Principles of Money, Banking, and Financial Markets
Final Test Solutions
Course Introduction
This course provides an in-depth exploration of the fundamental principles that govern money, banking systems, and financial markets. Students will examine the nature and functions of money, the structure and operation of banking institutions, and the various mechanisms through which financial markets facilitate the allocation of resources in an economy. The course also covers the role of central banks, the process of money creation, monetary policy tools, and how interest rates are determined. Emphasis is placed on understanding the interrelationship between financial institutions and markets, as well as their impact on economic stability and growth both domestically and globally.
Recommended Textbook
Money Banking and the Financial System 3rd Edition by R. Glenn Hubbard
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18 Chapters
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Chapter 1: Introducing Money and the Financial System
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Sample Questions
Q1) Borrowers who stated but did not document their incomes are referred to as A) subprime.
B) alt-A.
C) adjustable.
D) securitized.
Answer: B
Q2) Briefly discuss three reasons why firms may borrow funds from a bank.
Answer: Many firms rely on bank loans to meet their short-term needs for credit,such as funds to pay for inventories or to meet their payrolls.Many firms rely on bank loans to bridge the gap between the time they must pay for inventories or meet their payrolls and when they receive revenues from the sales of goods and services.Some firms also rely on bank loans to meet their long-term credit needs,such as funds they require to physically expand the firm.
Q3) In the United States,the lender of last resort is A) Fannie Mae.
B) the Federal Reserve.
C) the Federal Deposit Insurance Corporation.
D) the Securities and Exchange Commission.
Answer: B
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Page 3
Chapter 2: Money and the Payments System
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Sample Questions
Q1) What is the most important factor for Federal Reserve currency to be accepted as money?
A) its acceptance by businesses and households in the United States in exchange for goods and services
B) its designation as legal tender by the federal government
C) the willingness of the federal government to accept it in exchange for an equivalent amount of gold or silver coins
D) the willingness of foreign businesses and banks to accept it in exchange for goods and services
Answer: A
Q2) Which of the following is a form of e-money?
A) gold
B) PayPal
C) an American Express card
D) traveler's checks
Answer: B
Q3) In what way are other assets less liquid than money?
Answer: You incur transactions costs when you exchange other assets for money.
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4
Chapter 3: Interest Rates and Rates of Return
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Sample Questions
Q1) An speculator who buys a fifty-year corporate bond
A) must be expecting to still be alive in fifty years.
B) is subject to substantial reinvestment risk.
C) is probably expecting market interest rates to increase in the future.
D) is probably expecting market interest rates to decrease in the future.
Answer: D
Q2) Suppose you had $1,000 and were deciding between two investments.One pays 5% a year for two years while the other pays 8% the first year and 2% the second year.Which investment would provide a higher return?
Answer: The first investment which earned 5% a year for two years would result in $1,102.50 after two years.The second investment would result in $1,101.60.Thus,the first investment provides the higher return.
Q3) Which of the following is a coupon bond?
A) a U.S. savings bond
B) a U.S. Treasury bill
C) a U.S. Treasury note or bond
D) a zero-coupon bond
Answer: C
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Chapter 4: Determining Interest Rates
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Sample Questions
Q1) Interest rates typically fall during recessions,suggesting that
A) the supply curve for bonds shifts more to the left than does the demand curve for bonds.
B) the demand curve for bonds shifts more to the left than does the supply curve for bonds.
C) the supply curve for bonds shifts to the left and the demand curve for bonds shifts to the right.
D) the demand curve for bonds shifts to the left and the supply curve for bonds shifts to the right.
Q2) The two most important factors that cause the money demand curve to shift are
A) real GDP and the price level.
B) nominal GDP and the Fed.
C) the price level and the nominal interest rate.
D) the nominal interest rate and the money supply.
Q3) Higher expected inflation ________ the supply of bonds and ________ the demand for bonds.
A) increases; increases
B) increases; reduces C) reduces; increases
D) reduces; reduces
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Sample Questions
Q1) If the three-month Treasury bill has an interest rate of 0.2%,the ten-year Treasury bond has an interest rate of 2.75%,and a ten-year bond issued by Time Warner has an interest rate of 6%,what is the risk premium on Time Warner's bond?
Q2) Investors often pay professional analysts to gather and monitor information on the creditworthiness of borrowers because A) federal law requires it.
B) most investors are risk neutral.
C) the cost of acquiring information about a borrower's creditworthiness can be high. D) doing so increases the net-of-tax yield on most investments.
Q3) Which of the following accurately describes the tax treatment of municipal bonds?
A) All income from municipal bonds is tax free.
B) Interest is tax free, but unrealized capital gains are taxable.
C) Interest is tax free, but realized capital gains are taxable.
D) Interest is taxable, but capital gains are tax free.
Q4) Describe the facts found in the bond market about the relationship between interest rates on bonds of different maturities.
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Page 7
Chapter 6: The Stock Market, information, and Financial
Market Efficiency
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Sample Questions
Q1) When market participants have rational expectations,the deviation of the expected price from the actual future price is A) zero.
B) predictable, provided all relevant information is made use of. C) not predictable.
D) predictable under certain circumstances, but not under others.
Q2) In an efficient market with rational expectations,the actual price of an asset
A) will equal its expected price.
B) will often be below its expected price.
C) will often be above its expected price.
D) equals its expected price plus a random error term.
Q3) According to the Gordon growth model,an increase in the required return on equity
A) increases the future value of the stock.
B) reduces the current dividend.
C) reduces the value of a stock.
D) reduces the expected growth rate of the dividend.
Q4) What is the difference between adaptive expectations and rational expectations?
Q5) Explain how a bubble can develop in the market for an asset.
Q6) In what way do owners of stocks have limited liability?
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Chapter 7: Derivatives and Derivative Markets
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Q1) In a put options contract,the
A) seller has the obligation to receive the instrument at a specified time.
B) buyer has the obligation to deliver the instrument at a specified time.
C) buyer has the obligation to receive the instrument at a specified time.
D) seller has the obligation to deliver the instrument at a specified time.
Q2) Warren Buffet argued that ________ contributed significantly to the financial crisis.
A) all derivatives
B) only derivatives that are exchange traded
C) some derivatives that are not exchange traded
D) virtually no derivatives
Q3) Which of the following financial futures contracts are traded in the United States?
A) interest rates
B) stock indexes
C) currencies
D) all of the above
Q4) Suppose you purchase a call option with a strike price of $85 for an options price of $10 How much profit will you earn if you exercise it when the price is $100?
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Chapter 8: The Market for Foreign Exchange
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Sample Questions
Q1) If the forward exchange rate of the yen in terms of dollars is greater than the spot exchange rate
A) Japanese interest rates must be higher than U.S. interest rates.
B) U.S. interest rates must be higher than Japanese interest rates.
C) market participants must be expecting the dollar to appreciate against the yen.
D) market participants must be expecting the dollar to depreciate against the yen.
Q2) When a country's nominal exchange rate appreciates,the price of
A) that country's goods abroad increases.
B) that country's goods abroad decreases.
C) foreign goods sold in the country increases.
D) that country's goods produced and sold at home increases.
Q3) If interest rates are raised in Japan,U.S.investors will be inclined to ________ Japanese financial assets,________ the value of the Japanese yen relative to other currencies.
A) buy; raising B) buy; lowering C) sell; raising D) sell; lowering
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Chapter 9: Transactions Costs, asymmetric Information, and the Structure of the Financial System
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Sample Questions
Q1) Requirements for information disclosure for firms that desire to sell securities in financial markets
A) are very common in industrialized countries, including the United States.
B) are common in other industrialized countries, but have not yet been adopted in the United States.
C) have been adopted in the United States, but have not yet been adopted in other industrialized countries.
D) have yet to be adopted in the United States or other industrialized countries.
Q2) Financial intermediaries are able to act as delegated monitors for individual savers because
A) other investors are unable to gain a free ride on their monitoring efforts.
B) borrowers consider this role to be traditional for financial intermediaries and are willing to put up with it.
C) the federal government has granted them waivers from laws protecting privacy.
D) they employ a vast network of private detectives to carry out their monitoring role.
Q3) How do car dealers help reduce adverse selection?
Q4) How does the principal-agent problem increase the possibility of moral hazard?
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Chapter 10: The Economics of Banking
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Sample Questions
Q1) A financial contract in which a bank agrees to sell the expected future returns from an underlying bank loan to a third party is referred to as
A) loan sale.
B) loan commitment.
C) credit rationing.
D) microlending.
Q2) Using statistical models to estimate the maximum losses a portfolio's value is likely to sustain over a particular time period is called
A) gap analysis.
B) duration analysis.
C) value-at-risk approach.
D) credit-risk analysis.
Q3) On a bank's balance sheet,liabilities are
A) the uses of acquired assets.
B) the sources of acquired funds.
C) all those items of value owned by the bank.
D) by definition equal to the bank's assets.
Q4) What four off-balance-sheet activities have banks come to rely on to earn fee income?
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Chapter 11: Beyond Commercial Banks: Shadow Banks and
Nonbank Financial Institutions
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Sample Questions
Q1) When investment banks buy or sell securities on their own account,it's called A) financial engineering.
B) proprietary trading.
C) underwriting.
D) factoring.
Q2) The portfolios that mutual funds offer to savers are
A) usually made up of bonds.
B) usually made up of common stocks.
C) tax free in most states.
D) usually more liquid than the underlying assets.
Q3) How is the use of leverage a "double-edged sword"?
Q4) The largest institutional participants in capital markets are
A) pension funds.
B) insurance companies.
C) consumer finance companies.
D) business finance companies.
Q5) What are three reasons that employees may prefer to save through pensions provided by employers rather than through savings accounts?
Q7) What information is typically included in a prospectus? Page 13
Q6) What are some reasons that hedge funds have become controversial?
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Page 14
Chapter 12: Financial Crises and Financial Regulation
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Sample Questions
Q1) Which of the following is NOT an accurate description of the recession that accompanied the financial crisis of 2007-2009?
A) GDP declined by more than twice the rate of the average recession.
B) Inflation rose at nearly twice the rate as the average recession.
C) It lasted just under twice as long as the typical recession.
D) Peak unemployment was about one-third higher than usual.
Q2) How does the relationship between housing prices and rental rates provide evidence for or against the existence of a housing bubble?
Q3) As a part of the Dodd-Frank Act of 2010,Congress amended a portion of the Federal Reserve Act so the Fed could
A) now make loans to individual companies.
B) only make loans to commercial banks.
C) no longer make loans to individual companies.
D) no longer make any loans to private corporations.
Q4) When did Regulation Q finally disappear?
A) 1934
B) 1945
C) 1986
D) 2000
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Chapter 13: The Federal Reserve and Central Banking
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Q1) The Bank of the United States faced opposition from which of the following?
A) local banks who resented the Bank's supervision
B) advocates of limited government who distrusted its power
C) farmers and small businesses who resented the Bank's interference with their ability to obtain loans
D) all of the above
Q2) Which of the following officially ended the cooperation between the Treasury and the Fed that had taken place during World War II?
A) Truman Doctrine
B) Federal Reserve Act of 1951
C) Dodd-Frank Act
D) Treasury-Federal Reserve Accord
Q3) Who had served as a de facto lender of last resort during the 1907 panic?
A) The U.S. Treasury
B) J. P. Morgan
C) Henry Ford
D) John D. Rockefeller
Q4) How are the operations of the Federal Reserve financed?
Q5) Who are the members of the Financial Stability Oversight Council?
Q6) What was the original intent of the Federal Reserve Act of 1913?
Page 16
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Chapter 14: The Federal Reserves Balance Sheet and the
Money Supply Process
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Sample Questions
Q1) As of August 2016,the value of currency in circulation was about
A) $1.1 billion.
B) $24 billion.
C) $1.4 trillion.
D) $44 trillion.
Q2) On the books of the Fed,the difference between borrowed reserves and discount loans is equal to
A) excess reserves.
B) required reserves.
C) currency in circulation.
D) zero; they are the same thing.
Q3) If the Fed buys securities worth $10 million,then
A) bank reserves will increase by $10 million.
B) bank reserves will decrease by $10 million.
C) currency in circulation will increase by $10 million.
D) bank holdings of securities increase by $10 million.
Q4) Suppose the Fed makes a $5 million discount loan to a bank.Illustrate how this affects the balance sheets of the Fed and the banking system.
Q5) Briefly explain the process of multiple deposit creation.
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Chapter 15: Monetary Policy
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Q1) Reserve requirements are changed
A) more frequently than the discount rate is changed, but less frequently than open market operations are conducted.
B) more frequently than the discount rate is changed and more frequently than open market operations are conducted.
C) more frequently than open market operations are conducted, but less frequently than the discount rate is changed.
D) less frequently than open market operations are conducted and less frequently than the discount rate is changed.
Q2) Traditionally,Fed policymakers have been ________ to use higher interest rates to head off potential asset bubbles ________.
A) hesitant; because it may cause a slowdown in the economy
B) hesitant; because it would most likely result in rapid increases in inflation
C) eager; even though it may cause a slowdown in the economy
D) eager; because it would most likely result in sustained deflation
Q3) What is a matched sale-purchase transaction (also known as a reverse repo)?
Q4) Describe the temporary lending facilities that the Fed set up during the Financial Crisis of 2007-2009.
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Page 18
Chapter 16: The International Financial System and Monetary Policy
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Q1) What is the policy trilemma?
Q2) Which of the following three goals that make up the policy trilemma can be achieved at the same time in the eurozone countries?
A) exchange rate stability and free capital flows
B) monetary policy independence and exchange rate stability
C) free capital flows and monetary policy independence
D) exchange rate stability, free capital flows, and monetary policy independence
Q3) Under the Bretton Woods system,exchange rates were supposed to be adjusted A) only when a country experienced fundamental disequilibrium.
B) daily.
C) weekly.
D) following each annual meeting of the board of governors of the International Monetary Fund.
Q4) Assets denominated in foreign currency and used in international transactions are referred to as
A) foreign money.
B) international reserves.
C) international monetary base.
D) foreign exchange.
Page 19
Q5) Discuss the problems associated with the imposition of capital controls.
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Chapter 17: Monetary Theory I- the Aggregate Demand and Aggregate Supply Model
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Q1) Which of the following is NOT a recommended solution proposed for the slow growth of employment during the economic expansion that began in 2009?
A) expansionary monetary policy
B) Congress and the president addressing structural problems
C) the Fed reducing inflation by increasing its target for the federal funds rate
D) expansion of aggregate demand through fiscal policy
Q2) Suppose that initially U.S.households are saving only a small fraction of their incomes because they are relying on rapid increases in stock prices to increase their wealth.If stock prices decline and households decide to increase their saving rate,what will be impact on output in the new Keynesian view? Be sure to distinguish the short run from the long run.
Q3) Why are many economists skeptical of the Fed's ability to fine tune the economy?
A) Monetary policy only affects output in the long run.
B) Lags in policy make it difficult to properly time policy.
C) Fiscal policy can be implemented more quickly than monetary policy.
D) Monetary policy does not have any effect on output.
Q4) Make use of the misperceptions theory to explain why the short-run aggregate supply curve is upward sloping.
Page 20
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Chapter 18: Monetary Theory Ii: the Is-Mp Model
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Sample Questions
Q1) How does the goods market return to equilibrium if AE is less than production?
Q2) Which of the following is NOT generally recognized as a channel for monetary policy?
A) interest rate channel
B) balance sheet channel
C) financial market channel
D) bank lending channel
Q3) Monetary policy can have substantial effects on the economy even when nominal interest rates are very low
A) since real rates are what affect borrowing and spending decisions.
B) by improving borrower and bank balance sheets.
C) by reducing transactions costs.
D) only when the policy is substantial.
Q4) The ways in which monetary policy affect output and prices are known as A) channels.
B) stations.
C) vehicles.
D) means.
Q5) What is the multiplier? If MPC = 0.75,what is the value of the multiplier in the simple model of the economy?
21
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