Test Form A Instructions: Enter your -- Test Form (listed on the top right of this page) on your scantron,

-- ID number on your scantron -- Last (family) name and first (given) name on your scantron and on the line below, Name: ___________________________________ Choose the best answer among the possible answers given. You will have 75 minutes to complete this test. There are 55 questions, and each question is worth 1 point. No notes or books are allowed except for one reference sheet. 1. If the market interest rates fall from 5% to 4%, which of the following bonds would you prefer to hold if you will sell the bond? A) A bond with six months to maturity B) A bond with one year to maturity C) A bond with five years to maturity D) A bond with ten years to maturity E) A bond with twenty years to maturity 2. A real interest rate represents A) the earnings rate for savers in terms of additional goods and services that can be purchased. B) the cost for borrowers in terms of goods and services that can not be purchased. C) a nominal interest rate minus the (expected) inflation rate. D) A) and B). E) A), B) and C). 3. The too-big-to-fail policy A) would cause more problems today if it were explicitly used because of bank consolidation. B) relies on the purchase and assumption method when implemented by the Federal Deposit Insurance Corporation. C) relies on the lender of last resort policy when implemented by the Federal Reserve System. D) worsens moral hazard problems. E) does all of the above.

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4. The velocity of money A) is measured as the value of gross domestic product divided by the quantity of money. B) represents the rate at which an average dollar travels through the economy. C) is determined by factors such as customs of holding monetary assets and use of credit cards. D) can predict how much the value of goods and services produced will change when quantity of money changes. E) does all of the above 5. According to economists, money A) is an asset that people generally use to buy goods and services or repay debt. B) equals the value of currency, paper bills and metal coins that people hold. C) equals what people earn in a given time period. D) makes an economy more inefficient by encouraging greed. E) is another name for wealth. 6. If a bank becomes more efficient as it serves a larger market, the bank is said to benefit from A) diversification. B) consolidation. C) a high return on equity. D) economies of scale. E) economies of scope. 7. Inflation risk is the risk that A) expected inflation will occur. B) borrowers will default on their loans during times of high expected inflation. C) nominal interest rates will have to be adjusted upward because of inflation. D) the purchasing power of income earned from an asset will change when unexpected inflation occurs. E) the rates of return on assets will become unstable. 8. Bank charters A) reduce adverse selection. B) require that bank board members be qualified. C) require that banks purchase insurance against negligent or illegal behavior by employees. D) list all of the factors which need to be fulfilled, according to a state or the national government, before a bank is opened. E) do all of the above.

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9. According to the model of the money market, interest rates on bonds will increase when A) the prices of goods and services increase. B) income earned from producing goods and services increase. C) the risk of holding bonds and other non-monetary assets increases. D) all of the above occurs. E) none of the above occurs. 10. According to the model of the money market, the demand of monetary assets will decrease when A) the prices of goods and services increase. B) income earned from producing goods and services increase. C) the rate at which individuals and institutions choose to use monetary assets to conduct transactions increases. D) the central bank increases the supply of monetary assets. E) the central bank decreases the supply of monetary assets. 11. If new computer technology makes buying and selling of one kind of bond easier and less costly, then the bond's yield to maturity is predicted to _____ and its price is predicted to _____. A) rise; rise B) rise; fall C) fall; rise D) fall; fall E) remain constant; fall 12. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allowed banks A) to engage in inter-state branching unless state governments prohibited it. B) to invest in common stocks. C) to merge with insurance companies and securities firms. D) to pay market interest rates on demand deposits. E) to create bank holding companies. 13. Diversification A) allows investors to divide risk into individual parts so as to avoid the risk of holding a single asset. B) achieves a highest rate of return when assets generally perform well. C) reduces market risk so as to avoid many separate risks that exist in the market. D) increases the value of an asset's beta. E) reduces the risk that the value of all assets in the market will decline in value.

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14. Assets are considered a _______ of funds for a bank, and liabilities are considered a _______ of funds for a bank. A) use; source B) use; use C) source; use D) source; source E) waste; use 15. Sweep accounts A) have lessened the cost of reserve requirements for banks. B) sweep funds out of deposit accounts into the trash bin. C) enable banks to avoid paying interest to corporate customers. D) have reduced the assets of banks. E) all of the above. 16. The risk-based capital ratio A) accounts for off-balance sheet activities. B) accounts for more risky financial assets by using a higher weight in its calculation. C) accounts for less risky financial assets by using a lower weight in its calculation. D) is used today to determine the amount of premiums that depository institutions pay for deposit insurance. E) does all of the above. 17. When the relevant borrowing or saving interest rate is 2%, the present value of $500 to be paid next year is approximately A) $520. B) $502. C) $498. D) $490. E) $450. 18. If First State Bank has a GAP equal to +$10 million, then a 3 percentage point decrease in interest rates would cause its bank capital to A) increase by $200 thousand. B) increase by $300 thousand. C) increase by $900 thousand. D) decrease by $300 thousand. E) decrease by $900 thousand.

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19. According to the bond market model and model of the money market model, which of the following are true? A) The bond market model directly analyzes the effects from changes in expected inflation. B) The money market model directly analyzes the effects from changes in the supply of money. C) Both models predict an equilibrium interest rate on bonds. D) A) and B). E) A), B) and C). 20. Default or credit risk is A) the risk that assets will lose their value due to changes in interest rates. B) the risk that a loss larger than a maximum acceptable loss will occur during a time period. C) the risk that borrowers will be unwilling or unable to repay a loan on time or at all. D) the measure of how much the rate of return deviates from the expected rate of return. E) the risk that a saver will need to convert an asset to liquid funds by paying higher than expected transaction costs. 21. According to the model of the bond market, if stocks are expected to earn a higher rate of return and other factors remain constant, then A) the demand of bonds increases and the interest rate on bonds decreases. B) the demand of bonds decreases and the interest rate on bonds increases. C) the demand of bonds decreases and the price of bonds increases. D) the demand of bonds increases and the price of bonds increases. E) the demand of bonds increases and the interest rate on bonds increases. 22. Regulatory forbearance during the 1980s A) increased moral hazard problems for banks, especially those that were already insolvent. B) benefited financially healthy banks. C) allowed many insolvent banks to become profitable again. D) A) and B). E) A), B) and C).

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23. Interest rate risk is A) the risk that a saver will need to convert an asset to liquid funds by paying higher than expected transaction costs. B) the risk that the value of assets or liabilities will change due to changes in interest rates. C) the risk that a loss larger than a maximum acceptable loss will occur during a time period. D) the standard deviation of a rate of return divided by the expected rate of return. E) the measure of how much the rate of return is likely to deviate from the expected rate of return. 24. When Huiran writes a $100 check to her friend (who uses another bank), the assets of Huiran's bank _____ and the liabilities of Huiran's bank _____ when the check is processed. A) increase by $100; increase by $100 B) increase by $100; decrease by $100 C) decrease by $100; do not change D) decrease by $100; decrease by $100 E) do not change; increase by $100 25. Because it is a medium exchange, money A) reduces transaction costs. B) is a measure of wealth. C) is a measure of income. D) maintains its purchasing power over time. E) B) and C) 26. A bank facing a shortage of reserves might A) decide not to renew loans. B) borrow from the Federal Reserve System. C) sell securities. D) borrow from other banks. E) do all of the above. 27. Economists argue that consolidation will be beneficial for the banking system because it A) will reduce competition. B) will reduce lending to small businesses. C) will increase diversification of loans and other assets. D) will allow regulatory forbearance. E) will eliminate banks with personal service.

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28. When the central bank increases the quantity of money in circulation A) interest rates on bonds decrease if other factors remain constant according to the money market model. B) the demand of bonds increases if other factors remain constant according to the model of bond markets. C) expected inflation may increase if other factors remain constant. D) the price level may increase if other factors remain constant. E) all of the above may occur. 29. The Federal Reserve's lender of last resort policy A) is no longer necessary due to FDIC insurance. B) has not been relied upon since financial deregulation in 1980. C) is useful to prevent panic by bank customers, especially those not covered by FDIC insurance. D) A) and B). E) A) and C). 30. An asset's beta represents A) the risk that the value of a particular asset in a portfolio will change due to factors that specifically affect the asset. B) the risk that the value of all assets available in the market will change in value. C) the degree to which nominal interest rates are adjusted upward because of inflation. D) the purchasing power of income earned from an asset when unexpected inflation occurs. E) the degree to which an asset's rate of return will change when all assets in the market change in value. 31. Banks want to maintain a _____ level of bank capital to attain a _____ return on equity and want to maintain a _____ level of bank capital to protect against bank failure. A) low, low, high B) high, high, low C) low, high, high D) high, low, low E) high, high, high

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32. A difference between the payoff method and the purchase and assumption method of handling failed banks is A) that the FDIC guarantees all deposits when it uses the payoff method. B) that the FDIC uses the payoff method under the "too-big-to fail" policy. C) that the FDIC is more likely to use the payoff method when it fears that depositor losses may spur other bank failures. D) that the FDIC closes an insolvent bank under the payoff method but does not close it under the purchase and assumption method. E) that the FDIC uses the lender of last resort policy under the payoff method. 33. Which of the following is included in both M1 and M2? A) Currency B) Savings deposits C) Small time deposits D) Money market deposit accounts E) Savings bonds 34. When bond investors expect that the rate of inflation will _____ the demand of bonds will ____, leading to an _____ in yields to maturity and nominal interest rates. A) decrease; decrease; increase B) decrease; increase; increase C) increase; decrease; decrease D) increase; decrease; increase E) increase; increase; increase 35. The current yield of a coupon bond equals A) the face value payment divided by the bond's price. B) the yield to maturity minus the inflation rate. C) the coupon payment in the current period divided by the bond's price. D) the face value payment minus the bond's price divided by the bond's price. E) the coupon payment in the current period divided by the bond's face value payment. 36. When investors are risk averse, they A) prefer to buy stocks instead of bonds when the two types of assets have the same expected rate of return. B) prefer to buy safe assets when they have the same expected rate of return as risky assets. C) prefer to buy stocks with a high beta. D) prefer to invest their wealth in assets with the highest expected rate of return. E) prefer to visit Las Vegas casinos.

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37. If securitized loans that are formed from subprime loans are now believed to be more risky, we predict that A) the demand for these securities will increase. B) the price of these securities will increase. C) the yield to maturity on these securities will decrease. D) the yield to maturity on safe bonds like US Treasury securities will increase. E) the yield to maturity on safe bonds like US Treasury securities will decrease. 38. In which of the following situations would you prefer to be a borrower? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 4 percent and the expected inflation rate is 3 percent. D) The interest rate is 13 percent and the expected inflation rate is 15 percent. E) The interest rate is 25 percent and the expected inflation rate is 50 percent. 39. Securitization refers to A) creating a marketable security by bundling a portfolio of loans or other assets. B) diversifying risk of a portfolio of loans or other assets. C) securing a financial institution against interest rate risk. D) securing a financial institution against credit risk. E) securing the value of a portfolio by hedging with derivatives. 40. According to the model of the bond market, if the central bank buys bonds and other factors remain constant, then A) the demand of bonds increases and the interest rate on bonds decreases. B) the demand of bonds decreases and the interest rate on bonds increases. C) the demand of bonds decreases and the price of bonds increases. D) the demand of bonds increases and the price of bonds decreases. E) the demand of bonds decreases and the interest rate on bonds decreases. 41. Liquidity risk is A) the risk that assets will lose their value due to changes in interest rates. B) the risk that a loss larger than a maximum acceptable loss will occur during a time period. C) the standard deviation of a rate of return divided by the expected rate of return. D) the measure of how much the rate of return deviates from the expected rate of return. E) the risk that a saver will need to convert an asset to liquid funds by paying higher than expected transaction costs.

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42. A debit card differs from a credit card in that A) a debit card transaction is a loan while a credit card transaction is an immediate payment. B) a debit card transaction is a long-term loan while a credit card transaction is a shortterm loan. C) a credit card transaction is a loan while a debit card transaction is an immediate payment. D) a credit card transaction is a long-term loan while a debit card transaction is a shortterm loan. E) a debit card transaction results in a deduction from a checking account, while a credit card transaction results in a deduction from a savings account. 43. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 allowed banks A) to engage in inter-state branching unless state governments prohibited it. B) to invest in common stocks. C) to merge with insurance companies and securities firms. D) to pay market interest rates on demand deposits. E) to create bank holding companies. 44. Bank reserves include A) a bank's deposits at the Federal Reserve System and US government securities. B) vault cash and US government securities. C) vault cash and a bank's deposits at the Federal Reserve System. D) US government securities and municipal securities. E) a bank's deposits at other banks and a bank's deposits at the Federal Reserve System. 45. A system of deposit insurance A) attracts entrepreneurs into the banking industry who are more careless and risk seeking than average. B) allows bank managers to take risk without bearing the full consequences of some losses. C) increases the incentives of depositors to monitor the risk of their bank's assets. D) A) and B). E) A), B) and C).

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46. Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 A) increased bank capital requirements and imposed risk based capital ratios for many depository institutions. B) limited interest rates on deposits and imposed the required reserve ratio. C) prevented banks from underwriting securities and selling insurance. D) allowed bank holding companies and banks to engage in inter-state branching. E) imposed regulatory forbearance and the "too-big-to-fail" policy. 47. Which of the following statements accurately describes the aggregate measures of money? A) M1 is included in M2. B) Aggregate measures of money remained stable since the mid-1990s. C) Different measures of the money supply change together, so that a change in one measure implies a similar change in another measure. D) The velocity of M2 has remained stable since the mid-1990s. E) None of the above. 48. Which of the following are reported as assets on a bank's balance sheet? A) borrowed funds from other banks B) discount loans from the Federal Reserve System C) loans made to other banks D) fees from services E) deposits made by bank customers 49. The discount yield on a 180-day bond with a face value of $1000 and a price of $975 is A) 1%. B) 2.5%. C) 5%. D) 7.5%. E) 10%. 50. If the duration of a bank's assets is two years and the duration of its liabilities is three years, then a 2 percentage point increase in interest rates will cause the value of bank capital to _____ by _____. A) decrease, 1 percent B) decrease, 2 percent C) decrease, 5 percent D) increase, 1 percent E) increase, 2 percent

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51. The coefficient of variation is A) the difference between the expected rate of return on a risky asset and that on a safe asset. B) the standard deviation of a rate of return divided by the expected rate of return. C) the risk that a loss larger than a maximum acceptable loss will occur during a given time period. D) the measure of how much the rate of return deviates from the expected rate of return. E) the risk of assets losing their market value due to changes in interest rates. 52. A bond's yield to maturity A) acts as the bond's own interest rate. B) is calculated by setting the bond's price equal to the present value of its future payments. C) is inversely related to the bond's price. D) is directly rated to interest rates on other assets. E) All of the above are true. 53. In order for paper currency to effectively function as money, it must retain at least some A) inflation taxes. B) store of value. C) transaction costs. D) illiquidity. E) unit of exchange. 54. A liquid asset A) has no inflation risk. B) generally earns a low rate of interest. C) can be used to acquire funds to pay for goods and services or debt with little or no transaction costs. D) B) and C) E) A), B) and C) 55. If you expect the inflation rate to be 2% during the next year and a one-year bond has a nominal yield to maturity of 4% percent, then the real yield to maturity (real interest rate) on this bond is A) 1.67%. B) 2%. C) 6%. D) 8%. E) none of the above.

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Answer Key
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. E E E E A D D E D C C A A A A E D D E C B A B D A E C E C E C D A D C B E E A A E C C C

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45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55.

D A A C C E B E B D B

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