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Money and Banking Practice
Multiple Choice
Identify the choice that best completes the statement or answers the question.
____
1. Money's basic advantage as compared to barter is that
a. everybody has money but not everyone has the opportunity to barter.
b. a money system relies on a double coincidence of wants.
c. money reduces transaction costs.
d. money is the only medium you can use to store your wealth.
____
2. Open Market Operations are conducted by
a. the main Fed office in Washington, D.C.
b. the U.S. Treasury on behalf of the Fed.
c. the Federal Reserve Bank of New York.
d. a consortium of private banks contracted by the Fed.
____
3. Open market operations are the
a. buying and selling of Federal Reserve Notes in the open market.
b. means by which the Fed supplies the economy with currency.
c. means by which the Fed acts as the government's banker.
d. buying and selling of government securities by the Fed.
e. buying and selling of government securities by the Treasury.
____
4. If the Fed purchases government securities from a commercial bank, which of the following will happen?
a. The Fed will increase the bank's reserves on deposit at the Fed.
b. The Fed will decrease the bank's reserves on deposit at the Fed.
c. The assets (government securities) of the Fed will decrease.
d. The assets (government securities) of the Fed will increase.
e. a and d
____
5. When one commercial bank borrows from another commercial bank, it pays the __________ rate.
a. discount
b. bank interest
c. federal funds
d. prime
e. none of the above
____
6. The interest rate that a commercial bank pays when it borrows from the Fed is the __________ rate.
a. discount
b. exchange
c. federal
d. bank
____
7. Which of the following will decrease the money supply?
a. an increase in the discount rate (relative to the federal funds rate)
b. an increase in the required reserve ratio
c. an open market purchase by the Fed
d. a and b
e. a, b, and c
____
8. When the Fed sells government securities to a bank, the
a. bank’s reserves increase.
b. bank’s reserves decrease.
c. bank’s reserves do not change.
d. securities are an asset for the bank.
e. b and d
____
9. When the Fed increases the required reserve ratio, a bank's
a. required reserves are unaffected.
b. required reserves are increased.
c. required reserves are decreased.
d. excess reserves are decreased.
e. b and d
____ 10. Why does the president of the Federal Reserve Bank of New York hold a permanent seat on the FOMC?
a. The New York Fed is responsible for executing open market operations.
b. A substantial amount of financial activity takes place in New York City.
c. The Fed Board of Governors holds its regularly scheduled meetings in New York City.
d. The Federal Reserve Bank of New York is the original Fed district; the other eleven
districts were formed later by the Banking Act of 1935
e. a and b
____ 11. Fractional reserve banking originated
a. when the United States Congress passed a law regarding the required reserve ratio.
b. when goldsmiths realized they could issue warehouse receipts beyond gold on deposits.
c. with the establishment of the Federal Reserve System.
d. in the United States with the Clayton Act.
____ 12. Which of the following represents a double coincidence of wants?
a. Smith has what Jones has and neither wants what the other has.
b. Smith has what Jones wants but Jones doesn't have what Smith wants.
c. Smith has what Jones wants and Jones has what Smith wants.
d. Smith wants what Jones has, Jones wants what Brown has, and Brown wants what Smith
has.
e. none of the above
____ 13. Every time the Fed buys or sells on the open market, the __________ changes.
a. budget deficit
b. income tax rate
c. money supply
d. a and b
e. a, b, and c
____ 14. Suppose that the current federal funds rate is above the federal funds target rate. In order to lower the federal
funds rate the Fed will ________________ securities on the open market which will ________________ the
supply of reserves in the market for reserves, pushing the rate closer to the target rate.
a. sell; increase
b. purchase; increase
c. purchase; decrease
d. sell; decrease
Essay
15. List and describe the three functions of money.
16. Explain why it is not necessary for paper money to be backed by some commodity (e.g. gold) before it can
have value.
17. List and describe the three major monetary policy tools the Federal Reserve can use to increase the money
supply. Be specific in your response regarding which direction the tool would need to change in order for the
money supply to grow.
18. What is the name and make-up of the policymaking group that has the authority to conduct open market
operations? Describe how the use of open market operations helps to increase or decrease the money supply.
19. Explain the major differences between the Federal Reserve and the U.S. Treasury.
20. Explain the difference between the discount rate and the federal funds rate. If the Fed wants to lower one of
these rates, which one can the Fed change by issuing an order? Describe in detail how the Fed helps to lower
the other rate.
Money and Banking Practice
Answer Section
MULTIPLE CHOICE
1. ANS:
LOC:
2. ANS:
LOC:
3. ANS:
LOC:
4. ANS:
LOC:
5. ANS:
LOC:
6. ANS:
LOC:
7. ANS:
LOC:
8. ANS:
LOC:
9. ANS:
LOC:
10. ANS:
LOC:
11. ANS:
LOC:
12. ANS:
C
PTS: 1
The role of money
C
PTS: 1
The role of government
D
PTS: 1
The role of government
E
PTS: 1
Monetary and fiscal policy
C
PTS: 1
Monetary and fiscal policy
A
PTS: 1
Monetary and fiscal policy
D
PTS: 1
Monetary and fiscal policy
E
PTS: 1
Monetary and fiscal policy
E
PTS: 1
Monetary and fiscal policy
E
PTS: 1
The role of government
B
PTS: 1
The role of money
C
PTS: 1
DIF: Easy
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Difficult
NOT: New
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
DIF: Moderate
NAT: Analytic
NAT: Analytic
LOC:
13. ANS:
LOC:
14. ANS:
LOC:
The role of money
C
PTS: 1
Monetary and fiscal policy
B
PTS: 1
The role of money
DIF: Moderate
NAT: Analytic
DIF: Moderate
NOT: New
NAT: Analytic
ESSAY
15. ANS:
Money serves as a medium of exchange, a unit of account and a store of value. Medium of exchange - In a
money economy, money serves as the medium through which transactions are made. Unit of account - Money
is the common standard by which value is determined in a money economy (a "yardstick" of value). Store of
value - Money will retain value over time.
PTS: 1
DIF: Moderate
NAT: Analytic
LOC: The role of money
16. ANS:
The U.S. money supply is no longer backed by gold, but that does not mean that it does not have value. It is
the general acceptability of paper money that gives it value. As long as sellers continue to accept paper
money as payment in exchange for goods and services that are valuable, the paper money will continue to
have value.
PTS: 1
DIF: Moderate
NAT: Analytic
LOC: The role of money
17. ANS:
Open market operations are when the Fed buys or sells U.S. government securities in financial markets. In
order to increase the money supply, the Fed buys government securities (called an open market purchase). As
the Fed makes open market purchases, the money paid by the Fed to the seller of the securities will result in
an increase in bank reserves and the money supply will ultimately increase. Another option the Fed uses to
increase the money supply is to lower the discount rate. The discount rate is the interest rate charged by the
Fed to banks that need to borrow reserves. The lower the discount rate is relative to the federal funds rate, the
more likely the banks are to borrow from the Fed. As a bank borrows from the Fed, the bank's reserves
increase while the reserves of no other bank decrease, creating an increase in reserves for the banking system.
The final monetary policy tool used by the Fed is changing the required reserve ratio. If the Fed wants to
increase the money supply, they will decrease the required reserve ratio, allowing banks to loan a larger
portion of checkable deposits.
PTS: 1
DIF: Moderate
NAT: Analytic
LOC: Monetary and fiscal policy
18. ANS:
The group responsible for conducting open market operations is the Federal Open Market Committee
(FOMC). The FOMC is made up of twelve members. They are the seven board members, the president of the
New York Federal Reserve District Bank, and four other Federal Reserve District Bank presidents (who rotate
on and off the committee every year). In order to decrease the money supply, the Fed sells government
securities (called an open market sale). As the Fed makes an open market sale, the money paid to the Fed by
the buyer of the securities will result in a decrease in bank reserves and the money supply will ultimately
decrease.
PTS: 1
19. ANS:
DIF: Difficult
NAT: Analytic
LOC: The role of government
Although many people confuse the Treasury and the Fed, each has its own distinct role to play. The U.S.
Treasury is a budgetary agency, while the Federal Reserve is a monetary agency. The Treasury is responsible
for managing the financial affairs of the federal government. In this capacity they collect the taxes and
borrow the funds necessary to pay for government expenditures. The Fed is primarily concerned with the
availablity of money and credit for the entire economy, in doing so they help to provide a stable monetary
framework for the economy. Unlike the Treasury, the Fed can create money “out of thin air”. The Treasury
mints the coins, and the Fed issues paper money. The Treasury issues Treasury securities, but the Fed does
not.
PTS: 1
DIF: Difficult
NAT: Analytic
LOC: The role of government
NOT: New
20. ANS:
The federal funds rate is the interest rate that banks charge one another for borrowing funds, while the
discount rate is the interest rate that the Fed charges banks that borrow funds from them. The discount rate is
the rate that the Fed can change by issuing an order. The federal funds rate is determined in the federal funds
market. The Fed changes the federal funds rate by changing the amount of reserves in the banking system.
More specifically, if the Fed wants to lower the federal funds rate they will need to exert downward pressure
on this rate in the federal funds market. They can do this by conducting an open market purchase. This
purchase would inject more reserves into the banking system, thereby increasing the supply of reserves in the
federal funds market. As in any other market, when the supply increases the “price” paid (in this case, the
federal funds rate) to get that item would decline.
PTS: 1
DIF: Difficult
NAT: Analytic
LOC: Monetary and fiscal policy