DSE past paper Money and Banking (sample paper and practice paper excluded)

Question 1 (2012#7)
“ 9999 gold is preferred to cigarettes when used as money.” Give TWO reasons to explain this
argument. (4 marks)
 Gold is more durable while cigarettes may lose their value during transaction
 Gold is more generally accepted as medium of exchange than cigarette
 Gold is more homogenous while cigarettes have different qualities
 Any other relevant point
 Mark the first two points only

Question 2 (2012#13)
The following table shows the balance sheet of the banking system of any economy.
Assets ($million) Liabilities ($million)
Reserves 500 Deposits 2000
Loans 1500
Suppose the public does not hold cash and there are $100million excess reserves in the banking
system.
a) Find the required reserve ratio. Show your working. (2 marks)
b) Find the maximum possible amount of deposits if the banks are fully loaned up. Show you working.
(2 marks)
c) The central bank injects $200million newly-printed banknotes into the banking system. If the
banks lend out all their excess reserves, what will the amount of money supply be in economy?
(4 marks)
d) Base on the quantity theory of money, predict the effect of the monetary policy in (c) on the price
level. State the assumption(s) needed to reach your conclusion. (6 marks)

a) Required reserve ratio = ($500m-$100m)/$2000m = 20%

b) Maximum possible amount of deposits = $500m x 1/0.2 = $2500m
c) Deposit = $700m x 1/0.2 = $3500m
Cash in public circulation = 0
Money supply = deposit + cash in public circulation = $3500m
d) = QTM: MV=PY, where M = money stock, V=velocity of circulation of money, P= general price level
and Y = real output, assuming V constant.
= An increase in M leads to an increase in P when Y increases by a smaller proportion.
DSE past paper Money and Banking (sample paper and practice paper excluded)

OR = An increase in M leads to an increase in P by the same percentage when Y is constant

Question 3 (2013#3)
a) What is the relationship between nominal interest rate and real interest rate? (2 marks)
b) “When there is actual deflation, the nominal interest rate will be lower than the real interest rate.”
Do you agree? Explain (3 marks)

a) Nominal interest rate (R)= expected inflation rate + real interest rate (r)
b) No, R will be lower than r only when the expected inflation rate is negative. But the existence of
actual deflation does not imply that the deflation is expected. (3)
OR
Yes, because people may expect deflation beforehand and an expected deflation will result in a
nominal interest rate being lower than real interest rate. (3)
OR
Yes, because the realized (actual) real interest rate will be higher than the nominal interest rate
when there is actual deflation. (3)

Question 4 (2013#12ab)
The following table shows the balance sheet of the banking system of an economy.
Assets ($million) Liabilities ($million)
Reserves 400 Deposits 2000
Loans 1600
The public holds $1000million cash and all banks are fully loaned up.
a) Calculate the monetary base and the money supply in the economy. Show your workings.
(4 marks)
b) If the required reserve ratio is adjusted 25%, calculate the new money supply in the economy.
(2 marks)
a) Monetary base = $400m+$1000m = $1400m
Money supply = $1000m+$2000m= $3000m
b) New money supply = $1000m+$400m x 1/25% = $2600m
DSE past paper Money and Banking (sample paper and practice paper excluded)

Question 5 (2014#12ab)
The Prime Minister of Japan, Shinzo Abe, adopted a series of policy measures in 2013 to expand the
Japanese economy. One of the policy measures was stepping up the scale of the purchase of
government bonds and other financial assets by the central bank.
a) If the Japanese central bank purchases government bonds from Japanese commercial banks,
explain whether the monetary base of Japan would be affected (3 marks)
b) Describe the process of deposit creation / contraction which may result from the purchase of
government bonds by the central bank. Explain whether the process would further affect the
monetary base of Japan.

a) Monetary base = cash in public circulation + reserves held by commercial banks. (1) The monetary
base increases because the commercial banks have more reserves. (2)
b) Credit creation process:
When the central bank purchases bonds from commercial banks, more cash is injected to the
commercial banks as reserves and there would be excess reserves in the banking system. (1)
The banks would lend out the excess reserves (1)
And the bank loans will be re-deposited into the banking system. (1)
The process will go on and on (until the actual reserves are equal to required reserves)
No. The monetary base will remain unchanged as the sum of cash in public circulation and
reserves in banking system will not be affected by the credit creation process. (2)

Question 6 (2015#6)
Study the following balance sheet of the banking system in Country A.
Assets ($million) Liabilities ($million)
Reserves 1000 Deposits 5000
Loans 4000
Suppose all banks are fully loaned up and never hold excess reserves. The public always holds $150
million in cash.
(a) Calculate the following items of this banking system:
(i) legal reserve ratio (1 mark)
(ii) money supply (2 marks)
A firm in Country A has received $50 million from abroad and deposited the sum of money into a
bank.
DSE past paper Money and Banking (sample paper and practice paper excluded)

(b) Calculate the new monetary base in Country A. Show your workings. (2 marks)
(c) Calculate the new money supply in Country A. Show your workings. (3 marks)

a) Legal reserve ratio = $1000m/$5000m =0.2

Money supply = $150m+$5000m = $5150m
b) New monetary base = $150m + $1050m = $1200m
c) New money supply = $150m + 1050m/0.2 = $5400m

2012
DSE past paper Money and Banking (sample paper and practice paper excluded)

2013
DSE past paper Money and Banking (sample paper and practice paper excluded)
DSE past paper Money and Banking (sample paper and practice paper excluded)

2014
DSE past paper Money and Banking (sample paper and practice paper excluded)
DSE past paper Money and Banking (sample paper and practice paper excluded)

2015
28. Refer to the following diagram.

The curve of asset demand for money will shift from Ma1 to Ma2 when
A. The risk of investing in stock market increases.
B. The interest rate decreases.
C. The general price level rises.
D. The government reduces the income tax rate.

29. Study the following balance sheet of a banking system. The required reserve ratio is 20%.
Assets ($million) Liabilities ($million)
Reserves 300 Deposits 1000
Loans 700
If the central bank issues newly printed banknotes worth $200 million, the cash held by the non-bank
public will increase by $100 million and the money supply will increase by $500 million. The total
amount of excess reserves in the banking system will then be _________.
A. $100 million
B. $120 million
C. $280 million
D. $400 million
DSE past paper Money and Banking (sample paper and practice paper excluded)

30. Which of the following transactions would increase the money supply (M2) of Hong Kong?
A. Ms Chan transfers $500 000 from her time deposit account in a restricted licence bank to her time
deposit account in a licensed bank.
B. Mr Lee transfers $200 000 from his current account to his savings account in a licensed bank.
C. Mr Man deposits $100 000 cash into his savings account in a licensed bank.
D. Ms Chung deposits $600 000 cash into her time deposit account in a deposit-taking company.

31. If the nominal interest rate is 5% and the expected inflation rate is 3%, the cost of holding money
is _______, the nominal return of holding money is ________ and the expected real interest rate is ________.
A. 5% …… -3% …… 2%
B. 5% …… 0% …… 2%
C. 8% …… -3% …… 3%
D. 8% …… 0% …… 3%

32. The monetary base increases when

A. The commercial banks hold less excess reserves.
B. The commercial banks buy government bonds from the public.
C. The central bank buys government bonds from the public.
D. The central bank increases the discount rate.

33. The quantity theory of money implies that

A. An increase in money supply will lead to a rise in price level when real output is falling.
B. The economy is always at the full employment output level.
C. An increase in money supply will lead to a decrease in the velocity of circulation of money when
real output is kept constant.
D. An increase in money supply will lead to a same-proportional increase in real output.

42. Under the linked exchange rate system of Hong Kong, which of the following statements is correct?
A. The money supply (M1) of Hong Kong has to be fully backed by the US dollar.
B. The market exchange rate of HK dollar to the US dollar is fixed at 1USD to 7.8 HKD by the Hong
Kong Monetary Authority.
C. Hong Kong’s import volume will increase when US dollar appreciates against other currencies.
DSE past paper Money and Banking (sample paper and practice paper excluded)

D. A current account deficit in the US will lead to a current account deficit in Hong Kong.

35. Refer to the following news extract.

Yu’e Bao (餘額寶) is a new online investment fund introduced by Alibaba. Much of the popularity of

Yu’eBao has come from its ability to give customers the convenience of a demand deposit --- meaning
they can withdraw their funds whenever they like --- but with returns well above what a bank could
offer. It recently advertised an annualised return of 5.25%, but that level has on occasion risen to above
7% since the fund was set up. By contrast, banks offer 3.3% as interest for a one-year fixed deposit and
close to nothing on savings deposits.

Yu’e Bao is a better __________ as compared with bank deposits because _________.
A. Unit of account … … it provides a homogeneous means of payment.
B. Unit of account … … it can facilitate people’s buying and selling of goods and services.
C. Store of value … … it allows customers to have higher purchasing power in the future.
D. Store of value … … the customers can keep their unused funds in Yu’e Bao.

2012
27C 28B 29A 30A* 36D*
2013
25B* 26C 27B 28B* 30D 32B 40C
2014
30D* 31A 32A* 33A 36D* 37D*
2015
28A* 29B* 30A 31B* 32C 33A* 35C 40A 42C