Multiple Choice Problems. (There will be ten problems, worth 6 points each.)

Transcription

1 Economics 380 Fall 2009 Saunders Name Exam 1 (Practice!) Please answer each question. For short answer questions, show the formulas and calculations needed where appropriate. You have one hour and fifteen minutes (1:15). Good luck! Multiple Choice Problems. (There will be ten problems, worth 6 points each.) 1) Why would a saver with $10,000 be more likely to put it into a bank account than to lend it directly to a borrower? A) Direct loans of that sort are not legal in the United States. B) Interest received from a bank is deductible on the federal income tax, whereas interest received from an individual borrower is not. C) It is easier and less risky to save money in a bank account and allow the bank to serve as a go-between with potential borrowers. D) Banks pay higher interest rates on deposits than individual borrowers are likely to pay to individual lenders. 2) Which of the following rankings of sources of funds for businesses from the least important to the most important is correct? A) Bond issues, stock issues, loans from financial institutions B) Loans from financial institutions, bond issues, stock issues C) Stock issues, bond issues, loans from financial institutions D) Loans from financial institutions, stock issues, bond issues 3) When economists refer to the role of money as a store of value, they mean that A) money never loses its value, unlike other assets. B) money allows value to be stored easily. C) the value of money falls only when the quantity of money in circulation rises. D) the value of money falls only when the quantity of money in circulation falls. 1) 2) 3) 4) The purchasing power of money 4) A) is constant. B) is set by the Fed in January of each year. C) rises when prices fall. D) rises when prices rise. 5) A ʺprice indexʺ is a 5) A) measure of economic growth. B) measure of the interest rate. C) summary statistic that reflects changes in the price of a group of goods and services relative to the price in a base year. D) good whose price tends to increase and decrease at about the same rate as most other goods.

2 6) All of the following are problems associated with commodity money EXCEPT A) it is a cumbersome form of payments system. B) costs were incurred in certifying the purity and weight of commodity money. C) its value is dependent on its purity. D) commodities tend to have little value in and of themselves. 6) 7) Which of the following is NOT included in M1? 7) A) Currency B) Travelerʹs checks C) Savings account deposits D) Checking account deposits 8) The reason why many economists switched from using M1 to M2 as the best measure of the medium of exchange is that A) during the 1980s, new substitutes for checking accounts appeared and were included in M2. B) during the 1980s, inflation roared out of control and a better measure of the money supply seemed necessary. C) during the 1980s, the country went off the gold standard and began using fiat money for the first time. D) in 1982, the federal government ordered that all income taxes must be paid using M2. 9) Borrowers generally demand funds through the financial system in order to A) pay taxes or other obligations to the government. B) purchase consumer durables, houses, or business plant and equipment. C) meet business payrolls or other short-term business obligations. D) purchase food, clothing, or other nondurables. 8) 9) 10) If you purchase a Treasury bond, the Treasury bond is 10) A) an asset to you, but a liability to the U.S. government. B) an asset to you as well as an asset to the U.S. government. C) a liability to you, but an asset to the U.S. government. D) a liability to you as well as a liability to the U.S. government. 11) The purpose of diversification is to 11) A) reduce risk. B) reduce the brokerage fees involved in managing a financial portfolio. C) reduce tax liability. D) increase the liquidity of a financial portfolio.

3 12) The managers of a firm seek to obtain a loan from a local bank. They tell the bankʹs loan officer that the loan is intended to finance an expansion in the company, but in reality they intend to use the funds to finance next monthʹs payroll. This incident is an example of A) a situation in which direct finance, rather than indirect finance, should have been employed. B) banksʹ failing to charge high enough interest rates on business loans. C) the problem of asymmetric information. D) the problem of the illiquidity of bank loans. 12) 13) If a business fails to make a profit 13) A) you would probably be better off holding a bond issued by the business than holding stock issued by the business. B) its shareholders may end up being liable for much more than they have invested in the business. C) you would probably be better off holding stock issued by the business than holding a bond issued by the business. D) it must still pay a dividend. 14) Secondary markets for financial instruments are important because, among other things, A) taxes on trading in these markets are an important source of revenue for governments. B) they provide a place where people interested in financial matters can meet. C) they are where companies and governments raise new funds. D) they make it easier for investors to hold a diversified portfolio of assets. 14) 15) U.S. Treasury bills 15) A) have a maturity of at least two years. B) have the largest trading volume of any money market asset. C) have a default risk slightly greater than that of corporate bonds. D) may only be purchased directly from the federal government. 16) Which of the following is a capital market asset? 16) A) Corporate bonds B) Treasury bills C) Eurodollars D) Commercial paper 17) The coupon rate is the 17) A) difference between the face value of the bond and its par value. B) yearly coupon payment divided by the face value of the bond. C) yearly coupon payment divided by the market value of the bond. D) difference between the face value of the bond and its market value. 18) At an interest rate of 3%, what is the present value of $1000 to be received five years from now? A) $863 B) $850 C) $1159 D) $ )

4 19) The yield to maturity is equal to 19) A) interest rate on the asset minus any taxes owed on the interest received. B) any payments received from an asset at the date the asset matures. C) the face value or par value of a coupon bond. D) the interest rate at which the present value of an assetʹs returns is equal to its value today. 20) If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that A) the market price of your bond will fall. B) the coupon payments on your bond will fall. C) the market price of your bond will rise. D) the par value of your bond will rise. 21) Which of the following is the correct expression for the expected real interest rate? A) r = i - B) r = i/ C) r = i + D) r = i 20) 21) 22) Economists believe that as a saverʹs wealth increases, the saver will generally A) increase the fraction of wealth held as common stock. B) increase his or her holdings of all assets proportionately. C) decrease the fraction held as corporate bonds. D) increase the fraction of wealth held as cash. 23) The main reason that savers must assess the impact of inflation on returns is A) an increase in inflation will lower the nominal return on an asset. B) real after-tax returns generally rise during periods of inflation. C) inflation has a larger impact on the returns on luxury assets than on the returns on necessity assets. D) changes in the value of money will affect the real value of returns. 22) 23) 24) A risk-averse saver will 24) A) will only choose investments with zero risk. B) sometimes accept a lower expected return in exchange for less risk. C) always accept a lower expected return in exchange for less risk. D) never accept a lower expected return in exchange for less risk. 25) Suppose that information is made public that Mammoth Computer is having severe financial difficulties. The effect will be to A) lower the yield on Mammothʹs long-term bonds. B) increase the yield on rival Orange Computerʹs long-term bonds. C) increase the yield on Mammothʹs long-term bonds. D) increase the yield on both Mammothʹs long-term bonds and rival Orange Computerʹs long-term bonds. 25)

5 26) Which of the following assets has the lowest information costs? 26) A) A bond issued by the city of Smallplace, South Dakota B) A U.S. Treasury bond C) A bond issued by General Motors D) A share of stock issued by General Motors 27) If the returns on two assets are perfectly positively correlated, adding the second asset to your portfolio when you already own the first A) has no effect on the risk in the portfolio. B) reduces the risk in the portfolio only if you are risk averse. C) increases the risk in the portfolio. D) reduces the risk in the portfolio. 27) 28) The bond demand curve slopes down because 28) A) the lender is willing and able to purchase more bonds when the price of the bond is low. B) when bond prices are low, inflation is low. C) the borrower is willing and able to purchase more bonds when the price of the bond is low. D) interest rates decline as bond prices decline. 29) If the equilibrium interest rate in the loanable funds market on a oneyear discount bond is 10%, then the equilibrium price in the bond market must be A) $9000. B) $ C) $11,000. D) $10, ) Which of the following would NOT cause the demand curve for bonds to shift? A) A change in wealth B) A change in the price of bonds C) A change in expected inflation D) A change in the liquidity of bonds 31) If the expected gains on stocks rise, while the expected returns on bonds do not change, then A) the demand curve for bonds will shift to the right. B) the equilibrium interest rate will fall. C) the supply curve for loanable funds will shift to the right. D) the equilibrium interest rate will rise. 29) 30) 31) 32) Which age group typically has the highest savings rate? 32) A) Elderly people B) Young people C) Middle-aged people D) Savings rates are approximately the same for all age groups. 33) The demand curve for bonds would be shifted to the left by an 33) A) increase in the liquidity of bonds relative to other assets. B) increase in expected returns on bonds. C) increase in expected inflation. D) increase in wealth.

6 34) If a governmentʹs income tax receipts exceed its expenditures, the government is running a A) deficit and is a net saver of funds. B) surplus and is a net saver of funds. C) deficit and is a net borrower of funds. D) surplus and is a net borrower of funds. 34) 35) During an economic recession, 35) A) the bond demand curve shifts to the left, the bond supply curve shifts to the right, and the equilibrium interest rate usually rises. B) the bond demand curve shifts to the right, the bond supply curve shifts to the left, and the equilibrium interest rate usually falls. C) the bond demand and supply curves both shift to the right and the equilibrium interest rate usually rises. D) the bond demand and supply curves both shift to the left and the equilibrium interest rate usually falls.

7 Short Answer Problems. (There will be four or five worth 40 pts total.) 36) When a saver deposits funds in a bank, she may earn about 5% on the deposit. When the bank lends these funds out, it may charge the borrower 9% on the loan. Why donʹt the saver and the borrower get together directly and avoid the bank? In that situation wouldnʹt the saver be able to earn more on her funds and the borrower have to pay less to borrow these funds? 37) During the late nineteenth century many farmers in the American Midwest complained that the real interest rates they were paying on their mortgages were higher than the nominal rates. Is this possible? Arenʹt real rates always lower than nominal rates? 38) Suppose that the inflation rate is currently 8% and that most investors believe that inflation will remain at this level indefinitely. You are convinced, however, that the inflation will decline to 5% or less. Should you buy a 10-year Treasury bond or a 10- year TIPS? 39) During 2000, the government repurchased $30 billion in U.S. Treasury bonds outstanding. This was the first time this had been done since the administration of Herbert Hoover in the early 1930s. Analyze the impact of this repurchase on the bond market. 40) Assess the impact on the bond market of the rise in Internet trading of stocks.