Macroeconomics midterm 2 (chapters 9, 10 , 12, 13, 15 ,16)

Modern economists rely on financial intermediaries to_______________

bridge the gap between savers and borrowers

Both households and businesses rely on _________-to thrive

credit

As interest rates increases, demand for borrowing____________

decreases

What is the leverage ratio?

ratio of debt over equity

When a company or the government sells a bond, its as if they are___

taking out a loan

With investment, the higher the interest rate, the smaller the____________________

the smaller the quanitity demanded of savings will be

The market for loanable funds is comprised of:

the supply of savings and the demand for borrowing

The price of the bond will indicate what_____________ the bond seller is borrowing

what rate of interest the bond seller is borrowing

A bank run occurs when:

when depositors lose trust in a bank and rush to the bank to pull out their deposits

In a world without saving or borrowing, income and consumption would be_______________

would have to be equal

If a homebuyer puts down 20 % on the purchase of a home, them immediately after closing the buyer has a leverage ratio of_______________

4 If home value was 100,000, that would be 80,000 in debt and 20,000 in equity (80,000/20,000)

If a consumer has a saving rate of 30%, what fraction of their income do they consume?

70%V

What is a bond?

A sophisticated IOU that documents who owns how much and when payment must be paid

What is a stock?

A stock is a certificate of ownership in a corporation

Who created the LIfecycle Theory of saving?

Franco Modigliani

What is a saving?

Income that is not spent on consumption goods

What is a firm's insolvency?

Liabilities > assets

What statements give us an explanation for the low quality of many mortgage securities?

Outright fraud in the way that these securities were explained The belief that American housing prices would not fall Poor performance of rating agencies

Where does the supply of loanable funds come from?

Savings

Supply equals what? Demand equals what?

Supply= savings Demand= borrowing

The FDIC ensures that______________

depositors can get their money back, even if their bank fails

Howard schultz is used in the video as an example of an ________________

entrepreneur who used different types of financial intermediaries to raise capital

What is politicized lending?

ex. Japan Many banks are bankrupt or propped up by the government, banks pressured to lend money to well-connected political allies result: economic growth was zero during this period

Higher default rates create what?

losses for banks

Securitization refers to_____________

the bundling together of mortgages which are then sold as liquid financial assets

How much you save and borrow depends on how patient you are or using the language of economics, it depends on your_______________

time preference

High leverage of banks accelerated losses and many banks_____________

were pushed to insolvency

Where does the money come from for shadow banking?

From investors

What are zombie banks?

Insolvent banks that are propped up by the government, like some banks in Japan When banks are propped up by the government, the supply of savings no longer flows to where it can be most effective

What is a result of insecure property rights?

People are reluctant to put their savings in a domestic institution

What is present value PV?

Present value is the discounted value of a steam of payments

Usury laws that limit interest rates than someone can be charged for a loan are an example of__________________

Price ceilings, which don't work well By setting a max price on loanable funds, these laws could discourage some saving and borrowing that would otherwise take place

What are important roles of financial intermediaries?

Reduce costs of moving savings from savers to borrowers and investors

What have insecure property rights in Russia led to?

Russia does not respect the rights of minority shareholders Investors are reluctant to invest in russia, leading to slower economic growth

What are some types of bond?

T-bonds T-notes T-bills zero-coupon bonds Perpetuity

What is interest rate in relation to saving?

The "market price" of saving - Interest is the reward of saving - Other things being equal, the quantity supplied of savings increases as the interest rate increases

What is the maturity date?

The date at which you receive the face value or cash amount

What does the market for loanable funds determine?

The equilibrium interest rate The equilibrium quantity of savings/borrowing

What are initial public offering (IPO)?

The first time a corporation sells stick to the public to raise capital

What are some roles of banks?

- gather savings reduce cost of mobilizing savings to productive uses -specialize in evaluating risk -division of labor (bank employees evaluate risk better than depositors

What determines the demand for savings?

- smoothing consumption - financing large investments - interest rate

What are three examples of financial intermediaries?

-Banks -Bond market -stock market

If the government borrows 100 billion USD, what will happen to the graph?

-Supply curve will shift to the left -Private demand curve will not change -Increases interest rate for everyone -Higher interest means less private borrowing

Why do banks securitize?

-To get more liquid cash -Makes the balance sheet safer -Loan assets can be held by institutions with long term a perspective To put a better face on bad loans

What makes a bond?

-maturity date -face value -coupon payment

When intermediation fails, what happens?

-reducing the supply of savings -raising the cost of intermediation -reducing the effectiveness of lendin All resulting in slower economic growth

What is generally essential to making profitable investments? (like education, inter-state highway system...)

Borrowing

What are the three main stages of the lifecycle theory?

Borrowing then saving then dissaving

What is the theory of the Lifecycle theory of saving?

Borrwing, saving, and dissaving at different times in life, workers can smooth their consumption path, improving their overall satisfaction

What do financial intermediaries do?

Bridge gap between savers and borrowers Gather savings and allocate it to the most profitable investments Promote economic growth

What are some examples that have immediate costs, future benefits, and have overcome time preference?

College education

What is coupon payment?

The amount that bond pays until maturity date

In which case would the owner's equity on a house definitely rise?

The buyer pays down the mortgage and the house's value goes up

What is arbitrage?

The buying and selling of equally risky assets, ensures that equally risky assets earn equal returns

What is face value?

The cash amount you receive at the maturity date

What is time preference?

The desire to have goods and services sooner rather than later

What is the price of saving and borrowing?

The interest rate

What is one problem with the use of government guarantees covering the shadow banking system?

These guarantees could exacerbate the problem of managers having an incentive to take big risks

Why might have the Lehman Brothers had an incentive to take a lot of risk?

They received huge bonuses if the company was profitable but faced little downside risk if the company was not Their leverage ratio was frighteningly high, which is evidence of the risky behavior undertaken by its managers

What is the result when people become more thrifty?

They save more 1.) Lower equilibrium for interest rate 2.) Greater savings/borrowing

What is a financial intermediary

An institution that helps bridge the gap between savers and borrowers

What is the rate of return equation?

Asset incomie-price/ price x100

What is true of bonds and risk?

All bonds involve a risk

What is an investment?

The purchase of new capital: tools, machinery, factories

What is the leverage ratio?

The ratio of debt over equity (D/E)

Why do people borrow, save, and dissave according to the lifecycle theory?

To smooth their consumption

With the saving and consumption model, what is a fact?

Whatever a consumer does not save is consumed

What is a lender? (bond)

one who buys a bond

Why is the supply of loanable funds upward sloping?

At higher interest rates agents are willing to save more

Why is the demand of loanable funds downward sloping?

At lower interest rates, agents want to borrow more

Which of the following is NOT one of the four reasons why financial intermediaries might fail? Consumer indifference Politicized lending Insecure property rights Controls on interest rates

Consumer indifference

How to calculate owner equity?

E = value of asset (V) minus the debt (D)

Since investors are less optimistic, what happens to the supply and demand curve of interest rates and quanitity?

The demand curves shifts to the left 1.) Lower equilibrium interest rate 2.) Lower savings/ borrowing g

The shadow banking system are more prone to __________________because________________

more prone to panic than commercial banks because deposits are not always guaranteed The FDIC insures deposits at commercial banks and, since its creation, has essentially eliminated bank runs

What are some factors that lead to the failure of intermediation failing?

- Insecure property rights (which we see in Brazil and Argentina) - Politicized lending - Government banks (we see in Japan) - Interest rate controls -Inflation - Bank failures and panics

What are some examples of consumption smoothing?

Save during working years to provide for retirement Manage flunctuations in income: Save during good times in order to ride out bad times

What is true for countries where share of government ownership of banks is especially high?

They will have lower GDP per capita growth and lower productivity growth

The higher the risk the greater the ____________ required to get lenders to buy the bonds

the greater the interest rate

What is insolvency?

the inability to pay debts when they are due because liabilities far exceed the value of assets

An investment will be profitable only if its rate of return is greater than what?

the interest rate

What is the general goal of savings, where do financial intermediaries want them to go?

Want savings to go to borrowers and investors Move savings to more highly valued uses

When does the market for loanable funds occur?

When suppliers of loanable funds (savers) trade with demanders of loanable funds (borrowers)

How is a typical pattern of a persons income described?

Income is low when the person is young Income rises throughout their working career Income falls drastically at retirement

What does issuing bonds allow?

allows borrowing directly from the public

In the bond market, the higher risk means____________return

higher return

What grade is associated with bonds with the lowest risk?

AAA

The economy was fragile leading up to the Great Recession in part because____________(leverage)

BOTH homeowners and banks were using more leverage

The difference between the value of a house and the unpaid amount of the mortgage is known as______________

The owners equity Equity serves as a cushion in case the value of the property were to fall

An employer automatically enrolling employees in a retirement plan is an example of a nudge that leads to ___________________

higher rates of saving

As borrowing and the interest rate increases, what happens to saving, consumption, and investment?

-Saving increases -Consumption decreases -Investment decreases

What are four things that determines the supply of loanable funds?

-Smoothing consumption -Impatience -Market and psychological factors -Interest rates

Where does the money come from with traditional banks?

From depositors

What does high leverage of homeowners mean?

Defaults accelerated as home prices fell

Suppose the government cuts sales tax what happens to the equilibrium interest rate and quantity loanable funds?

Interest rate goes up, quantity goes down If taxes on consumption go down, households consume more, save less The supply curve will shift to the left

What is true of time preference and saving?

The greater the preference for thing snow, the smaller will be the saving

Argentina and Brazil have an issue with financial intermediaries, more specifically_______________

property rights over bank deposits are insecure

What is not an explanation for the low quality of many mortgage securities?

Laws preventing the securitization of high quality mortgages

What is crowding out?

The decrease in private spending that occurs when the government borrows more

What is a borrower? (bond)

one who issues a bond

As the financial crisis unfolded, banks could nt access capital and started selling assets simply to cover operation costss. This reduced__________

the price of these asssets, pushing more banks closer to insolvency causing more assets to be put up for sal e