Finamarketsintst-EXAMENES[1]
320 Pages

Finamarketsintst-EXAMENES[1]

Course Number: ECON 3022, Spring 2011

College/University: Universidad de Puerto Rico

Word Count: 76896

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CONTENTS Preface Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17 Chapter 18 Chapter 19 Chapter 20 Chapter 21 Chapter 22 Chapter 23 Why Study Financial Markets and Institutions?............................................................1 Overview of the Financial...

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Chapter CONTENTS Preface 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17 Chapter 18 Chapter 19 Chapter 20 Chapter 21 Chapter 22 Chapter 23 Why Study Financial Markets and Institutions?............................................................1 Overview of the Financial System.................................................................................9 Understanding Interest Rates.......................................................................................21 The Behavior of Interest Rates ....................................................................................37 The Risk and Term Structure of Interest Rates............................................................55 Structure of Central Banks and the Federal Reserve System.......................................71 Conduct of Monetary Policy: Tools, Goals and Targets .............................................89 The Money Markets ..................................................................................................109 The Capital Markets ..................................................................................................119 The Stock Market and the Efficient Markets Hypothesis..........................................131 The Mortgage Markets..............................................................................................141 The Foreign Exchange Market ..................................................................................151 The International Financial System...........................................................................165 Theory of Financial Structure....................................................................................187 The Banking Firm and Bank Management ...............................................................203 The Commercial Banking Industry: Structure and Competition ...............................221 Savings Associations and Credit Unions...................................................................239 Banking Regulation...................................................................................................253 Insurance Companies and Pension Funds .................................................................263 Venture Capital Firms, Finance Companies and Financial Conglomerates ..............271 Investment Banks, Brokerage Firms, and Mutual Funds...........................................281 Risk Management in Financial Institutions ...............................................................291 Hedging with Financial Derivatives ..........................................................................303 PREFACE This Test Bank to accompany Financial Markets and Institutions, Fourth Edition, by Frederic S. Mishkin and Stanley G. Eakins, has been thoroughly updated to reflect content changes from the previous edition. It contains multiple choice, true/false, and short discussion questions for each of the textbooks twenty-three chapters. There are approximately 40-80 multiple-choice questions, 10 true/false questions, and 5-8 discussion questions for each chapter. This edition of the Test Bank was prepared by Professor James Eaton of Bridgewater College. Please send any comments or questions regarding its content to jeaton@bridgewater.edu. Jim Eaton Bridgewater College Bridgewater, VA Chapter 1 Why Study Financial Markets and Institutions? 1.1 Multiple Choice Questions 1) Financial markets and institutions A) involve the movement of huge quantities of money. B) affect the profits of businesses. C) affect the types of goods and services produced in an economy. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer2) Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called A) commodity markets. B) fund-available markets. C) derivative exchange markets. D) financial markets. Register to View Answer3) The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of $100 per year) is commonly referred to as the A) inflation rate. B) exchange rate. C) interest rate. D) aggregate price level. Register to View Answer4) The bond markets are important because A) they are easily the most widely followed financial markets in the United States. B) they are the markets where foreign exchange rates are determined. C) they are the markets where interest rates are determined. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer5) Interest rates are important to financial institutions since an interest rate increase A) decreases the cost of acquiring funds. B) increases the cost of acquiring funds. C) raises the income from assets. D) (B) and (C) of the above. E) (A) and (C) of the above. Register to View Answer 1 6) Typically, increasing interest rates A) discourage corporate investments. B) discourage individuals from saving. C) encourage corporate expansion. D) encourage corporate borrowing. E) none of the above. Register to View Answer7) Compared to interest rates on long-term U.S. government bonds, interest rates on ____ fluctuate more and are lower on average. A) medium-quality corporate bonds B) low-quality corporate bonds C) high-quality corporate bonds D) three-month Treasury bills E) none of the above Register to View Answer8) Compared to interest rates on long-term U.S. government 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 Register to View Answer9) The stock market is important because A) it is where interest rates are determined. B) it is the most widely followed financial market in the United States. C) it is where foreign exchange rates are determined. D) all of the above. Register to View Answer10) Stock prices since the 1950s have been 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. Register to View Answer 2 11) A rising stock market index due to higher share prices A) increases peoples wealth and as a result may increase their willingness to spend. B) increases the amount of funds that business firms can raise by selling newly issued stock. C) decreases the amount of funds that business firms can raise by selling newly issued stock. D) both (A) and (B) of the above. Register to View Answer12) A declining stock market index due to lower share prices A) reduces peoples wealth and as a result may reduce their willingness to spend. B) increases peoples wealth and as a result may increase their willingness to spend. C) decreases the amount of funds that business firms can raise by selling newly issued stock. D) both (A) and (C) of the above. E) both (B) and (C) of the above. Register to View Answer13) Changes in stock prices A) affect peoples wealth and their willingness to spend. B) affect firms decisions to sell stock to finance investment spending. C) are characterized by considerable fluctuations. D) all of the above. E) only (A) and (B) of the above. Register to View Answer14) (I) Debt markets are often referred to generically as the bond market. (II) A bond is a security that is a claim on the earnings and assets of a corporation. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer15) (I) A bond is a debt security that promises to make payments periodically for a specified period of time. (II) A stock is a security that is a claim on the earnings and assets of a corporation. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 3 16) The price of one countrys currency in terms of anothers is called A) the exchange rate. B) the interest rate. C) the Dow Jones industrial average. D) none of the above. Register to View Answer17) A stronger dollar benefits _____ and hurts _____ A) American businesses; American consumers. B) American businesses; foreign businesses. C) American consumers; American businesses. D) foreign businesses; American consumers. Register to View Answer18) A weaker dollar benefits _____ and hurts _____ A) American businesses; American consumers. B) American businesses; foreign consumers. C) American consumers; American businesses. D) foreign businesses; American consumers. Register to View Answer19) From 1980 to early 1985 the dollar _____ in value, thereby benefiting American _____ A) appreciated; consumers. B) appreciated; businesses. C) depreciated; consumers. D) depreciated; businesses. Register to View Answer20) Money is defined as A) anything that is generally accepted in payment for goods and services or in the repayment of debt. B) bills of exchange. C) a riskless repository of spending power. D) all of the above. E) only (A) and (B) of the above. Register to View Answer21) The organization responsible for the conduct of monetary policy in the United States is the A) Comptroller of the Currency. B) U.S. Treasury. C) Federal Reserve System. D) Bureau of Monetary Affairs. Register to View Answer 4 22) The central bank of the United States is A) Citicorp. B) Bank America. C) The treasury. D) The Fed. E) none of the above. Register to View Answer23) Economists group commercial banks, savings and loan associations, credit unions, mutual funds, mutual savings banks, insurance companies, pension funds, and finance companies together under the heading financial intermediaries. Financial intermediaries A) act as middlemen, borrowing funds from those who have saved and lending these funds to others. B) produce nothing of value and are therefore a drain on societys resources. C) help promote a more efficient and dynamic economy. D) do all of the above. E) do only (A) and (C) of the above. Register to View Answer24) Economists group commercial banks, savings and loan associations, credit unions, mutual funds, mutual savings banks, insurance companies, pension funds, and finance companies together under the heading financial intermediaries. Financial intermediaries A) act as middlemen, borrowing funds from those who have saved and lending these funds to others. B) play an important role in determining the quantity of money in the economy. C) help promote a more efficient and dynamic economy. D) do all of the above. E) do only (A) and (C) of the above. Register to View Answer25) Banks are important to the study of money and the economy because they A) provide a channel for linking those who want to save with those who want to invest. B) have been a source of rapid financial innovation that is expanding the alternatives available to those wanting to invest their money. C) are the only financial institution to play a role in determining the quantity of money in the economy. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer 5 26) Banks, savings and loan associations, mutual savings banks, and credit unions A) are no longer important players in financial intermediation. B) have been providing services only to small depositors since deregulation. C) have been adept at innovating in response to changes in the regulatory environment. D) all of the above. E) only (A) and (C) of the above. Register to View Answer27) (I) Banks are financial intermediaries that accept deposits and make loans. (II) Included under the term banks are firms such as commercial banks, savings and loan associations, mutual savings banks, credit unions, and insurance companies. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 6 1.2 True/False 1) Money is anything accepted by anyone as payment for services or goods. Register to View Answer2) Interest rates are determined in the bond markets. Register to View Answer3) A stock is a debt security that promises to make periodic payments for a specific period of time. Register to View Answer4) Monetary policy affects interest rates but has little effect on inflation or business cycles. Register to View Answer5) The government organization responsible for the conduct of monetary policy in the United States is the U.S. Treasury. Register to View Answer6) Interest rates can be accurately described as the rental price of money. Register to View Answer7) Holding everything else constant, as the dollar weakens vacations abroad become less attractive. Register to View Answer8) In recent years, financial markets have become more stable and less risky. Register to View Answer9) Financial innovation has provided more options to both investors and borrowers. Register to View Answer10) A financial intermediary borrows funds from people who have saved. Register to View Answer 7 1.3 Essay 1) Have interest rates been more or less volatile in recent years? Why? 2) Why should consumers be concerned with movements in foreign exchange rates? 3) What is monetary policy and who is responsible for its implementation? 4) What are financial intermediaries and what do they do? 5) What is money? 6) How does a bond differ from a stock? 7) Why is the stock market so important to individuals, firms, and the economy? 8 Chapter 2 Overview of the Financial System 2.1 Multiple Choice Questions 1) Every financial market has the following characteristic: 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. Register to View Answer2) Financial markets have the basic function of A) bringing together people with funds to lend and 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) both (A) and (B) of the above. E) both (B) and (C) of the above. Register to View Answer3) Which of the following can be described as involving direct finance? A) A corporations stock is traded in an over-the-counter market. B) People buy shares in a mutual fund. C) A pension fund manager buys commercial paper in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets. E) None of the above. Register to View Answer4) Which of the following can be described as involving direct finance? A) A corporations stock is traded in an over-the-counter market. B) A corporation buys commercial paper issued by another corporation. C) A pension fund manager buys commercial paper from the issuing corporation. D) Both (A) and (B) of the above. E) Both (B) and (C) of the above. Register to View Answer5) Which of the following can be described as involving indirect finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys commercial paper in a secondary market. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer 9 6) Which of the following can be described as involving indirect finance? A) A bank buys a U.S. Treasury bill from one of its depositors. B) A corporation buys commercial paper issued by another corporation. C) A pension fund manager buys commercial paper in the primary market. D) Both (B) and (C) of the above. Register to View Answer7) Financial markets improve economic welfare because A) they allow funds to move from those without productive investment opportunities to those who have such opportunities. B) they allow consumers to time their purchases better. C) they weed out inefficient firms. D) they do all of the above. E) they do (A) and (B) of the above. Register to View Answer8) Which of the following are securities? A) A certificate of deposit B) A share of Texaco common stock C) A Treasury bill D) All of the above E) Only (A) and (B) of the above Register to View Answer9) Which of the following statements about the characteristics of debt and equity are true? A) They can both be long-term financial instruments. B) They both involve a claim on the issuers income. C) They both enable a corporation to raise funds. D) All of the above E) Only (A) and (B) of the above Register to View Answer10) Which of the following are long-term financial instruments? A) A negotiable certificate of deposit B) A bankers acceptance C) A U.S. Treasury bond D) A U.S. Treasury bill Register to View Answer11) Which of the following are short-term financial instruments? A) A negotiable certificate of deposit B) A bankers acceptance C) A U.S. Treasury bond D) Both (A) and (B) of the above E) Both (B) and (C) of the above Register to View Answer10 12) Which of the following are short-term financial instruments? A) A bankers acceptance B) A share of Walt Disney Corporation stock C) A Treasury note with a maturity of 4 years D) All of the above Register to View Answer13) Which of the following are primary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) The options markets E) None of the above Register to View Answer14) Which of the following are secondary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) The options markets E) All of the above Register to View Answer15) A corporation acquires new funds only when its securities are sold A) in the secondary market by an investment bank. B) in the primary market by an investment bank. C) in the secondary market by a stock exchange broker. D) in the secondary market by a commercial bank. Register to View Answer16) Intermediaries who are agents of investors and match buyers with sellers of securities are called A) investment bankers. B) traders. C) brokers. D) dealers. E) none of the above. Register to View Answer17) Intermediaries who link buyers and sellers by buying and selling securities at stated prices are called A) investment bankers. B) traders. C) brokers. D) dealers. E) none of the above. Register to View Answer11 18) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house. Register to View Answer19) Which of the following statements about financial markets and securities are true? A) Most common stocks are traded over-the-counter, although the largest corporations have their shares traded at organized stock exchanges such as the New York Stock Exchange. B) A corporation acquires new funds only when its securities are sold in the primary market. C) Money market securities are usually more widely traded than longer-term securities and so tend to be more liquid. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer20) Which of the following statements about financial markets and securities are true? A) A bond is a long-term security that promises to make periodic payments called dividends to the firms residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is long term if its maturity is ten years or longer. D) The maturity of a debt instrument is the time (term) to that instruments expiration date. Register to View Answer21) Which of the following statements about financial markets and securities are true? A) Few common stocks are traded over-the-counter, although the over-the-counter markets have grown in recent years. B) A corporation acquires new funds only when its securities are sold in the primary market. C) Capital market securities are usually more widely traded than longer term securities and so tend to be more liquid. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 12 22) Which of the following markets is sometimes organized as an over-the-counter market? A) The stock market B) The bond market C) The foreign exchange market D) The federal funds market E) all of the above Register to View Answer23) Which of the following instruments is not traded in a money market? A) Bankers acceptances B) U.S. Treasury Bills C) Eurodollars D) Commercial paper E) None of the above Register to View Answer24) Which of the following instruments is not traded in a money market? A) Bankers acceptances B) U.S. Treasury Bills C) Eurodollars D) Commercial paper E) Residential mortgages Register to View Answer25) Which of the following instruments are traded in a capital market? A) U.S. government agency securities B) Negotiable bank CDs C) Repurchase agreements D) Eurodollars E) None of the above Register to View Answer26) Which of the following instruments are traded in a capital market? A) Corporate bonds B) U.S. Treasury bills C) Bankers acceptances D) Repurchase agreements Register to View Answer27) Bonds that are sold in a foreign country and are denominated in that countrys currency are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Register to View Answer13 28) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Register to View Answer29) Financial intermediaries A) exist because there are substantial information and transaction costs in the economy. B) improve the lot of the small saver. C) are involved in the process of indirect finance. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer30) The main sources of financing for businesses, in order of importance, are A) financial intermediaries, issuing bonds, issuing stocks. B) issuing bonds, issuing stocks, financial intermediaries. C) issuing stocks, issuing bonds, financial intermediaries. D) issuing stocks, financial intermediaries, issuing bonds. Register to View Answer31) The presence of transaction costs in financial markets explains, in part, why A) financial intermediaries and indirect finance play such an important role in financial markets. B) equity and bond financing play such an important role in financial markets. C) corporations get more funds through equity financing than they get from financial intermediaries. D) direct financing is more important than indirect financing as a source of funds. Register to View Answer32) Financial intermediaries can substantially reduce transaction costs per dollar of transactions because their large size allows them to take advantage of A) poorly informed consumers. B) standardization. C) economies of scale. D) their market power. Register to View Answer 14 33) 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 Register to View Answer34) When the lender and the borrower have different amounts of information regarding a transaction, ______________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Register to View Answer35) When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, ______________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Register to View Answer36) When the borrower engages in activities that make it less likely that the loan will be repaid, _____________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Register to View Answer37) The concept of adverse selection helps to explain A) which 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) only (A) and (B) of the above. E) only (A) and (C) of the above. Register to View Answer 15 38) Adverse selection is a problem associated with equity and debt contracts arising from A) the lenders relative lack of information about the borrowers potential returns and risks of his investment activities. B) the lenders inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults. C) the borrowers lack of incentive to seek a loan for highly risky investments. D) none of the above. Register to View Answer39) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the A) moral hazard problem. B) adverse selection problem. C) shirking problem. D) free-rider problem. E) principal-agent problem. Register to View Answer40) Financial institutions expect that A) moral hazard will occur, as the least desirable credit risks will be the ones most likely to seek out loans. B) opportunistic behavior will occur, as the least desirable credit risks will be the ones most likely to seek out loans. C) borrowers will commit moral hazard by taking on too much risk, and this is what drives financial institutions to take steps to limit moral hazard. D) none of the above will occur. Register to View Answer41) Successful financial intermediaries have higher earnings on their investments because they are better equipped than individuals to screen out good from bad risks, thereby reducing losses due to A) moral hazard. B) adverse selection. C) bad luck. D) financial panics. Register to View Answer42) In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called A) comparative informational disadvantage. B) asymmetric information. C) variant information. D) caveat venditor. Register to View Answer 16 43) The largest depository institution at the end of 2001 was A) life insurance companies. B) pension funds. C) state retirement funds. D) none of the above. Register to View Answer44) The value of assets held by commercial banks in 2001 was $6.7 trillion dollars, making commercial banks the A) second most important sector of financial intermediaries after mutual funds. B) second most important sector of financial intermediaries after life insurance companies. C) second most important sector of financial intermediaries after private pension funds. D) largest sector of financial intermediaries. Register to View Answer45) Which of the following financial intermediaries are depository institutions? A) A savings and loan association B) A commercial bank C) A credit union D) All of the above E) Only (A) and (C) of the above Register to View Answer46) 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 Register to View Answer47) Which of the following are not investment intermediaries? A) A life insurance company B) A pension fund C) A mutual fund D) Only (A) and (B) of the above Register to View Answer48) Which of the following are investment intermediaries? A) Finance companies B) Mutual funds C) Pension funds D) All of the above E) Only (A) and (B) of the above Register to View Answer 17 49) The government regulates financial markets for three main reasons: A) to ensure soundness of the financial system, to improve control of monetary policy, and to increase the information available to investors. B) to improve control of monetary policy, to ensure that financial intermediaries earn a normal rate of return, and to increase the information available to investors. C) to ensure that financial intermediaries do not earn more than the normal rate of return, to ensure soundness of the financial system, and to improve control of monetary policy. D) to ensure soundness of financial intermediaries, to increase the information available to investors, and to prevent financial intermediaries from earning less than the normal rate of return. Register to View Answer50) Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a A) bank holiday. B) financial panic. C) financial disintermediation. D) financial collapse. Register to View Answer 2.2 True/False 1) Every financial market allows loans to be made. Register to View Answer2) An example of direct financing is if you were to lend money to your neighbor. Register to View Answer3) The New York Stock Exchange is an example of a primary market. Register to View Answer4) Commercial paper is not traded in the capital market. Register to View Answer5) Eurodollars are traded in the money market. Register to View Answer6) The process of financial intermediation is also known as direct finance. Register to View Answer7) A mutual fund is not a depository institution. Register to View Answer8) A pension fund is not a contractual savings institution. Register to View Answer18 9) Equity represents an ownership interest in a firm and entitles the holder to the residual cash flows. Register to View Answer10) Adverse selection refers to those most at risk being most aggressive in their search for funds. Register to View Answer 2.3 Essay 1) Distinguish between direct financing and indirect financing. 2) Distinguish between primary markets and secondary markets. 3) Why is it so important for an economy to have fully developed financial markets? 4) Why are financial intermediaries so important to an economy? 5) Describe how over-the-counter markets work. 6) What are adverse selection and moral hazard? 19 20 Chapter 3 Understanding Interest Rates 3.1 Multiple Choice Questions 1) A loan that requires the borrower to make the same payment every period until the maturity date is called a A) simple loan. B) fixed-payment loan. C) discount loan. D) same-payment loan. E) none of the above. Register to View Answer2) A coupon bond pays the owner of the bond A) the same amount every month until maturity date. B) the face value of the bond plus an interest payment once the maturity date has been reached. C) a fixed interest payment every period and repays the face value at the maturity date. D) the face value at the maturity date. E) none of the above. Register to View Answer3) A credit market instrument that pays the owner the face value of the security at the maturity date and nothing prior to then is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Register to View Answer4) (I) A simple loan requires the borrower to repay the principal at the maturity date along with an interest payment. (II) A discount bond is bought at a price below its face value, and the face value is repaid at the maturity date. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 21 5) Which of the following are true of coupon bonds? A) The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid. B) U.S. Treasury bonds and notes are examples of coupon bonds. C) Corporate bonds are examples of coupon bonds. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer6) Which of the following are generally true of all bonds? A) The longer a bonds maturity, the lower is the rate of return that occurs as a result of the increase in an 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 long-term bonds are more volatile than those for shorterterm bonds. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer7) (I) A discount bond requires the borrower to repay the principal at the maturity date plus an interest payment. (II) A coupon bond pays the lender a fixed interest payment every year until the maturity date, when a specified final amount (face or par value) is repaid. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer8) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is A) $650. B) $1,300. C) $130. D) $13. E) None of the above. Register to View Answer9) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of A) 5 percent. B) 8 percent. C) 10 percent. D) 40 percent. Register to View Answer 22 10) 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 Register to View Answer11) Dollars received in the future are worth _____ than dollars received today. The process of calculating what dollars received in the future are worth today is called _____ A) more; discounting. B) less; discounting. C) more; inflating. D) less; inflating. Register to View Answer12) The process of calculating what dollars received in the future are worth today is called A) calculating the yield to maturity. B) discounting the future. C) deflating the future. D) none of the above. Register to View Answer13) With an interest rate of 5 percent, the present value of $100 received one year from now is approximately A) $100. B) $105. C) $95. D) $90. Register to View Answer14) With an interest rate of 10 percent, the present value of a security that pays $1,100 next year and $1,460 four years from now is A) $1,000. B) $2,560. C) $3,000. D) $2,000. Register to View Answer15) With an interest rate of 8 percent, the present value of $100 received one year from now is approximately A) $108. B) $100. C) $96. D) $93. Register to View Answer23 16) With an interest rate of 6 percent, the present value of $100 received one year from now is approximately A) $106. B) $100. C) $94. D) $92. Register to View Answer17) The interest rate that equates the present value of payments received from a debt instrument with its market price today is the A) simple interest rate. B) discount rate. C) yield to maturity. D) real interest rate. Register to View Answer18) The interest rate that financial economists consider to be the most accurate measure is the A) current yield. B) yield to maturity. C) yield on a discount basis. D) coupon rate. Register to View Answer19) Financial economists consider the ______ to be the most accurate measure of interest rates. A) simple interest rate B) discount rate C) yield to maturity real interest rate Register to View Answer20) For a simple loan, the simple interest rate equals the A) real interest rate. B) nominal interest rate. C) current yield. D) yield to maturity. Register to View Answer21) 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 Register to View Answer 24 22) The yield to maturity of a one-year, simple loan of $500 that requires an interest payment of $40 is A) 5 percent. B) 8 percent. C) 12 percent. D) 12.5 percent. Register to View Answer23) The yield to maturity of a one-year, simple loan of $400 that requires an interest payment of $50 is A) 5 percent. B) 8 percent. C) 12 percent. D) 12.5 percent. Register to View Answer24) A $10,000, 8 percent coupon bond that sells for $10,000 has a yield to maturity of A) 8 percent. B) 10 percent. C) 12 percent. D) 14 percent. Register to View Answer25) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 12 percent coupon bond selling for $1,000 D) A 12 percent coupon bond selling for $1,100 Register to View Answer26) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 15 percent coupon bond selling for $1,000 D) A 15 percent coupon bond selling for $900 Register to View Answer 25 27) Which of the following are 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 negatively related. C) The yield to maturity is greater than the coupon rate when the bond price is below the par value. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer28) Which of the following are 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 negatively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer29) Which of the following are 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) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer30) The yield to maturity on a consol bond that pays $100 yearly and sells for $500 is A) 5 percent. B) 10 percent. C) 12.5 percent. D) 20 percent. E) 25 percent. Register to View Answer31) The yield to maturity on a consol bond that pays $200 yearly and sells for $1000 is A) 5 percent. B) 10 percent. C) 20 percent. D) 25 percent. Register to View Answer 26 32) The yield to maturity for a one-year discount bond equals A) the increase in price over the year, divided by the initial price. B) the increase in price over the year, divided by the face value. C) the increase in price over the year, divided by the interest rate. D) none of the above. Register to View Answer33) If a $10,000 face value discount bond maturing in one year is selling for $8,000, then its yield to maturity is A) 10 percent. B) 20 percent. C) 25 percent. D) 40 percent. Register to View Answer34) If a $10,000 face value discount bond maturing in one year is selling for $9,000, then its yield to maturity is A) 9 percent. B) 10 percent. C) 11 percent. D) 12 percent. Register to View Answer35) If a $10,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 5 percent. B) 10 percent. C) 50 percent. D) 100 percent. Register to View Answer36) If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 0 percent. B) 5 percent. C) 10 percent. D) 20 percent. Register to View Answer 27 37) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. C) The current yield is always a poor approximation for the yield to maturity. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer38) The nearer the bonds price is to the bonds par value and the longer the maturity of the bond the more closely _____ approximates _____ A) current yield; yield to maturity. B) current yield; coupon rate. C) yield to maturity; current yield. D) yield to maturity; coupon rate. Register to View Answer39) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The current yield and the yield to maturity always move together. C) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer40) The current yield is a less accurate measure of the yield to maturity the ______ the time to maturity of the bond and the ______ the price is from/to the par value. A) shorter; closer B) shorter; farther C) longer; closer D) longer; farther Register to View Answer41) The current yield on a $6,000, 10 percent coupon bond selling for $5,000 is A) 5 percent. B) 10 percent. C) 12 percent. D) 15 percent. Register to View Answer 28 42) The current yield on a $5,000, 8 percent coupon bond selling for $4,000 is A) 5 percent. B) 8 percent. C) 10 percent. D) 20 percent. E) none of the above. Register to View Answer43) For a consol, the current yield is an _____ of the yield to maturity. A) underestimate B) overestimate C) exact measure D) approximate measure Register to View Answer44) Which of the following are true of the yield on a discount basis as a measure of the interest rate? A) It uses the percentage gain on the face value of the security, rather than the percentage gain on the purchase price of the security. B) It puts the yield on the annual basis of a 360-day year. C) It ignores the time to maturity. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer45) The formula for the measure of the interest rate called the yield on a discount basis is peculiar because A) it uses the percentage gain on the face value of the bill, rather than the percentage gain on the purchase price of the bill. B) it ignores the time to maturity. C) it puts the yield on the annual basis of a 360-day year. D) both (A) and (B) of the above. E) both (A) and (C) of the above. Register to View Answer46) The yield on a discount basis of a 180-day $1,000 Treasury bill selling for $950 is A) 10 percent. B) 20 percent. C) 25 percent. D) 40 percent. Register to View Answer 29 47) The yield on a discount basis of a 90-day $1,000 Treasury bill selling for $950 is A) 5 percent. B) 10 percent. C) 15 percent. D) 20 percent. E) none of the above. Register to View Answer48) The yield on a discount basis of a 90-day $1,000 Treasury bill selling for $900 is A) 10 percent. B) 20 percent. C) 25 percent. D) 40 percent. Register to View Answer49) The yield on a discount basis of a 180-day $1,000 Treasury bill selling for $900 is A) 10 percent. B) 20 percent. C) 25 percent. D) 40 percent. Register to View Answer50) The Fisher equation states that A) the nominal interest rate equals the real 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) both (A) and (B) of the above are true. E) both (A) and (C) of the above are true. Register to View Answer51) 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. E) none of the above. Register to View Answer 30 52) If you expect the inflation rate to be 5 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) -12 percent. B) -2 percent. C) 2 percent. D) 12 percent. Register to View Answer53) The nominal interest rate minus the expected rate of inflation A) defines the real interest rate. B) is a better 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) indicates all of the above. E) indicates only (A) and (B) of the above. Register to View Answer54) 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. Register to View Answer55) In which of the following situations would you prefer to be making a loan? 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. Register to View Answer56) In which of the following situations would you prefer to be borrowing? 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. Register to View Answer 31 57) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one year later? A) 5 percent B) 10 percent C) -5 percent D) 25 percent E) None of the above Register to View Answer58) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one year later? A) 5 percent B) 10 percent C) -5 percent D) -10 percent E) None of the above Register to View Answer59) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year later is A) 5 percent. B) 10 percent. C) 14 percent. D) 15 percent. Register to View Answer60) The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year later is A) -10 percent. B) -5 percent. C) 0 percent. D) 5 percent. Register to View Answer61) Which of the following are generally true of all 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 losses on bonds whose term to maturities are longer than the holding period. C) The longer a bonds maturity, the greater is the size of the price change associated with an interest rate change. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 32 62) Which of the following are true concerning the distinction between interest rates and return? 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 sum of 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) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer63) 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 Register to View Answer64) 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 Register to View Answer65) (I) Prices of longer-maturity bonds respond more dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for short-term bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer66) (I) Prices of longer-maturity bonds respond less dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for shorter-term bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer33 67) The riskiness of an assets return that results from interest rate changes has been given the special name of A) interest-rate risk. B) liquidity risk. C) bond-market risk. D) yield-to-maturity risk. Register to View Answer68) If an investors holding period is longer than the term to maturity of a bond, the investor is exposed to A) interest-rate risk. B) reinvestment risk. C) bond-market risk. D) yield-to-maturity risk. Register to View Answer69) (I) The average lifetime of a debt securitys stream of payments is called duration. (II) The duration of a portfolio is the weighted average of the durations of the individual securities, with the weights reflecting the proportion of the portfolio invested in each. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true D) Both are false. Register to View Answer70) The duration of a ten-year, 10 percent coupon bond when the interest rate is 10 percent is 6.76 years. What happens to the price of the bond if the interest rate falls to 8 percent? A) it rises 20 percent B) it rises 12.3 percent C) it falls 20 percent D) it falls 12.3 percent Register to View Answer 34 3.2 True/False 1) A bonds current market value is equal to the present value of the coupon payments plus the present value of the face amount. Register to View Answer2) The current yield is the best measure of an investors return from holding a bond. Register to View Answer3) Unless a bond defaults, an investor cannot lose money investing in bonds. Register to View Answer4) The current yield is the yearly coupon rate divided by the current market price. Register to View Answer5) Prices for long-term bonds are more volatile than for shorter-term bonds. Register to View Answer6) A long-term bonds price is less affected by interest rate movements than is a shortterm bonds price. Register to View Answer7) Increasing duration implies that interest rate risk has increased. Register to View Answer8) All else being equal, the greater the interest rate the greater is the duration. Register to View Answer9) The real rate is equal to the nominal rate plus inflation. Register to View Answer10) The current yield goes up as the yield to maturity on a bond falls. Register to View Answer 35 3.3 Essay 1) Distinguish between interest rates, yield to maturity, and current yield. 2) Describe the cash flows received from ownership of a coupon bond. What are the sources of income? 3) What concept is used to value a bond? 4) Why are long-term bonds more risky than short-term bonds? 5) What is interest rate risk and how is it measured? 6) Why may a bonds rate of return differ from its yield to maturity? 7) How does reinvestment risk differ from interest rate risk? 36 Chapter 4 The Behavior of Interest Rates 4.1 Multiple Choice Questions 1) As the price of a bond _____ and the expected return _____, bonds become more attractive to investors and the quantity demanded rises. A) falls; rises B) falls; falls C) rises; rises D) rises; falls Register to View Answer2) 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 Register to View Answer3) When the price of a bond is above the equilibrium price, there is an excess _____ for (of) bonds and the price will _____ A) demand; rise. B) demand; fall. C) supply; fall. D) supply; rise. Register to View Answer4) When the price of a bond is below the equilibrium price, there is an excess _____ for (of) bonds and the price will _____ A) demand; rise. B) demand; fall. C) supply; fall. D) supply; rise. Register to View Answer5) When the price of a bond is _____ the equilibrium price, there is an excess supply of bonds and the price will _____ A) above; rise. B) above; fall. C) below; fall. D) below; rise. Register to View Answer 37 6) When the price of a bond is _____ the equilibrium price, there is an excess demand of bonds and the price will _____ A) above; rise. B) above; fall. C) below; fall. D) below; rise. Register to View Answer7) 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. Register to View Answer8) When the interest rate on a bond is below 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. Register to View Answer9) 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. Register to View Answer10) 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) below; demand; rise. B) below; demand; fall. C) below; supply; fall. D) above; supply; rise. Register to View Answer11) When the demand for bonds ______ or the supply of bonds _____, interest rate rise. A) increases; increases. B) increases; decreases. C) decreases; decreases. D) decreases; increases. Register to View Answer 38 12) When the demand for bonds ______ or the supply of bonds _____, interest rates fall. A) increases; increases. B) increases; decreases. C) decreases; decreases. D) decreases; increases. Register to View Answer13) Factors that determine the demand for an asset include changes in the A) wealth of investors. B) liquidity of bonds relative to alternative assets. C) expected returns on bonds relative to alternative assets. D) risk of bonds relative to alternative assets. E) all of the above. Register to View Answer14) In a recession when income and wealth are falling, the demand for bonds _____ and the demand curve shifts to the _____ A) falls; right. B) falls; left. C) rises; right. D) rises; left. Register to View Answer15) During business cycle expansions when income and wealth are rising, the demand for bonds _____ and the demand curve shifts to the _____ A) falls; right. B) falls; left. C) rises; right. D) rises; left. Register to View Answer16) For a holding period of one year, the expected return on a consol is _____ the higher is the price of the consol today, and _____ the higher is the price of the consol next year. A) higher; higher B) higher; lower C) lower; higher D) lower; lower Register to View Answer17) Higher expected interest rates in the future ____ the demand for long-term bonds and shift the demand curve to the _____ A) increase; left. B) increase; right. C) decrease; left. D) decrease; right. Register to View Answer39 18) Lower expected interest rates in the future ____ the demand for long-term bonds and shift the demand curve to the _____ A) increase; left. B) increase; right. C) decrease; left. D) decrease; right. Register to View Answer19) When people begin to expect a large stock market decline, the demand curve for bonds shifts to the _____ and the interest rate _____ A) right; rises. B) right; falls. C) left; falls. D) left; rises. Register to View Answer20) When people begin to expect a large run up in stock prices, the demand curve for bonds shifts to the _____ and the interest rate _____ A) right; rises. B) right; falls. C) left; falls. D) left; rises. Register to View Answer21) An increase in the expected rate of inflation will _____ the expected return on bonds relative to that on _____ assets, and shift the _____ curve to the left. A) reduce; financial; demand B) reduce; real; demand C) raise; financial; supply D) raise; real; supply Register to View Answer22) A decrease in the expected rate of inflation will _____ the expected return on bonds relative to that on _____ assets. A) reduce; financial B) reduce; real C) raise; financial D) raise; real Register to View Answer23) When the expected inflation rate increases, the demand for bonds _____, the supply of bonds _____, and the interest rate ______ A) increases; increases; rises. B) decreases; decreases; falls. C) increases; decreases; falls. D) decreases; increases; rises. Register to View Answer40 24) When the expected inflation rate decreases, the demand for bonds _____, the supply of bonds _____, and the interest rate ______ A) increases; increases; rises. B) decreases; decreases; falls. C) increases; decreases; falls. D) decreases; increases; rises. Register to View Answer25) When bond interest rates become more volatile, the demand for bonds _____ and the interest rate _____ A) increases; rises. B) increases; falls. C) decreases; falls. D) decreases; rises. Register to View Answer26) When bond interest rates become less volatile, the demand for bonds _____ and the interest rate _____ A) increases; rises. B) increases; falls. C) decreases; falls. D) decreases; rises. Register to View Answer27) When prices in the stock market become more uncertain, the demand curve for bonds shifts to the _____ and the interest rate _____ A) right; rises. B) right; falls. C) left; falls. D) left; rises. Register to View Answer28) 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. E) more; right; rises. Register to View Answer 41 29) When bonds become more widely traded, and as a consequence the market becomes more 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. Register to View Answer30) 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. Register to View Answer31) Factors that cause the demand curve for bonds to shift to the left include A) an increase in the inflation rate. B) an increase in the liquidity of stocks. C) a decrease in the volatility of stock prices. D) all of the above. E) none of the above. Register to View Answer32) Factors that cause the demand curve for bonds to shift to the left include A) a decrease in the inflation rate. B) an increase in the volatility of stock prices. C) an increase in the liquidity of stocks. D) all of the above. E) only (A) and (B) of the above. Register to View Answer33) During an economic expansion, the supply of bonds _____ and the supply curve shifts to the _____ A) increases, left. B) increases, right. C) decreases, left. D) decreases, right. Register to View Answer 42 34) During a recession, the supply of bonds _____ and the supply curve shifts to the _____ A) increases, left. B) increases, right. C) decreases, left. D) decreases, right. Register to View Answer35) An increase in expected inflation causes the supply of bonds to _____ and the supply curve to shift to the _____ A) increase, left. B) increase, right. C) decrease, left. D) decrease, right. Register to View Answer36) When the federal governments budget deficit increases, the _____ curve for bonds shifts to the _____ A) demand; right. B) demand; left. C) supply; left. D) supply; right. Register to View Answer37) When the federal governments budget deficit decreases, the _____ curve for bonds shifts to the _____ A) demand; right. B) demand; left. C) supply; left. D) supply; right. Register to View Answer38) When the inflation rate is expected to increase, the expected return on bonds relative to real assets falls for any given interest rate; the _____ for bonds falls and the _____ curve shifts to the left. A) demand; demand B) demand; supply C) supply; demand D) supply; supply Register to View Answer 43 39) When the inflation rate is expected to increase, the real cost of borrowing declines at any given interest rate; the _____ of bonds increases and the _____ curve shifts to the right. A) demand; demand B) demand; supply C) supply; demand D) supply; supply Register to View AnswerFigure 4-1 40) In Figure 4-1, the most likely cause of the increase in the equilibrium interest rate from i1 to i2 is A) an increase in the price of bonds. B) a business cycle boom. C) an increase in the expected inflation rate. D) a decrease in the expected inflation rate. Register to View Answer41) In Figure 4-1, the most likely cause of the increase in the equilibrium interest rate from i1 to i2 is A) an increase in the expected inflation rate. B) a decrease in the expected inflation rate. C) a sharp decline in the growth rate of the money supply. D) a combination of both (A) and (C) of the above. Register to View Answer42) In Figure 4-1, the most likely cause of a decrease in the equilibrium interest rate from i2 to i1 is A) an increase in the expected inflation rate. B) a decrease in the expected inflation rate. C) a business cycle expansion. D) a combination of both (A) and (C) of the above. Register to View Answer 44 43) Factors that can cause the supply curve for bonds to shift to the right include A) an expansion in overall economic activity. B) a decrease in expected inflation. C) a decrease in government deficits. D) all of the above. E) only (A) and (B) of the above. Register to View Answer44) Factors that can cause the supply curve for bonds to shift to the left include A) an expansion in overall economic activity. B) a decrease in expected inflation. C) an increase in government deficits. D) only (A) and (C) of the above. Register to View Answer45) The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates _____ as the expected rate of inflation _____ A) rise; increases. B) rise; stabilizes. C) rise; decreases. D) fall; increases. E) fall; stabilizes. Register to View Answer46) An increase in the expected rate of inflation causes the demand curve for bonds to _____ and the supply curve for bonds to _____ A) fall; fall. B) fall; rise. C) rise; fall. D) rise; rise. Register to View Answer47) A decrease in the expected rate of inflation causes the demand curve for bonds to _____ and the supply curve of bonds to _____ A) fall; fall. B) fall; rise. C) rise; fall. D) rise; rise. Register to View Answer48) When the economy slips into a recession, normally the demand for bonds _____, the supply of bonds _____, and the interest rate _____ A) increases; increases; rises. B) decreases; decreases; falls. C) increases; decreases; falls. D) decreases; increases; rises. Register to View Answer45 49) When the economy enters into a boom, normally the demand for bonds _____, the supply of bonds _____, and the interest rate _____ A) increases; increases; rises. B) decreases; decreases; falls. C) increases; decreases; rises. D) decreases; increases; rises. Register to View Answer Figure 4-2 50) In Figure 4-2, one possible explanation for the increase in the interest rate from i1 to i2 is A) an increase in the expected inflation rate. B) a decrease in the expected inflation rate. C) an increase in economic growth. D) a decrease in economic growth. Register to View Answer51) In Figure 4-2, one possible explanation for the increase in the interest rate from i1 to i2 is A) an increase in economic growth. B) an increase in government budget deficits. C) a decrease in government budget deficits. D) a decrease in economic growth. E) a decrease in the riskiness of bonds relative to other investments. Register to View Answer52) In Figure 4-2, one possible explanation for a decrease in the interest rate from i2 to i1is A) an increase in economic growth. B) an increase in government budget deficits. C) an increase in expected inflation. D) a decrease in economic growth. E) a decrease in the riskiness of bonds relative to other investments. Register to View Answer46 53) In Keyness 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. Register to View Answer54) In his liquidity preference framework, Keynes assumed that money has a zero rate of return; thus, A) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. B) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. C) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. D) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. Register to View Answer55) The loanable funds 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) the supply of money; bonds. Register to View Answer56) When comparing the loanable funds and liquidity preference frameworks of interest rate determination, which of the following are true? A) The liquidity preference framework is easier to use when analyzing the effects of changes in expected inflation. B) The loanable funds framework provides a simpler analysis of the effects of changes in income, the price level, and the supply of money. C) In most instances, the two approaches to interest rate determination yield the same predictions. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 47 57) A higher level of income causes the demand for money to _____ and the interest rate to _____ A) decrease; decrease. B) decrease; increase. C) increase; decrease. D) increase; increase. Register to View Answer58) A lower level of income causes the demand for money to _____ and the interest rate to _____ A) decrease; decrease. B) decrease; increase. C) increase; decrease. D) increase; increase. Register to View Answer59) A rise in the price level causes the demand for money to _____ and the demand curve to shift to the _____ A) decrease; right. B) decrease; left. C) increase; right. D) increase; left. Register to View Answer60) A decline in the price level causes the demand for money to _____ and the demand curve to shift to the _____ A) decrease; right. B) decrease; left. C) increase; right. D) increase; left. Register to View Answer61) A decline in the expected inflation rate causes the demand for money to _____ and the demand curve to shift to the _____ A) decrease; right. B) decrease; left. C) increase; right. D) increase; left. Register to View Answer62) Holding everything else equal, a decrease in the money supply causes A) interest rates to decline initially. B) interest rates to increase initially. C) bond prices to increase initially. D) both (A) and (C) of the above. E) both (B) and (C) of the above. Register to View Answer48 Figure 4-3 63) In Figure 4-3, the factor responsible for the decline in the interest rate is A) a decline in the price level. B) a decline in income. C) an increase in the money supply. D) a decline in the expected inflation rate. Register to View Answer64) In Figure 4-3, 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) only (A) and (B) of the above. Register to View Answer65) In Figure 4-3, an increase in the interest rate from i2 to i1 can be explained by A) a decrease in money growth. B) an increase in money growth. C) a decline in the price level. D) an increase in the expected price level. Register to View Answer66) 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. Register to View Answer67) Of the four effects on interest rates from an increase in the money supply, the initial effect is, generally, the A) income effect. B) liquidity effect. C) price level effect. D) expected inflation effect. Register to View Answer49 68) If the liquidity effect is smaller than the other effects, and the adjustment of expected inflation is slow, then the A) interest rate will fall. B) interest rate will rise. C) interest rate will initially fall but eventually climb above the initial level in response to an increase in money growth. D) interest rate will initially rise but eventually fall below the initial level in response to an increase in money growth. Register to View Answer69) When the growth rate of the money supply increases, interest rates end up being permanently lower if A) the liquidity effect is larger than the other effects. B) there is fast adjustment of expected inflation. C) there is slow adjustment of expected inflation. D) the expected inflation effect is larger than the liquidity effect. Register to View Answer70) When the growth rate of the money supply decreases, interest rates end up being permanently lower if A) the liquidity effect is larger than the other effects. B) there is fast adjustment of expected inflation. C) there is slow adjustment of expected inflation. D) the expected inflation effect is larger than the liquidity effect. Register to View Answer71) When the growth rate of the money supply is decreased, interest rates will rise immediately if the liquidity effect is _____ than the other effects and if there is _____ adjustment of expected inflation. A) larger; fast B) larger; slow C) smaller; slow D) smaller; fast Register to View Answer72) When the growth rate of the money supply is increased, interest rates will rise immediately if the liquidity effect is _____ than the other effects and if there is _____ adjustment of expected inflation. A) larger; fast B) larger; slow C) smaller; slow D) smaller; fast Register to View Answer 50 73) If the Fed wants to permanently lower interest rates, then it should lower the rate of money growth if A) there is fast adjustment of expected inflation. B) there is slow adjustment of expected inflation. C) the liquidity effect is smaller than the expected inflation effect. D) the liquidity effect is larger than the other effects. Register to View Answer74) If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth if A) there is fast adjustment of expected inflation. B) there is slow adjustment of expected inflation. C) the liquidity effect is smaller than the expected inflation effect. D) the liquidity effect is larger than the other effects. Register to View Answer75) Holding everything else equal, an increase in the money supply causes A) interest rates to decline initially. B) interest rates to increase initially. C) bond prices to decline initially. D) both (A) and (C) of the above. E) both (B) and (C) of the above. Register to View Answer76) It is entirely possible that when the money supply rises, interest rates may _____ if the _____ effect is more than offset by changes in income, the price level, and expected inflation. A) fall; liquidity B) fall; risk C) rise; liquidity D) rise; risk Register to View Answer77) Milton Friedman contends that it is entirely possible that when the money supply rises, interest rates may _____ if the _____ effect is more than offset by changes in income, the price level, and expected inflation. A) fall; liquidity B) fall; risk C) rise; liquidity D) rise; risk Register to View Answer 51 Figure 4-4 78) Figure 4-4 illustrates the effect of an increased rate of money supply growth. 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. Register to View Answer79) Figure 4-4 illustrates the effect of an increased rate of money supply growth. 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. Register to View Answer 52 Figure 4-5 80) Figure 4-5 illustrates the effect of an increased rate of money supply growth. 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. Register to View Answer81) Figure 4-5 illustrates the effect of an increased rate of money supply growth. 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. Register to View Answer 4.2 True/False 1) When interest rates change, the demand curve for bonds shifts to the left. Register to View Answer2) When an economy grows out of a recession, normally the demand for bonds increases and the supply of bonds increases. Register to View Answer 53 3) When the federal governments budget deficit decreases, the demand curve for bonds shifts to the right. Register to View Answer4) When the price level falls, the demand curve for money shifts to the left and the interest rate falls. Register to View Answer5) When the Federal Reserve increases the money stock, the money supply curve shifts to the left and the interest rate falls. Register to View Answer6) When the growth rate of the money supply increases, interest rates end up being permanently higher if the expected inflation effect is larger than the liquidity effect. Register to View Answer7) When income and wealth are rising, the demand for bonds rises and the demand curve shifts to the right. Register to View Answer8) An increase in the inflation rate will cause the demand curve for bonds to shift to the right. Register to View Answer9) In Keynes liquidity preference framework, individuals are assumed to hold their wealth in the form of money and bonds. Register to View Answer10) An increase in the money supply will always lower interest rates. Register to View Answer 4.3 Essay 1) Distinguish between interest rates, yield to maturity, and current yield. 2) Describe the cash flows received from ownership of a coupon bond. What are the sources of income? 3) What concept is used to value a bond? 4) Why are long-term bonds more risky than short-term bonds? 5) What is interest rate risk and how is it measured? 6) Explain why interest rates may rise when money supply growth increases. 54 Chapter 5 The Risk and Term Structure of Interest Rates 5.1 Multiple Choice 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 terms to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities. Register to View Answer2) 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 terms to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities. Register to View Answer3) Which of the following long-term bonds should have the lowest interest rate? A) Corporate Baa bonds B) U.S. Treasury bonds C) Corporate Aaa bonds D) Municipal bonds Register to View Answer4) Which of the following long-term bonds should have the highest interest rate? A) Corporate Baa bonds B) U.S. Treasury bonds C) Corporate Aaa bonds D) Municipal bonds Register to View Answer5) 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) either (B) or (D) occur. Register to View Answer6) Bonds with relatively low risk of default are called A) zero coupon bonds. B) junk bonds. C) investment grade bonds. D) none of the above. Register to View Answer55 7) Bonds with relatively high risk of default are called A) Brady bonds. B) junk bonds. C) zero coupon bonds. D) investment grade bonds. Register to View Answer8) A corporation suffering big losses might be more likely to suspend interest payments on its bonds, thereby A) raising the default risk and causing the demand for its bonds to rise. B) raising the default risk and causing the demand for its bonds to fall. C) lowering the default risk and causing the demand for its bonds to rise. D) lowering the default risk and causing the demand for its bonds to fall. Register to View Answer9) (I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay. (II) The spread between the interest rates on bonds with default risk and default-free bonds is called the risk premium. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer10) Holding everything else constant, if a corporation begins to suffer large losses, then the default risk on A) corporate bonds will increase, and the expected return on these bonds will increase. B) corporate bonds will decrease, and the expected return on these bonds will increase. C) corporate bonds will increase, and the expected return on these bonds will decrease. D) corporate bonds will decrease, and the expected return on these bonds will decrease. Register to View Answer11) Holding everything else the same, if a corporations earnings rise, then the default risk on its bonds will A) increase, and the expected return on these bonds will decrease. B) decrease, and the expected return on these bonds will decrease. C) increase, and the expected return on these bonds will increase. D) decrease, and the expected return on these bonds will increase. Register to View Answer 56 12) If a corporation begins to suffer large losses, then the default risk on A) corporate bonds will increase, and the equilibrium interest rate on these bonds will increase. B) corporate bonds will decrease, and the equilibrium interest rate on these bonds will increase. C) corporate bonds will increase, and the equilibrium interest rate on these bonds will decrease. D) corporate bonds will decrease, and the equilibrium interest rate on these bonds will decrease. Register to View Answer13) If a corporations earnings rise, then the default risk on its bonds will A) increase, and the equilibrium interest rate on these bonds will decrease. B) decrease, and the equilibrium interest rate on these bonds will decrease. C) increase, and the equilibrium interest rate on these bonds will increase. D) decrease, and the equilibrium interest rate on these bonds will increase. Register to View Answer14) When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the _____ and the demand curve for Treasury bonds shifts to the _____ A) right; right. B) right; left. C) left; left. D) left; right. Register to View Answer15) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer16) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the left. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the right. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 57 17) Following the stock market crash of 1987, the spread between interest rates on junk bonds and U.S. government bonds A) fell by two percentage points. B) fell by six percentage points. C) rose by two percentage points. D) rose by six percentage points. Register to View Answer18) The stock market crash of October 19, 1987 had a major impact on bond markets. As investors began to doubt the financial health of corporations, A) the interest rate on both corporate and U.S. Treasury securities rose, but the rate on Treasury securities rose by less than the rate on corporate securities, increasing the interest rate spread between the two. B) the interest rate on both corporate and U.S. Treasury securities rose, but the rate on corporate securities rose by less than the rate on Treasury securities, decreasing the interest rate spread between the two. C) the interest rate on corporate securities rose and the rate on Treasury securities declined, increasing the interest rate spread between the two. D) the interest rate on both corporate and U.S. Treasury securities declined, but the rate on corporate securities declined by less than the rate on Treasury securities, decreasing the interest rate spread between the two. Register to View Answer19) When budget talks between congressional Republicans and President Clinton occurred in late 1995, A) fear of a government default rose, Treasury bond values fell, and interest rates on Treasury bonds rose. B) fear of a government default rose, Treasury bond values fell, and interest rates on Treasury bonds fell. C) no one feared a government default, but Treasury bond values fell, and interest rates on Treasury bonds rose. D) no one feared a government default, but Treasury bond values fell, and interest rates on Treasury bonds fell. Register to View Answer20) The spread between interest rates on low quality corporate bonds and U.S. government bonds A) widened significantly during the Great Depression. B) narrowed significantly during the Great Depression. C) was reversed during the Great Depression. D) did not change during the Great Depression. Register to View Answer 58 21) Corporate bonds are not as liquid as government bonds because A) fewer corporate bonds for any one corporation are traded, making them more costly to sell. B) the corporate bond rating must be calculated each time they are traded. C) corporate bonds are not callable. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer22) (I) The risk premium widens as the default risk on corporate bonds increases. (II) The risk premium widens as corporate bonds become less liquid. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer23) When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the _____ and the demand curve for Treasury bonds shifts to the _____ A) right; right. B) right; left. C) left; left. D) left; right. Register to View Answer24) When the corporate bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the _____ and the demand curve for Treasury bonds shifts to the _____ A) right; right. B) right; left. C) left; left. D) left; right. Answer B 25) (I) If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest rate to rise. (II) If a corporate bond becomes less liquid, the demand for Treasury bonds does not change. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 59 26) (I) If a corporate bond becomes less liquid, the interest rate on the bond will fall. (II) If a corporate bond becomes less liquid, the interest rate on Treasury bonds will fall. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer27) Which of the following bonds generally has the lowest interest rate? A) Treasury bonds B) Corporate Baa bonds C) Municipal bonds D) Corporate Aaa bonds Register to View Answer28) If income tax rates were lowered, then A) the interest rate on municipal bonds would fall. B) the interest rate on Treasury bonds would rise. C) the interest rate on municipal bonds would rise. D) the price of Treasury bonds would fall. Register to View Answer29) If income tax rates rise, then A) the prices of municipal bonds will fall. B) the prices of Treasury bonds will rise. C) the interest rate on Treasury bonds will rise. D) the interest rate on municipal bonds will rise. Register to View Answer30) An increase in marginal tax rates would likely have the effect of _____ the demand for municipal bonds and _____ the demand for U.S. government bonds. A) increasing; increasing B) increasing; decreasing C) decreasing; increasing D) decreasing; decreasing Register to View Answer31) A decrease in marginal tax rates would likely have the effect of _____ the demand for municipal bonds and _____ the demand for U.S. government bonds. A) increasing; increasing B) increasing; decreasing C) decreasing; increasing D) decreasing; decreasing Register to View Answer 60 32) Which of the following statements are true? A) Because coupon payments on municipal 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 increase the demand for municipal bonds, lowering their interest rates. C) Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption. D) All of the above are true statements. E) Only (A) and (B) are true statements. Register to View Answer33) Which of the following statements are true? A) Because coupon payments on municipal 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 increase the demand for Treasury bonds, lowering their interest rates. C) Interest rates on municipal bonds will be higher than on comparable bonds without the tax exemption. D) Only (A) and (B) are true statements. Register to View Answer34) When a municipal bond is given tax-free status, the demand for municipal bonds shifts ______, causing the interest rate on the bond to _____ A) leftward; rise. B) leftward; fall. C) rightward; rise. D) rightward; fall. Register to View Answer35) When a municipal bond is given tax-free status, the demand for Treasury bonds shifts _____, and the interest rate on Treasury bonds _____ A) leftward; rises. B) leftward; falls. C) rightward; rises. D) rightward; falls. Register to View Answer36) If municipal bonds were to lose their tax-free status, then the demand for Treasury bonds would shift _____, and the interest rate on Treasury bonds would _____ A) rightward; fall. B) rightward; rise. C) leftward; fall. D) leftward; rise. Register to View Answer 61 37) The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent. As a result of this tax cut, the demand for muncipal bonds should shift to the ______ and the interest rate on municipal bonds should ______. A) right; decline B) right; increase C) left; decline D) left; increase Register to View Answer38) The relationship among interest rates on bonds with identical default risk, but different maturities, is called the A) time-risk structure of interest rates. B) liquidity structure of interest rates. C) bond demand curve. D) yield curve. Register to View Answer39) Yield curves can be classified as A) upward-sloping. B) downward-sloping. C) flat. D) all of the above. E) only (A) and (B) of the above. Register to View Answer40) Typically, yield curves are A) gently upward-sloping. B) gently downward-sloping. C) flat. D) bowl shaped. E) mound shaped. Register to View Answer41) 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. E) medium-term interest rates are below both short-term and long-term interest rates. Register to View Answer 62 42) 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. Register to View Answer43) According to the pure expectations theory of the term structure, A) the interest rate on long-term bonds will exceed the average of expected future short-term interest rates. B) interest rates on bonds of different maturities move together over time. C) buyers of bonds prefer short-term to long-term bonds. D) all of the above. E) only (A) and (B) of the above. Register to View Answer44) According to the pure expectations theory of the term structure, A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future. B) when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future. C) buyers of bonds prefer short-term to long-term bonds. D) all of the above. E) only (A) and (B) of the above. Register to View Answer45) According to the pure expectations theory of the term structure, A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise 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) all of the above. E) only (A) and (B) of the above. Register to View Answer 63 46) According to the pure expectations theory of the term structure, A) yield curves should be as equally likely to slope downward as slope upward. B) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future. C) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future. D) all of the above. E) only (A) and (B) of the above. Register to View Answer47) If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the pure expectations theory predicts that todays interest rate on the four-year bond is A) 1 percent. B) 2 percent. C) 4 percent. D) none of the above. Register to View Answer48) If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the pure expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of A) one year. B) two years. C) three years. D) four years. E) five years. Register to View Answer49) If the expected path of one-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the pure 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. Register to View Answer 64 50) According to the market segmentation theory of the term structure, A) the interest rate for bonds of one maturity is determined by supply and demand for bonds of that maturity. B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time. C) investors strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward. D) all of the above. E) none of the above. Register to View Answer51) According to the market segmentation of the term structure, A) the interest rate for bonds of one maturity is determined by supply and demand for bonds of that maturity. B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time. C) investors strong preference for short-term relative to long-term bonds explains why yield curves typically slope downward. D) only (A) and (B) of the above. Register to View Answer52) The liquidity premium theory of the term structure A) indicates that todays long-term interest rate equals the average of short-term interest rates that people expect to occur over the life of the long-term bond. B) assumes that bonds of different maturities are perfect substitutes. C) suggests that markets for bonds of different maturities are completely separate because people have preferred habitats. D) does none of the above. Register to View Answer53) The liquidity premium theory of the term structure A) assumes investors tend to prefer short-term bonds because they have less interest rate risk. B) assumes that interest rates on the long-term bond respond to demand and supply conditions for that bond. C) assumes that an average of expected short-term rates is an important component of interest rates on long-term bonds. D) assumes all of the above. E) assumes none of the above. Register to View Answer 65 54) According to the liquidity premium 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 plus a liquidity premium. B) buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of different maturities move together over time. C) even with a positive liquidity premium, if future short-term interest rates are expected to fall significantly, then the yield curve will be downward-sloping. D) all of the above. E) only (A) and (B) of the above. Register to View Answer55) 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) all of the above. E) only (A) and (B) of the above. Register to View Answer56) If the yield curve slope is flat, the liquidity premium theory indicates that the market is predicting A) a mild rise in short-term interest rates in the near future and a mild decline further out in the future. B) constant short-term interest rates in the near future and further out in the future. C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future. D) constant short-term interest rates in the near future and a mild decline further out in the future. Register to View Answer57) If the yield curve has a mild upward slope, the liquidity premium theory 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. Register to View Answer 66 58) According to the liquidity premium theory of the term structure, a downwardsloping yield curve indicates that A) short-term interest rates are expected to rise in the future. B) short-term interest rates are expected to remain unchanged in the future. C) short-term interest rates are expected to decline moderately in the future. D) short-term interest rates are expected to decline sharply in the future. Register to View Answer59) According to the liquidity premium theory of the term structure, when the yield curve has its usual slope, the market expects A) short-term interest rates to stay near their current levels. B) short-term interest rates to rise sharply. C) short-term interest rates to drop sharply. D) none of the above. Register to View Answer60) In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the A) market segmentation theory. B) pure expectations theory. C) liquidity premium theory. D) separable markets theory. Register to View Answer61) Which theory of the term structure proposes that bonds of different maturities are not substitutes for one another? A) market segmentation theory. B) pure expectations theory. C) liquidity premium theory. D) separable markets theory. Register to View Answer62) Since yield curves are usually upward sloping, the _____ indicates that, on average, people tend to prefer holding short-term bonds to long-term bonds. A) market segmentation theory B) pure expectations theory C) liquidity premium theory D) both (A) and (B) of the above E) both (A) and (C) of the above Register to View Answer 67 63) _____ cannot explain the empirical fact that interest rates on bonds of different maturities tend to move together. A) The market segmentation theory B) The pure expectations theory C) The liquidity premium theory D) both (A) and (B) of the above E) both (A) and (C) of the above Register to View Answer64) Which of the following theories of the term structure is (are) able to explain the fact that interest rates on bonds of different maturities tend to move together over time? A) The expectations hypothesis B) The segmented markets theory C) The preferred habitat theory D) Both (A) and (B) of the above E) Both (A) and (C) of the above Register to View Answer65) Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that views long-term interest rates as equaling the average of future short-term rates expected to occur over the life of the bond is the A) expectations hypothesis. B) preferred habitat theory. C) liquidity premium theory. D) segmented markets theory. Register to View Answer66) Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that assumes that bonds of different maturities are not substitutes for one another is the A) expectations hypothesis. B) segmented markets theory. C) liquidity premium theory. D) preferred habitat theory. Register to View Answer67) The moderately upward-sloping yield curve on March 3, 1997, indicated that A) short-term rates were expected neither to rise nor fall in the near future. B) short-term rates were expected to remain relatively unchanged, but that longterm rates were expected to fall. C) short-term rates were expected neither to rise nor fall, but that long-term rates were expected to rise moderately. D) short-term rates were expected to rise moderately in the near future. Register to View Answer 68 68) The steep upward sloping yield curve on January 2, 2002 indicated that A) short-term rates were expected neither to rise nor fall in the near future. B) short-term rates were expected to remain relatively unchanged, but that longterm rates were expected to fall. C) short-term rates were expected neither to rise nor fall, but that long-term rates were expected to rise moderately. D) short-term rates were expected to rise moderately in the near future. Register to View Answer 5.2 True/False 1) The term structure of interest rates describes how interest rates move over time. Register to View Answer2) The risk structure of interest rates describes the relationship between the interest rates of different bonds with the same maturity. Register to View Answer3) The risk premium on corporate bonds becomes smaller as the liquidity of the bonds falls. Register to View Answer4) An increase in income tax rates will cause the interest rates on tax exempt municipal bonds to fall relative to the interest rate on taxable corporate securities. Register to View Answer5) The interest rates on bonds of different maturities tend to move together over time. Register to View Answer6) The pure expectations theory is able to explain why yield curves are usually upward-sloping. Register to View Answer7) A mildly upward sloping yield curve suggests that the market is predicting constant short-term interest rates. Register to View Answer8) Bonds with the lowest risk of default are often referred to as junk bonds. Register to View Answer9) An increase in the marginal tax rate would likely increase the demand for municipal bonds, and decrease the demand for U.S. government bonds. Register to View Answer10) When yield curves are downward sloping, long-term interest rates are above shortterm interest rates. Register to View Answer69 5.3 Essay 1) Contrast the liquidity premium theory to the market segmentation theory of the term structure of interest rates. 2) Why would an increase in the income tax rate reduce borrowing costs to municipalities? 3) Discuss what is shown by a yield curve. 4) Why is it unlikely that the pure expectations theory alone is the correct theory for explaining the yield curve? 5) What is meant by the risk structure of interest rates? 6) How would a severe recession affect the risk premium on corporate bonds? 70 Chapter 6 Structure of Central Banks and the Federal Reserve System 6.1 Multiple Choice Questions 1) Americans fear of centralized power and their distrust of moneyed interests explains why the U.S. did not have a central bank until the A) 17th century. B) 18th century. C) 19th century. D) 20th century. Register to View Answer2) Bank panics in 1819, 1837, 1857, 1873, 1884, 1893, and 1907 convinced many that A) the Federal Reserve needed greater control over the banking system. B) the Federal Reserve needed greater authority to deal with problem banks. C) a central bank was needed to prevent future financial panics. D) both (A) and (B) of the above. Register to View Answer3) The unusual structure of the Federal Reserve System is perhaps best explained by A) Americans fear of centralized power. B) the traditional American distrust of moneyed interests. C) Americans desire to remove control of the money supply from the U.S. Treasury. D) all of the above. E) only (A) and (B) of the above. Register to View Answer4) The traditional American distrust of moneyed interests and the fear of centralized power help to explain A) the failures of the first two experiments in central banking in the United States. B) the decentralized structure of the Federal Reserve System. C) why the Board of Governors of the Federal Reserve System is not located in New York. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 71 5) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that A) the First Bank of the United States had failed to serve as a lender of last resort. B) the Second Bank of the United States had failed to serve as a lender of last resort. C) the Federal Reserve System had failed to serve as a lender of last resort. D) a central bank was needed to prevent future panics. Register to View Answer6) Nationwide financial panics in 1873, 1884, 1893, and 1907 might have been avoided had A) the First Bank of the United States served its intended role of lender of last resort. B) the Second Bank of the United States served its intended role of lender of last resort. C) the Second Bank of the United States not been abolished in 1836 by President Andrew Jackson. D) the Federal Reserve served its intended role of lender of last resort. Register to View Answer7) The many regional Federal Reserve banks resulted from a compromise between parties favoring A) establishment of a central bank and those opposed to its establishment. B) a private central bank and those favoring a government institution. C) establishment of the Board of Governors in Washington, D.C. and those preferring its establishment in New York City. D) none of the above. Register to View Answer8) Which of the following is an element of the Federal Reserve System? A) The Federal Reserve Banks B) The Board of Governors C) The FDIC D) All of the above E) Only (A) and (B) of the above Register to View Answer9) Which of the following is an element of the Federal Reserve System? A) The Federal Reserve Banks B) The Board of Governors C) The FOMC D) All of the above Register to View Answer 72 10) 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 Federal Advisory Council E) Member commercial banks Register to View Answer11) Which of the following functions are not performed by any of the twelve regional Federal Reserve Banks? A) Check clearing B) Conducting economic research C) Setting interest rates payable on time deposits D) Issuing new currency Register to View Answer12) Which Federal Reserve Bank president always has a vote in the Federal Open Market Committee? A) Philadelphia B) Boston C) San Francisco D) New York Register to View Answer13) Each Fed bank president attends FOMC meetings; although only _____ Fed bank presidents vote on policy, all _____ provide input. A) three; ten B) five; ten C) three; twelve D) five; twelve Register to View Answer14) The _____ Fed bank, with about 25 percent of the systems assets, is the most important of the Federal Reserve Banks. A) Chicago B) Los Angeles C) Miami D) New York E) Washington, D.C. Register to View Answer 73 15) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited to A) four percent annually. B) five percent annually. C) six percent annually. D) eight percent annually. Register to View Answer16) All _____ are required to be members of the Fed. A) state chartered banks B) nationally chartered banks C) banks with less than $100 million in assets D) banks with less than $500 million in assets Register to View Answer17) Which of the following banks are required to be members of the Federal Reserve System? A) state chartered banks B) insured banks C) banks having over $500 million in assets D) none of the above Register to View Answer18) Of all commercial banks, A) about 15 percent belong to the Federal Reserve System. B) about 20 percent belong to the Federal Reserve System. C) about 30 percent belong to the Federal Reserve System. D) about 50 percent belong to the Federal Reserve System. Register to View Answer19) Banks subject to reserve requirements set by the Federal Reserve System include A) only state chartered banks. B) only nationally chartered banks. C) only banks with less than $100 million in assets. D) only banks with less than $500 million in assets. E) all banks whether or not they are members of the Federal Reserve System. Register to View Answer20) The Feds support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from its A) concern over declining Fed membership. B) belief that all banking regulations should be eliminated. C) belief that interest rate ceilings were too high. D) belief that depositors had to become more knowledgeable of banking operations. Register to View Answer74 21) Which of the following are duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Regulating credit with the approval of the President under the Credit Control Act of 1969. D) None of the above has been a duty of the Board since the mid-1980s. Register to View Answer22) Which of the following are not duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Approving the discount rate established by the Federal Reserve banks. D) Representing the United States in negotiations with foreign governments on economic matters. Register to View Answer23) The chairman of the Board of Governors of the Federal Reserve System exercises a high degree of control over the Board A) through his ability to set the agenda of the Board and the FOMC. B) through his role as spokesman for the Fed with the President and before Congress. C) because he can veto decisions made by a majority of the other board members. D) because of all of the above. E) because of only (A) and (B) of the above. Register to View Answer24) Members of the Board of Governors are A) chosen by the Federal Reserve Bank presidents. B) appointed by the newly elected President of the United States, as are cabinet positions. C) appointed by the President of the United States and confirmed by the Senate as members resign. D) never allowed to serve more than seven-year terms. Register to View Answer 75 25) Each member of the seven-member Board of Governors is appointed by the president and confirmed by the Senate to serve A) 4-year terms. B) 6-year terms. C) 14-year terms. D) as long as the appointing president remains in office. Register to View Answer26) The Board of Governors A) establishes, within limits, reserve requirements. B) effectively sets the discount rate. C) sets margin requirements. D) does all of the above. E) does only (A) and (B) of the above. Register to View Answer27) Although neither _____ nor the _____ is officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee. A) margin requirements; discount rate B) margin requirements; federal funds rate C) reserve requirements; discount rate D) reserve requirements; federal funds rate Register to View Answer28) Although the Federal Open Market Committee does not have formal authority to set _____ and the _____, it does possess the authority in practice. A) margin requirements; discount rate B) margin requirements; federal funds rate C) reserve requirements; discount rate D) reserve requirements; federal funds rate Register to View Answer29) Which of the following are true statements? A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of open market operations as a monetary policy tool. D) All of the above are true statements. E) Only (A) and (B) of the above are true statements. Register to View Answer 76 30) The Federal Open Market Committee consists of A) the five senior members of the seven-member Board of Governors. B) the seven members of the Board of Governors and seven presidents of the regional Fed banks. C) the seven members of the Board of Governors and five presidents of the regional Fed banks. D) the twelve regional Fed bank presidents and the chairman of the Board of Governors. Register to View Answer31) The Federal Reserve entity that determines monetary policy strategy is the A) Board of Governors. B) chairman of the Board of Governors. C) Federal Open Market Committee. D) Shadow Open Market Committee. Register to View Answer32) Which of the following are true statements? A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary policy tool. D) All of the above are true statements. E) Only (A) and (B) of the above are true statements. Register to View Answer33) Designers of the Federal Reserve Act of 1913 had not intended for the Fed to use A) open market operations as a monetary policy tool. B) reserve requirements as a monetary policy tool. C) the discount rate as a monetary policy tool. D) either (A) or (B) of the above. E) either (A) or (C) of the above. Register to View Answer34) The designers of the Federal Reserve Act of 1913 intended the Fed to have one primary monetary tool: A) open market operations. B) discounting. C) setting reserve requirements. D) setting margin requirements. Register to View Answer 77 35) The designers of the Federal Reserve Act meant to create a central bank characterized by its A) system of checks and balances and decentralization of power. B) strong concentration of power in the hands of a few men. C) inability to function as a lender-of-last-resort. D) responsiveness to the electorate. Register to View Answer36) Which of the following are true statements? A) The Banking Act of 1933 set in motion a series of changes that gave the Board of Governors more control over Fed operations. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary policy tool. D) All of the above are true statements. E) Only (A) and (B) of the above are true statements. Register to View Answer37) Which of the following are true statements? A) The Banking Act of 1933 set in motion a series of changes that gave the Board of Governors more control over Fed operations. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of open market operations as a monetary policy tool. D) All of the above are true statements. E) Only (A) and (B) of the above are true statements. Register to View Answer38) The power within the Federal Reserve was effectively transferred to the Board of Governors by A) the banking legislation of the Great Depression. B) Supreme Court decisions in the 1950s. C) the Depository Institutions Deregulation and Monetary Control Act of 1980. D) the Accord of 1951. Register to View Answer39) Factors that provide the Federal Reserve with a high degree of independence include A) 14-year terms for members of the Board of Governors. B) a four-year term for the chairman of the Board of Governors that is not coincident with the Presidents term of office. C) constitutional independence from Congress and the President. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 78 40) Federal Reserve independence is thought to A) introduce a short-term bias to monetary policymaking. B) lead to better fiscal and monetary policy coordination. C) introduce longer-run considerations to monetary policymaking. D) do both (A) and (B) of the above. Register to View Answer41) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to A) withhold appropriations from the Board of Governors. B) withhold appropriations from the Federal Open Market Committee. C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies. D) do all of the above. Register to View Answer42) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress because A) Congress can pass legislation that would restrict the Feds independence. B) Congress can withhold the Feds appropriations. C) Congress can remove members of the Board of Governors on a whim. D) of all of the above. Register to View Answer43) According to the author of your textbook, the Fed 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) both (A) and (C) of the above. Register to View Answer44) According to the author of your textbook, A) the Fed appears to be remarkably free of the political pressures that influence other government agencies. B) since the president can protect the Fed from Congress, the Fed may be responsive to the presidents policy preferences. C) the Fed appears to be more responsive to the political pressures that influence other government agencies. D) both (A) and (B) of the above. E) both (B) and (C) of the above. Register to View Answer 79 45) Which of the following have acted to limit the Federal Reserves independence? A) The Full Employment and Balanced Growth Act of 1978 B) House Concurrent Resolution 133 C) Both of the above D) Neither of the above Register to View Answer46) The Fed may feel pressure to support the presidents policies since the president can A) dismiss members of the Board of Governors appointed by previous presidents. B) appoint a new chairman of the Board of Governors immediately after taking office. C) veto legislation that might limit the Feds discretionary authority and power. D) do all of the above. E) do both (A) and (C) of the above. Register to View Answer47) The Fed may feel pressure to support the presidents policies since the president A) can appoint a majority of the Board of Governors after a few years, as few appointees serve their full 14-year terms. B) can veto legislation that might limit the Feds discretionary power and authority. C) can dismiss Board members that have been appointed by previous presidents. D) can do all of the above. E) can do only (A) and (B) of the above. Register to View Answer48) The oldest central bank, founded in 1694, is the A) Bank of England. B) Deutsche Bundesbank. C) Bank of Japan. D) Federal Reserve System. Register to View Answer49) The newest central bank, which began operations in January, 1999, is the A) European Central Bank. B) Bank of Argentina. C) Bank of Korea. D) Bank of New Zealand. Register to View Answer50) Which of the following central banks has the greatest degree of independence? A) Bank of England B) European Central Bank C) Bank of Japan D) Federal Reserve System Register to View Answer80 51) Which of the following central banks has the greatest degree of independence? A) Bank of England B) Bank of Canada C) Bank of Japan D) Swiss National Bank Register to View Answer52) Of the following central banks, the one that enjoys the least degree of independence is the A) Federal Reserve System. B) Deutsche Bundesbank. C) Bank of Italy. D) Swiss National Bank. Register to View Answer53) A 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 give up multiple policy goals to focus strictly on inflation. D) have required their central banks to coordinate policies with their ministers of finance. Register to View Answer54) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize A) the publics welfare. B) profits. C) its own welfare. D) conflict between the executive and legislative branches of government. Register to View Answer55) The theory of bureaucratic behavior suggests that the Federal Reserve will A) try to avoid a conflict with the President and Congress over increases in interest rates. B) try to gain regulatory power over more banks. C) devise clever strategies in an effort to avoid blame for poor economic performance. D) do all of the above. Register to View Answer 81 56) Which of the following actions are consistent with the theory of bureaucratic behavior? A) The Fed reports its target paths for more than one monetary aggregate. B) The Fed delays the release of Federal Open Market Committee directives. C) The Fed blames high interest rates on budget deficits rather than on inflationary money growth. D) All of the above are consistent with the theory of bureaucratic behavior. E) Only (B) and (C) are consistent with the theory of bureaucratic behavior. Register to View Answer57) According to the theory of bureaucratic behavior, A) the objective of a bureaucracy is to maximize its own welfare, meaning that it seeks additional power and prestige. B) the objective of a bureaucracy is to maximize consumers surplus, meaning that it seeks additional regulatory powers. C) the objective of a bureaucracy is to protect the industry it regulates, meaning that it seeks additional regulatory powers. D) none of the above describes the objective of a bureaucracy. Register to View Answer58) According to the theory of bureaucratic behavior, A) the objective of a bureaucracy is to maximize its own welfare, meaning that it seeks additional power and prestige. B) the bureaucracy will fight vigorously to preserve its autonomy; thus, it will attempt to avoid conflict with the President and Congress C) the bureaucracy will support legislation that gives it additional regulatory power. D) all of the above describe bureaucratic behavior. Register to View Answer59) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) resists so vigorously congressional attempts to limit the central banks autonomy. B) is so secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 82 60) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) is supportive of congressional attempts to limit the central banks autonomy. B) is so secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) is willing to take on powerful groups that may threaten its autonomy. Register to View Answer61) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed 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 counter-cyclical bias to monetary policy. Register to View Answer62) 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 both (A) and (C) of the above. Register to View Answer63) The case for Federal Reserve independence includes the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) a Federal Reserve under the control of Congress or the President might make the so-called political business cycle more pronounced. D) all of the above. Register to View Answer64) The case for Federal Reserve independence includes the idea that A) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. B) a Federal Reserve under the control of Congress or the President might make the so-called political business cycle more pronounced. C) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day. D) only (A) and (B) of the above. Register to View Answer 83 65) The case for Federal Reserve independence does not include the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) policy is always performed better by an elite group such as the Fed. D) a Federal Reserve under the control of Congress or the President might make the so-called political business cycle more pronounced. Register to View Answer66) The case for Federal Reserve independence does not include the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) a Federal Reserve under the control of Congress or the President might make the so-called political business cycle more pronounced. D) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day. Register to View Answer67) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would A) impart an 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) do all of the above. E) do only (A) and (B) of the above. Register to View Answer68) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would A) impart an 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 less pronounced. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer69) Supporters of the current system of Fed independence believe that a less autonomous Fed would A) adopt a long-run bias toward policymaking. B) pursue overly expansionary monetary policies. C) be more likely to create a political business cycle. D) do only (B) and (C) of the above. Register to View Answer 84 70) Critics of the current system of Fed independence contend that A) the current system is undemocratic. B) voters have too much say about monetary policy. C) the President has too much control over monetary policy on a day-to-day basis. D) all of the above are true. Register to View Answer71) Critics of Fed independence argue A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one. B) that an independent Fed conducts monetary policy with a consistent inflationary bias. C) that the Fed, since it does not face a binding budget constraint, spends too much of its earnings. D) only (A) and (B) of the above. Register to View Answer72) Critics of Fed independence argue A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one. B) that independence seemingly does little to guarantee good monetary policy. C) that its independence may encourage the Fed to pursue a course of narrow selfinterest rather than the public interest. D) all of the above. Register to View Answer 6.2 True/False 1) The unusual structure of the Federal Reserve System is best explained by Americans fear of centralized power. Register to View Answer2) Rapid money supply growth and uncontrollable inflation were among the factors which motivated the creation of the Federal Reserve System. Register to View Answer3) The Washington, D.C. Fed bank, with over 30 percent of the systems assets, is the most important Federal Reserve Bank. Register to View Answer4) The FOMC is an element of the Federal Reserve System. Register to View Answer 85 5) All nationally chartered banks are required to be members of the Fed. Register to View Answer6) Designers of the Federal Reserve Act of 1913 intended the Fed to use open market operations as a policy tool. Register to View Answer7) Each member of the seven-member board is appointed by the President and confirmed by the Senate to serve 14-year terms. Register to View Answer8) The Board of Governors does not set reserve requirements. Register to View Answer9) Monetary policy is set by the Board of Governors. Register to View Answer10) Federal Reserve monetary policy decisions must be approved by the Secretary of the Treasury before they may be implemented. Register to View Answer11) The FOMC issues directives to the trading desk at the New York Fed. Register to View Answer12) Critics of the current system of Fed independence contend that the President has too much control over monetary policy on a day-to-day basis. Register to View Answer 6.3 Essay 1) Congressman Jack Kemp is reported to have said that he wanted to become the most powerful man in Washington, D.C.the chairman of the Board of Governors of the Federal Reserve System. What does Representative Kemps comment imply about the power of the chairman of the Federal Reserve? Do you think he may have been exaggerating? Explain. 2) Paul Volcker is reported to have said that the Federal Reserve is free to pursue any policy it desires, as long as it convinces Congress that such a policy is reasonable. What does Volckers comment suggest about the independence of the Fed? Explain. 3) What are the factors that promote the independence of the Federal Reserve? 86 4) What factors limit the independence of the Federal Reserve? 5) What are the arguments for and against an independent Fed? 6) What is the theory of bureaucratic behavior? What types of behavior does it predict the Fed might undertake? 87 88 Chapter 7 Conduct of Monetary Policy: Tools, Goals, and Targets 7.1 Multiple Choice 1) An open market purchase of securities by the Fed will A) increase assets of the nonbank public and increase assets of the banking system. B) decrease assets of the nonbank public and increase assets of the Fed. C) decrease assets of the banking system and increase assets of the Fed. D) have no effect on assets of the nonbank public but increase assets of the Fed. E) increase assets of the banking system and decrease assets of the Fed. Register to View Answer2) An open market sale of securities by the Fed will A) decrease liabilities of the Fed and decrease assets of the banking system. B) decrease assets of the nonbank public and decrease assets of the Fed. C) increase liabilities of the banking system and increase assets of the Fed. D) have no effect on assets of the nonbank public but increase liabilities of the Fed. E) decrease assets of the banking system and increase assets of the Fed. Register to View Answer3) If the Federal Reserve wants to expand reserves in the banking system, it will A) purchase government securities. B) lower the discount rate. C) sell government securities. D) raise reserve requirements. Register to View Answer4) If the Federal Reserve wants to lower the monetary base and the money supply, it will A) purchase government securities. B) raise the discount rate. C) sell government securities. D) lower reserve requirements. Register to View Answer5) A discount loan by the Fed to a bank causes A) an increase in reserves in the banking system and a decrease in the monetary base. B) a decrease in reserves at the Fed and a decrease in the monetary base. C) a decrease in reserves in the banking system and a decrease in the monetary base. D) an increase in reserves in the banking system and an increase in the monetary base. Register to View Answer 89 6) When a bank repays a discount loan to the Fed, there is A) an increase in reserves in the banking system and a decrease in the monetary base. B) a decrease in reserves at the Fed and a decrease in the monetary base. C) an increase in reserves in the banking system and an increase in the monetary base. D) an increase in reserves at the Fed and an increase in the monetary base. Register to View Answer7) The federal funds rate is A) the interest rate on loans from the Fed to a bank. B) the price the Fed pays for government securities. C) the interest rate on loans of reserves from one bank to another. D) the price banks pay the Fed for government securities. E) the interest rate on loans from a bank to the federal government. Register to View Answer8) The discount rate is A) the interest rate on loans from the Fed to a bank. B) the price the Fed pays for government securities. C) the interest rate on loans of reserves from one bank to another. D) the price banks pay the Fed for government securities. E) the interest rate on loans from a bank to the federal government. Register to View Answer9) Holding everything else constant, if the federal funds rate rises, then A) the demand for excess reserves rises because they have a higher return. B) the demand for excess reserves falls because they have a higher cost. C) the demand for required reserves rises because the cost of borrowing from the Fed is relatively lower. D) the demand for required reserves falls because the cost of borrowing from the Fed is relatively higher. E) demand for reserves will not change because the Fed sets the level of required reserves. Register to View Answer10) Holding everything else constant, if the federal funds rate falls, then A) the supply of required reserves rises because the cost of borrowing from the Fed is relatively lower. B) the supply of required reserves falls because the cost of borrowing from the Fed is relatively higher. C) the supply of excess reserves falls because they have a lower return. D) the supply of excess reserves rises because they have a lower cost. E) the supply of reserves will not change because the Fed sets the level of required reserves. Register to View Answer 90 11) An open market purchase A) shifts the supply curve for reserves to the right and causes the federal funds rate to fall. B) shifts the demand curve for reserves to the right and causes the federal funds rate to rise. C) shifts the supply curve for reserves to the left and causes the federal funds rate to rise. D) shifts the demand curve for reserves to the left and causes the federal funds rate to fall. Register to View Answer12) The supply curve for reserves shifts to the left and the federal funds rate rises when A) the Fed raises reserves requirements or does an open market sale. B) the Fed raises the discount rate or does an open market purchase. C) the Fed raises the discount rate or does an open market sale. D) the Fed raises reserves requirements or raises the discount rate. Register to View Answer13) The demand curve for reserves shifts to the left and the federal funds rate falls when A) the Fed decreases reserve requirements or does an open market purchase. B) the Fed lowers the discount rate. C) the Fed lowers the discount rate or does an open market purchase. D) the Fed decreases reserves requirements. E) the Fed does an open market sale. Register to View Answer14) The actual execution of open market operations is done at A) the Board of Governors in Washington, D.C. B) the Federal Reserve Bank of New York. C) the Federal Reserve Bank of Philadelphia. D) the Federal Reserve Bank of Boston. Register to View Answer15) The Federal Open Market Committee makes the Feds decisions on the purchase or sale of government securities, but these purchases or sales are executed by the Federal Reserve Bank of A) Chicago. B) Boston. C) New York. D) San Francisco. Register to View Answer 91 16) An open market transaction intended to change the level of bank reserves is a A) repurchase agreement. B) reverse repo. C) dynamic operation. D) defensive operation. Register to View Answer17) If the Federal Reserve wants to drain reserves from the banking system, it will A) purchase government securities. B) lower the discount rate. C) sell government securities. D) raise reserve requirements. Register to View Answer18) The Federal Reserve will engage in an outright purchase if it wants to _____ reserves _____ in the banking system. A) increase; permanently B) increase; temporarily C) decrease; temporarily D) decrease; permanently Register to View Answer19) If the Fed wants to temporarily drain reserves from the banking system, it will engage in A) a repurchase agreement. B) a matched sale-purchase transaction. C) a pump agreement. D) none of the above. Register to View Answer20) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to _____ reserves _____ in the banking system. A) increase; permanently B) increase; temporarily C) decrease; temporarily D) decrease; permanently Register to View Answer21) The major loan extended to Continental Illinois in 1984 is an example of which type of discount loan? A) Seasonal credit B) Extended credit C) Adjustment credit D) Installment credit Register to View Answer 92 22) The most common type of discount loan that the Fed extends to banks is called A) seasonal credit. B) extended credit. C) adjustment credit. D) installment credit. Register to View Answer23) The most common type of discount loan, _____ credit loans, are intended to help banks with _____-term liquidity problems that often result from _____ deposit outflows. A) extended; short; temporary B) adjustment; short; temporary C) extended; long; permanent D) seasonal; long; permanent Register to View Answer24) A bank faces three costs when it borrows from the discount window: A) the interest cost; the cost of complying with Fed investigations of the soundness of the bank; the cost of being turned down for a discount loan in the future. B) the interest cost; the administrative cost to the bank; the cost of being turned down for a discount loan in the future. C) the interest cost; the origination fee charged by the Fed; the administrative cost to the bank. D) only (A) and (B) of the above. Register to View Answer25) A financial panic was averted in October 1987 following Black Monday when the Fed announced that A) it was lowering the discount rate on extended credit. B) it would provide discount loans to any bank that would make loans to the security industry. C) it stood ready to purchase common stocks to prevent a further slide in stock prices. D) all of the above. Register to View Answer26) Discount policy A) can be used to signal the Feds intentions about future monetary policy. B) can be important in preventing financial panics. C) is the Feds preferred method for changing the level of reserves in the banking system. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 93 27) Disadvantages of discount policy include A) the confusion concerning the Feds intentions about future monetary policy because of the uncertainty about what a change in the discount rate is intended to signal. B) large fluctuations in the money supply from even small changes in the discount rate. C) its powerful effect, when compared to open market operations, on the monetary base. D) only (A) and (B) of the above. Register to View Answer28) Disadvantages of using reserve requirements to control the money supply include A) their overly-powerful impact on the money supply. B) creating potential liquidity problems for banks with high levels of excess reserves. C) their overly-powerful impact on the monetary base. D) all of the above. Register to View Answer29) The Fed is reluctant to use reserve requirements to control the money supply because A) of their overly-powerful impact on the money supply. B) they have the potential to create liquidity problems for banks with low excess reserves. C) frequent changes in reserve requirements complicate liquidity management for banks. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer30) When the Federal Reserve was created, its most important role was intended to be as A) a storage facility for the nations gold. B) a lender-of-last-resort. C) a regulator of bank holding companies. D) none of the above. Register to View Answer31) At its inception, the Federal Reserve was intended to be A) the Treasurys banker. B) the issuer of government debt. C) a lender-of-last-resort. D) a regulator of bank holding companies. Register to View Answer 94 32) Changes in the reserve requirement are an infrequently used monetary policy tool since A) this tool is too blunt. B) this tool is too weak. C) banks find it costly to adjust to such changes. D) both (A) and (C) of the above are true. Register to View Answer33) Open market operations as a monetary policy tool have the advantage that A) they are flexible and precise. B) they are easily reversed if mistakes are made. C) they can be implemented quickly without administrative delays. D) all of the above. E) only (A) and (B) of the above. Register to View Answer34) What actions did the Fed take following the terrorist attacks of September 11, 2001? A) It increased discount lending and conducted open market purchases to meet the liquidity needs of the financial system. B) It decreased discount lending and conducted open market sales to meet the liquidity needs of the financial system. C) It suspended monetary policy actions so as to avoid taking hasty actions which might ultimately prove to be unwise. D) It reduced its monetary liabilities in order to stabilize the financial system. Register to View Answer35) Price stability is desirable because A) inflation creates uncertainty, making it difficult to plan for the future. B) everyone is better off when prices are stable. C) price stability increases the profitability of the Fed. D) it guarantees full employment. Register to View Answer36) The Federal Reserve desires interest rate stability because A) it allows for less uncertainty about future planning. B) interest rate volatility often leads to demands to curtail the Feds power. C) it guarantees full employment. D) of both (A) and (B) of the above. Register to View Answer37) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called A) structural unemployment. B) frictional unemployment. C) cyclical unemployment. D) underemployment. Register to View Answer95 38) When there is a mismatch between job requirements and the skills of available workers, the resulting unemployment is called A) structural unemployment. B) frictional unemployment. C) cyclical unemployment. D) underemployment. Register to View Answer39) The goal for high employment should be a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the A) frictional level of unemployment. B) structural level of unemployment. C) natural rate level of unemployment. D) ideal level of unemployment. Register to View Answer40) Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth by A) encouraging firms to invest. B) encouraging people to save. C) doing both (A) and (B) of the above. D) doing neither (A) nor (B) of the above. Register to View Answer41) Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth by A) encouraging firms to invest and people to save. B) encouraging firms to limit their price increases and people to consume. C) doing both (A) and (B) of the above. D) doing neither (A) nor (B) of the above. Register to View Answer42) The Feds game plan can be described as follows: A) The Fed uses its policy tools to adjust intermediate targets that directly impact its operating targets in a way that allows the Fed to achieve its goals. B) The Fed uses its policy tools to adjust operating targets that directly impact its intermediate targets in a way that allows the Fed to achieve its goals. C) The Fed uses its operating targets to adjust its intermediate targets that directly impact its policy tools in a way that allows the Fed to achieve its goals. D) none of the above. Register to View Answer 96 43) If the Feds strategy for conducting monetary policy is thought of as a game plan that proceeds in stages, then the game plan can be summarized as follows: A) The Fed selects its policy goals, then the intermediate targets consistent with achieving its policy goals, then the operating targets consistent with its intermediate targets. Finally, it adjusts its policy tools to effect the desired targets and goals. B) The Fed selects its policy goals, then the operating targets consistent with achieving its policy goals, then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy tools to effect the desired targets and goals. C) The Fed selects its policy goals, then the operating targets consistent with achieving its policy goals, then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy tools to effect the desired targets and goals. D) The Fed selects its policy tools, then the operating targets consistent with achieving its policy tools, then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy goals to effect the desired targets and tools. E) none of the above. Register to View Answer44) An advantage of an intermediate targeting strategy is that it provides the Fed with A) more timely information regarding the effect of monetary policy. B) a slow adjustment process. C) a target that is precisely correlated with economic activity. D) all of the above. E) only (A) and (B) of the above. Register to View Answer45) Which of the following is not a requirement in selecting an intermediate target? A) measurability B) controllability C) flexibility D) predictability Register to View Answer46) Which of the following is a potential operating target for the Fed? A) The monetary base B) The M1 money supply C) Nominal GNP D) The discount rate Register to View Answer 97 47) Which of the following is a potential operating target for the Fed? A) Nonborrowed reserves B) The federal funds rate C) The monetary base D) All of the above Register to View Answer48) Which of the following is not an operating target? A) Nonborrowed reserves B) Monetary base C) Federal funds interest rate D) Discount rate E) All are operating targets. Register to View Answer49) When it comes to choosing an operating target, both the _____ rate and _____ aggregates are easily controllable using the Feds policy tools. A) federal funds; monetary B) federal funds; reserve C) three-month T-bill; monetary D) thirty-year T-bond; reserve Register to View Answer50) If the desired intermediate target is an interest rate, then the preferred operating target will be a(n) _____ variable like the _____ A) interest rate; three-month T-bill rate. B) interest rate; federal funds rate. C) monetary aggregate; monetary base. D) monetary aggregate; non-borrowed base. Register to View Answer51) If the desired intermediate target is a monetary aggregate, then the preferred operating target will be a(n) _____ variable like the _____ A) interest rate; three-month T-bill rate. B) interest rate; federal funds rate. C) reserve aggregate; monetary base. D) reserve aggregate; narrow money supply M1. Register to View Answer52) If the Fed focuses on a money supply target, fluctuations of money demand will cause the ______ to fluctuate. A) money supply B) interest rate C) unemployment rate D) inflation rate Register to View Answer 98 53) If the Fed focuses on an interest rate target, fluctuations of money demand will cause the ______ to fluctuate. A) money supply B) interest rate C) unemployment rate D) inflation rate Register to View Answer54) The policy that meant the Fed would make loans to member commercial banks whenever they showed up at the discount window with eligible paper was known as A) free reserves targeting. B) the real bills doctrine. C) nonborrowed reserves targeting. D) leaning against the wind. Register to View Answer55) The real bills doctrine was the guiding principle for the conduct of monetary policy during the A) 1910s. B) 1940s. C) 1950s. D) 1960s. Register to View Answer56) By the end of World War I, the Feds policies of rediscounting eligible paper and keeping interest rates low led to A) accelerating inflation. B) stable prices and strong economic growth, as predicted by the real bills doctrine. C) recession as reserves were steadily drained from the banking system. D) none of the above. Register to View Answer57) The Feds operating strategy that led to double-digit inflation following the end of World War I was known as A) the free reserves policy. B) the federal-funds targeting strategy. C) the real bills doctrine. D) pegging the money supply. Register to View Answer58) The Fed accidentally discovered open market operations in the early A) 1920s. B) 1910s. C) 1900s. D) 1890s. Register to View Answer99 59) The Fed accidentally discovered open market operations when A) it came to the rescue of failing banks in the early 1930s and found that its purchases of bank loans injected reserves into the banking system. B) it purchased securities for income following the 1920-1921 recession. C) it attempted to slow inflation in 1919 by selling securities and found that its sales drained reserves from the banking system. D) it reinterpreted a key provision of the Federal Reserve Act. Register to View Answer60) In the 1930s, the Fed A) failed to perform its role as lender of last resort. B) raised reserve requirements in three steps in 1936-37. C) was given broad authority over reserve requirements. D) all of the above. E) only (A) and (B) of the above. Register to View Answer61) In the 1930s, the Fed A) did not have enough power to perform the role of lender of last resort. B) raised reserve requirements in three steps in 1936-37. C) was given less authority over reserve requirements. D) all of the above. E) only (A) and (B) of the above. Register to View Answer62) During World War II, whenever interest rates would rise and the price of bonds would begin to fall, the Fed would A) lower reserve requirements. B) raise reserve requirements. C) make open market purchases of government securities. D) make open market sales of government securities. Register to View Answer63) During World War II, the Fed in effect relinquished its control of monetary policy through its policy of A) continually lowering reserve requirements. B) continually raising reserve requirements. C) pegging interest rates. D) targeting free reserves. Register to View Answer 100 64) Under the free reserves monetary policy of the 1950s and 1960s, the Fed interpreted an increase in free reserves as A) an easing of money market conditions requiring open market sales to withdraw reserves from the banking system. B) an easing of money market conditions requiring open market sales to inject reserves into the banking system. C) a tightening of money market conditions requiring open market sales to withdraw reserves from the banking system. D) a tightening of money market conditions requiring open market purchases to inject reserves into the banking system. Register to View Answer65) During the 1950s and 1960s, the Fed considered free reserves to be a particularly good indicator of money market conditions because it thought that free reserves A) represented the amount of slack in the banking system. B) represented the amount of reserves that could be expected to be used to make loans and create deposits. C) would never be lent by banks. D) represented both (A) and (B) of the above. E) represented both (A) and (C) of the above. Register to View Answer66) Under the free reserves monetary policy of the 1950s and 1960s, the Fed interpreted an increase in free reserves as a(n) _____ of money market conditions requiring open market _____ to withdraw reserves from the banking system. A) tightening; purchases B) easing; purchases C) tightening; sales D) easing; sales Register to View Answer67) Under the free reserves monetary policy of the 1950s and 1960s, the Fed interpreted a decrease in free reserves as a(n) _____ of money market conditions requiring open market _____ to inject reserves into the banking system. A) tightening; purchases B) easing; purchases C) tightening; sales D) easing; sales Register to View Answer68) A procyclical monetary policy causes the money supply to ______ during recessions and to ______ when the economy is growing. A) increase; increase B) decrease; decrease C) increase; decrease D) decrease; increase Register to View Answer101 69) A policy of targeting free reserves is likely to prove to be A) procyclical. B) stabilizing. C) too difficult to implement practically. D) none of the above. Register to View Answer70) In practice, the Feds policy of targeting _____ in the 1960s proved to be _____, destabilizing the economy. A) money market conditions; countercyclical B) money market conditions; procyclical C) monetary aggregates; countercyclical D) monetary aggregates; procyclical Register to View Answer71) Although the Fed professed employment of a monetary aggregate targeting strategy during the 1970s, its behavior suggests that it emphasized A) free reserve targeting. B) interest rate targeting. C) a real bills doctrine. D) price index targeting. Register to View Answer72) The Feds use of the federal funds rate as an operating target in the 1970s resulted in A) countercyclical monetary policy. B) too slow growth in M1 throughout the decade. C) procyclical monetary policy. D) too rapid growth in M1 throughout the decade. E) none of the above. Register to View Answer73) The Feds operating procedures employed between 1979 and 1982 resulted in _____ swings in the federal funds rate and _____ swings in the M1 growth rate. A) increased; increased B) increased; decreased C) decreased; decreased D) decreased; increased Register to View Answer74) Explanations for the Feds poor monetary control during 1979-1982 include A) the acceleration of financial deregulation. B) the suspension of credit controls in mid-1979. C) the Feds desire to fight inflation without taking all the criticism for the high interest rate policy. D) only (A) and (B) of the above. E) only (A) and (C) of the above. Register to View Answer102 75) The fluctuations in both money supply growth and the federal funds rate during 1979-1982 suggest that the Fed A) had shifted to borrowed reserves as an operating target. B) had shifted to nonborrowed reserves as an operating target. C) had shifted to the monetary base as an operating target. D) never intended to target monetary aggregates. Register to View Answer76) The fluctuations in both money supply growth and the federal funds rate during 1979-1982 suggest that the Fed A) never intended to target monetary aggregates. B) used the announced strategy of targeting nonborrowed reserves as a smoke screen to fight inflation. C) had shifted to the monetary base as an operating target. D) both (A) and (B) of the above. Register to View Answer77) Fed policy since 1982 suggests A) that it is finally using a monetary aggregate as its intermediate target. B) that it is less concerned with fluctuations in the federal funds rate than in the 1979-1982 period. C) that it is more concerned with exchange rates than with interest rates. D) none of the above. Register to View Answer78) Fed policy since 1982 suggests that A) monetary aggregates continue to be rejected as its intermediate target. B) it is pursuing a policy of interest rate smoothing. C) it is now more concerned with exchange rates than with interest rates. D) all of the above are true. E) only (A) and (B) of the above are true. Register to View Answer79) By 1985, the strength of the dollar had caused a deterioration in American competitiveness with foreign businesses. In response, the Fed A) increased money growth to lower the value of the dollar. B) decreased money growth to lower the value of the dollar. C) increased money growth to raise the value of the dollar. D) decreased money growth to raise the value of the dollar. Register to View Answer 103 80) By 1985, the strength of the dollar had caused a deterioration in American competitiveness with foreign businesses. In response, the Fed _____ money growth to _____ the value of the dollar. A) increased; raise B) increased; lower C) decreased; raise D) decreased; lower Register to View Answer81) During the period 1985-87, the actions of monetary policy authorities indicate that they were most directly concerned with A) stabilizing interest rates, even at the expense of losing control of monetary aggregates. B) eliminating even moderate inflation. C) lowering the value of the dollar. D) none of the above. Register to View Answer82) Volatile fluctuations in money supply growth in the United Kingdom in the 1970s suggest that the Bank of England A) did not pursue its M3 monetary target seriously. B) did not pursue its M1 monetary target seriously. C) used the announced strategy of targeting the federal funds rate as a smoke screen to fight inflation. D) did both (A) and (C) of the above. E) did both (B) and (C) of the above. Register to View Answer83) The Canadian experience with monetary policy during the 1970s and 1980s closely parallels that of the United States in which respects? A) The Canadian central bank announced a strategy of targeting a monetary aggregate in the 1970s. B) The Canadian central bank abandoned its monetary targeting strategy because of exchange rate concerns. C) The Canadian central banks announced strategy of targeting money was merely a smoke screen to fight inflation. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer 104 84) The German Bundesbank experience with monetary policy during the 1970s and 1980s is similar to that of Canadas central bank in which respects? A) Both the German and Canadian central banks announced strategies to target monetary aggregates in the 1970s. B) Both the German and Canadian central banks were willing to abandon monetary targeting due to exchange rate concerns. C) Although the Canadian central bank abandoned its monetary targeting strategy permanently, the Bundesbank has continued to target money. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer85) The Bundesbank experience with monetary policy during the 1970s and 1980s is similar to that of Canadas central bank in which respects? A) Both the German and Canadian central banks announced strategies to target monetary aggregates in the 1970s. B) Both the German and Canadian central banks were willing to abandon monetary targeting due to exchange rate concerns. C) Although the German central bank abandoned its monetary targeting strategy permanently, the Canadian central bank has continued to target money. D) Only (A) and (B) of the above. Register to View Answer86) Since 1978, the central bank of Japan has conducted monetary policy A) using an interest rate as its operating target. B) in a way that has produced relatively stable money growth. C) to successfully lower Japans inflation rate. D) to achieve all of the above. E) to achieve only (B) and (C) of the above. Register to View Answer87) Since 1978, the central bank of Japan has conducted monetary policy A) using the monetary base as its operating target. B) in a way that has produced relatively stable money growth. C) to help its exporters by lowering the value of the yen. D) to achieve all of the above. Register to View Answer 105 7.2 True/False 1) An objective of the Federal Reserve in its conduct of monetary policy is high employment. Register to View Answer2) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called frictional unemployment. Register to View Answer3) The discount rate is an operating target. Register to View Answer4) Flexibility is a requirement in selecting an intermediate target. Register to View Answer5) The real bills doctrine was the guiding principle for the conduct of monetary policy during the 1910s. Register to View Answer6) The Fed accidentally discovered open market operations in the early 1890s. Register to View Answer7) During World War II, the Fed in effect relinquished its control of monetary policy through its policy of pegging interest rates. Register to View Answer8) The Feds use of the federal funds rate as an operating target in the 1970s resulted in countercyclical monetary policy. Register to View Answer9) The Fed policy since 1982 suggests that it is using a monetary aggregate as its intermediate target. Register to View Answer10) Since 1978, the central bank of Japan has conducted monetary policy in a way that has produced relatively stable money growth. Register to View Answer11) Financial innovation, deregulation, and the breakdown of a stable relationship between M1 and economic activity all contributed to the Fed abandoning M1 as an intermediate target. Register to View Answer12) Inflation targeting makes the central bank less accountable. Register to View Answer 106 7.3 Essay 1) Explain why the use of an interest rate targeting strategy may result in procyclical monetary growth. 2) The interest rate targeting strategy employed by the Fed in the 1960s and 1970s led to procyclical money growth. True, false, or uncertain? Why? 3) If inflation and unemployment are of direct concern to Fed officials, why do they make such a big issue about money growth and interest rates? Why dont they just target the unemployment rate and the inflation rate directly? Explain. 4) Describe the goals of the Federal Reserve. What happens when these goals come into conflict? How would one decide if lower inflation is more important than lower unemployment? Explain. 5) Can the Fed control the money supply? Has it done so? What evidence can you provide to support your answer to each question? 6) Compare the advantages and disadvantages of monetary targeting and inflation targeting. 107 108 Chapter 8 The Money Markets 8.1 Multiple Choice 1) Activity in money markets increased significantly in the late 1970s and early 1980s because A) of rising short-term interest rates. B) of regulations that limited what banks could pay for deposits. C) of both (A) and (B) of the above. D) of neither (A) nor (B) of the above. Register to View Answer2) Money market securities are A) short-term. B) low risk. C) very liquid. D) all of the above. E) only (A) and (B) of the above. Register to View Answer3) Money market instruments A) are usually sold in large denominations. B) have low default risk. C) mature in one year or less. D) are characterized by all of the above. E) are characterized by only (A) and (B) of the above. Register to View Answer4) The banking industry A) should have an efficiency advantage in gathering information that should eliminate the need for the money markets. B) exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders. C) is subject to more regulations and governmental costs than are the money markets. D) all of the above are true. E) only (A) and (B) of the above are true. Register to View Answer 109 5) In situations where the asymmetric information problem is not severe, A) the money markets have a distinct cost advantage over banks in providing short-term funds. B) banks have a distinct cost advantage over the money markets in providing short-term funds. C) banks have a comparative advantage over the money markets in providing short-term funds. D) banks have an absolute advantage over the money markets in providing shortterm funds. Register to View Answer6) Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over banks in attracting funds because the brokerage firms A) were not subject to deposit reserve requirements. B) were not subject to the deposit interest rate ceilings. C) were not limited in how much they could borrow from depositors. D) had the advantage of all the above. E) had the advantage of only (A) and (B) of the above. Register to View Answer7) Which of the following statements about the money market are true? A) Not all commercial banks deal for their customers in the secondary market. B) Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds. C) The single most influential participant in the U.S. money market is the U.S. Treasury Department. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer8) Which of the following statements about the money markets are true? A) Most money market securities do not pay interest. Instead the investor pays less for the security than it will be worth when it matures. B) Pension funds invest a portion of their assets in the money market to have sufficient liquidity to meet their obligations. C) Unlike most participants in the money market, the U.S. Treasury Department is always a demander of money market funds and never a supplier. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 110 9) Which of the following are true statements about participants in the money markets? A) Large banks participate in the money markets by selling large negotiable CDs. B) The U.S. government and corporations borrow in the money markets because cash inflows and outflows are rarely synchronized. C) The Federal Reserve is the single most influential participant in the U.S. money market. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer10) The most influential participant(s) in the U.S. money market A) is the Federal Reserve. B) is the U.S. Treasury Department. C) are the largest money center banks. D) are the investment banks that underwrite securities. Register to View Answer11) The primary function of large diversified brokerage firms in the money market is to A) sell money market securities to the Federal Reserve for its open market operations. B) make a market for money market securities by maintaining an inventory from which to buy or sell. C) buy money market securities from corporations that need liquidity. D) buy T-bills from the U.S. Treasury Department. Register to View Answer12) Finance companies raise funds in the money market by selling A) commercial paper. B) federal funds. C) negotiable certificates of deposit. D) Eurodollars. Register to View Answer13) Finance companies play a unique role in money markets by A) giving consumers indirect access to money markets. B) combining consumers investments to purchase money market securities on their behalf. C) borrowing in capital markets to finance purchases of money market securities. D) assisting the government in its sales of U.S. treasury securities. Register to View Answer 111 14) When inflation rose in the late 1970s, A) consumers moved money out of money market mutual funds because their returns did not keep pace with inflation. B) banks solidified their advantage over money markets by offering higher deposit rates. C) brokerage houses introduced highly popular money market mutual funds drawing significant amounts of money out of bank deposits. D) consumers were unable to take advantage of higher rates in money markets because of the requirement of large transaction sizes. Register to View Answer15) Money market instruments issued by the U.S. Treasury are called A) Treasury bills. B) Treasury notes. C) Treasury bonds. D) Treasury strips. Register to View Answer16) The Treasury auctions 91-day and 182-day Treasury bills once a week. It auctions 52-week bills A) once a month. B) once every 13 weeks. C) once a year. D) every two weeks. Register to View Answer17) Which of the following statements are true of Treasury bills? A) The market for Treasury bills is extremely deep and liquid. B) Occasionally, investors find that earnings on T-bills do not compensate them for changes in purchasing power due to inflation. C) By volume, most Treasury bills are sold to individuals who submit noncompetitive bids. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer18) Suppose that you purchase a 91-day Treasury bill for $9,850 that is worth $10,000 when it matures. The securitys annualized yield if held to maturity is about A) 4.5 percent. B) 5 percent. C) 6 percent. D) 7 percent. Register to View Answer 112 19) If your competitive bid for a Treasury bill is successful, then A) you will certainly pay less than if you had submitted a noncompetitive bid. B) you will probably pay more than if you had submitted a noncompetitive bid. C) you will pay the average of prices offered in other successful competitive bids. D) you will pay the same as other successful competitive bidders. Register to View Answer20) If your noncompetitive bid for a Treasury bill is successful, then A) you will certainly pay less than if you had submitted a competitive bid. B) you will certainly pay more than if you had submitted a competitive bid. C) you will pay the average of prices offered in other noncompetitive bids. D) you will pay the same as other successful noncompetitive bidders. Register to View Answer21) Federal funds A) are short-term funds transferred between financial institutions, usually for a period of one day. B) actually have nothing to do with the federal government. C) provide banks with an immediate infusion of reserves should they be short. D) are all of the above. E) are only (A) and (B) of the above. Register to View Answer22) Federal funds are A) usually overnight investments. B) borrowed by banks that have a deficit of reserves. C) lent by banks that have an excess of reserves. D) all of the above. E) only (A) and (B) of the above. Register to View Answer23) The Fed can influence the federal funds interest rate by adjusting the level of reserves available to banks in the system. The Fed can A) lower the federal funds interest rate by adding reserves. B) raise the federal funds interest rate by removing reserves. C) remove reserves by selling securities. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer 113 24) The Federal Reserve can influence the federal funds interest rate by A) buying securities which adds reserves, thereby raising the federal funds rate. B) buying securities which removes reserves, thereby lowering the federal funds rate. C) buying securities which adds reserves, thereby lowering the federal funds rate. D) buying securities which removes reserves, thereby raising the federal funds interest rate. Register to View Answer25) The Fed can lower the federal funds interest rate by A) selling securities, thereby adding reserves. B) selling securities, thereby lowering reserves. C) buying securities, thereby adding reserves. D) buying securities, thereby lowering reserves. Register to View Answer26) If the Fed wants to lower the federal funds interest rate, it will A) add reserves to the banking system by selling securities. B) add reserves to the banking system by buying securities. C) remove reserves from the banking system by selling securities. D) remove reserves from the banking system by buying securities. Register to View Answer27) If the Fed wants to raise the federal funds interest rate, it will A) sell securities to add reserves to the banking system. B) sell securities to remove reserves from the banking system. C) buy securities to add reserves to the banking system. D) buy securities to remove reserves from the banking system. Register to View Answer28) Government securities dealers frequently engage in repos to A) manage liquidity. B) take advantage of anticipated changes in interest rates. C) lend or borrow for a day or two with what is essentially a collateralized loan. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer29) Repos are A) usually low risk loans. B) usually collateralized with Treasury securities. C) low interest rate loans. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 114 30) A negotiable certificate of deposit A) is a term security because it has a specified maturity date. B) is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and interest. C) can be bought and sold until maturity. D) is all of the above. E) is only (A) and (B) of the above. Register to View Answer31) Negotiable certificates of deposit A) are bearer instruments because their holders earn the interest and principal at maturity. B) typically have a maturity of one to four months. C) are usually denominated at $100,000. D) are all of the above. E) are only (A) and (B) of the above. Register to View Answer32) Commercial paper securities A) are issued only by the largest and most creditworthy corporations, as they are unsecured. B) carry an interest rate that varies according to the firms level of risk. C) never have a term to maturity that exceeds 270 days. D) all of the above. E) only (A) and (B) of the above. Register to View Answer33) Unlike most money market securities, commercial paper A) is not generally traded in a secondary market. B) usually has a term to maturity that is longer than a year. C) is not popular with most money market investors because of the high default risk. D) all of the above. E) only (A) and (B) of the above. Register to View Answer34) A bankers acceptance is A) used to finance goods that have not yet been transferred from the seller to the buyer. B) an order to pay a specified amount of money to the bearer on a given date. C) a relatively new money market security that arose in the 1960s as international trade expanded. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 115 35) Bankers acceptances A) can be bought and sold until they mature. B) are issued only by large money center banks. C) carry low interest rates because of the very low default risk. D) are all of the above. E) are only (A) and (B) of the above. Register to View Answer36) Eurodollars A) are time deposits with fixed maturities and are, therefore, somewhat illiquid. B) offer the borrower a lower interest rate than can be received in the domestic market. C) are still limited to London banks. D) are all of the above. E) are only (A) and (B) of the above. Register to View Answer37) Which of the following statements about money market securities are true? A) The interest rates on all money market instruments move very closely together over time. B) The secondary market for Treasury bills is extensive and well developed. C) There is no well-developed secondary market for commercial paper. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer38) Money market mutual funds A) are funds that aggregate money from a group of small investors and invest it in money market instruments. B) have grown enormously popular since their inception in the early 1970s. C) received a flood of funds in the early 1980s as depositors withdrew their funds from banks which were restricted from paying more than 5.25percent in interest on savings accounts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer39) The assets of money market mutual funds have increased from under $100 billion in 1980 to more than A) $500 billion in 2000. B) $1trillion in 2000. C) $1.5 trillion in 2000. D) $2 trillion in 2000. Register to View Answer 116 40) Which of the following statements are true of money market mutual funds? A) Commercial paper is by far the largest component of these funds. B) Although investors know that MMMFs are not insured, they regard their funds to be very safe. C) Money market mutual funds typically pay investors a higher return than is available from banks. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 8.2 True/False 1) Money market securities are short-term instruments with an original maturity of less than one year. Register to View Answer2) Money market securities include Treasury bills, commercial paper, federal funds, repurchase agreements, negotiable certificates of deposit, bankers acceptances, and Eurodollars. Register to View Answer3) The term money market is actually a misnomer, because liquid securities are traded in these markets rather than money. Register to View Answer4) Money markets are referred to as retail markets because small individual investors are the primary buyers of money market securities. Register to View Answer5) The U.S. Treasury Department is the single most influential participant in the U.S. money market. Register to View Answer6) Banks are unusual participants in the money market because they buy, but do not sell, money market instruments. Register to View Answer7) Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds. Register to View Answer8) The market for U.S. Treasury bills is a shallow market because so few individual investors buy T-bills. Register to View Answer 117 9) The T-bill is not an investment to be used for anything but temporary storage of excess funds because it barely keeps up with inflation. Register to View Answer10) The main purpose for federal funds is to provide banks with an immediate infusion of reserves should they be short. Register to View Answer11) The Fed can influence the federal funds rate by adjusting the level of reserves in the banking system. Register to View Answer12) Commercial paper securities are unsecured promissory notes, issued by corporations, that mature in no more than 270 days. Register to View Answer13) A bankers acceptance is an order to pay a specified amount of money to the bearer on a given date. Bankers acceptances have been used since the twelfth century. Register to View Answer14) Interest rates on bankers acceptances are low because the risk of default is very low. Register to View Answer 8.3 Essay 1) Explain why banks, which would seem to have a comparative advantage in gathering information, have not eliminated the need for the money markets. 2) Explain how the Federal Reserve can influence the federal funds interest rate. 3) Explain why the money markets are referred to as wholesale markets. 4) Which are the three most important assets of mutual funds? 5) Explain why money market interest rates move so closely together over time. 6) Why did money market funds grow rapidly between 1975 and 1985? 118 Chapter 9 The Capital Markets 9.1 Multiple Choice 1) (I) Securities that have an original maturity that is greater than one year are traded in capital markets. (II) The best known capital market securities are stocks and bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer2) (I) Securities that have an original maturity that is greater than one year are traded in money markets. (II) The best known money market securities are stocks and bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer3) (I) Firms and individuals use the capital markets for long-term investments. (II) The capital markets provide an alternative to investment in assets such as real estate and gold. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer4) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will A) rise before they pay off their debt. B) fall before they pay off their debt. C) become more volatile before they pay off their debt. D) become more stable before they pay off their debt. Register to View Answer5) A firm that chooses to finance a new plant by issuing money market securities A) must incur the cost of issuing new securities to roll over its debt. B) runs the risk of having to pay higher interest rates when it rolls over its debt. C) incurs both the cost of reissuing securities and the risk of having to pay higher interest rates on the new debt. D) is more likely to profit if interest rates rise while the plant is being constructed. Register to View Answer 119 6) The primary reason that individuals and firms choose to borrow long-term is to A) reduce the risk that interest rates will fall before they pay off their debt. B) reduce the risk that interest rates will rise before they pay off their debt. C) reduce monthly interest payments, as interest rates tend to be higher on shortterm than long-term debt instruments. D) reduce total interest payments over the life of the debt. Register to View Answer7) A firm will borrow long-term A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt. B) if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the expected premium that is paid for borrowing long term. C) if short-term interest rates are expected to decline during the term of the debt. D) if long-term interest rates are expected to decline during the term of the debt. Register to View Answer8) The primary issuers of capital market securities include A) the federal and local governments. B) the federal and local governments, and corporations. C) the federal and local governments, corporations, and financial institutions. D) local governments and corporations. Register to View Answer9) Governments never issue stock because A) they cannot sell ownership claims. B) the Constitution expressly forbids it. C) of both (A) and (B) of the above. D) of neither (A) nor (B) of the above. Register to View Answer10) (I) The primary issuers of capital market securities are federal and local governments, and corporations. (II) Governments never issue stock because they cannot sell ownership claims. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer11) (I) The primary issuers of capital market securities are financial institutions. (II) The largest purchasers of capital market securities are corporations. A) (I) is true, (II) false. B) (I) is false, (II) true C) Both are true. D) Both are false. Register to View Answer120 12) The distribution of a firms capital between debt and equity is its A) leverage ratio. B) liability structure C) acid ratio. D) capital structure. Register to View Answer13) The largest purchasers of capital market securities are A) households. B) corporations C) governments. D) central banks. Register to View Answer14) Although individuals and households are the largest purchasers of capital market securities, they frequently purchase these securities through financial institutions such as A) mutual funds. B) pension funds. C) money market mutual funds. D) all of the above. E) only (A) and (B) of the above. Register to View Answer15) (I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering. A) (I) is true, (II) false. B) (I) is false, (II) true C) Both are true. D) Both are false. Register to View Answer16) Organized exchanges account for about _____ percent of the total dollar volume of domestic stock shares traded. A) 30 B) 45 C) 60 D) 70 Register to View Answer 121 17) Organized exchanges account for about _____ percent of the total dollar volume of domestic stocks traded. A) 60 B) 70 C) 80 D) 90 Register to View Answer18) (I) The largest of the organized stock exchanges in the United States is the New York Stock Exchange. (II) To be listed on the NYSE, a firm must have a minimum of 10 million shares traded publicly. A) (I) is true, (II) false. B) (I) is false, (II) true C) Both are true. D) Both are false. Register to View Answer19) To list on the NYSE, a firm must A) have at least 2000 stockholders, each owning 100 shares or more. B) have pretax earnings of at least $1 million per year. C) have a total of $100 million in market value of publicly traded shares. D) meet all of the above requirements. E) meet (A) and (B) of the above requirements. Register to View AnswerSecurities not listed on one of the exchanges trade in the over-the-counter market. In this exchange, dealers make a market by F) buying stocks for inventory when investors want to sell. G) selling stocks from inventory when investors want to buy. H) doing both of the above. I) doing neither of the above. Register to View Answer20) (I) Capital market securities fall into two categories: bonds and stocks. (II) Longterm bonds include government bonds and long-term notes, municipal bonds, and corporate bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer21) The _____ value of a bond is the amount that the issuer must pay at maturity. A) market B) present C) face D) amortized Register to View Answer122 22) The _____ rate is the rate of interest that the issuer must pay. A) market B) coupon C) discount D) funds Register to View Answer23) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer24) Federal government bonds are subject to _____ risk but are free of _____ risk. A) default; interest rate B) default; underwriting C) interest rate; default D) interest rate; underwriting Register to View Answer25) The prices of Treasury notes, bonds, and bills are quoted as a percentage of A) the coupon rate. B) the previous days closing value. C) $100 face value. D) $1000 face value. Register to View Answer26) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest rate risk. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer27) To sell an old bond when interest rates have _____, the holder will have to ______ the price of the bond until the yield to the buyer is the same as the market rate. A) risen; lower B) risen; raise C) fallen; lower D) risen; inflate Register to View Answer123 28) Most of the time, the interest rate on Treasury notes and bonds is A) above that on money market securities because of interest rate risk. B) above that on money market securities because of default risk. C) below that on money market securities because of interest rate risk. D) below that on money market securities because of default risk. Register to View Answer29) (I) In most years the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer30) (I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities. (II) A STRIP separates the periodic interest payments from the final principal repayment. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer31) Which of the following statements about Treasury inflation-indexed bonds is not true? A) The principal amount used to compute the interest payment varies with the consumer price index. B) The interest payment rises when inflation occurs. C) The interest rate rises when inflation occurs. D) At maturity the securities pay the greater of face-value or inflation-adjusted principal. Register to View Answer32) The interest rates on government agency bonds are A) are almost identical to those available on Treasury securities since it is unlikely that the federal government would permit its agencies to default on their obligations. B) are significantly higher than those available on Treasury securities due to their low liquidity. C) are significantly lower than those available on Treasury securities because agency interest payments are tax exempt. D) are significantly lower than those available on Treasury securities because the interest rate risk on agency securities is lower than that on Treasury securities. Register to View Answer124 33) (I) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. (II) General obligation bonds do not have specific assets pledged as security or a specific source of revenue allocated for their repayment. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer34) (I) Most corporate bonds have a face value of $1000, pay interest semi-annually, and can be redeemed anytime the issuer wishes. (II) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer35) The bond contract that states the lenders rights and privileges and the borrowers obligations is called the A) bond syndicate. B) restrictive covenant. C) bond covenant. D) bond indenture. Register to View Answer36) Policies that limit the discretion of managers as a way of protecting bondholders interests are called A) restrictive covenants. B) debentures. C) sinking funds. D) bond indentures. Register to View Answer37) Typically, the interest rate on corporate bonds will be A) higher the more restrictions are placed on management through restrictive covenants, because corporate earnings will be limited by the restrictions. B) higher the more restrictions are placed on management through restrictive covenants, because the bonds will be considered safer by bondholders. C) lower the more restrictions are placed on management through restrictive covenants, because the bonds will be considered safer by buyers. D) lower the fewer restrictive covenants are placed on management, because corporate earnings will be higher the fewer the restrictions. Register to View Answer 125 38) Restrictive covenants can A) limit the amount of dividends the firm can pay. B) limit the ability of the firm to issue additional debt. C) restrict the ability of the firm to enter into a merger agreement. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer39) (I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders. (II) Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer40) Call provisions will be exercised when A) interest rates and bond values rise. B) interest rates rise and bond values fall. C) interest rates fall and bond values rise. D) interest rates and bond values fall. Register to View Answer41) A requirement in the bond indenture that the firm pay off a portion of the bond issue each year is called A) a call provision. B) a restrictive covenant. C) a sinking fund. D) a shelf registration. Register to View Answer42) (I) Callable bonds must have a higher yield than comparable noncallable bonds. (II) Convertible bonds are attractive to bondholders and sell for a higher price than comparable nonconvertible bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 126 43) Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are called A) junk bonds. B) callable bonds. C) convertible bonds. D) debentures. Register to View Answer44) Financial guarantees A) are insurance policies to back bond issues. B) are purchased by financially weaker security issuers. C) lower the risk of the bonds covered by the guarantee. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer45) (I) A share of common stock in a firm represents an ownership interest in that firm. (II) A share of preferred stock is as much like a bond as it is like common stock. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer46) Preferred stockholders hold a claim on assets A) that has priority over the claims of both common stockholders and bondholders. B) that has priority over the claims of neither common stockholders nor bondholders. C) that has priority over the claims of common stockholders, but after that of bondholders. D) that has priority over the claims of bondholders but after that of common stockholders. Register to View Answer47) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders. (II) Firms issue preferred stock in far greater amounts than common stock. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 127 48) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders. (II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer49) (I) Firms issue common stock in far greater amounts than preferred. (II) The total volume of stock issued is much less than the volume of bonds issued. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 9.2 True/False 1) The primary issuers of capital market securities are local governments and corporations. Register to View Answer2) Governments never issue stock because they cannot sell ownership claims. Register to View Answer3) Dealers make a market in over-the-counter stock by buying for inventory when investors want to sell and selling from inventory when investors want to buy. Register to View Answer4) To sell an old bond when rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. Register to View Answer5) Most of the time, the interest rate on Treasury notes is below that on money market securities because of their low default risk. Register to View Answer6) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. Register to View Answer7) Most corporate bonds have a face value of $1000, are sold at a discount, and can only be redeemed at the maturity date. Register to View Answer128 8) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons. Register to View Answer9) A sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond issue each year. Register to View Answer10) Debentures are long-term unsecured bonds that are backed only by the general creditworthiness of the issuer. Register to View Answer11) In a leveraged buy out, a firm greatly increases its debt level by issuing junk bonds to finance the purchase of another firms stock. Register to View Answer12) A financial guarantee ensures that the lender (bond purchaser) will be paid both principal and interest in the event the issuer defaults. Register to View Answer13) Common stockholders hold a claim on assets that has priority over claims of bondholders, but after that of preferred stockholders. Register to View Answer 9.3 Essay 1) What is a bond indenture? 2) What role do restrictive covenants play in bond markets? 3) What is the basic difference between common and preferred stock? 4) What is difference between a general obligation and a revenue bond? 5) What are STRIPS? 6) What is a convertible bond? How does the convertibility feature affect the bonds price and interest rate? 129 130 Chapter 10 The Stock Market and the Efficient Market Hypothesis 10.1 Multiple Choice 1) A basic principle of finance is that the value of any investment is A) the present value of all future net cash flows generated by the investment. B) the undiscounted sum of all future net cash flows generated by the investment. C) unrelated to the future net cash flows generated by the investment. D) unrelated to the degree of risk associated with the future net cash flows generated by the investment. Register to View Answer2) A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investors valuation of this stock if she expects it to be selling for $30 in one year and requires 15 percent return on equity investments? A) $30.24 B) $26.30 C) $26.09 D) $27.74 Register to View Answer3) A stock currently sells for $30 per share and pays $1.00 per year in dividends. What is an investors valuation of this stock if he expects it to be selling for $37 in one year and requires 12 percent return on equity investments? A) $38 B) $33.50 C) $34.50 D) $33.93 Register to View Answer4) In the one-period valuation model, a stocks value will be higher A) the higher is its expected future price. B) the lower is its dividend. C) the higher is the required return on investments in equity. D) all of the above. Register to View Answer5) In the one-period valuation model, a stocks value falls if the ______ rises. A) dividend B) expected future price C) required return on equity D) current price Register to View Answer 131 6) In the generalized dividend valuation model a stocks value depend only on A) its future dividend payments and its future price. B) its future dividend payments and the required return on equity. C) its future price and the required return on investments on equity. D) its future dividend payments. Register to View Answer7) Which of the following is not an element of the Gordon growth model of stock valuation? A) the stocks most recent dividend paid B) the expected constant growth rate of dividends. C) the required return on investments in equity. D) the stocks expected future price. Register to View Answer8) According to the Gordon growth model, what is an investors valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investors required return is 11 percent? A) $100 B) $9.09 C) $10 D) $4.76 Register to View Answer9) According to the Gordon growth model, what is an investors valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investors required return is 15 percent? A) $6.67 B) $10 C) $20 D) $4 Register to View Answer10) Holding other things constant, a stocks value will be highest if its dividend growth rate is A) 15 percent B) 10 percent C) 5 percent D) 2 percent Register to View Answer 132 11) Holding other things constant, a stocks value will be highest if its most recent dividend is A) $2.00 B) $5.00 C) $0.50 D) $1.00 Register to View Answer12) Holding other things constant, a stocks value will be highest if the investors required return on investments in equity is A) 20 percent B) 15 percent C) 10 percent D) 5 percent Register to View Answer13) Suppose the average industry PE ratio for auto parts retailers is 20. What is the current price of Auto Zone stock if the retailers earnings per share are projected to be $1.85? A) $21.85 B) $37 C) $10.81 D) $9.25 Register to View Answer14) Which of the following is true regarding the Gordon growth model? A) Dividends are assumed to grow at a constant rate forever. B) The dividend growth rate is assumed to be greater than the required return on equity. C) Both (A) and (B). D) Neither (A) nor (B). Register to View Answer15) The PE ratio approach to valuing stock is especially useful for valuing A) privately held firms. B) firms that dont pay dividends. C) both (A) and (B). D) neither (A) nor (B). Register to View Answer16) The PE ratio approach to valuing stock is especially useful for valuing A) publicly held corporations. B) firms that regularly pay dividends. C) both (A) and (B). D) neither (A) nor (B). Register to View Answer 133 17) A weakness of he PE approach to valuing stock is that A) it is difficult to estimate the constant growth rate of a firms dividends. B) it is difficult to estimate the required return on equity. C) it is difficult to predict how much a firm will pay in dividends. D) it is based on industry averages rather than firm-specific factors. Register to View Answer18) A firms current dividend is $1.00 per year and is expected to grow at a constant rate of 4 percent over time. Some investors have required returns on investments in equity of 12 percent, some 10 percent, and some 8 percent. The market price of this firms stock will be slightly above A) $25 B) $12.50 C) $16.67 D) $18 Register to View Answer19) The market price of a security represents the highest value any investor puts on the security. (II) Superior information about a security increases its value by reducing its risk. A) (I) is true, I(I) is false. B) (I) is false, I(I) is true. C) Both are true. D) Both are false. Register to View Answer20) The main cause of fluctuations in stock prices is changes in A) tax laws. B) errors in technical stock analysis. C) daily trading volume in stock markets. D) information available to investors. E) total household wealth in the economy. Register to View Answer21) Stock values computed by valuation models may differ from actual market prices because A) it is difficult to estimate future dividend growth rates. B) it is difficult to estimate the risk of a stock. C) it is difficult to forecast a stocks future dividends. D) all of the above are true. Register to View Answer 134 22) According to the efficient market 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. Register to View Answer23) The efficient market hypothesis A) is based on the assumption that prices of securities fully reflect all available information. B) holds that the expected return on a security equals the equilibrium return. C) both (A) and (B). D) neither (A) nor (B). Register to View Answer24) If the optimal forecast of the return on a security exceeds the equilibrium return, then A) the market is inefficient. B) an unexploited profit opportunity exists. C) the market is in equilibrium. D) only (A) and (B) of the above are true. E) only (B) and (C) of the above are true. Register to View Answer25) According to the efficient market hypothesis A) one cannot expect to earn an abnormally high return by purchasing a security. B) information in newspapers and in the published reports of financial analysts is already reflected in market prices. C) unexploited profit opportunities abound, thereby explaining why so many people get rich by trading securities. D) all of the above are true. E) only (A) and (B) of the above are true. Register to View Answer26) Another way to state the efficient market condition is that in an efficient market, A) unexploited profit opportunities will be quickly eliminated. B) unexploited profit opportunities will never exist. C) arbitrageurs guarantee that unexploited profit opportunities never exist. D) both (A) and (C) of the above occur. Register to View Answer 135 27) Another way to state the efficient market hypothesis is that in an efficient market, A) unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure that they are instantaneously dissipated. B) unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them. C) every financial market participant must be well informed about securities. D) only (A) and (C) of the above. Register to View Answer28) A situation in which the price of an asset differs from its fundamental market value is called A) an unexploited profit opportunity. B) a bubble. C) a correction. D) a mean reversion. Register to View Answer29) A situation in which the price of an asset differs from its fundamental market value A) indicates that unexploited profit opportunities exist. B) indicates that unexploited profit opportunities do not exist. C) need not indicate that unexploited profit opportunities exist. D) indicates that the efficient market hypothesis is fundamentally flawed. Register to View Answer30) Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period A) usually beat the market in the next time period. B) usually beat the market in the next two subsequent time periods. C) usually beat the market in the next three subsequent time periods. D) usually do not beat the market in the next time period. Register to View Answer31) The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analyst A) will certainly mean higher returns than if you had made selections by throwing darts at the financial page. B) will always mean lower returns than if you had made selections by throwing darts at the financial page. C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page. D) is good for the economy. Register to View Answer 136 32) Ivan Boesky, the most successful of the so-called arbs in the 1980s, was able to outperform the market on a consistent basis, indicating that A) securities markets are not efficient. B) unexploited profit opportunities were abundant. C) investors can outperform the market with inside information. D) only (B) and (C) of the above. Register to View Answer33) To say that stock prices follow a "random walk" is to argue that A) stock prices rise, then fall. B) stock prices rise, then fall in a predictable fashion. C) stock prices tend to follow trends. D) stock prices are, for all practical purposes, unpredictable. Register to View Answer34) To say that stock prices follow a "random walk" is to argue that A) stock prices rise, then fall, then rise again. B) stock prices rise, then fall in a predictable fashion. C) stock prices tend to follow trends. D) stock prices cannot be predicted based on past trends. Register to View Answer35) Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets theory, 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. Register to View Answer36) Tests used to rate the performance of rules developed in technical analysis conclude that A) technical analysis outperforms the overall market. B) technical analysis far outperforms the overall market, suggesting that stockbrokers provide valuable services. C) technical analysis does not outperform the overall market. D) technical analysis does not outperform the overall market, suggesting that stockbrokers do not provide services of any value. Register to View Answer37) Which of the following types of information will most likely enable the exploitation of a profit opportunity? A) Financial analysts' published recommendations B) Technical analysis C) Hot tips from a stockbroker D) Insider information Register to View Answer137 38) Which of the following types of information will most likely enable the exploitation of a profit opportunity? A) Financial analysts' published recommendations B) Technical analysis C) Hot tips from a stockbroker D) None of the above Register to View Answer39) 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) only (B) and (C) of the above are true. Register to View Answer40) The efficient market hypothesis suggests that A) investors should not try to outguess the market by constantly buying and selling securities. B) investors do better on average if they adopt a "buy and hold" strategy. C) buying into a mutual fund is a sensible strategy for a small investor. D) all of the above are sensible strategies. E) only (A) and (B) of the above are sensible strategies. Register to View Answer41) 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 market hypothesis. B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated. C) consistent with the efficient market hypothesis if the earnings were not as low as anticipated. D) the result of none of the above. Register to View Answer42) Important implications of the efficient market hypothesis include which of the following? A) Future changes in stock prices should, for all practical purposes, be unpredictable. B) Stock prices will respond to announcements only when the information in these announcements is new. C) Sometimes a stock price declines when good news is announced. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 138 43) Although the verdict is not yet in, the available evidence indicates that, for many purposes, the efficient market hypothesis is A) a good starting point for analyzing expectations. B) not a good starting point for analyzing expectations. C) too general to be a useful tool for analyzing expectations. D) none of the above. Register to View Answer44) The efficient market hypothesis suggests that A) investors should purchase no-load mutual funds which have low management fees. B) investors can use the advice of technical analysts to outperform the market. C) investors let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy. D) only (A) and (B) of the above are sensible strategies. Register to View Answer 10.2 True/False 1) Evidence that stock prices sometimes fall when a firm announces good news contradicts the efficient market hypothesis. Register to View Answer2) If the security markets are truly efficient, there is no need to pay for help selecting securities. Register to View Answer3) Evidence that a mutual fund has performed extraordinarily well in the past contradicts the efficient market hypothesis. Register to View Answer4) In an efficient market, every stock is a good choice. Register to View Answer5) Technical analysts look at historical prices for information to project future prices. Register to View Answer6) The evidence suggests technical analysts are not superior stock pickers. Register to View Answer7) If the markets are efficient, the optimal investment strategy will be to buy and hold so as to minimize transaction costs. Register to View Answer 139 8) In an efficient market, abnormal returns are not possible even using inside information. Register to View Answer9) It is probably a good use of an investor's time to watch as many shows featuring technical analysts as possible. Register to View Answer 10.3 Essay 1) How is it possible that a firm can announce a record breaking loss, yet its stock price rise when the announcement is made? 2) What is the optimal investment strategy according to the efficient market hypothesis? Why? 3) Explain what the market reaction will be in an efficient market if a firm announces a fully anticipated filing for bankruptcy. 4) Explain how the market's reaction to a mispriced security will lead to the correct pricing of all securities. 5) What is the role of the required return on investments in equity in stock valuation models? 140 Chapter 11 The Mortgage Markets 11.1 Multiple Choice 1) Which of the following are important ways in which mortgage markets differ from the stock and bond markets? A) The usual borrowers in the capital markets are government entities and businesses, whereas the usual borrowers in the mortgage markets are individuals. B) Most mortgages are secured by real estate, whereas the majority of capital market borrowing is unsecured. C) Because mortgages are made for different amounts and different maturities, developing a secondary market has been more difficult. D) All of the above are important differences. E) Only (A) and (B) of the above are important differences. Register to View Answer2) Which of the following are important ways in which mortgage markets differ from stock and bond markets? A) The usual borrowers in capital markets are government entities, whereas the usual borrowers in mortgage markets are small businesses. B) The usual borrowers in capital markets are government entities and large businesses, whereas the usual borrowers in mortgage markets are small businesses. C) The usual borrowers in capital markets are government entities and large businesses, whereas the usual borrowers in mortgage markets are small businesses and individuals. D) The usual borrowers in capital markets are businesses and government entities, whereas the usual borrowers in mortgage markets are individuals. Register to View Answer3) Which of the following are true of mortgages? A) A mortgage is a long-term loan secured by real estate. B) A borrower pays off a mortgage in a combination of principal and interest payments that result in full payment of the debt by maturity. C) Over 80 percent of mortgage loans finance residential home purchases. D) All of the above are true of mortgages. E) Only (A) and (B) of the above are true of mortgages. Register to View Answer 141 4) Which of the following are true of mortgages? A) A mortgage is a long-term loan secured by real estate. B) Borrowers pay off mortgages over time in some combination of principal and interest payments that result in full payment of the debt by maturity. C) Less than 65 percent of mortgage loans finance residential home purchases. D) All of the above are true of mortgages. E) Only (A) and (B) of the above are true of mortgages. Register to View Answer5) Which of the following are true of mortgages? A) Prior to the 1920s, U.S. banking legislation discouraged mortgage lending by banks. B) In the 1920s, most mortgages were balloon loans, which required the borrower to pay the entire loan amount after three to five years. C) Because mortgages are long-term loans secured by real estate, mortgage lenders tended to fail when land prices declined, as was often the case during economic recessions. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer6) Which of the following is true of mortgage interest rates? A) Interest rates on mortgage loans are determined by three factors: current longterm markets rates, the term of the mortgage, and the number of discount points paid. B) Mortgage interest rates tend to track along with Treasury bond rates. C) The interest rate on 15-year mortgages is lower than the rate on 30-year mortgages, all else the same. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer7) Which of the following are true of mortgages? A) More than 80 percent of mortgage loans finance residential home purchases. B) The National Banking Act of 1863 rewarded banks that increased mortgage lending. C) Most mortgages during the 1920s and 1930s were balloon loans. D) All of the above are true. E) Only (A) and (C) of the above are true. Register to View Answer 142 8) Which of the following is true of mortgage interest rates? A) Longer-term mortgages have lower interest rates than shorter-term mortgages. B) Mortgage rates are lower than Treasury bond rates, because of the taxdeductibility of mortgage interest rates. C) In exchange for points, lenders reduce interest rates on mortgage loans. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer9) Which of the following is true of mortgage interest rates? A) Longer-term mortgages have higher interest rates than shorter-term mortgages. B) In exchange for points, lenders reduce interest rates on mortgage loans. C) Mortgage rates are lower than Treasury bond rates because of the tax deductibility of mortgage interest payments. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer10) Which of the following reduces moral hazard for the mortgage borrower? A) Collateral B) Down payments C) Private mortgage insurance D) Borrower qualifications Register to View Answer11) Which of the following protects the mortgage lenders right to sell property if the underlying loan defaults? A) A lien B) A down payment C) Private mortgage insurance D) Borrower qualification E) Amortization Register to View Answer12) Which of the following is true of mortgage interest rates? A) Mortgage rates are closely tied to Treasury bond rates, but mortgage rates tend to stay below Treasury rates because mortgages are secured with collateral. B) Longer-term mortgages have higher interest rates than shorter-term mortgages. C) Interest rates are higher on mortgage loans on which lenders charge points. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 143 13) During the early years of an amortizing mortgage loan, the lender applies A) most of the monthly payment to the outstanding principal balance. B) all of the monthly payment to the outstanding principal balance. C) most of the monthly payment to interest on the loan. D) all of the monthly payment to interest on the loan. E) the monthly payment equally to interest on the loan and the outstanding principal balance. Register to View Answer14) During the last years of an amortizing mortgage loan, the lender applies A) most of the monthly payment to the outstanding principal balance. B) all of the monthly payment to the outstanding principal balance. C) most of the monthly payment to interest on the loan. D) all of the monthly payment to interest on the loan E) the monthly payment equally to interest on the loan and the outstanding principal balance. Register to View Answer15) During the last years of a balloon mortgage loan, the lender applies A) most of the monthly payment to the outstanding principal balance. B) all of the monthly payment to the outstanding principal balance. C) most of the monthly payment to interest on the loan. D) all of the monthly payment to interest on the loan. E) the monthly payment equally to interest on the loan and the outstanding principal balance. Register to View Answer16) During the early years of a balloon mortgage loan, the lender applies A) most of the monthly payment to the outstanding principal balance. B) all of the monthly payment to the outstanding principal balance. C) most of the monthly payment to interest on the loan. D) all of the monthly payment to interest on the loan. E) the monthly payment equally to interest on the loan and the outstanding principal balance. Register to View Answer17) A borrower who qualifies for an FHA or VA loan enjoys the advantage that A) the mortgage payment is much lower. B) only a very low or zero down payment is required. C) the cost of private mortgage insurance is lower. D) the government holds the lien on the property. Register to View Answer 144 18) (I) Conventional mortgages are originated by private lending institutions, and FHA or VA loans are originated by the government. (II) Conventional mortgages are insured by private companies, and FHA or VA loans are insured by the government. A) (I) is true, I(I) is false. B) (I) is false, I(I) is true. C) Both are true. D) Both are false. Register to View Answer19) Borrowers tend to prefer ______ to ______, whereas lenders prefer ______ A) fixed-rate loans; ARMs; fixed-rate loans. B) ARMs; fixed-rate loans; fixed-rate loans. C) fixed-rate loans; ARMs; ARMs. D) ARMs; fixed-rate loans; ARMs. Register to View Answer20) (I) ARMs offer lower initial rates and the rate may fall during the life of the loan. (II) Conventional mortgages do not allow a borrower to take advantage of falling interest rates. A) (I) is true, I(I) is false. B) (I) is false, I(I) is true. C) Both are true. D) Both are false. Register to View Answer21) Growing-equity mortgages (GEMs) A) help the borrower pay off the loan in a shorter time. B) have such low payments in the first few years that the principal balance increases. C) offer borrowers payments that are initially lower than the payments on a conventional mortgage. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer22) A borrower with a 30-year loan can create a GEM by A) simply increasing the monthly payments beyond what is required and designating that the excess be applied entirely to the principal. B) converting his ARM into a conventional mortgage. C) converting his conventional mortgage into an ARM. D) converting his conventional mortgage into a GPM. Register to View Answer 145 23) Which of the following are useful for home buyers who expect their income to rise in the future? A) GPMs B) RAMs C) GEMs D) (A) and (B) E) (A) and (C) Register to View Answer24) Which of the following are useful for home buyers who expect their income to fall in the future? A) GPMs B) RAMs C) GEMs D) (A) and (B) E) (A) and (C) Register to View Answer25) Retired people can live on the equity they have in their homes by using a A) GEM. B) GPM. C) SAM. D) RAM. Register to View Answer26) Second mortgages serve the following purposes A) they give borrowers a way to use the equity they have in their homes as security for another loan. B) they allow borrowers to get a tax deduction on loans secured by their primary residence or vacation home. C) they allow borrowers to convert their conventional mortgages into GEMs. D) all of the above. E) only (A) and (B) of the above. Register to View Answer27) Which of the following is a disadvantage of a second mortgage compared to credit card debt? A) The loans are secured by the borrowers home. B) The borrower gives up the tax deduction on the primary mortgage. C) The borrower must pay points to get a second mortgage loan. D) The borrower will find it more difficult to qualify for a second mortgage loan. Register to View Answer 146 28) The share of the mortgage market held by savings and loans is approximately A) 50 percent. B) 40 percent. C) 20 percent. D) 10 percent. Register to View Answer29) The share of the mortgage market held by commercial banks is approximately A) 50 percent. B) 25 percent. C) 15 percent. D) 5 percent. Register to View Answer30) A loan-servicing agent will A) package the loan for an investor. B) hold the loan in their investment portfolio. C) collect payments from the borrower. D) (A) and (C). E) (B) and (C). Register to View Answer31) Distinct elements of a mortgage loan include A) origination. B) investment. C) servicing. D) all of the above. E) only (B) and (C). Register to View Answer32) The Federal National Mortgage Association (Fannie Mae) A) was set up to buy mortgages from thrifts so that these institutions could make more loans. B) funds purchases of mortgages by selling bonds to the public. C) provides insurance for certain mortgage contracts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer33) The Federal Housing Administration (FHA) A) was set up to buy mortgages from thrifts so that these institutions could make more loans. B) funds purchases of mortgages by selling bonds to the public. C) provides insurance for certain mortgage contracts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer147 34) _______ issues participation certificates, and ________ provides federal insurance for participation certificates. A) Freddie Mac; Freddie Mac B) Freddie Mac; Ginnie Mae C) Ginnie Mae; Freddie Mac D) Ginnie Mae; Ginnie Mae E) Freddie Mac; no one Register to View Answer35) REMICs are most like A) Freddie Mae pass-through securities. B) Ginnie Mae pass-through securities. C) participation certificates. D) collateralized mortgage obligations. Register to View Answer36) Ginnie Mae A) insures qualifying mortgages. B) insures pass-through certificates. C) insures collateralized mortgage obligations. D) (A) and (B). E) (B) and (C). Register to View Answer37) Mortgage-backed securities A) have been growing in popularity in recent years as institutional investors look for attractive investment opportunities. B) are securities collateralized by a pool of mortgages. C) are securities collateralized by both insured and uninsured mortgages. D) all of the above. E) only (A) and (B) of the above. Register to View Answer38) The most common type of mortgage-backed security is A) the mortgage pass-through, a security that has the borrowers mortgage payments pass through the trustee before being disbursed to the investors. B) collateralized mortgage obligations, a security which reduces prepayment risk. C) the participation certificate, a security which passes the borrowers mortgage payments equally among all the owners of the certificates. D) the securitized mortgage, a security which increases the liquidity of otherwise illiquid mortgages. Register to View Answer 148 11.2 True/False 1) Down payments are designed to reduce the likelihood of default on mortgage loans. Register to View Answer2) Discount points (or simply points) are interest payments made at the beginning of a loan. Register to View Answer3) Private mortgage insurance is a policy that guarantees to make up any discrepancy between the value of the property and the loan amount, should a default occur. Register to View Answer4) During the early years of the loan, the lender applies most of the payment to the principal on the loan. Register to View Answer5) One important advantage to a borrower who qualifies for an FHA or VA loan is the very low interest rate on the mortgage. Register to View Answer6) Adjustable-rate mortgages generally have lower initial interest rates than do fixedrate mortgages. Register to View Answer7) Mortgage interest rates loosely track interest rates on three-month Treasury bills. Register to View Answer8) An advantage of a graduated-payment mortgage is that borrowers will qualify for a larger loan than if they requested a conventional mortgage. Register to View Answer9) Nearly half the funds for mortgage lending come from mortgage pools and trusts. Register to View Answer10) Many institutions that make mortgage loans do not want to hold large portfolios of long-term securities, because it would subject them to unacceptably high interestrate risk. Register to View Answer11) A problem that initially hindered the marketability of mortgages in a secondary market was that they were not standardized. Register to View Answer 149 12) Mortgage-backed securities have declined in popularity in recent years as institutional investors have sought higher returns in other markets. Register to View Answer13) Mortgage-backed securities are marketable securities collateralized by a pool of mortgages. Register to View Answer 11.3 Essay 1) How has the modern mortgage market changed over recent years? 2) Explain the features of mortgage loans that are designed to reduce the likelihood of default. 3) What are points? What is their purpose? 4) How does an amortizing mortgage loan differ from a balloon mortgage loan? 5) Evaluate the advantages and disadvantages, from both the lenders and the borrowers perspectives, of fixed-rate and adjustable-rate mortgages. 150 Chapter 12 The Foreign Exchange Market 12.1 Multiple Choice 1) When the value of the British pound changes from $1.50 to $1.25, then A) the pound has appreciated and the dollar has appreciated. B) the pound has depreciated and the dollar has appreciated. C) the pound has appreciated and the dollar has depreciated. D) the pound has depreciated and the dollar has depreciated. Register to View Answer2) When the value of the dollar changes from 0.5 to 0.75, then A) the pound has appreciated and the dollar has appreciated. B) the pound has depreciated and the dollar has appreciated. C) the pound has appreciated and the dollar has depreciated. D) the pound has depreciated and the dollar has depreciated. Register to View Answer3) When the exchange rate changes from 0.9 euros to the dollar to 1.0 euros to the dollar, then A) the euro has appreciated and the dollar has appreciated. B) the euro has depreciated and the dollar has appreciated. C) the euro has appreciated and the dollar has depreciated. D) the euro has depreciated and the dollar has depreciated. Register to View Answer4) When the exchange rate changes from 1.0 euros to the dollar to 0.9 euros to the dollar, then A) the euro has appreciated and the dollar has appreciated. B) the euro has depreciated and the dollar has appreciated. C) the euro has appreciated and the dollar has depreciated. D) the euro has depreciated and the dollar has depreciated. Register to View Answer5) If the dollar _____ from 0.8 euros per dollar to 1.2 euros per dollar, the euro _____ from 1.25 dollars to 0.83 dollars per euro. A) appreciates; appreciates B) appreciates; depreciates C) depreciates; depreciates D) depreciates; appreciates Register to View Answer 151 6) If the dollar appreciates from 0.8 euros per dollar to 1.2 euros per dollar, the euro depreciates from _____ dollars to _____ dollars per euro. A) 1.25; 0.83 B) 0.83; 1.25 C) 0.83; 1.66 D) 1.25; 1.66 Register to View Answer7) If the dollar depreciates relative to the Swiss franc, A) Swiss chocolate will become more expensive in the United States. B) American computers will become less expensive in Switzerland. C) Swiss chocolate will become cheaper in the United States. D) both (A) and (B) of the above. Register to View Answer8) If the dollar appreciates relative to the Swiss franc, A) Swiss chocolate will become more expensive in the United States. B) American computers will become less expensive in Switzerland. C) Swiss chocolate will become cheaper in the United States. D) both (A) and (B) of the above. Register to View Answer9) When the exchange rate for the euro changes from $0.80 to $1.00 then, holding everything else constant, A) the euro has appreciated and German cars sold in the United States become more expensive. B) the euro has appreciated and German cars sold in the United States become less expensive. C) the euro has depreciated and American wheat sold in Germany becomes more expensive. D) the euro has depreciated and American wheat sold in Germany becomes less expensive. Register to View Answer10) When the exchange rate for the euro changes from $1.00 to $0.80, then, holding everything else constant, A) the euro has appreciated and German cars sold in the United States become more expensive. B) the euro has appreciated and German cars sold in the United States become less expensive. C) the euro has depreciated and American wheat sold in Germany becomes more expensive. D) the euro has depreciated and American wheat sold in Germany becomes less expensive. Register to View Answer 152 11) The starting point for understanding how exchange rates are determined is a simple idea called _____, which states that 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) Greshams law B) the law of one price C) purchasing power parity D) arbitrage Register to View Answer12) The theory of purchasing power parity is a theory of how exchange rate are determined in A) the long run. B) the short run. C) both (A) and (B). D) none of the above. Register to View Answer13) 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 Register to View Answer14) 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. Register to View Answer15) In the long run, a rise in a countrys price level (relative to the foreign price level) causes its currency to _____, while a fall in the countrys relative price level causes its currency to _____ A) appreciate; appreciate. B) appreciate; depreciate. C) depreciate; appreciate. D) depreciate; depreciate. Register to View Answer 153 16) If the 2003 inflation rate in Britain is 6 percent, and the inflation rate in the U.S. is 4 percent, then the theory of purchasing power parity predicts that, during 2003, the value of the British pound in terms of U.S. dollars will A) rise by 10 percent. B) rise by 2 percent. C) fall by 10 percent. D) fall by 2 percent. E) do none of the above. Register to View Answer17) The theory of purchasing power parity cannot fully explain exchange rate movements because A) not all goods are identical in different countries. B) monetary policy differs across countries. C) some goods are not traded between countries. D) of both (A) and (C) of the above. E) of both (B) and (C) of the above. Register to View Answer18) 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. Register to View Answer19) Increased demand for a countrys _____ 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 Register to View Answer20) If the demand for _____ goods decreases relative to _____ goods, the domestic currency will depreciate. A) foreign; domestic B) foreign; foreign C) domestic; domestic D) domestic; foreign Register to View Answer 154 21) Higher tariffs and quotas cause a countrys currency to _____ in the _____ run. A) depreciate; short B) appreciate; short C) depreciate; long D) appreciate; long Register to View Answer22) Lower tariffs and quotas cause a countrys currency to _____ in the _____ run. A) depreciate; short B) appreciate; short C) depreciate; long D) appreciate; long Register to View Answer23) If the inflation rate in the United States is higher than that of Germany and productivity is growing at a slower rate in the United States than it is in Germany, in the long run, A) the euro should appreciate relative to the dollar. B) the euro should depreciate relative to the dollar. C) there should be no change in the euro price of dollars. D) it is not clear what will happen to the euro price of dollars. Register to View Answer24) If the French demand for American exports rises at the same time that U.S. productivity rises relative to French productivity, then, in the long run, A) the euro should appreciate relative to the dollar. B) the dollar should depreciate relative to the euro. C) the dollar should appreciate relative to the euro. D) it is not clear whether the euro should appreciate or depreciate relative to the dollar. Register to View Answer25) The theory of asset demand suggests that the most important factor affecting the demand for domestic and foreign deposits 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. Register to View Answer26) When Franois the Foreigner considers the expected return of dollar deposits in terms of foreign currency, the expected return must be adjusted for A) any expected appreciation or depreciation of the dollar. B) any expected appreciation or depreciation of the foreign currency. C) both (A) and (B) of the above. D) neither (A) nor (B) of the above. Register to View Answer155 27) The expected return on the dollar deposit 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 Register to View Answer28) If the interest rate on foreign deposits (iF) increases, holding everything else constant, A) the expected return on these deposits must also increase. B) the expected return on domestic deposits must decrease. C) the expected return on domestic deposits must increase. D) both (A) and (B) of the above. E) both (A) and (C) of the above. Register to View Answer29) If the interest rate on dollar deposits is 10 percent, and the dollar is expected to appreciate by 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. E) 24 percent. Register to View Answer30) If the interest rate is 7 percent on euro deposits and 5 percent on dollar deposits, and if the dollar is expected to appreciate at a 4 percent rate, A) euro deposits have a higher expected return than dollar deposits. B) the expected return on euro deposits in dollars is 11 percent. C) the expected return on dollar deposits in euros is 1 percent. D) the expected return on euro deposits in dollars is 3 percent. E) the expected return on dollar deposits in euros is 3 percent. Register to View Answer31) If the interest rate is 13 percent on euro deposits and 15 percent on dollar deposits, and if the euro is expected to appreciate at a 4 percent rate relative to the dollar, then A) euro deposits have a lower expected return than dollar deposits. B) the expected return on euro deposits in dollars is 9 percent. C) the expected return on dollar deposits in euros is 19 percent. D) both (A) and (B) of the above will occur. E) none of the above will occur. Register to View Answer 156 32) The expected return on dollar deposits in terms of dollars, RD, is A) always the interest rate on dollar deposits, iD, for any exchange rate. B) the interest rate on dollar deposits, iD, only when Et > Eet+1. C) the interest rate on dollar deposits, iD, only when Et < Eet+1. D) the interest rate on dollar deposits, iD, only when Et = Eet+1. Register to View Answer33) The condition which 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. Register to View Answer34) 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. Register to View Answer35) According to the interest parity condition, the domestic interest rate is equal to A) the foreign interest rate plus the expected appreciation of the domestic currency. B) the foreign interest rate less the expected appreciation of the domestic currency. C) the foreign interest rate less the expected depreciation of the domestic currency. D) the foreign interest rate less the expected depreciation of the domestic currency weighted by the domestic interest rate. Register to View Answer36) According to the interest parity condition, if the domestic interest rate is A) above the foreign interest rate, then there is expected appreciation of the foreign currency. B) above the foreign interest rate, then there is expected depreciation of the foreign currency. C) below the foreign interest rate, then there is expected appreciation of the foreign currency. D) below the foreign interest rate, then the interest parity condition is violated. Register to View Answer 157 37) According to the interest parity condition, if the domestic interest rate is 12 percent and the foreign interest rate is 10 percent, then A) the expected appreciation of the foreign currency must be 4 percent. B) the expected appreciation of the foreign currency must be 2 percent. C) the expected depreciation of the foreign currency must be 2 percent. D) the expected depreciation of the foreign currency must be 4 percent. Register to View Answer38) According to the interest parity condition, if the domestic interest rate is 10 percent and the foreign interest rate is 12 percent, then A) the expected appreciation of the foreign currency must be 4 percent. B) the expected appreciation of the foreign currency must be 2 percent. C) the expected depreciation of the foreign currency must be 2 percent. D) the expected depreciation of the foreign currency must be 4 percent. Register to View Answer39) When Americans or foreigners expect the return on _____ deposits to be high relative to the return on _____ deposits, there is a higher demand for dollar deposits and a correspondingly lower demand for foreign deposits. A) dollar; dollar B) dollar; foreign C) foreign; dollar D) foreign; foreign Register to View Answer40) When Americans or foreigners expect the return on dollar deposits to be high relative to the return on foreign deposits, there is a _____ demand for dollar deposits and a correspondingly _____ demand for foreign deposits. A) higher; higher B) higher; lower C) lower; higher D) lower; lower Register to View Answer41) As the relative expected return on dollar deposits increases, foreigners will want to hold more _____ deposits and less _____ deposits. A) foreign; foreign B) foreign; dollar C) dollar; foreign D) dollar; dollar Register to View Answer 158 42) As the relative expected return on dollar deposits increases, A) foreigners will want to hold fewer dollar deposits and more foreign deposits. B) Americans will want to hold more dollar deposits and less foreign deposits. C) Americans will want to hold fewer dollar deposits and more foreign deposits. D) Americans and foreigners will be indifferent towards holding dollar deposits or foreign deposits. Register to View Answer43) An increase in the foreign interest rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to depreciate. A) domestic; right B) domestic; left C) foreign; right D) foreign; left Register to View Answer44) A decrease in the foreign interest rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to appreciate. A) domestic; right B) domestic; left C) foreign; right D) foreign; left Register to View Answer45) A rise in the expected future exchange rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to appreciate. A) domestic; right B) domestic; left C) foreign; right D) foreign; left Register to View Answer46) A fall in the expected future exchange rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to depreciate. A) domestic; right B) domestic; left C) foreign; right D) foreign; left Register to View Answer47) An increase in the domestic interest rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to appreciate. A) domestic; right B) domestic; left C) foreign; right D) foreign; left Register to View Answer159 48) A decrease in the domestic interest rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to depreciate. A) domestic; right B) domestic; left C) foreign; right D) foreign; left Register to View Answer49) Which of the following causes a depreciation of the domestic currency? A) A lower domestic interest rate due to a lower expected inflation rate. A B) decline in the domestic real interest rate. C) A decrease in the domestic money supply. D) All of the above. Register to View Answer50) Which of the following causes an appreciation of the domestic currency? A) A lower domestic interest rate due to a lower expected inflation rate. B) A decline in the domestic real interest rate. C) An increase in the domestic money supply. D) All of the above. Register to View Answer51) When the domestic nominal interest rate rises because of an increase in expected inflation, the expected appreciation of the dollar declines, _____ shifts out more than _____, and the exchange rate declines. A) R ; R F F B) R ; R D D C) R ; R D F D) R ; R Register to View Answer52) When an increase in the money supply causes the exchange rate to fall by more in the short run than it does in the long run, it is called A) exchange rate disequilibrium. B) exchange rate overshooting. C) the J-curve effect. D) none of the above. Register to View AnswerF D 160 53) In the long run, a one-time percentage increase in the money supply is matched by the same one-time percentage rise in the price level, A) leaving unchanged the real money supply and all other economic variables such as interest rates. This proposition is called money neutrality. B) leaving unchanged the real money supply and the nominal exchange rate. This proposition is called money neutrality. C) leaving unchanged the real money supply and all other economic variables such as interest rates. This proposition is called money illusion. D) leaving unchanged the real money supply and the nominal exchange rate. This proposition is called money illusion. Register to View Answer54) Money neutrality means that in the long run the domestic interest rate and R remain unchanged, implying that the fall in the exchange rate is greater in the _____ run than in the _____ run, a phenomenon called exchange rate overshooting. A) short; short B) short; long C) long; short D) long; long Register to View Answer55) A lower domestic money supply causes the domestic currency to A) depreciate in the short run. B) depreciate in the long run. C) appreciate in the short run. D) do both (A) and (B) of the above. E) do both (B) and (C) of the above. Register to View Answer56) A higher domestic money supply causes the domestic currency to A) depreciate more in the short run than in the long run. B) depreciate more in the long run than in the short run. C) appreciate more in the short run than in the long run. D) appreciate more in the long run than in the short run. Register to View Answer57) The weakness of the dollar in the late 1970s and the strength of the dollar in the early 1980s can be explained by movements in A) real interest rates, but not nominal interest rates. B) nominal interest rates, but not real interest rates. C) relative price levels, but not real interest rates. D) none of the above. Register to View AnswerD 161 58) Evidence from the United States during the period 1973-2001 indicates the correspondence between nominal interest rates and exchange rate movements is A) much closer than that between real interest rates and exchange rate movements. B) not nearly as close as that between government spending and exchange rate movements. C) not nearly as close as that between government deficits and exchange rate movements. D) not nearly as close as that between real interest rates and exchange rate movements. Register to View Answer 12.2 True/False 1) The foreign exchange market is organized as an over-the-counter market in which deposits denominated in foreign currencies are bought and sold. Register to View Answer2) When the value of the dollar changes from 0.5 pounds to 0.75 pounds, then the pound has appreciated and the dollar has depreciated. Register to View Answer3) When the exchange rate for the euro changes from $0.90 to $0.85, then holding everything else constant, the euro has depreciated and American wheat sold in Germany becomes more expensive. Register to View Answer4) The theory of purchasing power parity cannot fully explain exchange rate movements because fiscal policy differs across countries. Register to View Answer5) If the dollar depreciates relative to the British pound, British sweaters will become more expensive in the United States. Register to View Answer6) If the dollar appreciates relative to the Swiss franc, Swiss chocolate will become cheaper in the United States. Register to View Answer7) If the exchange rate between the dollar and the Swiss franc changes from 1.8 to 1.5 francs per dollar, the franc depreciates and the dollar appreciates. Register to View Answer59) An increase in tariffs and quotas on imports causes a countrys currency to appreciate. Register to View Answer162 60) Increased demand for a countrys exports causes its currency to depreciate. Register to View Answer61) As the relative expected return on dollar deposits increases, Americans will want to hold fewer dollar deposits and more foreign deposits. Register to View Answer62) According to the interest rate parity condition, if the domestic interest rate is 12 percent and the foreign interest rate is 10 percent, then the expected appreciation of the foreign currency must be 2 percent. Register to View Answer63) A fall in the expected future exchange rate shifts the expected return schedule for domestic deposits to the right and causes the domestic currency to depreciate. Register to View Answer 12.3 Essay 1) Explain the logic underlying the law of one price and the theory of purchasing power parity. 2) Explain graphically how a change in the domestic price level will affect exchange rates, holding everything else constant. 3) Explain the theory of interest rate parity. 4) Explain graphically how a change in the foreign interest rate will affect exchange rates. 5) Discuss the relationship between changes in domestic real and nominal interest rates and exchange rates. 6) Explain graphically how an increase in a countrys money supply will affect the exchange rate for its currency. 163 164 Chapter 13 The International Financial System 13.1 Multiple Choice 1) A central bank sale of _____ to purchase ______ in the foreign exchange market results in an equal rise in its international reserves and the monetary base. A) foreign assets; domestic currency B) foreign assets; foreign currency C) domestic currency; foreign assets D) domestic currency; domestic currency Register to View Answer2) A central bank sale of _____ to purchase ______ in the foreign exchange market results in an equal decline in its international reserves and the monetary base. A) foreign assets; domestic currency B) foreign assets; foreign currency C) domestic currency; foreign assets D) domestic currency; domestic currency Register to View Answer3) A central bank _____ of domestic currency and corresponding _____ of foreign assets in the foreign exchange market leads to an equal _____ in its international reserves and the monetary base. A) sale; purchase; decline B) sale; sale; increase C) purchase; sale; increase D) purchase; sale; decline Register to View Answer4) A central bank _____ of domestic currency and corresponding _____ of foreign assets in the foreign exchange market leads to an equal _____ in its international reserves and the monetary base. A) sale; purchase; increase B) sale; sale; decline C) purchase; sale; increase D) purchase; purchase; decline Register to View Answer5) When the central bank allows the purchase or sale of domestic currency to have an effect on the monetary base, it is called A) an unsterilized foreign exchange intervention. B) a sterilized foreign exchange intervention. C) an exchange rate feedback rule. D) a money neutral foreign exchange intervention. Register to View Answer165 6) A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called A) an unsterilized foreign exchange intervention. B) a sterilized foreign exchange intervention. C) an exchange rate feedback rule. D) a money neutral foreign exchange intervention. Register to View Answer7) An unsterilized intervention in which domestic currency is sold to purchase foreign assets leads to A) a gain in international reserves. B) an increase in the money supply. C) an appreciation in the domestic currency. D) all of the above. E) only (A) and (B) of the above. Register to View Answer8) An unsterilized intervention in which domestic currency is sold to purchase foreign assets leads to A) a gain in international reserves. B) a decrease in the money supply. C) an appreciation in the domestic currency. D) all of the above. E) only (A) and (B) of the above. Register to View Answer9) If the Federal Reserve decides to sell dollars in order to buy foreign assets in the foreign exchange market, the effect is the same as A) an open market sale of bonds to decrease the monetary base and the money supply. B) an open market purchase of bonds to decrease the monetary base and the money supply. C) an open market sale of bonds to increase the monetary base and the money supply. D) an open market purchase of bonds to increase the monetary base and the money supply. Register to View Answer 166 10) If the Federal Reserve decides to purchase dollars by selling foreign assets in the foreign exchange market, the effect is the same as A) an open market sale of bonds to decrease the monetary base and the money supply. B) an open market purchase of bonds to decrease the monetary base and the money supply. C) an open market sale of bonds to increase the monetary base and the money supply. D) an open market purchase of bonds to increase the monetary base and the money supply. Register to View Answer11) An unsterilized intervention in which the domestic currency is sold to purchase foreign assets results in an expected _____ of the domestic currency that shifts the F R schedule to the _____ A) depreciation; right. B) appreciation; right. C) depreciation; left. D) appreciation; left. Register to View Answer12) An unsterilized intervention in which the domestic currency is purchased by selling foreign assets results in an expected _____ of the domestic currency that shifts the F R schedule to the _____ A) depreciation; right. B) appreciation; right. C) depreciation; left. D) appreciation; left. Register to View Answer13) An expected appreciation of the domestic currency that shifts the R schedule to the left is caused by A) a sterilized intervention in which the domestic currency is sold to purchase foreign assets. B) a sterilized intervention in which the domestic currency is purchased by selling foreign assets. C) an unsterilized intervention in which the domestic currency is sold to purchase foreign assets. D) an unsterilized intervention in which the domestic currency is purchased by selling foreign assets. Register to View AnswerF 167 14) Because sterilized interventions mean offsetting open market operations, there is no impact on the monetary base and the money supply, and therefore a sterilized intervention A) causes the exchange rate to overshoot in the short run. B) causes the exchange rate to undershoot in the short run. C) causes the exchange rate to depreciate in the short run, but has no effect on the exchange rate in the long run. D) has no effect on the exchange rate. Register to View Answer15) Because sterilized interventions mean offsetting open market operations, A) there is no impact on the monetary base. B) there is no impact on the money supply. C) there is no effect on the exchange rate. D) all of the above occur. E) only (A) and (B) of the above occur. Register to View Answer16) In the balance of payments bookkeeping system, payments from foreigners to Americans are entered in the A) Receipts column with a plus (+) sign to reflect that they are credits. B) Receipts column with a minus (-) sign to reflect that they are debits. C) Payments column with a minus (-) sign to reflect that they are debits. D) Payments column with a plus (+) sign to reflect that they are credits. Register to View Answer17) In the balance of payments bookkeeping system, all payments to foreigners are entered in the A) Receipts column with a plus (+) sign to reflect that they are credits. B) Receipts column with a minus (-) sign to reflect that they are debits. C) Payments column with a minus (-) sign to reflect that they are debits. D) Payments column with a plus (+) sign to reflect that they are credits. Register to View Answer18) Which of the following appear as credits in the U.S. balance of payments? A) Capital outflows B) Foreign aid C) Merchandise exports D) All of the above Register to View Answer19) Which of the following appear as debits in the U.S. balance of payments? A) Capital inflows B) Merchandise and service exports C) Foreign aid D) All of the above Register to View Answer168 20) In the balance of payments accounting system, the sale of Compaq computers abroad are entered in the _____ column with a _____ sign. A) receipts; negative B) receipts; positive C) payments; negative D) payments; positive Register to View Answer21) In the balance of payments accounting system, American purchases of BMW automobiles are entered in the _____ column with a _____ sign. A) receipts; negative B) receipts; positive C) payments; negative D) payments; positive Register to View Answer22) In the balance of payments accounting system, American gifts to foreigners are entered in the _____ column with a _____ sign. A) receipts; negative B) receipts; positive C) payments; negative D) payments; positive Register to View Answer23) In the balance of payments accounting system, foreign aid is entered in the _____ column with a _____ sign. A) receipts; negative B) receipts; positive C) payments; negative D) payments; positive Register to View Answer24) In the balance of payments accounting system, capital inflows are entered in the _____ column with a _____ sign. A) receipts; negative B) receipts; positive C) payments; negative D) payments; positive Register to View Answer25) In the balance of payments accounting system, capital outflows are entered in the _____ column with a _____ sign. A) receipts; negative B) receipts; positive C) payments; negative D) payments; positive Register to View Answer169 26) The difference between merchandise exports and imports is called the A) current account balance. B) capital account balance. C) official reserve transactions balance. D) trade balance. E) Register to View Answer27) An examination of the U.S. balance of payments indicates that the current account balance can A) show a surplus only if the trade balance shows a surplus. B) show a deficit only if the trade balance shows a deficit. C) show a deficit even if the trade balance shows a surplus. D) only (A) and (B) of the above. Register to View Answer28) A current account _____ indicates that the United States is _____ its claims on foreign wealth. A) surplus; increasing B) surplus; decreasing C) deficit; increasing D) balance; decreasing Register to View Answer29) A current account _____ indicates that the United States is _____ its claims on foreign wealth. A) deficit; decreasing B) deficit; increasing C) surplus; decreasing D) balance; increasing Register to View Answer30) Holding other factors constant, which of the following would increase the size of the U.S. current account deficit? A) An increase in the amount of services purchased from foreigners B) An increase in unilateral transfers from Americans to foreigners C) An increase in Americans net investment income D) Only (A) and (B) of the above Register to View Answer 170 31) Holding other factors constant, which of the following would increase the size of the U.S. current account surplus? A) Payments by the U.S. government to help emerging democracies in Eastern Europe B) Increasing travel by American college students to Japan C) Payments by foreign governments to the U.S. to help pay for the Persian Gulf war D) Both (A) and (B) of the above Register to View Answer32) Economists closely follow the current account balance because they believe it can provide information on the future movement of A) interest rates. B) gold flows. C) exchange rates. D) special drawing rights. Register to View Answer33) The capital account describes the flow of capital between the United States and other countries. Capital inflows are A) American purchases of foreign assets. B) foreign purchases of American assets. C) both (A) and (B) of the above. D) neither (A) nor (B) of the above. Register to View Answer34) Which of the following appears in the capital account part of the balance of payments? A) A gift to an American from his English aunt B) A purchase by the Honda corporation of a U.S. Treasury bill C) A purchase by the Bank of England of a U.S. Treasury bill D) Income earned by the Honda corporation on its automobile plant in Ohio Register to View Answer35) Given the size of the statistical discrepancy needed to balance the balance of payments account, one can infer that A) hidden capital flows into the U.S. are inconsequential. B) items in the balance of payments are measured quite accurately. C) many international transactions go unrecorded. D) all of the above. Register to View Answer 171 36) Many believe that the statistical discrepancy is primarily the result of A) large hidden capital flows into the U.S. B) large hidden capital flows out of the U.S. C) measurement errors due to exchange rate calculations. D) none of the above. Register to View Answer37) The current account balance plus the capital account balance equals A) the official reserve transactions balance. B) the trade balance. C) the change in government reserve assets. D) both (A) and (C) of the above. Register to View Answer38) If the current account balance shows a surplus, and capital account receipts exceed capital account payments, then the official reserve transactions balance A) must be positive, indicating an increase in U.S. international reserves or a decrease in foreign central banks international reserves. B) must be negative, indicating an increase in U.S. international reserves or a decrease in foreign central banks international reserves. C) must be negative, indicating a decrease in U.S. international reserves or a decrease in foreign central banks international reserves. D) must be negative, indicating a decrease in U.S. international reserves or an increase in foreign central banks international reserves. Register to View Answer39) A balance of payments _____ is associated with a _____ of international reserves. A) deficit; loss B) deficit; gain C) surplus; loss D) balance; gain Register to View Answer40) A balance of payments _____ is associated with a _____ of international reserves. A) surplus; loss B) surplus; gain C) deficit; gain D) balance; loss Register to View Answer41) The official reserve transactions balance A) equals the current account balance plus the items in the capital account. B) tells us the net amount of international reserves that must move between central banks in order to finance international transactions. C) has an important impact on the money supply. D) all of the above. Register to View Answer172 42) Because other countries hold dollars as international reserves, a U.S. official reserve transactions deficit can be financed by A) an increase in U.S. international reserves. B) an increase in foreign holdings of dollars. C) a decrease in foreign holdings of dollars. D) only (A) and (B) of the above. Register to View Answer43) When a reserve currency country runs a balance of payments deficit and a nonreserve currency country buys the reserve currency to finance the reserve countrys deficits, the monetary base in the nonreserve country ______ and the monetary base in the reserve country _____ A) increases; decreases. B) increases; does not change. C) decreases; does not change. D) decreases; increases. Register to View Answer44) Under the gold standard, if a countrys currency appreciated, the country would _____ international reserves (gold), causing its monetary base to _____ and putting downward pressure on its currency. A) gain; rise B) gain; fall C) lose; rise D) lose; fall Register to View Answer45) Under the gold standard, if a countrys currency depreciated, the country would _____ international reserves (gold), causing its monetary base to _____ and putting upward pressure on its currency. A) gain; rise B) gain; fall C) lose; rise D) lose; fall Register to View Answer46) Under a gold standard in which one dollar could be turned in to the U S. Treasury and exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th of an ounce of gold, an exchange rate of _____ marks to the dollar would stimulate a flow of gold from Germany to the United States. A) 6 B) 5 C) 4 D) 3 Register to View Answer 173 47) Under a gold standard in which one dollar could be turned in to the U.S. Treasury and exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th of an ounce of gold, an exchange rate of _____ marks to the dollar would stimulate a flow of gold from the United States to Germany. A) 7 B) 6 C) 5 D) 4 Register to View Answer48) Before World War I, the economy operated under a gold standard. Under this international financial system, if the British pound began to appreciate relative to the dollar, A) American importers would increasingly purchase British imports with gold. B) Britain would gain international reserves. C) the British monetary base would begin to fall. D) all of the above. E) only (A) and (B) of the above. Register to View Answer49) Before World War I, the economy operated under a gold standard. Under this international financial system, if the British pound began to depreciate relative to the dollar, A) gold would flow from the United States to Great Britain. B) the money supply in the United States would rise. C) the money supply in Great Britain would rise. D) all of the above would occur. Register to View Answer50) Under the gold standard, a country that abided by the rules of the game A) lost control over its monetary policy because its money supply was largely determined by gold flows between countries. B) would experience deflation when world gold production slowed. C) would experience inflation when world gold production increased. D) would experience all of the above. E) would experience only (A) and (B) of the above. Register to View Answer51) Under the gold standard, a country that abided by the rules of the game A) lost control over its monetary policy because its money supply was largely determined by gold flows between countries. B) would experience deflation when world gold production increased. C) would experience inflation when world gold production slowed. D) would experience only (A) and (B) of the above. Register to View Answer 174 52) The Bretton Woods system was one in which central banks A) bought and sold their own currencies to keep their exchange rates fixed. B) agreed not to intervene in the foreign exchange market to maintain a fixed exchange rate regime that had existed prior to World War I. C) agreed to limit domestic money growth to the average of the five largest industrial nations. D) agreed to limit domestic money growth to the average of the seven largest industrial nations. Register to View Answer53) The Bretton Woods agreement created the _____, which was given the task of promoting the growth of world trade by setting rules for the maintenance of fixed exchange rates and by making loans to countries that were experiencing balance of payments difficulties. A) IMF B) World Bank C) Central Settlements Bank D) Bank of International Settlements E) European Exchange Rate Mechanism (ERM) Register to View Answer54) The Bretton Woods agreement set up the _____, which currently provides long-term loans to assist developing countries to build dams, roads, and other physical capital that contributes to economic development. A) International Monetary Fund B) World Bank C) Central Settlements Bank D) Bank of International Settlements E) European Exchange Rate Mechanism (ERM) Register to View Answer55) Which of the following are true statements about the Bretton Woods system? A) The Bretton Woods system was a fixed exchange rate regime, in which central banks bought and sold their own currencies to keep their exchange rates fixed. B) To maintain fixed exchange rates when countries had balance of payments deficits and were losing international reserves, the IMF would loan deficit countries international reserves contributed by other members. C) The German mark was called a reserve currency because it was used to denominate the securities central banks held as international reserves. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 175 56) Which of the following are true statements about the Bretton Woods system? A) The Bretton Woods system was a flexible exchange rate regime, in which central banks allowed their currencies to float within a wide trading band. B) The U.S. dollar was called a reserve currency because it was used to denominate the securities central banks held as international reserves. C) The Bretton Woods agreement broke down in 1945. D) Only (A) and (B) of the above are true. Register to View Answer57) When the domestic currency is undervalued, A) the central bank must purchase the domestic currency to keep the exchange rate fixed, but as a result it gains international reserves. B) the central bank must sell the domestic currency to keep the exchange rate fixed, but as a result it gains international reserves. C) the central bank must purchase the domestic currency to keep the exchange rate fixed, but as a result it loses international reserves. D) the central bank must sell the domestic currency to keep the exchange rate fixed, but as a result it loses international reserves. Register to View Answer58) Under a fixed exchange rate regime, when the domestic currency is overvalued, A) the central bank must purchase the domestic currency to keep the exchange rate fixed, but as a result it loses international reserves. B) the central bank must sell the domestic currency to keep the exchange rate fixed, but as a result it loses international reserves. C) the central bank must purchase the domestic currency to keep the exchange rate fixed, but as a result it gains international reserves. D) the central bank must sell the domestic currency to keep the exchange rate fixed, but as a result it gains international reserves. Register to View Answer59) Under a fixed exchange rate regime, if the domestic currency is initially _____, that is _____ par, the central bank must intervene to sell the domestic currency by purchasing foreign assets. A) overvalued; below B) overvalued; above C) undervalued; below D) undervalued; above Register to View Answer60) If the domestic currency is initially undervalued, that is below par, the central bank must intervene to sell the _____ currency by purchasing _____ assets. A) domestic; foreign B) domestic; domestic C) foreign; foreign D) foreign; domestic Register to View Answer176 61) If a central bank does not want to see its currency fall in value, it may pursue _____ monetary policy to _____ the domestic interest rate, thereby strengthening its currency. A) expansionary; raise B) contractionary; raise C) expansionary; lower D) contractionary; lower Register to View Answer62) If a central bank does not want to see its currency rise in value, it may pursue _____ monetary policy to _____ the domestic interest rate, thereby weakening its currency. A) expansionary; raise B) contractionary; raise C) expansionary; lower D) contractionary; lower Register to View Answer63) If a countrys central bank eventually runs out of international reserves, A) it cannot keep its currency from appreciating and a revaluation must occur in which the par exchange rate is reset at a higher level. B) it cannot keep its currency from depreciating and a revaluation must occur in which the par exchange rate is reset at a higher level. C) it cannot keep its currency from depreciating and a devaluation must occur in which the par exchange rate is reset at a lower level. D) it cannot keep its currency from appreciating and a devaluation must occur in which the par exchange rate is reset at a lower level. Register to View Answer64) To maintain fixed exchange rates when countries had balance of payments deficits and were losing international reserves, A) the IMF would loan deficit countries international reserves contributed by other members. B) the IMF would loan surplus countries international reserves contributed by other members. C) the World Bank would loan deficit countries international reserves contributed by other members. D) the World Bank would loan surplus countries international reserves contributed by other members. Register to View Answer65) Under the Bretton Woods system, the IMF could encourage _____ countries to pursue _____ monetary policies that would strengthen their currencies or eliminate their balance of payment deficits. A) surplus; expansionary B) surplus; contractionary C) deficit; expansionary D) deficit; contractionary Register to View Answer177 66) Under the Bretton Woods system, a country running a balance of payments _____ lost international reserves and had to implement _____ monetary policy to strengthen its currency. A) surplus; expansionary B) surplus; contractionary C) deficit; expansionary D) deficit; contractionary Register to View Answer67) Under the Bretton Woods system, a country running a balance of payments surplus _____ international reserves and had to implement _____ monetary policy to weaken its currency. A) lost; expansionary B) lost; contractionary C) gained; expansionary D) gained; contractionary Register to View Answer68) Which of the following were weaknesses of the Bretton Woods system? A) The IMF had no way to force surplus countries to either revalue their exchange rates upwards or pursue more expansionary policies. B) The reserve-currency country, the United States, could not devalue its currency even if the dollar was overvalued. C) The IMF could not loan deficit countries international reserves. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer69) Which of the following were weaknesses of the Bretton Woods system? A) The IMF had no way to force surplus countries to either revalue their exchange rates upwards or pursue more expansionary policies. B) The reserve-currency country, the United States, could not devalue its currency even if the dollar was overvalued. C) Currencies that were either significantly over- or undervalued were prone to speculative attacks that led to large revaluations. D) All of the above. E) Only (A) and (C) of the above. Register to View Answer 178 70) The Bretton Woods system broke down in the early 1970s for all but one of the following reasons: A) deficit countries losing international reserves were not willing to devalue their currencies. B) surplus countries were not willing the revalue their currencies upwards. C) surplus countries were not willing to pursue more expansionary policies. D) the United States had been pursuing an inflationary monetary policy to reduce domestic unemployment. Register to View Answer71) Policy makers in a country with a balance of payments surplus may not want to see their countrys currency appreciate because A) this would hurt consumers in their country by making foreign goods more expensive. B) this would hurt domestic businesses by making foreign goods cheaper in their country. C) this would increase inflation in their country. D) this would decrease the wealth of the country. Register to View Answer72) Under the current managed float exchange rate regime, countries with balance of payments deficits frequently do not want to see their currencies depreciate because it makes _____ goods more expensive for _____ consumers and can stimulate inflation. A) foreign; foreign B) foreign; domestic C) domestic; foreign D) domestic; domestic Register to View Answer73) Which of the following is true? A) Special drawing rights are loans to countries made by the IMF. B) Changes in the quantity of special drawing rights are tied to changes in the quantity of gold. C) Special drawing rights are a paper substitute for gold. D) Special drawing rights are not held as international reserves. Register to View Answer74) Special Drawing Rights (SDRs) A) are a paper substitute for gold that have been issued by the IMF since 1970. B) function as international reserves. C) are backed by gold, and issue is limited to the gold stocks issued to the IMF by member countries. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 179 75) In the European Monetary System, A) intervention must be symmetric when a currency falls outside the limits, but may be asymmetric if a currency is inside the limits. B) intervention may be symmetric when a currency falls outside the limits, but must be asymmetric if a currency is inside the limits. C) intervention must be symmetric when a currency falls outside the limits, and no intervention is allowed if a currency is inside the limits. D) intervention must be asymmetric when a currency falls outside the limits, but no intervention is allowed if a currency is inside the limits. Register to View Answer76) In 1979, members of the European Monetary System agreed A) to fix their exchange rates against the dollar and float against each other. B) to fix their exchange rates against one another and against the dollar. C) to fix their exchange rates against one another and float against the dollar. D) to float their exchange rates against the dollar and float against each other. Register to View Answer77) Under the Exchange Rate Mechanism of the European Monetary System, when the Italian lira depreciates below its lower limit against the German mark, the Bank of Italy must buy _____ and sell _____, thereby _____ international reserves. A) lira; marks; losing B) lira; marks; gaining C) marks; lira; gaining D) marks; lira; losing Register to View Answer78) Under the Exchange Rate Mechanism of the European Monetary System, when the Italian lira depreciates below its lower limit against the German mark, the German central bank must buy _____ and sell _____, thereby _____ international reserves. A) lira; marks; losing B) lira; marks; gaining C) marks; lira; gaining D) marks; lira; losing Register to View Answer79) A weakness of fixed exchange rate systems such as those in the Bretton Woods system or the European Monetary System is that there is no way to force _____ countries to either revalue their exchange rates upwards or pursue _____ expansionary policies. A) surplus; less B) surplus; more C) deficit; less D) deficit; more Register to View Answer 180 80) Leading up to the foreign exchange crisis of September 1992, A) both the Bank of England and the Bundesbank wanted to pursue an expansionary monetary policy. B) the Bank of England wanted to pursue an expansionary monetary policy and the Bundesbank wanted to pursue a contractionary monetary policy. C) the Bank of England wanted to pursue a contractionary monetary policy and the Bundesbank wanted to pursue an expansionary monetary policy. D) both the Bank of England and the Bundesbank wanted to pursue a contractionary monetary policy. Register to View Answer81) When the Bundesbank lowered German mark interest rates in September 1992, A) there was a massive sell-off of German marks, requiring intervention to support the value of the mark. B) there was a massive sell-off of British pounds, requiring intervention to support the value of the pound. C) there was a gradual sell-off of German marks, which avoided the need for intervention to support the value of the mark. D) there was a gradual sell-off of British pounds, which avoided the need for intervention to support the value of the pound. Register to View Answer82) In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to the British pound, but it failed because A) participants in the foreign exchange market came to expect the appreciation of the mark. B) participants in the foreign exchange market came to expect the depreciation of the mark. C) participants in the foreign exchange market came to expect the revaluation of the dollar. D) participants in the foreign exchange market came to expect the end of the Exchange Rate Mechanism. Register to View Answer83) Under the Bretton Woods system, when a nonreserve-currency country was running a balance of payments deficit, A) it gained international reserves. B) it lost international reserves. C) it was necessary for the policymakers to implement a contractionary monetary policy. D) both (A) and (C) of the above. E) both (B) and (C) of the above. Register to View Answer 181 84) Under the Bretton Woods system, when a nonreserve-currency country was running a balance of payments deficit, A) it gained international reserves. B) it lost international reserves. C) it was necessary for the policymakers to implement an expansionary monetary policy. D) both (A) and (C) of the above. Register to View Answer85) To keep from running out of international reserves under the Bretton Woods system, a country had to implement _____ monetary policy to _____ its currency. A) expansionary; strengthen B) expansionary; weaken C) contractionary; strengthen D) contractionary; weaken Register to View Answer86) Because the United States was the reserve-currency country under the Bretton Woods system, it could run large balance of payments _____ without _____ significant amounts of international reserves. A) deficits; losing B) deficits; gaining C) surpluses; losing D) surpluses; gaining Register to View Answer87) In 1970 and early 1971, the United States ran large balance of payments _____, causing an ______ dollar and an _____ German mark. A) deficits; undervalued; overvalued B) deficits; overvalued; undervalued C) surpluses; undervalued; overvalued D) surpluses; overvalued; undervalued Register to View Answer88) The German central bank gained international reserves in the early 1970s because it sold A) marks to prevent mark appreciation. B) dollars to prevent mark appreciation. C) marks to prevent mark depreciation. D) dollars to prevent mark depreciation. Register to View Answer 182 89) In response to the overvalued dollar in early 1971, the German Bundesbank bought _____ and sold _____ to keep the exchange rate fixed, gaining international reserves. A) marks; dollars B) marks; pounds C) dollars; marks D) dollars; pounds Register to View Answer90) In response to the overvalued dollar in early 1971, the German Bundesbank bought dollars and sold marks to keep the exchange rate fixed, gaining international reserves. The huge purchase of international reserves meant that the German monetary base began to _____, leading to a _____ growth in the German money supply. A) decline; sluggish B) decline; rapid C) grow; sluggish D) grow; rapid Register to View Answer91) Since the abandonment of the Bretton Woods system, balance of payments considerations have become _____ important and exchange rate considerations _____ important in the conduct of monetary policy. A) more; less B) more; more C) less; less D) less; more Register to View Answer92) The euro is unlikely to seriously challenge the dollar as a reserve currency as long as A) the European Unions share of world GDP remains significantly smaller than that of the United States. B) the European Unions share of world exports remains significantly smaller than that of the United States. C) Europe neglects to integrate its financial markets. D) the European Union is unable to function as a cohesive political entity. Register to View Answer93) Under dollarization a country A) abandons its own currency and adopts the money of another country. B) backs its currency 100 percent with foreign reserves. C) earns seignorage because it no longer bears the cost of issuing its own currency. D) must worry about a speculative attack on its currency. Register to View Answer 183 94) A disadvantage of dollarization is that it A) prevents a central bank from creating inflation. B) avoids the possibility of a speculative attack on the domestic currency. C) it does not allow a country to pursue its own independent monetary policy. D) is a strong commitment to exchange rate stability.. Register to View Answer95) (I) Controls on capital outflows may increase capital flight by weakening confidence in the government. (II) Controls on capital outflows are an inadequate substitute for financial reform to deal with currency crises. A) (I) is true; (II) false. B) (I) is false; (II) true. C) Both are true. D) Both are false. Register to View Answer96) The most effective way to deal with currency crises is to A) impose controls on capital inflows. B) impose controls on capital outflows. C) impose controls on both capital inflows and outflows. D) improve bank regulation and supervision. Register to View Answer97) An argument in supports of the view that the world needs an international lender of last resort such as the IMF is that A) central banks in emerging-market countries lack credibility as inflation fighters. B) an international lender of last resort creates a safety net that protects bank depositors. C) the IMF is slow to lend, which ultimately reduces the amount that must be borrowed. D) the IMF imposes requirements that borrowing countries must enact microeconomic policies to reform their financial systems. Register to View Answer 184 13.2 True/False 1) An unsterilized intervention in which domestic currency is sold to purchase foreign assets leads to a gain in international reserves. Register to View Answer2) The difference between merchandise exports and imports is called the current account balance. Register to View Answer3) The current account balance plus the capital account balance equals the official reserve transactions balance. Register to View Answer4) In the balance of payments accounting system, capital inflows are entered in the receipts column with a positive sign. Register to View Answer5) In contrast to other countries currencies, the Japanese yen and yen-denominated assets are the major component of international reserves held by countries. Register to View Answer6) Tying currencies to gold resulted in an international financial system with fixed exchange rates between countries. Register to View Answer7) The Bretton Woods agreement created the International Development Association. Register to View Answer8) The Bretton Woods system was a fixed exchange rate regime, in which central banks bought and sold their own currencies to keep their exchange rates fixed. Register to View Answer9) If a countrys central bank eventually runs out of international reserves, it cannot keep its currency from depreciating and a devaluation must occur. Register to View Answer10) Special drawing rights are loans to countries made by the IMF. Register to View Answer 185 13.3 Essay 1) Briefly explain what it means to be a reserve-currency country. What are the advantages? Can you think of any disadvantages? 2) Describe the mechanism involving flows of gold that enables the gold standard to keep exchange rates fixed at par value. What does this mechanism indicate about the ability of a country to control its monetary policy under a gold standard? 3) One outcome of the establishment of the Bretton Woods system is that the United States became the reserve-currency country. Why did the United States obtain this unique position? 4) What international considerations affect the conduct of monetary policy? Are these considerations as influential for the United States as for other countries? Why or why not? 5) Do you believe that returning to the gold standard would be beneficial to the world economy? Discuss the pros and cons of such a move. 6) Explain graphically how a country must intervene in the foreign exchange market under a fixed exchange rate regime if its currency is undervalued. 7) Explain graphically the speculative attacks that occurred against the British pound in 1992, the Mexican peso in 1994, and the Thai baht in 1997. 186 Chapter 14 Theory of Financial Structure 14.1 Multiple Choice Questions 1) Of the following sources of external finance for American nonfinancial businesses, the least important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) loans from other financial intermediaries. Register to View Answer2) Of the following sources of external finance for American nonfinancial businesses, the most important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) loans from other financial intermediaries. Register to View Answer3) Of the sources of external funds for nonfinancial businesses in the United States, corporate bonds and commercial paper account for approximately _____ of the total. A) 35 percent B) 10 percent C) 50 percent D) 5 percent Register to View Answer4) Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately _____ of the total. A) 10 percent B) 20 percent C) 30 percent D) 40 percent Register to View Answer 187 5) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Marketable securities account for a larger share of external business financing in the United States than in most other countries. B) Since 1970, less than 5 percent of newly issued corporate bonds and commercial paper have been sold directly to American households. C) The stock market accounted for a sizeable fraction of the financing of American businesses in the 1970-1996 period. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer6) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Direct finance is used in less than 5 percent of the external financing of American businesses. B) Only large, well-established corporations have access to securities markets to finance their activities. C) Bank loans in the United States provide four times more financing of corporate activities than do stock markets. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer7) (I) In the United States bank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer8) Which of the following is not one of the eight basic facts 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) New security issues are the most important source of external funds to finance businesses. Register to View Answer 188 9) Which of the following is not one of the eight basic facts about financial structure? A) The financial system is among the most heavily regulated sectors of the economy. B) Issuing marketable securities is 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. Register to View Answer10) Because information is scarce, A) equity contracts are used 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, can help reduce moral hazard. D) all of the above are true. E) only (B) and (C) of the above are true. Register to View Answer11) Which of the following best explains the recent decline in the role of financial intermediaries? A) Private production and sale of information B) Government regulation to increase information C) Improvements in information technology D) None of the above can explain the recent decline Register to View Answer12) 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. Register to View Answer13) If borrowers take on big risks after obtaining a loan, then lenders face the problem of A) moral hazard. B) free-riding. C) adverse selection. D) costly state verification. Register to View Answer 189 14) Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ______, which gives rise to the problem of ______. A) low; moral hazard B) low; adverse selection C) high; moral hazard D) high; adverse selection Register to View Answer15) In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will A) reflect the highest quality of used cars in the market. B) reflect the lowest quality of used cars in the market. C) reflect the average quality of used cars in the market. D) none of the above. Register to View Answer16) 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. Register to View Answer17) 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. Register to View Answer18) Adverse selection is a problem associated with equity and debt contracts arising from A) the lenders relative lack of information about the borrowers potential returns and risks of his investment activities. B) the lenders inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults. C) the borrowers lack of incentive to seek a loan for highly risky investments. D) none of the above. Register to View Answer 190 19) Moral hazard is a problem associated with debt and equity contracts arising from A) the borrowers incentive to take highly risky investments. B) the owners inability to ensure that managers will act in the owners interest. C) the difficulty lenders have in sorting out good credit risks from bad credit risks. D) all of the above. E) only (A) and (B) of the above. Register to View Answer20) Because of the adverse selection problem, A) lenders may make a disproportionate amount of loans to bad credit risks. B) lenders may refuse loans to individuals with low net worth. C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above. Register to View Answer21) 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) all of the above. Register to View Answer22) The problem of adverse selection helps to explain A) why banks prefer to make loans secured by collateral. B) why banks have a comparative advantage in raising funds for American businesses. C) why borrowers are willing to offer collateral to secure their promises to repay loans. D) all of the above. E) only (A) and (B) of the above. Register to View Answer23) 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 collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) only (A) and (B) of the above. Register to View Answer 191 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) all of the above. Register to View Answer25) 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) do all of the above. Register to View Answer26) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) provide information that is valued by consumers of used cars. B) are able to prevent others from free-riding off the information that they provide. C) can profit by becoming experts in determining whether an automobile is a good car or a lemon. D) do all of the above. Register to View Answer27) 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. Register to View Answer 192 28) In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A) Federal Communications Commission. B) Federal Trade Commission. C) Securities and Exchange Commission. D) U.S. Treasury Department. E) Federal Reserve System. Register to View Answer29) The authors analysis of adverse selection indicates that financial intermediaries in general, and banks in particular because they hold a large fraction of non-traded loans, 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) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. 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) all of the above. E) only (A) and (B) of the above. Register to View Answer30) The authors analysis of adverse selection indicates that financial intermediaries A) overcome free-rider problems by holding non-traded loans. B) must buy securities from corporations to diversify the risk that results from holding non-tradable loans. C) have not been very successful in dealing with adverse selection problems in financial markets. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer31) Financial intermediaries and, particularly, banks have the ability to avoid the freerider problem as long as they primarily A) make private loans. B) acquire a diversified portfolio of stocks. C) buy junk bonds. D) do a balanced combination of (A) and (B) of the above. Register to View Answer 193 32) 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. Register to View Answer33) Collateral is A) property that is pledged to the lender if a borrower cannot make his or her debt payments. B) a prevalent feature of debt contracts for households. C) a prevalent feature of debt contracts for business. D) all of the above. E) only (A) and (C) of the above. Register to View Answer34) The majority of household debt in the United States consists of A) credit card debt. B) consumer installment debt. C) collateralized loans. D) unsecured loans, such as student loans. Register to View Answer35) 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. Register to View Answer36) Because of the moral hazard problem, A) lenders will write debt contracts that restrict certain activities of borrowers. B) lenders will more readily lend to borrowers with high net worth. C) debt contracts are used less frequently to raise capital than are equity contracts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 194 37) 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 Register to View Answer38) Because managers (_____) have less incentive to maximize profits than the stockholders-owners (_____) do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities. A) principals; agents B) principals; principals C) agents; agents D) agents; principals Register to View Answer39) The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) would not arise if the owners of the firm had complete information about the activities of the managers. C) in financial markets helps to explain why equity is a relatively important source of finance for American business. D) all of the above. E) only (A) and (B) of the above. Register to View Answer40) Solutions to the moral hazard problem include A) high net worth. B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer41) 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. Register to View Answer 195 42) 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 firms activities. B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It does both (A) and (B) of the above. E) It does both (A) and (C) of the above. Register to View Answer43) Debt contracts A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. B) have an advantage over equity contracts in that they have a lower cost of state verification. C) are used much more frequently to raise capital than are equity contracts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer44) Equity contracts account for a small fraction of external funds raised by American businesses because A) costly state verification makes the equity contract less desirable than the debt contract. B) of the greater 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) of all of the above. E) of both (A) and (B) of the above. Register to View Answer45) A debt contract is said to be incentive compatible if A) the borrowers net worth reduces the probability of moral hazard. B) restrictive covenants limit the type of activities that can be undertaken by the borrower. C) both (A) and (B) of the above occur. D) neither (A) nor (B) of the above occur. Register to View Answer 196 46) A debt contract is more likely to be incentive compatible if A) the company must follow standard accounting principles. B) the funds are provided by a venture capital firm. C) owners of the firm have more of their own money in the business. D) all of the above. E) only (B) and (C). Register to View Answer47) A clause in a mortgage loan contract requiring the borrower to purchase homeowners insurance is an example of A) a restrictive covenant. B) a collusive agreement between mortgage lenders and insurance companies. C) both (A) and (B) of the above. D) neither (A) and (B) of the above. Register to View Answer48) A debt contract that specifies that the company can only use the funds to finance certain activities A) is a private loan. B) contains a restrictive covenant. C) increases the problem of adverse selection. D) all of the above. E) only (A) and (B). Register to View Answer49) Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets? A) Covenants reduce moral hazard by restricting borrowers undesirable behavior. B) Covenants require that borrowers keep collateral in good condition. C) Covenants require periodic accounting statements and income reports. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer50) 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 costly 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) all of the above. E) only (A) and (B) of the above. Register to View Answer 197 51) Governments in developing countries sometimes adopt policies that retard the efficient operation of their financial systems. These actions include policies that A) prevent lenders from foreclosing on borrowers with political clout. B) nationalize banks and direct credit to politically-favored borrowers. C) make it costly to collect payments and collateral from defaulting debtors. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer52) Financial crises A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms. B) occur when adverse selection and moral hazard problems in financial markets become more significant. C) frequently lead to sharp contractions in economic activity. D) all of the above. E) only (A) and (B) of the above. Register to View Answer53) Financial crises A) cause failures of financial intermediaries and leave only securities markets to channel funds from savers to borrowers. B) are a recent phenomenon that occurs only in developing countries. C) invariably lead to debt deflation. D) all of the above. E) none of the above. Register to View Answer54) Factors that lead to worsening conditions in financial markets include A) increases in interest rates. B) declining stock prices. C) increasing uncertainty in financial markets. D) all of the above. E) only (A) and (B) of the above. Register to View Answer55) Factors that lead to worsening conditions in financial markets include A) declining interest rates. B) unanticipated increases in the price level. C) bank panics. D) only (A) and (C) of the above. E) only (B) and (C) of the above. Register to View Answer 198 56) 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 Register to View Answer57) An examination of past financial crises in the United States indicates that a bank panic has typically been A) the one key factor that initiates a financial crisis. B) a consequence of worsening conditions during a financial crisis. C) the result of declining interest rates that raised adverse selection problems. D) an event that is unrelated to episodes that have come to be recognized as financial panics. Register to View Answer58) Most financial crises in the United States have begun with A) a steep stock market decline. B) an increase in uncertainty resulting from the failure of a major firm. C) a steep decline in interest rates. D) all of the above. E) only (A) and (B) of the above. Register to View Answer59) Most financial crises in the United States have begun with A) a sharp rise in interest rates. B) a steep stock market decline. C) an increase in uncertainty resulting from the failure of a major firm. D) all of the above. E) only (A) and (B) of the above. Register to View Answer60) In addition to having a direct effect on increasing adverse selection problems, increases in interest rates also promote financial crises by _____ firms and households interest payments, thereby _____ their cash flow. A) increasing; increasing B) increasing; decreasing C) decreasing; increasing D) decreasing; decreasing Register to View Answer 199 61) Deterioration in a firms balance sheet and a decline in net worth, which increases adverse selection and moral hazard problems, can be caused by A) a sharp drop in the price level. B) a sharp increase in uncertainty. C) a sharp depreciation of the domestic currency. D) all of the above. E) only (A) and (C). Register to View Answer62) Adverse selection and moral hazard problems increased in magnitude during the early years of the Great Depression as A) stock prices declined to 10 percent of their level in 1929. B) banks failed. C) the aggregate price level declined. D) a result of all of the above. E) a result of (A) and (B) of the above. Register to View Answer63) Adverse selection and moral hazard problems increased in magnitude during the early years of the Great Depression as A) stock prices declined to 10 percent of their level in 1929. B) banks failed. C) the aggregate price level rose. D) a result of all of the above. E) a result of (A) and (B) of the above. Register to View Answer64) Financial crises in the United States and Mexico A) were similar in being precipitated by an increase in interest rates abroad. B) were different because in Mexico speculative attacks in the foreign exchange market played a key role. C) were similar in being preceded by stock market declines. D) all of the above. E) only (A) and (C). Register to View Answer65) Stock market declines preceded a full blown financial crisis A) in the United States in 1987. B) in Thailand in 1997. C) in Indonesia in 1997. D) all of the above. E) only (B) and (C). Register to View Answer 200 66) Which of the following factors led up to the Mexican financial crisis of 1994? A) Speculative attacks on the peso and a rise in actual and expected inflation. B) A rise in domestic interest rates and a deterioration of in bank balance sheets. C) A rise in foreign interest rates and domestic stock market declines. D) all of the above. E) only (B) and (C). Register to View Answer67) Institutional features of debt markets in Asia that propelled several countries into financial crisis include A) debt contracts with long duration. B) firms with debt denominated in U. S. dollars. C) governments that could not intervene to protect depositors. D) all of the above. E) only (A) and (C). Register to View Answer 14.2 True/False 1) American businesses get more funds from direct financing than from indirect financing. Register to View Answer2) American businesses use stock to finance about 10 percent of their external financing. Register to View Answer3) One reason why indirect financing is used is to minimize adverse selection problems. Register to View Answer4) Issuing marketable securities is the primary way businesses finance their operations. Register to View Answer5) Because of the adverse selection problem, lenders may refuse loans to individuals with low net worth. Register to View Answer6) The concept of adverse selection helps to explain why indirect finance is more important than direct finance as a source of business finance. Register to View Answer7) The problem of adverse selection helps to explain why direct finance is more important than indirect finance as a source of business finance. Register to View Answer201 8) The concept of adverse selection helps explain why collateral is an important feature of many debt contracts. Register to View Answer9) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it makes debt contracts incentive compatible. Register to View Answer10) Factors that lead to worsening conditions in financial markets include increasing interest rates and unanticipated increases in the price level. Register to View Answer11) The principal-agent problem is an example of the adverse selection problem that can result from asymmetric information. Register to View Answer 14.3 Essay 1) Explain how the lemons problem could cause financial markets to fail. 2) Distinguish between adverse selection and moral hazard. 3) What facts about financial structure can be explained by adverse selection? 4) What facts about financial structure can be explained by moral hazard? 5) What factors usually cause an increase in moral hazard and adverse selection? 6) What is the principal-agent problem? 7) Describe the sequence of events in a financial crisis and explain why they can cause economic activity to decline? 202 Chapter 15 The Banking Firm and Bank Management 15.1 Multiple Choice Questions 1) Which of the following statements are true? A) A banks assets are its sources of funds. B) A banks liabilities are its uses of funds. C) A banks balance sheet shows that total assets equal total liabilities plus equity capital. D) Each of the above. Register to View Answer2) Which of the following statements is true? A) A banks assets are its uses of funds. B) A banks assets are its sources of funds. C) A banks liabilities are its uses of funds. D) Only (B) and (C) of the above are true. Register to View Answer3) Which of the following statements is false? A) A banks assets are its uses of funds. B) A bank issues liabilities to acquire funds. C) The banks assets provide the bank with income. D) Bank capital is an asset in the bank balance sheet. Register to View Answer4) A banks balance sheet A) shows that total assets equal total liabilities plus equity capital. B) lists sources and uses of bank funds. C) indicates whether or not the bank is profitable. D) does all of the above. E) does only (A) and (B) of the above. Register to View Answer5) Which of the following are reported as liabilities on a banks balance sheet? A) Reserves B) Checkable deposits C) Loans D) Deposits with other banks Register to View Answer 203 6) Which of the following are reported as liabilities on a banks balance sheet? A) Discount loans B) Cash items in the process of collection C) State government securities D) All of the above E) Only (A) and (B) of the above Register to View Answer7) The share of checkable 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. Register to View Answer8) Checkable deposits and money market deposit accounts are A) payable on demand. B) liabilities of the banks. C) assets of the banks. D) only (A) and (B) of the above. E) only (A) and (C) of the above. Register to View Answer9) Which of the following statements is false? A) Checkable deposits are usually the lowest cost source of bank funds. B) Checkable deposits are the primary source of bank funds. C) Checkable deposits are payable on demand. D) Checkable deposits include NOW accounts. Register to View Answer10) In recent years, the interest paid on checkable and time deposits has accounted for around _____ of total bank operating expenses, while the costs involved in servicing accounts have been approximately _____ of operating expenses. A) 35 percent; 55 percent B) 55 percent; 35 percent C) 45 percent; 50 percent D) 30 percent; 45 percent Register to View Answer11) Because checking accounts are _____ liquid for the depositor than passbook savings, they earn _____ interest rates. A) less; higher B) less; lower C) more; higher D) more; lower Register to View Answer 204 12) Because passbook savings are _____ liquid for the depositor than checking accounts, they earn _____ interest rates. A) less; higher B) less; lower C) more; higher D) more; lower Register to View Answer13) Which of the following are transaction deposits? A) Savings accounts B) Small-denomination time deposits C) Money market deposit accounts D) Certificates of deposit Register to View Answer14) Which of the following are nontransaction deposits? A) Savings accounts B) Small-denomination time deposits C) Negotiable order of withdraw accounts D) All of the above E) Only (A) and (B) of the above Register to View Answer15) Which of the following are not nontransaction deposits? A) Savings accounts B) Small-denomination time deposits C) Negotiable order of withdraw accounts D) Certificates of deposit Register to View Answer16) 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 Register to View Answer17) Bank loans from the Federal Reserve are called _____ and represent a _____ of funds. A) discount loans; use B) discount loans; source C) fed funds; use D) fed funds; source Register to View Answer 205 18) Which of the following would substitute for discount loans? A) Loans to businesses B) Repurchase agreements C) Investing in Eurodollars D) Loans to bank holding companies E) Reverse repurchase agreements Register to View Answer19) Loan loss reserves are listed on the _____ side of the banks balance sheet, indicating that they represent a _____ of funds. A) liability; use B) liability; source C) asset; use D) asset; source Register to View Answer20) When a bank decides that a $1 million loan will not be paid back and formally writes it off, A) the loan loss reserve account will drop by $1 million. B) the loan loss reserve account will rise by $1 million. C) the banks assets are lowered by $1 million. D) both (A) and (C) of the above occur. E) both (B) and (C) of the above occur. Register to View Answer21) Which of the following are reported as assets on a banks balance sheet? A) Discount loans from the Fed B) Loans C) Borrowings D) Only (A) and (B) of the above Register to View Answer22) Which of the following are reported as assets on a banks balance sheet? A) Cash items in the process of collection B) Deposits with other banks C) Checkable deposits D) Bank capital E) Only (A) and (B) of the above Register to View Answer23) Which of the following are reported as assets on a banks balance sheet? A) Borrowings B) Reserves C) Savings deposits D) Bank capital E) Only (A) and (B) of the above Register to View Answer206 24) Which of the following are not reported as assets on a banks balance sheet? A) Cash items in the process of collection B) Deposits with other banks C) U.S. Treasury securities D) Checkable deposits Register to View Answer25) Which of the following are not reported as assets on a banks balance sheet? A) Cash items in the process of collection B) Borrowings C) U.S. Treasury securities D) Reserves Register to View Answer26) Because of their _____ liquidity, _____ U.S. government securities are called secondary reserves. A) low; short-term B) low; long-term C) high; short-term D) high; long-term Register to View Answer27) 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 required reserves. D) of none of the above. Register to View Answer28) The most important category of assets on a banks balance sheet is A) discount loans. B) securities. C) loans. D) cash items in the process of collection. Register to View Answer29) Which of the following bank assets is the least liquid? A) Reserves B) Secondary reserves C) Cash items in process of collection D) Deposits with other banks Register to View Answer 207 30) Which of the following bank assets is the most liquid? A) Consumer loans B) Reserves C) Cash items in process of collection D) U.S. government securities Register to View Answer31) Loans A) are the largest category of bank assets. B) provide most of the banks revenues. C) earn the highest return of all bank assets. D) do each of the above. E) do only (A) and (B) of the above. Register to View Answer32) A banks largest source of funds is its A) nontransaction deposits. B) checking deposits. C) borrowing from the Fed. D) federal funds. Register to View Answer33) 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 Register to View Answer34) 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 Register to View Answer35) When you deposit a $50 bill in the Security Pacific National Bank, A) its liabilities decrease by $50. B) its assets increase by $50. C) its reserves increase by $50. D) only (B) and (C) of the above occur. Register to View Answer 208 36) When you deposit a $50 bill in the Security Pacific National Bank, A) its liabilities decrease by $50. B) its assets increase by $50. C) its reserves decrease by $50. D) only (B) and (C) of the above occur. Register to View Answer37) When you deposit $50 in currency at Old National Bank, A) its assets increase by $50. B) its reserves increase by less than $50 because of reserve requirements. C) its liabilities decrease by $50. D) only (A) and (B) of the above occur. Register to View Answer38) 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) only (A) and (B) of the above occur. Register to View Answer39) When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then A) the liabilities of the First National Bank decrease by $10. B) the reserves of the First National Bank increase by $10. C) the liabilities of Citibank decrease by $10. D) the assets of Citibank decrease by $10. Register to View Answer40) When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then A) the liabilities of the First National Bank decrease by $10. B) the liabilities of Citibank increase by $10. C) the reserves of the First National Bank increase by $10. D) all of the above occur. E) only (A) and (B) of the above occur. Register to View Answer41) Holding all else constant, when a bank receives the funds for a deposited check, A) cash items in the process of collection fall by the amount of the check. B) bank assets increase by the amount of the check. C) bank liabilities decrease by the amount of the check. D) all of the above. Register to View Answer 209 42) Holding all else constant, when a bank receives the funds for a deposited check, A) cash items in the process of collection fall by the amount of the check. B) bank assets remain unchanged. C) bank liabilities decrease by the amount of the check. D) all of the above. E) only (A) and (B) of the above. Register to View Answer43) A banker has which of the following concerns: A) To acquire funds at low cost B) To minimize risk by diversifying asset holdings C) To have enough ready cash to meet deposit outflows D) Each of the above Register to View Answer44) 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 high interest rates, but who are also good credit risks C) Acquiring funds at a relatively low cost, so that profitable lending opportunities can be realized D) All of the above Register to View Answer45) Bankers concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Fed, 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) none of the above. Register to View Answer46) When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the banks final balance sheet, A) the assets at the bank increase by $200,000. B) the liabilities of the bank increase by $200,000. C) reserves increase by $200,000. D) each of the above occurs. Register to View Answer 210 47) When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the banks 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. Register to View Answer48) If a bank has $1 million of deposits, a required reserve ratio of 20 percent, and $300,000 in reserves, it need not rearrange its balance sheet if there is a deposit outflow of A) $50,000. B) $75,000. C) $150,000. D) either (A) or (B) of the above. Register to View Answer49) If a bank has $100,000 of deposits, a required reserve ratio of 20 percent, and $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is A) $30,000. B) $25,000. C) $20,000. D) $10,000. Register to View Answer50) If a bank has $200,000 of deposits, a required reserve ratio of 20 percent, and $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is A) $50,000. B) $40,000. C) $30,000. D) $25,000. Register to View Answer51) If a bank has $10 million of deposits, a required reserve ratio of 10 percent, and $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) either (A) or (B) of the above. Register to View Answer 211 52) Banks protect themselves from the disruption of deposit outflows by A) holding excess reserves. B) selling securities. C) calling in loans. D) doing all of the above. E) doing only (A) and (B) of the above. Register to View Answer53) In general, banks would prefer to meet deposit outflows by _____ rather than _____ A) selling loans; selling securities. B) selling loans; borrowing from the Fed. C) borrowing from the Fed; selling loans. D) calling in loans; selling securities. Register to View Answer54) Which of the following do banks hold as insurance against the high cost of deposit outflows? A) Excess reserves B) Secondary reserves C) Bank equity capital D) Each of the above E) Only (A) and (B) of the above Register to View Answer55) The _____ are the costs associated with deposit outflows, the _____ excess reserves banks will want to hold. A) lower; more B) higher; less C) higher; more D) None of the above, since deposit outflows cannot be anticipated. Register to View Answer56) A bank can reduce its total amount of loans outstanding by A) calling in loans, that is, by not renewing some loans when they come due. B) selling them to other banks. C) selling them to the Federal Reserve. D) doing all of the above. E) doing only (A) and (B) of the above. Register to View Answer 212 57) Which of the following statements are accurate descriptions of modern liability management? A) Greater flexibility in liability management has allowed banks to increase the proportion of their assets held in loans. B) New financial instruments enable banks to acquire funds quickly. C) The introduction of negotiable CDs have significantly reduced the percentage of funds that banks borrow from one another to finance loans. D) All of the above have occurred since 1960. E) Only (A) and (B) of the above have occurred since 1960. Register to View Answer58) Banks fail A) when the value of bank reserves falls below the value of its required reserves, causing the bank to become insolvent. B) when the value of bank loans falls below the value of its secondary reserves, causing the bank to become insolvent. C) when the value of bank assets falls below the value of its liabilities, causing the bank to become insolvent. D) when all of the above occur. Register to View Answer59) Banks fail when the value of bank _____ fall below the value of its _____, causing the bank to become insolvent. A) reserves; required reserves B) loans; secondary reserves C) securities; deposit liabilities D) assets; liabilities Register to View Answer60) A bank failure is less likely to occur when A) a bank holds less U.S. government securities. B) a bank suffers large deposit outflows. C) a bank holds more excess reserves. D) a bank has less bank capital. Register to View Answer61) A bank failure is more likely to occur when A) a bank holds less U.S. government securities. B) a bank suffers large deposit outflows. C) a bank holds less equity capital. D) each of the above occur. E) only (A) and (B) of the above occur. Register to View Answer 213 62) 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. Register to View Answer63) 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. Register to View Answer64) The amount of assets per dollar of equity capital is called the A) asset ratio. B) equity ratio. C) equity multiplier. D) asset multiplier. E) return on equity. Register to View Answer65) For a given return on assets, A) the lower is bank capital, the lower is the return for the owners of the bank. B) the lower is bank capital, the higher is the return for the owners of the bank. C) the lower is bank capital, the lower is the credit risk for the owners of the bank. D) both (A) and (C) of the above. Register to View Answer66) 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) none of the above. Register to View Answer67) Which of the following is an argument in support of a regulated minimum capital requirement? A) Banks that hold too little capital are too profitable. B) Banks that hold too little capital impose costs on other banks because they are more likely to fail. C) Banks that hold too little capital have an unfair competitive advantage over savings and loans. D) All of the above. Register to View Answer214 68) Conditions that likely contributed to a credit crunch in 1990-92 include A) a decline in bank capital caused by loan losses due to 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) all of the above. E) only (A) and (B) of the above. Register to View Answer69) Conditions that likely contributed to a credit crunch in 1990-92 include A) a hike in the equity multiplier caused by loan losses due to 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) all of the above. E) only (A) and (B) of the above. Register to View Answer70) Examples of off-balance-sheet activities include A) loan sales. B) foreign exchange market transactions. C) trading in financial futures. D) all of the above. E) only (A) and (B) of the above. Register to View Answer71) Examples of off-balance-sheet activities include A) loan sales. B) extending loans to depositors. C) borrowing from other banks. D) all of the above. Register to View Answer72) When a bank sells all or part of the cash stream from a specific loan, A) it thereby removes the loan from its balance sheet. B) it usually does so at a loss. C) it usually does so at a profit. D) both (A) and (B) of the above. E) both (A) and (C) of the above. Register to View Answer 215 73) Which of the following are important factors in determining the degree and timing of financial innovation? A) Changes in technology B) Changes in market conditions C) Changes in regulation D) All of the above E) Only (A) and (B) of the above Register to View Answer74) 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. Register to View Answer75) 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. Register to View Answer76) Large fluctuations in interest rates lead to A) substantial capital gains and losses to owners of securities. B) greater uncertainty about returns on investments. C) greater interest-rate risk. D) all of the above. Register to View Answer77) The most significant change in the economic environment that changed the demand for financial products since 1970 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. Register to View Answer78) In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 3.5 percent; in the 1970s it fluctuated between ____ percent and ____ percent. A) 4; 14 B) 4; 11.5 C) 2; 14 D) 2; 11.5 Register to View Answer 216 79) 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) have many attractive attributes, explaining why so few households now seek fixed-rate mortgages. D) do only (A) and (B) of the above. E) none of the above. Register to View Answer80) Adjustable rate mortgages A) benefit homeowners when interest rates are falling. B) reduce financial institutions interest-rate risk. C) reduce households risk of having to pay higher mortgage payments when interest rates rise. D) do only (A) and (B) of the above. Register to View Answer81) The most important source of the changes in supply conditions that stimulate financial innovation has been the A) aging of the baby-boomer generation. B) dramatic increase in the volatility of interest rates. C) improvement in computer and telecommunications technology. D) dramatic increase in competition from foreign banks. E) deregulation of financial institutions. Register to View Answer82) Examples of financial services that became practical realities as the result of new computer technology include A) credit cards. B) electronic banking facilities. C) checking accounts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer83) Credit cards date back to A) prior to World War II. B) just after World War II. C) the early 1950s. D) the late 1950s. Register to View Answer 217 84) A firm issuing credit cards earns income from A) loans it makes to credit card holders. B) payments made to it by stores on credit card purchases. C) payments made to it by manufacturers of the products sold in stores on credit card purchases. D) all of the above. E) only (A) and (B) of the above. Register to View Answer85) The entry of AT&T and GM into the credit card business is an indication of A) governments 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. Register to View Answer86) Bank managers look 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. Register to View Answer87) Checking accounts that earn interest (such as NOW accounts) were not available until A) 1962. B) 1972. C) 1982. D) 1992. Register to View Answer88) Burdensome regulations, along with rising interest rates and inflation, help to explain A) the rapid pace of financial innovations in banking in the 1960s and 1970s. B) the low rate of bank failures in the 1980s. C) both (A) and (B) of the above. D) neither (A) nor (B) of the above. Register to View Answer89) The Federal Reserves Regulation Q A) set maximum interest rates banks could pay on deposits. B) set minimum interest rates banks could pay on deposits. C) set maximum interest rates banks could charge on loans. D) discouraged disintermediation. Register to View Answer 218 90) As a result of disintermediation, the banking system ______ deposits and bank lending ______. A) gains; increase B) gains; decrease C) loses; increase D) loses; decrease Register to View Answer91) Which of the following is not a reason for the disappointing revenue growth and profits of Internet-only banks? A) high cost per transaction B) security concerns C) customer preferences D) technical problems Register to View Answer92) It now appears that the predominant delivery system for banking services in the future will be A) Internet-only banks. B) traditional banks. C) traditional banks supplemented with on-lineservices. D) none of the above Register to View Answer93) The growing use and proliferation of ATMs has been stimulated by A) lower transaction costs. B) greater customer convenience. C) declining cost of the ATM equipment. D) all of the above. Register to View Answer 15.2 True/False 1) Since their introduction in 1961, negotiable CDs have become an important source of bank funds. Register to View Answer2) Deposits that banks keep in accounts at the Federal Reserve less vault cash is called reserves. Register to View Answer3) When a bank receives additional deposits, it gains an equal amount of reserves; when it loses deposits, it loses an equal amount of reserves. Register to View Answer 219 4) To keep enough cash on hand to meet depositors demand for withdrawals, banks must engage in liquidity management Register to View Answer5) Required reserves are insurance against the costs associated with deposit outflows. The higher the costs associated with deposit outflows, the more required reserves banks will want to hold. Register to View Answer6) A bank maintains bank capital to lessen the chance that it will become insolvent. Register to View Answer7) Given the return on assets, the higher the bank capital, the higher the return for the owners of the bank. Register to View Answer8) Loan loss reserves are an asset on a banks balance sheet. Register to View Answer9) Off-balance-sheet activities consist of trading financial instruments and generating income from fees and loan sales, all of which affect bank profits but are not visible on bank balance sheets. Register to View Answer10) Americans are the biggest users of checks in the world, but lag behind Europeans in the proportion of noncash payments that are made by electronic means. Register to View Answer 15.3 Essay 1) Explain the off-balance-sheet activities banks engage in, the risks from undertaking these activities, and the controls that banks set up to restrict bank employees from taking on too much risk. 2) What financial innovations are best explained as attempts to avoid regulations? 3) Discuss the recent trends in bank performance measures. 4) Explain how loan loss reserves work. What are the advantages to bank managers from adding to loan loss reserves? 5) What new forms of banking have been spawned by the advances in information technology of the last two decades? Is it likely that traditional banks will disappear as a result of these innovations? Why? 6) What new forms of making payments have been spawned by the advances in information technology of the last two decades? Is it likely that ours will become a cashless society anytime soon as a result of these innovations? Why? 220 Chapter 16 Commercial Banking Industry: Structure and Competition 16.1 Multiple Choice 1) The modern commercial banking system began in America when the A) Bank of United States was chartered in New York in 1801. B) Bank of North America was chartered in Philadelphia in 1782. C) Bank of United States was chartered in Philadelphia in 1801. D) Bank of North America was chartered in New York in 1782. Register to View Answer2) A major controversy involving the banking industry in its early years was A) whether banks should both accept deposits and make loans or whether these functions should be separated into different institutions. B) whether the federal government or the states should charter banks. C) what percent of deposits banks should hold as fractional reserves. D) whether banks should be allowed to issue their own bank notes. Register to View Answer3) 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. Register to View Answer4) Because of the abuses by state banks and the clear need for a central bank to help the federal government raise funds during the War of 1812, Congress created the A) Bank of United States in 1812. B) Bank of North America in 1814. C) Second Bank of the United States in 1816. D) Second Bank of North America in 1815. Register to View Answer5) The Second Bank of the United States was denied a new charter by A) President Andrew Jackson. B) Vice President John Calhoun. C) President Benjamin Harrison. D) President John Q. Adams. Register to View Answer 221 6) Before 1863, A) federally-chartered banks had regulatory advantages not granted to statechartered banks. B) the number of federally-chartered banks grew at a much faster rate than at any other time since the end of the Civil War. C) banks acquired funds by issuing bank notes. D) the Federal Reserve System regulated only federally-chartered banks. E) the Comptroller of the Currency regulated both state- and federally-chartered banks. Register to View Answer7) Before 1863, A) the Federal Reserve System regulated only federally-chartered banks. B) the Comptroller of the Currency regulated both state- and federallychartered banks. C) the number of federally-chartered banks grew at a much faster rate than at any other time since the end of the Civil War. D) none of the above. Register to View Answer8) Although the National Bank Act of 1863 was designed to eliminate state-chartered banks by imposing a prohibitive tax on banknotes, these banks have been able to stay in business by A) issuing credit cards. B) ignoring the regulations. C) issuing deposits. D) branching into other states. Register to View Answer9) The belief that bank failures were regularly caused by fraud or the lack of sufficient bank capital explains, in part, the passage of A) the National Bank Charter Amendments of 1918. B) the Glass/St. Germain Act of 1982. C) the National Bank Act of 1863. D) none of the above. Register to View Answer10) To eliminate the abuses of the state-chartered banks, the _____ created a new banking system of federally chartered banks, supervised by the _____ A) National Banking Act of 1863; Office of the Comptroller of the Currency. B) Federal Reserve Act of 1863; Office of the Comptroller of the Currency. C) National Banking Act of 1863; Office of Thrift Supervision. D) Federal Reserve Act of 1863; Office of Thrift Supervision. Register to View Answer 222 11) The National Banking Act of 1863, and subsequent amendments to it, A) created a banking system of federally-chartered banks. B) established the Office of the Comptroller of the Currency. C) broadened the regulatory powers of the Federal Reserve. D) did all of the above. E) did only (A) and (B) of the above. Register to View Answer12) The regulatory system that has evolved in the United States whereby banks are regulated at the state level, the national level, or both, is known as a A) bilateral regulatory system. B) tiered regulatory system. C) two-tiered regulatory system. D) dual banking system. Register to View Answer13) Today the United States has a dual banking system in which banks supervised by the _____ and by the _____ operate side-by-side. A) federal government; municipalities B) state governments; municipalities C) federal government; states D) municipalities; states Register to View Answer14) The Federal Reserve Act of 1913 required that A) state banks be subject to the same regulations as national banks. B) national banks establish branches in the cities containing Federal Reserve banks. C) national banks join the Federal Reserve System. D) all of the above be done. Register to View Answer15) The Federal Reserve Act required all _____ banks to become members of the Federal Reserve System, while _____ banks could choose to become members of the system. A) state; national B) state; municipal C) national; state D) national; municipal Register to View Answer 223 16) With the creation of the Federal Deposit Insurance Corporation, member banks of the Federal Reserve System _____ to purchase FDIC insurance for their depositors, while non-member commercial banks _____ to buy deposit insurance. A) could choose; were required B) could choose; were given the option C) were required, could choose D) were required; were required Register to View Answer17) With the creation of the Federal Deposit Insurance Corporation, A) member banks of the Federal Reserve System were given the option to purchase FDIC insurance for their depositors, while non-member commercial banks were required to buy deposit insurance. B) member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors, while non-member commercial banks could choose to buy deposit insurance. C) both member and non-member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors. D) both member and non-member banks of the Federal Reserve System could choose, but were not required, to purchase FDIC insurance for their depositors. Register to View Answer18) Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been A) the creation of the FDIC. B) rapid economic growth since 1941. C) the employment of new procedures by the Federal Reserve. D) better bank management. Register to View Answer19) Investment banking activities of the commercial banks were blamed for many bank failures. This led to the passage of A) the National Bank Charter Amendments of 1918. B) the Glass/St. Germain Act of 1982. C) the National Bank Act of 1863. D) the Glass-Steagall Act of 1933. E) the establishment of the FDIC in 1933. Register to View Answer20) The Glass-Steagall Act A) prohibited commercial banks from issuing equity to finance bank expansion. B) prohibited commercial banks from engaging in underwriting of and dealing in corporate securities. C) prohibited commercial banks from selling new issues of government securities. D) prohibited commercial banks from purchasing any debt securities. Register to View Answer 224 21) Which bank regulatory agency has the sole regulatory authority over bank holding companies? A) The FDIC B) The Comptroller of the Currency C) The FHLBS D) The Federal Reserve System Register to View Answer22) State banks that are not members of the Federal Reserve System are most likely to be examined by the A) Federal Reserve System. B) FDIC. C) FHLBS. D) Comptroller of the Currency. Register to View Answer23) Which regulatory body charters national banks? A) The Federal Reserve B) The FDIC C) The Comptroller of the Currency D) None of the above Register to View Answer24) Which of the following statements concerning bank regulation in the United States are true? A) The Office of the Comptroller of the Currency has the primary responsibility for the 3000 national banks. B) The Federal Reserve and the state banking authorities jointly have responsibility for the 1000 state banks that are members of the Federal Reserve System. C) The Fed has sole regulatory responsibility over bank holding companies. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer25) Which of the following statements concerning bank regulation in the United States are true? A) The Office of the Comptroller of the Currency has the primary responsibility for state banks that are members of the Federal Reserve System. B) The Federal Reserve and the state banking authorities jointly have responsibility for the 1000 state banks that are members of the Federal Reserve System. C) The Office of the Comptroller of the Currency has sole regulatory responsibility over bank holding companies. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer225 26) 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) regulations that restrict the ability of these financial institutions to open branches. D) all of the above. Register to View Answer27) 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) only efficient banks operating within the United States. D) none of the above. Register to View Answer28) The McFadden Act of 1927 A) effectively prohibited banks from branching across state lines. B) required that banks maintain bank capital equal to at least 6 percent of their assets. C) effectively required that banks maintain a correspondent relationship with large money center banks. D) did all of the above. Register to View Answer29) The legislation that effectively prohibited banks from branching across state lines and forced all national banks to conform to the branching regulations in the state in which they reside is the A) McFadden Act. B) National Banking Act. C) Glass-Steagall Act. D) Garn-St. Germain Act. Register to View Answer30) Which of the following is an advantage of forming a bank holding company? A) It allows ownership of several banks where branching is prohibited. B) It allows owners to engage in activities that banks are prohibited from engaging in. C) Holding companies can issue commercial paper as a source of funds. D) All of the above. Register to View Answer 226 31) Bank holding companies are restricted to owning A) only banks. B) banks and other companies not related to banking. C) banks and other companies closely related to banking. D) no more than one bank. Register to View Answer32) The permissible activities of bank holding companies are specified by the Federal Reserves Regulation A) Q. B) D. C) Y. D) Z. Register to View Answer33) Which of the following are true statements concerning bank holding companies? A) Bank holding companies own almost all large banks. B) Bank holding companies have experienced dramatic growth in the past twentyfive years. C) Through a loophole in the McFadden Act, bank holding companies have successfully evaded interstate branching restrictions. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer34) The bank holding company form of organization can provide a bank with important advantages in that A) it allows banks to circumvent restrictive branch banking requirements. B) bank holding companies can engage in activities closely related to banking, which individual banks cannot. C) bank holding companies can issue commercial paper, allowing the bank to tap non-deposit sources of funds. D) all of the above. E) only (A) and (B) of the above. Register to View Answer35) As a result of shared electronic banking facilities, A) barriers to branching have become less burdensome. B) banking has become less competitive. C) both of the above have occurred. D) neither of the above has occurred. Register to View Answer 227 36) The McFadden Acts prohibition against interstate branching A) has been weakened by the introduction of shared electronic banking facilities that provide banking services nationwide. B) has been weakened by the acquisition of failing banks by out-of-state financial institutions. C) keeps many inefficient banks in business. D) all of the above. Register to View Answer37) The only country without a true national banking system in which banks have branches throughout the nation is A) Canada. B) France. C) Italy. D) the United States. Register to View Answer38) As a result of restrictive banking regulations, the United States A) has too few banks when compared to other industrialized countries. B) has banks that are quite large relative to those in other countries. C) has too many banks when compared to other industrialized countries. D) both (A) and (B) of the above. Register to View Answer39) Although it has a population about half that of the United States, Japan has A) many more banks. B) about 10 percent of the number of banks. C) about 5 percent of the number of banks. D) about 1 percent of the number of banks. Register to View Answer40) The legislation that separated investment banking from commercial banking is known as the A) National Bank Act of 1863. B) Federal Reserve Act of 1913. C) Glass-Steagall Act. D) McFadden Act. Register to View Answer41) The prohibition against banks underwriting corporate securities and engaging in brokerage, real estate, and insurance activities was repealed by the A) Gramm-Leach-Bliley Financial Services Modernization Act. B) Competitive Equality in Banking Act C) Depositary Institution Deregulation and Monetary Control Act. D) Glass Steagall Act Register to View Answer 228 42) Recently, commercial banks have been allowed to A) invest in real estate. B) enter certain insurance markets. C) underwrite stocks. D) do all of the above. E) only (A) and (B) of the above. Register to View Answer43) 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) British-style universal C) barrier-free D) dividerless E) severable Register to View Answer44) 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 E) severable Register to View Answer45) A major difference between the United States and Japanese banking systems is that A) American 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 American banks cannot. C) bank holding companies are illegal in the United States. D) only (A) and (C) of the above. E) only (B) and (C) of the above. Register to View Answer46) Major differences between the United States and Japanese banking systems include: A) American 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 American banks cannot. C) bank holding companies are illegal in Japan. D) only (A) and (C) of the above. E) only (B) and (C) of the above. Register to View Answer 229 47) Which of the following is a reason for the rapid expansion of international banking? A) The rapid growth in international trade B) The growth of multinational corporations C) The desire of U.S. banks to expand D) Each of the above Register to View Answer48) Since the passage of the International Banking Act of 1978, the competitive advantage enjoyed by foreign banks has been A) reduced. B) mildly expanded. C) completely eliminated. D) greatly expanded. Register to View Answer49) U.S. banks have most of their foreign branches in A) Latin America, the Far East, the Caribbean, and London. B) Latin America, the Middle East, the Caribbean, and London. C) Mexico, the Middle East, the Caribbean, and London. D) South America, the Middle East, the Caribbean, and Canada. Register to View Answer50) Eurodollars are A) dollar-denominated 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-denominated deposits held in U.S. banks by Europeans. Register to View Answer51) 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. Register to View Answer52) The main center of the Eurodollar market is A) London. B) Basel. C) Paris. D) New York. Register to View Answer 230 53) The worlds largest bank as of 2001 was A) Deutsch Bank. B) Sumitomo Bank. C) Bank of Tokyo. D) Bank of America. Register to View Answer54) So-called fallen angels differ from junk bonds in that A) junk bonds refer to previously issued bonds which have had their credit ratings fall below Baa. B) fallen angels refer to newly issued bonds with low credit ratings. C) junk bonds refer to newly issued bonds with low credit ratings. D) both (A) and (B) of the above. Register to View Answer55) 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 issued bonds which have had their credit ratings fall below Baa. B) junk bonds refer to previously issued bonds which 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. Register to View Answer56) High-yield bonds rated below investment grade by the bond-rating agencies are frequency referred to as A) municipal bonds. B) Yankee bonds. C) fallen angels. D) junk bonds. Register to View Answer57) In 1977, ______ 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 Carl Ichan Register to View Answer 231 58) The practice of creating marketable debt instruments that are backed by otherwise illiquid assets is known as A) standardization. B) homogenization. C) securitization. D) adverse selection. Register to View Answer59) 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. Register to View Answer60) The bundling of GNMA-guaranteed mortgages into a saleable security (usually for large institutional investors) is called A) disintermediation. B) quasi-intermediation. C) futures bundling. D) hedge optioning. E) securitization. Register to View Answer61) Of all residential mortgages, approximately _____ are now securitized. A) one-fourth B) two-fifths C) one-half D) two-thirds E) three-fourths Register to View Answer62) In the usual GNMA pass-through security, the _____ has direct ownership of a prorata share of the portfolio of mortgage loans. A) seller B) buyer C) financial institution issuing the mortgage loan D) financial institution securitizing the mortgage loan Register to View Answer 232 63) In the usual GNMA pass-through security, A) the seller has direct ownership of a pro-rata share of the portfolio of mortgage loans. B) the financial institution issuing the mortgage loan has direct ownership of a pro-rata share of the portfolio of mortgage loans. C) the buyer has direct ownership of a pro-rata share of the portfolio of mortgage loans. D) the financial institution securitizing the mortgage loan has direct ownership of a pro-rata share of the portfolio of mortgage loans. Register to View Answer64) Since 1974, commercial banks importance as a source of funds for borrowers A) has shrunk dramatically, from around 35 percent of total credit advanced to below 20 percent by 1996. B) has shrunk dramatically, from around 70 percent of total credit advanced to below 50 percent by 1996. C) has expanded dramatically, from around 50 percent of total credit advanced to above 70 percent by 1996. D) has expanded dramatically, from around 30 percent of total credit advanced to above 50 percent by 1996. Register to View Answer65) Since 1974, commercial banks importance as a source of funds for borrowers has shrunk dramatically, from around _____ percent of total credit advanced to below _____ percent by 2001. A) 60; 30 B) 35; 30 C) 25; 20 D) 30; 15 Register to View Answer66) Thrift institutions importance as a source of funds for borrowers A) has shrunk from around 40 percent of total credit advanced in the late 1970s to below 30 percent by 2001. B) has shrunk from over 20 percent of total credit advanced in the late 1970s to below 10 percent by 2001. C) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above 25 percent by 2001. D) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above 30 percent by 2001. Register to View Answer 233 67) Since the late 1970s, thrift institutions importance as a source of funds for borrowers has shrunk markedly, from above _____ percent of total credit advanced to below _____ percent by 2001. A) 30; 20 B) 30; 15 C) 40; 5 D) 20; 10 Register to View Answer68) The recent dismal performance of the banking industry has led to a large number of bank failures and mergers that have reduced the number of commercial banks from around _____ in the 1970s to below _____ today. A) 25,000; 10,000 B) 15,000; 10,000 C) 25,000; 20,000 D) 15,000; 5,000 Register to View Answer69) The process in which people seeking higher interest rates take their money out of financial institutions is called A) capital motility. B) loophole mining. C) disintermediation. D) deposit jumping. Register to View Answer70) One factor contributing to the decline in cost advantages that banks once had is the decline in the importance of checkable deposits from over _____ percent of banks source of funds to _____ percent today. A) 70; 30 B) 60; 10 C) 50; 20 D) 40; 15 Register to View Answer71) The most important developments that have reduced banks cost advantages in the past twenty years include A) the elimination of Regulation Q ceilings. B) the competition from money market mutual funds. C) the growth of securitization. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 234 72) The most important developments that have reduced banks cost advantages in the past twenty years include A) the growth of the junk bond market. B) the competition from money market mutual funds. C) the growth of securitization. D) all of the above. E) only (A) and (B) of the above. Register to View Answer73) The most important developments that have reduced banks income advantages in the past twenty years include A) the growth of the commercial paper market. B) the growth of the junk bond market. C) the growth of securitization. D) all of the above. E) only (A) and (B) of the above. Register to View Answer74) The most important developments that have reduced banks income advantages in the past twenty years include A) the growth of the commercial paper market. B) the growth of the junk bond market. C) the elimination of Regulation Q ceilings. D) all of the above. E) only (A) and (B) of the above. Register to View Answer75) One factor contributing to the decline in income advantages that banks once had is the increased competition from the commercial paper market which has grown from _____ of commercial and industrial bank loans to over _____ percent today. A) 10; 20 B) 5; 20 C) 10; 40 D) 5; 40 Register to View Answer76) Rising market interest rates in the 1960s and the 1970s, combined with regulated deposit rate ceilings, A) worked in the short-run to give mortgage-issuing institutions a source of lowcost funds. B) led eventually to an outflow of deposits from depository institutions. C) led to financial innovations that worked to undo these regulations. D) did all of the above. E) did only (A) and (C) of the above. Register to View Answer 235 16.2 True/False 1) Today the United States has a dual banking system in which banks supervised by the federal government and banks supervised by the states operate side-by-side. Register to View Answer2) Bank holding companies are regulated by the FDIC. Register to View Answer3) The existence of large numbers of banks in the United States must be seen as an indication of the presence of vigorous competition. Register to View Answer4) Even when an ATM is owned by a bank, states typically have special provisions that allow wider establishment of ATMs than is permissible for traditional brick and mortar branches. Register to View Answer5) Bank holding companies that have begun to rival the money center banks in size but whose headquarters are not based in one of the money center cities are called superregional banks. Register to View Answer6) The future structure of the U.S. banking industry is likely to be characterized by many more smaller banks, as customers demand neighborhood banks operated by people they know personally. Register to View Answer7) Restrictions on commercial banks; securities and insurance activities put American banks at a competitive disadvantage relative to foreign banks. Register to View Answer8) Eurodollars are created when deposits in accounts in the United States are transferred to a bank outside the country and are kept in the form of dollars. Register to View Answer9) Financial innovation has widened the cost advantages that banks have in acquiring funds, helping to explain why bank profitability has soared in recent years. Register to View Answer10) A traditional source of low-cost funds for banks checkable deposits has declined dramatically in importance, falling from over 60 percent of bank liabilities to below 20 percent today. Register to View Answer 236 16.3 Essay 1) What are the reasons for the decline of traditional banking? 2) Is the large number of banking firms in the United States an indication of a competitive banking industry? Explain why or why not. 3) Are bank consolidation and nationwide banking good things? Why? 4) When and why was the Glass-Steagall Act passed? When and why was it repealed? 5) Describe Edge act corporations, international banking facilities, and the structure of foreign banks in the United States. 237 238 Chapter 17 Savings Associations and Credit Unions 17.1 Multiple Choice 1) Savings banks A) were first established in Scotland and England. B) were established to encourage saving by the poor. C) were very conservative with their funds, placing most of them in commercial banks. D) all of the above. E) only (A) and (B) of the above. Register to View Answer2) Which of the following statements about mutual savings banks are true? A) There are currently about 800 mutual savings banks in the United States. B) Most mutual savings banks are located along the eastern seaboard. C) Most mutual savings banks are federally-chartered. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer3) Which of the following statements concerning the mutual form of ownership of savings banks are true? A) The mutual form of ownership accentuates the principal-agent problem that exists in corporations. B) More capital is available, contributing to the safety of mutual savings banks compared to other banking organizations. C) Managers of mutual savings banks are more risk averse than in the corporate form, because the value of their ownership does not increase if the firm does well. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer4) Savings and loan associations A) were established by Congress to encourage home ownership. B) were, initially, not permitted to accept demand deposits. C) held about 85 percent of their assets in the form of mortgages prior to the Great Depression. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 239 5) Savings and loans A) were, initially, allowed to attract funds by offering savings accounts that paid a slightly higher interest rate than that offered by commercial banks. B) held about 85 percent of their total assets as mortgages prior to the Great Depression. C) did not weather the Great Depression well, as thousands of S&Ls failed in the 1930s. D) all of the above. E) only (A) and (B) of the above. Register to View Answer6) Thrifts A) fueled the home-building boom from 1934-1978. B) suffered in the 1970s as inflation rose above deposit interest rate ceilings. C) have grown in importance in attracting deposits relative to commercial banks since 1980. D) all of the above. E) only (A) and (B) of the above. Register to View Answer7) Thrifts suffered problems in the 1970s as A) market interest rates rose above the rates thrifts could pay on deposits and savings accounts. B) thrift customers moved their funds from thrifts to money market mutual funds. C) government regulators severely limited the scope of activities that thrifts could undertake to grow their way out of trouble. D) all of the above occurred. E) only (A) and (B) of the above occurred. Register to View Answer8) In the early stages of the 1980s banking crisis, financial institutions were especially hurt by A) the sharp increases in interest rates from late 1979 until 1981. B) the severe recession in 1981-82. C) the sharp decline in the price level from mid-1980 to early 1983. D) all of the above. E) only (A) and (B) of the above. Register to View Answer9) 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) all of the above. Register to View Answer 240 10) Savings and loans lost a total of $10 billion in 1981-1982 due to a combination of rising interest rates in 1979-1981 and A) the recession of 1981-1982 that reduced real estate prices enough to cause significant loan defaults. B) the regulatory restrictions enacted by Congress in 1981 and 1982. C) the loss of market share to commercial banks that were allowed to compete directly with thrifts in the real estate market. D) the acceleration of inflation in 1981-1982 that caused thrifts to lose additional funds to money market mutual funds. Register to View Answer11) In the 1980s, thrift institutions, which had been almost entirely restricted to making loans for home mortgages only, were allowed by regulators to A) finance acquisitions in commercial real estate. B) extend consumer loans. C) purchase junk bonds. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer12) The government granted thrifts greater powers in the early 1980s in hopes of turning the industrys problems around. These powers A) required greater expertise in managing risk than many thrift managers possessed. B) encouraged thrifts to expand lending rapidly in real estate, increasing their exposure to risk. C) expanded the scope and complexity of thrift lending activities that went beyond what regulators could effectively monitor, given their limited resources. D) did all of the above. E) did only (A) and (B) of the above. Register to View Answer13) Although as many as half of the S&Ls in the United States had a negative net worth and were thus insolvent by the end of 1982, regulators adopted a policy of _____, which amounted to _____ capital requirements. A) regulatory forbearance; raising B) regulatory forbearance; lowering C) regulatory agnosticism; raising D) regulatory agnosticism; lowering Register to View Answer 241 14) 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 selection C) regulatory agnosticism; moral hazard D) regulatory agnosticism; adverse selection Register to View Answer15) Which of the following reasons explain why federal regulators adopted a policy of regulatory forbearance toward insolvent financial institutions in the early 1980s? A) The FSLIC lacked sufficient funds to cover insured deposits in the insolvent S&Ls. B) The regulators were reluctant to close the firms that justified their regulatory existence. C) The Federal Home Loan Bank Board and the FSLIC were reluctant to admit that they were in over their heads with problems. D) All of the above. E) Only (A) and (B) of the above. Register to View Answer16) The policy of regulatory forbearance A) meant delaying the closing of zombie S&Ls as their losses mounted during the 1980s. B) benefited zombie S&Ls at the expense of healthy S&Ls, as healthy institutions lost deposits to insolvent institutions. C) contributed to declining profitability in the S&L industry and an increase in the number of zombie S&Ls. D) all of the above. E) only (A) and (B) of the above. Register to View Answer17) The policy of regulatory forbearance A) meant delaying the closing of zombie S&Ls as their losses mounted during the 1980s. B) benefited zombie S&Ls at the expense of healthy S&Ls, as healthy institutions lost deposits to insolvent institutions. C) had the advantage of benefiting healthy S&Ls by giving them the opportunity to attract deposits that began to leave the zombie S&Ls. D) both (A) and (B) of the above. E) both (A) and (C) of the above. Register to View Answer 242 18) Which of the following are reasons that explain why regulators pursued a policy of regulatory forbearance toward thrifts in the early 1980s? A) Regulators knew that the FSLIC did not have sufficient funds to close insolvent S&Ls and pay off their depositors. B) Regulators were probably too close to the people they were supposed to be regulating to close down thrifts and put them out of business. C) Regulators preferred to sweep the problems that thrifts were suffering under the rug in the hope that they would go away as the economy improved. D) All of the above explain regulatory forbearance. E) Only (A) and (B) of the above explain regulatory forbearance. Register to View Answer19) Examples of the huge risks that zombie S&Ls undertook include A) building shopping centers in the desert. B) buying manufacturing plants to convert manure to methane. C) purchasing billions of dollars of junk bonds. D) all of the above. E) only (A) and (B) of the above. Register to View Answer20) Zombie S&Ls A) paid above market interest rates to attract deposits to fuel their lending boom. B) offered loans at below market interest rates to expand their lending. C) drove down the profitability of solvent S&Ls, threatening to turn them into zombies too. D) did all of the above. E) did only (A) and (B) of the above. Register to View Answer21) According to the text, the Competitive Equality in Banking Act of 1987 A) turned the thrift industry around by providing the necessary funds to close the zombie S&Ls. B) lowered the cost of bailing out the S&Ls by quickly closing zombie S&Ls before they could cause other thrifts to fail. C) failed to provide the funds necessary to close ailing S&Ls, and actually encouraged regulators to continue to pursue regulatory forbearance. D) did both (A) and (B) of the above. Register to View Answer22) The Competitive Equality in Banking Act of 1987 A) discouraged regulators from pursuing regulatory forbearance. B) directed regulators to close zombie S&Ls as quickly as administratively possible. C) encouraged regulators to continue their policy of regulatory forbearance. D) did both (A) and (B) of the above. Register to View Answer 243 23) The Competitive Equality Banking Act of 1987 A) provided insufficient funds to the FSLIC to close down insolvent S&Ls. B) actually directed S&L regulators to continue to pursue regulatory forbearance, further delaying the closing of insolvent S&Ls. C) created a new agency, the Resolution Trust Corporation, to manage insolvent thrifts. D) did all of the above. E) did only (A) and (B) of the above. Register to View Answer24) The major provisions of the Competitive Equality Banking Act of 1987 include A) expanding the responsibilities of the FDIC, which is now the sole administrator of the federal deposit insurance system. B) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. C) directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance. D) all of the above. E) only (A) and (B) of the above. Register to View Answer25) The major provisions of the Competitive Equality Banking Act of 1987 include A) the abolishment of the Federal Home Loan Bank Board and the FSLIC. B) transferring the regulatory role of the Federal Home Loan Bank Board to the Office of Thrift Supervision, a bureau within the U.S. Treasury Department. C) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. D) all of the above. E) none of the above. Register to View Answer26) An analysis of the political economy of the savings and loan crisis helps one to understand A) why politicians hampered the efforts of thrift regulators, cutting regulatory appropriations and encouraging regulatory forbearance. B) why thrift regulators were so reluctant to admit that any problem even existed in the thrift industry. C) why thrift regulators willingly acceded to pressures placed upon them by members of Congress. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 244 27) 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) all of the above. Register to View Answer28) The political economy of the S&L crisis shows that the principal-agent problem occurs in politics. In this instance, the agent-regulators did not act to protect taxpayers because A) regulators wanted to escape blame, hoping the situation would improve before others discovered the problem. B) regulators responded to pressure to pursue regulatory forbearance from politicians who had accepted campaign donations from owners of S&Ls. C) Congress was unwilling to allocate the necessary funds regulators needed to close insolvent S&Ls. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer29) That taxpayers were poorly served by thrift regulators in the 1980s is now quite clear. This poor performance is explained by A) regulators desire to escape blame for poor performance, leading to a perverse strategy of regulatory gambling. B) regulators incentives to accede to pressures imposed by politicians, who sought to keep regulators from imposing tough regulations on institutions that were major campaign contributors. C) Congresss unwillingness to appropriate sufficient funds to permit regulators to examine the many thrift institutions that needed monitoring. D) all of the above. E) only (A) and (B) of the above. Register to View Answer30) That taxpayers were poorly served by thrift regulators in the 1980s is now quite clear. This poor performance can not be explained by A) regulators desire to escape blame for poor performance, leading to a perverse strategy of regulatory gambling. B) regulators incentives to accede to pressures imposed by politicians, who sought to keep regulators from imposing tough regulations on institutions that were major campaign contributors. C) Congresss dogged determination to protect taxpayers from the unsound banking practices of managers at many of the nations savings and loans. D) any of the above. Register to View Answer245 31) That several hundred S&Ls were not even examined once in the period January 1984 through June 1986 can be explained by A) Congresss unwillingness to allocate the necessary funds to thrift regulators. B) regulators reluctance to find the specific problem thrifts that they knew existed. C) prohibitions against onerous regulatory restrictions against S&Ls as mandated in the Competitive Banking Equality Act. D) all of the above. E) only (A) and (B) of the above. Register to View Answer32) Bureaucratic gambling refers to A) the strategy of thrift managers that they would not be audited by thrift regulators in the 1980s due to the relatively weak bureaucratic power of thrift regulators. B) the risk that thrift regulators took in publicizing the plight of the S&L industry in the early 1980s. C) the strategy adopted by thrift regulators of lowering capital requirements and pursuing regulatory forbearance in the 1980s in the hope that conditions in the S&L industry would improve. D) none of the above. Register to View Answer33) Charles Keating A) was allowed to acquire Lincoln Savings and Loan of Irvine, California, even though he had been accused of fraud by the SEC only four and a half years earlier. B) fired Lincolns conservative lending officers and internal auditors, even though he had promised regulators he would keep them. C) enlisted the help of five senators to delay the seizure of Lincolns assets. D) did all of the above. Register to View Answer34) Examiners from the Federal Home Loan Bank Board of San Francisco recommended that Lincoln Savings and Loan be seized when they discovered that A) officials at the thrift had attempted to mislead them. B) it had exceeded the 10 percent limit on equity investments by $600 million. C) its owner, Charles Keating, had been convicted of embezzlement ten years before he purchased the thrift. D) all of the above. E) both (A) and (B) of the above. Register to View Answer 246 35) The bailout of the savings and loan industry was much delayed and, therefore, much more costly to taxpayers because A) of regulators initial attempts to downplay the seriousness of problems within the thrift industry. B) politicians who received generous campaign contributions from the savings and loan industry, like regulators, hoped that the problems in the industry would ease over time. C) Congress encouraged, and thrift regulators acceded to, a policy of regulatory forbearance. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer36) The bailout of the savings and loan industry was much delayed and, therefore, much more costly to taxpayers because A) of regulators initial attempts to downplay the seriousness of problems within the thrift industry. B) politicians who received generous campaign contributions from the savings and loan industry, like regulators, hoped that the problems in the industry would ease over time. C) Congress did not wait long enough for many of the problems in the thrift industry to correct themselves. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer37) Prior to August 1989, the agency that regulated the nations savings and loan associations was the A) Federal Home Loan Bank Board. B) Office of Thrift Supervision. C) Resolution Trust Corporation. D) Comptroller of the Currency. Register to View Answer38) The Federal Home Loan Bank Board and the FSLIC, both of which failed in their regulatory tasks, were abolished by the A) Competitive Equality Banking Act of 1987. B) Financial Institutions Reform, Recovery and Enforcement Act of 1989. C) Office of Thrift Supervision. D) Office of the Comptroller of the Currency. Register to View Answer 247 39) The major provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 include A) the abolishment of the Federal Home Loan Bank Board and the FSLIC. B) transferring the regulatory role of the Federal Home Loan Bank Board to the Office of Thrift Supervision, a bureau within the U.S. Treasury Department. C) expanding the responsibilities of the FDIC, which is now the sole administrator of the federal deposit insurance system. D) all of the above. E) only (A) and (B) of the above. Register to View Answer40) The major provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 include A) the abolishment of the Federal Home Loan Bank Board and the FSLIC. B) transferring the regulatory role of the Federal Home Loan Bank Board to the Office of Thrift Supervision, a bureau within the U.S. Treasury Department. C) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. D) all of the above. E) only (A) and (B) of the above. Register to View Answer41) The major provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 include A) transferring the regulatory role of the Federal Home Loan Bank Board to the Office of Thrift Supervision, a bureau within the U.S. Treasury Department. B) expanding the responsibilities of the FDIC, which is now the sole administrator of the federal deposit insurance system. C) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. D) all of the above. E) only (A) and (B) of the above. Register to View Answer42) The major provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 include A) expanding the responsibilities of the FDIC, which is now the sole administrator of the federal deposit insurance system. B) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. C) directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 248 43) The major provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 include A) reducing the regulatory responsibilities of the FDIC. B) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. C) directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance. D) all of the above. E) only (A) and (B) of the above. Register to View Answer44) To replenish the reserves of the Savings Association Insurance Fund, insurance premiums for S&Ls were increase from ____ cents per $100 of deposits to _____ cents and can rise as high as 32.5 cents. A) 12.5; 17.5 B) 17.5; 20.5 C) 20.8; 23.0 D) 23.0; 27.5 Register to View Answer45) Since 1993, the number of savings and loan associations has A) held steady. B) risen sharply. C) risen slightly. D) declined substantially. Register to View Answer46) The largest asset held by S&Ls is A) consumer loans. B) securities. C) mortgage loans. D) consumer savings. Register to View Answer47) (I) S&Ls net worth ratio is about the same as that of commercial banks. (II) Goodwill accounts for a majority of S&Ls capital. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer 249 48) Credit unions are characterized by A) mutual ownership. B) common bond membership. C) nonprofit, tax-exempt status. D) all of the above. E) none of the above. Register to View Answer49) The smallest average-size depository institution is A) credit unions. B) savings and loan associations. C) commercial banks. D) money market mutual funds. Register to View Answer50) Which of the following is a lender of last resort for credit unions? A) National Credit Union Administration B) Federal Reserve System C) State central credit unions D) The Central Liquidity Facility Register to View Answer51) The day-to-day liquidity needs of credit unions are met by A) National Credit Union Administration B) Federal Reserve System C) State central credit unions D) The Central Liquidity Facility Register to View Answer52) Since 1980 the number of credit unions has A) declined substantially. B) remained steady. C) increased substantially. D) declined slightly. Register to View Answer53) Credit unions main source of funds is A) regular share accounts. B) share certificates. C) share draft accounts. D) share certificates. Register to View Answer 250 54) Credit unions main type of loans is A) mortgages. B) automobile. C) credit cards. D) nonresidential real estate. Register to View Answer 17.2 True/False 1) The mutual form of ownership accentuates the principal-agent problem that exists in corporations. Register to View Answer2) Savings and loans are not as heavily concentrated in mortgages and have had more flexibility in their investing practices than mutual savings banks. Register to View Answer3) The congressionally imposed cap on the interest rate that S&Ls could pay on savings accounts became a serious problem for them in the 1970s when inflation rose. Register to View Answer4) Regulatory forbearance reduces moral hazard because an operating but insolvent S&L will take fewer risks than healthy S&Ls that can take risks and still remain solvent. Register to View Answer5) The Competitive Equality in Banking Act of 1987 allowed the FSLIC to borrow all the funds it needed to close insolvent S&Ls and pay off depositors. Register to View Answer6) In the 1980s, regulators engaged in bureaucratic gambling when they allowed insolvent S&Ls to continue operating. Register to View Answer7) FIRREA imposed new restrictions on thrift activities that, in essence, re-regulated the S&L industry to the asset choices it had before 1982. Register to View Answer8) Total assets of savings and loans peaked in 1988. Register to View Answer 251 9) Credit unions view commercial banks as government-supported and hence unfair competitors due to their tax advantages. Register to View Answer10) Mutual savings banks are the only financial institutions that are tax-exempt. Register to View Answer 17.3 Essay 1) Explain why thrift regulators engaged in regulatory forbearance in the 1980s. 2) How has the thrift industry been transformed since FIRREA? 3) Why have commercial banks gone to court in an effort to limit the activities of credit unions? 4) Explain how the Lincoln Savings and Loan scandal is an application of the principal-agent problem. 5) Why didnt the Competitive Equality in Banking Act of 1987 solve the problems in the thrift industry? 252 Chapter 18 Banking Regulation 18.1 Multiple Choice 1) During the boom years of the 1920s, bank failures were quite A) uncommon, averaging less than 30 per year. B) uncommon, averaging less than 100 per year. C) common, averaging about 600 per year. D) common, averaging about 2000 per year. Register to View Answer2) 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. Register to View Answer3) Moral hazard is an important feature 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) both (A) and (B) of the above. E) both (B) and (C) of the above. Register to View Answer4) 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 Register to View Answer5) 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. Register to View Answer253 6) Although the FDIC 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. Register to View Answer7) 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. Register to View Answer8) Deposit insurance A) attracts risk-prone entrepreneurs to the banking industry. B) encourages bank managers to take on greater risks than they otherwise would. C) reduces the incentives of depositors to monitor the riskiness of their banks asset portfolios. D) does all of the above. E) does only (A) and (B) of the above. Register to View Answer9) If the FDIC 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 Register to View Answer10) One problem of the too-big-to-fail policy is that it A) reduces the incentives for moral hazard by big banks. B) increases the incentives for moral hazard by big banks. C) reduces the incentives for adverse selection by big banks. D) increases the incentives for adverse selection by big banks. Register to View Answer11) 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 Register to View Answer254 12) The too-big-to-fail policy A) exacerbates 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) does only (A) and (C) of the above. Register to View Answer13) The primary difference between the payoff and the purchase and assumption methods of handling failed banks is A) that the FDIC guarantees all deposits, not just those under the $100,000 limit, when it uses the payoff method. B) that the FDIC guarantees all deposits, not just those under the $100,000 limit, when it uses the purchase and assumption method. C) that the FDIC 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) both (A) and (B) of the above. E) both (B) and (C) of the above. Register to View Answer14) The primary difference between the payoff and the purchase and assumption methods of handling failed banks is A) that the FDIC guarantees all deposits, not just those under the $100,000 limit, when it uses the payoff method. B) that the FDIC guarantees all deposits, not just those under the $100,000 limit, when it uses the purchase and assumption method. C) that the FDIC is less 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) both (A) and (B) of the above. E) both (B) and (C) of the above. Register to View Answer15) According to the FDIC in 1991, the Bank of New England was A) too big to fail. B) too big to save. C) too small to fail D) too small to save. Register to View Answer16) According to the FDIC in 1990, the Freedom National Bank of Harlem was A) too big to fail. B) too big to save. C) not too big to fail D) not too big to save. Register to View Answer255 17) The failure of the Bank of New England cost its largest depositors A) $225 million. B) $450 million. C) $750 million. D) $2.3 billion. E) nothing. Register to View Answer18) The failure of the Freedom National Bank of Harlem cost its largest depositors A) nothing. B) fifty cents on the dollar for deposits in excess of $100,000. C) ninety cents on the dollar for deposits in excess of $100,000. D) ninety-eight cents on the dollar for deposits in excess of $100,000. Register to View Answer19) 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) prohibiting banks from holding risky assets such as common stocks. C) establishing a minimum interest rate floor that banks can earn on certain assets. D) doing all of the above. E) doing only (A) and (B) of the above. Register to View Answer20) One way for bank regulators to assure depositors that banks are not taking on too much risk is to require that banks A) diversify its loan portfolio. B) reduce its equity capital. C) reduce the size of its loan portfolio. D) do both (A) and (B) of the above. E) do both (B) and (C) of the above. Register to View Answer21) Banks do not want to hold too much capital because A) they do not bear fully the costs of bank failures. B) higher returns on equity are earned when bank capital is smaller. C) higher capital levels attract the scrutiny of regulators. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 256 22) The increased integration of financial markets across countries and the need to make the playing field equal for banks from different countries led to the Basel agreement to A) standardize bank capital requirements internationally. B) reduce, across the board, bank capital requirements in all countries. C) sever the link between risk and capital requirements. D) do all of the above. Register to View Answer23) Under the Basel Plan, A) assets and off-balance sheet activities are assigned to different categories to reflect the degree of credit risk. B) a banks total capital must equal or exceed 8 percent of total risk-adjusted assets. C) both of the above. D) none of the above. Register to View Answer24) Of the following assets, the one which has the highest capital requirement under the Basel Accord is A) municipal bonds. B) residential mortgages. C) commercial paper. D) securities issued by government agencies. Register to View Answer25) Which of the following is not true regarding the Basel 2 proposals to reform the original 1988 Basel accord? A) It attempts to link capital requirements more closely to actual risk by expanding the number of risk categories. B) It focuses on assessing the quality of risk management in banking institutions. C) It attempts to improve market discipline by requiring increased disclosure of pertinent information about banks. D) It has been well received by banks and national regulatory agencies. Register to View Answer26) Ways in which bank regulations reduce the adverse selection and moral hazard problems in banking include A) a chartering process designed to prevent crooks from getting control of a bank. B) restrictions that prevent banks from acquiring certain risky assets, such as common stocks. C) high bank capital requirements to increase the cost of bank failure to the owners. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 257 27) 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 Register to View Answer28) The chartering process is especially designed to deal with the _____ problem, and restrictions on asset holdings 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 Register to View Answer29) Regular bank examinations and restrictions on asset holdings indirectly help to reduce the _____ problem because, given fewer opportunities to take on risk, riskprone entrepreneurs will be discouraged from entering the banking industry. A) moral hazard B) adverse selection C) ex post shirking D) post-contractual opportunism. Register to View Answer30) Regular bank examinations and restrictions on asset holdings indirectly help to _____ the adverse selection problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be _____ from entering the banking industry. A) increase; encouraged B) increase; discouraged C) reduce; encouraged D) reduce; discouraged Register to View Answer31) The legislation that separated investment banking from commercial banking is known as the A) National Bank Act of 1863. B) Federal Reserve Act of 1913. C) Glass-Steagall Act. D) McFadden Act. Register to View Answer 258 32) The Depository Institutions Deregulation and Monetary Control Act of 1980 A) approved NOW accounts nationwide. B) restricted the use of ATS accounts. C) imposed restrictive usury ceilings on large agricultural loans. D) did all of the above. Register to View Answer33) The Depository Institutions Deregulation and Monetary Control Act of 1980 A) approved NOW accounts nationwide. B) imposed uniform reserve requirements. C) mandated the phase out of interest rate ceilings on deposits. D) did all of the above. E) did only (A) and (B) of the above. Register to View Answer34) As a way of stemming the decline in the number of savings and loans and mutual savings banks, the Garn-St. Germain Act of 1982 allowed A) MMCs. B) MMMFs. C) MMDAs. D) NOWs. Register to View Answer35) An impact of the Garn-St. Germain Act of 1982 has been to A) put savings and loans at a competitive disadvantage. B) make the banking system more competitive. C) give money market mutual funds a competitive advantage. D) do both (A) and (B) of the above. E) do both (A) and (C) of the above. Register to View Answer36) Moral hazard and adverse selection problems increased in prominence in the 1980s A) as deregulation opened up more avenues for savings and loans and mutual savings banks to take on more risk. B) following a burst of financial innovation in the 1970s and early 1980s that produced new financial instruments and markets, thereby widening the scope for risk taking. C) following an increase in federal deposit insurance from $40,000 to $100,000. D) all of the above. E) only (A) and (B) of the above. Register to View Answer 259 37) Moral hazard and adverse selection problems increased in prominence in the 1980s A) as deregulation opened up more avenues for savings and loans and mutual savings banks to take on more risk. B) following a burst of financial innovation in the 1970s and early 1980s that produced new financial instruments and markets, thereby widening the scope for risk taking. C) following a decrease in federal deposit insurance from $100,000 to $40,000. D) all of the above. E) only (A) and (B) of the above. Register to View Answer38) The Federal Deposit Insurance Corporation Improvement Act of 1991 A) increased the FDICs ability to borrow from the Treasury to deal with failed banks. B) reduced the scope of deposit insurance in several ways. C) eliminated governmentally-administered deposit insurance. D) did only (A) and (B) of the above. Register to View Answer39) The Federal Deposit Insurance Corporation Improvement Act of 1991 A) reduced the scope of deposit insurance in several ways. B) eliminated restrictions on nationwide banking. C) allowed well-capitalized banks to do some securities underwriting. D) did only (A) and (B) of the above. E) did only (A) and (C) of the above. Register to View Answer40) The Federal Deposit Insurance Corporation Improvement Act of 1991 A) reduced the scope of deposit insurance in several ways. B) limited the FDICs ability to use the too-big-to-fail policy. C) requires the FDIC to intervene earlier when a bank gets into trouble. D) did all of the above. Register to View Answer41) The Federal Deposit Insurance Corporation Improvement Act of 1991 A) instructed the FDIC to come up with risk-based deposit insurance premiums. B) expanded the FDICs ability to use the too-big-to-fail policy. C) instructed the FDIC to wait longer before intervening when a bank gets into trouble. D) did all of the above. Register to View Answer 260 42) Market-value accounting has a number of advantages over historical-cost accounting, including A) giving regulators the ability to close a bank before its net worth falls to zero. B) reducing the incidence in the number of banks that bet-the-bank by taking excessive risks in hopes of staying in operation. C) making it more difficult for bank officials to hide insolvencies. D) making it more difficult for regulators and politicians to hide insolvencies. E) all of the above Register to View Answer43) Research by the World Bank on the effects of deposit insurance concludes that A) adoption of deposit insurance will promote stability and efficiency in the banking systems of emerging-market economies. B) adoption of explicit government deposit insurance is associated with a higher incidence of banking crises. C) adoption of deposit insurance has the greatest benefits in countries that have weaker institutional environments. D) none of the above are true. Register to View Answer 18.2 True/False 1) To understand banking regulation in the United States, it is helpful to understand the concepts of asymmetric information, adverse selection, and moral hazard. Register to View Answer2) Because asymmetric information problems in the banking industry are a fact of life throughout the world, bank regulation in other countries is similar to that in the United States. Register to View Answer3) The failure of one bank can hasten the failure of others in what is referred to as a contagion effect. Register to View Answer4) To be classified as a well-capitalized bank, a banks leverage ratio must exceed 8 percent. Register to View Answer5) Once a bank has been chartered, it is required to file periodic call reports that reveal the banks assets and liabilities, income, ownership, and other details. Register to View Answer6) Truth in lending was mandated under the Consumer Protection Act of 1969 and requires all lenders to reveal the annual percentage rate, or APR, on loans. Register to View Answer261 7) Probably the most important feature of FDICIA is its prompt corrective action provisions which require the FDIC to intervene earlier and more vigorously when a bank gets into trouble. Register to View Answer8) According to some economists, Congress made a mistake when it passed the FDICIA of not requiring the FDIC to assess risk-based insurance premiums. Register to View Answer9) When the payoff method is used to resolve a failed bank, both large and small are protected from suffering losses. Register to View Answer 18.3 Essay 1) What do we learn about the causes of banking crises by comparing crises throughout the world to those that have occurred in the United States? 2) What is the asymmetric information problem and how does it contribute to our understanding of the structure of bank regulation in the United States and other countries? 3) Why did the United States experience a banking crisis in the 1980s? 4) How has bank regulation changed in the United States since the late 1980s? What accounts for these changes? 5) How have bank capital requirements changed since the banking crisis of the 1980s? Explain. 6) Describe the CAMELS rating system used by bank examiners. 7) How does market-value accounting for capital requirements work? What are its advantages and disadvantages? 262 Chapter 19 Insurance Companies and Pension Funds 19.1 Multiple Choice 1) The earliest form of insurance was ______ insurance. A) life B) health C) automobile D) property and casualty Register to View Answer2) Adverse selection occurs when those _____ likely to get _____ insurance payoffs are the ones who want to purchase insurance the most. A) least; large B) least; small C) most; large D) most; small Register to View Answer3) When those most likely to produce the outcome insured against are the ones who purchase insurance, insurance companies are said to face the problem of A) fraudulent claims. B) moral hazard. C) adverse selection. D) pecuniary purchases. Register to View Answer4) To prevent adverse selection, health and life insurance companies A) sometimes charge higher premiums to people with certain pre-existing health conditions. B) require potential policyholders to submit medical records, and may refuse to sell policies to people with certain pre-existing health conditions. C) charge the same premiums to all policyholders. D) will do both (A) and (B) of the above. Register to View Answer5) In the case of an insurance policy, _____ occurs when the existence of insurance encourages the insured party to take risks that increase the likelihood of an insurance payoff. A) moral hazard B) opportunism C) adverse selection D) shirking Register to View Answer 263 6) Some automobile owners will drive faster knowing that they are covered by health and automobile insurance. This behavior creates the problem of A) fraudulent claims. B) moral hazard. C) adverse selection. D) pecuniary purchases. Register to View Answer7) In the case of an insurance policy, _____ occurs when the existence of insurance encourages the insured party to take risks that increase the likelihood of an insurance payoff; _____ occurs when those most likely to get large insurance payoffs are the ones who want to purchase insurance the most. A) moral hazard; insurance market discrimination B) moral hazard; insurance segregation C) moral hazard; adverse selection D) adverse selection; moral hazard Register to View Answer8) To prevent the moral hazard problem, health and life insurance companies may write policies A) for which premiums increase dramatically once the policyholder is discovered to have contracted an illness. B) containing provisions which either reduce or eliminate benefits to persons who contract pre-specified illnesses. C) limiting the amount the companies will pay in the event that claims are submitted by policyholders. D) with all of the above provisions. E) with only (A) and (B) of the above provisions. Register to View Answer9) To prevent the moral hazard problem, health and life insurance companies may write policies A) that increase benefits dramatically once the policyholder is discovered to have contracted an illness so that the patient can recover sooner. B) containing provisions which either reduce or eliminate benefits to persons who contract pre-specified illnesses. C) boosting the amount the companies will pay health providers in the event that claims are submitted by policyholders. D) with only (A) and (B) of the above provisions. Register to View Answer10) Insurance management tools that give policyholders incentives to avoid accidents insured against include A) deductibles. B) risk-based premiums. C) coinsurance. D) all of the above. Register to View Answer264 11) Which is not a management practice for reducing the problems of adverse selection and moral hazard in insurance? A) deductibles B) restrictive provisions C) coinsurance D) reinsurance Register to View Answer12) Insurance companies employ underwriters A) as an alternative to higher deductibles. B) to control the risky behavior of their policy holders. C) to control the risk incurred on their behalf by agents. D) to encourage the loyalty of exclusive agents. E) to maintain the independence of independent agents. Register to View Answer13) __________ companies get a tax advantage; most new insurance companies organize as ________ companies. A) Mutual insurance; mutual insurance B) Mutual insurance; stock C) Stock; stock D) Stock; mutual insurance Register to View Answer14) (I) A minority of life insurance companies are organized as mutual companies. (II) State governments have the major responsibility for regulating insurance companies. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Register to View Answer15) Which of the following do not help people during their retirement? A) Term life insurance B) Annuity C) Whole life insurance D) Universal life insurance Register to View Answer16) A term life insurance policy provides A) insurance benefits only. B) savings benefits only. C) both insurance and savings benefits. D) none of the above. Register to View Answer 265 17) Which of the following types of life insurance provides no savings element? A) term B) whole C) universal D) none of the above have a savings element. Register to View Answer18) Which of the following is true of life insurance companies? A) They hold long-term assets that are not particularly liquid. B) They hold short-term liquid assets. C) Payouts to policyholders are relatively predictable. D) Both (A) and (C) of the above. Register to View Answer19) Of the following financial intermediaries, which holds the least liquid assets? A) Property and casualty insurance companies B) Life insurance companies C) Money market mutual funds D) Commercial banks Register to View Answer20) Relative to life insurance companies, property and casualty insurance companies hold A) more liquid assets. B) more long-term government bonds. C) more commercial mortgages. D) fewer municipal bonds. Register to View Answer21) The federal regulatory agency responsible for regulating the activities of life insurance companies is A) the FDIC. B) the Fed. C) the FHLBS. D) none of the above; there is no such federal regulatory agency. Register to View Answer22) Insurance companies attempts to minimize adverse selection and moral hazard explain which of the following insurance practices? A) Risk-assessment screening B) Risk-based premiums C) Restrictive provisions D) All of the above E) Only (A) and (B) of the above Register to View Answer 266 23) Insurance companies attempts to minimize adverse selection and moral hazard explains which of the following insurance practices? A) Collateral deposits B) Risk-based premiums C) Compensating balances D) All of the above E) Only (A) and (B) of the above Register to View Answer24) Insurance companies attempts to minimize adverse selection and moral hazard explain which of the following insurance practices? A) Gender-neutral premiums B) Flat-rate premiums C) Restrictive provisions D) All of the above E) Only (A) and (B) of the above Register to View Answer25) Insurance companies attempts to minimize adverse selection and moral hazard explain which of the following insurance practices? A) Collection of information and screening of potential policyholders B) Risk-based premiums C) Cancellation of insurance D) All of the above Register to View Answer26) Insurance companies attempts to minimize adverse selection and moral hazard explain which of the following insurance practices? A) Collection of information and screening of potential policyholders B) Risk-based premiums C) Deductibles and coinsurance D) All of the above E) Only (A) and (B) of the above Register to View Answer27) If automobile insurance companies were to be prevented from charging risk-based premiums, but could selectively screen potential policyholders, the likely effect would be to A) increase the number of young men obtaining insurance coverage relative to young women. B) decrease the number of young women obtaining insurance coverage relative to young men. C) decrease the number of young men obtaining insurance coverage relative to young women. D) both (A) and (B) of the above. Register to View Answer 267 28) The fact that insurance companies charge young males higher automobile insurance premiums than young females is an example of A) risk-based premiums. B) an attempt to minimize adverse selection. C) coinsurance. D) all of the above. E) only (A) and (B) of the above. Register to View Answer29) Insurance management tools that give policyholders incentives to avoid accidents insured against include A) deductibles. B) risk-based premiums. C) coinsurance. D) all of the above. Register to View Answer30) Clauses in life insurance policies that eliminate death benefits if the insured person commits suicide is an example of a A) restrictive provision. B) restrictive covenant. C) anti-fraud exclusion. D) risk-based deductible. Register to View Answer31) Social Security is a A) fully funded pension plan. B) federally insured private pension plan. C) government sponsored private pension plan. D) pay-as-you-go system. Register to View Answer32) The Social Security system is an example of a public pension plan that is A) underfunded. B) fully funded. C) overfunded. D) none of the above. Register to View Answer33) Fraudulent practices and other abuses of private pension funds led Congress to enact the A) FDIC Act. B) Federal Reserve Act. C) FHLBS. D) Employee Retirement Income Security Act. Register to View Answer 268 34) Keough plans and IRAs are A) individual pension plans. B) government pension plans. C) corporate pension plans. D) public pension plans. Register to View Answer35) Pension plan assets are invested mainly in A) government securities. B) corporate bonds. C) certificates of deposit. D) stock. Register to View Answer36) Which of the following pensions does not promise employees a specific retirement benefit? A) defined-benefit plan B) defined-contribution plan C) overfunded plan. D) underfunded plan. Register to View Answer 19.2 True/False 1) Adverse selection occurs when those most likely to get insurance payoffs are the ones who want to purchase the insurance the most. Register to View Answer2) The fact that insurance companies charge young males higher automobile insurance premiums than young females is an example of coinsurance. Register to View Answer3) When a life-long chain smoker attempts to purchase a life insurance policy, the insurance company faces the problem of adverse selection. Register to View Answer4) The higher the insurance coverage, the more the policyholder can gain from risky activities that make an insurance payoff less likely. Register to View Answer5) Vesting refers to the length of time that a person must be enrolled in a pension plan before being entitled to receive benefits. Register to View Answer 269 6) The Pension Benefit Guarantee Corporation performs a role similar to that of the Office of Thrift Supervision. Register to View Answer7) Social Security is a pay-as-you-go system. Register to View Answer8) The Social Security system is an example of a pension plan that is fully funded. Register to View Answer9) A whole life insurance policy pays a death benefit if the policyholder dies. Register to View Answer10) Most private pension plans are insured by the Penny Benny, which pays benefits when a plans sponsor goes bankrupt. Register to View Answer 19.3 Essay 1) Would you prefer the manager of the pension plan in which you are enrolled to be paid a flat fee, independent of the performance of the plan, or be paid based on the funds performance, even if that might mean paying him or her a higher salary? Explain. 2) Who has the strongest incentive to monitor the performance of individual pension plans such as Keoghs and IRAs? Explain. 3) Why do life insurance companies and pension plans invest heavily in long-term assets? 4) Why must insurance companies screen applicants so carefully? 5) Distinguish between different types of life insurance. 6) What are the major differences between life insurance and property and casualty insurance? 7) Describe the alternatives for privatizing Social Security. 270 Chapter 20 Venture Capital Firms, Finance Companies, and Financial Conglomerates 20.1 Multiple Choice 1) A ______ is a specialized firm that finances young, start-up companies. A) venture capital firm B) finance company C) small-business finance company D) capital-creation company Register to View Answer2) Venture capital firms are usually organized as A) closed-end mutual funds B) limited partnerships C) corporations D) nonprofit businesses Register to View Answer3) Which of the following is not a characteristic feature of venture capital firms? A) Funding just one or a small number of firms. B) Holding equity in the firms that are funded. C) Having a long-term investment horizon. D) Providing advice and assistance to the firms that are funded. Register to View Answer4) Which of the following is a characteristic feature of venture capital firms? A) Developing a portfolio of companies. B) Holding debt in the firms that are funded. C) Allowing firms to use the funds as they see fit. D) Having a short-term investment horizon. Register to View Answer5) The largest industry group receiving venture capital funding is A) computer software. B) medical/health. C) computer hardware. D) none of the above. Register to View Answer6) The source of venture capital funding has A) shifted from wealthy individuals to pension funds and corporations. B) shifted from pension funds and corporations to wealthy individuals. C) decreased since 1990. D) none of the above. Register to View Answer271 7) A typical venture capital firm has a ______ number of investors who each contribute a ______ amount of money to the fund. A) large; small B) small; large C) large; large D) small; small Register to View Answer8) The 20-year average return of venture capital firms has been about ______. A) 50 percent B) 8 percent C) 20 percent D) 100 percent Register to View Answer9) The earliest examples of finance companies date back to the beginning of the 1800s when retailers offered A) installment credit to customers. B) balloon loans to customers. C) zero-interest loans to customers. D) all of the above to customers. Register to View Answer10) Most automobile financing is provided by A) commercial banks. B) thrifts. C) finance companies owned by automobile companies. D) finance companies owned by real estate brokers. Register to View Answer11) Finance companies A) are money market intermediaries. B) borrow in large amounts, but lend in small amounts. C) are virtually unregulated. D) are all of the above. E) are only (A) and (B) of the above. Register to View Answer12) Consumer finance companies can be distinguished from commercial banks because consumer finance companies A) often accept loans with much higher default risk than banks would. B) are often wholly owned by a manufacturer that might be willing to offer favorable credit terms to sell products. C) typically offer lower interest rates to its loan customers than do banks. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer272 13) Which of the following statements about finance companies are true? A) Finance company delinquency rates are usually higher than those for banks or thrifts. B) Finance companies charge higher interest rates than do commercial banks. C) Interest-rate risk is a more serious problem for finance companies than for banks and thrifts. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer14) The three types of finance companies are A) business, consumer, and retail. B) business, sales, and consumer. C) retail, wholesale, and consumer. D) retail, business, and sales. Register to View Answer15) Of the types of loans made by finance companies, A) consumer loans account for about 50 percent of all loans. B) real estate loans account for about 40 percent of all loans. C) business loans account for about 55 percent of all loans. D) consumer and real estate loans account for about 55 percent of all loans. Register to View Answer16) Which of the following statements about finance companies are true? A) Finance companies offered loans secured by accounts receivable before commercial banks did. B) Finance companies gained a reputation for being more innovative than banks at finding ways to finance small businesses. C) Loans secured by motor vehicles, which include loans to buy autos for business use and for resale, are the second most common type of finance company loan. D) All of the above are true. E) Only (A) and (B) of the above. Register to View Answer17) Which of the following statements about finance companies are true? A) Finance companies have gained a reputation for being more innovative than banks at finding ways to finance small businesses. B) Loans secured by automobiles are the most common type of finance company loan. C) Because finance companies are virtually unregulated, they charge lower interest rates than do commercial banks. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 273 18) Business finance companies provide specialized forms of credit to businesses by making loans and purchasing accounts receivable at a discount; this provision of credit is called A) discounting. B) factoring. C) refinancing D) sparking. Register to View Answer19) Firms might sell accounts receivable to finance companies A) to obtain quick cash. B) to avoid the cost of funding a credit department. C) because they dont want to spoil their relationships with customers over bill collection hassles. D) for all of the above reasons. Register to View Answer20) Business finance companies specialize in leasing because A) it makes repossession of an asset easier. B) the lessee is often not required to make as large an up-front payment as is usually required on a loan to purchase. C) the finance company might capture tax benefits if the firm leasing the asset does not have income to offset with depreciation. D) of all of the above. E) of only (A) and (B) of the above. Register to View Answer21) Business finance companies provide A) factoring. B) equipment that can be leased. C) checking accounts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer22) In a _____ arrangement, the finance company pays for the car dealerships inventory of cars received from the manufacturer and puts a lien on each car financed. A) factoring B) floor plan C) roll over leasing Register to View Answer 274 23) Consumer finance companies A) make loans to consumers who cannot obtain credit from other sources. B) are owned by separate corporations or banks. C) charge high interest rates because their loans are high risk. D) do all of the above. Register to View Answer24) Consumer finance companies A) charge low interest rates on consumer loans. B) make relatively safe loans because finance companies require high levels of collateral. C) provide small retailers with private label credit card services. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer25) Finance companies that make loans to purchase items from a particular retailer or manufacturer are called A) retail finance companies. B) sales finance companies. C) consumer finance companies. D) corporate finance companies. Register to View Answer26) GMAC is an example of a A) captive finance company. B) corporate finance company. C) floor plan finance company. D) business finance company. Register to View Answer27) Finance companies are far less regulated than banks and thrifts because A) its depositors are exclusively large institutional investors. B) there are no regulations on subsidiaries of a bank holding company. C) there are no depositors to protect. D) there are few cases of finance companies failing. E) the capital-to-total-assets ratio of finance companies is relatively strong compared to that of banks and thrifts. Register to View Answer 275 28) Usury statutes A) allow consumers to declare bankruptcy while still retaining ownership of many of their assets. B) require finance companies to disclose the annual percentage rate charged on loans. C) impose restrictions on finance companies ability to collect on delinquent loans. D) set a ceiling on interest rates that can be charged on finance company loans. E) only (A) and (B) of the above. Register to View Answer29) Finance companies are required by truth in lending regulations to disclose the annual percentage rate charged on loans. This regulation is known as A) Regulation Q. B) Regulation Z. C) Regulation T. D) Regulation C. Register to View Answer30) Regulations designed to protect consumers in their dealings with finance companies include A) truth in lending legislation. B) usury statutes. C) bankruptcy statutes. D) all of the above. E) only (A) and (B) of the above. Register to View Answer31) The primary asset of a typical finance company is its A) commercial paper. B) reserves for loan losses. C) loan portfolio. D) bank loans. Register to View Answer32) On average, finance companies have a _____ capital-to-assets ratio. A) 12 percent B) 10 percent C) 9 percent D) 8 percent Register to View Answer 276 33) The primary source of income for finance companies is A) interest income from its loan portfolio. B) income from leasing cars and trucks. C) interest income from commercial paper. D) income from loan origination fees. Register to View Answer34) Finance companies total assets have shown steady growth except in the A) early 1980s, when interest rates increased sharply. B) mid 1980s, when defaults on consumer debt rose sharply. C) late 1980s, when legislation that supported the revival of the commercial banking industry was passed. D) early 1990s, when a recession caused a dip in business loans. E) mid and late 1990s, when growth in the assets of commercial banks was very strong. Register to View Answer35) Financial conglomerates began A) when Prudential Insurance Company acquired Bache Securities. B) when Merrill Lynch made a cash management account available to its customers. C) when Citicorp merged with the Travelers Group. D) when Sears added Coldwell Banker Real Estate and Dean Witter to its holdings of Allstate Insurance Company and Allstate Life Insurance Company. E) when Travelers Insurance merged with Salomon Smith Barney. Register to View Answer36) One goal of creating a financial conglomerate is to achieve economies of scope, which reflect A) savings achieved through increased size. B) savings that come from cutting jobs. C) savings that come from larger issues of bonds and stocks to finance operations. D) revenues that come from offering a product in many locations. E) revenues that come from offering many products in one location. Register to View Answer37) An exception to the rule that financial conglomerates tend to fail is A) General Electric Capital Services. B) Sears. C) Citigroup. D) Travelers. E) Xerox. Register to View Answer 277 38) General Electric Capital Services does not own A) one of the major investment banks. B) one of the largest commercial banks. C) one of the leading suppliers of private-label credit cards. D) one of the largest property and casualty reinsurers. Register to View Answer 20.2 True/False 1) Venture capital firms reduce risk by investing in only a few companies which can be carefully monitored and nurtured. Register to View Answer2) Investors in venture capital firms expect to profit quickly from their investment. Register to View Answer3) A balloon loan requires the borrower to make a single large payment at the loans maturity to retire the debt. Register to View Answer4) Finance companies face several types of risk. The greatest is liquidity risk. Register to View Answer5) Not until the Great Depression did commercial banks begin competing for loans secured by accounts receivable. Register to View Answer6) When finance companies provide credit to business firms by purchasing their accounts receivable at a discount, the credit is referred to as a floor plan. Register to View Answer7) Sales finance companies make loans to consumers to purchase items from a particular retailer or manufacturer. Register to View Answer8) A sales finance company, also called a captive finance company, is owned by the manufacturer to make loans to consumers to help finance the purchase of the manufacturers products. Register to View Answer9) Captive finance companies often offer interest rates below those of banks to increase sales. Register to View Answer 278 10) Compared to commercial banks and thrifts, finance companies are heavily regulated. Register to View Answer11) Finance companies allocate a portion of their income each period to an account to be used to offset losses, called the reserve for loan losses. Register to View Answer12) Financial conglomerates are firms offering a variety of financial services under one umbrella. Register to View Answer 20.3 Essay 1) What niche in the financial system do venture capital firms fill? 2) How do venture capital firms overcome the problem of information asymmetries that accompany start-up firms? 3) Explain why sales finance companies might offer loans at below market interest rates. 4) Why have finance companies been more innovative than commercial banks and thrifts? 5) Explain the advantages to both firms and finance companies when finance companies lease business equipment to firms. 6) Explain how economies of both scale and scope confer advantages that financial conglomerates might enjoy. 7) What types of risk do finance companies face that commercial banks do not? What types of risk do commercial banks face that finance companies do not? 279 280 Chapter 21 Investment Banks, Brokerage Firms, and Mutual Funds 21.1 Multiple Choice 1) An investment bank is a financial institution that A) bundles small deposits into larger loans. B) helps corporations raise funds. C) holds most of its assets in commercial paper. D) does all of the above. E) does only (A) and (B) of the above. Register to View Answer2) The Glass-Steagall Act A) separated commercial and investment banking. B) made it illegal for a commercial bank to buy or sell securities on behalf of its customers. C) made it illegal for investment banks to engage in the underwriting of corporate securities. D) did all of the above. E) did only (A) and (B) of the above. Register to View Answer3) Investment banks sell _____ securities to the public, and brokerage firms sell _____ securities to the public. A) new; existing B) new and existing; existing C) existing; new D) existing; new and existing Register to View Answer4) The primary function of investment banks is A) the bundling of deposits into loans. B) extending long-term credit to other financial institutions. C) helping corporations raise funds. D) providing credit to firms engaged in international trade. Register to View Answer5) Tasks that investment bankers perform when acting as an underwriter to sell securities to the public include: A) pricing the security. B) preparing the filings required by the Securities and Exchange Commission. C) arranging for the security to be rated. D) all of the above. E) only (A) and (B) of the above. Register to View Answer281 6) Investment banks find it less difficult to price securities if the firm has prior issues currently selling in the market, called A) secondary issues. B) seasoned issues. C) sustained issues. D) scarf issues. Register to View Answer7) The process of underwriting a stock or bond issue requires that the securities firm A) assure the public that the issue is legitimate and not a fraudulent confidence game. B) purchase the entire issue at a predetermined price if the quantity demanded by consumers is insufficient at the predetermined price. C) purchase the entire issue at a predetermined price and then resell it in the market. D) do both (A) and (B) of the above. Register to View Answer8) Underwriters assist firms with filing documents required by the SEC. The registration statement contains information A) about the firms financial condition, management, competition, industry, and experience. B) disclosing how the funds will be used. C) about managements assessment of the risk of the securities. D) about all of the above. E) about only (A) and (B) of the above. Register to View Answer9) By law, investors must be given a portion of the registration statement before they can invest in a new security. This document is called a A) prospectus. B) proxy statement. C) fiduciary warrant. D) fiduciary warranty. Register to View Answer10) Investment banks advertise upcoming securities offerings with block ads in the Wall Street Journal. Such an ad is called a A) tombstone. B) marker. C) prospectus. D) registration statement. Register to View Answer 282 11) Most investment banks are attached to A) large commercial banks. B) large brokerage houses. C) finance companies. D) large nonfinancial corporations, such as automobile manufacturers. Register to View Answer12) From an investment bankers perspective, the best outcome occurs when a new issue is A) undersubscribed. B) fully subscribed. C) oversubscribed. D) syndicated. Register to View Answer13) The largest underwriter of debt and equity issues in the United States, as of 2001, was A) Morgan Stanley. B) Citicorp/Salomon Smith Barney C) Lehman Brothers. D) Goldman, Sachs. Register to View Answer14) Often investment bankers will form a group, each one buying only a portion of the new securities to be issued. Such a group is called a A) posse. B) syndicate. C) underwriting club. D) debt pack. Register to View Answer15) If the investment banker makes no guarantee regarding the price the issuing firm will receive, but agrees to sell the securities on a commission basis, the agreement is called a A) best-effort agreement. B) brokered agreement. C) private-placement agreement. D) jump-start agreement. Register to View Answer16) Under best-efforts underwriting, A) the underwriter pays for the entire security issue. B) the underwriter sells the security on a commission basis. C) the underwriter spreads the risk among different brokerage houses. D) the underwriter makes a special appeal to the Securities and Exchange Commission to delay the issue. Register to View Answer 283 17) Private placements A) do not require the services of investment bankers. B) need not be registered with the SEC. C) are more common in the sale of stocks than for bonds. D) are all of the above. E) are only (A) and (B) of the above. Register to View Answer18) The most active investment banking firm in the private placement market is A) Merrill Lynch. B) Lehman Brothers. C) Goldman, Sachs. D) Morgan Stanley. Register to View Answer19) The buyers of private placement issues are most likely to be A) insurance companies. B) pension funds. C) investment banks. D) all of the above. E) only (A) and (B) of the above. Register to View Answer20) The buyers of private placement securities are most likely to be A) insurance companies. B) pension funds and mutual funds. C) commercial banks. D) all of the above. E) only (A) and (B) of the above. Register to View Answer21) Which of the following statements about private placements are true? A) Private placements are more common for the sale of bonds than for stocks. B) Investment bankers, though not required for a private placement, often facilitate the transaction. C) Investment bankers help the issuing firm file the paperwork required by the SEC. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer 284 22) Investment bankers have been active in the mergers and acquisitions market since the 1960s. Their contributions have included A) helping firms that want to acquire another firm locate a firm to pursue. B) helping would-be acquirers solicit shareholders through a tender offer. C) helping target firms ward off undesired takeover attempts. D) all of the above. E) only (A) and (B) of the above. Register to View Answer23) The best known investment banker involved in mergers and acquisitions, and the man credited with inventing the junk bond market, is A) Ivan Boskey. B) Michael Milken. C) James Garner. D) Michael Douglas. Register to View Answer24) ______ perform their main function in the primary market for securities and ______ perform theirs in the secondary market. A) investment banks; securities brokers and dealers B) securities brokers and dealers; investment banks C) securities brokers; securities dealers D) securities dealers; securities brokers Register to View Answer25) Which of the following best explains the difference between brokers and dealers? A) Brokers are pure middlemen; dealers make markets by standing ready to buy and sell at given prices. B) Dealers are pure middlemen; brokers make markets by standing ready to buy and sell at given prices. C) Dealers link up buyers and sellers, but do not stand ready to buy and sell from their inventories of securities; brokers stand ready to buy and sell from their inventories of securities. D) There is no difference between brokers and dealers. Register to View Answer26) Securities dealers A) hold inventories of securities, which they sell to customers who want to buy. B) hold securities that they have purchased from customers who wanted to sell. C) are called market takers, as they have significantly cut into the market that brokers used to dominate. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer 285 27) Securities dealers A) sell securities out of their inventories to customers who want to buy. B) buy securities, which they add to their inventories, from customers who want to sell. C) are largely responsible for the health and growth of small businesses in the United States. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer28) An instruction to a securities agent to buy or sell the security at the current market price is called A) a limit order. B) a market order. C) a pit order. D) an option order. Register to View Answer29) To take advantage of stock price decreases, an investor would use a A) market order. B) limit order. C) short sale. D) margin credit. Register to View Answer30) Which of the following statements about cash management accounts (CMAs) are true? A) The cash management account was developed in 1977 by Merrill Lynch. B) The advantage of brokerage-based cash management accounts is that they make it easier to buy and sell securities. C) As a result of CMAs, the distinction between banking activities and the activities of nonbank financial institutions has become more clearly defined. D) All of the above are true. E) Only (A) and (B) of the above are true. Register to View Answer31) An investment pool is formed A) to manipulate the market by spreading false rumors. B) to lower brokerage fees by combining security purchases. C) to share investment advice among member investors. D) to take advantage of tax breaks introduced by the 1933 and 1934 securities acts. Register to View Answer 286 32) SEC registration is A) not required for securities that are sold through a private placement. B) required for all securities. C) not required if less than $1.5 million in securities are issued per year. D) not required if the securities mature in less than one year. E) not required if securities are underwritten by an investment bank. Register to View Answer33) Mutual funds offer investors all of the following except A) greater-than-average returns. B) diversified portfolios. C) lower transaction costs. D) professional investment management. Register to View Answer34) Mutual funds A) pool the resources of many small investors by selling these investors shares and using the proceeds to buy securities. B) allow small investors to obtain the benefits of lower transaction costs in purchasing securities. C) provide small investors a diversified portfolio that reduces risk. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer35) Most mutual funds are structured in two ways. The most common structure is a(n) _____ fund, from which shares can be redeemed at any time at a price that is tied to the asset value of the fund. A(n) _____ fund has a fixed number of nonredeemable shares that are traded in the over-the-counter market. A) close-end; open-end B) open-end; close-end C) no-load; close-end D) no-load; load E) load; no-load Register to View Answer36) _________ funds are the simplest type of investment funds to manage. A) Balanced B) Global equity C) Growth D) Index Register to View Answer 287 37) The majority of mutual fund assets are now owned by A) individual investors. B) institutional investors. C) fiduciaries. D) business organizations. E) retirees. Register to View Answer38) Which of the following is most likely to be a no-load fund? A) Value funds B) Hedge funds C) Growth funds D) Index funds Register to View Answer39) When investors switch between funds in different families, mutual funds may charge A) a contingent deferred sales charge. B) a redemption fee. C) an exchange fee. D) 12b-1 fees. E) an account maintenance fee. Register to View Answer40) The Securities Acts of 1933 and 1934 did not A) regulate the activities of investment funds. B) require funds to register with the SEC. C) include antifraud rules covering the purchase and sale of fund shares. D) apply to investment funds. Register to View Answer41) The largest share of total investment in mutual funds is in A) stock funds. B) hybrid funds C) bond funds. D) money market funds. Register to View Answer42) Hedge funds A) are low risk because they are market-neutral. B) are low risk if they buy Treasury bonds. C) are low risk because they hedge their investments. D) are high risk because they are market-neutral. E) are high risk, even though they may be market-neutral. Register to View Answer 288 43) The near collapse of Long Term Capital Management was caused by A) the high management fees charged by the funds two Nobel Prize winners. B) the funds high leverage ratio of 20 to 1. C) a sharp decrease in the spread between corporate bonds and Treasury bonds. D) a sharp increase in the spread between corporate bonds and Treasury bonds. E) the funds shift away from a market-neutral investment strategy. Register to View Answer 21.2 True/False 1) The Glass-Steagall Act made it illegal for an investment bank to buy or sell securities on behalf of its customers. Register to View Answer2) When a firm issues stock for the first time in an initial public offering, it is difficult for an investment bank to determine what the correct price should be. Register to View Answer3) An undersubscribed issue occurs when sales agents have been unable to generate sufficient interest among their customers to sell all the securities by the issue date. Register to View Answer4) Resisted takeovers are called hostile. Register to View Answer5) Private placements are more common for the sale of stocks than for bonds. Register to View Answer6) Investment bankers perform a number of tasks required to sell securities to the public, among them pricing the security, preparing the filings required by the SEC, arranging for the security to be rated, and marketing the security through their contacts with brokerage houses. Register to View Answer7) One disadvantage of the private placement of securities issues is the high cost of registering the issue. Register to View Answer8) Junk bonds are high-risk, high-return equity securities that were used primarily to finance takeover attempts. Register to View Answer9) The Securities Acts Amendment of 1975 abolished fixed commissions. Register to View Answer 289 10) An investment pool is formed to manipulate the market for a stock by spreading false rumors about the health of the firm. Register to View Answer11) One factor explaining the rapid growth in mutual funds is that they are financial intermediaries that are not regulated by the federal government. Register to View Answer 21.3 Essay 1) Explain how rulings by the courts and regulators have made the markets served by both commercial and investment banks more competitive markets. 2) What services do investment bankers provide for firms that are issuing new securities? 3) What is underwriting? 4) Explain why private placements of securities are an attractive way of raising funds for some firms. 5) Describe the differences between brokers and securities dealers. 6) Explain the popularity of mutual funds. 290 Chapter 22 Risk Management in Financial Institutions 22.1 Multiple Choice 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 Register to View Answer2) 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. Register to View Answer3) 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. Register to View Answer4) Banks attempts to solve adverse selection and moral hazard problems help explain loan management principles such as A) screening and monitoring of loan applicants. B) collateral and compensating balances. C) credit rationing. D) all of the above. E) only (A) and (B) of the above. Register to View Answer5) 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 Register to View Answer291 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 Register to View Answer7) Provisions in loan contracts that proscribe borrowers from engaging in specified risky activities are called A) proscription bonds. B) restrictive covenants. C) due-on-sale clauses. D) liens. Register to View Answer8) Banks attempt to screen good from bad credit risks to reduce the incidence of loan defaults. To do this, banks A) specialize in lending to certain industries or regions. B) write restrictive covenants into loan contracts. C) expend resources to acquire accurate credit histories of their potential loan customers. D) do all of the above. Register to View Answer9) A banks commitment (for a specified future period of time) to provide a firm with loans up to a given amount at an interest rate that is tied to a market interest rate is called A) credit rationing. B) a line of credit. C) continuous dealings. D) none of the above. Register to View Answer10) Long-term relationships between banks and their customers and lines of credit A) reduce the costs of information collection. B) make it easier for banks to screen good from bad risks. C) enable banks to deal with moral hazard contingencies that are neither anticipated nor specified in restrictive covenants. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer 292 11) Compensating balances A) are a particular form of collateral commonly required on commercial loans. B) are a required minimum amount of funds that a borrower (i.e., a firm receiving a loan) must keep in a checking account at the bank. C) allow banks to monitor firms check payment practices which can yield information about their borrowers financial conditions. D) all of the above. Register to View Answer12) A bank that wants to monitor the check payment practices of its commercial borrowers, so that moral hazard can be prevented, will require borrowers to A) place a bank officer on their board of directors. B) place a corporate officer on the banks board of directors. C) keep compensating balances in a checking account at the bank. D) do all of the above. E) do only (A) and (B) of the above. Register to View Answer13) Of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the A) requirement that firms keep compensating balances at the banks from which they obtain their loans. B) requirement that firms place on their board of directors an officer from the bank. C) inclusion of restrictive covenants in loan contracts. D) requirement that individuals provide detailed credit histories to bank loan officers. Register to View Answer14) 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. Register to View Answer15) When a lender refuses to make a loan, even though 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) tacit collusion. D) coercive behavior. E) none of the above. Register to View Answer 293 16) Credit rationing occurs when a bank A) refuses to make a loan of any amount to a borrower, even when she is willing to pay a higher interest rate. B) restricts the size of the loan to less than the borrower would like. C) does either (A) or (B) of the above. D) does neither (A) nor (B) of the above. Register to View Answer17) Because larger loans create greater incentives for borrowers to engage in undesirable activities that make it less likely they will repay the loans, banks A) ration credit, granting borrowers smaller loans than they have requested. B) ration credit, charging higher interest rates to borrowers who want large loans than to those who want small loans. C) ration credit, charging higher fees as a percentage of the loan to borrowers who want large loans than to those who want small loans. D) do none of the above. Register to View Answer18) 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. Register to View Answer19) Which of the following are not rate-sensitive assets? A) Securities with a maturity of less than one year. B) Variable-rate mortgages. C) Fixed-rate mortgages. D) All of the above are rate-sensitive assets. E) None of the above is a rate-sensitive asset. Register to View Answer20) Liabilities that are partially, but not fully, rate-sensitive include A) checkable deposits. B) federal funds. C) non-negotiable CDs. D) fixed-rate mortgages. E) money market deposit accounts. Register to View Answer 294 21) If a bank has more rate-sensitive liabilities than assets, then a(n) ______ in interest rates will _____ bank profits. A) increase; increase B) increase; reduce C) decline; reduce D) decline; not affect Register to View Answer22) If a bank has more rate-sensitive assets than liabilities, then a(n) ______ in interest rates will ______ bank profits. A) increase; increase B) increase; reduce C) decline; increase D) decline; not affect Register to View Answer23) If a bank has ______ rate-sensitive assets than liabilities, then a(n) _________ in interest rates will increase bank profits. A) more; decline B) more; increase C) less; increase D) both (A) and (C) Register to View Answer24) The difference between rate-sensitive liabilities and rate-sensitive assets is known as the A) duration. B) interest-sensitivity index. C) rate-risk index. D) gap. Register to View Answer Figure 22-1 First National Bank Assets Rate-sensitive Fixed-rate $20 million $80 million Liabilities $50 million $50 million 25) Referring to Figure 22-1, First National Bank has a gap of ______. A) -30 B) +30 C) 60 D) 0 Register to View Answer 295 26) Referring to Figure 22-1, if interest rates rise by 5 percentage points, then bank profits (measured using 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. Register to View Answer27) Referring to Figure 22-1, 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 _____ by _____ of the total original asset value. A) decline; 5 percent B) decline; 10 percent C) decline; 15 percent D) decline; 25 percent Register to View Answer Figure 22-2 First National Bank Assets Rate-sensitive Fixed-rate $40 million $60 million Liabilities $50 million $50 million 28) Referring to Figure 22-2, First National Bank has a gap of ______. A) 10 B) -10 C) 20 D) 0 Register to View Answer29) Referring to Figure 22-2, if interest rates rise by 5 percentage points, then bank profits (measured using 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. Register to View Answer 296 30) Referring to Figure 22-2, assuming that the average duration of the banks 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 Register to View Answer31) If the First State Bank has a gap equal to a positive $20 million, then a 5 percentage point drop in interest rates will cause profits to A) increase by $10 million. B) increase by $1.0 million. C) decline by $10 million. D) decline by $1.0 million. Register to View Answer32) 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. Register to View Answer33) 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. Register to View Answer34) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals by 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. E) none of the above. Register to View Answer 297 35) Duration gap analysis A) is a refinement of basic gap analysis that accounts for interest-rate changes over a multiyear period. B) is a refinement of basic gap analysis that accounts for how long a gap will last. C) is a complement to basic gap analysis that accounts for the effect of interest rate changes on market value. D) is a complement to basic gap analysis that accounts for the influence of partially rate sensitive assets. Register to View Answer36) Duration analysis involves comparing the average duration of the banks _____ to the average duration of its _____ A) securities portfolio; non-deposit liabilities. B) loan portfolio; non-deposit liabilities. C) loan portfolio; deposit liabilities. D) assets; deposit liabilities. E) assets; liabilities. Register to View Answer37) To use the concept of duration to analyze the effect of changes in interest rates on the market value of an asset, a bank manager would multiply A) the negative of the duration of the asset by the change in the interest rate, i. B) the negative of the duration of the asset by i /(1 + i). C) the duration of the asset by the change in the interest rate, i. D) the duration of the asset by i /(1 + i). Register to View Answer38) If a bank has a duration gap of 2 years, then a rise in interest rates from 6 percent to 9 percent will lead to A) a rise in the market value of its net worth of 5.66 percent. B) a fall in the market value of its net worth of 5.66 percent. C) a rise in net interest income of 5.66 percent. D) a fall in net interest income of 5.66 percent. E) an unknown change. Register to View Answer39) If a bank has a duration gap of 2 years, then a fall in interest rates from 6 percent to 3 percent will lead to A) a rise in the market value of its net worth of 5.66 percent. B) a fall in the market value of its net worth of 5.66 percent. C) a rise in net interest income of 5.66 percent. D) a fall in net interest income of 5.66 percent. E) an unknown change. Register to View Answer 298 40) If a decline in interest rates causes a banks market value of net worth to rise, then the bank must have a A) negative duration gap. B) positive duration gap. C) negative gap. D) positive gap. Register to View Answer41) If a rise in interest rates causes a banks market value of net worth to rise, then the bank must have a A) negative duration gap. B) positive duration gap. C) negative gap. D) positive gap. Register to View Answer42) One problem with duration gap analysis is that A) it is calculated assuming that the yield curve is flat. B) it is calculated assuming that the yield curve does not change. C) it does not measure the sensitivity of net worth to interest rate changes. D) it does not measure the sensitivity of income to interest rate changes. E) it applies only to financial institutions. Register to View Answer43) One problem with basic gap analysis is that A) it is calculated assuming interest rates on all maturities are equal. B) it is calculated assuming interest rates on all maturities change by equal amounts. C) it does not measure the sensitivity of net worth to interest rate changes. D) it does not measure the sensitivity of income to interest rate changes. E) it applies only to financial institutions. Register to View Answer44) A bank manager concerned about interest income who expects interest rates to rise and who knows the bank currently has a positive gap should A) increase rate-sensitive assets and increase rate-sensitive liabilities. B) decrease rate-sensitive assets and increase rate-sensitive liabilities. C) decrease rate-sensitive assets and decrease rate-sensitive liabilities. D) increase rate-sensitive assets and decrease rate-sensitive liabilities. Register to View Answer 299 45) A bank manager concerned about interest income who expects interest rates to fall and who knows the bank currently has a positive gap should A) increase rate-sensitive assets and increase rate-sensitive liabilities. B) decrease rate-sensitive assets and increase rate-sensitive liabilities. C) decrease rate-sensitive assets and decrease rate-sensitive liabilities. D) increase rate-sensitive assets and decrease rate-sensitive liabilities. Register to View Answer 22.2 True/False 1) If a bank has more rate-sensitive liabilities than assets, then an increase in interest rates will reduce bank profits. Register to View Answer2) The difference between rate-sensitive liabilities and rate sensitive assets is known as the duration. Register to View Answer3) If a bank has a negative gap, then a decrease in interest rates will increase income. Register to View Answer4) Banks face the problem of adverse selection in loan markets because bad credit risks are the ones most likely to seek bank loans. Register to View Answer5) Due on sale clauses in loan contracts reduce moral hazard. Register to View Answer6) A correspondent account is sometimes required of a borrower as a condition for a loan. Register to View Answer7) Credit rationing reduces adverse selection problems. Register to View Answer8) Developing and maintaining long-term customer relationships help to reduce banks costs of screening and monitoring borrowers. Register to View Answer 300 9) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals by the change in the interest rate is called duration analysis. Register to View Answer10) If interest rates rise by 5 percentage points, then bank profits (measured using gap analysis) will increase. Register to View Answer 22.3 Essay 1) What is gap analysis and why is it important to a bank? 2) What is duration gap analysis and why is it important to a bank? 3) Explain how banks benefit from long-term customer relationships. 4) Explain how banks benefit from specialization in lending. 5) What special assumptions do income and duration gap analyses make about interest rate changes and the yield curve? 301 302 Chapter 23 Hedging with Financial Derivatives 23.1 Multiple Choice 1) Financial derivatives include A) stocks. B) bonds. C) futures. D) none of the above. Register to View Answer2) Financial derivatives include A) stocks. B) bonds. C) forward contracts. D) both (A) and (B). Register to View Answer3) Which of the following is not a financial derivative? A) Stock B) Futures C) Options D) Forward contracts Register to View Answer4) A contract that requires the investor to buy securities on a future date is called a A) short contract. B) long contract. C) hedge. D) cross. Register to View Answer5) A contract that requires the investor to sell securities on a future date is called a A) short contract. B) long contract. C) hedge. D) micro hedge. Register to View Answer6) A long contract 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. Register to View Answer303 7) A short contract 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. Register to View Answer8) 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. Register to View Answer9) 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. Register to View Answer10) 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) $96,000 face value securities for $100,000. C) $100,000 face value securities for $96,000. D) 100,000 face value securities for $100,000. Register to View Answer11) 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) $86,956 for $100,000 face value bonds. D) $86,956 for $115,000 face value bonds. Register to View Answer12) If you sold a short contract on financial futures, you hope interest rates A) rise. B) fall. C) are stable. D) fluctuate. Register to View Answer 304 13) If you bought a long contract on financial futures, you hope that interest rates A) rise. B) fall. C) are stable. D) fluctuate. Register to View Answer14) If you sold a short futures contract, you will hope that bond prices A) rise. B) fall. C) are stable. D) fluctuate. Register to View Answer15) The elimination of riskless profit opportunities in the futures market is referred to as A) speculation. B) hedging. C) arbitrage. D) open interest. E) mark to market. Register to View Answer16) Futures contracts are regularly traded on the A) Chicago Board of Trade. B) New York Stock Exchange. C) American Stock Exchange. D) Chicago Board of Options Exchange. Register to View Answer17) Financial futures are regularly traded on all of the following except the A) Chicago Board of Trade. B) Chicago Mercantile Exchange. C) New York Futures Exchange. D) Chicago Commodity Markets Board. Register to View Answer18) The agency responsible for regulation of the futures exchanges and trading in financial futures is the A) Commodity Futures Trading Commission. B) Securities Exchange Commission. C) Federal Board of Trade. D) none of the above. Register to View Answer 305 19) The purpose of the Commodity Futures Trading Commission is to do all of the following except A) oversee futures trading. B) see that prices are not manipulated. C) approve proposed futures contracts. D) establish minimum prices for futures contracts. Register to View Answer20) The number of contracts outstanding in a particular financial future is the A) demand coefficient. B) open interest. C) index level. D) outstanding balance. Register to View Answer21) The futures markets have grown rapidly in recent years because A) interest rate volatility has increased. B) financial managers are more risk averse. C) both (A) and (B). D) neither (A) nor (B). Register to View Answer22) The advantage of forward contracts over future contracts is that forward contracts A) are standardized. B) have lower default risk. C) are more liquid. D) none of the above. Register to View Answer23) 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) both (A) and (B) are true. Register to View Answer24) Futures markets have grown rapidly because futures A) are standardized. B) have lower default risk. C) are liquid. D) all of the above. Register to View Answer 306 25) 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. Register to View Answer26) 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) marked to market daily. Register to View Answer27) 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. Register to View Answer28) 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. Register to View Answer29) 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. Register to View Answer30) 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. Register to View Answer 307 31) The risk that occurs because stock prices fluctuate is called A) stock market risk. B) reinvestment risk. C) interest rate risk. D) default risk. Register to View Answer32) The most widely traded stock index future is on the A) Dow Jones 1000 index. B) S & P 500 index. C) NASDAQ index. D) Dow Jones 30 index. Register to View Answer33) 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) None of the above would be likely to purchase a futures contract Register to View Answer34) 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 $12,500 B) gain $12,500 C) lose $50 D) gain $50 Register to View Answer35) 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 $12,500 B) gain $12,500 C) lose $50 D) gain $50 Register to View Answer36) 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 reduce stock market risk. D) Both (B) and (C) are correct. Register to View Answer 308 37) 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. Register to View Answer38) 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) do none of the above. Register to View Answer39) 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) doing none of the above. Register to View Answer40) 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. Register to View Answer41) 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. Register to View Answer42) The price specified in an option contract at which the holder can buy or sell the underlying asset is called the A) premium. B) strike price. C) exercise price. D) both (B) and (C) are true. Register to View Answer 309 43) 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. Register to View Answer44) 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 Register to View Answer45) 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. Register to View Answer46) An option that can be exercised only at maturity is called a(n) A) swap. B) stock option. C) European option. D) American option. Register to View Answer47) Options on individual stocks are referred to as A) stock options. B) futures options. C) American options. D) individual options. Register to View Answer48) Options on futures contracts are referred to as A) stock options. B) futures options. C) American options. D) individual options. Register to View Answer 310 49) The agency which regulates stock options is the A) Securities and Exchange Commission. B) Commodities Futures Trading Commission. C) Federal Trade Commission. D) Both (A) and (B) are true. Register to View Answer50) The agency which regulates future options is the A) Securities and Exchange Commission. B) Commodities Futures Trading Commission. C) Federal Trade Commission. D) Both (A) and (B) are true. Register to View Answer51) 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. Register to View Answer52) An option that gives the owner the right 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. Register to View Answer53) 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. Register to View Answer54) 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. Register to View Answer 311 55) 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. Register to View Answer56) 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. Register to View Answer57) If you buy an option to buy treasury 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. Register to View Answer58) If you buy an option to sell treasury 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. Register to View Answer59) If you buy an option to buy treasury 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. Register to View Answer60) If you buy an option to sell treasury 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. Register to View Answer 312 61) 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. Register to View Answer62) 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. Register to View Answer63) 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. Register to View Answer64) All other things held constant, premiums on put options will increase when the A) exercise price increases. B) volatility of the underlying asset falls. C) term to maturity increases. D) (A) and (C) are both true. Register to View Answer65) 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. Register to View Answer66) All other things held constant, premiums on both put and call options will increase when the A) exercise price increases. B) volatility of the underlying asset increases. C) term to maturity decreases. D) futures price increases. Register to View Answer 313 67) 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. Register to View Answer68) 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. Register to View Answer69) 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. Register to View Answer70) 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. Register to View Answer71) 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) swapation. D) national swap. Register to View Answer72) 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) swapation. D) national swap. Register to View Answer314 73) If Second National Bank has more rate-sensitive assets than rate sensitive liabilities, it can reduce interest rate risk with a swap which requires Second National 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. Register to View Answer74) If Second National Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce interest rate risk with a swap which requires Second National 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. Register to View Answer75) 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. Register to View Answer76) 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. Register to View Answer77) The disadvantage of swaps is that A) they lack liquidity. B) it is difficult to arrange for a counterparty. C) they suffer from default risk. D) all of the above. Register to View Answer78) 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. Register to View Answer 315 79) Intermediaries are active in the swap markets because A) they increase liquidity. B) they reduce default risk. C) they reduce search cost. D) all of the above are true. Register to View Answer80) A valid concern about financial derivatives is that A) they allow financial institutions to increase their leverage. B) they are too sophisticated because they are so complicated. C) the notional amounts can greatly exceed a financial institutions capital. D) all of the above are valid concerns. E) none of the above is a valid concern. Register to View Answer81) The biggest danger of financial derivatives A) occurs when notional amounts exceed a banks capital. B) occurs when financial market prices and rates are highly volatile. C) occurs in trading activities of financial institutions. D) occurs in the large amount of credit exposure. Register to View Answer 23.2 True/False 1) If a bank has more rate-sensitive liabilities than assets, a rise in interest rates will reduce bank profits, and a decline in interest rates will raise bank profits. Register to View Answer2) Credit rationing occurs when lenders refuse to make loans even though borrowers are willing to pay more than the stated interest rate. Register to View Answer3) A forward contract is more flexible than a futures contract. Register to View Answer4) Futures contracts are standardized. Register to View Answer5) A long contract obligates the holder to sell securities in the future. Register to View Answer6) A short contract obligates the holder to sell securities in the future. Register to View Answer 316 7) One problem with a futures contract is finding a counterparty. Register to View Answer8) Futures contracts are subject to default risk. Register to View Answer9) Futures trading is regulated by the Commodity Futures Trading Commission. Register to View Answer10) Open interest allows investors to change the interest rate on futures contracts. Register to View Answer11) To reduce the interest rate risk of holding a portfolio of securities, futures contracts should be sold. Register to View Answer12) To reduce exchange rate risk from selling goods to a foreign country, futures contracts should be sold. Register to View Answer13) An option that gives the holder the right to buy an asset in the future is a put. Register to View Answer14) Option premiums increase as the term to maturity increases. Register to View Answer15) Option premiums fall as the volatility of the underlying asset falls. Register to View Answer16) Using options to control interest rate risk reduces the chance of a loss but increases the chance of a gain. Register to View Answer17) One advantage of using options to hedge is that the accounting transaction will never require the firm to show large unrecognized losses. Register to View Answer18) Interest rate swaps involve the exchange of a set of payments in one currency for a set of payments in another. Register to View Answer19) Currency swaps involve the exchange of a set of payments on one currency for a set of payments in another. Register to View Answer20) If Friendly Finance Company has more interest rate sensitive assets than interest rate sensitive liabilities, it may reduce risk with a swap. Register to View Answer317 21) Interest rate swaps are more liquid than futures contracts. Register to View Answer22) Intermediaries add value to the swap market by reducing default risk. Register to View Answer 23.3 Essay 1) How do the concepts of adverse selection and moral hazard explain the credit risk management principles that banks adopt? 2) Distinguish between forward and futures contracts. 3) Why have the futures markets grown so rapidly in recent years? 4) Explain how a short hedge could be used to immunize a treasury portfolio against interest rate risk. 5) Explain how a long hedge could be used to protect a bank from the risk that interest rates could rise before a loan is funded. 6) How would a firm use exchange rate futures to lock in current exchange rates? 7) Explain how a swap could be used to reduce interest rate risk for a bank with more rate- sensitive assets than rate-sensitive liabilities. 8) Define and distinguish between call options and put options. 9) Explain how option contracts could be used to protect against losses in portfolio value that may occur as interest rates increase. 10) Explain the advantages of protecting against interest rate risk using options rather than futures contracts. 11) Discuss the advantages of using swaps to protect against interest rate risk rather than restructuring the balance sheet. 318

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Universidad de Puerto Rico - ECON - 3022
MarketRates PrimeRate FederalFunds CommercialPaper(Financial) 1Month 2Months 3Months CertificartesofDeposits 1Month 3Months 6Months DiscountRate OneMonthEurodollarDeposits8marzo 3.25 0.15 0.23 0.22 0.20 0.18 0.21 0.31 0.75 0.2810marzo 3.25 0.14 0.26 0.2
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Market Rates Prime Rate Federal Funds Commercial Paper (Financial) 1 Month 2 Months 3 Months Certificartes of Deposits 1 Month 3 Months 6 Months Discount Rate One-Month Eurodollar Deposits8 marzo 3.25 0.15 0.23 0.22 0.20 0.18 0.21 0.31 0.75 0.2810 marzo
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Captulo4:Porquelastasasdeinterscambian?Determinantesdelademandadeactivos:Unactivoesunpedazodepropiedadqueesundepsitodevalor.Afrontarladudade compraroposeerunactivo,osiparacomprarunactivoenlugardeotro,lapersona debeconsiderarlosfactoresderiquezas,rendimi
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Capitulo17:BancayManejodeInstitucionesFinancierasEstadodeSituacin: Lospasivossedividenencuatrocategoras: Depsitosdecheques: permitequeeldueodelacuentaescribachequesaotras entidadesypersonas Depsitosdenotransaccin: aunquenopermitequeseescribanchequesdeest
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Max Sauberman Ms. Tipiere American Literature Acc. One Flew Over the Cuckoos Nest Chapter 25 Journal As the characters leave their normal environment, and take an excursion on the high seas, there is strong evidence for character development in many. McMu
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Harvard - AMLIT - 101
Max Sauberman Ms. Tipiere American Literature Acc. One Flew Over the Cuckoos Nest Chapters 6-8 Notes Fat Man: One Christmas at midnight, someone who fits the description of Santa Claus stumbles into the ward. The orderlies corner him, and keep him in the
Harvard - AMLIT - 101
Max Sauberman Ms. Tipiere American Literature Acc. One Flew Over the Cuckoos Nest Chapters 6-8 VocabularyLatrine Gawking Uncouth Convalescents Geriatrics Ambles Gaudy OglingNoun Verb Adjective Noun Noun Noun Adjective VerbCommunal toilet Staring rudely
Harvard - AMLIT - 101
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Harvard - AMLIT - 101
Max Sauberman Ms. Tipiere American Literature Acc. One Flew Over the Cuckoos Nest Chapters 9-11 Notes Breakfast: At breakfast, McMurphy is loud, thinking that Nurse Ratched is going to be easy to break. Chief observes that McMurphy simply caught Ratched o
Harvard - AMLIT - 101
Max Sauberman Ms. Tipiere American Literature Acc. One Flew Over the Cuckoos Nest Chapters 9-11 VocabularySnigger Twitches Glum Gala Maudlin LiensVerb Noun Adjective Noun Adjective NounTo snicker; laugh disrespectfully Sharp or sudden feelings of physi
Harvard - AMLIT - 101
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Harvard - AMLIT - 101
Max Sauberman Ms. Tipiere American Literature Acc. One Flew Over the Cuckoos Nest Chapters 12-15 Notes Chief Sweeping: A visiting doctor addresses the residents while Chief comes past, sweeping the floor. He pushes the broom past a picture that Public Rel
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Harvard - AMLIT - 101
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