Exam 4

Suppose the reserve requirement is 20 percent. If a bank has checkable deposits of $4 million and actual reserves of $1 million, it can safely lend out:

$200,000.

What distinguishes the M2 and M3 money supplies?

M3 is distinguished from M2 by large time deposits (certificates of deposits).

LgResRat Checdep Acreser 10% 40000 10000 20 40000 10000 25 40000 10000 30 40000 10000 Refer to the above table. When the legal reserve ratio is 10 percent, the money creating potential of this single bank is: A) $0. B) $6,000. C) $30,000. D) $60,000.

b

What are the three basic functions of money? Describe how rapid inflation can undermine money's ability to perform each of the three functions.

The three basic functions of money are the medium of exchange, which is the buying and selling of goods. Next is the unit of account which is how much goods and services are worth. Last is the store of value which allows for the transfer purchasing power from the present to the future. Rapid inflation reduces the purchasing power of money, meaning that you can buy less with the money you have. This affects the unit of account on goods and services that are purchased greatly. It also creates a distrust in the measure of value for money.

Which of the following best describes what occurs when monetary authorities sell government securities?

There is a decrease in the size of commercial banks' excess reserves, the money supply decreases, and interest rates rise, thereby causing a decrease in investment spending and real GDP.

The federal funds market is the market in which:

banks borrow reserves from one another on an overnight basis.

In essence, which of the following groups "creates" money?

banks' loan officers when they grant loans

Banks create money when they:

buy government bonds from households.

A bank can get additional excess reserves by doing any of the following except

buying Treasury securities from the Fed.

LgResRat Checdep Acreser 10% 40000 10000 20 40000 10000 25 40000 10000 30 40000 10000 Refer to the above table. When the legal reserve ratio is 30 percent, the monetary multiplier is: A) 5. B) 4. C) 3.33. D) 2.5.

c

The major purpose of the Federal Reserve buying government securities in open-market operations is to

allow banks to increase their lending.

Near-monies:

are certain highly liquid financial assets that do not function directly as a medium of exchange but can be readily converted into M1.

The concept of time preference in financial investing rests on the belief that people:

are impatient.

The market for immediately available reserve balances at the Federal Reserve is known as the:

federal funds market.

If you deposit a $50 bill in a commercial bank that has a 10 percent legal reserve requirement, the bank will:

have $45 of additional excess reserves.

Commercial banks and thrift institutions:

have become increasingly similar in recent years.

Firms whose central business is providing individual account shares of a group of stocks, bonds, or both are known as:

mutual funds companies.

A newspaper headline reads, "Fed Raises Discount Rate for Third Time This Year." This headline indicates that the Federal Reserve is most likely trying to

reduce inflationary pressures in the economy.

The Federal Open Market Committee (FOMC):

sets the Fed's monetary policy and directing the purchase and sale of government securities.

Strengths of Monetary Policy

speed flexibility no political pressure

what action would it take if it were pursing an easy money policy to increase economic growth and reduce unemployment?

target an interest rate that puts twice as much weight on closing the unemployment gap as it does on closing the inflation gap.

The four main tools of monetary policy are

the discount rate, the reserve ratio, interest on excess reserves, and open-market operations.

M3 =

M2 + large time deposits (those of $100,000 or more).

Myrna borrows $500 at an annually compounded interest rate of 8 percent that she will repay at the end of 10 years. How much will be required to pay off the loan at the end of 10 years?

$1,079.46.

Answer the question on the basis of the following information about a banking system: new currency deposited in the system = $40 billion; legal reserve ratio = 0.20; excess reserves prior to the currency deposit = $0. Refer to the information. With the $40 billion deposit, the banking system will be able to expand the money supply through loans by:

$160 billion.

Assets Liabil/Net worth reserv 200 check depo1000 secuti 300 stock shar 400 Loans 500 propertry 400 Refer to the given data. If the Fed increased the reserve requirement from 20 percent to 25 percent, a deficiency of reserves in the commercial banking system of _____ would occur and the monetary multiplier would fall to ____.

$50 billion; 4

Which of the following equations shows how much X dollars will be worth if invested at an annual interest rate i for t years, if interest is compounded annually?

(1 + i)tX

What is the basic determinant of (a) the transactions demand and (b) the asset demand for money?

(a) The level of nominal GDP: The higher this level, the greater the amount of money demanded for transactions. (b) The interest rate: The higher the interest rate, the smaller the amount of money demanded as an asset.

The entire banking system can create an amount of money which is a multiple of the system 's excess reserves, even though each bank in the system can only lend dollar for dollar with its excess reserves.

1. Required reserve ratio assumed to be 20 percent. (The actual reserve ratio averages 10 percent of checkable deposits.) 2. Initially banks have no excess reserves; they are "loaned up." 3. When banks have excess reserves, they loan it all to one borrower, who writes check for entire amount to give to someone else, who deposits it at another bank. The check clears against original lender.

Which of the following monetary policy tools was introduced in 2008?

Interest on reserves held at the Fed.

Currency (paper money plus coins) constitutes about:

45 percent of the U.S. M1 money supply.

Lee buys a bond for $10,000 and receives interest payments of $400 every six months. The interest rate on the bond is approximately:

8 percent.

Other things equal, which of the following would increase the federal funds rate?

A decline in excess reserves in the banking system.

Graph (x-risk level, y-average expected rate of return) C-75 degree B-middle 45 degree A- flat line across Refer to the graph. Which of the three Security Market Lines depicts the situation where investors most dislike risk?

Line C.

Which of the following describes the identity embodied in a balance sheet?

Assets equal liabilities plus net worth.

M2 =

M1 + non-checkable savings deposits + money market deposit accounts + small time deposits + money market mutual fund balances

The Phillips Curve suggests an inverse relationship between increases in the price level and the level of unemployment.

False

easy monetary policy

Fed policies that expand the money supply and thus lower interest rates in an effort to stimulate the economy

Explain why a single commercial bank can safely lend only an amount equal to its excess reserves but the commercial banking system can lend by a multiple of its excess reserves. What is the monetary multiplier, and how does it relate to the reserve ratio?

For a single commercial bank they can only lend an amount equal to its excess reserves because there is a possibility that the checks for the entire amount of the loan will be drawn and cleared against it. This is bad because then they would lose reserves equal to the amount that they lend. As for commercial banking systems, they can lend multiple of their excess reserves because one bank loses reserves to other banks, but the system doesn't. The monetary multiplier is the multiple of excess reserves that the banking system can expand checkable deposits and thus the money supply by making new loans. The equation for this is one divided by the required reserve ratio.

Which of the following is correct? -Both the granting and repaying of bank loans expand the aggregate money supply. -Granting and repaying bank loans do not affect the money supply. -Granting a bank loan destroys money; repaying a bank loan creates money. -Granting a bank loan creates money; repaying a bank loan destroys money.

Granting a bank loan creates money; repaying a bank loan destroys money.

Why is the face value of a coin greater than its intrinsic value?

If the face value of a coin were not greater than its intrinsic (metallic) value, people would remove coins from circulation and sell them for their metallic content.

Assume that Smith deposits $600 in currency into her checking account in the XYZ Bank. Later that same day Jones negotiates a loan for $1,200 at the same bank. In what direction and by what amount has the supply of money changed?

Increased by $1,200.

Mutual funds are very popular. What do they do? What sorts of different types of mutual funds are there? And why do you think they are so popular with investors? If you were investing today, where would you put your money--be specific and why?

Mutual funds are portfolios of stocks and bonds that are selected and purchased by mutual fund companies, using the money from individual investors. They are different types of fund like some that invest in tech companies or ones that invest in government bonds. There are also actively managed funds or passively. These depend on whether or not the managers are constantly buying and selling to try and generate high returns or not. I think they are popular because it takes the pressure off investors and into the hands of people who know more about the stock market. If I was investing today, I think I would have a portfolio of different tech companies. Technology has a major impact in today's world and especially in the future so it makes me think that it'll be a safer option.

What near-monies are included in M2 money supply?

Near-monies are components of M2 and M3 not included in M1.

Are credit cards money?

No--Credit cards are not money, but their use involves short term loans; their convenience allows you to keep M1 balances low because you need less for daily purchases.

Where is this missing money?

Outside the country

How do stocks and bonds differ in terms of the future payments that they are expected to make? Which type of investment (stocks or bonds) is considered to be riskier? Given what you know, which investment (stocks or bonds) do you think commonly goes by the name "fixed income"?

Stocks are different because they owned by you and may result in either profits or losses. Bonds are a debt contract. Meaning that stocks would be the riskier investment because the outcome in more unpredictable. There can either be a high return, low return or a return that is around the same that was invested. I think bonds would be considered a fixed income.

What is the heart of our monetary system?

The Federal Reserve Banking System

Suppose a bank discovers its reserves will temporarily fall slightly short of those legally required. How might it remedy this situation through the Federal funds market? Now assume the bank finds that its reserves will be substantially and permanently deficient. What remedy is available to this bank?

The bank can remedy this by borrowing funds from other banks or the large firms that are all in the Federal funds market. Also, ways are that they can suspend operations until their reserves see an increase or they can lower their deposit levels. If a bank finds that its reserves will be substantially and permanently deficient, they can borrow funds from large firms in the Federal funds market. Another solution is to suspend their operations or reduce the amount of loans they have that are outstanding. The last solution is to buy securities that permanently increase their reserves.

What is the basic objective of monetary policy? What are the major strengths of monetary policy? Why is monetary policy easier to conduct than fiscal policy in a highly divided national political environment? Which do you think is the most effective?

The basic objective of monetary policy is to keep the economy stable. The three things monetary policy strives for is price-level stability, full employment and economic growth. Major strengths of monetary policy are that it is faster and is more flexible than fiscal policy and that it is less political. Monetary policy changes are more subtle and less noticed than fiscal policy changes. This allows for less political pressures on decisions that are made. The members also serve 14-year terms. I think that because of this fiscal policy is more effective in the long run because it can have more dramatic changes. However, I do think the monetary policy can be effective as well because the Federal Reserve can buy and sell securities daily.

What "backs" the money supply? Is it gold, silver, or paper?

The government's ability to keep its value stable provides the backing.

discount rate

The interest rate on the loans that the Fed makes to banks

What are the components of the M1 money supply?

The narrowest definition of the U.S. Money supply is called M1. M1 consists of currency (in circulation) + checkable deposits.

What "backs" the money supply in the United States? What determines the value (domestic purchasing power) of money? How does the purchasing power of money relate to the price level? Who is the U.S. is responsible for maintaining money 's purchasing power?

There is no concrete backing for the U.S. in terms of money. Paper money has the value that we decide it has. We do this by if we are willing to accept it in exchanges of goods and services. Because it is widely accepted, it is the general standard. The purchasing power of money is inversely related to the price level. Meaning if one goes up, the other goes down and so on. The Board of Governors of the Federal Reserve System are the ones who are responsible for maintain the purchasing power of money.

Suppose that you are a member of the Board of Governors of the Federal Reserve System. The economy is experiencing a sharp rise in the inflation rate. What change in the Federal funds rate would you recommend? How would your recommended change get accomplished? What impact would the actions have on the lending ability of the banking system, the real interest rate, investment spending, aggregate demand, and inflation?

To reduce inflation, it is best to raise the federal fund rate. The Federal Reserve can either sell securities, raise the reserve ratio or raise the discount rate. This is normally accomplished using open-market operations or selling bonds. Or a raise in the reserve ratio and discount rate. The tight monetary policy will reduce the lending ability of the banking system, increase the real interest rate, reduce investment spending, reduce aggregate demand and reduce inflation.

Currency is legal tender or fiat money. In general, it must be accepted in repayment of debt, but that doesn't mean that private firms and government are mandated to accept cash; alternative means of payment may be required. (Note that checks are not legal tender but, in fact, are generally acceptable in exchange for goods, services, and resources. Legal cases have essentially determined that pennies are not legal tender.)

True

Excessive inflation may make money worthless and unacceptable. An extreme example of this was German hyperinflation after World War I, which made the mark worth less than 1 billionth of its former value within a four-year period. -Worthless money leads to the use of other currencies that are more stable -Worthless money may lead to barter exchange system -Maintaining the value of money

True

Monetary policy tries to keep money relatively scarce to maintain its purchasing power, while expanding enough to allow the economy to grow.

True

Money is debt; paper money is a debt of Federal Reserve Banks and checkable deposits are liabilities of banks and thrifts because depositors own them.

True

Money's purchasing power determines its value. Higher prices mean less purchasing power.

True

The Federal Open Market Committee (FOMC) includes the seven governors plus five regional Federal Reserve Bank presidents whose terms alternate. They set policy on buying and selling of government bonds, the most important type of monetary policy, and meet several times each year.

True

The government tries to keep supply stable with appropriate fiscal policy.

True

The relative scarcity of money compared to goods and services will allow money to retain its purchasing power.

True

The value of money arises not from anything intrinsic, but its value in exchange for goods and services.

True

Is it possible that a bank panic could happen again?

Yes but not probable. There are preventative policys

LgResRat Checdep Acreser 10% 40000 10000 20 40000 10000 25 40000 10000 30 40000 10000 Refer to the above table. If the legal reserve ratio falls from 25 percent to 10 percent, excess reserves of this single bank will: A) Rise by $6,000 and the monetary multiplier will increase from 4 to 10. B) Rise by $60,000 and the monetary multiplier will increase from 4 to 10. C) Fall by $6,000 and the monetary multiplier will decline from 30 to 10. D) Fall by $2,000 and the monetary multiplier will decline from 10 to 4.

a

LgResRat Checdep Acreser 10% 40000 10000 20 40000 10000 25 40000 10000 30 40000 10000 Refer to the above table. When the legal reserve ratio is 25 percent, the excess reserves of this single bank are: A) $0. B) $1,000. C) $5,000. D) $30,000.

a

If you write a check on a bank to purchase a used Honda Civic, you are using money primarily as

a medium of exchange.

Graph (x-risk level, y-average expected rate of return) C-75 degree B-middle 45 degree A- flat line across Refer to the graph. An increase in investor concern about risk would be shown by:

a shift from line A to line B.

Which of the components is legal tender? (M1 money supply)

currency

What is the largest component? (of M1 money supply)

currency, and it is the only part that is legal tender.

LgResRat Checdep Acreser 10% 40000 10000 20 40000 10000 25 40000 10000 30 40000 10000 Refer to the above table. When the legal reserve ratio is 20 percent, the money creating potential of the entire banking system is: A) $4,000. B) $6,000. C) $8,000. D) $10,000.

d

Suppose that, for every 1-percentage-point decline of the discount rate, commercial banks collectively borrow an additional $2 billion from Federal Reserve Banks. Also assume that the reserve ratio is 20 percent. If the Fed increases the discount rate from 4.0 percent to 4.25 percent, bank reserves will:

decline by $0.5 billion and the money supply will decline by $2.5 billion.

A federal funds rate reduction that is caused by monetary policy will:

decrease the prime interest rate.

The demand for federal funds is:

downsloping.

If, in the market for money, the amount of money supplied exceeds the amount of money households and businesses want to hold, the interest rate will:

fall, causing households and businesses to hold more money.

Indy owns 100 shares of stock in Pet Mart Corporation that he purchased for $20 per share. Every year he has received, from company profits, $1 for each share he owns. Refer to the information given. Indy should necessarily sell his stock if:

he expects the sum of future capital gains and dividends to be negative.

What is the goal of monetary policy?

help the economy achieve price stability, full employment and economic growth.

"Subprime mortgage loans" refer to:

high-interest-rate loans to home buyers with above-average credit risk.

What actions would the Federal Reserve take if it were pursuing a tight money policy to curb inflation

increase the discount rate in the market.

New York Life, Prudential, and Hartford are all primarily:

insurance companies.

tight money policy

monetary policy that reduces the money supply. curb inflation

Monetary policy is thought to be:

more effective in controlling demand-pull inflation than in moving the economy out of a recession.

The reserve ratio

the fraction of deposits that banks hold as reserves

What is one of the advantages of monetary policy over fiscal policy?

the quickness with which it can be used

If the price index rises from 100 to 120, the purchasing power value of the dollar:

will fall by one-sixth.