MIDTERM REVIEW

Part 1: Multiple Choices Questions

1. Which function of money eliminates the requirement of a "double coincidence of wants," which exists in a barter economy?A) Store of valueB) Standard of valueC) Medium of exchangeD) Standard of deferred payment

2. Which of the following assets is most liquid?A) Government bonds.B) Land.C) Bank accountsD) Money.

3. Which of the following is not a function of money?A) Medium of exchangeB) IntermediationC) Medium of account.D) Store of value

4. A monetary system in which the value of the monetary unit is kept equal to a specified quantity of a particular commodity is calledA) a fiat-money standard.B) a gold standard.C) a commodity standard.D) bimetallism.

5. What was the main attraction of the gold standard?A) It would allow greater use of discretionary monetary policy.B) It would allow greater exchange rate flexibility.C) It would eliminate the use of use of discretionary monetary policy.D) It would give gold intrinsic value.

6. Gresham's Law states thatA) good money drives out bad money.B) bad money drives out good money.C) gold coins drive out silver coins.D) silver standard drives out gold standard.

7. The current monetary system in Canada can be characterized as aA) gold standard system.B) commodity money system.C) fiat money system.D) representative full-bodied monetary system.

8. The Canadian Payments Association is mandated to accomplish two primary objectives:A) To control the volume of paper currency in the economy.B) To develop and operate the national clearing and settlement system.C) To develop and operate the national clearing and settlement system and plan the

evolution of the national payment system.D) To develop and operate the national clearing and settlement system and regulate

the banking system.

9. The Canadian Payments Association was created byA) The Canadian Banker's Association.B) The Bank of Canada.C) an Act of Parliament.D) all of the above.

10. Which of the following is not included in M2?A) Currency and coins in public circulation.B) Demand deposits.C) Money market mutual funds.D) Personal savings deposits.

11. Which one of the following increase the social welfare loss due to inflation?A) The fact that tax systems are based on nominal income and expenses.B) Uncertainty associated with higher and more volatile prices.C) The added difficulties of interpreting financial statements.D) All of the above

12. Financial intermediation reduces costs byA) easing the liquidity constraint of households and firms.B) shifting risk.C) economies of scale and scope.D) making loans.

13. Financial intermediaries increase economic efficiency byA) adding another layer to the savings-investment process, increase the problems of

asymmetric information.B) reducing risk through portfolio diversification.C) borrowing long-term and lending short-term.D) causing adverse selection.

14. BrokersA) make profits by speculating.B) act as agents for buyers and/or sellers.C) act as agents for financial institutions.D) provide investment loans.

15. Which of the following is not a financial intermediary?A) Chartered banks.B) Life insurance companies.C) Trust and mortgage loan companies.D) The Bank of Canada.

16. Newly issued securities are sold in theA) Toronto Stock Exchange.B) money market.C) primary market.D) secondary market.

17. Money market instrumentsA) bear no specified interest payment.B) never sell at a premium to face value.C) have less than 1 year to maturity.D) are risk free.

18. Which one of the following is a capital market instrument?A) Money market mutual fund.B) Saving deposit.C) Cash.D) Mortgage.

19. The overnight rate will generally remain A) below the bank rate because the Bank of Canada will borrow at that rate.B) below the deposit rate because the Bank of Canada will borrow at that rate.C) above the bank rate because the Bank of Canada will borrow at that rate.D) above the deposit rate because the Bank of Canada will borrow at that rate.

20. Treasury bills areA) money market instruments.B) capital market instruments.C) issued by the Bank of Canada.D) always sold at face value.

21. If the market price of a bond is $95 and its face value is $100, then it is soldA) at par.B) at a loss.C) at a discount.D) at a premium.

23. The Bank Rate is the rate of interestA) charged by chartered banks on loans to its best customers.B) offered by chartered banks to deposits.C) charged on interbank deposits.D) charged by the Bank of Canada on loans made to members of the Canadian

Payments Association.

24. The typical maturity of Treasury Bills isA) 91 to 365 daysB) 1 business day.C) 10 to 365 days.D) At any time.

25. Open market operations refer to the Bank of Canada's purchase or sale of ________ in the open market.A) Canadian dollars.B) government securities.C) certificates of deposits.D) derivative products.

26. The Canadian Payment Association is responsible for which of the following:A) To pay each of the federal government’s outstanding payables as they come dueB) To facilitate the development of new technologies that might impact the payments

systemC) To account for and audit the reserve requirements of the Canadian banking systemD) To provide consultation to the government on the 2010 CPA requirementsE) To act as the government of Canada’s banker

27. To borrow funds directly from the money market, corporations can issue

A) Treasury bills.B) bankers' acceptances.C) corporate paper.D) letters of credit.

28. Which of the following is a capital market instrument?A) Commercial paperB) Letter of credit.C) Corporate bond.D) Treasury bill.

29. Which of the following has the lowest default risk?A) Government of Canada bonds.B) Provincial bonds.C) Municipal bonds.D) Corporate bonds.

30. Private corporations can issue _____________ to raise funds in the capital marketA) corporate bonds and commercial paper.B) corporate bonds and stocks.C) commercial paper and stocks.D) corporate bonds, commercial paper and stocks.

31. Which of the following is an example of derivatives?A) Eurocurrency instruments.B) Letters of credit.C) Options.D) Special Purchase and Resale Agreements.

32. A financial instrument that gives the investor the opportunity to purchase a financial instrument at a specified price is known as aA) forward rate agreement.B) call option.C) put option.D) swap.

33. The degree to which individuals value immediate consumption over deferred consumption is calledA) the discount rate.B) present value.C) the rate of time preference.D) the market interest rate.

34. Which of the following is not a function of the Bank of Canada?A) Acting as the federal government’s bankerB) Supervising the Chartered BanksC) Issuing currencyD) Setting the rate of inflationE) Regulating the supply of money

35. The annual interest rate at time t (today) can be expressed asA) Rt = (dollars to be paid back one year from today – dollars received today)/(dollars

received today)B) Rt = (dollars received today - dollars to be paid back one year from today)/(dollars

received today)C) Rt = (dollars to be paid back one year from today – dollars received today)/(dollars

to be paid back one year from today)D) Rt = (dollars received today - dollars to be paid back one year from today)/(dollars

to be paid back one year from today)

36. The present value of a stream of cash flows decreases whenA) the interest rate decreases.B) the length of time before the economic agent will receive the cash flows decreases.C) the interest rate increases.D) the number of cash inflows decreases.

37. What annual interest rate generates a present value of $90 when the future value one year hence is $100?A) 9.0%B) 10%C) 1.11%D) 11.1%

38. What is the present value of a $1,000 bond with a coupon payment of $65 annually and a term to maturity of 5 years if the yield on comparable securities is 8 percent? A) $1052.18.B) $940.11.C) $943.40.D) $1000.

39. The discount factor for a 2-year loan at an interest rate Rt isA) 1/(1 + Rt)B) 1/(1 + Rt)2

C) 1/(1 + PVt)D) 1/(1 + FV)

40. The yield to maturity of a financial instrument isA) the difference between its present value and its future value.B) the difference between its future value and its future value.C) the ratio of its future value to its present value.D) the rate of return if it is held until maturity.

41. The loanable funds theory explains that equilibrium interest rate level is determined byA) the demand for money and the supply of money.B) the demand for money and the supply of loanable funds.C) the demand for and the supply of loanable funds.D) the demand for bonds and the supply of money.

42. According to the loanable funds theory, which of the following would shift the supply curve of loanable funds leftward?A) An increase in the wealth of households.B) An increase in bond returns relative to other assets.C) An increase in the riskiness of bonds.D) An increase in the government budget deficit.

43. The motives for holding money areA) transaction and precautionary motives.B) transaction and speculative motives.C) transaction, liquidity and speculative motives.D) transaction, precautionary and speculative motives.

44. Many individuals would have a speculative motive for holding money balancesA) if they expected interest rates to rise.B) if they expected interest rates to fall.C) if their income to rose.D) if their income to fell.

45. The term structure of interest rates involves the relationship betweenA) liquidity and yield.B) term to maturity and default risk.C) default risk and yield.D) time to maturity and yield.

46. In analyzing the term structure of interest rates, the following variables are held constant exceptA) tax treatment of interest.B) liquidity.C) default risk.D) term to maturity.

47. The expectations theory of term structure assumes thatA) investors have preferences for short-term securities.B) investors have preferences for long-term securities.C) investors are indifferent to long-term and short-term bonds as long as their

expected yields are the same.D) long-term and short-term bonds are not substitutes.

48. According to the market segmentation theory of term structureA) investors are indifferent to the maturity of debt instruments.B) borrowers prefer to borrow short term and lend long term.C) the slope of the yield curve reflects market expectations about future interest rates.D) Long-term and short-term bonds are not substitutes to each other.

49. The Canadian bond rating services like Dominion Bond Rating and Canadian Bond Rating considerA) government of Canada bonds to be of the lowest quality.B) government of Canada bonds to be of the highest quality.C) corporate bonds to be of the highest quality.D) neither government of Canada bonds nor corporate bonds to be of highest quality.

50. An importer of German automobiles is most likely to be concerned aboutA) market risk.B) systemic risk.C) default risk.D) foreign exchange risk.

51. Liquidity risk is most likely to be encountered for assets A) that trade in high volumes.B) that trade sporadically with low volumes.C) that sell quickly.D) that come from other countries.

52. Which of the following is correct?A) Risk and uncertainty are the same.B) Risk does not mean uncertainty.C) Risk cannot be measured or quantified.D) People cannot make informed decisions in the face of risk.

53. The risk associated with the likelihood that a borrower will not fulfill his or her financial obligations with respect to interest, principal or both is calledA) the liquidity risk.B) the systemic riskC) the market risk.D) the default risk.

54. In the fractional reserve banking system:A) half of the total money supply is held in reserves as currencyB) a fraction of the total money supply is held in reserves as currency.C) an amount equal to the total money supply is held in reserves as currency.D) no fraction of the total money supply is held in reserves as currency.

55. Most modern banking systems are based on:A) money of intrinsic value.

B) commodity money.C) 100 percent reserves.D) fractional reserves.

56. Which one of the following is presently a major deterrent to bank panics in Canada?A) the reserve requirementB) the fractional reserve systemC) the gold standardD) deposit insurance

57. The claims of the owners of a firm against the firm's assets are called:A) working capitalB) assetsC) net worthD) liabilities

58. Which of the following are all assets to a chartered bank?A) demand deposits, stock shares, and reservesB) vault cash, property, and reservesC) vault cash, property, and stock sharesD) vault cash, stock shares, and demand deposits

59. The reserves of a chartered bank consist of:A) the amount of money market funds it holds.B) the small deposits at the Bank of Canada and vault cash.C) government bonds which the bank holds.D) the bank's net worth.

60. The reserve ratio is equal to:A) a chartered bank's demand-deposit liabilities divided by its desired reserve.B) a chartered bank's desired reserve divided by its demand-deposit liabilities.C) a chartered bank's demand-deposit liabilities multiplied by its excess reserves.D) a chartered bank's excess reserves divided by its desired reserve.

61. Which of the following is correct?A) Desired reserves minus actual reserves equal excess reserves.B) Desired reserves equal excess reserves minus actual reserves.C) Desired reserves equal actual reserves plus excess reserves.D) Actual reserves minus desired reserves equal excess reserves.

62. The prime interest rate is:A) The rate any customer who has not declared bankruptcy receivesB) ¼ % above the bank rate (25 basis points)C) The rate the bank’s customers generally receiveD) Independently set by each bank but generally about 1.5% above the bank rateE) Both (b) and (c)

63. Suppose the ABC bank has excess reserves of $4,000 and outstanding demand deposits of $80,000. If the desired reserve ratio is 25 percent, what is the size of the bank's actual reserves?A) $16,000B) $84,000C) $24,000D) $20,000

64. If actual reserves in the banking system are $8,000, demand deposits are $70,000, and the desired reserve ratio is 10 percent, then excess reserves:A) are zero.B) are $1,000.C) are $2,000.D) cannot be determined from this information.

65. When a bank has a cheque drawn and cleared against it:A) excess reserves in the banking system decline.B) the nation's total money supply falls.C) the bank's balance sheet does not change.D) the amount of desired reserves the bank has will fall.

66. The reserves of a chartered bank consist of:A) The amount of money market funds it holdsB) The small deposits at the Bank of Canada and vault cashC) Government bonds which the bank holdsD) The bank’s net worthE) None of the above

67. When chartered banks use excess reserves to buy government securities from the public:A) new money is created.B) chartered bank reserves increase.C) the money supply falls.D) demand deposits decline.

68. The relative importance of various asset items on a chartered bank's balance sheet reflects a bank's pursuit of which two conflicting goals?A) profits and riskB) liquidity and profitsC) assets and liabilitiesD) buying and selling government securities

69. The value of the money multiplier is:A) 1/MPS.B) 1/Excess Reserves.C) 1/MPC.D) 1/Desired Reserve Ratio.

70. If the desired reserve ratio were 15 percent, the value of the monetary multiplier would be:A) 5.50.B) 6.67.C) 7.32.D) 8.54.

71. If actual reserves in the banking system are $50,000, excess reserves are $5,000, and demand deposits are $225,000, then the money multiplier:A) is 10.B) is 4.C) is 5.D) cannot be determined from this information.

72. If the desired reserve ratio falls:A) banks would be prompted to reduce their lending.B) the size of the money multiplier would increase.C) the actual reserves of banks would increase.D) none of the above would occur.

73. Which of the following is correct?A) Both the granting and repaying of bank loans expand the aggregate money supply.B) Granting and repaying bank loans do not affect the money supply.C) Granting a bank loan destroys money; repaying a bank loan creates money.D) Granting a bank loan creates money; repaying a bank loan destroys money.

74. When a bank loan is repaid the supply of money:A) is constant, but its composition will have changed.B) is decreased.C) is increased.D) may either increase or decrease.

75. Which of the following is an asset on the balance sheet of the Bank of Canada?A) reserves of chartered banksB) Government of Canada depositsC) Bank of Canada notes in circulationD) advances to chartered banks

76. The asset demand for money:A) is unrelated to both the interest rate and the level of GDP.B) varies inversely with the rate of interest.C) varies inversely with the level of real GDP.D) varies directly with the level of nominal GDP.

77. In which of the following instances can we be certain that the quantity of money demanded by the public will decrease?A) nominal GDP decreases and the interest rate decreasesB) nominal GDP increases and the interest rate decreasesC) nominal GDP decreases and the interest rate increasesD) nominal GDP increases and the interest rate increases

78. If the quantity of money demanded exceeds the quantity supplied:A) the supply-of-money curve will shift to the left.B) the demand-for-money curve will shift to the right.C) the interest rate will rise.D) the interest rate will fall.

79. Which statement is true?A) Bond prices and the interest rate are inversely related.B) A lower interest rate raises the opportunity cost of holding money.C) The supply of money is directly related to the interest rate.D) The total demand for money is directly related to the interest rate.

80. An increase in interest rate generally results in what effects on inflation and GDP?A) Inflation increases, GDP decreasesB) Inflation and GDP increasesC) Inflation decreases, GDP stays the sameD) Inflation and GDP decreasesE) Interest rate only affects inflation, not GDP

81. In the Canadian economy, the money supply is controlled byA) Parliament.B) the House of Commons Committee on Finance.C) the Bank of Canada.D) the Department of Finance.

82. "Open-market operations" refers to:A) purchases of stocks in the Toronto Stock Exchange.B) the purchase or sale of government securities by the Bank of Canada.C) central bank lending to chartered banks.D) the specifying of margin requirements on stock purchases.

83. The bank rate is the rate of interest at whichA) chartered banks lend to large corporations.B) the Bank of Canada lends to large corporations.C) savings and loan associations lend to home builders.D) the Bank of Canada lends to chartered banks.

84. A Special Purchase and Resale Agreement (SPRA) is:A) A promise by the Bank of Canada to buy shares at a fixed future rateB) A one day purchase (and next day buyback) of short-term securities by the Bank of

Canada from an investment dealer to inject money into the economyC) A one day sale (and next day repurchase) of short-term securities by the Bank of

Canada to an investment dealer to decrease money in the economyD) Continuous purchasing and sales of T-bills at the T-Bill auctionsE) Any of the above can be called an SPRA

85. The purpose of a restrictive monetary policy is to:A) increase aggregate demand.B) decrease aggregate demand.C) increase investment demand.D) decrease investment demand.

86. Which of the following best describes the cause-effect chain of a restrictive monetary policy?A) A decrease in the money supply will lower the interest rate, increase investment

spending, and increase GDP.B) A decrease in the money supply will raise the interest rate, decrease investment

spending, and decrease GDP.C) An increase in the money supply will raise the interest rate, decrease investment

spending, and decrease GDP.D) An increase in the money supply will lower the interest rate, decrease investment

spending, and increase GDP.

87. Which of the following is an expansionary monetary policy?A) Increase the money supply to shift the aggregate demand curve rightward.B) Increase the money supply to shift the aggregate demand curve leftward.C) Increase the money supply to shift the aggregate supply curve leftward.D) Decrease the money supply to shift the aggregate demand curve leftward.

88. Restrictive monetary policy is:A) When the Bank of Canada follows strict guidelines of the federal government

regarding its monetary policyB) The Bank is restricted to lowering or increasing the overnight rate by no more than

25%C) In times of inflation, the bank uses policies to decrease the amount of money

available, thereby increasing the interest rate and decreasing spending

D) In times of recession, the bank uses policies to increase the amount of money available, thereby decreasing the interest rate and increasing spending

E) All of the above

89. Ownership of common stock convey a number of rights such as:A) Participation in the profits of the firmB) Voting rightsC) Limited liabilityD) All of the above are correct

90. Treasury bills areA) money market instruments.B) capital market instruments.C) issued by the Bank of Canada.D) always sold at face value.

91. The interest rate isA) the present value of money.B) the future value of money.C) the price of renting money.D) the rate of change in the general price index.

92. The Taylor Rule suggests:A) If GDP rises by 1% above the bank rate, the bank rate should raise the overnight rate

by ½ a percent pointB) If GDP is equal to potential GDP and inflation is equal to its target rate of 3%, the

overnight rate should remain at about 4%C) If inflation rises by 1% above its target of 3%, then the Bank of Canada should raise

the overnight rate by ½ a percentage pointD) Both A and B are correctE) None of the above

93. The present value of a stream of cash flows decreases whenA) the interest rate decreases.B) the length of time before the economic agent will receive the cash flows decreases.C) the interest rate increases.D) the number of cash inflows decreases.

94. The Fisher effect which results from an increase in inflation expectations is best described graphically as a shift to the ________ for the demand for loanable funds and a shift to the ___________ for the supply for loanable funds.

A) right; left.B) right; right.C) left; left.D) left; right.

95. A decrease in interest rates would causeA) a leftward shift of the demand for money curve.B) a rightward shift of the demand for money curve.C) a movement up the demand for money curve.D) a movement down the demand for money curve.

96. Liquidity risk is most likely to be encountered for assets A) that trade in high volumes.B) that trade sporadically with low volumes.C) that sell quickly.D) that come from other countries.

97. What was the main attraction of the gold standard?A) It would allow greater use of discretionary monetary policy.B) It would allow greater exchange rate flexibility.C) It would eliminate the use of use of discretionary monetary policy.D) It would give gold intrinsic value.

98. What was the most significant problem created by the gold standard?A) It caused inflation.B) It caused recessions.C) It did not allow governments the use of monetary policy to fight recessions.D) It prevented the use of gold for jewelry.

99. Which of the following is not included in M2?A) Currency and coins in public circulation.B) Demand deposits.C) Money market mutual funds.D) Personal savings deposits.

100. How does a properly functioning financial system affect the information gathering process?

A) Individuals must spend at least 95% of their time collecting, analyzing, and interpreting information before making a decision

B) Banks and markets greatly decrease the need for individual information gathering by performing such services as credit checking and requiring market prospectuses

C) Only those individuals making risky decisions must gather information, others are risk-averse and always choose the least risky decision

D) Too much information results in “information asymmetry” so the banks try to eliminate this

E) The Bank of Canada releases reports 8 times per year about the Canadian economy and interest rates

Part 2: Short-answer Questions

1. Compare between the money and capital markets. List and briefly describe each market’s components.

2. Assume that there are three chartered banks in which each uses a 10% reserve. a. Using the theory of multiple expansion of deposits, shows and draws a chart for

each bank what happens when $10,000 is deposits into Bank 1. b. Calculate the money multiplier and the maximum demand-deposit.

3. List five core principles of the financial system.One of them states that “Time has value”. Explain this statement.

4. Describe the Expectation theory. How is it different from the Market Segmentation and the Preferred-Habitat.

5. Describe the Risk-return analysis.

6. List and explain eight types of risk that affect people’s investment decisions.

7. Explain how the Bank of Canada uses “inflation targeting” to achieve its monetary policy.

8. Describe four ways of how inflation can negatively affect social welfare. (Hint: Chapter 2. Page 27-28)

9. Why is it important that a business or investor to matching between the assets and debt.

10. Show how balance sheet in Bank 1 changes when a check is drawn against Bank 1 and deposit in Bank 2? (Changes in Assets and Liabilities and Net worth)

11. List and briefly explains what three types of derivatives that are used in stock trading market.

12. Explain the difference between the Canadian stock market indexes and the U.S stock market indexes. And why one closes with uptrend (positive index) while the other closes with downtrend (negative index) at the end of the day?

13. Using the loanable funds approach, draw a supply and demand loanble funds curves, and determine the equilibrium interest rate.

Explain how inflation shifts the loanable funds demand and supply.

14. Distinguish between nominal and real interest rate using Fisher equation.

Investors are more concerned about the changes of interest rate. Explain this statement.

15. Using three examples to explain and demonstrate how stock markets can destabilize the economy.

16. Illustrate what happens to the equilibrium interest rate when government demand for loanable funds decreases and increases.

Explain when government demand for loanable funds may increase.

17. Explain what happens when switching government deposits from the Bank of Canada to the Chartered Bank.

18. Lists 3 important rates in the band.

If the bank rate is set at 3.00%. Calculate how other rates are set.