short answer qs
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- What is money? What are the functions of money? Provide two measures of money in the economy and explain how they differ.
- *Money is anything that is generally accepted in payment for goods/services and repayment of debt. *3 functions are: -Medium of exchange: used to pay for goods/services -Unit of account: used to measure value in the economy -Store of value: repository of purchasing power over time. *2 measures of money: -M1: measure of money that compromises the most liquid assets. -M2: much broader and adds assets that have check writing features to M1.
- What are the general observations you can make from the above graph? Name three of the factors responsible for the observed pattern in interest rates.
- *Interest rates for different maturities move together. The yield on municipal bonds is is generally the lowest. *Three factors responsible: -Default risk: the chance that the issuer of the bond will be unable to make interest payments or pay off the face value when the bond matures. -Liquidity: an asset that can be cheaply and quickly be converted into cash. -Income tax consideration: interest payments on municipal bonds are exempt from federal income taxes.
- Describe the formal structure and allocation of policy tools in the Federal Reserve.
- *Required reserve ratio: all banks are required to gold a minimum percentage of deposits as reserves. *Discount rate: the interest rate at which the Fed stands ready to lend reserves to depository banks. *Open market operation: a purchase of US gov. securities
- What are the factors that make the Fed more independent? Less independent? Should the Fed be more independent? Pros and cons.
- *Members of the board are appointed for long terms. The Fed is financially independent. *The President appoints the Chairmen and Board members and can influence legislation. Congress can amend Fed legislation. *Case for: Avoids political business cycle. Less likely budget deficits will be inflationary. *Case against: Fed may not be accountable for its actions. Has performed poorly in the past (Great Depression).
- If inflation and unemployment are of direct concern to Fed officials, why do they make such a big issue about money growth and interest rates? Why don't they just target the unemployment rate and the inflation rate directly?
- *The federal funds rate's interest rate is indicative of the Fed's stance of monetary policy, so the Fed tries to influence it directly. Economic growth and price stability both effect the unemployment rate. If they just focus directly on the price stability then it will cause conflicts with short term goals and initially worsen the unemployment rate and inflation issues.
- Describe the goals of the Fed. What happens when these goals come into conflict? How would one decide if lower inflation is more important than lower unemployment?
- *6 goals of the Fed: -High employment (consistent with stable price level) -Economic growth (increase when business invest in capital equipment to help productivity) -Price stability (raising price level causes uncertainty in the economy) -Interest rate stability (fluctuations in interest rates causes uncertainty in the economy) -Stability in financial market (financial crisis can interfere with financial markets to channel funds to people) -Stability in foreign trade (less volatile dollar can spur in international trade) *Conflicts tend to happen in the short run and cause issue with goals of monetary policy. *Inflation does not effect the natural rate of unemployment, but it can effect price stability which would later effect businesses and then cause a lower employment
- What are adverse selection and moral hazard? What is the main consequence of these problems? What can banks do to alleviate them?
- *Adverse selection: when potential borrowers who are most likely to produce adverse outcomes are the ones most likely to produce adverse outcomes are the ones most likely to seek a loan and be selected. *Moral hazard: the risk that the borrowers has incentives to engage in undesirable activities from the lender's point of view making it less likely that the loan will be paid back. *The main consequence is that the banks would make less profit and savers receive less of an interest payment. *Screen out good from bad credit risks and monitor parties they lend to.
- Describe three money market instruments.
- *Treasury bills: most widely held liquid security . Virtually zero default risk. Market for T-bills is deep and liquid. *Federal funds: short term funds transfered between financial institutions to meet reserve requirements. *Repurchase agreements (Repos): essentially a collateralized loan in which security dealers use the repo to manage their liquidity.
- What is a convertible bond? Why do firms issue them? How does the convertibility feature affect the bond's price and interest rate?
- *A bond that can be converted into common stock. *Firms use them to avoid sending a negative signal to the market *The conversion feature causes lower interest rates.
- Explain 3 differences between domestic and foreign trade that emanate from the existence of national boundaries
- 1. Exchange rates: the price of currency in terms of another, used to translate values from one currency to another. 2. Commercial policies: a national gov. can introduce a variety of restrictions upon international transactions that cannot be impose on domestic transaction 3. Marketing considerations: differences in demand patterns, sales techniques, and market requirements make international transactions more difficult.
- What can you say about the following relationships? Absolute advantage and the direction of international trade. Comparative advantage and the direction of international trade.
- *Absolute advantage is used less with international trade because a country gains less when it is giving up so much in terms of opportunity cost. *Comparative advantage is used more with international trade because a country gains more out of the trade because it is giving up less in terms of opportunity cost
- What are the main reasons why we could blame the lenders for their role in the subprime crisis?
- *Lent to house borrowers with weak credit. Provided teasers like minimal or zero down payment and low introductory adjustable rate mortgages as well as lax documentation and credit checks.
- Explain some of the policies of the Fed and gov. that led to or amplified the current financial crisis.
- *Federal gov. leaned on the mortgage industry, including Fannie Mac and Freddie Mac, to lower lending standards. *The Fed lowered interest rates earlier in the decade which led to the rise in the house prices.