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Money and Banking Final

Terms in this set (30)

When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called an
exchange market
In a banking panic, the source of contagion is the
asymmetric information problem
In a financial crisis, a substantial decrease in the aggregate price level that reduces households' and firms' net worth may stall a recovery from a recession. This process is called
debt deflation
A problem for equity contracts, when the manager only owns a small portion of the firm, is a particular type of ____ called the ____ problem
moral hazard; principal-agent
If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of
adverse selection
As regulators increase the required ratio of bank capital to liabilities, banks tend to
buy riskier assets
Which of the following can be described as involving indirect finance
You make a deposit at a bank
Financial markets have the basic function of
getting people with funds together with people who want to borrow funds
For a given return on assets, the higher bank capital is
the lower the possibility of bank failure, the lower is the return for the owners of the bank
What was the primary cause of the rise of sale and repurchase agreements?
Increase in institutional investing
In an ____ market, dealers in different locations buy and sell securities to anyone who comes to them and is willing to accept their prices
over-the-counter
A mutual fund that allows investors to purchase shares in a diversified portfolio instead individual shares of the assets represented in that portfolio is taking advantage of _____ and thereby ___
economies of scale; lowers transaction costs
If a bank has $100,000 of checkable deposits, a required reserve ratio of 25 percent, and it holds $40,000 in reserves, and $60,000 in assets, then what is the largest deposit outflow it can sustain without needing to sell assets?
$20,000
A bank is illiquid when
it cannot meet its liabilities in a short period of time
The market for debt that is typically short term is called the
money market
In general, banks make profits by selling __ liabilities and buying ___ assets
short-term;long-term
If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could
borrow from another bank in the federal funds market
A self-fulfilling bank run occurs when
solvent banks become illiquid if all depositors request funds back
The central question in the article by Kashyap, Rajan, and Stein, "Banks as Liquidity Providers" is
is it necessary that one institution is involved in both deposit taking and lending?
A policy of ____ requires that liquid reserves equal deposits
narrow banking
Banks acquire the funds that they use to purchase income-earning assets from such sources as
borrowings, savings accounts
American businesses get their external funds from
loans from nonbank financial intermediaries
Financial markets improve economic welfare because
they allow consumers to time their purchase better
Maturity transformation can be described as
borrowing short and lending long
Bank capital is equal to ______ minus ______
total assets; total liabilities
BANKING MODEL
Assume there are no banks. Let theta be the fraction of endowment agents invest in the liquid asset in period 0. Given an agent's choice of theta in period 0, write down their optimal consumption choices if they are early and if they are late.
early: c_1=theta, c_2=0
late: c_1=0, c_2=theta+(1-theta)(1+r)
c_2=theta + (1-theta)(1+r)
BANKING MODEL
Write down the utility maximization problem of an agent clearly stating all the constraints. What is their trade off in expected consumption in period 1 and 2 if they vary theta between 0 and 1? What parameters does this tradeoff depend on?
max pi*u(c_1)+(1-pi)u(c_2)
such that c_1=theta
c_2=theta+(1-theta)(1+r)
theta is between 0 and 1
Let u(c)=ln(c) so that u'(c)=1/c. Set up the tangency condition for optimality and derive the equilibrium allocation for c_1,c_2, and theta as a function of parameters assuming an interior solution
Tangency Condition = C_2/C_1 = (1-pi)*r / pi
c_1 = theta = pi(1+(1/r))
c_2 = (1-pi)(1+r)
Given a bank's choice of theta^ in period 0, write down the bank's optimal choice to give early and late agents (what are the bank's constraints for theta and theta^?). Explain the constrains in words. Write down the utility maximization problem of the bank. Solve for the optimal allocation of c_1^, c_2^, c_1^ assuming as in part c that utility is u(c)=ln(c) so that u'(c)=1/c.
c_1^ = theta/pi
c_2^-(1-theta)(1+r) / (1-pi)

max pi u(c1^)+(1-pi)u(c2^)
such that theta ^

TC: (pi)(1/c1^)*(1/pi)+(1-pi)(1/c_2^)(-1-r/1-pi)=0 max
TC: c_2^/c_1^ = 1+r
c_1^ = 1
c_2^ = 1+r
theta = pi
Fiat money is _____ while commodity money is _____
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