Final Exam—Money and Banking

Fall, 2021
Part 1: Multiple-Choice Questions (2.5% each 45% in total)
Chapter 8.
1. The publication, Consumer’s Reports, is one tool designed to address:
A) adverse selection.
B) moral hazard.
C) the free-rider problem.
D) symmetric information.

2. Analysis of adverse selection indicates that financial intermediaries,

especially banks
A) have advantages in overcoming the free-rider problem, helping to explain
why indirect finance is a more important source of business finance than is
direct finance.
B) despite their success in overcoming free-rider problems, nevertheless play
a minor role in moving funds to corporations.
C) provide better-known and larger corporations a higher percentage of their
external funds than they do to newer and smaller corporations which rely to a
greater extent on the new issues market for funds.
D) must buy securities from corporations to diversify the risk that results
from holding non-tradable loans.

3. Assume there are two companies. Both issue stock, but one is high quality
and the other low quality. If potential investors cannot distinguish the quality
of the company:
A) the shares of the low quality firm will disappear from the market.
B) the shares of both companies will trade on the market.
C) the shares of the high quality firm will disappear from the market.
D) this is an example of moral hazard and the shares of both companies will
cease to trade.

4. The principal-agent problem

A) occurs when managers have more incentive to maximize profits than the
stockholders-owners do.

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B) in financial markets helps to explain why equity is a relatively important
source of finance for American business.
C) would not arise if the owners of the firm had complete information about
the activities of the managers.
D) explains why direct finance is more important than indirect finance as a
source of business finance.

5. Because of the adverse selection problem

A) good credit risks (i.e., borrowers less likely to default) are more likely to
seek loans causing lenders to make a disproportionate amount of loans to
good credit risks.
B) lenders may refuse loans to individuals with high net worth, because of
their greater proclivity to “skip town.”
C) lenders are reluctant to make loans that are not secured by collateral.
D) lenders will write debt contracts that restrict certain activities of borrowers.

Chapter 9.
6. Which of the following are reported as liabilities on a bank’s balance
sheet?
A) reserves
B) discount loans
C) U.S. Treasury securities
D) real estate loans

7. When $1 million is deposited at a bank, the required reserve ratio is 20

percent, and the bank chooses not to hold any excess reserves but makes loans
instead, then, in the bank’s final balance sheet
A) the assets at the bank increase by $800,000.
B) the liabilities of the bank increase by $1,000,000.
C) the liabilities of the bank increase by $800,000.
D) reserves increase by $160,000.

8. A rumor starts that says a bank has suffered significant losses and may
not be able to honor its promises to depositors. This causes most of the
depositors to line up in front of the bank the next morning wanting to
withdraw their deposits. This is an example of:
A) liquidity risk.

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B) operational risk.
C) interest rate risk.
D) credit risk.

9. A bank’s assets tend to be long-term while its liabilities are short-term.

Therefore, when interest rates rise, the value of the bank’s assets:
A) increases by more than the value of its liabilities.
B) will decrease by more than the value of its liabilities.
C) increases and the value of its liabilities decreases.
D) decreases and the value of its liabilities increases.

10. Conditions that likely contributed to a credit crunch (or credit

tightening) during the global financial crisis include
A) capital shortfalls caused in part by falling real estate prices.
B) regulated hikes in bank capital requirements.
C) falling interest rates that raised interest rate risk, causing banks to choose
to hold more capital.
D) increases in reserve requirements.

11. If a bank needs to acquire funds quickly to meet an unexpected deposit

outflow, the bank could
A) borrow from another bank in the federal funds market.
B) buy U.S. Treasury bills.
C) increase loans.
D) buy corporate bonds.

12. A bank’s off-balance-sheet activities usually:

A) increase both its assets and liabilities while reducing net income.
B) increase its net income but do not directly change its assets or liabilities.
C) increases a bank's liabilities but not its assets.
D) increases a bank’s assets but not its liabilities.

13. For a given return on assets, the lower is bank capital

A) the lower is the credit risk for the owners of the bank.
B) the lower the possibility of bank failure.
C) the lower is the return for the owners of the bank.
D) the higher is the return for the owners of the bank.

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Chapter 12.
14. Debt deflation occurs when
A) rising interest rates worsen adverse selection and moral hazard problems.
B) lenders reduce their lending due to declining stock prices (equity deflation)
that lowers the value of collateral.
C) an economic downturn causes the price level to fall and a deterioration in
firms’ net worth because of the increased burden of indebtedness.
D) corporations pay back their loans before the scheduled maturity date.

15. Contagion is:

A) the failure of one bank spreading to other banks through depositors
withdrawing of funds.
B) the phenomenon that if one bank loan defaults it will cause other bank
loans to default.
C) the rapid contraction of investment spending that occurs when interest
rates are increased by the Federal Reserve.
D) the rapid inflation that results from the printing of money.

16. Agency problems in the subprime mortgage market included all of the
following EXCEPT
A) homeowners could refinance their houses with larger loans when their
homes appreciated in value.
B) mortgage originators had little incentives to make sure that the mortgagee
is a good credit risk.
C) underwriters of mortgage-backed securities had weak incentives to make
sure that the holders of the securities would be paid back.
D) the evaluators of securities, the credit rating agencies, were subject to
conflicts of interest.

Chapter 13.
17. The key factor leading to the financial crises in Mexico and the East
Asian countries was
A) severe fiscal imbalances.
B) a sharp increase in the stock market.
C) a sharp decline in interest rates.
D) a deterioration in banks’ balance sheets because of increasing loan losses.

18. The chaebols encouraged the Korean government to open up Korean

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financial markets to foreign capital. The Korean government responded by
A) allowing unlimited short-term foreign borrowing but maintained quantity
restrictions on long-term foreign borrowing by financial institutions.
B) allowing unlimited short-term and long-term foreign borrowing by
financial institutions.
C) maintaining quantity restrictions on short-term foreign borrowing but
allowing unlimited long-term foreign borrowing by financial institutions.
D) not allowing any foreign borrowing by financial institutions.