UNIVERSITY OF SYDNEY
ECOS2004 Money and Banking
Mid-Semester Test #1
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April 2019
Instructions: _______________________________________________________________________
Time allowed: 90 minutes (plus 5 minutes’ reading time).
The exam consists of two sections: Sections I and II.
Section I includes 30 multiple choice questions, each worth 1 mark. To give your answers in this section, mark the letter representing the best response on the accompanying multiple-choice answer sheet. You must use a pencil for the machine to be able to read your answer.
Section II includes 5 short answer questions, each worth 4 marks. You should answer every question. Answers should be short and clear. Write your answers in the answer booklet provided.
Make sure you write your student number on the multiple-choice answer sheet as well as on the answer booklet for Section II. You should enclose the multiple-choice answer sheet with the answer booklet when you submit your completed answers at the end of this exam.
This is a closed-book exam.
Non-programmable calculators may be used. No other aids are allowed.
This exam form should be returned at the end of the exam. That is, the exam may NOT be removed.
Section I: Multiple-Choice Questions (questions 1 to 30, each worth 1 mark)
Answer all 30 questions on the computer answer sheet provided.
1. A fall in interest rates might be expected to lead businesses to:
(a) Increase employment
(b) Reduce investment spending
(c) Repay debt
(d) Reduce borrowing
2. A fall in the value of the Australian dollar would be likely to:
(a) Increase spending on imports
(b) Raise import prices
(c) Reduce the overall inflation rate
(d) Encourage Australian residents to travel abroad
3. Direct finance for a household is different from intermediated finance because it means:
(a) The household gets the loan directly from a bank
(b) The household gets an increase in income so they don’t have to borrow
(c) The household doesn’t need a credit rating to get a loan
(d) The household borrows directly from another household or business
4. The adverse selection problem in the market for loans refers to the fact that:
(a) It is difficult for borrowers to select the lowest cost lender
(b) Borrowers may use the borrowed funds to invest in projects that perform adversely
(c) Without full information, lenders will tend to attract the least creditworthy borrowers
(d) Once a borrower has received the loan, they have limited incentive to repay
5. In Australia the monetary aggregate known as M3 includes:
(a) Currency, bank deposits and non-borrowed reserves
(b) Currency and bank deposits
(c) Currency, bank deposits and stored value cards
(d) Currency and deposits with all ADIs
6. Suppose you have purchased a 5-year government bond with a yield to maturity of 3.5 per cent. The following day, the market yield on that bond rises to 4 per cent. Which of the following statements is most accurate?
(a) You are better off than previously because bonds now have a higher yield
(b) You are worse off than previously because bond prices have fallen
(c) Your net worth is unchanged because you still own the bond
(d) The effect on your net worth cannot be determined without more information
7. A commercial bank has funds on deposit with a central bank which has set a negative interest rate. The interest rate is minus 1.5 per cent. If the bank has a $40 million deposit lodged at that rate and makes no other transactions, what will be its account balance after one year?
(a) $41.5 million
(b) $38.5 million
(c) $40.6 million
(d) $39.4 million
8. Suppose you hold a one-year security with a yield to maturity of 3.6 per cent. Expected inflation for the year ahead at the time of purchase is 2.5 per cent. Actual inflation over the year turns out to be 2.8 per cent. Which of the following correctly states the ex ante and ex post real interest rates on the security?
(a) Ex ante = 1.1 per cent; ex post = 3.6 per cent
(b) Ex ante = 3.6 per cent; ex post = 1.1 per cent
(c) Ex ante = 1.1 per cent; ex post = 0.8 per cent
(d) Ex ante = 0.8 per cent; ex post = 1.1 per cent
9. Which of the following factors would be likely to make an investor reduce their demand for government bonds:
(a) An increase in company taxes
(b) A fall in expected housing prices and rents
(c) A fall in expected inflation
(d) A rise in forecasts of company profits
10. What effect would an unanticipated increase in government spending be likely to have on the price of government bonds and their yield to maturity?
(a) The price would rise and the yield would fall
(b) The price would fall and the yield would rise
(c) Both price and yield would fall
(d) Both price and yield would rise
11. If the yield curve on government bonds has a steeper upward slope than usual, what would be a possible explanation for this?
(a) The policy interest rate is currently below average
(b) The policy interest rate is currently above average
(c) Bond prices are expected to rise in the future
(d) Volatility in bond markets is below average
12. A coupon bond with a $4 million face value which makes a coupon payment of $100,000 has a coupon rate of
(a) 4 per cent
(b) 40 per cent
(c) 2.5 per cent
(d) 4.1 per cent
13. Which of the following bonds should be most attractive to an investor?
(a) a $10,000 face-value security with a 3 percent coupon selling for $10,000
(b) a $10,000 face-value security with a 2 percent coupon selling for $10,000
(c) a $10,000 face-value security with a 2 percent coupon selling for $9,000
(d) a $10,000 face-value security with a 3 percent coupon selling for $9,000
14. The yield on a consol equals the
(a) price divided by the coupon payment
(b) coupon payment divided by the price
(c) price divided by the face value
(d) face value divided by the price
15. A consol paying $40 dollars annually when the interest rate is 5 percent has a price of
16. Which of the following tendencies is not explained by the expectations theory of the term structure
(a) The yield curve slopes downward when short term rates are unusually high
(b) The yield curve slopes upward on average
(c) Short term and long term interest rate movements are correlated over time
(d) The yield curve slopes upward when the policy interest rate is low
17. Suppose there is an increase in the default risk on corporate bonds. Which of the following curves shifts to the right as a result?
(a) Supply of corporate bonds
(b) Supply of government bonds
(c) Demand for government bonds
(d) Demand for corporate bonds
18. Suppose the bond market is out of equilibrium, such that the demand for bonds exceeds supply. What will happen to the price and yield to bring the market back to equilibrium?
(a) The interest rate on the bond falls and its price rises
(b) The interest rate on the bond rises and its price falls
(c) The demand curve for bonds shifts to the left
(d) The supply curve for bonds shifts to the right
19. If the expected path of one-year interest rates over the next three years is 2 percent, 2.4 percent, 2.5 percent, and the three-year term premium is 0.3 per cent, then theory suggests that today’s interest rate on a three-year bond should be:
(a) 2.5 per cent
(b) 2.6 per cent
(c) 2.7 per cent
(d) 2.8 per cent
20. During the 1990s, nominal interest rates were generally lower than in the previous two decades. Which of the following factors could best help to explain that?
(a) Interest rates were more tightly regulated during that period
(b) Inflation expectations were declining
(c) Yields on alternative assets such as equities were rising
(d) Exchange rates became more stable
21. Suppose interest rates on 1-year and 10-year government securities are currently 2.5 per cent and 3 per cent respectively. Investor A invests only in the 1-year securities while Investor B invests only in 10-year securities. How could this difference of behavior be explained?
(a) Investor A has higher wealth
(b) Investor B has higher expectations of future inflation
(c) Investor A faces a higher tax rate
(d) Investor B has a higher tolerance for risk
22. The ratio of broad money to the monetary base is known as
(a) The simple deposit ratio
(b) The money multiplier
(c) The currency ratio
(d) The deposit multiplier
23. If the central bank accommodates an increase in demand for bank reserves, which of the following best describes the initial impact of that action?
(a) The monetary base will expand
(b) The short term interest rate will increase
(c) Inflation expectations will increase
(d) The exchange rate will depreciate
24. Which of the following has been given as a reason for central banks to shift from quantity setting to rate setting approaches to monetary policy?
(a) Interest rates are too politically sensitive to be left to the market
(b) Money demand is highly unstable
(c) Interest rates should be set in bond markets rather than money markets
(d) It is important to coordinate interest rates internationally
25. In Australia, yields on state government securities are usually higher than those on federal government securities of the same maturity. Which of the following factors could explain this?
(a) Federal government securities are more liquid and therefore more attractive to investors
(b) State governments have more productive investment projects available to them and can afford to pay higher interest
(c) The federal government has a high deficit and so cannot afford to pay high interest rates
(d) All of the above
26. In the late 1980s, the yield curve in Australia was strongly inverted. Which statement best explains the reason for that?
(a) There was a strong rise in the term premium
(b) Volatility in bonds markets made longer term securities less attractive
(c) Nominal interest rates were expected to fall because they were higher than average
(d) Nominal interest rates were expected to rise because of rising inflation
27. Why would banks choose to hold excess reserves above their regulatory requirement?
(a) To earn additional interest at the central bank
(b) To meet unexpected deposit outflows
(c) To absorb unexpected loan losses
(d) Both (b) and (c)
28. What effect would an increase in bank reserve requirements have on the monetary system if the supply of reserves is fixed?
(a) The money multiplier is reduced and the deposit multiplier is increased
(b) The deposit multiplier is increased and broad money is reduced
(c) The money multiplier is reduced and broad money is reduced.
(d) The deposit multiplier is reduced and broad money is increased
29. Which of the following are assets of a commercial bank?
(a) Loans, reserves, and capital
(b) Capital, securities, and deposits
(c) Reserves, deposits and capital
(d) Loans, reserves and securities
30. Suppose a central bank undertakes quantitative easing (QE) by buying securities from pension funds. Which of the following is true?
(a) The monetary base is increased and bank deposits are increased
(b) There is no impact on the money supply but bank reserves are increased
(c) The QE operation stimulates the economy by providing free money to the banks
(d) The QE operation is likely to be highly inflationary in the long run
Section II (Questions 31 to 35, each worth 4 points)
Answer the questions in the answer booklet provided.
31. Bank A has assets of $400m. There are five items on the balance sheet: government securities; capital; reserves held at the central bank; deposits of customers; and loans to customers. Construct a balance sheet for Bank A assuming it has the following characteristics:
i. The ratio of capital to total assets is 6 per cent
ii. The ratio of reserves to total assets is 3 per cent
iii. The ratio of liquid assets to total assets is 15 per cent
32. (a) Show the effect on the balance sheet of Bank A if there is an unexpected deposit outflow of $9m.
(b) If the deposit outflow was $16m instead of $9m, what amount of securities would need to be sold to meet the outflow after using all the available reserves?
(c) Over time, what actions might the bank need to take to rebuild its reserves and liquidity?
33. (a) Suppose that the loan portfolio of Bank A includes a $40m loan to an individual customer, and it is discovered that the customer will not be able to repay the loan in full. The bank now expects to recover only 75 per cent of the value of the loan. Show the impact of this on the balance sheet of Bank A.
(b) Suppose there is a regulatory requirement that capital must be at least 5 per cent of the value of loans on the balance sheet. How much additional capital would Bank A need to raise to meet this requirement?
34. Consider the aggregate banking system in Country B. Suppose that, as a result of a financial panic, depositors withdraw a total of $300m from their banks to hold currency. Show the impact of this on the balance sheets of depositors, banks, and the central bank.
35. Suppose that banks in Country C are required to hold reserves equal to 7.5 per cent of deposits and they hold no excess reserves. Also suppose that desired holdings of currency by the non-bank public are 2.5 per cent of deposits. Calculate the following:
(a) The money multiplier
(b) The effect on the total supply of broad money if the central bank supplies an additional $20m of bank reserves.
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