Money and Banking Exam 1 Practice Test

A credit boom can lead to a(n) ________ such as we saw in the tech stock market in the late 1990s. : A) asset-price bubble B) decrease in moral hazard C) decline in lending D) liability war

A) asset-price bubble

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 earnings were not as high as anticipated. B) consistent with the efficient markets hypothesis if the earnings were not as low as anticipated. C) clearly inconsistent with the efficient markets hypothesis. D) consistent with the efficient markets hypothesis if the favorable earnings were expected.

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

The reduction in transactions costs per dollar of investment as the size of transactions increases is: A) economies of scale. B) economies of trade. C) diversification. D) discounting.

A) economies of scale.

Bank capital is listed on the ________ side of the bank's balance sheet because it represents a ________ of funds. A) liability; source B) liability; use C) asset; use D) asset; source

A) liability; source

When Jane Brown writes a $100 check to her nephew (who lives in another state), Ms. Brown's bank ________ assets of $100 and ________ liabilities of $100. : A) loses; loses B) loses; gains C) gains; gains D) gains; loses

A) loses; loses

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

A) moral hazard problem.

One reason financial systems in developing and transition countries are underdeveloped is: A) the legal system may be poor making it difficult to enforce restrictive covenants. B) they have weak links to their governments. C) the accounting standards are too stringent for the banks to meet. D) they make loans only to nonprofit entities.

A) the legal system may be poor making it difficult to enforce restrictive covenants.

The largest percentage of banks' holdings of securities consist of: A) tax-exempt municipal securities. B) Treasury and government agency securities. C) corporate securities. D) state and local government securities.

B) Treasury and government agency securities.

In a bank panic, the source of contagion is the: A) free-rider problem. B) asymmetric information problem. C) transactions cost problem. D) too-big-to-fail problem

B) asymmetric information problem.

A bank with insufficient reserves can increase its reserves by: A) buying municipal bonds. B) calling in loans. C) lending federal funds. D) buying short-term Treasury securities.

B) calling in loans.

According to the efficient markets hypothesis, the current price of a financial security: A) is determined by the highest successful bidder. B) fully reflects all available relevant information. C) is a result of none of the above. D) is the discounted net present value of future interest payments.

B) fully reflects all available relevant information.

In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity. A) proportional to B) less than C) greater than D) equal to

B) less than

The goals of bank asset management include: A) minimizing liquidity. B) purchasing securities with high returns and low risk. C) lending at high interest rates regardless of risk. D) maximizing risk.

B) purchasing securities with high returns and low risk.

Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are: A) illegal. B) restrictive covenants. C) limited-liability clauses. D) risk insurance.

B) restrictive covenants.

Rational expectations forecast errors will on average be ________ and therefore ________ be predicted ahead of time. A) negative; can B) zero; cannot C) positive; can D) positive; cannot

B) zero; cannot

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

C) $25,000.

A serious consequence of a financial crisis is: A) an increase in asset prices. B) financial engineering. C) a contraction in economic activity. D) financial globalization.

C) a contraction in economic activity.

The view that expectations change relatively slowly over time in response to new information is known in economics as: A) slow-response expectations. B) rational expectations. C) adaptive expectations. D) irrational expectations.

C) adaptive expectations.

Debt deflation occurs when: A) rising interest rates worsen adverse selection and moral hazard problems. B) corporations pay back their loans before the scheduled maturity date. C) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness. D) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral.

C) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness.

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) costly state verification. C) asymmetric information. D) free-riding.

C) asymmetric information.

If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits. A) more; a decline B) fewer; a surge C) more; an increase D) fewer; an increase

C) more; an increase

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

C) more; lower

In October 2008, the stock market crashed, falling by ________ from its peak value a year earlier. A) over 30% B) over 50% C) over 40% D) over 25%

C) over 40%

The mismanagement of financial liberalization in emerging market countries can be understood as a severe ________. A) lemons problem. B) asymmetric information problem. C) principal/agent problem D) free-rider problem.

C) principal/agent problem

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) sell securities the bank owns and put the funds into the reserve account. C) shrink the size of the bank. D) pay higher dividends.

C) shrink the size of the bank.

If additional information is not used when forming an optimal forecast because it is not available at that time, then expectations are: A) formed adaptively. B) formed equivalently. C) still considered to be formed rationally. D) obviously formed irrationally.

C) still considered to be formed rationally.

Of the following sources of external finance for American nonfinancial businesses, the least important is: A) bonds and commercial paper. B) loans from other financial intermediaries. C) stocks. D) loans from banks.

C) stocks.

When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to make any loans but to hold excess reserves instead, then, in the bank's final balance sheet, : A) the liabilities of the bank decrease by $1 million. B) liabilities increase by $200,000. C) the assets at the bank increase by $1 million. D) reserves increase by $200,000.

C) the assets at the bank increase by $1 million.

Adverse selection is a problem associated with equity and debt contracts arising from: A) the lender's inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults. B) the borrower's lack of incentive to seek a loan for highly risky investments. C) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. D) the lender's inability to restrict the borrower from changing his behavior once given a loan.

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

The major criticism of the view that expectations are formed adaptively is that: A) it is easier to model adaptive expectations than it is to model rational expectations. B) adaptive expectations models have no predictive power. C) this view ignores that people use more information than just past data to form their expectations. D) people are irrational and therefore never learn from past mistakes.

C) this view ignores that people use more information than just past data to form their expectations.

Because ________ are less liquid for the depositor than ________, they earn higher interest rates. A) money market deposit accounts; passbook savings B) money market deposit accounts; time deposits. C) time deposits; passbook savings. D) passbook savings; time deposits.

C) time deposits; passbook savings.

Which of the following are reported as liabilities on a bank's balance sheet? A) Deposits with other banks B) Reserves C) Loans D) Checkable deposits

D) Checkable deposits

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do. A) agents; agents B) principals; principals C) principals; agents D) agents; principals

D) agents; principals

1) Periodic payments of net earnings to shareholders are known as: A) interest. B) capital gains. C) profits. D) dividends.

D) dividends.

The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient market, : A) it will tend to go unnoticed for some time. B) prices will reflect the unexploited profit opportunity. C) financial analysts are your best source of this information. D) it will be quickly eliminated.

D) it will be quickly eliminated.

The inaccurate ratings provided by credit-rating agencies: A) meant that investors actually took on less risk. B) will not be a problem when determining capital requirements under Basel 2. C) were irrelevant since no one pays any attention to them anyway. D) meant that investors did not have the information they needed to make informed choices about their investments.

D) meant that investors did not have the information they needed to make informed choices about their investments.

The originate-to-distribute business model has a serious ________ problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk. : A) democratization of credit B) debt deflation C) collateralized debt D) principal-agent

D) principal-agent

In the one-period valuation model, an increase in the required return on investments in equity: A) increases the current price of a stock. B) reduces the expected sales price of a stock. C) increases the expected sales price of a stock. D) reduces the current price of a stock.

D) reduces the current price of a stock.

Information plays an important role in asset pricing because it allows the buyer to more accurately judge ________. A) policy B) capital C) liquidity D) risk

D) risk