Subjective Short Answer
1. What is the main function of the financial system?
2. The financial system is important because it helps to match one person’s _____ with another person’s _____.
3. When someone borrows to purchase capital goods, he is using someone else’s _____ to fund his _____.
4. What is a bond buyer promised when she buys a bond?
5. What does the maturity of a bond indicate?
6. A _____ is a certificate of indebtedness and a _____ is a claim to partial ownership in a firm.
7. A restaurant chain announces declining revenues. What’s the name of the type of risk that this news raises for holders
of this chain’s bonds? What does this news to do the interest rate on this chain’s bonds?
8. Concerns about the bankruptcy of an appliance manufacturer diminish after a new CEO is appointed and some of the
company’s less productive factories are sold. What type of risk for bondholders falls? What happens to the interest rate on
this company’s bonds?
9. Bond A and Bond B have identical characteristics except that Bond A has a higher interest rate. Which bond has a
higher credit risk?
10. Bond A and Bond B are identical except Bond B has a longer term. Therefore, we expect Bond _____ to pay a higher
rate of interest.
11. Bonds issued by state and local governments are called _____ bonds. Bonds issued by financially shaky corporations
are called _____ bonds. Of these two, which type of bond usually pays a relatively higher interest rate?
municipal, junk, junk
12. If federal tax rates increased, what would happen to the interest rate on municipal bonds?
the interest rate would rise
13. List three characteristics of a bond that would make its interest rate higher than otherwise.
14. Stock in Frozen Dreams, an ice cream manufacturer, has a price to earnings ratio of 24. Is this comparatively high or
low? What are two explanations for the size of this company’s price to earnings ratio?
15. How do banks make profits?
16. What is a mutual fund?
17. _____ and _____ are the two most important financial intermediaries.
18. The two most important financial markets are the _____ market and the _____ market.
19. In a closed economy private saving is $500 billion and the government budget deficit is $100 billion. What is
investment?
20. In a closed economy taxes are $750 billion, government transfers are $400 billion, government expenditures are $500
billion, and investment is $400 billion. What are private saving, public saving and national saving?
21. In a closed economy, GDP is $1000, government purchases are $200, and consumption is $700. If the government has
a budget surplus of $25, what are investment, taxes, private saving, and national saving?
22. In the terminology of macroeconomics, what’s the difference between a saver and an investor?
23. Robert buys bonds. Rachel buys a new truck for her landscaping business. Identify both as savers, investors, both, or
neither.
24. A _____ does not engage in international trade in goods and services and it does not engage in international borrowing
and lending.
25. National saving is the sum of _____ and _____. In a closed economy it is equal to _____ in equilibrium.
26. In a closed economy, Y – C – G equals _____. The variable Y is _____, C is _____, and G is _____.
27. The income that households have left after paying their taxes and paying for their consumption is known as _____.
28. Public saving is the difference between _____ and _____.
29. In macroeconomics, _____ refers to the purchase of new capital.
30. What variable adjusts to balance demand and supply in the market for loanable funds?
31. What is the source of the supply of loanable funds?
32. A higher interest rate makes _____ more attractive. Therefore the quantity of loanable funds supplied increases.
33. A higher interest rate makes _____ less attractive. Therefore the quantity of loanable funds demanded decreases.
34. What happens to desired investment spending if the interest rate rises? Is this response relevant to the supply of
loanable funds curve or the demand for loanable funds curve?
35. Suppose there is a shortage in the market for loanable funds. Is the interest rate above or below its equilibrium level?
How do desired saving and desired investment at this interest rate compare?
36. If at some interest rate desired investment is $400 billion, desired private saving is $600 billion, and the budget deficit
is $300 billion, is there a surplus or a shortage in the market for loanable funds? What does this imply would happen to
interest rates?
37. Congress and the President implement an investment tax credit. Which curve in the market for loanable funds shifts,
which direction does it shift, and what happens to the interest rate?
38. When tax code changes increase saving incentives, the interest rate will _____ and investment will _____.
39. When tax code changes reduce saving incentives, the interest rate will _____ and investment will _____.
40. When tax code changes increase investment incentives, the _____ for loanable funds curve shifts to the _____. This
results in a(n) _____ in the interest rate and a(n) _____ in investment.
41. When tax code changes reduce investment incentives, the _____ for loanable funds curve shifts to the _____. This
results in a(n) _____ in the interest rate and a(n) _____ in investment.
42. If the government budget deficit increases, which curve in the market for loanable funds shifts, which direction does it
shift, and what happens to the interest rate?
43. If the government reduces transfer payments, what happens to the budget deficit? What curve does this change in the
market for loanable funds, which direction does it shift, and what happens to the equilibrium interest rate?
44. The interest rate will _____ and the quantity of loanable funds invested will _____ when the government decreases the
budget deficit.
45. When the government increases spending (holding taxes constant), the budget balance _____. This causes the interest
rate in the market for loanable funds to _____ and investment to _____.
46. When the government increases its borrowing, the budget _____ increases and government debt _____. The resulting
change in investment due to this increased government borrowing is called _____.
47. An increase in the government budget deficit causes national saving to _____, the interest rate to _____, and
investment to _____.
48. Congress and the President allow people to make greater contributions to tax-deferred savings accounts. Which curve
in the market for loanable funds would shift, which direction would it shift, what would happen to the interest rate, and
what would happen to investment spending?
49. Which government policy raises the interest rate and raises investment spending?
50. If consumers reduced their spending, what would happen to the interest rate and investment?
51. What are the basic differences between bonds and stocks?
higher return.
52. Which of the two bonds in each example would you expect to generally pay the higher interest rate? Explain why.
a.
a U.S. government bond or a Venezuelan government bond
b.
a U.S. government bond or a municipal bond with the same term and issued by a creditworthy
municipality.
c.
a 6-month Treasury bill or a 20-year Treasury bond
d.
a Microsoft bond or a bond issued by a new recording company
market perceives a higher level of risk for the Venezuelan bond relative to the U.S.
bond.
likely pay the higher interest rate.
The future is uncertain and therefore more risky for a 20-year bond than for a 6-month
bill.
Since Microsoft is less likely to default than a new and unknown company, the interest
on the bond of the new company is likely to be higher.
53. Suppose that you are a broker and people tell you the following about themselves. What sort of bond would you
recommend to each? Defend your choices.
a.
“I am in a high federal income tax bracket and I don’t want to take very much risk.“
b.
“I want a high return and I am willing to take a lot of risk to get it.”
c.
“I want a decent return and I have enough deductions that I don’t value tax breaks highly.”
A junk bond. Junks bonds have a high return because they have high risk.
A corporate bond that isn’t a junk bond. Corporate bonds have more risk than
return.
54. Your brother-in-law wants to buy either stock or bonds in Cedar Valley Furniture, which manufactures wooden
furniture. He wants your advice on whether to buy stock or bonds. Explain how each of his quotes below should affect his
choice between the stock and the bond.
a.
“I have reason to believe that people are soon going to find rocking chairs have health
benefits.”
b.
“I would like to tell people I am part owner of Cedar Valley Furniture.”
c.
“I do not want to take on much risk.”
law’s purposes.
indicates your brother-in-law would prefer to buy stock.
c.
somewhat more risky. So, your brother-in-law may prefer the bond.
55. Suppose the Move It! exercise chain has revenues of $45 million, accounting costs of $15 million, and currently has
issued 10 million shares of stocks selling at $90 each. Compute the price-earning ratio. Show your work. Is this ratio
relatively high or low? What might an increase in the price-earnings ratio indicate?
earnings in the future or that the stock has become overvalued.
56. In the national income accounting identity showing the equality between national saving and investment, what are the
algebraic expressions for private saving and public saving?
Private saving is Y – C – T, Public Saving is T – G
57. Identify each of the following acts as representing either saving or investment.
a.
Fred uses some of his income to buy government bonds.
b.
Julie takes some of her income and buys mutual funds.
c.
Alex purchases a new truck for his delivery business using borrowed funds.
d.
Elaine uses some of her income to buy stock in a major corporation.
e.
Henrietta hires a builder to construct a new building for her bicycle shop.
Fred is saving.
Julie is saving.
Alex is investing.
Elaine is saving.
Henrietta is investing.
58. Draw and label a graph showing equilibrium in the market for loanable funds.
59. Explain why the demand for loanable funds slopes downward and why the supply of loanable funds slopes upward.
60. The model of the market for loanable funds shows that an investment tax credit will cause interest rates to rise and
investment to rise. Yet we also suppose that higher interest rates lead to lower investment. How can these two conclusions
be reconciled?
61. Using a graph representing the market for loanable funds, show and explain what happens to interest rates and
investment if the government budget goes from a deficit to a surplus.