Financial Sector: Unit Diagnostic (Macroeconomics Unit 4)

This diagnostic helps you find which Unit 4 topics to revisit: one or two short questions on each topic, 4.1 to 4.7. Answer every question before opening any answers (about 30 minutes).

These are original Marlbridge practice questions, not past exam questions. The set is not calibrated, so it gives no predicted score. Valdoria is a fictional country; its currency is the valda (VD) and its central bank is the Central Bank of Valdoria (CBV). All data are fictional. A four-function calculator is enough. Unless stated, checking accounts pay no interest, banks lend all excess reserves and the public holds no extra cash. Only the stated change happens.

Question 1 (multiple choice · 4.1)

A previously issued Valdorian bond pays a fixed VD 45 of interest a year. Market interest rates on new bonds fall, and the bond’s price rises from VD 900 to VD 1,000. Taking the return as yearly interest ÷ price, what happens to the return a new buyer earns?

(A) It rises from 4.5% to 5%.
(B) It stays the same, because the interest payment is fixed.
(C) It falls from 5% to 4.5%.
(D) It rises, because the bond is now worth more.

Answer and explanation

Answer: (C). 45 ÷ 900 = 5%; 45 ÷ 1,000 = 4.5%. A higher price for the same fixed payment means a lower return.

(A) reverses the move.
(B) The payment is fixed, so the price adjusts, and with it the return to a new buyer.
(D) A higher price is a gain for the current owner; a new buyer gets a lower return.

If you missed this: read “Bond prices and interest rates” in the Topic 4.1 study guide.

Question 2 (multiple choice · 4.2)

A Valdorian savings deposit pays a nominal interest rate of 1%. Over the year, the price level falls by 2%. What real interest rate did the saver earn?

(A) −1%
(B) 1%
(C) 3%
(D) −3%

Answer and explanation

Answer: (C). Real rate = nominal − inflation = 1 − (−2) = 3%. Falling prices mean each valda buys more.

(A) adds the inflation rate (1 + (−2)) instead of subtracting it.
(B) is the nominal rate, ignoring the change in prices.
(D) subtracts the wrong way round (−2 − 1). Deflation raises the real rate above the nominal rate.

If you missed this: read “Calculating a real rate in hindsight” and Worked example 2 in the Topic 4.2 study guide.

Question 3 (multiple choice · 4.3)

Which transaction increases M1 but leaves M2 unchanged?

(A) A household deposits VD 500 of banknotes into its checking account.
(B) A household moves VD 500 from its savings deposit into its checking account.
(C) A household moves VD 500 from its checking account into a small time deposit.
(D) A household buys a VD 500 phone with a credit card.

Answer and explanation

Answer: (B). Savings deposits are in M2 only; checking deposits are in M1 and M2. The money enters M1 but stays inside M2.

(A) Currency falls and deposits rise by the same amount, so M1 does not change.
(C) is the reverse of (B): M1 falls.
(D) A credit card is a loan, not money.

If you missed this: read Worked example 2 in the Topic 4.3 study guide.

Question 4 (multiple choice · 4.4)

A Valdorian bank makes a new loan of VD 50 million by adding it to the borrower’s checking account. What is the effect at that moment?

(A) M1 rises by VD 50 million.
(B) M1 does not change, because the bank’s reserves fall by VD 50 million.
(C) The monetary base rises by VD 50 million.
(D) M1 rises by VD 50 million multiplied by the money multiplier.

Answer and explanation

Answer: (A). The borrower has a new deposit and nobody has less money: lending creates money.

(B) Reserves leave only when the borrower spends the loan, and then they move to another bank.
(C) Lending creates deposits, not currency or reserves.
(D) The multiplier describes many rounds across the system, not one loan.

If you missed this: read part (c) of Worked example 1 in the Topic 4.4 study guide.

Question 5 (multiple choice · 4.4)

A Valdorian bank has demand deposits of VD 500 million and reserves of VD 130 million. The required reserve ratio is 20%, and every other bank is fully loaned up. If the bank lends all its excess reserves, what is the maximum increase in the money supply for the whole banking system?

(A) VD 30 million
(B) VD 150 million
(C) VD 500 million
(D) VD 650 million

Answer and explanation

Answer: (B). Required reserves = 0.2 × 500 = 100. Excess reserves = 130 − 100 = 30. Multiplier = 1 ÷ 0.2 = 5. Maximum increase = 30 × 5 = VD 150 million.

(A) is the most this one bank can lend, not the total for the system.
(C) multiplies the required reserves, which the bank must keep.
(D) multiplies all the reserves. Only excess reserves can be lent.

If you missed this: read “Fractional reserve banking” and “The money multiplier” in the Topic 4.4 study guide.

Question 6 (multiple choice · 4.5)

A new payment app lets Valdorians keep their wealth in an interest-earning fund until the moment they pay. The CBV takes no action. What happens?

(A) Money demand shifts left; the nominal interest rate falls; prices of existing bonds fall.
(B) Money supply shifts right; the nominal interest rate falls; prices of existing bonds rise.
(C) Money demand shifts right; the nominal interest rate rises; prices of existing bonds fall.
(D) Money demand shifts left; the nominal interest rate falls; prices of existing bonds rise.

Answer and explanation

Answer: (D). People hold less money at every rate, so MD shifts left. The surplus of money is used to buy bonds, so bond prices rise and the rate falls.

(A) gets the rate right but not bond prices, which move opposite to rates.
(B) The quantity of money has not changed; only how much people want to hold.
(C) has the shift the wrong way round.

If you missed this: read “What shifts the curves” in the Topic 4.5 study guide.

Question 7 (multiple choice · 4.6)

Valdoria has limited reserves and a recessionary output gap. Which set of actions is all expansionary?

(A) Buy government bonds, raise the required reserve ratio, lower the discount rate
(B) Sell government bonds, lower the required reserve ratio, lower the discount rate
(C) Buy government bonds, lower the required reserve ratio, lower the discount rate
(D) Buy government bonds, lower the required reserve ratio, raise the interest on reserves

Answer and explanation

Answer: (C). Each action adds excess reserves or makes reserves cheaper, so interest rates fall.

(A) A higher reserve ratio cuts excess reserves: contractionary.
(B) Selling bonds removes reserves: contractionary.
(D) Higher interest on reserves raises the policy rate: contractionary.

If you missed this: read “The tools” in the Topic 4.6 study guide.

Question 8 (multiple choice · 4.6)

Valdoria has limited reserves and a required reserve ratio of 25%. The CBV sells VD 6 billion of government bonds to households, who pay from their checking accounts. What is the maximum decrease in the money supply?

(A) VD 1.5 billion
(B) VD 6 billion
(C) VD 18 billion
(D) VD 24 billion

Answer and explanation

Answer: (D). Deposits and reserves fall by 6 at once. Required reserves fall by only 0.25 × 6 = 1.5, so banks are 4.5 short and cut lending by up to 4.5 × 4 = 18. Total: 6 + 18 = VD 24 billion (= 6 × 4).

(A) is the fall in required reserves.
(B) is the fall in the monetary base only.
(C) forgets the 6 of deposits that left at once.

If you missed this: read Worked example 1, especially Check 2, in the Topic 4.6 study guide.

Question 9 (multiple choice · 4.7)

Valdoria’s government moves from a balanced budget to a budget surplus. Using the supply-side view of the loanable funds market, what happens?

(A) Supply shifts right; the real interest rate falls; private investment rises.
(B) Demand shifts right; the real interest rate rises; private investment falls.
(C) Supply shifts left; the real interest rate rises; private investment falls.
(D) The money supply shifts right; the nominal interest rate falls.

Answer and explanation

Answer: (A). A surplus is positive public saving, so national saving rises, the real rate falls and firms borrow more.

(B) describes a larger deficit.
(C) treats the surplus as less saving. A surplus adds to national saving.
(D) uses the wrong model: the budget affects loanable funds, not the money supply.

If you missed this: read “What shifts the curves” in the Topic 4.7 study guide.

Question 10 (short answer · 4.2)

A Valdorian lender and borrower agree a one-year loan at a nominal rate of 9%. Both expect inflation of 5%.

(a) Calculate the real interest rate they expect. (b) Actual inflation is 7.5%. Calculate the real rate in hindsight and say who gains. (c) For next year, both now expect 7.5% inflation and want the same expected real rate as in (a). Calculate the nominal rate they will agree.

Worked answer

(a) 9 − 5 = 4%.

(b) 9 − 7.5 = 1.5%. The borrower gains: inflation was higher than expected, so repayments buy less than planned.

(c) Nominal = expected real + expected inflation = 4 + 7.5 = 11.5%.

If you missed this: read “How lenders and borrowers set a nominal rate” in the Topic 4.2 study guide.

Question 11 (short answer · 4.5)

Valdoria’s money demand is Qd = 560 − 20i, where Qd is in VD billion and i is the nominal interest rate in per cent. The money supply is VD 480 billion.

(a) Calculate the equilibrium nominal interest rate. (b) At 6%, calculate the shortage or surplus of money and explain how the rate adjusts. (c) The CBV wants a rate of 3%. By how much must it change the money supply?

Worked answer

(a) 560 − 20i = 480, so 20i = 80 and i = 4%.

(b) At 6%, Qd = 560 − 120 = 440: a surplus of VD 40 billion. People buy bonds, bond prices rise and the rate falls to 4%.

(c) At 3%, Qd = 560 − 60 = 500. The money supply must rise by VD 20 billion, from 480 to 500.

If you missed this: read Worked example 1 in the Topic 4.5 study guide.

Question 12 (short answer · 4.7)

In one year Valdoria has Y = 800, C = 520, T = 170 and G = 150 (VD billion).

(a) Calculate private, public and national saving. (b) Valdorians lend VD 15 billion more abroad than foreigners lend into Valdoria. Calculate domestic investment.

Worked answer

(a) Private saving = 800 − 170 − 520 = 110. Public saving = 170 − 150 = 20 (a surplus). National saving = 130 (check: 800 − 520 − 150 = 130).

(b) Net capital inflow is −15, so investment = 130 − 15 = VD 115 billion. Funds lent abroad cannot finance investment at home.

If you missed this: read “National saving and investment” in the Topic 4.7 study guide.

Your next step

Topic	Question(s)	If you missed it, read
4.1 Financial assets	1	Financial assets study guide
4.2 Nominal v. real interest rates	2, 10	Nominal v. real interest rates study guide
4.3 Definition, measurement and functions of money	3	Money study guide
4.4 Banking and the expansion of the money supply	4, 5	Banking study guide
4.5 The money market	6, 11	Money market study guide
4.6 Monetary policy	7, 8	Monetary policy study guide
4.7 The loanable funds market	9, 12	Loanable funds study guide

How to use your result

No mistakes in a topic: tick it off, but try its practice set once.
One mistake: read the section named in the answer, then redo the question without looking.
Two or more mistakes, or a guess: work through that topic’s study guide and practice set first.
Mixed up nominal and real rates: revisit Topics 4.2, 4.5 and 4.7 together.
Mixed up the monetary base and the money supply: revisit Topics 4.3, 4.4 and 4.6.

Then try the mixed unit review.