Question 1

Which is the main interest rate targeted by the Federal Reserve?&#10;A) 30-year mortgage rate&#10;B) Fed funds rate&#10;C) 10-year Treasury rate&#10;D) 10-year Inflation-Protected Treasury rate

Accepted Answer

The Fed funds rate is the main interest rate targeted by the Federal Reserve, as it is the rate at which banks lend to each other overnight and influences other interest rates and the overall economy.

Question 2

If the central bank wishes to lower its target rate, they:&#10;A) Use open market operations to lower reserves in the system&#10;B) Use open market operations to raise reserves in the system&#10;C) Raise long-term interest rates&#10;D) Start selling holdings of government securities

Accepted Answer

To lower its target rate, the central bank uses open market operations to increase reserves in the banking system. This is done by purchasing government securities, which adds liquidity to the system and lowers interest rates.

Question 3

The term structure of interest rates shows:&#10;A) How short and long term interest rates are equal to each other&#10;B) That interest rates of different maturities are not related to one another&#10;C) The central bank uses open market operations to alter their target interest rate&#10;D) How interest rates of different maturities are related to each other

Accepted Answer

The term structure of interest rates, also known as the yield curve, illustrates the relationship between interest rates (or yields) and different maturities. It shows how the yield of bonds varies with their time to maturity, reflecting the market's current expectations of future interest rates, inflation, and risk premiums.

Question 4

Assuming no risk and no term premium, the two-year bond rate is equal to:&#10;A) The average of one-year bond rates over the two years&#10;B) The highest of the one-year bond rates over the two years&#10;C) The lowest of the one-year bond ratea over the two years&#10;D) One third of the one-year rate in year one plus two-thirds of the one-year rate in year two

Accepted Answer

According to the expectations theory, the two-year bond rate is equal to the average of the one-year bond rates expected over the two years, assuming no risk and no term premium.

Question 5

An inverted yield curve often indicates:&#10;A) That a change in the central bank governor is impending&#10;B) That a major democratic election is about to occur&#10;C) That markets expect a recession to occur&#10;D) That markets expect an economic upturn

Accepted Answer

An inverted yield curve occurs when short-term interest rates exceed long-term rates, which is often interpreted by markets as a sign that a recession is likely in the near future. This expectation is based on the assumption that central banks will lower interest rates to combat the recession, making long-term securities more attractive despite their lower yields.

Question 6

Milton Friedman believe that inflation is caused entirely by:&#10;A) The central bank's creation of the money supply&#10;B) Shortages in markets that hinder production&#10;C) Governments that spend too much money&#10;D) The dollar value being too high

Accepted Answer

Milton Friedman, a prominent economist, famously stated, "Inflation is always and everywhere a monetary phenomenon," meaning he believed inflation is caused by an increase in the money supply, which is controlled by the central bank.

Question 7

The Quantity Theory of Money states that money supply times the velocity of money is equal to:&#10;A) Inflation&#10;B) Total output&#10;C) Nominal GDP&#10;D) Real GDP

Accepted Answer

The Quantity Theory of Money is often represented by the equation MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the quantity of goods and services produced (output). PQ together represents Nominal GDP, making C the correct answer.

Question 8

Inflation being volatile and different from what markets expect:&#10;A) Is beneficial to the economy&#10;B) Causes more spending on manufacturing to occur&#10;C) Causes citizens to save more&#10;D) Damages the relationship between borrowers and lenders

Accepted Answer

Inflation that is volatile and differs from market expectations can damage the relationship between borrowers and lenders because it affects the real value of loans and repayments. If inflation is higher than expected, lenders lose because the money they get back has less purchasing power. If it's lower, borrowers may pay back more in real terms than they anticipated. This unpredictability can lead to reduced lending and borrowing activity, impacting the overall economy.

Question 9

Quantitative Easing refers to a type of open market operations where the central bank buys ____ on a large scale&#10;A) Long-term securities&#10;B) Short-term securities&#10;C) Shares of stock from domestic citizens&#10;D) Shares of stock from overseas

Accepted Answer

Quantitative Easing (QE) is a monetary policy tool used by central banks to stimulate the economy by buying long-term securities, such as government bonds, from the open market to increase the money supply and encourage lending and investment.

Question 10

A dramatic rise in the price that is not in keeping with the true fundamental value is referrred to as an:&#10;A) Run on the market&#10;B) Asset bubble&#10;C) Economic boom&#10;D) Flight to quality

Accepted Answer

An asset bubble occurs when the price of an asset rises rapidly to levels that are not supported by its fundamental value, often due to speculative demand.

Deck 5: Money, Banking, and the Real Economy