ECON330 Final 60 Multiple Choice Questions o How to Calculate Bond Prices 3 Questions P C 1 i C 1 i 2 C 1 i n M 1 i n o o P Bond Price o C Coupon Payment o i Interest Rate or Required Yield o M Value at Maturity or Par Value o Graphing Bond Supply and Demand 3 Questions o Determinants of Demand of Bonds Wealth An increase in wealth increases the change in quantity of bonds demanded Expected Return An increase in expected return increase the change in quantity of bonds demanded Risk An increase in risk decreases the change in quantity of bonds demanded Liquidity An increase in liquidity increases the change in the quantity of bonds demanded Expected Interest Rate An increase in expected interest rate decreases the quantity of bonds demanded at each bond price Expected Inflation An increase in expected inflation decreases the quantity of bonds demanded at each bond price o Determinants of Supply of Bonds Profitability of Investments An increase in the profitability of investments will increase the quantity supplied at each bond price Expected Inflation An increase in the expected inflation will increase the quantity supplied at each bond price Government Deficit An increase in the government deficit will increase the quantity supplied at each bond price o Fisher Effect The outcome that when expected inflation occurs interest rates will rise i ir P e i Nominal Interest Rate ir Real Interest Rate Pe Expected Rate of Inflation o Liquidity Preference Framework A model developed by John Maynard Keynes that predicts the equilibrium interest rate on the basis of the supply and demand for money Shifts in the Demand for Money Income Effect Higher level of income causes the demand for money at each interest rate to increase and the demand curve to shift to the right Price Level Effect A rise in the price level causes the demand for money at each interest rate to increase and the demand curve to shift to the right Shifts in Supply of Money An increase in the money supply engineered by the Federal Reserve will shift the supply curve for money to the right o Monetary Supply Monetary Base 1 Question o Monetary Base The sum of the Fed s monetary liabilities currency in circulation and reserves and the U S Treasury s monetary liabilities Treasury currency in circulation primary coins MB MB C R M1 m MB Monetary Base C Currency in circulation R Total reserves in banking system m Money multiplier M1 Money supply o Fed s Balance Sheet Federal Reserve System Assets Government securities Liabilities Currency in circulation Discount loans Reserves o Open Market Purchase from a Commercial Bank Commercial Bank Securities Asset Reserves Asset Federal Reserve System Securities Asset Reserves Liability Result Reserves Monetary Base but no change in currency o Open Market Purchase from a Nonbank Public Nonbank Public Ex Goldman Sachs Securities Asset Checkable Deposits Asset Commercial Bank Securities Asset Checkable Deposits Federal Reserve System Securities Asset Reserves Liability Liability Result Reserves Monetary Base o Open Market Purchase from Public Cashing a Check Public Securities Asset Currency Asset Federal Reserve System Securities Asset Currency Liability Result R unchanged and MB o Open Market Purchase Summary The effect of an open market purchase on reserves depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits The effect of an open market purchase on the monetary base always increases the monetary base by the amount of the purchase o Required Reserves Reserves that the Fed requires banks to hold o Excess Reserves Any additional reserves that banks chose to hold o Required Reserve Ratio The fraction of deposits that the Fed requires be kept as reserves o Discount Rate The interest rate charged banks for discount loans o Simple Deposit Multiplier Assuming banks do not hold excess reserves RR Required Reserves R Total Reserves R Total Reserves r Required Reserve Ratio Amount of Checkable Deposits D Total D R 1 r Taking change in yield into account o Capital Regulation 2 Questions o Federal Reserve Structure Fed Monetary Policy Open Market Operations 17 Questions DD DR 1 r o The Federal Reserve is the central bank of the United States of America Central Bank Is the government s bank and its role is to manage the finances of the government and control the availability of credit and money Primary Objectives Low and stable inflation high and stable growth with high employment stable financial markets interest rate stability and exchange rate stability However these goals are conflicting and therefore tradeoffs must be made Open Market Operations The Fed s buying or selling of bonds in the open market Three day to day functions o Manage the payments system settle inter bank payments o Provide loans during times of financial stress the lender of last resort o Oversee commercial banks and the financial system to ensure confidence in their soundness o Origins of the Federal Reserve System Why it did not exist prior to 1913 Fear of centralized power Distrust of moneyed interests Events that lead to the creation of the Federal Reserve No lender of last resort Nationwide bank panics on a regular basis Panic of 1907 so severe that the public was convinced a central bank was needed Created in 1913 through the Federal Reserve Act of 1913 Elaborate system of checks and balances Decentralized o Structure of the Federal Reserve System Federal Reserve Banks The 12 district banks in the Federal Reserve System Each of the 12 district banks districts has a main Federal Reserve Bank and at least one branch office Functions of the Federal Reserve Banks o Clear checks o Issue new currency and withdraw damaged currency from circrulation o Administer and make discount loans to banks in their districts o Evaluate proposed mergers and applications for banks to expand their activities Monetary Policy of the Federal Reserve Banks o Directors establish the discount rate o Decide which banks can obtain discount loans o Five of the 12 bank presidents have a vote in the Federal Open Market Committee FOMC Special Role of the Federal Reserve Bank of New York o The New York Fed houses the open market desk All of the Feds open market operations are directed through this trading desk o The president of New York Fed is the only permanent member of the FOMC serving as the vice chairman of the committee The banks are quasi public o Owned by member commercial banks in the district o