tesfatsi@iastate.edu
ANSWER OUTLINE WITH COMMENTARY
ECON 353 -- SECTION 1 L. Tesfatsion
SECOND MIDTERM EXAM: 40 POINTS TOTAL April 4, 2002
Q1. The key difference between nominal GDP (gross domestic product)
and real GDP for the United States is that
A. Nominal GDP includes production outside the borders of the U.S.
whereas real GDP does not.
B. Nominal GDP includes financial assets whereas real GDP includes only
real assets.
C. Nominal GDP is the initial measure of output and real GDP is the
final revised measure of output.
D D. Nominal GDP is not corrected for possible changes in prices whereas
real GDP is corrected for possible changes in prices.
NOTE: Variant of Q1 on Exercise 1.
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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.
NOTE: Variant of Q3 on Exercise 1 and Q5 on the first midterm.
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Q3. Which of the following can be described as DIRECT finance:
A. Enron Corporation sells its holdings of U.S. Treasury bonds in the
U.S. government bond market.
B B. Jipu.com sells newly issued stock shares in a 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.
NOTE: Variant of Q16 on the first midterm exam.
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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. An issuer of a common stock share promises to make one or more payments
to the purchaser in accordance with a definite time schedule.
C. All debt instruments are traded in the money market and all equity
instruments are traded in the capital market.
D. All of the above statements are true.
E. Only A and B are true.
NOTE: 14 people incorrectly answered E. Please review the
discussion of common stock shares in the Notes on Mishkin Chapter 2:
Part B. An issuer of a common stock share makes no promise of any
payments to the purchaser (scheduled or not). Dividends may or may
not be paid -- there is no obligation on the part of the issuer to
pay them. This is a critical distinction between debt instruments
and common stock shares, or great practical importance to any
would-be investors.
This is a variant and blend of Q17 and Q18 on the first midterm
exam.
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Q5. Which of the following statements is/are true in general for
COUPON BONDS?
A. The issuer makes a fixed coupon payment in every payment period during
the life of the bond, plus a face value payment at maturity.
B. 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.
C. Treasury notes are examples of coupon bonds.
D D. All of the above.
E. Only A and B.
NOTE: 29 people incorrectly answered E. Please review
Mishkin Chapter 4, and the accompanying online notes for Mishkin
Chapter 4:Part B, where it is pointed out that Treasury notes (as
well as Treasury bonds and corporate bonds) are coupon bonds.
Recall, in particular, the discussion in class, in Mishkin Chapter
4, and in the online notes for Mishkin Chapter 4: Part B, on
"Reading Financial Bond Tables" where it is seen that coupon rates
are regularly reported for Treasury bonds. Only *coupon* bonds have
*coupon* rates.
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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.
NOTE: Variant of Q1 on Exercise 3.
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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.
NOTE: 27 people incorrectly answered D. However, as stressed
in class lectures on Mishkin Chapter 3, and again when going over
the answer key for the First Midterm Exam (travelers check question
Q22), the only legal tender in the U.S. is U.S. government issued
notes and coins. No private-issued money is legal tender.
15 people incorrectly answered A, thus overlooking that B is
also a correct statement. Please review the discussion in Mishkin
Chapter 3 (and the accompanying online notes) on the narrowest
measure of money M1 (which includes checkable deposit accounts) and
the next most narrow measure of money M2 (which includes M1).
Please note that this question is very similar in form to Q22
on the First Midterm Exam.
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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).
NOTE: Variant of Q5 on Exercise 3.
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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 Bank of North America to issue collateralized notes for the first
time.
C. the North to use commodity monies and backed paper monies for the
first time.
D D. the U.S. Treasury to issue unbacked paper money ("greenbacks") as
legal tender in the U.S. for the first time.
E. the U.S. Treasury to issue Federal Reserve Notes for the first time.
NOTE: 35 people correctly answered D. The remaining people
scattered their answers across the remaining possibilities. Please
note this question (how the North attempted to finance its war
efforts during the Civil War) is one of the "key in-class discussion
questions" for Mishkin Chapter 3 discussed at some length in class.
(The basic material for the class discussion was taken from websites
on the history of money listed at the "Websites Related to Mishkin
Chapter 3" site linked to the Econ 353 syllabus.)
Please note that a similar type question (for the American
Revolution instead of the Civil War) appeared on the First Midterm
Exam (Q26) and on Exercise 3 (Q6).
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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. 10 percent.
C. 8 percent.
D. 5 percent.
E E. 4 percent.
NOTE: 14 people incorrectly answered A and 19 people incorrectly
answered D. Current yield for a coupon bond is the coupon payment C
divided by the purchase price Pb, thus it here reduces to $400/$10,000
or 4/100 or 4 percent. Please review the discussion of the current
yield in Mishkin Chapter 4. Current yield is one of the three
interest rate measures most extensively used in practice -- e.g., in
financial bond tables. (The other two are yield to maturity and
discount yield.)
This question is a variant of Q1 on Exercise 5.
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Q11. "Present value" is considered to be one of the most important
concepts ever articulated in financial economics because
A. it measures the implicit discount rate used by the market to price assets.
B. it provides an accurate assessment for future interest rate risk.
C C. it permits payment streams on different financial assets to be compared
with each other in terms of a common unit of account.
D. it provides an accurate assessment of an asset's real purchasing power.
E. it provides a way to measure the current value of a financial asset
without having to consider the timing and amount of future payments.
NOTE: 11 people incorrectly answered D and 19 people
incorrectly answered E. Please review the definition of this
extremely important concept discussed in Mishkin Chapter 4 and in
the online Notes on Mishkin Chapter 4: Part A. Present value makes
no correction for inflationary effects (so D is incorrect) and its
calculation requires a careful consideration of the timing and
amount of future payments (so E is incorrect).
Please not that this question was taken almost verbatim from
the first midterm exam (Q31). The large number of people getting
this answer wrong suggests that the online answer key for the First
Midterm Exam was not sufficiently used as a review tool for the
Second Midterm Exam.
Important Advice: Any questions that you get wrong on an exam
should be looked at closely to figure out what went wrong, so that
the mistake or misunderstanding is not repeated on later exams.
Please recall that all exams for Econ 353 are comprehensive, so this
same advice applies for the Final Exam -- any mistakes or misunderstandings
that arose for you on either of the first two midterm exams should
be carefully considered and corrected prior to the final exam.
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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 A. i = 2 percent and the expected inflation rate = -3 percent
B. i = 7 percent and the expected inflation rate = 3 percent
C. i = 13 percent and the expected inflation rate = 10 percent
D. i = 25 percent and the expected inflation rate = 23 percent
NOTE: This question is a variant of Q37 on the first midterm.
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Q13 "Interest rate risk" is the risk faced by ____ in the form of
__________.
A. a potential lender; fluctuations in the purchase price of bonds
B. a borrower who has already issued a bond; fluctuations in the interest
payments the borrower will have to make to the bond holder.
C C. a bond holder; fluctuations in the yield to maturity, hence in
the period-by-period return rate on the bond.
D. a potential borrower; fluctuations in the interest payments the borrower
will have to make to the lender.
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.
NOTE: 18 people incorrectly answered D, 12 people incorrectly
answered B, and 7 people incorrectly answered A. The definition of
interest rate risk is covered in Mishkin Chapter 4 and in the online
notes for Mishkin Chapter 4: Part B, and it was discussed in class.
Particular emphasis was placed on the fact that interest rate risk
is a particular type of risk faced by bond HOLDERS, i.e., those who
already have purchased bonds and are worried about possible capital
losses due to fluctuations in the yield to maturity (equivalently,
the bond price) and hence in the overall return rate on the held bonds.
This question was taken nearly verbatim from the first midterm
exam (Q39). Again, it appears that the First Midterm Exam was
insufficiently used as a review tool for the Second Midterm Exam.
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Q14. 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
NOTE: 26 people correctly answered D, with all remaining answers
scattered across remaining possibilities. Please review Mishkin
Chapter 5, particularly Table 3: "Factors that Shift the Supply of
Bonds" and the accompanying discussion.
All else equal, an increase in the expected profitability of
investments should lead more people to borrow funds in order to
exploit these investment opportunities. An increase in the expected
inflation rate lowers the real cost of future interest payments that
bond suppliers (borrowers) will have to pay to lenders, which makes
borrowing more attractive. A higher government deficit (gap between
the government's expenditures and its revenues) suggests that
government will need to engage in additional borrowing (i.e., will
have to supply more bonds in the bond market) in order to finance
this deficit.
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Q15. 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
E. only A and B
NOTE: 23 people correctly answered A, with remaining answers
scattered across remaining possibilities. Please review Mishkin
Chapter 5, in particular Table 2: "Factors that Shift the Demand
Curve for Money" and the accompanying discussion.
An increase in the expected inflation rate reduces the real
purchasing power of interest payments, which makes the purchase of
bonds LESS attractive to buyers -- hence B is incorrect. An
increase in the expected profitability of capital investment will
tend to pull funds AWAY from bond purchase (lending to others) and
TOWARD capital investment (purchase of real assets or purchase of
stock shares, which are a claim on real assets).
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Q16. 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
NOTE: This question is a variant of Q4 on Exercise 6.
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Q17. If 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, this might lead
people to ________ because ____________.
A. demand fewer bonds today; bond prices a year from now will be lower
than expected.
B B. demand more bonds today; bond prices a year from now will be higher
than expected.
C. supply more bonds today; bond prices a year from now will be lower
than expected.
D. supply more bonds today; bond prices a year from now will be higher
than expected.
NOTE: 20 people incorrectly answered A. The yield to maturity
being LOWER next year corresponds to a HIGHER bond price next year,
not a lower bond price next year. Thus A is incorrect because its
second part is incorrect.
Please recheck this crucial inverse relationship between the
yield to maturity on a bond and the bond's price, discussed in Mishkin
Chapter 4, in the online notes on Mishkin Chapter 4: Part A, and
stressed repeatedly in class. An understanding of this inverse
relationship is of direct practical importance for personal
financial decision making and for interpreting the meaning of
everyday financial news reports.
This question is a blend of Q2, Q5, and Q6 on Exercise 6.
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Q18. If Fed Chairman Alan Greenspan 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
that (all else equal) 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
NOTE: This question is an almost verbatim version of Q6 on
Exercise 6.
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Q19. 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 affected by government
policy actions (such as new bond issue to fund government deficits);
B. 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.
C. 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)
D D. all of the above
E. only B and C
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Q20. In GDP accounting for the HC, _______ 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
NOTE: This question is a variant of Q1 on Exercise 8.
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Q21. If the euro-U.S.$ exchange rate changes from 1 euro per U.S.$
to 0.87 euros per U.S.$, then
A. the euro has appreciated and the U.S.$ has appreciated
B. the euro has depreciated and the U.S.$ has appreciated
C C. the euro has appreciated and the U.S.$ has depreciated
D. the euro has depreciated and the U.S.$ has depreciated
NOTE: 34 people incorrectly answered B. Please recheck the
meanings of "appreciated" (worth more) and "depreciated" (worth
less). If one dollar used to buy 1 euro, and now it only buys 0.87
euros (i.e.,less than 1 euro), then each dollar is worth LESS than
before and so it has DEPRECIATED. (Conversely, the euro has gone
from buying 1 dollar to buying 1/0.87 = 1.5 dollars, so the euro has
APPRECIATED).
APOLOGIES: This answer was incorrectly keyed as "B" in the
original answer outline posted on 4/4/02.
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Q22. The HC central bank might sometimes be reluctant to permit a
depreciation of the HC currency because it _______ the cost to HC
citizens of goods imported from ROW and might therefore encourage
_________ .
A. raises; HC producers to lower their prices
B. lowers; HC producers to lower their prices
C C. raises; HC producers to raise their prices
D. lowers; HC producers to raise their prices
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Q23. 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
NOTE: The PPP condition is discussed in Mishkin Chapter 7, and
in the online Notes on Mishkin Chapter 7. The correct answer, D,
gives in words the PPP condition in level form (as opposed to its
expression in terms of inflation rates): Er = 1, where the real
exchange rate Er is defined to be Er = E*P/PROW. The PPP condition
Er=1 appears as equation (3) in the online Notes on Mishkin Chapter 7.
I am not sure why this question, intended to be perfectly
straightforward, caused problems for so many students. Something
about the phrase "in level form" perhaps? The expression of the PPP
in RATES OF CHANGE form states that the percentage change in the
NOMINAL exchange rate E equals the inflation rate in ROW minus the
inflation rate in HC. The PPP in this rates-of-change form appears
as equation (4) in the online Notes on Mishkin Chapter 7.
Please recall that the PPP condition and the Interest Parity
condition are two of the most fundamental arbitrage relations used
in international finance today. Please be sure to review carefully
the extended discussion of these conditions in Mishkin Chapter 7 and
the online Notes on Mishkin Chapter 7 for the final exam.
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Q24. 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
NOTE: 35 people incorrectly answered D. However, the PPP
condition does not require ROW and the HC to have the same inflation
rates.
To see this explicitly, consider the PPP condition in rates of
change form. This form asserts that the percentage rate of change
of the NOMINAL exchange rate E is equal to the inflation rate in ROW
minus the inflation rate in the HC. Consequently, there is no
requirement that the inflation rates in ROW and the HC have to be
equal. Rather, the PPP condition simply says that the DIFFERENCE in
these two inflation rates is what determines the percentage rate of
change in E.
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Q25. If the inflation rate in China is 3 percent during 2003, and
the inflation rate in Argentina is 35 percent during 2003, then the
theory of PURCHASING POWER PARITY predicts that, during 2003, the
value of the Chinese currency (yuan) measured in terms of the
Argentinian 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
NOTE: This question is a variant of Q5 on Exercise 7.
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Q26. 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.
NOTE: 17 students incorrectly answered C. Please review
carefully the distinction between interest parity and balance of
payments equilibrium. These concepts are discussed in Mishkin
Chapters 7 and 19, respectively, as well as in the associated online
notes on these chapters.
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Q27. 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.
NOTE: 21 students incorrectly answered B. Recall, however,
that interest parity presumes that the deposit accounts in ROW and
the HC have the SAME risk characteristics. The focus of interest
parity is on C, not on any intrinsic risk differences in the deposit
accounts per se. Please review the interest parity discussion in
Mishkin Chapter 7 and the online Notes on Mishkin Chapter 7.
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Q28. 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 1 percent, then the INTEREST PARITY CONDITION predicts that, on
average, nominal interest rates on U.S. bank deposit accounts should
be about
A. 2 percent.
B. -2 percent.
C. -4 percent
D D. 4 percent
NOTE: 29 students incorrectly answered A. The interest parity
condition states that
iHC + percentage rate of = iROW
change in E
-1% 3%
Here the U.S. is the HC, the U.S.'s major trading partners
constitute ROW, and E is the U.S. effective exchange rate index. As
indicated above, iROW (the average nominal interest rate for ROW) is
3 percent, and E is expected to depreciate (decrease) by 1 percent.
Consequently, interest parity predicts that iHC (the nominal
interest rate for the HC) will equal 4%.
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Q29. 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
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Q30. Possible benefits of the 1991 Maastricht Treaty on European
Union for the European countries that have agreed to abide by it
include
A. adoption of the euro as a common unit of account in 1999 and as a common
currency in 2002, which should help to reduce transactions costs.
B. elimination of exchange rate risk among these countries following the
adoption of the euro as a common currency in 2002.
C. much greater ability to respond to external shocks in a flexible way.
D. all of the above.
E E. only A and B.
NOTE: 42 students incorrectly answered D. Please refer to
Section III: "Pondering the Introduction of the Euro," the final
section of the Online Notes on Mishkin Chapter 7. As explained in
this section (see in particular the discussion of potential costs),
the establishment of a SINGLE currency under the direction of a
SINGLE central bank (two major features of the 1991 Maastricht
Treaty) has many commentators worried that the treaty members will
be LESS able to respond flexibly to external shocks.
The potential benefits and costs of having a common currency
euro zone is listed as a "key in-class discussion question" for
Mishkin Chapter 7. This question was taken up in class on Thursday,
March 28th.
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Q31. 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.
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Q32. As conventionally defined in GDP national income accounting in the
United States, the U.S. CAPITAL 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. U.S. net exports+net factor payments to the U.S.+net transfers to U.S.
E E. both A and B.
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Q33. 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
NOTE: This question is a variant of Q4 on Exercise 8.
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Q34. 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
NOTE: This question is a variant of Q2 on Exercise 8.
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Q35. 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 BP, and the HC capital
account KA = NKA-BP introduced in the online notes for Mishkin
Chapter 19, the BALANCE OF PAYMENTS ACCOUNTING IDENTITY for the HC
requires that the sum of _________ and ___________ equals
_____________ A A. CA; NKA; BP
B. CA; NKA; 0
C. KA; BP; CA
D. CA; KA; BP
NOTE: This question is a variant of Q5 on Exercise 8.
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Q36. Assume the world is divided between HC and ROW, and that all
currency reserves are held by the HC central bank. Then the balance
of payments BP 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.
NOTE: A surprisingly large number of people (16) incorrectly
answered E, which actually describes the current account CA and not
the balance of payments BP. Please review the connections and
distinctions between CA and the BP explained at some length in the
online Notes on Mishkin Chapter 7 and Notes on Mishkin Chapter 19.
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Q37. 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 BP, and the HC capital
account KA = NKA-BP introduced in the online notes for Mishkin
Chapter 19, a BALANCE OF PAYMENTS EQUILIBRIUM for the HC requires
that the sum of _________ and ___________ equals _____________
A. CA; NKA; BP
B B. CA; NKA; 0
C. KA; BP; CA
D. CA; KA; BP
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Q38. If the balance of payments BP 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
E. none of the above
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Q39. A "balance of payments crisis" is said to occur for the HC when
A. the HC balance of payments BP is negative for a sustained period of time
B. the HC central bank is experiencing losses of ROW currency reserves
for a sustained period of time
C. the HC central bank is experiencing losses of HC currency reserves for
a sustained period of time
D D. both A and B
E. both A and C
NOTE: 30 people incorrectly answered E. Please review the
discussion in Mishkin Chapter 19 and the online Notes on Mishkin
Chapter 19. As stressed in class on March 28 and again on April 2,
a balance of payments "crisis" is a situation in which there is an
EXCESS DEMAND for ROW currency by private HC and ROW citizens. The
HC central bank is then sitting there making up the difference by
supplying the needed additional ROW currency reserves to the foreign
exchange market, hence the HC central bank is LOSING its reserves of
ROW currency. The problem is that the HC central bank must
ultimately run out of these ROW currency reserves and everyone knows
it. (Could the HC central bank ever "run out" of HC currency
reserves?)
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Q40. 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
NOTE: Despite the problems some people had on Q39 in defining a
balance of payments crisis, nearly everyone answered this question
correctly. This is a bit of a puzzle (i.e., those answering E on
Q39 should logically have selected D on Q40).