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Question 1
All of the following EXCEPT one is a property of an illiquid market. Which one does not belong?
Agents cannot buy or sell quickly
Attempts to buy or sell tend to move prices around a lot
Dealers in illiquid markets are well capitalized
Agents cannot buy or sell large quantities easily
Question 2
Which of the following statements about the banking system of Bagehot's day is INCORRECT?
The Bank of England could lend freely to meet an external drain because of its massive gold
reserves
A bank with too many discounts and too few notes could borrow from other banks using
rediscount
The division of the Bank of England into separate Banking and Issue departments served to
keep notes scarce, and so acted as a mechanism of discipline
The central bank could supply an internal drain because it was at a higher level in the money-
credit hierarchy than other banks
Question 3
Which of the following BEST describes the Bagehot Principle?
In times of crisis, lend freely against security that would be good in normal times
In times of crisis, lend selectively at market rates, only to those who you think will survive
In times of crisis, lend freely at a low rate to prevent insolvent borrowers from failing
Raise interest rates in booms, and lower them in recessions, to stabilize aggregate income
Question 4
Which of the following is NOT true about the discount mechanism in the "world that Bagehot knew"?
Discounting banks change their quoted discount rates in order to balance their own cash inflow
and outflow
The discounting bank raises its quoted discount rate to discourage demand for discount, and
lowers to encourage
The discounting bank can avoid liquidity risk by creating deposits rather than lending its note
reserve
The market rate of interest depends on the marketwide balance between cash inflow from
maturing bills and cash outflow from new discounts
Question 5
According to our model of dealer behavior, if the demand for a particular security exhausts the
dealer's inventory, which of the following is the dealer's MOST likely response?
Raise the ask (selling) price, to discourage demand
Lower the ask (selling) price
Lower the bid (buying) price
Stop quoting that security and lower the price on other securities to attract the demand
Question 6
Which of the following MOST accurately characterizes the economics of the dealer function?
Dealers make money by keeping prices constant even as demand fluctuates
Security markets become less liquid during a crisis because dealers have more difficulty making
markets
Dealers serve a social function by keeping prices at their fundamental value
A fall in the bid-ask spread encourages more dealers to enter the market