Econ 2035 Chapter 1-3
In a barter system individuals
find it difficult to specialize, but may be able to do so
Why does the payments system continue to change over time?
New forms of payments are introduced that increase the efficiency of the payments system by reducing transactions costs
In what sense do self-fulfilling expectations determine the acceptability of a medium of exchange?
People value something as money only if they believe others will accept it from them as payment.
What does research suggest as to the relationship between the independence of the central bank and inflation? What is the rationale for this relationship?
Research indicates that the more independent a central bank is from the rest of the government, the lower the country's inflation rate will be. The reason is that an independent central bank is better able to resist political pressures to increase the money supply.
What is a key financial service provided by the financial system?
Risk sharing, liquidity, and information
How long does it take prices of securities to adjust so as to eliminate arbitrage profits?
Seconds
Securitization is the process of
converting loan into securities
Interest-rate risk can best be characterized as the risk that
fluctuations in the price of a financial asset in response to changes in market interest rates.
By the end of 2009, loan losses were ________ at the end of 2007.
four times greater than
What is the most important factor for Federal Reserve currency to be accepted as money?
its acceptance by businesses and households in the United States in exchange for goods and services
The most important economic benefit from specialization is that it
leads to an increase in the standard of living in an economy
Until very recently, investment banks rarely engaged in what?
lending to households
If you buy a bond issued by Intel, the bond is a(n)
liability to Intel and an asset to you.
Which of the following is a consequence of extending the payback period of a student loan from 10 to 30 years?
more interest paid over the life of the loan
According to a Federal Reserve study, electronic payments now make up ________ of all noncash payments.
more than two-thirds
What determines the acceptability of dollar bills as a medium of exchange?
our society's willingness to use green paper notes issued by the Federal Reserve as money
A discount bond involves
payment by the borrower to the lender of the face value of the loan at maturity
What are some things on the Fed's list of the five most desirable outcomes for a payments system?
security, efficiency, speed
Fannie Mae and Freddie Mac both
sell bonds to investors and use the funds to purchase mortgages
Hyperinflations are usually caused by large budget deficits financed by
selling bonds to the central bank
The attribute that distinguishes money from other assets is that only money
serves as a medium of exchange
A decline in bank lending has the most significant effect on
smal businesses
Diversification refers to the
splitting of wealth into many assets
Financial securities that represent partial ownership of a corporation are known as
stocks
Economists define risk as
the chance that the value of financial assets will change from what you expect
When the price of a coupon bond increases
the current yield declines
In comparing the yield to maturity on a Treasury bill with the yield on a discount basis on the same bill, we can say that the yield to maturity
will always be greater than the yield on a discount basis
Unless otherwise indicated, when economists or investors refer to the interest rate on a financial asset, they are referring to the
yield to maturity
What is the rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950?
11.67%
If the real interest rate is -1.4% and the nominal interest rate is 0.6%, expected inflation equals
2%
What is the rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931?
2%
Suppose the GDP implicit price deflator was 112.7 in 2015 and 116.0 in 2016. Therefore, the inflation rate in 2016 would be
2.9%
As of late 2016, approximately what portion of U.S. currency is held outside of the United States?
2/3
If the real interest rate is 2% and expected inflation is 2%, the nominal interest rate is
4%
Suppose you have a fixed-rate mortgage with a nominal interest rate of 6% and the expected annual inflation rate over the life of the mortgage is 2%. What is the expected real interest rate?
4%
How many prices would there be in a barter economy with 100 goods?
4,950
What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now?
6%
A one-year discount bond with a par value of $1,000 sold today, at issuance, for $943 has a yield to maturity of
6.04%
Suppose Matt's New Cars issues and sells a one-year discount bond for $9,259 and repays $10,000 at maturity. The interest rate on this bond would be
8%
A coupon bond has an annual coupon of $75, a par value of $1,000, and a market price of $900. Its current yield equals
8.33%
What is the most efficient means of trade?
money
When economists refer to the role of money as a store of value, they mean that
money allows value to be stored easily
A monetary aggregate is a measure of
money broader than currency.
When economists refer to the role of money as a unit of account, they mean that
money gives traders a way of measuring value in the economy
Money eliminates the need for
people to have a double coincidence of wants
The price of a financial asset equals the
present value of all future payments.
A capital gain occurs when the
price of an asset increases
The amount of funds the borrower receives from the lender with a simple loan is called the
principal
If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that
the market price of your bond will rise
If the current price of a bond is equal to its face value
there is no capital gain or loss from holding the bond until maturity.
What is the price of a coupon bond that has annual coupon payments of $75, a par value of $1,000, a yield to maturity of 5%, and a maturity of two years?
$1,046.49
Suppose First National Bank makes a one-year simple loan of $1,000 at 7% interest to Harry's Restaurant. At the end of one year Harry's Restaurant will pay First National
$1,070
Which of the following represents the equation that would be used to determine the yield to maturity of a corporate bond with a face value of $1,000, price of $1,100, coupon rate of 5%, and maturity in three years?
$1,100 = $500/(1 + i) + $500/(1 + i)2 + 1,500/(1 + i)3
In May 2016, what was the total value of U.S. currency in circulation?
$1,375 billion
Which of the following represents the equation that would be used to determine the yield to maturity of a three-year fixed payment loan of $1,400 which has payments of $500 per year?
$1,400 = $500/(1 + i) + $500/(1 + i)2 + $500/(1 + i)3
$1 received n years from now has a value today of
$1/(1 + i)n
More than three-quarters of the value of all U.S. currency consists of
$100 bills
If you deposit $10,000 in a savings account at an annual interest rate of 6%, how much will you have in the account at the end of three years?
$11,910
As of May 2016, the amount of money as measured by M2 was about
$12.7 trillion.
If the annual interest rate is 8%, what would you expect to pay for a bond paying a lump sum of $10,000 in ten years?
$4,632
Suppose you put $500 in your savings account and earn 4% interest per year. How much will you have in your account after two years? Be sure to round off to the nearest cent.
$500 × 1.04 × 1.04 = $540.80
If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years?
$638
At an interest rate of 6%, how much will need to be invested today to have $10,000 in 5 years?
$7,473
If the annual interest rate is 9%, what would you expect to pay for a bond paying a lump sum of $10,000 in two years?
$8,417
At an interest rate of 3%, what is the present value of $1,000 to be received five years from now?
$863
Suppose Matt's New Cars issues a bond in which they'll need to pay $10,000 in one year, which includes 4% interest. How much will they receive for the bond?
$9,615
What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1,000, a yield to maturity of 10%, and a maturity of three years?
$962.70
The yield to maturity on a new one-year discount bond equals
(FV- P)/P
What is the yield on a discount basis for a U.S. Treasury bill that has a face value of $10,000, has a price of $9,500, and will mature in 180 days?
10.00%
According to the quantity theory of money, if the long-run economic growth rate is 2.5%, by how much should the Fed increase the money supply if it wants inflation to be 2%?
4.5%
A one-year discount bond with a par value of $5,000 sold today, at issuance, for $4,750 has a yield to maturity of
5.26%.
Suppose nominal GDP is $14 trillion and the money supply is $2 trillion. What is the velocity of money?
7
What is the yield to maturity of a consol with a coupon of $85 and a price of $944.44?
9.00%
Suppose a coupon bond with a par value of $1,000 is currently priced at $950 and has a coupon of $40. Which of the following is TRUE?
current yield > coupon rate
All of the following are examples of electronic
debit cards, ACH transactions, e-money
At the beginning of the financial crisis, banks were hurt by all of the following
declines in the value of mortgage-backed securities, defaults on mortgages by those with subprime mortgages, not being repaid on loans to real estate developers
A sustained decrease in the price level is known as
deflation
All of the following took place during the German hyperinflation in the 1920s
banks reduced lending, some banks only made loans to customers who agreed to repay in terms of foreign currencies or commodities, households and firms increased their demand for loans
As the housing bubble began to burst in 2006-2008, investors would only buy mortgage-backed securities at high yields to compensate for higher perceived default risk. As a result
banks suffered significant capital losses as the value of their holdings of mortgage-backed securities declined
From 1978 to 2016, the percentage of wealth held by households decreased for all of the following categories of assets
bonds, deposits, equity in unincorporated businesses
The main role of financial intermediaries is to
borrow funds from savers and lend them to borrowers
Which group is hurt by inflation being less than expected?
borrowers with fixed-rate mortgages
Because securitized loans are loans that have been bundled with other loans and sold to investors, they are
both financial assets and financial securities
A bank lending depositors' money to a local business and a pension fund investing contributions in shares of a company are similar financial activities in that
both involve funds being channeled from savers to borrowers through financial intermediaries
In comparing money to shares of Apple stock, we can say that
both money and shares of Apple stock are stores of value
In quantity theory terms, during a hyperinflation
both the money supply and velocity increase rapidly
Increased liquidity in recent decades has reduced interest rates on which of the following assets (holding constant all other things that affect interest rates)?
business loans
Financial markets
channel funds directly from lenders to borrowers
The role of the financial system is to
channel funds from households and other savers to businesses
The most common type of simple loan is a(an)
commercial loan from a bank
Why may investors buy a Treasury bill with a negative real interest rate?
concern about the high default risk of alternative investments
Debt instruments are also called
credit market instruments
The narrowest money measure is
currency plus all checking accounts
What is included in M2?
currency, money market deposit accounts, overnight repurchase agreements
Fundamentally, to reap the benefits of specialization, an economy must
develop ways for individuals to trade goods with one another
Alt-A borrowers were those who
did not provide documentation of their income when applying for a mortgage
A bond's price and its yield to maturity are inversely related because
discounting future payments at a higher rate reduces the present value of the payments.
The distinguishing feature of a well-functioning financial market is the
incorporation of available information into asset prices
What will result in a decrease in the price of an existing corporate bond?
increased default risk
What will lead to a higher interest rate on a loan?
increased perceived risk of default
Funds flow from lenders to borrowers
indirectly through financial intermediaries
By "specialization" economists mean a situation where
individuals produce the goods or services for which they have relatively the best ability
Research has shown that nations with highly independent central banks tend to have low
inflation
A coupon bond involves
interest payments from the borrower to the lender periodically during the life of the loan and payment by the borrower to the lender of the face value of the loan at maturity.
Though Treasury bonds may have little default risk, what type of risk exists when current interest rates are low?
interest-rate risk
Banks who held mortgage-backed securities "took a bath" during the financial crisis of 2007-2009 due to
rising yields in secondary markets which led to a decline in the price of mortgage-backed securities
The financial system provides risk sharing by allowing
savers to hold many assets
What isn't included in M1?
savings account deposits
What makes up the largest share of M2?
savings deposits
Which function of money enhances the ability of households to accumulate wealth?
store of value
The rate of return is equal to the
sum of the current yield and the actual rate of capital gain or loss.
In the United States, monetary policy is carried out by
the Federal Reserve System
The Troubled Asset Relief Program (TARP) allowed
the Treasury to inject funds into commercial banks in return for stock in the banks
A borrower and a lender agree on a mortgage interest rate. If inflation turns out to be less than expected
the actual real interest rate will exceed the expected real interest rate
With respect to U.S. Treasury bills
the asked price is always greater than the bid price
A discount bond resembles a simple loan in that
the borrower repays in a single paym
The current yield is equal to
the coupon divided by the market price of the bond
The rate of return is equal to
the current yield plus the rate of capital gains.
Andy can't make a deal with Danny. Andy has an Alex Rodriguez baseball card and would like to trade it to Danny for Danny's Albert Pujols card, but Danny doesn't want an Alex Rodriguez card. Andy's problem illustrates the drawback to a barter system known as
the double coincidence of wants problem
All of the following took place during the economic crisis that began in 2007
the financial system was disrupted, large portions of the U.S. economy were cut off from the funds they needed to thrive, there was a devastating decline in the production of goods and services throughout the economy
A hyperinflation occurs when
the inflation rate exceeds 50% per month
The yield to maturity is equal to
the interest rate at which the present value of an asset's returns is equal to its price today
If, while you are holding a coupon bond, its market price falls, you can be sure that
the interest rate on other similar bonds must have risen
According to the equation of exchange, if the quantity of money decreases and the velocity of money remains constant, then
the level of nominal GDP must decrease
For a specific change in the yield to maturity
the longer the time until a bond matures, the greater will be the change in its price.
The payments system is
the mechanism for conducting economic transactions.
The problem of a double coincidence of wants refers to
the necessity in a barter system of each trading partner wanting what the other has to trade
Using a good as a medium of exchange confers the benefit that
the need to quote so many prices in trade is reduced
The expected real interest rate approximately equals
the nominal interest rate minus the expected rate of inflation
The velocity of money can best be described as
the number of times each dollar in the money supply is used to buy goods and services included in GDP
The bid price for a bond is
the price that you will receive from a securities dealer if you sell the bond
Compounding refers to
the process of earning interest on both the interest and the principal of an investment
Wealth is
the sum of the value of assets minus the sum of the value of liabilities
If i is the yield to maturity of a fixed-payment loan
the value of the loan today equals the present value of the loan payments discounted at rate i
If the current price of a bond is greater than its face value
the yield to maturity must be less than the coupon rate
Which criterion for suitability as a medium of exchange do Federal Reserve Notes meet?
Federal Reserve Notes meet all of the criteria for suitability as a medium of exchange.
What made the recession of 2007-2009 different than any other recession since the Great Depression?
It was accompanied by a financial crisis
What is true about M2?
Its total value is smaller than that of M1, apart from those assets also included in M1, it includes no assets that offer check-writing features, it includes large-denomination time deposits
The financial crisis of 2007-2009 worsened after the failure of which firm?
Lehman Brothers
Which firm did the Treasury allow to fail during the financial crisis?
Lehman Brothers
What is the largest measure of money in the United States?
M2
In the United States, the lender of last resort is
The Federal Reserve
By providing and communicating information, the financial system
relieves individual savers from the necessity of searching out individual borrowers
The purchasing power of money
rises when prices fall
The purpose of diversification is to
reduce risk
Bitcoin is a form of
e-money
An important reason why economies at an early stage of development tend to operate inefficiently is
the high transactions costs associated with barteR
What is an example of a coupon bond?
a US Treasury note or bond
What are examples of discount bonds?
A US savings bond, a US treasury bill, and a zero-coupon bond
What are examples of financial assets?
A bond issued by Google, a home mortgage loan, a certificate of deposit
What is a fixed payment loan?
A home mortgage
What aren't fixed payment loans?
A home mortgage, a car loan, and a student loan
What is an example of a barter transaction
An individual provides three light bulbs to her neighbor in exchange for two gallons of milk.
What are three reasons that banks charge interest on loans?
Banks charge interest on loans to compensate for inflation, to compensate for default risk, and to compensate for the opportunity cost of waiting to spend your money.
Briefly explain the difference in how banks and peer-to-peer lenders make profits on loans.
Banks have traditionally earned profits on loans by paying a lower interest rate to depositors than they charge to borrowers. Peer-to-peer lenders make profits by charging borrowers a one-time fee and charging the people providing funds a fee for collecting the payments from borrowers.
Describe the relationship between banks and small businesses during the 2000s
Banks typically applied fixed guidelines for granting loans, leaving little room for personal judgment, many small businesses were receiving loans from regional and national banks, more banks became convinced that it would be profitable to loosen their loan guidelines to make more borrowers eligible to receive credit
How do payments on a fixed-payment loan differ from a coupon bond?
Borrowers that use a coupon bond make interest payments at regular intervals and repay the face value when the bond reaches maturity. Those that borrow using a fixed-payment loan makes periodic payments that are equal and include both interest and principal.
What is the largest component of M1?
Checking deposits
What is included in M1, but not in M2?
Everything in M1 is in M2.
All of the following represent returns to savers
Dividends on stocks, interest on deposits, coupon payments on bonds
The American Civil War lasted from the spring of 1861 to the spring of 1865. During the war the Confederate government issued substantial amounts of fiat paper currency. What do you think happened to the price level (measured in Confederate dollars) in the Confederate states during the final months of the war?
During the final months of the war, the imminent demise of the Confederate government greatly reduced the willingness of people to hold Confederate currency. The usefulness of Confederate currency as a store of value and as a standard of deferred payment declined sharply. Those attempting to buy goods and services with the currency had to offer increasing amounts of it in order to find anyone willing to accept it. Or, put another way, the price level rose dramatically, measured in Confederate dollars.
What are problems with barter?
Each good has multiple prices, high transactions costs, lack of standardization of products exchanged
What is an example of a commodity money?
Gold coins
Which president said, "Prosperity is just around the corner"?
Herbert Hoover near the start of the Great Depression
What is a not liquid asset?
House
Explain the process by which prices of securities adjust so as to eliminate arbitrage profits.
In competing to buy securities where earning arbitrage profits is possible, traders force prices up to the level where arbitrage profits can no longer be earned.
Economic studies have shown that countries that have high inflation rates have lower rates of economic growth than do countries with low inflation rates. Explain what underlies this relationship between inflation and economic growth.
In terms of the issues discussed in this chapter, inflation reduces the usefulness of currency as a store of value and as a standard of deferred payment. In extreme cases, high rates of inflation have led to a shift to a barter system or to the use of foreign currency as a medium of exchange. These effects would tend to reduce the efficiency of the economy and the rate of economic growth.
What is the difference between money, income, and wealth?
Income is equal to a person's earnings over a period of time. Wealth is the sum of a person's assets minus the sum of a person's liabilities. Money is a medium of exchange and one component of a person's wealth.
The funds for loans from peer-to-peer lenders come from three key sources.
Individuals, financial firms, other businesses
Why isn't the current yield a good indicator of holding a bond?
It doesn't account for capital gains or losses
What are the five characteristics that make an asset suitable to be used as a medium of exchange?
It must be acceptable to most people; standardized in terms of quality; durable so that it doesn't become too worn out to be usable; valuable relative to its weight; divisible since prices of goods and services vary.
How does the existence of money affect economic growth?
It reduces transactions costs and other efficiencies of barter. People can specialize, becoming far more productive than if they tried to produce all goods and services they consume themselves.
What describes the behavior of M1 in recent decades?
It soared during the recessions of 1990-91, 2001, and 2007-2009.
Briefly discuss three reasons why firms may borrow funds from a bank
Many firms rely on bank loans to meet their short-term needs for credit, such as funds to pay for inventories or to meet their payrolls. Many firms rely on bank loans to bridge the gap between the time they must pay for inventories or meet their payrolls and when they receive revenues from the sales of goods and services. Some firms also rely on bank loans to meet their long-term credit needs, such as funds they require to physically expand the firm.
How did securitization and the bursting of the housing bubble contribute to the Financial Crisis of 2007-2009?
Many investment banks and other investors purchased mortgage-backed securities because they paid higher interest rates than securities of comparable default risk. When the housing bubble burst, the value of the mortgage-backed securities declined significantly, resulting in massive losses for those who owned them, including many investment banks.
What are significant costs that a barter system imposes on an economy?
Many prices must be maintained for each good, specialization of labor is hindered, the costs arising from the problem of finding two people who each want what the other produces
In Moscow in 1989, what were taxi drivers using as a medium of exchange?
Marlboro cigarettes
Why do individuals hold money when it does NOT provide the services that, say, a house does?
Money is the most liquid asset
What is a liquid asset?
Money market mutual fund
What are some financial intermediaries?
Mutual fund, bank, insurance company
The total payment to a lender for a one-period simple loan is
P(1 + i)
What is a form of e-money?
PayPal
The leading federal regulatory body for financial markets in the United States is the
Securities and Exchange Commission
interest on simple loans and discount bonds is paid in a single payment, while issuers of coupon bonds and fixed-payment loans make multiple payments of interest and principal
Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that
Make use of the quantity theory of money to solve the following problem. If the Fed has an inflation target of 2% and the velocity of money is constant, by how much should it increase the money supply each year if economic growth is expected to average 3%?
Since the percent change in the money supply equals the percent change in real GDP plus inflation, the money supply should grow by 2% + 3% = 5%.
Make use of the quantity equation to answer the following problem. If the Fed increases the money supply by 4%, velocity increases by 1%, and economic growth is 3%, by how much will the price level increase?
Since the percent change in the money supply plus the percent change in velocity equals the percent change in real GDP plus the percent change in the price level, the price level will increase by 2% (4% + 1% - 3%).
Make use of the quantity equation to answer the following problem. If the Fed increases the money supply by 6%, economic growth is 2%, and inflation is 2%, what is happening to the velocity of money? Be specific.
Since the percent change in the money supply plus the percent change in velocity equals the percent change in real GDP plus the percent change in the price level, velocity is declining by 2%.
A corporation issues a three-year bond with a coupon of $50 and a face value of $1,000. A year later, market interest rates have declined to 4%. What is the price of the bond a year after it was issued? Report your answer to the nearest dollar.
Since the price of the bond equals its present value, the price is $50 / 1.04 + $1,050 / (1.04)2 = $1,019.
A corporation issues a three year bond with a coupon of $50 and a face value of $1,000. Immediately after being issued, market interest rates decline to 4%. What is the price of the bond? Report your answer to the nearest dollar.
Since the price of the bond equals its present value, the price is $50 / 1.04 + $50 / (1.04)2 + $1,050 / (1.04)3 = $1,027.75.
According to the Fed, what are the five most desirable outcomes for a payments system?
Speed, Security, Efficiency, Smooth international transactions, and Effective collaboration among participants in the system
Which type of bond would you purchase if you expected higher rates of inflation during the life of the bond?
TIPS
What was the intent behind the intervention of the Fed and Treasury in financial markets during the Financial Crisis of 2007-2009?
The actions by the Fed and Treasury were meant to restore the flow of funds between savers and borrowers. Without an increase in the flow of funds to a more normal level, households would have a difficult time making certain purchases and businesses would have difficulty financing investments and inventories.
Why has M2 grown more quickly than M1 in recent decades?
The amount of funds in CDs and money market mutual funds shares has grown faster than currency or checking deposits.
Suppose a firm receives $975 for a discount bond with a face value of $1,000 to be repaid in one year. What is the amount of interest on the bond? What is the interest rate on the bond? Report a percentage with two decimal places.
The amount of interest is $1,000 - $975 or $25. the interest rate is $25 / $975 which equals 2.56%.
What criteria should be used in deciding the best definition of the money supply?
The answer depends on the purpose of the measurement. Economists are primarily interested in the relation between monetary aggregates and other economic variables, such as output, the price level, and interest rates. In this respect, a monetary aggregate is most useful when it is most closely related to these economic variables. Until the 1980s, M1 was the most widely accepted measure of the money supply. In the 1980s and 1990s, M2 has been most widely accepted.
How are interest payments on mortgages distributed to investors who own mortgage-backed securities?
The banks that grants, or originates, the original mortgages will still collect the interest paid by the borrowers and send those interest payments on to the government agency or financial firm to distribute to the investors who have bought the mortgage-backed security.
What is true about a fixed payment loan?
The borrower is required to make regular periodic payments to the lender, the payments made by the borrower include both interest and principal, a home mortgage is an example of fixed payment loan
Suppose a bond has a coupon of $40, face value of $1,000, and current price of $950. What is the coupon rate? What is its current yield? Report a percentage with two decimal places
The coupon rate is $40 / $1,000 = 4.00%. The current yield is $40 / $950 = 4.21%.
Suppose a bond has a coupon of $75, face value of $1,000, and current price of $1,100. What is the coupon rate? What is its current yield? Report a percentage with two decimal places.
The coupon rate is $75 / $1,000 = 7.50%. The current yield is $75 / $1,100 = 6.82%.
Suppose you had $1,000 and were deciding between two investments. One pays 5% a year for two years while the other pays 8% the first year and 2% the second year. Which investment would provide a higher return?
The first investment which earned 5% a year for two years would result in $1,102.50 after two years. The second investment would result in $1,101.60. Thus, the first investment provides the higher return.
What are important criteria for whether a good will be usable as a medium of exchange?
The good must be of standardized quality, the good must be valuable relative to its weight, the good must be durable so that value is not lost through product spoilage
Why did some economists and policymakers criticize the Fed and Treasury for arranging the sale of Bear Stearns to JP Morgan Chase in 2008?
The main concern was with the moral hazard problem, which is the possibility that managers of financial firms such as Bear Stearns might make riskier investments if they believe that the federal government will save them from bankruptcy
Briefly explain the process of securitizing mortgages
The mortgage lender sells the loan to a government-sponsored enterprise or financial firm that bundles the mortgage with mortgages from other lenders, providing the basis for a mortgage-backed security.
If fiat money has no value apart from its use as money, how can it be used as a medium of exchange?
The most important reason paper currency circulates as a medium of exchange is the confidence of consumers and firms that if they accept paper currency they will be able to pass it along when they need to buy goods and services. Also, the federal government has designated it to be legal tender, meaning the government accepts it in payment of taxes and requires it to be accepted in payment of debts.
How are TIPS adjusted for inflation?
The principal is adjusted for inflation each period
What are steps involved in using checks
The recipient must present the check to the bank, the bank must present the check to the check writer's bank, the funds must be transferred from the checkwriter's bank to the recipient's bank
What is normally the ultimate cause of hyperinflation?
The ultimate cause of hyperinflation is usually governments spending more than they collect in taxes, which results in government budget deficits. Governments that can't sell bonds to private investors will often sell them to their central banks. In paying for the bonds, the central bank increases the country's money supply. Excessive increases in the money supply result in hyperinflation.
What is the yield to maturity of a perpetuity with a coupon of $40 and a price of $800?
The yield to maturity equals $40 / $800 = 5%.
A one-year discount bond has a face value of $1,000 and price of $880. What is the yield to maturity on the bond? Report using percentages with two decimal places.
The yield to maturity is ($1,000 - $880) / $880 = 13.64%.
A one-year discount bond has a face value of $1,000 and a price of $925. What is the yield to maturity on the bond? Report using percentages with two decimal places.
The yield to maturity is ($1,000-$925) / $925 = 8.11%.
True statements about ACH transactions
They reduce the likelihood of missed payments, they reduce transactions costs associated with check processing, they reduce the costs that lenders incur in notifying customers of missed payments
U.S. Treasury bonds
are subject to fluctuations in their market prices and are therefore risky investments.
The use of checks in transactions
avoids the cost of transporting currency back and forth
What are four inefficiencies of a barter system?
Under a barter system, there are several inefficiencies. First, there must be a double coincidence of wants, resulting in high transaction costs. Second, there will be many prices for each good; one for each good for which it can be traded. Third, there is a lack of standardization in terms of the goods to be exchanged. Fourth, it will be difficult to accumulate wealth.
According to the equation of exchange, how can national income grow even though the amount of money does NOT?
Velocity increases
In what way are other assets less liquid than money?
You incur transactions costs when you exchange other assets for money.
Which country experienced hyperinflation of almost 15 billion percent in 2008?
Zimbabwe
What is an example of fiat money?
a Federal Reserve Note used as money in the twenty-first century United States
If an investor is certain that market interest rates will decline in the future, which of the following will she be most likely to purchase?
a fifty-year government bond
Commodity money can best be described as
a good used as money that also has value independent of its use as money
If a bank grants you a mortgage, the mortgage is
a liability to you, but an asset to the bank.
A debt instrument represents
a promise by a borrower to repay principal plus interest to a lender
An asset is
a thing of value that can be owned
If money is declared to be legal tender, it must be
accepted to settle private transactions and it must be accepted for the payment of taxes
Borrowers who stated but did not document their incomes are referred to as
alt-A
All of the following are examples of risky mortgages that became more common in the 2000s
alt-A mortgages, adjustable-rate mortgages with low rates for a few years and then higher rates in later years, subprime mortgages.
If you purchase a Treasury bond, the Treasury bond is
an asset to you, but a liability to the U.S. government
Barter is
an exchange of goods and services directly for goods and services
If the current price of a bond is less than its face value
an investor will receive a capital gain by holding the bond until maturity.
Which of the following best describes a "bubble"?
an unsustainable increase in the price of a class of assets
The coupon rate is the
annual coupon payment divided by the face value of the bond
Money can BEST be described as
anything that is generally accepted as payment for goods and services or in the settlement of debts
Money as a medium of exchange refers only to
anything that is generally accepted as payment for goods and services.
Economists define money as
anything that people are willing to accept in payment for goods and services or to pay off debts
Under a barter system
each good has many prices
When an economy relies on specialization
each individual in the economy produces the goods or services for which he or she has relatively the best ability
Under a system of barter
each individual trades output directly with another
According to the equation of exchange, if nominal GDP increases then
either the quantity of money and/or the velocity of money must also increase
Automatic teller machines and debit cards are examples of
electronic funds transfer systems
The Fed and Treasury took action to restore the flow of funds from savers to borrowers in order to encourage all of the following
enable households to purchase durable goods, increase the likelihood of purchases of houses, allow firms to finance purchases of structures and equipment
On a coupon bond, the yield to maturity
equates the present value of all the bond's payments to its price today
Nominal interest rates are higher than real interest rates as long as
expected inflation is positive
When prices rise, the purchasing power of money
falls
Ordinary (non-securitized) loans cannot be resold after they have been granted by a bank or another lender. Therefore, these loans are
financial assets but not financial securities
The difference between money and income is that whereas income is an individual's
flow of earnings over a period of time, money is an individual's stock of currency and currency substitutes
The financial system is primarily a means by which
funds are transferred from savers to borrowers
By designating Federal Reserve currency as legal tender, the federal government
has mandated that Federal Reserve currency be accepted for payment of debts
Since the year 2000, total currency in circulation
has more than tripled
The introduction of money to an economy results in
higher incomes, higher productivity, and increased specialization
The interest rate on loans made by peer-to-peer lenders tends to be
higher than the interest rate on bonds and lower than the interest rate on credit cards
How can a bond have a negative rate of return?
if the rate of capital loss exceeds the current yield
A "primary market" is a market
in which newly issued claims are sold to buyers by borrowers
Financial intermediaries
include banks and other depository institutions
The M2 aggregate
includes M1 plus short-term investment accounts
A person's earnings over a period of time is known as
income
The financial system performs the role of communicating information by
incorporating all available information into the prices of financial assets
All of the following were significant changes in the mortgage market in the 2000s
investment banks became significant participants in the secondary mortgage market, lenders loosened lending standards, mortgage-backed securities became more popular with investors.
For simple loans, the yield to maturity
is always equal to the specified simple interest rate
Money that has no value apart from its use as money
is known as fiat money
Fiat money
is money that would have no value if it were not usable as money
An speculator who buys a fifty-year corporate bond
is probably expecting market interest rates to decrease in the future
The Federal Reserve System
is the central bank of the United States
Liquidity
is the ease with which an asset can be exchanged for money
All of the following are problems associated with commodity money
it is a cumbersome form of payments system, its value is dependent on its purity, costs are incurred in certifying the purity and weight of commodity money
The Fed's current position towards the existing monetary aggregates is
it is an issue of ongoing research.
Evidence indicates that there's a strong relationship between money and inflation in
long run, but not the short run
Issuers of coupon bonds
make a single payment of principal when the bonds matures, but multiple payments of interest over the life of the bond
All of the following are true in Sweden
many branches of Sweden's banks do not accept cash deposits, some stores have stopped accepting cash payments, many churches encourage parishioners to make donations using a mobile banking app
Which function of money allows for specialization to take place?
medium of exchange
Money is a medium of exchange in that
money is generally accepted for buying and selling goods and services.
When economists refer to the role of money as a standard of deferred payment, they mean that
money provides a standard for payments that will occur in the future
Suppose $100 buys less in the year 2017 than in 2000. Then we can say that
money's store of value has decreased
If prices increase rapidly
money's usefulness as a store of value is diminished
All of the following statements regarding bitcoin transactions are true
no permanent record of bitcoin transactions exist, retailers pay a lower processing cost for bitcoin transactions than for credit card transactions, bitcoin transactions are final and unlike credit card transactions, cannot be disputed by the buyer
According to the equation of exchange, the money supply times the velocity of money equals the
nominal GDP
Money market deposit accounts are included in
only M2
In Sweden, cash accounts for ________ of transactions.
only about 2 percent
A simple loan involves
payment of interest by the borrower to the lender only at the time the loan matures
What forms the largest share of household holdings of financial assets?
pension fund reserves
Checks are
promises to pay, on demand, money deposited with a financial institution
The key to present value calculations is that they
provide a common unit for measuring funds at different times
Which of the following is the correct expression for the approximate expected real interest rate?
r = i - πe
All of the following are characteristics of debit cards
they can be used like checks,t hey eliminate the problem of trust since the bank's computer authorizes the transaction, when used at a store, the user's bank instantly credits the store's account with the amount and deducts it from the user's account
All of the following are true regarding securitized loans
they cannot be resold
Other assets are inferior to money in the sense that
they generate transactions costs when they are exchanged for money
Which type of borrowers were least likely to default in their mortgage at the beginning of the financial crisis?
those with fixed-rate mortgages who made large down payments
Which of the following types of mortgage loans became more common during the housing boom of the early-to-mid 2000s?
those with flawed credit histories
A system of barter has substantial transactions costs because
traders must spend considerable time searching for trading partners
The process by which investment banks guarantee a certain price to a firm issuing stocks or bonds is known as
underwriting
Which function of money eliminates the need for multiple prices for each good as in a barter system?
unit of account
According to the quantity theory of money, the growth rate of what is zero?
velocity
