Deck 18: Money, Inflation, and Banking: a Deeper Look

Question 1

A consumer is said to be risk-averse when the consumer

A)purchases assets with a zero nominal interest rate.
B)prefers to hold assets with more non-diversified risk.
C)prefers to not purchase a portfolio of assets.
D)purchases assets with maturities of less than one year.
E)prefers to hold assets with less non-diversified risk.

Answer 1

E

Question 2

The argument that deposit insurance can prevent the failure of an otherwise sound bank is based on the idea that

A)potential deposits need not be concerned about account overdrafts.
B)the existence of deposit insurance may prevent self-fulfilling panics.
C)deposit insurance restores confidence in the stock market.
D)bank examinations by the Canada Deposit Insurance Corporation (CDIC)weed out badly managed banks.
E)deposit insurance restores confidence in the bond market.

Answer 2

B

Question 3

Which asset is least liquid?

A)a chequing deposit
B)a savings deposit
C)a government bond
D)a factory
E)currency

Answer 3

D

Question 4

The Diamond-Dybvig model does NOT

A)provide an account of bank runs in Canada.
B)provide an account of bank runs in the 19th century United States.
C)show why a run can occur on an otherwise sound bank.
D)explain asset transformation.
E)explain why a financial intermediary is diversified.

Question 5

The phenomenon in which an insured individual takes less care in preventing the event against which he or she is insured is an example of

A)foolish behaviour.
B)double coincidence of wants.
C)moral hazard.
D)adverse selection.
E)nondiversifiable risk.

Question 6

The Diamond-Dybvig model provides a rationale for the phenomenon of

A)undercapitalized banks.
B)deflation.
C)banks making overly risky loans.
D)banks carrying too many illiquid assets.
E)bank runs.

Question 7

In Canada, the Canada Deposit Insurance Corporation (CDIC)insures the value of chartered bank deposits up to

A)$50,000.
B)$100,000.
C)$1,000,000.
D)$500,000.
E)$2,000,000.

Question 8

In the Diamond-Dybvig model, the bank's deposit contract has the following important features

A)it gives more consumption to early consumers than later consumers.
B)it implies that late consumers want to pose as early consumers.
C)it allows a bank depositor to withdraw currency.
D)it implies a bank run is prevented.
E)it insures depositors against the event that they consume early.

Question 9

A stock in Microsoft is

A)more risky than a government security.
B)more liquid than government-supplied currency.
C)an asset with a lower rate of return, on average, than a government of Canada Treasury bill.
D)less liquid than a house.
E)never sold.

Question 10

In a bank run in the Diamond-Dybvig model, it is in any depositor's interest to request withdrawal of his or her deposit because

A)government intervention assures that this is optimal behaviour.
B)the bank suspends withdrawal.
C)this avoids the possibility of consuming zero.
D)this avoids the possibility of having one unit of consumption.
E)there are plenty of liquid assets to go around.

Question 11

In the Diamond-Dybvig model

A)consumers are not risk averse.
B)the production technology yields more consumption goods in period 1 if interrupted, than if it is not interrupted an pays off in period 2.
C)a bank insures the consumer against the need for liquidity in period 1.
D)the production technology can be interrupted so as to give a return in period 0.
E)consumers can do as well on their own as they do with banks.

Question 12

In the Diamond-Dybvig model, a bank run occurs when

A)depositors see other depositors running on other banks.
B)depositors think the central bank cannot be trusted.
C)the banks suspends payments.
D)depositors think that everyone else will request withdrawal.
E)depositors think the bank managers have absconded with the bank's assets.

Question 13

Bank runs

A)were eliminated by the CDIC.
B)are a problem only in the Diamond-Dybvig model, not in any real economy.
C)were a persistent problem in Canada during the Great Depression.
D)were never a problem in Canada.
E)were never a problem in the United States.

Question 14

The Diamond-Dybvig model provides an account of

A)lack of diversification.
B)bank runs.
C)the role for deposit insurance.
D)the lender of last resort.
E)the role for a central bank.

Question 15

The founding of the Canada Deposit Insurance Corporation (CDIC)was much later than deposit insurance arrangements in other countries because

A)Canadian banks are relatively large and well diversified geographically.
B)Canada had a weak reactive government.
C)Canadian banks are so much smaller.
D)Canada's banking system started so much later.
E)Canada did not experience the episodes of widespread bank failure and banking panics.

Question 16

In the Diamond-Dybvig model a bank run occurs because

A)early consumers all choose to withdraw their deposits in period 2.
B)early consumers all choose to withdraw their deposits in period 1.
C)late consumers all choose to withdraw their deposits in period 1.
D)early and late consumers choose not to deposit in the bank.
E)late consumers all choose to withdraw their deposits in period 2.

Question 17

The Diamond-Dybvig bank provides a useful social service because

A)it is well-diversified.
B)it is immune from bank runs.
C)it holds liquid assets.
D)it is forced to do so by the government.
E)it participates in interbank markets.

Question 18

In a bank run, the equilibrium deposit contract in the Diamond-Dybvig model

A)makes both early consumers and late consumers worse off.
B)makes early consumers no better off and makes late consumers worse off.
C)makes early consumers worse off and makes late consumers better off.
D)makes both early and late consumers better off.
E)provides an illiquidity transformation service to consumers.

Question 19

A bank

A)cannot be regulated.
B)is essentially the same as an insurance company.
C)has assets with maturity that is different from that of its liabilities.
D)performs no useful social function.
E)is not a financial intermediary.

Question 20

Banks in the Diamond-Dybvig model can offer depositors increased liquidity because

A)the bank only holds a small amount of illiquid assets.
B)both individual depositors' liquidity needs and average depositor liquidity needs are predictable.
C)neither individual depositors' liquidity needs nor average depositor liquidity needs are predictable.
D)while individual depositors' liquidity needs are unpredictable, average depositor liquidity needs are predictable.
E)while individual depositors' liquidity needs are predictable, average depositor liquidity needs are unpredictable.

Question 21

One characteristic of a financial intermediary is that

A)it acts as a broker in the sale of stocks and bonds.
B)it cannot processes information.
C)it is a lending institution only.
D)it intermediates between workers and firms.
E)it transforms assets.

Question 22

A depository institution can make highly illiquid and long-maturity loans with funds obtained by issuing transaction deposits because

A)depositors, taken as a group, behave in a predictable manner.
B)most transaction depositors have very transaction patterns.
C)depository institutions have a large pool of assets to draw from.
D)depository institutions tend to be owned by individuals with a high tolerance of risk.
E)depository institutions are skilled at evaluating credit risks.

Question 23

Examples of financial intermediaries include

A)mutual funds.
B)stock exchanges.
C)financial markets.
D)insurance companies.
E)credit markets.

Question 24

What is the role of deposit insurance, and what problems can result when deposit insurance systems are
introduced? Discuss.

Question 25

An asset's liquidity depends upon

A)how long it takes to sell the asset at market value and the costs of selling the asset.
B)the fraction of its value that can be obtained if it is sold immediately and the absolute size of its value.
C)the value of the asset at time of sale and the costs of selling the asset.
D)the absolute size of its value and how long it takes to sell the asset at market value.
E)the costs of selling the asset and the fraction of its value that can be obtained if it is sold immediately.

Question 26

Moral hazard is a problem in providing deposit insurance because insured banks are

A)encouraged to take on more risk.
B)overly cautious due to extra regulations adopted by the Canada Deposit Insurance Corporation.
C)more likely to offer interest rates on loans that are greater than market interest rates.
D)more likely to provide bank managers with lavish perquisites.
E)more likely to make bookkeeping errors.

Question 27

Which asset is most liquid?

A)a stock
B)a government bond
C)a bank deposit
D)a house
E)currency

Question 28

The maturity of a 30-year bond that makes coupon payments is

A)uncertain.
B)somewhat more than 30 years.
C)exactly 30 years.
D)somewhat less than 30 years.
E)up to the discretion of the issuer.

Question 29

The Diamond-Dybvig model

A)shows why illiquid assets are useful.
B)illustrates the role of moral hazard in banking.
C)shows how monetary policy can prevent banking crises.
D)shows that Keynesian fiscal policy is effective.
E)demonstrates how the banking system can be unstable.

Question 30

For assessing whether and how much of an asset to hold, the important consideration is the asset's amount of

A)relative risk.
B)rate of return risk.
C)nondiversifiable risk.
D)diversifiable risk.
E)absolute risk.