Monetary Economics
Mock Exam
Course Introduction
Monetary Economics explores the role of money and monetary institutions in shaping economic activity, focusing on how monetary policy influences inflation, interest rates, output, and employment. The course examines the theoretical foundations of money, the mechanisms of money creation, and the transmission of monetary policy through the banking system and financial markets. Students analyze contemporary issues such as central banking strategies, the effectiveness of policy tools, and the dynamics of inflation targeting, providing a comprehensive understanding of how monetary economics impacts both national and global economies.
Recommended Textbook
Money Banking and Financial Markets 3rd Edition by
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Page 2
Stephen G. Cecchetti
Chapter 1: An Introduction to Money and the Financial System
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Sample Questions
Q1) When an individual obtains a car loan and makes all of the regular monthly payments, the sum of the payments made will exceed the purchase price of the car.This is due primarily to the core principle:
A)Risk requires compensation
B)Information is the basis for decisions
C)Markets determine prices and allocate resources
D)Time has value
Answer: D
Q2) If the U.S.Supreme Court ruled that states could no longer require people to have auto insurance, do you think most people would cancel their policies? Explain.
Answer: Probably not.Auto insurance falls under the principle that risk requires compensation.For most people the additional risk they would face of driving without insurance exceeds the cost of the insurance, so they are better off purchasing auto insurance to reduce their risk.
Q3) Identify the six parts of the financial system.
Answer: They are: money, financial markets, financial instruments, financial institutions, government regulatory agencies, and central banks.
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Page 3
Chapter 2: Money and the Payments System
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Sample Questions
Q1) When the Continental Congress issued currency to finance the Revolutionary War, the Continental Congress:
A)Issued too many "continentals," making the currency worthless
B)Tied the value of the "continental" to gold
C)Tied the value of the "continental" to gold to French "assignats."
D)Made "continentals" legal tender
Answer: A
Q2) The introduction of money market substitutes for basic checking accounts was fueled partially by:
A)The relatively high rates of inflation that existed in the late 1970s and early 1980s
B)The reluctance of many retailers to accept checks
C)The high number of bank failures that were occurring in the 1970s
D)The higher interest rates banks had to pay on checking accounts
Answer: A
Q3) What does it mean to say that an asset is "liquid"?
Answer: an asset is liquid when it can be converted into a means of payment, quickly without suffering a loss in value.
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Sample Questions
Q1) Disability Income Insurance:
A)Is available only to people who have been at their jobs for more than 5 years
B)Is provided by the government through Social Security
C)Is not that critical since the odds are less than 1 in 10 working adults will be disabled for a period exceeding 90 days
D)Is not a transfer of risk since it seeks to replace wages
Answer: B
Q2) Briefly explain one function of financial instruments that can make them very different from money.
Answer: While financial instruments can function as a means of payment and a store of value, similar to money, one function that can make them very different from money is their ability to transfer risk between buyer and seller.A good example of this is the use of a futures contract that guarantees to the seller of the contract a price well into the future.Another common example is an insurance policy that transfers risk from the insured (a homeowner) to the insurer (the insurance company.)
Q3) Is the obtaining of a car loan a primary or secondary market transaction?
Answer: The obtaining of a car loan is a primary market transaction since the loan represents a newly-issued instrument by the bank.
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Chapter 4: Future Value, Present Value, and Interest Rates
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Sample Questions
Q1) The "coupon rate" is:
A)The annual amount of interest payments made on a bond as a percentage of the amount borrowed
B)The change in the value of a bond expressed as a percentage of the amount borrowed
C)Another name for the yield on a bond, assuming the bond is sold before it matures
D)The total amount of interest payments made on a bond as a percentage of the amount borrowed
Q2) Which of the following expresses 5.5%?
A)0.0055
B)5.50
C)0.550
D)0.0550
Q3) A lender expects to earn a real interest rate of 4.5% over the next 12 months.She charges a 9.25% (annual) nominal rate for a 12-month loan.What inflation rate is she expecting? If the lender is in a 30% marginal tax bracket and the borrower is in a 25% marginal tax bracket, what are the real after-tax rates each expects?
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Chapter 5: Understanding Risk
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Sample Questions
Q1) Briefly explain the difference between idiosyncratic risk and systematic risk.Provide an example of each.
Q2) Explain the following: Risk results from the fact that more outcomes could happen than will happen.
Q3) Sometimes spreading has an advantage over hedging to lower risk because:
A)It can be difficult to find assets that move predictably in opposite directions
B)It is cheaper to spread than hedge
C)Spreading increases expected returns, hedging does not
D)Spreading does not affect expected returns
Q4) A portfolio of assets has lower risk than holding one asset, but the same expected return and higher transaction costs.Which of the following statements is most correct?
A)The portfolio is attractive to people who are risk-averse and risk-neutral, but not to risk seekers
B)The portfolio is attractive to investors who are risk-neutral
C)The portfolio is not attractive to investors who are risk-neutral
D)The portfolio is attractive to investors who are risk seekers
Q5) Why isn't it correct to say that people who are risk averse avoid risk?
Q6) Explain the rapid rise in popularity of mutual funds.
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Sample Questions
Q1) As bond prices increase:
A)The quantity of bonds supplied increases
B)The quantity of bonds supplied decreases
C)The quantity of bonds demanded increases
D)Yields increase
Q2) The bond supply curve slopes upward because:
A)As bond prices rise people holding bonds are more tempted to hold them
B)As bond prices rise yields increase
C)For companies seeking financing, the higher the price of bonds the more attractive it is to sell bonds
D)As bond prices rise yields decrease
Q3) An increase in expected inflation for any given nominal interest rate will cause:
A)The bond supply curve to shift to the left
B)The bond demand curve to shift to the right
C)The price of bonds to decrease
D)The price of bonds to increase
Q4) Explain the relationship between coupon rate (or coupon yield) and current yield.
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Chapter 7: The Risk and Term Structure of Interest Rates
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Q1) If an economy is experiencing rapid economic growth, explain what you would expect to happen to the yield curve and why?
Q2) As GDP rises the:
A) Risk spread and term spread decrease
B) Risk spread and term spread increase
C) Risk spread increases and the term spread decreases
D) Risk spread decreases and the term spread increases
Q3) Under the expectations hypothesis, if expectations are for lower inflation in the future than what it currently is, the yield curve's slope:
A) Will become more upward sloping
B) Will become flat
C) Will be negative
D) Will be vertical
Q4) What is the effective after-tax yield to an investor from a bond paying $70 per $1,000 annually, if the investor is in a 25% marginal tax bracket? Explain.
Q5) Consider the yield curve below. Using the Expectations Hypothesis, what conclusion can we draw from the data? Now, using the Liquidity Premium Theory, cite two possible conclusions we can draw from the data.
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Chapter 8: Stocks, Stock Markets, and Market Efficiency
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Sample Questions
Q1) As the corporation uses more debt financing, which of the following holds true for the stockholders?
A)The expected return to the stockholders decreases and the standard deviation of that return decreases
B)The expected return to the stockholders increases and the standard deviation of the return decreases
C)The expected return to the stockholders increases and the standard deviation of the return increases
D)The expected return to the stockholders decreases and the standard deviation of the return increases
Q2) Does the concept of limited liability make owning stocks more or less attractive? Explain.
Q3) Considering the return an investor requires from a stock, what are the two components that make up that return? Briefly explain each of these components.
Q4) The investment you made in a mutual fund one year ago lost 50% of its value over the past year.What percentage increase is needed in the fund to restore your portfolio to the level it was one year ago?
Q5) Explain why being a residual claimant can increase the risk from owning stocks.
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Sample Questions
Q1) Assume we have a stock currently worth $100.We also assume the interest rate is zero, and we can buy options for this stock with a strike price of $100.If the stock can rise or fall by $20 with equal probability over the option period, and the option cannot be exercised until the expiration date, what is the time value of the option?
A)$20
B)$0
C)$10
D)$100
Q2) A baker of bread has a long-term fixed-price contract to supply bread.Which of the following would NOT reduce her risk?
A)Taking the long position in wheat futures contract.
B)Hedging this risk in the wheat futures market.
C)Finding a wheat farmer who will take the short position in a wheat futures contract.
D)Finding a wheat farmer who will take the long position in a wheat futures contract.
Q3) What questions should an employee ask before accepting options as part of or instead of a salary?
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11
Chapter 10: Foreign Exchange
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Sample Questions
Q1) A country that exports less than it imports will:
A)Have a current account deficit and a capital account deficit
B)Have a current account surplus and a capital account deficit
C)Have a current account surplus and a capital account surplus
D)Have a current account deficit and a capital account surplus
Q2) Considering the dollar-euro market, as a dollar will purchase more euros, holding other factors constant:
A)We would expect the supply curve of dollars to slope downward
B)Foreign goods become relatively less expensive than American goods
C)Foreign assets become relatively more expensive than American assets
D)American goods become relatively less expensive than foreign goods
Q3) Explain why many industrialized countries do not often intervene in the foreign exchange market.
Q4) Which of the following does not contribute to the failure of the law of one price?
A)Tariffs
B)Transportation costs
C)Technical specifications
D)Tastes are similar across countries
Q5) Briefly describe the foreign exchange market.
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Chapter 11: The Economics of Financial Intermediation
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Q1) Requiring a home buyer to have a large down payment reduces the risk to a mortgage lender because:
A)If the price of the home falls the buyer is still likely to stay
B)The buyer is less likely to sell the house
C)It means the buyer likely underpaid when she bought the house
D)It means there is more information available on the buyer
Q2) The interest rates charged on most credit cards is:
A)High due to the problem of adverse selection
B)High because Visa and MasterCard have a virtual monopoly on this business
C)High due to diseconomies of scale that exist in this market
D)Lower than they should be given the problem of adverse selection
Q3) Asymmetric information poses two important obstacles to the smooth flow of funds from savers to investors.They are:
A)Adverse selection, which arises before the transaction occurs, and moral hazard, which occurs after the transaction
B)Moral hazard, which arises before the transaction occurs, and adverse selection, which occurs after the transaction
C)Adverse selection and moral hazard, both of which occur after the transaction
D)Adverse selection and moral hazard, both of which occur before the transaction
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Page 13
Chapter 12: Depository Institutions: Banks and Bank Management
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Sample Questions
Q1) What are the securities that U.S.banks are allowed to own and why are they often referred to as secondary reserves?
Q2) Suppose a particular depository institution that specializes in residential mortgages is owned by its depositors.The institution is probably a:
A)Regional or super-regional bank
B)Money center bank
C)Community bank
D)Savings bank
Q3) Considering the balance sheet for all commercial banks in the U.S., the largest category of assets is:
A)Cash items
B)U.S.Government Securities
C)Required reserves
D)Loans
Q4) If you focus on interest-rate risk, can you explain why banks offer higher interest rates on longer-term CDs than they do on short-term CDs?
Q5) Why would a bank usually want to minimize the amount of excess reserves it has on hand?
14
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Chapter 13: Financial Industry Structure
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Sample Questions
Q1) Which of the following is an example of the economies of scale argument for increased profits for large financial holding companies?
A)Financial holding companies offer a wide array of services under one name
B)Financial holding companies need only one CEO, one Board of Directors, and one accounting system regardless of size
C)Financial holding companies are well diversified so risk is reduced
D)The profitability of financial holding companies does not rely on one particular line of business
Q2) The use of coinsurance clauses and deductibles is an attempt by insurance companies to deal with the problem of:
A)Non-payment of premiums
B)Adverse selection
C)Insufficient government regulation
D)Moral hazard
Q3) From a transaction cost perspective, discuss why a firm may contract with an investment bank to underwrite or place an issue.
Q4) Explain why a large equipment provider that sells to many of its commercial customers on account may use a finance company.
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Chapter 14: Regulating the Financial System
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Sample Questions
Q1) Which of the following statements is most correct?
A)Financial regulators do everything possible to encourage competition in banking
B)Financial regulators work to prevent monopolies but also work to prevent strong competition in banking
C)Financial regulators discourage competition in banking
D)Financial regulators prefer banks to have monopoly power in their geographic markets
Q2) Following the consolidation that resulted from the 2007-2009 financial crisis in the US, the 4 largest commercial banks share of total deposits was:
A)75%
B)50%
C)40%
D)25%
Q3) What is the difference between a bank that is insolvent and one that is illiquid?
Q4) Why do bank runs usually have people rushing to their bank instead of waiting for the lines to taper off so they do not have to wait so long?
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Chapter 15: Central Banks in the World Today
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Sample Questions
Q1) History has shown us central banks:
A)Have always prevented financial crisis
B)Seldom minimize a financial crisis
C)Sometimes can make a financial crisis worse
D)Are independent from most financial crisis
Q2) The number of central banks that exist in the world today is:
A)Less than 10
B)About 250
C)Over 170
D)Over 50 but less than 100
Q3) Central banks are in a position to control risk in the economy because they:
A)Control the unemployment rate
B)Control the economy's real growth rate
C)Control short-term interest rates
D)Can change taxes
Q4) Which of the following statements is most accurate?
A)As the inflation rate increases, inflation becomes less stable
B)As the inflation rate decreases, inflation becomes less stable
C)As the inflation rate decreases, inflation becomes more volatile
D)As the inflation rate increases, inflation becomes more stable
17
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Chapter 16: The Structure of Central Banks: the Federal Reserve
and the European Central Bank
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Q1) Current law regarding the Fed's Board of Governors stipulates that:
A)No more than three governors can come from the same district
B)No more than two governors can come from the same district
C)Every district must have at least one governor on the board
D)No more than one governor can come from the same district
Q2) In its role as bank for the U.S.government, the Federal Reserve performs all of the following services, except:
A)Issuing new currency
B)Making discount loans
C)Maintaining the U.S.Treasury's bank account
D)Managing U.S.Treasury borrowings
Q3) As a means to make sure the U.S.President cannot unduly influence the Chairman of the Board of Governors:
A)The Chairman's term does not coincide with the Presidential term
B)The President cannot reappoint the Chairman
C)The Chairman cannot serve for more than four years
D)The Chairman must be a Governor that was appointed to the Board by another president
Q4) Why are so few state chartered banks members of the Federal Reserve System?
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Q5) In what ways do the regional Federal Reserve Banks influence monetary policy?
Chapter 17: The Central Bank Balance Sheet and the Money Supply Process
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Q1) To obtain a discount loan from the Fed, a commercial bank must:
A)Prove that it will fail if it does not obtain the loan
B)Prove that the loan will be used to make loans
C)Provide collateral
D)Agree to more frequent examinations
Q2) If there were an increase in the number of bank failures, we should expect the amount of excess reserves in the banking system to:
A)Decrease
B)Increase
C)Not change
D)Decrease since failing banks lost theirs
Q3) Which of the following statements is most correct?
A)Discount loans are initiated by the Federal Reserve
B)Discount loans are made when banks need relatively small amounts of cash for the long term
C)Discount loans are made when banks need relatively large amounts of cash for the long term
D)Discount loans are made when banks need relatively small amounts of cash for the short term
Page 19
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Chapter 18: Monetary Policy: Stabilizing the Domestic Economy
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Sample Questions
Q1) An increase in the federal funds rate should:
A)Cause mortgage rates to increase by less than the increase in the federal funds rate
B)Have an inverse impact on mortgage rates
C)Not impact mortgage rates since the federal funds rate is a very short-term rate
D)Cause the mortgage rates to increase by more than the increase in the federal funds rate
Q2) How does credit easing alter the outlook for the economy and inflation?
Q3) Consider the desirable features of monetary policy operating instruments and the use of intermediate targets.What missing feature makes a target intermediate rather than operating? Why did the Fed abandon the use of most intermediate targets?
Q4) The components of the formula for the Taylor rule includes each of the following, except:
A)The target federal funds rate
B)The current inflation rate
C)The 30-year U.S.Treasury bond rate
D)The inflation gap
Q5) Describe the supply curve in the market for bank reserves.
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Chapter 19: Exchange-Rate Policy and the Central Bank
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Q1) Could a country be open to international capital flows, control its domestic interest rate and fix its exchange rate? Explain.
Q2) In Hong Kong, the monetary authority can only increase the monetary base if they accumulate more U.S.dollars because:
A)The currency of Hong Kong is the U.S.dollar
B)The monetary authority in Hong Kong operates a currency board where its sole objective is to fix the exchange rate between its currency and the U.S.dollar
C)The IMF required Hong Kong to peg its currency to the U.S.dollar in order to obtain a loan
D)Hong Kong has received substantial funding from the U.S.Treasury and the loans were conditional on maintaining the value of the Hong Kong currency
Q3) Under the Bretton Woods System each participating country had to:
A)Be willing to exchange their own currency for gold
B)Hold ample reserves of currency of each of the participating countries
C)Stand ready to exchange its own currency for U.S.dollars at a fixed exchange rate
D)Adopt capital controls
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Chapter 20: Money Growth, Money Demand, and Modern Monetary Policy
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Q1) A major contributing factor to the instability of money demand over the past 25 years is the:
A)Introduction of financial instruments that pay higher returns than money but can be used as a means of payment
B)Fed has changed the way the money aggregates are defined
C)Failure of many savings and loans
D)Introduction of credit cards
Q2) If the correlation between the rate of inflation and the rate of money growth were closer to -1 rather than +1 would the Fed care any more or less about the growth rate of money? Explain your answer.
Q3) During the period of October 1979 to October 1982; the FOMC's primary operating target resulted in:
A)The most stable period for the federal funds rate in history
B)Reserves being highly volatile
C)The federal funds rate experiencing high volatility
D)The federal funds rate dropping to 2 percent (an all time low to that date) and not rising above 3 percent
Q4) On what aspect of policymaking, according to Robert Lucas, have policymakers been shortsighted in the past?
Page 22
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Chapter 21: Output, Inflation, and Monetary Policy
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Q1) The dynamic aggregate demand curve has a negative slope for all of the following reasons except:
A)The reduction in real wealth caused by inflation
B)The fact that high rates of inflation are good for the stock market
C)The redistribution that occurs as inflation has a greater impact on the poor than it does on the wealthy
D)Higher current inflation leads policy makers to increase the real interest rate, which depresses various components of aggregate expenditures
Q2) To economists, inflation means all of the following except:
A)A one-time increase in the price level
B)A sustained increase in the price level
C)A continually rising price level
D)Temporary or permanent changes in a continuously rising price level
Q3) In the short run, the point on the aggregate demand curve where an economy will end up depends on:
A)The money supply
B)The long-run rate of inflation
C)Potential output
D)The short-run aggregate supply curve
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Page 23
Chapter 22: Understanding Business Cycle Fluctuations
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Q1) The longest recession since the 1940's began in:
A)1952
B)1973
C)1981
D)2007
Q2) Central bankers with a relatively flat monetary policy reaction curve will:
A)Move interest rates more aggressively when inflation rises, leading to more volatility in output
B)Move interest rates more aggressively when inflation rises, leading to less volatility in output
C)Move interest rates less aggressively when inflation rises, leading to more volatility in output
D)Move interest rates less aggressively when inflation rises, leading to less volatility in output
Q3) Explain why changes in the central bank's inflation target will shift the dynamic aggregate demand curve.
Q4) Why do negative supply shocks pose a particularly difficult dilemma for monetary policymakers?
Q5) Neutralizing demand shocks is easier in theory than in practice.Why?
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) If a borrower's net worth increases:
A)The likelihood of moral hazard also increases
B)The borrowers are likely to want to take more risk
C)The moral hazard risk for the potential lenders decreases
D)The supply of loans decreases
Q2) What role, if any, did the accounting scandals involving some U.S.companies in 2001 and 2002 play in the supply of loans?
Q3) The technological changes that seem to be occurring in lending:
A)Will not impact the transmission mechanisms of monetary policy
B)Can reduce the importance of the bank lending channel
C)Will increase the supply of loans because they eliminate the problems of adverse selection and moral hazard
D)Will increase the demand for loans because they eliminate the problems of adverse selection and moral hazard
Q4) Asset-backed securities include:
A)Mortgage-backed securities held by government-sponsored enterprises
B)Car loans and student loans
C)Credit card debt
D)All of the answers given are correct
Page 25
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