Sapling HW's

T/F: Until recently, shadow banks and depository banks have faced roughly the same degree of regulatory oversight. This has led to a significant degree of under-regulation for shadow banks since they engage in much riskier activities than do depository banks.

False

T/F: With respect to monetary policy, lobbyists have a significant role in influencing policy makers.

False

Another potential role of central banks is to foster confidence in the banking system by making sure that people can retrieve their money even if a bank goes bankrupt. In economics, the term for this is:

Deposit Insurance

Major Goals of the Wall Street Reform & Consumer Protection Act:

-A new bureau was created to protect borrowers and to police deceptive or confusing practices by banks. -Derivatives were required to be traded in a more easily observed marketplace. -The government's authority to seize banks that require a bailout was extended to include other financial institutions.

NOT a Major Goal of the Wall Street Reform & Consumer Protection Act:

-The allowed profitability of shadow banks was explicitly capped to incentivize people to switch their funds to the less risky (and more easily regulated) depository banks. -The Speculation Identification and Stabilization Committee was formed to identify asset bubbles and then inform the public about these bubbles.

What will cause AD to shift to the left (downward)?

-a central bank sells bonds on the open market -an increase in the required reserve ratio

What will cause AD to shift to the right (upward)?

-a decrease in the discount rate -a central bank uses open market operations to conduct expansionary monetary policy -an increase in the money supply -the federal reserve buys bonds from private banks

WILL NOT cause an AD curve shift:

-central bank increases the discount rate -increase in personal income tax rate -increase in nation's resource endowment -an increase in the required reserve ratio

Contractionary Monetary Policy

-increasing the reserve requirement -Fed selling more t-bills

Expansionary Monetary Policy

-lowering the discount rate

Expansionary Fiscal Policy

-reducing income tax -increasing government infrastructural spending

Scenarios that would decrease the money supply:

-the central bank sells bonds -the Fed discourages quantitative easing

Scenarios that would increase the money supply:

-the government decreases the reserve requirement -the discount rate decreases

WILL cause an AD curve shift:

-use of expansionary monetary policy -federal reserve purchases bonds on open market -increase in money supply

How can the government increase/decrease the money supply using the following corresponding policy tools? 1) Open Market Operations 2) Reserve Requirement 3) Discount Rate 4) Quantitative Easing

1) A central bank purchasing existing bonds. 2) An increase in the percentage of deposits that banks must keep on hand. 3) An increase in the interest rate that a central bank charges commercial banks for loans. 4) A central bank purchasing a large quantity of longer-term T-Bills.

The country of Utopia is on the verge of a financial crisis. Use the labels to identify the various aspects of the situation (asset bubble, commercial banking, maturity transformation, shadow banking, securitization). Utopian National Bank 1) The Utopian National Bank (UNB) takes deposits from the public 2) Then lends these funds primarily to homeowners who want 30 year mortgages. 3) The UNB often pools several mortgages into a package, then sells the package off in shares. Investment Bank of Utopia 4) The Investment Bank of Utopia does not take deposits from the public, but buys and sells a variety of securities. 5) Recently, the price of gold has risen sharply because of rising demand. Not wanting to be left out of such a lucrative market, IBU has invested heavily in gold, borrowing heavily to come up with the necessary funds.

1) commercial banking 2) maturity transformation 3) securitization 4) shadow banking 5) asset bubble

The country of Utopia is experiencing a full blown financial crisis. Use the labels to identify the various aspects of the situation (financial contagion, deleveraging, laissez-faire, debt overhang, lender of last resort). The Crisis The Investment Bank of Utopia (IBU) has invested heavily in gold because its price had been rising sharply. However, extensive new gold deposits have been found in nearby Paradise, and the price of gold now falls precipitously. 1) The IBU finds that the price of gold has fallen so low, the bank actually owes more on the loans it took on to buy the gold than the gold is worth. 2) The IBU's level of debt needs to be reduced, and it has no choice but to sell as many assets as possible to come up with the funds. 3) The IBU asks the Utopian Central Bank, the government banking authority, to help IBU by loaning it funds to pay off the debts. 4) The Central Bank officials do not make the loans believing it better to allow market forces to control the banking sector. 5) So many banks are selling assets to pay off gold debts, the prices of other assets have fallen as well. Even though the Utopian National Bank did not buy gold, it finds itself also facing lower asset values, leaving it also short of funds.

1) debt overhang 2) deleveraging 3) lender of last resort 4) laissez-faire 5) financial contagion

Fill in the blank with either increase/decrease, When a country falls into a financial crisis, it is common for lenders to believe the government's risk of default will __________. To protect themselves, lenders will then __________ interest rates on loans to the government. This will __________ the government's cost of borrowing, which will in turn __________ the probability of the government defaulting on its loans.

1) increase 2) increase 3) increase 4) increase

In many countries, one of the roles of the central bank is to provide loans to distressed financial institutions. In economics, the term for this is:

Lender of Last Resort

Suppose that there are four firms. One firm, Analytical Investments, is a typical shadow bank and uses short-term loans to make long-term investments. Suppose that these short-term loans must be repaid every week. Another firm, Business Investing, is a firm that invests money on the behalf of clients. They require their clients to sign away the right to withdraw their money for 10 years from the time of investment. A third firm, Common Cents, finances their operations through bonds that have a one year maturity date. Finally, a fourth firm, Downtown Bank, finances all of its operations through the demand deposits of its customers. Since the customers have demand deposits, this money can be withdrawn almost instantaneously. Assuming that the different times-to-repayment for the borrowed money is the only difference between the four firms, rank the four firms in terms of their susceptibility to failure due to bank runs. You should assume that none of the four benefit from FDIC protection or similar policies.

Most Susceptible ------------------- Downtown Bank Analytical Investments Common Cents Business Investing ------------------- Least Susceptible

Contagion/Not Contagion: A company heavily invests in an asset whose value later falls sharply due to a large increase in the supply of that asset. The company goes out of business as a result of the fall in value.

Not Contagion

Contagion/Not Contagion: Two companies heavily invest in an asset whose value later falls sharply due to a large increase in the supply of that asset. The fall in value causes both companies to go out of business.

Not Contagion

Of the Federal Reserve Bank's tools of monetary policy, which is used most often?

Open Market Operations

Which tool of monetary policy has the Federal Reserve Bank used least often?

The Reserve Requirement

Contractionary Fiscal Policy

-decreasing social welfare payments

1. Suppose that the price of some good has increased by 30% each year for the past few years. At this point, Bob's pretty sure that the good is overpriced (the current price is $10,000, but he doesn't think it is actually worth more than $3,000). However, Bob thinks that there is a 90% chance that the price will increase by 30% this year, with a 10% chance that the price falls back to $3,000. If Bob's expectations are correct, what is the expected return (in percent terms) from investing in the good? (Be sure to include a negative sign if the number is negative.) 2. If Bob is risk-neutral and could expect an 8% return if he invested in the stock market, will he invest in the good or the stock market? a) there's not enough information to tell. b) he's indifferent between investing in the two. c) he'll invest in the stock market. d) he'll invest in the good.

1. 20% 2. d) he'll invest in the good.

Brian has grown tired of paying rent each month to his landlord and has decided to purchase a condo. Brian has been saving money and has $10788.00 that he will use as a down payment on this condo. He will take out a mortgage to pay the remaining price. Brian finds a suitable condo and negotiates a price of $513199.00. 1. Upon moving in, how much equity does Brian have in this condo? a) $502411.00 b) $10788.00 c) $513199.00 d) $0 2. What is Brian's leverage ratio associated with this condo when he moves in? a) 0.02102109 b) 46.57128 c) $502411.00 d) 0.02147246

1. b) $10788.00 2. b) 46.57128

1. What happens to the interest rate in response to the Fed's bond purchases in relation to the graph and how you moved the curve(s)? a) it increases b) it decreases c) it stays the same d) we cannot tell 2. What kind of policy does this Fed action constitute? a) expansionary fiscal policy b) contractionary fiscal policy c) expansionary monetary policy d) contractionary monetary policy

1. b) it decreases 2. c) expansionary monetary policy

Suppose that a revolutionary young artist dies unexpectedly in a plane crash. The pre-crash expected lifetime supply curve of his art is drawn in red on the graph below. However, since he died unexpectedly at a young age, the realized supply curve for his art becomes a vertical line at the total number of paintings that he produced (shown in orange). The demand curve for the artist's art is not known with certainty (especially given his high-profile demise) to people in our example. They only know that the lifetime supply is now fixed. Answer the following three questions that compare the outcomes from movement to a new equilibrium from a change in supply with the outcomes of an asset bubble for the artist's art. (use graph) 1) Under which scenario(s) might we see a rapid price increase in a short period of time? a) only adjustment to new equilibrium b) only asset bubble c) both of the above 2) Under which scenario(s) might we see people buying the art at the old price with hope of selling it for more in the future? a) only adjustment to new equilibrium b) only asset bubble c) both of the above 3) Under which scenario(s) do we see expect to see a dramatic price drop following the dramatic price rise? a) only adjustment to new equilibrium b) only asset bubble c) both of the above

1. c) both of the above 2. c) both of the above 3. b) only asset bubble

1. Storgan Manley is a large financial institution. Storgan Manley increases it's profitability by borrowing money to invest. What is this process called? a) deleveraging b) securitization c) leverage d) subprime lending 2. One of the causes of the financial crisis of 2008 was the connectedness of financial institutions, where financial assets for one firm are often debt for other financial institutions. Suppose that some of Storgan Manley's assets lose value as other financial institutions experience financial difficulty. What is this called? a) securitization b) balance sheet effect c) spider web effect d) savings and loan crisis

1. c) leverage 2. b) balance sheet effect

Contagion/Not Contagion: Investors in the U.S. have invested heavily in lesser-developed countries due to high predicted growth rates in real GDP of those countries. One country enters a recession, making the predicted growth rates of that country overly optimistic in hindsight and resulting in that country defaulting on many of its loans. As a result, U.S. investors retrieve their investments in the other lesser developed countries out of fear that those growth forecasts are also overly optimistic. These lesser-developed countries enter a recession as a result of the substantial loss of capital.

Contagion

Contagion/Not Contagion: There is a bubble in the price of small, animal-shaped bean bag toys. The price eventually drops significantly, diminishing the wealth of collectors of these toys. Because collectors become warier of collectibles in general, the price of baseball cards also drops substantially, lowering the wealth of serious baseball card collectors.

Contagion

T/F: In the US, the reserve ratio varies from state to state.

False

T/F: Monetary Policy is subject to more public scrutiny than fiscal policy and is therefore tougher to implement.

False

T/F: Only depository banks are vulnerable to bank runs since shadow banks don't hold deposits and thus there are no depositors to make a run.

False

T/F: The primary reason why the Federal Reserve requires commercial banks to keep a specified amount of reserves is to ensure bank liquidity.

False

T/F: The reserve ratio determines the interest rate that customers receive for depositing money in a bank.

False

T/F: Unlike depository banks (which were originally founded as non-profit), the inherent for-profit nature of shadow banks leads to overly risky behavior as the shadow banks attempt to provide owners the rate of return necessary for the owners to be willing to continue owning the bank.

False

Which tool of monetary policy has been created only recently as a response to the financial crisis of 2007-2008?

Term Auction Facility

T/F: An advantage of monetary policy is that it can be implemented quickly.

True

T/F: Excess Reserves = (actual reserves) - (required reserves)

True

T/F: Excess reserves refer to the amount of total reserves that banks are legally permitted to lend.

True

T/F: If shadow banks and depository banks invest in the same asset markets, a crisis among shadow banks can spread to depository banks due to the effects of deleveraging.

True

T/F: Monetary policy does not directly affect the distribution of resources while fiscal policy does.

True

T/F: Reserve Ratio = (required reserves) / (checkable-deposit liabilities)

True

T/F: Since 2000, the Fed has made frequent use of monetary policy.

True

T/F: The business model of both shadow banks and depository banks is based on maturity transformation.

True

There were many causes of the Financial Crisis of 2007-2008 in the US. Which of the following most accurately describes the role of securitization in contributing to this crisis? a) Banks bundled mortgages together and then sold them on the market as a financial asset. However, the risk level of these securitized assets was often much higher than the purchaser thought. b) Banks failed to securitize their loans by requiring sufficient down payments from home buyers. This resulted in even small declines in housing prices causing many homes to go into foreclosure. c) Globalization has increased the connectedness of the major economies of the world. Correspondingly, there has been a decrease in the economic security of the U.S., where the U.S. has been adversely affected by the many European nations that have suffered recessions. d) In providing aid to firms that were at risk of becoming insolvent, the U.S. government securitized these firms. In the future, firms are more now likely to engage in risky investments since the government securitizes these behaviors.

a) Banks bundled mortgages together and then sold them on the market as a financial asset. However, the risk level of these securitized assets was often much higher than the purchaser thought.

Note that if shadow banks and depository banks participate heavily in some of the same asset markets, then failure by multiple large shadow banks can lead to problems for depository banks through deleveraging in the shared market. If shadow banks' engaging in risky investments (in other asset markets) makes it more likely that they will fail (leading to the need to deleverage), which of the following must be the case? a) Engaging in these risky investments leads to a negative externality. b) Engaging in these risky investments leads to a positive externality. c) The risk on these assets essentially creates a market-imposed price floor. d) The risk on these assets essentially creates a market-imposed price ceiling. e) None of the above. Given the correct answer for your above question, which of the following must be true? a) The risk assumed by shadow banks is equal to the socially optimal level of risk. b) In the absence of preventative regulation, the risk assumed by shadow banks will be less than is socially optimal. c) Shadow banks are engaging in riskier behavior than their customers would prefer they engage in. d) In the absence of preventative regulation, the risk assumed by shadow banks will be greater than is socially optimal. e) None of the above.

a) Engaging in these risky investments leads to a negative externality. d) In the absence of preventative regulation, the risk assumed by shadow banks will be greater than is socially optimal.

There were many causes of the Financial Crisis of 2007-2008 in the US. Which of the following most accurately describes the role of leverage in contributing to this crisis? a) Leverage refers to the extent to which a person or firm has borrowed in relation to how much they have in equity in that same asset. Investment firms were highly leveraged in the time period leading up to the financial crisis, meaning they had borrowed a lot relative to their equity in assets. This was caused, in part, by lending money to people for homes without the borrower putting any, or very little, money down on the houses. This made firms quite vulnerable to even relatively small declines in asset values. b) Leverage refers to people using mortgages with variable interest rates, rather than fixed interest rates. When interest rates increased, many people found they could no longer afford their mortgage payments. c) Leverage refers to the extent to which various components of the financial system are connected to one another. Mortgages in the U.S. had been increasingly securitized, causing a high level of connectedness across the financial system. d) Leverage refers to the ability of the Federal Reserve Bank to influence interest rates in another country. Because interest rates had gone so low, expansionary monetary policy was no longer effective and one of the primary policy tools of the government was no longer effective.

a) Leverage refers to the extent to which a person or firm has borrowed in relation to how much they have in equity in that same asset. Investment firms were highly leveraged in the time period leading up to the financial crisis, meaning they had borrowed a lot relative to their equity in assets. This was caused, in part, by lending money to people for homes without the borrower putting any, or very little, money down on the houses. This made firms quite vulnerable to even relatively small declines in asset values.

Which of the following is a general characteristic of participants in an asset bubble but not a general characteristic of everyday investors (such as people who invest money in a 401(k) retirement account)? a) Participants in an asset bubble pay more than an item is reasonably worth whereas everyday investors do not. b) Participants in an asset bubble invest only money that they are willing to gamble away whereas everyday investors invest mostly that they depend on for retirement. c) Participants in an asset bubble buy the asset with the expectation that it will rise in price whereas everyday investors do not. d) All of the above. e) None of the above Given your answer above, in which of the following cases might an everyday investor become an accidental participant in an asset bubble? a) Investors might become unwitting participants in asset bubbles if the true value of some good is unknown, even to experts. b) Investors cannot avoid being participants in asset bubbles. c) Never. An investor can always avoid asset bubbles by not paying more for an asset than it will be worth in 10 years. d) Investors can avoid asset bubbles if they avoid the stock market and real estate.

a) Participants in an asset bubble pay more than an item is reasonably worth whereas everyday investors do not. a) Investors might become unwitting participants in asset bubbles if the true value of some good is unknown, even to experts.

The following statements regarding savings and loans (S&L's) are all true except... a) S&L's are not covered by federal deposit insurance. b) S&L's are deposit-taking financial institutions. c) During the 1970s inflation made savers less willing to deposit their money in S&L's. d) Because of their troubles in the 1970s, Congress loosened regulations on S&L's. e) During the real estate boom in the 1970s and 1980s, S&L's took on more risky loans.

a) S&L's are not covered by federal deposit insurance.

Contractionary or restrictive monetary policy (tight money policy) will cause interest rates to ___________ . a) increase b) decrease c) increase sometimes and decrease sometimes

a) increase

Subprime lending is thought to be a contributing factor to the recent housing bubble. Which of the following is an example of subprime lending? a) Vincenzo does not have sufficient income to afford the payments on the mortgage for which he is applying. However, Vincenzo's older and wealthier girlfriend has agreed to co-sign the loan. The bank agrees to loan Vincenzo more than he can afford to repay because of existence of his co-signer. b) Bradley is a first-time home buyer who does not enough money for the usual 20% required for a down payment. Nonetheless, a bank offers Bradley a loan because his income is sufficient and home prices have historically increased. c) Jurgen wants to purchase a home and is hoping to minimize his monthly mortgage payments. The bank offers Jurgen an adjustable rate loan which has a lower initial rate but will potentially increase in the future. d) Chris is a real estate tycoon. He owns many homes and apartment complexes. Because he owns so many properties, he is particularly vulnerable to fluctuations in the real estate market. His bank is willing to loan him more money despite this risk.

b) Bradley is a first-time home buyer who does not enough money for the usual 20% required for a down payment. Nonetheless, a bank offers Bradley a loan because his income is sufficient and home prices have historically increased.

Which of the following is true of financial crises, such as the one the United States suffered in 2008? a) Financial crises are usually seen only in poorer, developing nations, rather than in a wealthy, Western economy like the United States. b) Financial crises often start with institutions which are not well regulated, like the shadow banks which were not under the regulatory authority of the Federal Reserve. c) Financial crises always start with real estate bubbles. d) The pattern of a rapid descent into recession, followed by a very slow recovery, is highly unusual.

b) Financial crises often start with institutions which are not well regulated, like the shadow banks which were not under the regulatory authority of the Federal Reserve.

The statements below refer to the Troubled Asset Relief Program (TARP). Which one is false? a) Recipients of TARP funds include nonfinancial institutions such as General Motors and Chrysler. b) Only firms who had paid an insurance premium to the government could receive TARP funds. c) TARP demonstrates moral hazard, since firms could be encouraged to take on larger risks under the assumption of a government bailout. d) TARP allowed the U.S. Treasury to make emergency loans to financial institutions.

b) Only firms who had paid an insurance premium to the government could receive TARP funds.

When a rising aggregate price level is a concern but GDP is growing at an acceptable rate, ________ is appropriate. a) expansionary monetary policy (easy money policy) b) contractionary or restrictive monetary policy (tight money policy) c) it's unclear what type of monetary policy

b) contractionary or restrictive monetary policy (tight money policy)

Celebrity chef Robbie Fray has been growing in popularity. The television studio had raised ticket prices from $75 to $300. Customers paying $300 are thrilled about going to a filming of their favorite show. Shortly after this price increase, Robbie Fray decides to check into a weight loss clinic and make the show about vegetable smoothies. Unable to sell tickets for $300 after Robbie Fray's reform, the studio lowers the price to $80 per ticket. Does the preceding description fit the definition of an asset bubble? a) Yes, since the intermediate price of $300 per ticket was significantly higher than the $75 or $80 per ticket before and after prices, this must have been an asset bubble. b) Yes, the increase in price followed by a decrease in price is enough to show there was an asset bubble regardless of how much higher the final price ($80) was. c) No, since people were using the tickets instead of investing in them, this was not an asset bubble. d) No, since the price did not fall to its original level (or even lower), it was not an asset bubble. With the sudden rise in enthusiasm for Robbie Fray's show, some had bought tickets from the television studio for $300 with intention of selling them second-hand for even more. Some scalpers succeeded in selling tickets for $1,000. However, with Robbie Fray's changes to the show, most scalpers are experiencing significant financial losses as ticket prices plummet. Did the second-hand market for tickets experience an asset bubble? a) Yes b) No

c) No, since people were using the tickets instead of investing in them, this was not an asset bubble. a) Yes

Which of the following is an example of open market operation? a) A bank loaning out all but the requisite 10% of its funds to hold in storage. b) Naftali runs a bazaar in Baghdad selling odds and ends type trinkets to tourists. c) The U.S. central bank sells bonds to the public via the commercial banking system. d) The central bank lowers the interest rate from 5% to 3% on the loans it gives to commercial banks.

c) The U.S. central bank sells bonds to the public via the commercial banking system.

When inflation is occurring and GDP is not growing at an acceptable rate, __________ is appropriate. a) expansionary monetary policy (easy money policy) b) contractionary or restrictive monetary policy (tight money policy) c) it's unclear what type of monetary policy

c) it's unclear what type of monetary policy

Which of the following has influence over United States Federal Reserve (the Fed)? a) US Senate b) US President c) Board of Governors of the Fed d) All of the above

d) All of the above

Which of the following exercises the most power over the quantity of money in the US economy? a) US President b) US Congress c) Fort Knox d) US Treasury Department e) US Federal Reserve f) US Supreme Court g) Warren Buffet

e) US Federal Reserve