Economics 105

Fall 2019

Dr. Martin Santamaria

Student Name:_____________________________________

Student ID:________________________________________

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Economics 105
2nd Midterm Examination
Fall 2019

Instructions:

a. You have 1 hour and 50 minutes to finish your exam. Write your name and ID number on the
upper left corner of this page.
b. Confirm that your test has 12 pages. The last two pages can be used as scratch paper. You may
detach any of the two last pages.
c. Use a pen to write your answers. You give up your right to a regrade if you choose to use a
pencil. With you, you should only have a pen, and a calculator.
d. Show ALL your work.
e. The table below indicates how points will be allocated on the exam. You can answer the
questions in any order you like. Use your time carefully and efficiently.

Question Points Your Score

MC 30
Question 1 10
Question 2 10
Question 3 10
Question 4 20
Question 5 10
Question 6 10
Exam Total 100

f. You are NOT allowed to use your cell phone during the exam. Please, turn off your cell phone
and put it away. If you are found using a cell phone during the examination, you will be
considered in violation of academic integrity, and you will be reported to the Academic Integrity
Office.
g. Once you started the exam you are not allowed to leave the room until you turn in your exam.
h. KEEP YOUR EYES ON YOUR OWN PAPER, AND KEEP YOUR PAPER OUT OF VIEW OF YOUR
NEIGHBORS.
 Economics 105

Fall 2019

Dr. Martin Santamaria

Part I. Multiple Choice Questions (30 points total, 3 points each)

Please, write your answers on the space provided below:

1.______ 2. ______ 3.______ 4._______ 5._______ 6.________

7.______ 8.______ 9._______ 10.______

1. A Country’s yearly investment spending is 1 billion dollars, Private Savings equals 1.5 billion and
the country has a Net Outflow of Capital of 200 million dollars, then the government:
A. Is running a 300 million dollar deficit.
B. Is running a 300 million dollar surplus.
C. Is running a 200 million dollar surplus.
D. None of the above.

2. According to the twin deficit hypothesis, an increase in government budget deficit is typically
financed by:

A. An increase in private savings

B. A decrease in private investment.
C. An increase in net foreign investment.
D. None of the above.

3. When an individual deposits currency into a checking account:

A. bank reserves increase which allows banks to lend more and, ultimately, increases the money
supply.
B. bank reserves decrease which reduces the amount banks can lend thereby reducing the growth
of the money supply.
C. bank reserves are unchanged.
D. bank liabilities increase which reduces the amount banks can lend, thereby reducing the growth
of the money supply.

4. Assets of the commercial banking system include:

A. reserves and loans.

B. deposits.
C. reserves and deposits.
D. loans and deposits.
 Economics 105

Fall 2019

Dr. Martin Santamaria

5. Suppose that a bank decides to pull all of it’s individual mortgage loans into a pool of mortgage
loans and sell shares of this pool to investors. Then:
A. this bank is issuing Mortgage backed securities.
B. this bank Is no longer exposed to the risk of the loans not being repaid.
C. The investors exposure to risk of an individual mortgage defaulting if diversified/hedged.
D. All of the above.

6. If banks' desired reserve ratio increases from .10 to .15, the public still desires to hold the same
amount of currency, and the Fed takes no actions, the money supply will:

A. increase.
B. decrease.
C. not change.
D. either increase or decrease.

7. Jordan has the following assets and liabilities:

Jordan's wealth (i.e. net worth) is _____, the value of Jordan's assets is _____ and the value of
Jordan's liability is _____.

A. $107,000; $213,000; $100,000

B. $109,000; $213,000; $104,000
C. $111,000 ; $213,000; $100,000
D. $213,000; $317,000; $104,000

8. You expect a share of EconNews.Com to sell for $65 a year from now and to pay a $2 dividend
per share in one year. What should you pay (rounded to the nearest dollar) for the stock today if
you require an 8% return?

A. $60
B. $62
C. $67
D. $70
 Economics 105

Fall 2019

Dr. Martin Santamaria

9. One year before maturity the price of a bond with a principal amount of $1,000 and a coupon
rate of 5% paid annually fell to $981. The one year interest rate:

A. rose to 8.5%
B. rose to 7.0%
C. rose to 6.0%
D. remained at 5.0%

10. The uses of money are:

A. To buy goods and services.

B. To store value.
C. As a unit of account.
D. All of the above.
 Economics 105

Fall 2019

Dr. Martin Santamaria

Short Answer Questions (67 points)

Question 1 (10 points)

Consider the diagram below for the Federal funds market, where banks can borrow and lend overnight
to fulfill the reserve requirements.

Federal Funds
Interest Rate Supply

2%

Demand

Q1
Loanable Funds

Use the diagram above, to show how an increase in expected inflation of 2% would affect the Federal
funds market. Justify your answer.
 Economics 105

Fall 2019

Dr. Martin Santamaria

Question 2 (10 points)

“For the first time since the government implemented new stress test rules on Canadian home loans, the
bar has been lowered — meaning a would-be homebuyer could be approved for a bigger mortgage
today than they would have yesterday.

The so-called stress test, formally in place since January 2018, is a financial bar that any Canadian
looking to take out a mortgage must pass to be approved for one.”

CBC News, Pete Evans, July 19th, 2019

a) (8 points) What do you think will be the effect on Mortgage interest rates of the less strict stress
test for mortgage loans? Justify your answer using a diagram for the market for mortgage loans
and showing how the change in regulation would affect the market.

b) (2 points) What do you think would be the effect on the housing market. Why?
 Economics 105

Fall 2019

Dr. Martin Santamaria

Question 3 (10 points)

True, False or Uncertain. Justify your answer. The government should eliminate all purchases that are
financed by borrowing because that borrowing crowds out private investment spending.

Question 4 (20 points)

You want to buy a GM Bond, with par value = 1000, 10% coupon (paid annually) with a two-year
maturity.

a) (5 points) Explain in words what is the meaning of the present value of the bond.

Suppose after one year, after you collect the coupon payment, you decide to sell the bond.

b) (5 points) What is the present value of the bond you are selling?
 Economics 105

Fall 2019

Dr. Martin Santamaria

In class, we discussed that bonds are a type of financial asset.

c) (4 points) How do economists define an asset?

d) (6 points) In addition to bonds, name and explain two other kind of financial assets.
 Economics 105

Fall 2019

Dr. Martin Santamaria

Question 5 (10 points)

Suppose that the FED balance sheet looks like this:

Assets Liabilities

Bank Reserves $2000 billion

Treasury Bills $ 4,000 billilion

Money in circulation $2000 billion

The FED buys 100 billion USD of T-bills from Citibank and pays by crediting the 100 billion to Citibank’s
account at the Federal Reserve Bank.

a) (5 points) Show how the balance sheet of the FED will change as a result of the open market
operation.

b) (5 points) Do you expect the total change in M1 to be bigger or smaller than 100 billion? Explain
 Economics 105

Fall 2019

Dr. Martin Santamaria

Question 6) (10 points)

The NASDAQ composite index is stock market index of technology firms. As figure below shows there
was a sharp increase of the NASDAQ as a result of the development of the internet in the early ninethy’s
followed by a even faster decrease towards the end of the nineties.

NASDAQ COMPOSITE INDEX

How would explain the behavior of the NASDAQ during the 1990’s? Explain
 Economics 105

Fall 2019

Dr. Martin Santamaria

SCRATCH PAPER
 Economics 105

Fall 2019

Dr. Martin Santamaria

SCRATCH PAPER
 Economics 105

Fall 2019

Dr. Martin Santamaria

SCRATCH PAPER