chapter 14

Discounting

define: Discounting is the process of determining the present value of a payment or a stream of payments that is to be received in the future. application: Given the time value of money, a dollar is worth more today than it would be worth tomorrow. Discounting is the primary factor used in pricing a stream of tomorrow's cash flows. analysis: the department of treasury will oversee how this plays out in the economy.

Excess reserve

define: Excess reserves are capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors or internal controls. For commercial banks, excess reserves are measured against standard reserve requirement amounts set by central banking authorities. These required reserve ratios set the minimum liquid deposits (such as cash) that must be in reserve at a bank; more is considered excess. analysis: after the required reserves are set by the feds this is the money that is left afterwards.

Open market operation

define: Open market operations (OMO) refers to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system application:Purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy. The Fed's goal in using this technique is to adjust and manipulate the federal funds rate, which is the rate at which banks borrow reserves from one another. analysis: facilitated by the Federal Reserve (Fed). They are a group of 7 members

Discount rate

define: The interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve Bank's discount window. application: The discount rate also refers to the interest rate used in discounted cash flow (DCF) analysis to determine the present value of future cash flows. The discount rate in DCF analysis takes into account not just the time value of money, but also the risk or uncertainty of future cash flows; the greater the uncertainty of future cash flows, the higher the discount rate. A third meaning of the term "discount rate" is the rate used by pension plans and insurance companies for discounting their liabilities. analysis: when the banks take out a loan from the fed government. They are given an interest rate. This is usually only over the course of one night to balance their sheets.

Bond

define: certificate acknowledging a debt and the amount of interest to be paid each year until repayment - sort of like an I Owe yoU. application: it can be a pierce of paper that shows that one person borrowed money and they will pay it later or it can be signed by corps and the gov (simple or complex) bonds can be actively traded. analysis:

Portfolio decision

define: is the art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance. application: is all about determining strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other trade-offs encountered in the attempt to maximize return at a given appetite for risk. analysis:

Required reserves

define: min amount of reserves a bank is required to hold ( = required reserve ratio x transaction deposits) application: usually held in the form of actual vault cash or credit (deposited) analysis: federal reserve requirement on banks. use this to make sure that they have enough funds and do not lend out all their money.

Yield

define: the income return on an investment, such as the interest received from holding a particular security. application: usually expressed as an annual percentage rate based on the investment's cost, current market value or face value. Also may be considered known or anticipated depending on the security in question as certain securities may experience fluctuations in value. The higher the risk is considered to be, the higher the associated yield potential. Except in the most secure investments, such as zero coupon bonds, a yield is not a guarantee. analysis: the fed will set interest rates on the investment and department of treasury will see how it plays out in the economy.

Federal funds rate

define: the interest rate for interbank reserve loans application: if a bank isn't doing too well they can ask other banks for help. Usually they borrow reserves from one that can has plenty to spare- this may be able to bride the temporary deficit. These reserves are known as "federal funds" and are typically lent for short periods of times such as overnight. Typically they will charge interest rates on its loan. analysis: this is used to satisfy the fed and to help the banks that are suffering get back on their feet temporarily.

Monetary policy

define: the use of money and credit controls to influence desired macroeconomic outcomes application: in order to regulate the bank lending-gov must control amount of money in the economy analysis: federal reserve system controls the supply of money with this mechanism. They don't only limit the amount of loans that are readily available from the reserves but it can also determine how much the reserves have. If there was a lack of gov regulation then individual banks would make the decision on how much money is supplied.