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ECON Exam #2
Ch 5-9
| Term | Definition |
|---|---|
| Wealth | the total resources owned by the individual, including all assets |
| Expected Return | the return expected over the next period on one asset relative to other assets |
| Risk | the degree of uncertainty associated with the return on one asset relative to other assets |
| Liquidity | the ease and speed with which an asset can be turned into cash relative to other assets |
| Bond Supply | (Govt. + Corp) Borrowers/Issuers; Curve Up |
| Bond Demand | (Households) Lenders/Buyers; Curve Down |
| Shifters of Demand | Wealth + = + Return + = + Risk + = - Liquid + = + Inflate + = - Interest + = - |
| Shifters of Supply | Govt. Deficit + = + Profit + = + Inflate + = + |
| Fisher Effect | When expected inflation +, interest rates will + |
| The demand curve for bonds has the usual downward slope, indicating that at ______ prices of the bond, the ______ is higher. | lower; quantity demanded |
| When the interest rate on a bond is _____ the equilibrium interest rate, in the bond market there is excess ______ and the interest rate will _____. | above; demand; fall |
| If stock prices are expected to drop dramatically, then the demand for stocks will _____ and that of Treasury bills will ____. | decrease; increase |
| An increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to _____ and the demand curve to shift to the ______.` | fall; left |
| If expected interest rate is up, the demand for bonds _____ and the demand curve shifts to the _____. | decrease; left |
| In the bond market, the bond demanders are the _____ and the bond suppliers are the _____. | lenders; borrowers |
| When the expected inflation rate increases, the real cost of borrowing ____ and bond supply ______. | decreases; increases |
| Higher govt deficits ____ the supply of bonds and shift the supply curve to the ____. | increase, right |
| If the liquidity effect is smaller than the other effect, and the adjustment to expected inflation is slow, then the interest rate will | initially fall, but eventually climb above the initial level in response to an increase in money growth |
| Collateral | a prevalent feature of debt contracts for both households and businesses |
| Debt contracts are extremely complicated legal documents that place substantial ______ ______ on borrowers | restrictive covenants |
| Adverse Selection | before transaction, fixed by screening |
| Moral Hazard | after transaction, fixed by monitoring collateral |
| If the expected return on U.S. T-Bonds falls from 4 to 3 % and the expected return on corporate bonds falls from 6 to 3%, then the expected return of US Treasury bonds _____ relative to corporate bonds and the demand for US Treasury bonds _____. | rises; rises |
| Because of the "lemons problem" the price a buyer of a used car pays is | between the price of a lemon and a peach |
| If you default on your auto loan, your car will be repossessed because it has been pledged as _____ for the loan | collateral |
| That only large, well-established corporations have access to securities markets | explains why indirect finance is such an important source of external funds for businesses |
| Net worth can perform a similar role to | collateral |
| A problem for equity contracts is a particular type of ______ called the ______ problem. | moral hazard; principal-agent |
| Solutions to the moral hazard problem include | monitoring and enforcement of restrictive covenants |
| Bank reserves include | vault cash + deposits at the Fed |
| Which of the following are reported as assets on a bank's balance sheets? Discount Loan Deposits at the Fed Checkable Deposits Bank Capital | Deposits at the Fed |
| If a bank has $500,000 of checkable deposits, and it holds $75,000 in required reserves, then what would be the required reserve ratio? | 75,000 = rr * 500,000 rr = 75,000/500,000 = 0.15 = 15% |
| With a 12% reserve required ratio, calculate the max amount SNB could lend when a $8,000 deposit is made into SNB | RR = rr * D Max Loan = D - RR RR = 8,000 * 12% = 960 Max Loan = 8,000 - 960 = 7,040 |
| Assets (Own) | 1. Reserves = VC + Dep at Fed 2. SR = Govt and other Liquid Securities (T-Bills) 3. Loans to Businesses, Consumers, and other Banks |
| Liabilities (Owe) | 1. Deposits 2. Fed Fund = Other Banks 3. Discount Loan = Central Bank -------- Capital = Equity = Net Worth * Liquid Management |
| Reserves | Cash Funds that bankers maintain to meet deposits outflows and other payments **Reserve = Required Reserve + Excess Reserve |
| Required Reserves | a minimum amount of cash funds that banks are required by regulators to hold |
| T-Accounts | simplified balance sheets that list only changes in liabilities and assets |
| Return on Assets (ROA) | profit/asset |
| Return on Equity (ROE) | profit/equity |
| Leverage | = Asset/(Asset - Liability) = Asset / Equity |
| Higher Leverage | Higher debt rate |
| Credit Risk | the risk of borrowers defaulting on the loans |
| Interest Rate Risk | the risk that interest rate changes will affect the returns on its assets or the cost of its liablities |
| Managing Credit Risk | Screen, Monitor, Collateral, Restrictive Covenants |
| Interest Rate Risk is determined by | the amount of rate-sensitive assets/liabilities the change in interest rates |
| Gap Analysis | Change in interest rate (new - old) * (assets - liabilities) |
| If assets > liabilities and interest rate rises then | profitability rises |
| If assets > liabilities and interest rate falls then | profitability falls |
| If assets < liabilities and interest rate rises then | profitability falls |
| If assets < liabilities and interest rate falls then | profitability rises |
| Strategy: if interest rate is down, what does that mean for assets and liabilities | bad for assets = try to extend contract with previous interest rate for as long as possible good for liability = cut current contract and create new one with new interest rate for as long as possible |
| Strategy: if interest rate is up, what does that mean for assets and liabilities | good for assets = cut current contract and start new one far as long as possible with new interest rate bad for liabilities = try to extend current contract with previous interest rate for as long as possible |
| Which of the following statements are true? A. assets are its sources of funds B. liabilities are its uses of funds C. capital is recorded as an assets on the balance sheet D. balance sheet shows that total assets = total liabilities + equity capital | D. A bank's balance sheet shows that total assets equal total liabilities plus equity capital |
| Secondary Reserves include | Short-term US government securities |
| Which of the following are transaction deposits? A. savings accounts B. small-denomination time deposits C. checkable deposits D. certificates of deposit | C. checkable deposits |
| Bank loans from the Federal Reserve are called ___ and represent a ___ of funds. | discount loans; source |
| Banks may borrow from or lend to another bank in the Federal Funds market. A loan of excess reserves from one bank to another bank is recorded as ____ for the borrowing bank and ____ for the lending bank. | a liability; an asset |
| When you deposit $50 in your account at FNB and a $100 check you have written on this account is cashed at SNB, then | the reserves at FNB fall by $50 |
| Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves, borrowing from the Fed, and borrowings from other banks to deal with deposit outflows is an example of | liquidity management |
| If, after deposit outflow, a bank needs an additional $3 mil to meet its reserve requirements, the bank can | sell $3 mil of securities |
| If a bank has $200,000 of checkable deposits, a required reserve ratio of 20%, and it holds $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is | 200,000 - 50,000 = 150,000 (0.2) = 30,000 80,000 - 50,000 = 30,000 Max = 50,000 |
| Bank capital has both benefits and costs for the bank owners. Higher bank capital ___ the likelihood of bankruptcy, but higher bank capital ___ the return on equity for a given return on assets | reduces; reduces |
| Suppose that from a new checkable deposit, FNB holds $2 mil in VC, $12 mil Dep of Fed, and $9 mil in ER. Given this info, compute the required reserve ratio that FNB faces given this info | VC + Dep of Fed = Reserves 2 + 12 = 14 mil Reserve Total = RR + ER 14 = x + 9 = 5 mil |
| When $400 mil is deposited at a bank, the RR is 20%, and the bank chooses not to hold excess reserves instead, then, in the bank's final balance sheet, the assets increases by _____ , and the total reserves by ____. | Assets = $400 mil Reserves = ER + RR = $400 mil |
| GAP analysis means change in profit in terms of | Dollar |
| Duration analysis means change in profit in terms of | Percent |
| 3 players in the money supply process | Central Bank (Fed Reserve System) Bank (Depository Institutions; Fin Intermediaries) Depositors (Individuals and Institutions) |
| MB = | C + R C = Currency in Circulation R = Reserves in Banking System (VC + Dep of Fed = RR + ER) |
| OMO buy securities | MB increase |
| OMO sell securities | MB decreases |
| MBn = | MB - BR BR = Borrowed Reserves |
| If reserves increase by 100, by how much will the money supply increase? | (1/10%)*100 = 1000 |
| Change in M = | m * (change in MB) m = money multiplier |
| m = | 1/reserve ratio |
| Factors that determine money supply | Change in required reserve ratio, currency holdings, and excess reserves |
| 5 factors that affect change in M | RR + = m - = change in M - ER + = m - = change in M - C + = m - = change in M - MBn + = change in MB + = change in M + BR + = change in MB + = change in M + |
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