Eco 301 Test

If the interest rate is 5%, the value of $1,000 at the end of 10 years is

$1,628.89.

If the required reserve ratio is 3%, an initial demand deposit made in a bank of $100,000 can result in an expansion in the money supply of

$3,333,000.

Joshua says that he would need 3% interest in order to lend you money which you will pay back in two years. This implies that for Joshua the present value of $100 to be received two years from today is what amount?

$94.26

Sherry says that she requires a 3% rate of interest in order to lend you some money. This implies that for Sherry the present value of $100 to be received one year from today is

$97.09. Correct. The present value of $X to be received one year from today at i% interest is $X/(1 + i). Thus, the present value of $100 to be received one year from today at 3% interest is $100/(1 + 0.03) = $97.09.

When the parties to a transaction have different levels of knowledge about each other and/or the nature and implications of the transaction, it is said that there exists __________ information.

asymmetric Correct. Asymmetric information is said to exist when there is unequal information available to the parties in a transaction.

The market for bonds is a subset of the market for loanable funds

True Buying bonds is one of many ways that savers can supply funds to the loanable funds market and one of the many ways that borrowers may demand loanable funds.

Commonly accepted and widely used money that has no intrinsic value is known as

fiat money. Correct. Fiat money is an asset that functions throughout society as money but has no intrinsic value, such as US currency.

During World War II, the US government financed the dramatic increase in wartime spending by

increasing tax rates and selling war bonds.

To achieve its goal of monetary stability, the Bank of England sets a target

inflation rate of 2% per year.

The relationship between the economy-wide price level and the level of real GDP illustrated by the aggregate demand curve is

inverse. Correct. The aggregate demand curve slopes downward indicating an inverse relationship between the economy-wide price level and the level of real GDP.

Bond prices and interest rates are

inversely related. Correct. Bond prices and interest rates move in opposite directions.

The responsibilities of the European Central Bank include

monetary policy, foreign exchange operations, and maintenance of the payments system. Correct. The European Central Bank has four primary responsibilities: monetary policy, foreign exchange operations, maintenance of the payments system, and holding and management of official foreign reserves of Euro area countries.

The business of banking solves the problem of

a liquidity mismatch with savers desiring liquidity and borrowers desiring illiquid loans. Correct. The business of banking solves the problem of a liquidity mismatch between borrowers and lenders. Lenders (savers) desire liquidity, while borrowers want long-term loans that are by definition illiquid.

If the public's confidence in the banking system is shaken, it may cause

a run on banks. Correct. A loss in confidence can cause a run on the banking system, where depositors all descend on banks at the same time to withdraw their deposits.

The result of asymmetric information in a market is __________ selection.

adverse Correct. Adverse selection is a situation where undesirable results occur because the two parties in a transaction, the buyer and seller, have different amounts of information.

The bond rating system, in which companies like Moody's and Standard & Poor's provide ratings for a company's default risk, is one way to deal with

adverse selection. Correct. Bond rating services, such as Moody's and Standard & Poor's, collect information about bond issuers and rate their creditworthiness to provide information that partially levels the information playing field between bond issuers and potential bond buyers.

Using a two-part aggregate supply curve, an increase in aggregate demand when the economy is at less than full employment would be expected to lead to __________ in real GDP and __________ in the price level.

an increase; no increase Correct. Using the model of the two-part aggregate supply curve, an increase in demand would be expected to raise the real GDP but with no change in the price level.

Imagine that Roland goes to his bank and deposits $10,000 in cash into his savings account. The bank, wanting to use those funds to generate revenue for itself, will look to make a loan with this cash. An important determinant of how much of that $10,000 the bank can lend is the

required reserve ratio. orrect. The required reserve ratio determines the portion of a bank's deposits that must be maintained at the bank in the form of cash or reserves. If that ratio is 10%, then the bank must keep 10%, or $1,000, of Roland's deposit as reserves, while $9,000 can be used to make loans.

The Federal Reserve district banks are primarily responsible for

the check-clearing system, supervising and examining banks in their districts, and keeping track of the economy in their districts.

Three things fully describe the aspects of a bond. They are

the face value, the coupon rate, and the term to maturity

A major advantage that municipal bonds have over corporate bonds for investors is that

the income earned on municipal bonds is not subject to federal income tax. Correct. The income earned on municipal bonds is tax-exempt; therefore, for a corporate bond and a municipal bond that offer the same interest rate, the after-tax rate of return on the municipal bond will be higher.

The quantity of loanable funds supplied is directly related to interest rates because as interest rates increase

the opportunity cost of household consumption increases, causing households to bring more of their after-tax income to the pool of loanable funds. Correct. The interest rate measures the opportunity of current household consumption, so an increase in the interest rate will reduce current household consumption and increase household saving, bringing more loanable funds to the loanable funds market.

According to the pure expectations theory, a flat yield curve means the market

thinks that future interest rates will be exactly the same as current interest rates.

In the early stages of the 2007 financial crisis, the Fed introduced term auction lending

to increase the amount of liquidity in the financial system.

In the country of Trivia, it is widely believed that the marginal propensity to consume is 0.75. This means that a onetime increase in spending of $50 billion will result in an increase in GDP equal to

$200 billion Correct. The spending multiplier for Trivia is equal to: 1/(1 - MPC) = 1/(1 - 0.75) = 1/0.25 = 4. If spending in Trivia increases by $50 billion, then GDP will also increase: increase in spending × spending multiplier = $50 billion × 4 = $200 billion.

You own a 10-year, $10,000 US Treasury bond with a coupon rate of 2%. There are two years left to maturity, and you are planning to sell the bond in the secondary market. If the interest rate is 5%, how much can you expect to get for the bond?

$9,442 Correct. The price of a bond on the secondary market is the present value of the income stream it is expected to generate. In this case: PBOND = $200/(1 + k) + $10,200/(1 + k)2 = $200/1.05 + $10,200/(1.05)2 = $9,442.

Sarah is considering the purchase of a 10-year, $10,000 bond being issued by Disreputable, Inc. The bond offers an interest rate of 5.5%. The rate on a similar US Treasury bond is 2.5%. All else equal, what will Sarah's default premium be if she purchases the Disreputable, Inc. bond?

3.0% Correct. The default risk premium is the difference between the interest rate on a bond and the interest rate on a risk-free bond, usually considered to be US Treasury securities. In this case that would be 5.5% - 2.5% = 3.0%.

Carlos is considering buying either a corporate bond or a municipal bond that are exactly the same except for their yield. Carlos is in the 33% marginal tax bracket, and the municipal bond he is considering pays a 4% interest rate. To make Carlos indifferent between the two bonds, the corporate bond must offer an interest rate of how much?

5.97%.

Consider the figure below. Which of the following would lead to a shift in the demand for bonds from Demand1 to Demand0?

A decrease in societal wealth Correct. Many things can result in a decrease in the demand for bonds, among them, a decrease in societal wealth, a decline in expected returns to bonds relative to other assets, an increase in the relative riskiness of bonds, a decrease in the liquidity of bonds, and an increase in information costs related to the bond market.

Liquidity is the term that has which of these meanings?

A measure of the ease with which one asset can be converted into another asset, usually money Correct. Liquidity is defined as the ease with which one asset can be converted into another asset, especially money.

Suppose the market for loanable funds is currently in equilibrium. Which of the following factors will cause an increase in the interest rate?

An increase in business confidence Correct. An increase in business confidence will make businesses want to borrow more, increasing the demand for loanable funds and causing the interest rate to increase.

The rational expectations approach postulates what two aggregate supply curves?

An upward-sloping short-run aggregate supply curve and a vertical long-run supply curve at the full-employment level of GDP. Correct. In the rational expectations formulation of aggregate supply, there is an upward-sloping short-run aggregate supply curve and a vertical long-run aggregate supply curve at the full-employment level of GDP.

Which of these statements best describes the function of banks as part of the aggregate economy?

Banks create or reduce the amount of money available in the economy.

Which of these statements is most true of the function of banks?

Banks play a key role in creating money, and they help with the problem of adverse selection.

Which of these is an example of asymmetric information in banking?

Borrowers know more about their capacity to repay loans than lenders. Correct. Borrowers know more about their capacity to repay loans than lenders do, meaning that there is asymmetric information in this relationship.

Aggregate demand is equal to

C + I + G + (X - M). Correct. Aggregate demand is the sum of consumption expenditures (C), investment spending (I), government spending (G), and net exports (X - M).

Consider the figure below. Which of the following will cause a shift in aggregate demand from AD2 to AD1?

Correct. An increase in interest rates will lead to a decrease in business investment spending, which is indicated by a shift in the aggregate demand curve from AD2 to AD1.

Imagine you run a company that produces recycled paper products. The selling price for items you produce is going up, so you increase production. After a time, you see that you have increased production more than the market is actually demanding. Which of these is the most likely reason for less demand than you had estimated based on a higher price for your items?

Inflation Correct. A scarcity of alternatives would produce greater demand, but inflation can be a partial reason for higher prices, rather than (or instead of) an increased demand.

You read a review written by a well-respected financial analyst who says that the steep yield curve we currently see suggests that borrowers require a relatively higher premium to hold longer-term bonds now, compared to short-term bonds. This analyst is most likely a proponent of which theory of interest rates?

Term premium

What would be expected in a market for used cars, assuming asymmetric information and buyers who have little way to determine good used cars from poor used cars?

The average price for used cars would go down and drive the better used cars out of the market. Correct. In the market for used cars, where buyers have a hard time distinguishing between a high-quality used car and a clunker, the average price for used cars will be driven down and the better used cars will disappear from this market.

The position of chair of the Federal Reserve is filled in what way?

The chair of the Fed is appointed by the president of the United States and confirmed by the US Senate.

What problem may occur if an economy has too few banks or none at all?

The economy will be underdeveloped, with a possible increase in unemployment and business failures. Correct. Without banks, economic studies have demonstrated that there can be related problems in overall economic development, including high unemployment and business failures.

Deductibles are one way insurance companies protect themselves from careless drivers.

True Careless drivers are a risk to insurance companies and sometimes a greater risk to the insurance company than they are to themselves. To overcome this moral hazard to some degree, car insurance typically carries a deductible for damages to the car.

Financial assets include intangibles that can change in value, such as stocks and bonds

True Financial assets are defined as including both tangible money and intangibles that have monetary value.

Real Business Cycle models, or RBCs, assume there is one perfectly rational household that represents all households, and one firm that represents all firms. Thus, these models are also referred to as representative agent models.

True RBCs are an economic model that assumes rational households and rational business firms.

The Financial Services Act of 2012 made it clear that the Bank of England is now the main regulator of British financial markets.

True The Bank of England became the most important regulator of the British financial markets after the passage of the Financial Services Act of 2012.

The securities that the Federal Reserve holds on its balance sheet include

US Treasury securities, federal agency debt, and privately issued mortgage-backed securities. Correct. The primary securities that the Fed holds on its balance sheet are US Treasury securities, federal agency debt, and privately issued mortgage-backed securities.

In which of the following situations did the three-part aggregate supply model not perform well?

Understanding the stagflation of the late 1960s and early 1970s Correct. The stagflation of the late 1960s and early 1970s caused economists to begin to question the robustness of the three-part aggregate supply curve and different models began to be used.

The risk that a bond issuer will not be able to live up to the promise they make when they issue a bond is known as __________ risk.

default Correct. The risk that a bondholder bears due to the possibility that a bond issuer is unable to live up to their promise is known as default risk.

In a barter economy, the number of prices necessary will

depend on the number of goods exchanged in the economy. Correct. The number of prices in a barter economy is equal to the number of paired goods. Therefore, a single good "A" may have a price measured in terms of many other goods that people might trade for good "A."

The Panic of 1907 was triggered by

excessive speculation in the stock market, excessively loose lending by banks and trusts, and a lack of effective oversight of financial markets.

The Pigou effect is one of the reasons that the aggregate demand curve slopes downward. According to this argument, when the price level

goes down, peoples' savings are able to purchase more stuff so the total level of spending increases. Correct. The Pigou effect suggests that when the economy-wide price level falls, the purchasing power of peoples' savings increases and therefore the level of total spending increases.

The entity responsible for making the monetary policy decisions in the European Central Bank is the

governing council. Correct. The governing council of the ECB has the responsibility of conducting monetary policy.

Stagflation is the term used for an economy experiencing a combination of

high unemployment and rising rates of inflation.

An inverted yield occurs when

long-term interest rates are lower than short-term interest rates. Correct. An inverted yield curve means that long-term interest rates are lower than short-term interest rates.

The Bank of England has two primary responsibilities, which are __________ and __________.

monetary stability; financial stability

A 10-year, $10,000 bond with a coupon rate of 5% is a promise by the issuer of the bond to

pay the bondholder $500 every year for 10 years and also a $10,000 payment in 10 years Correct. A 10-year, $10,000 bond with a coupon rate of 5% is a promise by the issuer of the bond to pay the bondholder $500 every year for 10 years and also a one-time payment of $10,000 in 10 years.

On payday you get paid in cash, so each week you put $10 into a shoebox in your closet so that you can buy a big-screen TV at the end of the year. In this situation, money is serving as a

store of value.

A yield curve illustrates the relationship between the

term to maturity of bonds and the interest rate they pay, at a particular point of time. Correct. A yield curve is the relationship between the term to maturity of bonds and the interest rate they pay, at a particular point in time.

The three reasons that the economy-wide price level and the level of real GDP move in opposite directions are

the Pigou effect, Keynes's interest rate effect, and the foreign trade effect. Correct. The Pigou effect, Keynes's interest rate effect, and the foreign trade effect are the three reasons that the aggregate demand curve slopes downward.

The primary responsibility of all central banks is monetary policy.

True

A yield curve generally slopes upward but may slope downward if short-term interest rates on bonds are higher than longer-term interest rates.

True A downward-sloping, or inverted, yield curve indicates that short-term rates are perceived as "too high" and will be lower in the future. It is a less typical yield curve and usually indicates fears of an economic slowdown.

Financial markets bring together __________ and __________.

borrowers; lenders

The two major goals of Canadian monetary policy are __________ and __________.

flexible exchange rates; inflation control

The three governing bodies of the European Central Bank (ECB) are the

governing council, general council, and executive board.

Which of the following could cause an increase in the supply of loanable funds?

Expansionary monetary policy being followed by the Federal Reserve

Which of these categories is the largest asset on the Federal Reserve's balance sheet—by far?

Securities Correct. The Fed's largest asset is its holdings of securities, which include US Treasury bills, notes, and bonds; federal agency debt; and privately issued mortgage-backed securities.

An increase in the price of bonds will cause a decrease in the demand for bonds

False An increase in the price of bonds will cause an increase in the quantity of bonds demanded

If the market interest rate exceeds the coupon rate on a bond, the selling price of the bond will be greater than the bond's face value.

False If the market interest rate exceeds the coupon rate on a bond, the selling price of the bond will be less than the bond's face value.​

A corporate bond offering an interest rate of 5% is as good a deal as a municipal bond offering the same interest rate.

False The municipal bond is a better deal for an investor because the interest income is tax-free so the after-tax rate of return on the municipal bond will be higher.

Following the Great Depression, the power of the Fed shifted to the

Federal Open Market Committee. Correct. The Banking Act of 1935 brought major changes to the Federal Reserve, one of which was the creation of the Federal Open Market Committee, which became the most powerful committee of the Fed.

Which entities, by definition, issue the legal contracts known as bonds?

Governments, corporations, and government agencies Correct. Bonds are promises to repay that are issued by governments, corporations, and government agencies

Money is most accurately defined by which of the following statements?

Money is anything generally accepted in exchange for goods and services. Correct. Money is what individuals and businesses use to buy the things they want or need. It does not have to come from the government or a central bank.

Financial assets include which of the following?

Money, bonds, and stocks Correct. Financial assets include all of the following: money, stocks, bonds, deposits in checking accounts, and deposits in savings accounts.

Consider the figure below. Which of the following occurrences will shift the supply of bonds from Supply0 to Supply1?

More optimistic outlook on the future by business, higher expected inflation in the future, federal government deficits, and increases in investment tax credits all lead to increases in the supply of bonds.

Consider the figure below. The initial equilibrium in the loanable funds market in Etopia is at A. If the banks in Etopia begin to see an upsurge in deposits, this will result in a new equilibrium at what point?

Point D with a decrease in the interest rate Correct. An upsurge in bank deposits in Etopia will result in an increased desire by bankers to make loans. The increase in loans will result in an increase in the supply of loanable funds, shifting the supply curve to S' while the demand for loanable funds remains unchanged. Thus, we can expect a fall in the interest rate and an increase in the quantity of loanable funds lent and borrowed in Etopia.

Which of these most accurately defines possible effects of fluctuating interest rates in the financial markets?

Prices and levels of employment

When a coffee shop lists a tall coffee on its menu at $2.95, the coffee shop is using money as a

unit of account. Correct. Money has three functions in society: a medium of exchange, a unit of account, and a store of value. In this example, the price of the coffee represents a unit of account. A unit of account is an agreed upon method of placing relative value on goods and services.

Suppose that the interest rate on a one-year bond is currently 3% and the market believes that the rate on a one-year bond one year from now will be 5%. If you follow the pure expectations theory of interest rates, then you would expect to see a(n) __________ yield curve.

upward-sloping Correct. When the market believes that future interest rates will be higher than current interest rates, then pure expectations theorists would predict an upward-sloping yield curve.

Imagine you live in a country suffering from extreme inflation of 20% per month. The money you earn, every single molino, is worth a little less each week, so you and many others around you begin to use the currency of a more prosperous neighboring country, the dolingo. What is the term for this practice of adopting another country's currency?

Dollarization Correct. Dollarization occurs when the citizens and merchants of a country begin to use the currency of another country for their transactions. Note that it is not always the US dollar that serves in this capacity.

Which of these groups of people is most hurt by inflation?

Lenders and working class people Correct. Lenders (savers) are hurt because the returns they receive are worth less than previously; working class people suffer because wages and salaries usually fail to keep up with inflation.

Which of the following statements most accurately describes the measurements of the money supply known as M1 and M2?

M1 was a measure of the money supply that worked well until the mid-1970s; then M2 became a more accurate measure until the 1990s. Correct. M1 was used until the mid-1970s, M2 was used successfully until the early 1990s, and there is currently no agreed-upon monetary aggregate.

If gold and silver became the primary types of commodity money in circulation, what would most likely be expected if there was a sudden and great amount of hoarding of these two items?

There would likely not be enough money, and the economy could slide into an economic recession. Correct. With a sudden and great amount of hoarding of the primary commodity money, it would become difficult to buy and sell, and the economy could slide into an economic recession.

When the Federal Reserve was created in 1913, what were its two primary purposes?

To maintain the gold standard and be a "lender of last resort" to commercial banks

Inflation is a benefit in the short run to

borrowers. Correct. Inflation favors borrowers as they are able to pay off their loans with dollars whose purchasing power has declined. In the long run, borrowers will also suffer from the negative impact of that same inflation.

The three theories that economists have developed to explain the shape of the yield curve are

the pure expectations theory, the term premium theory, and the segmented market theory Correct. The three theories that economists have developed to explain the shape of the yield curve are the pure expectations theory, the term premium theory, and the segmented market theory.