unit 10/13

Question 1

1) Depositors lack of information about the quality of bank assets can lead to
A) bank panics.
B) bank booms.
C) sequencing.
D) asset transformation.

Answer 1

A) bank panics.

Question 2

4) Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the
A) too-big-to-fail effect.
B) moral hazard problem.
C) adverse selection problem. D) contagion effect.

Answer 2

D) contagion effect.

Question 3

7) To prevent bank runs and the consequent bank failures, the United States established the ________ in 1934 to provide deposit insurance.
A) FDIC
B) SEC
C) Federal Reserve
D) ATM

Answer 3

A) FDIC

Question 4

8) The primary difference between the “payoff” and the “purchase and assumption” methods of handling failed banks is
A) that the FDIC guarantees all deposits when it uses the “payoff” method.
B) that the FDIC guarantees all deposits when it uses the “purchase and assumption” method.
C) that the FDIC is more likely to use the “payoff” method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures.
D) that the FDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions.

Answer 4

B) that the FDIC guarantees all deposits when it uses the “purchase and assumption” method.

Question 5

9) Deposit insurance has not worked well in countries with
A) a weak institutional environment.
B) strong supervision and regulation.
C) a tradition of the rule of law.
D) few opportunities for corruption.

Answer 5

A) a weak institutional environment.

Question 6

10) When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of
A) moral hazard.
B) split incentives.
C) ex ante shirking.
D) pre-contractual opportunism.

Answer 6

A) moral hazard.

Question 7

11) Moral hazard is an important concern of insurance arrangements because the existence of insurance
A) provides increased incentives for risk taking.
B) is a hindrance to efficient risk taking.
C) causes the private cost of the insured activity to increase.
D) creates an adverse selection problem but no moral hazard problem

Answer 7

A) provides increased incentives for risk taking.

Question 8

12) When bad drivers line up to purchase collision insurance, automobile insurers are subject to the
A) moral hazard problem.
B) adverse selection problem.
C) assigned risk problem.
D) ill queue problem.

Answer 8

B) adverse selection problem.

Question 9

13) Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions EXCEPT
A) forgiving tax debt.
B) lending from the central bank.
C) lending directly from the government’s treasury department.
D) nationalizing and guaranteeing that all creditors will be repaid their loans in full.

Answer 9

A) forgiving tax debt.

Question 10

14) Although the FDIC was created to prevent bank failures, its existence encourages banks to
A) take too much risk.
B) hold too much capital.
C) open too many branches.
D) buy too much stock.

Answer 10

A) take too much risk.

Question 11

16) The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry.
A) an adverse selection
B) a moral hazard
C) a lemons
D) a revenue

Answer 11

A) an adverse selection

Question 12

20) In May 1991, the FDIC announced that it would sell the government’s final 26% stake in Continental Illinois, ending government ownership of the bank that it had rescued in 1984. The FDIC took control of the bank, rather than liquidate it, because it believed that Continental Illinois
A) was a good investment opportunity for the government.
B) could be the Chicago branch of a new governmentally-owned interstate banking system. C) was too big to fail.
D) would become the center of the new midwest region central bank system.

Answer 12

D) would become the center of the new midwest region central bank system.

Question 13

25) The too-big-to-fail policy
A) reduces moral hazard problems.
B) puts large banks at a competitive disadvantage in attracting large deposits.
C) treats large depositors of small banks inequitably when compared to depositors of large banks.
D) allows small banks to take on more risk than large banks.

Answer 13

C) treats large depositors of small banks inequitably when compared to depositors of large banks

Question 14

) A bank failure is less likely to occur when
A) a bank holds less U.S. government securities. B) a bank suffers large deposit outflows.
C) a bank holds fewer excess reserves.
D) a bank has more bank capital.

Answer 14

D) a bank has more bank capital.

Question 15

8) The Basel Accord, an international agreement, requires banks to hold capital based on
A) risk-weighted assets.
B) the total value of assets.
C) liabilities.
D) deposits.

Answer 15

A) risk-weighted assets.

Question 16

19) The federal agencies that examine banks include A) the Federal Reserve System.
B) the Internal Revenue Service.
C) the SEC.
D) the U.S. Treasury

Answer 16

B) the Internal Revenue Service.

Question 17

27) An important factor in producing the global financial crisis was
A) lax consumer protection regulation.
B) onerous rules placed on mortgage originators.
C) weak incentives for mortgage brokers to use complicated mortgage products.
D) strong incentives for the mortgage brokers to verify income information.

Answer 17

A) lax consumer protection regulation.

Question 18

28) Competition between banks
A) encourages greater risk taking.
B) encourages conservative bank management. C) increases bank profitability.
D) eliminates the need for government regulation.

Answer 18

A) encourages greater risk taking.

Question 19

29) Regulations that reduced competition between banks included
A) branching restrictions.
B) bank reserve requirements.
C) the dual system of granting bank charters.
D) interest-rate ceilings.

Answer 19

A) branching restrictions.

Question 20

1) The evidence from banking crises in other countries indicates that
A) deposit insurance is to blame in each country.
B) a government safety net for depositors need not increase moral hazard.
C) regulatory forbearance never leads to problems.
D) deregulation combined with poor regulatory supervision raises moral hazard incentives.

Answer 20

D) deregulation combined with poor regulatory supervision raises moral hazard incentives.

Question 21

As in the United States, an important factor in the banking crises in Latin America was the
A) financial liberalization that occurred in the 1980s.
B) decline in real interest rates that occurred in the 1980s.
C) high inflation that occurred in the 1980s.
D) sluggish economic growth that occurred in the 1980s.

Answer 21

A) financial liberalization that occurred in the 1980s.

Question 22

9) China is trying to move its banking system from being strictly ________ owned by having them issue shares overseas.
A) state
B) domestic investor
C) depositor
D) domestic corporate

Answer 22

A) state

Question 23

1) The government agency that oversees the banking system and is responsible for the conduct of monetary policy in the United States is
A) the Federal Reserve System.
B) the United States Treasury.
C) the U.S. Gold Commission.
D) the House of Representatives.

Answer 23

A) the Federal Reserve System

Question 24

2) Individuals that lend funds to a bank by opening a checking account are called
A) policyholders.
B) partners.
C) depositors.
D) debt holders.

Answer 24

C) depositors.

Question 25

3) The three players in the money supply process include A) banks, depositors, and the U.S. Treasury. B) banks, depositors, and borrowers. C) banks, depositors, and the central bank. D) banks, borrowers, and the central bank.

Answer 25

C) banks, depositors, and the central bank.

Question 26

4) Of the three players in the money supply process, most observers agree that the most important player is A) the United States Treasury. B) the Federal Reserve System. C) the FDIC. D) the Office of Thrift

Answer 26

B) the Federal Reserve System.

Question 27

1) Both ________ and ________ are Federal Reserve assets. A) currency in circulation; reserves B) currency in circulation; securities C) securities; loans to financial institutions D) securities; reserves

Answer 27

C) securities; loans to financial institutions

Question 29

2) The monetary liabilities of the Federal Reserve include A) securities and loans to financial institutions. B) currency in circulation and reserves. C) securities and reserves. D) currency in circulation and loans to financial institutions.

Answer 29

B) currency in circulation and reserves

Question 30

4) The sum of the Fed's monetary liabilities and the U.S. Treasury's monetary liabilities is called A) the money supply. B) currency in circulation. C) bank reserves. D) the monetary base.

Answer 30

D) the monetary base.

Question 31

5) The monetary base consists of A) currency in circulation and Federal Reserve notes. B) currency in circulation and the U.S. Treasury's monetary liabilities. C) currency in circulation and reserves. D) reserves and Federal Reserve Notes.

Answer 31

C) currency in circulation and reserves.

Question 32

6) Total reserves minus bank deposits with the Fed equals A) vault cash. B) excess reserves. C) required reserves. D) currency in circulation.

Answer 32

A) vault cash.

Question 33

7) Reserves are equal to the sum of A) required reserves and excess reserves. B) required reserves and vault cash reserves. C) excess reserves and vault cash reserves. D) vault cash reserves and total reserves.

Answer 33

A) required reserves and excess reserves.

Question 34

1) The monetary base minus currency in circulation equals A) reserves. B) the borrowed base. C) the nonborrowed base. D) discount loans.

Answer 34

A) reserves.

Question 35

2) The monetary base minus reserves equals A) currency in circulation. B) the borrowed base. C) the nonborrowed base. D) discount loans.

Answer 35

A) currency in circulation.

Question 36

3) High-powered money minus reserves equals A) reserves. B) currency in circulation. C) the monetary base. D) the nonborrowed base.

Answer 36

B) currency in circulation.

Question 37

5) Purchases and sales of government securities by the Federal Reserve are called A) discount loans. B) federal fund transfers. C) open market operations. D) swap transactions

Answer 37

C) open market operations.

Question 38

6) When the Federal Reserve purchases a government bond from a primary dealer, reserves in the banking system ________ and the monetary base ________, everything else held constant. A) increase; increases B) increase; decreases C) decrease; increases D) decrease; decreases

Answer 38

A) increase; increases

Question 39

7) When the Federal Reserve sells a government bond to a primary dealer, reserves in the banking system ________ and the monetary base ________, everything else held constant. A) increase; increases B) increase; decreases C) decrease; increases D) decrease; decreases

Answer 39

D) decrease; decreases

Question 40

10) When the Fed buys $100 worth of bonds from a primary dealer, reserves in the banking system A) increase by $100. B) increase by more than $100. C) decrease by $100. D) decrease by more than $100.

Answer 40

A) increase by $100.

Question 41

14) When the Federal Reserve extends a discount loan to a bank, the monetary base ________ and reserves ________. A) remains unchanged; decrease B) remains unchanged; increase C) increases; increase D) increases; remain unchanged

Answer 41

C) increases; increase

Question 42

17) There are two ways in which the Fed can provide additional reserves to the banking system: it can ________ government bonds or it can ________ discount loans to commercial banks. A) sell; extend B) sell; call in C) purchase; extend D) purchase; call in

Answer 42

C) purchase; extend

Question 43

21) Suppose a person cashes his payroll check and holds all the funds in the form of currency. Everything else held constant, total reserves in the banking system ________ and the monetary base ________. A) remain unchanged; increases B) decrease; increases C) decrease; remains unchanged D) decrease; decreases

Answer 43

C) decrease; remains unchanged

Question 44

22) Suppose your payroll check is directly deposited to your checking account. Everything else held constant, total reserves in the banking system ________ and the monetary base ________. A) remain unchanged; remains unchanged B) remain unchanged; increases C) decrease; increases D) decrease; decreases

Answer 44

A) remain unchanged; remains unchanged

Question 45

23) The Fed does not tightly control the monetary base because it does NOT completely control A) open market purchases. B) open market sales. C) borrowed reserves. D) the discount rate.

Answer 45

C) borrowed reserves.

Question 46

25) The relationship between borrowed reserves (BR), the nonborrowed monetary base (MBn), and the monetary base (MB) is A) MB = MBn - BR. B) BR = MBn - MB. C) BR = MB - MBn. D) MB = BR - MBn.

Answer 46

C) BR = MB - MBn.

Question 47

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

Answer 47

Open market purchase, extending discount loans

Question 48

2) When the Fed supplies the banking system with an extra dollar of reserves, deposits ________ by ________ than one dollar—a process called multiple deposit creation. A) increase; less B) increase; more C) decrease; less D) decrease; more

Answer 48

B) increase; more

Question 49

4) In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a bank that previously had no excess reserves, the bank can now increase its loans by A) $10. B) $100. C) $100 times the reciprocal of the required reserve ratio. D) $100 times the required reserve ratio.

Answer 49

B) $100.

Question 50

4) Everything else held constant, when the federal funds rate is ________ the interest rate paid on excess reserves, the quantity of reserves demanded rises when the federal funds rate ________. A) above; rises B) above; falls C) below; rises D) below; falls

Answer 50

B) above; falls

Question 51

6) In the market for reserves, when the federal funds rate is above the interest rate paid on excess reserves, the demand curve for reserves is A) vertical. B) horizontal. C) positively sloped. D) negatively sloped.

Answer 51

D) negatively sloped.

Question 52

7) When the federal funds rate equals the interest rate paid on excess reserves A) the supply curve of reserves is vertical. B) the supply curve of reserves is horizontal. C) the demand curve for reserves is vertical. D) the demand curve for reserves is horizontal.

Answer 52

D) the demand curve for reserves is horizontal.

Question 53

8) The quantity of reserves supplied equals A) nonborrowed reserves minus borrowed reserves. B) nonborrowed reserves plus borrowed reserves. C) required reserves plus borrowed reserves. D) total reserves minus required reserves.

Answer 53

B) nonborrowed reserves plus borrowed reserves.

Question 54

9) In the market for reserves, when the federal funds interest rate is below the discount rate, the supply curve of reserves is A) vertical. B) horizontal. C) positively sloped. D) negatively sloped.

Answer 54

A) vertical.

Question 55

13) In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, an open market purchase ________ the supply of reserves and causes the federal funds interest rate to ________, everything else held constant. A) decreases; fall B) increases; fall C) increases; rise D) decreases; rise

Answer 55

B) increases; fall

Question 56

2) Open market purchases raise the ________ thereby raising the ________. A) money multiplier; money supply B) money multiplier; monetary base C) monetary base; money supply D) monetary base; money multiplier

Answer 56

C) monetary base; money supply

Question 57

5) Open market sales ________ reserves and the monetary base thereby ________ the money supply. A) raise; lowering B) raise; raising C) lower; lowering D) lower; raising

Answer 57

C) lower; lowering

Question 58

4) Which of the following monetary policy tools is more effective when the economy faces the interest rate effective-lower-bound problem? A) open market operation B) discount policy C) required reserve ratio D) the Fed's liquidity provision

Answer 58

D) the Fed's liquidity provision

Question 59

5) The purpose of the commitment by the Fed to keep the federal funds rate at zero for a long period of time is to A) lower the long term interest rates. B) lower the short term interest rates. C) increase the long term interest rates. D) increase the short term interest rates.

Answer 59

A) lower the long term interest rates.