Virtual University Solved Assignments Online Quiz Past Papers GDB VUsolutions VU solutions

Of all of the component parts of aggregate demand, the part least sensitive to changes in the real interest rate is:

► Investment ► Government purchases

► Consumption ► Net exports

If government purchases increase and push current output above potential output, then monetary policymakers are likely to:

► Raise the real interest rate ► Lower the real interest rate

► Keep the real interest rate constant focussing on changing nominal interest rate only

► Purchase Treasury securities

This will cause the inflation to rise and to slow down the inflation they will raise the interest rate.

Which one of the following is NOT true for gap analysis?

► It is the difference between the yield on interest sensitive assets and liabilities

► It is the difference in the maturity of assets and liabilities

► Banks manage credit risk by using gap analysis

► It is a formal study of what a business is doing currently and where it wants to go in the future

Gap analysis highlights the gap or difference between the yield on interest sensitive assets and the yield on interest-sensitive liabilities 􀂃 Multiplying the gap by the projected change in the interest rate yields the change in the bank’s

Profit 􀂃 Gap analysis can be further refined to take account of differences in the maturity of assets and liabilities􀂃 Banks can manage interest-rate risk by matching the interest-rate sensitivity of assets with the interest-rate sensitivity of liabilities,

􀂃 Purchase short term securities to match variable rate deposits

􀂃 Make long term loans at floating rates

A U.S. institution, United Bank, buys some financial assets denominated in British pounds. Fluctuations in the dollar value of the pound will give rise to:

► Credit risk ► Operational risk

► Foreign exchange risk ► Country risk

High State Bank purchases some U.S. Treasury bonds. We would view such bonds as being free of:

► Credit risk ► Interest rate risk

► Reinvestment risk ► All of the given options

Required reserve-to-deposit ratio is a factor that affects the quantity of money. This factor is controlled by which of the following?

► Central bank ► Bank regulators

► Commercial banks ► Non bank public

The real purchasing power of money in circulation is expressed as which of the following?

► MV·PY ► M/P

► PY ► M/Y

The FOMC targets the federal funds rate, but if they are going to alter the course of the economy they must influence which one of the following?

► The money growth rate as well ► The long-term nominal interest rate as well

► The real interest rate as well ► The nominal exchange rate as well

If real interest rate increases, investment will:

► Increase ► Decrease

► Remain constant ► None of the given options

The aggregate demand curve will be relatively flat in which of the following case?

► If current output is very sensitive to inflation

► If current output is not sensitive to inflation

► If policymakers react more cautiously, to a movement of current inflation

► If the monetary policy reaction curve is also flat

The aggregate demand curve will be relatively flat if current output is very sensitive to inflation (a change in current inflation causes a large movement in current output) Steep if current output is not very sensitive to inflation

Which of the following will shift the Aggregate Demand curve to the right?

► A decrease in autonomous money demand ► An increase in Exports

► An increase in potential output ► An increase in Government purchases

Increases in aggregate Demand arising from a change in monetary policy, such as a higher inflation target, will shift the aggregate demand curve to the right. Increases in interest rate intensive components of aggregate demand, such as government purchases, will also shift the aggregate demand curve to the right.

When you need more units of money to buy the same amount of good which you bought a month or a year ago. What does it mean?

► Your economy has a high economic growth rate ► Your economy’s GDP value is more than previous year

► Price in your economy is falling causing deflation ► Price in your economy is raising causing inflation

Question No: 43 ( Marks: 3 )

Give a single line definition of the following.

Answer:

1) Credit risk: This is a risk which arises when loans are not repaid. It is avoided by diversification and checking credit worthiness.

2) Interest-rate risk: The assets and liabilities of a bank are sensitive to interest rate but liabilities are of short term and assets of long term so by an increase in interest rate banks have the risk that value of assets fall more than that of liabilities affecting the net worth or capital of bank.

3) Liquidity risk: It is a risk associated with a sudden increase in demand of funds. If bank can not meet the withdrawal requirement of all its customers, bank is considered illiquid and it may fail.

Question No: 44 ( Marks: 3 )

Describe the role of Central bank as “The Bankers Bank”.

Answer: The central Bank works as a Banker’s Bank. The role which it plays is

 Lender of last resort. If banks go illiquid or during financial stress central bank provide discount loans to banks.

 Manage interbank payment system

 Monitors the working of banks and stabilizing financial system

Question No: 45 ( Marks: 3 )

What is the effect of an increase in potential output on inflation and output?

Answer: Increase in potential output shifts long run aggregate supply curve to right, this shift has no impact on short run aggregate supply curve so inflation and output remains unchanged. But in long run now as potential output is increased so current output will be below potential output creating recessionary output gap causing inflation to fall and output begins to rise.

Question No: 46 ( Marks: 5 )

Which relationship is shown by the monetary policy reaction curve?

What will be the change in monetary policy reaction curve if the given factors change?

a. An increase in the Central Bank’s Inflation Target

b. An increase in the Long-run real interest rate

Answer: Monetary policy reaction curve gives a relationship between inflation and real interest rate. It is set so that when current inflation equals target inflation, real interest rate equals long run real interest rate.

a. Increase in central bank’s inflation target shifts the monetary policy reaction curve to right

b. Increase in long run real interest rate shifts the curve to left.

Question No: 47 ( Marks: 5 )

Fill the table below:

Financial intermediary	Primary Sources of Funds (Liabilities)	Primary Uses of funds (Assess)	Services provided
Depository institutions (Bank)	Checkable deposits, savings and time deposits Borrowing from other sources	Cash reserves, Market securities, loans	Pool savings, access to payment system, Diversification, liquidity
Insurance company	Expected claims	Corporate and government bonds, stocks	Pooling of risk

Question No: 48 ( Marks: 10 )

Discuss the factors that cause an increase or decrease in the transaction and portfolio demand for money.

Answer:

Transaction Demand for money: The quantity of money people hold for transaction purposes is called transaction demand for money. It depend on following factors

 Nominal income of people: As the nominal income increases spending increases which causes an increase in the demand for money holding.

 Cost of holding money: The cost of money holding is the interest foregone in holding the money in hand. So if the nominal interest rate is higher people will prefer keeping money in banks etc so demand for money holding decreases.

 Availability of substitutes: If people have cheaper alternative means of payment they will hold less money.

Portfolio Demand for Money: Money is one instrument that people can hold in their investment portfolio. The demand for holding money in portfolio is dependent on following factors:

 Wealth: An increase in wealth increases the demand for money

 Return on alternative investments: As the return on alternative investments fall people hold more money.

 Expected future interest rate: An increase in expected future interest rate increases holding demand for money

 Riskiness of alternatives: Riskier the alternative investments greater the demand for money.

 Liquidity: If alternative investments become more liquid demand for money decreases

Question No: 49 ( Marks: 10 )

If Excess reserves are not available how a bank manages Liquidity risk?

Answer: One way of managing liquidity risk is to keep excess reserves but this is not profitable as reserve is interest free.

There are two other ways through which a bank can manage liquidity risk.

 Adjusting other assets of balance sheet

 Adjusting liability side

In adjusting assets banks can instead of paying through reserves, fulfill withdrawal requirements by adjusting other assets. Banks can either

 sell their securities

 sell their loans

 refuse a loan renewal

The second option banks have is to adjust their liabilities.

 Borrow from other banks or central bank

 Attracting more deposits