AP Economics - Chapters 31, 32, 33, and 34
commercial bank
A firm that engages in the business of banking (accepts deposits, offers checking accounts, and makes loans)
M2
more broadly defined money supply M2 = M1+ noncheckable savings (including money market deposit accounts), small time deposits (deposits of less than $100,000), and individual money market mutual fund balances
M1
most narrowly defined money supply M1 = currency in the hands of the public + checkable deposits of commercial banks and thrift institutions
actively managed funds
mutual funds that have portfolio managers who constantly buy and sell assets in an attempt to generate higher returns than some benchmark rate of return for similar portfolios
index funds
mutual funds that select stock or bond portfolios to exactly match a stock or bond index (a collection of stocks or bonds meant to capture the overall behavior of a particular category of investments) such as the Standard and Poor's 500 Index or the Russell 3000 Index
passively managed funds
mutual funds whose portfolios are not regularly updated by a fund manager attempting to generate high returns. once initial portfolio is selected, it is left unchanged so that investors receive whatever return that unchanging portfolio subsequently generates ex) index funds
Federal Reserve Note
paper money issued by the Federal Reserve Banks
interest
payment made for the use of money (of borrowed funds)
dividends
payments by a corporation of all or part of its profit to its stockholders (the corporate owners)
mutual funds
portfolios of stocks and bonds selected and purchased by mutual fund companies, which finance the purchases by pooling money from thousands of individual fund investors; included both index funds as well as actively managed funds; fund returns (profits or losses) pass through to the individual fund investors who invest in the funds
beta
a relative measure of nondiversifiable risk that measures how the nondiversifiable risk of a given asset or portfolio compares with that of the market portfolio (the portfolio that contains every asset available in the financial markets)
thrift institutions
a savings and loan association, mutual savings bank, or credit union
liquidity trap
a situation in a severe recession in which the Fed's injection of additional reserves into the banking system has little or no additional positive impact on lending, borrowing, investment, or aggregate demand
unit of account
a standard unit in which prices can be stated and the value of goods and services can be compared; one of the three functions of money
limited liability rule
rule limiting the risks involved in investing in corporations and encouraging investors to invest in stocks by capping their potential losses at the amount that they paid for their shares
defaults
situations in which borrowers stop making loan payments or do not pay back loans that they took out and are now due
economic investment
spending for the production and accumulation of capital and additions to inventories
balance sheet
a statement of the assets, liabilities, and net worth of a firm or individual at some given time
fractional reserve banking system
a system in which commercial banks and thrift institutions hold less than 100% of their checkable-deposit liabilities as require reserves
diversifiable risk
aka idiosyncratic risk; investment risk that investors can reduce via diversification
reserve ratio
aka reserve requirement; the fraction of checkable deposits that a bank must hold as reserves in a Federal Reserve Bank or in its own bank vault;
nondiversifiable risk
aka systemic risk; investment risk that investors are unable to reduce via diversification
store of value
an asset set aside for future use; one of the three functions of money
time deposits
an interest-earning deposit in a commercial bank or thrift institution that the depositor can withdraw without penalty after the end of a specified period
stock
an ownership share in a corporation
checkable deposit
any deposit in a commercial bank or thrift institution against which a check may be written
medium of exchange
any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter
Board of Governors
the Board of Governors of the Federal Reserve / Federal Reserve Board; the seven-member group that supervises and controls the money and banking system of the United States
compound interest
the accumulation of money that builds over time in an investment or interest-bearing account as new interest is earned on previous interest that is not withdrawn
arbitrage
the activity of selling one asset and buying an identical asset to benefit from temporary differences in prices or rates of return; the practice that equalizes prices or returns on similar financial instruments and thus eliminates further opportunities for riskless financial gains
excess reserves
the amount by which a bank's or thrift's actual reserves exceed its required reserves; actual reserves minus required reserves
asset demand for money
the amount of money people want to hold as a store of value; this amount varies inversely with the interest rate
transactions demand for money
the amount of money people want to hold for use as a medium of exchange )to make payments); varies directly with nominal GDP
prime interest rate
the benchmark interest rate that banks use as a reference point for a wide range of loans to businesses and individuals
financial services industry
the broad category of firms that provide financial products and services to help households and businesses earn interest, receive dividends, obtain capital gains, insure against losses, and plan for retirement; includes commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, investment banks, and securities firms
open-market operations
the buying and selling of U.S. government securities by the federal Reserve Banks for purposes of carrying out monetary policy
vault cash
the currency a bank has in its vault and cash drawers
liquidity
the ease with which an asset can be converted quickly into cash with little or no loss of purchasing power money = perfectly liquid
money market deposit accounts (MMDAs)
bank- and thrift-provided interest-bearing accounts that contain a variety of short-term securities; such accounts have minimum balance requirements and limits on the frequency of withdrawals
actual reserves
the fund that a bank has on deposit at the Federal Reserve Bank of its districts (plus its vault cash)
near-monies
financial assets, the most important of which are noncheckable savings accounts, time deposits, and U.S. short-term securities and savings bonds, which are not a medium of exchange but can be readily converted into money
subprime mortgage loans
high-interest rate loans to home buyers with above-average credit risk
moral hazard
individuals or institutions may change their behavior as a result of a contract or agreement ex) a bank whose deposits are insured against losses may take riskier loans and investments
money market mutual funds (MMMFs)
interest-bearing accounts offered by investment companies, which pool depositors' funds for the purchase of short-term securities depositors can write checks in minimum amounts or more against their accounts
required reserves
the funds that banks and thrifts must deposit with the Federal Reserve Bank (or hold as vault cash) to meet the legal reserve requirement; a fixed percentage of the bank's or thrift's checkable deposits
capital gain
the gain realized when securities or properties are sold for a price greater than the price paid for them
time preference
the human tendency for people, because of impatience, to prefer to spend and consume in the present rather than save and wait to spend and consume in the future
cyclical asymmetry
the idea that monetary policy may be more successful in slowing expansions and controlling inflation than in extracting the economy from severe recessions
risk premium
the interest rate above the risk-free interest rate that must be paid and received to compensate a lender or investor for risk
Federal funds rate
the interest rate banks and other depository institutions charge one another on overnight loans made out of their excess reserves
risk-free interest rate
the interest rate earned on short-term U.S. government bonds
discount rate
the interest rate that the Federal Reserve Banks charge on loans they make to commercial banks and thrift institutions
term auction facility
the monetary policy procedure used by the Federal Reserve, in which commercial banks anonymously bid to obtain loans being made available by the Fed as a way to expand reserves in the banking system
monetary multiplier
the multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans (or buying securities); equal to 1 divided by the reserve requirement
percentage rate of return
the percentage gain or loss, relative to the buying price, of an economic investment or financial investment over some period of time
market portfolio
the portfolio consisting of every financial asset (including every stock and bond) traded in the financial markets the market portfolio is used to calculate beta (a measure of the degree of riskiness) for specific stocks, bonds, and mutual funds
average expected rate of return
the probability-weighted average of an investment's possible future returns
securitization
the process of aggregating many individual financial debts, such as mortgages or student loans, into a pool and then issuing new securities (financial instruments) backed by the pool. The holders of the new securities are entitled to receive the debt payments made on the individual financial debts in the pool
financial investment
the purchase of a financial asset (such as a stock, bond, or mutual fund) or real asset (such as a house, land, or factories) or the building of such assets in the expectation of financial gain
diversification
the strategy of investing in a large number of investments in order to reduce the overall risk to an entire investment portfolio
total demand for money
the sum of the transactions demand for money and the asset demand for money
risk
the uncertainty as to the actual future returns of a particular financial investment or economic investment
portfolios
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legal tender
a nation's official currency (bills and coins) payment of debt must be accepted in this monetary unit, but creditors can specify the form of payment ("cash only" or "check or credit card only")
expansionary monetary policy
Federal Reserve System actions to increase the money supply, lower interest rates, and expand real GDP; an easy money policy
restrictive monetary policy
Federal Reserve System actions to reduce the money supply, increase interest rates, and reduce inflation; a tight money policy
Federal Reserve Banks
The 12 banks chartered by the U.S. government to control the money supply and perform other functions
Federal Open Market Committee (FOMC)
The 12-member group that determines the purchase and sale policies of the Federal Reserve Banks in the market for U.S. government securities
Taylor rule
a modern monetary rule proposed by economist John Taylor that would stipulate exactly how much the Federal Reserve should change real interest rates in response to divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation
Federal Reserve System
The U.S. central bank, consisting of the Board of Governors of the Federal Reserve and the 12 Federal Reserve Banks, which controls the lending activity of the nation's banks and thrifts and thus the money supply; commonly referred to as the "Fed"
Troubled Asset Relief Program (TARP)
a 2008 Federal gov't program that authorized the U.S. Treasury to loan up to $700 billion to critical financial institutions and other U.S. firms that were in extreme financial trouble and therefore at high risk of failure
monetary policy
a central bank's changing of the money supply to influence interest rates and assist the economy in achieving price stability, full employment, and economic growth
savings account
a deposit in a commercial bank or thrift institution on which interest payments are received; generally used for saving rather than daily transactions; a component of the M2 money supply
bond
a financial device through which a borrower (a firm or gov't) is obligated to pay the principal and interest on a loan at a specific date in the future
Wall Street Reform and Consumer Protection Act of 2010
a law that gave authority to the federal Reserve to regulate all large financial institutions, created an oversight council to look for growing risk to the financial system, established a process for the Federal gov't to sell off the assets of large failing financial institutions, provided Federal regulatory oversight of asset-backed securities, and created a financial consumer protection bureau within the Fed
bankrupt
a legal situation in which an individual or a firm finds that it cannot make timely interest payments on money that it has borrowed. In such cases, a bankruptcy judge can order the individual or firm to liquidate (turn into cash) its assets in order to pay lenders at least some portion of the amount they are owed
Security Market Line (SML)
a line that shows the average expected rate of return of all financial investments at each level of nondiversifiable risk, the latter measured by beta
token money
bills or coins for which the amount printed on the currency bears no relationship to the value of the paper or metal embodied within it; for currency still circulating, money for which the face value exceeds the commodity value
mortgage-backed securities
bonds that represent claims to all or part of the monthly mortgage payments from the pools of mortgage loans made by leaders to borrowers to help them purchase residential property
probability-weighted average
each of the possible future rates of return from an investment multiplied by its respective probability (expressed as a decimal) of happening
present value
today's value of some amount of money that is to be received sometime in the future