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Financial Markets and Institutions, 7e (Mishkin) Chapter 1 Why Study Financial Markets and Institutions?

1.1 Multiple Choice

1) Financial markets and institutions A) involve the movement of huge quantities of money. B) affect the profits of businesses. C) affect the types of goods and services produced in an economy. D) do all of the above. E) do only A and B of the above. Answer: D Question Status: Previous Edition

2) Financial market activities affect A) personal wealth. B) spending decisions by individuals and business firms. C) the economy's location in the business cycle. D) all of the above. Answer: D Question Status: Previous Edition

3) Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called A) commodity markets. B) funds markets. C) derivative exchange markets. D) financial markets. Answer: D Question Status: Previous Edition

4) The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of $100 per year) is commonly referred to as the A) inflation rate. B) exchange rate. C) interest rate. D) aggregate price level. Answer: C Question Status: Previous Edition

5) The bond markets are important because A) they are easily the most widely followed financial markets in the United States. B) they are the markets where interest rates are determined. C) they are the markets where foreign exchange rates are determined. D) all of the above. Answer: B Question Status: Previous Edition

6) Interest rates are important to financial institutions since an interest rate increase ________ the cost of acquiring funds and ________ the income from assets.

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A) decreases; decreases B) increases; increases C) decreases; increases D) increases; decreases Answer: B Question Status: Previous Edition

7) Typically, increasing interest rates A) discourages individuals from saving. B) discourages corporate investments. C) encourages corporate expansion. D) encourages corporate borrowing. E) none of the above. Answer: B Question Status: Previous Edition

8) Compared to interest rates on long-term U.S. government bonds, interest rates on ________ fluctuate more and are lower on average. A) medium-quality corporate bonds B) low-quality corporate bonds C) high-quality corporate bonds D) three-month Treasury bills E) none of the above Answer: D Question Status: Previous Edition

9) Compared to interest rates on long-term U.S. government bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average. A) more; lower B) less; lower C) more; higher D) less; higher Answer: A Question Status: Previous Edition

10) The stock market is important because A) it is where interest rates are determined. B) it is the most widely followed financial market in the United States. C) it is where foreign exchange rates are determined. D) all of the above. Answer: B Question Status: Previous Edition


11) Stock prices since the 1980s have been A) relatively stable, trending upward at a steady pace. B) relatively stable, trending downward at a moderate rate. C) extremely volatile. D) unstable, trending downward at a moderate rate. Answer: C Question Status: Previous Edition

12) The largest one-day drop in the history of the American stock markets occurred in A) 1929. B) 1987. C) 2000. D) 2001. Answer: B Question Status: Previous Edition

13) A declining stock market index due to lower share prices A) reduces people's wealth and as a result may reduce their willingness to spend. B) increases people's wealth and as a result may increase their willingness to spend. C) decreases the amount of funds that business firms can raise by selling newly issued stock. D) both A and C of the above. E) both B and C of the above. Answer: D Question Status: Previous Edition

14) Changes in stock prices A) affect people's wealth and their willingness to spend. B) affect firms' decisions to sell stock to finance investment spending. C) are characterized by considerable fluctuations. D) all of the above. E) only A and B of the above. Answer: D Question Status: Previous Edition

15) (I) Debt markets are often referred to generically as the bond market. (II) A bond is a security that is a claim on the earnings and assets of a corporation. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: A Question Status: Previous Edition


16) (I) A bond is a debt security that promises to make payments periodically for a specified period of time. (II) A stock is a security that is a claim on the earnings and assets of a corporation. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C Question Status: Previous Edition

17) The price of one country's currency in terms of another's is called A) the foreign exchange rate. B) the interest rate. C) the Dow Jones industrial average. D) none of the above. Answer: A Question Status: Previous Edition

18) A stronger dollar benefits ________ and hurts ________ A) American businesses; American consumers. B) American businesses; foreign businesses. C) American consumers; American businesses. D) foreign businesses; American consumers. Answer: C Question Status: Previous Edition

19) A weaker dollar benefits ________ and hurts ________ A) American businesses; American consumers. B) American businesses; foreign consumers. C) American consumers; American businesses. D) foreign businesses; American consumers. Answer: A Question Status: Previous Edition

20) From 1980 to early 1985 the dollar ________ in value, thereby benefiting American ________ A) appreciated; businesses. B) appreciated; consumers. C) depreciated; businesses. D) depreciated; consumers. Answer: B Question Status: Previous Edition


21) Money is defined as A) anything that is generally accepted in payment for goods and services or in the repayment of debt. B) bills of exchange. C) a riskless repository of spending power. D) all of the above. E) only A and B of the above. Answer: A Question Status: Previous Edition

22) The organization responsible for the conduct of monetary policy in the United States is the A) Comptroller of the Currency. B) U.S. Treasury. C) Federal Reserve System. D) Bureau of Monetary Affairs. Answer: C Question Status: Previous Edition

23) The central bank of the United States is A) Citicorp. B) The Fed. C) Bank of America. D) The Treasury. E) none of the above. Answer: B Question Status: Previous Edition

24) Monetary policy is chiefly concerned with A) how much money businesses earn. B) the level of interest rates and the nation's money supply. C) how much money people pay in taxes. D) whether people have saved enough money for retirement. Answer: B Question Status: Previous Edition

25) Economists group commercial banks, savings and loan associations, credit unions, mutual funds, mutual savings banks, insurance companies, pension funds, and finance companies together under the heading financial intermediaries. Financial intermediaries A) act as middlemen, borrowing funds from those who have saved and lending these funds to others. B) produce nothing of value and are therefore a drain on society's resources. C) help promote a more efficient and dynamic economy. D) do all of the above. E) do only A and C of the above. Answer: E Question Status: Previous Edition


26) Economists group commercial banks, savings and loan associations, credit unions, mutual funds, mutual savings banks, insurance companies, pension funds, and finance companies together under the heading financial intermediaries. Financial intermediaries A) act as middlemen, borrowing funds from those who have saved and lending these funds to others. B) play an important role in determining the quantity of money in the economy. C) help promote a more efficient and dynamic economy. D) do all of the above. E) do only A and C of the above. Answer: D Question Status: Previous Edition

27) Banks are important to the study of money and the economy because they A) provide a channel for linking those who want to save with those who want to invest. B) have been a source of financial innovation that is expanding the alternatives available to those wanting to invest their money. C) are the only financial institution to play a role in determining the quantity of money in the economy. D) do all of the above. E) do only A and B of the above. Answer: E Question Status: Previous Edition

28) Banks, savings and loan associations, mutual savings banks, and credit unions A) are no longer important players in financial intermediation. B) have been providing services only to small depositors since deregulation. C) have been adept at innovating in response to changes in the regulatory environment. D) all of the above. E) only A and C of the above. Answer: C Question Status: Previous Edition

29) (I) Banks are financial intermediaries that accept deposits and make loans. (II) The term "banks" includes firms such as commercial banks, savings and loan associations, mutual savings banks, credit unions, insurance companies, and pension funds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: A Question Status: Previous Edition

30) ________ was the stock market's worst one-day drop in history in the 1980s. A) Black Friday B) Black Monday C) Blackout Day D) none of the above Answer: B Question Status: Previous Edition

31) The largest financial intermediaries are A) insurance companies.


B) finance companies. C) banks. D) all of the above. Answer: C Question Status: Previous Edition

32) In recent years A) interest rates have remained constant. B) the success of financial institutions has reached levels unprecedented since the Great Depression. C) stock markets have crashed. D) all of the above. Answer: C Question Status: Previous Edition

33) A security A) is a claim or price of property that is subject to ownership. B) promises that payments will be made periodically for a specified period of time. C) is the price paid for the usage of funds. D) is a claim on the issuer's future income. Answer: D Question Status: Previous Edition

34) ________ are an example of a financial institution. A) Banks B) Insurance companies C) Finance companies D) All of the above Answer: D Question Status: Previous Edition

35) Monetary policy affects A) interest rates. B) inflation. C) business cycles. D) all of the above. Answer: D Question Status: Previous Edition

36) A rising stock market index due to higher share prices A) increases people's wealth and as a result may increase their willingness to spend. B) increases the amount of funds that business firms can raise by selling newly issued stock. C) decreases the amount of funds that business firms can raise by selling newly issued stock. D) both A and B of the above. Answer: D Question Status: Previous Edition

37) From the peak of the high-tech bubble in 2000, the stock market ________ by over ________ by late 2002. A) collapsed; 75% B) rose; 35%


C) collapsed; 30% D) rose; 50% Answer: C Question Status: New Question

1.2 True/False

1) Money is anything accepted by anyone as payment for services or goods. Answer: TRUE Question Status: Previous Edition

2) Interest rates are determined in the bond markets. Answer: TRUE Question Status: Previous Edition

3) A stock is a debt security that promises to make periodic payments for a specific period of time. Answer: FALSE Question Status: Previous Edition

4) Monetary policy affects interest rates but has little effect on inflation or business cycles. Answer: FALSE Question Status: Previous Edition

5) The government organization responsible for the conduct of monetary policy in the United States is the U.S. Treasury. Answer: FALSE Question Status: Previous Edition

6) Interest rates can be accurately described as the rental price of money. Answer: TRUE Question Status: Previous Edition

7) Holding everything else constant, as the dollar weakens vacations abroad become less attractive. Answer: TRUE Question Status: Previous Edition

8) In recent years, financial markets have become more stable and less risky. Answer: FALSE Question Status: Previous Edition

9) Financial innovation has provided more options to both investors and borrowers. Answer: TRUE Question Status: Previous Edition

10) A financial intermediary borrows funds from people who have saved. Answer: TRUE Question Status: Previous Edition

11) Holding everything else constant, as the dollar strengthens foreigners will buy more U.S. exports. Answer: FALSE


Question Status: Previous Edition

12) In a bull market stock prices are rising, on average. Answer: TRUE Question Status: Previous Edition

13) Financial institutions are among the largest employers in the country and frequently pay very high salaries. Answer: TRUE Question Status: Previous Edition

14) Different interest rates have a tendency to move in unison. Answer: TRUE Question Status: Previous Edition

15) Financial markets are what makes financial institutions work. Answer: FALSE Question Status: Previous Edition

16) In recent years, financial markets have become more risky. However, only a limited number of tools (such as derivatives) are available to assist in managing this risk. Answer: FALSE Question Status: New Question

1.3 Essay

1) Have interest rates been more or less volatile in recent years? Why? Question Status: Previous Edition

2) Why should consumers be concerned with movements in foreign exchange rates? Question Status: Previous Edition

3) How does the value of the dollar affect the competitiveness of American businesses? Question Status: Previous Edition

4) What is monetary policy and who is responsible for its implementation? Question Status: Previous Edition

5) What are financial intermediaries and what do they do? Question Status: Previous Edition


6) What is money? Question Status: Previous Edition

7) How does a bond differ from a stock? Question Status: Previous Edition

8) Why is the stock market so important to individuals, firms, and the economy? Question Status: Previous Edition

9) What is the central bank and what does it do? Question Status: Previous Edition

10) If you are planning a vacation to Europe, do you prefer a strong dollar or weak dollar relative to the euro? Why? Question Status: New Question


Financial Markets and Institutions, 7e (Mishkin) Chapter 2 Overview of the Financial System

2.1 Multiple Choice

1) Every financial market performs the following function: A) It determines the level of interest rates. B) It allows common stock to be traded. C) It allows loans to be made. D) It channels funds from lenders-savers to borrowers-spenders. Answer: D Question Status: Previous Edition

2) Financial markets have the basic function of A) bringing together people with funds to lend and people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) both A and B of the above. E) both B and C of the above. Answer: A Question Status: Previous Edition

3) Which of the following can be described as involving direct finance? A) A corporation's stock is traded in an over-the-counter market. B) People buy shares in a mutual fund. C) A pension fund manager buys commercial paper in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets. E) None of the above. Answer: E Question Status: Previous Edition

4) Which of the following can be described as involving direct finance? A) A corporation's stock is traded in an over-the-counter market. B) A corporation buys commercial paper issued by another corporation. C) A pension fund manager buys commercial paper from the issuing corporation. D) Both A and B of the above. E) Both B and C of the above. Answer: B Question Status: Previous Edition

5) Which of the following can be described as involving indirect finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys commercial paper in a secondary market. D) All of the above. E) Only A and B of the above. Answer: E Question Status: Previous Edition


6) Which of the following can be described as involving indirect finance? A) A bank buys a U.S. Treasury bill from one of its depositors. B) A corporation buys commercial paper issued by another corporation. C) A pension fund manager buys commercial paper in the primary market. D) Both A and C of the above. Answer: D Question Status: Previous Edition

7) Financial markets improve economic welfare because A) they allow funds to move from those without productive investment opportunities to those who have such opportunities. B) they allow consumers to time their purchases better. C) they weed out inefficient firms. D) they do all of the above. E) they do A and B of the above. Answer: E Question Status: Previous Edition

8) A country whose financial markets function poorly is likely to A) efficiently allocate its capital resources. B) enjoy high productivity. C) experience economic hardship and financial crises. D) increase its standard of living. Answer: C Question Status: Previous Edition

9) Which of the following are securities? A) A certificate of deposit B) A share of Texaco common stock C) A Treasury bill D) All of the above E) Only A and B of the above Answer: D Question Status: Previous Edition

10) Which of the following statements about the characteristics of debt and equity are true? A) They both can be long-term financial instruments. B) They both involve a claim on the issuer's income. C) They both enable a corporation to raise funds. D) All of the above. E) Only A and B of the above. Answer: D Question Status: Previous Edition


11) The money market is the market in which ________ are traded. A) new issues of securities B) previously issued securities C) short-term debt instruments D) long-term debt and equity instruments Answer: C Question Status: Previous Edition

12) Long-term debt and equity instruments are traded in the ________ market. A) primary B) secondary C) capital D) money Answer: C Question Status: Previous Edition

13) Which of the following are primary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) The options markets E) None of the above Answer: E Question Status: Previous Edition

14) Which of the following are secondary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) The options markets E) All of the above Answer: E Question Status: Previous Edition

15) A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank. Answer: B Question Status: Previous Edition

16) Intermediaries who are agents of investors and match buyers with sellers of securities are called A) investment bankers. B) traders. C) brokers. D) dealers. E) none of the above. Answer: C Question Status: Previous Edition


17) Intermediaries who link buyers and sellers by buying and selling securities at stated prices are called A) investment bankers. B) traders. C) brokers. D) dealers. E) none of the above. Answer: D Question Status: Previous Edition

18) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house. Answer: A Question Status: Previous Edition

19) Which of the following statements about financial markets and securities are true? A) Most common stocks are traded over-the-counter, although the largest corporations have their shares traded at organized stock exchanges such as the New York Stock Exchange. B) A corporation acquires new funds only when its securities are sold in the primary market. C) Money market securities are usually more widely traded than longer-term securities and so tend to be more liquid. D) All of the above are true. E) Only A and B of the above are true. Answer: D Question Status: Previous Edition

20) Which of the following statements about financial markets and securities are true? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is long term if its maturity is ten years or longer. D) The maturity of a debt instrument is the time (term) that has elapsed since it was issued. Answer: C Question Status: Previous Edition

21) Which of the following statements about financial markets and securities are true? A) Few common stocks are traded over-the-counter, although the over-the-counter markets have grown in recent years. B) A corporation acquires new funds only when its securities are sold in the primary market. C) Capital market securities are usually more widely traded than longer-term securities and so tend to be more liquid. D) All of the above are true. E) Only A and B of the above are true. Answer: B Question Status: Previous Edition


22) Which of the following markets is sometimes organized as an over-the-counter market? A) The stock market B) The bond market C) The foreign exchange market D) The federal funds market E) all of the above Answer: E Question Status: Previous Edition

23) Bonds that are sold in a foreign country and are denominated in that country's currency are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Answer: A Question Status: Previous Edition

24) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Answer: B Question Status: Previous Edition

25) Financial intermediaries A) exist because there are substantial information and transaction costs in the economy. B) improve the lot of the small saver. C) are involved in the process of indirect finance. D) do all of the above. E) do only A and B of the above. Answer: D Question Status: Previous Edition

26) The main sources of financing for businesses, in order of importance, are A) financial intermediaries, issuing bonds, issuing stocks. B) issuing bonds, issuing stocks, financial intermediaries. C) issuing stocks, issuing bonds, financial intermediaries. D) issuing stocks, financial intermediaries, issuing bonds. Answer: A Question Status: Previous Edition

27) The presence of transaction costs in financial markets explains, in part, why A) financial intermediaries and indirect finance play such an important role in financial markets. B) equity and bond financing play such an important role in financial markets. C) corporations get more funds through equity financing than they get from financial intermediaries. D) direct financing is more important than indirect financing as a source of funds. Answer: A Question Status: Previous Edition


28) Financial intermediaries can substantially reduce transaction costs per dollar of transactions because their large size allows them to take advantage of A) poorly informed consumers. B) standardization. C) economies of scale. D) their market power. Answer: C Question Status: Previous Edition

29) The purpose of diversification is to A) reduce the volatility of a portfolio's return. B) raise the volatility of a portfolio's return. C) reduce the average return on a portfolio. D) raise the average return on a portfolio. Answer: A Question Status: Previous Edition

30) An investor who puts all her funds into one asset ________ her portfolio's ________. A) increases; diversification B) decreases; diversification C) increases; average return D) decreases; average return Answer: B Question Status: Previous Edition

31) Through risk-sharing activities, a financial intermediary ________ its own risk and ________ the risks of its customers. A) reduces; increases B) increases; reduces C) reduces; reduces D) increases; increases Answer: B Question Status: Previous Edition

32) The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A) noncollateralized risk B) free-riding C) asymmetric information D) costly state verification Answer: C Question Status: Previous Edition


33) When the lender and the borrower have different amounts of information regarding a transaction, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: A Question Status: Previous Edition

34) When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: B Question Status: Previous Edition

35) When the borrower engages in activities that make it less likely that the loan will be repaid, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: C Question Status: Previous Edition

36) The concept of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets. B) why indirect finance is more important than direct finance as a source of business finance. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B of the above. E) only A and C of the above. Answer: D Question Status: Previous Edition

37) Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) none of the above. Answer: A Question Status: Previous Edition


38) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the A) moral hazard problem. B) adverse selection problem. C) shirking problem. D) free-rider problem. E) principal-agent problem. Answer: B Question Status: Previous Edition

39) Successful financial intermediaries have higher earnings on their investments because they are better equipped than individuals to screen out good from bad risks, thereby reducing losses due to A) moral hazard. B) adverse selection. C) bad luck. D) financial panics. Answer: B Question Status: Previous Edition

40) In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called A) comparative informational disadvantage. B) asymmetric information. C) variant information. D) caveat venditor. Answer: B Question Status: Previous Edition

41) Which of the following financial intermediaries are depository institutions? A) A savings and loan association B) A commercial bank C) A credit union D) All of the above E) Only A and C of the above Answer: D Question Status: Previous Edition

42) Which of the following is a contractual savings institution? A) A life insurance company B) A credit union C) A savings and loan association D) A mutual fund Answer: A Question Status: Previous Edition


43) Which of the following are not investment intermediaries? A) A life insurance company B) A pension fund C) A mutual fund D) Only A and B of the above Answer: D Question Status: Previous Edition

44) Which of the following are investment intermediaries? A) Finance companies B) Mutual funds C) Pension funds D) All of the above E) Only A and B of the above Answer: E Question Status: Previous Edition

45) The government regulates financial markets for two main reasons: A) to ensure soundness of the financial system and to increase the information available to investors. B) to improve control of monetary policy and to increase the information available to investors. C) to ensure that financial intermediaries do not earn more than the normal rate of return and to improve control of monetary policy. D) to ensure soundness of financial intermediaries and to prevent financial intermediaries from earning less than the normal rate of return. Answer: A Question Status: Previous Edition

46) Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a A) bank holiday. B) financial panic. C) financial disintermediation. D) financial collapse. Answer: B Question Status: Previous Edition

47) Foreign currencies that are deposited in banks outside the home country are known as A) foreign bonds. B) Eurobond. C) Eurocurrencies. D) Eurodollars. Answer: C Question Status: Previous Edition


48) U.S. dollars deposited in foreign banks outside the United States or in foreign branches of U.S. are referred to as A) Eurodollars. B) Eurocurrencies. C) Eurobonds. D) foreign bonds. Answer: A Question Status: Previous Edition

49) Banks providing depositors with checking accounts that enable them to pay their bills easily is known as A) liquidity services. B) asset transformation. C) risk sharing. D) transaction costs. Answer: A Question Status: Previous Edition

50) A ________ is when one party in a financial contract has incentives to act in its own interest rather than in the interests of the other party. A) moral hazard B) risk C) conflict of interest D) financial panic Answer: C Question Status: Previous Edition

51) Fire and casualty insurance companies are what type of intermediary? A) Contractual savings institution B) Depository institutions C) Investment intermediaries D) None of the above Answer: A Question Status: Previous Edition

52) The country whose banks are the most restricted in the range of assets they may hold is A) Japan. B) Canada. C) Germany. D) the United States. Answer: D Question Status: Previous Edition

53) The largest depository institution (value of assets) at the end of 2009 was A) commercial banks. B) pension funds. C) credit unions. D) mutual funds. Answer: A Question Status: New Question


2.2 True/False

1) Every financial market allows loans to be made. Answer: FALSE Question Status: Previous Edition

2) An example of direct financing is if you were to lend money to your neighbor. Answer: TRUE Question Status: Previous Edition

3) The New York Stock Exchange is an example of a primary market. Answer: FALSE Question Status: Previous Edition

4) A bond denominated in euros and issued in a country that uses the euro as its currency is an example of a Eurobond. Answer: FALSE Question Status: Previous Edition

5) Most people's involvement with the financial system is through financial intermediaries rather than financial markets. Answer: TRUE Question Status: Previous Edition

6) A financial intermediary's risk-sharing activities are also referred to as asset transformation. Answer: TRUE Question Status: Previous Edition

7) The process of financial intermediation is also known as direct finance. Answer: FALSE Question Status: Previous Edition

8) A mutual fund is not a depository institution. Answer: TRUE Question Status: Previous Edition

9) A pension fund is not a contractual savings institution. Answer: FALSE Question Status: Previous Edition

10) Equity represents an ownership interest in a firm and entitles the holder to the residual cash flows. Answer: TRUE Question Status: Previous Edition

11) Adverse selection refers to those with high credit risks, being most aggressive in their search for funds. Answer: TRUE Question Status: Previous Edition


12) The capital market is a financial market in which only short-term debt instruments (generally those with an original maturity of less than one year) are traded. Answer: FALSE Question Status: Previous Edition

13) American investors pay attention to only the Dow Jones Industrial Average. Answer: FALSE Question Status: Previous Edition

14) The government agency that insures each depositor at a commercial bank, savings and loan association, or mutual savings bank up to a loss of $100,000 per account ($250,000 for individual retirement accounts) is the Securities and Exchange Commission (SEC). Answer: FALSE Question Status: Previous Edition

15) Many common stocks are traded over the counter, although a majority of the largest corporations have their shares traded at organized stock exchanges. Answer: TRUE Question Status: New Question

16) Many common stocks are traded at organized exchanges, although a majority of the largest corporations have their shares traded over the counter. Answer: FALSE Question Status: New Question

17) Corporations that issue new securities to raise capital now conduct more of this business in financial markets in Europe and Asia than in the U.S. Answer: TRUE Question Status: New Question

2.3 Essay

1) Distinguish between direct financing and indirect financing. Question Status: Previous Edition

2) Distinguish between primary markets and secondary markets. Question Status: Previous Edition

3) Distinguish between money markets and capital markets. Question Status: Previous Edition

4) Why is it so important for an economy to have fully developed financial markets? Question Status: Previous Edition

5) Why are financial intermediaries so important to an economy? Question Status: Previous Edition

6) Describe how over-the-counter markets work. Question Status: Previous Edition


7) What are adverse selection and moral hazard? Question Status: Previous Edition

8) Why can a financial intermediary's risk-sharing activities be described as asset transformation? Question Status: Previous Edition

9) Discuss the differences between depository institutions, contractual savings institutions, and investment intermediaries. Question Status: Previous Edition

10) What are some of the differences between an organized exchange and an over-the-counter market? Question Status: New Question


Financial Markets and Institutions, 7e (Mishkin) Chapter 3 What Do Interest Rates Mean and What Is Their Role in Valuation?

3.1 Multiple Choice

1) A loan that requires the borrower to make the same payment every period until the maturity date is called a A) simple loan. B) fixed-payment loan. C) discount loan. D) same-payment loan. E) none of the above. Answer: B Question Status: Previous Edition

2) A coupon bond pays the owner of the bond A) the same amount every month until the maturity date. B) a fixed interest payment every period, plus the face value of the bond at the maturity date. C) the face value of the bond plus an interest payment once the maturity date has been reached. D) the face value at the maturity date. E) none of the above. Answer: B Question Status: Previous Edition

3) A bond's future payments are called its A) cash flows. B) maturity values. C) discounted present values. D) yields to maturity. Answer: A Question Status: Previous Edition

4) A credit market instrument that pays the owner the face value of the security at the maturity date and nothing prior to then is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Answer: D Question Status: Previous Edition


5) (I) A simple loan requires the borrower to repay the principal at the maturity date along with an interest payment. (II) A discount bond is bought at a price below its face value, and the face value is repaid at the maturity date. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C Question Status: Previous Edition

6) Which of the following are true of coupon bonds? A) The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid. B) U.S. Treasury bonds and notes are examples of coupon bonds. C) Corporate bonds are examples of coupon bonds. D) All of the above. E) Only A and B of the above. Answer: D Question Status: Previous Edition

7) Which of the following are generally true of all bonds? A) The longer a bond's maturity, the lower is the rate of return that occurs as a result of the increase in the interest rate. B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise. C) Prices and returns for long-term bonds are more volatile than those for shorter-term bonds. D) All of the above are true. E) Only A and B of the above are true. Answer: D Question Status: Previous Edition

8) (I) A discount bond requires the borrower to repay the principal at the maturity date plus an interest payment. (II) A coupon bond pays the lender a fixed interest payment every year until the maturity date, when a specified final amount (face or par value) is repaid. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: B Question Status: Previous Edition


9) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is A) $650. B) $1,300. C) $130. D) $13. E) None of the above. Answer: A Question Status: Previous Edition

10) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of A) 5 percent. B) 8 percent. C) 10 percent. D) 40 percent. Answer: A Question Status: Previous Edition

11) The concept of ________ is based on the notion that a dollar paid to you in the future is less valuable to you than a dollar today. A) present value B) future value C) interest D) deflation Answer: A Question Status: Previous Edition

12) Dollars received in the future are worth ________ than dollars received today. The process of calculating what dollars received in the future are worth today is called ________. A) more; discounting B) less; discounting C) more; inflating D) less; inflating Answer: B Question Status: Previous Edition

13) The process of calculating what dollars received in the future are worth today is called A) calculating the yield to maturity. B) discounting the future. C) compounding the future. D) compounding the present. Answer: B Question Status: Previous Edition


14) With an interest rate of 5 percent, the present value of $100 received one year from now is approximately A) $100. B) $105. C) $95. D) $90. Answer: C Question Status: Previous Edition

15) With an interest rate of 10 percent, the present value of a security that pays $1,100 next year and $1,460 four years from now is approximately A) $1,000. B) $2,000. C) $2,560. D) $3,000. Answer: B Question Status: Previous Edition

16) With an interest rate of 8 percent, the present value of $100 received one year from now is approximately A) $93. B) $96. C) $100. D) $108. Answer: A Question Status: Previous Edition

17) With an interest rate of 6 percent, the present value of $100 received one year from now is approximately A) $106. B) $100. C) $94. D) $92. Answer: C Question Status: Previous Edition

18) The interest rate that equates the present value of the cash flow received from a debt instrument with its market price today is the A) simple interest rate. B) discount rate. C) yield to maturity. D) real interest rate. Answer: C Question Status: Previous Edition


19) The interest rate that financial economists consider to be the most accurate measure is the A) current yield. B) yield to maturity. C) yield on a discount basis. D) coupon rate. Answer: B Question Status: Previous Edition

20) Financial economists consider the ________ to be the most accurate measure of interest rates. A) simple interest rate B) discount rate C) yield to maturity D) real interest rate Answer: C Question Status: Previous Edition

21) For a simple loan, the simple interest rate equals the A) real interest rate. B) nominal interest rate. C) current yield. D) yield to maturity. Answer: D Question Status: Previous Edition

22) For simple loans, the simple interest rate is ________ the yield to maturity. A) greater than B) less than C) equal to D) not comparable to Answer: C Question Status: Previous Edition

23) The yield to maturity of a one-year, simple loan of $500 that requires an interest payment of $40 is A) 5 percent. B) 8 percent. C) 12 percent. D) 12.5 percent. Answer: B Question Status: Previous Edition

24) The yield to maturity of a one-year, simple loan of $400 that requires an interest payment of $50 is A) 5 percent. B) 8 percent. C) 12 percent. D) 12.5 percent. Answer: D Question Status: Previous Edition


25) A $10,000, 8 percent coupon bond that sells for $10,000 has a yield to maturity of A) 8 percent. B) 10 percent. C) 12 percent. D) 14 percent. Answer: A Question Status: Previous Edition

26) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 12 percent coupon bond selling for $1,000 D) A 12 percent coupon bond selling for $1,100 Answer: C Question Status: Previous Edition

27) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 15 percent coupon bond selling for $1,000 D) A 15 percent coupon bond selling for $900 Answer: D Question Status: Previous Edition

28) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are negatively related. C) The yield to maturity is greater than the coupon rate when the bond price is below the par value. D) All of the above are true. E) Only A and B of the above are true. Answer: D Question Status: Previous Edition

29) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are negatively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) All of the above are true. E) Only A and B of the above are true. Answer: E Question Status: Previous Edition

30) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are positively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) All of the above are true. E) Only A and B of the above are true. Answer: A Question Status: Previous Edition


31) A consol bond is a bond that A) pays interest annually and its face value at maturity. B) pays interest in perpetuity and never matures. C) pays no interest but pays its face value at maturity. D) rises in value as its yield to maturity rises. Answer: B Question Status: Previous Edition

32) The yield to maturity on a consol bond that pays $100 yearly and sells for $500 is A) 5 percent. B) 10 percent. C) 12.5 percent. D) 20 percent. E) 25 percent. Answer: D Question Status: Previous Edition

33) The yield to maturity on a consol bond that pays $200 yearly and sells for $1000 is A) 5 percent. B) 10 percent. C) 20 percent. D) 25 percent. Answer: C Question Status: Previous Edition

34) A frequently used approximation for the yield to maturity on a long-term bond is the A) coupon rate. B) current yield. C) cash flow interest rate. D) real interest rate. Answer: B Question Status: Previous Edition

35) The current yield on a coupon bond is the bond's ________ divided by its ________. A) annual coupon payment; price B) annual coupon payment; face value C) annual return; price D) annual return; face value Answer: A Question Status: Previous Edition

36) When a bond's price falls, its yield to maturity ________ and its current yield ________. A) falls; falls B) rises; rises C) falls; rises D) rises; falls Answer: B Question Status: Previous Edition


37) The yield to maturity for a one-year discount bond equals A) the increase in price over the year, divided by the initial price. B) the increase in price over the year, divided by the face value. C) the increase in price over the year, divided by the interest rate. D) none of the above. Answer: A Question Status: Previous Edition

38) If a $10,000 face value discount bond maturing in one year is selling for $8,000, then its yield to maturity is A) 10 percent. B) 20 percent. C) 25 percent. D) 40 percent. Answer: C Question Status: Previous Edition

39) If a $10,000 face value discount bond maturing in one year is selling for $9,000, then its yield to maturity is approximately A) 9 percent. B) 10 percent. C) 11 percent. D) 12 percent. Answer: C Question Status: Previous Edition

40) If a $10,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 5 percent. B) 10 percent. C) 50 percent. D) 100 percent. Answer: D Question Status: Previous Edition

41) If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 0 percent. B) 5 percent. C) 10 percent. D) 20 percent. Answer: A Question Status: Previous Edition


42) The Fisher equation states that A) the nominal interest rate equals the real interest rate plus the expected rate of inflation. B) the real interest rate equals the nominal interest rate less the expected rate of inflation. C) the nominal interest rate equals the real interest rate less the expected rate of inflation. D) both A and B of the above are true. E) both A and C of the above are true. Answer: D Question Status: Previous Edition

43) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) 7 percent. B) 22 percent. C) -15 percent. D) -8 percent. E) none of the above. Answer: D Question Status: Previous Edition

44) If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) -12 percent. B) -2 percent. C) 2 percent. D) 12 percent. Answer: C Question Status: Previous Edition

45) The nominal interest rate minus the expected rate of inflation A) defines the real interest rate. B) is a better measure of the incentives to borrow and lend than the nominal interest rate. C) is a more accurate indicator of the tightness of credit market conditions than the nominal interest rate. D) all of the above. E) only A and B of the above. Answer: D Question Status: Previous Edition

46) The nominal interest rate minus the expected rate of inflation A) defines the real interest rate. B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate. C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate. D) defines the discount rate. Answer: A Question Status: Previous Edition


47) In which of the following situations would you prefer to be making a loan? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent. Answer: B Question Status: Previous Edition

48) In which of the following situations would you prefer to be borrowing? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent. Answer: D Question Status: Previous Edition

49) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one year later? A) 5 percent B) 10 percent C) -5 percent D) 25 percent E) None of the above Answer: D Question Status: Previous Edition

50) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one year later? A) 5 percent B) 10 percent C) -5 percent D) -10 percent E) None of the above Answer: C Question Status: Previous Edition

51) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year later is A) 5 percent. B) 10 percent. C) 14 percent. D) 15 percent. Answer: D Question Status: Previous Edition


52) The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year later is A) -10 percent. B) -5 percent. C) 0 percent. D) 5 percent. Answer: C Question Status: Previous Edition

53) Which of the following are generally true of all bonds? A) The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period. B) A rise in interest rates is associated with a fall in bond prices, resulting in capital losses on bonds whose term to maturities are longer than the holding period. C) The longer a bond's maturity, the greater is the price change associated with a given interest rate change. D) All of the above are true. E) Only A and B of the above are true. Answer: D Question Status: Previous Edition

54) Which of the following are true concerning the distinction between interest rates and return? A) The rate of return on a bond will not necessarily equal the interest rate on that bond. B) The return can be expressed as the sum of the current yield and the rate of capital gains. C) The rate of return will be greater than the interest rate when the price of the bond falls between time t and time t + 1. D) All of the above are true. E) Only A and B of the above are true. Answer: E Question Status: Previous Edition

55) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding? A) A bond with one year to maturity B) A bond with five years to maturity C) A bond with ten years to maturity D) A bond with twenty years to maturity Answer: A Question Status: Previous Edition

56) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding? A) 5 percent B) 10 percent C) 15 percent D) 20 percent Answer: C Question Status: Previous Edition


57) (I) Prices of longer-maturity bonds respond more dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for short-term bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: A Question Status: Previous Edition

58) (I) Prices of longer-maturity bonds respond less dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for shorter-term bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: D Question Status: Previous Edition

59) The riskiness of an asset's return that results from interest rate changes is called A) interest-rate risk. B) coupon-rate risk. C) reinvestment risk. D) yield-to-maturity risk. Answer: A Question Status: Previous Edition

60) If an investor's holding period is longer than the term to maturity of a bond, he or she is exposed to A) interest-rate risk. B) reinvestment risk. C) bond-market risk. D) yield-to-maturity risk. Answer: B Question Status: Previous Edition

61) Reinvestment risk is the risk that A) a bond's value may fall in the future. B) a bond's future coupon payments may have to be invested at a rate lower than the bond's yield to maturity. C) an investor's holding period will be short and equal in length to the maturity of the bonds he or she holds. D) a bond's issuer may fail to make the future coupon payments and the investor will have no cash to reinvest. Answer: B Question Status: Previous Edition


62) (I) The average lifetime of a debt security's stream of payments is called duration. (II) The duration of a portfolio is the weighted average of the durations of the individual securities, with the weights reflecting the proportion of the portfolio invested in each. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C Question Status: Previous Edition

63) The duration of a ten-year, 10 percent coupon bond when the interest rate is 10 percent is 6.76 years. What happens to the price of the bond if the interest rate falls to 8 percent? A) It rises 20 percent. B) It rises 12.3 percent. C) It falls 20 percent. D) It falls 12.3 percent. Answer: B Question Status: Previous Edition

64) When the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment for the interest, it is called a ________. A) fixed-payment loan B) discount loan C) simple loan D) none of the above Answer: C Question Status: Previous Edition

65) A discount bond A) is also called a coupon bond. B) is also called a zero-coupon bond. C) is also called a fixed-payment bond. D) is also called a corporate bond. Answer: B Question Status: Previous Edition

66) The interest rate that is adjusted for actual changes in the price level is called the A) ex post real interest rate. B) expected interest rate. C) ex ante real interest rate. D) none of the above. Answer: A Question Status: Previous Edition


67) The change in the bond's price relative to the initial purchase price is A) the current yield. B) coupon payment. C) yield to maturity. D) rate of capital gain. Answer: D Question Status: Previous Edition

68) The return on a bond is equal to the yield to maturity when A) the holding period is longer than the maturity of the bond. B) the maturity of the bond is longer than the holding period. C) the holding period and the maturity of the bond are identical. D) none of the above. Answer: C Question Status: Previous Edition

69) Bonds whose term to maturity is shorter than the holding period are also subject to A) default. B) reinvestment risk. C) both of the above. D) none of the above. Answer: B Question Status: Previous Edition

70) A ________ is a type of loan that has the same cash flow payment every year throughout the life of the loan. A) discount loan B) simple loan C) fixed-payment loan D) interest-free loan Answer: C Question Status: Previous Edition

3.2 True/False

1) A bond's current market value is equal to the present value of the coupon payments plus the present value of the face amount. Answer: TRUE Question Status: Previous Edition

2) Discounting the future is the procedure used to find the future value of a dollar received today. Answer: FALSE Question Status: Previous Edition

3) The current yield is the best measure of an investor's return from holding a bond. Answer: FALSE Question Status: Previous Edition


4) Unless a bond defaults, an investor cannot lose money investing in bonds. Answer: FALSE Question Status: Previous Edition

5) The current yield is the yearly coupon payment divided by the current market price. Answer: TRUE Question Status: Previous Edition

6) Prices for long-term bonds are more volatile than for shorter-term bonds. Answer: TRUE Question Status: Previous Edition

7) A long-term bond's price is less affected by interest rate movements than a short-term bond's price. Answer: FALSE Question Status: Previous Edition

8) Increasing duration implies that interest-rate risk has increased. Answer: TRUE Question Status: Previous Edition

9) All else being equal, the greater the interest rate the greater the duration is. Answer: FALSE Question Status: Previous Edition

10) Interest-rate risk is the uncertainty that an investor faces because the interest rate at which a bond's future coupon payments can be invested is unknown. Answer: FALSE Question Status: Previous Edition

11) The real interest rate is equal to the nominal rate minus inflation. Answer: TRUE Question Status: Previous Edition

12) The current yield goes up as the price of a bond falls. Answer: TRUE Question Status: Previous Edition

13) Changes in interest rates make investments in long-term bonds risky. Answer: TRUE Question Status: Previous Edition

14) Bonds with a maturity that is longer than the holding period have no interest-rate risk. Answer: FALSE Question Status: Previous Edition


3.3 Essay

1) Distinguish between coupon rate, yield to maturity, and current yield. Question Status: Previous Edition

2) Describe the cash flows received from owning a coupon bond. Question Status: Previous Edition

3) What concept is used to value a bond? Question Status: Previous Edition

4) How is a bond's current yield calculated? Why is current yield a more accurate approximation of yield to maturity for a long-term bond than for a short-term bond? Question Status: Previous Edition

5) Why are long-term bonds more risky than short-term bonds? Question Status: Previous Edition

6) What is interest-rate risk and how is it measured? Question Status: Previous Edition

7) Why may a bond's rate of return differ from its yield to maturity? Question Status: Previous Edition

8) How does reinvestment risk differ from interest-rate risk? Question Status: Previous Edition

9) What is the distinction between the nominal interest rate and the real interest rate? Which is a better indicator of incentives to borrow and lend? Why? Question Status: Previous Edition

10) Describe how Treasury Inflation Protection Securities (TIPS) work and how they help policymakers estimate expected inflation. Question Status: Previous Edition

11) What is the purpose of discounting cash flows? Question Status: Previous Edition


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; rises B) falls; falls C) rises; rises D) rises; falls Answer: A Question Status: Previous Edition

2) The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases. A) falls; supply B) falls; quantity supplied C) rises; supply D) rises; quantity supplied Answer: D Question Status: Previous Edition

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; rise B) demand; fall C) supply; fall D) supply; rise Answer: C Question Status: Previous Edition

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; rise B) demand; fall C) supply; fall D) supply; rise Answer: A Question Status: Previous Edition

5) When the price of a bond is ________ the equilibrium price, there is an excess supply of bonds and the price will ________. A) above; rise B) above; fall C) below; fall D) below; rise Answer: B Question Status: Previous Edition


6) When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and the price will ________. A) above; rise B) above; fall C) below; fall D) below; rise Answer: D Question Status: Previous Edition

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; rise B) demand; fall C) supply; fall D) supply; rise Answer: B Question Status: Previous Edition

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; rise B) demand; fall C) supply; fall D) supply; rise Answer: D Question Status: Previous Edition

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; fall B) above; demand; rise C) below; supply; fall D) above; supply; rise Answer: A Question Status: Previous Edition

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; rise B) below; demand; fall C) below; supply; rise D) above; supply; fall Answer: C Question Status: Previous Edition


11) When the demand for bonds ________ or the supply of bonds ________, interest rates rise. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Answer: D Question Status: Previous Edition

12) When the demand for bonds ________ or the supply of bonds ________, interest rates fall. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Answer: B Question Status: Previous Edition

13) When the demand for bonds ________ or the supply of bonds ________, bond prices rise. A) increases; decreases B) decreases; increases C) decreases; decreases D) increases; increases Answer: A Question Status: Previous Edition

14) When the demand for bonds ________ or the supply of bonds ________, bond prices fall. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Answer: D Question Status: Previous Edition

15) Factors that determine the demand for an asset include changes in the A) 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 Question Status: Previous Edition

16) The demand for an asset rises if ________ falls. A) risk relative to other assets B) expected return relative to other assets C) liquidity relative to other assets D) wealth Answer: A Question Status: Previous Edition


17) The higher the standard deviation of returns on an asset, the ________ the asset's ________. A) greater; risk B) smaller; risk C) greater; expected return D) smaller; expected return Answer: A Question Status: Previous Edition

18) Diversification benefits an investor by A) increasing wealth. B) increasing expected return. C) reducing risk. D) increasing liquidity. Answer: C Question Status: Previous Edition

19) In a recession when income and wealth are falling, the demand for bonds ________ and the demand curve shifts to the ________. A) falls; right B) falls; left C) rises; right D) rises; left Answer: B Question Status: Previous Edition

20) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________. A) falls; right B) falls; left C) rises; right D) rises; left Answer: C Question Status: Previous Edition

21) Higher 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: C Question Status: Previous Edition


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 Question Status: Previous Edition

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; falls B) right; rises C) left; falls D) left; rises Answer: A Question Status: Previous Edition

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; rises B) right; falls C) left; falls D) left; rises Answer: D Question Status: Previous Edition

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; demand B) reduce; real; demand C) raise; financial; supply D) raise; real; supply Answer: B Question Status: Previous Edition

26) A decrease in the expected rate of inflation will ________ the expected return on bonds relative to that on ________ assets. A) reduce; financial B) reduce; real C) raise; financial D) raise; real Answer: D Question Status: Previous Edition


27) When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: D Question Status: Previous Edition

28) When the expected inflation rate decreases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: C Question Status: Previous Edition

29) When bond prices become more volatile, the demand for bonds ________ and the interest rate ________. A) increases; rises B) increases; falls C) decreases; falls D) decreases; rises Answer: D Question Status: Previous Edition

30) When bond prices become less volatile, the demand for bonds ________ and the interest rate ________. A) increases; rises B) increases; falls C) decreases; falls D) decreases; rises Answer: B Question Status: Previous Edition

31) When prices in the stock market become more uncertain, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: B Question Status: Previous Edition


32) When stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D Question Status: Previous Edition

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; rises B) right; falls C) left; falls D) left; rises Answer: B Question Status: Previous Edition

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; rises B) right; falls C) left; falls D) left; rises Answer: D Question Status: Previous Edition

35) Factors that cause the demand curve for bonds to shift to the left include A) 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 Question Status: Previous Edition

36) Factors that cause the demand curve for bonds to shift to the left include A) 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 Question Status: Previous Edition


37) During an economic expansion, the supply of bonds ________ and the supply curve shifts to the ________. A) increases, left B) increases, right C) decreases, left D) decreases, right Answer: B Question Status: Previous Edition

38) During a recession, the supply of bonds ________ and the supply curve shifts to the ________. A) increases, left B) increases, right C) decreases, left D) decreases, right Answer: C Question Status: Previous Edition

39) An increase in expected inflation causes the supply of bonds to ________ and the supply curve to shift to the ________. A) increase, left B) increase, right C) decrease, left D) decrease, right Answer: B Question Status: Previous Edition

40) When the federal government's budget deficit increases, the ________ curve for bonds shifts to the ________. A) demand; right B) demand; left C) supply; left D) supply; right Answer: D Question Status: Previous Edition

41) When the federal government's budget deficit decreases, the ________ curve for bonds shifts to the ________. A) demand; right B) demand; left C) supply; left D) supply; right Answer: C Question Status: Previous Edition


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; demand B) demand for; supply C) supply of; demand D) supply of; supply Answer: A Question Status: Previous Edition

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; demand B) demand for; supply C) supply of; demand D) supply of; supply Answer: D Question Status: Previous Edition

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 Question Status: Previous Edition

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 rate B) decrease; expected inflation rate C) increase; government budget deficit D) decrease; government budget deficit Answer: A Question Status: Previous Edition


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 Question Status: Previous Edition

47) Factors that can cause the supply curve for bonds to shift to the right include A) 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 Question Status: Previous Edition

48) Factors that can cause the supply curve for bonds to shift to the left include A) 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 Question Status: Previous Edition

49) The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates ________ as the expected rate of inflation ________. A) rise; increases B) rise; stabilizes C) rise; decreases D) fall; increases E) fall; stabilizes Answer: A Question Status: Previous Edition

50) An increase in the expected rate of inflation causes the demand for bonds to ________ and the supply for bonds to ________. A) fall; fall B) fall; rise C) rise; fall D) rise; rise Answer: B Question Status: Previous Edition


51) A decrease in the expected rate of inflation causes the demand for bonds to ________ and the supply of bonds to ________. A) fall; fall B) fall; rise C) rise; fall D) rise; rise Answer: C Question Status: Previous Edition

52) When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: B Question Status: Previous Edition

53) When the economy enters into a boom, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; rises D) decreases; increases; rises Answer: A Question Status: Previous Edition


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 rate B) decrease; the expected inflation rate C) increase; economic growth D) decrease; economic growth Answer: C Question Status: Previous Edition

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 Question Status: Previous Edition

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 Question Status: Previous Edition

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 Question Status: Previous Edition


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; fall B) rise; rise C) fall; fall D) fall; rise Answer: A Question Status: Previous Edition

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 Question Status: Previous Edition

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 Question Status: Previous Edition

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 Question Status: Previous Edition

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 Question Status: Previous Edition


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 Question Status: Previous Edition

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 Question Status: Previous Edition

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 Question Status: Previous Edition

66) Holding everything else constant, an increase in the money supply causes A) 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 Question Status: Previous Edition

67) Holding everything else constant, a decrease in the money supply causes A) 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 Question Status: Previous Edition


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 Question Status: Previous Edition

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 Question Status: Previous Edition

70) In Figure 4.3, an increase in the interest rate from i 2 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 Question Status: Previous Edition


71) If the liquidity effect is smaller than the other effects, and the adjustment of expected inflation is slow, then the A) 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 Question Status: Previous Edition

72) When the growth rate of the money supply increases, interest rates end up being permanently lower if A) 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 Question Status: Previous Edition

73) When the growth rate of the money supply decreases, interest rates end up being permanently lower if A) 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 Question Status: Previous Edition

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; rapid B) larger; slow C) smaller; slow D) smaller; rapid Answer: B Question Status: Previous Edition

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; rapid B) larger; slow C) smaller; slow D) smaller; rapid Answer: D Question Status: Previous Edition


76) If the Fed wants to permanently lower interest rates, then it should lower the rate of money growth if A) 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 Question Status: Previous Edition

77) If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth if A) 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 Question Status: Previous Edition

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; liquidity B) fall; risk C) rise; liquidity D) rise; risk Answer: C Question Status: Previous Edition

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; quickly B) larger; quickly C) larger; slowly D) smaller; slowly Answer: C Question Status: Previous Edition


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 Question Status: Previous Edition

81) ________ is the total resources owned by an individual, including all assets. A) Expected return B) Wealth C) Liquidity D) Risk Answer: B Question Status: Previous Edition

82) A ________ prefers stock in a less risky asset than in a riskier asset. A) risk preferrer B) risk-averse person C) risk lover D) risk-favorable person Answer: B Question Status: Previous Edition

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 Question Status: Previous Edition

84) Determining asset prices using stocks of assets rather than flow is called A) asset transformation. B) expected return. C) asset market approach. D) market equilibrium. Answer: C Question Status: Previous Edition


85) What is the model whose equations are estimated using statistical procedures used in forecasting interest rates called? A) econometric model B) liquidity preference framework C) market equilibrium D) Fisher effect Answer: A Question Status: Previous Edition

4.2 True/False

1) When interest rates decrease, the demand curve for bonds shifts to the left. Answer: FALSE Question Status: Previous Edition

2) When an economy grows out of a recession, normally the demand for bonds increases and the supply of bonds increases. Answer: TRUE Question Status: Previous Edition

3) When the federal government's budget deficit decreases, the demand curve for bonds shifts to the right. Answer: FALSE Question Status: Previous Edition

4) Investors make their choices of which assets to hold by

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