Chapter 14 Part 3

Question 1

An additional factor is the velocity of money which measures the

Answer 1

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

Question 2

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

Answer 2

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

Question 3

federal funds

Answer 3

These short-term loans of excess reserves that banks lend each other

Question 4

federal funds rate

Answer 4

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.

Question 5

open market operations can be implemented very

Answer 5

quietly, without disrupting the financial markets.

Question 6

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

Answer 6

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

Question 7

Open market operations involve the purchase and sale of

Answer 7

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

Question 8

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

Answer 8

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

Question 9

Should the Fed wish to tighten (reduce) the money supply, it will

Answer 9

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.

Question 10

A repurchase agreement (also known as a repo) is a contract entered into by

Answer 10

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).

Question 11

A reverse repo (also known as a matched sale) occurs when the FRB

Answer 11

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)

Question 12

The Securities Exchange Act of 1934 gave the Federal Reserve Board the power to determine the amount of credit that could be extended to

Answer 12

purchase securities. Regulation T applies to brokerage firms. Regulation U applies to banks and all other lenders.

Question 13

By increasing margin requirements, the FRB

Answer 13

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

Question 14

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

Answer 14

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

Question 15

Fundamental analysis involves a review of

Answer 15

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

Question 16

The capital structure of a company refers to

Answer 16

the methods by which a company raises money to finance its operations and expansion. These methods include the company’s issuance of debt and equity securities (both common and preferred stocks). a corporation is generally capitalized by issuing debt (bonds or notes), equity securities (preferred stock and common stock), paid-in capital (the excess above the par value of the stock that is issued), and the retained earnings (profits after all dividends are paid). by analyzing the long-term liabilities and stockholders’ equity sections on a corporation’s balance sheet, you can identify the source of the corporation’s capital structure.

Question 17

In the event a corporation must liquidate its assets, it must pay owners and creditors in a certain order the liquidation priority. The assets are paid to holders of:

Answer 17

Secured debt, including secured bonds; Unsecured debt, including debentures and general debt; Preferred stock; Common stock

Question 18

A company’s market capitalization is

Answer 18

calculated by multiplying its current market price by the number of shares outstanding. Remember, market capitalization does not include treasury stock.

Question 19

Large-Cap Stocks

Answer 19

Market capitalization above $10 billion. These are mature companies, usually with a history of consistent dividend payments

Question 20

Mid-Cap Stocks

Answer 20

Market capitalization from approximately $2 billion up to $10 billion. These companies are more volatile and growth-oriented