Finc 408 Exam 2

How many members in the Board of Governors of the Fed, how long are they in office for, and who appoints them

7 members, 14 years, the president

How many members in the Federal Open Market Committee

12... 7 of which come from the Board of Governors

most important players in the financial markets

central banks

Central banks actions affect (3 things)

interest rates, amount of credit, and the money supply

what act created the federal reserve system

federal reserve act of 1913

how many directors in each district bank?

9 directors
Three A directors- bankers elected by member banks
Three B directors - non bankers appointed by member banks
Three C directors - non bankers appointed by Board of Govenors

What are the functions of the federal reserve bank (5 things)

Clear checks and administer the payment system
Issue new currency and withdraw damaged currency
Evaluate mergers and banking activities
Examine banks in their district
Collect data on local business conditions and research topics on conduct of monetary policy

FOMC directs \________

open market conditions

\_____________ establish the discount rate and \___________ review and determine the discount rate

12 federal reserve banks; Board of Governors

All \_______________ are required to be members of the Fed

national banks (Banks chartered by states are not required to be members. About 1/3rd of all commercial banks in US are members)

Reserve requirements are \_____________ and are set by the \______________

moneys deposited with the Federal Reserve banks that earn little interest; board of governors

Board of Governors chairman serves how long of a term? and how long is the term of the 7 members of the board of governors?

4 years; 14 years

All 7 directors of the Board of Governors are also members of the \_______

FOMC (along with 5 regional members.... the New York District President plus 4 other Fed District bank presidents)

Chairman of Board of Governors presides as chairman of \_________

FOMC

\_____________ help to control the money supply and is the most important tool in the Fed arsenal.

Open market conditions

FOMC is focal point of \___________

monetary policy

What act granted FOMC authority to determine open market operations

Banking Act of 1933

which act gave the board authority over reserve requirements

Banking Act of 1935

What 2 factors make the Fed independent

Members of Board have long terms
Fed is financially independent—this is most important

What 2 factors make the Fed dependent

Congress can amend Fed legislation
President appoints Chairmen and Board members and can influence legislation

Monetary policy is important because it affects \______ (3 things)

The money supply
Interest rates
Economic activity

Monetary liabilities of the Fed (2 things)

1. Currency in circulation (currency outside of banks)... EX: Fed notes, money

2. Reserves (currency held at banks plus deposits held at the federal reserve)... Reserves assets for banks, liabilities for the Fed. Two categories—required and excess reserves

Assets of the Fed are \_______ and \_______

Government securities and discount loans

Why are Fed assets important

Changes in assets change reserves and the money supply.
Fed assets earn interest, its liabilities do not

What is the most important monetary policy tool

Open market operations

Open market purchase \________ reserves, deposits, MB and money supply

expand

Open market sale \________ reserves, deposits, MB and money supply

shrink

The bonds used in open market operations are those issued by the \________ and \_________

US treasury and government agencies

A discount loan \________ reserves, deposits, MB and money supply

expands

The percentage of all deposits that banks are required to hold in reserve is called the \___________

required reserve ratio.... NOTE: required reserves \= required reserve ratio times the amount of deposits

When discount lending increases, the quantity of reserves supplied \___________

increases

As rates drop, reserves demanded \__________

increases

Open Market Operations:
Purchase of Gvts. causes Funds Rate to \_______
Sale of Gvts. Causes Funds Rate to \_______

fall; rise

Discount Lending:
Fed lowers discount rate, Funds rate \_______
Fed raises discount rate, Funds rate \______

falls; rises

Reserve Requirement:
When raised, Funds rate \_____
When lowered, Funds rate \_____

rises; falls

Dynamic Market Operations are \____________

Meant to change level of Reserves

Defensive Market Operations are \_________

Meant to offset other factors affecting Reserves, typically uses repurchase agreements and reverse repos

What is the funtion of the lender of last resort

to prevent banking panics and prevent nonbank financial panics

What are the three types of discount loans

Adjustment Credit
Seasonal Credit
Extended Credit

Advantages (1) and Disadvantages (4) of the reserve requirement

Advantages:
Powerful effect

Disadvantages:
Small changes have very large effect on Money supply
Raising causes liquidity problems for banks
Frequent changes cause uncertainty for banks
Tax on banks

Advantages of Open Market Operations (4)

Fed has complete control of size and timing

Open market operations-flexible and precise

Open market operations easily reversed

Open market operations done quickly

The feds three tools to conduct monetary policy and affect the Fed funds rate

open market operations
discount policy
change the reserve requirements

Goals of monetary policy (6)

High employment
Economic growth
Price stability
Interest rate stability
Financial market stability
Foreign exchange market stability

What are the three criteria for choosing targets

Measurability
Controllability
Ability to predictably affect goals

Lessons from Monetary targeting

Success requires correcting overshoots
Operating procedures not critical
Breakdown of relationship between M and goals made M-targeting untenable; led to inflation targeting

Lessons from inflation targeting

Decline in π still led to output loss
Worked to keep π low
Kept π in public eye—reduced political pressures for inflationary policy

the term money markets is used to refer to markets where

large denomination, low risk, short term financial securities are traded

money market transactions are done through

OTC markets (electronic communication)

Purpose of money markets

Investors in Money Market: Provides a place for warehousing surplus funds for short periods of time

Money market acts as a buffer for temporary use of cash inflows and outflows

Borrowers from money market provide low-cost source of temporary funds

six primary money market participants

US Treasury
Federal Reserve system
Commercial banks
Businesses
Investment and security firms
Individuals

7 money market instruments

Treasury Bills
Federal Funds
Repurchase Agreements
Negotiable Certificates of Deposit
Commercial Paper
Banker's Acceptance
Eurodollars

Treasury Bills are used to finance \______

the national debt

Treasury bills are ST or LT borrowings of the federal government?

ST (28 days to one year)

Treasury bills are issued at a \_________ and can be redeemed at their \____________

discount; par or face value

Market for T-Bills is extremely \_______ and \_______

deep (many buyers and sellers) and liquid (they can be easily bought and sold)

T-Bill discounting formula on pg 150 of study guide

T-Bill discounting formula on pg 150 of study guide

Federal Funds are

Short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day.... in easier wording it is the overnight borrowing and lending among commercial banks for the purpose of meeting the Feds reserve requirement

What sets the Fed fund rate

Forces of supply and demand set Feds fund rate

Main purpose for Fed funds is to

is to provide banks with reserves to meet their reserve requirements at Fed.

difference between fed funds and repurchase agreements

Non banks can participate in repurchase agreements

Repurchase agreements (repos)

When a firm sells Treasury securities in a repo and the firm agrees to repurchase the securities at a specified time and price.

maturity of repos

3-14 days... very ST

Negotiable certificates of deposit are

Bank issued term securities which have a specified maturity date and are issued by banks.... In other words it is a bank-issued security that documents a deposit and specifies the interest rate and the maturity date

Are negotiable certificates of deposit a bearer instrument

yes

What does a bearer instrument mean?

whoever holds it at maturity can redeem it

Denominations for a CD range from \__________ and mature in

range from $100,000 to $10 million and mature in 1 to 4 months

Commercial Paper are \____________

Unsecured promissory notes, issued by corporations

Commercial paper matures in less than \___________

270 days

Commercial paper are issued on a discounted basis? T or F

True

Bankers acceptance is \___________________

An order to pay a specified amount to the bearer on a given date if specified conditions have been met, usually delivery of promised goods. Crucial to Intl. trade

Banker's acceptance are traded on a \_______ basis in the \_______ market

discount; secondary

Advantages of Banker's acceptance (4)

Exporter paid immediately
Exporter shielded from foreign exchange risk
Exporter does not have to assess the financial security of the importer
Importer's bank guarantees payment

Eurodollars

Dollar denominated deposits held in foreign banks

SLIDE 23 on Lecture 11-12

SLIDE 23 on Lecture 11-12

The correlation of interest rates among money market securities is because they are all ST and of low risk. Two significant differences that distinguish one security from another is \_________ and \_______

default risk and liquidity

Money market mutual funds are

Open-end investment funds that invest only in short-term securities

Money market mutual funds are popular among

small investors

Purpose of the Capital Markets is for

Original maturity is greater than one year, typically for long-term financing or investments

Best known capital market securities are

stocks and bonds

Primary issuers of securities in capital markets are

Federal and local governments: debt issuers
Corporations: equity and debt issuers

Largest purchaser of securities in capital markets are

you and me (households are the main buyers)

Primary market transactions include

initial public offerings (IPOs)

Secondary markets are where previously issued securities trade. Where do these occur?

OTC markets or organized exchanges (NYSE)

Bonds represent

a debt owed by the issuer to the investor

The coupon rate of a bond is the

rate of interest the issuer must pay annually

The par, face, or maturity value of a bond is the

amount that the issuer must pay at maturity

If repayment terms are not met with a bond, the owner of the bond has

a claim on the assets of the issuer

Treasury bills have maturities \__________ while Treasury notes have maturities \_________ while treasury bonds have maturities \_________

less than 1 year (money market security); between 1-10 years; greater than 10 years

Treasury notes and bonds have \_______ but are free of

interest rate risk; default risk

Treasury notes and bonds have very \_______ interest rates because \_________

low; because of their low risk of default

Municipal bonds are issued by \____________ and are used to \______________

local, county, and state government; finance public interest projects

Tax-free municipal interest rate \=

taxable interest rate (1 marginal tax rate)

What are the two types of municipal bonds

General obligation bonds (full faith and credit) and Revenue bonds (Bond repaid from project)

General obligation bonds

are backed by the full faith and credit of the issuer

Revenue bonds

are backed by the cash flows of a particular project

Municipal bonds have default risk? T or F

yes but still less risky than corporate bonds

Corporate bonds have a face value of \_______ and pay interest

$1000; semiannually

Restrictive covenants

restrictions on management designed to protect bondholders. EX: a limit on dividends a firm can pay

With corporate bonds the degree of risk and interest rate do not vary with each bond no matter the level of risk. T or F?

F
Degree of risk varies with each bond
Interest rate varies with level of risk

Call provisions

state the price and time at which the issuer can force the holder to sell the bond back before maturity. In other words it allows the issuer to call (redeem) the bond before matiry