Exam 2
10 ^th Week
ECON 3313
Kenneth R. Szulczyk

These multiple choice questions will not appear on the exam, but they reflect the style of questions from the test bank.

1. _____ If the price of a futures contract increases, then:

(a) The additional funds will be required from either the buyer or the seller until the delivery date.
(b) The exchange will collect the amount of the increase from the buyer of the contract and transfer it to the account of the seller of the contract.
(c) The exchange will collect the amount of the increase from both the buyer and the seller and place it in escrow until the delivery date.
(d) The exchange will collect the amount of the increase from the seller of the contract and transfer it to the account of the buyer of the contract.

2. _____ If you look at the financial page listings for futures contracts and find that futures prices on Treasury bonds are falling over a particular time period, futures market investors must expect that:

(a) Treasury bond prices will be higher in the future.
(b) Treasury bond yields will be higher in the future.
(c) Treasury bond yields will be lower in the future.
(d) Futures prices will rise again at the end of the period.

3. _____ Investors are charged a fee to buy an option. What is this fee called?

(a) Option premium.
(b) Call option.
(c) Hedging.
(d) Put option.

4. _____ When a buyer has the obligation to pay for an asset as set forth in the futures contract, what is this called?

(a) Put option.
(b) Long position.
(c) Call option.
(d) Short position.

5. _____ When buyers and sellers agree to trade a certain quantity of a security for a specific price and at a specified date in the future, what is this?

(a) The futures market.
(b) A variable-rate certificate of deposit.
(c) Securitization.
(d) A variable-rate mortgage.

6. _____ If a bank granted a loan to a customer at 15%, and the funds will be given to the customer one year from now, how can the bank protect itself from interest rate risk, if the market interest rate is 10% now?

(a) Issue a futures contract now at 10% for certificates of deposit, so the bank would have a source of funds for next year.
(b) Issue more interest bearing checking accounts.
(c) Sell variable-rate certificates of deposit now, and hold the funds raised in a vault until they are needed for next year.
(d) Grant more fixed-rate mortgages for next year, so this provides a source of funds next year.

7. _____ Which of the following institutions would be classified as a securities market institution?

(a) Pension fund.
(b) Credit union.
(c) Money market deposit accounts.
(d) An organized exchange.

8. _____ Why is the Dow Jones Industrial Average so useful?

(a) It provides investors with slow information.
(b) It provides investors with broad movements in the stock market.
(c) It provides the government with information, so it can regulate the financial markets more efficiently.
(d) It is computed by government officials and likely to be manipulated because of political pressure.

9. _____ What are money market deposit accounts?

(a) Investors can buy shares into a pool of corporate stock.
(b) Just like money market mutual funds, but they have a higher risk associated with them.
(c) Just like money market mutual funds, but they are not covered by deposit insurance.
(d) Equivalent to money market mutual funds, but they are offered by commercial banks.

10. _____ What kind of insurance company tends to purchase long-term corporate bonds, because it can predict with accuracy future payments?

(a) Property and casualty insurance company.
(b) Life insurance company.
(c) Federal Deposit Insurance Company.
(d) A vested pension plan

11. _____ Blood tests administered to applicants for medical insurance are an example of an attempt by insurance companies to deal with the problems of:

(a) Moral hazard.
(b) The drug abuse problems currently plaguing the country.
(c) Adverse selection.
(d) Failure of policyholders to keep paying their premiums.

12. _____ Credit unions have invested primarily in:

(a) Corporate stock.
(b) Commercial paper.
(c) Corporate bonds.
(d) Mortgages.

13. _____ A bank’s net worth will decline following an increase in interest rates if the value of its:

(a) Fixed-rate assets is greater than the value of its fixed-rate liabilities.
(b) Fixed-rate assets is less than the value of its fixed-rate liabilities.
(c) Fixed-rate assets is greater than the value of its variable-rate assets.
(d) Fixed-rate liabilities is greater than the value of its variable-rate liabilities.

14. _____ Which of the following things do banks do with the funds they acquire from savers?

(a) Invest in corporate stock.
(b) Invest in corporate bonds.
(c) Make loans to individuals.
(d) All of the above.

15. _____ When a bank is holding a financial security such as a U.S. government bond, how is this recorded on a balance sheet?

(a) As an asset.
(b) As a capital.
(c) As a liability.
(d) As net worth.

16. _____ If there is a possibility that depositors may withdraw more money from their accounts than the amount of cash in a bank’s vault, what is this called?

(a) Floating rate debt.
(b) Liquidity risk.
(c) Securitization.
(d) Interest rate risk.

17. _____ What is bank net worth?

(a) It is a loan received from the central bank.
(b) The amount of checking and savings deposits.
(c) What ever is left when total assets minus total liabilities.
(d) The amount of government securities that a bank holds.

18. _____ If a bank is not holding enough required reserves, which strategy can the bank do below to acquire more required reserves?

(a) The bank buys more U.S. government securities.
(b) The bank grants more loans to borrowers.
(c) The bank borrows from the Federal Reserve.
(d) The bank buys more marketable securities.

19. _____ Which agency below acts as the lender of the last resort?

(a) The Comptroller of the Currency.
(b) The Federal Deposit Insurance Corporation.
(c) A Federal Reserve Bank.
(d) A state banking authority.

20. _____ From the items below, which one is a reason that government regulates the banking sector?

(a) The government wants to ensure the financial system is unstable.
(b) The government wants to provide high-cost financing for home buyers.
(c) The government wants to protects the banks’ power.
(d) The central bank wants more control over the money supply, when implementing monetary policy.

21. _____ Critics of allowing bank examiners too much discretion argue that doing so results in banks:

(a) Charging higher interest rates on loans.
(b) Being too conservative in making loans.
(c) Having to pay bribes in order to receive favorable examiner’s reports.
(d) Declining to accept deposits from some depositors.

22. _____ Comparing the U.S. banking system to the systems in other major industrial countries, which of the following statements is true?

(a) The United States has more banks and more bank offices per capita.
(b) The United States has fewer banks and fewer bank offices per capita.
(c) The United States has more banks, but about the same number of bank offices per capita.
(d) The United States has about the same number of banks, but more bank offices per capita.

23. _____ How did Money Market Mutual Funds hurt commercial banks and savings and loan institutions during the 1970s?

(a) Money Market Mutual Funds could offer lower interest rates to investors, causing investors to withdraw their funds from the banks.
(b) Money Market Mutual Funds could offer higher interest rates to investors, causing investors to withdraw their funds from the banks.
(c) Money Market Mutual Funds could offer the same interest rates to investors, causing investors to withdraw their funds from the banks.
(d) Money Market Mutual Funds could offer higher risk and lower liquidity to investors, causing investors to withdraw their funds from the banks.

24. _____ Why did the U.S. government divide up the functions of investment and commercial banking?

(a) The government believed that banks were underwriting too many risky securities.
(b) The government believed that banks were making too much money by offering investment and commercial banking.
(c) The government wanted to prevent banks from crossing state lines, isolating banks from too much competition.
(d) The government believed that banks were charging exorbitant prices for underwriting corporate securities.

25. _____ What is a benefit of international banks?

(a) These banks innovate more, when they are regulated more.
(b) These banks have less innovation, when they are regulated more.
(c) These banks decrease the liquidity and increase the risk in international finance.
(d) These banks can only link savers and borrowers within one country.

26. _____ If your U.S. company invested $2 million into Russia and the loan is denominated in rubles, what happens to your investment if the exchange rate changes from [ $1 to 2,000 rubles ] to [ $1 to 1,000 rubles ]?

(a) Your company has been hurt by exchange rate risk.
(b) Your company has benefitted from the exchange rate risk.
(c) There is no change to your company’s investment in Russia.
(d) There is not enough information to solve this problem.

27. _____ When an international bank is not located in a financial center, has little regulation, has low tax rates, and has strict-customer confidentiality laws, what is this called?

(a) Offshore markets.
(b) Foreign bank subsidiary.
(c) Edge Act corporation.
(d) International banking facility.

28. _____ What is the preferred method by foreign banks to enter the United States banking market?

(a) Agency office.
(b) Edge Act corporation.
(c) Foreign bank branch.
(d) Subsidiary U.S. bank.

29. _____ A currency swap is:

(a) The informal name bankers give to the exchange rate.
(b) An exchange of the expected future returns on debt instruments denominated in different currencies.
(c) An agreement by one government to provide aid to another government in the form of a loan denominated in the recipient’s currency.
(d) An agreement to buy and sell a specified amount of foreign currency at a specified future date.

30. _____ A banker’s acceptance is:

(a) Currency accepted for deposit in a foreign bank.
(b) A loan that uses as collateral funds in a foreign bank.
(c) An order to pay a specified amount of money to the holder of the acceptance on a specified date.
(d) An agreement to transfer a loan from one bank to another.

31. _____ If the money multipliers become more stable, what happens to the Fed’s control of the money supply?

(a) The Fed has less control over the money supply.
(b) The Fed has more control over the money supply.
(c) This has no effect on the Fed’s control of the money supply.
(d) At first the Fed has more control, then this control becomes weaker over time.

32. _____ If the Fed buys securities worth $10 million, then (assume some customers will withdraw some deposits as currency):

(a) Bank reserves will increase by $10 million.
(b) Bank reserves will decrease by $10 million.
(c) Currency in circulation will increase by $10 million.
(d) The sum of bank reserves and currency in circulation will increase by $10 million.

33. _____ Does it make any difference on the money supply, whom the Fed buys U.S. government securities from, such as an individual, business, or bank?

(a) No.
(b) Yes.
(c) Maybe.
(d) Need more information.

34. _____ When the public avoids paying taxes or participates in more illegal activity, what happens to the currency-deposit ratio?

(a) The ratio decreases.
(b) The ratio does not change.
(c) The ratio increases.
(d) The ratio first increases then decreases.

35. _____ Which of the following assumptions made in deriving the simple deposit multiplier so unrealistic?

(a) The Fed sets the required reserve ratio.
(b) The Fed is able to affect the level of reserves in the banking system.
(c) Banks loan out all of their excess reserves.
(d) The simple deposit multiplier is equal to 1 divided by the required reserve ratio.

36. _____ If the Fed bought from you a $20,000 T-bill and used a Fed check, what is the effect on the money supply, if the required reserve ratio is 10% and no currency is withdrawn from the banks (using simple money multiplier)?

(a) There is no change in the money supply.
(b) The money supply increases by $200,000.
(c) The money supply increases by $180,000.
(d) The money supply decreases by $200,000.

Essay Questions

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

1. What are the three factors that influence the size of the option premium?

2. You have a call option for gold, which specifies gold for $200 per ounce in the contract. What shall you do if the market price of gold is $250 per ounce?

3. (a) What are the two ways the federal government can enter the financial markets?

(b) Is there a potential problem of doing this?

4. (a) What are the two ways to organize a life insurance company?

(b) Does one way have any benefits of the other method?

5. (a) Drawing a T-account, please record the transaction where you deposit $5,000 into a bank. The bank is required to hold 10% of the deposit as required reserves.

(b) The bank decides to lend out all of its excess reserves as a credit card loan, please record this transaction.

6. (a) Looking at the bank’s balance sheet below, what happens to this bank when the interest rate increases?

(b) If you believe interest rates will increase, what will be your strategy?

7. What are the three ways the banks have found to circumvent regulations? Please explain.

8 (i). The Fed buys a $20,000 T-bill from you by using a “Fed” check.bPlease record this transaction in the T-account below. The required reserve ratio is 10%, so allocate the reserves between Required Reserves and Excess Reserves.

Your Bank

Change in M1: _______________

(ii) Your bank lends out its excess reserves for a home loan. Please record this transaction at your bank above and the First National Bank below:

First National Bank

Total change in M1 from first two transactions: _______________

(iii) The First National bank lends out its excess reserves as a loan. Please record this transaction for the First National bank above and the Norwest bank below:

Norwest Bank

Total change in M1 from first three transactions: _______________

Answers: