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After studying this chapter, you will be able to 1. Describe the money supply and explain the functions of the Federal Reserve System 2. Identify the most common types of commercial banking institutions and distinguish commercial banking from investment banking 3. Explain the meaning of an economic bubble and describe the forces behind the housing bubble of 2002- 2006 4. Describe the innovations and evolutions in mortgage lending that expanded homeownership but ultimately triggered the subprime…

Anything generally accepted as a means of paying for goods and services; serves as a medium of exchange, a unit of accounting, a store of value, and a standard of deferred value


The amount of money in circulation at any given point in time

money supply

The central banking system of the United States; responsible for regulating banks and implementing monetary policy

Federal Reserve System

Interest rate that member banks charge each other to borrow money overnight from the funds they keep in the Federal Reserve accounts

federal funds rate

Interest rate that member banks pay when they borrow funds from the Fed

discount rate

Sums of money, equal to a certain percentage of their deposits, that banks are legally required to keep on hand


( FDIC) Federal agency responsible for protecting money in customer accounts and managing the transition of assets whenever a bank fails

Federal Deposit Insurance Corporation

Government- sponsored enterprise responsible for guaranteeing and

Fannie Mae

Financial market in which mortgages are bought and sold, providing much of the funds that are loaned to home buyers

secondary mortgage market

Secondary mortgage institution similar to Fannie Mae

Freddie Mac

Financial institutions that accept deposits, offer various types of checking and savings accounts, and provide loans

commercial banks

Banks that provide financial services to consumers

retail banks

Banks that provide financial services to businesses; can also refer to private equity management

merchant banks

Banking institutions that offer deposit accounts and focus on offering home mortgage loans; also called thrifts or savings and loan associations

thrift banks

Not- for- profit, member- owned cooperatives that offer deposit accounts and lending services to consumers and small businesses

credit unions

Banking services for wealthy individuals and families

private banking

Firms that offer a variety of services related to initial public stock offerings, mergers and acquisitions, and other investment matters

investment banks

Nonbank companies that use their own funds to offer mortgages

independent mortgage companies

Nonbank companies that initiate loans on behalf of a mortgage lender in exchange for a fee

mortgage brokers

Nonbank institutions that lend money to consumers and businesses for cars and other vehicles, home improvements, expansion, purchases, and other purposes

finance companies

Companies that offer opinions about the creditworthiness of borrowers and of specific investments

credit rating agencies

Market situation in which frenzied demand for an asset pushes the price of that asset far beyond its true economic value


The percentage of an asset's market value that a lender is willing to finance when offering a loan; the rest of the purchase price has to be paid by the buyer as a down payment

loan-to-value ( LTV)

( ARM) Mortgage that features variable interest rates over the life of the loan

adjustable rate mortgage

Type of ARM that lets borrowers choose from several repayment options

option ARM

Payment situation in which the balance owed on a loan increases over time rather than decreases

negative amortization

Home loans offered to the most creditworthy customers

prime mortgages

Home loans for borrowers with low credit scores

subprime mortgages

Situation in which borrowers stop making payments on a loan


Process in which debts such as mortgages are pooled together and transformed into investments


( ABSs) Credit derivatives based on auto loans, credit card debts, and other loan assets

asset-backed securities

( MBSs) Credit derivatives based on home mortgages

mortgage-backed securities

Lenders taking possession of homes after borrowers default on their payments


Severe shortage of liquidity throughout a sector of the economy or the entire economy, during which companies can't get enough cash to meet their operating needs

liquidity crisis

Situation in which credit has become so scarce that it is virtually unavailable, at any cost, to most potential borrowers

credit freeze

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