Money and Banking
Mock Exam
Course Introduction
Money and Banking is a comprehensive course that explores the critical roles money, financial institutions, and central banks play in the functioning of the modern economy. Students examine the nature and functions of money, the structure and operation of banking systems, and the influence of monetary policy on economic activity. The course covers topics such as the evolution of money, the creation of credit, the role of commercial banks and the central bank, interest rate determination, and the transmission mechanisms of monetary policy. Analyzing current events and policy issues, students gain insight into the challenges and opportunities facing the financial sector in a global context.
Recommended Textbook
Money Banking and Financial Markets 5th Edition by Stephen Cecchetti
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Page 2
Chapter 1: An Introduction to Money and the Financial System
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Sample Questions
Q1) Which core principle(s) could you use to explain why credit card issuers charge such high rates of interest?
Answer: You could explain the high rates of interest from three principles. First, risk requires compensation, and certainly the credit card issuers are taking a risk when they let people use the cards. There is a risk that some users may not repay the credit card company. Second, you can also justify it from the principle that time has value. The borrowers are using the issuer's funds, and the issuer needs to be compensated for letting the borrower use these funds. Some borrowers do not repay for considerable periods of time. Third, you could also invoke the principle that people use information in making their decisions. Credit card issuers need to acquire information on each applicant before a card is issued and this process is costly. Unfortunately, the applicants who are denied do not get the card, but those who are approved must help cover the information costs.
Q2) Identify which item is not one of the six parts of the financial system.
A) Financial markets
B) Central banks
C) Credit cards
D) Financial institutions
Answer: C
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Chapter 2: Money and the Payments System
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Sample Questions
Q1) Sophia receives a $400 gift card for her campus bookstore from her parents. Which of the following is true regarding the $400 gift card?
A) It is counted only in M1.
B) It is included in both M1 and M2.
C) It is counted in only M2.
D) Stored-value cards are not counted in either M1 or M2.
Answer: D
Q2) The U.S. Treasury estimates that the fraction of U.S. currency held outside the United States is:
A) about one-fourth.
B) about half.
C) between one-half and two-thirds.
D) less than 10%.
Answer: C
Q3) Money eliminates the need for:
A) a search for a double coincidence of wants.
B) government regulation.
C) specialization of labor.
D) financial Intermediaries.
Answer: A
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Sample Questions
Q1) Loans made between borrowers and lenders are:
A) usually not taxable at the federal level.
B) legal only in the state of origination.
C) assets of the lenders.
D) assets of the borrowers.
Answer: C
Q2) An insurance company is an example of a financial institution that:
A) transfers risk.
B) acts as a broker.
C) serves as a depository institution.
D) sells derivative securities.
Answer: A
Q3) Which of the following statements is most correct?
A) Financial intermediaries are banks.
B) A bank is a financial intermediary.
C) Financial intermediaries are insurance companies.
D) Financial intermediaries are essential to direct finance.
Answer: B
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Chapter 4: Future Value, Present Value and Interest Rates
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Sample Questions
Q1) A monthly growth rate of 0.6% is an annual growth rate of:
A) 7.20%
B) 6.00%
C) 7.60%
D) 7.44%
Q2) The shorter the time until a payment the:
A) higher the present value.
B) lower the present value because time is valuable.
C) lower must be the interest rate.
D) higher must be the interest rate.
Q3) Credit:
A) probably came into being at the same time as coinage.
B) predates coinage by 2,000 years.
C) did not exist until the middle ages.
D) first became popular due to the writings of Aristotle.
Q4) How might the behavior of professional investment managers prior to the financial crisis of
2007-2009 contributed to the depth of the plunge of corporate and mortgage security prices during the crisis?
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Chapter 5: Understanding Risk
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Q1) Which of the following would not be included in a definition of risk?
A) Risk is a measure of uncertainty.
B) Risk can always be avoided at no cost.
C) Risk has a time horizon.
D) Risk usually involves some future payoff.
Q2) An investor puts $2,000 into an investment that will pay $2,500 one-fourth of the time; $2,000 one-half of the time, and $1,750 the rest of the time. What is the investor's expected return?
A) 12.5%
B) $250.00
C) 6.25%
D) 3.125%
Q3) An individual owns a $100,000 home. She determines that her chances of suffering a fire in any given year to be 1/1000 (0.001). She correctly calculates her expected loss in any year to be
$100. Explain why this really isn't a good way to measure her potential for loss.
Q4) What is the probability of tossing a pair of dice once and getting a 1? How about a 7?
Q5) Explain why a riskier asset offers a higher expected return.
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Sample Questions
Q1) The impact of a decrease in expected inflation in the bond market will have a relatively large effect on the prices of bonds prices because the bond demand curve:
A) will shift right as will the bond supply curve.
B) will shift right but the bond supply curve shifts left.
C) and supply curves will shift left.
D) will shift left as the bond supply curve shifts right.
Q2) If the U.S. government's borrowing needs increase, all other factors constant the:
A) price of bonds will increase.
B) supply of bonds will increase.
C) demand for bonds will decrease.
D) supply of bonds and the demand for bonds will both increase.
Q3) If you were going to issue bonds, would you prefer to be in a country where the average inflation rate is 3% inflation but fluctuates wildly, or in a country with a higher, 4% expected inflation rate that is stable (meaning it's always 4%). Explain.
Q4) Calculate the holding period return for a $1,000 face value bond with a $60 annual coupon purchased for $970.00 and sold three years later for $1,060.00.
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Page 8
Chapter 7: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) Suppose that interest rates are expected to remain unchanged over the next few years. However, there is a risk premium for longer-term bonds. According to the liquidity premium theory, the yield curve should be:
A) upward sloping and very steep.
B) upward sloping and relatively flat.
C) inverted.
D) vertical.
Q2) In 2003, ratings agencies downgraded bonds issued by the State of California several times. How will this affect the market for these bonds?
A) Yields on these bonds will decrease and the yield on Treasury bonds will increase.
B) The yield on these bonds will not change, nor will the yield on Treasury bonds.
C) The yield on these bonds and on Treasury bonds will both decrease.
D) Yields on these bonds will increase.
Q3) Under the expectations hypothesis of the term structure of interest rates, explain the impact of a U.S. Treasury decision to phase out the 30-year bond and to only focus on 3-month,
1-year, 5-year and 10-year bonds?
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Page 9
Chapter 8: Stocks, Stock Markets and Market Efficiency
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Sample Questions
Q1) Why does the Dow Jones Industrial Average have a value over 15,000 when the 30 stocks that make up the index all have values less than $200 per share?
Q2) Many small companies currently pay no dividends to their shareholders. Based on the dividend discount model, how is it possible for these stocks to sell for a positive price?
Q3) This is a two-part question: We have a firm that needs $1000 to obtain a new machine for its business. It can either issue stock or bonds, or some combination of both. If it issues bonds it will have to pay $8.00 in interest for every $100 borrowed. Finally, assume the company will earn $150 in good years and $75 in bad years, with equal probability. The first part of the question is to (a) determine the payment to the equity holders under the following three scenarios: (i) the first is the firm uses 0% debt financing; (ii) the second is the firm uses 50% debt financing, and (iii) the third finds the firm using 80% debt financing. The second part of the question is to (b) determine the expected equity return (%) under each scenario.
Q4) From the perspective of the theory of efficient markets, explain why it may be difficult for professional portfolio managers who have an exceptional year to continuously outperform the market average.
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Page 10
Chapter 9: Derivatives: Futures, Options, and Swaps
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Sample Questions
Q1) The user of a commodity who is trying to insure against the price of the commodity rising would:
A) take the short position in a futures contract.
B) take the long position in a futures contract.
C) be better off speculating on price movements and earning higher profits.
D) want to hedge by selling a futures contract.
Q2) How did CDS' contribute to the financial crisis of 2007-2009?
Q3) Options are popular because of all of the following EXCEPT:
A) stock prices are volatile.
B) they offer a tool to transfer risk.
C) they present a tool to limit losses but also limit gains.
D) they offer opportunities for high leverage.
Q4) If the option holder is the individual with the options, why is anyone an option writer?
Q5) The intrinsic value of a call option:
A) is the difference between the option price and the interest rate.
B) must be less than or equal to zero.
C) is the greater of zero or the difference between the price of the underlying asset and the strike price.
D) will be negative if the time value of the option is negative.
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Chapter 10: Foreign Exchange
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Sample Questions
Q1) A U.S. resident who wants to purchase an automobile that comes from Japan:
A) will be supplying yen on the foreign exchange market.
B) will make up part of the demand for dollars on the foreign exchange market.
C) will make up part of the supply of dollars on the foreign exchange market.
D) will not be a participant in the foreign exchange market.
Q2) Explain why many industrialized countries do not often intervene in the foreign exchange market.
Q3) The law of one price fails as a result of:
A) low tariffs.
B) insignificant transportation costs.
C) similar technical specifications.
D) goods that cannot be traded.
Q4) 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?
Q5) The theory of purchasing power parity assumes:
A) the real exchange and nominal exchange rates are fixed.
B) the nominal exchange rate is fixed but the real exchange rate is flexible.
C) the real exchange rate is fixed but the nominal exchange rate is flexible.
D) the real exchange rate varies with the inflation differential.
Page 12
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Chapter 11: The Economics of Financial Intermediation
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Sample Questions
Q1) In the bond market, the assigning of a risk premium is a tool designed to address the problem of:
A) adverse selection.
B) information asymmetry.
C) the free-rider.
D) moral hazard.
Q2) Recent history has shown that the government regulations requiring the disclosure of information from public corporations have:
A) all but eliminated the problems of asymmetric information.
B) reduced but not eliminated the problems of asymmetric information.
C) just about eliminated the market for information services.
D) resulted in symmetric information.
Q3) Financial intermediaries reduce the problems in lending associated with information asymmetries by all of the following except:
A) collecting and processing standardized information.
B) screening applicants to be sure they are creditworthy.
C) monitoring loan recipients to be sure the funds are used properly.
D) charging interest rates high enough to discourage undesirable borrowers.
Q4) Explain why deflation can be so troubling to borrowers and lenders.
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Chapter 12:Depository Institutions: Banks and Bank Management
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Sample Questions
Q1) If a bank has $150 million in assets and a net worth of $20 million, its asset-to-equity ratio is:
A) 6.5 to 1.
B) 7.5 to 1.
C) 0.13 to 1.
D) 0.15 to 1.
Q2) Which of the following is a bank asset?
A) Demand deposits
B) Borrowings from other banks
C) Mortgage loans
D) CDs
Q3) A bank faces foreign exchange risk when:
A) it has assets denominated in one currency and liabilities in another.
B) it lends to foreign borrowers because they are less likely to repay a U.S. bank.
C) foreign governments restrict dollar-denominated payments.
D) it has branches in other countries.
Q4) The primary difference among various kinds of depository institutions is in the composition of their loan portfolios. Agree or disagree? Explain.
Page 14
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Chapter 13:Financial Industry Structure
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Sample Questions
Q1) A young father needing to provide his family with financial security would be better off purchasing:
A) a whole life insurance policy.
B) a term life insurance policy.
C) as much life insurance as they can afford.
D) no life insurance; instead he should focus on saving.
Q2) Finance companies perform all of the following functions, except:
A) issue commercial paper and securities.
B) take deposits.
C) make loans.
D) lease equipment to firms.
Q3) One way that a bank could offer non-bank services across more than one state was to:
A) file for a foreign bank charter.
B) be a federally chartered bank rather than a state chartered bank.
C) create a bank holding company.
D) become a central bank.
Q4) 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.
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Chapter 14: Regulating the Financial System
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Sample Questions
Q1) If the government did not offer the too-big-to-fail safety net:
A) large banks would be more disciplined by the potential loss of large corporate accounts.
B) the moral hazard problem of insuring large banks would increase.
C) the moral hazard problem of insuring large banks would not be affected.
D) the FDIC deposit insurance limits would have to be raised.
Q2) The existence of a lender of last resort creates moral hazard for bank managers because:
A) they have an incentive to take too much risk in their operations.
B) officials are likely to undervalue the bank's portfolio of assets.
C) they are less likely to apply for a direct loan from the central bank.
D) banks seek loans from the central bank only after exploring other options.
Q3) The purpose of the government's safety net for banks is to do each of the following, except:
A) protect the integrity of the financial system.
B) eliminate all risk that investors face.
C) stop bank panics.
D) improve the efficiency of the economy.
Q4) How does the lender of last resort potentially create a moral hazard problem?
Q5) 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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Sample Questions
Q1) 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.
Q2) The monetary policy framework is:
A) the law that created the Federal Reserve System.
B) the idea that central banks should be interconnected across countries.
C) a way to prioritize and implement the central bank's objectives when they are in conflict.
D) a growing belief that there should be one central bank headquartered at the World Bank.
Q3) Which is a function of modern central banks?
A) To control securities markets
B) To control the government's budget
C) To control the availability of money and credit
D) To manage fiscal policy
Q4) Discuss how the goals of central bankers can be linked to risk and the ability or inability of individuals to eliminate this risk.
Q5) What are the operational components of central bank independence?
Page 17
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Chapter 16: The Structure of Central Banks: The Federal
Reserve and the European Central Bank
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Q1) Currently the requirement of holding a non-interest-bearing reserve account at the Fed must be met by:
A) all banks, member or not.
B) only member banks.
C) member banks and nonmember banks over $100 million in assets.
D) only nationally chartered banks.
Q2) Which of the books used at the FOMC meetings is/are treated as secret documents and not released to the public until after a number of years have passed?
A) The Bluebook and the Beigebook
B) The Beigebook and the Greenbook
C) The Tealbook
D) The Bluebook and the Greenbook
Q3) The European Central Bank has ensured independence by appointing Executive Board members for:
A) life.
B) eight-year non-renewable terms.
C) fourteen-year terms.
D) twenty-year terms.
Q4) Who makes up the voting members of the Federal Reserve's Open Market Committee?
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Chapter 17: The Central Bank Balance Sheet and the Money
Supply Process
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Sample Questions
Q1) Tom decides to withdraw $300 out of his checking account. The impact of this transaction on the Fed's balance sheet will be:
A) no change in total assets or total liabilities, but an increase in the liability of currency and a decrease in the liability of reserves by $300 respectively.
B) no change in total assets but the liability of currency increases by $300.
C) total assets decrease by $300 and the liability of currency increases by $300.
D) no change in either total assets or total liabilities.
Q2) Mary decides to withdraw $500 out of her checking account. The impact of this transaction on the Banking System's balance sheet will be to:
A) only reduce checkable deposits by $500.
B) increase reserves and reduce checkable deposits by $500 respectively.
C) decrease reserves and checkable deposits by $500 respectively.
D) only reduce reserves by the required reserve rate times $500.
Q3) What happens to the monetary base if people, fearing a bank run, convert their checking deposits into currency holdings?
Q4) Why do most central banks publish their balance sheets so frequently?
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Page 19
Chapter 18:Monetary Policy: Stabilizing the Domestic Economy
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Sample Questions
Q1) Given the following formula for the Taylor rule: ?Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap) If the current rate of inflation is 4%, natural rate of interest is 2%, and the target rate of inflation is 2%, and output is 3% above its potential, the target federal funds rate would be: ?
A) 7%.?
B) 8.5%.?
C) 5%.?
D) 4.5%.
Q2) The key to the success of forward guidance as a monetary policy tool is:
A) timing.
B) a favorable exchange rate.
C) transparency.
D) credibility.
Q3) The interest rate on primary credit extended by the Fed is?
A) the average of the prime interest rate charged by the ten largest banks in the nation?
B) below the IOER?
C) equal to the IOER?
D) above the IOER
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Chapter 19:Exchange Rate Policy and the Central Bank
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Q1) Imagine the exchange rate between the British pound (£) and the U.S. dollar ($) is fixed at $1.40/£ and capital flows freely between Great Britain and the U.S. Explain what the price of shares of stock in XYZ Inc. would be selling for in London if they are $80 per share in the U.S. and why.
Q2) The Breton Woods System was an agreement that:
A) required each participating country to peg their currency to the U.S. dollar.
B) required each participating country to abolish all trade barriers.
C) required each participating country to stay on the gold standard.
D) standardized tariffs across all participating countries.
Q3) An open-market purchase of foreign bonds to increase a central bank's international reserves:
A) increases the central bank's liabilities and assets.
B) decreases the central bank's assets and liabilities.
C) increases the central bank's assets but decreases its liabilities.
D) increases the central bank's liabilities and decreases its assets.
Q4) Compare the monetary policy of the 50 states that make up the United States to the exchange rate regime of dollarization.
Q5) What are the pros and cons of a currency board?
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Chapter 20:Money Growth, Money Demand and Modern Monetary Policy
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Q1) To say that the relationship between the velocity of money and the opportunity cost of holding money is not stable is the same as saying:
A) the supply of money is not stable.
B) the money market is always in disequilibrium.
C) money demand is stable.
D) money demand is not stable.
Q2) The equation for money demand expressed in the chapter that is derived from the equation of exchange is:
\( M^{d}=\frac{1}{V} P Y \)
We see that the equation does not explicitly address the interest rate. In fact, Professor Fisher assumed that velocity is constant which means 1/V is also a constant. Why do you think Professor Fisher left the interest rate out of the equation? Do you think he would if he were alive today? Explain.
Q3) During economic slowdowns (recessions) the velocity of money tends to:
A) remain relatively stable.
B) increase slightly.
C) increase dramatically.
D) decrease.
Q4) In what ways have financial innovations affected the demand for money?
Page 22
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Chapter 21:Output, Inflation, and Monetary Policy
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Q1) How would the discovery of a previously unknown large reserve of oil affect the short-run aggregate supply curve and why? What other change could have the same effect?
Q2) Which of the following is not a part of aggregate expenditure?
A) Consumption
B) The nominal interest rate
C) Government purchases
D) Net exports
Q3) Explain the changes that would cause the dynamic aggregate demand curve to shift.
Q4) A monetary policy reaction curve requires the central bank to have a(n):
A) money growth target.
B) inflation target.
C) unemployment target.
D) economic growth target.
Q5) Rank the components of aggregate demand by their sensitivity to changes in the real interest rate. Start with the most sensitive to the least sensitive.
Q6) Why would central bankers have to pay attention to forecasts regarding consumer sentiment and expectations of business owners and managers?
Page 23
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Chapter 22:Understanding Business Cycle Fluctuations
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Q1) Unemployment insurance and the proportional nature of the tax system are examples of:
A) discretionary fiscal policy.
B) automatic fiscal policy.
C) both discretionary and automatic fiscal policy.
D) expansionary fiscal policy.
Q2) Why do increases in potential output allow monetary policymakers to think "opportunistically" about disinflation?
Q3) In which situation would policymakers be unable to neutralize the effect on the economy?
A) The federal government runs a deficit
B) An increase in the price of oil
C) Imports exceed exports
D) Consumer confidence declines
Q4) In an economy like the United States, the impact of a decrease in import prices on overall inflation can be best described as:
A) nonexistent.
B) a modest increase.
C) a modest decrease.
D) a significant decrease, particularly as globalization and trade increase.
Page 24
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) The movement away from bank lending towards asset-backed securities has:
A) increased the importance of the bank-lending channel of monetary policy.
B) eliminated the bank-lending channel as a mechanism for monetary policy.
C) decreased the importance of the bank-lending channel.
D) led the FOMC to abandon interest-rate targets.
Q2) The Federal Reserve surveys lending officers regularly to:
A) determine the interest rates they charge.
B) get a feel for the supply and demand for loans.
C) get a feel for the quantity and quality of loans.
D) all of the answers given are correct.
Q3) The Federal Reserve's surveys of bank loan officers contain questions about:
A) the interest rates being charged.
B) the supply of and demand for loans.
C) the quantity and quality of loans.
D) all of the answers given are correct.
Q4) Explain why a corporation may find it advantageous to undertake greater investment when the value of its stock shares increase.
Q5) Why is deflation, combined with a recessionary gap, and a nominal interest rate that cannot be reduced a monetary policymaker's nightmare?
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