1.Interest rates are an important economic variable because

a.interest rates determine household wage income in the economy.

b.interest rates determine the quantity of money in circulation.

c.interest rates reflect the costs of borrowing and the benefits of lending.

d.high interest rates increase the incentive to borrow in the economy.

e.all of the above.

2.By acting as financial intermediaries, banks

a.allow funds to be put to more productive uses in the economy.

b.link borrowers that have excess funds with lenders that have shortages of

funds.

c.decrease the amount of economic wealth created in the economy.

d.all of the above.

e.none of the above.

3.A security is

a.a share of ownership in a corporation.

b.a claim on the issuer's future income or assets.

c.a debt instrument that promises to make periodic interest payments.

d.the price paid for the rental of funds.

e.a debt instrument issued by the federal government.

4.In general, the difference between stocks and bonds is that

a.bonds are riskier.

b.bonds tend to provide a higher return.

c.bondholders are residual claimants.

d.stockholders are residual claimants.

e.only bond markets occur in exchanges on a trading floor.

5.Which of the following is not an agency that regulates financial markets?

a.the SEC. d.the OTS.

b.the Fed. e.the FCC.

c.the OCC.

6.Which of the following is an example of indirect finance?

a.a bank loan d.open market operations.

b.an IPO e.commercial paper.

c.the initial sale of bonds by the Treasury Department.

page 2

7.The money market is

a.the market where previously issued stocks are traded.

b.the market for long-term Treasury bonds.

c.the market where repurchase agreements are traded.

d.the market for goods and services in the overall economy.

e.the market for short-term debt securities.

8.Throughout history, many items have served as commodity money, including agricultural products such as maize or tobacco.A problem with using agricultural products as commodity money is that

a.they are not standardized, so they may not be fungible.

b.they are not durable, so they may not be a good store of value.

c.they may not be portable, so it may be difficult to use them as a medium of

exchange.

d.all of the above.

e.none of the above.

9.Which of the following will lead to an increase in M3?

a.an increase in currency in circulation.

b.an increase in travelers' checks.

c.an increase in small time deposits.

d.an increase in institutional money market funds.

e.all of the above.

10.Which of the following is an example of a fixed-payment loan?

a.commercial paperd. U.S. Savings Bonds

b.a home mortgagee.commercial loans

c.repurchase agreements

11.The yield to maturity is

a.a measure of the return on a bond if it is sold before maturity.

b.the interest rate that equates the price of the bond with the present value of the

stream of payments provided by the bond.

c.always greater than one.

d.the interest rate that equates the price of a bond with the coupon payments

provided by the bond.

e.increasing as the price of the bond increases.

12.Suppose that you take out a simple loan where you borrow $1000 this year and pay back $1080 next year.The yield to maturity for this simple loan is

a.80% d.9.25%

b.0.8%e.92.5%

c.8%

page 3

13.How much would investors be willing to pay for a perpetuity that pays $100 per year if interest rates are 5%?

a.$20c.$5e.$100

b.$2000d.$500

14.Which of the following is true for a perpetuity?

a.The yield to maturity is identical to the current yield.

b.The yield to maturity is greater than the current yield.

c.The yield to maturity is less than the current yield.

d.The face value of the bond is greater than the price of the bond.

e.The face value of the bond is identical to the price of the bond.

15.If you put $100 in the bank today, and interest rates are 10%, how much will you have at the end of three years?

a.$103c. $133e.$91

b. $130d.$121

16.What was the price paid in class for Series D bonds (the last bond sale)?

a.$7c.$10 e.$12

b.$9d.$11

17.The formulaF - Px360is the equation for the

Fdays to maturity

a.yield to maturity. d.return on a bond.

b.yield on a discount basis. e.rate of capital gain.

c.current yield.

18.Which of the following will cause an increase in the demand for bonds?

a.an increase in the liquidity of stocks.

b.an increase in the riskiness of bonds.

c.a decrease in the riskiness of stocks.

d.a decrease in the expected return of bonds.

e.a decrease in the expected return on stocks.

19.Yield curves

a.show the interest rates earned on bonds of different maturity dates.

b.are unrelated to inflationary expectations.

c.almost always slope downwards.

d.have become steeper in the last year.

e.all of the above.

20.The type of bonds with the best tax advantages are

a.Treasury bonds.d.municipal bonds.

b.corporate bonds.e.junk bonds.

c.government agency bonds.

page 3

PART IITRUE/FALSE(20 points)

Circle "T" if the statement is true and "F" if the statement is false.

TF1.Short-term debt instruments are defined as those that mature in one

year or less.

TF2.Capital market instruments include U.S Treasury bills, commercial

paper, and federal funds.

TF3.Money and income are not identical because money is a stock variable

and income is a flow variable.

TF4.The first known coins in the Western world were developed during the

Roman Empire.

TF5.Many items have functioned as commodity money over time, including

maize, tobacco leaves, cocoa beans, cattle, salt, cigarettes, and slave

girls.

TF6.The Fisher effect shows that an increase in expected inflation will lead

to an increase in real interest rates.

TF7.In terms of their payment streams, a simple loan is identical to a

discount bond.

TF8.A lender can lose purchasing power if the rate of inflation is greater

than the nominal interest rate.

TF9.An upward shift of the yield curve implies that inflationary

expectations among investors have declined.

TF10. McCulloch v. Maryland is the Supreme Court case which established

the Constitutional principle that allows for the tax advantages of

federal government agency bonds.

page 5

PART IIISHORT ANSWER(40 points)

Answer the following questions to the best of your abilities.You

do not need to use complete sentences.Show all work where appropriate.

1.What is a secondary market?List three securities that are traded in secondary markets.

2.List four types of financial intermediaries.

3.Briefly describe the history of the payments system.

4.What are the functions of money?

5.Write the Fisher equation, and express what it means in words.

6.For a coupon bond, when is the coupon rate equal to the yield to maturity?

page 6

7.Using both the bond and loanable funds markets, show the effects of a decrease in expected inflation.Explain.

8.What are three factors that may lead to an increase in the supply of bonds?

9.Suppose that ATM machines and other technologies lead to a decline in the demand for money, as seen in the early 1990s.In the Keynesian liquidity preference model, what are the effects of such a decrease in money demand?Show graphically and explain.What happens to the price of bonds?