ECON7200 ONLINE QUIZ
ECONOMICS OF FINANCIAL MARKETS
Deadline: Tuesday 24/10/2023 – 16:00 (Brisbane time)
Instruction:
• Use the Blackboard submission link provided.
• Submit using only Word, .pdf, or image (.jpg, .png) formats.
• You can either type or write and scan your answer.
PART A: MULTIPLE CHOICE QUESTIONS
Each Question is worth 1 mark (25 Marks Total)
1. The cryptocurrency Bitcoin can satisfy which two of the three functions of money. Which
function does it NOT satisfy?
A. unit of account
B. store of value
C. medium of exchange
D. bitcoin satisfies all of the functions of money
2. Using the simple model of multiple deposit creation, what is the required reserve ratio equal to
when the multiplier is two?
A. 0 percent.
B. 25 percent.
C. 50 percent.
D. 100 percent.
3. Which of the following is involved in securitization?
A. the transformer
B. the servicer
C. the undertaker
D. the liberator
4. If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to
A. sell securities the bank owns and put the funds into the reserve account.
B. pay higher dividends.
C. borrow more reserve from the Central Bank.
D. issue more shares.
5. Inflation targeting has the following advantages EXCEPT FOR ________.
A. increased monetary policy transparency
B. reduction of the time-inconsistency problem
C. immediate signal on the achievement of the target
D. consistency with democratic principles
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6. One possible reason for slower growth in developing and transition countries is
A. capital can be directed to its most productive use.
B. strict accounting standards are too stringent for the banks to meet.
C. the severity of adverse selection and moral hazard problems.
D. the weak link between government and financial intermediaries.
7. Banks may borrow from or lend to another bank in the Australian Cash Market. A loan of excess
reserves from one bank to another bank is recorded as a(n) ________ for the lending bank and a(n)
________ for the borrowing bank.
A. asset; liability
B. liability; asset
C. asset; asset
D. liability; liability
8. Agency problems in the subprime mortgage market included all of the following EXCEPT
A. mortgage originators had little incentives to make sure that the mortgagee is a good credit risk.
B. the evaluators of securities, the credit rating agencies, were subject to conflicts of interest.
C. homeowners could refinance their houses with larger loans when their homes appreciated in
value.
D. underwriters of mortgage-backed securities had weak incentives to make sure that the holders of
the securities would be paid back.
9. Regular bank examinations and restrictions on asset holdings help to indirectly reduce the
________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs
will be discouraged from entering the banking industry.
A. ex post shirking
B. post-contractual opportunism
C. moral hazard
D. adverse selection
10. The Central Bank can engage in preemptive strikes against a rise in inflation by ________ the
federal funds interest rate; it can act preemptively against a credit-driven asset bubble by
________ the federal funds interest rate.
A. raising; lowering
B. lowering; raising
C. lowering; lowering
D. raising; raising
11. Which of the following is a consequence of the too-big-to-fail policy?
A. The market becomes more concentrated as large bank becomes larger.
B. The adverse selection problem worsens.
C. Large banks are bought by the government.
D. More small banks are formed to compete against “the establishment”.
12. A consol paying $150 annually when the interest rate is 5 percent has a price of
A. $7.5.
B. $75.
C. $300.
D. $3000.
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13. When a cyber attack targeting commercial banks results in a slowdown of the check-clearing
process, float tends to ________ causing the Central Bank to initiate ________ open market
________.
A. increase; defensive; sales
B. decrease; defensive; sales
C. decrease; dynamic; purchases
D. increase; dynamic; purchases
14. If a mutual fund outperforms the market in one period, the efficient market hypothesis suggests
that this fund is
A. highly likely to consistently outperform the market in subsequent periods due to its superior
investment strategy.
B. likely to under-perform the market in subsequent periods to average its overall returns.
C. not likely to outperform the market in any subsequent period.
D. not likely to consistently outperform the market in subsequent periods.
15. If the Taylor Principle is not followed and nominal interest rates decreased while the inflation rate
increases, then real interest rates will ________ and the economy will be ________.
A. rise; expanding
B. rise; contracting
C. fall; expanding
D. fall; contracting
16. Consumer protection legislation includes legislation to
A. require banks to make loans to everyone who applies.
B. reduce the amount of interest that bank's can charge on loans.
C. reduce discrimination in credit markets.
D. require banks to make periodic reports to the Better Business Bureau.
17. Which of the following is an example of microprudential supervision?
A. Global collaboration on banking regulations.
B. Imposing a higher capital buffer for banks post-GFC.
C. Focusing on financial system liquidity.
D. None of the above.
18. If during the past decade the average rate of monetary growth has been 15% and the average
inflation rate has been 10%, everything else held constant, when the RBA announces that the new
rate of monetary growth will be 20%, the adaptive expectation forecast of the inflation rate is
A. between 15% and 20%.
B. 10%.
C. 15%.
D. 20%.
19. The concept of adverse selection helps to explain all of the following EXCEPT
A. why firms are more likely to obtain funds from banks and other financial intermediaries, rather
than from the securities markets.
B. why many stockholders are actively involved in the company’s daily business activities.
C. why direct finance is less important than indirect finance as a source of business finance.
D. why the financial system is so heavily regulated.
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20. What is the return on a 10% coupon bond with a face value of $3,000 that initially sells for $2,000
and sells for $1,600 next year?
A. 10 percent
B. 5 percent
C. -5 percent
D. -10 percent
21. The lower a security's price in the secondary market the ________ funds a firm can raise from
selling securities in the ________ market.
A. more; primary
B. less; primary
C. more; secondary
D. less; secondary
22. Although the subprime mortgage market problem began in the United States, the first indication of
the seriousness of the crisis began in
A. Europe.
B. Australia.
C. Asia.
D. South America.
23. The interest rate that describes how well a lender has done in real terms after the fact is called the
A. ex post nominal interest rate.
B. ex ante nominal interest rate.
C. ex post real interest rate.
D. ex ante real interest rate.
24. If a bank has excess reserves of $5,000 and checkable deposit liabilities of $80,000, and if the
reserve requirement is 25 percent, then total reserve amount the bank has is
A. $5,000.
B. $10,000.
C. $20,000.
D. $25,000.
25. Suppose a person cashes half his payroll check and holds half the funds in the form of currency.
Everything else held constant, total reserves in the banking system ________ and the monetary
base ________.
A. decrease; remains unchanged
B. remain unchanged; increases
C. decrease; increases
D. decrease; decreases
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PART B: SHORT-ANSWER QUESTION
Answer all 6 questions (75 Marks Total)
• Show all workings.
• Round your answers to two decimal places.
• Fully label your graphs, if you are required to draw one.
• Questions in Part B carry marks as indicated.
B1. (12 marks)
(a) (7 marks) Bank of Brisbane started its first day of operations with $100 million in capital. It
received a total of $100 million in checkable deposits. The bank makes a $120 million commercial loan
and invests $100 million in shares and $20 million in Treasury bonds. Assume required reserves are 8%
of deposits and all remaining assets (if any) are kept as excess reserves; if the bank instead requires
more fund, it can borrow from the Bank of Gold Coast at the cash rate of 4%, or it can borrow from the
RBA at the borrowing rate of 4.25%. Write the balance sheet of Bank of Brisbane.
(b) (5 marks) Suppose that APRA requires banks to hold a minimum of 10% of its total assets as bank
capital, does Bank of Brisbane satisfy APRA’s requirement? If yes, should Bank of Brisbane do
anything further? If no, what can the bank do to rectify the situation?
B2. (12 marks)
Suppose the balance sheet of the Sunshine Coast Bank can be divided as follows:
Assets Liabilities
Rate-sensitive $90 million $100 million
Fixed-rate $90 million $40 million
Bank Capital $40 million
(a) (3 marks) Use the gap analysis to calculate the change in the bank’s profit if the interest rate
increases from 5% to 10%.
(b) (6 marks) Suppose that the average duration of its assets is seven years, while the average duration
of its liabilities is three years. Use the duration analysis to calculate the approximate change of the
bank’s net worth as a percentage of the total original asset value if the interest rate increases from 5% to
10%.
(c) (3 marks) Given your answers above, suggest what the bank manager can do to reduce the interest
rate risk the bank faces when the interest rate is too high and is likely to fall in the near future.
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B3. (10 marks)
The figure below shows how interest rates respond over time to an open market purchase by the central
bank.
(a) (3 marks) According to this figure, is the liquidity effect larger than the other three effects? In
addition, how fast is the adjustment of expected inflation?
(b) (7 marks) Explain your answer by describing how money demand or supply moves after each
effect, and the overall effect on the interest rate. Use a money demand and supply graph in your answer.
B4. (12 marks)
Suppose that the required reserve ratio is 12%, excess reserve is $300 billion, excess reserve ratio is
0.2 and currency in circulation is $1200 billion.
(a) (6 marks) Calculate the money supply, and the money multiplier.
(b) (6 marks) Suppose the Central Bank acts as a lender of last resort and lends $2000 billion to two
failing commercial banks. However, instead of lending out the money and keeping the ratios
constant, the commercial banks instead kept the extra borrowings from the Central Bank as excess
reserve instead. Assume that currency and deposits remain the same (while excess reserve and excess
reserve ratio change), calculate the new monetary base, money supply, and money multiplier.
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B5. (15 marks)
The following table shows the nominal interest rate for U.S. Treasury bonds with different maturities in
September between 2021 and 2023:
Time
6
months
1 year 2 years 3 years 5 years 7 years
10
years
20
years
30
years
30/09/21 0.05 0.09 0.28 0.53 0.98 1.32 1.52 2.02 2.08
30/09/22 3.92 4.05 4.22 4.25 4.06 3.97 3.83 4.08 3.79
29/09/23 5.53 5.46 5.03 4.80 4.60 4.61 4.59 4.92 4.73
Source: U.S. Treasury
Use the liquidity premium theory to answer the following questions:
(a) (9 marks) According to the table, what is the market predicting about the movement of future short-
term interest rates and expected inflations in each of the three periods? Explain your answer using the
shape of the yield curve.
(b) (3 marks) In September 2021, the spread between the six-month and 10-year Treasury bonds is the
highest out of three years. Why is that the case?
(c) (3 marks) Meanwhile, in September 2023, the spread between the six-month and 10-year Treasury
bonds is the most negative out of three years. Why is that the case?
B6. (14 marks)
Using graphs of the market for reserves, explain and indicate what happens to the cash rate,
borrowed reserves, and nonborrowed reserves in the following situations, holding everything else
constant. Note that different starting positions of the graph can result in different results; your answer
must cover all potential scenarios.
(a) (10 marks) The RBA decreases the reserve requirement for Australian banks.
(b) (4 marks) A potential economic crisis looms, and the RBA decreases the discount rate to prepare
to act as a lender of last resort to any commercial banks seeking help.