Introduction to Financial Systems Study Guide
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Course Introduction
Introduction to Financial Systems provides students with a comprehensive overview of the structures, functions, and components of modern financial systems. The course explores the roles of financial markets, institutions, and instruments in facilitating the flow of funds between savers and borrowers, supporting economic development, and managing risk. Key topics include the regulatory framework, the central banking system, payment mechanisms, and the impact of globalization and technological innovation on financial services. By analyzing real-world examples and case studies, students gain a foundational understanding of how financial systems operate and their significance in the broader economy.
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MandB 3 3rd Edition by Dean Croushore
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Page 2
Chapter 1: Money and the Financial System
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Q1) When the overall level of business activity declines persistently, there is said to be
A)a revolution.
B)a hyperinflation.
C)a recession.
D)an expansion.
Answer: C
Q2) The Federal Reserve creates money by
A)printing bills and circulating them in public meetings.
B)giving dollar bills to banks to circulate.
C)changing a number in its computer system.
D)spending money on government purchases.
Answer: C
Q3) During the 2000s, banks became complacent about making mortgage loans because
A)there was not a single bank failure in the decade.
B)bank stocks performed better than the rest of the stock market.
C)the banks counted on housing prices to keep appreciating.
D)the government eliminated the FDIC.
Answer: C
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Page 3
Chapter 2: The Financial System and the Economy
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Sample Questions
Q1) The probabilities of different returns on a stock over the year are: \[\begin{array} {cc
} \text { Probability } & \text { Return } \\
10 \% & - 5 \% \\
15 \% & 0 \% \\
20 \% & 5 \% \\
30 \% & 10 \% \\
25 \% & 20 \% \end{array}\]
The expected return on the stock is_____ percent.
A)8.5
B)9.0
C)9.5
D)10.0
Answer: A
Q2) A security has a price of $3,000 and an amount to be repaid in a single payment of $3,400.What is the amount of interest on the security?
Answer: Interest = amount repaid minus price = $3,400 - $3,000 = $400
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Page 4
Chapter 3: Money and Payments
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Q1) In an economy, the amount of money held in currency and coins is $3,500, the amount of money held as traveler's check is $1,000, the amount of money held as checkable deposits is $2,000, the amount of money held in savings deposit is $4,000, and the amount of money held with retailed money market mutual funds is $700.M1 in the economy equals
A)$3,500.
B)$6,500.
C)$10,500.
D)$11,300.
Answer: B
Q2) If money is gold or silver, it is called_____ money
A)fiat
B)inside
C)commodity
D)glitter
Answer: C
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Chapter 4: Present Value
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Q1) Consider a one-year discount bond that pays $1,000 at maturity.If the annual rate of discount is 7 percent, the present value of the bond is
A)$930.00.
B)$934.58.
C)$993.00.
D)$993.46.
Q2) The difference between the present value of a perpetuity that pays $250 every year and a perpetuity that pays $500 every year when the annual rate of discount is 5% is A)$500.
B)$750.
C)$5,000.
D)$7,500.
Q3) Which of the following statements is true?
A)A coupon bond is a debt security with only one payment.
B)The amount invested in a financial security is referred to as perpetuity.
C)A coupon bond is a debt security that pays interest forever and never repays principal.
D)The present value of a perpetuity varies directly with the annual repayments.
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Chapter 5: The Structure of Interest Rates
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Q1) The present value of a twoyear bond with a future payment of $1,345.50 and the yield to maturity of 3.6 percent is
A)$1,300
B)$1,500.50
C)$1,253.62
D)$1,246.72
Q2) Which of the following is true of a certificate of deposit?
A)It is sold by large corporations to raise short-term funds.
B)A fall in its demand will lead to an increase in the price of the security and a fall in its yield to maturity.
C)Higher the term to maturity of a certificate of deposit, higher the yield to maturity.
D)It is not a liquid security and cannot be transferred from one party to another.
Q3) An inverted yield curve indicates that
A)an economic expansion has just begun.
B)an economic expansion has been going on for several years.
C)a recession is about to begin.
D)a recession is nearly over.
Q4) What do steep upward-sloping yield curves indicate about the business cycle?
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Page 7
Chapter 6: Real Interest Rates
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Q1) The amount of interest paid on a debt security in dollar terms as a percent of the principal is referred to as the
A)expected real interest rate.
B)realized real interest rate.
C)after-tax real interest rate.
D)nominal interest rate.
Q2) One year ago, you bought a bond for $10,000.You received interest of $400 at the end of the year, as well as your $10,000 principal.If the inflation rate over the last year was 5 percent, calculate your real return.Show your work.
Q3) John bought an inflation-indexed security for $10,000 in January 2014.The security promises an annual interest rate of 5 percent and makes payments twice a year.If the value of the inflation index in January 2014 was 106 and its value in July 2014 was 105, John will receive an interest income of______ .
A)?$504.76
B)?$226.40
C)?$182.72
D)$368.56
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Chapter 7: Stocks and Other Assets
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Q1) A stock index tells you
A)the average price of a collection of stocks.
B)the expected changes in the prices of select stocks over a year.
C)where to buy or sell stocks.
D)what stocks to buy or sell.
Q2) In the second half of the 1990s, the average annual real return to the stock market was about each year.
A)23 percent.
B)10 percent.
C)5 percent.
D)2 percent.
Q3) In the CAPM, systematic risk
A)is also known as idiosyncratic risk.
B)can be diversified away.
C)is also known as market risk.
D)is the risk to a stock's return that is not attributable to the fluctuations in the overall stock market.
Q4) Write a formula for the equity premium.
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Chapter 8: How Banks Work
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Q1) A bank offers credit cards with a 25 percent interest rate, when its competitors' cards have just a 15 percent interest rate.Despite the high rate, the bank finds itself losing money because many of its customers fail to repay the balances on their cards.The bank's losses are most likely to have occurred because of
A)bad management.
B)the lock-in effect.
C)redlining.
D)adverse selection.
Q2) Suppose a bank has $200 million as transaction deposits, and holds $25 million as reserves.If the reserve requirement is uniformly 10% on any positive amount, the bank's excess reserves equals
A)$25 million.
B)$10 million.
C)$5 million.
D)$1 million.
Q3) In a recent year, a bank earned $36 million in interest on its assets of $523 million, it paid out $9 million in interest on its liabilities (excluding capital) of $470 million, and it paid its workers $21.5 million in total compensation.Calculate the bank's spread and its return on equity.
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Page 10
Chapter 9: Governments Role in Banking
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Q1) Which of the following acts gives the responsibility as the lender of last resort to the central bank in the U.S?
A)National Bank Act
B)Federal Reserve Act
C)Bank Holding Company Act
D)McFadden Act
Q2) Credit Unions get slight competitive advantage over commercial banks and thrifts because they
A)get their charter from the Comptroller of the Currency.
B)get tax exemptions as they are often run as non-profit organizations.
C)are insured by the Federal Deposit Insurance Corporation.
D)can rely on the funds from the Federal Reserve at times of emergency.
Q3) Which of the following is NOT a reason for the government to regulate banks?
A)To reduce the externalities caused by bank problems
B)To stabilize the money supply
C)To prevent bank runs
D)To keep banks large
Q4) In a market with six banks of equal size, two of the banks propose merging.Does the merger violate the U.S. Department of Justice's guidelines?
Page 11
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Chapter 10: Economics Growth and Business Cycles
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Q1) Consider the following production function Y = A×K<sup>a</sup>×L<sup>1?a</sup>.
If a = 0.4, and over the past year output grew 4 percent, total factor productivity (TFP) grew 2.6 percent, and capital grew 2 percent, what was the growth rate of labor?
A)4 percent
B)3 percent
C)2 percent
D)1 percent
Q2) In which of the following periods was unemployment the highest in the U.S.economy?
A)Great Depression
B)Economic liftoff period
C)Long boom period
D)Reorganization period
Q3) A particularly bad recession (in which output declines much more than usual for a recession) is called
A)an inflationary period.
B)a downturn.
C)a peak.
D)a depression.
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Page 12
Chapter 11: Modeling Money
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Q1) The cost of going to an ATM is $1 in an economy.If the nominal interest rate in the economy is 5 percent, what is the total cost associated with holding cash for an individual who spends $10 daily and has a 15 percent probability of having his cash lost or stolen? Assume that he visits the ATM once in every T days.
A)(182.5/T) + (0.2 × T)
B)(182.5/T) + (0.2 × T).
C)(365/T) + (0.5 × T)
D)(365/T) + T
Q2) In the liquidity-preference model, the nominal interest rate is represented on the vertical axis and the quantity of money is represented on the horizontal axis.Hence, A)the money demand curve slopes downward and the money supply curve is vertical. B)the money demand curve slopes upward and the money supply curve is horizontal.
C)both the money demand and money supply curve slope downward.
D)both the money demand and money supply curve slope upward.
Q3) Describe the standard equation used to describe the demand for money.In that equation, what would happen to the demand for money if prices were to double?
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13
Chapter 12: The Aggregate-Demandaggregate-Supply Model
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Q1) A rise in the incomes of foreign consumers, everything else remaining unchanged, causes net exports to
A)decline.
B)not change.
C)rise.
D)rise at first, then decline later.
Q2) Consumption spending is about_____ of aggregate demand.
A)2/3
B)1/2
C)3/4
D)5/6
Q3) In the aggregate demand-aggregate supply model, an increase in the expected price level, everything else remaining unchanged, causes the _____curve to shift_____ .
A)short-run aggregate supply; right
B)short-run aggregate supply; left
C)aggregate-demand; left
D)aggregate-demand; right
Q4) Describe the effect of expansionary monetary policy in a recession.Contrast the results with no monetary policy action.
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Chapter 13: Modern Macroeconomic Models
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Q1) In the two-period model, suppose a household's income in the first period is $50,000, income in the second period is $60,000, and the real interest rate is 25 percent.Draw a diagram showing the budget constraint.Now, suppose the real interest rate declines to 20 percent.Draw the new budget constraint.For the budget constraints you have drawn, be sure to show the values of the intercepts on each axis.If the household decides that its consumption in period 1 should always be one half of the present value of income, determine whether the household is worse off or better off because of the decline in the real interest rate.Show your work.
Q2) In a structural VAR, a restriction that describes the impact of the current-period value of one variable on the value of another variable in the distant future is known as a_____ restriction.
A)contemporaneous
B)long-run
C)short-run
D)structural
Q3) Describe the general procedures followed by DSGE researchers creating a new model.
Q4) What are the advantages and disadvantages of VAR models?
Q5) Can VARs be used to analyze the effects of monetary policy?
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Chapter 14: Economic Interdependence
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Q1) If the annual inflation rate is 3 percent in France and 5 percent in Italy, by how much will the real exchange rate change over a year? Assume that both countries use the euro so their nominal exchange rate cannot change.
A)2 percent
B)3/5 percent
C) 3/5 percent
D) 2 percent
Q2) In 2005, exchange rates were 1.74 U.S.dollars per British pound, 112 Japanese yen per U.S.dollar, and 1.20 dollars per euro.In 2000, the exchange rates were 1.62 U.S.dollars per British pound, 102 Japanese yen per U.S.dollar, and 0.94 dollars per euro.For each currency, explain whether it appreciated or depreciated from 2000 to 2005 versus the other two currencies.
Q3) If three bushels of rice produced in Japan trade for 2 bushels of rice produced in Guatemala, the _____is equal to 1.5.
A)inflation rate
B)interest rate
C)nominal exchange rate
D)real exchange rate
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Page 16
Chapter 15: The Federal Reserve System
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Q1) Describe the Beigebook, the Greenbook, and the Bluebook.
Q2) Why isn't the right to vote at FOMC meetings considered to be very important within the Fed?
Q3) Comment on the success of various Fed chairmen in reducing inflation.
Q4) Under which Fed Chairman did the inflation rate decline the most?
A)William McChesney Martin
B)Arthur Burns
C)Paul Volcker
D)Alan Greenspan
Q5) One half of a percentage point equals ____basis points.
A)0.5
B)5
C)50
D)500
Q6) Describe the relationship between central bank independence and macroeconomic variables such as inflation and growth.
Q7) Are there any benefits to having both banking supervisors and economic researchers working together at a Reserve bank?
Q8) Why are the deliberations of the FOMC kept secret?
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Chapter 16: Monetary Control
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Q1) An increase in interest rates
A)decreases the M2 money multiplier.
B)decreases the ratio of excess reserves to transaction accounts held by banks
C)increases the money supply for a given amount of monetary base.
D)increases the ratio of excess reserves to transaction accounts held by banks
Q2) A secondary credit discount loan has an interest rate that is______ a primary credit discount loan.
A)1/4
B)1/2
C)1
D)2
Q3) Suppose the M1 multiplier is currently 1.95 and the M2 multiplier is currently 8.03.If the ratio of retail money-market mutual funds to transaction accounts increases, the M1 multiplier will _____and the M2 multiplier will ______.
A)not change; increase
B)increase; also increase
C)decrease; also decrease
D)increase; not change
Q4) Since the 2008 financial crisis, what has happened to the M1 and M2 multipliers?
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Chapter 17: Monetary Policy: Goals and Tradeoffs
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Q1) An equation that sums the squared output gap to the squared inflation gap, with a weight that determines the tradeoff between them is referred to as the
A)Fed's objective function.
B)cost of disinflation.
C)Sharpe ratio.
D)Phillips equation.
Q2) The unemployment rate minus the natural rate of unemployment is known as the A)nominal rate of unemployment.
B)ideal unemployment rate.
C)unemployment gap.
D)non-accelerating inflation rate of unemployment (NAIRU).
Q3) The unemployment rate when the economy is producing output equal to its potential is known as
A)the rate of disguised unemployment.
B)the potential rate of unemployment.
C)the natural rate of unemployment.
D)equilibrium rate of unemployment.
Q4) Why is it difficult for policymakers to set policy based on the value of the unemployment rate relative to the natural rate of unemployment?
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Chapter 18: Rules for Monetary Policy
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Q1) In inflation targeting, the range that represents the goal for the inflation rate is known as the
A)target band.
B)optimal range.
C)central tendency.
D)ultimate goal.
Q2) When a central bank decreases money growth, the bank is said to_______ monetary policy.
A)tighten
B)loosen
C)?destabilize
D)ease
Q3) Under an activist rule,
A)the growth rate of money supply is greater than the inflation rate.
B)monetary policy is allowed to change over the course of the business cycle.
C)the growth rate of money supply is lower than the inflation rate.
D)monetary policy is not changed over the course of the business cycle.
Q4) What challenges do policymakers and researchers face in using the Taylor rule?
Q5) How does a central bank establish credibility?
Q6) What are the major advantages and disadvantages of inflation targeting?
Page 20
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