Important Flashcards
describe 2 kinds of bank liabilities
- checkable deposits
2. nontransactional deposits (saving accounts, money market deposits, CD)
2 kinds of bank borrowings
- federal funds market
2 .discount loans
Repo vs. Reverse Repo
- when a bank sells security for increase in cash and promises to buy the asset back overnight
- the Fed sells securities to banks
banks assets
- the most liquid asset by the bank ()
- vault cash (cash on hand, at other banks, or with the Fed) = () + ()
- cash in process of collection
- marketable securities
- loans (2/3 of all assets)
- reserves
2. excess reserve + required reserve `
If interest rate on reserves increase, no bank will lend on higher rate, the iff will () without an OMO
- interest rate serves as a () for the federal fund’s rate
- increase
2. floor
- disadvantages of loans (2)
2. 3 types of loans
- highly illiquid + default risk
- to consumers and industries, C&I
- real estate = mortgage
- consumer loans
net worth = asset - liabilities
bank failure?
the bank cannot repay its depositors in full with enough reserves left to meet its reserve requirement
ROA
1. calculation + definition
savers care about this
the value of a bank’s profit to the value of its assets
ROE
2. calculation + def
shareholders care about this
managers want to increase ROE –> that encourages the bank to make more loans
leverage
high leverage can magnify both wins and losses
a measure f how much debt an investor assumes in making an investment
leverage
high leverage can magnify both wins and losses; increases both default risk and interest rate risk
a measure f how much debt an investor assumes in making an investment
savers are subject to MH in 2 ways
1. explain 2 ways
2solution
- bank managers are compensated on high ROE to shareholders –> more investments on risky assets –> more risks
- FDIC discourages deposits to check bank activities with their loans
- savers prefer high net workth
3 types of risks the bank faces & solutions
- liquidity risk
- credit risk
- interest rate risk
- asset management + liability management + reverse repo agreements (the bank buys asset from other banks and agree to sell the securities to the other bank later –> temporarily increase asset)
- credit-risk analysis + collateral & compensating balance + credit rationing
- evalute IR Risk using gap and duration analysis
Gap analysis
1.1. calculates vulnerability of bank’s profit to changes in market interest rates
- most banks have negative gaps + reduce gap reduces interest rate risk
- rise in interest rate lowers PV of the loan that will be paid in the future and thereby decreasing bank’s net worth/capital
duration analysis
1. how sensitive a bank’s capital is to changes in market interest rates.
- if a bank has a positive duration gap
- increase in IR causes decreases in PV in assets greater than the change in PV of liabilities –> decrease in bank capital
duration analysis
1. how sensitive a bank’s capital is to changes in market interest rates.
- if a bank has a positive duration gap
- increase in IR causes decreases in PV in assets greater than the change in PV of liabilities –> decrease in bank capital
4 components of federal reserve system
()federal reserve banks in the nation
() board of directors in each district bank
- board of governors
- federal reserve banks
- FOMC
- Member banks (hold stocks in FDB because this policy influences member banks to participate in monetary policy)
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IR () during a recession and () in inflation because …
- higher IR = higher opportunity cost to holding reserves
?
() board of governors
- determines and administers monetary policy through OMO, RR, discount lending
- determines RR, discount rate
- financial regulation (margin requirements for security purchases)
- 7
() members in FOMC
- gives direction to OMO
- green book
- bluebook
- beige book
- sets targets for iff
(adjust reserves by buying/selling treasury securities through trading desks)
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- green = national economic forecast
- blue = projections for monetary aggregates
- beige = local economic summaries
() members in FOMC
- gives direction to OMO
- green book
- bluebook
- beige book
- sets targets for iff
(adjust reserves by buying/selling treasury securities through trading desks)
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- green = national economic forecast
- blue = projections for monetary aggregates
- beige = local economic summaries
Fed’s earnings come from …
- interest on securities
- interest on discount loans
- fees for check-clearing process
ch14
- money supply equation
- what factor is bank determined and what factor is not
M = B * m
what is the base comprised of = principal liabilities
- are coins in circulation the liability of the Fed
all currency in circulation and reserves held by banks
- no
what is currency in circulation = currency outstanding, () vault cash
what is vault cash
- excluding
2. currency held by depository financial institutions and is counted as part of reserves)
reserves = () + ()
*Fed has no control over excess reserves
- deposits by commercial banks and savings institutions with the Fend
- vault cash
what are Fed’s principal assets?
- what does the Fed determine in terms of discount loans
- securities and discount loans
2. discount rate
how does the Fed increase monetary base?
2 ways?
- OMO
2. discount loans
Monetary base change method 1: OMO
1. a buy of securities is an () policy; why?
- how does the balance sheet change (both Fed & banks)
- expansionary; from a bond perspective, an increase in the demand for bonds leads to an increase in price of bonds –> lower yields –> lower interest rate –> more borrowing
- Fed: reserves +1m; securities + 1m
bank: reserves + 1m; securities -1m
total +1m
Monetary base change method 1: discount loans
1. if a bank obtains a loan from the Fed
- Fed: reserves +1m(L); loans + 1m
bank: reserves +1m; discount loans + 1m(L) - as R increases, the monetary base increases
Monetary base change method 1: discount loans
1. if a bank obtains a loan from the Fed
- Fed: reserves +1m(L); loans + 1m
bank: reserves +1m; discount loans + 1m(L) - as R increases, the monetary base increases
- what are the + for OMO/ - for discount loans
- more control on OMO
2. flexibility
explain equation:
monetary Base= Bnon + BR
- currency is (); reserves can be ()
- Bnon = nonborrowed
- Br = borrowed （discount loans)
- nonborrowed, both
Bank bahavior
1.holding excess reserves by banks are () related to the market interest rate
holding excess reserves by banks are inversely related to the market interest rate because opportunity cost of holding increases as interest rate increases)
Bank behavior
1.holding excess reserves by banks are () related to the market interest rate
holding excess reserves by banks are inversely related to the market interest rate because the opportunity cost of holding increases as interest rate increases)
when the spread between the rates on 3-month T-bills and discount loans increases
the volume of discount lending increases
the monetary base consists of the non-borrowed base, determined primarily by the Fed through()
Borrowed part through (discount lending )
- OMO)
- if C/D = 0 and ER/D = 0 (simplifying assumptions) , the money multiplier = ()
- simple deposit multiplier
3 traditional monetary policy tools
- OMO 2. discount lending 3. RRR
dynamic vs defensive OMO
- dynamic = OMO intended to change monetary policy (outright purchase & sales)
- defensive = offsetting temporary fluctuations in the monetary base (Federal Repo)
define federal repo
- the Fed buys securities from a dealer and the dealer agrees to buy them back at a give price
define federal repo
- the Fed buys securities from a dealer and the dealer agrees to buy them back at a give price
open market sales
- matched sale-purchase transactions ( reverse repo) –> the bank sells securities to dealers who agree to sell them back to the Fed in the future
operation twist
no increase in the monetary base
- sells short-term bonds; buys long-term bonds –> increase in short-term interest rates and decrease long-term interest rates
what happens when there is an increase in discount rate? (policy wise)
- higher id, less borrowing from the Fed –> reduces monetary base –> (decrease in Demand leads to lower Price of loans) increase interest rates –> upward pressure on interest rates
the reserve requirement is the () preferred method
- least because it has multiple effects and major shifts in bank portfolios and can be disruptive unless done gradually in small steps
open market purchase () / () the () of the reserve system; it shifts the () in the federal funds market
- what happens when there is an open market purchase
- increases or decreases the nonborrowed part of the reserve –> increase in total reserves –> shifting the supply of reserves.
the inverse relationship between iff and liquidity causes the demand in the federal funds market to be () related
- inversely
- when iff is high, banks will offer more reserves and hold less liquid/idle cash
- when iff falls, banks would want to hold more vault cash
does the increase in discount rate shift the entire supply curve?
- no, it only moves the horizontal part of supply curve
- the increase in discount rate has an impact only if banks have borrowed reserves –> only if and curve cuts the horizontal of the supply curve
does the increase in discount rate shift the entire supply curve?
- no, it only moves the horizontal part of supply curve
- the increase in discount rate has an impact only if banks have borrowed reserves –> only if and curve cuts the horizontal of the supply curve
a change in required reserve ration changes the () in federal funds market;
- demand in the federal fund’s rate
- if RRR increases –> more people want to hold reserves –> increase in demand shifts demand out –> to offset the change the fed can operate an open market purchase to shift out supply, thereby increasing reserves without changing iff
why did banks abandon the traditional aproach of finding a target and address it with OMO
- Reserves used to be scarce. This is no longer true because the Fed’s increase in assets of the balance sheet –> more reserves. Draining these large quantities of reserves using OMO is disruptive
what is the target range
- Irb - ion rrp
examples of tradeoffs between monetary targeting and monetary policy
- OMO VS. inflation
- Lower federal funds rate cause interest rates to fall through omo purchase –> increase in money supply can lead to inflation
- omo sales decrease money supply + locks inflation but reduces the supply of loanable funds, which pushes up the interest rate and dampens investment and economic growth.
2 lags and concerns
impact lag & information lag
2 lags and concerns
impact lag & information lag
4 monetary policy tool
- OMO
- RRR
- Discount lending
- interest on reverse
policy instruments 2
- reserves
2. iff
intermediate targets (2)
- financial variables (M1 & SR IR) that the fed believes will directly help it to achieve its goals
monetary aggregates and interest rates
operating targets
- fed can directly influence with monetary policy tools and that are closely related to intermediate targets
() and () provides feedback to policy
- policy instruments + intermediate targets
what criteria does the fed ues to select target variable 3
- the fed must choose one intermediate targets
- measurable; controllable, predictable
