FIN 453 Independent Study Final

If a futures contract for U.S. Treasury bonds increases by "18" in the financial quotes, the value of the contract increased by $56,250 $562.50 $56.25 $5,625

$562.50 The values are reported in thirty-seconds of a percent. So, an increase of 18 indicates eighteen thirty seconds or 18/32. These are sold in increments of 1000,so the increase is 18/32 * $1000 or $562.50 (page 189 of the textbook).

If the forward exchange rate for the pound in terms of dollars is higher than today's spot rate, then we would expect the

dollar to depreciate

Suppose that during the next year you expect the dollar will appreciate against the pound from 0.5 pound to the dollar to 0.75 pound to the dollar. How much will you expect to make on an investment of$10,000 in British government securities that will mature in one year and pay interest of 8%? 8% 28% -59.5% -28%

-28% Since the dollar appreciated, the investment in pounds, including interest, could be exchanged for fewer dollars at the end of the year. The exchange rate increased from .5 to .75 or generated a loss of 33%. However, the investment earned 8%. A net loss of 28% resulted from the transaction.

Calculate the yield to maturity (YTM) for a one-year discount bond with a face value of $1,000 and a purchase price of $850 0.0176 0.15 0.015 0.176

0.176

If the price of a pair of Levi's jeans is $30 in the U.S. and 5,000 Yen in Japan, and the nominal exchange rate is 100 Yen to the dollar,the real exchange rate is 1.66 pairs of jeans in Japan per American pair of jeans 0.6 pair of jeans in Japan per American pair of jeans 6 pairs of jeans in Japan per American pair of jeans

0.6 pair of jeans in Japan per American pair of jeans If the exchange rate is 100 yen to the dollar, then 5000 Yen equal 50 dollars. Therefore the Japanese are paying $50 for the same jeans that cost $30 in the U.S.Thirty is 60percent of 50 or .6 pair of jeans in Japan per American pair of jeans.

According to the Capital Asset Pricing Model (CAPM), what would be the value of beta if the risk-free rate is 2%, the risk premium on the market portfolio is 8%, and the expected return on the asset is 12%? 2 1 .5 1.25

1.25 The expected return on the asset is 12% minus the risk-free rate of 2%, generating a value of 10% for the risk premium on the asset;therefore, if the risk premium on the market portfolio is 8% then beta has to be 1.25. 10% / 8% Therefore, to find Beta, you take the expected return, subtract the risk-free rate and divide by the risk premium to get beta

A schedule of one-year interest rates for bonds maturing in 1, 2, 3,and 4 years, successively, is 8%, 9%, 10%, and 11%. According to the expectations theory, the expected one year rate two years ahead is 10% 8.5% 17% 12%

12%

The amount of gain in reducing idiosyncratic risk by adding additional stocks to a portfolio is sharply reduced after reaching which of the following numbers of stock in a portfolio?' 8 1,000 500 20

20 According to the textbook, adding 20 stocks to a portfolio of New York Stock Exchange-listed stocks will reduce idiosyncratic risk by about 21.7%; further reductions from additions of more stock result in minimal reductions in such risk.

Differentiate between cost-push and demand-pull inflation.

Cost-Push: results from workers' pressure for higher wages. Demand-Pull: results from policymakers' attempts to increase aggregate demand.

An individual purchases a corporate bond that is currently returning 12%. If the expected inflation rate is 5%, and the individual's tax rate is 30%, the real rate of return (after taxes and inflation are accounted for) is 8.4% 7% -18% 3.4%

3.4% (Return % * (1-Tax Rate)) - Inflation Rate

If you are comparing a corporate bond yield of 12% with a Treasury bond yield of 6%, then the default risk premium is 6% 24% 12% 18%

6%

Capital Adequecy Management

A bank determines how much capital the bank should hold as a way to reduce moral hazard.

. Which of the following situations affecting the nonbank public would cause the currency-to-deposit ratio (C/D) to rise? A period of bank panics occurs. An increase occurs in the interest paid on checkable deposits. Wealth increases for the economy as a whole. The size of the underground economy decreases.

A period of bank panics occurs.

Which of the following reasons best explains why the bond demand curve is equivalent to the loanable funds supply curve? A fall in bond prices is equivalent to a drop in the loanable funds interest rate. The bond demand curve cannot be equivalent to the loanable funds supply curve. A rise in bond prices in the bond demand curve diagram is equivalent to a fall in loanable funds interest rates in the loanable funds supply curve diagram. A rise in bond prices in the bond demand curve diagram is equivalent to a rise in loanable funds interest rates in the loanable funds supply curve diagram.

A rise in bond prices in the bond demand curve diagram is equivalent to a fall in loanable funds interest rates in the loanable funds supply curve diagram.

Which of the following statements best describes the behavior of arisk-neutral saver? A risk-neutral saver evaluates both variability of expected returns and their size. A risk-neutral saver is willing to hold risky assets because of the possibility of making a high return. A risk-neutral saver judges assets only on their expected returns and is not concerned with the variability of returns.

A risk-neutral saver judges assets only on their expected returns and is not concerned with the variability of returns.

Which of the following criteria best expresses a saver's portfolio allocation decision with respect to expected returns on assets? A saver will seek to invest when inflation is at its peak to ensure the maximum nominal return on investment. A saver will generally ignore inflation and choose the asset with the highest stated interest rate of return. A saver will seek to choose the asset with the highest real rate of return after taking taxes and inflation into account. A saver will generally ignore tax differentials on alternative investments.

A saver will seek to choose the asset with the highest real rate of return after taking taxes and inflation into account. Savers would ignore inflation and tax differentials at their own peril since the expected real rate of return is the principal criterion for making asset choices in terms of expected returns on assets.

Loan Commitments

A type of off-balance-sheet activity that a bank can engage in: A bank agrees to provide borrowers with a stated amount of funds during some specified period of time.

Loan Sales

A type of off-balance-sheet activity that a bank can engage in: A financial contract by which the bank agrees to sell the expected future returns from an underlying bank loan to a third party

Standby Letters of Credit

A type of off-balance-sheet activity that a bank can engage in: Selling this to a borrower by which the bank promises to lend the borrower funds to pay off its maturing commercial paper if necessary

To organize foreign activities, U.S. banks can use which of the following? branches Edge Act Corporations interests in foreign financial firms all of these options

ALL

Which of the following statements about the effects of efficient markets is incorrect? Higher stock prices signal higher future profit expectations. "Churning" portfolios is not a profitable strategy. Higher bond prices mean risk premiums and borrowing costs are falling. Above-normal profit opportunities still exist in the trading process.

Above-normal profit opportunities still exist in the trading process.

Checkable deposits

Accounts that grant a depositor the right to write checks to individuals, businesses, and the government

Derive the aggregate demand curve and explain what causes the AD curve to shift.

Aggegate Demand Curve is the demand for Goods and services (C) plus the consumer demand for investment in business, inventory, equipment, and housing (I) plus the demand for government purchases of goods and services plus net exports (NX). Yd = C + I + G + NX

Derive the aggregate supply curve and explain how shifts in the short-run and long-run curves occur.

Aggegate Supply = Output at full employment + (Price Level minus Expected Price Level) AS = Y^ + (P - Pe). In the long run it is just AS = Y^. In the Short run it is upward sloping, in the long run it is vertical, it will supply at a certain place regardless of price. Output will be based on full employment

Discuss the history of the banking industry in the United States.

Alexander Hamilton tried to establish a nationwide banking system in 1791. Later Andrew Jackson tried again with the Second Bank in 1836. This also failed. The national Banking Act of 1863 created our current dual banking system where there are federally chartered national banks supervised by the office of the comptroller of currency and state-chartered banks

Which of the following is not true of membership in the FDIC? All national banks are members of the FDIC. Most large state banks are members of the FDIC. All commercial banks are members of the FDIC. Some state banks are not members of the FDIC.

All commercial banks are members of the FDIC.

Fed Balance Sheet items that cause an increase in the monetary base

An incrase in Securities, An increase in Disount Loans, An increase in Federal Reserve Float, an increase in other Federal Reserve Assets, An increase in Treasury Currency Outstanding, an increase in Gold and SDR certicates, a Decrease in US Treasury Deposits with the FED, a decrease in foreign/other deposits at the FED, a decrease in Federal reserve liabilities

Discuss regulation of international banks.

BIS (Bank of international Settlements) and IOSCO (International Organization of Securities Commissions) Help create stability, insurance, and coordination.

Describe the sequence of events in the regulatory process.

Crisis -> Regulation -> Response by Financial System -> Regulatory Response

Discuss the significance of regulations in preventing bank runs and contagion effect, and the justification for insurance as a prevention of bank panics.

Bank runs occur when depositors lose confidence in a bank's underlying value of its assets often due to bad news. Depositors then worry they will not get paid and begin to remove their assets. Banks must oblige on a first come first serve basis untill all liquid funds are gone, this then spreads to other banks. The FED was created to create stability in the banking industry and the FDIC (Federal Deposit Insurance Corporation) to guarantee this won't happen as the consequences can be severe in the economy and stop others from being able to take out needed loans, etc.

Bank Net Worth

Banks Assets minus liabilities

Use the simple deposit multiplier to show how multiple deposit expansion and multiple deposit contraction occur when bank reserves rise or fall.

Banks are the link between the FED and the Nonbank public. The many banks affect the money supply by the movement of money downstream and the holding of money in reserves. The Change in depoists = the Change in Reserves divided bt the Reserve to Deposit Ratio that is required. dD = dR/(R/D)

In what sense can a reserve requirement be said to be a tax on bank intermediation? Banks are unable to lend out all their deposits. Banks must pay taxes on the amount by which they fail to meet their reserve requirements. Banks must pay tax on any funds deposited in a reserve account at a rate equal to the applicable corporate income tax rate. Banks must pay tax on any funds removed from a reserve account at a rate equal to the applicable corporate income tax rate.

Banks are unable to lend out all their deposits. The effect of reserve requirements is to impose an implicit tax,not an explicit tax.

Explain how banks can affect the money multiplier by altering reserves and discount loans (loans banks get directly from the Fed).

Banks can affect the multiplier by carrying excess reserves beyond the requirement or by offering their own rates. above or below the Fed Rate

Which of the following statements best expresses the relationship between bond prices and bond yields? Bond prices and bond yields are inversely related. The greater the time to maturity for a given asset, the lower will be the price change caused by a given shift in the yield to maturity. Bond prices and bond yields are positively related.

Bond prices and bond yields are inversely related.

Which of the following statements correctly identifies the principal problem of using floating-rate debt to reduce interest-rate risk? Borrowers may default on floating-rate debt if interest rates rise. Floating-rate debt increases interest-rate risk for banks but reduces interest risk for borrowers. Floating-rate debt will eliminate interest-rate risk. Bank profits may fluctuate more than they would if interest rates were fixed.

Borrowers may default on floating-rate debt if interest rates rise.

The problem of asymmetric information occurs in financial markets when Market prices of stocks and bonds do not reflect all of the information available to company insiders. Borrowers may withhold vital information from lenders. Lenders monitor securities market information more carefully than do borrowers.

Borrowers may withhold vital information from lenders.

Overseas Organization of US Banks

Branches (wholly owned), Edge Act Corporations (Edge Act 1919, serve customers active in international commerce, can only perform international banking services),. Us Banks can also hold Interests in foregin financial service firms.

Discuss how the federal government budget deficit affects the monetary base.

Budget Defecit Occurs when the government expenditures exceed tax constraint. This Deficit is financed through the selling of treasury securities. Therefore increasing the monetary base

A discount bond differs from a coupon bond in that Buyers of discount bonds receive only the face value of the bond at maturity while buyers of coupon bonds receive periodic interest payments representing the coupon rate during the life of the bond in addition to receiving the face value of the bond at its maturity. Market fluctuations may result in capital gains and losses for coupon bonds but not for discount bonds if the bonds are sold before their maturity date. Buyers of discount bonds receive coupon interest payments during the life of the bond while buyers of coupon bonds receive only the face value at the maturity of the bond.

Buyers of discount bonds receive only the face value of the bond at maturity while buyers of coupon bonds receive periodic interest payments representing the coupon rate during the life of the bond in addition to receiving the face value of the bond at its maturity.

What is the dominant currency of the Euromarket? Dollar Yen Euro

Dollar The U.S. dollar remains the dominant currency in the Euromarkets.

Derive the complete money multiplier, beginning with the simple deposit multiplier and incorporating the behavior of the nonbank public and the banks.

C/D = Circulation/Deposit Ratio. R/D = Reserve to Deposit Ratio. money Supply (m) = (1+C/D)/(C/D+R/D). m times B (Monetary Base) = Money Supply

If a wave of counterfeit currency hit the United States, what would happen to the currency-deposit ratio? C/D stays the same C/D rises cannot tell from the data provided. C/D falls

C/D falls Increased risk of currency reduces demand for currency so C/D falls. See discussion on page 401 of the textbook.

Explain the issues associated with Fed policy concerning reserve requirements.

Changing reserve requirements rarely ever happens. They are like a tax on on bank deposits and it is debated whehter the FED should be able to even set this. It does create more liquidity for banks, it also gives the Fed more monetary control by knowing this amount at each bank.

Liabilities that are found on a typical commercial bank balance sheet.

Checkable Deposits, Non Transaction Deposits, Borrowings (From Fed), misc liabilities, equity capital

List and explain the costs of reducing inflation.

Cold turkey (Classical) approach: The public expects shift by monetary authority but it never happens. Keynsian slow deflation ( Money supply expected to grow over time, but it doesn't. Price levels fall slowly and economy returns to full employment with lower inflation)

Explain the components of the monetary base (MB).

Comprises all currency in circulation and reserves held by banks. Determined by the FED.

Which of the following statements best explains why the U.S. was without a central bank between 1836 and 1913? The commercial banking system worked well enough, so little concern existed over financial system stability. Conflicts among various business, government, geographic, and financial interests prevented agreement on how to organize and establish a central bank. Little need for a check-clearing system existed until 1913. Major U.S. private bankers like J. P. Morgan had enough resources to maintain liquidity in the banking system.

Conflicts among various business, government, geographic, and financial interests prevented agreement on how to organize and establish a central bank.

The main source of power in the Federal Reserve System rests on the Fed's Ability to eliminate business cycles Control of monetary policy Independence from the legislative and executive branches of the federal government Control of fiscal policy

Control of monetary policy

Eurocurrency

Deposits deonominated in a currency other than that of the issuing domestic financial center. Traded through Euromarkets

How does diversification reduce risk? Diversification provides a means of investing in a variety of different assets so that the overall returns will average out. Diversification enables the risks incurred by large investors to reduce the risks of small investors. Diversification provides a way to invest in a variety of high-return assets without incurring any offsetting risk. Diversification enables savers to invest in a single safe asset which is just one of many assets offered by a financial institution.

Diversification provides a means of investing in a variety of different assets so that the overall returns will average out.

Differentiate between dynamic and defensive open market operations and explain when each type of operation is used.

Dynamic = Change monetary Policy as determined by FOMC. Defensive = Offset fluctuations in the monetary base due to economic distrurbances. (This is much more common)

Deposits of U.S. Dollars in European banks (maintained in dollars)are called: Eurodollar banker's acceptance currency swap global dollars

Eurodollar

A credit Crunch Increases willingness to borrow from banks (T/F)

F

Which of the following statements does not describe Fed actions during the Great Depression of the 1930s? The Fed raised the interest rate it charged on loans to member banks in 1931. Fed actions lowered the value of the dollar against other currencies. The Fed thought the economy would work itself out of the Depression by itself. The Fed failed to act decisively as a lender of last resort.

Fed actions lowered the value of the dollar against other currencies.

Monetizing the government debt occurs when the Treasury deposits tax revenues in its tax and loan (T&L)accounts Fed buys Treasury bonds to finance the budget deficit Fed sells Treasury bonds to finance the budget deficit Treasury transfers its deposit accounts from commercial banks to the Fed

Fed buys Treasury bonds to finance the budget deficit

Which of the following statements is correct? Federal Reserve district banks pay dividends on their earnings to member banks. The boards of directors of the district banks are all local bankers. Federal Reserve district banks are owned by the government. Member banks receive no return on the stock they own in Federal district banks.

Federal Reserve district banks pay dividends on their earnings to member banks.

List and explain the terms found on the Fed's complete balance sheet.

Feds Assets (Securities, Discount Loans, Items in Process of Collection, Gold, Coin, Other Assets). Fed's labilities ( Outstanding Currency, U.S. treasury deposits, deferred availability credit items, deposits, other liabilities)

Which of the following statements best explains the role of financial markets? Financial markets issue claims (IOUs) on savers directly to borrowers. Financial markets issue claims (IOUs) on borrowers directly to savers. Financial markets eliminate risk. Financial markets create assets for borrowers that become liabilities for lenders.

Financial markets issue claims (IOUs) on borrowers directly to savers.

Nontransaction Deposits

For savers who use commercial banks to be able to earn some interest on their deposits and don't need to use their funds day-to-day. i.e. money market deposit accounts, time deposits (CDs), etc

Foreign Banks in the US

Foreign Bank Branches or Subsidiary US banks (which act like a local bank and obey local regulation, but owned by a foreign bank)

Germany Banking Industry

Full universal banking, Banks have ownership in the companies that they back, this creates strong alliances and very few large banks

Understand GDP and its significance in predicting economic changes.

GDP and Economic Growth used to have a stronger relationship. Not as much any more, However, GDP is still a way many economists predict economic growth

Federal Opn Market Committee (FOMC)

Gives direction to the Fed's open market operations. Members are the chairman of the board of governors, other fed governors, the president of the Fed Reserve Bank, and the presidents of four of the other 11 national Fed banks

Board of Governors

Headquartered in Washington, DC. Seven members are appointed by the President of the United States. and confirmed by the US senate. Members serve non-renewable 14 year terms. The board issues monetary policy and some regulation

If the fluctuations in expected real interest rates are small, then which of the following statements provides an explanation of how the upward-sloping yield curve can be used for economic forecasting? An upward sloping yield curve provides a signal that a recession is likely. If real interest rates are constant, then an upward sloping yield curve means higher inflation is expected. If real interest rates are constant, then an upward sloping yield curve suggests that lower inflation is expected.

If real interest rates are constant, then an upward sloping yield curve means higher inflation is expected.

Explain the alternative approaches the Fed can use to change the monetary base.

If the FED purchases Securities from Banks of the Public, they gain currency which adds currency into the banking system or into circulation, thus increasing the Monetary Base. They can also set a discounted interest rate. Which will then create more money for Banks and those that borrow from the banks, which will grow the monetary base.

If the Fed reduces the money supply unexpectedly, the new Keynesians believe that the effect will be which of the following? In the short run the AD curve shifts left, and in the long run the SRAS curve shifts downward. In the short run the AD curve remains unchanged, but the SRAS curve shifts upward in the long run. In the short run the AD curve shifts right, and in the long run the SRAS curve shifts upward. In the short run the AD curve shifts right, but the SRAS curve remains unchanged in the long run.

In the short run the AD curve shifts left, and in the long run the SRAS curve shifts downward. An unexpected fall in the money supply is contractionary in the short run and has a negative effect on the SRAS curve in the long run.

Discount Policy

Includes seetting the discount rate and terms of discount lending. It is the oldest of the Fed's tools for regulating money supply

Things that Increase Money Supply

Increase in Monetary Base, Decrease in Reserve Requirements, Decrease in the Discount Rate, Decrease in Circulation/Deposit Ratio, Decrease in Excess Reserves, decrease in variability in deposit outflows.

Things that cause Right Shifts (Higher Demand at any price) in the Aggregate Demand Curve (AD)

Increase in Money Supply, Decrease in interest rate, increase in expected future output, increase in government purchases, increase in the expected future profitability of capital, decrease in business taxes

Use graphic analysis to predict the effects of changes in Fed policy on the level of bank reserves and the federal funds rate.

Increase in Non-Borrowed Reserves (Purchasing Treasuries) leads to a fall in Federal Funds rate. If the Discount Rate rises, the Fed Funds rate rises. If the Required Reserves increases then the Fed Rate increases

Inflation Level Calc

Inflation = Percent Change in Money Supply plus percent change in velocity of money minus the percent change in output. I = cM + cV - cY

What will most likely happen to interest rates during a recession? Interest rates will rise because the bond demand curve shifts to the left. Interest rates will rise because the loanable funds supply curve shifts to the right. Interest rates will fall because a fall in bond supply and afall in demand results in a higher equilibrium bond price and a lower interest rate in the loanable funds market.

Interest rates will fall because a fall in bond supply and afall in demand results in a higher equilibrium bond price and a lower interest rate in the loanable funds market.

. Which of the following is an incentive for buying a Treasury STRIP? Investors can buy the rights to a variable interest rate return if they hold the STRIP instrument until maturity. Investors can gain the certainty of a known return if they hold the STRIP instruments until maturity. Investors can potentially earn a higher interest rate from STRIPS than they expected when they bought the instrument if they hold it until maturity.

Investors can gain the certainty of a known return if they hold the STRIP instruments until maturity. STRIPS are payment free government bonds. Face value only is paid back. Guaranteed return. Discount bond model

Japan Banking Industry

Japan has more of a group financing system. Each industrial group has a main bank that owns some equity in member firms, is a primary source of creidt, monitors firm activities, and helps firms recover from financial distress

Eurodollars

Keeping US dollars in European banks

If a Treasury yield curve slopes upward to the right, what is the correct interpretation? Lower yields imply lower demand and lower bond prices. Lower yields imply higher demand and higher bond prices. Higher yields imply higher demand and higher bond prices.

Lower yields imply higher demand and higher bond prices.

Monetary Base Calcs

MB = Currency in Circulation + Federal Reserves. Currency In Circulation = Currency Outstanding - Vault Cash.

Discuss the circumstances under which banks will seek discount loans and identify the pros and cons of Fed discount loan policy.

Pros: Fed is able to be the lender of last resort, and changing the discount policy can signal the Feds intentions. Cons: economists usually don't think this is the best way to go for monetary control, it is harder to change (because banks must accept the rate) and it can have unintended consequences.

Money Supply

Monetary Base x Money Multiplier (Monetary Base is determined by the FED. Money Multiplier is determined by the FED, the banking system, and the public). This is M1 money supply

Discuss how the nonbank public makes decisions that can affect the money multiplier.

Money Supply Equals Money in Circulation + Checkable Deposits (M=C+D). The money in Deposit is subject to Multiple Deposit Expansion and Multiple Deposit Contraction. So the C/D (Ratio of Circulation to Deposits) will determine the money multiplier dertermined by the non bank public.

Explain how the banking industry is regulated/monitored.

National Banks are chartered, supervised, and examined by the Comptroller of Currency. State-chartered banks are chartered by state authorities and supervised by either the FED or the FDIC. Savings Institutions are Chartered, supervised, and examined by the Office of Thrift Supervision (OTS). All of these banks are insured by FDIC. Credit Unions are chartered, supervised, examined, and insured by NCUA

The issue of Fed independence typically rises over Role of the Fed in managing monetary policy Negative reaction by the public to Fed policy Expansion of the money supply Academic disagreement regarding monetary policy

Negative reaction by the public to Fed policy The public's negative reaction to Fed Policy creates political pressures regarding Fed Independence.

Bank ROA

Net (After-Tax) Profit/Bank Assets

Bank ROE

Net After Tax Profit/Bank Equity Capital

Which of the following statements is correct? New classicals believe that the aggregate supply curve is vertical in the short run. New Keynesians believe that the aggregate supply curve slopes upward in the long run. New Keynesians believe that the aggregate supply curve is vertical in the short run. New classicals believe that the aggregate supply curve slopes upward in the short run.

New classicals believe that the aggregate supply curve slopes upward in the short run.

Can a one-time change in government spending cause permanent inflation?

No

Bank Failure

Occurs when a bank cannot pay its depositors in full with enough reserves left to meet its reserve requirements

Discuss the problems the Fed faces in achieving monetary policy goals.

Price Stability and Economic Growth are often competing factors. It also has no control over prices and real output, so it can't directly ensure these goals are achieved, there are also timing issues in achieving these goals (information lags, impact lags, etc)

6 Goals of Monetary Policy

Price Stability, High Employment, Economic Growth, Financial Market Stability, Interest Rate Stability, and Foreign-Exchange Market Stability

Discuss the causes of price level changes and the causes of inflation, or sustained increases in the general price level.

Prices will change in response to monetary policy, aggregate demand, or shocks to aggregate supply

Which of the following statements about purchasing power parity is correct? Purchasing power parity assumes that nominal exchange rates remain constant. Purchasing power parity assumes that real exchange rates are constant, so fluctuations in nominal exchange rates are due to changes in inflation rates between two countries. Purchasing power parity assumes that inflation rates between two countries are constant. Purchasing power parity assumes that if the U.S. price level rises 5% more than the French price level, the U.S. exchange rate will rise.

Purchasing power parity assumes that real exchange rates are constant, so fluctuations in nominal exchange rates are due to changes in inflation rates between two countries.

The Depository Institutions Deregulation and Monetary Control Act of 1980 Required all banks to maintain reserve deposits with the Fed Eliminated the requirement that banks hold reserve deposits with the Fed Required all state banks to join the Federal Reserve System Prohibited nonmember banks from receiving discount loans

Required all banks to maintain reserve deposits with the Fed

Assets on a commercial bank's balance sheet

Reserves, Cash items in process, deposits at other banks, securities, loans, misc assets

Reserves

The most liquid holding by a bank in their assets. This consists of vault cash. The FED has a required reserves amount that is a percentage of a banks checkable deposits.

Members of the Board of Governors Must resign when the President who has appointed them leaves office May serve no more than three consecutive four-year terms Serve one nonrenewable 14-year term Serve for life or good behavior

Serve one nonrenewable 14-year term

List and explain the principal costs of inflation.

Shoe Leather Costs (Cost to consumers and businesses of making more trips to the bank to avoid holding significant amounts of currency), Menu Costs (The costs to firms of changing prices),

Things that shift the Aggregate Supply Curve to the left (Supply less at a given price)

Short-Term (Increased Costs in labor or inputs, increase in the expected price level) Long Term (Decrease in Capital and labor inputs, decrease in productivity)

Borrowings

Short-term loans that banks make in the federal funds market

In an open economy, if the domestic interest rate is below the world interest rate, then The real world interest rate is likely to fall. That economy will become a net borrower abroad. That economy will become a net lender abroad.

That economy will become a net lender abroad.

Explain the duties of the twelve regional Fed banks.

The Fed banks manage Checks clearing in the payments system, manage currency in circulation by issuing new FED Reserve Notes and withdrawing damaged notes from Circulation. Conduct Discount lending, performing supervisory and regulatory functions, and providing services to businesses by collecting and making available data on district business activities and by publishing articles on monetary poloicy

In the 1970s, the Federal Reserve Open Market Committee instructed the Open Market Trading Desk to implement policies that would achieveboth interest rate stability and monetary aggregate growth stability. What was wrong with this policy directive? Using the fed funds rate as an operating target may result in acountercylical monetary policy; that is, in shrinking the money supply during an economic upturn. Fiscal policy was highly effective in stabilizing the economy,so monetary policy was considered unnecessary. Monetary aggregates are much more difficult to measure than are changes in interest rates. The Fed cannot attain both interest rate stability and monetary aggregate growth stability simultaneously.

The Fed cannot attain both interest rate stability and monetary aggregate growth stability simultaneously.

The Fed often issues its policy statements in vague language that is difficult to understand. Why doesn't the Fed come right out and tell the public what it is going to do? The Fed's intentions are obvious if one watches its trading activity on any given day. The Fed does not want to be accountable for its errors. The Fed does not want to tell the public what it knows about what is going to happen in the economy. The Fed does not want to influence financial markets.

The Fed does not want to influence financial markets.

Which of the following Fed actions would not increase the monetary base? The Fed sells U.S. Treasury securities. All Fed actions result in an increase in currency in circulation. The Fed increases the amount of discount loans. The Fed buys U.S. Treasury securities.

The Fed sells U.S. Treasury securities.

In which of the following cases would a Federal open market purchase not increase the monetary base? The Fed sells securities to the nonbank public. The Fed buys securities from the nonbank public, which deposits the checks for the proceeds in the banking system. The Fed buys securities from the nonbank public, which deposits the checks for the proceeds in the banking system but leaves the balance on deposit without spending it. The Fed buys securities from the nonbank public, which holds the proceeds in currency.

The Fed sells securities to the nonbank public.

Which of the following statements is true? The Fed sets both the discount rate and the conditions for the availability of discount loans. The Secretary of the Treasury sets both the discount rate and the conditions for the availability of discount loans. The Fed sets the discount rate, but Congress sets the conditions for the availability of discount loans. The Fed sets the discount rate, but the Secretary of the Treasury sets the conditions for the availability of discount loans.

The Fed sets both the discount rate and the conditions for the availability of discount loans.

Explain the organization and creation of the Federal Reserve System.

The Federal Reserve Act divided the United States into 12 Federal Reserve Districts, each of which has a federal reserve bank in one city and usually additional branches in other cities. This was created by the act in 1913 to create checks and balances in economic power. Between (Public and private sectors), (States and Regions), (Banks and Businesses)

Which of the following conditions may limit the Fed's independence from external pressure? The President can appoint a new Board chairman every four years. The Fed's profits have exceeded $15 billion per year. Board members are appointed for long, nonrenewable terms of office. The Fed is exempt from the congressional appropriations process.

The President can appoint a new Board chairman every four years.

List the pros and cons associated with maintaining the current level of Fed independence from the executive and legislative branches of the federal government.

The argument for Independence, is that monetary policy which is so important and effects so many things is too technical to be determined by politicians. The argument against their independence is that politicians should represent the people and so they should control the FED to maintain the policies to be in the best interests of the people

If a bank has deposits of $10 million, reserves of $1 million (the required reserve ratio is 10%), and a bank customer writes a check for$1 million, which of the following statements best explains the condition of the bank? The bank has experienced liability risk which it could manage by not renewing large CDs (time deposit certificates). The bank has experienced credit risk which it could manage through raising the amount it spends on information costs. The bank has experienced liquidity risk which it could manage by buying $1 million worth of T-bills. The bank has experienced liquidity risk which it could manage by borrowing $1 million in the fed funds market.

The bank has experienced liquidity risk which it could manage by borrowing $1 million in the fed funds market.

If a bank customer writes a check on the bank for $10,000, and the bank's reserve ratio is 10%, what is the reserve status of the bank? The bank must make up $100,000 in deficient reserves. The bank must make up $90,000 in deficient reserves. The bank must make up $10,000 in deficient reserves. The bank must make up $9,000 in deficient reserves.

The bank must make up $9,000 in deficient reserves.

If investors are more optimistic about stocks than they are about bonds, which of the following results is likely to occur? The bond demand curve will shift to the left, lowering bond prices, resulting in a shift to the left in the loanable funds market and higher interest rates. Investors will prefer bonds to stocks because bonds have lower risk. The bond demand curve will shift right, and the loanable funds curve will shift left. Investors will move to the left along an existing bond demand curve, thus raising bond prices and lowering interest rates.

The bond demand curve will shift to the left, lowering bond prices, resulting in a shift to the left in the loanable funds market and higher interest rates.

How does the government budget deficit affect the bond market? The increased supply of bonds will increase the price of bonds and lower the interest rates on government bonds. The bond supply curve will shift to the right, but households will likely keep savings constant, so bond prices fall and interest rates rise. The government budget deficit will have no effect on the bond demand and supply curves.

The bond supply curve will shift to the right, but households will likely keep savings constant, so bond prices fall and interest rates rise.

Who among the following components of the Federal Reserve System has the greatest power in influencing monetary policy? The chairman of the Board of Governors The district Federal Reserve banks The member banks The governors (other than the chairman) of the Board of Governors

The chairman of the Board of Governors Historically, member banks, district Federal Reserve banks, and governors other than the chairman have been dominated by the power of the chairman.

Which of the following statements best defines the default risk premium? The default-risk premium is the lower yield an investor requires for higher default risk. The default-risk premium is also known as the market-risk premium. The default-risk premium is the higher yield an investor requires for higher default risk.

The default-risk premium is the higher yield an investor requires for higher default risk.

Which of the following appears to be evidence against the public interest view of the Fed's motivation? The failure of the Fed to emphasize the goal of price stability The conflict with the Treasury over interest rate fixing during World War II The unwillingness of the Fed to turn over its excess profits to the Treasury The independence of Fed chairmen from the authority of the President

The failure of the Fed to emphasize the goal of price stability

Member Banks

The federal reserve act required all national banks to become member banks of the Federal Reserve System. State banks may elect to become members. Only about 1 in 7 banks is a member.

Suppose the Fed buys $150 million of Japanese yen with Federal Reserve notes. What is the net effect on the monetary base? The monetary base falls by $150 million. The monetary base rises by $150 million. The monetary base stays the same since Japanese yen would not count in the Fed's balance sheet. The net effect cannot be determined without knowing the dollar/yen exchange rate.

The monetary base rises by $150 million.

One of the tradeoffs to consider in choosing a more liquid asset over a less liquid asset is that The more liquid asset is likely to have a higher price and earn a lower return than the less liquid asset. The more liquid asset is likely to be riskier than the less liquid asset. The more liquid asset is likely to have a lower price and earn ahigher return than the less liquid asset. Risk-loving savers will always prefer more liquid assets over less liquid assets.

The more liquid asset is likely to have a higher price and earn a lower return than the less liquid asset.

Open Market Operations

The purchases and sales of securities in financial markets by the FED

To conduct open market operations, the FOMC issues a directive to The Board of Governors in Washington, D. C. Chairman of the New York Stock Exchange The trading desk at the Federal Reserve Bank of New York The presidents of the district banks

The trading desk at the Federal Reserve Bank of New York

Explain off balance sheet activities.

There are three main types of off-balance sheet activities. Standby letters of Credit, loan commitments, and loan sales. This generates fee income for banks without hitting the balance sheet.

How banks manage moral hazard

This can be reduced by banks by offering up some of the money from other depositors as well as their own funds for loans. Another way to reduce this is to insist bankshareholders put up some of their own money when the bank makes loans. This will help ensure the bank is acting responsibly with the loans it makes (This is called Capital Adequecy Management)

how banks manage interest rate risk

This is experienced when changes in market interest rates cause bank profits to fluctuate. Banks can manage this by creating floating-rate debts for borrowers,

how banks manager credit risk

This is the risk that borrowers may default on their loans. This is the problem of adverse selection. Banks can combat this by doing credit-risk analysis on individuals, diversifying their portfolio, taking collateral, and creating long-standing relationships with borrowers

how banks manage liquidity risk

This is the risk that depositors may collectively withdraw too much at once. Banks can manage this liquidity risk by lending money through the federal funds market, or using overnight perchase agreements.

Which of the following countries hold the largest total of foreign liabilities and assets? France Japan U.K. China

UK

Which two countries have the longest history of international banking? U.S. and Japan U.K. and Switzerland U.S. and Italy France and Germany

UK and Switzerland

IBFs (International Banking Facilities)

US instituations that aren't allowed to conduct domestic banking business.

Euromarkets

Unregulated banking centers where much of current international business is conducted

Which of the following statements correctly characterizes the 'lemons' problem? Credit rationing will be reduced as strong borrowers take out more loans. When interest rates are high, adverse selection will eliminate many strong borrowers and leave mainly risky borrowers. Adverse selection weeds out poor lending risks and only borrowers with good credit ratings will be able to get loans. Owners who sell high-quality cars are likely to get a better price than are sellers of 'lemons.'

When interest rates are high, adverse selection will eliminate many strong borrowers and leave mainly risky borrowers.

Which of the following will cause inflation? a fall in aggregate supply a reduction in private investment a one-time increase in the money supply a reduction in government spending

a one-time increase in the money supply An increase in the money supply will cause inflation. Each of the other choices will reduce the aggregate price level.

Which of the following is a coupon bond? a zero-coupon bond a U.S. savings bond a Treasury bill (T-bill) a 20-year Treasury bond

a 20-year Treasury bond

A rise in interest rates of two percentage points will produce the greatest reduction in the present value of which of the following securities? a 20-year Treasury bond a 30-year Treasury bond a 5-year Treasury note a 30-day Treasury bill

a 30-year Treasury bond Whenever the number of years during which the expected stream of returns increases, the present value of that stream of returns falls.(Review the box called 'Consider This' on page 72 of the textbook).

Which of the following financial assets would be purchased in a money market? shares of AT&T stock a 10-year Treasury note a 60-day Treasury bill a 30-year Treasury bond

a 60-day Treasury bill

Which of the following describes a repurchase agreement (also called a"repo" or RP)? buying back 1,000 shares of stock today that you sold for ahigher price yesterday a securities firm agreeing to buy back all stock purchases that cause an investor to lose money a bank selling $1 million in Treasury securities today and agreeing to buy them back tomorrow at a slightly higher price

a bank selling $1 million in Treasury securities today and agreeing to buy them back tomorrow at a slightly higher price

When a bank issues a checkable deposit and loans the funds out to abusiness, it has transformed a financial asset for a saver into a liability for a borrower a short-term liability to a borrower into a long-term asset to a saver a financial liability for a saver into a financial asset for a borrower one liability into another liability

a financial asset for a saver into a liability for a borrower

. Which of the following would be considered a derivative financial asset? a futures contract to deliver corn in 60 days stock purchased from the New York Stock Exchange bonds purchased in the secondary bond market any asset purchased in the cash securities market

a futures contract to deliver corn in 60 days

Long-term inflation is principally the result of chronic federal budget deficits a monetary phenomenon caused by excess wage demands by unionized workers the result of the slowdown in the growth rate of aggregate supply since 1973

a monetary phenomenon

An older saver would choose which of the following portfolios a portfolio with assets likely to increase nominal returns to reduce the risk of living on a fixed income a portfolio based on maximizing expected real returns to ensure having money for retirement a portfolio with safe assets and an expected real rate of return near zero

a portfolio with safe assets and an expected real rate of return near zero

If the wealth elasticity of demand for financial assets is less than 1.0, a 1% increase in wealth would lead to an equal percentage change in the demand for investment assets no change in the percentage of a given asset in an investment portfolio a reduction in the percentage of a given asset in an investment portfolio a more than proportionate increase in demand for financial assets

a reduction in the percentage of a given asset in an investment portfolio

Which of the following changes in variables affecting the complete money multiplier will cause the money supply to fall? a rise in the required reserve ratio a fall in the required reserve ratio a fall in the excess reserves/deposit (ER/D) ratio a fall in the currency/deposit (C/D) ratio

a rise in the required reserve ratio

The monetary base is equal to all currency in circulation plus reserves held by banks all currency in circulation plus all deposits in depository institutions checkable deposits in depository institutions plus reserves held by banks all currency in circulation plus checkable deposits in depository institutions

all currency in circulation plus reserves held by banks

The concept of present value is important because it enables us to calculate present value of money market instruments but not capital market instruments allows us to compare returns on different financial instruments with different maturities earning different interest rates insures that a fall in interest rates will result in lower measures of present value

allows us to compare returns on different financial instruments with different maturities earning different interest rates

Most economists believe that changes in the price level have an effect on the quantity of output supplied in the short run, but not in the long run no effect on the quantity of output supplied in either the short run or the long run an effect on the quantity of output supplied in both the short run and the long run an effect on the quantity of output supplied in the long run,but not in the short run

an effect on the quantity of output supplied in the short run, but not in the long run

If the bond market is initially in equilibrium, and bond prices temporarily drop below equilibrium, the result will be an excess demand for bonds and an excess supply of loanable funds an excess supply of bonds and an excess supply of loanable funds an excess supply of bonds and an excess demand for loanable funds an excess demand for bonds and an excess demand for loanable funds

an excess demand for bonds and an excess supply of loanable funds If the price of bonds falls below equilibrium, an excess demand for bonds results; however, lower bond prices mean higher loanable funds interest rates, resulting in an excess supply of loanable funds.

Which of the following would cause the long-run aggregate supply curve to shift? an increase in labor productivity an increase in the price level a decrease in the expected price level an autonomous increase in consumption spending

an increase in labor productivity

Which of the following would shift the aggregate demand curve to the left? an increase in money demand a cut in federal income taxes an increase in the money supply an increase in the price level

an increase in money demand

Which of the following open market operations is considered to be a dynamic transaction? an open market operation that is intended to influence interest rates and the money supply an open market operation that compensates for increased currency demand during the Christmas season an open market operation that offsets a sharp rise in the Fed float an open market operation that compensates for fluctuations in Treasury deposits from tax and loan accounts to the Fed's accounts

an open market operation that is intended to influence interest rates and the money supply These three transactions describe defensive Federal open market operations designed to offset fluctuations in the factors that either decrease or increase the monetary base.

Which of the following best defines the term "Eurodollar"? any U.S. dollar deposited in a bank outside the U.S. anywhere in the world any dollar deposited by a European central bank in a New York bank any European currency borrowed by American banks dollars spent by European tourists in the U.S.

any U.S. dollar deposited in a bank outside the U.S. anywhere in the world

If a bank anticipates a fall in interest rates, it should arrange to have a positive duration gap arrange to have a negative duration gap lengthen the average duration of its liabilities relative to the average duration of its assets

arrange to have a positive duration gap

Derivative financial instruments are assets whose values are derived from primary financial markets financial assets whose value is derived from prices set in the stock market assets that derive their value from underlying assets loans made by banks at an interest rate derived from the market interest rate

assets that derive their value from underlying assets

An order to pay a specified amount of money to the holder of this document on a specified date is called a: euroloan banker's acceptance check currency swap

banker's acceptance A banker's acceptance is a time draft. It is an order to pay aspecified amount of money to the holder on a specific date.

Why aren't Treasury deposits with the Fed part of the monetary base? because they aren't assets of either the nonbank public or banks because no deposits at the Fed are included in the monetary base because the Fed is unable to exercise effective control over their size because they are currency and currency is not included in the monetary base

because no deposits at the Fed are included in the monetary base

If you believed strongly in the expectations theory, you would likely change your relative demand for instruments of different maturities to take advantage of different yields agree with the conclusion that the expectations theory explains the upward slope of the yield curve, but not parallel shifts in the curve believe that expected returns would be about equal for bonds of different maturities be unable to infer expectations of future short-term rates from current long-term rates

believe that expected returns would be about equal for bonds of different maturities

The main purpose of increasing the focus on liability management by commercial banks is to borrow additional funds so they can make more loans reduce bank debt reduce the amount of required reserves make sure the bank's balance sheet balances

borrow additional funds so they can make more loans

Moral hazard problems arise when borrowers default on loans borrowers have an incentive to conceal information lenders have difficulty in distinguishing between good and lemon firms when a downturn in economic activity makes repaying loans difficult for borrowers

borrowers have an incentive to conceal information

By saying that the U.S. has a dual banking system, we mean that the U.S. has both a central bank and a system of commercial banks both commercial banks and savings & loan intermediaries exist in the U.S. both the U.S. Treasury and the Federal Reserve are involved in regulating banks both state and federal governments may charter, regulate and examine banks in the U.S.

both state and federal governments may charter, regulate and examine banks in the U.S.

If a Fed watcher expects the fed funds rate to fall, he or she knows that the Fed will most likely seek a slowdown in overall economic activity buy government bonds decrease the supply of fed funds sell government bonds

buy government bonds

In a Federal Reserve repurchase agreement, the Fed does not require collateral if it agrees to buy securities from a dealer overnight, since the dealer may just buy them back tomorrow buys securities from a dealer in the government securities market, and the dealer agrees to buy them back at a given price at a specified future date does not consider such transactions as open market operations sells securities to a dealer in the government securities market and agrees to buy them back the next day

buys securities from a dealer in the government securities market, and the dealer agrees to buy them back at a given price at a specified future date

If you deposit a $50 check in the bank, before the check has cleared the change in your bank's balance sheet there will be a $50 increase in reserves and a $50 increase in checkable deposits cash items in the process of collection and a $50 increase in checkable deposits cash items in the process of collection and a $50 increase in reserves cash and a $50 increase in checkable deposits

cash items in the process of collection and a $50 increase in checkable deposits

An increase in the expected inflation rate in the U.S. will cause the U.S. exchange rate to depreciate reduce the nominal interest rate in the U.S. cause the U.S. exchange rate to appreciate increase the budget deficit in the U.S. relative to the budget deficits of foreign governments

cause the U.S. exchange rate to depreciate

Changes in the money supply over extended time periods are primarily due to changes in the monetary base rather than changes in the money multiplier increases in the percentage of deposits held in currency and excess reserves changes in the money multiplier rather than changes in the monetary base

changes in the monetary base rather than changes in the money multiplier

Which of the following will not shift the short-run aggregate supply function? changes in the costs of nonlabor inputs changes in the expected price level changes in the price level changes in labor costs

changes in the price level Changes in labor costs, nonlabor inputs and expectations will cause the short-run aggregate supply function to shift.

A change in bond demand occurs when bond prices rise changes in wealth occur changes in loanable funds interest rates occur bond prices fall

changes in wealth occur A change in bond demand (a shift in the bond demand curve) can occur only when some factor other than a change in bond prices occurs,since a change in bond prices can only cause a movement along a bond demand curve.

Private pension funds hold the highest percentage of assets in: corporate equities and mutual fund shares government securities mortgages corporate bonds

corporate equities and mutual fund shares

In examining data on financial intermediaries in the United States,which type of institution holds the lowest percentage of assets? mutual funds credit unions life insurers commercial banks

credit unions Credit unions have the lowest percentage of assets. See chart on page 247.

An exchange of expected future returns on debt instruments denominated in different currencies is called: banker's acceptance currency swap exchange rate risk risk management

currency swap By definition, currency swap is an exchange of expected future returns on debt instruments denominated in different currencies.

If the Fed buys $1 million in securities from a local Bank, the local bank's balance sheet would reflect a $1 million decrease in securities and a $1 million increase in reserves decrease in liabilities increase in liabilities increase in securities and a $1 million decrease in reserves

decrease in securities and a $1 million increase in reserves

Attempts by the federal government to maintain banking stability resulted in limits on sources of funds for large borrowers an increase in loans granted by banks to high-quality borrowers giving banks a competitive advantage in the market for loans decreased stability in banks because unregulated financial institutions began offering close substitutes for bank deposits and loans

decreased stability in banks because unregulated financial institutions began offering close substitutes for bank deposits and loans

If the dollar can be exchanged for fewer pesos today than yesterday,we say the dollar has depreciated remained constant in value become more valuable relative to the peso appreciated

depreciated

The most serious cost of inflation is distortion of information provided by prices caused by inflation uncertainty menu costs shoe-leather costs distortion of taxes paid on nominal incomes

distortion of information provided by prices caused by inflation uncertainty Although each of these answers identifies an inflation cost, the most serious cost is distortion of information.

An Edge Act Corporation may: engage in domestic and international banking services engage only in domestic banking services engage only in international banking services

engage only in international banking services

Fluctuations in a bank's net worth that accompanies increases or decreases in exchange rates are called: global risk interest rate risk exchange rate risk liquidity risk

exchange rate risk

In the context of the evaluation of the efficient markets hypothesis,pricing anomalies refer to the existence of trading strategies that appear to have offered above-normal returns gap between actual and expected prices spread between the price at which a broker will purchase stock from an investor and the price at which the broker will sell stock to an investor difficulty in practice of computing stock prices on the basis of expectations of future

existence of trading strategies that appear to have offered above-normal returns

If the Treasury sells $2 million in gold, the Fed's gold and SDR certificate account will fall by $2 million, whereas the monetary base will rise by $2 million rise by $2 million, as will the monetary base rise by $2 million, whereas the monetary base will fall by $2 million fall by $2 million, as will the monetary base

fall by $2 million, as will the monetary base When the Fed acquires gold or SDRs, the monetary base rises; when it sells gold, its gold and SDR account falls, as does the monetary base.

The largest group in the financial system in terms of the quantity of funds moved between savers and borrowers is financial intermediaries commercial banks the corporate bond market financial markets

financial intermediaries

Under conditions of exchange rate market equilibrium, if the nominal interest rates on U.S. assets and Australian assets differ, the rate difference is most likely attributable to expected changes in information costs between the two countries fluctuations in the exchange rate between the two countries changes in liquidity between the two countries changes in risk between the two countries

fluctuations in the exchange rate between the two countries Assets are assumed to have identical risk, liquidity, and information costs in considering the interest rate parity condition.

If financial market participants base their decisions on rational expectations, then market prices of financial assets will provide a best estimate of the prediction of upturns and downturns in financial markets fundamental value of financial assets the reduction in risk from investing in financial markets

fundamental value of financial assets

Investors are better off when financial asset prices are determined in an efficient market because returns on assets will be higher returns from assets traded in an efficient market are not subject to state or local taxes risky assets are not allowed to be traded in an efficient market funds will flow from savers to investors offering the most profitable investment opportunities

funds will flow from savers to investors offering the most profitable investment opportunities

An important difference between futures and options contracts is that futures contracts are traded primarily in commodity markets,while options contracts are traded primarily in financial markets the buyer of a futures contract assumes the long position, while the buyer of an options contract assumes the short position futures contracts have symmetric rights while options contracts have asymmetric rights futures contracts have asymmetric rights while options contracts have symmetric rights

futures contracts have symmetric rights while options contracts have asymmetric rights

Although open market operations and discount loans both change the monetary base, the Fed has greater control over open market operations than over discount loans very little control over either discount loans or open market operations complete control over both discount loans and open market operations greater control over discount loans than over open market operations

greater control over open market operations than over discount loans

The seller of a futures contract assumes the long position has the obligation to receive the underlying financial instrument at the specified future date has the obligation to deliver the underlying financial instrument at the specified date may, at his or her option, deliver or receive the underlying financial instrument at the specified date

has the obligation to deliver the underlying financial instrument at the specified date

Stocks with higher betas will generally result in lower expected returns because of their increased liquidity lower expected returns because of their lower risk higher expected returns because of their higher risk lower systematic risk, but higher idiosyncratic risk

higher expected returns because of their higher risk

Basis risk is a problem in hedging when perfect correlation exists between the rate on the hedged instrument and on the instrument actually traded in the futures market hedgers fail to fulfill their futures contracts imperfect correlation exists between the rate on the hedged instrument and on the instrument actually traded in the futures market financial markets are highly liquid

imperfect correlation exists between the rate on the hedged instrument and on the instrument actually traded in the futures market

If Treasury currency outstanding increases, the monetary base will increase, provided the increase in currency is held by banks decrease increase whether the increase in currency is held by banks or by the public increase, provided the increase in currency is held by the public

increase whether the increase in currency is held by banks or by the public

The currency premium in foreign-exchange markets helps to offset anticipated declines in exchange rates rises as domestic interest rates fall indicates investors' collective preference for financial instruments helps to offset anticipated increases in exchange rates

indicates investors' collective preference for financial instruments

Merchant banking refers to banking activities carried out by companies that are not banks banking services available to businesses but not to the general public investment banks investing their own funds in companies banking services available only to retail merchants

investment banks investing their own funds in companies

Factoring is calculating the optimal par values of stocks and bonds is purchasing accounts receivable at a discount involves selling stocks and using the proceeds to buy bonds has been declared illegal under the Factoring Reform Act of 1994

is purchasing accounts receivable at a discount

The key reason that expected inflation can distort financial decisions is that lenders have an easier time calculating expected inflation than do borrowers expected inflation results in substantial menu costs lenders pay taxes on nominal rather than real returns expected inflation reduces the real value of the national debt

lenders pay taxes on nominal rather than real returns

Which type of insurance incurs the lowest risk? property and casualty risk is the same for both life insurance

life insurance Due to the law of large numbers, Life insurers face relatively low risk in the aggregate. Refer to the checkpoint discussion on page 261.

The major reason why U.S. banks are regulated so heavily is that banks are subject to substantial interest rate risk the FDIC lacks sufficient funds to bail out failing banks banks cannot make a profit without federal subsidies liquidity risk and information problems are closely associated with bank runs

liquidity risk and information problems are closely associated with bank runs

If the U.S. imposes higher import quotas on Japanese autos, then the long-run exchange rate for the dollar will rise long-run exchange rate for the dollar will fall quantity of U.S. made autos sold in the U.S. will fall exports of U.S. autos to Japan will rise

long-run exchange rate for the dollar will rise

According to new Keynesians, the cost of reducing the inflation rate is higher interest rates greater trade deficits greater government spending lost jobs and output

lost jobs and output

One reason that the principal-agent problem is a general one in equity contracts is that since top management usually also owns the bulk of the firm's stock, it has little incentive to respond to the wishes of the remaining shareholders many uses of corporate funds are hidden from view the Securities and Exchange Commission does a poor job of detecting fraud by top management most uses of corporate funds are highly visible

many uses of corporate funds are hidden from view

A defined benefits plan may be either under funded or over funded may be under funded but cannot be over funded is always fully funded may be over funded but cannot be under funded

may be either under funded or over funded

Individuals assuming greater risk when covered by insurance is called: adverse risk pooling moral hazard risk hazard

moral hazard

The use of deductibles and coinsurance are examples of attempts by insurance companies to deal with the problem of adverse selection excessive government regulation failure of policyholders to keep paying their premiums moral hazard

moral hazard

Compared to the banking systems in other major industrial countries, the banking system in the United States has fewer banks and is more concentrated fewer banks and is less concentrated more banks and is less concentrated more banks and is more concentrated

more banks and is less concentrated

The largest source of funds for commercial banks is checkable deposits discount loans from the Fed borrowings from the fed funds market nontransaction deposits

nontransaction deposits

When market participants have rational expectations, the deviation of the expected price from the actual future price is predictable under certain circumstances, but not under others not predictable zero predictable, provided all relevant information is made use of

not predictable

Banks use credit rationing rather than simply raising the interest rate charged borrowers with higher default risks because of interest rate ceilings in many states use of credit rationing is encouraged by the Federal Reserve of fear of offending the loan applicants of fear of adverse selection problems

of fear of adverse selection problems

. Banking markets that have little or no regulation and low taxation on profits are called: Edge Act corporations Euromarkets international banking markets offshore markets

offshore markets Offshore markets have little or no regulation and tax bank profits at a very low rate.

If the economy is in short-run equilibrium an excess supply of aggregate output will occur an excess demand for aggregate output will occur households and business firms will demand more output than is currently being produced output will take place at the level where the short-run aggregate supply curve crosses the aggregate demand curve

output will take place at the level where the short-run aggregate supply curve crosses the aggregate demand curve

Demand-pull inflation results from attempts by financial markets to deal with bracket creep workers' pressure for higher wages policymakers' attempts to increase aggregate demand for current output above the full employment level attempts by the public to receive higher after-tax returns on their savings

policymakers' attempts to increase aggregate demand for current output above the full employment level

When the market price of a financial instrument equals its present value, savers and borrowers can be sure that the inflation rate equals the interest rate inflation rate will be zero in the future price communicates information about market participants' expectations of value interest rate will be zero in the future

price communicates information about market participants' expectations of value

If there is an excess supply of loanable funds at a given interest rate, then the price of bonds will fall price of bonds will rise price of bonds may rise or fall depending upon the reasons for the excess supply of loanable funds interest rate will rise

price of bonds will rise

Perhaps the most important reason why the U.S. created the Federal Reserve System in 1913 was to prevent banks from selling securities to their own trust accounts provide a lender of last resort enable banks to keep their reserves on deposit at the Fed provide open market purchases and sales of Treasury securities by the central bank

provide a lender of last resort

The segmented markets theory provides an explanation of the upward slope of the Treasury yield curve, but cannot explain parallel shifts in the curve explains why bonds of different maturities are perfect substitutes cannot explain the upward slope of the Treasury yield curve provides a logical explanation of why parallel shifts occur in the Treasury yield curve

provides an explanation of the upward slope of the Treasury yield curve, but cannot explain parallel shifts in the curve

The result of the supply shocks of 1973-1974 was to reduce both aggregate output and the price level reduce aggregate output and raise the price level raise both aggregate output and the price level reduce the price level and raise aggregate output

reduce aggregate output and raise the price level The OPEC supply shocks caused stagflation or lower output along with higher inflation.

Geographic restrictions on banks reduce the amount of local lending they undertake reduce their exposure to credit risk reduce their ability to take advantage of economies of scale raise the costs of their providing risk-sharing, liquidity, and information services

reduce their ability to take advantage of economies of scale

An increase in Treasury cash holdings reduces currency in the hands of the public increases the federal budget deficit reduces the federal budget deficit increases the monetary base

reduces currency in the hands of the public

If market participants believe that the default risk is increasing,the likely result will be a fall in default risk-free bond prices rise in demand for default risk-free bonds, a fall in demand for high-default-risk bonds, and a larger risk premium fall in demand for default risk-free bonds, a rise in demand for high default-risk bonds, and a smaller risk premium

rise in demand for default risk-free bonds, a fall in demand for high-default-risk bonds, and a larger risk premium

Finance companies\ take in deposits from savers and purchase assets with funds bring together small savers and large borrowers take in deposits from savers and make loans to borrowers sell commercial paper and securities and make loans to borrowers with the funds

sell commercial paper and securities and make loans to borrowers with the funds The role of finance companies is to sell commercial paper and make loans to borrowers with the funds.

Mutual funds take in deposits from savers and purchase assets with the funds bring together small savers and small borrowers sell shares to savers and purchase assets with the funds take in deposits from savers and make loans to borrowers

sell shares to savers and purchase assets with the funds

Securitization refers to banks insisting that collateral be supplied on previously unsecured loans changing the mix in an investment portfolio away from stocks and toward bonds reducing the exposure of a bank's portfolio to interest rate risk selling directly to investors' loans or securities that were formerly held by financial intermediaries

selling directly to investors' loans or securities that were formerly held by financial intermediaries

If, as a lender, you are concerned that interest rates might rise during the term for which you wish to make a loan, you can hedge against this possible rise by buying futures contracts on Treasury bills selling futures contracts on Treasury bills buying call options on Treasury bills increasing the size of your loan

selling futures contracts on Treasury bills

An increase in the expected price level shifts the short-run aggregate supply curve up and to the left has no effect on the short-run aggregate supply curve results in a movement along the short-run aggregate supply curve rather than a shift in the short-run aggregate supply curve shifts the short-run aggregate supply curve down and to the right

shifts the short-run aggregate supply curve up and to the left

The preferred-habitat theory shows a more significant expected decline in short-term rates than the expectation theory shows shows the same pattern of future short-term rates as shown by the expectations theory can explain the upward shift of the yield curve, but cannot explain the parallel shifts in the curve as in the case of the expectations theory

shows a more significant expected decline in short-term rates than the expectation theory shows

Index arbitrage refers to selling futures contracts and buying options contracts on the same stock simultaneous trading in stock index futures and the underlying stocks selling futures contracts on stocks and buying equivalent futures contracts on bonds. buying futures contracts and selling options contracts on the same stock

simultaneous trading in stock index futures and the underlying stocks

Which of the following statements best expresses the role of speculators in financial markets speculators increase liquidity for hedgers in markets speculators make high profits by assuming the same market positions that hedgers assume speculators disrupt markets by raising prices to higher levels than would exist in their absence speculators reduce liquidity for hedgers in markets

speculators increase liquidity for hedgers in markets

During the postwar period which of the following goals has been emphasized by the Fed? stabilizing the value of the dollar versus the yen stabilizing economic growth stabilizing short-term nominal interest rates stabilizing share prices on the New York Stock Exchange

stabilizing economic growth

. The real interest rate can be obtained by adding the expected rate of inflation to the nominal interest rate using the Fisher equation, adjusting the real interest rate on apoint-for-point basis with increases in the expected rate of inflation subtracting the expected rate of inflation from the nominal interest rate changes in supply and demand in the bond market

subtracting the expected rate of inflation from the nominal interest rate

The Fed uses operating targets as well as intermediate targets because the public is much less familiar with the variables used as operating targets, so for policy to be effective intermediate targets must also be announced the Federal Reserve Act of 1913 requires it to do so if one set of targets proves ineffective in attaining policy goals, the other set is available the Fed controls intermediate targets only indirectly

the Fed controls intermediate targets only indirectly The decision by the Fed to use both intermediate and operating targets is based on the fact that intermediate targets can be controlled only indirectly, whereas it has much more control over operating targets and can gauge their attainment much more effectively (pages 480-481 of the textbook).

Under a rules strategy for enhancing central bank credibility the Fed would announce a rule for money growth and then stick to it the Fed would adjust the money supply by a higher percentage in an economic upturn than in an economic downturn the Fed would select a rule for money growth but not announce it to the public Congress would assign a money growth rate to the Fed

the Fed would announce a rule for money growth and then stick to it

Savings institutions (savings and loan associations) are regulated today by state banking regulatory agencies the Federal Reserve Board the Office of Thrift Supervision the Federal Savings and Loan Insurance Corporation

the Office of Thrift Supervision

The intrinsic value of an option is the amount the option is expected to be worth on its expiration date equal to the option premium impossible to determine in the absence of information on the future prices of the underlying asset the amount the option is actually worth if it is immediately exercised

the amount the option is actually worth if it is immediately exercised

The yield to maturity gives us an interest rate that equates which of the following two sets of data? the yield on a discount basis and the bid price of a bond the present value of an asset and its yield to maturity the interest rate used to discount future income streams and the current yield the current price of an asset and the discounted value of the future income stream from that asset

the current price of an asset and the discounted value of the future income stream from that asset

The natural rate of unemployment is that unemployment rate at which all frictional unemployment has vanished there is no structural unemployment the economy produces the full employment level of output the aggregate demand curve crosses the short-run aggregate supply curve

the economy produces the full employment level of output

The largest percentage change in quantity of financial assets held by financial intermediaries between 1978 and 2003 occurred in the growth in mutual fund shares the growth in bank deposits the growth in home mortgages the growth in pension fund reserves

the growth in mutual fund shares

Which of the following types of information does the manager of the Open Market Trading Desk not take into account when implementing open market directives from the Fed? the level of inflation in the overall economy the desired level of reserves recommended by the open market directive the level of reserves in the banking system bids and offers from Treasury security dealers

the level of inflation in the overall economy The manager of the Open Market Trading Desk takes reserves,desired level of reserves and bids and offers from Treasury security dealers into account in implementing open market directives.

One advantage of buying an option contract is that an option contract provides fewer insurance benefits than a futures contract an options contract provides less opportunity for gain than a futures contract the maximum loss is the option premium an options contract involves lower cost than a futures contract

the maximum loss is the option premium

Discount Window

the means by which the Fed makes discount loans to banks, serving as a channel to meet the liquidity needs of banks

The new classical explanation of aggregate supply is also known as Keynesianism the misperception theory Monetarism the adaptive expectations theory

the misperception theory

Over periods of several years, the primary determinant of changes in the money supply is changes in the required reserve ratio discount loans the money multiplier the nonborrowed monetary base

the nonborrowed monetary base

Which of the following represents the sale of securities in asecondary market? the purchase of $1 million in 30-year corporate bonds from an investment banker the purchase of 100 shares of IBM stock from a private investor the purchase of a new issue of government Treasury bills directly from the Treasury the sale of $1 million in 10-year Treasury notes by the Treasury to Zion's Bank

the purchase of 100 shares of IBM stock from a private investor

The government budget constraints best explain that an increase in government deficits leads to an increase in the monetary base that the Fed can increase the budget deficit by conducting open market operations that countries in which the government has a high level of control over their central banks tend to monetize government budget deficits at higher levels than countries in which central banks have ahigher level of independence the relationship between federal budget deficits, changes in Treasury security holdings by banks and the nonbank public, and changes in the monetary base

the relationship between federal budget deficits, changes in Treasury security holdings by banks and the nonbank public, and changes in the monetary base

Diversification cannot reduce the risk of investing in a portfolio of assets if the assets in the portfolio are highly liquid the returns on the assets in the portfolio move together perfectly the risks are idiosyncratic risks investors choose a mix of short-term and long-term investments

the returns on the assets in the portfolio move together perfectly

In an efficient financial market the self-interested actions of informed traders cause available information to be incorporated in market prices prices of financial assets remain constant adaptive expectations ensure that asset prices are at least equal to their fundamental value investors often attain unexploited profits

the self-interested actions of informed traders cause available information to be incorporated in market prices

The explanation of exchange rate determination in the short run is based on the assumption that the short-run exchange rate is defined as the price of financial assets in one currency relative to the price of financial assets in another currency changes in price levels are unimportant in the short run short-run exchange rates are based on equivalent exchanges of actual goods and services nominal exchange rates remain constant in the short run

the short-run exchange rate is defined as the price of financial assets in one currency relative to the price of financial assets in another currency

A major problem in relying on discount loan policy as a monetary policy tool is that the spread between the fed funds rate and the discount rate set by the Fed can cause unintended increases or decreases in the monetary base and the money supply the Fed has a tighter rein over discount policy than it has over open market operations increases in the discount rate may provide erroneous signals of Fed monetary policy intentions discount policy is ineffective in addressing the illiquidity problems of individual banks

the spread between the fed funds rate and the discount rate set by the Fed can cause unintended increases or decreases in the monetary base and the money supply

The term structure of interest rates explains why yields differ for financial instruments with differing maturities the Treasury yield curve always slopes upward yields are held constant along a given Treasury yield curve yields differ for financial instruments with the same maturities

yields differ for financial instruments with differing maturities

If the federal government raises taxes by $1 billion and then spends the money to pay government bills, the effect on the monetary base will be a net decline in bank reserves a fall in the monetary base of $1 billion zero a rise in the monetary base of $1 billion

zero The funds paid in taxes flow back into bank reserves when the government pays its bills, so the monetary base doesn't change.