AMERICAN UNIVERSITY OF RAS AL KHAIMAH

SCHOOL OF BUSINESS

DEPARTMENT OF BUSINESS ADMINISTRATION

Course: Money and Banking

Course Code: ECON 310

Test 1

Student Name:…………………………………Student ID:…………………..

(This Test 1 accounts for 20% of your total marks)

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1. The periodic payments on equity securities are called
a. interest payments.
b. dividends.
c. equity shares.
d. stock repurchases.

2. The periodic payments on debt securities are called

a. interest payments.
b. dividends.
c. debt swaps.
d. subordinations.

3. When a household borrows using credit cards and by taking out loans for large purchases (such as
automobiles), the resulting security is known as
a. a discount bond.
b. a Treasury bill.
c. mortgage debt.
d. consumer credit.

4. In the event that a firm goes bankrupt and is liquidated, who is paid off first, second, and third
between workers, debt holders, and stockholders?
a. (1) debt holders; (2) workers; (3) stockholders
b. (1) stockholders; (2) workers; (3) debt holders
c. (1) workers; (2) debt holders; (3) stockholders
d. (1) workers; (2) stockholders; (3) debt holders

5. A company that transfers funds from savers to borrowers by receiving funds from savers and
investing in securities issued by borrowers is known as
a. a financial intermediary.
b. a brokerage.
c. an investment bank.
d. a secondary market maker.

6. In its role as a medium of exchange, money makes exchanges easier by reducing

a. inflation.
b. transactions costs.
c. costs of pricing goods.
d. legal costs in negotiating loan contracts.

7. When you buy something one day and pay for it later, and the repayment you make is denoted in
terms of money, money is serving the role of
a. medium of exchange.
b. unit of account.
c. store of value.
d. standard of deferred payment.

8. Outside money is
a. money created by the government or by nature.
b. money created by the private sector, such as checking accounts at banks.
c. money that has value only because the government decrees that it has value.
d. checks that are in the process of clearing but have not cleared yet.

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 9. U.S. currency is currently
a. commodity money.
b. full-bodied money.
c. inside money.
d. fiat money.

10. Money created in the private sector, such as checking accounts at banks, is
a. fiat money.
b. commodity money.
c. outside money.
d. inside money.
11. If money is gold or silver, it is called ____ money
a. fiat
b. inside
c. commodity
d. glitter

12. Aaron takes $100 out of his checking account and puts it in his savings account while Biff
withdraws $200 from his money market mutual fund in the form of cash. The total effect is that
M1 ____ and M2 ____.
a. is unchanged; falls by $100
b. is unchanged; is unchanged
c. rises by $100; falls by $100
d. rises by $100; is unchanged

13. The liquidity of a monetary asset is

a. the difference between the interest rate on the asset and the interest rate on short-term
government securities.
b. how quickly and easily it can be used to purchase goods and services.
c. its time to maturity.
d. also called its principal value.

14. M1 consists of
a. coins, paper currency, and travelers checks.
b. coins, paper currency, travelers checks, and amounts in checking accounts.
c. coins, paper currency, travelers checks, and amounts in checking accounts and savings
accounts.
d. coins, paper currency, travelers checks, and amounts in checking accounts and retail
money-market mutual funds.

15. Discounting is the process of dividing a future value by the ________ to obtain the ________
value.
a. discount factor; past
b. discount factor; present
c. rate of discount; past
d. rate of discount; present

16. Consider a one-year discount bond that pays $1,000 one year from now. If the rate of discount is 7
percent, the present value of the bond is
a. $930.00.
b. $934.58.
c. $993.00.
d. $993.46.

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17. Consider a one-year discount bond that has a present value of $1,500. If the rate of discount is 4
percent, the future value of the bond (the amount the bond pays in one year) is
a. $1,560.00.
b. $1,540.00.
c. $1,440.00.
d. $1,442.31.

18. A debt security that pays interest forever and never repays the principal is
a. a fiduciary obligation.
b. a federal funds loans.
c. a perpetuity.
d. a junk bond.
19. A bond that makes a regular interest payment until maturity, at which time the face value is repaid
(so there is no amortization), is called a
a. coupon bond.
b. fixed-payment security.
c. discount bond.

20. Consider a perpetuity that pays $150 every year. If the rate of discount is 4 percent, the present
value of the bond is
a. $210.00.
b. $3,000.00.
c. $3,600.00.
d. $3,750.00.

21. Suppose you take out a home equity loan of $100,000 for 5 years at an annual interest rate of 5
percent, with payments to be made monthly. The relevant formula is:
.

What will your monthly payments be?

a. $1,320.71
b. $1,887.12
c. $1,924.79

22. Put the following securities in order according to their likely yields to maturity, from highest to
lowest, in the middle of an economic expansion.
A: The on-the-run Treasury bond with ten years to maturity
B: The off-the-run Treasury bond with nine-and-one-half years to maturity
C: The off-the-run Treasury bond with twenty-four years to maturity

a. A, C, B
b. B, A, C
c. C, B, A
d. C, A, B

23. Securitization is
a. the process of turning assets such as mortgages into securities sold to investors.
b. the method used by financial intermediaries when they purchase securities in the
secondary market.
c. a procedure used by the Federal Reserve and the Securities and Exchange Commission
when allowing a bond to be sold on the primary market.
d. the main method used by the Department of Homeland Securitization.

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24. The on-the-run ten-year Treasury security is
a. the ten-year government bond that is in greatest demand by investors who want to hold it
until it matures.
b. a ten-year government bond that can be used to pay estate taxes, also known as a flower
bond.
c. a non-taxable ten-year government bond.
d. the ten-year government bond that was the most recently issued.

25. In October 2001, when the U.S. government announced that it would stop selling 30-year bonds,
the price of 30-year bonds in the secondary market ____ and the yield ____.
a. rose; rose
b. rose; fell
c. fell; rose
d. fell; fell

26. What does a downward-sloping yield curve imply, according to the expectations theory of the term
structure of interest rates?
a. Investors expect long-term interest rates to rise in the future.
b. Investors expect future short-term interest rates to be lower than the current short-term
interest rate.
c. Investors expect future short-term interest rates to be the same as the current short-term
interest rate.

27. The term premium is

a. the interest rate on a long-term bond minus the average interest rate on future short-term
bonds.
b. the interest rate on a long-term bond plus the average interest rate on future short-term
bonds.
c. the average interest rate on future short-term bonds.
d. the standard deviation of the interest rate on long-term bonds.

28. When an economic expansion has just begun, you are likely to observe that
a. the yield curve is sharply upward sloping.
b. the yield curve is somewhat upward sloping.
c. the yield curve is flat or inverted.
d. the yield curve is upward sloping for short times to maturity, then downward sloping for
longer times to maturity.

29. If expected inflation is 3 percent, the nominal interest rate is 5 percent, and the actual inflation rate
turns out to be 4 percent, then the realized real interest rate is ____ than the expected real interest
rate and borrowers ____ relative to lenders.
a. less; gain
b. less; lose
c. greater; gain
d. greater; lose

30. The nominal interest rate adjusted for actual inflation is the
a. expected real interest rate.
b. realized real interest rate.
c. after-tax real interest rate.
d. yield curve.

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31. (2 marks). Suppose you are an investor with a choice between three investments in debt
securities that are identical in every way except in terms of their interest rates and taxability.

Investment A: Interest rate 10 percent, tax rate 40 percent of interest income

Investment B: Interest rate 8 percent, tax rate 30 percent of interest income
Investment C: Interest rate 6.5 percent, tax rate 0 percent

Which investment provides the highest after-tax return? Show your work.

[After-tax return = (1  t)  interest rate].

32. Suppose the quantity demanded for a security is

BD = 150  0.1b,
and the quantity supplied of the security is
BS = 50 + 0.1b,
where b is the price of the security in dollars. The equilibrium price of the security is
a. $50.
b. $125.
c. $250.
d. $500.

33. (7 marks). Loretta buys a one-year debt security on December 31, 2013, for $10,000, which will pay
her a nominal interest rate of 5% percent. From December 31, 2013, to December 31, 2014, the
inflation rate is 2 percent. Loretta has a tax rate of 40 percent.

a. How much nominal interest (in dollars) does Loretta earn during the year? Show your
calculations.

b. How much (in dollars) does Loretta pay in taxes on her interest income? Show your
calculations.

c. How much (in dollars) is Loretta's after-tax nominal income? Show your calculations.

d. How much principal (in dollars) does Loretta lose because of inflation? Show your
calculations.

e. How much real interest income (in dollars) does Loretta earn? Show your calculations.

f. How much (in dollars) is Loretta's after-tax real interest income? Show your calculations.

g. What percent of Loretta's nominal interest income goes to: (1) her, in the form of after tax
real interest income; (2) the government, in the form of taxes; and (3) inflation, in the
form of lost principal value? Show your calculations.

TOTAL: 40 Marks

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