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.