Finance 301 1st Edition Lecture 6Outline of Last Lecture I. Why debt security yields varyII. Yield CurveIII. Yield DifferentialsIV. Yield Differentials On Money Market SecuritiesV. Yield Differentials On Capital Market SecuritiesVI. Estimating Appropriate YieldOutline of Current LectureVII. Organizational structure of the FedVIII. How Fed Controls Money SupplyIX. How Fed operations effect interest ratesX. Adjusting Reserve Requirement RatioXI. Adjusting the Fed’s Loan RateXII. Feds Lending Role During Credit CrisisXIII. Global Monetary PolicyCurrent LectureI. Organizational structure of the Feda. Federal Reserve district banksi. We have 12 federal reserve district banks, they keep up with their region and regulate them keep up with employment inflation and price levels in their areaii. Charter with the federal reserve, then they get shares in the federal reserve and become a member bank can be up to 6 % dividendiii. The jobs are they loan money to member banks and they buy and sell treasuries with their banks and they also replace currency in the circulation for example if they are too damaged to use and they can print new money into economy and they also clear checksb. Member Banksi. Commercial banks- 35% of the banks in this country other 65 percent are state charter banks this means that the state they are charter with regulates them instead of the federal reserve federal deposit insuranceii. FDIC insure your checking account up to 250,000 got changed recently used to be 100,000iii.c. Board of Governorsi. 7 peopleii. They are appointed to 14 year terms by the president and they arestaggered every 2 years. We give them 14 years because you cant have major changes the economy would go haywire, politics wont be involved presidents will come and go and they cant influence these people that much. Don’t want your politicians influended easilyiii. Janet yellen - alabamaiv. Vice chairman goes and reports to congress and tell them what theyre working on d. Federal Open Market Committeei. Made up of the 7 members of the Board of Governors plus the presidents of 5 Fed district banks (the New York district bank plus 4 of the other 11 as determined on a rotating basis).ii. Releases statement on what they are going to do. 12 ones that vote on what to do 12-0 11-1 or 10-2 theyre all very one sidediii. Federal-advice from commercial banksiv. Consumer-advice from consumers such as me and you, how people are doing, involvementv. Thrift- credit unions and savings banks and loanse. Advisory Committeesi. Federal Advisory Council ii. Consumer Advisory Council iii. Thrift Institutions Advisory CouncilII. How Fed Controls Money Supplya. The FOMC meets eight times a year, sets targets for the money supply growth level and the interest rate level, and implements monetary policy.i. Pre-meeting economic report (Beige book) - a consolidated reportof regional economic conditions in each district.ii. Economic presentations - Presentations include data and trends for wages, consumer prices, unemployment, GDP, inventories, foreign exchange rates, interest rates, and financial market conditions.iii. FOMC decisions - each member can offer recommendations iv. FOMC Statement - a statement that summarizes their conclusion.v. Minutes of FOMC Meeting - provided to the public and are also accessible on Federal Reserve websites.vi.1. Rate at which banks loan to each other they cant tell the banks what theyre loaning to each other, they influence it by adding money to money supply or taking it out2. Low rate means interest rates would be lower because banks can borrow from other banks without fear of losing money. It’s a very low rate to borrow influencing banks into loaning more moneyb. Role of the Fed’s Trading Desk – “Open Market Operations”i. Role of the Fed’s Trading Desk – “Open Market Operations”ii. If a change in monetary policy is appropriate, the FOMC decision is forwarded to the Trading Desk (Open Market Desk) at the NY Fed through a policy directive.iii. Fed purchase of securities – putting money into money supply to lower interest rates, want to control interest rates, inflation, and try to control economy and unemploymentiv. Fed sale of securities – less supply get picky of who they loan to interest rates go upv. Fed trading of repurchase agreements - trading the treasuries , but trading them with repurchase agreements on holidays and weekends, when there is gonna be a lot of spending used for shortterm money supply growthvi. Fed purchasing Mortgage backed securities . Piece of paper asset for debt on the housevii. Open market operations buying and selling treasuries securitiesviii. Auction off treasuries and securities they are taking on debt to paytheir deficits ix. When fed purchases securities they are buying from banks they are investors of treasuries from us governmentsx. Taking money out of the money supplyxi. Control of M1 versus M2 1. The optimal form of money should (1) be controllable by the Fed and (2) have a predictable impact on economic variables when adjusted by the Fed. 2. Don’t care about keeping records of checking accounts because of spending3. Monitor money supply by peoples savings, investmentsIII. How Fed operations effect interest ratesa. Even though most interest rates are market determined, the Fed can havea strong influence on these rates by controlling the supply of loanable funds.b. Open Market Operations in Response to the Economyi. 2001–2003: The Fed frequently used open market operations to reduce interest rates during this period of weak economic conditions.ii. 2004–2007: The Fed’s concern shifted from a weak economy to high inflation as the economy improved. They raised interest ratesduring this time period.iii. 2008: The Fed used open market operations to reduce interest rates in an attempt to stimulate the economy when economic conditions weakened due to the credit crisis.IV. Adjusting Reserve Requirement Ratioa. What is it? How much a bank has to keep, how much of your deposits 10% raise or lower this to effect interest ratesb. From 10 to 15 percent interest rates would rise, less supplyc.V. Adjusting the Fed’s Loan Ratea. Rate that government or federal reserve will loan to banksb. 3 percent discount rate if they lower to 2 percent it will lower interest rates because they will borrow more money and then they have more money to lendc. Federal funds would be lower because they rather have them borrowing from each other out in