Federal Reserve & Economics

What are 5 functions of the federal reserve system? (not in relation to regulating monetary policy directly)

1. Auditing Member Banks 2. Lending to Commercial Banks 3. Acting as an agent for the US Treasury 4. Regulating bank Credit 5. Being a lender of last resort

What are the four stages of the Business Cycle?

1. Expansion 2. Peak 3. Contraction 4. Trough

What are two effects of the US dollar appreciating in relation to other currencies?

1. US exports become less competitive in world markets 2. Foreign imports become more competitive in US markets

What are two effects of the US dollar depreciating in relation to other currencies?

1. US exports become more competitive in world markets 2. Foreign imports become less competitive in US markets

Current Yield Formula

Annual Dividends/ Market Price

Which of the following is correct concerning the federal funds market? [A] Non-U.S. banks are prohibited from participating. [B] Smaller regional banks are a primary source of federal funds. [C] The sole participants are banks. [D] The federal funds rate is always kept either below or at the same level as the discount rate.

B. Federal funds are excess funds deposited by commercial banks at Federal Reserve Banks. One major source of federal funds are smaller regional banks as well as large regional banks, savings and loans, federal agencies and securities firms. In normal market situations the federal funds rate is higher than the discount rate but fluctuates based on interest rate moves and funds available.

You believe that the Federal Reserve Board will raise interest rates over the next few months and inflation has been slowly going up. Based on these facts which of the following investment choices would be the LEAST appealing? [A] a bond portfolio with varied maturities [B] a mutual fund that consists of long term U.S. Government Bonds [C] Treasury Bills [D] Money Market fund

B. Of the choices offered the LEAST attractive would be the mutual fund that consists of long term U.S. Government bonds. When you expect interest rates to go up soon you should invest in securities with short-term maturities, let the rates go up and then be able to reinvest at a higher rate.

Which of the following actions taken by the Federal Reserve Boards Open Market Committee (FOMC) would MOST likely cause a rise in interest rates? [A] The distribution of government securities [B] selling securities through open market operations [C] buying securities through open market operations [D] Calling in outstanding Treasury bonds

B. When the Federal Open Market Committee sells government securities, they sell them to member banks, therefore taking money out of the system. This shrinking of the money supply would cause a tightening of money and credit which could cause banks to increase interest rates.

To stimulate the economy, the Fed would _____ US Gov securities

BUY

The World Bank

Bank's purpose is to assist developing nations by providing them with loans

Currently, there is an inverted yield curve. Which of the following would be TRUE in this situation? [A] Typically, the bond market will see increases in the amount of issuances of discount bonds. [B] Typically, the bond market will see decreases in the amount of issuances of discount bonds. [C] Typically, increases in yields will be anticipated by investors in the bond markets. [D] Typically, decreases in yields will be anticipated by investors in the bond markets

C. When we see a negative yield curve (inverted yield curve), it is an indication that a sharp rise in rates has just occurred. The yields on short-term securities will be greater than yields on long-term securities. (Remember, Short-Term react the quickest). Next, after the short-term yield increase, it would be anticipated that long-term rates will be increasing as more long-term bonds with higher yields come to market.

Which of the following rates would be changed least frequently: [A] Federal funds [B] Prime [C] Passbook savings [D] Discount

C. The passbook savings rate is the least sensitive to interest rate changes. Conversely, the federal funds rate is the most sensitive.

If the Fed ____ the discount rate, it would have the effect of stimulating the economy

DECREASED

Eurodollars

Deposits in US dolalrs that have been deposited with banks outside of the US and are frequently used to settle international transactions

Floating Exchange Rate

Determined by the intervention by the central banks and market forces, supply and demand

Keynesian Economic Theory

Economic theory states that an increase in government spending can help to avoid/prevent a depression/economic instability

Monetarist Theory

Economic theory states that controlling the money supply ha sa great impact on economy

Supply-Side Economics Theory

Economic theory states that reductions in tax rates and seize of government will stimulate the economy.

Breakeven formula for put options (no stock transactions involved)

Exercise Px - Premium

Expansion

Expansion indicates a recovery period

Coupon Rate/Nominal Yield

Fixed rate of interest that is paid to investors

Federal Funds

Funds deposited by commercial banks at Federal reserve banks that are in excess of bank reserve requirements

A decline in which of the following would probably cause the Federal Reserve to increase the money supply? I.Consumer Price Index (CPI) II.Unemployment. III.Municipal bond yields IV.Gross Domestic Product (GDP)

I & IV A decline in the GDP (a measure of economic activity) and the CPI (a measure of inflation) would indicate consumers were producing less and buying less, bringing down economic activity and prices as well. This implies that money has been too tight (rates are too high), at which point, the Federal Reserve might increase the money supply, thereby lowering interest rates with the expectation it would spur economic growth and likely stop the fall in CPI. Declining municipal bond yields and a lower unemployment rate could be the result of the Fed already having increased the money supply, so they wouldn't prompt the Fed to increase the money supply even further.

If the Federal Reserve buys government securities in the open market, which of the following will normally occur? I.Bond prices will increase. II.Bond prices will decrease. III.Yields will increase. IV.Yields will decrease.

I & IV Buying government securities in the open market allows the Federal Reserve to increase the supply of money in circulation. This usually pushes interest rates down, causing bond prices to increase. I and IV are correct.

An increase in the Federal Reserve's Discount Rate would most likely lead to an increase in which of the following? I.Broker Loan Rate II.Prime Rate III.Discount on Treasury Bills IV.Availability of Bank Loans

I, II, & III The discount rate is an interest rate and all interest rates tend to move in the same direction at the same time thus if the discount rate increased, the: •Broker Loan rate would increase •Yields on T-Bills would increase thus increasing the discount in price

Commercial paper in the money market: I.is usually priced based on the semi-annual interest payment. II.is a promissory note issued by a major corporation. III.is guaranteed by the FDIC up to $40,000 face amount. IV.is usually priced to yield less than Treasury Bills for the same maturities

II The only statement that is correct regarding Commercial Paper is that these are promissory notes issued by major corporations.

Which of the following would increase U.S. exports? I.Strengthening dollar II.Weakening dollar III.Balance of payment deficits IV.Balance of payment credits

II & IV A weakening dollar would tend to increase exports because as the dollar weakens, other currencies have more buying power. A deficit would tend to promote the U.S. to take actions which would increase exports to lower the deficit.

A registered representative is planning on recommending the purchase of a Brokered CD to a client. In doing so, the RR must make which TWO of the following disclosures? I.A disclosure pertaining to the legislative risks associated with such products. II.A disclosure related to interest rate risk and how it affects brokered CDs. III.A disclosure of risks that may be incurred by the fluctuation of currency values. IV.A disclosure of liquidity risk associated with brokered CDs.

II & IV Brokered CDs are typically offered by brokerage firms. They are time deposits which pay a set rate of return over the time held. Both interest rate risk and liquidity risk are concerns with brokered CDs, because rates may fluctuate and though Brokered CDs are liquid investments, they are not as liquid as other investments.

If the Fed _____ the discount rate, it would have the effect of slowing the economy

INCREASED

A US balance of payments deficit would increase(worsen) due to

Increase in US investments abroad, US tourists spending abroad, US loans to other countries raising dividends and interest payments on foreign-owned securities, money going out of the US

Contraction

Indicates a recessionary period

During periods of deflation, you would buy ____ term bonds

LONG

Long Puts protect or Hedge a _____ stock option

LONG

Capital Market Instruments

Long term debt and equity instruments

If the Federal Reserve attempts to control the economy by influencing interest rates, it is using:

Monetary Policy The Federal Reserve Board attempts to control money and credit by utilizing Monetary Policy and would impact interest rates by engaging in Open Market Operations.

Consumer Price Index (CPI)

Monthly measure of the change in price of the average goods and services brought by wage earners in selected US cities

Producer Price Index (PPI)

Monthly measure of the change in producer prices of industrial and farm commodities

A US balance of payments deficit would decrease (improve) due to:

New foreign investments in the US commodity exports, spending by foreign tourist in US, increased dividend and interest earned on foreign investments, money coming into the use

Peak

Peak indicates the top of an expansion period

Discount Rate

Rate charged by fed reserve on loans to cover deposit requireemnts

Maturity of a Repurchase Agreement

Repos are generally overnight transaction but can have maturities of up to 3 months.

Commercial Paper

Represents unsecured promissory notes of corporations and are one of the best ways for a corporation to raise short term funds

To slow down the economy the Fed would ___ US Govt securities

SELL

During periods of inflation, you would buy _____ term bonds

SHORT

If the Fed increased reserve requirements, banks would lend less freely, thereby _____ the economy

SLOWING

Money Market Instruments

Short term debt instruments with maturities of 12 months or less and most are highly liquid

Eurodollar Certificates of Deposit (Eurodollar CDs)

Short term instruments issued by banks outside of US

Individual Certificates of Deposits (CDs)

Short term instruments which are guaranteed by banks in return for time deposits

Jumbo Certificates of Deposit (Jumbo CDs)

Short term instruments with a minimum deposit of $100,000 that are issued and guaranteed by banks

An inverted yield curve means that:

Short-term interest rates are higher than long-term rates A yield curve is a graph that shows the relationship between interest rates and maturities. If short-term rates are lower than long-term rates, it is called a positive (normal) yield curve. If short-term rates are higher than long-term rates, it is called an inverted yield curve.

Repurchase Agreement (REPOs

Short-term money market instruments which are agreements. Securities are sold by a firm with the agreement to repurchase them at a later date at an agreed upon price

Zero Coupon Bonds

Sold at deep discount and pay no interest while the bonds are outstanding

If the Fed lowered reserve requirements, banks may lend more money freely, thereby ____ the economy

Stimulating

Prime Rate

The interest rate charged by commercial banks on loans to their best customers

International Monetary Fund (MF)

This organization is funded by industrialized nations. Its purpose include promoting monetary and exchange stability and international trade

Ascending/Normal Yield Curve

This yield curve shows short-term yields as substantially lower than long-term yields

Gross National Product (GNP)

Total value of all goods and services produced and shipped inside and outside the country

The interbank Market

Unregulated, decentralized global market which trades currencies

Banker's Acceptances

Used to finance foreign trade

Moral Suasion

When the fed tries to influence or persuade member banks to adopt certain policies rather than mandate change through regulations or FOMC actions

Open Market Operations

When the federal reserve buys or sells gov securities including T-bills, t-notes, t-bonds, and Fed agency issues in order to inject money into or remove money from the economy

Inflationary Period

When we see too much money chasing too few goods which causes rising prices and interest rates

Descending/Inverted Yield Curve

Yield curve shows short-term yields as substantially higher than long-term yields

Eurodollar bonds

bonds issued outside of the us by either foreign or domestic corporations

Recovery is often defined as

increase in GDP for at least 6 months

Trough

indicates the bottom of a recessionary period

Long-term equity anticipation securities (LEAPS)

long-term options on stocks and on stock indexes. These options give investors essentially the same privileges as short-term options but have the added benefit of the longer-term expiration

An investor who establishes a Long Straddle expects the market to _____

make a major move either up or down

Recession is often defined as:

mild consecuritve 6 months decline in stock prices, business activity, and employment

In the money or intrinsic value of a Put

occurs when the market price of the stock is less than the exercise price of the option

Interest rate options

options on the YIELD of US treasury seucirities (not price). Value of these options is based on interest rate and interest rate movements, not on the market price of the underlying treasuries

Federal funds rate

rate banks charge each other for overnight loans

LIBOR

rate that international banks charge each other

NYSE Minimum maintenance for a SHORT margin account

require customer must maintain 30% of the current market value of securities in the form of equity in the short margin account

Gross Domestic Product (GDP)

total value of all goods and services produced within US boundaries