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# ECON Exam #2

### Ch 5-9

TermDefinition
Wealth the total resources owned by the individual, including all assets
Expected Return the return expected over the next period on one asset relative to other assets
Risk the degree of uncertainty associated with the return on one asset relative to other assets
Liquidity the ease and speed with which an asset can be turned into cash relative to other assets
Bond Supply (Govt. + Corp) Borrowers/Issuers; Curve Up
Bond Demand (Households) Lenders/Buyers; Curve Down
Shifters of Demand Wealth + = + Return + = + Risk + = - Liquid + = + Inflate + = - Interest + = -
Shifters of Supply Govt. Deficit + = + Profit + = + Inflate + = +
Fisher Effect When expected inflation +, interest rates will +
The demand curve for bonds has the usual downward slope, indicating that at ______ prices of the bond, the ______ is higher. lower; quantity demanded
When the interest rate on a bond is _____ the equilibrium interest rate, in the bond market there is excess ______ and the interest rate will _____. above; demand; fall
If stock prices are expected to drop dramatically, then the demand for stocks will _____ and that of Treasury bills will ____. decrease; increase
An increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to _____ and the demand curve to shift to the ______.` fall; left
If expected interest rate is up, the demand for bonds _____ and the demand curve shifts to the _____. decrease; left
In the bond market, the bond demanders are the _____ and the bond suppliers are the _____. lenders; borrowers
When the expected inflation rate increases, the real cost of borrowing ____ and bond supply ______. decreases; increases
Higher govt deficits ____ the supply of bonds and shift the supply curve to the ____. increase, right
If the liquidity effect is smaller than the other effect, and the adjustment to expected inflation is slow, then the interest rate will initially fall, but eventually climb above the initial level in response to an increase in money growth
Collateral a prevalent feature of debt contracts for both households and businesses
Debt contracts are extremely complicated legal documents that place substantial ______ ______ on borrowers restrictive covenants
Adverse Selection before transaction, fixed by screening
Moral Hazard after transaction, fixed by monitoring collateral
If the expected return on U.S. T-Bonds falls from 4 to 3 % and the expected return on corporate bonds falls from 6 to 3%, then the expected return of US Treasury bonds _____ relative to corporate bonds and the demand for US Treasury bonds _____. rises; rises
Because of the "lemons problem" the price a buyer of a used car pays is between the price of a lemon and a peach
If you default on your auto loan, your car will be repossessed because it has been pledged as _____ for the loan collateral
That only large, well-established corporations have access to securities markets explains why indirect finance is such an important source of external funds for businesses
Net worth can perform a similar role to collateral
A problem for equity contracts is a particular type of ______ called the ______ problem. moral hazard; principal-agent
Solutions to the moral hazard problem include monitoring and enforcement of restrictive covenants
Bank reserves include vault cash + deposits at the Fed
Which of the following are reported as assets on a bank's balance sheets? Discount Loan Deposits at the Fed Checkable Deposits Bank Capital Deposits at the Fed
If a bank has \$500,000 of checkable deposits, and it holds \$75,000 in required reserves, then what would be the required reserve ratio? 75,000 = rr * 500,000 rr = 75,000/500,000 = 0.15 = 15%
With a 12% reserve required ratio, calculate the max amount SNB could lend when a \$8,000 deposit is made into SNB RR = rr * D Max Loan = D - RR RR = 8,000 * 12% = 960 Max Loan = 8,000 - 960 = 7,040
Assets (Own) 1. Reserves = VC + Dep at Fed 2. SR = Govt and other Liquid Securities (T-Bills) 3. Loans to Businesses, Consumers, and other Banks
Liabilities (Owe) 1. Deposits 2. Fed Fund = Other Banks 3. Discount Loan = Central Bank -------- Capital = Equity = Net Worth * Liquid Management
Reserves Cash Funds that bankers maintain to meet deposits outflows and other payments **Reserve = Required Reserve + Excess Reserve
Required Reserves a minimum amount of cash funds that banks are required by regulators to hold
T-Accounts simplified balance sheets that list only changes in liabilities and assets
Return on Assets (ROA) profit/asset
Return on Equity (ROE) profit/equity
Leverage = Asset/(Asset - Liability) = Asset / Equity
Higher Leverage Higher debt rate
Credit Risk the risk of borrowers defaulting on the loans
Interest Rate Risk the risk that interest rate changes will affect the returns on its assets or the cost of its liablities
Managing Credit Risk Screen, Monitor, Collateral, Restrictive Covenants
Interest Rate Risk is determined by the amount of rate-sensitive assets/liabilities the change in interest rates
Gap Analysis Change in interest rate (new - old) * (assets - liabilities)
If assets > liabilities and interest rate rises then profitability rises
If assets > liabilities and interest rate falls then profitability falls
If assets < liabilities and interest rate rises then profitability falls
If assets < liabilities and interest rate falls then profitability rises
Strategy: if interest rate is down, what does that mean for assets and liabilities bad for assets = try to extend contract with previous interest rate for as long as possible good for liability = cut current contract and create new one with new interest rate for as long as possible
Strategy: if interest rate is up, what does that mean for assets and liabilities good for assets = cut current contract and start new one far as long as possible with new interest rate bad for liabilities = try to extend current contract with previous interest rate for as long as possible
Which of the following statements are true? A. assets are its sources of funds B. liabilities are its uses of funds C. capital is recorded as an assets on the balance sheet D. balance sheet shows that total assets = total liabilities + equity capital D. A bank's balance sheet shows that total assets equal total liabilities plus equity capital
Secondary Reserves include Short-term US government securities
Which of the following are transaction deposits? A. savings accounts B. small-denomination time deposits C. checkable deposits D. certificates of deposit C. checkable deposits
Bank loans from the Federal Reserve are called ___ and represent a ___ of funds. discount loans; source
Banks may borrow from or lend to another bank in the Federal Funds market. A loan of excess reserves from one bank to another bank is recorded as ____ for the borrowing bank and ____ for the lending bank. a liability; an asset
When you deposit \$50 in your account at FNB and a \$100 check you have written on this account is cashed at SNB, then the reserves at FNB fall by \$50
Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves, borrowing from the Fed, and borrowings from other banks to deal with deposit outflows is an example of liquidity management
If, after deposit outflow, a bank needs an additional \$3 mil to meet its reserve requirements, the bank can sell \$3 mil of securities
If a bank has \$200,000 of checkable deposits, a required reserve ratio of 20%, and it holds \$80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is 200,000 - 50,000 = 150,000 (0.2) = 30,000 80,000 - 50,000 = 30,000 Max = 50,000
Bank capital has both benefits and costs for the bank owners. Higher bank capital ___ the likelihood of bankruptcy, but higher bank capital ___ the return on equity for a given return on assets reduces; reduces
Suppose that from a new checkable deposit, FNB holds \$2 mil in VC, \$12 mil Dep of Fed, and \$9 mil in ER. Given this info, compute the required reserve ratio that FNB faces given this info VC + Dep of Fed = Reserves 2 + 12 = 14 mil Reserve Total = RR + ER 14 = x + 9 = 5 mil
When \$400 mil is deposited at a bank, the RR is 20%, and the bank chooses not to hold excess reserves instead, then, in the bank's final balance sheet, the assets increases by _____ , and the total reserves by ____. Assets = \$400 mil Reserves = ER + RR = \$400 mil
GAP analysis means change in profit in terms of Dollar
Duration analysis means change in profit in terms of Percent
3 players in the money supply process Central Bank (Fed Reserve System) Bank (Depository Institutions; Fin Intermediaries) Depositors (Individuals and Institutions)
MB = C + R C = Currency in Circulation R = Reserves in Banking System (VC + Dep of Fed = RR + ER)
OMO sell securities MB decreases
MBn = MB - BR BR = Borrowed Reserves
If reserves increase by 100, by how much will the money supply increase? (1/10%)*100 = 1000
Change in M = m * (change in MB) m = money multiplier
m = 1/reserve ratio
Factors that determine money supply Change in required reserve ratio, currency holdings, and excess reserves
5 factors that affect change in M RR + = m - = change in M - ER + = m - = change in M - C + = m - = change in M - MBn + = change in MB + = change in M + BR + = change in MB + = change in M +
Created by: cds-02
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