171A- Ch. 1-6 Q & A

An example of typically given to illustrate systemic financial risk is a run on the bank (I.e. many bank depositors simultaneously withdrawing their funds from a bank). Explain why.

A bank run could theoretically occur at any bank and spread across the financial system as more people demand their money from their banks. The interconnectedness of banks could possibly cause a failure of the entire financial system.

"Derivatives markets are nothing more than legalized gambling casinos and serve no economic function." Comment on this statement

Derivative contracts provide issuers and investors an inexpensive way of controlling some major risks. Controlling risk can take the form of greatly reducing price volatility for corporations and, subsequently, consumers. The increasing complexity of derivatives shows just how useful they can be in managing highly specific types of risk.

describe the current system for charging premiums for federal deposit insurance and how it differs from the way premiums were charged up until 1980.

Today, banks no longer pay premiums for federal government insurance. Instead, they effectively pay a premium in the form of a fine only if they violate risk-based capital requirements or acts that violate the supervisory process. This differs from the pre-1980 era when all banks paid premiums based on a set rate.

a) Why do credit rating agencies evaluate municipal debt obligations of U.S. entities that are tax-backed and revenue-backed in a different way? b) which type of municipal debt is analyzed in a manner similar to corporate debt?

a) CRAs evaluate tax-backed and revenue-backed debt obligations differently because tax-backed debt requires an analysis of future tax revenue while revenue-backed debt requires an analysis of cash flow generated by a specific project. b) The analysis of revenue-backed debt obligations is comparable to the factors considered when rating corporate debt.

What role does a CRA play in the financial market?

CRA ratings provide a critical function in the financial system by reducing information asymmetry in the market for debt obligations and private contracts.

What is meant by a performance-based management fee, and what is the basis for determining performance in such an arrangement?

Performance-based management fees, sometimes combined with a fixed fee based on assets managed, are variable fees to investors that depend upon the returns generated by the asset management company. These fees are generally a percentage of the return generated by the asset management firm.

What are the different forms of support that government bailouts can take?

Government bailouts can take the form of federal loans, lines of credit, and stock warrants.

explain why you agree or disagree: "risk-based capital requirements for banks consider only credit risk."

Risk-based capital requirements for banks consider not only credit risk but also the capital requirement's link to the bank's total assets. This change happened in 1988 with the implementation of the Basel Accords. Essentially, banks now have to counteract the increased risk of an asset with an increased capital requirement.

what is meant by the "rating shopping hypothesis"?

This hypothesis asserts that an issuer will search among the CRAs for the one that provides the best credit rating.

In an April 8, 2008, article in Bloomberg Businessweek, statement: "China investment Corp.'s chief risk officer denies allegations that the fund has hidden objectives in its investment strategy." a) what is the "China investment Corp."? b) what types of allegations do you think the quotation is referring to?

a) China Investment Corp. is China's sovereign wealth fund. b) The allegations likely refer to the Corp's noncommercial purposes, possibly investments in specific industries to gain military technology or trade secrets.

Explain each deposit account: a) demand deposits b) certificates of deposit c) money market demand accounts d) share deposits e) negotiable order of withdrawal accounts

a) Demand deposits do not pay interest but can always be withdrawn on demand. b) Certificates of deposit have a fixed maturity date and pay either a fixed or a floating interest rate. c) A money market demand account is an account that pays interest based on short-term interest rates. d) Share deposits are accounts at a credit union which are similar to checking accounts but pay interest. e) Negotiable order of withdrawal accounts are similar to demand deposits but pay interest.

Explain what is meant by each of the following: a) individual banking b) institutional banking c) global banking

a) Individual banking encompasses consumer lending, residential mortgage lending, consumer installment loans, credit card financing, automobile and boat financing, brokerage services, student loans, and individual-oriented financial investment services. b) Institutional banking encompasses loans to nonfinancial corporations, financial corporations, and government entities. c) Global banking covers a broad range of activities involving corporate financing and capital market and foreign exchange products and services. Global banks compete directly with investment banking firms.

a) in setting forth monetary policy, certain objectives, such as price stability, can be quantified. Explain why. b) in contract to such objectives as price stability, monetary policy objectives dealing with financial stability cannot be quantified. Explain why.

a) Price stability objectives target a specific rate like inflation, which is easily quantified. b) Other factors dealing with financial stability are often complex nonmonetary factors which change over time and cannot be necessarily counted or quantified.

What is meant by a systemically important financial institution (SIFI)?

A systemically important financial institution is one that in the view of regulators is a large firm whose failure would cause a financial crisis.

A bank issues an obligation to depositors in which it agrees to pay 3% guaranteed for one year. With the funds it obtains, the bank can invest in a wide range of financial assets. What is the risk if the bank uses the funds to invest in common stock?

If the bank invests the funds in common stock, it faces market risk and will be subject to the level and volatility of market prices.

In January 2003, the U.S. SEC published a report on the role and function of the CRAs in the operation of the securities markets. Part 2 of the report provides a background discussion of how credit ratings have become incorporated into the U.S. regulatory framework. Give at least two examples of how regulators have used credit ratings to do the stipulated activities

In 1975, the term "NRSRO" was adopted so that the SEC could determine how much capital brokerage firms and dealer firms must hold for different grades of debt instruments on their balance sheets. Additionally, the Secondary Market Enhancement Act of 1984 stipulated that mortgage-related securities be rated in one of the two highest rating categories by at least one of the CRAs.

Explain why you agree or disagree with the following statement: " when a household purchases life insurance, there is no risk, insofar as the issuer of the policy guarantees a death benefit payment."

Life insurance companies provide protection in the form of financial guarantees to policyholders. Life insurance companies are therefore the risk bearers, not households.

Give three reasons for the trend toward greater integration of financial markets throughout the world.

1) Deregulation or liberalization of markets and the activities of market participants in key financial centers of the world 2) Technological advances for monitoring world markets, executing orders, and analyzing financial opportunities 3) Increased institutionalization of financial markets

On August 25, 2017, Facebook's common stock closed at a price of $166.32 and the market cap of the company was $489.97 billion. What was the approximate number of shares outstanding?

29,459,476 ($489.97 billion divided by $166.32)

explain the ways in which a bank can accommodate withdrawal of deposits.

Banks are generally able to accommodate for withdrawal of deposits through their required reserves. If banks are temporarily short of their required reserves, they can borrow reserves in the federal funds market or borrow temporarily from the Fed at its discount window.

what is the difference between the claim of a debtholder of Chevron Corp. and the common stockholder of the Chevron Corp.?

Based on Chevron's earnings, debtholders will be paid first, and then common stockholders will receive the remaining amount.

What is the relationship between a CRA and a nationally recognized statistical rating organization?

Because CRAs play a critical role in credit markets by performing credit analysis on entities issuing securities or private contracts, in the United States, entities that have been recognized by the Securities and Exchange Commission (SEC) to assign ratings are referred to as nationally recognized statistical rating organizations (NRSROs).

In 2016, McDonald's issued in the Swiss bond market an eight-year bond denominated in Swiss francs (CHS). The par value was CHF 400 million. From the perspective of the classified as being issued in the domestic market, the foreign market, or the offshore market.

Because McDonald's is an American corporation selling a financial instrument in Switzerland, the bond would be issued on Switzerland's foreign market.

A U.S. investor who purchases the bonds issued by the U.S. government makes the following statement: "By buying this debt instrument, I am not exposed to default risk or purchasing power risk." Explain why you agree or disagree with this statement.

Because no investment is without risk, the investor is wrong in his analysis of both default risk and purchasing power risk. However, the U.S. government is extremely unlikely to default anytime soon and a U.S. bond is likely one of the world's safest bond investments as far as default risk is concerned. The stability of the U.S. government provides no guarantee of future purchasing power, so this risk remains on the table for the investor.

Explain why you agree or disagree: "not only does the Fed have the power to examine banks, it now oversees the country's systemic risk."

Modern legislation has significantly expanded the Fed's role to include examining banks and overseeing the country's systemic risk. The Financial Services Modernization Act of 1999 made the Fed the umbrella regulator for financial holding companies. Additionally, the Dodd-Frank Act made the Fed the primary regulator of all financial firms that the Financial Stability Oversight Council (FSOC) designates as systemically significant, as well as the safety and soundness authority over the payment, clearing, and settlement systems that the FSOC identifies as systemically important and that are not regulated by the Commodities Futures Trading Commission or the SEC.

Consider this headline from the New York Times of Mark 26, 1933: "Bankers Will Fight Deposit Guarantees... bad Banking would be encouraged." a) what do you think this headline is saying? b) discuss the pros and cons of whether deposits should be insured by the U.S. government

a) The headline is likely saying that removing deposit guarantees would lead to banks making riskier investments as they would not be constrained by deposit guarantees. b) Insuring all deposits provides stability across the banking system and gives depositors peace of mind concerning the safety of their money. However, requiring deposit insurance has historically incentivized some banks to take on more risk under the assumption that federal guarantees would protect their depositors, should the investments fail to generate a return.

Explain the difference between each of the following: a) money market and capital market b) primary market and secondary market c) domestic market and foreign market d) national market and Euromarket

a) The money market is used to exchange short-term debt instruments, while the capital market is used to exchange longer-maturity financial assets. b) The primary market is used to exchange newly issued financial claims, while the secondary market is used to exchange previously issued financial claims. c) The domestic market is where issuers domiciled in a country issue securities and where those securities are subsequently traded. The foreign market of any country is where the securities of issuers not domiciled in the country are sold and traded. d) The Euromarket allows newly issued securities to be available in multiple countries simultaneously, while the national market only allows them to be available in the country where the national market exists initially. Securities issued in the national market of a country are issued under the jurisdiction of the country where the national market exists. Securities issued in the Euromarket, however, are issued outside of the jurisdiction of any single country.

Match the type of liabilities to these four assets that an individual might have: a) car insurance company b) variable- rate certificate of deposit c) fixed-rate certificate of deposit d) a life insurance policy that allows the holder's beneficiary to recieve $100,000 when the holder dies; however, if the death is accidental, the beneficiary will recieve $150,000

a) Type 2 (amount of cash outlay KNOWN, timing of cash outlay KNOWN) b) Type 3 (KNOWN, UNCERTAIN) c) Type 1 (UNCERTAIN, KNOWN) d) Type 4 (UNCERTAIN, UNCERTAIN)

Indicate whether each of the following instruments trades in the money market or the capital market: a) General Motors Acceptance Corporation issues a financial instrument with four months to maturity b) The U.S. Treasury issues a security with 10 years to maturity c) Microsoft Corporation issues common stock d) The State of Mississippi issues a financial instrument with eight months to maturity

a) money market b) capital market c) capital market d) money market

what was the purpose of the Targeted Asset Relief Program (TARP)?

The purpose of TARP was to deal with the adverse economic consequences resulting from the subprime mortgage crisis that began in the summer of 2007.

what is the difference between FDI and foreign portfolio investment?

Foreign portfolio investment is of a more temporary nature than foreign direct investment.

What factors affect the interest rate used to discount the cash flow expected from a financial asset?

Purchasing power risk, credit risk, and currency risk

What is the purpose of the Basel Committee on Banking Supervision of the BIS?

The purpose of the Basel Committee on Banking Supervision is to educate policymakers on the key issues associated with the supervision of banks and by doing so improve the quality of bank supervision throughout the world.

Explain how a financial intermediary reduces the cost of contracting and information processing.

Financial intermediaries have highly trained employees focused on contracting and information processing. This lowers the cost of contracting and information processing through increased efficiency via economies of scale.

Does ERISA require that a corporation establish a pension fund?

ERISA does not require that a corporation establish a pension plan.

why is there concern that investors over rely on credit ratings when making investment decisions?

The reason for concern is that investors, particularly institutional investors, may rely on ratings without performing their own credit analysis and that herd behavior may result from relying solely on ratings.

In September 1990, a study by the U.S Congress, office of technolofy assessment, titles "Electronic Bulls & Bears: U.S. Securities Markets and Information Technology," included the following statement: "Securities markets have five basic functions in a capitalistic economy: 1) they make it possible for corporations and governmental units to raise capital 2) they help to allocate capital toward productive uses 3) they provide an opportunity for people to increase their savings by investing in them 4) they reveal investors' judgements about the potential earning capacity of corporations, this giving guidance to corporate managers 5) they generate employment and income For each of the functions cited above, explain how financial markets (or securities markets, in the parlance of this Congressional study) perform each function

1) Financial markets allow corporations and governmental units to sell financial assets in exchange for capital. 2) Investors looking for a return use often put their money to work for other companies who can then employ more people, fund innovation, and serve consumers better. 3) Financial markets provide many different investment options, all of which show the potential of returns. These range from low return, low risk government bonds to high risk, potentially high return equities or derivative contracts. 4) The price of a financial asset, determined through the price discovery process of a financial market, provides important signals that are responsive to actions that corporate managers make. 5) When capital is put to use through financial market investments, it allows employers to employ more people and provide higher incomes.

What is meant by the "institutionalization," of capital markets?

As markets have grown tremendously in size, institutional investors have begun to trade much more than retail investors. This means that more and more trading is being conducted by highly experienced and large institutional investors. Another effect of this trend is that investors increasingly look for global portfolio diversification and arbitrage opportunities.

What is a central bank, and how does it participate in the financial market of another country as a foreign investor?

A central bank is an institution of a country which acts to influence financial markets at the macroeconomic level. A central bank can participate in another country's financial market by buying or selling financial assets either to stabilize that country's currency relative to its domestic currency or as an investment vehicle.

why does a defined benefit plan create a future liability for a plan sponsor?

A defined benefit plan requires the sponsor to pay qualified employees covered by the plan benefits when they retire in the future. The financial risk associated with the future payments of a defined benefit plan are those of the sponsor because the sponsor is obligated to make the payments to pay qualified employees regardless of future corporate earnings.

Explain whether you agree or disagree: "A nationally statistical rating organization is permitted to provide a credit rating for any type of debt obligation."

A nationally recognized statistical rating organization may only issue ratings for different types of debt obligations based on which of the five rating categories it is registered in.

What is a rating transition matrix, and how can it be used by an investor?

A rating transition matrix is a table of information published periodically by a CRA that shows the hypothetical probability of how multiple issue grades may change over a set time period. Investors can use this information to make informed credit decisions.

what is a supranational institute, and what is its general objective?

A supranational institution is an organization formed by two or more central governments through international treaties with the purpose of promoting economic development for their member countries.

What is the difference between a financial asset and a tangible asset?

A tangible asset's value depends on its physical properties, while a financial asset represents a legal claim to some future benefit.

why do you think a debt instrument whose interest rate is changed periodically based on some market interest rate depository institution than a long-term debt instrument with a fixed interest rate?

A variable, market-based interest rate can adapt to changing market conditions that may impact the indebted party's ability to repay the amount owed. Because future outside economic forces are unpredictable, having the market periodically set the rate could properly adjust the rate to account for changes in the risk of default that a fixed interest rate simply could not.

explain why you agree or disagree: "in recent years, the differences in regulatory treatment and activities of banks compared to thrifts have increased."

Although there are differences between banks and thrifts in terms of the activities in which they specialize and certain regulatory oversight, all depository institutions have become more alike as a result of the Dodd-Frank Act and the adoption of the international capital standards required by the Basel Accords.

What is the source of income for an asset management firm?

Asset management firms receive their compensation primarily from management fees charged based on the market value of the assets managed for clients.

Explain why liquidity may depend not only on the type of financial asset but also on the quality one wishes to sell or buy.

Available liquidity is dependent on the number of market participants and relative demand for a financial asset. If an investor wants to sell 100,000 shares of common stock in a relatively small company all at the same time, he will have great difficulty finding buyers at the price he wants. However, if he wanted to sell 100 shares all at once, he would likely have no problem. Highly specific financial assets are less likely to have liquidity in their markets because there is often a mismatch between buyers and sellers, or no demand at all for certain financial assets.

What is meant by corporate governance risk, and why do credit rating agencies employ it?

Corporate governance risk is the eagerness of corporate management to present favorable results to shareholders and the market for the purpose of acting in their own self-interest. CRAs employ this to ensure that management avoids scandals and losses by acting in the interest of the company, rather than themselves.

When assigning a credit rating, the CRAs analyze a company's business risk. What is meant by business risk?

Business risk is the risk associated with generating operating cash flows, which are uncertain.

The Insightful Management Company sells financial advice to investors. This is the only service provided by the company. Is this company a financial intermediary? Explain your answer.

By definition, a financial intermediary obtains funds by issuing financial claims against themselves to market participants, and then invests those funds. A company that only sells financial advice does not fit this description and is therefore not a financial intermediary.

why is it difficult to determine the cash flow of a financial asset?

Cash flow can be influenced by a large number of factors, and it is difficult to know with certainty how these factors will change in the future. Some of these factors are controlled by the issuer, such as timing of dividend payments, but other factors remain out of their control. It is also more difficult to determine the default rate of less stable issuers.

why are the characteristics of an issuer important in determining the price of a financial asset?

Characteristics of an issuer can collectively determine a risk level of a financial asset. The level of risk can have a large impact on the expected cash flow.

what are the two basic types of derivative instruments?

Futures/forward contracts and options contracts

what is the basic function of depository institutions?

Depository institutions raise funds through deposits and other sources and then use those funds to make direct loans to individuals, nonfinancial and financial businesses, and state and local governments. They generate a profit by earning a spread between the return realized on their investment and the cost of obtaining funds.

Explain how the household sector participates as both a borrower and a lender of funds in the financial market.

Households issue debt obligations in the financial market when they borrow funds to finance consumer purchases on credit, purchase a home by borrowing funds, or obtain student loans to pay for higher education. When households save, they use those funds to invest in financial assets. Most households both save and borrow funds, making them important participants in the financial market.

What is the difference between an emerging stock market and a frontier stock market?

Emerging markets are currently developing while frontier markets have not begun developing yet.

What is meant by "regulation of financial activities"?

Financial activity regulation consists of rules about traders of securities and trading on financial markets, for instance, laws that prevent insider trading.

"All financial intermediaries provide the same economic functions. Therefore, the same investment strategy should be used in the management of all financial intermediaries." Indicate whether you agree or disagree with this statement and explain.

Financial intermediaries vary greatly in their organizational structure and purpose (such as commercial banks versus investment companies), therefore, they should have different investment strategies that suit the needs of their clients and themselves.

Why are households viewed as the ultimate risk bearers?

Households are the ultimate bearers of financial risk in the financial system. Although there are financial institutions and government programs that provide different forms of guarantees for the financial products that they issue, if the guarantors fail to fulfill their obligation, the risk is borne by households.

what is the basic function of insurance companies?

Insurance companies provide insurance protection against the occurrence of future events that will adversely affect the insured. For providing this protection they receive an insurance premium.

Each year, millions of American investors pour billions of dollars into investment companies, which use those dollars to buy the common stock of other companies. What do investment companies offer investors who prefer to invest in the investment companies rather than buying the common stock of these other companies directly?

Investing in investment companies offer a number of advantages to investors, including cost effective information processing and contracting which the investors themselves do not even need to deal with. High specialization and many more available supporting resources generally make investment companies better at generating returns than individual investors effectively. Investment companies may also allow investors to better diversify their portfolios because of their expertise in the wide range of available financial products.

Macro vs Microprudential policy

Macroprudential policy focuses on the welfare of the entire financial system by ultimately acting to limit costs to real GDP. Because this policy involves interconnected institutions, correlations and common exposure are important aspects to pay attention to. This is a top-down approach that focuses on the large scale. Microprudential policy focuses on the welfare of the individual financial institutions by ultimately acting to limit consequences for consumers in a particular institution. Because this policy involves independent institutions, correlations and common exposure are not important aspects to pay attention to. This is a bottom-up approach that focuses on the small scale.

On August 25, 2017, the market capitalization of ExxonMobil was $324.73 billion. In terms of market cap, how would this company's stock be classified?

Mega-cap stock

how do nonfinancial corporations participate in the financial markets?

Nonfinancial corporations issue both common stock and debt obligations, which are then traded in financial markets. Additionally, nonfinancial corporations sometimes invest excess cash in the financial markets on a short-term basis.

What is the purpose of the Markets Committee of the BIS?

The Markets Committee's purpose is to provide policy guidelines for enhancing market transparency, developments in finance markets, and an exchange of views on future developments that will have an impact on financial markets while also providing a forum for central bankers to discuss the specifics of their own market operations.

what is meant by a rating "notch"?

Rating notches are essentially subcategories within a grade of bond ratings. For example, Fitch's AA grade has the more detailed subcategories of AA+, AA, and AA.

Why is the distinction between investment grade and non investment important for investors?

Regulations may prohibit institutional investors from purchasing noninvestment-grade debt.

In March 1996, the Committee on Payment and Settlement Systems of the BIS published a report titled "Settlement Risk in Foreign Exchange Transactions" that offers a practical approach that banks can employ when dealing with settlement risk. What is meant by "settlement risk"?

Settlement risk is the risk that when there is a settlement of a trade or obligation, the transfer fails to take place as expected. Settlement risk consists of counterparty risk (a form of credit risk) and a form of liquidity risk.

Explain why some subsidiaries of a nonfinancial business can be classified as financial businesses.

Some nonfinancial corporations have subsidiaries that are involved in the same activities as financial corporations and are referred to as captive finance companies. These subsidiaries often provide a wide range of financial products and services.

what is mean by "systemic financial risk"?

Systemic financial risk means risk to the entire financial system, which is better understood as the probability that an entire system will collapse or fail.

What does the Financial Stability Oversight Council (FSOC) have the authority to do?

The Financial Stability Oversight Council (FSOC) has the authority to constrain nonbank financial entities from what the FSOC views as excessive risk taking that threatens the stability of the financial system.

How did the U.S. congress deal with the financial problems faced by Fannie Mae and Freddie Mac in 2008?

The U.S. Congress dealt with both entities by bailing them out and placing them under conservatorship of the U.S. government. The government promised future capital investments of $100 billion to each entity in exchange for a form of stock and a 79.9% ownership stake.

What two solutions to the "too big to fail" issue have been suggested?

The first approach is a commitment by the government that it will no longer permit a bailout. The second approach is the implementation of the Dodd-Frank Act which authorizes the Financial Stability Oversight Council to constrain nonbank financial entities from what the Council views as excessive risk taking that threatens the stability of the financial system.

what are the two principal roles of financial assets?

The first is to transfer funds from those who have surplus funds to invest to those who need funds to invest in tangible assets. The second economic function is to transfer funds in such a way as to redistribute the unavoidable risk associated with the cash flow generated by tangible assets among those seeking and those providing the funds.

What are the views held by economists on the degree of regulation needed for financial markets?

The first view is that there should be large-scale government interventions to solve problems that involve massive market failures. The second view is that government intervention is the problem, not the solution, and in fact may lead to market failures by implementing policies that are not beneficial to financial markets.

A U.S. investor who purchases the bonds issued by the Japanese government makes the following comment: "Assuming that the japanese government does not default, I know what the cash flow of the bond will be." Explain why you agree or disagree with this statement

The investor is correct that the cash flow of the bond is known with certainty if the Japanese government does not default. However, the purchasing power of the cash flow received cannot be known with certainty even with the assumption that the Japanese government will not default.

what is the concern with the issuer-pay model used by credit rating agencies?

The issuer-pay model can result in a potential for conflicts of interest, which calls into question the objectivity of ratings. More specifically, it has been argued that issuers will select a CRA from which it can obtain the highest possible rating, and that, in an attempt to attract issuers, a CRA will compromise its rating criteria to the benefit of the issuer.

Why do CRAs assign both a local currency debt rating and a foreign currency debt rating?

The reason for distinguishing between local debt ratings and foreign currency debt ratings is that historically, the default frequency differs by the currency denomination of the debt.

What is the economic rationale for the widespread use of disclosure regulation?

The managers of the issuing firm have more information about the financial health and future of the firm than investors who own or are considering the purchase of the firm's securities, therefore disclosure regulation is necessary to prevent asymmetric information.

what is the basic principle followed in determining the value of a financial asset?

The price of a financial asset is equal to the present value of its expected cash flow, even if the cash flow is not known with certainty.

what are the stated objectives of SWFs?

The primary motive given for the establishment of an SWF is to maximize returns available from investments outside the country that has established the SWF. SWFs are generally used for commercial purposes but may be used for noncommercial purposes.

Why do some economists believe that disclosure regulation is unnecessary?

They argue that the securities market would, without governmental assistance, get all the information necessary for a fair pricing of new as well as existing securities.

What are the primary assets held by S&Ls?

They primarily hold qualified thrift investments.

In 2004, then chair of the president's council of Economic Advisors, Gregory Mankiw, stated: "Expecting a government bailout if things go wrong creates an incentive for a company to take on risk and enjoy the associated increase in return." Explain whether you agree or disagree with this statement.

This statement makes sense because unregulated action in systemically important financial institutions combined with the near guarantee of a government bailout creates moral hazard.

Explain what is meant by each of the following: a) reserve ratio b) required reserves c) excess reserves

a) Reserve ratios are a specified percentage of their deposits in a noninterest-bearing account at one of the 12 Federal Reserve Banks. b) Required reserves are the dollar amounts based on a bank's reserve ratios that are required to be kept on deposit at a Federal Reserve Bank. c) Excess reserves are the positive difference between actual reserves and required reserves.

Why is the holding of a claim on a financial intermediary by an investor considered an indirect investment in another entity?

When an investor holds a claim on a financial intermediary, he or she also effectively has made an indirect investment in the borrowing entity because the financial intermediary's direct investment is in that borrowing entity.

Statement in 2009 titled "finance: a return from risk" states: "banks are dangerous institutions. they borrow short and lend long. they create liabilities which promise to be liquid and hold few liquid assets themselves. that though is hugely valuable for the rest of the economy. household savings can be channeled to finance illiquid projects while providing access to liquidity for those savers who may need it" Explain what this means.

When banks receive their depositor's money, they are liable to pay some or all of it back to the depositors at any time. Banks then take this money and loan it out to individuals who often cannot afford to pay back even the initial amount of the loan before the addition of interest until a time further in the future. Because banks are large institutions and most depositors leave a significant portion of their deposits in banks for a long period of time, banks have the ability to borrow short and lend long. This service makes illiquid investment projects feasible and puts capital to use in search of returns.

a) what is the function of the PBGC? b) explain agree or disagree. "workers whose pension plan is insured by the PBGC are guaranteed the full amount of their pension income."

a) The Pension Benefit Guaranty Corporation (PBGC) insures qualified private defined benefit plans. b) The PBGC's guarantee is not a guarantee by the U.S. government. Moreover, the likelihood is that without a bailout, the PBGC will not have sufficient funds to pay off the obligations that it has insured.

A) in what ways does a government act like a financial intermediary? b) what are the concerns when a government plays the role of a financial intermediary?

a) A government acts like a financial intermediary by providing loans and guarantees. b) By providing low interest loans, a government may fuel bubbles and cause market failure by encouraging activity that would otherwise not take place. Additionally, a government may underestimate risk when pricing loans due to the lack of a profit motive.

a) How is an asset class defined? b) what are the traditional asset classes?

a) An asset class is defined in terms of the investment attributes that the members of the asset class have in common or by the characteristics of a group of assets that is treated as an asset class by asset managers. b) Common stocks, bonds, cash equivalents, and real estate

Statement: "Although a commonly held view of systemic risk suggests that financial stability can be secured through a macroprudential approach, an analysis of the origin of financial crises with significant macroeconomic costs suggests that a macroprudential perspective is important" a) What is meant by "financial stability"? b) Why is a macroprudential perspective important when dealing with financial stability?

a) Financial stability in this context refers to a state of the financial system where systemic risk is low. b) Regulation of the broader financial system and not only select financial institutions may be necessary to create financial stability. The importance of macroprudential policy for securing financial stability became clear to many leaders after the 2008-2009 global financial crisis.

a) what are the arguments in favor of government bailouts? b) what are the arguments against government bailouts?

a) Proponents of bailouts argue that the interconnectedness of financial institutions throughout the United States and global markets creates systems and institutions within financial markets that are "too big to fail." Should these institutions fail, the domestic and global consequences would be far severer than the cost of a bailout. Therefore, a bailout must occur to prevent further damage to the financial system. b) Opponents of bailouts argue that bailing out the largest institutions incentivizes bad or irresponsible behavior at those institutions because they know that, should they fail, the government will bail them out. These bad incentives are also known as moral hazard.