Ecpnpmics 230
Sample Final Examination
1) Because of the moral hazard problem,
A)
B)
C)
D)
E)
lenders will write debt contracts that restrict certain activities of borrowers.
lenders will more readily lend to borrowers with high net worth.
debt contracts are used less frequently to raise capital than are equity contracts.
all of the above.
only (a) and (b) of the above.
2) The concept of adverse selection helps to explain
A)
B)
C)
D)
E)
why only large, well-established corporations have access to securities markets.
why collateral is an important feature of debt contracts.
why direct finance is a more important source of business finance than is indirect finance.
all of the above.
only (a) and (b) of the above.
3) Financial crises
A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and
the failures of many financial and nonfinancial firms.
B) occur when adverse selection and moral hazard problems in financial markets become more
significant.
C) frequently lead to sharp contractions in economic activity.
D) all of the above.
E) only (a) and (b) of the above.
4) Solutions to the moral hazard problem include
A)
B)
C)
D)
E)
high net worth.
monitoring and enforcement of restrictive covenants.
greater reliance on equity contracts and less on debt contracts.
all of the above.
only (a) and (b) of the above.
5) Which of the following is not one of the eight basic puzzles about financial structure?
A) Issuing marketable securities is the primary way businesses finance their operations.
B) Banks are the most important source of external funds to finance businesses.
C) Indirect finance, which involves the activities of financial intermediaries, is many times more
important than direct finance, in which businesses raise funds directly from lenders in financial
markets.
D) The financial system is among the most heavily regulated sectors of the economy.
6) The sum of the Fed's monetary liabilities and the U.S. Treasury's monetary liabilities is call
A) the money supply.
B) currency in circulation.
C) bank reserves.
D) the monetary base.
7) When the Fed wants to increase the level of reserves in the banking system, it can
A)
B)
C)
D)
purchase government bonds.
sell government bonds.
extend discount loans to banks.
do both (a) and (c).
8) In the simple deposit expansion model, a decline in checkable deposits of $500 when the required
reserve ratio is equal to 10 percent implies that the Fed
A)
B)
C)
D)
purchased $50 in government bonds.
sold $500 in government bonds.
sold $50 in government bonds.
purchased $500 in government bonds.
9) A single bank cannot loan more than its excess reserves because
A)
B)
C)
D)
the bank will lose these reserves as the deposits created by the loan find their way to other banks.
the Federal Reserve will refuse to release these reserves to other banks, thereby punishing the bank.
it is a violation of the Federal Reserve's Regulation M.
of neither (a) nor (b) of the above.
10) The banking system as a whole can generate a multiple expansion of deposits because
A)
B)
C)
D)
a single bank can loan out more than its excess reserves.
the simple deposit multiplier is a fraction smaller than one.
when a bank loses its excess reserves, these reserves do not leave the banking system.
of none of the above.
11) If a member of the nonbank public sells a government bond to the Federal Reserve in exchange for
currency,
A)
B)
C)
D)
the monetary base will rise, but currency in circulation will remain unchanged.
the monetary base will remain unchanged, but reserves will rise.
the monetary base will remain unchanged, but reserves will fall.
the monetary base will rise, but reserves will remain unchanged.
12) Because an increase in the monetary base will mean an increase in the level of currency in circulation,
A) the actual money multiplier will be smaller than the simple deposit multiplier.
B) a given change in the monetary base will lead to a smaller increase in checkable deposits than
indicated by the simple deposit multiplier.
C) a given change in the monetary base will lead to a larger increase in checkable deposits than indicated
by the simple deposit multiplier.
D) both (a) and (b) of the above will occur.
13) For a given level of the monetary base, an increase in the required reserve ratio on checkable deposits
causes the money multiplier to _____ and the money supply to _____.
A) decrease; decrease B)
increase; increase C) decrease; increase D)
increase; increase
14) For a given level of the monetary base, a decrease in the excess reserves ratio causes the money
multiplier to _____ and the money supply to _____.
A) increase; increase B)
increase; increase C) decrease; increase D)
decrease; decrease
15) For a given level of the monetary base, an increase in the currencys ratio causes the money multiplier to
_____ and the money supply to _____.
A) decrease; increase B)
decrease; decrease C) increase; increase D)
increase; increase
16) If the required reserve ratio is ten percent, currency in circulation is $400 billion, checkable deposits are
$800 billion, and excess reserves total $0.8 billion, then the money supply is
A) $8000.
B). $1200.
C)
$8400.
D)
$1200.8.
17) The Fed uses three policy tools to manipulate the money supply: _____ , which affect the monetary
base; changes in _____, which affect the monetary base by influencing the quantity of discount loans; and
changes in _____, which affect the money multiplier.
A)
B)
C)
D)
open market operations; the discount rate; reserve requirements.
open market operations; the discount rate; margin requirements.
the discount rate; open market operations; reserve requirements.
the discount rate; open market operations; margin requirements.
18) Today the United States has a dual banking system in which banks supervised by the _____ and by the
_____ operate side by side.
A)
B)
C)
D)
federal government; municipalities
federal government; states
state governments; municipalities
municipalities; states
19) The Glass-Steagall Act
A)
B)
C)
D)
prohibited commercial banks from issuing equity to finance bank expansion.
prohibited commercial banks from engaging in underwriting and dealing of corporate securities.
prohibited commercial banks from purchasing any debt securities.
prohibited commercial banks from selling new issues of government securities.
20) Which of the following is an advantage of forming a bank holding company?
A)
B)
C)
D)
Holding companies can issue commercial paper as a source of funds.
It allows owners to engage in activities that banks are prohibited from engaging in.
It allows ownership of several banks where branching is prohibited.
All of the above.
21) The most important developments that have reduced banks' cost advantages in the past twenty years
include:
A)
B)
C)
D)
E)
the elimination of Regulation Q ceilings.
the competition from money market mutual funds.
the growth of securitization.
all of the above.
only (a) and (b) of the above.
22) The most important developments that have reduced banks' income advantages in the past twenty years
include:
A)
B)
C)
D)
E)
the growth of the commercial paper market.
the growth of the junk bond market.
the growth of securitization.
all of the above.
only (a) and (b) of the above.
23) The existence of deposit insurance can increase the likelihood that depositors will need deposit
protection, as banks with deposit insurance
A)
B)
C)
D)
are placed at a competitive disadvantage in acquiring funds.
are likely to regard deposits as an unattractive source of funds due to depositors' demands for safety.
are likely to take on greater risks than they otherwise would.
are likely to be too conservative, reducing the probability of turning a profit.
24) The too-big-to-fail policy
A)
B)
C)
D)
exacerbates moral hazard problems.
puts large banks at a competitive disadvantage in attracting large deposits.
treats large depositors of small banks inequitably when compared to depositors of large banks.
does only (a) and (c) of the above.
25) The Fed's discount loans are of three types: _____ is the most common category; _____ is given to a
limited number of banks in vacation and agricultural areas; _____ is given to banks that have experienced
severe liquidity problems.
A)
B)
C)
D)
extended credit; seasonal credit; adjustment credit
seasonal credit; extended credit; adjustment credit
adjustment credit; seasonal credit; extended credit
seasonal credit; adjustment credit; extended credit
26) Open market operations as a monetary policy tool have the advantages that
A)
B)
C)
D)
E)
they are flexible and precise.
they can be implemented quickly without administrative delays.
they are not easily reversed.
all of the above.
only (a) and (b) of the above.
27) Disadvantages of discount policy include
A) the confusion concerning the Fed's intentions about future monetary policy because of the uncertainty
about what a change in the discount rate is intended to signal.
B) large fluctuations in the volume of discount loans caused by infrequent adjustments in the discount rate
to market interest rates.
C) its relative imprecision, when compared to open market operations, over control of the money supply.
D) all of the above.
E) only (a) and (b) of the above.
28) The Fed is reluctant to use reserve requirements to control the money supply because
A)
B)
C)
D)
E)
frequent changes in reserve requirements complicate liquidity management for banks.
the have the potential to create liquidity problems for banks with low excess reserves.
of their weak impact on the money supply.
of all of the above.
of only (a) and (b) of the above.
29) If the required reserve ratio is five percent, currency in circulation is $400 billion, checkable deposits
are $800 billion, and excess reserves total $0.8 billion, then the money multiplier is approximately
A) 2.5.
B)
0.551.
C)
2.3.
D)
2.72.
30) The Federal Open Market Committee consists of
A)
B)
C)
D)
the five senior members of the seven-member Board of Governors.
the seven members of the Board of Governors and five presidents of the regional Fed banks.
the seven members of the Board of Governors and seven presidents of the regional Fed banks.
the twelve regional Fed bank presidents and the chairman of the Board of Governors.
31) Which of the following statements are true?
A) A bank's assets are its uses of funds.
B) A bank's liabilities are its sources of funds.
C) A bank's balance sheet has the property that total assets equal the sum of total liabilities and equity
capital.
D) Each of the above are true.
E) Only (a) and (b) of the above are true.
32) When you deposit a $50 bill in the Security Pacific National Bank,
A)
B)
C)
D)
E)
its liabilities increase by $50.
its assets increase by $50.
its reserves increase by $50.
all of the above occur.
only (b) and (c) of the above occur.
33) Which of the following have resulted from more active liability management on the part of banks?
A)
B)
C)
D)
E)
Checking deposits have become a less important source of bank funds.
Banks have increased loans.
Banks make more active use of the federal funds market.
Each of the above.
Only (a) and (b) of the above.
34) If the First State Bank, has a gap equal to a positive $20 million, then a 5 percentage point drop in
interest rates will cause profits to
A) increase by $10 million. B)
C) increase by $1.0 million. D)
decline by $1.0 million.
decline by $10 million.
35) Long-term relationships between banks and their customers, and lines of credit
A) increase the costs of information collection.
B) make it easier for banks to screen good from bad risks.
C) enable banks to deal with moral hazard contingencies that are neither anticipated nor specified in
restrictive covenants.
D) do only (b) and (c) of the above.
36) According to the author of your textbook,
A) the Fed appears to be remarkably free of the political pressures that influence other government
agencies.
B) as the president can protect the Fed from Congress, the Fed may be responsive to the president's policy
preferences.
C) the Fed appears to be more responsive to the political pressures that influence other government
agencies.
D) both (a) and (b) of the above.
E) both (b) and (c) of the above.
37) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress
because
A) Congress can remove members of the Board of Governors on a whim.
B) Congress can pass legislation that would restrict the Fed's independence.
C) Congress can withhold the Fed's appropriations.
D) of all of the above.
38) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of the President
because
A)
B)
C)
D)
the President can veto legislation that would limit the Fed's appropriations.
the President can veto legislation that would restrict the Fed's independence.
the President can remove members of the Board of Governors on a whim.
of only (a) and (b) of the above.
39) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional
control would
A)
B)
C)
D)
E)
impart an inflationary bias to monetary policy.
force monetary authorities to sacrifice the long-run objective of price stability.
make the so-called political business cycle less pronounced.
do all of the above.
do only (a) and (b) of the above.
40) Critics of Fed independence argue
A) that independence seemingly does little to guarantee good monetary policy.
B) that its independence may encourage the Fed to pursue a course of narrow self-interest rather than the
public interest.
C) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.
D) all of the above.
Part B: Complete the following sentences by filling in the blanks. Note that it may take several words
to complete one blank.
1.
According to the Liquidity Preference Theory, money demand is a positive function of
__________ and __________, but a negative function of __________.
2.
The risk structure of interest rates is explained by three factors: __________, __________, and the
income tax treatment of the bond.
3.
During a business cycle expansion, the demand for bond __________, and the supply of bond
__________, as a result interest rate __________.
4.
Economic analysis of the eight puzzles of financial markets suggest that our financial structure is
best understood as a response to the problems of __________ and ___________.
5.
The __________ is unique to __________ financing. It results when the manager behaves
contrary to the wishes of the stockholders due to the separation of ownership and control.
6.
The process of transforming illiquid assets into liquid marketable securities is called __________.
7.
Bank managers use two methods to measure interest rate risk. __________ shows how a change
in interest rate affects bank’s __________, while __________ measures the impact of a change in
interest rate on bank’s __________.
8.
The four principles of bank management are: (a) __________; (b) __________; (c) __________;
and (d) __________. Increasingly, because of off-balance sheet activities, regulators are requiring
banks to also engage in __________ management.
9.
In bank examination, banks are rated according to a system known as CAMEL. It stands for
__________, __________, __________, __________, and __________.
10.
One of the characteristics of the U.S. banking system is that, compared to other countries, there are
__________ per capita. The recent trend of bank consolidation is probably due to the repeal of the
__________ Act by the __________ of 1994.
11.
Chartering of National banks is the responsibility of the __________.
12.
The Federal Reserve System, through its Regulation Y, has sole regulatory authority over
__________.
13.
The three objectives of bank regulation are: (a) __________; (b) _________: and (c) __________.
14.
In the formal structure of the Federal Reserve System, discount rate is set by __________. In
reality, however, it is set by the __________.
15.
The current federal funds target rate is __________ percent. If the effective (market) rate is below
this target rate, the Fed can increase the effective rate by engaging in open market _________ of
securities. This will drain __________ from the banking system.
Part C: Short answer.
Carefully, explain how a change in market interest rate affects the components of the M1 money multiplier
model, and hence the M1 money supply. How can we say that the Fed controls the money supply?
Explain.
Solution to part A:
1.
7.
13.
19.
25.
31.
37.
E;
D;
A;
B;
C;
D;
B;
2.
8.
14.
20.
26.
32.
38.
E;
C;
A;
D;
E;
D;
B.
3.
9.
15.
21.
27.
33.
39.
D;
A;
B;
E;
D;
D;
E;
4.
10.
16.
22.
28.
34.
40.
E;
C;
B;
D;
E;
B;
D.
5.
11.
17.
23.
29.
35.
A;
D;
A;
C;
D;
D;
6.
12.
18.
24.
30.
36.
D;
D;
B;
D;
B;
D;
Solution to Part B:
1.
2.
3.
4.
5.
6.
7.
8.
9.
real income; the price level; nominal interest rate
default risk; term structure risk
increases; increases; can increase, decrease, or stay the same
transaction costs; asymmetric information
principle-agent problem; equity
securitization
gap analysis; profitability; duration analysis; net worth
liquidity management; asset management; liability management; capital adequacy management
capital adequacy; asset quality; management quality; earnings; liquidity
10.
11.
12.
13.
14.
15.
more bank; McFadden Act; Reigle-Neal Act
Comptroller of the Currency
bank holding companies
to provide information to the financial markets; protect depositors; prevent banking panic
the regional Federal Reserve Banks; Federal Open Market Committee (FOMC)
4.75%, sale; reserves
Solution to Part C:
An increase in the interest rate, for example:
1.
2.
3.
This decreases the currency/deposit ratio, all else the same, this increases the money multiplier and
hence the money supply.
This decreases the excess reserve/deposit ratio, all else the same, this increases the money
multiplier and hence the money supply.
This increases discount borrowing by the banks, all else the same, monetary base increases, and
hence the money supply.
In the long run, we know the most important determinants of the money supply is non-borrowed base and
the Fed controls non-borrowed base with the use of open market operation. Thus, the Fed can exercise
reasonably good control over the money supply in the long run. The reason is that the Fed can use open
market operation to offset any undesirable short-run changes.