Money and Banking Final

Net Interest Margin

(bank's interest income - interest expenses)/ total bank assets net interest income as a percentage of total bank assets

Four Broad Categories of Banks Assets

- cash - securities - loans - all other assets (ex.- building and equipment and collateral repossessed from borrowers who defaulted)

Three Types of Cash Assets

- reserves - cash items in process of collection - balances of accounts that banks hold at other banks

Three Features of a Good Monetary Policy

1) easily observable by everyone 2) controllable and quickly changed 3) tightly linked to the policymaker's objectives

Five Objectives of the Central Bank

1) low and stable inflation 2) light and stable real growth, together with high employment 3) stable financial markets and institutions 4) stable interest rates 5) stable exchange rate

Four Goals of Dodd-Frank Act

1) make financial system robust 2) anticipate and prevent financial crises by limiting systemic risk 3) end too big to fail 4) reduce moral hazard resulting from policy actions such as those taken in 2007-2009 crisis

Three Important Jobs of the Central Bank

1) provide loans during times of financial stress 2) manage the payments system 3) oversee commercial banks and financial system

Four Conventional Policy Tools

1) target federal funds rate range 2) interest rate on excess reserves 3) discount rate 4) reserve requirement

Three Reasons for the Government to get Involved in the Financial System

1) to protect investors 2) to protect bank customers from monopolistic exploitation 3) to safeguard the stability of the financial system

Five Functions of Financial Intermediaries

1. pooling savings: pooling resources of small savers 2. safekeeping and accounting: providing safekeeping and accounting services as well as access to the payment system 3. providing liquidity: supplying liquidity by converting savers' balances directly into a means of payment whenever needed 4. diversifying risk: providing ways to diversify risk 5. collecting and processing information services: collecting and processing info in ways that reduce information costs

How many banks are in the Federal reserve System?

12 banks

Currency Board

A fixed-exchange-rate system in which the central bank commits to holding enough foreign currency assets (often dollars) to back domestic currency liabilities at a fixed rate.

Which of the following are examples of non-depository institutions? A) GSEs B) Security Firms C) Thrifts D) Insurance Companies

A) GSEs B) Security Firms D) Insurance Companies

Depository institutions, non-depository institutions, and commercial banks A) are all financial intermediaries B) offer the same kinds of financial services to the public C) have the same type of liabilities D) are different because only depository institutions are profit-driven

A) are all financial intermediaries

Which of the following is classified as a bank liability? (more than one answer) A) certificates of deposit B) non-transaction deposits C) borrowed funds D) cash assets and securities E) demand deposits

A) certificates of deposit B) non-transaction deposits C) borrowed funds E) demand deposits

An easing on monetary policy means A) decreasing the target interest rate B) decreasing the central bank's balance sheet C) increasing the reserve requirements D) increasing the federal funds rate

A) decreasing the target interest rate

Since the Great Recession in the United States, reserves have been so abundant that the A) federal funds rate is not easily manipulated with open market operations B) Fed cannot affect the federal funds rate C) Fed prefers to target the discount rate D) IOER rate is ineffective

A) federal funds rate is not easily manipulated with open market operations

Which of the following statements is NOT considered a major difficulty with the use of quantitative easing? (multiple answers) A) federal funds rate will go negative B) tends to decrease policymakers' credibility C) it has been overused throughout time D) it is difficult to know the level of purchases required

A) federal funds rate will go negative B) tends to decrease policymakers' credibility C) it has been overused throughout timefor

As independent banks failed during the 2007-2009 financial crisis, a run on money-market mutual funds (MMMF) was stopped by A) government guarantee of (MMMF) B) private liquidity bailout of the banking system C) loans from he Federal Reserve Bank D) direct foreign investment

A) government guarantee of (MMMF)

Local banking monopolies were the rule in U.S. banking up until the 1970s. What single factor best explains their decline? A) improvements in technology B) foreign banks entering the market C) low profits D) government breakups of monopolies

A) improvements in technology

If demand for reserves remains constant and the market federal funds rate is below the target rate, the Fed would A) increase the IOER B) decrease the IOER C) do nothing and let the market work D) increase the supply of reserves

A) increase the IOER

Adjustable rate mortgages (ARMs)_______ interest rate risk and _____ credit risk. A) lower; raise B) raise; raise C) lower; lower D) raise; lower

A) lower; raise

In a loan contract, which of the following is the bank NOT required to disclose? A) names of other local banks with lower rates or fees B) info to allow interest rate charged by the bank to be compared to rates charged by its competitors C) interest rate on the loan in nominal terms D) fees charged by the bank

A) names of other local banks with lower rates or fees

Overall, historical data indicates that A) rate predicted by the Taylor rule is generally close to the actual target federal funds rate. B) we could replace FOMC with the Taylor ruse and have no difference in policy C) the Taylor rule is particularly good at handling sudden shocks to the economy D) rate predicted by Taylor rule is generally far from the actual target federal funds rate

A) rate predicted by the Taylor rule is generally close to the

If central bankers raise the interest rate, the asset-price channel of monetary policy implies that A) stock prices will decrease B) stock prices will remain the same but bond prices will increase C) bond prices will remain flat D) stock prices will increase and bond prices will remain flat

A) stock prices will decrease

In the short run, a nation's exchange rate is based on A) supply and demand for its financial assets B) its inflation rate versus that in other nations C) purchasing power parity D) central bank, which fixes the rate

A) supply and demand for its financial assets

Most economists view capital controls A) unfavorably B) as a framework fro allocating capital to its most efficient uses C) as useful for developing countries to exploit their comparative advantages D) as a method for quickly transmitting info to markets and institutions in other countries

A) unfavorably

A bank's reserves include A) vault cash B) U.S. Treasury Securities C) the bank's loan portfolio D) U.S. Treasury bills and vault cash

A) vault cash

Lending and borrowing involve _______ costs; the text credits financial intermediaries' skill in lowering ______ costs with their continued importance. A) only transactions; transactions B) both transactions and information; information C) only information; information D) both transactions and information; transactions

B) both transactions and information; information

In what way are banks essential to the operation of a modern economy? (multiple answers) A) determine money supply B) direct resources from savers to investors C) direct resources from investors to savers D) solve problems caused by information asymmetries

B) direct resources from savers to investors D) solve problems caused by information asymmetries

The price for private information is likely higher than it should be due to the problem of A) adverse selection B) free-riders C) the government regulations regarding information D) moral hazard

B) free-riders

In one word, securities firms produce A) capital B) information C) liquidity D) diversification

B) information

The text showed in an exhibit that the United States, the united Kingdom, Germany, and Japan all fund the majority of their business finance through A) financial markets B) internal funds C) the government D) financial intermediaries

B) internal funds

Securities firms include A) insurance companies, pension funds, and investment banks B) investment banks, brokerages, and mutual fund companies C) commercial banks, investment banks, and central banks D) dealers, brokers, and arbitrageurs

B) investment banks, brokerages, and mutual fund companies

The Dodd-Frank does all of the following except A) sets out new rules for financial institutions and markets B) repeals the Glass-Steagall Act of 1933 C) requires closer government oversight over key establishments called systemically important financial institutions D) sharply alters the authorities of the government agencies that govern the financial sector

B) repeals the Glass-Steagall Act of 1933

Which of the following is a solution to the moral hazard in equity finance? (One or more answers) A) inability to fire managers B) require managers to own a stake in the firm C) align managers' interests with stockholders' interests D) ability to fire managers

B) require managers to own a stake in the firm C) align managers' interests with stockholders' interests D) ability to fire managers

In the period of 1979-1982, if the Fed has set an interest rate target that was equal to the actual market interest rates that occures, the A) economy would have been better off B) target would not have been politically acceptable C) target would have been a federal funds rate of 0% D) inflation rate would have risen further

B) target would not have been politically acceptable

Trade-offs are a fact of economic life. This is especially true when it comes to the Federal Reserve Bank, which faces A) trade-off between taxes and inflation B) trade-off between price stability and economic growth C) trade-off between unemployment and growth D) trade-off between inflation and stagflation

B) trade-off between price stability and economic growth

Why do debt contacts encourage risk taking?

Because debt contracts allow owners to keep all the profits in exceess of loan payments

CAMELS Acronym

C - capital adequacy A - asset quality M - management E - earnings L - liquidity S - sensitivity to risk

Comparing the European and the U.S. central bank systems, the Governing Council of the European system resembles the A) Board of Governors B) Presidents of the Regional federal Reserve Banks C) FOMC D) Chairman of the Board of Governors of the Fed

C) FOMC

According to Akerlof's paper on adverse selection in used car markets, if used cars can be classified as either "peaches" (above-average quality) or "lemons" (below-average quality), then used cars will sell for _______ and the supply of used cars will be made up of________. A) the price of a lemon; half peaches and half lemons B) the price of a lemon; lemons only C) a price between a peach and a lemon; lemons only D) a price between a peach and a lemon; half peaches and half lemons

C) a price between a peach and a lemon; lemons only

Which of the following is a characteristic of financial crisis? A) sudden downturn in the business cycle B) sudden unanticipated shift to illiquidity in markets C) abrupt change that yields markets with high valuations D) negative effects of easy credit

C) abrupt change that yields markets with high valuations

A bank's net worth is synonymous with its A) assets B) assets + bank's liabilities C) capital D) required reserves

C) capital

Which of the following is NOT a cash asset held by banks? A) correspondent bank deposits B) reserves C) cash included in the M1 monetary aggregate D) cash items in the process of collection

C) cash included in the M1 monetary aggregate

Fixed exchange rate regimes include each of the following except which one? A) Bretton Woods exchange rate system B) exchange rate pegs C) dollarization D) currency boards

C) dollarization

Until 2008, the Fed could make the market federal funds rate equal the target rate by A) mandating that all loans be transacted at the target rate B) setting the discount rate below the federal funds rate C) entering the federal funds market as a borrower or lender D) paying higher interest on reserves

C) entering the federal funds market as a borrower or lender

Which of the following accounts could appear on BOTH the assets side and the liabilities and capital side of a bank's balance sheet? A) discount loans B) reserves C) federal funds D) securities

C) federal funds

Indicate characteristics of the effective lower bound (ELB). (multiple answers) A) it is less than zero due to the transaction costs of storing and insuring cash B) it does not restrict what monetary policymakers can do C) it is below zero D) its level is not precisely known

C) it is below zero D) its level is not precisely known

Examples of economies of scale include the: A) additional fees financial intermediaries charge on small accounts B) decrease in overall transaction costs that occur as volume increases C) reduction in cost per transaction that occurs as the number of transactions increase D) decrease in overall information costs that occur as more transactions are handled

C) reduction in cost per transaction that occurs as the number of transactions increase

Which of the following is true about solving principal-agent problems in debt and equity markets? A) the problem may be reduced if covenants force firm managers to pledge their own personal assets toward firm success or failure B) the problem may be reduced if firm managers share more in the upside of risk. C) the problem may be reduced in managers report more directly to owners D) in the last few years, firms have had great success in reducing moral hazard problems by tying manager compensation to firm performance

C) the problem may be reduced in managers report more directly to owners

Which of the following is NOT true about currency boards? A) between 10-20 exist today B)provide example of a hard peg system C) they provide an example of dollarization D) with a currency board, central bank's only function is maintaining the exchange rate

C) they provide an example of dollarization

Why is "too-big-to-fail policy" ripe for reform? (multiple answers) A) deposit insurance ceiling is meaningless for small banks B) it only applies to banks that are most likely to fail C) undermines market discipline that creditors impose on banks D) there is evidence that it worsens moral hazard

C) undermines market discipline that creditors impose on banks D) there is evidence that it worsens moral hazard

Cash Items in Process of Collection

Checks and other cash items that have been deposited with the Reserve banks for collection on behalf of an institution having an account

If the Fed were to increase the required reserve rate from ten percent to twenty percent, the simple deposit expansion multiplier would A) double B) increase by 10% C) decrease by a factor of 10 D) be half as large as it was before the increase

D) be half as large as it was before the increase

The procedure that estimates the interest-rate sensitivity of a bank's assets and liabilities is called A) managing credit risk B) estimating operating risk differential C) trading risk minimization D) gap analysis

D) gap analysis

Services offered by banks include: A) setting interest rates and making loans B) making discount loans and providing monthly bank statements C) controlling the payments system and making loans to other banks D) providing internet access to bank info and ATM machines

D) providing internet access to bank info and ATM machines

Which of the following was NOT one of the positive effects of the 1988 Basel Accord, according to the text? A) provided framework to help less developed nations improve bank regulation B) created uniform international system to weigh risk C) made regulators rethink bank capital D) set reserve requirements for commercial banks

D) set reserve requirements for commercial banks

Which of the following is NOT true about investment banks? A) they rely heavily on their reputations B) they help firms issue new equity and debt C) they assist firms with mergers and acquisitions D) they accept deposits from customers

D) they accept deposits from customers

Purchase-and-Assumption Method

FDIC finds a firm willing to take over failed bank; FDIC has to pay banks to purchase failed institutions

Payoff Method

FDIC pays off all of the bank's depositors and then sells all the bank's assets in an attempt to recover the amount paid out

Target Federal Funds Rate Range

FOMC's target range for interest rate that banks pay on overnight loans from other intermediaries; primary policy instrument

Unsterilized Foreign Exchange Intervention

Foreign exchange intervention that both alters the composition and changes the size of the central bank's balance sheet

Who were the original bankers? Why them and how did it grow beyond them?

Goldsmiths; needed vaults to protect their gold and jewelry; people began asking them to hold things on their behalf

Which of the following nations receives the highest percentage of business financing fro financial intermediaries? A) Japan B) Germany C) United States D) United Kingdom

Japan has a % greater than 20%

Discount Lending

Lending by the Federal Reserve, usually to commercial banks.

Return on Assets (ROA)

Net Income after Taxes /Total Bank Assets bank net profits after taxes divided by total bank assets; a measure of bank profitability

European Central Bank (ECB)

The central authority, located in Frankfurt, Germany, which oversees monetary policy in the common currency area; six member executive board

Bank-Lending Channel

The channel of the monetary policy transmission mechanism in which changes in policy affect national income through their impact on banks' willingness to make loans.

Bank Charter

The license authorizing the operation of a bank.

Natural Rate of Interest

The real short-term interest rate that prevails when the economy is using resources normally.

Board of Governors of the Federal Reserve System

The seven-member board that supervises the Federal Reserve system, including participation in both monetary policy and financial regulatory decisions

_______ are no longer the principal source of bank funds.

Traditional checking accounts

Federal Open Market Committee

a committee of the Federal Reserve Board that meets regularly to set monetary policy, including the interest rates that are charged to banks.

Basel Accord

agreement requiring internationally active banks to hold capital equal to or greater than a specified share (8% or as agreed by regulators) of their risk-adjusted assets

Macro-Prudential Regulation

aimed at limiting systemic risks in the financial system

Micro-Prudential Regulation

aimed at limiting the risks within intermediaries in order to reduce the probability of an individuals institution's failure

Trading Risk

aka market risk; risk that traders who work for a bank will create losses on the bank's own account

Targeted Asset Purchases

an unconventional monetary policy in which the central bank alters the mix of assets on its balance sheet in order to change their relative prices (and hence interest rates) in a way that stimulates economic activity

Collateral

assets pledged to pay fro a loan in the event that the borrower doesn't make the required payments

Off-Balance-Sheet Activities

bank activities, such as trading in derivatives and issuing loan commitments, that are neither assets nor liabilities on the bank's balance sheet

Bank Capital (Equity Capital)

bank assets - bank liabilities net worth of the bank; value of bank to its owners; owners stake in the bank

Reserves

bank's vault cash plus the balance in its account at the Federal Reserve

What is the second most important source of bank funds?

borrowing

Quantitative Easing

central bank supplies aggregate reserves beyond the quantity needed to lower policy rate

Central Bank Independence

central bank's freedom from political pressure; inconsistent with representative polucy

Monetary Policy

central bank's management of money, credit, and interest rates

Asset-Price Channel

changes in policy affect national income through their impact on stock prices and value of real estate

Exchange Rate Channels

channel of monetary policy transmission mechanism where changes in policy affect national income through their impact on exchange rates

Balance Sheet Channel

channel of monetary policy transmission mechanism where changes in policy affect national income through their impact on household and firm balance sheets

Whole Life Insurance

combination of term life insurance and a savings account in which a policyholder pays a fixed premium over their lifetime in return fro a fixed benefit when the policyholder dies

Forward Guidance

communication by the central bank about future policy prospects

Financial Holding Company

company that owns a variety of financial intermediaries

Interest Rate

cost of borrowing and reward to lending

Dollarization

country formally adopts the currency of another country for use in all its financial transactions

Speculative Attack

crisis in which financial market participants believe the government will become unable to maintain its exchange rate at the current fixed level, so they sell currency, forcing immediate devaluation

Vault Cash

currency that is physically held inside a bank's vault and automated teller machines (ATMs)

Intermediaries

determine which firms can access the stock and bond markets

Net Worth

difference between a firm's or household's assets and liabilities; value of the bank to its owners

Interest Rate Speed

difference between interest rate a bank receives on its assets and the interest rate it pays to obtain liabilities; aka risk spread

Secondary Credit

discount loans to banks that are not eligible for primary credit; interest rate is usually 50 basis points above primary discount rate

Eurodollars

dollar-denominated deposits outside the U.S.

Bank Run

event when depositors lose confidence in a bank and make withdrawals, exhausting the bank's reserves

Hard Pegs

exchange rate system in which central bank implements an institutional mechanism that ensures its ability to convert domestic currency into foreign currency to which its pegged

Economies of Scale

factors that cause a producer's average cost per unit to fall as output rises

Fire Sale

fall in the price of assets that takes place when financial institutions must sell their assets quickly in the midst of a crisis

Depository Institutions

financial institution that accepts deposits and makes loans; includes commercial banks, savings and loans, and credit unions

Central Bank

financial institution that manages the gov. finance's, controls the availability of money and credit in the economy, and serves as the bank to commercial banks; Federal reserve for the U.S.

Nondepository Institutions

financial intermediary that does not issue deposit liabilities

Sterilized Foreign Exchange Interventions

foreign exchange intervention that alters the composition of the central bank's assets but leaves the size of its liabilities unchanged

Government Examination

formal examination of an institution's books by specialists provides detailed info on the firm's operation

Deposit Insurance

government guarantee that depositors will receive the full value of their accounts (up to a legal limit) should a ban fail

Fiscal Policy

government's tax and expenditure policies, usually formulated by elected officials

Too-Big-to-Fail Policy

idea some financial institutions are so large that government officials cannot allow them to fail because their failure will put the entire financial system at risk

Zero Lower Bound

idea that a nominal interest rate cannot fall below zero

Universal Bank

institution that engages in all aspects of financial intermediation, including banking, insurance, real estate, brokerage services, and investment banking

Term Life insurance

insurance that provides a payment to the policyholder's beneficiaries in the event of the insured's death at any time during the policy' term

Discount Rate

interest rate at which the Fed makes discount loans to commercial banks

Discount Rate

interest rate at which the Federal Reserve makes discount loans to commercial banks

Federal Funds Rate

interest rate banks charge each other for overnight loans on their excess deposits at the Fed; interest rate targeted by the FOMC

Interest Rate on Excess Reserves

interest rate paid by the Fed on reserves that the banks hold in their accounts at the central bank in excess of reserve requirements

Price Stability

keep inflation low so prices are stable on average

Banks used to install _____ to make consumers feel safe. Now, they rely on ________ and government guarantees like ________.

large safes; their reputations; deposit insurance

Restrictive Covenants

limit the amount of risk a borrower can assume by restrict buyer from taking some kind of action or which requires they abstain from a specific action

Discount Loan

loan from Federal reserve, usually to a commercial bank

Unsecured Loans

loan not guaranteed by collateral

Inflation Targeting

monetary policy strategy that involves the public announcement of a numerical inflation target, together with a commitment to make price stability a leading objective

Return on Equity (ROE)

net profit after taxes/bank capital bank net profits after taxes divided by bank capital; a measure of the return to the bank's owners

Effective Lower Bound

nominal interest rate level below which people will switch from bank deposits to cash

Market Federal Funds Rate

overnight interest rate at which lending between banks takes place in the market; differs from the federal funds rate target set by the FOMC

Unconventional Monetary Policy Tools

policy mechanisms, that are usually reserved for extraordinary episodes when conventional interest rate policy is insufficient for economic stabilization; includes policy duration commitments, quantitative easing, and credit easing

Loan Loss Reserves

portion of bank capital that is set aside to cover potential losses from defaulted loans

Credit Risk

probability that a borrower will not repay a loan

Adverse Selection

problem of distinguishing a good risk from a bad one before making a loan or providing insurance; before a transaction occurs; caused by asymmetric info

Underwriting

process through which an investment bank guarantees the price of a new security to a corporation and then sells it to the public

Consumer Finance Firms

provide small installment loans to individual customers

Foreign Exchange Intervention

purchase or sale of foreign exchange by government officials with the intention of moving the nominal exchange rate

Reserve Requirement

regulation obligating depository institutions to hold a certain fraction of their demand deposits as either vault cash or deposits at the central bank

Required Reserve Rate

reserves/(deposits - capital)

Moral Hazard

risk a borrower or someone who is insured will behave in a way that is not in the interest of the lender or insurer; caused by asymmetric information

Operational Risk

risk financial institution faces from a computer hardware or software failure, natural disaster, terrorist attack, and the like

Liquidity Risk

risk that a financial institution's liability holders will suddenly seek to cash in their claims; the risk is depositors will unexpectedly withdraw deposit

Interest Rate Risk

risk that changes in interest rates will affect a financial intermediary's net worth; arises from mismatch in maturity of assets and liabilities

Repurchase Agreements (repo)

short-term collateralized loan in which a security is exchanged for cash, with the agreement that the parties will reverse the transaction on a specific future date, as soon as the next day

Primary Credit

short-term, usually overnight, discount loans made by the Fed to commercial banks; rate set at a spread above target federal funds rate

Bank liabilities tend to be _____ term, while its assets tend to be ____ term.

short; long

Information Asymmetry

situation in which one party is more informed than another because of the possession of private information; borrowers have info that lenders don't

Monetary Policy Framework

structure in which central bankers clearly state their goals and the tradeoffs among them; consists of: 1) accountability 2) independence 3) good communication

Dual Banking System

system in the United States in which banks supervised by federal government and state government authorities coexist

Monetary Policy Transmission Mechanism

the channels through which changes in the central bank balance sheet influence real economic activity

Time Consistency

the condition in which there is no future incentive to renege on a promise or policy commitment made today

Overnight Cash Rate

the overnight interest rate on interbank loans in Europe; the European analog to the market federal funds rate

What makes up a banks total assets?

total bank assets = total bank liabilities + bank capital

What is the breakdown of a bank's balance sheet?

total bank assets = total bank liabilities + total bank capital

Lender of Last Resort

ultimate source of credit to banks during a panic; role for a central bank

Hyperinflation

very rapid rise in the price level; an extremely high rate of inflation.

Potential Output

what the economy is capable of producing when its resources are used at normal rates; sustainable output; leads to sustainable growth

Where did "moral hazard" originate from?

when economists who were studying insurance noted that insurance policy changes the behavior of the person who is insured

Vesting

when the contributions your employer has made to the pension plan on your behalf belong to you

Insolvent

when the value of a firm's/bank's assets is less than the value of its liabilities; negative net worth