MGT411- Money & Banking Spring 2009 Final Term Paper

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FINALTERM EXAMINATION
Spring 2009
MGT411- Money & Banking

Question No: 1 ( Marks: 1 ) - Please choose one
Among the following which one is less liquid asset?
► Checking account
► Car
► Share
► Debit card

Question No: 2 ( Marks: 1 ) - Please choose one
Which one of the following is the primary cause of inflation?
► Decreased money supply
► Increased money supply
► Decreased interest rates
► Increased purchasing power

Question No: 3 ( Marks: 1 ) - Please choose one
In order to understand the link among money, inflation and economic growth. We need to measure which of the following?
► Quantity of money
► Volume of demand deposits
► Inflation rates
► Interest rates

Question No: 4 ( Marks: 1 ) - Please choose one
A borrower is promised a $100 payment (including interest) one year from today. If the lender has an 8% opportunity cost of money, he should be willing to accept what amount today?
► Rs.100.00
► Rs.108.20
► Rs.92.59
► Rs.96.40

Question No: 5 ( Marks: 1 ) - Please choose one
Which of the following provides the greatest incentive to borrow?
► A high real interest rate
► A low real interest rate
► A high nominal interest rate
► A low nominal interest rate

Question No: 6 ( Marks: 1 ) - Please choose one
The relationship between the price and the interest rate for a zero coupon bond is best described as _________.
► Volatile
► Stable
► Inverse
► No relationship

Question No: 7 ( Marks: 1 ) - Please choose one
The coupon rate of bond:
► Is another term for the current yield
► Is another term for the yield to maturity
► Could not be calculated for a zero-coupon bond
► None of the given options

Question No: 8 ( Marks: 1 ) - Please choose one
Which of the following best describes default risk?
► The chance the issuer will be unable to make interest payments or repay principal
► The chance the issuer will retire the debt early
► The chance the issuing firm will be sold to another firm
► The chance the issuer will sell more debt

Question No: 9 ( Marks: 1 ) - Please choose one
Which of the following ratings shows “Highest quality and credit worthiness”?
► AAA
► AA
► BB
► A

Question No: 10 ( Marks: 1 ) - Please choose one
Considering the Liquidity Premium Theory, if investors expect short term interest rates to decrease:
► The yield curve must have a positive slope
► The yield curve must be inverted
► The yield curve could be flat
► The slope of the yield curve should actually increase

Question No: 11 ( Marks: 1 ) - Please choose one
Stock market bubbles can lead to:
► An inefficient allocation of resources
► Stock market crashes
► Patterns of volatile returns from the stock market
► All of the given options

Question No: 12 ( Marks: 1 ) - Please choose one
Which of the following does not include in the bank's reserves?

► Treasury bills
► Currency in the bank
► Bank's deposits at the Federal Reserves
► Currency in ATM machines

Question No: 13 ( Marks: 1 ) - Please choose one
Which of the following is a Depository institution?

► Commercial bank
► Savings institution
► Credit union
► All of the given options

Question No: 14 ( Marks: 1 ) - Please choose one
A bank's Return on Equity is calculated by which of the following?

► Dividing the banks liabilities by the bank's capital
► Dividing the bank's net profit after taxes by the bank's capital
► Bank's assets plus the net profit after taxes and dividing this sum by the bank's capital
► Dividing the bank's net profit after taxes by the sum of the bank's assets and its liabilities

Question No: 15 ( Marks: 1 ) - Please choose one
___________ is a component of the liability side of the commercial bank’s balance sheet.
► Deposits
► Loans
► Securities
► All of the given options

Question No: 16 ( Marks: 1 ) - Please choose one
Which one of the following is the similiraity between pension funds and insurance companies?
► Pooling the savings of many investors
► Spreading risk
► Accepting deposits
► Both pool the savings of many investors and spread risk

Question No: 17 ( Marks: 1 ) - Please choose one
Pooling of small savings to provide loans is a function of which of the following institution?

► Insurance company
► Depository Institutions (Bank)
► Investment Bank
► Securities firm

Question No: 18 ( Marks: 1 ) - Please choose one
Funds of depository institution are primarily used in which of the following?

► Corporate bonds, Government bonds, Stocks, Mortgage
► Cash, Loan, Securities
► Stocks, Government bonds, corporate bonds, commercial papers
► Commercial papers, Bonds

Question No: 19 ( Marks: 1 ) - Please choose one
Which one of the following refers to the risk assessment and loss reimbursement guarantee by the individual risk experts of the relevant field?
► Underwriting process
► Insurance process
► Research process
► None of the given options

Question No: 20 ( Marks: 1 ) - Please choose one
The federal government is concerned about the health of the banking system for many reasons. Which of the following reason is the most important?

► Banks are where government bonds are traded.
► A significant number of people are employed in the banking industry.
► Banks are of great importance in enabling the economy to operate efficiently.
► Many people earn the majority of their income from interest on bank deposits.

Question No: 21 ( Marks: 1 ) - Please choose one
"The Government is too big to fail" policy applies to the______________.

► Bank run in specific highly populated states which impacts a large percent of the total population
► Banks that have branches in more than two states
► Large corporate payroll accounts held by some banks where many people would lose their income
► Large banks whose failure would certainly start a widespread panic in the financial system

Question No: 22 ( Marks: 1 ) - Please choose one
One advantage a central bank has over other businesses including banks is that___________.

► It receives all of its funding from the government
► It doesn't have stockholders
► It can control its balance sheet at its own will
► It doesn't have a board of directors

Question No: 23 ( Marks: 1 ) - Please choose one
An open market purchase of U.S. Treasury securities by the Fed will cause the Fed's balance sheet to show _________.

► A decrease in the asset of securities and a decrease in the liability of reserves
► A decrease in the liability of reserves
► No change in the size of balance sheet except composition of assets
► An increase in the asset category of securities and the liability category of reserves

Question No: 24 ( Marks: 1 ) - Please choose one
If required reserves are expressed by RR ; the required reserve rate by rD and deposits by D; the simple deposit expansion multiplier is expressed as:

► rDD
► (1/rD) D
► 1/rD
► rD times 10

Question No: 25 ( Marks: 1 ) - Please choose one
Which of the following best completes the statement; if people decrease their currency holdings, all else the same, the monetary base

► Will not change but the quantity of M2 will increase
► Will increase along with the quantity of M2
► Will decrease along with the quantity of M2
► There will be no change either to the monetary base or M2

Question No: 26 ( Marks: 1 ) - Please choose one
Identify the most appropriate statement.
► The FOMC sets the federal funds rate
► The discount rate is the primary policy tool of the FOMC
► The difference between the target and actual federal funds rate is the dealer's spread
► The FOMC sets the target federal funds rate

Question No: 27 ( Marks: 1 ) - Please choose one
Interest rate charged on overnight loans between the banks is known as:
► Discount rate
► Inflation rate
► Internal rate of return
► Target federal funds rate

Question No: 28 ( Marks: 1 ) - Please choose one
Key assumptions behind the quantity theory of money include which of the following?

► The change in nominal GDP is zero
► Percentage change in the price level equals the percentage change in real GDP
► The velocity of money is constant
► The money supply is fixed

Question No: 29 ( Marks: 1 ) - Please choose one
Which of the following statements is incorrect?

► The velocity of M2 is more volatile in the short run than the long run
► Money velocity being stable in the long run was correct as per Fisher's assumption
► The velocity of M2 is less stable than the velocity of M1
► The velocity of M2 is relatively stable over long time periods

Question No: 30 ( Marks: 1 ) - Please choose one
Inflation in the long run would be determined by which one of the following?

► The exchange rate
► Aggregate demand
► The rate of money growth
► Aggregate supply

Question No: 31 ( Marks: 1 ) - Please choose one
Of all of the component parts of aggregate demand, the part least sensitive to changes in the real interest rate is:

► Investment
► Government purchases
► Consumption
► Net exports

Question No: 32 ( Marks: 1 ) - Please choose one
If government purchases increase and push current output above potential output, then monetary policymakers are likely to:

► Raise the real interest rate
► Lower the real interest rate
► Keep the real interest rate constant focussing on changing nominal interest rate only
► Purchase Treasury securities

Question No: 33 ( Marks: 1 ) - Please choose one
Which one of the following is NOT true for gap analysis?
► It is the difference between the yield on interest sensitive assets and liabilities
► It is the difference in the maturity of assets and liabilities
► Banks manage credit risk by using gap analysis
► It is a formal study of what a business is doing currently and where it wants to go in the future

Question No: 34 ( Marks: 1 ) - Please choose one
A U.S. institution, United Bank, buys some financial assets denominated in British pounds. Fluctuations in the dollar value of the pound will give rise to:
► Credit risk
► Operational risk
► Foreign exchange risk
► Country risk

Question No: 35 ( Marks: 1 ) - Please choose one
High State Bank purchases some U.S. Treasury bonds. We would view such bonds as being free of:
► Credit risk
► Interest rate risk
► Reinvestment risk
► All of the given options

Question No: 36 ( Marks: 1 ) - Please choose one
Required reserve-to-deposit ratio is a factor that affects the quantity of money. This factor is controlled by which of the following?
► Central bank
► Bank regulators
► Commercial banks
► Non bank public

Question No: 37 ( Marks: 1 ) - Please choose one
The real purchasing power of money in circulation is expressed as which of the following?
► MV•PY
► M/P
► PY
► M/Y

Question No: 38 ( Marks: 1 ) - Please choose one
The FOMC targets the federal funds rate, but if they are going to alter the course of the economy they must influence which one of the following?
► The money growth rate as well
► The long-term nominal interest rate as well
► The real interest rate as well
► The nominal exchange rate as well

Question No: 39 ( Marks: 1 ) - Please choose one
If real interest rate increases, investment will:
► Increase
► Decrease
► Remain constant
► None of the given options

Question No: 40 ( Marks: 1 ) - Please choose one
The aggregate demand curve will be relatively flat in which of the following case?
► If current output is very sensitive to inflation
► If current output is not sensitive to inflation
► If policymakers react more cautiously, to a movement of current inflation
► If the monetary policy reaction curve is also flat

Question No: 41 ( Marks: 1 ) - Please choose one
Which of the following will shift the Aggregate Demand curve to the right?
► A decrease in autonomous money demand
► An increase in Exports
► An increase in potential output
► An increase in Government purchases

Question No: 42 ( Marks: 1 ) - Please choose one
When you need more units of money to buy the same amount of good which you bought a month or a year ago. What does it mean?
► Your economy has a high economic growth rate
► Your economy’s GDP value is more than previous year
► Price in your economy is falling causing deflation
► Price in your economy is raising causing inflation

Question No: 43 ( Marks: 3 )
Give a single line definition of the following.

Answer:
1) Credit risk: This is a risk which arises when loans are not repaid. It is avoided by diversification and checking credit worthiness.

2) Interest-rate risk: The assets and liabilities of a bank are sensitive to interest rate but liabilities are of short term and assets of long term so by an increase in interest rate banks have the risk that value of assets fall more than that of liabilities affecting the net worth or capital of bank.

3) Liquidity risk: It is a risk associated with a sudden increase in demand of funds. If bank can not meet the withdrawal requirement of all its customers, bank is considered illiquid and it may fail.

Question No: 44 ( Marks: 3 )
Describe the role of Central bank as “The Bankers Bank”.

Answer: The central Bank works as a Banker’s Bank. The role which it plays is
• Lender of last resort. If banks go illiquid or during financial stress central bank provide discount loans to banks.
• Manage interbank payment system
• Monitors the working of banks and stabilizing financial system

Question No: 45 ( Marks: 3 )
What is the effect of an increase in potential output on inflation and output?

Answer: Increase in potential output shifts long run aggregate supply curve to right, this shift has no impact on short run aggregate supply curve so inflation and output remains unchanged. But in long run now as potential output is increased so current output will be below potential output creating recessionary output gap causing inflation to fall and output begins to rise.

Question No: 46 ( Marks: 5 )
Which relationship is shown by the monetary policy reaction curve?
What will be the change in monetary policy reaction curve if the given factors change?
a. An increase in the Central Bank’s Inflation Target
b. An increase in the Long-run real interest rate

Answer: Monetary policy reaction curve gives a relationship between inflation and real interest rate. It is set so that when current inflation equals target inflation, real interest rate equals long run real interest rate.
a. Increase in central bank’s inflation target shifts the monetary policy reaction curve to right
b. Increase in long run real interest rate shifts the curve to left.



Question No: 47 ( Marks: 5 )
Fill the table below:


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Question No: 48 ( Marks: 10 )
Discuss the factors that cause an increase or decrease in the transaction and portfolio demand for money.
Answer:
Transaction Demand for money: The quantity of money people hold for transaction purposes is called transaction demand for money. It depend on following factors
• Nominal income of people: As the nominal income increases spending increases which causes an increase in the demand for money holding.
• Cost of holding money: The cost of money holding is the interest foregone in holding the money in hand. So if the nominal interest rate is higher people will prefer keeping money in banks etc so demand for money holding decreases.
• Availability of substitutes: If people have cheaper alternative means of payment they will hold less money.

Portfolio Demand for Money: Money is one instrument that people can hold in their investment portfolio. The demand for holding money in portfolio is dependent on following factors:
• Wealth: An increase in wealth increases the demand for money
• Return on alternative investments: As the return on alternative investments fall people hold more money.
• Expected future interest rate: An increase in expected future interest rate increases holding demand for money
• Riskiness of alternatives: Riskier the alternative investments greater the demand for money.
• Liquidity: If alternative investments become more liquid demand for money decreases




Question No: 49 ( Marks: 10 )
If Excess reserves are not available how a bank manages Liquidity risk?
Answer: One way of managing liquidity risk is to keep excess reserves but this is not profitable as reserve is interest free.
There are two other ways through which a bank can manage liquidity risk.
• Adjusting other assets of balance sheet
• Adjusting liability side

In adjusting assets banks can instead of paying through reserves, fulfill withdrawal requirements by adjusting other assets. Banks can either
• sell their securities
• sell their loans
• refuse a loan renewal

The second option banks have is to adjust their liabilities.
• Borrow from other banks or central bank
• Attracting more deposits



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