Exam 1
5 ^th Week
ECON 3313
Kenneth R. Szulczyk

1. _____ Which answer below would be a benefit in investing your funds in a financial institution, like a bank?

(a) A bank account increases investor’s risk.
(b) A bank account is not a liquid investment.
(c) A bank account is a liquid investment.
(d) A bank collects information on borrowers poorly.

2. _____ Which of the following is NOT a key financial service provided by the financial system?

(a) Liquidity.
(b) Risk sharing
(c) Profitability.
(d) Information.

3. _____ What is the purpose of a financial market?

(a) Allow banks to link buyers and sellers of financial securities.
(b) Buyers and sellers come together to buy and sell financial securities.
(c) Buyers and sellers come together to trade one good for another good.
(d) Buyers and sellers are linked by a government agency. The government agency controls the transaction.

4. _____ Why is liquidity so important?

(a) Stronger liquidity causes the economy to grow faster.
(b) Liquidity causes problems when converting nominal GDP into real GDP.
(c) Liquidity defines the money supply for countries with sophisticated financial markets.
(d) Liquidity helps the Fed in controlling the money supply.

5. _____ What is a “central bank”?

(a) Any commercial bank that is willing to make loans to other commercial banks.
(b) The largest bank in a particular banking system.
(c) A special governmental or quasi-governmental institution in the financial system that regulates the medium of exchange.
(d) Any commercial bank located in the capital of a country.

6. _____ Which function of money conveniently allows a way of placing value on goods and services?

(a) Medium of Exchange.
(b) Unit of Account.
(c) Store of Value.
(d) Standard of Deferred Payment.

7. _____ Under a barter system, it is difficult to store purchasing power, because many goods deteriorate over time. If money was introduced, which function of money would eliminate this problem?

(a) Medium of Exchange.
(b) Store of Value.
(c) Unit of Account.
(d) Standard of Deferred Payment.

8. _____ Under a system of barter:

(a) Currency is accepted for purchases, but personal checks are not.
(b) Only agricultural goods may be traded.
(c) Each individual trades output directly with another.
(d) Goods may be traded for money, but money may not be traded for goods.

9. _____ The U.S. government is introducing new $100, $50, $20, $10, $5, and new quarters which represent the 50 states. If the new “money” confuses people, which desirable property of money is the U.S. government violating?

(a) Standardized quality.
(b) Valuable relative to its weight.
(c) Durable.
(d) Divisible.

10. _____ When the Federal Reserve Bank defined the M2 definition of the money supply, what approach do they use?

(a) The transaction approach.
(b) The liquidity approach.
(c) The medium of exchange approach.
(d) The unit of account approach.

11. _____ Derivative markets exist in order to:

(a) Overcome some of the information problems involved in trades on the over-the-counter market.
(b) Allow for the direct cash sale of bonds.
(c) Allow for the direct cash sale of common stock.
(d) Reduce the risk of exposure to price fluctuations in cash markets.

12. _____ What is one method that a saver may directly lend to a borrower?

(a) A saver pays an insurance premium.
(b) A saver buys a corporate bond.
(c) A saver opens a checking account.
(d) A saver opens a savings account.

13. _____ What are investment banks?

(a) They are identical to commercial banks.
(b) They regulate the secondary markets.
(c) They accept checking accounts and make commercial loans.
(d) They help corporations and government issue new securities.

14. _____ One benefit of mutual funds is to diversity their portfolios of common stock. What does this accomplish?

(a) Increases the risk of investing in mutual funds.
(b) Lowers the risk of investing in mutual funds.
(c) Allows investors to make a higher return.
(d) Causes zero risk for investors.

15. _____ Which factor is causing the financial markets to become global?

(a) Countries tighten regulations, preventing savers from investing in the international markets.
(b) Industrialized countries are experiencing negative growth, causing lower savings.
(c) Corporations remained in their home countries and ignore the international markets.
(d) Many countries repealed laws that restricted savers from investing in foreign countries.

16. _____ If you received a loan and make monthly payments every month, where the payment covers the principal and interest, what kind of loan is this?

(a) Simple loan.
(b) Coupon bond.
(c) Discount bond.
(d) Fixed-payment loan.

17. _____ You bought a bond with a face value of $1,000 with a stated interest rate of 10% with a maturity of 2 years. The interest is paid yearly. What market price do you pay for the bond if the market interest rate is 5%?

(a) $1,092.97
(b) $952.38
(c) $1,210
(d) $1,000

18. _____ If you buy a financial instrument/loan that has no stated interest rate on it, what kind of financial instrument/loan is this?

(a) Simple loan.
(b) Coupon bond.
(c) Discount bond.
(d) Fixed-payment loan.

19. _____ If you know that nominal interest rates are going to fluctuate greatly and you have money to invest, which security listed below would be the most safe to invest in?

(a) 30-year corporate bonds.
(b) 20-year Treasury bonds.
(c) The capital market.
(d) A six-month Treasury bill.

20. _____ What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1,000, a yield to maturity of 10%, and a maturity of three years?

Note: From test bank. On the exam the number of payments will not exceed two.

(a) $211.38
(b) $898.84
(c) $1255.00
(d) $962.70

21. _____ What is the demand curve for bonds?

(a) The demand curve shows the relationship between quantity demanded and market price of bonds.
(b) The demand curve shows the relationship between quantity supplied and market price of bonds.
(c) The demand curve shows the relationship between a bond’s market price and the interest rate.
(d) The demand curve shows the relationship between the buyers and sellers of bonds.

22. _____ If the bond market has a surplus of bonds (with no government interference), what happens to the price of the bonds?

(a) Quantity supplied is greater than quantity demanded, causing bond prices to decrease.
(b) Quantity demanded is greater than quantity supplied, causing bond prices to increase.
(c) Nothing happens to the bond’s price, the market is in equilibrium.
(d) The bond prices first rise and then falls as the market approaches equilibrium.

23. _____ What happens to the bond market, when wealth in an economy is increasing?

(a) The demand for bonds increases, causing the demand curve to shift right.
(b) The demand for bonds decreases, causing the demand curve to shift left.
(c) The supply for bonds increases, causing the supply curve to shift right.
(d) The supply for bonds decreases, causing the supply curve to shift left.

24. _____ What happens to the bond market, if the supply for bonds decreases?

(a) Both the bond price and interest rate will increase.
(b) Both the bond price and interest rate will decrease.
(c) The bond price will increase, while the interest rate will decrease.
(d) The bond price will decrease, while the interest rate will increase.

25. _____ Suppose that Congress passes an investment tax credit. The likely result will be:

(a) The supply curve for bonds will shift to the right.
(b) The equilibrium interest rate will fall.
(c) Demand curve for loanable funds will to the left.
(d) Supply curve for loanable funds will shift to the left.

26. _____ Under the expectations theory if market participants expect that future short-term rates will be higher than current short-term rates, the yield curve will:

(a) Slope upward.
(b) Slope upward, downward, or be flat depending on risk, liquidity, cost of information, and tax considerations.
(c) Slope downward.
(d) Be flat.

27. _____ Why does government have little risk of default?

(a) The U.S. government can control the market interest rates and can borrow at a low interest rate.
(b) The U.S. government can illegally seize property and pay off its debt.
(c) The government can raise taxes to pay off debt.
(d) The government is too large to bankrupt.

28. _____ If municipal bonds are tax exempt while U.S. government securities are subjected to taxes, how does taxes affect the interest rates?

(a) Municipal governments pay a lower interest rate than the U.S. government.
(b) Municipal governments pay a higher interest rate than the U.S. government.
(c) Municipal governments pay the same interest rate as the U.S. government.
(d) Not enough information is given to answer this question.

29. _____ When economists plot U.S. government securities by the market interest rate and maturity, what is this graph called?

(a) Yield curve.
(b) Risk premium.
(c) Liquidity premium.
(d) Bond rating.

30. _____ If you plotted a yield curve and it is downward sloping, what kind of economic activity is the yield curve predicting?

(a) The economy will experience strong growth within a year.
(b) The economy will experience a recession within a year.
(c) The economy will experience higher inflation within a year.
(d) The economy will experience higher income within a year.

Essay Questions

These questions reflect the style of the instructor; I will explain these in class.

1. Please list three variables in our economy that the central bank can influence?

2. What items are included in the M1 definition of the money supply?

3. (a) You bought a Treasury bill with a face value of $10,000 with a maturity of 1 year. What market price do you pay for the bond if the market interest rate is 30%?

(b) What is your total rate of return for this T-bill?

4. (a) We have a two-year bond with a coupon rate of 5%, has a face value of $500, and the bond pays interest annually. What is the market price of this bond if the market interest rate is 10%?

(b) If you hold this bond for only one year and sell it for $500, what is your total rate of return?

5. Please draw the supply and demand curves for the bond market. What happens when the government's deficit increases and borrows more from the financial markets?

Explain in words and show graphically.

6. (a) Please explain the Preferred Habitat Theory.

(b) Does this theory explain the two characteristics of the yield curve? Please explain.

7. Please draw the supply and demand curves for two bond markets: U.S. Federal Government bonds and municipal bonds. Start both markets with the same price and interest rate. What happens to the market when municipal bond's interest income become exempt from U.S. Federal income taxes?

Explain in words and show graphically.

Answers: