Econ 423 Spring 2008 Byrns Legibly enter all required information on a Scantron sheet. Major Exam #2

1. Unintended consequences from the exercise of a Federal Reserve System tool proved to be the most significant when the Fed first began to: (a) adjust the discount rate it charged for loans to banks with liquidity problems. (b) fine-tune margin requirements to regulate the stock market. (c) credit banks with reserves to pay for U.S. Treasury bonds it acquired so that it could use interest income for its operating budget. (d) raise the required reserve ratio to limit the lending activities of overly aggressive banks.

2. A foundation for both President Reagan’s and President Bush’s tax cuts is the notion that excessively high tax rates reduce taxed behavior (via, e.g., tax evasion and avoidance, and less investment and production) so much that tax revenue may fall. This idea is expressed as the: (a) Phillips curve. (b) Laffer curve. (c) efficient markets theory. (d) liquidity preference theorem. (e) Fisher effect.

3. A potentially sound investment that would be least likely to generate the errors commonly associated with representativeness would be for you to buy shares in a: (a) firm that a friend tells you is sure to rise, based on information acquired from a mutual acquaintance who is a corporate insider. (b) poorly managed firm that is a likely acquisition target because of the low price/earnings ratio for the firm’s stock. (c) small-cap stock touted by Mad Money’s Jim Cramer. (d) corporation with the lowest price for its stock of all firms in its industry. (e) well managed firm if the stock has a relatively high price/earnings ratio.

4. A structural budget deficit for given federal tax and spending policies is based on projections about how revenues and spending would be related if: (a) financial markets operated efficiently. (b) Laffer curves were stable. (c) national output was at a full employment level. (d) Phillips curves were stable. (e) automatic stabilizers were not operational.

5. In situations where the asymmetric information problem is not severe: (a) the money markets have a distinct cost advantage over banks in providing short-term funds. (b) banks have a distinct cost advantage over the money markets in providing short-term funds. (c) banks have a comparative advantage over the money markets in providing short-term funds. (d) banks have an absolute advantage over the money markets in providing short-term funds.

6. Ben Bernanke is among many central bankers all over the world who increasingly favor: (a) setting the growth of the money supply at a low fixed percentage rate regardless of short run economic conditions. (b) expanding the money supply at rates that would precisely yield price level stability. (c). pursuing deflationary policies that would reduce nominal interest rates to zero. (d) targeting inflation at a low rate (2% or so) to significantly reduce the risk of deflation.

7. Commercial paper is characterized by (a) non-collateralization. (b) maturity in less than 271 days. (c) issuance primarily by large, well-established and relatively stable corporations. (d) very infrequently sold in a secondary market. (e) All of the above.

8. Crowding-out is most likely to be a significant problem when the economy is: (a) in the midst of a deep depression. (b) at full employment but the federal government runs a huge budget deficit. (c) suffering from severe fiscal drag. (d) characterized by a huge structural budget surplus. (e) on the left side of a Laffer curve.

9. A clause in a bond indenture requiring the firm to pay off a portion of the bond issue each year is a: (a) call provision. (b) nonrestrictive covenant. (c) sinking fund. (d) shelf registration.

10. Federal Reserve System actions increasing the monetary base would not include: (a) lowering the discount rate. (b) augmenting paychecks for exemplary Fed employees with end-of-year bonuses. (c) making loans to investment banks with liquidity problems caused by non-performing subprime loans. (d) reducing the reserve requirement ratio. (e) buying U.S. Treasury bonds in open market operations.

11. If the Federal Reserve System changed margin requirements, stock market speculation would not be affected at all according to: (a) efficient markets theory. (b) the kinked demand curve model. (c) Lerner asymmetric reaction functions. (d) price leadership models. (e) prospect theory’s reflection effect.

12. Natural rate theory suggests that if policy makers continually aim for a target interest rate below the natural rate, maintaining the target rate would require: (a) high real interest rates and low nominal interest rates. (b) constant or declining rates of inflation. (c) actual inflation to exceed expected inflation continuously. (d) tariff barriers to prevent competition from cheap labor.

13. If, after considering risk, a 12.5% annual return is appropriate on a financial investment in an apartment complex that generates a consistent net cash flow of $2 million annually, then the apartment complex is worth approximately: (a) $2 million. (b) $4 million. (c) $8 million. (d) $16 million. (e) $32 million.

14. Call provisions in corporate bonds are most likely to be exercised when interest rates: (a) and bond values rise. (b rise and bond values fall. (c) fall and bond values rise. (d) and bond values fall.

15. John Maynard Keynes’s proposal to fight a depression with fiscal policy is most consistent with the notion that the resulting federal deficits would be covered by: (a) selling Treasury bonds. (b) increasing tariffs on imports. (c) issuing new monetary base. (d) reducing government spending. (e) borrowing from foreigners.

16. Keynesian multiplier analysis is most closely related to the: (a) law of comparative advantage. (b) income velocity of money. (c) commerce clause of the U.S. Constitution. (d) Fisher effect of expected inflation on ex ante nominal interest rates. (e) exchange rate of the U.S. dollar. .

17. The reflection effect is central to prospect theory as developed by cognitive psychologists, and addresses people’s tendencies to be: (a) risk averse when contemplating potential gains but loss averse when faced with prospective losses. (b) too rigid in their responses to stimuli, with the result that most individuals’ investment portfolios are inadequately diversified. (c) overly cautious when adjusting portfolios because errors of commission are more profoundly regretted than errors of omission. (d) fixated on previous errors, causing sunk costs to be factored into decisions too heavily. (e) too easily swayed by how prospective choices are presented, or framed.

18. Not among the major advantages of market-value accounting over historical-cost accounting would be that market-value accounting: (a) improves the ability of regulators to close a bank before its net worth falls to zero. (b) reduces the incidence in the number of banks that "bet- the-bank" by taking excessive risks in hopes of staying in operation. (c) makes it harder for bank officials to hide insolvencies. (d) makes it harder for regulators and politicians to hide insolvencies. (e) requires fewer resources to acquire data and perform calculations.

19. Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been (a) the creation of the FDIC. (b) rapid economic growth since 1941. (c) the employment of new procedures by the Federal Reserve. (d) flow of more conservative officials into bank management. (e) relative deregulation of the financial sector since 1981.

20. Of the following, the only people or organizations that have less priority than preferred stockholders to funds generated when a bankrupt corporation is liquidated would be: (a) government organizations owed taxes. (b) owners of common stock. (c) employees owed back wages. (d) owners of debentures. (e) banks that hold commercial paper.

21. Politicians are currently debating whether to repeal or extend the “alternative minimum tax,” which significantly limits the ability of people in the upper tax brackets to use tax exemptions and deductions to reduce their income taxes. One consequence of the alternative minimum tax is that it: (a) decreases the amounts of funds available to lobbyists. (b) increases the tendency to save and invest from windfall gains. (c) increases interest costs to state and local governments. (d) increases the federal budget deficit.

22. The classical or neoclassical perspective on macroeconomics is least compatible with: (a) neutrality of money. (b) asymmetric wage and price reaction functions. (c) rational expectations. (d) real business cycles. (e) efficient markets theory.

23. The existence of bubbles in financial markets is least consistent with: (a) herding. (b) Keynesian beauty contests. (c) market timing strategies. (d) momentum investing. (e) present value analysis.

24. Reasons for private individuals increasingly to manage their personal investment portfolios do not include improvements or increases in: (a) the availability of relevant information for investment decisions. (b) the illusion of control among investors. (c) computer and telecommunications technology. (d) publicity about the growing ratio of bezzle to market capitalization. (e) investor overconfidence.

25. Member banks must purchase stock in their Federal Reserve District Banks; annual dividends paid on that stock are limited to at most: (a) four percent. (b) five percent. (c) six percent. (d) seven percent.

26. Suppose a corporation retained significant earnings in recent years and accumulated a lot of liquid assets. From the perspectives of shareholders, the poorest of the following motives for executives who began to aggressively acquire other mature firms would be: (a) economies of scale. (b) complementary markets and resources. (c) diversification. (d) unused tax shields. (e) synergies [e.g., economies of scope].

27. Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are called: (a) junk bonds. (b) callable bonds. (c) convertible bonds. (d) debentures. (e) omega bonds.

28. The ability of the Comptroller of the Currency to charter national banks, in tandem with the ability of states’ banking authorities to charter state banks, created what is known as the (a) Bilateral Banking Commission. (b) dual banking system. (c) creative response solution. (d) Eurodollar market. (e) split banking system.

29. The highest cost of financial capital from the perspectives of top-level executives in mature corporations that are reasonably sound is funding from: (a) common stock. (b) commercial loans. (c) preferred stock. (d) long term bonds.

30. The interest rates paid will tend to be lowest on: (a) U.S. Treasury bonds. (b) investment grade municipal bonds. (c) Aaa corporate bonds. (d) IPO securities. (e) US Treasury bills.

31. The money supply is negatively related to the: (a) monetary base. (b) margin requirement ratio. (c) actual money multiplier. (d) percentages of excess reserves held by banks. (e) potential money multiplier.

32. The most important decisions about monetary policy are made by the: (a) Treasurer of the United States. (b) Chairman of the Board of Governors of the Federal Reserve System. (c) Secretary of the Treasury of the United States. (d) Open Market Committee of the Federal Reserve System. (e) U.S. Congress.

33. The only sound reason for investors to buy and hold investment grade municipal bonds is: (a) being very close to retirement age. (b) desires of union managers of pension funds to hold the most secure assets for their members. (c) minimizing tax liabilities if you are in the highest income tax bracket. (d) the motive of patriotism and civic responsibility. (e) hedging against interest rate risk.

34. The primary reason individuals and firms choose to borrow long-term is to reduce the risk that interest rates will (a) rise before they pay off their debt. (b) fall before they pay off their debt. (c) become more volatile before they pay off their debt. (d) become more stable before they pay off their debt.

35. The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will (a) rise before they pay off their debt. (b) fall before they pay off their debt. (c) become more volatile before they pay off their debt. (d) become more stable before they pay off their debt.

36. The speculative [asset] demand for money described by John Maynard Keynes is most closely related to the use of money as a/an: (a) medium of exchange. (b) standard unit of account. (c) measure of value. (d) store of value. (e) standard of deferred payment.

37. The structures of payments promised to owners of preferred stock issued by a well-established major corporation makes these instruments most like: (a) U.S. Treasury bonds. (b) “blue chip” common stocks. (c) perpetuities. (d) municipal bonds. (e) T-bills.