Chapter 14 Part 3 Flashcards
An additional factor is the velocity of money which measures the
number of times a dollar is spent over a given period. The effect of these changes on the reserve requirement can be drastic; therefore, this is one of the least used tools of monetary policy
The FRB was originally established to aid the banking system in emergency situations by acting as a banker’s bank. The FRB always stands ready to lend money lo its members. It fulfills that function through its discount window. The rate charged for loans is called the
discount rate. When members of the Fed borrow using the discount window, new money is injected into the system (which then is expanded by the multiplier effect). The FHB can encourage or discourage use of the discount window borrowing by changing the rate of interest it charges for those loans. By decreasing the discount rate, the FrB encourages borrowing which expands the money supply. Conversely, the money supply will contract with an increase in the discount rate. A change in the discount rate is usually taken as a very strong sign that monetary policy has shifted. The discount rate is the only rate directly set by the FrB. Although il is largely symbolic, this rate acts as the base on which other key interest rates are built, such as the fed funds rate
federal funds
These short-term loans of excess reserves that banks lend each other
federal funds rate
The rate of interest charged on these loans. The federal funds rate is determined by supply and demand. Since federal funds arc short-term (overnight), they are considered money-market instruments. Due to the short duration of the loan, the fed funds rate is normally considered to be the most volatile interest rate. The effective federal funds rate is published daily and shows the average rate charged the previous night for federal funds. Although the FRB does not directly set the fed funds rate, it does set a target. The frb’s Open Market
Operations are designed to maintain the fed funds rate within this prescribed target range.
open market operations can be implemented very
quietly, without disrupting the financial markets.
The Federal Open Market Committee (FOMC) oversees the FRB’s buying and selling of U.S. government securities in the secondary markets. Open market operations is the
most effective and frequently used tool of monetary control employed by the FRB. It is also the most flexible tool and the easiest to reverse
Open market operations involve the purchase and sale of
U.S. government securities, primarily Treasury bills. The FRB, however, also trades government notes and bonds. These trades are executed through primary government dealers, banks, and brokerage firms appointed by the FRB
If the Fed buys securities, it pays for these securities with funds that are ultimately deposited in commercial banks. This causes deposits at banks to
increase and thus adds to the funds available for loans. The result is an increase in reserves. Money becomes more available and interest rates tend to move downward. This is referred to as easy money policy
Should the Fed wish to tighten (reduce) the money supply, it will
sell securities to banks and securities dealers. The banks and dealers will pay for these securities by withdrawing the money from their demand (checking) accounts. The withdrawal of money from the banks will decrease the amount of money available for loans. This will have a tightening effect on the money supply, causing interest rates to rise.
A repurchase agreement (also known as a repo) is a contract entered into by
the Federal Reserve to purchase U.S. government securities from dealers, at a fixed price, with provisions for their resale back to the dealer at the same price plus a negotiated rate of interest. When the Fed effects a repo, it is lending money and, therefore, increases bank reserves (easy money policy).
A reverse repo (also known as a matched sale) occurs when the FRB
sells securities to dealers with the intention of bitying the securities back at a future date. This has the short-term effect of absorbing funds from the money supply (tight money policy)
The Securities Exchange Act of 1934 gave the Federal Reserve Board the power to determine the amount of credit that could be extended to
purchase securities. Regulation T applies to brokerage firms. Regulation U applies to banks and all other lenders.
By increasing margin requirements, the FRB
reduces the amount broker-dealers and banks may lend, causing the money supply to tighten. Changing the margin requirement is the least effective method the FRB has to control credit because it only affects stock market transactions
There are times when the Fed tries to influence bank lending policies through moral suasion (also called jawboning). The Fed exerts its influence through the
public media or through the examiners sent to member banks. Its effmts to control the money supply by these means are limited by the extent to which they can elicit cooperation from these institutions
Fundamental analysis involves a review of
the corporation’s basic makeup. The review would include an analysis of the company’s financial statements to detcnnine its financial health. It is important also to look at the company’s management, its competitors, and its standing in the marketplace. Based on the information given, a fundamental analyst will attempt to determine whether the stock is trading at the right price
