Money and Banking Study Guide Questions
Course Introduction
Money and Banking explores the fundamental principles of how money functions within an economy and the critical roles that banks and other financial institutions play in facilitating economic activity. The course covers topics such as the evolution of money, the structure and operations of central and commercial banks, the process of money creation, and the conduct of monetary policy. Students analyze how interest rates are determined, examine the transmission mechanisms of monetary policy, and assess the impact of banking regulations and financial innovation. Real-world case studies and recent developments provide context for understanding the interconnectedness of money, banking systems, and macroeconomic stability.
Recommended Textbook
The Economics of Money Banking and Financial Markets 10th 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) Financial institutions that accept deposits and make loans are called A) exchanges.
B) banks.
C) over-the-counter markets.
D) finance companies.
Answer: B
Q2) If your nominal income in 1998 is $50,000,and prices increase by 50% between 1998 and 2011,then to have the same real income,your nominal income in 2011 must be A) $50,000.
B) $75,000.
C) $100,000.
D) $150,000.
Answer: B
Q3) What happens to economic growth and unemployment during a business cycle recession? What is the relationship between the money growth rate and a business cycle recession?
Answer: During a recession,output declines and unemployment increases. Prior to almost every recession in the U.S.the money growth rate has declined,however,not every decline is followed by a recession.
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Chapter 2: An Overview of the Financial System
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Q1) The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market.
A) more; primary
B) more; secondary
C) less; primary
D) less; secondary
Answer: A
Q2) Although the dominance of ________ over ________ is clear in all countries,the relative importance of bond versus stock markets differs widely.
A) financial intermediaries; securities markets
B) financial intermediaries; government agencies
C) government agencies; financial intermediaries
D) government agencies; securities markets
Answer: A
Q3) Distinguish between a foreign bond and a Eurobond.
Answer: A foreign bond is sold in a foreign country and priced in that country's currency. A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency.
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4
Chapter 3: What Is Money
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Sample Questions
Q1) A problem with barter exchange when there are many goods is that in a barter system
A) transactions costs are minimized.
B) there exists a multiple number of prices for each good.
C) there is only one store of value.
D) exchange of services is impossible.
Answer: B
Q2) For a commodity to function effectively as money it must be
A) easily standardized, making it easy to ascertain its value.
B) difficult to make change.
C) deteriorate quickly so that its supply does not become too large.
D) hard to carry around.
Answer: A
Q3) If the price level doubles,the value of money
A) doubles.
B) more than doubles, due to scale economies.
C) rises but does not double, due to diminishing returns.
D) falls by 50 percent.
Answer: D
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Page 5
Chapter 4: Understanding Interest Rates
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Sample Questions
Q1) The yield to maturity for a one-year discount bond equals the increase in price over the year,divided by the A) initial price.
B) face value.
C) interest rate.
D) coupon rate.
Q2) The ________ interest rate more accurately reflects the true cost of borrowing. A) nominal
B) real
C) discount
D) market
Q3) A discount bond selling for $15,000 with a face value of $20,000 in one year has a yield to maturity of A) 3 percent.
B) 20 percent.
C) 25 percent.
D) 33.3 percent.
Q4) Would it make sense to buy a house when mortgage rates are 14% and expected inflation is 15%? Explain your answer.
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Chapter 5: The Behavior of Interest Rates
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Q1) The figure above illustrates the effect of an increased rate of money supply growth at time period T0.From the figure,one can conclude that the
A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation.
B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation.
C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation.
D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation.
Q2) The demand for gold increases,other things equal,when
A) the market for silver becomes more liquid.
B) interest rates are expected to rise.
C) interest rates are expected to fall.
D) real estate prices are expected to increase.
Q3) Everything else held constant,would an increase in volatility of stock prices have any impact on the demand for rare coins? Why or why not?
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Chapter 6: The Risk and Term Structure of Interest Rates
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Q1) Corporate bonds are not as liquid as government bonds because A) fewer corporate bonds for any one corporation are traded, making them more costly to sell.
B) the corporate bond rating must be calculated each time they are traded.
C) corporate bonds are not callable.
D) corporate bonds cannot be resold.
Q2) If the expected path of one-year interest rates over the next five years is 4 percent,5 percent,7 percent,8 percent,and 6 percent,then the expectations theory predicts that today's interest rate on the five-year bond is
A) 4 percent.
B) 5 percent.
C) 6 percent.
D) 7 percent.
Q3) A decrease in default risk on corporate bonds ________ the demand for these bonds,and ________ the demand for default-free bonds,everything else held constant.
A) increases; lowers B) lowers; increases
C) does not change; greatly increases D) moderately lowers; does not change
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Q1) The advantage of a "buy-and-hold strategy" is that
A) net profits will tend to be higher because there will be fewer brokerage commissions.
B) losses will eventually be eliminated.
C) the longer a stock is held, the higher will be its price.
D) profits are guaranteed.
Q2) According to the efficient markets hypothesis,purchasing the reports of financial analysts
A) is likely to increase one's returns by an average of 10%.
B) is likely to increase one's returns by about 3 to 5%.
C) is not likely to be an effective strategy for increasing financial returns.
D) is likely to increase one's returns by an average of about 2 to 3%.
Q3) Your best friend calls and gives you the latest stock market "hot tip" that he heard at the health club. Should you act on this information? Why or why not?
Q4) 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) Of the sources of external funds for nonfinancial businesses in the United States,loans from banks and other financial intermediaries account for approximately ________ of the total.
A) 6%
B) 40%
C) 56%
D) 60%
Q2) The analysis of how asymmetric information problems affect economic behavior is called ________ theory.
A) uneven
B) parallel
C) principal
D) agency
Q3) Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called
A) collateral.
B) points.
C) interest.
D) good faith money.
Q4) How does a mutual fund lower transactions costs through economies of scale?
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Chapter 9: Financial Crises
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Q1) Although the subprime mortgage market problem began in the United States,the first indication of the seriousness of the crisis began in
A) Europe.
B) Australia.
C) China.
D) South America.
Q2) The economy recovers quickly from most recessions,but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression.
A) debt deflation
B) illiquidity
C) an improvement in banks' balance sheets
D) increases in bond prices
Q3) At the time of the South Korean financial crisis,the merchant banks were
A) almost virtually unregulated.
B) subject to heavy government regulation.
C) engaged in long-term lending to the corporate sector.
D) restricted to long-term foreign borrowing.
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Chapter 10: Banking and the Management of Financial Institutions
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Q1) Secondary reserves are so called because
A) they can be converted into cash with low transactions costs.
B) they are not easily converted into cash, and are, therefore, of secondary importance to banking firms.
C) 50% of these assets count toward meeting required reserves.
D) they rank second to bank vault cash in importance of bank holdings.
Q2) If a bank has $50 million in rate-sensitive assets and $20 million in rate-sensitive liabilities then
A) an increase in interest rates will reduce bank profits.
B) a decrease in interest rates will reduce bank profits.
C) interest rate changes will not impact bank profits.
D) a decrease in interest rates will increase bank profits.
Q3) Which of the following would not be a way to increase the return on equity?
A) Buy back bank stock
B) Pay higher dividends
C) Acquire new funds by selling negotiable CDs and increase assets with them
D) Sell more bank stock
Q4) How can specializing in lending help to reduce the adverse selection problem in lending?
Page 12
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Chapter 11: Economic Analysis of Financial Regulation
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Q1) An analysis of the political economy of the savings and loan crisis helps one to understand
A) why politicians aided the efforts of thrift regulators, raising regulatory appropriations and encouraging closing of insolvent thrifts.
B) why thrift regulators were so quick to inform Congress of the problems that existed in the thrift industry.
C) why thrift regulators willingly acceded to pressures placed upon them by members of Congress.
D) why politicians listened so closely to the taxpayers they represented.
Q2) All of the following are common to banking crises in different countries except A) financial liberalization or innovation.
B) weak bank regulatory systems.
C) a government safety net.
D) a dual banking system.
Q3) The Resolution Trust Corporation was created by the FIRREA in order to
A) manage and resolve insolvent S&Ls.
B) build up trust in government regulation.
C) regulate the S&L industry.
D) purchase large amounts of government debt.
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Page 13
Chapter 12: Banking Industry: Structure and Competition
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Q1) Sweep accounts which were created to avoid reserve requirements became possible because of a change in
A) deposit ceilings.
B) technology.
C) government rules.
D) bank mergers.
Q2) Disintermediation resulted from
A) interest rate ceilings combined with inflation-driven increases in interest rates.
B) elimination of Regulation Q (the regulation imposing interest rate ceilings on bank deposits).
C) increases in federal income taxes.
D) reserve requirements.
Q3) Both ________ and ________ were financial innovations that occurred because of interest rate volatility.
A) adjustable-rate mortgages; commercial paper
B) adjustable-rate mortgages; financial derivatives
C) sweep accounts; financial derivatives
D) sweep accounts; commercial paper
Q4) Why did the interest rate volatility of the 1970s spur financial innovation?
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Chapter 13: Central Banks and the Federal Reserve System
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Q1) In the Governing Council,the decision of what policy to implement is made by
A) majority vote of the Executive Board members.
B) majority vote of the heads of the National Banks.
C) consensus.
D) majority vote of all members of the Governing Council.
Q2) Critics of the current system of Fed independence contend that A) the current system is undemocratic.
B) voters have too much say about monetary policy.
C) the president has too much control over monetary policy on a day-to-day basis.
D) the Board of Governors is held responsible for policy missteps.
Q3) The three largest Federal Reserve banks (New York,Chicago,and San Francisco)combined hold more than ________ percent of the assets of the Federal Reserve System.
A) 25
B) 33
C) 50
D) 67
Q4) Who are the voting members of the Federal Open Market Committee and why is this committee important? Where does the power lie within this committee?
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Chapter 14: The Money Supply Process
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Sample Questions
Q1) The sum of the Fed's monetary liabilities and the U.S.Treasury's monetary liabilities is called
A) the money supply.
B) currency in circulation.
C) bank reserves.
D) the monetary base.
Q2) If the required reserve ratio is 10 percent,the simple deposit multiplier is
A) 5.0.
B) 2.5.
C) 100.0.
D) 10.0
Q3) Total reserves are the sum of ________ and ________.
A) excess reserves; borrowed reserves
B) required reserves; currency in circulation
C) vault cash; excess reserves
D) excess reserves; required reserves
Q4) Explain the complete formula for the M1 money supply,and explain how changes in required reserves,excess reserves,the currency ratio,the nonborrowed base,and borrowed reserves affect the money supply.
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Chapter 15: Tools of Monetary Policy
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Q1) The Fed's lender-of-last-resort function
A) has proven to be ineffective.
B) cannot prevent runs by large depositors.
C) is no longer necessary due to FDIC insurance.
D) creates a moral hazard problem.
Q2) When bad storms slow the check-clearing process,float tends to ________ causing the Fed to initiate defensive open market ________.
A) decrease; sales
B) decrease; purchases
C) increase; sales
D) increase; purchases
Q3) If Treasury deposits at the Fed are predicted to ________,the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) increase; defensive; inject
B) decrease; defensive; inject
C) increase; dynamic; inject
D) decrease; dynamic; drain
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Chapter 16: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) Supply-side economic policies seek to
A) raise interest rates through contractionary monetary policy.
B) increase federal government expenditures.
C) increase consumption expenditures by increasing taxes.
D) increase saving and investment using tax incentives.
Q2) Which of the following is a potential operating instrument for the central bank?
A) The monetary base
B) The M1 money supply
C) Nominal GDP
D) The discount rate
Q3) Estimates suggest that,in the United States economy,it takes just over ________ for monetary policy to affect output and just over ________ for monetary policy to affect the inflation rate.
A) 1 year; 2 years
B) 2 years; 1 year
C) 1 year; 6 months
D) 6 months; 1 year
Q4) Explain the time-inconsistency problem.What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem?
Page 18
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Chapter 17: The Foreign Exchange Market
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Q1) ________ in the expected future domestic exchange rate causes the demand for domestic assets to increase and the domestic currency to ________,everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Q2) ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to depreciate,everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Q3) The theory of purchasing power parity states that exchange rates between any two currencies will adjust to reflect changes in
A) the trade balances of the two countries.
B) the current account balances of the two countries.
C) fiscal policies of the two countries.
D) the price levels of the two countries.
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Chapter 18: The International Financial System
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Q1) Under the Bretton Woods system,the United States was designated as the
A) reserve-currency country.
B) fixed-rate country.
C) par-standard country.
D) dollar-standard country.
Q2) Under a fixed exchange rate regime,if the domestic currency is initially undervalued,that is,above par,the central bank must intervene to sell the ________ currency by purchasing ________ assets.
A) domestic; foreign
B) domestic; domestic
C) foreign; foreign
D) foreign; domestic
Q3) A case for capital inflow controls can be made because capital inflows
A) can cause a lending boom and lead to excessive risk taking.
B) never finance productive investments.
C) always finance productive investments.
D) are less likely to cause financial crises than regulation of banking activities.
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Page 20
Chapter 19: Quantity Theory, inflation and the Demand for Money
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Sample Questions
Q1) The equation of exchange is
A) M × P = V × Y.
B) M + V = P + Y.
C) M + Y = V + P.
D) M × V = P × Y.
Q2) Because Treasury bills pay a higher return than money and have no risk
A) the transactions demand for money may be zero.
B) the precautionary demand for money may be zero.
C) the speculative demand for money may be zero.
D) all three of the above motives for holding money will be zero.
Q3) Financing government spending with taxes
A) causes both reserves and the monetary base to rise.
B) causes both reserves and the monetary base to decline.
C) causes reserves to rise, but the monetary base to decline.
D) has no net effect on the monetary base.
Q4) According to the quantity theory of money demand,
A) an increase in interest rates will cause the demand for money to fall.
B) a decrease in interest rates will cause the demand for money to increase.
C) interest rates have no effect on the demand for money.
D) an increase in money will cause the demand for money to fall.
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Chapter 20: The Is Curve
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Q1) In the Keynesian cross diagram,a decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________,everything else held constant.
A) up; rise
B) up; fall
C) down; rise
D) down; fall
Q2) If net exports increase by 250 and the mpc is 0.75,equilibrium aggregate output increases by
A) 250.
B) 500.
C) 750.
D) 1000.
Q3) The marginal propensity to consume (mpc)can be defined as the fraction of A) a change in income that is spent.
B) a change in income that is saved.
C) income that is spent.
D) income that is saved.
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Chapter 21: The Monetary Policy and Aggregate Demand
Curves
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Q1) An autonomous easing of monetary policy
A) causes an upward movement along the monetary policy curve.
B) causes a downward movement along the monetary policy curve.
C) shifts the monetary policy curve upward.
D) shifts the monetary policy curve downward.
Q2) When the financial crisis started in August 2007,inflation was rising and the Fed began an aggressive easing lowering of the federal funds rate,which indicated that
A) the Fed pursued an autonomous monetary policy tightening.
B) the Fed pursued an autonomous monetary policy easing.
C) the Fed had an automatic negative response to inflation based on the Taylor rule.
D) the Fed had an automatic positive response to inflation based on the Taylor rule.
Q3) Based on the Taylor Principle,a central bank's endogenous response of decreasing interest rates when inflation falls
A) causes an upward movement along the monetary policy curve.
B) causes a downward movement along the monetary policy curve.
C) shifts the monetary policy curve upward.
D) shifts the monetary policy curve downward.
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Page 23
Chapter 22: Aggregate Demand and Supply Analysis
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Q1) Suppose the U.S.economy is producing at the natural rate of output. An appreciation of the U.S.dollar will cause ________ in real GDP in the short run and ________ in inflation in the long run,everything else held constant.(Assume the appreciation causes no effects in the supply side of the economy.)
A) an increase; an increase
B) a decrease; a decrease
C) no change; an increase
D) no change; a decrease
Q2) Everything else held constant,an increase in government spending ________ aggregate ________.
A) increases; demand
B) decreases; demand
C) decreases; supply
D) increases; supply
Q3) As of 2009,China's economy had recovered from the global recession that began in 2008.Use aggregate demand and aggregate supply analysis to explain why,and to explain the likely consequences for China of an increase in the growth rate of the global economy.
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24
Chapter 23: Monetary Policy Theory
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Q1) When the economy suffers a permanent negative supply shock and the central bank does not respond by changing the autonomous component of monetary policy,then
A) inflation will be lower.
B) output will be at its potential.
C) output will be unchanged.
D) inflation will be unchanged.
Q2) If aggregate output is below the natural rate level,nonactivists of policies would recommend that the government A) do nothing.
B) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to the right.
C) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the right.
D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the left.
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25
Chapter 24: The Role of Expectations in Monetary Policy
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Q1) The interest rate thought to have the most important impact on aggregate demand is the
A) short-term interest rate.
B) T-bill rate.
C) rate on 90-day CDs.
D) long-term interest rate.
Q2) Whether one views the discretionary policies of the 1960s and 1970s as destabilizing or believes the economy would have been less stable without these policies,most economists agree that
A) stabilization policies proved more difficult in practice than many economists had expected.
B) stabilization policies proved not to be inflationary.
C) the nondiscretionary policymakers were right in believing that the private economy is inherently stable.
D) the discretionary policymakers were right in believing that the private economy is inherently stable.
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Chapter 25: Transmission Mechanisms of Monetary Policy
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Q1) The subprime financial crisis caused a recession because of the ________ in adverse selection and moral hazard problems and the ________ in housing prices.
A) increase; increase
B) increase; decrease C) decrease; increase
D) decrease; decrease
Q2) According to Tobin's q theory,when equity prices are high the market price of existing capital is ________ relative to new capital,so expenditure on fixed investment is ________.
A) cheap; low
B) dear ; low
C) cheap; high
D) dear; high
Q3) Economic theory suggests that ________ interest rates are ________ important than ________ interest rates in explaining investment behavior.
A) nominal; more; real
B) real; less; nominal
C) real; more; nominal
D) market; more; real
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Page 27
Chapter 26: The ISLM Model
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Q1) Everything else held constant,if aggregate output is to the right 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
Q2) According to the liquidity preference theory,the demand for money is ________ related to aggregate output and ________ related to interest rates.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
Q3) If the economy is on the LM curve,but is to the left of the IS curve,aggregate output will ________ and the interest rate will ________.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
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