ECO301 2nd chance exam
According to Irving Fisher's equation of exchange, nominal GDP can increase only if the velocity of money is also increasing.
False
According to the Gordon Growth Model of stock price determination, holding all else constant, rising treasury bond prices should lead to decreasing stock prices.
False
According to the empirical evidence presented by Chairman Bernanke, the Fed's low interest rate policy in the early 2000s helped cause the financial crisis in that it was an important contributor to the housing bubble which in turn triggered the financial crisis.
False
The search costs associated with monetary exchange are not very sensitive to the particular form of the medium of exchange. However, exchange costs are very sensitive to the form the medium of exchange takes.
True
Economists define an asset's liquidity as
how quickly the asset can be converted into the medium of exchange without loss of market value.
an increase in a bond's tax liability
causes yield to rise because investors care about after-tax returns and must be compensated for paying higher taxes
an increase in a bond's liquidity
causes yields to fall because investors incur lower costs in selling the bond
an increase in a bond's info costs
causes yields to rise because investors mist spend more resources to evaluate the bond
an increase in a bond's default risk
causes yields to rise because investors must eb compensated for bearing additional risk
According to the quantity theory of money, if the long-run rate of growth of real GDP in 301land is 3.5 percent and the monetary authority in 301land (i.e. the 301land Fed) causes the money supply to grow at a rate of 2.5 percent, 301land will experience
deflation.
Q3: If you deposit $10,000 in a savings account at an annual interest rate of 6%, how much will you have in the account at the end of three years?
$11,910
Which of the following is least useful in ensuring that intrinsically worthless fiat money is valuable in trade.
regulation of the production and use of cryptocurrencies
Currently, a three-month Treasury bill has a yield of 5% while the yield on a ten-year Treasury bond is 4.7%. What is the risk premium of the typical A-rated ten-year corporate bond with a yield of 5.5%?
0.8%
maturity of notes
2-10yrs
A one-year bond currently pays 5% interest. It's expected that it will pay 4.5% next year and 4% the following year. The two-year term premium is 0.2% while the three-year term premium is 0.35%. What is the interest rate on a two-year bond according to the liquidity premium theory?
4.95
Suppose we are in an era in which the rate of growth of the price level is positive but declining, which of the following categories of economic agents is least likely to benefit from this phenomena?
Deficit spending units that have taken fixed rate loans
Suppose we are in an era in which the rate of growth of the price level is positive and increasing, which of the following categories of economic agents is most likely to benefit from this phenomena?
Deficit spending units who have taken fixed rate loans
Which of the following exchanges or potential exchanges is NOT an example of asymmetric information in the market in question?
A potential buyer of an experimental product and the producer have equally incomplete information about the likelihood that the product will perform as intended.
According to Chairman Bernanke, increasing federal government deficits has been an undesirable consequence of the large-scale asset purchases made by the Fed in response to the recent financial crisis.
False
An asset that is an effective store of value and that is used as a medium or unit of account, must also be a medium of exchange or money.
False
Which of the following statements is the most accurate/complete explanation for the gains from intertemporal trade for the borrower
Borrowers prefer to consume more than their current income in the current period (ex. 𝑐1>𝑦1c1>y1). In the absence of opportunities for intertemporal trade, they are forced to consume their income in a pattern that exactly matches the pattern in which they receive their income (𝑐1=𝑦1 𝑎𝑛𝑑 𝑐2=𝑦2c1=y1 and c2=y2). The introduction of opportunities for intertemporal trade allows them to borrow against their future income. As such, they get to consume their income in the pattern they prefer and enjoy an increase in utility.
An investor who makes optimal use of a given information set in forming expectations about an asset price will expend resources to evaluate the information contained in that information set up to the level of expenditures at which the improvement in the accuracy of their expectation (or forecast) if they spend one more unit of resources is greater than the opportunity costs of expending one additional unit of resources to evaluate this information.
False
Define 𝑟𝐷rD as the real interest rate at which domestic demand for loanable funds in a small open economy (SOE) is equal to domestic supply of loanable funds. When the prevailing world real interest rate (i.e. 𝑟𝑤rw) is greater than 𝑟𝐷rD , the SOE will be a net borrower on the international capital market.
False
Fiat money issued by the US government has intrinsic value because legal tender laws ensure that there is a demand for it and enforcement of anti-counterfeiting laws limits its supply.
False
Financial Intermediaries will arise in all economies irrespective of the preferences of households or economic agents. For example, financial intermediaries will arise in a economy in which all inhabitants follow Polonius' advice and prefer to consume the Polonius combination.
False
Q5: While variation in stock prices affects optimizing households' consumption of goods and services via its effect on households' wealth, changes in wealth caused by variation in stock prices have no effect on households' labor supply decisions.
False
The "Great Moderation" is a term used to describe the substantial reduction in the volatility of interest rates and stock prices in the period from the mid-1980s to 2007.
False
The Federal Reserve's creation of extraordinary lending facilities in response to the economic crisis triggered by the COVID-19 pandemic is NOT an example of a central bank performing its lender of last resort function.
False
The Federal Reserve's policy responses during the Great Depression era are consistent with the assertion that its performance with respect to its "lender of last resort" function was very good but that it failed to properly execute its mandate to ensure macroeconomic stability.
False
The ex-post real interest rate is most useful for planning purposes while the ex-ante real interest rate is more useful for evaluating results of prior decisions.
False
The introduction of intratemporal trading opportunities in an economy in which these opportunities did not previously exist will allow households to spend their income in patterns that differ from the pattern in which their income is received.
False
The probability that the law of one price will prevail in the market for any given financial asset is independent of the extent to which financial arbitrage is feasible in that market.
False
When a central bank adjusts the level of short-term interest rates in order to influence the rate of inflation and/or the rate of unemployment it is performing its function as a "lender of last resort".
False
While the future value of any given current sum, depends on prevailing interest rates, the present value of a sum of money to be received in the future is only dependent on the prevailing rate of inflation.
False
Unsustainable deficits and debt servicing costs force the monetary authority in 301land to resort to printing money which culminates in hyperinflation. Assume that conditions in 301land are such that the Ricardian Equivalence Hypothesis holds and that there is a full Fisher effect. Which of the following interest rate scenario is most likely to materialize in 301land?
Nominal interest rates will increase but there will be no change in real interest rates.
Which of the following characterizations of intertemporal trade is the least accurate?
Opportunities for intertemporal trade allow economic agents to alter the composition of the market basket of goods they consume within any given time period.
Which of the following statements is the most accurate/complete explanation for the observation that rational optimizing agents emphasize real interest rates ( or real rates of return) over nominal interest rates (or nominal rates of return) when making decisions about how to allocate resources across time periods?
Optimizing agents ultimate concern is with the utility implications of their resource allocation decisions. While nominal interest rates ( or nominal rates of return ) are expressed in dollars, real interest rates ( or real rates of return) are expressed in terms of market baskets of goods and services that yield utility upon consumption. As such, optimizing agents emphasize real interest rates (or real rates of return) because real rates are more informative about impact on utility than nominal rates.
If both the past behavior of policy makers in the US and objective analysis of market conditions leads to the conclusion that a financial institution is "too big to fail", there would be
a moral hazard problem in that "too big to fail' status insures the financial institution in question against the risk of failure and thereby incentivizes it to take on more risk which increases the probability that tax payers will have to bail it out.
Which of the following is the least likely consequence of rising stock prices?
a reduction in the rate of economic growth
a comparison of the level of utility Crusoe and Friday enjoy before the introduction of trading opportunities and their levels of utility after they react to the introduction of intratemporal trade.
after the introduction of intratemporal trading opportunities both Crusoe and Friday pick the production combination indicated by the points labelled P* and maximize utility by trading to consume the combination of apricots (i.e. A) and bacon (i.e. B) at which their marginal rate of substitution is just equal to the prevailing terms of trade.
Which of the following observations is not consistent with an accurate explanation of how and why variation in stock prices affects expectations about future economic conditions.
Significant and sustained increases in stock prices typically induce consumers and businesses to implement upward revisions of their subjective estimates of the probability of a recession occurring in the near future.
Which of the following statements is not consistent with an accurate explanation of how and why variation in stock prices affects expectations about future economic conditions.
Significant and sustained increases in stock prices typically induce consumers and businesses to implement upward revisions of their subjective estimates of the probability of a recession occurring in the near future.
identification problem.
Since the interest rate differential between any pair of fin instruments is potentially attributable to differences in any combination of their defining attributes, it is difficult to assign any observed interest rate differential to one of the previously noted defining attributes.
Consider regression equations of the form 𝑖𝑡=𝛼+𝛽𝜋𝑒𝑡+𝜀𝑡it=α+βπte+εt in which 𝑖𝑡it is the nominal rate of return on an asset class, 𝜋𝑒𝑡πte is the expected rate of inflation, and 𝜀𝑡εt is a random error term. Regressions of this form may be used to test the empirical validity of Fisher Hypothesis. Suppose an analyst estimates this regression for each of four asset classes, namely, stocks, real estate, bonds, and commercial paper. Estimates of 𝛽β for each of the four asset classes are reported below as possible choices. Which asset class should an investor invest in if his/her primary concern is to protect his/her real return from inflation?
Stocks: 𝛽=.75
Q6: Which of the following was a strength of the gold standard?
The gold standard limited the monetary authority's ability to vary the money supply in pursuit of its policy goals and thereby reduced the likelihood of policy mistakes.
As a theory of stock price determination, the Gordon Growth Model (GGM) identifies factors that cause variation in stock prices and the mechanisms via which these factors affect stock prices. Which of the following statements is the most accurate explanation of what the GGM tells us about how an improvement in a dividend-paying firm's technology will affect its current stock price.
The improvement in the firm's technology will lead to an increase in expected future profits, an increase in the expected growth rate of dividends and thereby to an increase in the stock price.
Which of the following statement is the most accurate depiction of the effect of introducing intratemporal trading opportunities in an economy in which these opportunities did not previously exist?
The introduction of intratemporal trading opportunities in an economy in which these opportunities did not previously exist, allows economic agents to separate their production decisions from their consumption decisions and thereby facilitates specialization in accordance with comparative advantage which raises the level of utility of all traders.
According to Chairman Bernanke the "Great Moderation" may have encouraged complacency that induced economic agents into taking on too much debt. This state of affairs contributed to the financial crisis by making the US economy more vulnerable to triggers such as the decline in house prices.
True
According to Chairman Bernanke, the most recent financial crisis in the US was triggered in part by the decline in house prices and the associated mortgage losses. However, these events may not have led to a major financial crisis if the economy did not already have some significant vulnerabilities.
True
During a financial panic financial institutions or firms may go bankrupt because they are forced to sell illiquid assets at a discount in order to make timely payoffs to short-term lenders and/or depositors.
True
If gold is the medium of exchange in an economy, discovery of new gold deposits will lead to a reduction in the value or price of gold and to an increase in the general price level as measured by indices such as the consumer price index (CPI) and the GDP deflator.
True
Rational economic agents' ultimate concern is with maximizing utility. Consequently, if there is some action they can take that will increase their utility, we can predict with a high degree of confidence that they will take that action. The ubiquitous emergence of financial intermediaries across both space and time is a reflection of the fact that introduction of financial intermediaries in an economy increases the utility of the typical economic agent or household.
True
Some financial economists believe that the Gordon Growth Model's (GGM) assumption of a constant growth rate of dividends limits its relevance for non-dividend-paying firms and for dividend-paying firms with unstable growth. As such, they believe the GGM is most useful for discovering the value of broad-based stock indices.
True
The Ricardian Equivalence Hypothesis implies that deficit-financed tax cuts should lead to increases in private savings rates if private actors are rational, have infinite planning horizons, and do not face liquidity or credit constraints.
True
The implication of the efficient market hypothesis that only news about fundamentals should lead to non-random movements in stock prices means that under the Gordon Growth Model (GGM) of stock price determination, only news that has implications for current dividends (Dt), the expected growth rate of dividends (g), and the required rate of return on equity (rE) should lead to non-random movements in the stock prices of dividend-paying firms.
True
Theories of the term structure of interest rates that are successful in explaining why short and long-term interest rates tend to move together suggest that any change in the economic environment which leads investors to expect changes in future short term interest rates is likely to result in a shifting yield curve.
True
Which of the following best describes a "bubble"?
an unsustainable increase in the price of a class of assets
The chart below shows the yield differential between 30-year and 10-year US government bonds from August 2019 to early July 2020. Which of the following statements is the most accurate characterization of the behavior of yield curves during the period illustrated?
Yield curves were upward sloping during the entire period under consideration but were on average steeper during the last four months of the period.
The procyclicality of the yield differential between Baa corporate bonds and long-term U.S. government bonds of identical maturity is a reflection of the observation that
as the economy goes into recession, lenders perceive an increase in default risk and shift funds out of risky corporate bonds into relatively safe U.S. government bonds.
The quantity LD*-LS* in the diagram below measures the degree of credit rationing in that
at the interest rate 𝑟⋅𝐿rL⋅ some borrowers are denied credit even if they are willing to pay interest rates that are equal to or greater than 𝑟⋅𝐿rL⋅.
Q1: Suppose initially there are no opportunities for intertemporal trade in 301land and that these opportunities are subsequently introduced. The set of feasible combinations of current and future consumption available to the representative household in 301land will expand and the expansion will include
combinations of current and future consumption that require the household to borrow against its future income and some combinations that were not previously feasible due to the household's inability to earn interest income in the absence of lending and borrowing opportunities.
According to the quantity theory of money, if the long-run rate of growth of real GDP in 301land is 2 percent and the monetary authority in 301land (i.e. the 301land Fed) causes the money supply to grow at a rate of 3.5 percent, 301land will experience
inflation.
Which of the following is not a credible signal of product quality in markets characterized by asymmetric information?
informative newspaper advertising
Which of the following is least likely to lead to make an economy vulnerable to a financial panic or crisis?
interest rates that are high relative to historical averages
Which of the following is NOT likely to alleviate (or fix) a financial panic?
large-scale asset sales by the central bank
Excess volatility refers to
movements in market prices of stock that are larger than movements in their fundamental values.
Liquidationist Theory
the depression was a necessary corrective to the excesses of the 1920s
net worth
the difference between the value of a firm's assets and the value of its liabilities
An investor who perceives a strategy of buying a series of short-term securities to cover a given holding period as a perfect substitute for buying and holding a long-term bond whose length of time to maturity exactly matches his/her holding period
must be risk neutral in that he/she does not care about the uncertainty associated with future short-term securities.
When market participants form their expectations about future stock prices rationally, the deviation of the expected price from the actual future price is
not predictable.
municipal bonds
not subject to federal, state, or local taxes
If a one-year bond currently yields 5%, is expected to yield 7% one year from now, is expected to yield 8.5 % two years from now, and expected to yield 8.5% three years from now, the pure expectations theory of the term structure of interest rates
predicts that the yield today on a four-year bond should be 7.25 percent
A ranking of various theories of the term structure according to the degree of substitutability they assume exists between short and long-term securities would look like (highest to lowest)
pure expectations, preferred habitat, segmented markets.
Credit rationing is a form of
quantity rationing.
It might be argued that the manner in which investors form their expectations has implications for the nature of the forecast errors they make. In addition, since various forms of the efficient market hypothesis differ with respect to the information set investors are assumed to have and since the manner in which expectations are formed depends in part on the information set investors use, the manner in which expectations are formed is compatible with some forms of the efficient market hypothesis and not others. In light of the foregoing which of the following lists of the three attributes (i.e. is manner in which expectations are formed, nature of forecast errors, and form of the efficient market hypothesis) is most compatible?
rational expectations; random unforecastable errors; semi-strong form of the efficient market hypothesis
trade credit
the practice of buying goods and services now and paying for them later
If the current price of a coupon bond is less than its face value
the yield to maturity must be greater than the coupon rate.
If the current price of a coupon bond is greater than its face value
the yield to maturity must be less than the coupon rate.
If market participants rely only on past stock prices to forecast future stock prices,
they are forming adaptive expectations.
According to the efficient markets hypothesis, the difference between today's price for a share of stock and tomorrow's price is
unforecastable.
The moral hazard problem associated with asymmetric information about product quality in markets
usually materializes after a product has been exchanged and implies that one party is incentivized to take actions that are not in the best interest of the counterparty.
The efficient markets hypothesis predicts that an investor
will not be able to consistently earn above-normal profits from buying or selling stocks.
defining attributes that lead to interest rate differentials.
•Differences in default risk •Differences in liquidity •Differences in informational Costs •Differential tax treatment •Differences in length of time to maturity •Differences in currency denomination
Financial markets communicate information by
incorporating all available information into the prices of financial assets.
The distinguishing feature of a well-functioning financial market is the
incorporation of available information into asset prices.
Consider the regression equation: 𝑖𝑡=𝛼+𝛽𝜋𝑒𝑡+𝜀𝑡it=α+βπte+εt in which 𝑖𝑡it is the nominal interest rate, 𝜋𝑒𝑡πte is the expected rate of inflation, and 𝜀𝑡εt is a random error term. Suppose an analyst estimates this equation using real world data and finds that 𝛽β is equal to 0.4. If expected inflation increases from 1 percent to 5 percent it would be reasonable for the analyst to expect the nominal interest rate to
increase by 1.6 percent
If a large open economy (LOE), like the United States, reduces its budget deficit. Under the assumption that there is some degree of Ricardian failure in the LOE, which of the following is the most likely effect of the reduction the LOE's deficits on a small open economy?
increased investment
Suppose a society decides that it will pick one of two commodities (say A and B) as its medium of exchange. If the opportunity costs of using A as the medium of exchange is equal to the opportunity costs of using B as the medium of exchange and the monetary authority's ability to pursue its price stability goal is the same for both commodities, which of the following attributes of A and B will not influence the society's choice of which commodity to use as its medium of exchange?
search costs associated with barter exchange
Which of the following is included in M1, but not in M2?
Everything in M1 is in M2.
Laborie Cars issues a bond which offers potential buyers a payment of $10,000 in two years. If potential buyers insist on an annual rate of return of 4 percent, what price will they be willing to pay for property rights to the promised future payment?
$9245.56
The yield to maturity of a one-year discount bond with a par (or face) value of $5000 and that sold today (at issuance) for $4600 is
8.70 %
the yield differentials between high yield bonds (or high risk bonds) and safe government bonds in the US and in the Euro zone from July 2019 to early June 8, 2020. Which of the following statements is the most likely explanation for the decline in these yield differentials after the initial upward spike?
After the initial spike in the yield differential, monetary policy responses by monetary authorities (like the Fed in the US) and fiscal policy responses in the form of stimulus packages (such as the CARES Act in the US) alleviated concerns about the magnitude and duration of the economic fallout from the pandemic and led market participants to perceive a reduction in economic risk. In response, market participants started to reverse their earlier flight to quality by increasing demand for high yield bonds relative to demand for safer government bonds.
Which of the following statements is the most accurate/complete explanation for the view that variation in stock prices has implications for investment in physical capital, and thereby, for economic growth?
All credible theories of economic growth imply that an economy's capital stock is an important determinant of its rate of economic growth. Since investment in physical capital is the flow that adds to a national economy's capital stock, any change in the economic environment that leads to variation in investment, will affect economic growth. Firms frequently rely on new stock issuance to finance investment in physical capital. Since the productivity of any given issuance of new stock is positively correlated with the prevailing stock price, stock price fluctuations have important implications for an economy's investment in physical capital, its capital stock, and its rate of economic growth.
The loan supply curve (LS) in the diagram below indicates that banks do not supply loans at interest rates above 𝑟⋅𝐿rL⋅. Which of the following statements is the most accurate description of the contribution of moral hazard problems in determining the shape of this loan supply curve?
As banks increase the rate they charge on loans (i.e. 𝑟𝐿rL) beyond some point the loan recipients who take high interest rate loans will take on greater risk in order to earn the higher returns needed to pay the high loan rates. This leads to a dome-shaped relationship between 𝑟𝐿rL and the expected rate of return (𝑟𝑒re) on banks' loan portfolios in which 𝑟⋅𝐿rL⋅ is the rate at which 𝑟𝑒re is maximized. Since the expected rate of return falls if loan rates are increased beyond 𝑟⋅𝐿rL⋅, banks refuse to make loans at interest rates higher than 𝑟⋅𝐿rL⋅.
The diagram below illustrates conditions in loan markets characterized by asymmetric information. The loan supply curve (LS) in the diagram indicates that banks do not supply loans at interest rates above rL*. Which of the following statements is the most accurate description of the contribution of adverse selection problems in determining the shape of this loan supply curve?
As banks increase the rate they charge on loans (𝑟𝐿rL) beyond some point the rising interest rate causes low risk borrowers to exit the market so that the pool of loan applicants becomes dominated by high risk borrowers. This leads to a dome-shaped relationship between 𝑟𝐿rL and the expected rate of return (𝑟𝑒re) on banks' loan portfolios in which 𝑟⋅𝐿rL⋅ is the rate at which 𝑟𝑒re is maximized. Since the expected rate of return falls if loan rates are increased beyond 𝑟⋅𝐿rL⋅, banks refuse to make loans at interest rates higher than 𝑟⋅𝐿rL⋅.
Which of the following is the most accurate description of what happens to the demand and supply curves for loanable funds and interest rates at the onset of a recession?
At the onset of a recession, wealth decreases and expectations of future profits are revised downwards. The decrease in wealth leads to a decrease in the supply of loanable funds while the decrease in expected future profits leads to a decrease in the demand for loanable funds. Since the decrease in the demand for loanable funds is greater than the decrease in the supply of loanable funds, interest rates fall.
Which of the following is the most accurate description of what happens to the bond demand and bond supply curves and to interest rates at the onset of an expansion?
At the onset of an expansion, wealth increases and expectations of future profits are revised upwards. The increase in wealth leads to an increase in bond demand while the increase in expected future profits leads to an increase in bond supply. Since the increase in bond supply is greater than the increase in bond demand, bond prices fall and interest rates rise.
Let 𝑟𝑎𝑡rtarepresent the ex-post real interest rate; 𝑟𝑒𝑡rte= the ex-ante real interest rates; 𝜋𝑒𝑡πte = the expected rate of inflation; 𝜋𝑎𝑡πta = the actual rate of inflation; and 𝑖𝑡it=the nominal interest rate on a loan. If 𝜋𝑎𝑡<𝜋𝑒𝑡πta<πte, which of the following is the most accurate explanation of the impact on lenders and borrowers?
Both lenders' and borrowers' ultimate concern is with maximizing their utility. Since real rates of interest are more informative about the impact of borrowing and lending decisions than nominal interest rates, lenders and borrowers focus on real interest rates in making these decisions. At the initiation of a loan, borrowers expect to pay and lenders expect to receive 𝑟𝑒𝑡 = 𝑖𝑡 − 𝜋𝑒𝑡rte=it−πte. When the loan is completed, the interest rate borrowers actually pay and lenders actually receive is 𝑟𝑎𝑡=𝑖𝑡−𝜋𝑎𝑡.rta=it−πta. 𝜋𝑎𝑡<𝜋𝑒𝑡⟹𝑟𝑎𝑡>𝑟𝑒𝑡πta<πte⟹rta>rte. As such, lenders are better off relative to what they expected and borrowers are worse off relative to what they expected.
Let 𝑟𝑎𝑡rtarepresent the ex-post real interest rate; 𝑟𝑒𝑡rte= the ex-ante real interest rates; 𝜋𝑒𝑡πte = the expected rate of inflation; 𝜋𝑎𝑡πta = the actual rate of inflation; and 𝑖𝑡it=the nominal interest rate on a loan. If 𝜋𝑎𝑡>𝜋𝑒𝑡πta>πte, which of the following statements is the most accurate explanation of the impact on lenders and borrowers?
Both lenders' and borrowers' ultimate concern is with maximizing their utility. Since real rates of interest are more informative about the impact of borrowing and lending decisions than nominal interest rates, lenders and borrowers focus on real interest rates in making these decisions. At the initiation of a loan, borrowers expect to pay and lenders expect to receive 𝑟𝑒𝑡=𝑖𝑡−𝜋𝑒𝑡rte=it−πte. When the loan is completed, the interest rate borrowers actually pay and lenders actually receive is 𝑟𝑎𝑡=𝑖𝑡−𝜋𝑎𝑡.rta=it−πta. 𝜋𝑎𝑡>𝜋𝑒𝑡⟹𝑟𝑎𝑡<𝑟𝑒𝑡πta>πte⟹rta<rte. As such, lenders are worse off relative to what they expected and borrowers are better off relative to what they expected.
the yield differentials between high yield bonds (or high risk bonds) and safe government bonds in the US and in the Euro zone from July 2019 to early June 8, 2020. Which of the following statements is the most likely and accurate explanation for the upward spike in these yield differentials in March 2020?
By early March 2020 news about the corona virus pandemic led market participants in both the US and Euro zone to perceive an increase in economic risk. In response, a flight to quality ensued in which market participants redirected funds from risky bonds into relatively safer government bonds.
Which of the following indicates or implies an advantage of fiat money over commodity money?
Commodity monies have intrinsic value while fiat monies are intrinsically worthless.
Which of the following statements is the most accurate/complete explanation for the existence of financial intermediaries?
Divisibility problems, inadequate risk diversification, maturity mismatches, and asymmetric information problems associated with intertemporal trade, lead to significant transactions costs. Financial intermediaries have a comparative advantage in managing these problems which allows them to lower transactions costs below what DSUs and SSUs can achieve on their own. As such, the introduction of financial intermediaries leads to an increase in utility for the representative economic agent.
adaptive expectations
Economists frequently talk about the efficiency of markets. Exactly what is it that they expect markets to do efficiently?
rational expectations
Economists frequently talk about the efficiency of markets. Exactly what is it that they expect markets to do efficiently?
Which of the following statements is the most accurate/complete explanation for the empirical observation that deficit spending units (DSUs) and surplus spending units (SSUs) typically prefer indirect lending via financial intermediaries to direct lending?
Financial intermediaries have a comparative advantage in alleviating conditions such as divisibility problems, maturity mismatches, inadequate risk diversification, and asymmetric information that affect intertemporal trade and explain the transactions costs associated with lending and borrowing. As such, financial intermediaries are able to lower transactions costs by more than SSUs and DSUs can on their own. Given that SSUs and DSUs ultimate concern is with utility and that lower transactions costs imply greater utility for DSUs and SSUs, they prefer indirect lending.
Suppose the expected rate of inflation (i.e. 𝜋𝑒πe ) falls from 5% to 2%. According to the Fisher Hypothesis (assume full Fisher effect), this should lead to the effects illustrated in the diagram below. Which of the following is the most accurate explanation for the shift in the demand for loanable funds (i.e. DLFs to DLFs*)
Given the initial nominal interest rate (i*), the decrease in the expected rate of inflation induces demanders of loanable funds to perceive an increase in the real costs of borrowing. As a result, the demand for loanable funds shifts to DLFs* reflecting the fact that demanders want to borrow less loanable funds at each and every nominal interest rate.
Suppose the expected rate of inflation (i.e. 𝜋𝑒πe ) falls from 5% to 2%. According to the Fisher Hypothesis (assume full Fisher effect), this should lead to the effects illustrated in the diagram below. Which of the following is the most accurate explanation for the shift in the supply of loanable funds (i.e. SLFs to SLFs*)
Given the initial nominal interest rate (i*), the decrease in the expected rate of inflation induces suppliers of loanable funds to perceive an increase in the real rate of return they will receive on their savings. As a result, the supply of loanable funds shifts out reflecting the fact that suppliers want to supply more loanable funds at each and every nominal interest rate.
Suppose 301land is an economy in which opportunities for intertemporal trade have just been introduced. Which of the following households or economic agents in 301land are least likely to gain utility from the introduction of intertemporal trade?
Households or economic agents whose preferences are such that they prefer to consume their income in exactly the same pattern in which they receive their income.
E1: Which of the following statements is the most accurate/complete explanation of the effect of hyperinflations on money?
Hyperinflations erode money's value or purchasing power and make it less attractive as a store of value. In response, optimizing agents will reduce their demand for money. Since money must be held in order to serve as a medium of exchange and since hyperinflations impair money's effectiveness as a store of value, hyperinflations also impair money's efficacy as a medium of exchange.
Suppose initially there are no opportunities for intertemporal trade in 301land and that these opportunities are subsequently introduced. Which of the following statements makes the most accurate comparison between an economic agents opportunities to shift consumption across time before and after the introduction of opportunities for intertemporal trade?
In the absence of intertemporal trade, economic agents in 301land can transform units of current consumption into units of future consumption at a rate of one for one but are unable to transform future consumption into current consumption. However, the introduction of opportunities for intertemporal trade allows households to transform units of current consumption into units of future consumption at a rate of 1 for (1+𝑟)(1+r) and to transform units of future consumption into units of current consumption at a rate of 1 for 1(1+𝑟)1(1+r).
Which of the following is the most accurate characterization of interest rate risk?
Interest rate risk is the risk that the price of a financial asset will fluctuate in response to changes in market interest rates and thereby expose owners of the financial asset to the possibility of suffering capital losses.
Which of the following is an indispensable ingredient in any theory of the term structure of interest rates that is able to explain the empirical observation that about 85% of yield curves in the U.S. are upward sloping?
Investors must have a preference for short-term securities over long-term securities.
flight to quality
Investors respond to increased perception of risk by moving resources out of risky assets into safe assets. leads to increases in default risk premium
the most accurate/complete explanation for the gains from intertemporal trade for the lender illustrated in the diagram?
Lenders prefer to consume more than their future income in the future and can achieve this objective by consuming less than their current income in the current period. (ex. 𝑐1<𝑦1𝑎𝑛𝑑𝑐2>𝑦2c1<y1andc2>y2). In the absence of intertemporal trading opportunities, lenders do not earn interest on their savings. However, when intertemporal trading opportunities are introduced, lenders earn interest income which leads to an increase in their level of utility above what it would have been in the absence of opportunities to lend.
Which of the following statements about price discovery in markets is incorrect?
Market participants' ability to make adjustment for real world phenomena such as government price controls and hyperinflation implies that these phenomena have no implications for the optimality of price discovery and the efficient allocation of resources.
Which of the following is NOT a channel via which variation in stock prices affects aggregate economic activity?
Policy makers vary tax rates in response to variation in stock prices and such variation in tax rates affects aggregate economic activity.
Financial economists typically interpret an inversion of the yield curve as an indicator of future recession. Which of the following statements is the most accurate and most complete explanation/justification for this view?
Rational investors know that interest rates are procyclical and that the Fed typically responds to looming recession by lowering interest rates. Consequently, when they believe the economy is about to enter into a recession, rational investors will expect future short term interest rates to fall. Under the preferred habitat or liquidity premium theory of the term structure of interest rates, the yield curve becomes inverted only if future short term interest rates are expected to fall. As such, the preferred habitat or liquidity premium theory implies that inverted yield curves may be an indicator of coming recession. In addition, empirical evidence compiled by Wheelcock and Wohar shows that since 1953, episodes during which the yield curve became inverted were followed, within a year, by a recession.
Which of the following statements is the most accurate/complete explanation of the effects of optimizing economic agents' expectations about future economic conditions on current economic outcomes?
Resource allocation decisions such as how much to consume now vs how much to consume in the future, how much to work now vs how much to work in the future, and how much to invest in physical capital are planning problems that typically require decision makers to form expectations about future realizations of relevant economic variables. As such, any change in the economic environment that affects expectations about future economic conditions will have important implications for the current resource allocation decisions optimizing agents make, and thereby, for current economic outcomes.
Which of the following statements is the most accurate explanation for why the well known inverse relationship between a bond's price and its yield to maturity is compatible with the best interest of optimizing surplus spending units?
Surplus spending units buy bonds to transfer current resources into the future. In so doing, they are acquiring property rights to the set of fixed future payments the bond promises. As the price they pay for these property rights increases, their yield to maturity falls.
Which of the following statements is the most accurate/complete explanation of the mechanism via which Treasury Inflation-Protection Securities (TIPS) protect investors from inflation?
The Treasury Department pays a fixed contractual interest rate on TIPS and adjusts the principal for inflation. Consequently, when the rate of growth of the price level is positive, the principal is adjusted upwards so investors' effective rate of return or interest rate rises above the contractual rate to compensate for the rising price level.
Under conventional monetary policy, if the Fed believes that the economy is slowing down or about to enter a recession, it attempts to encourage demand for interest sensitive goods such as consumer durables, housing, and investment in physical capital by lowering the federal funds rate which is a very short term interest rate. However, the interest rates that are relevant for decisions about purchasing interest sensitive goods are longer term interest rates. Which of the following statements is the most accurate explanation for why the Fed's focus on the very short term federal funds rate is consistent with its objective of encouraging demand for interest sensitive goods?
The reduction in the current federal funds rate leads market participants to expect future values of the federal funds rate to be lower. Since the yield or interest rates on longer term bonds is an average of the short term interest rates or yield expected over the life of the longer term bond plus a term premium, the longer term yields or interest rates that are relevant for decisions about purchasing interest sensitive goods also fall. As such, the yield curve shifts and demand for interest sensitive goods is encouraged.
Which of the following attributes of the Preferred Habitat Theory of the term structure of interest rates most directly implies that market participants' expectations of future inflation can be extracted or inferred from yield curves?
The shape of the yield curve depends in part on investors' expectations about future short-term nominal interest rates.
Which of the following conditions would not lead to important departures from the assertion of the pure expectations theory that expected holding period returns from alternative investment strategies covering a given holding period will be equal in equilibrium?
The transactions costs associated with buying and selling short-term securities are exactly equal to that associated with buying and selling long-term securities.
Which of the following statements is the least accurate characterization of what all departures from the efficient market hypothesis have in common?
They all confirm that stock prices move only in response to news about fundamentals (i.e. information about fundamentals that was not included in the underlying information set at date t )
A fundamental problem with yield curves based on corporate bonds is that differing degrees of default risk among corporate bonds would make it difficult to unambiguously assign responsibility for observed yield differentials to variation in length of time to maturity.
True
a comparison of the level of utility Crusoe and Friday enjoy before the introduction of trading opportunities and their levels of utility after they react to the introduction of intratemporal trade.
before the introduction of intratemporal trading opportunities both Crusoe and Friday pick the production combination indicated by the points labelled E* and maximize utility by consuming the combination of apricots (i.e. A) and bacon (i.e. B) at which their marginal rate of substitution is just equal to the marginal rate of transformation.
debentures
bonds issued without specific collateral
A bank lending depositors' money to a local business and a pension fund investing contributions in shares of a company are similar financial activities in that
both involve funds being channeled from savers to borrowers through financial intermediaries.
Q2: 301Land is initially a barter economy with 200 goods. If 301land transforms into a monetary economy by converting one of the 200 goods into a medium of exchange and a medium (or unit) of account, the number of distinct relative prices agents operating in 301land will have to keep track of will
decrease by 19,701.
Restrictive covenants
either place limits on the uses of the funds the borrower receives or require that the borrower pay off the bond if the borrower's net worth drops below a certain level
Suppose that the U.S. is a net lender on international capital markets. Holding all else constant, technological improvement in the rest of the world (ROW) will
lead to increases in the demand for loanable funds in the ROW and to an increase in desired international borrowing (at the initial world real interest rate), and thereby, impart upward pressure on the world real interest rate.
Suppose that the U.S. is initially a net lender on international capital markets. Holding all else constant, a decrease in corporate income taxes in the U.S. will
lead to increases in the demand for loanable funds in the U.S. and to a decrease in desired international lending (at the initial world real interest rate), and thereby, impart upward pressure on the world real interest rate.
Historical accounts of the German hyperinflation in the early 1920s indicate that workers reacted to the astonishingly rapid rate at which the purchasing power of money was declining by converting their paychecks into goods as quickly as possible. According to the quantity theory of money, this response should have
led to an increase in the velocity of money.
bonds
maturity of 10yrs+
bills
maturity of 1yr or less
Which of the following functions of money can only be performed by money?
medium of exchange
Q4: The yield curve is a graphical representation of the
relationship that exists at a specific point in time between the length of time to maturity and the yield on securities that are identical in all respects except length of time to maturity.
Mean reversion refers to the tendency for
stocks with high returns today to experience low returns in the future and for stocks with low returns today to experience high returns in the future.
taxation of Treasury Bonds
subject to federal taxes but not state or local
Corporate Bonds
subject to federal, state, and local taxes
The additional interest that investors require to buy a long-term bond instead of a sequence of short-term bonds is known as the
term premium
Suppose the yield differential between 30-year and 10-year US government bonds (calculated as the 30-year yield minus the 10-year yield) during a given time interval was consistently negative (for example, it is negative for every day of an 18 month period). Under the preferred habitat (or liquidity premium) theory of the term structure of interest rates, it would be reasonable to infer that
that the yield curve was downward sloping and that market participants expected future short-term interest rates to fall.
relationship banking
the ability of banks to assess credit risks on the basis of private information about borrowers
the great moderation
the name given to the period of decreased macroeconomic volatility experienced in the United States starting in the 1980s.
Chairman Bernanke's observation that longer-term rates tend to fall when the Fed lowers the short term rate (i.e. the federal funds rate) is consistent with
the pure expectations and the preferred habitat theories of the term structure.
Under conventional monetary policy in the US, expansionary monetary policy exerts downward pressure on risk free interest rates such as the yield on 10-year US government bonds. As such, the 10-year yield is frequently used as the empirical measure of the risk free interest rate. Holding all else constant, under this scenario the Gordon Growth Model (GGM), predicts that
the reduction in the risk-free rate will lead to a reduction in the rate of return on equity, and thereby, to an increase in stock prices.
credit rationing
the restriction of credit by lenders such that borrowers cannot obtain the funds they desire at the given interest rate
