Fin 453 Final
Fed activity during 2008 crisis
$1.5 Trillion supplied to the markets by the Fed - $400 billion- term auction credit facility Intermediate term loans to commercial banks (give banks more stable liquidity) - $300 billion- commercial paper funding facility Lehman defaulting on their commercial paper caused investors to doubt. Corporations could not afford investors not funding their short term financing. - $500 billion- central bank liquidity swaps People were hoarding their money because of the problems in the commercial paper market. No dollars were flowing in the global markets, and international trade was affected because most international trade happens in dollars. U.S. sent dollars in exchange for X-countries currency to X-country with the agreement to be paid back soon. $300 billion- Treasury security market relief Massive shock to demand on U.S. securities Price went through the roof and yields dropped. Bought a ton of treasuries as a result
How much was JS fined for not having a charter and starting a bank?
$1000
What is the price of a one-year Treasury bill that pays $100 at maturity if the yield to maturity on the bond is 4%?
$96.15
Federal Budget deficit
- $779 billion
Outcome of S&L Crisis
- 1,200 Thrifts (Savings Banks) failed from 1980 - 1994 FSLIC becomes insolvent Cost to taxpayers - approximately $160 billion
FOMC
- 12 member group (7 board of governors, New York Fed President, 5 other bank presidents which rotate from the remaining 11 banks) - All bank presidents participate in the meeting - Controls interest rate on excess reserves and discount rate - Sets fed funds rate target, open market operations, and liquidity/credit facilities - Beige/teal book - Forward guidance
Evidence and data supporting the creation/existence/benefits of Fed
- 1854-1919: average contraction was 21 months, preceded by expansion of 27 months - Post WWII: 11 months of contraction, 58 months of expansion - 1927-1933: Lost 9-12,000 banks (almost half of all banks) - 4,000 bank failures in 1933 - 9 bank failures in 1934 Glass Steagle Act- FDIC Insurance (second safety net) Depression to now: only 3 banking crisis
Board of Governors
- 7 board members chosen by the president, confirmed by the senate (14 year terms) - set reserve requirement - Emergency Powers - can lend to banks in distress
Riegle-Neal Passed in 1994
- Allows bank holding companies to acquire banks in any state and supersedes all state laws - Geographic barriers are eliminated
Great depression stats
- At least 9,755 banks fail from 1929 - 1933 (4,000 in 1933 alone) - Unemployment reaches somewhere between 25 and 30%
Graham Leach Bliley Financial Services Modernization Act of 1999
- Banks are allowed to hold Commercial banks Insurance companies Investment banks Asset management arms - Commercial banks still prevented from: Owning stocks and corporate bonds
Bank examinations
- Banks are visited on a regular schedule by bank examiners from the OCC, the Federal Reserve System, the FDIC, or other agencies - Bank examiners review the bank's financial statements and its confidential accounts. - The results are summarized in a "CAMELS" rating given to the bank
Characteristics of many and small banks era
- Block Competition - Restrict Growth Opportunities - Preserve margins - Create system of many, many small and undiversified banks
Factors that shift bond supply:
- Changes in government borrowing - changes in general business conditions - changes in expected inflation - Selling activity of the FED
Factors that shift bond supply:
- Changes in government borrowing - changes in general business conditions - changes in expected inflation (shifts both) - Selling activity of the FED (shifts both)
Glass Steagall Act of 1933
- Creates FDIC Insurance - Institutes Reg. Q (interest rates on checking accounts and deposits) - Scope of services restrictions - Prohibits banks from holding corporate debt and stock
Effect of unconventional policy tools
- Doesn't affect the size of balance sheet but reallocates balance sheet items - Drains reserves from fed funds market - Causes supply to shift to the left, pushes effective fed funds rate up
Main causes of the S&L Crisis
- Elimination of Reg. Q (DIDMCA 1980) - Yield Curve Inversion - Oil Prices Plummet - Agriculture Prices Plummet - Localized Real Estate Collapse (Texas and Oklahoma) - Regulatory office moved from Little Rock to Dallas in 1983 - Favorable tax treatment of commercial real estate removed in 1986
FDIC Improvement Act (FIDICIA) Passed in 1991
- Established risk-based FDIC insurance premiums and capital requirements
Overview of the Bank Panic of 1907
- F.A. Heinz - copper magnet,owns banks, pushed stock prices = loses. Bank shuts down - Knickerbocker Trust - Another chain of banks that closes - Bank runs - JP Morgan - Lender of Last Resort - Gets US govt, carnegie and banks to commit to bail out banks
Dodd-Frank Act of 2010
- Financial Stability Oversight Council (FSOC) given responsibility for monitoring systemic risk and identifying Systemically Important Financial Institutions (SIFIs) - Expands authority of government to force liquidation of SIFIs - Institutes Volker Rule (limits commercial bank investment in hedge funds/proprietary trading)
Characteristics of few and large banks
- Freer competition - Allow for scope of services and geographic expansion - Let market determine revenues and margins - Create system of few and large banks
Likely next actions
- Increase interest rates - If they increase rates too fast, they could trigger inflation
After charter expires on the national banking act of 1863, the problems persist:
- Inflation fluctuates wildly - Banks fail regularly - Business cycle volatility is prevalent - Bank panic of 1907 sends shockwaves through entire financial system
Bank risks
- Liquidity - Credit - Interest rates - Trading risk
Key Points in banking regulation history Pre-2008
- Major shift in landscape from small and many to large and few - Probability of a single institution failing decreases substantially - Probability of systemic risk conditional on a single failure increases dramatically - Very hard to reverse the decision
Key characteristics of money
- Means of payment - Unit of account - Store of value
Early efforts
- National Banking Act of 1863 - Problems persist - Federal Reserve Act of 1913 - McFadden Act of 1927
Policy tools vs. intermediate targets vs. objectives
- Objectives - stable prices, full employment - Intermediate targets - things the fed doesn't have control over but can manipulate - Policy tools- things the fed can directly change
Money multiplier went down significantly below 1 because:
- People are holding more cash - Required reserve ratio went up - Banks are holding more cash
McFadden Act of 1927
- Rechartered the Federal Reserve in perpetuity (was set to expire in 1934) - After success of roaring 20s is attributed to the Federal Reserve - Allows national banks to operate out of multiple locations (previously could only operate out of single building) but subjects them to interstate branching restrictions imposed by states - byproduct is prohibition on interstate branching
National Banking Act of 1863
- Required charter (either with US or state governments) - Federal government issues its own currency - 10% tax on individual bank notes - intended to eliminate system of individual bank notes (that way if a bank crept out of town like a wildcat, the currency that remained would still have value)
Banking Crisis at the same time as the S&L Crisis causes
- Scope of services restrictions limit ability of banks to handle adversity - Geographic restrictions increase probability of bank failure in face of localized recessions
Why the financial system is important
- The financial system allows us to specialize and advance technology - specialization and exchange - Transfer risk
Feds balance sheet today
- Went from 850 billion to 4.5 trillion - Big unwind - too much on balance sheet - need to shrink balance sheet - difficult to do without causing another recession or inflation
What caused the bank failures
- bank runs - prisoner's dilemma
currency
- central banks liability - Created by the Treasury and controlled by the Federal Reserve. Only has value if backed up by the Fed, which is why it represents a liability to the Federal Reserve
Tealbook
- economic forecasts for the coming years - discussion of financial markets
Keynesian economics
- encourages government action to increase or decrease demand and output - increase government spending in times of recession, reduce taxes, reduce interest rates, then unwind once out of the recession
How many financial crisis were within 1863 to 1907?
- five serious financial crisis
Austrian Economics
- free market, private ownership of property, and limited government. - the economy will fix itself
12 Bank Presidents
- recommend the discount rate
Credit spread
- spread between US treasury and Baa bonds - Measure of aggregate default risk - concurrent indicator
Between September 2007 and December 2008, the FOMC lowered its target for the federal funds rate 10 times. What was the target fed funds rate range by the end of the 2008?
0.00 - 0.25%
4 main pressure points from 08 (listed by Colby in the youtube video)
1) Term Auction Credit Facility- 400 Billion 2) Commercial Paper Funding facility- 300 Billion (Lehman) 3) US Treasury Holdings- (300 Billion) 4) Other Assets (Central Bank Liquidity swaps)- 500 Billion
Primary policy tools of the fed
1. Discount Rate 2. Target Fed funds rate 3. Required reserve ratio 4. Deposit Rate
Total required reserves at US banks are $65,965 million Total excess reserves at US banks are $1,120,371 million Total deposit accounts at banks are $1,029,500 million Cash in the hands of the public is $943,800 million What is the excess-reserves-to-deposit ratio?
1.0883
How much debt did the united order of 1831 cause?
10k
Total required reserves at US banks are $65,965 million Total excess reserves at US banks are $1,120,371 million Total deposit accounts at banks are $1,029,500 million Cash in the hands of the public is $943,800 million Assuming that banks hold no excess reserves and there is no cash in the hands of the non-banking public, what is the money multiplier if the required reserve ratio is 8.5%?
11.765
Consumption
13 trillion
Board of Governors Terms
14 years
History of the fed
1791: first central bank (twenty year charter) 1816: second central bank 1913 creation of the fed (McFadden act of 1933 renewed charter indefinitely)
When did the church create the bank?
1836, failed in the summer of 1837
When was FDIC insurance created?
1933- Glass Steagall Act
Current GDP
20 trillion
Current amount of debt
21 trillion
Assume an investor purchases a long-term bond with the following characteristics: $100 face value, 6.5% coupon rate, and semi-annual coupon payments. If the investor buys the bond for $102.35 and sells the bond one year later at a price of $99.50, what is the investor's holding period return? Hint: the investor received two coupon payments (assume the coupon payments are not reinvested).
3.57%
The chairperson of the Board of Governors of the Federal Reserve serves a ______ term and may be reappointed to more than one term.
4-year
If the price of a $100 face value bond with an annual coupon rate of 4% is $97.50, what is the current yield?
4.1%
What is the equivalent muni bond for a 7% treasury with a 35% tax rate.
4.55%
Following the consolidation resulting from the financial crisis of 2008, roughly ____% of deposits at US commercial banks were held in only four banks (Bank of America, JP Morgan, Wells Fargo, and Citi)
40%
How much debt did the building of the Kirtland temple cause?
40-70k
Highlights of free banking era
50% of banks failed 16% failed within a year The average life span was 5 years Money Supply and inflation volatility Business Cycle Volatility
FOMC meets every __________________.
6 weeks
Money multiplier before 08 and now
90's- 2.6 Now- below 1
Based on the formula that estimates the money supply as a function of the deposit expansion multiplier and the monetary base, which of the following would increase the money supply?
A decrease in the required reserve ratio
In order for a commodity-based currency to be successful as a means of payment, unit of account, and store of wealth each of the following characteristics is important EXCEPT ________________.
A government must be able and willing to control the quantity
Financial markets gather information from a large number of individual participants and aggregate it into ___________ that signals what is valuable and what is not.
A set of prices
Which of the following can a wheat farmer use to mitigate the risk of falling grain prices? A. A bank CD B. A wheat futures contract C. A wheat stock D. A wheat bond
A wheat futures contract
Most companies seeking to raise capital in the stock or bond markets would be unsuccessful without the assistance and reputation of a well-known investment bank (such as Goldman Sachs or JP Morgan) backing them up. This is an example of financial intermediaries providing ____________ to reduce adverse selection.
A. Certification
Advantages of decentralized electronic exchanges (relative to centralized, open-outcry exchanges), include _______________ (select all that apply). A. Customers can see the orders B. Trading occurs 24 hours a day C. The overall trading system is less prone to error D. Transaction costs are lower
A. Customers can see the orders B. Trading occurs 24 hours a day D. Transaction costs are lower
Which of the following entities in the European System of Central Banks is most similar to the FOMC in the US Federal Reserve System?
A. Governing Council
The top four categories, Aaa down to Baa in the Moody's scheme, are considered _______________ bonds.
A. Investment-grade
Seasonal credit is used primarily by _______________ banks in the Midwest.
A. Small agricultural
The relationship among bonds with the same risk characteristics but different maturities is called the __________________ of interest rates.
A. Term structure
Which of the following contains anecdotal information about current business activity and is published (and made publicly available) about two weeks prior to each upcoming FOMC meeting?
A. The beige book
The general rule in the United State is that _____________________.
A. The interest income from a bond issued by one government is not taxed by another government
Which of the following is an example of adverse selection in the financial markets? A. When considering lending to two potential borrowers, a bank cannot tell which of the two borrowers is a higher credit risk B. GM defaulting on its bonds in 2009 and filing for bankruptcy C. After lending money to your brother to start a restaurant, he is seriously injured in an auto accident and is unable to repay your loan D. After several years of strong performance, a CEO inexplicably begins to embezzle millions of dollars from the company's bank account
A. When considering lending to two potential borrowers, a bank cannot tell which of the two borrowers is a higher credit risk
Reserves are injected into the banking system through ____________.
An increase in the size of the Fed's balance sheet
Why did the real estate bubble in Kirtland pop?
Andrew Jackson: instituted that all real estate owned by the government needed to be bought using gold and silver (cannot use bank notes) Caused real estate crash do to the drastic weakening value of bank notes used to purchase real estate Kirtland was hit especially hard due to the amount of new real estate because of the population influx
insolvency
Assets worth less than Liabilities
Solution to liquidity risk
Assets: hold reserves (Required reserve rate), hold and sell securities - secondary reserves (help with liquidity and credit risk), Sell loans (MBS)
How much did the average LDS family lose?
Average loss per Mormon family was 25-50% of a year's wage
Generally speaking, which of the following characteristics would create a higher level of interest-rate risk in a bond? Another way of saying this is which of the following characteristics would make the price of a bond more volatile in the face of changing yields to maturity? A. A high coupon rate B. A long time to maturity C. A high current yield D. Low inflation risk
B. A long time to maturity
The phrase moral hazard originated when economists who were studying insurance noted that ______________________________.
B. An insurance policy changes the behavior of the person who is insured
_____________ is the risk that the issuer of a bond may not make the promised payments A. Inflation risk B. Default risk C. Interest-rate risk D. Inversion risk
B. Default risk
If the Fed wishes to lower the market fed funds rate through open market operations, it will do which of the following? A. Decrease the supply of reserves B. Increase the supply of reserves C. Decrease the demand for reserves D. Increase the demand for reserves
B. Increase the supply of reserves
Which of the following is not one of the primary functions of financial intermediaries A. Pooling the resources of small savers B. Provide lobbying services to steer important financial regulation C. Provide ways to diversify risk D. Collecting and processing information in ways that reduce information costs
B. Provide lobbying services to steer important financial regulation
Any increase in the government's borrowing needs _____________________. A. Shifts the supply of bonds to the left B. Shifts the supply of bonds to the right C. Shifts the demand for bonds to the left D. Shifts the demand for bonds to the right
B. Shifts the supply of bonds to the right
CEO of Tyco:
Birthday party is best example of moral hazard
Funding liquidity refers to a financial institution's ability to _______________________.
Borrow money to buy securities or make loans
Criteria used by supervisors in evaluating the riskiness of a bank
C - Capital adequacy A - Asset quality M - Management E - Earnings L - Liquidity S - Sensitivity
Private information services face what is called a ______________ problem. A. Lone ranger B. Moral hazard C. Free rider D. Sweetheart
C. Free rider
Borrowers who want to issue bonds and firms that want to issue stock know much more about their business prospects and their willingness to work than potential lenders or investors. This is known as ____________________.
C. Information asymmetry
Term Deposit Facility (TDF)
CD's that the Fed offers on a term basis with a fixed rate
__________________ monitor and stabilize the economy.
Central banks
What is it called when many institutions have exposure to the same specific risk factor?
Common exposure
Risk requires _____________________.
Compensation
Regulators have long believed that excessive competition within the banking industry facilitates instability and can contribute to problems of insolvency and bank runs. What is it about excessive competition that regulators fear?
Competition leads to higher interest rates on deposits and lower interest rates on loans
This phenomenon of spreading panic on the part of depositors in banks is called ____________.
Contagion
A(n) _________________ is the person or institution on the other side of a contract.
Counterparty
If bond price < face value, then
Coupon rate < current yield < YTM
If bond price = face value, then
Coupon rate = current yield = YTM
If bond price > face value, then
Coupon rate > current yield > YTM
banks trading risk
Created by derivatives trading. Risk of Moral hazard among your traders. They win on the upside and the bank loses on the downside. Swap risk for potential downside. Example: Nick Leeson for Barings Investment Bank. Sunk the bank trading futures.
Federal Reserve Act of 1913
Creates Federal Reserve Fed given the responsibility to serve as lender of last resort
solutions to credit risk
Credit Ratings, diversification of loans
A ________________ is a promise by a bank to lend the cardholder money with which to make purchases.
Credit card
Monetary Base
Currency + Reserves
The monetary base = ___________________________.
Currency in the hands of the public + reserves in the banking system
_________________ is something of value pledged by a borrower to the lender in the event of the borrower's default.
D. Collateral
Much of what financial intermediaries do (to reduce transaction costs) takes advantage of what are known as ____________, in which the average cost of producing a good or service falls as the quantity produced increases.
D. Economies of scale
Assume the borrowing needs of the US government increase considerably. Simultaneously, bonds become increasingly risky investments relative to stocks. What is/are the likely effect(s) in the bond markets? I. The demand for bonds will shift to the right II. The supply of bonds will shift to the right III. The yields to maturity on bonds will increase A. I B. I and II C. I and III D. II and III E. I, II, and III
D. II and III
Which of the following is most commonly used as the benchmark when comparing bond yields to determine risk (credit) spreads?
D. US Treasury bonds
banks interest-rate risk
Different time-frame on interest rates. Short-term = liabilities are not fixed, while loans = assets are. If interest rates change, your interest payments will increase unproportionately to interest income. = Flattening yield curve.
_________________ loans are loans the Fed makes when banks need short-term cash.
Discount
Current rates
Discount rate = 2.75% EFFR = 2-2.25% Deposit Rate = 2.2%
The _____________________ act (passed in 2010) is the largest U.S. regulatory change to the financial system since the 1930s.
Dodd-Frank
Financial crisis reason banks used MBS
During the financial crisis, banks used MBS to speculate
Assume market participants' (investors and borrowers alike) expectations for inflation rise considerably. What effect(s) will this have on bond markets? I. The supply of bonds will shift to the right II. The demand for bonds will shift to the left III. The prices on bonds will decrease A. I B. I and II C. I and III D. II and III E. I, II, and III
E. I, II, and III
In order for financial markets to function effectively, _______________________. I. Transaction costs must be kept low II. The information the market pools and communicates must be accurate and widely available III. The promises of borrowers to pay lenders in the market must be credible A. I B. I and II C. I and III D. II and III E. I, II, and III 8
E. I, II, and III
Today, much of the activity that once occurred in big-city financial exchanges is handled by ______________.
Electronic networks
During the financial crisis, the Federal Reserve allowed some non-depository institutions to access its lending facilities. In the absence of new oversight, the access to central bank loans granted by the Fed in the crisis will ______________.
Encourage these borrowers to take greater risks in the future.
Minimum bid rate
European equivalent of the Fed's target federal funds rate
There are two types of reserves: those that banks are required to hold, called required reserves, and those they hold voluntarily, called ___________ reserves.
Excess
The _______________________ explains why yields on bonds of different times to maturity tend to move together but does NOT explain why the yield curve slopes upwards.
Expectations hypothesis
Safety nets created
FDIC Lender of last resort
Junk bonds that were once investment-grade bonds are known as ____________. A. Sliders B. Fallen angels C. Broken vessels D. TIPS
Fallen Angels
Purchase-and-assumption method
Fed finds a firm willing to take over the failed bank
Overnight Reverse Repurchase Agreement
Fed sells a security to an eligible counterparty and agrees to buy the security back the next day
The FOMC could control any interest rate, but the rate it has traditionally chose (ignoring the past several years) to control is the ___________?
Federal funds rate
Currency that has no commodity backing it up and is valuable primarily because of a government's order or edict is referred to as ___________ currency.
Fiat
We use ______________ to transfer resources from savers to investors and to transfer risk to those who are best equipped to bear it.
Financial Instruments
Financial institutions are also known as __________________________.
Financial Intermediaries
solution to interest-rate risk
Floating interest rates (adjustable mortgage rates), Time deposits - Large Cd's because it is a medium term of time at a fixed non-moving interest payment rate. It won't change with changing rates. Lastly, Derivatives. Ex: Interest-Rate swaps.
Managers must compute an estimate of the change in the bank's profit for each one-percentage-point change in the interest rate. This procedure is called ________ analysis.
Gap
combatting adverse selection
Get info, use mechanics/parents, ratings agencies, test drive 1. Govt. requires info gathering 2. Private collection of info gathering 3. Collateral is taken
___________ has been the most common commodity-based money.
Gold
Compared to the period of 1960 to 1980, what happened during the period of 1990 to 2009?
Growth in M2 stopped being a useful tool for forecasting inflation
Assume that a financial crisis leads to the following: banks decide to hold higher excess reserves and the non-banking public decides to carry more cash in their wallets and homes. Which of the following would result? I. The cash to deposit ratio would increase II. The excess reserves to deposit ratio would increase III. The money multiplier would increase
I and II
The key to understanding why the yield curve generally slopes upwards is the fact that longer-term Treasury bonds have higher __________ than shorter-term Treasury bonds and bills. I. Inflation risk II. Interest-rate risk III. Default risk
I and II
Banks use which of the following to try to mitigate credit risk? I. Diversification II. Interest-Rate Swaps III. Credit Risk Analysis
I and III
The risk (credit) spread __________________. I. Measures the difference between the yields of US Treasury bonds and corporate bonds II. Is a reliable concurrent signal of moderate to severe recessions III. Offers more frequent data than GDP reports
I, II, and III
Which of the following are goals that Congress established for the Federal Reserve? I. Maximum employment II. Stable prices III. Moderate long-term interest rates
I, II, and III
Since the Federal Reserve can only control two of the four variables that determine the money supply, it no longer targets the money supply as policy tool. Instead, for short-run policy, ________________ have become the monetary policy tool of choice for the Federal Reserve.
Interest rates
Central bankers use the term ___________________ to refer to instruments that are not directly under their control but lie instead somewhere between their policymaking tools and their objectives.
Intermediate targets
We know that banks held large amounts of mortgage backed securities before and during the crisis. Assuming these mortgage backed securities had AAA ratings, what benefit did this provide the banks?
It reduced the amount of capital the banks were required to hold
Pre free banking era history
Jefferson and Hamilton = first national bank 1791. 20 year charter 1810 Jefferson finished presidency 1811 Charter ends War of 1812 = war debt 1816 another central bank. Charter isn't extended by Jackson in 1836 Starts free banking era
Pressure points of 2008
Lehman defaulting on their commercial paper
For a typical U.S. bank, prior to the financial crisis of 2007 - 2009, the return on assets was about 1.3%, while the return on equity was 10 to 12 times that high. Which of the following words or phrases best explains this phenomenon?
Leverage
Basel III (2011)
Liquidity Coverage Ratio must be 100% or higher: stock of high quality liquid assets/expected cash outflows over next 30 days under systemic financial distress scenario Net Stable Funding Ratio must be 100% or higher: amount of stable funding/required amount of stable funding (stable funding = "those types and amounts of equity and liability financing expected to be reliable sources of funds over a one-year time horizon under conditions of extended stress.")
_________________ are amounts the bank sets aside to cover potential losses from defaulted loans.
Loan loss reserves
Which of the following is considered an asset on the balance sheet of the Federal Reserve?
Loans issued to banks by the Federal Reserve
Which of the following is NOT included in the measure of M2? A. M1 B. Savings deposits (accounts) C. Retail money market mutual fund shares D. M0
M0
MS equation
M1+M2
Money supply
MB*m(money multiplier) or currency + deposits
The problem is that traders normally share in the profits from good investments, but the bank pays for the losses. Heads, the trader wins; tails, the bank loses. This arrangement creates ________________.
Moral hazard
Externalities
Negative externalities- the cost to society may be big, but the benefit outweighs the cost to the average individual or company (pollution, building a property that blocks the view of your neighbors) Positive externality- the costs are to the individual or company but society benefits much more All Fed's externalities are positive
Which of the following Regional Banks is the Federal Reserve System's point of contact with the financial markets?
New York
The first screen, put in place to make sure the people who own and run banks are not criminals, is to require _______________.
New banks to obtain a charter
When the Federal Reserve buys or sells securities in financial markets, it engages in _______.
Open market operations
When the World Trade Center Towers collapsed on September 11, 2001, the Bank of New York was shut down for several days and recovered very slowly. Which of the following was the primary reason for their problems?
Operational risk
Which of the following is an example of a derivative instrument? A. Stock B. Bond C. Options D. Treasury bonds
Options
Savings account =
Passbook savings
_________________________ invest individual and company contributions in stocks, bonds, and real estate in order to provide payments to retired workers.
Pension funds
In order for people to be willing to participate in a market, they must __________________.
Perceive it as fair
One of the common ways that CalPERS monitors the companies in which it invests is by _________________.
Placing CalPERS representatives on the companies' boards of directors
________________ is extended on a very short-term basis, usually overnight, to institutions that the Fed's bank supervisors deem to be sound.
Primary credit
________________are where a borrower obtains funds directly from a lender by selling newly issued securities.
Primary financial markets
Principle-agent problem
Principle wants lots of personal things The agent wants increased value. They two may not directly coincide
Which of the following is an example of paying someone else to shoulder a risk you don't want to take? A. Purchasing a bond B. Purchasing car insurance C. Purchasing a Wall Street Journal D. Purchasing a house
Purchasing car insurance
__________________ occurs when the central bank expands the supply of aggregate reserves to the banking system beyond the level that would be needed to maintain its policy rate objective.
Quantitative easing
Financial institutions _________________________. A. Are regulated by the Federal Communications Commission B. Reduce transaction costs by specializing in the issuance of standardized securities C. Increase the problems caused by asymmetric information D. Make short-term loans while taking in long-term deposits
Reduce transaction costs by specializing in the issuance of standardized securities
banks credit risk
Risk of default
Which Federal Reserve Regional Bank serves Utah?
San Francisco
M2
Savings accounts and some money market accounts
Since securities are often very liquid, we sometimes refer to them as ___________________.
Secondary reserves
Which of the following is one of the two main forms of safety nets our government provides for the banking industry
Serving as Lender of Last Resort
Increases in wealth in the general population ________________________. A. Shift the supply of bonds to the left B. Shift the supply of bonds to the right C. Shift the demand for bonds to the left D. Shift the demand for bonds to the right
Shift the demand for bonds to the right
Metamorphosis of Fed Balance Sheet during and after crisis
Size of Fed Balance Sheet before crisis: $900 billion Size of Fed Balance Sheet after crisis: $2.3 trillion Size of Fed Balance Sheet today: $4.5 trillion
Which of the following is NOT a characteristic of money? A. Means of payment B. Unit of account C. Source of interest D. Store of wealth
Source of Interest
_______________ improves welfare.
Stability
Today, the reserve requirement exists primarily to _________________.
Stabilize the demand for reserves and help the Fed maintain the market fed funds rate close to the target
DIDMCA of 1980
Stopped Reg Q
Factors affecting the supply of and demand for reserves
Supply: Fed OMO's Demand: Legal requirements, Lending, Liquidity
Which of the three branches of the Federal Reserve System performs the following functions? - Sets the reserve requirement - Approves/disapproves discount rate recommendations - Invokes emergency powers to lend to nonbanks when circumstances are deemed "unusual and exigent"
The Board of Governors of the Federal Reserve
When the case of an insolvent institution is resolved by the FDIC using the purchase-and-assumption method, which of the following is true?
The FDIC sells the failed bank to a solvent bank at a negative price
Beige book
The Fed's publication that summarizes all the data that it gathers and that describes the current state of the economy (made public about two weeks before FOMC meeting)
Which of the following is NOT a part of the Federal Reserve System of the US?
The Governing Council of the Federal Reserve
For most individuals, the most common form of electronic funds transfer is _______________.
The automated clearing house transaction
Suppose a bank customer unexpectedly withdraws $10 million. Which of the following is the quickest PLAUSIBLE method the bank will use to meet this withdrawal demand?
The bank will sell T-bills and other liquid securities
Banks hold reserves because regulation requires it and because prudent business practice dictates it. Reserves include the cash in the bank's vault (and currency in its ATMs), called vault cash, as well as _________________________.
The bank's deposits at the Federal Reserve System
The _________________ is the most important member of the Federal Open Market Committee.
The chair of the Board of Governors of the Federal Reserve System
If the price of a $100 face value bond is $104.35, _______________.
The current yield is greater than the yield to maturity
The Federal Reserve allows the market fed funds rate to fluctuate around its target within a corridor or channel. What serves as the ceiling for this corridor?
The discount rate
When the yield curve becomes inverted, ______________________.
The economy tends to go into a recession roughly a year later
The most important part of a bank examination is _______________________.
The evaluation of past due loans
What is the primary reason that fiat currencies "work" as a means of payment?
The governments that issues them mandate that businesses & individuals accept them
The European equivalent of the Fed's target fed funds rate is _______________.
The minimum bid rat
Stock exchanges are organized to eliminate ____________________.
The need for costly information gathering
The separation of ownership and management is known as ________________________ and is a prime example of moral hazard in equity contracts.
The principal-agent problem
What is the most common downfall of government-issued paper currencies (as demonstrated by two examples presented in the book)?
The quantity of the currency issued becomes excessive
When the Federal Reserve buys $1 million worth of Treasury bills from a US commercial bank through its open market operations ____________________________.
The reserves portion of its liabilities increases by $1 million
According to the text, which of the following was the clearest concurrent indicator or predictor of the 2007-2008 recession?
The risk spread
Banks liquidity risk
The risk that the bank will not have enough liquidable assets to pay-off withdrawals.
Which of the following is NOT a CONVENTIONAL policy tool of the Federal Reserve? A. The target federal funds rate B. The discount rate C. The term auction Facility D. The deposit rate
The term auction Facility
The reason your repayments total more than the original loan amount is that you are paying interest to compensate the lender for _____________.
The time during which you used the funds
What function do financial instruments play that money does not?
They allow for the transfer of risk
Sellers on eBay have much more information about the items they are selling and their own reliability. Aware of this problem, the people who started eBay took two steps. Which of the following was one of those steps?
They offered insurance to protect buyers who don't receive their purchases
"The primary objective of the European System of Central Banks shall be ___________________."
To maintain price stability
Too big to fail actually means ___________________.
Too complex to be shut down or sold in an orderly fashion to another institution
In order to provide liquidity, financial markets need to be structured in a way that ___________.
Transaction costs are low
Capital is the cushion that banks have against ______________________.
Unexpected withdrawals of liabilities
Problems the Fed was created to remedy
Volatility in business cycles Bank failures Money Supply and Inflation Volatility
Current Yield
Yearly coupon payment/price paid
YTM
Yield bondholders receive if they hold bond to maturity
Bonds that offer no periodic coupon payments are referred to as __________________.
Zero-coupon bonds
m equation
[(1+C/D)/(C/D+r(d)+ER/d)]*MB
Too big to fail
a financial institution becomes so large and so interconnected with other financial institutions that its failure would be a disaster for the wider economy
moral hazard
after transaction
solutions to moral hazard
align incentives Monitoring Keep management on a short leash
targeted asset purchases (TAP)
an unconventional monetary policy in which the central bank alters the mix of assets on its balance sheet in order to change their relative prices (and hence interest rates) in a way that stimulates economic activity
Orson Hyde couldn't get a charter, so the church started an __________ .
anti-bank
adverse selection
before transaction
Quantitative easing
buy bonds, increasing supply of reserves more than they need to (rates drop)(short end is already at 0, so they do QE to bring down long-term rates)
M1
currency, checking accounts
Credit ratings issued by Moody's and Standard & Poor's measure the ____________ risk of a bond.
default
Primary Credit
discount loans available to healthy banks experiencing temporary liquidity problems
Secondary credit
discount loans to banks that are not eligible for primary credit
Common exposure
exposure of many financial institutions to the same risk factor
Primary benefit of small and many banks
failure of a single bank does not translate to systemic crisis
Primary cost of large and few banks
failure of single bank translates to systemic crisis
Seasonal Credit
given to meet the needs of a limited number of small banks in vacation and agricultural areas that have a seasonal pattern of deposits
Original colonists were fleeing at least three forms of oppression:
government, economic, religious
Financial instruments help to _____________.
hedge risk
solutions to trading risk
incentives, meetings, daily check-ups, limits on how much risk traders can take
discouraged workers
individuals who would like to work but have given up looking for a job
Why has inflation not kicked in with the expansion in the MS?
m has decreased significantly
Most important characteristic of money
means of payment
National debt
more than $21 trillion
liquidity
not able to meet withdrawal demands
Unemployed
people not working who have looked for work during previous 4 weeks
Primary cost of many and small banks
probability of failure of an individual bank is high (lack of diversification)
Primary benefit of large and few banks
probability of failure of individual bank is low (good diversification)
Heritage led to long period of almost no ______________________.
regulation in the banking sector Wildcat banking era provided some evidence that we need regulation.
"Core" meaning
removes the effects of food and energy
American heritage =
strong distaste for concentrated power
Fed Funds rate equivalent in europe is:
the minimum bid rate
EFFR demand kink is caused by:
the point where demand for reserves hits the deposit rate (the rate that excess reserves receives- at this point, banks are indifferent about holding excess reserves or lending them out to other banks) Kink in supply to infinity is the scale of QE
EFFR kink in supply is because:
this is the rate at which the fed lends out at. When EFFR hits this level there is no way for them to borrow cheaper than the Fed, so they are indifferent.
Credit easing
when the fed buys privately owned assets from banks (MBS in the financial crisis)
