Money and Banking
Solved Exam Questions
Course Introduction
This course explores the fundamental principles of money, banking, and financial institutions within the context of the global economy. Students will examine the functions and evolution of money, the creation and regulation of money supply, and the roles of central banks such as the Federal Reserve. The course also covers the structure and operation of financial markets, the management of interest rates, and the effects of monetary policy on economic growth and stability. Through real-world case studies and analysis, students will develop an understanding of how monetary institutions and banking systems influence both domestic and international financial environments.
Recommended Textbook
Money Banking and Financial Markets 4th Edition by Stephen G. Cecchetti
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Chapter 1: An Introduction to Money and the Financial System
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Sample Questions
Q1) Mutual funds have:
A)been created for very wealthy individuals with a lot of money to invest.
B)increased the risks associated with constructing a portfolio.
C)reduced the costs associated with gathering information on stocks and bonds.
D)increased the transactions costs associated with participating in financial markets.
Answer: C
Q2) If the U.S.Supreme Court ruled that states could no longer require people to have auto insurance, do you think most people would cancel their policies? Explain. Answer: Probably not.Auto insurance falls under the principle that risk requires compensation.For most people the additional risk they would face of driving without insurance exceeds the cost of the insurance, so they are better off purchasing auto insurance to reduce their risk.
Q3) The New York Stock Exchange is an example of a:
A)financial instrument.
B)financial institution.
C)financial market.
D)bank.
Answer: C
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Chapter 2: Money and the Payments System
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Sample Questions
Q1) M1 has decreased in its usefulness in understanding inflation due to:
A)the increased use of checks in the economy.
B)the introduction of money market mutual fund shares and similar checking substitutes.
C)more reliance on the use of currency.
D)the increased use of electronic payments.
Answer: B
Q2) Which of the following would not be considered a characteristic of money?
A)It is a store of value.
B)It is a means of payment.
C)It must have intrinsic value.
D)It is a unit of account.
Answer: C
Q3) When the Continental Congress issued currency to finance the Revolutionary War, the Continental Congress:
A)issued too many "continentals," eventually making the currency worthless.
B)tied the value of the "continental" to gold.
C)tied the value of the "continental" to gold to French "assignats."
D)made "continentals" legal tender.
Answer: A
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Sample Questions
Q1) Secondary financial markets:
A)are financial markets for all financial instruments rated less than investment grade.
B)are financial markets where existing securities are bought and sold.
C)eliminate the transaction costs for buyers and sellers.
D)are only for stock.
Answer: B
Q2) A futures contract is an example of:
A)a derivative instrument.
B)an instrument used solely by financial institutions.
C)a high-risk security that will only have value if certain events occur.
D)a contract that is traded but is not a financial instrument.
Answer: A
Q3) Which of the following is likely to be a primary financial market transaction?
A)You cash the check your grandmother sent you for your birthday.
B)You call a broker and purchase bonds for your retirement fund.
C)A city issues bonds to finance new road construction.
D)A supermarket needs to borrow the funds for a second location and takes out a loan from a commercial bank to pay for it.
Answer: C
Page 5
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Chapter 4: Future Value, Present Value, and Interest Rates
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Q1) Compound interest means that:
A)you get an interest deduction for paying your loan off early.
B)you get interest on interest.
C)you get an interest deduction if you take out a loan for longer than one year.
D)interest rates will rise on larger loans.
Q2) Discussions in recent years about the vulnerability of the Social Security System cause some people to feel the payments promised will not materialize.Discuss the possible changes we might observe now.
Q3) Explain the suggestion that people may have their own "personal discount rate" and how that may affect decisions about borrowing and other financial matters.
Q4) 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.
Q5) Explain why the Fisher equation is not highly accurate at high rates of inflation.Use an example.
Q6) Explain why, if real interest rates are so important, we see most interest rates quoted in nominal terms.
Page 6
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Chapter 5: Understanding Risk
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Q1) What would be the standard deviation for a $1000 risk-free asset that returns $1,100?
Q2) If ABC Inc.and XYZ Inc.have returns that are perfectly positively correlated:
A)adding XYZ Inc.to a portfolio that consists of only ABC Inc.will reduce risk.
B)adding ABC Inc.to a portfolio that includes only XYZ Inc.will increase risk.
C)adding XYZ Inc.to a portfolio that consists of only ABC Inc.will neither increase nor decrease the risk of the portfolio.
D)adding XYZ Inc.to a portfolio that consists of only ABC Inc.will neither increase nor decrease idiosyncratic risk but will lower systematic risk.
Q3) An individual faces two alternatives for an investment: Asset A has the following probability return schedule:
Q4) Diversification is the principle of:
A)eliminating risk.
B)reducing the risk we carry to just two.
C)holding more than one asset to reduce risk.
D)eliminating investments from our portfolio that have idiosyncratic risk.
Q5) How are the decisions of government policy makers, such as the Federal Reserve, related to risk and an individual investor's portfolio?
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Page 7
Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Sample Questions
Q1) Suppose a family member approaches you to borrow $2,000 for the down payment on an automobile.You have the cash available in a savings account that currently earns 5% annual interest.You and the family member consider the following repayment options:
(i) Borrower repays $259 each year over the next ten years.
(ii) Borrower repays $300 each year over the next five years, plus a lump-sum payment of $895 in the fifth year.
(iii) Borrower repays you $2,100 at the end of one year.
For each of the options above, show that the present values of each option are approximately equal.Then, relate each of the options above to the four types of bonds, indicating which option is equivalent to which type of bond.Explain why.
Q2) U.S.government bonds that provide for bondholders to receive a fixed rate of interest plus the change in the consumer price index were designed to remove:
A)default risk.
B)liquidity risk.
C)inflation risk.
D)interest-rate risk.
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Chapter 7: The Risk and Term Structure of Interest Rates
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Sample Questions
Q1) A flight to quality refers to a move by investors:
A)away from bonds towards stocks.
B)towards securities of other countries and away from U.S.Treasuries.
C)towards precious metals and away from U.S.Treasury bonds.
D)away from low-quality bonds towards high-quality bonds.
Q2) An inverted yield curve is a valuable forecasting tool because:
A)the yield curve usually is inverted so it reflects a growing economy.
B)the yield curve seldom is inverted and can signal an economic slowdown.
C)investors are expecting higher short-term rates in the future, and this usually signals an economic slowdown.
D)inverted yield curves signal better economic times are expected.
Q3) If the Federal Reserve surprises investors by announcing an easing of monetary policy:
A)it should have no impact on the slope of the yield curve.
B)we should expect the yield curve to possibly become inverted.
C)the yield curve would flatten.
D)we should expect the yield curve to steepen.
Q4) Why do economists pay particular attention to inverted yield curves?
Q5) Explain why an inverted yield curve is a valuable forecasting tool.
Q6) Briefly describe the two different types of junk bonds (high-yield bonds).
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Chapter 8: Stocks, Stock Markets, and Market Efficiency
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Q1) Discuss whether the economy would be more or less efficient if public corporations issued fewer shares of stock.
Q2) 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?
Q3) What price would an individual be willing to pay today for a stock that is expected to sell for $100 two years from now and which pays an annual dividend that is $6.00? Assume the individual has a discount rate of 8% (0.08).
Q4) After one year, a company will pay $20 in dividends.It commits to paying $21 two years from the current date.This growth rate in dividends is expected to continue indefinitely.The interest rate is 8%.Compute the current price of this stock, using the dividend-discount model.
Q5) The stock market bubble of the late 1990s and early 2000s:
A)saw internet and computer technology companies over-invest.
B)saw an efficient allocation of resources toward the high-growth computer/internet sector.
C)was a good example of the theory of efficient markets.
D)was an example that not all bubbles burst.
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Q1) There's a call option written for 100 shares of GM stock for $85.00 a share, prior to the third Friday of October 2017: The option writer:
A)has the option but not the requirement of selling 100 shares of GM for $85.00.
B)will sell 100 shares of GM for $85.00 on the third Friday of October 2017.
C)has the option to back out of this contract prior to the third Friday of October 2017.
D)is required to post margin.
Q2) The time value of the option can best be defined as (excluding its intrinsic value):
A)the commission earned by a broker.
B)the fee earned for the potential benefits from buying the option.
C)the service fee charged by the SEC for regulating the option market.
D)the fee paid for the potential benefits from buying an option.
Q3) The clearing corporation's main role in the futures market is to:
A)set the market price of the contract.
B)act as the counterparty to both sides of the transaction, thereby guaranteeing payment.
C)provide the underlying assets so the contracts can be created.
D)all of the above.
Q4) What are the three main ways to categorize derivatives?
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Chapter 10: Foreign Exchange
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Q1) An increase in European wealth, all other factors held constant should:
A)have no impact at all on the demand for dollars.
B)cause the demand for dollars to decrease.
C)cause the demand for dollars to increase.
D)cause the supply of dollars to increase while the demand stays constant.
Q2) Considering foreign exchange transactions:
A)the U.S.dollar is exchanged in roughly 50% of all currency transactions.
B)all transactions involve the use of the U.S.dollar.
C)most of these transactions are handled in New York.
D)more transactions are handled in London than anywhere else.
Q3) The theory of purchasing power parity says:
A)the real exchange rate is always greater than one.
B)a dollar should buy the same goods no matter where in the world you go.
C)the dollar price of a basket of goods in the U.S.should equal the yen price of a basket of goods in Japan.
D)the real exchange rate is always less than one.
Q4) Explain why the law of one price may best be applied to financial assets.
Q5) If a country is running a current account deficit year after year, what should we expect to happen to the exchange rate for that country? Explain.
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Chapter 11: The Economics of Financial Intermediation
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Sample Questions
Q1) The screening process a bank follows for a loan applicant:
A)uses information that anyone can obtain, the bank can usually obtain it cheaper.
B)includes information that can be available to other firms, as well as proprietary information that only the bank would have.
C)is based on just public information.
D)uses only confidential information.
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) A firm that has a well-earned reputation for providing high quality:
A)has found a way to address the free-rider problem.
B)has found a way to address the moral hazard problem.
C)has found a way to address the problem of adverse selection.
D)will not survive in a market if low quality is provided at a lower price.
Q4) Explain why deflation can be so troubling to borrowers and lenders.
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Page 13
Chapter 12: Depository Institutions: Banks and Bank Management
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Sample Questions
Q1) If a bank has a net worth that is negative, what do you know about the relationship between the amounts the bank has in assets and liabilities?
Q2) If Bank A sells some its loans to Bank B for cash, everything else equal:
A)Bank A's assets decrease and Bank B's assets increase.
B)Bank A becomes less liquid while Bank B becomes more liquid.
C)Banks A's total assets do not change, but Bank A is more liquid.
D)Bank A's liabilities decrease by the amount of the loans that are sold.
Q3) Considering that, on average, the return on assets is the same for small and large banks, and the return on equity is higher for large banks than small banks, what can be one of the explanations for the trend toward bank mergers?
Q4) You are provided with the following information: a bank has a net income after taxes of $3.5 million; it has assets of $150 million; and bank capital of $12.5 million.What is the bank's return on assets; its return on equity, and its debt-to-equity ratio?
Q5) A bank's reserves include:
A)vault cash.
B)U.S.Treasury Securities.
C)the bank's loan portfolio.
D)U.S.Treasury bills and vault cash.
Page 14
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Chapter 13: Financial Industry Structure
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Sample Questions
Q1) One of the results of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 was:
A)a reversal of the branching restrictions of the McFadden Act.
B)an increase in the number of banks in the U.S.
C)a decrease in the average size of banks.
D)a decrease in commercial banks but an increase in the number of savings and loans and savings banks.
Q2) In the early years of the Great Depression, 1929-1933:
A)over one half of all U.S.banks failed.
B)two-thirds of U.S.banks failed.
C)more than a third of all U.S.banks failed.
D)a little less than one-quarter of U.S.banks failed.
Q3) Over the last twenty years in the U.S., the number of banks has:
A)steadily increased.
B)stayed about the same.
C)steadily decreased.
D)more than doubled.
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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Q1) Governments supervise banks mainly to do each of the following, except:
A)reduce the potential cost to taxpayers of bank failures.
B)be sure the banks are following the regulations set out by banking laws.
C)reduce the moral hazard risk.
D)eliminate all risk faced by investors.
Q2) 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.
Q3) Why is it that a run on a single bank can turn into a widespread financial panic, or what the text identified as contagion?
Q4) If the lender of last resort function of the government is to be effective in working to minimize a crisis, it must be:
A)reserved only for those banks that are most deserving.
B)used on a limited basis.
C)credible, with banks knowing they can get loans quickly.
D)only available during economic downturns.
Q5) 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) Predict how monetary policymaking would change, if at all, if members of the Board of Governors of the Federal Reserve were popularly elected to two-year terms and could run for re-election.
Q2) One problem for the Federal Reserve regarding setting policy stems from the fact that:
A)there are multiple goals that may be inconsistent with each other.
B)there are more policy instruments than goals.
C)Congress sets very tight goal ranges that the central bankers must hit.
D)the membership of its governing board changes so often.
Q3) The 1990s saw inflation fall and real growth increase in the U.S.and in many other countries.This is partially attributed to all of the following except:
A)technological innovation.
B)redesign of many central banks.
C)central banks became better at their jobs.
D)central banks focused more on exchange rates in a global environment.
Q4) The Federal Reserve didn't always communicate its actions to the public like it does today.As recently as the mid 1990s, secrecy ruled.Why do you think the Fed and most central banks now are more public about their actions and the reasons for them?
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Chapter 16: The Structure of Central Banks: The Federal
Reserve and the European Central Bank
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Q1) The objectives set for the Fed by Congress are:
A)very specific; this adds to the Fed's accountability.
B)by design, quite vague, allowing the Fed to really set its own goals.
C)specific regarding inflation, but vague on all other goals.
D)specific on the growth rate for the economy, but vague on all other objectives.
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 blue book and the beige book
B)The beige book and the green book
C)The teal book
D)The blue book and the green book
Q3) Why did it take almost 150 years before the U.S.had a permanent central bank?
Q4) During World War II, the Fed accommodated the war effort by:
A)significantly curtailing credit in the economy.
B)keeping bond prices high and interest rates low.
C)selling any Treasury securities the public did not purchase.
D)curtailing credit and keeping bond prices high.
Q5) What are the three branches that make up the Federal Reserve System?
Q6) Who makes up the voting members of the Federal Reserve's Open Market Committee? Page 18
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Chapter 17: The Central Bank Balance Sheet and the Money
Supply Process
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Q1) When the Fed makes a discount loan, the impact on the Banking System's balance sheet is:
A)an increase in liabilities with no change in assets.
B)an increase in assets and a decrease in liabilities.
C)a decrease in assets and an increase in liabilities.
D)the same as that of an open market purchase.
Q2) Monetary policy operations for central banks are run through changes in the liability category of:
A)government's accounts.
B)currency.
C)reserves.
D)gold.
Q3) Why would it be correct to say that, if we assume that people do not change their currency holdings and that banks do not hold any excess reserves, the equation
Q4) If reserves pay interest below the market federal funds rate, why would a bank hold any excess reserves?
Q5) Given the prevalence of electronic payment mechanisms like credit cards and debit cards and the safety of checks, why is the amount of currency in the hands of the public increasing?
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Chapter 18: Monetary Policy: Stabilizing the Domestic Economy
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Q1) Which of the following would be categorized as an unconventional monetary policy tool?
A)Discount window lending
B)Targeted asset purchases
C)Federal funds rate target
D)Deposit rate
Q2) The Fed could use reserve requirements as a monetary policy instrument.In terms of desirable features for policy instruments, assess the viability of using reserve requirements.
Q3) Which of the following statements is most correct?
A)The FOMC is more successful at keeping the market rate closer to the target rate than the ECB.
B)The FOMC is more successful than the ECB at keeping the market rate within a 100 basis point band of the target rate.
C)The ECB has kept the market rate within a 100 basis point band of the target rate; the FOMC cannot make this claim.
D)The ECB seldom has the market rate within 100 basis points of the target rate.
Q4) Explain the three desirable features of a good monetary policy instrument.
Q5) Is discount lending used to keep banks from failing? Explain.
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Chapter 19: Exchange-Rate Policy and the Central Bank
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Q1) Purchasing power parity implies:
A)a basket of goods should sell for the same price in all countries, even if trade barriers exist.
B)a basket of goods will sell for the same price in all countries as long as there are no trade barriers is a free flow of capital across borders.
C)a basket of goods cannot sell for the same price in different countries due to the different wage rates.
D)as long as all goods and services are traded freely across international boundaries, one unit of domestic currency should buy the same basket of goods anywhere in the world.
Q2) Fixed exchange rate regimes include each of the following, except:
A)the Bretton Woods exchange rate system.
B)exchange rate pegs.
C)dollarization.
D)currency boards.
Q3) Compare the monetary policy of the 50 states that make up the United States to the exchange rate regime of dollarization.
Q4) What are the cost and benefits to a country instituting capital controls?
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Page 22
Chapter 20: Money Growth, Money Demand, and Modern Monetary Policy
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Q1) For many of the countries that made up the Soviet Union, the period immediately following the collapse of the Soviet Union in 1990 found these countries experiencing extremely high rates of inflation.To solve this problem, a number of countries:
A)turned the authority to print money over to an independent central bank.
B)imposed price controls.
C)devalued their currencies.
D)returned to a gold standard.
Q2) You graduate from law school and can now begin charging clients fees for your time.What impact will this have on your demand for money?
A)Your increased income will likely cause your demand for money to decrease
B)Your opportunity cost of making trips to the bank will decrease
C)Your increased income will likely cause your demand for money to increase
D)Your demand for money will not be affected
Q3) History shows that:
A)countries with low rates of money growth have high rates of inflation.
B)money growth and inflation are not related.
C)countries with high rates of money growth have high rates of inflation.
D)money growth rates equal inflation rates.
Q4) In what ways have financial innovations affected the demand for money?
Page 23
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Chapter 21: Output, Inflation, and Monetary Policy
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Q1) Why might it be argued that prolonged recessionary or expansionary gaps could actually affect potential output?
Q2) If policymakers are aggressive in keeping current inflation near the target inflation rate then the monetary policy reaction curve will:
A)be steep.
B)be flat.
C)have an undefined slope.
D)be vertical.
Q3) Can central bankers set short-term interest rate targets and still control inflation in the long run or are these goals mutually impossible? Explain.
Q4) In the face of constant velocity, explain what happens to aggregate demand if the growth rate of money is less than the rate of inflation.
Q5) Explain the changes that would cause the dynamic aggregate demand curve to shift.
Q6) Discuss what happens to the monetary policy reaction curve if the Fed were to lower their inflation target and why?
Q7) 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) Which of the following statements is most correct?
A)Policymakers can eliminate the effects of negative supply shock.
B)Policymakers can neutralize movements in aggregate demand.
C)Policymakers can shift the short-run aggregate supply curve.
D)Shifts in the monetary policy reaction function used to stabilize the economy shift the short-run aggregate supply curve.
Q2) Possible explanations that have been offered for the Great Moderation experienced in the United States include all of the following except:
A)good fortune.
B)economies that have become more flexible in absorbing shocks.
C)calm financial markets.
D)better understanding and use of monetary policy.
Q3) During the Great Moderation experienced in the United States during the 1990s the volatility of inflation and growth:
A)moved in opposite directions.
B)both dropped significantly.
C)both increased but only slightly.
D)disappeared.
Q4) What explanations have been offered to account for the Great Moderation?
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) The relationship between interest rates and stock prices is referred to as:
A)the interest-rate mechanism of monetary policy.
B)the investment-spending mechanism of monetary policy.
C)the wealth-creating mechanism of monetary policy.
D)the asset-price channel of monetary policy.
Q2) If central bankers raise the interest rate, the asset-price channel of monetary policy implies:
A)stock prices will decrease.
B)stock prices will remain the same but bond prices will increase.
C)bond prices will remain flat.
D)stock prices will increase and bond prices will remain flat.
Q3) Why did the FOMC cut the target federal funds rate so aggressively between January and November of 2001 when most measures of economic activity showed that the economy was already rebounding from the recession earlier in the year?
Q4) Each of the following is a transmission channel of monetary policy, except:
A)the household net worth channel.
B)the Treasury Securities channel.
C)the asset-price channel.
D)the exchange-rate channel.
Page 26
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