Money, Banking, and Financial Markets (Econ 353)
Final Examination, spring 2006
May 2, 2006
Name_______________________________________ Univ. Id #______________________
Note: Each multiple-choice question is worth 4 points. Question 10 (bonus) is worth 4 points. Problems 19, 20, and 21 carry 12, 10, and 10 points, respectively.
1) 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 shortsighted because of their desire to win reelection; thus, the political process may generate a political business cycle, in which just before an election expansionary policies are pursued to lower unemployment and interest rates.
C) Putting the Fed under control of the President, as a part of the U.S. Treasury, may place too much pressure on the Fed to finance federal budget deficits, thereby imparting an inflationary bias to monetary policy.
D) All of the above are true statements.
2) Which of the following is an assumption of the simple model of multiple deposit creation?
A) The required reserve ratio is zero.
B) Depositors hold no currency.
C) Open market sales increase bank reserves.
D) Banks do not lend all their excess reserves.
3) For a given level of the monetary base, a decrease in the required reserve ratio on checkable deposits will mean
A) a decrease in the money supply. B) an increase in the money supply.
C) a decrease in checkable deposits. D) an increase in discount borrowing.
4) The Political Business Cycle refers to:
A) expansionary policies designed to lower unemployment and interest rates before an election.
B) business cycles caused by campaign spending before each four-year election.
C) a two-year cycle caused by elections in the US House of Representatives.
D) contractionary policies designed to lower inflation rates before elections.
5) Factors that cause an increase in the money multiplier include:
A) a lowering of the required reserve ratio.
B) an increase in the market interest rate.
C) an increase in expected deposit outflows.
D) only (a) and (b) of the above.
6) In the market for reserves, an open market ______shifts the supply curve to the left, ____
federal funds interest rate.
A) sale; lowering
B) sale; raising
C) purchase; lowering
D) purchase; raising
7) Using money demand and money supply:
A) an increase in income will increase money demand and increase the interest rate.
B) an increase in prices will increase money demand and decrease the interest rate.
C) an increase in expected inflation will decrease money demand and decrease interest rates.
D)an increase in the money supply will increase the interest rate.
8) If long-term interest rates are expected to rise in the future, then
A) People demand fewer bonds now, firms issue more bonds now, and interest rates rise now.
B) People demand more bonds now, firms issue more bonds now, and interest rates fall now.
C) People buy more bonds now, firms issue more bonds now, and interest rates rise now.
D) People buy fewer bonds now, firms issue fewer bonds now, and interest rates fall now.
9) A deposit of 100 pays 110 in one year, and the inflation rate turns out to be -5% (negative inflation is called deflation). The real rate of return is
A) 10%
B) 5%
C) 15%
D) none of the above
10) (Bonus Question) : The term “non-borrowed” reserves in the context of banking system means
A) reserves that are not borrowed from other banks, but includes discount loans from the Fed
B) reserves that are not borrowed from the Fed, but includes reserves borrowed from other banks
C) neither borrowed from the Fed, nor from other banks
D) none of the above
11) Which of the following $1,000 face-value securities has the lowest 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 $1,000.
D) A 5 percent coupon bond with a price of $1,200.
E) A 5 percent coupon bond with a price of $1,500.
12) Bank A faces a 15% reserve requirement ratio. If this bank gains $100 of deposits and $100 of new reserves, then this bank has:
A) $15 of new required reserves.
B) $15 of new loans.
C) $15 of excess reserves.
D) $85 of new required reserves.
13) Why does an increase in the excess reserves ratio cause the money supply to fall?
A) Because as the excess reserves ratio rises, people withdraw more currency from banks.
B) Because as the excess reserves ratio rises, the Fed lowers the discount rate.
C) Because as banks hold more excess reserves, they make fewer loans.
D) Because the Fed makes fewer discount loans as the ratio rises.
14) The money multiplier shows:
A) the change in the money supply from a $1.00 change in savings accounts.
B) the change in the money supply from a $1.00 change in the monetary base.
C) the change in the money supply from a $1.00 change in bank loans.
D) the change in the money supply from a $1.00 change in checking accounts.
15) Which of the following is not an advantage of open market operations compared to other methods of changing the money supply?
A) Open market operations are easily reversible.
B) Open market operations are done at the Fed's initiative.
C) Open market operations can be implemented quickly.
D) Open market operations do not need the approval of Congress.
16) Which of the following is an element of the Federal Reserve System?
A) The Federal Reserve Banks
B) The Board of Governors
C) The FDIC
D) Each of the above
E) Only (a) and (b) of the above
17) Each Fed bank president attends FOMC meetings; although only _____ Fed bank presidents vote on policy, all _____ provide input.
A) three, ten B) five, ten C) three, twelve D) five, twelve
18) Members of the Board of Governors are
A) chosen by the Federal Reserve Bank presidents.
B) appointed by the newly elected President of the United States, as are cabinet positions.
C) appointed by the President of the United States and confirmed by the Senate as members resign.
D) never allowed to serve more than seven-year terms.
19 Briefly discuss the following (based on the Fed’s chapter Monetary Policy and the Economy)
(a) What are the goals (objectives) of monetary policy? Differentiate between the goals and the instruments (the variables that Fed can control) of monetary policy. (4 points)
(b) What are the various tools that the Fed can use to conduct monetary policy? (4 points)
(c) How does interest rate adjustment help in achieving monetary policy objectives? (4 points)
Goals: both price and output stability
Instruments: money supply, interest rates
Tools: Open market operations, discount loans, reserve requirements
Interest rates affect household and firms behavior. See the details in the Fed’s chapter Monetary Policy and the Economy.
20. Assume that the required reserve ratio rd is 10%.
a. (4 points) Suppose the banking system does not carry any excess reserves and public does not want to hold additional currency. What will be the impact on money supply of $1 million open market purchase by the fed?
b. (6 points) Assume that the banking system has excess reserves equal to $ 4 billion. Further, the currency in circulation equals $ 400 billion, and the total amount of checkable deposits equals $920 billion. Based on these numbers, calculate
1. required reserves held by the banking system
2. total reserves held by the banking system,
3. monetary base
4. total money supply (M1)
5. the money multiplier
Answer:
(a) Open market purchase will increase reserves by $1 million. We know that in a simple deposib multiplier model, change in deposits = change in monetary base/reserve requirement ratio. Hence, the deposits and money supply will increase by $10 million.
(b) 1. RR = 0.1*920 = 92, 2. R = ER + RR = 4+ 92 = 96, 3. MB = C+ R= 400+96 = 496, 4. M1 = C+D = 400 + 920 = 1320, 5. m = M1/MB = 1320/496 = 2.66
21. You want to invest some of your savings for the next two years.
(b) (5 points) Your bank is offering you a certificate of deposit with an annual interest rate of 10 %. There is another option you want to consider: a 2-year 10% coupon bond with a face value of $1000, selling at a price of 1010. How will you choose between the two options? No calculations are required here. You can simply argue.
(c) (5 points) One year later the (one year) bond market interest rate falls to 5%. If you were holding the bond, what would be your one year return? (Show your work)
Answer:
(a) Since the price of bond is higher than its face value, its yield to maturity must be lower than its coupon rate of 10%. Hence, it makes sense to go for deposits.
(b) After one year if the interest rate rises to 5%, the price of bond will be
P = 1100/1.05 = 1047.6
One year return R = (1047.6+100)/1010 – 1 = 0.1362 = 13.6%
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