Money & Capital Markets Exam 1: Chapters 1, 2, 3, 4, 5 & 6. Name. Multiple Choice: 4 points each

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1 Money & Capital Markets Exam 1: Chapters 1, 2, 3, 4, 5 & 6 Name Multiple Choice: 4 points each MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Evidence from business cycle fluctuations in the United States indicates that changes in money might be a driving force behind these fluctuations. Specifically, the evidence suggests that A) recessions have been preceded by a decline in the growth rate of money. B) recessions have been preceded by a increase in the growth rate of money. C) a negative relationship between money growth and general economic activity exists. D) recessions have been preceded by an increase in the growth rate of money and followed by a substantial decrease in money growth. 2) Banks are important to the study of money and the economy because they A) have been a source of rapid financial innovation that is expanding the alternatives available to those wanting to invest their money. B) play an important role in determining the quantity of money in the economy. C) provide a channel for linking those who want to save with those who want to invest. D) do each of the above. E) do only (a) and (b) of the above. 3) Which of the following are true statements? A) The inflation rate is measured as the rate of change in the aggregate price level. B) Money or the money supply is defined as anything that is generally accepted in payment forgoods and services or in the repayment of debts. C) Inflation is a condition of a continually rising price level. D) All of the above are true statements. E) Only (a) and (b) of the above are true statements. 4) A stronger dollar benefits and hurts A) American businesses; American consumers B) foreign businesses; American consumers C) American consumers; American businesses D) American businesses; foreign businesses 5) When the total value of final goods and services is calculated using current prices, the resulting measure is referred to as A) nominal GDP. B) real GDP. C) the GDP deflator. D) the index of leading indicators.

2 6) Which of the following can be described as involving indirect finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys commercial paper in the secondary market. D) Both (a) and (b) of the above. E) Both (b) and (c) of the above. 7) Financial intermediaries A) improve the lot of the small saver. B) are involved in the process of indirect finance. C) exist because there are substantial information and transactions costs in the economy. D) do each of the above. E) do only (a) and (b) of the above. 8) Which of the following statements about financial markets and securities are true? A) A bond is a debt security that promises to make payments for a specified period of time. B) A debt instrument is short term if its maturity is less than one year. C) The maturity of a debt instrument is the time (term) to that instrument's expiration date. D) All of the above are true. 9) Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's inability to legally require sufficient collateral to cover a loss if the borrower defaults. B) the borrower's lack of incentive to seek a loan for highly risky investments. C) the lender's relative lack of information about the borrowers potential returns and risks of his investment activities. D) none of the above. 10) The presence of transaction costs in financial markets explains, in part, why A) corporations get more funds through equity financing than they get from financial intermediaries. B) financial intermediaries and indirect finance play such an important role in financial markets. C) equity and bond financing play such an important role in financial markets. D) direct financing is more important than indirect financing as a source of funds.

3 11) Which of the following are true statements? A) The conversion of a barter economy to one that uses money increases efficiency by increasing the cost to those who wish to specialize. B) The conversion of a barter economy to one that uses money increases efficiency by reducing transactions costs. C) The conversion of a barter economy to one that uses money increases efficiency by increasing the cost of exchange. D) All of the above are true. 12) When economists say that money promotes efficiency, they mean that money A) reduces transactions costs. B) encourages specialization and the division of labor. C) is inexpensive to produce. D) does both (a) and (b) of the above. 13) Recent financial innovation makes the Federal Reserve's job of conducting monetary policy A) more difficult, since the Fed no longer knows what to consider money. B) easier, since the Fed no longer knows what to consider money. C) easier, since the Fed now knows what to consider money. D) more difficult, since the Fed now knows what to consider money. 14) If there are five goods in a barter economy, one needs to know ten prices in order to exchange one good for another. If, however, there are ten goods in a barter economy, then one needs to know prices in order to exchange one good for another. A) 45 B) 30 C)25 D) 20 15) Which of the following statements accurately describes the three different measures of the money supply--ml, M2, and M3? A) Initial estimates of the money supply are a reliable guide to what is happening to the money supply in the short run. B) M2 is the narrowest measure. C) The three measures do not move together, so they cannot be used interchangeably by policymakers. D) All of the above. E) Only (a) and (b) of the above. 16) A $10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of A) 14 percent. B) 8 percent. C)10 percent. D) 12 percent. 17) In which of the following situations would you prefer to be borrowing? A) The interest rate is 13 percent and the expected inflation rate is 15 percent. B) The interest rate is 9 percent and the expected inflation rate is 7 percent. C) The interest rate is 4 percent and the expected inflation rate is 1 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

4 18) Prices and returns for bonds are more volatile than those for bonds. A) short-term; long-term B) short-term; short-term C) long-term; long-term D) long-term; short-term 19) Which of the following are true for a coupon bond? A) The price of a coupon bond and the yield to maturity are positively related. B) The yield to maturity is greater than the coupon rate when the bond price is above the par value. C) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. D) All of the above are true. E) Only (a) and (b) of the above are true. 20) Which of the following are generally true of all bonds? A) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise. B) Prices and returns for long term bonds are more volatile than those for shorter term bonds. C) The longer a bond's maturity, the lower is the rate of return that occurs as a result of the increase in the interest rate. D) All of the above are true. E) Only (a) and (b) of the above are true. 21) If wealth decreases, the demand for stocks and that of long-term bonds. A) decreases; increases B) increases; decreases C) decreases; decreases D) increases; increases 22) If the expected return on RST stock falls from eight to five percent and the expected return on XYZ stock rises from three to four percent, then the expected return of holding XYZ stock relative to RST stock and demand for XYZ stock. A) falls; rises B) rises; rises C) falls; falls D) rises; falls 23) When the interest rate on a bond is the equilibrium interest rate, in the bond market there is excess and the interest rate will. A) above; demand; rise B) above; supply; rise C) below; supply; fall D) above; demand; fall 24) When a recession occurs, normally the demand for bonds and the supply of bonds A) decreases; decreases B) increases; decreases C) decreases; increases D) increases; increases 25) When the Fed increases the money stock, the money supply curve shifts to the and the interest rate A) left; rises B) right; falls C) right; rises D) left; falls

5 26) An increase in the expected rate of inflation causes the demand curve for bonds to and the supply curve of bonds to A) rise; fall B) fall, rise C) fall; fall D) rise; rise 27) In Figure 5-2, one factor that would not have caused the demand for bonds to increase (shift to the right) is A) an increase in the expected return on bonds relative to other assets. B) a decrease in the expected return on bonds relative to other assets. C) a reduction in the riskiness of bonds relative to other assets. D) an increase in wealth. 28) In Figure 5-2, one factor that would not have caused the supply of bonds to shift to the right is A) an increase in expected profitable investment opportunities. B) an increase in expected inflation. C) an increase in government budget deficits. D) a business cycle contraction. 29) In Figure 5-3, the increase in the interest rate from i2 to il can be explained by A) an increase in income. B) a decrease in money growth. C) a decline in the expected price level. D) all of the above. E) only (a) and (b) of the above.

6 30) Figure 5-5 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) the liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to B) the liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to C) the liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to D) the liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to 31) Figure 5-7 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) the liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to B) the liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to C) the liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to D) the liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to

7 32) In Figure 5-1, the increase in the interest rate from il to i2 due to an increase in the expected inflation rate is called the r A) liquidity effect. B) Fisher effect. C) income effect. D) Keynes effect. 33) When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the. A) left; left B) left; right C) right; left D) right; right 34) If income tax rates were lowered, then A) the interest rate on municipal bonds would fall. B) the prices of municipal bonds would fall. C) the interest rate on Treasury bonds would rise. D) both (a) and (b) would occur. 35) If the yield curve is flat for short maturities and then slopes downward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting. A) a decline in shoit-term interest rates in the near future and an even steeper decline further out in the future. B) constant short-term interest rates in the near future and a decline further out in the future. C) a rise in short-term interest rates in the near future and a decline further out in the future. D) a decline in short-term interest rates in the near future and a rise further out in the future. 36) If the yield curve has a mild upward slope, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting A) a decline in short-term interest rates in the near future and a rise further out in the future. B) constant short-term interest rates in the near future and further out in the future. C) a decline in short-term interest rates in the near future and an even steeper decline further out in the future. D) a rise in short-term interest rates in the near future and a decline further out in the future. 37) If a corporation begins to suffer large losses, then A) the default risk on the corporate bond will increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall. B) the default risk on the corporate bond will decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise. C) the default risk on the corporate bond will decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. D) the default risk on the corporate bond will increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. 38) According to the expectations theory of the term structure A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds. B) interest rates on bonds of different maturities do not move together over time. C) buyers of bonds do prefer short-term to long-term bonds. D) all of the above.

8 39) Which of the following statements are true? A) The expected return on corporate bonds decreases as default risk increases. B) An increase in default risk on corporate bonds lowers the demand for these bonds, but increases the demand for default-free bonds. C) A corporate bond's return becomes more uncertain as default risk increases. D) As their relative riskiness increases, the expected return on corporate bonds decreases relative to the expected return on default-free bonds. E) All of the above are true statements. 40) The U-shaped yield curve in Figure 6-2 indicates that interest rates are expected to. A) short-term; fall moderately in the near-term and rise later on. B) short-term; rise in the near-term and fall later on. C) short-term; fall sharply in the near-term and rise later on. D) short-term; remain unchanged in the near-term and rise later on. FIN Examination #1 - Dr. Hobbs February 15, 2001 Mishkin Chapters 1-6 Essay #1: 20 points A recent article in the Wall Street Journal discussed the psychological effect of the Fed's recent reductions the in the federal funds rate target. The Fed's recent string of rate reductions is the most aggressive since The main thesis of the article is that the Fed reduced the federal funds interest rate mainly to reverse the loss of consumer and business confidence. One sign that business confidence is low is that investment expenditures dropped dramatically in the fourth quarter of In addition the press is filled with reports that businesses have become more pessimistic concerning the profitability of investments in the near term. The government reported that the quarter's real, or inflation-adjusted, growth in gross domestic product slipped to an annual rate of 1.4%, its slowest pace since business investment on equipment and software actually fell at a 5% rate -- a dramatic reversal from 21 % growth in the first quarter of A big December drop was reported last week in orders for capital goods... suggesting that the capital retrenchment isn't over. Use Loanable Funds Market Analysis to show what is likely to happen in the boild market given what you have read above. Write a short essay identifying the relevant shift parameter(s) then show the effects of changes in them using a Loanable Funds diagram. Draw large enough to be clear and to label every aspect of your analysis - you're not designing postage stamps.

9 FIN Examination # 1 - Dr. Hobbs February 15, 2001 Mishkin Chapters 1-6 Essay #2: 20 points a) Suppose the supply of money and demand for money drawn below. The Fed introduces an expansionary monetary policy move to counter the recession we have entered. As a result income is rising/unchanged/falling (Circle One) and expectations of inflation are rising/unchanged/falling (Circle One). Show the effects in the model below - label all axes and curves. What happens to the interest rate under this scenario so far? Circle One: It rises It stays the same It falls b) We took a good deal of time early in this course to review the "transmission mechanism" of an increase in the supply of money. When the money supply is increased (as above) that increase in money works its way into Aggregate Demand through "direct" and "indirect"-paths. Explain these paths below.