Mishkin Chap 14, 16-24

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184 terms · Economics of Money and Banking

1) The payoffs for financial derivatives are linked to

C) previously issued securities.

2) Hedging risk for a long position is accomplished by

B) taking a short position.

3) A long contract requires that the investor

B) buy securities in the future.

4) To say that the forward market lacks liquidity means that

C) it may be difficult to make the transaction.

5) Suppose you are currently in the long position of a long-term bond. In this case, to hedge against a capital loss, you would enter into a ________ contract to ________ a long-term bond in the future.

A) interest-rate forward; sell

6) Forward contracts are of limited usefulness to financial institutions because

A) of default risk.

7) When interest rates fall, a bank that perfectly hedges its portfolio of Treasury securities in the futures market

C) has no change in its income.

8) By taking the short position on a futures contract of $100,000 at a price of 115 you are agreeing to ________ a ________ face value security for ________.

A) sell; $100,000; $115,000.

9) On the expiration date of a futures contract, the price of the contract converges to the

C) price of the underlying asset.

10) Assume you are holding Treasury securities and have sold futures to hedge against interest-rate risk. If interest rates rise

B) the decrease in the value of the securities equals the increase in the value of the futures contracts.

11) Options are contracts that give the purchasers the

A) option to buy or sell an underlying asset.

12) The price specified on an option at which the holder can buy or sell the underlying asset is called the

C) strike price.

13) If you buy a call option on Treasury futures at 115, and at expiration the market price is 110, the ________ will ________ exercised.

C) call; not be

14) If, for a $1000 premium, you buy a $100,000 call option on bond futures with a strike price of 114, and at the expiration date the price is 110, your ________ is ________.

B) loss; $1000

15) Explain the profits and losses of buying futures relative to buying call options.

The profit-loss function for futures is linear. Both gains and losses grow linearly for each $1 change in the underlying security price at expiration. The profit curve for options is nonlinear. The loss is limited to the amount of the premium. Profits are a linear function of the asset price at expiration, but profits from options are always less than for futures by the amount of the premium. The key differences are that options losses are limited, while futures losses are not. Gains for futures and options are linear functions of the expiration price, but option profits are always less than futures profits by the amount of the premium.

16) A swap that involves the exchange of one set of interest payments for another set of interest payments is called

A) an interest rate swap.

17) If Second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce interest-rate risk with a swap that requires Second National to

B) receive fixed rate while paying floating rate.

18) A advantage of using swaps to hedge interest-rate risk is that swaps

B) can be written for long horizons.

1) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that

D) a central bank was needed to prevent future panics.

2) Which of the following is NOT an entity of the Federal Reserve System?

B) The Comptroller of the Currency

3) The Federal Reserve Banks are ________ institutions since they are owned by the ________.

A) quasi-public; private commercial banks in the district where the Reserve Bank is located

4) The nine directors of the Federal Reserve Banks are split into three categories: ________ are professional bankers, ________ are leaders from industry, and ________ are to represent the public interest and are not allowed to be officers, employees, or stockholders of banks.

D) 3; 3; 3

5) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited by law to ________ percent annually.

C) six

6) The president from which Federal Reserve Bank always has a vote in the Federal Open Market Committee?

D) New York

7) Which of the following functions is not performed by any of the twelve regional Federal Reserve Banks?

C) Setting interest rates payable on time deposits

8) Prior to 1980, member banks left the Federal Reserve System due to

B) the high cost of required reserves.

9) Members of the Board of Governors are

C) appointed by the president of the United States and confirmed by the Senate.

10) Which of the followings is a duty of the Board of Governors of the Federal Reserve System?

A) Setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash.

11) The Federal Open Market Committee consists of the

C) seven members of the Board of Governors and five presidents of the regional Fed banks.

12) Although neither ________ nor the ________ are officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee.

C) reserve requirements; discount rate

13) Why does the Federal Reserve Bank of New York play a special role within the Federal Reserve System?

The New York district contains the largest banks in the country. The New York Fed supervises and examines these banks to insure their soundness and the safety of the nation's financial system. The New York Fed conducts open market operations and foreign exchange transactions for the Fed and Treasury. The New York Fed belongs to the Bank for International Settlements, so its president and the chairman of the Board of Governors represent the U.S. at the monthly meetings of the world's central banks. The New York Fed president is the only president of a regional Fed who is a permanent voting member of the FOMC.

14) Instrument independence is the ability of ________ to set monetary policy ________.

D) the central bank; instruments

15) The ability of a central bank to set monetary policy goals is

B) goal independence.

16) Explain two concepts of central bank independence. Is the Fed politically independent? Why do economists think central bank independence is important?

Instrument independence is the ability of the central bank to set its instruments, and goal independence is the ability of a central bank to set its goals. The Fed enjoys both types of independence. The Fed is largely independent of political pressure due to its earnings and the conditions of appointment of the Board of Governors and its chairman. However, some political pressure can be applied through the threat or enactment of legislation affecting the Fed. Independence is important because there is some evidence that independent central banks pursue lower rates of inflation without harming overall economic performance.

17) The political business cycle refers to the phenomenon that just before elections, politicians enact ________ policies. After the elections, the bad effects of these policies (for example, ________) have to be counteracted with ________ policies.

B) expansionary; a higher inflation rate; contractionary

18) Critics of the current system of Fed independence contend that

A) the current system is undemocratic.

19) Make the case for and against an independent Federal Reserve.

CASE FOR: 1. An independent Federal Reserve can shield the economy from the political business cycle, and it will be less likely to have an inflationary bias to monetary policy. 2. Control of the money supply is too important to leave to inexperienced politicians.
CASE AGAINST: 1. It is undemocratic to have monetary policy be controlled by a small number of individuals that are not accountable. 2. In the past, an independent Fed has not used its freedom wisely. 3. Its independence may encourage it to pursue its own self-interest rather than the public's interest.

1) Of the three players in the money supply process, most observers agree that the most important player is

B) the Federal Reserve System.

2) Both ________ and ________ are Federal Reserve assets.

C) securities; loans to financial institutions

3) The monetary base consists of

C) currency in circulation and reserves.

4) Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say First National Bank has ________ million dollars in excess reserves.

B) nine

5) Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say First National Bank faces a required reserve ratio of ________ percent.

A) ten

6) When banks borrow money from the Federal Reserve, these funds are called

B) discount loans.

7) High-powered money minus currency in circulation equals

A) reserves.

8) When the Federal Reserve purchases a government bond from a bank, reserves in the banking system ________ and the monetary base ________, everything else held constant.

A) increase; increases

9) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds. If the proceeds are kept in ________, the open market purchase has no effect on reserves; if the proceeds are kept as ________, reserves increase by the amount of the open market purchase.

C) currency; deposits

10) If a member of the nonbank public sells a government bond to the Federal Reserve in exchange for currency, the monetary base will ________, but ________.

D) rise; reserves will remain unchanged

11) When the Federal Reserve extends a discount loan to a bank, the monetary base ________ and reserves ________.

C) increases; increase

12) An increase in ________ leads to an equal ________ in the monetary base in the short run.

B) float; increase

13) Explain two ways by which the Federal Reserve System can increase the monetary base. Why is the effect of Federal Reserve actions on bank reserves less exact than the effect on the monetary base?

The Fed can increase the monetary base by purchasing government bonds and by extending discount loans. If the person selling the security chooses to keep the proceeds in currency, bank reserves do not increase. Because the Fed cannot control the distribution of the monetary base between reserves and currency, it has less control over reserves than the base.

14) In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a bank that previously had no excess reserves, deposits in the banking system can potentially increase by

C) $100 times the reciprocal of the required reserve ratio.

15) If reserves in the banking system increase by $100, then checkable deposits will increase by $1000 in the simple model of deposit creation when the required reserve ratio is

B) 0.10.

16) In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the required reserve ratio is equal to 20 percent implies that the Fed

C) purchased $200 in government bonds.

17) The money supply is ________ related to the nonborrowed monetary base, and ________ related to the level of borrowed reserves.

C) positively; positively

18) In the model of the money supply process, the bank's role in influencing the money supply process is represented by

A) the excess reserve.

19) Models describing the determination of the money supply and the Fed's role in this process normally focus on ________ rather than ________, since Fed actions have a more predictable effect on the former.

D) the monetary base; reserves

20) The total amount of required reserves in the banking system is equal to the ________ the required reserve ratio and checkable deposits.

C) product of

21) If the Fed injects reserves into the banking system and they are held as excess reserves, then the monetary base ________ and the money supply ________.

D) increases; remains unchanged

22) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is ________ billion.

C) $1400

23) Everything else held constant, an increase in the currency-checkable deposit ratio will mean

C) a decrease in the money supply.

24) During the 2007-2009 financial crisis the currency ratio

D) decreased slightly.

1) The interest rate charged on overnight loans of reserves between banks is the

C) federal funds rate.

2) Everything else held constant, when the federal funds rate is ________ the interest rate paid on reserves, the quantity of reserves demanded rises when the federal funds rate ________.

B) above, falls

3) Which of the following is NOT an argument for the Federal Reserve paying interest on excess reserve holdings?

C) Paying interest will help the Federal Reserve have more control of the amount of discount loans.

4) In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, then an open market ________ the supply of reserves, raising the federal funds interest rate, everything else held constant.

A) sale decreases

5) In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, an open market sale ________ the supply of reserves causing the federal funds rate to ________, everything else held constant.

D) decreases; increase

6) Everything else held constant, in the market for reserves, when the federal funds rate is 3%, raising the discount rate from 5% to 6%

C) has no effect on the federal funds rate.

7) Everything else held constant, in the market for reserves, when the demand for federal funds intersects the reserve supply curve on the vertical section, increasing the discount rate

C) has no effect on the federal funds rate.

8) Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?

The three tools are open market operations, the purchase and sale of government securities; discount policy, controlling the price and quantity of discount loans to banks; and reserve requirements, setting the percentage of deposits that banks must hold in reserve. Open market operations and the discount rate affect the monetary base, and reserve requirements affect the money multiplier.

9) State whether the following statement is true or false AND explain why: "A decrease in the discount rate will always cause a decrease in the federal reserve funds rate."

FALSE. Since the discount rate is set above the federal funds rate, a decrease in the discount rate will only cause a decrease in the federal funds rate if the discount rate is decreased below the original federal funds rate level. If the decrease in the discount rate is such that the new rate is still above the federal funds rate, then the federal funds rate does not change, everything else held constant.

10) Open market sales ________ reserves and the monetary base thereby ________ the money supply.

C) lower; lowering

11) The actual execution of open market operations is done at

B) the Federal Reserve Bank of New York.

12) When good weather speeds the check-clearing process, float tends to ________ causing the Fed to initiate defensive open market ________.

B) decrease; purchases

13) If Treasury deposits at the Fed are predicted to increase, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) defensive; inject

14) The facility that was created in December of 2007 that banks can use to borrow from the Fed that has less of a stigma for banks compared to borrowing from the discount window is the

B) Term Auction Facility.

15) The most important advantage of discount policy is that the Fed can use it to

B) perform its role as lender of last resort.

1) A nominal anchor promotes price stability by

C) keeping inflation expectations low.

2) Monetary policy is considered time-inconsistent because

C) policymakers are tempted to pursue discretionary policy that is more expansionary in the short run.

3) Explain the time-inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem?

With policy discretion, policymakers have an incentive to attempt to increase output by pursuing expansionary policies once expectations are set. The problem is that this policy results not in higher output, but in higher actual and expected inflation. The solution is to adopt a rule to constrain discretion. Nominal anchors can provide the necessary constraint on discretionary behavior.

4) The most common definition that monetary policymakers use for price stability is

D) low and stable inflation.

5) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called

B) frictional unemployment.

6) Supply-side economic policies seek to

D) increase saving and investment using tax incentives.

7) Foreign exchange rate stability is important because a decline in the value of the domestic currency will ________ the inflation rate, and an increase in the value of the domestic currency makes domestic industries ________ competitive with competing foreign industries.

B) increase; less

8) Which set of goals can, at times, conflict in the short run?

C) High employment and price level stability.

9) Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal in the ________.

B) price stability; long run

10) Which of the following is NOT an element of inflation targeting?

C) An information-inclusive approach in which only monetary aggregates are used in making decisions about monetary policy

11) Which of the following is NOT an advantage of inflation targeting?

C) There is an immediate signal on the achievement of the target.

12) Inflation targets can increase the central bank's flexibility in responding to declines in aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to ________ monetary policy without fearing that this action will trigger a rise in inflation expectations.

B) demand; loosen

13) The type of monetary policy regime that the Federal Reserve has been following in recent years can best be described as

C) policy with an implicit nominal anchor.

14) When compared to the Fed's ________ anchor approach, ________ targeting can make the institutional framework for the conduct of monetary policy more consistent with democratic principles.

D) implicit; inflation

15) Explain the Federal Reserve's "just do it" approach to monetary policy. What are the advantages and disadvantages to this type of strategy?

The Federal Reserve doesn't use an explicit nominal anchor such as a monetary aggregate or the inflation rate. Its strategy revolves around using an implicit nominal anchor in the form of an overriding concern to control inflation in the long run. This involves forward-looking behavior and "pre-emptive strikes" by policy actions to prevent inflation. This forward-looking behavior is necessary because of the long time lags between monetary policy action and its impact on inflation.
THE ADVANTAGES: 1. it doesn't rely on a stable money-inflation relationship; 2. the demonstrated success it has had in the United States.
THE DISADVANTAGES: 1. there is a lack of transparency; 2. its success depends on the individuals in charge of policy; 3. there is low accountability of the central bank.

16) The "Greenspan doctrine" - central banks should not try to prick bubbles - was based on which of the following arguments?

A) Asset-price bubbles are nearly impossible to identify.
B) Monetary actions would be likely to affect asset prices in general, rather than the specific assets that are experiencing a bubble.
C) Raising interest rates has often been found to cause a bubble to burst more severely.
D) Monetary policy actions to prick bubbles can have harmful effects on the aggregate economy.
Correct: E) all of the above.

17) Suppose interest rates are kept very low for a long time such that there is a spike in the amount of lending. Everything else held constant, this could cause ________ bubble.

B) a credit-driven

18) Which of the following is not an operating instrument?

D) Discount rate

19) If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because

A) of fluctuations in the demand for reserves.

20) Which of the following is not a requirement in selecting a policy instrument?

C) Flexibility

21) Explain how targeting nonborrowed reserves can result in federal funds rate instability.

When nonborrowed reserves are held constant, increases in the demand for reserves result in the federal funds rate increasing and decreases in the demand for nonborrowed reserves result in the federal funds rate declining. Since fluctuations in demand do not cause monetary policy actions, the result is the federal funds rate will fluctuate (assuming the equilibrium federal funds rate is below the discount rate).

1) Although foreign exchange market trades are said to involve the buying and selling of currencies, most trades involve the buying and selling of

A) bank deposits denominated in different currencies.

2) An agreement to exchange dollar bank deposits for euro bank deposits in one month is a

C) forward transaction.

3) When the value of the British pound changes from $1.25 to $1.50, the pound has ________ and the U.S. dollar has ________.

C) appreciated; depreciated

4) If the U.S. dollar appreciates from 1.25 Swiss franc per U.S. dollar to 1.5 francs per dollar, then the franc depreciates from ________ U.S. dollars per franc to ________ U.S. dollars per franc.

A) 0.80; 0.67

5) Everything else held constant, when a country's currency depreciates, its goods abroad become ________ expensive while foreign goods in that country become ________ expensive.

D) less; more

6) The starting point for understanding how exchange rates are determined is a simple idea called ________, which states: if two countries produce an identical good, the price of the good should be the same throughout the world no matter which country produces it.

B) the law of one price

7) The theory of purchasing power parity cannot fully explain exchange rate movements because

C) some goods are not traded between countries.

8) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should

A) depreciate in the long run.

9) Higher tariffs and quotas cause a country's currency to ________ in the ________ run, everything else held constant.

D) appreciate; long

10) Everything else held constant, increased demand for a country's exports causes its currency to ________ in the long run, while increased demand for imports causes its currency to ________.

B) appreciate; depreciate

11) Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity explain all exchange rate movements? What factors determine long-run exchange rates?

With no trade barriers and low transport costs, the law of one price states that the price of traded goods should be the same in all countries. The purchasing power parity theory extends the law of one price to total economies. PPP states that exchange rates should adjust to reflect changes in the price levels between two countries. PPP may fail to fully explain exchange rates because goods are not identical, and price levels include traded and nontraded goods and services. Long-run exchange rates are determined by domestic price levels relative to foreign price levels, trade barriers, import and export demand, and productivity.

12) As the relative expected return on dollar assets increases, foreigners will want to hold more ________ assets and less ________ assets, everything else held constant.

C) dollar; foreign

13) Everything else held constant, when the current value of the domestic exchange rate increases, the ________ of domestic assets ________.

A) quantity supplied; does not change

14) Suppose that the Federal Reserve conducts an open market sale. Everything else held constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar will ________.

A) increase; appreciate

15) ________ in the foreign interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant.

B) An increase; depreciate

16) Explain the effect of an increase in the expected future exchange rate on the equilibrium exchange rate, everything else held constant.

When the expected future exchange rate increases, the relative expected return on the domestic assets increases. This will cause the demand for domestic assets to increase and the current value of the exchange rate will appreciate.

17) Everything else held constant, if a factor increases the demand for ________ goods relative to ________ goods, the domestic currency will appreciate.

D) domestic; foreign

18) If the U.S. Congress imposes a quota on imports of Japanese cars due to claims of "unfair" trade practices, and Japanese demand for American exports increases at the same time, then, in the long run ________, everything else held constant.

B) the Japanese yen will depreciate relative to the U.S. dollar

20) When Americans or foreigners expect the return on dollar assets to be high relative to the return on foreign assets, there is a ________ demand for dollar assets and a correspondingly ________ demand for foreign assets.

B) higher; lower

21) ________ in the domestic interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant.

D) A decrease; depreciate

4) Hedging risk for a short position is accomplished by

A) Taking a long position.

6) A contract that requires the investor to buy securities on a future date is called

B) long contract.

8) A person who agrees to buy an asset at a future date has gone

A) long.

9) Short contracts requires that the investor

A) sell securities in the future.

9) On the expiration date of a futures contract, the price of the contract

C) always equals the price of the underlying asset.

6) By selling short a futures contract of $100,000 at a price of 115 you are agreeing to deliver

A) $100,000 face value securities for $115,000

7) By selling short a futures contract of $100,000 at a price of 96 you are agreeing to deliver

C) $100,000 face value securities for $96,000

9) If Second National Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce interest rate risk wit a swap that requires Second National to

A) pay fixed rate while receiving floating rate.

9) Which of the following is not a requirement in selecting an intermediate target?

C) Flexibility

26) For the classical economist, the quantity theory of money provided an explanation of movements in the price level. Movement in the price level result

A) solely from changes in the quantity of money

22) Everything else held constant, aggregate demand increases when

A) taxes are cut.

2) The aggregate supply curve shows the relationship between

D) the price level and the level of aggregate output supplied.

1) A central bank ________ of domestic currency and corresponding ________ of foreign assets in the foreign exchange market leads to an equal decline in its international reserves and the monetary base, everything else held constant.

C) purchase; sale

2) A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called

B) a sterilized foreign exchange intervention.

3) Everything else held constant, if a central bank makes an unsterilized sale of foreign assets, then the domestic money supply will ________ and the domestic currency will ________.

C) decrease; appreciate

4) Because sterilized interventions mean offsetting open market operations, there is no impact on the monetary base and the money supply, and therefore a sterilized intervention

D) has no effect on the exchange rate.

5) If the United States has a current account deficit with England of $1 million, and the Bank of England sells $1 million worth of pounds in the foreign exchange market, then England ________ $1 million of international reserves and its monetary base ________ by $1 million.

A) gains; rises

6) Which of the following does not appear in the current account part of the balance of payments?

A) A loan of $1 million from Bank of America to Brazil.

7) If the current account balance shows a surplus, and the capital account also shows a surplus, then the official reserve transactions balance

A) must be positive.

8) Under a gold standard in which one dollar could be turned in to the U.S. Treasury and exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th of an ounce of gold, an exchange rate of ________ marks to the dollar would stimulate a flow of gold from the United States to Germany.

D) 4

9) Under the Bretton Woods system, the organization assigned the task of making loans to countries that were experiencing balance of payments difficulties is known as the

C) International Monetary Fund.

10) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is, ________ par, the central bank must intervene to sell the domestic currency by purchasing foreign assets.

D) undervalued; above

11) When the domestic currency is initially overvalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

A) purchase; decline

12) Under the current managed float exchange rate regime; countries with surpluses in their balance of payments frequently do not want to see their currencies appreciate because it makes their goods ________ expensive abroad and foreign goods ________ in their countries.

A) more; cheaper

13) Explain the situation of an overvalued exchange rate in a fixed exchange rate system. What alternative policies are available to eliminate the overvaluation of the exchange rate?

The par value is above the equilibrium value, resulting in overvaluation of the exchange rate. One approach is to pursue contractionary monetary policies, raising interest rates and increasing the demand for domestic assets. This process continues until equilibrium at par value is restored. Another alternative is for the central bank to purchase domestic currency by selling foreign assets.

1) Because the quantity theory of money tells us how much money is held for a given amount of aggregate income, it is also a theory of

B) the demand for money.

2) The velocity of money is

A) the average number of times that a dollar is spent in buying the total amount of final goods and services.

3) If the money supply is $500 and nominal income is $4,000, the velocity of money is

C) 8.

4) The equation of exchange states that the quantity of money multiplied by the number of times this money is spent in a given year must equal

A) nominal income.

5) Cutting the money supply by one-third is predicted by the quantity theory of money to cause

D) a decline in the price level by one-third.

6) For the classical economists, the quantity theory of money provided an explanation of movements in the price level. Changes in the price level result

A) from proportional changes in the quantity of money.

7) Fisher's quantity theory of money suggests that the demand for money is purely a function of ________, and ________ no effect on the demand for money.

A) income; interest rates have

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