Money and banking final
Question content area Part 1 How are finance companies able to compete against commercial banks?
Finance companies have a small advantage over commercial banks in monitoring the value of collateral, which gives them an advantage in consumer durables, inventories, and business equipment. A lower degree of regulation allows finance companies to provide loans tailored to match the needs of borrowers more closely than do the standard loans that commercial banks provide.
What incentives would the partners in an investment bank have to turn it into a public corporation?
Going public provides more access to capital and leverage. Going public eliminates the risk involved to the top executives, as it is not solely their money that is being risked.
Why would a fund's trade moving against it cause it to burn through its capital?
Hedge funds are highly leveraged, and a margin is generally required for their trades. Capital serves as margin, so capital is used as a cushion between losses.
Does Greenspan's analysis provide insight into why the Fed during his tenure may have been reluctant to take action against asset bubbles?
If Greenspan believes that most bubbles burst without severe economic consequences, then, yes, it would explain the Fed's actions.
All of the following are reasons why one bank failure might lead to many bank failures, except:
If multiple banks have to sell the same assets, the prices of those assets are likely to rise.
Which of the following could be a negative implication if "the maturity of the debt is less than the maturity of the assets it funds"?
If the debt is not renewed, or rolled over, the asset side of the balance sheet becomes unsustainable.
What does "liquidate" mean in this context?
Liquidate means to let prices fall to their equilibrium level
Does Bernanke's observation help to explain the role bank panics played in the severity of the Great Depression?
When thousands of banks failed, it became difficult for their customers to obtain credit, thus exacerbating the severity of the Great Depression. Yes, Bernanke's observation helps to explain the role bank panics played in the severity of the Great Depression.
If becoming a public corporation increases the risk in investment banking, how do publicly traded investment banks succeed in selling stock to investors?
Investors desire investment banks' stocks because of the potentially high profits of these banks due to their access to high leverage.
What does it mean to conduct monetary policy?
It means to control the money supply within the circulation.
Was deflation during the early 1930s good or bad for firms?
It was bad for firms that were borrowers because it effectively raised interest rates.
The Federal Reserve arranged a buyout of Bear Stearns by
JP Morgan Chase
What is the argument in favor of believing that repealing the Glass-Steagall Act did not play a role in the financial crisis?
Large banks that combine commercial and investment banking activity were not at the center of the financial crisis.
The debt-deflation process is the process of ____________ that can increase the severity of an economic downturn
falling asset prices
What does a hedge fund's trades "moving against it" mean? "Moving against it" means that
if a hedge fund bets one way and the price moves another away, it has to exit the position fast.
What does Greenspan mean that "the added risk had not been compensated by higher capital"? In order to compensate for the risk, Greenspan believes that nonbank financial institutions should have voluntarily
increased their capital.
The debt-deflation process is the process of ____________________________ that can increase the severity of an economic downturn.
increasing bankruptcies and defaults
The debt-deflation process contributed to the severity of the Great Depression by ______ the real interest rate and the real value of debts, which _______ the burden on borrowers and led to ______ loan defaults.
increasing, increased, more
What is the Fed's primary tool for implementing monetary policy?
interest on reserve balances (IORB)
Morgan stanley bridges the gap between UBER who is ________, and investors who are ________.
looking to find investors looking for new investment opportunities
Morgan Stanley serves the important role of
lowering transaction costs and helping the financial market run more efficiently
What does Bernanke mean by the short-term funding market?
markets not subject to the same regulations as commercial banks
A house price bubble
occurs when house prices move beyond their fundamental values.
Does this process provide any insight into why the Federal Reserve rescued Bear Stearns? A debt-deflation process
pushes down the price of those assets which other investment banks hold, thus worsening their balance sheets, which in turn can accelerate bankruptcies. Your answer is correct. would occur if Bear Stearns goes bankrupt and has to sell its assets.
Nonbank forms of credit
refer to credit from providers other than banks.
How does the interest on reserve balances rate serves as a reservation rate?
reservation rate is the lowest rate at which a bank can lend
What is the shadow banking system?
A collection of nonbank financial institutions that channel money from savers to borrowers.
What is an accredited investor?
A high net worth or high income individual.
What are the two main ways in which the government can keep one bank failure from leading to a bank panic?
A central bank can act as a lender of last resort, and the government can insure deposits.
What basket of services does a medical insurance policy guarantee?
A basket of "covered" services, i.e., specific practices and procedures as outlined by the insurance policy.
What is a lender of last resort?
A lender of last resort is an institution that serves as an ultimate source of credit to which banks can turn during a panic. Is an entity that seeks to stop a bank failure from turning into a bank panic by making sure solvent institutions can meet their depositors' withdrawal demands. The Federal Reserve acts as a lender of last resort.
Why should a recession connected with a financial crisis be more severe than a recession that did not involve a financial crisis?
A recession that includes a financial crisis is generally more complex and has more severe consequences, such as decreasing asset prices and lending, which affects the economy for a longer time period than a traditional recession.
Underwriting
An activity in which an investment bank guarantees to the issuing corporation the price of a new security and then resells the security for a profit.
Why would bank lending being "information sensitive" make it difficult to replace with nonbank forms of credit?
Banks have economies of scale or some other advantage in evaluating the riskiness of loans.
How does arbitrage ensure that the federal funds rate does not fall far below the interest on reserve balances rate?
Banks will rush to borrow
How does the discount rate act a ceiling for federal funds rate?
Because banks will not likely borrow at a higher rate than they can borrow from the Fed
Give an example of banks arbitraging between the federal funds market and interest on reserve balances.
Borrowing at one price and lending at a higher price
Proprietary trading
Buying and selling securities and other assets for a bank's own account rather than for clients.
Market making
Buying and selling securities, typically those that are not traded on exchanges, and maintaining an inventory of the securities in order to serve as an intermediary between buyers and sellers.
Is an investment bank that buys securities with its own capital acting as a financial intermediary?
By buying securities with its own capital the bank expects to get profit from the yield or the changes in price. and An investment bank that buys securities with its own capital is not acting as a financial intermediary.
What does he mean by a "sustained run"? Why can't a bank by itself survive a sustained run?
By "sustained run," Bernanke means a bank run that lasts for a significant period of time. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposit withdrawals and its assets are long term and not easily liquidated.
In what ways are contractual savings institutions different from commercial banks
Contractual savings institutions do not accept deposits like traditional commercial banks do.
Why might the fact that medical services are always improving and getting more expensive create difficulties for companies offering medical insurance policies?
Cost uncertainties make difficult the determination of appropriate policy premiums. Policies must be kept affordable while meeting consumer expectations of the highest standard of care.
What would the FOMC do if the economy is in a recession and not meeting its maximum employment and price stability dual mandate?
FOMC decreases the FFR target range, Fed lowersits administered rates, Market rates decrease; the FFR shifts down into the lower target range
What does it mean to implement monetary policy?
Fed uses monetary policy to achieve FFR target - FFR is (The federal funds rate is the target interest rate set by the FOMC)
Why was there a panic in the short-term funding market but not a panic among depositors at commercial banks?
Depositors at commercial banks were covered by deposit insurance.
financial engineering
Developing new financial securities or investment strategies, using sophisticated mathematical models.
What are the Fed's dual mandate goals?
Maximum employment and price stability
Why would long-term interest rates have a closer connection to house prices than overnight interest rates?
Mortgage companies generally markup mortgages 2-3% above the 10 year Treasury bond yield
Does a bank have to be insolvent to experience a run?
No, bank runs are caused by bank panics, which can occur whether a bank is insolvent or not.
Prices fall when a country experiences deflation, so isn't deflation good for consumers?
No, borrowers would be hurt by the higher real interest rates and higher real value of debts that deflation causes.
How did the emergence of shadow banking increase the risk to the financial system?
Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow short and lend long. Your answer is correct. In the event of a nonbank financial institution run, there is no equivalent of the FDIC.
What does a fund's "dumping its positions" mean?
Selling before a margin call Selling before capital runs out
What is the discount rate?
The Discount rate is the interest rate the fed charges on loans that it makes to banks (discount loans)
Why would it matter to Greenspan whether low long-term interest rates were more responsible for the housing bubble than low short-term interest rates?
To lessen the Federal Reserve's responsibility under Greenspan's watch as Chairman for causing, at least partially, the housing bubble with low interest rates.
In what sense is an investment bank that engages in underwriting acting as a financial intermediary?
Underwriting is financial intermediation because the bank brings together savers and the issuers of securities.
How does the Fed use open market operations to ensure reserves remain ample?
The fed can increase reserves by making open market purchases
What does Greenspan mean by "debt leverage"?
borrowing and purchasing assets with borrowed funds
Why is the money market mutual fund industry so important?
The money market mutual fund industry is important because many firms rely on the access to commercial paper to meet payroll and other operating costs, and the elimination of this market would hurt access to this source of funding and have severe adverse consequences for the real economy.
Which of the following reasons might explain why repealing the Glass-Steagall Act may have been a bad idea?
The repeal of Glass-Steagall increased the risk to the financial system.
In what ways does the shadow banking system differ from the commercial banking system?
The shadow banking system invests in more risky assets and tends to be highly leveraged than commercial banks. The shadow banking system, unlike the commercial banking system, does not offer traditional banking services such as taking in deposits. The commercial banking system, unlike the shadow banking system, is heavily regulated by the government.
What does Bernanke mean by "solvent under normal conditions"?
The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is positive.
In what ways are contractual savings institutions similar to commercial banks?
They both borrow short and lend long.
In what ways are investment institutions similar to commercial banks?
They both borrow short and lend long.
How is being a lender of last resort connected to the too-big-to-fail policy?
The too-big-to-fail policy and the lender of last resort strive to prevent systemic risk, where the failure of a few firms leads to the widespread failure of solvent banks. The too-big-to-fail policy and the lender of last resort have to provide liquidity to banks during bank panics.
If money market mutual funds have problems, can't savers just deposit their money in banks?
Yes, they can, but doing so will severely impact the financial system because the funds make up a large fraction of the market for commercial paper and because many firms have become heavily dependent on sales of commercial paper to finance their operations.
The "fragility" of commercial banking means that ________.
banks borrow short to lend long and are relatively illiquid on any given day
Why did Bear Stearns almost fail?
because lenders declined to renew Bear's short-term loans This is the correct answer. because Bear liquidated assets in order to pay back short-term loans Your answer is correct. because lenders lost faith in Bear's ability to pay back short-term loans
Contagion is when ________.
the failure of one bank causes runs on other banks. If multiple banks experience bank runs, the result is a bank panic.
An IPO refers to
the first time that a firm sells stock to the public
Is this feature of a defined-benefit retirement plan alluring to employers or to employees or to both? Briefly explain.
Both, since employees know they will get a fixed sum in retirement regardless of how the market performs and employers can attract quality employees and keep any excess if the plan overperforms.
Can these views help to explain the actions by the Fed during the early years of the Great Depression?
Yes, to an extent, because the Federal Reserve was acting on the predominant economic model of the time, which said that the economy will self-adjust and any attempt to intervene will either do nothing or create negative consequences.
