Money, Banking, and the Financial System (Hubbard/O’Brien)
Chapter 1 Introducing Money and the Financial System
1.1 Key Components of the Financial System
1) The financial system is primarily a means by which
A) borrowers can use savers’ funds until the savers themselves need the funds.
B) money is put into circulation.
C) the government puts into operation its plans for the economy.
D) business firms distribute their goods.
2) Which of the following is NOT a financial asset?
A) a bond issued by Google
B) Wells Fargo Bank
C) a home mortgage loan
D) a certificate of deposit
3) If you buy a bond issued by Intel, the bond is a(n):
A) liability to Intel and an asset to you.
B) liability to you and an asset to Intel.
C) liability to both you and Intel.
D) asset to both you and Intel.
4) Which of the following forms the largest share of household holdings of financial assets?
A) corporate equities
B) bank deposits
C) pension funds reserves
D) life insurance
5) Which of the following is NOT a key financial service provided by the financial system?
A) risk sharing
B) profitability
C) liquidity
D) information
6) Economists define risk as
A) the difference between the interest rate borrowers pay and the interest rate lenders receive.
B) the chance that the value of financial assets will change from what you expect.
C) the ease with which an asset can be exchanged for other assets or for goods and services.
D) the difference between the return on common stock and the return on corporate bonds.
7) Economists define liquidity as
A) the difference between the return on the asset and the return on a long-term U.S. Treasury
bond.
B) the fraction the asset makes up of an investor’s portfolio.
C) the ease with which an asset can be exchanged for money.
D) the difference between the total demand for an asset and the total supply of the asset.
8) Which of the following assets is the most liquid?
A) money market mutual fund
B) computer
C) washing machine
D) U.S. Treasury bond
9) By providing and communicating information, the financial system
A) reduces the difference between the return on three-month U.S. Treasury bills and the return
on thirty-year U.S. Treasury bonds.
B) relieves individual savers from the necessity of searching out individual borrowers.
C) eliminates the risk in investing in the stock market.
D) guarantees investors a reasonable return on their money.
10) Financial securities that represent partial ownership of a corporation are known as
A) bonds.
B) stocks.
C) coupons.
D) dividends.
11) Securitization is the process of
A) issuing stocks to finance capital spending.
B) issuing bonds to finance purchases of equipment and structures.
C) reducing risk by decreasing corporate debt loads.
D) converting loans into securities.
12) If a bank grants you a mortgage, the mortgage is
A) an asset to you as well as an asset to the bank.
B) an asset to you, but a liability to the bank.
C) a liability to you, but an asset to the bank.
D) a liability to you as well as a liability to the bank.
13) Financial markets
A) channel funds indirectly between borrowers and lenders.
B) channel funds directly from lenders to borrowers.
C) act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio
to savers.
D) generally provide lenders with lower returns than do financial intermediaries.
14) If you purchase a Treasury bond, the Treasury bond is
A) an asset to you as well as an asset to the U.S. government.
B) an asset to you, but a liability to the U.S. government.
C) a liability to you, but an asset to the U.S. government.
D) a liability to you as well as a liability to the U.S. government.
15) The bond market is important because
A) it is the major source of borrowed funds for U.S. business.
B) it provides a rate of return significantly greater than the stock market.
C) it provides foreign purchasers of U.S. products a means to exchange their currencies for U.S.
dollars.
D) it provides a way for businesses and governments to borrow funds from savers and it is the
market that determines interest rates.
16) Funds flow from lenders to borrowers
A) indirectly through financial markets.
B) directly through financial intermediaries.
C) indirectly through financial intermediaries.
D) primarily through government agencies.
17) Which of the following is NOT a financial intermediary?
A) NASDAQ
B) Allstate Insurance Company
C) Bank of America
D) Vanguard Total Stock Market Index Fund
18) Which of the following is NOT a financial intermediary?
A) mutual fund
B) bank
C) stock exchange
D) insurance company
19) The main role of financial intermediaries is to
A) provide funds to the federal government to cover the budget deficit.
B) borrow funds from savers and lend them to borrowers.
C) provide advice to consumers on how they should handle their finances.
D) help ensure that there is enough money in circulation.
20) Financial intermediaries
A) include banks and other depository institutions.
B) include the New York and American Stock exchanges.
C) directly issue claims on individual borrowers to savers.
D) are owned and operated by the federal government.
21) A “primary market” is a market
A) for government securities.
B) in which newly issued claims are sold to buyers by borrowers.
C) in which newly issued claims are sold by savers to borrowers.
D) for debt by large or “primary” corporations.
22) A bank lending depositors’ money to a local business and a pension fund investing
contributions in shares of a company are similar financial activities in that
A) both involve the use of financial markets.
B) both involve funds being channeled from savers to borrowers through financial
intermediaries.
C) both involve a reduction in the overall level of liquidity in the financial system.
D) both involve in an increase in the overall level of risk in the financial system.
23) The leading federal regulatory body for financial markets in the United States is the
A) Federal Bureau of Investigation.
B) Securities and Exchange Commission.
C) Federal Financial Market Bureau.
D) Investors Protection Agency.
24) Economists define money as
A) cash in circulation.
B) deposits in commercial banks.
C) anything that people are willing to accept in payment for goods and services or to pay off
debts.
D) bonds issued by large corporations.
25) The Federal Reserve System
A) is in charge of managing the New York Stock Exchange.
B) is headed by the Secretary of the Treasury.
C) is the central bank of the United States.
D) is responsible for conducting fiscal policy for the United States.
26) Monetary policy refers to the government’s
A) decisions on how much money to spend.
B) decisions on how much money to collect in taxes.
C) plans for retiring the national debt.
D) management of the money supply and interest rates to achieve macroeconomic objectives.
27) Diversification refers to the
A) splitting of wealth into many assets.
B) difference between the liquidity of an asset and its risk.
C) difficulty of converting investments in common stocks into investments in bonds.
D) difficulty of selling common stocks in a weak market.
28) The purpose of diversification is to
A) increase the liquidity of a financial portfolio.
B) reduce the brokerage fees involved in managing a financial portfolio.
C) reduce risk.
D) reduce tax liability.
29) The financial system provides risk sharing by allowing
A) borrowers to obtain funds either directly or indirectly.
B) savers to earn interest tax-free.
C) borrowers to convert liabilities into assets.
D) savers to hold many assets.
30) Liquidity
A) is the best available measure of the riskiness of an asset.
B) is a characteristic of money, and of no other asset.
C) is the ease with which an asset can be exchanged for money.
D) was declining for many financial assets during the 1990s.
31) Which of the following assets is the least liquid?
A) money market mutual fund
B) stock
C) treasury bond
D) house
32) Increased liquidity in recent decades has reduced interest rates on which of the following
assets (holding constant all other things that affect interest rates)?
A) U.S. government bonds
B) bonds issued by large corporations
C) business loans
D) bonds issued by state governments
33) The financial system performs the role of communicating information by
A) constantly increasing the liquidity of most assets.
B) constantly reducing the riskiness of most assets.
C) incorporating all available information into the prices of financial assets.
D) providing to investors for a nominal charge all government reports available about a
particular company.
34) The distinguishing feature of a well-functioning financial market is the
A) continual increase in the liquidity of most assets.
B) continual reduction in the riskiness of most assets.
C) increased ease of converting common stocks into bonds.
D) incorporation of available information into asset prices.
35) In the United States, monetary policy is carried out by
A) the Federal Reserve System.
B) Congress.
C) the President.
D) Congress and the President acting together.
36) In the United States, the lender of last resort is
A) Fannie Mae.
B) the Federal Reserve.
C) the Federal Deposit Insurance Corporation.
D) Securities and Exchange Commission.
37) A decline in bank lending has the most significant effect on
A) small businesses.
B) large businesses.
C) state governments.
D) federal government.
38) How is the high unemployment rate that resulted from the Financial Crisis of 2007-2009
likely to affect those who graduated from college during the recession?
39) Briefly explain the process of securitizing mortgages.
40) How are interest payments on mortgages distributed to investors who own mortgage-backed
securities?
41) How do pawn shops provide financing?
1.2 The Financial Crisis of 2007-2009
1) Fannie Mae and Freddie Mac both
A) sell bonds to investors and use the funds to purchase mortgages.
B) help regulate the banking system.
C) directly lend funds to people seeking mortgages.
D) reduce access to funds for mortgages by purchasing existing mortgages.
2) All of the following are examples of risky mortgages that became more common in the 2000s
EXCEPT
A) alt-A mortgages.
B) adjustable-rate mortgages with low rates for a few years and then higher rates in later years.
C) mortgages requiring down payments of at least 20%.
D) subprime mortgages.
3) Which of the following best describes a “bubble”?
A) when the price of an asset reaches a new high
B) an unsustainable increase in the price of a class of assets
C) rapid increases in inflation
D) when bond prices rise more quickly than stock prices
4) All of the following were significant changes in the mortgage market in the 2000s EXCEPT
A) investment banks became significant participants in the secondary mortgage market.
B) lenders loosened lending standards.
C) mortgage-backed securities became more popular with investors.
D) borrowers tended to increase the amount of their down payments.
5) Which type of borrowers were least likely to default in their mortgage at the beginning of the
financial crisis?
A) those with fixed-rate mortgages who made large down payments
B) those with alt-A loans
C) subprime borrowers
D) those with adjustable-rate mortgages
6) The Troubled Asset Relief Program (TARP) allowed
A) the Treasury to inject funds into commercial banks in return for stock in the banks.
B) the Fed to provide funds to commercial banks in return for stock.
C) the Treasury to insure bank deposits at major U.S. banks.
D) the Fed to make loans to banks as the lender of last resort.
7) Which firm did the Treasury allow to fail during the financial crisis?
A) J.P. Morgan
B) Bear Stears
C) Lehman Brothers
D) American International Group (AIG)
8) Alt-A borrowers were those who
A) used mortgages to purchase apartments.
B) chose adjustable-rate mortgages instead of fixed-rate mortgages.
C) borrowed using “interest-only” mortgages.
D) did not provide documentation of their income when applying for a mortgage.
9) The financial crisis of 2007-2009 worsened after the failure of which firm?
A) General Motors
B) Lehman Brothers
C) Bear Stearns
D) American International Group (AIG)
10) At the beginning of the financial crisis, banks were hurt by all of the following EXCEPT
A) declines in the value of mortgage-backed securities.
B) defaults on mortgages by those with subprime mortgages.
C) holding too many Treasury bonds.
D) not being repaid on loans to real estate developers.
11) Why did some economists and policymakers criticize the Fed and Treasury for arranging the
sale of Bear Stearns to JP Morgan Chase in 2008?
12) What was the intent behind the intervention of the Fed and Treasury in financial markets
during the Financial Crisis of 2007-2009?
13) How did securitization and the bursting of the housing bubble contribute to the Financial
Crisis of 2007-2009?