tesfatsi@iastate.edu
ANSWER OUTLINE
ECON 353 -- SECTION 2 L. Tesfatsion
SECOND MIDTERM EXAM: 40 POINTS TOTAL April 3, 2001
1-2 Auction markets and over-the-counter (OTC) markets are DISTINGUISHED
by the following characteristics:
A. Auction markets only handle trades in real assets whereas OTC
markets only handle trades in financial assets.
B. Trades in an auction market are handled through decentralized facilities
whereas trades in an OTC market are handled through a centralized facility.
C C. Trades in auction markets are generally handled by brokers whereas
trades in OTC markets are generally handled by dealers
D. All of the above are true
E. Only B and C are true
2-2 Which of the following can be described as PRIMARY market transactions:
A. A broker facilitates a stock share sale from one household to another
B B. An investment banker facilitates the sale of newly issued corporate bonds
C. A dealer helps the Fed sell some of its inventory of U.S. Treasury
bonds in open market operations in order to regulate the Fed Funds rate
D. You buy shares of a long-established money market mutual fund.
E. All of the above
3-2. A primary way in which dealers DIFFER from financial intermediaries
is as follows:
A. Dealers hold asset inventories for resale.
B. The main source of profits for dealers is buying assets at low prices and
then reselling these same assets at higher prices.
C. Dealers do not engage in asset transformation.
D D. All of the above.
E. Only A and B above.
4-2 Whatever a society uses as money, the defining characteristic is that
A. it must be completely inflation proof.
B B. it must be generally acceptable as payment for goods and services
and repayment of debts.
C. it must contain at least some amount of a precious metal.
D. it must be produced by government.
E. both B and D
5-2 The conversion of a barter economy to one that uses money
A. decreases efficiency by reducing the volume of trade.
B. increases efficiency by discouraging specialization (division of labor).
C C. increases efficiency by reducing double coincidence of wants problems.
D. decreases efficiency by increasing the number of prices.
E. both B and C
6-2. When a person withdraws funds from a U.S. checkable deposit account and
deposits them in a (noninstitutional) U.S. money market mutual fund, then
A. M1 and M2 both increase
B. M1 and M2 both decrease
C C. M1 decreases and M2 stays the same
D. M1 decreases and M2 increases
E. None of the above.
7-2. Which of the following is true in general for COUPON BONDS?
A. The issuer is required to make all principal plus interest payments
in one fixed payment occurring at the maturity date of the coupon bond.
B. The issuer makes a fixed coupon payment in every payment period
through to maturity, at which time the issuer also pays the face value.
C. Corporate bonds frequently take this form.
D. Mortgages frequently take this form.
E E. Only B and C of the above
8-2. For a coupon bond, its purchase price is _________ than its face value
if and only if its coupon rate is __________ than its yield to maturity.
A. greater; less
B. less; greater
C C. less; less
D. none of the above.
9-2 Letting "*" denote multiplication, if the annual interest rate is 5
percent, then the PRESENT VALUE TODAY of a payment stream ($60, $30) with $60
to be received at the end of the first year and $30 to be received at the end
of the second year is given by
2
A. $60*(1 + .05) + $30*(1 + .05) C. $60*(1 + .05) + $30/(1 + .05)
2 2
B B. $60/(1 + .05) + $30/(1 + .05) D. [$60 + $30] divided by (1 + .05)
10-2 The (ANNUAL) YIELD TO MATURITY i on a coupon bond with a purchase
price $450, a face value $600, a 2-year coupon payment stream ($50,$50),
and a 2-year maturity is calculated as follows:
A. i equals the annual interest rate that, when used to calculate the
present value of the income stream ($50,$50), results in a present
value equal to $450.
B B. i equals the annual interest rate that, when used to calculate the
present value of the income stream ($50,$650), results in a present
value equal to $450.
C. i equals the annual interest rate that, when used to calculate the
present value of the income stream ($50,$50), results in a present
value equal to $600.
D. i equals the annual interest rate that, when used to calculate the
present value of the income stream ($50,$650), results in a present
value equal to $600.
11-2 Suppose a two-year security selling for $200 pays $110 at the end of the
first year and $121 at maturity (the end of the second year). Then, letting *
denote multiplication, its yield to maturity i is the solution to
A. $200*i = $110 + $121
B. $200*(1+i) = $110 + $121
C. $200*i = $110 + $121 - $200
D D. $200*(1+i)*(1+i) = $110*(1+i) + $121
12-2 Which of the following holds for a coupon bond that has an annual coupon
payment C and that is purchased on January 1, 1999, and sold on January 1, 2000:
A. The (annual) current yield on the coupon bond is equal to the coupon
payment C divided by the purchase price.
B. The return rate on the coupon bond over 1999 can be expressed as the sum
of the current yield and the rate of capital gain or loss.
C. The return rate on the coupon bond over 1999 will be GREATER than the
current yield if the purchase price is GREATER than the sale price.
D. All of the above are true.
E E. Only A and B are true.
13-2 The reason that bonds with ______ maturities are more susceptible
to interest rate risk is that ________
A. shorter; there is greater risk of interest payment default
B. longer; there is greater risk of interest payment default
C. shorter; there is less chance of capital gain from yield changes
D D. longer; there is a greater chance of capital loss from yield changes
14-2 Suppose a consol bond pays $1 on January 2 of each year. Suppose you
purchased this consol bond for $1000 on January 1, 1999 and sold it for $1009
on December 31, 1999. Suppose the inflation rate during 1999 was 3 percent.
Then your NOMINAL return rate on the consol bond for 1999 was _______ and your
REAL return rate on the consol bond for 1999 was _________.
A. 1 percent; 4 percent
B. 10 percent; 13 percent
C C. 1 percent; -2 percent
D. 10 percent; 7 percent
15-2 In a primary bond market, the supply curve for bonds slopes upward to
the right because, at a HIGHER bond price, the yield to maturity is ______ ,
which is an incentive to ______ to supply more bonds.
A. higher; borrowers
B B. lower; borrowers
C. lower; lenders
D. higher; lenders
16-2 When the price of bonds is ABOVE the equilibrium price level, then
there is an ________ bonds and the price of bonds can be expected to ____.
A. excess demand for; fall
B. excess demand for; rise
C. excess supply of; rise
D D. excess supply of; fall
17-2 If there is a sudden market-wide DECREASE in the expected inflation
rate from this year to the next, then (all else equal) this will tend to
______ lending today due to the corresponding increase in the current _______.
A. discourage; price of bonds.
B. discourage; nominal interest rate.
C C. encourage; real interest rate.
D. discourage; real interest rate.
18-2 Suppose the U.S. Treasury bond market is currently in a demand=supply
equilibrium. Suddenly the Fed Chairman, Alan Greenspan, announces that he
expects that the inflation rate from this year to the next will be LOWER than
previously anticipated. Then the analysis in Mishkin Chapter 5 predicts that
(all else equal) the effect on the market for newly issued U.S. Treasury
bonds today will be that the equilibrium PRICE of U.S. Treasury bonds will
_____ and the equilibrium QUANTITY of U.S. Treasury bonds purchased will______.
A. definitely increase; definitely decrease.
B. definitely decrease; either increase or decrease.
C. either increase or decrease; definitely increase.
D D. definitely increase; either increase or decrease.
19-2 In a world divided between HC and ROW, multiplying any valuation V
measured in HC currency units by the HC exchange rate ______________
A. corrects V for changes in the HC price level
B. transforms V into pure quantity terms
C C. transforms V into a valuation measured in ROW currency units
D. corrects V for changes in the HC inflation rate
20-2 A DEPRECIATION of a home country's currency ______ the cost of foreign
goods relative to domestic goods, and this in turn can result in ________
A. lowers; deflation if home-country producers lower their prices in turn
B. lowers; a competitive advantage for foreign producers
C C. raises; inflation if home-country producers raise their prices in turn
D. raises; a competitive advantage for foreign producers
21-2 Central banks sometimes use reserve transactions to offset depreciations
of their domestic currency. Specifically, they _______ domestic currency in
the foreign exchange market, which shifts ____________.
A. buy; the supply curve for the domestic currency to the left
B. sell; the supply curve for the domestic currency to the right
C. buy; the demand curve for the domestic currency to the left
D. sell; the demand curve for the domestic currency to the right
E E. buy; the demand curve for the domestic currency to the right
22-2 According to the Law of One Price, if the price of Spanish wine is
2,000 pesetas per bottle (750ml) and the price of Italian wine is 20,000 lira
per bottle (750ml), the wine is of equal quality, and there are no
transaction costs, then the exchange rate between the Spanish peseta and the
Italian lira should be
A. 100 pesetas per lira
B. 10 peseta per lira
C. 1 peseta per lira
D D. 0.10 pesetas per lira
23-2 In a world divided between HC and ROW, the HC real exchange rate is
defined to be
A. the HC nominal exchange rate plus the ROW inflation rate minus the
HC inflation rate.
B. the HC nominal exchange rate minus the HC inflation rate
C. the HC nominal exchange rate times the ROW aggregate price level
divided by the HC aggregate price level
D D. the HC nominal exchange rate times the HC aggregate price level
divided by the ROW aggregate price level
24-2 In a world divided between and ROW, the Purchasing Power Parity (PPP)
condition asserts that
A. the HC nominal exchange rate will stay constant over time
B B. the HC real exchange rate will stay constant over time
C. the HC real interest rate will stay constant over time
D. the value of GDP in the HC and ROW will stay equal over time
25-2 In order for the purchasing Power Parity (PPP) condition to reduce to
a straightforward application of the Law of One Price, the following
conditions need to hold:
A. HC and ROW must produce the same bundle of goods and services.
B. information about availability and prices of goods and services must
be freely available to everyone in the HC and ROW, and there must not
be any trade barriers between the HC and ROW.
C. the HC and ROW aggregate price levels must equal each other over time
D. all of the above
E E. only A and B above
26-2 If the inflation rate in Malaysia is 1 percent during 2001, and the
inflation rate in South Africa is 2 percent during 2001, then the Purchasing
Power Parity (PPP) theory predicts that, during 2001, the value of the South
African currency (rands) measured in terms of the Malaysian currency (ringgits)
-- i.e., the number of ringgits per rand -- will
A A. fall by 1 percent
B. rise by 1 percent
C. fall by 3 percent
D. rise by 3 percent
27-2 Given a world divided between HC and ROW, the Interest Parity Condition
is _________ condition that predicts a short-run relationship between _____.
A A. an equilibrium (arbitrage); HC and ROW interest rates
B. an accounting identity; HC savings and HC investment
C. a balance of payments; HC borrowing and foreign reserve transactions
D. bond market clearing; HC borrowing and ROW saving
E. none of the above
28-2 Given a world divided between HC and ROW, some of the key assumptions
underlying the Interest Parity Condition include
A. Faced with equally risky options, savers always attempt to maximize
expected return
B. Investment opportunities in the HC and ROW have the same risk
C. The HC real exchange rate stays constant over time
D. All of the above
E E. Only A and B
29-2 If the average nominal interest rate on bank deposit accounts across
foreign countries who are major trading partners of the U.S. is 4 percent,
and the U.S. effective exchange rate index for these countries (i.e., a
weighted average of their exchange rates measured in foreign currency units
per U.S. dollar) is expected to appreciate by 3 percent, then interest parity
predicts that, on average, nominal interest rates on U.S. bank deposit
accounts should be about
A. 3.5 percent.
B. 7 percent.
C C. 1 percent
D. -1 percent
30-2 In U.S. national income accounting, U.S. private saving plus ROW saving
must, by definition, equal
A. U.S. national saving minus total U.S. investment
B B. total U.S. investment minus U.S. government saving
C. U.S. government saving minus total U.S. investment
D. total U.S. investment
31-2 As conventionally defined in GDP national income accounting in the
United States, the _________ keeps track of __________________ .
A. capital account; net exports, net factor payments, and net transfers
B. current account; net trades in financial assets and existing real assets
C C. capital account; net trades in financial assets and existing real assets
D. current account; current official reserve transactions.
32-2 According to U.S. national income accounting principles, which item(s)
below would be directly entered as items in the U.S. CURRENT account CA:
A. A U.S. citizen's purchase of a Nepalese government bond
B. U.S. government foreign aid to Bosnia
C. Purchases by U.S. tourists of special spices newly produced in Ethiopia
D. Interest income received by U.S. holders of a Lithuanian bond issue
E E. All but A
33-2 According to U.S. national income accounting principles, which item(s)
below would be directly entered as items in the U.S. CAPITAL account KA:
A. Purchases by Kuwait of suntan lotion newly produced in Florida
B B. Purchase of the U.S. Chrysler company by a German corporation
C. Dividends received by U.S. holders of stock shares in French companies.
D. Purchase of land by the U.S. government from private U.S. ranchers
E. Both B and D
34-2 Assuming the world is divided between HC and ROW, if the HC is running a
current account SURPLUS, then HC national saving is GREATER than ___________.
A. ROW national saving.
B. HC consumption expenditures.
C C. total HC investment.
D. total HC investment minus Row saving.
35-2 A U.S. current account _____ indicates that the U.S. is DECREASING its
net claims on foreign assets because the U.S. is _______ the rest of the world.
A. surplus; a net borrower from
B. deficit; a net lender to
C. surplus; a net lender to
D D. deficit; a net borrower from
36-2 Using the definitions for CA, KA, NKA, and BP as detailed in the
online notes for Mishkin Chapter 19, and assuming the world is divided
between HC and ROW, the HC balance of payments ACCOUNTING IDENTITY states
A. the sum of CA and NKA is zero
B B. the sum of CA and NKA equals BP.
C. BP equals zero.
D. the sum of CA and KA equals BP.
E. none of the above.
37-2 Using the definitions for CA, KA, NKA, and BP as detailed in the
online notes for Mishkin Chapter 19, and assuming the world is divided
between HC and ROW, the HC has a balance of payments DEFICIT if
A. the HC central bank is decreasing its net HC currency reserve holdings.
B. CA is negative.
C. the sum of CA and KA is negative.
D D. the HC central bank is decreasing its net ROW currency reserve holdings.
E. none of the above.
38-2 If, instead, the HC is in a balance of payments EQUILIBRIUM, this means
A. BP equals zero
B. in net terms the HC central bank is neither buying nor selling ROW
currency in the foreign exchange market.
C. HC government expenditures are equal to HC tax revenues
D. in net terms the HC is neither borrowing from nor lending to ROW.
E E. both A and B.
39-2 The International Monetary Fund (IMF) was established by the 1945
Bretton Woods Agreement to maintain __________ exchange rates and to provide
loans to member countries to help with _____________.
A. flexible; severe reserve shortages due to bank panics
B. fixed; purchasing power parity problems
C. flexible; long-term development projects.
D D. fixed; temporary balance of payments problems.
E. none of the above
40-2 Critics of the International Monetary Fund (IMF) argue that the
lender-of-last-resort function of the IMF increases the potential for
_________ in the future.
A. interest rate risk problems
B B. moral hazard problems
C. adverse selection problems
D. debt deflation problems