TRUE/FALSE QUESTIONS

Briefly explain your answer

1. The yield curve is the graph that show relationship between interest rates on bonds and default risk on bonds with different rating

2. If the short-term interest rates are expected to increase, the yield curve is becoming downward sloping and the financial markets predict recession

3. Investors demand compensation for default risk in the form of risk premium. The higher the default risk, the higher the bond rating, the lower the risk premium.

4. Municipal bonds are usually tax-free. Since investors care about after-tax return on their investment, these bonds have higher yields than bonds whose interest rate payments are taxable

6. When bank lends long and borrows short, increases in interest rates will drive down the bank’s profits.

7. Banks can manage liquidity risk by adjusting rate sensitivity gap.

8. Banks manage credit risk by monitoring borrowers to lower adverse selection

9. “ A bank that expects interest rates to increase in the future will want to hold more of rate -sensitive assets and fewer rate- sensitive liabilities”

10. The central bank uses its balance sheet to control the money supply and credit in the economy

11. Central bank liabilities include currency held by the banking system and banking system reserves.

12. The monetary base, also called the high-powered money, is the sum of currency held by banks as vault cash and reserves, the two primary liabilities of the central bank

13. Open market purchases of government securities expand the central bank assets and liabilities.

14. While the central bank controls the money multiplier and the monetary base, it can completely control the quantity of money in the economy.

15. The primary tool of monetary policy is discount lending.

16. Open market operations are used to control the target federal funds rate.

17. The federal funds rate is the rate the Fed charges commercial banks for any loans it extends to them.

18. Fed’s two main monetary policy targets are price stability and high employment.

19. Targets for the federal funds rate are determine in the market for the reserves

20. The Fed can achieve its monetary policy goals directly