Macroeconomics, 9e (Abel/Bernanke/Croushore)
Chapter 7 The Asset Market, Money, and Prices
7.1 What Is Money?
1) A disadvantage of the barter system is that
A) no trade occurs.
B) people must produce all their own food, clothing, and shelter.
C) the opportunity to specialize is greatly reduced.
D) gold is the only unit of account.
2) The use of money is more efficient than barter because the introduction of money
A) reduces the need for economic specialization.
B) reduces the need to exchange goods.
C) reduces the need for other stores of value.
D) reduces transaction costs.
3) In economics, money refers to
A) income.
B) wealth.
C) assets used and accepted as payment.
D) currency.
4) The following are all functions of money except
A) medium of exchange.
B) store of value.
C) unit of account.
D) source of anxiety.
5) moneys primary role in the economy comes from the benefits of lowering transactions costs
and allowing specialization. This function of money is called
A) store of value.
B) medium of exchange.
C) standard of deferred payment.
D) unit of account.
6) For something to satisfy the medium-of-exchange function of money, it must be
A) backed by gold.
B) readily exchangeable for other goods.
C) issued by a central bank.
D) an inherently valuable commodity.
7) Which of the following best illustrates the medium of exchange function of money?
A) The price of a new car is $25,000.
B) A penny saved is a penny earned.
C) A person owes $10,000 on his or her credit card.
D) You pay $3 to purchase a bag of apples.
8) In some countries, prices in stores are listed in terms of U.S. dollars, rather than in units of the
local currency. That’s most likely because
A) the country’s political system is unstable.
B) interest rates are higher using U.S. dollars than using the local currency.
C) there is no other store of value.
D) the country has experienced high rates of inflation.
9) The number of units of one good that trade for one unit of alternative goods can be determined
most easily when
A) there is one unit of account.
B) the goods all weigh about the same.
C) the goods are all new.
D) the goods are actively traded through barter.
10) A good that is used as a medium of exchange as well as being a consumption good is called
A) a barter money.
B) a commodity money.
C) a legal tender.
D) a debased money.
11) Why do people keep currency in their pockets when bank deposits pay interest?
A) Because banks might steal your money.
B) Because currency is more liquid.
C) Because bank deposits lose value due to inflation.
D) Because bank deposits lose value due to changes in interest rates.
12) One of moneys primary roles in the economy comes from the use of money to transfer
purchasing power to the future. This role of money is called
A) store of value.
B) unit of account.
C) medium of exchange.
D) standard of deferred payment.
13) Which of the following measures is the best measure of money as a medium of exchange?
A) M1
B) M2
C) M3
D) None of the above
14) Suppose your bank raises its minimum-balance requirement for free checking on checking
accounts by $500. You take $500 out of your passbook savings account and put it in your
checking account. What is the overall effect on M1 and M2?
A) M1 rises by $500, M2 falls by $500.
B) M1 is unchanged, M2 is unchanged.
C) M1 rises by $500, M2 is unchanged.
D) M1 is unchanged, M2 falls by $500.
15) M1 does not include
A) MMMFs.
B) travelers’ checks.
C) currency.
D) transaction accounts.
16) Which of the following is not part of M1?
A) Transaction accounts
B) Checking accounts
C) Time deposits
D) Traveler’s checks
17) Which of the following statements about M1 and M2 is true?
A) Demand deposits are not part of M1.
B) M2 is more liquid than M1.
C) M1 is larger than M2.
D) Savings deposits are part of M2.
18) Which of the following statements about M1 and M2 is not true?
A) Transaction accounts are part of M1.
B) M2 is more liquid than M1.
C) M2 is larger than M1.
D) Transaction accounts are part of M2.
19) M2 includes
A) large-denomination time deposits.
B) institutional MMMFs.
C) commercial paper.
D) M1.
20) M2 does not include
A) Treasury bonds.
B) passbook savings accounts.
C) small-denomination time deposits.
D) M1.
21) Which of the following is not included in M2?
A) Money market mutual funds held by individuals
B) Money market deposit accounts
C) Money market mutual funds held by institutions
D) Small-denomination time deposits
22) Over half of U.S. currency is
A) held abroad.
B) used in the underground economy.
C) held by banks as reserves.
D) held by businesses, especially retailers, for making transactions.
23) People in other countries want to hold U.S. dollars as a
A) medium of exchange.
B) store of value.
C) unit of account.
D) standard of deferred payment.
24) We shouldn’t be concerned about U.S. currency held abroad because
A) the currency will never return to the United States.
B) foreigners use it to buy U.S. bonds.
C) it represents an interest-free loan to the United States.
D) foreigners can’t spend it in their own countries.
25) What’s the most common way for a central bank to reduce the money supply?
A) Collect higher taxes
B) Sell bonds to the public
C) Buy bonds from the government
D) Buy bonds from the public
26) Suppose you read in the paper that the Federal Reserve plans to expand the money supply.
The Fed is most likely to do this by
A) printing more currency and distributing it.
B) purchasing government bonds from the public.
C) selling government bonds to the public.
D) buying newly issued government bonds directly from the government itself.
27) A developing country does not have enough taxes to cover its expenditures and is unable to
borrow. This government would be most likely to cover its deficit by
A) purchasing government bonds from the public.
B) selling government bonds to the public.
C) selling newly issued government bonds directly to the central bank.
D) buying newly issued government bonds directly from the central bank.
28) What are the major components of M1? What are the major components of M2? Describe
each component.
29) What function is money playing in each of these situations:
a. You walk into a store in Germany and see that all the prices are in euros.
b. You buy a candy bar for $1.25.
c. Your Aunt Jane keeps $100 bills tucked into many books in her house.
30) What happens to M1 and M2 due to each of the following changes?
(a) You take $500 out of your checking account and put it into a passbook savings account.
(b) You take $1000 out of your checking account and buy traveler’s checks.
(c) You take $1500 out of your money—market mutual fund and deposit into your checking
account.
(d) You cash in $2000 in savings bonds and invest the money in a certificate of deposit.
31) Why is per-capita U.S. currency demand so large? Who is holding large amounts of U.S.
currency and why are they doing so? Should U.S. policymakers be concerned about this? Why?
7.2 Portfolio Allocation and the Demand for Assets
1) You are putting together a portfolio of assets. The four most important characteristics of the
assets you will choose are expected return, time to maturity,
A) risk, and liquidity.
B) risk, and collateral
C) risk, and reward.
D) liquidity, and standard issue size.
2) People’s best guesses about returns on assets are called
A) expected returns.
B) liquidity.
C) risk.
D) the term structure of returns.
3) The set of assets that a holder of wealth chooses to own is called
A) an asset assortment.
B) a wealth strategy.
C) a portfolio.
D) an investment envelope.
4) The uncertainty about the return an asset will earn is
A) liquidity.
B) risk.
C) time to maturity.
D) stochastic dominance.
5) The risk premium is
A) the amount by which the expected return on a risky asset exceeds the return on an otherwise
comparable safe asset.
B) a measure of the riskiness of the overall economy in a domestic country compared with a
foreign country.
C) the amount an investor must pay to insure his or her stock portfolio to protect against a fall in
value.
D) the amount an investment bank charges to guarantee an annuity that pays a fixed rate of
return in the future.
6) The amount by which the expected return on a risky asset exceeds the return on an otherwise
comparable safe asset is known as the
A) CDS spread.
B) risk premium.
C) VIX.
D) term spread.
7) The existence of a ________ means that the interest rate on a two-year bond will exceed the
average interest rate on two successive one-year bonds.
A) risky asset.
B) securitization premium.
C) term structure.
D) risk premium.
8) The ease and quickness with which an asset can be exchanged for goods, services, or other
assets is its
A) risk.
B) time to maturity.
C) velocity.
D) liquidity.
9) Time to maturity refers to the amount of time until
A) an asset repays the principal to an investor.
B) an asset pays interest for the first time.
C) a bond can be sold on the secondary market.
D) the yield curve shows an upward slope.
10) Compared with money, bonds have
A) less risk and less liquidity.
B) less risk and more liquidity.
C) more risk and less liquidity.
D) more risk and more liquidity.
11) AAA Company stock has a higher expected rate of return than ZZZ Company stock. All else
being equal, you would expect that relative to ZZZ, AAA company stock provides
A) less risk and less liquidity.
B) less risk and more liquidity.
C) more risk and less liquidity.
D) more risk and more liquidity.
12) The least liquid asset on this list is
A) money.
B) bonds.
C) houses.
D) stocks.
13) In the early 2000s, lenders began issuing mortgage loans to people who would normally not
be qualified to take out loans because they did not meet lending standards. Those borrowers are
known as
A) alternative borrowers.
B) weak borrowers.
C) subprime borrowers.
D) credit risks.
14) The financial crisis occurred in 2008 in large part because of losses on securities consisting
of bundles of mortgage loans known as
A) home loan loss reserves.
B) credit default swaps.
C) mortgage-backed securities.
D) naked put options.
15) A one-year bond has an interest rate of 5% today. Investors expect that in one year, a one
year bond will have an interest rate equal to 7%. According to the expectations theory of the term
structure of interest rates, in equilibrium, a two-year bond today will have an interest rate equal
to
A) 3.0%.
B) 5.0%.
C) 5.5%.
D) 6.0%.
16) The idea that investors today compare the returns on bonds with differing times to maturity
to see which is expected to give them the highest return is the underlying principle behind the
________ of the term structure of interest rates.
A) expectations theory
B) investors’ viewpoint analysis
C) segmented-markets theory
D) yield comparison theory
17) The interest rate on long-term bonds is somewhat higher than suggested by the expectations
theory because
A) the expectations theory doesn’t account for taxes.
B) a risk premium exists.
C) an inflation premium must be added to long-term bonds.
D) the Fed can only control short-term interest rates.
18) By spreading her investments out over many different assets, an investor achieves
A) a higher expected return.
B) increased risk.
C) diversification.
D) greater liquidity.
19) Suppose that you could buy a one-year bond today, which has an interest rate of 3%. If you
wait a year and buy a one-year bond then, the interest rate will be 4%. Two years from now, a
one-year bond is expected to offer an interest rate of 5%. According to the expectations theory of
the term structure of interest rates, what is the interest rate on a two-year bond today? What is the
interest rate on a three-year bond today?
20) Suppose that:
1) The interest on a one-year bond today is 3%;
2) The interest on a one-year bond starting one year from now is expected to be 4% per year;
3) The interest on a one-year bond starting two years from now is expected to be 5% per year;
4) The risk premium on a two-year bond is 0.5%; and
5) The risk premium on a three-year bond is 1.0%.
Use that information to answer the following questions.
a) According to the expectations theory, what is the interest rate today on a two-year bond?
Show your work.
b) According to the expectations theory, what is the interest rate today on a three-year bond?
Show your work.
c) Plot the yield curve.
7.3 The Demand for Money
1) A 10% decrease in real income usually leads to ________ in money demand.
A) an increase
B) no change
C) a decrease of less than 10%
D) a decrease of 10%
2) A 5% increase in real income usually leads to ________ in money demand.
A) a decrease
B) no change
C) an increase of less than 5%
D) a decrease of 5%
3) Which of the following is most likely to lead to a decrease of 10% in the nominal demand for
money?
A) An increase in real income of 5%
B) A decrease in real income of 5%
C) A decline of 10% in the price level
D) An increase of 10% in the price level
4) Which of the following is most likely to lead to an increase of 1% in the nominal demand for
money?
A) An increase in real income of 0.5%
B) A decrease in real income of 0.5%
C) A decline of 1% in the price level
D) An increase of 1% in the price level
5) The opportunity cost of holding currency decreases when
A) income decreases.
B) the interest rate on bonds decreases.
C) the interest rate on money decreases.
D) wealth decreases.
6) An increase in the real interest rate would cause an increase in the real demand for money
A) no matter what the change in expected inflation.
B) if expected inflation fell by less than the rise in the real interest rate.
C) if expected inflation fell by the same amount as the rise in the real interest rate.
D) if expected inflation fell by more than the rise in the real interest rate.
7) An increase in expected inflation is likely to cause
A) a decline in the demand for real balances.
B) an increase in the demand for real balances.
C) no change in the demand for real balances.
D) no change in the demand for real balances only if the income elasticity of real money demand
is zero.
8) Mr. Pierpont has wealth of $200,000. He wants to keep at least $80,000 in bonds at all times,
and will shift $10,000 into bonds from his checking account for each percentage point that the
interest rate on bonds exceeds the interest rate on his checking account. If the interest rate on
checking accounts is 4% and the interest rate on bonds is 9%, how much does Mr. Pierpont keep
in his checking account?
A) $50,000
B) $70,000
C) $130,000
D) $150,000