AMERICAN UNIVERSITY OF RAS AL KHAIMAH

SCHOOL OF BUSINESS

DEPARTMENT OF BUSINESS ADMINISTRATION

Course: Money and Banking

Course Code: ECON 310

Test 2

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

(This Test 2 accounts for 20% of your total marks)

1|Page
1. When people or firms that are worse-than-average risks are most likely to enter a contract that is
offered to everyone, the problem is called
a. irrational expectations.
b. adverse selection.
c. opportunity cost.
d. moral hazard.

2. If a business firm takes out a loan from a bank, but does not use the funds as the bank intended, the
problem is
a. moral hazard.
b. adverse selection.
c. intermediation.
d. securitization.

3. A legally enforced part of a loan contract that requires the borrower to act in a certain way or to
use the borrowed funds for a particular purpose is known as
a. collateral.
b. a net worth requirement.
c. a covenant.
d. a binding restriction.

4. Savings-and-loan associations suffered losses in the late 1970s when

a. the farm sector of the economy became unprofitable, forcing many farmers into
bankruptcy, leading to many bad farm loans.
b. inflation rose, causing short-term interest rates to rise.
c. oil prices rose sharply, causing S&Ls to lose money invested in the oil sector.
d. short-term interest rates fell, causing S&Ls to suffer capital losses on their portfolios of
short-term securities.
5. A situation in which banks do not lend as they ordinarily would, but rather have much higher
requirements for borrowers to qualify for loans than normal, is known as a(n)
a. lending crisis.
b. moral hazard issue.
c. credit crunch.
d. adverse selection response.

6. A bank's reserves equal its

a. government securities.
b. transactions deposits.
c. vault cash plus deposits at the Federal Reserve.
d. cash assets plus government securities.
7. The reserve requirement is 0 percent on the first $8 million in transaction deposits, 3 percent on
amounts between $8 million and $50 million, and 10 percent on amounts above $50 million. A
bank with transaction deposits totaling $47 million has required reserves equal to
a. $0.47 million.
b. $1.05 million.
c. $1.17 million.
d. $1.41 million.

2|Page
 8. The market in which banks with excess reserves lend them to banks that desire additional reserves
is known as the ________ market.
a. federal reserves
b. excess reserves
c. federal funds
d. excess funds
9. The discount rate is the interest rate on
a. loans of reserves between banks.
b. discount loans from the Federal Reserve.
c. discount bonds.
d. federal agency securities.

10. A bank is said to have ____ when its average costs decline when it offers a wider variety of
products.
a. economies of scope.
b. economies of scale.
c. cost diminution.
d. decreasing returns to scale.

11. A bank's spread equals

a. the bank's average profit per dollar of assets.
b. the bank's return on equity.
c. the average interest rate on all the bank's investments minus the inflation rate.
d. the average interest rate on the bank's assets minus the average interest rate on its
liabilities.

12. Which size category of banks generally has the smallest spread?
a. Small banks
b. Slightly smaller than medium-sized banks
c. Slightly larger than medium-sized banks
d. Large banks

13. In a recent year, a bank earned $12 million in interest on its assets of $177 million, it paid out $8
million in interest on its liabilities (excluding capital) of $172 million, and it paid its workers $3
million in total compensation. The bank's spread is
a. 2.1 percent.
b. 2.5 percent.
c. 2.9 percent.
d. 3.3 percent.

14. Which of the following is NOT a reason that the government regulates banks?
a. To reduce the externalities caused by bank problems
b. To stabilize the money supply
c. To prevent bank runs
d. To keep banks large

15. When many depositors go to a bank at the same time to withdraw their money, there is said to be
a. contagion.
b. a loss of credibility.
c. a loss of reserves.
d. a bank run.

3|Page
16. When a bank run spreads from one bank to another, there is said to be
a. contagion.
b. a loss of credibility.
c. a loss of reserves.
d. an over-run.

17. A financial holding company (FHC) is the only banking corporation that can
a. own an insurance underwriter or a merchant-banking firm.
b. own an insurance underwriter or an insurance agency.
c. own an insurance agency or a securities agency.
d. own a securities agency or a securities underwriting firm.

18. The main idea of the government’s supervision and regulation of banks is that it is willing to
________ banks that are solvent, ________ banks that are insolvent or badly run.
a. insure deposits for; and provide loans to
b. close; but insure deposits for
c. close; but provide loans to
d. insure deposits for or provide loans to; but will close

19. The too-big-to-fail policy is a policy under which bank regulators will not close a bank that is
deemed to
a. have one of the top ten biggest headquarters buildings.
b. have at least one account with a balance greater than $1 million.
c. be so large that its closure would affect the financial system and cause other banks to fail.
d. be larger than the Federal Reserve System.

20. Under the payoff method of handling a bank failure, the FDIC
a. takes over the bank and runs it.
b. closes the bank, sells off the assets, pays off insured depositors, and then pays off creditors
of the bank if funds remain.
c. keeps the bank open and lends funds to it so that it survives.
d. finds a buyer for the bank, giving the buyer the good assets of the bank, and assumes the
bad loans of the bank.

21. The least costly method for the FDIC to close an insolvent bank is
a. payoff.
b. purchase and assumption.
c. assistance.
d. foreclosure.

22. The United States has a dual banking system, which means that a bank
a. has two regulators.
b. may hold its reserves either in the form of vault cash or as deposits at a Federal Reserve
Bank.
c. may take out a primary credit discount loan or a secondary credit discount loan.
d. may choose whether to be chartered by federal government authorities or by a state
government.

4|Page
23. Suppose the banking market in Cedar Rapids consists of banks that have the following shares of
the market: 24 percent, 18 percent, 17 percent, 14 percent, 9 percent, 8 percent, 4 percent, 3
percent, 2 percent, 1 percent. Calculate the HHI.
a. 100
b. 576
c. 780
d. 1,560

24. Someone who visits the ATM once every 8 days, and who spends $25 per day, has an average cash
balance of
a. $12.50.
b. $25.
c. $100.
d. $200.

25. Someone who visits the ATM once every 7 days, and who has an average cash balance of $70,
spends ____ per day.
a. $5
b. $10
c. $15
d. $20

26. Someone who has an average cash balance of $45, and who spends $15 per day, visits the ATM
once every ____ days.
a. 4
b. 5
c. 6
d. 7

27. If the cost of going to the ATM is $1 and the nominal interest rate is 5 percent, someone who has a
15 percent probability of having his cash lost or stolen and who spends $10 each day, has the
following total cost of holding cash.
a. (182.5/T) + (0.2  T)
b. (182.5/T) + (0.2  T)
c. (365/T) + (0.5  T)
d. (365/T) + T

28. If the nominal interest rate is 5 percent, someone who has a 15 percent probability of having his
cash lost or stolen and who spends $10 each day, and who has the total cost of holding cash =
(365/T) + T, faces a cost of going to the ATM of
a. $1.
b. $2.
c. $3.
d. $4.

29. If the cost of going to the ATM is $1 and the nominal interest rate is 5 percent, someone who
spends $10 each day and has the total cost of holding cash = (365/T) + T, has a ____ probability of
having his cash lost or stolen.
a. 5 percent
b. 10 percent

5|Page
 c. 15 percent
d. 20 percent

30. Suppose someone's cost of going to the ATM is $1.50, there is a 12 percent probability of having
his cash lost or stolen, and he spends $5 each day. If his total cost of holding cash = (547.50/T) +
(0.375  T), then the nominal interest rate is
a. 1 percent.
b. 2 percent.
c. 3 percent.
d. 4 percent.
31. If the nominal interest rate is 3 percent and the cost of going to the ATM is $1.50, someone who
has a 12 percent probability of having his cash lost or stolen and has the total cost of holding cash
= (547.50/T) + (0.375  T) spends ____ per day.
a. $20
b. $15
c. $10
d. $5

32. If the cost of going to the ATM is $1 and the nominal interest rate is 5 percent, someone who has a
15 percent probability of having his cash lost or stolen and spends $10 each day will go to the
ATM once every ____ days.
a. 10
b. 13
c. 16
d. 19

33. Suppose the money demand function is

MD = P  [(0.25  Y)  (100  i)],
where Y is expressed in billions of dollars and i is expressed in percentage points. If P = 2, Y =
5,000, and i = 5, then the nominal quantity of money demanded equals
a. 750.
b. 1,000.
c. 1,500.
d. 2,000.

34. In a market with six banks of equal size, two of the banks propose merging. Does the merger
violate the Justice Department's guidelines?

ANSWER:

6|Page
35. (6 marks) Reserve requirements for banks are currently:

Amount of Bank's Reserve

Transaction Deposits Requirement
The first $6.6 million 0 percent
Amounts from $6.6 to $45.4 million 3 percent
Amounts over $45.4 million 10 percent

Calculate the reserve requirements for three banks with the following amounts of transaction
deposits. Calculate both the marginal reserve requirement (the additional amount of required
reserves per dollar of additional transaction deposits) and the average reserve requirement
(required reserves divided by transaction deposits).
a. $38.8 million
b. $95.6 million
c. $3,400 million

ANSWER:

_____________________________NO MORE QUESTIONS____________________________

7|Page