tesfatsi AT iastate.edu
ANSWER OUTLINE
ECON 353 L. Tesfatsion
SECOND MIDTERM EXAM: 50 POINTS TOTAL November 3, 2005
Q1. A key difference between GDP (gross DOMESTIC product) and GNP (gross
NATIONAL product) for the United States is that
A. Gross DOMESTIC product includes production outside the borders of the
U.S. whereas gross NATIONAL product does not.
B B. Gross NATIONAL product includes production outside the borders of the
U.S. whereas gross DOMESTIC product does not.
C. Gross NATIONAL product includes a measure of intermediate good
production whereas gross DOMESTIC product does not.
D. Gross DOMESTIC product is not corrected for possible changes in prices
whereas gross NATIONAL product is corrected for possible changes in prices.
Q2. The AGGREGATE PRICE LEVEL for an economy over some time period is
____________ and the INFLATION RATE is the _________________.
A. a measure of the total value of all goods and services sold in the
economy during this time period; percent increase in this value from one
period to the next.
B. the sum of prices for all final goods and services produced in the
economy during this time period; a measure of the extent to which the
aggregate price level is high or low relative to its normal value.
C. a measure of the total value of all goods and services consumed in the
economy during this time period; percent change in this value from one
period to the next.
D D. a measure of the average price of goods and services in the economy
over this time period; percent change in the aggregate price level from
one period to the next.
Q3. Which of the following can be described as DIRECT finance:
A. Halliburton Corporation sells its holdings of U.S. Treasury bonds in the
U.S. government bond market.
B B. Wewilljipu.com sells newly issued stock shares in an initial public offering.
C. You contribute to your pension fund.
D. You acquire a mortgage from a savings and loan.
E. You buy shares of Intel on the Nasdaq.
Q4. Which of the following statements is/are TRUE?
A A. An issuer of a debt instrument promises to make one or more payments to
the purchaser in accordance with a definite time schedule.
B. All debt instruments are traded in the money market and all equity
instruments are traded in the capital market.
C. An issuer of a common stock share promises to make one or more payments
to the purchaser in accordance with a definite time schedule.
D. All of the above statements are true.
E. Only A and B are true.
Q5. Which of the following statements is/are true in general for COUPON BONDS?
A. The coupon rate exceeds the yield to maturity if and only if the
purchase price of the bond exceeds the face value of the bond.
B. The issuer makes a fixed coupon payment in every payment period during
the life of the bond, plus a face value payment at maturity.
C. Treasury bonds are examples of coupon bonds.
D D. All of the above.
E. Only A and B.
Q6. By definition, whatever a society uses as money must ________
A. always be accepted for debt repayments as a matter of legal right.
B B. be a generally accepted means of payment for goods and services
and for repayment of debts (as a matter of social custom).
C. be the only thing used as money in the society.
D. be supplied solely by some central governing body in order to
ensure its value over time.
E. all of the above.
Q7. Checkable deposit accounts supplied by reputable U.S. commercial banks
such as the First National Bank in Ames
A. are a generally accepted means of payment for goods and services
and for repayment of debts in the U.S.
B. constitute part of M2, the most commonly used measure of money in the U.S.
C. are legal tender in the U.S.
D. All of the above.
E E. Only A and B.
Q8. The conversion of a barter economy to one that uses money tends to
A. INCREASE efficiency by DISCOURAGING specialization (division of labor).
B. DECREASE efficiency by ENCOURAGING specialization (division of labor).
C C. INCREASE efficiency by ENCOURAGING specialization (division of labor).
D. DECREASE efficiency by DISCOURAGING specialization (division of labor).
Q9. Major crises are often times of significant financial innovation. For
example, the severe financing needs of the North during the U.S. Civil War led
____________.
A. the Continental Congress to produce debased coinage ("token coins") for
the first time.
B. the North to use commodity monies and backed paper monies for the first
time.
C C. the U.S. Treasury to issue unbacked paper money ("greenbacks") as
legal tender in the U.S. for the first time.
D. the Federal Reserve to introduce measures of the aggregate money supply
M1 and M2 for the first time.
Q10. 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 CURRENT YIELD is
A. 20 percent.
B B. 4 percent.
C. 8 percent.
D. 5 percent.
E. 10 percent.
Q11. PRESENT VALUE is considered to be one of the most important concepts
ever articulated in financial economics because
A. it provides an accurate assessment for future interest rate risk.
B B. it permits payment streams on different financial assets to be compared
with each other in terms of a common unit of account.
C. it provides a way to measure the current value of a financial asset
without having to consider the timing and amount of future payments.
D. it provides an accurate assessment of an asset's real purchasing power.
Q12 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 LEND through
coupon bond transactions:
A. i = 7 percent and the expected inflation rate = 3 percent
B B. i = 2 percent and the expected inflation rate = -3 percent
C. i = 25 percent and the expected inflation rate = 23 percent
D. i = 13 percent and the expected inflation rate = 10 percent
Q13 INTEREST RATE RISK is the risk faced by ____ in the form of __________.
A. a bond issuer; fluctuations in the interest payments the bond issuer will
have to make to the bond purchaser.
B. a potential lender; fluctuations in the purchase price of bonds
C. a potential borrower; fluctuations in the sale price of bonds.
D D. a bond holder; uncertainty regarding the bond's return rate due to
possible changes in the bond's yield to maturity.
Q14. The DEMAND CURVE for bonds in a PRIMARY bond market describes
A. the planned bond sales of borrowers.
B. the planned bond sales of lenders.
C C. the planned bond purchases of lenders.
D. the planned bond purchases of borrowers.
Q15. Key factors that are likely to cause the SUPPLY curve for bonds to shift
RIGHT (more bonds supplied for each bond price P) include
A. an increase in the expected profitability of capital investment
B. an increase in the expected inflation rate.
C. higher government deficits.
D D. all of the above
E. only A and B
Q16. Key factors that are likely to cause the DEMAND curve for bonds to shift
RIGHT (more bonds demanded for each bond price P) include
A A. a decrease in default risk
B. an increase in the expected inflation rate.
C. an increase in the expected profitability of capital investment.
D. all of the above
Q17. 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 supply of; rise
B. excess demand for; rise
C C. excess supply of; fall
D. excess demand for; fall
Q18. If the current Fed Chairman Alan Greenspan suddenly makes a credible
announcement that the average yield to maturity on bonds will be LOWER a year
from now than previously expected, the theory in Mishkin Chaper 5 predicts
(all else equal) that will lead people to ________ because ____________.
A. demand fewer bonds today; bond prices a year from now will be lower
than expected, leading to lower expected capital gains.
B B. demand more bonds today; bond prices a year from now will be higher
than expected, leading to higher expected capital gains.
C. supply more bonds today; bond prices a year from now will be lower
than expected, leading to higher expected capital gains.
D. supply more bonds today; bond prices a year from now will be higher
than expected, leading to lower expected capital gains.
Q19. If the recently designated Fed Chairman-to-be Ben Bernanke suddenly makes
a credible announcement today that the inflation rate will be LOWER next year
than previously expected, the theory in Mishkin Chapter 5 predicts (all else
equal) that this should lead in today's bond market to ______ in the equilibrium
price of bonds and ________ in the equilibrium quantity of bonds sold.
A. a definite fall; a definite rise
B. a definite rise; a definite fall
C. a definite fall; an ambiguous change
D D. a definite rise; an ambiguous change
E. an ambiguous change; a definite rise
Q20. The demand/supply bond market analysis discussed in Mishkin Chapter 5 is
useful for generating "short run" predictions about bond prices (or yields to
maturity), but generating reliable "long run" predictions is difficult because
A. the demand and supply curves for bonds are conditioned on things such
as current household income and wealth, current goods prices, and current
prices of other financial assets that tend to change over time.
B. the demand and supply curves for bonds are conditioned on expectations
about future events, and these expectations can change abruptly in
response to current events (e.g., new Fed announcements)
C. the demand and supply curves for bonds are affected by government
policy actions (such as emergency deficit financing of hurricane relief
efforts) that are difficult to foresee in advance.
D D. all of the above.
E. only A and B.
Q21. The BEHAVIORAL finance view argues that
A. stock prices are determined by dividend payouts as decided by the
behavior of company managers.
B B. stock prices are strongly affected by market psychology.
C. stock prices are largely determined by the effects of the behavior of
company managers on fundamental company financial conditions.
D. stock prices cannot reflect price bubbles.
Q22. According to the FUNDAMENTAL view of stock valuation,
A. the current market value of any stock share should fully reflect the
beliefs of all investors in the market.
B. the current market value of any stock share should be an optimal
weighted average of its past market values.
C. the current market value of any stock share should be an optimal
weighted average of all currently available stock shares.
D D. the current market value of any stock share should equal the present
value of its expected future cash flow (payment stream).
Q23. The Gordon Growth Model, an extension of the one-period stock valuation
model, predicts that the current price of a stock share will be LOWER if
A. the current dividend is LOWER.
B. the dividend growth rate is LOWER.
C. the required return on equity is SMALLER.
D. all of the above.
E E. only A and B.
Q24. The theory of RATIONAL EXPECTATIONS assumes that
A. forecasts (expectations of future events) are always correct.
B. people cautiously and incrementally adjust their expectations as new
information becomes available to them.
C C. people make optimal use of whatever information they have in forming
their expectations.
D. people form their price expectations by forming an optimal weighted
average of their past price observations.
Q25. According to Mishkin Chapter 7, the Efficient Market Hypothesis in its
third (and strongest) form implies that
A A. there can be no price bubbles, i.e., stock prices coincide with their
true fundamental values.
B. security prices can never fall in response to good news.
C. published reports of financial analysts are crucially important for
investors to acquire and study carefully.
D. buy and hold is NOT a good investment strategy.
Q26. Early evidence in FAVOR of the Efficient Market Hypothesis included
A. evidence that announcements confirming previously anticipated events
resulted in substantial movements in stock prices.
B B. evidence that technical analysis (predicting future prices on the basis
of past price patterns) was unable to persistently beat the market.
C. evidence that stock prices systematically reflected price bubbles.
D. evidence that stock prices reflected all insider information even if not
available to the public at large.
Q27. Later evidence ("anomalies") UNFAVORABLE to the Efficient Market
Hypothesis included
A A. evidence of excessive fluctuation in stock market prices relative to the
fluctuations in dividend payment streams.
B. evidence that technical analysis (predicting future prices on the basis
of past price patterns) was unable to persistently beat the market.
C. evidence that insider trading based on information not available to the
public at large could be profitable.
D. evidence that new information about a company could lead to substantial
sudden changes in its stock price.
Q28. Major DIFFERENCES between the NASDAQ Composite stock market index and
the Standard & Poor's 500 (S&P 500) stock market index include:
A. the NASDAQ Composite is market-capitalization (or market-value)
weighted index whereas the S&P 500 is a price-weighted index.
B. the NASDAQ Composite incorporates stock prices from a much more
diversified group of companies than the S&P 500.
C C. the NASDAQ Composite incorporates stock prices from a much larger
number of companies than the S&P 500.
D. all of the above.
Q29. If the euro-U.S.$ exchange rate changes from 1 euro per U.S.$ to 1.05
euros per U.S.$, then
A. the euro has appreciated and the U.S.$ has appreciated
B B. the euro has depreciated and the U.S.$ has appreciated
C. the euro has appreciated and the U.S.$ has depreciated
D. the euro has depreciated and the U.S.$ has depreciated
Q30. Suppose the world is divided between HC and ROW, and that all currency
reserves are held by the HC central bank. The HC central bank might sometimes
be reluctant to permit a depreciation of the HC currency because it would
_________ the cost to HC citizens of goods imported from ROW and might thus
encourage _________ .
A. raise; HC producers to lower their prices
B. lower; HC producers to lower their prices
C C. raise; HC producers to raise their prices
D. lower; HC producers to raise their prices
Q31. Given a world divided between HC and ROW, the PURCHASING POWER PARITY
condition in level form asserts that
A. the HC real interest rate does not change over time.
B. the HC nominal exchange rate is always equal to 1.
C. the HC inflation rate is always equal to the ROW inflation rate.
D D. the HC real exchange rate is always equal to 1.
E. none of the above
Q32. Given a world divided between HC and ROW, in order for the PURCHASING
POWER PARITY CONDITION to reduce to a straightforward application of the "law
of one price," the following condition(s) need(s) to hold:
A. information about the availability and price of goods and services in
the HC and ROW is freely available to everyone and there are no trade
barriers or other types of transactions costs between the HC and ROW.
B. the HC and ROW produce the same bundles of goods and services.
C. the HC and ROW have the same inflation rates.
D. all of the above
E E. only A and B above
Q33. If the inflation rate in China is 3 percent during 2005, and the inflation
rate in Mexico is 35 percent during 2005, then the theory of PURCHASING POWER
PARITY (IN RATE-OF-CHANGE FORM) predicts that, during 2005, the value of the
Chinese currency (yuan) measured in terms of the Mexican currency (pesos) --
i.e., the number E of pesos per yuan -- will
A. rise by 38 percent.
B. fall by 32 percent.
C C. rise by 32 percent.
D. fall by 38 percent.
E. none of the above.
Q34. Given a world divided between HC and ROW, INTEREST PARITY is __________
condition that asserts _______________.
A. a bond market equilibrium; the demand and supply for HC bonds
are equalized by the profit-seeking activities of HC and ROW lenders.
B. an accounting; the HC savings rate must equal the ROW savings rate.
C. a balance of payments; that interest rates in the HC and ROW are
equalized by the profit-seeking activities of HC and ROW speculators.
D D. an arbitrage; the expected returns on HC and ROW deposit accounts
are equalized by the profit-seeking activities of HC and ROW savers.
Q35. The INTEREST PARITY CONDITION assumes that investors carefully take
into account
A. the risk of default occurring on deposit accounts held domestically
versus in a foreign country.
B. the riskiness (volatility) of interest rates on deposit accounts held
domestically versus in a foreign country.
C C. the risk of loss occurring due to adverse movements in the exchange
rate during the time they are holding foreign-currency denominated
deposit accounts.
D. the risk that funds will be used to finance highly risky investments
when deposited into domestic versus foreign deposit accounts.
Q36. If the average nominal interest rate on bank deposit accounts across
foreign countries who are major trading partners of the U.S. is 3 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 DEPRECIATE by 2 percent, then the INTEREST
PARITY CONDITION predicts that, on average, nominal interest rates on U.S.
bank deposit accounts should be about
A. 1 percent.
B. -1 percent.
C. -5 percent
D D. 5 percent
Q37. In a two-country world divided between HC and ROW, in order to OFFSET
an APPRECIATION of HC currency, the HC central bank could _______ HC currency
in the foreign exchange market, which would tend to shift _________.
A A. sell; the supply curve for HC currency to the right
B. sell; the supply curve for HC currency to the left
C. sell; the demand curve for HC currency to the right
D. buy; the demand curve for HC currency to the right
E. buy; the demand curve for HC currency to the left
Q38. Possible benefits to a country from becoming a member of a common
currency region such as the euro area include:
A. elimination of the need to conduct foreign exchange market transactions
when trades take place between member countries.
B. elimination of exchange rate risk (uncertainty regarding return rates
due to uncertainty regarding movements in exchange rates) on financial
investments among member countries.
C. much greater ability of the member countries to respond flexibly to
external shocks that particularly affect them.
D. all of the above.
E E. only A and B.
Q39. The plan is for the ten countries that joined the European Union (EU)
in May 2004 to eventually become members of the euro area. However, the
entry of these countries into the euro area is not certain because entry
requires meeting a set of requirements known as the MAASTRICHT CONVERGENCE
CRITERIA. These requirements include:
A. stability of institutions guaranteeing democracy.
B. an exchange rate pegged to the U.S. dollar in a sustainable way.
C C. price stability, sustainable government finances, and convergence in
long-term interest rates.
D. adherence to the protocols of the European NATO Alliance.
Q40. As conventionally defined in GDP national income accounting in the
United States, the U.S. CURRENT ACCOUNT keeps track of______________ .
A. net trades in existing real assets between the U.S. and ROW.
B. net trades in financial assets between the U.S. and ROW.
C. all current purchases by U.S. citizens from the rest of the world.
D D. U.S. net exports+net factor payments to the U.S.+net transfers to U.S.
E. both A and B.
Q41. Which of the following would be directly entered as a DECREASE in the
size of the U.S. CURRENT ACCOUNT CA?
A. A decline in U.S. net investment income
B. An increase in the amount of services purchased by the U.S. from foreigners
C. An increase in unilateral transfers from the U.S. to foreigners
D D. All of the above
E. None of the above
Q42. As conventionally defined in GDP national income accounting in the
United States, the U.S. CAPITAL ACCOUNT keeps track of______________ .
A. net trades between the U.S. and ROW in pre-existing real assets.
B. net trades between the U.S. and ROW in financial assets.
C. all current purchases by U.S. citizens from ROW.
D. U.S. net exports+net factor payments to the U.S.+net transfers to U.S.
E E. both A and B.
Q43. In GDP national income accounting for a two-country world divided between
HC and ROW, _______ is defined to be the total income received by ROW from
the HC less the value of HC exports to ROW.
A. ROW borrowing
B. the ROW current account
C C. ROW saving
D. the ROW capital account
Q44. In GDP national income accounting for a two-country world divided
between HC and ROW, the HC CURRENT ACCOUNT CA is equal to _________ as an
accounting identity.
A. ROW Saving
B. HC National Saving
C. [-1] times ROW Saving
D. HC National Saving minus HC Total Gross Investment
E E. Both C and D.
Q45. Consider a two-country world divided betwen HC and ROW. If the HC
current account CA has a NEGATIVE value, this means that the HC is ________
to finance HC total gross investment using only HC national savings and that
____________.
A. more than able; ROW is borrowing from the HC
B. more than able; ROW is lending to the HC
C. not able; ROW is borrowing from the HC
D D. not able; ROW is lending to the HC
Q46. Assume the world is divided between HC and ROW, with all currency reserves
held by the HC central bank. Then the balance of payments BOP keeps track of
A. the degree to which the HC is borrowing from ROW
B. the degree to which HC exports exceed HC imports
C. the total volume of currency traded in the foreign exchange market
D D. the net change in ROW currency reserves held by the HC central bank
E. the degree to which HC national savings exceed HC total gross investment.
Q47. Assume that the world is divided between HC and ROW, and that all
currency reserves are held by the HC central bank. Using the definitions for
the HC current account CA, the HC "nonofficial" capital account NKA, the
balance of payments BOP, and the HC capital account KA = NKA-BOP introduced in
the online notes for Mishkin Chapter 20, the HC BALANCE OF PAYMENTS ACCOUNTING
IDENTITY requires that the sum of _________ and _________ equals___________ .
A A. CA; NKA; BOP
B. CA; NKA; 0
C. KA; BOP; CA
D. CA; KA; BOP
Q48. Assume that the world is divided between HC and ROW, and that all
currency reserves are held by the HC central bank. Using the definitions for
the HC current account CA, the HC "nonofficial" capital account NKA, the
balance of payments BOP, and the HC capital account KA = NKA-BOP introduced in
the online notes for Mishkin Chapter 20, an HC BALANCE OF PAYMENTS EQUILIBRIUM
requires that the sum of _________ and ___________ equals _____________.
A. CA; NKA; BOP
B B. CA; NKA; 0
C. KA; BOP; CA
D. CA; KA; BOP
Q49. Assume the world is divided between HC and ROW and that all currency
reserves are held by the HC central bank. If the balance of payments BOP is
NEGATIVE, this means that there is an _______ ROW currency and the HC central
bank must _______ ROW currency in exchange for HC currency in the foreign
exchange market in order to support the current transaction plans of HC and
ROW citizens at the current exchange rate.
A. excess supply of; buy
B B. excess demand for; sell
C. excess demand for; buy
D. excess supply of; sell
Q50. Assume the world is divided between HC and ROW, and that all currency
reserves are held by the HC central bank. A BALANCE OF PAYMENTS CRISIS is
said to occur for the HC when the HC balance of payments BOP is negative for
a sustained period of time. A situation that can drastically worsen a
balance of payments crisis for the HC is
A. an upward surge in HC exports to ROW.
B. a rise in the HC interest rate.
C C. speculators trying to move out of HC currency and into ROW currency in
anticipation of a depreciation of HC currency
D. speculators trying to move out of ROW currency and into HC currency in
anticipation of a depreciation of ROW currency