REVIEW QUESTIONS

Multiple Choice
1) Which of the following statements about the characteristics of debt and equity is FALSE?
A) They can both be long-term financial instruments.
B) They can both be short-term financial instruments.
C) They both involve a claim on the issuer's income.
D) They both enable a corporation to raise funds.

2) If the maturity of a debt instrument is less than one year, the debt is called
A) short-term.
B) intermediate-term.
C) long-term.
D) prima-term.

3) Which of the following statements best explains how the use of money in an economy
increases economic efficiency?
A) Money increases economic efficiency because it is costless to produce.
B) Money increases economic efficiency because it discourages specialization.
C) Money increases economic efficiency because it decreases transactions costs.
D) Money cannot have an effect on economic efficiency.

4) When money prices are used to facilitate comparisons of value, money is said to function as a
A) unit of account.
B) medium of exchange.
C) store of value.
D) payments-system ruler.

5) If there are four goods in a barter economy, then one needs to know ________ prices in order
to exchange one good for another.
A) 8
B) 6
C) 5
D) 4

6) With an interest rate of 6 percent, the present value of $100 next year is approximately
A) $106.
B) $100.
C) $94.
D) $92.

7) If a security pays $55 in one year and $133 in three years, its present value is $150 if the
interest rate is
A) 5 percent.
B) 10 percent.
C) 12.5 percent.
D) 15 percent.

8) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year
is
A) $650.
B) $1,300.
C) $130.
D) $13.

9) If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it
sells for $200?
A) 9 percent
B) 10 percent
C) 11 percent
D) 12 percent

10) The ________ is below the coupon rate when the bond price is ________ its par value.
A) yield to maturity; above
B) yield to maturity; below
C) discount rate; above
D) discount rate; below

11) Which of the following $1,000 face-value securities has the highest yield to maturity?
A) a 5 percent coupon bond selling for $1,000
B) a 10 percent coupon bond selling for $1,000
C) a 12 percent coupon bond selling for $1,000
D) a 12 percent coupon bond selling for $1,100

12) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for
$1,200 next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) 25 percent

13) Which of the following statements are TRUE?

A) A bank's assets are its sources of funds.
B) A bank's liabilities are its uses of funds.
C) A bank's balance sheet shows that total assets equal total liabilities plus equity capital.
D) A bank's balance sheet indicates whether or not the bank is profitable.

14) Which of the following are reported as liabilities on a bank's balance sheet?
A) reserves
B) checkable deposits
C) consumer loans
D) deposits with other banks
15) Bank capital is equal to ________ minus ________.
A) total assets; total liabilities
B) total liabilities; total assets
C) total assets; total reserves
D) total liabilities; total borrowings

16) Bank reserves include

A) deposits at the Fed and short-term treasury securities.
B) vault cash and short-term Treasury securities.
C) vault cash and deposits at the Fed.
D) deposits at other banks and deposits at the Fed.

17) Which of the following are reported as assets on a bank's balance sheet?
A) borrowings
B) reserves
C) savings deposits
D) bank capital

18) Which of the following bank assets is the most liquid?

A) consumer loans
B) reserves
C) state and local government securities
D) U.S. government securities

19) Bank's make their profits primarily by issuing

A) equity.
B) negotiable CDs.
C) loans.
D) NOW accounts.

20) Banks may borrow from or lend to another bank in the Federal Funds market. A loan of
excess reserves from one bank to another bank is recorded as a(n) ________ for the borrowing
bank and a(n) ________ for the lending bank.
A) asset; asset
B) asset; liability
C) liability; liability
D) liability; asset
21) When you deposit a $50 bill in the Security Pacific National Bank
A) its liabilities decrease by $50.
B) its assets increase by $50.
C) its reserves decrease by $50.
D) its cash items in the process of collection increase by $50.

22) If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it
holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its
balance sheet is
A) $30,000.
B) $25,000.
C) $20,000.
D) $10,000.

23) If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve
requirements, the bank can
A) reduce deposits by $3 million.
B) increase loans by $3 million.
C) sell $3 million of securities.
D) repay its discount loans from the Fed.

24) Banks hold excess and secondary reserves to

A) reduce the interest-rate risk problem.
B) provide for unexpected deposit outflows.
C) satisfy margin requirements.
D) achieve higher earnings than they can with loans.

25) In the absence of regulation, banks would probably hold

A) too much capital, reducing the efficiency of the payments system.
B) too much capital, reducing the profitability of banks.
C) too little capital.
D) too much capital, making it more difficult to obtain loans.

26) The monetary liabilities of the Federal Reserve include

A) securities and loans to financial institutions.
B) currency in circulation and reserves.
C) securities and reserves.
D) currency in circulation and loans to financial institutions.

27) Suppose that from a new checkable deposit, First National Bank holds two million dollars in
vault cash, eight million dollars on deposit with the Federal Reserve, and nine million dollars in
excess reserves. Given this information, we can say First National Bank faces a required reserve
ratio of ________ percent.
A) ten
B) twenty
C) eighty
D) ninety

28) When the Fed extends a $100 discount loan to the First National Bank, reserves in the
banking system
A) increase by $100.
B) increase by more than $100.
C) decrease by $100.
D) decrease by more than $100.
29) If reserves in the banking system increase by $100, then checkable deposits will increase by
$1000 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.10.
C) 0.05.
D) 0.20.

30) In the simple deposit expansion model, a decline in checkable deposits of $1,000 when the
required reserve ratio is equal to 20 percent implies that the Fed
A) sold $200 in government bonds.
B) sold $500 in government bonds.
C) purchased $200 in government bonds.
D) purchased $500 in government bonds.

31) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is
________ billion.
A) $8000
B) $1200
C) $1200.8
D) $8400

32) If the required reserve ratio is 10 percent, currency in circulation is $1,200 billion, checkable
deposits are $1,600 billion, and excess reserves total $2,500 billion, then the M1 money
multiplier is
A) 2.5.
B) 1.7.
C) 7.3.
D) 0.73.

Short Answer Questions

1. Using the loanable funds model of interest rate, describe what happens to each of the
following curves and variables when monetary policy becomes more expansionary:
a) Total demand for credit
b) Total supply of credit
c) Business investment
d) Household consumption
e) Capital inflow

Unless otherwise noted, the following assumptions are made in all of the applied problems: the
required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and
the public’s holdings of currency do not change.

2. If the Fed sells $2 million of bonds to the First National Bank, what happens to reserves and
 the monetary base? Use T-accounts to explain your answer.
3. If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with a
briefcase filled with currency, what happens to reserves and the monetary base? Use T-
accounts to explain your answer.
4. If the Fed lends five banks a total of $100 million but depositors withdraw $50 million and
hold it as currency, what happens to reserves and the monetary base? Use T-accounts to
explain your answer.
5. If the Fed buys $1 million of bonds from the First National Bank, but an additional 10% of
any deposit is held as excess reserves, what is the total increase in checkable deposits? (Hint:
Use T-accounts to show what happens at each step of the multiple expansion process.)
6. If the Fed reduces reserves by selling $5 million worth of bonds to the banks, what will the
T-account of the banking system look like when the banking system is in equilibrium? What
will have happened to the level of checkable deposits?
7. Suppose that the required reserve ratio is 9%, currency in circulation is $620 billion, the
amount of checkable deposits is $950 billion, and excess reserves are $15 billion.
a. Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the
money multiplier.
b. Suppose the central bank conducts an unusually large open market purchase of bonds
held by banks of $ 1,300 billion due to a sharp contraction in the economy. Assuming the
ratios you calculated in part (a) remain the same, predict the effect on the money supply.
c. Suppose the central bank conducts the same open market purchase as in part (b), except
that banks choose to hold all of these proceeds as excess reserves rather than loan them
out, due to fear of a financial crisis. Assuming that currency and deposits remain the
same, what happens to the amount of excess reserves, the excess reserve ratio, the money
supply, and the money multiplier?
d. Following the financial crisis in 2008, the Federal Reserve began injecting the banking
system with massive amounts of liquidity, and at the same time, very little lending
occurred. As a result, the Ml money multiplier was below I for most of the time from
October 2008 through 2011. How does this relate to your answer to the previous step?