,Chapter 01 A modern financial system: An overview
1: The exchange of goods and services is made more efficient by:
A: barter
B*: money
C: governments
D: some combination of government transfer and barter
2: A nation state that has only a barter system has high transaction costs because:
A: the difficulties of trade result in high legal costs because of the contracts required
B*: traders must spend quite a bit of time looking for trading partners
C: taxes under this system consume a large amount of output
D: the difficulties of trade require high insurance premiums
3: The term ‘medium of exchange’ for money refers to its use as:
A: coinage
B: currency
C*: anything that is widely accepted as payment for goods and services
D: any standard of value that prices can be expressed in
4: The role of money as a store of value refers to:
A: the value of money falling only when the money supply falls
B: the value of money falling only when the money supply increases
C*: the fact that money allows worth to be stored readily
D: the fact that money never loses its value compared with other assets
5: Money increases economic growth by assisting transfers from:
A: consumers to investors
B*: savers to borrowers
C: businesses to consumers
D: borrowers to investors
6: Financial markets have developed to facilitate the exchange of money between
savers and borrowers. Which of the following is NOT a function of money?
A: a store of value
B: a medium of exchange for settling economic transactions
C*: a claim to future cash flows
D: short-term protection against inflation
7: Buyers of financial claims lend their excess funds as they:
A: expect to borrow extra funds in the future
B*: want surplus funds in the future
, C: want to invest in the future
D: want to increase their costs relative to their incomes
8: Sellers of financial claims promise to pay back borrowed funds:
A: by borrowing extra funds in the future
B*: based on their expectation of having surplus funds in the future
C: by selling other assets
D: by reducing their costs relative to their incomes
9: A savings-surplus unit is one:
A: that needs to borrow funds from a surplus unit
B*: whose income exceeds its spending
C: whose spending exceeds its income
D: that generally is a company
10: The process of facilitating the flow of funds between borrowers and lenders
performed by the financial system:
A: is hindered by the problem of ‘double coincidence of wants’
B: greatly reduces the probability of inflation
C*: increases the rate of economic growth of a country
D: occurs only through financial intermediaries
11. The most fundamental economic function of a modern financial system is to:
A. Maximize bank profitability
B. Match surplus and deficit economic units efficiently
C. Increase government tax revenue
D. Facilitate only domestic investment
Correct Answer: B
Rationale: A modern financial system channels funds from surplus units (savers) to deficit units
(borrowers), enabling investment, consumption, and economic growth. Profit, taxation, and domestic focus
are secondary outcomes.
12. In a well-functioning financial system, liquidity creation primarily occurs through:
A. Government regulation
B. Mutual funds investing in long-term bonds
C. Banks transforming illiquid assets into liquid liabilities
D. Stock markets issuing new equity
, Correct Answer: C
Rationale: Banks create liquidity by converting long-term loans (illiquid) into short-term deposits (liquid).
Markets issue securities but do not perform maturity transformation.
13. One major reason financial markets increase economic efficiency is that they:
A. Allow firms to avoid disclosure requirements
B. Reduce transaction costs and information asymmetry
C. Replace the need for financial institutions
D. Increase speculative opportunities for investors
Correct Answer: B
Rationale: Markets reduce the cost of trading and provide information signals (prices). They do not remove
institutions or encourage secrecy.
14. Which financial market is most associated with price discovery?
A. Money markets
B. Capital markets
C. Derivatives markets
D. Primary markets
Correct Answer: C
Rationale: Derivatives markets aggregate expectations about future prices, making them highly efficient at
price discovery. Primary markets only issue securities; capital and money markets trade existing ones.
15. The distinguishing feature of primary markets is that they:
A. Sell only short-term assets
B. Facilitate resale of previously issued securities
C. Transfer funds from investors directly to borrowers
D. Are regulated differently from secondary markets
Correct Answer: C
Rationale: In primary markets, new securities are issued and the proceeds go to the issuer. Secondary
markets involve investor-to-investor trading.
16. Financial intermediation increases economic welfare because:
A. It guarantees elimination of all risk
B. It allows small savers to benefit from diversification and expertise
C. It removes the need for financial markets
D. It ensures government control over the financial sector
Correct Answer: B
1: The exchange of goods and services is made more efficient by:
A: barter
B*: money
C: governments
D: some combination of government transfer and barter
2: A nation state that has only a barter system has high transaction costs because:
A: the difficulties of trade result in high legal costs because of the contracts required
B*: traders must spend quite a bit of time looking for trading partners
C: taxes under this system consume a large amount of output
D: the difficulties of trade require high insurance premiums
3: The term ‘medium of exchange’ for money refers to its use as:
A: coinage
B: currency
C*: anything that is widely accepted as payment for goods and services
D: any standard of value that prices can be expressed in
4: The role of money as a store of value refers to:
A: the value of money falling only when the money supply falls
B: the value of money falling only when the money supply increases
C*: the fact that money allows worth to be stored readily
D: the fact that money never loses its value compared with other assets
5: Money increases economic growth by assisting transfers from:
A: consumers to investors
B*: savers to borrowers
C: businesses to consumers
D: borrowers to investors
6: Financial markets have developed to facilitate the exchange of money between
savers and borrowers. Which of the following is NOT a function of money?
A: a store of value
B: a medium of exchange for settling economic transactions
C*: a claim to future cash flows
D: short-term protection against inflation
7: Buyers of financial claims lend their excess funds as they:
A: expect to borrow extra funds in the future
B*: want surplus funds in the future
, C: want to invest in the future
D: want to increase their costs relative to their incomes
8: Sellers of financial claims promise to pay back borrowed funds:
A: by borrowing extra funds in the future
B*: based on their expectation of having surplus funds in the future
C: by selling other assets
D: by reducing their costs relative to their incomes
9: A savings-surplus unit is one:
A: that needs to borrow funds from a surplus unit
B*: whose income exceeds its spending
C: whose spending exceeds its income
D: that generally is a company
10: The process of facilitating the flow of funds between borrowers and lenders
performed by the financial system:
A: is hindered by the problem of ‘double coincidence of wants’
B: greatly reduces the probability of inflation
C*: increases the rate of economic growth of a country
D: occurs only through financial intermediaries
11. The most fundamental economic function of a modern financial system is to:
A. Maximize bank profitability
B. Match surplus and deficit economic units efficiently
C. Increase government tax revenue
D. Facilitate only domestic investment
Correct Answer: B
Rationale: A modern financial system channels funds from surplus units (savers) to deficit units
(borrowers), enabling investment, consumption, and economic growth. Profit, taxation, and domestic focus
are secondary outcomes.
12. In a well-functioning financial system, liquidity creation primarily occurs through:
A. Government regulation
B. Mutual funds investing in long-term bonds
C. Banks transforming illiquid assets into liquid liabilities
D. Stock markets issuing new equity
, Correct Answer: C
Rationale: Banks create liquidity by converting long-term loans (illiquid) into short-term deposits (liquid).
Markets issue securities but do not perform maturity transformation.
13. One major reason financial markets increase economic efficiency is that they:
A. Allow firms to avoid disclosure requirements
B. Reduce transaction costs and information asymmetry
C. Replace the need for financial institutions
D. Increase speculative opportunities for investors
Correct Answer: B
Rationale: Markets reduce the cost of trading and provide information signals (prices). They do not remove
institutions or encourage secrecy.
14. Which financial market is most associated with price discovery?
A. Money markets
B. Capital markets
C. Derivatives markets
D. Primary markets
Correct Answer: C
Rationale: Derivatives markets aggregate expectations about future prices, making them highly efficient at
price discovery. Primary markets only issue securities; capital and money markets trade existing ones.
15. The distinguishing feature of primary markets is that they:
A. Sell only short-term assets
B. Facilitate resale of previously issued securities
C. Transfer funds from investors directly to borrowers
D. Are regulated differently from secondary markets
Correct Answer: C
Rationale: In primary markets, new securities are issued and the proceeds go to the issuer. Secondary
markets involve investor-to-investor trading.
16. Financial intermediation increases economic welfare because:
A. It guarantees elimination of all risk
B. It allows small savers to benefit from diversification and expertise
C. It removes the need for financial markets
D. It ensures government control over the financial sector
Correct Answer: B
