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Assignment 2 - Money and Banking - Econ 3381-01 - Fall 2012

Note: Submit your answers using Blackboard Learn. Notice that the order in which the answers appear [i.e., A), B), C), and D)] are different in this PDF file and in Blackboard Learn.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Periodic payments of net earnings to shareholders are known as

 

1)

A)

dividends.

B) interest.

C) capital gains.

D) profits.

2) In the one-period valuation model, the current stock price increases if

 

2)

A)

dividends are cut.

B) the expected sales price falls. D) the expected sales price increases.

C)

the required return increases.

3) Using the one-period valuation model, assuming a year-end dividend of $1.00, an expected sales price of $100, and a required rate of return of 5%, the current price of the stock would be

3)

A)

$110.00.

B) $101.00.

C) $100.00.

D) $96.19.

4) In the generalized dividend model, if the expected sales price is in the distant future

4)

A) it is equally important with dividends in determining the current stock price.

 

B) it is less important than dividends but still affects the current stock price.

C) it does not affect the current stock price.

 

D) it is more important than dividends in determining the current stock price.

 

5) Using the Gordon growth formula, if D 1 is $2.00, k e is 12% or 0.12, and g is 10% or 0.10, then the current stock price is

5)

A)

$20.

B) $50.

C) $100.

D) $150.

6) Information plays an important role in asset pricing because it allows the buyer to more accurately judge

6)

A)

liquidity

B) policy

C) risk

D) capital

7) New information that might lead to a decrease in an asset's price might be

 

7)

A) an expected increase in the future sales price.

 

B) an expected decrease in the level of future dividends.

 

C) an expected increase in the dividend growth rate.

 

D) a decrease in the required rate of return.

8) The subprime financial crisis lead to a decline in stock prices because

 

8)

A) of a lowered required return on investment in equity.

 

B) of a lowered expected dividend growth rate.

 

C) higher expected future stock prices.

D) higher current dividends.

 

9) If expectations of the future inflation rate are formed solely on the basis of a weighted average of past inflation rates, then economics would say that expectation formation is

9)

A)

reasonable.

B) irrational.

C) adaptive.

D) rational.

10) If a forecast is made using all available information, then economists say that the expectation formation is

10)

A) reasonable.

B) irrational.

C) rational.

D) adaptive.

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11) According to rational expectations theory, forecast errors of expectations

11)

 

A) tend to be persistently high or low.

 

B) are unpredictable.

C) are more likely to be positive than negative.

D) are more likely to be negative than positive.

12) According to the efficient markets hypothesis, the current price of a financial security

12)

 

A) fully reflects all available relevant information.

 

B) is the discounted net present value of future interest payments.

 

C) is determined by the highest successful bidder.

 

D) is a result of none of the above.

13) The efficient markets hypothesis indicates that investors

 

13)

 

A) can use the advice of technical analysts to outperform the market.

B) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.

C) do better if they purchase loaded mutual funds.

 

D) do better on average if they adopt a "buy and hold" strategy.

 

14)

is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices.

14)

 

A)

Behavioral finance

B) Methodical finance D) Strategical finance

C)

Procedural finance

15)

and

may provide an explanation for stock market bubbles.

15)

 

A)

Overconfidence; social isolationism

B) Overconfidence; social contagion D) Underconfidence; social contagion

C)

Underconfidence; social isolationism

16) American businesses get their external funds primarily from

16)

 

A) loans from nonbank financial intermediaries.

 

B) bonds and commercial paper issues.

C) bank loans.

D) stock issues.

17) Of the following sources of external finance for American nonfinancial businesses, the least important is

17)

 

A)

stocks.

B) bonds and commercial paper. D) loans from other financial intermediaries.

C)

loans from banks.

18) Regulation of the financial system

 

18)

 

A)

occurs only in the United States.

B)

ensures the stability of the financial system.

C)

protects the wealth of owners of financial institutions.

D)

protects the jobs of employees of financial institutions.

 

19) A

is a provision that restricts or specifies certain activities that a borrower can engage in.

19)

 

A)

restrictive covenant

B) restrictive barrier D) residual claimant

C)

risk hedge

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20) The reduction in transactions costs per dollar of investment as the size of transactions increases is

20)

A)

discounting.

B) economies of scale. D) diversification.

C)

economies of trade.

21) A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called

21)

A)

noncollateralized risk.

B) asymmetric information. D) adverse selection.

C)

moral hazard.

22) The presence of

in financial markets leads to adverse selection and moral hazard

22)

problems that interfere with the efficient functioning of financial markets.

A)

asymmetric information

B) noncollateralized risk D) free-riding

C)

costly state verification

23) If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of

23)

A)

costly state verification.

B) free-riding. D) moral hazard.

C)

adverse selection.

24) An example of the

problem would be if Karen borrowed money from Paul in order to pay

24)

for school and instead took a trip to South Padre Island using those funds.

A)

costly state verification

B) moral hazard D) adverse selection

C)

agency

25) Government regulations require publicly traded firms to provide information, reducing

25)

A)

economies of scale.

B) transactions costs. D) the adverse selection problem.

C)

the need for diversification.

26) Because of the adverse selection problem,

 

26)

A) lenders are reluctant to make loans that are not secured by collateral.

B) good credit risks are more likely to seek loans causing lenders to make a disproportionate

 

amount of loans to good credit risks.

C) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town."

 

D) lenders will write debt contracts that restrict certain activities of borrowers.

27) Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are

27)

A)

restrictive covenants.

B) risk insurance. D) illegal.

C)

limited-liability clauses.

28) Solutions to the moral hazard problem include

 

28)

A) greater reliance on debt contracts than financial intermediaries.

B) low net worth.

C) monitoring and enforcement of restrictive covenants.

D) greater reliance on equity contracts and less on debt contracts.

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29) A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a

29)

A)

free-rider problem.

financial crisis.

B) fiscal imbalance. D) "lemons" problem.

 

C)

30) A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system

30)

A) allows for a more efficient use of funds.

 

B) reduces uncertainty in the economy and increases market efficiency.

C) increases economic activity.

D) causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently.

 

31) A sharp decline in the stock market means that the

of corporations has fallen making

31)

lenders

willing to lend.

A)

liability; more

liability; less

B) net worth; more D) net worth; less

 

C)

32) A credit boom can lead to a(n)

32)

A)

price bubble

liability war

such as the one we saw recently in the housing market. B) decrease in moral hazard D) decline in lending

C)

33) A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called

33)

A)

moral hazard.

B) illiquidity.

C) debt deflation.

D) insolvency.

34) If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n)

34)

A) financial recovery.

 

B) banking crisis.

C) reduction of the adverse selection and moral hazard problems.

D) increase in information available to investors.

35) When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that

35)

A) the amount that they owed on their mortgage was less than the value of their house.

B) the roof leaked during a rainstorm.

 

C) the basement flooded since they could not afford to fix the leaky plumbing.

 

D) the value of the house fell below the amount of the mortgage.

 

36) Which of the following statements are true?

 

36)

A) A bank's balance sheet indicates whether or not the bank is profitable.

B) A bank's assets are its sources of funds.

C) A bank's liabilities are its uses of funds.

D) A bank's balance sheet shows that total assets equal total liabilities plus equity capital.

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37) Which of the following statements are true?

 

37)

A) Checkable deposits are payable on demand.

 

B) Demand deposits are checkable deposits that pay interest.

 

C) Checkable deposits do not include NOW accounts.

 

D) Checkable deposits are the primary source of bank funds.

 

38) Banks acquire the funds that they use to purchase income-earning assets from such sources as

38)

A)

cash items in the process of collection

B) savings accounts. D) deposits at other banks.

 

C)

reserves.

39) Bank capital is listed on the of funds.

side of the bank's balance sheet because it represents a

39)

A)

asset; use

B) asset; source

C) liability; source

D) liability; use

40) The fraction of checkable deposits that banks are required by regulation to hold are

40)

A)

excess reserves.

B) required reserves. D) vault cash.

 

C)

total reserves.

41) Which of the following are not reported as assets on a bank's balance sheet?

 

41)

A)

Deposits with other banks

B) U.S. Treasury securities D) Checkable deposits

 

C)

Cash items in the process of collection

42) Which of the following bank assets is the most liquid?

 

42)

A)

Consumer loans

B) U.S. government securities D) Cash items in process of collection

C)

Reserves

43) Bank's make their profits primarily by issuing

 

43)

A)

negotiable CDs

B) loans

C) equity

D) NOW accounts

44) The most important category of assets on a bank's balance sheet is

 

44)

A)

securities.

B) discount loans. D) loans.

 

C)

cash items in the process of collection.

45) When a new depositor opens a checking account at McAllen National Bank, the bank's assets and its liabilities

45)

A)

increase; increase

B) increase; decrease D) decrease; decrease

 

C)

decrease; increase

46) With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is

46)

A)

$90.

B) $110.

C) $10.

D) $100.

47) If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in

47)

A)

deposits and reserves.

B) capital and reserves. D) capital and loans.

 

C)

deposits and loans.

48) A bank with insufficient reserves can increase its reserves by

 

48)

A)

buying short-term Treasury securities.

B) lending federal funds. D) calling in loans.

 

C)

buying municipal bonds.

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49)

may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow.

49)

 

A)

Calling in loans

B) Selling loans D) Selling securities

C)

Selling negotiable CDs

50) The goals of bank asset management include

50)

 

A) purchasing securities with high returns and low risk.

B) lending at high interest rates regardless of risk.

C) minimizing liquidity.

 

D) maximizing risk.

51) Holding large amounts of bank capital helps prevent bank failures because

51)

 

A) it makes loans easier to sell.

 

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

 

C) it makes it easier to call in loans.

 

D) it means that the bank has a higher income.

 

52) Conditions that likely contributed to a credit crunch in 2008 include:

52)

 

A) regulated hikes in bank capital requirements.

B) increases in reserve requirements.

 

C) falling interest rates that raised interest rate risk, causing banks to choose to hold more capital.

 

D) capital shortfalls caused in part by falling real estate prices.

53) Banks face the problem of likely to seek bank loans.

in loan markets because bad credit risks are the ones most

53)

 

A)

intentional fraud

B) adverse selection D) moral suasion

C)

moral hazard

54) To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also

54)

 

A) be prepared to extend the deadline when the borrower needs more time to comply.

B) monitor and enforce them.

 

C) be willing to rewrite the contract if the borrower cannot comply with the restrictions.

 

D) trust the borrower to do the right thing.

55) Long-term customer relationships credit risks.

the cost of information collection and make it easier to

55)

 

A)

increase; increase

B) increase; screen D) reduce; increase

C)

reduce; screen

56) Credit risk management tools include

 

56)

 

A)

interest rate swaps.

B) duration analysis. D) collateral.

C)

deductibles.

57) Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a

57)

 

A)

everyone-shares-equally constraint.

C)

last-in, first-out constraint.

B) double-coincidence of wants constraint. D) sequential service constraint.

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58) To prevent bank runs and the consequent bank failures, the United States established the in 1934 to provide deposit insurance.

58)

 

A)

ATM

B) Federal Reserve D) SEC

 

C)

FDIC

59) Deposit insurance has not worked well in countries with

 

59)

 

A)

a tradition of the rule of law.

B) strong supervision and regulation. D) a weak institutional environment.

C)

few opportunities for corruption.

60) When bad drivers line up to purchase collision insurance, automobile insurers are subject to the

60)

 

A)

adverse selection problem.

B) assigned risk problem. D) ill queue problem.

 

C)

moral hazard problem.

61) The result of the too-big-to-fail policy is that bank failures more likely.

banks will take on

risks, making

61)

 

A)

big; greater

B) small; greater

C) big; fewer

D) small; fewer

62) Regulations that reduced competition between banks included

 

62)

 

A) bank reserve requirements.

 

B) branching restrictions.

 

C) the dual system of granting bank charters.

 

D) interest-rate ceilings.

 

63) A common element in all of the banking crisis episodes in different countries is

 

63)

 

A)

increased regulation.

B) the existence of a government safety net. D) deposit insurance.

C)

lack of competition.

64) Financial innovations occur because of financial institutions search for

 

64)

 

A)

fame

B) recognition

C) profits

D) stability

65) Uncertainty about interest-rate movements and returns is called

 

65)

 

A)

interest-rate risk

B) financial creativity D) market potential

 

C)

interest-rate irregularities

66) The most important source of the changes in supply conditions that stimulate financial innovation has been the

66)

 

A) dramatic increase in competition from foreign banks.

 

B) improvement in computer and telecommunications technology.

C) dramatic increase in the volatility of interest rates.

 

D) deregulation of financial institutions.

67) The process of transforming otherwise illiquid financial assets into marketable capital market instruments is know as

67)

 

A)

securitization.

B) arbitrage. D) internationalization.

 

C)

program trading.

68)

is creating a marketable capital market instrument by bundling a portfolio of mortgage or auto loans.

68)

 

A)

diversification.

B) arbitrage.

C)

computerization.

D) securitization.

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69) One of the concerns of increased bank consolidation is the reduction in community banks which could result in

69)

A)

loss of cultural identity.

B) less lending to small businesses. D) higher interest rates.

C)

more bank regulation.

70) Reasons for holding Eurodollars include

70)

A) the fact that Eurodollar deposits are insured by the FDIC.

B) the fact that minimum transaction sizes are very low, making Eurodollars an attractive

savings instrument for consumers.

C) the fact that dollars are widely used to conduct international transactions.

D) the fact that Eurodollar deposits are heavily regulated.

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