Money and Banking Practice Questions
Course Introduction
Money and Banking explores the fundamental role of money in the economy, the structure and functioning of financial institutions, and the operations of central banks. The course covers topics such as the creation and regulation of money, the determinants of interest rates, the process of financial intermediation, and the impact of monetary policy on inflation, unemployment, and economic growth. Students will also analyze the role of banks within the financial system, the functioning of money markets and capital markets, and the relationship between financial stability and economic performance. Through real-world examples and case studies, the course emphasizes the significance of prudent banking practices and effective monetary policy for economic stability.
Recommended Textbook
Money Banking and Financial Markets 4th Edition by Stephen G. Cecchetti
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Page 2
Chapter 1: An Introduction to Money and the Financial System
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Sample Questions
Q1) The largest regulatory change in U.S.financial markets since 1930 is known as: A)Basel III.
B)the Fred-Bob Act.
C)the Gramm-Leach-Bliley Act.
D)the Dodd-Frank Act.
Answer: D
Q2) Identify the five core principles of Money and Banking.
Answer: #1) Time has value; #2) Risk requires compensation; #3) Information is the basis for decisions; #4) Markets determine prices and allocate resources; #5) Stability improves welfare.
Q3) In the United States, control of the quantity of money is given to the: A)President.
B)Federal Reserve System.
C)Bureau of Printing and Engraving.
D)Department of the Treasury.
Answer: B
Q4) Identify the six parts of the financial system.
Answer: They are: money, financial markets, financial instruments, financial institutions, government regulatory agencies, and central banks.
Page 3
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Chapter 2: Money and the Payments System
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Sample Questions
Q1) Have the growth rates of the two measures of money moved together over time? Explain.
Answer: From 1960 to 1980 the growth rates of the two money measures did move together.After 1980 M1 behaved very differently than M2.The main reason for this seems to be the high rates of inflation that began in the late 1970s and fostered innovation into other types of accounts that people could hold to earn a higher return and yet were relatively liquid, such as money market accounts.
Q2) U.S.currency is:
A)A commodity money
B)Fiat money
C)Tied to the value of gold at a fixed rate
D)The only store of value
Answer: B
Q3) M1 is:
A)less than 25% of GDP.
B)equal to GDP.
C)about four times larger than GDP.
D)about one fourth the amount of GDP.
Answer: A
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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 not considered to be a shadow bank?
A)Credit unions
B)Brokerages
C)Insurers
D)Money-market mutual funds
Answer: A
Q2) Why has the pace of structural change in financial markets accelerated in recent years?
Answer: The pace of structural change has accelerated dramatically in the past few years, driven by (1) ongoing technological advances in computing and communications and (2) increasing globalization.The former dramatically lowered the importance of a physical location of an exchange-as new technology allowed the rapid low-cost transmission of orders across long distances-while the latter encouraged unprecedented cross-border mergers of exchanges, integrating larger pools of providers and users of funds.
Q3) Is the obtaining of a car loan a primary or secondary market transaction?
Answer: The obtaining of a car loan is a primary market transaction since the loan represents a newly-issued instrument by the bank.
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Chapter 4: Future Value, Present Value, and Interest Rates
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Sample Questions
Q1) The future value of $100 that earns 10% annually for n years is best expressed by which of the following?
A)$100(0.1)n
B)$100 × n × (1.1)
C)$100(1.1)n
D)$100/(1.1)n
Q2) Which of the following statements is most correct?
A)We can always compute the ex post real interest rate but not the ex ante real rate. B)We cannot compute either the ex post or ex ante real interest rates accurately. C)We can accurately compute the ex ante real interest rate but not the ex post real rate. D)None of the statements are correct.
Q3) 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?
Q4) Explain why an increase in expected inflation will result in an increase in nominal interest rates, holding other factors constant.
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Chapter 5: Understanding Risk
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Sample Questions
Q1) Consider an individual who plans to buy a new home.He has two options: (i) pay for mortgage insurance (that insures the lender in case the borrower defaults), or (ii) pay the lender a higher interest rate for the mortgage.Describe how these two options are related to the concept of risk premium and the lender's aversion to risk.Why does the interest rate on the mortgage differ in these two options?
Q2) The Russian wheat crop fails, driving up wheat prices in the U.S.This is an example of:
A)idiosyncratic risk.
B)diversification.
C)systematic risk.
D)quantifiable risk.
Q3) An investment will pay $2000 a quarter of the time; $1,600 half of the time and $1,400 a quarter of the time.The standard deviation of this asset is:
A)$600
B)$1,650
C)$47,500
D)$217.94
Q4) Explain the rapid rise in popularity of mutual funds.
Q5) Why isn't it correct to say that people who are risk averse avoid risk?
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Sample Questions
Q1) When the price of a bond equals the face value the:
A)yield to maturity will be above the coupon rate.
B)yield to maturity will be below the coupon rate.
C)current yield is equal to the coupon rate.
D)yield to maturity is greater than the current yield.
Q2) If the purchase price of a bond exceeds the face value, the yield to maturity:
A)is greater than the coupon rate because the capital gain is positive.
B)will equal the current yield.
C)will be less than the coupon rate because the capital gain will be negative.
D)will be greater than the current yield.
Q3) Calculate the price of a $1,000 face value bond that offers a $45 annual coupon, and has six years to maturity, when the interest rate is 6.0% (0.060).
Q4) Which of the following best expresses the formula for determining the price of a U.S.Treasury bill that matures n periods from now per $100 of face value when the interest rate is i?
A)$100/(1 + i)<sup>n</sup>
B)$100(1 + i)
C)$100/(1 + i)
D)1 + $100/(1 + i)<sup>n</sup>
Page 8
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Chapter 7: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) During economic slowdowns why would you expect the risk premium to increase the most between U.S.Treasury bonds and junk bonds?
Q2) Explain why most retired individuals are not likely to be heavily invested in municipal bonds.
Q3) Why can't the Expectations Hypothesis stand alone as an adequate theory to explain yield curves?
Q4) Which fact about the term structure is the Expectations Theory able to explain?
A)Why interest rates on bonds with different terms to maturity tend to move together over time.
B)Why yields on short-term bonds are more volatile than yields on long-term bonds.
C)Why longer-term yields tend to be higher than shorter-term yields.
D)Why long-term bonds usually are less liquid than short-term bonds with the same default risk.
Q5) The term structure of interest rates:
A)always results in an upward sloping yield curve.
B)represents the variation in yields for securities differing in maturities.
C)usually results in a flat yield curve.
D)usually results in a downward sloping yield curve.
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Chapter 8: Stocks, Stock Markets, and Market Efficiency
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Sample Questions
Q1) You make a $1,000 investment in the stock of ABC Inc.Over the next year the investment decreases by 60%.What percentage increase do you need in the following year on your holding to be back to $1,000?
Q2) Management fees for mutual funds are:
A)different across funds and can significantly impact the return to an investor.
B)fixed by regulation.
C)fixed by regulation but can vary by the size of the fund.
D)usually a percentage of the return achieved by fund managers.
Q3) 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.
Q4) Considering the return an investor requires from a stock, what are the two components that make up that return? Briefly explain each of these components.
Q5) The theory of efficient markets implies:
A)stock prices should be highly unpredictable.
B)the price at which stocks currently trade only reflect past information.
C)expectations do not play a role in stock prices because this isn't real information.
D)the chartists are in fact correct that there are patterns in stock prices.
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Sample Questions
Q1) Considering a call option, if the price of the underlying asset decreases:
A)the intrinsic value of the option decreases if it is above zero.
B)the intrinsic value of the option increases if it is above zero.
C)the strike price decreases.
D)the value of the option increases.
Q2) The short position in a futures contract is the party that will:
A)deliver a commodity or financial instrument to the buyer at a future date.
B)suffer the loss.
C)accept the risk.
D)benefit from increases in price of the underlying asset.
Q3) If the price of an underlying asset has a standard deviation of zero:
A)options for this asset would likely not exist.
B)option for this asset would be highly valued.
C)the intrinsic value of options for this asset would equal the asset's price.
D)options for this asset would have a time value of the option equal to the price of the asset.
Q4) A lender obtains funds from depositors by offering short-term interest rates on savings accounts.The lender uses these funds to make longer-term installment loans.Explain how the lender might make use of the futures market to hedge the risk taken.
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Chapter 10: Foreign Exchange
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Sample Questions
Q1) Explain why a real exchange rate that does not equal one implies purchasing power parity does not hold.
Q2) Which of the following statements is most correct?
A)If the U.S.$ depreciates relative to the yen, then it is likely also depreciating relative to the euro.
B)If the U.S.$ is appreciating relative to the euro, the euro is likely depreciating relative to the yen.
C)If the U.S.$ is depreciating relative to the euro it is likely depreciating relative to all currencies.
D)If the U.S.$ is appreciating relative to the yen, the yen is depreciating relative to the U.S.$.
Q3) In looking at the foreign exchange rates in the Wall Street Journal you notice the U.S.dollar-euro spot rate is 1.085 /U.S.$ and the six-month forward rate is 1.098 /$.What does this imply?
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 15 times larger than world GDP.
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Chapter 11: The Economics of Financial Intermediation
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Sample Questions
Q1) A home mortgage is a good example of:
A)an unsecured loan.
B)a secured loan.
C)a high risk loan.
D)the problem of adverse selection.
Q2) A borrower who obtains funds from a lender to purchase additional inventory but uses the funds to finance a trip to Las Vegas for a weekend of gambling at the opening of a new casino is an example of:
A)the problem of adverse selection.
B)the free-rider.
C)the moral hazard problem.
D)lax government regulation.
Q3) Discuss the role that companies like Standard & Poor's, Dun & Bradstreet, and Moody's play in solving the problem of adverse selection.
Q4) What is the difference between economies of scale and economies of scope? Provide an example of each that pertains to financial institutions.
Q5) Why is it that financial intermediaries are so important in most economies?
Q6) Explain why deflation can be so troubling to borrowers and lenders.
Q7) What are the five functions performed by financial intermediaries?
Page 13
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Chapter 12: Depository Institutions: Banks and Bank Management
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Sample Questions
Q1) Loans made in the federal funds market:
A)are highly collateralized.
B)are made by the Federal Reserve System to the bank within 24 hours.
C)are unsecured loans.
D)are insured by the FDIC.
Q2) A bank's Return on Assets (ROA) is calculated by dividing:
A)the bank's assets by its net worth.
B)the bank's net profits after taxes by its assets.
C)the bank's net worth by its assets.
D)the bank's assets less its net profit after taxes by its net worth.
Q3) If a bank's return on equity remains constant, but the ratio of bank assets to bank capital decreases:
A)the bank's return on assets must have increased.
B)the bank's return on assets must have decreased.
C)the bank's assets and capital must have increased by the same percent.
D)the bank must be unprofitable.
Q4) A home buyer is presented with two options for financing the purchase of a home: a 20 year fixed rate mortgage or a 20 year adjustable-rate mortgage, where the rate adjusts once a year.Which mortgage would you expect to start at the lowest interest rate and why?
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Chapter 13: Financial Industry Structure
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Sample Questions
Q1) The Federal Deposit Insurance Corporation (FDIC) was created:
A)in 1933 as a part of the Glass-Steagall Act.
B)when the Federal Reserve was created in 1914.
C)prior to the stock market crash of 1929.
D)in 1927 as a part of the McFadden Act.
Q2) An Edge Act Corporation is:
A)a company created so a U.S.bank can operate in more than one state.
B)a subsidiary of a bank created to provide insurance and securities services.
C)a company created by a non-bank corporation used to purchase and operate banks.
D)a subsidiary of a domestic bank that is established specifically to engage in international banking transactions.
Q3) Which of the following is not true about the information and advice investment bankers provide to clients?
A)It is public information that the bank compiles and makes available to anyone.
B)It is highly valued if the fees paid for it are any indication of its value.
C)It is often used to identify possible acquisition and merger candidates.
D)It helps improve the allocation of resources across the economy.
Q4) Explain why anti-branching laws often created credit crunches that slowed economic growth.
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Chapter 14: Regulating the Financial System
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Sample Questions
Q1) In 1873, British economist Walter Bagehot proposed that the central bank function as the lender of last resort.Specifically, he suggested the central bank lend freely to banks which have good collateral at high rates of interest.Why the requirements of good collateral and a high rate of interest?
Q2) Discuss the ramifications of the FDIC reducing deposit insurance limits to $25,000.
Q3) The first test of the Federal Reserve as lender of last resort occurred with the:
A)attack on Pearl Harbor by the Japanese.
B)widespread failures of Savings and Loans in the 1980's.
C)introduction of flexible exchange rates in the U.S.in 1971.
D)stock market crash in 1929.
Q4) A long-standing goal of financial regulators has been to:
A)prevent banks from growing too big and powerful.
B)minimize the competition that banks face.
C)encourage banks to grow as large as possible.
D)discourage small rural banks.
Q5) What is the difference between a bank that is insolvent and one that is illiquid?
Q6) What was the primary motivation behind the creation of the 1988 Basel Accord?
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Chapter 15: Central Banks in the World Today
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Q1) The specific goals of central banks include each of the following, except:
A)high and stable real growth.
B)low and stable inflation.
C)high levels of exports.
D)low and stable unemployment.
Q2) All of the following are true about central bank independence except that it:
A)is usually given at the pleasure of governments.
B)can be eliminated by governments in a time of crisis.
C)is usually guaranteed by a country's constitution.
D)can be subverted by the actions of fiscal policymakers.
Q3) If one of the specific goals that central bankers focus on is economic growth, should they aim for the highest short-term growth rate the economy can achieve? Explain.
Q4) The ability to control inflation expectations is most closely related to a central bank's:
A)transparency.
B)credibility.
C)accountability.
D)willingness to communicate.
Q5) What are the operational components of central bank independence?
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Chapter 16: The Structure of Central Banks: The Federal Reserve
and the European Central Bank
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Sample Questions
Q1) If it is the real rate of interest that savers and borrowers respond to, how does the Fed impact a real rate by targeting a nominal rate of interest?
Q2) The ECB's Governing Council has price stability as a primary objective.It has defined price stability as:
A)a zero rate of inflation.
B)an inflation rate less than 5 percent.
C)an inflation rate below, but close to, 2 percent over the medium term.
D)an inflation rate in the three to five percent range.
Q3) How many members are on the Board of Governors of the Federal Reserve System?
A)Twelve, one for each district
B)Seven
C)Nine
D)Fourteen
Q4) If the current number of participating countries in the Euro system is eighteen as of 2014 and the number of large countries is four (Germany, France, Italy, and Spain), are policies likely to favor small or large countries? Explain.
Q5) Given the democratic political structure of the United States, make an argument against the independence granted the Federal Reserve.
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Chapter 17: The Central Bank Balance Sheet and the Money Supply Process
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Q1) Harry gets $1000 in currency from his grandfather when he graduates from college.He deposits these funds into his checking account.Considering Harry's personal balance sheet, his assets:
A)increased by $1000 when he deposited the $1000 into his checking account.
B)Increased when he received the $1000 in currency from his grandfather.
C)And liabilities increased by $1000 when he deposited the funds into his checking account.
D)Increased by $1000 and his liabilities decreased by $1000 when he deposited the funds into his checking account.
Q2) A central bank's purchase of securities made by writing checks on itself will:
A)decrease the size of its balance sheet.
B)have no impact at all on the balance sheet.
C)increase the size of their balance sheet.
D)only change the composition of its assets.
Q3) If we assume the required reserve rate is ten percent (0.1), and that the public does not change their currency holdings and that banks do not hold any excess reserves, what will be the change in deposits resulting from a $150 million open market purchase by the Fed?
Q4) Why do most central banks publish their balance sheets so frequently?
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Chapter 18: Monetary Policy: Stabilizing the Domestic Economy
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Q1) Central banks that have a hierarchical mandate with inflation targeting basically are saying:
A)hitting the inflation target is the first priority after all other stated objectives are reached.
B)hitting the inflation target is the only objective.
C)the inflation target is the second most important goal after economic growth, which is always the most important goal for monetary policymakers.
D)hitting the inflation target comes first, everything else comes second.
Q2) Discuss why the Fed can either select a quantity or a price (interest rate) target but not both.If it helps, you can use the market for reserves for an example.
Q3) If the current market federal funds rate equals the target rate and the demand for reserves increases, the likely response in the federal funds market will be:
A)a decrease in the market federal funds rate.
B)a market federal funds rate that will equal the target rate.
C)an increase in the market federal funds rate.
D)nothing; the Fed would act immediately and the market would not be affected.
Q4) How do targeted asset purchases alter the outlook for the economy and inflation?
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Chapter 19: Exchange-Rate Policy and the Central Bank
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Sample Questions
Q1) How did the gold standard contribute to the spreading of the Great Depression of the 1930s?
Q2) Which of the following statements is most correct?
A)A fixed exchange rate policy is a lack of a monetary policy.
B)A fixed exchange rate policy is appropriate for a country that lacks a central bank.
C)A fixed exchange rate policy is only appropriate for countries with little international reserves.
D)A fixed exchange rate policy is a monetary policy.
Q3) What are the pros and cons of a currency board?
Q4) When arbitrage occurs across countries with a flexible exchange rate and when the bonds in each country are identical and there are no barriers to capital flows then the:
A)interest rates on the bonds will be identical.
B)expected return on the bonds will be identical.
C)inflation rates in each country will be identical.
D)prices of the bonds will be identical.
Q5) Is the European Monetary Union a form of dollarization? Explain.
Q6) Describe the automatic stabilizers that are lost to a country that fixes its exchange rate to another currency.
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Chapter 20: Money Growth, Money Demand, and Modern Monetary Policy
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Q1) To use money growth as a short-term monetary policy instrument, a central bank must:
A)believe there is a stable link between the monetary base and the rate of inflation.
B)believe that only money matters.
C)believe that there is an unpredictable relationship between money aggregates and inflation.
D)believe the deposit expansion multiplier is volatile and unpredictable.
Q2) How does money velocity contribute to the observation that in countries with high rates of inflation the inflation rate exceeds the rate of money growth?
Q3) Which of the following expresses the equation of exchange?
A)MY = PV
B)MV = Y
C)MV = PY
D)MP = VY
Q4) When the former Soviet Union collapsed in 1990, most of the countries that made up the union experienced extremely high rate of inflation? What was the source of the high inflation and why did it happen?
Q5) What factors can cause the portfolio demand for money to increase?
Page 22
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Chapter 21: Output, Inflation, and Monetary Policy
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Q1) If most people expect the inflation rate will increase, the:
A)long-run aggregate supply curve would shift right.
B)aggregate demand curve would shift right.
C)short-run aggregate supply curve would shift to the right.
D)short-run aggregate supply curve would shift to the left.
Q2) If inflation is very high, say 50 or 100 percent a year, monetary policymakers wishing to lower it will shift their focus to controlling:
A)the long-term interest rate.
B)the short-term interest rate.
C)the exchange rate.
D)money growth.
Q3) What are the determinants of the potential output for an economy?
Q4) Is the actual amount of output that corresponds to the long-run aggregate supply curve fixed? Explain.
Q5) One way inflation reduces aggregate demand is by:
A)increasing nominal GDP.
B)increasing velocity.
C)reducing real balances.
D)increasing wealth.
Q6) Explain why the short-run aggregate supply curve has a positive slope.
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Chapter 22: Understanding Business Cycle Fluctuations
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Q1) 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.
Q2) Negative supply shocks cause shifts in:
A)only the short-run aggregate supply curve.
B)the dynamic aggregate demand curve.
C)the monetary policy reaction curve but only if policymakers do not change their inflation target.
D)the short-run aggregate supply curve and, possibly, the long-run aggregate supply curve.
Q3) Almost all recessions identified by the NBER are characterized by:
A)declining real GDP.
B)higher interest rates.
C)durations exceeding two years.
D)higher rates of inflation.
Q4) Explain the view called real business cycle theory.
Q5) Why can monetary policymakers neutralize demand shocks but not supply shocks?
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) Firm A has assets that are mainly in financial securities and whose liabilities carry variable interest rates; Firm B has the same assets as Firm A and the same amount of liabilities but its liabilities are all at fixed interest rates.If the central bank lowers interest rates, everything else constant:
A)Firm B's net worth will increase more than Firm A's.
B)Firm A's net worth will increase more than Firm B's.
C)Neither firm's net worth will change.
D)The net worth of both firms will increase and by the same amount.
Q2) The interest-rate channel of monetary policy transmission appears to be:
A)weak because the investment component of total spending isn't very sensitive to interest rates.
B)weak because the investment component of total spending is very sensitive to interest rates.
C)strong because the investment component of total spending isn't very sensitive to interest rates.
D)strong because the investment component of total spending is very sensitive to interest rates.
Q3) How does adverse selection factor into explaining the reduced supply of loans when interest rates increase?
Page 25
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