Certified Financial Management Specialist Practice Exam

Which of the following is an example of open market operations?

1. Adjusting reserve requirements

2. Setting federal interest rates

3. Buying and selling government bonds

4. Implementing corporate tax reductions

The correct answer is: Buying and selling government bonds

Open market operations refer to the activities undertaken by a central bank, such as the Federal Reserve, to manage the money supply and influence interest rates through the buying and selling of government securities, primarily government bonds. When the central bank buys bonds, it injects liquidity into the economy, encouraging lending and spending which can stimulate economic growth. Conversely, selling bonds withdraws liquidity, which can help control inflation and stabilize the economy. The choice involving buying and selling government bonds accurately describes this process and illustrates how central banks implement monetary policy. This mechanism is fundamental for achieving targets related to inflation and economic stability, making it a direct tool for shaping financial conditions in the economy. In contrast, adjusting reserve requirements pertains to the amount of funds banks must hold in reserve and does not involve trading securities. Setting federal interest rates usually manifests through open market operations but is not an action in itself within the scope of open market activity. Implementing corporate tax reductions is a fiscal policy measure and falls outside the realm of monetary policy tools like open market operations.