Chapter 4

Financial Markets and Institutions, 7e (Mishkin)Chapter 4 Why Do Interest Rates Change?

4.1 Multiple Choice

1) As the price of a bond ________ and the expected return ________, bonds become more attractive to investors and the quantity demanded rises.A) falls; risesB) falls; fallsC) rises; risesD) rises; fallsAnswer: A

2) The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases.A) falls; supplyB) falls; quantity suppliedC) rises; supplyD) rises; quantity suppliedAnswer: D

3) When the price of a bond is above the equilibrium price, there is excess ________ in the bond market and the price will ________.A) demand; riseB) demand; fallC) supply; fallD) supply; riseAnswer: C

4) When the price of a bond is below the equilibrium price, there is excess ________ in the bond market and the price will ________.A) demand; riseB) demand; fallC) supply; fallD) supply; riseAnswer: A

5) When the price of a bond is ________ the equilibrium price, there is an excess supply of bonds and the price will ________.A) above; riseB) above; fallC) below; fallD) below; riseAnswer: B

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6) When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and the price will ________.A) above; riseB) above; fallC) below; fallD) below; riseAnswer: D

7) When the interest rate on a bond is above the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.A) demand; riseB) demand; fallC) supply; fallD) supply; riseAnswer: B

8) When the interest rate on a bond is below the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.A) demand; riseB) demand; fallC) supply; fallD) supply; riseAnswer: D

9) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.A) above; demand; fallB) above; demand; riseC) below; supply; fallD) above; supply; riseAnswer: A

10) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.A) below; demand; riseB) below; demand; fallC) below; supply; riseD) above; supply; fallAnswer: C


11) When the demand for bonds ________ or the supply of bonds ________, interest rates rise.A) increases; increasesB) increases; decreasesC) decreases; decreasesD) decreases; increasesAnswer: D

12) When the demand for bonds ________ or the supply of bonds ________, interest rates fall.A) increases; increasesB) increases; decreasesC) decreases; decreasesD) decreases; increasesAnswer: B

13) When the demand for bonds ________ or the supply of bonds ________, bond prices rise.A) increases; decreasesB) decreases; increasesC) decreases; decreasesD) increases; increasesAnswer: A

14) When the demand for bonds ________ or the supply of bonds ________, bond prices fall.A) increases; increasesB) increases; decreasesC) decreases; decreasesD) decreases; increasesAnswer: D

15) Factors that determine the demand for an asset include changes in theA) wealth of investors.B) liquidity of bonds relative to alternative assets.C) expected returns on bonds relative to alternative assets.D) risk of bonds relative to alternative assets.E) all of the above.Answer: E

16) The demand for an asset rises if ________ falls.A) risk relative to other assetsB) expected return relative to other assetsC) liquidity relative to other assetsD) wealthAnswer: A


17) The higher the standard deviation of returns on an asset, the ________ the asset's ________.A) greater; riskB) smaller; riskC) greater; expected returnD) smaller; expected returnAnswer: A

18) Diversification benefits an investor byA) increasing wealth.B) increasing expected return.C) reducing risk.D) increasing liquidity.Answer: C

19) In a recession when income and wealth are falling, the demand for bonds ________ and the demand curve shifts to the ________.A) falls; rightB) falls; leftC) rises; rightD) rises; leftAnswer: B

20) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________.A) falls; rightB) falls; leftC) rises; rightD) rises; leftAnswer: C

21) Higher expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________.A) increase; leftB) increase; rightC) decrease; leftD) decrease; rightAnswer: C


22) Lower expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________A) increase; left.B) increase; right.C) decrease; left.D) decrease; right.Answer: B

23) When people begin to expect a large stock market decline, the demand curve for bonds shifts to the ________ and the interest rate ________.A) right; fallsB) right; risesC) left; fallsD) left; risesAnswer: A

24) When people begin to expect a large run up in stock prices, the demand curve for bonds shifts to the ________ and the interest rate ________.A) right; risesB) right; fallsC) left; fallsD) left; risesAnswer: D

25) An increase in the expected rate of inflation will ________ the expected return on bonds relative to that on ________ assets, and shift the ________ curve to the left.A) reduce; financial; demandB) reduce; real; demandC) raise; financial; supplyD) raise; real; supplyAnswer: B

26) A decrease in the expected rate of inflation will ________ the expected return on bonds relative to that on ________ assets.A) reduce; financialB) reduce; realC) raise; financialD) raise; realAnswer: D


27) When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________.A) increases; increases; risesB) decreases; decreases; fallsC) increases; decreases; fallsD) decreases; increases; risesAnswer: D

28) When the expected inflation rate decreases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________.A) increases; increases; risesB) decreases; decreases; fallsC) increases; decreases; fallsD) decreases; increases; risesAnswer: C

29) When bond prices become more volatile, the demand for bonds ________ and the interest rate ________.A) increases; risesB) increases; fallsC) decreases; fallsD) decreases; risesAnswer: D

30) When bond prices become less volatile, the demand for bonds ________ and the interest rate ________.A) increases; risesB) increases; fallsC) decreases; fallsD) decreases; risesAnswer: B

31) When prices in the stock market become more uncertain, the demand curve for bonds shifts to the ________ and the interest rate ________.A) right; risesB) right; fallsC) left; fallsD) left; risesAnswer: B


32) When stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________.A) right; risesB) right; fallsC) left; fallsD) left; risesAnswer: D

33) When bonds become more widely traded, and as a consequence the market becomes more liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.A) right; risesB) right; fallsC) left; fallsD) left; risesAnswer: B

34) When bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.A) right; risesB) right; fallsC) left; fallsD) left; risesAnswer: D

35) Factors that cause the demand curve for bonds to shift to the left includeA) an increase in the inflation rate.B) an increase in the liquidity of stocks.C) a decrease in the volatility of stock prices.D) all of the above.E) none of the above.Answer: D

36) Factors that cause the demand curve for bonds to shift to the left includeA) a decrease in the inflation rate.B) an increase in the volatility of stock prices.C) an increase in the liquidity of stocks.D) all of the above.E) only A and B of the above.Answer: C


37) During an economic expansion, the supply of bonds ________ and the supply curve shifts to the ________.A) increases, leftB) increases, rightC) decreases, leftD) decreases, rightAnswer: B

38) During a recession, the supply of bonds ________ and the supply curve shifts to the ________.A) increases, leftB) increases, rightC) decreases, leftD) decreases, rightAnswer: C

39) An increase in expected inflation causes the supply of bonds to ________ and the supply curve to shift to the ________.A) increase, leftB) increase, rightC) decrease, leftD) decrease, rightAnswer: B

40) When the federal government's budget deficit increases, the ________ curve for bonds shifts to the ________.A) demand; rightB) demand; leftC) supply; leftD) supply; rightAnswer: D

41) When the federal government's budget deficit decreases, the ________ curve for bonds shifts to the ________.A) demand; rightB) demand; leftC) supply; leftD) supply; rightAnswer: C


42) When the inflation rate is expected to increase, the expected return on bonds relative to real assets falls for any given interest rate; as a result, the ________ bonds falls and the ________ curve shifts to the left.A) demand for; demandB) demand for; supplyC) supply of; demandD) supply of; supplyAnswer: A

43) When the inflation rate is expected to increase, the real cost of borrowing declines at any given interest rate; as a result, the ________ bonds increases and the ________ curve shifts to the right.A) demand for; demandB) demand for; supplyC) supply of; demandD) supply of; supplyAnswer: D

Figure 4.1

44) In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i1 to i2 is

A) an increase in the price of bonds.B) a business cycle boom.C) an increase in the expected inflation rate.D) a decrease in the expected inflation rate.Answer: C

45) In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i1 to i2 is

a(n) ________ in the ________.A) increase; expected inflation rateB) decrease; expected inflation rateC) increase; government budget deficitD) decrease; government budget deficitAnswer: A


46) In Figure 4.1, the most likely cause of a decrease in the equilibrium interest rate from i2 to i1 is

A) an increase in the expected inflation rate.B) a decrease in the expected inflation rate.C) a business cycle expansion.D) a combination of both A and C of the above.Answer: B

47) Factors that can cause the supply curve for bonds to shift to the right includeA) an expansion in overall economic activity.B) a decrease in expected inflation.C) a decrease in government deficits.D) all of the above.E) only A and B of the above.Answer: A

48) Factors that can cause the supply curve for bonds to shift to the left includeA) an expansion in overall economic activity.B) a decrease in expected inflation.C) an increase in government deficits.D) only A and C of the above.Answer: B

49) The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates ________ as the expected rate of inflation ________.A) rise; increasesB) rise; stabilizesC) rise; decreasesD) fall; increasesE) fall; stabilizesAnswer: A

50) An increase in the expected rate of inflation causes the demand for bonds to ________ and the supply for bonds to ________.A) fall; fallB) fall; riseC) rise; fallD) rise; riseAnswer: B


51) A decrease in the expected rate of inflation causes the demand for bonds to ________ and the supply of bonds to ________.A) fall; fallB) fall; riseC) rise; fallD) rise; riseAnswer: C

52) When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________.A) increases; increases; risesB) decreases; decreases; fallsC) increases; decreases; fallsD) decreases; increases; risesAnswer: B

53) When the economy enters into a boom, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________.A) increases; increases; risesB) decreases; decreases; fallsC) increases; decreases; risesD) decreases; increases; risesAnswer: A


Figure 4.2

54) In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is a(n)

________ in ________.A) increase; the expected inflation rateB) decrease; the expected inflation rateC) increase; economic growthD) decrease; economic growthAnswer: C

55) In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is

A) an increase in economic growth.B) an increase in government budget deficits.C) a decrease in government budget deficits.D) a decrease in economic growth.E) a decrease in the riskiness of bonds relative to other investments.Answer: A

56) In Figure 4.2, one possible explanation for a decrease in the interest rate from i2 to i1 is

A) an increase in government budget deficits.B) an increase in expected inflation.C) a decrease in economic growth.D) a decrease in the riskiness of bonds relative to other investments.Answer: C

57) In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms:A) real assets and financial assets.B) stocks and bonds.C) money and bonds.D) money and gold.Answer: C


58) In his liquidity preference framework, Keynes assumed that money has a zero rate of return; thus, when interest rates ________ the expected return on money falls relative to the expected return on bonds, causing the demand for money to ________.A) rise; fallB) rise; riseC) fall; fallD) fall; riseAnswer: A

59) The loanable funds framework is easier to use when analyzing the effects of changes in ________, while the liquidity preference framework provides a simpler analysis of the effects from changes in income, the price level, and the supply of ________A) expected inflation; bonds.B) expected inflation; money.C) government budget deficits; bonds.D) the supply of money; bonds.Answer: B

60) When comparing the loanable funds and liquidity preference frameworks of interest rate determination, which of the following is true?A) The liquidity preference framework is easier to use when analyzing the effects of changes in expected inflation.B) The loanable funds framework provides a simpler analysis of the effects of changes in income, the price level, and the supply of money.C) In most instances, the two approaches to interest rate determination yield the same predictions.D) All of the above are true.E) Only A and B of the above are true.Answer: C

61) A higher level of income causes the demand for money to ________ and the interest rate to ________A) decrease; decrease.B) decrease; increase.C) increase; decrease.D) increase; increase.Answer: D

62) A lower level of income causes the demand for money to ________ and the interest rate to ________A) decrease; decrease.B) decrease; increase.C) increase; decrease.D) increase; increase.Answer: A


63) A rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________A) decrease; right.B) decrease; left.C) increase; right.D) increase; left.Answer: C

64) A decline in the price level causes the demand for money to ________ and the demand curve to shift to the ________A) decrease; right.B) decrease; left.C) increase; right.D) increase; left.Answer: B

65) A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________A) decrease; right.B) decrease; left.C) increase; right.D) increase; left.Answer: B

66) Holding everything else constant, an increase in the money supply causesA) interest rates to decline initially.B) interest rates to increase initially.C) bond prices to decline initially.D) both A and C of the above.E) both B and C of the above.Answer: A

67) Holding everything else constant, a decrease in the money supply causesA) interest rates to decline initially.B) interest rates to increase initially.C) bond prices to increase initially.D) both A and C of the above.E) both B and C of the above.Answer: B


Figure 4.3

68) In Figure 4.3, the factor responsible for the decline in the interest rate is A) a decline in the price level.B) a decline in income.C) an increase in the money supply.D) a decline in the expected inflation rate.Answer: C

69) In Figure 4.3, the decrease in the interest rate from i1 to i2 can be explained by

A) a decrease in money growth.B) an increase in money growth.C) a decline in the expected price level.D) only A and B of the above.Answer: B

70) In Figure 4.3, an increase in the interest rate from i2 to i1 can be explained by A) a decrease in money growth.B) an increase in money growth.C) a decline in the price level.D) an increase in the expected price level.Answer: A


71) If the liquidity effect is smaller than the other effects, and the adjustment of expected inflation is slow, then theA) interest rate will fall.B) interest rate will rise.C) interest rate will initially fall but eventually climb above the initial level in response to an increase in money growth.D) interest rate will initially rise but eventually fall below the initial level in response to an increase in money growth.Answer: C

72) When the growth rate of the money supply increases, interest rates end up being permanently lower ifA) the liquidity effect is larger than the other effects.B) there is fast adjustment of expected inflation.C) there is slow adjustment of expected inflation.D) the expected inflation effect is larger than the liquidity effect.Answer: A

73) When the growth rate of the money supply decreases, interest rates end up being permanently lower ifA) the liquidity effect is larger than the other effects.B) there is fast adjustment of expected inflation.C) there is slow adjustment of expected inflation.D) the expected inflation effect is larger than the liquidity effect.Answer: D

74) When the growth rate of the money supply is decreased, interest rates will rise immediately if the liquidity effect is ________ than the other effects and if there is ________ adjustment of expected inflation.A) larger; rapidB) larger; slowC) smaller; slowD) smaller; rapidAnswer: B

75) When the growth rate of the money supply is increased, interest rates will rise immediately if the liquidity effect is ________ than the other effects and if there is ________ adjustment of expected inflation.A) larger; rapidB) larger; slowC) smaller; slowD) smaller; rapidAnswer: D


76) If the Fed wants to permanently lower interest rates, then it should lower the rate of money growth ifA) there is fast adjustment of expected inflation.B) there is slow adjustment of expected inflation.C) the liquidity effect is smaller than the expected inflation effect.D) the liquidity effect is larger than the other effects.Answer: C

77) If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth ifA) there is fast adjustment of expected inflation.B) there is slow adjustment of expected inflation.C) the liquidity effect is smaller than the expected inflation effect.D) the liquidity effect is larger than the other effects.Answer: D

78) Milton Friedman contends that it is entirely possible that when the money supply rises, interest rates may ________ if the ________ effect is more than offset by changes in income, the price level, and expected inflation.A) fall; liquidityB) fall; riskC) rise; liquidityD) rise; riskAnswer: C

Figure 4.4

79) Figure 4.4 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the liquidity effect is ________ than the expected inflation effect and interest rates adjust ________ to changes in expected inflation.A) smaller; quicklyB) larger; quicklyC) larger; slowlyD) smaller; slowlyAnswer: C


80) Figure 4.4 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation.B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation.C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation.D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation.Answer: A

81) ________ is the total resources owned by an individual, including all assets.A) Expected returnB) WealthC) LiquidityD) RiskAnswer: B

82) A ________ prefers stock in a less risky asset than in a riskier asset.A) risk preferrerB) risk-averse personC) risk loverD) risk-favorable personAnswer: B

83) When the quantity of bonds demanded equals the quantity of bonds supplied, there is A) excess supply.B) excess demand.C) a market equilibrium.D) an asset market approach.Answer: C

84) Determining asset prices using stocks of assets rather than flow is calledA) asset transformation.B) expected return.C) asset market approach.D) market equilibrium.Answer: C


85) What is the model whose equations are estimated using statistical procedures used in forecasting interest rates called?A) econometric modelB) liquidity preference frameworkC) market equilibriumD) Fisher effectAnswer: A

5.1 Multiple Choice

1) The term structure of interest rates isA) the relationship among interest rates of different bonds with the same risk and maturity.B) the structure of how interest rates move over time.C) the relationship among the terms to maturity of different bonds from different issuers.D) the relationship among interest rates on bonds with different maturities but similar risk.Answer: DQuestion Status: Updated from Previous Edition

2) The risk structure of interest rates isA) the structure of how interest rates move over time.B) the relationship among interest rates of different bonds with the same maturity.C) the relationship among the terms to maturity of different bonds.D) the relationship among interest rates on bonds with different maturities.Answer: B

3) Which of the following long-term bonds should have the lowest interest rate?A) Corporate Baa bondsB) U.S. Treasury bondsC) Corporate Aaa bondsD) Municipal bondsAnswer: D

4) Which of the following long-term bonds should have the highest interest rate?A) Corporate Baa bondsB) U.S. Treasury bondsC) Corporate Aaa bondsD) Municipal bondsAnswer: A

5) The risk premium on corporate bonds becomes smaller ifA) the riskiness of corporate bonds increases.B) the liquidity of corporate bonds increases.C) the liquidity of corporate bonds decreases.D) the riskiness of corporate bonds decreases.E) either B or D of the above occur.


Answer: E


6) Bonds with relatively low risk of default are calledA) zero coupon bonds.B) junk bonds.C) investment-grade bonds.D) none of the above.Answer: C

7) Bonds with relatively high risk of default are calledA) Brady bonds.B) junk bonds.C) zero coupon bonds.D) investment-grade bonds.Answer: B

8) A corporation suffering big losses might be more likely to suspend interest payments on its bonds, therebyA) raising the default risk and causing the demand for its bonds to rise.B) raising the default risk and causing the demand for its bonds to fall.C) lowering the default risk and causing the demand for its bonds to rise.D) lowering the default risk and causing the demand for its bonds to fall.Answer: B

9) (I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay. (II) The spread between the interest rates on bonds with default risk and default-free bonds is called the risk premium.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: B

10) Holding everything else constant, if a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the expected return on those bonds will ________.A) increase: increaseB) decrease; increaseC) increase; decreaseD) decrease; decreaseAnswer: C


11) Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds will ________ and the expected return on those bonds will ________.A) increase; decreaseB) decrease; decreaseC) increase; increaseD) decrease; increaseAnswer: D

12) If a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________.A) increase; decreaseB) decrease; increaseC) increase; increaseD) decrease; decreaseAnswer: C

13) If a corporation's earnings rise, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________.A) increase; decreaseB) decrease; decreaseC) increase; increaseD) decrease; increaseAnswer: B

14) When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.A) right; rightB) right; leftC) left; leftD) left; rightAnswer: B

15) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: D


16) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the left. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the right.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

17) The spread between interest rates on low-quality corporate bonds and U.S. government bonds ________ during the Great Depression.A) was reversedB) narrowed significantlyC) widened significantlyD) did not changeAnswer: C

18) As a result of the subprime collapse, the demand for low -quality corporate bonds ________, the demand for high-quality Treasury bonds ________, and the risk spread ________.A) increased; decreased; was unchangedB) decreased; increased; increasedC) increased; decreased; decreasedD) decreased; increased; was unchangedAnswer: BQuestion Status: Updated from Previous Edition

19) Moody's and Standard and Poor's are agencies thatA) help investors collect when corporations default on their bonds.B) advise municipal bond issuers on the tax exempt status of their bonds.C) produce information about the probability of default on corporate bonds.D) maintain liquid markets for corporate bonds.Answer: C

20) If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond ________ and its yield ________.A) increases; decreasesB) decreases; increasesC) increases; increasesD) decreases; decreasesAnswer: B


21) Corporate bonds are not as liquid as government bonds becauseA) fewer bonds for any one corporation are traded, making them more costly to sell.B) the corporate bond rating must be calculated each time they are traded.C) corporate bonds are not callable.D) all of the above.E) only A and B of the above.Answer: A

22) (I) The risk premium widens as the default risk on corporate bonds increases. (II) The risk premium widens as corporate bonds become less liquid.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

23) When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.A) right; rightB) right; leftC) left; leftD) left; rightAnswer: D

24) When the corporate bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.A) right; rightB) right; leftC) left; leftD) left; rightAnswer: B

25) (I) If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest rate to rise. (II) If a corporate bond becomes less liquid, the demand for Treasury bonds does not change.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: A


26) (I) If a corporate bond becomes less liquid, the interest rate on the bond will fall. (II) If a corporate bond becomes less liquid, the interest rate on Treasury bonds will fall.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: B

27) If income tax rates were lowered, thenA) the interest rate on municipal bonds would fall.B) the interest rate on Treasury bonds would rise.C) the interest rate on municipal bonds would rise.D) the price of Treasury bonds would fall.Answer: C

28) If income tax rates rise, thenA) the prices of municipal bonds will fall.B) the prices of Treasury bonds will rise.C) the interest rate on Treasury bonds will rise.D) the interest rate on municipal bonds will rise.Answer: C

29) An increase in marginal tax rates would likely have the effect of ________ the demand for municipal bonds and ________ the demand for U.S. government bonds.A) increasing; increasingB) increasing; decreasingC) decreasing; increasingD) decreasing; decreasingAnswer: B

30) A decrease in marginal tax rates would likely have the effect of ________ the demand for municipal bonds and ________ the demand for U.S. government bonds.A) increasing; increasingB) increasing; decreasingC) decreasing; increasingD) decreasing; decreasingAnswer: C


31) Which of the following statements are true?A) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.B) An increase in tax rates will increase the demand for municipal bonds, lowering their interest rates.C) Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption.D) All of the above are true statements.E) Only A and B are true statements.Answer: D

32) Which of the following statements are true?A) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.B) An increase in tax rates will increase the demand for Treasury bonds, lowering their interest rates.C) Interest rates on municipal bonds will be higher than on comparable bonds without the tax exemption.D) Only A and B are true statements.Answer: A

33) When a municipal bond is given tax-free status, the demand for municipal bonds shifts ________, causing the interest rate on the bond to ________.A) leftward; riseB) leftward; fallC) rightward; riseD) rightward; fallAnswer: D

34) When a municipal bond is given tax-free status, the demand for Treasury bonds shifts ________, and the interest rate on Treasury bonds ________.A) leftward; risesB) leftward; fallsC) rightward; risesD) rightward; fallsAnswer: A

35) If municipal bonds were to lose their tax-free status, then the demand for Treasury bonds would shift ________, and the interest rate on Treasury bonds would ________.A) rightward; fallB) rightward; riseC) leftward; fallD) leftward; riseAnswer: A


36) The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent over the next ten years. As a result of this tax cut, the demand for municipal bonds should shift to the ________ and the interest rate on municipal bonds should ________.A) right; declineB) right; increaseC) left; declineD) left; increaseAnswer: D

37) The relationship among interest rates on bonds with identical default risk but different maturities is called theA) time-risk structure of interest rates.B) liquidity structure of interest rates.C) yield curve.D) bond demand curve.Answer: C

38) Yield curves can be classified asA) upward-sloping.B) downward-sloping.C) flat.D) all of the above.E) only A and B of the above.Answer: D

39) Typically, yield curves areA) gently upward-sloping.B) gently downward-sloping.C) flat.D) bowl shaped.E) mound shaped.Answer: A

40) When yield curves are steeply upward-sloping,A) long-term interest rates are above short-term interest rates.B) short-term interest rates are above long-term interest rates.C) short-term interest rates are about the same as long-term interest rates.D) medium-term interest rates are above both short-term and long-term interest rates.E) medium-term interest rates are below both short-term and long-term interest rates.Answer: A


41) Economists' attempts to explain the term structure of interest ratesA) illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.B) illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.C) prove that the real world is a special case that tends to get short shrift in theoretical models.D) have proved entirely unsatisfactory to date.Answer: A

42) According to the expectations theory of the term structure,A) the interest rate on long-term bonds will exceed the average of expected future short-term interest rates.B) interest rates on bonds of different maturities move together over time.C) buyers of bonds prefer short-term to long-term bonds.D) all of the above.E) only A and B of the above.Answer: B

43) According to the expectations theory of the term structure,A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.B) when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future.C) buyers of bonds prefer short-term to long-term bonds.D) all of the above.E) only A and B of the above.Answer: E

44) According to the expectations theory of the term structure,A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.B) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future.C) investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward.D) all of the above.E) only A and B of the above.Answer: A


45) According to the expectations theory of the term structure,A) yield curves should be equally likely to slope downward as to slope upward.B) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.C) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future.D) all of the above.E) only A and B of the above.Answer: E

46) If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the pure expectations theory predicts that today's interest rate on the four-year bond isA) 1 percent.B) 2 percent.C) 4 percent.D) none of the above.Answer: D

47) If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, then the pure expectations theory predicts that the bond with the highest interest rate today is the one with a maturity ofA) one year.B) two years.C) three years.D) four years.E) five years.Answer: E

48) If the expected path of one-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, then the pure expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity ofA) one year.B) two years.C) three years.D) four years.Answer: A


49) According to the market segmentation theory of the term structure,A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that maturity.B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time.C) investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward.D) all of the above.E) none of the above.Answer: D

50) According to the market segmentation theory of the term structure,A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that maturity.B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time.C) investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope downward.D) only A and B of the above.Answer: D

51) The liquidity premium theory of the term structureA) indicates that today's long-term interest rate equals the average of short-term interest rates that people expect to occur over the life of the long-term bond.B) assumes that bonds of different maturities are perfect substitutes.C) suggests that markets for bonds of different maturities are completely separate because people have different preferences.D) does none of the above.Answer: D

52) The liquidity premium theory of the term structureA) assumes investors tend to prefer short-term bonds because they have less interest-rate risk.B) assumes that interest rates on the long-term bond respond to demand and supply conditions for that bond.C) assumes that an average of expected short-term rates is an important component of interest rates on long-term bonds.D) assumes all of the above.E) assumes none of the above.Answer: D


53) According to the liquidity premium theory of the term structure,A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a liquidity premium.B) buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of different maturities move together over time.C) even with a positive liquidity premium, if future short-term interest rates are expected to fall significantly, then the yield curve will be downward-sloping.D) all of the above.E) only A and B of the above.Answer: D

54) According to the liquidity premium theory of the term structure,A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time.B) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.C) because of the positive term premium, the yield curve cannot be downward-sloping.D) all of the above.E) only A and B of the above.Answer: B

55) If the yield curve slope is flat, the liquidity premium theory indicates that the market is predictingA) a mild rise in short-term interest rates in the near future and a mild decline further out in the future.B) constant short-term interest rates in the near future and further out in the future.C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future.D) constant short-term interest rates in the near future and a mild decline further out in the future.Answer: C

56) If the yield curve has a mild upward slope, the liquidity premium theory indicates that the market is predictingA) a rise in short-term interest rates in the near future and a decline further out in the future.B) constant short-term interest rates in the near future and further out in the future.C) a decline in short-term interest rates in the near future and a rise further out in the future.D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future.Answer: B

57) According to the liquidity premium theory of the term structure, a downward-sloping yield curve indicates that short-term interest rates are expected toA) rise in the future.B) remain unchanged in the future.C) decline moderately in the future.D) decline sharply in the future.Answer: D


58) According to the liquidity premium theory of the term structure, when the yield curve has its usual slope, the market expectsA) short-term interest rates to rise sharply.B) short-term interest rates to drop sharply.C) short-term interest rates to stay near their current levels.D) none of the above.Answer: C

59) In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of theA) market segmentation theory.B) expectations theory.C) liquidity premium theory.D) separable markets theory.Answer: B

60) Which theory of the term structure proposes that bonds of different maturities are not substitutes for one another?A) market segmentation theoryB) expectations theoryC) liquidity premium theoryD) separable markets theoryAnswer: A

61) Since yield curves are usually upward sloping, the ________ indicates that, on average, people tend to prefer holding short-term bonds to long-term bonds.A) market segmentation theoryB) expectations theoryC) liquidity premium theoryD) both A and B of the aboveE) both A and C of the aboveAnswer: E

62) ________ cannot explain the empirical fact that interest rates on bonds of different maturities tend to move together.A) The market segmentation theoryB) The expectations theoryC) The liquidity premium theoryD) Both A and B of the aboveE) Both A and C of the aboveAnswer: A


63) Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that views long-term interest rates as equaling the average of future short-term rates expected to occur over the life of the bond is theA) pure expectations theory.B) preferred habitat theory.C) liquidity premium theory.D) segmented markets theory.Answer: A

64) Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that assumes that bonds of different maturities are not substitutes for one another is theA) expectations theory.B) segmented markets theory.C) liquidity premium theory.D) preferred habitat theory.Answer: B

65) A moderately upward-sloping yield curve indicates that short-term interest rates are expected toA) neither rise nor fall in the near future.B) remain relatively unchanged, but that long-term rates are expected to fall.C) neither rise nor fall, but that long-term rates are expected to rise moderately.D) rise moderately in the near future.Answer: A

66) A steep upward-sloping yield curve indicates that short-term interest rates are expected toA) neither rise nor fall in the near future.B) remain relatively unchanged, but that long-term rates are expected to fall.C) neither rise nor fall, but that long-term rates are expected to rise moderately.D) rise moderately in the near future.Answer: D

67) A bond rating of Aa or AA would mean that the quality of the bond isA) the highest.B) high.C) medium grade.D) speculative.Answer: B

68) ________ bonds are the most liquid of all long-term bonds. A) CallableB) MunicipalC) Corporate AaaD) U.S. Treasury Answer: D


69) ________ bonds are exempt from federal income taxes. A) Corporate AaaB) U.S. Treasury C) Corporate BaaD) Municipal Answer: D

70) The risk structure of interest rates is explained byA) default risk.B) liquidity.C) tax considerations.D) all of the above. Answer: D

71) The ________ theory is the most widely accepted theory of the term structure of interest rates because it explains the major empirical facts about the term structure so well. A) liquidity premiumB) market segmentationC) expectations D) none of the aboveAnswer: A

72) ________ are investment advisory firms that rate the quality of corporate and municipal bonds in terms of probability of default. A) Financial institutionsB) Credit-rating agenciesC) Securities companiesD) none of the aboveAnswer: B

73) If a bond has a favorable tax treatment, its required interest rate (all else equal)A) will be higher. B) will not be affected. C) will be lower.D) all of the above could happen. Answer: C

6.1 Multiple Choice

1) How expectations are formed is important because expectations influenceA) the demand for assets.B) bond prices.C) the risk structure of interest rates.


D) the term structure of interest rates.E) all of the above.Answer: E

2) According to the efficient market hypothesis, the current price of a financial securityA) is the discounted net present value of future interest payments.B) is determined by the highest successful bidder.C) fully reflects all available relevant information.D) is a result of none of the above.Answer: C

3) The efficient market hypothesisA) is based on the assumption that prices of securities fully reflect all available information.B) holds that the expected return on a security equals the equilibrium return.C) both A and B.D) neither A nor B.Answer: C

4) If the optimal forecast of the return on a security exceeds the equilibrium return, thenA) the market is inefficient.B) an unexploited profit opportunity exists.C) the market is in equilibrium.D) only A and B of the above are true.E) only B and C of the above are true.Answer: D

5) According to the efficient market hypothesisA) one cannot expect to earn an abnormally high return by purchasing a security.B) information in newspapers and in the published reports of financial analysts is already reflected in market prices.C) unexploited profit opportunities abound, thereby explaining why so many people get rich by trading securities.D) all of the above are true.E) only A and B of the above are true.Answer: E

6) Another way to state the efficient market condition is that in an efficient market,A) unexploited profit opportunities will be quickly eliminated.B) unexploited profit opportunities will never exist.C) arbitrageurs guarantee that unexploited profit opportunities never exist.D) both A and C of the above occur.Answer: A

7) Another way to state the efficient market hypothesis is that in an efficient market,


A) unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure that they are instantaneously dissipated.B) unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them.C) every financial market participant must be well informed about securities.D) only A and C of the above.Answer: B

8) A situation in which the price of an asset differs from its fundamental market value is calledA) an unexploited profit opportunity.B) a bubble.C) a correction.D) a mean reversion.Answer: B

9) A situation in which the price of an asset differs from its fundamental market valueA) indicates that unexploited profit opportunities exist.B) indicates that unexploited profit opportunities do not exist.C) need not indicate that unexploited profit opportunities exist.D) indicates that the efficient market hypothesis is fundamentally flawed.Answer: C

10) Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time periodA) usually beat the market in the next time period.B) usually beat the market in the next two subsequent time periods.C) usually beat the market in the next three subsequent time periods.D) usually do not beat the market in the next time period.Answer: D


11) The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analystA) will certainly mean higher returns than if you had made selections by throwing darts at the financial page.B) will always mean lower returns than if you had made selections by throwing darts at the financial page.C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.D) is good for the economy.Answer: C

12) Ivan Boesky, the most successful of the so-called arbs in the 1980s, was able to outperform the market on a consistent basis, indicating thatA) securities markets are not efficient.B) unexploited profit opportunities were abundant.C) investors can outperform the market with inside information.D) only B and C of the above.Answer: C

13) To say that stock prices follow a "random walk" is to argue thatA) stock prices rise, then fall.B) stock prices rise, then fall in a predictable fashion.C) stock prices tend to follow trends.D) stock prices are, for all practical purposes, unpredictable.Answer: D

14) To say that stock prices follow a "random walk" is to argue thatA) stock prices rise, then fall, then rise again.B) stock prices rise, then fall in a predictable fashion.C) stock prices tend to follow trends.D) stock prices cannot be predicted based on past trends.Answer: D

15) Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets theory,A) a waste of time.B) profitably employed by all financial analysts.C) the most efficient rules to employ.D) consistent with the random walk hypothesis.Answer: A


16) Tests used to rate the performance of rules developed in technical analysis conclude thatA) technical analysis outperforms the overall market.B) technical analysis far outperforms the overall market, suggesting that stockbrokers provide valuable services.C) technical analysis does not outperform the overall market.D) technical analysis does not outperform the overall market, suggesting that stockbrokers do not provide services of any value.Answer: C

17) Which of the following types of information will most likely enable the exploitation of a profit opportunity?A) Financial analysts' published recommendationsB) Technical analysisC) Hot tips from a stockbrokerD) Insider informationAnswer: D

18) Which of the following types of information will most likely enable the exploitation of a profit opportunity?A) Financial analysts' published recommendationsB) Technical analysisC) Hot tips from a stockbrokerD) None of the aboveAnswer: D

19) The advantage of a "buy and hold strategy" is thatA) net profits will tend to be higher because there will be fewer brokerage commissions.B) losses will eventually be eliminated.C) the longer a stock is held, the higher its price will be.D) only B and C of the above are true.Answer: A

20) The efficient market hypothesis suggests thatA) investors should not try to outguess the market by constantly buying and selling securities.B) investors do better on average if they adopt a "buy and hold" strategy.C) buying into a mutual fund is a sensible strategy for a small investor.D) all of the above are sensible strategies.E) only A and B of the above are sensible strategies.Answer: D


21) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon isA) clearly inconsistent with the efficient market hypothesis.B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated.C) consistent with the efficient market hypothesis if the earnings were not as low as anticipated.D) the result of none of the above.Answer: B

22) Important implications of the efficient market hypothesis include which of the following?A) Future changes in stock prices should, for all practical purposes, be unpredictable.B) Stock prices will respond to announcements only when the information in these announcements is new.C) Sometimes a stock price declines when good news is announced.D) All of the above.E) Only A and B of the above.Answer: D

23) Although the verdict is not yet in, the available evidence indicates that, for many purposes, the efficient market hypothesis isA) a good starting point for analyzing expectations.B) not a good starting point for analyzing expectations.C) too general to be a useful tool for analyzing expectations.D) none of the above.Answer: A

24) The efficient market hypothesis suggests thatA) investors should purchase no-load mutual funds, which have low management fees.B) investors can use the advice of technical analysts to outperform the market.C) investors let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.D) only A and B of the above are sensible strategies.Answer: A

25) The efficient market hypothesis applies toA) both the stock market and the foreign exchange market.B) the stock market but not the foreign exchange market.C) the foreign exchange market but not the stock market.D) neither the stock market nor the foreign exchange market.Answer: A


26) According to the January effect, stock pricesA) experience an abnormal price rise from December to January.B) experience an abnormal price decline from December to January.C) follow a random walk during January.D) set the pattern for the entire year in January.Answer: A

27) The small-firm effect refers to the observation that small firms' stocksA) follow a random walk but large firms' stocks do not.B) have earned abnormally low returns given their greater risk.C) have earned abnormally high returns even taking into account their greater risk.D) sell for lower prices than do large firms' stocks.Answer: C

28) The efficient markets hypothesis is weakened by evidence thatA) stock prices tend to follow a random walk.B) stock prices are more volatile than fluctuations in their fundamental values can explain.C) technical analysis does not outperform the overall market.D) an investment adviser's past success or failure at picking stocks does not predict his or her future performance.Answer: B

29) Mean reversion refers to the observation thatA) stock prices overact to news announcements.B) stocks prices are more volatile than fluctuations in their fundamental value would predict.C) stocks with low returns are likely to have high returns in the future.D) stocks with low returns are likely to have even lower returns in the future.Answer: C

30) Which of the following does not weaken the efficient markets hypothesis?A) Mean reversionB) Success of buy-and-hold strategyC) January effectD) Excessive volatilityAnswer: B

31) An important lesson from the Black Monday Crash of 1987 and the tech crash of 2000 is thatA) factors other than market fundamentals affect stock prices.B) the strong version of the efficient market hypothesis, that stock prices reflect the true fundamental value of securities, is correct.C) market psychology has little if any effect on stock prices.D) there is no such thing as a rational bubble.Answer: A


32) An investor gains from short selling by ________ and then later ________.A) buying a stock; selling it at a higher priceB) selling a stock; buying it back at a lower priceC) buying a stock; selling it at a lower priceD) selling a stock; buying it back at a higher priceAnswer: B

33) Which of the following is an insight from behavioral finance?A) The price of securities fully reflects all available information.B) Investor overconfidence leads to high trading volumes.C) The optimal forecast of a security's return equals the security's equilibrium return.D) Investment advisers cannot consistently beat the market.Answer: B

34) Which of the following is empirical evidence indicating that the efficient market hypothesis may not always be generally applicable?A) Small-firm effectB) January effectC) Market overreactionD) All of the aboveAnswer: D

35) An arrangement with a broker to borrow stocks from them and then sell it in the market, with the hope that they earn a profit by buying the stock back again after it has fallen in price is calledA) behavioral finance.B) short sales.C) smart money.D) random walk.Answer: B

36) Evidence in favor of market efficiency includesA) performance of investment analysts and mutual funds.B) whether stock prices reflect publicly available information.C) the random-walk behavior of stock prices.D) all of the above.Answer: D

37) Evidence against market efficiency does not include A) the small-firm effect.B) technical analysis.C) excessive volatility.D) mean reversion.Answer: B


38) Evidence in favor of market efficiency does not include A) random-walk behavior.B) technical analysis.C) performance of investment analysts and mutual funds.D) the January effect.Answer: D

39) The elimination of a riskless profit opportunity in a market is called A) the efficient market hypothesis.B) random walk.C) arbitrage.D) market fundamentals.Answer: C

9.1 Multiple Choice

1) Americans' fear of centralized power and their distrust of moneyed interests explain why the U.S. did not have a central bank until theA) 17th century.B) 18th century.C) 19th century.D) 20th century.Answer: D

2) Bank panics in 1819, 1837, 1857, 1873, 1884, 1893, and 1907 convinced many thatA) the Federal Reserve needed greater control over the banking system.B) the Federal Reserve needed greater authority to deal with problem banks.C) a central bank was needed to prevent future financial panics.D) both A and B of the above.Answer: C

3) The unusual structure of the Federal Reserve System is perhaps best explained byA) Americans' fear of centralized power.B) the traditional American distrust of moneyed interests.C) Americans' desire to remove control of the money supply from the U.S. Treasury.D) all of the above.E) only A and B of the above.Answer: E

4) The traditional American distrust of moneyed interests and the fear of centralized power help to explainA) the failures of the first two experiments in central banking in the United States.B) the decentralized structure of the Federal Reserve System.C) why the Board of Governors of the Federal Reserve System is not located in New York.


D) all of the above.E) only A and B of the above.Answer: D

5) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced thatA) the First Bank of the United States had failed to serve as a lender of last resort.B) the Second Bank of the United States had failed to serve as a lender of last resort.C) the Federal Reserve System had failed to serve as a lender of last resort.D) a central bank was needed to prevent future panics.Answer: D

6) Nationwide financial panics in 1873, 1884, 1893, and 1907 might have been avoided hadA) the First Bank of the United States served its intended role of lender of last resort.B) the Second Bank of the United States not been abolished in 1836 by President Andrew Jackson.C) the Second Bank of the United States served its intended role of lender of last resort.D) the Federal Reserve served its intended role of lender of last resort.Answer: B

7) The many regional Federal Reserve banks resulted from a compromise between parties favoringA) the establishment of a central bank and those opposed to its establishment.B) a private central bank and those favoring a government institution.C) the establishment of the Board of Governors in Washington, D.C., and those preferring its establishment in New York City.D) none of the above.Answer: B

8) Which of the following is an element of the Federal Reserve System?A) The Federal Reserve banksB) The Board of GovernorsC) The FDICD) All of the aboveE) Only A and B of the aboveAnswer: E

9) Which of the following is an element of the Federal Reserve System?A) The Federal Reserve banksB) The Board of GovernorsC) The FOMCD) All of the aboveAnswer: D

10) Which of the following is not an entity of the Federal Reserve System?A) Federal Reserve banks


B) The FDICC) The Board of GovernorsD) The Federal Advisory CouncilE) Member commercial banksAnswer: B


11) Which of the following functions are not performed by any of the twelve regional Federal Reserve banks?A) Check clearingB) Conducting economic researchC) Setting interest rates payable on time depositsD) Issuing new currencyAnswer: C

12) Which Federal Reserve Bank president always has a vote in the Federal Open Market Committee?A) PhiladelphiaB) New YorkC) BostonD) San FranciscoAnswer: B

13) Each Fed bank president attends FOMC meetings; although only ________ Fed bank presidents vote on policy, all ________ provide input.A) three; tenB) five; tenC) three; twelveD) five; twelveAnswer: D

14) The ________ Fed bank, with about 25 percent of the system's assets, is the most important of the Federal Reserve banks.A) ChicagoB) Los AngelesC) MiamiD) New YorkE) Washington, D.C.Answer: D

15) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited toA) four percent annually.B) five percent annually.C) six percent annually.D) eight percent annually.Answer: C


16) All ________ are required to be members of the Fed.A) state-chartered banksB) nationally chartered banksC) banks with more than $100 million in assetsD) banks with more than $500 million in assetsAnswer: B

17) Which of the following banks are required to be members of the Federal Reserve System?A) state-chartered banksB) insured banksC) banks having over $500 million in assetsD) none of the aboveAnswer: D

18) Of all commercial banks, about ________ percent belong to the Federal Reserve System. A) 15B) 20C) 30D) 50Answer: C

19) Banks subject to reserve requirements set by the Federal Reserve System includeA) only state-chartered banks.B) only nationally chartered banks.C) only banks with less than $100 million in assets.D) only banks with less than $500 million in assets.E) all banks whether or not they are members of the Federal Reserve System.Answer: E

20) The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from itsA) concern over declining Fed membership.B) belief that all banking regulations should be eliminated.C) belief that interest rate ceilings were too low.D) belief that depositors had to become more knowledgeable about banking operations.Answer: A

21) Which of the following are duties of the Board of Governors of the Federal Reserve System?A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash.B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q.C) Regulating credit with the approval of the President under the Credit Control Act of 1969.D) None of the above has been a duty of the Board since the mid-1980s.Answer: A


22) Which of the following are not duties of the Board of Governors of the Federal Reserve System?A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash.B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q.C) Approving the discount rate "established" by the Federal Reserve banks.D) Representing the United States in negotiations with foreign governments on economic matters.Answer: B

23) The chairman of the Board of Governors of the Federal Reserve System exercises a high degree of control over the boardA) through his ability to set the agenda of the Board and the FOMC.B) through his role as spokesperson for the Fed with the President and before Congress.C) because he can veto decisions made by a majority of the other Board members.D) because of all of the above.E) because of only A and B of the above.Answer: E

24) Members of the Board of Governors areA) chosen by the Federal Reserve Bank presidents.B) appointed by the newly elected president of the United States, as are cabinet positions.C) appointed by the president of the United States and confirmed by the Senate as members resign.D) never allowed to serve more than seven-year terms.Answer: C

25) Each member of the seven-member Board of Governors is appointed by the president and confirmed by the Senate to serveA) 4-year terms.B) 6-year terms.C) 14-year terms.D) as long as the appointing president remains in office.Answer: C

26) The Board of GovernorsA) establishes, within limits, reserve requirements.B) effectively sets the discount rate.C) sets margin requirements.D) does all of the above.E) does only A and B of the above.Answer: D


27) Although neither ________ nor the ________ is officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee.A) margin requirements; discount rateB) margin requirements; federal funds rateC) reserve requirements; discount rateD) reserve requirements; federal funds rateAnswer: C

28) Although the Federal Open Market Committee does not have formal authority to set ________ and the ________, it does possess the authority in practice.A) margin requirements; discount rateB) margin requirements; federal funds rateC) reserve requirements; discount rateD) reserve requirements; federal funds rateAnswer: C

29) Which of the following are true statements?A) The FOMC usually meets every six weeks to set monetary policy.B) The FOMC issues directives to the trading desk at the New York Fed.C) Designers of the Federal Reserve Act did not envision the use of open market operations as a monetary policy tool.D) All of the above are true statements.E) Only A and B of the above are true statements.Answer: D

30) The Federal Open Market Committee consists ofA) the five senior members of the seven-member Board of Governors.B) the seven members of the Board of Governors and seven presidents of the regional Fed banks.C) the seven members of the Board of Governors and five presidents of the regional Fed banks.D) the twelve regional Fed bank presidents and the chairman of the Board of Governors.Answer: C

31) The Federal Reserve entity that determines monetary policy strategy is theA) Board of Governors.B) Federal Open Market Committee.C) Chairman of the Board of Governors.D) Shadow Open Market Committee.Answer: B


32) Which of the following are true statements?A) The FOMC usually meets every six weeks to set monetary policy.B) The FOMC issues directives to the trading desk at the New York Fed.C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary policy tool.D) All of the above are true statements.E) Only A and B of the above are true statements.Answer: E

33) The designers of the Federal Reserve Act meant to create a central bank characterized by itsA) system of checks and balances and decentralization of power.B) strong concentration of power in the hands of a few people.C) inability to function as a lender of last resort.D) responsiveness to the electorate.Answer: A

34) The power within the Federal Reserve was effectively transferred to the Board of Governors byA) the banking legislation of the Great Depression.B) Supreme Court decisions in the 1950s.C) the Depository Institutions Deregulation and Monetary Control Act of 1980.D) the Treasury-Federal Reserve Accord of 1951.Answer: A

35) Factors that provide the Federal Reserve with a high degree of independence includeA) 14-year terms for members of the Board of Governors.B) a four-year term for the chairman of the Board of Governors that is not coincident with the president's term of office.C) constitutional independence from Congress and the president.D) all of the above.E) only A and B of the above.Answer: E

36) Federal Reserve independence is thought toA) introduce a short-term bias to monetary policymaking.B) lead to better fiscal and monetary policy coordination.C) introduce longer-run considerations to monetary policymaking.D) do both A and B of the above.Answer: C


37) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability toA) withhold appropriations from the Board of Governors.B) withhold appropriations from the Federal Open Market Committee.C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies.D) do all of the above.Answer: C

38) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress becauseA) Congress can pass legislation that would restrict the Fed's independence.B) Congress can withhold the Fed's budget requests.C) Congress can remove members of the Board of Governors whose views on policy differ from those of key members of Congress.D) All of the above.Answer: A

39) According to the textbook authors, the Fed isA) remarkably free of the political pressures that influence other government agencies.B) more responsive to the political pressures that influence other government agencies.C) probably somewhat constrained in its policymaking by the congressional threat to reduce Fed independence.D) both A and C of the above.Answer: D

40) According to the textbook authors,A) the Fed appears to be remarkably free of the political pressures that influence other government agencies.B) since the president can protect the Fed from Congress, the Fed may be responsive to the president's policy preferences.C) the Fed appears to be more responsive to the political pressures that influence other government agencies.D) both A and B of the above.E) both B and C of the above.Answer: D

41) The oldest central bank, founded in 1694, is theA) Bank of England.B) Deutsche Bundesbank.C) Bank of Japan.D) Federal Reserve System.Answer: A


42) The newest central bank, which began operations in January 1999, is theA) European Central Bank.B) Bank of Argentina.C) Bank of Korea.D) Bank of New Zealand.Answer: A

43) Which of the following central banks has the greatest degree of independence?A) Bank of EnglandB) European Central BankC) Bank of JapanD) Federal Reserve SystemAnswer: B

44) A trend in recent years is that more and more governmentsA) have been granting greater independence to their central banks.B) have been reducing the independence of their central banks to make them more accountable for poor economic performance.C) have mandated that their central banks give up multiple policy goals to focus strictly on inflation.D) have required their central banks to coordinate policies with their ministers of finance.Answer: A

45) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximizeA) the public's welfare.B) its own welfare.C) profits.D) conflict between the executive and legislative branches of government.Answer: B

46) The theory of bureaucratic behavior suggests that the Federal Reserve willA) try to avoid a conflict with the president and Congress over increases in interest rates.B) try to gain regulatory power over more banks.C) devise clever strategies in an effort to avoid blame for poor economic performance.D) do all of the above.Answer: D

47) According to the theory of bureaucratic behavior, the objective of bureaucracy isA) to maximize its own welfare, meaning that it seeks additional power and prestige.B) to maximize consumers' surplus, meaning that it seeks additional regulatory powers.C) to protect the industry it regulates, meaning that it seeks additional regulatory powers.D) none of the above.Answer: A


48) According to the theory of bureaucratic behavior,A) the objective of a bureaucracy is to maximize its own welfare, meaning that it seeks additional power and prestige.B) the bureaucracy will fight vigorously to preserve its autonomy; thus, it will attempt to avoid conflict with the president and Congress.C) the bureaucracy will support legislation that gives it additional regulatory power.D) all of the above describe bureaucratic behavior.Answer: D

49) The theory of bureaucratic behavior when applied to the Fed helps to explain why the FedA) resists so vigorously congressional attempts to limit the central bank's autonomy.B) is secretive about the conduct of future monetary policy.C) sought less control over banks in the 1980s.D) all of the above.E) only A and B of the above.Answer: E

50) The theory of bureaucratic behavior when applied to the Fed helps to explain why the FedA) is supportive of congressional attempts to limit the central bank's autonomy.B) is secretive about the conduct of future monetary policy.C) sought less control over banks in the 1980s.D) is willing to take on powerful groups that may threaten its autonomy.Answer: B

51) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed to more political pressures would impartA) an inflationary bias to monetary policy.B) a deflationary bias to monetary policy.C) a disinflationary bias to monetary policy.D) a countercyclical bias to monetary policy.Answer: A

52) Politicians in a democratic society may be shortsighted because of their desire to win reelection; thus, the political process canA) impart an inflationary bias to monetary policy.B) impart a deflationary bias to monetary policy.C) generate a political business cycle in which, just before an election, expansionary policies are pursued to lower unemployment and interest rates.D) cause both A and C of the above to occur.Answer: D


53) The case for Federal Reserve independence includes the idea thatA) political pressure would impart an inflationary bias to monetary policy.B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.C) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.D) all of the above.Answer: D

54) The case for Federal Reserve independence includes the idea thatA) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.B) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.C) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day.D) only A and B of the above.Answer: D

55) The case for Federal Reserve independence does not include the idea thatA) political pressure would impart an inflationary bias to monetary policy.B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.C) policy is always performed better by an elite group such as the Fed.D) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.Answer: C

56) The case for Federal Reserve independence does not include the idea thatA) political pressure would impart an inflationary bias to monetary policy.B) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day.C) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.D) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.Answer: B


57) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control wouldA) impart an inflationary bias to monetary policy.B) force monetary authorities to sacrifice the long-run objective of price stability.C) make the so-called political business cycle even more pronounced.D) do all of the above.E) do only A and B of the above.Answer: D

58) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control wouldA) impart an inflationary bias to monetary policy.B) force monetary authorities to sacrifice the long-run objective of price stability.C) make the so-called political business cycle less pronounced.D) do all of the above.E) do only A and B of the above.Answer: E

59) Supporters of the current system of Fed independence believe that a less autonomous Fed wouldA) adopt a long-run bias toward policymaking.B) pursue overly expansionary monetary policies.C) be more likely to create a political business cycle.D) do only B and C of the above.Answer: D

60) Critics of the current system of Fed independence contend thatA) the current system is undemocratic.B) voters have too much say about monetary policy.C) the president has too much control over monetary policy on a day-to-day basis.D) all of the above are true.Answer: A

61) Critics of Fed independence argueA) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.B) that an independent Fed conducts monetary policy with a consistent inflationary bias.C) that the Fed, since it does not face a binding budget constraint, spends too much of its earnings.D) only A and B of the above.Answer: A


62) Critics of Fed independence argueA) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.B) that independence seemingly does little to guarantee good monetary policy.C) that its independence may encourage the Fed to pursue a course of narrow self-interest rather than the public interest.D) all of the above.Answer: D

63) Instrument independence means the central bank is free fromA) political pressure regarding how it uses the tools of monetary policy.B) political pressure regarding the goals it pursues.C) both A and B of the above.D) neither A nor B of the above.Answer: A

64) Suppose legislation requiring the Fed to keep the inflation rate between 1.5% and 2.5% per year is passed by Congress. This law restricts the Fed'sA) instrument independence.B) goal independence.C) both A and B of the above.D) neither A nor B of the above.Answer: B

65) Cross-country evidence suggests that an increase in central bank independence results in a ________ inflation rate and ________ unemployment.A) lower; higherB) lower; no worseC) higher; lowerD) higher; higherAnswer: B

66) The Board of Governors of the Federal Reserve System A) appoint three directors to each Federal Reserve Bank.B) elect six members to member commercial banks. C) both of the above.D) none of the above. Answer: A

67) The Federal Advisory Council has ________ member(s) from each district. A) one B) two C) threeD) can have any number ofAnswer: A


68) The three largest Federal Reserve banks in terms of assets are those of New York, Chicago, andA) Atlanta.B) Los Angeles.C) Baltimore.D) San Francisco.Answer: D

69) The directors of a district bank are classified into three categories: A, B, and C. The three B directors areA) professional bankers.B) prominent leaders from industry, labor, agriculture, or the consumer sector. C) elected by the board of governors to represent the public interest. D) all of the above. Answer: B

70) The 12 Federal Reserve banks are involved in monetary policy in several ways:A) their directors establish the discount rate.B) they decide which banks can obtain discount loans from the Federal Reserve Bank.C) their directors select one commercial banker from each bank's district to serve on the Federal Advisory Council.D) all of the above.Answer: D

71) The ________ of the Board of Governors is the spokesperson for the Fed. A) chairmanB) presidentC) either of the above can be the spokespersonD) neither of the aboveAnswer: A

72) Currently, there are ________ countries that are members of the European Monetary Union.A) 10B) 12C) 15D) 20Answer: B

73) In November 2007, the Fed announced major enhancements to its communication strategy. Which of the following was a part of the changes?A) The forecast horizon for the FOMC's projections was extended from two calendar years to three.B) The committee publishes FOMC projections four times a year instead of twice a year.C) The release would include a narrative of the forces shaping the outlook and risks to that outlook.D) All of the above were proposed changes.Answer: D


10.1 Multiple Choice

1) Assets on the Fed's balance sheet includeA) government securities and currency in circulation.B) discount loans and reserves.C) government securities and discount loans.D) currency in circulation and reserves.Answer: C

2) The monetary base consists ofA) currency in circulation and reserves.B) government securities held by the Fed and discount loans.C) government securities held by the Fed and currency in circulation.D) discount loans and reserves.Answer: A

3) An open market purchase of securities by the Fed willA) increase assets of the nonbank public and increase assets of the banking system.B) decrease assets of the nonbank public and increase assets of the Fed.C) decrease assets of the banking system and increase assets of the Fed.D) have no effect on assets of the nonbank public but increase assets of the Fed.E) increase assets of the banking system and decrease assets of the Fed.Answer: D

4) An open market sale of securities by the Fed willA) decrease liabilities of the Fed and not affect assets of the banking system.B) decrease assets of the nonbank public and decrease assets of the Fed.C) increase liabilities of the banking system and increase assets of the Fed.D) have no effect on assets of the nonbank public but increase liabilities of the Fed.E) decrease assets of the banking system and increase assets of the Fed.Answer: A

5) If the Federal Reserve wants to expand reserves in the banking system, it willA) purchase government securities.B) raise the discount rate.C) sell government securities.D) raise reserve requirements.Answer: A


6) If the Federal Reserve wants to lower the monetary base and the money supply, it willA) increase bank reserves.B) lower the discount rate.C) sell government securities.D) lower reserve requirements.Answer: C

7) A discount loan by the Fed to a bank causes a(n) ________ in reserves in the banking system and a(n) ________ in the monetary base.A) increase; decreaseB) decrease; decreaseC) decrease; increaseD) increase; increaseAnswer: D

8) When a bank repays a discount loan to the Fed, there is a(n) ________ in reserves in the banking system and a(n) ________ in the monetary base.A) increase; decreaseB) decrease; decreaseC) decrease; increaseD) increase; increaseAnswer: B

9) The federal funds rate isA) the interest rate on loans from the Fed to a bank.B) the price the Fed pays for government securities.C) the interest rate on loans of reserves from one bank to another.D) the price banks pay the Fed for government securities.E) the interest rate on loans from a bank to the federal government.Answer: C

10) The discount rate isA) the interest rate on loans from the Fed to a bank.B) the price the Fed pays for government securities.C) the interest rate on loans of reserves from one bank to another.D) the price banks pay the Fed for government securities.E) the interest rate on loans from a bank to the federal government.Answer: A


11) Holding everything else constant, if the federal funds rate rises, then the demand forA) excess reserves rises because they have a higher return.B) excess reserves falls because they have a higher cost.C) required reserves falls because the cost of borrowing from the Fed is relatively higher.D) required reserves rises because the cost of borrowing from the Fed is relatively lower.E) reserves will not change because the Fed sets the level of required reserves.Answer: B

12) Holding everything else constant, if the federal funds rate falls, then the demand forA) excess reserves falls because they have a lower return.B) excess reserves rises because they have a lower cost.C) required reserves rises because the cost of borrowing from the Fed is relatively higher.D) required reserves rises because the cost of borrowing from the Fed is relatively lower.E) reserves will not change because the Fed sets the level of required reserves.Answer: B

13) Bank reserves can be categorized asA) vault cash and deposits at the Fed.B) required reserves and excess reserves.C) borrowed reserves and nonborrowed reserves.D) all of the above.Answer: D

14) An open market purchaseA) shifts the supply curve for reserves to the right and causes the federal funds rate to fall.B) shifts the demand curve for reserves to the right and causes the federal funds rate to rise.C) shifts the supply curve for reserves to the left and causes the federal funds rate to rise.D) shifts the demand curve for reserves to the left and causes the federal funds rate to fall.Answer: A

15) The supply curve for reserves is ________ when the federal funds rate is below the discount rate and ________ when the federal funds rate is above the discount rate.A) upward sloping; horizontalB) upward sloping; verticalC) vertical; horizontalD) vertical; downward slopingAnswer: C

16) The supply curve for reserves shifts to the left and the federal funds rate rises when the FedA) raises reserves requirements.B) does an open market purchase.C) does an open market sale.D) raises the discount rate.Answer: C


17) The demand curve for reserves shifts to the left and the federal funds rate falls when the FedA) decreases reserve requirements or does an open market purchase.B) lowers the discount rate.C) lowers the discount rate or does an open market purchase.D) decreases reserves requirements.E) does an open market sale.Answer: D

18) Under usual circumstances, an increase in the discount rate causesA) the federal funds rate to fall.B) the federal funds rate to rise.C) no change in the federal funds rate.D) the supply of reserves to increase.E) the supply of reserves to decrease.Answer: C

19) If the Fed increases reserve requirements, the demand for reserves ________ and the equilibrium federal funds rate ________.A) increases; dropsB) decreases; risesC) decreases; dropsD) increases; risesAnswer: D

20) The actual execution of open market operations is done atA) the Board of Governors in Washington, D.C.B) the Federal Reserve Bank of New York.C) the Federal Reserve Bank of Philadelphia.D) the Federal Reserve Bank of Boston.Answer: B

21) The Federal Open Market Committee makes the Fed's decisions on the purchase or sale of government securities, but these purchases or sales are executed by the Federal Reserve Bank ofA) Chicago.B) Boston.C) New York.D) San Francisco.Answer: C


22) An open market transaction intended to change the level of bank reserves is aA) repurchase agreement.B) reverse repo.C) dynamic operation.D) defensive operation.Answer: C

23) If the Federal Reserve wants to drain reserves from the banking system, it willA) purchase government securities.B) lower the discount rate.C) sell government securities.D) raise reserve requirements.Answer: C

24) The Federal Reserve will engage in an outright purchase if it wants to ________ reserves ________ in the banking system.A) increase; permanentlyB) increase; temporarilyC) decrease; temporarilyD) decrease; permanentlyAnswer: A

25) If the Fed wants to temporarily drain reserves from the banking system, it will engage inA) a repurchase agreement.B) a matched sale-purchase transaction.C) a "pump" agreement.D) none of the above.Answer: B

26) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to ________ reserves ________ in the banking system.A) increase; permanentlyB) increase; temporarilyC) decrease; temporarilyD) decrease; permanentlyAnswer: C

27) Discount loans to banks experiencing severe liquidity problems are calledA) primary credit.B) secondary credit.C) seasonal credit.D) lender-of-last-resort credit.Answer: B


28) Discount loans to healthy banks, who may borrow as much as they wish from the Fed, are calledA) primary credit.B) secondary credit.C) seasonal credit.D) lender-of-last-resort credit.Answer: A

29) Disadvantages of using reserve requirements to control the money supply includeA) their overly-powerful impact on the money supply.B) creating potential liquidity problems for banks with high levels of excess reserves.C) their overly-powerful impact on the monetary base.D) all of the above.Answer: A

30) The Fed is reluctant to use reserve requirements to control the money supply becauseA) of their overly-powerful impact on the money supply.B) they have the potential to create liquidity problems for banks with low excess reserves.C) frequent changes in reserve requirements complicate liquidity management for banks.D) of all of the above.E) of only A and B of the above.Answer: D

31) When the Federal Reserve was created, its most important role was intended to beA) a storage facility for the nation's gold.B) a lender of last resort.C) a regulator of bank holding companies.D) none of the above.Answer: B

32) At its inception, the Federal Reserve was intended to beA) the Treasury's banker.B) the issuer of government debt.C) a lender of last resort.D) a regulator of bank holding companies.Answer: C

33) Price stability is desirable becauseA) inflation creates uncertainty, making it difficult to plan for the future.B) everyone is better off when prices are stable.C) price stability increases the profitability of the Fed.D) it guarantees full employment.Answer: A


34) The Federal Reserve desires interest rate stability becauseA) it allows for less uncertainty about future planning.B) interest rate volatility often leads to demands to curtail the Fed's power.C) it guarantees full employment.D) both A and B of the above.Answer: D

35) When workers voluntarily quit a job or decline a job offer so they can search for a better one, the resulting unemployment is calledA) structural unemployment.B) frictional unemployment.C) cyclical unemployment.D) underemployment.Answer: B

36) When there is a mismatch between job requirements and the skills of available workers, the resulting unemployment is calledA) structural unemployment.B) frictional unemployment.C) cyclical unemployment.D) underemployment.Answer: A

37) The goal for high employment should be a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment theA) frictional rate of unemployment.B) structural rate of unemployment.C) natural rate of unemployment.D) ideal rate of unemployment.Answer: C

38) Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth byA) encouraging firms to invest.B) encouraging people to save.C) both A and B of the above.D) neither A nor B of the above.Answer: C


39) Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth byA) encouraging firms to invest and people to save.B) encouraging firms to limit their price increases.C) encouraging people to consume.D) all of the above.E) only A and C of the above.Answer: A

40) The Fed's monetary policy strategy can be described as follows:A) The Fed uses its policy tools to adjust intermediate targets that directly impact its operating targets in a way that allows the Fed to achieve its goals.B) The Fed uses its policy tools to adjust operating targets that directly impact its intermediate targets in a way that allows the Fed to achieve its goals.C) The Fed uses its operating targets to adjust its intermediate targets that directly impact its policy tools in a way that allows the Fed to achieve its goals.D) None of the above.Answer: B

41) If the Fed's strategy for conducting monetary policy is thought of as a game plan that proceeds in stages, then the game plan can be summarized as follows:A) The Fed selects its policy goals, then the intermediate targets consistent with achieving its policy goals, then the operating targets consistent with its intermediate targets. Finally, it adjusts its policy tools to effect the desired targets and goals.B) The Fed selects its policy goals, then the operating targets consistent with achieving its policy goals, then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy tools to effect the desired targets and goals.C) The Fed selects its policy goals, then the intermediate targets consistent with achieving its policy goals, then the policy tools consistent with its intermediate targets. Finally, it adjusts its operating targets to effect the desired targets and tools.D) The Fed selects its policy tools, then the operating targets consistent with achieving its policy tools, then the intermediate targets consistent with its operating targets. Finally, it adjusts its policy goals to effect the desired targets and tools.E) None of the above.Answer: A

42) An advantage of an intermediate targeting strategy is that it provides the Fed withA) more timely information regarding the effect of monetary policy.B) a slow adjustment process.C) a target that is precisely correlated with economic activity.D) all of the above.E) only A and B of the above.Answer: A


43) Which of the following is not a requirement in selecting an intermediate target?A) measurabilityB) controllabilityC) flexibilityD) predictabilityAnswer: C

44) Which of the following is a potential operating target for the Fed?A) The monetary baseB) The M1 money supplyC) Nominal GDPD) The discount rateAnswer: A

45) Which of the following is a potential operating target for the Fed?A) Nonborrowed reservesB) The federal funds rateC) The monetary baseD) All of the aboveAnswer: D

46) Which of the following is not an operating target?A) Nonborrowed reservesB) Monetary baseC) Federal funds interest rateD) Discount rateE) All are operating targetsAnswer: D

47) When it comes to choosing an operating target, both the ________ rate and ________ aggregates are easily controllable using the Fed's policy tools.A) federal funds; monetaryB) federal funds; reserveC) three-month Treasury bill; monetaryD) ten-year Treasury bond; reserveAnswer: B

48) If the desired intermediate target is an interest rate, then the preferred operating target will be a(n) ________ variable like the ________.A) interest rate; three-month Treasury bill rateB) interest rate; federal funds rateC) reserve aggregate; monetary baseD) reserve aggregate; nonborrowed baseAnswer: B


49) If the desired intermediate target is a monetary aggregate, then the preferred operating target will be a(n) ________ variable like the ________.A) interest rate; three-month Treasury bill rateB) interest rate; federal funds rateC) reserve aggregate; monetary baseD) reserve aggregate; nonborrowed reservesAnswer: C

50) If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, fluctuations in the reserves demand curve will cause ________ to fluctuate.A) nonborrowed reservesB) the federal funds interest rateC) monetary aggregatesD) the inflation rateAnswer: B

51) If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, an increase in the demand for reserves will result in a(n) ________ in ________.A) increase; nonborrowed reservesB) decrease; nonborrowed reservesC) increase; the federal funds interest rateD) decrease; the federal funds interest rateAnswer: C

52) If the Fed uses the federal funds rate as an interest rate target, fluctuations in the reserves demand curve will cause ________ to fluctuate.A) nonborrowed reservesB) the federal funds interest rateC) Treasury bill interest ratesD) the inflation rateAnswer: A

53) If the Fed uses the federal funds rate as an interest rate target, an increase in the demand for reserves will result in a(n) ________ in ________.A) increase; nonborrowed reservesB) decrease; nonborrowed reservesC) increase; the federal funds interest rateD) decrease; the federal funds interest rateAnswer: A


54) Under inflation targeting, a central bank must pursue policies thatA) keep the inflation rate at a target value of zero.B) keep the inflation rate at some specific target value.C) keep the inflation rate within a specific target range.D) lower the inflation rate, provided this can be done without raising the unemployment rate above a specified target value.Answer: C

55) The first country to mandate that its central bank adopt inflation targeting wasA) the United States.B) the United Kingdom.C) Canada.D) New Zealand.Answer: D

56) Banks' holding of deposits in accounts with the Fed, plus currency that is physically held in banks are calledA) the monetary base.B) government securities.C) open market operations.D) reserves.Answer: D

57) An open market ________ leads to a(n) ________ of reserves and deposits in the banking system and hence to a(n) ________ of the monetary base and the money supply.A) sale; expansion; contractionB) purchase; expansion; contractionC) sale; expansion; expansionD) purchase; expansion; expansionAnswer: D

58) Regulations making it obligatory for depository institutions to keep a certain fraction of their deposits in accounts with the Fed are A) open market operations.B) federal funds rate.C) required reserve ratio.D) reserve requirements.Answer: D


59) Which type of open market operation is intended to change the level of reserves?A) Defensive open market operationsB) Reserve requirementsC) Dynamic open market operationsD) Market equilibriumAnswer: C

60) The type of open market operation intended to offset movements in other factors that affect reserves and the monetary base is A) the dynamic open market operations.B) the defensive open market operations.C) the reserve requirements.D) market equilibrium.Answer: B

61) What goals are continually mentioned by central bank officials when discussing the objectives of monetary policy?A) High unemploymentB) Instability in foreign exchange marketsC) Interest-rate stabilityD) All of the aboveAnswer: C

62) Inflation targeting involves A) a public announcement of medium-term numerical targets for inflation.B) increased accountability of the central bank for attaining its inflation objectives.C) an information-inclusive approach in which many variables are used in making decisions about monetary policy.D) all of the above.Answer: A

63) During the 2007-2009 financial crisis, what actions did the Fed take to limit the scope of the crisis?A) The Fed lowered the spread on the discount rate to 50 basis points, and then to 25.B) The Fed set up the Term Auction Facility to provide further liquidity to banks.C) The Fed purchased assets of Bear Stearns to facilitate the purchase of Bear Stearns by J.P. Morgan.D) all of the above.Answer: D


64) Which of the following statements is true regarding the Fed's procedures for operating the discount window?A) The Fed's operating procedures and paying interest on reserves contains the federal funds rate between the interest rate paid on reserves and the discount rate.B) The Fed's operating procedures and paying interest on reserves creates more fluctuation in the federal funds rate than if they simply didn't pay interest on reserves.C) The Fed's operating procedures and paying interest on reserves has no impact on the fluctuation of the federal funds rate. D) None of the above is correct.Answer: A

65) Which of the following statements is true?A) Credit-driven asset bubbles are particularly dangerous. When asset prices fall, the deleveraging of credit markets reduces economic activity.B) Bubbles driven solely by irrational exuberance lead to a failure of financial institutions.C) Both A and B are correct.D) Neither A nor B is correct.Answer: A

66) If the Fed wants to "prick" an asset-pricing bubble driven by a credit boom, what is the primary tool for accomplishing this?A) Raising interest rates.B) Lowering interest rates.C) Increasing reserve requirements.D) Taking a short position in the overpriced asset.Answer: A

67) In response to an asset-price bubble, macroprudential regulation appears to be the right tool. What is macroprudential regulation?A) Increasing the federal funds rate across the macroeconomy.B) The use of tax incentives to capture some of the gains from bubbles.C) Regulatory policy to affect what is happening in credit markets in the aggregate.D) None of the above is correct.Answer: C


1) Activity in money markets increased significantly in the late 1970s and early 1980s because ofA) rising short-term interest rates.B) regulations that limited what banks could pay for deposits.C) both A and B of the above.D) neither A nor B of the above.Answer: C


2) Money market securities have all the following characteristics except they are notA) short term.B) money.C) low risk.D) very liquid.Answer: B

3) Money market instrumentsA) are usually sold in large denominations.B) have low default risk.C) mature in one year or less.D) are characterized by all of the above.E) are characterized by only A and B of the above.Answer: D

4) The banking industryA) should have an efficiency advantage in gathering information that would eliminate the need for the money markets.B) exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders.C) is subject to more regulations and governmental costs than the money markets.D) all of the above are true.E) only A and B of the above are true.Answer: D


5) In situations where asymmetric information problems are not severe,A) the money markets have a distinct cost advantage over banks in providing short-term funds.B) the money markets have a distinct cost advantage over banks in providing long-term funds.C) banks have a distinct cost advantage over the money markets in providing short-term funds.D) the money markets cannot allocate short-term funds as efficiently as banks can.Answer: A

6) Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over banks in attracting funds because the brokerage firmsA) were not subject to deposit reserve requirements.B) were not subject to the deposit interest rate ceilings.C) were not limited in how much they could borrow from depositors.D) had the advantage of all the above.E) had the advantage of only A and B of the above.Answer: E

7) Which of the following statements about the money markets are true?A) Not all commercial banks deal for their customers in the secondary market.B) Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds.C) The single most influential participant in the U.S. money market is the U.S. Treasury Department.D) All of the above are true.E) Only A and B of the above are true.Answer: E

8) Which of the following statements about the money markets are true?A) Most money market securities do not pay interest. Instead, the investor pays less for the security than it will be worth when it matures.B) Pension funds invest a portion of their assets in the money market to have sufficient liquidity to meet their obligations.C) Unlike most participants in the money market, the U.S. Treasury Department is always a demander of money market funds and never a supplier.D) All of the above are true.E) Only A and B of the above are true.Answer: D

9) Which of the following are true statements about participants in the money markets?A) Large banks participate in the money markets by selling large negotiable CDs.B) The U.S. government and corporations borrow in the money markets because cash inflows and outflows are rarely synchronized.C) The Federal Reserve is the single most influential participant in the U.S. money market.D) All of the above are true.E) Only A and B of the above are true.Answer: D


10) The most influential participant(s) in the U.S. money marketA) is the Federal Reserve.B) is the U.S. Treasury Department.C) are the large money center banks.D) are the investment banks that underwrite securities.Answer: A

11) The Fed is an active participant in money markets mainly because of its responsibility toA) lower borrowing costs to encourage capital investment.B) control the money supply.C) increase the interest income of retirees holding money market instruments.D) assist the Securities and Exchange Commission in regulating the behavior of other money market participants.Answer: B

12) Commercial banks are large holders of ________ and are the major issuer of ________.A) negotiable certificates of deposit; U.S. government securitiesB) U.S. government securities; negotiable certificates of depositC) commercial paper; EurodollarsD) Eurodollars; commercial paperAnswer: B

13) The primary function of large diversified brokerage firms in the money market is toA) sell money market securities to the Federal Reserve for its open market operations.B) make a market for money market securities by maintaining an inventory from which to buy or sell.C) buy money market securities from corporations that need liquidity.D) buy T-bills from the U.S. Treasury Department.Answer: B

14) Finance companies raise funds in the money market by sellingA) commercial paper.B) federal funds.C) negotiable certificates of deposit.D) Eurodollars.Answer: A

15) Finance companies play a unique role in money markets byA) giving consumers indirect access to money markets.B) combining consumers' investments to purchase money market securities on their behalf.C) borrowing in capital markets to finance purchases of money market securities.D) assisting the government in its sales of U.S. Treasury securities.Answer: A


16) When inflation rose in the late 1970s,A) consumers moved money out of money market mutual funds because their returns did not keep pace with inflation.B) banks solidified their advantage over money markets by offering higher deposit rates.C) brokerage houses introduced highly popular money market mutual funds, which drew significant amounts of money out of bank deposits.D) consumers were unable to take advantage of higher rates in money markets because of the requirement of large transaction sizes.Answer: C

17) Which of the following is the largest borrower in the money markets?A) commercial banksB) large corporationsC) the U.S. TreasuryD) U.S. firms engaged in foreign tradeAnswer: C

18) Money market instruments issued by the U.S. Treasury are calledA) Treasury bills.B) Treasury notes.C) Treasury bonds.D) Treasury strips.Answer: A

19) Which of the following statements are true of Treasury bills?A) The market for Treasury bills is extremely deep and liquid.B) Occasionally, investors find that earnings on T-bills do not compensate them for changes in purchasing power due to inflation.C) By volume, most Treasury bills are sold to individuals who submit noncompetitive bids.D) All of the above are true.E) Only A and B of the above are true.Answer: E

20) Suppose that you purchase a 91-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is aboutA) 4 percent.B) 5 percent.C) 6 percent.D) 7 percent.Answer: C


21) Suppose that you purchase a 182-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is aboutA) 1.5%.B) 2%.C) 3%.D) 6%.Answer: C

22) Treasury bills do notA) pay interest.B) have a maturity date.C) have a face amount.D) have an active secondary market.Answer: A

23) If your competitive bid for a Treasury bill is successful, then you willA) certainly pay less than if you had submitted a noncompetitive bid.B) probably pay more than if you had submitted a noncompetitive bid.C) pay the average of prices offered in other successful competitive bids.D) pay the same as other successful competitive bidders.Answer: B

24) If your noncompetitive bid for a Treasury bill is successful, then you willA) certainly pay less than if you had submitted a competitive bid.B) certainly pay more than if you had submitted a competitive bid.C) pay the average of prices offered in other noncompetitive bids.D) pay the same as other successful noncompetitive bidders.Answer: D

25) Federal fundsA) are short-term funds transferred between financial institutions, usually for a period of one day.B) actually have nothing to do with the federal government.C) provide banks with an immediate infusion of reserves.D) are all of the above.E) are only A and B of the above.Answer: D

26) Federal funds areA) usually overnight investments.B) borrowed by banks that have a deficit of reserves.C) lent by banks that have an excess of reserves.D) all of the above.E) only A and B of the above.Answer: D


27) The Fed can influence the federal funds interest rate by adjusting the level of reserves available to banks. The Fed canA) lower the federal funds interest rate by adding reserves.B) raise the federal funds interest rate by removing reserves.C) remove reserves by selling securities.D) do all of the above.E) do only A and B of the above.Answer: D

28) The Federal Reserve can influence the federal funds interest rate by buying securities, which ________ reserves, thereby ________ the federal funds rate.A) adds; raisingB) removes; loweringC) adds; loweringD) removes; raisingAnswer: C

29) The Fed can lower the federal funds interest rate by ________ securities, thereby ________ reserves.A) selling; addingB) selling; loweringC) buying; addingD) buying; loweringAnswer: C

30) If the Fed wants to lower the federal funds interest rate, it will ________ the banking system by ________ securities.A) add reserves to; sellingB) add reserves to; buyingC) remove reserves from; sellingD) remove reserves from; buyingAnswer: B

31) If the Fed wants to raise the federal funds interest rate, it will ________ securities to ________ the banking system.A) sell; add reserves toB) sell; remove reserves fromC) buy; add reserves toD) buy; remove reserves fromAnswer: B


32) Government securities dealers frequently engage in repos toA) manage liquidity.B) take advantage of anticipated changes in interest rates.C) lend or borrow for a day or two with what is essentially a collateralized loan.D) do all of the above.E) do only A and B of the above.Answer: D

33) Repos areA) usually low-risk loans.B) usually collateralized with Treasury securities.C) low interest rate loans.D) all of the above.E) only A and B of the above.Answer: D

34) A negotiable certificate of depositA) is a term security because it has a specified maturity date.B) is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and interest.C) can be bought and sold until maturity.D) all of the above.E) only A and B of the above.Answer: D

35) Negotiable certificates of depositA) are bearer instruments because their holders earn the interest and principal at maturity.B) typically have a maturity of one to four months.C) are usually denominated at $100,000.D) are all of the above.E) are only A and B of the above.Answer: E

36) Commercial paper securitiesA) are issued only by the largest and most creditworthy corporations, as they are unsecured.B) carry an interest rate that varies according to the firm's level of risk.C) never have a term to maturity that exceeds 270 days.D) all of the above.E) only A and B of the above.Answer: D


37) Unlike most money market securities, commercial paperA) is not generally traded in a secondary market.B) usually has a term to maturity that is longer than a year.C) is not popular with most money market investors because of the high default risk.D) all of the above.E) only A and B of the above.Answer: A

38) A banker's acceptance isA) used to finance goods that have not yet been transferred from the seller to the buyer.B) an order to pay a specified amount of money to the bearer on a given date.C) a relatively new money market security that arose in the 1960s as international trade expanded.D) all of the above.E) only A and B of the above.Answer: E

39) Banker's acceptancesA) can be bought and sold until they mature.B) are issued only by large money center banks.C) carry low interest rates because of the very low default risk.D) are all of the above.E) are only A and B of the above.Answer: D

40) EurodollarsA) are time deposits with fixed maturities and are, therefore, somewhat illiquid.B) may offer the borrower a lower interest rate than can be received in the domestic market.C) are limited to London banks.D) are all of the above.E) are only A and B of the above.Answer: E

41) Which of the following statements about money market securities are true?A) The interest rates on all money market instruments move very closely together over time.B) The secondary market for Treasury bills is extensive and well developed.C) There is no well-developed secondary market for commercial paper.D) All of the above are true.E) Only A and B of the above are true.Answer: D


42) Money market transactionsA) do not take place in any one particular location or building.B) are usually arranged purchases and sales between participants over the phone by traders and completed electronically.C) are both A and B of the above.D) are none the the above.Answer: C

43) Two important characteristics of any financial market are flexibility andA) risk.B) innovation.C) tolerance.D) capital. Answer: B

44) The main role of investment companies in the money market is to A) trade on behalf of commercial accounts.B) mediate the symmetric information problem between server-lender and borrower-spenders.C) both A and B of the above.D) neither A nor B of the above.Answer: A

45) In a direct placementA) the issuer bypasses the dealer and sells indirectly to the end investor.B) the dealer sells directly to the end investor.C) the issuer bypasses the dealer and sells directly to the end investor. D) none of the above.Answer: A

46) The advantage of mutual funds is that theyA) require no cash up front.B) give investors with relatively small amounts of cash to invest access to large-denomination securities.C) always yield the highest returns.D) both A and B of the above.Answer: B

47) Asset-backed commercial paper differs from conventional commercial paper in thatA) it is backed (secured) by some bundle of assets.B) its maturity usually extends well beyond 1 year.C) both A and B of the above.D) neither A nor B of the above.Answer: A



1) Compared to money market securities, capital market securities haveA) more liquidity.B) longer maturities.C) lower yields.D) less risk.Answer: B

2) (I) Securities that have an original maturity greater than one year are traded in capital markets. (II) The best known capital market securities are stocks and bonds.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

3) (I) Securities that have an original maturity greater than one year are traded in money markets. (II) The best known money market securities are stocks and bonds.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: D

4) (I) Firms and individuals use the capital markets for long-term investments. (II) Capital markets provide an alternative to investment in assets such as real estate and gold.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

5) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will ________ before they pay off their debt.A) riseB) fallC) become more volatileD) become more stableAnswer: A

6) The primary reason that individuals and firms choose to borrow long-term is toA) reduce the risk that interest rates will fall before they pay off their debt.B) reduce the risk that interest rates will rise before they pay off their debt.C) reduce monthly interest payments, as interest rates tend to be higher on short-term than long-term debt instruments.


D) reduce total interest payments over the life of the debt.Answer: B

7) A firm will borrow long-termA) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt.B) if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the expected premium that is paid for borrowing long-term.C) if short-term interest rates are expected to decline during the term of the debt.D) if long-term interest rates are expected to decline during the term of the debt.Answer: A

8) The primary issuers of capital market securities includeA) the federal and local governments.B) the federal and local governments, and corporations.C) the federal and local governments, corporations, and financial institutions.D) local governments and corporations.Answer: B

9) Governments never issue stock becauseA) they cannot sell ownership claims.B) the Constitution expressly forbids it.C) both A and B of the above.D) neither A nor B of the above.Answer: A

10) (I) The primary issuers of capital market securities are federal and local governments, and corporations. (II) Governments never issue stock because they cannot sell ownership claims.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C


11) (I) The primary issuers of capital market securities are financial institutions.(II) The largest purchasers of capital market securities are corporations.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: D

12) The distribution of a firm's capital between debt and equity is itsA) current ratio.B) liability structure.C) acid ratio.D) capital structure.Answer: D

13) The largest purchasers of capital market securities areA) households.B) corporations.C) governments.D) central banks.Answer: A

14) Individuals and households frequently purchase capital market securities through financial institutions such asA) mutual funds.B) pension funds.C) money market mutual funds.D) all of the above.E) only A and B of the above.Answer: E

15) (I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C


16) (I) Capital market securities fall into two categories: bonds and stocks. (II) Long-term bonds include government bonds and long-term notes, municipal bonds, and corporate bonds.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: B

17) The ________ value of a bond is the amount that the issuer must pay at maturity.A) marketB) presentC) discountedD) faceAnswer: D

18) The ________ rate is the rate of interest that the issuer must pay.A) marketB) couponC) discountD) fundsAnswer: B

19) (I) The coupon rate is the rate of interest that the issuer of the bond must pay.(II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

20) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate on old bonds fluctuates with market interest rates so they will remain attractive to investors.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: A


21) Treasury bonds are subject to ________ risk but are free of ________ risk.A) default; interest-rateB) default; underwritingC) interest-rate; defaultD) interest-rate; underwritingAnswer: C

22) The prices of Treasury notes, bonds, and bills are quotedA) as a percentage of the coupon rate.B) as a percentage of the previous day's closing value.C) as a percentage of $100 face value.D) as a multiple of the annual interest paid.Answer: C

23) The security with the longest maturity is a TreasuryA) note.B) bond.C) acceptance.D) bill.Answer: B

24) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest-rate risk.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

25) To sell an old bond when interest rates have ________, the holder will have to ________ the price of the bond until the yield to the buyer is the same as the market rate.A) risen; lowerB) risen; raiseC) fallen; lowerD) risen; inflateAnswer: A


26) Most of the time, the interest rate on Treasury notes and bonds is ________ that on money market securities because of ________ risk.A) above; interest-rateB) above; defaultC) below; interest-rateD) below; defaultAnswer: A

27) (I) In most years, the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

28) (I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities.(II) A Treasury STRIP separates the periodic interest payments from the final principal repayment.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: B

29) Which of the following statements about Treasury inflation-indexed bonds is not true?A) The principal amount used to compute the interest payment varies with the consumer price index.B) The interest payment rises when inflation occurs.C) The interest rate rises when inflation occurs.D) At maturity, the securities pay the greater of face value or inflation-adjusted principal.Answer: A

30) (I) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. (II) General obligation bonds do not have specific assets pledged as security or a specific source of revenue allocated for their repayment.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C


31) (I) Most corporate bonds have a face value of $1,000, pay interest semiannually, and can be redeemed anytime the issuer wishes. (II) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: A

32) The bond contract that states the lender's rights and privileges and the borrower's obligations is called theA) bond syndicate.B) restrictive covenant.C) bond covenant.D) bond indenture.Answer: D

33) Policies that limit the discretion of managers as a way of protecting bondholders' interests are calledA) restrictive covenants.B) debentures.C) sinking funds.D) bond indentures.Answer: A

34) Typically, the interest rate on corporate bonds will be ________ the more restrictions are placed on management through restrictive covenants, because ________.A) higher; corporate earnings will be limited by the restrictionsB) higher; the bonds will be considered safer by bondholdersC) lower; the bonds will be considered safer by buyersD) lower; corporate earnings will be higher with more restrictions in placeAnswer: C

35) Restrictive covenants canA) limit the amount of dividends the firm can pay.B) limit the ability of the firm to issue additional debt.C) restrict the ability of the firm to enter into a merger agreement.D) do all of the above.E) do only A and B of the above.Answer: D


36) (I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders.(II) Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

37) Call provisions will be exercised when interest rates ________ and bond values ________.A) rise; riseB) fall; riseC) rise; fallD) fall; fallAnswer: B

38) A requirement in the bond indenture that the firm pay off a portion of the bond issue each year is calledA) a sinking fund.B) a call provision.C) a restrictive covenant.D) a shelf registration.Answer: A

39) (I) Callable bonds usually have a higher yield than comparable noncallable bonds. (II) Convertible bonds are attractive to bondholders and sell for a higher price than comparable nonconvertible bonds.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: C

40) Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are calledA) junk bonds.B) callable bonds.C) convertible bonds.D) debentures.Answer: D


41) A secured bond is backed byA) the general creditworthiness of the borrower.B) an insurance company's financial guarantee.C) the expected future earnings of the borrower.D) specific collateral.Answer: D

42) Financial guaranteesA) are insurance policies to back bond issues.B) are purchased by financially weaker security issuers.C) lower the risk of the bonds covered by the guarantee.D) do all of the above.E) do only A and B of the above.Answer: D

43) In its simplest form, a credit default swap providesA) insurance against default in the principle and interest payments of a credit instrument.B) an alternative method for bond issuers to pay principle and interest payments via a swap.C) bond investors with a method to swap interest payments for principle payments during a "credit event."D) the government with a guarantee that certain bond issues will not run into credit problems.Answer: A

44) Corporate bonds are less risky if they are ________ bonds and municipal bonds are less risky if they are ________ bonds.A) secured; revenueB) secured; general obligationC) unsecured; revenueD) unsecured; general obligationAnswer: B

45) Which of the following are true for the current yield?A) The current yield is defined as the yearly coupon payment divided by the price of the security.B) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond.C) The current yield is always a poor approximation for the yield to maturity.D) All of the above are true.E) Only A and B of the above are true.Answer: A


46) The nearer a bond's price is to its par value and the longer the maturity of the bond, the more closely the ________ approximates the ________.A) current yield; yield to maturityB) current yield; coupon rateC) yield to maturity; current yieldD) yield to maturity; coupon rateAnswer: A

47) Which of the following are true for the current yield?A) The current yield is defined as the yearly coupon payment divided by the price of the security.B) The current yield and the yield to maturity always move together.C) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond.D) All of the above are true.E) Only A and B of the above are true.Answer: E

48) The current yield is a less accurate approximation of the yield to maturity the ________ the time to maturity of the bond and the ________ the price is from/to the par value.A) shorter; closerB) shorter; fartherC) longer; closerD) longer; fartherAnswer: B

49) The current yield on a $6,000, 10 percent coupon bond selling for $5,000 isA) 5%.B) 10%.C) 12%.D) 15%.Answer: C

50) The current yield on a $5,000, 8 percent coupon bond selling for $4,000 isA) 5%.B) 8%.C) 10%.D) 20%.E) none of the above.Answer: C


51) When an old bond's market value is above its par value, the bond is selling at a ________. This occurs because the old bond's coupon rate is ________ the coupon rates of new bonds with similar risk.A) premium; belowB) premium; aboveC) discount; belowD) discount; aboveAnswer: B

52) Corporations may enter the capital markets becauseA) they do not have sufficient capital to fund their investment opportunities.B) they want to preserve their capital to protect against expected needs. C) it is required by the Securities and Exchange Commission (SEC).D) none of the above. Answer: A

53) Capital market trading occurs in A) the primary market.B) the secondary market.C) both A and B of the above. D) none of the above.Answer: C

54) BondsA) are securities that represent a debt owed by the issuer to the investor.B) obligate the issuer to pay a specified amount at a given date, generally without periodic interest payments. C) both A and B of the above.D) none of the above.Answer: A

55) STRIPS (Separate Trading of Registered Interest and Principal Securities) are also calledA) interest-based securities.B) zero-coupon securities.C) leveraged securities.D) covenant securities. Answer: B

56) The risk on an agency bond isA) high.B) zero.C) moderate.D) low.Answer: D


57) The first step in finding the value of a bond is toA) discount back the cash flows using an interest rate that represents the yield available on other bonds of like risk and maturity. B) identify the cash flows the holder of the bond will receive. C) contact the holder of the bond. D) none of the above.Answer: B

58) A change in the current yield ________ signals a change in the same direction of the yield to maturity. A) never B) rarelyC) always D) oftenAnswer: C

59) By the time the subprime financial crisis hit in force, Fannie and Freddie had ________ subprime and Alt-A assets on their books.A) over $1 trillion ofB) very fewC) been prohibited from holdingD) none of the aboveAnswer: A


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