1. If the Bank of Canada purchases securities, and the sellers convert the proceeds of the sale into cu
ency.
a. The money supply and monetary base increase by the amount of the sale.
. The monetary base increases and the money supply decreases.
c. The monetary base and the money supply changes.
d. The monetary base and the money supply both increase by more than the amount of the sale.
2. Cu
ently reserve requirements in the Canadian banking system are equal to
a. 3%
. 0%
c. 2%
d. 5%
3. Because the Bank of Canada does not completely control ________, it does not tightly control the monetary base.
a. open market sales
. the bank rate
c. open market purchases
d. advances to banks
4. The Bank of Canada will engage in a sale and repurchase agreement when it wants to ________ reserves ________ in the banking system.
a. increase; permanently
. decrease; temporarily
c. increase; temporarily
d. decrease; permanently
5. A debt contract is incentive compatible
a. if the bo
ower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the bo
ower's net worth in the business.
b. if the bo
ower's net worth is sufficiently high so that the lender's risk of moral hazard is significantly reduced.
c. if the debt contract is treated like an equity.
d. if both (a) and (b) of the above occur.
6. Bank A has chequable deposits of $100 million, vault cash equalling $1 million and deposits at the Bank of Canada equalling $14 million. If the desired reserve rate is ten percent what is the maximum amount Bank A could lend?
a. $14 million
. $5 million
c. $4 million
d. $90 million
7. Financial intermediaries reduce the problems in lending associated with information asymmetries by all the following except:
a. collecting and processing standardized information.
. screening applicants to be sure they are creditworthy.
c. monitoring loan recipients to be sure the funds are used properly.
d. charging interest rates high enough to discourage undesirable bo
owers.
8. Firm A has assets that are mainly in financial securities and whose liabilities ca
y variable interest rates; Firm B has the same assets as Firm A and the same amount of liabilities but its liabilities are all at fixed interest rates. If the central bank lowers interest rates, everything else constant:
a. Firm B's net worth will increase more than Firm A's.
. Firm A's net worth will increase more than Firm B's.
c. Neither firm's net worth will change.
d. The net worth of both firms will increase and by the same amount.
9. The Efficient Markets Hypothesis is consistent with all of the following except
a. short run price movements are unpredictable.
. prices reflect all available information.
c. the best long term strategy is buy and hold.
d. managers that understand investor psychology outperform the market average return.
10. Tom decides to withdraw $300 out of his chequing account. The impact of this transaction on the Bank of Canada's balance sheet will be:
a. no change in total assets or total liabilities, but an increase in the liability of cu
ency and a decrease in the liability of reserves by $300 respectively.
. no change in total assets but a decrease in the liability of cu
ency and an increase in the liability of reserves by $300 respectively.
c. total assets decrease by $300 and the liability of cu
ency decreases by $300.
d. no change in either total assets or total liabilities.
11. The Bank of Canada sells U.S. Treasury bonds to chartered banks. Which of the following best describes the impact on the Bank's and the Banking System's balance sheets resulting from this transaction?
a. The Bank's assets and liabilities increase, the banking systems assets and liabilities decrease.
. The Bank's assets increase and its liabilities both increase. For the banking system, the value of assets and liabilities do not change, only the composition of assets changes.
c. The Bank's assets and liabilities do not change, only the compositions of the assets change. For the banking system, assets and liabilities increase.
d. The Bank's assets and liabilities both decrease. For the banking system, the value of assets and liabilities do not change, only the composition of assets changes.
12. The fact that financial intermediaries employ experts to ca
y out particular activities and so lower transactions costs is usually associated with the following economic concept:
a. the law of demand
. economies of scale
c. comparative advantage
d. information costs
13. Assume that the desired reserve rate is ten percent, banks want to hold excess reserves in an amount that equals three percent of deposits, and the public withdraws ten percent of every deposit in cash. An open market purchase of $1 million by the Fed will see banking system deposits increase by:
A) more than $1 million but less than $10 million.
B) exactly $1 million.
C) less than $1 million.
D) more than $10 million but less than $20 million.
14. An open market sale of securities by the central bank to banks will:
a. increase the banks' revenue even if the bank does nothing with the reserves.
. induce the banks to make more loans since their revenue will decrease if they do nothing.
c. increase the amount of deposits in the banking system.
d. increase the banks' willingness and ability to make loans.
15. If a person selling bonds to the Bank of Canada cashes the Bank's cheque
a. cu
ency in circulation remains unchanged, but reserves increase.
. reserves remain unchanged, but cu
ency in circulation increases.
c. reserves remain unchanged, but cu
ency in circulation declines.
d. cu
ency in circulation remains unchanged, but reserves decline.
16. Because the Bank of Canada does not completely control ________, it does not tightly control the monetary base.
a. open market sales
. the bank rate
c. open market purchases
d. advances to banks
17. In the early 1930s, the cu
ency ratio in the United States rose, as did the desired reserve ratio. Money supply analysis predicts that, all else constant, the money supply should have
a. risen.
. remain unchanged.
c. fallen.
d. either risen or fallen, since the two factors work in opposite directions.
18. The Bank of Canada will engage in a sale and repurchase agreement when it wants to ________ reserves ________ in the banking system.
a. increase; permanently
. decrease; temporarily
c. increase; temporarily
d. decrease; permanently
19. One problem with the too-big-to-fail policy is that it ________ the incentive for ___________ by banks.
a. increases; moral hazard
. decreases; moral hazard
c. increases; adverse selection
d. decreases; adverse selection
20. Covenants such as those to discourage undesirable behaviour of bo
owers and those which require bo
owers to maintain and insure their collateral are intended to help solve the
a. Adverse selection in equity contracts.
b. Moral hazard in debt contracts.
c. Adverse selection in debt contracts.
d. Moral hazard in equity contracts
21. If bank depositors begin to withdraw more cu
ency from banks,
a. The monetary base is unchanged
. Bank reserves increase
c. The monetary base decreases
d. Bank reserves are unchanged
22. In the (Keynesian) Liquidity Preference Framework, when income is ________ during a business cycle contraction, interest rates will ________.
a. rising, rise
. rising, fall
c. falling, rise
d. falling fall
23. In Canada banks are
a. encouraged to bo
ow from each other at the overnight rate during a presettlement period.
. encouraged to bo
ow from the Bank of Canada at the bank rate.
c. encouraged to leave large sums of money on deposit at the Bank of Canada
d. none of the above.
24. Mary Jones is the president of a local bank. She knows that half of the loan applicants in town she would classify as high risk and the other half as low risk. She observes that the other banks in town charge two different interest rates, a lower rate for low risk bo
owers and the higher rate for high risk bo
owers. She decides that to have an advantage over the other banks she will offer an average rate to everyone. The likely result will be:
a. Mary's bank will be highly successful as this will provide the bank with a large competitive advantage. b. Mary's bank is likely to see a dramatic increase in both types of bo
owers.
c. Mary's bank will experience adverse selection and have a disproportionate number of low risk bo
owers.
d. Mary's bank will experience adverse selection and have a disproportionate number of high risk bo
owers.
25. The Coyne Affair motivated the Bank Act which
a. established that the Bank of Canada had operational independence but did not have goal independence.
. resulted in the government writing regular directives to the Bank of Canada.
c. required that the Department of Finance and the Bank of Canada not collude in setting policy.
d. stipulated that the Bank of Canada was to conduct monetary policy in a way that was not transparent.
Question 2
After careful analysis, you have determined that a firm’s dividends should grow at 2%, on average, in the foreseeable future. The firm dividend starts at $3. The required rate of return on equity is 10%. Suppose the cu
ent price of the stock is $20.56.
(a) Assuming nothing changes, what is the price of the stock in three years?
(b) Is the stock price overpriced or underpriced? Why?
(c) Suppose after three years, dividends grow at a slower rate but constant of 1.8% for ever. Would you expect an increase or decrease in the required return? Compute the new required return.
d) Suppose the Fed make an open market purchase ($50 million) and First National Bank uses all proceeds from the Fed to make more loans. Draw T-account changes to First National Bank's