Financial Systems
Study Guide Questions
Course Introduction
This course provides an in-depth exploration of the structure, functions, and dynamics of financial systems, including their roles in the allocation of resources and risk within an economy. Students will examine key financial institutions such as banks, insurance companies, and investment firms, as well as the markets in which they operate. The course also covers regulatory frameworks, the impact of technological advancements, and the interplay between domestic and global financial systems. Through case studies and real-world examples, students will gain insight into how financial systems contribute to economic stability and growth, as well as the challenges they face in times of crisis.
Recommended Textbook
Financial Markets and Institutions Global 7th Edition by Frederic S Mishkin
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Chapter 1: Why Study Financial Markets and Institutions
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Q1) The central bank of the United States is A)Citicorp.
B)The Fed.
C)Bank of America.
D)The Treasury.
E)none of the above.
Answer: B
Q2) (I)Debt markets are often referred to generically as the bond market. (II)A bond is a security that is a claim on the earnings and assets of a corporation.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Answer: A
Q3) The price of one country's currency in terms of another's is called
A)the foreign exchange rate.
B)the interest rate.
C)the Dow Jones industrial average.
D)none of the above.
Answer: A
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Chapter 2: Overview of the Financial System
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Sample Questions
Q1) Many common stocks are traded over the counter, although a majority of the largest corporations have their shares traded at organized stock exchanges.
A)True
B)False
Answer: True
Q2) Adverse selection refers to those with high credit risks, being most aggressive in their search for funds.
A)True
B)False
Answer: True
Q3) Intermediaries who are agents of investors and match buyers with sellers of securities are called A)investment bankers. B)traders.
C)brokers.
D)dealers.
E)none of the above.
Answer: C
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Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation
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Sample Questions
Q1) The interest rate that equates the present value of the cash flow received from a debt instrument with its market price today is the
A)simple interest rate.
B)discount rate.
C)yield to maturity.
D)real interest rate.
Answer: C
Q2) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one year later?
A)5 percent
B)10 percent
C)-5 percent
D)-10 percent
E)None of the above
Answer: C
Q3) How does reinvestment risk differ from interest-rate risk?
Answer: not answered
Q4) Why may a bond's rate of return differ from its yield to maturity?
Answer: not answered
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Chapter 4: Why Do Interest Rates Change
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Q1) What is the expected return on a bond if the return is 9% two-thirds of the time and 3% one-third of the time? What is the standard deviation of the returns on this bond? Would you prefer this bond or one with an identical expected return and a standard deviation of 4.5? Why?
Q2) Higher expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________.
A)increase; left
B)increase; right
C)decrease; left
D)decrease; right
Q3) Determining asset prices using stocks of assets rather than flow is called A)asset transformation.
B)expected return.
C)asset market approach.
D)market equilibrium.
Q4) How will a decrease in the federal government's budget deficit affect the equilibrium interest rate in the bond market? Explain using the bond demand and supply framework.
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates
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Q1) According to the expectations theory of the term structure, A)yield curves should be equally likely to slope downward as to slope upward.
B)when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.
C)when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future.
D)all of the above.
E)only A and B of the above.
Q2) Yield curves can be classified as A)upward-sloping.
B)downward-sloping.
C)flat.
D)all of the above.
E)only A and B of the above.
Q3) Typically, yield curves are A)gently upward-sloping.
B)gently downward-sloping. C)flat.
D)bowl shaped.
E)mound shaped.
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Chapter 6: Are Financial Markets Efficient
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Q1) Evidence in favor of market efficiency does not include A)random-walk behavior.
B)technical analysis.
C)performance of investment analysts and mutual funds.
D)the January effect.
Q2) It is probably a good use of an investor's time to watch as many shows featuring technical analysts as possible.
A)True
B)False
Q3) The evidence suggests technical analysts are not superior stock pickers.
A)True
B)False
Q4) In an efficient market, abnormal returns are not possible, even using inside information.
A)True
B)False
Q5) Why are expectations important in understanding how financial instruments are valued?
Q6) What is a rational bubble?
Q7) Give evidence both for and against market efficiency.
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Chapter 7: Why Do Financial Institutions Exist
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Sample Questions
Q1) That most used cars are sold by intermediaries (i.e., used car dealers)provides evidence that these intermediaries
A)have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars.
B)are able to prevent potential competitors from free-riding off the information that they provide.
C)have failed to solve adverse selection problems in this market because "lemons" continue to be traded.
D)do all of the above.
Q2) Adverse selection is a problem associated with equity and debt contracts arising from
A)the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.
B)the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults.
C)the borrower's lack of incentive to seek a loan for highly risky investments. D)none of the above.
Q3) What factors usually cause an increase in moral hazard and adverse selection?
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Chapter 8: Why Do Financial Crises Occur and Why Are
They so Damaging to the Economy
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Sample Questions
Q1) When asset prices fall following a boom, A)moral hazard may increase in companies that have lost net worth in the bust.
B)financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging.
C)both A and B are correct.
D)none of the above are correct.
Q2) In an emerging market economy, a country typically faces a ________ fiscal policy before a crisis initiates.
A)solid
B)poor
C)weakening
D)uncertain
Q3) In an emerging market economy, a financial crisis generally begins with A)mismanagement of financial liberalization or innovation.
B)asset pricing booms and busts.
C)an increase in uncertainty caused by failure of financial institutions.
D)all of the above.
Q4) Why was the shadow banking system important during the 2007-2009 U.S. financial crisis?
Q5) What does the "twin crises" in an emerging economy financial crisis refer to?
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Chapter 9: Central Banks and the Federal Reserve System
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Sample Questions
Q1) The chairman of the Board of Governors of the Federal Reserve System exercises a high degree of control over the board
A)through his ability to set the agenda of the Board and the FOMC.
B)through his role as spokesperson for the Fed with the President and before Congress.
C)because he can veto decisions made by a majority of the other Board members.
D)because of all of the above.
E)because of only A and B of the above.
Q2) The theory of bureaucratic behavior suggests that the Federal Reserve will
A)try to avoid a conflict with the president and Congress over increases in interest rates.
B)try to gain regulatory power over more banks.
C)devise clever strategies in an effort to avoid blame for poor economic performance.
D)do all of the above.
Q3) All nationally chartered banks are required to be members of the Fed.
A)True
B)False
Q4) Describe the structure and responsibility for policy tools in The Federal Reserve System.
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Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Q1) Regulations making it obligatory for depository institutions to keep a certain fraction of their deposits in accounts with the Fed are
A)open market operations.
B)federal funds rate.
C)required reserve ratio.
D)reserve requirements.
Q2) Flexibility is a requirement in selecting an intermediate target.
A)True
B)False
Q3) Which of the following statements is true?
A)Credit-driven asset bubbles are particularly dangerous. When asset prices fall, the deleveraging of credit markets reduces economic activity.
B)Bubbles driven solely by irrational exuberance lead to a failure of financial institutions.
C)Both A and B are correct.
D)Neither A nor B is correct.
Q4) Open market purchases by the Fed increase the supply of nonborrowed reserves.
A)True
B)False
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Chapter 11: The Money Markets
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Sample Questions
Q1) Suppose that you purchase a 91-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is about
A)4 percent.
B)5 percent.
C)6 percent.
D)7 percent.
Q2) The advantage of mutual funds is that they
A)require no cash up front.
B)give investors with relatively small amounts of cash to invest access to large-denomination securities.
C)always yield the highest returns.
D)both A and B of the above.
Q3) Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds.
A)True
B)False
Q4) Explain why money market interest rates move so closely together over time.
Q5) Explain why the money markets are referred to as wholesale markets.
Q6) What are the main characteristics of money market securities?
Page 13
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Chapter 12: The Bond Market
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Sample Questions
Q1) (I)In most years, the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II)Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q2) (I)Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities. (II)A Treasury STRIP separates the periodic interest payments from the final principal repayment.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q3) What types of risks should bondholders be aware of and how do these affect bond prices and yields?
Q4) What is a callable bond? How does the callability feature affect the bond's price and interest rate?
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Chapter 13: The Stock Market
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Q1) (I)The largest of the organized stock exchanges in the United States is the New York Stock Exchange. (II)To be listed on the NYSE, a firm must have a minimum of $100 million in market value or $10 million in revenues.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q2) (I)Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders. (II)Firms issue preferred stock in far greater amounts than common stock.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.
Q3) A lower than average PE may mean that the market expects earnings to rise in the future.
A)True
B)False
Q4) What are the objectives of the Securities and Exchange Commission?
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Chapter 14: The Mortgage Markets
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Sample Questions
Q1) A borrower who qualifies for an FHA or VA loan enjoys the advantage that
A)the mortgage payment is much lower.
B)only a very low or zero down payment is required.
C)the cost of private mortgage insurance is lower.
D)the government holds the lien on the property.
Q2) Which of the following reduces moral hazard for the mortgage borrower?
A)collateral
B)down payments
C)private mortgage insurance
D)borrower qualifications
Q3) Mortgage-backed securities are marketable securities collateralized by a pool of mortgages.
A)True B)False
Q4) Why has the online lending market developed in recent years and what are the advantages and disadvantages of this development?
Q5) Closing for a mortgage loan refers to the moment the loan is paid off.
A)True B)False
Q6) How does an amortizing mortgage loan differ from a balloon mortgage loan?
Page 16
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Chapter 15: The Foreign Exchange Market
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Q1) The starting point for understanding how exchange rates are determined is a simple idea called ________, which states that if two countries produce an identical good, the price of the good should be the same throughout the world no matter which country produces it.
A)Gresham's law
B)the law of one price
C)purchasing power parity
D)arbitrage
Q2) When the exchange rate for the euro changes from $0.90 to $0.85, then holding everything else constant, the euro has depreciated and American wheat sold in Germany becomes more expensive.
A)True
B)False
Q3) When the exchange rate changes from 1.0 euros to the dollar to 1.2 euros to the dollar, the euro has ________ and the dollar has ________.
A)appreciated; appreciated
B)depreciated; appreciated
C)appreciated; depreciated
D)depreciated; depreciated
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Chapter 16: The International Financial System
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Q1) What is the bookkeeping system for recording all receipts and payments that have a direct bearing on the movement of funds between a nation and foreign countries?
A)current account
B)capital account
C)balance of payments
D)trade balance
Q2) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is ________ par, the central bank must intervene to buy the domestic currency by selling foreign assets.
A)overvalued; below
B)overvalued; above
C)undervalued; below
D)undervalued; above
Q3) Given the size of the statistical discrepancy needed to balance the balance of payments account, one can infer that
A)hidden capital flows into the U.S. are inconsequential.
B)items in the balance of payments are measured quite accurately.
C)many international transactions go unrecorded.
D)all of the above occur.
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Chapter 17: Banking and the Management of Financial Institutions
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Sample Questions
Q1) 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, increasing the return on equity.
D)none of the above.
Q2) A loan commitment is an agreement to provide a loan up to a certain dollar amount if a customer requests the loan during a specific time period.
A)True
B)False
Q3) Which of the following are primary concerns of a bank manager?
A)maintaining sufficient reserves to minimize the cost to the bank of deposit outflows
B)extending loans to borrowers who will pay high interest rates, but who are also good credit risks
C)acquiring funds at a relatively low cost, so that profitable lending opportunities can be realized
D)all of the above
Q4) Discuss the recent trends in bank performance measures.
Q5) What are a bank's major sources and uses of funds?
Page 19
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Chapter 18: Financial Regulation
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Sample Questions
Q1) Why did the United States experience a banking crisis in the 1980s?
Q2) The Dodd-Frank legislation of 2010 finally resolved the status of GSEs such as Freddie Mac.
A)True
B)False
Q3) When the payoff method is used to resolve a failed bank, both large and small depositors are protected from suffering losses.
A)True
B)False
Q4) According to some economists, Congress made a mistake when it passed the FDICIA of not requiring the FDIC to assess risk-based insurance premiums.
A)True
B)False
Q5) The Federal Deposit Insurance Corporation Improvement Act of 1991
A)increased the FDIC's ability to borrow from the Treasury to deal with failed banks. B)reduced the scope of deposit insurance in several ways.
C)eliminated governmentally administered deposit insurance.
D)did only A and B of the above.
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Chapter 19: Banking Industry: Structure and Competition
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Q1) Even when an ATM is owned by a bank, states typically have special provisions that allow wider establishment of ATMs than is permissible for traditional "brick and mortar" branches.
A)True
B)False
Q2) The existence of large numbers of banks in the United States indicates the presence of vigorous competition.
A)True
B)False
Q3) The National Banking Act of 1863, and subsequent amendments to it,
A)created a banking system of federally chartered banks.
B)established the Office of the Comptroller of the Currency.
C)broadened the regulatory powers of the Federal Reserve.
D)did all of the above.
E)did only A and B of the above.
Q4) An alternative corporate structure for U.S. banks that operate overseas is the Edge Act corporation, a special subsidiary engaged primarily in international banking.
A)True
B)False
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Chapter 20: The Mutual Fund Industry
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Sample Questions
Q1) Which of the following is a feature of index funds?
A)They have lower fees.
B)They select and hold stocks to match the performance of a stock index.
C)They do not require managers to select stocks and decide when to buy and sell.
D)All of the above.
Q2) Which of the following is an advantage to investors of an open-end mutual fund?
A)Once all the shares have been sold, the investor does not have to put in more money.
B)The investors can sell their shares in the over-the-counter market with low transaction fees.
C)The fund agrees to redeem shares at any time.
D)The market value of the fund's shares may be higher than the value of the assets held by the fund.
Q3) How is a mutual fund's net asset value calculated?
Q4) Money market mutual funds originated when the brokerage firm Merrill Lynch offered its customers an account from which funds could be taken to purchase securities and into which funds could be deposited when securities were sold.
A)True
B)False
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Chapter 21: Insurance Companies and Pension Funds
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Q1) Insurance companies' attempts to minimize adverse selection and moral hazard explain which of the following insurance practices?
A)collection of information and screening of potential policyholders
B)risk-based premiums
C)deductibles and coinsurance
D)all of the above
E)only A and B of the above
Q2) Why do life insurance companies and pension plans invest heavily in long-term assets?
Q3) Privatization of Social Security
A)would transform the program from an unfunded pay-as-you-go system to a fully funded pension plan.
B)would mean that workers' current contributions to Social Security would no longer be available to pay benefits to current retirees.
C)receives less public support when the stock market declines.
D)all of the above
E)none of the above
Q4) Distinguish between different types of life insurance.
Q5) Why must insurance companies screen applicants so carefully?
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Chapter 22: Investment Banks, Security Brokers and Dealers,
and Venture Capital Firms
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Q1) Private placements are more common for the sale of stocks than for bonds.
A)True
B)False
Q2) In a primary market, ________ sell new issues of securities; in a secondary market, ________ assist in trading previously issued securities.
A)securities dealers; securities brokers
B)securities brokers; securities dealers
C)investment banks; securities brokers and dealers
D)securities brokers and dealers; investment banks
Q3) An additional perk of a private equity firm is that the profits for both CEOs and the partners are taxed at the 15% capital gains rate rather than the 35% rate they would suffer if the income was received as income.
A)True
B)False
Q4) Investors in venture capital firms expect to profit quickly from their investment.
A)True
B)False
Q5) What is underwriting?
24
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Chapter 23: Risk Management in Financial Institutions
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Q1) Of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the requirement that
A)firms keep compensating balances at the banks from which they obtain their loans.
B)firms place on their board of directors an officer from the bank.
C)loan contracts include restrictive covenants.
D)individuals provide detailed credit histories to bank loan officers.
Q2) A bank manager concerned about interest income who expects interest rates to fall and who knows the bank currently has a positive gap should ________ rate-sensitive assets and ________ rate-sensitive liabilities.
A)increase; increase
B)decrease; increase
C)decrease; decrease
D)increase; decrease
Q3) How is credit risk related to the concepts of adverse selection and moral hazard?
Q4) What special assumptions do income and duration gap analyses make about interest rate changes and the yield curve?
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Chapter 24: Hedging With Financial Derivatives
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Q1) A swap that involves the exchange of one set of interest payments for another set of interest payments is called a(n)________.
A)interest-rate swap
B)currency swap
C)swaption
D)notional swap
Q2) If you buy an option to buy Treasury futures at 115, and at expiration the market price is 110,
A)the call will be exercised.
B)the put will be exercised.
C)the call will not be exercised.
D)the put will not be exercised.
Q3) All other things held constant, premiums on call options will increase when the A)exercise price falls.
B)volatility of the underlying asset falls.
C)term to maturity decreases.
D)futures price increases.
Q4) Option premiums increase as the term to maturity increases.
A)True
B)False
Page 26
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Chapter 25: Savings Associations and Credit Unions
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Q1) In the early stages of the banking crisis in the 1980s, financial institutions were especially hurt by
A)the sharp increases in interest rates from late 1979 until 1981.
B)the severe recession in 1981-82.
C)the sharp decline in the price level from mid-1980 to early 1983.
D)all of the above.
E)only A and B of the above.
Q2) The major provisions of the Competitive Equality in Banking Act of 1987 included A)abolishing the Federal Home Loan Bank Board and the FSLIC.
B)transferring the regulatory role of the Federal Home Loan Bank Board to the Office of Thrift Supervision, a bureau within the U.S. Treasury Department.
C)establishing the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership.
D)all of the above.
E)none of the above.
Q3) Credit unions are owned by stockholders.
A)True
B)False
Q4) Explain why thrift regulators engaged in regulatory forbearance in the 1980s.
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Chapter 26: Finance Companies
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Q1) A sales finance company differs from a captive finance company primarily in regulations and other restrictions.
A)True
B)False
Q2) In which industry is a floor plan common practice?
A)automobile
B)tech services
C)entertainment
D)apparel
Q3) Sales finance companies make loans to consumers to purchase items
A)on the Internet.
B)from any retailer.
C)from a particular retailer.
D)for a specific use.
Q4) In a lease financing arrangement, a finance company will purchase equipment, which it then leases to a company for a set period.
A)True
B)False
Q5) What are the various types of finance companies?
Q6) Describe the process of factoring? When and why is it used?
Page 28
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