ECON 330 Exam 1

Draw the Bond market. Be sure to label everything. Show what happens before and after a decrease in the desire of people to save rather than spend their income

Demand moves to the left because there is a decrease Bond Prices: Decrease Interest Rates: Increase Lending: Decrease

Does an increase in risk affect demand or supply? Left or right?

Demand; left

Does an increase in liquidity affect demand or supply? Left or right?

Demand; right

Does an increase in wealth affect demand or supply? Left or right?

Demand; right

Financial Innovation

Development of new financial products & services

Fiscal Policy

Govt spending and taxes to affect economy

Nominal Interest Rate

Growth in money from waiting

What role did the global pool of money play in the housing bubble?

It increased heavily. Got so big that banks/financial sector were required to create more mortgage backed securities

Financial intermediary's lower transaction costs by providing what two things?

Liquidity and Economies of Scale

Equation for finding present value

PV = Sum FV/(1+i)^t

Interest Rate

Price of Impatience

What is the key disadvantage of fiat money

Temptation to print money to pay bills

Security

a financial instrument that is a claim on the issuer's future income or assets Bond/ Loan: debt or borrowing Stock: ownership

Which of the following factors apart from securitization was responsible for the Great Recession of 2007-2009? a. An increase in funds lent to subprime borrowers. b. A sudden rise in equity prices c. An increase in the federal funds rate

a. An increase in funds lent to subprime borrowers.

Why do bank runs occur a. Asymmetric Information c. Financial dis-imediation b. Moral Hazard d. Capital Requirements

a. Asymmetric Information

Which of the following bonds would have the highest default risk? a. Junk bonds b. investment−grade bonds c. U.S. Treasury bonds d. Municipal bonds

a. Junk bonds

The most comprehensive measure of aggregate output is a. gross domestic product. b. national income. c. net national product. d. the stock value of the industrial 500.

a. gross domestic product.

The interest rate falls when either the demand for bonds ________ or the supply of bonds ________. a. increases; decreases c. increases; increases b. decreases; decreases d. decreases; increases

a. increases; decreases

There is ________ for any bond whose time to maturity matches the holding period a. no interest−rate risk b. yield−to−maturity risk c. a large interest−rate risk d. rate−of−return risk

a. no interest−rate risk

In order to reduce risk and increase the safety of financial institutions, commercial banks and other depository institutions are prohibited from a. owning common stock. b. owning municipal bonds. c. making real estate loans d. making personal loans

a. owning common stock.

Which of the following is true of securitization? (Circle All) a. It is a process that converts high-risk financial instruments into default-free financial instruments. b. It is a process that converts a series of financial instruments into marketable securities. c. A process that drives the prices of financial instruments above their fundamental values

b. It is a process that converts a series of financial instruments into marketable securities.

Which of the following is an example of financial intermediation? a. IBM issues a bond that is sold to a retired person. b. Saver makes a deposit in credit union; credit union makes loan to a member for a new car. c. IBM issues common stock that is sold to a college student. d. U.S. Treasury sells bonds to fund government spending.

b. Saver makes a deposit in credit union; credit union makes loan to a member for a new car. connects savers with borrowers

The Federal Reserve did not rescue the investment bank Lehman Brothers because of a. Moral Hazard c. Presidential Objection b. Systemic Risk d. Asymmetric Information

b. Systemic Risk

In the bond market, the bond demanders are the ________ and the bond suppliers are the ________. a. borrowers; lenders b. lenders; borrowers c. lenders; advancers d. borrowers; advancers

b. lenders; borrowers

In the bond market, the bond demanders are the ________ and the bond suppliers are the ________. a. borrowers; lenders b. lenders; borrowers c. lenders; advancers d. borrowers; advancers

b. lenders; borrowers

Financial intermediaries provide customers with liquidity services. Liquidity services a. are another term for asset transformation. b. make it easier for customers to conduct transactions. c. allow customers to have a cup of coffee while waiting in the lobby. d. are a result of the asymmetric information problem.

b. make it easier for customers to conduct transactions.

Kevin purchasing concert tickets with a $100 bill is an example of the _____ function of money. a. specialization b. medium of exchange c. unit of account d. store of value

b. medium of exchange

A well-functioning financial system: a. creates unpredictable market disruptions. b. solves asymmetric information problems. c. acts as a barrier to efficient allocation of capital d. causes financial frictions to increase in an economy

b. solves asymmetric information problems.

Who supplies bonds?

borrowers

The U.S. got its first National Currency around the a. 1780s c. 1860s e. 1930s b. 1830s d. 1910s

c. 1860s

The greatest period of financial regulation in the U.S. occurred in the a. Late 1800s c. Mid 1900s b. Early 1900s d. Post 2007 Financial Crisis

c. Mid 1900s

Which of the following can be described as involving indirect finance? a. You buy a U.S. Treasury bill from the U.S. Treasury at TreasuryDirect.gov. b. You make a loan to your neighbor. c. You buy shares in a mutual fund. d. You purchase shares in an initial public offering by a corporation in the primary market

c. You buy shares in a mutual fund.

Increasing the amount of information available to investors helps to reduce the problems of ________ and ________ in the financial markets. a. adverse selection; risk sharing b. moral hazard; transactions costs c. adverse selection; moral hazard d. adverse selection; economies of scale

c. adverse selection; moral hazard

Currency includes a. paper money, coins, and checks. b. paper money and checks. c. paper money and coins. d. checks & savings deposits.

c. paper money and coins.

Real Interest Rate

change in what one can consume by waiting When they are in equilibrium: i ~= r + π

Financial System

channels funds from savers (those who consume less than they earn) to borrows (those who consume more than they earn) Increase productivity and make a more efficient market, consumers can time purchases better Can be direct or indirect Directs: owning stocks or bonds Indirect: checking account at a bank

Financial Intermediaries

connect savers with borrowers or sellers of assets with borrowers or savers Examples: bank (depositors to borrowers), insurance company (savers for accidents to borrowers), stock broker (buyers of stock to seller of stock), investment bank, or mutual fund company (small savers to large borrowers or investors)

Buying a US treasury bond from your friend is an example of... a) primary market b) indirect finance c) financial intermediation d) secondary market

d) secondary market

Which of the following is not a contractual savings institution? a. A pension fund b. A life insurance company c. A fire and casualty insurance company d. A savings and loan association

d. A savings and loan association

The 1980s is known for banking _______________ a. Innovation c. Consolidation e. None of the above b. Deregulation d. All of the above

d. All of the above

People, in general, do not lend money to one another to buy a house or a car because: a. of information problems. b. they do not know about the effort other people will provide to repay their debts. c. they do not know about the capacity of other people to repay their debts. d. All of the above.

d. All of the above.

________ is the relative ease and speed with which an asset can be converted into a medium of exchange. a. Efficiency c. Specialization b. Deflation d. Liquidity

d. Liquidity

A ______ is bought at a price below its face value, & the _______ value is repaid at the maturity date. a. discount bond; discount b. coupon bond; discount c. coupon bond; face d. discount bond; face

d. discount bond; face

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families. a. credit risk c. adverse selection b. risk sharing d. moral hazard

d. moral hazard

The yield to maturity for a discount bond is ________ related to the current bond price. a. not b. positively c. directly d. negatively

d. negatively

When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors. a. bonds b. notes c. bills d. stock

d. stock

If you expect the inflation rate to be 15 percent next year and a one−year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is a. 7 percent. c. −15 percent. b. 22 percent. d. −8 percent.

d. −8 percent.

Capital Market

deal in long-term debt instruments

Money Market

deal in short-term debt instruments

Fisher Effect

demand decreases and supply increases Reaction to change in expected inflation Nominal Rate = real rate + expected inflation rate When the economy is "booming", supply and demand both increase

Wealth

funds, people borrow other people's wealth, value of all assets

Commodity Money

has intrinsic value

Inflation

increases the price of everything, caused by too much money

Expectation theory of interest rates

interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond, bond buyers do not have a preference for maturity (bonds are substitutes), they will not hold any quantity of a bond if its expected return is less than that of another bond with a different maturity

GDP

market value of all the final goods and services produced and sold in a specific time period by countries

Ownership

owner is entitled to something, but there is no promise of what the return will be (stock), with bonds the owner knows what will be paid or returned

If interest increases...

price decreases, longer maturity = more change in price

If interest decreases...

price increases, so long-term is better

Foreign Exchange Rate

price of a currency in terms of another currency

Who demands bonds?

savers

Does an increase in expected profitability of investment opportunities affect demand or supply? Left or right?

supply; right

Does an increase in govt deficits affect demand or supply? Left or right?

supply; right

Financial Market

where funds are exchanged

Foreign Exchange Market

where one goes to buy and sell different money or currencies

What two factors shift supply?

1. Expected Profitability 2. Government budget surplus or deficit

M1

Currency + Bank Reserves + Checking Accounts

What is the solution to the key disadvantage of fiat money

Independent Central Banks

What is the key advantage of commodity money (not a characteristic)

Universally Accepted

Buying a shares of UBER when they went public is an example of the... a) primary market b) secondary market c) financial intermediation d) indirect finance

a) primary market

The Troubled Asset Relief Program (TARP) authorized the Treasury to a. purchase subprime mortgage assets from troubled financial institutions. b. Take over commercial banks c. Merge troubled financial institutions d. Regulate Financial Institutions e. All of the above

a. purchase subprime mortgage assets from troubled financial institutions.

Commercial Bank

accepts deposits and is covered by deposit insurance

The Federal Reserve was created after the crisis surrounding a. The Revolution d. World War 1 b. Civil War e. Great Depression c. Banking Panics of the early 1900s

c. Banking Panics of the early 1900s

Inflation Rate

change in price of goods or services

Fiscal Policy

control of government spending and taxes to affect macro economy

Monetary Policy

control of the supply of money, interest rates, and prices

Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which it is sold are known as a. equity bonds. c. country bonds. b. foreign bonds. d. Eurobonds.

d. Eurobonds.

As a result of strict banking regulations, the United States has: a. Banks that are quite large relative to those in other countries b. too few banks when compared to other industrialized countries c. a few dominant banks that hold most of the assets in the banking industry d. many more smaller banks when compared to other industrialized countries

d. many more smaller banks when compared to other industrialized countries

Moral Hazard

(after the transaction): ensure borrower will not engage in activities that will prevent him/her to repay the loan.

Adverse Selection

(before the transaction): try to avoid selecting the risky borrower by gathering information about them

Why is financial regulation probably necessary?

-systemic risk -Asymmetric information

Order the dynamics of a Financial Crisis from 1 to 4 92. Credit and Asset Boom _____ 93. Banking Crisis _____ 94. Debt Deflation _____ 95. Price Deflation

1 2 3 4

What four factors shift demand for bonds?

1.

Three functions money must fufill

1. unit of account 2. medium of exchange 3. store of value

When was the federal reserve created?

1913 by the Federal Reserve Act

Glass-Steagall Act

1933 FDIC Separates commercial and investment banking FDIC creates deposit insurance

Who was the first Treasury Secretary of the United States?

Alexander Hamilton

What is the global pool of money?

All of the world's savings

What happens to the bond market after an increase in the expectations of the inflation rate.

Bond prices: decrease Nominal Interest Rates: Increase Supply shifts to the right and demand shifts to the left

What happens to the bond market when bond issuers become more risky?

Borrowing: Decrease Interest Rates: Increase Lending: Decrease Demand shifts to the left

What happens to the bond market when a consumers have a decrease in the desire to consume?

Borrowing: Increase Interest Rates: Decrease Lending: Increase Demand shifts to the right

What happens to the bond market with an increase in technology that makes it possible to buy and sell bond with more ease?

Borrowing: Increase Interest Rates: Decrease Lending: Increase Demand shifts to the right

Describe the process of Securitization

Bundling loans into securities . Played a predominant role in development of subprime mortgages in 2000s . Led to higher house prices To transform otherwise illiquid financial assets into marketable capital market securities (played a big role in mortgage market in mid 2000's)

Investor

Buyer of Capital

What is the key advantage of fiat money

CAN control supply

What is the key disadvantage of commodity money (not a characteristic)

Can't control supply

Financial Security

Claim on issuers future income or assets

Financial Intermediary

Connects savers with borrowers

Saver

Consumes less than their income

Central Bank

Controls Money Supply

Real Interest Rate

Cost in goods from borrowing