Anda di halaman 1dari 310

Financial Markets and Institutions, 7e (Mishkin)

Chapter 1 Why Study Financial Markets and Institutions?


1.1 Multiple Choice
1) Financial markets and institutions
A) involve the movement of huge quantities of money.
B) affect the profits of businesses.
C) affect the types of goods and services produced in an economy.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

2) Financial market activities affect


A) personal wealth.
B) spending decisions by individuals and business firms.
C) the economy's location in the business cycle.
D) all of the above.
Answer: D
Question Status: Previous Edition
3) Markets in which funds are transferred from those who have excess funds available to those who have
a shortage of available funds are called
A) commodity markets.
B) funds markets.
C) derivative exchange markets.
D) financial markets.
Answer: D
Question Status: Previous Edition

4) The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of
$100 per year) is commonly referred to as the
A) inflation rate.
B) exchange rate.
C) interest rate.
D) aggregate price level.
Answer: C
Question Status: Previous Edition

5) The bond markets are important because


A) they are easily the most widely followed financial markets in the United States.
B) they are the markets where interest rates are determined.
C) they are the markets where foreign exchange rates are determined.
D) all of the above.
Answer: B
Question Status: Previous Edition
6) Interest rates are important to financial institutions since an interest rate increase ________ the cost of
acquiring funds and ________ the income from assets.
1
Copyright 2012 Pearson Education, Inc.

A) decreases; decreases
B) increases; increases
C) decreases; increases
D) increases; decreases
Answer: B
Question Status: Previous Edition
7) Typically, increasing interest rates
A) discourages individuals from saving.
B) discourages corporate investments.
C) encourages corporate expansion.
D) encourages corporate borrowing.
E) none of the above.
Answer: B
Question Status: Previous Edition

8) Compared to interest rates on long-term U.S. government bonds, interest rates on ________ fluctuate
more and are lower on average.
A) medium-quality corporate bonds
B) low-quality corporate bonds
C) high-quality corporate bonds
D) three-month Treasury bills
E) none of the above
Answer: D
Question Status: Previous Edition

9) Compared to interest rates on long-term U.S. government 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
Question Status: Previous Edition

10) The stock market is important because


A) it is where interest rates are determined.
B) it is the most widely followed financial market in the United States.
C) it is where foreign exchange rates are determined.
D) all of the above.
Answer: B
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) Stock prices since the 1980s have been


A) relatively stable, trending upward at a steady pace.
B) relatively stable, trending downward at a moderate rate.
C) extremely volatile.
D) unstable, trending downward at a moderate rate.
Answer: C
Question Status: Previous Edition
12) The largest one-day drop in the history of the American stock markets occurred in
A) 1929.
B) 1987.
C) 2000.
D) 2001.
Answer: B
Question Status: Previous Edition
13) A declining stock market index due to lower share prices
A) reduces people's wealth and as a result may reduce their willingness to spend.
B) increases people's wealth and as a result may increase their willingness to spend.
C) decreases the amount of funds that business firms can raise by selling newly issued stock.
D) both A and C of the above.
E) both B and C of the above.
Answer: D
Question Status: Previous Edition

14) Changes in stock prices


A) affect people's wealth and their willingness to spend.
B) affect firms' decisions to sell stock to finance investment spending.
C) are characterized by considerable fluctuations.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

15) (I) Debt markets are often referred to generically as the bond market.
(II) A bond is a security that is a claim on the earnings and assets of a corporation.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) (I) A bond is a debt security that promises to make payments periodically for a specified period of
time.
(II) A stock is a security that is a claim on the earnings and assets of a corporation.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

17) The price of one country's currency in terms of another's is called


A) the foreign exchange rate.
B) the interest rate.
C) the Dow Jones industrial average.
D) none of the above.
Answer: A
Question Status: Previous Edition
18) A stronger dollar benefits ________ and hurts ________
A) American businesses; American consumers.
B) American businesses; foreign businesses.
C) American consumers; American businesses.
D) foreign businesses; American consumers.
Answer: C
Question Status: Previous Edition
19) A weaker dollar benefits ________ and hurts ________
A) American businesses; American consumers.
B) American businesses; foreign consumers.
C) American consumers; American businesses.
D) foreign businesses; American consumers.
Answer: A
Question Status: Previous Edition
20) From 1980 to early 1985 the dollar ________ in value, thereby benefiting American ________
A) appreciated; businesses.
B) appreciated; consumers.
C) depreciated; businesses.
D) depreciated; consumers.
Answer: B
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) Money is defined as


A) anything that is generally accepted in payment for goods and services or in the repayment of debt.
B) bills of exchange.
C) a riskless repository of spending power.
D) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition

22) The organization responsible for the conduct of monetary policy in the United States is the
A) Comptroller of the Currency.
B) U.S. Treasury.
C) Federal Reserve System.
D) Bureau of Monetary Affairs.
Answer: C
Question Status: Previous Edition
23) The central bank of the United States is
A) Citicorp.
B) The Fed.
C) Bank of America.
D) The Treasury.
E) none of the above.
Answer: B
Question Status: Previous Edition

24) Monetary policy is chiefly concerned with


A) how much money businesses earn.
B) the level of interest rates and the nation's money supply.
C) how much money people pay in taxes.
D) whether people have saved enough money for retirement.
Answer: B
Question Status: Previous Edition
25) Economists group commercial banks, savings and loan associations, credit unions, mutual funds,
mutual savings banks, insurance companies, pension funds, and finance companies together under the
heading financial intermediaries. Financial intermediaries
A) act as middlemen, borrowing funds from those who have saved and lending these funds to others.
B) produce nothing of value and are therefore a drain on society's resources.
C) help promote a more efficient and dynamic economy.
D) do all of the above.
E) do only A and C of the above.
Answer: E
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) Economists group commercial banks, savings and loan associations, credit unions, mutual funds,
mutual savings banks, insurance companies, pension funds, and finance companies together under the
heading financial intermediaries. Financial intermediaries
A) act as middlemen, borrowing funds from those who have saved and lending these funds to others.
B) play an important role in determining the quantity of money in the economy.
C) help promote a more efficient and dynamic economy.
D) do all of the above.
E) do only A and C of the above.
Answer: D
Question Status: Previous Edition

27) Banks are important to the study of money and the economy because they
A) provide a channel for linking those who want to save with those who want to invest.
B) have been a source of financial innovation that is expanding the alternatives available to those
wanting to invest their money.
C) are the only financial institution to play a role in determining the quantity of money in the economy.
D) do all of the above.
E) do only A and B of the above.
Answer: E
Question Status: Previous Edition

28) Banks, savings and loan associations, mutual savings banks, and credit unions
A) are no longer important players in financial intermediation.
B) have been providing services only to small depositors since deregulation.
C) have been adept at innovating in response to changes in the regulatory environment.
D) all of the above.
E) only A and C of the above.
Answer: C
Question Status: Previous Edition

29) (I) Banks are financial intermediaries that accept deposits and make loans.
(II) The term "banks" includes firms such as commercial banks, savings and loan associations, mutual
savings banks, credit unions, insurance companies, and pension funds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition
30) ________ was the stock market's worst one-day drop in history in the 1980s.
A) Black Friday
B) Black Monday
C) Blackout Day
D) none of the above
Answer: B
Question Status: Previous Edition
31) The largest financial intermediaries are
A) insurance companies.
6
Copyright 2012 Pearson Education, Inc.

B) finance companies.
C) banks.
D) all of the above.
Answer: C
Question Status: Previous Edition
32) In recent years
A) interest rates have remained constant.
B) the success of financial institutions has reached levels unprecedented since the Great Depression.
C) stock markets have crashed.
D) all of the above.
Answer: C
Question Status: Previous Edition
33) A security
A) is a claim or price of property that is subject to ownership.
B) promises that payments will be made periodically for a specified period of time.
C) is the price paid for the usage of funds.
D) is a claim on the issuer's future income.
Answer: D
Question Status: Previous Edition
34) ________ are an example of a financial institution.
A) Banks
B) Insurance companies
C) Finance companies
D) All of the above
Answer: D
Question Status: Previous Edition
35) Monetary policy affects
A) interest rates.
B) inflation.
C) business cycles.
D) all of the above.
Answer: D
Question Status: Previous Edition
36) A rising stock market index due to higher share prices
A) increases people's wealth and as a result may increase their willingness to spend.
B) increases the amount of funds that business firms can raise by selling newly issued stock.
C) decreases the amount of funds that business firms can raise by selling newly issued stock.
D) both A and B of the above.
Answer: D
Question Status: Previous Edition
37) From the peak of the high-tech bubble in 2000, the stock market ________ by over ________ by
late 2002.
A) collapsed; 75%
B) rose; 35%
7
Copyright 2012 Pearson Education, Inc.

C) collapsed; 30%
D) rose; 50%
Answer: C
Question Status: New Question
1.2 True/False
1) Money is anything accepted by anyone as payment for services or goods.
Answer: TRUE
Question Status: Previous Edition
2) Interest rates are determined in the bond markets.
Answer: TRUE
Question Status: Previous Edition
3) A stock is a debt security that promises to make periodic payments for a specific period of time.
Answer: FALSE
Question Status: Previous Edition
4) Monetary policy affects interest rates but has little effect on inflation or business cycles.
Answer: FALSE
Question Status: Previous Edition
5) The government organization responsible for the conduct of monetary policy in the United States is
the U.S. Treasury.
Answer: FALSE
Question Status: Previous Edition
6) Interest rates can be accurately described as the rental price of money.
Answer: TRUE
Question Status: Previous Edition
7) Holding everything else constant, as the dollar weakens vacations abroad become less attractive.
Answer: TRUE
Question Status: Previous Edition
8) In recent years, financial markets have become more stable and less risky.
Answer: FALSE
Question Status: Previous Edition
9) Financial innovation has provided more options to both investors and borrowers.
Answer: TRUE
Question Status: Previous Edition
10) A financial intermediary borrows funds from people who have saved.
Answer: TRUE
Question Status: Previous Edition
11) Holding everything else constant, as the dollar strengthens foreigners will buy more U.S. exports.
Answer: FALSE
8
Copyright 2012 Pearson Education, Inc.

Question Status: Previous Edition


12) In a bull market stock prices are rising, on average.
Answer: TRUE
Question Status: Previous Edition
13) Financial institutions are among the largest employers in the country and frequently pay very high
salaries.
Answer: TRUE
Question Status: Previous Edition
14) Different interest rates have a tendency to move in unison.
Answer: TRUE
Question Status: Previous Edition
15) Financial markets are what makes financial institutions work.
Answer: FALSE
Question Status: Previous Edition
16) In recent years, financial markets have become more risky. However, only a limited number of tools
(such as derivatives) are available to assist in managing this risk.
Answer: FALSE
Question Status: New Question
1.3 Essay
1) Have interest rates been more or less volatile in recent years? Why?
Question Status: Previous Edition
2) Why should consumers be concerned with movements in foreign exchange rates?
Question Status: Previous Edition
3) How does the value of the dollar affect the competitiveness of American businesses?
Question Status: Previous Edition
4) What is monetary policy and who is responsible for its implementation?
Question Status: Previous Edition
5) What are financial intermediaries and what do they do?
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

6) What is money?
Question Status: Previous Edition
7) How does a bond differ from a stock?
Question Status: Previous Edition
8) Why is the stock market so important to individuals, firms, and the economy?
Question Status: Previous Edition
9) What is the central bank and what does it do?
Question Status: Previous Edition
10) If you are planning a vacation to Europe, do you prefer a strong dollar or weak dollar relative to the
euro? Why?
Question Status: New Question

10
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 2 Overview of the Financial System
2.1 Multiple Choice
1) Every financial market performs the following function:
A) It determines the level of interest rates.
B) It allows common stock to be traded.
C) It allows loans to be made.
D) It channels funds from lenders-savers to borrowers-spenders.
Answer: D
Question Status: Previous Edition
2) Financial markets have the basic function of
A) bringing together people with funds to lend and people who want to borrow funds.
B) assuring that the swings in the business cycle are less pronounced.
C) assuring that governments need never resort to printing money.
D) both A and B of the above.
E) both B and C of the above.
Answer: A
Question Status: Previous Edition

3) Which of the following can be described as involving direct finance?


A) A corporation's stock is traded in an over-the-counter market.
B) People buy shares in a mutual fund.
C) A pension fund manager buys commercial paper in the secondary market.
D) An insurance company buys shares of common stock in the over-the-counter markets.
E) None of the above.
Answer: E
Question Status: Previous Edition

4) Which of the following can be described as involving direct finance?


A) A corporation's stock is traded in an over-the-counter market.
B) A corporation buys commercial paper issued by another corporation.
C) A pension fund manager buys commercial paper from the issuing corporation.
D) Both A and B of the above.
E) Both B and C of the above.
Answer: B
Question Status: Previous Edition
5) Which of the following can be described as involving indirect finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys commercial paper in a secondary market.
D) All of the above.
E) Only A and B of the above.
Answer: E
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) Which of the following can be described as involving indirect finance?


A) A bank buys a U.S. Treasury bill from one of its depositors.
B) A corporation buys commercial paper issued by another corporation.
C) A pension fund manager buys commercial paper in the primary market.
D) Both A and C of the above.
Answer: D
Question Status: Previous Edition
7) Financial markets improve economic welfare because
A) they allow funds to move from those without productive investment opportunities to those who have
such opportunities.
B) they allow consumers to time their purchases better.
C) they weed out inefficient firms.
D) they do all of the above.
E) they do A and B of the above.
Answer: E
Question Status: Previous Edition

8) A country whose financial markets function poorly is likely to


A) efficiently allocate its capital resources.
B) enjoy high productivity.
C) experience economic hardship and financial crises.
D) increase its standard of living.
Answer: C
Question Status: Previous Edition
9) Which of the following are securities?
A) A certificate of deposit
B) A share of Texaco common stock
C) A Treasury bill
D) All of the above
E) Only A and B of the above
Answer: D
Question Status: Previous Edition
10) Which of the following statements about the characteristics of debt and equity are true?
A) They both can be long-term financial instruments.
B) They both involve a claim on the issuer's income.
C) They both enable a corporation to raise funds.
D) All of the above.
E) Only A and B of the above.
Answer: D
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) The money market is the market in which ________ are traded.
A) new issues of securities
B) previously issued securities
C) short-term debt instruments
D) long-term debt and equity instruments
Answer: C
Question Status: Previous Edition
12) Long-term debt and equity instruments are traded in the ________ market.
A) primary
B) secondary
C) capital
D) money
Answer: C
Question Status: Previous Edition
13) Which of the following are primary markets?
A) The New York Stock Exchange
B) The U.S. government bond market
C) The over-the-counter stock market
D) The options markets
E) None of the above
Answer: E
Question Status: Previous Edition

14) Which of the following are secondary markets?


A) The New York Stock Exchange
B) The U.S. government bond market
C) The over-the-counter stock market
D) The options markets
E) All of the above
Answer: E
Question Status: Previous Edition
15) A corporation acquires new funds only when its securities are 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
Question Status: Previous Edition
16) Intermediaries who are agents of investors and match buyers with sellers of securities are called
A) investment bankers.
B) traders.
C) brokers.
D) dealers.
E) none of the above.
Answer: C
Question Status: Previous Edition
3
Copyright 2012 Pearson Education, Inc.

17) Intermediaries who link buyers and sellers by buying and selling securities at stated prices are called
A) investment bankers.
B) traders.
C) brokers.
D) dealers.
E) none of the above.
Answer: D
Question Status: Previous Edition

18) An important financial institution that assists in the initial sale of securities in the primary market is
the
A) investment bank.
B) commercial bank.
C) stock exchange.
D) brokerage house.
Answer: A
Question Status: Previous Edition
19) Which of the following statements about financial markets and securities are true?
A) Most common stocks are traded over-the-counter, although the largest corporations have their shares
traded at organized stock exchanges such as the New York Stock Exchange.
B) A corporation acquires new funds only when its securities are sold in the primary market.
C) Money market securities are usually more widely traded than longer-term securities and so tend to be
more liquid.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

20) Which of the following statements about financial markets and securities are 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 intermediate term if its maturity is less than one year.
C) A debt instrument is long term if its maturity is ten years or longer.
D) The maturity of a debt instrument is the time (term) that has elapsed since it was issued.
Answer: C
Question Status: Previous Edition

21) Which of the following statements about financial markets and securities are true?
A) Few common stocks are traded over-the-counter, although the over-the-counter markets have grown
in recent years.
B) A corporation acquires new funds only when its securities are sold in the primary market.
C) Capital market securities are usually more widely traded than longer-term securities and so tend to be
more liquid.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: B
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

22) Which of the following markets is sometimes organized as an over-the-counter market?


A) The stock market
B) The bond market
C) The foreign exchange market
D) The federal funds market
E) all of the above
Answer: E
Question Status: Previous Edition
23) Bonds that are sold in a foreign country and are denominated in that country's currency are known as
A) foreign bonds.
B) Eurobonds.
C) Eurocurrencies.
D) Eurodollars.
Answer: A
Question Status: Previous Edition
24) 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) Eurocurrencies.
D) Eurodollars.
Answer: B
Question Status: Previous Edition

25) Financial intermediaries


A) exist because there are substantial information and transaction costs in the economy.
B) improve the lot of the small saver.
C) are involved in the process of indirect finance.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

26) The main sources of financing for businesses, in order of importance, are
A) financial intermediaries, issuing bonds, issuing stocks.
B) issuing bonds, issuing stocks, financial intermediaries.
C) issuing stocks, issuing bonds, financial intermediaries.
D) issuing stocks, financial intermediaries, issuing bonds.
Answer: A
Question Status: Previous Edition
27) The presence of transaction costs in financial markets explains, in part, why
A) financial intermediaries and indirect finance play such an important role in financial markets.
B) equity and bond financing play such an important role in financial markets.
C) corporations get more funds through equity financing than they get from financial intermediaries.
D) direct financing is more important than indirect financing as a source of funds.
Answer: A
Question Status: Previous Edition
5
Copyright 2012 Pearson Education, Inc.

28) Financial intermediaries can substantially reduce transaction costs per dollar of transactions because
their large size allows them to take advantage of
A) poorly informed consumers.
B) standardization.
C) economies of scale.
D) their market power.
Answer: C
Question Status: Previous Edition

29) The purpose of diversification is to


A) reduce the volatility of a portfolio's return.
B) raise the volatility of a portfolio's return.
C) reduce the average return on a portfolio.
D) raise the average return on a portfolio.
Answer: A
Question Status: Previous Edition
30) An investor who puts all her funds into one asset ________ her portfolio's ________.
A) increases; diversification
B) decreases; diversification
C) increases; average return
D) decreases; average return
Answer: B
Question Status: Previous Edition
31) Through risk-sharing activities, a financial intermediary ________ its own risk and ________ the
risks of its customers.
A) reduces; increases
B) increases; reduces
C) reduces; reduces
D) increases; increases
Answer: B
Question Status: Previous Edition

32) 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
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

33) When the lender and the borrower have different amounts of information regarding a transaction,
________ is said to exist.
A) asymmetric information
B) adverse selection
C) moral hazard
D) fraud
Answer: A
Question Status: Previous Edition

34) When the potential borrowers who are the most likely to default are the ones most actively seeking a
loan, ________ is said to exist.
A) asymmetric information
B) adverse selection
C) moral hazard
D) fraud
Answer: B
Question Status: Previous Edition

35) When the borrower engages in activities that make it less likely that the loan will be repaid,
________ is said to exist.
A) asymmetric information
B) adverse selection
C) moral hazard
D) fraud
Answer: C
Question Status: Previous Edition

36) The concept of adverse selection helps to explain


A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than
from 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) only A and B of the above.
E) only A and C of the above.
Answer: D
Question Status: Previous Edition

37) 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) none of the above.
Answer: A
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

38) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the
A) moral hazard problem.
B) adverse selection problem.
C) shirking problem.
D) free-rider problem.
E) principal-agent problem.
Answer: B
Question Status: Previous Edition

39) Successful financial intermediaries have higher earnings on their investments because they are better
equipped than individuals to screen out good from bad risks, thereby reducing losses due to
A) moral hazard.
B) adverse selection.
C) bad luck.
D) financial panics.
Answer: B
Question Status: Previous Edition

40) In financial markets, lenders typically have inferior information about potential returns and risks
associated with any investment project. This difference in information is called
A) comparative informational disadvantage.
B) asymmetric information.
C) variant information.
D) caveat venditor.
Answer: B
Question Status: Previous Edition
41) Which of the following financial intermediaries are depository institutions?
A) A savings and loan association
B) A commercial bank
C) A credit union
D) All of the above
E) Only A and C of the above
Answer: D
Question Status: Previous Edition

42) 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
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

43) Which of the following are not investment intermediaries?


A) A life insurance company
B) A pension fund
C) A mutual fund
D) Only A and B of the above
Answer: D
Question Status: Previous Edition
44) Which of the following are investment intermediaries?
A) Finance companies
B) Mutual funds
C) Pension funds
D) All of the above
E) Only A and B of the above
Answer: E
Question Status: Previous Edition

45) The government regulates financial markets for two main reasons:
A) to ensure soundness of the financial system and to increase the information available to investors.
B) to improve control of monetary policy and to increase the information available to investors.
C) to ensure that financial intermediaries do not earn more than the normal rate of return and to improve
control of monetary policy.
D) to ensure soundness of financial intermediaries and to prevent financial intermediaries from earning
less than the normal rate of return.
Answer: A
Question Status: Previous Edition
46) Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a
A) bank holiday.
B) financial panic.
C) financial disintermediation.
D) financial collapse.
Answer: B
Question Status: Previous Edition
47) Foreign currencies that are deposited in banks outside the home country are known as
A) foreign bonds.
B) Eurobond.
C) Eurocurrencies.
D) Eurodollars.
Answer: C
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

48) U.S. dollars deposited in foreign banks outside the United States or in foreign branches of U.S. are
referred to as
A) Eurodollars.
B) Eurocurrencies.
C) Eurobonds.
D) foreign bonds.
Answer: A
Question Status: Previous Edition

49) Banks providing depositors with checking accounts that enable them to pay their bills easily is
known as
A) liquidity services.
B) asset transformation.
C) risk sharing.
D) transaction costs.
Answer: A
Question Status: Previous Edition

50) A ________ is when one party in a financial contract has incentives to act in its own interest rather
than in the interests of the other party.
A) moral hazard
B) risk
C) conflict of interest
D) financial panic
Answer: C
Question Status: Previous Edition
51) Fire and casualty insurance companies are what type of intermediary?
A) Contractual savings institution
B) Depository institutions
C) Investment intermediaries
D) None of the above
Answer: A
Question Status: Previous Edition
52) The country whose banks are the most restricted in the range of assets they may hold is
A) Japan.
B) Canada.
C) Germany.
D) the United States.
Answer: D
Question Status: Previous Edition
53) The largest depository institution (value of assets) at the end of 2009 was
A) commercial banks.
B) pension funds.
C) credit unions.
D) mutual funds.
Answer: A
Question Status: New Question
10
Copyright 2012 Pearson Education, Inc.

2.2 True/False
1) Every financial market allows loans to be made.
Answer: FALSE
Question Status: Previous Edition
2) An example of direct financing is if you were to lend money to your neighbor.
Answer: TRUE
Question Status: Previous Edition
3) The New York Stock Exchange is an example of a primary market.
Answer: FALSE
Question Status: Previous Edition
4) A bond denominated in euros and issued in a country that uses the euro as its currency is an example
of a Eurobond.
Answer: FALSE
Question Status: Previous Edition
5) Most people's involvement with the financial system is through financial intermediaries rather than
financial markets.
Answer: TRUE
Question Status: Previous Edition
6) A financial intermediary's risk-sharing activities are also referred to as asset transformation.
Answer: TRUE
Question Status: Previous Edition
7) The process of financial intermediation is also known as direct finance.
Answer: FALSE
Question Status: Previous Edition
8) A mutual fund is not a depository institution.
Answer: TRUE
Question Status: Previous Edition
9) A pension fund is not a contractual savings institution.
Answer: FALSE
Question Status: Previous Edition
10) Equity represents an ownership interest in a firm and entitles the holder to the residual cash flows.
Answer: TRUE
Question Status: Previous Edition
11) Adverse selection refers to those with high credit risks, being most aggressive in their search for
funds.
Answer: TRUE
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

12) The capital market is a financial market in which only short-term debt instruments (generally those
with an original maturity of less than one year) are traded.
Answer: FALSE
Question Status: Previous Edition
13) American investors pay attention to only the Dow Jones Industrial Average.
Answer: FALSE
Question Status: Previous Edition
14) The government agency that insures each depositor at a commercial bank, savings and loan
association, or mutual savings bank up to a loss of $100,000 per account ($250,000 for individual
retirement accounts) is the Securities and Exchange Commission (SEC).
Answer: FALSE
Question Status: Previous Edition
15) Many common stocks are traded over the counter, although a majority of the largest corporations
have their shares traded at organized stock exchanges.
Answer: TRUE
Question Status: New Question
16) Many common stocks are traded at organized exchanges, although a majority of the largest
corporations have their shares traded over the counter.
Answer: FALSE
Question Status: New Question
17) Corporations that issue new securities to raise capital now conduct more of this business in financial
markets in Europe and Asia than in the U.S.
Answer: TRUE
Question Status: New Question
2.3 Essay
1) Distinguish between direct financing and indirect financing.
Question Status: Previous Edition
2) Distinguish between primary markets and secondary markets.
Question Status: Previous Edition
3) Distinguish between money markets and capital markets.
Question Status: Previous Edition
4) Why is it so important for an economy to have fully developed financial markets?
Question Status: Previous Edition
5) Why are financial intermediaries so important to an economy?
Question Status: Previous Edition
6) Describe how over-the-counter markets work.
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

7) What are adverse selection and moral hazard?


Question Status: Previous Edition
8) Why can a financial intermediary's risk-sharing activities be described as asset transformation?
Question Status: Previous Edition
9) Discuss the differences between depository institutions, contractual savings institutions, and
investment intermediaries.
Question Status: Previous Edition
10) What are some of the differences between an organized exchange and an over-the-counter market?
Question Status: New Question

13
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 3 What Do Interest Rates Mean and What Is Their Role in Valuation?
3.1 Multiple Choice
1) A loan that requires the borrower to make the same payment every period until the maturity date is
called a
A) simple loan.
B) fixed-payment loan.
C) discount loan.
D) same-payment loan.
E) none of the above.
Answer: B
Question Status: Previous Edition

2) A coupon bond pays the owner of the bond


A) the same amount every month until the maturity date.
B) a fixed interest payment every period, plus the face value of the bond at the maturity date.
C) the face value of the bond plus an interest payment once the maturity date has been reached.
D) the face value at the maturity date.
E) none of the above.
Answer: B
Question Status: Previous Edition

3) A bond's future payments are called its


A) cash flows.
B) maturity values.
C) discounted present values.
D) yields to maturity.
Answer: A
Question Status: Previous Edition
4) A credit market instrument that pays the owner the face value of the security at the maturity date and
nothing prior to then is called a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond.
Answer: D
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

5) (I) A simple loan requires the borrower to repay the principal at the maturity date along with an
interest payment.
(II) A discount bond is bought at a price below its face value, and the face value is repaid at the maturity
date.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

6) Which of the following are true of coupon bonds?


A) The owner of a coupon bond receives a fixed interest payment every year until the maturity date,
when the face or par value is repaid.
B) U.S. Treasury bonds and notes are examples of coupon bonds.
C) Corporate bonds are examples of coupon bonds.
D) All of the above.
E) Only A and B of the above.
Answer: D
Question Status: Previous Edition

7) Which of the following are generally true of all bonds?


A) The longer a bond's maturity, the lower 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 long-term bonds are more volatile than those for shorter-term bonds.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

8) (I) A discount bond requires the borrower to repay the principal at the maturity date plus an interest
payment.
(II) A coupon bond pays the lender a fixed interest payment every year until the maturity date, when a
specified final amount (face or par value) is repaid.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

9) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is
A) $650.
B) $1,300.
C) $130.
D) $13.
E) None of the above.
Answer: A
Question Status: Previous Edition

10) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of
A) 5 percent.
B) 8 percent.
C) 10 percent.
D) 40 percent.
Answer: A
Question Status: Previous Edition
11) The concept of ________ is based on the 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
Question Status: Previous Edition

12) Dollars received in the future are worth ________ than dollars received today. The process of
calculating what dollars received in the future are worth today is called ________.
A) more; discounting
B) less; discounting
C) more; inflating
D) less; inflating
Answer: B
Question Status: Previous Edition

13) The process of calculating what dollars received in the future are worth today is called
A) calculating the yield to maturity.
B) discounting the future.
C) compounding the future.
D) compounding the present.
Answer: B
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

14) With an interest rate of 5 percent, the present value of $100 received one year from now is
approximately
A) $100.
B) $105.
C) $95.
D) $90.
Answer: C
Question Status: Previous Edition

15) With an interest rate of 10 percent, the present value of a security that pays $1,100 next year and
$1,460 four years from now is approximately
A) $1,000.
B) $2,000.
C) $2,560.
D) $3,000.
Answer: B
Question Status: Previous Edition

16) With an interest rate of 8 percent, the present value of $100 received one year from now is
approximately
A) $93.
B) $96.
C) $100.
D) $108.
Answer: A
Question Status: Previous Edition

17) With an interest rate of 6 percent, the present value of $100 received one year from now is
approximately
A) $106.
B) $100.
C) $94.
D) $92.
Answer: C
Question Status: Previous Edition

18) The interest rate that equates the present value of the cash flow received from a debt instrument with
its market price today is the
A) simple interest rate.
B) discount rate.
C) yield to maturity.
D) real interest rate.
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

19) The interest rate that financial economists consider to be the most accurate measure is the
A) current yield.
B) yield to maturity.
C) yield on a discount basis.
D) coupon rate.
Answer: B
Question Status: Previous Edition
20) Financial economists consider the ________ to be the most accurate measure of interest rates.
A) simple interest rate
B) discount rate
C) yield to maturity
D) real interest rate
Answer: C
Question Status: Previous Edition
21) For a simple loan, the simple interest rate equals the
A) real interest rate.
B) nominal interest rate.
C) current yield.
D) yield to maturity.
Answer: D
Question Status: Previous Edition
22) 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
Question Status: Previous Edition
23) The yield to maturity of a one-year, simple loan of $500 that requires an interest payment of $40 is
A) 5 percent.
B) 8 percent.
C) 12 percent.
D) 12.5 percent.
Answer: B
Question Status: Previous Edition
24) The yield to maturity of a one-year, simple loan of $400 that requires an interest payment of $50 is
A) 5 percent.
B) 8 percent.
C) 12 percent.
D) 12.5 percent.
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

25) A $10,000, 8 percent coupon bond that sells for $10,000 has a yield to maturity of
A) 8 percent.
B) 10 percent.
C) 12 percent.
D) 14 percent.
Answer: A
Question Status: Previous Edition
26) Which of the following $1,000 face value securities has the highest yield to maturity?
A) A 5 percent coupon bond selling for $1,000
B) A 10 percent coupon bond selling for $1,000
C) A 12 percent coupon bond selling for $1,000
D) A 12 percent coupon bond selling for $1,100
Answer: C
Question Status: Previous Edition
27) Which of the following $1,000 face value securities has the highest yield to maturity?
A) A 5 percent coupon bond selling for $1,000
B) A 10 percent coupon bond selling for $1,000
C) A 15 percent coupon bond selling for $1,000
D) A 15 percent coupon bond selling for $900
Answer: D
Question Status: Previous Edition
28) Which of the following are 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 negatively related.
C) The yield to maturity is greater than the coupon rate when the bond price is below the par value.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition
29) Which of the following are 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 negatively related.
C) The yield to maturity is greater than the coupon rate when the bond price is above the par value.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

30) Which of the following are 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) All of the above are true.
E) Only A and B of the above are true.
Answer: A
Question Status: Previous Edition
6
Copyright 2012 Pearson Education, Inc.

31) A consol bond is a bond that


A) pays interest annually and its face value at maturity.
B) pays interest in perpetuity and never matures.
C) pays no interest but pays its face value at maturity.
D) rises in value as its yield to maturity rises.
Answer: B
Question Status: Previous Edition
32) The yield to maturity on a consol bond that pays $100 yearly and sells for $500 is
A) 5 percent.
B) 10 percent.
C) 12.5 percent.
D) 20 percent.
E) 25 percent.
Answer: D
Question Status: Previous Edition

33) The yield to maturity on a consol bond that pays $200 yearly and sells for $1000 is
A) 5 percent.
B) 10 percent.
C) 20 percent.
D) 25 percent.
Answer: C
Question Status: Previous Edition
34) A frequently used approximation for the yield to maturity on a long-term bond is the
A) coupon rate.
B) current yield.
C) cash flow interest rate.
D) real interest rate.
Answer: B
Question Status: Previous Edition
35) The current yield on a coupon bond is the bond's ________ divided by its ________.
A) annual coupon payment; price
B) annual coupon payment; face value
C) annual return; price
D) annual return; face value
Answer: A
Question Status: Previous Edition
36) When a bond's price falls, its yield to maturity ________ and its current yield ________.
A) falls; falls
B) rises; rises
C) falls; rises
D) rises; falls
Answer: B
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

37) The yield to maturity for a one-year discount bond equals


A) the increase in price over the year, divided by the initial price.
B) the increase in price over the year, divided by the face value.
C) the increase in price over the year, divided by the interest rate.
D) none of the above.
Answer: A
Question Status: Previous Edition
38) If a $10,000 face value discount bond maturing in one year is selling for $8,000, then its yield to
maturity is
A) 10 percent.
B) 20 percent.
C) 25 percent.
D) 40 percent.
Answer: C
Question Status: Previous Edition
39) If a $10,000 face value discount bond maturing in one year is selling for $9,000, then its yield to
maturity is approximately
A) 9 percent.
B) 10 percent.
C) 11 percent.
D) 12 percent.
Answer: C
Question Status: Previous Edition

40) If a $10,000 face value discount bond maturing in one year is selling for $5,000, then its yield to
maturity is
A) 5 percent.
B) 10 percent.
C) 50 percent.
D) 100 percent.
Answer: D
Question Status: Previous Edition

41) If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to
maturity is
A) 0 percent.
B) 5 percent.
C) 10 percent.
D) 20 percent.
Answer: A
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

42) The Fisher equation states that


A) the nominal interest rate equals the real 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) both A and B of the above are true.
E) both A and C of the above are true.
Answer: D
Question Status: Previous Edition

43) 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.
E) none of the above.
Answer: D
Question Status: Previous Edition
44) If you expect the inflation rate to be 5 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) -12 percent.
B) -2 percent.
C) 2 percent.
D) 12 percent.
Answer: C
Question Status: Previous Edition

45) The nominal interest rate minus the expected rate of inflation
A) defines the real interest rate.
B) is a better measure of the incentives to borrow and lend than the nominal interest rate.
C) is a more accurate indicator of the tightness of credit market conditions than the nominal interest rate.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

46) 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
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

47) In which of the following situations would you prefer to be making a loan?
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
Question Status: Previous Edition
48) In which of the following situations would you prefer to be borrowing?
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
Question Status: Previous Edition
49) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one
year later?
A) 5 percent
B) 10 percent
C) -5 percent
D) 25 percent
E) None of the above
Answer: D
Question Status: Previous Edition

50) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one
year later?
A) 5 percent
B) 10 percent
C) -5 percent
D) -10 percent
E) None of the above
Answer: C
Question Status: Previous Edition

51) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year
later is
A) 5 percent.
B) 10 percent.
C) 14 percent.
D) 15 percent.
Answer: D
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

52) The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year
later is
A) -10 percent.
B) -5 percent.
C) 0 percent.
D) 5 percent.
Answer: C
Question Status: Previous Edition
53) Which of the following are generally true of all 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 losses on bonds
whose term to maturities are longer than the holding period.
C) The longer a bond's maturity, the greater is the price change associated with a given interest rate
change.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

54) Which of the following are true concerning the distinction between interest rates and return?
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 sum of 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) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

55) 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
Question Status: Previous Edition

56) 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
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

57) (I) Prices of longer-maturity bonds respond more dramatically to changes in interest rates.
(II) Prices and returns for long-term bonds are less volatile than those for short-term bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

58) (I) Prices of longer-maturity bonds respond less dramatically to changes in interest rates.
(II) Prices and returns for long-term bonds are less volatile than those for shorter-term bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: D
Question Status: Previous Edition

59) The riskiness of an asset's return that results from interest rate changes is called
A) interest-rate risk.
B) coupon-rate risk.
C) reinvestment risk.
D) yield-to-maturity risk.
Answer: A
Question Status: Previous Edition
60) If an investor's holding period is longer than the term to maturity of a bond, he or she is exposed to
A) interest-rate risk.
B) reinvestment risk.
C) bond-market risk.
D) yield-to-maturity risk.
Answer: B
Question Status: Previous Edition
61) Reinvestment risk is the risk that
A) a bond's value may fall in the future.
B) a bond's future coupon payments may have to be invested at a rate lower than the bond's yield to
maturity.
C) an investor's holding period will be short and equal in length to the maturity of the bonds he or she
holds.
D) a bond's issuer may fail to make the future coupon payments and the investor will have no cash to
reinvest.
Answer: B
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

62) (I) The average lifetime of a debt security's stream of payments is called duration.
(II) The duration of a portfolio is the weighted average of the durations of the individual securities, with
the weights reflecting the proportion of the portfolio invested in each.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

63) The duration of a ten-year, 10 percent coupon bond when the interest rate is 10 percent is 6.76 years.
What happens to the price of the bond if the interest rate falls to 8 percent?
A) It rises 20 percent.
B) It rises 12.3 percent.
C) It falls 20 percent.
D) It falls 12.3 percent.
Answer: B
Question Status: Previous Edition

64) When the lender provides the borrower with an amount of funds that must be repaid to the lender at
the maturity date, along with an additional payment for the interest, it is called a ________.
A) fixed-payment loan
B) discount loan
C) simple loan
D) none of the above
Answer: C
Question Status: Previous Edition

65) A discount bond


A) is also called a coupon bond.
B) is also called a zero-coupon bond.
C) is also called a fixed-payment bond.
D) is also called a corporate bond.
Answer: B
Question Status: Previous Edition
66) The interest rate that is adjusted for actual changes in the price level is called the
A) ex post real interest rate.
B) expected interest rate.
C) ex ante real interest rate.
D) none of the above.
Answer: A
Question Status: Previous Edition

13
Copyright 2012 Pearson Education, Inc.

67) The change in the bond's price relative to the initial purchase price is
A) the current yield.
B) coupon payment.
C) yield to maturity.
D) rate of capital gain.
Answer: D
Question Status: Previous Edition
68) The return on a bond is equal to the yield to maturity when
A) the holding period is longer than the maturity of the bond.
B) the maturity of the bond is longer than the holding period.
C) the holding period and the maturity of the bond are identical.
D) none of the above.
Answer: C
Question Status: Previous Edition
69) Bonds whose term to maturity is shorter than the holding period are also subject to
A) default.
B) reinvestment risk.
C) both of the above.
D) none of the above.
Answer: B
Question Status: Previous Edition
70) A ________ is a type of loan that has the same cash flow payment every year throughout the life of
the loan.
A) discount loan
B) simple loan
C) fixed-payment loan
D) interest-free loan
Answer: C
Question Status: Previous Edition

3.2 True/False
1) A bond's current market value is equal to the present value of the coupon payments plus the present
value of the face amount.
Answer: TRUE
Question Status: Previous Edition
2) Discounting the future is the procedure used to find the future value of a dollar received today.
Answer: FALSE
Question Status: Previous Edition
3) The current yield is the best measure of an investor's return from holding a bond.
Answer: FALSE
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

4) Unless a bond defaults, an investor cannot lose money investing in bonds.


Answer: FALSE
Question Status: Previous Edition
5) The current yield is the yearly coupon payment divided by the current market price.
Answer: TRUE
Question Status: Previous Edition
6) Prices for long-term bonds are more volatile than for shorter-term bonds.
Answer: TRUE
Question Status: Previous Edition
7) A long-term bond's price is less affected by interest rate movements than a short-term bond's price.
Answer: FALSE
Question Status: Previous Edition
8) Increasing duration implies that interest-rate risk has increased.
Answer: TRUE
Question Status: Previous Edition
9) All else being equal, the greater the interest rate the greater the duration is.
Answer: FALSE
Question Status: Previous Edition
10) Interest-rate risk is the uncertainty that an investor faces because the interest rate at which a bond's
future coupon payments can be invested is unknown.
Answer: FALSE
Question Status: Previous Edition
11) The real interest rate is equal to the nominal rate minus inflation.
Answer: TRUE
Question Status: Previous Edition
12) The current yield goes up as the price of a bond falls.
Answer: TRUE
Question Status: Previous Edition
13) Changes in interest rates make investments in long-term bonds risky.
Answer: TRUE
Question Status: Previous Edition
14) Bonds with a maturity that is longer than the holding period have no interest-rate risk.
Answer: FALSE
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

3.3 Essay
1) Distinguish between coupon rate, yield to maturity, and current yield.
Question Status: Previous Edition
2) Describe the cash flows received from owning a coupon bond.
Question Status: Previous Edition
3) What concept is used to value a bond?
Question Status: Previous Edition
4) How is a bond's current yield calculated? Why is current yield a more accurate approximation of yield
to maturity for a long-term bond than for a short-term bond?
Question Status: Previous Edition
5) Why are long-term bonds more risky than short-term bonds?
Question Status: Previous Edition
6) What is interest-rate risk and how is it measured?
Question Status: Previous Edition
7) Why may a bond's rate of return differ from its yield to maturity?
Question Status: Previous Edition
8) How does reinvestment risk differ from interest-rate risk?
Question Status: Previous Edition
9) What is the distinction between the nominal interest rate and the real interest rate? Which is a better
indicator of incentives to borrow and lend? Why?
Question Status: Previous Edition
10) Describe how Treasury Inflation Protection Securities (TIPS) work and how they help policymakers
estimate expected inflation.
Question Status: Previous Edition
11) What is the purpose of discounting cash flows?
Question Status: Previous Edition

16
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 4 Why Do Interest Rates Change?
4.1 Multiple Choice
1) As the price of a bond ________ and the expected return ________, bonds become more attractive to
investors and the quantity demanded rises.
A) falls; rises
B) falls; falls
C) rises; rises
D) rises; falls
Answer: A
Question Status: Previous Edition
2) 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
Question Status: Previous Edition

3) When the price of a bond is above the equilibrium price, there is excess ________ in the bond market
and the price will ________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
Answer: C
Question Status: Previous Edition

4) When the price of a bond is below the equilibrium price, there is excess ________ in the bond market
and the price will ________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
Answer: A
Question Status: Previous Edition
5) When the price of a bond is ________ the equilibrium price, there is an excess supply of bonds and
the price will ________.
A) above; rise
B) above; fall
C) below; fall
D) below; rise
Answer: B
Question Status: Previous Edition
1
Copyright 2012 Pearson Education, Inc.

6) When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and
the price will ________.
A) above; rise
B) above; fall
C) below; fall
D) below; rise
Answer: D
Question Status: Previous Edition

7) When the interest rate on a bond is above the equilibrium interest rate, there is excess ________ in the
bond market and the interest rate will ________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
Answer: B
Question Status: Previous Edition

8) When the interest rate on a bond is below the equilibrium interest rate, there is excess ________ in
the bond market and the interest rate will ________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
Answer: D
Question Status: Previous Edition

9) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________
in the bond market and the interest rate will ________.
A) above; demand; fall
B) above; demand; rise
C) below; supply; fall
D) above; supply; rise
Answer: A
Question Status: Previous Edition
10) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________
in the bond market and the interest rate will ________.
A) below; demand; rise
B) below; demand; fall
C) below; supply; rise
D) above; supply; fall
Answer: C
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) When the demand for bonds ________ or the supply of bonds ________, interest rates rise.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
Answer: D
Question Status: Previous Edition
12) When the demand for bonds ________ or the supply of bonds ________, interest rates fall.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
Answer: B
Question Status: Previous Edition
13) When the demand for bonds ________ or the supply of bonds ________, bond prices rise.
A) increases; decreases
B) decreases; increases
C) decreases; decreases
D) increases; increases
Answer: A
Question Status: Previous Edition
14) When the demand for bonds ________ or the supply of bonds ________, bond prices fall.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
Answer: D
Question Status: Previous Edition
15) Factors that determine the demand for an asset include changes in the
A) wealth of investors.
B) liquidity of bonds relative to alternative assets.
C) expected returns on bonds relative to alternative assets.
D) risk of bonds relative to alternative assets.
E) all of the above.
Answer: E
Question Status: Previous Edition

16) The demand for an asset rises if ________ falls.


A) risk relative to other assets
B) expected return relative to other assets
C) liquidity relative to other assets
D) wealth
Answer: A
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

17) The higher the standard deviation of returns on an asset, the ________ the asset's ________.
A) greater; risk
B) smaller; risk
C) greater; expected return
D) smaller; expected return
Answer: A
Question Status: Previous Edition
18) Diversification benefits an investor by
A) increasing wealth.
B) increasing expected return.
C) reducing risk.
D) increasing liquidity.
Answer: C
Question Status: Previous Edition
19) In a recession when income and wealth are falling, the demand for bonds ________ and the demand
curve shifts to the ________.
A) falls; right
B) falls; left
C) rises; right
D) rises; left
Answer: B
Question Status: Previous Edition
20) During business cycle expansions when income and wealth are rising, the demand for bonds
________ and the demand curve shifts to the ________.
A) falls; right
B) falls; left
C) rises; right
D) rises; left
Answer: C
Question Status: Previous Edition

21) Higher expected interest rates in the future ________ the demand for long-term bonds and shift the
demand curve to the ________.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

22) Lower expected interest rates in the future ________ the demand for long-term bonds and shift the
demand curve to the ________
A) increase; left.
B) increase; right.
C) decrease; left.
D) decrease; right.
Answer: B
Question Status: Previous Edition

23) When people begin to expect a large stock market decline, the demand curve for bonds shifts to the
________ and the interest rate ________.
A) right; falls
B) right; rises
C) left; falls
D) left; rises
Answer: A
Question Status: Previous Edition

24) When people begin to expect a large run up in stock prices, 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
Question Status: Previous Edition
25) An increase in the expected rate of inflation will ________ the expected return on bonds relative to
that on ________ assets, and shift the ________ curve to the left.
A) reduce; financial; demand
B) reduce; real; demand
C) raise; financial; supply
D) raise; real; supply
Answer: B
Question Status: Previous Edition

26) A decrease in the expected rate of inflation will ________ the expected return on bonds relative to
that on ________ assets.
A) reduce; financial
B) reduce; real
C) raise; financial
D) raise; real
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

27) When the expected inflation rate increases, the demand for bonds ________, the supply of bonds
________, and the interest rate ________.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
Answer: D
Question Status: Previous Edition

28) When the expected inflation rate decreases, the demand for bonds ________, the supply of bonds
________, and the interest rate ________.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
Answer: C
Question Status: Previous Edition

29) When bond prices become more volatile, the demand for bonds ________ and the interest rate
________.
A) increases; rises
B) increases; falls
C) decreases; falls
D) decreases; rises
Answer: D
Question Status: Previous Edition
30) When bond prices become less volatile, the demand for bonds ________ and the interest rate
________.
A) increases; rises
B) increases; falls
C) decreases; falls
D) decreases; rises
Answer: B
Question Status: Previous Edition

31) When prices in the stock market become more uncertain, 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: B
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) 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
Question Status: Previous Edition

33) When bonds become more widely traded, and as a consequence the market becomes more 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: B
Question Status: Previous Edition

34) 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
Question Status: Previous Edition
35) Factors that cause the demand curve for bonds to shift to the left include
A) an increase in the inflation rate.
B) an increase in the liquidity of stocks.
C) a decrease in the volatility of stock prices.
D) all of the above.
E) none of the above.
Answer: D
Question Status: Previous Edition

36) Factors that cause the demand curve for bonds to shift to the left include
A) a decrease in the inflation rate.
B) an increase in the volatility of stock prices.
C) an increase in the liquidity of stocks.
D) all of the above.
E) only A and B of the above.
Answer: C
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

37) During an economic expansion, the supply of bonds ________ and the supply curve shifts to the
________.
A) increases, left
B) increases, right
C) decreases, left
D) decreases, right
Answer: B
Question Status: Previous Edition

38) During a recession, the supply of bonds ________ and the supply curve shifts to the ________.
A) increases, left
B) increases, right
C) decreases, left
D) decreases, right
Answer: C
Question Status: Previous Edition
39) An increase in expected inflation causes the supply of bonds to ________ and the supply curve to
shift to the ________.
A) increase, left
B) increase, right
C) decrease, left
D) decrease, right
Answer: B
Question Status: Previous Edition
40) When the federal government's budget deficit increases, the ________ curve for bonds shifts to the
________.
A) demand; right
B) demand; left
C) supply; left
D) supply; right
Answer: D
Question Status: Previous Edition

41) When the federal government's budget deficit decreases, the ________ curve for bonds shifts to the
________.
A) demand; right
B) demand; left
C) supply; left
D) supply; right
Answer: C
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

42) When the inflation rate is expected to increase, the expected return on bonds relative to real assets
falls for any given interest rate; as a result, the ________ bonds falls and the ________ curve shifts to
the left.
A) demand for; demand
B) demand for; supply
C) supply of; demand
D) supply of; supply
Answer: A
Question Status: Previous Edition

43) When the inflation rate is expected to increase, the real cost of borrowing declines at any given
interest rate; as a result, the ________ bonds increases and the ________ curve shifts to the right.
A) demand for; demand
B) demand for; supply
C) supply of; demand
D) supply of; supply
Answer: D
Question Status: Previous Edition

Figure 4.1
44) In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i1 to i2 is
A) an increase in the price of bonds.
B) a business cycle boom.
C) an increase in the expected inflation rate.
D) a decrease in the expected inflation rate.
Answer: C
Question Status: Previous Edition

45) In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i1 to i2 is
a(n) ________ in the ________.
A) increase; expected inflation rate
B) decrease; expected inflation rate
C) increase; government budget deficit
D) decrease; government budget deficit
Answer: A
Question Status: Previous Edition
9
Copyright 2012 Pearson Education, Inc.

46) In Figure 4.1, the most likely cause of a decrease in the equilibrium interest rate from i2 to i1 is
A) an increase in the expected inflation rate.
B) a decrease in the expected inflation rate.
C) a business cycle expansion.
D) a combination of both A and C of the above.
Answer: B
Question Status: Previous Edition

47) Factors that can cause the supply curve for bonds to shift to the right include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) a decrease in government deficits.
D) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition

48) Factors that can cause the supply curve for bonds to shift to the left include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) an increase in government deficits.
D) only A and C of the above.
Answer: B
Question Status: Previous Edition
49) The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates
________ as the expected rate of inflation ________.
A) rise; increases
B) rise; stabilizes
C) rise; decreases
D) fall; increases
E) fall; stabilizes
Answer: A
Question Status: Previous Edition

50) An increase in the expected rate of inflation causes the demand for bonds to ________ and the
supply for bonds to ________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise
Answer: B
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

51) A decrease in the expected rate of inflation causes the demand for bonds to ________ and the supply
of bonds to ________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise
Answer: C
Question Status: Previous Edition
52) When the economy slips into a recession, normally the demand for bonds ________, the supply of
bonds ________, and the interest rate ________.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
Answer: B
Question Status: Previous Edition

53) When the economy enters into a boom, normally the demand for bonds ________,
the supply of bonds ________, and the interest rate ________.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; rises
D) decreases; increases; rises
Answer: A
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

Figure 4.2
54) In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is a(n)
________ in ________.
A) increase; the expected inflation rate
B) decrease; the expected inflation rate
C) increase; economic growth
D) decrease; economic growth
Answer: C
Question Status: Previous Edition

55) In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is
A) an increase in economic growth.
B) an increase in government budget deficits.
C) a decrease in government budget deficits.
D) a decrease in economic growth.
E) a decrease in the riskiness of bonds relative to other investments.
Answer: A
Question Status: Previous Edition

56) In Figure 4.2, one possible explanation for a decrease in the interest rate from i2 to i1 is
A) an increase in government budget deficits.
B) an increase in expected inflation.
C) a decrease in economic growth.
D) a decrease in the riskiness of bonds relative to other investments.
Answer: C
Question Status: Previous Edition

57) 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
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

58) In his liquidity preference framework, Keynes assumed that money has a zero rate of return; thus,
when interest rates ________ the expected return on money falls relative to the expected return on
bonds, causing the demand for money to ________.
A) rise; fall
B) rise; rise
C) fall; fall
D) fall; rise
Answer: A
Question Status: Previous Edition

59) The loanable funds 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) the supply of money; bonds.
Answer: B
Question Status: Previous Edition
60) When comparing the loanable funds and liquidity preference frameworks of interest rate
determination, which of the following is true?
A) The liquidity preference framework is easier to use when analyzing the effects of changes in
expected inflation.
B) The loanable funds framework provides a simpler analysis of the effects of changes in income, the
price level, and the supply of money.
C) In most instances, the two approaches to interest rate determination yield the same predictions.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: C
Question Status: Previous Edition

61) A higher level of income causes the demand for money to ________ and the interest rate to
________
A) decrease; decrease.
B) decrease; increase.
C) increase; decrease.
D) increase; increase.
Answer: D
Question Status: Previous Edition

62) A lower level of income causes the demand for money to ________ and the interest rate to
________
A) decrease; decrease.
B) decrease; increase.
C) increase; decrease.
D) increase; increase.
Answer: A
Question Status: Previous Edition

13
Copyright 2012 Pearson Education, Inc.

63) A rise in the price level causes the demand for money to ________ and the demand curve to shift to
the ________
A) decrease; right.
B) decrease; left.
C) increase; right.
D) increase; left.
Answer: C
Question Status: Previous Edition
64) A decline in the price level causes the demand for money to ________ and the demand curve to shift
to the ________
A) decrease; right.
B) decrease; left.
C) increase; right.
D) increase; left.
Answer: B
Question Status: Previous Edition

65) A decline in the expected inflation rate causes the demand for money to ________ and the demand
curve to shift to the ________
A) decrease; right.
B) decrease; left.
C) increase; right.
D) increase; left.
Answer: B
Question Status: Previous Edition

66) Holding everything else constant, an increase in the money supply causes
A) interest rates to decline initially.
B) interest rates to increase initially.
C) bond prices to decline initially.
D) both A and C of the above.
E) both B and C of the above.
Answer: A
Question Status: Previous Edition

67) Holding everything else constant, a decrease in the money supply causes
A) interest rates to decline initially.
B) interest rates to increase initially.
C) bond prices to increase initially.
D) both A and C of the above.
E) both B and C of the above.
Answer: B
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

Figure 4.3
68) In Figure 4.3, the factor responsible for the decline in the interest rate is
A) a decline in 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
Question Status: Previous Edition
69) In Figure 4.3, 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) only A and B of the above.
Answer: B
Question Status: Previous Edition

70) In Figure 4.3, an increase in the interest rate from i 2 to i1 can be explained by
A) a decrease in money growth.
B) an increase in money growth.
C) a decline in the price level.
D) an increase in the expected price level.
Answer: A
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

71) If the liquidity effect is smaller than the other effects, and the adjustment of expected inflation is
slow, then the
A) interest rate will fall.
B) interest rate will rise.
C) interest rate will initially fall but eventually climb above the initial level in response to an increase in
money growth.
D) interest rate will initially rise but eventually fall below the initial level in response to an increase in
money growth.
Answer: C
Question Status: Previous Edition

72) When the growth rate of the money supply increases, interest rates end up being permanently lower
if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.
Answer: A
Question Status: Previous Edition

73) When the growth rate of the money supply decreases, interest rates end up being permanently lower
if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.
Answer: D
Question Status: Previous Edition

74) When the growth rate of the money supply is decreased, interest rates will rise immediately if the
liquidity effect is ________ than the other effects and if there is ________ adjustment of expected
inflation.
A) larger; rapid
B) larger; slow
C) smaller; slow
D) smaller; rapid
Answer: B
Question Status: Previous Edition
75) When the growth rate of the money supply is increased, interest rates will rise immediately if the
liquidity effect is ________ than the other effects and if there is ________ adjustment of expected
inflation.
A) larger; rapid
B) larger; slow
C) smaller; slow
D) smaller; rapid
Answer: D
Question Status: Previous Edition

16
Copyright 2012 Pearson Education, Inc.

76) If the Fed wants to permanently lower interest rates, then it should lower 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: C
Question Status: Previous Edition
77) If the Fed 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
Question Status: Previous Edition
78) Milton Friedman contends that it is entirely 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
Question Status: Previous Edition

Figure 4.4
79) Figure 4.4 illustrates the effect of an increased rate of money supply growth. From the figure, one
can conclude that the liquidity effect is ________ than the expected inflation effect and interest rates
adjust ________ to changes in expected inflation.
A) smaller; quickly
B) larger; quickly
C) larger; slowly
D) smaller; slowly
Answer: C
Question Status: Previous Edition

17
Copyright 2012 Pearson Education, Inc.

80) Figure 4.4 illustrates the effect of an increased rate of money supply growth. 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
Question Status: Previous Edition

81) ________ is the total resources owned by an individual, including all assets.
A) Expected return
B) Wealth
C) Liquidity
D) Risk
Answer: B
Question Status: Previous Edition
82) A ________ prefers stock in a less risky asset than in a riskier asset.
A) risk preferrer
B) risk-averse person
C) risk lover
D) risk-favorable person
Answer: B
Question Status: Previous Edition
83) When the quantity of bonds demanded equals the quantity of bonds supplied, there is
A) excess supply.
B) excess demand.
C) a market equilibrium.
D) an asset market approach.
Answer: C
Question Status: Previous Edition
84) Determining asset prices using stocks of assets rather than flow is called
A) asset transformation.
B) expected return.
C) asset market approach.
D) market equilibrium.
Answer: C
Question Status: Previous Edition

18
Copyright 2012 Pearson Education, Inc.

85) What is the model whose equations are estimated using statistical procedures used in forecasting
interest rates called?
A) econometric model
B) liquidity preference framework
C) market equilibrium
D) Fisher effect
Answer: A
Question Status: Previous Edition

4.2 True/False
1) When interest rates decrease, the demand curve for bonds shifts to the left.
Answer: FALSE
Question Status: Previous Edition
2) When an economy grows out of a recession, normally the demand for bonds increases and the supply
of bonds increases.
Answer: TRUE
Question Status: Previous Edition
3) When the federal government's budget deficit decreases, the demand curve for bonds shifts to the
right.
Answer: FALSE
Question Status: Previous Edition
4) Investors make their choices of which assets to hold by comparing the expected return, liquidity, and
risk of alternative assets.
Answer: TRUE
Question Status: Previous Edition
5) A person who is risk averse prefers to hold assets that are more, not less, risky.
Answer: FALSE
Question Status: Previous Edition
6) Interest rates are procyclical in that they tend to rise during business cycle expansions and fall during
recessions.
Answer: TRUE
Question Status: Previous Edition
7) When income and wealth are rising, the demand for bonds rises and the demand curve shifts to the
right.
Answer: TRUE
Question Status: Previous Edition
8) An increase in the inflation rate will cause the demand curve for bonds to shift to the right.
Answer: FALSE
Question Status: Previous Edition

19
Copyright 2012 Pearson Education, Inc.

9) The Fisher Effect predicts that an increase in expected inflation will lower the interest rate on bonds.
Answer: FALSE
Question Status: Previous Edition
10) An increase in the federal government budget deficit will raise the interest rate on bonds.
Answer: TRUE
Question Status: Previous Edition
11) Holding everything else constant, an increase in wealth lowers the quantity demanded of an asset.
Answer: FALSE
Question Status: Previous Edition
12) An increase in an asset's expected return relative to that of an alternative asset, holding everything
else unchanged, raises the quantity demanded of the asset.
Answer: TRUE
Question Status: Previous Edition
13) The more liquid an asset is relative to alternative assets, holding everything else unchanged, the
more desirable it is, and the greater the quantity demanded.
Answer: TRUE
Question Status: Previous Edition
14) A movement along the demand (or supply) curve occurs when the quantity demanded (or supplied)
changes at each given price (or interest rate) of the bond in response to a change in some other factor
besides the bond's price or interest rate.
Answer: FALSE
Question Status: Previous Edition
4.3 Essay
1) Identify and explain the four factors that influence asset demand. Which of these factors affect total
asset demand and which influence investors to demand one asset over another?
Question Status: Previous Edition
2) How is the equilibrium interest rate determined in the bond market? Explain why the interest rate will
move toward equilibrium if it is temporarily above or below the equilibrium rate.
Question Status: Previous Edition
3) Use the bond demand and supply framework to explain the Fisher effect and why it occurs.
Question Status: Previous Edition
4) If investors perceive greater interest rate risk, what will happen to the equilibrium interest rate in the
bond market? Explain using the bond demand and supply framework.
Question Status: Previous Edition
5) How will a decrease in the federal government's budget deficit affect the equilibrium interest rate in
the bond market? Explain using the bond demand and supply framework.
Question Status: Previous Edition

20
Copyright 2012 Pearson Education, Inc.

6) What is the expected return on a bond if the return is 9% two-thirds of the time and 3% one-third of
the time? What is the standard deviation of the returns on this bond? Would you prefer this bond or one
with an identical expected return and a standard deviation of 4.5? Why?
Question Status: Previous Edition
7) Identify and describe three factors that cause the supply curve for bonds to shift.
Question Status: Previous Edition

21
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 5 How Do Risk and Term Structure Affect Interest Rates?
5.1 Multiple Choice
1) The term structure of interest rates is
A) the relationship among interest rates of different bonds with the same risk and maturity.
B) the structure of how interest rates move over time.
C) the relationship among the terms to maturity of different bonds from different issuers.
D) the relationship among interest rates on bonds with different maturities but similar risk.
Answer: D
Question Status: Updated from Previous Edition
2) 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 terms to maturity of different bonds.
D) the relationship among interest rates on bonds with different maturities.
Answer: B
Question Status: Previous Edition
3) Which of the following long-term bonds should have the lowest interest rate?
A) Corporate Baa bonds
B) U.S. Treasury bonds
C) Corporate Aaa bonds
D) Municipal bonds
Answer: D
Question Status: Previous Edition
4) Which of the following long-term bonds should have the highest interest rate?
A) Corporate Baa bonds
B) U.S. Treasury bonds
C) Corporate Aaa bonds
D) Municipal bonds
Answer: A
Question Status: Previous Edition
5) The risk premium on corporate bonds becomes smaller if
A) the riskiness of corporate bonds increases.
B) the liquidity of corporate bonds increases.
C) the liquidity of corporate bonds decreases.
D) the riskiness of corporate bonds decreases.
E) either B or D of the above occur.
Answer: E
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) Bonds with relatively low risk of default are called


A) zero coupon bonds.
B) junk bonds.
C) investment-grade bonds.
D) none of the above.
Answer: C
Question Status: Previous Edition
7) 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
Question Status: Previous Edition
8) A corporation suffering big losses might be more likely to suspend interest payments on its bonds,
thereby
A) raising the default risk and causing the demand for its bonds to rise.
B) raising the default risk and causing the demand for its bonds to fall.
C) lowering the default risk and causing the demand for its bonds to rise.
D) lowering the default risk and causing the demand for its bonds to fall.
Answer: B
Question Status: Previous Edition

9) (I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest
rates the firm must pay.
(II) The spread between the interest rates on bonds with default risk and default-free bonds is called the
risk premium.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition

10) Holding everything else constant, if a corporation begins to suffer large losses, then the default risk
on its bonds will ________ and the expected return on those bonds will ________.
A) increase: increase
B) decrease; increase
C) increase; decrease
D) decrease; decrease
Answer: C
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds
will ________ and the expected return on those bonds will ________.
A) increase; decrease
B) decrease; decrease
C) increase; increase
D) decrease; increase
Answer: D
Question Status: Previous Edition

12) If a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the
equilibrium interest rate on these bonds will ________.
A) increase; decrease
B) decrease; increase
C) increase; increase
D) decrease; decrease
Answer: C
Question Status: Previous Edition

13) If a corporation's earnings rise, then the default risk on its bonds will ________ and the equilibrium
interest rate on these bonds will ________.
A) increase; decrease
B) decrease; decrease
C) increase; increase
D) decrease; increase
Answer: B
Question Status: Previous Edition

14) When the default risk on corporate bonds decreases, other things equal, the demand curve for
corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right
Answer: B
Question Status: Previous Edition
15) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the
right.
(II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the
left.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: D
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the
left.
(II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the
right.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

17) The spread between interest rates on low-quality corporate bonds and U.S. government bonds
________ during the Great Depression.
A) was reversed
B) narrowed significantly
C) widened significantly
D) did not change
Answer: C
Question Status: Previous Edition

18) As a result of the subprime collapse, the demand for low -quality corporate bonds ________, the
demand for high-quality Treasury bonds ________, and the risk spread ________.
A) increased; decreased; was unchanged
B) decreased; increased; increased
C) increased; decreased; decreased
D) decreased; increased; was unchanged
Answer: B
Question Status: Updated from Previous Edition
19) Moody's and Standard and Poor's are agencies that
A) help investors collect when corporations default on their bonds.
B) advise municipal bond issuers on the tax exempt status of their bonds.
C) produce information about the probability of default on corporate bonds.
D) maintain liquid markets for corporate bonds.
Answer: C
Question Status: Previous Edition
20) If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the
bond ________ and its yield ________.
A) increases; decreases
B) decreases; increases
C) increases; increases
D) decreases; decreases
Answer: B
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) Corporate bonds are not as liquid as government bonds because


A) fewer 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) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition

22) (I) The risk premium widens as the default risk on corporate bonds increases.
(II) The risk premium widens as corporate bonds become less liquid.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

23) When the corporate bond market becomes less liquid, other things equal, the demand curve for
corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right
Answer: D
Question Status: Previous Edition
24) When the corporate 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 ________.
A) right; right
B) right; left
C) left; left
D) left; right
Answer: B
Question Status: Previous Edition

25) (I) If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest
rate to rise.
(II) If a corporate bond becomes less liquid, the demand for Treasury bonds does not change.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) (I) If a corporate bond becomes less liquid, the interest rate on the bond will fall.
(II) If a corporate bond becomes less liquid, the interest rate on Treasury bonds will fall.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition

27) If income tax rates were lowered, then


A) the interest rate on municipal bonds would fall.
B) the interest rate on Treasury bonds would rise.
C) the interest rate on municipal bonds would rise.
D) the price of Treasury bonds would fall.
Answer: C
Question Status: Previous Edition
28) If income tax rates rise, then
A) the prices of municipal bonds will fall.
B) the prices of Treasury bonds will rise.
C) the interest rate on Treasury bonds will rise.
D) the interest rate on municipal bonds will rise.
Answer: C
Question Status: Previous Edition
29) An increase in marginal tax rates would likely have the effect of ________ the demand for
municipal bonds and ________ the demand for U.S. government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing
Answer: B
Question Status: Previous Edition

30) A decrease in marginal tax rates would likely have the effect of ________ the demand for municipal
bonds and ________ the demand for U.S. government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing
Answer: C
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

31) Which of the following statements are true?


A) Because coupon payments on municipal bonds are exempt from 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 increase the demand for municipal bonds, lowering their interest rates.
C) Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption.
D) All of the above are true statements.
E) Only A and B are true statements.
Answer: D
Question Status: Previous Edition

32) Which of the following statements are true?


A) Because coupon payments on municipal bonds are exempt from 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 increase the demand for Treasury bonds, lowering their interest rates.
C) Interest rates on municipal bonds will be higher than on comparable bonds without the tax
exemption.
D) Only A and B are true statements.
Answer: A
Question Status: Previous Edition
33) When a municipal bond is given tax-free status, the demand for municipal bonds shifts ________,
causing the interest rate on the bond to ________.
A) leftward; rise
B) leftward; fall
C) rightward; rise
D) rightward; fall
Answer: D
Question Status: Previous Edition

34) When a municipal bond is given tax-free status, the demand for Treasury bonds shifts ________,
and the interest rate on Treasury bonds ________.
A) leftward; rises
B) leftward; falls
C) rightward; rises
D) rightward; falls
Answer: A
Question Status: Previous Edition

35) If municipal bonds were to lose their tax-free status, then the demand for Treasury bonds would shift
________, and the interest rate on Treasury bonds would ________.
A) rightward; fall
B) rightward; rise
C) leftward; fall
D) leftward; rise
Answer: A
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

36) The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent
over the next ten years. As a result of this tax cut, the demand for municipal bonds should shift to the
________ and the interest rate on municipal bonds should ________.
A) right; decline
B) right; increase
C) left; decline
D) left; increase
Answer: D
Question Status: Previous Edition

37) The relationship among interest rates on bonds with identical default risk but different maturities is
called the
A) time-risk structure of interest rates.
B) liquidity structure of interest rates.
C) yield curve.
D) bond demand curve.
Answer: C
Question Status: Previous Edition
38) Yield curves can be classified as
A) upward-sloping.
B) downward-sloping.
C) flat.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

39) Typically, yield curves are


A) gently upward-sloping.
B) gently downward-sloping.
C) flat.
D) bowl shaped.
E) mound shaped.
Answer: A
Question Status: Previous Edition

40) 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.
E) medium-term interest rates are below both short-term and long-term interest rates.
Answer: A
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

41) 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 behavior 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
Question Status: Previous Edition
42) According to the expectations theory of the term structure,
A) the interest rate on long-term bonds will exceed the average of expected future short-term interest
rates.
B) interest rates on bonds of different maturities move together over time.
C) buyers of bonds prefer short-term to long-term bonds.
D) all of the above.
E) only A and B of the above.
Answer: B
Question Status: Previous Edition

43) According to the expectations theory of the term structure,


A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the
future.
B) when the yield curve is downward-sloping, short-term interest rates are expected to decline in the
future.
C) buyers of bonds prefer short-term to long-term bonds.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

44) According to the expectations theory of the term structure,


A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise 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, explaining why yield
curves typically slope upward.
D) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

45) According to the expectations theory of the term structure,


A) yield curves should be equally likely to slope downward as to slope upward.
B) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the
future.
C) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively
stable in the future.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

46) If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2
percent, and 1 percent, then the pure expectations theory predicts that today's interest rate on the fouryear bond is
A) 1 percent.
B) 2 percent.
C) 4 percent.
D) none of the above.
Answer: D
Question Status: Previous Edition

47) If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent, 3
percent, 4 percent, and 5 percent, then the pure expectations theory predicts that the bond with the
highest interest rate today is the one with a maturity of
A) one year.
B) two years.
C) three years.
D) four years.
E) five years.
Answer: E
Question Status: Previous Edition

48) If the expected path of one-year interest rates over the next five years is 2 percent, 4 percent, 1
percent, 4 percent, and 3 percent, then the pure 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
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

49) According to the market segmentation theory of the term structure,


A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that
maturity.
B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on
bonds of different maturities do not move together over time.
C) investors' strong preference for short-term relative to long-term bonds explains why yield curves
typically slope upward.
D) all of the above.
E) none of the above.
Answer: D
Question Status: Previous Edition

50) According to the market segmentation theory of the term structure,


A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that
maturity.
B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on
bonds of different maturities do not move together over time.
C) investors' strong preference for short-term relative to long-term bonds explains why yield curves
typically slope downward.
D) only A and B of the above.
Answer: D
Question Status: Previous Edition

51) The liquidity premium theory of the term structure


A) indicates that today's long-term interest rate equals the average of short-term interest rates that people
expect to occur over the life of the long-term bond.
B) assumes that bonds of different maturities are perfect substitutes.
C) suggests that markets for bonds of different maturities are completely separate because people have
different preferences.
D) does none of the above.
Answer: D
Question Status: Previous Edition

52) The liquidity premium theory of the term structure


A) assumes investors tend to prefer short-term bonds because they have less interest-rate risk.
B) assumes that interest rates on the long-term bond respond to demand and supply conditions for that
bond.
C) assumes that an average of expected short-term rates is an important component of interest rates on
long-term bonds.
D) assumes all of the above.
E) assumes none of the above.
Answer: D
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

53) According to the liquidity premium theory of the term structure,


A) 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 liquidity premium.
B) buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of
different maturities move together over time.
C) even with a positive liquidity premium, if future short-term interest rates are expected to fall
significantly, then the yield curve will be downward-sloping.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

54) According to the liquidity premium theory of the term structure,


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 cannot be downward-sloping.
D) all of the above.
E) only A and B of the above.
Answer: B
Question Status: Previous Edition

55) If the yield curve slope is flat, the liquidity premium theory indicates that the market is predicting
A) a mild rise in short-term interest rates in the near future and a mild decline further out in the future.
B) constant short-term interest rates in the near future and further out in the future.
C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out
in the future.
D) constant short-term interest rates in the near future and a mild decline further out in the future.
Answer: C
Question Status: Previous Edition

56) If the yield curve has a mild upward slope, the liquidity premium theory 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
Question Status: Previous Edition

57) 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.
Answer: D
Question Status: Previous Edition
12
Copyright 2012 Pearson Education, Inc.

58) According to the liquidity premium theory of the term structure, when the yield curve has its usual
slope, the market expects
A) short-term interest rates to rise sharply.
B) short-term interest rates to drop sharply.
C) short-term interest rates to stay near their current levels.
D) none of the above.
Answer: C
Question Status: Previous Edition

59) In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major
shortcoming of the
A) market segmentation theory.
B) expectations theory.
C) liquidity premium theory.
D) separable markets theory.
Answer: B
Question Status: Previous Edition

60) Which theory of the term structure proposes that bonds of different maturities are not substitutes for
one another?
A) market segmentation theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: A
Question Status: Previous Edition

61) Since yield curves are usually upward sloping, the ________ indicates that, on average, people tend
to prefer holding short-term bonds to long-term bonds.
A) market segmentation theory
B) expectations theory
C) liquidity premium theory
D) both A and B of the above
E) both A and C of the above
Answer: E
Question Status: Previous Edition

62) ________ cannot explain the empirical fact that interest rates on bonds of different maturities tend to
move together.
A) The market segmentation theory
B) The expectations theory
C) The liquidity premium theory
D) Both A and B of the above
E) Both A and C of the above
Answer: A
Question Status: Previous Edition

13
Copyright 2012 Pearson Education, Inc.

63) Of the four theories that explain how interest rates on bonds with different terms to maturity are
related, the one that views long-term interest rates as equaling the average of future short-term rates
expected to occur over the life of the bond is the
A) pure expectations theory.
B) preferred habitat theory.
C) liquidity premium theory.
D) segmented markets theory.
Answer: A
Question Status: Previous Edition

64) Of the four theories that explain how interest rates on bonds with different terms to maturity are
related, the one that assumes that bonds of different maturities are not substitutes for one another is the
A) expectations theory.
B) segmented markets theory.
C) liquidity premium theory.
D) preferred habitat theory.
Answer: B
Question Status: Previous Edition

65) A moderately upward-sloping yield curve indicates that short-term interest rates are expected to
A) neither rise nor fall in the near future.
B) remain relatively unchanged, but that long-term rates are expected to fall.
C) neither rise nor fall, but that long-term rates are expected to rise moderately.
D) rise moderately in the near future.
Answer: A
Question Status: Previous Edition
66) A steep upward-sloping yield curve indicates that short-term interest rates are expected to
A) neither rise nor fall in the near future.
B) remain relatively unchanged, but that long-term rates are expected to fall.
C) neither rise nor fall, but that long-term rates are expected to rise moderately.
D) rise moderately in the near future.
Answer: D
Question Status: Previous Edition
67) A bond rating of Aa or AA would mean that the quality of the bond is
A) the highest.
B) high.
C) medium grade.
D) speculative.
Answer: B
Question Status: Previous Edition
68) ________ bonds are the most liquid of all long-term bonds.
A) Callable
B) Municipal
C) Corporate Aaa
D) U.S. Treasury
Answer: D
Question Status: Previous Edition
14
Copyright 2012 Pearson Education, Inc.

69) ________ bonds are exempt from federal income taxes.


A) Corporate Aaa
B) U.S. Treasury
C) Corporate Baa
D) Municipal
Answer: D
Question Status: Previous Edition
70) The risk structure of interest rates is explained by
A) default risk.
B) liquidity.
C) tax considerations.
D) all of the above.
Answer: D
Question Status: Previous Edition
71) The ________ theory is the most widely accepted theory of the term structure of interest rates
because it explains the major empirical facts about the term structure so well.
A) liquidity premium
B) market segmentation
C) expectations
D) none of the above
Answer: A
Question Status: Previous Edition

72) ________ are investment advisory firms that rate the quality of corporate and municipal bonds in
terms of probability of default.
A) Financial institutions
B) Credit-rating agencies
C) Securities companies
D) none of the above
Answer: B
Question Status: Previous Edition
73) If a bond has a favorable tax treatment, its required interest rate (all else equal)
A) will be higher.
B) will not be affected.
C) will be lower.
D) all of the above could happen.
Answer: C
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

5.2 True/False
1) The term structure of interest rates describes how interest rates move over time.
Answer: FALSE
Question Status: Previous Edition
2) The risk structure of interest rates describes the relationship between the interest rates of different
bonds with the same maturities.
Answer: TRUE
Question Status: Previous Edition
3) Following the subprime collapse, the spread (difference) between the interest rates on Baa bonds and
Treasury bonds widened.
Answer: TRUE
Question Status: Updated from Previous Edition
4) The risk premium on corporate bonds becomes smaller as the liquidity of the bonds falls.
Answer: FALSE
Question Status: Previous Edition
5) An increase in income tax rates will cause the interest rates on tax-exempt municipal bonds to fall
relative to the interest rate on taxable corporate securities.
Answer: TRUE
Question Status: Previous Edition
6) The interest rates on bonds of different maturities tend to move together over time.
Answer: TRUE
Question Status: Previous Edition
7) The expectations theory is able to explain why yield curves are usually upward-sloping.
Answer: FALSE
Question Status: Previous Edition
8) According to the expectations theory, the interest rate on a long-term bond is the average of the shortterm interest rates expected over the life of the long-term bond.
Answer: TRUE
Question Status: Previous Edition
9) The market segmentation theory is able to explain why interest rates on bonds of different maturities
move together over time.
Answer: FALSE
Question Status: Previous Edition
10) Bonds with the lowest risk of default are often referred to as junk bonds.
Answer: FALSE
Question Status: Previous Edition
11) A positive liquidity premium indicates that investors prefer long-term bonds over short-term bonds.
Answer: FALSE
Question Status: Previous Edition
16
Copyright 2012 Pearson Education, Inc.

12) A mildly upward-sloping yield curve suggests that the market is predicting constant short-term
interest rates.
Answer: TRUE
Question Status: Previous Edition
13) An increase in the marginal tax rate would likely increase the demand for municipal bonds, and
decrease the demand for U.S. government bonds.
Answer: TRUE
Question Status: Previous Edition
14) When yield curves are downward-sloping, long-term interest rates are above short-term interest
rates.
Answer: FALSE
Question Status: Previous Edition
15) Risk occurs when the issuer of the bond is unable or unwilling to make interest payments when
promised or pay off the face value when the bond matures.
Answer: FALSE
Question Status: Previous Edition
16) The spread between the interest rates on bonds with default risk and default-free bonds is called the
risk premium.
Answer: FALSE
Question Status: Previous Edition
5.3 Essay
1) Contrast the liquidity premium theory to the market segmentation theory of the term structure of
interest rates.
Question Status: Previous Edition
2) Why would an increase in the income tax rate reduce borrowing costs to municipalities?
Question Status: Previous Edition
3) Discuss what is shown by a yield curve.
Question Status: Previous Edition
4) Why is it unlikely that the expectations theory alone is the correct theory for explaining the yield
curve?
Question Status: Previous Edition
5) What is meant by the risk structure of interest rates?
Question Status: Previous Edition
6) How would a severe recession affect the risk premium on corporate bonds?
Question Status: Previous Edition

17
Copyright 2012 Pearson Education, Inc.

7) Explain why a flight to quality occurred following the subprime collapse and how this affected the
interest rates on lower-quality corporate bonds and Treasury bonds.
Question Status: Previous Edition
8) What do credit-rating agencies do and why is this work important?
Question Status: Previous Edition
9) Explain why the liquidity premium theory is so widely accepted.
Question Status: Previous Edition

18
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 6 Are Financial Markets Efficient?
6.1 Multiple Choice
1) How expectations are formed is important because expectations influence
A) the demand for assets.
B) bond prices.
C) the risk structure of interest rates.
D) the term structure of interest rates.
E) all of the above.
Answer: E
Question Status: Previous Edition

2) According to the efficient market 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
Question Status: Previous Edition
3) The efficient market hypothesis
A) is based on the assumption that prices of securities fully reflect all available information.
B) holds that the expected return on a security equals the equilibrium return.
C) both A and B.
D) neither A nor B.
Answer: C
Question Status: Previous Edition
4) If the optimal forecast of the return on a security exceeds the equilibrium return, then
A) the market is inefficient.
B) an unexploited profit opportunity exists.
C) the market is in equilibrium.
D) only A and B of the above are true.
E) only B and C of the above are true.
Answer: D
Question Status: Previous Edition
5) According to the efficient market hypothesis
A) one cannot expect to earn an abnormally high return by purchasing a security.
B) information in newspapers and in the published reports of financial analysts is already reflected in
market prices.
C) unexploited profit opportunities abound, thereby explaining why so many people get rich by trading
securities.
D) all of the above are true.
E) only A and B of the above are true.
Answer: E
Question Status: Previous Edition
1
Copyright 2012 Pearson Education, Inc.

6) Another way to state the efficient market condition is that in an efficient market,
A) unexploited profit opportunities will be quickly eliminated.
B) unexploited profit opportunities will never exist.
C) arbitrageurs guarantee that unexploited profit opportunities never exist.
D) both A and C of the above occur.
Answer: A
Question Status: Previous Edition
7) Another way to state the efficient market hypothesis is that in an efficient market,
A) unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure
that they are instantaneously dissipated.
B) unexploited profit opportunities will not exist for long, as market participants will act quickly to
eliminate them.
C) every financial market participant must be well informed about securities.
D) only A and C of the above.
Answer: B
Question Status: Previous Edition

8) A situation in which the price of an asset differs from its fundamental market value is called
A) an unexploited profit opportunity.
B) a bubble.
C) a correction.
D) a mean reversion.
Answer: B
Question Status: Previous Edition
9) A situation in which the price of an asset differs from its fundamental market value
A) indicates that unexploited profit opportunities exist.
B) indicates that unexploited profit opportunities do not exist.
C) need not indicate that unexploited profit opportunities exist.
D) indicates that the efficient market hypothesis is fundamentally flawed.
Answer: C
Question Status: Previous Edition
10) Studies of mutual fund performance indicate that mutual funds that outperformed the market in one
time period
A) usually beat the market in the next time period.
B) usually beat the market in the next two subsequent time periods.
C) usually beat the market in the next three subsequent time periods.
D) usually do not beat the market in the next time period.
Answer: D
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) The efficient market hypothesis suggests that allocating your funds in the financial markets on the
advice of a financial analyst
A) will certainly mean higher returns than if you had made selections by throwing darts at the financial
page.
B) will always mean lower returns than if you had made selections by throwing darts at the financial
page.
C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial
page.
D) is good for the economy.
Answer: C
Question Status: Previous Edition

12) Ivan Boesky, the most successful of the so-called arbs in the 1980s, was able to outperform the
market on a consistent basis, indicating that
A) securities markets are not efficient.
B) unexploited profit opportunities were abundant.
C) investors can outperform the market with inside information.
D) only B and C of the above.
Answer: C
Question Status: Previous Edition

13) To say that stock prices follow a "random walk" is to argue that
A) stock prices rise, then fall.
B) stock prices rise, then fall in a predictable fashion.
C) stock prices tend to follow trends.
D) stock prices are, for all practical purposes, unpredictable.
Answer: D
Question Status: Previous Edition
14) To say that stock prices follow a "random walk" is to argue that
A) stock prices rise, then fall, then rise again.
B) stock prices rise, then fall in a predictable fashion.
C) stock prices tend to follow trends.
D) stock prices cannot be predicted based on past trends.
Answer: D
Question Status: Previous Edition
15) Rules used to predict movements in stock prices based on past patterns are, according to the efficient
markets theory,
A) a waste of time.
B) profitably employed by all financial analysts.
C) the most efficient rules to employ.
D) consistent with the random walk hypothesis.
Answer: A
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) Tests used to rate the performance of rules developed in technical analysis conclude that
A) technical analysis outperforms the overall market.
B) technical analysis far outperforms the overall market, suggesting that stockbrokers provide valuable
services.
C) technical analysis does not outperform the overall market.
D) technical analysis does not outperform the overall market, suggesting that stockbrokers do not
provide services of any value.
Answer: C
Question Status: Previous Edition

17) Which of the following types of information will most likely enable the exploitation of a profit
opportunity?
A) Financial analysts' published recommendations
B) Technical analysis
C) Hot tips from a stockbroker
D) Insider information
Answer: D
Question Status: Previous Edition

18) Which of the following types of information will most likely enable the exploitation of a profit
opportunity?
A) Financial analysts' published recommendations
B) Technical analysis
C) Hot tips from a stockbroker
D) None of the above
Answer: D
Question Status: Previous Edition

19) 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 its price will be.
D) only B and C of the above are true.
Answer: A
Question Status: Previous Edition
20) The efficient market hypothesis suggests that
A) investors should not try to outguess the market by constantly buying and selling securities.
B) investors do better on average if they adopt a "buy and hold" strategy.
C) buying into a mutual fund is a sensible strategy for a small investor.
D) all of the above are sensible strategies.
E) only A and B of the above are sensible strategies.
Answer: D
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) Sometimes one observes that the price of a company's stock falls after the announcement of
favorable earnings. This phenomenon is
A) clearly inconsistent with the efficient market hypothesis.
B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated.
C) consistent with the efficient market hypothesis if the earnings were not as low as anticipated.
D) the result of none of the above.
Answer: B
Question Status: Previous Edition

22) Important implications of the efficient market hypothesis include which of the following?
A) Future changes in stock prices should, for all practical purposes, be unpredictable.
B) Stock prices will respond to announcements only when the information in these announcements is
new.
C) Sometimes a stock price declines when good news is announced.
D) All of the above.
E) Only A and B of the above.
Answer: D
Question Status: Previous Edition

23) Although the verdict is not yet in, the available evidence indicates that, for many purposes, the
efficient market hypothesis is
A) a good starting point for analyzing expectations.
B) not a good starting point for analyzing expectations.
C) too general to be a useful tool for analyzing expectations.
D) none of the above.
Answer: A
Question Status: Previous Edition
24) The efficient market hypothesis suggests that
A) investors should purchase no-load mutual funds, which have low management fees.
B) investors can use the advice of technical analysts to outperform the market.
C) investors let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.
D) only A and B of the above are sensible strategies.
Answer: A
Question Status: Previous Edition
25) The efficient market hypothesis applies to
A) both the stock market and the foreign exchange market.
B) the stock market but not the foreign exchange market.
C) the foreign exchange market but not the stock market.
D) neither the stock market nor the foreign exchange market.
Answer: A
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) According to the January effect, stock prices


A) experience an abnormal price rise from December to January.
B) experience an abnormal price decline from December to January.
C) follow a random walk during January.
D) set the pattern for the entire year in January.
Answer: A
Question Status: Previous Edition
27) The small-firm effect refers to the observation that small firms' stocks
A) follow a random walk but large firms' stocks do not.
B) have earned abnormally low returns given their greater risk.
C) have earned abnormally high returns even taking into account their greater risk.
D) sell for lower prices than do large firms' stocks.
Answer: C
Question Status: Previous Edition
28) The efficient markets hypothesis is weakened by evidence that
A) stock prices tend to follow a random walk.
B) stock prices are more volatile than fluctuations in their fundamental values can explain.
C) technical analysis does not outperform the overall market.
D) an investment adviser's past success or failure at picking stocks does not predict his or her future
performance.
Answer: B
Question Status: Previous Edition
29) Mean reversion refers to the observation that
A) stock prices overact to news announcements.
B) stocks prices are more volatile than fluctuations in their fundamental value would predict.
C) stocks with low returns are likely to have high returns in the future.
D) stocks with low returns are likely to have even lower returns in the future.
Answer: C
Question Status: Previous Edition
30) Which of the following does not weaken the efficient markets hypothesis?
A) Mean reversion
B) Success of buy-and-hold strategy
C) January effect
D) Excessive volatility
Answer: B
Question Status: Previous Edition
31) An important lesson from the Black Monday Crash of 1987 and the tech crash of 2000 is that
A) factors other than market fundamentals affect stock prices.
B) the strong version of the efficient market hypothesis, that stock prices reflect the true fundamental
value of securities, is correct.
C) market psychology has little if any effect on stock prices.
D) there is no such thing as a rational bubble.
Answer: A
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) An investor gains from short selling by ________ and then later ________.
A) buying a stock; selling it at a higher price
B) selling a stock; buying it back at a lower price
C) buying a stock; selling it at a lower price
D) selling a stock; buying it back at a higher price
Answer: B
Question Status: Previous Edition
33) Which of the following is an insight from behavioral finance?
A) The price of securities fully reflects all available information.
B) Investor overconfidence leads to high trading volumes.
C) The optimal forecast of a security's return equals the security's equilibrium return.
D) Investment advisers cannot consistently beat the market.
Answer: B
Question Status: Previous Edition
34) Which of the following is empirical evidence indicating that the efficient market hypothesis may not
always be generally applicable?
A) Small-firm effect
B) January effect
C) Market overreaction
D) All of the above
Answer: D
Question Status: Previous Edition

35) An arrangement with a broker to borrow stocks from them and then sell it in the market, with the
hope that they earn a profit by buying the stock back again after it has fallen in price is called
A) behavioral finance.
B) short sales.
C) smart money.
D) random walk.
Answer: B
Question Status: Previous Edition

36) Evidence in favor of market efficiency includes


A) performance of investment analysts and mutual funds.
B) whether stock prices reflect publicly available information.
C) the random-walk behavior of stock prices.
D) all of the above.
Answer: D
Question Status: Previous Edition
37) Evidence against market efficiency does not include
A) the small-firm effect.
B) technical analysis.
C) excessive volatility.
D) mean reversion.
Answer: B
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

38) Evidence in favor of market efficiency does not include


A) random-walk behavior.
B) technical analysis.
C) performance of investment analysts and mutual funds.
D) the January effect.
Answer: D
Question Status: Previous Edition
39) The elimination of a riskless profit opportunity in a market is called
A) the efficient market hypothesis.
B) random walk.
C) arbitrage.
D) market fundamentals.
Answer: C
Question Status: Previous Edition
6.2 True/False
1) Evidence that stock prices sometimes fall when a firm announces good news contradicts the efficient
market hypothesis.
Answer: FALSE
Question Status: Previous Edition
2) If the security markets are truly efficient, there is no need to pay for help selecting securities.
Answer: TRUE
Question Status: Previous Edition
3) Evidence that a mutual fund has performed extraordinarily well in the past contradicts the efficient
market hypothesis.
Answer: FALSE
Question Status: Previous Edition
4) Technical analysts look at historical prices for information to project future prices.
Answer: TRUE
Question Status: Previous Edition
5) The evidence suggests technical analysts are not superior stock pickers.
Answer: TRUE
Question Status: Previous Edition
6) If the markets are efficient, the optimal investment strategy will be to buy and hold so as to minimize
transaction costs.
Answer: TRUE
Question Status: Previous Edition
7) In an efficient market, abnormal returns are not possible, even using inside information.
Answer: FALSE
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

8) "Short selling" refers to the practice of buying a stock and holding it for only a short time before
selling it.
Answer: FALSE
Question Status: Previous Edition
9) Loss aversion means the unhappiness a person feels when he or she suffers a monetary loss exceeds
the happiness the same person experiences from receiving a monetary gain of the same amount.
Answer: TRUE
Question Status: Previous Edition
10) It is probably a good use of an investor's time to watch as many shows featuring technical analysts
as possible.
Answer: FALSE
Question Status: Previous Edition
11) Having performed well in the past indicates that an investment adviser or a mutual fund will perform
well in the future.
Answer: FALSE
Question Status: Previous Edition
12) Technical analysis is a popular technique used to predict stock prices by studying past stock price
data and searching for patterns such as trends and regular cycles.
Answer: TRUE
Question Status: Previous Edition
6.3 Essay
1) Why are expectations important in understanding how financial instruments are valued?
Question Status: Previous Edition
2) How is it possible that a firm can announce a record-breaking loss, yet its stock price rises when the
announcement is made?
Question Status: Previous Edition
3) What is the optimal investment strategy according to the efficient market hypothesis? Why?
Question Status: Previous Edition
4) Explain what the market reaction will be in an efficient market if a firm announces a fully anticipated
filing for bankruptcy.
Question Status: Previous Edition
5) How do loss aversion, overconfidence of investors, and social contagion affect market efficiency?
Question Status: Previous Edition
6) What is a rational bubble?
Question Status: Previous Edition
7) Give evidence both for and against market efficiency.
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 7 Why Do Financial Institutions Exist?
7.1 Multiple Choice
1) Of the following sources of external finance for American nonfinancial businesses, the least
important is
A) loans from banks.
B) stocks.
C) bonds and commercial paper.
D) nonbank loans.
Answer: B
Question Status: Previous Edition

2) Of the following sources of external finance for American nonfinancial businesses, the most
important is
A) loans from banks.
B) stocks.
C) bonds and commercial paper.
D) nonbank loans.
Answer: D
Question Status: Previous Edition

3) Of the sources of external funds for nonfinancial businesses in the United States, bonds account for
approximately ________ of the total.
A) 10%
B) 20%
C) 30%
D) 50%
Answer: C
Question Status: Previous Edition

4) Of the sources of external funds for nonfinancial businesses in the United States, stocks account for
approximately ________ of the total.
A) 10%
B) 20%
C) 30%
D) 40%
Answer: A
Question Status: Previous Edition

5) With regard to external sources of financing for nonfinancial businesses in the United States, which
of the following are accurate statements?
A) Marketable securities account for a larger share of external business financing in the United States
than in most other countries.
B) Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold
directly to American households.
C) The stock market accounted for the largest share of the financing of American businesses in the
1970-2000 period.
D) All of the above.
E) Only A and B of the above.
Answer: E
Question Status: Previous Edition

6) With regard to external sources of financing for nonfinancial businesses in the United States, which
of the following are accurate statements?
A) Direct finance is used in less than 5% of the external financing of American businesses.
B) Only large, well-established corporations have access to securities markets to finance their activities.
C) Loans from banks and other financial intermediaries in the United States provide five times more
financing of corporate activities than do stock markets.
D) All of the above.
E) Only A and B of the above.
Answer: D
Question Status: Previous Edition

7) (I) In the United States, nonbank loans are the most important source of external funds for
nonfinancial businesses.
(II) In Germany and Japan, issuing stocks and bonds is the most important source of external for
nonfinancial businesses.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

8) Which of the following is not one of the eight basic facts 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 businesses.
D) New security issues is the most important source of external funds to finance businesses.
Answer: D
Question Status: Previous Edition

9) Which of the following is not one of the eight basic facts about financial structure?
A) The financial system is among the most heavily regulated sectors of the economy.
B) Issuing marketable securities is 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) Financial intermediaries is the most important source of external funds to finance businesses.
Answer: B
Question Status: Previous Edition

10) Because information is scarce,


A) equity contracts are used much more frequently to raise capital than are debt contracts.
B) monitoring managers gives rise to costly state verification.
C) government regulations, such as standard accounting principles, can help reduce moral hazard.
D) all of the above are true.
E) only B and C of the above are true.
Answer: E
Question Status: Previous Edition

11) Which of the following best explains the recent decline in the role of financial intermediaries?
A) Private production and sale of information
B) Government regulation to increase information
C) Improvements in information technology
D) None of the above can explain the recent decline
Answer: C
Question Status: Previous Edition
12) (I) The total cost of carrying out a transaction in financial markets increases proportionally with the
size of the transaction.
(II) Financial intermediaries facilitate diversification when an investor has only a small sum to invest.
A) (I) is true; (II) false.
B) (I) is false; (II) true.
C) Both (I) and (II) are true.
D) Both (I) and (II) are false.
Answer: B
Question Status: Previous Edition

13) If bad credit risks are the ones who most actively seek loans and, therefore, receive them from
financial intermediaries, then financial intermediaries face the problem of
A) moral hazard.
B) adverse selection.
C) free-riding.
D) costly state verification.
Answer: B
Question Status: Previous Edition

14) If borrowers take on big risks after obtaining a loan, then lenders face the problem of
A) free-riding.
B) adverse selection.
C) moral hazard.
D) costly state verification.
Answer: C
Question Status: Previous Edition
15) Because of the lemons problem in the used car market, the average quality of the used cars offered
for sale will be ________, which gives rise to the problem of ________.
A) low; moral hazard
B) low; adverse selection
C) high; moral hazard
D) high; adverse selection
Answer: B
Question Status: Previous Edition

16) In the used car market, asymmetric information leads to the lemons problem because the price that
buyers are willing to pay will
A) reflect the highest quality of used cars in the market.
B) reflect the lowest quality of used cars in the market.
C) reflect the average quality of used cars in the market.
D) none of the above.
Answer: C
Question Status: Previous Edition
17) The problem created by asymmetric information before the transaction occurs is called ________,
while the problem created after the transaction occurs is called ________.
A) adverse selection; moral hazard
B) moral hazard; adverse selection
C) costly state verification; free-riding
D) free-riding; costly state verification
Answer: A
Question Status: Previous Edition

18) A borrower who takes out a loan usually has better information about the potential returns and risks
of the investment projects he plans to undertake than the lender does. This inequality of information is
called
A) moral hazard.
B) asymmetric information.
C) noncollateralized risk.
D) adverse selection.
Answer: B
Question Status: Previous Edition

19) 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) none of the above.
Answer: A
Question Status: Previous Edition

20) Moral hazard is a problem associated with debt and equity contracts arising from
A) the borrower's incentive to undertake highly risky investments.
B) the owners' inability to ensure that managers will act in the owners' interest.
C) the difficulty lenders have in sorting out good credit risks from bad credit risks.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

21) 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
22) 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 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) all of the above.
Answer: C
Question Status: Previous Edition

23) The problem of adverse selection helps to explain


A) why banks prefer to make loans secured by collateral.
B) why banks have a comparative advantage in raising funds for American businesses.
C) why borrowers are willing to offer collateral to secure their promises to repay loans.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

24) 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 collateral is an important feature of consumer, but not business, debt contracts.
C) why direct finance is more important than indirect finance as a source of business finance.
D) only A and B of the above.
Answer: A
Question Status: Previous Edition

25) The concept of adverse selection helps to 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) all of the above.
Answer: C
Question Status: Previous Edition
26) 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 of used cars.
B) are able to prevent potential competitors from free-riding off the information that they provide.
C) have failed to solve adverse selection problems in this market because "lemons" continue to be
traded.
D) do all of the above.
Answer: B
Question Status: Previous Edition

27) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these
intermediaries
A) provide information that is valued by consumers of used cars.
B) are able to prevent others from free-riding off the information that they provide.
C) can profit by becoming experts in determining whether an automobile is a good car or a lemon.
D) do all of the above.
Answer: D
Question Status: Previous Edition

28) 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, the majority of 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
Question Status: Previous Edition

29) In the United States, the government agency requiring that firms, which sell securities in public
markets, adhere to standard accounting principles and disclose information about their sales, assets, and
earnings is the
A) Federal Corporate Securities Commission.
B) Federal Trade Commission.
C) Securities and Exchange Commission.
D) U.S. Treasury Department.
E) Federal Reserve System.
Answer: C
Question Status: Previous Edition

30) An audit certifies that


A) a firm's loans will be repaid.
B) a firm's securities are safe investments.
C) a firm abides by standard accounting principles.
D) the information reported in a firm's accounting statements is correct.
Answer: C
Question Status: Previous Edition
31) The authors' analysis of adverse selection indicates that financial intermediaries in general, and
banks in particular (because they hold a large fraction of nontraded loans),
A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a
more important source of business finance than direct finance.
B) play a greater role in moving funds to corporations than do securities markets as a result of their
ability to overcome the free-rider problem.
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 the new issues market for funds.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

32) The authors' analysis of adverse selection indicates that financial intermediaries
A) overcome free-rider problems by holding nontraded loans.
B) must buy securities from corporations to diversify the risk that results from holding nontradable
loans.
C) have not been very successful in dealing with adverse selection problems in financial markets.
D) do all of the above.
E) do only A and B of the above.
Answer: A
Question Status: Previous Edition

33) The pecking order hypothesis predicts that the ________ a corporation is, the more likely it will be
to ________.
A) smaller and less well known; issue securities
B) larger and more well known; borrow from financial intermediaries
C) larger and more well known; issue securities
D) smaller and less well known; need external financing
Answer: C
Question Status: Previous Edition

34) Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long
as they primarily
A) make private loans.
B) acquire a diversified portfolio of stocks.
C) buy junk bonds.
D) do a balanced combination of A and B of the above.
Answer: A
Question Status: Previous Edition

35) Property that is pledged to the lender in the event that a borrower cannot make his or her debt
payment is called
A) points.
B) interest.
C) collateral.
D) good faith money.
Answer: C
Question Status: Previous Edition

36) Collateral is
A) property that is pledged to the lender if a borrower cannot make his or her debt payments.
B) a prevalent feature of debt contracts for households.
C) a prevalent feature of debt contracts for businesses.
D) all of the above.
E) only A and C of the above.
Answer: D
Question Status: Previous Edition

37) The majority of household debt in the United States consists of


A) credit card debt.
B) consumer installment debt.
C) collateralized loans.
D) unsecured loans, such as student loans.
Answer: C
Question Status: Previous Edition
38) 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
Question Status: Previous Edition
39) Because of the moral hazard problem,
A) lenders will write debt contracts that restrict certain activities of borrowers.
B) lenders will more readily lend to borrowers with high net worth.
C) debt contracts are used less frequently to raise capital than equity contracts.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

40) 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
Question Status: Previous Edition

41) Because managers (________) have less incentive to maximize profits than the stockholders-owners
(________) do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to
purchase equities.
A) principals; agents
B) principals; principals
C) agents; agents
D) agents; principals
Answer: D
Question Status: Previous Edition

42) The principal-agent problem


A) occurs when managers have more incentive to maximize profits than the stockholders-owners do.
B) would not arise if the owners of the firm had complete information about the activities of the
managers.
C) in financial markets helps to explain why equity is a relatively important source of finance for
American businesses.
D) all of the above.
E) only A and B of the above.
Answer: B
Question Status: Previous Edition

43) Solutions to the moral hazard problem include


A) high net worth.
B) monitoring and enforcement of restrictive covenants.
C) greater reliance on equity contracts and less on debt contracts.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

44) One financial intermediary in our financial structure that helps to reduce the moral hazard 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
Question Status: Previous Edition

45) A venture capital firm protects its equity investment from moral hazard 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 anyone but the venture capital
firm.
C) It prohibits the borrowing firm from replacing its management.
D) It does both A and B of the above.
E) It does both A and C of the above.
Answer: D
Question Status: Previous Edition

46) Debt contracts


A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals.
B) have an advantage over equity contracts in that they have a lower cost of state verification.
C) are used much more frequently to raise capital than equity contracts.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition
47) Equity contracts account for a small fraction of external funds raised by American businesses
because
A) costly state verification makes the equity contract less desirable than the debt contract.
B) there is greater 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) all of the above.
E) both A and B of the above.
Answer: E
Question Status: Previous Edition

48) A debt contract is said to be incentive compatible if


A) the borrower's net worth reduces the probability of moral hazard.
B) restrictive covenants limit the type of activities that can be undertaken by the borrower.
C) both A and B of the above occur.
D) neither A nor B of the above occur.
Answer: A
Question Status: Previous Edition
49) A debt contract is more likely to be incentive compatible if
A) the company must follow standard accounting principles.
B) the funds are provided by a venture capital firm.
C) owners of the firm have more of their own money in the business.
D) all of the above.
E) only B and C.
Answer: C
Question Status: Previous Edition

50) A clause in a mortgage loan contract requiring the borrower to purchase homeowner's insurance is
an example of
A) a restrictive covenant.
B) a collusive agreement between mortgage lenders and insurance companies.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: Previous Edition
51) A debt contract that specifies that the company can only use the funds to finance certain activities
A) is a private loan.
B) contains a restrictive covenant.
C) increases the problem of adverse selection.
D) all of the above.
E) only A and B of the above.
Answer: B
Question Status: Previous Edition

52) Which of the following are accurate statements concerning the role that restrictive covenants play in
reducing moral hazard in financial markets?
A) Covenants reduce moral hazard by restricting borrowers' undesirable behavior.
B) Covenants require that borrowers keep collateral in good condition.
C) Covenants require periodic accounting statements and income reports.
D) All of the above.
E) Only A and B of the above.
Answer: D
Question Status: Previous Edition

53) 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 costly 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) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

54) Governments in developing countries sometimes adopt policies that retard the efficient operation of
their financial systems. These actions include policies that
A) prevent lenders from foreclosing on borrowers with political clout.
B) nationalize banks and direct credit to politically favored borrowers.
C) make it costly to collect payments and collateral from defaulting debtors.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

55) Economies of scale


A) in the financial markets does not explain why financial intermediaries developed and have become
such an important part of our financial structure.
B) can be used to an advantage by reducing transaction cost.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: B
Question Status: Previous Edition

56) Liquidity services are services that


A) make it easier for customers to conduct transactions.
B) conducts transactions for the customer.
C) increase transaction costs.
D) all of the above.
Answer: A
Question Status: Previous Edition
57) Adverse selection
A) is a problem created by asymmetrical information after the transaction.
B) can be solved by eliminating asymmetrical information.
C) occurs when people who do not pay for information take advantage of the information other people
have to pay for.
D) all of the above.
Answer: B
Question Status: Previous Edition

58) The free-rider problem


A) occurs when people who do not pay for information take advantage of the information other people
have to pay for.
B) suggests that the private sale of information will only be a partial solution to the lemons problem.
C) prevents the private market from producing enough information to eliminate all the asymmetric
information that leads to adverse selection.
D) all of the above.
Answer: D
Question Status: Previous Edition

59) Bad firms


A) do not have an incentive to make themselves look good.
B) will slant the information they are required to transmit to the public.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: B
Question Status: Previous Edition

60) A bank
A) has the ability to profit from the information it produces.
B) avoids the free-rider problem by primarily making private loans rather than by purchasing securities
that are traded in the open market.
C) becomes an expert in determining good firms from bad firms.
D) all of the above.
Answer: D
Question Status: Previous Edition

61) Net worth


A) is the difference between current assets and current liabilities.
B) is the difference between assets and liabilities.
C) is total assets divided by total liabilities.
D) is total assets plus total liabilities.
Answer: B
Question Status: Previous Edition
62) Economies of scope refer to cost savings that arise when the
A) size of financial transactions increase.
B) size of financial transactions decrease.
C) number of different activities undertaken increases.
D) number of different activities undertaken decreases.
Answer: C
Question Status: Previous Edition - Different Chapter
63) A financial institution can achieve cost savings by engaging in multiple activities. These are called
economies of
A) scope.
B) scale.
C) complexity.
D) information.
Answer: A
Question Status: Previous Edition - Different Chapter

64) A financial institution can achieve cost savings in its credit card operations if it increases the number
of cardholders. This is an example of economies of
A) scope.
B) scale.
C) complexity.
D) information.
Answer: B
Question Status: Previous Edition - Different Chapter
65) Which combination of activities within a single financial institution is least likely to lead to conflicts
of interest?
A) auditing and management advisory services
B) commercial banking and investment banking
C) assessment of credit quality and consulting
D) consumer lending and business lending
Answer: D
Question Status: Previous Edition - Different Chapter

66) Conflicts of interest pose a problem because they


A) lower the quality of information.
B) increase problems of asymmetric information.
C) make the financial system less efficient.
D) do all of the above.
Answer: D
Question Status: Previous Edition - Different Chapter
67) An advantage of providing multiple financial services within one financial institution is that it
A) lowers information costs.
B) develops broader long-term relationships with customers.
C) both A and B of the above.
D) none of the above.
Answer: C
Question Status: Previous Edition - Different Chapter
68) A conflict of interest occurs when
A) a financial firm sells a service to its customers for a price that exceeds the cost of producing the
service.
B) lenders prefer higher interest rates and borrowers prefer lower interest rates.
C) riskier borrowers are the ones who are more likely to apply for loans.
D) people expected to provide reliable information to the public have incentives not to do so.
Answer: D
Question Status: Previous Edition - Different Chapter

69) A conflict of interest between providing impartial research about companies issuing securities and
selling those same securities arises in
A) investment banking.
B) commercial banking.
C) accounting firms.
D) mutual funds.
Answer: A
Question Status: Previous Edition - Different Chapter
70) If potential revenues from underwriting greatly exceed brokerage commissions, there is ________
incentive for investment bank analysts to report ________ information about firms issuing securities.
A) stronger; unbiased
B) stronger; favorable
C) weaker; unbiased
D) weaker; favorable
Answer: B
Question Status: Previous Edition - Different Chapter

71) Spinning is the practice of


A) investment banks allowing executives of potential client companies to buy underpriced initial public
offerings of other companies' securities.
B) investment bank analysts providing misleading information about a company to encourage more
investors to purchase the company's securities.
C) accounting firms encouraging its audit clients to also purchase its management advisory services.
D) credit rating agencies providing higher ratings on a company's securities in order to develop a longterm relationship with the company.
Answer: A
Question Status: Previous Edition - Different Chapter

72) Investment banks are guilty of conflict of interest when they


A) pressure their analysts to produce research favorable to their client firms.
B) permit executives of client firms to alter analysts' research on their firms.
C) prohibit analysts from making negative or controversial comments about client firms.
D) all of the above.
Answer: D
Question Status: Previous Edition - Different Chapter
73) Investment banks serve two client groups,
A) home buyers and mortgage lenders.
B) people saving for retirement and pension funds.
C) issuers of securities and investors in those securities.
D) mutual funds and investors with relatively small amounts to invest.
Answer: C
Question Status: Previous Edition - Different Chapter
74) Auditors attempt to reduce information asymmetry between a firm's managers and its
A) customers.
B) owners.
C) employees.
D) competitors.
Answer: B
Question Status: Previous Edition - Different Chapter
75) Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the
firm's largest source of profits and large clients pressured ________ office managers to give favorable
audits.
A) consulting; regional
B) consulting; national
C) auditing; regional
D) auditing; national
Answer: A
Question Status: Previous Edition - Different Chapter

76) The potential conflict of interest when a single accounting firm provides both auditing and
consulting services is that the firm can
A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its
consulting business.
B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its
auditing business.
C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting
services.
D) pressure its clients into paying high fees for both auditing and consulting services.
Answer: C
Question Status: Previous Edition - Different Chapter

77) The conflict of interest in credit-rating agencies arises because ________ pay to have securities rated
and, as a result, the agencies' ratings may be biased ________.
A) security issuers; downward
B) security issuers; upward
C) investors; downward
D) regulators; upward
Answer: B
Question Status: Previous Edition - Different Chapter

78) During the 2007-2009 financial crisis, housing prices began to fall and subprime mortgages began to
default. Which of the following statements is true about the rating of subprime mortgage products?
A) The rating agencies were way ahead of the market, giving many of the subprime products junk
ratings from the start.
B) Rating agencies were not involved. Subprime mortgages could not be structured, by law.
C) Many AAA-rated subprime products had to be downgraded over and over again until they reached
junk status.
D) None of the above are true.
Answer: C
Question Status: New Question

79) Since firms issuing new securities pay to have these securities rated, the credit-rating agencies have
incentive to ________ to attract more business.
A) give favorable ratings
B) give impartial ratings
C) lower the fees they charge
D) practice spinning
Answer: A
Question Status: Previous Edition - Different Chapter

80) The Sarbanes-Oxley Act of 2002 dealt with conflicts of interest in


A) investment banks.
B) accounting firms.
C) credit-rating agencies.
D) all of the above.
Answer: B
Question Status: Previous Edition - Different Chapter

81) The Global Legal Settlement of 2002 dealt with conflicts of interest in
A) accounting firms.
B) investment banks.
C) credit-rating agencies.
D) all of the above.
Answer: B
Question Status: Previous Edition - Different Chapter
82) Which of the following provisions of legislation to deal with conflicts of interest does not increase
the flow of information in financial markets?
A) requiring a firm's chief officers to certify its financial statements and other disclosures
B) requiring investment banks to make their analysts' recommendations public
C) requiring disclosure of off-balance-sheet transactions
D) increasing resources available to the Securities and Exchange Commission to supervise financial
markets
Answer: D
Question Status: Previous Edition - Different Chapter

83) The Global Legal Settlement includes what key element?


A) It directly reduces conflicts of interest.
B) It provides incentives for investment banks to not exploit conflicts of interest.
C) It has measures to improve the quality for information in financial markets.
D) All of the above.
Answer: D
Question Status: Previous Edition - Different Chapter
7.2 True/False
1) American businesses get more funds from direct financing than from indirect financing.
Answer: FALSE
Question Status: Previous Edition
2) American businesses use stock to finance about 10 percent of their external financing.
Answer: TRUE
Question Status: Previous Edition
3) One reason why indirect financing is used is to minimize adverse selection problems.
Answer: TRUE
Question Status: Previous Edition
4) Issuing marketable securities is the primary way businesses finance their operations.
Answer: FALSE
Question Status: Previous Edition
5) Because of the adverse selection problem, lenders may refuse loans to individuals with low net worth.
Answer: TRUE
Question Status: Previous Edition

6) The concept of adverse selection helps to explain why indirect finance is more important than direct
finance as a source of business finance.
Answer: TRUE
Question Status: Previous Edition
7) The problem of adverse selection helps to explain why direct finance is more important than indirect
finance as a source of business finance.
Answer: FALSE
Question Status: Previous Edition
8) The concept of adverse selection helps explain why collateral is an important feature of many debt
contracts.
Answer: TRUE
Question Status: Previous Edition
9) One way of describing the solution that high net worth provides to the moral hazard problem is to say
that it makes debt contracts incentive compatible.
Answer: TRUE
Question Status: Previous Edition
10) Economies of scale means that the percentage return on a financial transaction rises as the size of the
transaction rises.
Answer: FALSE
Question Status: Previous Edition
11) Agency theory focuses on how government agencies regulate financial intermediaries and markets.
Answer: FALSE
Question Status: Previous Edition
12) The principal-agent problem is an example of the adverse selection problem that can result from
asymmetric information.
Answer: FALSE
Question Status: Previous Edition
13) The financial system is one of the most heavily regulated sectors of the economy.
Answer: TRUE
Question Status: Previous Edition
14) Collateralized debt is also called secured debt.
Answer: TRUE
Question Status: Previous Edition
15) Most legal work in the U.S. involves the writing and enforcement of contracts, not ambulance
chasing, criminal law, and frivolous lawsuits.
Answer: TRUE
Question Status: New Question
16) The Sarbanes-Oxley Act of 2002 was passed in response to scandals in the investment banking
industry.
Answer: FALSE
Question Status: Previous Edition - Different Chapter

17) The Sarbanes-Oxley Act of 2002 provides for oversight of accounting firms but makes no provisions
for increasing the flow of information to financial markets.
Answer: FALSE
Question Status: Previous Edition - Different Chapter
18) The Sarbanes-Oxley Act of 2002 and the Global Legal Settlement of 2002 both have the potential to
reduce economies of scope.
Answer: TRUE
Question Status: Previous Edition - Different Chapter
19) The Global Legal Settlement of 2002 arose out of a lawsuit brought by New York Attorney General
Eliot Spitzer against the ten largest investment banks.
Answer: TRUE
Question Status: Previous Edition - Different Chapter
20) The Sarbanes-Oxley Act of 2002 established a Public Company Accounting Oversight Board
(PCAOB), overseen by the SEC, to supervise accounting firms and ensure that audits are independent
and controlled for quality.
Answer: TRUE
Question Status: Previous Edition - Different Chapter
21) Due to criticisms of rating agencies following the default of many subprime products, the SEC
prohibited credit rating agencies from structuring the same products that they rate.
Answer: TRUE
Question Status: New Question
7.3 Essay
1) What are economies of scale in financial transactions? How can financial intermediaries achieve these
economies?
Question Status: Previous Edition
2) Explain how the "lemons" problem could cause financial markets to fail.
Question Status: Previous Edition
3) Distinguish between adverse selection and moral hazard.
Question Status: Previous Edition
4) What facts about financial structure can be explained by adverse selection?
Question Status: Previous Edition
5) What facts about financial structure can be explained by moral hazard?
Question Status: Previous Edition
6) What factors usually cause an increase in moral hazard and adverse selection?
Question Status: Previous Edition
7) What is the principal-agent problem?
Question Status: Previous Edition

8) What is the free-rider problem? Describe some situations that this problem creates.
Question Status: Previous Edition
9) The U.S. has more lawyers per capita than any other country in the world. It is also among the richest
countries in the world. Explain why these two facts may not be mere coincidence.
Question Status: New Question
10) Why should we be concerned about conflicts of interest in the financial services industry?
Question Status: Previous Edition - Different Chapter
11) What conflicts of interest can arise in investment banking?
Question Status: Previous Edition - Different Chapter
12) What conflicts of interest can arise in accounting firms?
Question Status: Previous Edition - Different Chapter
13) What conflicts of interest can arise in credit-rating agencies?
Question Status: Previous Edition - Different Chapter
14) Evaluate the major provisions of Sarbanes-Oxley and the Global Legal Settlement as remedies for
conflict of interest problems.
Question Status: Previous Edition - Different Chapter
15) What issues do critics cite when discussing why Sarbanes-Oxley has led to a decline in U.S. capital
markets?
Question Status: New Question

Financial Markets and Institutions, 7e (Mishkin)


Chapter 8 Why Do Financial Crises Occur and Why Are They So Damaging to the Economy?
8.1 Multiple Choice
1) 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 more
significant.
C) frequently lead to sharp contractions in economic activity.
D) are all of the above.
E) are only A and B of the above.
Answer: D
Question Status: New Question

2) Financial crises
A) cause failures of financial intermediaries and leave only securities markets to channel funds from
savers to borrowers.
B) are a recent phenomenon that occur only in developing countries.
C) invariably lead to debt deflation.
D) all of the above.
E) none of the above.
Answer: E
Question Status: New Question

3) In an advanced economy, a financial crisis can begin in several ways, including:


A) mismanagement of financial liberalization or innovation.
B) asset pricing booms and busts.
C) an increase in uncertainty caused by failure of financial institutions.
D) all of the above.
Answer: D
Question Status: New Question
4) In an emerging market economy, a financial crisis generally begins with
A) mismanagement of financial liberalization or innovation.
B) asset pricing booms and busts.
C) an increase in uncertainty caused by failure of financial institutions.
D) all of the above.
Answer: A
Question Status: New Question
5) What is a credit boom?
A) an explosion in a credit cycle, which can increase or decrease lending in the short-run
B) essentially a lending spree on the part of banks and other financial institutions
C) when credit card receivables rise due to low initial interest rates
D) the signal of the end of a credit spree, with credit contracting rapidly
Answer: B
Question Status: New Question
1
Copyright 2012 Pearson Education, Inc.

6) The process of deleveraging refers to


A) cutbacks in lending by financial institutions.
B) a reduction in debt owed by banks.
C) both A and B.
D) none of the above.
Answer: A
Question Status: New Question
7) When asset prices fall following a boom,
A) moral hazard may increase in companies that have lost net worth in the bust.
B) financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging.
C) both A and B are correct.
D) none of the above are correct.
Answer: C
Question Status: New Question
8) During the 1800s, many U.S. financial crises were precipitated by an increase in ________, often
originating in London.
A) interest rates
B) housing prices
C) gasoline prices
D) heating oil prices
Answer: A
Question Status: New Question

9) Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.
A) currency
B) stock market
C) banking
D) commodities
Answer: C
Question Status: New Question
10) Stage Two of a financial crisis in an emerging market economy usually involves a ________ crisis.
A) currency
B) stock market
C) banking
D) commodities
Answer: A
Question Status: New Question
11) Stage Three of a financial crisis in an advanced economy features
A) a general increase in inflation.
B) debt deflation.
C) an increase in general price levels.
D) a full-fledged financial crisis.
Answer: B
Question Status: New Question

2
Copyright 2012 Pearson Education, Inc.

12) Stage Three of a financial crisis in an emerging market economy features


A) a general increase in inflation.
B) debt deflation.
C) an increase in general price levels.
D) a full-fledged financial crisis.
Answer: D
Question Status: New Question
13) Debt deflation refers to
A) an increase in net worth, leading to a relative fall in general debt levels.
B) a decline in general debt levels due to deleveraging.
C) a decline in bond prices as default rates rise.
D) a decline in net worth as price levels fall while debt burden remains unchanged.
Answer: D
Question Status: New Question
14) In an emerging market economy, a country typically faces a ________ fiscal policy before a crisis
initiates.
A) solid
B) poor
C) weakening
D) uncertain
Answer: A
Question Status: New Question
15) In an emerging market economy, bank regulators typically provide ________ supervision.
A) overbearing
B) adequate
C) weak
D) expert
Answer: C
Question Status: New Question
16) In an emerging market economy, there are typically two paths to a financial crisis: financial
liberalization/globalization and ________.
A) asset pricing bubbles
B) severe fiscal imbalances
C) a global financial crisis
D) none of the above
Answer: B
Question Status: New Question

17) In Stage Two of an financial crisis in an emerging economy, speculators engage in massive
________ of a currency if it is fixed against the U.S. dollar.
A) sales
B) purchases
C) either A or B can be correct
D) neither A nor B is correct
Answer: A
Question Status: New Question
3
Copyright 2012 Pearson Education, Inc.

18) Factors that lead to worsening conditions in financial markets include


A) increases in interest rates.
B) declining stock prices.
C) increasing uncertainty in financial markets.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Updated from Previous Edition

19) What does the "twin crises" in an emerging market financial crisis refer to?
A) both the currency crisis and the financial crisis
B) both the fiscal crisis and the banking crisis
C) both the inflation crisis and the asset bubble crisis
D) both the fiscal crisis and political crisis
Answer: A
Question Status: New Question
20) Factors that lead to worsening conditions in financial markets include
A) declining interest rates.
B) anticipated increases in the price level.
C) bank panics.
D) only A and C of the above.
E) only B and C of the above.
Answer: C
Question Status: Updated from Previous Edition

21) Most financial crises in the United States have begun with
A) a steep stock market decline.
B) an increase in uncertainty resulting from the failure of a major firm.
C) a steep decline in interest rates.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

22) In addition to having a direct effect on increasing adverse selection problems, increases in interest
rates also promote financial crises by ________ firms' and households' interest payments, thereby
________ their cash flow.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing
Answer: B
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

23) Adverse selection and moral hazard problems increased in magnitude during the early years of the
Great Depression as
A) stock prices declined to 10 percent of their levels in 1929.
B) banks failed.
C) the aggregate price level declined.
D) a result of all of the above.
E) a result of A and B of the above.
Answer: D
Question Status: Previous Edition

24) Prior to the financial crisis in Mexico in 1994, Mexico ran a budget deficit of around ________ of
GDP.
A) 120%
B) 40%
C) 15%
D) 1%
Answer: D
Question Status: New Question
25) Stock market declines preceded a full-blown financial crisis
A) in the United States in 1987.
B) in the United States in 2000.
C) in Indonesia in 1997.
D) in all of the above.
E) in none of the above.
Answer: E
Question Status: Updated from Previous Edition

26) Which of the following factors led up to the Mexican financial crisis of 1994?
A) speculative attacks on the peso and a rise in actual and expected inflation
B) a rise in domestic interest rates and a deterioration in bank balance sheets
C) a rise in foreign interest rates and domestic stock market declines
D) all of the above
E) only B and C of the above
Answer: E
Question Status: Previous Edition

27) Institutional features of debt markets in Asia that propelled several countries into financial crises
include
A) debt contracts with long durations.
B) firms with debt denominated in U.S. dollars.
C) governments that could not intervene to protect depositors.
D) all of the above.
E) only A and C of the above.
Answer: B
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

28) Argentina's 2001-2002 financial crisis was precipitated by


A) a weak and poorly supervised banking system.
B) a lending boom that fueled a stock market bubble.
C) difficulty financing a large budget deficit.
D) a decline in interest rates.
Answer: C
Question Status: Previous Edition
29) What is a credit default swap?
A) a swap agreement where two parties swap credit payments
B) an agreement to swap interest payments when one party defaults
C) a type of insurance against bond defaults
D) a swap between credit rating agencies
Answer: C
Question Status: New Question
30) Which of the following led to the U.S. financial crisis of 2007-2009?
A) financial innovation in mortgage markets
B) agency problems in mortgage markets
C) an increase in moral hazard at credit rating agencies
D) all of the above
E) only A and B of the above
Answer: E
Question Status: New Question

31) Approximately how large was the U.S. subprime mortgage market in 2007?
A) $100 million
B) $100 billion
C) $500 billion
D) $1 trillion
Answer: D
Question Status: New Question
32) When we refer to the shadow banking system, what are we talking about?
A) hedge funds, investment banks, and other nonbank financial firms that supply liquidity
B) the "underground" banking system used for illegal activities
C) the subsidiaries of depository institutions
D) none of the above
Answer: A
Question Status: New Question
33) The impact of the 2007-2009 financial crisis was widespread, including
A) the first major bank failure in the UK in over 100 years.
B) the failure of Bear Stearns, the fifth-largest U.S. investment bank.
C) the bailout of Fannie Mae and Freddie Mac by the U.S. Treasury.
D) all of the above.
E) only B and C of the above.
Answer: D
Question Status: New Question

6
Copyright 2012 Pearson Education, Inc.

8.2 True/False
1) Factors that can lead to worsening conditions in financial markets include increasing interest rates and
asset price booms.
Answer: TRUE
Question Status: New Question
2) During a bank panic, many banks fail in a very short time period.
Answer: TRUE
Question Status: New Question
3) The failure of Ohio Life Insurance and Trust in 1857 did not signal the start of a recession due to
prompt actions by the Fed.
Answer: FALSE
Question Status: New Question
4) Bank failures have been a feature of all U.S. financial crises from 1800 to 1944.
Answer: TRUE
Question Status: New Question
5) Debt deflation refers to the decline in debt values as creditors agree to lower interest rates as an
alternative to defaults.
Answer: FALSE
Question Status: New Question
6) The Internet stock market bubble of the late 1990s led to one of the worst financial crises in U.S.
history. Banks lost billions of dollars as Internet companies went bankrupt.
Answer: FALSE
Question Status: New Question
7) In an emerging market economy, a country often faces severe fiscal imbalances before a financial
crisis initiates.
Answer: FALSE
Question Status: New Question
8) In an emerging market economy, the financial globalization process further weakens the credit culture
by allowing domestic banks to borrow abroad.
Answer: TRUE
Question Status: New Question
9) In an emerging market economy, a lending boom and crash are inevitable outcomes of financial
liberalization and globalization.
Answer: FALSE
Question Status: New Question
10) Because asset markets are relatively small in an emerging market, they play less of a prominent role
in a financial crisis in those economies.
Answer: TRUE
Question Status: New Question

7
Copyright 2012 Pearson Education, Inc.

11) In the second stage of a financial crisis in an emerging economy, foreign exchange markets start
placing huge bets that there will be an appreciation of the emerging market country's currency.
Answer: FALSE
Question Status: New Question
8.3 Essay
1) Describe the sequence of events in a financial crisis in an advanced economy and explain why they
can cause economic activity to decline.
Question Status: New Question
2) Describe the sequence of events in a financial crisis in an emerging market economy and explain why
they can cause economic activity to decline.
Question Status: New Question
3) Contrast the stages of a financial crisis between an advanced economy and an emerging market
economy.
Question Status: New Question
4) What is the problem with government safety nets, such as deposit insurance, during the formative
stages of a financial crisis?
Question Status: New Question
5) Discuss the difference in Stage Two of a financial crisis between an advanced economy and an
emerging market economy.
Question Status: New Question
6) Discuss why some view the Fed as a culprit in the U.S. housing bubble during the 2000s.
Question Status: New Question
7) In an emerging market economy, a lending boom and crash are not inevitable outcomes of financial
liberalization and globalization. Discuss when a boom and crash will occur, and how it can be avoided.
Question Status: New Question
8) In the second stage of a financial crisis in an emerging economy, a speculative currency attack begins.
Why can't the government defend itself from such an attack?
Question Status: New Question
9) What does the "twin crises" in an emerging economy financial crisis refer to?
Question Status: New Question
10) Discuss some of the financial innovations in mortgage markets that led to the U.S. financial crisis in
2007.
Question Status: New Question
11) Why was the shadow banking system important during the 2007-2009 U.S. financial crisis?
Question Status: New Question

8
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 9 Central Banks and the Federal Reserve System
9.1 Multiple Choice
1) Americans' fear of centralized power and their distrust of moneyed interests explain why the U.S. did
not have a central bank until the
A) 17th century.
B) 18th century.
C) 19th century.
D) 20th century.
Answer: D
Question Status: Previous Edition

2) Bank panics in 1819, 1837, 1857, 1873, 1884, 1893, and 1907 convinced many that
A) the Federal Reserve needed greater control over the banking system.
B) the Federal Reserve needed greater authority to deal with problem banks.
C) a central bank was needed to prevent future financial panics.
D) both A and B of the above.
Answer: C
Question Status: Previous Edition
3) The unusual structure of the Federal Reserve System is perhaps best explained by
A) Americans' fear of centralized power.
B) the traditional American distrust of moneyed interests.
C) Americans' desire to remove control of the money supply from the U.S. Treasury.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

4) The traditional American distrust of moneyed interests and the fear of centralized power help to
explain
A) the failures of the first two experiments in central banking in the United States.
B) the decentralized structure of the Federal Reserve System.
C) why the Board of Governors of the Federal Reserve System is not located in New York.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition
5) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to
depositors that the American public finally became convinced that
A) the First Bank of the United States had failed to serve as a lender of last resort.
B) the Second Bank of the United States had failed to serve as a lender of last resort.
C) the Federal Reserve System had failed to serve as a lender of last resort.
D) a central bank was needed to prevent future panics.
Answer: D
Question Status: Previous Edition
1
Copyright 2012 Pearson Education, Inc.

6) Nationwide financial panics in 1873, 1884, 1893, and 1907 might have been avoided had
A) the First Bank of the United States served its intended role of lender of last resort.
B) the Second Bank of the United States not been abolished in 1836 by President Andrew Jackson.
C) the Second Bank of the United States served its intended role of lender of last resort.
D) the Federal Reserve served its intended role of lender of last resort.
Answer: B
Question Status: Previous Edition
7) The many regional Federal Reserve banks resulted from a compromise between parties favoring
A) the establishment of a central bank and those opposed to its establishment.
B) a private central bank and those favoring a government institution.
C) the establishment of the Board of Governors in Washington, D.C., and those preferring its
establishment in New York City.
D) none of the above.
Answer: B
Question Status: Previous Edition

8) 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) All of the above
E) Only A and B of the above
Answer: E
Question Status: Previous Edition

9) Which of the following is an element of the Federal Reserve System?


A) The Federal Reserve banks
B) The Board of Governors
C) The FOMC
D) All of the above
Answer: D
Question Status: Previous Edition
10) 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 Federal Advisory Council
E) Member commercial banks
Answer: B
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) Which of the following functions are not performed by any of the twelve regional Federal Reserve
banks?
A) Check clearing
B) Conducting economic research
C) Setting interest rates payable on time deposits
D) Issuing new currency
Answer: C
Question Status: Previous Edition

12) Which Federal Reserve Bank president always has a vote in the Federal Open Market Committee?
A) Philadelphia
B) New York
C) Boston
D) San Francisco
Answer: B
Question Status: Previous Edition
13) 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
Answer: D
Question Status: Previous Edition

14) The ________ Fed bank, with about 25 percent of the system's assets, is the most important of the
Federal Reserve banks.
A) Chicago
B) Los Angeles
C) Miami
D) New York
E) Washington, D.C.
Answer: D
Question Status: Previous Edition
15) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by
that stock is limited to
A) four percent annually.
B) five percent annually.
C) six percent annually.
D) eight percent annually.
Answer: C
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) All ________ are required to be members of the Fed.


A) state-chartered banks
B) nationally chartered banks
C) banks with more than $100 million in assets
D) banks with more than $500 million in assets
Answer: B
Question Status: Previous Edition
17) Which of the following banks are required to be members of the Federal Reserve System?
A) state-chartered banks
B) insured banks
C) banks having over $500 million in assets
D) none of the above
Answer: D
Question Status: Previous Edition
18) Of all commercial banks, about ________ percent belong to the Federal Reserve System.
A) 15
B) 20
C) 30
D) 50
Answer: C
Question Status: Previous Edition
19) Banks subject to reserve requirements set by the Federal Reserve System include
A) only state-chartered banks.
B) only nationally chartered banks.
C) only banks with less than $100 million in assets.
D) only banks with less than $500 million in assets.
E) all banks whether or not they are members of the Federal Reserve System.
Answer: E
Question Status: Previous Edition
20) The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980
stemmed in part from its
A) concern over declining Fed membership.
B) belief that all banking regulations should be eliminated.
C) belief that interest rate ceilings were too low.
D) belief that depositors had to become more knowledgeable about banking operations.
Answer: A
Question Status: Previous Edition

21) Which of the following are duties of the Board of Governors of the Federal Reserve System?
A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for
with cash.
B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q.
C) Regulating credit with the approval of the President under the Credit Control Act of 1969.
D) None of the above has been a duty of the Board since the mid-1980s.
Answer: A
Question Status: Previous Edition
4
Copyright 2012 Pearson Education, Inc.

22) Which of the following are not duties of the Board of Governors of the Federal Reserve System?
A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for
with cash.
B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q.
C) Approving the discount rate "established" by the Federal Reserve banks.
D) Representing the United States in negotiations with foreign governments on economic matters.
Answer: B
Question Status: Previous Edition

23) The chairman of the Board of Governors of the Federal Reserve System exercises a high degree of
control over the board
A) through his ability to set the agenda of the Board and the FOMC.
B) through his role as spokesperson for the Fed with the President and before Congress.
C) because he can veto decisions made by a majority of the other Board members.
D) because of all of the above.
E) because of only A and B of the above.
Answer: E
Question Status: Previous Edition
24) 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.
Answer: C
Question Status: Previous Edition
25) Each member of the seven-member Board of Governors is appointed by the president and confirmed
by the Senate to serve
A) 4-year terms.
B) 6-year terms.
C) 14-year terms.
D) as long as the appointing president remains in office.
Answer: C
Question Status: Previous Edition

26) The Board of Governors


A) establishes, within limits, reserve requirements.
B) effectively sets the discount rate.
C) sets margin requirements.
D) does all of the above.
E) does only A and B of the above.
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

27) Although neither ________ nor the ________ is officially set by the Federal Open Market
Committee, decisions concerning these policy tools are effectively made by the committee.
A) margin requirements; discount rate
B) margin requirements; federal funds rate
C) reserve requirements; discount rate
D) reserve requirements; federal funds rate
Answer: C
Question Status: Previous Edition

28) Although the Federal Open Market Committee does not have formal authority to set ________ and
the ________, it does possess the authority in practice.
A) margin requirements; discount rate
B) margin requirements; federal funds rate
C) reserve requirements; discount rate
D) reserve requirements; federal funds rate
Answer: C
Question Status: Previous Edition
29) Which of the following are true statements?
A) The FOMC usually meets every six weeks to set monetary policy.
B) The FOMC issues directives to the trading desk at the New York Fed.
C) Designers of the Federal Reserve Act did not envision the use of open market operations as a
monetary policy tool.
D) All of the above are true statements.
E) Only A and B of the above are true statements.
Answer: D
Question Status: Previous Edition

30) The Federal Open Market Committee consists of


A) the five senior members of the seven-member Board of Governors.
B) the seven members of the Board of Governors and seven presidents of the regional Fed banks.
C) the seven members of the Board of Governors and five presidents of the regional Fed banks.
D) the twelve regional Fed bank presidents and the chairman of the Board of Governors.
Answer: C
Question Status: Previous Edition
31) The Federal Reserve entity that determines monetary policy strategy is the
A) Board of Governors.
B) Federal Open Market Committee.
C) Chairman of the Board of Governors.
D) Shadow Open Market Committee.
Answer: B
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) Which of the following are true statements?


A) The FOMC usually meets every six weeks to set monetary policy.
B) The FOMC issues directives to the trading desk at the New York Fed.
C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary
policy tool.
D) All of the above are true statements.
E) Only A and B of the above are true statements.
Answer: E
Question Status: Previous Edition

33) The designers of the Federal Reserve Act meant to create a central bank characterized by its
A) system of checks and balances and decentralization of power.
B) strong concentration of power in the hands of a few people.
C) inability to function as a lender of last resort.
D) responsiveness to the electorate.
Answer: A
Question Status: Previous Edition
34) The power within the Federal Reserve was effectively transferred to the Board of Governors by
A) the banking legislation of the Great Depression.
B) Supreme Court decisions in the 1950s.
C) the Depository Institutions Deregulation and Monetary Control Act of 1980.
D) the Treasury-Federal Reserve Accord of 1951.
Answer: A
Question Status: Previous Edition
35) Factors that provide the Federal Reserve with a high degree of independence include
A) 14-year terms for members of the Board of Governors.
B) a four-year term for the chairman of the Board of Governors that is not coincident with the
president's term of office.
C) constitutional independence from Congress and the president.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

36) Federal Reserve independence is thought to


A) introduce a short-term bias to monetary policymaking.
B) lead to better fiscal and monetary policy coordination.
C) introduce longer-run considerations to monetary policymaking.
D) do both A and B of the above.
Answer: C
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

37) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to
A) withhold appropriations from the Board of Governors.
B) withhold appropriations from the Federal Open Market Committee.
C) propose legislation that would force the Fed to submit budget requests to Congress, as must other
government agencies.
D) do all of the above.
Answer: C
Question Status: Previous Edition

38) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress
because
A) Congress can pass legislation that would restrict the Fed's independence.
B) Congress can withhold the Fed's budget requests.
C) Congress can remove members of the Board of Governors whose views on policy differ from those
of key members of Congress.
D) All of the above.
Answer: A
Question Status: Previous Edition
39) According to the textbook authors, the Fed 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 policymaking by the congressional threat to reduce Fed
independence.
D) both A and C of the above.
Answer: D
Question Status: Previous Edition

40) According to the textbook authors,


A) the Fed appears to be remarkably free of the political pressures that influence other government
agencies.
B) since the president can protect the Fed from Congress, the Fed may be responsive to the president's
policy preferences.
C) the Fed appears to be more responsive to the political pressures that influence other government
agencies.
D) both A and B of the above.
E) both B and C of the above.
Answer: D
Question Status: Previous Edition

41) The oldest central bank, founded in 1694, is the


A) Bank of England.
B) Deutsche Bundesbank.
C) Bank of Japan.
D) Federal Reserve System.
Answer: A
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

42) The newest central bank, which began operations in January 1999, is the
A) European Central Bank.
B) Bank of Argentina.
C) Bank of Korea.
D) Bank of New Zealand.
Answer: A
Question Status: Previous Edition
43) Which of the following central banks has the greatest degree of independence?
A) Bank of England
B) European Central Bank
C) Bank of Japan
D) Federal Reserve System
Answer: B
Question Status: Previous Edition
44) A 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 give up multiple policy goals to focus strictly on inflation.
D) have required their central banks to coordinate policies with their ministers of finance.
Answer: A
Question Status: Previous Edition

45) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize
A) the public's welfare.
B) its own welfare.
C) profits.
D) conflict between the executive and legislative branches of government.
Answer: B
Question Status: Previous Edition
46) The theory of bureaucratic behavior suggests that the Federal Reserve will
A) try to avoid a conflict with the president and Congress over increases in interest rates.
B) try to gain regulatory power over more banks.
C) devise clever strategies in an effort to avoid blame for poor economic performance.
D) do all of the above.
Answer: D
Question Status: Previous Edition
47) According to the theory of bureaucratic behavior, the objective of bureaucracy is
A) to maximize its own welfare, meaning that it seeks additional power and prestige.
B) to maximize consumers' surplus, meaning that it seeks additional regulatory powers.
C) to protect the industry it regulates, meaning that it seeks additional regulatory powers.
D) none of the above.
Answer: A
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

48) According to the theory of bureaucratic behavior,


A) the objective of a bureaucracy is to maximize its own welfare, meaning that it seeks additional power
and prestige.
B) the bureaucracy will fight vigorously to preserve its autonomy; thus, it will attempt to avoid conflict
with the president and Congress.
C) the bureaucracy will support legislation that gives it additional regulatory power.
D) all of the above describe bureaucratic behavior.
Answer: D
Question Status: Previous Edition
49) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed
A) resists so vigorously congressional attempts to limit the central bank's autonomy.
B) is secretive about the conduct of future monetary policy.
C) sought less control over banks in the 1980s.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

50) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed
A) is supportive of congressional attempts to limit the central bank's autonomy.
B) is secretive about the conduct of future monetary policy.
C) sought less control over banks in the 1980s.
D) is willing to take on powerful groups that may threaten its autonomy.
Answer: B
Question Status: Previous Edition
51) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed
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
Question Status: Previous Edition

52) Politicians in a democratic society may be shortsighted 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 both A and C of the above to occur.
Answer: D
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

53) The case for Federal Reserve independence includes the idea that
A) political pressure would impart an inflationary bias to monetary policy.
B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender
of a sound dollar and a stable price level.
C) a Federal Reserve under the control of Congress or the president might make the so-called political
business cycle more pronounced.
D) all of the above.
Answer: D
Question Status: Previous Edition
54) The case for Federal Reserve independence includes the idea that
A) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender
of a sound dollar and a stable price level.
B) a Federal Reserve under the control of Congress or the president might make the so-called political
business cycle more pronounced.
C) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does
not answer to the voters on election day.
D) only A and B of the above.
Answer: D
Question Status: Previous Edition

55) The case for Federal Reserve independence does not include the idea that
A) political pressure would impart an inflationary bias to monetary policy.
B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender
of a sound dollar and a stable price level.
C) policy is always performed better by an elite group such as the Fed.
D) a Federal Reserve under the control of Congress or the president might make the so-called political
business cycle more pronounced.
Answer: C
Question Status: Previous Edition

56) The case for Federal Reserve independence does not include the idea that
A) political pressure would impart an inflationary bias to monetary policy.
B) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does
not answer to the voters on election day.
C) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender
of a sound dollar and a stable price level.
D) a Federal Reserve under the control of Congress or the president might make the so-called political
business cycle more pronounced.
Answer: B
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

57) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional
control would
A) impart an 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) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition
58) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional
control would
A) impart an 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 less pronounced.
D) do all of the above.
E) do only A and B of the above.
Answer: E
Question Status: Previous Edition

59) Supporters of the current system of Fed independence believe that a less autonomous Fed would
A) adopt a long-run bias toward policymaking.
B) pursue overly expansionary monetary policies.
C) be more likely to create a political business cycle.
D) do only B and C of the above.
Answer: D
Question Status: Previous Edition
60) Critics of the current system of Fed independence contend that
A) the current system is undemocratic.
B) voters have too much say about monetary policy.
C) the president has too much control over monetary policy on a day-to-day basis.
D) all of the above are true.
Answer: A
Question Status: Previous Edition
61) Critics of Fed independence argue
A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.
B) that an independent Fed conducts monetary policy with a consistent inflationary bias.
C) that the Fed, since it does not face a binding budget constraint, spends too much of its earnings.
D) only A and B of the above.
Answer: A
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

62) Critics of Fed independence argue


A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.
B) that independence seemingly does little to guarantee good monetary policy.
C) that its independence may encourage the Fed to pursue a course of narrow self-interest rather than the
public interest.
D) all of the above.
Answer: D
Question Status: Previous Edition
63) Instrument independence means the central bank is free from
A) political pressure regarding how it uses the tools of monetary policy.
B) political pressure regarding the goals it pursues.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: Previous Edition
64) Suppose legislation requiring the Fed to keep the inflation rate between 1.5% and 2.5% per year is
passed by Congress. This law restricts the Fed's
A) instrument independence.
B) goal independence.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: B
Question Status: Previous Edition

65) Cross-country evidence suggests that an increase in central bank independence results in a ________
inflation rate and ________ unemployment.
A) lower; higher
B) lower; no worse
C) higher; lower
D) higher; higher
Answer: B
Question Status: Previous Edition

66) The Board of Governors of the Federal Reserve System


A) appoint three directors to each Federal Reserve Bank.
B) elect six members to member commercial banks.
C) both of the above.
D) none of the above.
Answer: A
Question Status: Previous Edition
67) The Federal Advisory Council has ________ member(s) from each district.
A) one
B) two
C) three
D) can have any number of
Answer: A
Question Status: Previous Edition
13
Copyright 2012 Pearson Education, Inc.

68) The three largest Federal Reserve banks in terms of assets are those of New York, Chicago, and
A) Atlanta.
B) Los Angeles.
C) Baltimore.
D) San Francisco.
Answer: D
Question Status: Previous Edition
69) The directors of a district bank are classified into three categories: A, B, and C. The three B directors
are
A) professional bankers.
B) prominent leaders from industry, labor, agriculture, or the consumer sector.
C) elected by the board of governors to represent the public interest.
D) all of the above.
Answer: B
Question Status: Previous Edition

70) The 12 Federal Reserve banks are involved in monetary policy in several ways:
A) their directors establish the discount rate.
B) they decide which banks can obtain discount loans from the Federal Reserve Bank.
C) their directors select one commercial banker from each bank's district to serve on the Federal
Advisory Council.
D) all of the above.
Answer: D
Question Status: Previous Edition

71) The ________ of the Board of Governors is the spokesperson for the Fed.
A) chairman
B) president
C) either of the above can be the spokesperson
D) neither of the above
Answer: A
Question Status: Previous Edition
72) Currently, there are ________ countries that are members of the European Monetary Union.
A) 10
B) 12
C) 15
D) 20
Answer: B
Question Status: Previous Edition
73) In November 2007, the Fed announced major enhancements to its communication strategy. Which
of the following was a part of the changes?
A) The forecast horizon for the FOMC's projections was extended from two calendar years to three.
B) The committee publishes FOMC projections four times a year instead of twice a year.
C) The release would include a narrative of the forces shaping the outlook and risks to that outlook.
D) All of the above were proposed changes.
Answer: D
Question Status: New Question
14
Copyright 2012 Pearson Education, Inc.

9.2 True/False
1) The unusual structure of the Federal Reserve System is best explained by Americans' fear of
centralized power.
Answer: TRUE
Question Status: Previous Edition
2) Rapid money supply growth and uncontrollable inflation were among the factors which motivated the
creation of the Federal Reserve System.
Answer: FALSE
Question Status: Previous Edition
3) The Washington, D.C. Fed bank, with over 30 percent of the system's assets, is the most important
Federal Reserve Bank.
Answer: FALSE
Question Status: Previous Edition
4) The FOMC is an element of the Federal Reserve System.
Answer: TRUE
Question Status: Previous Edition
5) All nationally chartered banks are required to be members of the Fed.
Answer: TRUE
Question Status: Previous Edition
6) Each member of the seven-member Board is appointed by the president and confirmed by the Senate
to serve 14-year terms.
Answer: TRUE
Question Status: Previous Edition
7) The Board of Governors sets reserve requirements.
Answer: TRUE
Question Status: Previous Edition
8) Monetary policy is set by the Board of Governors.
Answer: FALSE
Question Status: Previous Edition
9) Federal Reserve monetary policy decisions must be approved by the Secretary of the Treasury before
they may be implemented.
Answer: FALSE
Question Status: Previous Edition
10) The FOMC issues directives to the trading desk at the New York Fed.
Answer: TRUE
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

11) Critics of the current system of Fed independence contend that the president has too much control
over monetary policy on a day-to-day basis.
Answer: FALSE
Question Status: Previous Edition
12) Countries with more independent central banks have lower inflation rates, but these have come at
the expense of greater output fluctuations.
Answer: FALSE
Question Status: Previous Edition
13) Announcing the FOMC's policy decision immediately after the FOMC meeting is an example of
how Fed policymaking has become more transparent.
Answer: TRUE
Question Status: Previous Edition
14) The Fed has goal independence but not instrument independence.
Answer: FALSE
Question Status: Previous Edition
15) The Federal Reserve banks act as liaisons between the business community and the Federal Reserve
System.
Answer: TRUE
Question Status: Previous Edition
16) The FOMC does not actually carry out securities purchases or sales.
Answer: TRUE
Question Status: Previous Edition
9.3 Essay
1) Former Congressman Jack Kemp reportedly once said that he wanted to become the most powerful
man in Washington,
chairman of the Board of Governors of the Federal Reserve System.the
What does Representative Kemp's comment imply about the power of the chairman of the Federal
Reserve? Do you think he may have been exaggerating? Explain.
Question Status: Previous Edition
2) Former Board of Governors chairman Paul Volcker reportedly once said that the Federal Reserve is
free to pursue any policy it desires, as long as it convinces Congress that such a policy is reasonable.
What does Volcker's comment suggest about the independence of the Fed? Explain.
Question Status: Previous Edition
3) What are the factors that promote the independence of the Federal Reserve?
Question Status: Previous Edition
4) What factors limit the independence of the Federal Reserve?
Question Status: Previous Edition
5) What are the arguments for and against an independent Fed?
Question Status: Previous Edition

16
Copyright 2012 Pearson Education, Inc.

6) What is the theory of bureaucratic behavior? What types of behavior does it predict the Fed might
undertake?
Question Status: Previous Edition
7) In recent years, has Fed policymaking become more or less transparent? Why?
Question Status: Previous Edition
8) Describe the structure and responsibility for policy tools in The Federal Reserve System.
Question Status: Previous Edition
9) Discuss similarities and differences between Ben Bernanke and Alan Greenspan in their respective
roles as chairman of the Federal Reserve Board.
Question Status: New Question

17
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 10 Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
10.1 Multiple Choice
1) Assets on the Fed's balance sheet include
A) government securities and currency in circulation.
B) discount loans and reserves.
C) government securities and discount loans.
D) currency in circulation and reserves.
Answer: C
Question Status: Previous Edition
2) The monetary base consists of
A) currency in circulation and reserves.
B) government securities held by the Fed and discount loans.
C) government securities held by the Fed and currency in circulation.
D) discount loans and reserves.
Answer: A
Question Status: Previous Edition
3) An open market purchase of securities by the Fed will
A) increase assets of the nonbank public and increase assets of the banking system.
B) decrease assets of the nonbank public and increase assets of the Fed.
C) decrease assets of the banking system and increase assets of the Fed.
D) have no effect on assets of the nonbank public but increase assets of the Fed.
E) increase assets of the banking system and decrease assets of the Fed.
Answer: D
Question Status: Previous Edition

4) An open market sale of securities by the Fed will


A) decrease liabilities of the Fed and not affect assets of the banking system.
B) decrease assets of the nonbank public and decrease assets of the Fed.
C) increase liabilities of the banking system and increase assets of the Fed.
D) have no effect on assets of the nonbank public but increase liabilities of the Fed.
E) decrease assets of the banking system and increase assets of the Fed.
Answer: A
Question Status: Previous Edition

5) If the Federal Reserve wants to expand reserves in the banking system, it will
A) purchase government securities.
B) raise the discount rate.
C) sell government securities.
D) raise reserve requirements.
Answer: A
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) If the Federal Reserve wants to lower the monetary base and the money supply, it will
A) increase bank reserves.
B) lower the discount rate.
C) sell government securities.
D) lower reserve requirements.
Answer: C
Question Status: Previous Edition
7) A discount loan by the Fed to a bank causes a(n) ________ in reserves in the banking system and a(n)
________ in the monetary base.
A) increase; decrease
B) decrease; decrease
C) decrease; increase
D) increase; increase
Answer: D
Question Status: Previous Edition

8) When a bank repays a discount loan to the Fed, there is a(n) ________ in reserves in the banking
system and a(n) ________ in the monetary base.
A) increase; decrease
B) decrease; decrease
C) decrease; increase
D) increase; increase
Answer: B
Question Status: Previous Edition

9) The federal funds rate is


A) the interest rate on loans from the Fed to a bank.
B) the price the Fed pays for government securities.
C) the interest rate on loans of reserves from one bank to another.
D) the price banks pay the Fed for government securities.
E) the interest rate on loans from a bank to the federal government.
Answer: C
Question Status: Previous Edition

10) The discount rate is


A) the interest rate on loans from the Fed to a bank.
B) the price the Fed pays for government securities.
C) the interest rate on loans of reserves from one bank to another.
D) the price banks pay the Fed for government securities.
E) the interest rate on loans from a bank to the federal government.
Answer: A
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) Holding everything else constant, if the federal funds rate rises, then the demand for
A) excess reserves rises because they have a higher return.
B) excess reserves falls because they have a higher cost.
C) required reserves falls because the cost of borrowing from the Fed is relatively higher.
D) required reserves rises because the cost of borrowing from the Fed is relatively lower.
E) reserves will not change because the Fed sets the level of required reserves.
Answer: B
Question Status: Previous Edition

12) Holding everything else constant, if the federal funds rate falls, then the demand for
A) excess reserves falls because they have a lower return.
B) excess reserves rises because they have a lower cost.
C) required reserves rises because the cost of borrowing from the Fed is relatively higher.
D) required reserves rises because the cost of borrowing from the Fed is relatively lower.
E) reserves will not change because the Fed sets the level of required reserves.
Answer: B
Question Status: Previous Edition

13) Bank reserves can be categorized as


A) vault cash and deposits at the Fed.
B) required reserves and excess reserves.
C) borrowed reserves and nonborrowed reserves.
D) all of the above.
Answer: D
Question Status: Previous Edition
14) An open market purchase
A) shifts the supply curve for reserves to the right and causes the federal funds rate to fall.
B) shifts the demand curve for reserves to the right and causes the federal funds rate to rise.
C) shifts the supply curve for reserves to the left and causes the federal funds rate to rise.
D) shifts the demand curve for reserves to the left and causes the federal funds rate to fall.
Answer: A
Question Status: Previous Edition
15) The supply curve for reserves is ________ when the federal funds rate is below the discount rate and
________ when the federal funds rate is above the discount rate.
A) upward sloping; horizontal
B) upward sloping; vertical
C) vertical; horizontal
D) vertical; downward sloping
Answer: C
Question Status: Previous Edition
16) The supply curve for reserves shifts to the left and the federal funds rate rises when the Fed
A) raises reserves requirements.
B) does an open market purchase.
C) does an open market sale.
D) raises the discount rate.
Answer: C
Question Status: Previous Edition
3
Copyright 2012 Pearson Education, Inc.

17) The demand curve for reserves shifts to the left and the federal funds rate falls when the Fed
A) decreases reserve requirements or does an open market purchase.
B) lowers the discount rate.
C) lowers the discount rate or does an open market purchase.
D) decreases reserves requirements.
E) does an open market sale.
Answer: D
Question Status: Previous Edition

18) Under usual circumstances, an increase in the discount rate causes


A) the federal funds rate to fall.
B) the federal funds rate to rise.
C) no change in the federal funds rate.
D) the supply of reserves to increase.
E) the supply of reserves to decrease.
Answer: C
Question Status: Previous Edition

19) If the Fed increases reserve requirements, the demand for reserves ________ and the equilibrium
federal funds rate ________.
A) increases; drops
B) decreases; rises
C) decreases; drops
D) increases; rises
Answer: D
Question Status: Previous Edition

20) The actual execution of open market operations is done at


A) the Board of Governors in Washington, D.C.
B) the Federal Reserve Bank of New York.
C) the Federal Reserve Bank of Philadelphia.
D) the Federal Reserve Bank of Boston.
Answer: B
Question Status: Previous Edition
21) The Federal Open Market Committee makes the Fed's decisions on the purchase or sale of
government securities, but these purchases or sales are executed by the Federal Reserve Bank of
A) Chicago.
B) Boston.
C) New York.
D) San Francisco.
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

22) An open market transaction intended to change the level of bank reserves is a
A) repurchase agreement.
B) reverse repo.
C) dynamic operation.
D) defensive operation.
Answer: C
Question Status: Previous Edition
23) If the Federal Reserve wants to drain reserves from the banking system, it will
A) purchase government securities.
B) lower the discount rate.
C) sell government securities.
D) raise reserve requirements.
Answer: C
Question Status: Previous Edition
24) The Federal Reserve will engage in an outright purchase if it wants to ________ reserves ________
in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: A
Question Status: Previous Edition

25) If the Fed wants to temporarily drain reserves from the banking system, it will engage in
A) a repurchase agreement.
B) a matched sale-purchase transaction.
C) a "pump" agreement.
D) none of the above.
Answer: B
Question Status: Previous Edition
26) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to ________
reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: C
Question Status: Previous Edition

27) Discount loans to banks experiencing severe liquidity problems are called
A) primary credit.
B) secondary credit.
C) seasonal credit.
D) lender-of-last-resort credit.
Answer: B
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

28) Discount loans to healthy banks, who may borrow as much as they wish from the Fed, are called
A) primary credit.
B) secondary credit.
C) seasonal credit.
D) lender-of-last-resort credit.
Answer: A
Question Status: Previous Edition
29) Disadvantages of using reserve requirements to control the money supply include
A) their overly-powerful impact on the money supply.
B) creating potential liquidity problems for banks with high levels of excess reserves.
C) their overly-powerful impact on the monetary base.
D) all of the above.
Answer: A
Question Status: Previous Edition
30) The Fed is reluctant to use reserve requirements to control the money supply because
A) of their overly-powerful impact on the money supply.
B) they have the potential to create liquidity problems for banks with low excess reserves.
C) frequent changes in reserve requirements complicate liquidity management for banks.
D) of all of the above.
E) of only A and B of the above.
Answer: D
Question Status: Previous Edition
31) When the Federal Reserve was created, its most important role was intended to be
A) a storage facility for the nation's gold.
B) a lender of last resort.
C) a regulator of bank holding companies.
D) none of the above.
Answer: B
Question Status: Previous Edition
32) At its inception, the Federal Reserve was intended to be
A) the Treasury's banker.
B) the issuer of government debt.
C) a lender of last resort.
D) a regulator of bank holding companies.
Answer: C
Question Status: Previous Edition
33) Price stability is desirable because
A) inflation creates uncertainty, making it difficult to plan for the future.
B) everyone is better off when prices are stable.
C) price stability increases the profitability of the Fed.
D) it guarantees full employment.
Answer: A
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

34) The Federal Reserve desires interest rate stability because


A) it allows for less uncertainty about future planning.
B) interest rate volatility often leads to demands to curtail the Fed's power.
C) it guarantees full employment.
D) both A and B of the above.
Answer: D
Question Status: Previous Edition
35) When workers voluntarily quit a job or decline a job offer so they can search for a better one, the
resulting unemployment is called
A) structural unemployment.
B) frictional unemployment.
C) cyclical unemployment.
D) underemployment.
Answer: B
Question Status: Previous Edition
36) When there is a mismatch between job requirements and the skills of available workers, the resulting
unemployment is called
A) structural unemployment.
B) frictional unemployment.
C) cyclical unemployment.
D) underemployment.
Answer: A
Question Status: Previous Edition

37) The goal for high employment should be a level of unemployment at which the demand for labor
equals the supply of labor. Economists call this level of unemployment the
A) frictional rate of unemployment.
B) structural rate of unemployment.
C) natural rate of unemployment.
D) ideal rate of unemployment.
Answer: C
Question Status: Previous Edition

38) Although the goals of high employment and economic growth are closely related, policies can be
specifically aimed at encouraging economic growth by
A) encouraging firms to invest.
B) encouraging people to save.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: C
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

39) Although the goals of high employment and economic growth are closely related, policies can be
specifically aimed at encouraging economic growth by
A) encouraging firms to invest and people to save.
B) encouraging firms to limit their price increases.
C) encouraging people to consume.
D) all of the above.
E) only A and C of the above.
Answer: A
Question Status: Previous Edition
40) The Fed's monetary policy strategy can be described as follows:
A) The Fed uses its policy tools to adjust intermediate targets that directly impact its operating targets in
a way that allows the Fed to achieve its goals.
B) The Fed uses its policy tools to adjust operating targets that directly impact its intermediate targets in
a way that allows the Fed to achieve its goals.
C) The Fed uses its operating targets to adjust its intermediate targets that directly impact its policy tools
in a way that allows the Fed to achieve its goals.
D) None of the above.
Answer: B
Question Status: Previous Edition

41) If the Fed's strategy for conducting monetary policy is thought of as a game plan that proceeds in
stages, then the game plan can be summarized as follows:
A) The Fed selects its policy goals, then the intermediate targets consistent with achieving its policy
goals, then the operating targets consistent with its intermediate targets. Finally, it adjusts its policy tools
to effect the desired targets and goals.
B) The Fed selects its policy goals, then the operating targets consistent with achieving its policy goals,
then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy tools to
effect the desired targets and goals.
C) The Fed selects its policy goals, then the intermediate targets consistent with achieving its policy
goals, then the policy tools consistent with its intermediate targets. Finally, it adjusts its operating targets
to effect the desired targets and tools.
D) The Fed selects its policy tools, then the operating targets consistent with achieving its policy tools,
then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy goals to
effect the desired targets and tools.
E) None of the above.
Answer: A
Question Status: Previous Edition

42) An advantage of an intermediate targeting strategy is that it provides the Fed with
A) more timely information regarding the effect of monetary policy.
B) a slow adjustment process.
C) a target that is precisely correlated with economic activity.
D) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

43) Which of the following is not a requirement in selecting an intermediate target?


A) measurability
B) controllability
C) flexibility
D) predictability
Answer: C
Question Status: Previous Edition
44) Which of the following is a potential operating target for the Fed?
A) The monetary base
B) The M1 money supply
C) Nominal GDP
D) The discount rate
Answer: A
Question Status: Previous Edition
45) Which of the following is a potential operating target for the Fed?
A) Nonborrowed reserves
B) The federal funds rate
C) The monetary base
D) All of the above
Answer: D
Question Status: Previous Edition
46) Which of the following is not an operating target?
A) Nonborrowed reserves
B) Monetary base
C) Federal funds interest rate
D) Discount rate
E) All are operating targets
Answer: D
Question Status: Previous Edition

47) When it comes to choosing an operating target, both the ________ rate and ________ aggregates are
easily controllable using the Fed's policy tools.
A) federal funds; monetary
B) federal funds; reserve
C) three-month Treasury bill; monetary
D) ten-year Treasury bond; reserve
Answer: B
Question Status: Previous Edition

48) If the desired intermediate target is an interest rate, then the preferred operating target will be a(n)
________ variable like the ________.
A) interest rate; three-month Treasury bill rate
B) interest rate; federal funds rate
C) reserve aggregate; monetary base
D) reserve aggregate; nonborrowed base
Answer: B
Question Status: Previous Edition
9
Copyright 2012 Pearson Education, Inc.

49) If the desired intermediate target is a monetary aggregate, then the preferred operating target will be
a(n) ________ variable like the ________.
A) interest rate; three-month Treasury bill rate
B) interest rate; federal funds rate
C) reserve aggregate; monetary base
D) reserve aggregate; nonborrowed reserves
Answer: C
Question Status: Previous Edition

50) If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, fluctuations in the reserves
demand curve will cause ________ to fluctuate.
A) nonborrowed reserves
B) the federal funds interest rate
C) monetary aggregates
D) the inflation rate
Answer: B
Question Status: Previous Edition

51) If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, an increase in the demand for
reserves will result in a(n) ________ in ________.
A) increase; nonborrowed reserves
B) decrease; nonborrowed reserves
C) increase; the federal funds interest rate
D) decrease; the federal funds interest rate
Answer: C
Question Status: Previous Edition

52) If the Fed uses the federal funds rate as an interest rate target, fluctuations in the reserves demand
curve will cause ________ to fluctuate.
A) nonborrowed reserves
B) the federal funds interest rate
C) Treasury bill interest rates
D) the inflation rate
Answer: A
Question Status: Previous Edition

53) If the Fed uses the federal funds rate as an interest rate target, an increase in the demand for reserves
will result in a(n) ________ in ________.
A) increase; nonborrowed reserves
B) decrease; nonborrowed reserves
C) increase; the federal funds interest rate
D) decrease; the federal funds interest rate
Answer: A
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

54) Under inflation targeting, a central bank must pursue policies that
A) keep the inflation rate at a target value of zero.
B) keep the inflation rate at some specific target value.
C) keep the inflation rate within a specific target range.
D) lower the inflation rate, provided this can be done without raising the unemployment rate above a
specified target value.
Answer: C
Question Status: Previous Edition

55) The first country to mandate that its central bank adopt inflation targeting was
A) the United States.
B) the United Kingdom.
C) Canada.
D) New Zealand.
Answer: D
Question Status: Previous Edition
56) Banks' holding of deposits in accounts with the Fed, plus currency that is physically held in banks
are called
A) the monetary base.
B) government securities.
C) open market operations.
D) reserves.
Answer: D
Question Status: Previous Edition

57) An open market ________ leads to a(n) ________ of reserves and deposits in the banking system
and hence to a(n) ________ of the monetary base and the money supply.
A) sale; expansion; contraction
B) purchase; expansion; contraction
C) sale; expansion; expansion
D) purchase; expansion; expansion
Answer: D
Question Status: Previous Edition

58) Regulations making it obligatory for depository institutions to keep a certain fraction of their
deposits in accounts with the Fed are
A) open market operations.
B) federal funds rate.
C) required reserve ratio.
D) reserve requirements.
Answer: D
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

59) Which type of open market operation is intended to change the level of reserves?
A) Defensive open market operations
B) Reserve requirements
C) Dynamic open market operations
D) Market equilibrium
Answer: C
Question Status: Previous Edition
60) The type of open market operation intended to offset movements in other factors that affect reserves
and the monetary base is
A) the dynamic open market operations.
B) the defensive open market operations.
C) the reserve requirements.
D) market equilibrium.
Answer: B
Question Status: Previous Edition

61) What goals are continually mentioned by central bank officials when discussing the objectives of
monetary policy?
A) High unemployment
B) Instability in foreign exchange markets
C) Interest-rate stability
D) All of the above
Answer: C
Question Status: Previous Edition

62) Inflation targeting involves


A) a public announcement of medium-term numerical targets for inflation.
B) increased accountability of the central bank for attaining its inflation objectives.
C) an information-inclusive approach in which many variables are used in making decisions about
monetary policy.
D) all of the above.
Answer: A
Question Status: Previous Edition

63) During the 2007-2009 financial crisis, what actions did the Fed take to limit the scope of the crisis?
A) The Fed lowered the spread on the discount rate to 50 basis points, and then to 25.
B) The Fed set up the Term Auction Facility to provide further liquidity to banks.
C) The Fed purchased assets of Bear Stearns to facilitate the purchase of Bear Stearns by J.P. Morgan.
D) all of the above.
Answer: D
Question Status: New Question

12
Copyright 2012 Pearson Education, Inc.

64) Which of the following statements is true regarding the Fed's procedures for operating the discount
window?
A) The Fed's operating procedures and paying interest on reserves contains the federal funds rate
between the interest rate paid on reserves and the discount rate.
B) The Fed's operating procedures and paying interest on reserves creates more fluctuation in the federal
funds rate than if they simply didn't pay interest on reserves.
C) The Fed's operating procedures and paying interest on reserves has no impact on the fluctuation of
the federal funds rate.
D) None of the above is correct.
Answer: A
Question Status: New Question

65) Which of the following statements is true?


A) Credit-driven asset bubbles are particularly dangerous. When asset prices fall, the deleveraging of
credit markets reduces economic activity.
B) Bubbles driven solely by irrational exuberance lead to a failure of financial institutions.
C) Both A and B are correct.
D) Neither A nor B is correct.
Answer: A
Question Status: New Question

66) If the Fed wants to "prick" an asset-pricing bubble driven by a credit boom, what is the primary tool
for accomplishing this?
A) Raising interest rates.
B) Lowering interest rates.
C) Increasing reserve requirements.
D) Taking a short position in the overpriced asset.
Answer: A
Question Status: New Question

67) In response to an asset-price bubble, macroprudential regulation appears to be the right tool. What is
macroprudential regulation?
A) Increasing the federal funds rate across the macroeconomy.
B) The use of tax incentives to capture some of the gains from bubbles.
C) Regulatory policy to affect what is happening in credit markets in the aggregate.
D) None of the above is correct.
Answer: C
Question Status: New Question

13
Copyright 2012 Pearson Education, Inc.

10.2 True/False
1) An objective of the Federal Reserve in its conduct of monetary policy is high employment.
Answer: TRUE
Question Status: Previous Edition
2) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is
called frictional unemployment.
Answer: TRUE
Question Status: Previous Edition
3) The discount rate is an operating target.
Answer: FALSE
Question Status: Previous Edition
4) The federal funds rate is an operating target.
Answer: TRUE
Question Status: Previous Edition
5) Open market purchases by the Fed increase the supply of nonborrowed reserves.
Answer: TRUE
Question Status: Previous Edition
6) Open market purchases by the Fed cause the federal funds rate to rise.
Answer: FALSE
Question Status: Previous Edition
7) Flexibility is a requirement in selecting an intermediate target.
Answer: FALSE
Question Status: Previous Edition
8) Inflation targeting makes the central bank less accountable.
Answer: FALSE
Question Status: Previous Edition
9) An open market sale leads to an expansion of reserves and deposits in the banking system and hence
to a decline in the monetary base and the money supply.
Answer: FALSE
Question Status: Previous Edition
10) Decreased transparency of the monetary policy strategy through communication with the public and
the markets about the plans and objectives of monetary policymakers is an element of inflation targeting.
Answer: FALSE
Question Status: Previous Edition
11) The Fed's operating procedures and paying interest on reserves contains the federal funds rate
between the interest rate paid on reserves and the discount rate.
Answer: TRUE
Question Status: New Question

14
Copyright 2012 Pearson Education, Inc.

12) An important lesson from the 20072009 financial crisis is that central banks and other regulators
should have a laissez-faire attitude and let credit-driven bubbles proceed without any reaction.
Intervention is always a mistake.
Answer: FALSE
Question Status: New Question
10.3 Essay
1) Explain how the Fed's use of its three tools of monetary policy affect supply and demand in the
market for reserves and the equilibrium federal funds interest rate.
Question Status: Previous Edition
2) Distinguish between the three types of Fed discount loans: primary credit, secondary credit, and
seasonal credit.
Question Status: Previous Edition
3) Why does the Fed use open market operations to a greater extent than reserve requirements in its
conduct of monetary policy?
Question Status: Previous Edition
4) Explain why the use of an interest rate targeting strategy may result in procyclical monetary growth.
Question Status: Previous Edition
5) "The interest rate targeting strategy employed by the Fed in the 1960s and 1970s led to procyclical
money growth." True, false, or uncertain? Why?
Question Status: Previous Edition
6) If inflation and unemployment are of direct concern to Fed officials, why do they make such a big
issue about money growth and interest rates? Why don't they just target the unemployment rate and the
inflation rate directly? Explain.
Question Status: Previous Edition
7) Describe the goals of the Federal Reserve. What happens when these goals come into conflict? How
would one decide if lower inflation is more important than lower unemployment? Explain.
Question Status: Previous Edition
8) Can the Fed control the money supply? Has it done so? What evidence can you provide to support
your answer to each question?
Question Status: Previous Edition
9) Compare the advantages and disadvantages of monetary targeting and inflation targeting.
Question Status: Previous Edition
10) Describe what criteria is applied when choosing a policy instrument.
Question Status: Previous Edition
11) Describe and discuss Chairman Bernanke's views on inflation targeting and transparency in central
banking.
Question Status: New Question

15
Copyright 2012 Pearson Education, Inc.

12) Discuss the role of the Fed as a lender of last resort during the 2007-2009 financial crisis.
Question Status: New Question
13) What is the argument for the Fed paying interest to banks on required reserves? Are there good
arguments for not doing this?
Question Status: New Question
14) Discuss how the monetary policy of the European Central Bank is similar to the U.S. How are they
different?
Question Status: New Question
15) Describe an asset-price bubble.
Question Status: New Question
16) What are the arguments for and against central bank intervention during asset-price bubbles?
Question Status: New Question

16
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 11 The Money Markets
11.1 Multiple Choice
1) Activity in money markets increased significantly in the late 1970s and early 1980s because of
A) rising short-term interest rates.
B) regulations that limited what banks could pay for deposits.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: C
Question Status: Previous Edition
2) Money market securities have all the following characteristics except they are not
A) short term.
B) money.
C) low risk.
D) very liquid.
Answer: B
Question Status: Previous Edition
3) Money market instruments
A) are usually sold in large denominations.
B) have low default risk.
C) mature in one year or less.
D) are characterized by all of the above.
E) are characterized by only A and B of the above.
Answer: D
Question Status: Previous Edition

4) The banking industry


A) should have an efficiency advantage in gathering information that would eliminate the need for the
money markets.
B) exists primarily to mediate the asymmetric information problem between saver-lenders and borrowerspenders.
C) is subject to more regulations and governmental costs than the money markets.
D) all of the above are true.
E) only A and B of the above are true.
Answer: D
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

5) In situations where asymmetric information problems are not severe,


A) the money markets have a distinct cost advantage over banks in providing short-term funds.
B) the money markets have a distinct cost advantage over banks in providing long-term funds.
C) banks have a distinct cost advantage over the money markets in providing short-term funds.
D) the money markets cannot allocate short-term funds as efficiently as banks can.
Answer: A
Question Status: Previous Edition
6) Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over
banks in attracting funds because the brokerage firms
A) were not subject to deposit reserve requirements.
B) were not subject to the deposit interest rate ceilings.
C) were not limited in how much they could borrow from depositors.
D) had the advantage of all the above.
E) had the advantage of only A and B of the above.
Answer: E
Question Status: Previous Edition

7) Which of the following statements about the money markets are true?
A) Not all commercial banks deal for their customers in the secondary market.
B) Money markets are used extensively by businesses both to warehouse surplus funds and to raise
short-term funds.
C) The single most influential participant in the U.S. money market is the U.S. Treasury Department.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

8) Which of the following statements about the money markets are true?
A) Most money market securities do not pay interest. Instead, the investor pays less for the security than
it will be worth when it matures.
B) Pension funds invest a portion of their assets in the money market to have sufficient liquidity to meet
their obligations.
C) Unlike most participants in the money market, the U.S. Treasury Department is always a demander
of money market funds and never a supplier.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

9) Which of the following are true statements about participants in the money markets?
A) Large banks participate in the money markets by selling large negotiable CDs.
B) The U.S. government and corporations borrow in the money markets because cash inflows and
outflows are rarely synchronized.
C) The Federal Reserve is the single most influential participant in the U.S. money market.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

10) The most influential participant(s) in the U.S. money market


A) is the Federal Reserve.
B) is the U.S. Treasury Department.
C) are the large money center banks.
D) are the investment banks that underwrite securities.
Answer: A
Question Status: Previous Edition
11) The Fed is an active participant in money markets mainly because of its responsibility to
A) lower borrowing costs to encourage capital investment.
B) control the money supply.
C) increase the interest income of retirees holding money market instruments.
D) assist the Securities and Exchange Commission in regulating the behavior of other money market
participants.
Answer: B
Question Status: Previous Edition

12) Commercial banks are large holders of ________ and are the major issuer of ________.
A) negotiable certificates of deposit; U.S. government securities
B) U.S. government securities; negotiable certificates of deposit
C) commercial paper; Eurodollars
D) Eurodollars; commercial paper
Answer: B
Question Status: Previous Edition
13) The primary function of large diversified brokerage firms in the money market is to
A) sell money market securities to the Federal Reserve for its open market operations.
B) make a market for money market securities by maintaining an inventory from which to buy or sell.
C) buy money market securities from corporations that need liquidity.
D) buy T-bills from the U.S. Treasury Department.
Answer: B
Question Status: Previous Edition
14) Finance companies raise funds in the money market by selling
A) commercial paper.
B) federal funds.
C) negotiable certificates of deposit.
D) Eurodollars.
Answer: A
Question Status: Previous Edition
15) Finance companies play a unique role in money markets by
A) giving consumers indirect access to money markets.
B) combining consumers' investments to purchase money market securities on their behalf.
C) borrowing in capital markets to finance purchases of money market securities.
D) assisting the government in its sales of U.S. Treasury securities.
Answer: A
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) When inflation rose in the late 1970s,


A) consumers moved money out of money market mutual funds because their returns did not keep pace
with inflation.
B) banks solidified their advantage over money markets by offering higher deposit rates.
C) brokerage houses introduced highly popular money market mutual funds, which drew significant
amounts of money out of bank deposits.
D) consumers were unable to take advantage of higher rates in money markets because of the
requirement of large transaction sizes.
Answer: C
Question Status: Previous Edition

17) Which of the following is the largest borrower in the money markets?
A) commercial banks
B) large corporations
C) the U.S. Treasury
D) U.S. firms engaged in foreign trade
Answer: C
Question Status: Previous Edition
18) Money market instruments issued by the U.S. Treasury are called
A) Treasury bills.
B) Treasury notes.
C) Treasury bonds.
D) Treasury strips.
Answer: A
Question Status: Previous Edition
19) Which of the following statements are true of Treasury bills?
A) The market for Treasury bills is extremely deep and liquid.
B) Occasionally, investors find that earnings on T-bills do not compensate them for changes in
purchasing power due to inflation.
C) By volume, most Treasury bills are sold to individuals who submit noncompetitive bids.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

20) Suppose that you purchase a 91-day Treasury bill for $9,850 that is worth $10,000 when it matures.
The security's annualized yield if held to maturity is about
A) 4 percent.
B) 5 percent.
C) 6 percent.
D) 7 percent.
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) Suppose that you purchase a 182-day Treasury bill for $9,850 that is worth $10,000 when it matures.
The security's annualized yield if held to maturity is about
A) 1.5%.
B) 2%.
C) 3%.
D) 6%.
Answer: C
Question Status: Previous Edition

22) Treasury bills do not


A) pay interest.
B) have a maturity date.
C) have a face amount.
D) have an active secondary market.
Answer: A
Question Status: Previous Edition
23) If your competitive bid for a Treasury bill is successful, then you will
A) certainly pay less than if you had submitted a noncompetitive bid.
B) probably pay more than if you had submitted a noncompetitive bid.
C) pay the average of prices offered in other successful competitive bids.
D) pay the same as other successful competitive bidders.
Answer: B
Question Status: Previous Edition
24) If your noncompetitive bid for a Treasury bill is successful, then you will
A) certainly pay less than if you had submitted a competitive bid.
B) certainly pay more than if you had submitted a competitive bid.
C) pay the average of prices offered in other noncompetitive bids.
D) pay the same as other successful noncompetitive bidders.
Answer: D
Question Status: Previous Edition
25) Federal funds
A) are short-term funds transferred between financial institutions, usually for a period of one day.
B) actually have nothing to do with the federal government.
C) provide banks with an immediate infusion of reserves.
D) are all of the above.
E) are only A and B of the above.
Answer: D
Question Status: Previous Edition

26) Federal funds are


A) usually overnight investments.
B) borrowed by banks that have a deficit of reserves.
C) lent by banks that have an excess of reserves.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition
5
Copyright 2012 Pearson Education, Inc.

27) The Fed can influence the federal funds interest rate by adjusting the level of reserves available to
banks. The Fed can
A) lower the federal funds interest rate by adding reserves.
B) raise the federal funds interest rate by removing reserves.
C) remove reserves by selling securities.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

28) The Federal Reserve can influence the federal funds interest rate by buying securities, which
________ reserves, thereby ________ the federal funds rate.
A) adds; raising
B) removes; lowering
C) adds; lowering
D) removes; raising
Answer: C
Question Status: Previous Edition
29) The Fed can lower the federal funds interest rate by ________ securities, thereby ________
reserves.
A) selling; adding
B) selling; lowering
C) buying; adding
D) buying; lowering
Answer: C
Question Status: Previous Edition

30) If the Fed wants to lower the federal funds interest rate, it will ________ the banking system by
________ securities.
A) add reserves to; selling
B) add reserves to; buying
C) remove reserves from; selling
D) remove reserves from; buying
Answer: B
Question Status: Previous Edition

31) If the Fed wants to raise the federal funds interest rate, it will ________ securities to ________ the
banking system.
A) sell; add reserves to
B) sell; remove reserves from
C) buy; add reserves to
D) buy; remove reserves from
Answer: B
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) Government securities dealers frequently engage in repos to


A) manage liquidity.
B) take advantage of anticipated changes in interest rates.
C) lend or borrow for a day or two with what is essentially a collateralized loan.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

33) Repos are


A) usually low-risk loans.
B) usually collateralized with Treasury securities.
C) low interest rate loans.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition
34) A negotiable certificate of deposit
A) is a term security because it has a specified maturity date.
B) is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and
interest.
C) can be bought and sold until maturity.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

35) Negotiable certificates of deposit


A) are bearer instruments because their holders earn the interest and principal at maturity.
B) typically have a maturity of one to four months.
C) are usually denominated at $100,000.
D) are all of the above.
E) are only A and B of the above.
Answer: E
Question Status: Previous Edition

36) Commercial paper securities


A) are issued only by the largest and most creditworthy corporations, as they are unsecured.
B) carry an interest rate that varies according to the firm's level of risk.
C) never have a term to maturity that exceeds 270 days.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

37) Unlike most money market securities, commercial paper


A) is not generally traded in a secondary market.
B) usually has a term to maturity that is longer than a year.
C) is not popular with most money market investors because of the high default risk.
D) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition
38) A banker's acceptance is
A) used to finance goods that have not yet been transferred from the seller to the buyer.
B) an order to pay a specified amount of money to the bearer on a given date.
C) a relatively new money market security that arose in the 1960s as international trade expanded.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

39) Banker's acceptances


A) can be bought and sold until they mature.
B) are issued only by large money center banks.
C) carry low interest rates because of the very low default risk.
D) are all of the above.
E) are only A and B of the above.
Answer: D
Question Status: Previous Edition

40) Eurodollars
A) are time deposits with fixed maturities and are, therefore, somewhat illiquid.
B) may offer the borrower a lower interest rate than can be received in the domestic market.
C) are limited to London banks.
D) are all of the above.
E) are only A and B of the above.
Answer: E
Question Status: Previous Edition

41) Which of the following statements about money market securities are true?
A) The interest rates on all money market instruments move very closely together over time.
B) The secondary market for Treasury bills is extensive and well developed.
C) There is no well-developed secondary market for commercial paper.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

42) Money market transactions


A) do not take place in any one particular location or building.
B) are usually arranged purchases and sales between participants over the phone by traders and
completed electronically.
C) are both A and B of the above.
D) are none the the above.
Answer: C
Question Status: Previous Edition

43) Two important characteristics of any financial market are flexibility and
A) risk.
B) innovation.
C) tolerance.
D) capital.
Answer: B
Question Status: Previous Edition
44) The main role of investment companies in the money market is to
A) trade on behalf of commercial accounts.
B) mediate the symmetric information problem between server-lender and borrower-spenders.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: Previous Edition
45) In a direct placement
A) the issuer bypasses the dealer and sells indirectly to the end investor.
B) the dealer sells directly to the end investor.
C) the issuer bypasses the dealer and sells directly to the end investor.
D) none of the above.
Answer: A
Question Status: Previous Edition
46) The advantage of mutual funds is that they
A) require no cash up front.
B) give investors with relatively small amounts of cash to invest access to large-denomination securities.
C) always yield the highest returns.
D) both A and B of the above.
Answer: B
Question Status: Previous Edition
47) Asset-backed commercial paper differs from conventional commercial paper in that
A) it is backed (secured) by some bundle of assets.
B) its maturity usually extends well beyond 1 year.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: New Question

9
Copyright 2012 Pearson Education, Inc.

11.2 True/False
1) Money market securities are short-term instruments with an original maturity of less than one year.
Answer: TRUE
Question Status: Previous Edition
2) Money market securities include Treasury bills, commercial paper, federal funds, repurchase
agreements, negotiable certificates of deposit, banker's acceptances, and Eurodollars.
Answer: TRUE
Question Status: Previous Edition
3) The term money market is actually a misnomer, because liquid securities are traded in these markets
rather than money.
Answer: TRUE
Question Status: Previous Edition
4) Money markets are referred to as retail markets because small individual investors are the primary
buyers of money market securities.
Answer: FALSE
Question Status: Previous Edition
5) The U.S. Treasury Department is the single most influential participant in the U.S. money market.
Answer: FALSE
Question Status: Previous Edition
6) The U.S. Treasury Department is the single largest borrower in the U.S. money market.
Answer: TRUE
Question Status: Previous Edition
7) Banks are unusual participants in the money market because they buy, but do not sell, money market
instruments.
Answer: FALSE
Question Status: Previous Edition
8) Money markets are used extensively by businesses both to warehouse surplus funds and to raise
short-term funds.
Answer: TRUE
Question Status: Previous Edition
9) The market for U.S. Treasury bills is a shallow market because so few individual investors buy Tbills.
Answer: FALSE
Question Status: Previous Edition
10) The T-bill is not an investment to be used for anything but temporary storage of excess funds
because it barely keeps up with inflation.
Answer: TRUE
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

11) The main purpose of federal funds is to provide banks with an immediate infusion of reserves should
they be short.
Answer: TRUE
Question Status: Previous Edition
12) The Fed can influence the federal funds rate by adjusting the level of reserves in the banking system.
Answer: TRUE
Question Status: Previous Edition
13) Commercial paper securities are unsecured promissory notes, issued by corporations, that mature in
no more than 270 days.
Answer: TRUE
Question Status: Previous Edition
14) A banker's acceptance is an order to pay a specified amount of money to the bearer on a given date.
Banker's acceptances have been used since the twelfth century.
Answer: TRUE
Question Status: Previous Edition
15) Interest rates on banker's acceptances are low because the risk of default is very low.
Answer: TRUE
Question Status: Previous Edition
16) The size of the asset-backed commercial paper market nearly doubled between 2004 and 2007 to
about $1 trillion.
Answer: TRUE
Question Status: New Question
17) In general, money market instruments are low-risk, high-yield securities.
Answer: FALSE
Question Status: Previous Edition
18) Commercial paper has been used in various forms since the 1930s.
Answer: FALSE
Question Status: Previous Edition
19) The Treasury accepts noncompetitive bids in ascending order of yield until the accepted bids reach
the offering amount.
Answer: FALSE
Question Status: Previous Edition
20) Not all commercial banks deal in the secondary money market for their customers.
Answer: TRUE
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

11.3 Essay
1) Explain why banks, which would seem to have a comparative advantage in gathering information,
have not eliminated the need for the money markets.
Question Status: Previous Edition
2) Explain how the Federal Reserve can influence the federal funds interest rate.
Question Status: Previous Edition
3) Explain why the money markets are referred to as wholesale markets.
Question Status: Previous Edition
4) Explain why money market interest rates move so closely together over time.
Question Status: Previous Edition
5) How are Treasury bills sold? How do competitive and noncompetitive bids differ?
Question Status: Previous Edition
6) What are the main characteristics of money market securities?
Question Status: Previous Edition
7) What are the major types of securities and who are the major participants in the money markets?
Question Status: Previous Edition
8) Explain how and why repurchase agreements would be used.
Question Status: Previous Edition
9) The size of the asset-backed commercial paper market nearly doubled between 2004 and 2007 to
about $1 trillion. Discuss how the subprime meltdown and collapse of the ABCP market almost led to
the collapse of the money market mutual fund market as well.
Question Status: New Question

12
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 12 The Bond Market
12.1 Multiple Choice
1) Compared to money market securities, capital market securities have
A) more liquidity.
B) longer maturities.
C) lower yields.
D) less risk.
Answer: B
Question Status: Previous Edition
2) (I) Securities that have an original maturity greater than one year are traded in capital markets.
(II) The best known capital market securities are stocks and bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

3) (I) Securities that have an original maturity greater than one year are traded in money markets.
(II) The best known money market securities are stocks and bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: D
Question Status: Previous Edition

4) (I) Firms and individuals use the capital markets for long-term investments.
(II) Capital markets provide an alternative to investment in assets such as real estate and gold.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition
5) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that
interest rates will ________ before they pay off their debt.
A) rise
B) fall
C) become more volatile
D) become more stable
Answer: A
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) The primary reason that individuals and firms choose to borrow long-term is to
A) reduce the risk that interest rates will fall before they pay off their debt.
B) reduce the risk that interest rates will rise before they pay off their debt.
C) reduce monthly interest payments, as interest rates tend to be higher on short-term than long-term
debt instruments.
D) reduce total interest payments over the life of the debt.
Answer: B
Question Status: Previous Edition

7) A firm will borrow long-term


A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates
before it retires its debt.
B) if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the
expected premium that is paid for borrowing long-term.
C) if short-term interest rates are expected to decline during the term of the debt.
D) if long-term interest rates are expected to decline during the term of the debt.
Answer: A
Question Status: Previous Edition

8) The primary issuers of capital market securities include


A) the federal and local governments.
B) the federal and local governments, and corporations.
C) the federal and local governments, corporations, and financial institutions.
D) local governments and corporations.
Answer: B
Question Status: Previous Edition
9) Governments never issue stock because
A) they cannot sell ownership claims.
B) the Constitution expressly forbids it.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: Previous Edition
10) (I) The primary issuers of capital market securities are federal and local governments, and
corporations.
(II) Governments never issue stock because they cannot sell ownership claims.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) (I) The primary issuers of capital market securities are financial institutions.
(II) The largest purchasers of capital market securities are corporations.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: D
Question Status: Previous Edition

12) The distribution of a firm's capital between debt and equity is its
A) current ratio.
B) liability structure.
C) acid ratio.
D) capital structure.
Answer: D
Question Status: Previous Edition
13) The largest purchasers of capital market securities are
A) households.
B) corporations.
C) governments.
D) central banks.
Answer: A
Question Status: Previous Edition
14) Individuals and households frequently purchase capital market securities through financial
institutions such as
A) mutual funds.
B) pension funds.
C) money market mutual funds.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

15) (I) There are two types of exchanges in the secondary market for capital securities: organized
exchanges and over-the-counter exchanges.
(II) When firms sell securities for the very first time, the issue is an initial public offering.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) (I) Capital market securities fall into two categories: bonds and stocks.
(II) Long-term bonds include government bonds and long-term notes, municipal bonds, and corporate
bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition

17) The ________ value of a bond is the amount that the issuer must pay at maturity.
A) market
B) present
C) discounted
D) face
Answer: D
Question Status: Previous Edition
18) The ________ rate is the rate of interest that the issuer must pay.
A) market
B) coupon
C) discount
D) funds
Answer: B
Question Status: Previous Edition
19) (I) The coupon rate is the rate of interest that the issuer of the bond must pay.
(II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market
interest rates.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition
20) (I) The coupon rate is the rate of interest that the issuer of the bond must pay.
(II) The coupon rate on old bonds fluctuates with market interest rates so they will remain attractive to
investors.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) Treasury bonds are subject to ________ risk but are free of ________ risk.
A) default; interest-rate
B) default; underwriting
C) interest-rate; default
D) interest-rate; underwriting
Answer: C
Question Status: Previous Edition
22) The prices of Treasury notes, bonds, and bills are quoted
A) as a percentage of the coupon rate.
B) as a percentage of the previous day's closing value.
C) as a percentage of $100 face value.
D) as a multiple of the annual interest paid.
Answer: C
Question Status: Previous Edition
23) The security with the longest maturity is a Treasury
A) note.
B) bond.
C) acceptance.
D) bill.
Answer: B
Question Status: Previous Edition
24) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until
the yield to the buyer is the same as the market rate.
(II) The risk that the value of a bond will fall when market interest rates rise is called interest-rate risk.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition
25) To sell an old bond when interest rates have ________, the holder will have to ________ the price of
the bond until the yield to the buyer is the same as the market rate.
A) risen; lower
B) risen; raise
C) fallen; lower
D) risen; inflate
Answer: A
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) Most of the time, the interest rate on Treasury notes and bonds is ________ that on money market
securities because of ________ risk.
A) above; interest-rate
B) above; default
C) below; interest-rate
D) below; default
Answer: A
Question Status: Previous Edition

27) (I) In most years, the rate of return on short-term Treasury bills is below that on the 20-year
Treasury bond.
(II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

28) (I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the
return on short-term Treasury securities is usually above that on longer-term Treasury securities.
(II) A Treasury STRIP separates the periodic interest payments from the final principal repayment.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition
29) Which of the following statements about Treasury inflation-indexed bonds is not true?
A) The principal amount used to compute the interest payment varies with the consumer price index.
B) The interest payment rises when inflation occurs.
C) The interest rate rises when inflation occurs.
D) At maturity, the securities pay the greater of face value or inflation-adjusted principal.
Answer: A
Question Status: Previous Edition
30) (I) Municipal bonds that are issued to pay for essential public projects are exempt from federal
taxation.
(II) General obligation bonds do not have specific assets pledged as security or a specific source of
revenue allocated for their repayment.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

31) (I) Most corporate bonds have a face value of $1,000, pay interest semiannually, and can be
redeemed anytime the issuer wishes.
(II) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

32) The bond contract that states the lender's rights and privileges and the borrower's obligations is
called the
A) bond syndicate.
B) restrictive covenant.
C) bond covenant.
D) bond indenture.
Answer: D
Question Status: Previous Edition

33) Policies that limit the discretion of managers as a way of protecting bondholders' interests are called
A) restrictive covenants.
B) debentures.
C) sinking funds.
D) bond indentures.
Answer: A
Question Status: Previous Edition
34) Typically, the interest rate on corporate bonds will be ________ the more restrictions are placed on
management through restrictive covenants, because ________.
A) higher; corporate earnings will be limited by the restrictions
B) higher; the bonds will be considered safer by bondholders
C) lower; the bonds will be considered safer by buyers
D) lower; corporate earnings will be higher with more restrictions in place
Answer: C
Question Status: Previous Edition

35) Restrictive covenants can


A) limit the amount of dividends the firm can pay.
B) limit the ability of the firm to issue additional debt.
C) restrict the ability of the firm to enter into a merger agreement.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

36) (I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders.
(II) Most corporate indentures include a call provision, which states that the issuer has the right to force
the holder to sell the bond back.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

37) Call provisions will be exercised when interest rates ________ and bond values ________.
A) rise; rise
B) fall; rise
C) rise; fall
D) fall; fall
Answer: B
Question Status: Previous Edition
38) A requirement in the bond indenture that the firm pay off a portion of the bond issue each year is
called
A) a sinking fund.
B) a call provision.
C) a restrictive covenant.
D) a shelf registration.
Answer: A
Question Status: Previous Edition
39) (I) Callable bonds usually have a higher yield than comparable noncallable bonds.
(II) Convertible bonds are attractive to bondholders and sell for a higher price than comparable
nonconvertible bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

40) Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are
called
A) junk bonds.
B) callable bonds.
C) convertible bonds.
D) debentures.
Answer: D
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

41) A secured bond is backed by


A) the general creditworthiness of the borrower.
B) an insurance company's financial guarantee.
C) the expected future earnings of the borrower.
D) specific collateral.
Answer: D
Question Status: Previous Edition
42) Financial guarantees
A) are insurance policies to back bond issues.
B) are purchased by financially weaker security issuers.
C) lower the risk of the bonds covered by the guarantee.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

43) In its simplest form, a credit default swap provides


A) insurance against default in the principle and interest payments of a credit instrument.
B) an alternative method for bond issuers to pay principle and interest payments via a swap.
C) bond investors with a method to swap interest payments for principle payments during a "credit
event."
D) the government with a guarantee that certain bond issues will not run into credit problems.
Answer: A
Question Status: New Question
44) Corporate bonds are less risky if they are ________ bonds and municipal bonds are less risky if they
are ________ bonds.
A) secured; revenue
B) secured; general obligation
C) unsecured; revenue
D) unsecured; general obligation
Answer: B
Question Status: Previous Edition

45) Which of the following are true for the current yield?
A) The current yield is defined as the yearly coupon payment divided by the price of the security.
B) The formula for the current yield is identical to the formula describing the yield to maturity for a
discount bond.
C) The current yield is always a poor approximation for the yield to maturity.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: A
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

46) The nearer a bond's price is to its par value and the longer the maturity of the bond, the more closely
the ________ approximates the ________.
A) current yield; yield to maturity
B) current yield; coupon rate
C) yield to maturity; current yield
D) yield to maturity; coupon rate
Answer: A
Question Status: Previous Edition

47) Which of the following are true for the current yield?
A) The current yield is defined as the yearly coupon payment divided by the price of the security.
B) The current yield and the yield to maturity always move together.
C) The formula for the current yield is identical to the formula describing the yield to maturity for a
discount bond.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition
48) The current yield is a less accurate approximation of the yield to maturity the ________ the time to
maturity of the bond and the ________ the price is from/to the par value.
A) shorter; closer
B) shorter; farther
C) longer; closer
D) longer; farther
Answer: B
Question Status: Previous Edition

49) The current yield on a $6,000, 10 percent coupon bond selling for $5,000 is
A) 5%.
B) 10%.
C) 12%.
D) 15%.
Answer: C
Question Status: Previous Edition
50) The current yield on a $5,000, 8 percent coupon bond selling for $4,000 is
A) 5%.
B) 8%.
C) 10%.
D) 20%.
E) none of the above.
Answer: C
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

51) When an old bond's market value is above its par value, the bond is selling at a ________. This
occurs because the old bond's coupon rate is ________ the coupon rates of new bonds with similar risk.
A) premium; below
B) premium; above
C) discount; below
D) discount; above
Answer: B
Question Status: Previous Edition

52) Corporations may enter the capital markets because


A) they do not have sufficient capital to fund their investment opportunities.
B) they want to preserve their capital to protect against expected needs.
C) it is required by the Securities and Exchange Commission (SEC).
D) none of the above.
Answer: A
Question Status: Previous Edition
53) Capital market trading occurs in
A) the primary market.
B) the secondary market.
C) both A and B of the above.
D) none of the above.
Answer: C
Question Status: Previous Edition
54) Bonds
A) are securities that represent a debt owed by the issuer to the investor.
B) obligate the issuer to pay a specified amount at a given date, generally without periodic interest
payments.
C) both A and B of the above.
D) none of the above.
Answer: A
Question Status: Previous Edition

55) STRIPS (Separate Trading of Registered Interest and Principal Securities) are also called
A) interest-based securities.
B) zero-coupon securities.
C) leveraged securities.
D) covenant securities.
Answer: B
Question Status: Previous Edition
56) The risk on an agency bond is
A) high.
B) zero.
C) moderate.
D) low.
Answer: D
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

57) The first step in finding the value of a bond is to


A) discount back the cash flows using an interest rate that represents the yield available on other bonds
of like risk and maturity.
B) identify the cash flows the holder of the bond will receive.
C) contact the holder of the bond.
D) none of the above.
Answer: B
Question Status: Previous Edition
58) A change in the current yield ________ signals a change in the same direction of the yield to
maturity.
A) never
B) rarely
C) always
D) often
Answer: C
Question Status: Previous Edition

59) By the time the subprime financial crisis hit in force, Fannie and Freddie had ________ subprime
and Alt-A assets on their books.
A) over $1 trillion of
B) very few
C) been prohibited from holding
D) none of the above
Answer: A
Question Status: New Question

12.2 True/False
1) The primary issuers of capital market securities are local governments and corporations.
Answer: FALSE
Question Status: Previous Edition
2) Capital market securities are less liquid and have longer maturities than money market securities.
Answer: TRUE
Question Status: Previous Edition
3) Governments never issue stock because they cannot sell ownership claims.
Answer: TRUE
Question Status: Previous Edition
4) To sell an old bond when rates have risen, the holder will have to discount the bond until the yield to
the buyer is the same as the market rate.
Answer: TRUE
Question Status: Previous Edition
5) Most of the time, the interest rate on Treasury notes is below that on money market securities because
of their low default risk.
Answer: FALSE
Question Status: Previous Edition
12
Copyright 2012 Pearson Education, Inc.

6) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation.
Answer: TRUE
Question Status: Previous Edition
7) Most municipal bonds are revenue bonds rather than general obligation bonds.
Answer: TRUE
Question Status: Previous Edition
8) Most corporate bonds have a face value of $1,000, are sold at a discount, and can only be redeemed at
the maturity date.
Answer: FALSE
Question Status: Previous Edition
9) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.
Answer: FALSE
Question Status: Previous Edition
10) A sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond
issue each year.
Answer: TRUE
Question Status: Previous Edition
11) Debentures are long-term unsecured bonds that are backed only by the general creditworthiness of
the issuer.
Answer: TRUE
Question Status: Previous Edition
12) In a leveraged buy-out, a firm greatly increases its debt level by issuing junk bonds to finance the
purchase of another firm's stock.
Answer: TRUE
Question Status: Previous Edition
13) A financial guarantee ensures that the lender (bond purchaser) will be paid both principal and
interest in the event the issuer defaults.
Answer: TRUE
Question Status: Previous Edition
14) The Commodity Futures Modernization Act (2000) removed derivative securities, such as credit
default swaps, from regulatory oversight.
Answer: TRUE
Question Status: New Question
15) The current yield on a bond is a good approximation of the bond's yield to maturity when the bond
matures in five years or less and its price differs from its par value by a large amount.
Answer: FALSE
Question Status: Previous Edition
16) The secondary market is where new issues of stocks and bonds are introduced.
Answer: FALSE
Question Status: Previous Edition
13
Copyright 2012 Pearson Education, Inc.

17) General obligation bonds have specific assets pledged as security or specific sources of revenue
allocated for their repayment.
Answer: FALSE
Question Status: Previous Edition
12.3 Essay
1) What is the purpose of the capital market? How do capital market securities differ from money
market securities in their general characteristics?
Question Status: Previous Edition
2) What is a bond indenture?
Question Status: Previous Edition
3) What role do restrictive covenants play in bond markets?
Question Status: Previous Edition
4) What is the difference between a general obligation bond and a revenue bond?
Question Status: Previous Edition
5) What are Treasury STRIPS?
Question Status: Previous Edition
6) What is a convertible bond? How does the convertibility feature affect the bond's price and interest
rate?
Question Status: Previous Edition
7) What is a bond's current yield? How does the current yield differ from the yield to maturity and what
determines how close the two values are?
Question Status: Previous Edition
8) Distinguish between general obligation and revenue municipal bonds.
Question Status: Previous Edition
9) What is a callable bond? How does the callability feature affect the bond's price and interest rate?
Question Status: Previous Edition
10) What types of risks should bondholders be aware of and how do these affect bond prices and yields?
Question Status: Previous Edition
11) Explain the different types of corporate bonds.
Question Status: Previous Edition
12) The Commodity Futures Modernization Act (2000) removed derivative securities, such as CDSs,
from regulatory oversight. This change opened the door for speculators to bet on the health of a
company or pool of assets, and was certainly a culprit in the 2007-2009 financial crisis. Why did
Congress pass such legislation?
Question Status: New Question

14
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 13 The Stock Market
13.1 Multiple Choice
1) (I) A share of common stock in a firm represents an ownership interest in that firm.
(II) A share of preferred stock is as much like a bond as it is like common stock.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

2) Preferred stockholders hold a claim on assets that has priority over the claims of
A) both common stockholders and bondholders.
B) neither common stockholders nor bondholders.
C) common stockholders, but after that of bondholders.
D) bondholders, but after that of common stockholders.
Answer: C
Question Status: Previous Edition
3) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common
stockholders, but after that of bondholders.
(II) Firms issue preferred stock in far greater amounts than common stock.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

4) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common
stockholders.
(II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

5) (I) Firms issue common stock in far greater amounts than preferred stock.
(II) In a given year, the total volume of stock issued is much less than the volume of bonds issued.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

6) The riskiest capital market security is


A) preferred stock.
B) common stock.
C) corporate bonds.
D) Treasury bonds.
Answer: B
Question Status: Previous Edition
7) (I) The largest of the organized stock exchanges in the United States is the New York Stock
Exchange.
(II) To be listed on the NYSE, a firm must have a minimum of $100 million in market value or $10
million in revenues.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

8) To list on the NYSE, a firm must


A) have earnings of at least $10 million per year.
B) have at least $500 million in outstanding debt.
C) have a total of $100 million in market value.
D) meet all of the above requirements.
E) meet A and C of the above requirements.
Answer: E
Question Status: Updated from Previous Edition

9) Securities not listed on one of the exchanges trade in the over-the-counter market. In this exchange,
dealers "make a market" by
A) buying stocks for inventory when investors want to sell.
B) selling stocks from inventory when investors want to buy.
C) doing both of the above.
D) doing neither of the above.
Answer: C
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

10) The most active stock exchange in the world is the


A) Nikkei Stock Exchange.
B) London Stock Exchange.
C) Shanghai Stock Exchange.
D) New York Stock Exchange.
Answer: A
Question Status: Previous Edition
11) Which of the following statements about trading operations in an organized exchange is correct?
A) Floor traders all deal in a wide variety of stocks.
B) In most trades, specialists match buy and sell orders.
C) In most trades, specialists buy for or sell from their own inventories.
D) The SuperDOT system is used to expedite large trades of over 100,000 shares.
Answer: B
Question Status: Previous Edition
12) Which of the following is not an advantage of Electronic Communications Networks (ECNs)?
A) All unfilled orders are available for review by ECN traders.
B) Transactions costs are lower for ECN trades.
C) Trades are made and confirmed faster.
D) ECNs work well for thinly traded stocks.
Answer: D
Question Status: Previous Edition
13) Which of the following statements is false regarding Electronic Communications Networks (ECNs)?
A) Archipelago and Instinet are two examples of ECNs.
B) Competition from ECNs has forced NASDAQ to cut its fees.
C) Traders benefit from lower trading costs and faster service.
D) ECNs allow institutional investors, but not individuals, to trade after hours.
Answer: D
Question Status: Previous Edition
14) A basic principle of finance is that the value of any investment is
A) the present value of all future net cash flows generated by the investment.
B) the undiscounted sum of all future net cash flows generated by the investment.
C) unrelated to the future net cash flows generated by the investment.
D) unrelated to the degree of risk associated with the future net cash flows generated by the investment.
Answer: A
Question Status: Previous Edition
15) A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investor's
valuation of this stock if she expects it to be selling for $30 in one year and requires a 15 percent return
on equity investments?
A) $30.24
B) $26.30
C) $26.09
D) $27.74
Answer: B
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) A stock currently sells for $30 per share and pays $1.00 per year in dividends. What is an investor's
valuation of this stock if he expects it to be selling for $37 in one year and requires a 12 percent return
on equity investments?
A) $38
B) $33.50
C) $34.50
D) $33.93
Answer: D
Question Status: Previous Edition

17) In the one-period valuation model, a stock's value will be higher


A) the higher its expected future price is.
B) the lower its dividend is.
C) the higher the required return on investments in equity is.
D) all of the above.
Answer: A
Question Status: Previous Edition
18) In the one-period valuation model, a stock's value falls if the ________ rises.
A) dividend
B) expected future price
C) required return on equity
D) current price
Answer: C
Question Status: Previous Edition
19) In the generalized dividend valuation model, a stock's value depends only on
A) its future dividend payments and its future price.
B) its future dividend payments and the required return on equity.
C) its future price and the required return on investments on equity.
D) its future dividend payments.
Answer: B
Question Status: Previous Edition
20) Which of the following is not an element of the Gordon growth model of stock valuation?
A) the stock's most recent dividend paid
B) the expected constant growth rate of dividends
C) the required return on investments in equity
D) the stock's expected future price
Answer: D
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) According to the Gordon growth model, what is an investor's valuation of a stock whose current
dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long
period of time and the investor's required return is 11 percent?
A) $110
B) $100
C) $11
D) $10
E) $5.24
Answer: A
Question Status: Previous Edition

22) According to the Gordon growth model, what is an investor's valuation of a stock whose current
dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long
period of time and the investor's required return is 15 percent?
A) $20
B) $11
C) $22
D) $7.33
E) $4.40
Answer: C
Question Status: Previous Edition

23) Holding other things constant, a stock's value will be highest if its dividend growth rate is
A) 15%.
B) 10%.
C) 5%.
D) 2%.
Answer: A
Question Status: Previous Edition
24) Holding other things constant, a stock's value will be highest if its most recent dividend is
A) $2.00.
B) $5.00.
C) $0.50.
D) $1.00.
Answer: B
Question Status: Previous Edition
25) Holding other things constant, a stock's value will be highest if the investor's required return on
investments in equity is
A) 20%.
B) 15%.
C) 10%.
D) 5%.
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) Suppose the average industry PE ratio for auto parts retailers is 20. What is the current price of Auto
Zone stock if the retailer's earnings per share is projected to be $1.85?
A) $21.85
B) $37
C) $10.81
D) $9.25
Answer: B
Question Status: Previous Edition

27) Which of the following is true regarding the Gordon growth model?
A) Dividends are assumed to grow at a constant rate forever.
B) The dividend growth rate is assumed to be greater than the required return on equity.
C) Both A and B of the above.
D) Neither A nor B of the above.
Answer: A
Question Status: Previous Edition
28) The PE ratio approach to valuing stock is especially useful for valuing
A) privately held firms.
B) firms that don't pay dividends.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: C
Question Status: Previous Edition
29) The PE ratio approach to valuing stock is especially useful for valuing
A) publicly held corporations.
B) firms that regularly pay dividends.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: D
Question Status: Previous Edition
30) A weakness of the PE approach to valuing stock is that it is
A) difficult to estimate the constant growth rate of a firm's dividends.
B) difficult to estimate the required return on equity.
C) difficult to predict how much a firm will pay in dividends.
D) based on industry averages rather than firm-specific factors.
Answer: D
Question Status: Previous Edition
31) (I) The market price of a security at a given time is the highest value any investor puts on the
security. (II) Superior information about a security increases its value by reducing its risk.
A) (I) is true, (II) is false.
B) (I) is false, (II) is true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) The main cause of fluctuations in stock prices is changes in


A) tax laws.
B) errors in technical stock analysis.
C) daily trading volume in stock markets.
D) information available to investors.
E) total household wealth in the economy.
Answer: D
Question Status: Previous Edition

33) Stock values computed by valuation models may differ from actual market prices because it is
difficult to
A) estimate future dividend growth rates.
B) estimate the risk of a stock.
C) forecast a stock's future dividends.
D) all of the above are true.
Answer: D
Question Status: Previous Edition

34) The 2001 terrorist attacks and the Enron financial scandal caused anticipated dividend growth to
________, investors' required return on equity to ________, and stock prices to ________.
A) decrease; increase; decrease
B) decrease; increase; increase
C) increase; decrease; decrease
D) increase; decrease; increase
Answer: A
Question Status: Previous Edition
35) Which of the following is not an objective of the Securities and Exchange Commission?
A) maintain integrity of the securities markets
B) advise investors about which particular stocks are good buys
C) require firms to provide specific information to investors
D) regulate major participants in securities markets
Answer: B
Question Status: Previous Edition
36) A share of common stock in a firm represents an ownership interest in that firm and allows
stockholders to
A) vote.
B) receive dividends.
C) receive interest payments.
D) only A and B of the above.
Answer: D
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

37) In 2010, the NYSE traded ________ shares on an average trading day.
A) 4 billion
B) 7 billion
C) 10 billion
D) 12 billion
Answer: A
Question Status: Updated from Previous Edition
38) Exchange traded funds (ETFs) have which of the following features?
A) They are listed and traded as individual stocks on a stock exchange.
B) They are indexed rather than actively managed.
C) Their value is based on the underlying net asset value of the stocks held in the index basket.
D) All of the above.
Answer: D
Question Status: Previous Edition
39) What is the primary disadvantage of an ETF?
A) ETFs tend to have lower management fees than comparable index mutual bonds.
B) ETFs usually have no minimum investment amount.
C) Investors have to pay a broker commission each time they buy or sell shares.
D) None of the above are disadvantages of an ETF.
Answer: C
Question Status: Previous Edition
40) A high price earnings ratio (PE) gives what interpretation?
A) The market expects earnings to fall in the future.
B) The market feels the firm's earnings are very high risk and are willing to pay a premium for them.
C) The market expects the earnings to rise in the future.
D) The firm is not paying a dividend.
Answer: C
Question Status: Previous Edition
41) A ________ PE may indicate that the market feels the firm's earnings are very ________ risk and is
therefore willing to pay a ________ for them.
A) high; low; premium
B) high; high; discount
C) low; low; discount
D) high; high; premium
Answer: A
Question Status: Previous Edition

42) The subprime financial crisis led to one of the worst bear markets in the last 50 years. Stock prices
likely fell due to
A) an increase in required returns on equity investments.
B) a decline in growth prospects for U.S. companies.
C) Both A and B are likely reasons.
D) None of the above are correct.
Answer: A
Question Status: New Question

8
Copyright 2012 Pearson Education, Inc.

13.2 True/False
1) More stock trading in the U.S. occurs in over-the-counter markets rather than on organized
exchanges.
Answer: FALSE
Question Status: Previous Edition
2) In over-the-counter markets, dealers increase the liquidity of thinly traded securities.
Answer: TRUE
Question Status: Previous Edition
3) Electronic Communications Networks apply technology to make organized exchanges more efficient
and speedy.
Answer: FALSE
Question Status: Previous Edition
4) All stocks pay dividends, as that is the only way an investor can profit from holding stock.
Answer: FALSE
Question Status: Previous Edition
5) Common stock is the riskiest corporate security, followed by preferred stock and then bonds.
Answer: TRUE
Question Status: Previous Edition
6) The Enron financial scandal increased uncertainty about the quality of accounting information and as
a result, increased required return on investment in stocks.
Answer: TRUE
Question Status: Previous Edition
7) The Dow Jones Industrial Average is the broadest and best indicator of the stock market's day-to-day
performance.
Answer: FALSE
Question Status: Previous Edition
8) The Securities and Exchange Commission requires firms to submit various documents to increase the
flow of information to investors but does not verify the accuracy of that information.
Answer: TRUE
Question Status: Previous Edition
9) About half of new equity issues are preferred stock.
Answer: FALSE
Question Status: Previous Edition
10) A stock's market value will be higher the higher its expected dividend stream is, all else being equal.
Answer: TRUE
Question Status: Previous Edition
11) The Gordon growth model assumes that a stock's dividend grows at a constant rate forever.
Answer: TRUE
Question Status: Previous Edition
9
Copyright 2012 Pearson Education, Inc.

12) A stock's market value will be higher the higher the investor's required rate of return is, all else
being equal.
Answer: FALSE
Question Status: Previous Edition
13) About 95% of orders to buy or sell on the NYSE are executed using SuperDOT.
Answer: TRUE
Question Status: Previous Edition
14) The Wall Street Journal reports on 23 different indexes in its "Markets Lineup" column.
Answer: FALSE
Question Status: Previous Edition
15) A lower than average PE may mean that the market expects earnings to rise in the future.
Answer: FALSE
Question Status: Previous Edition
13.3 Essay
1) How do corporate stocks differ from bonds?
Question Status: Previous Edition
2) How do common stocks differ from preferred stocks?
Question Status: Previous Edition
3) How do over-the-counter markets differ from organized exchanges?
Question Status: Previous Edition
4) What is the role of specialists on a stock exchange?
Question Status: Previous Edition
5) What are the advantages and disadvantages of Electronic Communications Networks (ECNs) for
trading stocks?
Question Status: Previous Edition
6) What is the role of the required return on equity investments in stock valuation models?
Question Status: Previous Edition
7) Using the Gordon growth model, explain why the 2001 terrorist attacks and the Enron financial
scandal caused stock prices to decline.
Question Status: Previous Edition
8) What are American Depository Receipts (ADRs)?
Question Status: Previous Edition
9) What are the objectives of the Securities and Exchange Commission?
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

10) What are the advantages and disadvantages of exchange traded funds (ETFs) fro trading stocks?
Question Status: Previous Edition
11) Why would a crisis in the subprime mortgage market lead to declining prices in the U.S. equity
markets?
Question Status: New Question

11
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 14 The Mortgage Markets
14.1 Multiple Choice
1) Which of the following are important ways in which mortgage markets differ from the stock and bond
markets?
A) The usual borrowers in the capital markets are government entities and businesses, whereas the usual
borrowers in the mortgage markets are individuals.
B) Most mortgages are secured by real estate, whereas the majority of capital market borrowing is
unsecured.
C) Because mortgages are made for different amounts and different maturities, developing a secondary
market has been more difficult.
D) All of the above are important differences.
E) Only A and B of the above are important differences.
Answer: D
Question Status: Previous Edition

2) Which of the following are important ways in which mortgage markets differ from stock and bond
markets?
A) The usual borrowers in capital markets are government entities, whereas the usual borrowers in
mortgage markets are small businesses.
B) The usual borrowers in capital markets are government entities and large businesses, whereas the
usual borrowers in mortgage markets are small businesses.
C) The usual borrowers in capital markets are government entities and large businesses, whereas the
usual borrowers in mortgage markets are small businesses and individuals.
D) The usual borrowers in capital markets are businesses and government entities, whereas the usual
borrowers in mortgage markets are individuals.
Answer: D
Question Status: Previous Edition

3) Which of the following are true of mortgages?


A) A mortgage is a long-term loan secured by real estate.
B) A borrower pays off a mortgage in a combination of principal and interest payments that result in full
payment of the debt by maturity.
C) Over 80 percent of mortgage loans finance residential home purchases.
D) All of the above are true of mortgages.
E) Only A and B of the above are true of mortgages.
Answer: D
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

4) Which of the following are true of mortgages?


A) A mortgage is a long-term loan secured by real estate.
B) Borrowers pay off mortgages over time in some combination of principal and interest payments that
result in full payment of the debt by maturity.
C) Less than 65 percent of mortgage loans finance residential home purchases.
D) All of the above are true of mortgages.
E) Only A and B of the above are true of mortgages.
Answer: E
Question Status: Previous Edition

5) Which of the following are true of mortgage interest rates?


A) Interest rates on mortgage loans are determined by three factors: current long-term market rates, the
term of the mortgage, and the number of discount points paid.
B) Mortgage interest rates tend to track along with Treasury bond rates.
C) The interest rate on 15-year mortgages is lower than the rate on 30-year mortgages, all else the same.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition

6) Which of the following are true of mortgages?


A) More than 80 percent of mortgage loans finance residential home purchases.
B) The National Banking Act of 1863 rewarded banks that increased mortgage lending.
C) Most mortgages during the 1920s and 1930s were balloon loans.
D) All of the above are true.
E) Only A and C of the above are true.
Answer: E
Question Status: Previous Edition

7) Which of the following is true of mortgage interest rates?


A) Longer-term mortgages have lower interest rates than shorter-term mortgages.
B) Mortgage rates are lower than Treasury bond rates because of the tax deductibility of mortgage
interest rates.
C) In exchange for points, lenders reduce interest rates on mortgage loans.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: C
Question Status: Previous Edition
8) Typically, discount points should not be paid if the borrower will pay off the loan in ________ years
or less.
A) 5
B) 10
C) 15
D) 20
Answer: A
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

9) Which of the following is true of mortgage interest rates?


A) Longer-term mortgages have higher interest rates than shorter-term mortgages.
B) In exchange for points, lenders reduce interest rates on mortgage loans.
C) Mortgage rates are lower than Treasury bond rates because of the tax deductibility of mortgage
interest payments.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

10) Which of the following reduces moral hazard for the mortgage borrower?
A) collateral
B) down payments
C) private mortgage insurance
D) borrower qualifications
Answer: B
Question Status: Previous Edition
11) Which of the following protects the mortgage lender's right to sell property if the underlying loan
defaults?
A) a lien
B) a down payment
C) private mortgage insurance
D) borrower qualification
E) amortization
Answer: A
Question Status: Previous Edition

12) Which of the following is true of mortgage interest rates?


A) Mortgage rates are closely tied to Treasury bond rates, but mortgage rates tend to stay below
Treasury rates because mortgages are secured with collateral.
B) Longer-term mortgages have higher interest rates than shorter-term mortgages.
C) Interest rates are higher on mortgage loans on which lenders charge points.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: B
Question Status: Previous Edition
13) During the early years of an amortizing mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal balance.
Answer: C
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

14) During the last years of an amortizing mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal balance.
Answer: A
Question Status: Previous Edition

15) During the last years of a balloon mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal balance.
Answer: D
Question Status: Previous Edition

16) During the early years of a balloon mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal balance.
Answer: D
Question Status: Previous Edition
17) A borrower who qualifies for an FHA or VA loan enjoys the advantage that
A) the mortgage payment is much lower.
B) only a very low or zero down payment is required.
C) the cost of private mortgage insurance is lower.
D) the government holds the lien on the property.
Answer: B
Question Status: Previous Edition
18) (I) Conventional mortgages are originated by private lending institutions, and FHA or VA loans are
originated by the government.
(II) Conventional mortgages are insured by private companies, and FHA or VA loans are insured by the
government.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Answer: B
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

19) Borrowers tend to prefer ________ to ________, whereas lenders prefer ________.
A) fixed-rate loans; ARMs; fixed-rate loans
B) ARMs; fixed-rate loans; fixed-rate loans
C) fixed-rate loans; ARMs; ARMs
D) ARMs; fixed-rate loans; ARMs
Answer: C
Question Status: Previous Edition
20) (I) ARMs offer lower initial rates and the rate may fall during the life of the loan.
(II) Conventional mortgages do not allow a borrower to take advantage of falling interest rates.
A) (I) is true, (II) is false.
B) (I) is false, (II) is true.
C) Both are true.
D) Both are false.
Answer: A
Question Status: Previous Edition

21) Growing-equity mortgages (GEMs)


A) help the borrower pay off the loan in a shorter time.
B) have such low payments in the first few years that the principal balance increases.
C) offer borrowers payments that are initially lower than the payments on a conventional mortgage.
D) do all of the above.
E) do only A and B of the above.
Answer: A
Question Status: Previous Edition
22) A borrower with a 30-year loan can create a GEM by
A) simply increasing the monthly payments beyond what is required and designating that the excess be
applied entirely to the principal.
B) converting his ARM into a conventional mortgage.
C) converting his conventional mortgage into an ARM.
D) converting his conventional mortgage into a GPM.
Answer: A
Question Status: Previous Edition

23) Which of the following are useful for home buyers who expect their income to rise in the future?
A) GPMs
B) RAMs
C) GEMs
D) Only A and B are useful.
E) Only A and C are useful.
Answer: E
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

24) Which of the following are useful for home buyers who expect their income to fall in the future?
A) GPMs
B) RAMs
C) GEMs
D) Only A and B are useful.
E) Only A and C are useful.
Answer: B
Question Status: Previous Edition

25) Retired people can live on the equity they have in their homes by using a
A) GEM.
B) GPM.
C) SAM.
D) RAM.
Answer: D
Question Status: Previous Edition
26) Second mortgages serve the following purposes:
A) they give borrowers a way to use the equity they have in their homes as security for another loan.
B) they allow borrowers to get a tax deduction on loans secured by their primary residence or vacation
home.
C) they allow borrowers to convert their conventional mortgages into GEMs.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

27) Which of the following is a disadvantage of a second mortgage compared to credit card debt?
A) The loans are secured by the borrower's home.
B) The borrower gives up the tax deduction on the primary mortgage.
C) The borrower must pay points to get a second mortgage loan.
D) The borrower will find it more difficult to qualify for a second mortgage loan.
Answer: A
Question Status: Previous Edition
28) With an option ARM loan, the borrower has an option to
A) reduce the monthly interest rate being charged.
B) reduce the monthly payment, possibly increasing the mortgage balance from one month to the next.
C) increase the outstanding balance by increasing the monthly payment.
D) Both A and C are correct.
Answer: B
Question Status: New Question
29) The share of the mortgage market held by savings and loans is
A) over 50 percent.
B) approximately 40 percent.
C) approximately 20 percent.
D) less than 10 percent.
Answer: D
Question Status: Updated from Previous Edition
6
Copyright 2012 Pearson Education, Inc.

30) The share of the mortgage market held by commercial banks is approximately
A) 50 percent.
B) 25 percent.
C) 15 percent.
D) 5 percent.
Answer: B
Question Status: Previous Edition
31) A loan-servicing agent will
A) package the loan for an investor.
B) hold the loan in their investment portfolio.
C) collect payments from the borrower.
D) do both A and C of the above.
E) do both B and C of the above.
Answer: C
Question Status: Previous Edition

32) Distinct elements of a mortgage loan include


A) origination.
B) investment.
C) servicing.
D) all of the above.
E) only B and C of the above.
Answer: D
Question Status: Previous Edition

33) The Federal National Mortgage Association (Fannie Mae)


A) was set up to buy mortgages from thrifts so that these institutions could make more loans.
B) funds purchases of mortgages by selling bonds to the public.
C) provides insurance for certain mortgage contracts.
D) does all of the above.
E) does only A and B of the above.
Answer: E
Question Status: Previous Edition

34) The Federal Housing Administration (FHA)


A) was set up to buy mortgages from thrifts so that these institutions could make more loans.
B) funds purchases of mortgages by selling bonds to the public.
C) provides insurance for certain mortgage contracts.
D) does all of the above.
E) does only A and B of the above.
Answer: C
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

35) ________ issues participation certificates, and ________ provides federal insurance for participation
certificates.
A) Freddie Mac; Freddie Mac
B) Freddie Mac; Ginnie Mae
C) Ginnie Mae; Freddie Mac
D) Ginnie Mae; Ginnie Mae
E) Freddie Mac; no one
Answer: E
Question Status: Previous Edition

36) REMICs are most like


A) Freddie Mac pass-through securities.
B) Ginnie Mae pass-through securities.
C) participation certificates.
D) collateralized mortgage obligations.
Answer: D
Question Status: Previous Edition
37) Ginnie Mae
A) insures qualifying mortgages.
B) insures pass-through certificates.
C) insures collateralized mortgage obligations.
D) does only A and B. of the above
E) does only B and C of the above.
Answer: B
Question Status: Previous Edition

38) Mortgage-backed securities


A) have been growing in popularity in recent years as institutional investors look for attractive
investment opportunities.
B) are securities collateralized by a pool of mortgages.
C) are securities collateralized by both insured and uninsured mortgages.
D) are all of the above.
E) are only A and B of the above.
Answer: D
Question Status: Previous Edition

39) The most common type of mortgage-backed security is


A) the mortgage pass-through, a security that has the borrower's mortgage payments pass through the
trustee before being disbursed to the investors.
B) collateralized mortgage obligations, a security which reduces prepayment risk.
C) the participation certificate, a security which passes the borrower's mortgage payments equally
among all the owners of the certificates.
D) the securitized mortgage, a security which increases the liquidity of otherwise illiquid mortgages.
Answer: A
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

40) The interest rate borrowers pay on their mortgages is determined by


A) current long-term market rates.
B) the term.
C) the number of discount points.
D) all of the above.
Answer: D
Question Status: Previous Edition
41) A loan for borrowers who do not qualify for loans at the usual market rate of interest because of a
poor credit rating or because the loan is larger than justified by their income is
A) a subprime mortgage.
B) a securitized mortgage.
C) an insured mortgage.
D) a graduated-payment mortgage.
Answer: A
Question Status: Previous Edition

42) The percentage of the total loan paid back immediately when a mortgage loan is obtained, which
lowers the annual interest rate on the debt, is called
A) discount points.
B) loan terms.
C) collateral.
D) down payment.
Answer: A
Question Status: Previous Edition

43) Which of the following terms are found in mortgage loan contracts to protect the lender from
financial loss?
A) collateral
B) down payment
C) private mortgage insurance
D) all of the above
Answer: D
Question Status: Previous Edition
44) What factors are used in determining a person's FICO score?
A) past payment history
B) outstanding debt
C) length of credit history
D) all of the above
Answer: D
Question Status: Previous Edition
45) Between 2000 and 2005, home prices increased an average of ________ per year.
A) 2%
B) 4%
C) 8%
D) 12%
Answer: C
Question Status: New Question
9
Copyright 2012 Pearson Education, Inc.

46) From 2000 to 2005, housing prices increased, on average, by over 40%. This runup in prices was
caused by
A) speculators.
B) an increase in subprime loans, which increased demand for new and existing houses.
C) both A and B.
D) None of the above are correct.
Answer: A
Question Status: New Question

14.2 True/False
1) Down payments are designed to reduce the likelihood of default on mortgage loans.
Answer: TRUE
Question Status: Previous Edition
2) Discount points (or simply points) are interest payments made at the beginning of a loan.
Answer: TRUE
Question Status: Previous Edition
3) A point on a mortgage loan refers to one monthly payment of principal and interest.
Answer: FALSE
Question Status: Previous Edition
4) Closing for a mortgage loan refers to the moment the loan is paid off.
Answer: FALSE
Question Status: Previous Edition
5) Private mortgage insurance is a policy that guarantees to make up any discrepancy between the value
of the property and the loan amount, should a default occur.
Answer: TRUE
Question Status: Previous Edition
6) During the early years of a mortgage loan, the lender applies most of the payment to the principal on
the loan.
Answer: FALSE
Question Status: Previous Edition
7) One important advantage to a borrower who qualifies for an FHA or VA loan is the very low interest
rate on the mortgage.
Answer: FALSE
Question Status: Previous Edition
8) Adjustable-rate mortgages generally have lower initial interest rates than fixed-rate mortgages.
Answer: TRUE
Question Status: Previous Edition
9) Mortgage interest rates loosely track interest rates on three-month Treasury bills.
Answer: FALSE
Question Status: Previous Edition
10
Copyright 2012 Pearson Education, Inc.

10) An advantage of a graduated-payment mortgage is that borrowers will qualify for a larger loan than
if they requested a conventional mortgage.
Answer: TRUE
Question Status: Previous Edition
11) Nearly half the funds for mortgage lending comes from mortgage pools and trusts.
Answer: TRUE
Question Status: Previous Edition
12) Many institutions that make mortgage loans do not want to hold large portfolios of long-term
securities, because it would subject them to unacceptably high interest-rate risk.
Answer: TRUE
Question Status: Previous Edition
13) A problem that initially hindered the marketability of mortgages in a secondary market was that they
were not standardized.
Answer: TRUE
Question Status: Previous Edition
14) Mortgage-backed securities have declined in popularity in recent years as institutional investors
have sought higher returns in other markets.
Answer: FALSE
Question Status: Previous Edition
15) Mortgage-backed securities are marketable securities collateralized by a pool of mortgages.
Answer: TRUE
Question Status: Previous Edition
16) Fannie Mae and Freddie Mac together either own or insure the risk on nearly one-fourth of
America's residential mortgages.
Answer: FALSE
Question Status: Previous Edition
17) A FICO score below 660 is considered good while a score above 720 is likely to cause problems in
obtaining a loan.
Answer: FALSE
Question Status: Previous Edition
18) Subprime loans are those made to borrowers who do not qualify for loans at the usual market rate of
interest because of a poor credit rating or because the loan is larger than justified by their income.
Answer: TRUE
Question Status: Previous Edition
19) An option ARM mortgage gives the borrower the option to reduce the monthly interest being
charged on the mortgage.
Answer: FALSE
Question Status: New Question

11
Copyright 2012 Pearson Education, Inc.

14.3 Essay
1) How has the modern mortgage market changed over recent years?
Question Status: Previous Edition
2) Explain the features of mortgage loans that are designed to reduce the likelihood of default.
Question Status: Previous Edition
3) What are points? What is their purpose?
Question Status: Previous Edition
4) How does an amortizing mortgage loan differ from a balloon mortgage loan?
Question Status: Previous Edition
5) Evaluate the advantages and disadvantages, from both the lender's and borrower's perspectives, of
fixed-rate and adjustable-rate mortgages.
Question Status: Previous Edition
6) Why has the online lending market developed in recent years and what are the advantages and
disadvantages of this development?
Question Status: Previous Edition
7) Why may Fannie Mae and Freddie Mac pose a threat to the health of the financial system?
Question Status: Previous Edition
8) What are mortgage-backed securities, why were they developed, what types of mortgage-backed
securities are there, and how do they work?
Question Status: Previous Edition
9) What are the benefits and side effects of securitized mortgages?
Question Status: Previous Edition
10) Discuss the pros and cons of a subprime market for residential mortgages in the U.S.
Question Status: New Question

12
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 15 The Foreign Exchange Market
15.1 Multiple Choice
1) American firms became less competitive compared to foreign firms during the 1980s because
A) the quality and productivity of American workers declined.
B) foreign firms were younger than American firms and as a result had more modern facilities that made
use of the latest technology.
C) the U.S. dollar became worth more in terms of foreign currencies.
D) the U.S. dollar became worth less in terms of foreign currencies.
Answer: C
Question Status: Previous Edition

2) A spot transaction in the foreign exchange market involves the


A) exchange of exports and imports at a specified future date.
B) exchange of bank deposits at a specified future date.
C) immediate (within two days) exchange of exports and imports.
D) immediate (within two days) exchange of bank deposits.
Answer: D
Question Status: Previous Edition
3) When the value of the British pound changes from $1.50 to $1.25, the pound has ________ and the
dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
Question Status: Previous Edition

4) When the value of the dollar changes from 0.50 to 0.75, the pound has ________ and the dollar has
________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
Question Status: Previous Edition
5) When the exchange rate changes from 1.0 euros to the dollar to 1.2 euros to the dollar, the euro has
________ and the dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: B
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) When the exchange rate changes from 1.0 euros to the dollar to 0.8 euros to the dollar, the euro has
________ and the dollar has ________.
A) appreciated; appreciated
B) depreciated; appreciated
C) appreciated; depreciated
D) depreciated; depreciated
Answer: C
Question Status: Previous Edition

7) If the dollar ________ from 1.2 euros per dollar to 0.8 euros per dollar, the euro ________ from 0.83
dollars to 1.25 dollars per euro.
A) appreciates; appreciates
B) appreciates; depreciates
C) depreciates; depreciates
D) depreciates; appreciates
Answer: D
Question Status: Previous Edition

8) If the dollar appreciates from 0.8 euros per dollar to 1.2 euros per dollar, the euro depreciates from
________ dollars to ________ dollars per euro.
A) 1.25; 0.83
B) 0.83; 1.25
C) 0.67; 1.50
D) 1.50; 0.67
Answer: A
Question Status: Previous Edition

9) If the dollar depreciates relative to the Swiss franc,


A) Swiss chocolate will become more expensive in the United States.
B) American computers will become less expensive in Switzerland.
C) Swiss chocolate will become cheaper in the United States.
D) both A and B of the above will happen.
Answer: D
Question Status: Previous Edition
10) If the dollar appreciates relative to the Swiss franc,
A) Swiss chocolate will become more expensive in the United States.
B) American computers will become less expensive in Switzerland.
C) Swiss chocolate will become cheaper in the United States.
D) both A and B of the above will happen.
Answer: C
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) When the exchange rate for the euro changes from $1.00 to $1.20, then, holding everything else
constant, the euro has
A) appreciated and German cars sold in the United States become more expensive.
B) appreciated and German cars sold in the United States become less expensive.
C) depreciated and American wheat sold in Germany becomes more expensive.
D) depreciated and American wheat sold in Germany becomes less expensive.
Answer: A
Question Status: Previous Edition

12) When the exchange rate for the euro changes from $1.20 to $1.00, then, holding everything else
constant, the euro has
A) appreciated and German cars sold in the United States become more expensive.
B) appreciated and German cars sold in the United States become less expensive.
C) depreciated and American wheat sold in Germany becomes more expensive.
D) depreciated and American wheat sold in Germany becomes less expensive.
Answer: C
Question Status: Previous Edition

13) The starting point for understanding how exchange rates are determined is a simple idea called
________, which states that 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
Question Status: Previous Edition

14) The theory of purchasing power parity is a theory of how exchange rates are determined in
A) the long run.
B) the short run.
C) both A and B of the above.
D) none of the above.
Answer: A
Question Status: Previous Edition
15) 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
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) 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
Question Status: Previous Edition

17) In the long run, a rise in a country's price level (relative to the foreign price level) causes its currency
to ________, while a rise in the country's relative productivity causes its currency to ________.
A) appreciate; appreciate
B) appreciate; depreciate
C) depreciate; appreciate
D) depreciate; depreciate
Answer: C
Question Status: Previous Edition

18) If the 2005 inflation rate in Britain is 6 percent, and the inflation rate in the U.S. is 4 percent, then
the theory of purchasing power parity predicts that, during 2005, the value of the British pound in terms
of U.S. dollars will
A) rise by 10 percent.
B) rise by 2 percent.
C) fall by 10 percent.
D) fall by 2 percent.
E) do none of the above.
Answer: D
Question Status: Previous Edition

19) The theory of purchasing power parity cannot fully explain exchange rate movements because
A) not all goods are identical in different countries.
B) monetary policy differs across countries.
C) some goods are not traded between countries.
D) both A and C of the above.
E) both B and C of the above.
Answer: D
Question Status: Previous Edition

20) The theory of purchasing power parity cannot fully explain exchange rate movements because
A) all goods are identical even if 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
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) In the short run, the quantity of dollars supplied (deposits, bonds, equities) is
A) fixed with respect to the exchange rate.
B) quite volatile and difficult to model in a supply-demand framework.
C) typically following the business cycle (procyclical).
D) is best represented with a horizontal supply curve.
Answer: A
Question Status: New Question
22) 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
Question Status: Previous Edition

23) If the demand for ________ goods decreases relative to ________ goods, the domestic currency will
depreciate.
A) foreign; domestic
B) foreign; foreign
C) domestic; domestic
D) domestic; foreign
Answer: D
Question Status: Previous Edition
24) Higher tariffs and quotas cause a country's currency to ________ in the ________ run.
A) depreciate; short
B) appreciate; short
C) depreciate; long
D) appreciate; long
Answer: D
Question Status: Previous Edition
25) Lower tariffs and quotas cause a country's currency to ________ in the ________ run.
A) depreciate; short
B) appreciate; short
C) depreciate; long
D) appreciate; long
Answer: C
Question Status: Previous Edition
26) If the inflation rate in the United States is higher than that in Germany and productivity is growing at
a slower rate in the United States than it is in Germany, in the long run,
A) the euro should appreciate relative to the dollar.
B) the euro should depreciate relative to the dollar.
C) there should be no change in the euro price of dollars.
D) it is not clear what will happen to the euro price of dollars.
Answer: A
Question Status: Previous Edition
5
Copyright 2012 Pearson Education, Inc.

27) If the French demand for American exports rises at the same time that U.S. productivity rises
relative to French productivity, then, in the long run,
A) the euro should appreciate relative to the dollar.
B) the dollar should depreciate relative to the euro.
C) the dollar should appreciate relative to the euro.
D) it is not clear whether the euro should appreciate or depreciate relative to the dollar.
Answer: C
Question Status: Previous Edition

28) The theory of asset demand suggests that the most important factor affecting the demand for
domestic and foreign deposits 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
Question Status: Previous Edition
29) When Franois the Foreigner considers the expected return on dollar deposits in terms of foreign
currency, the expected return must be adjusted for
A) any expected appreciation or depreciation of the dollar.
B) the interest rates on foreign deposits.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: Previous Edition

30) The expected return on dollar deposits in terms of foreign currency is the ________ the interest rate
on dollar deposits and the expected appreciation of the dollar.
A) product of
B) ratio of
C) sum of
D) difference in
Answer: C
Question Status: Previous Edition

31) If the interest rate on foreign deposits increases, holding everything else constant,
A) the expected return on these deposits must also increase.
B) the expected return on domestic deposits must decrease.
C) the expected return on domestic deposits must increase.
D) both A and B of the above.
E) both A and C of the above.
Answer: A
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) If the interest rate on dollar deposits is 10 percent, and the dollar is expected to appreciate by 7
percent over the coming year, the expected return on dollar deposits in terms of the foreign currency is
A) 3 percent.
B) 10 percent.
C) 13.5 percent.
D) 17 percent.
E) 24 percent.
Answer: D
Question Status: Previous Edition
33) If the interest rate is 7 percent on euro deposits and 5 percent on dollar deposits, and if the dollar is
expected to appreciate at a 4 percent rate,
A) euro deposits have a higher expected return than dollar deposits.
B) the expected return on euro deposits in terms of dollars is 11 percent.
C) the expected return on dollar deposits in terms of euros is 1 percent.
D) the expected return on euro deposits in terms of dollars is 3 percent.
E) the expected return on dollar deposits equals the expected return on euro deposits.
Answer: D
Question Status: Previous Edition

34) If the interest rate is 13 percent on euro deposits and 15 percent on dollar deposits, and if the euro is
expected to appreciate at a 4 percent rate relative to the dollar, then
A) euro deposits have a lower expected return than dollar deposits.
B) the expected return on euro deposits in terms of dollars is 9 percent.
C) the expected return on dollar deposits in terms of euros is 19 percent.
D) both A and B of the above will occur.
E) none of the above will occur.
Answer: E
Question Status: Previous Edition

35) The expected return on dollar deposits in terms of dollars, R D, is


A) always the interest rate on dollar deposits, i D, for any exchange rate.
B) the interest rate on dollar deposits, iD, only when Et > E e .
t+1

C) the interest rate on dollar deposits, i D, only when Et < E e .


t+1

D) the interest rate on dollar deposits, i D, only when Et = E e .


t+1

Answer: A
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

36) The condition which states that the domestic interest rate equals the foreign interest rate minus the
expected appreciation of the domestic currency is called
A) the purchasing power parity condition.
B) the interest parity condition.
C) money neutrality.
D) the theory of foreign capital mobility.
Answer: B
Question Status: Previous Edition
37) In a world with few impediments to capital mobility, the domestic interest rate equals the sum of the
foreign interest rate and the expected depreciation of the domestic currency, a situation known as the
A) interest parity condition.
B) purchasing power parity condition.
C) exchange rate parity condition.
D) foreign asset parity condition.
Answer: A
Question Status: Previous Edition

38) According to the interest parity condition, the domestic interest rate is equal to the foreign interest
rate
A) plus the expected appreciation of the domestic currency.
B) less the expected appreciation of the domestic currency.
C) less the expected depreciation of the domestic currency.
D) less the expected depreciation of the domestic currency weighted by the domestic interest rate.
Answer: B
Question Status: Previous Edition

39) According to the interest parity condition, if the domestic interest rate is ________ the foreign
interest rate, then ________.
A) above; there is expected appreciation of the foreign currency
B) above; there is expected depreciation of the foreign currency
C) below; there is expected appreciation of the foreign currency
D) below; the interest parity condition is violated
Answer: A
Question Status: Previous Edition

40) According to the interest parity condition, if the domestic interest rate is 12 percent and the foreign
interest rate is 10 percent, then the expected ________ of the foreign currency must be ________
percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: B
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

41) According to the interest parity condition, if the domestic interest rate is 10 percent and the foreign
interest rate is 12 percent, then the expected ________ of the foreign currency must be ________
percent.
A) appreciation; 4
B) appreciation; 2
C) depreciation; 2
D) depreciation; 4
Answer: C
Question Status: Previous Edition

42) When Americans and foreigners expect the return on ________ deposits to be high relative to the
return on ________ deposits, there is a higher demand for dollar deposits and a correspondingly lower
demand for foreign deposits.
A) dollar; dollar
B) dollar; foreign
C) foreign; dollar
D) foreign; foreign
Answer: B
Question Status: Previous Edition

43) When Americans and foreigners expect the return on dollar deposits to be high relative to the return
on foreign deposits, there is a ________ demand for dollar deposits and a correspondingly ________
demand for foreign deposits.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
Answer: B
Question Status: Previous Edition

44) As the relative expected return on dollar deposits increases, foreigners will want to hold more
________ deposits and less ________ deposits.
A) foreign; foreign
B) foreign; dollar
C) dollar; foreign
D) dollar; dollar
Answer: C
Question Status: Previous Edition
45) As the relative expected return on dollar deposits increases,
A) foreigners will want to hold fewer dollar deposits and more foreign deposits.
B) Americans will want to hold more dollar deposits and less foreign deposits.
C) Americans will want to hold fewer dollar deposits and more foreign deposits.
D) Americans and foreigners will be indifferent toward holding dollar deposits or foreign deposits.
Answer: B
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

46) An increase in the foreign interest rate shifts the expected return schedule for ________ deposits to
the ________ and causes the domestic currency to depreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Answer: C
Question Status: Previous Edition

47) A decrease in the foreign interest rate shifts the expected return schedule for ________ deposits to
the ________ and causes the domestic currency to appreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Answer: D
Question Status: Previous Edition

48) A rise in the expected future exchange rate shifts the expected return schedule for ________ deposits
to the ________ and causes the domestic currency to appreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Answer: D
Question Status: Previous Edition

49) A fall in the expected future exchange rate shifts the expected return schedule for ________ deposits
to the ________ and causes the domestic currency to depreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Answer: C
Question Status: Previous Edition
50) An increase in the domestic interest rate shifts the expected return schedule for ________ deposits to
the ________ and causes the domestic currency to appreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Answer: A
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

51) A decrease in the domestic interest rate shifts the expected return schedule for ________ deposits to
the ________ and causes the domestic currency to depreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Answer: B
Question Status: Previous Edition

52) Which of the following causes a depreciation of the domestic currency?


A) A lower domestic interest rate due to a lower expected inflation rate.
B) A decline in the domestic real interest rate.
C) A decrease in the domestic money supply.
D) All of the above.
Answer: B
Question Status: Previous Edition
53) Which of the following causes an appreciation of the domestic currency?
A) A lower domestic interest rate due to a lower expected inflation rate.
B) A decline in the domestic real interest rate.
C) An increase in the domestic money supply.
D) All of the above.
Answer: A
Question Status: Previous Edition
54) When the domestic nominal interest rate rises because of an increase in expected inflation, the
expected appreciation of the dollar declines, ________ shifts out more than ________, and the exchange
rate declines.
A) RF; RD
B) RF; RF
C) RD; RD
D) RD; RF
Answer: A
Question Status: Previous Edition

55) The weakness of the dollar in the late 1970s and the strength of the dollar in the early 1980s can be
explained by movements in
A) real interest rates, but not nominal interest rates.
B) nominal interest rates, but not real interest rates.
C) relative price levels, but not real interest rates.
D) none of the above.
Answer: A
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

56) Evidence from the United States during the period 1973-2010 indicates the correspondence between
nominal interest rates and exchange rate movements is
A) much closer than that between real interest rates and exchange rate movements.
B) not nearly as close as that between government spending and exchange rate movements.
C) not nearly as close as that between government deficits and exchange rate movements.
D) not nearly as close as that between real interest rates and exchange rate movements.
Answer: D
Question Status: Updated from Previous Edition

57) Forward exchange rates


A) involve the immediate exchange of bank deposits.
B) involve the exchange of bank deposits at some specified future date.
C) involve the immediate exchange of imports and exports.
D) none of the above.
Answer: B
Question Status: Previous Edition
58) The foreign exchange market
A) is organized as an over-the-counter market in which several hundred dealers stand ready to buy and
sell deposits denominated in foreign currencies.
B) is very competitive.
C) functions no differently from a centralized market.
D) all of the above.
Answer: D
Question Status: Previous Edition

59) The purchasing power parity theory


A) has significant predictive power in the short run.
B) is the starting point for understanding how exchange rates are determined.
C) does not take into account that many goods and services are not traded across borders.
D) is none of the above.
Answer: C
Question Status: Previous Edition
60) In the long run, ________ affect the exchange rate.
A) relative price levels
B) tariffs and quotas
C) productivity
D) all of the above.
Answer: D
Question Status: Previous Edition
61) Quotas
A) are restrictions placed on the quality of foreign goods that can be imported.
B) are fees placed on imported goods.
C) are restrictions placed on the quantity of foreign goods that can be exported.
D) are none of the above.
Answer: D
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

62) The more modern asset market approach to exchange rate determination
A) emphasizes the role of import and export demand.
B) emphasizes stocks of assets.
C) emphasizes both of the above.
D) emphasizes neither of the above.
Answer: B
Question Status: Previous Edition
63) With the start of the subprime financial crisis in August 2007, the dollar ________ in value against
the euro as the Fed lowered interest rates. By December of 2008, with the financial crisis spreading
throughout Europe, foreign central banks cut their interest rates, leading to a ________ in the value of
the dollar relative to the euro.
A) rose; further increase
B) rose; decline
C) declined; rise
D) declined; further decline
Answer: C
Question Status: New Question

15.2 True/False
1) The foreign exchange market is organized as an over-the-counter market in which deposits
denominated in foreign currencies are bought and sold.
Answer: TRUE
Question Status: Previous Edition
2) When the value of the dollar changes from 0.50 pounds to 0.75 pounds, the pound has appreciated
and the dollar has depreciated.
Answer: FALSE
Question Status: Previous Edition
3) When the exchange rate for the euro changes from $0.90 to $0.85, then holding everything else
constant, the euro has depreciated and American wheat sold in Germany becomes more expensive.
Answer: TRUE
Question Status: Previous Edition
4) The theory of purchasing power parity cannot fully explain exchange rate movements because fiscal
policy differs across countries.
Answer: FALSE
Question Status: Previous Edition
5) If the dollar depreciates relative to the British pound, British sweaters will become more expensive in
the United States.
Answer: TRUE
Question Status: Previous Edition
6) If the dollar appreciates relative to the Swiss franc, Swiss chocolate will become cheaper in the
United States.
Answer: TRUE
Question Status: Previous Edition
13
Copyright 2012 Pearson Education, Inc.

7) If the exchange rate between the dollar and the Swiss franc changes from 1.8 to 1.5 francs per dollar,
the franc depreciates and the dollar appreciates.
Answer: FALSE
Question Status: Previous Edition
8) An increase in tariffs and quotas on imports causes a country's currency to appreciate.
Answer: TRUE
Question Status: Previous Edition
9) In the short run, the quantity of dollars supplied is relatively fixed, and is best represented with a
vertical supply curve.
Answer: TRUE
Question Status: New Question
10) Increased demand for a country's exports causes its currency to depreciate.
Answer: FALSE
Question Status: Previous Edition
11) As the relative expected return on dollar deposits increases, Americans will want to hold fewer
dollar deposits and more foreign deposits.
Answer: FALSE
Question Status: Previous Edition
12) According to the interest parity condition, if the domestic interest rate is 12 percent and the foreign
interest rate is 10 percent, then the expected appreciation of the foreign currency must be 2 percent.
Answer: TRUE
Question Status: Previous Edition
13) A fall in the expected future exchange rate shifts the expected return schedule for domestic deposits
to the right and causes the domestic currency to depreciate.
Answer: FALSE
Question Status: Previous Edition
14) Depreciation of a currency makes it easier for domestic manufacturers to sell their goods abroad and
makes foreign goods less competitive in domestic markets.
Answer: TRUE
Question Status: Previous Edition
15) There are two kinds of exchange rate transactions.
Answer: TRUE
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

15.3 Essay
1) Explain the logic underlying the law of one price and the theory of purchasing power parity.
Question Status: Previous Edition
2) Explain graphically how a change in the domestic price level will affect exchange rates, holding
everything else constant.
Question Status: Previous Edition
3) Explain the theory of purchasing power parity.
Question Status: Previous Edition
4) Explain graphically how a change in the foreign interest rate will affect exchange rates.
Question Status: Previous Edition
5) Discuss the relationship between changes in domestic real and nominal interest rates and exchange
rates.
Question Status: Previous Edition
6) What are some of the long-run determinants of the exchange rate?
Question Status: Previous Edition
7) With the start of the subprime financial crisis in August 2007, the dollar began an accelerated decline
in value, falling by 9% against the euro. At that point, the financial crisis appeared to be a U.S. problem.
However, by mid-2008, the crisis spread to Europe. Discuss the reaction of the dollar to actions taken by
European central banks in late 2008 to deal with the widening financial crisis.
Question Status: New Question

15
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 16 The International Financial System
16.1 Multiple Choice
1) A central bank sale of ________ to purchase ________ in the foreign exchange market results in an
equal rise in its international reserves and the monetary base.
A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency
Answer: C
Question Status: Previous Edition

2) A central bank sale of ________ to purchase ________ in the foreign exchange market results in an
equal decline in its international reserves and the monetary base.
A) foreign assets; domestic currency
B) foreign assets; foreign currency
C) domestic currency; foreign assets
D) domestic currency; domestic currency
Answer: A
Question Status: Previous Edition

3) A central bank ________ of domestic currency and corresponding ________ of foreign assets in the
foreign exchange market leads to an equal ________ in its international reserves and the monetary base.
A) sale; purchase; decline
B) sale; sale; increase
C) purchase; sale; increase
D) purchase; sale; decline
Answer: D
Question Status: Previous Edition

4) A central bank ________ of domestic currency and corresponding ________ of foreign assets in the
foreign exchange market leads to an equal ________ in its international reserves and the monetary base.
A) sale; purchase; increase
B) sale; sale; decline
C) purchase; sale; increase
D) purchase; purchase; decline
Answer: A
Question Status: Previous Edition
5) When the central bank allows the purchase or sale of domestic currency to have an effect on the
monetary base, it is called
A) a sterilized foreign exchange intervention.
B) an unsterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money-neutral foreign exchange intervention.
Answer: B
Question Status: Previous Edition
1
Copyright 2012 Pearson Education, Inc.

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
Question Status: Previous Edition

7) An unsterilized intervention in which domestic currency is sold to purchase foreign assets leads to
A) a gain in international reserves.
B) an increase in the money supply.
C) an appreciation in the domestic currency.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

8) An unsterilized intervention in which domestic currency is sold to purchase foreign assets leads to
A) a gain in international reserves.
B) a decrease in the money supply.
C) an appreciation in the domestic currency.
D) all of the above.
E) only A and B of the above.
Answer: A
Question Status: Previous Edition
9) A Federal Reserve decision to sell dollars in order to buy foreign assets in the foreign exchange
market has the same effect as an open market ________ of bonds to ________ the monetary base and
the money supply.
A) sale; decrease
B) purchase; decrease
C) sale; increase
D) purchase; increase
Answer: D
Question Status: Previous Edition

10) A Federal Reserve decision to purchase dollars by selling foreign assets in the foreign exchange
market has the same effect as an open market ________ of bonds to ________ the monetary base and
the money supply.
A) sale; decrease
B) purchase; decrease
C) sale; increase
D) purchase; increase
Answer: A
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) 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
Question Status: Previous Edition

12) Because sterilized interventions mean offsetting open market operations,


A) there is no impact on the monetary base.
B) there is no impact on the money supply.
C) there is no effect on the exchange rate.
D) all of the above occur.
E) only A and B of the above occur.
Answer: D
Question Status: Previous Edition

13) The difference between merchandise exports and imports is called the
A) current account balance.
B) capital account balance.
C) balance of payments.
D) trade balance.
Answer: D
Question Status: Previous Edition
14) A current account ________ indicates that the United States is ________ its claims on foreign
wealth.
A) surplus; increasing
B) surplus; decreasing
C) deficit; increasing
D) balance; decreasing
Answer: A
Question Status: Previous Edition

15) A current account ________ indicates that the United States is ________ its claims on foreign
wealth.
A) deficit; decreasing
B) deficit; increasing
C) surplus; decreasing
D) balance; increasing
Answer: A
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) Holding other factors constant, which of the following would decrease the size of the U.S. current
account deficit?
A) an increase in the amount of services purchased from foreigners
B) an increase in the amount of goods purchases from foreigners
C) an increase in the amount of goods sold to foreigners
D) only A and B of the above
Answer: C
Question Status: Previous Edition

17) Holding other factors constant, which of the following would increase the size of the U.S. current
account deficit?
A) sales of U.S. farm products in Europe
B) visits by European tourists to the United States
C) increasing travel by American college students in Europe
D) both A and B of the above
Answer: C
Question Status: Previous Edition

18) The current account balance plus the capital account balance equals
A) the amount of unsterilized exchange market intervention.
B) the trade balance.
C) the net change in government international reserves.
D) both A and C of the above.
Answer: C
Question Status: Previous Edition
19) If the current account balance shows a surplus, and capital account receipts exceed capital account
payments, then the net change in government international reserves must be ________, indicating a(n)
________ in U.S. international reserves.
A) positive; increase
B) negative; increase
C) negative; decrease
D) positive; decrease
Answer: A
Question Status: Previous Edition

20) Which of the following statements is correct?


A) current account balance = capital account balance
B) current account balance = capital account balance + net change in government international reserves
C) current account balance + capital account balance = net change in government international reserves
D) current account balance + net change in government international reserves = capital account balance
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) The Bretton Woods system was one in which central banks
A) agreed to limit domestic money growth to the average of the seven largest industrial nations.
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) bought and sold their own currencies to keep their exchange rates fixed.
Answer: D
Question Status: Previous Edition

22) 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
E) European Exchange Rate Mechanism (ERM)
Answer: A
Question Status: Previous Edition

23) The Bretton Woods agreement set up the ________, which currently provides long-term loans to
assist developing countries to build dams, roads, and other physical capital that contributes to economic
development.
A) International Monetary Fund
B) World Bank
C) Central Settlements Bank
D) Bank of International Settlements
E) European Exchange Rate Mechanism (ERM)
Answer: B
Question Status: Previous Edition

24) What kind of exchange rate system did the Bretton Woods agreement establish?
A) floating
B) managed float
C) dirty float
D) fixed
Answer: D
Question Status: Previous Edition
25) In the Bretton Woods system, the anchor currency was the
A) euro.
B) British pound.
C) German mark.
D) U.S. dollar.
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) Which of the following are true statements about the Bretton Woods system?
A) The Bretton Woods system was a fixed exchange rate regime, in which central banks bought and sold
their own currencies to keep their exchange rates fixed.
B) To maintain fixed exchange rates when countries had balance of payments deficits and were losing
international reserves, the IMF would loan deficit countries international reserves contributed by other
members.
C) The German mark was called a reserve currency because it was used to denominate the securities
central banks held as international reserves.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

27) Which of the following are true statements about the Bretton Woods system?
A) The Bretton Woods system was a flexible exchange rate regime, in which central banks allowed their
currencies to float within a wide trading band.
B) The U.S. dollar was called a reserve currency because it was used to denominate the securities central
banks held as international reserves.
C) The Bretton Woods agreement broke down in 1945.
D) Only A and B of the above are true.
Answer: B
Question Status: Previous Edition

28) Under a fixed exchange rate regime, when the domestic currency is undervalued, the central bank
must ________ the domestic currency to keep the exchange rate fixed; as a result, it ________
international reserves.
A) purchase; gains
B) sell; gains
C) purchase; loses
D) sell; loses
Answer: B
Question Status: Previous Edition

29) Under a fixed exchange rate regime, when the domestic currency is overvalued, the central bank
must ________ the domestic currency to keep the exchange rate fixed; as a result, it ________
international reserves.
A) purchase; loses
B) sell; loses
C) purchase; gains
D) sell; gains
Answer: A
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

30) 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: C
Question Status: Previous Edition
31) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is ________
par, the central bank must intervene to buy the domestic currency by selling foreign assets.
A) overvalued; below
B) overvalued; above
C) undervalued; below
D) undervalued; above
Answer: B
Question Status: Previous Edition

32) If the domestic currency is initially undervalued, that is below 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
Question Status: Previous Edition

33) 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
Question Status: Previous Edition

34) 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
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

35) If a country's central bank eventually runs out of international reserves, it cannot keep its currency
from ________ and a ________ must occur in which the par exchange value is reset at a ________
level.
A) appreciating; revaluation; higher
B) depreciating; revaluation; higher
C) depreciating; devaluation; lower
D) appreciating; devaluation; lower
Answer: C
Question Status: Previous Edition
36) Depreciation of a currency occurs when
A) a floating exchange rate adjusts upward.
B) a floating exchange rate adjusts downward.
C) a fixed exchange rate is adjusted upward.
D) a fixed exchange rate is adjusted downward.
Answer: B
Question Status: Previous Edition
37) Policymakers may not want to see their country's currency appreciate because
A) this would hurt consumers in their country by making foreign goods more expensive.
B) this would hurt domestic businesses by making foreign goods cheaper in their country.
C) this would increase inflation in their country.
D) this would decrease the wealth of the country.
Answer: B
Question Status: Previous Edition
38) Under a managed float exchange rate regime, policymakers frequently do not want to see their
currencies depreciate because it makes ________ goods more expensive for ________ consumers and
contributes to inflation.
A) foreign; foreign
B) foreign; domestic
C) domestic; foreign
D) domestic; domestic
Answer: B
Question Status: Previous Edition

39) Revaluation of a currency's value occurs when


A) a floating exchange rate adjusts upward.
B) a floating exchange rate adjusts downward.
C) a fixed exchange rate is adjusted upward.
D) a fixed exchange rate is adjusted downward.
Answer: C
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

40) Leading up to the foreign exchange crisis of September 1992, the Bank of England wanted to pursue
a(n) ________ monetary policy and the German Bundesbank wanted to pursue a(n) ________ monetary
policy.
A) expansionary, expansionary
B) expansionary; contractionary
C) contractionary; expansionary
D) contractionary; contractionary
Answer: B
Question Status: Previous Edition
41) When the Bundesbank lowered German mark interest rates in September 1992,
A) there was a massive sell-off of German marks, requiring intervention to support the value of the
mark.
B) there was a massive sell-off of British pounds, requiring intervention to support the value of the
pound.
C) there was a gradual sell-off of German marks, which avoided the need for intervention to support the
value of the mark.
D) there was a gradual sell-off of British pounds, which avoided the need for intervention to support the
value of the pound.
Answer: B
Question Status: Previous Edition

42) 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) the end of the Exchange Rate Mechanism.
Answer: A
Question Status: Previous Edition

43) Under the Bretton Woods system, when a nonreserve-currency country was running a balance of
payments deficit,
A) it gained international reserves.
B) it lost international reserves.
C) it was necessary for the policymakers to implement a contractionary monetary policy.
D) both A and C of the above occurred.
E) both B and C of the above occurred.
Answer: E
Question Status: Previous Edition

44) Under a fixed exchange rate system,


A) an anchor country loses control over its monetary policy.
B) a country that ties its currency to that of another country gains control of the other country's monetary
policy.
C) a country that ties its currency to that of another country loses control over its monetary policy.
D) a country that ties its currency to that of another country acquires greater control over its monetary
policy.
Answer: C
Question Status: Previous Edition
9
Copyright 2012 Pearson Education, Inc.

45) The euro is unlikely to seriously challenge the dollar as a reserve currency as long as
A) the European Union's share of world GDP remains significantly smaller than that of the United
States.
B) the European Union's share of world exports remains significantly smaller than that of the United
States.
C) Europe neglects to integrate its financial markets.
D) the European Union is unable to function as a cohesive political entity.
Answer: D
Question Status: Previous Edition

46) Under dollarization, a country


A) backs its currency 100 percent with foreign reserves.
B) earns seigniorage because it no longer bears the cost of issuing its own currency.
C) abandons its own currency and adopts the money of another country.
D) must worry about a speculative attack on its currency.
Answer: C
Question Status: Previous Edition
47) A disadvantage of dollarization is that it
A) prevents a central bank from creating inflation.
B) avoids the possibility of a speculative attack on the domestic currency.
C) does not allow a country to pursue its own independent monetary policy.
D) is a strong commitment to exchange rate stability.
Answer: C
Question Status: Previous Edition
48) (I) Controls on capital outflows may increase capital flight by weakening confidence in the
government. (II) Controls on capital outflows are an inadequate substitute for financial reform to deal
with currency crises.
A) (I) is true; (II) false.
B) (I) is false; (II) true.
C) Both are true.
D) Both are false.
Answer: C
Question Status: Previous Edition

49) The most effective way to deal with currency crises is to


A) impose controls on capital inflows.
B) impose controls on capital outflows.
C) impose controls on both capital inflows and outflows.
D) improve bank regulation and supervision.
Answer: D
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

50) An argument that supports the view that the world needs an international lender of last resort such as
the IMF is that
A) central banks in emerging-market countries lack credibility as inflation fighters.
B) an international lender of last resort creates a safety net that protects bank depositors.
C) the IMF is slow to lend, which ultimately reduces the amount that must be borrowed.
D) the IMF imposes requirements that borrowing countries must enact microeconomic policies to
reform their financial systems.
Answer: A
Question Status: Previous Edition

51) The capital account describes the flow of capital between the United States and other countries.
Capital inflows are
A) American purchases of foreign assets.
B) foreign purchases of American assets.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: B
Question Status: Previous Edition

52) Which of the following appears in the capital account part of the balance of payments?
A) a gift to an American from his English aunt
B) a purchase by the Honda corporation of a U.S. Treasury bill
C) a purchase by the Bank of England of a U.S. Treasury bill
D) income earned by the Honda corporation on its automobile plant in Ohio
Answer: B
Question Status: Previous Edition
53) Given the size of the statistical discrepancy needed to balance the balance of payments account, one
can infer that
A) hidden capital flows into the U.S. are inconsequential.
B) items in the balance of payments are measured quite accurately.
C) many international transactions go unrecorded.
D) all of the above occur.
Answer: C
Question Status: Previous Edition

54) Many believe that the statistical discrepancy is primarily the result of
A) large hidden capital flows into the United States.
B) large hidden capital flows out of the United States.
C) measurement errors due to exchange rate calculations.
D) none of the above.
Answer: A
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

55) A balance of payments ________ is associated with a ________ of international reserves.


A) deficit; loss
B) deficit; gain
C) surplus; loss
D) balance; gain
Answer: A
Question Status: Previous Edition
56) A balance of payments ________ is associated with a ________ of international reserves.
A) surplus; loss
B) surplus; gain
C) deficit; gain
D) balance; loss
Answer: B
Question Status: Previous Edition
57) The official reserve transactions balance
A) equals the current account balance plus the items in the capital account.
B) tells us the net amount of international reserves that must move between central banks in order to
finance international transactions.
C) has an important impact on the money supply.
D) is all of the above.
Answer: D
Question Status: Previous Edition

58) Because other countries hold dollars as international reserves, a U.S. official reserve transactions
deficit can be financed by
A) an increase in U.S. international reserves.
B) an increase in foreign holdings of dollars.
C) a decrease in foreign holdings of dollars.
D) only A and B of the above.
Answer: B
Question Status: Previous Edition

59) When a reserve currency country runs a balance of payments deficit and a nonreserve currency
country buys the reserve currency to finance the reserve country's deficits, the monetary base in the
nonreserve country ________ and the monetary base in the reserve country ________.
A) increases; decreases
B) increases; does not change
C) decreases; does not change
D) decreases; increases
Answer: B
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

60) ________ is when the domestic currency is backed 100% by a foreign currency and in which the
note-issuing authority establishes a fixed exchange rate to this foreign currency and stands ready to
exchange domestic currency for the foreign currency at this rate whenever the public requests it.
A) dollarization
B) currency board
C) devaluation
D) revaluation
Answer: B
Question Status: Previous Edition

61) What shows international transactions that involve currently produced goods and services?
A) current account
B) balance of payments
C) trade balance
D) capital account
Answer: A
Question Status: Previous Edition
62) What is the bookkeeping system for recording all receipts and payments that have a direct bearing
on the movement of funds between a nation and foreign countries?
A) current account
B) capital account
C) balance of payments
D) trade balance
Answer: C
Question Status: Previous Edition

63) The official reserve transactions balance is referred to as


A) the capital account.
B) the current account.
C) the trade balance.
D) the net change in government international reserves.
Answer: D
Question Status: Previous Edition
64) A dirty float is
A) when the value of a currency is pegged relative to the value of one other currency.
B) when the value of a currency is allowed to fluctuate against all other currencies.
C) when countries intervene in foreign exchange markets in an attempt to influence their exchange rates
by buying and selling foreign assets.
D) when the value of a currency is pegged relative to an anchor currency.
Answer: C
Question Status: Previous Edition

13
Copyright 2012 Pearson Education, Inc.

65) Seigniorage is
A) when a country abandons its currency altogether and adopts that of another country.
B) when a country loses the revenue that it received by issuing money.
C) when the par exchange rate is reset at a lower level.
D) when the domestic currency is backed 100% by a foreign currency.
Answer: B
Question Status: Previous Edition
16.2 True/False
1) An unsterilized intervention in which domestic currency is sold to purchase foreign assets leads to a
gain in international reserves.
Answer: TRUE
Question Status: Previous Edition
2) The difference between merchandise exports and imports is called the current account balance.
Answer: FALSE
Question Status: Previous Edition
3) The current account balance plus the capital account balance equals the net change in government
international reserves.
Answer: TRUE
Question Status: Previous Edition
4) A central bank's international reserves are its holdings of assets denominated in foreign currencies.
Answer: TRUE
Question Status: Previous Edition
5) In contrast to other countries' currencies, the Japanese yen and yen-denominated assets are the major
component of international reserves held by countries.
Answer: FALSE
Question Status: Previous Edition
6) An anchor currency provides the base for a floating exchange rate system.
Answer: FALSE
Question Status: Previous Edition
7) In a fixed exchange rate system, a country whose currency is undervalued will lose international
reserves.
Answer: FALSE
Question Status: Previous Edition
8) The Bretton Woods system was a fixed exchange rate regime in which central banks bought and sold
their own currencies to keep their exchange rates fixed.
Answer: TRUE
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

9) If a country's central bank eventually runs out of international reserves, it cannot keep its currency
from depreciating and a devaluation must occur.
Answer: TRUE
Question Status: Previous Edition
10) When it acts as a lender of last resort, the IMF may increase the likelihood that financial institutions
take excessive risks and thus increase moral hazard.
Answer: TRUE
Question Status: Previous Edition
11) An unsterilized intervention in which domestic currency is purchased by selling foreign assets leads
to a rise in international reserves, a decrease in the money supply, and an appreciation of the domestic
currency.
Answer: FALSE
Question Status: Previous Edition
12) A sterilized intervention leaves the money supply changed and has a direct way of affecting interest
rates or the expected future exchange rate.
Answer: FALSE
Question Status: Previous Edition
13) A managed float regime is when countries intervene in foreign exchange markets in an attempt to
influence their exchange rates by buying and selling foreign assets.
Answer: TRUE
Question Status: Previous Edition
14) By the end of 2010, China had accumulated more than $2 trillion of international reserves.
Answer: TRUE
Question Status: New Question
16.3 Essay
1) How does a sterilized foreign exchange intervention differ from an unsterilized one in terms of its
effects on the exchange rate, international reserves, and the monetary base?
Question Status: Previous Edition
2) How does a fixed exchange rate regime differ from a system of floating exchange rates?
Question Status: Previous Edition
3) Briefly explain what it means to be a "reserve-currency" country. What are the advantages? Can you
think of any disadvantages?
Question Status: Previous Edition
4) What was the European Monetary System? How did its exchange rate mechanism work?
Question Status: Previous Edition
5) Explain graphically how a country must intervene in the foreign exchange market under a fixed
exchange rate regime if its currency is undervalued.
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

6) Explain graphically the speculative attacks that occurred against the British pound in 1992, the
Mexican peso in 1994, the Thai baht in 1997, the Brazilian real in 1999, and the Argentine peso in 2002.
Question Status: Previous Edition
7) What are the arguments for and against the IMF acting as an international lender of last resort?
Question Status: Previous Edition
8) Describe the pros and cons for controls on capital inflows and outflows.
Question Status: Previous Edition
9) By the end of 2010, China had accumulated more than $2 trillion of international reserves. How did
China accomplish this? Is the policy sustainable?
Question Status: New Question

16
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 17 Banking and the Management of Financial Institutions
17.1 Multiple Choice
1) Which of the following statements is 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 equity capital.
D) All of the above are true.
Answer: C
Question Status: Previous Edition
2) Which of the following statements is true?
A) A bank's assets are its uses of funds.
B) A bank's assets are its sources of funds.
C) A bank's liabilities are its uses of funds.
D) Only B and C of the above are true.
Answer: A
Question Status: Previous Edition
3) 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) A bank's assets provide the bank with income.
D) Bank capital is an asset on the bank balance sheet.
Answer: D
Question Status: Previous Edition
4) A bank's balance sheet
A) shows that total assets equal total liabilities plus equity capital.
B) lists sources and uses of bank funds.
C) indicates whether or not the bank is profitable.
D) does all of the above.
E) does only A and B of the above.
Answer: E
Question Status: Previous Edition

5) Which of the following are reported as liabilities on a bank's balance sheet?


A) reserves
B) checkable deposits
C) loans
D) deposits with other banks
Answer: B
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) Which of the following are reported as liabilities on a bank's balance sheet?


A) discount loans
B) cash items in the process of collection
C) state government securities
D) all of the above
E) only B and C of the above
Answer: A
Question Status: Previous Edition

7) The share of checkable 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
Question Status: Previous Edition
8) Checkable deposits and money market deposit accounts are
A) payable on demand.
B) liabilities of the banks.
C) assets of the banks.
D) only A and B of the above.
E) only A and C of the above.
Answer: D
Question Status: Previous Edition

9) Which of the following statements is false?


A) Checkable deposits are usually the lowest-cost source of bank funds.
B) Checkable deposits are the primary source of bank funds.
C) Checkable deposits are payable on demand.
D) Checkable deposits include NOW accounts.
Answer: B
Question Status: Previous Edition
10) Because checking accounts are ________ liquid for the depositor than passbook savings, they earn
________ interest rates.
A) less; higher
B) less; lower
C) more; higher
D) more; lower
Answer: D
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) Because passbook savings are ________ liquid for the depositor than checking accounts, they earn
________ interest rates.
A) less; higher
B) less; lower
C) more; higher
D) more; lower
Answer: A
Question Status: Previous Edition

12) Which of the following is checkable deposits?


A) savings accounts
B) Small-denomination time deposits
C) Money market deposit accounts
D) Certificates of deposit
Answer: C
Question Status: Previous Edition
13) Which of the following are not checkable deposits?
A) savings accounts
B) small-denomination time deposits
C) negotiable order of withdrawal accounts
D) all of the above
E) only A and B of the above
Answer: E
Question Status: Previous Edition

14) Which of the following are checkable deposits?


A) savings accounts
B) small-denomination time deposits
C) negotiable order of withdrawal accounts
D) certificates of deposit
Answer: C
Question Status: Previous Edition
15) Large-denomination 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
Question Status: Previous Edition
16) Bank loans from the Federal Reserve are called ________ and represent a ________ of funds.
A) discount loans; use
B) discount loans; source
C) fed funds; use
D) fed funds; source
Answer: B
Question Status: Previous Edition
3
Copyright 2012 Pearson Education, Inc.

17) Which of the following would substitute for discount loans?


A) loans to businesses
B) repurchase agreements
C) investing in Eurodollars
D) loans to bank holding companies
E) reverse repurchase agreements
Answer: B
Question Status: Previous Edition

18) Which of the following are reported as assets on a bank's balance sheet?
A) discount loans from the Fed
B) loans
C) borrowings
D) only A and B of the above
Answer: B
Question Status: Previous Edition
19) Which of the following are reported as assets on a bank's balance sheet?
A) cash items in the process of collection
B) deposits with other banks
C) checkable deposits
D) bank capital
E) only A and B of the above
Answer: E
Question Status: Previous Edition

20) Which of the following are reported as assets on a bank's balance sheet?
A) borrowings
B) reserves
C) savings deposits
D) bank capital
E) only A and B of the above
Answer: B
Question Status: Previous Edition
21) Which of the following are not reported as assets on a bank's balance sheet?
A) cash items in the process of collection
B) deposits with other banks
C) U.S. Treasury securities
D) checkable deposits
Answer: D
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

22) Which of the following are not reported as assets on a bank's balance sheet?
A) Cash items in the process of collection
B) Borrowings
C) U.S. Treasury securities
D) Reserves
Answer: B
Question Status: Previous Edition
23) Because of their ________ liquidity, ________ U.S. government securities are called secondary
reserves.
A) low; short-term
B) low; long-term
C) high; short-term
D) high; long-term
Answer: C
Question Status: Previous Edition

24) Secondary reserves ________


A) can be converted into cash with low transaction costs.
B) are not easily converted into cash and are, therefore, of secondary importance to banks.
C) count toward meeting required reserves, but only at a rate of $0.50 per dollar of secondary reserves.
D) none of the above.
Answer: A
Question Status: Previous Edition
25) The most important category of assets on a bank's balance sheet is
A) discount loans.
B) securities.
C) loans.
D) cash items in the process of collection.
Answer: C
Question Status: Previous Edition
26) Which of the following bank assets are the least liquid?
A) reserves
B) mortgage loans
C) cash items in process of collection
D) deposits with other banks
Answer: B
Question Status: Previous Edition
27) Which of the following bank assets are the most liquid?
A) consumer loans
B) reserves
C) cash items in process of collection
D) U.S. government securities
Answer: B
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

28) Loans
A) are the largest category of bank assets.
B) provide most of the bank's revenues.
C) earn the highest return of all bank assets.
D) do all of the above.
E) are only A and B of the above.
Answer: D
Question Status: Previous Edition

29) A bank's largest source of funds is its


A) nontransaction deposits.
B) checking deposits.
C) borrowing from the Fed.
D) federal funds.
Answer: A
Question Status: Previous Edition
30) 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
Question Status: Previous Edition
31) 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
Question Status: Previous Edition
32) When you deposit $50 in the First National Bank,
A) its liabilities decrease by $50.
B) its assets increase by $50.
C) its reserves increase by $50.
D) only B and C of the above occur.
Answer: D
Question Status: Previous Edition
33) When you deposit $50 in the First National Bank,
A) its liabilities decrease by $50.
B) its assets increase by $50.
C) its reserves decrease by $50.
D) only B and C of the above occur.
Answer: B
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

34) When you deposit $50 in currency at the Old National Bank,
A) its assets increase by $50.
B) its reserves increase by less than $50 because of reserve requirements.
C) its liabilities decrease by $50.
D) only A and B of the above occur.
Answer: A
Question Status: Previous Edition
35) When you deposit $50 in currency at the 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) only A and B of the above occur.
Answer: C
Question Status: Previous Edition
36) When a $10 check written on the First National Bank is deposited in an account at the Second
National Bank, then
A) the liabilities of the First National Bank decrease by $10.
B) the reserves of the First National Bank increase by $10.
C) the liabilities of the Second National Bank decrease by $10.
D) the assets of Second National Bank decrease by $10.
Answer: A
Question Status: Previous Edition

37) When a $10 check written on the First National Bank is deposited in an account at the Second
National Bank, then
A) the liabilities of the First National Bank decrease by $10.
B) the liabilities of the Second National Bank increase by $10.
C) the reserves of the First National Bank increase by $10.
D) all of the above occur.
E) only A and B of the above occur.
Answer: E
Question Status: Previous Edition

38) Holding all else constant, when a bank receives the funds for a deposited check,
A) cash items in process of collection fall by the amount of the check.
B) bank assets increase by the amount of the check.
C) bank liabilities decrease by the amount of the check.
D) all of the above occur.
Answer: A
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

39) Holding all else constant, when a bank receives the funds for a deposited check,
A) cash items in process of collection fall by the amount of the check.
B) bank assets remain unchanged.
C) bank liabilities decrease by the amount of the check.
D) all of the above occur.
E) only A and B of the above occur.
Answer: E
Question Status: Previous Edition

40) A bank manager has which of the following concerns?


A) to acquire funds at low cost
B) to minimize risk by diversifying asset holdings
C) to have enough ready cash to meet deposit outflows
D) all of the above
Answer: D
Question Status: Previous Edition
41) Which of the following are primary concerns of a bank manager?
A) maintaining sufficient reserves to minimize the cost to the bank of deposit outflows
B) extending loans to borrowers who will pay high interest rates, but who are also good credit risks
C) acquiring funds at a relatively low cost, so that profitable lending opportunities can be realized
D) all of the above
Answer: D
Question Status: Previous Edition
42) Bankers' concern regarding the optimal mix of excess reserves, secondary reserves, borrowings from
the Fed, 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) none of the above.
Answer: B
Question Status: Previous Edition

43) 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 instead makes loans, then in the bank's final balance sheet,
A) the assets at the bank increase by $200,000.
B) the liabilities of the bank increase by $200,000.
C) reserves increase by $200,000.
D) all of the above occur.
Answer: C
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

44) 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 instead makes loans, 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
Question Status: Previous Edition
45) If a bank has $1 million of deposits, a required reserve ratio of 20 percent, and $300,000 in reserves,
it need not rearrange its balance sheet if there is a deposit outflow of
A) $50,000.
B) $75,000.
C) $150,000.
D) either A or B of the above.
Answer: D
Question Status: Previous Edition

46) If a bank has $100,000 of deposits, a required reserve ratio of 20 percent, and $40,000 in reserves,
then the maximum deposit outflow it can sustain without altering its balance sheet is
A) $30,000.
B) $25,000.
C) $20,000.
D) $10,000.
Answer: B
Question Status: Previous Edition

47) If a bank has $200,000 of deposits, a required reserve ratio of 20 percent, and $80,000 in reserves,
then the maximum deposit outflow it can sustain without altering its balance sheet is
A) $50,000.
B) $40,000.
C) $30,000.
D) $25,000.
Answer: A
Question Status: Previous Edition

48) If a bank has $10 million of deposits, a required reserve ratio of 10 percent, and $2 million in
reserves, then it does not have enough reserves to support a deposit outflow of
A) $1.2 million.
B) $1.1 million.
C) $1 million.
D) either A or B of the above.
Answer: A
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

49) Banks can protect themselves from the disruption caused by deposit outflows by
A) holding excess reserves.
B) selling securities.
C) "calling in" loans.
D) doing all of the above.
E) doing only A and B of the above.
Answer: D
Question Status: Previous Edition
50) In general, banks would prefer to meet deposit outflows by ________ rather than ________
A) selling loans; selling securities.
B) selling loans; borrowing from the Fed.
C) borrowing from the Fed; selling loans.
D) "calling in" loans; selling securities.
Answer: C
Question Status: Previous Edition
51) Which of the following do banks hold as insurance against the high cost of deposit outflows?
A) excess reserves
B) secondary reserves
C) bank equity capital
D) all of the above
E) only A and B of the above
Answer: A
Question Status: Previous Edition

52) Which is the least costly way for a bank to handle deposit outflows?
A) Hold excess reserves.
B) Borrow from other banks.
C) Sell securities.
D) Call in loans.
Answer: A
Question Status: Previous Edition
53) The ________ the costs associated with deposit outflows are, the ________ excess reserves banks
will want to hold.
A) lower; more
B) higher; less
C) higher; more
D) none of the above, since deposit outflows cannot be anticipated
Answer: C
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

54) A bank can reduce its total amount of loans outstanding by


A) "calling in" loans; that is, by not renewing some loans when they come due.
B) selling loans to other banks.
C) selling loans to the Federal Reserve.
D) doing all of the above.
E) doing only A and B of the above.
Answer: E
Question Status: Previous Edition
55) Which of the following statements is an accurate description of modern liability management?
A) Greater flexibility in liability management has allowed banks to increase the proportion of their
assets held in loans.
B) New financial instruments enable banks to acquire funds quickly.
C) The introduction of negotiable CDs have significantly reduced the percentage of funds that banks
borrow from one another to finance loans.
D) All of the above have occurred since 1960.
E) Only A and B of the above have occurred since 1960.
Answer: E
Question Status: Previous Edition

56) Banks fail when the value of bank ________ falls below the value of ________, causing the bank to
become insolvent.
A) reserves; required reserves
B) loans; secondary reserves
C) assets; liabilities
D) income; expenses
Answer: C
Question Status: Previous Edition

57) A bank fails when the value of its ________ falls below the value of ________, causing the bank to
become insolvent.
A) reserves; required reserves
B) loans; secondary reserves
C) securities; deposit liabilities
D) assets; liabilities
Answer: D
Question Status: Previous Edition

58) Bank failure is less likely to occur when a bank


A) holds less in U.S. government securities.
B) suffers large deposit outflows.
C) holds more excess reserves.
D) has less bank capital.
Answer: C
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

59) A bank failure is more likely to occur when


A) a bank holds less in U.S. government securities.
B) a bank suffers large deposit outflows.
C) a bank holds less equity capital.
D) all of the above occur.
E) only A and B of the above occur.
Answer: D
Question Status: Previous Edition
60) The largest source of bank income is
A) interest on loans.
B) interest on securities.
C) service charges on deposit accounts.
D) noninterest income.
Answer: A
Question Status: Previous Edition
61) The largest operating expense for a bank is
A) salaries and employee benefits.
B) interest paid on discount loans.
C) interest paid on federal funds borrowed from other banks.
D) interest paid on deposits.
Answer: D
Question Status: Previous Edition
62) On a bank's income statement, the provision for loan losses is an ________ item and represents the
amount of ________ in the bank's loan loss reserves.
A) income; decrease
B) income; increase
C) expense; decrease
D) expense; increase
Answer: D
Question Status: Previous Edition

63) On a bank's income statement, the amount available to keep as retained earnings or pay to the
stockholders in dividends is the bank's
A) net income.
B) net operating income.
C) net extraordinary items.
D) net interest margin.
Answer: A
Question Status: Previous Edition

64) Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called
A) return on assets.
B) return after taxes.
C) return on equity.
D) equity multiplier.
Answer: C
Question Status: Previous Edition
12
Copyright 2012 Pearson Education, Inc.

65) Net profit after taxes per dollar of assets is a basic measure of bank profitability called
A) return on assets.
B) return on capital.
C) return on equity.
D) return after taxes.
Answer: A
Question Status: Previous Edition
66) The amount of assets per dollar of equity capital is called the
A) asset ratio.
B) equity ratio.
C) equity multiplier.
D) asset multiplier.
E) return on equity.
Answer: C
Question Status: Previous Edition

67) For a given return on assets, the lower the bank capital is,
A) the lower the return for the owners of the bank will be.
B) the higher the return for the owners of the bank will be.
C) the lower the credit risk for the owners of the bank will be.
D) both A and C of the above will happen.
Answer: B
Question Status: Previous Edition
68) 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, increasing the return on equity.
D) none of the above.
Answer: C
Question Status: Previous Edition
69) An argument that supports a regulated minimum capital requirement is that banks that hold too little
capital
A) are unprofitable.
B) impose costs on other banks because they are more likely to fail.
C) have an unfair competitive advantage over savings and loans.
D) includes all of the above.
Answer: B
Question Status: Previous Edition
70) Examples of off-balance-sheet activities include
A) loan sales.
B) foreign exchange market transactions.
C) trading in financial futures.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition
13
Copyright 2012 Pearson Education, Inc.

71) Examples of off-balance-sheet activities include


A) loan sales.
B) extending loans to depositors.
C) borrowing from other banks.
D) all of the above.
Answer: A
Question Status: Previous Edition
72) The danger of banks engaging in activities such as trading in financial futures and interest-rate
swaps is that these activities allow banks to
A) increase profits.
B) decrease risks.
C) avoid bank regulations.
D) engage in speculation.
Answer: D
Question Status: Previous Edition

73) When a bank sells all or part of the cash stream from a specific loan,
A) it removes the loan from its balance sheet.
B) it usually does so at a loss.
C) it usually does so at a profit.
D) both A and B of the above occur.
E) both A and C of the above occur.
Answer: E
Question Status: Previous Edition

74) A bank
A) obtains funds by borrowing and by issuing liabilities.
B) makes profits by charging an interest rate on their asset holdings of securities and loans that is lower
than the interest and other expenses on their liabilities.
C) does both A and B of the above.
D) does neither A nor B of the above.
Answer: A
Question Status: Previous Edition
75) ________ were once the most common type of nontransaction deposit.
A) Checking accounts
B) Time deposits
C) Savings accounts
D) none of the above
Answer: C
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

76) Discount loans are also known as ________.


A) interest-free loans
B) advances
C) credits
D) market loans
Answer: B
Question Status: Previous Edition
77) Bank capital
A) is raised by selling new equity.
B) is a cushion against a drop in the value of its assets.
C) comes from retained earnings.
D) is all of the above.
Answer: D
Question Status: Previous Edition
78) Before the 1960s,
A) over half of the sources of bank funds were obtained through checkable deposits that by law could
not pay any interest.
B) banks mostly borrowed from other banks to meet their reserve needs.
C) both A and B occurred.
D) neither A nor B occurred.
Answer: A
Question Status: Previous Edition

79) With large banks beginning to explore ways in which the liabilities on their balance sheets could
provide them with reserves and liquidity, this led to
A) the expansion of overnight loan markets.
B) the development of negotiable CDs.
C) the ability of money center banks to acquire funds quickly.
D) all of the above occurring.
Answer: D
Question Status: Previous Edition
80) In the late 1960s,
A) money market banks no longer needed to depend on checkable deposits as the primary source of
bank funds.
B) banks aggressively set target goals for their asset growth.
C) the new management of liabilities created more flexibility.
D) all of the above.
Answer: D
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

81) In recent years, the interest paid on checkable and time deposits has accounted for around ________
of total bank operating expenses, while the costs involved in running the bank have been approximately
________ of total operating expenses.
A) 50%; 50%
B) 50%; 25%
C) 30%; 50%
D) 25%; 75%
Answer: C
Question Status: Updated from Previous Edition

17.2 True/False
1) Since their introduction in 1961, negotiable CDs have become an important source of bank funds.
Answer: TRUE
Question Status: Previous Edition
2) Deposits that banks keep in accounts at the Federal Reserve less vault cash is called reserves.
Answer: FALSE
Question Status: Previous Edition
3) When a bank receives additional deposits, it gains an equal amount of reserves; when it loses
deposits, it loses an equal amount of reserves.
Answer: TRUE
Question Status: Previous Edition
4) To keep enough cash on hand to meet depositors' demand for withdrawals, banks must engage in
liquidity management.
Answer: TRUE
Question Status: Previous Edition
5) Required reserves are insurance against the costs associated with deposit outflows. The higher the
costs associated with deposit outflows, the more required reserves banks will want to hold.
Answer: FALSE
Question Status: Previous Edition
6) A bank maintains bank capital to lessen the chance that it will become insolvent.
Answer: TRUE
Question Status: Previous Edition
7) Given a bank's return on assets, the higher the bank capital, the higher the return for the owners of the
bank.
Answer: FALSE
Question Status: Previous Edition
8) Loan loss reserves are an asset on a bank's balance sheet.
Answer: FALSE
Question Status: Previous Edition

16
Copyright 2012 Pearson Education, Inc.

9) Off-balance-sheet activities consist of trading financial instruments and generating income from fees
and loan sales, all of which affect bank profits but are not visible on bank balance sheets.
Answer: TRUE
Question Status: Previous Edition
10) The value-at-risk method for estimating a bank's risk exposure measures the losses a bank could
incur under a worst-case scenario.
Answer: FALSE
Question Status: Previous Edition
11) The share of bank operating income earned from off-balance-sheet activities has increased over the
past two decades.
Answer: TRUE
Question Status: Previous Edition
12) Since a bank's assets exceed its equity capital, the return on assets always exceeds the return on
equity.
Answer: FALSE
Question Status: Previous Edition
13) A loan commitment is an agreement to provide a loan up to a certain dollar amount if a customer
requests the loan during a specific time period.
Answer: TRUE
Question Status: Previous Edition
14) Nontransaction deposits are the primary source of bank funds.
Answer: TRUE
Question Status: Previous Edition
15) Owners cannot write checks on nontransaction deposits, but the interest rate paid on these deposits
are usually higher than those on checkable deposits.
Answer: TRUE
Question Status: Previous Edition
17.3 Essay
1) What is the major focus of each of the following bank management concerns: asset management,
liability management, liquidity management, and capital adequacy management?
Question Status: Previous Edition
2) Explain the off-balance-sheet activities banks engage in, the risks they face from undertaking these
activities, and the controls they put in place to restrict bank employees from taking on too much risk.
Question Status: Previous Edition
3) Discuss the recent trends in bank performance measures.
Question Status: Previous Edition
4) What are a bank's major sources and uses of funds?
Question Status: Previous Edition

17
Copyright 2012 Pearson Education, Inc.

5) Distinguish between a bank's reserves, required reserves, excess reserves, and secondary reserves.
Question Status: Previous Edition
6) What costs do banks hope to avoid by holding excess reserves?
Question Status: Previous Edition
7) How did liability management change during the 1960s?
Question Status: Previous Edition
8) Explain how a capital crunch can lead to a credit crunch in our economy.
Question Status: New Question

18
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 18 Financial Regulation
18.1 Multiple Choice
1) During the boom years of the 1920s, bank failures were quite
A) uncommon, averaging less than 30 per year.
B) uncommon, averaging less than 100 per year.
C) common, averaging about 600 per year.
D) common, averaging about 2,000 per year.
Answer: C
Question Status: Previous Edition
2) 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) precontractual opportunism.
Answer: A
Question Status: Previous Edition

3) Moral hazard is an important consequence of insurance arrangements because the existence of


insurance
A) provides increased incentives for risk taking.
B) impedes efficient risk taking.
C) causes the private cost of the insured activity to increase.
D) does both A and B of the above.
E) does both B and C of the above.
Answer: A
Question Status: Previous Edition

4) 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
Question Status: Previous Edition
5) Although the FDIC 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
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) 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
Question Status: Previous Edition
7) Deposit insurance
A) attracts risk-prone entrepreneurs to the banking industry.
B) encourages bank managers to take on greater risks than they otherwise would.
C) reduces the incentives of depositors to monitor the riskiness of their banks' asset portfolios.
D) does all of the above.
E) does only A and B of the above.
Answer: D
Question Status: Previous Edition

8) The possibility that the failure of one bank can hasten the failure of other banks is called the
A) bank run effect.
B) moral hazard effect.
C) contagion effect.
D) adverse selection effect.
Answer: C
Question Status: Previous Edition
9) If the FDIC 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
Question Status: Previous Edition
10) If the FDIC uses the purchase and assumption method to handle a failed bank,
A) all deposits will suffer losses.
B) small deposits will be paid in full but deposits over the insurance limit will not.
C) all deposits will be paid in full.
D) none of the above will occur.
Answer: C
Question Status: Previous Edition
11) One problem of the too-big-to-fail policy is that it ________ the incentives for ________ by big
banks.
A) reduces; moral hazard by big banks.
B) increases; moral hazard by big banks.
C) reduces; adverse selection by big banks.
D) increases; adverse selection by big banks.
Answer: B
Question Status: Previous Edition
2
Copyright 2012 Pearson Education, Inc.

12) 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) large; fewer
D) large; greater
Answer: D
Question Status: Previous Edition

13) The too-big-to-fail policy


A) exacerbates 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) does only A and C of the above.
Answer: D
Question Status: Previous Edition
14) The primary difference between the "payoff" and the "purchase and assumption" methods of
handling failed banks is that the FDIC
A) guarantees all deposits, not just those under the $250,000 limit, when it uses the "payoff" method.
B) guarantees all deposits, not just those under the $250,000 limit, when it uses the "purchase and
assumption" method.
C) 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) does both A and B of the above.
E) does both B and C of the above.
Answer: B
Question Status: Previous Edition

15) The primary difference between the "payoff" and the "purchase and assumption" methods of
handling failed banks is that the FDIC
A) guarantees all deposits, not just those under the $250,000 limit, when it uses the "payoff" method.
B) guarantees all deposits, not just those under the $250,000 limit, when it uses the "purchase and
assumption" method.
C) is less 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) does both A and B of the above.
E) does both B and C of the above.
Answer: E
Question Status: Previous Edition

16) 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) prohibiting banks from holding risky assets such as common stocks.
C) establishing a minimum interest rate floor that banks can earn on certain assets.
D) doing all of the above.
E) doing only A and B of the above.
Answer: E
Question Status: Previous Edition
3
Copyright 2012 Pearson Education, Inc.

17) One way for bank regulators to assure depositors that a bank is not taking on too much risk is to
require the bank to
A) diversify its loan portfolio.
B) reduce its equity capital.
C) reduce the size of its loan portfolio.
D) do both A and B of the above.
E) do both B and C of the above.
Answer: A
Question Status: Previous Edition
18) Banks do not want to hold too much capital because
A) they do not bear fully the costs of bank failures.
B) higher returns on equity are earned when bank capital is smaller, all else equal.
C) higher capital levels attract the scrutiny of regulators.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

19) The increased integration of financial markets across countries and the need to make the playing
field equal for banks from different countries led to the Basel Accord agreement to
A) standardize bank capital requirements internationally.
B) reduce, across the board, bank capital requirements in all countries.
C) sever the link between risk and capital requirements.
D) do all of the above.
Answer: A
Question Status: Previous Edition

20) Under the Basel plan,


A) assets and off-balance sheet activities are assigned to various categories to reflect the degree of credit
risk.
B) a bank's total capital must equal or exceed 8 percent of total risk-weighted assets.
C) both of the above occur.
D) none of the above occur.
Answer: C
Question Status: Previous Edition

21) Of the following assets, the one which has the highest capital requirement under the Basel Accord is
A) municipal bonds.
B) residential mortgages.
C) commercial paper.
D) securities issued by industrialized countries' governments.
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

22) Which of the following is not true regarding the Basel 2 proposal to reform the original 1988 Basel
Accord?
A) It attempts to link capital requirements more closely to actual risk by expanding the number of risk
categories.
B) It focuses on assessing the quality of risk management in banking institutions.
C) It attempts to improve market discipline by requiring increased disclosure of pertinent information
about banks.
D) It has been well received by banks and national regulatory agencies.
Answer: D
Question Status: Previous Edition

23) Ways in which bank regulations reduce the adverse selection and moral hazard problems in banking
include
A) a chartering process designed to prevent crooks from getting control of a bank.
B) restrictions that prevent banks from acquiring certain risky assets, such as common stocks.
C) high bank capital requirements to increase the cost of bank failure to the owners.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

24) 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
Question Status: Previous Edition

25) The chartering process is especially designed to deal with the ________ problem, and restrictions on
asset holdings 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
Question Status: Previous Edition

26) Regular bank examinations and restrictions on asset holdings indirectly help to 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
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

27) Regular bank examinations and restrictions on asset holdings indirectly help to ________ the
adverse selection problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs
will be ________ from entering the banking industry.
A) increase; encouraged
B) increase; discouraged
C) reduce; encouraged
D) reduce; discouraged
Answer: D
Question Status: Previous Edition

28) The legislation that separated commercial banking from the securities industry is known as the
________.
A) National Bank Act
B) Federal Reserve Act
C) Glass-Steagall Act
D) McFadden Act
Answer: C
Question Status: Previous Edition

29) The Depository Institutions Deregulation and Monetary Control Act of 1980
A) approved NOW accounts nationwide.
B) restricted the use of ATS accounts.
C) imposed interest rate ceilings on bank loans.
D) did all of the above.
Answer: A
Question Status: Previous Edition
30) The Depository Institutions Deregulation and Monetary Control Act of 1980
A) approved NOW accounts nationwide.
B) imposed uniform reserve requirements.
C) mandated the phase out of interest-rate ceilings on deposits.
D) did all of the above.
E) did only A and B of the above.
Answer: D
Question Status: Previous Edition

31) As a way of stemming the decline in the number of savings and loans and mutual savings banks, the
Garn-St. Germain Act of 1982 allowed
A) money market certificates.
B) money market mutual funds.
C) money market deposit accounts.
D) negotiable order of withdrawal accounts.
Answer: C
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

32) An impact of the Garn-St. Germain Act of 1982 has been to


A) put savings and loans at a competitive disadvantage.
B) make the banking system more competitive.
C) give money market mutual funds a competitive advantage.
D) do both A and B of the above.
E) do both A and C of the above.
Answer: B
Question Status: Previous Edition

33) Moral hazard and adverse selection problems increased in prominence in the 1980s
A) as deregulation opened up more avenues for savings and loans and mutual savings banks to take on
more risk.
B) following a burst of financial innovation in the 1970s and early 1980s that produced new financial
instruments and markets, thereby widening the scope for risk taking.
C) following an increase in federal deposit insurance from $40,000 to $100,000.
D) because of all of the above.
E) because of only A and B of the above.
Answer: D
Question Status: Previous Edition

34) Moral hazard and adverse selection problems increased in prominence in the 1980s
A) as deregulation opened up more avenues for savings and loans and mutual savings banks to take on
more risk.
B) following a burst of financial innovation in the 1970s and early 1980s that produced new financial
instruments and markets, thereby widening the scope for risk taking.
C) following a decrease in federal deposit insurance from $100,000 to $40,000.
D) because of all of the above.
E) because of only A and B of the above.
Answer: E
Question Status: Previous Edition

35) The Federal Deposit Insurance Corporation Improvement Act of 1991


A) increased the FDIC's ability to borrow from the Treasury to deal with failed banks.
B) reduced the scope of deposit insurance in several ways.
C) eliminated governmentally administered deposit insurance.
D) did only A and B of the above.
Answer: D
Question Status: Previous Edition
36) The Federal Deposit Insurance Corporation Improvement Act of 1991
A) reduced the scope of deposit insurance in several ways.
B) eliminated restrictions on nationwide banking.
C) allowed well-capitalized banks to do some securities underwriting.
D) did only A and B of the above.
E) did only A and C of the above.
Answer: E
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

37) The Federal Deposit Insurance Corporation Improvement Act of 1991


A) reduced the scope of deposit insurance in several ways.
B) limited the FDIC's ability to use the "too-big-to-fail" policy.
C) requires the FDIC to intervene earlier when a bank gets into trouble.
D) did all of the above.
Answer: D
Question Status: Previous Edition
38) The Federal Deposit Insurance Corporation Improvement Act of 1991
A) instructed the FDIC to come up with risk-based deposit insurance premiums.
B) expanded the FDIC's ability to use the "too-big-to-fail" policy.
C) instructed the FDIC to wait longer before intervening when a bank gets into trouble.
D) did all of the above.
Answer: A
Question Status: Previous Edition
39) Which of the following is least likely to accompany financial consolidation and the development of
large, complex banking organizations?
A) More financial institutions will be considered too big to fail.
B) The government safety net will be extended to include nonbanking activities.
C) Moral hazard problems will become less important.
D) Banks will have greater incentives and opportunities to take on more risk.
Answer: C
Question Status: Previous Edition

40) What accounts for the problems facing China's four largest banks?
A) large loans to inefficient, state-owned enterprises
B) closing of unprofitable branches and laying off unproductive employees
C) selling shares in the bank overseas to raise capital
D) all of the above
Answer: A
Question Status: Previous Edition
41) World Bank research on the effects of deposit insurance concludes that
A) adoption of deposit insurance will promote stability and efficiency in the banking systems of
emerging-market economies.
B) adoption of explicit government deposit insurance is associated with a higher incidence of banking
crises.
C) adoption of deposit insurance has the greatest benefits in countries that have weaker institutional
environments.
D) none of the above are true.
Answer: B
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

42) Just prior to the 2007 financial crisis, mortgage loans known as NINJA loans were issued to
borrowers. What is a NINJA loan?
A) A loan issued by a Japanese bank, thus avoiding U.S. regulation.
B) A loan document originated by a mortgage banker named Bruce Lee.
C) A loan issued to borrowers with no income, employment, nor assets to speak of.
D) A loan issued with a "martial arts" clause.
Answer: C
Question Status: New Question

43) Which of the following categories is not part of the Dodd-Frank legislation of 2010?
A) capital requirements
B) consumer protection
C) "Volcker Rule"
D) derivatives
Answer: A
Question Status: New Question
44) In an effort to control the use of derivatives by financial institutions, the Dodd-Frank legislation of
2010 requires ________.
A) standardized derivatives products
B) over-the-counter trading (instead of exchange trading) of derivatives products
C) an increase in counterparty risk
D) all of the above
Answer: A
Question Status: New Question
45) An SIV, or structured investment vehicle, is an off-balance-sheet entity that shields a sponsoring
institution from risk. What happened to some of these SIVs when they ran into financial problems?
A) The SIV sued the sponsoring institution to pay, in full, all liabilities of the SIV.
B) The SIV still remained off-balance-sheet, but investors did sue sponsoring institutions.
C) Nothing! The SIV status as off-balance-sheet remained, a nice example of a financial structure that
worked during the financial crisis.
D) Troubled SIVs became an asset of the sponsoring institution -- the off-balance-sheet status was
meaningless.
Answer: D
Question Status: New Question

46) What role did the credit-rating agencies play leading up to the start of the financial crisis in 2007?
A) Inaccurate ratings provided by credit-rating agencies helped promote risk taking throughout the
financial system.
B) The credit-rating agencies were the first to see signs of trouble, and they developed more stringent
standards as the housing bubble evolved.
C) Solid ratings provided by credit-rating agencies helped limit risk taking throughout the financial
system.
D) The credit-rating agencies were largely uninvolved with the financial crisis.
Answer: A
Question Status: New Question

9
Copyright 2012 Pearson Education, Inc.

18.2 True/False
1) To understand banking regulation in the United States, it is helpful to understand the concepts of
asymmetric information, adverse selection, and moral hazard.
Answer: TRUE
Question Status: Previous Edition
2) Because asymmetric information problems in the banking industry are a fact of life throughout the
world, bank regulation in other countries is similar to that in the United States.
Answer: TRUE
Question Status: Previous Edition
3) The failure of one bank can hasten the failure of others in what is referred to as a contagion effect.
Answer: TRUE
Question Status: Previous Edition
4) To be classified as a well-capitalized bank, a bank's leverage ratio must exceed 8 percent.
Answer: FALSE
Question Status: Previous Edition
5) Once a bank has been chartered, it is required to file periodic call reports that reveal the bank's assets
and liabilities, income, ownership, and other details.
Answer: TRUE
Question Status: Previous Edition
6) "Truth in lending" was mandated under the Consumer Protection Act of 1969 and requires all lenders
to reveal the annual percentage rate, or APR, on loans.
Answer: TRUE
Question Status: Previous Edition
7) Probably the most important feature of FDICIA is its prompt corrective action provisions which
require the FDIC to intervene earlier and more vigorously when a bank gets into trouble.
Answer: TRUE
Question Status: Previous Edition
8) According to some economists, Congress made a mistake when it passed the FDICIA of not requiring
the FDIC to assess risk-based insurance premiums.
Answer: FALSE
Question Status: Previous Edition
9) The "too-big-to-fail" policy reduces the adverse selection problem in bank regulation.
Answer: FALSE
Question Status: Previous Edition
10) A better capitalized bank has more to lose when it fails and is less likely to take less risk.
Answer: TRUE
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

11) When the payoff method is used to resolve a failed bank, both large and small depositors are
protected from suffering losses.
Answer: FALSE
Question Status: Previous Edition
12) In the years just prior to the 2007-2009 financial crisis, mortgage loans were issued to borrowers
with no income or employment.
Answer: TRUE
Question Status: New Question
13) The Dodd-Frank legislation of 2010 finally resolved the status of GSEs such as Freddie Mac.
Answer: FALSE
Question Status: New Question
14) Prior to the 2007-2009 financial crisis, inaccurate ratings provided by credit rating agencies helped
promote risk taking throughout the financial system.
Answer: TRUE
Question Status: New Question
18.3 Essay
1) What do we learn about the causes of banking crises by comparing crises throughout the world to
those that have occurred in the United States?
Question Status: Previous Edition
2) What is the asymmetric information problem and how does it contribute to our understanding of the
structure of bank regulation in the United States and other countries?
Question Status: Previous Edition
3) Why did the United States experience a banking crisis in the 1980s?
Question Status: Previous Edition
4) How has bank regulation in the United States changed since the late 1980s? What accounts for these
changes?
Question Status: Previous Edition
5) How have bank capital requirements changed since the banking crisis of the 1980s? Explain.
Question Status: Previous Edition
6) Describe the CAMELS rating system used by bank examiners.
Question Status: Previous Edition
7) Why does the safety net created by deposit insurance increase the adverse selection and moral hazard
problems in banking? How do bank regulations attempt to overcome these problems?
Question Status: Previous Edition
8) Discuss some of the problems of Basel 2 that the 2007-2009 financial crisis revealed.
Question Status: New Question

11
Copyright 2012 Pearson Education, Inc.

9) Discuss the role of mark-to-market accounting during the 2007-2009 financial crisis. Did it help or
hurt credit markets and bank lending?
Question Status: New Question
10) Discuss the role of NINJA loans in the 2007-2009 financial crisis.
Question Status: New Question
11) Why is international financial regulation becoming more important in recent years?
Question Status: New Question
12) Describe 2 of the 5 different categories of regulation found in the Dodd-Frank legislation of 2010.
Question Status: New Question
13) How can we change the way the credit-rating system works to avoid the problems encountered with
ratings prior to the 2007-2009 financial crisis?
Question Status: New Question

12
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 19 Banking Industry: Structure and Competition
19.1 Multiple Choice
1) The modern commercial banking system began in America when the
A) Bank of the United States was chartered in New York in 1801.
B) Bank of North America was chartered in Philadelphia in 1782.
C) Bank of the United States was chartered in Philadelphia in 1801.
D) Bank of North America was chartered in New York in 1782.
Answer: B
Question Status: Previous Edition
2) A major controversy involving the U.S. banking industry in its early years was
A) whether banks should both accept deposits and make loans or whether these functions should be
separated into different institutions.
B) whether the federal government or the states should charter banks.
C) what percent of deposits banks should hold as fractional reserves.
D) whether banks should be allowed to issue their own bank notes.
Answer: B
Question Status: Previous Edition

3) The government institution that has responsibility for the amount of money and credit supplied in the
economy as a whole is the
A) central bank.
B) commercial bank.
C) bank of settlement.
D) Treasury Department.
Answer: A
Question Status: Previous Edition

4) Because of the abuses by state banks and the clear need for a central bank to help the federal
government raise funds during the War of 1812, Congress created the
A) First Bank of the United States in 1812.
B) Bank of North America in 1814.
C) Second Bank of the United States in 1816.
D) Federal Reserve System in 1813.
Answer: C
Question Status: Previous Edition

5) The Second Bank of the United States was denied a new charter by
A) President Andrew Jackson.
B) Vice President John Calhoun.
C) President Benjamin Harrison.
D) President John Q. Adams.
Answer: A
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) Before 1863,
A) federally chartered banks had regulatory advantages not granted to state-chartered banks.
B) the number of federally chartered banks grew at a much faster rate than at any other time since the
end of the Civil War.
C) banks acquired funds by issuing banknotes.
D) the Federal Reserve System regulated only federally chartered banks.
E) the Comptroller of the Currency regulated both state and federally chartered banks.
Answer: C
Question Status: Previous Edition

7) Before 1863,
A) the Federal Reserve System regulated only federally chartered banks.
B) the Comptroller of the Currency regulated both state and federally chartered banks.
C) the number of federally chartered banks grew at a much faster rate than at any other time since the
end of the Civil War.
D) none of the above occurred.
Answer: D
Question Status: Previous Edition

8) Although federal banking legislation in the 1860s attempted to eliminate state-chartered banks by
imposing a prohibitive tax on banknotes, these banks have been able to stay in business by
A) issuing credit cards.
B) ignoring the regulations.
C) issuing deposits.
D) branching into other states.
Answer: C
Question Status: Previous Edition

9) The belief that bank failures were regularly caused by fraud or the lack of sufficient bank capital
explains, in part, the passage of
A) the National Bank Charter Amendments of 1918.
B) the Glass-St. Germain Act of 1982.
C) the National Bank Act of 1863.
D) none of the above.
Answer: C
Question Status: Previous Edition
10) To eliminate the abuses of the state-chartered banks, the ________ created a new banking system of
federally chartered banks, supervised by the ________.
A) National Banking Act of 1863; Office of the Comptroller of the Currency
B) Federal Reserve Act of 1863; Office of the Comptroller of the Currency
C) National Banking Act of 1863; Office of Thrift Supervision
D) Federal Reserve Act of 1863; Office of Thrift Supervision
Answer: A
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

11) The National Banking Act of 1863, and subsequent amendments to it,
A) created a banking system of federally chartered banks.
B) established the Office of the Comptroller of the Currency.
C) broadened the regulatory powers of the Federal Reserve.
D) did all of the above.
E) did only A and B of the above.
Answer: E
Question Status: Previous Edition

12) The regulatory system that has evolved in the United States whereby banks are regulated at the state
level, the national level, or both, is known as a
A) bilateral regulatory system.
B) tiered regulatory system.
C) two-tiered regulatory system.
D) dual banking system.
Answer: D
Question Status: Previous Edition

13) Today the United States has a dual banking system in which banks supervised by the ________ and
by the ________ operate side by side.
A) federal government; municipalities
B) state governments; municipalities
C) federal government; states
D) municipalities; states
Answer: C
Question Status: Previous Edition

14) The Federal Reserve Act of 1913 required that


A) state banks be subject to the same regulations as national banks.
B) national banks establish branches in the cities containing Federal Reserve banks.
C) national banks join the Federal Reserve System.
D) all of the above be done.
Answer: C
Question Status: Previous Edition
15) The Federal Reserve Act required all ________ banks to become members of the Federal Reserve
System, while ________ banks could choose to become members of the system.
A) state; national
B) state; municipal
C) national; state
D) national; municipal
Answer: C
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

16) With the creation of the Federal Deposit Insurance Corporation, member banks of the Federal
Reserve System ________ to purchase FDIC insurance for their depositors, while nonmember
commercial banks ________ to buy deposit insurance.
A) could choose; were required
B) could choose; were given the option
C) were required, could choose
D) were required; were required
Answer: C
Question Status: Previous Edition

17) With the creation of the Federal Deposit Insurance Corporation,


A) member banks of the Federal Reserve System were given the option to purchase FDIC insurance for
their depositors, while nonmember commercial banks were required to buy deposit insurance.
B) member banks of the Federal Reserve System were required to purchase FDIC insurance for their
depositors, while nonmember commercial banks could choose to buy deposit insurance.
C) both member and nonmember banks of the Federal Reserve System were required to purchase FDIC
insurance for their depositors.
D) both member and nonmember banks of the Federal Reserve System could choose, but were not
required, to purchase FDIC insurance for their depositors.
Answer: B
Question Status: Previous Edition

18) Investment banking activities of the commercial banks were blamed for many bank failures. This led
to
A) the passage of the National Bank Charter Amendments Act of 1918.
B) the passage of the Garn-St. Germain Act of 1982.
C) the passage of the National Bank Act of 1863.
D) the passage of the Glass-Steagall Act of 1933.
E) the establishment of the Federal Deposit Insurance Corporation in 1933.
Answer: D
Question Status: Previous Edition
19) The Glass-Steagall Act prohibited commercial banks from
A) issuing equity to finance bank expansion.
B) engaging in underwriting of and dealing in corporate securities.
C) selling new issues of government securities.
D) purchasing any debt securities.
Answer: B
Question Status: Previous Edition
20) Which bank regulatory agency has the sole regulatory authority over bank holding companies?
A) the Federal Deposit Insurance Corporation
B) the Comptroller of the Currency
C) the Federal Bank Holding Company Agency
D) the Federal Reserve System
Answer: D
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

21) State banks that are not members of the Federal Reserve System are most likely to be examined by
the
A) Federal Reserve System.
B) Federal Deposit Insurance Corporation.
C) Federal Home Loan Bank System.
D) Comptroller of the Currency.
Answer: B
Question Status: Previous Edition

22) Which regulatory body charters national banks?


A) the Federal Reserve
B) the Federal Deposit Insurance Corporation
C) the Comptroller of the Currency
D) none of the above
Answer: C
Question Status: Previous Edition
23) Which of the following statements concerning bank regulation in the United States is true?
A) The Office of the Comptroller of the Currency has the primary responsibility for national banks.
B) The Federal Reserve and the state banking authorities jointly have responsibility for state banks that
are members of the Federal Reserve System.
C) The Fed has sole regulatory responsibility over bank holding companies.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: D
Question Status: Previous Edition
24) Which of the following statements concerning bank regulation in the United States are true?
A) The Office of the Comptroller of the Currency has the primary responsibility for state banks that are
members of the Federal Reserve System.
B) The Federal Reserve and the state banking authorities jointly have responsibility for state banks that
are members of the Federal Reserve System.
C) The Office of the Comptroller of the Currency has sole regulatory responsibility over bank holding
companies.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: B
Question Status: Previous Edition

25) Which of the following are important factors in determining the degree and timing of financial
innovation?
A) changes in technology
B) changes in financial market conditions
C) changes in regulation
D) all of the above
E) only A and B of the above
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

26) 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
Question Status: Previous Edition
27) Rising interest-rate risk ________ the ________ financial innovation.
A) increased; cost of
B) increased; demand for
C) reduced; cost of
D) reduced; demand for
Answer: B
Question Status: Previous Edition
28) Large fluctuations in interest rates lead to
A) substantial capital gains and losses to owners of securities.
B) greater uncertainty about returns on investments.
C) greater interest-rate risk.
D) all of the above.
Answer: D
Question Status: Previous Edition
29) In the 1950s, the interest rate on three-month Treasury bills fluctuated between 1.0% and 3.5%. In
the 1980s, the three-month Treasury bill rate ranged from 5% to over 15%. From this, one could predict
that in the 1980s interest-rate risk was ________ and the demand for financial innovation was
________.
A) greater; lower
B) greater; greater
C) lower; lower
D) lower; greater
Answer: B
Question Status: Previous Edition

30) The most significant change in the economic environment that changed the demand for financial
products since 1970 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
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

31) Adjustable-rate mortgages


A) protect households against higher mortgage payments when interest rates rise.
B) keep financial institutions' earnings high even when interest rates are falling.
C) have many attractive attributes, explaining why so few households now seek fixed-rate mortgages.
D) do only A and B of the above.
E) do none of the above.
Answer: E
Question Status: Previous Edition

32) Adjustable-rate mortgages


A) benefit homeowners when interest rates are falling.
B) reduce financial institutions' interest-rate risk.
C) reduce households' risk of having to pay higher mortgage payments when interest rates rise.
D) do only A and B of the above.
Answer: D
Question Status: Previous Edition
33) The most important source of the changes in supply conditions that stimulate financial innovation
has been the
A) aging of the baby-boomer generation.
B) dramatic increase in the volatility of interest rates.
C) improvement in information technology.
D) dramatic increase in competition from foreign banks.
E) deregulation of financial institutions.
Answer: C
Question Status: Previous Edition

34) Examples of financial services that became practical realities as the result of new computer
technology include
A) credit cards.
B) electronic banking facilities.
C) checking accounts.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

35) Credit cards date back to


A) prior to World War II.
B) just after World War II.
C) the early 1950s.
D) the late 1950s.
Answer: A
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

36) A firm issuing credit cards earns income from


A) loans it makes to credit card holders.
B) payments made to it by stores on credit card purchases.
C) payments made to it by manufacturers of the products sold in stores on credit card purchases.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

37) The entry of Sears, AT&T, and GM 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 Bank of America and Citicorp.
Answer: B
Question Status: Previous Edition
38) A smart card is a form of
A) stored-value card.
B) credit card.
C) debit card.
D) e-cash card.
Answer: A
Question Status: Previous Edition
39) Which of the following is not a financial innovation stimulated by information technology?
A) credit card
B) debit card
C) adjustable-rate mortgage
D) electronic banking
Answer: C
Question Status: Previous Edition
40) Which of the following is an example of a financial innovation introduced to avoid regulations?
A) securitization
B) junk bond
C) debit card
D) sweep account
Answer: D
Question Status: Previous Edition
41) "Stripping" a Treasury bond
A) means selling each of its future payments as a separate zero-coupon bond.
B) decreases the total present discounted value of future payments.
C) both A and B.
D) none of the above.
Answer: A
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

42) So-called fallen angels differ from junk bonds in that


A) junk bonds refer to previously issued bonds which have had their credit ratings fall below Baa.
B) fallen angels refer to newly issued bonds with low credit ratings.
C) junk bonds refer to newly issued bonds with low credit ratings.
D) they are both A and B of the above.
Answer: C
Question Status: Previous Edition
43) 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 issued bonds which have had their credit ratings fall below Baa.
B) junk bonds refer to previously issued bonds which 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
Question Status: Previous Edition

44) 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
Question Status: Previous Edition

45) In 1977, ________ 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 Boesky
D) Carl Ichan
Answer: A
Question Status: Previous Edition

46) The practice of creating marketable debt instruments that are backed by otherwise illiquid assets is
known as ________.
A) standardization
B) homogenization
C) securitization
D) adverse selection
Answer: C
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

47) 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
Question Status: Previous Edition
48) The bundling of mortgages into a saleable security (usually for large institutional investors) is called
________.
A) disintermediation
B) quasi-intermediation
C) futures bundling
D) hedge optioning
E) securitization
Answer: E
Question Status: Previous Edition

49) In the usual GNMA pass-through security, the ________ has direct ownership of a pro-rata share of
the portfolio of mortgage loans.
A) seller
B) buyer
C) financial institution issuing the mortgage loan
D) financial institution securitizing the mortgage loan
Answer: B
Question Status: Previous Edition

50) Bank managers look on reserve requirements as a


A) tax on deposits.
B) subsidy on deposits.
C) subsidy on loans.
D) tax on loans.
Answer: A
Question Status: Previous Edition
51) Checking accounts that earn interest (such as NOW accounts) were not available until ________.
A) 1962
B) 1972
C) 1982
D) 1992
Answer: B
Question Status: Previous Edition
52) Burdensome regulations, along with inflation and rising interest rates, help to explain
A) the rapid pace of financial innovations in banking in the 1960s and 1970s.
B) the low rate of bank failures in the 1980s.
C) both A and B of the above.
D) neither A nor B of the above.
Answer: A
Question Status: Previous Edition
10
Copyright 2012 Pearson Education, Inc.

53) The Federal Reserve's Regulation Q


A) set maximum interest rates banks could pay on deposits.
B) set minimum interest rates banks could pay on deposits.
C) set maximum interest rates banks could charge on loans.
D) discouraged disintermediation.
Answer: A
Question Status: Previous Edition
54) When disintermediation occurs, the banking system ________ deposits and bank lending ________.
A) gains; increases
B) gains; decreases
C) loses; increases
D) loses; decreases
Answer: D
Question Status: Previous Edition
55) Which of the following is not a reason for the disappointing revenue growth and profits of Internetonly banks?
A) high cost per transaction
B) security concerns
C) customer preferences
D) technical problems
Answer: A
Question Status: Previous Edition

56) It now appears that the predominant delivery system for banking services in the future will be
A) Internet-only banks.
B) traditional banks.
C) traditional banks supplemented with online services.
D) none of the above.
Answer: C
Question Status: Previous Edition
57) The growing use and proliferation of ATMs has been stimulated by
A) lower transaction costs.
B) greater customer convenience.
C) declining cost of the ATM equipment.
D) all of the above.
Answer: D
Question Status: Previous Edition
58) Since 1974, commercial banks' importance as a source of funds for borrowers has shrunk
dramatically, from around ________ percent of total credit advanced to near ________ percent by 2009.
A) 60; 30
B) 40; 25
C) 25; 20
D) 30; 15
Answer: B
Question Status: Updated from Previous Edition

11
Copyright 2012 Pearson Education, Inc.

59) Thrift institutions' importance as a source of funds for borrowers


A) has shrunk from around 40 percent of total credit advanced in the late 1970s to below 30 percent
today.
B) has shrunk from over 20 percent of total credit advanced in the late 1970s to below 10 percent today.
C) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above
25 percent today.
D) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to
above 30 percent today.
Answer: B
Question Status: Previous Edition

60) Since the late 1970s, thrift institutions' importance as a source of funds for borrowers has shrunk
markedly, from above ________ percent of total credit advanced to below ________ percent today.
A) 30; 20
B) 30; 15
C) 40; 5
D) 20; 10
Answer: D
Question Status: Previous Edition

61) Bank failures and mergers have caused the number of commercial banks in the U.S. to decline from
around ________ in the 1970s to below ________ today.
A) 25,000; 10,000
B) 15,000; 10,000
C) 25,000; 20,000
D) 15,000; 5,000
Answer: B
Question Status: Previous Edition
62) The traditional financial intermediation role of banking has been to make ________-term loans and
to fund them with ________-term deposits.
A) short; long
B) long; short
C) short; short
D) long; long
Answer: B
Question Status: Previous Edition

63) The process in which people seeking higher interest rates take their money out of financial
institutions is called ________.
A) capital mobility
B) loophole mining
C) disintermediation
D) deposit jumping
Answer: C
Question Status: Previous Edition

12
Copyright 2012 Pearson Education, Inc.

64) One factor contributing to the decline in cost advantages that banks once had is the decline in the
importance of checkable deposits from over ________ percent of banks' source of funds to ________
percent today.
A) 70; 30
B) 60; 5
C) 50; 20
D) 40; 15
Answer: B
Question Status: Updated from Previous Edition

65) The most important developments that have reduced banks' cost advantages in the past twenty years
include
A) the elimination of Regulation Q ceilings.
B) the competition from money market mutual funds.
C) the growth of securitization.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition
66) The most important developments that have reduced banks' cost advantages in the past twent y years
include
A) the growth of the junk bond market.
B) the competition from money market mutual funds.
C) the growth of securitization.
D) all of the above.
E) only A and B of the above.
Answer: B
Question Status: Previous Edition

67) The most important developments that have reduced banks' income advantages in the past twenty
years include
A) the growth of the commercial paper market.
B) the growth of the junk bond market.
C) the growth of securitization.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

68) The most important developments that have reduced banks' income advantages in the past twenty
years include
A) the growth of the commercial paper market.
B) the growth of the junk bond market.
C) the elimination of Regulation Q ceilings.
D) all of the above.
E) only A and B of the above.
Answer: E
Question Status: Previous Edition

13
Copyright 2012 Pearson Education, Inc.

69) One factor contributing to the decline in income advantages that banks once had is the increased
competition from the commercial paper market, which has grown in size to over ________ percent of
commercial and industrial bank loans today.
A) 20
B) 30
C) 40
D) 50
Answer: B
Question Status: Updated from Previous Edition
70) Rising market interest rates in the 1960s and the 1970s, combined with regulated deposit rate
ceilings,
A) worked in the short-run to give mortgage-issuing institutions a source of low-cost funds.
B) led eventually to an outflow of deposits from depository institutions.
C) led to financial innovations that worked to avoid these regulations.
D) did all of the above.
E) did only A and C of the above.
Answer: D
Question Status: Previous Edition

71) The presence of so many commercial banks in the United States is most likely the result of
A) consumers' strong preference for dealing with only local banks.
B) adverse selection and moral hazard problems that give local banks a competitive advantage over
larger banks.
C) regulations that restrict the ability of banks to open branches.
D) all of the above.
Answer: C
Question Status: Previous Edition

72) The McFadden Act of 1927


A) effectively prohibited banks from branching across state lines.
B) required that banks maintain bank capital equal to at least 6 percent of their assets.
C) effectively required that banks maintain a correspondent relationship with large money center banks.
D) did all of the above.
Answer: A
Question Status: Previous Edition
73) The legislation that effectively prohibited banks from branching across state lines and forced all
national banks to conform to the branching regulations of the state in which they reside is the
A) McFadden Act.
B) National Banking Act.
C) Glass-Steagall Act.
D) Garn-St. Germain Act.
Answer: A
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

74) Which of the following is an advantage of forming a bank holding company?


A) It allows ownership of several banks where branching is prohibited.
B) It allows owners to engage in activities related to banking that are prohibited to banks.
C) Both A and B of the above.
D) None of the above.
Answer: C
Question Status: Previous Edition
75) Which of the following are true statements concerning bank holding companies?
A) Bank holding companies own almost all large banks.
B) Bank holding companies have experienced dramatic growth in the past twenty-five years.
C) Through a loophole in the McFadden Act, bank holding companies have successfully evaded
interstate branching restrictions.
D) All of the above are true.
E) Only A and B of the above are true.
Answer: E
Question Status: Previous Edition

76) As a result of shared electronic banking facilities,


A) barriers to branching have become less burdensome.
B) banking has become less competitive.
C) both of the above have occurred.
D) neither of the above has occurred.
Answer: A
Question Status: Previous Edition
77) The McFadden Act's prohibition against interstate branching
A) was weakened by the introduction of shared electronic banking facilities that provide banking
services nationwide.
B) was weakened by regional compacts that allowed banks to own banks in other states in their region.
C) impeded banks' ability to diversify their loans and take advantage of economies of scale.
D) did all of the above.
Answer: D
Question Status: Previous Edition

78) A bank with a large credit-card customer base can market other financial products to these
customers at a low cost. This is an example of
A) economies of scale.
B) economies of scope.
C) becoming a superregional bank.
D) none of the above.
Answer: B
Question Status: Previous Edition

15
Copyright 2012 Pearson Education, Inc.

79) As a result of restrictive banking regulations, the United States


A) has too few banks when compared to other industrialized countries.
B) has banks that are quite large relative to those in other countries.
C) has too many banks when compared to other industrialized countries.
D) has both A and B of the above.
Answer: C
Question Status: Previous Edition
80) Which of the following is not expected to result from bank consolidation in the U.S.?
A) The disappearance of small community banks.
B) The acceleration of the decline in the number of banks.
C) Banks will be more efficient.
D) Banks will be less likely to fail.
Answer: A
Question Status: Previous Edition
81) The legislation that separated investment banking from commercial banking was the
A) National Bank Act.
B) Federal Reserve Act.
C) Glass-Steagall Act.
D) McFadden Act.
Answer: C
Question Status: Previous Edition
82) The prohibition against banks underwriting corporate securities and engaging in brokerage, real
estate, and insurance activities was repealed by the
A) Gramm-Leach-Bliley Financial Services Modernization Act.
B) Competitive Equality in Banking Act.
C) Depositary Institution Deregulation and Monetary Control Act.
D) Glass-Steagall Act.
Answer: A
Question Status: Previous Edition

83) The Riegle-Neal Act of 1994


A) required all banks to become universal banks.
B) removed ceilings on bank deposit interest rates.
C) allowed banks to underwrite insurance and securities and engage in real estate activities.
D) overturned prohibitions on interstate banking and branching.
Answer: D
Question Status: Previous Edition
84) In recent years, commercial banks have been allowed to
A) invest in real estate.
B) enter certain insurance markets.
C) underwrite stocks.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

16
Copyright 2012 Pearson Education, Inc.

85) 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) British-style universal
C) barrier-free
D) seamless
Answer: A
Question Status: Previous Edition

86) In a ________ banking system, commercial banks engage in securities underwriting, but separate
subsidiaries conduct the different activities. Also, banking and insurance are not typically undertaken
together in this system.
A) universal
B) British-style universal
C) divided
D) compartmentalized
E) severable
Answer: B
Question Status: Previous Edition

87) A major difference between the United States and Japanese banking systems is that
A) American 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 American
banks cannot.
C) bank holding companies are illegal in the United States.
D) both A and C of the above
E) both B and C of the above
Answer: B
Question Status: Previous Edition

88) Major differences between the United States and Japanese banking systems include:
A) American 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 American
banks cannot.
C) bank holding companies are illegal in Japan.
D) both A and C of the above.
E) both B and C of the above.
Answer: E
Question Status: Previous Edition

89) Which of the following is a reason for the rapid expansion of international banking?
A) the rapid growth in international trade
B) the growth of multinational corporations
C) the desire of U.S. banks to expand
D) all of the above
Answer: D
Question Status: Previous Edition

17
Copyright 2012 Pearson Education, Inc.

90) Since the passage of the International Banking Act of 1978, the competitive advantage enjoyed by
foreign banks has been ________.
A) reduced
B) mildly expanded
C) completely eliminated
D) greatly expanded
Answer: A
Question Status: Previous Edition

91) A special subsidiary of a U.S. bank that is engaged in international banking is called
A) an international banking facility.
B) an agency office.
C) an Edge Act corporation.
D) a foreign bank subsidiary.
Answer: C
Question Status: Previous Edition
92) U.S. banks have most of their foreign branches in
A) Latin America, the Far East, the Caribbean, and London.
B) Latin America, the Middle East, the Caribbean, and London.
C) Mexico, the Middle East, the Caribbean, and London.
D) South America, the Middle East, the Caribbean, and Canada.
Answer: A
Question Status: Previous Edition
93) Eurodollars are
A) dollar-denominated 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-denominated deposits held in U.S. banks by Europeans.
Answer: A
Question Status: Previous Edition
94) Deposits in European banks denominated in dollars for the purpose of international transactions are
known as ________.
A) Eurodollars
B) European Currency Units
C) euros
D) International Monetary Units
Answer: A
Question Status: Previous Edition

95) The main center of the Eurodollar market is ________.


A) London
B) Basel
C) Paris
D) New York
Answer: A
Question Status: Previous Edition

18
Copyright 2012 Pearson Education, Inc.

96) In 1975, financial institutions developed financial derivatives that included ________.
A) adjustable-rate mortgages
B) futures contracts
C) financial engineering
D) virtual banks
Answer: B
Question Status: Previous Edition
97) An electronic machine that allows customers to make deposits, get cash, transfer funds from one
account to another, and check balances is
A) an automated banking machine.
B) the virtual bank.
C) an automated teller machine.
D) a smart card.
Answer: C
Question Status: Previous Edition

98) A form of electronic money used on the Internet to pay for goods and services is
A) e-money.
B) e-cash.
C) a smart card.
D) a virtual bank.
Answer: B
Question Status: Previous Edition
99) A financial innovation that enables banks to avoid the "tax" from reserve requirements by taking any
balances above a certain amount in a corporation's checking account at the end of the business day and
investing them in overnight securities that pay interest is called a ________.
A) money market mutual fund
B) deposit rate ceiling
C) sweep account
D) disintermediation
Answer: C
Question Status: Previous Edition

100) There are approximately how many commerical banks in the United States currently?
A) 5,000
B) 7,500
C) 1,000
D) 1,250
Answer: B
Question Status: Previous Edition

19
Copyright 2012 Pearson Education, Inc.

101) Regulations restricting branching have promoted the development of what two financial
innovations?
A) bank consolidation and nationwide banking
B) bank holding companies and automated teller machines
C) money market mutual funds and sweep accounts
D) reserve requirements and restrictions on interest paid on deposits
Answer: B
Question Status: Previous Edition

102) In September of 2008, the money market mutual fund Reserve Primary Fund had a price of less
than $1.00 for a dollar invested. How did this happen?
A) The fund invested in debt of Lehman Brothers, which was worthless when Lehman went broke.
B) The fund invested in high-yield junk bonds, which defaulted.
C) The fund invested in Treasuries, which yielded less than 0% returns.
D) This actually didn't happen. It cannot happen since the fund only invested in low-risk debt.
Answer: A
Question Status: New Question

103) What is the key difference between an S&L and a mutual savings bank?
A) Mutual savings banks are jointly owned by depositors, whereas S&Ls aren't.
B) The FDIC insures an S&L's deposits, but not those of mutual savings banks.
C) Both A and B are correct.
D) Neither A nor B is correct.
Answer: A
Question Status: New Question
104) Because their members share a common bond, credit unions are typically quite small; most hold
less than ________ of assets.
A) $500,000
B) $10 million
C) $100 million
D) $1 billion
Answer: B
Question Status: New Question

19.2 True/False
1) Today, the United States has a dual banking system in which banks supervised by the federal
government and banks supervised by the states operate side by side.
Answer: TRUE
Question Status: Previous Edition
2) Bank holding companies are regulated by the FDIC.
Answer: FALSE
Question Status: Previous Edition
3) The existence of large numbers of banks in the United States indicates the presence of vigorous
competition.
Answer: FALSE
Question Status: Previous Edition
20
Copyright 2012 Pearson Education, Inc.

4) Even when an ATM is owned by a bank, states typically have special provisions that allow wider
establishment of ATMs than is permissible for traditional "brick and mortar" branches.
Answer: TRUE
Question Status: Previous Edition
5) Bank holding companies that have begun to rival the money center banks in size but whose
headquarters are not based in one of the money center cities are called superregional banks.
Answer: TRUE
Question Status: Previous Edition
6) The future structure of the U.S. banking industry is likely to be characterized by many more smaller
banks, as customers demand neighborhood banks operated by people they know personally.
Answer: FALSE
Question Status: Previous Edition
7) Restrictions on commercial banks' securities and insurance activities put American banks at a
competitive disadvantage relative to foreign banks.
Answer: TRUE
Question Status: Previous Edition
8) Eurodollars are created when deposits in accounts in the United States are transferred to a bank
outside the country and are kept in the form of dollars.
Answer: TRUE
Question Status: Previous Edition
9) Financial innovation has widened the cost advantages that banks have in acquiring funds, helping to
explain why bank profitability has soared in recent years.
Answer: FALSE
Question Status: Previous Edition
10) Americans are the biggest users of checks in the world but nonetheless are ahead of Europeans in the
proportion of noncash payments that are made by electronic means.
Answer: FALSE
Question Status: Previous Edition
11) Securitization is the process of transforming illiquid financial assets such as residential mortgages
into marketable securities.
Answer: TRUE
Question Status: Previous Edition
12) Disintermediation occurs when funds are deposited into banks and lent to borrowers.
Answer: FALSE
Question Status: Previous Edition
13) The principle underlying Treasury strips is that an investor will earn a higher interest rate when
reinvestment risk is eliminated.
Answer: TRUE
Question Status: Previous Edition

21
Copyright 2012 Pearson Education, Inc.

14) Economies of scope come from increasing the size of a given financial activity and economies of
scale come from combining different activities to lower their costs.
Answer: FALSE
Question Status: Previous Edition
15) Checkable deposits, a traditional source of low-cost funds for banks, have declined dramatically in
importance, falling from over 60 percent of bank liabilities to less than 10 percent today.
Answer: TRUE
Question Status: Previous Edition
16) A change in the financial environment will stimulate a search by financial institutions for
innovations that are likely to be profitable.
Answer: TRUE
Question Status: Previous Edition
17) Reserve requirements that force banks to keep a certain fraction of their deposits as reserves and
restrictions on the interest rates that can be paid on deposits have been the major forces behind financial
innovation.
Answer: TRUE
Question Status: Previous Edition
18) An alternative corporate structure for U.S. banks that operate overseas is the Edge Act corporation, a
special subsidiary engaged primarily in international banking.
Answer: TRUE
Question Status: Previous Edition
19) Unlike commercial banks, S&Ls can only be chartered by the federal government.
Answer: FALSE
Question Status: New Question
19.3 Essay
1) What financial innovations are best explained as attempts to avoid regulations?
Question Status: Previous Edition
2) What new forms of banking have been spawned by the advances in information technology of the
past two decades? Is it likely that traditional banks will disappear as a result of these innovations? Why?
Question Status: Previous Edition
3) What new forms of making payments have been spawned by the advances in information technology
of the past two decades? Is it likely that ours will become a cashless society anytime soon as a result of
these innovations? Why?
Question Status: Previous Edition
4) What are Treasury strips? What roles have reinvestment risk and information technology played in
the development of this financial product?
Question Status: Previous Edition

22
Copyright 2012 Pearson Education, Inc.

5) What are the reasons for the decline of traditional banking?


Question Status: Previous Edition
6) Is the large number of banking firms in the United States an indication of a competitive banking
industry? Explain why or why not.
Question Status: Previous Edition
7) Are bank consolidations and nationwide banking good things? Why?
Question Status: Previous Edition
8) When and why was the Glass-Steagall Act passed? When and why was it repealed?
Question Status: Previous Edition
9) Describe Edge Act corporations, international banking facilities, and the structure of foreign banks in
the United States.
Question Status: Previous Edition
10) Explain the innovations that have been created to lower interest-rate risk.
Question Status: Previous Edition
11) Explain what happened to the large, free-standing investment banks as a result of the 2007-2009
financial crisis.
Question Status: New Question

23
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 23 Risk Management in Financial Institutions
23.1 Multiple Choice
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
Question Status: Previous Edition

2) If borrowers with the most risky investment projects are more likely to seek bank loans than
borrowers with the safest investment projects, banks face the problem of ________.
A) adverse credit risk
B) adverse selection
C) moral hazard
D) conflict of interest
Answer: B
Question Status: Previous Edition

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
Question Status: Previous Edition

4) Banks' attempts to solve adverse selection and moral hazard problems help explain loan management
principles such as
A) screening and monitoring of loan applicants.
B) collateral and compensating balances.
C) credit rationing.
D) all of the above.
E) only A and B of the above.
Answer: D
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

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
Question Status: Previous Edition

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
Question Status: Previous Edition

7) Provisions in loan contracts that proscribe borrowers from engaging in specified risky activities are
called ________.
A) proscription bonds
B) collateral clauses
C) restrictive covenants
D) liens
Answer: C
Question Status: Previous Edition

8) Banks attempt to screen good credit risks from bad to reduce the incidence of loan defaults. To do
this, banks
A) specialize in lending to certain industries or regions.
B) write restrictive covenants into loan contracts.
C) expend resources to acquire accurate credit histories of their potential loan customers.
D) do all of the above.
Answer: D
Question Status: Previous Edition

9) A bank's commitment (for a specified future period of time) to provide a firm with loans up to a given
amount at an interest rate that is tied to a market interest rate is called
A) credit rationing.
B) a line of credit.
C) continuous dealings.
D) none of the above.
Answer: B
Question Status: Previous Edition

2
Copyright 2012 Pearson Education, Inc.

10) Lines of credit and long-term relationships between banks and their customers
A) reduce the costs of information collection.
B) make it easier for banks to screen good risks from bad.
C) enable banks to deal with moral hazard contingencies that are neither anticipated nor specified in
restrictive covenants.
D) do all of the above.
E) do only A and B of the above.
Answer: D
Question Status: Previous Edition

11) Compensating balances


A) are a particular form of collateral commonly required on commercial loans.
B) are a required minimum amount of funds that a borrower (i.e., a firm receiving a loan) must keep in a
checking account at the bank.
C) allow banks to monitor firms' check payment practices, which can yield information about their
borrowers' financial conditions.
D) are all of the above.
Answer: D
Question Status: Previous Edition

12) A bank that wants to monitor the check payment practices of its commercial borrowers, so that
moral hazard can be prevented, will require borrowers to
A) place a bank officer on their board of directors.
B) place a corporate officer on the bank's board of directors.
C) keep compensating balances in a checking account at the bank.
D) do all of the above.
E) do only A and B of the above.
Answer: C
Question Status: Previous Edition

13) Of the following methods that banks might use to reduce moral hazard problems, the one not legally
permitted in the United States is the requirement that
A) firms keep compensating balances at the banks from which they obtain their loans.
B) firms place on their board of directors an officer from the bank.
C) loan contracts include restrictive covenants.
D) individuals provide detailed credit histories to bank loan officers.
Answer: B
Question Status: Previous Edition
14) When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate
or even a higher rate, it is said to engage in ________.
A) constrained lending
B) strategic refusal
C) credit rationing
D) collusive behavior
Answer: C
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

15) When a lender refuses to make a loan, even though borrowers are willing to pay the stated interest
rate or even a higher rate, it is said to engage in ________.
A) specialized lending
B) strategic refusal
C) diversified lending
D) coercive behavior
E) none of the above
Answer: E
Question Status: Previous Edition

16) Credit rationing occurs when a bank


A) refuses to make a loan of any amount to a borrower, even when she is willing to pay a higher interest
rate.
B) restricts the amount of a loan to less than the borrower would like.
C) does either A or B of the above.
D) does neither A nor B of the above.
Answer: C
Question Status: Previous Edition

17) Because larger loans create greater incentives for borrowers to engage in undesirable activities that
make it less likely they will repay the loans, banks
A) ration credit, granting borrowers smaller loans than they have requested.
B) ration credit, charging higher interest rates to borrowers who want large loans than to those who want
small loans.
C) ration credit, charging higher fees as a percentage of the loan to borrowers who want large loans than
to those who want small loans.
D) do none of the above.
Answer: A
Question Status: Previous Edition

18) When banks offer borrowers smaller loans than they have requested, banks are said to ________.
A) shave credit
B) discount the loan
C) raze credit
D) ration credit
Answer: D
Question Status: Previous Edition
19) Which of the following are not generally rate-sensitive assets?
A) securities with a maturity of less than one year
B) variable-rate mortgages
C) fixed-rate mortgages
D) all of the above are rate-sensitive assets
E) none of the above are rate-sensitive assets
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

20) Liabilities that are partially, but not fully, rate-sensitive include ________.
A) checkable deposits
B) federal funds
C) non-negotiable CDs
D) fixed-rate mortgages
E) money market deposit accounts
Answer: A
Question Status: Previous Edition

21) If a bank has more rate-sensitive liabilities than rate-sensitive assets, then a(n) ________ in interest
rates will ________ bank profits.
A) increase; increase
B) increase; reduce
C) decline; reduce
D) decline; not affect
Answer: B
Question Status: Previous Edition

22) If a bank has more rate-sensitive assets than rate-sensitive liabilities, then a(n) ________ in interest
rates will ________ bank profits.
A) increase; increase
B) increase; reduce
C) decline; increase
D) decline; not affect
Answer: A
Question Status: Previous Edition
23) If a bank has ________ rate-sensitive assets than rate-sensitive liabilities, then a(n) ________ in
interest rates will increase bank profits.
A) more; decline
B) more; increase
C) less; increase
D) both A and C
Answer: B
Question Status: Previous Edition

24) The difference between rate-sensitive liabilities and rate-sensitive assets is known as the ________.
A) duration
B) interest-sensitivity index
C) interest-rate risk index
D) gap
Answer: D
Question Status: Previous Edition

5
Copyright 2012 Pearson Education, Inc.

First National Bank

Table 23.1
25) Referring to Table 23.1, First National Bank has a gap of ________.
A) -30
B) +30
C) 60
D) 0
Answer: A
Question Status: Updated from Previous Edition
26) Referring to Table 23.1, if interest rates rise by 5 percentage points, then 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: Updated from Previous Edition
27) Refer to Table 23.1. Assuming that the average duration of its assets is five years, while the average
duration of its liabilities is three years, a rise in interest rates from 5% to 10% will cause the net worth of
First National to ________ by ________ of the total original asset value.
A) increase; 11%
B) decline; 11%
C) increase; 10%
D) decline; 5%
Answer: B
Question Status: Updated from Previous Edition

First National Bank

Table 23.2
28) Referring to Table 23.2, First National Bank has a gap of ________.
A) -10
B) 10
C) 20
D) 0
Answer: A
Question Status: Updated from Previous Edition
6
Copyright 2012 Pearson Education, Inc.

29) Referring to Table 23.2, if interest rates rise by 5 percentage points, then 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 $2.0 million.
Answer: A
Question Status: Updated from Previous Edition

30) Refer to Table 23.2. Assuming that the average duration of the bank's assets is four years, while the
average duration of its liabilities is three years, a rise in interest rates from 5 percent to 10 percent will
cause the net worth of First National to ________ by ________ of the total original asset value.
A) decline; 5%
B) decline; 1.3%
C) decline; 6.2%
D) increase; 5%
Answer: C
Question Status: Updated from Previous Edition
31) If First State Bank has a gap equal to a positive $20 million, then a 5 percentage point drop in
interest rates will cause profits to
A) increase by $10 million.
B) increase by $1.0 million.
C) decline by $10 million.
D) decline by $1.0 million.
Answer: D
Question Status: Previous Edition

32) If 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
Question Status: Previous Edition

33) 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
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

34) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for
several maturity subintervals by the change in the interest rate is called
A) basic gap analysis.
B) the segmented maturity approach to gap analysis.
C) the maturity bucket approach to gap analysis.
D) the segmented maturity approach to interest-exposure analysis.
E) none of the above.
Answer: C
Question Status: Previous Edition
35) Duration gap analysis
A) is a refinement of basic gap analysis that accounts for interest-rate changes over a multiyear period.
B) is a refinement of basic gap analysis that accounts for how long a gap will last.
C) is a complement to basic gap analysis that accounts for the effect of interest rate changes on market
value.
D) is a complement to basic gap analysis that accounts for the influence of partially rate-sensitive assets.
Answer: C
Question Status: Previous Edition

36) Duration analysis involves comparing the average duration of the bank's ________ to the average
duration of its ________.
A) securities portfolio; nondeposit liabilities
B) loan portfolio; nondeposit liabilities
C) loan portfolio; rate-sensitive liabilities
D) rate-sensitive assets; rate-sensitive liabilities
E) assets; liabilities
Answer: E
Question Status: Previous Edition

37) To use the concept of duration to analyze the effect of changes in interest rates on the market value
of an asset, a bank manager would multiply
A) the negative of the duration of the asset by the change in the interest rate, i.
B) the negative of the duration of the asset by i /(1 + i).
C) the duration of the asset by the change in the interest rate, i.
D) the duration of the asset by i /(1 + i).
Answer: B
Question Status: Previous Edition

38) If a bank has a duration gap of 2 years, then a rise in interest rates from 6 percent to 9 percent will
lead to
A) a rise in the market value of its net worth of 5.66 percent.
B) a rise in net interest income of 5.66 percent.
C) a fall in the market value of its net worth of 5.66 percent.
D) a fall in net interest income of 5.66 percent.
E) an unknown change.
Answer: C
Question Status: Previous Edition

8
Copyright 2012 Pearson Education, Inc.

39) If a bank has a duration gap of 2 years, then a fall in interest rates from 6 percent to 3 percent will
lead to
A) a rise in the market value of its net worth of 5.66 percent.
B) a fall in the market value of its net worth of 5.66 percent.
C) a rise in net interest income of 5.66 percent.
D) a fall in net interest income of 5.66 percent.
E) an unknown change.
Answer: A
Question Status: Previous Edition

40) If a decline in interest rates causes the market value of a bank's net worth to rise, then the bank must
have a ________.
A) negative duration gap
B) positive duration gap
C) negative gap
D) positive gap
Answer: B
Question Status: Previous Edition

41) If a rise in interest rates causes the market value of a bank's net worth to rise, then the bank must
have a ________.
A) negative duration gap
B) positive duration gap
C) negative gap
D) positive gap
Answer: A
Question Status: Previous Edition

42) One problem with duration gap analysis is that it


A) is calculated assuming that the yield curve is flat.
B) is calculated assuming that the yield curve does not change.
C) does not measure the sensitivity of net worth to interest rate changes.
D) does not measure the sensitivity of income to interest rate changes.
E) applies only to financial institutions.
Answer: A
Question Status: Previous Edition

43) One problem with basic gap analysis is that it


A) is calculated assuming interest rates on all maturities are equal.
B) is calculated assuming interest rates on all maturities change by equal amounts.
C) measures the sensitivity of net worth to interest rate changes.
D) does not measure the sensitivity of income to interest rate changes.
E) applies only to financial institutions.
Answer: B
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

44) A bank manager concerned about interest income who expects interest rates to rise and who knows
the bank currently has a positive gap should ________ rate-sensitive assets and ________ rate-sensitive
liabilities.
A) increase; increase
B) decrease; increase
C) decrease; decrease
D) increase; decrease
Answer: D
Question Status: Previous Edition

45) A bank manager concerned about interest income who expects interest rates to fall and who knows
the bank currently has a positive gap should ________ rate-sensitive assets and ________ rate-sensitive
liabilities.
A) increase; increase
B) decrease; increase
C) decrease; decrease
D) increase; decrease
Answer: B
Question Status: Previous Edition

23.2 True/False
1) If a bank has more rate-sensitive liabilities than assets, then an increase in interest rates will reduce
bank profits.
Answer: TRUE
Question Status: Previous Edition
2) The difference between rate-sensitive liabilities and rate-sensitive assets is known as the duration gap.
Answer: FALSE
Question Status: Previous Edition
3) If a bank has a negative gap, then a decrease in interest rates will increase income.
Answer: TRUE
Question Status: Previous Edition
4) Banks face the problem of adverse selection in loan markets because bad credit risks are the ones
most likely to seek bank loans.
Answer: TRUE
Question Status: Previous Edition
5) Credit rationing reduces adverse selection problems.
Answer: TRUE
Question Status: Previous Edition
6) Credit rationing occurs when lenders charge higher interest rates on the loans they make to riskier
borrowers.
Answer: FALSE
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

7) Developing and maintaining long-term customer relationships help to reduce banks' costs of
screening and monitoring borrowers.
Answer: TRUE
Question Status: Previous Edition
8) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for
several maturity subintervals by the change in the interest rate is called duration analysis.
Answer: FALSE
Question Status: Previous Edition
9) If interest rates rise by 5 percentage points, then bank profits (measured using gap analysis) will
increase regardless of the income gap.
Answer: FALSE
Question Status: Previous Edition
23.3 Essay
1) What is the difference between credit risk and interest-rate risk?
Question Status: Previous Edition
2) How is credit risk related to the concepts of adverse selection and moral hazard?
Question Status: Previous Edition
3) What steps do banks take to reduce their exposure to credit risk?
Question Status: Previous Edition
4) How do the concepts of adverse selection and moral hazard explain the credit risk management
principles that banks adopt?
Question Status: Previous Edition
5) What is gap analysis and why is it important to a bank?
Question Status: Previous Edition
6) What is duration gap analysis and why is it important to a bank?
Question Status: Previous Edition
7) Explain how banks benefit from long-term customer relationships.
Question Status: Previous Edition
8) Explain how banks benefit from specialization in lending.
Question Status: Previous Edition
9) What special assumptions do income and duration gap analyses make about interest rate changes and
the yield curve?
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

Financial Markets and Institutions, 7e (Mishkin)


Chapter 24 Hedging with Financial Derivatives
24.1 Multiple Choice
1) Financial derivatives include ________.
A) stocks
B) bonds
C) futures
D) none of the above
Answer: C
Question Status: Previous Edition
2) Financial derivatives include ________.
A) stocks
B) bonds
C) forward contracts
D) both A and B
Answer: C
Question Status: Previous Edition
3) Which of the following is not a financial derivative?
A) stocks
B) futures
C) options
D) forward contracts
Answer: A
Question Status: Previous Edition
4) A contract that requires the investor to buy securities on a future date is called a ________.
A) short contract
B) long contract
C) hedge
D) cross
Answer: B
Question Status: Previous Edition
5) A contract that requires the investor to sell securities on a future date is called a ________.
A) short contract
B) long contract
C) hedge
D) micro hedge
Answer: A
Question Status: Previous Edition

1
Copyright 2012 Pearson Education, Inc.

6) A long contract 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
Question Status: Previous Edition
7) A short contract 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
Question Status: Previous Edition
8) Which is not a problem of forward contracts?
A) a lack of liquidity
B) a lack of flexibility
C) the difficulty of finding a counterparty
D) default risk
Answer: B
Question Status: Previous Edition
9) By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver ________
face value securities for ________.
A) $100,000; $115,000
B) $115,000; $110,000
C) $100,000; $100,000
D) $115,000; $115,000
Answer: A
Question Status: Previous Edition

10) By selling short a futures contract of $100,000 at a price of 96, you are agreeing to deliver ________
face value securities for ________.
A) $100,000; $104,167
B) $96,000; $100,000
C) $100,000; $96,000
D) $100,000; $100,000
Answer: C
Question Status: Previous Edition
11) By buying a long $100,000 futures contract for 115, you agree to pay ________ for ________ face
value securities.
A) $100,000; $115,000
B) $115,000; $100,000
C) $86,956; $100,000
D) $86,956; $115,000
Answer: B
Question Status: Previous Edition
2
Copyright 2012 Pearson Education, Inc.

12) If you sell a short contract on financial futures, you hope interest rates will ________.
A) rise
B) fall
C) not change
D) fluctuate
Answer: A
Question Status: Previous Edition
13) If you buy a long contract on financial futures, you hope interest rates will ________.
A) rise
B) fall
C) not change
D) fluctuate
Answer: B
Question Status: Previous Edition
14) If you sell a short futures contract, you hope that bond prices will ________.
A) rise
B) fall
C) not change
D) fluctuate
Answer: B
Question Status: Previous Edition
15) The elimination of riskless profit opportunities in the futures market is referred to as ________.
A) speculation
B) hedging
C) arbitrage
D) open interest
E) mark to market
Answer: C
Question Status: Previous Edition
16) Futures contracts are regularly traded on the
A) Chicago Board of Trade.
B) New York Stock Exchange.
C) American Stock Exchange.
D) Chicago Board Options Exchange.
Answer: A
Question Status: Previous Edition
17) Financial futures are regularly traded on all of the following except the
A) Chicago Board of Trade.
B) Chicago Mercantile Exchange.
C) New York Futures Exchange.
D) Chicago Commodity Markets Board.
Answer: D
Question Status: Previous Edition

3
Copyright 2012 Pearson Education, Inc.

18) The agency responsible for regulation of the futures exchanges and trading in financial futures is the
A) Commodity Futures Trading Commission.
B) Securities and Exchange Commission.
C) Federal Trade Commission.
D) Futures Exchange Commission.
Answer: A
Question Status: Previous Edition
19) The purpose of the Commodity Futures Trading Commission is to do all of the following except
A) oversee futures trading.
B) see that prices are not manipulated.
C) approve proposed futures contracts.
D) establish minimum prices for futures contracts.
Answer: D
Question Status: Previous Edition
20) 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
Question Status: Previous Edition
21) The futures markets have grown rapidly in recent years because
A) interest rate volatility has increased.
B) financial managers are more risk averse.
C) of both A and B.
D) of neither A nor B.
Answer: C
Question Status: Previous Edition
22) The advantage of forward contracts over futures contracts is that forward contracts
A) are standardized.
B) have lower default risk.
C) are more liquid.
D) are none of the above.
Answer: D
Question Status: Previous Edition
23) 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) both A and B are true.
Answer: C
Question Status: Previous Edition

4
Copyright 2012 Pearson Education, Inc.

24) Futures markets have grown rapidly because futures contracts


A) are standardized.
B) have lower default risk.
C) are liquid.
D) are all of the above.
Answer: D
Question Status: Previous Edition
25) 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
Question Status: Previous Edition
26) 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) marked to market daily.
Answer: D
Question Status: Previous Edition
27) Which of the following features of Treasury bond 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
Question Status: Previous Edition

28) Which of the following features of Treasury bond 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
Question Status: Previous Edition

29) 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
Question Status: Previous Edition
5
Copyright 2012 Pearson Education, Inc.

30) When a financial institution is hedging interest-rate risk on its overall portfolio, the hedge is a
________.
A) macro hedge
B) micro hedge
C) cross hedge
D) futures hedge
Answer: A
Question Status: Previous Edition
31) The risk that occurs because stock prices fluctuate is called ________.
A) stock market risk
B) reinvestment risk
C) interest-rate risk
D) default risk
Answer: A
Question Status: Previous Edition
32) The most widely traded stock index future is on the
A) Dow Jones 1000 index.
B) S&P 500 index.
C) NASDAQ index.
D) Dow Jones 30 index.
Answer: B
Question Status: Previous Edition
33) Who would be most likely to buy a long stock index future?
A) a mutual fund manager who believes the market will rise
B) a mutual fund manager who believes the market will fall
C) a mutual fund manager who believes the market will be stable
D) none of the above would be likely to purchase a futures contract
Answer: A
Question Status: Previous Edition
34) If you buy a futures contract on the S&P 500 Index at a price of 450 and the index rises to 500, you
will ________.
A) lose $12,500
B) gain $12,500
C) lose $50
D) gain $50
Answer: B
Question Status: Previous Edition

6
Copyright 2012 Pearson Education, Inc.

35) If you sell a futures contract on the S&P 500 Index at a price of 450 and the index rises to 500, you
will ________.
A) lose $12,500
B) gain $12,500
C) lose $50
D) gain $50
Answer: A
Question Status: Previous Edition
36) Which of the following is a likely reason for a portfolio manager to sell a stock index future short?
A) He believes the market will rise.
B) He wants to lock in current prices.
C) He wants to reduce stock market risk.
D) Both B and C are correct.
Answer: D
Question Status: Previous Edition
37) If a portfolio manager believes stock prices will fall and knows that a block of funds will be received
in the future, then he should
A) sell stock index futures short.
B) buy stock index futures long.
C) stay out of the futures market.
D) borrow and buy securities now.
Answer: A
Question Status: Previous Edition

38) 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) do none of the above.
Answer: A
Question Status: Previous Edition

39) 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) doing none of the above.
Answer: B
Question Status: Previous Edition

7
Copyright 2012 Pearson Education, Inc.

40) Options are contracts that give the purchasers the


A) opportunity 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
Question Status: Previous Edition
41) 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
Question Status: Previous Edition

42) The price specified in an option contract at which the holder can buy or sell the underlying asset is
called the ________.
A) premium
B) strike price
C) exercise price
D) both B and C of the above.
Answer: D
Question Status: Previous Edition

43) 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
Question Status: Previous Edition
44) 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
Question Status: Previous Edition

45) An option that can be exercised at any time up to maturity is called a(n) ________.
A) swap
B) stock option
C) European option
D) American option
Answer: D
Question Status: Previous Edition
8
Copyright 2012 Pearson Education, Inc.

46) An option that can be exercised only at maturity is called a(n) ________.
A) swap
B) stock option
C) European option
D) American option
Answer: C
Question Status: Previous Edition
47) Options on individual stocks are referred to as ________.
A) stock options
B) futures options
C) American options
D) individual options
Answer: A
Question Status: Previous Edition
48) Options on futures contracts are referred to as ________.
A) stock options
B) futures options
C) American options
D) individual options
Answer: B
Question Status: Previous Edition
49) The agency which regulates stock options is the
A) Securities and Exchange Commission.
B) Commodities Futures Trading Commission.
C) Federal Trade Commission.
D) Both A and B are true.
Answer: A
Question Status: Previous Edition
50) The agency which regulates futures options is the
A) Securities and Exchange Commission.
B) Commodities Futures Trading Commission.
C) Federal Trade Commission.
D) Both A and B are true.
Answer: B
Question Status: Previous Edition
51) An option that gives the owner the right to buy 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: A
Question Status: Previous Edition

9
Copyright 2012 Pearson Education, Inc.

52) An option that gives the owner the right 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
Question Status: Previous Edition

53) A call option gives the owner the ________ to ________ the underlying security.
A) right; sell
B) obligation; sell
C) right; buy
D) obligation; buy
Answer: C
Question Status: Previous Edition
54) A put option gives the owner the ________ to ________ the underlying security.
A) right; sell
B) obligation; sell
C) right; buy
D) obligation; buy
Answer: A
Question Status: Previous Edition
55) A call option gives the seller the ________ to ________ the underlying security.
A) right; sell
B) obligation; sell
C) right; buy
D) obligation; buy
Answer: B
Question Status: Previous Edition
56) A put option gives the seller the ________ to ________ the underlying security.
A) right; sell
B) obligation; sell
C) right; buy
D) obligation; buy
Answer: D
Question Status: Previous Edition
57) If you buy an option to buy Treasury 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
Question Status: Previous Edition

10
Copyright 2012 Pearson Education, Inc.

58) If you buy an option to sell Treasury 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
Question Status: Previous Edition
59) If you buy an option to buy Treasury 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
Question Status: Previous Edition
60) If you buy an option to sell Treasury 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
Question Status: Previous Edition
61) The main advantage of using options on futures contracts rather than the futures contracts
themselves is that interest-rate risk is
A) controlled while preserving the possibility of gains.
B) controlled while removing the possibility of losses.
C) not controlled but the possibility of gains is preserved.
D) not controlled but the possibility of gains is lost.
Answer: A
Question Status: Previous Edition

62) The main reason to buy an option on a futures contract rather than the futures contract itself 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
Question Status: Previous Edition
63) The main disadvantage of futures contracts as 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
Question Status: Previous Edition

11
Copyright 2012 Pearson Education, Inc.

64) All other things held constant, premiums on put options will increase when the
A) exercise price increases.
B) volatility of the underlying asset falls.
C) term to maturity increases.
D) A and C are both true.
Answer: D
Question Status: Previous Edition
65) 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
Question Status: Previous Edition
66) All other things held constant, premiums on both put and call options will increase when the
A) exercise price increases.
B) volatility of the underlying asset increases.
C) term to maturity decreases.
D) futures price increases.
Answer: B
Question Status: Previous Edition
67) An increase in the volatility of the underlying asset, all other things held constant, will ________ the
option premium.
A) increase
B) decrease
C) not affect
D) Not enough information is given.
Answer: A
Question Status: Previous Edition

68) An increase in the exercise price, all other things held constant, will ________ the premium on call
options.
A) increase
B) decrease
C) not affect
D) Not enough information is given.
Answer: B
Question Status: Previous Edition

69) 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 ________ options on financial futures.
A) buy put
B) buy call
C) sell put
D) sell call
Answer: A
Question Status: Previous Edition
12
Copyright 2012 Pearson Education, Inc.

70) 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
Question Status: Previous Edition
71) 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) notional swap
Answer: B
Question Status: Previous Edition

72) 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) notional swap
Answer: A
Question Status: Previous Edition

73) If Second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce
interest-rate risk with a swap which requires Second National 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
Question Status: Previous Edition

74) If Second National Bank has more rate-sensitive liabilities than rate-sensitive assets, it can reduce
interest-rate risk with a swap which requires Second National 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
Question Status: Previous Edition

13
Copyright 2012 Pearson Education, Inc.

75) 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
Question Status: Previous Edition
76) 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
Question Status: Previous Edition
77) The disadvantage of swaps is that
A) they lack liquidity.
B) it is difficult to arrange for a counterparty.
C) they suffer from default risk.
D) they are all of the above.
Answer: D
Question Status: Previous Edition
78) 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
Question Status: Previous Edition
79) Intermediaries are active in the swap markets because
A) they increase liquidity.
B) they reduce default risk.
C) they reduce search cost.
D) all of the above are true.
Answer: D
Question Status: Previous Edition
80) A valid concern about financial derivatives is that
A) they allow financial institutions to increase their leverage.
B) they are too sophisticated because they are so complicated.
C) the notional amounts can greatly exceed a financial institution's capital.
D) all of the above are valid concerns.
E) none of the above are valid concerns.
Answer: A
Question Status: Previous Edition

14
Copyright 2012 Pearson Education, Inc.

81) The biggest danger of financial derivatives occurs


A) when notional amounts exceed a bank's capital.
B) when financial market prices and rates are highly volatile.
C) in the trading activities of financial institutions.
D) in the large amount of credit exposure.
Answer: C
Question Status: Previous Edition
82) The use of financial derivatives by financial institutions to hedge can decrease risk. However, they
can also increase risk. Which of the following examples illustrates this?
A) Financial derivatives allow financial institutions to increase their leverage.
B) Some institutions such huge amounts of derivatives that the amounts exceed capital.
C) All of the above are valid examples.
D) None of the above are valid examples.
Answer: C
Question Status: New Question

24.2 True/False
1) A forward contract is more flexible than a futures contract.
Answer: TRUE
Question Status: Previous Edition
2) Futures contracts are standardized.
Answer: TRUE
Question Status: Previous Edition
3) A long contract obligates the holder to sell securities in the future.
Answer: FALSE
Question Status: Previous Edition
4) A short contract obligates the holder to sell securities in the future.
Answer: TRUE
Question Status: Previous Edition
5) One problem with a futures contract is finding a counterparty.
Answer: FALSE
Question Status: Previous Edition
6) Futures contracts are subject to default risk.
Answer: FALSE
Question Status: Previous Edition
7) Futures trading is regulated by the Commodity Futures Trading Commission.
Answer: TRUE
Question Status: Previous Edition
8) Open interest allows investors to change the interest rate on futures contracts.
Answer: FALSE
Question Status: Previous Edition
15
Copyright 2012 Pearson Education, Inc.

9) To reduce the interest-rate risk of holding a portfolio of bonds, Treasury bond futures contracts
should be bought.
Answer: FALSE
Question Status: Previous Edition
10) To reduce foreign exchange risk from selling goods to a foreign country, futures contracts should be
sold.
Answer: TRUE
Question Status: Previous Edition
11) An option that gives the holder the right to buy an asset in the future is a put.
Answer: FALSE
Question Status: Previous Edition
12) Option premiums increase as the term to maturity increases.
Answer: TRUE
Question Status: Previous Edition
13) Option premiums fall as the volatility of the underlying asset falls.
Answer: TRUE
Question Status: Previous Edition
14) Using options to control interest-rate risk reduces the chance of a loss but increases the chance of a
gain.
Answer: FALSE
Question Status: Previous Edition
15) One advantage of using options to hedge is that the accounting transaction will never require the
firm to show large unrecognized losses.
Answer: TRUE
Question Status: Previous Edition
16) Interest-rate swaps involve the exchange of a set of payments in one currency for a set of payments
in another.
Answer: FALSE
Question Status: Previous Edition
17) Currency swaps involve the exchange of a set of payments on one currency for a set of payments in
another.
Answer: TRUE
Question Status: Previous Edition
18) If Friendly Finance Company has more rate-sensitive assets than rate-sensitive liabilities, it may
reduce risk with a swap.
Answer: TRUE
Question Status: Previous Edition

16
Copyright 2012 Pearson Education, Inc.

19) Interest-rate swaps are more liquid than futures contracts.


Answer: FALSE
Question Status: Previous Edition
20) Intermediaries add value to the swap markets by reducing default risk.
Answer: TRUE
Question Status: Previous Edition
21) The 2007-2009 financial crisis illustrates that derivatives cannot be used to hedge -- financial
institutions should be barred from using them in any form.
Answer: TRUE
Question Status: New Question
24.3 Essay
1) Distinguish between forward and futures contracts.
Question Status: Previous Edition
2) Why have the futures markets grown so rapidly in recent years?
Question Status: Previous Edition
3) Explain how a short hedge could be used to hedge a Treasury portfolio against interest-rate risk.
Question Status: Previous Edition
4) Explain how a long hedge could be used to protect a bank from the risk that interest rates could rise
before a loan is funded.
Question Status: Previous Edition
5) How would a firm use exchange rate futures to lock in current exchange rates?
Question Status: Previous Edition
6) Explain how a swap could be used to reduce interest-rate risk for a bank with more rate-sensitive
assets than rate-sensitive liabilities.
Question Status: Previous Edition
7) Define and distinguish between call options and put options.
Question Status: Previous Edition
8) Explain how option contracts could be used to protect against losses in portfolio value that may occur
as interest rates increase.
Question Status: Previous Edition
9) Explain the advantages of protecting against interest-rate risk using options rather than futures
contracts.
Question Status: Previous Edition
10) Discuss the advantages of using swaps to protect against interest-rate risk rather than restructuring
the balance sheet.
Question Status: Previous Edition

17
Copyright 2012 Pearson Education, Inc.

11) Discuss the challenges regulators face in controlling the use of derivatives by financial institutions.
Question Status: New Question

18
Copyright 2012 Pearson Education, Inc.