A)market
B)coupon
C)discount
D)funds
Q5) What is a bond indenture?
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Chapter 13: The Stock Market
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Sample Questions
Q1) All stocks pay dividends, as that is the only way an investor can profit from holding stock.
A)True
B)False
Q2) A stock's market value will be higher the higher the investor's required rate of return is, all else being equal.
A)True
B)False
Q3) Why would a crisis in the subprime mortgage market lead to declining prices in the U.S. equity markets?
Q4) Which of the following is not an advantage of Electronic Communications Networks (ECNs)?
A)All unfilled orders are available for review by ECN traders.
B)Transactions costs are lower for ECN trades.
C)Trades are made and confirmed faster.
D)ECNs work well for thinly traded stocks.
Q5) How do over-the-counter markets differ from organized exchanges?
Q6) What is the role of specialists on a stock exchange?
Q7) How do corporate stocks differ from bonds?
Q8) What are the objectives of the Securities and Exchange Commission?
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Chapter 14: The Mortgage Markets
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Sample Questions
Q1) The most common type of mortgage-backed security is
A)the mortgage pass-through, a security that has the borrower's mortgage payments pass through the trustee before being disbursed to the investors.
B)collateralized mortgage obligations, a security which reduces prepayment risk.
C)the participation certificate, a security which passes the borrower's mortgage payments equally among all the owners of the certificates.
D)the securitized mortgage, a security which increases the liquidity of otherwise illiquid mortgages.
Q2) Subprime loans are those made to borrowers who do not qualify for loans at the usual market rate of interest because of a poor credit rating or because the loan is larger than justified by their income.
A)True
B)False
Q3) An advantage of a graduated-payment mortgage is that borrowers will qualify for a larger loan than if they requested a conventional mortgage.
A)True
B)False
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Chapter 15: The Foreign Exchange Market
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Q1) If the dollar depreciates relative to the British pound, British sweaters will become more expensive in the United States.
A)True
B)False
Q2) The weakness of the dollar in the late 1970s and the strength of the dollar in the early 1980s can be explained by movements in
A)real interest rates, but not nominal interest rates.
B)nominal interest rates, but not real interest rates.
C)relative price levels, but not real interest rates.
D)none of the above.
Q3) The theory of purchasing power parity cannot fully explain exchange rate movements because fiscal policy differs across countries.
A)True
B)False
Q4) Increased demand for a country's exports causes its currency to depreciate.
A)True
B)False
Q5) Explain the logic underlying the law of one price and the theory of purchasing power parity.
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Chapter 16: The International Financial System
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Sample Questions
Q1) If a central bank does not want to see its currency rise in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby weakening its currency.
A)expansionary; raise B)contractionary; raise C)expansionary; lower D)contractionary; lower
Q2) Under a fixed exchange rate regime, when the domestic currency is overvalued, the central bank must ________ the domestic currency to keep the exchange rate fixed; as a result, it ________ international reserves.
A)purchase; loses B)sell; loses
C)purchase; gains
D)sell; gains
Q3) If a country's central bank eventually runs out of international reserves, it cannot keep its currency from depreciating and a devaluation must occur.
A)True
B)False
Q4) What was the European Monetary System? How did its exchange rate mechanism work?
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Chapter 17: Banking and the Management of Financial Institutions
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Q1) Which of the following statements is false?
A)A bank's assets are its uses of funds.
B)A bank issues liabilities to acquire funds.
C)A bank's assets provide the bank with income.
D)Bank capital is an asset on the bank balance sheet.
Q2) Secondary reserves ________
A)can be converted into cash with low transaction costs.
B)are not easily converted into cash and are, therefore, of secondary importance to banks.
C)count toward meeting required reserves, but only at a rate of $0.50 per dollar of secondary reserves.
D)none of the above.
Q3) When a $10 check written on the First National Bank is deposited in an account at the Second National Bank, then
A)the liabilities of the First National Bank decrease by $10.
B)the liabilities of the Second National Bank increase by $10.
C)the reserves of the First National Bank increase by $10.
D)all of the above occur.
E)only A and B of the above occur.
Q4) What costs do banks hope to avoid by holding excess reserves?
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Chapter 18: Financial Regulation
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Sample Questions
Q1) Why did the United States experience a banking crisis in the 1980s?
Q2) What accounts for the problems facing China's four largest banks?
A)large loans to inefficient, state-owned enterprises
B)closing of unprofitable branches and laying off unproductive employees
C)selling shares in the bank overseas to raise capital
D)all of the above
Q3) The Federal Deposit Insurance Corporation Improvement Act of 1991
A)increased the FDIC's ability to borrow from the Treasury to deal with failed banks.
B)reduced the scope of deposit insurance in several ways.
C)eliminated governmentally administered deposit insurance.
D)did only A and B of the above.
Q4) Of the following assets, the one which has the highest capital requirement under the Basel Accord is
A)municipal bonds.
B)residential mortgages.
C)commercial paper.
D)securities issued by industrialized countries' governments.
Q5) Why is international financial regulation becoming more important in recent years?
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Chapter 19: Banking Industry: Structure and Competition
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Q1) State banks that are not members of the Federal Reserve System are most likely to be examined by the
A)Federal Reserve System.
B)Federal Deposit Insurance Corporation.
C)Federal Home Loan Bank System.
D)Comptroller of the Currency.
Q2) In recent years, commercial banks have been allowed to
A)invest in real estate.
B)enter certain insurance markets.
C)underwrite stocks.
D)do all of the above.
E)do only A and B of the above.
Q3) The regulatory system that has evolved in the United States whereby banks are regulated at the state level, the national level, or both, is known as a
A)bilateral regulatory system.
B)tiered regulatory system.
C)two-tiered regulatory system.
D)dual banking system.
Q4) When and why was the Glass-Steagall Act passed? When and why was it repealed?
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Chapter 20: The Mutual Fund Industry
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Q1) The near collapse of Long Term Capital Management was caused by
A)the high management fees charged by the fund's two Nobel Prize winners.
B)the fund's high leverage ratio of 20 to 1.
C)a sharp decrease in the spread between corporate bonds and Treasury bonds.
D)a sharp increase in the spread between corporate bonds and Treasury bonds.
E)the fund's shift away from a market-neutral investment strategy.
Q2) ________ bonds combine stocks into one fund.
A)Hybrid
B)Money market
C)Municipal
D)Equity
Q3) ________ intermediation means that small investors can pool their funds with other investors to purchase high face value securities.
A)Liquidity
B)Financial
C)Denomination
D)Share
Q4) Describe the practices of late trading and market timing and explain how these practices harm a mutual fund's shareholders.
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Chapter 21: Insurance Companies and Pension Funds
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Q1) What insurance protects against liability for harm the insured may cause to others as a result of product failure or accidents?
A)property insurance
B)health insurance
C)life insurance
D)casualty insurance
Q2) A monoline insurance company is an insurance company which specialize in credit insurance alone.
A)True
B)False
Q3) The broad categories of life insurance products including which of the following?
A)term
B)whole life
C)universal life
D)all of the above
Q4) Distinguish between different types of life insurance.
Q5) What are the major differences between life insurance and property and casualty insurance?
Q6) Why must insurance companies screen applicants so carefully?
Page 24
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Chapter 22: Investment Banks, Security Brokers and
Dealers, and Venture Capital Firms
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Q1) Which of the following provides funds to companies not yet ready to sell securities to the public?
A)investment banks
B)securities brokers and dealers
C)venture capital firms
D)none of the above
Q2) By law, investors must be given a portion of the registration statement before they can invest in a new security. This document is called a ________.
A)prospectus
B)proxy statement
C)fiduciary warrant
D)debenture
Q3) Investment bankers have been active in the mergers and acquisitions market since the 1960s. Their contributions have included
A)helping firms that want to acquire another firm locate a firm to pursue.
B)helping would-be acquirers solicit shareholders through a tender offer.
C)helping target firms ward off undesired takeover attempts.
D)all of the above.
E)only A and B of the above.
Page 25
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Chapter 23: Risk Management in Financial Institutions
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Q1) Of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the requirement that
A)firms keep compensating balances at the banks from which they obtain their loans.
B)firms place on their board of directors an officer from the bank.
C)loan contracts include restrictive covenants.
D)individuals provide detailed credit histories to bank loan officers.
Q2) A bank manager concerned about interest income who expects interest rates to fall and who knows the bank currently has a positive gap should ________ rate-sensitive assets and ________ rate-sensitive liabilities.
A)increase; increase
B)decrease; increase
C)decrease; decrease
D)increase; decrease
Q3) What is the difference between credit risk and interest-rate risk?
Q4) Credit rationing occurs when lenders charge higher interest rates on the loans they make to riskier borrowers.
A)True
B)False
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Chapter 24: Hedging With Financial Derivatives
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Q1) If you buy an option to sell Treasury futures at 110, and at expiration the market price is 115,
A)the call will be exercised.
B)the put will be exercised.
C)the call will not be exercised.
D)the put will not be exercised.
Q2) Financial derivatives include ________.
A)stocks
B)bonds
C)futures
D)none of the above
Q3) If a bank has a gap of -$10 million, it can reduce its interest-rate risk by
A)paying a fixed rate on $10 million and receiving a floating rate on $10 million.
B)paying a floating rate on $10 million and receiving a fixed rate on $10 million.
C)selling $20 million fixed-rate assets.
D)buying $20 million fixed-rate assets.
Q4) How would a firm use exchange rate futures to lock in current exchange rates?
Q5) Define and distinguish between call options and put options.
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Chapter 25: Savings Associations and Credit Unions
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Q1) The major provisions of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 included
A)abolishing the Federal Home Loan Bank Board and the FSLIC.
B)transferring the regulatory role of the Federal Home Loan Bank Board to the Office of Thrift Supervision, a bureau within the U.S. Treasury Department.
C)expanding the responsibilities of the FDIC, which is now the sole administrator of the federal deposit insurance system.
D)all of the above.
E)only A and B of the above.
Q2) The Competitive Equality in Banking Act of 1987 allowed the FSLIC to borrow all the funds it needed to close insolvent S&Ls and pay off depositors.
A)True
B)False
Q3) The smallest average-sized depository institution is ________.
A)credit unions
B)savings and loan associations
C)commercial banks
D)money market mutual funds
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Chapter 26: Finance Companies
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Q1) In a lease financing arrangement, a finance company will purchase equipment, which it then leases to a company for a set period.
A)True
B)False
Q2) What is default risk?
A)A problem that arises when a firm runs short of cash.
B)The risk of asset prices rising too high.
C)The chance that the borrower will fail to repay a loan.
D)The risk associated with longer-term contracts.
Q3) Usury statutes limit the level of interest rates that finance companies can charge their customers.
A)True
B)False
Q4) Finance companies face much stricter regulations than commercial banks.
A)True
B)False
Q5) What are the various types of finance companies?
Q6) Describe the process of factoring? When and why is it used?
Q7) Discuss the regulatory environment for finance companies relative to commercial banks.
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