DSST Money and Banking Practice Questions Answer Key

1. D: All of the answers apply to the concept of money, but none of the characteristics would have meaning if the commodity being used as money is not widely accepted in trade. Native Americans often used seashells, beads, and a variety of things known as “wampum.” It’s acceptance in trade was what made it count as money. Fungibility refers to the ease with which money can flow from one party or place to another. Though it was accepted currency during historical times, wampum was less fungible than gold coins. For example, gold coins were more easily transportable and easier to handle as they passed from hand to hand.
2. C: Answer “c” is FALSE and is also the correct answer because there is no longer any “gold standard,” nor any “silver standard.” A dollar cannot be exchanged for a specific amount of silver or gold. The one thing that characterizes “fiat money” is that it can’t be redeemed for anything—not for gold or silver, nor for any other commodity. Fiat money is “declared” by a government to have meaning and value. The value is derived from the strength of the government’s economy. The use of this type of specie (fiat money) allows a government banking system to put more or less of it in circulation, as part of its “monetary policy.” Regulating the money supply is one way of making adjustments to economic conditions. Answer choices “a,” “b,” and “d” are all true.
3. B: Money that is intrinsically worthless but backed up by a valuable substance is called representative money. A certificate is made of paper, but it’s not money unless it can be exchanged for something. “D” would therefore be an incorrect answer. But if a certificate guarantees exchange of a specific amount of silver or other valuable metal, it is “representative money.” Commodity money is of a type that trades of itself; commodity money can consist of any scarce commodity that is deemed to have value—jewels, precious metals, even glass beads. Fiat money, on the other hand, has no intrinsic value, but is rather a promise of value. The U.S. dollar and the euro are examples of fiat money.
4. A: The other answer choices are nonsensical or irrelevant. The use of money as a “unit of account” is a way of measuring the value of ownership items like houses, cars, clothing, and food, and also a means of valuing the cost of operations and capital holdings. Since a dollar has relatively stable value, the number of dollars used to buy something serves as a comparative measurement. One car may have a sticker price of $26,000, while another has a price tag of $34,000. As such, the dollar is a unit of account used by the holder in comparing values. It is the same with clothing, wages, factories, savings deposits, or just about anything. Money is the “unit of account” by which goods, wages, and a variety of other things can be measured.
5. C: Answer choice “c” is not a time deposit, whether there is activity on the account or not. Therefore, answer “c” is the correct answer. CDs, or certificates of deposit, are time deposits. Time requirements for time deposit CDs are for a minimum of one month but may extend into years. Time deposits guarantee a specified rate of interest with the requirement that the deposits remain on account for a period of time (the maturity date) without withdrawal. Early withdrawal subjects the account to penalties. A person may establish a Foreign Currency Fixed Deposit (FCFD) account under similar terms. FCFDs contain currency risk, since dollars must first be converted into the host currency and then changed back to dollars at the end of the term.
6. D: Banking regulations require that commercial banks maintain proper reserve ratios that can keep the bank afloat during “bank runs,” a high incidence of default, or other crises. Charging a higher rate of interest for loans than it pays for time deposits helps a commercial bank only if loans never default. That’s not realistic, as the current recession/crisis shows. Investing in “funds” helps a bank’s profit and bottom line. But investment firms sometimes go bankrupt, too. Commercial banking chains do employ risk managers who can set policies, but policies often come up short of expectations, especially during economic crises.
7. A: Another name for the interbank loan rate is the federal funds rate. Knowing that, you would likely have selected the correct answer choice of “a,” the Federal Reserve Bank. The FDIC, or Federal Deposit Insurance Corporation, insures bank deposits. The SEC regulates security trades. States do set some banking regulations, but they do not set interest rates for interbank loans. In fact, setting the federal funds rate for interbank loans is one of the most important and primary functions of the Federal Reserve System.
8. A: In addition to national bank licensing, the Office of the Controller of Currency (OCC) ensures that banks are meeting reserve requirements and that they become members of the FDIC. The Office of the Controller of Currency also investigates potential criminal money-laundering activities and cases of possible terrorist funding. You probably remember that the Federal Reserve sets the interest rate for interbank loans, so you can rule out choice “c.” Choice “d” is also incorrect and makes little sense. If you knew that answer option was incorrect, you probably wouldn’t choose “b” either.
9. C: The Federal Reserve Bank sets the federal funds rate and the reserve requirements for banks. If a bank holds reserves in excess of the federal requirement, it may earn additional profits by loaning that money out for additional profit with dwindling reserves at the federal funds rate of interest. Choice “d” is wrong because it should never be necessary for the Federal Reserve to “bail out” a bank. Nor does answer choice “a” make sense, because the federal funds rate is lower than the housing mortgage rate precisely to stimulate housing, so that condition is always the case. Answer “b” has it exactly backwards. If a bank doesn’t have enough cash reserves to meet obligations, the Federal Reserve requirements restrict more lending.
10. D: One means of stimulating or slowing the economy is by controlling interest rates. A lower federal funds rate spreads money around to institutions with dwindling reserves and, therefore, more money is available for borrowing. Lower federal funds rates translate to lower interest rates for consumers and other borrowers. If the availability of money causes a rapid rise in prices, the Federal Reserve may slow down borrowing by a marginal increase in the federal funds rate. The ideal objective is always economic stability—stable financial institutions, steady growth, and a low inflation rate.