Practice Questions for final exam – Econ 351 –Fall 2010 – These are mostly from the
material covered from exam 2 forward – there are practice questions for exam 1 and 2
posted on our practice page and you also have all the true false questions that were on
exam 1 and 2 so lots of questions to look at! Good luck!
True / False (Answer A for true and B for false)
1. NAIRU is defined as the rate of inflation at which we expect unemployment to begin
increasing.
2. According to the Fisher effect, higher real rates of interest cause inflation to go down
due to weaker aggregate demand.
3. In the cruise ship example explained in class, it takes longer for Fiscal Policy
authorities to turn the wheel (of the ship) than it does for Monetary Authorities.
4. The main measure of inflation used by the fed to gauge inflationary pressures is the
headline inflation number, the CPI (consumer price index)..
5. We argued, using the Taylor Rule, when the federal funds rate falls below 3%, Fed
policy is considered easy (accommodative).
6. According to the Fisher effect, if inflationary expectations rise, then real rates of
interest will rise as well.
7. During the late 1990s, the unemployment rate in the US fell below 4 percent!
8. By overheating, we mean either that the unemployment rate is too low or GDP growth
is too fast, or a combination of both.
9. If the current price of a US Treasury bond is 110, then that bond is selling at a
premium.
10. The Fed tends to care more about the core rate inflation as opposed to the overall rate
of inflation.
11. One reason the bond market rallies is the safe haven argument – that is, when the
financial waters get rough and murky, investors tend to prefer the safe haven of US
Treasuries.
12. If I expect interest rates to rise in the future, then I should sell bonds now.
13. If the spread between rates on Ford bonds and comparable US Treasuries rises then
we say that the risk premium on Ford bonds has risen.
14. 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.
15. Which of the following long-term bonds has the highest interest rate?
A) Corporate Aaa bonds
B) U.S. Treasury bonds
C) Corporate Aa bonds
D) Corporate Baa bonds
16. The risk premium on corporate bonds becomes smaller if
A) the riskiness of corporate bonds increases.
B) the liquidity of corporate bonds increases.
C) the liquidity of corporate bonds decreases.
D) the riskiness of corporate bonds decreases.
E) both (b) and (d) occur.
17. If the expected path of one-year interest rates over the next four years is 5 percent, 4
percent, 2 percent, 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. E) 5 percent.
18. 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.
19. Technical analysts try to find patterns in stock prices by looking at charts and thus,
are often referred to as chart watchers.
20. In class we argued that long rates react more to changes in inflationary expectations
relative to short rates. This higher volatility helps explain why the yield curve is
‘typically’ upward sloping.
21. The liquidity premium theory of the term structure helps explain why on average, the
Treasury yield curve typically slopes upward. The liquidity premium theory relies on the
fact that the longer the maturity, the less liquid the bond and thus, the higher the interest
rate (lower the price), since investors require a ‘liquidity premium’ in order to purchase
the longer-term security.
22. One reason China has such a large appetite for US Treasuries is due to the fact they
peg their currency to the US dollar. Recently, there has been pressure on the yuan
(Chinese currency) to appreciate and in order to offset that pressure, Chinese authorities
buy US dollars and subsequently, use those dollars to buy US Treasuries.
23. The risk structure of interest rates is
A) the structure of how risks in buying bonds 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.
24.
The risk premium on corporate bonds (yield on corporate’s minus yield of
Treasuries) becomes smaller if
A) the riskiness of corporate bonds increases.
B) the liquidity of corporate bonds increases.
C) the liquidity of corporate bonds decreases.
D) the riskiness of corporate bonds decreases.
E) both (b) and (d) occur.
25. If productivity growth falls and with it, inflationary expectations rise, then the bond
market should rally (according to the Fisher effect).
26. The slope of the yield curve did a great job in predicting the Gulf war recession
(1990-91), the problem was that it failed in terms of predicting the subsequent recovery.
27. According to your HW assignment on the yield curve, the slope of the yield curve is
typically higher during recoveries than it is during recessions.
28. Hubris is one reason that E. Asian countries called in the IMF to bail them out.
29. One silver lining of the East Asian crisis was that the inflow of foreign financial
capital to the US raised the prices on corporate bonds in the US making it cheaper for
firms to borrow through the corporate bond market.
30. It is often argued that the existence of the IMF creates a moral hazard problem in that
investors (and lenders) take on more risks knowing that if their investment is
unsuccessful, the IMF will bail them out anyway.
31. Very large export oriented firms characterized by economies of scale are consistent
with the ‘Japanese model.’
32. Moral hazard contributed to the Asian crisis. An example of this is when the
President of Indonesia “immorally” forced banks to lend his son money for a car
manufacturing plant.
33. An industry characterized by economies of scale simply means that bigger is better in
an average cost sense.
34. One benefit of the E. Asian crisis on the US economy is that the resulting intense
competition from abroad essentially forced US firms (and workers) to be more productive
just to compete.
35. If Asian firms would have hedged against exchange rate risk their debt payments to
western banks would have been much smaller.
36. On reason Asian banks borrowed off of western banks was due to the development
of public capital markets here in the US. Specifically, the corporate bond and the
commercial paper markets had become so developed by this time, western banks were
“looking for customers.”
37. One reason E. Asian firms had trouble servicing their domestic debt was due to the
fact that there were gluts in many of the export markets they were trying sell in. The
resulting fall in prices cut into the firms’ profits making it more difficult for them to
service debt.
38. The IMF is an international organization that some argue is just a pawn for the US,
since the US contributes the most to the IMF and has veto power when it comes to major
IMF decisions.
39. When currency pegs broke during the East Asian crisis, foreign denominated debt
held by E. Asian firms exploded, since when the pegs broke, US dollars, needed to
service that debt, became much more expensive in terms of the local currency.
40. Crony capitalism is the alleged network between the US Treasury and IMF – a secret
network involving payoffs and bribery.
41. During the credit crunch of 1998, Greenspan was worried about the credit markets:
The demand for commercial paper and corporate bonds rose dramatically causing the
yields on commercial paper and corporate bonds to rise dramatically.
42. During the Russian crisis the US T-bill market rallied.
43. The Fed cut in September of 1998, the first of three in a seven week period, came as
a complete surprise to many, if not all, investors.
44. The Fed’s second interest rate cut in October of 1998 was not effective in lowering
the commercial paper - bill spread
45. The credit crunch, in general, pushed interest rates higher in emerging economies.
46. One similarity between the Asian and Russian crises was that capital flowed into US
bond markets.
47. During the credit crunch of 1998, the spread between the commercial paper rate and
US T-bill rose dramatically up until the Fed’s surprise cut in October.
48. During the credit crunch of 1998, most foreign bond markets rallied.
49. The Fed cut in October of 1998, the second of three in a seven week period, came as
a complete surprise to many, if not all, investors.
50. The Fed’s first interest rate cut in September of 1998 was not effective in lowering
the commercial paper - bill spread.
51. The Russian default in August of 1998 came as a complete surprise to many
investors.
52. The role of banks during the credit crunch of 1998 is consistent with banks being a
spare tire.
L = - [α (π-π*)2 + β ( y-y*)2 ]
53. According to the loss function above, where the variables and parameters are defined
as in class, missing your inflation target by 100 basis points on the upside is just as costly
to social welfare as missing your inflation target by 100 basis points on the downside.
54. According to the loss function above, Paul Volcker’s β is bigger than his α consistent
with the notion that Paul Volcker is an inflation hawk.
55. We discussed that in the context of the loss function above, all policy makers have
their own personalized α’s and β’s and that what really matters is their relative
magnitude. That is, we argued that if α/β is greater than 1, then the policymaker is
considered to be dovish and would more than likely vote for policy easing in a
stagflation environment relative to a hawk, whose α/β is less than one.
56. According to the Taylor rule, if we are hitting our target for inflation and GDP
growth, then the federal funds rate should be set at 4%
57. The Taylor principle is a principle of fighting inflation by raising nominal interest
rates faster than inflation rises so that the real federal funds rate rises. For example, if the
actual inflation rate rises by 100 basis points then the Taylor principle tells us to raise the
federal funds rate by 150 basis points, all else constant.
58. The 2003 – 2004 period was when Alan Greenspan arguably had interest rates too
low for too long as he (and the FOMC) set the federal funds rate target at 1%. Taylor
(from the Taylor rule) recently argued that this rate (1%) was below the implied fed funds
rate from the Taylor rule. Given that GDP was growing at potential (target) and that
actual inflation was 1% where the target or optimal inflation rate is 2%, the Fed,
according to the Taylor rule should have had the federal funds target set at 2%.
59. Given a currency peg, if your currency is depreciating to the point where it is getting
outside of the (currency) band, then you can bring it back (intervene) by buying up your
(local) currency using your foreign reserves.