One way of describing the solution that high net worth provides to the moral hazard
problem is to say that it
A) collateralizes the debt contract.
B) makes the debt contract incentive compatible.
C) state verifies the debt contract.
D) removes all of the risk in the debt contract.
The aggregate demand curve is downward sloping because a higher inflation rate leads
the central bank to ________ real interest rates, thereby ________ the level of
equilibrium aggregate output., everything else held constant.
A) raise; lowering
B) raise; raising
C) reduce; lowering
D) reduce; raising
Differences in ________ explain why interest rates on Treasury securities are not all the
same.
A) risk
B) liquidity
C) time to maturity
D) tax characteristics
A possible sequence for the three stages of a financial crisis might be ________ leads to
________ leads to ________.
A) asset price declines; banking crises; unanticipated decline in price level
B) unanticipated decline in price level; banking crises; increase in interest rates
C) banking crises; increase in interest rates; unanticipated decline in price level
D) banking crises; increase in uncertainty; increase in interest rates
A bank that wants to monitor the check payment practices of its commercial borrowers,
so that moral hazard can be reduced, will require borrowers to
A) place a bank officer on their board of directors.
B) place a corporate officer on the bank’s board of directors.
C) keep compensating balances in a checking account at the bank.
D) purchase the bank’s CDs.
Interest rates increased continuously during the 1970s. The most likely explanation is
A) banking failures that reduced the money supply.
B) a rise in the level of income.
C) the repeated bouts of recession and expansion.
D) increasing expected rates of inflation.
Situation 20-2
Assume a closed economy. Suppose that autonomous consumption equals $400,
planned investment equals $500, government expenditure equals $200, net taxes
equals $50, and the mpc equals 0.9.
Using the information in situation 20-2, if government increases their spending by $50
and increases net taxes by 50, then equilibrium aggregate output will change by
A) -$100.
B) -$50.
C) $50.
D) $100.
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.
Everything else held constant, an increase in the money market fund ratio will result in
________ in the M1 money multiplier and ________ in the M2 money multiplier.
A) an increase; an increase
B) no change; an increase
C) a decrease; a decrease
D) no change; a decrease
When yield curves are flat
A) long-term interest rates are above short-term interest rates.
B) short-term interest rates are above long-term interest rates.
C) short-term interest rates are about the same as long-term interest rates.
D) medium-term interest rates are above both short-term and long-term interest rates.
Under a fixed exchange rate regime, if a country has an ________ exchange rate, then
its central bank’s attempt to keep its currency from depreciating will result in a
________ of international reserves.
A) undervalued; gain
B) undervalued; loss
C) overvalued; gain
D) overvalued; loss
________ work in the secondary markets matching buyers with sellers of securities.
A) Dealers
B) Underwriters
C) Brokers
D) Claimants
________ is the field of study that applies concepts from social sciences such as
psychology and sociology to help understand the behavior of securities prices.
A) Behavioral finance
B) Strategical finance
C) Methodical finance
D) Procedural finance
The agency that was created to protect depositors after the banking failures of
1930-1933 is the
A) Federal Reserve System.
B) Federal Deposit Insurance Corporation.
C) Treasury Department.
D) Office of the Comptroller of the Currency.
The Baumol-Tobin analysis suggests that
A) velocity is relatively constant.
B) the transactions component of the demand for money is negatively related to the
level of interest rates.
C) the speculative motive is nonexistent.
D) velocity is unrelated to the transactions motive.
Bank capital is equal to ________ minus ________.
A) total assets; total liabilities
B) total liabilities; total assets
C) total assets; total reserves
D) total liabilities; total borrowings
Ending the “Great Inflation” era in the 1970s is an example of
A) inflation targeting.
B) exchange rate targeting.
C) central bank independence.
D) appointment of a more conservative central banker.
E) all of the above.
Which of the following $1,000 face-value securities has the lowest 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
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.
Everything else held constant, an increase in the required reserve ratio on checkable
deposits causes the M1 money multiplier to ________ and the money supply to
________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
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
In emerging market countries, many firms have debt denominated in foreign currency
like the dollar or yen. A depreciation of the domestic currency
A) results in increases in the firm’s indebtedness in domestic currency terms, even
though the value of their assets remains unchanged.
B) results in an increase in the value of the firm’s assets.
C) means that the firm does not owe as much on their foreign debt.
D) strengthens their balance sheet in terms of the domestic currency.
The analysis of how asymmetric information problems affect economic behavior is
called ________ theory.
A) uneven
B) parallel
C) principal
D) agency
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
The efficient markets hypothesis indicates that investors
A) can use the advice of technical analysts to outperform the market.
B) do better on average if they adopt a “buy and hold” strategy.
C) let too many unexploited profit opportunities go by if they adopt a “buy and hold”
strategy.
D) do better if they purchase loaded mutual funds.
In the liquidity trap a small change in interest rates produces ________ change in the
quantity of money demanded.
A) a small
B) no
C) a proportionate
D) a very large
In the market for reserves, if the federal funds rate is between the discount rate and the
interest rate paid on excess reserves, a ________ in the reserve requirement ________
the demand for reserves, raising the federal funds interest rate, everything else held
constant.
A) rise; decreases
B) rise; increases
C) decline; increases
D) decline; decreases
An autonomous increase in money demand, other things equal, shifts the ________
curve to the ________.
A) IS; right
B) IS; left
C) LM; left
D) LM; right
If a foreign bank operates a subsidiary bank in the U.S., the subsidiary bank is
A) subject to the same regulations as a U.S. owned bank.
B) only subject to the regulations of the country in which the foreign bank is chartered.
C) restricted to making loans to only foreign citizens in the U.S.
D) restricted to accepting deposits from foreign citizens living in the U.S.
The legislation overturning the Glass-Steagall Act is
A) the McFadden Act.
B) the Gramm-Leach-Bliley Act.
C) the Garn-St. Germain Act
D) the Riegle-Neal Act.
According to the liquidity premium theory of the term structure, a steeply upward
sloping yield curve indicates that short-term interest rates are expected to
A) rise in the future.
B) remain unchanged in the future.
C) decline moderately in the future.
D) decline sharply in the future.
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.
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 countercyclical bias to monetary policy.
Everything else held constant, if a central bank makes an unsterilized sale of foreign
assets, then the domestic money supply will ________ and the domestic currency will
________.
A) increase; appreciate
B) increase; depreciate
C) decrease; appreciate
D) decrease; depreciate
The economist Irving Fisher, after whom the Fisher effect is named, explained why
interest rates ________ as the expected rate of inflation ________, everything else held
constant.
A) rise; increases
B) rise; stabilizes
C) fall; stabilizes
D) fall; increases
Explain through the component parts of aggregate demand why the aggregate demand
curve slopes down with respect to the inflation rate. Be sure to discuss two channels
through which changes in inflation rates affect demand.
Explain two ways by which the Federal Reserve System can increase the monetary
base. Why is the effect of Federal Reserve actions on bank reserves less exact than the
effect on the monetary base?
Explain the time-inconsistency problem. What is the likely outcome of discretionary
policy? What are the solutions to the time-inconsistency problem?
Would it make sense to buy a house when mortgage rates are 14% and expected
inflation is 15%? Explain your answer.
The Federal Reserve increases interest rates when it wants to reduce aggregate demand
to fight inflation. How do increases in the interest rate reduce aggregate demand?
Using the liquidity preference framework, show what happens to interest rates during a
business cycle recession.
How can specializing in lending help to reduce the adverse selection problem in
lending?
Your bank has the following balance sheet:
Assets Liabilities
Reserves $ 50 million Checkable deposits $200 million
Securities 50 million
Loans 150 million Bank capital 50 million
If the required reserve ratio is 10%, what actions should the bank manager take if there
is an unexpected deposit outflow of $50 million?
What factors have slowed down the movement to a system where all payments are
made electronically?
Keynes believed that unstable investment caused the Great Depression. Using the
simple Keynesian model, explain how a fall in investment affects equilibrium output.
Explain why the simple deposit multiplier overstates the true deposit multiplier.
Using the ISLM model, show graphically and explain the effects of a monetary
contraction. What is the effect on the equilibrium interest rate and level of output?
Explain the Fed’s three tools of monetary policy and how each is used to change the
money supply. Does each tool affect the monetary base or the money multiplier?
Using the liquidity preference framework, what will happen to interest rates if the Fed
increases the money supply?
Explain the law of one price and the theory of purchasing power parity. Why doesn’t
purchasing power parity explain all exchange rate movements in the short run? What
factors determine long-run exchange rates?
Because there is an imbalance of information in a lending situation, we must deal with
the problems of adverse selection and moral hazard. Define these terms and explain
how financial intermediaries can reduce these problems.
Explain the traditional interest-rate channel for expansionary monetary policy. Explain
how a tight monetary policy affects the economy through this channel.
