Question

18. The Bank of Canada will engage in a sale and repurchase agreement when it wants to ________ reserves ________ in the banking system. a. increase; permanently b. decrease; temporarily c. increase; temporarily d. decrease; permanently

19. One problem with the too-big-to-fail policy is that it ________ the incentive for ___________ by banks. a. increases; moral hazard b. decreases; moral hazard c. increases; adverse selection d. decreases; adverse selection

20. Covenants such as those to discourage undesirable behaviour of borrowers and those which require borrowers to maintain and insure their collateral are intended to help solve the a. Adverse selection in equity contracts. b. Moral hazard in debt contracts. c. Adverse selection in debt contracts. d. Moral hazard in equity contracts

21. If bank depositors begin to withdraw more currency from banks, a. The monetary base is unchanged b. Bank reserves increase c. The monetary base decreases d. Bank reserves are unchanged

Answer 1

Question 18
Answer - (b) The Bank of Canada will engage in a sale and repurchase agreement when it wants to decrease reserves temporarily in the banking system.
Reason- In order to increase capital in the short run, the bank will engage in repurchase agreement to buy and resell the securities at maturity period, to which the borrowers pay an amount at the existing repo rate.

Question 19
Answer - (a) One problem with the too-big-to-fail policy is that it increases the incentive for moral hazard by banks.
Reason - It increases the incentive for moral hazard by banks because all the banks are largely interconnected with each other and failure of one will impact the other banks as well, and the economy as a whole.

Question 20.
Answer- (b) Moral hazard in debt contracts.
Reason - Covenants are introduced to control moral hazards by keeping mandatory guidelines for the borrows to either restrict their risky ventures or to promote them to take up desirable investment. It is also used to keep the collateral valuable.

Question 21.
Answer - (b) Bank reserves increase
Reason- The banks usually keep minimum reseves but, in case the withdrawal rate increases, the banks must increase their cash reserves in order to meet the withdrawal demands of their customers.