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Macroeconomics (Acemoglu/Laibson/List)
Chapter 10 Credit Markets
10.1 What Is the Credit Market?
1) Economic agents who borrow funds are known as:
A) creditors.
B) debtors.
C) receivers.
D) investors.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
2) Credit is:
A) the loan that a debtor receives.
B) the income that an employee earns.
C) any good that is available for free.
D) any good that cannot be consumed but is used for the production of other goods.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
3) Which of the following statements is true?
A) Money that is lent out is considered to be a liability.
B) People who lend money are known as debtors.
C) People who borrow money are known as creditors.
D) Non-bank institutions are also a part of the credit market.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
4) The additional payment a borrower has to make on a loan is referred to as:
A) credit.
B) stock.
C) interest.
D) principal.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
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5) The total interest that a borrower has to pay on a loan is equal to the:
A) principal plus the rate of interest.
B) principal minus the rate of interest.
C) principal times the rate of interest.
D) principal divided by the rate of interest.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
6) The annual price of a one dollar loan is referred to as the:
A) principal.
B) service tax.
C) rate of interest.
D) discount value.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
7) Which of the following statements is true?
A) Banks are the only financial institutions that lend money and do not accept deposits.
B) Banks are the only financial institutions that do not lend money but accept deposits.
C) Out of two loans, the interest accumulated after the end of a year will be more on the one that
is a smaller principal.
D) Out of two loans, the interest accumulated after the end of a year will be more on the one that
is a larger principal.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
8) If an individual borrows $100 at an annual rate of interest of 5%, how much interest will he
have to pay at the end of a year?
A) $5
B) $10
C) $20
D) $50
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Borrowers and the Demand for Loans
2
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9) If an individual borrows $200 at an annual rate of interest of 10%, what is the total amount
that he will have to repay after one year?
A) $20
B) $200
C) $210
D) $220
Answer: D
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Borrowers and the Demand for Loans
10) If an individual borrows $100, and pays back $100 after a year to settle his loan, it implies
that the rate of interest is:
A) 0 %.
B) 1%.
C) 10%.
D) 100%.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Borrowers and the Demand for Loans
11) A debtor's quantity of credit demanded and the rate of interest are likely to be:
A) unrelated.
B) positively correlated.
C) negatively correlated.
D) positively related if the rate of interest is below 10% and negatively related if it is above 10%.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Borrowers and the Demand for Loans
12) An individual may borrow a certain sum of money from any of the three banks in his town.
Bank 1 offers him loans at an annual rate of 5%, Bank 2 offers him loans at an annual rate of 3%
per year, and Bank 3 offers him a loan at an annual rate of interest of 10%. A rational individual
will:
A) borrow from Bank 1.
B) borrow from Bank 2.
C) borrow from Bank 3.
D) be indifferent about borrowing from any of the three banks.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Borrowers and the Demand for Loans
3
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13) Assuming all else equal, a rise in the rate of interest:
A) results in a fall in the cost of borrowing.
B) results in a fall in the quantity of credit demanded.
C) results in an increase in the number of potential debtors.
D) results in a fall in the amount of interest accumulated on a loan.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
14) The real interest rate is given by:
A) the nominal interest rate adjusted for tax rates.
B) the nominal interest rate adjusted for inflation.
C) the nominal interest rate adjusted for income changes.
D) the nominal interest rate adjusted for changes in exchange rate.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
15) Which of the following equations is correct?
A) Real interest rate = Nominal interest rate + Inflation rate
B) Real interest rate = Nominal interest rate - Inflation rate
C) Real interest rate = Nominal interest rate × Inflation rate
D) Real interest rate = Nominal interest rate / Inflation rate
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
16) If the nominal interest rate in an economy is 6%, and the rate of inflation in the economy is
4%, the real interest rate in the economy is:
A) 2%.
B) 24%.
C) 1.5%.
D) 10%.
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Real and Nominal Interest Rates
4
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17) If the nominal interest rate in an economy is 4% and the real interest rate in the economy is
2%, the rate of inflation in the economy must be:
A) 2%.
B) 4%.
C) -2%.
D) 0.5%.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Real and Nominal Interest Rates
18) Consider two economies: A and B. The nominal interest rate is the same in both economies,
but the rate of inflation is higher in economy B. Which of the following statements will then be
true?
A) The real interest rate will be higher in economy A.
B) The real interest rate will be higher in economy B.
C) The real interest rate will be the same in both economies.
D) Whether the real interest rate is higher in economy A or B will depend on the number of
borrowers in both economies.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Real and Nominal Interest Rates
19) If the nominal interest rate is greater than the real interest rate in an economy:
A) inflation must be positive in the economy.
B) inflation must be negative in the economy.
C) inflation must be zero in the economy.
D) the real interest rate must be negative.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
20) If the real interest rate is greater than the nominal interest rate in an economy:
A) inflation must be positive in the economy.
B) inflation must be negative in the economy.
C) inflation must be zero in the economy.
D) the nominal interest rate must be equal to zero.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
5
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21) If the real interest rate is equal to the nominal interest rate in an economy:
A) inflation must be zero in the economy.
B) inflation must be positive in the economy.
C) inflation must be negative in the economy.
D) the nominal interest rate must be zero.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
22) If the nominal interest rate increases without any change in the rate of inflation:
A) the real interest rate decreases.
B) the real interest rate increases.
C) the real interest rate remains the same.
D) the ratio of real interest rate to nominal interest rate increases.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
23) An optimizing economic agent will use the ________ rate while calculating the economic
cost of a loan.
A) tax
B) exchange
C) real interest
D) nominal interest
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
24) If the annual inflation rate in an economy is "i", then $1 borrowed at the beginning of a year
will have the same purchasing power as ________ dollars at the end of the year.
A) i
B) (1/i)
C) (1 - i)
D) (1 + i)
Answer: D
Difficulty: Hard
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
6
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25) If the annual inflation rate in an economy is positive, the purchasing power of a dollar kept in
a bank:
A) will increase over time.
B) will decrease over time.
C) will remain the same over time.
D) can increase or decrease depending on the economic growth rate.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
26) If the annual inflation rate in an economy is negative, the purchasing power of a dollar:
A) will increase over time.
B) will decrease over time.
C) will remain the same over time.
D) can increase or decrease depending on the nominal interest rate.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Real and Nominal Interest Rates
27) The credit demand curve is the schedule that reports the relationship between the quantity of
credit demanded and ________ in an economy, assuming all else equal.
A) the average tax rate
B) the annual inflation rate
C) the real rate of interest
D) the nominal rate of interest
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
28) The credit demand curve is:
A) vertical.
B) horizontal.
C) upward sloping.
D) downward sloping.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
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29) The slope of the credit demand curve from the text book implies that the:
A) higher the rate of taxation, the lower the quantity of credit demanded.
B) higher the rate of taxation, the higher the quantity of credit demanded.
C) higher the real rate of interest, the higher the quantity of credit demanded.
D) higher the real rate of interest, the lower the quantity of credit demanded.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
30) When the credit demand curve is relatively steep:
A) the quantity of credit demanded is relatively sensitive to changes in the tax rates.
B) the quantity of credit demanded is relatively sensitive to changes in the real interest rate.
C) the quantity of credit demanded is not very sensitive to changes in the tax rates.
D) the quantity of credit demanded is not very sensitive to changes in the real interest rate.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
31) When the credit demand curve is relatively flat:
A) the quantity of credit demanded is relatively sensitive to changes in the taxation rates.
B) the quantity of credit demanded is relatively sensitive to changes in the real interest rates.
C) the quantity of credit demanded is not responsive to changes in the taxation rates.
D) the quantity of credit demanded is not responsive to changes in the real interest rate.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
32) Assuming all else equal, if there is an increase in the real interest rate:
A) the credit demand curve shifts to the left.
B) the credit demand curve shifts to the right.
C) there will be an upward movement along the credit demand curve.
D) there will be a downward movement along the credit demand curve.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
8
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33) Assuming all else equal, a decrease in the real interest rate will cause:
A) the credit demand curve to shift to the right.
B) the credit demand curve to shift to the left.
C) a downward movement along the credit demand curve.
D) an upward movement along the credit demand curve.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
34) Assuming all else equal, if the real interest rate increases, it will lead to:
A) a decrease in the quantity of credit demanded by a firm.
B) an increase in the quantity of credit demanded by a firm.
C) a rightward shift of the credit demand curve of a firm.
D) a leftward shift of the credit demand curve of a firm.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Demand Curve
35) Assuming all else equal, if the real interest rate decreases, it will lead to:
A) an increase in the quantity of credit demanded by a firm.
B) a decrease in the quantity of credit demanded by a firm.
C) the credit demand curve of a firm to shift to the right.
D) the credit demand curve of a firm shifts to the left.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
36) Factors that cause an increase in the demand for credit at a given real interest rate cause:
A) a downward movement along the credit demand curve.
B) an upward movement along the credit demand curve.
C) the credit demand curve to shift to the right.
D) the credit demand curve to shift to the left.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
9
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37) Factors that cause a decrease in the demand for credit at a given real interest rate cause:
A) a downward movement along the credit demand curve.
B) an upward movement along the credit demand curve.
C) the credit demand curve to shift to the right.
D) the credit demand curve to shift to the left.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
38) Which of the following is likely to shift the credit demand curve of an automobile
manufacturer to the right, assuming all else equal?
A) A decrease in the real interest rate
B) An increase in the real interest rate
C) A plan to increase production and expand to newer markets
D) A plan to decrease production and exit from existing markets
Answer: C
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Demand Curve
39) Which of the following is likely to shift the credit demand curve of a computer manufacturer
to the left, assuming all else equal?
A) An increase in the real interest rate
B) A decrease in the real interest rate
C) A decrease in the scale of production
D) An increase in the scale of production
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
40) Assuming all else equal, if an airline company decides to purchase new planes, it is likely to
cause:
A) a downward movement along its credit demand curve.
B) an upward movement along its credit demand curve.
C) its credit demand curve to shift to the right.
D) its credit demand curve to shift to the left.
Answer: C
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Demand Curve
10
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41) Assuming all else equal, if households are optimistic about their future income, it is likely to
cause a(n):
A) downward movement along their credit demand curve.
B) upward movement along their credit demand curve.
C) rightward shift of their credit demand curve.
D) leftward shift of their credit demand curve.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
42) Assuming all else equal, if households are pessimistic about their future income, it is likely
to cause a(n):
A) downward movement along their credit demand curve.
B) upward movement along their credit demand curve.
C) rightward shift of their credit demand curve.
D) leftward shift of their credit demand curve.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
43) John is expecting to get a hike in his monthly salary after three months. Assuming all else
equal, this is likely to cause a(n) ________ his current credit demand curve.
A) downward movement along
B) upward movement along
C) leftward shift in
D) rightward shift in
Answer: D
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Demand Curve
44) All else equal, an increase in government borrowing is likely to cause a(n):
A) leftward shift of the credit demand curve.
B) rightward shift of the credit demand curve.
C) upward movement along the credit demand curve.
D) downward movement along the credit demand curve.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
11
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45) All else equal, a decrease in government borrowing is likely to cause a(n):
A) leftward shift of the credit demand curve.
B) rightward shift of the credit demand curve.
C) upward movement along the credit demand curve.
D) downward movement along the credit demand curve.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
46) Savers are willing to lend out money because:
A) of altruism.
B) the rate of inflation in an economy is normally positive.
C) the rate of inflation in an economy is normally negative.
D) they prefer to spend money in the future rather than today.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Saving Decisions
47) Money or goods that parents leave to their children in their wills are referred to as:
A) charity.
B) bequests.
C) interest.
D) social responsibility.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Why Do People Save?
48) The opportunity cost of current consumption is:
A) the inflation rate.
B) real wage rate.
C) the real interest rate.
D) nominal wage rate.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
12
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49) Which of the following statements is true?
A) If the real interest rate increases, the opportunity cost of current consumption increases.
B) If the nominal wage rate increases, the opportunity cost of current consumption decreases.
C) If the real wage rate increases, the opportunity cost of current consumption decreases.
D) If the unemployment rate increases, the opportunity cost of current consumption decreases.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
50) Which of the following statements is true?
A) If the opportunity cost of current consumption is high, people will save more.
B) If the opportunity cost of current consumption is high, people will save less.
C) If the opportunity cost of current consumption is high, the inflation rate will increase.
D) If the opportunity cost of current consumption is high, the unemployment rate will decrease.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
51) Which of the following statements is true?
A) An increase in the real interest rate might discourage savings.
B) An increase in the real interest rate always encourages higher savings.
C) In an economy which has a positive inflation rate, the real wage rate is always greater than the
nominal wage rate.
D) An increase in the nominal wage rate leads to a decrease in the real wage rate if the price
level is stable.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
52) Assuming all else equal, the credit supply curve shows the relationship between the quantity
of credit supplied and the:
A) inflation rate.
B) real wage rate.
C) income tax rate.
D) real interest rate.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
13
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53) The credit supply curve is:
A) vertical.
B) horizontal.
C) upward sloping.
D) downward sloping.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
54) Assuming all else equal, the slope of the credit supply curve implies that:
A) as the inflation rate decreases, the quantity of credit supplied increases.
B) as the inflation rate increases, the quantity of credit supplied increases.
C) as the real interest rate increases, the quantity of credit supplied increases.
D) as the real interest rate decreases, the quantity of credit supplied increases.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
55) Assuming all else equal, an increase in the real interest rate will cause:
A) a leftward shift of the credit supply curve.
B) a rightward shift of the credit supply curve.
C) an upward movement along the credit supply curve.
D) a downward movement along the credit supply curve.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
56) Assuming all else equal, a decrease in the real interest rate will cause:
A) the credit supply curve to shift to the left.
B) the credit supply curve to shift to the right.
C) an upward movement along the credit supply curve.
D) a downward movement along the credit supply curve.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
14
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57) John makes it a point to save a portion of his salary every month. Assuming all else equal, if
the real interest rate increases, it is likely to cause:
A) an upward movement along John's credit supply curve.
B) a downward movement along John's credit supply curve.
C) John's credit supply curve to shift to the left.
D) John's credit supply curve to shift to the right.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Supply Curve
58) Assuming all else equal, any change that causes an increase in the credit supply at a given
real interest rate will cause:
A) the credit supply curve to shift to the left.
B) the credit supply curve to shift to the right.
C) an upward movement along the credit supply curve.
D) a downward movement along the credit supply curve.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
59) Assuming all else equal, any change that causes a decrease in the credit supply at a given real
interest rate will cause:
A) the credit supply curve to shift to the left.
B) the credit supply curve to shift to the right.
C) an upward movement along the credit supply curve.
D) a downward movement along the credit supply curve.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
60) Assuming all else equal, if a household is pessimistic about future income, it is likely to
cause a(n):
A) downward movement along the current credit supply curve of the household.
B) upward movement along the current credit supply curve of the household.
C) shift in the current credit supply curve of the household to the right.
D) shift in the current credit supply curve of the household to the left.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
15
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61) Assuming all else equal, if a household is optimistic about future income, it is likely to
cause:
A) a downward movement along the current credit supply curve of the household.
B) an upward movement along the current credit supply curve of the household.
C) the current credit supply curve of the household to shift to the right.
D) the current credit supply curve of the household to shift to the left.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
62) An automobile manufacturer decides to increase its retained earnings. Assuming all else
equal, this will cause:
A) the current credit supply curve of the firm to shift to the left.
B) the current credit supply curve of the firm to shift to the right.
C) an upward movement along the current credit supply curve of the firm.
D) a downward movement along the current credit supply curve of the firm.
Answer: B
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Supply Curve
63) Assuming all else equal, if a firm decides to pay more dividends and lowers the amount of
retained earnings it holds, it will cause:
A) the current credit supply curve of the firm to shift to the left.
B) the current credit supply curve of the firm to shift to the right.
C) an upward movement along the current credit supply curve of the firm.
D) a downward movement along the current credit supply curve of the firm.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Supply Curve
64) The market where borrowers obtain funds from savers is referred to as the:
A) spot market.
B) credit market.
C) capital market.
D) exchange market.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
16
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65) The loanable funds market is also referred to as the:
A) spot market.
B) credit market.
C) capital market.
D) exchange market.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
66) At the equilibrium rate of interest:
A) the quantity of credit demanded is zero.
B) the quantity of credit supplied is zero.
C) the quantity of credit demanded equals the quantity of credit supplied.
D) the quantity of credit demanded falls short of the quantity of credit supplied.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
67) If the real interest rate is greater than the equilibrium real interest rate:
A) interest rates tend to rise further.
B) the quantity of credit demanded equals the quantity of credit supplied.
C) the quantity of credit demanded falls short of the quantity of credit supplied.
D) the quantity of credit supplied falls short of the quantity of credit demanded.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
68) If the real interest rate is lower than the equilibrium real interest rate:
A) interest rates tend to fall further.
B) the quantity of credit demanded equals the quantity of credit supplied.
C) the quantity of credit demanded falls short of the quantity of credit supplied.
D) the quantity of credit supplied falls short of the quantity of credit demanded.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
17
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69) If the quantity of credit demanded in a market exceeds the quantity of credit supplied in the
market:
A) the real rate of interest tends to fall.
B) the real rate of interest tends to rise.
C) the rate of inflation tends to rise.
D) the unemployment rate tends to fall.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
70) If the quantity of credit supplied in a market exceeds the quantity of credit demanded in the
market:
A) the real rate of interest tends to fall.
B) the real rate of interest tends to rise.
C) the unemployment rate tends to rise.
D) the rate of inflation tends to fall.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
71) Which of the following statements is true?
A) An excess supply of credit exerts an upward pressure on the real rate of interest.
B) An excess demand for credit exerts an upward pressure on the real rate of interest.
C) At rates of interest below the equilibrium rate, there is an excess supply of credit.
D) At rates of interest above the equilibrium rate, there is an excess demand for credit.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
18
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The following figure shows two credit demand curves, CD1 and CD2, and two credit supply
curves, CS1 and CS2.
72) Refer to the figure above. What is the equilibrium rate of interest when the credit demand
curve is CD1 and the credit supply curve is CS1?
A) 2%
B) 3%
C) 4%
D) 5%
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
73) Refer to the figure above. What is the equilibrium quantity of credit when the credit demand
curve is CD1 and the credit supply curve is CS1?
A) $20
B) $30
C) $40
D) $50
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
19
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74) Refer to the figure above. What is the equilibrium rate of interest when the credit demand
curve is CD2 and the credit supply curve is CS1?
A) 2%
B) 3%
C) 4%
D) 5%
Answer: D
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
75) Refer to the figure above. What is the equilibrium quantity of credit when the credit demand
curve is CD2 and the credit supply curve is CS1?
A) $20
B) $30
C) $40
D) $50
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
76) Refer to the figure above. Which of the following statements is true when the credit demand
curve is CD1 and the credit supply curve is CS1?
A) At all rates of interest above 1% there will be an excess supply of credit.
B) At all rates of interest above 2% there will be an excess supply of credit.
C) At all rates of interest above 3% there will be an excess supply of credit.
D) At all rates of interest above 4% there will be an excess supply of credit.
Answer: D
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
77) Refer to the figure above. Which of the following statements is true when the credit demand
curve is CD1 and the credit supply curve is CS1?
A) At all rates of interest above 1% there will be a tendency for real interest rates to fall.
B) At all rates of interest above 2% there will be a tendency for real interest rates to fall.
C) At all rates of interest above 3% there will be a tendency for real interest rates to fall.
D) At all rates of interest above 4% there will be a tendency for real interest rates to fall.
Answer: D
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
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78) Refer to the figure above. Which of the following statements is true when the credit demand
curve is CD2 and the credit supply curve is CS1?
A) At all rates of interest below 5% there will be an excess demand for credit.
B) At all rates of interest below 6% there will be an excess demand for credit.
C) At all rates of interest below 7% there will be an excess demand for credit.
D) At all rates of interest below 8% there will be an excess demand for credit.
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
79) Refer to the figure above. Which of the following statements is true when the credit demand
curve is CD2 and the credit supply curve is CS1?
A) At all rates of interest below 5% there will be a tendency for the interest rate to rise.
B) At all rates of interest below 6% there will be a tendency for the interest rate to rise.
C) At all rates of interest below 7% there will be a tendency for the interest rate to rise.
D) At all rates of interest below 8% there will be a tendency for the interest rate to rise.
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
80) Everything else remaining unchanged, what is likely to happen to the equilibrium real
interest rate and quantity of credit if the credit demand curve shifts to the right?
A) Both equilibrium rate of interest and quantity of credit will increase.
B) Both equilibrium rate of interest and quantity of credit will decrease.
C) The equilibrium rate of interest will increase and the quantity of credit will decrease.
D) The equilibrium rate of interest will decrease and the quantity of credit will increase.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
81) Everything else remaining unchanged, what is likely to happen to the equilibrium real
interest rate and quantity of credit if the credit demand curve shifts to the left?
A) Both equilibrium rate of interest and quantity of credit will increase.
B) Both equilibrium rate of interest and quantity of credit will decrease.
C) The equilibrium rate of interest will increase and the quantity of credit will decrease.
D) The equilibrium rate of interest will decrease and the quantity of credit will increase.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
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82) Everything else remaining unchanged, what is likely to happen to the equilibrium real
interest rate and quantity of credit if the credit supply curve shifts to the left?
A) Both equilibrium rate of interest and quantity of credit will increase.
B) Both equilibrium rate of interest and quantity of credit will decrease.
C) The equilibrium rate of interest will increase and the quantity of credit will decrease.
D) The equilibrium rate of interest will decrease and the quantity of credit will increase.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
83) Everything else remaining unchanged, what is likely to happen to the equilibrium real
interest rate and quantity of credit if the credit supply curve shifts to the right?
A) Both equilibrium rate of interest and quantity of credit will increase.
B) Both equilibrium rate of interest and quantity of credit will decrease.
C) The equilibrium rate of interest will increase and the quantity of credit will decrease.
D) The equilibrium rate of interest will decrease and the quantity of credit will increase.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
84) What is meant by the term "rate of interest"? If the nominal rate of interest in an economy is
6%, and the rate of inflation in the economy is 4%, what is the real rate of interest in the
economy?
Answer: The rate of interest is the additional payment a borrower has to make on a one-dollar
loan typically at the end of a year.
The real rate of interest = nominal rate of interest - inflation rate → the real rate of interest
= 6% - 4% = 2%.
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Borrowers and the Demand for Loans; Real and Nominal Interest Rates
85) What does the slope of the credit demand curve imply? When do movements along a credit
demand curve occur?
Answer: The slope of the credit demand curve is negative and it implies an inverse relationship
between the real rate of interest and the quantity of credit demanded. This means that as the real
interest rate increases, the quantity of credit demanded decreases.
Movements along a credit demand curve occur when, everything else remaining unchanged,
there is a change in the real interest rate.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Demand Curve
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86) Everything else remaining unchanged, what is likely to happen to the credit demand curve of
a software producing firm if:
a. there is an increase in the real interest rate?
b. they plan to expand production in near future?
Answer:
a. If there is an increase in the real interest rate, there will be an upward movement along the
credit demand curve of the software manufacturer.
b. If they plan to expand production in near future, the credit demand curve of the software firm
is likely to shift to the right.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Demand Curve
87) List four reasons why people save.
Answer:
a. First, and foremost, people save for consumption after retirement.
b. People save to cope with possible emergencies or shortages of funds in the future.
c. People save to buy durable goods.
d. People save so that they can invest in a personal business.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Why Do People Save?
88) What does the slope of the credit supply curve imply? When do movements along a credit
supply curve occur?
Answer: The credit supply curve has a positive slope that implies a positive relationship
between the real interest rate and the quantity of credit supplied. This means that as the real
interest rate increases, the quantity of credit supplied increases.
Movements along a credit supply curve occur when there are changes in the real interest rate,
everything else remaining unchanged.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
89) Everything else remaining unchanged, what is likely to happen to the credit supply curve of
households if:
a. there is a decrease in the real interest rate?
b. households expect a recession in near future?
Answer:
a. Everything else remaining unchanged, if there is a decrease in the real interest rate, there will
be a downward movement along the credit supply curve of households.
b. Everything else remaining unchanged, if households expect a recession in near future, they
will tend to save more today. This will cause the credit supply curve of households to shift to the
right.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Credit Supply Curve
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90) What is the loanable funds market? What happens if the real interest rate in the market is
held above the equilibrium interest rate?
Answer: The loanable funds market is the market where borrowers obtain funds from savers.
In such a market, if the real interest rate is held above the equilibrium interest rate, the quantity
of credit supplied will exceed the quantity of credit demanded. This will create a downward
pressure on the real interest rate.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
91) Everything else remaining unchanged, what is likely to happen to the equilibrium quantity of
credit and the real interest rate if:
a. the credit demand curve shifts to the right?
b. the credit supply curve shifts to the left?
Answer:
a. Everything else remaining unchanged, if the credit demand curve shifts to the right, there will
be an increase in both the equilibrium quantity of credit and the real interest rate.
b. Everything else remaining unchanged, if the credit supply curve shifts to the left, there will
be an increase in the equilibrium real interest rate but a decrease in the equilibrium quantity of
credit.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Equilibrium in the Credit Market
92) An individual plans to borrow a sum of $10,000 for one year. The nominal interest charged
on the borrowed sum is 6%.
a. If he takes the loan, what will be the interest amount and the total amount that he would have
to pay at the end of the year?
b. If the rate of inflation in the economy is 10%, then is it a good idea for him to take the loan?
Why or why not?
Answer:
a. If the individual takes the loan, he will have to pay a rate of interest of 6% for the year.
Hence, interest amount = .06 × 10,000 = $600.
Total amount that he would have to pay back = $10,000 + $600 = $10,600.
b. A rational individual should make his borrowing decisions on the basis of the real interest
rate and not the nominal interest rate.
Annual real interest rate in this case = 6% - 10% = -4%.
Hence, for every $100 that he borrows, after adjusting for inflation, he is actually paying back
$96 after the end of the year. Hence, borrowing at an annual nominal interest rate of 6% when
the annual rate of inflation is 10% is a good idea, and he should take the loan.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Borrowers and the Demand for Loans; Real and Nominal Interest Rates
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93) a. Everything else remaining unchanged, what is likely to happen to the credit demand
curve of an economy if:
i. businesses in the economy see scope for growth and are planning to expand production in the
future?
ii. households are pessimistic about future incomes?
iii. the government is planning to borrow money from financial institutions for investment in
infrastructures?
b. Everything else remaining unchanged, what is likely to happen to the credit supply curve of
an economy if firms tend to hold on to retained earnings instead of paying dividends?
Answer:
a.
i. If businesses in the economy see scope for growth and are planning to expand production in
the future, the credit demand curve of the economy is likely to shift to the right.
ii. If households are pessimistic about future incomes, they are unlikely to borrow more today
as they may not be able to repay the loans in the future. This shifts the credit demand curve of
the economy to the left.
iii. If the government is planning to borrow money from financial institutions to invest in
infrastructures, the credit demand curve of the economy is likely to shift to the right.
b. If businesses hold on to retained earnings instead of paying dividends, they generate savings.
This shifts the credit supply curve to the right.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Credit Demand Curve; The Credit Supply Curve
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94) Illustrate graphically how the equilibrium quantity of credit and real rate of interest will
change from an initial equilibrium if:
a. credit demand decreases at the initial equilibrium rate of interest.
b. credit supply curve increases at the initial equilibrium rate of interest.
Answer: The equilibrium in the credit market is determined by the intersection of the credit
demand curve and the credit supply curve. This is illustrated in the figure below:
In the figure, CD1 is the credit demand curve and CS1 is the credit supply curve. The
intersection of these two curves determines the equilibrium real interest rate at I1 and the
equilibrium quantity of credit at C1.
a. If credit demand decreases, the credit demand curve shifts to the left. The equilibrium real
interest rate and the equilibrium level of credit will decrease. This is illustrated in the figure
below:
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After the credit demand curve shifts to the left to CD2, its intersection with CS1 will determine
the equilibrium real interest rate and the equilibrium quantity of credit. The new equilibrium real
interest rate is I2 and equilibrium quantity of credit is C2. It can be inferred from the figure that
I2 < I1 and C2 < C1.
b. If credit supply increases, the credit supply curve shifts to the right. The equilibrium real
interest rate will decrease and the equilibrium quantity of credit will increase. This is illustrated
in the figure below:
After the credit supply curve shifts to the right to CS2, its intersection with CD1 will determine
the equilibrium real interest rate and the equilibrium quantity of credit. The new equilibrium real
interest rate is I2 and equilibrium quantity of credit is C2. It can be inferred from the figure that
I2 < I1 and C2 > C1.
Difficulty: Hard
AACSB: Application of Knowledge
Topic: Equilibrium in the Credit Market
10.2 Banks and Financial Intermediation: Putting Supply and Demand Together
1) Institutions that channel funds from suppliers of financial capital to users of financial capital
are referred to as:
A) central banks.
B) mutual funds.
C) financial intermediaries.
D) deposit insurance committees.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Banks and Financial Intermediation: Putting Supply and Demand Together
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2) Companies that enable investors to use their savings to buy financial securities are referred to
as:
A) banks.
B) hedge fund companies.
C) private equity funds.
D) asset management companies.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Banks are Only One of Many Types of Financial Intermediaries
3) Investment pools gathered from a small number of very wealthy individuals or institutions are
referred to as:
A) hedge funds.
B) fixed deposits.
C) capital investment.
D) institutional savings.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Banks are Only One of Many Types of Financial Intermediaries
4) Which of these financial intermediaries is most likely to invest in new companies that are just
starting up and have no track record?
A) Hedge funds
B) Private equity funds
C) Venture capital funds
D) Asset management companies
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Banks are Only One of Many Types of Financial Intermediaries
5) Investments that a bank makes are known as:
A) liabilities.
B) assets.
C) deposits.
D) capital.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
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6) Claims that economic agents have against banks are known as:
A) liabilities.
B) assets.
C) deposits.
D) capital.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
7) Which of the following statements is true?
A) If a firm deposits a sum of $500 in a bank, the sum is a part of the bank's assets.
B) If a firm deposits a sum of $500 in a bank, the sum is a part of the bank's liability.
C) If a bank lends a sum of $600 to a firm, the sum is a part of the bank's liability.
D) If a bank lends a sum of $200 to a household, the sum is a part of the bank's liability.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Assets and Liabilities on the Balance Sheet of a Bank
8) The statement of assets and liabilities of an entity is referred to as:
A) a balance sheet.
B) the balance of payments.
C) an asset-liability sheet.
D) a profit and loss statement.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
9) In the United States, bank reserves include:
A) vault cash and the currency held by the public.
B) vault cash and the bank's holdings on deposit at the Federal Reserve Bank.
C) currency held by the public and bank's holdings on deposit at the Federal Reserve Bank.
D) vault cash, currency held by the public and bank's holdings on deposit at the Federal Reserve
Bank.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
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10) Cash equivalents are:
A) a part of a bank's liability.
B) riskless, liquid assets that banks can immediately access.
C) the amount of deposits held by the public in a particular bank.
D) assets that do not attract interest, and hence generate no additional revenue.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
11) An asset is said to be riskless if:
A) it offers a positive rate of interest.
B) it can be easily converted into cash.
C) its value does not change from day to day.
D) its value is more likely to fall in future.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
12) An asset is liquid if:
A) it offers a positive rate of interest.
B) its value does not change from day to day.
C) it can be easily converted into cash without loss of value.
D) its value is more likely to increase in future.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
13) Suppose Bank A holds $50,000 in deposits with other banks. In the balance sheet, this
amount will be accounted as Bank A's:
A) reserves.
B) cash equivalents.
C) long-term investments.
D) short-term borrowing.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
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14) The value of the real estate that a bank uses for its operations will be included in the bank's:
A) reserves.
B) cash equivalents.
C) long-term investments.
D) short-term borrowing.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
15) Which of the following is NOT an asset of a bank?
A) Official bank reserves
B) Stockholders' equity
C) Cash equivalents of the bank
D) Long-term investments made by the bank
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
16) Deposit made by the public into a savings account are referred to as:
A) overdraft.
B) demand deposits.
C) current deposits.
D) stockholders' equity.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
17) Demand deposits are termed so because:
A) depositors can demand any rate of interest on such deposits.
B) most consumers want to open such accounts as they are greatly in demand.
C) depositors can withdraw money from such deposits at any point of time.
D) there are no limitations on the amount of money that can be deposited into such accounts.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
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18) Borrowed funds that are to be repaid in a year or more are referred to as:
A) annual debt.
B) long-term debt.
C) loanable funds.
D) stockholders' equity.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
19) If a bank borrows funds for three years, the borrowing will be classified as:
A) long-term debt.
B) demand deposits.
C) stockholders' equity.
D) short-term borrowing.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
20) The difference between a bank's assets and liabilities is referred to as:
A) net profits.
B) gross profits.
C) retained earnings.
D) stockholders' equity.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
21) Which of the following equations is correct?
A) Stockholders' equity + total liabilities = total assets.
B) Stockholders' equity/total liabilities = total assets.
C) Stockholders' equity × total liabilities = total assets.
D) Stockholders' equity - total liabilities = total assets.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
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22) If the total assets of a bank equals $50,000 and the total liabilities of the bank equal $20,000,
stockholders' equity will equal:
A) $20,000.
B) $30,000.
C) $50,000.
D) $70,000.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Banks and Financial Intermediation: Putting Supply and Demand Together
23) If the stockholders' equity of a bank is $30,000 and the total liabilities of the bank is $10,000,
the total assets of the bank will equal:
A) $10,000.
B) $20,000.
C) $30,000.
D) $40,000.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
24) Which of the following will NOT be included in a bank's liability?
A) Cash equivalents of the bank
B) Long-term debt of the bank
C) Short-term borrowing by the bank
D) Demand deposits held with the bank
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
25) Differentiate between asset management companies and venture capital funds.
Answer: Asset management companies enable investors to use their savings to buy financial
securities like stocks and bonds. On the other hand, venture capital funds are a particular kind of
private equity fund that invest in new companies that are just starting up and therefore have no
track record.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Banks and Financial Intermediation: Putting Supply and Demand Together
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26) List the various categories in which a bank's assets are divided?
Answer: A bank's assets are divided into:
a. bank reserves: These include vault cash and its holdings on deposit at the central bank of the
country.
b. cash-equivalents: These are riskless, liquid assets that the bank can immediately access, like
deposits with other banks.
c. long-term investments: These are mostly comprised of loans to households and firms, but also
include things like the value of the real estate that the bank uses for its operations.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
27) List the various categories into which a bank's liabilities are divided?
Answer: A bank's liabilities are divided into the following.
a. Demand deposits: These are funds loaned to the bank by depositors.
b. Short-term borrowing: This is comprised of short-term loans that a bank has obtained from
other financial institutions
c. Long-term debt: This is defined as debt that is to be repaid in a year or more.
d. Stockholders' equity: This is defined as the difference between a bank's total assets and
liabilities.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Assets and Liabilities on the Balance Sheet of a Bank
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28) The following table shows different statistics related to the Bank of Barylia.
From the information in the table, estimate:
a. Total assets of the bank
b. Total liabilities of the bank
c. Stockholders' equity of the bank
Answer:
a. Total assets of the bank = Reserves + cash equivalents + long-term investments
= $(400 + 450 + 1,000) million
= $1,850 million
b. Total liabilities of the bank = Demand deposits + long-term debt + short-term borrowing
= $(800 + 300 + 375) million
= $1,475 million
c. Stockholders' equity = Total assets - Total liabilities
= $(1,850 - 1,475) million
= $375 million
Difficulty: Hard
AACSB: Application of Knowledge
Topic: Assets and Liabilities on the Balance Sheet of a Bank
10.3 What Banks Do
1) ________ refers to the time until debt must be repaid.
A) Principal
B) Maturity
C) Dividend
D) Time value of money
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Maturity Transformation
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2) Demand deposits have a ________ maturity.
A) 0-year
B) 1-year
C) 2-year
D) 3-year
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Maturity Transformation
3) The transfer of short-term liabilities into long-term investments is called:
A) risk transformation.
B) maturity transformation.
C) investment restructuring.
D) intertemporal transformation.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Maturity Transformation
4) One of the risks of maturity transformation is that:
A) it discourages savings.
B) it can lead to bank runs.
C) it can increase the rate of inflation.
D) it reduces the profitability of banks.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Maturity Transformation
5) As long as a bank's stockholders' equity is greater than zero:
A) bank runs are not possible.
B) the bank bears all the risk involved.
C) the customers of the bank bear all the risk involved.
D) the stockholders in the bank bear all the risk involved.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Management of Risk
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6) Normally, the Federal Deposit Insurance Corporation would shut down a bank when:
A) stockholders' equity is greater than zero.
B) assets of the bank exceed the liabilities of the bank.
C) liabilities of the bank exceed the assets of the bank.
D) assets of the bank equal the liabilities of the bank.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Management of Risk
7) Which of the following is a role of the Federal Deposit Insurance Corporation in the United
States?
A) It monitors the money supply.
B) It controls the real rate of interest.
C) It regulates banks that are insolvent.
D) It determines the monetary policy of the country.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Management of Risk
8) Which of the following is a role of the Federal Deposit Insurance Corporation in the United
States?
A) It monitors the money supply.
B) It controls the real rate of interest.
C) It safeguards deposits held with banks.
D) It determines the monetary policy of the country.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Management of Risk
9) One of the impacts of maturity transformation is that:
A) it increases the rate of inflation.
B) it decreases the rate of inflation.
C) relatively liquid assets become relatively illiquid.
D) relatively illiquid assets become relatively liquid.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Runs
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10) A bank is insolvent when:
A) its total assets exceed its total liabilities.
B) its total liabilities exceed its total assets.
C) its stockholders' equity exceeds its total assets.
D) its stockholders' equity exceeds its total liabilities.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Runs
11) A bank is solvent when:
A) the value of its total assets exceeds the value of its liabilities.
B) the value of its liabilities exceeds the value of its assets.
C) its stockholders' equity exceeds the value of its assets.
D) the value of its liabilities exceeds its stockholders' equity.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Runs
12) Consider two banks: Bank A and Bank B. Suppose the value of liabilities of both the banks
is equal. However, Bank A is solvent but Bank B is insolvent. This would imply that:
A) the value of Bank A's assets exceeds the value of Bank B's assets.
B) the value of Bank B's assets exceeds the value of Bank A's assets.
C) the value of Bank A's liabilities exceeds the value of Bank A's assets.
D) the value of Bank B's assets exceeds the value of Bank B's liabilities.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Bank Runs
13) A bank run occurs when:
A) a bank's assets exceeds its liabilities.
B) a bank sells its assets to its own stockholders.
C) the central monetary authority regulates the functioning of banks.
D) a bank experiences an extraordinarily large volume of withdrawals.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Runs
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14) An institutional bank run is most likely to occur when:
A) households deposit their money into a weak bank.
B) households withdraw their money from a weak bank.
C) firms and other banks withdraw money from a weak bank.
D) firms and other banks deposit their money into a weak bank.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Regulation and Bank Solvency
15) A well-capitalized bank:
A) owns far more than it owes.
B) does not have stockholders' equity.
C) is prone to bank runs.
D) only accepts deposits but does not advance loans.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Regulation and Bank Solvency
16) Systemically important financial institutions are:
A) all banks whose value of assets exceeds its value of liabilities.
B) all banks whose value of liabilities exceeds its value of assets.
C) large banks that have become a large market power.
D) banks that are owned and run by the government.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Too Big to Fail
17) In the case of banks, "living wills" spell out:
A) the amount of bank resources to be retained as stockholders' equity.
B) the balance sheet of systemically important financial institutions.
C) how a bank would sell its assets and pay of its creditors in the event of shutdown.
D) the long term business development plans of systematically important financial institutions.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Too Big to Fail
39
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18) Which of the following statements is true of the U.S. economy?
A) No bank runs have occurred after 1990 in the U.S. economy.
B) No bank runs have occurred before 1990 in the U.S. economy.
C) Almost one-fourth of the U.S. banks failed during the Great Depression.
D) The number of bank runs decreased after the FDIC was established.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Evidence-Based Economics: How Often Do Banks Fail?
19) The biggest wave of bank failures in the U.S. occurred:
A) before the Great Depression.
B) during the Great Depression.
C) in the early 1990s.
D) during 2007 to 2009.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Evidence-Based Economics: How Often Do Banks Fail?
20) The most established theory of stock prices relates a company's asset prices to:
A) the future value of inflation and interest rates.
B) past earnings of companies and past values of interest rates.
C) future earning prospects of companies and future values of interest rates.
D) future earning prospects of companies and future values of inflation rates.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Asset Price Fluctuations and Bank Failures
21) The theory of efficient markets suggests that:
A) interest rates and inflation rates are inversely related.
B) systemically important financial institutions are more likely to fail.
C) all movements in stock markets are based on rational appraisals of new information.
D) long-term investments by banks are more profitable than short-term investments.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Asset Price Fluctuations and Bank Failures
40
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22) What are the three functions that banks perform as financial intermediaries?
Answer: The three functions that banks perform as financial intermediaries are:
a. Banks identify good investment options.
b. Banks transform short-term liabilities like deposits, into long-term investments.
c. Banks transfer risk from depositors to the bank's stockholders and, in some cases, to the
government.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Banks Do
23) In banking terminology, what is meant by maturity? What is meant by maturity
transformation?
Answer: In banking terminology, maturity refers to the time until debt must be repaid. Maturity
transformation is a process by which banks take short-maturity liabilities and invest in longmaturity assets.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Maturity Transformation
24) Differentiate between a solvent bank and an insolvent bank. Which of the two is likely to
have a greater stockholders' equity?
Answer: A bank is solvent when the value of the bank's assets is greater than the value of its
liabilities. A bank becomes insolvent when the value of the bank's assets is less than the value of
its liabilities.
Since stockholders' equity is defined as total assets of a bank less the total liabilities, a solvent
bank is likely to have a greater stockholders' equity than an insolvent bank.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Runs
41
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25) The Bank of Lithasia plans to increase its revenue by using demand deposits held with the
bank for long-term investments. What is this process known as? Is there any risk associated with
this process? If yes, how can the risk be reduced?
Answer: The process that Bank of Lithasia is planning to apply is known as maturity
transformation. Maturity refers to the time until debt must be repaid. Maturity transformation
refers to the process by which banks take short-term liabilities and invest in long-term assets.
This process allows society to undertake long-term investments.
One of the implications of such maturity transformations is that it creates a mismatch between
the short-term maturities of deposits held with the bank and the long-term maturities of the
investment made by the banks. Hence, if a large number of depositors simultaneously want to
withdraw money from the bank, it can create a problem for the bank, as they may not have
enough funds to allow for the withdrawal. Moreover, it is not possible for banks to recover the
money they have used for long-term investments in such a short notice to repay the depositors.
Hence, maturity transformations can place banks in a risky position.
One possible method for banks to minimize the risks associated with maturity transformations is
to maintain some fraction of the deposit pool as reserves or some other form of cash-like
security. A small reserve usually suffices because only a small fraction of depositors are likely to
withdraw their deposits on the same day.
Difficulty: Hard
AACSB: Application of Knowledge
Topic: What Banks Do
26) Consider two banks: Bank A and Bank B. Bank A has total assets worth $50,000 and total
liabilities worth $24,000. Conversely, Bank B has total assets worth $100,000 and total liabilities
worth $90,000. Given this information, which of the two banks is more prone to bank runs and
why?
Answer: A bank run occurs when a bank experiences extraordinarily large volumes of
withdrawals driven by a concern that the bank will run out of liquid assets with which to pay its
depositors. This implies that bank runs are more likely to occur when depositors do not have
much confidence on the solvency of a bank. Hence, one of the key methods to prevent such bank
runs is to have lots of stockholders' equity and be well-capitalized. A bank is said to be wellcapitalized if it owns far more than what it owes.
From the given information, the stockholders' equity for both banks can be calculated.
Bank A's stockholders' equity = $50,000 - $24,000 = $26,000.
Bank B's stockholders' equity = $100,000 - $90,000 = $10,000.
The stockholders' equity implies that bank A owns more than it owes, while bank B owes more
than it owns. Hence, bank B is more prone to bank runs than bank A.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Bank Regulation and Bank Solvency
42
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