1、Answers to Some Review Questions113Answers to SOME Review QuestionsCHAPTER 1Introduction and Overview1. Provide a short discussion or definition of the following terms: economics, finance, the financial system, net lenders, net borrowers, direct and indirect finance, financial markets, financial int
2、ermediaries, liquidity, the business cycle, depository institutions, and monetary policy.Economics: The study of how a society decides what to produce, how to produce, and who gets what; the study of how scarce resources get allocated to satisfy unlimited wants.Finance: The study of how the financia
3、l system coordinates and channels the flow of funds from lenders to borrowersand vice versa and how new funds are created by depository institutions during the borrowing process; the raising and using of money by households, firms, governments, and the “rest of the world” (foreign) sectors. Net lend
4、ers: Spending units such as households and firms whose spending on consumption and investment is less than income.Net borrowers: Spending units such as households and firms whose spending on consumption and investment is more than income. Direct finance: When net lenders lend their surplus funds dir
5、ectly to net borrowers.Indirect finance: When net lenders deposit their surplus funds into financial intermediaries which in turn, lend the funds to net borrowers; when net borrowers borrow funds from financial intermediaries that have acquired funds to lend from net lenders and that issue their own
6、 liabilities. Financial intermediaries: Financial institutions that borrow from net lenders for the purpose of lending to net borrowers; financial intermediaries such as banks, savings and loan associations, credit unions, mutual funds, insurance companies, and finance companies issue monetary and o
7、ther claims on themselves; they serve as gobetweens to link up net lenders and net borrowers.Liquidity: The ease with which a financial or real asset can be converted to cash without loss of value.Business cycle: Shortrun fluctuations in the level of economic activity as measured by the output of go
8、ods and services in the economy.Depository institutions: Financial intermediaries that offer checkable deposits which are subject to withdrawal by writing a check to a third party and which are part of the nations money supply.Monetary policy: The Feds effort to promote the overall health and stabil
9、ity of the economy.2. Some people have money; some people need money. Explain how the financial system links these people together.Net lenders deposit surplus funds into financial intermediaries that in turn lend the funds to net borrowers. Net lenders gain interest payments from the financial inter
10、mediaries for the use of their funds. Net borrowers make interest payments to the financial intermediaries for the use of the borrowed funds. The profit to financial intermediaries is the difference between the cost of their liabilities and the earnings on their loans and investments. 5. Why do fina
11、ncial intermediaries exist? What services do they provide to the public? Are all financial institutions financial intermediaries?Financial intermediaries exist to link up net lenders and net borrowers and to help minimize the transactions costs associated with borrowing and lending. Financial servic
12、es provided by financial intermediaries include appraising and diversifying risk, offering a menu of financial claims that are relatively safe and liquid, and pooling funds from individual net lenders. Not all financial institutions are financial intermediaries. Financial intermediaries are a type o
13、f financial institution that issue claims on themselves. Other financial institutions, such as stock and bond brokers merely link up net lenders and net borrowers for a fee and do not issue claims on themselves.8. Why does the Fed monitor the economy? What actions can the Fed take to affect the over
14、all health of the economy?The Fed monitors the economy in order to promote the overall health and stability of the economy. The Fed can influence the economy through monetary policy. The Fed implements monetary policy to affect the level of interest rates and credit availability. When interest rates
15、 decrease and credit availability increases, the level of economic activity speeds up. When interest rates increase and credit availability decreases, the level of economic activity slows down.CHAPTER 2Principles of Money1. Discuss or define briefly the following terms and concepts: means of payment
16、, store of value, unit of account, barter, monetary aggregates, liquidity, domestic nonfinancial debt, electronic funds transfer system, and risk.Means of payment: Something that is generally accepted and used to make payments.Store of value: Something that retains its value over time.Unit of accoun
17、t: A standardized accounting unit, such as the dollar, which is the standard measure of value.Barter: Trading goods for goods in an exchange economy.Monetary Aggregates: The measures of money, including MI, M2, M3, and L, which the Fed keeps track of and monitors. Liquidity: The ease with which a no
18、n-monetary asset can be converted to money without loss of value.Domestic Nonfinancial Debt: Total credit market debt owed by the nonfinancial sector and accumulated in the past and present years; includes the debt owed by the household, nonfinancial business, government, and rest of the world (fore
19、ign) sectors.EFTS (Electronic Funds Transfer System): The transfer of funds to third parties in response to electronic instructions rather than instructions written on paper checks.Risk: The possibility of financial assets losing value.2. What are the functions of money? Which function do you think
20、is most important?The functions of money are to serve as a means of payment (medium of exchange), a unit of account, and a store of value.The most important function of money is to serve as a means of payment (medium of exchange). Thus, it is critical that money is generally accepted to make payment
21、s. Without a generally accepted means of payment, exchange is very costly. For an exchange to take place, there would have to be a double coincidence of wants where the person you wished to buy from wanted what you were offering in exchange. 5. How does the Fed calculate M1, M2, M3, and DNFD? Are th
22、ese aggregates all money? Why or why not? Which contains the most liquid assets? Which is smallest? Which is largest?To calculate M1, M2, M3, and DNFD, we merely add up the items included in the aggregate as follows:M1 = currency in the hands of the public + demand deposits at commercial banks + oth
23、er checkable deposits + travelers checksM2 = M1 + small savings and time deposits (less than $100,000), including money market deposit accounts + individual money market mutual fundsM3 = M2 + large time deposits + term repurchase agreements and term Eurodollars + institutional money market mutual fu
24、ndsDNFD = credit market debt of the U.S. Government and state and local governments + corporate bonds + mortgages + consumer credit (including bank loans) + other bank loans + commercial paper + other debt instrumentsAll of these aggregates except DNFD are a measure of money. M1 is the narrowest mea
25、sure of money and the smallest aggregate. M1 is generally used for transactions and contains the most liquid assetsassets that are money per se. M2 and M3 are progressively broader measures of money that include M1 and other near money assets. For example, M2 contains everything in M1 plus some othe
26、r highly liquid near monies. M3 contains everything in M2 plus other less liquid near money substitutes. DNFD is the largest aggregate but many of the items in DNFD are not money or near monies. DNFD is the broadest measure of nonfinancial credit in the domestic economy.10. Zoto is a remote island t
27、hat has experienced rapid economic growth. In contrast, Zaha is an island where growth has been sluggish and the level of economic activity remains low. How could the existence of money have affected these two outcomes?Since money facilitates economic development, one would suspect that Zoto has a s
28、ophisticated and advanced “money,” while Zaha relies mainly on barter. The existence of money could explain the differing growth rates. CHAPTER 3The Role of Money and Credit2. Briefly define the interest rate, reserves, the required reserve ratio, the inflation rate, and nominal GDP.Interest Rate: T
29、he cost to borrowers of obtaining money and the return (or yield) of money to lenders.Reserves: Assets that are held by depository institutions as either vault cash or reserve deposit accounts with the Fed.Required Reserve Ratio: Depository institutions must have reserve assets equal to a certain pe
30、rcentage of deposit liabilities; the required reserve ratio is that percentage.The Inflation Rate: The rate of change of a price index, such as the consumer price index. Nominal GDP: The quantity of final goods and services produced in an economy during a given time period and valued at todays price
31、s.8. What are the sources of credit? Explain the following statement: “The money supply is measured at a point in time while the flow of credit is measured over time.”Credit comes from depository institutions, other financial intermediaries, and other financial and nonfinancial institutions. The mon
32、ey supply is a stock, while credit is a flow. Flows over time lead to changes in stocks measured at different points in time. Likewise, changes in stocks measured at different points in time result from flows over time.11. Explain the difference between money and credit. Give an example of each.Money is anything that functions as a means of payment, unit of account, and store of value. Credit is the flow of money in a given time period from net lenders or financial intermediaries to net borrowers. Currency is money whereas a loan is credit.CHAPTER 4Financial Markets
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