Economics of Money, Banking, and Financial Markets, The, Canadian Edition, 8th edition Test Bank

Type:

Test Bank

Resource:

Economics of Money, Banking, and Financial Markets

Edition:

8th Edition

Author(s):

Frederick S. Mishkin Apostolos Serletis

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 1 Why Study Money, Banking, and Financial Markets?

1.1 Why Study Financial Markets?

1) Financial markets promote economic efficiency by ________.

A) channelling funds from investors to savers B) generating inflationary pressures C) channelling funds to those who have a productive use for them D) reducing investment spending Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 2) Well-functioning financial markets are the source of ________.

A) inflation B) deflation C) unemployment D) economic growth Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 3) A key factor in promoting strong economic growth is ________.

A) to reduce foreign trade B) well-functioning financial markets C) high interest rates D) stock market volatility Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 4) Markets in which funds are transferred from those who do not have a productive use for them to those who do are called ________.

A) commodity markets B) fund-available markets C) derivative exchange markets D) financial markets Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy

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5) ________ markets transfer funds from people who do not have a productive use for them to people who do.

A) Commodity B) Fund-available C) Financial D) Derivative exchange Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 6) Poorly performing financial markets can lead to ________.

A) increased wealth B) more poverty C) financial stability D) economic growth Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 7) The bond markets are important because they are ________.

A) easily the most widely followed of the financial markets in Canada B) the markets where foreign exchange rates are determined C) where corporations and governments can borrow to finance their activities D) the markets where all borrowers obtain funds Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 8) A security is also known as ________.

A) a financial instrument B) a contingent claim C) the interest rate D) a liability Answer: A Diff: 1 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy

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9) A bond ________.

A) is not as good an investment as stocks B) pays interest sporadically C) never pays interest D) makes periodic payments for a specified period Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 10) The fluctuation of interest rates ________.

A) never occurs because the central bank is responsible for setting the rate B) is due to changes in stock prices C) cannot occur because there is only one interest rate D) impacts all Canadians Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 11) The cost of borrowing funds is commonly referred to as the ________.

A) inflation rate B) exchange rate C) interest rate D) aggregate price level Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 12) Compared to interest rates on long-term bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average.

A) more; lower B) less; lower C) more; higher D) less; higher Answer: A Diff: 1 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy

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13) The interest rate on long-term corporate bonds is ________, on average, than other interest rates. The spread between it and other rates ________ over time.

A) lower; remains constant B) lower; fluctuates C) higher; remains constant D) higher; fluctuates Answer: D Diff: 1 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy 14) Everything else held constant, a rise in interest rates will lead to ________ house sales.

A) increased B) unchanged C) either increases, declines, or unchanged D) decreased Answer: D Diff: 2 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy 15) High interest rates might ________ purchasing a house or car but at the same time high interest rates might ________ saving.

A) discourage; encourage B) discourage; discourage C) encourage; encourage D) encourage; discourage Answer: A Diff: 2 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy 16) An increase in interest rates might ________ people to save because more can be earned in interest income.

A) encourage B) discourage C) disallow D) invalidate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy

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17) Everything else held constant, an increase in interest rates on student loans ________.

A) may increase the cost of education B) may reduce the cost of education C) has no effect on the cost of education D) increases the cost of education for students with no loans Answer: A Diff: 2 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy 18) A common stock ________.

A) cannot be purchased by individuals B) is also known as a debt security C) is a share of ownership in a corporation D) pays interest when the company makes profits.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 19) A share of common stock is a claim on a corporation's ________.

A) debt B) liabilities C) expenses D) earnings and assets Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 20) Lower interest rates might create an incentive for a company to ________ building a new plant thus generating more jobs.

A) complete B) postpone C) consider D) start Answer: C Diff: 1 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy

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21) Bonds of different maturities ________.

A) have no common features B) have interest rates that tend to move together C) have interest rates that can differ substantially D) B and C only Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 22) The stock market is important because it is ________.

A) where interest rates are determined B) the most widely followed of the financial markets in the Canada C) where foreign exchange rates are determined D) the market where most borrowers obtain funds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 23) Stock prices, as measured by the S&P/TSX Composite Index, ________.

A) have not changed much over time B) have risen smoothly over time C) have been extremely volatile over time D) have declined substantially since they peaked in the mid 1980s Answer: C Diff: 1 Type: MC Skill: Applied Objective: 1.1 Recognize the importance of financial markets in the economy 24) Stock prices are ________.

A) relatively stable and have trended upward at a steady pace over time B) relatively stable and have trended downward at a moderate rate over time C) extremely volatile over time D) unstable and have trended downward at a moderate rate over time Answer: C Diff: 2 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy

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25) Changes in stock prices ________.

A) do not affect people's wealth and their willingness to spend B) affect firms' decisions to sell stock to finance investment spending C) are predictable D) are unimportant to decision makers Answer: B Diff: 2 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 26) A ________ is an example of a security, which is a claim on a company's future income or ________.

A) bond; interest rate B) bond; debt C) stock; assets D) stock; debt Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 27) On ________, October 19, 1987, the market experienced its worst one-day drop in its entire history with the S&P/TSX Composite index falling by 11 percent.

A) "Terrible Tuesday" B) "Woeful Wednesday" C) "Freaky Friday" D) "Black Monday" Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 28) Fluctuations in stock prices ________.

A) have become less volatile since year 2000 B) since year 2000 are about the same as they were before year 2000 C) have become more volatile since year 2000 D) have been almost eliminated since year 2000 Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy

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29) The S&P/TSX Composite reached a peak of over 14000 in 2008 and then fell by ________.

A) 10% B) 30% C) 50% D) 70% Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 30) When I purchase a corporate ________, I am lending the corporation funds for a specific time. When I purchase a corporation's ________, I become an owner in the corporation.

A) bond; stock B) stock; bond C) stock; debt security D) bond; debt security Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 31) By 2020, the S&P/TSX Composite reached a new high of over ________.

A) 8000 B) 11000 C) 14000 D) 17000 Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 32) Why is it important to understand the bond market?

Answer: The bond market supports economic activity by enabling the government and corporations to borrow to undertake their projects and it is the market where interest rates are determined.

Diff: 2 Type: ES Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 33) What is a stock? How do stocks affect the economy?

Answer: A stock represents a share of ownership of a corporation, or a claim on a firm's earnings/assets. Stocks are part of wealth, and changes in their value affect people's willingness to spend. Changes in stock prices affect a firm's ability to raise funds, and thus their investment.

Diff: 2 Type: ES Skill: Recall Objective: 1.1 Recognize the importance of financial markets in the economy 8 .

1.2 Why Study Financial Institutions and Banking?

1) Channelling funds from individuals with surplus funds to those needing funds when the saver does not directly purchase the borrower's security is known as ________.

A) barter B) redistribution C) financial intermediation D) taxation Answer: C Diff: 2 Type: MC Skill: Applied Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 2) A financial crisis is ________.

A) not possible in the modern financial environment B) a major disruption in the financial markets C) a feature of developing economies only D) typically followed by an economic boom Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 3) Banks are important to the study of money and the economy because they ________.

A) channel funds from investors to savers B) have been a source of rapid financial innovation C) are the only important financial institution in the Canadian economy D) create inflation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 4) Financial crises are characterized by ________.

A) surging employment B) hyperinflation C) a decline in asset prices D) high profits in the financial sector Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 9 .

5) Chartered banks, trust and mortgage loan companies, and credit unions and caisses populaires ________.

A) no longer provide financial intermediation services B) since deregulation, now provide services only to small depositors C) accept deposits and make loans D) are the source of fluctuations in the stock market Answer: C Diff: 2 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 6) Banks ________.

A) are the smallest of the financial intermediaries in Canada B) are the largest of the financial intermediaries in Canada C) are barred from providing financial intermediation services D) are limited to providing financial intermediation services to corporations only Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 7) Financial institutions that accept deposits and make loans include ________.

A) stock exchanges B) banks C) investment banks D) finance companies Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 8) Which of the following are the largest financial intermediaries in the Canadian economy?

A) Insurance companies B) Finance companies C) Banks D) Mutual funds Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy

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9) The term "bank" generally includes all the following institutions EXCEPT ________.

A) chartered banks B) credit unions C) trust and mortgage loan companies D) finance companies Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 10) The delivery of financial services electronically is called ________.

A) e-business B) e-commerce C) e-finance D) e-possible Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 11) Financial innovation can lead to ________ and ________.

A) phishing; financial gain B) higher interest rates; higher inflation C) higher profits; financial disasters D) lower interest rates; lower inflation Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 12) What crucial role do financial intermediaries perform in an economy?

Answer: Financial intermediaries borrow funds from people who have saved and make loans to other individuals and businesses and thus improve the efficiency of the economy.

Diff: 1 Type: ES Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy

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13) Why is the study of financial innovation important?

Answer: Financial innovation shows how creative thinking on the part of financial institutions can lead to higher profits.

Diff: 2 Type: ES Skill: Recall Objective: 1.2 Describe how financial intermediation and financial innovation affect banking and the economy 1.3 Why Study Money and Monetary Policy?

1) Money is defined as ________.

A) bills of exchange B) anything that is generally accepted in payment for goods and services or in the repayment of debt C) a repository of spending power D) the unrecognized liability of governments Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 2) The cyclical upward and downward movement of aggregate output in the economy is referred to as the ________.

A) roller coaster B) see saw C) business cycle D) shock wave Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 3) Sustained downward movements in the business cycle are referred to as ________.

A) inflation B) recessions C) economic recoveries D) expansions Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables

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4) During a recession, output declines resulting in ________.

A) lower unemployment in the economy B) higher unemployment in the economy C) no impact on the unemployment in the economy D) higher wages for the workers Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 5) Prior to all recessions, there has been a drop in ________.

A) inflation B) the stock of money C) the rate of money growth D) interest rates Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 6) Evidence from business cycle fluctuations in Canada indicates that ________.

A) a negative relationship between money growth and general economic activity B) recessions have been preceded by declines in share prices on the stock market C) recessions have been preceded by a depreciation of the Canadian dollar D) recessions have been preceded by a decline in the growth rate of money Answer: D Diff: 2 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 7) ________ theory relates changes in the quantity of money to changes in aggregate economic activity and the price level.

A) Monetary B) Fiscal C) Financial D) Systemic Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables

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8) A sharp increase in the growth of the money supply is likely followed by ________.

A) a recession B) a depression C) an increase in the inflation rate D) no change in the economy Answer: C Diff: 2 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 9) Inflation ________.

A) can be explained by changes in the price level and money supply B) cannot be explained historically C) is unrelated to monetary variables D) changes in government policy Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 10) The average price level of goods and services in the economy is called ________ A) the aggregate price level B) inflation C) interest rates D) deflation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 11) It is true that inflation is a ________.

A) continuous increase in the money supply B) continuous fall in prices C) decline in interest rates D) continually rising price level Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables

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12) Which of the following is a true statement?

A) Money or the money supply is defined as Bank of Canada notes.

B) The average price of goods and services in an economy is called the aggregate price level.

C) The inflation rate is measured as the rate of change in the federal government budget deficit.

D) The aggregate price level is measured as the rate of change in the inflation rate.

Answer: B Diff: 2 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 13) If ten years ago the prices of the items bought last month by the average consumer would have been much lower, then one can likely conclude that ________.

A) the aggregate price level has declined during this ten-year period B) the average inflation rate for this ten-year period has been positive C) the average rate of money growth for this ten-year period has been positive D) the aggregate price level has risen during this ten-year period Answer: D Diff: 2 Type: MC Skill: Applied Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 14) From 1970-2020 the price level in Canada increased more than ________.

A) threefold B) sixfold C) sevenfold D) ninefold Answer: C Diff: 2 Type: MC Skill: Applied Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 15) Complete Milton Friedman's famous statement, "Inflation is always and everywhere a ________ phenomenon."

A) recessionary B) discretionary C) repressionary D) monetary Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables

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16) There is a ________ relationship between inflation and the growth rate of money ________.

A) positive; demand B) positive; supply C) negative; demand D) negative; supply Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 17) Evidence from Canada and other foreign countries indicates that ________.

A) there is a strong positive association between inflation and growth rate of money supply over long periods of time B) there is little support for the assertion that "inflation is always and everywhere a monetary phenomenon" C) countries with low monetary growth rates tend to experience higher rates of inflation, all else being constant D) money growth is clearly unrelated to inflation Answer: A Diff: 2 Type: MC Skill: Applied Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 18) The Covid-19 recession ________.

A) had little effect on the unemployment rate B) led to a sharp rise in the unemployment rate C) led to a small rise in the unemployment rate D) led to a drop in the unemployment rate Answer: B Diff: 2 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 19) Countries that experience very high rates of inflation may also have ________.

A) balanced budgets B) rapidly growing money supplies C) falling money supplies D) constant money supplies Answer: B Diff: 2 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 16 .

20) In the late 1970s, interest rates trended upward in Canada. During this same period, ________.

A) the rate of money growth declined B) the rate of money growth increased C) the government budget deficit (expressed as a percentage of GDP) trended downward D) inflation fell Answer: B Diff: 2 Type: MC Skill: Applied Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 21) The management of money and interest rates is called ________ policy and is conducted by a nation's ________ bank.

A) monetary; superior B) fiscal; superior C) fiscal; central D) monetary; central Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 22) What organization is responsible for the conduct of monetary policy in Canada?

A) Royal Canadian Mint B) The Department of Finance C) The Bank of Canada D) The Superintendent of Financial Institutions Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 23) ________ policy involves decisions about government spending and taxation.

A) Monetary B) Fiscal C) Risk Management D) Systemic Answer: B Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables

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24) When tax revenues are greater than government expenditures, the government has a budget ________.

A) crisis B) deficit C) surplus D) revision Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 25) A budget ________ occurs when government expenditures exceed tax revenues for a particular period.

A) deficit B) surplus C) surge D) surfeit Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 26) Budget deficits can be a concern because they might ________.

A) ultimately lead to higher inflation B) lead to lower interest rates C) lead to a slower rate of money growth D) lead to higher bond prices Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 27) What happens to economic growth and unemployment during a business cycle recession?

What is the relationship between the money growth rate and a business cycle recession?

Answer: During a recession, output declines and unemployment increases. Prior to every recession in Canada the money growth rate has declined, however, not every decline is followed by a recession.

Diff: 2 Type: ES Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables

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28) Describe the relationship between the aggregate price level and the growth rate in the money supply. Can this relationship explain inflation?

Answer: The price level and the money supply generally move closely together. There is a positive relationship between inflation and the growth rate of the money supply. Friedman says that "inflation is always and everywhere a monetary phenomenon."

Diff: 2 Type: ES Skill: Recall Objective: 1.3 Identify the basic links between monetary policy, the business cycle, and economic variables 1.4 Why Study International Finance?

1) Canadian companies can borrow funds ________.

A) only in Canadian financial markets B) only in foreign financial markets C) in both Canadian and foreign financial markets D) only from the Canadian government Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.4 Explain the importance of exchange rates in a global economy 2) The price of one country's currency in terms of another country's currency is called the ________.

A) foreign exchange rate B) interest rate C) TSE index D) inflation rate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.4 Explain the importance of exchange rates in a global economy 3) The foreign exchange rate is ________.

A) determined by the banks B) not important to most Canadians C) the relative price of two currencies D) the ratio of the foreign aggregate price level to the domestic aggregate price level Answer: C Diff: 1 Type: MC Skill: Recall Objective: 1.4 Explain the importance of exchange rates in a global economy

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4) The market where one currency is converted into another currency is called the ________ market.

A) security B) bond C) derivatives D) foreign exchange Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.4 Explain the importance of exchange rates in a global economy 5) Everything else constant, a stronger Canadian dollar will mean that ________.

A) vacationing in England becomes more expensive B) vacationing in England becomes less expensive C) French cheese becomes more expensive in the eyes of Canadians D) Japanese cars become more expensive in the eyes of Canadians Answer: B Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 6) Which of the following is most likely to result from a stronger Canadian dollar?

A) Canadian goods exported aboard will cost less in foreign countries, and so foreigners will buy more of them.

B) Canadian goods exported aboard will cost more in foreign countries and so foreigners will buy more of them.

C) Canadian goods exported abroad will cost more in foreign countries, and so foreigners will buy fewer of them.

D) Canadians will purchase fewer foreign goods.

Answer: C Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 7) Everything else held constant, a weaker Canadian dollar will likely hurt ________.

A) textile exporters in Quebec B) wheat farmers in Saskatchewan that sell domestically C) automobile manufacturers in Ontario that use domestically produced inputs D) furniture importers in British Columbia Answer: D Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy

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8) Everything else held constant, Canadians who love French wine benefit most from ________.

A) a decrease in the dollar price of euros B) an increase in the dollar price of euros C) a constant dollar price for euros D) a ban on imports from Europe Answer: A Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 9) Everything else held constant, a stronger Canadian dollar benefits ________ and hurts ________.

A) Canadian businesses; Canadian consumers B) Canadian businesses; foreign businesses C) Canadian consumers; Canadian businesses D) foreign businesses; Canadian consumers Answer: C Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 10) From 2002 to 2008, the Canadian dollar ________ in value.

A) appreciated by approximately 25% against the US dollar B) appreciated by approximately 50% against the US dollar C) depreciated by approximately 50% against the US dollar D) depreciated by approximately 25% against the US dollar Answer: B Diff: 1 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 11) When in 1985 a British pound cost approximately C$1.30, a Shetland sweater that cost 100 British pounds would have cost C$130. With a weaker Canadian dollar, the same Shetland sweater would have cost ________.

A) less than $130 B) more than $130 C) $130, since the exchange rate does not affect the prices that Canadian consumers pay for foreign goods D) $130, since the demand for Shetland sweaters will decrease to prevent an increase in price due to the stronger dollar Answer: B Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy

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12) Everything else held constant, a decrease in the value of the Canadian dollar relative to all foreign currencies means that the price of foreign goods purchased by Canadians ________.

A) increases B) decreases C) remains unchanged D) increases initially but then decreases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.4 Explain the importance of exchange rates in a global economy 13) Canadian farmers who sell beef to Europe benefit most from ________.

A) a decrease in the Canadian dollar price of euros B) an increase in the Canadian dollar price of euros C) a constant Canadian dollar price for euros D) a European ban on imports of Canadian beef Answer: B Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 14) If the Canadian dollar price of a euro increases from $1.00 to $1.10, then, everything else held constant, ________.

A) a European vacation becomes less expensive B) a European vacation becomes more expensive C) the cost of a European vacation is not affected D) foreign travel becomes impossible Answer: B Diff: 2 Type: MC Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy 15) From 2002—2011, the dollar strengthened in value against other currencies. Who was helped and who was hurt by this strong dollar?

Answer: Canadian consumers benefitted because imports were cheaper, and consumers could purchase more goods from abroad. Canadian businesses and workers were hurt as domestic and foreign sales of Canadian products fell.

Diff: 2 Type: ES Skill: Applied Objective: 1.4 Explain the importance of exchange rates in a global economy

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1.5 Money, Banking, and Financial Markets and Your Career 1) Students studying money, banking, and financial markets will learn ________.

A) critical thinking skills that will be useful in all careers B) how to time the market C) stock market tips D) nothing of practical value Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.5 Explain how the study of money, banking, and financial markets may advance your career 1.6 How We Will Study Money, Banking, and Financial Markets 1) The basic concepts used in the analytic framework of this text include all of the following EXCEPT ________.

A) the not-for-profit nature of most financial institutions B) a basic supply and demand analysis to explain the behavior of financial markets C) an approach to financial structure based on transaction costs and asymmetric information D) the concept of equilibrium Answer: A Diff: 1 Type: MC Skill: Recall Objective: 1.6 Describe how the text approaches the teaching of money, banking, and financial markets 2) Using a unified analytic framework to present the information in the text keeps the knowledge ________.

A) focused on theories that have little to do with actual behaviour B) theoretical and uninteresting C) abstract and not applicable to real life D) from becoming obsolete Answer: D Diff: 1 Type: MC Skill: Recall Objective: 1.6 Describe how the text approaches the teaching of money, banking, and financial markets

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 2 An Overview of the Financial System 2.1 Function of Financial Markets 1) Every financial market has which of the following characteristics?

A) It sets the level of interest rates.

B) It allows for common stock to be traded.

C) It allows for loans to be made.

D) It channels funds from lenders-savers to borrowers-spenders.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 2) The basic function of a financial market is________.

A) getting people with funds to lend together with people who want to borrow funds B) assuring that business cycle fluctuations are less pronounced C) assuring that governments never resort to printing money to cover their excess spending D) providing a risk-free repository of spending power for depositors Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 3) Financial markets improve economic welfare because ________.

A) they channel funds from investors to savers B) they allow consumers to better time their purchases C) they weed out inefficient firms D) they eliminate the need for indirect finance Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 4) Well-functioning financial markets ________.

A) cause inflation B) eliminate the need for indirect finance C) cause financial crises D) promote an efficient allocation of capital Answer: D Diff: 3 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance

1 .

5) A breakdown of financial markets can result in ________.

A) financial stability B) rapid economic growth C) political instability D) stable prices Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 6) The most important group of lender-savers are ________.

A) governments B) businesses C) households D) foreigners Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 7) Which of the following can best be qualified as direct finance?

A) You take out a mortgage from your local bank.

B) You borrow $2500 from a friend.

C) You buy shares of common stock in the secondary market.

D) You buy shares in a mutual fund.

Answer: B Diff: 2 Type: MC Skill: Applied Objective: 2.1 Compare and contrast direct and indirect finance 8) Assume that you borrow $2000 at 10 percent annual interest to finance a new business project.

For this loan to generate a positive profit, the minimum amount of annual earnings this project must generate is ________.

A) $400 B) $201 C) $200 D) $199 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 2.1 Compare and contrast direct and indirect finance

2 .

9) Assume you can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still manage to increase your income is ________.

A) 25 percent B) 12.5 percent C) 10 percent D) 5 percent Answer: D Diff: 3 Type: MC Skill: Applied Objective: 2.1 Compare and contrast direct and indirect finance 10) Which of the following can be described as involving direct finance?

A) A corporation issues new shares of stock.

B) People buy shares in a mutual fund.

C) A pension fund manager buys a short-term corporate security in the secondary market.

D) An insurance company buys shares of common stock in the over-the-counter markets.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 11) Which of the following can be described as involving direct finance?

A) A corporation takes out a loan from a bank.

B) People buy shares in a mutual fund.

C) A corporation buys a short-term corporate security in a secondary market.

D) People buy shares of common stock in the primary markets.

Answer: D Diff: 3 Type: MC Skill: Applied Objective: 2.1 Compare and contrast direct and indirect finance 12) Which of the following can be described as involving indirect finance?

A) You make a loan to your neighbor.

B) A corporation buys a share of common stock issued by another corporation in the primary market.

C) You buy a Canadian Treasury bill from the Bank of Canada.

D) You make a deposit at a bank.

Answer: D Diff: 3 Type: MC Skill: Applied Objective: 2.1 Compare and contrast direct and indirect finance

3 .

13) Securities are ________ for the person who buys them but are ________ for the individual or firm that issues them.

A) assets; liabilities B) liabilities; assets C) negotiable; nonnegotiable D) nonnegotiable; negotiable Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 14) With ________ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.

A) active B) determined C) indirect D) direct Answer: D Diff: 2 Type: MC Skill: Applied Objective: 2.1 Compare and contrast direct and indirect finance 15) How do financial intermediaries play an important role in the economy?

Answer: Financial intermediaries play an important role in the economy because they provide liquidity services, they lower transaction costs through economies of scale, they reduce the risk exposure of investors through risk sharing, and they solve the asymmetric information problems of adverse selection and moral hazard. By doing this, they allow small savers and borrowers to benefit from the existence of financial markets and its instruments. They also improve economic efficiency because they help financial markets to channel funds from lenders-savers to people with productive investment opportunities.

Diff: 3 Type: ES Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance 16) Distinguish between direct finance and indirect finance. Which of these is the most important source of funds for corporations in Canada?

Answer: With direct finance, funds flow directly from the lender/saver to the borrower. With indirect finance, funds flow from the lender/saver to a financial intermediary who then channels the funds to the borrower/investor. Financial intermediaries (indirect finance) are the major source of funds for corporations in Canada.

Diff: 3 Type: ES Skill: Recall Objective: 2.1 Compare and contrast direct and indirect finance

4 .

2.2 Structure of Financial Markets 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.

Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 2) Which of the following statements about the characteristics of debt and equities is true?

A) They can both be long-term financial instruments.

B) Bond holders are residual claimants.

C) The income from bonds is typically more variable than that from equities.

D) Bonds pay dividends.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 3) Which of the following statements about financial markets and securities is true?

A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants.

B) A debt instrument is qualified as intermediate term if its maturity is less than one year.

C) A debt instrument is qualified as intermediate term if its maturity is ten years or longer.

D) The maturity of a debt instrument is defined as the number of years (term) to that instrument's expiration date.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 4) An example of an intermediate-term debt would be ________.

A) a thirty-year mortgage B) a sixty-month car loan C) a six-month loan from a finance company D) a treasury bill Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets

5 .

5) If the maturity of a debt instrument is less than one year, the debt is qualified as ________.

A) short-term B) intermediate-term C) long-term D) prima-term Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 6) To be qualified as long-term debt the financial instrument must have a maturity that is ________.

A) between one and ten years B) less than a year C) between five and ten years D) ten years or longer Answer: D Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 7) When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors.

A) bonds B) debentures C) notes D) stock Answer: D Diff: 1 Type: MC Skill: Applied Objective: 2.2 Identify the structure and components of financial markets 8) Which of the following benefit directly from any increase in the corporation's profitability?

A) A bond holder B) A commercial paper holder C) A shareholder D) A Treasury bill holder Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets

6 .

9) A financial market where previously issued securities can be traded is called a ________ market.

A) primary B) secondary C) tertiary D) used securities Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 10) When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public.

A) underwrites B) undertakes C) overwrites D) overtakes Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 11) Which of the following markets is not a secondary market?

A) Foreign exchange market B) Futures market C) Options market D) Primary market Answer: D Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 12) ________ work in the secondary markets matching buyers with sellers of securities.

A) Dealers B) Underwriters C) Brokers D) Claimants Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets

7 .

13) A corporation can acquire new funds by having its securities sold in the ________.

A) primary market by an investment bank B) primary market by a stock exchange broker C) secondary market by a securities dealer D) secondary market by a commercial bank Answer: A Diff: 2 Type: MC Skill: Applied Objective: 2.2 Identify the structure and components of financial markets 14) A corporation can acquire new funds by having its securities sold in the ________.

A) secondary market by an investment bank B) primary market by an investment bank C) secondary market by a stock exchange broker D) secondary market by a commercial bank Answer: B Diff: 2 Type: MC Skill: Applied Objective: 2.2 Identify the structure and components of financial markets 15) An important function of secondary markets is to ________.

A) make it easier to sell financial instruments to raise funds B) raise funds for corporations through the sale of securities C) make it easier for governments to raise tax revenue D) make it easier to sell newly constructed houses Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 16) Secondary markets make financial instruments more ________.

A) solid B) vapid C) liquid D) risky Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets

8 .

17) A liquid asset is ________.

A) an asset that can easily and quickly traded in exchange for cash B) an ownership share of an ocean resort C) difficult to resell D) only sold in an over-the-counter market Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 18) The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market.

A) more; primary B) more; secondary C) less; primary D) less; secondary Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 19) Which of the following is a financial market in which only short-term debt instruments are traded?

A) Bond market B) Money market C) Capital market D) Stock market Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 20) Equity instruments are traded in the ________ market.

A) money B) bond C) capital D) commodities Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.2 Identify the structure and components of financial markets

9 .

21) Corporations receive funds when their stock is sold in the primary market, but pay close attention to the price of their stock in the secondary market. Why are corporations interested in the secondary market?

Answer: The existence of the secondary market makes their stock more liquid, and the price in the secondary market sets the price that the corporation would receive if they chose to sell more stock in the primary market.

Diff: 2 Type: ES Skill: Applied Objective: 2.2 Identify the structure and components of financial markets 22) Describe the two methods of organizing a secondary market.

Answer: A secondary market can be organized as an exchange where buyers and sellers meet in one central location to conduct trades. An example of an exchange is the Toronto Stock Exchange (TSX). A secondary market can also be organized as an over-the-counter market. In this type of market, dealers in different locations buy and sell securities at a negotiated price from their own portfolio (or a client's portfolio) to anyone who comes to. An example of an overthe-counter market is the OTCQX. Diff: 2 Type: ES Skill: Recall Objective: 2.2 Identify the structure and components of financial markets 23) Describe the difference between the money market and the capital market.

Answer: The money market in which short-term debt instruments are traded. The capital market is the market in which longer-term debt is traded.

Diff: 1 Type: ES Skill: Recall Objective: 2.2 Identify the structure and components of financial markets

10 .

2.3 Financial Market Instruments 1) Prices of money market instruments undergo the least fluctuations because of ________.

A) their shorter maturities. the short terms to maturity for the securities B) the strict regulations in the industry C) the price ceiling imposed by government regulation.

D) the absence of any meaningful competition in the market Answer: A Diff: 3 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 2) Treasury bills pay no interest but are sold at a ________. That is, you pay a lower purchase price than the amount you receive at maturity.

A) premium B) collateral C) default D) discount Answer: D Diff: 2 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 3) Treasury bills are considered the safest of all money market instruments because there is no risk of ________.

A) defeat B) default C) desertion D) demarcation Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 4) A debt instrument that is sold by a bank, pays annual interest, and at maturity reimburses the original purchase price. The instrument in question is known as ________.

A) commercial paper B) a negotiable certificate of deposit C) a municipal bond D) a federal bond Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments

11 .

5) A short-term debt instrument issued by large and trusted corporations is known as ________.

A) commercial paper B) corporate bonds C) municipal bonds D) commercial mortgages Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 6) ________ are short-term loans in which Treasury bills serve as collateral.

A) Repurchase agreements B) Negotiable certificates of deposit C) Overnight funds D) Government agency securities Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 7) Collateral is ________ the lender receives from the borrower if they do not honour their loan.

A) a liability B) an asset C) a gift D) an offering Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 8) Overnight funds are ________.

A) funds raised in the bond market by the federal government B) loans made to banks by the Bank of Canada C) loans made by banks to the Bank of Canada D) loans made by banks to other banks Answer: D Diff: 2 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments

12 .

9) Which of the following are short-term financial instruments?

A) A repurchase agreement B) A share in Walt Disney Corporation C) A bond with a maturity of four years D) A residential mortgage Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 10) Which of the following instruments are traded in a money market?

A) Provincial government bonds B) Treasury bills C) Corporate bonds D) Government agency securities Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 11) Which of the following instruments are traded in a money market?

A) Bank commercial loans B) Commercial paper C) Provincial government bonds D) Residential mortgages Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 12) Which of the following instruments is not traded in a money market?

A) Residential mortgages B) Treasury Bills C) Negotiable bank certificates of deposit D) Commercial paper Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments

13 .

13) Bonds issued by corporations are called ________ bonds.

A) corporate B) treasury C) municipal D) commercial Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 14) Equity and debt instruments with maturities greater than one year are known as ________ market instruments.

A) capital B) money C) federal D) benchmark Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 15) Explain why Government of Canada Treasury Bills are considered a very low risk financial instrument.

Answer: Government of Canada Treasury Bills are considered low risk, because they are the most actively traded of the money market instruments; their original maturity is no more than 12 months. Moreover, there is almost no probability of default. The federal government is always able to meet its debt obligations as it can raise taxes to service its debt or print more money.

Diff: 2 Type: ES Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments 16) Explain why only the largest and most trustworthy corporations issue the financial instruments known as commercial paper?

Answer: Commercial paper is an unsecured short-term debt instrument issued either in Canadian dollars or other currencies. Since it is unsecured, only the largest corporations and banks can issue commercial paper so that the market can trust them and invest in their issue. It is highly unlikely that an investor would trust a small unknown firm and finance it with an unsecured loan.

Diff: 2 Type: ES Skill: Recall Objective: 2.3 List and describe the different types of financial market instruments

14 .

2.4 Internationalization of Financial Markets 1) One reason for the extraordinary growth of foreign financial markets is ________.

A) decreased trade B) the growth in the pool of savings in foreign countries C) the recent introduction of the foreign bond D) slower technological innovation in foreign markets Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets 2) Bonds that are sold in a foreign country and are denominated in the country's currency in which they are sold are known as ________.

A) foreign bonds B) Eurobonds C) equity bonds D) country bonds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets 3) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as ________.

A) foreign bonds B) Eurobonds C) equity bonds D) country bonds Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets 4) If Microsoft sells a dollar denominated bond in London this bond is qualified as a ________.

A) Eurobond B) foreign bond C) British bond D) currency bond Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets

15 .

5) U.S. dollar deposits in foreign banks outside the U.S. or in foreign branches of U.S. banks are known as ________.

A) Atlantic dollars B) Eurodollars C) foreign dollars D) outside dollars Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets 6) If Volkswagen, a German company, sells a euro-denominated bond in London, the bond is known as a ________.

A) Eurobond B) foreign bond C) currency bond D) Deutsche bond Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets 7) Explain the difference between a foreign bond and a Eurobond.

Answer: A foreign bond is sold in a foreign country and priced in that country's currency. A Eurobond is sold in a foreign country and priced in a currency that is not that country's currency.

Diff: 1 Type: ES Skill: Recall Objective: 2.4 Recognize the international dimensions of financial markets

16 .

2.5 Function of Financial Intermediaries: Indirect Finance 1) The process of indirect finance using financial intermediaries is known as ________.

A) direct lending B) financial intermediation C) resource allocation D) financial liquidation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 2) The time and money spent in carrying out financial transactions are known as ________.

A) economies of scale B) financial intermediation C) liquidity services D) transaction costs Answer: D Diff: 1 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 3) Economies of scale enable financial institutions to ________.

A) reduce transactions costs B) avoid the asymmetric information problem C) avoid the adverse selection problem D) reduce the moral hazard problem Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 4) An example of economies of scale in the provision of financial services is ________.

A) investing in a diversified collection of assets B) providing depositors with a variety of savings certificates C) spreading the cost of borrowing funds over many customers D) spreading the cost of writing a standardized contract over many borrowers Answer: D Diff: 2 Type: MC Skill: Applied Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries

17 .

5) Financial intermediaries provide customers with liquidity services. Liquidity services ________.

A) make it easier for customers to conduct transactions B) allow customers to have a cup of coffee while waiting in the lobby C) are a result of the asymmetric information problem D) is another term used to describe asset transformation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 6) The process whereby financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as ________.

A) risk sharing B) risk aversion C) risk neutrality D) risk selling Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 7) The process of asset transformation refers to the conversion of ________.

A) safer assets into risky assets B) safer assets into safer liabilities C) risky assets into safer assets D) risky assets into risky liabilities Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 8) Reducing risk through the purchase of different financial assets whose returns do not always move together is ________.

A) diversification B) intermediation C) intervention D) discounting Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 18 .

9) The concept of diversification in finance is best captured by which of the following proverbs?

A) Don't look a gift horse in the mouth B) Don't put all your eggs in one basket C) It never rains, but it pours D) Make hay while the sun shines Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 10) Risk sharing is profitable for financial institutions due to ________.

A) low transactions costs B) asymmetric information C) adverse selection D) moral hazard Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 11) Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. When one party has more information than the other this is known as ________.

A) moral selection B) risk sharing C) asymmetric information D) adverse hazard Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 12) People that are perceived as bad credit risks are those most likely to apply for loans. In this case, the lender, which is most often a financial intermediary, faces a/an ________ problem.

A) moral hazard B) adverse selection C) free-riding D) provincial verification Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 19 .

13) The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is known as ________.

A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 14) 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) the borrower's lack of good options for obtaining funds Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 15) An example of the problem of ________ would be when a corporation sells bonds that were promoted as a means to finance a corporate expansion but the funds were instead used to pay for Caribbean cruises for all its employees and their families.

A) adverse selection B) moral hazard C) risk sharing D) credit risk Answer: B Diff: 3 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries

20 .

16) Typically, borrowers have more and better information relative to lenders about the potential returns and risks associated with an investment project. The difference in this information gap is known as ________, and it creates the ________ problem.

A) asymmetric information; risk sharing B) asymmetric information; adverse selection C) adverse selection; moral hazard D) moral hazard; adverse selection Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 17) Studies of major developed countries show that when businesses from these countries go looking for funds to finance their activities that they usually obtain these funds from ________.

A) government agencies B) equities markets C) financial intermediaries D) bond markets Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 18) The countries that have made the least use of securities markets are ________ and ________; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets.

A) Germany; Japan B) Germany; Great Britain C) Great Britain; Canada D) Canada; Japan Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries

21 .

19) Although the dominance of ________ over ________ is clear in all countries, the relative importance of the bond market compared to the stock market differs widely.

A) financial intermediaries; securities markets B) financial intermediaries; government agencies C) government agencies; financial intermediaries D) government agencies; securities markets Answer: A Diff: 3 Type: MC Skill: Recall Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 20) Because there is an imbalance of information in a lending situation, we must deal with the problems of adverse selection and moral hazard. Define these terms and explain how financial intermediaries can reduce these problems.

Answer: Adverse selection is the asymmetric information problem that exists before the transaction occurs. For lenders, it is the difficulty in judging a good credit risk from a bad credit risk. Moral hazard is the asymmetric information problem that exists after the transaction occurs.

For lenders, it is the difficulty in making sure the borrower uses the funds appropriately.

Financial intermediaries can reduce adverse selection through intensive screening and can reduce moral hazard by monitoring the borrower.

Diff: 2 Type: ES Skill: Applied Objective: 2.5 Summarize the roles of transaction costs, risk sharing, and information costs as they relate to financial intermediaries 2.6 Types of Financial Intermediaries 1) Financial institutions that accept deposits and make loans are known as ________ institutions.

A) investment B) contractual savings C) depository D) underwriting Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 2) Depository institutions include ________.

A) banks, mutual funds, and insurance companies B) banks, trust and mortgage loan companies, and credit unions C) finance companies, mutual funds, and money market funds D) pension funds, mutual funds, and banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 22 .

3) Which of the following is a depository institution?

A) A life insurance company B) A credit union C) A pension fund D) A mutual fund Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 4) Which of the following financial intermediaries is not a depository institution?

A) A savings and loan association B) A commercial bank C) A credit union D) A finance company Answer: D Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 5) The primary liabilities of chartered banks are ________.

A) bonds B) mortgages C) deposits D) commercial paper Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 6) The primary liabilities of depository institutions are ________.

A) premiums from policy holders B) corporate shares C) deposits D) bonds Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries

23 .

7) ________ institutions are financial intermediaries that acquire funds at periodic intervals on a contractual basis.

A) Investment B) Contractual savings C) Thrift D) Depository Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 8) Which of the following is a contractual savings institution?

A) A life insurance company B) A credit union C) A savings and loan association D) A mutual fund Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 9) Contractual savings institutions include ________.

A) mutual savings banks B) money market mutual funds C) commercial banks D) life insurance companies Answer: D Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 10) Which of the following are not contractual savings institutions?

A) Life insurance companies B) Credit unions C) Pension funds D) Government retirement funds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries

24 .

11) Which of the following is not a contractual savings institution?

A) A life insurance company B) A pension fund C) A finance association D) A property and casualty insurance company Answer: C Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 12) The primary assets of a pension fund are ________.

A) money market instruments B) corporate bonds and stocks C) consumer and business loans D) mortgages Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 13) Which of the following are investment intermediaries?

A) Life insurance companies B) Mutual funds C) Pension funds D) Government retirement funds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 14) An investment intermediary that lends funds to consumers is ________.

A) a finance company B) an investment bank C) a finance fund D) a consumer company Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries

25 .

15) The primary assets of a finance company are ________.

A) municipal bonds B) corporate stocks and bonds C) consumer and business loans D) mortgages Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 16) ________ are financial intermediaries that acquire funds by selling shares to many individuals and using the proceeds to purchase diversified portfolios of stocks and bonds.

A) Mutual funds B) Investment banks C) Finance companies D) Credit unions Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 17) An important feature of money market mutual fund shares is ________.

A) that they are subject to deposit insurance B) they offer deposit-type accounts C) the ability to borrow against shareholdings D) claims on shares of corporate stock Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 18) The primary assets of money market mutual funds are ________.

A) stocks B) bonds C) money market instruments D) deposits Answer: C Diff: 2 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries

26 .

19) The liquidity of financial assets held by contractual savings institutions ________.

A) is an important consideration B) is not an important consideration C) is restricted D) is an undertaking Answer: B Diff: 1 Type: MC Skill: Recall Objective: 2.6 List and describe the different types of financial intermediaries 2.7 Regulation of the Financial System 1) Which of the following is not a goal of financial regulation?

A) Ensuring the soundness of the financial system B) Reducing moral hazard C) Reducing adverse selection D) Ensuring that investors never suffer losses Answer: D Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 2) Increasing the amount of information available to investors helps to reduce the problems of ________ and ________ in the financial markets.

A) adverse selection; moral hazard B) adverse selection; risk sharing C) moral hazard; transactions costs D) adverse selection; economies of scale Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 3) A goal of the Ontario Securities Commission is to reduce problems arising from ________.

A) competition B) banking panics C) risk D) asymmetric information Answer: D Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations

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4) The purpose of the disclosure requirements is to ________.

A) increase the information available to investors B) prevent bank panics C) improve monetary control D) protect investors against financial losses Answer: A Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 5) Government regulations to reduce the possibility of financial panics include all the following EXCEPT ________.

A) transactions costs B) restrictions on assets and activities C) disclosure D) deposit insurance Answer: A Diff: 1 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 6) The Canada Deposit Insurance Corporation regulates ________.

A) brokerage firms B) banks C) credit unions D) mutual funds Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 7) In order to reduce risk and increase the safety of financial institutions, commercial banks and other depository institutions are prohibited from ________.

A) owning corporate bonds B) making real estate loans C) making personal loans D) owning common stock Answer: D Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations

28 .

8) The primary purpose of deposit insurance is to ________.

A) improve the flow of information to investors B) prevent banking panics C) protect bank shareholders against losses D) protect bank employees from unemployment Answer: B Diff: 2 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 9) Asymmetric information is a universal problem. This would suggest that financial regulations ________.

A) in industrial countries are an unqualified failure B) differ significantly around the world C) in industrialized nations are similar D) are unnecessary Answer: C Diff: 3 Type: MC Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 10) How do regulators help to ensure the soundness of financial intermediaries?

Answer: Regulators restrict who can set up as a financial intermediary, conduct regular examinations, restrict assets, and provide insurance to help ensure the soundness of financial intermediaries.

Diff: 2 Type: ES Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations 11) How does regulation reduce the problems of adverse selection and moral hazard? What regulations are or have been used to protect the public from panics?

Answer: Regulation attempts to reduce asymmetric information and financial instability.

Financial stability is promoted by regulations restricting entry, disclosure and/or examination, restrictions on assets and risk taking, deposit insurance, limits on competition, and interest rate controls.

Diff: 3 Type: ES Skill: Recall Objective: 2.7 Identify the reasons for, and list the types of financial market regulations

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 3 What Is Money?

3.1 Meaning of Money 1) A person's house is part of her ________.

A) money B) income C) liabilities D) wealth Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 2) Money is ________.

A) anything that is generally accepted in payment for goods and services or in the repayment of debt B) a flow of earnings per unit of time C) the total collection of pieces of property that are a store of value D) always based on a precious metal like gold or silver Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 3) To an economist, ________ is anything that is generally accepted in payment for goods and services or in the repayment of debt.

A) wealth B) income C) money D) credit Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 4) Currency is defined as ________.

A) anything accepted for payment of goods and services B) paper money and coins C) a unit of account D) foreign exchange Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 1 .

5) Money is ________.

A) the same as currency B) anything that is generally accepted in payment of goods or services or in the repayment of debts C) not used as a unit of account D) defined as paper money and coins Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 6) Currency includes ________.

A) paper money and coins B) paper money, coins, and cheques C) paper money and cheques D) paper money, coins, cheques, and savings deposits Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 7) Economists do not agree on a precise measure of money or the money supply because ________.

A) official statistics on the money supply not published because they are confidential, therefore economists must make them up B) deciding what is generally accepted as a means of payment for goods and services or in the repayment of debt is contentious C) many economists cannot agree if currency should be considered money D) definitions evolve all the time Answer: B Diff: 2 Type: MC Skill: Recall Objective: 3.1 Describe what money is 8) Economists do not have a single, precise definition of money because ________.

A) money supply statistics are a state secret B) the Bank of Canada does not compile or report different measures of the money supply C) the "moneyness" or liquidity of an asset is a matter of degree D) economists take pride in disagreeing among themselves and therefore refuse to agree on a single definition of money for ideological reasons Answer: C Diff: 2 Type: MC Skill: Recall Objective: 3.1 Describe what money is

2 .

9) The total collection of pieces of property that serve as a store value is a person's ________.

A) wealth B) income C) money D) credit Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 10) ________ is used to make purchases while ________ is the total collection of pieces of property that serve as a store value.

A) Money; income B) Wealth; income C) Income; money D) Money; wealth Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 11) ________ is a flow of earnings per unit of time.

A) Income B) Money C) Wealth D) Currency Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 12) An individual's annual salary is her ________.

A) money B) income C) wealth D) liabilities Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is

3 .

13) When we say that money is a stock variable, we mean that ________.

A) the quantity of money is measured at a given point in time B) we must attach a time period to the measure C) it is sold in the equity market D) money never loses purchasing power Answer: A Diff: 2 Type: MC Skill: Recall Objective: 3.1 Describe what money is 14) The difference between money and income is that ________.

A) money is a flow and income is a stock B) money is a stock and income is a flow C) there is no difference–money and income are both stocks D) there is no difference–money and income are both flows Answer: B Diff: 2 Type: MC Skill: Recall Objective: 3.1 Describe what money is 15) Income is a ________ and wealth is a ________.

A) stock; flow B) flow; stock C) variable; constant D) constant; variable Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is 16) Which of the following is a true statement?

A) Money and income are flow variables.

B) Money is a flow variable.

C) Income is a flow variable.

D) Money and income are stock variables.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.1 Describe what money is

4 .

17) Which of the following statements uses the economists' definition of money?

A) I plan to earn a lot of money over the summer.

B) Betsy is rich–she has a lot of money.

C) I hope that I have enough money to buy my lunch today.

D) The job with New Company gave me the opportunity to earn more money.

Answer: C Diff: 2 Type: MC Skill: Applied Objective: 3.1 Describe what money is 18) In the country of Moneyland the law permits people to repay their mortgage in rocks. Thus, ________.

A) Moneyland is a poor country B) rocks in this country are considered as money C) money is scarce D) Moneyland is a developing country Answer: B Diff: 2 Type: MC Skill: Applied Objective: 3.1 Describe what money is 19) Explain the concepts of wealth and income and how they relate to the concept of money.

Answer: Non-economists often use money synonymously with wealth or income. Wealth is a stock variable that describes the total collection of property that is used to store value. Income is a flow of earnings over some period. Money is a stock variable; it is a certain amount at a point of time and can be used in the payment of goods and services.

Diff: 2 Type: ES Skill: Applied Objective: 3.1 Describe what money is

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3.2 Functions of Money 1) If peanuts serve as a medium of exchange, a unit of account, and a store of value, then peanuts are ________.

A) bank deposits B) reserves C) money D) loanable funds Answer: C Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 2) For a commodity to function effectively as money it must be ________.

A) easily standardized, making it easy to ascertain its value B) difficult to make small change C) deteriorate quickly so that its supply does not become too large D) hard to carry around Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 3) ________ are the time and resources spent trying to exchange goods and services.

A) Bargaining costs B) Transaction costs C) Contracting costs D) Barter costs Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 4) Compared to an economy that uses a medium of exchange, in a barter economy ________.

A) transaction costs are higher B) transaction costs are lower C) liquidity costs are higher D) liquidity costs are lower Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money

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5) Of money's three functions, the one that distinguishes money from other assets is its function as a ________.

A) store of value B) unit of account C) standard of deferred payment D) medium of exchange Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 6) When compared to exchange systems that rely on money, disadvantages of the barter system include ________.

A) the requirement of a double coincidence of wants B) lowering the cost of exchanging goods over time C) lowering the cost of exchange to those who would specialize D) encouraging specialization and the division of labor Answer: A Diff: 2 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 7) The conversion of a barter economy to one that uses money ________.

A) increases efficiency by reducing the need to exchange goods and services B) increases efficiency by reducing the need to specialize C) increases efficiency by reducing transactions costs D) does not increase economic efficiency Answer: C Diff: 2 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 8) Which of the following statements best explains how the use of money in an economy increases 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 influence economic efficiency.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money

7 .

9) Which of the following is a true statement?

A) The conversion of a barter economy to one that uses money increases efficiency by increasing the cost of exchanging goods and services.

B) The conversion of a barter economy to one that uses money increases efficiency by increasing the cost to those who wish to specialize.

C) The conversion of a barter economy to one that uses money increases efficiency by reducing transactions costs.

D) The conversion of a barter economy to one that uses money does not increase efficiency.

Answer: C Diff: 3 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 10) When economists say that money promotes ________, they mean that money encourages specialization and the division of labour.

A) bargaining B) contracting C) efficiency D) greed Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 11) Money ________ transaction costs, allowing people to specialize in what they do best.

A) reduces B) increases C) enhances D) eliminates Answer: A Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 12) All of the following are necessary conditions for a commodity to function as money EXCEPT ________.

A) it must deteriorate quickly B) it must be divisible C) it must be easy to carry D) it must be widely accepted Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money

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13) Whatever a society uses as money, the distinguishing characteristic is that it must ________.

A) be completely inflation proof B) be generally acceptable as a means of payment for goods and services or in the repayment of debt C) be backed by gold D) be produced by the government Answer: B Diff: 2 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 14) All but the most primitive societies use money as a medium of exchange, implying that ________.

A) the use of money is economically efficient B) barter exchange is economically efficient C) barter exchange cannot work outside the family D) inflation is not a concern Answer: A Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 15) Kevin purchasing concert tickets with his debit card is an example of the ________ function of money.

A) medium of exchange B) unit of account C) store of value D) specialization Answer: A Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 16) 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 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money

9 .

17) A problem with the barter system when there are many goods is that ________.

A) transactions costs are minimized B) there exists a multiple number of prices for each good C) there is only one store of value D) exchange of services is impossible Answer: B Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 18) In a barter economy with N goods there are ________ distinct prices.

A) [N(N - 1)]/2 B) N(N/2) C) 2N D) N(N/2) - 1 Answer: A Diff: 3 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 19) If there are five goods in a barter economy, one needs to know ten prices to exchange one good for another. If, however, there are ten goods in a barter economy, then one needs to know ________ prices to exchange one good for another.

A) 20 B) 25 C) 30 D) 45 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 20) If there are four goods in a barter economy, then one needs to know ________ prices to exchange one good for another.

A) 8 B) 6 C) 5 D) 4 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money

10 .

21) Because it is a unit of account, money ________.

A) increases transaction costs B) reduces the number of prices that need to be calculated C) does not earn interest D) discourages specialization Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 22) Dennis notices that jackets are on sale for $99. In this case money is functioning as a ________.

A) medium of exchange B) unit of account C) store of value D) payments-system ruler Answer: B Diff: 2 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 23) As a store of value, money ________.

A) does not earn interest B) cannot be a durable asset C) must be currency D) is a way of saving for future purchases Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 24) Patrick transfers his pocket change into the jar on his desk each evening. By his actions, Patrick believes that money is a ________.

A) medium of exchange B) unit of account C) store of value D) unit of specialization Answer: C Diff: 2 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money

11 .

25) ________ is the relative ease and speed with which an asset can be converted into a medium of exchange.

A) Efficiency B) Liquidity C) Deflation D) Specialization Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 26) Increasing transactions costs of selling an asset make the asset ________.

A) more valuable B) more liquid C) less liquid D) more moneylike Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 27) Since it does not have to be converted into anything else to make purchases, ________ is the most liquid asset.

A) money B) a company's stock C) a bond D) gold Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 28) Of the following assets, the least liquid is ________.

A) stocks B) bonds C) chequing deposits D) a house Answer: D Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money

12 .

29) Ranking assets from most liquid to least liquid, the correct order is ________.

A) savings bonds; house; currency B) currency; savings bonds; house C) currency; house; savings bonds D) house; savings bonds; currency Answer: B Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 30) People hold money even during inflationary episodes when other assets prove to be better stores of value. This can be explained by the fact that money is all the following EXCEPT ________.

A) perfectly liquid B) a unique good for which there are no substitutes C) the only accepted commodity for conducting transactions D) backed by gold Answer: A Diff: 3 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money 31) If the price level doubles, the value of money ________.

A) doubles B) more than doubles, due to scale economies C) rises but does not double, due to diminishing returns D) falls by half Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 32) A fall in the price level ________.

A) does not affect the value of money B) has an uncertain effect on the value of money C) increases the value of money D) reduces the value of money Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money

13 .

33) Hyperinflation is ________.

A) a period of extreme inflation generally greater than 50 percent per month B) a period of anxiety caused by rising prices C) an increase in output caused by higher prices D) impossible today because of tighter regulations Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 34) During periods of hyperinflations, ________.

A) the value of money rises rapidly B) money no longer functions as a store of value and barter becomes more popular C) savers from the middle-class benefit as prices rise D) if prices double so does the value of money Answer: B Diff: 2 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 35) Because inflation in Germany after World War I sometimes exceeded 1000 percent per month, one can conclude that the German economy suffered from ________.

A) deflation B) disinflation C) hyperinflation D) superdeflation Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.2 List and summarize the functions of money 36) If merchants in the country of Zed choose to close their stores, preferring to be stuck with rotting food rather than with worthless currency, then one can conclude that Zed is experiencing a period of ________.

A) superdeflation B) hyperdeflation C) disinflation D) hyperinflation Answer: D Diff: 1 Type: MC Skill: Applied Objective: 3.2 List and summarize the functions of money

14 .

37) Explain how cigarettes could be used as "money" in prisoner-of-war camps of World War II. Answer: The cigarettes performed the three functions of money. They served as the medium of exchange because individuals did exchange items for cigarettes. They served as a unit of account because prices were quoted in terms of the number of cigarettes required for the exchange. They served as a store of value because an individual would be willing to save their cigarettes even if they did not smoke because they believed that they could exchange the cigarettes for something that they did want at some time in the future.

Diff: 2 Type: ES Skill: Applied Objective: 3.2 List and summarize the functions of money 38) Can packs of cigarettes be used as commodity money?

Answer: We must see whether cigarettes satisfy the 5 criteria for a commodity to function effectively as money: 1. Easily standardized—yes they are, cigarettes come is packs.

2. Widely accepted—yes, if they are used in a setting such as WW II prisoners of war.

3. Divisible—yes, packs of cigarettes are divisible to single cigarettes.

4. Easy to carry—yes, cigarettes are lightweight.

5. Must not deteriorate quickly—yes, cigarettes do not deteriorate easily.

Diff: 2 Type: ES Skill: Applied Objective: 3.2 List and summarize the functions of money 39) Economists say that money is a store of value. Since other assets are considered to be better stores of value, why then do people continue to hold money at all?

Answer: People hold money although it is not the best store of value, because of an important economic feature of money, liquidity. Liquidity is a highly desired property of assets. Liquidity measures how easily and fast an asset can be converted into a medium of exchange. Since money is a medium of exchange it is the most liquid asset, and thus, highly desirable although it is not the best store of value.

Diff: 2 Type: ES Skill: Applied Objective: 3.2 List and summarize the functions of money 40) Why are people willing to hold money even if it is not the best store of value?

Answer: The answer to this question relates to the economic concept of liquidity, the relative ease and speed with which an asset can be converted into a medium of exchange. Money is the most liquid asset of all because it is the medium of exchange; it does not have to be converted into anything else to make purchases. Other assets involve transaction costs when they are converted into money.

Diff: 2 Type: ES Skill: Applied Objective: 3.2 List and summarize the functions of money

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3.3 Evolution of the Payments System 1) The payments system is ________.

A) the method of conducting transactions in the economy B) used by union officials to negotiate workers' salaries C) an illegal method of rewarding contracts D) used by your employer to determine salary increases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 2) As the payments system evolves from barter to a monetary system, ________.

A) commodity money is likely to precede the use of paper currency B) transaction costs increase C) the number of prices that need to be calculated increase rather dramatically D) specialization decreases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 3) A disadvantage of ________ is that it can be very heavy and a challenge to move from one place to another.

A) commodity money B) fiat money C) electronic money D) paper money Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 4) Paper currency that has been declared legal tender but is not convertible into a precious metal is known as ________ money.

A) commodity B) fiat C) electronic D) funny Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems

16 .

5) When a paper currency is decreed by governments as legal tender, it must be ________.

A) paper currency backed by gold B) a precious metal such as gold or silver C) accepted as payment for debts D) convertible into an electronic payment Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 6) The evolution of the payments system from barter to precious metals, then to fiat money, then to cheques can best be understood because of the fact that ________.

A) paper is more costly to produce than precious metals B) precious metals were not generally acceptable C) precious metals were difficult to carry and transport D) paper money is less accepted than cheques Answer: C Diff: 2 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 7) A major drawback of paper currency when compared to cheques is that paper currency ________.

A) can get lost or stolen B) is hard to counterfeit C) is not the most liquid of assets D) must be backed by gold Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 8) The introduction of cheques into the payments system resulted in lower transaction costs for both the issuer and the recipient. Another advantage of cheques is that ________.

A) they provide convenient receipts for purchases B) if stolen they can easily be replaced without cost C) they are more widely accepted than currency D) the funds from a deposited cheque are immediately available for use Answer: A Diff: 2 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems

17 .

9) The evolution of the payments system from barter to precious metals, then to fiat money, and finally to cheques can best be understood because of ________.

A) government regulations designed to improve the efficiency of the payments system B) government regulations designed to promote the safety of the payments system C) innovations that lowered transaction costs when making purchases D) more intense competition among firms to attract a larger share of customers Answer: C Diff: 2 Type: MC Skill: Applied Objective: 3.3 Identify different types of payment systems 10) Compared to an electronic payments system, a payments system based on cheques has the major drawback that ________.

A) cheques are less costly to process B) cheques take longer to process, meaning that it may take several days before the depositor can get her cash C) fraud may be more difficult to commit when paper receipts are eliminated D) legal liability is more clearly defined Answer: B Diff: 3 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 11) Which of the following sequences accurately describes the evolution of the payments system?

A) Barter, coins made of precious metals, paper currency, cheques, electronic payments B) Barter, coins made of precious metals, cheques, paper currency, electronic payments C) Barter, cheques, paper currency, coins made of precious metals, electronic payments D) Barter, cheques, paper currency, electronic payments Answer: A Diff: 2 Type: MC Skill: Applied Objective: 3.3 Identify different types of payment systems 12) During the past two decades an important characteristic of the modern payments system has been the rapidly increasing use of ________.

A) cheques and decreasing use of currency B) electronic payments C) commodity monies D) fiat money Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems

18 .

13) Which of the following is not a form of e-money?

A) A debit card B) A credit card C) A stored-value card D) A smart card Answer: B Diff: 1 Type: MC Skill: Applied Objective: 3.3 Identify different types of payment systems 14) E-cash is used for payments ________.

A) that are always secure B) that are very important C) made on the internet D) in any transaction Answer: C Diff: 2 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 15) A smart card is the equivalent of ________.

A) cash B) a savings bonds C) a savings deposits D) a certificate of deposit Answer: A Diff: 1 Type: MC Skill: Applied Objective: 3.3 Identify different types of payment systems 16) An electronic payments system has not completely replaced the paper payments system because of all the following reasons EXCEPT ________.

A) expensive equipment is necessary to set up the system B) security concerns C) privacy concerns D) transportation costs Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems

19 .

17) In explaining the evolution of money, ________.

A) government regulation is the most important factor B) commodity money, because it is valued more highly, tends to drive out paper money C) new forms of money evolve to lower transaction costs D) paper money is always backed by gold and therefore more desirable than cheques Answer: C Diff: 2 Type: MC Skill: Applied Objective: 3.3 Identify different types of payment systems 18) The major drawback of using coins as a means of payment is that they ________.

A) are heavy and hard to transport B) are hard to counterfeit C) are not the most liquid of assets D) must be backed by gold Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 19) ________ money could be used for purposes other than as a medium of exchange, for example, gold coins could be melted down and turned into gold jewellery.

A) Commodity B) Fiat C) Paper D) Electronic Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 20) A feature of cryptocurrencies that make them attractive as a medium of exchange is ________.

A) anonymous transactions B) volatility of value C) heavy regulations by the central bank D) wide acceptance by businesses Answer: A Diff: 2 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems

20 .

21) Bitcoin and other cryptocurrencies fail to satisfy which two of the three functions of money?

A) Unit of account and store of value B) Medium of exchange and unit of account C) Medium of exchange and store of value D) Bitcoin satisfies all of the functions of money Answer: A Diff: 2 Type: MC Skill: Recall Objective: 3.3 Identify different types of payment systems 22) What factors have slowed down the movement to a system where all payments are made electronically?

Answer: The equipment necessary to set up the system is expensive, security of the information, and privacy concerns are issues that need to be addressed before an electronic payments system will be widely accepted.

Diff: 1 Type: ES Skill: Recall Objective: 3.3 Identify different types of payment systems 23) What is a cheque? what are their advantages and disadvantages?

Answer: A cheque is an instrument used to transfer money from your account to someone else's account when she deposits the cheque.

Advantages: Reduces transportation costs associated with the payments system as they frequently cancel each other. Also, they make the transactions for large amounts much easier as they can be written for any amount up to the balance in the account. Finally loss from theft is greatly reduced and they provide convenient receipts for purchases.

Disadvantages: It takes time to get cheques from one place to another, it takes several days for a cheque to be processed from your bank, and the paper work required to process them is costly.

Diff: 1 Type: ES Skill: Recall Objective: 3.3 Identify different types of payment systems 24) Explain the evolution of the payments system. Is the system headed towards a cashless society?

Answer: Societies begin with a barter system and then introduce commodity money which was replaced with paper money. Fiat money, is legal tender, based on the backing of an authority – typically the government. Cheques and electronic payments were the next evolution in the system. A cashless society is unlikely due to several concerns: 1) it is expensive to set up and 2) it raises privacy and security concerns.

Diff: 1 Type: ES Skill: Recall Objective: 3.3 Identify different types of payment systems

21 .

25) What are electronic payments? How do they reduce transaction costs? By how much?

Answer: In the past, when paying bills, you had to mail a cheque but now banks provide a website in which you log on, make a few clicks and make the payment that is transmitted electronically. You can even avoid logging in as recurring bills can be automatically deducted from your bank account. Electronic payments reduce transaction costs as you do not have to pay a stamp to send a cheque and also you save time paying your bills electronically. Estimated cost savings when a bill is paid electronically rather than a cheques exceed one dollar.

Diff: 2 Type: ES Skill: Recall Objective: 3.3 Identify different types of payment systems 3.4 Measuring Money 1) If an individual moves money from a demand deposit account to a money market mutual fund, ________.

A) M1+ decreases and M2 stays the same B) M1+ stays the same and M2+ increases C) M1+ stays the same and M2 stays the same D) M1+ decreases and M2 decreases Answer: D Diff: 3 Type: MC Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 2) If an individual moves money from a chequing account to a money market mutual fund, ________.

A) M1+ decreases and M2+ increases B) M1+ stays the same and M2+ increases C) M1+ decreases and M2+ stays the same D) M1+ increases and M2+ decreases Answer: C Diff: 3 Type: MC Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 3) Defining money becomes ________ difficult as the pace of financial innovation ________.

A) less; quickens B) more; quickens C) more; slows D) more; stops Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

22 .

4) Monetary aggregates are ________.

A) measures of the money supply reported by the Bank of Canada B) measures of the wealth of individuals C) never redefined since "money" never changes D) reported by the Department of Finance annually Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 5) Recent financial innovation makes the Bank of Canada's job of conducting monetary policy ________.

A) easier, since the Bank of Canada now knows what to consider as money B) more difficult, since the Bank of Canada now knows what to consider as money C) easier, since the Bank of Canada no longer knows what to consider as money D) more difficult, since the Bank of Canada no longer knows what to consider as money Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 6) ________ is the narrowest monetary aggregate that the Bank of Canada reports.

A) M1+ B) M2 C) M2+ D) M3 Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 7) The currency component includes paper money and coins held in ________.

A) bank vaults B) ATMs C) the hands of the nonbank public D) the central bank Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

23 .

8) The components of the M1+ monetary aggregate include chequable deposits and________.

A) currency B) currency plus savings deposits C) currency outside banks D) currency plus money market deposits Answer: C Diff: 2 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 9) The M1+ measure of money includes ________.

A) small denomination time deposits B) chequable deposits C) money market deposit accounts D) money market mutual fund shares Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 10) Which of the following is not included in the measure of M2?

A) Personal deposits B) Non-personal demand deposits C) Currency D) Foreign currency deposits Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 11) Which of the following is not included in M1+ but is included in M1++?

A) Currency outside banks B) Currency held by banks C) Chequable deposits at banks, TMLs and CUCPs D) Nonchequable deposits at banks, TMLs and CUCPs Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

24 .

12) Which of the following is not included in the M2 measure of money but is included in the M3 measure of money?

A) Currency B) Personal deposits C) Demand deposits D) Foreign currency deposits Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 13) Which of the following is included in both M1+ and M2?

A) Currency B) Savings deposits C) Small-denomination time deposits D) Money market deposit accounts Answer: A Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 14) Which of the following is not included in the monetary aggregate M2?

A) Currency B) Money market mutual funds C) Personal deposits D) Notice deposits Answer: B Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 15) Which of the following is included in M2+ but not in M2?

A) Personal deposits B) Demand deposits C) Currency D) Money market mutual funds Answer: D Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

25 .

16) If an individual redeems a Canada savings bond in exchange for currency, ________.

A) M1+ stays the same and M2++ decreases B) M1+ increases and M2++ increases C) M1+ increases and M2++ stays the same D) M1+ stays the same and M2++ stays the same Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 17) If an individual redeems a Canada savings bond for currency, ________.

A) M1+ stays the same and M2 decreases B) M1+ increases and M2 increases C) M1+ increases and M2 stays the same D) M1+ stays the same and M2 stays the same Answer: B Diff: 3 Type: MC Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 18) If an individual moves money from a notice deposit at a chartered bank to a deposit account at a credit union, ________.

A) M2 decreases and M2+ stays the same B) M2 decreases and M2+ increases C) M2 increases and M2+ stays the same D) M2 increases and M2+ increases Answer: A Diff: 3 Type: MC Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 19) If an individual deposits currency from his or her pockets to a personal deposit account at his or her chartered bank, ________.

A) M1+ decreases and M2+ stays the same B) M1+ stays the same and M2+ increases C) M1+ stays the same and M2+ stays the same D) M1+ increases and M2+ stays the same Answer: C Diff: 3 Type: MC Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

26 .

20) If an individual moves money from a money market mutual fund to currency, ________.

A) M1+ increases and M2+ stays the same B) M1+ stays the same and M2+ increases C) M1+ stays the same and M2+ stays the same D) M1+ increases and M2+ decreases Answer: A Diff: 2 Type: MC Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 21) The various measures of the money supply as calculated by the Bank of Canada are ________ indices.

A) simple-sum B) complex C) multiplicative D) accurate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 22) Divergent growth rates of monetary aggregates are problematic because ________.

A) it means that monetary aggregates are not very accurate B) it suggests that monetary policy is ineffective C) it means that the effects of monetary policy becomes harder to predict D) it suggests that the choice of monetary aggregate by policy makers does not matter Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 23) In the monetary aggregate index: M = X1 + X2 + ... + Xn, each of the n monetary components have ________.

A) a weight of 1/n B) different weights C) a weight of n D) a weight of 1 Answer: D Diff: 2 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

27 .

24) In the monetary aggregate index : M = X1 + X2 + ... + Xn, the Xs represent ________.

A) the proportional weights for calculating M B) the increasing weights in calculating M C) the n monetary components of M D) the decreasing weights in calculating M Answer: C Diff: 1 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 25) One formula used for calculating the stock of nominal monetary wealth is ________.

A) M = A1X1 + A2X2 + ... + AnXn B) M = C) M = X1 + X2 + +Xn D) M = Answer: C Diff: 3 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 26) Weighting monetary components within a simple-sum aggregate index ________.

A) has never been attempted because it is too complex B) might be attempted with rigorous use of microeconomic theory, aggregation theory, and index number theory C) might not perform as well as the simple-sum index D) might not predict inflation and business cycles better than conventional measures of the money supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 27) Why are most of the U.S. dollars held outside of the United States?

Answer: Concern about high inflation eroding the value of their own currency causes many people in foreign countries to hold U.S. dollars as a hedge against inflation risk.

Diff: 1 Type: ES Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

28 .

28) Data show that Canadian and American citizens hold, on average per person, $2000 CAD and $5000 USD of their currency respectively. Since money is bulky, it can be stolen, pays no interest and in general we do not see our fellow Canadians holding $2000 in their pockets, where are therefore these dollars and who is holding them?

Answer: One group that holds big amounts of currency are the criminals since currency is not traceable as cheques that can be used as evidence against them. Also, some businesses that are evading taxes operate as cash businesses which makes their transactions less traceable, and they can avoid declaring income on which they would have to pay taxes. Finally, one other group that holds Canadian and American (to a larger extent) dollars are foreigners in countries where they do not trust their own currency as they frequently experience high inflation that erodes the value of their currency.

Diff: 2 Type: ES Skill: Recall Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies 29) Explain the relationship between currency and the M1+ monetary aggregate. What does the "plus" sign represent?

Answer: Currency includes paper money and coins in circulation M1+ includes all chequable deposits at chartered banks, trust and mortgage loans companies, credit unions and caisses populaires. The "plus" sign represents TMLS, credit unions and caisses populaires.

Diff: 2 Type: ES Skill: Applied Objective: 3.4 Compare and contrast the M1, M2, and M3 money supplies

29 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 4 The Meaning of Interest Rates 4.1 Measuring Interest Rates 1) 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 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 2) The concept of ________ is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today.

A) present value B) future value C) interest D) deflation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 3) The present value of an expected future payment ________ as the interest rate increases.

A) falls B) rises C) is constant D) is unaffected Answer: A Diff: 1 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

1 .

4) By increasing the length of time to the promised future payment, the present value of the payment ________.

A) decreases B) increases C) has no effect on D) is irrelevant to Answer: A Diff: 1 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 5) With an interest rate of 6 percent, the present value of $100 next year is approximately ________.

A) $106 B) $100 C) $94 D) $92 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 6) Telling a person who has won $20 million in a lottery that her or she is to receive $1 million per year for the next twenty years ignores the process of ________.

A) face value B) par value C) deflation D) discounting the future Answer: D Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 7) A credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a ________.

A) simple loan B) fixed-payment loan C) coupon bond D) discount bond Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 2 .

8) A credit market instrument that requires the borrower to make the same payment every period until the maturity date is known as a ________.

A) simple loan B) fixed-payment loan C) coupon bond D) discount bond Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 9) Which of the following is true of fixed payment loans?

A) The borrower repays both the principal and interest at the maturity date.

B) Installment loans and mortgages are frequently of the fixed payment type.

C) The borrower pays interest periodically and the principal at the maturity date.

D) Commercial loans to businesses are often of this type.

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 10) A fully amortized loan is another name for ________.

A) a simple loan B) a fixed-payment loan C) a commercial loan D) an unsecured loan Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 11) A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a ________.

A) simple loan B) fixed-payment loan C) coupon bond D) discount bond Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 3 .

12) A ________ pays the owner a fixed coupon payment every year until the maturity date, when the ________ value is repaid.

A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 13) The ________ is the final amount that will be paid to the holder of a coupon bond.

A) discount value B) coupon value C) face value D) present value Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 14) When talking about a coupon bond, face value and ________ mean the same thing.

A) par value B) coupon value C) amortized value D) discount value Answer: A Diff: 2 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 15) The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the bond's ________.

A) coupon rate B) maturity rate C) face value rate D) payment rate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

4 .

16) If a $5000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is ________.

A) $650 B) $1300 C) $130 D) $13 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 17) An $8000 coupon bond with a $400 coupon payment every year has a coupon rate of ________.

A) 5 percent B) 8 percent C) 10 percent D) 40 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 18) All of the following are examples of coupon bonds EXCEPT ________.

A) Corporate bonds B) Treasury bills C) Zero coupon bonds D) Government bonds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 19) A bond that is bought at a price below its face value and the face value is repaid at a maturity date is called a ________.

A) simple loan B) fixed-payment loan C) coupon bond D) discount bond Answer: D Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 5 .

20) A ________ is bought at a price below its face value, and the ________ value is repaid at the maturity date.

A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face Answer: D Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 21) A discount bond ________.

A) pays the bondholder a fixed amount every period and the face value at maturity B) pays the bondholder the face value at maturity C) pays all interest and the face value at maturity D) pays the face value at maturity plus any capital gain Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 22) Examples of discount bonds include ________.

A) Treasury bills B) corporate bonds C) coupon bonds D) municipal bonds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 23) Which of the following is true for discount bonds?

A) A discount bond is bought at par.

B) The purchaser receives the face value of the bond at the maturity date.

C) Canada bonds and notes are examples of discount bonds.

D) The purchaser receives the par value at maturity plus any capital gains.

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

6 .

24) The interest rate that equates the present value of payments received from a debt instrument with its value today is the ________.

A) simple interest rate B) current yield C) yield to maturity D) real interest rate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 25) Economists consider the ________ to be the most accurate measure of interest rates.

A) simple interest rate B) current yield C) yield to maturity D) real interest rate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 26) For simple loans, the simple interest rate is ________ the yield to maturity.

A) greater than B) less than C) equal to D) not comparable to Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 27) If the amount payable in two years is $2420 for a simple loan at 10 percent interest, the loan amount is ________.

A) $1000 B) $1210 C) $2000 D) $2200 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

7 .

28) For a 3-year simple loan of $10000 at 10 percent, the amount to be repaid is ________.

A) $10030 B) $10300 C) $13000 D) $13310 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 29) If $22050 is the amount payable in two years for a $20000 simple loan made today, the interest rate is ________.

A) 5 percent B) 10 percent C) 22 percent D) 25 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 30) 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 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 31) The present value of a fixed-payment loan is calculated as the ________ of the present value of all cash flow payments.

A) sum B) difference C) multiple D) log Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 8 .

32) Which of the following is true for a coupon bond?

A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.

B) The price of a coupon bond and the yield to maturity are positively related.

C) The yield to maturity is greater than the coupon rate when the bond price is above the par value.

D) The yield is less than the coupon rate when the bond price is below the par value.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 33) The price of a coupon bond and the yield to maturity are ________ related; that is, as the yield to maturity ________, the price of the bond ________.

A) positively; rises; rises B) negatively; falls; falls C) positively; rises; falls D) negatively; rises; falls Answer: D Diff: 3 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 34) The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value.

A) greater; coupon; above B) greater; coupon; below C) greater; perpetuity; above D) less; perpetuity; below Answer: B Diff: 3 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 35) A $10000 8 percent coupon bond that sells for $10000 has a yield to maturity of ________.

A) 8 percent B) 10 percent C) 12 percent D) 14 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 9 .

36) Which of the following $1000 face-value securities has the highest yield to maturity?

A) A 5 percent coupon bond selling for $1000 B) A 10 percent coupon bond selling for $1000 C) A 12 percent coupon bond selling for $1000 D) A 12 percent coupon bond selling for $1100 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 37) Which of the following $5000 face-value securities has the highest yield-to maturity?

A) A 6 percent coupon bond selling for $5000 B) A 6 percent coupon bond selling for $5500 C) A 10 percent coupon bond selling for $5000 D) A 12 percent coupon bond selling for $4500 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 38) Which of the following $1000 face-value securities has the highest yield to maturity?

A) A 5 percent coupon bond with a price of $600 B) A 5 percent coupon bond with a price of $800 C) A 5 percent coupon bond with a price of $1000 D) A 5 percent coupon bond with a price of $1200 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 39) Which of the following $1000 face-value securities has the lowest yield to maturity?

A) A 5 percent coupon bond selling for $1000 B) A 10 percent coupon bond selling for $1000 C) A 15 percent coupon bond selling for $1000 D) A 15 percent coupon bond selling for $900 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

10 .

40) Which of the following bonds would you prefer to be buying?

A) A $10000 face-value security with a 10 percent coupon selling for $9000 B) A $10000 face-value security with a 7 percent coupon selling for $10000 C) A $10000 face-value security with a 9 percent coupon selling for $10000 D) A $10000 face-value security with a 10 percent coupon selling for $10000 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 41) A coupon bond that has no maturity date and no repayment of principal is called a ________.

A) consol B) cabinet C) Treasury bill D) government note Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 42) The price of a consol equals the coupon payment ________.

A) times the interest rate B) plus the interest rate C) minus the interest rate D) divided by the interest rate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 43) The interest rate on a consol equals the ________.

A) price times the coupon payment B) price divided by the coupon payment C) coupon payment plus the price D) coupon payment divided by the price Answer: D Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

11 .

44) A consol paying $20 annually when the interest rate is 5 percent has a price of ________.

A) $100 B) $200 C) $400 D) $800 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 45) If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is ________.

A) 2.5 percent B) 5 percent C) 7.5 percent D) 10 percent Answer: B Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 46) The yield to maturity for a perpetuity is a useful approximation for the yield to maturity on long-term coupon bonds. It is called the ________ when approximating the yield for a coupon bond.

A) current yield B) discount yield C) future yield D) star yield Answer: A Diff: 2 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 47) The yield to maturity for a one-year discount bond equals the increase in price over the year, divided by the ________.

A) initial price B) face value C) interest rate D) coupon rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 12 .

48) If a $10000 face-value discount bond maturing in one year is selling for $5000, then its yield to maturity is ________.

A) 5 percent B) 10 percent C) 50 percent D) 100 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 49) If a $5000 face-value discount bond maturing in one year is selling for $5000, then its yield to maturity is ________.

A) 0 percent B) 5 percent C) 10 percent D) 20 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 50) A discount bond selling for $15000 with a face value of $20000 in one year has a yield to maturity of ________.

A) 3 percent B) 20 percent C) 25 percent D) 33.3 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 51) The yield to maturity for a discount bond is ________ related to the current bond price.

A) negatively B) positively C) not D) directly Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 13 .

52) In Japan in 1998 and in the U.S. in 2008, interest rates were negative for a short period of time because investors found it convenient to hold six-month bills as a store of value because ________.

A) of the high inflation rate B) these bills sold at a discount from face value C) the bills were denominated in small amounts and could be stored electronically D) the bills were denominated in large amounts and could be stored electronically Answer: D Diff: 3 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 53) Negative yields to maturity imply that bond purchasers are better off to hold cash.

Acceptance of slightly negative yields by purchasers in recent times suggest that the ________.

A) convenience of storing large sums is also important to decisions B) inflation rate is positive C) governments have issued too many bonds D) decision makers are only concerned with yields Answer: A Diff: 3 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 54) If the interest rate is 10 percent and you borrow a $2000, 2-year fixed payments car loan with two annual payments, your loan payment each year is ________.

A) $1045.30 B) $1476.25 C) $1152.40 D) $1000.00 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

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55) The yield to maturity on a 10-year treasury note (with face value = $100 and annual coupon rate = 2.625 percent) is 3.37 percent. The market price of this bond must be ________ $100.

A) less than B) greater than C) equal to D) close to Answer: A Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 56) Last year you purchased a bond with an interest rate of 5 percent. If the interest rate on the bond market drops to 4 percent, which of the followings are correct?

I. The interest rate you are earning from this bond is lower.

II. The face value of your bond is lower.

III. You will receive the same amount of coupon payments from the issuer while you are holding the bond.

IV. People can offer a lower price to buy your bond today.

V. You can sell your bond at today's market for a higher price.

A) III and V B) I and III C) III and IV D) II, III, and IV E) V only Answer: A Diff: 2 Type: MC Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

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57) The yield to maturity on a 10-year coupon bond with face value = $1,000 and annual coupon rate = 3.25 percent is 2.42 percent. This implies: I. the price of this bond is $1,000.

II. the price of this bond is greater than $1,000.

III. the price of this bond is less than $1,000.

IV. the buyer of this bond will receive $32.5 from the bond issuer every year before maturity while holding the bond.

A) II only B) I and IV C) III and IV D) II and IV E) III only Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 58) The yield to maturity on a 10-year coupon bond, with face value = $1,000 and annual coupon rate = 3.25 percent, is 5.30 percent. This implies: I. the price of this bond is $1,000.

II. the price of this bond is greater than $1,000.

III. the price of this bond is less than $1,000.

IV. the buyer of the bond will receive $24.2 payment from the bond issuer every year before maturity while holding the bond.

V. the buyer of the bond will receive $32.5 payment from the bond issuer every year before maturity while holding the bond.

A) I and IV. B) II and IV. C) II and V. D) III and IV. E) III and V. Answer: E Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

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59) The yield to maturity on a 10-year treasury note (with face value = $100 and annual coupon rate = 2.625 percent) is 3.37 percent. If the price of this treasury note goes up, its: I. coupon rate drops below 2.625 percent.

II. coupon rate rises above 2.625 percent.

III. yield to maturity drops below 3.37 percent.

IV. yield to maturity above 3.37 percent.

A) III. B) I. C) IV. D) II and IV. E) I and III. Answer: A Diff: 3 Type: MC Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 60) If the interest rate is 5 percent, what is the present value of a security that pays you $1050 next year and $1102.50 two years from now? If this security sold for $2200, is the yield to maturity greater or less than 5 percent? Why? Answer: PV = $1050/(1 + .05) + $1102.50/(1 + 0.05)2 PV = $2000 If this security sold for $2200, the yield to maturity is less than 5 percent. The lower the interest rate the higher the present value.

Diff: 3 Type: ES Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 61) A relative has just won a state lottery paying $20 million in installments of $1 million per year for twenty years. Your relative states that she is $20 million richer. Is she correct? Create a simple example for two years to illustrate your position.

Answer: The relative is incorrect. The discounted present value of the payments is less than $20 million. The example should demonstrate that the discounted value of the payment due in one year is less than $1 million.

Diff: 3 Type: ES Skill: Applied Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

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62) What is a coupon bond? Describe its basic properties.

Answer: A coupon bonds pays the owner a fixed interest payment every year until the maturity date when a specified amount called the face value is repaid. A coupon bond is identified by three pieces of information: a. the corporation or government agency that issues the bond, b. the maturity date of the bond, and c. the bond's coupon rate, the dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond.

Diff: 2 Type: ES Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 63) Explain why the current bond prices and interest rates are negatively related.

Answer: There are two ways to show why current bond prices and interest rates are negatively related: a. From the bond price formula: we can see that as the interest rate (yield to maturity) rises, all denominators in the bond price formula must necessarily rise. Hence, a rise in the interest rates as measured by the yield to maturity means that the price of the bond must fall. b. An increase in the interest rate means that all the future coupon payments and final payment will be worth less when discounted to the present, thus, the price of the bond must fall.

Diff: 2 Type: ES Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments 64) How is current yield defined? How can it be used to determine yield to maturity for longterm bonds?

Answer: The current yield is the is the yield to maturity of a perpetuity or consol. It is given by the formula: ic = , where C is the yearly payment and P is the price of the perpetuity. When a coupon bond has a long term to maturity, it is very much like a perpetuity. The current yield will be very close to the yield to maturity for a long term bond and is used as an approximation to describe interest rates on long term bonds.

Diff: 3 Type: ES Skill: Recall Objective: 4.1 Calculate the present value of future cash flows and the yield to maturity of the four different types of credit market instruments

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4.2 The Distinction Between Interest Rates and Returns 1) The ________ is defined as the payments to the owner plus the change in a security's value expressed as a fraction of the security's purchase price.

A) yield to maturity B) current yield C) rate of return D) yield rate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 2) Which of the following is true concerning the distinction between interest rates and returns?

A) The rate of return on a bond will not necessarily equal the interest rate on that bond.

B) The return can be expressed as the difference between the current yield and the rate of capital gains.

C) The rate of return will be greater than the interest rate when the price of the bond falls between time t and time t + 1.

D) The return can be expressed as the sum of the discount yield and the rate of capital gains.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 3) The sum of the current yield and the rate of capital gain is called the ________.

A) rate of return B) discount yield C) perpetuity yield D) par value Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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4) What is the return on a 5 percent coupon bond that initially sells for $1000 and sells for $1200 next year?

A) 5 percent B) 10 percent C) -5 percent D) 25 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 5) What is the return on a 5 percent coupon bond that initially sells for $1000 and sells for $900 next year?

A) 5 percent B) 10 percent C) -5 percent D) -10 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 6) The return on a 5 percent coupon bond that initially sells for $1000 and sells for $950 next year is ________.

A) -10 percent B) -5 percent C) 0 percent D) 5 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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7) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding?

A) 5 percent B) 10 percent C) 15 percent D) 20 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 8) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding?

A) A bond with one year to maturity B) A bond with five years to maturity C) A bond with ten years to maturity D) A bond with twenty years to maturity Answer: A Diff: 1 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 9) An equal decrease in all bond interest rates ________.

A) increases the price of a five-year bond more than the price of a ten-year bond B) increases the price of a ten-year bond more than the price of a five-year bond C) decreases the price of a five-year bond more than the price of a ten-year bond D) decreases the price of a ten-year bond more than the price of a five-year bond Answer: B Diff: 2 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 10) An equal increase in all bond interest rates ________.

A) increases the return to all bond maturities by an equal amount B) decreases the return to all bond maturities by an equal amount C) has no effect on the returns to bonds D) decreases long-term bond returns more than short-term bond returns Answer: D Diff: 2 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 21 .

11) Which of the following is generally true of bonds?

A) The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period.

B) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on bonds whose terms to maturity are longer than the holding periods.

C) The longer a bond's maturity, the smaller is the size of the price change associated with an interest rate change.

D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 12) Which of the following is generally true of all bonds?

A) The longer a bond's maturity, the greater is the rate of return that occurs as a result of the increase in the interest rate.

B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise.

C) Prices and returns for short-term bonds are more volatile than those for longer term bonds.

D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer than the holding period.

Answer: B Diff: 3 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 13) Prices and returns for ________ bonds are more volatile than those for ________ bonds.

A) long-term; long-term B) long-term; short-term C) short-term; long-term D) short-term; short-term Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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14) The riskiness of an asset's returns due to changes in interest rates is ________.

A) exchange-rate risk B) price risk C) asset risk D) interest-rate risk Answer: D Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 15) Interest-rate risk is the riskiness of an asset's returns due to ________.

A) interest-rate changes B) changes in the coupon rate C) default of the borrower D) changes in the asset's maturity Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 16) Bonds whose term-to-maturity is longer than the holding period are subject to ________.

A) interest rate risk B) exchange-rate risk C) inflation D) deflation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 17) There is ________ for any bond whose time to maturity matches the holding period.

A) no interest-rate risk B) a large interest-rate risk C) rate-of-return risk D) yield-to-maturity risk Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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18) A two-year bond with $1,000 face-value and 10 percent coupon rate is sold for $1,000 today.

If one year later the market interest rate increases to 15 percent, this bond will have a market price of ________ .

A) $1043.48 B) $1047.62 C) $869.57 D) $918.71 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 19) A two-year bond with $1,000 face-value and 10 percent coupon rate is sold for $1,000 today.

If one year later the market interest rate decreases to 5 percent, this bond will have a market price of ________.

A) $1043.48 B) $956.52 C) $952.38 D) $1092.97 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 20) James buys a two-year bond with $1,000 face-value and 10 percent coupon rate for $1,000 today. If one year later the market interest rate increases to 15 percent and Adam sells the bond, his rate of return on this investment is ________ percent.

A) -4.3 B) 0 C) 4.3 D) 1.9 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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21) A three-year bond with $1,000 face-value and 10 percent coupon rate is sold for $1,000 today. If one year later the market interest rate increases to 15 percent, then this bond will have a market price of ________ next year.

A) $1092.97 B) $1047.62 C) $956.52 D) $918.71 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 22) A three-year bond with $1,000 face-value and 10 percent coupon rate is sold for $1,000 today. If one year later the market interest rate decreases to 5 percent, then this bond will have a market price of ________ next year.

A) $1136.16 B) $1047.62 C) $956.52 D) $918.71 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 23) James buys a three-year bond with $1,000 face-value and 10 percent coupon rate for $1,000 today. If one year later the market interest rate increases to 15 percent and James sells the bond, then his rate of return on this investment is ________ percent (negative if it is a loss).

A) 1.9 B) -8.1 C) -1.42 D) 4.3 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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24) Last year you purchased a bond with an interest rate of 5 percent. Now the interest rates on the bond markets drop. Then ________.

A) the face value of your bond is higher B) your return on this bond will be higher later when you hold it to the maturity date C) the interest rate you are earning from this bond is lower D) people can offer a lower price to buy your bond today E) you can sell your bond at today's market for a higher price Answer: E Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 25) Last year you purchased a bond with an interest rate of 5 percent. Now the interest rate on the bond market drops to 4 percent. Then ________.

A) you will receive the same amount of coupon payments from the issuer while you are holding the bond B) your return on this bond will be higher later when you hold it to the maturity date C) people can offer a lower price to buy your bond today D) the interest rate you are earning from this bond is lower E) the face value of your bond is lower Answer: A Diff: 2 Type: MC Skill: Recall Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 26) The yield to maturity on a 10-year coupon bond (with face value = $1,000 and annual coupon rate = 3.25 percent) is 2.42 percent. This implies: I. the price of this bond is $1,000.

II. the price of this bond is greater than $1,000.

III. the price of this bond is less than $1,000.

IV. the buyer of the bond will have a return of 2.42 percent if she sells the bond next year.

V. the buyer of the bond will have a return of 3.25 percent if she sells the bond next year.

A) I and IV B) II and IV C) II and V D) III and IV E) II only Answer: E Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

26 .

27) The yield to maturity on a 10-year coupon bond (with face value = $1,000 and annual coupon rate = 3.25 percent) is 2.42 percent. This implies: I. the bond is traded on the market for $1,000.

II. the buyer's return for holding the bond for 10 years will be 3.25 percent.

III. the buyer's return for holding the bond for 10 years will be 2.42 percent.

IV. the buyer of the bond will have a return of 2.42 percent if she sells the bond next year.

V. the buyer of the bond will have a return of 3.25 percent if she sells the bond next year.

A) I and IV B) II and IV C) II only D) III and IV E) III only Answer: C Diff: 3 Type: MC Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 28) Your favorite uncle advises you to purchase long-term bonds because their interest rate is 10 percent. Should you follow his advice?

Answer: It depends on where you think interest rates are headed in the future. If you think interest rates will be going up, you should not follow your uncle's advice because you would then have to discount your bond if you needed to sell it before the maturity date. Long-term bonds have a greater interest-rate risk.

Diff: 2 Type: ES Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain 29) Your friend tells you that she bought a 10-year to maturity discount bond that she plans to hold until maturity in order to finance her daughter's university education. She also tells you that she is worried that due to interest-rate-risk she may suffer significant capital losses if interest rates increase. Are her fears justified?

Answer: No, her fear of significant capital losses from future increases in the interest rates for bonds are not justified as she is planning to hold the 10-year bond until maturity when she is guaranteed to receive the face value of the bond back. There is no interest-rate-risk associated with this investment as the time to maturity matches the holding period and any increase in interest rates can have no effect on the price at the end of the holding period.

Diff: 2 Type: ES Skill: Applied Objective: 4.2 Recognize the distinctions among yield to maturity, current yield, rate of return, and rate of capital gain

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4.3 The Distinction Between Real and Nominal Interest Rates 1) The ________ interest rate is adjusted for expected changes in the price level.

A) ex ante real B) ex post real C) ex post nominal D) ex ante nominal Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 2) The ________ interest rate more accurately reflects the true cost of borrowing.

A) nominal B) real C) discount D) market Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 3) The nominal interest rate minus the expected rate of inflation ________.

A) defines the real interest rate B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate D) defines the discount rate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 4) In a country where prices never change, the nominal interest rate is equal to the ________.

A) real exchange rate B) inflation rate C) expected inflation rate D) real interest rate Answer: D Diff: 1 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates

28 .

5) The ________ states that the real interest rate equals the nominal interest rate minus the expected rate of inflation.

A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 6) The Fisher equation states that ________.

A) the real interest rate equals the nominal interest rate plus the expected rate of inflation B) the real interest rate equals the nominal interest rate less the expected rate of inflation C) the nominal interest rate equals the real interest rate less the expected rate of inflation D) the nominal interest rate equals the real interest rate plus the expected rate of inflation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 7) The nominal interest rate minus the expected rate of inflation ________.

A) defines the real rate of inflation B) is a worse measure of the incentives to borrow and lend than is the nominal interest rate C) is a more accurate indicator of the tightness of credit market conditions than is the nominal interest rate D) defines the bank rate Answer: C Diff: 3 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 8) The nominal interest rate minus the expected rate of inflation ________.

A) defines the real interest rate B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate D) defines the bank rate Answer: A Diff: 3 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates

29 .

9) The interest rate that describes how well a lender has done in real terms after the fact is called the ________.

A) ex post real interest rate B) ex ante real interest rate C) ex post nominal interest rate D) ex ante nominal interest rate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 10) The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation.

A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 11) If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the real rate of interest is ________.

A) 2 percent B) 8 percent C) 10 percent D) 12 percent Answer: D Diff: 1 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 12) In which of the following situations would you prefer to be the lender?

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 13 percent and the expected inflation rate is 15 percent.

D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

Answer: B Diff: 3 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates

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13) In which of the following situations would you prefer to be the 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 13 percent and the expected inflation rate is 15 percent.

D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

Answer: D Diff: 3 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 14) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________.

A) 7 percent B) 22 percent C) -15 percent D) -8 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 15) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________.

A) -5 percent B) -2 percent C) 2 percent D) 12 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 16) When the ________ interest rate is low, there are greater incentives to ________ and fewer incentives to ________.

A) nominal; lend; borrow B) real; lend; borrow C) real; borrow; lend D) market; lend; borrow Answer: C Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates

31 .

17) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________.

A) -3 percent B) -2 percent C) 3 percent D) 7 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 18) The interest rate on Real Return Bonds is a direct measure of ________.

A) the real interest rate B) the nominal interest rate C) the rate of inflation D) the rate of deflation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 19) Assuming the same coupon rate and maturity length, the difference between the yield on a Real Return Bond and the yield on a Canada bond provides insight into ________.

A) the nominal interest rate B) the real interest rate C) the nominal exchange rate D) the expected inflation rate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 20) Assuming the same coupon rate and maturity length, when the interest rate on a Real Return Bond is 3 percent, and the yield on a nonindexed Canada bond is 8 percent, the expected rate of inflation is ________.

A) 3 percent B) 5 percent C) 8 percent D) 11 percent Answer: B Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates

32 .

21) Comparing the interest rate of a Canada bond to the interest rate of a Real Return Bond provides insight on ________.

A) the expected rate of inflation B) the real interest rate C) the current yield D) the discounted yield Answer: A Diff: 1 Type: MC Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 22) If the interest rate on a Real Return Bond is 2 percent and the interest rate on a Canada bond of similar maturity is 5 percent then the expected rate of inflation is equal to ________.

A) -3 percent B) 7 percent C) 3 percent D) 2 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 23) If the interest rate on a Real Return Bond is 5 percent and the interest rate on a Canada bond of similar maturity is 2 percent then the expected rate of inflation is equal to ________.

A) -3 percent B) 7 percent C) 3 percent D) 2 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 24) If the interest rate on a Real Return Bond is 2 percent and the interest rate on a Canada bond of similar maturity is 5 percent then ________ is equal to 3 percent.

A) the expected rate of inflation B) the yield to maturity C) current yield D) expected interest rate Answer: A Diff: 2 Type: MC Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates

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25) Would it make sense to buy a house when mortgage rates are 14 percent and expected inflation is 15 percent? Explain your answer.

Answer: Even though the nominal rate for the mortgage appears high, the real cost of borrowing the funds is -1 percent. Yes, under this circumstance it would be reasonable to make this purchase.

Diff: 2 Type: ES Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates 26) Explain the Fisher equation. Construct a numerical example demonstrating that, depending on the expected rate of inflation, a lower nominal rate may still reflect a higher real cost of borrowing. Explain your example thoroughly.

Answer: The answer should list the equation that the nominal rate equals the real rate plus the expected rate of inflation, or an equivalent variant. The terms should be clearly defined. The example should have a higher real rate for the lower nominal rate due to relatively lower expected inflation. The example and the resultant impact on real borrowing costs should be thoroughly explained.

Diff: 2 Type: ES Skill: Recall Objective: 4.3 Interpret the distinction between real and nominal interest rates 27) A friend tells you that he can purchase a 10 percent coupon bond at face value. Your friend states that 10 percent is a "high" rate of interest. You know that the current rate of inflation is 8 percent, and you expect inflation to increase. What advice should you give to your friend about this bond?

Answer: The high nominal rate is reduced to a much lower real rate due to inflation. Interestrate risk should be a concern. An increase in expected inflation will increase nominal rates due to the Fisher effect. This will result in a capital loss, and the higher nominal rate reduces the real value of the 10 percent coupon rate.

Diff: 2 Type: ES Skill: Applied Objective: 4.3 Interpret the distinction between real and nominal interest rates

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 5 The Behaviour of Interest Rates 5.1 Determinants of Asset Demand 1) When a piece of property serves as a store of value it is known as ________.

A) an asset B) a unit of account C) a liability D) borrowing Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.1 Identify the factors that affect the demand for assets 2) Of the four factors that influence asset demand, which factor will cause the demand for all types of assets to increase, everything else held constant?

A) Wealth B) Expected returns C) Risk D) Liquidity Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.1 Identify the factors that affect the demand for assets 3) Everything else held constant, a decrease in wealth ________.

A) increases the demand for stocks B) increases the demand for bonds C) reduces the demand for silver D) increases the demand for gold Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 4) An increase in an asset's expected return compared to that of an alternative asset, holding everything else constant, ________ the quantity demanded for the first asset.

A) increases B) decreases C) has no effect on D) erases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.1 Identify the factors that affect the demand for assets 1 .

5) Everything else held constant, if the expected return of ABC's stock price rises from 5 to 10 percent and the expected return of CBS's stock price remains unchanged, then the expected return of holding CBS's stock ________ relative to ABC's stock and the demand for CBS stock ________.

A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: D Diff: 2 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 6) Everything else held constant, if the expected return of bonds fall from 10 to 5 percent and the expected return of GE's stock price rises from 7 to 8 percent, then the expected return of holding GE stock ________ compared to bonds and the demand for GE stock ________.

A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: A Diff: 2 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 7) If housing prices are expected to increase, then, other things equal, the demand for houses will ________ while the demand for Treasury bills will ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 8) If stock prices are expected to drop dramatically, then, other things equal, the demand for stocks will ________ while the demand for Treasury bills will ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 2 .

9) Everything else held constant, if the expected return of RST's stock price declines from 12 to 9 percent and the expected return of XYZ stock prices declines from 8 to 7 percent, then the expected return of holding RST stock ________ relative to XYZ stock and demand for XYZ stock ________.

A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: C Diff: 2 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 10) Everything else held constant, if the expected return on government bonds falls from 8 to 7 percent and the expected return on corporate bonds falls from 10 to 8 percent, then the expected return of corporate bonds ________ compared to government bonds and the demand for corporate bonds ________.

A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: D Diff: 2 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 11) An increase in the expected rate of inflation will ________ the expected return on bonds relative to the that on ________ assets, everything else held constant.

A) reduce; financial B) reduce; real C) raise; financial D) raise; real Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 12) If fluctuations in interest rates become less volatile, then, other things equal, the demand for stocks will ________ and the demand for long-term bonds will ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 3 .

13) If the price of gold becomes less volatile, then, other things equal, the demand for stocks will ________ and the demand for gold will ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 14) If brokerage commissions for selling bonds decrease, then, other things equal, the demand for bonds will ________ and the demand for real estate will ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 15) If gold becomes acceptable as a medium of exchange, the demand for gold will ________ and the demand for bonds will ________, everything else held constant.

A) decrease; decrease B) decrease; increase C) increase; increase D) increase; decrease Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 16) The demand for silver decreases, other things equal, when ________.

A) the gold market is expected to boom B) the market for silver becomes more liquid C) wealth grows rapidly D) interest rates are expected to rise Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets

4 .

17) You would be less likely to purchase bonds, other things equal, if ________.

A) you inherit $1 million from your Uncle Harry B) you expect interest rates to fall C) gold becomes more liquid D) stock prices are expected to fall Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 18) The demand for gold increases, other things equal, when ________.

A) the market for silver becomes more liquid in the future B) interest rates are expected to rise in the future C) interest rates are expected to fall in the future D) real estate prices are expected to increase in the future Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets 19) Holding all other factors constant, the quantity demanded of an asset is ________.

A) positively related to wealth B) negatively related to its expected return relative to alternative assets C) positively related to the risk of its returns relative to alternative assets D) negatively related to its liquidity relative to alternative assets Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.1 Identify the factors that affect the demand for assets 20) Everything else held constant, would an increase in volatility of stock prices have any impact on the demand for rare coins? Why or why not?

Answer: Yes, it would cause the demand for rare coins to increase. The increased volatility of stock prices means that there is relatively more risk in owning stock than there was previously and so the demand for an alternative asset, rare coins, would increase.

Diff: 2 Type: ES Skill: Applied Objective: 5.1 Identify the factors that affect the demand for assets

5 .

5.2 Supply and Demand in the Bond Market 1) In the bond market, the bond demanders are the ________ and the bond suppliers are the ________.

A) lenders; borrowers B) lenders; advancers C) borrowers; lenders D) borrowers; advancers Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 2) The demand curve for bonds has the usual downward slope, indicating that at ________ prices of the bond, everything else equal, the ________ is higher.

A) higher; demand B) higher; quantity demanded C) lower; demand D) lower; quantity demanded Answer: D Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 3) The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases.

A) falls; supply B) falls; quantity supplied C) rises; supply D) rises; quantity supplied Answer: D Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate

6 .

4) The market equilibrium in the bond market shows the market-clearing ________ and marketclearing ________.

A) price; deposit B) interest rate; deposit C) price; interest rate D) interest rate; premium Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 5) When the price of a bond is above its equilibrium price, there is an excess ________ bonds and its price will ________.

A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 6) When the price of a bond is ________ its equilibrium price, there is an excess demand for bonds and its price will ________.

A) above; rise B) above; fall C) below; fall D) below; rise Answer: D Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 7) When the interest rate of a bond is above its equilibrium interest rate, then in the bond market there is an excess ________ and the interest rate will ________.

A) demand; rise B) demand; fall C) supply; fall D) supply; rise Answer: B Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 7 .

8) When the interest rate of a bond is ________ the equilibrium interest rate, then in the bond market there is an excess ________ and the interest rate will ________.

A) above; demand; rise B) above; demand; fall C) below; supply; fall D) above; supply; rise Answer: B Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 9) If the price of bonds is set ________ their equilibrium price, this leads to a bond market that is characterized by excess ________.

A) above; demand B) above; supply C) below; demand D) below; supply Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 10) A situation in which the quantity of bonds supplied exceeds the quantity of bonds demanded is called a condition of excess supply; because borrowers want to sell ________ bonds than lender-savers want to buy, the price of bonds will ________.

A) fewer; fall B) fewer; rise C) more; fall D) more; rise Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate

8 .

11) The equilibrium price and corresponding equilibrium interest rate in the bond market are found where A) the bond demand curve and the bond supply curve intersect.

B) the bond demand is at its peak.

C) the bond supply is at its peak.

D) cannot be determined looking at the bond demand and bond supply curves.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.2 Draw the demand and supply curves for the bond market, and identify the equilibrium interest rate 5.3 Changes in Equilibrium Interest Rates 1) A movement along the bond demand or supply curve occurs when ________ changes.

A) bond price B) income C) wealth D) expected return Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 2) When the price of a bond decreases, all else equal, the bond demand curve ________.

A) shifts right B) shifts left C) does not shift D) inverts Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 3) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant.

A) falls; right B) falls; left C) rises; right D) rises; left Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 9 .

4) Everything else held constant, when households save less, wealth and the demand for bonds ________ and the bond demand curve shifts ________.

A) increase; right B) increase; left C) decrease; right D) decrease; left Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 5)

In the figure above, a factor that could cause the demand for bonds to decrease (shift to the left) is ________.

A) an increase in the expected return on bonds relative to other assets B) a decrease in the expected return on bonds relative to other assets C) an increase in wealth D) a reduction in the riskiness of bonds relative to other assets Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

10 .

6) Everything else held constant, an increase in expected inflation, lowers the expected return on ________ compared to ________ assets.

A) bonds; financial B) bonds; real C) physical; financial D) physical; real Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 7) Everything else held constant, an increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to ________ and the demand curve to shift to the ________.

A) rise; right B) rise; left C) fall; right D) fall; left Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 8) Everything else held constant, when stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________.

A) right; rises B) right; falls C) left; falls D) left; rises Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 9) Everything else held constant, an increase in the liquidity of bonds results in a ________ in demand for bonds and the demand curve shifts to the ________.

A) rise; right B) rise; left C) fall; right D) fall; left Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 11 .

10) Everything else held constant, when bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.

A) right; rises B) right; falls C) left; falls D) left; rises Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 11) During a recession, the supply of bonds ________ and the supply curve shifts to the ________, everything else held constant.

A) increases; left B) increases; right C) decreases; left D) decreases; right Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 12) In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to the ________ as business investments are expected to be more profitable.

A) supply; supply; right B) supply; supply; left C) demand; demand; right D) demand; demand; left Answer: A Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

12 .

13) When the inflation rate is expected to increase, the ________ for bonds falls, while the ________ curve shifts to the right, everything else held constant.

A) demand; demand B) demand; supply C) supply; demand D) supply; supply Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 14) Everything else held constant, during a business cycle expansion, the supply of bonds shifts to the ________ as businesses perceive more profitable investment opportunities, while the demand for bonds shifts to the ________ as a result of the increase in wealth generated by the economic expansion.

A) right; left B) right; right C) left; left D) left; right Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 15) When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant.

A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

13 .

16) When the government has a surplus, as occurred in the late 1990s, the ________ curve of bonds shifts to the ________, everything else held constant.

A) supply; right B) supply; left C) demand; right D) demand; left Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

17) In the figure above, a factor that could cause the supply of bonds to shift to the right is ________.

A) a decrease in government budget deficits B) a decrease in expected inflation C) a recession D) a business cycle expansion Answer: D Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

14 .

18) In the figure above, the price of bonds would fall from P1 to P2 if ________.

A) inflation is expected to increase in the future B) interest rates are expected to fall in the future C) the expected return on bonds relative to other assets is expected to increase in the future D) the riskiness of bonds falls relative to other assets Answer: A Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

19) In the figure above, a factor that could cause the supply of bonds to increase (shift to the right) is ________.

A) a decrease in government budget deficits B) a decrease in expected inflation C) expectations of more profitable investment opportunities D) a business cycle recession Answer: C Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

15 .

20) In the figure above, a factor that could cause the demand for bonds to shift to the right is ________.

A) an increase in the riskiness of bonds relative to other assets B) an increase in the expected rate of inflation C) expectations of lower interest rates in the future D) a decrease in wealth Answer: C Diff: 2 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 21) In the figure above, the price of bonds would fall from P2 to P1 if ________.

A) there is a business cycle recession B) there is a business cycle expansion C) inflation is expected to increase in the future D) inflation is expected to decrease in the future Answer: B Diff: 3 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 22) A decrease in the brokerage commissions in the housing market from 6 percent to 5 percent of the sales price will shift the ________ curve for bonds to the ________, everything else held constant.

A) demand; right B) demand; left C) supply; right D) supply; left Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 23) In the 1990s Japan had the lowest interest rates in the world due to a combination of ________.

A) inflation and recession B) deflation and expansion C) inflation and expansion D) deflation and recession Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 16 .

24) Holding everything else constant, if the price of a Bitcoin becomes less volatile, the demand for bonds ________, the price of bonds ________, and the interest rate ________.

A) falls; falls; rises B) falls; falls; falls C) rises; rises; rises D) rises; falls; rises Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 25) When inflation is expected to increase in the future, at the current market interest rate, the real interest rate ________. Therefore, bond demand ________ , bond supply ________, and the equilibrium interest rate ________.

A) decreases; decreases; increases; rises B) decreases; increases; increases; rises C) decreases; increases; decreases; falls D) decreases; increases; decreases; rises E) decreases; decreases; increases; falls Answer: A Diff: 3 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 26) Everything else held constant, during the economic expansion, the bond demand curve shifts to the ________ and the bond supply curve shifts to the ________. If the supply curve shifts more than the demand curve, then the equilibrium interest rate ________.

A) right; left; falls B) right; right; falls C) right; right, rises D) left; right; rises Answer: C Diff: 2 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

17 .

27) During periods of economic expansions, usually bond suppliers ________ their supply of bonds ________ than bond demanders ________ their demand for bonds.

A) increase; less; increase B) increase; more; increase C) decrease; more; increase D) decrease; less; decrease E) decrease; more; decrease Answer: B Diff: 2 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 28) If the brokerage commission in the housing market decreases from 6% to 5% of the sales price, then, other things equal, the ________ for houses ________ and the ________ for bonds ________.

A) demand; increases; demand; decreases B) demand; decreases; demand; increases C) supply; decreases; supply; increases D) supply; increases; demand; increases E) demand; increases; demand; increases Answer: A Diff: 3 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 29) Holding everything else constant, if the price of a Bitcoin becomes less volatile, the demand for bonds ________, the price of bonds ________, and the interest rate ________.

A) falls; falls; rises B) falls; falls; falls C) rises; rises; rises D) rises; falls; rises Answer: A Diff: 2 Type: MC Skill: Recall Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 30) What is the impact on interest rates when the Bank of Canada decreases the money supply by selling bonds to the public?

Answer: Bond supply increases and the bond supply curve shifts to the right. The new equilibrium bond price is lower and thus interest rates will increase.

Diff: 1 Type: ES Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 18 .

31) Use demand and supply analysis to explain why an expectation of interest rate hikes would cause Government bond prices to fall.

Answer: The expected return on bonds would decrease relative to other assets resulting in a decrease in the demand for bonds. The leftward shift of the bond demand curve results in a new lower equilibrium price for bonds.

Diff: 1 Type: ES Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market 32) Demonstrate graphically and explain the effect in the bond market of a decrease in the federal deficit. What is the effect on the interest rate and bond prices? How might capital spending be affected by the deficit?

Answer: A graph of the supply and demand for bonds should show the reduced deficit shifting the supply of bonds to the left. A correct graph will show a rise in bond prices and a fall in interest rates, and this should be explained. Lower interest rates stimulate capital spending, as explained in the discussion of the savings rate.

Diff: 3 Type: ES Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

19 .

33) Demonstrate graphically the effect of an increase in the personal savings rate. Show and explain the effect of increased savings on bond prices and interest rates. How would this change affect capital spending?

Answer: A graph of bond supply and demand should show an increase in bond demand. The increase in bond prices and the fall in the interest rates should be clearly shown and explained.

The increase in saving lowers interest rates, thus increasing capital spending.

Diff: 3 Type: ES Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

20 .

34) Demonstrate graphically and explain how increased profitability of investments and increased deficits affect bond prices and interest rates.

Answer: As increased deficits and increased profitability of investment both increase the supply of bonds, one graph showing this shift and the resulting fall in prices and increase in interest rates is appropriate.

Diff: 3 Type: ES Skill: Applied Objective: 5.3 List and describe the factors that affect the equilibrium interest rate in the bond market

21 .

5.4 Supply and Demand in the Market for Money: The Liquidity Preference Framework 1) In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms: ________.

A) real assets and financial assets B) stocks and bonds C) money and bonds D) money and gold Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 2) In Keynes's liquidity preference framework, ________.

A) the demand for bonds must equal the supply of money B) the demand for money must equal the supply of bonds C) an excess demand of bonds implies an excess demand for money D) an excess supply of bonds implies an excess demand for money Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 3) In Keynes's liquidity preference framework, if there is excess demand for money, there is ________.

A) excess demand for bonds B) equilibrium in the bond market C) excess supply of bonds D) too much money Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework

22 .

4) The bond supply and demand framework is easier to use when analyzing the effects of changes in ________, while the liquidity preference framework provides a simpler analysis of the effects from changes in income, the price level, and the supply of ________.

A) expected inflation; bonds B) expected inflation; money C) government budget deficits; bonds D) government budget deficits; money Answer: B Diff: 1 Type: MC Skill: Recall Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 5) Keynes assumed that money has ________ rate of return.

A) a positive B) a negative C) a zero D) an increasing Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 6) In Keynes's liquidity preference framework, as the expected return on bonds increases (holding everything else unchanged), the expected return on money ________, causing the demand for ________ to fall.

A) falls; bonds B) falls; money C) rises; bonds D) rises; money Answer: B Diff: 1 Type: MC Skill: Recall Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 7) The opportunity cost of holding money is ________.

A) the level of income B) the price level C) the interest rate D) the discount rate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 23 .

8) An increase in the interest rate ________.

A) increases the demand for money B) increases the quantity of money demanded C) decreases the demand for money D) decreases the quantity of money demanded Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 9) If there is an excess supply of money ________.

A) individuals sell bonds, causing the interest rate to rise B) individuals sell bonds, causing the interest rate to fall C) individuals buy bonds, causing interest rates to fall D) individuals buy bonds, causing interest rates to rise Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 10) When the interest rate is above the equilibrium interest rate, there is an excess ________ money and the interest rate will ________.

A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 11) In the market for money, an interest rate below equilibrium results in an excess ________ money and the interest rate will ________.

A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 24 .

12) Holding everything else constant in the market for money, as the interest rate rises, the opportunity cost of holding money ________ thus making money less desirable.

A) increases B) decreases C) remains the same D) fluctuates Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework 13) If there is an excess demand for money, people will try to ________ bonds, causing interest rates to ________.

A) sell; rise B) sell; fall C) buy; rise D) buy; fall Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.4 Describe the connection between the bond market and the money market through the liquidity preference framework

25 .

5.5 Changes in Equilibrium Interest Rates in the Liquidity Preference Framework 1) In the Keynesian liquidity preference framework, an increase in the interest rate causes the demand curve for money to ________, everything else held constant.

A) shift right B) shift left C) stay where it is D) invert Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 2) A lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant.

A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 3) When real income ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

A) falls; right; rises B) rises; right; rises C) falls; left; rises D) rises; left; rises Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate

26 .

4) A business cycle expansion increases income, causing money demand to ________ and interest rates to ________, everything else held constant.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: A Diff: 2 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 5) In the Keynesian liquidity preference framework, a rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

A) increase; left B) increase; right C) decrease; left D) decrease; right Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 6) A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant.

A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate

27 .

7) A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

A) decrease; right B) decrease; left C) increase; right D) increase; left Answer: B Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 8) ________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant.

A) A decrease; demand for; rise B) An increase; demand for; fall C) An increase; supply of; rise D) A decrease; supply of; fall Answer: A Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate

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9) In the figure above, one factor not responsible for the decline in the demand for money is ________.

A) a decline the price level B) a decline in income C) an increase in income D) a decline in the expected inflation rate Answer: C Diff: 2 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 10) In the figure above, the decrease in the interest rate from i1 to i2 can be explained by ________.

A) a decrease in money growth B) a decline in the expected price level C) an increase in income D) an increase in the expected price level Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate

29 .

11) In the figure above, the factor responsible for the decline in the interest rate is ________.

A) a decline the price level B) a decline in income C) an increase in the money supply D) a decline in the expected inflation rate Answer: C Diff: 1 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 12) In the figure above, the decrease in the interest rate from i1 to i2 can be explained by ________.

A) a decrease in money growth B) an increase in money growth C) a decline in the expected price level D) an increase in income Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate

30 .

13) Using the liquidity preference framework, what will happen to interest rates if the Bank of Canada increases the money supply?

Answer: The Bank of Canada's actions shift the money supply curve to the right. The new equilibrium interest rate will be lower than it was previously.

Diff: 1 Type: ES Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 14) Using the liquidity preference framework, show what happens to interest rates during a business cycle recession.

Answer: During a business cycle recession, income will fall. This causes the money demand curve to shift to the left. The resulting equilibrium will be at a lower interest rate.

Diff: 1 Type: ES Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 15) In the liquidity preference framework, demonstrate graphically the effect of a decrease in the money supply. Indicate on the graph the excess demand or excess supply of money. Explain the process of adjustment that results in a change in the equilibrium interest rate, and the direction of the change in rates.

Answer: The graph should show the money supply curve shifting to the left. At the original rate, excess supply is the difference between the demand curve and new supply curve at the original equilibrium interest rate. To adjust, individuals sell bonds, driving bond prices down and interest rates up until the new equilibrium rate is attained.

Diff: 3 Type: ES Skill: Recall Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 31 .

16) Economists recognize that interest rates are typically procyclical, meaning that interest rates increase during economic expansions and decline during recessions. Real income and generally inflation rise and fall with the economy. Using the liquidity preference model of interest rates, give three reasons why interest rates are procyclical.

Answer: The answer should explain that the income, price-level, and expected inflation effects would all increase interest rates during an expansion and decrease them in a recession.

Diff: 3 Type: ES Skill: Applied Objective: 5.5 List and describe the factors that affect the money market and the equilibrium interest rate 5.6 Money and Interest Rates 1) Milton Friedman called the response of lower interest rates resulting from an increase in the money supply the ________ effect.

A) liquidity B) price level C) expected-inflation D) income Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time 2) Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the ________.

A) liquidity effect B) income effect C) price level effect D) expected inflation effect Answer: A Diff: 1 Type: MC Skill: Recall Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

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3) If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is immediate, then the ________.

A) interest rate will fall B) interest rate will rise C) interest rate will fall immediately below the initial level when the money supply grows D) interest rate will rise immediately above the initial level when the money supply grows Answer: D Diff: 1 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

4) The figure above illustrates the effect of an increased rate of money supply growth at time 0.

From the figure, one can conclude that the ________.

A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation Answer: A Diff: 3 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time 33 .

5) The figure above, illustrates the effect of an increased rate of money supply growth at time 0.

From the figure, one can conclude that the ________.

A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation Answer: C Diff: 3 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

34 .

6) The figure above illustrates the effect of an increased rate of money supply growth at time T0.

From the figure, one can conclude that the ________.

A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation Answer: C Diff: 3 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

35 .

7) The figure above illustrates the effect of an increased rate of money supply growth at time T0.

From the figure, one can conclude that the ________.

A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation Answer: A Diff: 3 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

36 .

8) The figure above illustrates the effect of an increased rate of money supply growth at time T0.

From the figure, one can conclude that the ________.

A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation Answer: D Diff: 3 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

37 .

9) The figure above illustrates the effect of an increased rate of money supply growth at time T0.

From the figure, one can conclude that the ________.

A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation Answer: A Diff: 3 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time 10) Interest rates increased continuously during the 1970s. The most likely explanation is ________.

A) banking failures that reduced the money supply B) a rise in the level of income C) the repeated bouts of recession and expansion D) increasing expected rates of inflation Answer: D Diff: 2 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time 11) If the Bank of Canada wants to permanently lower interest rates, then it should raise the rate of money growth if ________.

A) there is fast adjustment of expected inflation B) there is slow adjustment of expected inflation C) the liquidity effect is smaller than the expected inflation effect D) the liquidity effect is larger than the other effects Answer: D Diff: 2 Type: MC Skill: Recall Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

38 .

12) When the growth rate of the money supply is increased, interest rates will fall immediately if the liquidity effect is ________ than the other money supply effects and there is a ________ adjustment of expected inflation.

A) larger; fast B) larger; slow C) smaller; slow D) smaller; fast Answer: B Diff: 2 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time 13) It is possible that when the money supply rises, interest rates may ________ if the ________ effect is more than offset by changes in income, the price level, and expected inflation.

A) fall; liquidity B) fall; risk C) rise; liquidity D) rise; risk Answer: C Diff: 2 Type: MC Skill: Applied Objective: 5.6 Identify and illustrate the effects on the interest rate of changes in money growth over time

39 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 6 The Risk and Term Structure of Interest Rates 6.1 Risk Structure of Interest Rates 1) The risk structure of interest rates is ________.

A) the structure of how interest rates move over time B) the relationship among interest rates of different bonds with the same maturity C) the relationship among the term to maturity of different bonds D) the relationship among interest rates on bonds with different maturities Answer: B Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 2) The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is ________.

A) interest rate risk B) inflation risk C) moral hazard D) default risk Answer: D Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 3) Canadian government bonds have no default risk because ________.

A) they are backed by the full faith and credit of the federal government B) the federal government can increase taxes or print money to pay for its obligations C) they are backed by gold reserves D) they can be exchanged for silver at any time Answer: B Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 4) Default risk is the risk that ________.

A) a bond issuer is unable to make interest payments B) a bond issuer is unable to make a profit C) a bond issuer is unable to pay the face value at maturity D) A and C only Answer: D Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

1 .

5) Bonds with no default risk are called ________.

A) flower bonds B) no-risk bonds C) default-free bonds D) zero-risk bonds Answer: C Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 6) The spread between the interest rates on bonds with default risk and default-free bonds is called the ________.

A) risk premium B) junk margin C) bond margin D) default premium Answer: A Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 7) If the probability of a bond defaulting increases because corporations are beginning to suffer large losses, then the default risk on corporate bonds will ________ and the expected return on these bonds will ________, everything else held constant.

A) decrease; increase B) decrease; decrease C) increase; increase D) increase; decrease Answer: D Diff: 3 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 8) Which of the following bonds are default-risk free?

A) Corporate bonds B) Investment-grade bonds C) Canadian government bonds D) Junk bonds Answer: C Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

2 .

9) A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium.

A) positive; raise B) positive; lower C) negative; raise D) negative; lower Answer: A Diff: 2 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 10) If a corporation begins to suffer large losses, then the default risk on the corporate bond will ________, everything else held constant.

A) increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall B) increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall C) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall D) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise Answer: A Diff: 3 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 11) If the possibility of default increases because corporations begin to suffer losses, then the default risk on corporate bonds will ________, and the bonds' returns will become ________ uncertain, meaning that the expected return on these bonds will decrease, everything else held constant.

A) increase; less B) increase; more C) decrease; less D) decrease; more Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

3 .

12) Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Government of Canada bonds to the ________.

A) right; right B) right; left C) left; right D) left; left Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 13) An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Government of Canada bonds, everything else held constant.

A) increase; increase B) reduce; reduce C) reduce; increase D) increase; reduce Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 14) An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on government securities, everything else held constant.

A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 15) An increase in default risk of corporate bonds ________ the demand for these bonds, but ________ the demand for default-free bonds, everything else held constant.

A) increases; lowers B) lowers; increases C) does not change; greatly increases D) moderately lowers; does not change Answer: B Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

4 .

16) As default risk increases and bond prices adjust, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant.

A) increases; less B) increases; more C) decreases; less D) decreases; more Answer: B Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 17) Which of the following statements is true?

A) A decrease in default risk of corporate bonds lowers the demand for these bonds but increases the demand for default-free bonds.

B) The interest rate on corporate bonds decreases as default risk increases.

C) A corporate bond's return becomes less uncertain as default risk increases.

D) As their relative riskiness increases, the interest rate of corporate bonds increases relative to the interest rate on default-free bonds.

Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 18) The spread between interest rates on low quality corporate bonds and Government of Canada bonds ________.

A) widens significantly during recessions B) narrows significantly during recessions C) narrows moderately during recessions D) does not change during recessions Answer: A Diff: 3 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 19) As their relative riskiness ________, the equilibrium price of corporate bonds ________ relative to the expected return on default-free bonds, everything else held constant.

A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; does not change Answer: B Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

5 .

20) Everything else held constant, if the federal government were to guarantee today that it will pay creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds will ________ and the interest rate on government securities will ________.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 21) Bonds with relatively high risk of default are called ________.

A) Brady bonds B) junk bonds C) zero coupon bonds D) investment grade bonds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 22) Bonds with relatively low risk of default are called ________ securities and have a rating of Baa (or BBB) or above; bonds with ratings below Baa (or BBB) have a higher default risk and are called ________.

A) investment grade; lower grade B) investment grade; junk bonds C) high quality; lower grade D) high quality; junk bonds Answer: B Diff: 2 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 23) Which of the following bonds would have the highest default risk?

A) Provincial bonds B) Investment-grade bonds C) Government of Canada bonds D) Junk bonds Answer: D Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

6 .

24) Which of the following long-term bonds has the highest interest rate?

A) Corporate Baa bonds B) Government of Canada bonds C) Corporate Aaa bonds D) Provincial bonds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 25) Which of the following securities has the lowest interest rate?

A) Junk bonds B) Government of Canada bonds C) Investment-grade bonds D) Corporate Baa bonds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 26) During the Great Depression years 1930-1933 many businesses were failing, we would expect the risk premium for ________ bonds to be very high.

A) Government of Canada B) corporate Aaa C) provincial D) corporate Baa Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 27) Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

7 .

28) If you have a very low tolerance for risk, which of the following bonds would you be least likely to hold in your portfolio?

A) A Government of Canada bond B) A provincial government bond C) A corporate bond with a rating of Aaa D) A corporate bond with a rating of Baa Answer: D Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 29) The collapse of the subprime mortgage market ________.

A) did not affect the corporate bond market B) increased the perceived riskiness of government bonds C) reduced the Baa-Aaa spread D) increased the Baa-Aaa spread Answer: D Diff: 3 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 30) The collapse of the subprime mortgage market increased the spread between Baa and default-free Government of Canada bonds. This is due to ________.

A) a reduction in risk B) a reduction in maturity C) a flight to quality D) a flight to liquidity Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 31) During a "flight to quality" ________.

A) the spread between Government of Canada bonds and Baa bonds increases B) the spread between Government of Canada bonds and Baa bonds decreases C) the spread between Government of Canada bonds and Baa bonds is not affected D) the change in the spread between Government of Canada bonds and Baa bonds cannot be predicted Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

8 .

32) Which of the following statements is true?

A) A liquid asset is one that can be quickly and cheaply converted into cash.

B) The demand for a bond declines when it becomes less liquid, decreasing the interest rate spread between it and relatively more liquid bonds.

C) The differences in bond interest rates reflect differences in default risk only.

D) The corporate bond market is the most liquid of the bond markets.

Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 33) Corporate bonds are not as liquid as Government of Canada bonds because ________.

A) fewer corporate bonds for any one corporation are traded, making them more costly to sell B) the corporate bond rating must be calculated each time they are traded C) corporate bonds are not callable D) corporate bonds cannot be resold Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 34) When Government of Canada bonds become relatively more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Government of Canada bonds shifts to the ________.

A) right; right B) right; left C) left; right D) left; left Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 35) A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Government of Canada bonds shifts to the ________.

A) right; right B) right; left C) left; left D) left; right Answer: D Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

9 .

36) An increase in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the interest rate on those corporate bonds, everything else held constant.

A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 37) The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Government of Canada bonds.

A) less liquid than B) less speculative than C) tax-exempt unlike D) lower-yielding than Answer: A Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 38) Bonds with relatively low risk of default are called ________.

A) zero coupon bonds B) junk bonds C) investment grade bonds D) fallen angels Answer: C Diff: 1 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 39) Which of the following statements is true?

A) Because coupon payments on tax-exempt bonds are exempt from U.S. federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.

B) An increase in tax rates will decrease the demand for tax-exempt bonds, lowering their interest rates.

C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption.

D) Because coupon payments on tax-exempt are exempt from U.S. federal income tax, the expected after-tax return on them will be lower for individuals in higher income tax brackets.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

10 .

40) Which of the following statements is true?

A) Because coupon payments on tax-exempt bonds are exempt from U.S. federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.

B) A decrease in tax rates will increase the demand for U.S bonds, lowering their interest rates.

C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption.

D) A decrease in tax rates will increase the supply of U.S bonds, lowering their interest rates.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 41) The interest rate on tax-exempt bonds falls relative to the interest rate on U.S. Treasury securities when ________.

A) there is a major default in the tax-exempt bond market B) income tax rates are raised C) tax-exempt bonds become less widely traded D) corporate bonds become riskier Answer: B Diff: 3 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 42) The interest rate on U.S. tax-exempt bonds rises relative to the interest rate on U.S. Treasury securities when ________.

A) income tax rates are raised B) tax-exempt bonds become more widely traded C) corporate bonds become riskier D) income tax rates are lowered Answer: D Diff: 3 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 43) Tax-exempt bond interest rates increase relative to corporate bond interest rates when ________.

A) income taxes are increased B) corporate bonds become riskier C) U.S. Treasury securities become more widely traded D) there is a major default in the tax-exempt bond market Answer: D Diff: 3 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

11 .

44) If income tax rates were lowered, then ________.

A) the interest rate on U.S. tax-exempt bonds would fall B) the interest rate on U.S. Treasury bonds would rise C) the interest rate on U.S. tax-exempt bonds would rise D) the price of U.S Treasury bonds would fall Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 45) If income tax rates were lowered, then ________.

A) the prices of U.S. tax-exempt bonds would fall B) the interest rate on U.S. tax-exempt bonds would fall C) the interest rate on U.S. Treasury bonds would rise D) the prices of U.S. tax-exempt bonds would rise Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 46) If U.S. income tax rates were lowered, then ________.

A) the interest rate on U.S. tax-exempt bonds would rise B) the interest rate on U.S. Treasury bonds would rise C) the interest rate on U.S. tax-exempt bonds would fall D) the interest rate on U.S. tax-exempt bonds would stay the same Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 47) Three factors explain the risk structure of interest rates: ________.

A) liquidity, default risk, and the income tax treatment of a security B) maturity, default risk, and the income tax treatment of a security C) maturity, liquidity, and the income tax treatment of a security D) maturity, default risk, and the liquidity of a security Answer: A Diff: 1 Type: MC Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

12 .

48) When the pandemic hit in March 2020, interest rates on Baa bonds ________ and the interest rate on Treasury bonds ________ A) increased; increased B) decreased: increased C) decreased; decreased D) increased; decreased Answer: D Diff: 2 Type: MC Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 49) The spread between the interest rates on Baa corporate bonds and Government of Canada bonds was very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

Answer: During the Great Depression many businesses failed. The default risk for the corporate bond increased compared to the default-free Treasury bond. The demand for corporate bonds decreased while the demand for Treasury bonds increased resulting in a larger risk premium.

Diff: 3 Type: ES Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 50) If the U.S. government where to raise the income tax rates, would this have any impact on a state's cost of borrowing funds? Explain.

Answer: Yes, if the U.S. government raises income tax rates, demand for municipal bonds which are federal income tax exempt would increase. This would lower the interest rate on the municipal bonds thus lowering the cost to the state of borrowing funds.

Diff: 3 Type: ES Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 51) Explain the factors that determine the risk structure of interest rates. Explain how a change of each factor changes interest rates.

Answer: Default risk is the risk that interest or principal payments will not be made.

Liquidity is the ability to convert an asset to cash quickly and cheaply.

Tax-exempt bonds are more attractive to investors in high tax brackets.

An increase in default risk, a reduction in liquidity, and a tax cut increase interest rates on the affected assets. A reduction of default risk, an increase in liquidity, and a tax increase reduce interest rates on the affected assets.

Diff: 3 Type: ES Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

13 .

52) Demonstrate graphically and explain how a reduction in default risk affects the demand or supply of corporate and Government of Canada bonds.

Answer: A reduction of default risk increases the demand for corporate bonds and reduces the demand for Government of Canada bonds. Corporate bond prices rise and interest rates fall.

Government of Canada bond prices fall and interest rates rise.

Diff: 2 Type: ES Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 53) Explain using a diagram how the "flight to quality" after the Subprime collapse lead to a rising spread between lower-quality (BBB-rated) and highest-quality (AAA-rated) bonds.

Answer: Students must use supply and demand analysis on a graph to show that the subprime collapse led to doubts about the financial health of lower-quality (BBB-rated) companies, reducing demand for their bonds shifting their demand curve to the left and thus decreasing their price and increasing their interest. The shift of the demand from BBB-rated to AAA-rated bonds known as "flight to quality" increased the demand of AAA-bonds shifting the demand curve to the right and thus increasing their price and decreasing their interest rates, resulting in a wider interest rate spread between BBB and AAA-rated bonds.

Diff: 3 Type: ES Skill: Applied Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates 54) Based on default risk, which bonds are called: a. "investment grade", b. "junk bonds" or "speculative-grade", and c. "fallen angels"?

Answer: a. Investment grade are the bonds that have a relatively low risk of default and are rated BBB or above. b. Junk bonds or speculative-grade are the bonds that have relatively higher risk of default and are rated BB or lower. c. Fallen angels are the bonds that their rating from investment grade has fallen to junk.

Diff: 1 Type: ES Skill: Recall Objective: 6.1 Identify and explain the three factors affecting the risk structure of interest rates

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6.2 Term Structure of Interest Rates 1) The term structure of interest rates is ________.

A) the relationship among interest rates of different bonds with the same maturity B) the structure of how interest rates move over time C) the relationship among the term to maturity of different bonds D) the relationship among interest rates on bonds with different maturities Answer: D Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 2) A plot of the interest rates on default-free Government of Canada bonds with different terms to maturity is called ________.

A) a risk-structure curve B) a default-free curve C) a yield curve D) an interest-rate curve Answer: C Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 3) Differences in ________ explain why interest rates on bonds are not all the same.

A) risk B) liquidity C) time to maturity D) tax characteristics Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 4) Typically, yield curves are ________.

A) gently upward sloping B) mound shaped C) flat D) bowl shaped Answer: A Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 15 .

5) When yield curves are steeply upward sloping, ________.

A) long-term interest rates are above short-term interest rates B) short-term interest rates are above long-term interest rates C) short-term interest rates are about the same as long-term interest rates D) medium-term interest rates are above both short-term and long-term interest rates Answer: A Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 6) When yield curves are flat, ________.

A) long-term interest rates are above short-term interest rates B) short-term interest rates are above long-term interest rates C) short-term interest rates are about the same as long-term interest rates D) medium-term interest rates are above both short-term and long-term interest rates Answer: C Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 7) When yield curves are downward sloping, ________.

A) long-term interest rates are above short-term interest rates B) short-term interest rates are above long-term interest rates C) short-term interest rates are about the same as long-term interest rates D) medium-term interest rates are above both short-term and long-term interest rates Answer: B Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 8) An inverted yield curve ________.

A) slopes up B) is flat C) slopes down D) has a U shape Answer: C Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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9) Economists' attempts to explain the term structure of interest rates ________.

A) illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence B) illustrate how economists continue to accept theories that fail to explain observed behaviour of interest rate movements C) prove that the real world is a special case that tends to get short shrift in theoretical models D) have proved entirely unsatisfactory to date Answer: A Diff: 3 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 10) According to the expectations theory of the term structure of interest rates, the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people are expecting over the life of the long-term bond.

A) average B) sum C) difference D) multiple Answer: A Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 11) The ________ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short-term interest rates that individuals are expecting over the life of the long-term bond, and investors have no preference for short-term bonds relative to long-term bonds.

A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory Answer: B Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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12) If bonds with different maturities are perfect substitutes, then the ________ on these bonds must be equal.

A) expected return B) surprise return C) surplus return D) excess return Answer: A Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 13) If the expected pattern of one-year interest rates over the next five years is 4 percent, 5 percent, 7 percent, 8 percent, and 6 percent, then the expectations theory predicts that today's interest rate on a five-year bond will be ________.

A) 4 percent B) 5 percent C) 6 percent D) 7 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 14) If the expected pattern of 1-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the expectations theory predicts that today's interest rate of the four-year bond will be ________.

A) 1 percent B) 2 percent C) 3 percent D) 4 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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15) If the expected pattern of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of ________.

A) two years B) three years C) four years D) five years Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 16) If the expected pattern of 1-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of ________.

A) one year B) two years C) three years D) four years Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 17) Over the next three years, the expected pattern of 1-year interest rates is 4 percent, 1 percent, and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond will be ________.

A) 1 percent B) 2 percent C) 3 percent D) 4 percent Answer: B Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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18) According to the expectations theory of the term structure of interest rates ________.

A) the interest rate on long-term bonds will exceed the average of short-term interest rates that people expect to occur over the life of the long-term bonds, because of their preference for shortterm securities B) interest rates on bonds of different maturities move together over time C) buyers of bonds always prefer short-term to long-term bonds D) buyers require an additional incentive to hold long-term bonds Answer: B Diff: 3 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 19) According to the expectations theory of the term structure of interest rates ________.

A) when the yield curve is steeply upward sloping, short-term interest rates are expected to remain relatively stable in the future B) when the yield curve is downward sloping, short-term interest rates are expected to remain relatively stable in the future C) investors have strong preferences for short-term relative to long-term bonds, thus explaining why yield curves typically slope upward D) yield curves should be equally likely to slope downward as slope upward Answer: D Diff: 3 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 20) According to the segmented markets theory of the term structure of interest rates ________.

A) bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time B) the interest rate for each bond of a different maturity is determined by the respective supply and demand for each of these bonds.

C) investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward D) because of the positive term premium, the yield curve cannot be downward-sloping Answer: B Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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21) According to the segmented markets theory of the term structure of interest rates ________.

A) the interest rate on long-term bonds will equal an average of short-term interest rates that people are expecting over the life of the long-term bonds B) buyers of bonds do not prefer bonds of one maturity over another C) interest rates on bonds of different maturities do not move together over time D) buyers require an additional incentive for holding long-term bonds Answer: C Diff: 3 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 22) According to this theory of the term structure of interest rates, bonds of different maturities are not substitutes for one another.

A) Segmented markets theory B) Expectations theory C) Liquidity premium theory D) Separable markets theory Answer: A Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 23) In actual practice, short-term interest rates and long-term interest rates usually move together; this is the major shortcoming of the ________.

A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory Answer: A Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 24) A key assumption in the segmented markets theory is that bonds of different maturities ________.

A) are not substitutes at all B) are perfect substitutes C) are substitutes only if the investor is given a premium incentive D) are substitutes but not perfect substitutes Answer: A Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 21 .

25) The segmented markets theory can explain ________.

A) why yield curves usually tend to slope upward B) why interest rates on bonds of different maturities tend to move together C) why yield curves tend to slope upward when short-term interest rates are low and to be inverted when short-term interest rates are high D) why yield curves have been used to forecast business cycles Answer: A Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 26) The expectations theory and the segmented markets theory do not explain the facts very well, but they provide the groundwork for the most widely accepted theory of the term structure of interest rates, ________.

A) the Keynesian theory B) separable markets theory C) liquidity premium theory D) the asset market approach Answer: C Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 27) According to the liquidity premium theory of the term structure of interest rates ________.

A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time B) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium C) because of the positive term premium, the yield curve will not be observed to be downward sloping D) the interest rate for each maturity bond is determined by supply and demand for that maturity bond Answer: B Diff: 3 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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28) The ________ of the term structure of interest rates states the following: the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a term premium that responds to supply and demand conditions for that bond.

A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory Answer: C Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 29) The additional incentive that the purchaser of a Treasury security requires to buy a long-term security rather than a short-term security is called the ________.

A) risk premium B) term premium C) tax premium D) market premium Answer: B Diff: 1 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 30) The preferred habitat theory of the term structure of interest rates is closely related to the ________.

A) expectations theory of the term structure of interest rates B) segmented markets theory of the term structure of interest rates C) liquidity premium theory of the term structure of interest rates D) the inverted yield curve theory of the term structure of interest rates Answer: C Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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31) If 1-year interest rates for the next three years are expected to be 4 percent, 2 percent, and 3 percent, and the 3-year term premium is 1 percent, than the 3-year bond rate will be ________.

A) 1 percent B) 2 percent C) 3 percent D) 4 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 32) If 1-year interest rates for the next five years are expected to be 4 percent, 2 percent, 5 percent, 4 percent, and 5 percent, and the 5-year term premium is 1 percent, than the 5-year bond rate will be ________.

A) 2 percent B) 3 percent C) 4 percent D) 5 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 33) According to the liquidity premium theory of the term structure of interest rates ________.

A) bonds of different maturities are not substitutes B) if yield curves are downward sloping, then short-term interest rates are expected to fall by so much that, even when the positive term premium is added, long-term rates fall below short-term rates C) yield curves should never slope downward D) interest rates on bonds of different maturities do not move together over time Answer: B Diff: 3 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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34) According to the liquidity premium theory of the term structure of interest rates, a steeply upward sloping yield curve indicates that short-term interest rates are expected to ________.

A) rise in the future B) remain unchanged in the future C) decline moderately in the future D) decline sharply in the future Answer: A Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 35) According to the liquidity premium theory of the term structure of interest rates, a slightly upward sloping yield curve indicates that short-term interest rates are expected to ________.

A) rise in the future B) remain unchanged in the future C) decline moderately in the future D) decline sharply in the future Answer: B Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 36) According to the liquidity premium theory of the term structure of interest rates, a flat yield curve indicates that short-term interest rates are expected to ________.

A) rise in the future B) remain unchanged in the future C) decline moderately in the future D) decline sharply in the future Answer: C Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 37) According to the liquidity premium theory of the term structure of interest rates, a downward sloping yield curve indicates that short-term interest rates are expected to ________.

A) rise in the future B) remain unchanged in the future C) decline moderately in the future D) decline sharply in the future Answer: D Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 25 .

38) According to the liquidity premium theory, a flat yield curve means that ________.

A) bond purchasers expect interest rates to rise in the future B) bond purchasers expect interest rates to stay the same C) bond purchasers expect interest rates to fall in the future D) the yield curve has nothing to do with expectations of bond purchasers Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 39) If the yield curve is flat for short maturities and then slopes downward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting ________.

A) a rise in short-term interest rates in the near future and a decline further out in the future B) constant short-term interest rates in the near future and a decline further out in the future C) a decline in short-term interest rates in the near future and a rise further out in the future D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future Answer: D Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 40) If the yield curve slope is flat for short maturities and then slopes steeply upward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting ________.

A) a rise in short-term interest rates in the near future and a decline further out in the future B) constant short-term interest rates in the near future and further out in the future C) a decline in short-term interest rates in the near future and a rise further out in the future D) constant short-term interest rates in the near future and a decline further out in the future Answer: C Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

26 .

41) If the yield curve has a mild upward slope, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting ________.

A) a rise in short-term interest rates in the near future and a decline further out in the future B) constant short-term interest rates in the near future and further out in the future C) a decline in short-term interest rates in the near future and a rise further out in the future D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 42) A particularly attractive feature of the ________ is that it tells you what the market is predicting about future short-term interest rates by just looking at the slope of the yield curve.

A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory Answer: C Diff: 2 Type: MC Skill: Recall Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

27 .

43) The steeply upward sloping yield curve in the figure above indicates that ________.

A) short-term interest rates are expected to rise in the future B) short-term interest rates are expected to fall moderately in the future C) short-term interest rates are expected to fall sharply in the future D) short-term interest rates are expected to remain unchanged in the future Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 44) The steeply upward sloping yield curve in the figure above indicates that ________ interest rates are expected to ________ in the future.

A) short-term; rise B) short-term; fall moderately C) short-term; remain unchanged D) long-term; fall moderately Answer: A Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

28 .

45) The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to ________.

A) rise in the near-term and fall later B) fall sharply in the near-term and rise later C) fall moderately in the near-term and rise later D) remain unchanged in the near-term and rise later Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 46) The U-shaped yield curve in the figure above indicates that the inflation rate is expected to ________.

A) remain constant in the near-term and fall later B) fall sharply in the near-term and rise later C) rise moderately in the near-term and fall later D) remain constant in the near-term and rise later Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

29 .

47) The inverted U-shaped yield curve in the figure above indicates that short-term interest rates are expected to ________.

A) rise in the near-term and fall later B) fall moderately in the near-term and rise later C) fall sharply in the near-term and rise later D) remain unchanged in the near-term and fall later Answer: A Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 48) The inverted U-shaped yield curve in the figure above indicates that the inflation rate is expected to ________.

A) remain constant in the near-term and fall later B) fall moderately in the near-term and rise later C) rise moderately in the near-term and fall later D) remain unchanged in the near-term and rise later Answer: C Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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49) An inverted yield curve predicts that short-term interest rates ________.

A) are expected to rise in the future B) will rise and then fall in the future C) will remain unchanged in the future D) will fall in the future Answer: D Diff: 1 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 50) When short-term interest rates are expected to fall sharply in the future, the yield curve will ________.

A) slope up B) be flat C) be inverted D) be an inverted U shape Answer: C Diff: 1 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 51) If investors expect interest rates to fall significantly in the future, the yield curve will be inverted. This means that the yield curve has a ________ slope.

A) steep upward B) slight upward C) flat D) downward Answer: D Diff: 1 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 52) A flat or downward-sloping yield curve suggests that the economy is more likely to enter ________.

A) a recession B) an expansion C) a boom time D) a period of increasing output Answer: A Diff: 1 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 31 .

53) A ________ yield curve predicts a future increase in inflation.

A) steeply upward sloping B) slight upward sloping C) flat D) downward sloping Answer: A Diff: 1 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 54) If the expected pattern of 1-year interest rates over the next two years is 4 percent, and 1 percent, then the expectations theory predicts that today's interest rate on a 2-year bond will be ________.

A) 1 B) 2.5 C) 5 D) 4 Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 55) If the expected pattern of 1-year interest rates over the next three years is 4 percent, 1 percent, and 1 percent, then the expectations theory predicts that today's interest rate on a 3-year bond will be ________.

A) 1 B) 2 C) 3 D) 6 Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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56) The current 1-year bond and 2-year bond interest rates are both 4 percent and the 2-year term premium is estimated to be 1 percent. The liquidity premium theory of the term structure predicts that the expected 1-year bond interest rate next year is ________ percent.

A) 4 B) 2 C) 5 D) 2.5 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 57) The current 1-year, 2-year, and 3-year bond interest rates are 3 percent, 4.5 percent, and 6 percent, respectively, and the 1-year, 2-year, and 3-year term premia are 0 percent, 0.5 percent, and 1 percent, respectively. The liquidity premium theory of the term structure predicts that the expected 1-year bond interest rate is ________ percent next year and ________ percent the year after.

A) 2.5; 5 B) 5; 7 C) 5; 2.5 D) 1; 2 Answer: B Diff: 3 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 58) The current 1-year bond and 2-year bond interest rates are both 4 percent and the market expects the 1-year bond interest rate to go down by 1 percent next year. This implies that the 2year term premium is ________.

A) 1 percent B) 5 percent C) 2 percent D) 0.5 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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59) Over the next three years, the expected path of 1-year interest rates is 4 percent, 1 percent, and 1 percent, and the current 1-year, 2-year, and 3-year bond interest rates are 4 percent, 2 percent and 4 percent, respectively. Then the 3-year term premium is ________.

A) 3 percent B) 5 percent C) 2 percent D) 4 percent Answer: C Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 60) The current 1-year bond and 2-year bond interest rates are both 4 percent and the 1-year and 2-year term premia are 0 and 1 percent, respectively. The liquidity premium theory of the term structure predicts that the expected 1-year bond interest rate next year is ________.

A) 2.5 percent B) 4 percent C) 5 percent D) 2 percent E) 1 percent Answer: D Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 61) Over the next three years, the expected path of 1-year interest rates is 4 percent, 1 percent, and 1 percent, and the current 3-year bond interest rate is 4 percent. The liquidity premium theory predicts that the 3-year term premium is ________.

A) 4 percent B) 1 percent C) 5 percent D) 3 percent E) 2 percent Answer: E Diff: 2 Type: MC Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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62) If a higher inflation rate is expected in the future, what effect would this have on the shape of the yield curve? Why? Answer: The yield curve should have a steep upward slope. Nominal interest rates will increase if the inflation rate increases, therefore, bond purchasers will require a higher term premium to hold the riskier long-term bond.

Diff: 1 Type: ES Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 63) What is the shape of the yield curve when short rates are expected to fall in the medium term, and then increase? Demonstrate this graphically.

Answer: The curve will have a U shape reflecting the expected fall and then increase.

Diff: 3 Type: ES Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

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64) What is the shape of the yield curve when short-term rates are expected to rise sharply in the mid-term and moderately in the long-term?

Answer:

The students must draw a yield curve like the one above and explain that the sharp increase in short-term rates in the mid-term is shown as the part of the yield curve with a steep slope and the moderate increase in the long-term is the later part of the yield curve.

Diff: 2 Type: ES Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities 65) What can be inferred about future economic growth and real economic output when interest rates on 1-2-3-4-5- year bonds are 2.0 percent, 2.1 percent, 2.3 percent, 2.4 percent, and 2.5 percent respectively?

Answer: According to these interest rates, the yield curve is gently upward sloping, indicating that short-term interest rates are not expected to change significantly in the next 5 years. We do know that periods of economic growth and output booms are associated with rising interest rates, and recessions are associated with low interest rates. As the yield curve is found to be an accurate predictor of the business cycle, we would expect no significant changes in real output over the next 5 years.

Diff: 3 Type: ES Skill: Applied Objective: 6.2 List and explain the three theories of why interest rates vary across different maturities

36 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 7 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 7.1 Computing the Price of Common Stock 1) A stockholder's ownership of a company's stock gives her the right to ________.

A) vote and be the primary claimant of all cash flows B) vote and be the residual claimant of all cash flows C) manage and assume responsibility for all liabilities D) vote and assume responsibility for all liabilities Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 2) Stockholders' rights include ________.

A) the right to vote B) the right to manage C) primary claims on all cash flows D) ownership of bonds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 3) Stockholders' rights include ________.

A) the right to manage B) the right to change personnel policy C) the right to veto management's decisions D) residual claim on all of a company's assets Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 4) Stockholders are residual claimants, meaning that they ________.

A) have the first priority claim on all of a company's assets B) are liable for all of a company's debts C) will never share in a company's profits D) receive the remaining cash flow after all other claims against the firm's assets have been satisfied Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 1 .

5) Common stock is the principal way that corporations raise ________.

A) short-term debt B) foreign exchange C) long-term debt D) equity capital Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 6) Dividends are paid from ________.

A) liabilities B) debts C) net earnings D) interest Answer: C Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 7) Periodic payments of net earnings to shareholders are known as ________.

A) capital gains B) dividends C) profits D) interest Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 8) The value of any investment is found by computing the ________.

A) present value of all future sales B) present value of all future liabilities C) future value of all future expenses D) present value of all future cash flows Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock

2 .

9) The value of any investment is found by computing the ________.

A) present value of all coupon payments B) present value of all future liabilities C) future value of all dividends D) value in today's dollars of all future cash flows Answer: D Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 10) In the one-period valuation model, the value of a share of stock today depends upon ________.

A) the present value of both dividends and the predicted future price of the stock B) only the present value of future dividends C) the actual value of the dividends and the predicted future price of the stock to be received in one year D) the future value of dividends and the actual sales price of the stock Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 11) In the one-period valuation model, the current stock price increases if ________.

A) the expected sales price increases B) the expected sales price falls C) the required return increases D) the dividend payout is cut Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 12) In the one-period valuation model, an increase in the required return on investments in equity ________.

A) increases the expected sales price of a stock B) increases the current price of a stock C) reduces the expected sales price of a stock D) reduces the current price of a stock Answer: D Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock

3 .

13) In the one-period valuation model with no dividend payments the current price of the stock is given by ________.

A) P0 = B) P0 =

+

C) P0 =

× 100

D) P0 =

× 365

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 14) Using the one-period valuation model, assuming a year-end dividend of $0.11, a predicted sales price of the stock of $110, and a required rate of return on investments in equity of 10 percent, the current price of the stock would be ________.

A) $110.11 B) $121.12 C) $100.10 D) $100.11 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 15) Using the one-period valuation model, assuming a year-end dividend of $1.00, a predicted sales price of the stock of $100, and a required rate of return on investments in equity of 5 percent, the current price of the stock would be ________.

A) $110.00 B) $101.00 C) $100.00 D) $96.19 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock

4 .

16) A group of financial analysts predict that the price of corporation's XYZ stock one year from now will be $20. XYZ has just announced that is not going to pay a dividend next year. Given that you are satisfied with a 10 percent return on this investment, your valuation of this stock today would be ________.

A) $18.00 B) $18.18 C) $21.10 D) $21.00 Answer: B Diff: 3 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 17) A group of financial analysts predict that the price of corporation's XYZ stock one year from now will be $120. XYZ has just announced that is not going to pay a dividend next year. Given that you are satisfied with a 12 percent return on this investment, your valuation of this stock today would be ________.

A) $100.20 B) $108.80 C) $107.14 D) $132.00 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 18) General Electric announces that it is going to cut its dividends by $0.02 per share in the future. This, everything else remaining the same, will cause its current stock price to ________.

A) increase B) decrease C) remain the same D) fluctuate Answer: B Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 19) In the generalized dividend model, if the expected sales price is in the distant future ________.

A) it will not likely affect the current stock price B) it is more important than dividends in determining the current stock price C) it as equally important as dividends in determining the current stock price D) it is less important than dividends but will still affect the current stock price Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 5 .

20) In the generalized dividend model, a stock's predicted sales price far in the future does not affect its current price because ________.

A) its present value cannot be computed B) its present value is almost zero C) its sales price does not affect the current price D) its stock may never be sold Answer: B Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 21) In the generalized dividend model, the current stock price equals the sum of ________.

A) the actual value of the future dividend stream B) the present value of the future dividend stream C) the future value of the future dividend stream D) the present value of the future sales price Answer: B Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 22) Using the Gordon growth model, a stock's current price will increase if ________.

A) the dividend growth rate increases B) the growth rate of dividends falls C) the required rate of return on equity rises D) the expected sales price rises Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 23) In the Gordon growth model, a decrease in the required rate of return on investments in equity ________.

A) increases the current stock price B) increases the future stock price C) reduces the future stock price D) reduces the current stock price Answer: A Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock

6 .

24) Using the Gordon growth formula, if D1 is $2.00, ke is 12 percent (or 0.12), and g is 10 percent (or 0.10), then the current stock price will be ________.

A) $20 B) $50 C) $100 D) $150 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 25) Using the Gordon growth formula, if D1 is $1.00, ke is 10 percent (or 0.10), and g is 5 percent (or 0.05), then the current stock price is ________.

A) $10 B) $20 C) $30 D) $40 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 26) One of the assumptions of the Gordon Growth Model is that dividends will continue growing at ________ rate.

A) an increasing B) a fast C) a constant D) an escalating Answer: C Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock 27) In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity.

A) greater than B) equal to C) less than D) proportional to Answer: C Diff: 2 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock

7 .

28) What is the current price of a telecommunication company's stock if the current dividend is $0.80, the expected constant growth rate in dividends is 5% and the required return on investments in equity is 10%?

A) $16.00 B) $16.80 C) $8.00 D) $8.40 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 29) What is the current price of a utility company's stock if the current dividend is $0.20, the expected constant growth rate in dividends is 2% and the required return on investments in equity is 8%?

A) $2.00 B) $2.20 C) $3.20 D) $3.40 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 30) A company's dividend in one year is $1.00 and this is expected to increase at a constant rate of 2%. If the required return on investments in equity for this stock increases from 10% to 12$ by how much will the stock price change?

A) It increases by 20% B) It decreases by 20% C) It increases by 16.67% D) It decreases by 16.67% Answer: B Diff: 2 Type: MC Skill: Applied Objective: 7.1 Calculate the price of common stock 31) A corporation's dividend payment is set by ________.

A) its board of directors B) its debtholders C) the corporation's CFO (chief financial officer) D) the stockholders themselves Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.1 Calculate the price of common stock

8 .

32) You believe that a corporation's dividends will grow 5 percent per year on average into the foreseeable future. If the company's last dividend payment was $5 what should be the current price of the stock assuming a 12 percent required return?

Answer: Use the Gordon Growth Model. $5(1 + .05)/(.12 - .05) = $75 Diff: 3 Type: ES Skill: Applied Objective: 7.1 Calculate the price of common stock 33) What rights does ownership interest give stockholders?

Answer: Stockholders have the right to vote on issues brought before the stockholders, be the residual claimant, that is, receive a portion of any net earnings of the corporation, and the right to sell the stock.

Diff: 1 Type: ES Skill: Recall Objective: 7.1 Calculate the price of common stock 34) Explain the Gordon growth model of stock pricing. Explain how changes in each component affect the current stock price. On what assumptions is the model based?

Answer: The basic model is P0 = where P0 = D1 = ke = g =

the current stock price the next period's dividend the required rate of return the dividend growth rate

Increases in the dividend or the dividend growth rate increase the stock price, while an increase in the required rate of return lowers the stock price.

The two assumptions that are the basis of the model are that dividends are assumed to grow at a constant rate, and that the dividend growth rate is less than the required rate of return.

Diff: 1 Type: ES Skill: Recall Objective: 7.1 Calculate the price of common stock 35) Explain why the Gordon growth model does not need to incorporate the end period price.

Answer: Students must explain that since the end period is presumed to be an infinite number of years in the future, the present value of that amount is effectively zero.

Diff: 2 Type: ES Skill: Recall Objective: 7.1 Calculate the price of common stock

9 .

7.2 How the Market Sets Stock Prices 1) In asset markets, an asset's price is ________.

A) set equal to the highest price a seller will accept B) set equal to the highest price a buyer is willing to pay C) set equal to the lowest price a seller is willing to accept D) set by the buyer willing to pay the highest price Answer: D Diff: 1 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 2) Information plays an important role in asset pricing because it allows the buyer to judge more accurately ________.

A) liquidity B) risk C) capital D) policy Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.2 Recognize the impact of new information on stock prices 3) New information that might lead to a decrease in an asset's price might be ________.

A) an expected decrease in the level of future dividends B) a decrease in the required rate of return C) an expected increase in the dividend growth rate D) an expected increase in the future sales price Answer: A Diff: 2 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 4) A change in perceived risk of a stock changes ________.

A) the expected dividend growth rate B) the expected sales price C) the required rate of return D) the current dividend Answer: C Diff: 2 Type: MC Skill: Recall Objective: 7.2 Recognize the impact of new information on stock prices

10 .

5) A stock's price will fall if there is ________.

A) a decrease in perceived risk B) an increase in the required rate of return C) an increase in the future sales price D) current dividends are high Answer: B Diff: 2 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 6) A monetary expansion ________ stock prices due to a decrease in the ________ and an increase in the ________, everything else held constant.

A) reduces; future sales price; expected rate of return B) reduces; current dividend; expected rate of return C) increases; required rate of return; future sales price D) increases; required rate of return; dividend growth rate Answer: D Diff: 3 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 7) The subprime financial crisis led to a decline in stock prices because ________.

A) of a lowered expected dividend growth rate B) of a lowered required return on investment in equity C) higher expected future stock prices D) higher current dividends Answer: A Diff: 2 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 8) Increased uncertainty resulting from the subprime crisis ________ the required return on investment in equity.

A) raised B) lowered C) had no impact on D) decreased Answer: A Diff: 3 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices

11 .

9) In October 2008, the stock market crashed, falling by ________ from its peak value a year earlier.

A) over 40 percent B) over 30 percent C) over 50 percent D) over 25 percent Answer: A Diff: 1 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 10) Increased uncertainty about the economy will ________.

A) increase stock prices due to a higher required return B) not affect stock prices C) increase stock prices due to a lower required return D) depress stock prices due to a higher required return Answer: D Diff: 2 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 11) Dishonest corporate accounting procedures would cause stock prices to ________.

A) remain unchanged B) decrease due to lower expected dividend growth and lower required return C) decrease due to lower expected dividend growth and higher required return D) increase due to higher expected dividend growth and lower required return Answer: C Diff: 2 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices 12) The Covid-19 pandemic in February 2020 led to a ________ revision by investors' expectations about dividend growth and a ________ required return on investment in equity.

Both factors resulted in a ________ in stock prices.

A) upward; higher; rise B) downward; lower; fall C) downward; higher; fall D) downward; lower; rise Answer: C Diff: 2 Type: MC Skill: Applied Objective: 7.2 Recognize the impact of new information on stock prices

12 .

7.3 The Theory of Rational Expectations 1) Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that ________.

A) expectations influence the behaviour of participants in the economy and thus have a major impact on economic activity B) expectations influence only a few individuals, have little impact on the overall economy, but can have important effects on a few markets C) expectations influence many individuals, have little impact on the overall economy, but can have distributional effects D) models that ignore expectations have little predictive power, even in the short run Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 2) The view that expectations change relatively slowly over time in response to new information is known in economics as ________.

A) rational expectations B) irrational expectations C) slow-response expectations D) adaptive expectations Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 3) If expectations of the future inflation rate are formed solely based on a weighted average of past inflation rates, then economics would say that expectation formation is ________.

A) irrational B) rational C) adaptive D) reasonable Answer: C Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations

13 .

4) If expectations are formed adaptively, then people ________.

A) use more information than just past data on a single variable to form their expectations on the future direction of that variable B) often change their expectations quickly when faced with new and relevant information C) use only the information from past data on a single variable to form their expectations on the future direction of that variable D) never change their expectations once they set and formed Answer: C Diff: 2 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 5) If during the past decade the average rate of monetary growth has been 5 percent and the average inflation rate has been 5 percent, everything else held constant, when the Bank of Canada announces that the new rate of monetary growth will be 10 percent, the adaptive expectation forecast of the future rate of inflation will be ________.

A) 5 percent B) between 5 and 10 percent C) 10 percent D) more than 10 percent Answer: A Diff: 3 Type: MC Skill: Applied Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 6) The major criticism of the view that expectations are formed adaptively is that ________.

A) this view ignores the fact that people use more information than just past data to form their expectations B) it is easier to model adaptive expectations than it is to model rational expectations C) adaptive expectations models have no predictive power D) people are irrational and therefore never learn from past mistakes Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 7) According to the theory of rational expectations, the term "optimal forecast" is essentially synonymous with ________.

A) correct forecast B) the correct guess C) the actual outcome D) the best guess Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 14 .

8) If a forecast is made using all available information, then economists say that the expectation formation is ________.

A) rational B) irrational C) adaptive D) reasonable Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 9) If a forecast made using all available information is not perfectly accurate, then it ________.

A) is still a rational expectation B) cannot be a rational expectation C) is an adaptive expectation D) is a second-best expectation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 10) If additional information is not used when forming an optimal forecast because it is not available at that time, then expectations are ________.

A) obviously formed irrationally B) still considered to be formed rationally C) formed adaptively D) formed equivalently Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 11) An expectation may fail to be rational if ________.

A) relevant information was not available at the time the forecast is made B) relevant information is available but ignored at the time the forecast is made C) information changes after the forecast is made D) information was available to insiders only Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations

15 .

12) According to the theory of rational expectations, forecast errors of expectations ________.

A) are more likely to be negative than positive B) are more likely to be positive than negative C) tend to be persistently high or low D) are unpredictable Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 13) Rational expectations forecast errors will, on average, be ________ and therefore ________ be predicted ahead of time.

A) positive; can B) positive; cannot C) negative; can D) zero; cannot Answer: D Diff: 2 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 14) People have a strong incentive to form rational expectations because ________.

A) they are guaranteed of success in the stock market B) it is costly not to do so C) it is costly to do so D) everyone wants to be rational Answer: B Diff: 2 Type: MC Skill: Applied Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 15) If market participants notice that a variable behaves differently now than in the past, then, according to rational expectations theory, we can expect market participants to ________.

A) change the way they form their expectations about future values of the variable B) begin to make systematic mistakes when forecasting the future behaviour of this variable.

C) no longer pay close attention to the behaviour of this variable D) simply give up trying to forecast this variable Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations

16 .

16) According to the theory of rational expectations, ________.

A) expectations of inflation are viewed as being an average of past inflation rates B) expectations of inflation are viewed as being an average of expected future inflation rates C) expectations formation indicates that changes in expectations occur slowly over time as past data change D) expectations will not differ from optimal forecasts that use all available information Answer: D Diff: 2 Type: MC Skill: Recall Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 17) Suppose Barbara looks out in the morning and sees a clear sky so decides that a picnic for lunch is a good idea. Last night the weather forecast included a 100 percent chance of rain by midday, but Barbara did not watch the local news program. Is Barbara's prediction of good weather at lunch time rational? Why or why not?

Answer: No, this prediction does not use rational expectations. Although Barbara based her guess on the information that was available to her at the time, additional information was readily available that could have been used to improve her prediction.

Diff: 3 Type: ES Skill: Applied Objective: 7.3 Compare and contrast adaptive expectations and rational expectations 18) Assume that your economics professor announces to your class that after thirty years of giving exams only on scheduled dates, this semester she will give only surprise quizzes. What is the rational expectation response to this new policy? Why does your self-interest require that you change your behaviour? What would the consequences be for students who changed their expectations about exams adaptively?

Answer: Instead of being able to study for exams on known dates, students must now be prepared for an exam at any possible time. Students must study regularly, before each class. Selfinterest dictates that students change their behaviour, as their grade depends upon it. Students who change their behaviour adaptively don't adjust until they have experienced one or more surprise quizzes, which likely hurt their grades.

Diff: 3 Type: ES Skill: Applied Objective: 7.3 Compare and contrast adaptive expectations and rational expectations

17 .

7.4 The Efficient Market Hypothesis: Rational Expectations in Financial Markets 1) The theory of rational expectations, when applied to financial markets, is known as ________.

A) monetarism B) the efficient markets hypothesis C) the theory of strict liability D) the theory of impossibility Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 2) Monetary economists and financial economists developed ________ theories on expectations formations.

A) parallel B) opposing C) dissimilar D) unusual Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 3) If the optimal forecast of the return on a security exceeds the equilibrium return, then ________.

A) the market is inefficient B) no unexploited profit opportunities exist C) the market is in equilibrium D) the market is myopic Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds

18 .

4) Another way to state the efficient markets condition is this way: in an efficient market, ________.

A) unexploited profit opportunities will be quickly eliminated B) unexploited profit opportunities will never exist C) unexploited profit opportunities never existed D) every financial market participant must be well informed about securities Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 5) ________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and quickly act to eliminate the unexploited profit opportunity.

A) Arbitrage B) Mediation C) Asset capitalization D) Market intercession Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 6) The efficient markets hypothesis suggests that if an unexploited profit opportunity exist in an efficient market, ________.

A) it will tend to go unnoticed for some time B) it will be quickly eliminated C) financial analysts are your best source of this information D) prices will reflect the unexploited profit opportunity Answer: B Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds

19 .

7) Financial markets quickly eliminate unexploited profit opportunities through changes in ________.

A) dividend payments B) tax laws C) asset prices D) monetary policy Answer: C Diff: 1 Type: MC Skill: Applied Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 8) The elimination of unexploited profit opportunities requires that ________ market participants be well informed.

A) all B) a few C) zero D) many Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 9) If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

A) A stock that has done poorly in the past is more likely to do well in the future B) One investment is as good as any other because the securities' prices are correct C) A security's price reflects all available information about the intrinsic value of the security D) Security prices can be used by managers to assess their cost of capital accurately Answer: A Diff: 3 Type: MC Skill: Applied Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 10) According to the efficient markets hypothesis, purchasing the reports of financial analysts ________.

A) is likely to increase one's returns by an average of 10 percent B) is likely to increase one's returns by about 3 to 5 percent C) is not likely to be an effective strategy for increasing financial returns D) is likely to increase one's returns by an average of about 2 to 3 percent Answer: C Diff: 3 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 20 .

11) You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor ________.

A) may or may not be better than the other forecasts Past performance is no guarantee of the future B) will always be the best of the group C) will be worse in the future What goes up must come down D) will be worse in the near future, but improve over time Answer: A Diff: 3 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 12) Sometimes the price of a company's stock falls even after it announces positive news about its latest quarterly earnings. This phenomenon is ________.

A) clearly inconsistent with the efficient markets hypothesis B) consistent with the efficient markets hypothesis if the earnings were not as high as anticipated C) consistent with the efficient markets hypothesis if the earnings were not as low as anticipated D) consistent with the efficient markets hypothesis if the favorable earnings were expected Answer: B Diff: 3 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 13) According to the efficient markets hypothesis, the current price of a financial security ________.

A) is the discounted net present value of future interest payments B) is determined by the highest successful bidder C) fully reflects all available relevant information D) is a result of none of the above Answer: C Diff: 1 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds

21 .

14) You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn ________.

A) above average returns since you will share in the higher profits B) above average returns since your stock price will appreciate as higher profits are earned C) below average returns since computer makers have low profit rates D) a normal return since stock prices adjust to reflect expected changes in profitability almost immediately Answer: D Diff: 3 Type: MC Skill: Applied Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 15) The efficient markets hypothesis indicates that investors ________.

A) can use the advice of technical analysts to outperform the market B) do better on average if they adopt a "buy and hold" strategy C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy D) do better if they purchase loaded mutual funds Answer: B Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 16) The efficient markets hypothesis suggests that investors ________.

A) should purchase no-load mutual funds which have low management fees B) can use the advice of technical analysts to outperform the market C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy D) act on all "hot tips" they hear Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 17) The advantage of a "buy-and-hold strategy" is that ________.

A) net profits will tend to be higher because there will be fewer brokerage commissions B) losses will eventually be eliminated C) the longer a stock is held, the higher will be its price D) profits are guaranteed Answer: A Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 22 .

18) For small investors, the best way to pursue a "buy and hold" strategy is to ________.

A) buy and sell individual stocks frequently B) buy no-load mutual funds with high management fees C) buy no-load mutual funds with low management fees D) buy load mutual funds Answer: C Diff: 2 Type: MC Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 19) If a corporation announces that it expects quarterly earnings to increase by 25 percent and it sees instead an increase of 22 percent, what should happen to the price of the corporation's stock if the efficient markets hypothesis holds, everything else held constant?

Answer: The stock's price should fall. The price had adjusted based on the statement of expected earnings. When the actual number turned out to be lower than expected, the stock price changes to reflect the additional information.

Diff: 3 Type: ES Skill: Applied Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 20) Your best friend calls and gives you the latest stock market "hot tip" that he heard at the health club. Should you act on this information? Why or why not?

Answer: No, if this information is readily available, it will already be reflected in the stock price.

Diff: 1 Type: ES Skill: Applied Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 21) If you your stockbroker tells you that you should buy stock in Ford as it has devised a new hybrid engine system that will reduce consumption of fuel by 90 percent, would you follow this advice and buy Ford's stock?

Answer: The efficient market hypothesis indicates that you should be skeptical of any such information. If the market is efficient then it has already priced Ford's stock so that its expected return will equal the equilibrium return. The tip is not valuable. But if the tip is based on new information and gives you an edge on the rest of the market, only them it can be valuable to you and you should buy the stock. In any other case Ford stock price will have already reflected the news.

Diff: 2 Type: ES Skill: Applied Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds

23 .

22) What is a recommended strategy for a small investor and how it is associated with the efficient market hypothesis?

Answer: Students should be able to explain that a recommended strategy is to purchase no-load mutual funds. EMH suggests that only "extremely clever investors" may be able to outperform a buy-and-hold strategy.

Diff: 3 Type: ES Skill: Recall Objective: 7.4 Explain why arbitrage opportunities imply that the efficient market hypothesis holds 7.5 Why the Efficient Market Hypothesis Does Not Imply That Financial Markets are Efficient 1) A situation when an asset price differs from its fundamental value is ________.

A) a random walk B) an inflation C) a deflation D) a bubble Answer: D Diff: 1 Type: MC Skill: Recall Objective: 7.5 Identify and explain the implications of the efficient market hypothesis for financial markets 2) In a rational bubble, investors can have ________ expectations that a bubble is occurring but continue to hold the asset anyway.

A) irrational B) adaptive C) rational D) myopic Answer: C Diff: 1 Type: MC Skill: Recall Objective: 7.5 Identify and explain the implications of the efficient market hypothesis for financial markets

24 .

7.6 Behavioural Finance 1) ________ is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behaviour of securities prices.

A) Behavioural finance B) Strategical finance C) Methodical finance D) Procedural finance Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold 2) If a market participant believes that a stock price is irrationally high, they may try to borrow stock from brokers to sell in the market and then make a profit by buying the stock back again after the stock falls in price. This practice is called ________.

A) short selling B) double dealing C) undermining D) long marketing Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold 3) ________ means people are more unhappy when they suffer losses than they are happy when they achieve gains.

A) Loss fundamentals B) Loss aversion C) Loss leader D) Loss cycle Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold

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4) Loss aversion can explain why very little ________ actually takes place in the securities market.

A) short selling B) bargaining C) bartering D) negotiating Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold 5) Psychologists have found that people tend to be ________ in their own judgments.

A) underconfident B) overconfident C) indecisive D) insecure Answer: B Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold 6) ________ and ________ may provide an explanation for stock market bubbles.

A) Overconfidence; social contagion B) Underconfidence; social contagion C) Overconfidence; social isolationism D) Underconfidence; social isolationism Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold 7) Investors tend to trade on their beliefs rather than on pure facts. This statement might explain why securities markets have ________ that the efficient market hypothesis does not predict.

A) large trading volumes B) short sales C) a random walk D) arbitrage Answer: A Diff: 1 Type: MC Skill: Recall Objective: 7.6 Summarize the reasons why behavioural finance suggests that the efficient market hypothesis may not hold

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 8 An Economic Analysis of Financial Structure 8.1 Basic Facts About Financial Structure Throughout the World 1) The financial system includes all but the following type of institutions.

A) Banks B) Insurance companies C) Mutual funds D) Public relations firms Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 2) Canadian businesses used stocks for external financing ________ percent over the 1970-2000 period.

A) 2 B) 12 C) 22 D) 0.2 Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 3) Canadian businesses get their external funds primarily from ________.

A) bank loans B) bonds and commercial paper issues C) stock issues D) loans from nonbank financial intermediaries Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 4) Of the sources of external funds for nonfinancial businesses in Canada, loans from banks and other financial intermediaries account for ________ of the total.

A) 6 percent B) 40 percent C) 56 percent D) over 70 percent Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 1 .

5) Stocks and bonds supply less than ________ of the external funds for Canadian corporations need to finance their activities.

A) one-third B) one-quarter C) one-half D) two-thirds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 6) Of the sources of external funds for nonfinancial businesses in Canada, corporate bonds and commercial paper account for approximately ________ of the total.

A) 5 percent B) 10 percent C) 15 percent D) 50 percent Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 7) Of the following sources of external finance for Canadian nonfinancial businesses, the least important is ________.

A) loans from banks B) stocks C) bonds and commercial paper D) loans from other financial intermediaries Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 8) Of the sources of external funds for nonfinancial businesses in Canada, stocks account for approximately ________ of the total.

A) 2 percent B) 12 percent C) 20 percent D) 40 percent Answer: B Diff: 3 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system

2 .

9) Which of the following statements concerning external sources of financing for nonfinancial businesses in Canada is true?

A) Stocks are a far more important source of funds than are bonds.

B) Stocks and bonds, combined, supply less than one-half of external funding.

C) Financial intermediaries are the least important source of external funds for businesses.

D) Since 1970, more than half of the new issues of stock have been sold to Canadian households.

Answer: B Diff: 2 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 10) Which of the following statements concerning external sources of financing for nonfinancial businesses in Canada is true?

A) Issuing marketable securities is the primary way that they finance their activities.

B) Bonds are the least important source of external funds to finance their activities.

C) Stocks are a relatively unimportant source of finance for their activities.

D) Selling bonds directly to Canadian households is a major source of funding for Canadian businesses.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 11) Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds ________.

A) by issuing stock B) by issuing bonds C) from nonbank loans D) from bank loans Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 12) As a source of funds for nonfinancial businesses, bonds are relatively more important than stocks in ________.

A) Canada B) Germany C) Japan D) the United States Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system

3 .

13) Direct finance involves the sale to ________ of marketable securities such as stocks and bonds.

A) households B) insurance companies C) pension funds D) financial intermediaries Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 14) Regulation of the financial system ________.

A) occurs only in Canada B) protects the jobs of employees of financial institutions C) protects the wealth of owners of financial institutions D) ensures the stability of the financial system Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 15) One purpose of regulation of financial markets is to ________.

A) limit the profits of financial institutions B) increase competition among financial institutions C) promote the provision of information to shareholders, depositors and the public D) guarantee that the maximum rates of interest are paid on deposits Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 16) Property that is pledged to the lender if a borrower cannot make his or her debt payment is called ________.

A) collateral B) points C) interest D) good faith money Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system

4 .

17) Collateralized debt is also known as ________.

A) unsecured debt B) secured debt C) unrestricted debt D) promissory debt Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 18) Credit card debt is ________.

A) secured debt B) unsecured debt C) restricted debt D) unrestricted debt Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 19) The predominant form of household debt is ________.

A) consumer installment debt B) collateralized debt C) unsecured debt D) unrestricted debt Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 20) If you default on your auto loan, your car will be repossessed because it has been pledged as ________ for the loan.

A) interest B) collateral C) dividend D) commodity Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system

5 .

21) Commercial and farm mortgages, in which property is pledged as collateral, account for ________.

A) one-quarter of borrowing by nonfinancial businesses B) one-half of borrowing by nonfinancial businesses C) one-twentieth of borrowing by nonfinancial businesses D) two-thirds of borrowing by nonfinancial businesses Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 22) A ________ is a provision that restricts or specifies certain activities that a borrower can engage in.

A) residual claimant B) risk hedge C) restrictive barrier D) restrictive covenant Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 23) A clause in a mortgage loan contract requiring the borrower to purchase homeowner's insurance is an example of a ________.

A) proscriptive covenant B) prescriptive covenant C) restrictive covenant D) constraint-imposed covenant Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 24) Which of the following is not one of the eight basic puzzles about financial structure?

A) Stocks are the most important source of finance for Canadian businesses.

B) Issuing marketable securities is not the primary way businesses finance their operations.

C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.

D) Banks are the most important source of external funds to finance businesses.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system

6 .

25) Which of the following is not one of the eight basic puzzles about financial structure?

A) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower.

B) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.

C) Collateral is a prevalent feature of debt contracts for both households and business.

D) There is very little regulation of the financial system.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 8.1 Identify eight basic facts about the global financial system 8.2 Transaction Costs 1) The current structure of financial markets is at least partly the result of attempts by financial market participants to ________.

A) adapt to continually changing government regulations B) deal with the great number of small firms in the United States C) reduce transaction costs D) cartelize the provision of financial services Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 2) The two ways financial intermediaries can reduce transactions costs are ________ and ________.

A) economies of scale; expertise B) moral hazard; adverse selection C) direct finance; indirect finance D) stocks; bonds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 3) The reduction in transactions costs per dollar invested as the size of transactions increases is known as ________.

A) discounting B) economies of scale C) economies of trade D) diversification Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 7 .

4) Which of the following is not a benefit to an individual when purchasing a mutual fund?

A) Reduced risk B) Lower transactions costs C) Free-riding D) Diversification Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 5) Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs.

A) expertise B) diversification C) regulations D) equity Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 6) Financial intermediaries' low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions.

A) liquidity B) conduction C) transcendental D) equitable Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 7) A solution to high transaction costs is to bundle the funds of many investors so that they can take advantage of the ________ that result.

A) economies of scale B) high interest rates C) high rates of return D) lower risk Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries

8 .

8) To reduce transaction cost, the students in your class have decided to pool their money to buy one bond and then distribute its return among themselves. This strategy is an example of ________.

A) economies of scale B) a cooperative game C) risk sharing D) moral hazard Answer: A Diff: 2 Type: MC Skill: Applied Objective: 8.2 Summarize how transaction costs affect financial intermediaries 9) Financial intermediaries can reduce transaction costs through ________ and ________.

A) economies of scale; expertise B) restrictive covenants; unsecured debts C) moral hazard; adverse selection D) economies of scale; regulation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 10) Liquidity service offered by financial intermediary make it ________.

A) easier for customers to conduct transactions B) more difficult to undertake indirect financial transactions C) easier to monitor restrictive covenants D) more difficult to conduct transactions Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries 11) How does a mutual fund lower transactions costs through economies of scale?

Answer: The mutual fund takes the funds of the individuals who have purchased shares and uses them to purchase bonds or stocks. Because the mutual fund will be purchasing large blocks of stocks or bonds they will be able to obtain them at lower transactions costs than the individual purchases of smaller amounts could.

Diff: 2 Type: ES Skill: Recall Objective: 8.2 Summarize how transaction costs affect financial intermediaries

9 .

8.3 Asymmetric Information: Adverse Selection and Moral Hazard 1) A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is known as ________.

A) moral hazard B) asymmetric information C) noncollateralized risk D) adverse selection Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 2) The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets.

A) noncollateralized risk B) free-riding C) asymmetric information D) costly state verification Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 3) The problem created by asymmetric information before the transaction occurs is known as________, while the problem created after the transaction occurs is known as ________.

A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard

10 .

4) If bad credit risks are the ones who most likely borrow, then financial intermediaries face the problem of ________.

A) moral hazard B) adverse selection C) free-riding D) costly state verification Answer: B Diff: 2 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 5) An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds.

A) moral hazard B) adverse selection C) costly state verification D) agency Answer: A Diff: 2 Type: MC Skill: Applied Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 6) The analysis of how asymmetric information problems affect economic behavior is called ________ theory.

A) uneven B) parallel C) principal D) agency Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 7) Nobel prize winner George Akerlof is associated with the "________ problem."

A) lemons B) efficient markets C) riskiness D) volatility Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 11 .

8) In the absence of asymmetric information, the lemons problem ________.

A) goes away B) becomes worse C) is not important D) remains the same Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 9) The solution to the adverse selection problem in financial markets is to ________.

A) supply lenders with full details on the borrowers B) supply borrowers with full details on the lenders C) supply governmental agencies with financial information D) produce more free riders Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 10) The remedies for the adverse selection include all but the following.

A) Private production and sale of information B) Free-riding C) Government regulation D) Financial intermediation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 11) ________ occurs when one party to a transaction has information about a hidden feature and takes advantage of this situation by engaging in a transaction with less informed parties.

A) Adverse selection B) Moral hazard C) Transactions costs D) Free-riding Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard

12 .

12) ________ occurs when an informed party takes a hidden (unobserved) action that harms the less-informed party.

A) Adverse selection B) Moral hazard C) Transactions costs D) Free-riding Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 13) Explain the problem of asymmetric information, adverse selection and moral hazard, and why these problems are important for the financial system.

Answer: Asymmetric information is an imbalance of information between two parties to a contract. In financial markets, lenders know less about a borrower's planned use of the lender's funds than does the lender. The problem of adverse selection arises when the least qualified individuals are more likely to apply for loans. This is a problem that exists prior to making a loan. Moral hazard is a problem that exists after a loan has been made. This is the problem that the borrower will take excessive risks, or behave in ways that jeopardize repayment of a loan.

These problems exist for all financial contracts.

Diff: 3 Type: ES Skill: Recall Objective: 8.3 Describe why asymmetric information leads to adverse selection and moral hazard 8.4 The Lemons Problem: How Adverse Selection Influences Financial Structure 1) Bundling investors funds together ________.

A) increases transactions costs per dollar of investment B) reduces transaction costs per dollar of investment C) increases moral hazard D) explains why stocks are the most import means of external financing for Canadian businesses Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 2) The "lemons problem" is a term used to describe the ________.

A) moral hazard problem B) adverse selection problem C) free-rider problem D) the diversification problem Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 13 .

3) Because of the "lemons problem" the price one must pay for a used car is ________.

A) equal to the price of a lemon B) less than the price of a lemon C) equal to the price of a peach D) between the price of a lemon and a peach Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 4) 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) the lender's inability to restrict the borrower from changing his behavior once given a loan Answer: A Diff: 3 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 5) The "lemons problem" exists because of ________.

A) transactions costs B) economies of scale C) rational expectations D) asymmetric information Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 6) The ________ problem helps to explain why the private production and sale of information cannot eliminate ________.

A) free-rider; adverse selection B) free-rider; moral hazard C) principal-agent; adverse selection D) principal-agent; moral hazard Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced

14 .

7) The free-rider problem occurs because ________.

A) people who pay for information use it freely B) people who do not pay for information yet manage to use it anyway C) information can never be sold at any price D) it is never profitable to produce information Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 8) With regard to external sources of financing for nonfinancial businesses in Canada, which of the following are accurate statements?

A) Direct finance accounts for a larger share of external business financing than indirect finance.

B) Since 1970, most of the newly issued corporate bonds and commercial paper have been sold directly to households.

C) Indirect finance accounts for a larger share of external business financing than direct finance.

D) Smaller businesses almost always raise funds by issuing marketable securities.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 9) Government agencies require that firms that sell securities in public markets adhere to ________.

A) intermediation rules B) nondisclosure clauses C) independent audits D) collateral rules Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 10) Government regulations require publicly traded firms to provide information thus reducing ________.

A) transactions costs B) the need for diversification C) the adverse selection problem D) the benefits of economies of scale Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced

15 .

11) A lesson learned from the Enron collapse is that government regulation ________.

A) always fails B) can reduce but not eliminate asymmetric information C) increases the problem of asymmetric information D) should be reduced Answer: B Diff: 3 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 12) Adverse selection ________.

A) is a problem stemming from symmetric information B) occurs after the transaction C) is not important in financial markets D) explains why large firms are more likely to obtain funds from securities markets Answer: D Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 13) 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 in the market for used cars B) are able to prevent potential competitors from free-riding off the information that they provide C) have failed to solve the adverse selection problem in this market because "lemons" continue to be traded D) have solved the moral hazard problem by providing valuable information to their customers Answer: B Diff: 3 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 14) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries ________.

A) have solved the moral hazard problem created by the consumers in the market for used cars B) are not able to prevent others from free-riding off the information that they provide C) help solve the adverse selection problem D) only sell "lemons" Answer: C Diff: 3 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced

16 .

15) Analysis of adverse selection indicates that financial intermediaries, especially banks, ________.

A) have an inherent advantage in overcoming the free-rider problem, thus explaining why indirect finance is a more important source of business finance than is direct finance B) despite their success in overcoming the free-ride problems, nevertheless play a minor role in moving funds to corporations C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on new issues of marketable securities D) must buy securities from corporations to diversify the risk that results from holding nontradable loans Answer: A Diff: 3 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 16) The concept of adverse selection helps to explain all the following EXCEPT ________.

A) why firms are more likely to obtain funds from banks and other financial intermediaries, rather than through the securities markets B) why indirect finance is more important than direct finance as a source of business finance C) why direct finance is more important than indirect finance as a source of business finance D) why the financial system is so heavily regulated compared to other industries Answer: C Diff: 3 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 17) The problem of adverse selection helps to explain ________.

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets B) why direct finance is more important than indirect finance as a source of business finance C) why collateral is not an important feature of debt contracts D) why banks prefer to make unsecured loans Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 18) The problem of adverse selection helps to explain ________.

A) why banks prefer to make unsecured loans B) why banks do not have advantage in raising funds for businesses C) why borrowers are willing to offer collateral to secure their promises to repay loans D) why the financial system is so heavily regulated Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 17 .

19) As information technology improves, the lending role of financial institutions such as banks should ________.

A) increase somewhat B) decrease C) stay the same D) increase significantly Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 20) That only large, well-established corporations have access to securities markets ________.

A) explains why indirect finance is such an important source of external funds for businesses B) can be explained by the problem of moral hazard C) can be explained by government regulations that prohibit small firms from acquiring funds in securities markets D) explains why newer and smaller corporations rely so heavily on the new issues market to obtain funds Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 21) Because of the adverse selection problem, ________.

A) good credit risks are more likely to seek loans causing lenders to make a disproportionate amount of loans to good credit risks B) lenders may refuse loans to individuals with a high net worth, because of their greater proclivity to "skip town" C) lenders are reluctant to make loans that are not secured by collateral D) lenders will write debt contracts that restrict certain activities of borrowers Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 22) Net worth can perform a similar role to ________.

A) diversification B) collateral C) intermediation D) economies of scale Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced

18 .

23) Government regulations require publicly traded firms to provide information, reducing ________.

A) transactions costs B) the need for diversification C) the adverse selection problem D) free-riders Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 24) The concept of adverse selection helps explain ________.

A) why collateral is not a common feature of many debt contracts B) why large, well-established corporations find it so difficult to borrow funds in securities markets C) why financial markets are among the most heavily regulated sectors of the economy D) why stocks are the most important source of external financing for businesses Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 25) How does collateral help to reduce the adverse selection problem in credit market?

Answer: Collateral is property that is promised to the lender if the borrower defaults thus reducing the lender's losses. Lenders are more willing to make loans when there is collateral that can be sold if the borrower defaults.

Diff: 1 Type: ES Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 26) Explain the "lemons problem" as it applies to the used-car market. Why does this problem exist? How does this market resolve this problem?

Answer: The lemons problem exists because of asymmetric information. Buyers of used cars do not know if cars are lemons (bad) or peaches (good). The market price will be an average of the price of a lemon and a peach. Because of this, owners of lemons are more likely to sell their cars, an example of adverse selection. The resolution to this problem is that dealers (intermediaries) sell most used cars. Dealers specialize in the production of information about used cars. They can use this information to provide guarantees or develop a reputation for selling quality used cars. Dealers help solve the adverse selection problem in the used car market.

Diff: 3 Type: ES Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced

19 .

27) Using Enron as an example, explain how government regulation can lessen asymmetric information problems but not eliminate them.

Answer: The government can regulate firms and require them to have independent audits and disclose the results but as shown by the collapse of Enron, this is not 100 percent effective. That firm had a complex set of transactions hidden from the auditors and eventually the financial instability led to its collapse.

Diff: 2 Type: ES Skill: Recall Objective: 8.4 Recognize adverse selection and summarize ways in which it can be reduced 8.5 How Moral Hazard Affects the Choice Between Debt and Equity Contracts 1) Equity contracts ________.

A) are claims to a share in the profits and assets of a business B) have the advantage over debt contracts of a lower costly state verification C) are used much more frequently to raise capital than are debt contracts D) are not subject to the moral hazard problem Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 2) A problem for equity contracts is a particular type of ________ called the ________ problem.

A) adverse selection; principal-agent B) moral hazard; principal-agent C) adverse selection; free-rider D) moral hazard; free-rider Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 3) Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer.

A) principal-agent B) adverse selection C) free-rider D) debt deflation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it

20 .

4) Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do.

A) principals; agents B) principals; principals C) agents; agents D) agents; principals Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 5) The principal-agent problem ________.

A) occurs when managers have more incentive to maximize profits than the stockholders-owners do B) in financial markets helps to explain why equity is a relatively important source of finance for Canadian business C) would not arise if the owners of the firm had complete information about the activities of the managers D) explains why direct finance is more important than indirect finance as a source of business finance Answer: C Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 6) The principal-agent problem ________.

A) arises because principals have incentives to free-ride off the monitoring activities paid for by other principals B) arises because principals find it simple to monitor agents' activities C) arises because agents' incentives are always compatible with those of the principals D) arises because principals' incentives are always compatible with those of the agents Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it

21 .

7) The Enron and Tyco scandals are an example of ________.

A) the free-rider problem B) the adverse selection problem C) the principal-agent problem D) the "lemons problem" Answer: C Diff: 2 Type: MC Skill: Applied Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 8) The name economists give to the process by which stockholders gather information by frequent monitoring of the firm's activities is ________.

A) costly state verification B) the free-rider problem C) costly avoidance D) debt intermediation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 9) Because information is scarce ________.

A) this helps explain why equity contracts are used so much more frequently to raise capital than are debt contracts B) the monitoring process can give rise to costly state verification C) government regulations, such as standard accounting principles, have no impact on problems such as moral hazard D) developing nations do not rely heavily on banks for business financing Answer: B Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 10) Government regulations designed to reduce the moral hazard problem include ________.

A) laws that force firms to adhere to standard accounting principles B) light sentences for those who commit the fraud of hiding or stealing profits C) state verification subsidies D) state licensing restrictions Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 22 .

11) Venture capital firms have been important in developing the ________ sector in Canada.

A) financial B) high tech C) oil and gas D) government Answer: B Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 12) One financial intermediary in our financial structure that helps to reduce the moral hazard problem arising from the principal-agent problem is the ________.

A) venture capital firm B) money market mutual fund C) pawn broker D) savings and loan association Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 13) A venture capital firm protects its equity investment from the moral hazard problem through which of the following means?

A) It places people on the board of directors to better monitor the borrowing firm's activities.

B) It writes contracts that prohibit the sale of an equity investment to the venture capital firm.

C) It prohibits the borrowing firm from replacing its management team.

D) It requires a 50 percent stake in the company.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 14) Equity contracts account for a small fraction of external funds raised by Canadian businesses because ________.

A) costly state verification makes the equity contract less desirable than the debt contract B) of the reduced scope for moral hazard problems under equity contracts, as compared to debt contracts C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt D) there is no moral hazard problem when using a debt contract Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 23 .

15) Debt contracts ________.

A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals B) have a higher cost of state verification than equity contracts C) are used less frequently to raise capital than are equity contracts D) never result in a loss for the lender Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 16) Since they require less monitoring of firms, ________ contracts are used more frequently than ________ contracts to raise capital.

A) debt; equity B) equity; debt C) debt; loan D) equity; stock Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 17) Explain the principal-agent problem as it pertains to equity contracts.

Answer: The principals are the stockholders who own most of the equity. The agents are the managers of the firm who generally own only a small portion of the firm. The problem occurs because the agents may not have as much incentive to profit maximize as the stockholders.

Diff: 1 Type: ES Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it 18) Explain the four tools that can help solve the principal-agent problem.

Answer: These are: production of information monitoring, government regulation to increase information, financial intermediation and debt contracts.

Diff: 1 Type: ES Skill: Recall Objective: 8.5 Recognize the principle-agent problem arising from moral hazard in equity contracts and summarize methods for reducing it

24 .

8.6 How Moral Hazard Influences Financial Structure in Debt Marketsw section 1) Although debt contracts require less monitoring than equity contracts, debt contracts are still subject to ________ since borrowers have an incentive to take on more risk than the lender would like.

A) moral hazard B) agency theory C) diversification D) the "lemons" problem Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 2) A debt contract is incentive-compatible ________.

A) if the borrower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the borrower's net worth in the business B) if the borrower's net worth is sufficiently low so that the lender's risk of moral hazard is significantly reduced C) if the debt contract is treated like an equity D) if the lender has the incentive to behave in the way that the borrower expects and desires Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 3) High net worth helps to diminish the problem of the moral hazard problem by ________.

A) requiring the state to verify the debt contract B) collateralizing the debt contract C) making the debt contract incentive compatible D) giving the debt contract characteristics of equity contracts Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 4) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it ________.

A) collateralizes the debt contract B) makes the debt contract incentive compatible C) state verifies the debt contract D) removes all the risk in the debt contract Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 25 .

5) Which of the following is not one of the four types of restrictive covenants?

A) Covenants to discourage undesirable behaviour B) Covenants to encourage desirable behaviour C) Covenants to keep collateral valuable D) Covenants for incentive-compatibility Answer: D Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 6) A clause in a debt contract requiring that the borrower purchase insurance against loss of the asset financed with the loan is called a ________.

A) collateral-insurance clause B) prescription covenant C) restrictive covenant D) proscription covenant Answer: C Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 7) Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are ________.

A) limited-liability clauses B) risk insurance C) restrictive covenants D) illegal Answer: C Diff: 1 Type: MC Skill: Applied Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 8) For restrictive covenants to help reduce the moral hazard problem they must be ________ by the lender.

A) monitored and enforced B) written in all capitals C) easily changed D) impossible to remove Answer: A Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts

26 .

9) Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that ________.

A) borrowers may find loopholes that make the covenants ineffective B) they are inexpensive to monitor and enforce C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate others' monitoring and enforcement efforts D) they reduce the value of the debt contract Answer: A Diff: 2 Type: MC Skill: Applied Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 10) Solutions to the moral hazard problem include ________.

A) low net worth B) monitoring and enforcement of restrictive covenants C) greater reliance on equity contracts and less on debt contracts D) greater reliance on debt contracts than financial intermediaries Answer: B Diff: 1 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 11) A key finding of the economic analysis of financial structure is that ________.

A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses B) while free-rider problems limit the extent to which securities markets finance some business activities, nevertheless most funds going to businesses are channeled through securities markets C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets D) economists do not have a very good explanation for why securities markets are so heavily regulated Answer: A Diff: 3 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 12) One reason financial systems in developing and transition countries are underdeveloped is ________.

A) they have weak links to their governments B) they make loans only to non-profit organizations C) the legal system may be underfunded making it difficult to enforce restrictive covenants D) the accounting standards are so stringent that the banks cannot meet them Answer: C Diff: 3 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 27 .

13) One reason China has been able to grow so rapidly even though its financial development is still in its early stages is ________.

A) the high savings rate of around 40 percent B) the shift of labour to the agricultural sector C) the stringent enforcement of financial contracts D) the ease of obtaining high-quality information about creditors Answer: A Diff: 3 Type: MC Skill: Applied Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 14) China's reforms to strengthen the financial system includes ________.

A) privatizing state-owned banks B) diluting legal reforms C) industrializing the labour force D) maintaining a highly agrarian labour force Answer: A Diff: 2 Type: MC Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 15) How do restrictive covenants reduce moral hazard in debt contracts?

Answer: Restrictive covenants keep borrowers from taking excessive risks. Restrictive covenants can encourage desirable behaviour, such as buying insurance to repay the loan in case of death of the borrower and maintaining high net worth. Covenants encourage the borrower to keep collateral valuable, including purchasing insurance to protect assets against risk of loss.

Covenants require borrowers to provide information about activities, including accounting and income reports. This reduces moral hazard.

Diff: 2 Type: ES Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 16) Why does the free-rider problem occur in the debt market?

Answer: Restrictive covenants can reduce moral hazard, but they must be monitored and enforced to be effective. If bondholders know that other bondholders are monitoring and enforcing the restrictive covenants, they can free ride. Other bondholders will follow suit resulting in not enough resources devoted to monitoring and enforcing restrictive covenants.

Diff: 1 Type: ES Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 17) Explain how high net worth and collateral reduce the problem of moral hazard.

Answer: High net worth and collateral makes the debt contract incentive-compatible by aligning the incentives of the borrowers with those of the lenders.

Diff: 1 Type: ES Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts 28 .

18) Explain the difference between net worth and collateral.

Answer: Net worth is the difference between a borrower's assets and liabilities. Collateral represents assets pledged to the lender.

Diff: 2 Type: ES Skill: Recall Objective: 8.6 Summarize the methods used to reduce moral hazard in debt contracts

29 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 9 Economic Analysis of Financial Regulation 9.1 Asymmetric Information and the Government Safety Net 1) When depositors lack of information about the quality of bank assets it can lead to ________.

A) bank panics B) bank booms C) sequencing D) asset transformation Answer: A Diff: 1 Type: MC Skill: Applied Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 2) Deposit insurance covers deposits up to $100,000, but as part of a doctrine called "too-big-tofail" the CDIC sometimes ends up covering all deposits to avoid disrupting the financial system.

When the CDIC does this, it uses the ________.

A) "payoff" method B) "purchase and assumption" method C) "inequity" method D) "Basel" method Answer: B Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 3) The fact that banks operate on a "sequential service constraint" means that ________.

A) all depositors share equally in the bank's funds during a crisis B) depositors arriving last are just as likely to receive their funds as those arriving first C) depositors arriving first have the best chance of withdrawing their funds D) banks randomly select the depositors who will receive all of their funds Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets

1 .

4) Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a ________.

A) last-in, first-out constraint B) sequential service constraint C) double-coincidence of wants constraint D) everyone-shares-equally constraint Answer: B Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 5) Because of asymmetric information, the failure of one bank can lead to runs on other banks.

This is the ________.

A) too-big-to-fail effect B) moral hazard problem C) adverse selection problem D) contagion effect Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 6) The contagion effect refers to the fact that ________.

A) deposit insurance has eliminated the problem of bank failures B) bank runs involve only sound banks C) bank runs involve only insolvent banks D) the failure of one bank can hasten the failure of other banks Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 7) To prevent bank runs and the consequent bank failures, the Canada established the ________ to provide deposit insurance.

A) CDIC B) OSC C) Bank of Canada D) ATM Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 2 .

8) Deposit insurance is a guarantee by the CDIC to pay deposits off in full on the first ________ they have in deposits in a bank.

A) $60000 B) $200,000 C) $100,000 D) $150,000 Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 9) The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is ________.

A) that the CDIC guarantees all deposits when it uses the "payoff" method B) that the CDIC guarantees all deposits when it uses the "purchase and assumption" method C) that the CDIC is more likely to use the "payoff" method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures D) that the CDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions Answer: B Diff: 3 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 10) Deposit insurance has not worked well in countries with ________.

A) a weak institutional environment B) strong supervision and regulation C) a tradition of the rule of law D) few opportunities for corruption Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets

3 .

11) When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of ________.

A) moral hazard B) split incentives C) ex ante shirking D) pre-contractual opportunism Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 12) Moral hazard is an important concern of insurance arrangements because the existence of insurance ________.

A) provides increased incentives for risk taking B) is a hindrance to efficient risk taking C) causes the private cost of the insured activity to increase D) creates an adverse selection problem Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 13) When bad drivers line up to purchase collision insurance, automobile insurers are subject to the ________.

A) moral hazard problem B) adverse selection problem C) assigned risk problem D) ill queue problem Answer: B Diff: 1 Type: MC Skill: Applied Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 14) Deposit insurance is only one type of government safety net. All the following are types of government support for troubled financial institutions EXCEPT ________.

A) forgiving tax debt B) lending from the central bank C) lending directly from the government's treasury department D) nationalizing and guaranteeing that all creditors will be repaid their loans in full Answer: A Diff: 3 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 4 .

15) Although the CDIC was created to prevent bank failures, its existence encourages banks to ________.

A) take too much risk B) hold too much capital C) open too many branches D) buy too much stock Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 16) A system of deposit insurance ________.

A) attracts risk-taking entrepreneurs into the banking industry B) encourages bank managers to decrease risk C) increases the incentives of depositors to monitor the riskiness of their bank's asset portfolio D) increases the likelihood of bank runs Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 17) The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry.

A) an adverse selection B) a moral hazard C) a lemons D) a revenue Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 18) Since depositors, like any lender, only receive fixed payments while the bank keeps any surplus profits, they face the ________ problem that banks may take on too ________ risk.

A) adverse selection; little B) adverse selection; much C) moral hazard; little D) moral hazard; much Answer: D Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 5 .

19) The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance ________.

A) are likely to take on greater risks than they otherwise would B) are likely to be too conservative, reducing the probability of turning a profit C) are likely to regard deposits as an unattractive source of funds due to depositors' demands for safety D) are placed at a competitive disadvantage in acquiring funds Answer: A Diff: 3 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 20) When the CDIC takes control of the bank, rather than liquidate it, it believes that the takeover ________.

A) was a good investment opportunity for the government B) could be part of a new governmentally owned banking system C) was too big to fail D) would become the center of the new central bank system Answer: C Diff: 3 Type: MC Skill: Applied Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 21) If the CDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses.

A) payoff; large B) payoff; no C) purchase and assumption; large D) purchase and assumption; no Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets

6 .

22) Acquiring information on a bank's activities to determine a bank's risk is difficult for depositors and is another argument for government ________.

A) regulation B) ownership C) recall D) forbearance Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 23) The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely.

A) small; fewer B) small; greater C) big; fewer D) big; greater Answer: D Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 24) A problem with the too-big-to-fail policy is that it ________ the incentives for ________ by big banks.

A) increases; moral hazard B) decreases; moral hazard C) decreases; adverse selection D) increases; adverse selection Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 25) The too-big-to-fail policy ________.

A) reduces moral hazard problems B) puts large banks at a competitive disadvantage in attracting large deposits C) treats large depositors of small banks inequitably when compared to depositors of large banks D) allows small banks to take on more risk than large banks Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 7 .

26) Regulators attempt to reduce the riskiness of banks' asset portfolios by ________.

A) limiting the amount of loans in particular categories or to individual borrowers B) encouraging banks to hold risky assets such as common stocks C) establishing a minimum interest rate floor that banks can earn on certain assets D) requiring collateral for all loans Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 27) According to the World Bank, the adoption of explicit government deposit insurance is associated with ________ banking sector stability and a ________ incidence of banking crises.

A) less; lower B) more; lower C) more; higher D) less; higher Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets 28) The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.

Answer: The adverse selection problem occurs because risk-loving individuals might view the banking system as a wonderful opportunity to use other peoples' funds knowing that those funds are protected. The moral hazard problem comes about because depositors will not impose discipline on the banks since their funds are protected and the banks knowing this will be tempted to take on more risk than they would otherwise.

Diff: 2 Type: ES Skill: Recall Objective: 9.1 Identify the reasons for and the forms of a government safety net in financial markets

8 .

9.2 Types of Financial Regulation 1) A bank failure is less likely to occur when ________.

A) a bank holds less government securities B) a bank suffers large deposit outflows C) a bank holds fewer excess reserves D) a bank has more bank capital Answer: D Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 2) The leverage ratio is the ratio of a bank's ________.

A) assets divided by its liabilities B) income divided by its assets C) capital divided by its total assets D) capital divided by its total liabilities Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 3) To be considered well capitalized, a bank's leverage ratio must exceed ________.

A) 10 percent B) 8 percent C) 5 percent D) 3 percent Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 4) Off-balance-sheet activities ________.

A) generate fee income with no increase in risk B) increase bank risk but do not increase income C) generate fee income but increase a bank's risk D) generate fee income and reduce risk Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

9 .

5) The Basel Accord, an international agreement, requires banks to hold capital based on ________.

A) risk-weighted assets B) the total value of assets C) liabilities D) deposits Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 6) The Basel Accord requires banks to hold as capital an amount that is at least ________ of their risk-weighted assets.

A) 10 percent B) 8 percent C) 5 percent D) 3 percent Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 7) Under the Basel Accord, assets and off-balance sheet activities were sorted according to ________ categories with each category assigned a different weight to reflect the amount of ________.

A) 2; adverse selection B) 2; credit risk C) 4; adverse selection D) 4; credit risk Answer: D Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

10 .

8) The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same capital requirement is known as ________.

A) competition in laxity B) depositor supervision C) regulatory arbitrage D) a dual banking system Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 9) Agreements such as the ________ are attempts to standardize international banking regulations.

A) Basel Accord B) UN Bank Accord C) GATT Accord D) WTO Accord Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 10) Banks engage in regulatory arbitrage by ________.

A) keeping high-risk assets on their books while removing low-risk assets with the same capital requirement B) keeping low-risk assets on their books while removing high-risk assets with the same capital requirement C) hiding risky assets from regulators D) buying risky assets from arbitragers Answer: A Diff: 3 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

11 .

11) Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in ________.

A) reduced risk taking by banks B) reduced supervision of banks by regulators C) increased fraudulent behavior by banks D) increased risk taking by banks Answer: D Diff: 3 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 12) Overseeing who operates banks and how they are operated is called ________.

A) prudential supervision B) hazard insurance C) regulatory interference D) loan loss reserves Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 13) The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem.

A) adverse selection; adverse selection B) adverse selection; moral hazard C) moral hazard; adverse selection D) moral hazard; moral hazard Answer: B Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 14) The chartering process is like ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets.

A) screening; restrictive covenants B) screening; branching restrictions C) identifying; branching restrictions D) identifying; credit rationing Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 12 .

15) Banks will be examined at least once a year and given a CAMELS rating by examiners. The L stands for ________.

A) liabilities B) liquidity C) loans D) leverage Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 16) Bank examiners include ________.

A) the Bank of Canada B) Canada Revenue Agency C) the OSC D) the Department of Finance Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 17) Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth.

A) call reports B) balance reports C) regulatory sheets D) examiner updates Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 18) Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry.

A) moral hazard B) adverse selection C) ex post shirking D) post-contractual opportunism Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 13 .

19) The current supervisory practice toward risk management ________.

A) focuses on the quality of a bank's balance sheet B) determines whether capital requirements have been met C) evaluates the soundness of a bank's risk-management process D) focuses on eliminating all risk Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 20) Regulations designed to provide information to the marketplace so that investors can make informed decisions are called ________.

A) disclosure requirements B) efficient market requirements C) asset restrictions D) capital requirements Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 21) With ________, firms value assets on their balance sheet at what they would sell for in the market.

A) mark-to-market accounting B) book-value accounting C) historical-cost accounting D) off-balance sheet accounting Answer: A Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

14 .

22) During times of financial crisis, mark-to-market accounting ________.

A) requires that a financial firms' assets be marked down in value which can worsen the lending crisis B) leads to an increase in the financial firms' balance sheets since they can now get assets at bargain prices C) leads to an increase in financial firms' lending D) results in financial firms' assets increasing in value Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 23) Consumer protection legislation includes legislation to ________.

A) require banks to make loans to everyone who applies B) reduce the amount of interest that banks can charge on loans C) require banks to make periodic reports to the Better Business Bureau D) reduce discrimination in credit markets Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 24) Competition among banks ________.

A) encourages conservative bank management B) increases bank profitability C) encourages greater risk taking D) eliminates the need for government regulation Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 25) An important factor in producing the subprime mortgage crisis was ________.

A) lax consumer protection regulation B) onerous rules placed on mortgage originators C) weak incentives for mortgage brokers to use complicated mortgage products D) strong incentives for the mortgage brokers to verify income information Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

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26) Which of the following is not a reason financial regulation and supervision is difficult in real life?

A) Financial institutions have strong incentives to avoid existing regulations B) Unintended consequences may happen if details in the regulations are not precise C) Regulated firms lobby politicians to lean on regulators to ease the rules D) Financial institutions are not required to follow the rules Answer: D Diff: 3 Type: MC Skill: Applied Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 27) The ________ allowed chartered banks to own investment banking subsidiaries.

A) Bank of Canada Act B) Financial Institutions and Deposit Insurance System Amendment Act C) Bank Holding Company Act D) Monetary Control Act Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 28) Interest rate ceilings on loans were removed under which Bank Act? A) The Bank Act of 1954 B) The Bank Act of 1967 C) The Bank Act of 1981 D) The Bank Act of 1991 Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 29) Which of the following pieces of legislation is associated with the Bank Act of 1992?

A) Chartered banks were allowed to own investment banking subsidiaries.

B) Foreign banks were allowed to establish subsidiaries in Canada.

C) Reserve requirements for banks were phased out.

D) The 6% interest rate ceiling on loans was removed.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

16 .

30) Which of the following pieces of legislation is associated with the Bank Act of 1981?

A) Chartered banks were now allowed to own investment banking subsidiaries.

B) Foreign banks were allowed to establish subsidiaries in Canada.

C) Reserve requirements for banks were phased out.

D) The 6% interest rate ceiling on loans was removed.

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 31) Which of the following pieces of legislation is associated with the Bank Act of 1981?

A) Chartered banks were allowed to own investment banking subsidiaries.

B) Reserve requirements on Canadian-dollar deposits were lowered.

C) Reserve requirements for banks were phased out.

D) The 6% interest rate ceiling on loans was removed.

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 32) Which of the following pieces of legislation is associated with the Bank Act of 1967?

A) Chartered banks were allowed to own investment banking subsidiaries.

B) Reserve requirements on Canadian-dollar deposits were lowered.

C) Reserve requirements for banks were phased out.

D) The 6% interest rate ceiling on loans was removed.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 33) Banking regulation suffers from the principal-agent problem. Describe how this problem relates to regulators and politicians.

Answer: Taxpayers are the principals, and regulators and politicians are the agents. Regulators want to escape blame for poor performance, so they have incentives to loosen capital requirements and practice forbearance, the opposite of what they should do. Regulators must also please politicians, who in turn receive contributions from the banks being regulated. Thus, politicians may pressure regulators to practice forbearance, and fail to address problems if resolving problems conflicts with their personal interests.

Diff: 2 Type: ES Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems

17 .

34) What is the "too-big-to-fail" policy of the CDIC? how is it associated with asymmetric information problems?

Answer: Students must explain that because the failure of a very large bank makes it more likely that a major financial disruption may occur, bank regulators are usually reluctant to allow a big bank to fail and cause losses to its depositors. Thus, the too-big-to-fail policy increases the moral hazard incentives of big banks as they know that they can take more risk as the CDIC will try and save them in case they encounter difficulties, instead of using the alternative payoff method according to which depositors are paid only up to $100,000 for their deposits in the event that the bank fails.

Diff: 2 Type: ES Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 35) What are the three pillars that Basel 2 is based on?

Answer: Pillar 1 links capital requirements for large, internationally active banks to three types of actual risk: market risk, credit risk, and operational risk. Pillar 2 focuses on strengthening the supervisory process. Pillar 3 focuses on improving market discipline through increased disclosure.

Diff: 2 Type: ES Skill: Recall Objective: 9.2 List and summarize the types of financial regulation and how each reduces asymmetric information problems 9.3 CDIC Deposit Insurance Coverage 1) The CDIC does not insure ________.

A) savings and chequing accounts B) term deposits with a maturity of less than 5 years C) money orders and drafts D) mutual funds Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 2) The primary rationale for deposit insurance is ________.

A) protecting depositors from bank insolvency B) increasing creditworthiness of subprime mortgages C) increasing barriers to entry in the banking industry to promote financial stability D) altering risk profiles of both banks and depositors Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 18 .

3) Among the following, which one does the CDIC not insure?

A) Cryptocurrencies B) Term deposits C) GICs D) Chequing accounts Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 4) In the 1998-1999 fiscal year, the flat rate insurance premium was ________.

A) 1/6 of 1 percent B) 1/4 of 1 percent C) 1/3 of 1 percent D) 1/2 of 1 percent Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 5) The Differential Premiums By-law came into effect for the premium year beginning ________.

A) May 1, 1999 B) January 1, 1999 C) May 31, 1999 D) December 31, 1999 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 6) CDIC premium revenue is ________.

A) the same for all deposit taking institutions B) vary from 15 cents to 20 cents per dollar C) based on the risk profile of the member institution D) capped at 15 cents for "worst" institutions Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions

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7) The Differential Premiums By-law classifies CDIC institutions according to their risk profile. ________ dominate the criteria.

A) Capital adequacy measures B) Quantitative aspects C) Qualitative aspects D) CAMELS rating Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 8) The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 1 was ________.

A) 3.0 percent B) 7.5 percent C) 15.0 percent D) 30.0 percent Answer: B Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 9) The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 2 was ________.

A) 3.0 percent B) 7.5 percent C) 15.0 percent D) 30.0 percent Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 10) The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 3 was ________.

A) 3.0 percent B) 7.5 percent C) 15.0 percent D) 30.0 percent Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 20 .

11) According to CDIC risk profiles, ________.

A) group 1 is the best and group 4 is the worst B) group 4 is the best and group 1 is the worst C) all banks are similar D) there is no way to distinguish between them Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 12) The 2017 premium rate (as a percentage of insured deposits) for member institutions in category 4 was ________.

A) 3.0 percent B) 7.5 percent C) 15.0 percent D) 33.33 percent Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 13) Bail-in is an important tool ________.

A) that relies on shareholder-funded capital injections to support failing institutions B) that allows OSFI to ensure failing institutions remain open while losses are covered by shareholders and certain investors C) that allows the CDIC to ensure failing institutions remain open while losses are covered by shareholders and certain investors D) that relies on taxpayer-funded capital injections to support failing institutions Answer: C Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions

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14) A bank's risk profile for the purpose of determining in which risk profile it should belong to is dominated by which of the following criteria?

A) Capital adequacy B) Income volatility C) Asset concentration D) Profitability Answer: A Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 15) By compensating only the insured depositors rather than all depositors, the opting-out legislation A) Increases the adverse selection problem.

B) Reduces the adverse selection problem.

C) Increases the moral hazard problem.

D) Reduces the moral hazard problem.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 16) What are the provisions under the October 15, 1999 Opting-Out By-law?

Answer: According to the By-law, Schedule III banks that accept primarily wholesale deposits (defined as $150,000 or more) could opt out of CDIC membership and therefore to operate without deposit insurance. The new legislation however includes provisions to protect depositors who hold deposits eligible for CDIC protection. These include the requirement for an opted out bank to inform all depositors by posting notices in its branches that their deposits will not be protected by the CDIC and not to charge any early withdrawal penalties for depositors who choose to withdraw.

Diff: 2 Type: ES Skill: Recall Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 17) Describe how the CDIC premiums have evolved over the past years.

Answer: CDIC premiums were fixed and unrelated to the risk profiles of the various member institutions. In 1999, the Differential Premiums By-Laws differentiated the premiums of member institutions according to a variety of both qualitative and quantitative aspects, dominated by capital adequacy measures.

Diff: 2 Type: ES Skill: Applied Objective: 9.3 Examine how the Canada Deposit Insurance Corporation (CDIC) provides deposit insurance in Canadian banks and savings institutions 22 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 10 Banking Industry: Structure and Competition 10.1 Historical Development of the Canadian Banking System 1) The modern Canadian banking system began with ________.

A) the Chartered Bank of Upper Canada in 1821 B) the Bank of Montreal in 1817 C) the Bank of Lower Canada in 1801 D) the Bank of New Brunswick in 1820 Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features 2) The government institution that has responsibility for money and credit supplied in the economy is the ________.

A) central bank B) commercial bank C) bank of settlement D) monetary fund Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features 3) Currency circulated by banks that could be redeemed for gold was is known as ________.

A) junk bonds B) banknotes C) gold bills D) state money Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features

1 .

4) The regulatory system that permitted the organization of a bank by any group that met certain criteria is known as a ________.

A) bilateral regulatory system B) tiered regulatory system C) two-tiered regulatory system D) free banking system Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features 5) The U.S. banking system is a dual system because ________.

A) banks offer both chequing and savings accounts B) it includes both banks and thrift institutions C) it is regulated by both state and federal governments D) it was established before the Civil War, requiring separate regulatory bodies for the North and South Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features 6) Which bank became the Canadian government's fiscal agent in 1864?

A) The Bank of Canada B) The Chartered Bank of Upper Canada C) The Bank of Montreal D) Scotia Bank Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features 7) The Finance Act of 1914 required that ________.

A) local banks be subject to the same regulations as national banks B) national banks establish branches in large cities C) the Department of Finance act as a lender of last resort D) the Bank of Canada act as a lender of last resort Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features

2 .

8) Explain how the dual banking system arose in the United States.

Answer: The modern US system because with all commercial banks being chartered by the state in which they operated. However lax banking laws led to bank failures. To eliminate the abuses that led to the failures, federally charged banks were created under the National Bank Act of 1863. As a result today, the US has dual banking system in which banks are supervised by either the state or the federal government.

Diff: 2 Type: ES Skill: Recall Objective: 10.1 Recognize the key features of the Canadian banking system and the historical context of the implementation of these features 10.2 Financial Innovation and the Growth of the "Shadow Banking System" 1) Financial innovations occur because of financial institutions search for ________.

A) profits B) more customers C) stability D) recognition Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 2) ________ is the process of researching and developing profitable new products and services by financial institutions.

A) Financial engineering B) Financial manipulation C) Customer manipulation D) Customer engineering Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 3) The most significant change in the economic environment that affected the demand for financial products in recent years has been ________.

A) the aging of the baby-boomer generation B) the dramatic increase in the volatility of interest rates C) the dramatic increase in competition from foreign banks D) the deregulation of financial institutions Answer: B Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 3 .

4) In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 5.5 percent; in the 1980s it fluctuated between ________ percent and ________ percent.

A) 7; 20 B) 4; 11.5 C) 4; 18 D) 5; 10 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 5) Uncertainty about interest-rate movements and returns is called ________.

A) market potential B) interest-rate irregularities C) interest-rate risk D) financial innovation Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 6) Rising interest-rate risk ________.

A) increased the cost of financial innovation B) increased the demand for financial innovation C) reduced the cost of financial innovation.

D) reduced the demand for financial innovation Answer: B Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 7) Adjustable-rate mortgages ________.

A) protect households against higher mortgage payments when interest rates rise B) keep financial institutions' earnings high even in times of falling interest rates C) benefit homeowners when interest rates are falling D) generally, have higher initial interest rates compared to conventional fixed-rate mortgages Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

4 .

8) The agreement to provide a standardized commodity to a buyer on a specific date at a predetermined future price is known as________.

A) a put option B) a call option C) a futures contract D) a mortgage-backed security Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 9) An instrument developed to help investors and institutions hedge interest-rate risk is ________.

A) a bond B) a sweep account C) a financial derivative D) a mortgage-backed security Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 10) Financial instruments whose payoffs are linked to previously issued securities are called ________.

A) real-return bonds B) financial derivatives C) hedge securities D) reversible bonds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 11) Both ________ and ________ were financial innovations that occurred because of interest rate risk volatility.

A) adjustable-rate mortgages; commercial paper B) adjustable-rate mortgages; financial derivatives C) sweep accounts; financial derivatives D) sweep accounts; commercial paper Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 5 .

12) The most important source of the changes in supply conditions that stimulate financial innovation has been the ________.

A) deregulation of financial institutions B) dramatic increase in the volatility of interest rates C) improvement in computer and telecommunications technology D) dramatic increase in competition from foreign banks Answer: C Diff: 3 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 13) New computer technology has ________.

A) increased the cost of financial innovation B) increased the demand for financial innovation C) reduced the cost of financial innovation D) reduced the demand for financial innovation Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 14) Credit cards date back to ________.

A) before the second World War B) just after the second World War C) the early 1950s D) the late 1950s Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 15) A firm issuing credit cards earns income from ________.

A) loans it makes to credit card holders B) subsidies from local governments C) payments made to it by manufacturers of the products that are sold in stores and purchased using a credit card.

D) sales of the card in foreign countries Answer: A Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 6 .

16) The entry of General Motors and Walmart into the credit card business is an indication of ________.

A) government's efforts to deregulate the provision of financial services B) the rising profitability of credit card operations C) the reduction in costs of credit card operations since 1990 D) the sale of unprofitable operations by the chartered banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 17) A debit card differs from a credit card in that ________.

A) a debit card is a loan while for a credit card the purchase is immediately deducted from the card holder's bank account B) a debit card is a long-term variable-rate loan while a credit card is a short-term loan C) a credit card is a loan while for a debit card the purchase is immediately deducted from the card holder's bank account D) a credit card is a long-term loan while a debit card is a short-term variable-rate loan Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 18) Automated teller machines (ATMs) ________.

A) are more costly to use than human tellers, so banks discourage their use by charging more for the use of ATMs B) cost about the same to use as human tellers in banks, so banks discourage their use by charging more for use of ATMs C) cost less than human tellers, so banks may encourage their use by charging less for using ATMs D) cost nothing to use, so banks provide their services free of charge Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

7 .

19) The declining cost of computer technology has made ________ a reality.

A) brick and mortar banking B) commercial banking C) virtual banking D) investment banking Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 20) Bank customers perceive Internet banks as being ________.

A) more secure than physical bank branches B) a better method for purchasing long-term savings products C) better at keeping customer information private D) prone to many more technical problems compared to a traditional brick-and-mortar bank Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 21) A disadvantage of virtual banks (clicks) is that ________.

A) their hours are more limited than physical banks B) they are more secure than physical banks C) they are more costly to operate than physical banks D) customers worry about the security of on-line transactions Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 22) So-called fallen angels differ from junk bonds in that ________.

A) junk bonds refer to newly issued bonds with low credit ratings, whereas fallen angels refer to previously bonds that have had their credit ratings fall below Baa B) junk bonds refer to previously bonds that have had their credit ratings fall below Baa, whereas fallen angels refer to newly issued bonds with low credit ratings C) junk bonds have ratings below Baa, whereas fallen angels have ratings below C D) fallen angels have ratings below Baa, whereas junk bonds have ratings below C Answer: A Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

8 .

23) Newly-issued high-yield bonds rated below investment grade by the bond-rating agencies are frequently referred to as ________.

A) municipal bonds B) Yankee bonds C) "fallen angels" D) junk bonds Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 24) In 1977, he pioneered the concept of selling new public issues of junk bonds for companies that had not yet achieved investment-grade status.

A) Michael Milken B) Roger Milliken C) Ivan Boskey D) Carl Ichan Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 25) One factor contributing to the rapid growth of the commercial paper market since 1970 is ________.

A) the fact that commercial paper has no default risk B) improved information technology making it easier to screen credit risks C) government regulation D) FDIC insurance for commercial paper Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 26) The development of money market mutual funds contributed to the growth of ________ since the money market mutual funds need to hold liquid, high-quality, short-terms assets.

A) the commercial paper market B) the municipal bond market C) the corporate bond market D) the junk bond market Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 9 .

27) The process of transforming otherwise illiquid financial assets into marketable capital market instruments is known as ________.

A) securitization B) internationalization C) arbitrage D) program trading Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 28) ________ is creating a marketable capital market instrument by bundling a portfolio of mortgage or auto loans.

A) Diversification B) Arbitrage C) Computerization D) Securitization Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 29) The driving force behind the securitization of mortgages and automobile loans has been ________.

A) the rising regulatory constraints on substitute financial instruments B) the desire of mortgage and auto lenders to exit this field of lending C) the improvement in computer technology D) the relaxation of regulatory restrictions on credit card operations Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

10 .

30) According to Edward Kane, because the banking industry is one of the most ________ industries in America, it is an industry in which ________ is especially likely to occur.

A) competitive; loophole mining B) competitive; innovation C) regulated; loophole mining D) regulated; innovation Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 31) Loophole mining refers to financial innovation designed to ________.

A) hide transactions from the CRA B) conceal transactions from the Bank of Canada C) get around regulations D) conceal transactions from the Department of Finance Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 32) Prior to 2008, bank managers in the U.S. looked on reserve requirements ________.

A) as a tax on deposits B) as a subsidy on deposits C) as a subsidy on loans D) as a tax on loans Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 33) Prior to 2008, a U.S. bank's cost of holding reserves equaled ________.

A) the interest paid on deposits times the amount of reserves B) the interest paid on deposits times the amount of deposits C) the interest earned on loans times the amount of loans D) the interest earned on loans times the amount on reserves Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

11 .

34) Prior to 1980, the Fed set an interest rate ________ that is a maximum limit on the interest rate that could be paid on time deposits.

A) floor B) ceiling C) wall D) window Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 35) The process in which people take their funds out of the banking system seeking higheryielding securities is called ________.

A) capital mobility B) loophole mining C) disintermediation D) deposit jumping Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 36) Money market mutual funds ________.

A) function as interest-earning chequing accounts B) are legally deposits C) are subject to reserve requirements D) have an interest-rate ceiling Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 37) In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in the situation known as "breaking the buck." This means that ________.

A) they could no longer afford to redeem shares at the par value of $1 B) they required shareholders to contribute a dollar more in fees each month C) shareholders were able to redeem shares for more than a $1 D) shares earned more than a dollar in interest Answer: A Diff: 3 Type: MC Skill: Applied Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 12 .

38) In this type of arrangement, any balances above a certain amount in a corporation's chequing account at the end of the business day are "removed" and invested in overnight securities that pay the corporation interest. This innovation is referred to as a ________.

A) sweep account B) share draft account C) removed-repo account D) stockman account Answer: A Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 39) Sweep accounts which were created to avoid reserve requirements became possible because of a change in ________.

A) demand conditions B) supply conditions C) government rules D) bank mergers Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 40) Sweep accounts ________.

A) have made reserve requirements nonbinding for many banks B) sweep funds out of deposit accounts into long-term securities C) enable banks to avoid paying interest to corporate customers D) reduce banks' assets Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

13 .

41) Financial innovation has caused ________.

A) banks to suffer declines in their cost advantages in acquiring funds, although it has not caused a decline in income advantages B) banks to suffer a simultaneous decline of cost and income advantages C) banks to suffer declines in their income advantages in acquiring funds, although it has not caused a decline in cost advantages D) banks to achieve competitive advantages in both costs and income Answer: B Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 42) Disintermediation resulted from ________.

A) interest rate ceilings combine with inflation-driven increases in interest rates B) elimination of Regulation Q (the regulation imposing interest rate ceilings on bank deposits) C) increases in federal income taxes D) reserve requirements Answer: A Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 43) The experience of disintermediation in the banking industry illustrates that ________.

A) more regulation of financial markets may avoid such problems in the future B) banks are unable to remain competitive with other financial intermediaries C) consumers no longer desire the services that banks provide D) markets invent alternatives to costly regulations Answer: D Diff: 2 Type: MC Skill: Applied Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 44) One factor contributing to the decline in cost advantages that banks once had is the ________.

A) decline in the importance of chequable deposits as part of a banks' source of funds B) decline in the importance of savings deposits as part of a banks' source of funds C) increase in the importance of chequable deposits as part of a banks' source of funds D) increase in the importance of savings deposits as part of a banks' source of funds Answer: A Diff: 2 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 14 .

45) Banks have attempted to maintain adequate profit levels by ________.

A) making fewer riskier loans, such as commercial real estate loans B) pursuing new off-balance-sheet activities C) increasing reserve deposits at the Bank of Canada D) decreasing capital accounts Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 46) The decline in traditional banking internationally can be attributed to ________.

A) increased regulation B) improved information technology C) increasing monopoly power of banks over depositors D) increased protection from competition Answer: B Diff: 1 Type: MC Skill: Applied Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 47) Why did the interest rate volatility of the 1970s spur financial innovation?

Answer: Banks were very vulnerable to interest-rate risk in the mortgage loans. To protect themselves, banks began to issue adjustable-rate mortgages whose interest rate will increase along with market interest rates. Additionally financial derivatives were developed to help hedge against interest-rate risk.

Diff: 2 Type: ES Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 48) What are the adjustable-rate mortgages?

Answer: Adjustable-rate mortgages are mortgage loans on which the interest rate changes when a market interest rate (usually the treasury bill rate) changes.

Diff: 2 Type: ES Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

15 .

49) What important changes in banking have occurred as the result of low-cost information technology? Discuss four examples of these changes.

Answer: Information technology lowers the cost of procession financial transactions making it profitable to create new financial services, and it makes it easier for firms to issue new securities.

Examples include credit and debit cards, electronic banking, junk bonds, growth of the commercial paper market, and securitization.

Diff: 2 Type: ES Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 50) Explain why the profitability of traditional banking has declined and how banks have responded.

Answer: Banks have lost cost advantages because of disintermediation that resulted in innovations such as money market funds which competed for deposits, and reduced banks' deposit base. Banks responded with interest-paying chequing deposits that increased bank costs.

The development markets for junk bond, commercial paper, and securitized assets eroded banks' income advantages.

Banks have responded by making riskier loans (commercial mortgages and funding for takeovers and buyouts) and have moved into more off-balance-sheet activities.

Diff: 3 Type: ES Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 51) What bonds are commonly called "junk bonds"? Why innovations in computer technology helped the "junk bonds" market?

Answer: Junk bonds are the bonds whose credit rating is below BBB. Before the advent of computers and advanced telecommunications, it was difficult to acquire information about the financial situation of firms that might want to sell securities. Because of the difficulty in screening out bad from good credit risks, the only firms that were able to sell bonds were very well-established corporations that had high credit ratings. Before the 1980s, then, only corporations that could issue bonds with ratings of BBB or above could raise funds by selling newly issued bonds. With the improvement in information technology in the 1970s, it became easier for investors to acquire financial information making it easier to screen out bad from good risks.

Diff: 2 Type: ES Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system

16 .

52) How banks suffered a decline in income advantages on uses of funds (assets) due to financial innovation?

Answer: a. The commercial paper market: information technology improvements have made it easier for corporations to issues securities directly to the public. Business customers find it now cheaper to go to the commercial paper market instead of going to banks to finance short-term credit needs.

Thus, before 1970 nonfinancial commercial paper equalled 5 percent of commercial bank loans, whereas the figure has risen to 20 percent today. b. The rise of the junk bond market has also eaten into banks' loan business. Improvements in information technology have made it easier for corporations to sell their bonds directly to the public, thereby bypassing banks. c. Improvement s to computer technology have also led to securitization. Computers enable other financial institutions to originate loans because they can now accurately evaluate credit risk with statistical methods, while computers have lowered transaction costs, making it possible to bundle these loans and sell them as securities. When default risk can easily be evaluated with computers, banks no longer have an advantage in making loans.

Diff: 3 Type: ES Skill: Recall Objective: 10.2 Explain how financial innovation led to the growth of the shadow banking system 10.3 Structure of the Canadian Chartered Banking Industry 1) The six largest chartered banks in Canada together hold ________ of the assets in the industry.

A) over 90 percent B) nearly 75 percent C) just over 50 percent D) 25 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry 2) Which of the following are true statements?

A) Schedule I banks have more powers than Schedule II banks.

B) Widely held foreign banks can own 50 percent of a Canadian bank subsidiary.

C) A Schedule II bank may have a significant shareholder (more than 10 percent) for up to 10 years after chartering.

D) A Schedule III bank is a foreign bank is not allowed to branch directly into Canada.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry

17 .

3) Which of the following are true statements?

A) Schedule I and Schedule II banks have different powers.

B) Widely held foreign banks can own 50 percent of a Canadian bank subsidiary.

C) Any widely held and regulated Canadian financial institution, other than a bank, may own 100 percent of a bank.

D) Schedule I banks have the same powers than Schedule II banks.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry 4) Which of the following are true statements?

A) Schedule I banks have more powers than Schedule II banks.

B) A Schedule II bank may enter the Canadian banking industry only as a Schedule II bank.

C) A Schedule II bank may have a significant shareholder (more than 10 percent) for up to 10 years after chartering.

D) A foreign bank may enter the Canadian banking industry only as a Schedule III bank.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry 5) The difference between a Schedule II and a Schedule III bank is that ________.

A) a Schedule II bank is a Canadian subsidiary of a foreign bank B) a Schedule III bank is a foreign bank is not allowed to branch directly into Canada C) a foreign bank may enter the Canadian banking industry only as a Schedule III bank D) widely held foreign banks can own 50 percent of a Canadian bank subsidiary Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry 6) New technology and the Internet have helped in the development of a ________ and ________ banking system in Canada.

A) more competitive; technologically stagnant B) more competitive; innovative C) less competitive; innovative D) less competitive; technologically stagnant Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry

18 .

7) What do Vancity Community Investment Bank and Tangerine have in common?

A) They have no head office.

B) They operate out of the United States C) They are Schedule II banks D) They are mostly virtual banks Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.3 Identify the key structural changes in the chartered banking industry 10.4 Comparison with the United States 1) The presence of so many commercial banks in the United States is most likely the result of ________.

A) consumers' strong desire for dealing with only local banks B) adverse selection and moral hazard problems that give local banks a competitive advantage over larger banks C) prior regulations that restrict the ability of these financial institutions to open branches D) consumers' preference for state banks Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries 2) The large number of banks in the United States is an indication of ________.

A) vigorous competition within the banking industry B) lack of competition within the banking industry C) regulations that restrict branch operations D) consumer preference for local banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries 3) Lack of competition in the United States banking industry can be attributed to ________.

A) the fact that competition does not benefit consumers B) the fact that branching has eliminated competition C) recent legislation restricting competition D) past regulations that the ability of banks to open branches Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries

19 .

4) Which of the following is a true statement concerning bank holding companies?

A) Bank holding companies own few large banks.

B) Bank holding companies are an important advantage to circumvent restrictive branching regulations.

C) The McFadden Act has prevented bank holding companies from establishing branch banks.

D) Bank holding companies can own only banks.

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries 5) A financial innovation that developed because of banks avoidance of bank branching restrictions was ________.

A) money market mutual funds B) commercial paper C) junk bonds D) bank holding companies Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries 6) ATMs were developed because of breakthroughs in technology and as a ________.

A) means of avoiding restrictive branching regulations B) means of avoiding paying interest to corporate customers C) way of concealing transactions from the SEC D) increasing the competition from foreign banks Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries

20 .

7) Describe the financial innovations that were stimulated as a response to branching restrictions in the U.S.?

Answer: Bank holding companies: a bank holding company is a corporation that owns several different companies. This form of corporate ownership has important advantages for banks. It has allowed them to circumvent restrictive branching regulations, because the holding company can own a controlling interest in several banks even if branching is not permitted. Also, these corporations can engage in other activities related to banking such as the provision of investment advice, data processing and transmission services, leasing, credit card services, and servicing of loans in other states.

Automated teller machines: Banks realized that if they did not own or rent the ATM, but instead let it be owned by someone else and paid for each transaction with a fee, the ATM would probably not be considered a branch of the bank and thus would not be subject to branching regulations.

Diff: 2 Type: ES Skill: Recall Objective: 10.4 Identify the key differences between the Canadian and U.S. banking industries 10.5 Competition Across All Four Pillars 1) The separation of the banking and other financial services industries was known as ________.

A) convergence B) consolidation C) the four-pillar approach D) underwriting Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 2) The four-pillars were identified as ________.

A) banking, brokerage, trusts, and mutual funds B) banking, brokerage, credit unions, and mutual funds C) banking, brokerage, credit unions, and insurance D) banking, brokerage, trusts, and insurance Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry

21 .

3) The Glass-Steagall Act, before its repeal in 1999, prohibited commercial banks in the U.S. from ________.

A) issuing equity to finance bank expansion B) engaging in underwriting and dealing of corporate securities C) selling new issues of government securities D) purchasing any debt securities Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 4) The primary reason for the recent reduction in the number of financial institutions is ________.

A) financial failures B) re-regulation of banking C) restrictions on branching D) financial consolidation Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 5) The ability to use one resource to provide different products and services is known as ________.

A) economies of scale B) economies of scope C) diversification D) vertical integration Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 6) The business term for economies of scope is ________.

A) economies of scale B) diversification C) cooperation D) synergies Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 22 .

7) Experts predict that the future structure of the banking industry will have ________.

A) an increased number of banks B) as few as ten banks C) large, complex banking organizations D) many, small banking organizations Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 8) Bank consolidation will likely result in ________.

A) less competition B) the elimination of credit unions C) large, complex banking organizations D) a shift in assets from larger banks to smaller banks Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 9) Banking consolidation in Canada will result in ________.

A) an increased number of small banks B) an increase in bank size C) a reduction in bank size D) elimination of small banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 10) As the banking system in Canada evolves, it is expected that ________.

A) the number and importance of small banks will increase B) the number and importance of large banks will decrease C) small banks will grow at the expense of large banks D) the number and importance of large banks will increase Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry

23 .

11) Bank consolidation will likely result in ________.

A) less competition B) the elimination of credit unions C) more competition D) a shift in assets from larger banks to smaller banks Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 12) In a/an ________ banking system, commercial banks engage in securities underwriting, but legal subsidiaries conduct these different activities. Also, banking and insurance are not typically undertaken jointly in this system.

A) universal B) British-style universal C) short-fence D) shadow Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 13) In a ________ banking system, commercial banks engage in securities underwriting.

A) British-style universal B) German-style universal C) Japanese-style universal D) South American-style universal Answer: A Diff: 2 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 14) In a ________ banking system, commercial banks provide a full range of banking, securities, and insurance services, all within a single legal entity.

A) universal B) severable C) barrier-free D) shadow Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 24 .

15) In a ________-style universal banking system, commercial banks are allowed to hold equity stakes in commercial firms.

A) British B) German C) Japanese D) South American Answer: C Diff: 2 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 16) A major difference between the British-style and Japanese banking systems is that ________.

A) British-style banks are allowed to hold substantial equity stakes in commercial firms, whereas Japanese banks cannot B) Japanese banks are allowed to hold substantial equity stakes in commercial firms, whereas British-style banks cannot C) bank holding companies are illegal in British-style banks D) Japanese banks are usually organized as bank holding companies Answer: B Diff: 3 Type: MC Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry 17) What is the international experience on the separation of banking and other financial services industries throughout the world? What are the main frameworks?

Answer: Canada and the U.S.: Not many other countries after the Great Depression followed them in separating the banking and other financial services industries. This separation was the most prominent difference between banking regulation in Canada and the U.S. versus the rest of the world.

The frameworks British: This framework is found also in the U.K., Australia, Canada and now the U.S. In this framework banks engage in in securities underwriting but it differs from the German in three ways: separate legal entities are common; bank equity holdings and combinations of banking and insurance firms are less common.

Japanese: The main difference between the Japanese and British frameworks is that Japanese banks are allowed to hold substantial equity stakes in commercial firms.

Diff: 3 Type: ES Skill: Recall Objective: 10.5 Summarize the factors that led to consolidation in the chartered banking industry

25 .

10.6 The Near Banks: Regulation and Structure 1) Near banks are defined as ________.

A) banks, brokers, and credit unions and caisses populaires B) banks and trust and mortgage loan companies C) trust and mortgage loan companies, and credit unions and caisses populaires D) trust and mortgage loan companies, and brokers Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.6 Summarize the distinctions between chartered banks and trust and loan companies and credit unions and caisses populaires 2) Trust and mortgage loan companies are usually ________.

A) operating under a charter issued by either the federal government or one of the provincial governments B) investors in commercial loans C) more profitable than chartered banks and credit unions and caisses populaires D) regulated and supervised by the TML Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.6 Summarize the distinctions between chartered banks and trust and loan companies and credit unions and caisses populaires 3) An essential characteristic of credit unions is that ________.

A) they are typically large B) branching is prohibited C) their lending is primarily for mortgage loans D) they are organized for individuals with a common bond Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.6 Summarize the distinctions between chartered banks and trust and loan companies and credit unions and caisses populaires 4) Credit unions are usually ________.

A) more profitable than Schedule I banks B) regulated by the OSFI C) regulated by a central bank D) investors in mortgage loans Answer: D Diff: 1 Type: MC Skill: Recall Objective: 10.6 Summarize the distinctions between chartered banks and trust and loan companies and credit unions and caisses populaires 26 .

5) Describe the characteristics of cooperative banks: credit unions and caisses populaires.

Answer: - They are small lending institutions.

- They are organized by a particular group of individuals with a common bond.

- Stress the provision of credit to the "little man."

- There are two cooperative financial systems in Canada: the caisses populaires in Quebec and the credit unions in the rest of the country.

- They carry retail financial services.

- Typically they are quite small.

- They are non-profit-seeking financial institutions.

- They accept deposits and lend money only to members.

- Members have voting rights.

- Not directly covered by CDIC but indirectly through provincial stabilization funds.

Diff: 2 Type: ES Skill: Recall Objective: 10.6 Summarize the distinctions between chartered banks and trust and loan companies and credit unions and caisses populaires 10.7 International Banking 1) The spectacular growth in international banking can be explained by ________.

A) the rapid growth in international trade B) the 1988 Basel Agreement C) the desire for U.S. banks to escape burdensome domestic regulations D) the creation of the World Trade Organization Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 2) What country is given credit for the birth of the Eurodollar market?

A) The United States B) England C) The Soviet Union D) Japan Answer: C Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada

27 .

3) Deposits in European banks denominated in dollars for the purpose of international transactions are known as ________.

A) Eurodollars B) European Currency Units C) European Monetary Units D) International Monetary Units Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 4) The main centre of the Eurodollar market is ________.

A) London B) Basel C) Paris D) New York Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 5) Eurodollars are ________.

A) dollar-dominated deposits held in banks outside the United States B) deposits held by U.S. banks in Europe C) deposits held by U.S. banks in foreign countries D) dollar-dominated deposits held in U.S. banks by Europeans Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 6) Reasons for holding Eurodollars include ________.

A) the fact that Eurodollar deposits are insured by the FDIC B) the fact that dollars are widely used to conduct international transactions C) the fact that minimum transaction sizes are very low, making Eurodollars an attractive savings instrument for consumers D) the fact that Eurodollar deposits are heavily regulated Answer: B Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada

28 .

7) During the 1970s and early 1980s, most of the sovereign lending was ________ leading to ________ consequences.

A) unregulated; near disastrous B) regulated; near disastrous C) illegal; serious legal D) regulated; serious legal Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 8) Canadian banks have most of their foreign branches in ________.

A) the U.S., Mexico, South America, Europe, and Asia B) Latin America, the Middle East, Mexico, and Europe C) Mexico, the Middle East, the Caribbean, and London D) South America, the Middle East, and the Caribbean Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 9) Foreign banks may enter the Canadian financial services industry ________ as a ________ bank(s).

A) either; schedule II or III B) either; schedule I or II C) only as; schedule II D) only; schedule III Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 10) Describe how was the Eurocurrencies market created.

Answer: The most important of the Eurocurrencies are Eurodollars and this market was fathered–ironically–by the Soviet Union. In the early 1950s during the height of the Cold War the Soviets fearing that the U.S. would freeze its substantial dollar balances held by banks in the United States, they moved the deposits to Europe so that they would be safe from expropriation.

They also wanted to keep the deposits in dollars so that they could be used in their international transactions. When they moved their dollars in Europe the Eurodollar was born.

Diff: 2 Type: ES Skill: Applied Objective: 10.7 Identify the reasons for Canadian banks to operate in foreign countries and for foreign banks to operate in Canada 29 .

10.8 The 2001 Bank Act Reform 1) The Bank Act Reform took effect in ________.

A) October 2001 B) January 2001 C) December 2001 D) May 2001 Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 2) Prior to the Bank Act Reform, the organizational structure of Canada's bank financial groups was the ________ model.

A) bank-as-parent B) financial liberalization C) securitization D) British universal Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 3) One advantage of the holding company form of corporate ownership is that ________.

A) it allows them to engage in other activities related to banking B) there is more regulation C) it demands less flexibility to achieve economies of scale D) it prevents strategic partnerships Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 4) Holding companies are viable options for financial groups if the transition to a holding company would be ________ and exhibit ________.

A) tax-neutral; decreased costs B) tax-neutral; economies of scope C) tax-free; decreased costs D) tax-free; fewer joint ventures Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 30 .

5) The 2001 Bank Act Reform legislation provides ________.

A) greater flexibility for bank involvement in the IT area B) a list of restricted activities C) details on why banks cannot expand their use of information technology D) less ability for banks to join strategic alliances and joint ventures Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 6) The 2001 Bank Reform Act states that ________.

A) medium sized banks can be closely held if there is a 35 percent public float B) large banks with shareholders equity greater than $5 billion can be closely held C) all banks, regardless of size and capitalization, can be closely held D) small banks must be widely held Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 7) Merger review policy within the 2001 Bank Act Reform acknowledges that ________.

A) mergers are legitimate business options B) mergers are anti-competitive and reduce financial stability C) mergers are only allowable within small, widely held, banks D) mergers are only allowable if the public believes they are warranted Answer: A Diff: 1 Type: MC Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation 8) Describe some of the major implications of the 2001 Bank Act Reform.

Answer: A bank holding company structure, new ownership rules, expanded permitted investments, expanded access to the payments and clearance system and a transparent merger review policy will allow opportunities for strategic alliances and joint ventures. These developments will create a more dynamic market for financial services leading to the possibility of greater economic growth.

Diff: 1 Type: ES Skill: Recall Objective: 10.8 Assess the reasons for separating banking from other financial services through legislation

31 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 11 Financial Crises 11.1 What Is a Financial Crisis?

1) A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a ________.

A) financial crisis B) fiscal imbalance C) free-rider problem D) "lemons" problem Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.1 Define the term financial crisis 2) Asymmetric information problems that act as a barrier to efficient allocation of capital are often described as ________.

A) financial treason B) financial markets C) financial frictions D) financial allocations Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.1 Define the term financial crisis

1 .

11.2 Dynamics of Financial Crises 1) The elimination of restrictions on financial markets and institutions is also known as ________.

A) financial engineering B) financial lending C) financial liberalization D) financial deleveraging Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 2) A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system ________.

A) causes severe adverse selection and moral hazard problems that make financial markets incapable of channelling funds efficiently B) allows for a more efficient use of funds C) increases economic activity D) reduces uncertainty in the economy and increases market efficiency Answer: A Diff: 3 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 3) The dark side of financial liberalization is ________.

A) market allocations B) credit booms C) currency appreciation D) financial innovation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 4) When the value of loans begins to drop, the net worth of financial institutions falls causing them to cut back on lending in a process called ________.

A) deflation B) releveraging C) capitulation D) deleveraging Answer: D Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis

2 .

5) When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a ________.

A) credit bust B) credit boom C) deleveraging D) market race Answer: B Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 6) When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in ________.

A) a contraction of economic activity B) an economic boom C) an increased opportunity for growth D) a call for government regulation Answer: A Diff: 2 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis 7) A decline in asset prices can lead to ________.

A) worsening adverse selection and moral hazard problems B) declining uncertainty C) increased economic activity D) anticipated increase in the price level Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 8) Factors that lead to worsening conditions in financial system include ________.

A) increases in net worth B) unanticipated increases in the price level C) unanticipated increases in the value of the domestic currency D) unanticipated declines in the value of the domestic currency Answer: D Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis

3 .

9) Factors that lead to worsening conditions in financial system include ________.

A) declining interest rates B) unanticipated increases in the price level C) the deterioration in banks' balance sheets D) increases in bond prices Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 10) When there is a deterioration in financial institutions' balance sheets ________.

A) economic activity contracts B) asset prices increase C) financial engineering takes place D) financial globalization increases its pace Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 11) Government safety nets ________.

A) weaken market discipline B) reduce moral hazard C) incent banks to take less risk D) require banks to loan less funds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 12) A sharp decline in the stock market means that the ________ of corporations has fallen.

A) net worth B) interest rates C) liabilities D) payrolls Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis

4 .

13) In a bank panic ________.

A) free-rider activities increase B) bond prices increase C) transactions costs increase D) multiple banks fail Answer: D Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 14) In a bank panic, the source of contagion is the ________.

A) free-rider problem B) too-big-to-fail problem C) transactions cost problem D) asymmetric information problem Answer: D Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 15) Factors that lead to worsening conditions in a financial system include ________.

A) increases in net worth B) stock market increases C) decreases in interest rates D) stock market declines Answer: D Diff: 1 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis 16) Share prices are a valuation of a corporation's ________.

A) collateral B) net worth C) current capital D) net earnings Answer: B Diff: 1 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis

5 .

17) A sharp decline in the stock market means that the ________ of corporations has fallen making lenders ________ willing to lend.

A) net worth; less B) net worth; more C) liability; less D) liability; more Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 18) A(n) ________ is an increase in prices of assets above their fundamental economic values.

A) decrease in moral hazard B) asset-price bubble C) decline in lending D) liability war Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 19) Most financial crises have started during periods of ________ either after the start of a recession or a stock market crash.

A) high uncertainty B) low interest rates C) low asset prices D) high financial regulation Answer: A Diff: 1 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis 20) The start of a recession or a stock market crash can result in ________.

A) high financial regulation B) low interest rates C) low asset prices D) high uncertainty Answer: D Diff: 1 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis

6 .

21) Banking crises or bank panics have started when ________.

A) there is a reduction of the adverse selection and moral hazard problems B) there have been periods of low interest rates C) depositors withdraw their funds from banks D) when information is made available to investors Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 22) If uncertainty about a banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) ________.

A) banking crisis B) financial recovery C) reduction of the adverse selection and moral hazard problems D) increase in information available to investors Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 23) A sharp stock market decline increases moral hazard incentives ________.

A) since borrowing firms have less to lose if their investments fail B) because it is immoral to profit from someone's loss C) since lenders are more willing to make loans D) reducing uncertainty in the economy and increasing market efficiency Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 24) If debt contracts are of long maturity, then an unanticipated decline in the aggregate price level results in ________.

A) a decline in a firm's net worth B) an increase in a firm's net worth C) a decrease in adverse selection and moral hazard D) an increase in willingness to lend Answer: A Diff: 2 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis

7 .

25) Factors that lead to worsening conditions in financial system include ________.

A) increases in net worth B) unanticipated increases in the price level C) decreases in interest rates D) unanticipated declines in the price level Answer: D Diff: 2 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis 26) An unanticipated decline in the price level increases the burden of debt on borrowing firms but does not raise the real value of borrowing firms' assets. The result is ________.

A) that net worth in real terms declines B) that adverse selection and moral hazard problems are reduced C) an increase in the real net worth of the borrowing firm D) an increase in lending Answer: A Diff: 3 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis 27) A bank panic can lead to a severe contraction in economic activity due to ________.

A) a decline in international trade B) the losses of bank shareholders C) the losses of bank depositors D) a decline in lending for productive investment Answer: D Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 28) If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

A) Increase in interest rates B) A bank panic C) A stock market decline D) Increase in uncertainty Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis

8 .

29) If the anatomy of a financial crisis is thought of as a sequence of events, which of the following events would be least likely to be the initiating cause of the financial crisis?

A) Increase in interest rates B) Stock market decline C) Unanticipated decline in price level D) Increase in uncertainty Answer: C Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 30) An economic downturn which causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness results in ________.

A) asset bubbles B) rising interest rates C) debt deflation D) financial recovery Answer: C Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 31) Debt deflation occurs when ________.

A) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness B) rising interest rates worsen adverse selection and moral hazard problems C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral D) corporations pay back their loans before the scheduled maturity date Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 32) A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called ________.

A) debt deflation B) moral hazard C) insolvency D) illiquidity Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis

9 .

33) A possible sequence for the three stages of a financial crisis in Canada might be ________ leads to ________ leads to ________.

A) asset price declines; banking crises; unanticipated decline in price level B) unanticipated decline in price level; banking crises; increase in interest rates C) banking crises; increase in interest rates; unanticipated decline in price level D) banking crises; increase in uncertainty; increase in interest rates Answer: A Diff: 2 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis 34) The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression.

A) debt deflation B) illiquidity C) an improvement in banks' balance sheets D) increases in bond prices Answer: A Diff: 3 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 35) The Irish government helped mitigate the financial crisis by ________.

A) guaranteeing all deposits B) privatizing the banking system C) increasing short term borrowing D) refusing to inject more capital into the failing system Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 36) The government bailout of troubled financial institutions occurred in the U.S. and many other countries. Which country saw their banking system collapse requiring the government to take over its three largest banks?

A) Iceland B) England C) Germany D) Belgium Answer: A Diff: 1 Type: MC Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis

10 .

37) Like a collateralized debt obligation (CDO), a structured investment vehicle pays off cash flows from pools of assets, however, rather than long-term debt the structured investment vehicle backs ________.

A) commercial paper B) Treasury bills C) corporate bonds D) municipal bonds Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 38) How do increases in interest rates play a role in promoting financial crises?

Answer: Students should discuss the increase in adverse selection, the decline in lending, the decline in investment and aggregate economic activity, and the effects on cash flow.

Diff: 2 Type: ES Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 39) Describe an asset-price bubble.

Answer: An asset-price bubble is a term which describes asset prices (in the stock market or real estate) that have been driven above their fundamental economic values by investor psychology.

Diff: 2 Type: ES Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 40) What is debt deflation?

Answer: Debt deflation occurs when a decline in price levels leads to deterioration in firms' net worth because of the increased burden of indebtedness.

Diff: 2 Type: ES Skill: Recall Objective: 11.2 Identify the key features of the three stages of a financial crisis 41) Typically, the economy recovers quickly from a recession. Why did this not happen in the United States during the Great Depression?

Answer: The 25 percent decline in the price level from 1930-1933 triggered a debt deflation.

The loss of net worth increased adverse selection and moral hazard problems in the credit markets and increased and prolonged the economic contraction.

Diff: 2 Type: ES Skill: Applied Objective: 11.2 Identify the key features of the three stages of a financial crisis

11 .

11.3 The Global Financial Crisis of 2007—2009 1) ________ is a process of bundling together smaller loans (like mortgages) into standard debt securities.

A) Securitization B) Origination C) Debt deflation D) Distribution Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 2) Financial innovations that emerged after 2000 in the mortgage markets included all of the following EXCEPT ________.

A) adjustable-rate mortgages B) subprime mortgages C) Alt-A mortgages D) mortgage-backed securities Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 3) ________ is the development of new, sophisticated financial instruments.

A) Discounting B) Origination C) Financial engineering D) Distribution Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009

12 .

4) A ________ pays out cash flows from subprime mortgage-backed securities in different tranches, with the highest-rated tranche paying out first, while lower ones paid out less if there were losses on the mortgage-backed securities.

A) collateralized debt obligation (CDO) B) adjustable-rate mortgage C) negotiable CD D) discount bond Answer: A Diff: 3 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 5) A bank loan to a household or business was not a security because ________.

A) it could not be bought or sold in a financial market B) it was not a debt instrument C) there was no market for them D) they increased the asymmetric information problem Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 6) The originate-to-distribute business model has a serious ________ problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk.

A) principal-agent B) debt deflation C) democratization of credit D) collateralized debt Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009

13 .

7) The originate-to-distribute business model is when ________.

A) mortgage originators made sure that the mortgage was a good credit risk B) mortgage originators distributed the mortgage to an investor as an underlying asset in a security C) homeowners could refinance their houses with larger loans when their homes appreciated in value D) mortgage originators were the credit rating agencies Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 8) Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a ________.

A) severe adverse selection problem B) decline in mortgage applications C) call to deregulate the industry D) decrease in the demand for houses Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 9) The agency problem in the mortgage markets was due to the ________ business model.

A) originate-to-distribute B) business-as-usual C) securitization D) "pass-through" Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 10) Credit default swaps ________.

A) provide payments to holders of bonds if they default B) decrease asymmetric information in the mortgage markets C) had strong incentives to make sure CDO holders would be paid off D) were only a small part of an insurance companies' portfolios Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 14 .

11) The housing boom in the United States was aided by ________.

A) liquidity from China and India B) higher interest rates C) tariffs reducing global trade D) weak balance sheets in the banking industry Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 12) Credit market problems of adverse selection and moral hazard increased as a result of all of the following EXCEPT ________.

A) increase in housing market prices B) increased uncertainty from the failures of financial institutions C) deterioration in financial institutions' balance sheets D) decline in the stock market of over 40 percent from its peak Answer: A Diff: 2 Type: MC Skill: Applied Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 13) The housing price bubble ________.

A) was aided by low interest rates on residential mortgages B) only occurred in the emerging economies C) was not a contributing factor to the 2007-2008 recession D) cannot be explained Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 14) Agency problems in the subprime mortgage market included all of the following EXCEPT ________.

A) homeowners could refinance their houses with larger loans when their homes appreciated in value B) mortgage originators had little incentives to make sure that the mortgage is a good credit risk C) underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 15 .

15) Agency problems in the subprime mortgage market included all the following EXCEPT ________.

A) homeowners could refinance their houses with larger loans when their homes appreciated in value B) mortgage originators had little incentives to make sure that the mortgage is a good credit risk C) underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 16) Credit rating agencies were subject to conflicts of interest in the subprime mortgage market because ________.

A) banks were earning large fees by underwriting the mortgage-backed securities B) they had little incentives to make sure that the mortgage was a good credit risk C) they had weak incentives to make sure that the holders of the securities would be paid back D) they were earning fees from rating the mortgage-backed securities and from advising clients on how to structure the securities to get the highest ratings Answer: D Diff: 3 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 17) Increased complexity of structured products can ________.

A) destroy information and improve adverse selection problems B) increase information and worsen adverse selection problems C) make asymmetric information better in the financial system D) make asymmetric information worse in the financial system Answer: D Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009

16 .

18) As housing prices rose, many subprime borrowers were able to ________.

A) default on their mortgage B) reduce their loan-to-value ratio C) get piggyback mortgages D) walk away from their houses Answer: C Diff: 2 Type: MC Skill: Applied Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 19) When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that ________.

A) the value of the house fell below the amount of the mortgage B) the basement flooded since they could not afford to fix the leaky plumbing C) the roof leaked during a rainstorm D) the amount that they owed on their mortgage was less than the value of their house Answer: A Diff: 2 Type: MC Skill: Applied Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 20) Between October 2007 and March 2009, asset prices in the stock market fell by ________.

A) over 50 percent B) 10 percent C) around 16 percent D) less than 30 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 21) Although the subprime mortgage market problem began in the United States, the first indication of the seriousness of the crisis began in ________.

A) Europe B) Australia C) China D) South America Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009

17 .

22) Fitch and Standard & Poor announced downgrades on ________ of mortgage-backed securities and CDOs. A) more than $10 billion B) more than $100 billion C) $50 billion D) more than $10 million Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 23) U.S. firms affected by the financial crisis included ________.

A) Bear Stearns and Merrill Lynch B) AIG and JP Morgan C) Manulife and RBC D) Capital One and BNP Paribas Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 24) Which investment bank filed for bankruptcy on September 15, 2008, making it the largest bankruptcy filing in U.S. history?

A) Lehman Brothers B) Merrill Lynch C) Bear Stearns D) Goldman Sachs Answer: A Diff: 1 Type: MC Skill: Applied Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 25) During the 2007—2009 financial crisis in the U.S. the credit spreads peaked at ________ in December 2008.

A) nearly 6 percent B) nearly 5 percent C) nearly 4 percent D) 3 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 18 .

26) By 2012, the debt to GDP ratio for Greece had climbed to ________.

A) 60% B) 100% C) 160% D) 200% Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 27) The coronavirus pandemic resulted in the Bank of Canada reducing its policy rate to A) 0.75% B) 0.50% C) 0.25% D) 0.00% Answer: C Diff: 2 Type: MC Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 28) What triggered the 2007–2009 financial crises?

Answer: The crises was triggered by mismanagement of financial innovation in the subprime residential mortgage market and the bursting of a bubble in housing prices.

Diff: 1 Type: ES Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009 29) How can asymmetric information lead to a bank panic?

Answer: Depositors cannot judge the quality of their banks' loan portfolios. So, when they hear about a failed financial institution, they may worry about the safety of their deposits and begin to withdraw their funds from their bank. Even healthy institutions can go under if enough deposits are withdrawn quickly.

Diff: 3 Type: ES Skill: Recall Objective: 11.3 Describe the causes and consequences of the global financial crisis of 2007— 2009

19 .

11.4 Canada and the 2007–2009 Financial Crisis 1) Under the Montreal Accord, investors ________.

A) froze losses to $200 million B) agreed to a standstill period C) were bailed out by the Bank of Canada D) were bailed out by the CDIC Answer: B Diff: 1 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 2) In Canada, an early symptom of the U.S. subprime mortgage market problem was the ________.

A) financial engineering of the asset-backed commercial paper market B) freezing of the asset-backed commercial paper market C) increase of the asset-backed commercial paper market D) restructuring of the asset-backed commercial paper market Answer: B Diff: 3 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 3) During the Canada's Asset-Backed Commercial Paper Crisis (ABCP) saga, The Bank of Canada ________.

A) shut down all non-bank sponsored conduits B) refused to accept ABCPs as collateral for loans to banks C) provided liquidity as a lender to the market D) was bailed out by the CDIC Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 4) "Plain vanilla" assets are ________.

A) unsecured promissory notes B) residential mortgages C) subprime mortgages D) CDOs Answer: B Diff: 1 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009

20 .

5) Asset-backed commercial paper is backed by all the following EXCEPT ________.

A) unsecured promissory notes B) mortgages C) car loans D) credit card receivables Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 6) The risk of asset-backed commercial paper depends on ________.

A) unsecured promissory notes B) the underlying securities C) commercial paper D) Treasury bills Answer: B Diff: 1 Type: MC Skill: Applied Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 7) The "democratization of credit" was attributed to ________.

A) the subprime mortgage market B) the 2000–2001 recession C) growth of prime mortgages D) asset-price gaps Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 8) What event allowed U.S.-style subprime mortgages into Canada?

A) The Canadian government allowing U.S. companies into the Canadian mortgage insurance market.

B) Lobbying by Canadian financial institutions.

C) Changes to the Bank of Canada's role in financial regulation.

D) CMHC relaxing regulation on the mortgage market.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009

21 .

9) Financial crises ________.

A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms B) occur when adverse selection and moral hazard problems in financial markets become less significant C) frequently lead to sharp expansions in economic activity D) are a free-rider problem Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 10) Canada avoided a financial crisis for all the reasons below EXCEPT ________.

A) Canadian banks were more tightly regulated B) Canada's banks were more conservative in their lending practices C) The Canadian financial institutions were well diversified relative to U.S. peers D) Canada did not allow any U.S.-style subprime mortgages Answer: D Diff: 1 Type: MC Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 11) What triggered the Canada's Asset-Backed Commercial Paper Crisis (ABCP) saga in Canada?

Answer: The ABCP saga was triggered when investors in the Canadian ABCP market declined to roll over maturing notes because of concerns about exposure to the U.S. subprime mortgage sector in the underlying assets.

Diff: 2 Type: ES Skill: Applied Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009 12) What were some of the changes to the regulations for real estate lending that were implemented in 2012?

Answer: A reduction in the maximum amortization period to 25 years, a restriction on a home to 80% of its value and a requirement that housing costs are not more than 39% of gross household income.

Diff: 2 Type: ES Skill: Recall Objective: 11.4 Describe Canada's response to the global financial crisis of 2007–2009

22 .

11.5 Response of Financial Regulation 1) A major shift in the US system of financial regulation in the aftermath to the financial crisis is ________.

A) an easing of monetary policy B) a tightening of monetary policy C) a shift from microprudential supervision to macroprudential supervision D) a shift from macroprudential supervision to microprudential supervision Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 2) When regulators examine a financial institution's risk incurring activities it is engaging in ________ supervision.

A) microprudential B) macroprudential C) both microprudential and macroprudential D) neither microprudential nor macroprudential Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 3) When regulators examine the financial system's risk incurring activities it is engaging in ________ supervision.

A) microprudential B) macroprudential C) both microprudential and macroprudential D) neither microprudential nor macroprudential Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009

23 .

4) The recognition that increased availability of credit leading to higher asset prices and financial buffers at lending institutions and therefore further expansion of credit availability is referred to as ________.

A) microprudential supervision B) macroprudential supervision C) the leverage cycle D) a liquidity crisis Answer: C Diff: 2 Type: MC Skill: Applied Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 5) When regulators examine the adequacy of the financial system's liquidity it is engaging in ________ supervision.

A) microprudential B) macroprudential C) both microprudential and macroprudential D) neither microprudential nor macroprudential Answer: B Diff: 1 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 6) When regulators examine a financial institution's capital ratios it is engaging in ________ supervision.

A) microprudential B) macroprudential C) both microprudential and macroprudential D) neither microprudential nor macroprudential Answer: A Diff: 1 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009

24 .

7) The net stable funding ratio is the ratio of ________ and ideally should be relatively ________.

A) the percentage of long-term to total funding; low B) the percentage of long-term to total funding; high C) the percentage of short-term to total funding; low D) the percentage of short-term to total funding; high Answer: C Diff: 2 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 8) The Dodd-Frank Act of 2010 requires financial institutions to ________.

A) lend to all individuals who need loans B) require verification of a borrower's job status but not credit history and income C) require verification of a borrower's income and job status but not their credit history D) require verification of a borrower's income, credit history and job status Answer: D Diff: 2 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 9) The Dodd-Frank Act of 2010 ________.

A) prevents the US government from taking over small financial institutions and rescue them from a potential bankruptcy B) allows the US government from taking over small financial institutions and rescue them from a potential bankruptcy C) prevents the US government from taking over large financial institutions and rescue them from a potential bankruptcy D) allows the US government from taking over large financial institutions and rescue them from a potential bankruptcy Answer: D Diff: 2 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009

25 .

10) The Volcker rule ________.

A) raises the limit on proprietary trading but decreases the allowable holdings of hedge funds B) raises the limit on proprietary trading and increases the allowable holdings of hedge funds C) lowers the limit on proprietary trading and decreases the allowable holdings of hedge funds D) lowers the limit on proprietary trading but increases the allowable holdings of hedge funds Answer: C Diff: 3 Type: MC Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 11) Describe the rising phase of the leverage cycle.

Answer: A boom in lending, increased asset prices and increasing financial buffers at financial institutions which lead to further rounds of credit expansion.

Diff: 1 Type: ES Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009 12) Describe the declining phase of the leverage cycle.

Answer: A reduction in lending, decreased asset prices and decreasing financial buffers at financial institutions which lead to further rounds of credit contraction.

Diff: 1 Type: ES Skill: Recall Objective: 11.5 Summarize the changes to financial regulation that occurred in response to the global financial crisis of 2007–2009

26 .

11.6 Too Big To Fail and Future Regulation 1) The too-big-to-fail problem is a ________ problem.

A) economic B) regulatory C) moral hazard D) adverse selection Answer: C Diff: 1 Type: MC Skill: Recall Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 2) Other than breaking systematically important financial institutions, the too-big-to-fail problem could be mitigated by requiring ________.

A) lower capital requirements B) making capital requirements procyclical C) making it easier for the Fed to bail out failing banks D) revoking the Volker rule Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 3) To reduce the incentives of financial institution managers to engage in excessive risk-taking regulators might require that bonuses be ________.

A) paid immediately B) paid after several years C) paid after several years only if the firm remains in good financial health D) paid in the form of stock options Answer: C Diff: 2 Type: MC Skill: Recall Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 4) Which of the following issues was NOT addressed by Dodd-Frank regulations?

A) stricter consumer protection laws B) privately owned, government-sponsored enterprises (GSEs) C) resolution authority over the large financial institutions D) higher requirements on firms dealing in derivatives Answer: B Diff: 2 Type: MC Skill: Recall Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 27 .

5) One of the concerns about the Orderly Liquidation Authority is that it would legitimize federal bailouts of large financial entities and thus increase the ________ problem.

A) too-big-to-fail B) regulatory forbearance C) lemons D) fiduciary Answer: A Diff: 2 Type: MC Skill: Recall Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 6) One suggested method of reducing excessive risk-taking by SIFIs is to require them to hold ________ capital when credit is expanding rapidly and ________ capital when credit is contracting.

A) less; more B) more; no C) more; less D) less; no Answer: C Diff: 2 Type: MC Skill: Recall Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 7) Explain why the too-big-to-fail problem is a moral hazard problem.

Answer: The student should point out that when financial firms become very large their managers will come to believe that should they run into financial and liquidity problems, the government or the central bank will have no choice but to bail them out. This will lead them to take higher risks to seek higher profits.

Diff: 2 Type: ES Skill: Applied Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes 8) Explain the reasoning behind the recommendation that capital requirements be pro-cyclical.

Answer: When the economy is improving the requirement that financial institutions increase their capital requirements will curtail their risk-taking behaviour and when the economy is slowing, lower capital requirements will encourage them to take more risk and lend to businesses and individuals.

Diff: 1 Type: ES Skill: Applied Objective: 11.6 Identify the gaps in current financial regulation and how those gaps may be addressed with future regulatory changes

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 12 Banking and the Management of Financial Institutions 12.1 The Bank Balance Sheet 1) 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 capital.

D) A bank's balance sheet indicates whether the bank is profitable.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 2) Which of the following statements is false?

A) A bank's assets are its uses of funds.

B) A bank issues liabilities to acquire funds.

C) The bank's assets provide the bank with income.

D) Bank capital is recorded as an asset on the bank balance sheet.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 3) Which of the following are reported as liabilities on a bank's balance sheet?

A) Reserves B) Demand and notice deposits C) Loans D) Deposits with other banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 4) Which of the following are reported as liabilities on a bank's balance sheet?

A) Advances B) Reserves C) Securities D) Loans Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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5) The share of chequable deposits in total bank liabilities has ________.

A) expanded moderately over time B) expanded dramatically over time C) shrunk over time D) remained virtually unchanged since 1960 Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 6) Which of the following statements is false?

A) Chequable deposits are usually the lowest cost source of bank funds.

B) Demand deposits are the primary source of bank funds.

C) Chequable deposits are payable on demand.

D) Chequable deposits include notice deposits.

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 7) Which of the following statements is true?

A) Chequable deposits are payable on demand.

B) Chequable deposits do not include notice deposits.

C) Chequable deposits are the primary source of bank funds.

D) Chequable deposits are chequable deposits that pay interest.

Answer: A Diff: 2 Type: MC Skill: Applied Objective: 12.1 Summarize the features of a bank balance sheet 8) Large-denomination certificates of deposits (CDs) are ________, so that like a bond they can be resold in a ________ market before they mature.

A) nonnegotiable; secondary B) nonnegotiable; primary C) negotiable; secondary D) negotiable; primary Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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9) Because ________ are less liquid for the depositor than ________, they earn higher interest rates.

A) savings account; time deposits B) money market deposit accounts; time deposits C) money market deposit accounts; savings account D) time deposits; savings account Answer: D Diff: 2 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 10) Bank loans from the Bank of Canada are called ________ and represent a ________ of funds.

A) advances; use B) advances; source C) overnight funds; use D) overnight funds; source Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 11) Which of the following is not a source of borrowings for a bank?

A) Overnight funds B) Eurodollars C) Time deposits D) Advances Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 12) 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 Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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13) Bank capital is listed on the ________ side of the bank's balance sheet because it represents a ________ of funds.

A) liability; use B) liability; source C) asset; use D) asset; source Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 14) Bank reserves include ________.

A) deposits at the Bank of Canada and short-term securities B) vault cash and short-term securities C) vault cash and deposits at the Bank of Canada D) deposits at other banks and deposits at the Bank of Canada Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 15) The fraction of chequable deposits that banks choose to hold are ________.

A) excess reserves B) desired reserves C) required reserves D) total reserves Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 16) Which of the following are reported as assets on a bank's balance sheet?

A) Time deposits B) Reserves C) Notice deposits D) Bank capital Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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17) Which of the following are not reported as assets on a bank's balance sheet?

A) Cash items in the process of collection B) Loans C) Securities D) Demand deposits Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 18) Through correspondent banking, large banks provide services to small banks, including ________.

A) loan guarantees B) foreign exchange transactions C) issuing stock D) debt reduction Answer: B Diff: 2 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 19) Which of the following bank assets is the most liquid?

A) Consumer loans B) Reserves C) Cash items in process of collection D) Government securities Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 20) Because of their ________ liquidity, ________ government securities are called secondary reserves.

A) low; short-term B) low; long-term C) high; short-term D) high; long-term Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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21) Secondary reserves are so called because ________.

A) they can be converted into cash with low transactions costs B) they are not easily converted into cash, and are, therefore, of secondary importance to banking firms C) 50 percent of these assets count toward meeting desired reserves D) they rank second to bank vault cash in importance of bank holdings Answer: A Diff: 3 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 22) Bank's make their profits primarily by issuing ________.

A) equity B) negotiable CDs C) loans D) notice deposits Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 23) The most important category of assets on a bank's balance sheet is ________.

A) advances B) securities C) loans D) cash items in the process of collection Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 24) Which of the following are qualified as assets for a bank?

A) The building that is owned by the bank and from which it conducts its business B) A discount loan C) A negotiable CD D) A customer's chequing account Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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25) The most important category of assets on a bank's balance sheet is ________.

A) other assets B) securities C) loans D) cash items in the process of collection Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 26) The risk that net cash withdrawals might be negative is known as ________.

A) interest risk B) default risk C) systematic risk D) banker's risk Answer: D Diff: 2 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 27) Banks hold provincial and municipal government securities because ________.

A) they can purchase them at a price below their market price B) legislation from the Bank Act of 1981 requires them to do so C) they are more likely to do business with banks that hold their securities D) they are more marketable than Government of Canada bonds Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet 28) What are the main items in a bank's asset side of the balance sheet? Discuss them briefly.

Answer: The students must answer that the main items in a bank's asset side of the balance sheet are: - Cash reserves: vault cash, settlement balances - Deposits at other banks: interbank deposits - Cash items in process of collection: items in transit or bank float - Securities: government of Canada, provincial and municipal, and other securities - Loans: commercial, industrial, real estate - Fixed and other assets: physical capital, etc.

Diff: 2 Type: ES Skill: Recall Objective: 12.1 Summarize the features of a bank balance sheet

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12.2 Basic Banking 1) Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy ________ with a different set of characteristics.

A) loans; deposits B) securities; deposits C) liabilities; assets D) assets; liabilities Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 2) In general, banks make profits by selling ________ liabilities and buying ________ assets.

A) long-term; shorter-term B) short-term; longer-term C) illiquid; liquid D) risky; risk-free Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 3) Asset transformation can be described as ________.

A) borrowing long and lending short B) borrowing short and lending long C) borrowing and lending only for the short term D) borrowing and lending for the long term Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 4) A T-account represents ________.

A) a simplified balance sheet B) asset transformation C) T-bills D) term deposits Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account

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5) When a new depositor opens a chequing account at the First National Bank, the bank's assets ________ and its liabilities ________.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: A Diff: 1 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 6) When Jane Brown writes a $100 cheque to her nephew (who lives in another province), Ms. Brown's bank ________ assets of $100 and ________ liabilities of $100.

A) gains; gains B) gains; loses C) loses; gains D) loses; loses Answer: D Diff: 1 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 7) When you deposit a $50 bill in the New 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 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 8) When you deposit $50 in currency at Old National Bank, ________.

A) its assets increase by less than $50 because of reserve requirements B) its reserves increase by less than $50 because of reserve requirements C) its liabilities increase by $50 D) its liabilities decrease by $50 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account

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9) Holding all else constant, when a bank receives the funds for a deposited cheque, ________.

A) cash items in the process of collection fall by the amount of the cheque B) bank assets increase by the amount of the cheque C) bank liabilities decrease by the amount of the cheque D) bank reserves increase by the amount of desired reserves Answer: A Diff: 3 Type: MC Skill: Recall Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 10) When a $10 cheque written on the First National Bank is deposited in an account at CIBC, then ________.

A) the liabilities of the First National Bank increase by $10 B) the reserves of the First National Bank increase by $ 10 C) the liabilities of CIBC increase by $10 D) the assets of CIBC fall by $10 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 11) When a $10 cheque written on the First National Bank is deposited in an account at CIBC, then ________.

A) the reserves of the First National Bank decrease by $10 B) the reserves of the First National Bank increase by $10 C) the reserves of CIBC decrease by $10 D) the assets of CIBC decrease by $10 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 12) When you deposit $50 in your account at First National Bank and a $100 cheque you have written on this account is cashed at Chemical Bank, then ________.

A) the assets of First National rise by $50 B) the assets of Chemical Bank rise by $50 C) the reserves at First National fall by $50 D) the liabilities at Chemical Bank rise by $50 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account

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13) When $1 million is deposited at a bank, the desired reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the bank's final balance sheet, ________.

A) the assets at the bank increase by $800,000 B) the liabilities of the bank increase by $1,000,000 C) the liabilities of the bank increase by $800,000 D) reserves increase by $160,000 Answer: B Diff: 3 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 14) When $1 million is deposited at a bank, the desired reserve ratio is 20 percent, and the bank chooses not to make any loans but to hold excess reserves instead, then, in the bank's final balance sheet, ________.

A) the assets at the bank increase by $1 million B) the liabilities of the bank decrease by $1 million C) reserves increase by $200,000 D) liabilities increase by $200,000 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 15) With a 10 percent reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is ________.

A) $90 B) $100 C) $10 D) $110 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 16) Using T-accounts show what happens to reserves at New National Bank if one individual deposits $1000 in cash into her chequing account and another individual withdraws $750 in cash from her chequing account.

Answer: New National Bank Assets

Liabilities

Reserves + $250 Demand deposits + $250 Diff: 1 Type: ES Skill: Applied Objective: 12.2 Apply changes to a bank's assets and liabilities on a T-account 11 .

12.3 General Principles of Bank Management 1) Which of the following are primary concerns of the bank manager?

A) Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows B) Extending loans to borrowers who will pay low interest rates, but who are poor credit risks C) Acquiring funds at a relatively high cost, so that profitable lending opportunities can be realized D) Maintaining high levels of capital and thus maximizing the returns for the shareholders Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 2) If a bank has $100,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds $40000 in reserves (including desired reserves), then the maximum deposit outflow it can sustain without altering its balance sheet is ________.

A) $30000 B) $25000 C) $20000 D) $10000 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 3) If a bank has $200,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds $80000 in reserves (including desired reserves), then the maximum deposit outflow it can sustain without altering its balance sheet is ________.

A) $50000 B) $40000 C) $30000 D) $25000 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits

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4) If a bank has $10 million of demand deposits, a desired reserve ratio of 10 percent, and it holds $2 million in reserves (including desired reserves), then it will not have enough reserves to support a deposit outflow of ________.

A) $1.2 million B) $1.1 million C) $1 million D) $900,000 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 5) If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in an equal reduction in ________.

A) deposits and reserves B) deposits and loans C) capital and reserves D) capital and loans Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 6) A $5 million deposit outflow from a bank has the immediate effect of ________.

A) reducing deposits and reserves by $5 million B) reducing deposits and loans by $5 million C) reducing deposits and securities by $5 million D) reducing deposits and capital by $5 million Answer: A Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits

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7) Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Bank of Canada, and borrowings from other banks to deal with deposit outflows is an example of ________.

A) liability management B) liquidity management C) managing interest rate risk D) managing credit risk Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 8) If, after a deposit outflow, a bank needs an additional $3 million to meet its desired reserves, the bank can ________.

A) reduce deposits by $3 million B) increase loans by $3 million C) sell $3 million of securities D) repay its advances from the Bank of Canada Answer: C Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 9) A bank with insufficient reserves can increase its reserves by ________.

A) lending funds on the overnight market B) calling in loans C) buying short-term securities D) buying provincial bonds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 10) Of the following, which would be the first choice for a bank facing a reserve deficiency?

A) Call in loans B) Borrow from the Bank of Canada C) Sell securities D) Borrow from other banks Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 14 .

11) In general, banks would prefer to acquire funds quickly by ________ rather than ________.

A) reducing loans; selling securities B) reducing loans; borrowing from the Bank of Canada C) borrowing from the Bank of Canada; reducing loans D) "calling in" loans; selling securities Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 12) ________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow.

A) Selling securities B) Selling loans C) Calling in loans D) Selling negotiable CDs Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 13) Banks hold excess and secondary reserves to ________.

A) reduce the interest-rate risk problem B) cover deposit outflows C) satisfy margin requirements D) achieve higher earnings than they can with loans Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits

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14) Which of the following statements most accurately describes the task of bank asset management?

A) Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity.

B) Banks seek to have the highest liquidity possible subject to earning a positive rate of return on their operations.

C) Banks seek to prevent bank failure at all cost; since a failed bank earns no profit, liquidity needs supersede the desire for profits.

D) Banks seek to acquire funds in the least costly way.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 15) The goals of bank asset management include ________.

A) maximizing risk B) minimizing liquidity C) lending at high interest rates regardless of risk D) purchasing securities with high returns and low risk Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 16) Banks that suffered significant losses in the 1980s made the mistake of ________.

A) holding too many liquid assets B) minimizing default risk C) failing to diversify their loan portfolio D) holding only safe securities Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 17) A bank will want to hold more excess reserves (everything else equal) when ________.

A) it expects to have deposit inflows soon B) brokerage commissions on selling bonds increase C) the cost of selling loans falls D) the discount rate decreases Answer: B Diff: 2 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 16 .

18) As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________.

A) decrease; increase B) increase; decrease C) increase; increase D) decrease; not be affected Answer: C Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 19) Which of the following would a bank hold as insurance against the high cost of deposit outflows?

A) Loans B) Secondary reserves C) Bank capital D) Mortgages Answer: D Diff: 1 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 20) Which of the following has not resulted from more active liability management on the part of banks?

A) Increased bank holdings of cash items B) Aggressive targeting of goals for asset growth by banks C) Increased use of negotiable CDs to raise funds D) An increased proportion of bank assets held in the form of loans Answer: A Diff: 2 Type: MC Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 21) Modern liability management has resulted in ________.

A) increased sales of certificates of deposits (CDS) to raise funds B) increase importance of deposits as a source of funds C) reduced borrowing by banks in the overnight loan market D) failure by banks to coordinate management of assets and liabilities Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 17 .

22) A bank failure occurs whenever ________.

A) a bank cannot satisfy its obligations towards its depositors while having access to sufficient funds to meet its needs in terms of reserves B) a bank suffers a large deposit outflow C) a bank must call in a large volume of loans D) a bank is not allowed to borrow anymore funds from the Bank of Canada Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 23) A bank is insolvent when ________.

A) its liabilities exceed its assets B) its assets exceed its liabilities C) its capital exceeds its liabilities D) its assets increase in value Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 24) Holding large sums of capital helps prevent bank failures because ________.

A) it means that the bank has a higher income B) it makes loans easier to sell C) it can be used to absorb the losses resulting from bad loans D) it makes it easier to call in loans Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 25) Net profit after taxes per dollar of assets is a basic measure of bank profitability known as ________.

A) return on assets B) return on capital C) return on equity D) return on investment Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 18 .

26) Net profit after taxes per dollar of equity capital is a basic measure of bank profitability known as ________.

A) return on assets B) return on capital C) return on equity D) return on investment Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 27) The amount of assets per dollar of equity capital is known as the ________.

A) asset ratio B) equity ratio C) equity multiplier D) asset multiplier Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 28) For a given return on assets, the less capitalized is a bank, ________.

A) the lower is the return for the owners of the bank B) the higher is the return for the owners of the bank C) the lower is the credit risk for the owners of the bank D) the lower the possibility of bank failure Answer: B Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 29) Bank capital has both benefits and costs for the bank shareholders. Higher bank capital ________ the likelihood of bankruptcy, but higher bank capital ________ the return on equity for a given return on assets.

A) reduces; reduces B) increases; increases C) reduces; increases D) increases; reduces Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 19 .

30) 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 Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 31) Conditions that likely contributed to a credit crunch in 2008 include ________.

A) capital shortfalls caused in part by falling real estate prices B) regulated hikes in bank capital requirements C) falling interest rates that raised interest rate risk, causing banks to choose to hold more capital D) increases in reserve requirements Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 32) Which of the following would not be a strategy that would result in an increase on the return on equity?

A) Buy back bank stock B) Pay higher dividends C) Acquire new funds by selling negotiable CDs and increase assets with them D) Sell more bank stock Answer: D Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 33) If a bank needs to raise its level of capital relative to its assets, a bank manager might choose to ________.

A) buy back bank stock B) pay higher dividends C) sell bank stock D) sell securities the bank owns and transfer the funds into the reserve account Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits

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34) Your bank has the following balance sheet: Assets Reserves $50 million Securities 50 million Loans 150 million

Liabilities Deposits $200 million Bank capital 50 million

If the desired reserve ratio is 10 percent, what actions should the bank manager take if there is an unexpected deposit outflow of $50 million?

Answer: After the deposit outflow, the bank will have a reserve shortfall of $15 million. The bank manager could try to borrow in the overnight market, borrow from the Bank of Canada, sell $15 million of the securities the bank owns, sell off $15 million of the loans the bank owns, or lastly call-in $15 million of loans. All of the actions will be costly to the bank. The bank manager should try to acquire the funds with the least costly method.

Diff: 1 Type: ES Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 35) Assume that a customer deposits $1000 in her bank. Show in a T-account the effect of this deposit. If the bank is subject to reserve requirements (as some bank in other countries are), show in a second T-account the bank's balance sheet indicating required and excess reserves, assuming a 5 percent required reserve ratio. In a third T-account, show the change in the bank's balance sheet when the bank makes loans with the excess reserves.

Answer: Reserves $1000 Chequable deposits $1000

Required reserves Excess reserves

$100 $900

Chequable deposits

$1000

Required reserves Loans

$100

Chequable deposits

$1000 $900

Diff: 3 Type: ES Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits

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36) Credit Atlantic Bank has the following balance sheet: Reserves Canada Bonds Loans

$20 $30 $80

Chequable deposits Bank Capital

$120 $10

The bank's desired reserve ratio is 10 percent and there is a withdrawal of cash from chequable deposits equal to $20. Describe what is likely to happen in the bank's balance sheet and produce the new balance sheet for Credit Atlantic Bank.

Answer: The students must show that after the $20 withdrawal, chequable deposits and reserves will go down to $100 and $0 respectively. Then, since the desired reserve ratio is 10 percent, the managers of the bank will need $100 × 10 percent = $10 as reserves. The most likely way of increasing their reserves from $0 to $10 would be by selling Canada bonds that worth $10. They will do this instead of calling in loans as this is the most liquid of their assets and also this change will not harm the bank's customers. Thus, the new balance sheet will be: Reserves Canada Bonds Loans

$10 $10 $80

Chequable deposits Bank Capital

$100 $10

Diff: 3 Type: ES Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 37) Explain using an example the statement that "given the return on assets, the lower the bank capital, the higher the return for the owners of the bank."

Answer: The students must explain this in the following lines: Assuming that we have two identical banks that earn net profit after taxes $50 and their total assets are $100 for each, then the banks' ROA is equal to 50 percent. If bank A has bank capital equal to $40 and bank B has bank capital equal to $20, their respective ROE is 1.25 and 2.5. Thus, the bank with the lower bank capital–bank B–has the higher ROE. The shareholders of bank B earn double the profits for every dollar they invest in bank B than bank A. Diff: 3 Type: ES Skill: Applied Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits

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38) Explain the relationship between return on assets and return on equity. What incentives does this relationship give a bank manager? Is this the desired outcome preferred by regulators?

Discuss.

Answer: For a given return on assets, the greater the amount of capital, the lower is the return on equity. Bank managers who seek to increase the return on equity must increase the asset base, purchase riskier assets, or reduce the amount of capital by paying dividends or buying back stock.

Regulators (and depositors) prefer higher capital for bank safety. Managers typically prefer lower equity than regulators, resulting in regulatory bank capital requirements.

Diff: 2 Type: ES Skill: Recall Objective: 12.3 Identify the ways in which banks can manage their assets and liabilities to maximize profits 12.4 Managing Credit Risk 1) Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans.

A) adverse selection B) moral hazard C) moral suasion D) intentional fraud Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 2) If borrowers with the riskiest investment projects seek bank loans in higher proportion to those borrowers with the safest investment projects, banks are said to face the problem of ________.

A) adverse credit risk B) adverse selection C) moral hazard D) lemon lenders Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk

23 .

3) Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the ________.

A) adverse selection problem B) lemon problem C) adverse credit risk problem D) moral hazard problem Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 4) In order to reduce the ________ problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones.

A) moral hazard B) adverse selection C) moral suasion D) adverse lending Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 5) In one sense ________ appears surprising since it means that the bank is not ________ its portfolio of loans and thus is exposing itself to more risk.

A) specialization in lending; diversifying B) specialization in lending; rationing C) credit rationing; diversifying D) screening; rationing Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 6) From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem.

A) moral hazard; diversification B) diversification; moral hazard C) adverse selection; diversification D) diversification; adverse selection Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk

24 .

7) Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called ________.

A) proscription bonds B) restrictive covenants C) due-on-sale clauses D) liens Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 8) To reduce moral hazard problems, banks include restrictive covenants in loan contracts. For these restrictive covenants to be effective, banks must also ________.

A) monitor and enforce them B) be willing to rewrite the contract if the borrower cannot comply with the restrictions C) trust the borrower to do the right thing D) be prepared to extend the deadline when the borrower needs more time to comply Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 9) Long-term customer relationships ________ the cost of information collection and make it easier to ________ credit risks.

A) reduce; screen B) increase; screen C) reduce; increase D) increase; increase Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 10) Unanticipated moral hazard contingencies can be reduced by ________.

A) screening B) long-term customer relationships C) specialization in lending D) credit rationing Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk

25 .

11) A bank's commitment to provide a firm with loans up to pre-specified limit at an interest rate that is tied to a market interest rate is called ________.

A) an adjustable gap loan B) an adjustable portfolio loan C) loan commitment D) pre-credit loan line Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 12) Property promised to the lender as compensation if the borrower defaults is known as ________.

A) collateral B) deductibles C) restrictive covenants D) contingencies Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 13) When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in ________.

A) coercive bargaining B) strategic holding out C) credit rationing D) collusive behavior Answer: C Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 14) When banks offer borrowers smaller loans than they have requested, banks are said to ________.

A) shave credit B) rediscount the loan C) raze credit D) ration credit Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk

26 .

15) Credit risk management tools include ________.

A) deductibles B) collateral C) interest rate swaps D) duration analysis Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 16) How can specializing in lending help to reduce the adverse selection problem in lending?

Answer: Reducing the adverse selection problem requires the banks to acquire information to screen bad credit risks from good credit risks. It is easier for banks to obtain information about local businesses. Also, if the bank lends to firms in a few specific industries, they will become more knowledgeable about those industries and a better judge of creditworthiness in those industries.

Diff: 1 Type: ES Skill: Recall Objective: 12.4 List the ways in which banks deal with credit risk 12.5 Managing Interest-Rate Risk 1) Risk that is related to the uncertainty about interest rate movements is called ________.

A) default risk B) interest-rate risk C) the problem of moral hazard D) security risk Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 2) All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ________ in interest rates will ________ bank profits.

A) an increase; increase B) an increase; reduce C) a decline; reduce D) a decline; not affect Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk

27 .

3) If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits.

A) more; a decline B) more; an increase C) fewer; an increase D) fewer; a surge Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 4) If a bank has ________ rate-sensitive assets than liabilities, a ________ in interest rates will reduce bank profits, while a ________ in interest rates will raise bank profits.

A) more; rise; decline B) more; decline; rise C) fewer; decline; decline D) fewer; rise; rise Answer: B Diff: 1 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 5) If a bank's liabilities are more sensitive to interest rate movements than are its assets, then ________.

A) an increase in interest rates will reduce bank profits B) a decrease in interest rates will reduce bank profits C) interest rates changes will not impact bank profits D) an increase in interest rates will increase bank profits Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 6) The difference between rate-sensitive liabilities and rate-sensitive assets is known as the ________.

A) duration B) interest-sensitivity index C) rate-risk index D) gap Answer: D Diff: 1 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk

28 .

7) If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to ________.

A) increase by $15 million B) increase by $1.5 million C) decline by $15 million D) decline by $1.5 million Answer: D Diff: 1 Type: MC Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 8) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called ________.

A) basic duration analysis B) basic gap analysis C) interest-exposure analysis D) gap-exposure analysis Answer: B Diff: 3 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 9) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals times the change in the interest rate is called ________.

A) decline by $0.5 million B) decline by $1.5 million C) decline by $2.5 million D) increase by $1.5 million Answer: B Diff: 3 Type: MC Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk

29 .

Rate-sensitive Fixed-rate

Assets $20 million $80 million

Liabilities $50 million $50 million

10) If interest rates rise by 5 percentage points, say, from 10 to 15 percent, bank profits (measured using basic gap analysis) will ________.

A) decline by $0.5 million B) decline by $1.5 million C) decline by $2.5 million D) increase by $1.5 million Answer: B Diff: 3 Type: MC Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 11) Assuming that the average duration of its assets is five years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to decline by ________ of the total original asset value.

A) decline by $0.5 million B) decline by $1.5 million C) decline by $2.5 million D) increase by $2.0 million Answer: B Diff: 3 Type: MC Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk

Rate-sensitive Fixed-rate

Assets $40 million $60 million

Liabilities $50 million $50 million

12) If interest rates rise by 5 percentage points, say from 10 to 15 percent, bank profits (measured using basic gap analysis) will ________.

A) decline by $0.5 million B) decline by $1.5 million C) decline by $2.5 million D) increase by $2.0 million Answer: A Diff: 3 Type: MC Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk

30 .

13) Assuming that the average duration of its assets is four years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to ________ by ________ of the total original asset value.

A) decline; 5 percent B) decline; 10 percent C) decline; 15 percent D) increase; 20 percent Answer: A Diff: 3 Type: MC Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 14) Duration analysis involves comparing the average duration of the bank's ________ to the average duration of its ________.

A) securities portfolio; non-deposit liabilities B) assets; liabilities C) loan portfolio; deposit liabilities D) assets; deposit liabilities Answer: B Diff: 3 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 15) Because of an expected rise in interest rates in the future, a banker will likely ________.

A) make long-term rather than short-term loans B) buy short-term rather than long-term bonds C) buy long-term rather than short-term bonds D) make either short or long-term loans; expectations of future interest rates are irrelevant Answer: B Diff: 3 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 16) If a banker expects interest rates to fall in the future, her best strategy for the present is ________.

A) to increase the duration of the bank's liabilities B) to buy short-term bonds C) to sell long-term certificates of deposit D) to increase the duration of the bank's assets Answer: D Diff: 3 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk

31 .

17) Because ________ are less liquid for the depositor than ________, they earn higher interest rates.

A) money market deposit accounts; time deposits B) chequable deposits; savings account C) savings account; chequable deposits D) savings account; time deposits Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 18) Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the bank's assets to increase their rate sensitivity or, alternatively, ________ the duration of the bank's liabilities.

A) shortening; lengthening B) shortening; shortening C) lengthening; lengthening D) lengthening; shortening Answer: A Diff: 3 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 19) If a bank has $50 million in rate-sensitive assets and $20 million in rate-sensitive liabilities then A) an increase in interest rates will reduce bank profits.

B) a decrease in interest rates will reduce bank profits.

C) interest rate changes will not impact bank profits.

D) a decrease in interest rates will increase bank profits.

Answer: B Diff: 2 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 20) Assuming that the average duration of First National Bank's $100 million assets is five years, while the average duration of its $80 million liabilities is three years, then a 5 percentage point decrease in interest rates will cause the net worth of First National to ________ by $________ million dollars.

A) increase; 5 B) decline; 15 C) increase; 13 D) decline; 25 Answer: C Diff: 3 Type: MC Skill: Recall Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 32 .

21) Your bank has the following balance sheet: Assets Rate-sensitive $100 million Fixed-rate 100 million

Liabilities Rate-sensitive $75 million Fixed-rate 125 million

What would happen to bank profits if the interest rates in the economy go down? Is there anything that you could do to keep your bank from being so vulnerable to interest rate movements?

Answer: The bank's profits would go down because it has more interest-rate sensitive assets than liabilities. To reduce interest-rate sensitivity, the bank manager could use financial derivatives such as interest-rate swaps, options, or futures. The bank manager could also try to adjust the balance sheet so that the bank's profits are not vulnerable to the movement of the interest rate.

Diff: 3 Type: ES Skill: Applied Objective: 12.5 Apply gap analysis and duration analysis, and identify interest-rate risk 12.6 Off-Balance-Sheet Activities 1) Examples of off-balance-sheet activities include ________.

A) loan sales B) extending loans to depositors C) borrowing from other banks D) selling negotiable CDs Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 2) All of the following are examples of off-balance sheet activities that generate fee income for banks EXCEPT ________.

A) foreign exchange trades B) guaranteeing debt securities C) back-up lines of credit D) selling negotiable CDs Answer: D Diff: 2 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities

33 .

3) Which of the following is not an example of a backup line of credit?

A) Loan commitments B) Overdraft privileges C) Standby letters of credit D) Mortgages Answer: D Diff: 2 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 4) Off-balance sheet activities involving guarantees of securities and back-up lines of credit ________.

A) have no impact on the risk a bank faces B) does not change the risk a bank faces C) increase the risk a bank faces D) slightly reduce the risk a bank faces Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 5) When banks that are involved in trading activities attempt to outguess the markets, they are ________.

A) forecasting B) diversifying C) speculating D) engaging in riskless arbitrage Answer: C Diff: 2 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 6) Traders working for banks are subject to the ________.

A) principal-agent problem B) free-rider problem C) double-jeopardy problem D) exchange-risk problem Answer: A Diff: 2 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities

34 .

7) A reason why some rogue traders have bankrupted their banks is due to ________.

A) the separation of trading activities from the bookkeepers B) stringent supervision of trading activities by the bank management team C) accounting errors by the banks D) a failure by the banks to maintain proper internal controls Answer: D Diff: 3 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 8) One way for banks to reduce the principal-agent problems associated with trading activities is to ________.

A) set limits on the total amount of a traders' transactions B) make sure that the person conducting the trades is also the person responsible for recording the transactions C) encourage traders to take on more risk if the potential rewards are higher D) reduce the regulations on the traders so that they have more flexibility in conducting trades Answer: A Diff: 1 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 9) The principal-agent problem that arises because of a bank's trading activities can be reduced through ________.

A) creation of internal controls that combine trading activities with bookkeeping B) creation of internal controls that separate trading activities from bookkeeping C) elimination of regulation of banking D) elimination of internal controls Answer: B Diff: 3 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 10) Banks develop statistical models to calculate their maximum loss over a given period. This approach is known as the ________.

A) stress-testing approach B) value-at-risk approach C) trading-loss approach D) doomsday approach Answer: B Diff: 3 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities

35 .

11) Banks use the ________ approach to calculate the losses that they would incur in case an unusual combination of bad events should happen.

A) stress-test B) value-at-risk C) trading-loss D) maximum value Answer: A Diff: 3 Type: MC Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities 12) What is a loan sale and how does it work?

Answer: The students must explain that the loan sale is an off-balance-sheet activity that has grown in importance in recent years, and it generates income for banks. A loan sale is also called a secondary loan participation and involves a contract that sells all or part of the cash stream from a specific loan and thereby it removes it from the bank's balance sheet. Banks earn profit by selling the loans for an amount slightly higher than the original loan amount. The high interest rate for these loans makes them attractive and institutions are willing to buy them at the higher price which means that they earn a slightly lower interest rate than the original loan usually on the order of 0.15 percentage points.

Diff: 3 Type: ES Skill: Recall Objective: 12.6 Summarize the types of off-balance-sheet activities

36 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 13 Risk Management with Financial Derivatives 13.1 Hedging 1) Financial derivatives include ________.

A) stocks B) bonds C) futures D) foreign exchange Answer: C Diff: 1 Type: MC Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position 2) Financial derivatives include ________.

A) stocks B) bonds C) forward contracts D) foreign exchange Answer: C Diff: 1 Type: MC Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position 3) A contract that requires the investor to buy securities on a future date is called a ________.

A) short position B) long position C) hedge D) cross Answer: B Diff: 1 Type: MC Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position 4) A contract that requires the investor to sell securities on a future date is called a ________.

A) short position B) long position C) hedge D) micro hedge Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position

1 .

5) A long position requires that the investor ________.

A) sell securities in the future B) buy securities in the future C) hedge in the future D) close out his position in the future Answer: B Diff: 1 Type: MC Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position 6) A short position requires that the investor ________.

A) sell securities in the future B) buy securities in the future C) hedge in the future D) close out his position in the future Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position 7) Explain the terms hedge, long position and short position in the context of managing financial institutions' risk.

Answer: Hedging is the act of engaging in a financial transaction that reduces or eliminates risk. When a financial institution has bought an asset, it is said to have taken a long position, and this exposes the institution to risk if the returns on the asset are uncertain. On the other hand, if it has sold an asset that it has agreed to deliver to another party at a future date, it is said to have taken a short position and this can also expose the institution to risk.

Diff: 1 Type: ES Skill: Recall Objective: 13.1 Define a hedge, a long position, and a short position

2 .

13.2 Interest-Rate Forward Contracts 1) Forward contracts do not suffer from the problem of ________.

A) a lack of liquidity B) a lack of flexibility C) the difficulty of finding a counterparty D) default risk Answer: B Diff: 1 Type: MC Skill: Recall Objective: 13.2 Define a forward contract and summarize its advantages and disadvantages 2) What are the pros and cons of forward contracts?

Answer: The advantage of forward contracts is that they can be as flexible as the parties involved want them to be. This means that an institution may be able to hedge completely the interest-rate risk for the exact security it is holding in its portfolio.

There are two disadvantages of forward contracts. First, it may be very hard for an institution to find another party which is called counterparty to make the contract with. The second problem with forward contracts is that they are subject to default risk. The presence of default risk in forward contracts means that parties to these contracts must check each other out to be sure that the counterparty is both financially sound and likely to be honest and live up to its contractual obligations.

Diff: 2 Type: ES Skill: Recall Objective: 13.2 Define a forward contract and summarize its advantages and disadvantages

3 .

13.3 Financial Futures Contracts and Markets 1) Futures contracts are regularly traded on the ________.

A) Montreal Exchange B) Toronto Stock Exchange C) American Stock Exchange D) Chicago Board of Options Exchange Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 2) If you buy in March a bond future contract for 115 that matures on June 30 of the same year, and at the maturity date the same future sells for 110, you have a ________ of $________.

A) loss; 5000 B) loss; 5 C) profit; 5000 D) profit; 5 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 3) If you buy in February a bond future contract for 120 that matures on June 30 of the same year, and at the maturity date the same future sells for 110, you have a ________ of $________.

A) loss; 10000 B) loss; 10 C) profit; 10000 D) profit; 10 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract

4 .

4) If you buy in March a bond future contract for 97 that matures on June 30 of the same year, and at the maturity date the same future sells for 93, you have a ________ of $________.

A) loss; 4000 B) loss; 4 C) profit; 4000 D) profit; 4 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 5) If you buy in February a bond future contract for 125 that matures on June 30 of the same year, and at the maturity date the same future sells for 105, you have a ________ of $________.

A) loss; 20000 B) loss; 20 C) profit; 20000 D) profit; 20 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 6) If you buy in March a bond future contract for 125 that matures on June 30 of the same year, and at the maturity date the same future sells for 135, you have a ________ of $________.

A) loss; 10000 B) loss; 10 C) profit; 10000 D) profit; 10 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 7) If you buy in March a bond future contract for 110 that matures on June 30 of the same year, and at the maturity date the same future sells for 125, you have a ________ of $________.

A) loss; 15000 B) loss; 15 C) profit; 15000 D) profit; 15 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 5 .

8) If you buy in March a bond future contract for 150 that matures on June 30 of the same year, and on the maturity date the same future sells for 170, you have a ________ of $________.

A) loss; 20000 B) loss; 20 C) profit; 20000 D) profit; 20 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 9) If you sell in March a bond future contract for 115 that matures on June 30 of the same year, and at the maturity date the same future sells for 110, you have a ________ of $________.

A) loss; 5000 B) loss; 5 C) profit; 5000 D) profit; 5 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 10) If you sell in February a bond future contract for 120 that matures on June 30 of the same year, and at the maturity date the same future sells for 110, you have a ________ of $________.

A) loss; 10000 B) loss; 10 C) profit; 10000 D) profit; 10 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract

6 .

11) If you sell in March a bond future contract for 97 that matures on June 30 of the same year, and at the maturity date the same future sells for 93, you have a ________ of $________.

A) loss; 4000 B) loss; 4 C) profit; 4000 D) profit; 4 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 12) If you sell in February a bond future contract for 125 that matures on June 30 of the same year, and at the maturity date the same future sells for 105, you have a ________ of $________.

A) loss; 20000 B) loss; 20 C) profit; 20000 D) profit; 20 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 13) If you sell in March a bond future contract for 125 that matures on June 30 of the same year, and at the maturity date the same future sells for 135, you have a ________ of $________.

A) loss; 10000 B) loss; 10 C) profit; 10000 D) profit; 10 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 14) If you sell in March a bond future contract for 110 that matures on June 30 of the same year, and at the maturity date the same future sells for 125, you have a ________ of $________.

A) loss; 15000 B) loss; 15 C) profit; 15000 D) profit; 15 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 7 .

15) If you sell in March a bond future contract for 150 that matures on June 30 of the same year, and on the maturity date the same future sells for 170, you have a ________ of $________.

A) loss; 20000 B) loss; 20 C) profit; 20000 D) profit; 20 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 16) By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver ________.

A) $100,000 face value securities for $115,000 B) $115,000 face value securities for $110,000 C) $100,000 face value securities for $100,000 D) $115,000 face value securities for $115,000 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 17) By selling short a futures contract of $100,000 at a price of 96, you are agreeing to deliver ________.

A) $100,000 face value securities for $104,167 B) $96000 face value securities for $100,000 C) $100,000 face value securities for $96000 D) 100,000 face value securities for $100,000 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 18) By buying a long $100,000 futures contract for 115, you agree to pay ________.

A) $100,000 for $115,000 face value bonds B) $115,000 for $100,000 face value bonds C) $86956 for $100,000 face value bonds D) $86956 for $115,000 face value bonds Answer: B Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 8 .

19) If you sold a short contract on financial futures, you hope interest rates ________.

A) rise B) fall C) are stable D) fluctuate Answer: A Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 20) If you bought a long contract on financial futures, you hope that interest rates ________.

A) rise B) fall C) remain unchanged D) fluctuate Answer: B Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 21) If you sold a short futures contract, you would hope that bond prices ________.

A) rise B) fall C) are stable D) fluctuate Answer: B Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 22) The elimination of riskless profit opportunities in the futures market is referred to as ________.

A) speculation B) hedging C) arbitrage D) open interest Answer: C Diff: 1 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract

9 .

23) When a financial institution hedges the interest-rate risk for a specific asset, the hedge is called a ________.

A) macro hedge B) micro hedge C) cross hedge D) futures hedge Answer: B Diff: 2 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 24) When the financial institution is hedging interest-rate risk on its overall portfolio, then the hedge is a ________.

A) macro hedge B) micro hedge C) cross hedge D) futures hedge Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 25) The number of contracts outstanding in a particular financial future is the ________.

A) demand coefficient B) open interest C) index level D) outstanding balance Answer: B Diff: 1 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 26) The advantage of forward contracts over futures contracts is that forward contracts ________.

A) are standardized B) have lower default risk C) are more flexible D) have higher default risk Answer: C Diff: 1 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 10 .

27) Futures markets have grown rapidly because futures ________.

A) are standardized B) have higher default risk C) are illiquid D) are more flexible Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 28) Futures differ from forwards because they are ________.

A) used to hedge portfolios B) used to hedge individual securities C) used in both financial and foreign exchange markets D) standardized contracts Answer: D Diff: 2 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 29) Futures differ from forwards because they are ________.

A) used to hedge portfolios B) used to hedge individual securities C) used in both financial and foreign exchange markets D) traded on an exchange Answer: D Diff: 2 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 30) Which of the following features of futures contracts were not designed to increase liquidity?

A) Standardized contracts B) Traded up until maturity C) Not tied to one specific type of bond D) Marked to market daily Answer: D Diff: 3 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract

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31) Which of the following features of futures contracts were not designed to increase liquidity?

A) Standardized contracts B) Traded up until maturity C) Not tied to one specific type of bond D) Can be closed with offsetting trade Answer: D Diff: 3 Type: MC Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 32) If a firm is due to be paid in euros in two months, to hedge against exchange rate risk the firm should ________.

A) sell foreign exchange futures short B) buy foreign exchange futures long C) stay out of the exchange futures market D) buy foreign exchange forward contracts long Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 33) If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by ________.

A) selling foreign exchange futures short B) buying foreign exchange futures long C) staying out of the exchange futures market D) selling foreign exchange forward contracts short Answer: B Diff: 2 Type: MC Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 34) What is an interest-rate futures contract? How does it differ from an interest-rate forward contract?

Answer: An interest-rate futures contract is similar to an interest-rate forward contract in that it specifies that a financial instrument must be delivered by one party to another on a stated future date. However, it differs from an interest-rate forward contract in several ways that overcome some of the liquidity and default problems of forward contracts.

Diff: 1 Type: ES Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract

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35) Explain using an example the statement that "at the expiration date of a futures contract, the price of the contract is the same as the price of the underlying asset to be delivered."

Answer: Consider what happens on the expiration date of a June contract at the end of June when the price of the underlying $100,000 face value Canadian bond is 110 ($110,000). If the futures contract sells bellow 110, say at 109, a trader can buy the contract for $109,000 and take delivery of the bond and immediately sell it for $110,000, thereby earning a quick profit of $1000. That means that everyone will try to buy the contract and this will drive its price up to 110. If the price is 111 instead everyone will try to sell the contract at $111,000 and buy it from the market to deliver at $110,000. Thus everyone will try to sell and this will drive the price down to 110.

Diff: 3 Type: ES Skill: Applied Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract 36) Where are financial futures traded? Describe that market.

Answer: Financial futures contracts are traded on organized exchanges such as the Chicago Board of Trade, the Chicago Mercantile Exchange, the Montreal Exchange, the London International Financial Futures Exchange etc. These futures exchanges are highly competitive with one another, and each organization tries to design contracts and set rules that will increase the amount of futures trading on its exchange. The exchanges are also regulated to ensure that prices in the market are not manipulated.

Diff: 1 Type: ES Skill: Recall Objective: 13.3 Summarize the differences between a forward contract and a financial futures contract

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13.4 Options 1) Options are contracts that give the purchasers the ________.

A) option to buy or sell an underlying asset B) the obligation to buy or sell an underlying asset C) the right to hold an underlying asset D) the right to switch payment streams Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 2) The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________.

A) premium B) call C) strike price D) put Answer: C Diff: 1 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 3) The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________.

A) premium B) interest rate C) exercise price D) call Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 4) The seller of an option has the ________.

A) right to buy or sell the underlying asset B) the obligation to buy or sell the underlying asset C) ability to reduce transaction risk D) right to exchange one payment stream for another Answer: B Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 14 .

5) The seller of an option has the ________ to buy or sell the underlying asset, while the purchaser of an option has the ________ to buy or sell the asset.

A) obligation; right B) right; obligation C) obligation; obligation D) right; right Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 6) An option that can be exercised at any time up to its maturity is known as a(n) ________.

A) swap B) stock option C) European option D) American option Answer: D Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 7) An option that can be exercised only at maturity is known as a(n) ________.

A) swap B) stock option C) European option D) American option Answer: C Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 8) Options on individual stocks are referred to as ________.

A) stock options B) futures options C) American options D) individual options Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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9) Options on futures contracts are referred to as ________.

A) stock options B) futures options C) American options D) individual options Answer: B Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 10) An option that gives the owner the right to buy a financial instrument at the exercise price within a specified period is a(n) ________.

A) call option B) put option C) American option D) European option Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 11) A call option gives the owner ________.

A) the right to sell the underlying security B) the obligation to sell the underlying security C) the right to buy the underlying security D) the obligation to buy the underlying security Answer: C Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 12) A call option gives the seller ________.

A) the right to sell the underlying security B) the obligation to sell the underlying security C) the right to buy the underlying security D) the obligation to buy the underlying security Answer: B Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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13) A put option gives the owner ________.

A) the right to sell the underlying security B) the obligation to sell the underlying security C) the right to buy the underlying security D) the obligation to buy the underlying security Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 14) A put option gives the seller ________.

A) the right to sell the underlying security B) the obligation to sell the underlying security C) the right to buy the underlying security D) the obligation to buy the underlying security Answer: D Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 15) The main disadvantage of futures contracts ashen compared to options on futures contracts is that futures ________.

A) remove the possibility of gains B) increase the transactions cost C) are not as effective a hedge D) do not remove the possibility of losses Answer: A Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 16) All other things held constant, premiums on put options will increase when ________.

A) the exercise price falls B) their volatility of the underlying asset falls C) their term to maturity increases D) their term to maturity decreases Answer: C Diff: 3 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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17) An option that gives the owner the tight to sell a financial instrument at the exercise price within a specified period of time is a(n) ________.

A) call option B) put option C) American option D) European option Answer: B Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 18) If a bank manager wants to protect the bank against losses that would be incurred on its portfolio of treasury securities should interest rates rise, he could ________.

A) buy put options on financial futures B) buy call options on financial futures C) sell put options on financial futures D) sell call options on financial futures Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 19) If you buy a European call option on Canada bonds with a strike price of 115 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 110, you will ________ the option and potentially make a profit of $________.

A) not exercise; 5000 B) not exercise; 5 C) exercise; 5000 D) exercise; 5 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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20) If you buy a European call option on Canada bonds with a strike price of 120 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 117, you will ________ the option and potentially make a profit of $________.

A) not exercise; 3000 B) not exercise; 3 C) exercise; 3000 D) exercise; 3 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 21) If you buy a European call option on Canada bonds with a strike price of 110 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 103, you will ________ the option and potentially make a profit of $________.

A) not exercise; 7000 B) not exercise; 7 C) exercise; 7000 D) exercise; 7 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 22) If you buy a European call option on Canada bonds with a strike price of 115 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 120, you will ________ the option in order to make a profit of $________.

A) not exercise; 5000 B) not exercise; 5 C) exercise; 5000 D) exercise; 5 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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23) If you buy a European call option on Canada bonds with a strike price of 120 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 123, you will ________ the option in order to make a profit of $________.

A) not exercise; 3000 B) not exercise; 3 C) exercise; 3000 D) exercise; 3 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 24) If you buy a European call option on Canada bonds with a strike price of 110 assuming that the premium is $0, and on the maturity date the market price of Canada bonds is 117, you will ________ the option to make a profit of $________.

A) not exercise; 7000 B) not exercise; 7 C) exercise; 7000 D) exercise; 7 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 25) If you buy an option to buy Canada 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 Answer: C Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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26) if you buy an option to sell Canada 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 Answer: B Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 27) if you buy an option to buy Canada futures at 110, and at expiration the market price is 115, ________.

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 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 28) If you buy an option to sell Canada futures at 110, and at expiration the market price is 115, ________.

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 Answer: D Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 29) The main advantage of using options on futures contracts rather than the futures contracts themselves is that ________.

A) interest rate risk is controlled while preserving the possibility of gains B) interest rate risk is controlled, while removing the possibility of losses C) interest rate risk is not controlled, but the possibility of gains is preserved D) interest rate risk is not controlled, but the possibility of gains is lost Answer: A Diff: 3 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 21 .

30) The main reason to buy an option on a futures contract rather than buying the futures contract is ________.

A) to reduce transaction cost B) to preserve the possibility for gains C) to limit losses D) to remove the possibility for gains Answer: B Diff: 3 Type: MC Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 31) 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 Answer: A Diff: 3 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 32) An increase in the volatility of the underlying asset, all other things held constant, will ________ the option premium.

A) increase B) decrease C) increase or decrease D) Not enough information is given.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 33) An increase in the exercise price, all other things held constant, will ________ the premium on call options.

A) increase B) decrease C) increase or decrease D) Not enough information is given.

Answer: B Diff: 3 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 22 .

34) A futures contract has a ________ profit function; an option contract has a ________ profit function.

A) linear; linear B) nonlinear; nonlinear C) linear; nonlinear D) nonlinear; linear Answer: C Diff: 2 Type: MC Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 35) What are options? What are their differences from futures contracts?

Answer: Options are contracts that give the purchaser the option, or right, to buy or sell the underlying asset at a specified price, called the exercise price or strike price, within a specific period called the term to expiration. The seller, sometimes called the writer, of the option is obligated to buy or sell the asset to the purchaser if the owner of the option exercises the right to sell or buy. Because the right to buy or sell an asset at a specified price has value, the owner of an option is willing to pay an amount for it called premium. There are two types of option contracts: American options can be exercised at any time up to the expiration date of the contract, and European options can be exercised only on the expiration date.

Diff: 2 Type: ES Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 36) Why have options on financial futures become the most widely traded option contracts?

Answer: Option contracts are more likely to be written on financial futures than on underlying financial instruments such as bonds. As we know, at the expiration date, the price of the futures contract and of the deliverable debt instrument will be the same because of arbitrage. So it would seem that investors would be indifferent about having the option written on the asset or on the futures contract. However, financial futures contracts have been so well designed that their markets are often more liquid than the markets in the underlying assets. Investors would rather have the option written on the more liquid instrument, in this case the futures contract.

Diff: 3 Type: ES Skill: Recall Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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37) What is the value of a call option at expiration? Use an appropriate graph to show the profit and losses of the buyer and seller of a call option.

Answer: The value of a call option at expiration, or intrinsic value is given by: C = max (0, S X). The net profit for the buyer is equal to C - α. Students must use a graph similar to Figure 131 on page 325 of the text to explain the profit and losses of the buyer and the seller of a call option.

Diff: 3 Type: ES Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 38) What is the value of a put option at expiration? Use an appropriate graph to show the profit and losses of the buyer and seller of a put option.

Answer: The value of a put option at expiration, or intrinsic value is given by: P = max (X - S, 0). The net profit for the buyer is equal to P - β. Students must use a graph like Figure 13-2 on page 326 of the text to explain the profit and losses of the buyer and the seller of a put option.

Diff: 3 Type: ES Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options 39) Use an appropriate graph to show the profits and losses for the buyer of a call option and the buyer of a futures contract, when the price of the future and the exercise price of the option is 115 and the premium is equal to $2000.

Answer: Students should use a graph similar to Figure 13-3 on page 328 of the text and show the profit and loss of from the options and futures contract bought at 115.

Diff: 3 Type: ES Skill: Applied Objective: 13.4 Identify the different types of options contracts, and summarize the three conclusions regarding call and put options

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13.5 Swaps 1) A financial contract that obligates one party to exchange a set of payments it owns for another set of payments owned by another party is called a ________.

A) cross hedge B) cross call option C) cross put option D) swap Answer: D Diff: 1 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 2) A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is a(n) ________.

A) interest rate swap B) currency swap C) swaption D) national swap Answer: B Diff: 1 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 3) 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) national swap Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps

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4) If Second Bank has more rate-sensitive assets than rate sensitive liabilities, it can reduce interest rate risk with a swap which requires the Second Bank to ________.

A) pay a fixed rate while receiving a floating rate B) receive a fixed rate while paying a floating rate C) both receive and pay a fixed rate D) both receive and pay a floating rate Answer: B Diff: 3 Type: MC Skill: Applied Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 5) If Second Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce interest rate risk with a swap which requires the Second Bank to ________.

A) pay a fixed rate while receiving a floating rate B) receive a fixed rate while paying a floating rate C) both receive and pay a fixed rate D) both receive and pay a floating rate Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 6) If a bank has a gap of -$10 million, it can reduce its interest rate risk by ________.

A) paying a fixed rate on $10 million and receiving a floating rate on $10 million B) paying a floating rate on $10 million and receiving a fixed rate on $10 million C) selling $20 million fixed rate assets D) buying $20 million fixed rate assets Answer: A Diff: 2 Type: MC Skill: Applied Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 7) One advantage of using swaps to eliminate interest-rate risk is that swaps ________.

A) are less costly than futures B) are less costly than rearranging balance sheets C) are more liquid than futures D) have better accounting treatment than options Answer: B Diff: 2 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 26 .

8) The disadvantage of swaps is that ________.

A) they lack liquidity B) it is easy to arrange for a counterparty C) they do not have default risk D) they are costly Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 9) As compared to a default on the notional principle, a default on a swap ________.

A) is more costly B) is about as costly C) is less costly D) may cost more or less than default on the notional principle Answer: C Diff: 2 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps 10) Intermediaries are active in the swap markets because ________.

A) they increase liquidity B) they increase default risk C) they increase search cost D) they do not need counterparties Answer: A Diff: 2 Type: MC Skill: Recall Objective: 13.5 Define a swap and summarize the advantages and disadvantages of interest-rate swaps

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13.6 Credit Derivatives 1) ________ derivatives offer payoffs on previously issued securities, but ones that bear credit risk.

A) Credit B) Bond C) Note D) Stock Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.6 Summarize the three types of credit derivatives 2) Credit options are contracts where the purchaser gains the right to receive profits that are tied to ________.

A) the obligation to buy or sell an underlying asset B) the price of an underlying security or to an interest rate C) the right to hold an underlying asset D) the right to switch payment streams Answer: B Diff: 1 Type: MC Skill: Recall Objective: 13.6 Summarize the three types of credit derivatives 3) Which credit derivative is a combination of a bond and a credit option?

A) A bond-linked note B) A linked note C) A credit-linked note D) None of the above Answer: C Diff: 1 Type: MC Skill: Recall Objective: 13.6 Summarize the three types of credit derivatives 4) Transactions in which risky payments on loans are swapped for each other are called ________.

A) credit swaps B) exchange rate swaps C) credit options D) interest-rate swaps Answer: A Diff: 1 Type: MC Skill: Recall Objective: 13.6 Summarize the three types of credit derivatives

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 14 Central Banks and the Bank of Canada 14.1 Origins of the Bank of Canada 1) From 1929 to 1933 the Canadian real GDP fell by almost ________.

A) 30 percent B) 40 percent C) 50 percent D) 20 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 2) Unemployment rates in Canada after the Great Depression rose close to ________.

A) 20 percent B) 25 percent C) 30 percent D) 10 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 3) The Great Depression contributed to significant changes in Canadian ________.

A) monetary policy B) nationalization C) growth policy D) immigration Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 4) Bank of Canada started operations in ________.

A) 1935 B) 1925 C) 1867 D) 1914 Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada

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5) The Great Depression contributed to significant changes in Canadian ________.

A) deficits B) monetary policy C) foreign affairs policy D) immigration policy Answer: B Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 6) The Great Depression ________.

A) was of fundamental importance in the creation of the Bank of Montreal B) contributed to significant changes in government policy C) involved the largest increase in the level of economic activity in the history of Canada D) contributed to significant changes in foreign affairs policy Answer: B Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 7) The main motivation for the formation of the Bank of Canada was ________.

A) financial B) the need for Canada to reflect its growing political independence from Britain C) the need for Canada to coordinate its international trade policy D) government debt Answer: B Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 8) The Bank of Canada has regional offices in which of the following cities?

A) Saskatoon B) Edmonton C) Montreal D) Winnipeg Answer: C Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada

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9) The Bank of Canada has regional offices in the following cities, EXCEPT ________.

A) Toronto B) Vancouver C) Edmonton D) Halifax Answer: C Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 10) The oldest central bank, having been founded in 1656, is the ________.

A) Riksbank, the central bank of Sweden B) Deutsche Bundesbank, the central bank of Germany C) Bank of Japan D) Federal Reserve System, the central bank of the U.S. Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.1 Recognize the historical context of the development of the Bank of Canada 14.2 Formal Structure of the Bank of Canada 1) Which of the following are entities of the Bank of Canada?

A) The Office of the Superintendent of Financial Institutions (OSFI) B) The Governing Council C) The Canada Deposit Insurance Corporation (CDIC) D) The Federal Reserve unit Answer: B Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 2) Which of the following are entities of the Bank of Canada?

A) The Office of the Superintendent of Financial Institutions (OSFI) B) The Board of Directors C) The Canada Deposit Insurance Corporation (CDIC) D) The Department of Finance Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

3 .

3) All of the following have served as Bank of Canada governors EXCEPT for ________.

A) Roy Romanow B) David Dodge C) Gordon Thiessen D) John Crow Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 4) Which of the following is an element of the Bank of Canada?

A) The Office of the Superintendent of Financial Institutions (OSFI) B) The Governing Council C) The Board of Directors D) B and C only Answer: D Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 5) The overall responsibility for the operation of the bank of Canada is held by the ________.

A) Board of Directors B) Federal Government C) Ministry of Finance D) Provincial governments Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 6) The Board of Directors appoints the governor of the Bank of Canada for a renewable term of ________ years.

A) seven B) five C) eight D) six Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

4 .

7) The Bank of Canada quarterly Monetary Policy Report is published every ________, ________, ________ and ________.

A) January; April; July; October B) February; May; August; November C) March; June; September; December D) January; February; August; December Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 8) The ________ is/are responsible for the Bank of Canada's quarterly Monetary Policy Report.

A) Governing Council B) Board of Directors C) Governor of the Bank of Canada D) outside directors Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 9) Which of the following functions does the Bank of Canada perform?

A) Bank notes issue B) Municipal government fiscal policy management C) Provincial government fiscal policy management D) Advise the Federal Reserve Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 10) Which of the following is a responsibility of the Bank of Canada?

A) Funds management B) Fiscal policy C) Equalization payments D) Foreign policy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

5 .

11) New issues of Treasury bills are a responsibility of ________.

A) the Bank of Canada B) Canada Investment and Savings C) the Ministry of the Treasury D) the federal government Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 12) After they are issued, Treasury bills are the responsibility of ________.

A) the Bank of Canada B) Canada Investment and Savings C) the Ministry of the Treasury D) the federal government Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 13) Foreign exchange reserves are held by ________.

A) exchange fund account of the Bank of Canada B) exchange fund account of the Department of Finance C) Canada Investment and Savings D) the chartered banks Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 14) The benefit of the Bank of Canada's role as the lender-of-last-resort include ________.

A) easing liquidity problems of any financial institution B) deterring bank runs and panics C) reducing the monetary base to increase liquidity in the economy D) A and B only Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

6 .

15) Base money is also known as ________.

A) the monetary base B) power money C) monetary liability D) fund accounts Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 16) The Bank of Canada assumed the monopoly of issuing bank notes in year ________.

A) 1945 B) 1933 C) 1935 D) 1936 Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 17) Which of the following functions are not performed by the Bank of Canada?

A) Cheque clearing B) Conducting economic research C) Setting interest rates payable on time deposits D) Issuing new currency Answer: C Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 18) In its role as provider of paper money, the Bank of Canada ________.

A) works closely with private sector partnerships and note-issuing authorities in other countries to improve cost-effectiveness, increase the durability of Canadian bank notes, and reduce counterfeiting B) tries to preserve the integrity and safety of Canadian currency in the most economical and efficient manner possible C) None of the above.

D) A and B only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

7 .

19) In its role as the federal government's fiscal agent, the Bank of Canada provides debt management services for the federal government such as ________.

A) advising on provincial government borrowings B) managing new debt offerings by the federal government C) servicing the federal government's outstanding debt D) B and C only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 20) Which of the following functions are not performed by the Bank of Canada in its role as the federal government's fiscal agent?

A) Advising on federal government borrowings B) Managing new debt offerings by the federal government C) Setting interest rates payable on time deposits D) Servicing the federal government's outstanding debt Answer: C Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 21) In its role as provider of central banking services, the Bank of Canada ________.

A) serves as a lender of last resort if a deposit-taking institution faces a liquidity crisis B) plays a central role in Canada's national mortgage system C) is responsible for the government's operating accounts and for managing the government's foreign exchange reserves D) A and C only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 22) In its role as provider of central banking services, the Bank of Canada holds deposit accounts of the ________.

A) provincial governments B) directly clearing members of the Canadian Payments Association C) international organizations, such as the International Monetary Fund D) B and C only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

8 .

23) As the federal government's fiscal agent, the Bank of Canada provides ________ management services for the federal government.

A) debt B) cost C) financial D) economic Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 24) The Bank of Canada serves as a lender of last ________ when a deposit-taking financial institution faces a ________ crisis.

A) resort; liquidity B) minute; liquidity C) resort; profitability D) minute; profitability Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 25) Because of its unique power to ________ base money, the Bank of Canada can ease the liquidity problems of ________.

A) control; financial institutions B) control; provincial governments C) save; financial institutions D) save; provincial governments Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 26) Changes in the ________ lead to ________ changes in the money supply.

A) monetary base; multiple B) monetary base; equal C) inflation rate; multiple D) inflation rate; equal Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

9 .

27) Canada's national payments system currently clears and settles payments and transactions, at a volume that is currently ________ times annual GDP. A) 15 B) 10 C) 5 D) 2 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 28) The Bank of Canada's lender-of-last resort lending is coordinated with ________ and ________.

A) Office of the Superintendent of Financial Institutions Canada; Canada Deposit Insurance Corporation B) Office of the Superintendent of Financial Institutions Canada; the Department of Finance C) the Department of Finance; Canada Deposit Insurance Corporation D) Office of the Superintendent of Financial Institutions Canada; Canada Investment and Savings Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 29) In its responsibility for the government's operating accounts, the Bank of Canada ________.

A) shifts balances between the government's transactions account with the Bank of Canada and government's non-transactions accounts with deposit-taking institutions B) shifts balances between deposit-taking institutions C) sells Canada Savings Bonds to the public on behalf of the federal government D) manages the government's Exchange Fund Account Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 30) The Bank of Canada's goal of low inflation is closely tied to ________.

A) the goal of steady economic growth B) price volatility C) the goal of low interest rates D) the growth in the money supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

10 .

31) The purchase and sale of government securities by the Bank of Canada is known as ________.

A) open market buyback operations B) repurchase agreements C) interbank borrowing D) monetary base transactions Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 32) The Bank of Canada ultimate objective is ________.

A) price stability B) to keep interest rates low C) economic growth D) low unemployment Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 33) The responsibility of monetary policy in Canada was given by the 1967 Bank of Canada Act to the ________.

A) government B) Bank of Canada C) provincial governments D) parliament Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

11 .

34) What are the main functions of the Bank of Canada? Describe them briefly.

Answer: The main functions of the Bank of Canada are: a. Bank note issue: Since 1967 the Bank of Canada with the revision of the Bank Act was provided with unlimited powers to issue legal tender. The Bank also tries to preserve the integrity and safety of Canadian currency. b. Government debt and asset management services: The Bank of Canada in its role as the government's fiscal agent provides debt-management services for the federal government such as advising on borrowings, managing new debt offerings and servicing outstanding debt. c. Central banking services: The bank of Canada serves as the lender of last resort for the deposit-taking financial institutions. It also plays a central role in Canada's national payments system. Finally, the Bank acts as the holder of deposit accounts for the government. d. Monetary policy: The Bank of Canada employs tools such as open market operations to conduct monetary policy. The Bank's ultimate objective is to keep inflation low so that steady economic growth is achieved.

Diff: 3 Type: ES Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada 35) Describe the structure of the Bank of Canada.

Answer: The overall responsibility for the operation of the Bank of Canada rests with the Board of Directors which consists of fifteen members. The governor, the senior deputy governor, the deputy minister of finance and twelve outside directors. The board appoints the governor and the senior deputy governor with the government's approval for a term of seven years. The outside directors are appointed by the minister of finance for a three-year term and they are required to come from all regions of Canada and a variety of occupations with the exception of banking.

Diff: 3 Type: ES Skill: Recall Objective: 14.2 Describe the key features and functions of the Bank of Canada

12 .

14.3 How Independent is the Bank of Canada?

1) Instrument independence is the ability of ________ to set monetary policy ________.

A) the central bank; goals B) Parliament; goals C) Parliament; instruments D) the central bank; instruments Answer: D Diff: 1 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 2) Economist Stanley Fisher defined two types of independence of central banks: ________ and ________ independence.

A) instrument; goal B) policy; goal C) instrument; political D) parliamentary; decision Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 3) The ability of a central bank to set monetary policy instruments is ________.

A) political independence B) goal independence C) policy independence D) instrument independence Answer: D Diff: 1 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 4) Goal independence is the ability of ________ to set monetary policy ________.

A) the central bank; goals B) Congress; goals C) Congress; instruments D) the central bank; instruments Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada

13 .

5) The ability of a central bank to set monetary policy goals is ________.

A) political independence B) goal independence C) policy independence D) instrument independence Answer: B Diff: 1 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 6) Instrument independence is ________.

A) the ability of the central bank to set monetary policy goals B) the ability of the government to set monetary policy goals C) the ability of the government to set monetary policy instruments D) the ability of the central bank to set monetary policy instruments Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 7) Goal independence is ________.

A) the ability of the central bank to set monetary policy goals B) the ability of the government to set monetary policy goals C) the ability of the prime minister to set monetary policy instruments D) the ability of the government to set monetary policy instruments Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 8) The Bank of Canada enjoys ________.

A) instrument independence B) political dependence C) goal independence D) A and C only.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada

14 .

9) The Bank of Canada enjoys ________.

A) instrument independence B) political independence C) goal independence D) A and B only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 10) Under the current "joint responsibility system," ________.

A) in the event of a serious policy conflict the minister of finance can issue a directive that the Bank of Canada must follow B) the government accepts full responsibility for monetary policy C) the Bank of Canada does not have considerable autonomy in the conduct of day-to-day monetary policy D) A and B only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 11) Under the current "joint responsibility system," ________.

A) the Bank of Canada and the minister of finance consult regularly B) in the event of a serious policy conflict the minister of finance can issue a directive that the Bank of Canada must follow C) the Bank of Canada has full responsibility for monetary policy D) A and B only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 12) Under the current "joint responsibility system," ________.

A) the Bank of Canada does not have considerable autonomy in the conduct of day-to-day monetary policy B) in the event of a serious policy conflict the minister of finance can issue a directive that the Bank of Canada must follow C) the government has no responsibility for the policy being followed by the Bank of Canada D) the Bank of Canada has full responsibility for monetary policy Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada

15 .

13) According to the performance of the Canadian economy, and the evolution of economic theory, what is the most important goal of monetary policy?

A) Currency stability B) Price stability C) GDP growth D) Employment growth Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 14) Which goal has been set jointly by the Bank of Canada and the Department of Finance?

A) Currency stability B) GDP growth C) Price stability D) Employment growth Answer: C Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 15) Increased operational independence by the Bank of Canada has also raised the standards for ________.

A) accountability B) secrecy C) misconduct D) confusion Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada 16) Explain the joint responsibility system.

Answer: Under the joint responsibility system, the governor of the Bank of Canada and the minister of finance, acting on behalf of the government, consult regularly and, in the event of a serious disagreement over the conduct of monetary policy, the government has the right to override the Bank's decisions. In particular, the minister of finance can issue a directive to the Bank indicating the specific policy changes that the Bank must follow. The directive, however, must be published indicating not only the new policy that the Bank is supposed to undertake but also the period during which it is to apply.

Diff: 2 Type: ES Skill: Recall Objective: 14.3 Assess the degree of independence of the Bank of Canada

16 .

17) What contributed to the move towards accountability and transparency of the Bank of Canada?

Answer: The Bank's move towards accountability and transparency was motivated by a number of recent trends in society and the economy. These have included economic comprehension about interest rates, developments about targets and inflation, and greater openness in the government.

Diff: 2 Type: ES Skill: Applied Objective: 14.3 Assess the degree of independence of the Bank of Canada 14.4 Should the Bank of Canada Be Independent?

1) The political business cycle refers to the phenomenon that just before elections, politicians enact ________ policies. After the elections, the bad effects of these policies (for example, ________ ) have to be counteracted with ________ policies.

A) expansionary; higher unemployment; contractionary B) expansionary; a higher inflation rate; contractionary C) contractionary; higher unemployment; expansionary D) contractionary; a higher inflation rate; expansionary Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 2) The case for Bank of Canada independence includes the idea that ________.

A) a politically insulated Bank of Canada would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level B) a Bank of Canada under the control of the government might make the so-called political business cycle more pronounced C) the principal-agent problem is perhaps worse for the Bank than for politicians since the former does not answer to the voters on election day D) A and B only.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada

17 .

3) Which of the following statements concerning an independent central bank are true?

A) Politicians may prefer an independent central bank, as it can be used as a "whipping boy" or "scapegoat" for poor economic performance.

B) Politicians in a democratic society may be short-sighted because of their desire to win reelection; thus, the political process may generate a political business cycle, in which just before an election contractionary policies are pursued to raise unemployment and interest rates.

C) Putting the Bank of Canada under control of the government may place too much pressure on the Bank of Canada to finance federal budget deficits, thereby imparting an inflationary bias to monetary policy.

D) A and C only.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 4) Which of the following statements concerning an independent central bank are true?

A) Politicians may prefer an independent central bank, as it can be used as a "whipping boy" or "scapegoat" for poor economic performance.

B) Politicians in a democratic society may be short-sighted because of their desire to win reelection; thus, the political process may generate a political business cycle, in which just before election expansionary policies are pursued to lower unemployment and interest rates.

C) Putting the Bank of Canada under control of the government may place too much pressure on the Bank to finance federal budget deficits, thereby imparting an inflationary bias to monetary policy.

D) All of the above are true statements.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 5) The systematic and permanent differences in macroeconomic outcomes that differ by political party are known as ________ business cycles.

A) partisan B) electoral C) real D) nominal Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada

18 .

6) Advocates of Bank of Canada independence fear that subjecting the Bank to direct government control would ________.

A) impart an anti-inflationary bias to monetary policy B) force monetary authorities to sacrifice the long-run objective of price stability C) make the so-called political business cycle even more pronounced D) B and C only.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 7) The strongest argument for an independent Bank of Canada rests on the view that subjecting the Bank to more political pressures would impart ________.

A) an inflationary bias to monetary policy B) a deflationary bias to monetary policy C) a disinflationary bias to monetary policy D) a countercyclical bias to monetary policy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 8) Supporters of the current system of Bank of Canada independence believe that a less autonomous Bank would ________.

A) adopt a short-run bias toward policymaking B) pursue overly expansionary monetary policies C) be more likely to create a political business cycle D) do each of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 9) The strongest argument for an independent Bank of Canada rests on the view that subjecting the Bank to more political pressures would impart ________.

A) an inflationary bias to monetary policy B) a deflationary bias to monetary policy C) a disinflationary bias to monetary policy D) a countercyclical bias to monetary policy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 19 .

10) Politicians in a democratic society may be short-sighted because of their desire to win reelection; thus, the political process can ________.

A) impart an inflationary bias to monetary policy B) impart a deflationary bias to monetary policy C) generate a political business cycle, in which just before an election, expansionary policies are pursued to lower unemployment and interest rates D) cause A and C only Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 11) Putting the Bank of Canada under control of the government ________.

A) may place too much pressure on the Bank of Canada to finance federal budget deficits B) impart an inflationary bias to monetary policy C) generate a political business cycle, in which just before an election, contractionary policies are pursued to raise unemployment and interest rates D) may cause A and B only Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 12) Critics of the current system of Bank of Canada independence contend that ________.

A) the current system is undemocratic B) voters have too much say about monetary policy C) the governor has too much control over monetary policy on a day-today basis D) B and C only.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada

20 .

13) The case for Bank of Canada independence does not include the idea that ________.

A) political pressure would impart an inflationary bias to monetary policy B) a politically insulated Bank would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level C) a Bank of Canada under the control of the government might make the so-called political business cycle more pronounced D) the principal-agent problem is perhaps worse for the Bank of Canada than for politicians since the former does not answer to the voters on election day Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 14) Critics of Bank of Canada independence argue ________.

A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one B) that an independent Bank of Canada conducts monetary policy with a consistent inflationary bias C) that the Bank of Canada, since it does not face a binding budget constraint, spends too much of its earnings D) A and B only.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 15) Recent research indicates that inflation performance (low inflation) has been found to be best in countries with ________.

A) the most independent central banks B) political control of monetary policy C) money financing of budget deficits D) a policy of always keeping interest rates low Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada

21 .

16) Recent research indicates that inflation performance (low inflation) has been found to be best in countries with ________.

A) the most independent central banks B) the least independent central banks C) political control of monetary policy D) a policy of always keeping interest rates low Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 17) Recent research has found that countries with the most independent central banks have experienced ________.

A) the lowest average rates of inflation B) rates of inflation no different from countries with less independent central banks C) the highest average rates of inflation D) high inflation from financing deficits Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 18) Countries with the most independent central banks have low inflation ________.

A) but have higher unemployment than countries with less independent central banks B) but have higher output fluctuations than countries with less independent central banks C) and have lower rates of unemployment than countries with less independent central banks D) but have no higher unemployment or output fluctuations than countries with less independent central banks Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada

22 .

19) How do political cycles influence aggregate economic activity?

Answer: We distinguish between two types of political cycles: a. electoral business cycles: politicians maximize their popularity or their probability of reelection by following pre-election expansionary fiscal policies in order to please the voters.

These give rise to persistent cyclical patterns of key policy and target variable across electoral terms, regardless of the political orientation of the incumbent government. b. partisan business cycles: systematic and permanent differences in macroeconomic outcomes that differ by political party. In this case politicians are ideological; they represent the interests of different pressure groups and, when in office, follow policies which are favorable to their supporting groups.

Diff: 2 Type: ES Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada 20) Explain two concepts of central bank independence. Is the Bank of Canada politically independent? Why do economists think central bank independence is important?

Answer: Instrument independence is the ability of the central bank to set its instruments, and goal independence is the ability of a central bank to set its goals. The Bank of Canada enjoys instrument independence but not goal independence because of the "joint responsibility system."

Independence is important because there is some evidence that independent central banks pursue lower rates of inflation without harming overall economic performance.

Diff: 3 Type: ES Skill: Recall Objective: 14.4 Summarize the arguments for and against the independence of the Bank of Canada

23 .

14.5 Explaining Central Bank Behaviour 1) The theory of bureaucratic behaviour suggests that the objective of a bureaucracy is to maximize ________.

A) the public's welfare B) profits C) its own welfare D) conflict with the executive and legislative branches of government Answer: C Diff: 2 Type: MC Skill: Recall Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help explain central bank actions 2) The theory of bureaucratic behavior suggests that a consumer's behaviour is motivated by the ________.

A) maximization of personal welfare B) maximization social welfare C) minimization of government intervention D) minimization political pressure Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help explain central bank actions 3) The theory of bureaucratic behaviour suggests that the Bank of Canada will fight ________.

A) to preserve the public's welfare B) to maximize profits C) minimize its own welfare D) to preserve autonomy Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help explain central bank actions 4) What is the theory of bureaucratic behavior and how can it be used to explain the behavior of the Bank of Canada?

Answer: The theory of bureaucratic behavior concludes that the main objective of any bureaucracy is to maximize its own welfare, which is related to power and prestige. This can explain why the Bank of Canada has defended its autonomy and will avoid conflict with powerful groups that might threaten to curtail its power and reduce its autonomy.

Diff: 1 Type: ES Skill: Recall Objective: 14.5 Identify the ways in which the theory of bureaucratic behaviour can help explain central bank actions 24 .

14.6 Structure and Independence of Foreign Central Banks 1) Which of the following is not an entity of the Federal Reserve System?

A) Federal Reserve Banks B) The FDIC C) The Board of Governors D) The Board of Advisors Answer: D Diff: 1 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 2) Which of the following are entities of the Federal Reserve System?

A) Federal Reserve Banks B) The FOMC C) The Board of Advisors D) A and B only Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 3) Which of the following are entities of the Federal Reserve System?

A) Federal Reserve Banks B) The FDIC C) The Board of Advisors D) A and B only Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 4) The board of governors members of the federal reserve system in the U.S. are appointed by the ________ and confirmed by the ________.

A) president of the United States; Senate B) president of the United States; House of Representatives C) Senate; president of the United States D) House of Representatives; president of the United States Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 25 .

5) According to the textbook, the Federal Reserve is ________.

A) remarkably free of the political pressures that influence other government agencies B) more responsive to the political pressures that influence other government agencies C) constrained in its policy making by the congressional threat to reduce Fed independence D) A and C only.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 6) According to the textbook, the Federal Reserve is ________.

A) remarkably free of the political pressures that influence other government agencies B) more responsive to the political pressures that influence other government agencies C) probably somewhat constrained in its policy making by the congressional threat to reduce Fed independence D) A and C only.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 7) The European Central Bank is housed in ________.

A) Frankfurt B) London C) Paris D) Rome Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 8) The Executive Board of the European Central Bank ________.

A) consists of the European Central Bank's president, vice president, and four other members B) is responsible for the business of the European Central Bank C) is responsible for the implementation of monetary policy in accordance with the guidelines set by the Governing Council D) All of the above.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 26 .

9) The Eurosystem has a structure like that of the ________.

A) Bank of Canada B) Federal Reserve System C) Bank of England D) Swiss National Bank Answer: B Diff: 1 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 10) The Maastricht Treaty which established the European Central Bank, defined price stability as an inflation rate equal to ________.

A) It did not specify exactly.

B) 0 percent C) 1 percent D) 2 percent Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 11) Which of the following are entities of the Eurosystem?

A) The European Central Bank B) The central banks of the European Union countries that have adopted the euro C) The central banks of the euro area countries and of the European Union countries that have not yet adopted the euro D) A and B only Answer: D Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 12) Which of the following are entities of the Eurosystem?

A) The European Central Bank B) National finance ministries in each country C) The Governing Council of the European Central Bank D) A and C only Answer: D Diff: 1 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world

27 .

13) Regarding central bank independence, ________.

A) the Fed is more independent than the European Central Bank B) the European Central Bank is more independent than the Fed C) the trend in industrialized nations has been to reduce central bank independence D) the Bank of England has the longest tradition of independence of any central bank in the world Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 14) Of the major central banks of the world, the most independent is ________.

A) the Federal Reserve System B) the European Central Bank C) the Bank of Canada D) the Bank of England Answer: B Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 15) The oldest central bank, having been founded in 1694, is the ________.

A) Bank of England B) Deutsche Bundesbank C) Bank of Japan D) Federal Reserve System Answer: A Diff: 1 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 16) Which of the following statements are true of the Bank of England?

A) The Bank of England was established in 1919.

B) The governor and four deputy governors comprise the monetary policy making body.

C) Until 1997, the decision to raise or lower interest rates resided not with the Bank of England but with the chancellor of the Exchequer.

D) B and C only.

Answer: C Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world

28 .

17) Which of the following statements are true of the Bank of England?

A) The Bank of England was established in 1894.

B) Until 1997, the decision to raise or lower interest rates resided not with the Bank of England but with the chancellor of the Exchequer.

C) The government can overrule the Bank and set rates "in extreme economic circumstances" and "for a limited period."

D) B and C only.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 18) While legislation enacted in 1998 granted the Bank of Japan new powers and greater autonomy, its critics contend that its independence is ________.

A) limited by the Ministry of Finance's control over a portion of its budget B) too great because it need not pursue a policy of price stability even if that is the popular will of the people C) too great since the Ministry of Finance no longer has veto power over the bank's budget D) limited since the Ministry of Finance can dismiss senior bank officials Answer: A Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 19) The Bank of Japan was founded in ________.

A) 1882 B) 1922 C) 1932 D) 1952 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world

29 .

20) The trend in recent years is that more and more governments ________.

A) have been granting greater independence to their central banks B) have been reducing the independence of their central banks to make them more accountable for poor economic performance C) have mandated that their central banks focus on controlling inflation D) have required their central banks to cooperate more with their Ministers of Finance Answer: A Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 21) Which of the following statements about central bank structure and independence are true?

A) In recent years, except for the Bank of England and the Bank of Japan, most countries have reduced the independence of their central banks, subjecting them to greater democratic control.

B) Before the Bank of England was granted greater independence, the Federal Reserve was the most independent of the world's central banks.

C) Both theory and experience suggest that more independent central banks produce better monetary policy.

D) While the European Central Bank is independent, it is not as independent as the Federal Reserve.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 22) Which of the following statements about central bank structure and independence are NOT true?

A) In recent years, with the exception of the Bank of England and the Bank of Japan, most countries have reduced the independence of their central banks, subjecting them to greater democratic control.

B) Before the Bank of England was granted greater independence, the Federal Reserve was the most independent of the world's central banks.

C) Both theory and experience suggest that more independent central banks produce better monetary policy.

D) A and B only Answer: D Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world

30 .

23) Which of the following statements about central bank structure and independence are true?

A) In recent years there has been a remarkable trend toward increasing independence.

B) In recent years, greater independence has been granted to many central banks, except for the Bank of England and the Bank of Japan, which are still subject to strict governmental control.

C) In theory, central banks subject to government control produce better monetary policy, but experience suggests that more independent central banks have produced superior monetary policy results.

D) A and B only Answer: A Diff: 3 Type: MC Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 24) Why did the Governing Counsel of the ECB decide to operate by consensus?

Answer: Although its members have the legal right to vote, no formal vote is taken in the Governing Counsel and decisions are reached by consensus. One reason for that is because of worries that the casting of individual votes might lead to heads of National Central Banks supporting a monetary policy that would be appropriate for their individual countries, but not necessarily for the countries in the European Monetary Union as a whole.

Diff: 2 Type: ES Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world 25) What are the main differences between the European system of Central Banks and the Federal Reserve System?

Answer: Although their structure is similar some important differences distinguish the two: a. the budgets of the Federal Reserve Banks are controlled by the Board of Governors, while the National Central Banks control their own budgets and the budget of the ECB in Frankfurt. b. the monetary operations of the Eurosystem are conducted by all the National Central Banks in each country so that monetary operations are not centralized as they are in the Federal Reserve System. c. in contrast to the Federal Reserve the ECB is not involved in supervision and regulation of financial institutions; these tasks are left to the individual countries.

Diff: 3 Type: ES Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world

31 .

26) Describe the function and structure of the board of governors of the federal reserve system.

Answer: At the head of the federal Reserve System is the seven-member Board of Governors, headquartered in Washington D.C. Each governor is appointed by the president of the U.S. and confirmed by the Senate. The governors can serve one non-renewable 14-year term plus part of another term, with one governor's term expiring every other January. The chairman of the Board of Governors is chosen from among the seven governors and serves a 4-year term.

Diff: 2 Type: ES Skill: Recall Objective: 14.6 Discuss the structure and independence of other major central banks around the world

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 15 The Money Supply Process 15.1 Three Players in the Money Supply Process 1) The government agency that oversees the banking system and is responsible for the conduct of monetary policy in Canada is ________.

A) the Bank of Canada B) the Department of Finance C) the Canada Customs and Revenue Agency D) the House of Parliament Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.1 List and describe the "three players" that influence the money supply 2) Individuals that lend funds to a bank by opening a chequing account are called ________.

A) policyholders B) partners C) depositors D) debt holders Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.1 List and describe the "three players" that influence the money supply 3) The three players in the money supply process include ________.

A) banks, depositors, and the Department of Finance B) banks, depositors, and borrowers C) banks, depositors, and the central bank D) banks, borrowers, and the central bank Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.1 List and describe the "three players" that influence the money supply 4) Of the three players in the money supply process, most observers agree that the most important player is ________.

A) the Bank of Canada B) the Department of Finance C) the Canada Customs and Revenue Agency D) the House of Parliament Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.1 List and describe the "three players" that influence the money supply 1 .

5) Who are the three players in the money supply process? Describe their roles.

Answer: The three players are: the central bank, depository institutions (banks) and depositors.

The central bank (in Canada, the Bank of Canada) oversees the banking system and is responsible for the conduct of monetary policy. Banks are the financial intermediaries that accept deposits from individuals and institutions. Depositors, both individuals and institutions, hold deposits in banks.

Diff: 1 Type: ES Skill: Recall Objective: 15.1 List and describe the "three players" that influence the money supply 15.2 The Bank of Canada's Balance Sheet 1) Both ________ and ________ are Bank of Canada assets.

A) notes in circulation; reserves B) notes in circulation; government securities C) government securities; advances to banks D) government securities; reserves Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities 2) The monetary liabilities of the Bank of Canada include ________.

A) government securities and advances to banks B) notes in circulation C) government securities and reserves D) notes in circulation and advances to banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities 3) Both ________ and ________ are monetary liabilities of the Bank.

A) government securities; advances to banks B) notes in circulation; reserves C) government securities; reserves D) notes in circulation; advances to banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities

2 .

4) The sum of the Bank of Canada's monetary liabilities and the Canadian Mint's monetary liabilities is called ________.

A) the money supply B) notes in circulation C) bank reserves D) the monetary base Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities 5) The monetary base consists of ________.

A) notes in circulation and Canada bonds B) notes in circulation and securities C) notes in circulation and reserves D) reserves and Canada bonds Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities 6) The interest rate the Bank of Canada charges banks borrowing from the Bank is the ________.

A) overnight rate B) Treasury bill rate C) bank rate D) prime rate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities 7) When banks borrow money from the Bank of Canada, these funds are called ________.

A) Bank funds B) borrowed reserves C) Bank loans D) overnight funds Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities

3 .

8) Vault cash consists of currency physically held by banks ________.

A) in bank vaults B) in cash tills C) in automated banking machines D) All of the above.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.2 Classify the factors affecting the Bank of Canada's assets and liabilities 15.3 Control of the Monetary Base 1) The monetary base minus currency in circulation equals ________.

A) reserves B) the borrowed base C) the nonborrowed base D) advances to banks Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 2) The monetary base minus reserves equals ________.

A) currency in circulation B) the borrowed base C) the nonborrowed base D) advances to banks Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 3) High-powered money minus reserves equals ________.

A) reserves B) currency in circulation C) the monetary base D) the nonborrowed base Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet

4 .

4) High-powered money minus currency in circulation equals ________.

A) reserves B) the borrowed base C) the nonborrowed base D) advances to banks Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 5) Purchases and sales of government securities by the Bank of Canada are called ________.

A) advances to banks B) Bank fund transfers C) open market operations D) swap transactions Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 6) When the Bank of Canada purchases a government bond from a bank, reserves in the banking system ________ and the monetary base ________, everything else held constant.

A) increase; increases B) increase; decreases C) decrease; increases D) decrease; decreases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 7) Suppose a person cashes his payroll cheque and holds all the funds in the form of currency.

Everything else held constant, total reserves in the banking system ________ and the monetary base ________.

A) remain unchanged; increases B) decrease; increases C) decrease; remains unchanged D) decrease; decreases Answer: C Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 5 .

8) Suppose your paycheque is directly deposited to your chequing account. Everything else held constant, total reserves in the banking system ________ and the monetary base ________.

A) remain unchanged; remains unchanged B) remain unchanged; increases C) decrease; increases D) decrease; decreases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 9) When the Bank of Canada sells a government bond to a bank, reserves in the banking system ________ and the monetary base ________, everything else held constant.

A) increase; increases B) increase; decreases C) decrease; increases D) decrease; decreases Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 10) When a bank sells a government bond to the Bank of Canada, reserves in the banking system ________ and the monetary base ________, everything else held constant.

A) increase; increases B) increase; decreases C) decrease; increases D) decrease; decreases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 11) When a bank buys a government bond from the Bank of Canada, reserves in the banking system ________ and the monetary base ________, everything else held constant.

A) increase; increases B) increase; decreases C) decrease; increases D) decrease; decreases Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 6 .

12) The monetary base declines when ________.

A) the Bank extends advances to banks B) deposits at the Bank decrease C) float increases D) the Bank sells securities Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 13) When the Bank of Canada buys $100 worth of bonds from 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 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 14) When the Bank of Canada sells $100 worth of bonds to 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 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 15) If a person selling bonds to the Bank of Canada cashes the Bank's cheque, then reserves ________ and currency in circulation ________, everything else held constant.

A) remain unchanged; declines B) remain unchanged; increases C) decline; remains unchanged D) increase; remains unchanged Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 7 .

16) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds. If the proceeds are kept in ________, the open market purchase has no effect on reserves; if the proceeds are kept as ________, reserves increase by the amount of the open market purchase.

A) deposits; deposits B) deposits; currency C) currency; deposits D) currency; currency Answer: C Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 17) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds. If the proceeds are kept in currency, the open market purchase ________ reserves; if the proceeds are kept as deposits, the open market purchase ________ reserves.

A) has no effect on; has no effect on B) has no effect on; increases C) increases; has no effect on D) decreases; increases Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 18) When an individual sells a $100 bond to the Bank, she may either deposit the cheque she receives or cash it for currency. In both cases ________.

A) reserves increase B) high-powered money increases C) reserves decrease D) high-powered money decreases Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet

8 .

19) If a member of the nonbank public sells a government bond to the Bank of Canada in exchange for currency, the monetary base will ________, but ________.

A) remain unchanged; reserves will fall B) remain unchanged; reserves will rise C) rise; currency in circulation will remain unchanged D) rise; reserves will remain unchanged Answer: D Diff: 3 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 20) If a member of the nonbank public purchases a government bond from the Bank of Canada in exchange for currency, the monetary base will ________, but reserves will ________.

A) remain unchanged; rise B) remain unchanged; fall C) rise; remain unchanged D) fall; remain unchanged Answer: D Diff: 3 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 21) For which of the following is the change in reserves necessarily different from the change in the monetary base?

A) Open market purchases from a bank B) Open market purchases from an individual who deposits the cheque in a bank C) Open market purchases from an individual who cashes the cheque D) Open market sale to a bank Answer: C Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 22) An increase in ________ leads to an equal ________ in the monetary base in the long run.

A) float; increase B) float; decrease C) securities; increase D) securities; decrease Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 9 .

23) When a member of the nonbank public withdraws currency from her bank account, ________.

A) both the monetary base and bank reserves fall B) both the monetary base and bank reserves rise C) the monetary base falls, but bank reserves remain unchanged D) bank reserves fall, but the monetary base remains unchanged Answer: D Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 24) When a member of the nonbank public deposits currency into her bank account, ________.

A) both the monetary base and bank reserves fall B) both the monetary base and bank reserves rise C) the monetary base falls, but bank reserves remain unchanged D) bank reserves rise, but the monetary base remains unchanged Answer: D Diff: 2 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 25) When the Bank extends a $100 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 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 26) All else the same, when the Bank calls in a $100 loan previously extended 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 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 10 .

27) When the Bank of Canada extends a loan to a bank, the monetary base ________ and reserves ________.

A) remains unchanged; decrease B) remains unchanged; increase C) increases; increase D) increases; remain unchanged Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 28) When the Bank of Canada calls in a loan from a bank, the monetary base ________ and reserves ________.

A) remains unchanged; decrease B) remains unchanged; increase C) decreases; decrease D) decreases; remains unchanged Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 29) There are two ways in which the Bank can provide additional reserves to the banking system: it can ________ government bonds or it can ________ advances to banks to commercial banks.

A) sell; extend B) sell; call in C) purchase; extend D) purchase; call in Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 30) A decrease in ________ leads to an equal ________ in the monetary base in the short run.

A) float; increase B) float; decrease C) deposits at the Bank; decrease D) advances to banks; increase Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 11 .

31) An increase in ________ leads to an equal ________ in the monetary base in the short run.

A) float; decrease B) float; increase C) advances to banks; decrease D) deposits at the Bank of Canada; increase Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 32) A decrease in ________ leads to an equal ________ in the monetary base in the long run.

A) float; increase B) float; decrease C) securities; increase D) securities; decrease Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 33) The Bank of Canada does not tightly control the monetary base because it does not completely control ________.

A) open market purchases B) open market sales C) borrowed reserves D) the rate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 34) Subtracting borrowed reserves from the monetary base obtains ________.

A) reserves B) high-powered money C) the nonborrowed monetary base D) the borrowed monetary base Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet

12 .

35) The relationship between borrowed reserves, the nonborrowed monetary base, and the monetary base is ________.

A) MB = MBn - BR B) BR = MBn - MB C) BR = MB - MBn D) MB = BR - mn Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 36) Explain two ways by which the Bank of Canada can increase the monetary base. Why is the effect of Bank of Canada actions on bank reserves less exact than the effect on the monetary base?

Answer: The Bank can increase the monetary base by purchasing government bonds and by extending advances to banks. If the person selling the security chooses to keep the proceeds in currency, bank reserves do not increase. Because the Bank cannot control the distribution of the monetary base between reserves and currency, it has less control over reserves than the base.

Diff: 2 Type: ES Skill: Recall Objective: 15.3 Identify the factors that influence the monetary base and discuss their effects on the Bank of Canada's balance sheet 15.4 Multiple Deposit Creation: A Simple Model 1) When the Bank of Canada supplies the banking system with an extra dollar of reserves, deposits increase by more than one dollar–a process called ________.

A) extra deposit creation B) multiple deposit creation C) expansionary deposit creation D) stimulative deposit creation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 2) When the Bank of Canada supplies the banking system with an extra dollar of reserves, deposits ________ by ________ than one dollar–a process called multiple deposit creation.

A) increase; less B) increase; more C) decrease; less D) decrease; more Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 13 .

3) If the desired reserve ratio is equal to 10 percent, a single bank can increase its loans up to a maximum amount equal to ________.

A) its excess reserves B) 10 times its excess reserves C) 10 percent of its excess reserves D) its total reserves Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 4) In the simple deposit expansion model, if the Bank of Canada purchases $100 worth of bonds from a bank that previously had no excess reserves, the bank can now increase its loans by ________.

A) $10 B) $100 C) $100 times the reciprocal of the desired reserve ratio D) $100 times the desired reserve ratio Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 5) In the simple deposit expansion model, if the Bank of Canada purchases $100 worth of bonds from a bank that previously had no excess reserves, deposits in the banking system can potentially increase by ________.

A) $10 B) $100 C) $100 times the reciprocal of the desired reserve ratio D) $100 times the desired reserve ratio Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

14 .

6) The formula for the simple deposit multiplier can be expressed as ________.

A) △ R = ×△T B) △ D =

×△R

C) △ r =

×△T

D) △ R =

×△D

Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 7) In the simple model of multiple deposit creation in which banks do not hold excess reserves, the increase in chequable deposits equals the product of the change in excess reserves and the ________.

A) reciprocal of the excess reserve ratio B) simple deposit multiplier C) reciprocal of the simple deposit multiplier D) bank rate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 8) The simple deposit multiplier can be expressed as the ratio of the ________.

A) change in reserves in the banking system divided by the change in deposits B) change in deposits divided by the change in reserves in the banking system C) desired reserve ratio divided by the change in reserves in the banking system D) change in deposits divided by the desired reserve ratio Answer: A Diff: 2 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 9) If reserves in the banking system increase by $100, then chequable deposits will increase by $1000 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.01 B) 0.10 C) 0.05 D) 0.20 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 15 .

10) If reserves in the banking system increase by $100, then chequable deposits will increase by $500 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.01 B) 0.10 C) 0.05 D) 0.20 Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 11) If the desired reserve ratio is 10 percent, the simple deposit multiplier is ________.

A) 5.0 B) 2.5 C) 100.0 D) 10.0 Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 12) If the desired reserve ratio is 15 percent, the simple deposit multiplier is ________.

A) 15.0 B) 1.5 C) 6.67 D) 3.33 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 13) If the desired reserve ratio is 20 percent, the simple deposit multiplier is ________.

A) 5.0 B) 2.5 C) 4.0 D) 10.0 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

16 .

14) If the desired reserve ratio is 25 percent, the simple deposit multiplier is ________.

A) 5.0 B) 2.5 C) 4.0 D) 10.0 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 15) A simple deposit multiplier equal to one implies a desired reserve ratio equal to ________.

A) 100 percent B) 50 percent C) 25 percent D) 0 percent Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 16) A simple deposit multiplier equal to two implies a desired reserve ratio equal to ________.

A) 100 percent B) 50 percent C) 25 percent D) 0 percent Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 17) A simple deposit multiplier equal to four implies a desired reserve ratio equal to ________.

A) 100 percent B) 50 percent C) 25 percent D) 0 percent Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

17 .

18) In the simple deposit expansion model, if the banking system has excess reserves of $75, and the desired reserve ratio is 20 percent, the potential expansion of chequable deposits is ________.

A) $75 B) $750 C) $37.50 D) $375 Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 19) In the simple deposit expansion model, if the desired reserve ratio is 20 percent and the Bank of Canada increases reserves by $100, chequable deposits can potentially expand by ________.

A) $100 B) $250 C) $500 D) $1000 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 20) In the simple deposit expansion model, if the desired reserve ratio is 10 percent and the Bank of Canada increases reserves by $100, chequable deposits can potentially expand by ________.

A) $100 B) $250 C) $500 D) $1000 Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 21) In the simple deposit expansion model, an expansion in chequable deposits of $1000 when the desired reserve ratio is equal to 20 percent implies that the Bank of Canada ________.

A) sold $200 in government bonds B) sold $500 in government bonds C) purchased $200 in government bonds D) purchased $500 in government bonds Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

18 .

22) In the simple deposit expansion model, an expansion in chequable deposits of $1000 when the desired reserve ratio is equal to 10 percent implies that the Bank of Canada ________.

A) sold $1000 in government bonds B) sold $100 in government bonds C) purchased $1000 in government bonds D) purchased $100 in government bonds Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 23) In the simple deposit expansion model, a decline in chequable deposits of $1000 when the desired reserve ratio is equal to 20 percent implies that the Bank of Canada ________.

A) sold $200 in government bonds B) sold $500 in government bonds C) purchased $200 in government bonds D) purchased $500 in government bonds Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 24) In the simple deposit expansion model, a decline in chequable deposits of $1000 when the desired reserve ratio is equal to 10 percent implies that the Bank of Canada ________.

A) sold $1000 in government bonds B) sold $100 in government bonds C) purchased $1000 in government bonds D) purchased $100 in government bonds Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 25) In the simple deposit expansion model, a decline in chequable deposits of $500 when the desired reserve ratio is equal to 10 percent implies that the Bank of Canada ________.

A) sold $500 in government bonds B) sold $50 in government bonds C) purchased $50 in government bonds D) purchased $500 in government bonds Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

19 .

26) In the simple deposit expansion model, a decline in chequable deposits of $500 when the desired reserve ratio is equal to 20 percent implies that the Bank of Canada ________.

A) sold $250 in government bonds B) sold $100 in government bonds C) sold $50 in government bonds D) purchased $100 in government bonds Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 27) If reserves in the Bank of Canada increase by $100, then chequable deposits will increase by $400 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.01 B) 0.10 C) 0.20 D) 0.25 Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 28) If reserves in the banking system increase by $100, then chequable deposits will increase by $667 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.01 B) 0.05 C) 0.15 D) 0.20 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 29) If reserves in the banking system increase by $100, then chequable deposits will increase by $100 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.01 B) 0.10 C) 0.20 D) 1.00 Answer: D Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

20 .

30) If reserves in the banking system increase by $100, then chequable deposits will increase by $2000 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.01 B) 0.05 C) 0.10 D) 0.20 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 31) If reserves in the banking system increase by $200, then chequable deposits will increase by $500 in the simple model of deposit creation when the desired reserve ratio is ________.

A) 0.04 B) 0.25 C) 0.40 D) 0.50 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 32) If a bank has excess reserves of $10000 and demand deposit liabilities of $80000, and if the reserve requirement is 20 percent, then the bank has actual reserves of ________.

A) $16000 B) $20000 C) $26000 D) $36000 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 33) If a bank has excess reserves of $20000 and demand deposit liabilities of $80000, and if the reserve requirement is 20 percent, then the bank has total reserves of ________.

A) $16000 B) $20000 C) $26000 D) $36000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

21 .

34) If a bank has excess reserves of $5000 and demand deposit liabilities of $80000, and if the reserve requirement is 20 percent, then the bank has actual reserves of ________.

A) $11000 B) $20000 C) $21000 D) $26000 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 35) If a bank has excess reserves of $15000 and demand deposit liabilities of $80000, and if the reserve requirement is 20 percent, then the bank has total reserves of ________.

A) $11000 B) $21000 C) $31000 D) $41000 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 36) If a bank has excess reserves of $4000 and demand deposit liabilities of $100,000, and if the reserve requirement is 15 percent, then the bank has actual reserves of ________.

A) $17000 B) $19000 C) $24000 D) $29000 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 37) If a bank has excess reserves of $4000 and demand deposit liabilities of $100,000, and if the reserve requirement is 10 percent, then the bank has actual reserves of ________.

A) $14000 B) $19000 C) $24000 D) $29000 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

22 .

38) If a bank has excess reserves of $7000 and demand deposit liabilities of $100,000, and if the reserve requirement is 15 percent, then the bank has actual reserves of ________.

A) $17000 B) $22000 C) $27000 D) $29000 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 39) If a bank has excess reserves of $7000 and demand deposit liabilities of $100,000, and if the reserve requirement is 10 percent, then the bank has actual reserves of ________.

A) $14000 B) $17000 C) $22000 D) $27000 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 40) A bank has excess reserves of $6000 and demand deposit liabilities of $100,000 when the desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be ________.

A) -$5000 B) -$1000 C) $1000 D) $5000 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 41) A bank has excess reserves of $4000 and demand deposit liabilities of $100,000 when the desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be ________.

A) -$5000 B) -$1000 C) $1000 D) $5000 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

23 .

42) A bank has excess reserves of $10000 and demand deposit liabilities of $100,000 when the desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be ________.

A) -$5000 B) -$1000 C) $1000 D) $5000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 43) A bank has no excess reserves and demand deposit liabilities of $100,000 when the desired reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will now be ________.

A) -$5000 B) -$1000 C) $1000 D) $5000 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 44) A bank has excess reserves of $1000 and demand deposit liabilities of $80000 when the reserve requirement is 20 percent. If the reserve requirement is lowered to 10 percent, the bank's excess reserves will be ________.

A) $1000 B) $8000 C) $9000 D) $17000 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 45) A bank has excess reserves of $1000 and demand deposit liabilities of $80000 when the reserve requirement is 25 percent. If the reserve requirement is lowered to 20 percent, the bank's excess reserves will be ________.

A) $1000 B) $5000 C) $8000 D) $9000 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 24 .

46) Decisions by depositors to increase their holdings of ________, or of banks to hold ________ will result in a smaller expansion of deposits than the simple model predicts.

A) deposits; desired reserves B) deposits; excess reserves C) currency; desired reserves D) currency; excess reserves Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 47) Decisions by depositors to increase their holdings of ________, or of banks to hold excess reserves will result in a ________ expansion of deposits than the simple model predicts.

A) deposits; smaller B) deposits; larger C) currency; smaller D) currency; larger Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 48) Decisions by ________ about their holdings of currency and by ________ about their holdings of excess reserves affect the money supply.

A) borrowers; depositors B) banks; depositors C) depositors; borrowers D) depositors; banks Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

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49) Assume that no banks hold excess reserves, and the public holds no currency. If a bank sells a $100 security to the Bank of Canada, explain what happens to this bank and two additional steps in the deposit expansion process, assuming a 10 percent reserve requirement. How much do deposits and loans increase for the banking system when the process is completed?

Answer: Bank A first changes a security for reserves, and then lends the reserves, creating loans. It receives $100 in reserves from the sale of securities. Since all of these reserves will be excess reserves (there was no change in chequable deposits), the bank will loan out all $100. The $100 will then be deposited into Bank B. This bank now has a change in reserves of $100, of which $90 is excess reserves. Bank B will loan out this $90, which will be deposited into Bank C. Bank C now has an increase in reserves of $90, $81 of which is excess reserves. Bank C will loan out this $81 dollar and the process will continue until there are no more excess reserves in the banking system.

For the banking system, both loans and deposits increase by $1000.

Diff: 1 Type: ES Skill: Applied Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 50) Explain two reasons why the Bank of Canada does not have complete control over the level of bank deposits and loans. Explain how a change in either factor affects the deposit expansion process.

Answer: The Bank of Canada does not completely control the level of bank deposits and loans because banks can hold excess reserves and the public can change its currency holdings. A change in either factor changes the deposit expansion process. An increase in either excess reserves or currency reduces the amount by which deposits, and loans are increased.

Diff: 1 Type: ES Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts 51) Explain why the simple deposit multiplier overstates the true deposit multiplier.

Answer: The simple model ignores the role banks and their customers play in the creation process. The bank's customers can decide to hold currency and the bank can decide to hold excess reserves. Both of these will restrict the banking system's ability to create deposits. Thus, the true multiplier is less than the prediction of the simple deposit multiplier.

Diff: 1 Type: ES Skill: Recall Objective: 15.4 Explain and illustrate the deposit creation process through T-accounts

26 .

15.5 Factors That Determine the Money Supply 1) An increase in the nonborrowed monetary base, everything else held constant, will cause ________.

A) the money supply to fall B) the money supply to rise C) no change in the money supply D) demand deposits to fall Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.5 List the factors that affect the money supply 2) The money supply is ________ related to the nonborrowed monetary base, and ________ related to the level of borrowed reserves.

A) positively; negatively B) negatively; not C) positively; positively D) negatively; negatively Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.5 List the factors that affect the money supply 3) The money supply is ________ related to the level of borrowed reserves.

A) negatively B) not C) positively D) sometimes Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.5 List the factors that affect the money supply 4) Everything else held constant, a decrease in the desired reserve ratio will mean ________.

A) a decrease in the money supply B) an increase in the money supply C) a decrease in chequable deposits D) an increase in advances to banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.5 List the factors that affect the money supply

27 .

5) Everything else held constant, an increase in currency holdings will cause ________.

A) the money supply to rise B) the money supply to remain constant C) the money supply to fall D) chequable deposits to rise Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.5 List the factors that affect the money supply 15.6 Overview of the Money Supply Process 1) In the model of the money supply process, the Bank of Canada's role in influencing the money supply is represented by ________.

A) both desired reserves and currency holdings B) nonborrowed reserves and borrowed reserves C) only borrowed reserves D) only nonborrowed reserves Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.6 Summarize how the "three players" can influence the money supply 2) In the model of the money supply process, the depositor's role in influencing the money supply is represented by ________.

A) only the currency holdings B) both the currency holdings and desired reserves C) the currency holdings, desired reserves, and borrowed reserves D) only desired reserves Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.6 Summarize how the "three players" can influence the money supply 3) In the model of the money supply process, the bank's role in influencing the money supply process is represented by ________.

A) only the desired reserve ratio B) both the desired reserve ratio and the market interest rate C) only the currency ratio D) only borrowed reserves Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.6 Summarize how the "three players" can influence the money supply

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15.7 The Money Multiplier 1) The formula linking the money supply to the monetary base is ________.

A) M = m/MB B) M = m × MB C) m = M × MB D) MB = M × m Answer: B Diff: 1 Type: MC Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 2) If the money multiplier is equal to 2 and the money supply is equal to $100 billion, the monetary base is equal to ________.

A) $50 billion B) $200 billion C) $25 billion D) cannot be determined Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 3) If the money supply is equal to $400 billion and the monetary base is equal to $100 billion, the money multiplier is equal to ________.

A) 4 B) 0.25 C) 5 D) cannot be determined Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 4) If the money supply is equal to $500 billion and the monetary base is equal to $250 billion, the money multiplier is equal to ________.

A) 2 B) 0.5 C) 5 D) 0.25 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier

29 .

5) The equation linking the monetary base to the levels of chequable deposits and currency is ________.

A) MB = (r × D) + C B) MB = (r + D) + ER + C C) MB = (r/D) + ER + C D) MB = (r - D) + ER - C Answer: A Diff: 2 Type: MC Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 6) When currency is equal to $100 billion and reserves are equal to $200 billion, and we know that the money multiplier is equal to 2.5, then the money supply will be equal to ________.

A) $750 billion B) $250 billion C) $300 billion D) $450 billion Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 7) When currency is equal to $200 billion and reserves are equal to $350 billion, and we know that the money multiplier is equal to 1.5, then the money supply will be equal to ________.

A) $825 billion B) $225 billion C) $366.66 billion D) $500 billion Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 8) An increase in the monetary base that goes into ________ is not multiplied, while an increase that goes into ________ is multiplied.

A) deposits; currency B) excess reserves; currency C) currency; excess reserves D) currency; deposits Answer: D Diff: 1 Type: MC Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier

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9) When the monetary base is equal to $200 billion, the desired reserve ratio is 0.10 and the currency ratio is equal to 0.20, the money supply is equal to ________.

A) $800 billion B) $600 billion C) $500 billion D) $300 billion Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 10) When the monetary base is equal to $200 billion, the desired reserve ratio is 0.10 and the currency ratio is equal to 0.20, the money multiplier is equal to ________ and the money supply is equal to ________.

A) 4; $800 billion B) 3.67; $734 billion C) 4; $734 billion D) 3.67; $800 billion Answer: A Diff: 3 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 11) Assuming initially that r = 10 percent and c = 40 percent, an increase in r to 15 percent causes ________.

A) the money multiplier to increase from 2.55 to 2.8 B) the money multiplier to decrease from 2.8 to 2.55 C) the money multiplier to increase from 1.82 to 2 D) no change in the money multiplier Answer: B Diff: 3 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 12) Assuming initially that r = 10 percent and c = 40 percent, a decrease in r to 5 percent causes ________.

A) the money multiplier to increase from 2.8 to 3.11 B) the money multiplier to decrease from 3.11 to 2.8 C) the money multiplier to increase from 2 to 2.22 D) the money multiplier to decrease from 2.22 to 2 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier

31 .

13) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is ________.

A) $8000 billion B) $1200 billion C) $120 billion D) $8400 billion Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 14) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, and chequable deposits are $800 billion, then the money multiplier is approximately ________.

A) 2.5 B) 1.67 C) 2.0 D) 0.601 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 15) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $800 billion, and excess reserves total $0.8 billion, then the currency ratio is ________.

A) .25 B) .50 C) .40 D) .05 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 16) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $800 billion, and excess reserves total $0.8 billion, then the excess reserveschequable deposit ratio is ________.

A) 0.001 B) 0.10 C) 0.01 D) 0.05 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 32 .

17) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $800 billion, and excess reserves total $0.8 billion, then the monetary base is ________.

A) $480 billion B) $480.8 billion C) $80 billion D) $80.8 billion Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 18) If the desired reserve ratio is fifteen percent, currency in circulation is $400 billion, and chequable deposits are $800 billion, then the money multiplier is approximately ________.

A) 2.5 B) 1.67 C) 2.3 D) 0.651 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 19) If the desired reserve ratio is five percent, currency in circulation is $400 billion, and chequable deposits are $800 billion, then the money multiplier is approximately ________.

A) 2.5 B) 2.72 C) 2.3 D) 0.551 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 20) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is ________.

A) $10000 billion B) $4000 billion C) $1400 billion D) $10400 billion Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier

33 .

21) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, and chequable deposits are $1000 billion, then the money multiplier is approximately ________.

A) 2.5 B) 2.8 C) 2.0 D) 0.7 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 22) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $1000 billion, and excess reserves total $1 billion, then the currency ratio is ________.

A) .25 B) .50 C) .40 D) .05 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 23) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $1000 billion, and excess reserves total $1 billion, then the excess reserveschequable deposit ratio is ________.

A) 0.01 B) 0.10 C) 0.001 D) 0.05 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 24) If the desired reserve ratio is ten percent, currency in circulation is $400 billion, chequable deposits are $1000 billion, and excess reserves total $1 billion, then the monetary base is ________.

A) $400 billion B) $401 billion C) $500 billion D) $501 billion Answer: D Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 34 .

25) If the desired reserve ratio is fifteen percent, currency in circulation is $400 billion, and chequable deposits are $1000 billion, then the money multiplier is approximately ________.

A) 2.55 B) 2.67 C) 2.35 D) 0.551 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 26) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and chequable deposits are $900 billion, then the money supply is ________.

A) $2700 B) $3000 C) $1200 D) $1800 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 27) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and chequable deposits are $900 billion, then the money multiplier is approximately ________.

A) 2.5 B) 2.8 C) 2.0 D) 0.67 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 28) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and chequable deposits are $900 billion, then the currency ratio is ________.

A) .25 B) .33 C) .67 D) .375 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier

35 .

29) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and chequable deposits are $900 billion, then the level of excess reserves in the banking system is ________.

A) $300 billion B) $30 billion C) $3 billion D) 0 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 30) If the desired reserve ratio is one-third, currency in circulation is $300 billion, and chequable deposits are $900 billion, then the monetary base is ________.

A) $300 billion B) $600 billion C) $333 billion D) $667 billion Answer: B Diff: 2 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 31) When the nonborrowed monetary base is equal to $200 billion, the borrowed reserves are equal to $100 billion, and the money supply is equal to $700 billion, the money multiplier is ________.

A) 2.33 B) 2.67 C) 2.23 D) 2.16 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 15.7 Calculate and interpret changes in the money multiplier 32) The relationship between advances to banks, the nonborrowed monetary base, and the monetary base is ________.

A) MB = MBn - BR B) BR = MBn - MB C) BR = MB - MBn D) MB = BR - MBn Answer: C Diff: 1 Type: MC Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier

36 .

33) Recognizing the distinction between advances to banks and the nonborrowed monetary base, the money supply model is specified as ________.

A) M = m × (MBn - BR) B) M = m × (MBn + BR) C) M = m + (MBn - BR) D) M = m - (MBn + BR) Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 34) When the pandemic hit in March 2020, the federal reserve engaged in massive quantitative easing to prevent a collapse of the economy. This led to a ________ of the monetary base and a ________ in the excess reserve ratio, both factors combined resulted in a ________ of the money supply.

A) large increase; sharp increase; large contraction B) large increase; sharp decrease; equally large expansion C) large increase; sharp increase; a more limited expansion D) large decrease; sharp decrease; large contraction Answer: B Diff: 2 Type: MC Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 35) Explain the complete formula for the money supply, and explain how changes in desired reserves, excess reserves, the currency ratio, the nonborrowed base, and Bank of Canada lending affect the money supply.

Answer: The formula indicates that the money supply is the product of the multiplier times the base. Increases in any of the multiplier components reduce the multiplier and the money supply.

Increases in the nonborrowed base and Bank of Canada lending to banks increase the monetary base and the money supply.

Diff: 2 Type: ES Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 36) Explain what happens to the money multiplier and the money supply when depositor behaviour causes c to increase with all other variables remaining the same.

Answer: An increase in c means that depositors are converting some of their chequable deposits into currency. As shown before, chequable deposits undergo multiple expansion while currency does not. Hence when chequable deposits are being converted into currency, there is a switch from a component of the money supply that undergoes multiple expansion to one that does not.

The overall level of multiple expansion declines, and so must the multiplier and the money supply.

Diff: 1 Type: ES Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 37 .

37) How do changes in the desired reserve ratio affect the money multiplier?

Answer: Students can show this in two ways: a. The formula for the money multiplier is m = . Thus, an increase in the desired reserve ratio r will increase the denominator leaving the numerator unchanged ceteris paribus and so the money multiplier will fall. A decrease in the value of the desired reserve ratio will decrease the denominator and so the money multiplier will rise. b. When banks increase their holdings of reserves relative to chequable deposits, the banking system in effect has fewer reserves to support chequable deposits, This means that given the same level of MB, banks will reduce their loans causing a decline in the level of chequable deposits and a decline in the money supply and the multiplier will fall. The opposite will happen when banks decrease their holdings of reserves.

Diff: 2 Type: ES Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier 38) How changes in the nonborrowed monetary base affect the money supply?

Answer: The Bank of Canada's open market purchases increase the nonborrowed monetary base, and its open market sales decrease it. Holding all other variables constant, an increase in MBn arising from an open market purchase increases the amount of the monetary base that is available to support currency and deposits, so the money supply will increase. The opposite happens in the case of an open market sale that decreases MBn. The result is that the money supply is positively related to the nonborrowed monetary base MBn. Diff: 2 Type: ES Skill: Recall Objective: 15.7 Calculate and interpret changes in the money multiplier

38 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 16 Tools of Monetary Policy 16.1 The Framework for the Implementation of Monetary Policy 1) The interest rate on loans of reserves from one bank to another is ________.

A) the bank rate B) the fed funds rate C) the discount rate D) the overnight rate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 2) The overnight rate is ________.

A) the interest rate on loans from the Bank of Canada B) also known as the bank rate C) the rate banks give their best customers D) the interest rate on loans of reserves from one bank to another Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 3) The LVTS was put in place to eliminate ________.

A) systemic risk B) the principal-agent problem C) the moral hazard problem D) credit risk Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

1 .

4) The risk to the entire payments system due to the inability of one financial institution to fulfill its payment obligations in a timely fashion is known as ________.

A) systemic risk B) the principal-agent problem C) moral hazard D) credit risk Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 5) Although transactions in the LVTS account for less than ________ of the total number of transactions, they account for about ________ of the value of transactions.

A) 1 percent; 94 percent B) 5 percent; 90 percent C) 10 percent; 85 percent D) 20 percent; 80 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 6) The Large Value Transfer System (LVTS) ________.

A) was introduced on February 4, 1999 B) is the core of the Canadian payments system C) is an electronic net settlement network designed to provide settlement to paper-based payments items D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

2 .

7) Large Value Transfer System (LVTS) participants can make a payment only if they ________.

A) have positive settlement balances in their accounts with the Bank of Canada B) have posted collateral (such as Government of Canada treasury bills and bonds) C) have explicit lines of credit with other participants D) All of the above.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 8) The Large Value Transfer System (LVTS) ________.

A) is the core of the Canadian payments system B) is an electronic net settlement network designed to provide settlement to wholesale transactions C) is an electronic net settlement network designed to provide settlement to paper-based payment items D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 9) Where only the net credit or debit position of each participant vis-à-vis all other participants is calculated is known as ________.

A) multilateral netting B) principal-agent netting C) moral hazard netting D) credit risk netting Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

3 .

10) Multilateral netting is ________.

A) the netting of the credit or debit position of each participant vis-à-vis all other participants B) an electronic net settlement network designed to provide settlement to paper-based payment items C) the netting of the forward position of LVTS participants D) None of the above.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 11) The Automated Clearing Settlement System (ACSS) ________.

A) is the core of the Canadian payments system B) is an electronic net settlement network designed to provide settlement to wholesale transactions C) is an electronic net settlement network designed to provide settlement to paper-based payment items D) A and B only.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 12) The ACSS is operated by the ________.

A) Canadian Payments Association B) Bank of Canada C) Ministry of Finance D) LVTS Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

4 .

13) The Automated Clearing Settlement System (ACSS) ________.

A) was introduced on February 4, 1999 B) is an electronic net settlement network designed to provide settlement to wholesale transactions C) aggregates interbank payments and informs the Bank of Canada of the net amounts to be transferred from and to each participant's settlement account with the Bank of Canada D) A and B only.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 14) The overnight market in Canada is ________ with a ________ range of participants.

A) very liquid; broad B) very liquid; narrow C) not very liquid; broad D) not very liquid; narrow Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 15) The overnight interest rate is also known as the ________.

A) the bank rate B) the policy rate C) reference rate D) the growth rate of M2 Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

5 .

16) The target for the overnight interest rate is also known as the ________.

A) the bank rate B) the policy rate C) reference rate D) the growth rate of M2 Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 17) The primary indicator of the Bank of Canada's stance on monetary policy is ________.

A) the bank rate B) the overnight rate C) the growth rate of the monetary base D) the growth rate of M2 Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 18) The overnight rate is important because it is ________.

A) the primary indicator of the Bank of Canada's stance on monetary policy B) the interest rate paid on federal debt C) the interest rate charged on government loans D) A and C only.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 19) 45 basis points is equal to ________.

A) 0.45 percent B) 0.045 percent C) 4.5 percent D) 45 percent Answer: A Diff: 1 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 6 .

20) Changes to the operating band are announced by the Bank of Canada ________ times a year.

A) eight B) six C) four D) two Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 21) The Bank of Canada's operating band is ________ basis points or ________.

A) 50; 0.5 percent B) 100; 1 percent C) 50; 5 percent D) 100; 10 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 22) The overnight interest rate ________.

A) is the shortest-term rate available B) forms the base of any term structure of interest rates relation C) is the rate the Bank of Canada charges LVTS participants with negative settlement balances at the end of the banking day D) A and B only.

Answer: D Diff: 3 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

7 .

23) If the operating target of the Bank of Canada is 4.5 percent then the bank rate is ________.

A) 4.75 percent B) 5.25 percent C) 4.25 percent D) 4.5 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 24) If the operating target of the Bank of Canada is 4 percent then the bank rate is ________.

A) 4.25 percent B) 4.50 percent C) 3.5 percent D) 4 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 25) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent then the bank rate is ________.

A) 4 percent B) 3.75 percent C) 3.25 percent D) 4.5 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

8 .

26) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent then the operating target of the Bank's monetary policy is ________.

A) 3.75 percent B) 4 percent C) 3.25 percent D) 3 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 27) If the Bank of Canada pays on deposits to LVTS participants an interest rate of 3.5 percent then the operating target of the Bank's monetary policy is ________ and the bank rate is ________.

A) 3.75 percent; 4 percent B) 4 percent; 4.25 percent C) 3.25 percent; 3.5 percent D) 3 percent; 3.25 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 28) If the Bank of Canada charges for negative settlement balances to LVTS participants an interest rate of 3.5 percent then the operating target of the Bank's monetary policy is ________.

A) 3.25 percent B) 3.75 percent C) 3 percent D) 4 percent Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

9 .

29) The lower limit of the operating band for the overnight interest rate defines ________.

A) the bank rate B) the prime rate C) the rate the Bank of Canada pays LVTS participants with positive settlement balances at the end of the banking day D) the rate the Bank of Canada charges LVTS participants with negative settlement balances at the end of the banking day Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 30) At the end of each banking day, each LVTS participant must bring its settlement balance with the Bank of Canada ________.

A) close to zero B) to a positive balance C) to a negative balance D) to at least $1 million Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 31) The lower limit of the operating band for the overnight interest rate is ________.

A) the bank rate B) the prime rate C) the rate the Bank of Canada charges LVTS participants with negative settlement balances at the end of the banking day D) 50 basis points below the bank rate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

10 .

32) If the operating band for the overnight interest rate is from 3.5 to 4.0 percent, then ________.

A) the bank rate is 4.0 percent B) the bank rate is the lower limit of the operating band C) the bank rate is the rate the Bank of Canada charges LVTS participants with negative settlement balances at the end of the banking day D) A and C only.

Answer: D Diff: 1 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 33) If the operating band for the overnight interest rate is from 3.5 to 4.0 percent, then ________.

A) the rate on positive settlement balances at the Bank of Canada is 3.5 percent B) the rate on positive settlement balances at the Bank of Canada is the lower limit of the operating band C) the bank rate is the lower limit of the operating band D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 34) The operating band for the overnight interest rate is ________.

A) 50 basis points wide B) defines the rate of interest the Bank of Canada charges LVTS participants with negative settlement balances at the end of the banking day C) defines the rate of interest the Bank of Canada pays LVTS participants with negative settlement balances at the end of the banking day D) A and B only.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

11 .

35) Standing facilities ________.

A) refers to participant borrowing from each other to bring their settlement balances to zero at the end of the banking day B) refers to the Bank of Canada refusal to lend to or borrow from a participant to bring their settlement balances to zero at the end of the banking day C) refers to the Bank of Canada's building in Ottawa D) refers to the Bank of Canada being ready to lend to or borrow from a participant to bring their settlement balances to zero at the end of the banking day Answer: D Diff: 3 Type: MC Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 36) When the Bank of Canada lowers the operating band for the overnight interest rate, it ________.

A) lowers the bank rate by the same amount B) encourages LVTS participants to borrow reserves either from each other or from the Bank of Canada C) it reduces the monetary base and ultimately the money supply D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 37) If LVTS participating financial institutions have insufficient settlement balances ________.

A) they can borrow from each other in the pre-settlement trading period at the bank rate B) they can borrow from each other in the pre-settlement trading period at the overnight rate C) they can borrow from the Bank of Canada D) B and C only.

Answer: D Diff: 3 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

12 .

38) If LVTS participating financial institutions have insufficient settlement balances ________.

A) they can borrow from each other in the pre-settlement trading period B) they can borrow from the Bank of Canada C) they can borrow from the Bank of Canada at the prime rate D) A and B only.

Answer: D Diff: 3 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 39) LVTS participants with positive settlement balances at the end of the day ________.

A) are paid the bank rate B) are paid the overnight rate C) are paid the bank rate less 50 basis points D) are paid the prime rate Answer: C Diff: 3 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 40) The rate spread at the Bank of Canada for LVTS balances is ________.

A) 300 basis points B) 200 basis points C) 50 basis points D) 25 basis points Answer: C Diff: 1 Type: MC Skill: Applied Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

13 .

41) What is the service provided by the LVTS? why is it important?

Answer: The LVTS is an electronic, real-time net settlement network, designed to provide immediate finality and settlement to time-critical transactions. There are fifteen LVTS participants and all other members of the Canadian Payments Association can arrange LVTS payments for their clients through the LVTS participants. The importance of the LVTS is that it eliminates systemic risk–the risk to the entire payments system due to the inability of one financial institution to fulfill its payment obligations in a timely fashion.

Diff: 3 Type: ES Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 42) What is the function of the ACSS? Answer: The ACSS is an electronic payments system operated by the Canadian Payments Association. The ACSS aggregates interbank payments from non-LVTS paper-based payment items such as cheques, travellers' cheques, gift certificates and money orders, and transfers the net amounts from and to each participant's settlement account with the Bank of Canada. The Bank completes the settlement the next day through the LVTS. Diff: 2 Type: ES Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities) 43) What is the operating band for the overnight interest rate?

Answer: The Bank of Canada implements monetary policy by changing the overnight interest rate to influence other short-term interest rates and the exchange rate. The Bank's operational objective is to keep the overnight rate within a band of 50 basis points. Early in the morning (9:00 am) on each of the eight specified dates within the year the Bank announces an operating band of 50 basis points for the overnight rate.

Diff: 2 Type: ES Skill: Recall Objective: 16.1 Characterize the framework for the implementation of monetary policy in Canada (the LVTS, the target and the operating band for the overnight interest rate, and the Bank of Canada's standing liquidity facilities)

14 .

16.2 The Market for Settlement Balances and the Channel/Corridor System for Setting the Overnight Interest Rate 1) In Canada, the market for settlement balances (reserves) is where ________.

A) the federal funds rate is determined B) the overnight interest rate is determined C) the discount rate is determined D) LIBOR is determined Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 2) In the market for settlement balances, when the overnight interest rate is below the bank rate and above the bank rate less 50 basis points, the supply curve of reserves is ________.

A) vertical B) horizontal C) positively sloped D) negatively sloped Answer: A Diff: 3 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 3) The market equilibrium, in which the quantity of reserves demanded equals the quantity of reserves supplied ________.

A) determines the overnight rate B) occurs at the intersection of the vertical supply curve and the demand curve at the Bank of Canada's target level of reserves C) determines the interest rate charged on loans of these reserves D) All of the above.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate

15 .

4) When the overnight rate is up to 50 basis points below the bank rate ________.

A) the supply curve of settlement balances has a positive slope B) the demand curve for settlement balances is vertical C) the demand curve for settlement balances is horizontal D) the demand curve for settlement balances has a negative slope Answer: D Diff: 2 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 5) The quantity of reserves demanded rises when the ________.

A) bank rate rises B) bank rate falls C) overnight funds rate rises D) overnight rate falls Answer: D Diff: 1 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 6) The opportunity cost of holding excess reserves is ________.

A) the bank rate B) the prime rate C) the treasury bill rate D) the overnight rate Answer: D Diff: 3 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 7) A rise in the overnight rate ________.

A) decreases the opportunity cost of holding desired reserves B) lowers the opportunity cost of holding desired reserves C) increases the opportunity cost of holding excess reserves D) lowers the opportunity cost of holding excess reserves Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate

16 .

8) In the market for reserves, market equilibrium occurs where the ________.

A) quantity of reserves demanded equals the quantity supplied B) quantity of reserves demanded is above the quantity supplied C) quantity of reserves demanded is below the quantity supplied D) quantity of reserves demanded does not equal the quantity supplied Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 9) The channel/corridor system for setting interest rates ________.

A) is not appropriate for Canadian monetary policy B) limits the amount banks can borrow from the central bank C) enables the central bank to set the overnight, policy rate D) is being phased out as a monetary policy tool Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 10) Explain why the bank rate is an upper limit for the overnight rate.

Answer: Anytime the overnight rate is below the bank rate, banks are going to borrow money from each other in order to minimize their settlement balances with the bank of Canada. When the overnight rate starts to rise and exceeds the bank rate, then banks will be able to borrow as many funds as they require from the Bank of Canada by being charged the bank rate instead of the overnight rate that is now higher. Thus the bank rate is a ceiling for the overnight rate.

Diff: 2 Type: ES Skill: Applied Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate 11) Explain why the bank rate minus 50 basis points (ib-50) is the lower limit for the overnight rate.

Answer: When demand for reserves falls and the overnight rate tends to fall below the ib-50 rate, then the banks with excess reserves are better off leaving their credit (positive) balances with the LVTS where they will get an interest rate of ib-50. Thus, the overnight interest rate can never fall below this point.

Diff: 3 Type: ES Skill: Applied Objective: 16.2 Illustrate the market for reserves, and demonstrate how changes in monetary policy can affect the equilibrium overnight interest rate

17 .

16.3 The Bank of Canada's Approach to Monetary Policy 1) The goal of the Bank of Canada's current monetary policy is to keep the inflation rate within a target range of ________.

A) 2 percent to 3 percent B) 1 percent to 3 percent C) 1 percent to 4 percent D) 2 percent to 4 percent Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy 2) Monetary conditions are impacted by ________.

A) short-term interest rates and the foreign exchange rate B) open market operations and the prime rate C) the foreign exchange rate and the inflation rate D) the Department of Finance Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy 3) Core CPI excludes ________.

A) volatile components B) headline items C) indirect taxes D) energy costs Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy 4) If the Bank of Canada aims at stimulating the economy, it ________ the operating band for the overnight interest rate.

A) lowers B) raises C) leaves unchanged D) stabilizes Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy

18 .

5) The Bank of Canada uses ________ as its operating instrument.

A) the nominal interest rate B) the real interest rate C) open market operations D) M2 + Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy 6) It is the ________ assumption of ________ that allows for the transmission between nominal and real interest rates.

A) new Keynesian; sticky prices B) monetarist; sticky prices C) new Keynesian; perfect markets D) Bank of Canada; chartered banks allegiance to Canadian monetary policy Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy 7) If the Bank of Canada expects the economy exceeds its capacity, it ________ the operating band for the overnight interest rate.

A) lowers B) raises C) leaves unchanged D) stabilizes Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy 8) To keep inflation from falling below the target range, the Bank of Canada ________.

A) decreases the target for the overnight rate which causes the dollar to go down B) decreases the target for the overnight rate which causes the dollar to go up C) increases the target for the overnight rate which causes the dollar to go down D) increases the target for the overnight rate which causes the dollar to go up Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.3 Discuss the Bank of Canada's approach to monetary policy

19 .

16.4 Conventional Monetary Policy Tools 1) The Bank of Canada ________ conducting open market operations in Government of Canada treasury bills and bonds in 1994.

A) started B) stopped C) continued D) implemented Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 2) The Bank of Canada most common operations have been repurchase transactions with ________.

A) stockbrokers B) primary dealers C) the public D) other central banks Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 3) Special Purchase and Resale Agreements ________.

A) relieve undesired upward pressure on the overnight interest rate B) alleviate undesired downward pressure on the overnight financing rate C) relieve undesired downward pressure on the overnight interest rate D) alleviate undesired volatility in the overnight financing rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool

20 .

4) If the Bank of Canada wants to relieve undesired upward pressure on the overnight interest rate it will enter into a ________.

A) Special Purchase and Resale Agreement B) Sale and Repurchase Agreement C) Swap D) Reverse Repo Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 5) If the Bank of Canada wants to relieve undesired upward pressure on the overnight interest rate it will enter into a ________.

A) Resale Agreement B) Sale and Repurchase Agreement C) Swap D) Repo Answer: D Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 6) A repo is a ________.

A) Resale Agreement B) Purchase and Resale Agreement C) Swap D) Repo Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 7) Sale and Repurchase Agreements ________.

A) relieve undesired upward pressure on the overnight interest rate B) alleviate undesired downward pressure on the overnight financing rate C) relieve undesired downward pressure on the overnight interest rate D) alleviate undesired volatility in the overnight financing rate Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool

21 .

8) If the Bank of Canada wants to alleviate undesired downward pressure on the overnight financing rate it will enter into a ________.

A) Special Purchase and Resale Agreement B) Sale and Repurchase Agreement C) Swap D) Repo Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 9) A reverse repo is a ________.

A) Special Purchase and Resale Agreement B) Sale and Repurchase Agreement C) Swap D) Repo Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 10) If the Bank of Canada wants to alleviate undesired downward pressure on the overnight financing rate it will enter into a ________.

A) Purchase and Resale Agreement B) Repurchase Agreement C) Swap D) Reverse Repo Answer: D Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 11) If the Bank of Canada wants to temporarily inject reserves in the banking system, it will engage in ________.

A) a repurchase agreement B) a "swap" transaction C) a reverse repurchase agreement D) None of the above.

Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 22 .

12) If the Bank of Canada wants to temporarily drain reserves from the banking system, it will engage in ________.

A) a repurchase agreement B) a sale and repurchase agreement C) a "pump" agreement D) None of the above.

Answer: B Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 13) The Bank of Canada will engage in a sale and repurchase agreement when it wants to ________ reserves ________ in the banking system.

A) increase; permanently B) increase; temporarily C) decrease; temporarily D) decrease; permanently Answer: C Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 14) The Bank of Canada will engage in a repurchase and resale agreement when it wants to ________ reserves ________ in the banking system.

A) increase; permanently B) increase; temporarily C) decrease; temporarily D) decrease; permanently Answer: B Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 15) SPRAs and SRAs are ________ open market operations.

A) temporary B) permanent C) risky D) conducted 8 times a year Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 23 .

16) The Bank of Canada's repurchase transactions are an advantage because ________.

A) they occur at the initiative of the Bank of Canada B) the bank has complete control over the volume C) they are monopolized by the Bank of Canada D) A and B only.

Answer: D Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 17) If the Bank of Canada wants to temporarily inject reserves in the banking system, it will engage in ________.

A) a repurchase agreement B) a "swap" transaction C) a reverse repurchase agreement D) None of the above.

Answer: A Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 18) If the Bank of Canada wants to temporarily drain reserves from the banking system, it will engage in ________.

A) a repurchase agreement B) a sale and repurchase agreement C) a "pump" agreement D) None of the above.

Answer: B Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 19) The Bank of Canada will engage in a repurchase agreement when it wants to ________ reserves ________ in the banking system.

A) increase; permanently B) increase; temporarily C) decrease; temporarily D) decrease; permanently Answer: B Diff: 2 Type: MC Skill: Applied Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 24 .

20) In addition to targeting the overnight interest rate at the mid-point of the operating band, the Bank of Canada also targets ________.

A) the prime rate B) the level of settlement balances C) the treasury bill rate D) the money multiplier Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 21) If government deposits at the Bank of Canada are predicted to increase, the manager of the trading desk at the Bank will likely conduct activities to ________ reserves.

A) inject B) drain C) reverse D) flood Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 22) The target for settlement balances is set at ________.

A) zero with no adjustments for any pressures on the overnight rate B) zero but the Bank of Canada adjusts depending on the nature of the pressures on the overnight rate C) zero but the Bank of Canada adjusts depending on the nature of the pressures on the prime rate D) always positive with no adjustments Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 23) The Bank of Canada neutralizes special PRA operations to ________.

A) not to leave the system in a surplus position at the end of the day B) to leave the system in a surplus position at the end of the day C) to leave the system changed at the end of the day D) as to leave the system in a deficit position at the end of the day Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 25 .

24) The Bank of Canada neutralizes SRA operations to ________.

A) not to leave the system in a surplus position at the end of the day B) to leave the system in a surplus position at the end of the day C) as not to leave the system in a deficit position at the end of the day D) as to leave the system in a deficit position at the end of the day Answer: C Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 25) The Bank of Canada neutralizes government receipts by ________.

A) arranging an increase in government deposit auctions B) leaving the system in a surplus position at the end of the day C) reducing the banking system's settlement balances D) leaving the system in a deficit position at the end of the day Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 26) If government deposits at the Bank of Canada are predicted to decrease the Bank will offset the transaction through LVTS transfers to ________ settlement balances.

A) increase B) decrease C) flood D) inject Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 27) If government deposits at the Bank of Canada are predicted to increase, it will offset the transaction through government debt auctions to ________ settlement balances.

A) decrease B) increase C) inflate D) drain Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 26 .

28) If government deposits at the Bank of Canada are predicted to decrease, the Bank will offset the transaction through government deposit auctions to ________ settlement balances.

A) decrease B) increase C) inject D) resupply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 29) The facility at which banks can borrow reserves from the Bank of Canada is called the ________.

A) standing lending facility B) temporary lending facility C) permanent lending facility D) daily lending facility Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 30) A standing lending facility is ________.

A) one at which banks can borrow reserves from the Bank of Canada B) a temporary lending facility C) a permanent lending facility D) a daily lending facility Answer: A Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 31) One of the Bank of Canada's most important roles is to be ________.

A) the federal government's banker B) the issuer of government debt C) a lender-of-last-resort D) a regulator of banks Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool

27 .

32) The Bank of Canada's lender-of-last-resort function ________.

A) is no longer necessary due to CDIC insurance B) has proven to be ineffective C) is needed to prevent runs by large-denomination depositors D) A and B only.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 33) In March 2020, the Bank of Canada increased the target level of settlement balances from ________ to address the challenges posed by the Coronavirus pandemic.

A) $150 million to $500 million B) $150 million to $2 billion C) $500 million to $2 billion D) $1 billion to $500 million Answer: C Diff: 1 Type: MC Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 34) Explain the Bank of Canada's open market operations? What are SPRAs and SRAs? How are they used to impact the overnight rate?

Answer: SPRA is special Purchase and Resale Agreement and SRA is a Sale and Repurchase Agreement. SPRAS are used to relieve undesired upward pressure on the overnight interest rate.

SRAs alleviated undesired downward pressure on the overnight financing rate. Both are temporary measures.

Diff: 2 Type: ES Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 35) What are the advantages of SPRAs and SRAs? Answer: 1. The Bank of Canada has complete control over them as they occur at the initiative of the Bank of Canada.

2. They are flexible and precise; together with the Bank's standing facilities they can be used to any extent.

3. They are easily reversed.

4. They can be implemented quickly.

Diff: 3 Type: ES Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 28 .

36) What are the advantages and disadvantages of the Bank's lending policy?

Answer: The most important advantage is that the Bank can use it to perform its role of lender of last resort. But it is less effective compared to open market operations for two reasons. Open market buyback operations are completely at the discretion of the Bank of Canada, whereas the volume of normal advances is not. The Bank can change the bank rate but in the current channel/corridor system can't make banks borrow. In addition, open market buyback operations are more easily reversed than changes in Bank lending policy.

Diff: 3 Type: ES Skill: Recall Objective: 16.4 Summarize how conventional monetary policy tools are implemented and the relative advantages and limitations of each tool 16.5 Nonconventional Monetary Policy Tools During the Global Financial Crisis 1) The large-scale purchase of Government of Canada bonds which leads to the rapid expansion of the monetary base is known as ________.

A) quantitative easing B) management of expectations C) forward guidance D) credit easing Answer: A Diff: 3 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 2) If the Bank of Canada targets the overnight interest rate at the ________, it would be able to choose both the overnight interest rate and the quantity of reserves independently.

A) rate paid on excess reserves B) overnight interest rate C) policy rate D) 3-month treasury bills rate Answer: A Diff: 3 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective

29 .

3) Which of the following is not considered one of the strategies used by the Bank of Canada for increasing its lending facilities to provide liquidity to the financial markets during the recent financial crises caused by the coronavirus pandemic?

A) The expansion of the Standing Lending Facility.

B) The enhancing of its Standing Term Liquidity Facility.

C) The increase in the Target Level of Settlement Balances.

D) The introduction of New Lending Programs.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 4) During the Covid-19 pandemic, the Bank of Canada came up with several new and novel programs to help restore liquidity in the financial system. In one of these programs, the Bank of Canada purchased provincial ________ market securities on the ________ market.

A) money; secondary B) capital; secondary C) money; primary D) capital; primary Answer: C Diff: 2 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 5) During the 2008-2009 global financial crisis in the United States, huge increases in the monetary base led to large ________ in excess reserves and bank lending ________.

A) increases; increased B) decreases; decreased C) increases; decreased D) increases; did not change Answer: D Diff: 2 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective

30 .

6) Quantitative easing is regarded as ________.

A) the price of liquidity B) a risky monetary policy tool C) a very low-risk monetary policy tool D) an adequate policy tool Answer: B Diff: 3 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 7) Quantitative easing is a high-risk monetary policy tool as it runs the risk of ________.

A) possibly creating deflation B) possibly creating inflation and even hyperinflation C) not having the expected effect D) having very short-term and non-permanent effects Answer: B Diff: 3 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 8) Altering the composition of the Bank of Canada's balance sheet in order to improve the functioning of certain segments of the credit markets.is known as ________.

A) quantitative easing B) forward guidance C) managing risk expectations D) credit easing Answer: D Diff: 3 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 9) Say that the Bank of Canada announces that it will keep the policy rate at 0.25% for an extensive period of time without indicating that this decision may change depending on the circumstances. This is an example of ________.

A) a conditional commitment B) an unconditional commitment C) an open market commitment D) quotative commitment Answer: B Diff: 2 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 31 .

10) Helicopter money is a ________ policy tool that can potentially be used by a central bank to ________ output and at the same time fight ________ pressures.

A) conventional; increase; inflationary B) nonconventional; increase; inflationary C) nonconventional; increase; deflationary D) nonconventional; decrease; deflationary Answer: C Diff: 2 Type: MC Skill: Recall Objective: 16.5 Explain the key monetary policy tools that are used when conventional monetary policy is no longer effective 16.6 Monetary Policy Tools of the Federal Reserve and the European Central Bank 1) Describe some of the actions the Bank of Canada took to mitigate the effects of widening spreads and increased volatility in the term interbank market in the second half of 2008.

Answer: The Bank of Canada announced that it would enter into a series 28-day PRA transactions, thereby injecting huge amounts of liquidity in the markets. Moreover, the Bank expanded its list of acceptable collateral to include bank-sponsored asset-backed commercial paper and U.S. Treasuries. It also expanded its list of eligible counterparties. In engaging in these trades, the Bank takes securities onto its books in exchange for borrowings from the Bank's standing lending facility.

Diff: 3 Type: ES Skill: Recall Objective: 16.6 Identify the distinctions and similarities between the monetary policy tools of the Bank of Canada and those of the Federal Reserve and the European Central Bank 2) The Federal Reserve's lending of reserves to banks is called ________ lending.

A) discount window B) term C) prime D) target Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.6 Identify the distinctions and similarities between the monetary policy tools of the Bank of Canada and those of the Federal Reserve and the European Central Bank

32 .

3) The lending facility at the Federal Reserve sets a ________ on the short-term overnight interest rates.

A) ceiling B) floor C) target D) ceiling and floor Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.6 Identify the distinctions and similarities between the monetary policy tools of the Bank of Canada and those of the Federal Reserve and the European Central Bank 4) The primary indicator of the stance of monetary policy in the U.S. is the ________.

A) federal funds rate B) discount rate C) overnight rate D) prime rate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.6 Identify the distinctions and similarities between the monetary policy tools of the Bank of Canada and those of the Federal Reserve and the European Central Bank 5) The European Central bank uses the ________ to signal its stance on monetary policy.

A) target financing rate B) overnight cash rate C) overnight bank rate D) discount window Answer: A Diff: 1 Type: MC Skill: Recall Objective: 16.6 Identify the distinctions and similarities between the monetary policy tools of the Bank of Canada and those of the Federal Reserve and the European Central Bank 6) The equivalent to the Federal Reserve's discount rate in the European System of Central Banks is the ________.

A) federal funds rate B) marginal lending rate C) deposit facility rate D) LICO rate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 16.6 Identify the distinctions and similarities between the monetary policy tools of the Bank of Canada and those of the Federal Reserve and the European Central Bank

33 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 17 The Conduct of Monetary Policy: Strategy and Tactics 17.1 The Price Stability Goal and the Nominal Anchor 1) Price stability is defined as ________.

A) low inflation B) low and stable inflation C) stable inflation D) core inflation Answer: B Diff: 1 Type: MC Skill: Recall Objective: 17.1 Define and recognize the importance of a nominal anchor 2) The importance of a nominal anchor is to ________.

A) limit the time-inconsistency problem B) reduce inflation C) promote low inflation D) allow discretionary day-to-day monetary policy Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.1 Define and recognize the importance of a nominal anchor 3) Inflation leads to ________.

A) price instability B) lower economic growth C) public hostility D) all of the above Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.1 Define and recognize the importance of a nominal anchor 4) The nominal anchor ________.

A) acts like behavioural rule B) leads to inflation C) creates the time-inconsistency problem D) avoids the natural rate of unemployment Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.1 Define and recognize the importance of a nominal anchor

1 .

5) Describe the time-inconsistency problem as it pertains to monetary policy outcomes.

Answer: The time-inconsistency problem occurs when monetary policymakers are tempted to pursue a discretionary monetary policy that is more expansionary than firms or people expect because such a policy would boost economic output (or lower employment) in the short run.

Diff: 1 Type: ES Skill: Recall Objective: 17.1 Define and recognize the importance of a nominal anchor 17.2 Other Goals of Monetary Policy 1) The natural rate of unemployment ________.

A) is consistent with full employment B) is equal to zero C) equals the structural employment rate D) is the same as frictional employment Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue 2) High unemployment ________.

A) results in lower GDP B) leads to increased human misery C) cannot be a target of monetary policy D) A and B only Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue 3) The natural rate of output is also known as ________.

A) potential output B) NAIRU C) structural output D) GDP Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

2 .

4) Interest rate stability is desirable because ________.

A) fluctuations in interest rates create uncertainty B) it leads to financial market stability C) it leads to stability in the foreign exchange markets D) all of the above Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue 5) Increases in interest rates ________.

A) cause large capital losses B) could lead to bank failures C) affect consumers' willingness to buy houses D) all of the above Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue 6) A rise in the value of the Canadian dollar makes Canadian industries ________ competitive with those abroad, while a drop in the value of the dollar ________ inflation.

A) more; slows B) more; stimulates C) less; stimulates D) less; slows Answer: C Diff: 2 Type: MC Skill: Recall Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

3 .

17.3 Should Price Stability Be the Primary Goal of Monetary Policy?

1) Hierarchical mandates ________.

A) puts the goal of price stability first and then allows for other goals B) requires all goals to be met simultaneously C) is only used by the Bank of Canada D) is only used by the Federal Reserve Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates 2) In the long-run, there is no trade-off between ________ and ________.

A) inflation; unemployment B) inflation; price stability C) unemployment; price stability D) unemployment; economic growth Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates 3) Which of the following countries central banks have hierarchical mandates?

A) Reserve Bank of New Zealand B) Bank of Canada C) Bank of England D) all of the above Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates 4) Price stability is often the primary goal of central banks. Describe the five other goals of monetary policy Answer: The other objectives of monetary policy are: (1) high employment and output stability, (2) economic growth, (3) stability of financial markets, (4) interest-rate stability, and (5) stability in foreign exchange markets.

Diff: 1 Type: ES Skill: Recall Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates

4 .

17.4 Inflation Targeting 1) Inflation targeting includes ________.

A) a public announcement of medium-term targets for inflation B) an institutional commitment to price stability as the primary long run goal C) an information-inclusive approach in which many variables are used in making decisions about monetary policy D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 2) The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is ________.

A) monetary targeting B) inflation targeting C) targeting with an implicit nominal anchor D) interest-rate targeting Answer: B Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 3) Concerns about a dual mandate include ________.

A) over expansionary policy B) policies that lead to large output fluctuations C) time-inconsistency problems D) decreases in output and unemployment Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 4) Which of the following is not an element of inflation targeting?

A) A public announcement of medium-term numerical targets for inflation B) An institutional commitment to price stability as the primary long-run goal C) An information-inclusive approach in which only monetary aggregates are used in making decisions about monetary policy D) Increased accountability of the central bank for attaining its inflation objectives Answer: C Diff: 3 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

5 .

5) The first country to adopt inflation targeting was ________.

A) the United Kingdom B) Canada C) New Zealand D) Australia Answer: C Diff: 1 Type: MC Skill: Applied Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 6) New Zealand adopted inflation targeting in ________.

A) 1990 B) 1991 C) 1992 D) 1994 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 7) The Reserve Bank of New Zealand ________.

A) is one of the most independent central banks B) as the sole objective of price stability C) negotiates with the minister of finance when setting a Policy Targets Agreement D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 8) Tight monetary policy in New Zealand ________.

A) brought inflation down to below 2 percent B) reduced unemployment C) led to a higher economic growth rate D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

6 .

9) During the early period when Canada first adopted inflation targeting, the unemployment rate increased ________.

A) above 10 percent B) nearly 8 percent C) over 5 percent but less than 10 percent D) 5 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 10) In both New Zealand and Canada, what has happened to the unemployment rate since the countries adopted inflation targeting?

A) The unemployment rate increased sharply.

B) The unemployment rate remained constant.

C) The unemployment rate has declined substantially after a sharp increase.

D) The unemployment rate declined sharply immediately after the inflation targets were adopted.

Answer: C Diff: 1 Type: MC Skill: Applied Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 11) The United Kingdom uses ________ as its nominal anchor.

A) an inflation target B) monetary aggregates C) an interest rate target D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 12) Peak inflation in the United Kingdom was ________ in ________.

A) 9 percent; 1991 B) 4 percent; 1997 C) 12 percent; 1991 D) 8 percent; 1995 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

7 .

13) The target inflation range set by the Bank of England is ________.

A) 1-4 percent B) 1-3 percent C) 2-4 percent D) 2-3 percent Answer: A Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 14) Which of the following is an advantage of inflation targeting?

A) There is simplicity and clarity with regards to the target.

B) Inflation targeting does not rely on a stable money-inflation relationship.

C) It is understood by the public and is transparent.

D) All of the above.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 15) Which of the following is an advantage to inflation targeting?

A) There is a delayed signal about the success of having achieved the target.

B) Inflation targets could impose a rigid rule on policymakers.

C) There is potential for large output fluctuations.

D) There is transparency.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 16) Which of the following is an advantage to inflation targeting?

A) There is a delayed signal about the success of having achieved t the target.

B) Inflation targets could impose a rigid rule on policymakers.

C) There is potential for larger output fluctuations.

D) The central bank becomes more accountable.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

8 .

17) Which of the following is an advantage to inflation targeting?

A) There is a delayed signal about the success of having achieved the target.

B) Inflation targets could impose a rigid rule on policymakers.

C) There is potential for larger output fluctuations.

D) The performance has been quite good.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 18) Which of the following is an advantage to inflation targeting?

A) There is a delayed signal about the success of having achieved the target.

B) Inflation targets could impose a rigid rule on policymakers.

C) There is potential for larger output fluctuations.

D) It is easily understood by the public.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 19) Which of the following is a disadvantage of inflation targeting?

A) There is transparency.

B) Inflation targeting does not rely on a stable money-inflation relationship.

C) It imposes a rigid rule.

D) Inflation targeting reduces the effects of inflation shocks.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 20) Which of the following is a disadvantage of inflation targeting?

A) There is simplicity and clarity with regards to the target.

B) Inflation targeting does not rely on a stable money-inflation relationship.

C) There is a delayed signal on the achievement of the target.

D) Inflation targeting reduces the effects of inflation shocks.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

9 .

21) Which of the following is a disadvantage of inflation targeting?

A) There is simplicity and clarity with regards to the target.

B) Inflation targeting does not rely on a stable money-inflation relationship.

C) It imposes a rigid rule.

D) Inflation targeting reduces the effects of inflation shocks.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 22) Which of the following is disadvantage of inflation targeting?

A) There is simplicity and clarity with regards to the target.

B) Inflation targeting does not rely on a stable money-inflation relationship.

C) It may lead to larger output fluctuations.

D) Inflation targeting reduces the effects of inflation shocks.

Answer: C Diff: 1 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 23) Inflation targeting has the potential to reduce the likelihood that the central bank will fall into the time-inconsistency trap of trying to ________ output and employment in the short run by pursuing an overly ________ monetary policy.

A) lower; tight B) expand; expansionary C) lower; expansionary D) expand; tight Answer: B Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 24) The decision by inflation targeters to choose inflation targets ________ zero reflects the concern of monetary policymakers that particularly ________ inflation can have substantial negative effects on economic growth.

A) below; high B) below; low C) above; high D) above; low Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

10 .

25) What are the advantages inflation targeting?

Answer: The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical target for the inflation rate; 2. does not rely on a stable money-inflation relationship; 3. there is increased accountability of the central bank; 4. reduces the effects of inflationary shocks.

Diff: 2 Type: ES Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 26) What are the disadvantages inflation targeting?

Answer: The disadvantages of inflation targeting include: 1. there is a delayed signal about the achievement of the target; 2. it could lead to a rigid rule where the only focus is the inflation rate (has not happened in practice); 3. if sole focus is the inflation rate, larger output fluctuations can occur (has not happened in practice).

Diff: 2 Type: ES Skill: Recall Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting 17.5 Lessons for Monetary Policy Strategy from the Global Financial Crisis 1) Which of the following is not one of the four basic lessons for economists and policymakers on how the economy works?

A) Developments in the financial sector have a far greater impact on economic activity than was earlier realized.

B) The effective lower bound on interest rates can be a serious problem.

C) The cost of cleaning up after a financial crisis is very high.

D) Price and output stability lead to financial stability.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what they mean for inflation targeting 2) During the coronavirus pandemic, the effective lower bound on interest rates forced the Bank of Canada to use ________ policy tools, which are ________ to use effectively.

A) nonconventional monetary; easier B) nonconventional monetary; harder C) conventional monetary; easier D) conventional monetary; harder Answer: B Diff: 2 Type: MC Skill: Recall Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what they mean for inflation targeting

11 .

3) Did the financial crisis reveal that developments in the financial sector were less important than previously thought?

Answer: No. Financial developments had very significant impacts on the economy and those financial frictions could have a major disruptive impact on the economies of many countries.

Diff: 2 Type: ES Skill: Recall Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what they mean for inflation targeting 4) The effective lower bound on interest rates can be a serious problem?

Answer: The other nonconventional monetary policy tools are complicated and unpredictable.

Diff: 2 Type: ES Skill: Recall Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what they mean for inflation targeting 5) What are some of the costs of cleaning up after a financial crisis?

Answer: High and persistent unemployment, increased government debt and increased likelihood of defaults on government debt.

Diff: 2 Type: ES Skill: Recall Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what they mean for inflation targeting 6) Did the Great Moderation protect economies from financial instability.

Answer: No, the apparent stability of the economy obscured the fact that financial developments could create new problems for the economy.

Diff: 2 Type: ES Skill: Applied Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what they mean for inflation targeting

12 .

17.6 Should Central Banks Try to Stop Asset-Price Bubbles 1) The two types of asset-price bubbles are ________ and ________ bubbles.

A) credit-driven; debt driven B) rational; optimistic C) irrational exuberance; optimistic D) credit-driven; irrational exuberance Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-price bubbles 2) Define the two types of asset-price bubbles and explain why one of these is more is more problematic for the economy.

Answer: The two types of asset-price bubbles are credit-driven bubbles and those driven by irrational exuberance. Credit-driven bubbles occur when, as a result of overly easy monetary policy, credit becomes relatively available at low interest rates. This fuels the demand for different classes of assets causing their prices to rise, creating the expectation of further price rises and yet further increases in demand. When these bubbles end, the falling asset prices cause widespread financial problems leading to possibly a financial crisis. Bubbles driven by irrational exuberance are fueled by overly optimistic expectations. The bursting of these bubbles cause losses to speculators but not a widespread financial crisis.

Diff: 2 Type: ES Skill: Applied Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-price bubbles 3) Give five reasons why central banks should not try to prick an asset-price bubble.

Answer: The answer should include (1) a discussion of how difficult it is to identify asset-price bubbles, (2) the recognition that rising interest rates may reinforce the expectations of rising prices, (3) the possibility that raising interest rates to deal with one particular asset-price bubble might adversely affect the values of other assets, (4) the recognition that the attempts to prick an asset-price bubble might have detrimental effects on the overall economy , and (5) the possibility of an aggressive response by monetary authorities to offset the repercussions of the bursting of an asset-price bubble.

Diff: 3 Type: ES Skill: Recall Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-price bubbles

13 .

4) What are credit booms and why might a policy of leaning against a credit boom be preferred to leaning against asset-price bubbles?

Answer: Credit booms occur when it becomes much easier for investors to borrow because of lower interest costs and laxer credit standards and consequently greater risk taking by investors.

Policies designed to ensure that credit standards do not become laxer will do a better job of dealing with credit-driven bubbles which are more damaging to the economy.

Diff: 3 Type: ES Skill: Applied Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-price bubbles 5) Why might a policy of low interest rates encourage excessive risk taking?

Answer: When yields on safe investments become very low and real returns are extremely low, investors are induced to seek higher returns and are therefore subject to higher risk levels.

Diff: 2 Type: ES Skill: Recall Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-price bubbles 17.7 Tactics: Choosing the Policy Instrument 1) Which of the following is not an operating instrument?

A) Nonborrowed reserves B) Monetary base C) Overnight interest rate D) Bank rate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 2) Which of the following is a potential operating instrument (i.e., policy instrument) for the central bank?

A) The monetary base B) The M1 + C) GDP D) M2+ Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument

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3) Which of the following is not an operating instrument (i.e., policy instrument)?

A) Nonborrowed reserves B) Monetary base C) Overnight funds interest rate D) Long term interest rates Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 4) Which of the following is a potential operating instrument (i.e., policy instrument) for the central bank?

A) The monetary base B) The exchange rate C) The inflation rate D) Long term interest rates Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 5) Which of the following is a potential operating instrument (i.e., policy instrument) for the central bank?

A) Nonborrowed reserves B) The overnight funds rate C) The monetary base D) All of the above Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 6) A potential policy instrument (i.e., operating instrument) for the Bank of Canada is ________.

A) the monetary base B) borrowed reserves C) the overnight rate D) the nonborrowed monetary base E) All of the above.

Answer: E Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument

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7) Which of the following is not a criterion when choosing a policy instrument? ________.

A) The instrument must be observable and measurable.

B) The instrument must be controllable by the central bank.

C) The instrument must have a predictable effect on the goals.

D) The instrument must be closely linked to the goals of monetary policy.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 8) If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because ________.

A) of fluctuations in the demand for reserves B) of fluctuations in the consumption function C) bond values will tend to remain stable D) of fluctuations in the business cycle Answer: A Diff: 2 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 9) Fluctuations in the demand for reserves cause the Bank of Canada to lose control over a monetary aggregate if the Bank of Canada targets ________.

A) a monetary aggregate B) the monetary base C) an interest rate D) nominal GDP Answer: C Diff: 2 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 10) Interest rates are difficult to measure because ________.

A) data on them are not available in a timely manner B) real interest rates depend on the hard-to-determine expected inflation rate C) they fluctuate too often to be accurate D) they cannot be controlled by the Bank of Canada Answer: B Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument

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11) Which of the following criteria need not be satisfied when choosing an intermediate target?

A) The variable must be measurable.

B) The variable must be controllable.

C) The variable must be predictable.

D) The variable must be stable.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 12) Which of the following is not a requirement when selecting an intermediate target?

A) Measurability B) Controllability C) Flexibility D) Predictability Answer: C Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 13) When it comes to choosing a policy instrument, both the ________ rate and ________ aggregates are measured accurately and are available daily with almost no delay.

A) three-month T-bill; monetary B) three-month T-bill; reserve C) overnight rate; monetary D) overnight rate; reserve Answer: D Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 14) Which of the following best explains why the Bank of Canada does not use nominal GDP as an intermediate target?

A) Nominal GDP has little connection with Bank of Canada policy goals.

B) Nominal GDP is unaffected by open market operations.

C) The Bank of Canada has little direct control over nominal GDP. D) None of the above.

Answer: C Diff: 2 Type: MC Skill: Applied Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument

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15) Which of the following criteria must be satisfied when selecting an intermediate target?

A) The variable must be measurable and frequently available.

B) The variable must be controllable with the use of the central bank's policy tools.

C) The variable must have a predictable impact on the policy goal.

D) All of the above.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 16) If the desired intermediate target is an interest rate, then the preferred policy instrument will be a(n) ________ variable like the ________.

A) interest rate; three-month T-bill rate B) interest rate; overnight rate C) monetary aggregate; monetary base D) monetary aggregate; nonborrowed base Answer: B Diff: 1 Type: MC Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 17) Explain and demonstrate graphically how targeting nonborrowed reserves can result in overnight rate instability.

Answer: When nonborrowed reserves are held constant, increases in the demand for reserves result in the overnight rate increasing and decreases in the demand for nonborrowed reserves result in the overnight rate declining. Since fluctuations in demand do not cause monetary policy actions, the result is the overnight rate will fluctuate. See Figure 18-3 in the textbook.

Diff: 3 Type: ES Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 18) Explain and demonstrate graphically how targeting the overnight rate can result in fluctuations in nonborrowed reserves.

Answer: With an overnight rate target, fluctuations in demand for reserves require similar changes in the nonborrowed reserves to keep the overnight rate constant. See Figure 18-4 in the textbook.

Diff: 3 Type: ES Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 19) What criteria apply when choosing a policy instrument?

Answer: Three criteria apply when choosing a policy instrument: The instrument must be observable and measurable, it must be controllable by the central bank, and it must have a predictable effect on the goals.

Diff: 3 Type: ES Skill: Recall Objective: 17.7 Describe and assess the three criteria for choosing a policy instrument 18 .

17.8 Tactics: The Taylor Rule 1) According to the Taylor rule, the Bank of Canada should raise the overnight interest rate when inflation ________ the Bank of Canada's inflation target or when real GDP ________ the Bank of Canada's output target.

A) rises above; drops below B) drops below; drops below C) rises above; rises above D) drops below; rises above Answer: C Diff: 2 Type: MC Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate 2) According to the Taylor rule, the overnight interest rate should be set at ________.

A) π + ior - 0.5(π - π*) - 0.5(y - y) B) π + ior + 0.5(π - π*) + 0.5(y - y) C) r + π D) r - π Answer: B Diff: 1 Type: MC Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate 3) According to the Taylor rule, the overnight interest rate should be set at ________.

A) π + ior - 0.5(π - π*) - 0.5(y - y) B) π - ior - 0.5(π - π*) - 0.5(y - y) C) r + π D) r - π E) None of the above.

Answer: E Diff: 1 Type: MC Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate

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4) Using Taylor's rule, when the equilibrium real overnight rate is 3 percent, the positive output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal overnight rate target should be ________.

A) 5 percent B) 5.5 percent C) 6 percent D) 6.5 percent Answer: D Diff: 1 Type: MC Skill: Applied Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate 5) Using Taylor's rule, when the equilibrium real overnight rate is 2 percent, there is no output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal overnight rate should be ________.

A) 0 percent B) 1 percent C) 2 percent D) 3 percent Answer: B Diff: 1 Type: MC Skill: Applied Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate 6) According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should be ________ by ________ than the inflation rate increase.

A) increased; more B) increased; less C) decreased; more D) decreased; less Answer: A Diff: 1 Type: MC Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate

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7) If the Taylor Principle is not followed and nominal interest rates are increased by less than the increase in the inflation rate, then real interest rates will ________ and monetary policy will be too ________.

A) rise; tight B) rise; loose C) fall; tight D) fall; loose Answer: D Diff: 3 Type: MC Skill: Applied Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate 8) The rate of inflation tends to remain constant when ________.

A) the unemployment rate is above the NAIRU B) the unemployment rate equals the NAIRU C) the unemployment rate is below the NAIRU D) the unemployment rate increases faster than the NAIRU increases Answer: B Diff: 1 Type: MC Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate 9) The rate of inflation increases when ________.

A) the unemployment rate equals the NAIRU B) the unemployment rate exceeds the NAIRU C) the unemployment rate is less than the NAIRU D) the unemployment rate increases faster than the NAIRU increases Answer: C Diff: 1 Type: MC Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate

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10) Explain the Taylor rule, including the formula for setting the overnight rate target, and the components of the formula. If the Bank of Canada were to use this rule, how many goals would it use to set monetary policy?

Answer: The Taylor rule specifies that the target overnight rate should be set to equal the equilibrium real overnight rate, plus the rate of inflation (for the Fisher effect), plus one-half times the output gap, plus one-half times the inflation gap. The formula is overnight rate target = equilibrium real overnight rate + inflation rate + (output gap) + (inflation gap) The output gap is the percentage deviation of real GDP from potential full-employment real GDP. The inflation gap is the difference between actual inflation and the central bank's target rate of inflation. The equilibrium real overnight rate is the real rate consistent with full employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule sets the overnight rate recognizing the goals of low inflation and full employment (or equilibrium long-run economic growth).

Diff: 3 Type: ES Skill: Recall Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy instrument for setting the overnight interest rate

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 18 The Foreign Exchange Market 18.1 Foreign Exchange Market 1) The exchange rate is ________.

A) the price of one currency relative to gold B) the value of a currency relative to inflation C) the change in the value of money over time D) the price of one currency relative to another Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 2) Exchange rates are determined in ________.

A) the money market B) the foreign exchange market C) the stock market D) the capital market Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 3) Although foreign exchange market trades are said to involve the buying and selling of currencies, most trades involve the buying and selling of ________.

A) assets denominated in different currencies B) SDRs C) gold D) ECUs Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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4) The immediate (two-day) exchange of one currency for another is a ________.

A) forward transaction B) spot transaction C) money transaction D) exchange transaction Answer: B Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 5) An agreement to exchange dollar bank deposits for euro bank deposits in one month is a ________.

A) spot transaction B) future transaction C) forward transaction D) deposit transaction Answer: C Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 6) Today 1 euro can be purchased for $1.10. This is the ________.

A) spot exchange rate B) forward exchange rate C) fixed exchange rate D) financial exchange rate Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 7) In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the price is the ________.

A) spot exchange rate B) money exchange rate C) forward exchange rate D) fixed exchange rate Answer: C Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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8) When the value of the British pound changes from $1.25 to $1.50, the pound has ________ and the Canadian dollar has ________.

A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 9) When the value of the British pound changes from $1.50 to $1.25, then the pound has ________ and the Canadian dollar has ________.

A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 10) When the value of the dollar changes from £0.5 to £0.75, then the British pound has ________ and the Canadian dollar has ________.

A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 11) When the value of the dollar changes from £0.75 to £0.5, then the British pound has ________ and the Canadian dollar has ________.

A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 3 .

12) When the exchange rate for the Mexican peso changes from 9 pesos to the Canadian dollar to 10 pesos to the Canadian dollar, then the Mexican peso has ________ and the Canadian dollar has ________.

A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 13) When the exchange rate for the Mexican peso changes from 10 pesos to the Canadian dollar to 9 pesos to the Canadian dollar, then the Mexican peso has ________ and the Canadian dollar has ________.

A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 14) At one time, one Canadian dollar traded on the foreign exchange market for about 0.75 euros. Therefore, one euro would have purchased, at that time, about ________ Canadian dollars.

A) 0.75 B) 1.00 C) 1.33 D) 1.75 Answer: C Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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15) At one time, one Canadian dollar traded on the foreign exchange market for about 49.0 Indian rupees. Thus, one Indian rupee would have purchased, at that time, about ________ Canadian dollars.

A) 0.02 B) 1.20 C) 7.00 D) 49.0 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 16) At one time, one Canadian dollar traded on the foreign exchange market for about 1.15 Swiss francs. Therefore, one Swiss franc would have purchased, at that time, about ________ Canadian dollars.

A) 0.30 B) 0.87 C) 1.15 D) 3.10 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 17) At one time, one Canadian dollar traded on the foreign exchange market for about 3.33 Romanian new lei. Therefore, one Romanian new lei would have purchased, at that time, about ________ Canadian dollars.

A) 0.30 B) 1.86 C) 2.86 D) 3.33 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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18) If the Canadian dollar appreciates from 1.25 Swiss franc per Canadian dollar to 1.5 francs per dollar, then the franc depreciates from ________ Canadian dollars per franc to ________ Canadian dollars per franc.

A) 0.80; 0.67 B) 0.67; 0.80 C) 0.50; 0.33 D) 0.33; 0.50 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 19) If the British pound appreciates from $0.50 per pound to $0.75 per pound, the Canadian dollar depreciates from ________ per dollar to ________ per dollar.

A) £2; £2.5 B) £2; £1.33 C) £2; £1.5 D) £2; £1.25 Answer: B Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 20) If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the Canadian dollar depreciates from ________ per dollar to ________ per dollar.

A) 100¥; 50¥ B) 10¥; 5¥ C) 5¥; 10¥ D) 50¥; 100¥ Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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21) If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real depreciates from ________ per real to ________ per real.

A) $0.67; $0.50 B) $0.33; $0.50 C) $0.75; $0.50 D) $0.50; $0.67 E) $0.50; $0.75 Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 22) When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per pound, then, holding everything else constant, the pound has ________ and ________ expensive.

A) appreciated; British cars sold in Canada become more B) appreciated; British cars sold in Canada become less C) depreciated; American wheat sold in Britain becomes more D) depreciated; American wheat sold in Britain becomes less Answer: C Diff: 2 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 23) If the dollar depreciates relative to the Swiss franc, ________.

A) Swiss chocolate will become cheaper in Canada B) American computers will become more expensive in Switzerland C) Swiss chocolate will become more expensive in Canada D) Swiss computers will become cheaper in Canada Answer: C Diff: 2 Type: MC Skill: Applied Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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24) Everything else held constant, when a country's currency appreciates, the country's goods abroad become ________ expensive and foreign goods in that country become ________ expensive.

A) more; less B) more; more C) less; less D) less; more Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important 25) Everything else held constant, when a country's currency depreciates, its goods abroad become ________ expensive while foreign goods in that country become ________ expensive.

A) more; less B) more; more C) less; less D) less; more Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.1 Explain how the foreign exchange market works and why exchange rates are important

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18.2 Exchange Rates in the Long Run 1) According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos per pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate between the Colombian peso and the Brazilian real is ________.

A) 40 pesos per real B) 100 pesos per real C) 25 pesos per real D) 0.4 pesos per real Answer: C Diff: 2 Type: MC Skill: Applied Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 2) The starting point for understanding how exchange rates are determined is a simple idea called ________, which states: 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 Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 3) The ________ states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries.

A) theory of purchasing power parity B) law of one price C) theory of money neutrality D) quantity theory of money Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 4) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should ________.

A) depreciate B) appreciate C) float D) do none of the above Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 9 .

5) The theory of PPP suggests that if one country's price level falls relative to another's, its currency should ________.

A) depreciate B) appreciate C) float D) do none of the above Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 6) The theory of PPP suggests that if one country's price level falls relative to another's, its currency should ________.

A) depreciate in the long run B) appreciate in the long run C) appreciate in the short run D) depreciate in the short run Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 7) The theory of purchasing power parity states that exchange rates between any two currencies will adjust to reflect changes in ________.

A) the trade balances of the two countries B) the current account balances of the two countries C) fiscal policies of the two countries D) the price levels of the two countries Answer: D Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 8) If the real exchange rate between Canada and Japan is ________, then it is cheaper to buy goods in Japan than in Canada.

A) greater than 1.0 B) greater than 0.5 C) less than 0.5 D) less than 1.0 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

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9) According to PPP, the real exchange rate between two countries will always equal ________.

A) 0.0 B) 0.5 C) 1.0 D) 1.5 Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 10) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should ________.

A) depreciate in the long run B) appreciate in the long run C) depreciate in the short run D) appreciate in the short run Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 11) In the long run, a rise in a country's price level (relative to the foreign price level) causes its currency to ________, while a fall in the country's relative price level causes its currency to ________.

A) appreciate; appreciate B) appreciate; depreciate C) depreciate; appreciate D) depreciate; depreciate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 12) If the 2005 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2 percent, then the theory of purchasing power parity predicts that, during 2005, the value of the Canadian dollar in terms of Mexican pesos will ________.

A) rise by 6 percent B) rise by 2 percent C) fall by 6 percent D) fall by 2 percent Answer: D Diff: 3 Type: MC Skill: Applied Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

11 .

13) Assume that the following are the predicted inflation rates in these countries for the year: 2 percent for Canada, 3 percent for Canada; 4 percent for Mexico, and 5 percent for Brazil.

According to the theory of purchasing power parity and everything else held constant, which of the following would we expect to happen?

A) The Brazilian real will depreciate against the Canadian dollar.

B) The Mexican peso will depreciate against the Brazilian real.

C) The Canadian dollar will depreciate against the Mexican peso.

D) The Canadian dollar will depreciate against the Canadian dollar.

Answer: A Diff: 3 Type: MC Skill: Applied Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 14) According to the theory of purchasing power parity , a rise in Canada price level of 5 percent, and a rise in the Mexican price level of 6 percent cause ________.

A) the dollar to appreciate 1 percent relative to the peso B) the dollar to depreciate 1 percent relative to the peso C) the dollar to depreciate 5 percent relative to the peso D) the dollar to appreciate 5 percent relative to the peso Answer: A Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 15) Higher tariffs and quotas cause a country's currency to ________ in the ________ run, everything else held constant.

A) depreciate; short B) appreciate; short C) depreciate; long D) appreciate; long Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 16) Lower tariffs and quotas cause a country's currency to ________ in the ________ run, everything else held constant.

A) depreciate; short B) appreciate; short C) depreciate; long D) appreciate; long Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

12 .

17) Anything that increases the demand for foreign goods relative to domestic goods tends to ________ the domestic currency because domestic goods will only continue to sell well if the value of the domestic currency is ________, everything else held constant.

A) depreciate; lower B) depreciate; higher C) appreciate; lower D) appreciate; higher Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 18) Everything else held constant, increased demand for a country's ________ causes its currency to appreciate in the long run, while increased demand for ________ causes its currency to depreciate.

A) imports; imports B) imports; exports C) exports; imports D) exports; exports Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 19) Everything else held constant, increased demand for a country's exports causes its currency to ________ in the long run, while increased demand for imports causes its currency to ________.

A) appreciate; appreciate B) appreciate; depreciate C) depreciate; appreciate D) depreciate; depreciate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 20) Everything else held constant, if a factor increases the demand for ________ goods relative to ________ goods, the domestic currency will appreciate.

A) foreign; domestic B) foreign; foreign C) domestic; domestic D) domestic; foreign Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 13 .

21) Everything else held constant, if a change in a factor that can affect the exchange rate leads to a decrease in demand for ________ goods relative to ________ goods, the domestic currency will depreciate.

A) foreign; domestic B) foreign; foreign C) domestic; domestic D) domestic; foreign Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 22) An increase in a country's level of productivity will cause its currency to ________ because it can now produce goods at a ________ price, everything else held constant.

A) depreciate; lower B) appreciate; lower C) depreciate; higher D) appreciate; higher Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 23) If, in retaliation for "unfair" trade practices, the Canadian government imposes a 30 percent tariff on Japanese TV's, but at the same time the demand by Canadians for Japanese goods increases, then, in the long run, ________, everything else held constant.

A) the Japanese yen should appreciate relative to the Canadian dollar B) the Japanese yen should depreciate relative to the Canadian dollar C) there is no effect on the Japanese yen relative to the Canadian dollar D) the Japanese yen could appreciate, depreciate, or remain constant relative to the Canadian dollar Answer: D Diff: 2 Type: MC Skill: Applied Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

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24) If Canada imposes a quota on imports of Japanese cars due to claims of "unfair" trade practices, and Japanese demand for Canadian exports increases at the same time, then, in the long run ________, everything else held constant.

A) the Japanese yen will appreciate relative to the Canadian dollar B) the Japanese yen will depreciate relative to the Canadian dollar C) the Japanese yen will either appreciate, depreciate, or remain constant against the Canadian dollar D) there will be no effect on the Japanese yen relative to the Canadian dollar Answer: B Diff: 2 Type: MC Skill: Applied Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 25) If the inflation rate in Canada is higher than that in Mexico and productivity is growing at a slower rate in Canada compared to Mexico, then, in the long run, ________, everything else held constant.

A) the Mexican peso will appreciate relative to the Canadian dollar B) the Mexican peso will depreciate relative to the Canadian dollar C) the Mexican peso will either appreciate, depreciate, or remain constant relative to the Canadian dollar D) there will be no effect on the Mexican peso relative to the Canadian dollar Answer: A Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 26) If the Brazilian demand for Canadian exports rises while Canadian productivity is rising relative to Brazilian productivity, then, in the long run, ________, everything else held constant.

A) the Brazilian real will appreciate relative to the Canadian dollar B) the Brazilian real will depreciate relative to the Canadian dollar C) the Brazilian real will either appreciate, depreciate, or remain constant relative to the Canadian dollar D) there is no effect on the Brazilian real relative to the Canadian dollar Answer: B Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

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27) The theory of purchasing power parity cannot fully explain exchange rate movements because ________.

A) all goods are identical even when produced in different countries B) monetary policy differs across countries C) some goods are not traded between countries D) fiscal policy differs across countries Answer: C Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 28) Which of the following can cause a depreciation of the domestic currency in the long run?

I. An increase in domestic price level.

II. An increase in tariffs.

III. An increase in imports demand.

IV. An increase in export demand.

V. An increase in productivity.

A) I and II. B) I, II, and III. C) I and III. D) IV and V. Answer: C Diff: 2 Type: MC Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 29) Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity explain all exchange rate movements? What factors determine long-run exchange rates?

Answer: With no trade barriers and low transport costs, the law of one price states that the price of traded goods should be the same in all countries. The purchasing power parity theory extends the law of one price to total economies. PPP states that exchange rates should adjust to reflect changes in the price levels between two countries. PPP may fail to fully explain exchange rates because goods are not identical, and price levels include traded and nontraded goods and services. Long-run exchange rates are determined by domestic price levels relative to foreign price levels, trade barriers, import and export demand, and productivity.

Diff: 1 Type: ES Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

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30) What is the theory of purchasing power parity? Why cannot it not fully explain exchange rates?

Answer: The theory of PPP suggests that if one country's price level rises relative to another's, its currency should depreciate. PPP cannot fully explain exchange rates in the long run because some of the assumptions for PPP to hold are violated. These assumptions are that the goods traded are identical between countries, transportation costs are minimal and finally that trade barriers do not exist.

Diff: 2 Type: ES Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 31) What are the factors that affect exchange rates in the long-run?

Answer: a. Relative price levels: According to PPP when domestic price level rises relative to foreign, the domestic currency will depreciate. b. Trade barriers: when we impose trade barriers to imports then domestic currency will appreciate. c. Preferences for domestic versus foreign goods: when foreigners develop an appetite for Canadian goods, then the Canadian dollar will appreciate. d. Productivity: In the long-run as a country becomes more productive relative to other countries, its currency appreciates.

Diff: 3 Type: ES Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 32) Explain how trade barriers affect exchange rates in the long-run.

Answer: Increasing trade barriers cause a country's currency to appreciate in the long run. For example, suppose that Canada increases its tariff or puts a lower quota on Japanese cars. These increases in trade barriers increase the demand for Canadian cars, and the dollar tends to appreciate because Canadian cars will still sell well even with a higher value of the dollar.

Diff: 3 Type: ES Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run 33) Explain how productivity affects exchange rates in the long-run Answer: When productivity in a country rises, it tends to rise in domestic sectors that produce traded goods rather than nontraded goods. Higher productivity is therefore associated with a decline in the price of domestically produced traded goods relative to foreign-traded goods. As a result, the demand for domestic goods rises, and the domestic currency tends to appreciate.

Diff: 3 Type: ES Skill: Recall Objective: 18.2 Identify the main factors that affect exchange rates in the long-run

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18.3 Exchange Rates in the Short Run: A Supply and Demand Analysis 1) One way to understand the short-run behaviour of exchange rates is ________.

A) to use the theory of portfolio choice B) to understand the exchange rate is the price of one asset in terms of another C) to examine the long-run trends D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange 2) The ________ suggests that the most important factor affecting the demand for domestic and foreign assets is the expected return on domestic assets relative to foreign assets.

A) theory of asset demand B) law of one price C) interest parity condition D) theory of foreign capital mobility Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange 3) The theory of asset demand suggests that the most important factor affecting the demand for domestic and foreign assets is the ________ on these assets relative to one another.

A) interest rate B) risk C) expected return D) liquidity Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange

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4) The theory of asset demand suggests that the most important factor affecting the demand for domestic and foreign assets is ________.

A) the level of trade and capital flows B) the expected return on these assets relative to one another C) the liquidity of these assets relative to one another D) the riskiness of these assets relative to one another Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange 5) The demand curve for the domestic currency ________.

A) is downward sloping B) is vertical because the amount of foreign exchange is finite C) shifts when the exchange rate changes D) A and C only Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange 6) Everything else held constant, when the current value of the domestic currency increases, the ________ domestic assets ________.

A) demand for; increases B) quantity demanded of; increases C) demand for; decreases D) quantity demanded of; decreases Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange 7) Everything else held constant, when the current value of the domestic exchange rate increases, the ________ of domestic assets ________.

A) quantity supplied; does not change B) supply; decreases C) quantity supplied; increases D) supply; increases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.3 Draw the demand and supply curves for the foreign exchange market and interpret the equilibrium in the market for foreign exchange 19 .

18.4 Explaining Changes in Exchange Rates 1) An increase in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 2) As the relative expected return on dollar assets increases, foreigners will want to hold more ________ assets and less ________ assets, everything else held constant.

A) foreign; foreign B) foreign; dollar C) dollar; foreign D) dollar; dollar Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 3) When Canadians or foreigners expect the return on ________ assets to be high relative to the return on ________ assets, there is a higher demand for dollar assets and a correspondingly lower demand for foreign assets.

A) dollar; dollar B) dollar; foreign C) foreign; dollar D) foreign; foreign Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 4) When Canadians or foreigners expect the return on ________ assets to be high relative to the return on ________ assets, there is a ________ demand for dollar assets, everything else held constant.

A) dollar; foreign; constant B) dollar; foreign; higher C) foreign; dollar; higher D) foreign; dollar; constant Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 20 .

5) When Canadians or foreigners expect the return on dollar assets to be high relative to the return on foreign assets, there is a ________ demand for dollar assets and a correspondingly ________ demand for foreign assets.

A) higher; higher B) higher; lower C) lower; higher D) lower; lower Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 6) An increase in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 7) A decrease in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 8) A decrease in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

21 .

9) ________ in the domestic interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 10) ________ in the domestic interest rate causes the demand for domestic assets to shift to the right and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 11) ________ in the domestic interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 12) ________ in the domestic interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

22 .

13) ________ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 14) ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 15) ________ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 16) ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

23 .

17) Suppose that the Bank of Canada enacts expansionary policy. Everything else held constant, this will cause the demand for Canadian assets to ________ and the Canadian dollar to ________.

A) increase; appreciate B) decrease; appreciate C) increase; depreciate D) decrease; depreciate Answer: D Diff: 3 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 18) Suppose that the Bank of Canada sells bonds to the chartered banks. Everything else held constant, this will cause the demand for Canadian assets to ________ and the Canadian dollar will ________.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A Diff: 3 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 19) An increase in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 20) An increase in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

24 .

21) A decrease in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 22) A decrease in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 23) ________ in the foreign interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 24) ________ in the foreign interest rate causes the demand for domestic assets to shift to the right and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

25 .

25) ________ in the foreign interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 26) ________ in the foreign interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 27) ________ in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 28) ________ in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: C Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

26 .

29) ________ in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 30) ________ in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: B Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 31) Suppose that the European Central Bank enacts expansionary policy. Everything else held constant, this will cause the demand for Canadian assets to ________ and the Canadian dollar to ________.

A) increase; appreciate B) decrease; appreciate C) increase; depreciate D) decrease; depreciate Answer: A Diff: 3 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 32) Suppose that the European Central Bank conducts a main refinancing sale. Everything else held constant, this would cause the demand for Canadian assets to ________ and the Canadian dollar will ________.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D Diff: 3 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

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33) An increase in the expected future domestic exchange rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 34) An increase in the expected future domestic exchange rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 35) A decrease in the expected future domestic exchange rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 36) A decrease in the expected future domestic exchange rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

28 .

37) ________ in the expected future domestic exchange rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 38) ________ in the expected future domestic exchange rate causes the demand for domestic assets to shift to the right and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 39) ________ in the expected future domestic exchange rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 40) ________ in the expected future domestic exchange rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

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41) ________ in the expected future domestic exchange rate causes the demand for domestic assets to ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 42) ________ in the expected future domestic exchange rate causes the demand for domestic assets to shift to the ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 43) ________ in the expected future domestic exchange rate causes the demand for domestic assets to ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 44) ________ in the expected future domestic exchange rate causes the demand for domestic assets to shift to the ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

30 .

45) Suppose the Bank of Canada releases a policy statement today which leads people to believe that the Bank will be enacting expansionary monetary policy in the near future. Everything else held constant, the release of this statement would immediately cause the demand for Canadian assets to ________ and the Canadian dollar to ________.

A) increase; appreciate B) decrease; appreciate C) increase; depreciate D) decrease; depreciate Answer: D Diff: 3 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 46) Suppose a report was released today that showed the Euro-Zone inflation rate is running above the European Central Bank's inflation rate target. This leads people to expect that the European Central Bank will enact contractionary policy in the near future. Everything else held constant, the release of this report would immediately cause the demand for Canadian assets to ________ and the Canadian dollar will ________.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D Diff: 3 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 47) Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate than was expected. Everything else held constant, the release of the CPI report would immediately cause the demand for Canadian assets to ________ and the Canadian dollar would ________.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

31 .

48) During the beginning on the subprime crisis in the United States when the effects of the crisis were mostly confined within the United States, the U. S. dollar ________ because demand for U.S. assets ________.

A) appreciated; increased B) depreciated; increased C) appreciated; decreased D) depreciated; decreased Answer: D Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 49) When the effects of the subprime crisis started to spread more quickly throughout the rest of the world, the U.S. dollar ________ because demand for U.S. assets ________.

A) appreciated; increased B) depreciated; increased C) appreciated; decreased D) depreciated; decreased Answer: A Diff: 1 Type: MC Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 50) The Brexit vote in June 2016 resulted in higher expected trade barriers. Therefore, the expected value of the pound would be ________ in the future. The result was the sharp ________ in the equilibrium exchange rate for the British pound.

A) lower; fall B) higher; fall C) lower; rise D) higher; rise Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

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51) The Brexit vote in June 2016 resulted in higher expected trade barriers. The relative expected return on British (pound) assets therefore ________ and so the quantity demanded of pound assets ________ at any given exchange rate, shifting the demand curve for pound assets to the ________.

A) fell; declined; left B) fell; increased; right C) fell; declined; right D) rose; declined; left E) rose; increased; left Answer: A Diff: 1 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 52) Which of the following will cause the public to expect a depreciation of the domestic currency?

I. An increase in domestic price level.

II. An increase in tariffs.

III. An increase in imports demand.

IV. An increase in export demand.

V. An increase in productivity.

A) I and II. B) I, II, and III. C) I and III. D) IV and V. Answer: C Diff: 2 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 53) The Brexit vote in June 2016 in the United Kingdom shifted the ________ curve for British pounds on foreign currency markets to the ________.

A) supply; right B) demand; right C) supply; left D) demand; left Answer: D Diff: 2 Type: MC Skill: Applied Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

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54) Explain and show graphically the effect of an increase in the expected future exchange rate on the equilibrium exchange rate, everything else held constant.

Answer: See figure below.

When the expected future exchange rate increases, the relative expected return on the domestic assets increases. This will cause the demand for domestic assets to increase, and the current value of the exchange rate will appreciate.

Diff: 2 Type: ES Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 55) In the model of the demand and supply of dollar assets use a graph to explain how a change in the domestic interest rate affects the equilibrium exchange rate.

Answer: In the model of the equilibrium in the foreign exchange market, when the domestic interest rate iD rises, holding the current exchange rate Et and everything else constant, the return on dollar assets increases relative to foreign assets, so people will want to hold more dollar assets. The quantity of dollar assets demanded increases at every value of the exchange rate, as it can be shown on the graph by a rightward shift of the demand curve. At the new equilibrium point the exchange rate rises.

Diff: 2 Type: ES Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 34 .

56) In the model of the demand and supply of dollar assets use a graph to explain how a change in the foreign interest rate affects the equilibrium exchange rate.

Answer: When the foreign interest rate iF rises, holding current exchange rate Et and everything else constant, the return on foreign assets rises relative to dollar assets. Thus the relative expected return on dollar assets falls. Now people want to hold fewer dollar assets, and the quantity demanded decreases at every value of the exchange rate. This can be shown by a leftward shift of the demand curve for dollar assets. The new equilibrium is reached at a point where the value of the dollar has fallen.

Diff: 2 Type: ES Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run 57) Why are exchange rates so volatile?

Answer: The asset market approach of exchange rate determination gives us a straightforward explanation of volatile exchange rates. Because expected appreciation of the domestic currency affects the expected return on foreign deposits for both the domestic and the foreign investors, expectations on the price level, inflation, trade barriers, productivity, import demand, export demand, and the money supply play important roles in determining the exchange rate. When expectations about any of these variables change, our model indicates that there will be an immediate effect on the expected return of foreign deposits and therefore on the exchange rate. because expectations about all these variables change with just about any bit of news that appears, it is not surprising that the exchange rate is volatile. In addition, money supply increases produce exchange rate overshooting and this is an additional reason for the high volatility of exchange rates.

Diff: 3 Type: ES Skill: Recall Objective: 18.4 List and illustrate the factors that affect the exchange rate in the short-run

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 19 The International Financial System 19.1 Intervention in the Foreign Exchange Market 1) A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal decline in its international reserves and the monetary base, everything else held constant.

A) sale; purchase B) sale; sale C) purchase; sale D) purchase; purchase Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 2) A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal increase in its international reserves and the monetary base, everything else held constant.

A) sale; purchase B) sale; sale C) purchase; sale D) purchase; purchase Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 3) Suppose that the Bank of Japan buys Canadian dollar assets with yen-denominated assets.

Everything else held constant, this transaction will cause ________ in the foreign assets held by the Bank of Canada and ________ in the Canadian monetary base.

A) an increase; an increase B) an increase; a decrease C) a decrease; an increase D) a decrease; a decrease Answer: A Diff: 1 Type: MC Skill: Applied Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets

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4) Suppose that the Bank of Japan buys yen-denominated assets with Canadian dollar assets.

Everything else held constant, this transaction will cause ________ in the foreign assets held by the Bank of Canada and ________ in the Canadian monetary base.

A) an increase; an increase B) an increase; a decrease C) a decrease; an increase D) a decrease; a decrease Answer: D Diff: 1 Type: MC Skill: Applied Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 5) When the central bank allows the purchase or sale of domestic currency to influence the monetary base, it is called ________.

A) an unsterilized foreign exchange intervention B) a sterilized foreign exchange intervention C) an exchange rate feedback rule D) a money neutral foreign exchange intervention Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 6) A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called ________.

A) an unsterilized foreign exchange intervention B) a sterilized foreign exchange intervention C) an exchange rate feedback rule D) a money neutral foreign exchange intervention Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets

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7) Everything else held constant, if a central bank makes an unsterilized purchase of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 8) Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will increase, and the domestic currency will ________.

A) purchase; appreciate B) purchase; depreciate C) sale; appreciate D) sale; depreciate Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 9) Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will ________ and the domestic currency will appreciate.

A) purchase; increase B) purchase; decrease C) sale; increase D) sale; decrease Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets

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10) Everything else held constant, if a central bank makes an unsterilized sale of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 11) Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will decrease, and the domestic currency will ________.

A) purchase; appreciate B) purchase; depreciate C) sale; appreciate D) sale; depreciate Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 12) Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will ________ and the domestic currency will depreciate.

A) purchase; increase B) purchase; decrease C) sale; increase D) sale; decrease Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets

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13) Everything else held constant, if a central bank makes a sterilized purchase of foreign assets, then the domestic currency will ________.

A) appreciate B) depreciate C) either appreciate, depreciate, or remain constant D) not be affected Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 14) Because sterilized interventions mean offsetting open market operations, there is no impact on the monetary base and the money supply, and therefore a sterilized intervention ________.

A) causes the exchange rate to overshoot in the short run B) causes the exchange rate to undershoot in the short run C) causes the exchange rate to depreciate in the short run, but has no effect on the exchange rate in the long run D) has no effect on the exchange rate Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 15) Everything else held constant, if a central bank makes a sterilized sale of foreign assets, then the domestic currency will ________.

A) appreciate B) depreciate C) either appreciate, depreciate, or remain constant D) not be affected Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 16) Explain how an unsterilized purchase of foreign assets impacts the exchange rate everything else held constant.

Answer: An unsterilized intervention in which domestic currency is bought and foreign assets are sold leads to a fall in international reserves, a fall in the money supply, and an appreciation of the domestic currency.

Diff: 2 Type: ES Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 5 .

17) Explain what the unsterilized foreign exchange intervention is.

Answer: Unsterilized foreign exchange intervention is the one where a central bank allows the purchase or sale of domestic currency to have an effect on the monetary base. For example, when a central bank's purchase of domestic currency and corresponding sale of foreign assets in the foreign exchange market leads to an equal decline in its international reserves and the monetary base.

Diff: 2 Type: ES Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 18) Explain what the sterilized foreign exchange intervention is. Give an example.

Answer: A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called a sterilized foreign exchange intervention. For example, in the case of a $1 billion purchase of dollars by the Bank of Canada and a corresponding $1 billion sale of foreign assets, which as we know would decrease the monetary base by $1 billion, the Bank can conduct an open market purchase of $1 billion of government bonds, which would increase the monetary base by the same amount, exactly offsetting the purchase of dollars.

Diff: 2 Type: ES Skill: Recall Objective: 19.1 Use graphs and T-accounts to illustrate the distinctions between the effects of sterilized and unsterilized interventions on foreign exchange markets 19.2 Balance of Payments 1) The difference between merchandise exports and imports is called the ________ balance.

A) current account B) capital account C) official reserve transactions D) trade Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 2) The account that shows international transactions involving currently produced goods and services is called the ________.

A) trade balance B) current account C) balance of payments D) capital account Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 6 .

3) The account that shows international transactions involving financial transactions (stocks, bonds, bank loans, etc.) is called the ________.

A) trade balance B) current account C) balance of payments D) capital account Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 4) Which of the following does not appear in the current account part of the balance of payments?

A) A loan of $1 million from CIBC to Brazil B) Foreign aid to El Salvador C) An Air France ticket bought by a Canadian D) Income earned by GM from its plants abroad Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 5) Of the following, the one that appears in the current account of the balance of payments is ________.

A) an Italian investor's purchase of TD stock B) income earned by Canadian subsidiaries of Barclay's Bank of London C) a loan by a Swiss bank to a Canadian corporation D) a purchase of a British Treasury bond by the Bank of Canada Answer: B Diff: 2 Type: MC Skill: Applied Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments

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6) Capital ________ are Canadian purchases of foreign assets, and capital ________ are foreign purchases of American assets.

A) inflows; outflows B) inflows; inflows C) outflows; outflows D) outflows; inflows Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 7) Which of the following appears in the capital account part of the balance of payments?

A) A gift to a Canadian from his English aunt B) A purchase by the Honda corporation of a Canadian Treasury bill C) A purchase by the Bank of England of a Canadian Treasury bill D) Income earned by the Honda corporation on its automobile plant in Ontario Answer: B Diff: 2 Type: MC Skill: Applied Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 8) The net amount of international reserves that move between governments to finance international transactions is called the ________ balance.

A) capital account B) current account C) trade D) official reserve transactions Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 9) If the current account balance shows a surplus, and the capital account also shows a surplus, then the official reserve transactions balance ________.

A) must be positive B) must be negative C) must be zero D) can either be positive, negative, or zero Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 8 .

10) A current account surplus indicates that Canada is ________ its claims on foreign wealth, while a deficit indicates that this country is ________ its claims on foreign wealth.

A) reducing; reducing B) reducing; increasing C) increasing; reducing D) increasing; increasing Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 11) Because it provides some indication of what is happening to Canadian claims on foreign wealth and the demand for imports and exports, the ________ is closely followed by economists wanting information on the future movement of exchange rates.

A) trade balance B) capital account C) current account balance D) statistical discrepancy Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 12) Economists closely follow the current account balance because they believe it can provide information on the future movement of ________.

A) interest rates B) gold flows C) exchange rates D) special drawing rights Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments

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13) What is the current account? Why does the current account receive so much attention from economists?

Answer: The current account shows international transactions that involve currently produced goods and services. The current account tells us whether Canada (private sector and government combined) is increasing or decreasing its claims on foreign wealth. A surplus indicates that Canada is increasing its claims on foreign wealth, and is thus increasing its holdings of foreign capital, and a deficit indicates that Canada is reducing its holdings of foreign capital and foreign countries are increasing their claims on Canada.

Diff: 3 Type: ES Skill: Recall Objective: 19.2 Interpret the relationships among the current account and the financial account in the balance of payments 19.3 Exchange Rate Regimes in the International Financial System 1) Under a gold standard in which one dollar could be turned in to the Bank of Canada and exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th of an ounce of gold, an exchange rate of ________ marks to the dollar would stimulate a flow of gold from Canada to Germany.

A) 7 B) 6 C) 5 D) 4 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 2) A balance of payments deficit is associated with a ________ of international reserves, while a balance of payments surplus is associated with a ________.

A) loss; loss B) loss; gain C) gain; loss D) gain; gain Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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3) When gold production was low in the 1870s and 1880s, the money supply grew ________ causing ________.

A) rapidly; inflation B) rapidly; disinflation C) slowly; deflation D) slowly; disinflation Answer: C Diff: 2 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 4) The fixed exchange rate regime established at a meeting in New Hampshire in 1944 has been known as the ________.

A) General Agreement on Tariffs and Trade B) Bretton Woods system C) International Settlement Fund D) Balance of Payments Compliance Accord Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 5) Under the Bretton Woods system, the organization assigned the task of making loans to countries that were experiencing balance of payments difficulties is known as the ________.

A) World Bank B) International Development Association C) International Monetary Fund D) Bank of Canada Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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6) The Bretton Woods agreement created the ________, which was given the task of promoting the growth of world trade by setting rules for the maintenance of fixed exchange rates and by making loans to countries that were experiencing balance of payments difficulties.

A) IMF B) World Bank C) Central Settlements Bank D) Bank of International Settlements Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 7) The World Bank is an international organization that ________.

A) promotes the growth of trade by setting rules for how tariffs and quotas are set by countries B) makes loans to countries to finance projects such as dams and roads C) makes loans to countries with balance of payment difficulties D) helps developing countries that have been having difficulties in repaying their loans to come to terms with lenders in the West Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 8) Under the Bretton Woods system, the United States was designated as the ________.

A) reserve-currency country B) fixed-rate country C) par-standard country D) dollar-standard country Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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9) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to sell the domestic currency by purchasing foreign assets.

A) overvalued; below B) overvalued; above C) undervalued; below D) undervalued; above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 10) Under a fixed exchange rate regime, if the domestic currency is initially undervalued, that is, above par, the central bank must intervene to sell the ________ currency by purchasing ________ assets.

A) domestic; foreign B) domestic; domestic C) foreign; foreign D) foreign; domestic Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 11) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to purchase the domestic currency by selling foreign assets.

A) overvalued; below B) overvalued; above C) undervalued; below D) undervalued; above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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12) Under a fixed exchange rate regime, if the domestic currency is initially overvalued, that is, below par, the central bank must intervene to purchase the ________ currency by selling ________ assets.

A) domestic; foreign B) domestic; domestic C) foreign; foreign D) foreign; domestic Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 13) When the domestic currency is initially overvalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

A) purchase; decline B) sell; decline C) purchase; increase D) sell; increase Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 14) When the domestic currency is initially undervalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

A) purchase; decline B) sell; decline C) purchase; increase D) sell; increase Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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15) Under a fixed exchange rate regime, if a country has an overvalued exchange rate, then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

A) depreciating; gain B) depreciating; loss C) appreciating; gain D) appreciating; loss Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 16) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from depreciating will result in a ________ of international reserves.

A) undervalued; gain B) undervalued; loss C) overvalued; gain D) overvalued; loss Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 17) Under a fixed exchange rate regime, if a country has an undervalued exchange rate, then its central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

A) depreciating; gain B) depreciating; loss C) appreciating; gain D) appreciating; loss Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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18) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central bank's attempt to keep its currency from appreciating will result in a ________ of international reserves.

A) undervalued; gain B) undervalued; loss C) overvalued; gain D) overvalued; loss Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 19) Under a fixed exchange rate regime, if a country's central bank runs out of international reserves, it cannot keep its currency from ________.

A) depreciating B) appreciating C) deflating D) inflating Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 20) Under a fixed exchange rate regime, a country that depletes its international reserves in an attempt to keep its currency from ________ will be forced to ________ its currency.

A) depreciating; revalue B) depreciating; devalue C) appreciating; revalue D) appreciating; devalue Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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21) Under a fixed exchange rate regime, a central bank that does not want to acquire international reserves to keep its currency from ________ will decide to ________ its currency.

A) depreciating; revalue B) depreciating; devalue C) appreciating; revalue D) appreciating; devalue Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 22) Under a fixed exchange rate system, countries that ran large, persistent balance of payments deficits would ________ international reserves, thereby pressuring them into ________ their exchange rate.

A) gain; devaluing B) gain; revaluing C) lose; devaluing D) lose; revaluing Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 23) Under a fixed exchange rate system, countries that ran large, persistent balance of payments surpluses would ________ international reserves, thereby pressuring them into ________ their exchange rate.

A) gain; devaluing B) gain; revaluing C) lose; devaluing D) lose; revaluing Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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24) A balance of payments ________ is associated with a loss of international reserves, while a balance of payments ________ is associated with a gain.

A) surplus; surplus B) surplus; deficit C) deficit; surplus D) deficit; deficit Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 25) Under a fixed exchange rate regime, if a central bank must intervene to purchase the ________ currency by selling ________ assets, then, like an open market sale, this action reduces the monetary base and the money supply, causing the interest rate on domestic assets to rise.

A) domestic; foreign B) domestic; domestic C) foreign; foreign D) foreign; domestic Answer: A Diff: 3 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 26) Under a fixed exchange rate regime, if a central bank must intervene to purchase the domestic currency by selling foreign assets, then, like an open market sale, this action ________ the monetary base and the money supply, causing the interest rate on domestic assets to ________.

A) increases; rise B) increases; fall C) reduces; rise D) reduces; fall Answer: C Diff: 3 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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27) To keep from running out of international reserves under the Bretton Woods system, a country had to implement ________ monetary policy to ________ its currency.

A) expansionary; strengthen B) expansionary; weaken C) contractionary; strengthen D) contractionary; weaken Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 28) Under the Bretton Woods system, when a country adopted an expansionary monetary policy, thereby causing a balance of payments ________, the country would eventually be forced to implement ________ monetary policy.

A) deficit; expansionary B) deficit; contractionary C) surplus; expansionary D) surplus; contractionary Answer: B Diff: 2 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 29) Because the United States was the reserve-currency country under the Bretton Woods system, it could run large balance of payments ________ without ________ significant amounts of international reserves.

A) deficits; losing B) deficits; gaining C) surpluses; losing D) surpluses; gaining Answer: A Diff: 3 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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30) The Bretton Woods system was one in which central banks ________.

A) bought and sold their own currencies to keep their exchange rates fixed B) agreed not to intervene in the foreign exchange market to maintain a fixed exchange rate regime that had existed prior to World War I C) agreed to limit domestic money growth to the average of the five largest industrial nations D) agreed to limit domestic money growth to the average of the seven largest industrial nations Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 31) The Bretton Woods system broke down in the early 1970s for all but one of the following reasons.

A) Deficit countries losing international reserves were not willing to devalue their currencies.

B) Surplus countries were not willing to revalue their currencies upwards.

C) Surplus countries were not willing to pursue more expansionary policies.

D) America had been pursuing an inflationary monetary policy to reduce domestic unemployment.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 32) To maintain fixed exchange rates when countries had balance of payments deficits and were losing international reserves, the ________ would loan ________ countries international reserves contributed by other members.

A) IMF; deficit B) IMF; surplus C) World Bank; deficit D) World Bank; surplus Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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33) Under the Bretton Woods system, the IMF could encourage ________ countries to pursue ________ monetary policies that would strengthen their currency or eliminate their balance of payment deficits.

A) surplus; expansionary B) surplus; contractionary C) deficit; expansionary D) deficit; contractionary Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 34) Under the Bretton Woods system, the IMF could encourage deficit countries to pursue contractionary monetary policies that would ________ their currency or eliminate their balance of payment ________.

A) strengthen; surpluses B) strengthen; deficits C) weaken; surpluses D) weaken; deficits Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 35) A weakness of the Bretton Woods system was that the ________ had no way to force surplus countries to either revalue their exchange rates upwards or pursue more expansionary policies.

A) IMF B) World Bank C) European Exchange Rate Mechanism (ERM) D) Bank of International Settlements Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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36) Under the Bretton Woods system, a country running a balance of payments deficit ________ international reserves and had to implement ________ monetary policy to strengthen its currency.

A) lost; expansionary B) lost; contractionary C) gained; expansionary D) gained; contractionary Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 37) Under the Bretton Woods system, a country running a balance of payments ________ lost international reserves and had to implement ________ monetary policy to strengthen its currency.

A) surplus; expansionary B) surplus; contractionary C) deficit; expansionary D) deficit; contractionary Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 38) Under the Bretton Woods system, a country running a balance of payments surplus ________ international reserves and had to implement ________ monetary policy to weaken its currency.

A) lost; expansionary B) lost; contractionary C) gained; expansionary D) gained; contractionary Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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39) Under the Bretton Woods system, if IMF loans were insufficient to prevent ________ of a currency, then the country was allowed to devalue its currency by setting a new, ________ exchange rate.

A) depreciation; lower B) depreciation; higher C) appreciation; lower D) appreciation; higher Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 40) As a result of its power to dictate loan terms to borrowing countries (under the Bretton Woods system), the IMF could encourage ________ countries to pursue ________ monetary policies that would strengthen their currency or eliminate their balance of payments deficits.

A) surplus; contractionary B) surplus; expansionary C) deficit; contractionary D) deficit; expansionary Answer: C Diff: 3 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 41) Because central banks have not been willing to give up their option of intervening in the foreign exchange market, the current international financial system can best be described as a ________.

A) variable-pegged exchange rate system B) moving-pegged exchange rate system C) hybrid of a fixed exchange rate and flexible exchange rate system D) flexible-exchange, dollar-pegged exchange rate system Answer: C Diff: 3 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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42) The current international financial system is a managed float exchange rate system because ________.

A) exchange rates fluctuate in response to, but are not determined solely by, market forces B) all countries keep their currencies pegged to the dollar, which is not allowed to fluctuate C) all countries allow their exchange rates to fluctuate in response to market forces D) all countries peg their currencies to the dollar which is allowed to fluctuate in response to market forces Answer: A Diff: 3 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 43) Policymakers in a country with a balance of payments surplus may not want to see their country's currency appreciate because this would ________.

A) hurt consumers in their country by making foreign goods more expensive B) hurt domestic businesses by making foreign goods cheaper in their country C) increase inflation in their country D) decrease the wealth of the country Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 44) Under the current managed float exchange rate regime, countries with balance of payments deficits frequently do not want to see their currencies depreciate because it makes ________ goods more expensive for ________ consumers and can stimulate inflation.

A) foreign; foreign B) foreign; domestic C) domestic; foreign D) domestic; domestic Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

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45) Countries with surpluses in their balance of payments frequently do not want to see their currencies ________ because it makes their goods ________ expensive abroad.

A) appreciate; less B) appreciate; more C) depreciate; less D) depreciate; more Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 46) Countries with balance of payments deficits do not want to see their currencies ________ because it makes foreign goods ________ expensive for domestic consumers.

A) appreciate; less B) appreciate; more C) depreciate; less D) depreciate; more Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 47) Under the current managed float exchange rate regime, countries with ________ in their balance of payments frequently do not want to see their currencies ________ because it makes their goods more expensive abroad and foreign goods cheaper in their countries.

A) surpluses; depreciate B) deficits; depreciate C) surpluses; appreciate D) deficits; appreciate Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

25 .

48) Under the current managed float exchange rate regime; countries with surpluses in their balance of payments frequently do not want to see their currencies appreciate because it makes their goods ________ expensive abroad and foreign goods ________ in their countries.

A) more; cheaper B) more; costlier C) less; cheaper D) less; costlier Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 49) Under the current managed float exchange rate regime, countries with balance of payments ________ frequently do not want to see their currencies ________ because it makes foreign goods more expensive for domestic consumers and can stimulate inflation.

A) surpluses; depreciate B) deficits; depreciate C) surpluses; appreciate D) deficits; appreciate Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 50) Which of the following is true?

A) Special drawing rights are loans to countries made by the IMF. B) Changes in the quantity of special drawing rights are tied to changes in the quantity of gold.

C) Special drawing rights are a paper substitute for gold.

D) Special drawing rights are not held as international reserves.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 51) An ECU was ________.

A) a paper substitute for gold issued by the IMF B) a loan by European countries to the IMF C) a paper currency issued by the European Common Market D) a monetary unit created by the European Monetary System Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 26 .

52) Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

A) pounds; marks; losing B) pounds; marks; gaining C) marks; pounds; gaining D) marks; pounds; losing Answer: A Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 53) Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the German central bank was required to buy ________ and sell ________, thereby ________ international reserves.

A) pounds; marks; losing B) pounds; marks; gaining C) marks; pounds; gaining D) marks; pounds; losing Answer: B Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 54) Under the Exchange Rate Mechanism of the European Monetary System, when the German mark depreciated below its lower limit against the British pound, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

A) pounds; marks; losing B) pounds; marks; gaining C) marks; pounds; gaining D) marks; pounds; losing Answer: C Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

27 .

55) Under the Exchange Rate Mechanism of the European Monetary System, when the German mark depreciated below its lower limit against the British pound, the German central bank was required to buy ________ and sell ________, thereby ________ international reserves.

A) pounds; marks; losing B) pounds; marks; gaining C) marks; pounds; gaining D) marks; pounds; losing Answer: D Diff: 2 Type: MC Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 56) In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to the British pound, but it failed because participants in the foreign exchange market came to expect the ________.

A) appreciation of the mark B) depreciation of the mark C) revaluation of the dollar D) end of the Exchange Rate Mechanism Answer: A Diff: 2 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 57) The East Asia currency crisis in 1997 started in ________.

A) Japan B) Thailand C) South Korea D) the Philippines Answer: B Diff: 2 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

28 .

58) Between May and July 1997, concerns about the large current account deficit in Thailand and the weakness in the Thai financial system caused speculators to suspect that Thailand might be forced to ________.

A) devalue its currency B) sell baht to prop up its value C) buy dollars to prop up the baht D) impose capital controls Answer: A Diff: 2 Type: MC Skill: Applied Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

29 .

59) Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed exchange rate system. What alternative policies are available to eliminate the overvaluation of the exchange rate?

Answer: See the figure below.

The par value is above the equilibrium value, resulting in overvaluation of the exchange rate.

One approach is to pursue contractionary monetary policies, raising interest rates and increasing the demand for domestic assets. This process continues until equilibrium at par value is restored.

Another alternative is for the central bank to purchase domestic currency by selling foreign assets.

Diff: 2 Type: ES Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

30 .

60) What is the gold standard? What are the pros and cons of this system?

Answer: Before World War I, the world economy operated under the gold standard, a fixed exchange rate regime in which most currencies were convertible directly into gold at fixed rates, so exchange rates between countries were also fixed. The important advantage of this system of exchange rates was that fixed exchange rates encouraged world trade by eliminating the uncertainty that occurs when exchange rates fluctuate. The disadvantages are that the countries that use the gold standard have no control over their monetary policy because its money supply is determined by gold flows between countries. Moreover monetary policy throughout the world was greatly influenced by the production of gold and gold discoveries.

Diff: 3 Type: ES Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 61) How would the Bank of Canada operate in a fixed exchange rate regime when the dollar is overvalued and undervalued? What are the effects on international reserves?

Answer: When the domestic currency is overvalued then the Bank of Canada must purchase domestic currency to keep the exchange rate fixed, but as a result it loses international reserves.

When the domestic currency is undervalued, the Bank of Canada must sell Canadian dollars to keep the exchange rate fixed, but as a result it gains international reserves.

Diff: 2 Type: ES Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes 62) Assume that a fixed exchange rate is overvalued. Describe the situation of a speculative crisis against this currency. What can the central bank do to defend the currency? Why might the alternative of devaluation be preferable?

Answer: When the speculative attack begins, the expected depreciation of the domestic currency increases substantially, decreasing the demand for domestic assets. Contractionary monetary policy is needed to increase domestic interest rates enough to defend the currency. The cost to the central bank in terms of the costs of intervention and the contractionary effect on the economy may make devaluation preferable.

Diff: 2 Type: ES Skill: Recall Objective: 19.3 Identify the mechanisms for maintaining a fixed exchange rate, and assess the challenges faced by fixed rate regimes

31 .

19.4 Capital Controls 1) Which of the following is not a disadvantage of controls on capital outflows?

A) The controls may lead to excessive risk taking by the domestic banks.

B) They are seldom effective during a crisis.

C) Capital flight may increase after they are put in place.

D) Controls often lead to an increase in government corruption.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.4 Summarize the advantages and disadvantages of capital controls 2) A capital ________ can promote financial instability in an emerging-market country because it is what forces a country to ________ its currency.

A) inflow; devalue B) inflow; revalue C) outflow; devalue D) outflow; revalue Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.4 Summarize the advantages and disadvantages of capital controls 3) A capital ________ can promote financial instability in an emerging-market country because it can lead to a lending boom and excessive risk-taking on the part of banks, which helps trigger a ________.

A) inflow; financial crisis B) inflow; currency devaluation C) outflow; financial crisis D) outflow; currency devaluation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.4 Summarize the advantages and disadvantages of capital controls 4) A case for capital inflow controls can be made because capital inflows ________.

A) can cause a lending boom and lead to excessive risk taking B) never finance productive investments C) always finance productive investments D) are less likely to cause financial crises than regulation of banking activities Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.4 Summarize the advantages and disadvantages of capital controls

32 .

19.5 The Role of the IMF 1) In the 1990s, this agency has acted like an international lender of last resort to cope with financial instability.

A) World Bank B) European Central Bank C) IMF D) International Bank for Reconstruction and Development Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.5 Assess the role of the IMF as an international lender of last resort 2) An international lender of last resort creates a serious ________ problem because depositors and other creditors of banking institutions expect that they will be protected if a crisis occurs.

A) moral hazard B) adverse selection C) public choice D) strategic choice Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.5 Assess the role of the IMF as an international lender of last resort 3) An international lender of last resort creates a serious moral hazard problem because ________ and other ________ of banking institutions expect that they will be protected if a crisis occurs.

A) depositors; debtors B) depositors; creditors C) borrowers; debtors D) borrowers; creditors Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.5 Assess the role of the IMF as an international lender of last resort 4) Critics of the IMF contend that its lending in the Mexican crisis, which was used to bail out foreign ________, set the stage for the ________ crisis because these ________ expected to be bailed out if things went wrong.

A) lenders; East Asian; borrowers B) lenders; East Asian; lenders C) borrowers; Russian; borrowers D) borrowers; Russian; lenders Answer: B Diff: 1 Type: MC Skill: Applied Objective: 19.5 Assess the role of the IMF as an international lender of last resort 33 .

5) Critics of the IMF contend that its lending in the ________ crisis, which was used to bail out foreign lenders, set the stage for the ________ crisis because these lenders expected to be bailed out if things went wrong and thus provided funds that were used to fuel excessive risk taking.

A) Russian; Mexican B) Russian; East Asian C) Mexican; Russian D) Mexican; East Asian Answer: D Diff: 1 Type: MC Skill: Applied Objective: 19.5 Assess the role of the IMF as an international lender of last resort 6) An advantage of an international lender of last resort is its ability to prevent ________, in which a successful speculative attack on one currency leads to attacks on others.

A) contagion B) adverse selection C) moral hazard D) currency virus Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.5 Assess the role of the IMF as an international lender of last resort 7) An advantage of an international lender of last resort is its ability to prevent ________, in which a successful speculative attack on one currency leads to attacks on others; its disadvantage is the problem of ________ if creditors expect to be protected if a crisis occurs.

A) contagion; moral hazard B) contagion; adverse selection C) currency virus; moral hazard D) currency virus; adverse selection Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.5 Assess the role of the IMF as an international lender of last resort

34 .

19.6 International Considerations and Monetary Policy 1) In the early 1970s, the United States ran large balance of payments ________, causing an ________ dollar and an ________ German mark.

A) deficits; undervalued; overvalued B) deficits; overvalued; undervalued C) surpluses; undervalued; overvalued D) surpluses; overvalued; undervalued Answer: B Diff: 1 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 2) In response to the overvalued dollar in the early 1970s, the German Bundesbank bought ________ and sold ________ to keep the exchange rate fixed, gaining international reserves.

A) marks; dollars B) marks; pounds C) dollars; marks D) dollars; pounds Answer: C Diff: 1 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 3) In response to the overvalued dollar in the early 1970s, the German Bundesbank bought dollars and sold marks to keep the exchange rate fixed, gaining international reserves. The huge purchase of international reserves meant that the German monetary base began to ________, leading to ________ growth in the German money supply.

A) decline; sluggish B) decline; rapid C) grow; sluggish D) grow; rapid Answer: D Diff: 1 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations

35 .

4) The German central bank gained international reserves in the early 1970s because it sold ________ to prevent mark ________.

A) marks; appreciation B) dollars; appreciation C) marks; depreciation D) dollars; depreciation Answer: A Diff: 1 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 5) Since the abandonment of the Bretton Woods system, balance of payments considerations have become ________ important, and exchange rate considerations ________ important in the conduct of monetary policy.

A) more; less B) more; more C) less; less D) less; more Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 6) If a central bank does not want to see its currency fall in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby strengthening its currency.

A) expansionary; raise B) contractionary; raise C) expansionary; lower D) contractionary; lower Answer: B Diff: 1 Type: MC Skill: Recall Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations

36 .

7) If a central bank does not want to see its currency ________ in value, it may pursue contractionary monetary policy to raise the domestic interest rate, thereby ________ its currency.

A) fall; strengthening B) fall; weakening C) rise; strengthening D) rise; weakening Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 8) If a central bank does not want to see its currency rise in value, it may pursue ________ monetary policy to ________ the domestic interest rate, thereby weakening its currency.

A) expansionary; raise B) contractionary; raise C) expansionary; lower D) contractionary; lower Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 9) If a central bank does not want to see its currency ________ in value, it may pursue expansionary monetary policy to lower the domestic interest rate, thereby ________ its currency.

A) fall; strengthening B) fall; weakening C) rise; strengthening D) rise; weakening Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations

37 .

10) If a central bank does not want to allow the domestic currency to appreciate, it will ________ international reserves by selling its currency, thereby ________ the monetary base and increasing the risk of higher inflation.

A) lose; decreasing B) lose; increasing C) acquire; decreasing D) acquire; increasing Answer: D Diff: 1 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 11) If a central bank does not want to allow the domestic currency to depreciate, it will ________ international reserves by purchasing its currency, thereby ________ the monetary base and increasing the risk of higher unemployment.

A) lose; decreasing B) lose; increasing C) acquire; decreasing D) acquire; increasing Answer: A Diff: 1 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 12) A central bank's attempt to prevent an appreciation of its currency can stimulate domestic inflation if the ________ of its currency leads to ________ international reserves which ________ the monetary base.

A) purchase; higher; increases B) purchase; lower; decreases C) sale; lower; decreases D) sale; higher; increases Answer: D Diff: 2 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations

38 .

13) A central bank's attempt to prevent an appreciation of its currency can stimulate domestic inflation if the ________ of foreign currencies leads to ________ international reserves which ________ the monetary base.

A) purchase; higher; increases B) purchase; lower; decreases C) sale; lower; decreases D) sale; higher; increases Answer: A Diff: 2 Type: MC Skill: Applied Objective: 19.6 Identify the ways in which international monetary policy and exchange-rate arrangements can affect domestic monetary policy operations 19.7 To Peg or Not To Peg: Exchange-Rate Targeting as an Alternative Monetary Policy Strategy 1) A monetary policy strategy that uses a fixed exchange rate regime that ties the value of a currency to the currency of a large, low inflation country is called ________ targeting.

A) exchange-rate B) currency C) monetary D) inflation Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 2) Under an exchange-rate targeting rule for monetary policy, a crawling peg ________.

A) fixes the value of the domestic currency to a commodity such as gold B) fixes the value of the domestic currency to that of a large, low-inflation country C) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be higher than that of the anchor country D) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be lower than that of the anchor country Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting

39 .

3) An advantage of exchange-rate targeting is it helps keep inflation under control by tying the inflation rate for ________ traded goods to what is found in the ________ country.

A) domestically; anchor B) domestically; domestic C) internationally; anchor D) internationally; domestic Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 4) Exchange-rate targeting allows a central bank to ________, thus this will ________ the probability of policy developing a time-inconsistency problem.

A) be governed by a policy rule; decrease B) follow discretionary policy; decrease C) be governed by a policy rule; increase D) follow discretionary policy; increase Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 5) Which of the following is not an advantage to exchange-rate targeting?

A) It provides a strong nominal anchor to keep inflation under control.

B) It provides an automatic rule for policy to help avoid the time-inconsistency problem.

C) It is simple and clear so that the public can easily understand it.

D) It increases the accountability of policymakers.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 6) Under exchange-rate targeting, the central bank in the targeting country ________ lose the ability to pursue its own independent monetary policy and any shocks to the anchor country is ________ transmitted to the targeting country.

A) does; directly B) does not; directly C) does; not directly D) does not; not directly Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting

40 .

7) Both France and the United Kingdom successfully used exchange-rate targeting to lower inflation in the late 1980s and early 1990s by tying the value of their currencies to the ________.

A) American dollar B) German mark C) Swiss franc D) Euro Answer: B Diff: 1 Type: MC Skill: Applied Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 8) Which of the following is not a disadvantage of exchange-rate targeting?

A) It relies on a stable money-inflation relationship.

B) The targeting country gives up an independent monetary policy.

C) The targeting country is left open for a speculative attack.

D) It can weaken the accountability of policymakers.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 9) Two reasons for an industrialized country to adopt an exchange-rate targeting regime are if the country ________ conduct successful monetary policy on its own, and if the country wants to ________ integration of the domestic economy with its neighbors.

A) cannot; encourage B) cannot; discourage C) can; encourage D) can; discourage Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 10) Because many emerging market countries have not developed the political or monetary institutions that allow the successful use of discretionary monetary policy, ________.

A) they have little to gain from pegging their exchange rate to an anchor country like the U.S. or Germany B) they have little to gain from using a nominal anchor, because it would mean a monetary policy that is overly expansionary C) they have very little to gain from an independent monetary policy, but a lot to lose D) they would be better off giving their central bankers the independence to use discretion, rather than take their discretion away through any nominal anchor Answer: C Diff: 3 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 41 .

11) Emerging market countries are in effect between a rock and a hard place because ________.

A) they would be wise to adopt the monetary policy of the United States by pegging their currencies to the dollar, but this policy leaves them open to speculative attacks B) to avoid speculative attacks on their currencies they must peg their exchange rates to an anchor country, but this means giving central bankers in these countries too much discretion C) to avoid speculative attacks on their currencies they must peg their exchange rates to an anchor country, but this means giving central bankers in these countries too little discretion D) by adopting the monetary policy of the anchor country through an exchange rate peg, these countries allow for too little monetary expansion and thereby sacrifice economic growth for price stability Answer: A Diff: 2 Type: MC Skill: Applied Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 12) When a domestic currency is completely backed by a foreign currency and the note-issuing authority establishes a fixed exchange rate to this foreign currency, then the country is said to have ________.

A) created a currency board B) undergone dollarization C) adopted a managed exchange system D) adopted an exchange rate monetary system Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 13) When a country forgoes its own currency and starts using another country's currency as its own, we say that this country has ________.

A) created a currency board B) undergone dollarization C) adopted a managed exchange system D) adopted an exchange rate monetary system Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting

42 .

14) The revenue a government earns from issuing money is known as ________.

A) interest B) rent C) seignorage D) the national dividend E) the inflation tax Answer: C Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 15) A country that dollarizes ________.

A) maximizes its seignorage B) earns the same amount of seignorage as it would with a currency board C) earns the same amount of seignorage as it would with exchange-rate targeting D) eliminates its seignorage E) must pay seignorage to other governments for using their currency Answer: D Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 16) The seignorage for a government is greater for ________ than for ________.

A) dollarization; a currency board B) dollarization; exchange-rate targeting C) dollarization; monetary targeting D) dollarization; inflation targeting E) exchange-rate targeting; dollarization Answer: E Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 17) Exchange-rate targeting is not an option for the U.S. because ________.

A) the U.S. is already dollarized B) the U.S. is too large C) the Fed has adopted a monetary targeting strategy D) the Fed has adopted an inflation targeting strategy Answer: B Diff: 1 Type: MC Skill: Applied Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting

43 .

18) The monetary policy strategy that provides an automatic rule for the conduct of monetary policy is ________.

A) exchange-rate targeting B) monetary targeting C) inflation targeting D) the implicit nominal anchor Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 19) The monetary policy strategy that does not allow the policy to focus on domestic considerations is ________.

A) exchange-rate targeting B) monetary targeting C) inflation targeting D) the implicit nominal anchor Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 20) The monetary policy strategy that results in the loss of an independent monetary policy is ________.

A) exchange-rate targeting B) monetary targeting C) inflation targeting D) the implicit nominal anchor Answer: A Diff: 1 Type: MC Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 21) The monetary policy strategy that directly ties down the price of internationally traded goods is ________.

A) exchange-rate targeting B) monetary targeting C) inflation targeting D) the implicit nominal anchor Answer: A Diff: 3 Type: MC Skill: Applied Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting

44 .

22) Which of the following is not a weakness of dollarization?

A) Loss of seignorage.

B) Increased exposure to shocks from the anchor country.

C) Dollarization can be abandoned, which can lead to a change in value of the currency.

D) The inability of the central bank to create money and act as a lender of last resort.

Answer: C Diff: 2 Type: MC Skill: Applied Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 23) Explain an additional disadvantage for a country undergoing dollarization compared to a currency board or other exchange-rate targeting regimes.

Answer: The additional disadvantage to dollarization is that the government loses seignorage.

Seignorage is the income that a government earns by issuing its own currency.

Diff: 2 Type: ES Skill: Recall Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting 24) Explain the 1992 crisis that led to the breakdown of the European Union's Exchange Rate Mechanism. What disadvantages of exchange-rate targeting were exhibited during this crisis?

Answer: The 1992 crisis began with Germany raising interest rates in 1990 to stem inflationary pressures from reunification. This demand shock was immediately transmitted to the other nations in the exchange-rate mechanism. Thus, these countries did not have independent monetary policies and were subject to shocks from the anchor country. This gave rise to the second problem. Speculators bet that these other countries would not want the increased unemployment resulting from the tight monetary policy. Betting that their commitment was weak, speculators bet against these currencies, and a number were forced to devalue or drop out of the ERM. The disadvantages illustrated by this are the lack of independent policy subjecting member nations to shocks from the anchor nation, and the possibility of speculative attacks when commitment is felt to be weak.

Diff: 3 Type: ES Skill: Applied Objective: 19.7 Summarize the advantages and disadvantages of exchange-rate targeting

45 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 20 Quantity Theory, Inflation, and the Demand for Money 20.1 Quantity Theory of Money 1) The quantity theory of money is a theory of how ________.

A) the money supply is determined B) interest rates are determined C) the nominal value of aggregate income is determined D) the real value of aggregate income is determined Answer: C Diff: 1 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 2) Which events created the perfect storm for the Canadian economy in 2007-2008?

A) An oil price shock and the global financial crisis.

B) Housing prices had doubled in most major metropolitan areas.

C) Prime mortgage interest rates were rising.

D) All of the above.

Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 3) The effect of money on the economy is called ________.

A) monetary supply B) monetary policy C) fiscal policy D) monetary demand Answer: B Diff: 1 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money

1 .

4) The average number of times that a dollar is spent in buying the total amount of final goods and services produced during a given period is known as ________.

A) gross national product B) the spending multiplier C) the money multiplier D) velocity Answer: D Diff: 1 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 5) Because the quantity theory of money tells us how much money is held for a given amount of aggregate income, it is also a theory of ________.

A) interest-rate determination B) the demand for money C) exchange-rate determination D) the demand for assets Answer: B Diff: 1 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 6) The velocity of money is ________.

A) the average number of times that a dollar is spent in buying the total amount of final goods and services B) the ratio of the money stock to high-powered money C) the ratio of the money stock to interest rates D) the average number of times a dollar is spent in buying financial assets Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 7) If the money supply is $600 and nominal income is $3000, the velocity of money is ________.

A) 1/50 B) 1/5 C) 5 D) 50 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 2 .

8) If nominal GDP is $8 trillion, and the money supply is $2 trillion, the velocity of money is ________.

A) 0.25 B) 4 C) 8 D) 16 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 9) If nominal GDP is $10 trillion, and velocity of money is 10, the money supply is ________.

A) $1 trillion B) $5 trillion C) $10 trillion D) $100 trillion Answer: A Diff: 2 Type: MC Skill: Applied Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 10) If the money supply is $20 trillion and velocity of money is 2, then nominal GDP is ________.

A) $2 trillion B) $10 trillion C) $20 trillion D) $40 trillion Answer: D Diff: 2 Type: MC Skill: Applied Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 11) The velocity of money is defined as ________.

A) P + M + Y B) (P × M)/Y C) (Y × M)/P D) (P × Y)/M Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 3 .

12) The velocity of money is defined as ________.

A) real GDP divided by the money supply B) nominal GDP divided by the money supply C) real GDP times the money supply D) nominal GDP times the money supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 13) The equation of exchange states that the quantity of money multiplied by the number of times this money is spent each year must equal ________.

A) nominal income B) real income C) real gross national product D) velocity Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 14) In the equation of exchange, the concept that provides the link between M and PY is known as ________.

A) the velocity of money B) aggregate demand C) aggregate supply D) the money multiplier Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 15) The equation of exchange is ________.

A) M × P = V × Y B) M + V = P + Y C) M + Y = V + P D) M × V = P × Y Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money

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16) Irving Fisher's view that velocity is constant in the short run transforms the equation of exchange into the ________.

A) Friedman's theory of income determination B) quantity theory of money C) Keynesian theory of income determination D) monetary theory of income determination Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 17) The demand for money represents ________.

A) the quantity of money that people want to hold B) the relationship between inflation rates and the quantity of money C) the relationship between interest rates and income D) All of the above.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 18) Irving Fisher took the view that the institutional features of the economy which affect velocity change ________ over time so that velocity will be fairly ________ in the short run.

A) rapidly; erratic B) rapidly; stable C) slowly; stable D) slowly; erratic Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 19) In Irving Fisher's quantity theory of money, velocity was determined by ________.

A) interest rates B) real GDP C) the institutions in an economy that affect individuals' transactions D) the price level Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money

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20) The classical economists' conclusion that nominal income is determined by movements in the money supply rested on their belief that ________ could be treated as ________ in the short run.

A) the velocity of money; constant B) the velocity of money; variable C) money; constant D) money; variable Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 21) The view that the velocity of money is constant in the short run transforms the equation of exchange into the quantity theory of money. According to the quantity theory of money when the money supply doubles ________.

A) velocity falls by 50 percent B) velocity also doubles C) nominal incomes fall by 50 percent D) nominal income also doubles Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 22) Cutting the money supply by one-third is, according to the quantity theory of money, predicted to cause ________.

A) a sharp decline of one-third of real output in the short run, and a fall in the price level by onethird in the long run B) a decline in real output by one-third C) a decline in output by one-sixth, and a decline in the price level of one-sixth D) a decline in the price level by one-third Answer: D Diff: 2 Type: MC Skill: Applied Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money

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23) The classical economists believed that if the quantity of money doubled, ________.

A) output would also double B) prices would fall C) prices would also double D) prices would remain constant Answer: C Diff: 2 Type: MC Skill: Applied Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 24) Classical economists' prediction that prices double when the money supply doubles is based on their belief that in the short run the velocity of money is ________ and that real GDP is ________.

A) constant; constant B) constant; variable C) variable; variable D) variable; constant Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 25) For the classical economists, the quantity theory of money provided an explanation for movements in the price level. Accordingly, movements in the price level result ________.

A) solely from changes in the quantity of money B) primarily from changes in the quantity of money C) only partially from changes in the quantity of money D) from changes in factors other than the quantity of money Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 26) If initially the money supply is $1 trillion, the velocity of money is 5, the price level is 1, and real GDP is $5 trillion, then an increase in the money supply to $2 trillion will ________.

A) increase real GDP to $10 trillion B) cause velocity to fall to 2.5 C) increase the price level to 2 D) increase the price level to 2 and velocity to 10 Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 7 .

27) If initially the money supply is $2 trillion, the velocity of money is 5, the price level is 2, and real GDP is $5 trillion, then a fall in the money supply to $1 trillion will ________.

A) reduce real GDP to $2.5 trillion B) cause velocity to rise to 10 C) decrease the price level to 1 D) decrease the price level to 1 and decreases velocity to 2.5 Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 28) According to the quantity theory of money demand, ________.

A) an increase in interest rates will cause the demand for money to fall B) a decrease in interest rates will cause the demand for money to increase C) interest rates have no effect on the demand for money D) an increase in money will cause the demand for money to fall Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 29) Fisher's quantity theory of money suggests that the demand for money is purely a function of ________, and ________ no effect on the demand for money.

A) income; interest rates have B) interest rates; income has C) government spending; interest rates have D) expectations; income has Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 30) ________ quantity theory of money suggests that the demand for money is purely a function of income, and interest rates have no effect on the demand for money.

A) Keynes's B) Fisher's C) Friedman's D) Tobin's Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 8 .

31) Canadian empirically evidence of the long-term quantity of money shows ________.

A) a strong positive relationship between inflation and money growth rates B) a weak positive relationship between inflation and money growth rates C) a weak negative relationship between inflation and money growth rates D) a strong negative relationship between inflation and money growth rates Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 32) A plot of Canadian inflation against annual money growth rate between 1971 and 2020 shows ________.

A) money supply lags by two years B) money supply lags by one year C) that the two are contemporaneously correlated D) are uncorrelated Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 33) For the period 2009 to 2019, international evidence suggests that ________.

A) for many countries there is only a weak relationship between the growth rate of money in the long run and inflation B) for many countries there is a strong relationship between short run money growth rates and inflation but only a weak relationship but that in the long run, the relationship is uncertain C) a strong relationship exists between the growth rate of money in the long run and inflation only for Canada and the U.S. D) for many countries there is a strong relationship between the growth rate of money in the long run and inflation Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money

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34) Give the equation of exchange and explain the variables used in it. Why we call it an identity?

Answer: The equation of exchange is given by M × V = P × Y, where M is the money supply, V is the velocity of money, P is the price level and Y is aggregate output or income. It is an identity because it is a relationship that is true by definition. It does not tell us, for example, that when the money supply M changes, nominal income (P × Y) changes in the same direction: a rise in M for example could be offset by a fall in V that leaves M × V unchanged and therefore P × Y unchanged.

Diff: 2 Type: ES Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money 35) Explain the conclusion that the quantity theory of money is a good theory of inflation in the long run, but not in the short run. How does is this conclusion related to flexible wages and prices.

Answer: Inflation is always and everywhere a monetary phenomenon. is accurate in the long run but not supported empirically in the short run. The classical assumption that wages and prices are completely flexible may not be a good assumption for short-run fluctuations in inflation and aggregate output.

Diff: 2 Type: ES Skill: Recall Objective: 20.1 Assess the relationship between money growth and inflation in the short run and the long run as implied by the quantity theory of money

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20.2 Budget Deficits and Inflation 1) Budget deficits can be an important source of ________ monetary policy.

A) inflationary B) recessionary C) federal D) fiscal Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy 2) The government can ________ by ________.

A) raise revenue; levying taxes B) go into debt; issuing government bonds C) create money; levying taxes D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy 3) If the government deficit is financed by selling bonds to the public then ________.

A) there is no effect on the monetary base B) there is no effect on the money supply C) the money supply will increase D) A and B only.

Answer: D Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy 4) One part of monetizing the debt is for the central bank to ________.

A) conduct an open market purchase B) conduct an open market sale C) increasing the overnight rate D) decreasing the overnight rate Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy

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5) Financing a debt through the direct-issue of currency is called ________.

A) printing money B) monetizing the debt C) open market purchases D) open market sales Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy 6) In March 2007, the inflation rate in Zimbabwe reached ________.

A) over 1500 percent B) over 150 percent C) over 15 percent D) over 15000 percent Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy 7) The Zimbabwean hyperinflation was caused by ________.

A) the government printing too much currency B) wars between rebel factions C) persistent budget surpluses in recent years D) above average agricultural yields Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy 8) Explain how financing a persistent deficit by money creation will lead to sustained inflation.

Answer: A budget deficient can lead to an increase in the money supply if it is financed by the creation of high-powered money. Because the quantity theory of money explains inflation only in the long run, to produce inflation, the budget deficit must be persistent.

Diff: 1 Type: ES Skill: Recall Objective: 20.2 Identify the circumstances under which budget deficits can lead to inflationary monetary policy

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20.3 Keynesian Theories of Money Demand 1) The Keynesian theory of money demand emphasizes the importance of ________.

A) a constant velocity B) irrational behavior on the part of some economic agents C) interest rates on the demand for money D) expectations Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 2) Keynes hypothesized that the transactions component of money demand was primarily determined by the level of ________.

A) interest rates B) velocity C) income D) stock market prices Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 3) Keynes argued that the transactions component of the demand for money was primarily determined by the level of people's ________, which he believed were proportional to ________.

A) transactions; income B) transactions; age C) incomes; wealth D) incomes; age Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand

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4) Keynes hypothesized that the precautionary component of money demand was primarily determined by the level of ________.

A) interest rates B) velocity C) income D) stock market prices Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 5) Keynes argued that the precautionary component of the demand for money was primarily determined by the level of people's ________, which he believed were proportional to ________.

A) incomes; wealth B) incomes; age C) transactions; income D) transactions; age Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 6) The demand for money as a cushion against unexpected contingencies is called the ________.

A) transactions motive B) precautionary motive C) insurance motive D) speculative motive Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 7) Keynes hypothesized that the speculative component of money demand was primarily determined by the level of ________.

A) interest rates B) velocity C) income D) stock market prices Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 14 .

8) The speculative motive for holding money is closely tied to what function of money?

A) Store of wealth B) Unit of account C) Medium of exchange D) Standard of deferred payment Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 9) Of the three motives for holding money suggested by Keynes, which did he believe to be the most sensitive to interest rates?

A) The transactions motive B) The precautionary motive C) The speculative motive D) The altruistic motive Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 10) Because Keynes assumed that the expected return on money was zero, he argued that people would ________.

A) never hold money B) never hold money as a store of wealth C) hold money as a store of wealth when the expected return on bonds was negative D) hold money as a store of wealth only when forced to by law Answer: C Diff: 2 Type: MC Skill: Applied Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 11) The Keynesian theory of money demand predicts that people will increase their money holdings if they believe that ________.

A) interest rates are about to fall B) bond prices are about to rise C) expected inflation is about to fall D) bond prices are about to fall Answer: D Diff: 2 Type: MC Skill: Applied Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 15 .

12) If people expect nominal interest rates to be higher in the future, the expected return on bonds ________, and the demand for money ________.

A) rises; increases B) rises; decreases C) falls; increases D) falls; decreases Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 13) If people expect nominal interest rates to be lower in the future, the expected return on bonds will ________, and the demand for money will ________.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 14) Keynes argued that when interest rates were low relative to some normal value, people would expect bond prices to ________ so the quantity of money demanded would ________.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 15) Keynes argued that when interest rates were high relative to some normal value, people would expect bond prices to ________ , so the quantity of money demanded would ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 16 .

16) According to Keynes's liquidity preference theory, velocity increases when ________.

A) income increases B) wealth increases C) brokerage commissions increase D) interest rates increase Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 17) Keynes's theory of the demand for money implies that the velocity of money is ________.

A) not constant but fluctuates with movements in interest rates B) not constant but fluctuates with movements in the price level C) not constant but fluctuates with movements in the time of year D) a constant Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 18) Because interest rates can fluctuate substantially , the ________ theory of the demand for money tells us that the velocity of money has substantial fluctuations as well.

A) classical B) Cambridge C) liquidity preference D) Pigouvian Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 19) Keynes's liquidity preference theory tells us that the demand for money ________.

A) is purely a function of income, and interest rates have no effect on the demand for money B) is purely a function of interest rates, and income has no effect on the demand for money C) is a function of both incomes and interest rates D) is a function of both government spending and income Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand

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20) Keynes's model of the demand for money suggests that the velocity of money is ________.

A) constant B) positively related to interest rates C) negatively related to interest rates D) positively related to bond values Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 21) Keynes's liquidity preference theory tells us that the demand for money is ________.

A) constant B) positively related to interest rates C) negatively related to interest rates D) negatively related to bond values Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 22) Keynes's model of the demand for money suggests that the velocity of money is ________ related to ________.

A) positively; interest rates B) negatively; interest rates C) positively; bond values D) positively; stock prices Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 23) Keynes's liquidity preference theory tells us that the demand for money is ________ related to ________.

A) negatively; interest rates B) positively; interest rates C) negatively; income D) negatively; wealth Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand

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24) The Keynesian demand for real balances can be expressed as ________.

A) Md = f(i,Y) B) Md/P = f(i) C) Md/P = f(Y) D) Md/P = f(i,Y) Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 25) Explain the Keynesian theory of money demand. What motives did Keynes think determined money demand? What are the two reasons why Keynes thought velocity could not be treated as a constant?

Answer: Keynes believed the demand for money depended on income and interest rates. Money was held to facilitate normal transactions and as a precaution for unexpected transactions. For both motives, money demand depended on income. People also held money as an asset, for speculative purposes. The speculative motive depends on income and interest rates. People hold more money for speculative purposes when they expect bond prices to fall, generating a negative return on bonds. Since money demand varies with interest rates, velocity changes when interest rates change. Also, since money demand depends upon expectations about future interest rates, unstable expectations can make money demand, and thus velocity, unstable.

Diff: 2 Type: ES Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 26) Explain the transactions motive for holding money in Keynes's liquidity preference theory.

Answer: Following the classical approach, Keynes emphasized that the transactions component of the demand for money is determined primarily by the level of people's transactions. Because he believed that these transactions were proportional to income, like the classical economists he took the transactions component of the demand for money to be proportional to income.

Diff: 1 Type: ES Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand

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27) Explain the precautionary motive for holding money in Keynes's liquidity preference theory.

Answer: Keynes went beyond the classical analysis by recognizing that people in addition to holding money to carry out current transactions, they also hold money as a cushion against an unexpected need. These money balances are useful when consumers find unexpected opportunities for purchases of goods and services in the case of sales etc. Also precautionary money is helpful when consumers need money to pay an unexpected bill. Keynes, postulated that precautionary money demand is proportional to income.

Diff: 2 Type: ES Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand 28) Explain the speculative motive for holding money in Keynes's liquidity preference theory.

Answer: Keynes took the view that people also hold money as a store of wealth, and he called this reason for people holding money the speculative motive. Since he believed that wealth is closely tied to income, the speculative component of money demand would be related to income.

However, Keynes looked more carefully at the factors that influence the decisions regarding how much money to hold as a store of wealth, especially interest rates. He divided the assets that can be used to store wealth into two categories: money and bonds. Keynes assumed that the expected return to money was zero because in his time unlike today, most chequable deposits did not earn interest. For bonds there are two components of the expected return: the interest payment and the expected rate of capital gains. If interest rates are below some normal value then people expect interest rates on bonds to rise and so expect to suffer capital loses on them. As a result, the demand for money will increase.

Diff: 2 Type: ES Skill: Recall Objective: 20.3 Summarize the three motives underlying the liquidity preference theory of money demand

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20.4 Portfolio Theories of Money Demand 1) The theory of portfolio choice says that the demand for an asset is ________ related to ________.

A) positively; wealth B) negatively; expected return C) negatively; wealth D) positively; risk Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 2) According to the theory of portfolio choice, currency and chequable deposits are said to be ________.

A) dominated assets B) risky assets C) interest bearing D) income Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 3) According to the theory of portfolio choice, money is extremely safe ________.

A) in real terms B) in nominal terms C) relative to currency D) relative to inflation hedges Answer: B Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 4) Inflation hedges ________.

A) are assets that have real returns that are less affected by inflation B) increase the risk and return from holding currency C) are assets that exhibit a rate of return of zero D) are assets denominated in nominal terms Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand

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5) Examples of assets that qualify as inflation hedges include ________.

A) real return bonds B) the stock market C) bonds D) currency Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 6) Financial innovation will ________ and ________.

A) improve the liquidity of alternative assets; decrease the demand for money B) improve the liquidity of alternative assets; increase the demand for money C) reduce the relative liquidity of money; increase the demand for money D) A and C only.

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 7) There are ________ factors that affect the demand for money.

A) three B) five C) six D) seven Answer: D Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 8) An improvement in payment technologies will ________ the demand for money because ________.

A) decrease; more resources are put into money B) decrease; there is less need for money for transaction purposes C) increase; there is less need for money for transaction purposes D) increase; more resources are put into money Answer: B Diff: 1 Type: MC Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand

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9) Describe the factors that affect the demand for money.

Answer: The demand for money using Keynesian and portfolio theories indicates that seven factors affect the demand for money. These are interest rates, income, payment technology, wealth, riskiness of other assets, inflation risk, and liquidity of other assets.

Diff: 1 Type: ES Skill: Recall Objective: 20.4 Identify the factors underlying the portfolio choice theory of money demand 20.5 Empirical Evidence for the Demand for Money 1) The evidence on the interest sensitivity of the demand for money suggests that the demand for money is ________ to interest rates, and there is ________ evidence that a liquidity trap exists.

A) sensitive; substantial B) sensitive; little C) insensitive; substantial D) insensitive; little Answer: B Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 2) In the case of a liquidity trap, monetary policy has ________ effect on aggregate spending because a change in the money supply has ________ effect on interest rates.

A) no; no B) no; a large C) no; a small D) a large; a large Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 3) In the case of a liquidity trap, monetary policy ________.

A) has a large impact on interest rates B) has a small impact on interest rates C) has no impact on interest rates D) has a proportionate impact on interest rates Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand

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4) In the case of a liquidity trap, the money demand curve ________.

A) is horizontal B) is vertical C) is negatively sloped D) is positively sloped Answer: A Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 5) Evidence suggests that a liquidity trap can occur when ________.

A) real interest rates are at zero B) real interest rates are at or just above zero C) nominal interest rates are at zero D) nominal interest rates are at or just above zero Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 6) The reason that economists are so interested in the stability of the velocity of money is because if the demand for money is volatile, then the steady growth of the money supply ________.

A) is going to promote price stability at the expense of low unemployment B) is going to promote low unemployment at the expense of price stability C) is an ineffective way to conduct monetary policy D) can still be used to conduct monetary policy if the goal is price stability Answer: C Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 7) If the demand for money is volatile then ________.

A) the velocity of money will be unpredictable B) the quantity of money is not linked to aggregate spending C) the aggregate spending rises D) A and B only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand

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8) Until the early 1970s, evidence strongly supported ________.

A) the stability of the money demand function B) the volatility of money demand C) increasing financial innovation D) the increasing importance of fiscal policy to affect the economy Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 9) If the money demand function is volatile then ________.

A) the velocity of money will be unstable and monetary policy will be more effective B) monetary policy will be ineffective C) fiscal policy will be more effective than monetary policy D) neither fiscal nor monetary policy will impact aggregate output Answer: A Diff: 1 Type: MC Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand 10) Describe what the liquidity trap is. Explain how it can be problematic for monetary policymakers.

Answer: The liquidity trap describes the situation in which the demand for money is insensitive to changes in interest rates (i.e., the money demand curve is infinitely elastic). In this case, monetary policy has no direct effect on aggregate spending because a change in the money supply will not affect interest rates.

Diff: 2 Type: ES Skill: Recall Objective: 20.5 Assess and interpret the empirical evidence on the validity of the liquidity preference and portfolio theories of money demand

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 21 The IS Curve 21.1 Planned Expenditure and Aggregate Demand 1) His analysis started with the recognition that the total quantity demanded of an economy's output was the sum of four types of spending: consumer expenditure, planned investment spending, government spending, and net exports.

A) John Maynard Keynes B) Sir John Hicks C) Milton Friedman D) Paul A. Samuelson Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand 2) Keynes's motivation in developing the aggregate output determination model stemmed from his concern with explaining ________.

A) the hyperinflations of the 1920s B) why the Great Depression occurred C) the high unemployment in Great Britain before World War I D) the high unemployment in Great Britain after World War II Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand 3) Keynes was especially interested in explaining movements of ________ because he wanted to explain why the Great Depression had occurred and how government policy could be used to increase ________ in a similar economic situation.

A) aggregate output; wages B) aggregate output; employment C) wage rates; wages D) wage rates; employment Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand

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4) Keynes was especially concerned with explaining the ________.

A) recession of 1920-21 B) low levels of output and employment during the Great Depression C) strong economic growth of the 1920s D) high unemployment in Great Britain during the 1920s Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand 5) Keynes was especially concerned with explaining the ________ level of output and employment during the ________.

A) low; 1920s B) low; 1930s C) high; 1920s D) high; 1930s Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand 6) In the simple Keynesian model, equilibrium aggregate output is determined by ________.

A) aggregate demand B) aggregate supply C) the national demand for labor D) the price level Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand 7) Under Keynesian analysis, aggregate demand can be written as ________.

A) Yad = C + I + G + NX B) Yad = C + I + G - NX C) Yad = C - I - G - NX D) Yad = C + I - G - NX Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand

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8) During the Covid-19 pandemic, the unemployment rate in Canada rose to a peak of approximately ________.

A) 10% B) 12% C) 14% D) 20% Answer: C Diff: 1 Type: MC Skill: Recall Objective: 21.1 Explain the relationship between planned expenditure and aggregate demand 21.2 The Components of Aggregate Demand 1) Keynes reasoned that consumer expenditure is most closely related to ________.

A) the level of interest rates B) the price level C) disposable income D) the marginal tax rate Answer: C Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 2) In the Keynesian model of income determination, consumer expenditure includes spending by ________.

A) consumers on personal computers B) businesses on personal computers C) governments on personal computers D) foreigners on domestic personal computers Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 3) The marginal propensity to consume (mpc) can be defined as the fraction of ________.

A) a change in income that is spent B) a change in income that is saved C) income that is spent D) income that is saved Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 3 .

4) If the consumption function is expressed as C = a + mpc × YD, then "mpc" represents ________.

A) autonomous consumer expenditure B) the marginal propensity to consume C) the expenditure multiplier D) disposable income Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 5) If the consumption function is expressed as C = a + mpc × YD, then "a" represents ________.

A) autonomous consumer expenditure B) the marginal propensity to consume C) the expenditure multiplier D) disposable income Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 6) If the consumption function is C = 20 + 0.5YD, then an increase in disposable income by $100 will result in an increase in consumer expenditure by ________.

A) $25 B) $70 C) $50 D) $100 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 7) If the consumption function is C = 20 + 0.8YD, then an increase in disposable income by $100 will result in an increase in consumer expenditure by ________.

A) $58 B) $64 C) $80 D) $100 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 4 .

8) Assume that autonomous consumption equals $200 and that the mpc equals 0.8. If disposable income equals $1000, then total consumption equals ________.

A) $80 B) $200 C) $800 D) $1000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 9) Assume that autonomous consumption equals $200 and disposable income equals $1000. If total consumption equal $800, then the mpc equals ________.

A) 0.2 B) 0.6 C) 0.8 D) 1.0 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 10) Assume that disposable income equals $1000 and the mpc equals 0.6. If total consumption equal $800, then autonomous consumption is equal to ________.

A) $0 B) $200 C) $800 D) $1000 Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 11) Everything else held constant, if total consumption increases from $600 to $800 because of an increase of disposable income of $400, then the mpc is equal to ________.

A) 0.2 B) 0.4 C) 0.5 D) 0.6 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 5 .

12) Everything else held constant, if consumption expenditure increases by 65 for a 100 increase in disposable income, the mpc is ________.

A) 0 B) 0.5 C) 0.65 D) 1 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 13) Everything else held constant, if disposable income increases by 200 and consumption expenditure increases by 150, the mpc is ________.

A) 0 B) 0.15 C) 0.5 D) 0.75 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 14) Everything else held constant, if consumption expenditure falls by 160 when disposable income falls by 200, the mpc is ________.

A) 0 B) 0.2 C) 0.4 D) 0.8 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure)

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15) Economists define investment spending as the purchase of ________.

A) a new physical asset such as a new machine or a new house B) any physical asset, whether new or not, used by business to increase production C) any physical asset used by business to increase production and the repurchase of common stock D) business spending on capital and household spending on durable goods Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 16) Planned investment spending, a component of aggregate demand, is equal to ________.

A) fixed investment plus actual inventory investment B) fixed investment plus unplanned inventory investment C) fixed investment D) fixed investment plus planned inventory investment Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 17) There are two types of investment spending: ________ investment–the spending by business firms on equipment and structures, and planned spending on residential houses–and ________ investment–spending by business firms on additional holdings of raw materials, parts, and finished goods.

A) planned; gross B) planned; inventory C) fixed; gross D) fixed; inventory Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 18) A fall in inventories is synonymous with ________ investment.

A) negative fixed B) positive fixed C) positive inventory D) negative inventory Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 7 .

19) A difference between inventory investment and fixed investment is that ________.

A) fixed investment is never unplanned B) fixed investment is never planned C) inventory investment is never unplanned D) unplanned inventory investment is always zero Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 20) Keynes mentioned two factors that influenced planned investment spending. They are ________.

A) interest rates and disposable income B) interest rates and business expectations about the future C) disposable income and business expectations about the future D) interest rates and business expectations about inflation Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 21) Factors that influence planned investment spending include ________.

A) real interest rates B) financial frictions C) emotional waves of optimism and pessimism D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 22) Planned investment spending is higher ________.

A) when real interest rates are higher B) during financial frictions C) when businesses are optimistic about the future D) A and C only Answer: C Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure)

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23) Aggregate demand in an economy in the absence of government or foreign trade is equal to ________.

A) consumer expenditure plus actual investment B) consumer expenditure plus planned investment C) consumer expenditure plus inventory investment D) consumer expenditure plus fixed investment Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 24) What is the marginal propensity to consume according to Keynes's consumption theory?

Provide an example.

Answer: Marginal propensity to consume or mpc is the slope of the consumption function line or ΔC/ΔYD and reflects the change in consumer expenditure that results from an additional dollar of disposable income. Keynes assumed that mpc is constant between the values of 0 and 1.

If for example mpc = 0.5, this means that when disposable income increases by $1, the consumer will increase her consumption by $0.50.

Diff: 2 Type: ES Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 25) What do economists mean by "investment"?

Answer: Economists use the word investment somewhat differently from other people. When people say that they are making an investment, they are normally referring to the purchase of common stocks or bonds, purchases that do not necessarily involve newly produced goods and services. But when economists speak of investment spending, they are referring to the purchase of new physical assets such as new machines or new house–purchases that add to aggregate demand.

Diff: 2 Type: ES Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure)

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26) What types of investment exist according to Keynes's theory of the determination of aggregate output? what is a major difference between the two according to Keynes?

Answer: According to Keynes there are two types of investment. The first type is fixed investment, the spending by firms on equipment and structures and spending on housing. The second type is inventory investment, spending by firms on additional holdings of raw materials, parts, and finished goods, calculated as the change in holdings of these items in a given period say a year. The main difference between the two types of investment is that according to Keynes fixed investment is always planned, while inventory investment can be unplanned.

Diff: 2 Type: ES Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure) 27) How is Keynes's consumption function defined? describe the terms used in this function?

Answer: According to Keynes the consumer expenditure is related not to aggregate income, but to disposable income, the total income available for spending, equal to aggregate income (which is equivalent to aggregate output) minus taxes: Y - T. Keynes called the relationship between disposable income YD and consumer expenditure C the consumption function and expressed it as: C = a + (mpc × YD). The term mpc is the marginal propensity to consume, the term a stands for autonomous consumer expenditure, the amount of consumer expenditure that is independent of disposable income.

Diff: 2 Type: ES Skill: Recall Objective: 21.2 List and describe the factors that determine the four components of aggregate demand (or planned expenditure)

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21.3 Goods Market Equilibrium 1) If unplanned investment is positive, firms will ________ production and output will ________.

A) cut; rise B) cut; fall C) increase; rise D) increase; fall Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 2) If unplanned investment is negative, firms will ________ production and output will ________.

A) cut; rise B) cut; fall C) increase; rise D) increase; fall Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 3) In the Keynesian framework, as long as output is below the equilibrium level, unplanned inventory investment will remain ________ and firms will continue to ________ production.

A) negative; lower B) negative; raise C) positive; lower D) positive; raise Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 4) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain ________ and firms will continue to raise production.

A) below; negative B) above; negative C) below; positive D) above; positive Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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5) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain ________ and firms will continue to lower production.

A) below; negative B) above; negative C) below; positive D) above; positive Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 6) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain positive and firms will continue to ________ production.

A) below; lower B) above; lower C) below; raise D) above; raise Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 7) In the Keynesian framework, as long as output is above the equilibrium level, unplanned inventory investment will remain ________ and firms will continue to ________ production.

A) negative; lower B) negative; raise C) positive; lower D) positive; raise Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 8) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain negative, and firms will continue to ________ production.

A) below; lower B) above; lower C) below; raise D) above; raise Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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9) In the Keynesian framework, as long as output is below the equilibrium level, unplanned inventory investment will remain negative, firms will continue to ________ production, and output will continue to ________.

A) lower; fall B) lower; rise C) raise; fall D) raise; rise Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 10) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain ________, firms will continue to raise production, and output will continue to rise.

A) below; negative B) above; negative C) below; positive D) above; positive Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 11) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned inventory investment will remain ________, firms will continue to lower production, and output will continue to fall.

A) below; negative B) above; negative C) below; positive D) above; positive Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 12) An increase in unplanned inventory investment for the entire economy equals the excess of ________.

A) output over aggregate supply B) output over aggregate demand C) aggregate supply over output D) aggregate demand over output Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 13 .

13) A decrease in unplanned inventory investment for the entire economy equals the excess of ________.

A) output over aggregate supply B) output over aggregate demand C) aggregate supply over output D) aggregate demand over output Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 14) If aggregate demand is less than the level of aggregate output, then ________ inventory investment will be ________.

A) planned; positive B) actual; positive C) actual; negative D) planned; negative Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 15) If aggregate demand falls short of current output, business firms will ________ production to ________ inventories.

A) cut; keep from accumulating B) expand; keep from accumulating C) cut; build up D) expand; build up Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 16) If aggregated demand is less than actual output, unplanned inventory ________ will cause output to ________.

A) accumulation; rise B) depletion; fall C) depletion; rise D) accumulation; fall Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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17) If actual output is less than equilibrium output, firms will ________ output to keep from ________ inventories.

A) increase; accumulating B) increase; depleting C) decrease; depleting D) decrease; accumulating Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 18) If actual output is greater than equilibrium output, firms will ________ output to keep from ________ inventories.

A) increase; accumulating B) increase; depleting C) decrease; depleting D) decrease; accumulating Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 19) When the level of unplanned inventory investment is equal to zero, the economy is ________.

A) in disequilibrium B) in a recession C) in equilibrium D) overheating Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 20) If aggregate demand equals output, ________.

A) the economy is in a recession B) output will increase C) output will fall D) the economy is at its equilibrium level Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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Situation 21-1 Assume a closed economy with no government. Suppose that autonomous consumption equals $400, planned investment equals $500, and the mpc equals 0.9.

21) Using the information in Situation 21-1, if aggregate output is equal to $10000, then unplanned inventory investment equals ________.

A) -$1000 B) -$100 C) $0 D) $100 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 22) Using the information in Situation 21-1, if aggregate output equals $8000, the unplanned inventory investment equals ________.

A) -$100 B) $0 C) $100 D) $500 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 23) Using the information in Situation 21-1, the equilibrium level of aggregate output is ________.

A) $900 B) $8000 C) $9000 D) $10000 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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24) Using the information contained in Situation 21-1, if autonomous consumption increases by $100, then equilibrium aggregate output will change by ________.

A) -$1000 B) -$100 C) $100 D) $1000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 25) Using the information contained in Situation 21-1, if planned investment decreases by $100, the equilibrium aggregate output will change by ________.

A) -$1000 B) $-100 C) $100 D) $1000 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 26) Keynes believed that changes in autonomous spending were dominated by changes in ________.

A) consumer expenditure B) autonomous consumer expenditure C) investment spending D) taxes E) none of the above Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 27) Keynes believed that changes in autonomous spending were dominated by unstable fluctuations in ________, which are influenced by emotional waves of optimism and pessimism– factors he referred to as "animal spirits."

A) unplanned investment spending B) actual investment spending C) planned investment spending D) autonomous consumer expenditures Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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28) In the simple Keynesian framework, declines in planned investment spending that produce high unemployment can be offset by raising ________.

A) taxes B) government spending C) consumer confidence D) business confidence Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 29) The Keynesian framework indicates that government can play an important role in determining aggregate output by ________.

A) changing the level of government spending or taxes B) raising consumer confidence C) raising investor confidence D) changing the money supply and interest rates Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 30) A tax cut initially ________.

A) increases consumption expenditure by an amount greater than the tax cut B) increases consumption expenditure by an amount equal to the tax cut C) increases consumption expenditure by an amount that is less than the value of the tax cut D) has no effect on consumption expenditure E) reduces consumption expenditure by an amount that is less than the value of the tax cut Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 31) Assume equilibrium at full employment for an economy characterized by the simple Keynesian model. If the government raises taxes to eliminate a budget deficit, then ________.

A) the rate of unemployment will increase B) the level of aggregate output will increase C) the price level will increase D) the rate of interest will fall Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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Situation 21-2 Assume a closed economy. Suppose that autonomous consumption equals $400, planned investment equals $500, government expenditure equals $200, net taxes equals $50, and the mpc equals 0.9.

32) Using the information in situation 21-2, if government spending increases by $100, then the equilibrium aggregate output will change by ________.

A) -$1000 B) -$100 C) $100 D) $1000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 33) Using the information in Situation 21-2, if taxes increase by $10, then the equilibrium aggregate output will change by ________.

A) -$90 B) -$10 C) $10 D) $90 Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 34) Using the information in situation 21-2, if government increases their spending by $50 and increases net taxes by 50, then equilibrium aggregate output will change by ________.

A) -$100 B) -$50 C) $50 D) $100 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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35) In a closed economy, aggregate demand is the sum of ________.

A) consumer expenditure, actual investment spending, and government spending B) consumer expenditure, planned investment spending, and government spending C) consumer expenditure, actual investment spending, government spending, and net exports D) consumer expenditure, planned investment spending, government spending, and net exports Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 36) In an open economy, aggregate demand is the sum of ________.

A) consumer expenditure, actual investment spending, and government spending B) consumer expenditure, planned investment spending, and government spending C) consumer expenditure, actual investment spending, government spending, and net exports D) consumer expenditure, planned investment spending, government spending, and net exports Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 37) If net exports increase by 100 and the mpc is 0.75, equilibrium aggregate output increases by ________.

A) 100 B) 250 C) 400 D) 750 Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 38) If net exports increase by 250 and the mpc is 0.75, equilibrium aggregate output increases by ________.

A) 250 B) 500 C) 750 D) 1000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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39) If net exports decrease by 250 and the mpc is 0.75, equilibrium aggregate output ________.

A) increases by 1000 B) increases by 750 C) decreases by 750 D) decreases by 1000 Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 40) Aggregate output is ________ related to autonomous consumer expenditure, and is ________ related to planned investment spending.

A) negatively; negatively B) negatively; positively C) positively; negatively D) positively; positively Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 41) Aggregate output is ________ related to autonomous consumer expenditure and is ________ related to the level of taxes.

A) negatively; negatively B) negatively; positively C) positively; negatively D) positively; positively Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 42) Aggregate output is increased by a decrease in ________.

A) autonomous consumption B) government spending C) planned investment D) net taxes Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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43) Equilibrium output is reduced by an increase in ________.

A) planned investment B) taxes C) government spending D) net exports Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 44) Keynes believed that unstable investment caused the Great Depression. Using the simple Keynesian model, explain how a fall in investment affects equilibrium output.

Answer: A fall in investment will reduce aggregate output by a greater amount that the initial fall in investment. This happens because of the multiplier effect.

Diff: 2 Type: ES Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 45) Describe Keynes's equilibrium condition and what it implies.

Answer: Equilibrium occurs when the total quantity of the output equals the total amount of aggregate demand or planned expenditure. When Y = YAD producers are able to sell all their output and have no reason to change their production because there is no unplanned inventory investment.

Diff: 2 Type: ES Skill: Applied Objective: 21.3 Solve for the goods market equilibrium 46) Define the IS curve.

Answer: The IS curve shows the relationship between aggregate output and the real interest rate when the goods market is in equilibrium.

Diff: 2 Type: ES Skill: Applied Objective: 21.3 Solve for the goods market equilibrium

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21.4 Understanding the IS Curve 1) If the interest rate falls, other things being equal, investment spending will ________.

A) fall B) rise C) either rise, fall, or remain unchanged D) not be affected Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 2) When the interest rate rises, ________.

A) planned investment falls B) planned investment rises C) planned investment will be unaffected D) equilibrium income increases Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 3) When the interest rate is ________, ________ investments in physical capital will earn more than the cost of borrowed funds, so planned investment spending is ________.

A) high; few; high B) high; few; low C) low; few; high D) low; many; low E) high; many; high Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium

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4) When interest rates rise in Canada (with the price level fixed), the value of the dollar ________, domestic goods become ________ expensive, and net exports ________.

A) falls; less; fall B) falls; more; rise C) rises; more; fall D) rises; less; fall Answer: C Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 5) When interest rates fall in Canada (with the price level fixed), the value of the dollar ________, domestic goods become ________ expensive, and net exports ________.

A) falls; less; fall B) falls; less; rise C) falls; more; fall D) rises; less; fall Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 6) An increase in interest rates ________.

A) increases the value of the dollar, net exports, and equilibrium output B) increases the value of the dollar, reducing net exports and equilibrium output C) reduces the value of the dollar, net exports, and equilibrium output D) reduces the value of the dollar, increasing net exports and equilibrium output Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 7) A decrease in interest rates ________.

A) increases the value of the dollar, net exports, and equilibrium output B) increases the value of the dollar, reducing net exports and equilibrium output C) reduces the value of the dollar, net exports, and equilibrium output D) reduces the value of the dollar, increasing net exports and equilibrium output Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium

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8) The negative relation between investment spending and the interest rate is what gives the ________ curve its ________ slope.

A) IS; upward B) IS; downward C) LM; downward D) LM; upward Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 9) Points on the IS curve satisfy ________ market equilibrium.

A) money B) goods C) stock D) bond Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 10) The ________ traces out the points for which total quantity of goods produced equals total quantity of goods demanded.

A) LM curve B) IS curve C) consumption function D) investment schedule Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 11) The ________ describes points for which the goods market is in equilibrium.

A) LM curve B) IS curve C) consumption function D) investment schedule Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium

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12) Everything else held constant, if aggregate output is to the right of the IS curve, then there is an excess ________ of goods which will cause aggregate output to ________.

A) supply; fall B) supply; rise C) demand; fall D) demand; rise Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 13) Everything else held constant, if aggregate output is to the left of the IS curve, then there is an excess ________ of goods which will cause aggregate output to ________.

A) supply; fall B) supply; rise C) demand; fall D) demand; rise Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 14) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess supply of goods which will cause aggregate output to ________.

A) right; fall B) right; rise C) left; fall D) left; rise Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 15) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess demand of goods which will cause aggregate output to ________.

A) right; fall B) right; rise C) left; fall D) left; rise Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 26 .

16) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess ________ of goods which will cause aggregate output to fall.

A) right; supply B) right; demand C) left; supply D) left; demand Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 17) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess ________ of goods which will cause aggregate output to rise.

A) right; supply B) right; demand C) left; supply D) left; demand Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 18) Describe how the economy heads towards equilibrium and why it has a tendency to settle there.

Answer: When production is above the equilibrium level, output will exceed aggregate demand and firms will continue cutting production and aggregate output will decrease. When aggregate output is below the equilibrium level of output, firms want to increase production because inventories are declining by more than they desire and aggregate output will increase. When aggregate demand equals aggregate output there is no further tendency for output to change.

Diff: 2 Type: ES Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 19) The Bank of Canada increases interest rates when they want to reduce aggregate demand to fight inflation. How do increases in the interest rate reduce aggregate demand?

Answer: Increases in interest rates reduce planned investment. The decrease in investment reduces equilibrium output by a multiple amount due to the multiplier effect. Also, increases in interest rates increase the value of the dollar, reducing net exports, which reduce aggregate demand and equilibrium output by a multiple amount.

Diff: 2 Type: ES Skill: Recall Objective: 21.4 Describe why the IS curve slopes downward and why the economy heads to a goods market equilibrium 27 .

21.5 Factors That Shift the IS Curve 1) Other things equal, a decrease in autonomous consumption shifts the ________ curve to the ________.

A) IS; right B) IS; left C) LM; left D) LM; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 2) In the Keynesian cross diagram, a decline in autonomous consumer expenditure causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 3) An increase in autonomous consumer expenditure causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve

28 .

4) An increase in autonomous consumer expenditure causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to rise, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 5) A decline in autonomous consumer expenditure causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: C Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 6) A decline in autonomous consumer expenditure causes the aggregate demand function to shift down, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: C Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 7) An increase in autonomous consumer expenditure causes the aggregate demand function to shift up, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 29 .

8) An increase in autonomous consumer expenditure causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; LM; right B) rise; IS; right C) fall; LM; left D) fall; IS; left Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 9) A decrease in autonomous consumer expenditure causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; LM; right B) rise; IS; right C) fall; IS; left D) fall; LM; left Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 10) Everything else held constant, changes in the interest rate affect planned investment spending and hence the equilibrium level of output, but this change in investment spending ________.

A) merely causes a movement along the IS curve and not a shift B) is crowded out by higher taxes C) is crowded out by higher government spending D) is crowded out by lower consumer expenditures Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 11) A rise in autonomous planned investment spending causes the equilibrium level of aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.

A) rise; LM; right B) rise; IS; right C) fall; IS; left D) fall; LM; left Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 30 .

12) A decline in autonomous planned investment spending causes the equilibrium level of aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.

A) rise; LM; right B) rise; IS; right C) fall; IS; left D) fall; LM; left Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 13) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 14) An increase in investment spending because companies become more optimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve

31 .

15) An increase in investment spending because companies become more optimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to rise, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 16) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 17) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift down, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve

32 .

18) An increase in investment spending because companies become more optimistic about investment profitability causes the aggregate demand function to shift up, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 19) A decrease in autonomous planned investment spending, other things equal, shifts the ________ curve to the ________.

A) IS; right B) IS; left C) LM; left D) LM; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 20) An increase in government spending causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; LM; right B) rise; IS; right C) fall; IS; left D) fall; LM; left Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 21) A reduction in government spending causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; LM; right B) fall; IS; left C) fall; LM; left D) rise; IS; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 33 .

22) The IS curve shifts to the left when ________.

A) taxes increase B) government spending increases C) the money supply increases D) autonomous planned investment spending increases Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 23) A decline in taxes ________ consumer expenditure and shifts the ________ curve to the ________, everything else held constant.

A) raises; LM; right B) lowers; IS; left C) raises; IS; right D) lowers; LM; left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 24) A tax increase ________ disposable income, ________ consumption expenditure, and shifts the IS curve to the ________, everything else held constant.

A) increases; increases; right B) increases; decreases; left C) decreases; increases; left D) decreases; decreases; left Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 25) A tax cut ________ disposable income, ________ consumption expenditure, and shifts the IS curve to the ________, everything else held constant.

A) increases; increases; right B) increases; decreases; right C) decreases; increases; left D) decreases; decreases; left Answer: A Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve

34 .

26) If Canadian university students decide that drinking Mexican-brewed beer helps one get noticed, net exports will tend to fall, causing aggregate demand to ________ and the ________ curve to shift to the left, everything else held constant.

A) fall; LM B) fall; IS C) rise; LM D) rise; IS Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 27) If young business professionals in Canada suddenly decide that driving German-made cars is an important status symbol, net exports will tend to ________ causing aggregate demand to ________, everything else held constant.

A) fall; fall B) fall; rise C) rise; fall D) rise; rise Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 28) An autonomous depreciation of the Canadian dollar makes Canadian goods ________ relative to foreign goods and results in a ________ in Canadian net exports, everything else held constant.

A) cheaper; decline B) cheaper; rise C) more expensive; decline D) more expensive; rise Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 29) An autonomous appreciation of the Canadian dollar makes Canadian goods ________ expensive relative to foreign goods which ________ net exports in Canada.

A) less; decreases B) less; increases C) more; decreases D) more; increases Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 35 .

30) A shift in tastes that now favours foreign goods ________ net exports in Canada and causes the quantity of aggregate output demanded to ________ in Canada, everything else held constant.

A) decreases; rise B) decreases; fall C) increases; rise D) increases; fall Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 31) Everything else held constant, a shift in tastes in Canada that now favours Mexican goods will ________ net exports in Canada and cause the quantity of aggregate output demanded to ________ in Mexico.

A) decrease; rise B) decrease; fall C) increase; rise D) increase; fall Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 32) A shift in tastes in Canada that now favours American goods ________ net exports in Canada. and causes the quantity of aggregate output demanded to ________ in Canada, everything else held constant.

A) decreases; rise B) decreases; fall C) increases; rise D) increases; fall Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 33) Everything else held constant, a shift in tastes in Canada that now favours Canadian goods will ________ net exports in Canada and cause the quantity of aggregate output demanded to ________ in Mexico.

A) decrease; rise B) decrease; fall C) increase; rise D) increase; fall Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 36 .

34) A shift in tastes toward Canadian goods ________ net exports in Canada and causes the IS curve to shift to the ________ in Canada, everything else held constant.

A) decreases; right B) decreases; left C) increases; right D) increases; left Answer: C Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 35) A shift in tastes toward foreign goods ________ net exports in Canada and causes the IS curve to shift to the ________ in Canada everything else held constant.

A) decreases; right B) decreases; left C) increases; right D) increases; left Answer: B Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 36) A depreciation of the Canadian dollar makes Canadian goods cheaper relative to foreign goods, resulting in a ________ in net exports in Canada and a ________ shift of the IS curve in Canada, everything else held constant.

A) fall; leftward B) rise; leftward C) fall; rightward D) rise; rightward Answer: D Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 37) An appreciation of the Canadian dollar makes foreign goods cheaper relative to Canadian goods, resulting in a ________ in net exports in Canada and a ________ shift of the IS curve in Canada, everything else held constant.

A) fall; leftward B) rise; leftward C) fall; rightward D) rise; rightward Answer: A Diff: 2 Type: MC Skill: Applied Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 37 .

38) Which of the following does not shift the IS curve?

A) An increase in autonomous consumption.

B) An increase in government spending.

C) A decline in government spending.

D) A fall in the interest rate.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 39) What are the factors that can shift the IS curve to the right?

Answer: The factors that can shift the IS curve to the right are: an increase in autonomous consumer demand, an increase in investment spending unrelated to the interest rate, an increase in government spending, a decrease in taxes, and an increase in net exports.

Diff: 2 Type: ES Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve 40) What is the role of the government, according to Keynes, in stimulating the economy, raising aggregate output and reducing unemployment when the economy is in a recession?

Answer: Keynes realized that government spending and taxes could also affect the position of the aggregate demand function and hence be manipulated to restore the economy to full employment and Yad = C + I + G + NX. Thus, government spending adds directly to aggregate demand, while taxes do not affect aggregate demand directly. This is why when there are taxes disposable income does not equal aggregate output. It equals output Y minus taxes T: YD = Y T. According to Keynes's analysis an equal increase in government spending and taxes in the economy that is in recession can restore full employment output as government spending leads to a multiplied change in aggregate output through the expenditure multiplier: × G. The equal increase in taxes, only reduces consumer expenditure by mpc × T. Thus the final result is an increase in aggregate output.

Diff: 2 Type: ES Skill: Recall Objective: 21.5 List the factors that shift the IS curve, and describe how they shift the IS curve

38 .

Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 22 The Monetary Policy and Aggregate Demand Curves 22.1 The Bank of Canada and Monetary Policy 1) The Bank of Canada conducts monetary policy by ________.

A) setting the overnight interest rate B) buying and selling bonds in open market operations C) changing the tax rate to influence aggregate demand D) changing the exchange rate to influence aggregate demand Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates 2) The Bank of Canada controls the overnight rate by ________.

A) varying the settlement balances it provides to the banking system B) dictating terms of the LVTS C) managing government savings D) borrowing from the provincial government Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates 3) Because prices are slow to move in the short-run, when the Bank of Canada lowers the overnight rate, ________.

A) nominal interest rates rise B) real interest rates fall C) inflation falls D) real interest rates rise Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates

1 .

4) Because prices are sticky in the short-run, when the Bank of Canada raises the overnight rate, ________.

A) nominal interest rates fall B) real interest rates rise C) inflation falls D) real interest rates fall Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates 5) The overnight interest rate is a ________ interest rate, but it is the ________ interest rate that affects net exports and business spending, thereby determining the level of ________ .

A) real; nominal; equilibrium output B) nominal; real; equilibrium output C) real; nominal; expected inflation D) nominal; real; expected inflation Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates 6) Explain the relationship between Bank of Canada's overnight rate and the real interest rate.

Answer: Because prices are sticky–changes in monetary policy will not have an immediate effect on inflation and expected inflation. As a result, when the Bank of Canada lowers the overnight interest rate, real interest rates fall; and when the Bank of Canada raises the overnight rate, real interest rates rise.

Diff: 2 Type: ES Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates 7) Explain the relationship between real and nominal interest rates when inflation is expected to remain unchanged in the short run.

Answer: The Fisher equation states that real interest rate equals the nominal interest rate minus expected inflation. If there is no change in expected inflation, then over the short run, the real and nominal rates will be the same.

Diff: 2 Type: ES Skill: Recall Objective: 22.1 Recognize the impact of changes in the nominal overnight interest rate on short-term real interest rates

2 .

22.2 The Monetary Policy Curve 1) The monetary policy (MP) curve indicates the relationship between ________.

A) the overnight rate and the real interest rate B) the overnight rate and the inflation rate C) the inflation rate and the expected inflation rate D) the real interest rate the central bank sets and the inflation rate Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 2) An increase in the interest rate due to Taylor principle changes result in ________.

A) a movement up the monetary policy curve B) a movement down the monetary policy curve C) an upward shift of the monetary policy curve D) a downward shift of the monetary policy curve Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 3) If the central bank did not follow the Taylor principle ________.

A) inflation would spiral out of control B) it could rely on autonomous monetary policy changes C) it could rely on non-conventional monetary policy tools D) B and C only Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 4) If the central bank did not follow the Taylor principle so that the real interest rate fell when inflation rose, ________.

A) inflation would increase B) the nominal interest rate would not change C) expected inflation would be equal to zero D) output would remain unchanged Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 3 .

5) If the monetary policy rule is given by r = 1.0 + 0.5p, then 1.0 represents ________.

A) the autonomous component of the real interest rate set by the central bank B) the responsiveness of the real interest rate to the inflation rate C) the nominal rate as described by the Taylor principle D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 6) If the monetary policy rule is given by r = 1.0 + 0.5p, then 0.5 represents ________.

A) the autonomous component of the real interest rate set by the central bank B) the responsiveness of the real interest rate to the inflation rate C) the nominal rate as described by the Taylor principle D) none of the above Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 7) If the monetary policy rule is given by r = 1.0 + 0.5p, then r represents ________.

A) the autonomous component of the real interest rate set by the central bank B) the responsiveness of the real interest rate to the inflation rate C) the real interest rate that is sent by the central bank D) none of the above Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 8) Central banks aim to ________.

A) keep inflation stable B) keep expected inflation equal to zero C) reduce inflation to zero D) A and B only Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve

4 .

9) The reason inflation spiraled in Canada in the 1970s can be attributed to ________.

A) the central bank not following the Taylor Principle B) the OPEC oil embargo C) changing policies at the federal government level D) an aggressive central bank policy buying bonds Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 10) In the 1970s, the inflation rate in Canada reach levels over ________ percent.

A) 2 B) 5 C) 10 D) 12 Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 11) The Taylor Principle differs from the Taylor rule because ________.

A) it does not provide a rule for how monetary policy should react to conditions in the economy B) the Taylor principle relates to real interest rates and the Taylor rule pertains to nominal interest rates C) the Taylor principle is exclusively used by the Bank of Canada while the Taylor rule is used by the U.S. Fed D) the Taylor rule relates to inflation rates while the Taylor principle is applied to real interest rates Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 12) Higher inflation results from higher interest rates due to ________.

A) the Taylor principle B) the Taylor rule C) the slope of the monetary policy curve D) the Fisher equation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 5 .

13) Tightening monetary policy refers to ________.

A) higher real interest rates B) higher nominal interest rates C) lower real interest rates D) lower nominal interest rates Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 14) The upward slope of the MP curve indicates that ________.

A) the central bank lowers real interest rates when inflation rises B) the central bank raises real interest rates when inflation falls C) the central bank raises nominal interest rates when inflation rises D) the central bank raises real interest rates when inflation rises Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 15) The Taylor Principle states that central banks raise nominal rates by ________ than any rise in expected inflation so that real interest rates ________ when there is a rise in inflation.

A) less; rise B) more; fall C) less; fall D) more; rise Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 16) An autonomous tightening of monetary policy ________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve

6 .

17) An autonomous easing of monetary policy ________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 18) Based on the Taylor Principle, a central bank's endogenous response of raising interest rates when inflation rises ________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 19) Based on the Taylor Principle, a central bank's endogenous response of decreasing interest rates when inflation falls ________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 20) When the financial crisis started in August 2007, inflation was rising and the Bank of Canada began an aggressive easing lowering of the overnight rate, which indicated that ________.

A) the Bank of Canada pursued an autonomous monetary policy tightening B) the Bank of Canada pursued an autonomous monetary policy easing C) the Bank of Canada had an automatic negative response to inflation based on the Taylor rule D) the Bank of Canada had an automatic positive response to inflation based on the Taylor rule Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 7 .

21) An increase in the money supply, other things equal, shifts the ________ curve to the ________.

A) IS; right B) IS; left C) MP; left D) MP; right Answer: D Diff: 1 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 22) An expansionary monetary policy shifts the MP curve to the ________, reducing ________, everything else held constant.

A) left; output and increasing interest rates B) left; both real output and interest rates C) right; both interest rates and real output D) right; interest rates and increasing real output Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 23) If the Bank of Canada conducts open market purchases, the money supply ________, shifting the MP curve to the ________, everything else held constant.

A) decreases; right B) decreases; left C) increases; right D) increases; left Answer: C Diff: 1 Type: MC Skill: Applied Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 24) If the Bank of Canada conducts open market sales, the money supply ________, shifting the MP curve to the ________, everything else held constant.

A) decreases; right B) decreases; left C) increases; right D) increases; left Answer: B Diff: 1 Type: MC Skill: Applied Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 8 .

25) If the Bank of Canada conducts open market ________, the money supply ________, shifting the MP curve to the right, everything else held constant.

A) purchases; decreases B) sales; decreases C) purchases; increases D) sales; increases Answer: C Diff: 2 Type: MC Skill: Applied Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 26) If the Bank of Canada conducts open market ________, the money supply ________, shifting the MP curve to the left, everything else held constant.

A) purchases; decreases B) sales; decreases C) purchases; increases D) sales; increases Answer: B Diff: 2 Type: MC Skill: Applied Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 27) A decline in the money ________ shifts the MP curve to the ________, causing the interest rate to rise and output to fall, everything else held constant.

A) demand; right B) demand; left C) supply; right D) supply; left Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve

9 .

28) A decline in the money supply shifts the MP curve to the left, causing the interest rate to ________ and output to ________, everything else held constant.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 29) An increase in the money ________ shifts the MP curve to the ________, causing the interest rate to fall and output to rise, everything else held constant.

A) demand; right B) demand; left C) supply; right D) supply; left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 30) An increase in the money supply shifts the MP curve to the right, causing the interest rate to ________ and output to ________, everything else held constant.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 31) When the central bank ________ the money supply, the MP curve shifts to the right, interest rates ________, and equilibrium aggregate output ________, everything else held constant.

A) increases; fall; increases B) increases; rise; decreases C) decreases; rise; decreases D) decreases; fall; increases Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 10 .

32) An autonomous decrease in money demand, other things equal, shifts the ________ curve to the ________.

A) IS; right B) IS; left C) MP; left D) MP; right Answer: D Diff: 2 Type: MC Skill: Applied Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 33) An autonomous increase in money demand, other things equal, shifts the ________ curve to the ________.

A) IS; right B) IS; left C) MP; left D) MP; right Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 34) As bonds become a riskier asset, the demand for money ________ and, all else constant, the equilibrium interest rate ________.

A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: A Diff: 3 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve

11 .

35) An autonomous rise in ________ shifts the MP curve to the ________, everything else held constant.

A) net exports; right B) net exports; left C) money demand; right D) money demand; left Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 36) Despite an expansionary monetary policy, an economy experiences a recession. Everything else held constant, the recession could occur in spite of the rightward shift of the MP curve if ________.

A) consumer confidence decreases sharply B) there is an investment boom C) the money supply increases D) taxes are cut Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 37) When there is a rise in inflation and the central bank does not increase liquidity in the banking system, households and firms would try to increase their money holdings by selling bonds, which would ________ nominal interest rates. Because in the short run inflation expectations are unchanged, nominal and real interest rates move together. This leads to a/an ________ monetary policy (MP) curve.

A) raise; downward-sloping B) lower; downward-sloping C) lower; upward-sloping D) raise; upward-sloping Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve

12 .

38) Based on the Taylor Principle, a central bank's endogenous response of decreasing interest rates when inflation falls ________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 39) An autonomous tightening of monetary policy ________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 40) An autonomous easing of monetary policy________.

A) causes an upward movement along the monetary policy curve B) causes a downward movement along the monetary policy curve C) shifts the monetary policy curve upward D) shifts the monetary policy curve downward Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 41) Inflationary pressures caused the FOMC to increase the federal funds rate by ¼ of a percentage point in June 2004, and by exactly the same amount at every subsequent FOMC meeting through June of 2006. These actions ________.

A) caused an upward movement along the monetary policy curve B) caused a downward movement along the monetary policy curve C) shifted the monetary policy curve upward D) shifted the monetary policy curve downward Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 13 .

42) When it became clear that the coronavirus was spreading out of control, the Bank of Canada decided to lower the overnight interest rate. This translated into ________.

A) a downward shift in the monetary policy curve B) an upward shift of the monetary policy curve C) a movement towards the left along the monetary policy curve D) a movement towards the right along the monetary policy curve Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 43) Changes in monetary policy that shift the monetary policy curve are known as ________ changes, while changes that are reflected in movements along the monetary policy curve are ________ adjustments to interest rates.

A) Taylor principle-driven; automatic B) automatic; automatic C) autonomous; automatic D) Taylor principle-driven; autonomous Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 44) Describe how the Bank of Canada would apply the Taylor principle.

Answer: To stabilize inflation, the Bank of Canada raises nominal rates by more than any rise in expected inflation so that real interest rates rise when there is a rise in inflation.

Diff: 2 Type: ES Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 45) Explain the difference between autonomous changes in monetary policy and the Taylor principle.

Answer: The Bank of Canada uses autonomous monetary policy to shift the monetary policy curve to change in inflation rate, for example. The Taylor principle changes the real interest rate which does not impact the monetary policy curve.

Diff: 2 Type: ES Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve

14 .

46) Describe monetary easing at the Bank of Canada during the 2007-2009 Financial Crisis.

Answer: The Bank pursued autonomous monetary policy easing because of the negative shock to the economy from the disruption to financial markets indicated that despite current high inflation rates, the economy was likely to weaken in the near future and the inflation rate would fall.

Diff: 2 Type: ES Skill: Recall Objective: 22.2 Define and illustrate the monetary policy (MP) curve, and explain shifts in the MP curve 22.3 The Aggregate Demand Curve 1) In deriving the aggregate demand curve a ________ inflation rate leads the central bank to ________ real interest rates, thereby ________ the level of equilibrium aggregate output.

A) higher; raise; lowering B) lower; raise; lowering C) higher; lower; lowering D) higher; lower; raising Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 2) The aggregate demand curve is derived from the ________.

A) IS curve B) MP curve C) LM curve D) A and B only Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 3) Suppose the aggregate demand curve is given by Y = 12 - r then, if inflation increases by 1 percent ________.

A) aggregate output is unchanged B) aggregate output increases C) the nominal interest changes D) the real interest rate falls Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 15 .

4) Suppose the aggregate demand curve is given by Y = 12 - r then if the nominal interest rate increases by 1 percent ________.

A) aggregate output is unchanged B) aggregate output increases C) the nominal interest changes D) the real interest rate falls Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 5) Higher interest rates lead to reductions in the aggregate output due to ________.

A) reductions in autonomous consumer expenditure B) reductions in planned investment expenditure C) higher expected inflation D) higher employment Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 6) An increase in autonomous consumer expenditure causes the IS curve to shift ________ and the aggregate demand curve to shift ________.

A) left; left B) left; right C) right; left D) right; right Answer: A Diff: 2 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 7) An increase in financial frictions causes the IS curve to shift ________ and the aggregate demand curve to shift ________.

A) left; left B) left; right C) right; left D) right; right Answer: A Diff: 2 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 16 .

8) An increase in autonomous investment spending causes the IS curve to shift ________ and the aggregate demand curve to shift ________.

A) left; left B) left; right C) right; left D) right; right Answer: A Diff: 2 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 9) An increase in government purchases causes the IS curve to shift ________ and the aggregate demand curve to shift ________.

A) left; left B) left; right C) right; left D) right; right Answer: A Diff: 2 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 10) A decrease in taxes causes the IS curve to shift ________ and the aggregate demand curve to shift ________.

A) left; left B) left; right C) right; left D) right; right Answer: A Diff: 2 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 11) In the IS and MP framework, an expansionary monetary policy causes aggregate output to ________ and the interest rate to ________, everything else held constant.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 17 .

12) Everything else held constant, a monetary expansion is characterized by ________ output and ________ interest rates.

A) rising; rising B) rising; falling C) falling; rising D) falling; falling Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 13) A contractionary monetary policy shifts the MP curve to the ________, reducing ________, everything else held constant.

A) left; output and increasing interest rates B) left; both real output and interest rates C) right; both interest rates and real output D) right; interest rates and increasing real output Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 14) Everything else held constant, a monetary contraction is characterized by ________ output and ________ interest rates.

A) rising; rising B) rising; falling C) falling; rising D) falling; falling Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

18 .

15) In the money market, a condition of excess demand for money can be eliminated by a ________ in aggregate output or a ________ in the interest rate, everything else held constant.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 16) In the money market, a condition of excess supply of money can be eliminated by a ________ in aggregate output or a ________ in the interest rate, everything else held constant.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 17) In the IS-MP framework, an expansionary fiscal policy resulting from government purchases, causes aggregate output to ________ and the interest rate to ________, everything else held constant.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

19 .

18) In the IS-MP framework a contractionary fiscal policy causes aggregate output to ________ and the interest rate to ________, everything else held constant.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 19) Everything else held constant, an expansionary ________ policy will cause the interest rate to rise, while an expansionary ________ policy will cause the interest rate to fall.

A) monetary; monetary B) monetary; fiscal C) fiscal; monetary D) fiscal; fiscal Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 20) Aggregate output and the interest rate are ________ related to government spending and are ________ related to taxes.

A) positively; positively B) positively; negatively C) negatively; positively D) negatively; negatively Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 21) An increase in spending that results from expansionary ________ policy causes the interest rate to ________, everything else held constant.

A) fiscal; rise B) fiscal; fall C) incomes; rise D) incomes; fall Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 20 .

22) If an economy experiences high interest rates and high unemployment, the ISLM framework predicts that ________ policy has been too ________.

A) fiscal; expansionary B) fiscal; contractionary C) monetary; expansionary D) monetary; contractionary Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 23) Which of the following statements concerning IS - MP analysis is true?

A) For a given change in taxes, the IS curve will shift less than for an equal change in government spending.

B) Changes in net exports arising from a change in interest rates causes a shift in the IS curve.

C) A fall in the money supply shifts the LM curve to the right.

D) Expansionary fiscal policy will cause the interest rate to fall.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 24) A decline in autonomous consumer expenditure causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: C Diff: 1 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

21 .

25) A decline in autonomous consumer expenditure causes the aggregate demand function to shift down, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: C Diff: 1 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 26) An increase in autonomous consumer expenditure causes the aggregate demand function to shift up, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: B Diff: 1 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 27) An increase in autonomous consumer expenditure causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; MP; right B) rise; IS; right C) fall; MP; left D) fall; IS; left Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

22 .

28) A decrease in autonomous consumer expenditure causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; MP; right B) rise; IS; right C) fall; IS; left D) fall; MP; left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 29) Everything else held constant, changes in the interest rate affect planned investment spending and hence the equilibrium level of output, but this change in investment spending ________.

A) merely causes a movement along the IS curve and not a shift B) is crowded out by higher taxes C) is crowded out by higher government spending D) is crowded out by lower consumer expenditures Answer: A Diff: 3 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 30) A rise in autonomous planned investment spending causes the equilibrium level of aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.

A) rise; MP; right B) rise; IS; right C) fall; IS; left D) fall; MP; left Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

23 .

31) A decline in autonomous planned investment spending causes the equilibrium level of aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.

A) rise; MP; right B) rise; IS; right C) fall; IS; left D) fall; MP; left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 32) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 33) An increase in investment spending because companies become more optimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

24 .

34) An increase in investment spending because companies become more optimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to rise, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 35) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.

A) up; left B) up; right C) down; left D) down; right Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 36) A decrease in investment spending because companies become more pessimistic about investment profitability causes the aggregate demand function to shift down, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

25 .

37) An increase in investment spending because companies become more optimistic about investment profitability causes the aggregate demand function to shift up, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; left B) rise; right C) fall; left D) fall; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 38) A decrease in autonomous planned investment spending, other things equal, shifts the ________ curve to the ________.

A) IS; right B) IS; left C) MP; left D) MP; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 39) An increase in government spending causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; MP; right B) rise; IS; right C) fall; IS; left D) fall; MP; left Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

26 .

40) A reduction in government spending causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; MP; right B) fall; IS; left C) fall; MP; left D) rise; IS; right Answer: B Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 41) A decline in taxes ________ consumer expenditure and shifts the ________ curve to the ________, everything else held constant.

A) raises; MP; right B) lowers; IS; left C) raises; IS; right D) lowers; MP; left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 42) If Canadian college students decide that drinking Mexican-brewed beer helps one get noticed, net exports will tend to fall, causing aggregate demand to ________ and the ________ curve to shift to the left, everything else held constant.

A) fall; MP B) fall; IS C) rise; MP D) rise; IS Answer: B Diff: 2 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

27 .

43) Other things equal, a decrease in autonomous consumption shifts the ________ curve to the ________.

A) IS; right B) IS; left C) MP; left D) MP; right Answer: B Diff: 1 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 44) A decline in autonomous consumer expenditure causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; rise B) up; fall C) down; rise D) down; fall Answer: D Diff: 1 Type: MC Skill: Applied Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 45) The aggregate demand curve is downward sloping because a higher inflation rate leads the central bank to raise ________ interest rates, thereby ________ the level of equilibrium aggregate output., everything else held constant.

A) real; lowering B) real; raising C) nominal; lowering D) nominal; raising Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

28 .

46) The aggregate demand curve is downward sloping because a higher inflation rate leads the central bank to ________ real interest rates, thereby ________ the level of equilibrium aggregate output, everything else held constant.

A) raise; lowering B) raise; raising C) reduce; lowering D) reduce; raising Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 47) Everything else held constant, an increase in government spending will cause ________.

A) aggregate demand to increase B) aggregate demand to decrease C) the quantity of aggregate demand to increase D) the quantity of aggregate demand to decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 48) Everything else held constant, an autonomous easing of monetary policy will cause ________.

A) the quantity of aggregate demand to increase B) the quantity of aggregate demand to decrease C) aggregate demand to decrease D) aggregate demand to increase Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 49) Everything else held constant, an autonomous tightening of monetary policy will cause ________.

A) the quantity of aggregate demand to increase B) the quantity of aggregate demand to decrease C) aggregate demand to increase D) aggregate demand to decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 29 .

50) Everything else held constant, an autonomous easing of monetary policy will cause ________.

A) aggregate demand to increase B) aggregate demand to decrease C) the quantity of aggregate demand to increase D) the quantity of aggregate demand to decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 51) Everything else held constant, an increase in autonomous consumer spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 52) Everything else held constant, a decrease in autonomous consumer spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

30 .

53) Everything else held constant, an increase in autonomous planned investment spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 54) Everything else held constant, a decrease in autonomous planned investment spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 55) Everything else held constant, a decrease in net taxes will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 56) Everything else held constant, an increase in net taxes will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 31 .

57) Everything else held constant, an appreciation of the domestic currency will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 58) Everything else held constant, a depreciation of the domestic currency will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 59) Everything else held constant, a decrease in government spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

32 .

60) Using the IS - MP model, explain the effects of a monetary expansion combined with a fiscal contraction. How do the equilibrium level of output and interest rate change?

Answer: The monetary expansion shifts the LM curve to the right which by itself would cause the interest rate to decrease and aggregate output to increase. The fiscal contraction shifts the IS curve to the left which by itself would cause the interest rate to decrease and aggregate output to decrease. Therefore, the equilibrium interest rate unambiguously falls, while the effect on output is indeterminate.

Diff: 2 Type: ES Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 61) List the six factors that cause both the IS and the aggregate demand curve to shift.

Answer: 1. Autonomous consumption expenditure 2. Autonomous investment spending 3. Government purchases 4. Taxes 5. Autonomous net exports 6. Financial frictions.

Diff: 2 Type: ES Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 62) How does autonomous tightening of monetary policy impact the aggregate demand curve.

Answer: A rise in the real interest rate at any given inflation, shifts the monetary policy curve upward. The higher interest rates leads to lower output due to a decline in investment and net exports which lowers aggregate output and therefore the aggregate demand curve to the left.

Diff: 2 Type: ES Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve 63) Describe the relationship between the IS and MP curves and the aggregate demand curve.

Answer: Any factor that shifts the IS curve shifts the aggregate demand curve in the same direction. When the MP curve shifts up, the aggregate demand curve shifts left; when the MP curve shifts down the aggregate demand curve shifts right.

Diff: 2 Type: ES Skill: Recall Objective: 22.3 Explain why the aggregate demand (AD) curve slopes downward, and explain shifts in the AD curve

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 23 Aggregate Demand and Supply Analysis 23.1 Business Cycles and Inflation 1) Aggregate output (real GDP) can be divided into two components: the long-run trend, which is referred to as ________ and fluctuations around this trend, which is referred to as ________.

A) potential output; the business cycle B) the business cycle; potential output C) the business cycle; output gap D) potential output; inflation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.1 Describe the variables that aggregate demand and supply analysis are trying to explain 2) In the second quarter of 2020, Canadian aggregate output was about 10% below potential output, indicating that the output gap was ________.

A) -10% B) 10% C) -10% × GDP D) 10% × GDP Answer: A Diff: 1 Type: MC Skill: Recall Objective: 23.1 Describe the variables that aggregate demand and supply analysis are trying to explain 3) In the second quarter of 2020, real GDP was $1.84 trillion, while potential GDP was $2.05 trillion. What is the calculation for the output gap for that quarter?

A) -10% B) 10% C) -$0.21 trillion D) $0.21 trillion Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.1 Describe the variables that aggregate demand and supply analysis are trying to explain

1 .

4) The 2007—2009 recession caused by the global financial crisis is known as the ________.

A) Great Recession B) Great Depression C) Great Moderation D) Covid-19 Recession Answer: A Diff: 1 Type: MC Skill: Recall Objective: 23.1 Describe the variables that aggregate demand and supply analysis are trying to explain 5) During business cycle booms, the output gap ________ and the unemployment rate ________.

A) rises; declines B) falls; declines C) rises; increases D) falls; increases Answer: A Diff: 1 Type: MC Skill: Recall Objective: 23.1 Describe the variables that aggregate demand and supply analysis are trying to explain 6) The formula for the output gap is A) (Real GDP — Potential GDP) / Potential GDP B) (Nominal GDP — Potential GDP) / Potential GDP C) (Nominal GDP — Real GDP) / Real GDP D) (Potential GDP — Real GDP) / Real GDP Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.1 Describe the variables that aggregate demand and supply analysis are trying to explain

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23.2 Aggregate Demand 1) The aggregate demand curve is the total quantity of an economy's ________.

A) intermediate goods demanded at different inflation rates B) intermediate goods demanded at a particular inflation rate C) final goods and services demanded at a particular inflation rate D) final goods and services demanded at different inflation rates Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 2) Demand shocks are based on the ________ based factors that can shift the aggregate demand curve.

A) seven B) six C) five D) eight Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 3) The downward slope of the aggregate demand curve is due to ________ and ________.

A) planned investment spending; net exports B) planned investment spending; financial frictions C) net exports; financial frictions D) financial frictions; net transfers Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 4) The total quantity of an economy's final goods and services demanded at different inflation rates is ________.

A) the aggregate supply curve B) the aggregate demand curve C) the Phillips curve D) the aggregate expenditure function Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 3 .

5) One way to derive aggregate demand is by looking at its four component parts, which are ________.

A) consumer expenditures, planned investment spending, government spending, and net exports B) consumer expenditures, actual investment spending, government spending, and net exports C) consumer expenditures, planned investment spending, government spending, and gross exports D) consumer expenditures, planned investment spending, government spending, and taxes Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 6) By analyzing aggregate demand through its component parts, we can conclude that, everything else held constant, a decline in the inflation rate causes ________.

A) an increase in real interest rates, an increase in investment spending, and a decline in aggregate output demand B) a decline in real interest rates, a decrease in investment spending, and an increase in aggregate output demand C) a decline in real interest rates, an increase in investment spending, and an increase in aggregate output demand D) an increase in real interest rates, a decline in investment spending, and a decline in aggregate output demand Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 7) By looking at aggregate demand via its component parts, we can conclude that the aggregate demand curve is downward sloping because ________.

A) a lower inflation rate causes the real interest rate to fall, and stimulates planned investment spending B) a lower inflation rate causes the real interest rate to rise, and stimulates planned investment spending C) a higher inflation rate causes the real interest rate to fall, and stimulates planned investment spending D) a higher inflation rate causes the real interest rate to rise, and stimulates planned investment spending Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it

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8) Everything else held constant, an autonomous monetary policy easing ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 9) Everything else held constant, an autonomous monetary policy tightening ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 10) Everything else held constant, when financial frictions increase, the real cost of borrowing ________ so that planned investment spending ________ at any given inflation rate.

A) increases; falls B) decreases; falls C) decreases; rises D) increases; rises Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 11) Everything else held constant, an increase in financial frictions ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 5 .

12) Everything else held constant, an increase in government spending ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 13) Everything else held constant, a decrease in government spending ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 14) Everything else held constant, a decrease in net taxes ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 15) Everything else held constant, an increase in net taxes ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 6 .

16) Everything else held constant, a balanced budget increase in government spending (that is, an increase in government spending that is matched by an identical increase in net taxes) will ________.

A) increase aggregate demand, but not by as much as if just government spending increases B) increase aggregate demand by more than if just government spending increases C) not affect aggregate demand D) decrease aggregate demand Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 17) Everything else held constant, an increase in net exports ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 18) Everything else held constant, a decrease in net exports ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 19) Everything else held constant, an increase in planned investment expenditure ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 7 .

20) Everything else held constant, a decrease in planned investment expenditure ________ aggregate ________.

A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 21) Everything else held constant, aggregate demand increases when ________.

A) taxes are cut B) government spending is reduced C) animal spirits decrease D) the money supply is reduced Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 22) Everything else held constant, aggregate demand increases when ________.

A) net exports decrease B) taxes increase C) planned investment spending increases D) the money supply decreases Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 23) Everything else held constant, which of the following does not cause aggregate demand to increase?

A) An increase in net exports B) An increase in government spending C) An increase in taxes D) An increase in consumer optimism Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it

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24) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the inflation rate. Be sure to discuss two channels through which changes in inflation rates affect demand.

Answer: A fall in the inflation rate lowers real interest rates. Lower rates increase investment, thereby increasing aggregate demand. Lower interest rates also cause depreciation of the domestic currency, increasing net exports and aggregate demand.

Diff: 2 Type: ES Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 25) What are the factors that can shift the aggregate demand curve to the right?

Answer: These factors are: a. An increase in the money supply b. An increase in government spending c. A decrease in taxes d. An increase in net exports e. An increase in consumer optimism f. An increase in business optimism Diff: 2 Type: ES Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 26) Why is the aggregate demand curve downward sloping?

Answer: The aggregate demand function AD is downward sloping as a decrease in the price level will make the real money supply M/P to increase, which in turn will reduce the nominal interest rate. The fall in the interest rate will make more investment plans profitable, thus increasing spending in planned investment, which will increase aggregate demand.

Diff: 2 Type: ES Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it 27) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the price level. Be sure to discuss two channels through which changes in prices affect demand.

Answer: A fall in the price level increases the real value of a fixed nominal money supply. This increase in the real money supply lowers interest rates. Lower rates increase investment, thereby increasing aggregate demand. Lower interest rates also cause depreciation of the domestic currency, increasing net exports and aggregate demand.

Diff: 2 Type: ES Skill: Recall Objective: 23.2 Summarize and illustrate the aggregate demand curve and the factors that shift it

9 .

23.3 Aggregate Supply 1) The aggregate supply curve shows the relationship between ________.

A) the level of inputs and aggregate output B) the price level and the level of inputs C) the wage rate and the level of employment D) the price level and the level of aggregate output supplied Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 2) The aggregate supply curve is ________.

A) the total quantity of raw materials offered for sale at different prices B) the total quantity of final goods and services offered for sale at the current price level C) the total quantity of final goods and services offered for sale at different price levels D) the total quantity of intermediate and final goods and service offered for sale at different price levels Answer: C Diff: 1 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 3) Economists believe the natural rate of unemployment is approximately ________ percent.

A) seven B) six C) five D) four Answer: A Diff: 1 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 4) Some unemployment is always present due to the ________ and ________ components, which are greater than zero.

A) frictional; structural B) frictional; cyclical C) structural; cyclical D) involuntary; frictional Answer: A Diff: 1 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves

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5) The total quantity of final goods and services offered for sale at different price levels is ________.

A) the aggregate supply curve B) the aggregate demand curve C) the 45° line D) A and C only Answer: A Diff: 1 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 6) The long-run rate of unemployment to which an economy always gravitates is the ________.

A) normal rate of unemployment B) natural rate of unemployment C) neutral rate of unemployment D) inflationary rate of unemployment Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 7) The long-run aggregate supply curve is ________.

A) a vertical line through the non-inflationary rate of output B) a vertical line through the current level of output C) a vertical line through the natural rate level of output D) a horizontal line through the current level of output Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 8) The long-run aggregate supply curve is a vertical line passing through ________.

A) the natural rate of output B) the natural-rate price level C) the actual rate of unemployment D) the expected rate of inflation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves

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9) The short-run aggregate supply curve is upward sloping because in the short run, costs of many factors that go into producing goods and services are ________, meaning that the price for a unit of output will ________ relative to input prices and the profit per unit will rise.

A) fixed; rise B) fixed; fall C) flexible; rise D) flexible; fall Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 10) The positively sloped short-run aggregate supply curve reflects the assumption that labour prices are ________.

A) more flexible than output prices B) less flexible than output prices C) fixed in the long run D) perfectly flexible in both the short run and the long run Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 11) Everything else held constant, an increase in the cost of production ________ aggregate ________.

A) increases; demand B) decreases; demand C) increases; supply D) decreases; supply Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 12) Everything else held constant, a decrease in the cost of production ________ aggregate ________.

A) increases; demand B) decreases; demand C) increases; supply D) decreases; supply Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves

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13) Everything else held constant, when output is ________ the natural rate level, wages will begin to ________, increasing short-run aggregate supply.

A) above; fall B) above; rise C) below; fall D) below; rise Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 14) Everything else held constant, when output is ________ the natural rate level, wages will begin to ________, decreasing short-run aggregate supply.

A) above; fall B) above; rise C) below; fall D) below; rise Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 15) Everything else held constant, when actual output exceeds the natural rate of output ________ aggregate supply ________.

A) short-run; decreases B) short-run; increases C) long-run; increases D) long-run; decreases Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 16) If workers demand and receive higher real wages, the cost of production ________ and the short-run aggregate supply curve shifts ________.

A) rises; leftward B) rises; rightward C) falls; leftward D) falls; rightward Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves

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17) Everything else held constant, if workers expect an increase in the price level, ________ aggregate supply ________.

A) long-run; increases B) long-run; decreases C) short-run; decreases D) short-run; increases Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 18) Everything else held constant, a change in workers' expectations about the inflation rate will cause ________ to change.

A) aggregate demand B) short-run aggregate supply C) the production function D) long-run aggregate supply Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 19) A decrease in the availability of raw materials that increases the price level is called a ________ shock.

A) unfavourable demand B) favourable demand C) unfavourable supply D) favourable supply Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 20) An unfavourable supply shock causes ________ to ________.

A) aggregate demand; increase B) aggregate demand; decrease C) short-run aggregate supply; decrease D) short-run aggregate supply; increase Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves

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21) A favourable supply shock causes ________ to ________.

A) aggregate demand; increase B) aggregate demand; decrease C) short-run aggregate supply; decrease D) short-run aggregate supply; increase Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 22) Which of the following increases aggregate supply in the short-run, everything else held constant?

A) An increase in the price of crude oil B) A successful wage increase led by workers C) Expectations of a higher inflation rate D) A technological improvement that increases worker productivity Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 23) What is the shape of the long-run aggregate supply curve? Why? Answer: The long-run aggregate supply curve is vertical. The amount of output that can be produced by the economy in the long-run is determined by the amount of capital, the amount of labour supplied at full employment and the available technology. Some unemployment cannot be eliminated as it is frictional or structural. Thus, full employment is not at zero unemployment but is rather at a level above zero, at which the demand for labor equals the supply of labour. This natural rate of unemployment is where the economy gravitates in the long-run. The level of output produced at the natural rate of unemployment is called the natural rate of output; it is where the economy settles in the long-run for any price level. Hence the long-run aggregate supply curve (LRAS) is vertical at the natural rate of output.

Diff: 3 Type: ES Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves

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24) Explain why the short-run aggregate supply curve has a positive slope.

Answer: Because wages and prices take time to adjust to economic conditions, we say that they are sticky. The goal of businesses is to maximize profits made on each unit of output. If profit rises, more output will be produced, and the quantity of output supplied will increase. In the short-run, costs of many factors that go into producing goods and services are fixed. Wages for example, are often fixed for periods of time due to labor contracts, and raw materials are often bought by firms using long-term contracts that fix the price. Since the costs of production are fixed in the short-run, when the price level rises, the price of a unit of output will rise while the costs associated with it remain the same, thus increasing profit per unit produced. Firms will increase production, and the quantity of aggregate output rises as the price level rises in the short-run, resulting in an upward-sloping aggregate supply curve Diff: 2 Type: ES Skill: Recall Objective: 23.3 Illustrate and interpret the short-run and long-run aggregate supply curves 23.4 Shifts in the Aggregate Supply Curves 1) The long-run aggregate supply curve shifts to the right when there is ________.

A) a decrease in the total amount of capital in the economy B) a decrease in the total amount of labor supplied in the economy C) a decrease in the available technology D) a decline in the natural rate of unemployment Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.4 Illustrate and interpret shifts in the short-run and long-run aggregate supply curves 2) The long-run aggregate supply curve shifts to the right when there is ________.

A) an increase in the total amount of capital in the economy B) an increase in the available technology C) a decrease in the natural rate of unemployment D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.4 Illustrate and interpret shifts in the short-run and long-run aggregate supply curves

16 .

3) The short-run aggregate supply curve shifts to the right when ________.

A) output gap is higher B) output gap is lower C) expected inflation is higher D) expected inflation is lower Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.4 Illustrate and interpret shifts in the short-run and long-run aggregate supply curves 4) Which of the followings does not shift the short-run aggregate supply curve?

A) Supply shocks B) Persistent positive output gap C) Changes in expected inflation D) An increase in output gap Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.4 Illustrate and interpret shifts in the short-run and long-run aggregate supply curves

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23.5 Equilibrium in Aggregate Supply and Demand Analysis 1) The fact that an economy always returns to the natural rate level of output is known as ________.

A) the excess demand hypothesis B) the price-adjustment mechanism C) the self-correcting mechanism D) the natural rate of unemployment Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 2) Assuming the economy is starting at the natural rate of output and everything else held constant, the effect of ________ in aggregate ________ is a rise in both the inflation rate and output in the short-run, but in the long-run the only effect is a rise in the inflation rate.

A) a decrease; supply B) a decrease; demand C) an increase; supply D) an increase; demand Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 3) The aggregate demand-aggregate supply framework indicates that the long-run effect of a ________ in the money supply is an increase in ________, everything else held constant.

A) fall; aggregate output B) fall; the inflation rate C) rise; aggregate output D) rise; the inflation rate Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism

18 .

4) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate in the short run and ________ in the inflation rate in the short run.

A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: B Diff: 2 Type: MC Skill: Applied Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 5) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate in the long run and ________ in the inflation rate in the short run.

A) an increase; an increase B) a decrease; a decrease C) no change; a decrease D) no change; no change Answer: C Diff: 2 Type: MC Skill: Applied Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 6) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate and ________ in the aggregate price level in the long run.

A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: D Diff: 2 Type: MC Skill: Applied Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism

19 .

7) In deriving the aggregate demand curve a ________ in the price level leads to ________ in the real money supply because the nominal quantity of dollars can purchase ________ goods and services.

A) decline; an increase; more B) decline; a decrease; more C) rise; an increase; fewer D) rise; a decrease; more Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 8) In deriving the aggregate demand curve a ________ price level ________ the money supply in real terms, raises interest rates, and ________ the equilibrium level of aggregate output.

A) higher; reduces; raises B) higher; reduces; lowers C) lower; increases; raises D) lower; increases; lowers Answer: B Diff: 2 Type: MC Skill: Applied Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 9) The aggregate demand curve is downward sloping because a decrease in the price level increases the ________ money supply which ________ interest rates and increases the equilibrium level of aggregate output, everything else held constant.

A) real; lowers B) real; raises C) nominal; lowers D) nominal; raises Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism

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10) The aggregate demand curve has the usual downward slope, since a ________ price level ________ the real money supply, raises interest rates, and lowers the equilibrium level of aggregate output, everything else held constant.

A) lower; reduces B) lower; increases C) higher; reduces D) higher; increases Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 11) The aggregate demand curve has the usual downward slope, since a higher price level reduces the real money supply, ________ interest rates, and ________ the equilibrium level of aggregate output, everything else held constant.

A) raises; lowers B) raises; raises C) lowers; lowers D) lowers; raises Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 12) Everything else held constant, an increase in government spending will cause ________.

A) aggregate demand to increase B) aggregate demand to decrease C) the quantity of aggregate demand to increase D) the quantity of aggregate demand to decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 13) Everything else held constant, expansionary monetary policies will cause ________.

A) the quantity of aggregate demand to increase B) the quantity of aggregate demand to decrease C) aggregate demand to decrease D) aggregate demand to increase Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 21 .

14) Everything else held constant, contractionary monetary policies will cause ________.

A) the quantity of aggregate demand to increase B) the quantity of aggregate demand to decrease C) aggregate demand to increase D) aggregate demand to decrease Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 15) Everything else held constant, a purchase of government securities by the Bank of Canada will cause ________.

A) aggregate demand to increase B) aggregate demand to decrease C) the quantity of aggregate demand to increase D) the quantity of aggregate demand to decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism 16) Using the aggregate demand-aggregate supply model, explain and demonstrate graphically the short-run and long-run effects of an increase in the money supply.

Answer: An increase in the money supply increases aggregate demand. In the short run both the price level and real output increase. In the long run, wages adjust, decreasing short-run aggregate supply, raising inflation further and reducing real output until the economy returns to the natural level of output. The long-run result is to only increase the inflation rate.

Diff: 3 Type: ES Skill: Recall Objective: 23.5 Illustrate and interpret the short-run and long-run equilibria and the role of the self-correcting mechanism

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23.6 Changes in Equilibrium: Aggregate Demand Shocks 1) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Bank of Canada will cause ________ in real GDP in the long run and ________ in the inflation rate in the long run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 2) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the short run and ________ in the inflation rate in the short run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 3) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the long run and ________ in the inflation rate in the long run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand

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4) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ________ in real GDP in the short run and ________ in the inflation rate in the short run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 5) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ________ in real GDP in the long run and ________ in the inflation rate in the long run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 6) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Bank of Canada will cause ________ in real GDP the short run and ________ in the inflation rate in the short run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand

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7) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Bank of Canada will cause ________ in real GDP in the long run and ________ in the inflation rate in the long run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 8) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Bank of Canada will cause ________ in real GDP in the short run and ________ in the inflation rate in the short run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 9) Suppose the Canadian economy is producing at the natural rate of output. A depreciation of the Canadian dollar will cause ________ in real GDP in the short run and ________ in the inflation rate in the short run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.)

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand

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10) Suppose the Canadian economy is producing at the natural rate of output. A depreciation of the Canadian dollar will cause ________ in real GDP in the short run and ________ in the inflation rate in the long run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.)

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 11) Suppose the Canadian economy is producing at the natural rate of output. An appreciation of the Canadian dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.)

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 12) Suppose the Canadian economy is producing at the natural rate of output. An appreciation of the Canadian dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the long run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.)

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand

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13) Suppose the economy is producing below the natural rate of output and the government is suffering from large budget deficits. To deal with the deficit problem, suppose the government takes a policy action to reduce the size of the deficits. This policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run, everything else held constant.

A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) an increase; a decrease Answer: D Diff: 2 Type: MC Skill: Applied Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 14) According to aggregate demand and supply analysis, a positive demand shock caused by a tightening of monetary policy during the 1981 to 1985 period had by 1983 when compared to 1981 ________.

A) increased aggregate output, lowered unemployment, and raised inflation B) decreased aggregate output, raised unemployment, and raised inflation C) increased aggregate output, lowered unemployment, and lowered inflation D) decreased aggregate output, raised unemployment, and lowered inflation Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand 15) According to aggregate demand and supply analysis, a positive demand shock caused by a tightening of monetary policy during the 1981 to 1985 period had by 1985 when compared to 1983 ________.

A) increased aggregate output, lowered unemployment, and raised inflation B) decreased aggregate output, raised unemployment, and raised inflation C) increased aggregate output, lowered unemployment, and lowered inflation D) decreased aggregate output, raised unemployment, and lowered inflation Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.6 Illustrate and interpret the short-run and long-run effects of a shock to aggregate demand

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23.7 Changes in Equilibrium: Aggregate Supply (Inflation) Shocks 1) Suppose the economy is producing at the natural rate of output and the government passes legislation that severely restricts a company's ability to reduce production costs via outsourcing.

Everything else held constant, this policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run.

A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 2) Suppose the Canadian economy is operating at potential output. A negative supply shock that is accommodated by an open market purchase by the Bank of Canada will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant.

A) no change; an increase B) no change; a decrease C) an increase; an increase D) a decrease; a decrease Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks

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3) In the figure above, a ________ supply shock will shift the aggregate supply curve to AS2 and the economy will return to the long run equilibrium at point ________.

A) negative; 1 B) negative; 3 C) positive; 1 D) positive; 3 Answer: A Diff: 3 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 4) In the figure above, the shift of the aggregate supply curve from AS1 to AS2 and the following shift back to AS1 is called ________.

A) a self-correcting mechanism B) a self-fulfilling prophecy C) a self-adjusting mechanism D) a long-run correcting mechanism Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 29 .

5) In the figure above, at point 2, the shift of the aggregate supply curve from AS1 to AS2 can be the result of ________ wages that ________ production cost.

A) increasing; increase B) increasing; reduce C) decreasing; decrease D) decreasing; increase Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 6) In the figure above, an equilibrium output greater than Yn is ________ attainable in the ________-run.

A) only; short B) only; long C) not; short D) always; long Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 7) In the figure above, output levels below Yn will cause the aggregate ________ function to shift to the ________.

A) supply; right B) supply; left C) demand; left D) A and C only Answer: A Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks

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8) A theory of aggregate economic fluctuations called real business cycle theory holds that ________.

A) changes in the real money supply are the only demand shocks that affect the natural rate of output B) aggregate demand shocks do affect the natural rate of output C) aggregate supply shocks do affect the natural rate of output D) changes in net exports are the only demand shocks that affect the natural rate of output Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 9) Because shifts in aggregate demand are not viewed as being particularly important to aggregate output fluctuations, they do not see much need for activist policy to eliminate high unemployment. "They" refers to proponents of ________.

A) the natural rate hypothesis B) monetarism C) the Phillips curve model D) real business cycle theory Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 10) This theory views shocks to tastes (workers' willingness to work, for example) and technology (productivity) as the major driving forces behind short-run fluctuations in the business cycle because these shocks lead to substantial short-run fluctuations in the natural rate of output.

A) The natural rate hypothesis B) Hysteresis C) Real business cycle theory D) The Phillips curve model Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks

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11) According to aggregate demand and supply analysis, the negative supply shocks of 19731975 and 1978-1980 had the effect of ________.

A) increasing aggregate output, lowering unemployment, and raising the price level B) decreasing aggregate output, raising unemployment, and raising the price level C) increasing aggregate output, raising unemployment, and raising the price level D) decreasing aggregate output, raising unemployment, and lowering the price level Answer: B Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks 12) According to aggregate demand and supply analysis, a favourable supply shock caused by a fall in import prices has the effect of ________.

A) increasing aggregate output, lowering unemployment, and raising inflation B) decreasing aggregate output, raising unemployment, and raising inflation C) increasing aggregate output, lowering unemployment, and lowering inflation D) decreasing aggregate output, raising unemployment, and lowering inflation Answer: C Diff: 2 Type: MC Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks

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13) Explain and demonstrate graphically the effects of a negative supply shock. What happens to the economy if no action is taken? What happens if monetary and or fiscal policy is used to reduce unemployment?

Answer: The supply shock shifts the aggregate supply curve back to AS', reducing real output and raising the price level. If no action is taken, the supply curve eventually adjusts back to the original position. The economy adjusts from 1 to 4 back to 1. If policy actions are implemented, aggregate demand increases to AD', and the economy returns to full employment at a higher price level. The path is from 1 to 4 to 3.

Diff: 2 Type: ES Skill: Applied Objective: 23.7 Illustrate and interpret the short-run and long-run effects of temporary and permanent supply shocks

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23.8 Conclusions from Aggregate Demand and Supply Analysis 1) According to aggregate demand and supply analysis, the rising oil prices coupled with the subprime financial crisis in 2007–2009 in the U.S. caused the unemployment rate to ________ and the level of real aggregate output to ________.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: B Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis 2) The run-up of oil prices in 2007 led to ________.

A) a negative supply shock B) a negative demand shock C) a positive supply shock D) a positive negative shock Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis 3) Which of the following does not cause a shift in the aggregate demand curve, all thing equal?

A) Changes in the real interest rate B) Taxes C) Autonomous net exports D) The self-correcting mechanism Answer: D Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis 4) The increase in oil prices in the U.S. that occurred in 2007–2008 led to a ________ in the ________ aggregate supply curve.

A) fall; short run B) fall; long run C) rise; short run D) rise; long run Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis

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5) The Lehman Brothers bankruptcy caused a ________ ________ shock.

A) negative; demand B) negative; supply C) positive; demand D) positive; supply Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis 6) As a result of the coronavirus in Canada, the unemployment rate went from 5.7% in the fourth quarter of 2019 to ________ in the second quarter of 2020, while at the same time the inflation rate went from 2.1% to ________.

A) 13%; 0% B) 8%; 0% C) 8%; 5% D) 13%; 5% Answer: A Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis 7) The Covid-19—driven recession of year 2020 A) was triggered by a massive aggregate demand shock that induced a massive aggregate supply shock.

B) was only the result of a massive aggregate demand shock.

C) was triggered by a massive aggregate supply shock that induced a massive aggregate demand shock.

D) was only the result of a massive aggregate supply shock.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis 8) As a result of Covid-19 in Canada, the aggregate demand curve shifted to the ________ and the short-run aggregate supply curve shifted to the ________ which, combined with the drop in the price of oil, resulted in ________ A) left; left; an increase in inflation.

B) right; left; an increase in inflation.

C) left; left; a decrease in inflation.

D) left; right; a decrease in inflation.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 23.8 Summarize the conclusions from aggregate demand and supply analysis

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 24 Monetary Policy Theory 24.1 Response of Monetary Policy to Shocks 1) Policymakers cannot achieve both price stability and economic activity stability when facing ________.

A) supply shocks B) monetary policy shocks C) demand shocks D) all of the above Answer: A Diff: 1 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks 2) The coronavirus pandemic began in March 2020 that caused both consumer and business spending to fall ________.

A) shifted the aggregate demand curve to the right B) shifted the aggregate demand curve to the left C) shifted the aggregate supply curve to the right D) shifted the aggregate supply curve to the left Answer: B Diff: 1 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks 3) When the economy is hit by a negative demand shock and the central bank does not respond by changing the autonomous component of monetary policy, then, once the adjustment process is over ________.

A) inflation will be lower B) aggregate output will be at its potential C) aggregate output index will be lower D) inflation will not change E) both A and B Answer: E Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks

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4) When the economy is hit by a negative demand shock and the central bank pursues policies to increase aggregate demand to its initial level, then, once the adjustment process is over ________.

A) inflation will be lower B) aggregate output index will be unchanged C) output will be lower D) inflation will be unchanged E) both B and D Answer: E Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks 5) When the economy is hit by a negative supply shock and the central bank does not respond by changing the autonomous component of monetary policy, then in the long run ________.

A) inflation will be lower B) aggregate output index will be unchanged C) output will be lower D) inflation will be unchanged E) both B and D Answer: E Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks 6) When the economy suffers a negative supply shock and the central bank responds by changing the autonomous component of monetary policy to keep inflation at the target inflation rate, then ________.

A) aggregate output index drops further after the tightening monetary policy B) short-run aggregate supply will shift back down because output is below potential C) aggregate output is stabilized D) all of the above E) both A and B Answer: E Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks

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7) When the economy suffers a negative supply shock, the central bank's autonomous monetary policy to keep inflation at the target inflation rate leads to ________.

A) more stable economic activities B) a large deviation of output from its potential C) divine coincidence D) both B and C Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks 8) When the economy suffers a negative supply shock and the monetary policymakers try to stabilize economic activity in the short run, then ________.

A) aggregate demand curve shifts rightward B) output will be at its potential C) inflation rate will be higher D) all of the above E) both A and B Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks 9) Which of the following statements is CORRECT? A) If most shocks to the economy are aggregate demand shocks, then policy that stabilizes inflation will also stabilize economic activity, even in the short run.

B) If supply shocks are more common, then a central bank must choose between stabilizing inflation and stabilizing output in the short run.

C) Stabilizing economic activity in response to a supply shock results in a larger deviation of inflation from the inflation target rather than a stabilization of inflation.

D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under the conditions of aggregate demand shocks and supply shocks

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24.2 How Actively Should Policymakers Try to Stabilize Economic Activity?

1) Nonactivist policymakers believe that ________.

A) wages and prices are very flexible B) the self-correcting mechanism is very rapid C) government action is unnecessary D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 2) Activist policymakers believe that ________.

A) the self-correcting mechanism through wage and price adjustment is very slow B) wages and prices are sticky C) the government needs to pursue active policy to eliminate high unemployment when it develops D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 3) If aggregate output is below the natural rate level, activist policymakers would recommend that the government ________.

A) do nothing B) try to eliminate high unemployment by attempting to shift the aggregate supply curve to the right C) try to eliminate high unemployment by attempting to shift the aggregate demand curve to the right D) try to eliminate high unemployment by attempting to shift the aggregate demand curve to the left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach

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4) If aggregate output is below the natural rate level, nonactivist policymakers would recommend that the government ________.

A) do nothing B) try to eliminate high unemployment by attempting to shift the aggregate supply curve to the right C) try to eliminate high unemployment by attempting to shift the aggregate demand curve to the right D) try to eliminate high unemployment by attempting to shift the aggregate demand curve to the left Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 5) Nonactivists policymakers contend that a policy of shifting the aggregate ________ curve will be costly because it generates ________ volatility in both the price level and output.

A) supply; less B) supply; more C) demand; less D) demand; more Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 6) The existence of lags prevents the instantaneous adjustment of the economy to policies aimed at changing aggregate demand, thereby strengthening the case for ________.

A) supply-side policies B) a nonactivist policy C) activist policies D) demand-management policies Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach

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7) The data lag is ________.

A) the time it takes for policymakers to obtain data indicating what is happening in the economy B) the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy C) the time it takes to pass legislation to implement a particular economic policy D) the time it takes for policymakers to change policy instruments once they have decided on the new policy E) the time it takes for the policy to actually have an impact on the economy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 8) The recognition lag is ________.

A) the time it takes for policymakers to obtain data indicating what is happening in the economy B) the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy C) the time it takes to pass legislation to implement a particular policy D) the time it takes for policymakers to change policy instruments once they have decided on the new policy E) the time it takes for the policy to actually have an impact on the economy Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 9) The legislative lag represents ________.

A) the time it takes for policymakers to obtain data indicating what is happening in the economy B) the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy C) the time it takes to pass legislation to implement a particular policy D) the time it takes for policymakers to change policy instruments once they have decided on the new policy E) the time it takes for the policy to actually have an impact on the economy Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach

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10) The implementation lag is ________.

A) the time it takes for policymakers to obtain data indicating what is happening in the economy B) the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy C) the time it takes to pass legislation to implement a particular policy D) the time it takes for policymakers to change policy instruments once they have decided on the new policy E) the time it takes for the policy to actually have an impact on the economy Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 11) The effectiveness lag is ________.

A) the time it takes for policymakers to obtain data indicating what is happening in the economy B) the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy C) the time it takes to pass legislation to implement a particular policy D) the time it takes for policymakers to change policy instruments once they have decided on the new policy E) the time it takes for the policy actually to have an impact on the economy Answer: E Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 12) The time it takes for policymakers to obtain data indicating what is happening in the economy is known as ________.

A) the data lag B) the recognition lag C) the legislative lag D) the implementation lag E) the effectiveness lag Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach

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13) The time it takes for policymakers to be sure of what the data are signaling about the future course of the economy is known as ________.

A) the data lag B) the recognition lag C) the legislative lag D) the implementation lag E) the effectiveness lag Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 14) The time it takes to pass legislation to implement a particular policy is known as ________.

A) the data lag B) the recognition lag C) the legislative lag D) the implementation lag E) the effectiveness lag Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 15) The time it takes for policymakers to change policy instruments once they have decided on the new policy is known as ________.

A) the data lag B) the recognition lag C) the legislative lag D) the implementation lag E) the effectiveness lag Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach

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16) The time it takes for a policy to actually have an impact on the economy is known as ________.

A) the data lag B) the recognition lag C) the legislative lag D) the implementation lag E) the effectiveness lag Answer: E Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach 17) The nonactivists who opposed the recent fiscal stimulus package argue that ________.

A) a fiscal stimulus would take too long to take effect because of long implementation lags B) a fiscal stimulus might kick in after the economy had already recovered C) a fiscal stimulus could lead to more volatile inflation and economic activity D) all of the above E) none of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case for an activist policy approach

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24.3 Inflation: Always and Everywhere a Monetary Phenomenon 1) The economist who is famous for having said that, "Inflation is always and everywhere a monetary phenomenon" was ________.

A) John Maynard Keynes B) John R Hicks C) Milton Friedman D) Franco Modigliani Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run 2) Complete Milton Friedman's famous quote: "Inflation is always and everywhere a ________ phenomenon."

A) monetary B) political C) policy D) budgetary Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run 3) At first cut, the simple solution to fighting inflation is ________.

A) reducing the growth rate of the money supply B) limiting the number of terms that politicians can serve in elective office C) returning the economy to barter by prohibiting the use of fiat money D) to impose price controls on businesses that attempt to raise prices Answer: A Diff: 2 Type: MC Skill: Applied Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run

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4) "How do we prevent the inflationary fire from igniting again and stop the roller coaster ride in the inflation rate of the last 40 years?" Milton Friedman's famous proposition suggests the simple solution: ________.

A) reduce the number of terms that politicians are allowed to serve B) reduce the growth rate of the money supply C) reduce the marginal tax rate on low-income wage earners D) increase the marginal tax rates on businesses that hike prices in excess of 5 percent per year Answer: B Diff: 2 Type: MC Skill: Applied Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run 5) Milton Friedman's proposition concerning the cause of inflation implies a simple solution to the inflation problem: ________.

A) reduce government budget deficits B) limit the ability of fiscal policymakers to bring pressure to bear on the monetary authority C) limit the number of terms that politicians are allowed to serve D) reduce the growth rate of the money supply Answer: D Diff: 2 Type: MC Skill: Applied Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run 6) Milton Friedman's proposition that inflation is always and everywhere a monetary phenomenon holds only if ________.

A) government budget deficits do not rise continually B) the unemployment rate does not rise continually C) the inflation rate rises continually D) Canada does not experience more than one negative supply shock per decade Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run

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7) The monetary authorities can target any inflation rate in the ________ with ________ monetary policy adjustments.

A) short-run; automatic B) short-run autonomous C) long-run; autonomous D) long-run; automatic Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run 8) Potential output is ________.

A) independent of monetary policy B) positively related to monetary policy C) negatively related to monetary policy D) positively related to monetary policy only in recessions Answer: A Diff: 1 Type: MC Skill: Recall Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the longrun but cannot target a level of output in the long-run 24.4 Causes of Inflationary Monetary Policy 1) To say that inflation is a monetary phenomenon seems to beg the question: ________.

A) Why does inflationary monetary policy occur?

B) Why do politicians seek re-election?

C) Why is the Fed independent?

D) Why does the US Treasury print so much money?

Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 2) The combination of a successful wage push by workers and the government's commitment to high employment leads to ________.

A) demand-pull inflation B) supply-side inflation C) supply-shock inflation D) cost-push inflation Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 12 .

3) If workers do not believe that policymakers are serious about fighting inflation, they are most likely to push for higher wages, which will ________ aggregate ________ and lead to unemployment or inflation or both, everything else held constant.

A) decrease; demand B) increase; demand C) decrease; supply D) increase; supply Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 4) If workers believe that government policymakers will increase aggregate demand to avoid a politically unpopular increase in unemployment when workers demand higher wages, then workers will not fear higher unemployment and their wage demands will result in ________.

A) demand-pull inflation B) hyperinflation C) deflation D) cost-push inflation Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 5) If policymakers set a target for the unemployment rate that is too low because it is less than the natural rate of unemployment, this can set the stage for a higher rate of money growth and ________.

A) cost-push inflation B) demand-pull inflation C) cost-pull inflation D) demand-push inflation Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation

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6) Theoretically, one can distinguish a demand-pull inflation from a cost-push inflation by comparing ________.

A) how fast prices rise relative to wages B) the unemployment rate with its natural rate level C) when prices rise relative to wages D) government debt to real GDP Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 7) Demand-pull inflation can result when ________.

A) policymakers set an unemployment target that is too high B) a persistent budget deficit is financed by selling bonds to the public C) a persistent budget deficit is financed by selling bonds to the central bank D) workers get numerous wage increases Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 8) Which of the following is least likely to lead to inflationary monetary policy?

A) Rising unemployment B) Expanding federal budget deficits C) Declining oil prices D) Conflict in the Middle East Answer: C Diff: 2 Type: MC Skill: Applied Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 9) Which of the following is most likely to lead to inflationary monetary policy?

A) Declining oil prices B) Resolution of conflict in the Middle East C) The enactment of a free-trade agreement with Mexico D) Rising unemployment Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation

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10) Which of the following is most likely to lead to inflationary monetary policy?

A) Declining oil prices B) Resolution of conflict in the Middle East C) The enactment of a free-trade agreement with Mexico D) Rising government budget deficits Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation 11) Because policies in Canada were too expansionary from 1965 through 1973, Canada suffered ________.

A) demand-pull inflation B) cost-push inflation, as workers sought higher wages in order to keep up with inflation C) both demand-pull and cost-push inflation D) neither demand-pull nor cost-push inflation Answer: A Diff: 2 Type: MC Skill: Applied Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation

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12) Explain and show graphically why continuous monetary growth is needed to generate inflation. Describe how the inflation process is generated.

Answer: Only continuous monetary growth can cause continuous increases in aggregate demand of the sort needed to generate inflation. Other factors can increase demand and the price level, but none can increase demand continuously. In the graph, the monetary expansion shifts AD to the right. The increase in output above the natural rate increases wages, shift AS to the left. Monetary expansion shifts AD repeatedly, and wages continue to adjust.

Diff: 2 Type: ES Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation

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13) Why a cost-push inflation is a monetary phenomenon? Use the appropriate graph to support your answer.

Answer: Students must use a graph similar to the one below. Initially the economy is on point 1 with an aggregate output equal to the normal rate output. Supposing that workers succeed in seeking higher wages as they want to increase their real wages. The effect of such an increase will be like a negative supply shock and will shift the short-term aggregate supply curve to the left so that the economy slides to point 1'. If we have an activist government with a high employment target point 1' is associated with increased unemployment and lower output, so the government will implement policies to raise the aggregate demand and shift the aggregate demand curve to AD2 so that we will return to the natural rate level of output at point 2 with a higher price level. Workers may be encouraged to seek even higher wages due to the increased price level and if they succeed and the government continues to accommodate this the economy will move from point 2 to 2', 3, 3', and 4 on the graph. But the continuous shift of the demand curve to the right cannot be sustained by fiscal policy as government spending and tax cuts have limits. This policy can only be sustained to create inflation only with an increasing money supply. Thus, a cost-push inflation is a monetary phenomenon because it cannot occur without the monetary authorities pursuing an accommodating policy of a higher rate of money growth.

Diff: 3 Type: ES Skill: Recall Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating inflation

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24.5 Monetary Policy at the Effective Lower Bound 1) The MP curve is drawn on a graph with the ________ on the horizontal axis and the ________ on the vertical axis.

A) inflation rate; aggregate output B) nominal interest rate; inflation rate C) real interest rate; aggregate output D) inflation rate; real interest rate Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 2) When nominal interest rates are above zero, the MP curve has a ________ slope because when the inflation rate increases the monetary authorities will ________ the real interest rate.

A) negative; raise B) negative; lower C) positive; raise D) positive; lower Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 3) When nominal interest rates are zero, the MP curve has a ________ slope because monetary authorities ________ lower the nominal interest rate and the real interest rate ________ as inflation rates decline.

A) positive; cannot; falls B) negative; cannot; rises C) positive; can; falls D) negative; can; rises Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions

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4) If inflation was 1% and the monetary authorities set the nominal interest set at the zero lower bound, the real interest rate would be ________.

A) -1% B) 0% C) 1% D) 2% Answer: A Diff: 2 Type: MC Skill: Applied Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 5) The AD curve is drawn on a graph with the ________ on the horizontal axis and the ________ on the vertical axis.

A) aggregate output; inflation rate B) aggregate output; real interest rate C) inflation rate; aggregate output D) inflation rate; real interest rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 6) When nominal interest rates are above zero, the AD curve has a ________ slope because when the inflation rate increases the monetary authorities will ________ the real interest rate as inflation rises which will ________ investment and aggregate output.

A) negative; raise; decrease B) negative; lower; increase C) positive; raise; increase D) positive; lower; increase Answer: B Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions

19 .

7) When nominal interest rates are zero, the AD curve has a ________ slope because when aggregate output decreases the monetary authorities ________ lower the nominal interest rate.

As inflation rises the real interest rate _______which will ________ investment and aggregate output.

A) negative; can; increases; decrease B) negative; cannot; decrease; increase C) positive; cannot; increases; decrease D) positive; can; decreases; decrease Answer: C Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 8) A sudden shortage of liquidity during a financial crisis will shift the ________ curve to the ________.

A) AS; right B) AS; left C) AD; right D) AD; left Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 9) Financial frictions affect the ________ curve by ________ the real interest rate for investment causing investment and aggregate output to ________.

A) AD; increasing; decrease B) AD; decreasing; increase C) AS; increasing; decrease D) AS; decreasing; increase Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions

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10) To promote an economic expansion and an exit from the deflationary environment that the Japanese had been experiencing for the past fifteen years, the "Abenomics" aims at ________.

A) increasing inflation target B) increasing inflation expectations C) purchasing long-term bonds D) All of the above.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 11) The real interest rate for investments reflects not only the short-term real interest rate set by the central bank, but also the financial frictions. When the policy rate has hit the floor of the effective lower bound, to stimulate the economy at given inflation rates, policymakers can ________.

A) lower the financial frictions B) lower the short-term real interest rate C) raise the policy rate D) lower the policy rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 12) Liquidity provision and asset purchase may not be enough to stimulate the economy unless these policy actions are able to ________.

A) lower the real interest rate for investments B) lower the short-term real interest rate C) raise the policy rate above zero D) lower the policy rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions

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13) The Bank of Canada's quantitative easing is to purchase ________ to affect credit spreads.

A) long-term securities B) short-term securities C) both long-term and short-term securities D) private assets Answer: A Diff: 1 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 14) With the policy rate set at the effective lower bound, the rise in expected inflation will lead to a ________ in the real interest rate, which will cause investment spending and aggregate output to ________.

A) fall; rise B) fall; fall C) rise; rise D) rise; fall Answer: A Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 15) Which of the following is not one of the reasons why quantitative easing in and of itself will not necessarily be stimulative?

A) Most of the resulting increase in the monetary base just flows into holdings of excess reserves.

B) Banks just add to their holdings of excess reserves instead of making loans.

C) The asset purchase program involves only the purchase of short-term government securities.

D) The asset purchase program involves only the purchase of long-term government securities.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions

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16) Explain why the self-correcting mechanism is on longer operational when nominal interest rates are at the effective lower bound.

Answer: The self-correcting mechanism normally works by having wages and prices fall when the aggregate output level falls below its potential level. As this causes inflation to fall and possibly turn negative, real interest rates rise causing investment to fall and aggregate output to continue to fall below potential.

Diff: 2 Type: ES Skill: Applied Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 17) What three forms does non-conventional monetary policy take?

Answer: Liquidity provision, asset purchases (or quantitative easing) and management of expectations.

Diff: 2 Type: ES Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 18) What are the objectives of quantitative easing?

Answer: QE is intended to reduce financial frictions by injecting liquidity into financial markets which will lower credit spreads and the spread between long- and short-term interest rates.

Diff: 2 Type: ES Skill: Recall Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions 19) How does a commitment by monetary authorities to maintain low, short-term policy rates affect long-term interest rates?

Answer: Since long-term rates reflect both current short-term and expected future short-term interest rates, maintaining low policy rates will affect long-term rates. This follows directly from the expectations theory of interest rates.

Diff: 2 Type: ES Skill: Applied Objective: 24.5 Explain the unique challenges that monetary policymakers face at the effective lower bound, and illustrate how nonconventional monetary policy can be effective under such conditions

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 25 The Role of Expectations in Monetary Policy 25.1 Lucas Critique of Policy Evaluation 1) Today, most economists ________.

A) accept that expectations formation will change when the behavior of forecasted variables changes B) believe that the Lucas critique has been discredited C) accept the notion that there is no role for discretionary stabilization policy D) believe that having policy credibility is not an important factor to a successful anti-inflation policy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 2) Whether one views the discretionary policies of the 1960s and 1970s as destabilizing or believes the economy would have been less stable without these policies, most economists agree that ________.

A) stabilization policies proved more difficult in practice than many economists had expected B) stabilization policies proved not to be inflationary C) the nondiscretionary policymakers were right in believing that the private economy is inherently stable D) the discretionary policymakers were right in believing that the private economy is inherently stable Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 3) The argument that econometric policy evaluation is likely to be misleading if policymakers assume stable economic relationships is known as ________.

A) the monetarist revolution B) the Lucas critique C) public choice theory D) new Keynesian theory Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique

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4) Lucas argues that when policies change, expectations will change thereby ________.

A) changing the relationships in econometric models B) causing the government to abandon its discretionary stance C) forcing the Fed to keep its deliberations secret D) making it easier to predict the effects of policy changes Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 5) The rational expectations hypothesis implies that when macroeconomic policy changes, ________.

A) the economy will become highly unstable B) the way expectations are formed will change C) people will be slow to catch on to the change D) people will make systematic mistakes Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 6) The Lucas critique indicates that ________.

A) advocates of discretionary policies' criticisms of rational expectations models are wellfounded B) advocates of discretionary policies' criticisms of rational expectations models are not wellfounded C) expectations are important in determining the outcome of a discretionary policy D) expectations are not important in determining the outcome of a discretionary policy Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 7) The Lucas critique is an attack on the usefulness of ________.

A) conventional econometric models as forecasting tools B) conventional econometric models as indicators of the potential impacts on the economy of various policies C) rational expectations models of macroeconomic activity D) the relationship between the quantity theory of money and aggregate demand Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique

2 .

8) The interest rate thought to have the most important impact on aggregate demand is the ________.

A) short-term interest rate B) Treasury bill rate C) interest rate on 90-day CDs D) long-term interest rate Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 9) A rise in short-term interest rates that is believed to be only temporary ________.

A) is likely to have a significant effect on long-term interest rates B) will have a bigger impact on long-term interest rates than if the rise in short-term rates had been permanent C) is likely to have only a small impact on long-term interest rates D) cannot possibly affect long-term interest rates Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique 10) According to the Lucas critique, if past increases in the short-term interest rate have always been temporary, then ________.

A) the term-structure relationship using past data will then show only a weak effect of changes in the short-term interest rate on the long-term rate B) the term-structure relationship using past data will show no effect of changes in the short-term interest rate on the long-term rate C) one cannot predict the term-structure relationship as it depends on expectations D) the term-structure relationship using past data will nevertheless show a strong effect of changes in the short-term interest rate on the long-term rate because of a change in the way expectations are formed Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.1 Summarize the Lucas critique

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25.2 Policy Conduct: Rules or Discretion 1) A policy in which the money supply is kept growing at a constant rate regardless of the state of the economy is ________.

A) a Taylor rule B) a discretionary policy C) a policy rule advocated by monetarists D) advocated by activists Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 2) The Lucas critique highlighted the need for ________.

A) better econometric models B) new policy models that included rational expectations C) fiscal policy D) adaptive expectations Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 3) Operating with discretion in a monetary policy sense implies ________.

A) making no commitment to future actions B) a constant growth rate rule C) introducing a zero-inflation rule D) making decisions without regulatory oversight Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 4) The time inconsistency problem with respect to policy conduct means ________.

A) the tendency to deviate from long-run plans when making short run decisions B) implementing a constant growth rate rule C) that politicians are not elected for long enough time frames D) there is no room for hard and fast monetary rules Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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5) The time inconsistency problem means that policy makers are always tempted to pursue ________ policy in the short run.

A) expansionary B) contractionary C) inconsistent D) non-discretionary Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 6) The best way to keep inflation under control is to ________.

A) abandon discretionary policy B) abandon expansionary policy C) invoke activist solutions D) A and B only Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 7) The opposite of a discretionary approach is a ________ approach.

A) rules based B) activist C) non-activist D) Keynesian Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 8) Milton Friedman and his followers are known as ________.

A) monetarists B) activists C) Keynesians D) neo-Keynesians Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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9) A rule that is advocated by monetarists is the ________ rule.

A) constant money growth rate B) escalating money growth rate C) fiscal expansionism D) interest rate sterilization Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 10) An example of a rule used in non-discretionary monetary policy is ________.

A) the Taylor rule B) the Taylor principle C) the Keynesian rule D) the interest rate consistency rule Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 11) One example where a rules-based approach would have improved the economy is ________.

A) during the Great Depression B) during the financial crisis in 2007 C) the subprime mortgage markets D) the derivatives market Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 12) The political business cycle can lead to ________.

A) expansionary monetary policy B) expansionary fiscal policy C) corruption D) A and B only Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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13) The Lucas critique indicates that ________.

A) Keynesian criticisms of rational expectations models are well-founded B) Keynesian criticisms of rational expectations models are not well-founded C) expectations are important in determining the outcome of an activist policy D) expectations are not important in determining the outcome of an activist policy Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 14) One of the drawbacks of rules based monetary policy is ________.

A) it can be too rigid a system and unable to address unforeseen contingencies B) it minimizes the role of central banks and bankers C) these types of programs are difficult to implement in practice D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 15) One of the drawbacks of rules based monetary policy is ________.

A) they do not incorporate the judgment of monetary policy makers B) they are too complicated for the public to understand C) these types of programs are difficult to implement in practice D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 16) One of the drawbacks of rules based monetary policy is ________.

A) the true model of the economy is unknown, so a single rule may not be appropriate B) they are too complicated for the public to understand C) these types of programs are difficult to implement in practice D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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17) One of the drawbacks of rules based monetary policy is ________.

A) the current relationship between variables may not hold in the future B) they are too complicated for the public to understand C) these types of programs are difficult to implement in practice D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 18) One of the drawbacks of rules based monetary policy is ________.

A) it is subject to the Lucas critique B) they are too complicated for the general public to understand C) these types of programs are difficult to implement in practice D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 19) Monetarists argue that the Bank of Canada should pursue ________.

A) an interest-rate targeting strategy B) an exchange-rate targeting strategy C) a discretionary monetary policy D) a constant growth rate rule Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 20) If aggregate output is below the natural rate level, advocates of nondiscretionary policy would recommend that the government ________.

A) do nothing B) try to eliminate the higher unemployment by attempting to shift the aggregate supply curve to the right C) try to eliminate the higher unemployment by attempting to shift the aggregate demand curve to the right D) try to eliminate the higher unemployment by attempting to shift the aggregate demand curve to the left Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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21) Advocates of nondiscretionary policy contend that a discretionary policy of shifting the aggregate ________ curve will be costly because it produces ________ volatility in both the price level and output.

A) supply; less B) supply; more C) demand; less D) demand; more Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 22) Some economists contend that a policy of shifting the aggregate demand curve will be costly because it produces more price level and output volatility. These economists likely are advocates of ________ policy.

A) supply-side B) discretionary C) demand-management D) nondiscretionary Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 23) The existence of lags prevents the instantaneous adjustment of the economy to policies that change aggregate demand, thereby strengthening the case for ________ policy.

A) supply-side B) nondiscretionary C) discretionary D) demand-management Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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24) Which of the following views are consistent with the case for nondiscretionary macroeconomic policy?

A) Even with time lags, discretionary policy moves the economy to full employment before the economy's self-correcting mechanism would.

B) The wage and price adjustment process being extremely slow, a nondiscretionary policy results in a large loss of output.

C) Workers will come to expect expansionary policies whenever the economy moves below full employment.

D) A discretionary, accommodating policy of shifting the aggregate demand curve will produce less volatility in both the price level and output due to the short time it takes to shift aggregate demand.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 25) If expectations about policy affect how wages are set, then the case for a(n) ________ policy is much stronger.

A) discretionary B) nondiscretionary C) interventionist D) stabilization Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 26) Evidence indicating that the wage and price adjustment process is extremely slow would strengthen the case for ________.

A) a nondiscretionary policy B) a constant-money-growth-rate rule C) a discretionary policy D) none of the above Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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27) Advocates of nondiscretionary policy emphasize the importance of a constant money growth rate rule more than the balanced-budget amendment or restrictions on union power because ________.

A) they regard excessive money growth as the cause of inflation B) they believe that excessive government spending, not excessive monetary growth, is the cause of inflation C) they believe that while unions cause inflation, they are too politically powerful to deal with D) they regard high tax rates as the cause of inflation Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 28) Advocates of nondiscretionary policy contend that a policy of shifting the aggregate demand curve will be costly because it produces more price level and output volatility. Thus, they favor ________.

A) a policy of variable money supply growth B) a supply-side policy C) a demand-management policy D) a constant-money-growth-rate rule Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 29) A credible, no accommodating policy rule has the ________ that workers are ________ likely to ask for higher wages and thus helps to reduce the output loss from controlling inflation.

A) advantage; less B) advantage; more C) disadvantage; less D) disadvantage; more Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 30) Monetarists contend that ________.

A) the self-correcting mechanism works slowly because wages are inflexible B) the aggregate supply curve does not move quickly to restore the economy to the natural rate of unemployment C) active government policy is required to restore the economy to full employment when unemployment is high D) the Bank of Canada should adopt and follow a money growth rule Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 11 .

31) Monetarists ________.

A) see wages as being sufficiently sticky so that the wage and price adjustment process is reasonably slow B) are skeptical of the need for active government policies to restore the economy to full employment C) argue for active government policy to restore the economy to full employment when unemployment is high D) A and B only Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 32) Monetarists believe in all the following EXCEPT that ________.

A) active government policies are required to restore the economy to full employment B) the Bank of Canada should adopt and follow a money growth rule C) the self-correcting mechanism works quickly because wages are sufficiently flexible D) the aggregate supply curve shifts quickly to restore the economy to the natural rate of unemployment Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 33) Arguments for adopting a policy rule include ________.

A) the time-inconsistency problem can lead to poor economic outcomes B) discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run C) policy makers and politicians cannot be trusted D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

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34) Arguments for adopting a policy rule include ________.

A) discretion avoids the straitjacket that would lock in the wrong policy if the model that was used to derive the policy rule proved to be incorrect B) discretion enables policy makers to change policy settings when an economy undergoes structural changes C) discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run D) all of the above Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 35) Arguments for discretionary policies include ________.

A) policy rules can be too rigid because they cannot foresee every contingency B) the time-inconsistency problem can lead to poor economic outcomes C) discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run D) all of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 36) Arguments for discretionary policies include ________.

A) policy rules can be too rigid because they cannot foresee every contingency B) policy rules do not easily incorporate the use of judgment C) discretion avoids the straitjacket that would lock in the wrong policy if the model that was used to derive the policy rule proved to be incorrect D) discretion enables policy makers to change policy settings when an economy undergoes structural changes E) all of the above Answer: E Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 37) ________ imposes a conceptual structure and inherent discipline on policy makers, but without eliminating all flexibility.

A) Constrained discretion B) A policy rule C) A discretionary policy D) The Taylor rule Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy 13 .

38) Describe discretionary and nondiscretionary policy in the case of a negative aggregate supply shock to the economy. Use a graph to support your answer.

Answer: When the economy moves from point 1 to 1' after a supply shock then policymakers have two choices: The nondiscretionary policy of doing nothing and letting the aggregate supply curve to move back to the original position, or the discretionary policy and try to shift the aggregate demand curve to move the economy to point 2.

Case for a discretionary policy: if the wages and prices adjust extremely slow a nondiscretionary policy is considered by an advocate for discretionary as costly because the slow movement of the economy back to full employment results in a large loss of output.

Case for a nondiscretionary policy: advocates for nondiscretionary policy view the wage and price adjustment process as more rapid than advocates for discretionary do and consider nondiscretionary policy less costly because output is soon back at the natural rate level. They suggest that a discretionary accommodating policy of shifting the aggregate demand curve to AD2 is costly because it produces more volatility in both the price level and output.

Diff: 2 Type: ES Skill: Recall Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy

14 .

25.3 The Role of Credibility and a Nominal Anchor 1) A credible nominal anchor ________.

A) can help overcome the time-inconsistency problem by providing an expected constraint on discretionary policy B) can help to anchor inflation expectations, which leads to smaller fluctuations in inflation C) is required for a policy rule D) all of the above E) A and B only Answer: E Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 2) Suppose that there is a positive aggregate demand shock, and the central bank commits to an inflation rate target. If the commitment is credible, then ________.

A) the public's expected inflation will remain unchanged B) the short-run aggregate supply curve will not shift C) over time inflation will fall back down to the inflation target D) all of the above E) A and B only Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 3) Suppose that there is a positive aggregate demand shock, and the central bank commits to an inflation rate target. But if the commitment is not credible, then ________.

A) the public's expected inflation will remain unchanged B) the short-run aggregate supply curve will rise C) over time inflation will fall back down to the inflation target D) all of the above E) A and B only Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

15 .

4) Suppose that there is a negative aggregate demand shock, and the central bank commits to an inflation rate target. If the commitment is credible, then ________.

A) the public's expected inflation will remain unchanged B) the short-run aggregate supply curve will rise C) over time inflation will fall D) all of the above E) A and C only Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 5) Suppose that there is a negative aggregate demand shock, and the central bank commits to an inflation rate target. But if the commitment is not credible, then ________.

A) the public's expected inflation will remain unchanged B) the short-run aggregate supply curve will rise C) economic contraction will be worse D) all of the above E) B and C only Answer: E Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 6) Suppose that there is a negative aggregate supply shock, and the central bank commits to an inflation rate target.

A) If the commitment is credible, the public's expected inflation will remain unchanged.

B) Credible policy produces better outcomes on both inflation and output in the short run.

C) Policies that are not credible produce worse economic contraction.

D) All of the above.

E) A and C only.

Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 7) The Canadian government can play an important role in establishing the credibility of antiinflation policy by ________.

A) demonstrating fiscal responsibility B) monitoring the Fed C) conducting fiscal policy D) all of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 16 .

8) If aggregate output is below the natural rate level, advocates of discretionary policy would recommend that the government ________.

A) do nothing B) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to the right C) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the right D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the left Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 9) When expectations of inflation are formed rationally, an anti-inflationary policy will be more successful if it is ________.

A) credible B) a surprise C) unanticipated D) announced Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 10) It may be necessary to cut the deficit as part of a credible anti-inflationary policy because the public knows that large deficits ________.

A) are inflationary in the long run B) create inefficiencies in the economy C) put pressure on the Bank of Canada to expand the money supply to keep interest rates from rising D) put pressure on the Bank of Canada to contract the money supply to prevent employment from rising beyond a critical level Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

17 .

11) By ________ its deficit, the government's credibility of implementing an anti-inflationary policy ________.

A) not changing; remains the same B) reducing; increases C) reducing; decreases D) not changing; increases Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 12) By ________ its deficit, the government makes an anti-inflationary policy ________ credible.

A) increasing; more B) reducing; more C) reducing; less D) not changing; more Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 13) An example of a nominal anchor ________.

A) is the inflation rate B) is the real interest rate C) are government expenditures D) is the marginal tax rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 14) The benefits of a credible nominal anchor include ________.

A) acting like a behaviour rule B) preventing the real business cycle from occurring C) encouraging an activist policy D) preventing discretion-based actions Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

18 .

15) The benefits of a credible nominal anchor include ________.

A) anchors inflation expectations B) preventing the real business cycle from occurring C) encouraging activist policy D) preventing discretion-based actions Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 16) With a positive aggregate demand shock, monetary policy credibility can ________.

A) stabilize inflation B) set inflation equal to zero C) determine the effective interest rate D) prevent financial malfeasance Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 17) If a positive aggregate demand shock occurs and monetary policy is not credible then ________.

A) inflation will increase B) the equilibrium interest rate will fall C) there will be a corresponding autonomous decrease in aggregate supply D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 18) A positive aggregate demand shock will only impact ________.

A) the equilibrium output B) the equilibrium inflation rate C) the short run aggregate supply curve D) none of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

19 .

19) An example of a positive aggregate demand shock is ________.

A) carbon cap-and-trade program B) productivity improving technological innovation C) an increase in the price of oil D) the shale gas revolution Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 20) The difference in outcomes occurring with a credible nominal anchor and without one, given a positive aggregate demand shock is that ________.

A) with the credible policy there is no shift in the aggregate supply curve B) there is no difference, but credibility provides a sense of security C) without a credible policy, inflation will continue to spiral upwards D) with a credible policy, the aggregate supply curve quickly shifts back to its original position Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 21) With a negative aggregate demand shock, monetary policy credibility can ________.

A) stabilize output B) push inflation to zero C) determine the effective interest rate D) prevent financial malfeasance Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 22) If a negative aggregate demand shock occurs and monetary policy is not credible then ________.

A) economic activity will decrease B) the equilibrium interest rate will rise C) there will be a corresponding autonomous increase in inflation D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

20 .

23) A negative aggregate demand shock will only impact ________.

A) the equilibrium interest rate B) the equilibrium inflation rate C) the short run aggregate supply curve D) none of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 24) An example of a negative aggregate demand shock is ________.

A) a global carbon cap-and-trade program B) a global financial crisis C) a decrease in the price of oil D) a thermonuclear war Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 25) The difference in outcomes occurring with a credible nominal anchor and without one, given a negative aggregate demand shock is that ________.

A) with the credible policy there is no shift in the aggregate supply curve B) there is no difference, but credibility provides a sense of security C) without credible policy, inflation will continue to spiral upwards D) with a credible policy, the aggregate supply curve quickly shifts back to its original position Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 26) Which of the following components is not included in the equation for the short-run aggregate supply curve?

A) The nominal interest rate B) The inflation rate C) Expected inflation D) The output gap Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

21 .

27) With a negative aggregate supply shock, monetary policy credibility can ________.

A) produce a better outcome B) push inflation down towards zero C) determine the effective interest rate D) prevent financial malfeasance Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 28) If a negative aggregate supply shock occurs and monetary policy is not credible then ________.

A) inflation will higher and output lower than with credible policy B) the equilibrium interest rate will fall C) there will be a corresponding autonomous decrease in aggregate supply D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 29) A negative aggregate supply shock will impact ________.

A) the equilibrium output B) the equilibrium inflation rate C) the short run aggregate supply curve D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 30) An example of a negative supply shock is ________.

A) carbon cap-and-trade program B) a rapid increase in energy costs C) a fall in the price of oil D) the shale gas revolution Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

22 .

31) The difference in outcomes occurring with a credible nominal anchor and without one, given a negative aggregate supply shock is that ________.

A) the overall economic outlook is better B) there is no difference, but credibility provides national security C) without credible policy, inflation will continue to spiral upwards D) with credible policy, the aggregate supply curve shifts back quickly Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 32) The three big oil price shocks occurred in ________.

A) 1973, 1979, 2007 B) 1972, 1979, 2007 C) 1973, 1978, 2007 D) 1973, 1979, 2006 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 33) After the first two oil price shocks ________.

A) the Canadian inflation rate increased sharply B) the Bank of Canada reversed its monetary policy stance C) there was no discernable impact on aggregate output D) the Bank of Canada implemented a nominal credible anchor policy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 34) The oil shock of 2007 ________.

A) had little impact on the inflation rate in Canada B) led to a sharp increase in the inflation rate C) did not impact Canadian output D) was beneficial to the Canadian economy because Canada is a net exporter of oil Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

23 .

35) The reason Canada fared differently between the first two oil shocks and the third is because ________.

A) a nominal anchor was in place during the third oil shock in 2007 B) by 2007 Canada became a net exporter of oil, so Canadians benefitted from higher oil prices C) in 2007, the global financial crisis overshadowed any oil price shocks D) none of the above Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 36) The global economic crisis that arose in October 2008 was the result of ________.

A) higher oil prices B) the collapse of the subprime mortgage market C) the European debt crisis D) fiscal and monetary issues stemming from the US debt ceiling Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 37) The oil crisis in the 1970s led to an unemployment rate of over ________ percent.

A) 13 B) 12 C) 10 D) 14 Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 38) The ________ is the credibility of the central bank, the more rapid will be the ________ in inflation and the ________ will be the loss of output to achieve the inflation objective.

A) greater; decline; lower B) greater; increase; lower C) greater; decline; greater D) greater; increase; greater Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

24 .

39) Empirical evidence on the importance of credibility in dealing with inflation includes experience from countries such as ________.

A) Bolivia B) Argentina C) Zimbabwe D) Brazil Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 40) The Bank of Canada has not always had a reputation for garnering credibility. These include countervailing monetary policies in ________.

A) early 1970s B) early 1960s C) the course of the Coyne affair D) during the global financial crisis Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 41) In the face of inflation shocks in the 1970s, the Bank of Canada ________.

A) increased the growth rate of the monetary aggregates B) decreased the growth rate of monetary aggregates C) began to accept the Lucas critique D) instituted contractionary monetary policy Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 42) In the face of inflation shocks in the 1970s, the Bank of Canada ________.

A) increased the growth rate of the monetary aggregates B) decreased the growth rate of monetary aggregates C) lowered its inflation target D) raised its inflation targets Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

25 .

43) Between 1981 and 1984, Canada experienced ________.

A) a reduction in inflation B) a gradual increase in inflation C) a sharp increase in inflation D) lower than average interest rates Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 44) In the first half of 1985, Bolivia's inflation rate was approximately ________.

A) 200,000 percent B) 20000 percent C) 2000 percent D) 200 percent Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 45) In August 1985, the Bolivian government announced ________.

A) it would reduce public sector wages B) the New Economic Policy C) a credible nominal anchor D) a replacement for the head of its central bank Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 46) Which of the following formed part of the Bolivian government's plan to reduce inflation?

A) Daily balancing of the budget B) Contractionary monetary policy C) Creation of a new currency D) Nationalization of 10 percent of private industrial activity Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

26 .

47) The New Economic Policy implemented by the Bolivian government to reduce inflation, resulted in an output loss of ________ percent of GDP. A) 1 percent B) 5 percent C) 10 percent D) nearly 18 percent Answer: B Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 48) Prior to 1980, Canada's inflation rate ________.

A) was growing at a slow and stable rate B) was never considered to be difficult to control C) reached double digits D) was tied to the U.S. inflation rate Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 49) Gerald Bouey, the Governor of the Bank of Canada at the time, helped in establishing the Bank's credibility by ________.

A) generating double digit inflation B) creating two severe recessions in the 1980s C) reorganizing the Bank of Canada's upper management team D) developing new and better measures of the monetary aggregates Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank 50) The 1981–1982 recession in Canada yielded an unemployment rate of ________.

A) just less than 10 percent B) 10 percent C) just over 10 percent D) 20 percent Answer: A Diff: 2 Type: MC Skill: Recall Objective: 25.3 Summarize and illustrate the benefits of a credible central bank

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25.4 Approaches to Establishing Central Bank Credibility 1) Approaches to establishing central bank credibility include ________.

A) its continued success at keeping inflation under control B) establishing central bank independence C) the appointment of a more conservative central banker D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 2) Approaches to establishing central bank credibility include ________.

A) its continued success at keeping inflation under control B) inflation targeting C) exchange rate targeting D) all of the above Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 3) Approaches to establishing central bank credibility include ________.

A) inflation targeting B) exchange rate targeting C) establishing central bank independence D) the appointment of a more conservative central banker E) all of the above Answer: E Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 4) The notion of hiring central bankers who are "conservative" and have a strong aversion to inflation was introduced by ________.

A) John Kenneth Galbraith B) Ben Bernanke C) Gerald Bouey D) Kenneth Rogoff Answer: D Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility

28 .

5) An advantage of Nominal GDP targeting includes all the following EXCEPT: ________.

A) It focuses on controlling inflation.

B) It focuses on stabilizing real GDP. C) It focuses on stabilizing nominal GDP. D) It encourages more expansionary monetary policy if real GDP growth should fall below its potential.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 6) Which of the following is a criticism of Nominal GDP targeting?

A) It focuses on controlling inflation.

B) It focuses on stabilizing real GDP. C) It is complicated for the public to understand.

D) It encourages more expansionary monetary policy if real GDP growth should fall below its potential.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 7) Which of the following is a criticism of Nominal GDP targeting?

A) It focuses on controlling inflation.

B) It focuses on stabilizing real GDP. C) It requires accurate estimates of potential GDP growth.

D) It encourages more expansionary monetary policy if real GDP growth should fall below its potential.

Answer: C Diff: 2 Type: MC Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 8) Provide several ways that the central bank could establish credibility.

Answer: Some ways in which the central bank could establish credibility include the following: continued success of keeping inflation under control, inflation targeting, public announcements of medium-term numerical targets for inflation, giving the central bank more independence from the political process, appoint "conservative" central bankers who have a strong aversion to inflation.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility

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9) Describe the two main benefits of a credible nominal anchor.

Answer: First, a credible nominal anchor acts like a behaviour rule and reduces the issues associated with the time-inconsistency problem. Second, a credible commitment to a nominal anchor will help anchor inflation expectations which leads to smaller fluctuations in inflation which helps with price stability.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 10) Explain how the impacts of a positive aggregate demand shock can be mitigated by monetary policy credibility.

Answer: Monetary policy credibility has the benefit of stabilizing inflation in the short run when faced with a positive demand shock as the public's expectation of inflation will remain unchanged.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 11) Explain the difference in how the Canadian economy responding during the three oil shocks and the role monetary policy credibility played.

Answer: Three oil shocks occurred in 1973, 1979 and 2007. After the first two episodes, monetary policy was weak because the Bank of Canada was unable to keep inflation under control and inflation increased to over 10 percent. During the oil crisis in 2007, the Bank of Canada had established monetary policy credibility and inflation never rose about 4 percent.

Economists attribute the lower inflation rate to the credibility of the Bank of Canada in keeping inflation within the target range.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 12) Explain why the Bank of Canada had a credibility problem during the 1970s.

Answer: In the early 1970s, the Bank of Canada accommodated inflationary shocks by raising the rate of growth of monetary aggregates, thereby forming expectations of rising inflation.

When in 1975 the Bank of Canada adopted a gradual anti-inflation policy, the public had no reason to believe in such a policy. This reduced the credibility of the Bank of Canada in the eyes of the public.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility

30 .

13) Describe how the Bolivian government managed its hyperinflation by introducing credibility.

Answer: In the first half of 1985, the Bolivian economy faced inflation of 20000 percent. In August 1985, the Bolivian president announced his anti-inflation program, the New Economic Plan. To rein in money growth and establish credibility, the new government reduced the budget deficit by shutting down state owned enterprises, eliminated subsidies, freezing public sector salaries and collecting a new wealth tax. The budget was balanced on a day-by day-basis. The finance minister would not authorize spending more than the amount of tax revenue that had been collected the day before. The Bolivian inflation was stopped within one month and output loss was less than 5 percent of GDP. Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 14) How did Canada win the battle against inflation?

Answer: The Bank of Canada battled against double digit inflation and stayed the course over two major recessions in the 1980s. By the end of 1983, inflation had fallen to less than 5 percent.

In 1988, the Bank of Canada and federal government announced jointly a series of inflation targets.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 15) Provide some alternate approaches to establishing credibility.

Answer: To achieve credibility, the central bank may announce inflation targeting or exchange rate targeting that allows a country to peg its exchange rate to an anchor country that has a strong nominal anchor. Another method is to appoint central bankers who have a strong version to inflation.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility 16) Describe how a nominal anchor can help a central bank achieve credibility.

Answer: An important way to constrain discretion is to commit to a nominal anchor that ties down the price level or inflation to achieve price stability. If the commitment to a nominal anchor has credibility, i.e., it's believed by the public, it can act as a behaviour rule and will anchor expectations reducing output fluctuations.

Diff: 2 Type: ES Skill: Recall Objective: 25.4 Identify ways in which central banks can establish and maintain credibility

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Economics of Money, Banking, and Fin. Markets, 8Ce (Mishkin) Chapter 26 Transmission Mechanisms of Monetary Policy 26.1 Transmission Mechanisms of Monetary Policy 1) Economic theory suggests that ________ interest rates are ________ important than ________ interest rates in explaining investment behaviour.

A) nominal; more; real B) real; less; nominal C) real; more; nominal D) market; more; real Answer: C Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 2) According to the traditional interest-rate channel, expansionary monetary policy lowers the real interest rate, thereby raising expenditures ________.

A) on business investment decisions B) by all levels of governments C) on consumer nondurables D) on net exports Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 3) The monetary transmission mechanism that links monetary policy to GDP through real interest rates and investment spending is known as ________.

A) the traditional interest-rate channel B) Tobin's' q theory C) the wealth effect D) the cash flow channel Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

1 .

4) If the aggregate price level adjusts slowly over time, then an expansionary monetary policy lowers ________.

A) only the short-term nominal interest rate B) only the short-term real interest rate C) both the short-term nominal and real interest rates D) the short-term nominal, the short-term real, and the long-term real interest rates Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 5) If monetary policy can influence ________ prices and conditions in ________ markets, then it can affect spending through channels other than the traditional interest-rate channel.

A) asset; labor B) asset; credit C) commodity; labor D) commodity; credit Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 6) An expansionary monetary policy lowers the real interest rate, causing the domestic currency to ________, thereby ________ net exports.

A) appreciate; raising B) appreciate; lowering C) depreciate; raising D) depreciate; lowering Answer: C Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 7) An expansionary monetary policy increases net exports by ________ interest rates and ________ the value of the dollar.

A) lowering nominal; decreasing B) lowering real; decreasing C) raising nominal; increasing D) raising real; increasing Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 2 .

8) A contractionary monetary policy raises the real interest rate, causing the domestic currency to ________, thereby ________ net exports.

A) appreciate; raising B) appreciate; lowering C) depreciate; raising D) depreciate; lowering Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 9) A contractionary monetary policy decreases net exports by ________ interest rates and ________ the value of the dollar.

A) lowering real; decreasing B) lowering real; increasing C) raising nominal; increasing D) raising real; increasing Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 10) Tobin's q is defined as the market value of firms ________ the replacement cost of capital.

A) times B) minus C) plus D) divided by Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 11) Tobin's q theory suggests that monetary policy may affect investment spending through its impact on ________.

A) stock prices B) interest rates C) bond prices D) cash flow Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 3 .

12) During the Great Depression, Tobin's q ________.

A) rose dramatically, as did real interest rates B) fell to unprecedentedly low levels C) stayed fairly constant, in contrast to most other economic measures D) rose only slightly, in spite of Hoover's attempts to prop it up Answer: B Diff: 2 Type: MC Skill: Applied Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 13) According to Tobin's q theory, ________ policy can affect ________ spending through its effect on the prices of common stock.

A) fiscal; consumption B) fiscal; investment C) monetary; consumption D) monetary; investment Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 14) According to Tobin's q theory, if q is ________, new plant and equipment capital is ________ relative to the market value of business firms, so companies can buy a lot of new investment goods with only a ________ issue of stock.

A) high; expensive; large B) high; cheap; large C) high; cheap; small D) low; cheap; large E) low; cheap; small Answer: C Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

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15) According to Tobin's q theory, when equity prices are low the market price of existing capital is ________ relative to new capital, so expenditure on fixed investment is ________.

A) cheap; low B) expensive; low C) cheap; high D) expensive; high Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 16) According to Tobin's q theory, when equity prices are high the market price of existing capital is ________ relative to new capital, so expenditure on fixed investment is ________.

A) cheap; low B) expensive; low C) cheap; high D) expensive; high Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 17) Franco Modigliani has found that an expansionary monetary policy can cause stock market prices to ________ and consumption to ________.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 18) The ________ proposes that two types of monetary transmission channels arise because of problems in credit markets A) interest rate channel B) asset price channel C) credit view D) Tobin q theory Answer: A Diff: 1 Type: MC Skill: Applied Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 5 .

19) A rise in stock prices ________ the net worth of firms and so leads to ________ investment spending because of the reduction in moral hazard.

A) raises; higher B) raises; lower C) reduces; higher D) reduces; lower Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 20) Because of the presence of asymmetric information problems in credit markets, an expansionary monetary policy causes a ________ in net worth, which ________ the adverse selection problem, thereby ________ increased lending to finance investment spending.

A) decline; increases; encouraging B) rise; increases; discouraging C) rise; reduces; encouraging D) decline; reduces; discouraging Answer: C Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 21) Due to asymmetric information in credit markets, monetary policy may affect economic activity through the balance sheet channel, where an increase in the money supply ________.

A) raises stock prices, lowering the cost of new capital relative to firms' market value, thus increasing investment spending B) raises firms' net worth, decreasing adverse selection and moral hazard problems, thus increasing banks' willingness to lend to finance investment spending C) raises the level of bank reserves, deposits, and bank loans, thereby raising spending by those individuals who do not have access to credit markets D) lowers the value of the dollar, increasing net exports and aggregate demand Answer: B Diff: 3 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

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22) An expansionary monetary policy raises firms' cash flows by ________ interest rates.

A) lowering real B) lowering nominal C) raising real D) raising nominal Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 23) If a contractionary monetary policy lowers the price level by more than expected, it raises the real value of consumer debt. This reduces consumer expenditure through ________.

A) the bank lending channel B) Tobin's q C) the traditional interest-rate channel D) the household liquidity effect Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 24) An expansionary monetary policy may cause asset prices to rise, thereby reducing the likelihood of financial distress and causing consumer durable and housing expenditures to rise.

This monetary transmission mechanism is referred to as ________.

A) the household liquidity effect B) the wealth effect C) Tobin's q theory D) the cash flow effect Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

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25) According to the household liquidity effect, an expansionary monetary policy causes a ________ in the value of households' financial assets, causing consumer durable expenditure to ________.

A) decline; rise B) rise; rise C) rise; fall D) decline; fall Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 26) According to the household liquidity effect, higher stock prices lead to increased consumption expenditures because consumers ________.

A) feel more secure about their financial position B) want to sell stocks and spend the proceeds before stock prices fall C) believe that their wages will increase due to increased profitability of firms D) can now afford more expensive imports Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 27) The subprime financial crisis caused a recession because of the ________ in adverse selection and moral hazard problems and the ________ in housing prices.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

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28) The transmission mechanisms of monetary policy include traditional interest-rate channels that operate ________.

A) only through businesses' decisions about investment spending B) only through consumers' decisions about spending on services and non-durable goods C) only through consumers' decisions about spending on housing and durable goods D) through investment spending decisions made by consumers and businesses Answer: D Diff: 2 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 29) Which economist supports the idea that there is strong evidence for substantial interest-rate effects on consumer and investment that operate through the real cost borrowing?

A) Ben Bernanke B) Mark Gertler C) John Taylor D) Irving Fisher Answer: C Diff: 1 Type: MC Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 30) Explain the traditional interest-rate channel for expansionary monetary policy. Explain how a tight monetary policy affects the economy through this channel.

Answer: In the traditional channel, a monetary expansion reduces real interest rates, lowering the cost of capital and increasing investment spending. The increase in investment increases aggregate demand. A monetary contraction has the opposite effect, raising real interest rates, lowering investment and aggregate spending.

Diff: 2 Type: ES Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy 31) Explain how expansionary and contractionary monetary policies affect aggregate demand through the exchange rate channel.

Answer: An expansionary monetary policy reduces real interest rates, causing depreciation of the domestic currency. This depreciation increases net exports and aggregate spending. A monetary contraction increases real interest rates, causing appreciation of the domestic currency, reducing net exports and aggregate spending.

Diff: 2 Type: ES Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

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32) Discuss three channels by which monetary policy affects stock prices and aggregate spending.

Answer: The answer should include three of the following: In Tobin's q theory, a monetary expansion increases stock prices, increasing the value of the firm relative to the cost of new capital. This stimulates investment in new capital goods, which in turn increases aggregate spending.

A monetary expansion increases stock prices, increasing wealth and stimulating consumption and aggregate spending.

Expansionary monetary policy increases equity prices. This improves firms' balance sheets, reducing adverse selection and moral hazard and increasing lending for investment, which increases aggregate spending.

In the household liquidity effect, the increase in equity prices due to a monetary expansion improves consumer balance sheets, reducing the probability of financial distress, and increasing consumer spending on durable goods and housing.

Diff: 3 Type: ES Skill: Recall Objective: 26.1 List and summarize the transmission mechanisms through which monetary policy can affect the real economy

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26.2 Lessons for Monetary Policy 1) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include: A) It is dangerous always to associate the easing or tightening of monetary policy with a fall or a rise in short-term interest rates.

B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.

C) Avoiding fluctuations in the level of unemployment is an important objective of monetary policy, thus providing a rationale for interest-rate stability as the primary long-run goal for monetary policy.

D) A and B only.

Answer: D Diff: 3 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy 2) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include: A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.

B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.

C) Avoiding fluctuations in the level of unemployment is an important objective of monetary policy, thus providing a rationale for interest-rate stability as the primary long-run goal for monetary policy.

D) A and B only.

Answer: B Diff: 3 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy

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3) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include: A) Monetary policy can be highly effective in reviving a weak economy so long as short-term interest rates are not too close to zero.

B) Avoiding fluctuations in the level of unemployment is an important objective of monetary policy, thus providing a rationale for interest-rate stability as the primary long-run goal for monetary policy.

C) Other asset prices beside those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

D) A and B only.

Answer: C Diff: 3 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy 4) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include: A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.

B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.

C) Avoiding fluctuations in the level of unemployment is an important objective of monetary policy, thus providing a rationale for interest-rate stability as the primary long-run goal for monetary policy.

D) Other asset prices beside those on short-term debt instruments do not contain important information about the stance of monetary policy because they are not important elements in various monetary policy transmission mechanisms.

Answer: B Diff: 3 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy

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5) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. Which of the following is not one of these lessons?

A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.

B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.

C) Avoiding unanticipated fluctuations in the price level is an important objective of monetary policy, thus providing a rationale for price stability as the primary long-run goal for monetary policy.

D) Other asset prices beside those on short-term debt instruments do not contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

Answer: A Diff: 3 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy 6) In the late 1990s and early 2000s, the Japanese economy experienced ________.

A) easy monetary policy as indicated by falling nominal interest rates B) easy monetary policy as indicated by short-term interest rates near zero C) tight monetary policy as indicated by falling asset prices D) tight monetary policy as indicated by short-term interest rates near zero Answer: C Diff: 2 Type: MC Skill: Applied Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy 7) Recent Japanese experience has been characterized by tight monetary policy, as indicated by ________.

A) falling interest rates B) short-term interest rates near zero C) falling asset prices D) low real interest rates Answer: C Diff: 2 Type: MC Skill: Applied Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy

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8) In a period of deflation, when there is a declining price level, ________ nominal interest rates do not necessarily indicate that the cost of borrowing is ________ or that monetary policy is easy.

A) low; low B) low; high C) high; low D) high; high Answer: A Diff: 2 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy 9) In a period of deflation, when there is a declining price level, low nominal interest rates do not necessarily indicate that the cost of borrowing is ________ or that monetary policy is ________.

A) low; tight B) low; easy C) high; tight D) high; easy Answer: B Diff: 2 Type: MC Skill: Recall Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of monetary policy

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