ECO3223 Final Exam Review Guide Exam 1 Questions 1 The function performed by the financial markets that permits households to increase future consumption at the expense of lower current consumption is a The wealth function correct b The liquidity function enables individuals to convert their wealth c Payment function permits the ownership of the economic good or into consumption at low costs asset to change hands d The credit function permits individuals to increase current consumption at the cost of future consumption 2 Which of the following is TRUE a The Federal Reserve compiles data on the monetary aggregates in order to gather information on activities in the financial markets true b The Federal Reserve uses the information from the nations money supply when setting tax policy The Treasury Department uses the information from the nations money supply when setting tax policy c The Treasury department defines the monetary aggregates or what constitutes the nations money supply The Federal Reserve defines the monetary aggregates and tracks their value because i They provide information on changes that are taking place in financial markets and among financial institutions ii Changes in the monetary aggregates tend to help forecast the economy d The Treasury Department monitors the nations money supply to gather information to be used in determining its monetary policy The Federal Reserve monitors the nations money supply to gather information to be used in determining its monetary policy 3 On September 23 2013 The Treasury Department auctioned off 30 billion of 3 month U S Treasury bills How would you characterize this market a Spot and Primary Correct remember that T billls are always newly issued b Capital and open i Spot ownership of assets changes hands immediately ii Primary financial assets are initially introduced i Capital for longer term assets more than one year ii Open assets are freely bought and sold to 3rd parties c Negotiated and futures i Negotiated he financial contract is between two people ii Futures forward futures and options market contracts specify the terms under which the change of ownership will take place in the future if at all d Money and secondary i Money financial market for short term assets with maturities less than one year ii Secondary existing assets are traded Similar review question A 3 month treasury bill with two months left to maturity is traded in a market that is money and open 4 5 Joe is trying to manage his assets in order to finance the expense of sending his daughter to the Bahamas for Spring Break which he estimates will cost 1000 while continuing to save for his retirement If he receives 6000 for the month and has expenses of 4500 which of the following COULD he do a He could finance the Spring Break trip and increase his financial assets by 1000 if he increased his debt by 500 Correct i Debt Current expenditures out of current income Current income Financial Assets ii 500 4500 6000 1000 got a negative number so that is why he is increasing his debt if positive number he is decreasing his debt James owns a home whose market value is 300 000 on which he owes 100 000 He also possesses 50 000 in stock He wants to begin operating a small business which would require him to purchase the non financial assets of the business for 50 000 He can either take out a home equity loan borrow against the equity he has in the house or sell stock What are the consequences for his balance sheet where expansion contraction implies an increase decrease in total assets a If he financed the purchase by selling stock his non financial assets would increase but his balance sheet would neither expand nor contract i Household balance sheet equation 1 Financial Assets Non financial assets Total liabilities Net Worth House Hold 2 His non financial assets would increase by purchasing the business but his financial assets would decrease from selling the stock Causing no change in the overall balance sheet ii Financial Assets Bank deposits corporate stock mutual funds other iii Non Financial Assets housing durable goods other iv Liabilities bank loans credit card debt mortgages other 6 Banks benefit from securitizing mortgages by a Removing risky assets from the balance sheets while retaining the servicing rights on the mortgages correct i Banks benefit from securitizing mortgages by removing the risky mortgages from their books receiving funds that can be used for additional loans and investments retaining the service rights on mortgages thus collecting fees for processing the mortgage payments b Removing risky assets from the balance sheets despite the fact they lose the servicing rights of the mortgages They still keep the servicing rights c Acquiring risky assets with higher expected returns while retaining the servicing rights on the mortgages They are removing risky assets d Acquiring risky assets with higher expected returns despite the fact they lose the servicing rights on the mortgages they remove risky assets and keep servicing rights 7 a In 2012 total assets in U S commercial banks was about 12 trillion which Is comparable to the total assets under management by private and public pension funds but much larger than the total assets under management by brokers and dealers correct i Matching this to the table below you can see that there is about 12 Trillion in the pension funds The Mutual funds are what are under the control of brokers and that is much less than 12 Trillion 8 Under the Dodd Frank Financial Reform legislation Nationally Recognized Statistical Rating Organizations NRSROs a Can be sued by investors whose assets received inaccurate ratings provided they could show they suffered financial losses due to reckless conduct or willful misrepresentation on the part of the rating agency in arriving at their ratings correct 9 A Credit Default Swap CDS i NRSRO s must report the following Method used in obtaining ratings use of 3rd party information in ratings track record for the ratings 1 They can be deregistered by the SEC for poor ratings 2 history Individuals may take legal action against the ratings agencies if they can prove reckless conduct of willful misrepresentation in the ratings that led to financial losses for the individual b Can be deregistered for a history of poor ratings as determined by Congress since their poor ratings of financial derivatives contributed to the Financial Crisis They can only be deregistered by the SEC