Q&A Hero

Q: Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that A) borrowers may find loopholes that make the covenants ineffective. B) they are inexpensive to monitor and enforce. C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate others' monitoring and enforcement efforts. D) they reduce the value of the debt contract.

Q: For restrictive covenants to help reduce the moral hazard problem, they must be ________ by the lender. A) monitored and enforced B) written in all capitals C) easily changed D) impossible to remove

Q: Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are A) limited-liability clauses. B) risk insurance. C) restrictive covenants. D) illegal.

Q: An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds. A. moral hazard B. adverse selection C. costly state verification D. agency

Q: The problem faced by the lender that the borrower may take on additional risk after receiving the loan is called A. adverse selection. B. moral hazard. C. transactions costs. D) diversification.

Q: If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of A. moral hazard. B. adverse selection. C. free-riding. D. costly state verification.

Q: The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A. noncollateralized risk B. free-riding C. asymmetric information D. costly state verification

Q: A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called A. moral hazard. B. asymmetric information. C. noncollateralized risk. D. adverse selection.

Q: How does a mutual fund lower transactions costs through economies of scale?

Q: Financial intermediaries' low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions. A. liquidity B. conduction C. transcendental D. equitable

Q: Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs. A. expertise B. diversification C. regulations D. equity

Q: Which of the following is NOT a benefit to an individual purchasing a mutual fund? A. reduced risk B. lower transactions costs C. free-riding D. diversification

Q: By bundling share purchases of many investors together mutual funds can take advantage of economies of scale and thereby lower A. adverse selection. B. moral hazard. C. transactions costs. D. diversification.

Q: The reduction in transactions costs per dollar of investment as the size of transactions increases is A. discounting. B. economies of scale. C. economies of trade. D. diversification.

Q: One purpose of regulation of financial markets is to A. limit the profits of financial institutions. B. increase competition among financial institutions. C. promote the provision of information to shareholders, depositors and the public. D. guarantee that the maximum rates of interest are paid on deposits.

Q: Regulation of the financial system A. occurs only in the United States. B. protects the jobs of employees of financial institutions. C. protects the wealth of owners of financial institutions. D. ensures the stability of the financial system.

Q: Direct finance involves the sale to ________ of marketable securities such as stocks and bonds. A. households B. insurance companies C. pension funds D. financial intermediaries

Q: As a source of funds for nonfinancial businesses, stocks are relatively more important in A. the United States. B. Germany. C. Japan. D. Canada.

Q: Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds A. by issuing stock. B. by issuing bonds. C. from nonbank loans. D. from bank loans.

Q: With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A. Marketable securities account for a larger share of external business financing in the United States than in Germany and Japan. B. Since 1970, most of the newly issued corporate bonds and commercial paper have been sold directly to American households. C. Direct finance accounts for more than 50 percent of the external financing of American businesses. D. Smaller businesses almost always raise funds by issuing marketable securities.

Q: Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE? A. Issuing marketable securities is the primary way that they finance their activities. B. Bonds are the least important source of external funds to finance their activities. C. Stocks are a relatively unimportant source of finance for their activities. D. Selling bonds directly to the American household is a major source of funding for American businesses.

Q: Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE? A. Stocks are a far more important source of finance than are bonds. B. Stocks and bonds, combined, supply less than one-half of the external funds. C. Financial intermediaries are the least important source of external funds for businesses. D. Since 1970, more than half of the new issues of stock have been sold to American households.

Q: Of the four sources of external funding for nonfinancial businesses, the least often used in the U.S. is A. bank loans. B. nonbank loans. C. bonds. D. stock.

Q: Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately ________ of the total. A. 2% B. 11% C. 20% D. 40%

Q: Of the following sources of external finance for American nonfinancial businesses, the least important is A. loans from banks. B. stocks. C. bonds and commercial paper. D. loans from other financial intermediaries.

Q: Why are policymakers willing to use rules for monetary policy as general guides, but unlikely to follow such rules blindly?

Q: Of the sources of external funds for nonfinancial businesses in the United States, corporate bonds and commercial paper account for approximately ________ of the total. A. 5% B. 10% C. 32% D. 50%

Q: What are the major advantages and disadvantages of inflation targeting?

Q: Of the sources of external funds for nonfinancial businesses in the United States, loans from banks and other financial intermediaries account for approximately ________ of the total. A) 6% B) 40% C) 56% D) 60%

Q: If a shock raises inflation, how fast should the central bank reduce it to its target level?

Q: American businesses get their external funds primarily from A. bank loans. B. bonds and commercial paper issues. C. stock issues. D. loans from nonbank financial intermediaries.

Q: What challenges do policymakers and researchers face in using the Taylor rule?

Q: You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn A. above average returns since you will share in the higher profits. B. above average returns since your stock price will definitely appreciate as higher profits are earned. C. below average returns since computer makers have low profit rates. D. a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.

Q: In general, periods in which the Taylor rule suggested tighter monetary policy than the Fed actually put in place are periods of rising inflation. Periods in which the Taylor rule suggested that monetary policy should be easier than the Fed actually put in place are periods of declining inflation. Describe a recent exception to these results.

Q: Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is A. clearly inconsistent with the efficient markets hypothesis. B. consistent with the efficient markets hypothesis if the earnings were not as high as anticipated. C. consistent with the efficient markets hypothesis if the earnings were not as low as anticipated. D. consistent with the efficient markets hypothesis if the favorable earnings were expected.

Q: Suppose the economy is thought to be 2 percent below potential (i.e., the output gap is −2 percent), when potential output grows 4 percent per year. Suppose the Fed is following the Taylor rule, with an inflation rate of 3 percentover the past year. The federal funds rate is currently 3 percent. The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 5 each. The inflation target is 1 percent.a. Is thefedfundsratecurrentlytoohighortoolow?By how much?Show your work.Suppose that all the conditions are the same as described above, except that the output gap is b. +2 percent instead of −2 percent. Is the fed funds rate currently too high or too low? By how much ?Show your work.Suppose a year has gone by, output is now 3 percent above potential, and the inflation ratec. was 5 percent over the year. What federal funds rate should the Fed now set (assuming the inflation target does not change)? Show your work.

Q: Which of the following types of information most likely allows the exploitation of a profit opportunity? A. financial analysts' published recommendations B. technical analysis C. hot tips from a stockbroker D. insider information

Q: Suppose the economy is thought to be 2 percent above potential (i.e., the output gap is 2 percent), when potential output grows 4 percent per year. Suppose the Fed is following the Taylor rule, with an inflation rate of 2 percentover the past year. The federal funds rate is currently 3 percent. The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 5 each. The inflation target is 1 percent.a. Is the fed funds rate currently too high or too low ? By how much ? Show your work.Suppose a year has gone by, output is now just 1 percent above potential, and inflation rateb. was 5 percent over the year. What federal funds rate should the Fed now set (assuming the inflation target does not change)?

Q: You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor A. may or may not be better than the other forecasts. Past performance is no guarantee of the future. B. will always be the best of the group. C. will definitely be worse in the future. What goes up must come down. D. will be worse in the near future, but improve over time.

Q: Why do monetarists favor the use of a nonactivist rule for monetary policy?

Q: According to the efficient markets hypothesis, purchasing the reports of financial analysts A. is likely to increase one's returns by an average of 10%. B. is likely to increase one's returns by about 3 to 5%. C. is not likely to be an effective strategy for increasing financial returns. D. is likely to increase one's returns by an average of about 2 to 3%.

Q: Why have economists abandoned the use of money-growth rules in the United States? Explain.

Q: The efficient markets hypothesis implies that future changes in exchange rates should for all practical purposes be A. unpredictable. B. set by each country. C. increasing. D. pegged to a standard such as the U.S. dollar or the Euro.

Q: Describe time inconsistency and explain how it can be avoided by a central bank setting monetary policy.

Q: When we describe stock prices as following a random walk, we mean that future changes in stock prices are A. unpredictable. B. increasing. C. decreasing. D. constant.

Q: How does a central bank establish credibility?

Q: If future changes in stock prices are unpredictable, then we say that the stock prices follow a A. random walk. B. straight and narrow path. C. meandering path. D. generalized walk.

Q: What causes the formation of an expectations trap and how can the Fed prevent one from forming?

Q: Tests used to rate the performance of rules developed in technical analysis conclude that technical analysis A. outperforms the overall market. B. far outperforms the overall market, suggesting that stockbrokers provide valuable services. C. does not outperform the overall market. D. does not outperform the overall market, suggesting that stockbrokers do not provide services of any value.

Q: A benefit to policymakers of following rules rather than discretion is a. they could employ a larger staff of economists.b. they will contribute to the formation of an expectations trap. c. they would not be able to pursue time-inconsistent policies.d. they would gain flexibility in case the economy's structure changed.

Q: Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets hypothesis A. a waste of time. B. profitably employed by all financial analysts. C. the most efficient rules to employ. D. consistent with the random walk hypothesis.

Q: Which of the following best describes the reason why policymakers do not generally like to commit to following a rule for monetary policy?a. Because changes to the economy's structure will prevent any rule from working well for long b. Because rules do not effectively prevent time-inconsistencyc. Because rules without credibility are worse than discretion d. Because central bankers like to feel important

Q: The efficient markets hypothesis predicts that stock prices follow a "random walk." The implication of this hypothesis for investing in stocks is A. a "churning strategy" of buying and selling often to catch market swings. B. turning over your stock portfolio each month, selecting stocks by throwing darts at the stock page. C. a "buy and hold strategy" of holding stocks to avoid brokerage commissions. D. following the advice of technical analysts.

Q: Which of the following happened as a result of inflation targeting in New Zealand ?a. It made the goals of the central bank explicit.b. It led to a higher expected inflation rate.c. It increased the inflation rate in the country.d. It lowered the credibility of the central bank.

Q: To say that stock prices follow a "random walk" is to argue that stock prices A. rise, then fall, then rise again. B. rise, then fall in a predictable fashion. C. tend to follow trends. D. cannot be predicted based on past trends.

Q: Central banks that use inflation targeting usually communicate their goals and plans in a document known as the a. directive.b. inflation report. c. target analysis. d. communique.

Q: When Happy Feet Corporation announces that their fourth quarter earnings are up 10%, their stock price falls. This is consistent with the efficient markets hypothesis A. if earnings were not as high as expected. B. if earnings were not as low as expected. C. if a merger is anticipated. D. the company just invented a new bunion product.

Q: Which of the following is a disadvantage of inflation targeting?a. It reduces the flexibility of the central bank.b. It makes the goals of the central bank explicit. c. It leads to the problem of time inconsistency. d. It raises the expected inflation rate.

Q: The number and availability of discount brokers has grown rapidly since the mid-1970s. The efficient markets hypothesis predicts that people who use discount brokers A. will likely earn lower returns than those who use full-service brokers. B. will likely earn about the same as those who use full-service brokers, but will net more after brokerage commissions. C. are going against evidence suggesting that full-service brokers can help outperform the market. D. are likely to outperform the market by a wide margin.

Q: Usually inflation targets are set for a a. low but positive inflation rate.b. high and positive inflation rate. c. negative inflation rate.d. zero inflation rate.

Q: Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period usually A. beat the market in the next time period. B. beat the market in the next two subsequent time periods. C. beat the market in the next three subsequent time periods. D. do not beat the market in the next time period.

Q: A central bank that is explicit about its goals and plans is said to be a. obvious.b. transparent. c. translucent. d. opaque.

Q: If a mutual fund outperforms the market in one period, evidence 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 consistently outperform the market in subsequent periods. D. not likely to outperform the market in any subsequent period.

Q: In inflation targeting, the range that represents the goal for the inflation rate is known as the a. target band.b. optimal range.c. central tendency. d. ultimate goal.

Q: ________ and ________ may provide an explanation for stock market bubbles. A. Overconfidence; social contagion B. Underconfidence; social contagion C. Overconfidence; social isolationism D. Underconfidence; social isolationism

Q: A system in which the central bank attempts to achieve a certain rate of change in the overall price level within some period is referred to asa. disinflation equilibrium. b. deflation.c. inflation targeting.d. rational expectations trapping.

Q: Psychologists have found that people tend to be ________ in their own judgments. A. underconfident B. overconfident C. indecisive D. insecure

Q: Suppose the federal funds rate is 6 percent. If the output gap increases by 2 percentage points and the weight on output gap is 0.6, by how much should the federal funds rate increase according to the Taylor rule if all other variables remain unchanged?a. It should increase by 0.4 percentage points. b. It should increase by 0.6 percentage points. c. It should increase by 2 percentage points.d. It should increase by 1.2 percentage points.

Q: Loss aversion can explain why very little ________ actually takes place in the securities market. A. short selling B. bargaining C. bartering D. negotiating

Q: New Zealand was the first country to implement a system of a. disinflation.b. deflation.c. inflation targeting. d. expectations traps.

Q: ________ means people are more unhappy when they suffer losses than they are happy when they achieve gains. A. Loss fundamentals B. Loss aversion C. Loss leader D. Loss cycle

Q: Taylor's rule implies that monetary policy should have been easier than the Fed's actual policy in thea. 1950sb. 1960s c. 1970s d. 1980s

Q: If a market participant believes that a stock price is irrationally high, they may try to borrow stock from brokers to sell in the market and then make a profit by buying the stock back again after the stock falls in price. This practice is called A. short selling. B. double dealing. C. undermining. D. long marketing.

Q: If the Fed follows the Taylor rule and actual inflation is below the inflation target set by the Fed,a. the Fed should reduce the nominal federal funds rate.b. the Fed should reduce the supply of money.c. the Fed should charge a higher tax rate.d. the Fed should spend lesser money.

Q: ________ is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices. A. Behavioral finance B. Strategical finance C. Methodical finance D. Procedural finance

Q: Suppose the Fed follows the Taylor rule. Which of the following is likely to happen if the Fed overestimates potentialoutput?a. The inflation rate will rise.b. The federal funds rate will fall.c. The money supply will decrease.d. The income tax rates will increase.

Q: Stock market crashes lead us to believe that A. factors other than market fundamentals have an effect on asset prices. B. unexploited profit opportunities never exist. C. crashes are always predictable when market participants behave rationally. D. bubbles are a natural outcome of an efficient market.

Q: Suppose the economy is thought to be 1 percent below potential (i.e., the output gap is −1 percent), when potential output grows 4 percent per year. Suppose the Fed is following the Taylor rule, with an inflation rate of 4 percent over the past year. The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each. The federal funds rate is 8.5 percent. What is the inflation target?a. 0 percent b. 1 percent c. 2 percent d. 3 percent

Q: The efficient markets hypothesis implies that prices in the stock market A. follow a definite pattern. B. are more likely to go up than down. C. always undervalue the true assets of a corporation. D. are unpredictable.

Q: Suppose the economy is thought to be 5 percent below potential (i.e., the output gap is −5 percent), when potential output grows 3 percent per year. Suppose the Fed is following the Taylor rule, with an inflation rate of 6 percent over the past year. The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each. The inflation target is 1 percent. What should the federal funds rate be?a. 4 percent b. 6 percent c. 8 percent d. 9 percent