tesfatsi@iastate.edu
ANSWER KEY
ECON 353 -- SECTION 1 L. Tesfatsion
FIRST MIDTERM EXAM: 40 POINTS TOTAL February 28, 2002
Q1. Nominal GDP (gross domestic product) for the United States in year
2002 is a measure of the
A. total value of final goods and services newly produced in 2002
using U.S.-owned assets, measured in year 2002 prices.
B B. total value of final goods and services newly produced within the
borders of the U.S. in 2002, measured in year 2002 prices.
C. total value of final goods and services newly produced within the borders
of the U.S. in 2002, measured in prices for some fixed base year.
D. total value of all goods, services, and financial assets existing within
the borders of the U.S. in 2002, measured in year 2002 prices.
Q2. The U.S. Consumer Price Index (CPI) for year 20020 is a measure of
A. the inflation-adjusted value of the U.S. nominal GDP level in 2002.
B. the average price of the goods and services included in U.S. GDP in 2002.
C. the sum of prices for the goods and services included in U.S. GDP in 2002.
D D. the value of a basic basket of goods and services bought by a typical
U.S. urban household in 2002.
Q3. Recurrent fluctuations that occur in time series data for real GDP
and other key macro variables are referred to as
A A. the business cycle.
B. variable trends.
C. standard deviations.
D. measurement errors.
E. recessions.
Q4. 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 C. Federal Reserve System.
D. Bureau of Monetary Affairs.
Q5. Which of the following statements is/are TRUE:
A. The average price of goods and services in an economy is called the
aggregate price level.
B. The inflation rate is measured as the rate of change in the aggregate
price level.
C. There are several different measures in use in the U.S. for the
aggregate price level, and hence for the inflation rate.
D D. All of the above.
E. Only A and B.
Q6. Evidence from the U.S. and from other countries, presented in Mishkin
Chapter 1, indicates that
A. there is a strong negative correlation between the average price
level and the money supply (M2) -- that is, when one is increasing,
the other tends to be decreasing.
B. there is a strong positive correlation between the average price
level and the money supply (M2) -- that is, when one is increasing,
the other tends to be increasing as well.
C. a high average inflation rate is associated with a high average money
growth rate, and vice versa.
D. the supply of money (M2) is unrelated to the average price level.
E E. Only B and C are true.
Q7. Viewing U.S. time series data for real GDP, an interesting pattern that
stands out when comparing data before 1950 to data after 1950 is an apparent
increased stabilization of real GDP around its trend line, which some have
attributed to _________.
A. increased specialization in the production of particular goods and services.
B B. the national government undertaking more responsibility for managing the
economy as a whole, starting with the 1946 Employment Act and the 1952
Price Stabilization Act.
C. more Democrats being elected president.
D. the absence of oil price shocks.
E. the information technology (IT) revolution.
Q8. Securities are ________ for the issuer and _________ for the purchaser.
A. puts; calls
B. assets; liabilities
C C. liabilities; assets
D. liquid; illiquid
Q9. Market structure is generally tailored to the type of item being bought
and sold. For example, a basic reason why one might be surprised to see a
retail stock share store in Ames with displayed stock shares for sale is that
A. stock share exchanges involve adverse selection.
B. stock shares must be sold (by law) only through securities markets.
C C. directly viewing and handling stock shares is not very informative about
the underlying value of the stock.
D. the purchase and sale of stock shares involves high transactions costs.
E. the purchase of a stock share always requires detailed contractual
arrangements regarding the payment to be made to the original issuer of
the share, which is too complicated for retail outlets to handle.
Q10. One major function that financial intermediaries perform that cannot
(by definition) be performed either by brokers or by dealers is
A. matching buyers of financial assets with sellers of financial assets.
B. reduction of transactions costs.
C. "making the market" by mediating both purchase and sale prices for
financial assets.
D D. financial asset transformation.
E. provision of sound investment advice.
Q11. Brokers DIFFER from dealers in the following key way(s):
A. Brokers engage in financial asset transformation.
B. Brokers do not take positions in the financial assets they trade.
C. Brokers charge commissions to the users of their services.
D. all of the above.
E E. only B and C above.
Q12. A type of financial institution that plays a major role in the sale of
securities in PRIMARY markets is
A. a stock exchange.
B B. an investment bank.
C. a savings and loan.
D. a commercial bank.
Q13. A dealer's "bid-ask spread" for a financial asset
A. is the bid (buy) price minus the asked (sell) price posted by the
dealer for the financial asset.
B. measures the gross profit margin of the dealer on trades in the asset.
C. is the asked (sell) price minus the bid (buy) price posted by the
dealer for the financial asset.
D D. Both B and C are true.
E. Both A and B are true.
Q14. Which of the following can be described as SECONDARY market transactions:
A The U.S. Treasury holds an auction for a new issue of Treasury bonds.
B. An investment banker facilitates the sale of a newly issued corporate bond.
C. A bank buys commercial paper newly issued by a corporation.
D D. You purchase a share of Amazon.com from a Nasdaq dealer.
E. Only A, B, and C.
Q15. Auction markets and over-the-counter (OTC) markets are DISTINGUISHED
by the following characteristic(s):
A. Auction markets only handle trades in financial assets whereas OTC
markets handle trades in both real and financial assets.
B B. Trades in auction markets are conducted through a centralized facility
whereas trades in OTC markets are not.
C. Trades in auction markets are generally handled by dealers whereas
trades in OTC markets are generally handled by brokers.
D. All of the above are true.
E. Only B and C are true.
Q16. Which of the following can be described as DIRECT finance:
A. You buy shares in a mutual fund.
B. A pension fund manager buys commercial paper in a secondary market.
C C. The U.S. government sells newly issued eurobonds to the Indonesian government.
D. You take out a loan from a bank.
E. You buy shares of IBM on the New York Stock Exchange.
Q17. Common stock shares and corporate bonds are DISTINGUISHED by the
following key characteristic(s):
A. by law, corporations must pay out their profits as dividends to their
common stock holders.
B B. the payments to corporate bond holders are not dependent on the amount of
corporate profits (unless bankruptcy occurs).
C. if bankruptcy occurs, stock holder claims are prior to bond holder claims.
D. All of the above.
E. Only A and B.
Q18. Which of the following statements is/are TRUE?
A. A bond is a debt instrument that promises to make payments for
a specified period of time (i.e., over its maturity).
B. The maturity of a debt instrument is the length of time to the
debt instrument's expiration date.
C. Debt instruments with maturities greater than a year are traded in
the capital market.
D D. All of the above statements are true.
E. Only A and B are true.
Q19. The presence of ___________ in financial markets leads to
adverse selection and moral hazard problems that interfere with the
functioning of financial markets.
A. noncollateralized risk
B. free-riding
C. costly state verification
D D. asymmetric information
E. default risk
Q20. By definition, money is
A. anything that must be accepted by law in repayment of debt.
B. a riskless repository of spending power.
C. a government-mandated medium of exchange.
D. income (e.g., dollars received per unit of time).
E E. anything that is generally accepted in payment for goods and services
or in the repayment of debt.
Q21. The organization responsible for the conduct of monetary policy in the
United States is the
A. U.S. Treasury.
B. Comptroller of the Currency.
C. U.S. Congress.
D D. Federal Reserve System.
E. The executive branch (the President and his administration).
Q22. Traveler's checks issued by American Express (a private U.S. company)
A. constitute part of M1, the narrowest measure of money in the U.S.
B. serve as a generally acceptable means of payment for goods and services
and for repayment of debts in the U.S.
C. are legal tender in the U.S.
D. All of the above.
E E. Only A and B.
Q23. For an economy with at least four goods, the DISADVANTAGES of a
barter payment system relative to a monetary payment system include:
A. the need for more prices to support exchanges.
B. the requirement of a double coincidence of wants for each exchange.
C. the discouragement of specialized production (division of labor).
D D. All of the above.
E. Only A and B.
Q24. For an economy with exactly 9 distinct types of goods, _______
goods-for-goods prices are needed to fully support exchange under a barter
payment system while ______ money-for-goods prices are needed to fully
support exchange under a monetary payment system.
A. 36; 18
B. 18; 9
C. 72; 18
D D. 36; 9
E. 72; 9
Q25 The observed tendency for the form of money to evolve from commodity
money to fiat money increases the fragility of money because
A. fiat money is rigidly backed, i.e., it is collateralized by a fixed
amount of gold, which leads to inflexibility in the exchange system.
B. fiat money can lose much of its value if people lose confidence in its
general acceptability as a means of payment for goods and services.
C. fiat money can lose much of its value in hyperinflations.
D. All of the above.
E E. Only B and C.
Q26. Problems experienced by the thirteen colonies in attempting to finance
their war efforts during the American Revolution subsequently led to the
beginnings of the modern U.S. financial system with
A. the issuing of "greenbacks" by the U.S. Treasury in 1776.
B B. the chartering of the Bank of North America in 1782 and the first issue
of state bank notes.
C. the first issue of backed paper monies in 1789.
D. the establishment of the Federal Reserve System in 1783.
E. the establishment of a dual banking system (chartering of banks at state
and national levels) in 1784.
Q27. U.S. monetary policy makers worry about being able to accurately
measure and control the money supply because
A. their primary responsibility is to use changes in the money supply to
control the current account deficit.
B. by law they need to keep track of the flow of money through the economy.
C C. they use changes in the money supply in order to affect the Federal
funds rate (hence other key interest rates), with the ultimate objective
of maintaining a low inflation rate and a satisfactory GDP growth rate.
D. they need to control the amount of legal tender in the economy in order
to keep the national debt in check.
Q28. A _________ is typically bought at a price below its face value, and the
only payment received by the purchaser is the _______ at the maturity date.
A. coupon bond; face value
B. fixed payment loan; fixed (balloon) payment
C C. discount bond; face value
D. discount bond; principal
Q29. If a coupon bond with an $8000 face value and a 5 year maturity has a
$400 coupon payment and a purchase price of $10,000, then the coupon rate is
A. 4 percent.
B B. 5 percent.
C. 8 percent.
D. 10 percent.
E. 20 percent.
Q30. The coupon rate on a coupon bond with a $1000 face value, a 5 percent
current yield, and a current purchase price of $4000 is
A. 5 percent.
B. 8 percent.
C. 10 percent.
D. 15 percent.
E E. 20 percent.
Q31. "Present value" is considered to be one of the most important concepts
ever articulated in financial economics because
A. it corrects for changes in real purchasing power due to price effects.
B. it measures the implicit discount rate used by the market to price assets.
C. it provides an accurate assessment for future return rates.
D D. it permits payment streams on different financial assets to be compared
with each other in terms of a common unit of account (current dollars).
E. it provides a way to measure the value of a financial asset solely in
terms of its current (present) payments, ignoring future payments.
Q32. Letting "*" denote multiplication, if the annual interest rate is 8
percent, then the PRESENT VALUE of a payment stream ($30,$0,$15) with $30 to
be received at the end of the FIRST year, $0 to be received at the end of the
SECOND year, and $15 to be received at the end of the THIRD year is given by
3 3
A A. $30/(1.08) + $15/(1.08) C. $30*(1.08) + $15*(1.08)
B. [$30 + $15] divided by 3 D. $30/(1.08) + $15/(1.24)
Q33. Letting"*" denote multiplication, the (ANNUAL) YIELD TO MATURITY i on
a two-year discount bond with a purchase price of $450 and a face value of
$550 is given by the following formula:
2 2
A. $550 = $450/(1+i) C C. $450 = $550/(1+i)
B. i = 0 D. $450 = $550/(1+2i)
Q34. Which of the following is/are true in general for coupon bonds?
A. Holding fixed the coupon payment, face value, and maturity of the bond,
its purchase price is inversely related to its yield to maturity (i.e.,
when one is high, the other is low, and vice versa).
B. If the purchase price of the bond equals its face value, then its
coupon rate equals its yield to maturity.
C. If the purchase price of the bond is less than its face value, then its
coupon rate is less than its yield to maturity.
D D. All of the above are true.
E. Only A and B are true.
Q35. If the average yield to maturity on bonds is currently low, and you
suddenly hear a credible announcement from the Fed Chairman Alan Greenspan that
this average yield to maturity will be higher a year from now than previously
expected, then it would probably be best to ________ because ____________.
A. hold off selling bonds today; the real return rate on bonds between now and
next year will be higher than expected.
B hold off selling bonds today; bond prices a year from now will be higher
than expected.
C. buy bonds today; bond prices a year from now will be higher than expected.
D D. hold off buying bonds today; bond prices a year from now will be lower
than expected.
E. sell bonds today; inflation a year from now will be higher than expected.
Q36. Which of the following securities, each with a face value of $5000,
has the HIGHEST yield to maturity?
A. a coupon bond with a 7 percent coupon rate and a purchase price of $5000
B B. a coupon bond with a 7 percent coupon rate and a purchase price of $4000
C. a coupon bond with a 5 percent coupon rate and a purchase price of $8000
D. a coupon bond with a 6 percent coupon rate and a purchase price of $6000
Q37 Letting i denote the current average yield to maturity on coupon bonds, in
which of the following situations would you prefer to be PLANNING TO BORROW
through coupon bond transactions:
A. i = 2 percent and the expected inflation rate = -1 percent
B. i = 7 percent and the expected inflation rate = 3 percent
C C. i = 13 percent and the expected inflation rate = 11 percent
D. i = 25 percent and the expected inflation rate = 20 percent
Q38 Smart investors need to understand the distinction between the "yield to
maturity" on a financial asset and its "return rate" because
A. many investors sell financial assets prior to their maturity.
B. the yield to maturity assumes the asset will be held to maturity,
whereas the return rate can be calculated for any holding period.
C. the yield to maturity ignores capital gain or loss that might accrue
to an investor who sells a financial asset prior to maturity.
D. the return rate on a financial asset for any given holding period takes
into account capital gain or loss over the holding period as well as
payments received over the holding period.
E E. all of the above.
Q39 "Interest rate risk" is the risk faced by ____ in the form of __________.
A. a potential borrower; fluctuations in the interest payments the borrower
will have to make to the lender.
B B. a bond holder; fluctuations in the yield to maturity, hence in
the period-by-period return rate on the bond.
C. a potential lender; fluctuations in the purchase price of bonds
D. a borrower who has already issued a bond; fluctuations in the interest
payments the borrower will have to make to the bond holder.
E. a person who has re-sold a bond in a secondary market; fluctuations in
the interest payments the seller will have to make to the buyer.
Q40. Suppose you have been promised a payment of $1000 on March 1, 2002,
and suppose the inflation rate over the coming year (through March 1, 2003)
is expected to be 4 percent. Suppose you intend to store this $1000 under
your mattress for this entire year. Then the NOMINAL return rate you should
expect to earn on this $1000 over the coming year is ____ and the REAL return
rate that you should expect to earn on this $1000 over the coming year is _____.
A. 4 percent; 0 percent
B. 0 percent; 4 percent
C C. 0 percent; -4 percent
D. 3 percent; -1 percent
E. 3 percent; 7 percent