Buisness Management Answers Over 100 Questions

Business Essentials, 9e (Ebert/Griffin)
Chapter 15 Money and Banking

1) Any object can serve as money if it is portable, divisible, durable, and stable.
Answer: TRUE
Explanation: These characteristics make money able to be used for trade instead of bartering
with actual goods.
Page Ref: 388
Difficulty: Easy
Objective: 15.1
Learning Outcome: Discuss the functions of different types of financial institutions in the
monetary system
Skill: Concept
2) The M-2 money supply includes everything that is in the M-1 money supply.
Answer: TRUE
Explanation: The M-2 definition of money is broader than the M-1 definition.
Page Ref: 390
Difficulty: Easy
Objective: 15.1
monetary system
Skill: Concept
3) In mutual savings banks, all depositors are considered owners of the bank.
Answer: TRUE
Explanation: All profits are divided proportionately among depositors, who receive dividends.
Page Ref: 392
Difficulty: Easy
Objective: 15.2
monetary system
Skill: Concept
4) A banker's acceptance requires payment by a specified date.
Answer: TRUE
Explanation: Banks can draw up a banker's acceptance, which promises that the bank will pay
some specified amount at a future date.
Page Ref: 393
Difficulty: Easy
Objective: 15.2
monetary system
Skill: Concept
1
Copyright 2013 Pearson Education, Inc. Publishing as Prentice Hall
5) Through the Federal Deposit Insurance Corporation, a deposit in a member bank is currently
insured up to $50,000.
Answer: FALSE
Explanation: They are actually insured up to $250,000.
Page Ref: 396
Difficulty: Easy
Objective: 15.3
monetary system
Skill: Concept
6) As the government's bank, the Fed produces the nation's paper currency and lends money to
the government.
Answer: TRUE
Explanation: It also lends money to the government by buying bonds issued by the Treasury
Department to help finance the national deficit.
Page Ref: 398
Difficulty: Easy
Objective: 15.4
monetary system
Skill: Concept
7) Like most of the federal government, the governors of the Federal Reserve System are
democratically elected by the citizens of the United States.
Answer: FALSE
Explanation: The governors of the Federal Reserve System are appointed by government
officials.
Page Ref: 397
Difficulty: Easy
Objective: 15.4
monetary system
Skill: Concept
8) The divisibility characteristic of money is illustrated by a financial company's ability to divide
its monetary assets among several investments.
Answer: TRUE
Explanation: Divisibility refers to the ability to divide money into smaller parts; for example, a
dollar bill can be divided into ten dimes or four quarters.
Page Ref: 388
Difficulty: Moderate
Objective: 15.1
monetary system
Skill: Concept
2
9) The reason why a savings account is not considered a component of the M-1 money supply is
that it bears interest.
Answer: FALSE
Explanation: It is not considered as a component because M-1 includes only the most liquid
forms of moneycash, checks, and checking accounts.
Page Ref: 389
Objective: 15.1
monetary system
Skill: Concept
10) The prime rate of a particular bank is the average interest rate of the commercial loans
currently being paid by borrowers from that bank.
Answer: FALSE
Explanation: The prime rate is set by the respective states in which the banks do business.
Page Ref: 392
Objective: 15.2
monetary system
Skill: Concept
11) In order to save money on transactional costs, the U.S. Treasury is moving to electronic fund
transfers for payments rather than issuing checks.
Answer: TRUE
Explanation: The U.S. Treasury reports that it costs $1.03 to issue a check payment, but only
$0.105 to issue an EFT payment.
Page Ref: 394
Objective: 15.2
monetary system
Skill: Concept
12) Savings and loan associations began primarily to loan money to small to medium-sized
businesses.
Answer: FALSE
Explanation: Traditionally, S&Ls loaned money primarily for home mortgages; many have now
ventured into other areas of investments.
Page Ref: 392
Objective: 15.2
monetary system
Skill: Concept
3
13) Individual retirement accounts can be opened only by self-employed people such as doctors,
small business owners, and consultants.
Answer: FALSE
Explanation: Individual retirement accounts are tax-deferred pension funds that any wage
earners and their spouses can set up to supplement their retirement income.
Page Ref: 393
Objective: 15.2
monetary system
Skill: Concept
14) Banks create money through contracts with the government to mint bills and coins.
Answer: FALSE
Explanation: Banks create money by taking in deposits and making loans.
Page Ref: 395
Objective: 15.3
monetary system
Skill: Concept
15) One of the daily responsibilities of the Federal Reserve System is to regulate the current
federal funds rate.
Answer: FALSE
Explanation: The Federal Reserve System has no direct control over the interest rate charged
between banks in lending reserves to each other.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Concept
16) Open-market operations is often a more effective method for the Federal Reserve System to
expand the money supply than is minting more dollars and coins.
Answer: TRUE
Explanation: Buying securities from banks is quicker and easier than minting moneyand the
banks involved have immediately available cash for lending.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Concept
4
17) The Federal Reserve Bank has the responsibility of ensuring the reasonableness of the
interest rates for business and personal loans within the United States.
Answer: FALSE
Explanation: The Fed has no direct control over how individual banks conduct their loans.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Concept
18) Banks are subject to prosecution when they fail to maintain systems for identifying and
reporting suspicious activities.
Answer: TRUE
Explanation: Banks need to be able to report suspicious activities such as large cash deposits.
Page Ref: 400-401
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
19) An example of a point-of-sale (POS) terminal is when you go to the grocery store and the
system transfers funds from your account to the store's account.
Answer: TRUE
Explanation: POS sales often take the form of debit card purchases.
Page Ref: 403
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
20) Due to privacy issues, anti-terrorist policies enacted in the early 2000s have had few
significant repercussions on banking practices.
Answer: FALSE
Explanation: Anti-terrorist policies have had significant impact on banking practices.
Page Ref: 401
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
5
21) The Federal Reserve System has been instrumental in providing interbank clearing of
electronic payments for the nation's financial institutions.
Answer: FALSE
Explanation: This is actually regulated by NACHA, an independent association.
Page Ref: 401
Objective: 15.5
monetary system
Skill: Concept
22) Since late 2008, investors of certain banks have been prevented from having complete
control over the sale of their banks' stocks.
Answer: TRUE
Explanation: The Troubled Asset Recovery Program has given the U.S. Treasury significant
control over which stocks of the bailed-out banks can be sold and to whom.
Page Ref: 400
Objective: 15.5
monetary system
Skill: Concept
23) The international payments process that moves money between buyers and sellers on
different continents is subject to worldwide policy systems.
Answer: FALSE
Explanation: The international payments process that moves money between buyers and sellers
on different continents is not subject to any worldwide policy system beyond loosely structured
agreements among countries.
Page Ref: 406
Objective: 15.6
monetary system
Skill: Concept
24) In international payments, equal money inflows and outflows can result in no money being
transferred between countries.
Answer: TRUE
Explanation: If trade between any two countries is in balance, money does not flow between the
two countries.
Page Ref: 406
Objective: 15.6
monetary system
Skill: Concept
6
25) The one area that the Federal Reserve System has very little control over is the strength of
the U.S. dollar against other currencies.
Answer: FALSE
Explanation: Federal interest rate policies contribute to the strength of the U.S. dollar.
Page Ref: 404
Objective: 15.6
monetary system
Skill: Concept
26) The International Monetary Fund seeks to promote stable exchange rates.
Answer: TRUE
Explanation: The IMF is a UN agency made up of 150 countries that promote exchange rate
stability, provide short-term loans to member countries, build cooperation on monetary issues,
and develop a system of international payments.
Page Ref: 405
Objective: 15.6
monetary system
Skill: Concept
27) A very strong euro in comparison to the U.S. dollar would benefit American businesses more
than European businesses in the global economy.
Answer: TRUE
Explanation: A weak dollar means that more American goods would in general be sought after
and bought over European goods, which would necessarily be more expensive.
Page Ref: 404
Objective: 15.6
monetary system
Skill: Application
28) The overall value of the U.S. M-2 has grown considerably since 1979 due primarily to the
increased use of credit cards and debit cards.
Answer: FALSE
Explanation: Credit cards are not considered in the calculation for M-2, and thus increased use
of them has had no direct bearing on the exponential growth of M-2.
Page Ref: 390
Objective: 15.1
monetary system
Skill: Concept
7
29) The Federal Deposit Insurance Corporation is the government agency that regulates
American banks.
Answer: TRUE
Explanation: Up to 99 percent of American banks are regulated through the FDIC. Some states
regulate their local banks.
Page Ref: 396
Objective: 15.3
monetary system
Skill: Concept
30) A single dollar deposited into a commercial bank has the potential of creating up to $3.50 in
the overall money supply.
Answer: TRUE
Explanation: The interest created by loans increases the money supply.
Page Ref: 395
Objective: 15.3
monetary system
Skill: Concept
31) The increased activity of the financial market in the past five years has resulted in a severe
drop in the required premiums for commercial banks to be members of the Federal Deposit
Insurance Corporation.
Answer: FALSE
Explanation: In recent years, the FDIC has raised the premiums charged to member banks to
keep up with losses incurred by failed banks.
Page Ref: 396
Objective: 15.3
monetary system
Skill: Concept
8
32) At any given time, there may be up to 15 different discount rates set by the Federal Reserve
System for loaning money to commercial banks.
Answer: FALSE
Explanation: The Federal Reserve consists of 12 banking districts. So there would be at most 12
different discount rates.
Page Ref: 399
AACSB: Analytic skills
Objective: 15.4
monetary system
Skill: Concept
33) An overly large decrease in the reserve requirement by the Federal Reserve System could
result in inflation.
Answer: FALSE
Explanation: A decrease in the reserve requirement reduces the amount of deposits that each
bank has to keep on hand; therefore, a decrease in the reserve requirement increases money
supply. But if the requirement is too low, there may end up being a larger money supply than
demand for goods, leading to deflation.
Page Ref: 398
Objective: 15.4
monetary system
Skill: Concept
34) Which of the following has a fixed term?
A) demand deposits
B) time deposits
C) money market mutual funds
D) credit card accounts
E) savings accounts
Answer: B
Explanation: B) Time deposits are intended to be held until maturity.
Page Ref: 390
Difficulty: Easy
Objective: 15.1
monetary system
Skill: Concept
9
35) Which of the following financial institutions is considered a thrift institution?

A) pension fund
B) credit union
C) commercial bank
D) savings and loan association
E) securities investment firms
Answer: B
Explanation: B) Credit unions formed to help certain groups of people manage their money with
more thrift.
Page Ref: 392
Difficulty: Easy
Objective: 15.2
monetary system
Skill: Application
36) The Norton County Bank performs such tasks as making monthly bill payments, managing
investment portfolios, and managing the estates of deceased persons. What are such services
called?
A) special banker's services
B) financial advice services
C) public services
D) trust services
E) amalgamation services
Answer: D
Explanation: D) For a fee, a bank's trust department will perform all of these functions.
Page Ref: 393
Difficulty: Easy
Objective: 15.2
monetary system
Skill: Application
37) Which of the following agencies guarantees the safety of all of its members' bank accounts?
A) Internal Revenue Service
B) Federal Open Market Committee
C) Federal Reserve Bank
D) Federal Deposit Insurance Corporation
E) Federal Exchange Commission
Answer: D
Explanation: D) This is the primary responsibility of this agency.
Page Ref: 396
Difficulty: Easy
Objective: 15.3
monetary system
Skill: Concept
10
38) Which of the following terms refers to the percentage of its deposits a bank must hold, in
cash or on deposit, with a Federal Reserve bank?
A) discount rate
B) key rate
C) prime rate
D) federal insurance premium
E) reserve requirement
Answer: E
Explanation: E) This is controlled by the Fed.
Page Ref: 398
Difficulty: Easy
Objective: 15.4
monetary system
Skill: Concept
39) Which of the following terms refers to the interest level at which member banks can borrow
money from the Federal Reserve System?
A) discount rate
B) key rate
C) prime rate
Answer: A
Explanation: A) This is one of the many interest controls that the Fed has at its disposal.
Page Ref: 399
Difficulty: Easy
Objective: 15.4
monetary system
Skill: Concept
11
40) Which of the following terms refers to the interest level at which commercial banks lend
reserves to each other, usually overnight?
A) discount rate
B) key rate
C) prime rate
Answer: B
Explanation: B) The Fed has no direct control over this.
Page Ref: 399
Difficulty: Easy
Objective: 15.4
monetary system
Skill: Concept
41) Which of the following best describes what is called the "open-market operations" of the
Federal Reserve System?
A) the development of new financial opportunities for banks
B) the minting of new money to disperse into the money market
C) the control of interest rates among banks
D) the maintenance of a well-functioning lending system among banks
E) the buying and selling of securities
Answer: E
Explanation: E) This allows the Fed to ensure an active market.
Page Ref: 399
Difficulty: Easy
Objective: 15.4
monetary system
Skill: Concept
42) Which of the following indices indicates the relative strength of the currencies of two
countries?
A) trade rate
B) exchange rate
C) trade balance
D) relative gross national products
E) international loan rate
Answer: B
Explanation: B) This is the ratio of one currency against the other.
Page Ref: 403
Difficulty: Easy
Objective: 15.6
monetary system
Skill: Concept
12
43) Toyota, based in Japan, would like to build a new factory and a new retail distribution center.
Both or either of these may be built in the United States and in Canada. Currently, the U.S. dollar
is weak compared to the Canadian dollar. Which of the following would be in Toyota's best
interest?
A) build the cars in Canada and sell them in the United States
B) build the cars in the United States and sell them in Canada
C) build the cars in Canada and sell them in both countries
D) build the cars in the United States and sell them in both countries
E) build the cars in both countries and sell them in both countries
Answer: B
Explanation: B) Since transportation costs would be negligible here, it would behoove Toyota to
build the cars where it would be cheaper to build them and to sell them where they could get the
higher price.
Page Ref: 404
Objective: 15.6
monetary system
Skill: Application
44) Which of the following best describes the portability characteristic of money?
A) It neither dies nor spoils and if it wears out, it can be replaced.
B) Units of money can be matched with the value of goods.
C) It can be exchanged across national borders.
D) It allows people to measure the relative value of goods and services.
E) It is light and easy to handle.
Answer: E
Explanation: E) Money is easy to carry, which makes it easy to use.
Page Ref: 388
Objective: 15.1
monetary system
Skill: Concept
13
45) Which of the following is a consequence of the divisibility characteristic of money?

A) Units of money do not expire after a certain time limit.
B) Units of money can be accurately matched with the value of goods.
C) Units of money are easily carried.
D) Units of money have relatively stable value.
E) Units of money of different nations are easily converted to other units of money.
Answer: B
Explanation: B) Modern currency is easily divisible into smaller parts, each with a fixed value;
one dollar can be exchanged for 10 dimes. Thus, the actual value of goods can be approximated
very well by units of money.
Page Ref: 388
Objective: 15.1
monetary system
Skill: Concept
46) Which of the following affects the value of money?
A) how much currency is in circulation
B) how many units the currency can be divided into
C) how portable the form of currency is
D) how durable the form of currency is
E) how much currency has been saved
Answer: A
Explanation: A) If there is too much money in circulation, we end up with inflation. If there is
too little, everyone starves.
Page Ref: 389
Objective: 15.1
monetary system
Skill: Concept
47) Which of the following best describes the durability characteristic of money?
B) Units of money can be matched with the value of goods.
C) Units of money allow people to measure the relative value of goods and services.
D) Units of money of different nations are easily converted to other units of money.
E) Units of money have lasting value.
Answer: A
Explanation: A) In addition, currency is difficult to counterfeit.
Page Ref: 388
Objective: 15.1
monetary system
Skill: Concept
14
48) Which of the following best describes the stability characteristic of money?
B) Units of money of different nations are easily converted to other units of money.
C) Units of money can be matched with the value of goods.
D) Units of money allow people to measure the relative value of goods and services.
E) Units of money have relatively constant value.
Answer: E
Explanation: E) The value of currency fluctuates a little, though its value is related to what we
can buy with it.
Page Ref: 388
Objective: 15.1
monetary system
Skill: Concept
49) Money frees society from a system of barter. In doing so, money is performing which of the
following functions?
A) store of value
B) measure of worth
C) unit of account
D) determination factor
E) medium of exchange
Answer: E
Explanation: E) We use money as a way of buying and selling things; without money, we would
all be involved in a system of barter.
Page Ref: 389
Objective: 15.1
monetary system
Skill: Concept
15
50) Which of the following is NOT part of the M-1 supply?

A) currency at hand
B) currency amount of written checks
C) currency available through a debit card
D) currency in checking accounts
E) currency value of time deposits
Answer: E
Explanation: E) M-1 includes only the most liquid forms of money: cash, checks, and checking
accounts.
Page Ref: 389
Objective: 15.1
monetary system
Skill: Concept
51) Which of the following is NOT part of the M-2 money supply?
A) debit card account
B) time deposits
C) money market mutual funds
D) savings account
E) credit card account
Answer: E
Explanation: E) The major components of M-2 are M-1, time deposits, money market mutual
funds, and savings accounts.
Page Ref: 390
Objective: 15.1
monetary system
Skill: Concept
52) Which of the following financial institutions earn profits from loans taken from the funds in
each of its depositors' accounts?
A) securities investment firms
B) pension funds
C) credit unions
D) commercial banks
E) mutual savings banks
Answer: D
Explanation: D) This is one of the primary ways that commercial banks earn a profit.
Page Ref: 391
Objective: 15.2
monetary system
Skill: Concept
16
53) Which of the following statements is true?

A) Since insurance companies generate the vast majority of revenue from investments of
premium payments, market fluctuations will not affect one's health care benefits.
B) Since insurance companies generate the vast majority of revenue from premium payments,
market fluctuations generally do not affect one's health insurance premium.
C) Since insurance companies also generate revenue from investments of premium payments,
market fluctuations may affect one's health insurance premium.
D) Since insurance companies also generate revenue from investments of premium payments,
market fluctuations may affect one's health care benefits.
E) Since insurance companies generate revenue from both premium payments and investments
thereof, market fluctuations will not generally affect one's health insurance benefits.
Answer: C
Explanation: C) Insurance premiums are set to make a profit, not simply to have an expected
break-even value (as they were originally meant to do). Thus, if market fluctuations get too
erratic, premiums might be set higher to compensate for this.
Page Ref: 392
AACSB: Reflective thinking skills
Objective: 15.2
monetary system
Skill: Synthesis
54) Which of the following financial institutions are considered to be owned by their depositors?
A) commercial banks and savings and loan associations
B) savings and loan associations and mutual savings banks
C) mutual savings banks and credit unions
D) credit unions and pension funds
E) pension funds and savings institutions
Answer: C
Explanation: C) These are the co-owned institutions. The others are owned by the investors.
Page Ref: 391-392
Objective: 15.2
monetary system
Skill: Concept
17
55) When buying from a supplier in France, LTD, based in Cleveland, Ohio, has arranged for its
bank to pay the supplier the cost of the desired material when it has passed customs in the United
States. Which of the following terms is this type of bank promise called?
A) banker's acceptance
B) bank trust service
C) certified check
D) letter of credit
E) currency exchange agreement
Answer: D
Explanation: D) A letter of credit is payable only after certain conditions are met.
Page Ref: 393
Objective: 15.2
monetary system
Skill: Application
56) David has a savings account and a home mortgage with a financial institution. Each year, this
institution sends him a dividend check based on his accounts. Which of the following financial
institutions is David using here?
A) commercial bank
B) savings institution
C) credit union
D) savings and loan association
E) mutual savings bank
Answer: E
Explanation: E) In mutual savings banks, all depositors are considered owners of the bank; all
profits are divided proportionately among depositors, who receive dividends.
Page Ref: 391-392
Objective: 15.2
monetary system
Skill: Application
18
57) Which of the following actions can the Federal Deposit Insurance Company take in the event
of a failure of one of its insured banks?
A) The FDIC can seize the assets of the bank and its investors and settle the bank's debts.
B) The FDIC can allow the bank to stay afloat by granting a loan of federal money.
C) The FDIC can conduct an inquiry into the investors' assets and actions to determine if there
was any malfeasance that caused the bank failure.
D) The FDIC can allow another bank to take responsibility for the failed bank's liabilities
through sale of the failed bank.
E) The FDIC can settle the bank's debts through its insurance deposit fund and regulate the
bank's transactions more strictly.
Answer: D
Explanation: D) The FDIC can do one of two actions: sell the failed bank or pay off its debts by
seizure of its assets (and not those of the investors).
Page Ref: 397
Objective: 15.3
monetary system
Skill: Application
58) Which of the following statements best explains how financial institutions create money?
A) By opening new checking accounts and giving more people access to readily available cash,
financial institutions expand the money supply.
B) By issuing money through government contracts, financial institutions expand the money
supply.
C) By taking deposits and loaning out these funds, financial institutions expand the money
supply.
D) By collecting interest on its accounts through investments, financial institutions expand the
money supply.
E) By giving interest from its accounts to its clients, financial institutions expand the money
supply.
Answer: C
Explanation: C) Further, the money supply expands because banks are allowed to loan out most
(although not all) of the money they take in from deposits.
Page Ref: 396
Objective: 15.3
monetary system
Skill: Concept
19
59) Which of the following political bodies appoints the members of the board of governors for
the Federal Reserve System?
A) the Senate
B) the House of Representatives
C) the President of the United States
D) the Council of American Governors
E) the people of the United States
Answer: C
Explanation: C) The Fed's board of governors consists of seven members appointed by the
President for overlapping terms of fourteen years.
Page Ref: 397
Objective: 15.4
monetary system
Skill: Concept
60) How are the individual Federal Reserve Banks organized?
A) by size of financial institution memberssmall, medium, large, etc.
B) by type of financial institution memberscommercial banks, credit unions, etc.
C) by geographical regionSoutheast, Northeast, West, etc.
D) by financial purposebuying, lending, interest controlling, etc.
E) by legislative districts10th District of Massachusetts, 1st District of Colorado, etc.
Answer: C
Explanation: C) There are a total of 12 districts.
Page Ref: 397
Objective: 15.4
monetary system
Skill: Concept
20
61) Which of the following best describes two of the three primary functions of the Federal
Reserve System?
A) developing new financial markets and aiding banks in conducting their business
B) aiding banks in conducting business and managing the U.S. money supply and interest rates
C) managing the U.S. money supply and interest rates and monitoring interbank relationships
D) monitoring interbank relationships and acting as a bank for the federal government
E) acting as a bank for the federal government and developing new financial markets
Answer: B
Explanation: B) In addition, the Fed also clears checksabout 56 million each dayfor
commercial banks.
Page Ref: 398
Objective: 15.4
monetary system
Skill: Concept
62) Which of the following is NOT a primary tool for controlling the money supply?
A) taxation
B) reserve requirements
C) discount rate controls
D) credit controls
E) open-market operations
Answer: A
Explanation: A) The Fed uses four primary tools for controlling the money supply: reserve
requirements, discount rate controls, open-market operations, and selective credit controls.
Page Ref: 398
Objective: 15.4
monetary system
Skill: Concept
21
63) Which of the following statements best describes why U.S. Treasury securities have always
been considered risk-free investments?
A) They are backed by the U.S. government.
B) They have a guaranteed rate of return.
C) They are easily sold.
D) They are readily available for purchase.
E) They earn a great profit on the international money market.
Answer: A
Explanation: A) The other reasons here are all true because of the backing of the U.S.
government.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Concept
64) Which of the following laws has had significant effects in maintaining bank identity records?
A) the Check Clearing for the 21st Century Act
B) the USA Patriot Act
C) the Bank Secrecy Act
D) the Federal Reserve Act
E) the Emergency Economic Stabilization Act
Answer: B
Explanation: B) The CIP is a part of this law.
Page Ref: 401
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
65) Which of the following federal laws made transactions between banks significantly more
efficient?
A) the Check Clearing for the 21st Century Act
B) the Bank Secrecy Act
C) the USA Patriot Act
D) the Federal Reserve Act
E) the Economic Emergency Recovery Act
Answer: A
Explanation: A) It made electronic clearing of checks legal.
Page Ref: 401
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
22
66) Which of the following statements best describes how the Automated Clearing House
Network (ACH) maintains its integrity as a processor of electronic payments?
A) The ACH network is an institution within the Federal Bank System and is regulated by strict
government standards.
B) The ACH network is a for-profit company and is regulated by its need to make a profit, which
it can only do by strictly regulating itself.
C) The ACH network is a financial institution and is thus regulated by its obligations to its
investors.
D) The ACH network is a not-for-profit association and is regulated by its independence from
outside interests.
E) The ACH network is a professional organization to which all financial institutions are
obligated to contribute resources and is regulated by the interests of these institutions.
Answer: D
Explanation: D) It is no longer a part of NACHA, but as a non-profit, it cannot be swayed by the
personal interests of the investors and other institutions.
Page Ref: 401
Objective: 15.5
monetary system
Skill: Concept
67) Which of the following financial institutions was taken over by the Federal House Finance
Agency in 2008 as a part of the Emergency Economic Recovery Act?
A) Lehman Brothers Holdings
B) Bear Stearns Companies
C) Federal Home Loan Mortgage Corporation
D) Federal Home Loan Banks System
E) Federal Agricultural Mortgage Corporation
Answer: C
Explanation: C) The Federal Home Loan Mortgage Corporation was taken over by the
government in order to ensure that no more subprime loans and other abuses were made.
Page Ref: 400
Objective: 15.5
monetary system
Skill: Concept
23
68) Which of the following transactions is not included among Automated Clearing House
payments?
A) ATM deposits
B) business-to-business electronic payments
C) checks
D) Internet-initiated debit card payments
E) local tax payments
Answer: A
Explanation: A) This is handled by the individual banks.
Page Ref: 401
Objective: 15.5
monetary system
Skill: Concept
69) Which of the following pieces of information is not required by the USA Patriot Act for
banks to collect for every customer?
A) name
B) address
C) date of birth
D) place of birth
E) tax identification number
Answer: D
Explanation: D) This is the only one not necessary to be collected.
Page Ref: 401
Objective: 15.5
monetary system
Skill: Concept
24
70) Which of the following institutions most helps simplify transactions made among buyers and
sellers in different countries?
A) the U.S. State Department
B) the International Monetary Fund
C) the World Bank
D) commercial banks
E) the Internet
Answer: D
Explanation: D) If money inflows and outflows are equal for two countries, money does not
have to flow between them; if inflows and outflows are not equal, a flow of money is made to
cover the difference.
Page Ref: 404
Objective: 15.6
monetary system
Skill: Concept
71) Which of the following is the main justification for the World Bank to fund national
improvements by making loans to build roads and hospitals?
A) The resulting improvements will help stabilize the political situation, and hence the
international trade, of certain developing countries.
B) The resulting improvements will help increase the productive capacity, and hence the
C) The resulting improvements will help increase the population morale, and hence the
D) The resulting improvements will help increase the overall quality of life, and hence the
E) The resulting improvements will help increase the value of the currency, and hence the
Answer: B
Explanation: B) The World Bank provides only a very limited scope of services; the resulting
improvements, however, eventually enable borrowing countries to increase productive capacity
and international trade.
Page Ref: 405
Objective: 15.6
monetary system
Skill: Concept
25
72) Which of the following describes the requirements that the International Monetary Fund has
made on certain developing countries?
A) that the government decrease spending in order to bring inflation under control
B) that private industries decrease prices in order to bring inflation under control
C) that the government increase loans in order to create more money in the local markets
D) that the local banks increase loans in order to create more money in the local markets
E) that the government and private industries partner in creating more jobs in the region
Answer: A
Explanation: A) The IMF likes austerity in governments, but not private industries.
Page Ref: 405
Objective: 15.6
monetary system
Skill: Concept
73) David is saving $25 a week toward getting a new truck. Which function of money does this
illustrate?
A) stabilization of value
B) foundation of banking
C) medium of exchange
D) store of value
E) measure of worth
Answer: D
Explanation: D) In the form of currency, money can be used for future purchases and thus
"stores" value.
Page Ref: 389
Difficulty: Difficult
Objective: 15.1
monetary system
Skill: Application
26
74) A jeweler assesses the value of a flawless white diamond as considerably more than that of a
rhinestone. Which function of money does this illustrate?
A) foundation of banking
B) medium of exchange
C) store of value
D) measure of worth
E) stabilization of value
Answer: D
Explanation: D) Money lets us measure the value of goods and services.
Page Ref: 389
Objective: 15.1
monetary system
Skill: Application
75) In which of the following financial institutions would all of the people who allow it to hold
their funds be able to participate in major decision-making?
A) commercial bank
B) savings and loan association
C) savings institutions
D) credit union
E) pension fund
Answer: D
Explanation: D) A credit union is a nonprofit institution owned and run by its members.
Page Ref: 391-392
Objective: 15.2
monetary system
Skill: Concept
27
76) Which of the following reasons is the primary motivator for a commercial bank to acquire
new depositors?
A) A new deposit account will make more funds available to pay the interest on other deposit
accounts.
B) A new deposit account will make more funds available to pay the bank's employees.
C) A new deposit account will make more funds available to give out in loans.
D) A new deposit account will make more funds available to give out in dividends to its
investors.
E) A new deposit account will make more funds available to facilitate brokerage transactions.
Answer: C
Explanation: C) A commercial bank makes its profits from investments and loans derived from
its depositors' cash.
Page Ref: 391
Objective: 15.2
monetary system
Skill: Concept
77) Suppose a list of all American deposit institutions were created and a name chosen randomly
from this list. Which of the following would the chosen institution most likely be?
A) a commercial bank
B) a savings institution
C) a savings and loan association
D) a mutual savings bank
E) a credit union
Answer: A
Explanation: A) Despite the plethora of possible deposit financial institutions, the overwhelming
majority of them are commercial banks.
Page Ref: 391-392
Objective: 15.2
monetary system
Skill: Concept
28
78) Which of the following statements best describes why a decrease in reserve requirements
often results in an increase in the money supply?
A) A decrease in reserve requirements gives banks more money to better determine their interest
rates.
B) A decrease in reserve requirements gives banks more money to pay off their debts.
C) A decrease in reserve requirements gives banks more money to lend out.
D) A decrease in reserve requirements gives banks more money to offer in dividend payments to
their clients.
E) A decrease in reserve requirements gives banks more money to reward their employees for
meritorious financial ventures.
Answer: C
Explanation: C) A decrease in the reserve requirement "frees up" extra money that can be
distributed in the form of loans, for example.
Page Ref: 398
Objective: 15.4
monetary system
Skill: Concept
79) Which of the following statements best describes why an increase in the discount rate often
results in a decrease in the money supply?
A) An increase in the discount rate will lower the overall values of loans from the Federal
Reserve Banks to individual banks.
B) An increase in the discount rate will lower the overall values of loans from individual banks
to other financial institutions.
C) An increase in the discount rate will lower the overall number of banks issuing loans to
individuals.
D) An increase in the discount rate will lower the overall number of loans from the Federal
Reserve Banks to individual banks.
E) An increase in the discount rate will lower the overall number of loans from the Federal
Reserve Banks to individuals.
Answer: D
Explanation: D) An increase in the discount rate increases the amount of money each local bank
will pay to the Federal Reserve bank to borrow money, for example; this tightens money supply.
Page Ref: 397
Objective: 15.4
monetary system
Skill: Concept
29
80) Under which of the following circumstances would the Federal Reserve System want to
increase the money supply by increasing the discount rate?
A) The economy is experiencing severe inflation, and market activity is very low. Yet the
financial institutions have a great deal of M-1 resources at their disposal that they are not
investing.
B) The economy is experiencing severe inflation, and most financial institutions have low M-1
resources at their disposal. Yet there is a great deal of market activity.
C) The economy is experiencing severe deflation, and market activity is very low. Yet the
investing.
D) The economy is experiencing severe deflation, and most financial institutions have low M-1
resources at their disposal. Yet there is a great deal of market activity.
E) The economy is experiencing wild fluctuations, and most financial institutions have low M-1
resources at their disposal.
Answer: A
Explanation: A) The Fed helps counteract inflation by decreasing the money supply. By
increasing the discount rate, the Fed is discouraging further loans from itself and encouraging the
institutions to use their own funds for investment.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Application
30
81) Under which of the following circumstances would the Federal Reserve System want to
decrease the money supply by increasing the reserve requirement?
A) The economy is experiencing severe inflation, and market activity is very low. Yet the
investing.
B) The economy is experiencing severe inflation, yet market activity has been extremely high
and erratic.
C) The economy is experiencing severe deflation, and market activity is very low. Yet the
investing.
D) The economy is experiencing severe deflation, yet market activity has been extremely high
and erratic.
E) The economy is experiencing severe deflation, market activity is very low, and most financial
institutions are low on M-1 resources.
Answer: B
Explanation: B) The Fed helps counteract inflation by decreasing the money supply. Here the
market needs to be stabilized. By increasing the reserve requirement, the Fed will lower the
amount of investments made by the financial institutions.
Page Ref: 398
Objective: 15.4
monetary system
Skill: Application
82) Which of the following recent events represents the two most significant impacts on changes
in the money and banking system since 2000?
A) the rise in government intervention in helping to stabilize the U.S. financial system and the
increasingly strict regulation of the mortgage industry
B) the increasingly strict regulation of the mortgage industry and the enactment of anti-terrorist
policies
C) the enactment of anti-terrorist policies and the rise of electronic technologies
D) the rise of electronic technologies in banking and the rise in government intervention in
helping to stabilize the U.S. financial system
E) the rise in government intervention in helping to stabilize the U.S. financial system and the
enactment of anti-terrorist policies
Answer: D
Explanation: D) These changes have been the most far-reaching in banking practices.
Page Ref: 400-401
Objective: 15.5
monetary system
Skill: Synthesis
31
83) Regarding the international payments process, which statement is true?

A) In international trade, money will flow from the country with the strongest currency to that of
the weakest.
B) The World Bank monitors the trade of its members to insure that money is flowing properly
between the various countries.
C) The World Bank monitors the national banks of its members to insure that money is flowing
properly between the various countries.
D) By international law, international trade must involve money flowing between two countries.
E) Money does not actually have to flow between two countries.
Answer: E
Explanation: E) If trade between the two countries is in balance, meaning that money inflows
and outflows are equal for both countries, money does not have to flow between the two
countries.
Page Ref: 404
Objective: 15.6
monetary system
Skill: Concept
84) What are the components of the M-1 money supply?
Answer: The M-1 money supply is made up of currency (cash), checks, and checking accounts
(demand deposits).
Explanation: The oldest and most basic measure of the supply of money, M-1 counts only the
most liquid, or spendable, forms of money.
Page Ref: 389
Difficulty: Easy
Objective: 15.1
monetary system
Skill: Concept
85) What are the components of the M-2 money supply?
Answer: The M-2 money supply includes everything that is in the M-1 money supply (currency,
checks, and checking accounts); in addition, M-2 includes time deposits, money market mutual
funds, and savings accounts.
Explanation: M-2 includes everything in M-1 plus other forms of money that are not quite as
liquid.
Page Ref: 390
Difficulty: Easy
Objective: 15.1
monetary system
Skill: Concept
32
86) What is the difference between a public pension fund and a private pension fund?
Answer: A public pension fund includes Social Security and nearly $3 trillion in retirement
programs for state and local government employees. In contrast, a private pension fund is
operated by employers, unions, and other private groups.
Explanation: A pension fund is a pool of funds that is managed to provide retirement income for
its members. Private pension funds cover about 43 million people and have total assets of $13
trillion, down from $15 trillion before the recent recession.
Page Ref: 392
Difficulty: Easy
Objective: 15.2
monetary system
Skill: Concept
87) What is a debit card?
Answer: Debit cards allow only the transfer of money between accounts. They do not increase
the funds at an individual's disposal. They can, however, be used to make retail purchases.
Explanation: Debit cards are used more than credit cards as payment for U.S. consumer
transactions.
Page Ref: 402
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
88) What is the difference between a credit card and a debit card?
Answer: Credit cards allow users to borrow money and pay the money back over time. Unlike
credit cards, debit cards allow only the transfer of money between accounts.
Explanation: The risk of financial loss is greater for debit cards compared to credit cards.
Federal law limits the credit card user's liability to $50 for stolen or fraudulent use. Protection
against debit card losses can be higherranging up to $500depending on how quickly the lost
card is reported.
Page Ref: 401
Difficulty: Easy
Objective: 15.5
monetary system
Skill: Concept
33
89) Why are savings accounts not considered a component of M-1, whereas checking accounts
are?
Answer: M-1 comprises all currency in circulation and immediately available for circulation.
This includes checks, since it makes the currency in a checking account immediately useable. On
the other hand, currency in a savings account is not available for immediate use, since it needs to
be withdrawn physically from the bank in order to enter circulation.
Explanation: Like time deposits and money market mutual funds, savings deposits are not quite
as liquid as checks and other M1 forms of money.
Page Ref: 390
Objective: 15.1
monetary system
Skill: Concept
90) Which of the three functions of money does a time deposit account most exemplify?
Answer: By definition, a time deposit account has a fixed term, at the end of which it is has
accrued a much higher value than the original investment. Thus, investment in a time deposit is a
method to store (and gain) value.
Explanation: A time deposit less exemplifies the other two main functions of money, as a
medium of exchange and a measure of worth.
Page Ref: 390
Objective: 15.1
monetary system
Skill: Concept
91) What is Check 21?
Answer: Check 21 allows banks to present a substitute check for payment instead of the original
check; the receiving bank makes an electronic image of the paper check and sends the image to
the paying bank for instant payment.
Explanation: Check 21 is shorthand for the Check Clearing for the 21st Century Act, which
became federal law in 2004. More banks are adopting check image processing and benefitting
from its speed and cost efficiency: less paper handling, reduced reliance on physical
transportation, faster collection times, and elimination of expensive float.
Page Ref: 401
Objective: 15.5
monetary system
Skill: Concept
34
92) Why might nations decline International Monetary Fund funds?

Answer: Such nations may not want to accept the economic changes proposed by the IMF;
further, these nations may reject the IMF's requirement that they cut back social programs to
bring inflation under control, for example.
Explanation: The IMF may impose various conditions when it makes loans to nations suffering
from temporary negative trade balances.
Page Ref: 405
Objective: 15.6
monetary system
Skill: Concept
93) Explain how current financial institutions can create $342 out of a deposit of $200.
Answer: After the $200 is deposited into a bank, that bank can use up to 90 percent ($180) to
lend out. That loan is then deposited into some other account, 90 percent ($162) of which can
then be lent out by the bank. Thus, through loans, $342 = $180 + $162 has been brought into the
money supply.
Explanation: Financial institutions can create money not by printing bills and minting coins, but
by taking in deposits and making loans. This expands the money supply because they are
allowed to loan out most (although not all) of the money they take in from deposits.
Page Ref: 395
Objective: 15.3
monetary system
Skill: Application
94) Explain the need for requiring banks to be able to lend out only 90 percent of its deposit
funds.
Answer: If banks were allowed to lend out of all its deposit money, it would be possible to
create as much money as any bank or pair of banks would desire, leading to massive inflation.
Furthermore, a string of defaults would cause a system-wide panic as more and more customers
realize that their deposits are no longer in physical possession of their banksor even never
really existed in the first place.
Explanation: Holding a reserve, even if it's only 10 percent of the loan amount, is a government
regulatory tool as well as a way to help safeguard the depositors' funds.
Page Ref: 395
Objective: 15.3
monetary system
Skill: Concept
35
95) How does the Fed's monetary policy influence banks' willingness to loan money?
Answer: Monetary policy is the management of the nation's economic growth through money
supply and interest rates; by controlling these factors, the Fed influences banks' ability and
willingness to loan money.
Explanation: For example, in 2009, the Fed launched its most aggressive buying of long-term
Treasury bonds in history$300 billionto fight the recession. The purchases were intended to
push up market prices for Treasuries and thereby drive down interest rates. As long-term
Treasury rates fell, other interest rates soon followed, including rates for home mortgages,
business loans, and consumer loans.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Concept
96) What happens to demand and price during times of inflation?
Answer: Demand for goods and services increases, and prices increase during times of inflation;
this results directly from too much money in an economic system.
Explanation: In contrast, deflation occurs when the supply of goods outpaces the supply of
money, so demand for goods and services falls.
Page Ref: 398
Objective: 15.4
monetary system
Skill: Concept
36
Peter Gavin, a Minnesota native, has recently been elected to the U.S. House of Representatives.
Although a professor in education elected on a platform of educational reform, he was appointed
to the Joint Economic and Financial Services Committee. Thus, Gavin has come to rely on his
aides to learn the intricacies of the U.S. financial system.
97) During hearings about the effects of the Troubled Assets Relief Program, Gavin's committee
comes to learn that several of the bailed-out banks gave their top officers very high bonuses
shortly after the government loaned the banks enough money to keep afloat. Several of Gavin's
constituents were quite upset about this. Why would this have been a concern for them?
Answer: The bailout money came directly from taxes. Since the bailout was viewed as only
necessary to keep the economy from plunging into depression rather than a way to help fellow
citizens out of a financial jam, these bonuses were seen as unnecessary and even unethical, since
it was rewarding the very companies who got the economy into this mess in the first place.
Explanation: TARP support included $235 billion in direct investments to some 600 banks to
encourage lending. It was unclear to many in the public how paying huge executive bonuses
worked to encourage lending.
Page Ref: 400
Objective: 15.5
monetary system
Skill: Application
98) During these same hearings, several executives from the bailed-out banks testified that such
financial perks as these bonuses were necessary to get the economy rolling again. What
arguments might they have used?
Answer: Not everyone who received bonuses were those responsible for the economic
meltdown. In fact, many of these executives made the necessary decisions to halt teetering banks
from failing. Additionally, innovative and risk-taking decisions need to be made by the leaders of
these banks in order to get them out of the current economic doldrums. This can only be done
through the proper merit-based compensation.
Explanation: Arguments for merit-based compensation can backfire when the public perception
is that there is more blame than merit involved.
Page Ref: 400
Objective: 15.5
monetary system
Skill: Application
37
99) An inquiry into the possibly unethical relationship between a prominent commercial bank
and a little-known insurance company has begun. Gavin is surprised to find that insurance
companies are involved with corporate investments. How would his aides explain how insurance
companies use investments?
Answer: Insurance companies collect premium payments not only to earn profits and pay for
insured losses but also to invest in stocks, real estate, and other assets in order to earn profits and
generate the needed funds for insured losses.
Explanation: Earnings pay for insured losses, such as death benefits, automobile damage, and
health care expenses.
Page Ref: 392
Objective: 15.2
monetary system
Skill: Application
100) The inquiry has discovered that the bank involved has been selling its riskiest mortgage
accounts to the insurance company, which in turn has been selling these accounts packaged with
other more stable loans at a sharply discounted price to other banks. Gavin asks his aides why
this would be a beneficial relationship between the two institutions. What would his aides say?
Answer: By selling the risky loans out, the commercial banks are able to gain an initial profit
from these loans and then reduce the loss from the probable defaults of the loans. The insurance
company on the other hand can earn a profit through selling more lucrative loan packages to
other banks with the risky loans outweighed by the price of the more stable ones.
Explanation: Unlike commercial banks, insurance companies and other nondeposit institutions
use inflowing funds for purposes other than earning interest for depositors.
Page Ref: 391-392
Objective: 15.2
monetary system
Skill: Application
38
101) There is discussion of a bill raising insurance on bank deposits. Why would these premiums
need to be raised?
Answer: The Federal Deposit Insurance Corporation, through its Bank Insurance Fund (BIF),
insures the accounts of depositors in its member banks. If there are a great number of bank
failures, then more and more funds will need to be drawn from the BIF, which would then have
fewer banks from which to supply itself. Hence, the need to raise premiums among the insured
banks that are left.
Explanation: More than 99 percent of the nation's commercial banks and savings institutions pay
fees for membership in the FDIC. In return, the FDIC guarantees the safety of all accounts
checking, savings, and certificates of deposit (CDs)of every account owner up to the current
maximum of $250,000.
Page Ref: 396
Difficulty: Easy
Objective: 15.3
monetary system
Skill: Application
102) Gavin's district, like many others, is showing severe signs of inflation. What might his
committee recommend to the Federal Reserve System in order to curb the current trend?
Answer: Inflation occurs when prices increase dramatically throughout an economic system due
to an overabundance of money supply. The Committee might recommend that either the reserve
requirement or the discount rate be raised slightly to decrease the overall supply of money.
Explanation: The Fed, with its goal of economic stability, uses the money supply to avoid
extreme inflation or deflation. Because commercial banks are the main creators of money, much
of the Fed's management of the money supply takes the form of regulating the supply of money
through commercial banks.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Application
39
103) Gavin's committee is reviewing the current monetary policies of the Federal Reserve
System, particularly with regard to a weak or strong U.S. dollar. The economy of Gavin's district
is currently based primarily on manufacturing but is starting to see more and more factory
closures due to international competition. Would a weak or strong dollar be in the best interests
of Gavin's constituents? Explain.
Answer: In this case, a weaker dollar would be more beneficial. A weaker dollar would mean
that it would be cheaper to manufacture products in the United States (in Gavin's district, in
particular) than in other regions of the world, thus keeping the manufacturing sector of his
district healthy.
Explanation: A weaker dollar makes U.S. goods cheaper and more attractive on the world's
markets, thus increasing U.S. export sales. At the same time, the weaker dollar makes foreign
imports more expensive, so U.S. consumers can afford fewer imported products, many of which
are available only from foreign manufacturers.
Page Ref: 404
Objective: 15.6
monetary system
Skill: Application
104) A recent report to the House reveals that unemployment continues to be high and that the
economy is "sluggish." At the same time, the discount rate is very close to zero, and the reserve
requirement for banks was recently lowered to an all-time low. What actions might the Federal
Reserve System do in order stimulate the economy?
Answer: Given the two main tools for controlling the money supply and stimulating the
economydiscount rate and reserve requirementare incredibly low with no discernible effect,
the Federal Reserve System would probably choose to buy bonds through open-market
operations more actively. This would free up more cash for investment in the economyand
hopefully start reducing unemployment.
Explanation: While some claim such bond purchases are essential for economic recovery, critics
fear they may stimulate destructive spiraling inflation.
Page Ref: 399
Objective: 15.4
monetary system
Skill: Application
40
105) Gavin has asked one of aides to investigate whether the International Monetary Fund would
be able to provide his district with a loan to foster international trade with the products made
within his district. What would his aide most likely say?
Answer: The IMF generally gives loans to nations, not parts of nations such as a political
district. Furthermore, it only gives loans to nations suffering from negative trade balances in
order to foster international trade with those nations. If the nation involved (the United States, in
this case) is already heavily involved with international trade, it is very unlikely that the IMF
would see the need to get involved.
Explanation: IMF funds are often accompanied by conditions, such as the country must cut back
social programs and spending in order to bring inflation under control. A political district would
not be able to deal with such conditions.
Page Ref: 405
Objective: 15.6
monetary system
Skill: Application
41
StarMart is a large, respected retail chain with more than 120 stores spread across the country.
The company is keen to enter into a co-branding agreement with Axiom Financial Services.
Under this agreement, Star's customers will be provided with an Axiom-Star Credit Card
entitling them to reward points every time they swipe their credit cards at StarMart. Cardholders
will be able to redeem points for special discounts, free merchandise, and exclusive services.
StarMart is planning on a targeted direct marketing campaign using StarMart's knowledge of
consumer buying patterns and Axiom's access to financial information.
106) A senior manager argues that the negative perception associated with mounting credit card
debt will affect StarMart. Which of the following would be the most effective measure StarMart
could take to address this potential problem?
A) offering to forgive all debt more than 90 days old
B) making it clear that StarMart is a different entity than Axiom-Star
C) pointing out the records and practices of the worst-behaved credit companies
D) extending the expiration date of StarMart reward points
E) extending credit only to those who are very likely to be able to pay their bills
Answer: E
Explanation: E) Getting into the credit business is a risky proposition when credit card
companies are unpopular. Having fair policies is a good step toward dealing with the potential
for negative feedback. Extending credit only to those who are capable of paying their bills,
Choice E, is a good way to avoid making the problem of mounting debt even worse. Choice A
would be an invitation to run up large bills and then ignore them. Choices B and C attempt to
shift the blame elsewhere, but this would just make StarMart look less ethical. Choice D might
make more people sign up for the card, but it wouldn't help address the issue of mounting credit
card debt.
Page Ref: 390
Objective: 15.1
Skill: Critical Thinking
42
107) A senior manager argues that the negative perception associated with mounting credit card
debt will affect StarMart. Which of the following would be the LEAST effective measure
StarMart could take to address this potential problem?
A) publicizing the company's policies in clear and easy-to-understand language
B) charging no more than the typical interest rate for month-to-month debt
C) ensuring that fees for exceeding credit limits are no higher than necessary
D) increasing the value of the promotional items that attract new credit card customers
E) offering free debt counseling to Axiom-Star customers
Answer: D
Explanation: D) All of the choices are reasonable ways for StarMart to help consumers avoid
excessive debt except Choice D, which would encourage customers to spend themselves into
deep credit card debt. This might yield short-term profits, but it would not be a good response to
the manager's concern.
Page Ref: 390
Objective: 15.1
43
Subprime loans have higher interest rates than conventional loans. Subprime loans are designed
for borrowers with low credit scores who would not qualify for conventional loans. The
borrower pays a higher rate to compensate the lender for the greater risk of a default. Subprime
loans typically have adjustable rates, meaning that the interest rate can change over the life of the
loan. Borrowers who take out adjustable subprime loans usually try to keep the rate as low as
possible at the start of the loan, even when doing so would lead to higher payments over the
entire life of the loan. After a large number of people defaulted on their subprime loans, research
revealed that the majority of people who took out subprime loans could have qualified for
conventional loans.
108) The statements above most strongly suggest that if all subprime loan borrowers had taken
out the loan that was most appropriate for their needs, then what would have been the outcome?
A) None of them would have taken out an adjustable loan.
B) None of them would have taken out a subprime loan.
C) Most of them would have paid less in interest.
D) Most of them would have taken out a conventional loan to cover any expenses not covered by
a subprime loan.
E) Most of them would have paid money at the start of the loan in order to get a reduced interest
rate over the life of the loan.
Answer: C
Explanation: C) Subprime loans cost more than conventional loans, but most people who took
out subprime loans could have gotten conventional loans. So if everyone had gotten the most
appropriate loan, most of the people who took out subprime loans would have gotten lower rates
and therefore paid less in interest, Choice C. Choices A and B go too far. There might have been
some people who were better off with these loans. Choices D and E are possible events, but
there's no evidence that either would have happened most of the time.
Page Ref: 391
Objective: 15.2
monetary system
44
109) Taking out a subprime loan to buy a house is most likely to be a reasonable financial
decision when which of the following is true?
A) Qualifying for a conventional loan is impossible.
B) Owning a home is an important life goal for the borrower.
C) Adjustable rates are likely to be higher than fixed rates.
D) The borrower reasonably expects to have greater financial means in the near future.
E) The previous owner of the house took out a subprime loan.
Answer: D
Explanation: D) Can a subprime loan ever be a good idea? Sure. If you need a subprime loan
because you can't qualify for a conventional one, then you're probably a high-risk buyer. But if
you're about to come into more money in the near future, Choice D, then it might be worth
getting a bad rate now if you reasonably think you'll be able to afford it later. Choice A: Not
being able to get a regular loan doesn't mean that a subprime loan is a good idea. Maybe you
really can't afford it. Choice B: Wanting a house desperately isn't a reason to take out a highinterest loan. Choices C and E tell us nothing about the buyer and his or her ability to pay.
Page Ref: 391
Objective: 15.2
monetary system
45
Domino Grace is a financial services company. It has started using scientific principles of
management to analyze the compensation system for its financial advisors. Under the current
system, revenue goals are based on the financial advisors' performances in the previous year.
Domino Grace management believes that the financial advisors could generate much more
revenue if they were encouraged to offer derivatives, a complex but potentially profitable
investment product.
110) Which of the following, if true, would strengthen the argument of Domino Grace's
management?
A) Higher revenues would lead to higher profits for Domino Grace.
B) If the derivative investments perform poorly, managers at Domino Grace will not pay any
financial penalties.
C) Domino Grace financial advisors are well-trained in handling complicated investment
options.
D) Many other investment firms have offered derivatives.
E) Derivative investments are so complicated that most investors will not understand what they
are buying.
Answer: C
Explanation: C) Derivatives might sound like a good idea, but they are complex. Can Domino
Grace's employees handle them? If Choice C is true, the answer is more likely to be "yes, they
can" and so Choice C strengthens the argument. Choice A says that higher revenues would be
good, but that adds nothing. The question here is how to get higher revenues. Choice B weakens
the argument slightly by suggesting that management might have a financial interest in doing
something risky. Choice D doesn't help because the issue at hand is Domino Grace. Choice E is a
reason to avoid derivatives.
Page Ref: 393
Objective: 15.2
monetary system
46
111) Which of the following, if true, would weaken the argument of Domino Grace's
management?
A) Competitors of Domino Grace have lured new customers by offering access to exotic new
investment options.
B) A new political administration is expected to pass new financial regulations affecting
derivative investments.
C) Derivative investments are similar to most investments in that when a trade is made a gain on
one side is mirrored by a loss on the other.
D) Many of the investors who are interested in derivative investments are also interested in
traditional investments.
E) The opinions of Domino Grace stockholders are representative of the opinions of the
investment community in general.
Answer: B
Explanation: B) Derivative investments sound like a pretty good idea, but the possibility of new
government regulation in Choice B makes them sound less promising. Choice A makes it sound
as though Domino Grace will need to offer derivatives (or something else complex and exotic) to
keep up. Choice C points out a similarity between derivatives and traditional investments.
There's nothing in there that makes derivatives sound worse than what Domino Grace is doing
now. Choice D makes a transition to derivatives sound easier. Choice E doesn't help because we
don't know what those opinions are or what difference they would make.
Page Ref: 393
Objective: 15.2
monetary system
47
112) Suppose that investments in derivatives generated $5 million of revenue for Domino Grace
during this calendar year. The managers who proposed offering derivatives contend that this
statistic demonstrates that offering derivatives increased Domino Grace revenues this calendar
year by $5 million. Which of the following points out a flaw in this argument?
A) It assumes that offering derivatives could not have generated less than $5 million.
B) It claims without warrant that offering derivatives will generate high revenues in future years.
C) It fails to demonstrate that offering derivatives generated more money than any alternative
would generate.
D) It fails to account for the revenues that could have been generated by alternative uses of the
resources that went into offering derivatives.
E) It ignores the possibility that some investors lost money by investing in derivatives through
Domino Grace.
Answer: D
Explanation: D) The investments generated money, but it must have taken some effort and
resources to generate that money. If those efforts and resources had been devoted to some other
project, then that project could have made some money, too. The managers ignore this and so
commit this flaw in Choice D. Choices A and B would have been bogus claims, but the managers
don't make those claims. Choice C goes too far. Choice E doesn't describe a flaw because the
statistic describes what Domino Grace earned and not what the investors made on these
investments.
Page Ref: 393
Objective: 15.2
monetary system
48
Gizmo Sprockets is a successful U.S. distributor of home appliance parts. Having been in
business for more than ten years, it has contracts with thousands of retailers and repair shops
throughout the country. The CEO wants Gizmo to go international, opening some locations in
large economies such Brazil and India. He thinks that since the principles of how people do
business in a free market are essentially the same anywhere, the expansion of Gizmo's business
into other countries should be fairly straightforward. In other words, because the company has
been successful in the United States, it will also be successful in international markets.
113) Gizmo's marketing director argues that because the global economy is interconnected, if
Gizmo continues to be profitable in the United States, it should be able to invest that money to
do well internationally. Which of the following, if true, would most weaken her argument?
A) Gizmo's existing products can be used in other countries.
B) The currency exchange rate between countries can fluctuate.
C) Current Gizmo employees will need some cultural training to do business effectively in other
countries.
D) Investors will not be willing to put money into Gizmo's foreign business expansion without a
business plan.
E) Marketing strategies that are successful in the United States are not always successful
overseas.
Answer: B
Explanation: B) The marketing director is neglecting the fact that the currency exchange rate
between countries fluctuates. This means that if the U.S. dollar becomes weak against the local
currency, finances in U.S. currency will not go as far in that country. Choice A would strengthen
the marketing director's argument, because Gizmo could set up the same production methods
overseas as it uses in the United States. Choices C, D, and E are incorrect because Gizmo could
implement special cultural training, develop a detailed business plan, and plan specialized
marketing strategies, respectively, and still parlay its domestic financial success to international
success.
Page Ref: 403
Objective: 15.6
49
Douglas & Reynolds, an American financial firm, has recently fallen on hard times. Its CEO
notes that the firm has lost money for three straight years. Over the same period, the euro has lost
15 percent of its value while the Chinese yuan has increased its value by 15 percent. He therefore
concludes that the company should discontinue its foreign currency investments in the euro in
favor of the yuan in order to increase its profits.
114) Which of the following, if true, most weakens the CEO's argument?
A) Over the last ten years, investments in the yuan have only marginally outperformed
investments in the euro.
B) Research shows that a vast majority of American voters approve of European governments
and disapprove of the Chinese government.
C) The amount of capital the company currently has invested in the euro is significantly larger
than the amount invested in the yuan.
D) In the past six months, Europe has shown signs of recovering from a financial crisis while
China has shown signs of entering one.
E) A competing firm recorded record profits after shifting its investments from Japanese yen to
U.S. dollars.
Answer: D
Explanation: D) Since the CEO bases his argument on trends from the past three years, new
information suggesting that earlier trends may no longer apply to the current economic
environment weakens his argument. Choice A slightly strengthens the CEO's argument as it
suggests that the yuan has been a better investment over the long term, albeit only a slightly
better one. It's not known whether American public approval of foreign governments, Choice B,
will affect the company's determination to increase its profits. Choice C is irrelevant, as the
relative amounts of money currently invested do not have an impact on future investment
strategies. Choice E is only tangentially related to the CEO's argument, as it is unreasonable to
assume that the mere act of shifting investments between markets will always cause similar
profit increases, or that what works for a competing firm will also work for Douglas & Reynolds.
Page Ref: 403
Objective: 15.6
50
The Greenmax beverage company has built a successful business in the United States, having
secured a small but consistent slice of the energy drink market. The company is preparing to go
global with its brand and market its product overseas.
115) Greenmax's Chief Financial Officer likes the idea of expanding into markets in the southern
hemisphere because he argues that this will help the company generate a consistent year-round
cash flow. Which of the following, if true, would strengthen the CFO's argument?
A) Energy drinks are popular in many different parts of the world.
B) Demand for energy drinks is much greater in developed countries than in emerging markets.
C) Greenmax has tapped about as much of the energy drink market share in the United States as
it can get.
D) The energy drink market in the southern hemisphere is dominated by the biggest name
brands.
E) Demand for energy drinks is heavily seasonal, with products selling much better at the hottest
times of the year than others.
Answer: E
Explanation: E) Since the southern hemisphere has its hottest months during the times of the
year when it is coolest in the northern hemisphere, selling Greenmax products to countries in
both hemispheres would help generate even levels of sales revenue year-round. Choice A would
support the idea that international markets can generate increased revenue, but not consistent
year-round cash flow. Choice B argues against expanding into the southern hemisphere, since
broadly speaking, most of the world's developed countries are in the northern hemisphere.
Choice C says that the U.S. market is tapped but doesn't address the issue of whether expanding
to the southern hemisphere would help, whereas Choice D suggests that Greenmax would face
an uphill climb as it took on established brands there.
Page Ref: 404
Objective: 15.6
51
Munschausen is a German-based appliance company that is preparing to begin international

operations, wherein it plans to open several production facilities and sales centers abroad. The
company needs a substantial amount of capital to start its international operations and needs to
decide whether it should pursue debt financing by acquiring loans, or whether it can get equity
financing from investors.
116) Which of the following, if true, would strengthen the case for Munschausen's seeking to
acquire capital by debt financing?
A) Munschausen will have very slim profit margins in its international sales.
B) Munschausen will hire many new salespeople to work internationally.
C) Munschausen will have a steady stream of revenue from its international sales.
D) Munschausen will be launching several new product lines soon.
E) Munschausen will have to specially train its employees to work internationally.
Answer: C
Explanation: C) A steady stream of revenue will help Munschausen to repay its debt financing
according to a consistent schedule. Choice A would weaken the case for debt financing of
Munschausen's international operations, because it would mean that the company would have
little room to repay the debt. Choices B, D, and E would mean that Munschausen will have
significant expenses, which would make it difficult to pay back debts.
Page Ref: 404
Objective: 15.6
117) Which of the following, if true, would weaken the case for Munschausen's seeking to
acquire capital by debt financing?
A) Munschausen has several marketing managers with international experience.
B) Munschausen projects rapid growth into international markets that it targets.
C) Munschausen plans to sell its products only in the most advanced economies.
D) Munschausen will grow its business only slowly for its first several years.
E) Munschausen gets its engineering talent from all over the world.
Answer: D
Explanation: D) If Munschausen's business grows only slowly, this will make it very difficult to
repay debts. Choices A and E are human resource issues that are not relevant to whether the
company should seek to acquire capital by debt financing. Choices B and C would tend to
strengthen the case for debt financing, since rapid growth or steady sources of revenue from
selling its products in economies where consumers have strong purchasing power both would
suggest that Munschausen could easily repay the debts.
Page Ref: 404
Objective: 15.6
52
118) Which of the following, if true, would strengthen the case for Munschausen's seeking to
acquire capital by equity financing?
A) Most investors are not currently expressing interest in German companies.
B) Munschausen is not sure whether its international sales will be profitable.
C) Munschausen employs some of the best engineers in Germany.
D) Munschausen will get savings through economies of scale by producing in greater quantity.
E) Several venture capitalists are interested in investing in Munschausen.
Answer: E
Explanation: E) Financing by equity is preferable to debt financing because of the liability
involved in indebtedness, so if Munschausen can get equity financing from investors, this would
be a good option. Choices A and B would weaken the case that Munschausen could successfully
acquire equity financing. Choices C and D are not relevant to whether Munschausen could or
should acquire capital by equity financing.
Page Ref: 404
Objective: 15.6
119) Which of the following, if true, would weaken the case for Munschausen's seeking to
acquire capital by equity financing?
A) The equity capital market in Europe is currently very strong.
B) Equity financiers expect a consistent return on their investments.
C) Many of the companies in Germany get financing from equity capital.
D) Only the largest companies are listed on Germany's public stock exchange.
E) Most of the companies in Germany are listed on its stock exchange.
Answer: D
Explanation: D) This would mean that Munschausen would not be able to get capital through its
stock, and it would also decrease the chances that it would be able to get investment capital by
other means. Choices A, C, and E would strengthen the case that Munschausen could acquire
capital by equity financing. Choice B would weaken the case only if Munschausen could not
provide a consistent return on investments.
Page Ref: 404
Objective: 15.6
53

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Business Essentials, 9e (Ebert/Griffin)

Chapter 15 Money and Banking

35) Which of the following financial institutions is considered a thrift institution?

45) Which of the following is a consequence of the divisibility characteristic of money?

50) Which of the following is NOT part of the M-1 supply?

53) Which of the following statements is true?

83) Regarding the international payments process, which statement is true?

92) Why might nations decline International Monetary Fund funds?

Munschausen is a German-based appliance company that is preparing to begin international

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