Question ECO/561 Week 5 Knowledge Check

1 . The Classical Theory of Asset Prices assumes which of the following ideas?

• A. The interest rate to use is the nominal rate, assets are the discounted sum of their future values, and expected income is the best information available.
• B. Actual past income is the best information available, assets are the discounted sum of their future values, and the interest rate is the safe interest rate plus a risk premium.
• C. The value of an asset is the discounted present value of expected cash flows, expected income is the best information available, and the interest rate is the safe interest rate plus a risk premium.
• D. The interest rate to use is the real rate, expected income is the best information available, and the assets are the discounted sum of their future values.

2 . Economists use two principle interest rates: nominal and real. The purpose of this distinction is to

• A. use nominal interest rates during periods when the economy is growing and real interest rates during economic down turns
• B. adjust for the influences that inflation may have on business profits
• C. account for and factor the influences that inflation may have on the behavior that consumers and firms use to determine how much to save out of their incomes

3 . During periods of increasing inflationary pressure, the Federal Reserve should

• A. buy member bank’s bonds to encourage increased lending to the public
• B. sell bonds to member banks to discourage lending to the public
• C. reduce the discount rate to make it easier for small businesses to borrow money

4 . What is the increased moral hazard associated with the too big to fail (TBTF) bailouts of the largest of financial institutions?

• A. Financial institutions might misuse the bailout funds and continue the same practices that lead to the original failure.
• B. Depositors will lose their deposits.
• C. Employees of the financial institutions will lose their jobs.

5 . The Federal Reserve’s primary tool for managing the money flow is

• A. discount rate
• B. reserve ratio
• C. open-market operations
• D. term auction facility

6 . Which of the following is a major drawback of a flexible exchange rate?

• A. Government intervention in the form of reserves
• B. Use of exchange controls
• C. Discouraging the flow of trade due to risks and uncertainties

7 . The major advantage to a flexible exchange-rate policy is

• A. automatic adjustments to balance of payments
• B. relative interest rates between countries are automatically adjusted
• C. increased foreign investment
• D. increased overall wealth

8 . _____________suggests that a country will engage in trade and export products that it can produce at a lower-opportunity cost than a competing nation.

• A. Comparative advantage
• B. Absolute advantage
• C. Arbitrage
• D. Heckscher-Ohlin theory

9 . Absolute advantage encourages a country to

• A. enact protective tariffs
• B. specialize and trade with other countries
• C. export the technology that gives it an absolute advantage

10 . The _____________________ explains that long-run trends in exchange rates are based on a predictable relationship between product price levels and exchange rates.

• A. monetary approach to exchange rates
• B. asset market approach to exchange rates
• C. purchasing power parity

11 . A business traveler to Germany who, upon deplaning in Berlin, uses an airport ATM to withdraw 100 Euros from her U.S. bank would receive which kind of exchange rate?

• A. Spot
• B. Forward
• C. Fixed
• D. Flexible

12 . Suppose Nation A can produce 2 million pounds of sugar per week OR 1 million pounds of rice in a week and Nation B can produce 10 million pounds of sugar per week OR 3 million pounds of rice in a week. If this is a two-good, two nation model, what would Nation B’s best choice in regards to trade and specialization?

• A. Nation B should produce both rice and sugar.
• B. Nation B should produce only sugar and trade for rice.
• C. Nation B should produce sugar, produce rice, and trade some sugar for rice.
• D. Nation B should produce sugar, produce rice, and trade some rice for sugar.

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