Money and Banking Exam Preparation Guide
Course Introduction
Money and Banking explores the fundamental role of money, financial institutions, and the banking system in the modern economy. This course examines the functions of money, the process of money creation, and the behavior of financial markets. Students analyze how central banks, especially the Federal Reserve, influence monetary policy, interest rates, and economic stability. Topics also include the structure and operations of commercial banks, the evolution of payment systems, and the impact of banking regulations. By understanding the connections between money, banking, and economic outcomes, students gain insights into critical issues such as inflation, financial crises, and the global financial system.
Recommended Textbook
The Economics of Money Banking and Financial Markets 6th Canadian Edition by Frederic S. Mishkin
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Chapter 1: Why Study Money, Banking, and Financial Markets
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Sample Questions
Q1) The most comprehensive measure of aggregate output is ________.
A)gross domestic product
B)net national product
C)the TSE Index
D)national income
Answer: A
Q2) If an economy has aggregate output of $2 trillion, then aggregate income is
A)$1 trillion
B)$2 trillion
C)$3 trillion
D)$4 trillion
Answer: B
Q3) A share of common stock is a claim on a corporation's ________.
A)debt
B)liabilities
C)expenses
D)earnings and assets
Answer: D
Page 3
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Chapter 2: An Overview of the Financial System
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Q1) Which of the following financial intermediaries is not a depository institution?
A)A savings and loan association
B)A commercial bank
C)A credit union
D)A finance company
Answer: D
Q2) If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of ________.
A)moral hazard
B)adverse selection
C)free-riding
D)costly state verification
Answer: B
Q3) The primary liabilities of depository institutions are ________.
A)premiums from policies
B)shares
C)deposits
D)bonds
Answer: C
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Chapter 3: What Is Money
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Q1) Which of the following is not a form of e-money?
A)A debit card
B)A credit card
C)A stored-value card
D)A smart card
Answer: B
Q2) What are electronic payments? how do they reduce transaction costs? by how much?
Answer: In the past when paying bills you had to mail a cheque but now banks provide a website in which you log on, make a few clicks and make the payment that is transmitted electronically. You can even avoid logging in as reoccurring bills can be automatically deducted from your bank account. Electronic payments reduce transaction costs as you do not have to pay a stamp to send a cheque and also you save time paying your bills electronically. Estimated cost savings when a bill is paid electronically rather than a cheques exceed one dollar.
Q3) As the payments system evolves from barter to a monetary system, ________.
A)commodity money is likely to precede the use of paper currency
B)transaction costs increase
C)the number of prices that need to be calculated increase rather dramatically
D)specialization decreases
Answer: A
Page 5
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Chapter 4: Understanding Interest Rates
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Q1) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding?
A)5 percent
B)10 percent
C)15 percent
D)20 percent
Q2) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________.
A)-3 percent
B)-2 percent
C)3 percent
D)7 percent
Q3) Duration is ________.
A)an asset's term to maturity
B)the time until the next interest payment for a coupon bond
C)the average lifetime of a debt security's stream of payments
D)the time between interest payments for a coupon bond
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Chapter 5: The Behaviour of Interest Rates
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Q1) Demonstrate graphically and explain the effect in the bond market of a decrease in the federal deficit. What is the effect on the interest rate and bond prices? How might capital spending be affected by the deficit?
Q2) Economists recognize that interest rates are typically procyclical, meaning that interest rates increase during economic expansions and decline during recessions. Real income and generally inflation rise and fall with the economy. Using the liquidity preference model of interest rates, give three reasons why interest rates are procyclical.
Q3) If fluctuations in interest rates become smaller, then, other things equal, the demand for stocks ________ and the demand for long-term bonds ________.
A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases
Q4) Use demand and supply analysis to explain why an expectation of interest rate hikes would cause Government bond prices to fall.
Q5) What is the impact on interest rates when the Bank of Canada decreases the money supply by selling bonds to the public?
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Chapter 6: The Risk and Term Structure of Interest Rates
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Q1) According to the liquidity premium theory of the term structure, a flat yield curve indicates that short-term interest rates are expected to ________.
A)rise in the future
B)remain unchanged in the future
C)decline moderately in the future
D)decline sharply in the future
Q2) According to the liquidity premium theory of the term structure ________.
A)bonds of different maturities are not substitutes
B)if yield curves are downward sloping, then short-term interest rates are expected to fall by so much that, even when the positive term premium is added, long-term rates fall below short-term rates
C)yield curves should never slope downward
D)interest rates on bonds of different maturities do not move together over time
Q3) The interest rate on tax-exempt bonds rises relative to the interest rate on U.S. Treasury securities when ________.
A)income tax rates are raised
B)tax-exempt bonds become more widely traded
C)corporate bonds become riskier
D)income tax rates are lowered
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Q1) ________ means people are more unhappy when they suffer losses than they are happy when they achieve gains.
A)Loss fundamentals
B)Loss aversion
C)Loss leader
D)Loss cycle
Q2) The major criticism of the view that expectations are formed adaptively is that
A)this view ignores the fact that people use more information than just past data to form their expectations
B)it is easier to model adaptive expectations than it is to model rational expectations
C)adaptive expectations models have no predictive power
D)people are irrational and therefore never learn from past mistakes
Q3) To say that stock prices follow a "random walk" is to argue that stock prices
A)rise, then fall, then rise again
B)rise, then fall in a predictable fashion
C)tend to follow trends
D)cannot be predicted based on past trends
Page 9
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Chapter 8: An Economic Analysis of Financial Structure
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Q1) Explain the problem of asymmetric information, adverse selection and moral hazard, and why these problems are important for the financial system.
Q2) Of the sources of external funds for nonfinancial businesses in Canada, corporate bonds and commercial paper account for approximately ________ of the total.
A)5 percent
B)10 percent
C)15 percent
D)50 percent
Q3) Because information is scarce ________.
A)helps explain why equity contracts are used so much more frequently to raise capital than are debt contracts
B)monitoring managers gives rise to costly state verification
C)government regulations, such as standard accounting principles, have no impact on problems such as moral hazard
D)developing nations do not rely heavily on banks for business financing
Q4) Explain the "lemons problem" as it applies to the used-car market. Why does this problem exist? How does this market resolve this problem?
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Chapter 9: Financial Crises
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Q1) Financial crises ________.
A)are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms
B)occur when adverse selection and moral hazard problems in financial markets become less significant
C)frequently lead to sharp expansions in economic activity
D)are a free-rider problem
Q2) What were some of the changes to the regulations for real estate lending that were implemented in 2012?
Q3) If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n)________.
A)banking crisis
B)financial recovery
C)reduction of the adverse selection and moral hazard problems
D)increase in information available to investors
Q4) How can asymmetric information lead to a bank panic?
Q5) Describe the declining phase of the leverage cycle.
Q6) Describe the rising phase of the leverage cycle.
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Chapter 10: Economic Analysis of Financial Regulation
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Q1) In terms of international banking crises, deposit insurance ________.
A)was always a key factor
B)couldn't be implicated as it only exists in Canada
C)played a role in a few countries but wasn't consistently complicit
D)is considered to be the best response to financial instability
Q2) The evidence from banking crises in other countries indicates that ________.
A)deposit insurance is to blame in each country
B)a government safety net for depositors need not increase moral hazard
C)regulatory forbearance never leads to problems
D)deregulation combined with poor regulatory supervision raises moral hazard incentives
Q3) Overseeing who operates banks and how they are operated is called ________.
A)prudential supervision
B)hazard insurance
C)regulatory interference
D)loan loss reserves
Q4) What are the three pillars that Basel 2 is based on?
Q5) What is the "too-big-to-fail" policy of the CDIC? how is it associated with asymmetric information problems?
Page 12
Q6) Describe how the CDIC premiums have evolved over the past years.
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Chapter 11: Banking Industry: Structure and Competition
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Q1) Financial innovation has caused ________.
A)banks to suffer declines in their cost advantages in acquiring funds, although it has not caused a decline in income advantages
B)banks to suffer a simultaneous decline of cost and income advantages
C)banks to suffer declines in their income advantages in acquiring funds, although it has not caused a decline in cost advantages
D)banks to achieve competitive advantages in both costs and income
Q2) Prior to 1980, the Fed set an interest rate ________ that is a maximum limit on the interest rate that could be paid on time deposits.
A)floor
B)ceiling
C)wall
D)window
Q3) The entry of GM and Walmart into the credit card business is an indication of
A)government's efforts to deregulate the provision of financial services
B)the rising profitability of credit card operations
C)the reduction in costs of credit card operations since 1990
D)the sale of unprofitable operations by Bank of America and Citicorp
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Chapter 12: Banking and the Management of Financial Institutions
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Sample Questions
Q1) Which of the following statements are true?
A)A bank's assets are its sources of funds.
B)A bank's liabilities are its uses of funds.
C)A bank's balance sheet shows that total assets equal total liabilities plus capital.
D)A bank's balance sheet indicates whether or not the bank is profitable.
Q2) Which of the following are not reported as assets on a bank's balance sheet?
A)Cash items in the process of collection
B)Loans
C)Securities
D)Demand deposits
Q3) If interest rates increase from 3% to 4%, a $100,000 10 year bond with a duration of 8 years would ________ in price by approximately ________.
A)increase; 7.8%
B)decrease; 7.8%
C)increase; 9.7%
D)decrease; 9.7%
Q4) Explain using an example the statement that "given the return on assets, the lower the bank capital, the higher the return for the owners of the bank."
Page 14
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Chapter 13: Risk Management With Financial Derivatives
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Q1) If you sell in April a stock index future contract on the S&P 500 index at the price of 1000 points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is at 900, you have a ________ of $________.
A)loss; 25000
B)loss; 100
C)profit; 25000
D)profit; 100
Q2) Options on individual stocks are referred to as ________.
A)stock options
B)futures options
C)American options
D)individual options
Q3) The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________.
A)premium
B)call
C)strike price
D)put
Q4) Where are financial futures traded? Describe that market.
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Chapter 14: Central Banks and the Bank of Canada
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Q1) Which of the following statements about central bank structure and independence are true?
A)In recent years, with the exception of the Bank of England and the Bank of Japan, most countries have reduced the independence of their central banks, subjecting them to greater democratic control.
B)Before the Bank of England was granted greater independence, the Federal Reserve was the most independent of the world's central banks.
C)Both theory and experience suggest that more independent central banks produce better monetary policy.
D)While the European Central Bank is independent, it is not as independent as the Federal Reserve.
Q2) How do political cycles influence aggregate economic activity?
Q3) Recent research indicates that inflation performance (low inflation)has been found to be best in countries with ________.
A)the most independent central banks
B)the least independent central banks
C)political control of monetary policy
D)a policy of always keeping interest rates low
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Chapter 15: The Money Supply Process
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Q1) The money supply is ________ related to the nonborrowed monetary base, and ________ related to the level of borrowed reserves.
A)positively; negatively
B)negatively; not
C)positively; positively
D)negatively; negatively
Q2) Everything else held constant, a decrease in the desired reserve ratio will mean ________.
A)a decrease in the money supply
B)an increase in the money supply
C)a decrease in chequable deposits
D)an increase in advances to banks
Q3) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is ________.
A)$8000 billion
B)$1200 billion
C)$120 billion
D)$8400 billion
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Chapter 16: Tools of Monetary Policy
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Q1) One of the Bank of Canada's most important roles is to be ________.
A)the Federal government's banker
B)the issuer of government debt
C)a lender-of-last-resort
D)a regulator of banks
Q2) If LVTS participating financial institutions have insufficient settlement balances ________.
A)they can borrow from each other in the pre-settlement trading period at the bank rate
B)they can borrow from each other in the pre-settlement trading period at the overnight rate
C)they can borrow from the Bank of Canada
D)B and C only.
Q3) What is the service provided by the LVTS? why is it important?
Q4) The primary indicator of the stance of monetary policy in the U.S. is the ________.
A)federal funds rate
B)discount rate
C)overnight rate
D)prime rate
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Chapter 17: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) One of the factors that contributed to the success German policymakers had using a monetary targeting type policy was that ________.
A)they used a rigid target for the money growth rate
B)they implemented policy so their inflation rate goal was met in the short run
C)the money target was flexible to allow the Bundesbank to concentrate on other goals as needed
D)they rarely communicated the intentions of policy to the public in order to keep the public from panicking
Q2) Which of the following countries have hierarchical mandates?
A)Reserve Bank of New Zealand
B)Bank of Canada
C)Bank of England
D)all of the above
Q3) Price stability is defined as ________.
A)low inflation
B)low and stable inflation
C)stable inflation
D)core inflation
Q4) What are the advantages inflation targeting?
19
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Chapter 18: The Foreign Exchange Market
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Q1) If the real exchange rate between Canada and Japan is ________, then it is cheaper to buy goods in Japan than in Canada.
A)greater than 1.0
B)greater than 0.5
C)less than 0.5
D)less than 1.0
Q2) One way to understand the short-run behaviour of exchange rates is ________.
A)to use the theory of portfolio choice
B)to understand the exchange rate is the price of one asset in terms of another C)to examine the long-run trends
D)A and B only.
Q3) On January 25, 2009, one Canadian dollar traded on the foreign exchange market for about 49.0 Indian rupees. Thus, one Indian rupee would have purchased about ________ Canadian dollars.
A)0)02
B)1)20
C)7)00
D)49.0
Q4) Explain how trade barriers affect the exchange rates in the long-run.
Q5) Explain how productivity affects exchange rates in the long-run
Page 20
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Chapter 19: The International Financial System
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Q1) Under a fixed exchange rate regime, a central bank that does not want to acquire international reserves to keep its currency from ________ will decide to ________ its currency.
A)depreciating; revalue
B)depreciating; devalue
C)appreciating; revalue
D)appreciating; devalue
Q2) Because the United States was the reserve-currency country under the Bretton Woods system, it could run large balance of payments ________ without ________ significant amounts of international reserves.
A)deficits; losing
B)deficits; gaining
C)surpluses; losing D)surpluses; gaining
Q3) When gold production was low in the 1870s and 1880s, the money supply grew ________ causing ________.
A)rapidly; inflation
B)rapidly; disinflation
C)slowly; deflation
D)slowly; disinflation
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Chapter 20: Quantity Theory, Inflation, and the Demand for Money
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Q1) Keynes's liquidity preference theory indicates that the demand for money is ________ related to ________.
A)negatively; interest rates
B)positively; interest rates
C)negatively; income
D)negatively; wealth
Q2) Keynes's liquidity preference theory indicates that the demand for money ________.
A)is purely a function of income, and interest rates have no effect on the demand for money
B)is purely a function of interest rates, and income has no effect on the demand for money
C)is a function of both income and interest rates
D)is a function of both government spending and income
Q3) Budget deficits can be an important source of ________ monetary policy.
A)inflationary
B)recessionary
C)federal
D)fiscal
Q4) Describe the factors that affect the demand for money.
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Chapter 21: The Is Curve
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Q1) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain negative and firms will continue to ________ production.
A)below; lower
B)above; lower C)below; raise D)above; raise
Q2) Planned investment spending, a component of aggregate demand, is equal to ________.
A)fixed investment plus actual inventory investment
B)fixed investment plus unplanned inventory investment
C)fixed investment
D)fixed investment plus planned inventory investment
Q3) Everything else held constant, a shift in tastes in Canada towards Canadian goods will ________ net exports in Canada and cause the quantity of aggregate output demanded to ________ in Mexico.
A)decrease; rise
B)decrease; fall
C)increase; rise
D)increase; fall
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Chapter 22: The Monetary Policy and Aggregate Demand
Curves
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Q1) If the central bank did not follow the Taylor principle ________.
A)inflation would spiral out of control
B)it could rely on autonomous monetary policy changes
C)it could rely on non-conventional monetary policy tools
D)B and C only
Q2) An autonomous rise in ________ shifts the MP curve to the ________, everything else held constant.
A)net exports; right
B)net exports; left
C)money demand; right
D)money demand; left
Q3) A decline in autonomous planned investment spending causes the equilibrium level of aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.
A)rise; MP; right
B)rise; IS; right
C)fall; IS; left
D)fall; MP; left
Q4) Describe monetary easing at the Bank of Canada during the 2007-2009 Financial Crisis.
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Chapter 23: Aggregate Demand and Supply Analysis
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Q1) The empirical Phillips curve describes a ________ correlation between ________ and inflation.
A)negative; unemployment
B)negative; aggregate output
C)positive; unemployment
D)positive; aggregate output
Q2) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the price level. Be sure to discuss two channels through which changes in prices affect demand.
Q3) The total quantity of final goods and services offered for sale at different price levels is ________.
A)the aggregate supply curve
B)the aggregate demand curve
C)the 45° line
D)A and D only.
Q4) What was the theoretical flaw in the original Phillips curve observes by Friedman and Phelps?
Q5) What is the shape of the long-run aggregate supply curve? Why?
Q6) Explain how not following the Taylor principle leads to unstable inflation
25
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Chapter 24: Monetary Policy Theory
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Q1) In the new classical model, an unanticipated increase in the money supply causes
A)the aggregate demand curve to shift to the right along a stationary aggregate supply curve
B)both the aggregate demand and supply curves to shift simultaneously to the right
C)the aggregate demand curve to shift to the right as the aggregate supply curve simultaneously shifts to the left
D)both the aggregate demand and supply curves to shift simultaneously to the left
Q2) When nominal interest rates are zero, the MP curve has a ________ slope because monetary authorities ________ lower the nominal interest rate and the real interest rate ________ as inflation rates decline.
A)positive; cannot; falls
B)negative; cannot; rises
C)positive; can; falls
D)negative; can; rises
Q3) What three forms does non-conventional monetary policy take?
Q4) What are the objectives of quantitative easing?
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Chapter 25: The Role of Expectations in Monetary Policy
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Q1) Arguments for adopting a policy rule include ________.
A)the time-inconsistency problem can lead to poor economic outcomes
B)discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run
C)policy makers and politicians cannot be trusted
D)all of the above
Q2) An example of a negative aggregate demand shock is ________.
A)a global carbon cap-and-trade program
B)a global financial crisis
C)a decrease in the price of oil
D)thermonuclear war
Q3) Describe how the Bolivian government managed its hyperinflation by introducing credibility.
Q4) The benefits of a credible nominal anchor include ________.
A)acting like a behaviour rule
B)preventing the real business cycle from occurring
C)encouraging activist policy
D)preventing discretion based actions
Q5) Provide some alternate approaches to establishing credibility.
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Chapter 26: Transmission Mechanisms of Monetary Policy
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Q1) The monetarist reduced-form evidence does not specify the working of the economy and thus is considered to be a ________.
A)scientific model
B)open model
C)black box
D)black hole
Q2) Monetarists assert that monetary policy may affect aggregate demand through ________.
A)only an interest rate channel
B)only an exchange rate channel
C)only two channels: interest rates and exchange rates
D)many channels
Q3) Monetarists claim that ________ models ignore important transmission mechanisms and therefore ________ the importance of the effects of monetary policy on the economy.
A)structural; overstate
B)reduced-form; overstate
C)reduced-form; understate
D)structural; understate
Q4) What are the advantages of reduced-form evidence?
Page 28
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Chapter 27: Financial Crises in Emerging Markets
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Q1) An important factor leading up to the Mexican financial crisis of 1994-1995 was
A)the failure of the Mexican oil monopoly
B)increasing loan losses at Mexican banks
C)the ratification of the North American Free Trade Agreement
D)the failure to ratify the North American Free Trade Agreement
Q2) A feature of debt markets in emerging-market countries is that debt contracts are typically ________.
A)very short term
B)long term
C)intermediate term
D)perpetual
Q3) The mismanagement of financial liberalization in emerging market countries can be understood as a severe ________.
A)asymmetric information problem
B)lemons problem
C)principal/agent problem
D)free-rider problem
Q4) Explain what is meant by prudential regulation.
Q5) What is a currency mismatch and why does it create risks?
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Chapter 28: The ISLM Model
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Sample Questions
Q1) If an economy experiences high interest rates and high unemployment, the ISLM framework predicts that ________ policy has been too ________.
A)fiscal; expansionary
B)fiscal; contractionary
C)monetary; expansionary
D)monetary; contractionary
Q2) Everything else held constant, if aggregate output is to the left of the LM curve, then there is an excess ________ of money which will cause the interest rate to ________.
A)supply; fall
B)supply; rise
C)demand; fall
D)demand; rise
Q3) The ________ describes the combinations of interest rates and aggregate output for which the quantity of money demanded equals the quantity of money supplied.
A)IS curve
B)LM curve
C)consumption function
D)investment schedule
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Chapter 29: Non-Bank Finance
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Sample Questions
Q1) The conversion of insurance companies from being owned by policy holders to stock holders is known as ________.
A)conversion
B)securitization
C)demutualization
D)regulation
Q2) Provincial regulation for finance companies does not cover any of the following except for ________.
A)the maximum amount they can loan to individual consumers
B)restrictions on branching
C)assets they hold
D)how they raise their funds
Q3) An investment bank purchases securities from a corporation at a predetermined price and then resells them in the market. This process is called ________.
A)underwriting
B)underhanded
C)understanding
D)undertaking
Q4) How do sovereign wealth funds raise national security issues?
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