Chapter 27 Money and Banking

Ch27 Money and Banking Multiple Choice Questions 1. In macroeconomics, ___________________________ describes a situation in which two people each want to exchange some good or service that the other can provide. A. a medium of exchange B. a double coincidence of wants C. interrelated banking D. the usefulness of money Answer: B Reference: Explanation: Type: Multiple Choice 2. Which of the following is omitted in a barter transaction? A. trade B. medium of exchange C. store of value D. money Answer: D Reference: Explanation: Type: Multiple Choice 3. If Bill performs plumbing upgrades for Alice in exchange for her incorporating his business, then their _________________________ will be satisfied. A. balance of trade B. double coincidence of wants C. convenience of exchange D. division of labor Answer: B Reference: Explanation: Type: Multiple Choice 4. ____________ is a completely inadequate mechanism ____________________ in a modern advanced economy. A. Currency; for providing a medium of exchange B. Money; for providing a store of value C. Barter; for trying to coordinate trades D. Money; to use as a unit of account Answer: C Reference: Explanation: Type: Multiple Choice 5. In macroeconomics, a _______________ describes the common way in which market values are measured in an economy. A. unit of account B. medium of exchange C. store of value D. unit of exchange Answer: A Reference: Explanation: Type: Multiple Choice 6. In uncertain economic times, ____________________ serves as a way of preserving economic value that can be spent or consumed in the future. A. buying a new car B. owning gold C. refinancing your home mortgage D. obtaining a credit card Answer: B Reference: Explanation: Type: Multiple Choice 7. In modern economies, credit cards are a _________________ because of their wide acceptance as a method of payment for both goods and services. A. unit of exchange B. store of value C. unit of account D. medium of exchange Answer: D Reference: Explanation: Type: Multiple Choice 8. ________________ serves society in three functions: medium of exchange, unit of account, and store of value. A. Money B. Currency C. Barter D. A double coincidence of wants Answer: A Reference: Explanation: Type: Multiple Choice 9. Lance paid $175,000 for his house in 2003 and sold it for $325,000 in 2006. What function did the house serve during the time Lance owned it? A. medium of exchange B. unit of account C. store of value D. unit of exchange Answer: C Reference: Explanation: Type: Multiple Choice Category: Analyze 10. In 2010, Tara used $50,000.00 from funds she had invested in certificates of deposit as a down payment to buy a house. What function did this portion of her investments serve when she made the down payment? A. unit of exchange. B. medium of exchange. C. store of value. D. unit of account. Answer: B Reference: Explanation: Type: Multiple Choice Category: Analyze 11. Which of the following would function as a store of value, and also provide a medium of exchange, and unit of account? A. a new car B. an iPod C. an estate D. gym membership Answer: C Reference: Explanation: Type: Multiple Choice Category: Analyze 12. If mollusk shells were accepted as a method of payment in modern-day markets, what economic role would they play in the financial system? A. capital exchange B. currency exchange C. unit of exchange D. medium of exchange Answer: D Reference: Explanation: Type: Multiple Choice 13. Which of the following is a valid criticism of the use of money as a store of value in modern economies? A. annual inflationary loss of buying power B. money supply is too narrowly defined C. storing money is wasteful D. imperfect as a unit of account Answer: A Reference: Explanation: Type: Multiple Choice Category: Evaluate 14. Which of the following would be classified in the M1 category of the money supply? A. savings deposits B. money market deposit C. demand deposits D. certificates of deposit Answer: C Reference: Explanation: Type: Multiple Choice 15. With respect to measuring the money supply, which of the following terms describes a checking account? A. demand certificates B. currency deposits C. cash certificates D. demand deposits Answer: D Reference: Explanation: Type: Multiple Choice 16. _________________________ are included in the aggregate amount of MI money currently in circulation. A. Savings deposits B. Traveler's checks C. Short-term bonds D. Foreign currency deposits Answer: B Reference: Explanation: Type: Multiple Choice 17. Which category of the money supply would you be contributing to if you invest in money market funds? A. M2 B. M1 C. time deposits D. savings deposits Answer: A Reference: Explanation: Type: Multiple Choice Category: Analyze 18. Which of the following terms is considered to be a narrow definition of the money supply that includes, among other things, currency? A. savings B. money C. M2 D. M1 Answer: D Reference: Explanation: Type: Multiple Choice 19. Antonio tries to limit his risk of overexposure to debt by using a ________________ to store a certain amount of value that he then uses to make purchases. A. debit card B. credit card C. smart card D. chip card Answer: C Reference: Explanation: Type: Multiple Choice 20. If Brent uses his credit card to purchase a new television, then the money to pay the retailer is taken from: A. his M1 funds. B. his M2 funds. C. the credit card company's M1 funds. D. the credit card company's M2 funds. Answer: C Reference: Explanation: Type: Multiple Choice 21. If Evelyn uses her debit card to buy an iPod, then the money to pay the retailer will come from: A. the debit card company's M1 funds. B. the debit card company's M2 funds. C. her M2 funds. D. her M1 funds. Answer: D Reference: Explanation: Type: Multiple Choice 22. If Sarah uses her smart card to purchase movies over the internet, then the money to pay the retailer will come from: A. Sarah's M1 funds. B. the smart card company's M1 funds. C. the smart card company's M2 funds. D. Sarah's M2 funds. Answer: A Reference: Explanation: Type: Multiple Choice 23. Stealth bank has deposits of $600 million. It holds reserves of $30 million and government bonds worth $80 million. If the bank sells its loans at market value of $400 million, what will its total assets equal? A. $110 million B. $710 million C. $480 million D. $510 million Answer: D Reference: Explanation: Type: Multiple Choice 24. Stealth bank holds deposits of $600 million. It holds reserves of $30 million and government bonds worth $80 million. The current market value of the bank's loans is $400 million. What is the value of the bank’s total liabilities? A. $600 million B. $110 million C. $200 million D. $90 million Answer: A Reference: Explanation: Type: Multiple Choice 25. Stealth bank has deposits of $700 million. It holds reserves of $20 million and has purchased government bonds worth $350 million. The bank's loans, if sold at current market value, would be worth $600 million. What does Stealth bank’s net worth equal? A. $120 million B. $270 million C. $1.02 billion D. $970 million Answer: B Reference: Explanation: Type: Multiple Choice 26. Stealth bank has deposits of $700 million. It holds reserves of $20 million and has purchased government bonds worth $350 million. The banks loans, if sold at current market value, would be worth $600 million. What is the total value of Stealth bank’s assets? A. $1.3 billion B. $1.7 billion C. $970 million D. $470 million Answer: C Reference: Explanation: Type: Multiple Choice 27. Stealth bank holds deposits of $200 million. It holds reserves of $15 million. It has purchased government bonds worth $75 million. The current value of its loans, if sold at market value, is $130 million. What is the value of the Stealth bank’s liabilities? A. $20 million B. $200 million C. $5 million D. $330 million Answer: B Reference: Explanation: Type: Multiple Choice 28. Stealth bank has deposits of $350 million. It holds reserves of $30 million and government bonds worth $70 million. If the bank sells its loans at market value of $400 million, what will its total assets equal? A. $500 million B. $750 million C. $450 million D. $380 million Answer: A Reference: Explanation: Type: Multiple Choice 29. Stealth bank has deposits of $300 million. It holds reserves of $20 million and has purchased government bonds worth $300 million. The bank's loans, if sold at current market value, would be worth $600 million. What does Stealth bank’s net worth equal? A. $20 million B. $620 million C. $1.22 billion D. $920 million Answer: B Reference: Explanation: Type: Multiple Choice 30. Why do banks use a T-account? A. if a bank has become bankrupt, net worth will be shown as a zero on the balance sheet B. the T-account separates the liabilities on the left from assets on the right C. the T-account separates assets on the left from liabilities on the right D. the T-account ensures the final entry made under the assets column is bank reserves Answer: C Reference: Explanation: Type: Multiple Choice 31. In modern economies, _____________________ receive money from savers and provide funds to borrowers. A. governments B. credit unions C. banks D. financial intermediaries Answer: D Reference: Explanation: Type: Multiple Choice 32. ___________are funds that the bank keeps on hand that are not loaned out or invested in bonds. A. Certificates of deposit B. Reserves C. Time deposits D. Demand deposits Answer: B Reference: Explanation: Type: Multiple Choice 33. In macroeconomics, _____________________________ describes a situation where a bank’s liabilities can be withdrawn in the short-term while its assets are being repaid in the long-term. A. diversification B. reserve ratio C. an asset-liability time mismatch D. a negative net worth Answer: C Reference: Explanation: Type: Multiple Choice 34. Banks can protect themselves against an unexpectedly high rate of loan defaults and against the risk of ____________________ by adopting a strategy that will ______________. A. rising interest rates; diversify its loans B. rising interest rates; provide loans to a variety of customers C. an increased reserve requirement; provide loans to a variety of customers D. an asset-liability time mismatch; diversify its loans Answer: D Reference: Explanation: Type: Multiple Choice 35. The money multiplier is equal to the _______________ in the economy divided by the original _________________. A. total money; quantity of money B. original quantity of reserves; reserve ratio C. quantity of money; total money D. reserve ratio; original quantity of reserves Answer: A Reference: Explanation: Type: Multiple Choice 36. The quantity of money in an economy and the _____________________ are inextricably intertwined. A. value of assets for loans B. quantity of credit for loans C. financial stress in the banking system D. extraordinary gains that can be made with money Answer: B Reference: Explanation: Type: Multiple Choice 37. The process of banks making loans in financial capital markets is intimately tied to the: A. redistribution of wealth. B. financial stress levels of banks. C. creation of money. D. home construction industry. Answer: C Reference: Explanation: Type: Multiple Choice 38. Banks typically come under financial stress because of: A. the money multiplier effect. B. a widespread decline in the value of their assets. C. diversification of loan assets. D. risks associated with extraordinary economic gains. Answer: B Reference: Explanation: Type: Multiple Choice 39. If loans become far less available, then sectors of the economy that ______________ like business investment, home construction, and car manufacturing can be dealt a crushing blow. A. depend on borrowed money B. typically generate extraordinary gains C. make loans to financial capital markets D. failed to diversify risk Answer: A Reference: Explanation: Type: Multiple Choice 40. If the central bank increases the amount of reserves banks are required to hold to 20%, then: A. the money multiplier will increase and the supply of money in the economy will decrease. B. both the money multiplier and the supply of money in the economy will increase. C. the money multiplier will decrease and the supply of money in the economy will increase. D. both the money multiplier and supply of money in the economy will decrease. Answer: D Reference: Explanation: Type: Multiple Choice 41. If the central bank decreases the amount of reserves banks are required to hold from 20% to 10%, then: A. the money multiplier will increase and the supply of money in the economy will decrease. B. both the money multiplier and the supply of money in the economy will decrease. C. both the money multiplier and the supply of money in the economy will increase. D. the money multiplier will decrease and the supply of money in the economy will increase. Answer: C Reference: Explanation: Type: Multiple Choice 42. _________________________ are a form of deposits held in banks that are available by making a cash withdrawal or writing a check. A. Direct deposits B. Savings deposits C. Time deposits D. Demand deposits Answer: D Reference: Explanation: Type: Multiple Choice 43. __________________ pool the deposits of many investors together and invest them in a safe way like short-term government bonds. A. Money market funds B. Savings deposits C. Time deposits D. Certificates of deposit Answer: A Reference: Explanation: Type: Multiple Choice 44. _______________________ that require the depositor to commit to leaving their funds in the bank for a certain period of time, in exchange for a higher rate of interest are also called ________________. A. Demand deposits; certificates of deposit B. Certificates of deposit; time deposits C. Money market funds; time deposits D. Bonds; term deposits Answer: B Reference: Explanation: Type: Multiple Choice 45. The term ___________________ describes the proportion of deposits that the bank must hold in the form of reserves that are not loaned out or invested in bonds. A. reserve ratio B. reserve funds C. term deposits D. bond reserves Answer: A Reference: Explanation: Type: Multiple Choice 46. _____________ are a form of financial instrument through which corporations and governments borrow money from financial investors and promise to repay with interest. A. Certificates of deposit B. Bonds C. Money market funds D. Time deposits Answer: B Reference: Explanation: Type: Multiple Choice 47. In an economy with _______________, money loses some buying power each year, but it remains money. A. inflation B. currency C. deflation D. a market orientation Answer: A Reference: Explanation: Type: Multiple Choice 48. The people in an economy have $10 million in money. There is only one bank that all the people deposit their money in and it holds 5% of the deposits as reserves. What is the money multiplier in this economy? A. 5 B. 1 C. 20 D. 10 Answer: C Reference: Explanation: Type: Multiple Choice 49. The people in an economy have $10 million in money. There is only one bank that all the people deposit their money in and it holds 10% of the deposits as reserves. What is the money multiplier in this economy? A. 5 B. 10 C. 20 D. 1 Answer: B Reference: Explanation: Type: Multiple Choice 50. The market where loans are made to borrowers is called the: A. secondary loan market. B. money market. C. loan market. D. primary loan market. Answer: D Reference: Explanation: Type: Multiple Choice 51. The market in which loans are bought and sold is called the: A. loan market. B. money market. C. secondary loan market. D. primary loan market. Answer: C Reference: Explanation: Type: Multiple Choice Essay Questions 1. Identify and briefly explain the circumstances that could lead to a bank developing a negative net worth, and the various methods that banks may employ to protect themselves from this type of outcome. Banks run a risk of negative net worth if the value of their assets declines. The value of assets can decline because of an unexpectedly high number of defaults on loans, or if interest rates rise and the bank suffers an asset-liability time mismatch in which the bank is receiving a low rate of interest on its long-term loans but must pay the currently higher market rate of interest to attract depositors. Banks can protect themselves against these risks by choosing to diversify their loans or to hold a greater proportion of their assets in bonds and reserves. Reference: Explanation: Type: Essay 2. Provide a breakdown of a banking institution's sources of revenue and categories of expenses. A bank receives revenue from two sources: interest payments to the bank from those who have received bank loans, and other fees and charges imposed by the bank. Banks have four main categories of expenses: interest payments to depositors; loans that are not repaid; operating costs of employees, office space and equipment; and taxes. Reference: Explanation: Type: Essay 3. Identify and briefly explain the three specific functions of money that economists have identified. Economists have identified three specific functions of money. First, money serves as a medium of exchange, which means that money must be very widely accepted as a method of payment in the markets for goods, labor, and financial capital. Second, money serves as a unit of account, which means that it is the ruler by which other values are measured. Third, money serves as a store of value; that is, when you receive money, you know that you don’t need to spend it immediately because it will still hold its value the next day, or the next year. Reference: Explanation: Type: Essay 4. Briefly describe the items that are included in the M1 definition of money. Three items together, currency, traveler’s checks, and checking accounts in banks, make up the definition of money known as M1. Reference: Explanation: Type: Essay 5. Briefly describe the items that are included in the M2 definition of money. M2, includes everything in M1, but also adds savings deposits in banks and the relatively small (that is, less than about $100,000) certificates of deposit or time deposits Reference: Explanation: Type: Essay 6. Briefly explain how macroeconomic policies concerning money are generally conducted and identify and briefly discuss two key messages relating to M1 and M2 and the banking system in the modern economy. Macroeconomic policies concerning money are largely conducted through the banking system. The first key message relating to M1 and M2 is that money in a modern economy is not just paper bills and coins; instead, money is closely linked to bank accounts. The second key message is that most money deposited in the form of bank accounts exists only as electronic records on computers. Reference: Explanation: Type: Essay 7. Briefly explain the role played by banks between savers and borrowers and the economic benefit, if any, derived from their taking on this role. Banks are financial intermediaries that operate between a saver who deposits money in a bank and a borrower who receives a loan from that bank. As intermediaries, banks make it far easier for a complex economy to carry out the extraordinary range of transactions that occur in goods, labor, and financial capital markets. Reference: Explanation: Type: Essay 8. Briefly describe how banks periodically evaluate their financial condition, including a description of the tool used in this process. Banks evaluate their financial condition by comparing their assets, which are defined as items of value owned by the firm, with their liabilities, which are any amounts or debts owed by the firm. A balance sheet is an accounting tool that lists assets and liabilities. Because of the two-column format of the balance sheet, with the T-shape formed by the vertical line down the middle and the horizontal line under “Assets” and “Liabilities,” it is sometimes called a T-account. Reference: Explanation: Type: Essay 9. Identify and briefly describe the assets shown on a T account for a bank. For a bank, the assets shown on the left side of the T account are the financial instruments that either the bank is holding—its reserves—or those instruments where other parties owe money to the bank—like loans made by the bank and bonds purchased by the bank. Liabilities shown on the right side of the T account are what the bank owes to others: specifically, the bank owes any deposits made in the bank to those who have made them. The net worth of the bank is the total assets minus total liabilities. Reference: Explanation: Type: Essay 10. Stealth Bank is holding $4 million in reserves, $9 million in government bonds and $9.6 million in low risk mortgage loans. Out of the $20 million in customers' deposits, Stealth holds $13.1 million in the form of certificates of deposit. Describe the formula for determining Stealth Bank's net worth and, using the figures above, determine the Bank's net worth. Identify the criteria for classifying a bank as healthy or unhealthy and determine which applies to Stealth Bank in these circumstances. The net worth of a bank is defined as its total assets minus its total liabilities. ($4mil + $8mil + $9.6) - $20 = $2.6 million net worth For the Stealth Bank, net worth is equal to $2.6 million; that is, $22.6 million in assets minus $20 million in liabilities. For a financially healthy bank, the net worth will be positive. If a bank has negative net worth, and depositors tried to withdraw their money, the bank would not be able to give all depositors their money. In the circumstances noted above, Stealth Bank has a positive net worth and is therefore a healthy bank. Reference: Explanation: