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  1. Which of the following statements concerning the financial system is (are) correct? (RM 3)

    I It facilitates the transfer of loanable funds from savers to borrowers and determines the cost and amount of credit in the economy.

    II Its importance to the economy is shown by the effects that it has on total spending, employment, and economic growth. 

    A. I only   
    B. II only   
    C. Both I and II   
    D. Neither I nor II
    • C. Both I and II    
    •  
    • The financial system brings together borrowers and lenders (demanders and suppliers of funds). It determines how much credit will be provided in the economy and at what interest rates. The financial system also influences the overall health of the economy by affecting the total volume of spending and employment and, therefore, affecting the rate of economic growth.
  2. All the following statements concerning the functions of markets in an economic system are correct, EXCEPT:  (RM 4-5)
     
    A. They allocate scarce resources and labor to the production of various goods and services, using prices to determine which and how much of each will be produced.   
    B. They permit buyers and sellers to exchange goods, services, and resources.  C. They reduce productivity, innovation, and responsiveness to consumer demand by equalizing wages, salaries, profits, and products.   
    D. They distribute income to persons and businesses. 
    C. They reduce productivity, innovation, and responsiveness to consumer demand by equalizing wages, salaries, profits, and products.

    Markets allocate scarce resources to the production of goods and services through a system of prices. This price system enables buyers of goods, services, and resources to find sellers. In so doing, markets provide income to suppliers of goods, services, and resources. C is incorrect because markets increase productivity, innovation, and responsiveness to consumer demand. The price system rewards these characteristics, since the highest financial returns go to those who are most productive, innovative, and closely attuned to what consumers want.
  3. Which of the following statements concerning product and factor markets in the economy is (are) correct?
    (RM 5)

    I            There is a flow of expenditures from consuming to producing units through the product market, and a flow of incomes from the producing to the consuming units through the factor markets.

    II            Consuming units spend most of their incomes from the product markets in the factor markets.

    A. I only   
    B. II only   
    C. Both I and II   
    D. Neither I nor II 
    A. I only   

    I is correct because consumers buy goods and services from producers in product markets. Also, consumers derive their incomes by providing their labor or other factors of production in factor markets. II is incorrect. Consumers spend the incomes they derive from factor markets on goods and services they buy in product markets.
     
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  4. All the following statements concerning financial markets are correct, EXCEPT:(RM 5-7)
     
    A. They determine the volume of available credit. 
    B. They set security prices and interest rates.   
    C. They are where factors of production are allocated to producers who hire labor and other resources.   
    D. They channel the savings of households to those who want to spend more than their current income and to invest.   
    C. They are where factors of production are allocated to producers who hire labor and other resources.

    This is correct because it describes factor markets, not financial markets. The remaining three statements are correct descriptions of functions performed by financial markets. They channel funds from savers to borrowers. They establish prices for these funds. They determine, partly through those prices, how much credit will be supplied and demanded.
    (this multiple choice question has been scrambled)
  5. All the following statements concerning financial market activities are correct, EXCEPT:(RM 5-7)  

    A. Most of the flow of savings is used to finance investment in capital goods and inventories of other products.   
    B. Suppliers of funds usually receive only promises from the financial markets.   
    C. Financial markets make it possible to exchange current income for future income by loans.   
    D. Suppliers of funds in the financial markets are always guaranteed the return of their funds and extra rewards for waiting and risks. 
    D. Suppliers of funds in the financial markets are always guaranteed the return of their funds and extra rewards for waiting and risks.

    Suppliers of funds are not always guaranteed the return of their funds. Though such guarantees are sometimes present (for example, the purchaser of U.S. Treasury bills is sure to be repaid), often there is great risk. Moreover, in cases where the supplier of funds accepts the risk, it is not guaranteed that he or she will receive high rewards for doing so. A, B, and C correctly describe activities in financial markets. Most funds supplied are used to purchase inventory, equipment, and other capital goods. In return for supplying funds, suppliers receive a promise of future income and return of principal (though these promises are not necessarily guarantees). By using some of their current income and supplying it to the financial markets, savers expect to receive a larger income in the future in the form of a return on their investment.
    (this multiple choice question has been scrambled)
  6. Which of the following are examples of savings?(RM 6)

    I               Noncash expenses of business firms

    II             Excess of personal income over current consumption expenditures of households

    III            Purchases of plant and equipment by business firms
     
    A. II and III only   
    B. I and II only   
    C. I and III only   
    D. I, II, and III   
    E. None of the above 
    B. I and II only

    Noncash expenses are a way of saving because they reduce net profit without entailing a cash outlay. Therefore, I is correct. II is also correct. It is the definition of savings for households. III is incorrect. It is an example of investment, not savings.
    (this multiple choice question has been scrambled)
  7. Which of the following statements concerning the importance of financial markets to the economy as a whole is (are) correct? (RM 6-7)

    I            The economy expands and living standards rise when consumer savings are kept from business firms and governments that would spend the funds on investment.

    II            Higher unemployment and reduced future income and consumption could be caused by the failure to return the households’ savings to the stream of the economy’s spending.  

    A. II only   
    B. Neither I nor II 
    C. I only   
    D. Both I and II   
    A. II only

    I is incorrect because the economy would contract and living standards would fall if consumer savings were not supplied to business firms and governments. As indicated in II, which is correct, this would lead to unemployment, lower incomes, and lower consumption levels.
    (this multiple choice question has been scrambled)
  8. All the following statements concerning certain functions of the financial markets are correct, EXCEPT:(RM 7-11)  

    A. The sale of insurance in financial markets reduces the risks of the public.   
    B. Savings flow through the financial markets into investment.   
    C. Financial markets provide a way to keep savings as a store of wealth or purchasing power.   
    D. The policy function of the financial system is to issue both life and property insurance policies. 
    D. The policy function of the financial system is to issue both life and property insurance policies.

    The policy function of the financial system is to serve as a channel through which the federal government carries out monetary and fiscal policy in order to stabilize the economy and control inflation. The others are correct and refer to the financial system’s savings function, wealth function, and risk function, respectively.
    (this multiple choice question has been scrambled)
  9. Which of the following statements concerning the credit function of the financial system is (are) correct?           
    (RM 9)

    I            Credit is a loan in return for a promise of future payment of funds.

    II            Continuing inflation and the tax deductibility of interest payments have reduced the use of credit in the U.S. economy.  

    A. Neither I nor II 
    B. Both I and II   
    C. I only   
    D. II only   
    C. I only   

    II is incorrect because the use of credit is encouraged by the tax deductibility of interest payments and by inflation, which allows the borrower to repay with cheaper dollars than he or she received. I is a correct definition of credit, the supplying of funds in return for a promise to repay principal and interest in the future.
     
    (this multiple choice question has been scrambled)
  10. All the following statements concerning liquidity are correct, EXCEPT:(RM 9)  

    A. Savers generally maximize the amount of money they hold because this decreases liquidity.   
    B. An asset is said to be liquid when it can be exchanged for money quickly and with little risk of loss.   
    C. Money is considered perfectly liquid because it can be spent directly, without converting it to another form of asset first.  
    D. Deposits in banks, savings and loan associations, and credit unions are all considered as forms of assets that are liquid. 
    • A. Savers generally maximize the amount of money they hold because this decreases liquidity.   
    •  
    • If savers maximize the amount of money they hold, they are increasing their liquidity position, not reducing it. Liquidity is the ability to convert an asset into cash quickly with little or no loss of value. Money is money and, therefore, is perfectly liquid. Deposits in banks, savings and loans, and credit unions normally can be withdrawn at any time for 100 cents on the dollar, making them liquid assets.
  11. Which of the following statements on liquidity and financial markets is (are) correct? (RM 9)

    I            The system of financial markets provides liquidity to investors in stocks, bonds, or similar assets.

    II            Money generally earns a higher rate of return than is earned by other classes of assets traded in financial markets.  

    A. I only   
    B. II only   
    C. Both I and II   
    D. Neither I nor II 
    • A. I only    
    •  
    • I is correct because it correctly describes the liquidity function of financial markets. II, however, is incorrect because money earns the lowest rate, zero, in comparison with other financial assets, such as savings accounts, Treasury bills, or bonds.
  12. Which of the following statements concerning the payments function of the financial system is (are) correct?
    (RM 9-10)

    I            Credit cards issued by banks, retailers, and others are considered payment service mechanisms.

    II            Financial assets such as checking accounts, NOW accounts, and credit union share draft accounts are considered payment services, since they serve as a medium of exchange.  

    A. I only   
    B. II only   
    C. Both I and II   
    D. Neither I nor II 
     
    • C. Both I and II  Credit cards are mechanisms for paying for goods and services. Also, checking accounts, NOW accounts, and credit union share draft accounts can be used to make such payments.
    •  
  13. All the following are principal suppliers of funds in the money market, EXCEPT:            (RM 12)  

    A. Commercial banks   
    B. Money market mutual funds   
    C. U.S. Treasury   
    D. Finance companies 
    C. U.S. Treasury

    Money market mutual funds, commercial banks, and finance companies all are important suppliers of money market funds. The U.S. Treasury, on the other hand, is a major demander of money market funds, especially through its weekly sale of Treasury bills.
    (this multiple choice question has been scrambled)
  14. Which of the following statements concerning money markets is correct? (RM 12-13)
     
    A. A money market instrument usually matures less than a year after it is issued. 
    B. Money markets are important sources of funds for financing residential real estate purchases by families.   
    C. Most long-term investments in construction are permanently financed in money markets.   
    D. Nonfinancial corporations cannot demand or supply funds in money markets. 
     
    • A. A money market instrument usually matures less than a year after it is issued. 
    • Money market instruments have short original maturity dates, ranging from overnight up to one year.
    • The typical duration of residential mortgages is 25 or 30 years, far longer than the duration of money market instruments.
    • Nonfinancial corporations frequently borrow short-term funds in the money market. Also, at times when they have short-term excesses of cash, they will invest in money market instruments in order to realize at least a small rate of return on their funds.
  15. All the following are principal suppliers of funds in the capital market, EXCEPT:
    (RM 12-13)  

    A. U.S. Treasury 
    B. Savings and loan associations   
    C. Insurance companies   
    D. Pension funds   
    A. U.S. Treasury

    The principal suppliers of funds in the capital market are long-term investors, such as insurance companies, pension funds, and savings and loans. The U.S. Treasury, on the other hand, is a major demander of capital market funds through its issuance of long-term bonds.
    (this multiple choice question has been scrambled)
  16. Which of the following statements comparing the money market and the capital market is (are) correct?
    (RM 12-13)

    I            Short-term lending and borrowing of working capital are main functions of the money market, while the capital market emphasizes longer-term transactions, such as mortgage loans.

    II            Capital market transactions are restricted to Washington and state capital borrowing, while money market transactions can occur anywhere.  

    A. Neither I nor II
    B. II only   
    C. Both I and II   
    D. I only   
    D. I only 

    I correctly differentiates between money and capital markets, with the former focusing on short-term funds and the latter on long-term funds. II, however, is incorrect because business firms located all over the world are important participants in the capital market.
     
    (this multiple choice question has been scrambled)
  17. All the following are considered money market instruments, EXCEPT:
    (RM 12-13)  

    A. Commercial paper 
    B. Mortgage loans   
    C. Federal funds   
    D. U.S. Treasury bills   
    B. Mortgage loans

    Mortgage loans typically are long-term financial assets, having original maturities of more than one year.Treasury bills, federal funds, and commercial paper, are money market instruments with original maturities of one year or less.
    (this multiple choice question has been scrambled)
  18. All the following are considered capital market instruments, EXCEPT:           
    (RM 13)

    A. Federal funds   
    B. Consumer installment loans 
    C. Common stocks   
    D. Corporate, government, and foreign bonds   
    A. Federal funds

    Federal funds are loaned and borrowed for very short durations, such as a few hours or days. Therefore, federal funds are classified as money market instruments. Longer-term financial assets, such as common stocks, bonds, and installment loans, are capital market instruments because they have original durations of more than one year.
    (this multiple choice question has been scrambled)
  19. Which of the following statements concerning open and negotiated financial markets is (are) correct?           
    (RM 14)

    I            In an open market, securities are sold under contracts to one or a few bidders and are often held to maturity.

    II            In a negotiated market, securities are sold to the highest bidders and can usually be resold before maturity.
     
    A. Both I and II   
    B. Neither I nor II 
    C. II only   
    D. I only   
    B. Neither I nor II

    The definitions of "open market" and "negotiated market" have been reversed in this question. A negotiated market is one in which securities are sold to one or a few buyers and usually held to maturity. An example would be a corporate loan that is privately placed with a life insurance company. An open market, on the other hand, is one in which securities are sold to the highest bidder, who may or may not hold them until maturity. An example would be the sale of a new issue of U.S. Treasury bills, as occurs in weekly auctions
    (this multiple choice question has been scrambled)
  20. Which of the following describes a transaction involving an open market?           
    (RM 14)  

    A. A broker arranges a sale of securities on a stock exchange.   
    B. A home buyer gets a mortgage from a savings and loan association.   
    C. A person arranges a car loan at a bank. 
    D. A corporation negotiates the sale of bonds to an insurance company.   
     
    A. A broker arranges a sale of securities on a stock exchange.

    The others are examples of transactions in negotiated markets. The stock exchange, on the other hand, is an open, or auction, type of market.
    (this multiple choice question has been scrambled)
  21. Which of the following statements concerning primary and secondary securities markets is (are) correct?           
    (RM 14)

    I            Securities sold in primary markets are stocks and bonds that are newly issued to support investment.

    II            Secondary markets provide liquidity for investors in previously-issued securities.  

    A. Both I and II   
    B. I only   
    C. Neither I nor II 
    D. II only   
    A. Both I and II

    A primary market is one that involves the purchase and sale of newly-issued securities, usually to finance new capital formation. A secondary market is one in which already-issued securities are traded, providing some degree of liquidity to investors who wish to sell their securities before the maturity date (if any).
     
    (this multiple choice question has been scrambled)
  22. A primary market is one that involves the purchase and sale of newly-issued securities, usually to finance new capital formation. A secondary market is one in which already-issued securities are traded, providing some degree of liquidity to investors who wish to sell their securities before the maturity date (if any).
    Which of the following statements concerning spot and futures markets is (are) correct?            (RM 14)

    I            A spot market involves trades for immediate delivery.

    II            A forward or futures market involves trades for delivery at a specified later date.  

    A. Both I and II   
    B. II only   
    C. Neither I nor II 
    D. I only   
    A. Both I and II

    I correctly defines a spot market, in which delivery of the security being traded is virtually immediate. Also, as indicated in II, a forward or futures market involves delivery of the security being traded at a later date.
    (this multiple choice question has been scrambled)
  23. All the following statements concerning the rate of savings in the U.S. are correct, EXCEPT: (RM 15)  

    A. It has been growing rapidly since the year 2000.   
    B. It is likely to lead to lower or only slowly growing living standards in the future. 
    C. It is due in part to the changing attitudes of Americans toward the importance of saving.   
    D. It tends to produce high interest rates in the U.S. financial system.   
    A. It has been growing rapidly since the year 2000.

    Savings rates in the U.S. have fallen in the past decade. This tends to produce high interest rates because the supply of savings is so small. An increasing portion of the U.S. population generally tends to favor consumption over savings. Low savings rates dampen the rise in future living standards.
    (this multiple choice question has been scrambled)
  24. All the following statements concerning factors that tie the financial markets together are correct, EXCEPT:
    (RM 15-16)  

    A. In a perfect market, a single participant can dictate the securities’ prices because few traders have full information affecting securities’ values. 
    B. An efficient market reflects new information on securities with a new set of prices.   
    C. The basic thing traded in all financial markets is credit.   
    D. Speculators act as arbitrageurs to keep prices consistent among the different financial markets.   
     
    A. In a perfect market, a single participant can dictate the securities’ prices because few traders have full information affecting securities’ values. 

    Financial markets are tied together by the fact that credit is the item traded in all of them. Also, arbitrageurs keep prices consistent among markets by buying securities where credit is temporarily undervalued and selling them where it is temporarily overvalued. Moreover, financial markets are fairly efficient in properly adjusting the prices of securities as new information affecting the securities becomes available.In a perfect market there are many participants, each of whom is a price-taker, not a price-maker.
    (this multiple choice question has been scrambled)
  25. Which of the following statements concerning the markets of the financial system is (are) correct?           
    (RM 15-16)
    I            A change in interest rates in one part of the financial system is likely to affect all financial markets.II            Borrowers may get credit in different markets of the financial system, depending on which markets offer the best interest rate.  

    A. Both I and II   
    B. II only   
    C. I only   
    D. Neither I nor II
    A. Both I and II

    I is correct because interest rates in different sectors of the financial system, such as the market for various types of short-term securities, tend to bear a stable relationship to each other. If, for instance, U.S. Treasury bill rates should rise, there would soon be an increase in other short-term rates, such as those on federal funds and commercial paper. II is also correct. For example, consumers may obtain auto financing from banks, credit unions, or sales finance companies, depending on where they can obtain the best set of terms.
    (this multiple choice question has been scrambled)
  26. Which of the following statements concerning arbitrage in security markets is (are) correct?           
    (RM 16)

    I            Arbitrage is the process in which investors respond to attractive interest rates or securities prices by adjusting the holdings in their security portfolios, buying in one market and selling in another.

    II            As a result of arbitrage, interest rates and security prices never reach an equilibrium because of the actions of speculators who seek profits.
     
    A. II only   
    B. Neither I nor II 
    C. I only   
    D. Both I and II   
    C. I only

    I correctly describes the arbitrage process. II, however, is incorrect, Arbitrageurs help bring about an equilibrium set of relationships among interest rates and security prices. They buy credit and securities that are undervalued, bringing up their prices, and sell credit and securities in markets where they are overvalued, driving their prices down to an equilibrium level.
    (this multiple choice question has been scrambled)
  27. All the following are major trends operating in the financial system in recent years, EXCEPT:         (RM 16 & 17)
     
    A. Increasing globalization of money and capital markets 
    B. Increasing safety of financial institutions   
    C. Increasing financial sophistication on the part of borrowers   
    D. Increasing competition among suppliers of financial service   
    E. Increasing use of technology for the production and delivery of financial services   
    B. Increasing safety of financial institutions

    The financial system does seem to be characterized by increasing competition among financial institutions, by growing financial sophistication among consumers, by increasing use of technology, and by a trend toward globalization of the financial markets. Unfortunately, B is incorrect. The failure rate of many types of financial institutions, both large and small, has been rising in recent years, though the trend is now showing signs of moderating.
    (this multiple choice question has been scrambled)

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