Knowledge Check Week 5 Study Guide

Topics: Monetary policy, Central bank, Inflation Pages: 13 (1608 words) Published: August 17, 2015
Knowledge Check Week 5 Study Guide
Concepts

Mastery

Score: 12 / 12

Questions

Monetary Policy

100%

1

Interest Rates

100%

2

Exchange Rates

100%

Trade and Specialization

100%

3

4

6

7

10

8

9

12

5

11

Concept: Monetary Policy
Mastery

100%

Questions

1

3

4

5

1.
The Classical Theory of Asset Prices assumes which of the following ideas?

A.

The interest rate to use is the nominal rate, assets are the discounted sum of their future values, and expected
income is the best information available.

B.

Actual past income is the best information available,
assets are the discounted sum of their future values, and
the interest rate is the safe interest rate plus a risk
premium.

C.

The value of an asset is the discounted present value of
expected cash flows, expected income is the best
information available, and the interest rate is the safe
interest rate plus a risk premium.

D.

The interest rate to use is the real rate, expected income
is the best information available, and the assets are the
discounted sum of their future values.

Correct:
The Correct Answer is: C.
Investors purchase assets based on a rational expectation of a stream of future income. The interest rate is based on what investors would receive if they placed their capital in a risk-free investment, such as a government bond or certificate of deposit that is guaranteed by a government agency. However, each investor has a certain risk tolerance and may elect to incur some risk; this is known as a risk premium.

3.
During periods of increasing inflationary pressure, the Federal Reserve should

A.

buy member bank’s bonds to encourage increased
lending to the public

B.

sell bonds to member banks to discourage lending to the
public

C.

reduce the discount rate to make it easier for small
businesses to borrow money

Correct:
The Correct Answer is: B.
Increasing inflationary pressures means that more dollars are in the economy than there are goods and services. This leads to a general price-level increase: inflation. When the Federal Reserve sells bonds, this restricts the amount of money an individual bank may loan to individuals and firms under the fractional reserve requirement, thereby reducing the amount of money in circulation. 4.

What is the increased moral hazard associated with the too big to fail (TBTF) bailouts of the largest of financial institutions?

A.

Financial institutions might misuse the bailout funds and
continue the same practices that lead to the original
failure.

B.

Depositors will lose their deposits.

C.

Employees of the financial institutions will lose their
jobs.

Correct:
The Correct Answer is: A.
When private institutions are allowed to fail, the investors bear the burden for the loss; they are also the first to benefit when correct decisions are made related to pricing and risk. This positive relationship between risk and profit is the backbone of a capitalistic economy. When banks become too large—with many interrelationships with other financial institutions—their ability to make decisions may become distorted by the loss reduction of the risk-price relationship. 5.

The Federal Reserve’s primary tool for managing the money flow is

A.

discount rate

B.

reserve ratio

C.

open-market operations

D.

term auction facility

Correct:
The Correct Answer is: C.
The open-market operation affects both the money supply and the base, and it is used by the Federal Reserve every day. The Federal Reserve’s use of both the discount rate and term auction facility is initiated by the borrowers and is used for member banks to borrow to meet reserve requirements and not as a tool for controlling the money supply. Reserve ratios have fallen into disuse.

Concept: Interest Rates
Mastery

2.

100%

Questions

2

Economists use two principle interest...
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