Name: ------
Midterm I Econ. 207. Prince Sultan University, Fall 2007. Dr. Kassim Dakhlallah
Part I. Multiple Choice. ( 45 points)
Circle the letter of the choice that best answers the question,. PLEASE, allocate your time efficiently!!!!
1) If nominal GDP in 2001 is $9 trillion, and 2001 real GDP in 1996 prices is $6 trillion, the GDP deflator price index is
(a) 67.
(b) 100.
(c) 150.
(d) 200.
(e) cannot be determined.
Answer: C
Question Status: New
2) If the price level increases from 200 in year 1 to 220 in year 2, the rate of inflation from year 1 to year 2 is
(a) 20%.
(b) 10%.
(c) 11%.
(d) 120%.
(e) 220%.
Answer: B
Question Status: Study Guide
3) Economies of scale enable financial institutions to
(a) reduce transactions costs.
(b) avoid the asymmetric information problem.
(c) eliminate the need to diversify.
(d) reduce moral hazard.
(e) avoid adverse selection problems.
Answer: A
Question Status: New
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 borrowed funds over many customers.
(d) spreading the cost of writing a standardized contract over many borrowers.
(e) all of the above.
Answer: D
Question Status: New
5) Regulations that protect against financial panics include
(a) restrictions on entry.
(b) disclosure.
(c) deposit insurance.
(d) restrictions on assets and activities.
(e) all of the above.
Answer: E
Question Status: New
6) The agency that was created to protect depositors after the banking panics of 1930–1933 is the
(a) Federal Reserve System.
(b) Federal Deposit Insurance Corporation.
(c) Treasury Department.
(d) Office of the Comptroller of the Currency.
(e) all of the above.
Answer: B
Question Status: New
7) Money is
(a) anything that is generally accepted in payment for goods and services or in the repayment of debt.
(b) frequently—but incorrectly—used synonymously with wealth.
(c) paper money, coins, and checks.
(d) all of the above.
(e) only (a) and (c) of the above.
Answer: D
Question Status: Revised
8) Although not a unique store of value, people find money a convenient store of value because
(a) it does not decline in value when prices rise.
(b) its value remains fixed to the price level; that is, if prices double so does the value of money.
(c) it is the most liquid asset.
(d) of all of the above.
(e) of none of the above.
Answer: C
Question Status: Previous Edition
9) Which of the following is included in both M1 and M2?
(a) Currency
(b) Savings deposits
(c) Small time deposits
(d) Money market deposit accounts
(e) Savings bonds
Answer: A
Question Status: New
10) A clause in a mortgage loan contract requiring the borrower to purchase homeowner’s insurance is an example of a
(a) restrictive covenant.
(b) collusive agreement between mortgage lenders and insurance companies.
(c) both (a) and (b) of the above.
(d) neither (a) and (b) of the above.
Answer: A
Question Status: Previous Edition
11) Because of the adverse selection problem,
(a) lenders may make a disproportionate amount of loans to bad credit risks.
(b) lenders may refuse loans to individuals with low net worth.
(c) lenders are reluctant to make loans that are not secured by collateral.
(d) all of the above.
Answer: D
Question Status: Previous Edition
12) Which of the following are not reported as assets on a bank’s balance sheet?
(a) Discount loans from the Fed
(b) Loans
(c) Reserves
(d) Only (a) and (b) of the above
Answer: A
Question Status: Previous Edition
13) When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, 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 Citibank fall by $10.
(d) the assets of Citibank fall by $10.
(e) none of the above occurs.
Answer: E
Question Status: Previous Edition
14) When a bank’s _____ exceed it ______, it is ______.
(a) assets; liabilities; illiquid
(b) assets; capital; illiquid
(c) capital; assets; insolvent
(d) liabilities; assets; illiquid
(e) liabilities; assets; insolvent
Answer: E
Question Status: New
First National Bank
Assets / LiabilitiesRate-sensitive / $20 million / $50 million
Fixed-rate / $80 million / $50 million
15) If interest rates rise by 5 percentage points, say, from 10 to 15%, bank profits (measured using 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
Question Status: Previous Edition
Part II: Essay Type questions (55 points). Please answer 3 out of 4 questions in the space provide below .
1) 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 of 10%, show in a second T-account the banks balance sheet indicating required and excess reserve. In a third T-account, show the change in the bank’s balance sheet when the bank makes loans with the excess reserves. (18.33 points)
Answer:
Reserves / $1000 / Checkable deposits / $1000Required reserves / $100 / Checkable deposits / $1000
Excess reserves / $900
Required reserves / $100 / Checkable deposits / $1000
Loans / $900
2) Explain the problem of asymmetric information, adverse selection and moral hazard, and why these problems are important for the financial system (18.33 points).
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.
3) Assume the following balance sheet for the First National Bank:
Assets / LiabilitiesRate-sensitive assets / $40 million / Rate-sensitive liabilities / $80 million
Fixed-rate assets / $60 million / Fixed-rate liabilities / $20 million
Using gap analysis, what is the effect of a 4 percent increase in interest rates? What is the effect of a 3 percent decrease in rates? Why is knowledge of interest-rate risk important? How might banks respond if rates are expected to change unfavorably? (18.33
Answer: The gap is –$40 million. A 4 percent rate increase reduces profits by $1.6 million, while a 3 percent rate decrease increases profits by $1.2 million. Obviously, knowledge of interest-rate risk is important for understanding the impact of interest rate changes on bank profits. If an adverse change in interest rates is expect, banks can change their assets and liability mix to reduce or eliminate unfavorable gaps.