AP Macroeconomics Modules 22-29 Test Review
What is the amount you will receive in three years if you loan $1,000 at 5% interest?
$1,000 × (1.05)3 = $1,000 × 1.16 = $1,157.63
What is the present value of $1,000 received in three years if the interest rate is 5%?
$1,000/(1.05)3 = $863.84
Bank Deposit
A bank deposit is a claim on a bank that obliges the bank to give the depositor his or her cash when demanded.
Bank
A bank is a financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance the illiquid investment spending needs of borrowers.
Bank Run
A bank run is a phenomenon in which many of a bank's depositors try to withdraw their funds due to fears of a bank failure.
Central Bank
A central bank is an institution that oversees and regulates the banking system and controls the monetary base.
Commercial Bank
A commercial bank accepts deposits and is covered by deposit insurance.
Default
A default occurs when a borrower fails to make payments as specified by the loan or bond contract.
Financial Asset
A financial asset is a paper claim that entitles the buyer to future income from the seller.
Leverage
A financial institution engages in leverage when it finances its investments with borrowed funds.
Financial Intermediary
A financial intermediary is an institution that transforms the funds it gathers from many individuals into financial assets.
Wealth
A household's wealth is the value of its accumulated savings.
Liability
A liability is a requirement to pay money in the future.
Life Insurance Company
A life insurance company sells policies that guarantee a payment to a policyholder's beneficiaries when the policyholder dies.
Loan
A loan is a lending agreement between an individual lender and an individual borrower
Loan-Backed Security
A loan-backed security is an asset created by pooling individual loans and selling shares in that pool.
Medium of Exchange
A medium of exchange is an asset that individuals acquire for the purpose of trading goods and services rather than for their own consumption.
Money Aggregate
A monetary aggregate is an overall measure of the money supply.
Mutual Fund
A mutual fund is a financial intermediary that creates a stock portfolio and then resells shares of this portfolio to individual investors.
Pension Fund
A pension fund is a type of mutual fund that holds assets in order to provide retirement income to its members.
Physical Asset
A physical asset is a claim on a tangible object that gives the owner the right to dispose of the object as he or she wishes.
Savings and Loan (Thrift)
A savings and loan (thrift) is another type of deposit-taking bank, usually specialized in issuing home loans.
Stock
A stock is a share in the ownership of a company.
Store of Value
A store of value is a means of holding purchasing power over time.
Unit of Account
A unit of account is a measure used to set prices and make economic calculations.
Vicious Cycle of Deleveraging
A vicious cycle of deleveraging takes place when asset sales to cover losses produce negative balance sheet effects on other firms and force creditors to call in their loans, forcing sales of more assets and causing further declines in asset prices.
Savings-Investment Spending Identity
According to the savings-investment spending identity, savings and investment spending are always equal for the economy as a whole.
Illiquid
An asset is illiquid if it cannot be quickly converted into cash without much loss of value
Liquid
An asset is liquid if it can be quickly converted into cash without much loss of value.
Diversification
An individual can engage in diversification by investing in several different assets so that the possible losses are independent events
Investment Bank
An investment bank trades in financial assets and is not covered by deposit insurance.
Open-Market Operation
An open-market operation is a purchase or sale of government debt by the Fed.
In which monetary aggregate(s) calculated by the Federal Reserve are checkable deposits included?
M1 and M2
Fiat Money
Fiat money is a medium of exchange whose value derives entirely from its official status as a means of payment
Financial Risk
Financial risk is uncertainty about future outcomes that involve financial losses and gains
Securitization
In securitization a pool of loans is assembled and shares of that pool are sold to investors.
Money
Money is any asset that can easily be used to purchase goods and services
Federal Funds Market
The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves.
Federal Funds Rate
The federal funds rate is the interest rate determined in the federal funds market.
Interest Rate
The interest rate is the price, calculated as a percentage of the amount borrowed, charged by lenders to borrowers for the use of their savings for one year
Monetary Base
The monetary base is the sum of currency in circulation and bank reserves.
Monetary Multiplier
The money multiplier is the ratio of the money supply to the monetary base. It indicates the total number of dollars created in the banking system by each $1 addition to the monetary base.
Money Supply
The money supply is the total value of financial assets in the economy that are considered money.
Transaction Costs
Transaction costs are the expenses of negotiating and executing a deal
What does the Board of Governors of the Federal Reserve System do?
oversee the Federal Reserve System and serve on the Federal Open Market Committee
The federal government is said to be "dissaving" when a. there is a budget deficit. b. there is a budget surplus. c. there is no budget surplus or deficit. d. savings does not equal investment spending. e. national savings equals private savings.
A
The fraction of bank deposits actually held as reserves is the a. reserve ratio. b. required reserve ratio. c. excess reserve ratio. d. reserve requirement. e. monetary base.
A
Which of the following contributed to the creation of the Federal Reserve System? I. the bank panic of 1907 II. the Great Depression III. the savings and loan crisis of the 1980s a. I only b. II only c. III only d. I and II only e. I, II, and III
A
Which of the following is a part of both the Federal Reserve System and the federal government? a. the Federal Reserve Board of Governors b. the 12 regional Federal Reserve Banks c. the Reconstruction Finance Corporation d. commercial banks e. the Treasury Department
A
Which of the following is the most liquid monetary aggregate? a. M1 b. M2 c. M3 d. near-moneys e. dollar bills
A
Assume that any money lent by a bank is deposited back in the banking system as a checkable deposit and that the reserve ratio is 10%. Trace out the effects of a $100 million open-market purchase of U.S. Treasury bills by the Fed on the value of checkable bank deposits. What is the size of the money multiplier?
An open-market purchase of $100 million by the Fed increases banks' reserves by $100 million as the Fed credits their accounts with additional reserves. In other words, this open-market purchase increases the monetary base (currency in circulation plus bank reserves) by $100 million. Banks lend out the additional $100 million. Whoever borrows the money puts it back into the banking system in the form of deposits. Of these deposits, banks lend out $100 million × (1 − rr) = $100 million × 0.9 = $90 million. Whoever borrows the money deposits it back into the banking system. And banks lend out $90 million × 0.9 = $81 million, and so on. As a result, bank deposits increased by $100 million + $90 million + $81 million +...= $100 million/rr = $100 million/0.1 = $1,000 million = $1 billion. Since in this simplified example all money lent out is deposited back into the banking system, there is no increase of currency in circulation, so the increase in bank deposits is equal to the increase in the money supply. In other words, the money supply increases by $1 billion. This is greater than the increase in the monetary base by a factor of 10: in this simplified model in which deposits are the only component of the money supply and in which banks hold no excess reserves, the money multiplier is 1/rr = 10.
A financial intermediary that provides liquid financial assets in the form of deposits to lenders and uses their funds to finance the illiquid investment spending needs of borrowers is called a a. mutual fund. b. bank. c. corporation. d. pension fund. e. life insurance company.
B
If the interest rate is zero, then the present value of a dollar received at the end of the year is a. more than $1. b. equal to $1. c. less than $1. d. zero. e. infinite.
B
What is the present value of $100 realized two years from now if the interest rate is 10%? a. $80 b. $83 c. $90 d. $100 e. $110
B
Which of the following is NOT a role of the Federal Reserve System? a. controlling bank reserves b. printing currency (Federal Reserve notes) c. carrying out monetary policy d. supervising and regulating banks e. holding reserves for commercial banks
B
Which of the following is the best example of using money as a store of value? a. A customer pays in advance for $10 worth of gasoline at a gas station. b. A babysitter puts her earnings in a dresser drawer while she saves to buy a bicycle. c. Travelers buy meals on board an airline flight. d. Foreign visitors to the United States convert their currency to dollars at the airport. e. You use $1 bills to purchase soda from a vending machine.
B
Bank Reserves
Bank reserves are the currency banks hold in their vaults plus their deposits at the Federal Reserve.
If the interest rate is 10%, the present value of $1 paid to you one year from now is a. $0. b. $0.89. c. $0.91. d. $1. e. more than $1.
C
When you decide you want "$10 worth" of a product, money is serving which role(s)? I. medium of exchange II. store of value III. unit of account a. I only b. II only c. III only d. I and II only e. I, II, and III
C
Which of the following changes would be the most likely to reduce the size of the money multiplier? a. a decrease in the required reserve ratio b. a decrease in excess reserves c. an increase in cash holding by consumers d. a decrease in bank runs e. an increase in deposit insurance
C
Capital Inflow
Capital inflow is the net inflow of funds into a countr
Checkable Bank Deposits
Checkable bank deposits are bank accounts on which people can write checks.
Commodity Money
Commodity money is a good used as a medium of exchange that has intrinsic value in other uses
Commodity-Backed Money
Commodity-backed money is a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods
Excess Reserves
Excess reserves are a bank's reserves over and above its required reserves.
Explain why a system of commodity-backed money uses resources more efficiently than a system of commodity money.
Commodity-backed money uses resources more efficiently than simple commodity money, like gold and silver coins, because commodity-backed money ties up fewer valuable resources. Although a bank must keep some of the commodity—generally gold and silver—on hand, it has to keep only enough to satisfy demand for redemptions. It can then lend out the remaining gold and silver, which allows society to use these resources for other purposes, with no loss in the ability to achieve gains from trade.
Currency in Circulation
Currency in circulation is cash held by the public
A nonprofit institution collects the savings of its members and invests those funds in a wide variety of assets in order to provide its members with income after retirement. This describes a a. mutual fund. b. bank. c. savings and loan. d. pension fund. e. life insurance company.
D
Bank reserves include which of the following? I. currency in bank vaults II. bank deposits held in accounts at the Federal Reserve III. customer deposits in bank checking accounts a. I only b. II only c. III only d. I and II only e. I, II, and III
D
Decreasing which of the following is a task of the financial system? I. transaction costs II. risk III. liquidity a. I only b. II only c. III only d. I and II only e. I, II, and III
D
If the interest rate is 5%, the amount received one year from now as a result of lending $100 today is a. $90. b. $95. c. $100. d. $105. e. $110.
D
The monetary base equals a. currency in circulation. b. reserves held by banks. c. currency in circulation − reserves held by banks. d. currency in circulation + reserves held by banks. e. currency in circulation/reserves held by banks.
D
When you use money to purchase your lunch, money is serving which role(s)? I. medium of exchange II. store of value III. unit of account a. I only b. II only c. III only d. I and III only e. I, II, and III
D
Who oversees the Federal Reserve System? a. the presidents of the Regional Federal Reserve Banks b. the president of the United States c. the Federal Open Market Committee d. the Board of Governors of the Federal Reserve System e. the Reconstruction Finance Corporation
D
Deposit Insurance
Deposit insurance guarantees that a bank's depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account.
Bank regulation includes which of the following? I. deposit insurance II. capital requirements III. reserve requirements a. I only b. II only c. III only d. I and II e. I, II, and III
E
In the United States, the dollar is a. backed by silver. b. backed by gold and silver. c. commodity-backed money. d. commodity money. e. fiat money.
E
Suppose, for simplicity, that a bank uses a single interest rate for loans and deposits, there is no inflation, and all unspent money is deposited in the bank. The interest rate measures which of the following? I. the cost of using a dollar today rather than a year from now II. the benefit of delaying the use of a dollar from today until a year from now III. the price of borrowing money calculated as a percentage of the amount borrowed a. I only b. II only c. III only d. I and II only e. I, II, and III
E
Which of the following contributed to the financial crisis of 2008? a. subprime lending b. securitization c. deleveraging d. low interest rates leading to a housing boom e. all of the above
E
Which of the following is NOT a type of financial asset? a. bonds b. stocks c. bank deposits d. loans e. houses
E
List and describe the four most important types of financial intermediaries.
Mutual fund-a financial intermediary that creates a stock portfolio by buying and holding shares in companies and then selling shares of the stock portfolio to individual investors. Life insurance company-a firm that guarantees a payment to the policyholder's beneficiaries (typically, the family) when the policyholder dies. Bank-an institution that helps resolve the conflict between lenders' needs for liquidity and the illiquid financing needs of borrowers who don't want to use the stock or bond markets. Pension fund-a nonprofit institution that collects the savings of its members and invests those funds in a variety of assets, providing its members with income when they retire.
National Savings
National savings, the sum of private savings and the budget balance, is the total amount of savings generated within the economy.
Near-Moneys
Near-moneys are financial assets that can't be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits
Calculate the net present value of each of the three hypothetical projects described below. Assume the interest rate is 5%. Project A: You receive an immediate payoff of $1,000. Project B: You pay $100 today in order to receive $1,200 a year from now. Project C: You receive $1,200 today but must pay $200 one year from now.
Project A net present value: $1,000 Project B net present value: −$100 + ($1,200/1.05) = $1,042.86 Project C net present value: $1,200 − ($200/1.05) = $1,009.52
Reserve Requirements
Reserve requirements are rules set by the Federal Reserve that determine the required reserve ratio for banks
Subprime Lending
Subprime lending is lending to home buyers who don't meet the usual criteria for being able to afford their payments
What group determines monetary policy?
The Federal Open Market Committee (FOMC)
What are the similarities between the Panic of 1907, the S&L crisis, and the crisis of 2008?
The Panic of 1907, the S&L crisis, and the crisis of 2008 all involved losses by financial institutions that were less regulated than banks. In the crises of 1907 and 2008, there was a widespread loss of confidence in the financial sector and collapse of credit markets. Like the crisis of 1907 and the S&L crisis, the crisis of 2008 exerted a powerful negative effect on the economy.
Balance Sheet Effect
The balance sheet effect is the reduction in a firm's net worth from falling asset prices.
Describe the balance sheet effect. Describe the vicious cycle of deleveraging. Why is it necessary for the government to step in to halt a vicious cycle of deleveraging?
The balance sheet effect occurs when asset sales cause declines in asset prices, which then reduce the value of other firms' net worth as the value of the assets on their balance sheets declines. In the vicious cycle of deleveraging, the balance sheet effect on firms forces their creditors to call in their loan contracts, forcing the firms to sell assets to pay back their loans, leading to further asset sales and price declines. Because the vicious cycle of deleveraging occurs across different firms and no single firm can stop it, it is necessary for the government to step in to stop it.
The required reserve ratio is 5%. If a bank has deposits of $100,000 and holds $10,000 as reserves, how much are its excess reserves? Explain.
The bank must hold $5,000 as required reserves (5% of $100,000). It is holding $10,000, so $5,000 must be excess reserves.
Budget Balance
The budget balance is the difference between tax revenue and government spending.
Budget Deficit
The budget deficit is the difference between tax revenue and government spending when government spending exceeds tax revenue
Budget Surplus
The budget surplus is the difference between tax revenue and government spending when tax revenue exceeds government spending
Why did the creation of the Federal Reserve fail to prevent the bank runs of the Great Depression? What measures did stop the bank runs?
The creation of the Federal Reserve failed to prevent bank runs because it did not eradicate the fears of depositors that a bank collapse would cause them to lose their money. The bank run eventually stopped after federal deposit insurance was instituted and the public came to understand that their deposits were protected.
Suppose you hold a gift certificate, good for certain products at participating stores. Is this gift certificate money? Why or why not?
The defining characteristic of money is its liquidity: how easily it can be used to purchase goods and services. Although a gift certificate can easily be used to purchase a very defined set of goods or services (the goods or services available at the store issuing the gift certificate), it cannot be used to purchase any other goods or services. A gift certificate is therefore not money since it cannot easily be used to purchase all goods or services.
Discount Rate
The discount rate is the interest rate the Fed charges on loans to banks.
Discount Window
The discount window is an arrangement in which the Federal Reserve stands ready to lend money to banks.
Required Reserve Ratio
The required reserve ratio is the smallest fraction of deposits that the Federal Reserve allows banks to hold.
Reserve Ratio
The reserve ratio is the fraction of bank deposits that a bank holds as reserves.
