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Review 6 May 2016, questions and answers

Applied Economics (King's College London)

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Money and Banking (6SSMN962),

School of Management and Business
King’s College London
Autumn 2016

Multiple Choice Questions for Practice (Lectures 5-8)

An answer key is posted and it will be visible on Friday December 2.
You are strongly advised to first attempt the MCQs without consulting the answer
key.

1) Which of the following statements are TRUE?

A) A bank's assets are its sources of funds.
B) A bank's liabilities are its uses of funds.
C) A bank's balance sheet shows that total assets equal total liabilities plus equity
capital.
D) A bank's balance sheet indicates whether or not the bank is profitable.
Answer: C

2) Which of the following statements is FALSE?

A) A bank's assets are its uses of funds.
B) A bank issues liabilities to acquire funds.
C) The bank's assets provide the bank with income.
D) Bank capital is recorded as an asset on the bank balance sheet.
Answer: D

3) Which of the following are reported as liabilities on a bank's balance sheet?

A) reserves
B) checkable deposits
C) consumer loans
D) deposits with other banks
Answer: B

4) Bank ________ is/are listed on the liability side of the bank's balance sheet.
A) reserves
B) capital
C) securities
D) cash items
Answer: B

5) Because of their ________ liquidity, ________ U.S. government securities are

called secondary reserves.
A) low; short-term
B) low; long-term
C) high; short-term
D) high; long-term
Answer: C

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6) The most important category of assets on a bank's balance sheet is

A) other assets.
B) securities.
C) loans.
D) cash items in the process of collection.
Answer: C

7) Asset transformation can be described as

A) borrowing long and lending short.
B) borrowing short and lending long.
C) borrowing and lending only for the short term.
D) borrowing and lending for the long term.
Answer: B

8) Which of the following are primary concerns of the bank manager?

A) maintaining sufficient reserves to minimize the cost to the bank of deposit
outflows
B) extending loans to borrowers who will pay low interest rates, but who are poor
credit risks
C) acquiring funds at a relatively high cost, so that profitable lending opportunities
can be realized
D) maintaining high levels of capital and thus maximizing the returns to the owners
Answer: A

9) The goals of bank asset management include

A) maximizing risk.
B) minimizing liquidity.
C) lending at high interest rates regardless of risk.
D) purchasing securities with high returns and low risk.
Answer: D

10) A bank failure occurs whenever

A) a bank cannot satisfy its obligations to pay its depositors and other creditors.
B) a bank suffers a large deposit outflow.
C) a bank has to call in a large volume of loans.
D) a bank refuses to make new loans.
Answer: A

11) A bank is insolvent when

A) its liabilities exceed its assets.
B) its assets exceed its liabilities.
C) its capital exceeds its liabilities.
D) its assets increase in value.
Answer: A

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12) Bank capital has both benefits and costs for the bank owners. Higher bank capital
________ the likelihood of bankruptcy, but higher bank capital ________ the return
on equity for a given return on assets.
A) reduces; reduces
B) increases; increases
C) reduces; increases
D) increases; reduces
Answer: A

13) In the absence of regulation, banks would probably hold

A) too much capital, reducing the efficiency of the payments system.
B) too much capital, reducing the profitability of banks.
C) too little capital.
D) too much capital, making it more difficult to obtain loans.
Answer: C

14) Banks face the problem of ________ in loan markets because bad credit risks are
the ones most likely to seek bank loans.
A) adverse selection
B) moral hazard
C) moral suasion
D) intentional fraud
Answer: A

15) In one sense ________ appears surprising since it means that the bank is not
________ its portfolio of loans and thus is exposing itself to more risk.
A) specialization in lending; diversifying
B) specialization in lending; rationing
C) credit rationing; diversifying
D) screening; rationing
Answer: A

16) Risk that is related to the uncertainty about interest rate movements is called
A) default risk.
B) interest-rate risk.
C) the problem of moral hazard.
D) security risk.
Answer: B

17) The difference of rate-sensitive liabilities and rate-sensitive assets is known as

the
A) duration.
B) interest-sensitivity index.
C) rate-risk index.
D) gap.
Answer: D

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18) American businesses get their external funds primarily from

A) bank loans.
B) bonds and commercial paper issues.
C) stock issues.
D) loans from nonbank financial intermediaries.
Answer: D

19) Of the following sources of external finance for American nonfinancial

businesses, the least important is
A) loans from banks.
B) stocks.
C) bonds and commercial paper.
D) loans from other financial intermediaries.
Answer: B

20) Which of the following statements concerning external sources of financing for
nonfinancial businesses in the United States are TRUE?
A) Stocks are a far more important source of finance than are bonds.
B) Stocks and bonds, combined, supply less than one-half of the external funds.
C) Financial intermediaries are the least important source of external funds for
businesses.
D) Since 1970, more than half of the new issues of stock have been sold to American
households.
Answer: B

21) Which of the following statements concerning external sources of financing for
nonfinancial businesses in the United States are TRUE?
A) Issuing marketable securities is the primary way that they finance their activities.
B) Bonds are the least important source of external funds to finance their activities.
C) Stocks are a relatively unimportant source of finance for their activities.
D) Selling bonds directly to the American household is a major source of funding for
American businesses.
Answer: C

22) Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds
A) by issuing stock.
B) by issuing bonds.
C) from nonbank loans.
D) from bank loans.
Answer: D

23) Collateralized debt is also known as

A) unsecured debt.
B) secured debt.
C) unrestricted debt.
D) promissory debt.
Answer: B

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24) If you default on your auto loan, your car will be repossessed because it has been
pledged as ________ for the loan.
A) interest
B) collateral
C) dividend
D) commodity
Answer: B

25) A ________ is a provision that restricts or specifies certain activities that a

borrower can engage in.
A) residual claimant
B) risk hedge
C) restrictive barrier
D) restrictive covenant
Answer: D

26) The reduction in transactions costs per dollar of investment as the size of
transactions increases is
A) discounting.
B) economies of scale.
C) economies of trade.
D) diversification.
Answer: B

27) 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

28) The problem faced by the lender that the borrower may take on additional risk
after receiving the loan is called
A) adverse selection.
B) moral hazard.
C) transactions costs.
D) diversification.
Answer: B

29) The "lemons problem" exists because of

A) transactions costs.
B) economies of scale.
C) rational expectations.
D) asymmetric information.
Answer: D

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30) Managers (________) may act in their own interest rather than in the interest of
the stockholder-owners (________) because the managers have less incentive to
maximize profits than the stockholder-owners do.
A) principals; agents
B) principals; principals
C) agents; agents
D) agents; principals
Answer: D

31) The principal-agent problem would not occur if ________ of a firm had complete
information about actions of the ________.
A) owners; customers
B) owners; managers
C) managers; customers
D) managers; owners
Answer: B

32) Economic theory suggests that ________ interest rates are ________ important
than ________ interest rates in explaining investment behavior.
A) nominal; more; real
B) real; less; nominal
C) real; more; nominal
D) market; more; real
Answer: C

33) The monetary transmission mechanism that links monetary policy to GDP
through real interest rates and investment spending is called the
A) traditional interest-rate channel.
B) Tobins' q theory.
C) wealth effects.
D) cash flow channel.
Answer: A

34) An expansionary monetary policy lowers the real interest rate, causing the
domestic currency to ________, thereby ________ net exports.
A) appreciate; raising
B) appreciate; lowering
C) depreciate; raising
D) depreciate; lowering
Answer: C

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35) Tobin's q is defined as the market value of firms ________ the replacement cost
of capital.
A) times
B) minus
C) plus
D) divided by
Answer: D

36) A major disruption in financial markets characterized by sharp declines in asset

prices and firm failures is called a
A) financial crisis.
B) fiscal imbalance.
C) free-rider problem.
D) "lemons" problem.
Answer: A

37) A serious consequence of a financial crisis is

A) a contraction in economic activity.
B) an increase in asset prices.
C) financial engineering.
D) financial globalization.
Answer: A

38) When financial institutions go on a lending spree and expand their lending at a
rapid pace they are participating in a
A) credit boom.
B) credit bust.
C) deleveraging.
D) market race.
Answer: A

39) When the value of loans begins to drop, the net worth of financial institutions
falls causing them to cut back on lending in a process called
A) deleveraging.
B) releveraging.
C) capitulation.
D) deflation.
Answer: A

40) The most common definition that monetary policymakers use for price stability is
A) low and stable deflation.
B) an inflation rate of zero percent.
C) high and stable inflation.
D) low and stable inflation.
Answer: D

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41) Which set of goals can, at times, conflict in the short run?
A) high employment and economic growth
B) interest rate stability and financial market stability
C) high employment and price level stability
D) exchange rate stability and financial market stability
Answer: C

42) The primary goal of the European Central Bank is

A) price stability.
B) exchange rate stability.
C) interest rate stability.
D) high employment.
Answer: A

43) The mandate for the monetary policy goals that has been given to the European
Central Bank is an example of a ________ mandate.
A) primary
B) dual
C) secondary
D) hierarchical
Answer: D

44) The mandate for the monetary policy goals that has been given to the Federal
Reserve System is an example of a ________ mandate.
A) primary
B) dual
C) secondary
D) hierarchical
Answer: B

45) The type of monetary policy that is used in Canada, New Zealand, and the United
Kingdom is
A) monetary targeting.
B) inflation targeting.
C) targeting with an implicit nominal anchor.
D) interest-rate targeting.
Answer: B

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