Money And Banking

Front 1

-What do financial markets do?

Back 1

They get people with funds to lend together with people who want to borrow funds.

Front 2

-direct vs. indirect finance

Back 2

Indirect finance is where borrowers borrow funds from the financial market through indirect means, such as through a financial intermediary. This is different from direct financing where there is a direct connection to the financial markets as indicated by the borrower issuing securities directly on the market. Common methods for direct financing include a financial auction (where price of the security is bid upon) or an initial public offering (where the security is sold for a set initial price).

Front 3

Suppose your bond is selling for $950, and has a coupon rate of 7%; it matures in 4 years, and the par value is $1000. What is the YTM?

Back 3

The coupon payment is $70 (that's 7% of $1000), so the equation to satisfy is

(Current yield is $70/$950 = 7.37%)One thing to notice is that the YTM is greater than the current yield, which in turn is greater than the coupon rate.This will always be true for a bond selling at a discount. In fact, you will always have this:

Front 4

-coupon rate, face value, coupon bond, discount bond

Back 4

Annual payout as a percentage of the bond's par value.

Front 5

-Nominal vs. real interest rates

Back 5

nominal = the rate of interest before adjustment for inflation

real = approximately the nominal interest rate minus the inflation rate

Front 6

-The theory of asset demand: What determines demand for different assets?

Back 6

The amount of liquidity

Front 7

-Determination of interest rates in the bond market

Back 7

?

Front 8

-How do various events affect D and S for bonds, and how do changes in D & S for bonds affect bond prices and yield? (Draw the graphs, shift the curves, explain.)

Back 8

?

Front 9

-Which are the most important sources of funding for companies?

Back 9

loans from other financial intermediaries

Front 10

Moral Hazard

Back 10

occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information

Front 11

Adverse Selection

Back 11

It refers to a market process in which "bad" results occur when buyers and sellers have asymmetric information (i.e. access to different information): the "bad" products or customers are more likely to be selected.

Front 12

Asymmetric Information

Back 12

decisions in transactions where one party has more or better information than the other

Front 13

How can financial intermediaries reduce the problems related to Moral Hazard, Adverse Selection, Asymmetric Information?

Back 13

?

Front 14

What is the role of transaction costs.

Back 14

financial intermediaries and indirect finance play such an important role in financial markets.

Front 15

How does a fall in asset prices, deflation, and uncertainty etc. increase asymmetric information and start a financial crisis.

Back 15

Causes lenders to become more cautious and reduce the amount of loans they make.
Causes borrowing firms to have less to lose so they are willing to take on addtional risk.
Causes a serious deterioration in borrowing firms' balance sheets.

Front 16

Why may banks want to hold excess reserves?

Back 16

In case there is slow economic activity and people are late on their payments.

Front 17

How do changes in deposits affect required reserves?

Back 17

?

Front 18

Basic T-accounts and balance sheet

Back 18

?

Front 19

Bank capital management: Insolvency and failure

Back 19

?

Front 20

the possibility of a credit crunch if banks need to increase amount of bank capital during crises

Back 20

?

Front 21

What are some of the regulations on banks, and how do they help reduce the effects of moral hazard and adverse selection?

Back 21

?

Front 22

The FDIC: What could the consequences of abolishing FDIC?

Back 22

Bank panics and failures.

Front 23

The FDIC: How does FDIC create a moral hazard problem?

Back 23

Makes banks riskier because they know that they can't lose the money

Front 24

Dual banking systems with many regulators

Back 24

federally chartered banks are supervised by the controller of currency.

state banks are supervised by the states

Front 25

Why are there so many banks in the US?

Back 25

there were previous restrictions on branch banking

Front 26

Holding companies as a way to get around the law

Back 26

Any company that has control over a bank. Can hold several different banks in different states.

Front 27

What are the 3 parts of the Fed?

Back 27

12 Regional Banks
Board of governors
FOMC

Front 28

What does each part of the Fed do?

Back 28

12 Banks - Examine banks in their area. Collect data & do studies on local economy

Board of Governors - (7) 14 year terms, non renewable, appointed by President. : Set the reserve req., approve discount rate, give direction to trading desk in NY

FOMC - 7 governors and 5 regional presidents set target for federal funds rate. Chairman is Ben Bernacke.

Front 29

Which tools does each part of the Fed decide over?

Back 29

?

Front 30

The three tools of monetary policy

Back 30

1) Open Market Operations ( buy or sell short-term government bonds. Buy bonds = increase money supply and lower interest rates.)



2) Discount Rate
3) Reserve Requirements

Front 31

The role of FOMC meetings

Back 31

FOMC - 7 governors and 5 regional presidents set target for federal funds rate. Chairman is Ben Bernacke.

Front 32

Fed Independence: What ensures independence?

Back 32

14 year non renewable terms. Has its own revenues.

Front 33

What limits independence?

Back 33

Chairman has only a 4 year renewable. Renewed by president..

Fed legislation given by congress can decide to change the rules.

Front 34

For/against central bank independence in general

Back 34

FOR:
-avoids political business cycle
- otherwise too easy to finance gov. debt
AGAINST:
- Undemocratic
- instrumental independence
- good independece - larger problem?

Front 35

The monetary base is comprised of

Back 35

C (currency in circulation) + R (reserves)

Front 36

How does the Fed change the monetary base?

Back 36

open market sales shrink reserves and the monetary base, thereby decreasing the money supply

Front 37

How the public affects the composisiton on MB

Back 37

?

Front 38

Why does the Fed control the monetary base, but not the money supply?

Back 38

?

Front 39

Deposit creation in the banking system

Back 39

Reserves / required reserve ratio = deposit creation

Front 40

The money multiplier: understand and use

Back 40

relationship between monetary base and money supply.

m= (1+c)/(r+e+c)

Front 41

Explain the curves for Demand and supply for reserves graph?

Back 41

/

Front 42

How does the Fed change the fed runds rate?

Back 42

Open market operations: open market purchase. When Fed buys securities from a bank reserves shifts out, lowering the fed funds rate.

Front 43

Dynamic vs. defensive open market operations?

Back 43

Dynamic is when they try to change to fed funds rate (buying or selling gov. securities)
Defensive is when the fed is trying to keep the same federal funds rate.

Front 44

Why reserve requirement changes are not used actively as a tool?

Back 44

?

Front 45

The main role of discount loans is the for the Fed to

Back 45

be a lender of last resort

Front 46

Money target vs. inflation target

Back 46

Fed can control either reserves or fed funds rate. Fed:decided to focus on the fed funds rate, why? - because the interest rate in general has a closer relationship to the goals of monetary policy.

Front 47

An inflation target for the US?

Back 47

2%

Front 48

Why is it not possible to control both the monetary base target or the federal funds rate target?

Back 48

?

Front 49

What is the Taylor Rule?

Back 49

A monetary policy rule/equation that helps the central bank decide if it should change interest rates.

Front 50

Money demand and supply

Back 50

chapter 5

Front 51

Shifts in demand and supply curves, How does the Fed affect the money supply?

Back 51

Fed affects the money supply most commonly by open market operations.

Front 52

What is the alternative/complementary model for interest rate detirmination to the bond market model?

Back 52

?

Front 53

Aggregate Demand

Back 53

the total demand for final goods and services in the economy.

Front 54

Aggregate Supply

Back 54

is the total supply of goods and services produced by a national economy during a specific time period.

Front 55

The aggregate demand curve - Why does it slope down?

Back 55

When Price goes down, then interest goes down, and investments go up.

Front 56

How can monetary policy shift the AD curve?

Back 56

Money supply goes up, interest goes down, and investments go up. (shifts curve right)

Front 57

Factors that can shift the AD curve?

Back 57

Lowering the interest rate will shift the AD to the right.

Front 58

LRAS

Back 58

Long Run Aggregate Supply
-At the natural level of unemployment output level is detirmined by: amount of physical capital, technology, and labor (amount of workers)

Front 59

SRAS

Back 59

Short Run Aggregate Supply
Producers want to maximize profits.
Profits = price - cost
-In the short run as prices change the production cost stay constant
-Price goes up, profits go up, production increases.
-Main production cost is wages

Front 60

Explain the continuous changes in M and in inflation.

Back 60

Inflation is the continuous increase in price level. Lowering the interest rate increases the money supply, which will increase demand.

Front 61

You make a deposit at a bank, is an example of...

Back 61

indirect finance

Front 62

A borrower who takes out a loan usually has more information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called:

Back 62

Asymmetric information

Front 63

Government regulations require publically traded firms to disclose information, reducing...

Back 63

the adverse selection problem.

Front 64

At the last meeting of the FOMC, they decided to

Back 64

Keep the target for the federal funds rate at 0-.25%

Front 65

Rank assests from most liquid to least liquid....

Back 65

Checking deposits; corporate bond; refrigerator

Front 66

Fearing the possibility of insolvency, the management decides to try to increase the capital/asset ratio of the bank. The capital/asset ratio can be increased by:

Back 66

Not paying out dividends to increase retained earnings.

Front 67

A bank would rather lend to a company with:

Back 67

High net worth, because they are likely to engage in less risky projects.

Front 68

If bad credit risks are the ones who most actively seek loans, then financial intermediaries face the problem of ..

Back 68

adverse selection.

Front 69

The federal funds rate is..

Back 69

the interest rate banks pay on overnight loans from other banks.

Front 70

Financial markets have the basic function of

Back 70

getting people with funds to lend together with people who want to borrow funds.

Front 71

What factors affect bond demand?

Back 71

Other commodities being more liquid (demand down).
Fall in stock prices (demand up)
transaction fees on stock trading falls (demand down)
bond prices get less volatile (demand up)

Front 72

Based on the expectations theory, if you expect the state of the economy to stay the same in the next couple of years, with about the same inflation rate, you would expect to see a flat yield curve. However, yield curves have a tendancy to slope up in stable times. One theory suggests that the slope is due mainly to a compensation for:

Back 72

Interest risk, with a higher compensation on long-term bonds

Front 73

You bought a 3% coupon bond last year at face value, $1000. Coupon payments are annual. After one year, you have received one coupon payment and you want to sell the bond. There is still one more year to maturity. If market interest rates are 4%, what price will you be able to sell the bond at?

Back 73

$30 + $1000
PV=-----------------
(1+.04)

1030
PV= -------
1.04

PV = 990.38

Front 74

What can a bank do if its reserve requirement is low?

Back 74

Borrow fromt the Fed.
Reduce loans.
Sell CD's + Buy securities

Front 75

What shifts the SRAS?

Back 75

- Anything that changes production costs. (wages increase=shifts left, higher productivity =shifts right)

Front 76

Why is it important to keep inflation expectations down?

Back 76

?

Front 77

What's the time inconsistency problem?

Back 77

If people are used to prices going up, then people will expect the price level to go up, and the price will go up

Front 78

How should the Fed deal with stagflation?

Back 78

?

Front 79

Demand pull vs. cost push inflation

Back 79

Demand pull inflation is the shift out from demand. The cost push inflation shift comes from the SRAS, and moves it to the left.

Front 80

The Fisher effect

Back 80

When there is a shift in equilibrium down, interest rates have increased as a result of increase in expected inflation.

Front 81

When the public's holdings of currency increases, what defensive market operations typically occur?

Back 81

A defensive open market purchase.

Front 82

Defensive open market operations

Back 82

are intended to offset movement in other factors that affect reserves and the monetary base.

Front 83

when the fed increases reserve requirements, it reduces the money supply by causing...

Back 83

the money multiplier to fall

Front 84

The Fisher equation

Back 84

Letting r denote the real interest rate, i denote the nominal interest rate, and let π denote the inflation rate, the Fisher equation is:
i = r + pie