Financial Markets and Institutions – Exam 1, UARK, 2026 –
Study Material and Practice Questions
When reserve requirements increase, interest rates ____. - ANS✔✔ Increase ; banks must hold
more reserves causing lending supply to decrease driving up interest rates.
The Federal Reserve ____ the money supply when it sells government securities. - ANS✔✔
Decreases; when the Fed sells securities to the market, the funds are recycled back to the Fed
so the monetary base decreases. This is a part of open market operations.
True or false? High stock prices are a goal of monetary policy. - ANS✔✔ False ; the Fed has
nothing to do with stock prices directly and focuses only on the Dual Mandate.
True or false? If the amount of cash in the economy decreases, the Fed may offset their effects
with open market sales. - ANS✔✔ False ; Selling will decrease the cash/money supply but the
Fed would want to increase it in this case.
True or false? The Fed perfectly controls the money supply. - ANS✔✔ False ; the Fed doesn't
control the money supply, it just influences it through directly controlling the monetary base
The Fed may influence the Fed Funds Rate in all the following ways except...
A. buying bonds in the open market
B. selling in the REPO market
C. exercising its regulatory power over interest rates
adjusting the interest on reserves - ANS✔✔ C ; Regulatory power is NOT a monetary policy tool.
An "expansionary" fiscal policy would likely include...
,A. tax increases
B. budget deficits
C. lowering the Discount Rate
D. budget surpluses - ANS✔✔ B ; Expansionary fiscal policy means an increase in government
spending (usually financed by deficit spending).
An increase in the money supply should ultimately cause...
A. higher business investment and higher household borrowing
B. lower business investment and higher exports
C. lower household borrowing and lower exports
D. lower business investment and higher household spending - ANS✔✔ A ; an increase in the
money supply lowers interest rates.
Which of these financial instruments are capital market instruments?
A. Commercial paper
B. Federal funds - overnight
C. Mortgage loans
D. 6-month CDs - not 1 year - ANS✔✔ C ; the key difference is maturity - money market
instruments are <1 year while capital markets are 1+ years.
A bank makes a 3-year fixed-rate loan of $1 million to a business and funds the loan with ten 1-
year certificates of deposit of $100,000 gathered from 10 different depositors at the bank.
Which of the characteristics below of financial intermediation is not represented in this
transaction?
, A. currency transformation
B. financial intermediation
C. denomination divisibility
maturity transformation - ANS✔✔ A ; in this example it did perform a maturity transformation
(transformed from ST -> LT), acted as an intermediary and denomination divisibility (collected
10 transactions and transformed into one large).
What is the fundamental function of the financial system in the US? - ANS✔✔ To channel funds
from those who have extra money to those who need funding.
Why are direct financing transactions more costly or inconvenient than intermediated
transactions"? - ANS✔✔ Because of the high transaction costs and asymmetric information.
Only big corporations may be able to overcome these obstacles. Financial intermediaries
decrease these costs and take advantage of economies of scale.
What is the concept of financial intermediation? How does the possibility of financial
intermediation increase the efficiency of the financial system? - ANS✔✔ Financial
intermediation is the process by which financial institutions mediate unmatched preferences of
ultimate borrowers (DSUs) and ultimate lenders (SSUs). Financial intermediaries buy financial
claims with one set of characteristics from DSUs, then issue their own liabilities with different
characteristics to SSUs. Thus, financial intermediaries "transform" claims to make them more
attractive to both DSUs and SSUs. This increases the amount and regularity of participation in
the financial system, makes financial markets more efficient.
What is the difference between money markets and capital markets? Which market would
General Motors use to finance a new assembly plant? Why? - ANS✔✔ Money markets are
markets for liquidity, whether borrowed to finance current operations or lent to avoid holding
idle cash in the short term. Money markets tend to be wholesale OTC markets made by dealers.
Capital markets are where real assets or "capital goods" are permanently financed. Investors
would purchase those securities to build wealth over the long term, not to store liquidity.
Study Material and Practice Questions
When reserve requirements increase, interest rates ____. - ANS✔✔ Increase ; banks must hold
more reserves causing lending supply to decrease driving up interest rates.
The Federal Reserve ____ the money supply when it sells government securities. - ANS✔✔
Decreases; when the Fed sells securities to the market, the funds are recycled back to the Fed
so the monetary base decreases. This is a part of open market operations.
True or false? High stock prices are a goal of monetary policy. - ANS✔✔ False ; the Fed has
nothing to do with stock prices directly and focuses only on the Dual Mandate.
True or false? If the amount of cash in the economy decreases, the Fed may offset their effects
with open market sales. - ANS✔✔ False ; Selling will decrease the cash/money supply but the
Fed would want to increase it in this case.
True or false? The Fed perfectly controls the money supply. - ANS✔✔ False ; the Fed doesn't
control the money supply, it just influences it through directly controlling the monetary base
The Fed may influence the Fed Funds Rate in all the following ways except...
A. buying bonds in the open market
B. selling in the REPO market
C. exercising its regulatory power over interest rates
adjusting the interest on reserves - ANS✔✔ C ; Regulatory power is NOT a monetary policy tool.
An "expansionary" fiscal policy would likely include...
,A. tax increases
B. budget deficits
C. lowering the Discount Rate
D. budget surpluses - ANS✔✔ B ; Expansionary fiscal policy means an increase in government
spending (usually financed by deficit spending).
An increase in the money supply should ultimately cause...
A. higher business investment and higher household borrowing
B. lower business investment and higher exports
C. lower household borrowing and lower exports
D. lower business investment and higher household spending - ANS✔✔ A ; an increase in the
money supply lowers interest rates.
Which of these financial instruments are capital market instruments?
A. Commercial paper
B. Federal funds - overnight
C. Mortgage loans
D. 6-month CDs - not 1 year - ANS✔✔ C ; the key difference is maturity - money market
instruments are <1 year while capital markets are 1+ years.
A bank makes a 3-year fixed-rate loan of $1 million to a business and funds the loan with ten 1-
year certificates of deposit of $100,000 gathered from 10 different depositors at the bank.
Which of the characteristics below of financial intermediation is not represented in this
transaction?
, A. currency transformation
B. financial intermediation
C. denomination divisibility
maturity transformation - ANS✔✔ A ; in this example it did perform a maturity transformation
(transformed from ST -> LT), acted as an intermediary and denomination divisibility (collected
10 transactions and transformed into one large).
What is the fundamental function of the financial system in the US? - ANS✔✔ To channel funds
from those who have extra money to those who need funding.
Why are direct financing transactions more costly or inconvenient than intermediated
transactions"? - ANS✔✔ Because of the high transaction costs and asymmetric information.
Only big corporations may be able to overcome these obstacles. Financial intermediaries
decrease these costs and take advantage of economies of scale.
What is the concept of financial intermediation? How does the possibility of financial
intermediation increase the efficiency of the financial system? - ANS✔✔ Financial
intermediation is the process by which financial institutions mediate unmatched preferences of
ultimate borrowers (DSUs) and ultimate lenders (SSUs). Financial intermediaries buy financial
claims with one set of characteristics from DSUs, then issue their own liabilities with different
characteristics to SSUs. Thus, financial intermediaries "transform" claims to make them more
attractive to both DSUs and SSUs. This increases the amount and regularity of participation in
the financial system, makes financial markets more efficient.
What is the difference between money markets and capital markets? Which market would
General Motors use to finance a new assembly plant? Why? - ANS✔✔ Money markets are
markets for liquidity, whether borrowed to finance current operations or lent to avoid holding
idle cash in the short term. Money markets tend to be wholesale OTC markets made by dealers.
Capital markets are where real assets or "capital goods" are permanently financed. Investors
would purchase those securities to build wealth over the long term, not to store liquidity.
