Econ 423 Midterm

Assets Liabilities Rate-sensitive $40 million $50 million Fixed-rate $60 million $50 million Suppose the First National Bank has a balance sheet as shown above. If interest rates rise by 5 percentage points, say from 10 to 15%, bank profits (measured using gap analysis) will A. decline by $0.5 million. B. decline by $1.5 million. C. decline by $2.5 million. D. increase by $2.0 million.

A. decline by $0.5 million.

If a bank has $10 million of checkable deposits, a required reserve ratio of 10 percent, and it holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow of A. $1.2 million. B. $1.1 million. C. $1 million. D. $900,000.

A. $1.2 million. Feedback: Let D (in $M) be the maximal deposit outflow that can be supported by the bank. Then D satisfies required reserve after D outflow = (0.10)*(10 - D) = 2 - D So D = $1.11M.

Assume that the following are the predicted inflation rates in these countries for the year: 2% for the United States, 3% for Canada; 4% for Mexico, and 5% for Brazil. According to the theory of purchasing power parity (PPP) and everything else held constant, which of the following would we expect to happen? A. The Brazilian real will depreciate against the U.S. dollar. B. The Mexican peso will depreciate against the Brazilian real. C. The Canadian dollar will depreciate against the Mexican peso. D. The U.S. dollar will depreciate against the Canadian dollar.

A. The Brazilian real will depreciate against the U.S. dollar.

A bank failure occurs whenever A. a bank cannot satisfy its obligations to pay its depositors and other creditors. B. a bank suffers a large deposit outflow. C. a bank has to call in a large volume of loans. D. a bank refuses to make new loans.

A. a bank cannot satisfy its obligations to pay its depositors and other creditors.

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% loss if the borrower defaults. C. the borrower's lack of incentive to seek a loan for highly risky investments. D. the lender's inability to restrict the borrower from changing his behavior once given a loan.

A. the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.

Using the Gordon growth formula, if the first year-end dividend to be paid is $1.00, the required return is 10% or 0.10, and dividend growth rate is 5% or 0.05, then the current stock price is A. $10. B. $20. C. $30. D. $40.

B. $20.

If borrowers with the most risky investment projects seek bank loans in higher proportion to those borrowers with the safest investment projects, banks are said to face the problem of A. adverse credit risk. B. adverse selection. C. moral hazard. D. lemon lenders.

B. adverse selection.

If expectations are formed rationally, then individuals A. will have a forecast that is 100% accurate all of the time. B. change their forecast when faced with new information. C. use only the information from past data on a single variable to form their forecast. D. have forecast errors that are persistently low.

B. change their forecast when faced with new information.

Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is A. consistent with the efficient markets hypothesis if the favorable earnings were expected. B. consistent with the efficient markets hypothesis if the earnings were not as high as anticipated. C. consistent with the efficient markets hypothesis if the earnings were not as low as anticipated. D. clearly inconsistent with the efficient markets hypothesis.

B. consistent with the efficient markets hypothesis if the earnings were not as high as anticipated.

First National Bank Assets Liabilities Rate-sensitive $20 million $50 million Fixed-rate $80 million $50 million If interest rates rise by 5 percentage points, say, from 10 to 15%, bank profits (measured using gap analysis) will A. decline by $0.5 million. B. decline by $1.5 million. C. decline by $2.5 million. D. increase by $1.5 million.

B. decline by $1.5 million. Feedback: gap = $20M - $50M = -$30M so change in profit = (-$30M) * (5%) = -$1.5M

When the expected return on ________ assets is high relative to the expected return on ________ assets, there is a ________ demand for domestic assets, everything else held constant. A. domestic; foreign; constant B. domestic; foreign; higher C. foreign; domestic; higher D. foreign; domestic; constant

B. domestic; foreign; higher

When the uncertainty in the outlook of the economy increases, risk-averse investors' required returns on investment in equity ________ and the stock prices will ________, everything else held constant. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease

B. increase; decrease

According to the Gordon growth model, a monetary expansion (when the Fed lowers interest rates) ________ stock prices due to a decrease in the ________ and likely also an increase in the ________, everything else held constant. A. increases; required rate of return; future sales price B. increases; required rate of return; dividend growth rate C. reduces; current dividend; expected rate of return D. reduces; future sales price; expected rate of return

B. increases; required rate of return; dividend growth rate

Which of the following bank assets is the most liquid? A. consumer loans B. reserves C. state and local government securities D. U.S. government securities

B. reserves

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

B. short-term; longer-term

When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the bank's final balance sheet A. the 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.

B. the liabilities of the bank increase by $1,000,000.

If the British pound appreciates from $0.50 per pound to $0.75 per pound, the U.S. dollar depreciates from ________ per dollar to ________ per dollar. A. £2; £2.5 B. £2; £1.33 C. £2; £1.5 D. £2; £1.25

B. £2; £1.33

Using the one-period valuation model, assuming a year-end dividend of $0.11, an expected sales price of $110, and a required rate of return of 10%, the current valuation of the stock would be A. $110.11. B. $121.12. C. $100.10. D. $109.89

C. $100.10.

Does the efficient markets hypothesis imply that the average investor will not earn anything by purchasing stock? A. Yes, the efficient markets hypothesis implies that the best that the average investor can do is break even. B. Yes, the efficient markets hypothesis implies that stock purchases are extremely risky and that the average investor has no hope of recovering any loss. C. No, the efficient market hypothesis implies that the average investor should not expect to receive abnormally high returns on a consistent basis. D. No, the efficient market hypothesis implies that the investor will consistently earn abnormally high returns by purchasing stock.

C. No, the efficient market hypothesis implies that the average investor should not expect to receive abnormally high returns on a consistent basis.

Financial markets quickly eliminate unexploited profit opportunities through changes in A. tax laws. B. monetary policy. C. asset prices. D. dividend payments.

C. asset prices.

When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per pound, then, holding everything else constant, the pound has ________ and ________ expensive. A. appreciated; British cars sold in the United States become more B. appreciated; British cars sold in the United States become less C. depreciated; American wheat sold in Britain becomes more D. depreciated; American wheat sold in Britain becomes less

C. depreciated; American wheat sold in Britain becomes more

Holding large amounts of bank capital helps prevent bank failures because A. it means that the bank has a higher income. B. it makes loans easier to sell. C. it can be used to absorb the losses resulting from bad loans. D. it makes it easier to call in loans.

C. it can be used to absorb the losses resulting from bad loans.

If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to A. buy back bank stock. B. pay higher dividends. C. reduce the bank's assets by making fewer loans. D. sell securities the bank owns and put the funds into the reserve account.

C. reduce the bank's assets by making fewer loans

If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can A. reduce deposits by $3 million. B. increase loans by $3 million. C. sell $3 million of securities that the bank currently owns. D. repay its discount loans from the Fed.

C. sell $3 million of securities that the bank currently owns.

Amy deposits $50 in her account at Bank of America (BoA). Meanwhile, a $100 check she wrote on this account is cashed at PNC. As a consequence of the two events, A. the assets of BoA rise by $50. B. the assets of PNC rise by $50. C. the reserves at BoA fall by $50. D. the liabilities at PNC rise by $50.

C. the reserves at BoA fall by $50.

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 and the risk of bank failure D. too much capital, making it more difficult to obtain loans.

C. too little capital, increasing the return on equity and the risk of bank failure

When expectations are formed rationally, forecast errors will, on average, be ________ and ________ be predicted ahead of time. A. positive; can B. positive; cannot C. zero; cannot D. negative; can

C. zero; cannot

Which of the following would NOT be a way to increase the return on equity? A. Buy back bank stock B. Pay higher dividends C. Acquire new funds by selling negotiable CDs and increase assets with them D. Sell more bank stock

D. Sell more bank stock

The theory of purchasing power parity (PPP) implies that the real exchange rate should always be 1, which fails to match the data. It is because the theory ignores ________. A. non-tradable goods and services B. transportation costs and other frictions such as trade barriers C. hard-to-measure differences such as quality or brand reputation in the same type of goods or services D. all of the above

D. all of the above

If, in retaliation for "unfair" trade practices, country A imposes a 30 percent tariff on country B's products, but at the same time, A's demand for B's goods increases, then, in the long run, ________, everything else held constant. A. currency B should appreciate relative to currency A B. currency B should depreciate relative to currency A C. there is no effect on currency B relative to currency A D. currency B could appreciate, depreciate, or remain unchanged relative to currency A

D. currency B could appreciate, depreciate, or remain unchanged relative to currency A

Suppose the Federal Reserve releases a policy statement today which leads people to believe that the Fed will be enacting expansionary monetary policy (lowering interest rates) in the near future. Everything else held constant, the release of this statement would immediately cause the demand for U.S. assets to ________ and the U.S. dollar to ________. A. increase; appreciate B. decrease; appreciate C. increase; depreciate D. decrease; depreciate

D. decrease; depreciate

Everything else held constant, if there is an increase in the demand for ________ goods relative to ________ goods, the ________ currency will __________. A. foreign; domestic; foreign; depreciate B. foreign; domestic; domestic; appreciate C. domestic; foreign; domestic; depreciate D. domestic; foreign; domestic; appreciate

D. domestic; foreign; domestic; appreciate

Banks may borrow from or lend to another bank in the Federal Funds market. A loan of excess reserves from one bank to another bank is recorded as a(n) ________ for the borrowing bank and a(n) ________ for the lending bank. A. asset; asset B. asset; liability C. liability; liability D. liability; asset

D. liability; asset

Once borrowers have a loan, they are more likely to invest in high-risk investment projects. In this case, banks face the A. adverse selection problem. B. lemon problem. C. adverse credit risk problem. D. moral hazard problem.

D. moral hazard problem.

Suppose a firm in country A imports input goods from country B to produce its own product and sell to consumers in country A. All else unchanged, if country A's currency appreciates relative to B's currency, this particular firm ____________. A. faces higher cost of purchasing inputs B. should consider switching to a domestic supplier of inputs C. should consider exporting to country B D. none of the above

D. none of the above

In general, banks would prefer to acquire funds quickly by ________ rather than ________. A. reducing loans; selling securities B. "calling in" loans; selling securities C. reducing loans; borrowing from other banks D. selling securities; reducing loans

D. selling securities; reducing loans

In the one-period valuation model, the current stock price increases if A. dividends are cut. B. the required return increases. C. the expected sales price falls. D. the expected sales price increases.

D. the expected sales price increases.

Using the Gordon growth model, a stock's current price decreases when A. the expected dividend payment increases. B. the required return on equity decreases. C. the dividend growth rate increases. D. the growth rate of dividends decreases.

D. the growth rate of dividends decreases.