AP Economics - Chapters 31, 32, 33, and 34

commercial bank

A firm that engages in the business of banking (accepts deposits, offers checking accounts, and makes loans)

M2

more broadly defined money supply M2 = M1+ noncheckable savings (including money market deposit accounts), small time deposits (deposits of less than $100,000), and individual money market mutual fund balances

M1

most narrowly defined money supply M1 = currency in the hands of the public + checkable deposits of commercial banks and thrift institutions

actively managed funds

mutual funds that have portfolio managers who constantly buy and sell assets in an attempt to generate higher returns than some benchmark rate of return for similar portfolios

index funds

mutual funds that select stock or bond portfolios to exactly match a stock or bond index (a collection of stocks or bonds meant to capture the overall behavior of a particular category of investments) such as the Standard and Poor's 500 Index or the Russell 3000 Index

passively managed funds

mutual funds whose portfolios are not regularly updated by a fund manager attempting to generate high returns. once initial portfolio is selected, it is left unchanged so that investors receive whatever return that unchanging portfolio subsequently generates ex) index funds

Federal Reserve Note

paper money issued by the Federal Reserve Banks

interest

payment made for the use of money (of borrowed funds)

dividends

payments by a corporation of all or part of its profit to its stockholders (the corporate owners)

mutual funds

portfolios of stocks and bonds selected and purchased by mutual fund companies, which finance the purchases by pooling money from thousands of individual fund investors; included both index funds as well as actively managed funds; fund returns (profits or losses) pass through to the individual fund investors who invest in the funds

beta

a relative measure of nondiversifiable risk that measures how the nondiversifiable risk of a given asset or portfolio compares with that of the market portfolio (the portfolio that contains every asset available in the financial markets)

thrift institutions

a savings and loan association, mutual savings bank, or credit union

liquidity trap

a situation in a severe recession in which the Fed's injection of additional reserves into the banking system has little or no additional positive impact on lending, borrowing, investment, or aggregate demand

unit of account

a standard unit in which prices can be stated and the value of goods and services can be compared; one of the three functions of money

limited liability rule

rule limiting the risks involved in investing in corporations and encouraging investors to invest in stocks by capping their potential losses at the amount that they paid for their shares

defaults

situations in which borrowers stop making loan payments or do not pay back loans that they took out and are now due

economic investment

spending for the production and accumulation of capital and additions to inventories

balance sheet

a statement of the assets, liabilities, and net worth of a firm or individual at some given time

fractional reserve banking system

a system in which commercial banks and thrift institutions hold less than 100% of their checkable-deposit liabilities as require reserves

diversifiable risk

aka idiosyncratic risk; investment risk that investors can reduce via diversification

reserve ratio

aka reserve requirement; the fraction of checkable deposits that a bank must hold as reserves in a Federal Reserve Bank or in its own bank vault;

nondiversifiable risk

aka systemic risk; investment risk that investors are unable to reduce via diversification

store of value

an asset set aside for future use; one of the three functions of money

time deposits

an interest-earning deposit in a commercial bank or thrift institution that the depositor can withdraw without penalty after the end of a specified period

stock

an ownership share in a corporation

checkable deposit

any deposit in a commercial bank or thrift institution against which a check may be written

medium of exchange

any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter

Board of Governors

the Board of Governors of the Federal Reserve / Federal Reserve Board; the seven-member group that supervises and controls the money and banking system of the United States

compound interest

the accumulation of money that builds over time in an investment or interest-bearing account as new interest is earned on previous interest that is not withdrawn

arbitrage

the activity of selling one asset and buying an identical asset to benefit from temporary differences in prices or rates of return; the practice that equalizes prices or returns on similar financial instruments and thus eliminates further opportunities for riskless financial gains

excess reserves

the amount by which a bank's or thrift's actual reserves exceed its required reserves; actual reserves minus required reserves

asset demand for money

the amount of money people want to hold as a store of value; this amount varies inversely with the interest rate

transactions demand for money

the amount of money people want to hold for use as a medium of exchange )to make payments); varies directly with nominal GDP

prime interest rate

the benchmark interest rate that banks use as a reference point for a wide range of loans to businesses and individuals

financial services industry

the broad category of firms that provide financial products and services to help households and businesses earn interest, receive dividends, obtain capital gains, insure against losses, and plan for retirement; includes commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, investment banks, and securities firms

open-market operations

the buying and selling of U.S. government securities by the federal Reserve Banks for purposes of carrying out monetary policy

vault cash

the currency a bank has in its vault and cash drawers

liquidity

the ease with which an asset can be converted quickly into cash with little or no loss of purchasing power money = perfectly liquid

money market deposit accounts (MMDAs)

bank- and thrift-provided interest-bearing accounts that contain a variety of short-term securities; such accounts have minimum balance requirements and limits on the frequency of withdrawals

actual reserves

the fund that a bank has on deposit at the Federal Reserve Bank of its districts (plus its vault cash)

near-monies

financial assets, the most important of which are noncheckable savings accounts, time deposits, and U.S. short-term securities and savings bonds, which are not a medium of exchange but can be readily converted into money

subprime mortgage loans

high-interest rate loans to home buyers with above-average credit risk

moral hazard

individuals or institutions may change their behavior as a result of a contract or agreement ex) a bank whose deposits are insured against losses may take riskier loans and investments

money market mutual funds (MMMFs)

interest-bearing accounts offered by investment companies, which pool depositors' funds for the purchase of short-term securities depositors can write checks in minimum amounts or more against their accounts

required reserves

the funds that banks and thrifts must deposit with the Federal Reserve Bank (or hold as vault cash) to meet the legal reserve requirement; a fixed percentage of the bank's or thrift's checkable deposits

capital gain

the gain realized when securities or properties are sold for a price greater than the price paid for them

time preference

the human tendency for people, because of impatience, to prefer to spend and consume in the present rather than save and wait to spend and consume in the future

cyclical asymmetry

the idea that monetary policy may be more successful in slowing expansions and controlling inflation than in extracting the economy from severe recessions

risk premium

the interest rate above the risk-free interest rate that must be paid and received to compensate a lender or investor for risk

Federal funds rate

the interest rate banks and other depository institutions charge one another on overnight loans made out of their excess reserves

risk-free interest rate

the interest rate earned on short-term U.S. government bonds

discount rate

the interest rate that the Federal Reserve Banks charge on loans they make to commercial banks and thrift institutions

term auction facility

the monetary policy procedure used by the Federal Reserve, in which commercial banks anonymously bid to obtain loans being made available by the Fed as a way to expand reserves in the banking system

monetary multiplier

the multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans (or buying securities); equal to 1 divided by the reserve requirement

percentage rate of return

the percentage gain or loss, relative to the buying price, of an economic investment or financial investment over some period of time

market portfolio

the portfolio consisting of every financial asset (including every stock and bond) traded in the financial markets the market portfolio is used to calculate beta (a measure of the degree of riskiness) for specific stocks, bonds, and mutual funds

average expected rate of return

the probability-weighted average of an investment's possible future returns

securitization

the process of aggregating many individual financial debts, such as mortgages or student loans, into a pool and then issuing new securities (financial instruments) backed by the pool. The holders of the new securities are entitled to receive the debt payments made on the individual financial debts in the pool

financial investment

the purchase of a financial asset (such as a stock, bond, or mutual fund) or real asset (such as a house, land, or factories) or the building of such assets in the expectation of financial gain

diversification

the strategy of investing in a large number of investments in order to reduce the overall risk to an entire investment portfolio

total demand for money

the sum of the transactions demand for money and the asset demand for money

risk

the uncertainty as to the actual future returns of a particular financial investment or economic investment

portfolios

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legal tender

a nation's official currency (bills and coins) payment of debt must be accepted in this monetary unit, but creditors can specify the form of payment ("cash only" or "check or credit card only")

expansionary monetary policy

Federal Reserve System actions to increase the money supply, lower interest rates, and expand real GDP; an easy money policy

restrictive monetary policy

Federal Reserve System actions to reduce the money supply, increase interest rates, and reduce inflation; a tight money policy

Federal Reserve Banks

The 12 banks chartered by the U.S. government to control the money supply and perform other functions

Federal Open Market Committee (FOMC)

The 12-member group that determines the purchase and sale policies of the Federal Reserve Banks in the market for U.S. government securities

Taylor rule

a modern monetary rule proposed by economist John Taylor that would stipulate exactly how much the Federal Reserve should change real interest rates in response to divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation

Federal Reserve System

The U.S. central bank, consisting of the Board of Governors of the Federal Reserve and the 12 Federal Reserve Banks, which controls the lending activity of the nation's banks and thrifts and thus the money supply; commonly referred to as the "Fed"

Troubled Asset Relief Program (TARP)

a 2008 Federal gov't program that authorized the U.S. Treasury to loan up to $700 billion to critical financial institutions and other U.S. firms that were in extreme financial trouble and therefore at high risk of failure

monetary policy

a central bank's changing of the money supply to influence interest rates and assist the economy in achieving price stability, full employment, and economic growth

savings account

a deposit in a commercial bank or thrift institution on which interest payments are received; generally used for saving rather than daily transactions; a component of the M2 money supply

bond

a financial device through which a borrower (a firm or gov't) is obligated to pay the principal and interest on a loan at a specific date in the future

Wall Street Reform and Consumer Protection Act of 2010

a law that gave authority to the federal Reserve to regulate all large financial institutions, created an oversight council to look for growing risk to the financial system, established a process for the Federal gov't to sell off the assets of large failing financial institutions, provided Federal regulatory oversight of asset-backed securities, and created a financial consumer protection bureau within the Fed

bankrupt

a legal situation in which an individual or a firm finds that it cannot make timely interest payments on money that it has borrowed. In such cases, a bankruptcy judge can order the individual or firm to liquidate (turn into cash) its assets in order to pay lenders at least some portion of the amount they are owed

Security Market Line (SML)

a line that shows the average expected rate of return of all financial investments at each level of nondiversifiable risk, the latter measured by beta

token money

bills or coins for which the amount printed on the currency bears no relationship to the value of the paper or metal embodied within it; for currency still circulating, money for which the face value exceeds the commodity value

mortgage-backed securities

bonds that represent claims to all or part of the monthly mortgage payments from the pools of mortgage loans made by leaders to borrowers to help them purchase residential property

probability-weighted average

each of the possible future rates of return from an investment multiplied by its respective probability (expressed as a decimal) of happening

present value

today's value of some amount of money that is to be received sometime in the future