Assignment 8: Solution
1) Which among the following pays out cash flows from subprime mortgage-backed
securities in different tranches, if there were losses on the mortgage-backed securities
with highest-rated tranch paying out first, while lower ones paid out less.
A) Collateralized debt obligation (CDO)
B) Adjustable-rate mortgage
C) Negotiable CD
D) Discount bond
Answer: A
Explanation: Collateralized Debt Obligation (CDO) is a financial product that pays out
cash flows from subprime mortgage-backed securities in different tranches. These tranches
operate in a hierarchical manner, meaning that if there were losses on the mortgage-backed
securities, the highest-rated tranch (the safest one) pays out first, while lower-rated
tranches pay out less. This structure is designed to provide different levels of risk and
return to investors who hold different tranches of the CDO.
2) Of the following monetary aggregates, ________ has the largest size
A) money market deposit accounts.
B) demand deposits.
C) M1.
D) M2.
Answer: D
Explanation: M2 is a broader monetary aggregate that includes more components than M1.
It includes all the items in M1 (such as demand deposits and currency in circulation) and
adds additional components like savings accounts, time deposits, and small-denomination
time deposits. Therefore, M2 has the largest size among the options provided.
3) If in an economy some individuals redeem a savings bond for currency
A) M1 increases and M2 increases.
B) M1 stays the same and M2 decreases.
C) M1 increases and M2 stays the same.
D) M1 stays the same and M2 stays the same.
Answer: A
Explanation: When individuals redeem a savings bond for currency, it increases the
currency component of M1 because currency in circulation goes up. Additionally, it also
increases M2 because savings bonds are considered part of M2 (as they are time deposits)
until they are redeemed for currency or deposited into a transaction account. So, both M1
and M2 increase in this scenario.
4) Which of the following is included in both M1 and M2?
A) Savings deposits
B) Currency
C) Small-denomination time deposits
D) Money market deposit accounts
Answer: B
5) In case where government finances its spending by selling bonds to the central bank,
the monetary base will ________ and the money supply will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) not change; not change
Answer: A
Explanation: Currency (physical cash) is included in both M1 and M2. M1 consists of
currency, demand deposits, traveler's checks, and other checkable deposits. M2 includes
all the components of M1 plus additional items like savings deposits, small-denomination
time deposits, and money market deposit accounts. So, currency is a common component
in both M1 and M2.
6) Calculate the simple deposit multiplier If the required reserve ratio is 10 percent
A) 100
B) 90
C) 110
D) 10
Answer: D
Explanation:
Simple Deposit Multiplier = 1 / Required Reserve Ratio
7) Bonds with relatively low risk of default are called ________ securities and have a
rating of Baa (or BBB) and above; bonds with ratings below Baa (or BBB) have a
higher default risk and are called ________.
A) investment grade; lower grade
B) investment grade; junk bonds
C) high quality; lower grade
D) high quality; junk bonds
Answer: B
Explanation: Bonds with relatively low risk of default are called "investment grade"
securities and typically have a rating of Baa (or BBB) and above by credit rating agencies.
These bonds are considered safer investments.
8) Of money’s three functions, the one that distinguishes money from other assets is its
function as a
A) store of value.
B) unit of account.
C) standard of deferred payment.
D) medium of exchange.
Answer: D
Explanation: Among these functions, the one that distinguishes money from other assets
is its role as a medium of exchange. While other assets may serve as stores of value or
units of account, money uniquely facilitates direct transactions between individuals or
entities.
9) The monetary base consists of
A) currency in circulation and RBI Reserve notes.
B) currency in circulation and the Indian Treasury’s monetary liabilities.
C) currency in circulation and reserves.
D) reserves and RBI Reserve Notes.
Answer: C
Explanation: The monetary base, also known as the money base or high-powered money,
consists of two main components:
1. Currency in Circulation: This includes the physical currency (coins and banknotes) that
is in the hands of the public and not held by banks.
2. Reserves: Reserves are the funds held by commercial banks at their central bank (in this
case, the Reserve Bank of India or RBI). These reserves are required by banks to meet
their reserve requirements and include both required reserves and excess reserves.
10) Purchases and sales of government securities by the RBI are called
A) discount loans.
B) RBI fund transfers.
C) open market operations.
D) swap transactions.
Answer: C
Explanation: Open market operations refer to the buying and selling of government
securities (bonds) by a central bank, such as the Reserve Bank of India (RBI), in the open
market to influence the money supply and achieve specific monetary policy objectives.
These operations involve the purchase or sale of government securities in the open market,
affecting the level of reserves in the banking system and, consequently, the interest rates
and overall monetary conditions in the economy.
