ECON365 STUDY GUIDE FOR MIDTERM II Chapters 5,6,11 MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If wealth increases, the demand for stocks ________ and that of long-term bonds ________, everything else held constant. A) increases; decreases B) decreases; decreases C) decreases; increases D) increases; increases 2) Everything else held constant, if the expected return on ABC stock rises from 5 to 10 percent and the expected return on CBS stock is unchanged, then the expected return of holding CBS stock ________ relative to ABC stock and the demand for CBS stock ________. A) falls; rises B) falls; falls C) rises; rises D) rises; falls 3) 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) raise; real B) raise; financial C) reduce; financial D) reduce; real 4) In the bond market, the bond demanders are the ________ and the bond suppliers are the ________. A) lenders; borrowers B) borrowers; lenders C) borrowers; advancers D) lenders; advancers 5) The demand curve for bonds has the usual downward slope, indicating that at ________ prices of the bond, everything else equal, the ________ is higher. A) lower; demand B) lower; quantity demanded C) higher; demand D) higher; quantity demanded 6) In the bond market, the market equilibrium shows the market-clearing ________ and market-clearing ________. A) interest rate; premium B) interest rate; deposit C) price; deposit D) price; interest rate 7) A movement along the bond demand or supply curve occurs when ________ changes. A) wealth B) bond price C) income D) expected return 8) If the price of bonds is set ________ the equilibrium price, the quantity of bonds demanded exceeds the quantity of bonds supplied, a condition called excess ________. A) below; demand B) above; demand C) above; supply D) below; supply 9) When the price of a bond is above the equilibrium price, there is an excess ________ bonds and price will ________. A) supply of; rise B) supply of; fall C) demand for; fall D) demand for; rise 10) When the interest rate on a bond is above the equilibrium interest rate, in the bond market there is excess ________ and the interest rate will ________. A) supply; fall B) demand; fall C) supply; rise D) demand; rise 1 11) 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; left D) rises; right 12) Everything else held constant, if interest rates are expected to fall in the future, the demand for long-term bonds today ________ and the demand curve shifts to the ________. A) rises; left B) rises; right C) falls; right D) falls; left 13) Everything else held constant, an increase in expected inflation, lowers the expected return on ________ compared to ________ assets. A) bonds; real B) physical; real C) bonds; financial D) physical; financial 14) 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) demand; demand; left C) demand; demand; right D) supply; supply; left 15) Higher government deficits ________ the supply of bonds and shift the supply curve to the ________, everything else held constant. A) decrease; left B) decrease; right C) increase; left D) increase; right 16) In the figure above, a factor that could cause the supply of bonds to shift to the right is: A) a business cycle expansion. B) a decrease in expected inflation. C) a recession. D) a decrease in government budget deficits. 17) In the figure above, the price of bonds would fall from P1 to P2 when A) the riskiness of bonds falls relative to other assets. B) inflation is expected to increase in the future. C) interest rates are expected to fall in the future. D) the expected return on bonds relative to other assets is expected to increase in the future. 18) In the figure above, a factor that could cause the demand for bonds to decrease (shift to the left) is: A) a reduction in the riskiness of bonds relative to other assets. B) a decrease in the expected return on bonds relative to other assets. C) an increase in the expected return on bonds relative to other assets. D) an increase in wealth. 2 19) When the inflation rate is expected to increase, the ________ for bonds falls, while the ________ curve shifts to the right, everything else held constant. A) supply; demand B) demand; supply C) demand; demand D) supply; supply 20) 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) fall; left B) rise; right C) fall; right D) rise; left 21) In Liquidity preference framework, individuals are assumed to hold their wealth in two forms: A) stocks and bonds. B) real assets and financial assets. C) money and bonds. D) money and gold. 22) In Liquidity preference framework, A) the demand for money must equal the supply of bonds. B) the demand for bonds must equal the supply of money. C) an excess demand of bonds implies an excess demand for money. D) an excess supply of bonds implies an excess demand for money. 23) In 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; money B) falls; bonds C) rises; bonds D) rises; money 24) The opportunity cost of holding money is A) the discount rate. C) the price level. B) the level of income. D) the interest rate. 25) When the interest rate is above the equilibrium interest rate, there is an excess ________ money and the interest rate will ________. A) demand for; fall B) supply of; fall C) supply of; rise D) demand for; rise 26) A lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant. A) increase; increase B) decrease; decrease C) increase; decrease D) decrease; increase 27) In the 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; right B) decrease; right C) increase; left D) decrease; left 28) When the Central Bank decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant. A) left; falls B) right; rises C) right; falls D) left; rises 29) ________ 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) A decrease; supply of; fall D) An increase; supply of; rise 3 30) In the figure above, one factor not responsible for the decline in the demand for money is A) a decline in income. B) a decline in the expected inflation rate. C) an increase in income. D) a decline the price level. 31) In the figure above, the factor responsible for the decline in the interest rate is A) a decline in income. B) a decline in the expected inflation rate. C) a decline the price level. D) an increase in the money supply. 32) The risk 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 interest rates on bonds with different maturities. D) the relationship among the term to maturity of different bonds. 33) 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) default risk. C) moral hazard. D) inflation risk. 4 34) The spread between the interest rates on bonds with default risk and default-free bonds is called the A) risk premium. B) default premium. C) junk margin. D) bond margin. 35) If a corporation begins to suffer large losses, then the default risk on the corporate bond will A) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise. B) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. C) increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. D) increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall. 36) A(n) ________ in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the yield on corporate bonds, all else equal. A) decrease; increase; increase B) decrease; decrease;decrease C) increase; increase; increase D) increase; decrease; increase 37) As default risk increases, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant. A) increases; less B) decreases; less C) increases; more D) decreases; more 38) When the Treasury bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________. NOTE: Treasure bonds and corporate bonds are substitute assets. A) right; left B) left; left C) right; right D) left; right 39) 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 Treasury bonds shifts to the ________. NOTE: Treasure bonds and corporate bonds are substitute assets. A) left; left B) left; right C) right; left D) right; right 40) The term structure of interest rates is A) the relationship among interest rates of different bonds with the same maturity. B) the relationship among the term to maturity of different bonds. C) the relationship among interest rates on bonds with different maturities. D) the structure of how interest rates move over time. 41) A plot of the interest rates on default-free government bonds with different terms to maturity is called A) a default-free curve. B) an interest-rate curve. C) a yield curve. D) a risk-structure curve. 5 42) Differences in ________ explain why interest rates on Treasury securities are not all the same. A) risk B) tax characteristics C) time to maturity D) liquidity 43) When yield curves are steeply upward sloping, A) medium-term interest rates are above both short-term and long-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) long-term interest rates are above short-term interest rates. 44) When yield curves are downward sloping, A) medium-term interest rates are above both short-term and long-term interest rates. B) long-term interest rates are above short-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) short-term interest rates are above long-term interest rates. 45) If bonds with different maturities are perfect substitutes, then the ________ on these bonds must be equal. A) excess return B) surplus return C) surprise return D) expected return 46) If the expected path 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 the five-year bond is A) 4 percent. B) 5 percent. C) 6 percent. D) 7 percent. 47) According to the segmented markets theory of the term structure A) investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward. B) because of the positive term premium, the yield curve will not be observed to be downward-sloping. C) bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time. D) the interest rate for each maturity bond is determined by supply and demand for that maturity bond. 48) According to the segmented markets theory of the term structure A) interest rates on bonds of different maturities do not move together over time. B) buyers of bonds do not prefer bonds of one maturity over another. C) buyers require an additional incentive to hold long-term bonds. D) 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. 49) According to the liquidity premium theory of the term structure A) 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. B) yield curves should never slope downward. C) bonds of different maturities are not substitutes. D) interest rates on bonds of different maturities do not move together over time. 6 50) According to the liquidity premium theory of the term structure, 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. 51) Which of the following are reported as liabilities on a bank's balance sheet? A) Deposits with other banks B) Reserves C) Loans D) Checkable deposits 52) Which of the following are reported as liabilities on a bank's balance sheet? A) Reserves B) U.S. Treasury securities C) Loans D) Loans from Central Bank 53) Bank capital is listed on the ________ side of the bank's balance sheet because it represents a ________ of funds. A) asset; use B) asset; source C) liability; use D) liability; source 54) Bank reserves include A) deposits at other banks and deposits at the Central Bank. B) vault cash and deposits at the Central Bank. C) deposits at the Central Bank and short-term treasury securities. D) vault cash and short-term Treasury securities. 55) Which of the following are reported as assets on a bank's balance sheet? A) Borrowings B) Savings deposits C) Bank capital D) Reserves 56) 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) liabilities; assets B) assets; liabilities C) loans; deposits D) securities; deposits 57) When a new depositor opens a checking account at the First National Bank, the bank's assets ________ and its liabilities ________. A) decrease; decrease B) increase; decrease C) increase; increase D) decrease; increase 58) When you deposit a $50 bill in the Security Pacific National Bank, A) its cash items in the process of collection increase by $50. B) its reserves decrease by $50. C) its assets increase by $50. D) its liabilities decrease by $50. 59) When $1 million is deposited at a bank, the required 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 liabilities of the bank increase by $800,000. B) the liabilities of the bank increase by $1,000,000. C) reserves increase by $160,000. D) the assets at the bank increase by $800,000. 7 60) When $1 million is deposited at a bank, the required 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) reserves increase by $200,000. B) the assets at the bank increase by $1 million. C) the liabilities of the bank decrease by $1 million. D) liabilities increase by $200,000. 61) If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is A) $20,000. B) $30,000. C) $25,000. D) $10,000. 62) If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can A) reduce deposits by $3 million. B) increase loans by $3 million. C) repay its discount loans from the Fed. D) sell $3 million of securities. 63) If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could A) buy U.S. Treasury bills. B) borrow from another bank. C) increase loans. D) buy corporate bonds. 64) The goals of bank asset management include A) minimizing liquidity. B) purchasing securities with high returns and low risk. C) maximizing risk. D) lending at high interest rates regardless of risk. 65) A bank failure occurs whenever A) a bank is not allowed to borrow from the Fed. B) a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet its reserve requirements. C) a bank has to call in a large volume of loans. D) a bank suffers a large deposit outflow. 66) A bank is insolvent when A) its capital exceeds its liabilities. C) its assets increase in value. B) its assets exceed its liabilities. D) its liabilities exceed its assets. 67) For a given return on assets, the lower is bank capital, A) the lower is the return for the owners of the bank. B) the lower the possibility of bank failure. C) the lower is the credit risk for the owners of the bank. D) the higher is the return for the owners of the bank. 68) Bank capital has both benefits and costs for the bank owners. Higher bank capital ________ the likelihood of bankruptcy, but higher bank capital ________ the return on equity for a given return on assets. A) reduces; increases B) increases; reduces C) reduces; reduces D) increases; increases 8 69) Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans. A) moral suasion B) moral hazard C) adverse selection D) intentional fraud 70) Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the A) moral hazard problem. B) lemon problem. C) adverse credit risk problem. D) adverse selection problem. 71) 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) adverse lending B) adverse selection C) moral hazard D) moral suasion 72) Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called A) liens. B) proscription bonds. C) restrictive covenants. D) due-on-sale clauses. 73) Property promised to the lender as compensation if the borrower defaults is called A) restrictive covenants. B) collateral. C) deductibles. D) contingencies. 74) Collateral requirements lessen the consequences of ________ because the collateral reduces the lender's losses in the case of a loan default and it reduces ________ because the borrower has more to lose from a default. A) moral hazard; adverse selection B) diversification; moral hazard C) adverse selection; moral hazard D) adverse selection; diversification 75) 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) a decline; not affect B) a decline; reduce C) an increase; reduce D) an increase; increase 9 Answer Key Testname: STUDY GUIDE 2 F2014 1) D 2) B 3) D 4) A 5) B 6) D 7) B 8) A 9) B 10) B 11) D 12) B 13) A 14) A 15) D 16) A 17) B 18) B 19) B 20) A 21) C 22) D 23) A 24) D 25) B 26) B 27) A 28) D 29) A 30) C 31) D 32) A 33) B 34) A 35) D 36) D 37) D 38) D 39) B 40) C 41) C 42) C 43) D 44) D 45) D 46) C 47) D 48) A 49) A 10 Answer Key Testname: STUDY GUIDE 2 F2014 50) D 51) D 52) D 53) D 54) B 55) D 56) A 57) C 58) C 59) B 60) B 61) C 62) D 63) B 64) B 65) B 66) D 67) D 68) C 69) C 70) A 71) B 72) C 73) B 74) C 75) C 11
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