Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 1 Why Study Money, Banking, and Financial Markets?
1.1
Why Study Financial Markets?
1) Financial markets promote economic efficiency by ________.
A) channelling funds from investors to savers
B) creating inflation
C) channelling funds to those who have a productive use for them
D) reducing investment
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
2) Well-functioning financial markets promote ________.
A) inflation
B) deflation
C) unemployment
D) economic growth
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
3) A key factor in producing high economic growth is ________.
A) eliminating foreign trade
B) well-functioning financial markets
C) high interest rates
D) stock market volatility
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
4) Markets in which funds are transferred from those who do not have a productive use for
them to those who do are called ________.
A) commodity markets
B) fund-available markets
C) derivative exchange markets
D) financial markets
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
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5) ________ markets transfer funds from people who do not have a productive use for them to
people who do.
A) Commodity
B) Fund-available
C) Financial
D) Derivative exchange
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
6) Poorly performing financial markets can be the cause of ________.
A) wealth
B) poverty
C) financial stability
D) financial expansion
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
7) The bond markets are important because they are ________.
A) easily the most widely followed financial markets in Canada
B) the markets where foreign exchange rates are determined
C) where corporations and governments borrow to finance their activities
D) the markets where all borrowers get their funds
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
8) A security is also known as ________.
A) a financial instrument
B) a contingent claim
C) the interest rate
D) a liability
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
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9) A bond is ________.
A) not as good as investment as stocks
B) pays interest sporadically
C) never pays interest
D) makes payments periodically for a specified period of time
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
10) The fluctuation of interest rates ________.
A) never occurs because the central bank is involved in setting the rate
B) is due to changes in stock prices
C) cannot occur because there is only one interest rate
D) impacts all Canadians
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
11) The cost of borrowing is commonly referred to as the ________.
A) inflation rate
B) exchange rate
C) interest rate
D) aggregate price level
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
12) Compared to interest rates on long-term bonds, interest rates on three-month Treasury bills
fluctuate ________ and are ________ on average.
A) more; lower
B) less; lower
C) more; higher
D) less; higher
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
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13) The interest rate on long-term corporate bonds is ________, on average, than other interest
rates. The spread between it an other rates ________ over time.
A) lower; remains constant
B) lower; fluctuates
C) higher; remains constant
D) higher; fluctuates
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
14) Everything else held constant, a rise in interest rates will cause spending on housing to
________.
A) rise
B) remain unchanged
C) either rise, fall, or remain the same
D) fall
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
15) High interest rates might ________ purchasing a house or car but at the same time high
interest rates might ________ saving.
A) discourage; encourage
B) discourage; discourage
C) encourage; encourage
D) encourage; discourage
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
16) An increase in interest rates might ________ saving because more can be earned in interest
income.
A) encourage
B) discourage
C) disallow
D) invalidate
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
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17) Everything else held constant, an increase in interest rates on student loans ________.
A) may increase the cost of education
B) may reduce the cost of education
C) has no effect on educational costs
D) increases costs for students with no loans
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
18) A common stock ________.
A) cannot be purchased by individuals
B) is also known as a debt security
C) is a share of ownership in a corporation
D) is a claim on assets
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
19) A share of common stock is a claim on a corporation's ________.
A) debt
B) liabilities
C) expenses
D) earnings and assets
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
20) Lower interest rates might cause a corporation to ________ building a new plant that would
provide more jobs.
A) complete
B) postpone
C) consider
D) start
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
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21) Bonds of different maturities ________.
A) show no common features
B) have interest rates that tend to move together
C) have interest rates that can differ substantially
D) B and C only
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
22) The stock market is important because it is ________.
A) where interest rates are determined
B) the most widely followed financial market in the Canada
C) where foreign exchange rates are determined
D) the market where most borrowers get their funds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
23) Stock prices, as measured by the S&P/TSX Composite Index, ________.
A) have not changed much over time
B) have risen smoothly over time
C) have been extremely volatile over time
D) have declined substantially since they peaked in the mid 1980s
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 1.1 Recognize the importance of financial markets in the economy.
24) Stock prices are ________.
A) relatively stable trending upward at a steady pace
B) relatively stable trending downward at a moderate rate
C) extremely volatile
D) unstable trending downward at a moderate rate
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
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25) Changes in stock prices ________.
A) do not affect people's wealth and their willingness to spend
B) affect firms' decisions to sell stock to finance investment spending
C) are predictable
D) are unimportant to decision makers
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
26) A ________ is an example of a security, which is a claim on future income or ________.
A) bond; interest rate
B) bond; debt
C) stock; assets
D) stock; debt
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
27) On ________, October 19, 1987, the market experienced its worst one-day drop in its entire
history with the S&P/TSX Composite falling by 11 percent.
A) "Terrible Tuesday"
B) "Woeful Wednesday"
C) "Freaky Friday"
D) "Black Monday"
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
28) Fluctuations in stock prices ________.
A) have become less smaller since the year 2000
B) since the year 2000 are about the same as they were before the year 2000
C) have become more volatile since the year 2000
D) have been almost eliminated since the year 2000
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
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29) The S&P/TSX Composite reached a peak of over 14000 in 2008 and then fell by ________.
A) 10%
B) 30%
C) 50%
D) 70%
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
30) Why is it important to understand the bond market?
Answer: The bond market supports economic activity by enabling the government and
corporations to borrow to undertake their projects and it is the market where interest rates are
determined.
Diff: 2
Type: ES
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
31) What is a stock? How do stocks affect the economy?
Answer: A stock represents a share of ownership of a corporation, or a claim on a firm's
earnings/assets. Stocks are part of wealth, and changes in their value affect people's willingness
to spend. Changes in stock prices affect a firm's ability to raise funds, and thus their investment.
Diff: 2
Type: ES
Skill: Recall
Objective: 1.1 Recognize the importance of financial markets in the economy.
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1.2
Why Study Financial Institutions and Banking?
1) Channelling funds from individuals with savings to those desiring funds when the saver does
not purchase the borrower's security is known as ________.
A) barter
B) redistribution
C) financial intermediation
D) taxation
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
2) A financial crisis is ________.
A) not possible in the modern financial environment
B) a major disruption in the financial markets
C) a feature of developing economies only
D) typically followed by an economic boom
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
3) Banks are important to the study of money and the economy because they ________.
A) channel funds from investors to savers
B) have been a source of rapid financial innovation
C) are the only important financial institution in the US economy
D) create inflation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
4) Financial crises are characterized by ________.
A) surging employment
B) hyperinflation
C) decline in asset prices
D) high profits in the financial sector
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
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5) Chartered banks, trust and mortgage loan companies, and credit unions and caisses
populaires ________.
A) no longer provide financial intermediation
B) since deregulation now provide services only to small depositors
C) accept deposits and make loans
D) create fluctuations in the stock market
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
6) Banks ________.
A) are the smallest of the financial intermediaries
B) are the largest financial intermediaries
C) are barred from providing financial intermediation services
D) can only provide services to corporations
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
7) Financial institutions that accept deposits and make loans include ________.
A) exchanges
B) banks
C) over-the-counter markets
D) finance companies
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
8) Which of the following are the largest financial intermediaries in the Canadian economy?
A) Insurance companies
B) Finance companies
C) Banks
D) Mutual funds
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
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9) The term "bank" generally includes all of the following institutions except ________.
A) chartered banks
B) credit unions
C) trust and mortgage loan companies
D) finance companies
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
10) The delivery of financial services electronically is called ________.
A) e-business
B) e-commerce
C) e-finance
D) e-possible
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
11) Financial innovation can lead to ________ and ________.
A) phishing; financial gain
B) higher interest rates; higher inflation
C) higher profits; financial disasters
D) lower interest rates; lower inflation
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
12) What crucial role do financial intermediaries perform in an economy?
Answer: Financial intermediaries borrow funds from people who have saved and make loans
to other individuals and businesses and thus improve the efficiency of the economy.
Diff: 1
Type: ES
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
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13) Why is the study of financial innovation important?
Answer: Financial innovation shows how creative thinking on the part of financial institutions
can lead to higher profits.
Diff: 2
Type: ES
Skill: Recall
Objective: 1.2 Describe how financial intermediation and financial innovation affect banking
and the economy
1.3
Why Study Money and Monetary Policy?
1) Money is defined as ________.
A) bills of exchange
B) anything that is generally accepted in payment for goods and services or in the repayment of
debt
C) a repository of spending power
D) the unrecognized liability of governments
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
2) The upward and downward movement of aggregate output produced in the economy is
referred to as the ________.
A) roller coaster
B) see saw
C) business cycle
D) shock wave
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
3) Sustained downward movements in the business cycle are referred to as ________.
A) inflation
B) recessions
C) economic recoveries
D) expansions
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
12
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4) During a recession, output declines resulting in ________.
A) lower unemployment in the economy
B) higher unemployment in the economy
C) no impact on the unemployment in the economy
D) higher wages for the workers
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
5) Prior to all recessions, there has been a drop in ________.
A) inflation
B) the money stock
C) the rate of money growth
D) interest rates
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
6) Evidence from business cycle fluctuations in Canada indicates that ________.
A) a negative relationship between money growth and general economic activity exists
B) recessions have been preceded by declines in share prices on the stock exchange
C) recessions have been preceded by dollar depreciation
D) recessions have been preceded by a decline in the growth rate of money
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
7) ________ theory relates changes in the quantity of money to changes in aggregate economic
activity and the price level.
A) Monetary
B) Fiscal
C) Financial
D) Systemic
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
13
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8) A sharp increase in the growth of the money supply is likely followed by ________.
A) a recession
B) a depression
C) an increase in the inflation rate
D) no change in the economy
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
9) Inflation ________.
A) can be explained by changes in the price level and money supply
B) cannot be explained historically
C) is unrelated to monetary variables
D) changes in government policy
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
10) The average price of goods and services in the economy is called ________.
A) the aggregate price level
B) inflation
C) interest rates
D) deflation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
11) It is true that inflation is a ________.
A) continual increase in the money supply
B) continuous fall in prices
C) decline in interest rates
D) continual increase in the price level
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
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12) Which of the following is a true statement?
A) Money or the money supply is defined as Bank of Canada notes.
B) The average price of goods and services in an economy is called the aggregate price level.
C) The inflation rate is measured as the rate of change in the federal government budget deficit.
D) The aggregate price level is measured as the rate of change in the inflation rate.
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
13) If ten years ago the prices of the items bought last month by the average consumer would
have been much lower, then one can likely conclude that ________.
A) the aggregate price level has declined during this ten-year period
B) the average inflation rate for this ten-year period has been positive
C) the average rate of money growth for this ten-year period has been positive
D) the aggregate price level has risen during this ten-year period
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
14) From 1968-2014 the price level in Canada increased more than ________.
A) twofold
B) threefold
C) sixfold
D) ninefold
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
15) Complete Milton Friedman's famous statement, "Inflation is always and everywhere a
________ phenomenon."
A) recessionary
B) discretionary
C) repressionary
D) monetary
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
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16) There is a ________ association between inflation and the growth rate of money ________.
A) positive; demand
B) positive; supply
C) negative; demand
D) negative; supply
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
17) Evidence from Canada and other foreign countries indicates that ________.
A) there is a strong positive association between inflation and growth rate of money supply
over long periods of time
B) there is little support for the assertion that "inflation is always and everywhere a monetary
phenomenon"
C) countries with low monetary growth rates tend to experience higher rates of inflation, all
else being constant
D) money growth is clearly unrelated to inflation
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
18) Countries with low inflation rates include ________.
A) Canada, Sweden and the United States
B) Canada, Ukraine and the United States
C) Turkey, Ukraine and Zambia
D) Turkey, Ukraine and Canada
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
19) Countries that experience very high rates of inflation may also have ________.
A) balanced budgets
B) rapidly growing money supplies
C) falling money supplies
D) constant money supplies
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
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20) In the 1970s, in Canada, interest rates trended upward. During this same time period,
________.
A) the rate of money growth declined
B) the rate of money growth increased
C) the government budget deficit (expressed as a percentage of GNP) trended downward
D) inflation fell
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
21) The management of money and interest rates is called ________ policy and is conducted by
a nation's ________ bank.
A) debt; superior
B) fiscal; superior
C) fiscal; central
D) monetary; central
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
22) ________ policy involves decisions about government spending and taxation.
A) Monetary
B) Fiscal
C) Risk Management
D) Systemic
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
23) When tax revenues are greater than government expenditures, the government has a budget
________.
A) crisis
B) deficit
C) surplus
D) revision
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
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24) A budget ________ occurs when government expenditures exceed tax revenues for a
particular time period.
A) deficit
B) surplus
C) surge
D) surfeit
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
25) Budget deficits can be a concern because they might ________.
A) ultimately lead to higher inflation
B) lead to lower interest rates
C) lead to a slower rate of money growth
D) lead to higher bond prices
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
26) Budget deficits are important because deficits ________.
A) cause bank failures
B) always cause interest rates to fall
C) may lead to a financial crisis
D) always cause prices to fall
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
27) 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 every
recession in Canada the money growth rate has declined, however, not every decline is
followed by a recession.
Diff: 2
Type: ES
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
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Copyright © 2017 Pearson Canada, Inc.
28) Describe the relationship between the aggregate price level and the growth rate in money
supply. Can the relationship be used to explain inflation?
Answer: The price level and the money supply generally move closely together. There is a
positive relationship between inflation and the growth rate of the money supply. Friedman says
that "inflation is always and everywhere a monetary phenomenon."
Diff: 2
Type: ES
Skill: Recall
Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and
economic variables
1.4
Why Study International Finance?
1) Canadian companies can borrow funds ________.
A) only in Canadian financial markets
B) only in foreign financial markets
C) in both Canadian and foreign financial markets
D) only from the Canadian government
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.4 Explain the importance of exchange rates in a global economy
2) The price of one country's currency in terms of another country's currency is called the
________.
A) foreign exchange rate
B) interest rate
C) TSE index
D) inflation rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.4 Explain the importance of exchange rates in a global economy
3) The foreign exchange rate is ________.
A) determined by the banks
B) not important to Canadian individuals
C) the relative price of two currencies
D) the ratio of the foreign aggregate price level to the domestic aggregate price level
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 1.4 Explain the importance of exchange rates in a global economy
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4) The market where one currency is converted into another currency is called the ________
market.
A) security
B) bond
C) derivatives
D) foreign exchange
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 1.4 Explain the importance of exchange rates in a global economy
5) Everything else constant, a stronger Canadian dollar will mean that ________.
A) vacationing in England becomes more expensive
B) vacationing in England becomes less expensive
C) French cheese becomes more expensive
D) Japanese cars become more expensive
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
6) Which of the following is most likely to result from a stronger Canadian dollar?
A) Canadian goods exported aboard will cost less in foreign countries, and so foreigners will
buy more of them.
B) Canadian goods exported aboard will cost more in foreign countries and so foreigners will
buy more of them.
C) Canadian goods exported abroad will cost more in foreign countries, and so foreigners will
buy fewer of them.
D) Canadians will purchase fewer foreign goods.
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
7) Everything else held constant, a weaker Canadian dollar will likely hurt ________.
A) textile exporters in Quebec
B) wheat farmers in Saskatchewan that sell domestically
C) automobile manufacturers in Ontario that use domestically produced inputs
D) furniture importers in British Columbia
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
20
Copyright © 2017 Pearson Canada, Inc.
8) Everything else held constant, Canadians who love French wine benefit most from
________.
A) a decrease in the dollar price of euros
B) an increase in the dollar price of euros
C) a constant dollar price for euros
D) a ban on imports from Europe
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
9) Everything else held constant, a stronger Canadian dollar benefits ________ and hurts
________.
A) Canadian businesses; Canadian consumers
B) Canadian businesses; foreign businesses
C) Canadian consumers; Canadian businesses
D) foreign businesses; Canadian consumers
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
10) From 2002 to 2011, the Canadian dollar ________ in value.
A) appreciated by approximately 25%
B) appreciated by approximately 50%
C) depreciated by approximately 50%
D) depreciated by approximately 25%
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
11) When in 1985 a British pound cost approximately C$1.30, a Shetland sweater that cost 100
British pounds would have cost $130. With a weaker Canadian dollar, the same Shetland
sweater would have cost ________.
A) less than $130
B) more than $130
C) $130, since the exchange rate does not affect the prices that Canadian consumers pay for
foreign goods
D) $130, since the demand for Shetland sweaters will decrease to prevent an increase in price
due to the stronger dollar
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
21
Copyright © 2017 Pearson Canada, Inc.
12) Everything else held constant, a decrease in the value of the Canadian dollar relative to all
foreign currencies means that the price of foreign goods purchased by Canadians ________.
A) increases
B) decreases
C) remains unchanged
D) increases initially but then decreases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 1.4 Explain the importance of exchange rates in a global economy
13) Canadian farmers who sell beef to Europe benefit most from ________.
A) a decrease in the Canadian dollar price of euros
B) an increase in the Canadian dollar price of euros
C) a constant Canadian dollar price for euros
D) a European ban on imports of Canadian beef
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
14) If the Canadian dollar price of a euro increases from $1.00 to $1.10, then, everything else
held constant, ________.
A) a European vacation becomes less expensive
B) a European vacation becomes more expensive
C) the cost of a European vacation is not affected
D) foreign travel becomes impossible
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
15) From 2002-2011, the dollar strengthened in value against other currencies. Who was helped
and who was hurt by this strong dollar?
Answer: Canadian consumers benefitted because imports were cheaper and consumers could
purchase more. Canadian businesses and workers in those businesses were hurt as domestic and
foreign sales of Canadian products fell.
Diff: 2
Type: ES
Skill: Applied
Objective: 1.4 Explain the importance of exchange rates in a global economy
22
Copyright © 2017 Pearson Canada, Inc.
1.5
Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation Rate
1) The most comprehensive measure of aggregate output is ________.
A) gross domestic product
B) net national product
C) the TSE Index
D) national income
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
2) The gross domestic product is the ________.
A) the value of all wealth in an economy
B) the value of all goods and services sold to other nations in a year
C) the market value of all final goods and services produced in an economy in a year
D) the market value of all intermediate goods and services produced in an economy in a year
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
3) You buy a second hand car from a dealer. Which of the following items are counted in
Canadian GDP?
A) No part of the purchase price as this car was manufactured in an earlier year
B) The portion of the purchase price attributable to repairs made by the dealer
C) The portion of the purchase price attributable to both repairs and commissions to the
salesman
D) The portion of the purchase price attributable to repairs, commissions and profits to the
dealer
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
23
Copyright © 2017 Pearson Canada, Inc.
4) If an economy has aggregate output of $2 trillion, then aggregate income is ________.
A) $1 trillion
B) $2 trillion
C) $3 trillion
D) $4 trillion
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
5) When the total value of final goods and services is calculated using current prices, the
resulting measure is referred to as ________.
A) real GDP
B) the GDP deflator
C) nominal GDP
D) the index of leading indicators
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
6) Nominal GDP is output measured in ________ prices while real GDP is output measured in
________ prices.
A) current; current
B) current; fixed
C) fixed; fixed
D) fixed; current
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
7) GDP measured with constant prices is referred to as ________.
A) real GDP
B) nominal GDP
C) the GDP deflator
D) industrial production
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
24
Copyright © 2017 Pearson Canada, Inc.
8) If your nominal income in 2013 was $30000, and prices doubled between 2002 and 2013, to
have the same real income, your nominal income in 2002 must be ________.
A) $10000
B) $15000
C) $20000
D) $100,000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
9) If your nominal income in 2002 is $50000, and prices increase by 50 percent between 2002
and 2013, then to have the same real income, your nominal income in 2013 must be ________.
A) $50000
B) $75000
C) $100,000
D) $150,000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
10) To convert a nominal GDP to a real GDP, you would use ________.
A) the PCE deflator
B) the CPI measure
C) the GDP deflator
D) the PPI measure
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
11) If nominal GDP in 2013 is $10 trillion, and 2013 real GDP in 2002 prices is $9 trillion, the
GDP deflator price index is ________.
A) 1
B) 1.1
C) 11
D) 100
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
25
Copyright © 2017 Pearson Canada, Inc.
12) When prices are measured in terms of fixed (base-year) prices they are called ________
prices.
A) nominal
B) real
C) inflated
D) aggregate
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
13) The measure of the aggregate price level that is most frequently reported in the media is the
________.
A) GDP deflator
B) producer price index
C) consumer price index
D) household price index
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
14) To calculate the growth rate of a variable, you will ________.
A) calculate the percentage change from one time period to the next
B) calculate the difference between the two variables
C) add the ending value to the beginning value
D) divide the increase by the number of time periods
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
15) If real GDP grows to $9.5 trillion in 2014 from $9 trillion in 2013, the growth rate for real
GDP is ________.
A) 6 percent
B) 10 percent
C) 5 percent
D) 0.5 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
26
Copyright © 2017 Pearson Canada, Inc.
16) If real GDP in 2013 is $10 trillion, and in 2014 real GDP is $9.5 trillion, then real GDP
growth from 2013 to 2014 is ________.
A) 0.5 percent
B) 5 percent
C) 0 percent
D) -5 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
17) If the aggregate price level at time t is denoted by Pt, the inflation rate from time t - 1 to t is
defined as
A)
=( )/
B)
= (Pt + 1 - Pt - 1)/ Pt - 1
C)
= (Pt + 1 - Pt)/ Pt
D)
= (Pt - Pt - 1)/ Pt
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
18) If the price level increases from 200 in year 1 to 220 in year 2, the rate of inflation from
year 1 to year 2 is ________.
A) 20 percent
B) 10 percent
C) 11 percent
D) 120 percent
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
27
Copyright © 2017 Pearson Canada, Inc.
19) If the CPI is 120 in 2002 and 180 in 2012, then between 2002 and 2012, prices have
increased by ________.
A) 180 percent
B) 80 percent
C) 60 percent
D) 50 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
20) If the CPI in 2012 is 200, and in 2013 the CPI is 180, the rate of inflation from 2012 to
2013 is ________.
A) 20 percent
B) 10 percent
C) 0 percent
D) -10 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
21) What is measured by the Gross Domestic Product (GDP)? what is INCLUDED and what is
EXCLUDED in the calculation of GDP?
Answer: GDP is the most commonly used measure of aggregate output. It is the market value
of all final goods and services produced in the economy during the course of a year. In
calculating the GDP we exclude two sets of items. First, we exclude all goods that have been
produced in the past, and not in the measured year, and second we exclude all intermediate
goods as their value is included in the value of the final goods.
Diff: 2
Type: ES
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
28
Copyright © 2017 Pearson Canada, Inc.
22) Are the following transactions included in the calculation of the GDP? Why?
a. books you buy from the university bookstore
b. purchase of government bonds
c. writing a cheque to your dentist for his services
d. purchase by a car manufacturer of tyres for the produced vehicles
Answer:
a. Yes, it is a purchase of a final good, the book.
b. No, purchases of stocks and bonds are not included in the calculation of the GDP.
c. Yes, it is a service that should be included in the GDP.
d. No, because the tyres for the car manufacturer are an intermediate good and as such it is not
included in the calculation of the GDP.
Diff: 2
Type: ES
Skill: Applied
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
23) What is the aggregate income? How is the aggregate income related to the gross domestic
product?
Answer: Aggregate income is the total income of factors of production. It is equal to
aggregate output.
Diff: 2
Type: ES
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
24) Why is the real GDP a better measure of economic activity than nominal GDP?
Answer: Real GDP is a more reliable measure because values are measured in terms of fixed
prices.
Diff: 2
Type: ES
Skill: Recall
Objective: Appendix: Defining Aggregate Output, Income, the Price Level, and the Inflation
Rate
29
Copyright © 2017 Pearson Canada, Inc.
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 2 An Overview of the Financial System
2.1
Function of Financial Markets
1) Every financial market has which of the following characteristics?
A) It determines the level of interest rates.
B) It allows common stock to be traded.
C) It allows loans to be made.
D) It channels funds from lenders-savers to borrowers-spenders.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
2) Financial markets have the basic function of ________.
A) getting people with funds to lend together with people who want to borrow funds
B) assuring that the swings in the business cycle are less pronounced
C) assuring that governments need never resort to printing money
D) providing a risk-free repository of spending power
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
3) Financial markets improve economic welfare because ________.
A) they channel funds from investors to savers
B) they allow consumers to time their purchase better
C) they weed out inefficient firms
D) eliminate the need for indirect finance
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
4) Well-functioning financial markets ________.
A) cause inflation
B) eliminate the need for indirect finance
C) cause financial crises
D) produce an efficient allocation of capital
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
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Copyright © 2017 Pearson Canada, Inc.
5) A breakdown of financial markets can result in ________.
A) financial stability
B) rapid economic growth
C) political instability
D) stable prices
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
6) The principal lender-savers are ________.
A) governments
B) businesses
C) households
D) foreigners
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
7) Which of the following can be described as direct finance?
A) You take out a mortgage from your local bank.
B) You borrow $2500 from a friend.
C) You buy shares of common stock in the secondary market.
D) You buy shares in a mutual fund.
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
8) Assume that you borrow $2000 at 10 percent annual interest to finance a new business
project. For this loan to be profitable, the minimum amount this project must generate in annual
earnings is ________.
A) $400
B) $201
C) $200
D) $199
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
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Copyright © 2017 Pearson Canada, Inc.
9) You can borrow $5000 to finance a new business venture. This new venture will generate
annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds
and still increase your income is ________.
A) 25 percent
B) 12.5 percent
C) 10 percent
D) 5 percent
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
10) Which of the following can be described as involving direct finance?
A) A corporation issues new shares of stock.
B) People buy shares in a mutual fund.
C) A pension fund manager buys a short-term corporate security in the secondary market.
D) An insurance company buys shares of common stock in the over-the-counter markets.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
11) Which of the following can be described as involving direct finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys a short-term corporate security in a secondary market.
D) People buy shares of common stock in the primary markets.
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
12) Which of the following can be described as involving indirect finance?
A) You make a loan to your neighbor.
B) A corporation buys a share of common stock issued by another corporation in the primary
market.
C) You buy a Canadian Treasury bill from the Bank of Canada.
D) You make a deposit at a bank.
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
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Copyright © 2017 Pearson Canada, Inc.
13) Securities are ________ for the person who buys them, but are ________ for the individual
or firm that issues them.
A) assets; liabilities
B) liabilities; assets
C) negotiable; nonnegotiable
D) nonnegotiable; negotiable
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
14) With ________ finance, borrowers obtain funds from lenders by selling them securities in
the financial markets.
A) active
B) determined
C) indirect
D) direct
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 2.1 Compare and contrast direct and indirect finance
15) How do financial intermediaries play an important role in the economy?
Answer: Financial intermediaries play an important role in the economy because they provide
liquidity services, they lower transaction costs through economies of scale, they reduce the risk
exposure of investors through risk sharing, and they solve the asymmetric information
problems of adverse selection and moral hazard. By doing this, they allow small savers and
borrowers to benefit from the existence of financial markets and its instruments. They also
improve economic efficiency because they help financial markets to channel funds from
lenders-savers to people with productive investment opportunities.
Diff: 3
Type: ES
Skill: Recall
Objective: 2.1 Compare and contrast direct and indirect finance
33
Copyright © 2017 Pearson Canada, Inc.
2.2
Structure of Financial Markets
1) Which of the following statements about the characteristics of debt and equity is false?
A) They can both be long-term financial instruments.
B) They can both be short-term financial instruments.
C) They both involve a claim on the issuer's income.
D) They both enable a corporation to raise funds.
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
2) Which of the following statements about the characteristics of debt and equities is true?
A) They can both be long-term financial instruments.
B) Bond holders are residual claimants.
C) The income from bonds is typically more variable than that from equities.
D) Bonds pay dividends.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
3) Which of the following statements about financial markets and securities is true?
A) A bond is a long-term security that promises to make periodic payments called dividends to
the firm's residual claimants.
B) A debt instrument is intermediate term if its maturity is less than one year.
C) A debt instrument is intermediate term if its maturity is ten years or longer.
D) The maturity of a debt instrument is the number of years (term) to that instrument's
expiration date.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
4) Which of the following is an example of an intermediate-term debt?
A) A thirty-year mortgage
B) A sixty-month car loan
C) A six month loan from a finance company
D) A Treasury bond
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
34
Copyright © 2017 Pearson Canada, Inc.
5) If the maturity of a debt instrument is less than one year, the debt is called ________.
A) short-term
B) intermediate-term
C) long-term
D) prima-term
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
6) Long-term debt has a maturity that is ________.
A) between one and ten years
B) less than a year
C) between five and ten years
D) ten years or longer
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
7) When I purchase ________, I own a portion of a firm and have the right to vote on issues
important to the firm and to elect its directors.
A) bonds
B) bills
C) notes
D) stock
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 2.2 Identify the structure and components of financial markets
8) Which of the following benefit directly from any increase in the corporation's profitability?
A) A bond holder
B) A commercial paper holder
C) A shareholder
D) A T-bill holder
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
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Copyright © 2017 Pearson Canada, Inc.
9) A financial market in which previously issued securities can be resold is called a ________
market.
A) primary
B) secondary
C) tertiary
D) used securities
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
10) When an investment bank ________ securities, it guarantees a price for a corporation's
securities and then sells them to the public.
A) underwrites
B) undertakes
C) overwrites
D) overtakes
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
11) Which of the following is not a secondary market?
A) Foreign exchange market
B) Futures market
C) Options market
D) Primary market
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
12) ________ work in the secondary markets matching buyers with sellers of securities.
A) Dealers
B) Underwriters
C) Brokers
D) Claimants
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
36
Copyright © 2017 Pearson Canada, Inc.
13) A corporation acquires new funds only when its securities are sold in the ________.
A) primary market by an investment bank
B) primary market by a stock exchange broker
C) secondary market by a securities dealer
D) secondary market by a commercial bank
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 2.2 Identify the structure and components of financial markets
14) A corporation acquires new funds only when its securities are sold in the ________.
A) secondary market by an investment bank
B) primary market by an investment bank
C) secondary market by a stock exchange broker
D) secondary market by a commercial bank
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 2.2 Identify the structure and components of financial markets
15) An important function of secondary markets is to ________.
A) make it easier to sell financial instruments to raise funds
B) raise funds for corporations through the sale of securities
C) make it easier for governments to raise taxes
D) create a market for newly constructed houses
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
16) Secondary markets make financial instruments more ________.
A) solid
B) vapid
C) liquid
D) risky
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
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Copyright © 2017 Pearson Canada, Inc.
17) A liquid asset is ________.
A) an asset that can easily and quickly be sold to raise cash
B) a share of an ocean resort
C) difficult to resell
D) always sold in an over-the-counter market
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
18) 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
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
19) A financial market in which only short-term debt instruments are traded is called the
________ market.
A) bond
B) money
C) capital
D) stock
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
20) Corporations receive funds when their stock is sold in the primary market. Why do
corporations pay attention to what is happening to their stock in the secondary market?
Answer: The existence of the secondary market makes their stock more liquid and the price in
the secondary market sets the price that the corporation would receive if they choose to sell
more stock in the primary market.
Diff: 2
Type: ES
Skill: Applied
Objective: 2.2 Identify the structure and components of financial markets
38
Copyright © 2017 Pearson Canada, Inc.
21) Describe the two methods of organizing a secondary market.
Answer: A secondary market can be organized as an exchange where buyers and sellers meet
in one central location to conduct trades. An example of an exchange is the New York Stock
Exchange. A secondary market can also be organized as an over-the-counter market. In this
type of market, dealers in different locations buy and sell securities to anyone who comes to
them and is willing to accept their prices. An example of an over-the-counter market is the
federal funds market.
Diff: 2
Type: ES
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
22) Describe the difference between the money market and the capital market.
Answer: The money market in which short-term debt instruments are traded. The capital
market is the market in which longer-term debt is traded.
Diff: 1
Type: ES
Skill: Recall
Objective: 2.2 Identify the structure and components of financial markets
2.3
Financial Market Instruments
1) Prices of money market instruments undergo the least price fluctuations because of
________.
A) the short terms to maturity for the securities
B) the heavy regulations in the industry
C) the price ceiling imposed by government regulators
D) the lack of competition in the market
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
2) Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower
purchase price than the amount you receive at maturity.
A) premium
B) collateral
C) default
D) discount
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
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Copyright © 2017 Pearson Canada, Inc.
3) Treasury bills are considered the safest of all money market instruments because there is no
risk of ________.
A) defeat
B) default
C) desertion
D) demarcation
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
4) A debt instrument sold by a bank to its depositors that pays annual interest of a given amount
and at maturity pays back the original purchase price is called ________.
A) commercial paper
B) a negotiable certificate of deposit
C) a municipal bond
D) federal funds
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
5) A short-term debt instrument issued by well-known corporations is called ________.
A) commercial paper
B) corporate bonds
C) municipal bonds
D) commercial mortgages
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
6) ________ are short-term loans in which Treasury bills serve as collateral.
A) Repurchase agreements
B) Negotiable certificates of deposit
C) Overnight funds
D) Government agency securities
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
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7) Collateral is ________ the lender receives if the borrower does not pay back the loan.
A) a liability
B) an asset
C) a present
D) an offering
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
8) Overnight funds are ________.
A) funds raised by the federal government in the bond market
B) loans made by the Bank of Canada to banks
C) loans made by banks to the Bank of Canada
D) loans made by banks to each other
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
9) Which of the following are short-term financial instruments?
A) A repurchase agreement
B) A share of Walt Disney Corporation stock
C) A Treasury note with a maturity of four years
D) A residential mortgage
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
10) Which of the following instruments are traded in a money market?
A) Provincial government bonds
B) Treasury bills
C) Corporate bonds
D) Government agency securities
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
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11) Which of the following instruments are traded in a money market?
A) Bank commercial loans
B) Commercial paper
C) Provincial government bonds
D) Residential mortgages
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
12) Which of the following instruments is not traded in a money market?
A) Residential mortgages
B) Treasury Bills
C) Negotiable bank certificates of deposit
D) Commercial paper
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
13) Bonds issued by corporations are called ________ bonds.
A) corporate
B) Treasury
C) municipal
D) commercial
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
14) Equity and debt instruments with maturities greater than one year are called ________
market instruments.
A) capital
B) money
C) federal
D) benchmark
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
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15) Explain why Government of Canada Treasury Bills are considered as a financial instrument
with very low risk.
Answer: Government of Canada Treasury Bills are considered low risk, because they are the
most actively traded money market instruments; their original maturity is no more than 12
months. Moreover, there is almost no probability of default. The federal government is always
able to meet its debt obligations as it can raise taxes to service its debt.
Diff: 2
Type: ES
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
16) Explain why only the largest and most trustworthy corporations issue the financial
instruments known as commercial paper?
Answer: Commercial paper is an unsecured short-term debt instrument issued either in
Canadian dollars or other currencies. Since it is unsecured, only the largest corporations and
banks are able to issue commercial paper so that the market can trust them and invest in their
issue. It is highly unlikely that an investor would trust a small unknown firm and finance it with
an unsecured loan.
Diff: 2
Type: ES
Skill: Recall
Objective: 2.3 List and describe the different types of financial market instruments
2.4
Internationalization of Financial Markets
1) One reason for the extraordinary growth of foreign financial markets is ________.
A) decreased trade
B) increases in the pool of savings in foreign countries
C) the recent introduction of the foreign bond
D) slower technological innovation in foreign markets
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.4 Recognize the international dimensions of financial markets
2) Bonds that are sold in a foreign country and are denominated in the country's currency in
which they are sold are known as ________.
A) foreign bonds
B) Eurobonds
C) equity bonds
D) country bonds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.4 Recognize the international dimensions of financial markets
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3) Bonds that are sold in a foreign country and are denominated in a currency other than that of
the country in which it is sold are known as ________.
A) foreign bonds
B) Eurobonds
C) equity bonds
D) country bonds
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.4 Recognize the international dimensions of financial markets
4) If Microsoft sells a bond in London and it is denominated in dollars, the bond is a ________.
A) Eurobond
B) foreign bond
C) British bond
D) currency bond
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.4 Recognize the international dimensions of financial markets
5) U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks
are called ________.
A) Atlantic dollars
B) Eurodollars
C) foreign dollars
D) outside dollars
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.4 Recognize the international dimensions of financial markets
6) 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.
Diff: 1
Type: ES
Skill: Recall
Objective: 2.4 Recognize the international dimensions of financial markets
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2.5
Function of Financial Intermediaries: Indirect Finance
1) The process of indirect finance using financial intermediaries is called ________.
A) direct lending
B) financial intermediation
C) resource allocation
D) financial liquidation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
2) The time and money spent in carrying out financial transactions are called ________.
A) economies of scale
B) financial intermediation
C) liquidity services
D) transaction costs
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
3) Economies of scale enable financial institutions to ________.
A) reduce transactions costs
B) avoid the asymmetric information problem
C) avoid adverse selection problems
D) reduce moral hazard
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
4) An example of economies of scale in the provision of financial services is ________.
A) investing in a diversified collection of assets
B) providing depositors with a variety of savings certificates
C) spreading the cost of borrowed funds over many customers
D) spreading the cost of writing a standardized contract over many borrowers
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
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5) Financial intermediaries provide customers with liquidity services. Liquidity services
________.
A) make it easier for customers to conduct transactions
B) allow customers to have a cup of coffee while waiting in the lobby
C) are a result of the asymmetric information problem
D) are another term for asset transformation
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
6) The process where financial intermediaries create and sell low-risk assets and use the
proceeds to purchase riskier assets is known as ________.
A) risk sharing
B) risk aversion
C) risk neutrality
D) risk selling
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
7) The process of asset transformation refers to the conversion of ________.
A) safer assets into risky assets
B) safer assets into safer liabilities
C) risky assets into safer assets
D) risky assets into risky liabilities
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
8) Reducing risk through the purchase of assets whose returns do not always move together is
________.
A) diversification
B) intermediation
C) intervention
D) discounting
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
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9) The concept of diversification is captured by the statement ________.
A) don't look a gift horse in the mouth
B) don't put all your eggs in one basket
C) it never rains, but it pours
D) make hay while the sun shines
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
10) Risk sharing is profitable for financial institutions due to ________.
A) low transactions costs
B) asymmetric information
C) adverse selection
D) moral hazard
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
11) Typically, borrowers have superior information relative to lenders about the potential
returns and risks associated with an investment project. The difference in information is called
________.
A) moral selection
B) risk sharing
C) asymmetric information
D) adverse hazard
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
12) If bad credit risks are the ones who most actively seek loans and, therefore, receive them
from financial intermediaries, then financial intermediaries face the problem of ________.
A) moral hazard
B) adverse selection
C) free-riding
D) costly state verification
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
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13) The problem created by asymmetric information before the transaction occurs is called
________, while the problem created after the transaction occurs is called ________.
A) adverse selection; moral hazard
B) moral hazard; adverse selection
C) costly state verification; free-riding
D) free-riding; costly state verification
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
14) Adverse selection is a problem associated with equity and debt contracts arising from
________.
A) the lender's relative lack of information about the borrower's potential returns and risks of
his investment activities
B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the
borrower defaults
C) the borrower's lack of incentive to seek a loan for highly risky investments
D) the borrower's lack of good options for obtaining funds
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
15) An example of the problem of ________ is when a corporation uses the funds raised from
selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees
and their families.
A) adverse selection
B) moral hazard
C) risk sharing
D) credit risk
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
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16) Typically, borrowers have superior information relative to lenders about the potential
returns and risks associated with an investment project. The difference in information is called
________, and it creates the ________ problem.
A) asymmetric information; risk sharing
B) asymmetric information; adverse selection
C) adverse selection; risk sharing
D) moral hazard; adverse selection
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
17) Studies of the major developed countries show that when businesses go looking for funds to
finance their activities they usually obtain these funds from ________.
A) government agencies
B) equities markets
C) financial intermediaries
D) bond markets
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
18) The countries that have made the least use of securities markets are ________ and
________; in these two countries finance from financial intermediaries has been almost ten
times greater than that from securities markets.
A) Germany; Japan
B) Germany; Great Britain
C) Great Britain; Canada
D) Canada; Japan
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
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19) 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
Diff: 3
Type: MC
Skill: Recall
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
20) Because there is an imbalance of information in a lending situation, we must deal with the
problems of adverse selection and moral hazard. Define these terms and explain how financial
intermediaries can reduce these problems.
Answer: Adverse selection is the asymmetric information problem that exists before the
transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit
risk. Moral hazard is the asymmetric information problem that exists after the transaction
occurs. For lenders, it is the difficulty in making sure the borrower uses the funds appropriately.
Financial intermediaries can reduce adverse selection through intensive screening and can
reduce moral hazard by monitoring the borrower.
Diff: 2
Type: ES
Skill: Applied
Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as
they relate to financial intermediaries
2.6
Types of Financial Intermediaries
1) Financial institutions that accept deposits and make loans are called ________ institutions.
A) investment
B) contractual savings
C) depository
D) underwriting
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
2) Depository institutions include ________.
A) banks, mutual funds, and insurance companies
B) banks, trust and mortgage loan companies, and credit unions
C) finance companies, mutual funds, and money market funds
D) pension funds, mutual funds, and banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
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3) Which of the following is a depository institution?
A) A life insurance company
B) A credit union
C) A pension fund
D) A mutual fund
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
4) Which of the following financial intermediaries is not a depository institution?
A) A savings and loan association
B) A commercial bank
C) A credit union
D) A finance company
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
5) The primary assets of credit unions are ________.
A) municipal bonds
B) business loans
C) consumer loans
D) mortgages
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
6) The primary liabilities of a chartered bank are ________.
A) bonds
B) mortgages
C) deposits
D) commercial paper
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
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7) The primary liabilities of depository institutions are ________.
A) premiums from policies
B) shares
C) deposits
D) bonds
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
8) ________ institutions are financial intermediaries that acquire funds at periodic intervals on
a contractual basis.
A) Investment
B) Contractual savings
C) Thrift
D) Depository
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
9) Which of the following is a contractual savings institution?
A) A life insurance company
B) A credit union
C) A savings and loan association
D) A mutual fund
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
10) Contractual savings institutions include ________.
A) mutual savings banks
B) money market mutual funds
C) commercial banks
D) life insurance companies
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
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11) Which of the following are not contractual savings institutions?
A) Life insurance companies
B) Credit unions
C) Pension funds
D) Government retirement funds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
12) Which of the following is not a contractual savings institution?
A) A life insurance company
B) A pension fund
C) A finance association
D) A property and casualty insurance company
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
13) The primary assets of a pension fund are ________.
A) money market instruments
B) corporate bonds and stock
C) consumer and business loans
D) mortgages
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
14) Which of the following are investment intermediaries?
A) Life insurance companies
B) Mutual funds
C) Pension funds
D) Government retirement funds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
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15) An investment intermediary that lends funds to consumers is ________.
A) a finance company
B) an investment bank
C) a finance fund
D) a consumer company
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
16) The primary assets of a finance company are ________.
A) municipal bonds
B) corporate stocks and bonds
C) consumer and business loans
D) mortgages
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
17) ________ are financial intermediaries that acquire funds by selling shares to many
individuals and using the proceeds to purchase diversified portfolios of stocks and bonds.
A) Mutual funds
B) Investment banks
C) Finance companies
D) Credit unions
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
18) An important feature of money market mutual fund shares is ________.
A) deposit insurance
B) they offer deposit-type accounts
C) the ability to borrow against shareholdings
D) claims on shares of corporate stock
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
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19) The primary assets of money market mutual funds are ________.
A) stocks
B) bonds
C) money market instruments
D) deposits
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
20) The liquidity of assets in contractual savings institutions ________.
A) is an important consideration
B) is not an important consideration
C) is restricted
D) is an undertaking
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 2.6 List and describe the different types of financial intermediaries
2.7
Regulation of the Financial System
1) Which of the following is not a goal of financial regulation?
A) Ensuring the soundness of the financial system
B) Reducing moral hazard
C) Reducing adverse selection
D) Ensuring that investors never suffer losses
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
2) Increasing the amount of information available to investors helps to reduce the problems of
________ and ________ in the financial markets.
A) adverse selection; moral hazard
B) adverse selection; risk sharing
C) moral hazard; transactions costs
D) adverse selection; economies of scale
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
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3) A goal of the Ontario Securities Commission is to reduce problems arising from ________.
A) competition
B) banking panics
C) risk
D) asymmetric information
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
4) The purpose of the disclosure requirements is to ________.
A) increase the information available to investors
B) prevent bank panics
C) improve monetary control
D) protect investors against financial losses
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
5) Government regulations to reduce the possibility of financial panic include all of the
following except ________.
A) transactions costs
B) restrictions on assets and activities
C) disclosure
D) deposit insurance
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
6) The Canada Deposit Insurance Corporation regulates ________.
A) brokerage firms
B) banks
C) credit unions
D) mutual funds
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
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7) In order to reduce risk and increase the safety of financial institutions, commercial banks and
other depository institutions are prohibited from ________.
A) owning corporate bonds
B) making real estate loans
C) making personal loans
D) owning common stock
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
8) The primary purpose of deposit insurance is to ________.
A) improve the flow of information to investors
B) prevent banking panics
C) protect bank shareholders against losses
D) protect bank employees from unemployment
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
9) Asymmetric information is a universal problem. This would suggest that financial
regulations ________.
A) in industrial countries are an unqualified failure
B) differ significantly around the world
C) in industrialized nations are similar
D) are unnecessary
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
10) How do regulators help to ensure the soundness of financial intermediaries?
Answer: Regulators restrict who can set up as a financial intermediary, conduct regular
examinations, restrict assets, and provide insurance to help ensure the soundness of financial
intermediaries.
Diff: 2
Type: ES
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
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11) How does regulation reduce the problems of adverse selection and moral hazard? What
regulations are or have been used to protect the public from panics?
Answer: Regulation attempts to reduce asymmetric information and financial instability.
Financial stability is promoted by regulations restricting entry, disclosure and/or examination,
restrictions on assets and risk taking, deposit insurance, limits on competition, and interest rate
controls.
Diff: 3
Type: ES
Skill: Recall
Objective: 2.7 Identify the reasons for, and list the types of financial market regulations
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 3 What Is Money?
3.1
Meaning of Money
1) A person's house is part of her ________.
A) money
B) income
C) liabilities
D) wealth
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
2) Money is ________.
A) anything that is generally accepted in payment for goods and services or in the repayment of
debt
B) a flow of earnings per unit of time
C) the total collection of pieces of property that are a store of value
D) always based on a precious metal like gold or silver
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
3) To an economist, ________ is anything that is generally accepted in payment for goods and
services or in the repayment of debt.
A) wealth
B) income
C) money
D) credit
Answer: C
Diff: 1
Type: MC
Skill: Recall
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Objective:
3.1 Describe what money is
4) Currency is defined as ________.
A) anything accepted for payment of goods and services
B) paper money and coins
C) a unit of account
D) foreign exchange
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
5) Money is ________.
A) the same as currency
B) anything that is generally accepted in payment of goods or services or in the repayment of
debts
C) not used as a unit of account
D) defined as paper money and coins
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
6) Currency includes ________.
A) paper money and coins
B) paper money, coins, and cheques
C) paper money and cheques
D) paper money, coins, cheques, and savings deposits
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
7) There is no single precise measure of money or the money supply for economists because
________.
A) the government considers money supply statistics to be confidential and refuses to publish
them
B) deciding what is generally accepted in payment for goods and services or in the repayment
of debt is difficult to determine
C) economists cannot agree if currency should be considered money
D) definitions change all the time
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
8) Even economists have no single, precise definition of money because ________.
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A) money supply statistics are a state secret
B) the Bank of Canada does not employ or report different measures of the money supply
C) the "moneyness" or liquidity of an asset is a matter of degree
D) economists find disagreement interesting and refuse to agree for ideological reasons
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
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9) The total collection of pieces of property that serve to store value is a person's ________.
A) wealth
B) income
C) money
D) credit
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
10) ________ is used to make purchases while ________ is the total collection of pieces of
property that serve to store value.
A) Money; income
B) Wealth; income
C) Income; money
D) Money; wealth
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
11) ________ is a flow of earnings per unit of time.
A) Income
B) Money
C) Wealth
D) Currency
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
12) An individual's annual salary is her ________.
A) money
B) income
C) wealth
D) liabilities
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
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13) When we say that money is a stock variable, we mean that ________.
A) the quantity of money is measured at a given point in time
B) we must attach a time period to the measure
C) it is sold in the equity market
D) money never loses purchasing power
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
14) The difference between money and income is that ________.
A) money is a flow and income is a stock
B) money is a stock and income is a flow
C) there is no difference—money and income are both stocks
D) there is no difference—money and income are both flows
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
15) Income is a ________ and wealth is a ________.
A) stock; flow
B) flow; stock
C) variable; constant
D) constant; variable
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
16) Which of the following is a true statement?
A) Money and income are flow variables.
B) Money is a flow variable.
C) Income is a flow variable.
D) Money and income are stock variables.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.1 Describe what money is
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17) Which of the following statements uses the economists' definition of money?
A) I plan to earn a lot of money over the summer.
B) Betsy is rich—she has a lot of money.
C) I hope that I have enough money to buy my lunch today.
D) The job with New Company gave me the opportunity to earn more money.
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 3.1 Describe what money is
18) In the country of Moneyland the law allows you to repay mortgage in rocks. Thus,
________.
A) Moneyland is a poor country
B) rocks in this country are considered as money
C) money is scarce
D) Moneyland is a developing country
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 3.1 Describe what money is
19) Explain the concepts of wealth and income and how they relate to the concept of money.
Answer: Non-economists often use money synonymously with wealth or income. Wealth is
a stock variable that describes the total collection of property that is used to store value. Income
is a flow of earnings over some period of time. Money is a stock variable; it is a certain
amount at a point of time and can be used in the payment of goods and services.
Diff: 2
Type: ES
Skill: Applied
Objective: 3.1 Describe what money is
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3.2
Functions of Money
1) If peanuts serve as a medium of exchange, a unit of account, and a store of value, then
peanuts are ________.
A) bank deposits
B) reserves
C) money
D) loanable funds
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
2) 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
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
3) ________ are the time and resources spent trying to exchange goods and services.
A) Bargaining costs
B) Transaction costs
C) Contracting costs
D) Barter costs
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
4) Compared to an economy that uses a medium of exchange, in a barter economy ________.
A) transaction costs are higher
B) transaction costs are lower
C) liquidity costs are higher
D) liquidity costs are lower
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
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5) Of money's three functions, the one that distinguishes money from other assets is its function
as a ________.
A) store of value
B) unit of account
C) standard of deferred payment
D) medium of exchange
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
6) When compared to exchange systems that rely on money, disadvantages of the barter system
include ________.
A) the requirement of a double coincidence of wants
B) lowering the cost of exchanging goods over time
C) lowering the cost of exchange to those who would specialize
D) encouraging specialization and the division of labor
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
7) The conversion of a barter economy to one that uses money ________.
A) increases efficiency by reducing the need to exchange goods and services
B) increases efficiency by reducing the need to specialize
C) increases efficiency by reducing transactions costs
D) does not increase economic efficiency
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
8) Which of the following statements best explains how the use of money in an economy
increases economic efficiency?
A) Money increases economic efficiency because it is costless to produce.
B) Money increases economic efficiency because it discourages specialization.
C) Money increases economic efficiency because it decreases transactions costs.
D) Money cannot have an effect on economic efficiency.
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
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9) Which of the following is a true statement?
A) The conversion of a barter economy to one that uses money increases efficiency by
increasing the cost of exchange.
B) The conversion of a barter economy to one that uses money increases efficiency by
increasing the cost to those who wish to specialize.
C) The conversion of a barter economy to one that uses money increases efficiency by reducing
transactions costs.
D) The conversion of a barter economy to one that uses money does not increases efficiency.
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
10) When economists say that money promotes ________, they mean that money encourages
specialization and the division of labour.
A) bargaining
B) contracting
C) efficiency
D) greed
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
11) Money ________ transaction costs, allowing people to specialize in what they do best.
A) reduces
B) increases
C) enhances
D) eliminates
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
12) All of the following are necessary criteria for a commodity to function as money except
________.
A) it must deteriorate quickly
B) it must be divisible
C) it must be easy to carry
D) it must be widely accepted
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
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13) Whatever a society uses as money, the distinguishing characteristic is that it must
________.
A) be completely inflation proof
B) be generally acceptable as payment for goods and services or in the repayment of debt
C) contain gold
D) be produced by the government
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
14) All but the most primitive societies use money as a medium of exchange, implying that
________.
A) the use of money is economically efficient
B) barter exchange is economically efficient
C) barter exchange cannot work outside the family
D) inflation is not a concern
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
15) Kevin purchasing concert tickets with his debit card is an example of the ________
function of money.
A) medium of exchange
B) unit of account
C) store of value
D) specialization
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
16) When money prices are used to facilitate comparisons of value, money is said to function as
a ________.
A) unit of account
B) medium of exchange
C) store of value
D) payments-system ruler
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
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17) 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
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
18) In a barter economy the number of prices in an economy with N goods is ________.
A) [N(N - 1)]/2
B) N(N/2)
C) 2N
D) N(N/2) - 1
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
19) If there are five goods in a barter economy, one needs to know ten prices in order to
exchange one good for another. If, however, there are ten goods in a barter economy, then one
needs to know ________ prices in order to exchange one good for another.
A) 20
B) 25
C) 30
D) 45
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
20) If there are four goods in a barter economy, then one needs to know ________ prices in
order to exchange one good for another.
A) 8
B) 6
C) 5
D) 4
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
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21) Because it is a unit of account, money ________.
A) increases transaction costs
B) reduces the number of prices that need to be calculated
C) does not earn interest
D) discourages specialization
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
22) Dennis notices that jackets are on sale for $99. In this case money is functioning as a
________.
A) medium of exchange
B) unit of account
C) store of value
D) payments-system ruler
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
23) As a store of value, money ________.
A) does not earn interest
B) cannot be a durable asset
C) must be currency
D) is a way of saving for future purchases
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
24) Patrick places his pocket change into his savings bank on his desk each evening. By his
actions, Patrick indicates that he believes that money is a ________.
A) medium of exchange
B) unit of account
C) store of value
D) unit of specialization
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
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25) ________ is the relative ease and speed with which an asset can be converted into a
medium of exchange.
A) Efficiency
B) Liquidity
C) Deflation
D) Specialization
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
26) Increasing transactions costs of selling an asset make the asset ________.
A) more valuable
B) more liquid
C) less liquid
D) more moneylike
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
27) Since it does not have to be converted into anything else to make purchases, ________ is
the most liquid asset.
A) money
B) stock
C) artwork
D) gold
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
28) Of the following assets, the least liquid is ________.
A) stocks
B) travellers cheques
C) chequing deposits
D) a house
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
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29) Ranking assets from most liquid to least liquid, the correct order is ________.
A) savings bonds; house; currency
B) currency; savings bonds; house
C) currency; house; savings bonds
D) house; savings bonds; currency
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
30) People hold money even during inflationary episodes when other assets prove to be better
stores of value. This can be explained by the fact that money is all of the following except
________.
A) perfectly liquid
B) a unique good for which there are no substitutes
C) the only thing accepted in economic exchange
D) backed by gold
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
31) 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 half
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
32) A fall in the level of prices ________.
A) does not affect the value of money
B) has an uncertain effect on the value of money
C) increases the value of money
D) reduces the value of money
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
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33) A hyperinflation is ________.
A) a period of extreme inflation generally greater than 50 percent per month
B) a period of anxiety caused by rising prices
C) an increase in output caused by higher prices
D) impossible today because of tighter regulations
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
34) During hyperinflations, ________.
A) the value of money rises rapidly
B) money no longer functions as a good store of value and people may resort to barter
transactions on a much larger scale
C) middle-class savers benefit as prices rise
D) money's value remains fixed to the price level; that is, if prices double so does the value of
money
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
35) Because inflation in Germany after World War I sometimes exceeded 1000 percent per
month, one can conclude that the German economy suffered from ________.
A) deflation
B) disinflation
C) hyperinflation
D) superdeflation
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.2 List and summarize the functions of money
36) If merchants in the country Zed choose to close their doors, preferring to be stuck with
rotting merchandise rather than worthless currency, then one can conclude that Zed is
experiencing a ________.
A) superdeflation
B) hyperdeflation
C) disinflation
D) hyperinflation
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 3.2 List and summarize the functions of money
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37) Explain how cigarettes could be called "money" in prisoner-of-war camps of World War II.
Answer: The cigarettes performed the three functions of money. They served as the medium
of exchange because individuals did exchange items for cigarettes. They served as a unit of
account because prices were quoted in terms of the number of cigarettes required for the
exchange. They served as a store of value because an individual would be willing to save their
cigarettes even if they did not smoke because they believed that they could exchange the
cigarettes for something that they did want at some time in the future.
Diff: 2
Type: ES
Skill: Applied
Objective: 3.2 List and summarize the functions of money
38) Can packs of cigarettes be used as commodity money?
Answer: We must see whether cigarettes satisfy the 5 criteria for a commodity to function
effectively as money:
1. Easily standardized—yes they are, cigarettes come is packs.
2. Widely accepted—yes, if they are used in a setting such as WW II prisoners of war.
3. Divisible—yes, packs of cigarettes are divisible to single cigarettes.
4. Easy to carry—yes, cigarettes are lightweight.
5. Must not deteriorate quickly—yes, cigarettes do not deteriorate easily.
Diff: 2
Type: ES
Skill: Applied
Objective: 3.2 List and summarize the functions of money
39) Economists say that money is a store of value. since there are other assets that are a more
desirable store of money, why do people hold money at all?
Answer: People hold money although it is not the best store of value, because of an important
economic feature of money, liquidity. Liquidity is a highly desired property of assets. Liquidity
measures how easily and fast an asset can be converted into a medium of exchange. Since
money is a medium of exchange it is the most liquid asset, and thus, highly desirable although
it is not the best store of value.
Diff: 2
Type: ES
Skill: Applied
Objective: 3.2 List and summarize the functions of money
40) Why are people are willing to hold money even if it is not the most attractive store of
value?
Answer: The answer to this question relates to the economic concept of liquidity, the relative
ease and speed with which an asset can be converted into a medium of exchange. Money is the
most liquid asset of all because it is the medium of exchange; it does not have to be converted
into anything else in order to make purchases. Other assets involve transaction costs when they
are converted into money.
Diff: 2
Type: ES
Skill: Applied
Objective: 3.2 List and summarize the functions of money
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3.3
Evolution of the Payments System
1) The payments system is ________.
A) the method of conducting transactions in the economy
B) used by union officials to set salary caps
C) an illegal method of rewarding contracts
D) used by your employer to determine salary increases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
2) As the payments system evolves from barter to a monetary system, ________.
A) commodity money is likely to precede the use of paper currency
B) transaction costs increase
C) the number of prices that need to be calculated increase rather dramatically
D) specialization decreases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
3) A disadvantage of ________ is that it can be very heavy and hard to transport from one place
to another.
A) commodity money
B) fiat money
C) electronic money
D) paper money
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
4) Paper currency that has been declared legal tender but is not convertible into coins or
precious metals is called ________ money.
A) commodity
B) fiat
C) electronic
D) funny
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
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5) When paper currency is decreed by governments as legal tender, legally it must be
________.
A) paper currency backed by gold
B) a precious metal such as gold or silver
C) accepted as payment for debts
D) convertible into an electronic payment
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
6) The evolution of the payments system from barter to precious metals, then to fiat money,
then to cheques can best be understood as a consequence of the fact that ________.
A) paper is more costly to produce than precious metals
B) precious metals were not generally acceptable
C) precious metals were difficult to carry and transport
D) paper money is less accepted than cheques
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
7) Compared to cheques, paper currency and coins have the major drawbacks that they
________.
A) are easily stolen
B) are hard to counterfeit
C) are not the most liquid assets
D) must be backed by gold
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
8) Introduction of cheques into the payments system reduced the costs of exchanging goods and
services. Another advantage of cheques is that ________.
A) they provide convenient receipts for purchases
B) they can never be stolen
C) they are more widely accepted than currency
D) the funds from a deposited cheque are available for use immediately
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
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9) The evolution of the payments system from barter to precious metals, then to fiat money,
then to cheques can best be understood as a consequence of ________.
A) government regulations designed to improve the efficiency of the payments system
B) government regulations designed to promote the safety of the payments system
C) innovations that reduced the costs of exchanging goods and services
D) competition among firms to make it easier for customers to purchase their products
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 3.3 Identify different types of payment systems
10) Compared to an electronic payments system, a payments system based on cheques has the
major drawback that ________.
A) cheques are less costly to process
B) cheques take longer to process, meaning that it may take several days before the depositor
can get her cash
C) fraud may be more difficult to commit when paper receipts are eliminated
D) legal liability is more clearly defined
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
11) Which of the following sequences accurately describes the evolution of the payments
system?
A) Barter, coins made of precious metals, paper currency, cheques, electronic funds transfers
B) Barter, coins made of precious metals, cheques, paper currency, electronic funds transfers
C) Barter, cheques, paper currency, coins made of precious metals, electronic funds transfers
D) Barter, cheques, paper currency, electronic funds transfers
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 3.3 Identify different types of payment systems
12) During the past two decades an important characteristic of the modern payments system has
been the rapidly increasing use of ________.
A) cheques and decreasing use of currency
B) electronic payments
C) commodity monies
D) fiat money
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
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13) Which of the following is not a form of e-money?
A) A debit card
B) A credit card
C) A stored-value card
D) A smart card
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 3.3 Identify different types of payment systems
14) E-cash is used for payments ________.
A) that are always secure
B) that are very important
C) on the internet
D) in any transaction
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
15) A smart card is the equivalent of ________.
A) cash
B) savings bonds
C) savings deposits
D) certificates of deposit
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 3.3 Identify different types of payment systems
16) An electronic payments system has not completely replaced the paper payments system
because of all of the following reasons except ________.
A) expensive equipment is necessary to set up the system
B) security concerns
C) privacy concerns
D) transportation costs
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.3 Identify different types of payment systems
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17) In explaining the evolution of money, ________.
A) government regulation is the most important factor
B) commodity money, because it is valued more highly, tends to drive out paper money
C) new forms of money evolve to lower transaction costs
D) paper money is always backed by gold and therefore more desirable than cheques
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 3.3 Identify different types of payment systems
18) What factors have slowed down the movement to a system where all payments are made
electronically?
Answer: The equipment necessary to set up the system is expensive, security of the
information, and privacy concerns are issues that need to be addressed before an electronic
payments system will be widely accepted.
Diff: 1
Type: ES
Skill: Recall
Objective: 3.3 Identify different types of payment systems
19) What is a cheque? what are their advantages and disadvantages?
Answer: A cheque is an instrument used to transfer money from your account to someone
else's account when she deposits the cheque.
Advantages: Reduces transportation costs associated with the payments system as they
frequently cancel each other. Also, they make the transactions for large amounts much easier as
they can be written for any amount up to the balance in the account. Finally loss from theft is
greatly reduced and they provide convenient receipts for purchases.
Disadvantages: It takes time to get cheques from one place to another, it takes several days for
a cheque to be processed from your bank, and the paper work required to process them is
costly.
Diff: 1
Type: ES
Skill: Recall
Objective: 3.3 Identify different types of payment systems
20) Explain the evolution of the payments system. Is the system headed towards a cashless
society?
Answer: Societies begin with a barter system and then introduce commodity money which
was replaced with paper money. Fiat money, is legal tender, based on the backing of an
authority — typically the government. Cheques and electronic payments were the next
evolution in the system. A cashless society is unlikely due to several concerns: 1) it is
expensive to set up and 2) it raises privacy and security concerns.
Diff: 1
Type: ES
Skill: Recall
Objective: 3.3 Identify different types of payment systems
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21) What are electronic payments? how do they reduce transaction costs? by how much?
Answer: In the past when paying bills you had to mail a cheque but now banks provide a
website in which you log on, make a few clicks and make the payment that is transmitted
electronically. You can even avoid logging in as reoccurring bills can be automatically
deducted from your bank account. Electronic payments reduce transaction costs as you do not
have to pay a stamp to send a cheque and also you save time paying your bills electronically.
Estimated cost savings when a bill is paid electronically rather than a cheques exceed one
dollar.
Diff: 2
Type: ES
Skill: Recall
Objective: 3.3 Identify different types of payment systems
3.4
Measuring Money
1) If an individual moves money from a demand deposit account to a money market mutual
fund, ________.
A) M1+ decreases and M2 stays the same
B) M1+ stays the same and M2+ increases
C) M1+ stays the same and M2 stays the same
D) M1+ decreases and M2 decreases
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
2) If an individual moves money from a chequing account to a money market mutual fund,
________.
A) M1+ decreases and M2+ increases
B) M1+ stays the same and M2+ increases
C) M1+ decreases and M2+ stays the same
D) M1+ increases and M2+ decreases
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
3) Defining money becomes ________ difficult as the pace of financial innovation ________.
A) less; quickens
B) more; quickens
C) more; slows
D) more; stops
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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4) Monetary aggregates are ________.
A) measures of the money supply reported by the Bank of Canada
B) measures of the wealth of individuals
C) never redefined since "money" never changes
D) reported by the Department of Finance annually
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
5) Recent financial innovation makes the Bank of Canada's job of conducting monetary policy
________.
A) easier, since the Bank of Canada now knows what to consider money
B) more difficult, since the Bank of Canada now knows what to consider money
C) easier, since the Bank of Canada no longer knows what to consider money
D) more difficult, since the Bank of Canada no longer knows what to consider money
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
6) ________ is the narrowest monetary aggregate that the Bank of Canada reports.
A) M0
B) M1+
C) M2
D) M3
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
7) The currency component includes paper money and coins held in ________.
A) bank vaults
B) ATMs
C) the hands of the nonbank public
D) the central bank
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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8) The components of the M1+ monetary aggregate are chequable deposits plus ________.
A) currency
B) currency plus savings deposits
C) currency outside banks
D) currency plus money market deposits
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
9) The M1+ measure of money includes ________.
A) small denomination time deposits
B) chequable deposits
C) money market deposit accounts
D) money market mutual fund shares
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
10) Which of the following is not included in the measure of M2?
A) Personal deposits
B) Non-personal demand deposits
C) Currency
D) Foreign currency deposits
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
11) Which of the following is not included in M1+ but is included in M1++?
A) Currency outside banks
B) Currency held by banks
C) Chequable deposits at banks, TMLs and CUCPs
D) Nonchequable deposits at banks, TMLs and CUCPs
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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12) Which of the following is not included in the M2 measure of money but is included in the
M3 measure of money?
A) Currency
B) Personal deposits
C) Demand deposits
D) Foreign currency deposits
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
13) Which of the following is included in both M1+ and M2?
A) Currency
B) Savings deposits
C) Small-denomination time deposits
D) Money market deposit accounts
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
14) Which of the following is not included in the monetary aggregate M2?
A) Currency
B) Money market mutual funds
C) Personal deposits
D) Notice deposits
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
15) Which of the following is included in M2+ but not in M2?
A) Personal deposits
B) Demand deposits
C) Currency
D) Money market mutual funds
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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16) If an individual redeems a Canada savings bond for currency, ________.
A) M1+ stays the same and M2++ decreases
B) M1+ increases and M2++ increases
C) M1+ increases and M2++ stays the same
D) M1+ stays the same and M2++ stays the same
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
17) If an individual redeems a Canada savings bond for currency, ________.
A) M1+ stays the same and M2 decreases
B) M1+ increases and M2 increases
C) M1+ increases and M2 stays the same
D) M1+ stays the same and M2 stays the same
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
18) If an individual moves money from a notice deposit at a bank to a deposit account at a
credit union, ________.
A) M2 decreases and M2+ stays the same
B) M2 decreases and M2+ increases
C) M2 increases and M2+ stays the same
D) M2 increases and M2+ increases
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
19) If an individual moves money from currency to a personal deposit account, ________.
A) M1+ decreases and M2+ stays the same
B) M1+ stays the same and M2+ increases
C) M1+ stays the same and M2+ stays the same
D) M1+ increases and M2+ stays the same
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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20) If an individual moves money from a money market mutual fund to currency, ________.
A) M1+ increases and M2+ stays the same
B) M1+ stays the same and M2+ increases
C) M1+ stays the same and M2+ stays the same
D) M1+ increases and M2+ decreases
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
21) The currency component of M2 shows that there is ________ in cash in the hands of each
person in Canada.
A) $150
B) $15000
C) $1500
D) $15
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
22) The measures of money supply used by the Bank of Canada are ________ indices.
A) simple-sum
B) complex
C) multiplicative
D) accurate
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
23) Divergent growth rates of monetary aggregates are problematic because ________.
A) it means that monetary aggregates are not very accurate
B) it suggests that monetary policy is ineffective
C) it means that the effect of monetary policy becomes harder to predict
D) it suggests that the choice of monetary aggregate by policy makers does not matter
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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24) In the money index used by the Bank of Canada: M = X1 + X2 + ... + Xn, the n monetary
components have ________.
A) a weight of 1/n
B) different weights
C) a weight of n
D) a weight of 1
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
25) In the money index used by the Bank of Canada: M = X1 + X2 + ... + Xn, the Xs are
________.
A) the proportional weights for calculating M
B) the increasing weights in calculating M
C) the n monetary components of M
D) the decreasing weights in calculating M
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
26) The formula used the Bank of Canada in calculating the money supply is ________.
A) M = A1X1 + A2X2 + ... + AnXn
B) M =
C) M = X1 + X2 + +Xn
D) M =
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
27) Weighting monetary components in a simple-sum aggregate index ________.
A) has never been attempted because it is too complex
B) might be attempted with rigourous use of microeconomic, aggregation and index number
theory
C) might not perform as well as the simple-sum index
D) might not predict inflation and business cycles better than conventional measures
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
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28) Why are most of the U.S. dollars held outside of the United States?
Answer: Concern about high inflation eroding the value of their own currency causes many
people in foreign countries to hold U.S. dollars as a hedge against inflation risk.
Diff: 1
Type: ES
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
29) Data show that an average Canadian and American citizens hold CA$1500 and US$2000 of
their currency respectively. Since money is bulky, it can be stolen, pays no interest and in
general we do not see our fellow Canadians holding $1500 in their pockets, where are these
dollars and who is holding them?
Answer: One group that hold big amounts of currency are the criminals since currency is not
traceable as cheques that can be used as evidence against them. Also, some businesses that are
evading taxes operate as cash businesses which makes their transactions less traceable and they
can avoid declaring income on which they would have to pay taxes. Finally, one group that
holds Canadian and American (to a larger extent) dollars are foreigners in countries where they
do not trust their own currency as they frequently experience high inflation that erodes the
value of their currency.
Diff: 2
Type: ES
Skill: Recall
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
30) Explain the relationship between currency and the M1+ monetary aggregate. What does the
"plus" sign represent?
Answer: Currency includes paper money and coins in circulation M1+ includes all
chequeable deposits at chartered banks, trust and mortgage loans companies, credit unions and
caisses populaires. The "plus" sign represents TMLS, credit unions and caisses populaires.
Diff: 2
Type: ES
Skill: Applied
Objective: 3.4 Compare and contrast the M1 and M2 money supplies
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 4 Understanding Interest Rates
4.1
Measuring Interest Rates
1) If a security pays $55 in one year and $133 in three years, its present value is $150 if the
interest rate is ________.
A) 5 percent
B) 10 percent
C) 12.5 percent
D) 15 percent
Answer: B
Diff: 1
Type: MC
Skill: Applied
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Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
2) The concept of ________ is based on the common-sense notion that a dollar paid to you in
the future is less valuable to you than a dollar today.
A) present value
B) future value
C) interest
D) deflation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
3) The present value of an expected future payment ________ as the interest rate increases.
A) falls
B) rises
C) is constant
D) is unaffected
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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4) An increase in the time to the promised future payment ________ the present value of the
payment.
A) decreases
B) increases
C) has no effect on
D) is irrelevant to
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
5) With an interest rate of 6 percent, the present value of $100 next year is approximately
________.
A) $106
B) $100
C) $94
D) $92
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
6) To claim that a lottery winner who is to receive $1 million per year for twenty years has won
$20 million ignores the process of ________.
A) face value
B) par value
C) deflation
D) discounting the future
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
7) A credit market instrument that provides the borrower with an amount of funds that must be
repaid at the maturity date along with an interest payment is known as a ________.
A) simple loan
B) fixed-payment loan
C) coupon bond
D) discount bond
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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8) A credit market instrument that requires the borrower to make the same payment every
period until the maturity date is known as a ________.
A) simple loan
B) fixed-payment loan
C) coupon bond
D) discount bond
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
9) Which of the following is true of fixed payment loans?
A) The borrower repays both the principal and interest at the maturity date.
B) Installment loans and mortgages are frequently of the fixed payment type.
C) The borrower pays interest periodically and the principal at the maturity date.
D) Commercial loans to businesses are often of this type.
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
10) A fully amortized loan is another name for ________.
A) a simple loan
B) a fixed-payment loan
C) a commercial loan
D) an unsecured loan
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
11) A credit market instrument that pays the owner a fixed coupon payment every year until the
maturity date and then repays the face value is called a ________.
A) simple loan
B) fixed-payment loan
C) coupon bond
D) discount bond
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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12) A ________ pays the owner a fixed coupon payment every year until the maturity date,
when the ________ value is repaid.
A) coupon bond; discount
B) discount bond; discount
C) coupon bond; face
D) discount bond; face
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
13) The ________ is the final amount that will be paid to the holder of a coupon bond.
A) discount value
B) coupon value
C) face value
D) present value
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
14) When talking about a coupon bond, face value and ________ mean the same thing.
A) par value
B) coupon value
C) amortized value
D) discount value
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
15) The dollar amount of the yearly coupon payment expressed as a percentage of the face
value of the bond is called the bond's ________.
A) coupon rate
B) maturity rate
C) face value rate
D) payment rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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16) If a $5000 coupon bond has a coupon rate of 13 percent, then the coupon payment every
year is ________.
A) $650
B) $1300
C) $130
D) $13
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
17) An $8000 coupon bond with a $400 coupon payment every year has a coupon rate of
________.
A) 5 percent
B) 8 percent
C) 10 percent
D) 40 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
18) All of the following are examples of coupon bonds except ________.
A) Corporate bonds
B) Treasury bills
C) Zero coupon bonds
D) Government bonds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
19) A bond that is bought at a price below its face value and the face value is repaid at a
maturity date is called a ________.
A) simple loan
B) fixed-payment loan
C) coupon bond
D) discount bond
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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20) A ________ is bought at a price below its face value, and the ________ value is repaid at
the maturity date.
A) coupon bond; discount
B) discount bond; discount
C) coupon bond; face
D) discount bond; face
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
21) A discount bond ________.
A) pays the bondholder a fixed amount every period and the face value at maturity
B) pays the bondholder the face value at maturity
C) pays all interest and the face value at maturity
D) pays the face value at maturity plus any capital gain
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
22) Examples of discount bonds include ________.
A) Treasury bills
B) corporate bonds
C) coupon bonds
D) municipal bonds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
23) Which of the following is true for discount bonds?
A) A discount bond is bought at par.
B) The purchaser receives the face value of the bond at the maturity date.
C) Canada bonds and notes are examples of discount bonds.
D) The purchaser receives the par value at maturity plus any capital gains.
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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24) The interest rate that equates the present value of payments received from a debt instrument
with its value today is the ________.
A) simple interest rate
B) current yield
C) yield to maturity
D) real interest rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
25) Economists consider the ________ to be the most accurate measure of interest rates.
A) simple interest rate
B) current yield
C) yield to maturity
D) real interest rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
26) For simple loans, the simple interest rate is ________ the yield to maturity.
A) greater than
B) less than
C) equal to
D) not comparable to
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
27) If the amount payable in two years is $2420 for a simple loan at 10 percent interest, the
loan amount is ________.
A) $1000
B) $1210
C) $2000
D) $2200
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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28) For a 3-year simple loan of $10000 at 10 percent, the amount to be repaid is ________.
A) $10030
B) $10300
C) $13000
D) $13310
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
29) If $22050 is the amount payable in two years for a $20000 simple loan made today, the
interest rate is ________.
A) 5 percent
B) 10 percent
C) 22 percent
D) 25 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
30) If a security pays $110 next year and $121 the year after that, what is its yield to maturity if
it sells for $200?
A) 9 percent
B) 10 percent
C) 11 percent
D) 12 percent
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
31) The present value of a fixed-payment loan is calculated as the ________ of the present
value of all cash flow payments.
A) sum
B) difference
C) multiple
D) log
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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32) Which of the following is true for a coupon bond?
A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon
rate.
B) The price of a coupon bond and the yield to maturity are positively related.
C) The yield to maturity is greater than the coupon rate when the bond price is above the par
value.
D) The yield is less than the coupon rate when the bond price is below the par value.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
33) The price of a coupon bond and the yield to maturity are ________ related; that is, as the
yield to maturity ________, the price of the bond ________.
A) positively; rises; rises
B) negatively; falls; falls
C) positively; rises; falls
D) negatively; rises; falls
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
34) The yield to maturity is ________ than the ________ rate when the bond price is ________
its face value.
A) greater; coupon; above
B) greater; coupon; below
C) greater; perpetuity; above
D) less; perpetuity; below
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
35) A $10000 8 percent coupon bond that sells for $10000 has a yield to maturity of ________.
A) 8 percent
B) 10 percent
C) 12 percent
D) 14 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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36) Which of the following $1000 face-value securities has the highest yield to maturity?
A) A 5 percent coupon bond selling for $1000
B) A 10 percent coupon bond selling for $1000
C) A 12 percent coupon bond selling for $1000
D) A 12 percent coupon bond selling for $1100
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
37) Which of the following $5000 face-value securities has the highest yield-to maturity?
A) A 6 percent coupon bond selling for $5000
B) A 6 percent coupon bond selling for $5500
C) A 10 percent coupon bond selling for $5000
D) A 12 percent coupon bond selling for $4500
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
38) Which of the following $1000 face-value securities has the highest yield to maturity?
A) A 5 percent coupon bond with a price of $600
B) A 5 percent coupon bond with a price of $800
C) A 5 percent coupon bond with a price of $1000
D) A 5 percent coupon bond with a price of $1200
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
39) Which of the following $1000 face-value securities has the lowest yield to maturity?
A) A 5 percent coupon bond selling for $1000
B) A 10 percent coupon bond selling for $1000
C) A 15 percent coupon bond selling for $1000
D) A 15 percent coupon bond selling for $900
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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40) Which of the following bonds would you prefer to be buying?
A) A $10000 face-value security with a 10 percent coupon selling for $9000
B) A $10000 face-value security with a 7 percent coupon selling for $10000
C) A $10000 face-value security with a 9 percent coupon selling for $10000
D) A $10000 face-value security with a 10 percent coupon selling for $10000
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
41) A coupon bond that has no maturity date and no repayment of principal is called a
________.
A) consol
B) cabinet
C) Treasury bill
D) Government note
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
42) The price of a consol equals the coupon payment ________.
A) times the interest rate
B) plus the interest rate
C) minus the interest rate
D) divided by the interest rate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
43) The interest rate on a consol equals the ________.
A) price times the coupon payment
B) price divided by the coupon payment
C) coupon payment plus the price
D) coupon payment divided by the price
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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44) A consol paying $20 annually when the interest rate is 5 percent has a price of ________.
A) $100
B) $200
C) $400
D) $800
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
45) If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is
________.
A) 2.5 percent
B) 5 percent
C) 7.5 percent
D) 10 percent
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
46) The yield to maturity for a perpetuity is a useful approximation for the yield to maturity on
long-term coupon bonds. It is called the ________ when approximating the yield for a coupon
bond.
A) current yield
B) discount yield
C) future yield
D) star yield
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
47) 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
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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48) If a $10000 face-value discount bond maturing in one year is selling for $5000, then its
yield to maturity is ________.
A) 5 percent
B) 10 percent
C) 50 percent
D) 100 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
49) If a $5000 face-value discount bond maturing in one year is selling for $5000, then its yield
to maturity is ________.
A) 0 percent
B) 5 percent
C) 10 percent
D) 20 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
50) A discount bond selling for $15000 with a face value of $20000 in one year has a yield to
maturity of ________.
A) 3 percent
B) 20 percent
C) 25 percent
D) 33.3 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
51) The yield to maturity for a discount bond is ________ related to the current bond price.
A) negatively
B) positively
C) not
D) directly
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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52) In Japan in 1998 and in the U.S. in 2008, interest rates were negative for a short period of
time because investors found it convenient to hold six-month bills as a store of value because
________.
A) of the high inflation rate
B) these bills sold at a discount from face value
C) the bills were denominated in small amounts and could be stored electronically
D) the bills were denominated in large amounts and could be stored electronically
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
53) If the interest rate is 5 percent, what is the present value of a security that pays you $1050
next year and $1102.50 two years from now? If this security sold for $2200, is the yield to
maturity greater or less than 5 percent? Why?
Answer: PV = $1050/(1 + .05) + $1102.50/
PV = $2000
If this security sold for $2200, the yield to maturity is less than 5 percent. The lower the interest
rate the higher the present value.
Diff: 3
Type: ES
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
54) A relative has just won a state lottery paying $20 million in installments of $1 million per
year for twenty years. Your relative states that she is $20 million richer. Is she correct? Create a
simple example for two years to illustrate your position.
Answer: The relative is incorrect. The discounted present value of the payments is less than
$20 million. The example should demonstrate that the discounted value of the payment due in
one year is less than $1 million.
Diff: 3
Type: ES
Skill: Applied
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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55) What is a coupon bond? Describe its basic properties.
Answer: A coupon bonds pays the owner a fixed interest payment every year until the
maturity date when a specified amount called the face value is repaid. A coupon bond is
identified by three pieces of information:
a.
the corporation or government agency that issues the bond,
b.
the maturity date of the bond, and
c.
the bond's coupon rate, the dollar amount of the yearly coupon payment expressed as a
percentage of the face value of the bond.
Diff: 2
Type: ES
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
56) Explain why the current bond prices and interest rates are negatively related.
Answer: There are two ways to show why current bond prices and interest rates are
negatively related:
a.
From the bond price formula: we can see that as the interest rate (yield to maturity)
rises, all denominators in the bond price formula must necessarily rise. Hence, a rise in the
interest rates as measured by the yield to maturity means that the price of the bond must fall.
b.
An increase in the interest rate means that all the future coupon payments and final
payment will be worth less when discounted to the present, thus, the price of the bond must fall.
Diff: 2
Type: ES
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
57) How is current yield defined? How can it be used to determine yield to maturity for
long-term bonds?
Answer: The current yield is the is the yield to maturity of a perpetuity or consol. It is given
by the formula:
ic = , where C is the yearly payment and P is the price of the perpetuity. When a coupon
bond has a long term to maturity, it is very much like a perpetuity. The current yield will be
very close to the yield to maturity for a long term bond and is used as an approximation to
describe interest rates on long term bonds.
Diff: 3
Type: ES
Skill: Recall
Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the
four different types of credit market instruments
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4.2
The Distinction Between Interest Rates and Returns
1) The ________ is defined as the payments to the owner plus the change in a security's value
expressed as a fraction of the security's purchase price.
A) yield to maturity
B) current yield
C) rate of return
D) yield rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
2) Which of the following is true concerning the distinction between interest rates and returns?
A) The rate of return on a bond will not necessarily equal the interest rate on that bond.
B) The return can be expressed as the difference between the current yield and the rate of
capital gains.
C) The rate of return will be greater than the interest rate when the price of the bond falls
between time t and time t + 1.
D) The return can be expressed as the sum of the discount yield and the rate of capital gains.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
3) The sum of the current yield and the rate of capital gain is called the ________.
A) rate of return
B) discount yield
C) perpetuity yield
D) par value
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
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4) What is the return on a 5 percent coupon bond that initially sells for $1000 and sells for
$1200 next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) 25 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
5) What is the return on a 5 percent coupon bond that initially sells for $1000 and sells for $900
next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) -10 percent
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
6) The return on a 5 percent coupon bond that initially sells for $1000 and sells for $950 next
year is ________.
A) -10 percent
B) -5 percent
C) 0 percent
D) 5 percent
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
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7) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to
maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent
over the course of the year, what is the yearly return on the bond you are holding?
A) 5 percent
B) 10 percent
C) 15 percent
D) 20 percent
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
8) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which
bond would you prefer to have been holding?
A) A bond with one year to maturity
B) A bond with five years to maturity
C) A bond with ten years to maturity
D) A bond with twenty years to maturity
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
9) An equal decrease in all bond interest rates ________.
A) increases the price of a five-year bond more than the price of a ten-year bond
B) increases the price of a ten-year bond more than the price of a five-year bond
C) decreases the price of a five-year bond more than the price of a ten-year bond
D) decreases the price of a ten-year bond more than the price of a five-year bond
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
10) An equal increase in all bond interest rates ________.
A) increases the return to all bond maturities by an equal amount
B) decreases the return to all bond maturities by an equal amount
C) has no effect on the returns to bonds
D) decreases long-term bond returns more than short-term bond returns
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
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11) Which of the following is generally true of bonds?
A) The only bond whose return equals the initial yield to maturity is one whose time to
maturity is the same as the holding period.
B) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on
bonds whose terms to maturity are longer than the holding periods.
C) The longer a bond's maturity, the smaller is the size of the price change associated with an
interest rate change.
D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
12) Which of the following is generally true of all bonds?
A) The longer a bond's maturity, the greater is the rate of return that occurs as a result of the
increase in the interest rate.
B) Even though a bond has a substantial initial interest rate, its return can turn out to be
negative if interest rates rise.
C) Prices and returns for short-term bonds are more volatile than those for longer term bonds.
D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer
than the holding period.
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
13) Prices and returns for ________ bonds are more volatile than those for ________ bonds.
A) long-term; long-term
B) long-term; short-term
C) short-term; long-term
D) short-term; short-term
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
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14) The riskiness of an asset's returns due to changes in interest rates is ________.
A) exchange-rate risk
B) price risk
C) asset risk
D) interest-rate risk
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
15) Interest-rate risk is the riskiness of an asset's returns due to ________.
A) interest-rate changes
B) changes in the coupon rate
C) default of the borrower
D) changes in the asset's maturity
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
16) Bonds whose term-to-maturity is longer than the holding period are subject to ________.
A) interest rate risk
B) exchange-rate risk
C) inflation
D) deflation
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
17) There is ________ for any bond whose time to maturity matches the holding period.
A) no interest-rate risk
B) a large interest-rate risk
C) rate-of-return risk
D) yield-to-maturity risk
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
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18) Your favorite uncle advises you to purchase long-term bonds because their interest rate is
10 percent. Should you follow his advice?
Answer: It depends on where you think interest rates are headed in the future. If you think
interest rates will be going up, you should not follow your uncle's advice because you would
then have to discount your bond if you needed to sell it before the maturity date. Long-term
bonds have a greater interest-rate risk.
Diff: 2
Type: ES
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
19) Your friend tells you that she bought a 10-year to maturity discount bond that she plans to
hold until maturity in order to finance her daughter's university education. She also tells you
that she is worried that due to interest-rate-risk she may suffer significant capital losses if
interest rates increase. Are her fears justified?
Answer: No, her fear of significant capital losses from future increases in the interest rates for
bonds are not justified as she is planning to hold the 10-year bond until maturity when she is
guaranteed to receive the face value of the bond back. There is no interest-rate-risk associated
with this investment as the time to maturity matches the holding period and any increase in
interest rates can have no effect on the price at the end of the holding period.
Diff: 2
Type: ES
Skill: Applied
Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return,
and rate of capital gain
4.3
The Distinction Between Real and Nominal Interest Rates
1) The ________ interest rate is adjusted for expected changes in the price level.
A) ex ante real
B) ex post real
C) ex post nominal
D) ex ante nominal
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
2) The ________ interest rate more accurately reflects the true cost of borrowing.
A) nominal
B) real
C) discount
D) market
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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3) The nominal interest rate minus the expected rate of inflation ________.
A) defines the real interest rate
B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest
rate
C) is a less accurate indicator of the tightness of credit market conditions than is the nominal
interest rate
D) defines the discount rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
4) In a country where prices never change, the nominal interest rate is equal to the ________.
A) real exchange rate
B) inflation rate
C) expected inflation rate
D) real interest rate
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
5) The ________ states that the real interest rate equals the nominal interest rate minus the
expected rate of inflation.
A) Fisher equation
B) Keynesian equation
C) Monetarist equation
D) Marshall equation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
6) The Fisher equation states that ________.
A) the real interest rate equals the nominal interest rate plus the expected rate of inflation
B) the real interest rate equals the nominal interest rate less the expected rate of inflation
C) the nominal interest rate equals the real interest rate less the expected rate of inflation
D) the nominal interest rate equals the real interest rate plus the expected rate of inflation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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7) The nominal interest rate minus the expected rate of inflation ________.
A) defines the real rate of inflation
B) is a worse measure of the incentives to borrow and lend than is the nominal interest rate
C) is a more accurate indicator of the tightness of credit market conditions than is the nominal
interest rate
D) defines the bank rate
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
8) The nominal interest rate minus the expected rate of inflation ________.
A) defines the real interest rate
B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest
rate
C) is a less accurate indicator of the tightness of credit market conditions than is the nominal
interest rate
D) defines the bank rate
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
9) The interest rate that describes how well a lender has done in real terms after the fact is
called the ________.
A) ex post real interest rate
B) ex ante real interest rate
C) ex post nominal interest rate
D) ex ante nominal interest rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
10) The ________ states that the nominal interest rate equals the real interest rate plus the
expected rate of inflation.
A) Fisher equation
B) Keynesian equation
C) Monetarist equation
D) Marshall equation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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11) If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the
real rate of interest is ________.
A) 2 percent
B) 8 percent
C) 10 percent
D) 12 percent
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
12) In which of the following situations would you prefer to be the lender?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
13) In which of the following situations would you prefer to be the borrower?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
14) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is ________.
A) 7 percent
B) 22 percent
C) -15 percent
D) -8 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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15) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is ________.
A) -5 percent
B) -2 percent
C) 2 percent
D) 12 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
16) When the ________ interest rate is low, there are greater incentives to ________ and fewer
incentives to ________.
A) nominal; lend; borrow
B) real; lend; borrow
C) real; borrow; lend
D) market; lend; borrow
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
17) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is ________.
A) -3 percent
B) -2 percent
C) 3 percent
D) 7 percent
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
18) The interest rate on Real Return Bonds is a direct measure of ________.
A) the real interest rate
B) the nominal interest rate
C) the rate of inflation
D) the rate of deflation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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19) Assuming the same coupon rate and maturity length, the difference between the yield on a
Real Return Bond and the yield on a Canada bond provides insight into ________.
A) the nominal interest rate
B) the real interest rate
C) the nominal exchange rate
D) the expected inflation rate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
20) Assuming the same coupon rate and maturity length, when the interest rate on a Real
Return Bond is 3 percent, and the yield on a nonindexed Canada bond is 8 percent, the expected
rate of inflation is ________.
A) 3 percent
B) 5 percent
C) 8 percent
D) 11 percent
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
21) By subtracting from the interest rate of a Canada coupon bond the interest rate of a similar
maturity's real return bond, provides us with an insight about ________.
A) the expected inflation
B) the real interest rate
C) the current yield
D) the discounted yield
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
22) If the interest rate on a Real Return Bond is 2 percent and the interest rate on a Canada
bond of similar maturity is 5 percent then the expected rate of inflation is equal to ________.
A) -3 percent
B) 7 percent
C) 3 percent
D) 2 percent
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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23) If the interest rate on a Real Return Bond is 5 percent and the interest rate on a Canada
bond of similar maturity is 2 percent then the expected rate of inflation is equal to ________.
A) -3 percent
B) 7 percent
C) 3 percent
D) 2 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
24) If the interest rate on a Real Return Bond is 2 percent and the interest rate on a Canada
bond of similar maturity is 5 percent then ________ is equal to 3 percent.
A) the expected rate of inflation
B) the yield to maturity
C) current yield
D) expected interest rate
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
25) Would it make sense to buy a house when mortgage rates are 14 percent and expected
inflation is 15 percent? Explain your answer.
Answer: Even though the nominal rate for the mortgage appears high, the real cost of
borrowing the funds is -1 percent. Yes, under this circumstance it would be reasonable to make
this purchase.
Diff: 2
Type: ES
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
26) Explain the Fisher equation. Construct a numerical example demonstrating that, depending
on the expected rate of inflation, a lower nominal rate may still reflect a higher real cost of
borrowing. Explain your example thoroughly.
Answer: The answer should list the equation that the nominal rate equals the real rate plus the
expected rate of inflation, or an equivalent variant. The terms should be clearly defined. The
example should have a higher real rate for the lower nominal rate due to relatively lower
expected inflation. The example and the resultant impact on real borrowing costs should be
thoroughly explained.
Diff: 2
Type: ES
Skill: Recall
Objective: 4.3 Interpret the distinction between real and nominal interest rates
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27) A friend tells you that he can purchase a 10 percent coupon bond at face value. Your friend
states that 10 percent is a "high" rate of interest. You know that the current rate of inflation is 8
percent, and you expect inflation to increase. What advice should you give to your friend about
this bond?
Answer: The high nominal rate is reduced to a much lower real rate due to inflation.
Interest-rate risk should be a concern. An increase in expected inflation will increase nominal
rates due to the Fisher effect. This will result in a capital loss, and the higher nominal rate
reduces the real value of the 10 percent coupon rate.
Diff: 2
Type: ES
Skill: Applied
Objective: 4.3 Interpret the distinction between real and nominal interest rates
4.4
Web Appendix 4.1: Measuring Interest-Rate Risk: Duration
1) Duration is ________.
A) an asset's term to maturity
B) the time until the next interest payment for a coupon bond
C) the average lifetime of a debt security's stream of payments
D) the time between interest payments for a coupon bond
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Measuring Interest-Rate Risk: Duration
2) Comparing a discount bond and a coupon bond with the same maturity, ________.
A) the coupon bond has the greater effective maturity
B) the discount bond has the greater effective maturity
C) the effective maturity cannot be calculated for a coupon bond
D) the effective maturity cannot be calculated for a discount bond
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Measuring Interest-Rate Risk: Duration
3) If a financial institution has 50 percent of its portfolio in a bond with a five-year duration and
50 percent of its portfolio in a bond with a seven-year duration, what is the duration of the
portfolio?
A) 12 years
B) 7 years
C) 6 years
D) 5 years
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: Appendix: Measuring Interest-Rate Risk: Duration
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4) The duration of a coupon bond increases ________.
A) the longer is the bond's term to maturity
B) when interest rates increase
C) the higher the coupon rate on the bond
D) the higher the bond price
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Measuring Interest-Rate Risk: Duration
5) All else equal, when interest rates ________, the duration of a coupon bond ________.
A) rise; falls
B) rise; increases
C) falls; falls
D) falls; does not change
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Measuring Interest-Rate Risk: Duration
6) All else equal, the ________ the coupon rate on a bond, the ________ the bond's duration.
A) higher; longer
B) higher; shorter
C) lower; shorter
D) greater; longer
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Measuring Interest-Rate Risk: Duration
7) An asset's interest rate risk ________ as the duration of the asset ________.
A) increases; decreases
B) decreases; decreases
C) decreases; increases
D) remains constant; increases
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Measuring Interest-Rate Risk: Duration
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 5 The Behaviour of Interest Rates
5.1
Determinants of Asset Demand
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1) Pieces of property that serve as a store of value are called ________.
A) assets
B) units of account
C) liabilities
D) borrowings
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.1 Identify the factors that affect the demand for assets
2) Of the four factors that influence asset demand, which factor will cause the demand for all
assets to increases, everything else held constant?
A) Wealth
B) Expected returns
C) Risk
D) Liquidity
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.1 Identify the factors that affect the demand for assets
3) Everything else held constant, a decrease in wealth ________.
A) increases the demand for stocks
B) increases the demand for bonds
C) reduces the demand for silver
D) increases the demand for gold
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
4) An increase in an asset's expected return relative to that of an alternative asset, holding
everything else constant, ________ the quantity demanded of the asset.
A) increases
B) decreases
C) has no effect on
D) erases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.1 Identify the factors that affect the demand for assets
5) Everything else held constant, if the expected return on ABC stock rises from 5 to 10 percent
and the expected return on CBS stock is unchanged, then the expected return of holding CBS
stock ________ relative to ABC stock and the demand for CBS stock ________.
A) rises; rises
B) rises; falls
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C) falls; rises
D) falls; falls
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
6) Everything else held constant, if the expected return on bonds falls from 10 to 5 percent and
the expected return on GE stock rises from 7 to 8 percent, then the expected return of holding
GE stock ________ relative to bonds and the demand for GE stock ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
7) If housing prices are expected to increase, then, other things equal, the demand for houses
will ________ and that of Treasury bills will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
8) If stock prices are expected to drop dramatically, then, other things equal, the demand for
stocks will ________ and that of Treasury bills will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
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9) Everything else held constant, if the expected return on RST stock declines from 12 to 9
percent and the expected return on XYZ stock declines from 8 to 7 percent, then the expected
return of holding RST stock ________ relative to XYZ stock and demand for XYZ stock
________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
10) Everything else held constant, if the expected return on government bonds falls from 8 to 7
percent and the expected return on corporate bonds falls from 10 to 8 percent, then the expected
return of corporate bonds ________ relative to government bonds and the demand for corporate
bonds ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
11) An increase in the expected rate of inflation will ________ the expected return on bonds
relative to the that on ________ assets, everything else held constant.
A) reduce; financial
B) reduce; real
C) raise; financial
D) raise; real
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
12) If fluctuations in interest rates become smaller, then, other things equal, the demand for
stocks ________ and the demand for long-term bonds ________.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
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13) If the price of gold becomes less volatile, then, other things equal, the demand for stocks
will ________ and the demand for gold will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
14) If brokerage commissions on bond sales decrease, then, other things equal, the demand for
bonds will ________ and the demand for real estate will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
15) If gold becomes acceptable as a medium of exchange, the demand for gold will ________
and the demand for bonds will ________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; increase
D) increase; decrease
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
16) The demand for silver decreases, other things equal, when ________.
A) the gold market is expected to boom
B) the market for silver becomes more liquid
C) wealth grows rapidly
D) interest rates are expected to rise
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
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17) You would be less willing to purchase bonds, other things equal, if ________.
A) you inherit $1 million from your Uncle Harry
B) you expect interest rates to fall
C) gold becomes more liquid
D) stock prices are expected to fall
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
18) 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
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
19) Holding all other factors constant, the quantity demanded of an asset is ________.
A) positively related to wealth
B) negatively related to its expected return relative to alternative assets
C) positively related to the risk of its returns relative to alternative assets
D) negatively related to its liquidity relative to alternative assets
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.1 Identify the factors that affect the demand for assets
20) 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?
Answer: Yes, it would cause the demand for rare coins to increase. The increased volatility of
stock prices means that there is relatively more risk in owning stock than there was previously
and so the demand for an alternative asset, rare coins, would increase.
Diff: 2
Type: ES
Skill: Applied
Objective: 5.1 Identify the factors that affect the demand for assets
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5.2
Supply and Demand in the Bond Market
1) The demand curve for bonds has the usual downward slope, indicating that at ________
prices of the bond, everything else equal, the ________ is higher.
A) higher; demand
B) higher; quantity demanded
C) lower; demand
D) lower; quantity demanded
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
2) The supply curve for bonds has the usual upward slope, indicating that as the price
________, ceteris paribus, the ________ increases.
A) falls; supply
B) falls; quantity supplied
C) rises; supply
D) rises; quantity supplied
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
3) In the bond market, the market equilibrium shows the market-clearing ________ and
market-clearing ________.
A) price; deposit
B) interest rate; deposit
C) price; interest rate
D) interest rate; premium
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
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4) When the price of a bond is above the equilibrium price, there is an excess ________ bonds
and price will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
5) When the price of a bond is ________ the equilibrium price, there is an excess demand for
bonds and price will ________.
A) above; rise
B) above; fall
C) below; fall
D) below; rise
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
6) When the interest rate on a bond is above the equilibrium interest rate, in the bond market
there is excess ________ and the interest rate will ________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
7) When the interest rate on a bond is ________ the equilibrium interest rate, in the bond
market there is excess ________ and the interest rate will ________.
A) above; demand; rise
B) above; demand; fall
C) below; supply; fall
D) above; supply; rise
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
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8) If the price of bonds is set ________ the equilibrium price, the quantity of bonds demanded
exceeds the quantity of bonds supplied, a condition called excess ________.
A) above; demand
B) above; supply
C) below; demand
D) below; supply
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the
equilibrium interest rate
5.3
Changes in Equilibrium Interest Rates
1) A movement along the bond demand or supply curve occurs when ________ changes.
A) bond price
B) income
C) wealth
D) expected return
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
2) When the price of a bond decreases, all else equal, the bond demand curve ________.
A) shifts right
B) shifts left
C) does not shift
D) inverts
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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3) During business cycle expansions when income and wealth are rising, the demand for bonds
________ and the demand curve shifts to the ________, everything else held constant.
A) falls; right
B) falls; left
C) rises; right
D) rises; left
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
4) Everything else held constant, when households save less, wealth and the demand for bonds
________ and the bond demand curve shifts ________.
A) increase; right
B) increase; left
C) decrease; right
D) decrease; left
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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5)
In the figure above, a factor that could cause the demand for bonds to decrease (shift to the left)
is ________.
A) an increase in the expected return on bonds relative to other assets
B) a decrease in the expected return on bonds relative to other assets
C) an increase in wealth
D) a reduction in the riskiness of bonds relative to other assets
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
6) Everything else held constant, an increase in expected inflation, lowers the expected return
on ________ compared to ________ assets.
A) bonds; financial
B) bonds; real
C) physical; financial
D) physical; real
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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7) Everything else held constant, an increase in the riskiness of bonds relative to alternative
assets causes the demand for bonds to ________ and the demand curve to shift to the
________.
A) rise; right
B) rise; left
C) fall; right
D) fall; left
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
8) Everything else held constant, when stock prices become less volatile, the demand curve for
bonds shifts to the ________ and the interest rate ________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
9) Everything else held constant, an increase in the liquidity of bonds results in a ________ in
demand for bonds and the demand curve shifts to the ________.
A) rise; right
B) rise; left
C) fall; right
D) fall; left
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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10) Everything else held constant, when bonds become less widely traded, and as a
consequence the market becomes less liquid, the demand curve for bonds shifts to the
________ and the interest rate ________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
11) During a recession, the supply of bonds ________ and the supply curve shifts to the
________, everything else held constant.
A) increases; left
B) increases; right
C) decreases; left
D) decreases; right
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
12) In a business cycle expansion, the ________ of bonds increases and the ________ curve
shifts to the ________ as business investments are expected to be more profitable.
A) supply; supply; right
B) supply; supply; left
C) demand; demand; right
D) demand; demand; left
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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13) When the inflation rate is expected to increase, the ________ for bonds falls, while the
________ curve shifts to the right, everything else held constant.
A) demand; demand
B) demand; supply
C) supply; demand
D) supply; supply
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
14) Everything else held constant, during a business cycle expansion, the supply of bonds shifts
to the ________ as businesses perceive more profitable investment opportunities, while the
demand for bonds shifts to the ________ as a result of the increase in wealth generated by the
economic expansion.
A) right; left
B) right; right
C) left; left
D) left; right
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
15) When the economy slips into a recession, normally the demand for bonds ________, the
supply of bonds ________, and the interest rate ________, everything else held constant.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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16) When the government has a surplus, as occurred in the late 1990s, the ________ curve of
bonds shifts to the ________, everything else held constant.
A) supply; right
B) supply; left
C) demand; right
D) demand; left
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
17) In the figure above, a factor that could cause the supply of bonds to shift to the right is
________.
A) a decrease in government budget deficits
B) a decrease in expected inflation
C) a recession
D) a business cycle expansion
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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18) In the figure above, the price of bonds would fall from P1 to P2 if ________.
A) inflation is expected to increase in the future
B) interest rates are expected to fall in the future
C) the expected return on bonds relative to other assets is expected to increase in the future
D) the riskiness of bonds falls relative to other assets
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
19) In the figure above, a factor that could cause the supply of bonds to increase (shift to the
right) is ________.
A) a decrease in government budget deficits
B) a decrease in expected inflation
C) expectations of more profitable investment opportunities
D) a business cycle recession
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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20) In the figure above, a factor that could cause the demand for bonds to shift to the right is
________.
A) an increase in the riskiness of bonds relative to other assets
B) an increase in the expected rate of inflation
C) expectations of lower interest rates in the future
D) a decrease in wealth
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
21) In the figure above, the price of bonds would fall from P2 to P1 if ________.
A) there is a business cycle recession
B) there is a business cycle expansion
C) inflation is expected to increase in the future
D) inflation is expected to decrease in the future
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
22) A decrease in the brokerage commissions in the housing market from 6 percent to 5 percent
of the sales price will shift the ________ curve for bonds to the ________, everything else held
constant.
A) demand; right
B) demand; left
C) supply; right
D) supply; left
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
23) In the 1990s Japan had the lowest interest rates in the world due to a combination of
________.
A) inflation and recession
B) deflation and expansion
C) inflation and expansion
D) deflation and recession
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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24) What is the impact on interest rates when the Bank of Canada decreases the money supply
by selling bonds to the public?
Answer: Bond supply increases and the bond supply curve shifts to the right. The new
equilibrium bond price is lower and thus interest rates will increase.
Diff: 1
Type: ES
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
25) Use demand and supply analysis to explain why an expectation of interest rate hikes
would cause Government bond prices to fall.
Answer: The expected return on bonds would decrease relative to other assets resulting in a
decrease in the demand for bonds. The leftward shift of the bond demand curve results in a new
lower equilibrium price for bonds.
Diff: 1
Type: ES
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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26) Demonstrate graphically and explain the effect in the bond market of a decrease in the
federal deficit. What is the effect on the interest rate and bond prices? How might capital
spending be affected by the deficit?
Answer: A graph of the supply and demand for bonds should show the reduced deficit
shifting the supply of bonds to the left. A correct graph will show a rise in bond prices and a
fall in interest rates, and this should be explained. Lower interest rates stimulate capital
spending, as explained in the discussion of the savings rate.
Diff: 3
Type: ES
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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27) Demonstrate graphically the effect of an increase in the personal savings rate. Show and
explain the effect of increased savings on bond prices and interest rates. How would this
change affect capital spending?
Answer: A graph of bond supply and demand should show an increase in bond demand. The
increase in bond prices and the fall in the interest rates should be clearly shown and explained.
The increase in saving lowers interest rates, thus increasing capital spending.
Diff: 3
Type: ES
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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28) Demonstrate graphically and explain how increased profitability of investments and
increased deficits affect bond prices and interest rates.
Answer: As increased deficits and increased profitability of investment both increase the
supply of bonds, one graph showing this shift and the resulting fall in prices and increase in
interest rates is appropriate.
Diff: 3
Type: ES
Skill: Applied
Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond
market
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5.4
Supply and Demand in the Market for Money: The Liquidity Preference Framework
1) In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in
two forms: ________.
A) real assets and financial assets
B) stocks and bonds
C) money and bonds
D) money and gold
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
2) In Keynes's liquidity preference framework, ________.
A) the demand for bonds must equal the supply of money
B) the demand for money must equal the supply of bonds
C) an excess demand of bonds implies an excess demand for money
D) an excess supply of bonds implies an excess demand for money
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
3) In Keynes's liquidity preference framework, if there is excess demand for money, there is
________.
A) excess demand for bonds
B) equilibrium in the bond market
C) excess supply of bonds
D) too much money
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
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4) The bond supply and demand framework is easier to use when analyzing the effects of
changes in ________, while the liquidity preference framework provides a simpler analysis of
the effects from changes in income, the price level, and the supply of ________.
A) expected inflation; bonds
B) expected inflation; money
C) government budget deficits; bonds
D) government budget deficits; money
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
5) Keynes assumed that money has ________ rate of return.
A) a positive
B) a negative
C) a zero
D) an increasing
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
6) In Keynes's liquidity preference framework, as the expected return on bonds increases
(holding everything else unchanged), the expected return on money ________, causing the
demand for ________ to fall.
A) falls; bonds
B) falls; money
C) rises; bonds
D) rises; money
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
7) The opportunity cost of holding money is ________.
A) the level of income
B) the price level
C) the interest rate
D) the discount rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
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8) An increase in the interest rate ________.
A) increases the demand for money
B) increases the quantity of money demanded
C) decreases the demand for money
D) decreases the quantity of money demanded
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
9) If there is an excess supply of money ________.
A) individuals sell bonds, causing the interest rate to rise
B) individuals sell bonds, causing the interest rate to fall
C) individuals buy bonds, causing interest rates to fall
D) individuals buy bonds, causing interest rates to rise
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
10) When the interest rate is above the equilibrium interest rate, there is an excess ________
money and the interest rate will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
11) In the market for money, an interest rate below equilibrium results in an excess ________
money and the interest rate will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 5.4 Describe the connection between the bond market and the money market
through the liquidity preference framework
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5.5
Changes in Equilibrium Interest Rates in the Liquidity Preference Framework
1) In the Keynesian liquidity preference framework, an increase in the interest rate causes the
demand curve for money to ________, everything else held constant.
A) shift right
B) shift left
C) stay where it is
D) invert
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
2) A lower level of income causes the demand for money to ________ and the interest rate to
________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
3) When real income ________, the demand curve for money shifts to the ________ and the
interest rate ________, everything else held constant.
A) falls; right; rises
B) rises; right; rises
C) falls; left; rises
D) rises; left; rises
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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4) A business cycle expansion increases income, causing money demand to ________ and
interest rates to ________, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
5) In the Keynesian liquidity preference framework, a rise in the price level causes the demand
for money to ________ and the demand curve to shift to the ________, everything else held
constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
6) A rise in the price level causes the demand for money to ________ and the interest rate to
________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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7) A decline in the expected inflation rate causes the demand for money to ________ and the
demand curve to shift to the ________, everything else held constant.
A) decrease; right
B) decrease; left
C) increase; right
D) increase; left
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
8) ________ in the money supply creates excess ________ money, causing interest rates to
________, everything else held constant.
A) A decrease; demand for; rise
B) An increase; demand for; fall
C) An increase; supply of; rise
D) A decrease; supply of; fall
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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9) In the figure above, one factor not responsible for the decline in the demand for money is
________.
A) a decline the price level
B) a decline in income
C) an increase in income
D) a decline in the expected inflation rate
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
10) In the figure above, the decrease in the interest rate from i1 to i2 can be explained by
________.
A) a decrease in money growth
B) a decline in the expected price level
C) an increase in income
D) an increase in the expected price level
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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11) In the figure above, the factor responsible for the decline in the interest rate is ________.
A) a decline the price level
B) a decline in income
C) an increase in the money supply
D) a decline in the expected inflation rate
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
12) In the figure above, the decrease in the interest rate from i1 to i2 can be explained by
________.
A) a decrease in money growth
B) an increase in money growth
C) a decline in the expected price level
D) an increase in income
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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13) Milton Friedman called the response of lower interest rates resulting from an increase in the
money supply the ________ effect.
A) liquidity
B) price level
C) expected-inflation
D) income
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
14) Using the liquidity preference framework, what will happen to interest rates if the Bank of
Canada increases the money supply?
Answer: The Bank of Canada's actions shift the money supply curve to the right. The new
equilibrium interest rate will be lower than it was previously.
Diff: 1
Type: ES
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
15) Using the liquidity preference framework, show what happens to interest rates during a
business cycle recession.
Answer: During a business cycle recession, income will fall. This causes the money demand
curve to shift to the left. The resulting equilibrium will be at a lower interest rate.
Diff: 1
Type: ES
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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16) In the liquidity preference framework, demonstrate graphically the effect of a decrease in
the money supply. Indicate on the graph the excess demand or excess supply of money. Explain
the process of adjustment that results in a change in the equilibrium interest rate, and the
direction of the change in rates.
Answer: The graph should show the money supply curve shifting to the left. At the original
rate, excess supply is the difference between the demand curve and new supply curve at the
original equilibrium interest rate. To adjust, individuals sell bonds, driving bond prices down
and interest rates up until the new equilibrium rate is attained.
Diff: 3
Type: ES
Skill: Recall
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
17) Economists recognize that interest rates are typically procyclical, meaning that interest rates
increase during economic expansions and decline during recessions. Real income and generally
inflation rise and fall with the economy. Using the liquidity preference model of interest rates,
give three reasons why interest rates are procyclical.
Answer: The answer should explain that the income, price-level, and expected inflation
effects would all increase interest rates during an expansion and decrease them in a recession.
Diff: 3
Type: ES
Skill: Applied
Objective: 5.5 List and describe the factors that affect the money market and the equilibrium
interest rate
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5.6
Does a Higher Rate of Growth of the Money Supply Lower Interest Rates?
1) Of the four effects on interest rates from an increase in the money supply, the one that works
in the opposite direction of the other three is the ________.
A) liquidity effect
B) income effect
C) price level effect
D) expected inflation effect
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
2) If the liquidity effect is smaller than the other effects, and the adjustment to expected
inflation is immediate, then the ________.
A) interest rate will fall
B) interest rate will rise
C) interest rate will fall immediately below the initial level when the money supply grows
D) interest rate will rise immediately above the initial level when the money supply grows
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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3) In the figure above, illustrates the effect of an increased rate of money supply growth at time
period 0. From the figure, one can conclude that the ________.
A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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4) In the figure above, illustrates the effect of an increased rate of money supply growth at time
period 0. 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
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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5) 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) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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6) 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
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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7) 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) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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8) 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
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
9) Interest rates increased continuously during the 1970s. The most likely explanation is
________.
A) banking failures that reduced the money supply
B) a rise in the level of income
C) the repeated bouts of recession and expansion
D) increasing expected rates of inflation
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth
over time
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5.7
Web Appendix 1: Models of Asset Pricing
1) The riskiness of an asset is measured by ________.
A) the magnitude of its return
B) the absolute value of any change in the asset's price
C) the standard deviation of its return
D) risk is impossible to measure
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
2) Holding many risky assets and thus reducing the overall risk an investor faces is called
________.
A) diversification
B) foolishness
C) risk acceptance
D) capitalization
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
3) The ________ the returns on two securities move together, the ________ benefit there is
from diversification.
A) less; more
B) less; less
C) more; more
D) more; greater
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
4) A higher ________ means that an asset's return is more sensitive to changes in the value of
the market portfolio.
A) alpha
B) beta
C) CAPM
D) APT
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
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5) The riskiness of an asset that is unique to the particular asset is ________.
A) systematic risk
B) portfolio risk
C) investment risk
D) nonsystematic risk
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
6) The risk of a well-diversified portfolio depends only on the ________ risk of the assets in the
portfolio.
A) systematic
B) nonsystematic
C) portfolio
D) investment
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
7) Both the CAPM and APT suggest that an asset should be priced so that it has a higher
expected return ________.
A) when it has a greater systematic risk
B) when it has a greater risk in isolation
C) when it has a lower systematic risk
D) when it has a lower systematic risk and a lower risk in isolation
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Models of Asset Pricing
8) In contrast to the CAPM, the APT assumes that there can be several sources of ________
that cannot be eliminated through diversification.
A) nonsystematic risk
B) systematic risk
C) credit risk
D) arbitrary risk
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
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9) Both the CAPM and APT suggest that an asset should be priced so that it has a higher
expected return ________.
A) when it has a greater systematic risk
B) when it has a greater risk in isolation
C) when it has a lower systematic risk
D) when it has a lower systematic risk and a lower risk in isolation
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Models of Asset Pricing
10) A limitation of the CAPM is the assumption that ________.
A) there are multiple sources of systematic risk
B) there is a single source of systematic risk
C) investors have different assessments of expected returns and standard deviations
D) they cannot borrow freely at the risk-free rate
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Models of Asset Pricing
5.8 Web Appendix 2: Applying the Asset Market Approach to a Commodity Market: The
Case of Gold
1) When stock prices become more volatile, the ________ curve for gold shifts right and gold
prices ________, everything else held constant.
A) demand; increase
B) demand; decrease
C) supply; increase
D) supply; decrease
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Applying the Asset Market Approach to a Commodity Market: The Case
of Gold
2) A return to the gold standard, that is, using gold for money will ________ the ________ for
gold, ________ its price, everything else held constant.
A) increase; demand; increasing
B) decrease; demand; decreasing
C) increase; supply; increasing
D) decrease; supply; increasing
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Applying the Asset Market Approach to a Commodity Market: The Case
of Gold
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3) When gold prices become more volatile, the ________ curve for gold shifts to the ________;
________ the price of gold.
A) supply; right; increasing
B) supply; left; increasing
C) demand; right; decreasing
D) demand; left; decreasing
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Applying the Asset Market Approach to a Commodity Market: The Case
of Gold
4) Discovery of new gold in Alaska will ________ the ________ of gold, ________ its price,
everything else held constant.
A) increase; demand; increasing
B) decrease; demand; decreasing
C) decrease; supply; increasing
D) increase; supply; decreasing
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Applying the Asset Market Approach to a Commodity Market: The Case
of Gold
5) An increase in the expected inflation rate will ________ the ________ for gold, ________
its price, everything else held constant.
A) increase; demand; increasing
B) decrease; demand; decreasing
C) increase; supply; increasing
D) decrease; supply; increasing
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Applying the Asset Market Approach to a Commodity Market: The Case
of Gold
6) The price of gold should be ________ to the expected inflation rate.
A) positively related
B) negatively related
C) inversely related
D) unrelated
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Applying the Asset Market Approach to a Commodity Market: The Case
of Gold
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Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 6 The Risk and Term Structure of Interest Rates
6.1
Risk Structure of Interest Rates
1) The risk structure of interest rates is ________.
A) the structure of how interest rates move over time
B) the relationship among interest rates of different bonds with the same maturity
C) the relationship among the term to maturity of different bonds
D) the relationship among interest rates on bonds with different maturities
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
2) The risk that interest payments will not be made, or that the face value of a bond is not
repaid when a bond matures is ________.
A) interest rate risk
B) inflation risk
C) moral hazard
D) default risk
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
3) Canadian government bonds have no default risk because ________.
A) they are backed by the full faith and credit of the federal government
B) the federal government can increase taxes to pay its obligations
C) they are backed with gold reserves
D) they can be exchanged for silver at any time
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
4) Default risk is the risk that ________.
A) a bond issuer is unable to make interest payments
B) a bond issuer is unable to make a profit
C) a bond issuer is unable to pay the face value at maturity
D) A and C only
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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5) Bonds with no default risk are called ________.
A) flower bonds
B) no-risk bonds
C) default-free bonds
D) zero-risk bonds
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
6) The spread between the interest rates on bonds with default risk and default-free bonds is
called the ________.
A) risk premium
B) junk margin
C) bond margin
D) default premium
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
7) If the probability of a bond default increases because corporations begin to suffer large
losses, then the default risk on corporate bonds will ________ and the expected return on these
bonds will ________, everything else held constant.
A) decrease; increase
B) decrease; decrease
C) increase; increase
D) increase; decrease
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
8) Which of the following bonds are considered to be default-risk free?
A) Municipal bonds
B) Investment-grade bonds
C) Canadian government bonds
D) Junk bonds
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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9) A bond with default risk will always have a ________ risk premium and an increase in its
default risk will ________ the risk premium.
A) positive; raise
B) positive; lower
C) negative; raise
D) negative; lower
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
10) If a corporation begins to suffer large losses, then the default risk on the corporate bond
will ________, everything else held constant.
A) increase and the bond's return will become more uncertain, meaning the expected return on
the corporate bond will fall
B) increase and the bond's return will become less uncertain, meaning the expected return on
the corporate bond will fall
C) decrease and the bond's return will become less uncertain, meaning the expected return on
the corporate bond will fall
D) decrease and the bond's return will become less uncertain, meaning the expected return on
the corporate bond will rise
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
11) If the possibility of a default increases because corporations begin to suffer losses, then the
default risk on corporate bonds will ________, and the bonds' returns will become ________
uncertain, meaning that the expected return on these bonds will decrease, everything else held
constant.
A) increase; less
B) increase; more
C) decrease; less
D) decrease; more
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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12) Other things being equal, an increase in the default risk of corporate bonds shifts the
demand curve for corporate bonds to the ________ and the demand curve for Canada bonds to
the ________.
A) right; right
B) right; left
C) left; right
D) left; left
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
13) An increase in the riskiness of corporate bonds will ________ the price of corporate bonds
and ________ the price of Canada bonds, everything else held constant.
A) increase; increase
B) reduce; reduce
C) reduce; increase
D) increase; reduce
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
14) An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds
and ________ the yield on government securities, everything else held constant.
A) increase; increase
B) reduce; reduce
C) increase; reduce
D) reduce; increase
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
15) An increase in default risk on corporate bonds ________ the demand for these bonds, but
________ 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
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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16) As default risk increases and bond prices adjust, the expected return on corporate bonds
________, and the return becomes ________ uncertain, everything else held constant.
A) increases; less
B) increases; more
C) decreases; less
D) decreases; more
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
17) Which of the following statements is true?
A) A decrease in default risk on corporate bonds lowers the demand for these bonds, but
increases the demand for default-free bonds.
B) The interest rate on corporate bonds decreases as default risk increases.
C) A corporate bond's return becomes less uncertain as default risk increases.
D) As their relative riskiness increases, the interest rate on corporate bonds increases relative to
the interest rate on default-free bonds.
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
18) The spread between interest rates on low quality corporate bonds and Canada bonds
________.
A) widens significantly during recessions
B) narrows significantly during recessions
C) narrows moderately during recessions
D) does not change during recessions
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
19) As their relative riskiness ________, the equilibrium price of corporate bonds ________
relative to the expected return on default-free bonds, everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; does not change
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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20) Everything else held constant, if the federal government were to guarantee today that it will
pay creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds
will ________ and the interest rate on government securities will ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
21) Bonds with relatively high risk of default are called ________.
A) Brady bonds
B) junk bonds
C) zero coupon bonds
D) investment grade bonds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
22) Bonds with relatively low risk of default are called ________ securities and have a rating of
Baa (or BBB) and above; bonds with ratings below Baa (or BBB) have a higher default risk and
are called ________.
A) investment grade; lower grade
B) investment grade; junk bonds
C) high quality; lower grade
D) high quality; junk bonds
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
23) Which of the following bonds would have the highest default risk?
A) Provincial bonds
B) Investment-grade bonds
C) Canada bonds
D) Junk bonds
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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24) Which of the following long-term bonds has the highest interest rate?
A) Corporate Baa bonds
B) Canada bonds
C) Corporate Aaa bonds
D) Provincial bonds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
25) Which of the following securities has the lowest interest rate?
A) Junk bonds
B) Canada bonds
C) Investment-grade bonds
D) Corporate Baa bonds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
26) During the Great Depression years 1930-1933 there was a very high rate of business
failures and defaults, we would expect the risk premium for ________ bonds to be very high.
A) federal government
B) corporate Aaa
C) provincial
D) corporate Baa
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
27) Risk premiums on corporate bonds tend to ________ during business cycle expansions and
________ during recessions, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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28) If you have a very low tolerance for risk, which of the following bonds would you be least
likely to hold in your portfolio?
A) A federal government bond
B) A provincial bond
C) A corporate bond with a rating of Aaa
D) A corporate bond with a rating of Baa
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
29) The collapse of the subprime mortgage market ________.
A) did not affect the corporate bond market
B) increased the perceived riskiness of Treasury securities
C) reduced the Baa-Aaa spread
D) increased the Baa-Aaa spread
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
30) The collapse of the subprime mortgage market increased the spread between Baa and
default-free Canada bonds. This is due to ________.
A) a reduction in risk
B) a reduction in maturity
C) a flight to quality
D) a flight to liquidity
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
31) During a "flight to quality" ________.
A) the spread between Canada bonds and Baa bonds increases
B) the spread between Canada bonds and Baa bonds decreases
C) the spread between Canada bonds and Baa bonds is not affected
D) the change in the spread between Canada bonds and Baa bonds cannot be predicted
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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32) Which of the following statements is true?
A) A liquid asset is one that can be quickly and cheaply converted into cash.
B) The demand for a bond declines when it becomes less liquid, decreasing the interest rate
spread between it and relatively more liquid bonds.
C) The differences in bond interest rates reflect differences in default risk only.
D) The corporate bond market is the most liquid bond market.
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
33) Corporate bonds are not as liquid as Canada 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
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
34) When Canada bonds become more liquid, other things equal, the demand curve for
corporate bonds shifts to the ________ and the demand curve for Canada bonds shifts to the
________.
A) right; right
B) right; left
C) left; right
D) left; left
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
35) A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand
curve for corporate bonds to the ________ and the demand curve for Canada bonds shifts to the
________.
A) right; right
B) right; left
C) left; left
D) left; right
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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36) An increase in the liquidity of corporate bonds will ________ the price of corporate bonds
and ________ the interest rate on those corporate bonds, everything else held constant.
A) increase; increase
B) reduce; reduce
C) increase; reduce
D) reduce; increase
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
37) The risk premium on corporate bonds reflects the fact that corporate bonds have a higher
default risk and are ________ Canada bonds.
A) less liquid than
B) less speculative than
C) tax-exempt unlike
D) lower-yielding than
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
38) Bonds with relatively low risk of default are called ________.
A) zero coupon bonds
B) junk bonds
C) investment grade bonds
D) fallen angels
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
39) Which of the following statements is true?
A) Because coupon payments on tax-exempt bonds are exempt from federal income tax, the
expected after-tax return on them will be higher for individuals in higher income tax brackets.
B) An increase in tax rates will decrease the demand for tax-exempt bonds, lowering their
interest rates.
C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax
exemption.
D) Because coupon payments on tax-exempt are exempt from federal income tax, the expected
after-tax return on them will be lower for individuals in higher income tax brackets.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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40) Which of the following statements is true?
A) Because coupon payments on tax-exempt bonds are exempt from federal income tax, the
expected after-tax return on them will be higher for individuals in higher income tax brackets.
B) An decrease in tax rates will increase the demand for U.S Treasury bonds, lowering their
interest rates.
C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax
exemption.
D) An decrease in tax rates will increase the supply of U.S Treasury bonds, lowering their
interest rates.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
41) The interest rate on tax-exempt bonds falls relative to the interest rate on U.S. Treasury
securities when ________.
A) there is a major default in the tax-exempt bond market
B) income tax rates are raised
C) tax-exempt bonds become less widely traded
D) corporate bonds become riskier
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
42) The interest rate on tax-exempt bonds rises relative to the interest rate on U.S. Treasury
securities when ________.
A) income tax rates are raised
B) tax-exempt bonds become more widely traded
C) corporate bonds become riskier
D) income tax rates are lowered
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
43) Tax-exempt bond interest rates increase relative to corporate bond interest rates when
________.
A) income taxes are increased
B) corporate bonds become riskier
C) U.S. Treasury securities become more widely traded
D) there is a major default in the tax-exempt bond market
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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44) If income tax rates were lowered, then ________.
A) the interest rate on tax-exempt bonds would fall
B) the interest rate on U.S. Treasury bonds would rise
C) the interest rate on tax-exempt bonds would rise
D) the price of Canada bonds would fall
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
45) If income tax rates were lowered, then ________.
A) the prices of tax-exempt bonds would fall
B) the interest rate on tax-exempt bonds would fall
C) the interest rate on U.S. Treasury bonds would rise
D) the prices of tax-exempt bonds would rise
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
46) If income tax rates were lowered, then ________.
A) the interest rate on tax-exempt bonds would rise
B) the interest rate on U.S. Treasury bonds would rise
C) the interest rate on tax-exempt bonds would fall
D) the interest rate on tax-exempt bonds would stay the same
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
47) Three factors explain the risk structure of interest rates: ________.
A) liquidity, default risk, and the income tax treatment of a security
B) maturity, default risk, and the income tax treatment of a security
C) maturity, liquidity, and the income tax treatment of a security
D) maturity, default risk, and the liquidity of a security
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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48) The spread between the interest rates on Baa corporate bonds and Canada bonds was very
large during the Great Depression years 1930-1933. Explain this difference using the bond
supply and demand analysis.
Answer: During the Great Depression many businesses failed. The default risk for the
corporate bond increased compared to the default-free Treasury bond. The demand for
corporate bonds decreased while the demand for Treasury bonds increased resulting in a larger
risk premium.
Diff: 3
Type: ES
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
49) If the U.S. government where to raise the income tax rates, would this have any impact on a
state's cost of borrowing funds? Explain.
Answer: Yes, if the U.S. government raises income tax rates, demand for municipal bonds
which are federal income tax exempt would increase. This would lower the interest rate on the
municipal bonds thus lowering the cost to the state of borrowing funds.
Diff: 3
Type: ES
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
50) Explain the factors that determine the risk structure of interest rates. Explain how a change
of each factor changes interest rates.
Answer: Default risk is the risk that interest or principal payments will not be made.
Liquidity is the ability to convert an asset to cash quickly and cheaply.
Tax-exempt bonds are more attractive to investors in high tax brackets.
An increase in default risk, a reduction in liquidity, and a tax cut increase interest rates on the
affected assets. A reduction of default risk, an increase in liquidity, and a tax increase reduce
interest rates on the affected assets.
Diff: 3
Type: ES
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
51) Demonstrate graphically and explain how a reduction in default risk affects the demand or
supply of corporate and Canada bonds.
Answer: A reduction of default risk increases the demand for corporate bonds and reduces the
demand for Canada bonds. Corporate bond prices rise and interest rates fall. Canada bond
prices fall and interest rates rise.
Diff: 2
Type: ES
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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52) Explain using a diagram how the "flight to quality" after the Subprime collapse lead to a
rising spread between lower-quality (BBB-rated) and highest-quality (AAA-rated) bonds.
Answer: Students must use supply and demand analysis on a graph to show that the subprime
collapse led to doubts about the financial health of lower-quality (BBB-rated) companies,
reducing demand for their bonds shifting their demand curve to the left and thus decreasing
their price and increasing their interest. The shift of the demand from BBB-rated to AAA-rated
bonds known as "flight to quality" increased the demand of AAA-bonds shifting the demand
curve to the right and thus increasing their price and decreasing their interest rates, resulting in
a wider interest rate spread between BBB and AAA-rated bonds.
Diff: 3
Type: ES
Skill: Applied
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
53) Based on default risk, which bonds are called: a. "investment grade", b. "junk bonds" or
"speculative-grade", and c. "fallen angels"?
Answer:
a. Investment grade are the bonds that have a relatively low risk of default and are rated BBB or
above.
b. Junk bonds or speculative-grade are the bonds that have relatively higher risk of default and
are rated BB or lower.
c. Fallen angels are the bonds that their rating from investment grade has fallen to junk.
Diff: 1
Type: ES
Skill: Recall
Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates
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6.2
Term Structure of Interest Rates
1) The term structure of interest rates is ________.
A) the relationship among interest rates of different bonds with the same maturity
B) the structure of how interest rates move over time
C) the relationship among the term to maturity of different bonds
D) the relationship among interest rates on bonds with different maturities
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
2) A plot of the interest rates on default-free Canada bonds with different terms to maturity is
called ________.
A) a risk-structure curve
B) a default-free curve
C) a yield curve
D) an interest-rate curve
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
3) Differences in ________ explain why interest rates on Treasury securities are not all the
same.
A) risk
B) liquidity
C) time to maturity
D) tax characteristics
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
4) Typically, yield curves are ________.
A) gently upward sloping
B) mound shaped
C) flat
D) bowl shaped
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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5) When yield curves are steeply upward sloping, ________.
A) long-term interest rates are above short-term interest rates
B) short-term interest rates are above long-term interest rates
C) short-term interest rates are about the same as long-term interest rates
D) medium-term interest rates are above both short-term and long-term interest rates
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
6) When yield curves are flat, ________.
A) long-term interest rates are above short-term interest rates
B) short-term interest rates are above long-term interest rates
C) short-term interest rates are about the same as long-term interest rates
D) medium-term interest rates are above both short-term and long-term interest rates
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
7) When yield curves are downward sloping, ________.
A) long-term interest rates are above short-term interest rates
B) short-term interest rates are above long-term interest rates
C) short-term interest rates are about the same as long-term interest rates
D) medium-term interest rates are above both short-term and long-term interest rates
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
8) An inverted yield curve ________.
A) slopes up
B) is flat
C) slopes down
D) has a U shape
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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9) Economists' attempts to explain the term structure of interest rates ________.
A) illustrate how economists modify theories to improve them when they are inconsistent with
the empirical evidence
B) illustrate how economists continue to accept theories that fail to explain observed behavior
of interest rate movements
C) prove that the real world is a special case that tends to get short shrift in theoretical models
D) have proved entirely unsatisfactory to date
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
10) According to the expectations theory of the term structure, the interest rate on a long-term
bond will equal the ________ of the short-term interest rates that people expect to occur over
the life of the long-term bond.
A) average
B) sum
C) difference
D) multiple
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
11) The ________ of the term structure of interest rates states that the interest rate on a
long-term bond will equal the average of short-term interest rates that individuals expect to
occur over the life of the long-term bond, and investors have no preference for short-term
bonds relative to long-term bonds.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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12) If bonds with different maturities are perfect substitutes, then the ________ on these bonds
must be equal.
A) expected return
B) surprise return
C) surplus return
D) excess return
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
13) 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
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
14) If the expected path of 1-year interest rates over the next four years is 5 percent, 4 percent,
2 percent, and 1 percent, then the expectations theory predicts that today's interest rate on the
four-year bond is ________.
A) 1 percent
B) 2 percent
C) 3 percent
D) 4 percent
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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15) If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3
percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest
interest rate today is the one with a maturity of ________.
A) two years
B) three years
C) four years
D) five years
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
16) If the expected path of 1-year interest rates over the next five years is 2 percent, 4 percent, 1
percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest
interest rate today is the one with a maturity of ________.
A) one year
B) two years
C) three years
D) four years
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
17) Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent.
The expectations theory of the term structure predicts that the current interest rate on 3-year
bond is ________.
A) 1 percent
B) 2 percent
C) 3 percent
D) 4 percent
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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18) According to the expectations theory of the term structure ________.
A) the interest rate on long-term bonds will exceed the average of short-term interest rates that
people expect to occur over the life of the long-term bonds, because of their preference for
short-term securities
B) interest rates on bonds of different maturities move together over time
C) buyers of bonds prefer short-term to long-term bonds
D) buyers require an additional incentive to hold long-term bonds
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
19) According to the expectations theory of the term structure ________.
A) when the yield curve is steeply upward sloping, short-term interest rates are expected to
remain relatively stable in the future
B) when the yield curve is downward sloping, short-term interest rates are expected to remain
relatively stable in the future
C) investors have strong preferences for short-term relative to long-term bonds, explaining why
yield curves typically slope upward
D) yield curves should be equally likely to slope downward as slope upward
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
20) According to the segmented markets theory of the term structure ________.
A) bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest
rates on bonds of different maturities move together over time
B) the interest rate for each maturity bond is determined by supply and demand for that
maturity bond
C) investors' strong preferences for short-term relative to long-term bonds explains why yield
curves typically slope downward
D) because of the positive term premium, the yield curve will not be observed to be
downward-sloping
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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21) According to the segmented markets theory of the term structure ________.
A) the interest rate on long-term bonds will equal an average of short-term interest rates that
people expect to occur over the life of the long-term bonds
B) buyers of bonds do not prefer bonds of one maturity over another
C) interest rates on bonds of different maturities do not move together over time
D) buyers require an additional incentive to hold long-term bonds
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
22) According to this theory of the term structure, bonds of different maturities are not
substitutes for one another.
A) Segmented markets theory
B) Expectations theory
C) Liquidity premium theory
D) Separable markets theory
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
23) In actual practice, short-term interest rates and long-term interest rates usually move
together; this is the major shortcoming of the ________.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
24) A key assumption in the segmented markets theory is that bonds of different maturities
________.
A) are not substitutes at all
B) are perfect substitutes
C) are substitutes only if the investor is given a premium incentive
D) are substitutes but not perfect substitutes
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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25) The segmented markets theory can explain ________.
A) why yield curves usually tend to slope upward
B) why interest rates on bonds of different maturities tend to move together
C) why yield curves tend to slope upward when short-term interest rates are low and to be
inverted when short-term interest rates are high
D) why yield curves have been used to forecast business cycles
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
26) The expectations theory and the segmented markets theory do not explain the facts very
well, but they provide the groundwork for the most widely accepted theory of the term structure
of interest rates, ________.
A) the Keynesian theory
B) separable markets theory
C) liquidity premium theory
D) the asset market approach
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
27) According to the liquidity premium theory of the term structure ________.
A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on
bonds of different maturities do not move together over time
B) the interest rate on long-term bonds will equal an average of short-term interest rates that
people expect to occur over the life of the long-term bonds plus a term premium
C) because of the positive term premium, the yield curve will not be observed to be downward
sloping
D) the interest rate for each maturity bond is determined by supply and demand for that
maturity bond
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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28) The ________ of the term structure states the following: the interest rate on a long-term
bond will equal an average of short-term interest rates expected to occur over the life of the
long-term bond plus a term premium that responds to supply and demand conditions for that
bond.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
29) The additional incentive that the purchaser of a Treasury security requires to buy a
long-term security rather than a short-term security is called the ________.
A) risk premium
B) term premium
C) tax premium
D) market premium
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
30) The preferred habitat theory of the term structure is closely related to the ________.
A) expectations theory of the term structure
B) segmented markets theory of the term structure
C) liquidity premium theory of the term structure
D) the inverted yield curve theory of the term structure
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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31) If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the
3-year term premium is 1 percent, than the 3-year bond rate will be ________.
A) 1 percent
B) 2 percent
C) 3 percent
D) 4 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
32) If 1-year interest rates for the next five years are expected to be 4, 2, 5, 4, and 5 percent,
and the 5-year term premium is 1 percent, than the 5-year bond rate will be ________.
A) 2 percent
B) 3 percent
C) 4 percent
D) 5 percent
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
33) According to the liquidity premium theory of the term structure ________.
A) bonds of different maturities are not substitutes
B) if yield curves are downward sloping, then short-term interest rates are expected to fall by so
much that, even when the positive term premium is added, long-term rates fall below
short-term rates
C) yield curves should never slope downward
D) interest rates on bonds of different maturities do not move together over time
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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34) According to the liquidity premium theory of the term structure, a steeply upward sloping
yield curve indicates that short-term interest rates are expected to ________.
A) rise in the future
B) remain unchanged in the future
C) decline moderately in the future
D) decline sharply in the future
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
35) According to the liquidity premium theory of the term structure, a slightly upward sloping
yield curve indicates that short-term interest rates are expected to ________.
A) rise in the future
B) remain unchanged in the future
C) decline moderately in the future
D) decline sharply in the future
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
36) According to the liquidity premium theory of the term structure, a flat yield curve indicates
that short-term interest rates are expected to ________.
A) rise in the future
B) remain unchanged in the future
C) decline moderately in the future
D) decline sharply in the future
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
37) According to the liquidity premium theory of the term structure, a downward sloping yield
curve indicates that short-term interest rates are expected to ________.
A) rise in the future
B) remain unchanged in the future
C) decline moderately in the future
D) decline sharply in the future
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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38) According to the liquidity premium theory, a yield curve that is flat means that ________.
A) bond purchasers expect interest rates to rise in the future
B) bond purchasers expect interest rates to stay the same
C) bond purchasers expect interest rates to fall in the future
D) the yield curve has nothing to do with expectations of bond purchasers
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
39) If the yield curve is flat for short maturities and then slopes downward for longer
maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds)
indicates that the market is predicting ________.
A) a rise in short-term interest rates in the near future and a decline further out in the future
B) constant short-term interest rates in the near future and a decline further out in the future
C) a decline in short-term interest rates in the near future and a rise further out in the future
D) a decline in short-term interest rates in the near future and an even steeper decline further
out in the future
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
40) If the yield curve slope is flat for short maturities and then slopes steeply upward for longer
maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds)
indicates that the market is predicting ________.
A) a rise in short-term interest rates in the near future and a decline further out in the future
B) constant short-term interest rates in the near future and further out in the future
C) a decline in short-term interest rates in the near future and a rise further out in the future
D) constant short-term interest rates in the near future and a decline further out in the future
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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41) If the yield curve has a mild upward slope, the liquidity premium theory (assuming a mild
preference for shorter-term bonds) indicates that the market is predicting ________.
A) a rise in short-term interest rates in the near future and a decline further out in the future
B) constant short-term interest rates in the near future and further out in the future
C) a decline in short-term interest rates in the near future and a rise further out in the future
D) a decline in short-term interest rates in the near future and an even steeper decline further
out in the future
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
42) A particularly attractive feature of the ________ is that it tells you what the market is
predicting about future short-term interest rates by just looking at the slope of the yield curve.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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43) The steeply upward sloping yield curve in the figure above indicates that ________.
A) short-term interest rates are expected to rise in the future
B) short-term interest rates are expected to fall moderately in the future
C) short-term interest rates are expected to fall sharply in the future
D) short-term interest rates are expected to remain unchanged in the future
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
44) The steeply upward sloping yield curve in the figure above indicates that ________ interest
rates are expected to ________ in the future.
A) short-term; rise
B) short-term; fall moderately
C) short-term; remain unchanged
D) long-term; fall moderately
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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45) The U-shaped yield curve in the figure above indicates that short-term interest rates are
expected to ________.
A) rise in the near-term and fall later on
B) fall sharply in the near-term and rise later on
C) fall moderately in the near-term and rise later on
D) remain unchanged in the near-term and rise later on
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
46) The U-shaped yield curve in the figure above indicates that the inflation rate is expected to
________.
A) remain constant in the near-term and fall later on
B) fall sharply in the near-term and rise later on
C) rise moderately in the near-term and fall later on
D) remain constant in the near-term and rise later on
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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47) The mound-shaped yield curve in the figure above indicates that short-term interest rates
are expected to ________.
A) rise in the near-term and fall later on
B) fall moderately in the near-term and rise later on
C) fall sharply in the near-term and rise later on
D) remain unchanged in the near-term and fall later on
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
48) The mound-shaped yield curve in the figure above indicates that the inflation rate is
expected to ________.
A) remain constant in the near-term and fall later on
B) fall moderately in the near-term and rise later on
C) rise moderately in the near-term and fall later on
D) remain unchanged in the near-term and rise later on
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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49) An inverted yield curve predicts that short-term interest rates ________.
A) are expected to rise in the future
B) will rise and then fall in the future
C) will remain unchanged in the future
D) will fall in the future
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
50) When short-term interest rates are expected to fall sharply in the future, the yield curve will
________.
A) slope up
B) be flat
C) be inverted
D) be an inverted U shape
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
51) If investors expect interest rates to fall significantly in the future, the yield curve will be
inverted. This means that the yield curve has a ________ slope.
A) steep upward
B) slight upward
C) flat
D) downward
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
52) When the yield curve is flat or downward-sloping, it suggests that the economy is more
likely to enter ________.
A) a recession
B) an expansion
C) a boom time
D) a period of increasing output
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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53) A ________ yield curve predicts a future increase in inflation.
A) steeply upward sloping
B) slight upward sloping
C) flat
D) downward sloping
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
54) If a higher inflation is expected, what would you expect to happen to the shape of the yield
curve? Why?
Answer: The yield curve should have a steep upward slope. Nominal interest rates will
increase if the inflation rate increases, therefore, bond purchasers will require a higher term
premium to hold the riskier long-term bond.
Diff: 1
Type: ES
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
55) What is the shape of the yield curve when short rates are expected to fall in the medium
term, and then increase? Demonstrate this graphically.
Answer: The curve will have a U shape reflecting the expected fall and then increase.
Diff: 3
Type: ES
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
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56) What is the shape of the yield curve when short-term rates are expected to rise sharply in
the mid-term and moderately in the long-term?
Answer:
The students must draw a yield curve like the one above and explain that the sharp increase in
short-term rates in the mid-term is shown as the part of the yield curve with a steep slope and
the moderate increase in the long-term is the later part of the yield curve.
Diff: 2
Type: ES
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
57) When interest rates on 1-2-3-4-5 year bonds are 2.0, 2.1, 2.3, 2.4, and 2.5 percent
respectively, what information do we derive on future economic growth and real output?
Answer: According to these interest rates, the yield curve is gently upward sloping, indicating
that short-term interest rates are not expected to change significantly in the next 5 years. We do
know that periods of economic growth and output booms are associated with rising interest
rates, and recessions are associated with low interest rates. As the yield curve is found to be an
accurate predictor of the business cycle, we would expect no significant changes in real output
over the next 5 years.
Diff: 3
Type: ES
Skill: Applied
Objective: 6.2 List and explain the three theories of why interest rates vary across different
maturities
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 7 The Stock Market, the Theory of Rational Expectations, and the Efficient
Market Hypothesis
7.1
Computing the Price of Common Stock
1) A stockholder's ownership of a company's stock gives her the right to ________.
A) vote and be the primary claimant of all cash flows
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B) vote and be the residual claimant of all cash flows
C) manage and assume responsibility for all liabilities
D) vote and assume responsibility for all liabilities
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
2) Stockholders' rights include ________.
A) the right to vote
B) the right to manage
C) primary claims on all cash flows
D) ownership of bonds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
3) Stockholders' rights include ________.
A) the right to manage
B) the right to change personnel policy
C) the right to veto management's decisions
D) residual claim on all of a company's assets
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
4) Stockholders are residual claimants, meaning that they ________.
A) have the first priority claim on all of a company's assets
B) are liable for all of a company's debts
C) will never share in a company's profits
D) receive the remaining cash flow after all other claims are paid
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
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5) Common stock is the principal way that corporations raise ________.
A) short-term debt
B) foreign exchange
C) long-term debt
D) equity capital
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
6) Dividends are paid from ________.
A) liabilities
B) debts
C) net earnings
D) interest
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
7) Periodic payments of net earnings to shareholders are known as ________.
A) capital gains
B) dividends
C) profits
D) interest
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
8) The value of any investment is found by computing the ________.
A) present value of all future sales
B) present value of all future liabilities
C) future value of all future expenses
D) present value of all future cash flows
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
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9) The value of any investment is found by computing the ________.
A) present value of all coupon payments
B) present value of all future liabilities
C) future value of all dividends
D) value in today's dollars of all future cash flows
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
10) In the one-period valuation model, the value of a share of stock today depends upon
________.
A) the present value of both dividends and the expected sales price
B) only the present value of the future dividends
C) the actual value of the dividends and expected sales price received in one year
D) the future value of dividends and the actual sales price
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
11) In the one-period valuation model, the current stock price increases if ________.
A) the expected sales price increases
B) the expected sales price falls
C) the required return increases
D) dividends are cut
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
12) In the one-period valuation model, an increase in the required return on investments in
equity ________.
A) increases the expected sales price of a stock
B) increases the current price of a stock
C) reduces the expected sales price of a stock
D) reduces the current price of a stock
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
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13) In the one-period valuation model with no dividend payments the current price of the stock
is given by ________.
A) P0 =
B) P0 =
+
C) P0 =
× 100
D) P0 =
× 365
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
14) Using the one-period valuation model, assuming a year-end dividend of $0.11, an expected
sales price of $110, and a required rate of return of 10 percent, the current price of the stock
would be ________.
A) $110.11
B) $121.12
C) $100.10
D) $100.11
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
15) Using the one-period valuation model, assuming a year-end dividend of $1.00, an expected
sales price of $100, and a required rate of return of 5 percent, the current price of the stock
would be ________.
A) $110.00
B) $101.00
C) $100.00
D) $96.19
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
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16) The analysts predict that the price of corporation's XYZ stock one year from now will be
$20. XYZ announced that is not going to pay dividends next year. You decide that you would
be satisfied to earn a 10 percent on the investment on this stock, thus, this stock is worth
________ for you now.
A) $18.00
B) $18.18
C) $21.10
D) $21.00
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
17) The analysts predict that the price of corporation's XYZ stock one year from now will be
$120. XYZ announced that is not going to pay dividends next year. You decide that you would
be satisfied to earn a 12 percent on the investment on this stock, thus, this stock is worth
________ for you now.
A) $100.20
B) $108.80
C) $107.14
D) $132.00
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
18) General Electric announces that it is going to cut its dividends by $0.02 per share in the
future. This, everything else remaining the same, will cause its current stock price to ________.
A) increase
B) decrease
C) remain the same
D) fluctuate
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
19) In the generalized dividend model, if the expected sales price is in the distant future
________.
A) it does not affect the current stock price
B) it is more important than dividends in determining the current stock price
C) it is equally important with dividends in determining the current stock price
D) it is less important than dividends but still affects the current stock price
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
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20) In the generalized dividend model, a future sales price far in the future does not affect the
current stock price because ________.
A) the present value cannot be computed
B) the present value is almost zero
C) the sales price does not affect the current price
D) the stock may never be sold
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
21) In the generalized dividend model, the current stock price is the sum of ________.
A) the actual value of the future dividend stream
B) the present value of the future dividend stream
C) the future value of the future dividend stream
D) the present value of the future sales price
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
22) Using the Gordon growth model, a stock's price will increase if ________.
A) the dividend growth rate increases
B) the growth rate of dividends falls
C) the required rate of return on equity rises
D) the expected sales price rises
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
23) In the Gordon growth model, a decrease in the required rate of return on equity ________.
A) increases the current stock price
B) increases the future stock price
C) reduces the future stock price
D) reduces the current stock price
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
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24) Using the Gordon growth formula, if D1 is $2.00, ke is 12 percent or 0.12, and g is 10
percent or 0.10, then the current stock price is ________.
A) $20
B) $50
C) $100
D) $150
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
25) Using the Gordon growth formula, if D1 is $1.00, ke is 10 percent or 0.10, and g is 5
percent or 0.05, then the current stock price is ________.
A) $10
B) $20
C) $30
D) $40
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
26) One of the assumptions of the Gordon Growth Model is that dividends will continue
growing at ________ rate.
A) an increasing
B) a fast
C) a constant
D) an escalating
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
27) In the Gordon Growth Model, the growth rate is assumed to be ________ the required
return on equity.
A) greater than
B) equal to
C) less than
D) proportional to
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 7.1 Calculate the price of common stock
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28) What is the current price of a telecommunication company's stock if the current dividend is
$0.80, the expected constant growth rate in dividends is 5% and the required return is 10%?
A) $16.00
B) $16.80
C) $8.00
D) $8.40
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
29) What is the current price of a utility company's stock if the current dividend is $0.20, the
expected constant growth rate in dividends is 2% and the required return is 8%?
A) $2.00
B) $2.20
C) $3.20
D) $3.40
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
30) A company's dividend in one year is $1.00 and this is expected to increase at a constant rate
of 2%. If the required return on this stock increases from 10% to 12$ by how much will the
stock price change?
A) Increase by 20%
B) Decrease by 20%
C) Increase by 16.67%
D) Decrease by 16.67%
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 7.1 Calculate the price of common stock
31) You believe that a corporation's dividends will grow 5 percent on average into the
foreseeable future. If the company's last dividend payment was $5 what should be the current
price of the stock assuming a 12 percent required return?
Answer: Use the Gordon Growth Model.
$5(1 + .05)/(.12 - .05) = $75
Diff: 3
Type: ES
Skill: Applied
Objective: 7.1 Calculate the price of common stock
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32) What rights does ownership interest give stockholders?
Answer: Stockholders have the right to vote on issues brought before the stockholders, be the
residual claimant, that is, receive a portion of any net earnings of the corporation, and the right
to sell the stock.
Diff: 1
Type: ES
Skill: Recall
Objective: 7.1 Calculate the price of common stock
33) Explain the Gordon growth model of stock pricing. Explain how changes in each
component affect the current stock price. On what assumptions is the model based?
Answer: The basic model is
0=
where
P0 = the current stock price
D1 = the next period's dividend
ke = the required rate of return
g = the dividend growth rate
Increases in the dividend or the dividend growth rate increase the stock price, while an increase
in the required rate of return lowers the stock price.
The two assumptions that are the basis of the model are that dividends are assumed to grow at a
constant rate, and that the dividend growth rate is less than the required rate of return.
Diff: 1
Type: ES
Skill: Recall
Objective: 7.1 Calculate the price of common stock
34) Explain why the Gordon growth model does not need to incorporate the end period price.
Answer: Students must explain that since the end period is presumed to be an infinite number
of years in the future, the present value of that amount is effectively zero.
Diff: 2
Type: ES
Skill: Recall
Objective: 7.1 Calculate the price of common stock
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7.2
How the Market Sets Stock Prices
1) In asset markets, an asset's price is ________.
A) set equal to the highest price a seller will accept
B) set equal to the highest price a buyer is willing to pay
C) set equal to the lowest price a seller is willing to accept
D) set by the buyer willing to pay the highest price
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
2) Information plays an important role in asset pricing because it allows the buyer to more
accurately judge ________.
A) liquidity
B) risk
C) capital
D) policy
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.2 Recognize the impact of new information on stock prices
3) New information that might lead to a decrease in an asset's price might be ________.
A) an expected decrease in the level of future dividends
B) a decrease in the required rate of return
C) an expected increase in the dividend growth rate
D) an expected increase in the future sales price
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
4) A change in perceived risk of a stock changes ________.
A) the expected dividend growth rate
B) the expected sales price
C) the required rate of return
D) the current dividend
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 7.2 Recognize the impact of new information on stock prices
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5) A stock's price will fall if there is ________.
A) a decrease in perceived risk
B) an increase in the required rate of return
C) an increase in the future sales price
D) current dividends are high
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
6) A monetary expansion ________ stock prices due to a decrease in the ________ and an
increase in the ________, everything else held constant.
A) reduces; future sales price; expected rate of return
B) reduces; current dividend; expected rate of return
C) increases; required rate of return; future sales price
D) increases; required rate of return; dividend growth rate
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
7) The subprime financial crisis lead to a decline in stock prices because ________.
A) of a lowered expected dividend growth rate
B) of a lowered required return on investment in equity
C) higher expected future stock prices
D) higher current dividends
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
8) Increased uncertainty resulting from the subprime crisis ________ the required return on
investment in equity.
A) raised
B) lowered
C) had no impact on
D) decreased
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
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9) In October 2008, the stock market crashed, falling by ________ from its peak value a year
earlier.
A) over 40 percent
B) over 30 percent
C) over 50 percent
D) over 25 percent
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
10) An increase in uncertainty for the economy will ________.
A) increase stock prices due to a higher required return
B) not affect stock prices
C) increase stock prices due to a lower required return
D) depress stock prices due to a higher required return
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
11) Dishonest corporate accounting procedures would cause stock prices to ________.
A) remain unchanged
B) decrease due to lower expected dividend growth and lower required return
C) decrease due to lower expected dividend growth and higher required return
D) increase due to higher expected dividend growth and lower required return
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 7.2 Recognize the impact of new information on stock prices
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7.3
The Theory of Rational Expectations
1) Economists have focused more attention on the formation of expectations in recent years.
This increase in interest can probably best be explained by the recognition that ________.
A) expectations influence the behavior of participants in the economy and thus have a major
impact on economic activity
B) expectations influence only a few individuals, have little impact on the overall economy, but
can have important effects on a few markets
C) expectations influence many individuals, have little impact on the overall economy, but can
have distributional effects
D) models that ignore expectations have little predictive power, even in the short run
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
2) The view that expectations change relatively slowly over time in response to new
information is known in economics as ________.
A) rational expectations
B) irrational expectations
C) slow-response expectations
D) adaptive expectations
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
3) If expectations of the future inflation rate are formed solely on the basis of a weighted
average of past inflation rates, then economics would say that expectation formation is
________.
A) irrational
B) rational
C) adaptive
D) reasonable
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
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4) If expectations are formed adaptively, then people ________.
A) use more information than just past data on a single variable to form their expectations of
that variable
B) often change their expectations quickly when faced with new information
C) use only the information from past data on a single variable to form their expectations of
that variable
D) never change their expectations once they have been made
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
5) If during the past decade the average rate of monetary growth has been 5 percent and the
average inflation rate has been 5 percent, everything else held constant, when the Bank of
Canada announces that the new rate of monetary growth will be 10 percent, the adaptive
expectation forecast of the inflation rate is ________.
A) 5 percent
B) between 5 and 10 percent
C) 10 percent
D) more than 10 percent
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
6) The major criticism of the view that expectations are formed adaptively is that ________.
A) this view ignores the fact that people use more information than just past data to form their
expectations
B) it is easier to model adaptive expectations than it is to model rational expectations
C) adaptive expectations models have no predictive power
D) people are irrational and therefore never learn from past mistakes
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
7) In rational expectations theory, the term "optimal forecast" is essentially synonymous with
________.
A) correct forecast
B) the correct guess
C) the actual outcome
D) the best guess
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
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8) If a forecast is made using all available information, then economists say that the expectation
formation is ________.
A) rational
B) irrational
C) adaptive
D) reasonable
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
9) If a forecast made using all available information is not perfectly accurate, then it is
________.
A) still a rational expectation
B) not a rational expectation
C) an adaptive expectation
D) a second-best expectation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
10) If additional information is not used when forming an optimal forecast because it is not
available at that time, then expectations are ________.
A) obviously formed irrationally
B) still considered to be formed rationally
C) formed adaptively
D) formed equivalently
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
11) An expectation may fail to be rational if ________.
A) relevant information was not available at the time the forecast is made
B) relevant information is available but ignored at the time the forecast is made
C) information changes after the forecast is made
D) information was available to insiders only
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
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12) According to rational expectations theory, forecast errors of expectations ________.
A) are more likely to be negative than positive
B) are more likely to be positive than negative
C) tend to be persistently high or low
D) are unpredictable
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
13) Rational expectations forecast errors will on average be ________ and therefore ________
be predicted ahead of time.
A) positive; can
B) positive; cannot
C) negative; can
D) zero; cannot
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
14) People have a strong incentive to form rational expectations because ________.
A) they are guaranteed of success in the stock market
B) it is costly not to do so
C) it is costly to do so
D) everyone wants to be rational
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
15) If market participants notice that a variable behaves differently now than in the past, then,
according to rational expectations theory, we can expect market participants to ________.
A) change the way they form expectations about future values of the variable
B) begin to make systematic mistakes
C) no longer pay close attention to movements in this variable
D) give up trying to forecast this variable
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
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16) According to rational expectations, ________.
A) expectations of inflation are viewed as being an average of past inflation rates
B) expectations of inflation are viewed as being an average of expected future inflation rates
C) expectations formation indicates that changes in expectations occur slowly over time as past
data change
D) expectations will not differ from optimal forecasts that use all available information
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
17) Suppose Barbara looks out in the morning and sees a clear sky so decides that a picnic for
lunch is a good idea. Last night the weather forecast included a 100 percent chance of rain by
midday but Barbara did not watch the local news program. Is Barbara's prediction of good
weather at lunch time rational? Why or why not?
Answer: No, this prediction does not use rational expectations. Although Barbara based her
guess on the information that was available to her at the time, additional information was
readily available that could have been used to improve her prediction.
Diff: 3
Type: ES
Skill: Applied
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
18) Assume that your economics professor announces to your class that after thirty years of
giving exams only on scheduled dates, this semester she will give only surprise quizzes. What
is the rational expectation response to this new policy? Why does your self-interest require that
you change your behavior? What would the consequences be for students who changed their
expectations about exams adaptively?
Answer: Instead of being able to study for exams on known dates, students must now be
prepared for an exam at any possible time. Students must study regularly, before each class.
Self-interest dictates that students change their behavior, as their grade depends upon it.
Students who change their behavior adaptively don't adjust until they have experienced one or
more surprise quizzes, which in all likelihood hurt their grades.
Diff: 3
Type: ES
Skill: Applied
Objective: 7.3 Compare and contrast adaptive expectations and rational expectations
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7.4
The Efficient Market Hypothesis: Rational Expectations in Financial Markets
1) The theory of rational expectations, when applied to financial markets, is known as
________.
A) monetarism
B) the efficient markets hypothesis
C) the theory of strict liability
D) the theory of impossibility
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
2) Monetary economists and financial economists developed ________ theories on
expectations formations.
A) parallel
B) opposing
C) dissimilar
D) unusual
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
3) If the optimal forecast of the return on a security exceeds the equilibrium return, then
________.
A) the market is inefficient
B) no unexploited profit opportunities exist
C) the market is in equilibrium
D) the market is myopic
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
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4) Another way to state the efficient markets condition is: in an efficient market, ________.
A) unexploited profit opportunities will be quickly eliminated
B) unexploited profit opportunities will never exist
C) unexploited profit opportunities never existed
D) every financial market participant must be well informed about securities
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
5) ________ occurs when market participants observe returns on a security that are larger than
what is justified by the characteristics of that security and take action to quickly eliminate the
unexploited profit opportunity.
A) Arbitrage
B) Mediation
C) Asset capitalization
D) Market intercession
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
6) The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in
an efficient market, ________.
A) it will tend to go unnoticed for some time
B) it will be quickly eliminated
C) financial analysts are your best source of this information
D) prices will reflect the unexploited profit opportunity
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
7) Financial markets quickly eliminate unexploited profit opportunities through changes in
________.
A) dividend payments
B) tax laws
C) asset prices
D) monetary policy
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
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8) The elimination of unexploited profit opportunities requires that ________ market
participants be well informed.
A) all
B) a few
C) zero
D) many
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
9) If in an efficient market all prices are correct and reflect market fundamentals, which of the
following is a false statement?
A) A stock that has done poorly in the past is more likely to do well in the future
B) One investment is as good as any other because the securities' prices are correct
C) A security's price reflects all available information about the intrinsic value of the security
D) Security prices can be used by managers to assess their cost of capital accurately
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
10) 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 percent
B) is likely to increase one's returns by about 3 to 5 percent
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 percent
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
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11) You have observed that the forecasts of an investment advisor consistently outperform the
other reported forecasts. The efficient markets hypothesis says that future forecasts by this
advisor ________.
A) may or may not be better than the other forecasts Past performance is no guarantee of the
future
B) will always be the best of the group
C) will definitely be worse in the future What goes up must come down
D) will be worse in the near future, but improve over time
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
12) Sometimes one observes that the price of a company's stock falls after the announcement of
favorable earnings. This phenomenon is ________.
A) clearly inconsistent with the efficient markets hypothesis
B) consistent with the efficient markets hypothesis if the earnings were not as high as
anticipated
C) consistent with the efficient markets hypothesis if the earnings were not as low as
anticipated
D) consistent with the efficient markets hypothesis if the favorable earnings were expected
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
13) According to the efficient markets hypothesis, the current price of a financial security
________.
A) is the discounted net present value of future interest payments
B) is determined by the highest successful bidder
C) fully reflects all available relevant information
D) is a result of none of the above
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
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14) You read a story in the newspaper announcing the proposed merger of Dell Computer and
Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to
invest in Gateway stock, you can expect to earn ________.
A) above average returns since you will share in the higher profits
B) above average returns since your stock price will definitely appreciate as higher profits are
earned
C) below average returns since computer makers have low profit rates
D) a normal return since stock prices adjust to reflect expected changes in profitability almost
immediately
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
15) The efficient markets hypothesis indicates that investors ________.
A) can use the advice of technical analysts to outperform the market
B) do better on average if they adopt a "buy and hold" strategy
C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy
D) do better if they purchase loaded mutual funds
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
16) The efficient markets hypothesis suggests that investors ________.
A) should purchase no-load mutual funds which have low management fees
B) can use the advice of technical analysts to outperform the market
C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy
D) act on all "hot tips" they hear
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
17) 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
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
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18) For small investors, the best way to pursue a "buy and hold" strategy is to ________.
A) buy and sell individual stocks frequently
B) buy no-load mutual funds with high management fees
C) buy no-load mutual funds with low management fees
D) buy load mutual funds
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
19) If a corporation announces that it expects quarterly earnings to increase by 25 percent and it
actually sees an increase of 22 percent, what should happen to the price of the corporation's
stock if the efficient markets hypothesis holds, everything else held constant?
Answer: The stock's price should fall. The price had adjusted based on the statement of
expected earnings. When the actual number turned out to be lower than expected, the stock
price changes to reflect the additional information.
Diff: 3
Type: ES
Skill: Applied
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
20) 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?
Answer: No, if this information is readily available, it will already be reflected in the stock
price.
Diff: 1
Type: ES
Skill: Applied
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
21) If you your stock broker tells you that you should buy stock in Ford as it has devised a new
hybrid engine system that will reduce consumption of fuel by 90 percent, would you follow this
advice and buy Ford's stock?
Answer: The efficient market hypothesis indicates that you should be skeptical of any such
information. If the market is efficient then it has already priced Ford's stock so that its expected
return will equal the equilibrium return. The tip is not valuable. But if the tip is based on new
information and gives you an edge on the rest of the market, only them it can be valuable to
you and you should buy the stock. In any other case Ford stock price will have already reflected
the news.
Diff: 2
Type: ES
Skill: Applied
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
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22) What is a recommended strategy for a small investor and how it is associated with the
efficient market hypothesis?
Answer: Students should be able to explain that a recommended strategy is to purchase
no-load mutual funds. EMH suggests that only "extremely clever investors" may be able top
outperform a buy-and-hold strategy.
Diff: 3
Type: ES
Skill: Recall
Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis
holds
7.5 Why the Efficient Market Hypothesis Does Not Imply That Financial Markets are
Efficient
1) A situation when an asset price differs from its fundamental value is ________.
A) a random walk
B) an inflation
C) a deflation
D) a bubble
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 7.5 Identify and explain the implications of the efficient market hypothesis for
financial markets
2) In a rational bubble, investors can have ________ expectations that a bubble is occurring but
continue to hold the asset anyway.
A) irrational
B) adaptive
C) rational
D) myopic
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 7.5 Identify and explain the implications of the efficient market hypothesis for
financial markets
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7.6
Behavioral Finance
1) ________ is the field of study that applies concepts from social sciences such as psychology
and sociology to help understand the behavior of securities prices.
A) Behavioral finance
B) Strategical finance
C) Methodical finance
D) Procedural finance
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient
market hypothesis may not hold
2) If a market participant believes that a stock price is irrationally high, they may try to borrow
stock from brokers to sell in the market and then make a profit by buying the stock back again
after the stock falls in price. This practice is called ________.
A) short selling
B) double dealing
C) undermining
D) long marketing
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient
market hypothesis may not hold
3) ________ means people are more unhappy when they suffer losses than they are happy when
they achieve gains.
A) Loss fundamentals
B) Loss aversion
C) Loss leader
D) Loss cycle
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient
market hypothesis may not hold
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4) Loss aversion can explain why very little ________ actually takes place in the securities
market.
A) short selling
B) bargaining
C) bartering
D) negotiating
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient
market hypothesis may not hold
5) Psychologists have found that people tend to be ________ in their own judgments.
A) underconfident
B) overconfident
C) indecisive
D) insecure
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient
market hypothesis may not hold
6) ________ and ________ may provide an explanation for stock market bubbles.
A) Overconfidence; social contagion
B) Underconfidence; social contagion
C) Overconfidence; social isolationism
D) Underconfidence; social isolationism
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient
market hypothesis may not hold
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7.7
Web Appendix: Evidence on the Efficient Market Hypothesis
1) If a mutual fund outperforms the market in one period, evidence suggests that this fund is
________.
A) highly likely to consistently outperform the market in subsequent periods due to its superior
investment strategy
B) likely to under-perform the market in subsequent periods to average its overall returns
C) not likely to consistently outperform the market in subsequent periods
D) not likely to outperform the market in any subsequent period
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
2) Studies of mutual fund performance indicate that mutual funds that outperformed the market
in one time period usually ________.
A) beat the market in the next time period
B) beat the market in the next two subsequent time periods
C) beat the market in the next three subsequent time periods
D) do not beat the market in the next time period
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
3) The number and availability of discount brokers has grown rapidly since the mid-1970s. The
efficient markets hypothesis predicts that people who use discount brokers ________.
A) will likely earn lower returns than those who use full-service brokers
B) will likely earn about the same as those who use full-service brokers, but will net more after
brokerage commissions
C) are going against evidence suggesting that full-service brokers can help outperform the
market
D) are likely to outperform the market by a wide margin
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
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4) When Happy Feet Corporation announces that their fourth quarter earnings are up 10
percent, their stock price falls. This is consistent with the efficient markets hypothesis
________.
A) if earnings were not as high as expected
B) if earnings were not as low as expected
C) if a merger is anticipated
D) the company just invented a new bunion product
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
5) 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
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
6) The efficient markets hypothesis predicts that stock prices follow a "random walk." The
implication of this hypothesis for investing in stocks is ________.
A) a "churning strategy" of buying and selling often to catch market swings
B) turning over your stock portfolio each month, selecting stocks by throwing darts at the stock
page
C) a "buy and hold strategy" of holding stocks to avoid brokerage commissions
D) following the advice of technical analysts
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
7) Rules used to predict movements in stock prices based on past patterns are, according to the
efficient markets hypothesis, ________.
A) a waste of time
B) profitably employed by all financial analysts
C) the most efficient rules to employ
D) consistent with the random walk hypothesis
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
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8) Tests used to rate the performance of rules developed in technical analysis conclude that
technical analysis ________.
A) outperforms the overall market
B) far outperforms the overall market, suggesting that stockbrokers provide valuable services
C) does not outperform the overall market
D) does not outperform the overall market, suggesting that stockbrokers do not provide services
of any value
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
9) Which of the following accurately summarizes the empirical evidence about technical
analysis?
A) Technical analysts fare no better than other financial analysis—on average they do not
outperform the market.
B) Technical analysts tend to outperform other financial analysis, but on average they
nevertheless underperform the market.
C) Technical analysts fare no better than other financial analysis, and like other financial
analysts they outperform the market.
D) Technical analysts fare no better than other financial analysis, and like other financial
analysts they underperform the market.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
10) Evidence in support of the efficient markets hypothesis includes ________.
A) the failure of technical analysis to outperform the market
B) the small-firm effect
C) the January effect
D) excessive volatility
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
11) Evidence against market efficiency includes ________.
A) failure of technical analysis to outperform the market
B) the random walk behavior of stock prices
C) the inability of mutual fund managers to consistently beat the market
D) the January effect
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
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12) The small-firm effect refers to the ________.
A) negative returns earned by small firms
B) returns equal to large firms earned by small firms
C) abnormally high returns earned by small firms
D) low returns after adjusting for risk earned by small firms
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
13) The January effect refers to the fact that ________.
A) most stock market crashes have occurred in January
B) stock prices tend to fall in January
C) stock prices have historically experienced abnormal price increases in January
D) the football team winning the Super Bowl accurately predicts the behavior of the stock
market for the next year
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
14) When a corporation announces a major decline in earnings, the stock price may initially
decline significantly and then rise back to normal levels over the next few weeks. This impact
is called ________.
A) the January effect
B) mean reversion
C) market overreaction
D) the small-firm effect
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
15) A phenomenon closely related to market overreaction is ________.
A) the random walk
B) the small-firm effect
C) the January effect
D) excessive volatility
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
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16) Excessive volatility refers to the fact that ________.
A) stock returns display mean reversion
B) stock prices can be slow to react to new information
C) stock price tend to rise in the month of January
D) stock prices fluctuate more than is justified by dividend fluctuations
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
17) Mean reversion refers to the fact that ________.
A) small firms have higher than average returns
B) stocks that have had low returns in the past are more likely to do well in the future
C) stock returns are high during the month of January
D) stock prices fluctuate more than is justified by fundamentals
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Evidence on the Efficient Market Hypothesis
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 8 An Economic Analysis of Financial Structure
8.1
Basic Facts About Financial Structure Throughout the World
1) The financial system includes all but the following type of institutions.
A) Banks
B) Insurance companies
C) Mutual funds
D) Public relations firms
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
2) Canadian businesses used stocks for external financing ________ percent over the
1970-2002 period.
A) 2
B) 12
C) 22
D) 0.2
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
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3) Canadian businesses get their external funds primarily from ________.
A) bank loans
B) bonds and commercial paper issues
C) stock issues
D) loans from nonbank financial intermediaries
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
4) Of the sources of external funds for nonfinancial businesses in Canada, loans from banks and
other financial intermediaries account for ________ of the total.
A) 6 percent
B) 40 percent
C) 56 percent
D) over 70 percent
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
5) Stocks and bonds supply less than ________ of the external funds for Canadian corporations
need to finance their activities.
A) one-third
B) one-quarter
C) one-half
D) two-thirds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
6) Of the sources of external funds for nonfinancial businesses in Canada, corporate bonds and
commercial paper account for approximately ________ of the total.
A) 5 percent
B) 10 percent
C) 15 percent
D) 50 percent
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
7) Of the following sources of external finance for Canadian nonfinancial businesses, the least
important is ________.
A) loans from banks
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B) stocks
C) bonds and commercial paper
D) loans from other financial intermediaries
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
8) Of the sources of external funds for nonfinancial businesses in Canada, stocks account for
approximately ________ of the total.
A) 2 percent
B) 12 percent
C) 20 percent
D) 40 percent
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
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9) Which of the following statements concerning external sources of financing for nonfinancial
businesses in Canada is true?
A) Stocks are a far more important source of finance than are bonds.
B) Stocks and bonds, combined, supply less than one-half of the external funds.
C) Financial intermediaries are the least important source of external funds for businesses.
D) Since 1970, more than half of the new issues of stock have been sold to Canadian
households.
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
10) Which of the following statements concerning external sources of financing for
nonfinancial businesses in Canada is true?
A) Issuing marketable securities is the primary way that they finance their activities.
B) Bonds are the least important source of external funds to finance their activities.
C) Stocks are a relatively unimportant source of finance for their activities.
D) Selling bonds directly to the Canadian household is a major source of funding for Canadian
businesses.
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
11) Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds
________.
A) by issuing stock
B) by issuing bonds
C) from nonbank loans
D) from bank loans
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
12) As a source of funds for nonfinancial businesses, bonds are relatively more important than
stocks in ________.
A) Canada
B) Germany
C) Japan
D) the US
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
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13) Direct finance involves the sale to ________ of marketable securities such as stocks and
bonds.
A) households
B) insurance companies
C) pension funds
D) financial intermediaries
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
14) Regulation of the financial system ________.
A) occurs only in Canada
B) protects the jobs of employees of financial institutions
C) protects the wealth of owners of financial institutions
D) ensures the stability of the financial system
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
15) One purpose of regulation of financial markets is to ________.
A) limit the profits of financial institutions
B) increase competition among financial institutions
C) promote the provision of information to shareholders, depositors and the public
D) guarantee that the maximum rates of interest are paid on deposits
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
16) 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
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
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17) Collateralized debt is also know as ________.
A) unsecured debt
B) secured debt
C) unrestricted debt
D) promissory debt
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
18) Credit card debt is ________.
A) secured debt
B) unsecured debt
C) restricted debt
D) unrestricted debt
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
19) The predominant form of household debt is ________.
A) consumer installment debt
B) collateralized debt
C) unsecured debt
D) unrestricted debt
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
20) If you default on your auto loan, your car will be repossessed because it has been pledged
as ________ for the loan.
A) interest
B) collateral
C) dividend
D) commodity
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
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21) Commercial and farm mortgages, in which property is pledged as collateral, account for
________.
A) one-quarter of borrowing by nonfinancial businesses
B) one-half of borrowing by nonfinancial businesses
C) one-twentieth of borrowing by nonfinancial businesses
D) two-thirds of borrowing by nonfinancial businesses
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
22) A ________ is a provision that restricts or specifies certain activities that a borrower can
engage in.
A) residual claimant
B) risk hedge
C) restrictive barrier
D) restrictive covenant
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
23) A clause in a mortgage loan contract requiring the borrower to purchase homeowner's
insurance is an example of a ________.
A) proscriptive covenant
B) prescriptive covenant
C) restrictive covenant
D) constraint-imposed covenant
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
24) Which of the following is not one of the eight basic puzzles about financial structure?
A) Stocks are the most important source of finance for Canadian businesses.
B) Issuing marketable securities is not the primary way businesses finance their operations.
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) Banks are the most important source of external funds to finance businesses.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
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25) Which of the following is not one of the eight basic puzzles about financial structure?
A) Debt contracts are typically extremely complicated legal documents that place substantial
restrictions on the behavior of the borrower.
B) 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.
C) Collateral is a prevalent feature of debt contracts for both households and business.
D) There is very little regulation of the financial system.
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 8.1 Identify eight basic facts about the global financial system
8.2
Transaction Costs
1) The current structure of financial markets can be best understood as the result of attempts by
financial market participants to ________.
A) adapt to continually changing government regulations
B) deal with the great number of small firms in the United States
C) reduce transaction costs
D) cartelize the provision of financial services
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
2) The two ways financial intermediaries can reduce transactions costs are ________ and
________.
A) economies of scale; expertise
B) moral hazard; adverse selection
C) direct finance; indirect finance
D) stocks; bonds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
3) The reduction in transactions costs per dollar of investment as the size of transactions
increases is known as ________.
A) discounting
B) economies of scale
C) economies of trade
D) diversification
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
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4) Which of the following is not a benefit to an individual purchasing a mutual fund?
A) Reduced risk
B) Lower transactions costs
C) Free-riding
D) Diversification
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
5) Financial intermediaries develop ________ in things such as computer technology which
allows them to lower transactions costs.
A) expertise
B) diversification
C) regulations
D) equity
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
6) Financial intermediaries' low transaction costs allow them to provide ________ services that
make it easier for customers to conduct transactions.
A) liquidity
B) conduction
C) transcendental
D) equitable
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
7) A solution to the high transaction costs is to bundle the funds of many investors so that they
can take advantage of ________.
A) economies of scale
B) high interest rates
C) high rates of return
D) lower risk
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
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8) If all the students in your class pool their money in order to buy one bond and share its return
accordingly, in order to eliminate transaction costs, this is an example of ________.
A) economies of scale
B) cooperative game
C) risk sharing
D) moral hazard
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
9) Financial intermediaries are able to reduce transaction costs through ________ and
________.
A) economies of scale; expertise
B) restrictive covenants; unsecured debts
C) moral hazard; adverse selection
D) economies of scale; regulation
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
10) Liquidity service offered by financial intermediary make it ________.
A) easier for customers to conduct transactions
B) more difficult to undertake indirect financial transactions
C) easier to monitor restrictive covenants
D) more difficult to conduct transactions
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
11) How does a mutual fund lower transactions costs through economies of scale?
Answer: The mutual fund takes the funds of the individuals who have purchased shares and
uses them to purchase bonds or stocks. Because the mutual fund will be purchasing large
blocks of stocks or bonds they will be able to obtain them at lower transactions costs than the
individual purchases of smaller amounts could.
Diff: 2
Type: ES
Skill: Recall
Objective: 8.2 Summarize how transaction costs affect financial intermediaries
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8.3
Asymmetric Information: Adverse Selection and Moral Hazard
1) A borrower who takes out a loan usually has better information about the potential returns
and risk of the investment projects he plans to undertake than does the lender. This inequality
of information is called ________.
A) moral hazard
B) asymmetric information
C) noncollateralized risk
D) adverse selection
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
2) The presence of ________ in financial markets leads to adverse selection and moral hazard
problems that interfere with the efficient functioning of financial markets.
A) noncollateralized risk
B) free-riding
C) asymmetric information
D) costly state verification
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
3) The problem created by asymmetric information before the transaction occurs is called
________, while the problem created after the transaction occurs is called ________.
A) adverse selection; moral hazard
B) moral hazard; adverse selection
C) costly state verification; free-riding
D) free-riding; costly state verification
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
4) If bad credit risks are the ones who most actively seek loans then financial intermediaries
face the problem of ________.
A) moral hazard
B) adverse selection
C) free-riding
D) costly state verification
Answer: B
Diff: 2
Type: MC
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Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
5) An example of the ________ problem would be if Brian borrowed money from Sean in
order to purchase a used car and instead took a trip to Atlantic City using those funds.
A) moral hazard
B) adverse selection
C) costly state verification
D) agency
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
6) The analysis of how asymmetric information problems affect economic behavior is called
________ theory.
A) uneven
B) parallel
C) principal
D) agency
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
7) Nobel prize winner George Akerlof is associated with the "________ problem."
A) lemons
B) efficient markets
C) riskiness
D) volatility
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
8) In the absence of asymmetric information, the lemons problem ________.
A) goes away
B) becomes worse
C) is not important
D) remains the same
Answer: A
Diff: 1
Type: MC
Skill: Recall
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Objective:
hazard
8.3 Discuss why asymmetric information leads to adverse selection and moral
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9) The solution to the adverse selection problem in financial markets is to ________.
A) supply lenders with full details on the borrowers
B) supply borrowers with full details on the lenders
C) supply governmental agencies with financial information
D) produce more free riders
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
10) The remedies for the adverse selection include all but the following.
A) Private production and sale of information
B) Free-riding
C) Government regulation
D) Financial intermediation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
11) Explain the problem of asymmetric information, adverse selection and moral hazard, and
why these problems are important for the financial system.
Answer: Asymmetric information is an imbalance of information between two parties to a
contract. In financial markets, lenders know less about a borrower's planned use of the lender's
funds than does the lender. The problem of adverse selection arises when the least qualified
individuals are more likely to apply for loans. This is a problem that exists prior to making a
loan. Moral hazard is a problem that exists after a loan has been made. This is the problem that
the borrower will take excessive risks, or behave in ways that jeopardize repayment of a loan.
These problems exist for all financial contracts.
Diff: 3
Type: ES
Skill: Recall
Objective: 8.3 Discuss why asymmetric information leads to adverse selection and moral
hazard
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8.4
The Lemons Problem: How Adverse Selection Influences Financial Structure
1) Bundling investors funds together ________.
A) increases transactions costs per dollar of investment
B) reduces transaction costs per dollar of investment
C) increases moral hazard
D) explains why stocks are the most import means of external financing for Canadian
businesses
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
2) The "lemons problem" is a term used to describe the ________.
A) moral hazard problem
B) adverse selection problem
C) free-rider problem
D) the diversification problem
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
3) Because of the "lemons problem" the price a buyer of a used car pays is ________.
A) equal to the price of a lemon
B) less than the price of a lemon
C) equal to the price of a peach
D) between the price of a lemon and a peach
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
4) Adverse selection is a problem associated with equity and debt contracts arising from
________.
A) the lender's relative lack of information about the borrower's potential returns and risks of
his investment activities
B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the
borrower defaults
C) the borrower's lack of incentive to seek a loan for highly risky investments
D) the lender's inability to restrict the borrower from changing his behavior once given a loan
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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5) The "lemons problem" exists because of ________.
A) transactions costs
B) economies of scale
C) rational expectations
D) asymmetric information
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
6) The ________ problem helps to explain why the private production and sale of information
cannot eliminate ________.
A) free-rider; adverse selection
B) free-rider; moral hazard
C) principal-agent; adverse selection
D) principal-agent; moral hazard
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
7) The free-rider problem occurs because ________.
A) people who pay for information use it freely
B) people who do not pay for information use it
C) information can never be sold at any price
D) it is never profitable to produce information
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
8) With regard to external sources of financing for nonfinancial businesses in Canada, which of
the following are accurate statements?
A) Direct finance accounts for a larger share of external business financing in Canada than
indirect finance.
B) Since 1970, most of the newly issued corporate bonds and commercial paper have been sold
directly to Canadian households.
C) Indirect finance accounts for a larger share of external business financing in Canada than
direct finance.
D) Smaller businesses almost always raise funds by issuing marketable securities.
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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9) Government agencies require that firms that sell securities in public markets adhere to have
________.
A) intermediation
B) nondisclosure
C) independent audits
D) collateral
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
10) Government regulations require publicly traded firms to provide information, reducing
________.
A) transactions costs
B) the need for diversification
C) the adverse selection problem
D) economies of scale
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
11) A lesson of the Enron collapse is that government regulation ________.
A) always fails
B) can reduce but not eliminate asymmetric information
C) increases the problem of asymmetric information
D) should be reduced
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
12) Adverse selection ________.
A) is a problem of symmetric information
B) occurs after the transaction
C) is not important in financial markets
D) why large firms are more likely to obtain funds from securities markets
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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13) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence
that these intermediaries ________.
A) have been afforded special government treatment, since used car dealers do not provide
information that is valued by consumers of used cars
B) are able to prevent potential competitors from free-riding off the information that they
provide
C) have failed to solve adverse selection problems in this market because "lemons" continue to
be traded
D) have solved the moral hazard problem by providing valuable information to their customers
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
14) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence
that these intermediaries ________.
A) have solved the moral hazard problem created by the consumers of used cars
B) are not able to prevent others from free-riding off the information that they provide
C) help solve the adverse selection problem
D) only sell "lemons"
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
15) Analysis of adverse selection indicates that financial intermediaries, especially banks,
________.
A) have advantages in overcoming the free-rider problem, helping to explain why indirect
finance is a more important source of business finance than is direct finance
B) despite their success in overcoming free-rider problems, nevertheless play a minor role in
moving funds to corporations
C) provide better-known and larger corporations a higher percentage of their external funds
than they do to newer and smaller corporations which rely to a greater extent on the new issues
market for funds
D) must buy securities from corporations to diversify the risk that results from holding
non-tradable loans
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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16) The concept of adverse selection helps to explain all of the following except ________.
A) why firms are more likely to obtain funds from banks and other financial intermediaries,
rather than from the securities markets
B) why indirect finance is more important than direct finance as a source of business finance
C) why direct finance is more important than indirect finance as a source of business finance
D) why the financial system is so heavily regulated
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
17) The problem of adverse selection helps to explain ________.
A) which firms are more likely to obtain funds from banks and other financial intermediaries,
rather than from securities markets
B) why direct finance is more important than indirect finance as a source of business finance
C) why collateral is not an important feature of debt contracts
D) why banks prefer to make loans unsecured
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
18) The problem of adverse selection helps to explain ________.
A) why banks prefer to make loans unsecured
B) why banks do not have advantage in raising funds for businesses
C) why borrowers are willing to offer collateral to secure their promises to repay loans
D) why the financial system is so heavily regulated
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
19) As information technology improves, the lending role of financial institutions such as banks
should ________.
A) increase somewhat
B) decrease
C) stay the same
D) increase significantly
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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20) That only large, well-established corporations have access to securities markets ________.
A) explains why indirect finance is such an important source of external funds for businesses
B) can be explained by the problem of moral hazard
C) can be explained by government regulations that prohibit small firms from acquiring funds
in securities markets
D) explains why newer and smaller corporations rely so heavily on the new issues market for
funds
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
21) Because of the adverse selection problem, ________.
A) good credit risks are more likely to seek loans causing lenders to make a disproportionate
amount of loans to good credit risks
B) lenders may refuse loans to individuals with high net worth, because of their greater
proclivity to "skip town"
C) lenders are reluctant to make loans that are not secured by collateral
D) lenders will write debt contracts that restrict certain activities of borrowers
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
22) Net worth can perform a similar role to ________.
A) diversification
B) collateral
C) intermediation
D) economies of scale
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
23) Government regulations require publicly traded firms to provide information, reducing
________.
A) transactions costs
B) the need for diversification
C) the adverse selection problem
D) free-riders
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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24) The concept of adverse selection helps to explain ________.
A) why collateral is not a common feature of many debt contracts
B) why large, well-established corporations find it so difficult to borrow funds in securities
markets
C) why financial markets are among the most heavily regulated sectors of the economy
D) why stocks are the most important source of external financing for businesses
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
25) How does collateral help to reduce the adverse selection problem in credit market?
Answer: Collateral is property that is promised to the lender if the borrower defaults thus
reducing the lender's losses. Lenders are more willing to make loans when there is collateral
that can be sold if the borrower defaults.
Diff: 1
Type: ES
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
26) Explain the "lemons problem" as it applies to the used-car market. Why does this problem
exist? How does this market resolve this problem?
Answer: The lemons problem exists because of asymmetric information. Buyers of used cars
do not know if cars are lemons (bad) or peaches (good). The market price will be an average of
the price of a lemon and a peach. Because of this, owners of lemons are more likely to sell their
cars, an example of adverse selection. The resolution to this problem is that dealers
(intermediaries) sell most used cars. Dealers specialize in the production of information about
used cars. They can use this information to provide guarantees, or develop a reputation for
selling quality cars. Dealers help solve the adverse selection problem in the used car market.
Diff: 3
Type: ES
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
27) Explain how government regulation can lessen asymmetric information problems but not
eliminate them using Enron as an example.
Answer: The government can regulate firms and require them to have independent audits and
disclose the results but as shown by the collapse of Enron, this is not 100 percent effective.
That firm had a complex set of transactions hidden from the auditors and eventually the
financial instability led to its collapse.
Diff: 2
Type: ES
Skill: Recall
Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced
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8.5
How Moral Hazard Affects the Choice Between Debt and Equity Contracts
1) Equity contracts ________.
A) are claims to a share in the profits and assets of a business
B) have the advantage over debt contracts of a lower costly state verification
C) are used much more frequently to raise capital than are debt contracts
D) are not subject to the moral hazard problem
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
2) A problem for equity contracts is a particular type of ________ called the ________
problem.
A) adverse selection; principal-agent
B) moral hazard; principal-agent
C) adverse selection; free-rider
D) moral hazard; free-rider
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
3) Moral hazard in equity contracts is known as the ________ problem because the manager of
the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.
A) principal-agent
B) adverse selection
C) free-rider
D) debt deflation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
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4) Managers (________) may act in their own interest rather than in the interest of the
stockholder-owners (________) because the managers have less incentive to maximize profits
than the stockholder-owners do.
A) principals; agents
B) principals; principals
C) agents; agents
D) agents; principals
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
5) The principal-agent problem ________.
A) occurs when managers have more incentive to maximize profits than the
stockholders-owners do
B) in financial markets helps to explain why equity is a relatively important source of finance
for Canadian business
C) would not arise if the owners of the firm had complete information about the activities of the
managers
D) explains why direct finance is more important than indirect finance as a source of business
finance
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
6) The principal-agent problem ________.
A) arises because principals have incentives to free-ride off of the monitoring expenditures of
other principals
B) arises because principals find it simple to monitor agents' activities
C) arises because agents' incentives are always compatible with those of the principals
D) arises because principals' incentives are always compatible with those of the agents
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
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7) The recent Enron and Tyco scandals are an example of ________.
A) the free-rider problem
B) the adverse selection problem
C) the principal-agent problem
D) the "lemons problem"
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
8) The name economists give the process by which stockholders gather information by frequent
monitoring of the firm's activities is ________.
A) costly state verification
B) the free-rider problem
C) costly avoidance
D) debt intermediation
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
9) Because information is scarce ________.
A) helps explain why equity contracts are used so much more frequently to raise capital than
are debt contracts
B) monitoring managers gives rise to costly state verification
C) government regulations, such as standard accounting principles, have no impact on
problems such as moral hazard
D) developing nations do not rely heavily on banks for business financing
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
10) Government regulations designed to reduce the moral hazard problem include ________.
A) laws that force firms to adhere to standard accounting principles
B) light sentences for those who commit the fraud of hiding and stealing profits
C) state verification subsidies
D) state licensing restrictions
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
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11) Venture capital firms have been important in developing the ________ sector in Canada.
A) financial
B) high tech
C) oil and gas
D) government
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
12) One financial intermediary in our financial structure that helps to reduce the moral hazard
from arising from the principal-agent problem is the ________.
A) venture capital firm
B) money market mutual fund
C) pawn broker
D) savings and loan association
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
13) A venture capital firm protects its equity investment from moral hazard through which of
the following means?
A) It places people on the board of directors to better monitor the borrowing firm's activities.
B) It writes contracts that prohibit the sale of an equity investment to the venture capital firm.
C) It prohibits the borrowing firm from replacing its management.
D) It requires a 50 percent stake in the company.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
14) Equity contracts account for a small fraction of external funds raised by Canadian
businesses because ________.
A) costly state verification makes the equity contract less desirable than the debt contract
B) of the reduced scope for moral hazard problems under equity contracts, as compared to debt
contracts
C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt
D) there is no moral hazard problem when using a debt contract
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
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15) Debt contracts ________.
A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals
B) have a higher cost of state verification than equity contracts
C) are used less frequently to raise capital than are equity contracts
D) never result in a loss for the lender
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
16) Since they require less monitoring of firms, ________ contracts are used more frequently
than ________ contracts to raise capital.
A) debt; equity
B) equity; debt
C) debt; loan
D) equity; stock
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
17) Explain the principal-agent problem as it pertains to equity contracts.
Answer: The principals are the stockholders who own most of the equity. The agents are the
managers of the firm who generally own only a small portion of the firm. The problem occurs
because the agents may not have as much incentive to profit maximize as the stockholders.
Diff: 1
Type: ES
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
18) Explain the four tools that can help solve the principal-agent problem.
Answer: These are: production of information monitoring, government regulation to increase
information, financial intermediation and debt contracts.
Diff: 1
Type: ES
Skill: Recall
Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity
contracts and summarize methods for reducing it
245
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8.6
How Moral Hazard Influences Financial Structure in Debt Markets
1) Although debt contracts require less monitoring than equity contracts, debt contracts are still
subject to ________ since borrowers have an incentive to take on more risk than the lender
would like.
A) moral hazard
B) agency theory
C) diversification
D) the "lemons" problem
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
2) A debt contract is incentive compatible ________.
A) if the borrower has the incentive to behave in the way that the lender expects and desires,
since doing otherwise jeopardizes the borrower's net worth in the business
B) if the borrower's net worth is sufficiently low so that the lender's risk of moral hazard is
significantly reduced
C) if the debt contract is treated like an equity
D) if the lender has the incentive to behave in the way that the borrower expects and desires
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
3) High net worth helps to diminish the problem of moral hazard problem by ________.
A) requiring the state to verify the debt contract
B) collateralizing the debt contract
C) making the debt contract incentive compatible
D) giving the debt contract characteristics of equity contracts
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
4) One way of describing the solution that high net worth provides to the moral hazard problem
is to say that it ________.
A) collateralizes the debt contract
B) makes the debt contract incentive compatible
C) state verifies the debt contract
D) removes all of the risk in the debt contract
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
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5) Which of the following is NOT one of the four types of restrictive covenants?
A) Convenants to discourage undesirable behaviour
B) Convenants to encourage desirable behaviour
C) Covenants to keep collateral valuable
D) Covenants for incentive compatibility
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
6) A clause in a debt contract requiring that the borrower purchase insurance against loss of the
asset financed with the loan is called a ________.
A) collateral-insurance clause
B) prescription covenant
C) restrictive covenant
D) proscription covenant
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
7) Professional athletes often have contract clauses prohibiting risky activities such as skiing
and motorcycle riding. These clauses are ________.
A) limited-liability clauses
B) risk insurance
C) restrictive covenants
D) illegal
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
8) For restrictive covenants to help reduce the moral hazard problem they must be ________ by
the lender.
A) monitored and enforced
B) written in all capitals
C) easily changed
D) impossible to remove
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
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9) Although restrictive covenants can potentially reduce moral hazard, a problem with
restrictive covenants is that ________.
A) borrowers may find loopholes that make the covenants ineffective
B) they are inexpensive to monitor and enforce
C) too many resources may be devoted to monitoring and enforcing them, as debtholders
duplicate others' monitoring and enforcement efforts
D) they reduce the value of the debt contract
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
10) Solutions to the moral hazard problem include ________.
A) low net worth
B) monitoring and enforcement of restrictive covenants
C) greater reliance on equity contracts and less on debt contracts
D) greater reliance on debt contracts than financial intermediaries
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
11) A key finding of the economic analysis of financial structure is that ________.
A) the existence of the free-rider problem for traded securities helps to explain why banks play
a predominant role in financing the activities of businesses
B) while free-rider problems limit the extent to which securities markets finance some business
activities, nevertheless the majority of funds going to businesses are channeled through
securities markets
C) given the great extent to which securities markets are regulated, free-rider problems are not
of significant economic consequence in these markets
D) economists do not have a very good explanation for why securities markets are so heavily
regulated
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
12) One reason financial systems in developing and transition countries are underdeveloped is
________.
A) they have weak links to their governments
B) they make loans only to nonprofit entities
C) the legal system may be poor making it difficult to enforce restrictive covenants
D) the accounting standards are too stringent for the banks to meet
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
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13) One reason China has been able to grow so rapidly even though its financial development is
still in its early stages is ________.
A) the high savings rate of around 40 percent
B) the shift of labor to the agricultural sector
C) the stringent enforcement of financial contracts
D) the ease of obtaining high-quality information about creditors
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
14) China's reforms to strengthen the financial system includes ________.
A) privatizing state-owned banks
B) diluting legal reforms
C) industrializing the labour force
D) maintaining highly agrarian labour force
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
15) How do restrictive covenants reduce moral hazard in debt contracts?
Answer: Restrictive covenants keep borrowers from taking excessive risks. Restrictive
covenants can encourage desirable behaviour, such as buying insurance to repay the loan in
case of death of the borrower, and maintaining high net worth. Covenants encourage the
borrower to keep collateral valuable, including purchasing insurance to protect assets against
risk of loss. Covenants require borrowers to provide information about activities, including
accounting and income reports. This reduces moral hazard.
Diff: 2
Type: ES
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
16) Why does the free-rider problem occur in the debt market?
Answer: Restrictive covenants can reduce moral hazard but they must be monitored and
enforced to be effective. If bondholders know that other bondholders are monitoring and
enforcing the restrictive covenants, they can free ride. Other bondholders will follow suit
resulting in not enough resources devoted to monitoring and enforcing restrictive covenants.
Diff: 1
Type: ES
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
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17) Explain how high net worth and collateral reduce the problem of moral hazard.
Answer: High net worth and collateral makes the debt contract incentive-compatible by
aligning the incentives of the borrowers with those of the lenders.
Diff: 1
Type: ES
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
18) Explain the difference between net worth and collateral.
Answer: Net worth is the difference between a borrowers assets and liabilities. Collateral
represents assets pledged to the lender.
Diff: 2
Type: ES
Skill: Recall
Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 9
Financial Crises
9.1
What is a Financial Crisis?
1) A major disruption in financial markets characterized by sharp declines in asset prices and
firm failures is called a ________.
A) financial crisis
B) fiscal imbalance
C) free-rider problem
D) "lemons" problem
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.1 Define the term "financial crises"
2) Asymmetric information problems that act as a barrier to efficient allocation of capital are
often described as ________.
A) financial treason
B) financial markets
C) financial frictions
D) financial allocations
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.1 Define the term "financial crises"
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9.2
Dynamics of Financial Crises
1) The elimination of restrictions on financial markets and institutions is also known as
________.
A) financial engineering
B) financial lending
C) financial liberalization
D) financial deleveraging
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
2) 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 less
significant
C) frequently lead to sharp expansions in economic activity
D) are a free-rider problem
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
3) A financial crisis occurs when an increase in asymmetric information from a disruption in
the financial system ________.
A) causes severe adverse selection and moral hazard problems that make financial markets
incapable of channelling funds efficiently
B) allows for a more efficient use of funds
C) increases economic activity
D) reduces uncertainty in the economy and increases market efficiency
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
4) The dark side of financial liberalization is ________.
A) market allocations
B) credit booms
C) currency appreciation
D) financial innovation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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5) When the value of loans begins to drop, the net worth of financial institutions falls causing
them to cut back on lending in a process called ________.
A) deflation
B) releveraging
C) capitulation
D) deleveraging
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
6) When financial institutions go on a lending spree and expand their lending at a rapid pace
they are participating in a ________.
A) credit bust
B) credit boom
C) deleveraging
D) market race
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
7) When financial intermediaries deleverage, firms cannot fund investment opportunities
resulting in ________.
A) a contraction of economic activity
B) an economic boom
C) an increased opportunity for growth
D) a call for government regulation
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
8) A decline in asset prices can lead to ________.
A) worsening adverse selection and moral hazard problems
B) declining uncertainty
C) increased economic activity
D) anticipated increase in the price level
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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9) Factors that lead to worsening conditions in financial system include ________.
A) increases in net worth
B) unanticipated increases in the price level
C) unanticipated increases in the value of the domestic currency
D) unanticipated declines in the value of the domestic currency
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
10) Factors that lead to worsening conditions in financial system include ________.
A) declining interest rates
B) unanticipated increases in the price level
C) the deterioration in banks' balance sheets
D) increases in bond prices
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
11) When there is a deterioration in financial institutions' balance sheets ________.
A) economic activity contracts
B) asset prices increase
C) financial engineering takes place
D) financial globalization increases its pace
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
12) Government safety nets ________.
A) weaken market discipline
B) reduce moral hazard
C) incent banks to take less risk
D) require banks to loan less funds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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13) A sharp decline in the stock market means that the ________ of corporations has fallen.
A) net worth
B) interest rates
C) liabilities
D) payrolls
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
14) In a bank panic ________.
A) free-rider increase
B) bond prices increase
C) transactions costs increase
D) multiple banks fail
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
15) In a bank panic, the source of contagion is the ________.
A) free-rider problem
B) too-big-to-fail problem
C) transactions cost problem
D) asymmetric information problem
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
16) Factors that lead to worsening conditions in financial system include ________.
A) increases in net worth
B) stock market increases
C) decreases in interest rates
D) stock market declines
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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17) Share prices are a valuation of a corporation's ________.
A) collateral
B) net worth
C) current capital
D) net earnings
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
18) A sharp decline in the stock market means that the ________ of corporations has fallen
making lenders ________ willing to lend.
A) net worth; less
B) net worth; more
C) liability; less
D) liability; more
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
19) A(n) ________ is an increase in prices of assets above their fundamental economic values.
A) decrease in moral hazard
B) asset-price bubble
C) decline in lending
D) liability war
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
20) Most financial crises have started during periods of ________ either after the start of a
recession or a stock market crash.
A) high uncertainty
B) low interest rates
C) low asset prices
D) high financial regulation
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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21) The start of a recession or a stock market crash can result in ________.
A) high financial regulation
B) low interest rates
C) low asset prices
D) high uncertainty
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
22) Banking crises or bank panics have started when ________.
A) there is a reduction of the adverse selection and moral hazard problems
B) there have been periods of low interest rates
C) depositors withdraw their funds from banks
D) when information is made available to investors
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
23) If uncertainty about banks' health causes depositors to begin to withdraw their funds from
banks, the country experiences a(n) ________.
A) banking crisis
B) financial recovery
C) reduction of the adverse selection and moral hazard problems
D) increase in information available to investors
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
24) A sharp stock market decline increases moral hazard incentives ________.
A) since borrowing firms have less to lose if their investments fail
B) because it is immoral to profit from someone's loss
C) since lenders are more willing to make loans
D) reducing uncertainty in the economy and increasing market efficiency
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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25) If debt contracts are of fairly long maturity, then an unanticipated decline in the aggregate
price level results in ________.
A) a decline in a firm's net worth
B) an increase in a firm's net worth
C) a decrease in adverse selection and moral hazard
D) an increase in willingness to lend
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
26) Factors that lead to worsening conditions in financial system include ________.
A) increases in net worth
B) unanticipated increases in the price level
C) decreases in interest rates
D) unanticipated declines in the price level
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
27) An unanticipated decline in the price level increases the burden of debt on borrowing firms
but does not raise the real value of borrowing firms' assets. The result is ________.
A) that net worth in real terms declines
B) that adverse selection and moral hazard problems are reduced
C) an increase in the real net worth of the borrowing firm
D) an increase in lending
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
28) A bank panic can lead to a severe contraction in economic activity due to ________.
A) a decline in international trade
B) the losses of bank shareholders
C) the losses of bank depositors
D) a decline in lending for productive investment
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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29) If the anatomy of a financial crisis is thought of as a sequence of events, which of the
following events would be least likely to be the initiating cause of the financial crisis?
A) Increase in interest rates
B) Bank panic
C) Stock market decline
D) Increase in uncertainty
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
30) If the anatomy of a financial crisis is thought of as a sequence of events, which of the
following events would be least likely to be the initiating cause of the financial crisis?
A) Increase in interest rates
B) Stock market decline
C) Unanticipated decline in price level
D) Increase in uncertainty
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
31) An economic downturn which causes the price level to fall and a deterioration in firms' net
worth because of the increased burden of indebtedness results in ________.
A) asset bubbles
B) rising interest rates
C) debt deflation
D) financial recovery
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
32) Debt deflation occurs when ________.
A) an economic downturn causes the price level to fall and a deterioration in firms' net worth
because of the increased burden of indebtedness
B) rising interest rates worsen adverse selection and moral hazard problems
C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the
value of collateral
D) corporations pay back their loans before the scheduled maturity date
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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33) A substantial decrease in the aggregate price level that reduces firms' net worth may stall a
recovery from a recession. This process is called ________.
A) debt deflation
B) moral hazard
C) insolvency
D) illiquidity
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
34) A possible sequence for the three stages of a financial crisis in Canada might be ________
leads to ________ leads to ________.
A) asset price declines; banking crises; unanticipated decline in price level
B) unanticipated decline in price level; banking crises; increase in interest rates
C) banking crises; increase in interest rates; unanticipated decline in price level
D) banking crises; increase in uncertainty; increase in interest rates
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
35) 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
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
36) The Irish government helped mitigate the financial crisis by ________.
A) guaranteeing all deposits
B) privatizing the banking system
C) increasing short term borrowing
D) refusing to inject more capital into the failing system
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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37) The government bailout of troubled financial institutions occurred in the U.S. and many
other countries. Which country saw their banking system collapse requiring the government to
take over its three largest banks?
A) Iceland
B) England
C) Germany
D) Belgium
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
38) Like a CDO, a structured investment vehicle pays off cash flows from pools of assets,
however, rather than long-term debt the structured investment vehicle backs ________.
A) commercial paper
B) Treasury notes
C) corporate bonds
D) municipal bonds
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
39) How do increases in interest rates play a role in promoting financial crises?
Answer: Students should discuss the increase in adverse selection, the decline in lending, the
decline in investment and aggregate economic activity, and the effects on cash flow.
Diff: 2
Type: ES
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
40) Describe an asset-price bubble.
Answer: An asset-price bubble is a term which describes asset prices (in the stock market or
real estate) that have been driven above their fundamental economic values by investor
psychology.
Diff: 2
Type: ES
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
41) What is debt deflation?
Answer: Debt deflation occurs when a decline in price levels leads to deterioration in firms'
net worth because of the increased burden of indebtedness.
Diff: 2
Type: ES
Skill: Recall
Objective: 9.2 Identify the key features of the three stages of a financial crisis
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42) Typically, the economy recovers fairly quickly from a recession. Why did this not happen
in the United States during the Great Depression?
Answer: The 25 percent decline in the price level from 1930-1933 triggered a debt deflation.
The loss of net worth increased adverse selection and moral hazard problems in the credit
markets and increased and prolonged the economic contraction.
Diff: 2
Type: ES
Skill: Applied
Objective: 9.2 Identify the key features of the three stages of a financial crisis
9.3
The Global Financial Crisis of 2007-2009
1) ________ is a process of bundling together smaller loans (like mortgages) into standard debt
securities.
A) Securitization
B) Origination
C) Debt deflation
D) Distribution
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
2) Financial innovations that emerged after 2000 in the mortgage markets included all of the
following except ________.
A) adjustable-rate mortgages
B) subprime mortgages
C) Alt-A mortgages
D) mortgage-backed securities
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
3) ________ is the development of new, sophisticated financial instruments.
A) Discounting
B) Origination
C) Financial engineering
D) Distribution
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
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4) A ________ pays out cash flows from subprime mortgage-backed securities in different
tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there
were losses on the mortgage-backed securities.
A) collateralized debt obligation (CDO)
B) adjustable-rate mortgage
C) negotiable CD
D) discount bond
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
5) A bank loan to a household or business was not a security because ________.
A) it could not be bought or sold in a financial market
B) it was not a debt instrument
C) there was no market for them
D) they increased the asymmetric information problem
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
6) The originate-to-distribute business model has a serious ________ problem since the
mortgage broker has little incentive to make sure that the mortgagee is a good credit risk.
A) principal-agent
B) debt deflation
C) democratization of credit
D) collateralized debt
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
7) The originate-to-distribute business model is when ________.
A) mortgage originators made sure that the mortgage was a good credit risk
B) mortgage originators distributed the mortgage to an investor as an underlying asset in a
security
C) homeowners could refinance their houses with larger loans when their homes appreciated in
value
D) mortgage originators were the credit rating agencies
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
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8) Mortgage brokers often did not make a strong effort to evaluate whether the borrower could
pay off the loan. This created a ________.
A) severe adverse selection problem
B) decline in mortgage applications
C) call to deregulate the industry
D) decrease in the demand for houses
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
9) The agency problem in the mortgage markets was due to the ________ business model.
A) originate-to-distribute
B) business-as-usual
C) securitization
D) "pass-through"
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
10) Credit default swaps ________.
A) provide payments to holders of bonds if they default
B) decrease asymmetric information in the mortgage markets
C) had strong incentives to make sure CDO holders would be paid off
D) were only a small part of insurance companies portfolios
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
11) The housing boom in the United States was aided by ________.
A) liquidity from China and India
B) higher interest rates
C) tariffs reducing global trade
D) weak balance sheets in the banking industry
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
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12) The "democratization of credit" was attributed to ________.
A) the subprime mortgage market
B) the 2000-2001 recession
C) growth of prime mortgages
D) asset-price gaps
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
13) Credit market problems of adverse selection and moral hazard increased as a result of all of
the following except ________.
A) increase in housing market prices
B) increased uncertainty from the failures of financial institutions
C) deterioration in financial institutions' balance sheets
D) decline in the stock market of over 40 percent from its peak
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
14) The housing price bubble ________.
A) was aided by low interest rates on residential mortgages
B) only occurred in the emerging economies
C) was not a contributing factor to the 2007-2008 recession
D) cannot be explained
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
15) Agency problems in the subprime mortgage market included all of the following except
________.
A) homeowners could refinance their houses with larger loans when their homes appreciated in
value
B) mortgage originators had little incentives to make sure that the mortgage is a good credit
risk
C) underwriters of mortgage-backed securities had weak incentives to make sure that the
holders of the securities would be paid back
D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
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16) Agency problems in the subprime mortgage market included all of the following except
________.
A) homeowners could refinance their houses with larger loans when their homes appreciated in
value
B) mortgage originators had little incentives to make sure that the mortgage is a good credit
risk
C) underwriters of mortgage-backed securities had weak incentives to make sure that the
holders of the securities would be paid back
D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
17) Credit rating agencies were subject to conflicts of interest in the subprime mortgage market
because ________.
A) banks were earning large fees by underwriting the mortgage-backed securities
B) they had little incentives to make sure that the mortgage was a good credit risk
C) they had weak incentives to make sure that the holders of the securities would be paid back
D) they were earning fees from rating the mortgage-backed securities and from advising clients
on how to structure the securities to get the highest ratings
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
18) Increased complexity of structured products can ________.
A) destroy information and improve adverse selection problems
B) increase information and worsen adverse selection problems
C) make asymmetric information better in the financial system
D) make asymmetric information worse in the financial system
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
19) As housing prices rose, many subprime borrowers were able to ________.
A) default on their mortgage
B) reduce their loan-to-value ratio
C) get piggyback mortgages
D) walk away from their houses
Answer: C
Diff: 2
Type: MC
Skill: Applied
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2007-2009
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20) When housing prices began to decline after their peak in 2006, many subprime borrowers
found that their mortgages were "underwater." This meant that ________.
A) the value of the house fell below the amount of the mortgage
B) the basement flooded since they could not afford to fix the leaky plumbing
C) the roof leaked during a rainstorm
D) the amount that they owed on their mortgage was less than the value of their house
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
21) Between October 2007 and March 2009, asset prices in the stock market fell by ________.
A) over 50 percent
B) 10 percent
C) around 16 percent
D) less than 30 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
22) 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
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
23) Fitch and Standard & Poor announced downgrades on ________ of mortgage-backed
securities and CDOs.
A) more than $10 billion
B) more than $100 billion
C) $50 billion
D) more than $10 million
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
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24) U.S. firms affected by the financial crisis included ________.
A) Bear Stearns and Merrill Lynch
B) AIG and JP Morgan
C) Manulife and RBC
D) Capital One and BNP Paribas
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
25) Which investment bank filed for bankruptcy on September 15, 2008 making it the largest
bankruptcy filing in U.S. history?
A) Lehman Brothers
B) Merrill Lynch
C) Bear Stearns
D) Goldman Sachs
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
26) During the 2007-2009 financial crisis in the U.S. the credit spreads peaked at ________ in
December 2008.
A) nearly 6 percent
B) nearly 5 percent
C) nearly 4 percent
D) 3 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
27) By 2012, the debt to GDP ratio for Greece had climbed to ________.
A) 60%
B) 100%
C) 160%
D) 200%
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
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28) What triggered the 2007-2008 financial crises ?
Answer: The crises was triggered by mismanagement of financial innovation in the sub prime
residential mortgage market and the bursting of a bubble in housing prices.
Diff: 1
Type: ES
Skill: Recall
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
2007-2009
29) How can asymmetric information lead to a bank panic?
Answer: Depositors cannot judge the quality of their banks' loan portfolios. So, when they
hear about a failed financial institution, they may worry about the safety of their deposits and
begin to withdraw their funds from their bank. Even healthy institutions can go under if enough
deposits are withdrawn quickly.
Diff: 3
Type: ES
Skill: Recall
Objective: 9.1 Define the term "financial crises"
9.4
Canada and the 2007-2009 Financial Crisis
1) Under the Montreal Accord, investors ________.
A) froze losses to $200 million
B) agreed to a standstill period
C) were bailed out by the Bank of Canada
D) were bailed out by the CDIC
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
2) In Canada, an early symptom of the U.S. subprime mortgage market problem was the
________.
A) financial engineering of the asset-backed commercial paper market
B) freezing of the asset-backed commercial paper market
C) increase of the asset-backed commercial paper market
D) restructuring of the asset-backed commercial paper market
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
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3) During the ABCP saga, The Bank of Canada ________.
A) shut down all non-bank sponsored conduits
B) refused to accept ABCPs as collateral for loans to banks
C) provided liquidity as a lender to the market
D) was bailed out by the CDIC
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
4) "Plain vanilla" assets are ________.
A) unsecured promissory notes
B) residential mortgages
C) subprime mortgages
D) CDOs
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
5) Asset-backed commercial paper is backed by all of the following except ________.
A) unsecured promissory notes
B) mortgages
C) car loans
D) credit card receivables
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
6) The risk of asset-backed commercial paper depends on ________.
A) unsecured promissory notes
B) the underlying securities
C) commercial paper
D) Treasury bills
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
7) What triggered the ABCP saga in Canada?
Answer: The ABCP saga was triggered when investors in the Canadian ABCP market
declined to roll over maturing notes because of concerns about exposure to the U.S. subprime
mortgage sector in the underlying assets.
Diff: 2
Type: ES
Skill: Applied
Objective: 9.3 Describe the causes and consequences of the global financial crisis of
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2007-2009
8) What were some of the changes to the regulations for real estate lending that were
implemented in 2012?
Answer: A reduction in the maximum amortization period to 25 years, a restriction on a home
to 80% of its value and a requirement that housing costs are not more than 39% of gross
household income.
Diff: 2
Type: ES
Skill: Recall
Objective: 9.4 Describe the impact of the 2007-2009 financial crisis on Canada
9.5
Response of Financial Regulation
1) A major shift in the US system of financial regulation in the aftermath to the financial crisis
is ________.
A) an easing of monetary policy
B) a tightening of monetary policy
C) a shift from microprudential supervision to macroprudential supervision
D) a shift from macroprudential supervision to microprudential supervision
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
2) When regulators examine a financial institution's risk incurring activities it is engaging in
________ supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
3) When regulators examine the financial system's risk incurring activities it is engaging in
________ supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
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global financial crisis of 2007-2009
4) The recognition that increased availability of credit leading to higher asset prices and
financial buffers at lending institutions and therefore further expansion of credit availability is
referred to as ________.
A) microprudential supervision
B) macroprudential supervision
C) the leverage cycle
D) a liquidity crisis
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
5) When regulators examine the adequacy of the financial system's liquidity it is engaging in
________ supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
6) When regulators examine a financial institution's capital ratios it is engaging in ________
supervision.
A) microprudential
B) macroprudential
C) both microprudential and macroprudential
D) neither microprudential nor macroprudential
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
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7) The net stable funding ratio is the ratio of ________ and ideally should be relatively
________.
A) the percentage of long-term to total funding; low
B) the percentage of long-term to total funding; high
C) the percentage of short-term to total funding; low
D) the percentage of short-term to total funding; high
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
8) The Dodd-Frank Act of 2010 requires financial institutions to ________.
A) lend to all individuals who need loans
B) require verification of a borrowers job status but not credit history and income
C) require verification of a borrowers income and job status but not their credit history
D) require verification of a borrowers income, credit history and job status
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
9) The Dodd-Frank Act of 2010 ________.
A) prevents the US government from taking over small financial institutions and rescue them
from a potential bankruptcy
B) allows the US government from taking over small financial institutions and rescue them
from a potential bankruptcy
C) prevents the US government from taking over large financial institutions and rescue them
from a potential bankruptcy
D) allows the US government from taking over large financial institutions and rescue them
from a potential bankruptcy
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
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10) The Volcker rule ________.
A) raises the limit on proprietary trading but decreases the allowable holdings of hedge funds
B) raises the limit on proprietary trading and increases the allowable holdings of hedge funds
C) lowers the limit on proprietary trading and decreases the allowable holdings of hedge funds
D) lowers the limit on proprietary trading but increases the allowable holdings of hedge funds
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
11) Describe the rising phase of the leverage cycle.
Answer: A boom in lending, increased asset prices and increasing financial buffers at
financial institutions which lead to further rounds of credit expansion.
Diff: 1
Type: ES
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
12) Describe the declining phase of the leverage cycle.
Answer: A reduction in lending, decreased asset prices and decreasing financial buffers at
financial institutions which lead to further rounds of credit contraction.
Diff: 1
Type: ES
Skill: Recall
Objective: 9.5 Summarize the changes to financial regulation that occured in response to the
global financial crisis of 2007-2009
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9.6
Too-Big-To-Fail and Future Regulation
1) The too-big-to-fail problem is a ________ problem.
A) economic
B) regulatory
C) moral hazard
D) adverse selection
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes
2) Other than breaking systematically important financial institutions, the too-big-to-fail
problem could be mitigated by requiring ________.
A) lower capital requirements
B) making capital requirements procyclical
C) making it easier for the Fed to bail out failing banks
D) revoking the Volker rule
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes
3) To reduce the incentives of financial institution managers to engage in excessive risk taking
regulators might require that bonuses be ________.
A) paid immediately
B) paid after several years
C) paid after several years only if the firm remains in good financial health
D) paid in the form of stock options
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes
4) Explain why the too-big-to-fail problem is a moral hazard problem.
Answer: The student should point out that when financial firms become very large their
managers will come to believe that should they run into financial and liquidity problems, the
government or the central bank will have no choice but to bail them out. This will lead them to
take higher risks to seek higher profits.
Diff: 2
Type: ES
Skill: Applied
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes
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5) Explain the reasoning behind the recommendation that capital requirements be pro-cyclical.
Answer: When the economy is improving the requirement that financial institutions increase
their capital requirements will curtail their risk taking behaviour and when the economy is
slowing, lower capital requirements will encourage them to take more risk and lend to
businesses and individuals.
Diff: 1
Type: ES
Skill: Applied
Objective: 9.6 Identify the gaps in current financial regulation and how those gaps may be
addressed with future regulatory changes
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 10 Economic Analysis of Financial Regulation
10.1
Asymmetric Information and the Government Safety Net
1) When depositors lack of information about the quality of bank assets it can lead to
________.
A) bank panics
B) bank booms
C) sequencing
D) asset transformation
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
2) Deposit insurance covers deposits up to $100,000, but as part of a doctrine called
"too-big-to-fail" the CDIC sometimes ends up covering all deposits to avoid disrupting the
financial system. When the CDIC does this, it uses the ________.
A) "payoff" method
B) "purchase and assumption" method
C) "inequity" method
D) "Basel" method
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
3) The fact that banks operate on a "sequential service constraint" means that ________.
A) all depositors share equally in the bank's funds during a crisis
B) depositors arriving last are just as likely to receive their funds as those arriving first
C) depositors arriving first have the best chance of withdrawing their funds
D) banks randomly select the depositors who will receive all of their funds
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Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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4) Depositors have a strong incentive to show up first to withdraw their funds during a bank
crisis because banks operate on a ________.
A) last-in, first-out constraint
B) sequential service constraint
C) double-coincidence of wants constraint
D) everyone-shares-equally constraint
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
5) Because of asymmetric information, the failure of one bank can lead to runs on other banks.
This is the ________.
A) too-big-to-fail effect
B) moral hazard problem
C) adverse selection problem
D) contagion effect
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
6) The contagion effect refers to the fact that ________.
A) deposit insurance has eliminated the problem of bank failures
B) bank runs involve only sound banks
C) bank runs involve only insolvent banks
D) the failure of one bank can hasten the failure of other banks
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
7) To prevent bank runs and the consequent bank failures, the Canada established the ________
to provide deposit insurance.
A) CDIC
B) OSC
C) Bank of Canada
D) ATM
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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8) Deposit insurance is a guarantee by the CDIC to pay deposits off in full on the first
________ they have deposited in the bank.
A) $60000
B) $200,000
C) $100,000
D) $150,000
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
9) The primary difference between the "payoff" and the "purchase and assumption" methods of
handling failed banks is ________.
A) that the CDIC guarantees all deposits when it uses the "payoff" method
B) that the CDIC guarantees all deposits when it uses the "purchase and assumption" method
C) that the CDIC is more likely to use the "payoff" method when the bank is large and it fears
that depositor losses may spur business bankruptcies and other bank failures
D) that the CDIC is more likely to use the purchase and assumption method for small
institutions because it will be easier to find a purchaser for them compared to large institutions
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
10) Deposit insurance has not worked well in countries with ________.
A) a weak institutional environment
B) strong supervision and regulation
C) a tradition of the rule of law
D) few opportunities for corruption
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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11) When one party to a transaction has incentives to engage in activities detrimental to the
other party, there exists a problem of ________.
A) moral hazard
B) split incentives
C) ex ante shirking
D) pre-contractual opportunism
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
12) Moral hazard is an important concern of insurance arrangements because the existence of
insurance ________.
A) provides increased incentives for risk taking
B) is a hindrance to efficient risk taking
C) causes the private cost of the insured activity to increase
D) creates an adverse selection problem
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
13) When bad drivers line up to purchase collision insurance, automobile insurers are subject to
the ________.
A) moral hazard problem
B) adverse selection problem
C) assigned risk problem
D) ill queue problem
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
14) Deposit insurance is only one type of government safety net. All of the following are types
of government support for troubled financial institutions except ________.
A) forgiving tax debt
B) lending from the central bank
C) lending directly from the government's treasury department
D) nationalizing and guaranteeing that all creditors will be repaid their loans in full
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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15) Although the CDIC was created to prevent bank failures, its existence encourages banks to
________.
A) take too much risk
B) hold too much capital
C) open too many branches
D) buy too much stock
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
16) A system of deposit insurance ________.
A) attracts risk-taking entrepreneurs into the banking industry
B) encourages bank managers to decrease risk
C) increases the incentives of depositors to monitor the riskiness of their bank's asset portfolio
D) increases the likelihood of bank runs
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
17) The government safety net creates ________ problem because risk-loving entrepreneurs
might find banking an attractive industry.
A) an adverse selection
B) a moral hazard
C) a lemons
D) a revenue
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
18) Since depositors, like any lender, only receive fixed payments while the bank keeps any
surplus profits, they face the ________ problem that banks may take on too ________ risk.
A) adverse selection; little
B) adverse selection; much
C) moral hazard; little
D) moral hazard; much
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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19) The existence of deposit insurance can increase the likelihood that depositors will need
deposit protection, as banks with deposit insurance ________.
A) are likely to take on greater risks than they otherwise would
B) are likely to be too conservative, reducing the probability of turning a profit
C) are likely to regard deposits as an unattractive source of funds due to depositors' demands
for safety
D) are placed at a competitive disadvantage in acquiring funds
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
20) When the CDIC takes control of the bank, rather than liquidate it, it believes that the
takeover ________.
A) was a good investment opportunity for the government
B) could be part of a new governmentally owned banking system
C) was too big to fail
D) would become the center of the new central bank system
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
21) If the CDIC decides that a bank is too big to fail, it will use the ________ method,
effectively ensuring that ________ depositors will suffer losses.
A) payoff; large
B) payoff; no
C) purchase and assumption; large
D) purchase and assumption; no
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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22) Acquiring information on a bank's activities in order to determine a bank's risk is difficult
for depositors and is another argument for government ________.
A) regulation
B) ownership
C) recall
D) forbearance
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
23) The result of the too-big-to-fail policy is that ________ banks will take on ________ risks,
making bank failures more likely.
A) small; fewer
B) small; greater
C) big; fewer
D) big; greater
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
24) A problem with the too-big-to-fail policy is that it ________ the incentives for ________
by big banks.
A) increases; moral hazard
B) decreases; moral hazard
C) decreases; adverse selection
D) increases; adverse selection
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
25) The too-big-to-fail policy ________.
A) reduces moral hazard problems
B) puts large banks at a competitive disadvantage in attracting large deposits
C) treats large depositors of small banks inequitably when compared to depositors of large
banks
D) allows small banks to take on more risk than large banks
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
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26) Regulators attempt to reduce the riskiness of banks' asset portfolios by ________.
A) limiting the amount of loans in particular categories or to individual borrowers
B) encouraging banks to hold risky assets such as common stocks
C) establishing a minimum interest rate floor that banks can earn on certain assets
D) requiring collateral for all loans
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
27) The government safety net creates both an adverse selection problem and a moral hazard
problem. Explain.
Answer: The adverse selection problem occurs because risk-loving individuals might view
the banking system as a wonderful opportunity to use other peoples' funds knowing that those
funds are protected. The moral hazard problem comes about because depositors will not impose
discipline on the banks since their funds are protected and the banks knowing this will be
tempted to take on more risk than they would otherwise.
Diff: 2
Type: ES
Skill: Recall
Objective: 10.1 Identify the reasons for and the forms of a government safety net in financial
markets
10.2
Types of Financial Regulation
1) A bank failure is less likely to occur when ________.
A) a bank holds less government securities
B) a bank suffers large deposit outflows
C) a bank holds fewer excess reserves
D) a bank has more bank capital
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
2) The leverage ratio is the ratio of a bank's ________.
A) assets divided by its liabilities
B) income divided by its assets
C) capital divided by its total assets
D) capital divided by its total liabilities
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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3) To be considered well capitalized, a bank's leverage ratio must exceed ________.
A) 10 percent
B) 8 percent
C) 5 percent
D) 3 percent
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
4) Off-balance-sheet activities ________.
A) generate fee income with no increase in risk
B) increase bank risk but do not increase income
C) generate fee income but increase a bank's risk
D) generate fee income and reduce risk
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
5) The Basel Accord, an international agreement, requires banks to hold capital based on
________.
A) risk-weighted assets
B) the total value of assets
C) liabilities
D) deposits
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
6) The Basel Accord requires banks to hold as capital an amount that is at least ________ of
their risk-weighted assets.
A) 10 percent
B) 8 percent
C) 5 percent
D) 3 percent
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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7) Under the Basel Accord, assets and off-balance sheet activities were sorted according to
________ categories with each category assigned a different weight to reflect the amount of
________.
A) 2; adverse selection
B) 2; credit risk
C) 4; adverse selection
D) 4; credit risk
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
8) The practice of keeping high-risk assets on a bank's books while removing low-risk assets
with the same capital requirement is known as ________.
A) competition in laxity
B) depositor supervision
C) regulatory arbitrage
D) a dual banking system
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
9) Agreements such as the ________ are attempts to standardize international banking
regulations.
A) Basel Accord
B) UN Bank Accord
C) GATT Accord
D) WTO Accord
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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10) Banks engage in regulatory arbitrage by ________.
A) keeping high-risk assets on their books while removing low-risk assets with the same capital
requirement
B) keeping low-risk assets on their books while removing high-risk assets with the same capital
requirement
C) hiding risky assets from regulators
D) buying risky assets from arbitragers
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
11) Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital
requirements may result in ________.
A) reduced risk taking by banks
B) reduced supervision of banks by regulators
C) increased fraudulent behavior by banks
D) increased risk taking by banks
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
12) Overseeing who operates banks and how they are operated is called ________.
A) prudential supervision
B) hazard insurance
C) regulatory interference
D) loan loss reserves
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
13) The chartering process is especially designed to deal with the ________ problem, and
regular bank examinations help to reduce the ________ problem.
A) adverse selection; adverse selection
B) adverse selection; moral hazard
C) moral hazard; adverse selection
D) moral hazard; moral hazard
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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14) The chartering process is similar to ________ potential borrowers and the restriction of risk
assets by regulators is similar to ________ in private financial markets.
A) screening; restrictive covenants
B) screening; branching restrictions
C) identifying; branching restrictions
D) identifying; credit rationing
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
15) Banks will be examined at least once a year and given a CAMELS rating by examiners.
The L stands for ________.
A) liabilities
B) liquidity
C) loans
D) leverage
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
16) Bank examiners include ________.
A) the Bank of Canada
B) Canada Revenue Agency
C) the OSC
D) the Department of Finance
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
17) Banks are required to file ________ usually quarterly that list information on the bank's
assets and liabilities, income and dividends, and so forth.
A) call reports
B) balance reports
C) regulatory sheets
D) examiner updates
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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18) Regular bank examinations and restrictions on asset holdings help to indirectly reduce the
________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs
will be discouraged from entering the banking industry.
A) moral hazard
B) adverse selection
C) ex post shirking
D) post-contractual opportunism
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
19) The current supervisory practice toward risk management ________.
A) focuses on the quality of a bank's balance sheet
B) determines whether capital requirements have been met
C) evaluates the soundness of a bank's risk-management process
D) focuses on eliminating all risk
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
20) Regulations designed to provide information to the marketplace so that investors can make
informed decisions are called ________.
A) disclosure requirements
B) efficient market requirements
C) asset restrictions
D) capital requirements
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
21) With ________, firms value assets on their balance sheet at what they would sell for in the
market.
A) mark-to-market accounting
B) book-value accounting
C) historical-cost accounting
D) off-balance sheet accounting
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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22) During times of financial crisis, mark-to-market accounting ________.
A) requires that a financial firms' assets be marked down in value which can worsen the lending
crisis
B) leads to an increase in the financial firms' balance sheets since they can now get assets at
bargain prices
C) leads to an increase in financial firms' lending
D) results in financial firms' assets increasing in value
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
23) Consumer protection legislation includes legislation to ________.
A) require banks to make loans to everyone who applies
B) reduce the amount of interest that bank's can charge on loans
C) require banks to make periodic reports to the Better Business Bureau
D) reduce discrimination in credit markets
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
24) Competition between banks ________.
A) encourages conservative bank management
B) increases bank profitability
C) encourages greater risk taking
D) eliminates the need for government regulation
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
25) An important factor in producing the subprime mortgage crisis was ________.
A) lax consumer protection regulation
B) onerous rules placed on mortgage originators
C) weak incentives for mortgage brokers to use complicated mortgage products
D) strong incentives for the mortgage brokers to verify income information
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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26) Which of the following is not a reason financial regulation and supervision is difficult in
real life?
A) Financial institutions have strong incentives to avoid existing regulations
B) Unintended consequences may happen if details in the regulations are not precise
C) Regulated firms lobby politicians to lean on regulators to ease the rules
D) Financial institutions are not required to follow the rules
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
27) The ________ allowed chartered banks to own investment banking subsidiaries.
A) Bank of Canada Act
B) Financial Institutions and Deposit Insurance System Amendment Act
C) Bank Holding Company Act
D) Monetary Control Act
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
28) Banking regulation suffers from the principal-agent problem. Describe how this problem
relates to regulators and politicians.
Answer: Taxpayers are the principals, and regulators and politicians are the agents.
Regulators want to escape blame for poor performance, so they have incentives to loosen
capital requirements and practice forbearance, the opposite of what they should do. Regulators
must also please politicians, who in turn receive contributions from the banks being regulated.
Thus, politicians may pressure regulators to practice forbearance, and fail to address problems
if resolving problems conflicts with their personal interests.
Diff: 2
Type: ES
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
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29) What is the "too-big-to-fail" policy of the CDIC? how is it associated with asymmetric
information problems?
Answer: Students must explain that because the failure of a very large bank makes it more
likely that a major financial disruption may occur, bank regulators are usually reluctant to allow
a big bank to fail and cause losses to its depositors. Thus, the too-big-to-fail policy increases
the moral hazard incentives of big banks as they know that they can take more risk as the CDIC
will try and save them in case they encounter difficulties, instead of using the alternative payoff
method according to which depositors are paid only up to $100,000 for their deposits in the
event that the bank fails.
Diff: 2
Type: ES
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
30) What are the three pillars that Basel 2 is based on?
Answer: Pillar 1 links capital requirements for large, internationally active banks to three
types of actual risk: market risk, credit risk, and operational risk. Pillar 2 focuses on
strengthening the supervisory process. Pillar 3 focuses on improving market discipline through
increased disclosure.
Diff: 2
Type: ES
Skill: Recall
Objective: 10.2 List and summarize the types of financial regulation and how each reduces
asymmetric information problems
10.3
CDIC Deposit Insurance Coverage
1) The CDIC does not insure ________.
A) savings and chequing accounts
B) term deposits with a maturity of less than 5 years
C) money orders and drafts
D) mutual funds
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
2) The primary rationale for deposit insurance is ________.
A) protecting depositors from bank insolvency
B) increasing creditworthiness of subprime mortgages
C) increasing barriers to entry in the banking industry to promote financial stability
D) altering risk profiles of both banks and depositors
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
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3) The CDIC does not insure term deposits with an initial maturity date of more than ________.
A) 5 years
B) 2 years
C) 1 year
D) 90 days
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
4) In the 1998-1999 fiscal year, the flat rate insurance premium was ________.
A) 1/6 of 1 percent
B) 1/4 of 1 percent
C) 1/3 of 1 percent
D) 1/2 of 1 percent
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
5) The Differential Premiums By-law came into effect for the premium year beginning
________.
A) May 1, 1999
B) January 1, 1999
C) May 31, 1999
D) December 31, 1999
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
6) CDIC premium revenue is ________.
A) the same for all deposit taking institutions
B) vary from 15 cents to 20 cents per dollar
C) based on the risk profile of the member institution
D) capped at 15 cents for "worst" institutions
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
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7) The Differential Premiums By-law classifies CDIC institutions according to their risk
profile. ________ dominate the criteria.
A) Capital adequacy measures
B) Quantitative aspects
C) Qualitative aspects
D) CAMELS rating
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
8) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk
category 1 was ________.
A) 1/36 of 1 percent
B) 1/18 of 1 percent
C) 1/9 of 1 percent
D) 2/9 of 1 percent
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
9) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk
category 2 was ________.
A) 1/36 of 1 percent
B) 1/18 of 1 percent
C) 1/9 of 1 percent
D) 2/9 of 1 percent
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
10) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk
category 3 was ________.
A) 1/36 of 1 percent
B) 1/18 of 1 percent
C) 1/9 of 1 percent
D) 2/9 of 1 percent
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
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11) According to CDIC risk profiles, ________.
A) group 1 is the best and group 4 is the worst
B) group 4 is the best and group 1 is the worst
C) all banks are considered to be similar
D) there is no way to distinguish between them
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
12) The 2011 premium rate (as a percentage of insured deposits) for member institutions in risk
category 4 was ________.
A) 1/36 of 1 percent
B) 1/18 of 1 percent
C) 1/9 of 1 percent
D) 2/9 of 1 percent
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
13) Banking reform possibilities include ________.
A) coinsurance
B) bank mergers
C) reduced capitalization requirements
D) reducing the scope of deposit insurance
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
14) Deposit co-insurance requires that ________.
A) only a percentage of a deposit would be covered by insurance
B) the amount of deposits covered by insurance would be lowered
C) there be joint insurance from both bankers and depositors
D) both the federal and provincial governments provide deposit insurance
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
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15) The MacKay Task Force may recommend that the ________.
A) OFSI and CDIC be amalgamated
B) CDIC be abolished
C) Standards of Sound Business Practices be implemented
D) OFSI and CDIC should be separated
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 10.3 Examine CDIC Developments
16) What are the provisions under the October 15, 1999 Opting-Out By-law?
Answer: According to the By-law, Schedule III banks that accept primarily wholesale
deposits (defined as $150,000 or more) could opt out of CDIC membership and therefore to
operate without deposit insurance. The new legislation however includes provisions to protect
depositors who hold deposits eligible for CDIC protection. These include the requirement for
an opted out bank to inform all depositors by posting notices in its branches that their deposits
will not be protected by the CDIC and not to charge any early withdrawal penalties for
depositors who choose to withdraw.
Diff: 2
Type: ES
Skill: Recall
Objective: 10.3 Examine CDIC Developments
17) Describe how the CDIC premiums have evolved over the past years.
Answer: CDIC premiums were fixed and unrelated to the risk profiles of the various member
institutions. In 1999, the Differential Premiums By-Laws differentiated the premiums of
member institutions according to a variety of both qualitative and quantitative aspects,
dominated by capital adequacy measures.
Diff: 2
Type: ES
Skill: Applied
Objective: 10.3 Examine CDIC Developments
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10.4
Web Appendix 1: The 1980s Canadian Bank Crisis
1) In the mid-1980s, how many chartered banks failed in Canada?
A) Two
B) Three
C) Five
D) Ten
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The 1980s Canadian Banking Crisis
2) One of the reasons for the failure of Canadian Commercial and Northland banks was
________.
A) moral hazard
B) adverse selection
C) the lack of deposit insurance
D) rising oil prices
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The 1980s Canadian Banking Crisis
3) The Bank of Credit and Commerce International (BCCI) operated in ________ countries
prior to its collapse.
A) 70
B) 5
C) 70
D) 50
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The 1980s Canadian Banking Crisis
4) The Basel Committee ruled that regulators in other countries could ________ of a foreign
bank if they feel that it lacks effective oversight.
A) restrict operations
B) ban operations
C) takeover
D) merge operations
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The 1980s Canadian Banking Crisis
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5) The Inspector General of Banks was the predecessor of the ________.
A) Office of the Superintendent of Financial Institutions
B) Office of Regulatory Forbearance
C) Canadian Commercial Regulatory Committee
D) Basel Committee
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The 1980s Canadian Banking Crisis
6) Sometimes regulators refrain from putting insolvent banks out of business. This is also
known as ________.
A) a decrease in deposit insurance
B) a decrease in interest rates to fight the inflation problem
C) regulatory forbearance
D) increased regulation that prohibited banks from making risky loans
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The 1980s Canadian Banking Crisis
7) Bank failures in Canada arose due to historical accident, including ________ and ________.
A) sharp increase in interest rates; severe recession
B) sharp increase in interest rates; a housing boom
C) sharp decrease in interest rates; severe recession
D) sharp decrease in interest rates; a housing bubble
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The 1980s Canadian Banking Crisis
8) How did the increase in the interest rates in the early 1980s contribute to the insolvency of
Canadian Commercial and Northland?
Answer: The banks suffered from an interest-rate risk problem. They had many fixed-rate
mortgages with low interest rates. As interest rates in the economy began to climb, banks began
to lose profitability. In addition, the 1981-1982 recession and a collapse in the prices of energy
and farm products hit the economy of Alberta very hard. Losses mounted and the banks had
negative net worths and were insolvent by 1985.
Diff: 2
Type: ES
Skill: Applied
Objective: Appendix: The 1980s Canadian Banking Crisis
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10.5
Web Appendix 2: Banking Crises Throughout the World
1) The evidence from banking crises in other countries indicates that ________.
A) deposit insurance is to blame in each country
B) a government safety net for depositors need not increase moral hazard
C) regulatory forbearance never leads to problems
D) deregulation combined with poor regulatory supervision raises moral hazard incentives
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
2) The Japanese equivalent of the CDIC played a ________ role in that country's banking
crisis.
A) tiny
B) huge
C) important
D) dominant
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
3) A common element in all of the banking crisis episodes in different countries is ________.
A) the existence of a government safety net
B) deposit insurance
C) increased regulation
D) lack of competition
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
4) In terms of international banking crises, deposit insurance ________.
A) was always a key factor
B) couldn't be implicated as it only exists in Canada
C) played a role in a few countries but wasn't consistently complicit
D) is considered to be the best response to financial instability
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
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5) The cost of rescuing banks ranges from ________ to ________ percent of GDP.
A) 1; 57
B) 1; 11
C) 1; 13
D) 4; 57
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
6) The Depository Institutions Deregulation and Monetary Control Act of 1980 ________.
A) separated investment banks and commercial banks
B) restricted the use of ATS accounts
C) imposed restrictive usury ceilings on large agricultural loans
D) increased deposit insurance from $40000 to $100,000
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
7) One of the problems experienced by the savings and loan industry during the 1980s was
________.
A) managers lack of expertise to manage risk in new lines of business
B) heavy regulations in the new areas open to S&Ls
C) slow growth in lending
D) close monitoring by the FSLIC
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
8) The S&L Crisis can be analyzed as a principal-agent problem. The agents in this case, the
________, did not have the same incentive to minimize cost to the economy as the principals,
the ________.
A) politicians/regulators; taxpayers
B) taxpayers; politician/regulators
C) taxpayers; bank managers
D) bank managers; politicians/regulators
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Banking Crises Throughout the World
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9) In the early stages of the 1980s banking crisis, financial institutions were especially harmed
by ________.
A) declining interest rates from late 1979 until 1981
B) the severe recession in 1981-82
C) the disinflation from mid 1980 to early 1983
D) the increase in energy prices in the early '80s
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
10) When regulators chose to allow insolvent S&Ls to continue to operate rather than to close
them, they were pursuing a policy of ________.
A) regulatory forbearance
B) regulatory kindness
C) ostrich reasoning
D) ignorance reasoning
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
11) The policy of ________ exacerbated ________ problems as savings and loans took on
increasingly huge levels of risk on the slim chance of returning to solvency.
A) regulatory forbearance; moral hazard
B) regulatory forbearance; adverse hazard
C) regulatory agnosticism; moral hazard
D) regulatory agnosticism; adverse hazard
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
12) As in the United States, an important factor in the banking crises in Latin America was the
________.
A) financial liberalization that occurred in the 1980s
B) decline in real interest rates that occurred in the 1980s
C) high inflation that occurred in the 1980s
D) sluggish economic growth that occurred in the 1980s
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Banking Crises Throughout the World
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13) FDICIA ________ incentives for banks to hold capital and ________ incentives to take on
excessive risk.
A) increased; decreased
B) increased; increased
C) decreased; decreased
D) decreased; increased
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
14) 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
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Banking Crises Throughout the World
15) When comparing the banking crisis in the United States to the crises in Latin America, cost
to the taxpayers of the government bailouts was ________.
A) higher in Latin American than in the United States
B) higher in the United States than in Latin America
C) about the same in both Latin America and the United States
D) positive in Latin America but negative in the United States
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
16) The Japanese banking system went through a cycle of ________ in the 1990s similar to the
one that occurred in the U.S. in the 1980s.
A) regulatory forbearance
B) policy antagonism
C) regulatory ignorance
D) policy renewal
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
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17) China is trying to move its banking system from being strictly ________ owned by having
them issue shares overseas.
A) state
B) domestic investor
C) depositor
D) domestic corporate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
18) The evidence from banking crises in other countries indicates that ________.
A) deposit insurance is to blame in each country
B) a government safety net for depositors need not increase moral hazard
C) regulatory forbearance never leads to problems
D) deregulation combined with poor regulatory supervision raises moral hazard incentives
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Banking Crises Throughout the World
19) Banking crises have occurred throughout the world. What similarities do we find when we
look at the different countries?
Answer: Financial deregulation with inadequate supervision can lead to increased moral
hazard as banks take on more risk. Although deposit insurance was not necessarily a major
factor in every country's bank crisis, there was always some kind of government safety net. The
presence of the government safety net also leads to increased risk-taking from the banks.
Diff: 2
Type: ES
Skill: Recall
Objective: Appendix: Banking Crises Throughout the World
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 11 Banking Industry: Structure and Competition
11.1
Historical Development of the Canadian Banking System
1) The modern Canadian banking system began with ________.
A) the Chartered Bank of Upper Canada in 1821
B) the Bank of Montreal in 1817
C) the Bank of Lower Canada in 1801
D) the Bank of New Brunswick in 1820
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
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2) The government institution that has responsibility for the amount of money and credit
supplied in the economy as a whole is the ________.
A) central bank
B) commercial bank
C) bank of settlement
D) monetary fund
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
3) Currency circulated by banks that could be redeemed for gold was called ________.
A) junk bonds
B) banknotes
C) gold bills
D) state money
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
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4) The regulatory system that permitted the organization of a bank by any group that met
certain criteria is known as a ________.
A) bilateral regulatory system
B) tiered regulatory system
C) two-tiered regulatory system
D) free banking system
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
5) The U.S. banking system is considered to be a dual system because ________.
A) banks offer both chequing and savings accounts
B) it actually includes both banks and thrift institutions
C) it is regulated by both state and federal governments
D) it was established before the Civil War, requiring separate regulatory bodies for the North
and South
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
6) Which bank became the government's fiscal agent in 1864?
A) The Bank of Canada
B) The Chartered Bank of Upper Canada
C) The Bank of Montreal
D) The US Treasury
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
7) The Finance Act of 1914 required that ________.
A) local banks be subject to the same regulations as national banks
B) national banks establish branches in large cities
C) the Department of Finance to act as a lender of last resort
D) the Bank of Canada to act as a lender of last resort
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
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8) Explain how the dual banking system arose in the United States.
Answer: The modern US system because with all commercial banks being chartered by the
state in which they operated. However lax banking laws led to bank failures. To eliminate
the abuses that led to the failures, federally charged banks were created under the National
Bank Act of 1863. As a result today, the US has dual banking system in which banks are
supervised by either the state or the federal government.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.1 Recognize the key features of the Canadian banking system and the historical
context of the implementation of these features
11.2
Financial Innovation and the Growth of the "Shadow Banking System"
1) Financial innovations occur because of financial institutions search for ________.
A) profits
B) fame
C) stability
D) recognition
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
2) ________ is the process of researching and developing profitable new products and services
by financial institutions.
A) Financial engineering
B) Financial manipulation
C) Customer manipulation
D) Customer engineering
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
3) The most significant change in the economic environment that changed the demand for
financial products in recent years has been ________.
A) the aging of the baby-boomer generation
B) the dramatic increase in the volatility of interest rates
C) the dramatic increase in competition from foreign banks
D) the deregulation of financial institutions
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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4) In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and
5.5 percent; in the 1980s it fluctuated between ________ percent and ________ percent.
A) 7; 20
B) 4; 11.5
C) 4; 18
D) 5; 10
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
5) Uncertainty about interest-rate movements and returns is called ________.
A) market potential
B) interest-rate irregularities
C) interest-rate risk
D) financial creativity
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
6) Rising interest-rate risk ________.
A) increased the cost of financial innovation
B) increased the demand for financial innovation
C) reduced the cost of financial innovation
D) reduced the demand for financial innovation
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
7) Adjustable rate mortgages ________.
A) protect households against higher mortgage payments when interest rates rise
B) keep financial institutions' earnings high even when interest rates are falling
C) benefit homeowners when interest rates are falling
D) generally have higher initial interest rates than on conventional fixed-rate mortgages
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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8) The agreement to provide a standardized commodity to a buyer on a specific date at a
specific future price is ________.
A) a put option
B) a call option
C) a futures contract
D) a mortgage-backed security
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
9) An instrument developed to help investors and institutions hedge interest-rate risk is
________.
A) a bond
B) a sweep account
C) a financial derivative
D) a mortgage-backed security
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
10) Financial instruments whose payoffs are linked to previously issued securities are called
________.
A) grandfathered bonds
B) financial derivatives
C) hedge securities
D) reversible bonds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
11) Both ________ and ________ were financial innovations that occurred because of interest
rate risk volatility.
A) adjustable-rate mortgages; commercial paper
B) adjustable-rate mortgages; financial derivatives
C) sweep accounts; financial derivatives
D) sweep accounts; commercial paper
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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12) The most important source of the changes in supply conditions that stimulate financial
innovation has been the ________.
A) deregulation of financial institutions
B) dramatic increase in the volatility of interest rates
C) improvement in computer and telecommunications technology
D) dramatic increase in competition from foreign banks
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
13) New computer technology has ________.
A) increased the cost of financial innovation
B) increased the demand for financial innovation
C) reduced the cost of financial innovation
D) reduced the demand for financial innovation
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
14) Credit cards date back to ________.
A) prior to the second World War
B) just after the second World War
C) the early 1950s
D) the late 1950s
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
15) A firm issuing credit cards earns income from ________.
A) loans it makes to credit card holders
B) subsidies from the local governments
C) payments made to it by manufacturers of the products sold in stores on credit card purchases
D) sales of the card in foreign countries
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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16) The entry of GM and Walmart into the credit card business is an indication of ________.
A) government's efforts to deregulate the provision of financial services
B) the rising profitability of credit card operations
C) the reduction in costs of credit card operations since 1990
D) the sale of unprofitable operations by Bank of America and Citicorp
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
17) A debit card differs from a credit card in that ________.
A) a debit card is a loan while for a credit card purchase, payment is made immediately
B) a debit card is a long-term loan while a credit card is a short-term loan
C) a credit card is a loan while for a debit card purchase, payment is made immediately
D) a credit card is a long-term loan while a debit card is a short-term loan
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
18) Automated teller machines ________.
A) are more costly to use than human tellers, so banks discourage their use by charging more
for use of ATMs
B) cost about the same to use as human tellers in banks, so banks discourage their use by
charging more for use of ATMs
C) cost less than human tellers, so banks may encourage their use by charging less for using
ATMs
D) cost nothing to use, so banks provide their services free of charge
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
19) The declining cost of computer technology has made ________ a reality.
A) brick and mortar banking
B) commercial banking
C) virtual banking
D) investment banking
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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20) Bank customers perceive Internet banks as being ________.
A) more secure than physical bank branches
B) a better method for the purchase of long-term savings products
C) better at keeping customer information private
D) prone to many more technical problems
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
21) A disadvantage of virtual banks (clicks) is that ________.
A) their hours are more limited than physical banks
B) they are more secure than physical banks
C) they are more costly to operate than physical banks
D) customers worry about the security of on-line transactions
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
22) So-called fallen angels differ from junk bonds in that ________.
A) junk bonds refer to newly issued bonds with low credit ratings, whereas fallen angels refer
to previously bonds that have had their credit ratings fall below Baa
B) junk bonds refer to previously bonds that have had their credit ratings fall below Baa,
whereas fallen angels refer to newly issued bonds with low credit ratings
C) junk bonds have ratings below Baa, whereas fallen angels have ratings below C
D) fallen angels have ratings below Baa, whereas junk bonds have ratings below C
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
23) Newly-issued high-yield bonds rated below investment grade by the bond-rating agencies
are frequently referred to as ________.
A) municipal bonds
B) Yankee bonds
C) "fallen angels"
D) junk bonds
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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24) In 1977, he pioneered the concept of selling new public issues of junk bonds for companies
that had not yet achieved investment-grade status.
A) Michael Milken
B) Roger Milliken
C) Ivan Boskey
D) Carl Ichan
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
25) One factor contributing to the rapid growth of the commercial paper market since 1970 is
________.
A) the fact that commercial paper has no default risk
B) improved information technology making it easier to screen credit risks
C) government regulation
D) FDIC insurance for commercial paper
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
26) The development of money market mutual funds contributed to the growth of ________
since the money market mutual funds need to hold liquid, high-quality, short-terms assets.
A) the commercial paper market
B) the municipal bond market
C) the corporate bond market
D) the junk bond market
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
27) The process of transforming otherwise illiquid financial assets into marketable capital
market instruments is known as ________.
A) securitization
B) internationalization
C) arbitrage
D) program trading
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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28) ________ is creating a marketable capital market instrument by bundling a portfolio of
mortgage or auto loans.
A) Diversification
B) Arbitrage
C) Computerization
D) Securitization
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
29) The driving force behind the securitization of mortgages and automobile loans has been
________.
A) the rising regulatory constraints on substitute financial instruments
B) the desire of mortgage and auto lenders to exit this field of lending
C) the improvement in computer technology
D) the relaxation of regulatory restrictions on credit card operations
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
30) According to Edward Kane, because the banking industry is one of the most ________
industries in America, it is an industry in which ________ is especially likely to occur.
A) competitive; loophole mining
B) competitive; innovation
C) regulated; loophole mining
D) regulated; innovation
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
31) Loophole mining refers to financial innovation designed to ________.
A) hide transactions from the CRA
B) conceal transactions from the Bank of Canada
C) get around regulations
D) conceal transactions from the Department of Finance
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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32) Prior to 2008, bank managers in the U.S. looked on reserve requirements ________.
A) as a tax on deposits
B) as a subsidy on deposits
C) as a subsidy on loans
D) as a tax on loans
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
33) Prior to 2008, a U.S. bank's cost of holding reserves equaled ________.
A) the interest paid on deposits times the amount of reserves
B) the interest paid on deposits times the amount of deposits
C) the interest earned on loans times the amount of loans
D) the interest earned on loans times the amount on reserves
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
34) Prior to 1980, the Fed set an interest rate ________ that is a maximum limit on the interest
rate that could be paid on time deposits.
A) floor
B) ceiling
C) wall
D) window
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
35) The process in which people take their funds out of the banking system seeking
higher-yielding securities is called ________.
A) capital mobility
B) loophole mining
C) disintermediation
D) deposit jumping
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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36) Money market mutual funds ________.
A) function as interest-earning chequing accounts
B) are legally deposits
C) are subject to reserve requirements
D) have an interest-rate ceiling
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
37) In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in
the situation know as "breaking the buck." This means that ________.
A) they could no longer afford to redeem shares at the par value of $1
B) they required shareholders to contribute a dollar more in fees each month
C) shareholders were able to redeem shares for more than a $1
D) shares earned more than a dollar in interest
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
38) In this type of arrangement, any balances above a certain amount in a corporation's
chequing account at the end of the business day are "removed" and invested in overnight
securities that pay the corporation interest. This innovation is referred to as a ________.
A) sweep account
B) share draft account
C) removed-repo account
D) stockman account
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
39) Sweep accounts which were created to avoid reserve requirements became possible because
of a change in ________.
A) demand conditions
B) supply conditions
C) government rules
D) bank mergers
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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40) Sweep accounts ________.
A) have made reserve requirements nonbinding for many banks
B) sweep funds out of deposit accounts into long-term securities
C) enable banks to avoid paying interest to corporate customers
D) reduce banks' assets
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
41) Financial innovation has caused ________.
A) banks to suffer declines in their cost advantages in acquiring funds, although it has not
caused a decline in income advantages
B) banks to suffer a simultaneous decline of cost and income advantages
C) banks to suffer declines in their income advantages in acquiring funds, although it has not
caused a decline in cost advantages
D) banks to achieve competitive advantages in both costs and income
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
42) Disintermediation resulted from ________.
A) interest rate ceilings combine 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
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
43) The experience of disintermediation in the banking industry illustrates that ________.
A) more regulation of financial markets may avoid such problems in the future
B) banks are unable to remain competitive with other financial intermediaries
C) consumers no longer desire the services that banks provide
D) markets invent alternatives to costly regulations
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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44) One factor contributing to the decline in cost advantages that banks once had is the
________.
A) decline in the importance of chequable deposits as part of a banks' source of funds
B) decline in the importance of savings deposits as part of a banks' source of funds
C) increase in the importance of chequable deposits as part of a banks' source of funds
D) increase in the importance of savings deposits as part of a banks' source of funds
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
45) Banks have attempted to maintain adequate profit levels by ________.
A) making fewer riskier loans, such as commercial real estate loans
B) pursuing new off-balance-sheet activities
C) increasing reserve deposits at the Bank of Canada
D) decreasing capital accounts
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
46) The decline in traditional banking internationally can be attributed to ________.
A) increased regulation
B) improved information technology
C) increasing monopoly power of banks over depositors
D) increased protection from competition
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
47) Why did the interest rate volatility of the 1970s spur financial innovation?
Answer: Banks were very vulnerable to interest-rate risk in the mortgage loans. To protect
themselves, banks began to issue adjustable-rate mortgages whose interest rate will increase
along with market interest rates. Additionally financial derivatives were developed to help
hedge against interest-rate risk.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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48) What are the adjustable-rate mortgages?
Answer: Adjustable-rate mortgages are mortgage loans on which the interest rate changes
when a market interest rate (usually the treasury bill rate) changes.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
49) What important changes in banking have occurred as the result of low cost information
technology? Discuss four examples of these changes.
Answer: Information technology lowers the cost of procession financial transactions making
it profitable to create new financial services, and it makes it easier for firms to issue new
securities.
Examples include credit and debit cards, electronic banking, junk bonds, growth of the
commercial paper market, and securitization.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
50) Explain why the profitability of traditional banking has declined and how banks have
responded.
Answer: Banks have lost cost advantages because of disintermediation that resulted in
innovations such as money market funds which competed for deposits, and reduced banks'
deposit base. Banks responded with interest-paying chequing deposits that increased bank
costs.
The development markets for junk bond, commercial paper, and securitized assets eroded
banks' income advantages.
Banks have responded by making riskier loans (commercial mortgages and funding for
takeovers and buyouts) and have moved into more off-balance-sheet activities.
Diff: 3
Type: ES
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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51) What bonds are commonly called "junk bonds"? Why innovations in computer technology
helped the "junk bonds" market?
Answer: Junk bonds are the bonds whose credit rating is below BBB. Before the advent of
computers and advanced telecommunications, it was difficult to acquire information about the
financial situation of firms that might want to sell securities. Because of the difficulty in
screening out bad from good credit risks, the only firms that were able to sell bonds were very
well-established corporations that had high credit ratings. Before the 1980s, then, only
corporations that could issue bonds with ratings of BBB or above could raise funds by selling
newly issued bonds. With the improvement in information technology in the 1970s, it became
easier for investors to acquire financial information making it easier to screen out bad from
good risks.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
52) How banks suffered a decline in income advantages on uses of funds (assets) due to
financial innovation?
Answer:
a. The commercial paper market: information technology improvements have made it easier for
corporations to issues securities directly to the public. Business customers find it now cheaper
to go to the commercial paper market instead of going to banks to finance short-term credit
needs. Thus, before 1970 nonfinancial commercial paper equalled 5 percent of commercial
bank loans, whereas the figure has risen to 20 percent today.
b. The rise of the junk bond market has also eaten into banks' loan business. Improvements in
information technology have made it easier for corporations to sell their bonds directly to the
public, thereby bypassing banks.
c. Improvement s to computer technology have also led to securitization. Computers enable
other financial institutions to originate loans because they can now accurately evaluate credit
risk with statistical methods, while computers have lowered transaction costs, making it
possible to bundle these loans and sell them as securities. When default risk can easily be
evaluated with computers, banks no longer have an advantage in making loans.
Diff: 3
Type: ES
Skill: Recall
Objective: 11.2 Examine how financial innovation led to the growth of the shadow banking
system
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11.3
Structure of the Canadian Commercial Banking Industry
1) The six largest chartered banks in Canada together hold ________ of the assets in the
industry.
A) over 90 percent
B) nearly 75 percent
C) just over 50 percent
D) 25 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.3 Identify the key structural changes in the chartered banking industry
2) Which of the following are true statements?
A) Schedule I banks have more powers than Schedule II banks.
B) Widely held foreign banks can own 50 percent of a Canadian bank subsidiary.
C) A Schedule II bank may have a significant shareholder (more than 10 percent) for up to 10
years after chartering.
D) A Schedule III bank is a foreign bank is not allowed to branch directly into Canada.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.3 Identify the key structural changes in the chartered banking industry
3) Which of the following are true statements?
A) Schedule I and Schedule II banks have different powers.
B) Widely held foreign banks can own 50 percent of a Canadian bank subsidiary.
C) Any widely held and regulated Canadian financial institution, other than a bank, may own
100 percent of a bank.
D) Schedule I banks have the same powers than Schedule II banks.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.3 Identify the key structural changes in the chartered banking industry
4) Which of the following are true statements?
A) Schedule I banks have more powers than Schedule II banks.
B) A Schedule II bank may enter the Canadian banking industry only as a Schedule II bank.
C) A Schedule II bank may have a significant shareholder (more than 10 percent) for up to 10
years after chartering.
D) A foreign bank may enter the Canadian banking industry only as a Schedule III bank.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.3 Identify the key structural changes in the chartered banking industry
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5) The difference between a Schedule II and a Schedule III bank is that ________.
A) a Schedule II bank is a Canadian subsidiary of a foreign bank
B) a Schedule III bank is a foreign bank is not allowed to branch directly into Canada
C) a foreign bank may enter the Canadian banking industry only as a Schedule III bank
D) widely held foreign banks can own 50 percent of a Canadian bank subsidiary
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.3 Identify the key structural changes in the chartered banking industry
11.4
Comparison with the United States
1) The presence of so many commercial banks in the United States is most likely the result of
________.
A) consumers' strong desire for dealing with only local banks
B) adverse selection and moral hazard problems that give local banks a competitive advantage
over larger banks
C) prior regulations that restrict the ability of these financial institutions to open branches
D) consumers' preference for state banks
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
2) The large number of banks in the United States is an indication of ________.
A) vigorous competition within the banking industry
B) lack of competition within the banking industry
C) regulations that restrict branch operations
D) consumer preference for local banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
3) Lack of competition in the United States banking industry can be attributed to ________.
A) the fact that competition does not benefit consumers
B) the fact that branching has eliminated competition
C) recent legislation restricting competition
D) past regulations that the ability of banks to open branches
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
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4) Which of the following is a true statement concerning bank holding companies?
A) Bank holding companies own few large banks.
B) Bank holding companies are an important advantage to circumvent restrictive branching
regulations.
C) The McFadden Act has prevented bank holding companies from establishing branch banks.
D) Bank holding companies can own only banks.
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
5) A financial innovation that developed as a result of banks avoidance of bank branching
restrictions was ________.
A) money market mutual funds
B) commercial paper
C) junk bonds
D) bank holding companies
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
6) ATMs were developed because of breakthroughs in technology and as a ________.
A) means of avoiding restrictive branching regulations
B) means of avoiding paying interest to corporate customers
C) way of concealing transactions from the SEC
D) increasing the competition from foreign banks
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
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7) Describe the financial innovations that were stimulated as a response to branching
restrictions in the U.S.?
Answer: Bank holding companies: a bank holding company is a corporation that owns several
different companies. This form of corporate ownership has important advantages for banks. It
has allowed them to circumvent restrictive branching regulations, because the holding company
can own a controlling interest in several banks even if branching is not permitted. Also, these
corporations can engage in other activities related to banking such as the provision of
investment advice, data processing and transmission services, leasing, credit card services, and
servicing of loans in other states.
Automated teller machines: Banks realized that if they did not own or rent the ATM, but
instead let it be owned by someone else and paid for each transaction with a fee, the ATM
would probably not be considered a branch of the bank and thus would not be subject to
branching regulations.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.4 Summarize the factors that led to the consolidation in the chartered banking
industry
11.5
Competition Across All Four Pillars
1) The separation of the banking and other financial services industries was known as
________.
A) convergence
B) consolidation
C) the four-pillar approach
D) underwriting
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
2) The four-pillars were identified as ________.
A) banking, brokerage, trusts, and mutual funds
B) banking, brokerage, credit unions, and mutual funds
C) banking, brokerage, credit unions, and insurance
D) banking, brokerage, trusts, and insurance
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
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3) The Glass-Steagall Act, before its repeal in 1999, prohibited commercial banks from
________.
A) issuing equity to finance bank expansion
B) engaging in underwriting and dealing of corporate securities
C) selling new issues of government securities
D) purchasing any debt securities
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
4) The primary reason for the recent reduction in the number of financial institutions is
________.
A) financial failures
B) re-regulation of banking
C) restrictions on branching
D) financial consolidation
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
5) The ability to use one resource to provide different products and services is ________.
A) economies of scale
B) economies of scope
C) diversification
D) vertical integration
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
6) The business term for economies of scope is ________.
A) economies of scale
B) diversification
C) cooperation
D) synergies
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
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7) Experts predict that the future structure of the banking industry will have ________.
A) an increased number of banks
B) as few as ten banks
C) large, complex banking organizations
D) many, small banking organizations
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
8) Bank consolidation will likely result in ________.
A) less competition
B) the elimination of credit unions
C) large, complex banking organizations
D) a shift in assets from larger banks to smaller banks
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
9) Banking consolidation in Canada will result in ________.
A) an increased number of small banks
B) an increase in bank size
C) a reduction in bank size
D) elimination of small banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
10) As the banking system in Canada evolves, it is expected that ________.
A) the number and importance of small banks will increase
B) the number and importance of large banks will decrease
C) small banks will grow at the expense of large banks
D) the number and importance of large banks will increase
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
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11) Bank consolidation will likely result in ________.
A) less competition
B) the elimination of credit unions
C) more competition
D) a shift in assets from larger banks to smaller banks
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
12) In a ________ banking system, commercial banks engage in securities underwriting, but
legal subsidiaries conduct the different activities. Also, banking and insurance are not typically
undertaken together in this system.
A) universal
B) British-style universal
C) short-fence
D) compartmentalized
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
13) In a ________ banking system, commercial banks engage in securities underwriting.
A) British-style universal
B) German-style universal
C) Japanese-style universal
D) South American-style universal
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
14) In a ________ banking system, commercial banks provide a full range of banking,
securities, and insurance services, all within a single legal entity.
A) universal
B) severable
C) barrier-free
D) dividerless
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
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15) In a ________ banking system, commercial banks are allowed to hold equity stakes in
commercial firms.
A) British
B) German
C) Japanese
D) North American
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
16) A major difference between the British-style and Japanese banking systems is that
________.
A) British-style banks are allowed to hold substantial equity stakes in commercial firms,
whereas Japanese banks cannot
B) Japanese banks are allowed to hold substantial equity stakes in commercial firms, whereas
British-style banks cannot
C) bank holding companies are illegal in British-style banks
D) Japanese banks are usually organized as bank holding companies
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
17) What is the international experience on the separation of banking and other financial
services industries throughout the world? What are the main frameworks ?
Answer: Canada and the U.S.: Not many other countries after the Great Depression followed
them in separating the banking and other financial services industries. This separation was the
most prominent difference between banking regulation in Canada and the U.S. versus the rest
of the world.
The frameworks
British: This framework is found also in the U.K., Australia, Canada and now the U.S. In this
framework banks engage in in securities underwriting but it differs from the German in three
ways: separate legal entities are common, bank equity holdings and combinations of banking
and insurance firms are less common.
Japanese: The main difference between the Japanese and British frameworks is that Japanese
banks are allowed to hold substantial equity stakes in commercial firms.
Diff: 3
Type: ES
Skill: Recall
Objective: 11.5 Assess the reasons for separating banking from other financial services through
legislation
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11.6
The Near Banks: Regulation and Structure
1) Near banks are defined as ________.
A) banks, brokers, and credit unions and caisses populaires
B) banks and trust and mortgage loan companies
C) trust and mortgage loan companies, and credit unions and caisses populaires
D) trust and mortgage loan companies, and brokers
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.6 Summarize the distinctions between chartered banks and near banks (trust and
loan companies and credit union and caisses populaires
2) Trust and mortgage loan companies are usually ________.
A) operating under a charter issued by either the federal government or one of the provincial
governments
B) investors in commercial loans
C) more profitable than chartered banks and credit unions and caisses populaires
D) regulated and supervised by the TML
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.6 Summarize the distinctions between chartered banks and near banks (trust and
loan companies and credit union and caisses populaires
3) An essential characteristic of credit unions is that ________.
A) they are typically large
B) branching is prohibited
C) their lending is primarily for mortgage loans
D) they are organized for individuals with a common bond
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.6 Summarize the distinctions between chartered banks and near banks (trust and
loan companies and credit union and caisses populaires
4) Credit unions are usually ________.
A) more profitable than Schedule I banks
B) regulated by the OSFI
C) regulated by a central bank
D) investors in mortgage loans
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 11.6 Summarize the distinctions between chartered banks and near banks (trust and
loan companies and credit union and caisses populaires
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5) Describe the characteristics of cooperative banks: credit unions and caisses populaires.
Answer:
- They are small lending institutions.
- They are organized by a particular group of individuals with a common bond.
- Stress the provision of credit to the "little man."
- There are two cooperative financial systems in Canada: the caisses populaires in Quebec and
the credit unions in the rest of the country.
- They carry retail financial services.
- Typically they are quite small.
- They are non-profit-seeking financial institutions.
- They accept deposits and lend money only to members.
- Members have voting rights.
- Not directly covered by CDIC but indirectly through provincial stabilization funds.
Diff: 2
Type: ES
Skill: Recall
Objective: 11.6 Summarize the distinctions between chartered banks and near banks (trust and
loan companies and credit union and caisses populaires
11.7
International Banking
1) The spectacular growth in international banking can be explained by ________.
A) the rapid growth in international trade
B) the 1988 Basel Agreement
C) the desire for U.S. banks to escape burdensome domestic regulations
D) the creation of the World Trade Organization
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
2) What country is given credit for the birth of the Eurodollar market?
A) The United States
B) England
C) The Soviet Union
D) Japan
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
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3) Deposits in European banks denominated in dollars for the purpose of international
transactions are known as ________.
A) Eurodollars
B) European Currency Units
C) European Monetary Units
D) International Monetary Units
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
4) The main center of the Eurodollar market is ________.
A) London
B) Basel
C) Paris
D) New York
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
5) Eurodollars are ________.
A) dollar-dominated deposits held in banks outside the United States
B) deposits held by U.S. banks in Europe
C) deposits held by U.S. banks in foreign countries
D) dollar-dominated deposits held in U.S. banks by Europeans
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
6) Reasons for holding Eurodollars include ________.
A) the fact that Eurodollar deposits are insured by the FDIC
B) the fact that dollars are widely used to conduct international transactions
C) the fact that minimum transaction sizes are very low, making Eurodollars an attractive
savings instrument for consumers
D) the fact that Eurodollar deposits are heavily regulated
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
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7) During the 1970s and early 1980s, most of the sovereign lending was ________ leading to
________ consequences.
A) unregulated; near disastrous
B) regulated; near disastrous
C) illegal; serious legal
D) regulated; serious legal
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
8) Canadian banks have most of their foreign branches in ________.
A) the U.S., Mexico, South America, Europe, and Asia
B) Latin America, the Middle East, Mexico, and Europe
C) Mexico, the Middle East, the Caribbean, and London
D) South America, the Middle East, and the Caribbean
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
9) Foreign banks may enter the Canadian financial services industry ________ as a ________
bank(s).
A) either; schedule II or III
B) either; schedule I or II
C) only as; schedule II
D) only; schedule III
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
10) Describe how was the Eurocurrencies market created.
Answer: The most important of the Eurocurrencies are Eurodollars and this market was
fathered—ironically—by the Soviet Union. In the early 1950s during the height of the Cold
War the Soviets fearing that the U.S. would freeze its substantial dollar balances held by banks
in the United States, they moved the deposits to Europe so that they would be safe from
expropriatation. They also wanted to keep the deposits in dollars so that they could be used in
their international transactions. When they moved their dollars in Europe the Eurodollar was
born.
Diff: 2
Type: ES
Skill: Applied
Objective: 11.7 Identify the reasons for Canadian banks to operate in foreign countries and for
foreign banks to operate in Canada
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11.8
The 2001 Bank Act Reform
1) The Bank Act Reform took effect in ________.
A) October 2001
B) January 2001
C) December 2001
D) May 2001
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
2) Prior to the Bank Act Reform, the organizational structure of Canada's bank financial groups
was the ________ model.
A) bank-as-parent
B) financial liberalization
C) securitization
D) British universal
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
3) One advantage of the holding company form of corporate ownership is that ________.
A) it allows them to engage in other activities related to banking
B) there is more regulation
C) it demands less flexibility to achieve economies of scale
D) it prevents strategic partnerships
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
4) Holding companies are viable options for financial groups if the transition to a holding
company would be ________ and exhibit ________.
A) tax-neutral; decreased costs
B) tax-neutral; economies of scope
C) tax-free; decreased costs
D) tax-free; fewer joint ventures
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
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5) The 2001 Bank Act Reform legislation provides ________.
A) greater flexibility for bank involvement in the IT area
B) a list of restricted activities
C) details on why banks cannot expand their use of information technology
D) less ability for banks to join strategic alliances and joint ventures
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
6) The 2001 Bank Reform Act states that ________.
A) medium sized banks can be closely held if there is a 35 percent public float
B) large banks with shareholders equity greater than $5 billion can be closely held
C) all banks, regardless of size and capitalization, can be closely held
D) small banks must be widely held
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
7) Merger review policy within the 2001 Bank Act Reform acknowledges that ________.
A) mergers are legitimate business options
B) mergers are anti-competitive and reduce financial stability
C) mergers are only allowable within small, widely held, banks
D) mergers are only allowable if the public believes they are warranted
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
8) Describe some of the major implications of the 2001 Bank Act Reform.
Answer: A bank holding company structure, new ownership rules, expanded permitted
investments, expanded access to the payments and clearance system and a transparent merger
review policy will allow opportunities for strategic alliances and joint ventures. These
developments will create a more dynamic market for financial services leading to the
possibility of greater economic growth.
Diff: 1
Type: ES
Skill: Recall
Objective: 11.8 Understanding the 2001 Bank Act Reform
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 12 Banking and the Management of Financial Institutions
12.1
The Bank Balance Sheet
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1) Which of the following statements are true?
A) A bank's assets are its sources of funds.
B) A bank's liabilities are its uses of funds.
C) A bank's balance sheet shows that total assets equal total liabilities plus capital.
D) A bank's balance sheet indicates whether or not the bank is profitable.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
2) Which of the following statements is false?
A) A bank's assets are its uses of funds.
B) A bank issues liabilities to acquire funds.
C) The bank's assets provide the bank with income.
D) Bank capital is recorded as an asset on the bank balance sheet.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
3) Which of the following are reported as liabilities on a bank's balance sheet?
A) Reserves
B) Demand and notice deposits
C) Loans
D) Deposits with other banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
4) Which of the following are reported as liabilities on a bank's balance sheet?
A) Advances
B) Reserves
C) Securities
D) Loans
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
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5) The share of chequable deposits in total bank liabilities has ________.
A) expanded moderately over time
B) expanded dramatically over time
C) shrunk over time
D) remained virtually unchanged since 1960
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
6) Which of the following statements is false?
A) Chequable deposits are usually the lowest cost source of bank funds.
B) Demand deposits are the primary source of bank funds.
C) Chequable deposits are payable on demand.
D) Chequable deposits include notice deposits.
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
7) Which of the following statements is true?
A) Chequable deposits are payable on demand.
B) Chequable deposits do not include notice deposits.
C) Chequable deposits are the primary source of bank funds.
D) Chequable deposits are chequable deposits that pay interest.
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 12.1 Summarize the features of a bank balance sheet
8) Large-denomination CDs are ________, so that like a bond they can be resold in a ________
market before they mature.
A) nonnegotiable; secondary
B) nonnegotiable; primary
C) negotiable; secondary
D) negotiable; primary
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
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9) Because ________ are less liquid for the depositor than ________, they earn higher interest
rates.
A) savings account; time deposits
B) money market deposit accounts; time deposits
C) money market deposit accounts; savings account
D) time deposits; savings account
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
10) Bank loans from the Bank of Canada are called ________ and represent a ________ of
funds.
A) advances; use
B) advances; source
C) overnight funds; use
D) overnight funds; source
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
11) Which of the following is not a source of borrowings for a bank?
A) Overnight funds
B) Eurodollars
C) Time deposits
D) Advances
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
12) Bank capital is equal to ________ minus ________.
A) total assets; total liabilities
B) total liabilities; total assets
C) total assets; total reserves
D) total liabilities; total borrowings
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
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13) Bank capital is listed on the ________ side of the bank's balance sheet because it represents
a ________ of funds.
A) liability; use
B) liability; source
C) asset; use
D) asset; source
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
14) Bank reserves include ________.
A) deposits at the Bank of Canada and short-term securities
B) vault cash and short-term securities
C) vault cash and deposits at the Bank of Canada
D) deposits at other banks and deposits at the Bank of Canada
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
15) The fraction of chequable deposits that banks choose to hold are ________.
A) excess reserves
B) desired reserves
C) vault cash
D) total reserves
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
16) Which of the following are reported as assets on a bank's balance sheet?
A) Borrowings
B) Reserves
C) Notice deposits
D) Bank capital
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
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17) Which of the following are not reported as assets on a bank's balance sheet?
A) Cash items in the process of collection
B) Loans
C) Securities
D) Demand deposits
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
18) Through correspondent banking, large banks provide services to small banks, including
________.
A) loan guarantees
B) foreign exchange transactions
C) issuing stock
D) debt reduction
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
19) Which of the following bank assets is the most liquid?
A) Consumer loans
B) Reserves
C) Cash items in process of collection
D) Government securities
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
20) Because of their ________ liquidity, ________ government securities are called secondary
reserves.
A) low; short-term
B) low; long-term
C) high; short-term
D) high; long-term
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
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21) 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 percent of these assets count toward meeting desired reserves
D) they rank second to bank vault cash in importance of bank holdings
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
22) Bank's make their profits primarily by issuing ________.
A) equity
B) negotiable CDs
C) loans
D) notice deposits
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
23) The most important category of assets on a bank's balance sheet is ________.
A) advances
B) securities
C) loans
D) cash items in the process of collection
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
24) Which of the following are bank assets?
A) The building owned by the bank
B) A discount loan
C) A negotiable CD
D) A customer's chequing account
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
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25) What are the main items in a bank's asset side of the balance sheet? Discuss them briefly.
Answer: The students must answer that the main items in a bank's asset side of the balance
sheet are:
- Cash reserves: vault cash, settlement balances
- Deposits at other banks: interbank deposits
- Cash items in process of collection: items in transit or bank float
- Securities: government of Canada, provincial and municipal, and other securities
- Loans: commercial, industrial, real estate
- Fixed and other assets: physical capital, etc.
Diff: 2
Type: ES
Skill: Recall
Objective: 12.1 Summarize the features of a bank balance sheet
12.2
Basic Banking
1) Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and
return, and using the proceeds to buy ________ with a different set of characteristics.
A) loans; deposits
B) securities; deposits
C) liabilities; assets
D) assets; liabilities
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
2) In general, banks make profits by selling ________ liabilities and buying ________ assets.
A) long-term; shorter-term
B) short-term; longer-term
C) illiquid; liquid
D) risky; risk-free
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
3) Asset transformation can be described as ________.
A) borrowing long and lending short
B) borrowing short and lending long
C) borrowing and lending only for the short term
D) borrowing and lending for the long term
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
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4) A T-account represents ________.
A) a simplified balance sheet
B) asset transformation
C) T-bills
D) term deposits
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
5) When a new depositor opens a chequing account at the First National Bank, the bank's assets
________ and its liabilities ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
6) When Jane Brown writes a $100 cheque to her nephew (who lives in another province), Ms.
Brown's bank ________ assets of $100 and ________ liabilities of $100.
A) gains; gains
B) gains; loses
C) loses; gains
D) loses; loses
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
7) When you deposit a $50 bill in the New National Bank, ________.
A) its liabilities decrease by $50
B) its assets increase by $50
C) its reserves decrease by $50
D) its cash items in the process of collection increase by $50
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
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8) When you deposit $50 in currency at Old National Bank, ________.
A) its assets increase by less than $50 because of reserve requirements
B) its reserves increase by less than $50 because of reserve requirements
C) its liabilities increase by $50
D) its liabilities decrease by $50
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
9) Holding all else constant, when a bank receives the funds for a deposited cheque, ________.
A) cash items in the process of collection fall by the amount of the cheque
B) bank assets increase by the amount of the cheque
C) bank liabilities decrease by the amount of the cheque
D) bank reserves increase by the amount of desired reserves
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
10) When a $10 cheque written on the First National Bank is deposited in an account at CIBC,
then ________.
A) the liabilities of the First National Bank increase by $10
B) the reserves of the First National Bank increase by $ 10
C) the liabilities of CIBC increase by $10
D) the assets of CIBC fall by $10
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
11) When a $10 cheque written on the First National Bank is deposited in an account at CIBC,
then ________.
A) the reserves of the First National Bank decrease by $10
B) the reserves of the First National Bank increase by $10
C) the reserves of CIBC decrease by $10
D) the assets of CIBC decrease by $10
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
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12) When you deposit $50 in your account at First National Bank and a $100 cheque you have
written on this account is cashed at Chemical Bank, then ________.
A) the assets of First National rise by $50
B) the assets of Chemical Bank rise by $50
C) the reserves at First National fall by $50
D) the liabilities at Chemical Bank rise by $50
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
13) When $1 million is deposited at a bank, the desired reserve ratio is 20 percent, and the bank
chooses not to hold any excess reserves but makes loans instead, then, in the bank's final
balance sheet, ________.
A) the assets at the bank increase by $800,000
B) the liabilities of the bank increase by $1,000,000
C) the liabilities of the bank increase by $800,000
D) reserves increase by $160,000
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
14) When $1 million is deposited at a bank, the desired reserve ratio is 20 percent, and the bank
chooses not to make any loans but to hold excess reserves instead, then, in the bank's final
balance sheet, ________.
A) the assets at the bank increase by $1 million
B) the liabilities of the bank decrease by $1 million
C) reserves increase by $200,000
D) liabilities increase by $200,000
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
15) With a 10 percent reserve requirement ratio, a $100 deposit into New Bank means that the
maximum amount New Bank could lend is ________.
A) $90
B) $100
C) $10
D) $110
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
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16) Using T-accounts show what happens to reserves at New National Bank if one individual
deposits $1000 in cash into her chequing account and another individual withdraws $750 in
cash from her chequing account.
Answer: New National Bank
Assets
Liabilities
Reserves + $250 Demand deposits + $250
Diff: 1
Type: ES
Skill: Applied
Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account
12.3
General Principles of Bank Management
1) Which of the following are primary concerns of the bank manager?
A) Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows
B) Extending loans to borrowers who will pay low interest rates, but who are poor credit risks
C) Acquiring funds at a relatively high cost, so that profitable lending opportunities can be
realized
D) Maintaining high levels of capital and thus maximizing the returns to the owners
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
2) If a bank has $100,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds
$40000 in reserves, then the maximum deposit outflow it can sustain without altering its
balance sheet is ________.
A) $30000
B) $25000
C) $20000
D) $10000
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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3) If a bank has $200,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds
$80000 in reserves, then the maximum deposit outflow it can sustain without altering its
balance sheet is ________.
A) $50000
B) $40000
C) $30000
D) $25000
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
4) If a bank has $10 million of demand deposits, a desired reserve ratio of 10 percent, and it
holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow
of ________.
A) $1.2 million
B) $1.1 million
C) $1 million
D) $900,000
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
5) If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will
result in equal reductions in ________.
A) deposits and reserves
B) deposits and loans
C) capital and reserves
D) capital and loans
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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6) A $5 million deposit outflow from a bank has the immediate effect of ________.
A) reducing deposits and reserves by $5 million
B) reducing deposits and loans by $5 million
C) reducing deposits and securities by $5 million
D) reducing deposits and capital by $5 million
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
7) Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves,
borrowings from the Bank of Canada, and borrowings from other banks to deal with deposit
outflows is an example of ________.
A) liability management
B) liquidity management
C) managing interest rate risk
D) managing credit risk
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
8) If, after a deposit outflow, a bank needs an additional $3 million to meet its desired reserves,
the bank can ________.
A) reduce deposits by $3 million
B) increase loans by $3 million
C) sell $3 million of securities
D) repay its advances from the Bank of Canada
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
9) A bank with insufficient reserves can increase its reserves by ________.
A) lending overnight funds
B) calling in loans
C) buying short-term securities
D) buying provincial bonds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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10) Of the following, which would be the first choice for a bank facing a reserve deficiency?
A) Call in loans
B) Borrow from the Bank of Canada
C) Sell securities
D) Borrow from other banks
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
11) In general, banks would prefer to acquire funds quickly by ________ rather than ________.
A) reducing loans; selling securities
B) reducing loans; borrowing from the Bank of Canada
C) borrowing from the Bank of Canada; reducing loans
D) "calling in" loans; selling securities
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
12) ________ may antagonize customers and thus can be a very costly way of acquiring funds
to meet an unexpected deposit outflow.
A) Selling securities
B) Selling loans
C) Calling in loans
D) Selling negotiable CDs
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
13) Banks hold excess and secondary reserves to ________.
A) reduce the interest-rate risk problem
B) provide for deposit outflows
C) satisfy margin requirements
D) achieve higher earnings than they can with loans
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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14) Which of the following statements most accurately describes the task of bank asset
management?
A) Banks seek the highest returns possible subject to minimizing risk and making adequate
provisions for liquidity.
B) Banks seek to have the highest liquidity possible subject to earning a positive rate of return
on their operations.
C) Banks seek to prevent bank failure at all cost; since a failed bank earns no profit, liquidity
needs supersede the desire for profits.
D) Banks seek to acquire funds in the least costly way.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
15) The goals of bank asset management include ________.
A) maximizing risk
B) minimizing liquidity
C) lending at high interest rates regardless of risk
D) purchasing securities with high returns and low risk
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
16) Banks that suffered significant losses in the 1980s made the mistake of ________.
A) holding too many liquid assets
B) minimizing default risk
C) failing to diversify their loan portfolio
D) holding only safe securities
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
17) A bank will want to hold more excess reserves (everything else equal) when ________.
A) it expects to have deposit inflows in the near future
B) brokerage commissions on selling bonds increase
C) the cost of selling loans falls
D) the discount rate decreases
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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18) As the costs associated with deposit outflows ________, the banks willingness to hold
excess reserves will ________.
A) decrease; increase
B) increase; decrease
C) increase; increase
D) decrease; not be affected
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
19) Which of the following would a bank not hold as insurance against the highest cost of
deposit outflow-bank failure?
A) Excess reserves
B) Secondary reserves
C) Bank capital
D) Mortgages
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
20) Which of the following has not resulted from more active liability management on the part
of banks?
A) Increased bank holdings of cash items
B) Aggressive targeting of goals for asset growth by banks
C) Increased use of negotiable CDs to raise funds
D) An increased proportion of bank assets held in loans
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
21) Modern liability management has resulted in ________.
A) increased sales of certificates of deposits to raise funds
B) increase importance of deposits as a source of funds
C) reduced borrowing by banks in the overnight loan market
D) failure by banks to coordinate management of assets and liabilities
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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22) A bank failure occurs whenever ________.
A) a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet
its reserve requirements
B) a bank suffers a large deposit outflow
C) a bank has to call in a large volume of loans
D) a bank is not allowed to borrow from the Bank of Canada
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
23) A bank is insolvent when ________.
A) its liabilities exceed its assets
B) its assets exceed its liabilities
C) its capital exceeds its liabilities
D) its assets increase in value
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
24) Holding large amounts of bank capital helps prevent bank failures because ________.
A) it means that the bank has a higher income
B) it makes loans easier to sell
C) it can be used to absorb the losses resulting from bad loans
D) it makes it easier to call in loans
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
25) Net profit after taxes per dollar of assets is a basic measure of bank profitability called
________.
A) return on assets
B) return on capital
C) return on equity
D) return on investment
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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26) Net profit after taxes per dollar of equity capital is a basic measure of bank profitability
called ________.
A) return on assets
B) return on capital
C) return on equity
D) return on investment
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
27) The amount of assets per dollar of equity capital is called the ________.
A) asset ratio
B) equity ratio
C) equity multiplier
D) asset multiplier
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
28) For a given return on assets, the lower is bank capital, ________.
A) the lower is the return for the owners of the bank
B) the higher is the return for the owners of the bank
C) the lower is the credit risk for the owners of the bank
D) the lower the possibility of bank failure
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
29) Bank capital has both benefits and costs for the bank owners. Higher bank capital
________ the likelihood of bankruptcy, but higher bank capital ________ the return on equity
for a given return on assets.
A) reduces; reduces
B) increases; increases
C) reduces; increases
D) increases; reduces
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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30) In the absence of regulation, banks would probably hold ________.
A) too much capital, reducing the efficiency of the payments system
B) too much capital, reducing the profitability of banks
C) too little capital
D) too much capital, making it more difficult to obtain loans
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
31) Conditions that likely contributed to a credit crunch in 2008 include ________.
A) capital shortfalls caused in part by falling real estate prices
B) regulated hikes in bank capital requirements
C) falling interest rates that raised interest rate risk, causing banks to choose to hold more
capital
D) increases in reserve requirements
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
32) 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
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
33) If a bank needs to raise the amount of capital relative to assets, a bank manager might
choose to ________.
A) buy back bank stock
B) pay higher dividends
C) sell bank stock
D) sell securities the bank owns and put the funds into the reserve account
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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34) Your bank has the following balance sheet:
Assets
Reserves $50 million
Securities 50 million
Loans
150 million
Liabilities
Deposits
$200 million
Bank capital 50 million
If the desired reserve ratio is 10 percent, what actions should the bank manager take if there is
an unexpected deposit outflow of $50 million?
Answer: After the deposit outflow, the bank will have a reserve shortfall of $15 million. The
bank manager could try to borrow in the overnight market, borrow from the Bank of Canada,
sell $15 million of the securities the bank owns, sell off $15 million of the loans the bank owns,
or lastly call-in $15 million of loans. All of the actions will be costly to the bank. The bank
manager should try to acquire the funds with the least costly method.
Diff: 1
Type: ES
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
35) Assume that a customer deposits $1000 in her bank. Show in a T-account the effect of this
deposit. If the bank is subject to reserve requirements (as some bank in other countries are),
show in a second T-account the banks balance sheet indicating required and excess reserves,
assuming a 5 percent required reserve ratio. In a third T-account, show the change in the bank's
balance sheet when the bank makes loans with the excess reserves.
Answer:
Reserves
$1000
Chequable deposits $1000
Required reserves
Excess reserves
Required reserves
Loans
$100
$900
$100
Chequable deposits
$1000
Chequable deposits
$1000
$900
Diff: 3
Type: ES
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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36) Credit Atlantic Bank has the following balance sheet:
Reserves
Canada Bonds
Loans
$20
$30
$80
Chequable deposits
Bank Capital
$120
$10
The bank's desired reserve ratio is 10 percent and there is a withdrawal of cash from chequable
deposits equal to $20. Describe what is likely to happen in the bank's balance sheet and produce
the new balance sheet for Credit Atlantic Bank.
Answer: The students must show that after the $20 withdrawal, chequable deposits and
reserves will go down to $100 and $0 respectively. Then, since the desired reserve ratio is 10
percent, the managers of the bank will need $100 × 10 percent = $10 as reserves. The most
likely way of increasing their reserves from $0 to $10 would be by selling Canada bonds that
worth $10. They will do this instead of calling in loans as this is the most liquid of their assets
and also this change will not harm the bank's customers. Thus, the new balance sheet will be:
Reserves
Canada Bonds
Loans
$10
$10
$80
Chequable deposits
Bank Capital
$100
$10
Diff: 3
Type: ES
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
37) Explain using an example the statement that "given the return on assets, the lower the bank
capital, the higher the return for the owners of the bank."
Answer: The students must explain this in the following lines: Assuming that we have two
identical banks that earn net profit after taxes $50 and their total assets are $100 for each, then
the banks' ROA is equal to 50 percent. If bank A has bank capital equal to $40 and bank B has
bank capital equal to $20, their respective ROE is 1.25 and 2.5. Thus, the bank with the lower
bank capital—bank B—has the higher ROE. The shareholders of bank B earn double the profits
for every dollar they invest in bank B than bank A.
Diff: 3
Type: ES
Skill: Applied
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
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38) Explain the relationship between return on assets and return on equity. What incentives
does this relationship give a bank manager? Is this the desired outcome preferred by regulators?
Discuss.
Answer: For a given return on assets, the greater the amount of capital, the lower is the return
on equity. Bank managers who seek to increase the return on equity must increase the asset
base, purchase riskier assets, or reduce the amount of capital by paying dividends or buying
back stock.
Regulators (and depositors) prefer higher capital for bank safety. Managers typically prefer
lower equity than regulators, resulting in regulatory bank capital requirements.
Diff: 2
Type: ES
Skill: Recall
Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to
maximize profits
12.4
Managing Credit Risk
1) Banks face the problem of ________ in loan markets because bad credit risks are the ones
most likely to seek bank loans.
A) adverse selection
B) moral hazard
C) moral suasion
D) intentional fraud
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
2) If borrowers with the most risky investment projects seek bank loans in higher proportion to
those borrowers with the safest investment projects, banks are said to face the problem of
________.
A) adverse credit risk
B) adverse selection
C) moral hazard
D) lemon lenders
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
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3) Because borrowers, once they have a loan, are more likely to invest in high-risk investment
projects, banks face the ________.
A) adverse selection problem
B) lemon problem
C) adverse credit risk problem
D) moral hazard problem
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
4) In order to reduce the ________ problem in loan markets, bankers collect information from
prospective borrowers to screen out the bad credit risks from the good ones.
A) moral hazard
B) adverse selection
C) moral suasion
D) adverse lending
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
5) In one sense ________ appears surprising since it means that the bank is not ________ its
portfolio of loans and thus is exposing itself to more risk.
A) specialization in lending; diversifying
B) specialization in lending; rationing
C) credit rationing; diversifying
D) screening; rationing
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
6) From the standpoint of ________, specialization in lending is surprising but makes perfect
sense when one considers the ________ problem.
A) moral hazard; diversification
B) diversification; moral hazard
C) adverse selection; diversification
D) diversification; adverse selection
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
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7) Provisions in loan contracts that prohibit borrowers from engaging in specified risky
activities are called ________.
A) proscription bonds
B) restrictive covenants
C) due-on-sale clauses
D) liens
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
8) To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In
order for these restrictive covenants to be effective, banks must also ________.
A) monitor and enforce them
B) be willing to rewrite the contract if the borrower cannot comply with the restrictions
C) trust the borrower to do the right thing
D) be prepared to extend the deadline when the borrower needs more time to comply
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
9) Long-term customer relationships ________ the cost of information collection and make it
easier to ________ credit risks.
A) reduce; screen
B) increase; screen
C) reduce; increase
D) increase; increase
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
10) Unanticipated moral hazard contingencies can be reduced by ________.
A) screening
B) long-term customer relationships
C) specialization in lending
D) credit rationing
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
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11) A bank's commitment to provide a firm with loans up to pre-specified limit at an interest
rate that is tied to a market interest rate is called ________.
A) an adjustable gap loan
B) an adjustable portfolio loan
C) loan commitment
D) pre-credit loan line
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
12) Property promised to the lender as compensation if the borrower defaults is called
________.
A) collateral
B) deductibles
C) restrictive covenants
D) contingencies
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
13) When a lender refuses to make a loan, although borrowers are willing to pay the stated
interest rate or even a higher rate, the bank is said to engage in ________.
A) coercive bargaining
B) strategic holding out
C) credit rationing
D) collusive behavior
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
14) When banks offer borrowers smaller loans than they have requested, banks are said to
________.
A) shave credit
B) rediscount the loan
C) raze credit
D) ration credit
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
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15) Credit risk management tools include ________.
A) deductibles
B) collateral
C) interest rate swaps
D) duration analysis
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
16) How can specializing in lending help to reduce the adverse selection problem in lending?
Answer: Reducing the adverse selection problem requires the banks to acquire information to
screen bad credit risks from good credit risks. It is easier for banks to obtain information about
local businesses. Also if the bank lends to firms in a few specific industries they will become
more knowledgeable about those industries and a better judge of creditworthiness in those
industries.
Diff: 1
Type: ES
Skill: Recall
Objective: 12.4 List the ways in which banks deal with credit risk
12.5
Managing Interest-Rate Risk
1) Risk that is related to the uncertainty about interest rate movements is called ________.
A) default risk
B) interest-rate risk
C) the problem of moral hazard
D) security risk
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
2) All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are
its assets, then ________ in interest rates will ________ bank profits.
A) an increase; increase
B) an increase; reduce
C) a decline; reduce
D) a decline; not affect
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
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3) If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates
will increase bank profits.
A) more; a decline
B) more; an increase
C) fewer; an increase
D) fewer; a surge
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
4) If a bank has ________ rate-sensitive assets than liabilities, a ________ in interest rates will
reduce bank profits, while a ________ in interest rates will raise bank profits.
A) more; rise; decline
B) more; decline; rise
C) fewer; decline; decline
D) fewer; rise; rise
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
5) If a bank's liabilities are more sensitive to interest rate movements than are its assets, then
________.
A) an increase in interest rates will reduce bank profits
B) a decrease in interest rates will reduce bank profits
C) interest rates changes will not impact bank profits
D) an increase in interest rates will increase bank profits
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
6) The difference of rate-sensitive liabilities and rate-sensitive assets is known as the ________.
A) duration
B) interest-sensitivity index
C) rate-risk index
D) gap
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
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7) If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage
point increase in interest rates will cause profits to ________.
A) increase by $15 million
B) increase by $1.5 million
C) decline by $15 million
D) decline by $1.5 million
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
8) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap
times the change in the interest rate is called ________.
A) basic duration analysis
B) basic gap analysis
C) interest-exposure analysis
D) gap-exposure analysis
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
9) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap
for several maturity subintervals times the change in the interest rate is called ________.
A) basic gap analysis
B) the maturity bucket approach to gap analysis
C) the segmented maturity approach to gap analysis
D) the segmented maturity approach to interest-exposure analysis
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
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Assets
Rate-sensitive $20 million
$80 million
Fixed-rate
Liabilities
$50 million
$50 million
10) If interest rates rise by 5 percentage points, say, from 10 to 15 percent, bank profits
(measured using basic gap analysis) will ________.
A) decline by $0.5 million
B) decline by $1.5 million
C) decline by $2.5 million
D) increase by $1.5 million
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
11) Assuming that the average duration of its assets is five years, while the average duration of
its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net
worth of First National to decline by ________ of the total original asset value.
A) 5 percent
B) 10 percent
C) 15 percent
D) 25 percent
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
Assets
Rate-sensitive $40 million
$60 million
Fixed-rate
Liabilities
$50 million
$50 million
12) If interest rates rise by 5 percentage points, say from 10 to 15 percent, bank profits
(measured using basic gap analysis) will ________.
A) decline by $0.5 million
B) decline by $1.5 million
C) decline by $2.5 million
D) increase by $2.0 million
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
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13) Assuming that the average duration of its assets is four years, while the average duration of
its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net
worth of First National to ________ by ________ of the total original asset value.
A) decline; 5 percent
B) decline; 10 percent
C) decline; 15 percent
D) increase; 20 percent
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
14) Duration analysis involves comparing the average duration of the bank's ________ to the
average duration of its ________.
A) securities portfolio; non-deposit liabilities
B) assets; liabilities
C) loan portfolio; deposit liabilities
D) assets; deposit liabilities
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
15) Because of an expected rise in interest rates in the future, a banker will likely ________.
A) make long-term rather than short-term loans
B) buy short-term rather than long-term bonds
C) buy long-term rather than short-term bonds
D) make either short or long-term loans; expectations of future interest rates are irrelevant
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
16) If a banker expects interest rates to fall in the future, her best strategy for the present is
________.
A) to increase the duration of the bank's liabilities
B) to buy short-term bonds
C) to sell long-term certificates of deposit
D) to increase the duration of the bank's assets
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
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17) Because ________ are less liquid for the depositor than ________, they earn higher interest
rates.
A) money market deposit accounts; time deposits
B) chequable deposits; savings account
C) savings account; chequable deposits
D) savings account; time deposits
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
18) Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the
bank's assets to increase their rate sensitivity or, alternatively, ________ the duration of the
bank's liabilities.
A) shortening; lengthening
B) shortening; shortening
C) lengthening; lengthening
D) lengthening; shortening
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
19) Your bank has the following balance sheet:
Assets
Rate-sensitive
Fixed-rate
$100 million
100 million
Liabilities
Rate-sensitive
Fixed-rate
$75 million
125 million
What would happen to bank profits if the interest rates in the economy go down? Is there
anything that you could do to keep your bank from being so vulnerable to interest rate
movements?
Answer: The bank's profits would go down because it has more interest-rate sensitive assets
than liabilities. In order to reduce interest-rate sensitivity, the bank manager could use financial
derivatives such as interest-rate swaps, options, or futures. The bank manager could also try to
adjust the balance sheet so that the bank's profits are not vulnerable to the movement of the
interest rate.
Diff: 3
Type: ES
Skill: Applied
Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk
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12.6
Off-Balance-Sheet Activities
1) Examples of off-balance-sheet activities include ________.
A) loan sales
B) extending loans to depositors
C) borrowing from other banks
D) selling negotiable CDs
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
2) All of the following are examples of off-balance sheet activities that generate fee income for
banks except ________.
A) foreign exchange trades
B) guaranteeing debt securities
C) back-up lines of credit
D) selling negotiable CDs
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
3) Which of the following is not an example of a backup line of credit?
A) Loan commitments
B) Overdraft privileges
C) Standby letters of credit
D) Mortgages
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
4) Off-balance sheet activities involving guarantees of securities and back-up credit lines
________.
A) have no impact on the risk a bank faces
B) does not change the risk a bank faces
C) increase the risk a bank faces
D) slightly reduce the risk a bank faces
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
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5) When banks involved in trading activities attempt to outguess markets, they are ________.
A) forecasting
B) diversifying
C) speculating
D) engaging in riskless arbitrage
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
6) Traders working for banks are subject to the ________.
A) principal-agent problem
B) free-rider problem
C) double-jeopardy problem
D) exchange-risk problem
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
7) A reason why rogue traders have bankrupt their banks is due to ________.
A) the separation of trading activities from the bookkeepers
B) stringent supervision of trading activities by bank management
C) accounting errors
D) a failure to maintain proper internal controls
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
8) One way for banks to reduce the principal-agent problems associated with trading activities
is to ________.
A) set limits on the total amount of a traders' transactions
B) make sure that the person conducting the trades is also the person responsible for recording
the transactions
C) encourage traders to take on more risk if the potential rewards are higher
D) reduce the regulations on the traders so that they have more flexibility in conducting trades
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
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9) The principal-agent problem that exists for bank trading activities can be reduced through
________.
A) creation of internal controls that combine trading activities with bookkeeping
B) creation of internal controls that separate trading activities from bookkeeping
C) elimination of regulation of banking
D) elimination of internal controls
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
10) Banks develop statistical models to calculate their maximum loss over a given time period.
This approach is known as the ________.
A) stress-testing approach
B) value-at-risk approach
C) trading-loss approach
D) doomsday approach
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
11) When banks calculate the losses the institution would incur if an unusual combination of
bad events happened, the bank is using the ________ approach.
A) stress-test
B) value-at-risk
C) trading-loss
D) maximum value
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
12) What is a loan sale and how does it work?
Answer: The students must explain that the loan sale is an off-balance-sheet activity that has
grown in importance in recent years and it generates income for banks. A loan sale is also
called a secondary loan participation and involves a contract that sells all or part of the cash
stream from a specific loan and thereby it removes it from the bank's balance sheet. Banks earn
profit by selling the loans for an amount slightly higher than the original loan amount. The high
interest rate for these loans makes them attractive and institutions are willing to buy them at the
higher price which means that they earn a slightly lower interest rate than the original loan
usually on the order of 0.15 percentage points.
Diff: 3
Type: ES
Skill: Recall
Objective: 12.6 Summarize the types of off-balance-sheet activities
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12.7
Web Appendix 12.1: Duration Gap Analysis
1) If interest rates increase from 3% to 4%, a $100,000 10 year bond with a duration of 8 years
would ________ in price by approximately ________.
A) increase; 7.8%
B) decrease; 7.8%
C) increase; 9.7%
D) decrease; 9.7%
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Duration gap analysis
2) If interest rates increase from 3% to 4%, a $100,000 25 year bond with a duration of 21 years
would ________ in price by approximately ________.
A) increase; 24.3%
B) decrease; 24.3%
C) increase; 20.4%
D) decrease; 20.4%
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Duration gap analysis
3) Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of
liabilities with a duration of 1.05. What is its duration gap?
A) 0.95 years
B) 1.15 years
C) 1.35 years
D) 1.50 years
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Duration gap analysis
4) If interest rates increase from 9 percent to 10 percent, a bank with a duration gap of 2 years
would experience a decrease in its net worth of ________.
A) 0.9 percent of its assets
B) 0.9 percent of its liabilities
C) 1.8 percent of its liabilities
D) 1.8 percent of its assets
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Duration gap analysis
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5) Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of
liabilities with a duration of 1.05. If interest rates increase from 5 percent to 6 percent, the net
worth as a percentage of assets would ________ by approximately ________.
A) increase; 1.8%
B) decrease; 1.8%
C) increase; 1.4%
D) decrease; 1.4%
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Duration gap analysis
12.8
Web Appendix 12.2: Measuring Bank Performance
1) Most of a bank's operating income results from ________.
A) interest on assets
B) service charges on deposit accounts
C) off-balance-sheet activities
D) fees from standby lines of credit
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Measuring bank performance
2) Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of
liabilities with a duration of 1.05. The duration gap for this bank is ________.
A) 0.5 year
B) 1 year
C) 1.5 years
D) 2 years
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Measuring bank performance
3) One of the problems in conducting a duration gap analysis is that the duration gap is
calculated assuming that interest rates for all maturities are the same. That means that the yield
curve is ________.
A) flat
B) slightly upward sloping
C) steeply upward sloping
D) downward sloping
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: Appendix: Measuring bank performance
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4) All of the following are operating expenses for a bank except ________.
A) service charges on deposit accounts
B) salaries and employee benefits
C) rent on buildings
D) servicing costs of equipment such as computers
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Measuring bank performance
5) When a bank suspects that a $1 million loan might prove to be bad debt that will have to be
written off in the future the bank ________.
A) can set aside $1 million of its earnings in its loan loss reserves account
B) reduces its reported earnings by $1, even though it has not yet actually lost the $1 million
C) reduces its assets immediately by $1 million, even though it has not yet lost the $1 million
D) reduces its reserves by $1 million, so that they can use those funds later
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Measuring bank performance
6) For banks, ________.
A) return on assets exceeds return on equity
B) return on assets equals return on equity
C) return on equity exceeds return on assets
D) return on equity is another name for net interest margin
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Measuring bank performance
7) The quantity defined as interest income minus interest expenses divided by assets is a
measure of bank performance known as ________.
A) operating income
B) net interest margin
C) return on assets
D) return on equity
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Measuring bank performance
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 13 Risk Management with Financial Derivatives
13.1
Hedging
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1) Financial derivatives include ________.
A) stocks
B) bonds
C) futures
D) foreign exchange
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
2) Financial derivatives include ________.
A) stocks
B) bonds
C) forward contracts
D) foreign exchange
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
3) A contract that requires the investor to buy securities on a future date is called a ________.
A) short position
B) long position
C) hedge
D) cross
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
4) A contract that requires the investor to sell securities on a future date is called a ________.
A) short position
B) long position
C) hedge
D) micro hedge
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
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5) A long position requires that the investor ________.
A) sell securities in the future
B) buy securities in the future
C) hedge in the future
D) close out his position in the future
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
6) A short position requires that the investor ________.
A) sell securities in the future
B) buy securities in the future
C) hedge in the future
D) close out his position in the future
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
7) Explain the terms hedge, long position and short position in the context of managing
financial institutions' risk.
Answer: Hedging is the act of engaging in a financial transaction that reduces or eliminates
risk. When a financial institution has bought an asset, it is said to have taken a long position,
and this exposes the institution to risk if the returns on the asset are uncertain. On the other
hand, if it has sold an asset that it has agreed to deliver to another party at a future date, it is
said to have taken a short position and this can also expose the institution to risk.
Diff: 1
Type: ES
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position
374
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13.2
Forward Contracts and Markets
1) Forward contracts do not suffer from the problem of ________.
A) a lack of liquidity
B) a lack of flexibility
C) the difficulty of finding a counterparty
D) default risk
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 13.2 Define a forward contract and summarize its advantages and disadvantages
2) What are the pros and cons of forward contracts?
Answer: The advantage of forward contracts is that they can be as flexible as the parties
involved want them to be. This means that an institution may be able to hedge completely the
interest-rate risk for the exact security it is holding in its portfolio.
There are two disadvantages of forward contracts. First, it may be very hard for an institution to
find another party which is called counterparty to make the contract with. The second problem
with forward contracts is that they are subject to default risk. The presence of default risk in
forward contracts means that parties to these contracts must check each other out to be sure that
the counterparty is both financially sound and likely to be honest and live up to its contractual
obligations.
Diff: 2
Type: ES
Skill: Recall
Objective: 13.2 Define a forward contract and summarize its advantages and disadvantages
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13.3
Financial Futures Contracts and Markets
1) Futures contracts are regularly traded on the ________.
A) Montreal Exchange
B) Toronto Stock Exchange
C) American Stock Exchange
D) Chicago Board of Options Exchange
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
2) If you buy in March a bond future contract for 115 that matures on June 30 of the same year,
and at the maturity date the same future sells for 110, you have a ________ of $________.
A) loss; 5000
B) loss; 5
C) profit; 5000
D) profit; 5
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
3) If you buy in February a bond future contract for 120 that matures on June 30 of the same
year, and at the maturity date the same future sells for 110, you have a ________ of
$________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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4) If you buy in March a bond future contract for 97 that matures on June 30 of the same year,
and at the maturity date the same future sells for 93, you have a ________ of $________.
A) loss; 4000
B) loss; 4
C) profit; 4000
D) profit; 4
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
5) If you buy in February a bond future contract for 125 that matures on June 30 of the same
year, and at the maturity date the same future sells for 105, you have a ________ of
$________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
6) If you buy in March a bond future contract for 125 that matures on June 30 of the same year,
and at the maturity date the same future sells for 135, you have a ________ of $________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
377
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7) If you buy in March a bond future contract for 110 that matures on June 30 of the same year,
and at the maturity date the same future sells for 125, you have a ________ of $________.
A) loss; 15000
B) loss; 15
C) profit; 15000
D) profit; 15
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
8) If you buy in March a bond future contract for 150 that matures on June 30 of the same year,
and on the maturity date the same future sells for 170, you have a ________ of $________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
9) If you sell in March a bond future contract for 115 that matures on June 30 of the same year,
and at the maturity date the same future sells for 110, you have a ________ of $________.
A) loss; 5000
B) loss; 5
C) profit; 5000
D) profit; 5
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
378
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10) If you sell in February a bond future contract for 120 that matures on June 30 of the same
year, and at the maturity date the same future sells for 110, you have a ________ of
$________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
11) If you sell in March a bond future contract for 97 that matures on June 30 of the same year,
and at the maturity date the same future sells for 93, you have a ________ of $________.
A) loss; 4000
B) loss; 4
C) profit; 4000
D) profit; 4
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
12) If you sell in February a bond future contract for 125 that matures on June 30 of the same
year, and at the maturity date the same future sells for 105, you have a ________ of
$________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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13) If you sell in March a bond future contract for 125 that matures on June 30 of the same
year, and at the maturity date the same future sells for 135, you have a ________ of
$________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
14) If you sell in March a bond future contract for 110 that matures on June 30 of the same
year, and at the maturity date the same future sells for 125, you have a ________ of
$________.
A) loss; 15000
B) loss; 15
C) profit; 15000
D) profit; 15
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
15) If you sell in March a bond future contract for 150 that matures on June 30 of the same
year, and on the maturity date the same future sells for 170, you have a ________ of
$________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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16) By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver
________.
A) $100,000 face value securities for $115,000
B) $115,000 face value securities for $110,000
C) $100,000 face value securities for $100,000
D) $115,000 face value securities for $115,000
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
17) By selling short a futures contract of $100,000 at a price of 96, you are agreeing to deliver
________.
A) $100,000 face value securities for $104,167
B) $96000 face value securities for $100,000
C) $100,000 face value securities for $96000
D) 100,000 face value securities for $100,000
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
18) By buying a long $100,000 futures contract for 115, you agree to pay ________.
A) $100,000 for $115,000 face value bonds
B) $115,000 for $100,000 face value bonds
C) $86956 for $100,000 face value bonds
D) $86956 for $115,000 face value bonds
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
19) If you sold a short contract on financial futures, you hope interest rates ________.
A) rise
B) fall
C) are stable
D) fluctuate
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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20) If you bought a long contract on financial futures, you hope that interest rates ________.
A) rise
B) fall
C) are stable
D) fluctuate
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
21) If you sold a short futures contract, you will hope that bond prices ________.
A) rise
B) fall
C) are stable
D) fluctuate
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
22) The elimination of riskless profit opportunities in the futures market is referred to as
________.
A) speculation
B) hedging
C) arbitrage
D) open interest
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
23) When a financial institution hedges the interest-rate risk for a specific asset, the hedge is
called a ________.
A) macro hedge
B) micro hedge
C) cross hedge
D) futures hedge
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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24) When the financial institution is hedging interest-rate risk on its overall portfolio, then the
hedge is a ________.
A) macro hedge
B) micro hedge
C) cross hedge
D) futures hedge
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
25) The number of contracts outstanding in a particular financial future is the ________.
A) demand coefficient
B) open interest
C) index level
D) outstanding balance
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
26) The advantage of forward contracts over futures contracts is that forward contracts
________.
A) are standardized
B) have lower default risk
C) are more flexible
D) have higher default risk
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
27) Futures markets have grown rapidly because futures ________.
A) are standardized
B) have higher default risk
C) are illiquid
D) are more flexible
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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28) Futures differ from forwards because they are ________.
A) used to hedge portfolios
B) used to hedge individual securities
C) used in both financial and foreign exchange markets
D) standardized contracts
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
29) Futures differ from forwards because they are ________.
A) used to hedge portfolios
B) used to hedge individual securities
C) used in both financial and foreign exchange markets
D) traded on an exchange
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
30) Which of the following features of futures contracts were not designed to increase
liquidity?
A) Standardized contracts
B) Traded up until maturity
C) Not tied to one specific type of bond
D) Marked to market daily
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
31) Which of the following features of futures contracts were not designed to increase
liquidity?
A) Standardized contracts
B) Traded up until maturity
C) Not tied to one specific type of bond
D) Can be closed with off setting trade
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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32) If a firm is due to be paid in euros in two months, to hedge against exchange rate risk the
firm should ________.
A) sell foreign exchange futures short
B) buy foreign exchange futures long
C) stay out of the exchange futures market
D) buy foreign exchange forward contracts long
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
33) If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign
exchange rate risk by ________.
A) selling foreign exchange futures short
B) buying foreign exchange futures long
C) staying out of the exchange futures market
D) selling foreign exchange forward contracts short
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
34) What is an interest-rate futures contract? How does it differ from an interest-rate forward
contract?
Answer: An interest-rate futures contract is similar to an interest-rate forward contract in that
it specifies that a financial instrument must be delivered by one party to another on a stated
future date. However it differs from an interest-rate forward contract in several ways that
overcome some of the liquidity and default problems of forward contracts.
Diff: 1
Type: ES
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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35) Explain using an example the statement that "at the expiration date of a futures contract, the
price of the contract is the same as the price of the underlying asset to be delivered."
Answer: Consider what happens on the expiration date of a June contract at the end of June
when the price of the underlying $100,000 face value Canadian bond is 110 ($110,000). If the
futures contract sells bellow 110, say at 109, a trader can buy the contract for $109,000 and
take delivery of the bond and immediately sell it for $110,000, thereby earning a quick profit of
$1000. That means that everyone will try to buy the contract and this will drive its price up to
110. If the price is 111 instead everyone will try to sell the contract at $111,000 and buy it from
the market to deliver at $110,000. Thus everyone will try to sell and this will drive the price
down to 110.
Diff: 3
Type: ES
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
36) Where are financial futures traded? Describe that market.
Answer: Financial futures contracts are traded on organized exchanges such as the Chicago
Board of Trade, the Chicago Mercantile Exchange, the Montreal Exchange, the London
International Financial Futures Exchange etc. These futures exchanges are highly competitive
with one another, and each organization tries to design contracts and set rules that will increase
the amount of futures trading on its exchange. The exchanges are also regulated to ensure that
prices in the market are not manipulated.
Diff: 1
Type: ES
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract
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13.4
Stock Index Futures
1) If you buy in April a stock index future contract on the S&P 500 index at the price of 1000
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 900, you have a ________ of $________.
A) loss; 25000
B) loss; 100
C) profit; 25000
D) profit; 100
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
2) If you buy in April a stock index future contract on the S&P 500 index at the price of 800
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 795, you have a ________ of $________.
A) loss; 1250
B) loss; 5
C) profit; 1250
D) profit; 5
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
3) If you buy in April a stock index future contract on the S&P 500 index at the price of 1200
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1000, you have a ________ of $________.
A) loss; 50000
B) loss; 200
C) profit; 50000
D) profit; 200
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
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4) If you buy in April a stock index future contract on the S&P 500 index at the price of 1050
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1047, you have a ________ of $________.
A) loss; 750
B) loss; 3
C) profit; 750
D) profit; 3
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
5) If you sell in April a stock index future contract on the S&P 500 index at the price of 1000
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 900, you have a ________ of $________.
A) loss; 25000
B) loss; 100
C) profit; 25000
D) profit; 100
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
6) If you sell in April a stock index future contract on the S&P 500 index at the price of 800
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 795, you have a ________ of $________.
A) loss; 1250
B) loss; 5
C) profit; 1250
D) profit; 5
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
7) If you sell in April a stock index future contract on the S&P 500 index at the price of 1200
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1000, you have a ________ of $________.
A) loss; 50000
B) loss; 200
C) profit; 50000
D) profit; 200
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
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8) If you sell in April a stock index future contract on the S&P 500 index at the price of 1050
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1047, you have a ________ of $________.
A) loss; 750
B) loss; 3
C) profit; 750
D) profit; 3
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
9) The risk that occurs because stock prices fluctuate is called ________.
A) stock market risk
B) reinvestment risk
C) interest rate risk
D) default risk
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.4 Define and explain a stock index future
10) Who would be most likely to buy a long stock index future?
A) A mutual fund manager who believes the market will rise
B) A mutual fund manager who believes the market will fall
C) A mutual fund manager who believes the market will be stable
D) A mutual fund manager who does not believe in hedging
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
11) If you buy a futures contract on the S&P 500 Index at a price of 450 and the index rises to
500, you will ________.
A) lose $12500
B) gain $12500
C) lose $50
D) gain $50
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
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12) if you sell a futures contract on the S&P 500 Index at a price of 450 and the index rises to
500, you will ________.
A) lose $12500
B) gain $12500
C) lose $50
D) gain $50
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
13) Which of the following is a likely reason for a money market fund manager to sell a stock
index future short?
A) He believes the market will rise.
B) He wants to lock in current prices.
C) He wants to increase stock market risk.
D) He believes the market will be unchanged.
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
14) If a money manager believes stock prices will fall and knows that a block of funds will be
received in the future, then he should ________.
A) sell stock index futures short
B) buy stock index futures long
C) stay out of the futures market
D) borrow and buy securities now
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
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13.5
Options
1) Options are contracts that give the purchasers the ________.
A) option to buy or sell an underlying asset
B) the obligation to buy or sell an underlying asset
C) the right to hold an underlying asset
D) the right to switch payment streams
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
2) The price specified in an option contract at which the holder can buy or sell the underlying
asset is called the ________.
A) premium
B) call
C) strike price
D) put
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
3) The price specified in an option contract at which the holder can buy or sell the underlying
asset is called the ________.
A) premium
B) interest rate
C) exercise price
D) call
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
4) The seller of an option has the ________.
A) right to buy or sell the underlying asset
B) the obligation to buy or sell the underlying asset
C) ability to reduce transaction risk
D) right to exchange one payment stream for another
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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5) The seller of an option has the ________ to buy or sell the underlying asset, while the
purchaser of an option has the ________ to buy or sell the asset.
A) obligation; right
B) right; obligation
C) obligation; obligation
D) right; right
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
6) An option that can be exercised at any time up to maturity is called a(n) ________.
A) swap
B) stock option
C) European option
D) American option
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
7) An option that can be exercised only at maturity is called a(n) ________.
A) swap
B) stock option
C) European option
D) American option
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
8) Options on individual stocks are referred to as ________.
A) stock options
B) futures options
C) American options
D) individual options
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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9) Options on futures contracts are referred to as ________.
A) stock options
B) futures options
C) American options
D) individual options
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
10) An option that gives the owner the right to buy a financial instrument at the exercise price
within a specified period of time is a(n) ________.
A) call option
B) put option
C) American option
D) European option
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
11) A call option gives the owner ________.
A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
12) A call option gives the seller ________.
A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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13) A put option gives the owner ________.
A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
14) A put option gives the seller ________.
A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
15) The main disadvantage of futures contracts as compared to options on futures contracts is
that futures ________.
A) remove the possibility of gains
B) increase the transactions cost
C) are not as effective a hedge
D) do not remove the possibility of losses
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
16) All other things held constant, premiums on put options will increase when the ________.
A) exercise price falls
B) volatility of the underlying asset falls
C) term to maturity increases
D) term to maturity decreases
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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17) An option that gives the owner the tight to sell a financial instrument at the exercise price
within a specified period of time is a(n) ________.
A) call option
B) put option
C) American option
D) European option
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
18) If a bank manager wants to protect the bank against losses that would be incurred on its
portfolio of treasury securities should interest rates rise, he could ________.
A) buy put options on financial futures
B) buy call options on financial futures
C) sell put options on financial futures
D) sell call options on financial futures
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
19) If you buy a European call option on Canada bonds with a strike price of 115 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 110, you will
________ the option and potentially make a profit of $________.
A) not exercise; 5000
B) not exercise; 5
C) exercise; 5000
D) exercise; 5
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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20) If you buy a European call option on Canada bonds with a strike price of 120 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 117, you will
________ the option and potentially make a profit of $________.
A) not exercise; 3000
B) not exercise; 3
C) exercise; 3000
D) exercise; 3
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
21) If you buy a European call option on Canada bonds with a strike price of 110 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 103, you will
________ the option and potentially make a profit of $________.
A) not exercise; 7000
B) not exercise; 7
C) exercise; 7000
D) exercise; 7
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
22) If you buy a European call option on Canada bonds with a strike price of 115 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 120, you will
________ the option in order to make a profit of $________.
A) not exercise; 5000
B) not exercise; 5
C) exercise; 5000
D) exercise; 5
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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23) If you buy a European call option on Canada bonds with a strike price of 120 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 123, you will
________ the option in order to make a profit of $________.
A) not exercise; 3000
B) not exercise; 3
C) exercise; 3000
D) exercise; 3
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
24) If you buy a European call option on Canada bonds with a strike price of 110 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 117, you will
________ the option in order to make a profit of $________.
A) not exercise; 7000
B) not exercise; 7
C) exercise; 7000
D) exercise; 7
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
25) If you buy an option to buy Canada futures at 115, and at expiration the market price is 110,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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26) if you buy an option to sell Canada futures at 115, and at expiration the market price is 110,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
27) if you buy an option to buy Canada futures at 110, and at expiration the market price is 115,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
28) If you buy an option to sell Canada futures at 110, and at expiration the market price is 115,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
29) The main advantage of using options on futures contracts rather than the futures contracts
themselves is that ________.
A) interest rate risk is controlled while preserving the possibility of gains
B) interest rate risk is controlled, while removing the possibility of losses
C) interest rate risk is not controlled, but the possibility of gains is preserved
D) interest rate risk is not controlled, but the possibility of gains is lost
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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30) The main reason to buy an option on a futures contract rather than buying the futures
contract is ________.
A) to reduce transaction cost
B) to preserve the possibility for gains
C) to limit losses
D) to remove the possibility for gains
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
31) All other things held constant, premiums on call options will increase when the ________.
A) exercise price falls
B) volatility of the underlying asset falls
C) term to maturity decreases
D) futures price increases
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
32) An increase in the volatility of the underlying asset, all other things held constant, will
________ the option premium.
A) increase
B) decrease
C) increase or decrease
D) Not enough information is given.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
33) An increase in the exercise price, all other things held constant, will ________ the premium
on call options.
A) increase
B) decrease
C) increase or decrease
D) Not enough information is given.
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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34) What are options? What are their differences from futures contracts?
Answer: Options are contracts that give the purchaser the option, or right, to buy or sell the
underlying asset at a specified price, called the exercise price or strike price, within a specific
time period called the term to expiration. The seller, sometimes called the writer, of the option
is obligated to buy or sell the asset to the purchaser if the owner of the option exercises the right
to sell or buy. Because the right to buy or sell an asset at a specified price has value, the owner
of an option is willing to pay an amount for it called premium. There are two types of option
contracts: American options can be exercised at any time up to the expiration date of the
contract, and European options can be exercised only on the expiration date.
Diff: 2
Type: ES
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
35) Why have options on financial futures become the most widely traded option contracts?
Answer: Option contracts are more likely to be written on financial futures than on
underlying financial instruments such as bonds. As we know, at the expiration date, the price of
the futures contract and of the deliverable debt instrument will be the same because of
arbitrage. So it would seem that investors would be indifferent about having the option written
on the asset or on the futures contract. However, financial futures contracts have been so well
designed that their markets are often more liquid than the markets in the underlying assets.
Investors would rather have the option written on the more liquid instrument, in this case the
futures contract.
Diff: 3
Type: ES
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
36) What is the value of a call option at expiration? Use an appropriate graph to show the profit
and loses of the buyer and seller of a call option.
Answer: The value of a call option at expiration, or intrinsic value is given by: C = max (0, S
- X). The net profit for the buyer is equal to C - α. Students must use a graph similar to Figure
13-1 on page 325 of the text to explain the profit and loses of the buyer and the seller of a call
option.
Diff: 3
Type: ES
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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37) What is the value of a put option at expiration? Use an appropriate graph to show the profit
and loses of the buyer and seller of a put option.
Answer: The value of a put option at expiration, or intrinsic value is given by: P = max (X S, 0). The net profit for the buyer is equal to P - β. Students must use a graph similar to Figure
13-2 on page 326 of the text to explain the profit and loses of the buyer and the seller of a put
option.
Diff: 3
Type: ES
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
38) Use an appropriate graph to show the profits and losses for the buyer of a call option and
the buyer of a futures contract, when the price of the future and the exercise price of the option
is 115 and the premium is equal to $2000.
Answer: Students should use a graph similar to Figure 13-3 on page 328 of the text and show
the profit and loss of from the options and futures contract bought at 115.
Diff: 3
Type: ES
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
13.6
Swaps
1) A financial contract that obligates one party to exchange a set of payments it owns for
another set of payments owned by another party is called a ________.
A) cross hedge
B) cross call option
C) cross put option
D) swap
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
2) A swap that involves the exchange of a set of payments in one currency for a set of payments
in another currency is a(n) ________.
A) interest rate swap
B) currency swap
C) swaption
D) national swap
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
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3) A swap that involves the exchange of one set of interest payments for another set of interest
payments is called a(n) ________.
A) interest rate swap
B) currency swap
C) swaption
D) national swap
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
4) If Second Bank has more rate-sensitive assets than rate sensitive liabilities, it can reduce
interest rate risk with a swap which requires Second Bank to ________.
A) pay a fixed rate while receiving a floating rate
B) receive a fixed rate while paying a floating rate
C) both receive and pay a fixed rate
D) both receive and pay a floating rate
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
5) If Second Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce
interest rate risk with a swap which requires Second Bank to ________.
A) pay a fixed rate while receiving a floating rate
B) receive a fixed rate while paying a floating rate
C) both receive and pay a fixed rate
D) both receive and pay a floating rate
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
6) If a bank has a gap of -$10 million, it can reduce its interest rate risk by ________.
A) paying a fixed rate on $10 million and receiving a floating rate on $10 million
B) paying a floating rate on $10 million and receiving a fixed rate on $10 million
C) selling $20 million fixed rate assets
D) buying $20 million fixed rate assets
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
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7) One advantage of using swaps to eliminate interest-rate risk is that swaps ________.
A) are less costly than futures
B) are less costly than rearranging balance sheets
C) are more liquid than futures
D) have better accounting treatment than options
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
8) The disadvantage of swaps is that ________.
A) they lack liquidity
B) it is easy to arrange for a counterparty
C) they do not have default risk
D) they are costly
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
9) As compared to a default on the notional principle, a default on a swap ________.
A) is more costly
B) is about as costly
C) is less costly
D) may cost more or less than default on the notional principle
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
10) Intermediaries are active in the swap markets because ________.
A) they increase liquidity
B) they increase default risk
C) they increase search cost
D) they do not need counterparties
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of
interest-rate swaps
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13.7
Credit Derivatives
1) ________ derivatives offer payoffs on previously issued securities, but ones that bear credit
risk.
A) Credit
B) Bond
C) Note
D) Stock
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 13.7 Summarize the three types of credit derivatives
2) Credit options are contracts where the purchaser gains the right to receive profits that are tied
to ________.
A) the obligation to buy or sell an underlying asset
B) the price of an underlying security or to an interest rate
C) the right to hold an underlying asset
D) the right to switch payment streams
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 13.7 Summarize the three types of credit derivatives
3) Which credit derivative is a combination of a bond and a credit option?
A) A bond-linked note
B) A linked note
C) A credit-linked note
D) None of the above
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 13.7 Summarize the three types of credit derivatives
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 14 Central Banks and the Bank of Canada
14.1
Origins of the Bank of Canada
1) From 1929 to 1933 the Canadian real GDP fell by almost ________.
A) 30 percent
B) 40 percent
C) 50 percent
D) 20 percent
Answer: A
Diff: 1
Type: MC
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Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
2) Unemployment rates in Canada after the Great Depression rose close to ________.
A) 20 percent
B) 25 percent
C) 30 percent
D) 10 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
3) The Great Depression contributed to significant changes in Canadian ________.
A) monetary policy
B) nationalization
C) growth policy
D) immigration
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
4) Bank of Canada started operations in ________.
A) 1935
B) 1925
C) 1915
D) 1945
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
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5) The Great Depression contributed to significant changes in Canadian ________.
A) deficits
B) monetary policy
C) foreign affairs policy
D) immigration policy
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
6) The Great Depression ________.
A) was of fundamental importance in the creation of the Bank of Montreal
B) contributed to significant changes in government policy
C) involved the largest increase in the level of economic activity in the history of Canada
D) contributed to significant changes in foreign affairs policy
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
7) The main motivation for the formation of the Bank of Canada in 1934 was ________.
A) financial
B) the need for Canada to reflect its growing political independence from Britain
C) the need for Canada to coordinate its international trade policy
D) government debt
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
8) The Bank of Canada has regional offices in which of the following cities?
A) Saskatoon
B) Edmonton
C) Montreal
D) Winnipeg
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
9) The Bank of Canada has regional offices in the following cities, except ________.
A) Toronto
B) Vancouver
C) Edmonton
D) Halifax
Answer: C
Diff: 1
Type: MC
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Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
10) The oldest central bank, having been founded in 1656, is the ________.
A) Riksbank, the central bank of Sweden
B) Deutsche Bundesbank
C) Bank of Japan
D) Federal Reserve System
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.1 Recognize the historical context of the development of the Bank of Canada
14.2
Formal Structure of the Bank of Canada
1) Which of the following are entities of the Bank of Canada?
A) The Office of the Superintendent of Financial Institutions (OSFI)
B) The Governing Council
C) The Canada Deposit Insurance Corporation (CDIC)
D) The Federal Reserve
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
2) Which of the following are entities of the Bank of Canada?
A) The Office of the Superintendent of Financial Institutions (OSFI)
B) The Board of Directors
C) The Canada Deposit Insurance Corporation (CDIC)
D) The Department of Finance
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
3) All of the following have served as Bank of Canada governors except for ________.
A) Roy Romanow
B) David Dodge
C) Gordon Thiessen
D) John Crow
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
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4) Which of the following is an element of the Bank of Canada?
A) The Office of the Superintendent of Financial Institutions (OSFI)
B) The Governing Council
C) The Board of Directors
D) B and C only
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
5) The overall responsibility for the operation of the bank of Canada is held by the ________.
A) Board of Directors
B) Federal Government
C) Ministry of Finance
D) Provincial governments
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
6) The Board of Directors appoints the governor of the Bank of Canada for a renewable term of
________ years.
A) seven
B) five
C) eight
D) six
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
7) The Bank of Canada quarterly Monetary Policy Report is published every ________,
________, ________ and ________.
A) January; April; July; October
B) February; May; August; November
C) March; June; September; December
D) January; February; August; December
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
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8) Describe the structure of the Bank of Canada.
Answer: The overall responsibility for the operation of the Bank of Canada rests with the
Board of Directors which consists of fifteen members. The governor, the senior deputy
governor, the deputy minister of finance and twelve outside directors. The board appoints the
governor and the senior deputy governor with the governments approval for a term of seven
years. The outside directors are appointed by the minister of finance for a three-year term and
they are required to come from all regions of Canada and a variety of occupations with the
exception of banking.
Diff: 3
Type: ES
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
14.3
The Functions of the Bank of Canada
1) Which of the following functions does the Bank of Canada perform?
A) Bank note issue
B) Municipal government fiscal policy management
C) Provincial government fiscal policy management
D) Advise the Federal Reserve
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
2) Which of the following is a responsibility of the Bank of Canada?
A) Funds management
B) Fiscal policy
C) Equalization payments
D) Foreign policy
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
3) Treasury bills are a responsibility of ________.
A) the Bank of Canada
B) Canada Investment and Savings
C) Ministry of the Treasury
D) the federal government
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
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4) Foreign exchange reserves are held by ________.
A) the federal government
B) the department of finance
C) the Ministry of Central Banking
D) individual provinces and territories
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
5) The benefit of the Ban k of Canada's role as the lender-of-last-resort include ________.
A) easing liquidity problems of any financial institution
B) deterring bank runs and panics
C) reducing the monetary base to increase liquidity
D) A and B only
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
6) Base money is also know as ________.
A) monetary base
B) power money
C) monetary liability
D) fund accounts
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
7) The Bank of Canada assumed the monopoly of issuing bank notes in ________.
A) 1945
B) 1939
C) 1940
D) 1949
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
8) Which of the following functions are not performed by the Bank of Canada?
A) Cheque clearing
B) Conducting economic research
C) Setting interest rates payable on time deposits
D) Issuing new currency
Answer: C
Diff: 1
Type: MC
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Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
9) In its role as provider of paper money, the Bank of Canada ________.
A) works closely with private sector partnerships and note-issuing authorities in other countries
in order to improve cost-effectiveness, increase the durability of Canadian bank notes, and
reduce counterfeiting
B) tries to preserve the integrity and safety of Canadian currency in the most economical and
efficient manner possible
C) None of the above.
D) A and B only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
10) In its role as the federal government's fiscal agent, the Bank of Canada provides debt
management services for the federal government such as ________.
A) advising on provincial government borrowings
B) managing new debt offerings by the federal government
C) servicing the federal government's outstanding debt
D) B and C only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
11) Which of the following functions are not performed by the Bank of Canada in its role as the
federal government's fiscal agent?
A) Advising on federal government borrowings
B) Managing new debt offerings by the federal government
C) Setting interest rates payable on time deposits
D) Servicing the federal government's outstanding debt
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
12) In its role as provider of central banking services, the Bank of Canada ________.
A) serves as a lender of last resort if a deposit-taking institution faces a liquidity crisis
B) plays a central role in Canada's national mortgage system
C) is responsible for the government's operating accounts and for managing the government's
foreign exchange reserves
D) A and C only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
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Objective:
14.2 Describe the key features and functions of the Bank of Canada
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13) In its role as provider of central banking services, the Bank of Canada holds deposit
accounts of the ________.
A) provincial governments
B) directly clearing members of the Canadian Payments Association
C) international organizations, such as the International Monetary Fund
D) B and C only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
14) As the federal government's fiscal agent the Bank of Canada provides ________
management services for the federal government.
A) debt
B) cost
C) financial
D) economic
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
15) The Bank of Canada serves as a lender of last ________ when a deposit-taking financial
institution faces a ________ crisis.
A) resort; liquidity
B) minute; liquidity
C) resort; profitability
D) minute; profitability
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
16) Because of its unique power to ________ base money, the Bank of Canada can ease the
liquidity problems of ________.
A) create; financial institutions
B) create; provincial governments
C) save; financial institutions
D) save; provincial governments
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
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17) Changes in the ________ lead to ________ changes in the money supply.
A) monetary base; multiple
B) monetary base; equal
C) inflation rate; multiple
D) inflation rate; equal
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
18) Canada's national payments system currently clears and settles payments and transactions,
at a volume that is currently ________ times our annual GDP.
A) 15
B) 10
C) 5
D) 2
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
19) The Bank of Canada's lender-of-last resort lending is coordinated with ________ and
________.
A) Office of the Superintendent of Financial Institutions Canada; Canada Deposit Insurance
Corporation
B) Office of the Superintendent of Financial Institutions Canada; the Department of Finance
C) the Department of Finance; Canada Deposit Insurance Corporation
D) Office of the Superintendent of Financial Institutions Canada; Canada Investment and
Savings
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
20) In its responsibility for the government's operating accounts, the Bank of Canada
________.
A) shifts balances between accounts at the Bank of Canada and the banks
B) shifts balances between chartered banks
C) sells Canada Savings Bonds on behalf of the federal government
D) manages foreign exchange transactions
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
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21) The Bank of Canada's goal of low inflation is closely tied to ________.
A) economic growth
B) price volatility
C) low interest rates
D) growth in the money supply
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
22) The purchase and sale of government securities by the Bank of Canada is known as
________.
A) open market buyback operations
B) repurchase agreements
C) interbank borrowing
D) monetary base transactions
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
23) The Bank of Canada ultimate objective is ________.
A) price stability
B) to keep interest rates low
C) economic growth
D) low unemployment
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
24) The responsibility of monetary policy in Canada was given by the 1967 Bank of Canada
Act to the ________.
A) government
B) Bank of Canada
C) provincial governments
D) parliament
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
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25) What are the main functions of the Bank of Canada? Describe them briefly.
Answer: The main functions of the Bank of Canada are:
a. Bank note issue: Since 1967 the Bank of Canada with the revision of the Bank Act was
provided with unlimited powers to issue legal tender. The Bank also tries to preserve the
integrity and safety of Canadian currency.
b. Government debt and asset management services: The Bank of Canada in its role as the
government's fiscal agent provides debt-management services for the federal government such
as advising on borrowings, managing new debt offerings and servicing outstanding debt.
c. Central banking services: The bank of Canada serves as the lender of last resort for the
deposit-taking financial institutions. It also plays a central role in Canada's national payments
system. Finally the Bank acts as the holder of deposit accounts for the government.
d. Monetary policy: The Bank of Canada employs tools such as open market operations to
conduct monetary policy. The Bank's ultimate objective is to keep inflation low so that steady
economic growth is achieved.
Diff: 3
Type: ES
Skill: Recall
Objective: 14.2 Describe the key features and functions of the Bank of Canada
14.4
How Independent is the Bank of Canada?
1) Instrument independence is the ability of ________ to set monetary policy ________.
A) the central bank; goals
B) Parliament; goals
C) Parliament; instruments
D) the central bank; instruments
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
2) Economist Stanley Fisher defined two types of independence of central banks: ________ and
________ independence.
A) instrument; goal
B) policy; goal
C) instrument; political
D) parliamentary; decision
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
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3) The ability of a central bank to set monetary policy instruments is ________.
A) political independence
B) goal independence
C) policy independence
D) instrument independence
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
4) Goal independence is the ability of ________ to set monetary policy ________.
A) the central bank; goals
B) Congress; goals
C) Congress; instruments
D) the central bank; instruments
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
5) The ability of a central bank to set monetary policy goals is ________.
A) political independence
B) goal independence
C) policy independence
D) instrument independence
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
6) Instrument independence is ________.
A) the ability of the central bank to set monetary policy goals
B) the ability of the government to set monetary policy goals
C) the ability of the government to set monetary policy instruments
D) the ability of the central bank to set monetary policy instruments
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
7) Goal independence is ________.
A) the ability of the central bank to set monetary policy goals
B) the ability of the government to set monetary policy goals
C) the ability of the prime minister to set monetary policy instruments
D) the ability of the government to set monetary policy instruments
Answer: A
Diff: 2
Type: MC
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Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
8) The Bank of Canada enjoys ________.
A) instrument independence
B) political dependence
C) goal independence
D) A and C only.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
9) The Bank of Canada enjoys ________.
A) instrument independence
B) political independence
C) goal independence
D) A and B only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
10) Under the current "joint responsibility system," ________.
A) in the event of a serious policy conflict the minister of finance can issue a directive that the
Bank of Canada must follow
B) the government accepts full responsibility for monetary policy
C) the Bank of Canada does not have considerable autonomy in the conduct of day-to-day
monetary policy
D) A and B only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
11) Under the current "joint responsibility system," ________.
A) the Bank of Canada and the minister of finance consult regularly
B) in the event of a serious policy conflict the minister of finance can issue a directive that the
Bank of Canada must follow
C) the Bank of Canada has full responsibility for monetary policy
D) A and B only.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
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12) Under the current "joint responsibility system," ________.
A) the Bank of Canada does not have considerable autonomy in the conduct of day-to-day
monetary policy
B) in the event of a serious policy conflict the minister of finance can issue a directive that the
Bank of Canada must follow
C) the government has no responsibility for the policy being followed by the Bank of Canada
D) the Bank of Canada has full responsibility for monetary policy
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
13) Explain the joint responsibility system.
Answer: Under the joint responsibility system, the governor of the Bank of Canada and the
minister of finance, acting on behalf of the government, consult regularly and, in the event of a
serious disagreement over the conduct of monetary policy, the government has the right to
override the Bank's decisions. In particular, the minister of finance can issue a directive to the
Bank indicating the specific policy changes that the Bank must follow. The directive, however,
must be published indicating not only the new policy that the Bank is supposed to undertake
but also the period during which it is to apply.
Diff: 2
Type: ES
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
14.5
The Changing Face of the Bank of Canada
1) According to the performance of the Canadian economy, and the evolution of economic
theory, what is the most important goal of monetary policy?
A) Currency stability
B) Price stability
C) GDP growth
D) Employment growth
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
2) Which goal has been set jointly by the Bank and the Department of Finance?
A) Currency stability
B) GDP growth
C) Price stability
D) Employment growth
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
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3) Increased operational independence by the Bank of Canada has also raised the standards for
________.
A) accountability
B) secrecy
C) misconduct
D) confusion
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.3 Assess the degree of independence of the Bank of Canada
4) What contributed to the move towards accountability and transparency of the Bank of
Canada?
Answer: The Bank's move towards accountability and transparency was motivated by a
number of recent trends in society and the economy. These have included economic
comprehension about interest rates, developments about targets and inflation, and greater
openness in the government.
Diff: 2
Type: ES
Skill: Applied
Objective: 14.3 Assess the degree of independence of the Bank of Canada
14.6
Should the Bank of Canada Be Independent?
1) The political business cycle refers to the phenomenon that just before elections, politicians
enact ________ policies. After the elections, the bad effects of these policies (for example,
________ ) have to be counteracted with ________ policies.
A) expansionary; higher unemployment; contractionary
B) expansionary; a higher inflation rate; contractionary
C) contractionary; higher unemployment; expansionary
D) contractionary; a higher inflation rate; expansionary
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
2) The case for Bank of Canada independence includes the idea that ________.
A) a politically insulated Bank of Canada would be more concerned with long-run objectives
and thus be a defender of a sound dollar and a stable price level
B) a Bank of Canada under the control of the government might make the so-called political
business cycle more pronounced
C) the principal-agent problem is perhaps worse for the Bank than for politicians since the
former does not answer to the voters on election day
D) A and B only.
Answer: D
Diff: 3
Type: MC
Skill: Recall
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Objective:
Canada
14.4 Summarize the arguments for and against the independence of the Bank of
3) Which of the following statements concerning an independent central bank are true?
A) Politicians may prefer an independent central bank, as it can be used as a "whipping boy" or
"scapegoat" for poor economic performance.
B) Politicians in a democratic society may be shortsighted because of their desire to win
reelection; thus, the political process may generate a political business cycle, in which just
before an election contractionary policies are pursued to raise unemployment and interest rates.
C) Putting the Bank of Canada under control of the government may place too much pressure
on the Bank of Canada to finance federal budget deficits, thereby imparting an inflationary bias
to monetary policy.
D) A and C only
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
4) Which of the following statements concerning an independent central bank are true?
A) Politicians may prefer an independent central bank, as it can be used as a "whipping boy" or
"scapegoat" for poor economic performance.
B) Politicians in a democratic society may be shortsighted because of their desire to win
reelection; thus, the political process may generate a political business cycle, in which just
before an election expansionary policies are pursued to lower unemployment and interest rates.
C) Putting the Bank of Canada under control of the government may place too much pressure
on the Bank to finance federal budget deficits, thereby imparting an inflationary bias to
monetary policy.
D) All of the above are true statements.
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
5) The systematic and permanent differences in macroeconomic outcomes that differ by
political party are known as ________ business cycles.
A) partisan
B) electoral
C) real
D) nominal
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
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6) Advocates of Bank of Canada independence fear that subjecting the Bank to direct
government control would ________.
A) impart an anti-inflationary bias to monetary policy
B) force monetary authorities to sacrifice the long-run objective of price stability
C) make the so-called political business cycle even more pronounced
D) B and C only.
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
7) The strongest argument for an independent Bank of Canada rests on the view that subjecting
the Bank to more political pressures would impart ________.
A) an inflationary bias to monetary policy
B) a deflationary bias to monetary policy
C) a disinflationary bias to monetary policy
D) a countercyclical bias to monetary policy
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
8) Supporters of the current system of Bank of Canada independence believe that a less
autonomous Bank would ________.
A) adopt a short-run bias toward policymaking
B) pursue overly expansionary monetary policies
C) be more likely to create a political business cycle
D) do each of the above
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
9) The strongest argument for an independent Bank of Canada rests on the view that subjecting
the Bank to more political pressures would impart ________.
A) an inflationary bias to monetary policy
B) a deflationary bias to monetary policy
C) a disinflationary bias to monetary policy
D) a countercyclical bias to monetary policy
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
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10) Politicians in a democratic society may be shortsighted because of their desire to win
reelection; thus, the political process can ________.
A) impart an inflationary bias to monetary policy
B) impart a deflationary bias to monetary policy
C) generate a political business cycle, in which just before an election expansionary policies are
pursued to lower unemployment and interest rates
D) cause A and C only
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
11) Putting the Bank of Canada under control of the government ________.
A) may place too much pressure on the Bank of Canada to finance federal budget deficits
B) impart an inflationary bias to monetary policy
C) generate a political business cycle, in which just before an election contractionary policies
are pursued to raise unemployment and interest rates
D) may cause A and B only
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
12) Critics of the current system of Bank of Canada independence contend that ________.
A) the current system is undemocratic
B) voters have too much say about monetary policy
C) the governor has too much control over monetary policy on a day-today basis
D) B and C only.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
13) The case for Bank of Canada independence does not include the idea that ________.
A) political pressure would impart an inflationary bias to monetary policy
B) a politically insulated Bank would be more concerned with long-run objectives and thus be a
defender of a sound dollar and a stable price level
C) a Bank of Canada under the control of the government might make the so-called political
business cycle more pronounced
D) the principal-agent problem is perhaps worse for the Bank of Canada than for politicians
since the former does not answer to the voters on election day
Answer: D
Diff: 3
Type: MC
Skill: Recall
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Objective:
Canada
14.4 Summarize the arguments for and against the independence of the Bank of
14) Critics of Bank of Canada independence argue ________.
A) that it is undemocratic to have monetary policy controlled by an elite group responsible to
no one
B) that an independent Bank of Canada conducts monetary policy with a consistent inflationary
bias
C) that the Bank of Canada, since it does not face a binding budget constraint, spends too much
of its earnings
D) A and B only.
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
15) Recent research indicates that inflation performance (low inflation) has been found to be
best in countries with ________.
A) the most independent central banks
B) political control of monetary policy
C) money financing of budget deficits
D) a policy of always keeping interest rates low
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
16) Recent research indicates that inflation performance (low inflation) has been found to be
best in countries with ________.
A) the most independent central banks
B) the least independent central banks
C) political control of monetary policy
D) a policy of always keeping interest rates low
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
17) Recent research has found that countries with the most independent central banks have
experienced ________.
A) the lowest average rates of inflation
B) rates of inflation no different from countries with less independent central banks
C) the highest average rates of inflation
D) high inflation from financing deficits
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Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
18) Countries with the most independent central banks have low inflation ________.
A) but have higher unemployment than countries with less independent central banks
B) but have higher output fluctuations than countries with less independent central banks
C) and have lower rates of unemployment than countries with less independent central banks
D) but have no higher unemployment or output fluctuations than countries with less
independent central banks
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
19) How do political cycles influence aggregate economic activity?
Answer: We distinguish between two types of political cycles:
a. electoral business cycles: politicians maximize their popularity or their probability of
re-election by following pre-election expansionary fiscal policies in order to please the voters.
These give rise to persistent cyclical patterns of key policy and target variable across electoral
terms, regardless of the political orientation of the incumbent government.
b. partisan business cycles: systematic and permanent differences in macroeconomic outcomes
that differ by political party. In this case politicians are ideological; they represent the interests
of different pressure groups and, when in office, follow policies which are favorable to their
supporting groups.
Diff: 2
Type: ES
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
20) Explain two concepts of central bank independence. Is the Bank of Canada politically
independent? Why do economists think central bank independence is important?
Answer: Instrument independence is the ability of the central bank to set its instruments, and
goal independence is the ability of a central bank to set its goals. The Bank of Canada enjoys
instrument independence but not goal independence because of the "joint responsibility
system." Independence is important because there is some evidence that independent central
banks pursue lower rates of inflation without harming overall economic performance.
Diff: 3
Type: ES
Skill: Recall
Objective: 14.4 Summarize the arguments for and against the independence of the Bank of
Canada
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14.7
Explaining Central Bank Behaviour
1) The theory of bureaucratic behaviour suggests that the objective of a bureaucracy is to
maximize ________.
A) the public's welfare
B) profits
C) its own welfare
D) conflict with the executive and legislative branches of government
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help
explain central bank actions
2) The theory of bureaucratic behavior suggests that a consumer's behaviour is motivated by the
________.
A) maximization of personal welfare
B) maximization social welfare
C) minimization of government intervention
D) minimization political pressure
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help
explain central bank actions
3) The theory of bureaucratic behaviour suggests that the Bank of Canada will fight ________.
A) to preserve the public's welfare
B) to maximize profits
C) minimize its own welfare
D) to preserve autonomy
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help
explain central bank actions
4) What is the theory of bureaucratic behavior and how can it be used to explain the behavior of
the Bank of Canada?
Answer: The theory of bureaucratic behavior concludes that the main objective of any
bureaucracy is to maximize its own welfare, which is related to power and prestige. This can
explain why the Bank of Canada has defended its autonomy, and will avoid conflict with
powerful groups that might threaten to curtail its power and reduce its autonomy.
Diff: 1
Type: ES
Skill: Recall
Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help
explain central bank actions
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14.8
Structure and Independence of Foreign Central Banks
1) Which of the following is not an entity of the Federal Reserve System?
A) Federal Reserve Banks
B) The FDIC
C) The Board of Governors
D) The Board of Advisors
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
2) Which of the following are entities of the Federal Reserve System?
A) Federal Reserve Banks
B) The FOMC
C) The Board of Advisors
D) A and B only
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
3) Which of the following are entities of the Federal Reserve System?
A) Federal Reserve Banks
B) The FDIC
C) The Board of Advisors
D) A and B only
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
4) The board of governors members of the federal reserve system in the U.S. are appointed by
the ________ and confirmed by the ________.
A) president; senate
B) president; house of representatives
C) senate; president
D) house of representatives; president
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
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5) According to the authors of your textbook, the Federal Reserve is ________.
A) remarkably free of the political pressures that influence other government agencies
B) more responsive to the political pressures that influence other government agencies
C) constrained in its policy making by the congressional threat to reduce Fed independence
D) A and C only.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
6) According to the author of your textbook, the Federal Reserve is ________.
A) remarkably free of the political pressures that influence other government agencies
B) more responsive to the political pressures that influence other government agencies
C) probably somewhat constrained in its policy making by the congressional threat to reduce
Fed independence
D) A and C only.
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
7) The European Central Bank is located in ________.
A) Frankfurt
B) London
C) Paris
D) Rome
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
8) The Executive Board of the European Central Bank ________.
A) consists of the European Central Bank's president, vice president, and four other members
B) is responsible for the business of the European Central Bank
C) is responsible for the implementation of monetary policy in accordance with the guidelines
set by the Governing Council
D) All of the above.
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
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9) The Eurosystem has a structure like that of the ________.
A) Bank of Canada
B) Federal Reserve System
C) Bank of England
D) Swiss National Bank
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
10) The Maastricht Treaty which established the European Central Bank, defined price stability
as an inflation rate equal to ________.
A) It did not specify exactly.
B) 0 percent
C) 1 percent
D) 2 percent
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
11) Which of the following are entities of the Eurosystem?
A) The European Central Bank
B) The central banks of the European Union countries that have adopted the euro
C) The central banks of the euro area countries and of the European Union countries that have
not yet adopted the euro
D) A and B only
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
12) Which of the following are entities of the Eurosystem?
A) The European Central Bank
B) National finance ministries in each country
C) The Governing Council of the European Central Bank
D) A and C only
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
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13) Regarding central bank independence, ________.
A) the Fed is more independent than the European Central Bank
B) the European Central Bank is more independent than the Fed
C) the trend in industrialized nations has been to reduce central bank independence
D) the Bank of England has the longest tradition of independence of any central bank in the
world
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
14) Of the major central banks of the world, the most independent is ________.
A) the Federal Reserve System
B) the European Central Bank
C) the Bank of Canada
D) the Bank of England
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
15) The oldest central bank, having been founded in 1694, is the ________.
A) Bank of England
B) Deutsche Bundesbank
C) Bank of Japan
D) Federal Reserve System
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
16) Which of the following statements are true of the Bank of England?
A) The Bank of England was established in 1919.
B) The governor and four deputy governors comprise the monetary policy making body.
C) Until 1997, the decision to raise or lower interest rates resided not with the Bank of England
but with the chancellor of the Exchequer.
D) B and C only.
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
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17) Which of the following statements are true of the Bank of England?
A) The Bank of England was established in 1894.
B) Until 1997, the decision to raise or lower interest rates resided not with the Bank of England
but with the chancellor of the Exchequer.
C) The government can overrule the Bank and set rates "in extreme economic circumstances"
and "for a limited period."
D) B and C only.
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
18) While legislation enacted in 1998 granted the Bank of Japan new powers and greater
autonomy, its critics contend that its independence is ________.
A) limited by the Ministry of Finance's control over a portion of its budget
B) too great because it need not pursue a policy of price stability even if that is the popular will
of the people
C) too great since the Ministry of Finance no longer has veto power over the bank's budget
D) limited since the Ministry of Finance can dismiss senior bank officials
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
19) The Bank of Japan was founded in ________.
A) 1882
B) 1922
C) 1932
D) 1952
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
20) The trend in recent years is that more and more governments ________.
A) have been granting greater independence to their central banks
B) have been reducing the independence of their central banks to make them more accountable
for poor economic performance
C) have mandated that their central banks focus on controlling inflation
D) have required their central banks to cooperate more with their Ministers of Finance
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
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world
21) Which of the following statements about central bank structure and independence are true?
A) In recent years, with the exception of the Bank of England and the Bank of Japan, most
countries have reduced the independence of their central banks, subjecting them to greater
democratic control.
B) Before the Bank of England was granted greater independence, the Federal Reserve was the
most independent of the world's central banks.
C) Both theory and experience suggest that more independent central banks produce better
monetary policy.
D) While the European Central Bank is independent, it is not as independent as the Federal
Reserve.
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
22) Which of the following statements about central bank structure and independence are NOT
true?
A) In recent years, with the exception of the Bank of England and the Bank of Japan, most
countries have reduced the independence of their central banks, subjecting them to greater
democratic control.
B) Before the Bank of England was granted greater independence, the Federal Reserve was the
most independent of the world's central banks.
C) Both theory and experience suggest that more independent central banks produce better
monetary policy.
D) A and B only
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
23) Which of the following statements about central bank structure and independence are true?
A) In recent years there has been a remarkable trend toward increasing independence.
B) In recent years, greater independence has been granted to many central banks, with the
exception of the Bank of England and the Bank of Japan, which are still subject to strict
governmental control.
C) In theory, central banks subject to government control produce better monetary policy, but
experience suggests that more independent central banks have produced superior monetary
policy results.
D) A and B only
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
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world
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24) Why did the Governing Counsel of the ECB decided to operate by consensus?
Answer: Although its members have the legal right to vote, no formal vote is actually taken in
the Governing Counsel and decisions are reached by consensus. One reason for that is because
of worries that the casting of individual votes might lead to heads of National Central Banks
supporting a monetary policy that would be appropriate for their individual countries, but not
necessarily for the countries in the European Monetary Union as a whole.
Diff: 2
Type: ES
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
25) What are the main differences between the European system of Central Banks and the
Federal Reserve System?
Answer: Although their structure is similar some important differences distinguish the two:
a. the budgets of the Federal Reserve Banks are controlled by the Board of Governors, while
the National Central Banks control their own budgets and the budget of the ECB in Frankfurt.
b. the monetary operations of the Eurosystem are conducted by all the National Central Banks
in each country so that monetary operations are not centralized as they are in the Federal
Reserve System.
c. in contrast to the Federal Reserve the ECB is not involved in supervision and regulation of
financial institutions; these tasks are left to the individual countries.
Diff: 3
Type: ES
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
26) Describe the function and structure of the board of governors of the federal reserve system.
Answer: At the head of the federal Reserve System is the seven-member Board of Governors,
headquartered in Washington D.C. Each governor is appointed by the president of the U.S. and
confirmed by the Senate. The governors can serve one nonrenewable 14-year term plus part of
another term, with one governor's term expiring every other January. The chairman of the
Board of Governors is chosen from among the seven governors and serves a 4-year term.
Diff: 2
Type: ES
Skill: Recall
Objective: 14.6 Discuss the structure and independence of other major central banks around the
world
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 15 The Money Supply Process
15.1
Three Players in the Money Supply Process
1) The government agency that oversees the banking system and is responsible for the conduct
of monetary policy in Canada is ________.
A) the Bank of Canada
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B) the Department of Finance
C) the Canada Customs and Revenue Agency
D) the House of Parliament
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.1 List and describe the "three players" that influence the money supply
2) Individuals that lend funds to a bank by opening a chequing account are called ________.
A) policyholders
B) partners
C) depositors
D) debt holders
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.1 List and describe the "three players" that influence the money supply
3) The three players in the money supply process include ________.
A) banks, depositors, and the Department of Finance
B) banks, depositors, and borrowers
C) banks, depositors, and the central bank
D) banks, borrowers, and the central bank
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.1 List and describe the "three players" that influence the money supply
4) Of the three players in the money supply process, most observers agree that the most
important player is ________.
A) the Bank of Canada
B) the Department of Finance
C) the Canada Customs and Revenue Agency
D) the House of Parliament
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.1 List and describe the "three players" that influence the money supply
5) Who are the three players in the money supply process? Describe their roles.
Answer: The three players are: the central bank, depository institutions (banks) and
depositors. The central bank (in Canada, the Bank of Canada) oversees the banking system and
is responsible for the conduct of monetary policy. Banks are the financial intermediaries that
accept deposits from individuals and institutions. Depositors, both individuals and institutions,
hold deposits in banks.
Diff: 1
Type: ES
Skill: Recall
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Objective:
15.2
15.1 List and describe the "three players" that influence the money supply
The Bank of Canada's Balance Sheet
1) Both ________ and ________ are Bank of Canada assets.
A) notes in circulation; reserves
B) notes in circulation; government securities
C) government securities; advances to banks
D) government securities; reserves
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
2) The monetary liabilities of the Bank of Canada include ________.
A) government securities and advances to banks
B) notes in circulation
C) government securities and reserves
D) notes in circulation and advances to banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
3) Both ________ and ________ are monetary liabilities of the Bank.
A) government securities; advances to banks
B) notes in circulation; reserves
C) government securities; reserves
D) notes in circulation; advances to banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
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4) The sum of the Bank of Canada's monetary liabilities and the Canadian Mint's monetary
liabilities is called ________.
A) the money supply
B) notes in circulation
C) bank reserves
D) the monetary base
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
5) The monetary base consists of ________.
A) notes in circulation and Canada bonds
B) notes in circulation and securities
C) notes in circulation and reserves
D) reserves and Canada bonds
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
6) The interest rate the Bank of Canada charges banks borrowing from the Bank is the
________.
A) overnight rate
B) Treasury bill rate
C) bank rate
D) prime rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
7) When banks borrow money from the Bank of Canada, these funds are called ________.
A) Bank funds
B) borrowed reserves
C) Bank loans
D) overnight funds
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities
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15.3
Control of the Monetary Base
1) The monetary base minus currency in circulation equals ________.
A) reserves
B) the borrowed base
C) the nonborrowed base
D) advances to banks
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
2) The monetary base minus reserves equals ________.
A) currency in circulation
B) the borrowed base
C) the nonborrowed base
D) advances to banks
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
3) High-powered money minus reserves equals ________.
A) reserves
B) currency in circulation
C) the monetary base
D) the nonborrowed base
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
4) High-powered money minus currency in circulation equals ________.
A) reserves
B) the borrowed base
C) the nonborrowed base
D) advances to banks
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
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5) Purchases and sales of government securities by the Bank of Canada are called ________.
A) advances to banks
B) Bank fund transfers
C) open market operations
D) swap transactions
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
6) When the Bank of Canada purchases a government bond from a bank, reserves in the
banking system ________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
7) Suppose a person cashes his payroll cheque and holds all the funds in the form of currency.
Everything else held constant, total reserves in the banking system ________ and the monetary
base ________.
A) remain unchanged; increases
B) decrease; increases
C) decrease; remains unchanged
D) decrease; decreases
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
8) Suppose your payroll cheque is directly deposited to your chequing account. Everything else
held constant, total reserves in the banking system ________ and the monetary base ________.
A) remain unchanged; remains unchanged
B) remain unchanged; increases
C) decrease; increases
D) decrease; decreases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
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9) When the Bank of Canada sells a government bond to a bank, reserves in the banking system
________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
10) When a bank sells a government bond to the Bank of Canada, reserves in the banking
system ________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
11) When a bank buys a government bond from the Bank of Canada, reserves in the banking
system ________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
12) The monetary base declines when ________.
A) the Bank extends advances to banks
B) deposits at the Bank decrease
C) float increases
D) the Bank sells securities
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
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13) When the Bank of Canada buys $100 worth of bonds from First National Bank, reserves in
the banking system ________.
A) increase by $100
B) increase by more than $100
C) decrease by $100
D) decrease by more than $100
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
14) When the Bank of Canada sells $100 worth of bonds to First National Bank, reserves in the
banking system ________.
A) increase by $100
B) increase by more than $100
C) decrease by $100
D) decrease by more than $100
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
15) If a person selling bonds to the Bank of Canada cashes the Bank's cheque, then reserves
________ and currency in circulation ________, everything else held constant.
A) remain unchanged; declines
B) remain unchanged; increases
C) decline; remains unchanged
D) increase; remains unchanged
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
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16) The effect of an open market purchase on reserves differs depending on how the seller of
the bonds keeps the proceeds. If the proceeds are kept in ________, the open market purchase
has no effect on reserves; if the proceeds are kept as ________, reserves increase by the amount
of the open market purchase.
A) deposits; deposits
B) deposits; currency
C) currency; deposits
D) currency; currency
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
17) The effect of an open market purchase on reserves differs depending on how the seller of
the bonds keeps the proceeds. If the proceeds are kept in currency, the open market purchase
________ reserves; if the proceeds are kept as deposits, the open market purchase ________
reserves.
A) has no effect on; has no effect on
B) has no effect on; increases
C) increases; has no effect on
D) decreases; increases
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
18) When an individual sells a $100 bond to the Bank, she may either deposit the cheque she
receives or cash it for currency. In both cases ________.
A) reserves increase
B) high-powered money increases
C) reserves decrease
D) high-powered money decreases
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
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19) If a member of the nonbank public sells a government bond to the Bank of Canada in
exchange for currency, the monetary base will ________, but ________.
A) remain unchanged; reserves will fall
B) remain unchanged; reserves will rise
C) rise; currency in circulation will remain unchanged
D) rise; reserves will remain unchanged
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
20) If a member of the nonbank public purchases a government bond from the Bank of Canada
in exchange for currency, the monetary base will ________, but reserves will ________.
A) remain unchanged; rise
B) remain unchanged; fall
C) rise; remain unchanged
D) fall; remain unchanged
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
21) For which of the following is the change in reserves necessarily different from the change
in the monetary base?
A) Open market purchases from a bank
B) Open market purchases from an individual who deposits the cheque in a bank
C) Open market purchases from an individual who cashes the cheque
D) Open market sale to a bank
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
22) An increase in ________ leads to an equal ________ in the monetary base in the long run.
A) float; increase
B) float; decrease
C) securities; increase
D) securities; decrease
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
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23) When a member of the nonbank public withdraws currency from her bank account,
________.
A) both the monetary base and bank reserves fall
B) both the monetary base and bank reserves rise
C) the monetary base falls, but bank reserves remain unchanged
D) bank reserves fall, but the monetary base remains unchanged
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
24) When a member of the nonbank public deposits currency into her bank account, ________.
A) both the monetary base and bank reserves fall
B) both the monetary base and bank reserves rise
C) the monetary base falls, but bank reserves remain unchanged
D) bank reserves rise, but the monetary base remains unchanged
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
25) When the Bank extends a $100 loan to the First National Bank, reserves in the banking
system ________.
A) increase by $100
B) increase by more than $100
C) decrease by $100
D) decrease by more than $100
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
26) All else the same, when the Bank calls in a $100 loan previously extended to the First
National Bank, reserves in the banking system ________.
A) increase by $100
B) increase by more than $100
C) decrease by $100
D) decrease by more than $100
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
445
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27) When the Bank of Canada extends a loan to a bank, the monetary base ________ and
reserves ________.
A) remains unchanged; decrease
B) remains unchanged; increase
C) increases; increase
D) increases; remain unchanged
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
28) When the Bank of Canada calls in a loan from a bank, the monetary base ________ and
reserves ________.
A) remains unchanged; decrease
B) remains unchanged; increase
C) decreases; decrease
D) decreases; remains unchanged
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
29) There are two ways in which the Bank can provide additional reserves to the banking
system: it can ________ government bonds or it can ________ advances to banks to
commercial banks.
A) sell; extend
B) sell; call in
C) purchase; extend
D) purchase; call in
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
30) A decrease in ________ leads to an equal ________ in the monetary base in the short run.
A) float; increase
B) float; decrease
C) deposits at the Bank; decrease
D) advances to banks; increase
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
446
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31) An increase in ________ leads to an equal ________ in the monetary base in the short run.
A) float; decrease
B) float; increase
C) advances to banks; decrease
D) deposits at the Bank; increase
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
32) A decrease in ________ leads to an equal ________ in the monetary base in the long run.
A) float; increase
B) float; decrease
C) securities; increase
D) securities; decrease
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
33) The Bank does not tightly control the monetary base because it does not completely control
________.
A) open market purchases
B) open market sales
C) borrowed reserves
D) the rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
34) Subtracting borrowed reserves from the monetary base obtains ________.
A) reserves
B) high-powered money
C) the nonborrowed monetary base
D) the borrowed monetary base
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
447
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35) The relationship between borrowed reserves, the nonborrowed monetary base, and the
monetary base is ________.
A) MB = MBn - BR
B) BR = MBn - MB
C) BR = MB - MBn
D) MB = BR - mn
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
36) Explain two ways by which the Bank of Canada can increase the monetary base. Why is the
effect of Bank of Canada actions on bank reserves less exact than the effect on the monetary
base?
Answer: The Bank can increase the monetary base by purchasing government bonds and by
extending advances to banks. If the person selling the security chooses to keep the proceeds in
currency, bank reserves do not increase. Because the Bank cannot control the distribution of the
monetary base between reserves and currency, it has less control over reserves than the base.
Diff: 2
Type: ES
Skill: Recall
Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects
on the Bank of Canada's balance sheet
15.4
Multiple Deposit Creation: A Simple Model
1) When the Bank of Canada supplies the banking system with an extra dollar of reserves,
deposits increase by more than one dollar - a process called ________.
A) extra deposit creation
B) multiple deposit creation
C) expansionary deposit creation
D) stimulative deposit creation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
2) When the Bank of Canada supplies the banking system with an extra dollar of reserves,
deposits ________ by ________ than one dollar—a process called multiple deposit creation.
A) increase; less
B) increase; more
C) decrease; less
D) decrease; more
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
448
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3) If the desired reserve ratio is equal to 10 percent, a single bank can increase its loans up to a
maximum amount equal to ________.
A) its excess reserves
B) 10 times its excess reserves
C) 10 percent of its excess reserves
D) its total reserves
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
4) In the simple deposit expansion model, if the Bank of Canada purchases $100 worth of
bonds from a bank that previously had no excess reserves, the bank can now increase its loans
by ________.
A) $10
B) $100
C) $100 times the reciprocal of the desired reserve ratio
D) $100 times the desired reserve ratio
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
5) In the simple deposit expansion model, if the Bank of Canada purchases $100 worth of
bonds from a bank that previously had no excess reserves, deposits in the banking system can
potentially increase by ________.
A) $10
B) $100
C) $100 times the reciprocal of the desired reserve ratio
D) $100 times the desired reserve ratio
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
449
Copyright © 2017 Pearson Canada, Inc.
6) The formula for the simple deposit multiplier can be expressed as ________.
A) △R =
× △T
B) △D =
× △R
C) △r =
× △T
D) △R =
× △D
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
7) In the simple model of multiple deposit creation in which banks do not hold excess reserves,
the increase in chequable deposits equals the product of the change in excess reserves and the
________.
A) reciprocal of the excess reserve ratio
B) simple deposit multiplier
C) reciprocal of the simple deposit multiplier
D) bank rate
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
8) The simple deposit multiplier can be expressed as the ratio of the ________.
A) change in reserves in the banking system divided by the change in deposits
B) change in deposits divided by the change in reserves in the banking system
C) desired reserve ratio divided by the change in reserves in the banking system
D) change in deposits divided by the desired reserve ratio
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
9) If reserves in the banking system increase by $100, then chequable deposits will increase by
$1000 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.01
B) 0.10
C) 0.05
D) 0.20
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
450
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10) If reserves in the banking system increase by $100, then chequable deposits will increase
by $500 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.01
B) 0.10
C) 0.05
D) 0.20
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
11) If the desired reserve ratio is 10 percent, the simple deposit multiplier is ________.
A) 5.0
B) 2.5
C) 100.0
D) 10.0
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
12) If the desired reserve ratio is 15 percent, the simple deposit multiplier is ________.
A) 15.0
B) 1.5
C) 6.67
D) 3.33
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
13) If the desired reserve ratio is 20 percent, the simple deposit multiplier is ________.
A) 5.0
B) 2.5
C) 4.0
D) 10.0
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
451
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14) If the desired reserve ratio is 25 percent, the simple deposit multiplier is ________.
A) 5.0
B) 2.5
C) 4.0
D) 10.0
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
15) A simple deposit multiplier equal to one implies a desired reserve ratio equal to ________.
A) 100 percent
B) 50 percent
C) 25 percent
D) 0 percent
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
16) A simple deposit multiplier equal to two implies a desired reserve ratio equal to ________.
A) 100 percent
B) 50 percent
C) 25 percent
D) 0 percent
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
17) A simple deposit multiplier equal to four implies a desired reserve ratio equal to ________.
A) 100 percent
B) 50 percent
C) 25 percent
D) 0 percent
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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18) In the simple deposit expansion model, if the banking system has excess reserves of $75,
and the desired reserve ratio is 20 percent, the potential expansion of chequable deposits is
________.
A) $75
B) $750
C) $37.50
D) $375
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
19) In the simple deposit expansion model, if the desired reserve ratio is 20 percent and the
Bank of Canada increases reserves by $100, chequable deposits can potentially expand by
________.
A) $100
B) $250
C) $500
D) $1000
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
20) In the simple deposit expansion model, if the desired reserve ratio is 10 percent and the
Bank of Canada increases reserves by $100, chequable deposits can potentially expand by
________.
A) $100
B) $250
C) $500
D) $1000
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
21) In the simple deposit expansion model, an expansion in chequable deposits of $1000 when
the desired reserve ratio is equal to 20 percent implies that the Bank of Canada ________.
A) sold $200 in government bonds
B) sold $500 in government bonds
C) purchased $200 in government bonds
D) purchased $500 in government bonds
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
453
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22) In the simple deposit expansion model, an expansion in chequable deposits of $1000 when
the desired reserve ratio is equal to 10 percent implies that the Bank of Canada ________.
A) sold $1000 in government bonds
B) sold $100 in government bonds
C) purchased $1000 in government bonds
D) purchased $100 in government bonds
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
23) In the simple deposit expansion model, a decline in chequable deposits of $1000 when the
desired reserve ratio is equal to 20 percent implies that the Bank of Canada ________.
A) sold $200 in government bonds
B) sold $500 in government bonds
C) purchased $200 in government bonds
D) purchased $500 in government bonds
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
24) In the simple deposit expansion model, a decline in chequable deposits of $1000 when the
desired reserve ratio is equal to 10 percent implies that the Bank of Canada ________.
A) sold $1000 in government bonds
B) sold $100 in government bonds
C) purchased $1000 in government bonds
D) purchased $100 in government bonds
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
25) In the simple deposit expansion model, a decline in chequable deposits of $500 when the
desired reserve ratio is equal to 10 percent implies that the Bank of Canada ________.
A) sold $500 in government bonds
B) sold $50 in government bonds
C) purchased $50 in government bonds
D) purchased $500 in government bonds
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
454
Copyright © 2017 Pearson Canada, Inc.
26) In the simple deposit expansion model, a decline in chequable deposits of $500 when the
desired reserve ratio is equal to 20 percent implies that the Bank of Canada ________.
A) sold $250 in government bonds
B) sold $100 in government bonds
C) sold $50 in government bonds
D) purchased $100 in government bonds
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
27) If reserves in the Bank of Canada increase by $100, then chequable deposits will increase
by $400 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.01
B) 0.10
C) 0.20
D) 0.25
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
28) If reserves in the banking system increase by $100, then chequable deposits will increase
by $667 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.01
B) 0.05
C) 0.15
D) 0.20
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
29) If reserves in the banking system increase by $100, then chequable deposits will increase
by $100 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.01
B) 0.10
C) 0.20
D) 1.00
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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30) If reserves in the banking system increase by $100, then chequable deposits will increase
by $2000 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.01
B) 0.05
C) 0.10
D) 0.20
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
31) If reserves in the banking system increase by $200, then chequable deposits will increase
by $500 in the simple model of deposit creation when the desired reserve ratio is ________.
A) 0.04
B) 0.25
C) 0.40
D) 0.50
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
32) If a bank has excess reserves of $10000 and demand deposit liabilities of $80000, and if the
reserve requirement is 20 percent, then the bank has actual reserves of ________.
A) $16000
B) $20000
C) $26000
D) $36000
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
33) If a bank has excess reserves of $20000 and demand deposit liabilities of $80000, and if the
reserve requirement is 20 percent, then the bank has total reserves of ________.
A) $16000
B) $20000
C) $26000
D) $36000
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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34) If a bank has excess reserves of $5000 and demand deposit liabilities of $80000, and if the
reserve requirement is 20 percent, then the bank has actual reserves of ________.
A) $11000
B) $20000
C) $21000
D) $26000
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
35) If a bank has excess reserves of $15000 and demand deposit liabilities of $80000, and if the
reserve requirement is 20 percent, then the bank has total reserves of ________.
A) $11000
B) $21000
C) $31000
D) $41000
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
36) If a bank has excess reserves of $4000 and demand deposit liabilities of $100,000, and if
the reserve requirement is 15 percent, then the bank has actual reserves of ________.
A) $17000
B) $19000
C) $24000
D) $29000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
37) If a bank has excess reserves of $4000 and demand deposit liabilities of $100,000, and if
the reserve requirement is 10 percent, then the bank has actual reserves of ________.
A) $14000
B) $19000
C) $24000
D) $29000
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
457
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38) If a bank has excess reserves of $7000 and demand deposit liabilities of $100,000, and if
the reserve requirement is 15 percent, then the bank has actual reserves of ________.
A) $17000
B) $22000
C) $27000
D) $29000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
39) If a bank has excess reserves of $7000 and demand deposit liabilities of $100,000, and if
the reserve requirement is 10 percent, then the bank has actual reserves of ________.
A) $14000
B) $17000
C) $22000
D) $27000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
40) A bank has excess reserves of $6000 and demand deposit liabilities of $100,000 when the
desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess
reserves will be ________.
A) -$5000
B) -$1000
C) $1000
D) $5000
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
41) A bank has excess reserves of $4000 and demand deposit liabilities of $100,000 when the
desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess
reserves will be ________.
A) -$5000
B) -$1000
C) $1000
D) $5000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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42) A bank has excess reserves of $10000 and demand deposit liabilities of $100,000 when the
desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess
reserves will be ________.
A) -$5000
B) -$1000
C) $1000
D) $5000
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
43) A bank has no excess reserves and demand deposit liabilities of $100,000 when the desired
reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves
will now be ________.
A) -$5000
B) -$1000
C) $1000
D) $5000
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
44) A bank has excess reserves of $1000 and demand deposit liabilities of $80000 when the
reserve requirement is 20 percent. If the reserve requirement is lowered to 10 percent, the
bank's excess reserves will be ________.
A) $1000
B) $8000
C) $9000
D) $17000
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
45) A bank has excess reserves of $1000 and demand deposit liabilities of $80000 when the
reserve requirement is 25 percent. If the reserve requirement is lowered to 20 percent, the
bank's excess reserves will be ________.
A) $1000
B) $5000
C) $8000
D) $9000
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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46) Decisions by depositors to increase their holdings of ________, or of banks to hold
________ will result in a smaller expansion of deposits than the simple model predicts.
A) deposits; desired reserves
B) deposits; excess reserves
C) currency; desired reserves
D) currency; excess reserves
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
47) Decisions by depositors to increase their holdings of ________, or of banks to hold excess
reserves will result in a ________ expansion of deposits than the simple model predicts.
A) deposits; smaller
B) deposits; larger
C) currency; smaller
D) currency; larger
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
48) Decisions by ________ about their holdings of currency and by ________ about their
holdings of excess reserves affect the money supply.
A) borrowers; depositors
B) banks; depositors
C) depositors; borrowers
D) depositors; banks
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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49) Assume that no banks hold excess reserves, and the public holds no currency. If a bank
sells a $100 security to the Bank of Canada, explain what happens to this bank and two
additional steps in the deposit expansion process, assuming a 10 percent reserve requirement.
How much do deposits and loans increase for the banking system when the process is
completed?
Answer: Bank A first changes a security for reserves, and then lends the reserves, creating
loans. It receives $100 in reserves from the sale of securities. Since all of these reserve will be
excess reserves (there was no change in chequable deposits), the bank will loan out all $100.
The $100 will then be deposited into Bank B. This bank now has a change in reserves of $100,
of which $90 is excess reserves. Bank B will loan out this $90, which will be deposited into
Bank C. Bank C now has an increase in reserves of $90, $81 of which is excess reserves. Bank
C will loan out this $81 dollars and the process will continue until there are no more excess
reserves in the banking system.
For the banking system, both loans and deposits increase by $1000.
Diff: 1
Type: ES
Skill: Applied
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
50) Explain two reasons why the Bank of Canada does not have complete control over the level
of bank deposits and loans. Explain how a change in either factor affects the deposit expansion
process.
Answer: The Bank of Canada does not completely control the level of bank deposits and
loans because banks can hold excess reserves and the public can change its currency holdings.
A change in either factor changes the deposit expansion process. An increase in either excess
reserves or currency reduces the amount by which deposits and loans are increased.
Diff: 1
Type: ES
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
51) Explain why the simple deposit multiplier overstates the true deposit multiplier.
Answer: The simple model ignores the role banks and their customers play in the creation
process. The bank's customers can decide to hold currency and the bank can decide to hold
excess reserves. Both of these will restrict the banking system's ability to create deposits. Thus,
the true multiplier is less than the prediction of the simple deposit multiplier.
Diff: 1
Type: ES
Skill: Recall
Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts
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15.5
Factors That Determine the Money Supply
1) An increase in the nonborrowed monetary base, everything else held constant, will cause
________.
A) the money supply to fall
B) the money supply to rise
C) no change in the money supply
D) demand deposits to fall
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.5 List the factors that effect the money supply
2) The money supply is ________ related to the nonborrowed monetary base, and ________
related to the level of borrowed reserves.
A) positively; negatively
B) negatively; not
C) positively; positively
D) negatively; negatively
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.5 List the factors that effect the money supply
3) The money supply is ________ related to the level of borrowed reserves.
A) negatively
B) not
C) positively
D) sometimes
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.5 List the factors that effect the money supply
4) Everything else held constant, a decrease in the desired reserve ratio will mean ________.
A) a decrease in the money supply
B) an increase in the money supply
C) a decrease in chequable deposits
D) an increase in advances to banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.5 List the factors that effect the money supply
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5) Everything else held constant, an increase in currency holdings will cause ________.
A) the money supply to rise
B) the money supply to remain constant
C) the money supply to fall
D) chequable deposits to rise
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.5 List the factors that effect the money supply
15.6
Overview of the Money Supply Process
1) In the model of the money supply process, the Bank of Canada's role in influencing the
money supply is represented by ________.
A) both desired reserves and currency holdings
B) nonborrowed reserves and borrowed reserves
C) only borrowed reserves
D) only nonborrowed reserves
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.6 Summarize how the "three players" can influence the money supply
2) In the model of the money supply process, the depositor's role in influencing the money
supply is represented by ________.
A) only the currency holdings
B) both the currency holdings and desired reserves
C) the currency holdings, desired reserves, and borrowed reserves
D) only desired reserves
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.6 Summarize how the "three players" can influence the money supply
3) In the model of the money supply process, the bank's role in influencing the money supply
process is represented by ________.
A) only the desired reserve ratio
B) both the desired reserve ratio and the market interest rate
C) only the currency ratio
D) only borrowed reserves
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.6 Summarize how the "three players" can influence the money supply
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15.7
The Money Multiplier
1) The formula linking the money supply to the monetary base is ________.
A) M = m/MB
B) M = m × MB
C) m = M × MB
D) MB = M × m
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
2) If the money multiplier is equal to 2 and the money supply is equal to $100 billion, the
monetary base is equal to ________.
A) $50 billion
B) $200 billion
C) $25 billion
D) cannot be determined
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
3) If the money supply is equal to $400 billion and the monetary base is equal to $100 billion,
the money multiplier is equal to ________.
A) 4
B) 0.25
C) 5
D) cannot be determined
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
4) If the money supply is equal to $500 billion and the monetary base is equal to $250 billion,
the money multiplier is equal to ________.
A) 2
B) 0.5
C) 5
D) cannot be determined
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
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5) The equation linking the monetary base to the levels of chequable deposits and currency is
________.
A) MB = (r × D) + C
B) MB = (r + D) + ER + C
C) MB = (r/D) + ER + C
D) MB = (r - D) + ER - C
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
6) When currency is equal to $100 billion and reserves are equal to $200 billion, and we know
that the money multiplier is equal to 2.5, then the money supply will be equal to ________.
A) $750 billion
B) $250 billion
C) $300 billion
D) $450 billion
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
7) When currency is equal to $200 billion and reserves are equal to $350 billion, and we know
that the money multiplier is equal to 1.5, then the money supply will be equal to ________.
A) $825 billion
B) $225 billion
C) $366.66 billion
D) $500 billion
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
8) An increase in the monetary base that goes into ________ is not multiplied, while an
increase that goes into ________ is multiplied.
A) deposits; currency
B) excess reserves; currency
C) currency; excess reserves
D) currency; deposits
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
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9) When the monetary base is equal to $200 billion, the desired reserve ratio is 0.10 and the
currency ratio is equal to 0.20, the money supply is equal to ________.
A) $800 billion
B) $600 billion
C) $500 billion
D) $300 billion
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
10) When the monetary base is equal to $200 billion, the desired reserve ratio is 0.10 and the
currency ratio is equal to 0.20, the money multiplier is equal to ________ and the money
supply is equal to ________.
A) 4; $800 billion
B) 3.67; $734 billion
C) 4; $734 billion
D) 3.67; $800 billion
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
11) Assuming initially that r = 10 percent and c = 40 percent, an increase in r to 15 percent
causes ________.
A) the money multiplier to increase from 2.55 to 2.8
B) the money multiplier to decrease from 2.8 to 2.55
C) the money multiplier to increase from 1.82 to 2
D) no change in the money multiplier
Answer: B
Diff: 3
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
12) Assuming initially that r = 10 percent and c = 40 percent, a decrease in r to 5 percent causes
________.
A) the money multiplier to increase from 2.8 to 3.11
B) the money multiplier to decrease from 3.11 to 2.8
C) the money multiplier to increase from 2 to 2.22
D) the money multiplier to decrease from 2.22 to 2
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
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13) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is
________.
A) $8000 billion
B) $1200 billion
C) $120 billion
D) $8400 billion
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
14) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, and
chequable deposits are $800 billion, then the money multiplier is approximately ________.
A) 2.5
B) 1.67
C) 2.0
D) 0.601
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
15) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $800 billion, and excess reserves total $0.8 billion, then the currency ratio is
________.
A) .25
B) .50
C) .40
D) .05
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
16) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $800 billion, and excess reserves total $0.8 billion, then the excess
reserves-chequable deposit ratio is ________.
A) 0.001
B) 0.10
C) 0.01
D) 0.05
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
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17) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $800 billion, and excess reserves total $0.8 billion, then the monetary base is
________.
A) $480 billion
B) $480.8 billion
C) $80 billion
D) $80.8 billion
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
18) If the desired reserve ratio is fifteen percent, currency in circulation is $400 billion, and
chequable deposits are $800 billion, then the money multiplier is approximately ________.
A) 2.5
B) 1.67
C) 2.3
D) 0.651
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
19) If the desired reserve ratio is five percent, currency in circulation is $400 billion, and
chequable deposits are $800 billion, then the money multiplier is approximately ________.
A) 2.5
B) 2.72
C) 2.3
D) 0.551
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
20) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is
________.
A) $10000 billion
B) $4000 billion
C) $1400 billion
D) $10400 billion
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
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21) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, and
chequable deposits are $1000 billion, then the money multiplier is approximately ________.
A) 2.5
B) 2.8
C) 2.0
D) 0.7
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
22) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $1000 billion, and excess reserves total $1 billion, then the currency ratio is
________.
A) .25
B) .50
C) .40
D) .05
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
23) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $1000 billion, and excess reserves total $1 billion, then the excess
reserves-chequable deposit ratio is ________.
A) 0.01
B) 0.10
C) 0.001
D) 0.05
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
24) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable
deposits are $1000 billion, and excess reserves total $1 billion, then the monetary base is
________.
A) $400 billion
B) $401 billion
C) $500 billion
D) $501 billion
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
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25) If the desired reserve ratio is fifteen percent, currency in circulation is $400 billion, and
chequable deposits are $1000 billion, then the money multiplier is approximately ________.
A) 2.55
B) 2.67
C) 2.35
D) 0.551
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
26) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and
chequable deposits are $900 billion, then the money supply is ________.
A) $2700
B) $3000
C) $1200
D) $1800
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
27) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and
chequable deposits are $900 billion, then the money multiplier is approximately ________.
A) 2.5
B) 2.8
C) 2.0
D) 0.67
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
28) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and
chequable deposits are $900 billion, then the currency ratio is ________.
A) .25
B) .33
C) .67
D) .375
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
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29) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and
chequable deposits are $900 billion, then the level of excess reserves in the banking system is
________.
A) $300 billion
B) $30 billion
C) $3 billion
D) 0
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
30) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and
chequable deposits are $900 billion, then the monetary base is ________.
A) $300 billion
B) $600 billion
C) $333 billion
D) $667 billion
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
31) When the nonborrowed monetary base is equal to $200 billion, the borrowed reserves are
equal to $100 billion, and the money supply is equal to $700 billion, the money multiplier is
________.
A) 2.33
B) 2.67
C) 2.23
D) 2.16
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 15.7 Calculate and interpret changes in the money multiplier
32) The relationship between advances to banks, the nonborrowed monetary base, and the
monetary base is ________.
A) MB = MBn - BR
B) BR = MBn - MB
C) BR = MB - MBn
D) MB = BR - MBn
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
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33) Recognizing the distinction between advances to banks and the nonborrowed monetary
base, the money supply model is specified as ________.
A) M = m × (MBn - BR)
B) M = m × (MBn + BR)
C) M = m + (MBn - BR)
D) M = m - (MBn + BR)
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
34) Explain the complete formula for the money supply, and explain how changes in desired
reserves, excess reserves, the currency ratio, the nonborrowed base, and Bank of Canada
lending affect the money supply.
Answer: The formula is indicates that the money supply is the product of the multiplier times
the base. Increases in any of the multiplier components reduce the multiplier and the money
supply. Increases in the nonborrowed base and Bank of Canada lending to banks increase the
monetary base and the money supply.
Diff: 2
Type: ES
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
35) Explain what happens to the money multiplier and the money supply when depositor
behaviour causes c to increase with all other variables remaining the same.
Answer: An increase in c means that depositors are converting some of their chequable
deposits into currency. As shown before, chequable deposits undergo multiple expansion while
currency does not. Hence when chequable deposits are being converted into currency, there is a
switch from a component of the money supply that undergoes multiple expansion to one that
does not. The overall level of multiple expansion declines, and so must the multiplier and the
money supply.
Diff: 1
Type: ES
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
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36) How do changes in the desired reserve ratio affect the money multiplier?
Answer: Students can show this in two ways:
a. The formula for the money multiplier is m =
. Thus, an increase in the desired
reserve ratio r will increase the denominator leaving the numerator unchanged ceteris paribus
and so the money multiplier will fall. A decrease in the value of the desired reserve ratio will
decrease the denominator and so the money multiplier will rise.
b. When banks increase their holdings of reserves relative to chequable deposits, the banking
system in effect has fewer reserves to support chequable deposits, This means that given the
same level of MB, banks will reduce their loans causing a decline in the level of chequable
deposits and a decline in the money supply and the multiplier will fall. The opposite will
happen when banks decrease their holdings of reserves.
Diff: 2
Type: ES
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
37) How changes in the nonborrowed monetary base affect the money supply?
Answer: The Bank of Canada's open market purchases increase the nonborrowed monetary
base, and its open market sales decrease it. Holding all other variables constant, an increase in
MBn arising from an open market purchase increases the amount of the monetary base that is
available to support currency and deposits, so the money supply will increase. The opposite
happens in the case of an open market sale that decreases MBn. The result is that the money
supply is positively related to the nonborrowed monetary base MBn.
Diff: 2
Type: ES
Skill: Recall
Objective: 15.7 Calculate and interpret changes in the money multiplier
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15.8
Web Appendix 15.1: The Bank of Canada's Balance Sheet and the Monetary base
1) Which is the largest category of Bank of Canada assets?
A) Securities
B) Advances to banks
C) Gold
D) Coins
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
2) The two most important categories of assets on the Bank's balance sheet are ________ and
________ because they earn interest.
A) advances to banks; coins
B) securities; advances to banks
C) gold; coins
D) cash items in the process of collection; SDR certificate accounts
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
3) The volume of loans that the Bank of Canada makes to banks is affected by the Bank's
setting of the interest rate on these loans, called the ________.
A) overnight rate
B) prime rate
C) bank rate
D) interbank rate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
4) Which of the following are not assets on the Bank of Canada's balance sheet?
A) Advances to banks
B) Government of Canada deposits
C) Securities
D) Foreign deposits
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
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5) Which of the following are not assets on the Bank's balance sheet?
A) Securities
B) Advances to banks
C) Treasury bills
D) Bank notes in circulation
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
6) Which of the following are not liabilities on the Bank's balance sheet?
A) Advances to banks
B) Members of the CPA deposits
C) Bank notes in circulation
D) Government of Canada deposits
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
7) When the Bank of Canada purchases artwork to decorate its conference room ________.
A) reserves rise
B) reserves fall
C) bank notes in circulation falls
D) Bank of Canada assets rise
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Bank of Canada's Balance Sheet and the Monetary Base
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15.9
Web Appendix 15.2: The M2+ Money Multiplier
1) The equation that represents M2+ in the model of the money supply process is ________.
A) M2+ = C + D
B) M2+ = C + D + T - MMF
C) M2+ = C + D - T + MMF
D) M2+ = C + D + T + MMF
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
2) The M2+ money multiplier is ________.
A) negatively related to high-powered money
B) positively related to the time deposit ratio
C) positively related to the desired reserve ratio
D) positively related to the excess reserves ratio
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
3) Everything else held constant, an increase in the currency ratio will mean ________ in the
M2+ money multiplier and ________ in the M2+ money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
4) Everything else held constant, a decrease in the currency ratio will mean ________ in the
M2+ money multiplier.
A) an increase
B) a decrease
C) a reversal
D) no change
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
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5) Everything else held constant, an increase in the required reserve ratio will mean ________
in the M2+ money multiplier and ________ in the M2+ money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
6) Everything else held constant, an increase in the time deposit ratio will mean ________ in
the M2+ money multiplier and ________ in the M2+ money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
7) Everything else held constant, an increase in the time deposit ratio will result in ________ in
the M1+ money multiplier and ________ in the M2+ money multiplier.
A) an increase; an increase
B) no change; an increase
C) a decrease; a decrease
D) no change; a decrease
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
8) Everything else held constant, an increase in the money market fund ratio will mean
________ in the M2+ money multiplier and ________ in the M2+ money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
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9) Everything else held constant, an increase in the excess reserve ratio will mean ________ in
the M2+ money multiplier and ________ in the M2+ money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The M2+ Money Multiplier
15.10 Web Appendix 15.3: The Great Depression Bank Panics, 1930-1933, and the Money
Supply in the United States
1) During the Great Depression ________.
A) the currency-chequable deposits ratio increased sharply
B) the currency-chequable deposits ratio decreased sharply
C) the currency-chequable deposits ratio did not change, confirming that the theory of asset
demand provides the correct framework for understanding fluctuations in the
currency-chequable deposits ratio
D) the currency-chequable deposits ratio declined modestly, confirming that the theory of asset
demand provides the correct framework for understanding fluctuations in the
currency-chequable deposits ratio
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Great Depression bank panics, 1930-1933, and the money supply in
the United States
2) In the early 1930s, the currency ratio in the United States rose, as did the level of excess
reserves. Money supply analysis predicts that, all else constant, the money supply should have
________.
A) risen
B) fallen
C) remain unchanged
D) Any of the above are possible, since the two factors work in opposite directions.
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Great Depression bank panics, 1930-1933, and the money supply in
the United States
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3) During the bank panics of the Great Depression the excess reserve ratio ________.
A) increased sharply
B) decreased sharply
C) increased slightly
D) decreased slightly
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: The Great Depression bank panics, 1930-1933, and the money supply in
the United States
4) During the banking panic that occurred in the United States between October 1930 and
January 1931, ________.
A) both c and {ER/D} rose
B) {ER/D} more than doubled
C) the money supply declined sharply
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Great Depression bank panics, 1930-1933, and the money supply in
the United States
5) During the banking crisis in the United States that ended in March 1933, ________.
A) the money supply (M1) had declined by over 25 percent—by far the largest decline in
American history
B) the money supply declined despite a 20 percent rise in the monetary base
C) both c and {ER/D} rose
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Great Depression bank panics, 1930-1933, and the money supply in
the United States
6) The monetary base increased by 20 percent during the contraction of 1929-1933, but the
money supply fell by 25 percent. Explain why this occurred. How can the money supply fall
when the base increases?
Answer: The banking crisis caused the public to fear for the safety of their deposits,
increasing both the currency ratio and bank holdings of excess reserves in anticipation of
deposit outflows. Both of these changes reduce the money multiplier and the money supply. In
this case, the fall in the multiplier due to increases of currency and excess reserves more than
offset the increase in the base, causing the money supply to fall.
Diff: 3
Type: ES
Skill: Applied
Objective: Appendix: The Great Depression bank panics, 1930-1933, and the money supply in
the United States
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Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 16 Tools of Monetary Policy
16.1
The Framework for the Implementation of Monetary Policy
1) The interest rate on loans of reserves from one bank to another is ________.
A) the bank rate
B) the fed funds rate
C) the discount rate
D) the overnight rate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
2) The overnight rate is ________.
A) the interest rate on loans from the Bank of Canada
B) also know as the Bank rate
C) the rate banks give their best customers
D) the interest rate on loans of reserves from one bank to another
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
3) The LVTS was put in place in order to eliminate the ________.
A) systemic risk
B) principal-agent problem
C) moral hazard problem
D) credit risk
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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4) The risk to the entire payments system due to the inability of one financial institution to
fulfill its payment obligations in a timely fashion is known as ________.
A) systemic risk
B) the principal-agent problem
C) moral hazard
D) credit risk
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
5) Although transactions in the LVTS account for less than ________ of the total number of
transactions, they account for about ________ of the value of transactions.
A) 1 percent; 94 percent
B) 5 percent; 90 percent
C) 10 percent; 85 percent
D) 20 percent; 80 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
6) The Large Value Transfer System (LVTS) ________.
A) was introduced on February 4, 1999
B) is the core of the Canadian payments system
C) is an electronic net settlement network designed to provide settlement to paper-based
payments items
D) A and B only.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
7) Large Value Transfer System (LVTS) participants can make a payment only if they
________.
A) have positive settlement balances in their accounts with the Bank of Canada
B) have posted collateral (such as Government of Canada treasury bills and bonds)
C) have explicit lines of credit with other participants
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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8) The Large Value Transfer System (LVTS) ________.
A) is the core of the Canadian payments system
B) is an electronic net settlement network designed to provide settlement to wholesale
transactions
C) is an electronic net settlement network designed to provide settlement to paper-based
payment items
D) A and B only.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
9) Where only the net credit or debit position of each participant vis-à-vis all other participants
is calculated is known as ________.
A) multilateral netting
B) principal-agent netting
C) moral hazard netting
D) credit risk netting
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
10) Multilateral netting is ________.
A) the netting of the credit or debit position of each participant vis-à-vis all other participants
B) an electronic net settlement network designed to provide settlement to paper-based payment
items
C) the netting of the forward position of LVTS participants
D) None of the above.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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11) The Automated Clearing Settlement System (ACSS) ________.
A) is the core of the Canadian payments system
B) is an electronic net settlement network designed to provide settlement to wholesale
transactions
C) is an electronic net settlement network designed to provide settlement to paper-based
payment items
D) A and B only.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
12) The ACSS is operated by the ________.
A) Canadian Payments Association
B) Bank of Canada
C) Ministry of Finance
D) LVTS
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
13) The Automated Clearing Settlement System (ACSS) ________.
A) was introduced on February 4, 1999
B) is an electronic net settlement network designed to provide settlement to wholesale
transactions
C) aggregates interbank payments and informs the Bank of Canada of the net amounts to be
transferred from and to each participant's settlement account with the Bank of Canada
D) A and B only.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
14) The overnight market in Canada is ________ with a ________ range of participants.
A) very liquid; broad
B) very liquid; narrow
C) not very liquid; broad
D) not very liquid; narrow
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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Copyright © 2017 Pearson Canada, Inc.
15) The overnight interest rate is also known as the ________.
A) the bank rate
B) the policy rate
C) reference rate
D) the growth rate of M2
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
16) The target for the overnight interest rate is also known as the ________.
A) the bank rate
B) the policy rate
C) reference rate
D) the growth rate of M2
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
17) The primary indicator of the Bank of Canada's stance on monetary policy is ________.
A) the bank rate
B) the overnight rate
C) the growth rate of the monetary base
D) the growth rate of M2
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
18) The overnight rate is important because it is ________.
A) the primary indicator of the Bank of Canada's stance on monetary policy
B) the interest rate paid on federal debt
C) the interest rate charged on government loans
D) A and C only.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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19) 45 basis points is equal to ________.
A) 0.45 percent
B) 0.045 percent
C) 4.5 percent
D) 45 percent
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
20) Changes to the operating band are announced by the Bank of Canada ________ times a
year.
A) eight
B) six
C) four
D) two
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
21) The Bank of Canada's operating band is ________ basis points or ________.
A) 50; 0.5 percent
B) 100; 1 percent
C) 50; 5 percent
D) 100; 10 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
22) The overnight interest rate ________.
A) is the shortest-term rate available
B) forms the base of any term structure of interest rates relation
C) is the rate the Bank of Canada charges LVTS participants with negative settlement balances
at the end of the banking day
D) A and B only.
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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23) If the operating target of the Bank of Canada is 4.5 percent then the bank rate is ________.
A) 4.75 percent
B) 5.25 percent
C) 4.25 percent
D) 4.5 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
24) If the operating target of the Bank of Canada is 4 percent then the bank rate is ________.
A) 4.25 percent
B) 4.50 percent
C) 3.5 percent
D) 4 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
25) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent
then the bank rate is ________.
A) 4 percent
B) 3.75 percent
C) 3.25 percent
D) 4.5 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
26) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent
then the operating target of the Bank's monetary policy is ________.
A) 3.75 percent
B) 4 percent
C) 3.25 percent
D) 3 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
486
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27) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent
then the operating target of the Bank's monetary policy is ________ and the bank rate is
________.
A) 3.75 percent; 4 percent
B) 4 percent; 4.25 percent
C) 3.25 percent; 3.5 percent
D) 3 percent; 3.25
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
28) If the Bank of Canada charges for negative settlement balances to LVTS participants an
interest rate of 3.5 percent then the operating target of the Bank's monetary policy is ________.
A) 3.25 percent
B) 3.75 percent
C) 3 percent
D) 4 percent
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
29) The lower limit of the operating band for the overnight interest rate defines ________.
A) the bank rate
B) the prime rate
C) the rate the Bank of Canada pays LVTS participants with positive settlement balances at the
end of the banking day
D) the rate the Bank of Canada charges LVTS participants with negative settlement balances at
the end of the banking day
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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30) At the end of each banking day, each LVTS participant must bring its settlement balance
with the Bank of Canada ________.
A) close to zero
B) to a positive balance
C) to a negative balance
D) to at least $1 million
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
31) The lower limit of the operating band for the overnight interest rate is ________.
A) the bank rate
B) the prime rate
C) the rate the Bank of Canada charges LVTS participants with negative settlement balances at
the end of the banking day
D) 50 basis points below the bank rate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
32) If the operating band for the overnight interest rate is from 3.5 to 4.0 percent, then
________.
A) the bank rate is 4.0 percent
B) the bank rate is the lower limit of the operating band
C) the bank rate is the rate the Bank of Canada charges LVTS participants with negative
settlement balances at the end of the banking day
D) A and C only.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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33) If the operating band for the overnight interest rate is from 3.5 to 4.0 percent, then
________.
A) the rate on positive settlement balances at the Bank of Canada is 3.5 percent
B) the rate on positive settlement balances at the Bank of Canada is the lower limit of the
operating band
C) the bank rate is the lower limit of the operating band
D) A and B only.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
34) The operating band for the overnight interest rate is ________.
A) 50 basis points wide
B) defines the rate of interest the Bank of Canada charges LVTS participants with negative
settlement balances at the end of the banking day
C) defines the rate of interest the Bank of Canada pays LVTS participants with negative
settlement balances at the end of the banking day
D) A and B only.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
35) Standing facilities ________.
A) refers to participant borrowing form each other to bring their settlement balances to zero at
the end of the banking day
B) refers to the Bank of Canada refusal to lend to or borrow from a participant to bring
their settlement balances to zero at the end of the banking day
C) refers to the Bank of Canada's building in Ottawa
D) refers to the Bank of Canada being ready to lend to or borrow from a participant to bring
their settlement balances to zero at the end of the banking day
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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36) When the Bank of Canada lowers the operating band for the overnight interest rate, it
________.
A) lowers the bank rate by the same amount
B) encourages LVTS participants to borrow reserves either from each other or from the Bank of
Canada
C) it reduces the monetary base and ultimately the money supply
D) A and B only.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
37) If LVTS participating financial institutions have insufficient settlement balances ________.
A) they can borrow from each other in the pre-settlement trading period at the bank rate
B) they can borrow from each other in the pre-settlement trading period at the overnight rate
C) they can borrow from the Bank of Canada
D) B and C only.
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
38) If LVTS participating financial institutions have insufficient settlement balances ________.
A) they can borrow from each other in the pre-settlement trading period
B) they can borrow from the Bank of Canada
C) they can borrow from the Bank of Canada at the prime rate
D) A and B only.
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
39) LVTS participants with positive settlement balances at the end of the day ________.
A) are paid the bank rate
B) are paid the overnight rate
C) are paid the bank rate less 50 basis points
D) are paid the prime rate
Answer: C
Diff: 3
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
490
Copyright © 2017 Pearson Canada, Inc.
40) The rate spread at the Bank of Canada for LVTS balances is ________.
A) 300 basis points
B) 200 basis points
C) 50 basis points
D) 25 basis points
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
41) What is the service provided by the LVTS? why is it important?
Answer: The LVTS is an electronic, real-time net settlement network, designed to provide
immediate finality and settlement to time-critical transactions. There are fourteen LVTS
participants and all other members of the Canadian Payments Association are able to arrange
LVTS payments for their clients through the LVTS participants. The importance of the LVTS
is that it eliminates systemic risk—the risk to the entire payments system due to the inability of
one financial institution to fulfill its payment obligations in a timely fashion.
Diff: 3
Type: ES
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
42) What is the function of the ACSS?
Answer: The ACSS is an electronic payments system operated by the Canadian Payments
Association. The ACSS aggregates interbank payments from non-LVTS paper-based payment
items such as cheques, travellers' cheques, gift certificates and money orders, and transfers the
net amounts from and to each participant's settlement account with the Bank of Canada. The
Bank completes the settlement the next day through the LVTS.
Diff: 2
Type: ES
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
43) What is the operating band for the overnight interest rate?
Answer: The Bank of Canada implements monetary policy by changing the overnight interest
rate in order to influence other short-term interest rates and the exchange rate. The Bank's
operational objective is to keep the overnight rate within a band of 50 basis points. Early in the
morning (9:00 am) on each of the eight specified dates within the year the Bank announces an
operating band of 50 basis points for the overnight rate.
Diff: 2
Type: ES
Skill: Recall
Objective: 16.1 Characterize the framework for the implementation of monetary policy in
Canada
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Copyright © 2017 Pearson Canada, Inc.
16.2 The Market for Settlement Balances and the Channel/Corridor System for Setting the
Overnight Interest Rate
1) In Canada, the market for settlement balances (reserves) is where ________.
A) the federal funds rate is determined
B) the overnight interest rate is determined
C) the discount rate is determined
D) LIBOR is determined
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
2) In the market for settlement balances, when the overnight interest rate is below the bank rate
and above the bank rate less 50 basis points, the supply curve of reserves is ________.
A) vertical
B) horizontal
C) positively sloped
D) negatively sloped
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
3) The market equilibrium, in which the quantity of reserves demanded equals the quantity of
reserves supplied ________.
A) determines the overnight rate
B) occurs at the intersection of the vertical supply curve and the demand curve at the Bank of
Canada's target level of reserves
C) determines the interest rate charged on loans of these reserves
D) All of the above.
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
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Copyright © 2017 Pearson Canada, Inc.
4) When the overnight rate is up to 50 basis points below the bank rate ________.
A) the supply curve of settlement balances has a positive slope
B) the demand curve for settlement balances is vertical
C) the demand curve for settlement balances is horizontal
D) the demand curve for settlement balances has a negative slope
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
5) The quantity of reserves demanded rises when the ________.
A) bank rate rises
B) bank rate falls
C) overnight funds rate rises
D) overnight rate falls
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
6) The opportunity cost of holding excess reserves is ________.
A) the bank rate
B) the prime rate
C) the treasury bill rate
D) the overnight rate
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
7) A rise in the overnight rate ________.
A) decreases the opportunity cost of holding desired reserves
B) lowers the opportunity cost of holding desired reserves
C) increases the opportunity cost of holding excess reserves
D) lowers the opportunity cost of holding excess reserves
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
493
Copyright © 2017 Pearson Canada, Inc.
8) In the market for reserves, market equilibrium occurs where the ________.
A) quantity of reserves demanded equals the quantity supplied
B) quantity of reserves demanded is above the quantity supplied
C) quantity of reserves demanded is below the quantity supplied
D) quantity of reserves demanded does not equal the quantity supplied
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
9) The channel/corridor system for setting interest rates ________.
A) is not appropriate for Canadian monetary policy
B) limits the amount banks can borrow from the central bank
C) enables the central bank to set the overnight, policy rate
D) is being phased out as a monetary policy tool
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
10) Explain why the bank rate is an upper limit for the overnight rate.
Answer: Anytime the overnight rate is below the bank rate, banks are going to borrow money
from each other in order to minimize their settlement balances with the bank of Canada. When
the overnight rate starts to rise and exceeds the bank rate, then banks will be able to borrow as
many funds as they require from the Bank of Canada by being charged the bank rate instead of
the overnight rate that is now higher. Thus the bank rate is a ceiling for the overnight rate.
Diff: 2
Type: ES
Skill: Applied
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
11) Explain why the bank rate minus 50 basis points (ib-50) is the lower limit for the overnight
rate.
Answer: When demand for reserves falls and the overnight rate tends to fall below the ib-50
rate, then the banks with excess reserves are better off leaving their credit (positive) balances
with the LVTS where they will get an interest rate of ib-50. Thus the overnight interest rate can
never fall below this point.
Diff: 3
Type: ES
Skill: Applied
Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary
policy can effect the equilibrium overnight interest rate
494
Copyright © 2017 Pearson Canada, Inc.
16.3
The Bank of Canada's Approach to Monetary Policy
1) The goal of the Bank of Canada's current monetary policy is to keep the inflation rate within
a target range of ________.
A) 2 percent to 3 percent
B) 1 percent to 3 percent
C) 1 percent to 4 percent
D) 2 percent to 4 percent
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
2) Monetary conditions are impacted by ________.
A) short-term interest rates and the foreign exchange rate
B) open market operations and the prime rate
C) the foreign exchange rate and the inflation rate
D) the Department of Finance
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
3) Core CPI excludes ________.
A) volatile components
B) headline items
C) indirect taxes
D) energy costs
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
4) If the Bank of Canada expects the economy to slow down, it ________ the operating band
for the overnight interest rate.
A) lowers
B) raises
C) leaves unchanged
D) stabilizes
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
495
Copyright © 2017 Pearson Canada, Inc.
5) The Bank of Canada uses the ________ as its operating instrument.
A) nominal interest rate
B) real interest rate
C) open market operations
D) federal funds rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
6) It is the ________ assumption of ________ that allows for the transmission between nominal
and real interest rates.
A) new Keynesian; sticky prices
B) monetarist; sticky prices
C) new Keynesian; perfect markets
D) Bank of Canada; chartered banks allegiance to Canadian monetary policy
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
7) If the Bank of Canada expects the economy to to be exceeding its capacity, it ________ the
operating band for the overnight interest rate.
A) lowers
B) raises
C) leaves unchanged
D) stabilizes
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
8) To keep inflation from falling below the target range, the Bank of Canada ________.
A) decreases the target for the overnight rate which causes the dollar to go down
B) decreases the target for the overnight rate which causes the dollar to go up
C) increases the target for the overnight rate which causes the dollar to go down
D) increases the target for the overnight rate which causes the dollar to go up
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
496
Copyright © 2017 Pearson Canada, Inc.
16.4
Conventional Monetary Policy Tools
1) The Bank of Canada ________ conducting open market operations in Government of
Canada treasury bills and bonds in 1994.
A) started
B) stopped
C) continued
D) implemented
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
2) The Bank of Canada most common operations have been repurchase transactions with
________.
A) stockbrokers
B) primary dealers
C) the public
D) other central banks
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
3) Special Purchase and Resale Agreements ________.
A) relieve undesired upward pressure on the overnight interest rate
B) alleviate undesired downward pressure on the overnight financing rate
C) relieve undesired downward pressure on the overnight interest rate
D) alleviate undesired volatility in the overnight financing rate
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
497
Copyright © 2017 Pearson Canada, Inc.
4) If the Bank of Canada wants to relieve undesired upward pressure on the overnight interest
rate it will enter into a ________.
A) Special Purchase and Resale Agreement
B) Sale and Repurchase Agreement
C) Swap
D) Reverse Repo
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
5) If the Bank of Canada wants to relieve undesired upward pressure on the overnight interest
rate it will enter into a ________.
A) Resale Agreement
B) Sale and Repurchase Agreement
C) Swap
D) Repo
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
6) A repo is a ________.
A) Resale Agreement
B) Purchase and Resale Agreement
C) Swap
D) Repo
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
7) Sale and Repurchase Agreements ________.
A) relieve undesired upward pressure on the overnight interest rate
B) alleviate undesired downward pressure on the overnight financing rate
C) relieve undesired downward pressure on the overnight interest rate
D) alleviate undesired volatility in the overnight financing rate
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
498
Copyright © 2017 Pearson Canada, Inc.
8) If the Bank of Canada wants to alleviate undesired downward pressure on the overnight
financing rate it will enter into a ________.
A) Special Purchase and Resale Agreement
B) Sale and Repurchase Agreement
C) Swap
D) Repo
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
9) A reverse repo is a ________.
A) Special Purchase and Resale Agreement
B) Sale and Repurchase Agreement
C) Swap
D) Repo
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
10) If the Bank of Canada wants to alleviate undesired downward pressure on the overnight
financing rate it will enter into a ________.
A) Purchase and Resale Agreement
B) Repurchase Agreement
C) Swap
D) Reverse Repo
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
11) If the Bank of Canada wants to temporarily inject reserves in the banking system, it will
engage in ________.
A) a repurchase agreement
B) a "swap" transaction
C) a reverse repurchase agreement
D) None of the above.
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
499
Copyright © 2017 Pearson Canada, Inc.
12) If the Bank of Canada wants to temporarily drain reserves from the banking system, it will
engage in ________.
A) a repurchase agreement
B) a sale and repurchase agreement
C) a "pump" agreement
D) None of the above.
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
13) The Bank of Canada will engage in a sale and repurchase agreement when it wants to
________ reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
14) The Bank of Canada will engage in a repurchase and resale agreement when it wants to
________ reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
15) SPRAs and SRAs are ________ open market operations.
A) temporary
B) permanent
C) risky
D) conducted 8 times a year
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
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Copyright © 2017 Pearson Canada, Inc.
16) The Bank of Canada's repurchase transactions are an advantage because ________.
A) they occur at the initiative of the Bank of Canada
B) the bank has complete control over the volume
C) they are monopolized by the Bank of Canada
D) A and B only.
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
17) If the Bank of Canada wants to temporarily inject reserves in the banking system, it will
engage in ________.
A) a repurchase agreement
B) a "swap" transaction
C) a reverse repurchase agreement
D) None of the above.
Answer: A
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
18) If the Bank of Canada wants to temporarily drain reserves from the banking system, it will
engage in ________.
A) a repurchase agreement
B) a sale and repurchase agreement
C) a "pump" agreement
D) None of the above.
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
19) The Bank of Canada will engage in a repurchase agreement when it wants to ________
reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
501
Copyright © 2017 Pearson Canada, Inc.
20) In addition to targeting the overnight interest rate at the mid-point of the operating band, the
Bank of Canada also targets ________.
A) the prime rate
B) the level of settlement balances
C) the treasury bill rate
D) the money multiplier
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
21) If government deposits at the Bank of Canada are predicted to increase, the manager of the
trading desk at the Bank will likely conduct activities to ________ reserves.
A) inject
B) drain
C) reverse
D) flood
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
22) The target for settlement balances is set at ________.
A) zero with no adjustments for any pressures on the overnight rate
B) zero but the Bank makes adjustments depending on pressures on the overnight rate
C) zero but the Bank makes adjustments depending on pressures on the prime rate
D) always positive with no adjustments
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
23) The Bank of Canada neutralizes special PRA operations so as to ________.
A) not to leave the system in a surplus position at the end of the day
B) to leave the system in a surplus position at the end of the day
C) to leave the system changed at the end of the day
D) as to leave the system in a deficit position at the end of the day
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
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Copyright © 2017 Pearson Canada, Inc.
24) The Bank of Canada neutralizes SRA operations so as to ________.
A) not to leave the system in a surplus position at the end of the day
B) to leave the system in a surplus position at the end of the day
C) as not to leave the system in a deficit position at the end of the day
D) as to leave the system in a deficit position at the end of the day
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
25) The Bank of Canada neutralizes government receipts by ________.
A) arranging an increase in government deposit auctions
B) leaving the system in a surplus position at the end of the day
C) reducing the banking system's settlement balances
D) leaving the system in a deficit position at the end of the day
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
26) If government deposits at the Bank of Canada are predicted to decrease the Bank will offset
the transaction through LVTS transfers to ________ settlement balances.
A) increase
B) decrease
C) flood
D) inject
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
27) If government deposits at the Bank of Canada are predicted to increase, the Bank will offset
the transaction through government debt auctions to ________ settlement balances.
A) decrease
B) increase
C) inflate
D) drain
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
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28) If government deposits at the Bank of Canada are predicted to decrease, the Bank will
offset the transaction through government deposit auctions to ________ settlement balances.
A) decrease
B) increase
C) inject
D) resupply
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
29) The facility at which banks can borrow reserves from the Bank of Canada is called the
________.
A) standing lending facility
B) temporary lending facility
C) permanent lending facility
D) daily lending facility
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
30) A standing lending facility is ________.
A) the facility at which banks can borrow reserves from the Bank of Canada
B) a temporary lending facility
C) a permanent lending facility
D) a daily lending facility
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
31) One of the Bank of Canada's most important roles is to be ________.
A) the Federal government's banker
B) the issuer of government debt
C) a lender-of-last-resort
D) a regulator of banks
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
504
Copyright © 2017 Pearson Canada, Inc.
32) The Bank of Canada's lender-of-last-resort function ________.
A) is no longer necessary due to CDIC insurance
B) has proven to be ineffective
C) is needed to prevent runs by large-denomination depositors
D) A and B only.
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
33) Explain the Bank of Canada's open market operations? What are SPRAs and SRAs? How
are they used to impact the overnight rate?
Answer: SPRA is special Purchase and Resale Agreement and SRA is a Sale and Repurchase
Agreement. SPRAS are used to relieve undesired upward pressure on the overnight interest
rate. SRAs alleviated undesired downward pressure on the overnight financing rate. Both are
temporary measures.
Diff: 2
Type: ES
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
34) What are the advantages of SPRAs and SRAs?
Answer: 1. The Bank of Canada has complete control over them as they occur at the initiative
of the Bank of Canada.
2. They are flexible and precise; together with the Bank's standing facilities they can be used to
any extent.
3. They are easily reversed.
4. They can be implemented quickly.
Diff: 3
Type: ES
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
35) What are the advantages and disadvantages of the Bank's lending policy?
Answer: The most important advantage is that the Bank can use it to perform its role of
lender of last resort. But it is less effective compared to open market operations for two
reasons. Open market buyback operations are completely at the discretion of the Bank of
Canada, whereas the volume of normal advances is not. The Bank can change the bank rate but
in the current channel/corridor system can't make banks borrow. In addition, open market
buyback operations are more easily reversed than changes in Bank lending policy.
Diff: 3
Type: ES
Skill: Recall
Objective: 16.3 Summarize how conventional monetary policy tools are implemented and the
relative advantages and limitations of each tool
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16.5
Nonconventional Monetary Policy Tools During the Global Financial Crisis
1) The purchase of financial assets by the central bank through the creation of excess reserves
for banks is known as ________.
A) quantitative easing
B) conditional statements about the future path of the policy rate
C) interest rate expectations
D) credit easing
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
2) Quantitative easing is regarded as an unconventional form of monetary policy because it
targets the ________.
A) the price of liquidity
B) the overnight interest rate
C) the amount of liquidity provided by the central bank instead of targeting the price of
liquidity
D) settlement balances
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
3) Quantitative easing is regarded as ________.
A) the price of liquidity
B) a high-risk monetary policy tool
C) a low-risk monetary policy tool
D) a desired policy
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
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4) Quantitative easing is a high-risk monetary policy tool as it runs the risk of ________.
A) possibly creating deflation
B) possibly creating inflation and even hyperinflation
C) having no effect
D) having very short-term effects
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
5) The purchase of private sector assets by the central bank in critical markets is known as
________.
A) quantitative easing
B) conditional statements about the future path of the policy rate
C) managing interest rate expectations
D) credit easing
Answer: D
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
6) The difference between Term PRAs and special PRAs, is that term PRAs have ________.
A) a term shorter than one business day, typically a term of 2 hours
B) a term longer than one business day, typically a term of 28 business days
C) a term longer than year, typically a term of 3 years
D) a term longer than one business day, typically a term of 6 months
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
7) The Bank of Canada commitments regarding the operating band for the overnight interest
rate to align market expectations of future short-term interest rates with those of the Bank are
known as ________.
A) quantitative easing
B) conditional statements about the future path of the policy rate
C) interest rate expectations
D) credit easing
Answer: B
Diff: 3
Type: MC
Skill: Recall
Objective: 16.5.1 Explain the key monetary policy tools that are used when conventional
monetary policy is no longer effective
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8) The Federal Reserve's lending of reserves to banks is called ________ lending.
A) discount window
B) term
C) prime
D) target
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.5.2 Identify the distinctions and similarities between the monetary policy tools of
the Bank of Canada and those of the Federal Reserve and the European Central Bank
9) The lending facility at the Federal Reserve sets a ________ on the short-term overnight
interest rates.
A) ceiling
B) floor
C) target
D) ceiling and floor
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.5.2 Identify the distinctions and similarities between the monetary policy tools of
the Bank of Canada and those of the Federal Reserve and the European Central Bank
10) The primary indicator of the stance of monetary policy in the U.S. is the ________.
A) federal funds rate
B) discount rate
C) overnight rate
D) prime rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.5.2 Identify the distinctions and similarities between the monetary policy tools of
the Bank of Canada and those of the Federal Reserve and the European Central Bank
11) The European Central bank uses the ________ to signal its stance on monetary policy.
A) target financing rate
B) overnight cash rate
C) overnight bank rate
D) discount window
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 16.5.2 Identify the distinctions and similarities between the monetary policy tools of
the Bank of Canada and those of the Federal Reserve and the European Central Bank
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12) Describe some of the actions the Bank of Canada took to mitigate the effects of widening
spreads and increased volatility in the term interbank market in the second half of 2008.
Answer: The Bank of Canada announced that it would enter into a series 28-day PRA
transactions, thereby injecting huge amounts of liquidity in the markets. Moreover, the Bank
expanded its list of acceptable collateral to include bank-sponsored asset-backed commercial
paper and U.S. Treasuries. It also expanded its list of eligible counterparties. In engaging in
these trades, the Bank takes securities onto its books in exchange for borrowings from the
Bank's standing lending facility.
Diff: 3
Type: ES
Skill: Recall
Objective: 16.5.2 Identify the distinctions and similarities between the monetary policy tools of
the Bank of Canada and those of the Federal Reserve and the European Central Bank
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 17 The Conduct of Monetary Policy: Strategy and Tactics
17.1
The Price Stability Goal and the Nominal Anchor
1) Price stability is defined as ________.
A) low inflation
B) low and stable inflation
C) stable inflation
D) core inflation
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor
2) The importance of a nominal anchor is to ________.
A) limit the time-inconsistency problem
B) reduce inflation
C) promote low inflation
D) allow discretionary day-to-day monetary policy
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor
3) Inflation leads to ________.
A) price instability
B) lower economic growth
C) public hostility
D) all of the above
Answer: D
Diff: 1
Type: MC
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Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor
4) The nominal anchor ________.
A) acts like behavioural rule
B) leads to inflation
C) creates the time-inconsistency problem
D) avoids the natural rate of unemployment
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor
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5) Describe the time-inconsistency problem as it pertains to monetary policy outcomes.
Answer: The time-inconsistency problem occurs when monetary policymakers are tempted to
pursue a discretionary monetary policy that is more expansionary than firms or people expect
because such a policy would boost economic output (or lower employment) in the short run.
Diff: 1
Type: ES
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor
17.2
Other Goals of Monetary Policy
1) The natural rate of unemployment ________.
A) is consistent with full employment
B) is equal to zero
C) equals structural employment
D) is the same as frictional employment
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue
2) High unemployment ________.
A) results in lower GDP
B) leads to increased human misery
C) cannot be a target of monetary policy
D) A and B only
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue
3) Current estimates of NAIRU place it between ________ and ________.
A) 4 percent; 6 percent
B) 4 percent; 20 percent
C) 1 percent; 3 percent
D) 1 percent; 4 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue
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4) The natural rate of output is also known as ________.
A) potential output
B) NAIRU
C) structural output
D) GDP
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue
5) Interest rate stability is desirable because ________.
A) fluctuations in interest rates create uncertainty
B) it leads to financial market stability
C) stability in the foreign exchange markets
D) all of the above
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue
6) Increases in interest rates ________.
A) cause large capital losses
B) could lead to bank failures
C) affect consumers' willingness to buy houses
D) all of the above
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue
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17.3
Should Price Stability Be the Primary Goal of Monetary Policy?
1) Hierarchical mandates ________.
A) puts the goal of price stability first and then allows for other goals
B) requires all goals to be met simultaneously
C) is only used by the Bank of Canada
D) is only used by the Federal Reserve
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates
2) In the long-run, there is no trade-off between ________ and ________.
A) inflation; unemployment
B) inflation; price stability
C) unemployment; price stability
D) unemployment; economic growth
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates
3) Which of the following countries have hierarchical mandates?
A) Reserve Bank of New Zealand
B) Bank of Canada
C) Bank of England
D) all of the above
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates
4) Price stability is often the primary goal of central banks. Describe the five other goals of
monetary policy
Answer: The other objectives of monetary policy are: (1) high employment and output
stability, (2) economic growth, (3) stability of financial markets, (4) interest-rate stability, and
(5) stability in foreign exchange markets.
Diff: 1
Type: ES
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates
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17.4
Inflation Targeting
1) Inflation targeting includes ________.
A) a public announcement of medium-term targets for inflation
B) an institutional commitment to price stability as the primary long run goal
C) an information-inclusive approach in which many variables are used in making decisions
about monetary policy
D) all of the above
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
2) The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom
is ________.
A) monetary targeting
B) inflation targeting
C) targeting with an implicit nominal anchor
D) interest-rate targeting
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
3) Concerns about a dual mandate include ________.
A) over expansionary policy
B) policies that lead to large output fluctuations
C) time-inconsistency problems
D) decreases in output and unemployment
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
4) Which of the following is NOT an element of inflation targeting?
A) A public announcement of medium-term numerical targets for inflation
B) An institutional commitment to price stability as the primary long-run goal
C) An information-inclusive approach in which only monetary aggregates are used in making
decisions about monetary policy
D) Increased accountability of the central bank for attaining its inflation objectives
Answer: C
Diff: 3
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
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5) The first country to adopt inflation targeting was ________.
A) the United Kingdom
B) Canada
C) New Zealand
D) Australia
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
6) New Zealand adopted inflation targeting in ________.
A) 1990
B) 1991
C) 1992
D) 1994
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
7) The Reserve Bank of New Zealand ________.
A) is one of the most independent central banks
B) as the sole objective of price stability
C) negotiates with the minister of finance to make a Policy Targets Agreement
D) all of the above
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
8) Tight monetary policy in New Zealand ________.
A) brought inflation down to below 2 percent
B) reduced unemployment
C) experienced a growth rate occasionally greater than 5 percent
D) all of the above
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
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9) Canada's adoption of inflation targeting led to an unemployment rate of ________.
A) above 10 percent
B) nearly 8 percent
C) over 5 percent
D) 5 percent
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
10) In both New Zealand and Canada, what has happened to the unemployment rate since the
countries adopted inflation targeting?
A) The unemployment rate increased sharply.
B) The unemployment rate remained constant.
C) The unemployment rate has declined substantially after a sharp increase.
D) The unemployment rate declined sharply immediately after the inflation targets were
adopted.
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
11) The United Kingdom uses ________ as its nominal anchor.
A) inflation target
B) monetary aggregates
C) interest rate target
D) none of the above
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
12) Peak inflation in the United Kingdom was ________ in ________.
A) 9 percent; 1991
B) 4 percent; 1997
C) 12 percent; 1991
D) 8 percent; 1995
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
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13) The target inflation range set by the Bank of England is ________.
A) 1-4 percent
B) 1-3 percent
C) 2-4 percent
D) 2-3 percent
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
14) Which of the following is an advantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It is understood by the public and is transparent.
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
15) Which of the following is an advantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) There is transparency.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
16) Which of the following is an advantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) It increases accountability of the central bank.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
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17) Which of the following is an advantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) The performance has been quite good.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
18) Which of the following is an advantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) It is easily understood by the public.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
19) Which of the following is a disadvantage of inflation targeting?
A) There is transparency.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It imposes a rigid rule.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
20) Which of the following is a disadvantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) There is a delayed signal on the achievement of the target.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
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21) Which of the following is a disadvantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It imposes a rigid rule.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
22) Which of the following is disadvantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It may lead to larger output fluctuations.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
23) Inflation targeting has the potential to reduce the likelihood that the central bank will fall
into the time-inconsistency trap of trying to ________ output and employment in the short run
by pursuing overly ________ monetary policy.
A) lower; tight
B) expand; expansionary
C) lower; expansionary
D) expand; tight
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
24) The decision by inflation targeters to choose inflation targets ________ zero reflects the
concern of monetary policymakers that particularly ________ inflation can have substantial
negative effects on economic growth.
A) below; high
B) below; low
C) above; high
D) above; low
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
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25) What are the advantages inflation targeting?
Answer: The advantages of inflation targeting include: 1. the simplicity and clarity of a
numerical target for the inflation rate; 2. does not rely on a stable money-inflation relationship;
3. there is increased accountability of the central bank; 4. reduces the effects of inflationary
shocks.
Diff: 2
Type: ES
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
26) What are the disadvantages inflation targeting?
Answer: The disadvantages of inflation targeting include: 1. there is a delayed signal about
the achievement of the target; 2. it could lead to a rigid rule where the only focus is the inflation
rate (has not happened in practice); 3. if sole focus is the inflation rate, larger output
fluctuations can occur (has not happened in practice).
Diff: 2
Type: ES
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting
17.5
Lessons for Monetary Policy Strategy from the Global Financial Crisis
1) Did the financial crisis reveal that developments in the financial sector were less important
than previously thought?
Answer: No. Financial developments had very significant impacts on the economy and that
financial frictions could have a major disruptive impact on the economies of many countries.
Diff: 2
Type: ES
Skill: Recall
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting
2) Why is the zero lower bound on interest rates a serious problem?
Answer: The other nonconventional monetary policy tools are complicated and unpredictable.
Diff: 2
Type: ES
Skill: Recall
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting
3) What are some of the costs of cleaning up after a financial crisis?
Answer: High and persistent unemployment, increased government debt and increased
likelyhood of defaults on government debt.
Diff: 2
Type: ES
Skill: Recall
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting
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4) Did the Great Moderation protect economies from financial instability.
Answer: No, The apparent stability of the economy obscured the fact that financial
developments could create new problems for the economy.
Diff: 2
Type: ES
Skill: Applied
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting
17.6
Should Central Banks Try to Stop Asset-Price Bubbles
1) The two types of asset-price bubbles are ________ and ________ bubbles.
A) credit-driven; debt driven
B) rational; optimistic
C) irrational exuberance; optimistic
D) credit-driven; irrational exuberance
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.6 Summarize the arguments for and against central bank policy responses to
asset-price bubbles
2) Define the two types of asset-price bubbles and explain why one of these is more is more
problematic for the economy.
Answer: The two types of asset-price bubbles are credit-driven bubbles and those driven by
irrational exuberance. Credit-driven bubbles occur when, as a result of overly easy monetary
policy, credit becomes relatively available at low interest rates. This fuels the demand for
different classes of assets causing their prices to rise, creating the expectation of further price
rises and yet further increases in demand. When these bubbles end, the falling asset prices
cause widespread financial problems leading to possibly a financial crisis. Bubbles driven by
irrational exuberance are fueled by overly optimistic expectations. The bursting of these
bubbles cause losses to speculators but not a a widespread financial crisis.
Diff: 2
Type: ES
Skill: Applied
Objective: 17.6 Summarize the arguments for and against central bank policy responses to
asset-price bubbles
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3) Give five reasons why central banks should not try to prick an asset-price bubble.
Answer: The answer should include (1) a discussion of how difficult it is to identify
asset-price bubbles, (2) the recognition that rising interest rates may reinforce the expectations
of rising prices, (3) the possibility that raising interest rates to deal with one particular
asset-price bubble might adversely affect the values of other assets, (4) the recognition that the
attempts to prick an asset-price bubble might have detrimental effects on the overall economy ,
and (5) the possibility of an aggressive response by monetary authorities to offset the
repercussions of the bursting of an asset-price bubble.
Diff: 3
Type: ES
Skill: Recall
Objective: 17.6 Summarize the arguments for and against central bank policy responses to
asset-price bubbles
4) What are credit booms and why might a policy of leaning against a credit boom be preferred
to leaning against asset-price bubbles?
Answer: Credit booms occur when it becomes much easier for investors to borrow because of
lower interest costs and laxer credit standards and consequently greater risk taking by investors.
Policies designed to insure that credit standards do not become laxer will do a better job of
dealing with credit-driven bubbles which are more damaging to the economy.
Diff: 3
Type: ES
Skill: Applied
Objective: 17.6 Summarize the arguments for and against central bank policy responses to
asset-price bubbles
5) Why might a policy of low interest rates encourage excessive risk taking?
Answer: When yields on safe investments become very low and real returns are extremely
low, investors are induced to seek higher returns and are therefore subject to higher risk levels.
Diff: 2
Type: ES
Skill: Recall
Objective: 17.6 Summarize the arguments for and against central bank policy responses to
asset-price bubbles
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17.7
Tactics: Choosing the Policy Instrument
1) Which of the following is not an operating instrument?
A) Nonborrowed reserves
B) Monetary base
C) Overnight interest rate
D) Bank rate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
2) Which of the following is a potential operating instrument for the central bank?
A) The monetary base
B) The M1 money supply
C) GDP
D) The Bank rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
3) Which of the following is not an operating instrument?
A) Nonborrowed reserves
B) Monetary base
C) Overnight funds interest rate
D) Bank rate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
4) Which of the following is a potential operating instrument for the central bank?
A) The monetary base
B) The exchange rate
C) The inflation rate
D) The bank rate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
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5) Which of the following is a potential operating instrument for the central bank?
A) Nonborrowed reserves
B) The overnight funds rate
C) The monetary base
D) Each of the above
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
6) A potential policy instrument for the Bank of Canada is ________.
A) the monetary base
B) borrowed reserves
C) the overnight funds rate
D) the nonborrowed monetary base
E) All of the above
Answer: E
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
7) Due to the lack of timely data for the price level and economic growth, the Bank of Canada's
strategy ________.
A) targets the exchange rate, since the Bank of Canada can control this variable
B) targets the price of gold, since it is closely related to economic activity
C) uses an intermediate target, such as an interest rate
D) stabilizes the consumer price index, since the Bank of Canada can control the CPI
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
8) If the central bank targets a monetary aggregate, it is likely to lose control over the interest
rate because ________.
A) of fluctuations in the demand for reserves
B) of fluctuations in the consumption function
C) bond values will tend to remain stable
D) of fluctuations in the business cycle
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
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9) Fluctuations in the demand for reserves cause the Bank of Canada to lose control over a
monetary aggregate if the Bank of Canada targets ________.
A) a monetary aggregate
B) the monetary base
C) an interest rate
D) nominal GDP
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
10) Interest rates are difficult to measure because ________.
A) data on them are not available in a timely manner
B) real interest rates depend on the hard-to-determine expected inflation rate
C) they fluctuate too often to be accurate
D) they cannot be controlled by the Bank of Canada
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
11) Which of the following criteria need not be satisfied for choosing an intermediate target?
A) The variable must be measurable.
B) The variable must be controllable.
C) The variable must be predictable.
D) The variable must be stable.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
12) Which of the following is not a requirement in selecting an intermediate target?
A) Measurability
B) Controllability
C) Flexibility
D) Predictability
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
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13) When it comes to choosing an policy instrument, both the ________ rate and ________
aggregates are measured accurately and are available daily with almost no delay.
A) three-month T-bill; monetary
B) three-month T-bill; reserve
C) overnight rate; monetary
D) overnight rate; reserve
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
14) Which of the following best explains why the Bank of Canada does not use nominal GDP
as an intermediate target?
A) Nominal GDP has little connection with Bank policy goals.
B) Nominal GDP is unaffected by open market operations.
C) The Bank has little direct control over nominal GDP.
D) None of the above.
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
15) Which of the following criteria must be satisfied when selecting an intermediate target?
A) The variable must be measurable and frequently available.
B) The variable must be controllable with the use of the central bank's policy tools.
C) The variable must have a predictable impact on the policy goal.
D) Each of the above.
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
16) If the desired intermediate target is an interest rate, then the preferred policy instrument will
be a(n) ________ variable like the ________.
A) interest rate; three-month T-bill rate
B) interest rate; overnight rate
C) monetary aggregate; monetary base
D) monetary aggregate; nonborrowed base
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
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17) Explain and demonstrate graphically how targeting nonborrowed reserves can result in
overnight rate instability.
Answer: When nonborrowed reserves are held constant, increases in the demand for reserves
result in the overnight rate increasing and decreases in the demand for nonborrowed reserves
result in the overnight rate declining. Since fluctuations in demand do not cause monetary
policy actions, the result is the overnight rate will fluctuate. See Figure 18-3 in the textbook.
Diff: 3
Type: ES
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
18) Explain and demonstrate graphically how targeting the overnight rate can result in
fluctuations in nonborrowed reserves.
Answer: With a overnight rate target, fluctuations in demand for reserves require similar
changes in the nonborrowed reserves to keep the overnight rate constant. See Figure 18-4 in the
textbook.
Diff: 3
Type: ES
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
19) What criteria apply when choosing a policy instrument?
Answer: Three criteria apply when choosing a policy instrument: The instrument must be
observable and measurable, it must be controllable by the central bank, and it
must have a predictable effect on the goals.
Diff: 3
Type: ES
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument
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17.8
Tactics: The Taylor Rule
1) According to the Taylor rule, the Bank of Canada should raise the overnight interest rate
when inflation ________ the Bank of Canada's inflation target or when real GDP ________ the
Bank of Canada's output target.
A) rises above; drops below
B) drops below; drops below
C) rises above; rises above
D) drops below; rises above
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
2) According to the Taylor rule, the overnight interest rate should be set at ________.
A) π + ior - 0.5(π - π ) - 0.5(y - y)
B) π + ior + 0.5(π - π ) + 0.5(y - y)
C) r + π
D) r - π
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
3) According to the Taylor rule, the overnight interest rate should be set at ________.
A) π + ior - 0.5(π - π ) - 0.5(y - y)
B) π - ior - 0.5(π - π ) - 0.5(y - y)
C) r + π
D) r - π
E) none of the above
Answer: E
Diff: 1
Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
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4) Using Taylor's rule, when the equilibrium real overnight rate is 3 percent, the positive output
gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent,
the nominal overnight rate target should be ________.
A) 5 percent
B) 5.5 percent
C) 6 percent
D) 6.5 percent
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
5) Using Taylor's rule, when the equilibrium real overnight rate is 2 percent, there is no output
gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal
overnight rate should be ________.
A) 0 percent
B) 1 percent
C) 2 percent
D) 3 percent
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
6) According to the Taylor Principle, when the inflation rate rises, the nominal interest rate
should be ________ by ________ than the inflation rate increase.
A) increased; more
B) increased; less
C) decreased; more
D) decreased; less
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
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7) If the Taylor Principle is not followed and nominal interest rates are increased by less than
the increase in the inflation rate, then real interest rates will ________ and monetary policy will
be too ________.
A) rise; tight
B) rise; loose
C) fall; tight
D) fall; loose
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
8) The rate of inflation tends to remain constant when ________.
A) the unemployment rate is above the NAIRU
B) the unemployment rate equals the NAIRU
C) the unemployment rate is below the NAIRU
D) the unemployment rate increases faster than the NAIRU increases
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
9) The rate of inflation increases when ________.
A) the unemployment rate equals the NAIRU
B) the unemployment rate exceeds the NAIRU
C) the unemployment rate is less than the NAIRU
D) the unemployment rate increases faster than the NAIRU increases
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
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10) Explain the Taylor rule, including the formula for setting the overnight rate target, and the
components of the formula. If the Bank of Canada were to use this rule, how many goals would
it use to set monetary policy?
Answer: The Taylor rule specifies that the target overnight rate should be set to equal the
equilibrium real overnight rate, plus the rate of inflation (for the Fisher effect), plus one-half
times the output gap, plus one-half times the inflation gap. The formula is
overnight rate target = equilibrium real overnight rate + inflation rate +
(output gap) +
(inflation gap)
The output gap is the percentage deviation of real GDP from potential full-employment real
GDP. The inflation gap is the difference between actual inflation and the central bank's target
rate of inflation. The equilibrium real overnight rate is the real rate consistent with full
employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule
sets the overnight rate recognizing the goals of low inflation and full employment (or
equilibrium long-run economic growth).
Diff: 3
Type: ES
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate
17.9
Web Appendix 1: Monetary Targeting
1) Under monetary targeting, a central bank announces an annual growth rate target for
________.
A) a monetary aggregate
B) a reserve aggregate
C) the monetary base
D) GDP
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting
2) During the years 1979 to 1982, the Federal Reserve's announced policy was monetary
targeting. During this time period the Federal Reserve ________.
A) hit all of their monetary targets
B) did not hit any of their monetary targets because it is believed that controlling the money
supply was not the intent of the Federal Reserve
C) did not hit any of their monetary targets because they were unrealistic
D) hit about half of their monetary targets
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
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3) In July 1993, Board of Governors Chairman Alan Greenspan testified in Congress that the
Fed would no longer use what as a guide for conducting monetary policy?
A) The inflation rate
B) Monetary aggregates
C) Implicit nominal anchors
D) The federal funds rate
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
4) Compared to the United States, Japan's experience with monetary targeting performed
________.
A) better with regard to the inflation rate and output fluctuations
B) worse with regard to the inflation rate and output fluctuations
C) better with regard to the inflation rate, but worse with regard to output fluctuations
D) worse with regard to the inflation rate, but better with regard to output fluctuations
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
5) What does the Bank of Japan use as its daily operating target to conduct monetary policy?
A) Monetary aggregates
B) Non borrowed reserves
C) The inter-bank market interest rate
D) Reserve aggregates
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
6) Since 1978, the Bank of Japan has used an interest rate as its daily operating target
________.
A) providing additional evidence that interest rate smoothing is inconsistent with reducing
inflation
B) because money growth in Japan is very volatile
C) with very good success, suggesting that an interest rate operating target is not necessarily a
barrier to successful monetary policy
D) A and C only.
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
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7) One of the factors that contributed to the success German policymakers had using a
monetary targeting type policy was that ________.
A) they used a rigid target for the money growth rate
B) they implemented policy so their inflation rate goal was met in the short run
C) the money target was flexible to allow the Bundesbank to concentrate on other goals as
needed
D) they rarely communicated the intentions of policy to the public in order to keep the public
from panicking
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
8) Which of the following is the best description of the monetary policy strategy followed by
the European Central Bank (ECB)?
A) The ECB follows monetary targeting.
B) The ECB follows inflation targeting.
C) The ECB has a hybrid strategy with elements of both monetary targeting and inflation
targeting.
D) The ECB has a Fed-like "just do it" approach.
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting
9) Which of the following is an advantage to monetary targeting?
A) There is an immediate signal on the achievement of the target.
B) It does not rely on a stable money-inflation relationship.
C) It implies lack of transparency.
D) It implies smaller output fluctuations.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting
10) Which of the following is an advantage to monetary targeting?
A) There is almost immediate accountability.
B) It does not rely on a stable money-inflation relationship.
C) It implies lack of transparency.
D) It implies smaller output fluctuations.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting
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11) Which of the following is a disadvantage to monetary targeting?
A) It relies on a stable money-inflation relationship.
B) There is a delayed signal about the achievement of a target.
C) It implies larger output fluctuations.
D) It implies a lack of transparency.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting
12) Which of the following is a NOT an advantage to monetary targeting?
A) It relies on a stable money-inflation relationship.
B) There is a delayed signal about the achievement of a target.
C) It implies larger output fluctuations.
D) It implies a lack of transparency.
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting
13) If the relationship between the monetary aggregate and the goal variable is weak, then
________.
A) monetary aggregate targeting is superior to exchange-rate targeting
B) monetary aggregate targeting is superior to inflation targeting
C) inflation targeting is superior to exchange-rate targeting
D) monetary aggregate targeting will not work
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting
14) Why has the ECB seemed to have decided to try to "have its cake and eat it, too"?
Answer: The ECB's strategy is somewhat unclear and has been subject to criticism. Although
the "below, but close to, 2 percent" goal for inflation sounds like an inflation target, the ECB
has repeatedly stated that it does not have an inflation target. By not committing too strongly to
either a monetary-targeting strategy or an inflation-targeting strategy the ECB seems to have
decided to try to "have its cake and eat it, too." The resulting difficulty of assessing the ECB's
strategy has the potential to reduce the accountability of the institution.
Diff: 2
Type: ES
Skill: Applied
Objective: Appendix: Monetary targeting
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15) What are the advantages of monetary targeting?
Answer: One advantage of monetary targeting is that information on whether the central bank
is achieving its target is known almost immediately—figures for monetary aggregates are
typically reported within a couple of weeks. Thus monetary targets can send almost immediate
signals to the public and markets about the stance of monetary policy and the intentions of the
policymakers to keep inflation in check. In turn, these signals help fix inflation expectations
and produce less inflation. Monetary targets also allow almost immediate accountability for
monetary policy to keep inflation low, thus helping to constrain the monetary policymaker from
falling into the time-inconsistency trap.
Diff: 2
Type: ES
Skill: Recall
Objective: Appendix: Monetary targeting
17.10
Wed Appendix 2: A Brief History of Bank of Canada Policymaking
1) During the 1960s and early 1970s, the Bank of Canada used ________ as the intermediate
target in the conduct of monetary policy.
A) the interest rate
B) the exchange rate
C) the monetary base
D) None of the above
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
2) During the 1960s and early 1970s, the Bank of Canada used ________ as the intermediate
target(s), to keep the foreign exchange and domestic bonds markets functioning smoothly.
A) the exchange rate and the interest rate
B) the interest rate
C) the monetary base
D) None of the above
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
3) During the 1960s and early 1970s, the Bank of Canada's policy of using interest rates at the
intermediate target was ________.
A) expansionary and resulted in double digit inflation
B) contractionary and resulted in a decrease in the inflation rate
C) neither expansionary nor contractionary
D) None of the above
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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4) In the 1975-1981 period, the Bank of Canada selected an interest rate as an operating target
than a reserve aggregate primarily because it ________.
A) had no interest in targeting a monetary aggregate, as evidenced by its unwillingness to target
a reserve aggregate
B) was still very concerned with interest rate stability
C) was committed to the real bills doctrine
D) was committed to keeping the foreign exchange and domestic bonds markets functioning
smoothly
E) None of the above
Answer: E
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
5) In the 1975-1981 period, the Bank of Canada selected a monetary aggregate as an
intermediate target than an interest rate primarily because it ________.
A) was concerned about inflation
B) was still very concerned with achieving interest rate stability
C) was committed to the real bills doctrine
D) was committed to keeping the foreign exchange and domestic bonds markets functioning
smoothly
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
6) In the 1975-1981 period, the Bank of Canada used ________ as the intermediate target of
monetary policy.
A) the growth rate of M1
B) the growth rate of M2
C) the interest rate
D) the exchange rate
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
7) In the 1975-1981 period, the Bank of Canada used ________ as the operating target and
________ as the intermediate target of monetary policy.
A) an interest rate; a monetary aggregate
B) a monetary aggregate; an interest rate
C) the monetary base; a monetary aggregate
D) a monetary aggregate; inflation
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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8) During the 1975-1981 period, the Bank of Canada decided to target the growth rate of M1
because it ________.
A) was the most prominent measure of money
B) had a stable demand
C) had a predictable relationship with income and prices
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
9) During the 1975-1981 period, although the Bank of Canada was successful in keeping actual
M1 growth within the target range, ________.
A) the inflation rate by the end of the 1970s was almost at the same level as when monetary
gradualism was introduced in 1975
B) the inflation rate remained high
C) the demand for M1 became unstable
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
10) During the 1975-1981 period, although the Bank of Canada was successful in keeping
actual M1 growth within the target range, ________.
A) the inflation rate by the end of the 1970s was almost at the same level as when monetary
gradualism was introduced in 1975
B) a series of financial innovations motivated individuals and firms to substitute out of M1 and
into M2
C) the growth rate of M2 increased
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
11) When interest rates in the United States increased sharply in late 1979, the Bank of Canada
responded by an extremely restrictive monetary policy to ________.
A) resist depreciation of the Canadian dollar
B) resist the possible inflationary shock from import prices
C) A and B only.
D) None of the above.
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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12) The Bank of Canada formally abandoned monetary targeting ________.
A) in November 1982
B) because of the uncertainty about the stability of M1
C) because of the uncertainty about monetary aggregates as reliable guides to monetary policy
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
13) During the 1982-1988 period, the Bank of Canada looked at a list of factors in order to
design and implement monetary policy. This list included ________.
A) the interest rate
B) the exchange rate
C) the money supply
D) All of the above.
E) A and B only.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
14) During the 1982-1988 period, the Bank of Canada ________.
A) looked at a list of factors in order to design and implement monetary policy
B) switched its focus to a range of broad monetary aggregates, but no aggregate was found
suitable as a guide for conducting monetary policy
C) A and B only.
D) None of the above.
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
15) During the 1982-1988 period, the Bank of Canada used ________ as the operating target
and ________ as the intermediate target.
A) the interest rate; the exchange rate
B) the monetary base; the interest rate
C) the short-term interest rate; the long-term interest rate
D) the interest rate; the money supply
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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16) The Bank of Canada's anti-inflation policy during the 1982-1988 period can be viewed as
one where ________ became the operating target and ________ was the intermediate target.
A) the interest rate; the inflation rate
B) the interest rate; the exchange rate
C) the monetary base; the inflation rate
D) the monetary base; the exchange rate
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
17) The Bank of Canada adopted inflation targets ________.
A) because the 1982-1988 checklist approach to policy made it difficult for the Bank to control
money growth and inflation
B) following a three-year campaign to promote price stability as the long-term goal of
monetary policy
C) by announcing explicit targets for the inflation rate, rather than for money growth
D) All of the above.
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
18) Since 1989, the Bank of Canada used ________ as the operating target and ________ as the
ultimate goal of monetary policy.
A) the overnight interest rate; the exchange rate
B) the overnight interest rate; the inflation rate
C) the monetary base; the inflation rate
D) None of the above.
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
19) In its most recent attempt in lowering the inflation rate, the Bank of Canada announces
explicit targets for the rate of change in the CPI, because the CPI ________.
A) is the most commonly used and understood price measure in Canada
B) comes out monthly and without revisions, whereas other price measures are frequently
revised
C) A and B only.
D) None of the above.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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20) The midpoint of the Bank of Canada's inflation target range is ________.
A) 3 percent
B) 2 percent
C) 1 percent
D) None of the above.
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
21) In its most recent attempt in lowering the inflation rate, the Bank of Canada announces
explicit targets for the rate of change in "core CPI," because ________.
A) core CPI excludes volatile components, such as food, energy, and the effect of indirect taxes
B) core inflation is useful in assessing whether trend inflation is on track for the medium term
C) A and B only.
D) None of the above.
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
22) Bank of Canada policy since 1989 suggests ________.
A) that it is finally using a monetary aggregate as its intermediate target
B) that it is less concerned with fluctuations in the overnight interest rate
C) that it is more concerned with exchange rates than with interest rates
D) None of the above.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
23) The Bank of Canada can engage in preemptive strikes against a rise in inflation by
________ the overnight rate; it can act preemptively against negative demand shocks by
________ the overnight rate.
A) raising; lowering
B) raising; raising
C) lowering; lowering
D) lowering; raising
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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24) International policy coordination refers to ________.
A) central banks in major nations acting without regard to the global consequences of their
policies
B) central banks in major nations pursuing only domestic objectives
C) central banks adopting policies in pursuit of joint objectives
D) central banks all adopting identical policies
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 18 The Foreign Exchange Market
18.1
Foreign Exchange Market
1) The exchange rate is ________.
A) the price of one currency relative to gold
B) the value of a currency relative to inflation
C) the change in the value of money over time
D) the price of one currency relative to another
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
2) Exchange rates are determined in ________.
A) the money market
B) the foreign exchange market
C) the stock market
D) the capital market
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
3) Although foreign exchange market trades are said to involve the buying and selling of
currencies, most trades involve the buying and selling of ________.
A) assets denominated in different currencies
B) SDRs
C) gold
D) ECUs
Answer: A
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Diff: 1
Type: MC
Skill: Recall
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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4) The immediate (two-day) exchange of one currency for another is a ________.
A) forward transaction
B) spot transaction
C) money transaction
D) exchange transaction
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
5) An agreement to exchange dollar bank deposits for euro bank deposits in one month is a
________.
A) spot transaction
B) future transaction
C) forward transaction
D) deposit transaction
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
6) Today 1 euro can be purchased for $1.10. This is the ________.
A) spot exchange rate
B) forward exchange rate
C) fixed exchange rate
D) financial exchange rate
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
7) In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro,
the price is the ________.
A) spot exchange rate
B) money exchange rate
C) forward exchange rate
D) fixed exchange rate
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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8) When the value of the British pound changes from $1.25 to $1.50, the pound has ________
and the Canadian dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
9) When the value of the British pound changes from $1.50 to $1.25, then the pound has
________ and the Canadian dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
10) When the value of the dollar changes from £0.5 to £0.75, then the British pound has
________ and the Canadian dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
11) When the value of the dollar changes from £0.75 to £0.5, then the British pound has
________ and the Canadian dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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12) When the exchange rate for the Mexican peso changes from 9 pesos to the Canadian dollar
to 10 pesos to the Canadian dollar, then the Mexican peso has ________ and the Canadian
dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
13) When the exchange rate for the Mexican peso changes from 10 pesos to the Canadian
dollar to 9 pesos to the Canadian dollar, then the Mexican peso has ________ and the Canadian
dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
14) On January 25, 2009, one Canadian dollar traded on the foreign exchange market for about
0.75 euros. Therefore, one euro would have purchased about ________ Canadian dollars.
A) 0.75
B) 1.00
C) 1.33
D) 1.75
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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15) On January 25, 2009, one Canadian dollar traded on the foreign exchange market for about
49.0 Indian rupees. Thus, one Indian rupee would have purchased about ________ Canadian
dollars.
A) 0.02
B) 1.20
C) 7.00
D) 49.0
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
16) On January 25, 2009, one Canadian dollar traded on the foreign exchange market for about
1.15 Swiss francs. Therefore, one Swiss franc would have purchased about ________ Canadian
dollars.
A) 0.30
B) 0.87
C) 1.15
D) 3.10
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
17) On January 25, 2009, one Canadian dollar traded on the foreign exchange market for about
3.33 Romanian new lei. Therefore, one Romanian new lei would have purchased about
________ Canadian dollars.
A) 0.30
B) 1.86
C) 2.86
D) 3.33
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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18) If the Canadian dollar appreciates from 1.25 Swiss franc per Canadian dollar to 1.5 francs
per dollar, then the franc depreciates from ________ Canadian dollars per franc to ________
Canadian dollars per franc.
A) 0.80; 0.67
B) 0.67; 0.80
C) 0.50; 0.33
D) 0.33; 0.50
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
19) If the British pound appreciates from $0.50 per pound to $0.75 per pound, the Canadian
dollar depreciates from ________ per dollar to ________ per dollar.
A) £2; £2.5
B) £2; £1.33
C) £2; £1.5
D) £2; £1.25
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
20) If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the Canadian dollar
depreciates from ________ per dollar to ________ per dollar.
A) 100¥; 50¥
B) 10¥; 5¥
C) 5¥; 10¥
D) 50¥; 100¥
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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21) If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real
depreciates from ________ per real to ________ per real.
A) $0.67; $0.50
B) $0.33; $0.50
C) $0.75; $0.50
D) $0.50; $0.67
E) $0.50; $0.75
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
22) When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per
pound, then, holding everything else constant, the pound has ________ and ________
expensive.
A) appreciated; British cars sold in Canada become more
B) appreciated; British cars sold in Canada become less
C) depreciated; American wheat sold in Britain becomes more
D) depreciated; American wheat sold in Britain becomes less
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
23) If the dollar depreciates relative to the Swiss franc, ________.
A) Swiss chocolate will become cheaper in Canada
B) American computers will become more expensive in Switzerland
C) Swiss chocolate will become more expensive in Canada
D) Swiss computers will become cheaper in Canada
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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24) Everything else held constant, when a country's currency appreciates, the country's goods
abroad become ________ expensive and foreign goods in that country become ________
expensive.
A) more; less
B) more; more
C) less; less
D) less; more
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
25) Everything else held constant, when a country's currency depreciates, its goods abroad
become ________ expensive while foreign goods in that country become ________ expensive.
A) more; less
B) more; more
C) less; less
D) less; more
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are
important
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18.2
Exchange Rates in the Long Run
1) According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos
per pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange
rate between the Colombian peso and the Brazilian real is ________.
A) 40 pesos per real
B) 100 pesos per real
C) 25 pesos per real
D) 0.4 pesos per real
Answer: C
Diff: 2
Type: MC
Skill: Applied
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
2) The starting point for understanding how exchange rates are determined is a simple idea
called ________, which states: if two countries produce an identical good, the price of the good
should be the same throughout the world no matter which country produces it.
A) Gresham's law
B) the law of one price
C) purchasing power parity
D) arbitrage
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
3) The ________ states that exchange rates between any two currencies will adjust to reflect
changes in the price levels of the two countries.
A) theory of purchasing power parity
B) law of one price
C) theory of money neutrality
D) quantity theory of money
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
4) The theory of PPP suggests that if one country's price level rises relative to another's, its
currency should ________.
A) depreciate
B) appreciate
C) float
D) do none of the above
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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5) The theory of PPP suggests that if one country's price level falls relative to another's, its
currency should ________.
A) depreciate
B) appreciate
C) float
D) do none of the above
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
6) The theory of PPP suggests that if one country's price level falls relative to another's, its
currency should ________.
A) depreciate in the long run
B) appreciate in the long run
C) appreciate in the short run
D) depreciate in the short run
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
7) 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
Answer: D
Diff: 2
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
8) If the real exchange rate between Canada and Japan is ________, then it is cheaper to buy
goods in Japan than in Canada.
A) greater than 1.0
B) greater than 0.5
C) less than 0.5
D) less than 1.0
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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9) According to PPP, the real exchange rate between two countries will always equal
________.
A) 0.0
B) 0.5
C) 1.0
D) 1.5
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
10) The theory of PPP suggests that if one country's price level rises relative to another's, its
currency should ________.
A) depreciate in the long run
B) appreciate in the long run
C) depreciate in the short run
D) appreciate in the short run
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
11) In the long run, a rise in a country's price level (relative to the foreign price level) causes its
currency to ________, while a fall in the country's relative price level causes its currency to
________.
A) appreciate; appreciate
B) appreciate; depreciate
C) depreciate; appreciate
D) depreciate; depreciate
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
12) If the 2005 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2
percent, then the theory of purchasing power parity predicts that, during 2005, the value of the
Canadian dollar in terms of Mexican pesos will ________.
A) rise by 6 percent
B) rise by 2 percent
C) fall by 6 percent
D) fall by 2 percent
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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13) Assume that the following are the predicted inflation rates in these countries for the year: 2
percent for Canada, 3 percent for Canada; 4 percent for Mexico, and 5 percent for Brazil.
According to the purchasing power parity and everything else held constant, which of the
following would we expect to happen?
A) The Brazilian real will depreciate against the Canadian dollar.
B) The Mexican peso will depreciate against the Brazilian real.
C) The Canadian dollar will depreciate against the Mexican peso.
D) The Canadian dollar will depreciate against the Canadian dollar.
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
14) According to the purchasing power parity theory, a rise in Canada price level of 5 percent,
and a rise in the Mexican price level of 6 percent cause ________.
A) the dollar to appreciate 1 percent relative to the peso
B) the dollar to depreciate 1 percent relative to the peso
C) the dollar to depreciate 5 percent relative to the peso
D) the dollar to appreciate 5 percent relative to the peso
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
15) Higher tariffs and quotas cause a country's currency to ________ in the ________ run,
everything else held constant.
A) depreciate; short
B) appreciate; short
C) depreciate; long
D) appreciate; long
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
16) Lower tariffs and quotas cause a country's currency to ________ in the ________ run,
everything else held constant.
A) depreciate; short
B) appreciate; short
C) depreciate; long
D) appreciate; long
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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17) Anything that increases the demand for foreign goods relative to domestic goods tends to
________ the domestic currency because domestic goods will only continue to sell well if the
value of the domestic currency is ________, everything else held constant.
A) depreciate; lower
B) depreciate; higher
C) appreciate; lower
D) appreciate; higher
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
18) Everything else held constant, increased demand for a country's ________ causes its
currency to appreciate in the long run, while increased demand for ________ causes its
currency to depreciate.
A) imports; imports
B) imports; exports
C) exports; imports
D) exports; exports
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
19) Everything else held constant, increased demand for a country's exports causes its currency
to ________ in the long run, while increased demand for imports causes its currency to
________.
A) appreciate; appreciate
B) appreciate; depreciate
C) depreciate; appreciate
D) depreciate; depreciate
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
20) Everything else held constant, if a factor increases the demand for ________ goods relative
to ________ goods, the domestic currency will appreciate.
A) foreign; domestic
B) foreign; foreign
C) domestic; domestic
D) domestic; foreign
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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21) Everything else held constant, if a factor decreases the demand for ________ goods relative
to ________ goods, the domestic currency will depreciate.
A) foreign; domestic
B) foreign; foreign
C) domestic; domestic
D) domestic; foreign
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
22) An increase in productivity in a country will cause its currency to ________ because it can
produce goods at a ________ price, everything else held constant.
A) depreciate; lower
B) appreciate; lower
C) depreciate; higher
D) appreciate; higher
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
23) If, in retaliation for "unfair" trade practices, the Canadian government imposes a 30 percent
tariff on Japanese DVD recorders, but at the same time, Canadian demand for Japanese goods
increases, then, in the long run, ________, everything else held constant.
A) the Japanese yen should appreciate relative to the Canadian dollar
B) the Japanese yen should depreciate relative to the Canadian dollar
C) there is no effect on the Japanese yen relative to the Canadian dollar
D) the Japanese yen could appreciate, depreciate or remain constant relative to the Canadian
dollar
Answer: D
Diff: 2
Type: MC
Skill: Applied
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
24) If Canada imposes a quota on imports of Japanese cars due to claims of "unfair" trade
practices, and Japanese demand for Canadian exports increases at the same time, then, in the
long run ________, everything else held constant.
A) the Japanese yen will appreciate relative to the Canadian dollar
B) the Japanese yen will depreciate relative to the Canadian dollar
C) the Japanese yen will either appreciate, depreciate or remain constant against the Canadian
dollar
D) there will be no effect on the Japanese yen relative to the Canadian dollar
Answer: B
Diff: 2
Type: MC
Skill: Applied
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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25) If the inflation rate in Canada is higher than that in Mexico and productivity is growing at a
slower rate in Canada than in Mexico, then, in the long run, ________, everything else held
constant.
A) the Mexican peso will appreciate relative to the Canadian dollar
B) the Mexican peso will depreciate relative to the Canadian dollar
C) the Mexican peso will either appreciate, depreciate, or remain constant relative to the
Canadian dollar
D) there will be no effect on the Mexican peso relative to the Canadian dollar
Answer: A
Diff: 2
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
26) If the Brazilian demand for Canadian exports rises at the same time that Canadian
productivity rises relative to Brazilian productivity, then, in the long run, ________, everything
else held constant.
A) the Brazilian real will appreciate relative to the Canadian dollar
B) the Brazilian real will depreciate relative to the Canadian dollar
C) the Brazilian real will either appreciate, depreciate, or remain constant relative to the
Canadian dollar
D) there is no effect on the Brazilian real relative to the Canadian dollar
Answer: B
Diff: 2
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
27) The theory of purchasing power parity cannot fully explain exchange rate movements
because ________.
A) all goods are identical even if produced in different countries
B) monetary policy differs across countries
C) some goods are not traded between countries
D) fiscal policy differs across countries
Answer: C
Diff: 2
Type: MC
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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28) Explain the law of one price and the theory of purchasing power parity. Why doesn't
purchasing power parity explain all exchange rate movements? What factors determine
long-run exchange rates?
Answer: With no trade barriers and low transport costs, the law of one price states that the
price of traded goods should be the same in all countries. The purchasing power parity theory
extends the law of one price to total economies. PPP states that exchange rates should adjust to
reflect changes in the price levels between two countries. PPP may fail to fully explain
exchange rates because goods are not identical, and price levels include traded and nontraded
goods and services. Long-run exchange rates are determined by domestic price levels relative
to foreign price levels, trade barriers, import and export demand, and productivity.
Diff: 1
Type: ES
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
29) What is the theory of purchasing power parity? Why cannot it not fully explain exchange
rates?
Answer: The theory of PPP suggests that if one country's price level rises relative to
another's, its currency should depreciate. PPP cannot fully explain exchange rates in the long
run because some of the assumptions for PPP to hold are violated. These assumptions are that
the goods traded are identical between countries, transportation costs are minimal and finally
that trade barriers do not exist.
Diff: 2
Type: ES
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
30) What are the factors that affect exchange rates in the long-run?
Answer:
a. Relative price levels: According to PPP when domestic price level rises relative to foreign,
the domestic currency will depreciate.
b. Trade barriers: when we impose trade barriers to imports then domestic currency will
appreciate.
c. Preferences for domestic versus foreign goods: when foreigners develop an appetite for
Canadian goods, then the Canadian dollar will appreciate.
d. Productivity: In the long-run as a country becomes more productive relative to other
countries, its currency appreciates.
Diff: 3
Type: ES
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
31) Explain how trade barriers affect the exchange rates in the long-run.
Answer: Increasing trade barriers cause a country's currency to appreciate in the long run. For
example, suppose that Canada increases its tariff or puts a lower quota on Japanese cars. These
increases in trade barriers increase the demand for Canadian cars, and the dollar tends to
appreciate because Canadian cars will still sell well even with a higher value of the dollar.
Diff: 3
Type: ES
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
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32) Explain how productivity affects exchange rates in the long-run
Answer: When productivity in a country rises, it tends to rise in domestic sectors that produce
traded goods rather than nontraded goods. Higher productivity is therefore associated with a
decline in the price of domestically produced traded goods relative to foreign-traded goods. As
a result, the demand for domestic goods rises, and the domestic currency tends to appreciate.
Diff: 3
Type: ES
Skill: Recall
Objective: 18.2 Identify the main factors that effect exchange rates in the long-run
18.3
Exchange Rates in the Short Run: A Supply and Demand Analysis
1) One way to understand the short-run behaviour of exchange rates is ________.
A) to use the theory of portfolio choice
B) to understand the exchange rate is the price of one asset in terms of another
C) to examine the long-run trends
D) A and B only.
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
2) The ________ suggests that the most important factor affecting the demand for domestic and
foreign assets is the expected return on domestic assets relative to foreign assets.
A) theory of asset demand
B) law of one price
C) interest parity condition
D) theory of foreign capital mobility
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
3) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign assets is the ________ on these assets relative to one another.
A) interest rate
B) risk
C) expected return
D) liquidity
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
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4) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign assets is ________.
A) the level of trade and capital flows
B) the expected return on these assets relative to one another
C) the liquidity of these assets relative to one another
D) the riskiness of these assets relative to one another
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
5) The demand curve for the domestic currency ________.
A) is downward sloping
B) is vertical because the amount of foreign exchange is finite
C) shifts when the exchange rate changes
D) A and C only
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
6) Everything else held constant, when the current value of the domestic currency increases, the
________ domestic assets ________.
A) demand for; increases
B) quantity demanded of; increases
C) demand for; decreases
D) quantity demanded of; decreases
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
7) Everything else held constant, when the current value of the domestic exchange rate
increases, the ________ of domestic assets ________.
A) quantity supplied; does not change
B) supply; decreases
C) quantity supplied; increases
D) supply; increases
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and
interpret the equilibrium in the market for foreign exchange
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18.4
Explaining Changes in Exchange Rates
1) An increase in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
2) As the relative expected return on dollar assets increases, foreigners will want to hold more
________ assets and less ________ assets, everything else held constant.
A) foreign; foreign
B) foreign; dollar
C) dollar; foreign
D) dollar; dollar
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
3) When Canadians or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a higher demand for dollar assets and a correspondingly
lower demand for foreign assets.
A) dollar; dollar
B) dollar; foreign
C) foreign; dollar
D) foreign; foreign
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
4) When Canadians or foreigners expect the return on ________ assets to be high relative to the
return on ________ assets, there is a ________ demand for dollar assets, everything else held
constant.
A) dollar; foreign; constant
B) dollar; foreign; higher
C) foreign; dollar; higher
D) foreign; dollar; constant
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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5) When Canadians or foreigners expect the return on dollar assets to be high relative to the
return on foreign assets, there is a ________ demand for dollar assets and a correspondingly
________ demand for foreign assets.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
6) An increase in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
7) A decrease in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
8) A decrease in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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9) ________ in the domestic interest 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
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
10) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
right 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
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
11) ________ in the domestic interest rate causes the demand for domestic assets to decrease
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
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
12) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
left 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
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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13) ________ in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
14) ________ in the domestic interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
15) ________ in the domestic interest rate causes the demand for domestic assets to ________
and the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
16) ________ 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
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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17) Suppose that the Bank of Canada enacts expansionary policy. Everything else held
constant, this will cause the demand for Canadian assets to ________ and the Canadian dollar
to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
18) Suppose that the Bank of Canada sells bonds to the chartered banks. Everything else held
constant, this will cause the demand for Canadian assets to ________ and the Canadian dollar
will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Diff: 3
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
19) An increase in the foreign interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
20) An increase in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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21) A decrease in the foreign interest rate causes the demand for domestic assets to ________
and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
22) A decrease in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to ________, everything else held constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
23) ________ in the foreign interest 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
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
24) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
right 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
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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25) ________ in the foreign interest rate causes the demand for domestic assets to decrease 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
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
26) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
left 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
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
27) ________ in the foreign interest rate causes the demand for domestic assets to ________
and the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
28) ________ in the foreign interest rate causes the demand for domestic assets to shift to the
________ and the domestic currency to appreciate, everything else held constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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29) ________ in the foreign interest rate causes the demand for domestic assets to ________
and the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
30) ________ in the foreign 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
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
31) Suppose that the European Central Bank enacts expansionary policy. Everything else held
constant, this will cause the demand for Canadian assets to ________ and the Canadian dollar
to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: A
Diff: 3
Type: MC
Skill: Applied
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
32) Suppose that the European Central Bank conducts a main refinancing sale. Everything else
held constant, this would cause the demand for Canadian assets to ________ and the Canadian
dollar will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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33) An increase in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
34) An increase in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
35) A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held constant.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
36) A decrease in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to ________, everything else held
constant.
A) right; appreciate
B) right; depreciate
C) left; appreciate
D) left; depreciate
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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37) ________ 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
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
38) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the right 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
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
39) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to decrease 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
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
40) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the left 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
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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41) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to appreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
42) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to shift to the ________ and the domestic currency to appreciate, everything else held
constant.
A) An increase; right
B) An increase; left
C) A decrease; right
D) A decrease; left
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
43) ________ in the expected future domestic exchange rate causes the demand for domestic
assets to ________ and the domestic currency to depreciate, everything else held constant.
A) An increase; increase
B) An increase; decrease
C) A decrease; increase
D) A decrease; decrease
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
44) ________ in the expected future domestic exchange 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
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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45) Suppose the Bank of Canada releases a policy statement today which leads people to
believe that the Bank will be enacting expansionary monetary policy in the near future.
Everything else held constant, the release of this statement would immediately cause the
demand for Canadian assets to ________ and the Canadian dollar to ________.
A) increase; appreciate
B) decrease; appreciate
C) increase; depreciate
D) decrease; depreciate
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
46) Suppose a report was released today that showed the Euro-Zone inflation rate is running
above the European Central Bank's inflation rate target. This leads people to expect that the
European Central Bank will enact contractionary policy in the near future. Everything else held
constant, the release of this report would immediately cause the demand for Canadian assets to
________ and the Canadian dollar will ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: D
Diff: 3
Type: MC
Skill: Applied
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
47) Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in
the Canadian than was expected. Everything else held constant, the release of the CPI report
would immediately cause the demand for Canadian assets to ________ and the Canadian dollar
would ________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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48) During the beginning on the subprime crisis in the United States when the effects of the
crisis were mostly confined within the United States, the U. S. dollar ________ because
demand for U.S. assets ________.
A) appreciated; increased
B) depreciated; increased
C) appreciated; decreased
D) depreciated; decreased
Answer: D
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
49) When the effects of the subprime crisis started to spread more quickly throughout the rest
of the world, the U.S. dollar ________ because demand for U.S. assets ________.
A) appreciated; increased
B) depreciated; increased
C) appreciated; decreased
D) depreciated; decreased
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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50) Explain and show graphically the effect of an increase in the expected future exchange rate
on the equilibrium exchange rate, everything else held constant.
Answer: See figure below.
When the expected future exchange rate increases, the relative expected return on the domestic
assets increases. This will cause the demand for domestic assets to increase and the current
value of the exchange rate will appreciate.
Diff: 2
Type: ES
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
51) In the model of the demand and supply of dollar assets use a graph to explain how a change
in the domestic interest rate affects the equilibrium exchange rate.
Answer: In the model of the equilibrium in the foreign exchange market, when the domestic
interest rate iD rises, holding the current exchange rate Et and everything else constant, the
return on dollar assets increases relative to foreign assets, so people will want to hold more
dollar assets. The quantity of dollar assets demanded increases at every value of the exchange
rate, as it can be shown on the graph by a rightward shift of the demand curve. At the new
equilibrium point the exchange rate rises.
Diff: 2
Type: ES
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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52) In the model of the demand and supply of dollar assets use a graph to explain how a change
in the foreign interest rate affects the equilibrium exchange rate.
Answer: When the foreign interest rate iF rises, holding current exchange rate Et and
everything else constant, the return on foreign assets rises relative to dollar assets. Thus the
relative expected return on dollar assets falls. Now people want to hold fewer dollar assets, and
the quantity demanded decreases at every value of the exchange rate. This can be shown by a
leftward shift of the demand curve for dollar assets. The new equilibrium is reached at a point
where the value of the dollar has fallen.
Diff: 2
Type: ES
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
53) Why are exchange rates so volatile?
Answer: The asset market approach of exchange rate determination gives us a straightforward
explanation of volatile exchange rates. Because expected appreciation of the domestic currency
affects the expected return on foreign deposits for both the domestic and the foreign investors,
expectations on the price level, inflation, trade barriers, productivity, import demand, export
demand, and the money supply play important roles in determining the exchange rate. When
expectations about any of these variables change, our model indicates that there will be an
immediate effect on the expected return of foreign deposits and therefore on the exchange rate.
because expectations about all these variables change with just about any bit of news that
appears, it is not surprising that the exchange rate is volatile. In addition, money supply
increases produce exchange rate overshooting and this is an additional reason for the high
volatility of exchange rates.
Diff: 3
Type: ES
Skill: Recall
Objective: 18.4 List and illustrate the factors that effect the exchange rate in the short-run
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18.5
Appendix 1: The Interest Parity Condition
1) The condition that states that the domestic interest rate equals the foreign interest rate minus
the expected appreciation of the domestic currency is called ________.
A) the purchasing power parity condition
B) the interest parity condition
C) money neutrality
D) the theory of foreign capital mobility
Answer: B
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Interest Parity Condition
2) If the interest rate is 7 percent on euro-denominated assets and 5 percent on
dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, for
Francois the Frenchman the expected rate of return on dollar-denominated assets is ________.
A) 11 percent
B) 9 percent
C) 5 percent
D) 3 percent
E) 1 percent
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
3) If the interest rate is 7 percent on euro-denominated assets and 5 percent on
dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the
expected return on euro-denominated assets is ________.
A) 7 percent
B) 5 percent
C) 1 percent
D) 3 percent
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
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4) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on
peso-denominated assets, and if the euro is expected to appreciate at a 4 percent rate, for
Manuel the Mexican the expected rate of return on euro-denominated assets is ________.
A) 11 percent
B) 13 percent
C) 17 percent
D) 19 percent
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
5) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on
peso-denominated assets, and if the euro is expected to appreciate at a 4 percent rate, for
Francois the Frenchman the expected rate of return on peso-denominated assets is ________.
A) 11 percent
B) 15 percent
C) 17 percent
D) 19 percent
Answer: A
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
6) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the foreign currency is
________.
A) 3 percent
B) 10 percent
C) 13.5 percent
D) 17 percent
Answer: D
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
7) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent
over the coming year, the expected return on dollar deposits in terms of the dollar is ________.
A) 3 percent
B) 10 percent
C) 13.5 percent
D) 17 percent
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
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Copyright © 2017 Pearson Canada, Inc.
8) The expected return on dollar deposits in terms of foreign currency can be written as the
________ of the interest rate on dollar deposits and the expected appreciation of the dollar.
A) product
B) ratio
C) sum
D) difference
Answer: C
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Interest Parity Condition
9) In a world with few impediments to capital mobility, the domestic interest rate equals the
sum of the foreign interest rate and the expected depreciation of the domestic currency, a
situation known as the ________.
A) interest parity condition
B) purchasing power parity condition
C) exchange rate parity condition
D) foreign asset parity condition
Answer: A
Diff: 1
Type: MC
Skill: Recall
Objective: Appendix: The Interest Parity Condition
10) According to the interest parity condition, if the domestic interest rate is 12 percent and the
foreign interest rate is 10 percent, then the expected ________ of the foreign currency must be
________ percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: B
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
11) According to the interest parity condition, if the domestic interest rate is 10 percent and the
foreign interest rate is 12 percent, then the expected ________ of the foreign currency must be
________ percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: C
Diff: 1
Type: MC
Skill: Applied
Objective: Appendix: The Interest Parity Condition
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12) Explain the interest parity condition.
Answer: The domestic interest rate equals the foreign interest rate minus the expected
appreciation of the domestic currency.
Diff: 1
Type: ES
Skill: Recall
Objective: Appendix: The Interest Parity Condition
578
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