ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM SPRING Prof. Bill Even FORM 4. Directions

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1 ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM SPRING 2015 Prof. Bill Even FORM 4 Directions 1. You may not leave the room until you turn in your exam. 2. Fill in your scantron with your unique id and form number. Doing this properly is worth the equivalent of 1 question. 3. There are 46 multiple choice questions. Your grade is determined entirely upon the answers listed on your scantron. Your scantron will not be returned so be sure to record your answers on your exam so that you will be able to check your answers once the key is posted. 4. You may use a calculator. The use of a cell phone is strictly prohibited and considered academic dishonesty. 5. You have until the end of the period to finish the exam. Additional time may be purchased at a price of 5 percentage points per minute. 6. Academic dishonesty is a serious offense. In the event I find someone behaving in a dishonest manner, I will ask that the maximum penalty allowed by the university be imposed. 7. When you finish, turn in your scantron. You may keep your copy of the exam. 1

2 1. Which of the following statements is TRUE? a. there are 7 districts in the Federal Reserve b. the Federal Reserve was established in c. Janet Yellen is the current chair of the Federal Reserve d. All of the above 2. The dollar bill in the U.S. today is an example of a. a commodity money b. money backed by a valuable metal (gold) c. fiat money d. none of the above. 3. When a person puts a dollar bill in under the mattress to spend later, money is being used as a. When a person buys a ticket to the movie with a dollar bill, the money is being used as. a. unit of account; store of value b. medium of exchange; unit of account c. store of value; medium of exchange d. none of the above 4. Which of the following is TRUE? a. during the 1800s, bank runs could be caused by a drought that would make it difficult for farmers to repay their loans b. the establishment of FDIC in the 1930s helped eliminate bank runs c. at any point in time, banks can pay off all of their depositors because they have only a fraction of what they owe depositors on reserve d. all of the above are true 5. Suppose that both gold and silver coins currently circulate, but there is suddenly a sharp decrease in the price of silver. Based on this, Gresham s law predicts that: a. gold coins will stop circulating, but silver coins will continue circulating b. silver coins will stop circulating, but gold coins will continue circulating. c. both coins will stop circulating d. both coins will continue circulating 2

3 To answer the next 3 questions, assume that the banking system starts with the following "base case" balance sheet and that (i) the public initially holds $2000 of non-bank cash; (ii) the reserve ratio is 4%; (iii) banks always loan out the maximum amount allowed. BALANCE SHEET Reserves $2,000 Demand Deposits $50,000 Loans $40,000 Govt. bonds $23,000 Owner's Equity $15,000 $65,000 $65, Start with the base case balance sheet. If the Fed raises the reserve ratio from 4% to 5% and the bank system completely adjusts to this change, reserves will and M1 will. a. not change; not change b. increase $500; not change c. not change; decrease $10,000 d. increase $500; increase $5,000 d. none of the above. 7. Start with the base case balance sheet and the 4% reserve ratio. If the Fed sells $100 of government bonds to the banking system and the banking system completely adjusts to this change in their balance sheet, reserves will and M1 will. a. increase $100; increase $100 b.. increase $100; increase $2500 c. decrease $100; decrease $2500 d. decrease $100; decrease $100 e. none of the above. 8. Starting with the base case balance sheet and the 4% reserve ratio, if the public chooses to withdraw $50 of its cash into demand deposits, after the bank system completely adjusts to this change, a. the monetary base will fall by $50. b. M1 will fall by $1250 b. demand deposits will fall by $1250 d. all of the above 3

4 9. Suppose a bond has a maturity value of $1000 and a coupon rate of 5%. If you buy the bond for $900 you paid a price that is (above, below) par and your yield will be. a. above; 5% b. above; below 5% c. below; above 5% d. none of the above. 10. Consider a one year bond with a 7% coupon rate and a maturity value of $1000 that sells for $1020 today. The yield to maturity on this bond is: a. 3.9 % b. 4.9% c. 6.9% d. 7.9% 11. If the Federal Reserve wants to raise interest rates in the economy, it should a. buy government bonds on the open market b. raise the discount rate c. lower the reserve ratio d. all of the above. 12. Holding the coupon rate, maturity value and term of a bond constant, as the price of a bond rise, the yield on the bond: a. could rise or fall; b. falls. c. rises. d. does not change. 13. Consider a 10 year zero coupon bond with a maturity value of $1000 that sells for $600 today. The annual yield to maturity on this bond is: a. 3.2% b. 4.2% c. 5.2% d. 6.2% 14. Suppose stock prices reflect their fundamental value. Which of the following would lead to higher prices? a. news that corporate tax rates will be raised next year. b. news that corporate profits will rise next year, but by much less than previously expected. c. news that interest rates fall sharply over the next year. d. all of the above. 15. Suppose that you are offered a payment of $10,000 in 5 years and $20,000 in 10 years. If you can earn a risk free return of 3% on investments, what is the present value of these two payments? a. $23,508 b. $21,309 c. $19,712 d. $18,922 4

5 16. Suppose that a company has a high PE ratio relative to most companies. This suggests that a. investors believe that the company will have earnings growth higher than most companies in the future b. investors believe that this company s stock price will rise by more than the price of most other companies if interest rates fall c. investors believe that this company s stock price will fall by more than the price of most other companies if interest rates fall d. none of the above 17. If there is an announcement that the U.S. economy is growing much more rapidly than people expected, the likely response in the financial markets is that bond prices will because the news suggests that the Fed is now likely to raise interest rates a. fall; more b. fall; less c. rise; more d. rise; less 18. In the money supply / money demand model, if the interest rate is above the equilibrium interest rate, the market adjusts by: a. people selling bonds which drives bond prices down and interest rates up b. people selling bonds which drives bond prices and interest rates up c. people buying bonds which drives bond prices up and interest rates down d. people buying bonds which drives bond prices and interest rates up 19. A company whose stock price typically rises by 5% when the index of overall stock prices rises 10% would have a. beta of 2 b. beta of.5 c. a PE ratio of 2 d. a PE ratio of.5 5

6 20. According to the equation of exchange, higher inflation will result if a. the velocity of money falls b. the growth rate of real GDP rises c. the money supply grows faster d. all of the above 21. Suppose that Mexico s currency weakens relative to the Chinese yuan. Which of the following could explain this? a. an increase in Mexico s interest rates relative to China s. b. an increase in Mexican demand for Chinese exports. c. a higher inflation rate in China than in Mexico. d. all of the above. The diagram below plots the exchange rate in terms of number of Chinese yuan per Mexican peso since Given the change in the number of yuan per peso, we can conclude that since 2010, the Mexican peso relative to the Chinese yuan. Other things being the same, this means that the cost of Chinese goods in Mexico and the the cost of Mexican goods in China. a. appreciated; rose; fell. b. appreciated; fell; rose c. depreciated; rose; fell d. depreciated; fell; rose. 6

7 Use the following news item from the Wall Street Journal to answer the next three questions. Greek default or an exit from the euro could spark a wave of volatility across other Southern European countries, such as Spain, Italy and Portugal, that were hit hardest by the eurozone crisis. The potential turbulence this could create in the Euro zone has caused investors throughout the world to view the Euro zone as a risky place to invest. 23. If investors view the U.S. as a safe place to invest, increased concerns about risk in the Euro zone would cause a. the demand for the dollar to drop as foreign investors increase their purchases of U.S. stocks. This would cause the dollar to weaken. b. the demand for the dollar to rise as foreign investors increase their purchases of U.S. stocks. This would cause the dollar to strengthen. c. the supply of the dollar would increase as U.S. investors cut back on their purchases of stock in Europoe. This would cause the dollar to weaken. d. both b and c. 24. If there are increased concerns about risk in the Euro zone, the dollar is likely to (strengthen, weaken) and this will cause aggregate demand in the U.S. to (rise, fall). a. strengthen; rise b. strengthen; fall c. weaken; rise d. weaken; fall 25. The U.S. currently has a capital account surplus and a current account deficit. If investors view the U.S. as a relatively safe place to invest, increased concerns about risk in the Euro zone would cause the U.S. capital account surplus to and the U.S, current account deficit to. a. grow; grow b. grow; shrink c. shrink; shrink d. shrink; grow 7

8 26. If a country is a net lender, a. it must be a creditor nation b. its exports will exceed its imports c. it will have a current account deficit d. all of the above 27. Suppose that Korea is concerned that the demand for its exports from the U.S. has fallen and they decide to intervene in the foreign exchange market to reverse this. To achieve the desired objective, Korea should: a. buy Korean won with their holdings of dollars since this will weaken the won. b. buy Korean won with their holdings of dollars since this will strenghten the won. c. buy dollars with Korean won since this will weaken the won d. buy dolalrs with Korean won since this will strengthen the won 28. Assume that the China has a capital account deficit and a current account surplus. If there is a rapid decline in foreign investment in China, this would cause the Chinese capital account deficit to and their current account surplus to. a. shrink; grow b. shrink; shrink c. grow; grow d. grow; shrink 29. According to our classroom discussion of the situation in Venezuela, the Venezuelan government: a. supports multiple exchange rates between the dollar and the Bolivar (the Venezuelan currency) b. has set exchange rates that lead to a shortage of dollars in Venezuela c. has set exchange rates that cause the dollar to be much cheaper than in their black market. d. all of the above 30. Based on the supply/demand model for the dollar in foreign currency markets, which of the following would cause the dollar to appreciate relative to the Venezuelan Bolivar? a. an increase in Venezuelan demand for U.S. exports.. b. a decreased desire in the U.S. to invest in the Venezuelan stock market. c. high inflation in Venezuela d. all of the above. 8

9 31. An upward sloping yield curve a. is more common than a downward sloping yield curve b. implies that interest rates on short term bonds are lower than interest rates on long term bonds d. all of the above 32. Suppose interest rate parity holds and the dollar is expected to depreciate by 1% relative to the Euro over the next year. Also, suppose government bonds in the Euro zone pay 2% interest. If interest rate parity holds, U.S. government bonds must pay an interest rate of: a. 1% b. 2% c. 3% d. none of the above. 33. Based on the theory of interest rate parity, if interest rates in Venezuela exceed those in the U.S., a. interest rate parity cannot hold. b. the value of the Venezuelan Bolivar should fall relative to the dollar. c. the value of the dollar should fall relative to the Venezuelan Bolivar d. none of the above 34. Suppose the dollar is expected to depreciate by 1 percent over the next year relative to the Euro. Also, suppose 1 year government bonds currently offer an interest rate of 2% in the Euro zone and 4% in the U.S. Based on this information, a wise investor would: a. be indifferent between U.S. and Euro bonds since the exchange rate fluctuation will offset the lower interest rate in the Euro zone.. b. prefer U.S. bonds over Euro bonds since U.S bonds will net a 2% higher rate of return after adjusting for the exchange rate movement. c. prefer U.S. bonds over Euro bonds since they will net a 1% higher rate of return after adjusting for the exchange rate movement. d. prefer Euro bonds over U.S. bonds since Euro bonds will net a 1% higher rate of return after adjusting for the exchange rate movement. 9

10 35. According to the theory of purchasing power parity, the number of Mexican pesos per dollar will rise if : a. U.S. inflation is greater than Mexican inflation b. U.S. inflation is less than Mexican inflation c. U.S. demand for Mexican goods rises d. none of the above. 36. Suppose the exchange rate is currently 12 pesos per dollar and that the price of gold is $1200 per ounce in the U.S. and 12,000 pesos per ounce in Mexico. Based on these figures, we should expect to find people buy gold in and resell it in the other country. This will gradually cause gold prices to in Mexico relative to the U.S. a. U.S.; rise b. U.S.; fall c. Mexico; rise d. Mexico; fall 37. Which of the following would cause the U.S. current account deficit to increase? a. increased imports by the U.S. b. decreased imports by the U.S. c. increased exports by the U.S. d. b or c. 38. Which of the following would lead to a smaller capital account surplus in the U.S.? purchases of foreign bonds by U.S. citizens or purchases of U.S. bonds by foreign citizens. a. increased; increased b. increased; decreased c. decreased; increased d. decreased; decreased 39. Which of the following would simultaneously increase long run aggregate supply and contribute to lower real wages? a. an increase in the generosity of transfer programs. b. a decrease in the amount of physical capital. c. technological innovations that improve labor productivity d. none of the above. 10

11 Consider the diagram below to answer the next 2 questions: LAS SAS AD 40. At the short run equilibrium described in the above diagram, there is (upward, downward) pressure on real wages because the economy is (above, below) full employment. a. downward; above. b. downward; below c. upward; above. d. upward; below. 41. Starting at the short run equilibrium described in the above diagram, as the economy moves to the long run equilibrium, it should experience: a. increases in real wages and prices and decreases in unemployment. b. decreases in real wages, prices and unemployment. c. increases in real wages, prices and unemployment. d. decreases in real wages, increases in prices and unemployment. 42. Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the Federal Reserve cuts interest rates. Considering the likely effect of this on AD, we should expect that in the short run: a. prices rise, real wages rise, and the unemployment rate drops below the natural rate. b. prices rise, real wages fall, and the unemployment rate drops below the natural rate. c. prices fall, real wages fall, and the unemployment rate falls below the natural rate. d. prices fall, real wages rise, and the unemployment rate rises above the natural rate. e. none of the above. 11

12 43. Supply siders prefer economic policies that would increase long run aggregate supply. Some policies that would promote this include: a. a reduction in tax rates b. more generous welfare programs c. increased environmental regulation d. all of the above 44 Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the Fed cuts interest rates. Considering the likely effect of this on AD, we should expect that in the long run: a. prices fall and the real wage returns to its starting value. b. prices rise and the real wage falls c. prices rise and the real wage returns to its starting value d. none of the above 45. Which of the following would simultaneously increase long run aggregate supply and contribute to higher real wages? a. workers become more skilled b. more immigration is allowed. c. Social Security is made more generous. d. all of the above. 46. A increase in aggregate demand (AD) would be caused by transfers, government spending, or an expectation of future inflation. a. increased; increased; lower. b. decreased; increased; higher c. decreased; decreased; higher d. increased; increased; higher. 12