Fin FINAL EXAM
Tax Status
a security that is subject to taxing has to offer a higher yield in order to attract investors
The Federal District Banks
-12 district banks located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco •108 district bank directors (9 per district bank) •12 district bank presidents (1 per district bank) -Helping to manage check clearing needs for things like commercial and Treasury checks -Taking old or damaged currency and replacing it with new currency -providing loans to depositor institutions that might not have enough funds to meet the reserve requirements laid out by the FED
Common Economic Indicators
-Gross Domestic Product (GDP) •National income •Industrial Production Index •Retail Sales Index •Home Sales Index
reasons why stimulative monetary policy might fail
-The amount of time it took the Fed to come up with a suitable policy to address an issue took too long. -Businesses and households recognize that the stimulative monetary policy will result in higher inflation, so they borrow and make planned expenditures prior to the price increase, offsetting the effects of the policy. -Due to a weak economy and uncertainty about job security, individuals may still be unwilling to take on loans despite low interest rates, offsetting the intended effects of the monetary policy.
Federal Funds
-enables depository institutions to borrow or lend short-term funds to each other at the federal funds rate. -The most common maturities for these transactions are between 1 day and 7 days. -Commercial banks are the most active participants in the federal funds market -Most load transactions have maturity of 1 to 7 days -Most alone transactions are for $5 mill or more.
Negotiable Certificates of Deposit
-issued by financial institutions as a source of short-term funding, -typically in denominations that are multiples of $1 million. -Activity in their second market is moderate -they provide a return in the form of interest along with the difference between the secondary market selling price and the original purchase price
Repurchase Agreements
-loans backed by securities whose transaction amounts are typically for $10 million or more. -The size of the repo market is approximately $5 trillion -Most repo transactions are backed by gov securities
Advisory Committees
-the federal advisory council -the community depositor institutors advisory council -the community advisory council -Making recommendations to the Board of Governors about economic and banking issues
Commercial Paper (Money market instruments)
-typically issued in denominations that are multiples of $1 million -Short tern debt instruments -Firms are the most common investors in these securities -they are typically used to finance a firms investment in inventory and accounts receivable
What are the two major roles of Financial Markets
1) Accommodating corporate finance needs 2)Accommodating investment needs
10 steps involving the Fed Res Monetary policy decision-making process:
1) Two weeks prior to the FOMC meeting the FOMC members receive the BEIGE BOOK, which is a report of regional economic conditions from each of the 12 Fed Res banking districts 2)One week prior to the FOMC meeting, FOMC members receive expert analyses of the economy and economic forecasts based on information in the beige book 3)In FOMC meeting staff members make presentations abut correct economic conditions and recent econ trends 4)FOMC members discuss what the fed monetary policy should be 5)Voting FOMC members vote on whether the fed funds rate target should increase, decrease or stay the same 6) Voting members of the FOMC vote on how to communicate the chosen monetary policy to the public 7)The FOMC issues a clear and detailed statement that summarizes the decision about the selected target fed funds rate 8) the minutes of the FOMC meeting are posted on the website 9)If FOMC determines that a change in monetary policy is appropriate, its design is forward to the trading desk at the NY Fed Res District bank through a statement called the POLICY DIRECTIVE 10) the manager of the trading desk instructs traders who work at that desk on the amount of treasury securities to buy or sell in the secondary market.
Several Key roles of Financial Institutions
1) bridging the information gab between surplus and deficit unites when their expertise in evaluating credit worthiness 2) Diversifying their lonas, which allows them to absorb defaulted loans better than individual surplus units 3) offering deposit accounts that fir the needs of surplus unites 4)Providing surplus units with full information within markets, completely removing information asymmetry from financial markets 5) Repackaging depositor vends to fit the size and amatory length needs of deficit units 6)taking on riskier loans knowing the could be default
which of the following is consistent with the pure expectations theory of the yield curve? 1) An upward-sloping yield curve suggests that the market things interest rates are going to be higher in the future than they are today 2)An upward-sloping yield curve suggests that the market thinks interest rates are going to be lower in the future than they are today. 3)A flat yield curve suggests that the market thinks interest rates in the future will be higher than they are today. 4)A downward-sloping yield curve suggests that the market thinks interest rates in the future will be lower than they are today.
1, 4
Which of the following is constant with the liquidity premium theory of yield curve? 1)If liquidity influences the yield curve, the forward rate overestimates the market's expectation of the future interest rate. 2)If liquidity influences the yield curve, an upward-sloping yield curve suggests that the market thinks interest rates in the future will decrease. 3)If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate. 4)If liquidity influences the yield curve, an upward-sloping yield curve suggests that the market thinks interest rates in the future will increase.
1, 4 states that the term structure of interest rates is determined by expectations of interest rates as well as liquidity premium. -investors believe that interest rates will rise in the future, then the original yield curve is upward sloping. -investors believe that interest rates will fall in the future, then the original yield curve is downward sloping. -investors believe that interest rates will remain the same in the future, then the original yield curve is flat.
There are ------ members of the Federal Open Market Committee.
12
Which of the following are Key roles of financial Markets? 1)Reducing the liquidity of securities 2)Allowing Deficit units easier access to funding from surplus units outside of their own country 3)Serving as a mechanism for surplus units to purchase securities from deficit units 4) Facilitating the creation of new securities
2,3,4
Which of the following are organizational components of the Fed? 1) treasury secretary 2) the community Advisory Council 3) the new york District bank 4) the board of governors
2,3,4
Which of the following are ways that the Federal Reserve influences the U.S. economy through its monetary policies? Check all that apply. 1)Using open-market operations to buy securities, the Fed can increase the money supply, thereby increasing interest rates, which would cause security prices to decrease. 2)Using open-market operations to buy securities, the Fed can decrease the money supply, thereby decreasing interest rates and subsequently increasing the rate of inflation. 3) Using open-market operations to buy securities, the Fed can increase the money supply, thereby decreasing interest rates and subsequently increasing the rate of inflation. 4) Using open-market operations to buy securities, the Fed can increase the money supply, thereby decreasing interest rates, which would cause security prices to increase.
3,4
Reason the demand curve for loanable funds is downward sloping?
A lower real interest rate makes borrowing less expensive
Reason the supply curve for loanable funds is upward sloping?
A lower real interest rate makes saving less appealing
term to Maturity
A security with a longer term to maturity has to offer a higher yield in order to attract investors due to the constant function of interest rates and inflation
Liquidty
A security with a lower degree of liquidity has to offer a higher yield in order to attract investors
Aggregate demand can be calculated as:
AD = Consumer Spending + Business Investment + Government Expenditures + (Exports - Imports)
Derivative Securities
Are financial contracts such as forward contracts, future contracts, options contracts, and swaps, who's value is derived from some other asset, called the underlying asset -Securities that enable investors to speculate on movements in the value of underlying assets without having to purchase them.
Capital Market Securities
Are long-term securities such as binds, portages, and stocks, that have a maturity greater than one year -Common Stock
If investors review the information they have on food trucks and determine that there is a high degree of uncertainty surrounding the food truck businesses' cash flow generation, they revise their valuations of the food truck stocks downward. Consequently, the demand for food truck stocks decreases because investors believe it is currently being overvalued. On the other side of the market, investors that had been holding onto their stocks may try to sell them.
As a result, the supply of food truck stocks increases. Putting all of this together, an increase in supply and decrease in demand leads to a decrease in the equilibrium stock price.
The sectors that contribute to the supply and demand for loanable funds are
Businesses, the federal gov, foreign, households, and municipal gov
Depository Institutions
Commercial banks Savings Institutions Credit Unions
Suppose Moonlit productions need to raise money to finance its new manufacturing facility, but their CFO does not want to part with any of the firm's equity, Moonlight productions would likely issue ------- securities to obtain the funding Which of the following are ways that Moonlit productions could obtain funds to finance the expansion of its operations
DEBT Obtain finance: (examples of debt securities) -Issue Commercial Paper -Issue Corporate Bonds The company would pay back the principal loan plus accused interest rather than giving away any ownership.
A Firm that issues equity securities to expand operations Surplus Unit or a Deficit Unit
Deficit
Is the US government a Surplus Unit or a Deficit Unit
Deficit
Financial market participants who borrow money to finance purchases such as vehicles, furniture, equipment, etc., are considered to be contributing to the -------- for loanable funds.
Demand
Injection Molding Inc. borrows $130,000 to finance the purchase of injection molds for its next production cycle. Is the Supply or Demand for Loanable Funds and what sector?
Demand, Business
Argentina's government wants to obtain financing by issuing Argentina Treasury bills to U.S. investors. is the Supply or Demand for Loanable Funds and what sector?
Demand, Foreign sector
Primary Markets
Facilitate the creation of new securities, allowing firms to obtain new funds
Secondary Markets
Facilitate the trading of existing securities, allows investors to change the ownership of their securities
Surplus unit
Financial Markets participants who receive more money than they spend
Commercial banks
Financial intermediaries that facilitate the transfer of capital from surplus units to deficit units. Serves include, checking, savings, money market and time deposit accounts. Lend money to other banks via the federal funds market
non-depository institutions
Mutual Funds Securities firms insurance companies pension funds
Insurance companies
Invest in money market securities to maintain liquidity in their investment portfolios.
Pension funds
Invest in money market securities to maintain liquidity in their investment portfolios.
Finance Companies
Issue commercial paper.
Commercial banks and savings institutions
Issue commercial paper. Engage in repurchase agreements.
Which of the following does the Fed use as a reliable measure for monitoring and controlling the money supply? Check all that apply. M1 M2 M3
M2, M3
Member Banks
National and state banks can be member banks, which means they are part of the Federal Reserve System. -Maintaining reserve deposits in the Fed Res Bank in their districts
Google filed its initial public offering worth $1.67 billion in August of 2004 Primary or secondary market?
Primary Market
in 2018, CVS Health Corp. Issued $27 million in bonds to help fund its acquisition of Aetna Inc. Primary or secondary market?
Primary Market
If investors review the information they have on food trucks and determine that there is a high likelihood of a high return on their investment, they revise their valuations of the food truck stocks upward. Consequently, the demand for food truck stocks increases because investors believe it is currently being undervalued. On the other side of the market, investors that had been planning to sell their food truck stocks may decide not to because they think the stock price will go up in the future. As a result, the supply of food truck stocks decreases.
Putting all of this together, a decrease in supply and increase in demand leads to an increase in the equilibrium stock price.
SAVING and Supply
Saving is the source of supply of loanable funds, reducing the level of saving that households can shelter from income tax will discourage saving at each interest rate level, causing the supply of loanable funds to shift LEFT The result is a shortage of loanable funds at the initial interest rate. With more willing borrowers than lenders, the lenders will be able to raise the interest rate they charge for loans. As the interest rate increases, the quantity of loanable funds demanded decreases. Consequently, the equilibrium interest rate increases, and the equilibrium quantity of loanable funds supplied and demanded decreases.
Marth Steward sold nearly 4,000 shares of ImClone in December of 2001 Primary or secondary market?
Secondary Market
You sell your savings bond to investor willing to pay %15 more than you originally paid: Primary or secondary market?
Secondary Market
Deficit Units
Spend more money than they receive
Fisher Effect
States that nominal intrest rate on savings is composed of two factors 1-expected inflation 2-the real interest rate In response to decreases in expected inflation the nominal interest rate should fall. in response to a increase in expected inflation the nominal interest rate will increase. SOLVE for expected inflation: =Nominal interest rate- real interest rate
Any financial market participant that uses money in such a way where it can then be borrowed by another financial market participant is said to be contributing to the -------- of loanable funds.
Supply
Canada's government imposes a tax law that makes any savings during the year exempt from personal income taxes. is the Supply or Demand for Loanable Funds and what sector?
Supply,
The U.S. government runs a budget surplus and purchases $1 billion worth of bonds from banks with the excess funds. Is the Supply or Demand for Loanable Funds and what sector?
Supply, Federal gov
A Consumer that purchases equity securities from a new tech company Surplus Unit or a Deficit Unit
Surplus
An Angle investor Surplus Unit or a Deficit Unit
Surplus an Angle investors are individual or groups who provide funds for a start-up company
interest-inelastic demand curve
The Fed Gov tax policies and expenditures are independent of interest rates, the federal government's demand for loanable funds curve is vertical -If the Fed runs a budget deficit, then one way it can make up the for the discrepancy btwn tax rev and Gov Expenditure is by issuing U.S. Treasury securities. This results in an increase need for funds to pay off the debt is an outward shift of the vertical line, to the right
Systemic Risk
The idea that due to the high amounts of business transactions between financial institutions, financial instabilities that occur in just a few financial institutions can very easily spread to others. Exists because of the interconnections between financial instabilities and their dependency on one another for loans or payments
Money Market mutual funds
Use proceeds from shares sold to invest in banker's acceptances.
how to solve for appropriate yield to be offered on the commercial paper
Yn=Rf,n+CP+LP+TAYn=Rf,n+CP+LP+TA Yn=annualized yield of an n-year debt security Rf,n=annualized yield (return) of an n-year Treasury (risk-free) security with the same term to maturity as the debt security CP=credit risk premium to compensate for credit risk LP=liquidity premium to compensate for less liquidity TA=adjustment due to the difference in tax status
Depository institutions
accept deposits from surplus units and provide credit to deficit units through security purchases and loans nondepository institutions generate funds from sources other than deposits. -Commerical banks -Savings Inst. -Credit Unions
Money Market Securities
are short term securities, such as treasury bills, commercial paper, and negotiable certificates of deposit that have a maturity of one year or less. -Short term Securities that have a maturity of one year or less -Negotiable certificates of deposit
The Segmented market theory
choose securities with maturities that satisfy their forecasted cash flow needs -The segmented markets theory explains the yield curve's shape but is not the sole explanation for the yield curve. -Investors and borrowers typically stay within a particular maturity market; however, certain circumstances may cause them to deviate from their original strategies. -Investors and borrowers participate only in the maturity market that satisfies their forecasted cash flow needs, which is what causes the market segmentation. In other words, investors and borrowers will switch between short-term and long-term markets only if their financial needs change.
Mutual Funds
corporation that manages a portfolio of mutual funds, it is a type of collective investment system in which funds are collected from surplus units and invested in securities that comply with the mutual funds objective either, 1 concentrate on capital markets securities like stocks and bonds or 2 concentrate on money market securities like treasury bills and commercial papers.
When implementing a stimulative monetary policy, the goal of the Fed is to
decrease interest rates so that households and businesses both invest more. The FOMC engages in open market operations by purchasing Treasury securities, which results in an increase in the supply of funds for depository institutions that sell the securities to the Fed. Due to the increase in the supply of loanable funds, both the risk-free interest rate associated with Treasury securities and the credit risk premium (regardless of the investor's risk level) will decrease. Thus, it can be said that a firm's cost of equity will decrease.
If hundreds of training centers for unskilled workers close down, then........
fewer unskilled workers will get the training they need to be an attractive job market participant. As a result, the minimum unemployment rate will be higher than the initial minimum unemployment rate of 3.35 percent.
Credit Unions
financial cooperatives formed and owned by their members. they differ form commercial banks and savings inst. in that they are NONprofit, and restrict their business to their own members
M2
includes everything in M1 plus savings deposits, money market deposit accounts (MMDAs), overnight repurchase agreements (selling bonds with the intention of buying them back at a higher price the next day), and Eurodollars lasting less than one day (U.S. dollars deposited into an international bank account with the intention of withdrawing the money the next day).
M3
includes everything in M2 plus institutional money market mutual funds, large time deposits, repurchase agreements (selling bonds with the intention of buying them back at a higher price sometime in the future), and Eurodollars lasting more than one day (U.S. dollars deposited into an international bank account with the intention of withdrawing the money sometime in the future).
When implementing a restrictive monetary policy, the goal of the Fed is to
increase interest rates so that households and businesses both invest less. The FOMC engages in open market operations by selling Treasury securities, which results in a decrease in the supply of funds for depository institutions that purchase the securities from the Fed. Due to the decrease in the supply of loanable funds, both the risk-free interest rate associated with Treasury securities and the credit risk premium (regardless of the investor's risk level) will increase. Thus, it can be said that a firm's cost of equity will increase. The cost of a firm's equity is positively correlated to the risk-free rate, so if the Fed increases interest rates, a firm's cost of equity will also increase.
Banks acceptances
indicate that a bank accepts responsibility for a future payment and typically has a maturity between 30 days and 270 days. -the return on bankers acceptances is typically higher than the return on a T-bill -maturities on bankers acceptances typically range from 30-270 days
Corporate Finance
involves corporate surrounding financial operations such as how much funding is needed and what types of securities should be issued in order to receive that funding.
Forward Rate
is an estimate of Markets future interest rate, represents the future interest rate value on the one-year bond purchased in the second year.
M1
is the sum of currency held by the public plus checking deposits held at depository institutions, which are assets that have high liquidity and can be easily converted into currency. Because M1 is made up of such liquid assets, it is considered to be much more volatile than M2 or M3. Additionally, M1 does not include all of the funds that can be used for transaction purposes, which is another reason why the Fed deems M2 and M3 to be more reliable measures for monitoring and controlling the money supply. includes currency (like Felix's roll of quarters) and checking deposits (like demand deposits, negotiable order of withdrawal accounts, and automatic transfer balances).
If oil prices increase substantially, then------
it becomes more expensive for companies to produce goods, which in turn will cause them to raise prices. As a result, the new minimum inflation rate will be higher than the initial minimum inflation rate of 4.50 percent.
Quantitative easing is an example of -------monetary policy, which is generally used when interest rates are------- zero
non-traditional, near zero
Fed Gov runs a Budget Surplus
one way it can use the excess funds is by purchasing bonds from the banks, this INJECTS money to the economy because banks use the funds to provide loans to Businesses and Individuals. the SUPPLY Curve Shifts RIGHT
Insurance companies
provide policies to individuals that cover the costs of things like car accidents, property damage etc. Insurance policies are contracts in which the insurer agrees to pay a certain amount of money to the insured when a specific event occurs. in return the insured individual agrees to pay a certain amount of money called the Policy premium at regular intervals
How does issuing debt security's work
require the firm to pay back the principal of the loan plus accrued interest
New Leaf Investment Bank relies heavily on short-term debt to finance their operations and uses their holdings of mortgage-backed securities as collateral. Suddenly the prices of mortgage backed securities plummet, and they can no longer issue short-term debt to pay off the principal on maturing debt.
scenarios represent(s) a major source of systemic risk
Origin Savings and Loan Association originate thousands of subprime mortgages that are then sold to commercial banks, securities firms, and other savings institutions.
scenarios represent(s) a major source of systemic risk
The Federal Open Market Committee FOMC
the chair of board of governors -7 members of the board of governors -president of 5 fed district banks -Manipulating the money supply through open-market operations. If the federal government plans to borrow (lend) money, bonds can be sold (purchased) using open-market operations.
The five major components of the Fed are
the fed reserve bank, member banks, the Board of governors, the federal open market committee, various advisory committees
Credit Risk Premium
the security with the idea degree of risk has to offer a credit risk premium in order to attract investors. the Security with a higher credit risk will have a higher yield.
Treasury Bills
typical Treasury bill maturities: 52 weeks -They are virtually free of credit risk -Activity in their secondary market is high T-bills are short-term securities with 4-week, 13-week, 26-week, and 1-year maturities. The U.S. Treasury also issues T-bills that have maturities of less than 4 weeks, called cash management bills, however these are less common than the T-bills with maturities greater than 4 weeks.
An investment tax credit effectively lowers the taxes paid by firms that purchase new equipment or build a new manufacturing facility. Suppose the government repeals a previously existing investment tax credit.
will discourage firms from investing at every interest rate. Now the demand for loanable finds decreases and shifts left, NOW their is surplus of loanable funds at the initial interest rate. Lenders lower the interest rate to attract borrowers. The quantity of loanable funds supplied decreases. Interest rate decreases
The Board of Governors
•7 members •The Federal Reserve Chair (1 of the 7 members) •The Federal Reserve Vice Chair (1 of the 7 members) -Setting the minimum percentage of an investment in securities that must be with investor's cash -Revising the reserve requirement—the amount of funds banks must have in their reserves on any given day -Regulating member banks and bank holding companies.
Scenarios Where the Fed Would Use Stimulative Monetary Policy
•Gross Domestic Product (GDP) decreases significantly. •National income decreases significantly. •Industrial Production Index decreases significantly. •Retail Sales Index decreases significantly .•Home Sales Index decreases significantly .•Producer Price Index decreases significantly .•Consumer Price Index decreases significantly. •Wage rates decrease significantly. •Oil prices decrease significantly. •Gold prices decrease significantly.
Scenarios Where the Fed Would Use Restrictive Monetary Policy
•Gross Domestic Product (GDP) increases significantly. •National income increases significantly. •Industrial Production Index increases significantly. •Retail Sales Index increases significantly. •Home Sales Index increases significantly. •Producer Price Index increases significantly .•Consumer Price Index increases significantly .•Wage rates increase significantly. •Oil prices increase significantly .•Gold prices increase significantly.
Common Inflation Indicators
•Producer Price Index •Consumer Price Index •Wage rates •Oil prices •Gold prices