LESSON 2: MONEY & MONETARY SYSTEM Flashcards
What is borrowing money similar to?
Borrowing money is similar to renting money, where you pay interest as rent and return the principal with interest.
What is a term loan?
A term loan requires repayment of the borrowed amount plus interest by an agreed-upon time.
What happened to farmers during the Great Depression?
Banks stopped lending money, requiring farmers to pay off loans, leading to foreclosures.
What financing method replaced term loans?
The fully amortized loan, which allows borrowers to make equal payments over time.
What is the primary risk in lending money?
The risk that the loan will not be repaid, leading lenders to require security and credit standards.
What is Return on Investment (ROI)?
ROI is a ratio measuring profit from an investment relative to its cost, usually expressed as a percentage.
What are secured loans?
Loans backed by an asset like real estate, which can be foreclosed upon in case of default.
What are unsecured loans?
Loans given based on creditworthiness without collateral, often carrying higher interest rates.
Why do government-backed loans have lower interest rates?
They are guaranteed or insured, ensuring repayment and reducing risk for lenders.
What is the time value of money?
The concept that money today is worth more than the same amount in the future due to potential inflation and interest rate changes.
What is a yield curve?
A graph showing how long-term loans usually have higher interest rates than short-term loans due to inflation risk.
What is an inverted yield curve?
A situation where long-term interest rates are lower than short-term rates, often signaling an economic recession.
What is a pre-payment penalty on a mortgage?
A charge imposed when a loan is paid off early, protecting lenders from refinancing risks.
What is a loan lock-in?
A guarantee from the lender to close a loan at a specific interest rate within a set time frame.
How do economic conditions affect interest rates?
Higher job and economic growth lead to inflation, which increases interest rates.
What is the Federal Reserve System (FRS)?
The central bank of the U.S. that controls money supply, supervises banks, and stabilizes the financial system.
What is the role of the Federal Open Market Committee (FOMC)?
It sets interest rate targets and manages the money supply through buying and selling U.S. Treasury bonds.
What is the dual mandate of the Federal Reserve?
To maintain stable prices and achieve full employment.
How does the Federal Reserve influence interest rates?
By buying or selling Treasury bonds and adjusting the discount rate to control the money supply.
What is the Discount Rate?
The interest rate charged to member banks for short-term borrowing from the FED; it influences the Prime Rate, which is usually 3% higher.
How does the Money Supply impact the economy?
Too much money in circulation can cause inflation, while too little can slow the economy, leading to a recession.
What are the four measures of Money Supply?
M-0: Cash in circulation; M-1: M-0 + checking accounts; M-2: M-1 + savings accounts & small CDs; M-3: M-2 + large deposits, Eurodollars, & repurchase agreements.
What is the role of the Federal Deposit Insurance Corporation (FDIC)?
It insures deposits up to $250,000 in case of bank failure.
What is the Fed’s dual mandate?
To promote maximum employment and stable prices (low, stable inflation).
What inflation rate does the Fed target?
A long-term average of 2% inflation.
What is the Federal Funds Rate?
The interest rate financial institutions charge each other for overnight loans in the reserve market.
How does the Fed use the Federal Funds Rate to control the economy?
Raising it tightens (restricts) the economy; lowering it eases (stimulates) the economy.
What are the Fed’s traditional monetary policy tools?
Open market operations, the discount rate, and reserve requirements.
What are Open Market Operations?
The buying and selling of government securities to influence the money supply.
What is the Discount Rate’s role in monetary policy?
It’s the rate the Fed charges banks for short-term loans; banks avoid using it due to stigma.
What are Reserve Requirements?
The portion of deposits banks must hold in reserve; lowering them is expansionary, raising them is contractionary.
What is market conditions?
Market conditions refer to the state of an industry or economy, often used in reference to stock and real estate markets, which can be volatile or stable. They are indicators influencing decisions but are not reliable over long periods without reevaluation.
What drives the fluctuation of market conditions?
Market conditions fluctuate due to a wide range of factors, including the economy, the flow of money, access to credit, and employment stability.
How does the stock market represent market conditions?
The stock market may be broadly affected by economic downturns, leading to an overall “down” market, but some industries, like precious metals, may perform well despite the overall market decline.
How do market conditions affect decisions in real estate?
Market conditions can influence whether it’s a buyer’s or seller’s market, affecting decisions such as whether sellers should hold their properties or sell at a loss.
What is a purely competitive market?
A purely competitive market is a theoretical structure with four conditions: many buyers and small-scale firms, identical products, no entry/exit restrictions, and full knowledge of products and prices.
What are the criticisms of a purely competitive market?
The market is criticized for being stagnant, with products, pricing, and supply/demand levels rarely changing and little incentive for innovation.
What is a marketing exchange?
A marketing exchange occurs when two or more parties engage in the transfer of goods, services, or intellectual property, benefiting both participants.
What are the five conditions for a marketing exchange?
- At least two parties must be involved. 2. Each party must possess something valuable. 3. Effective communication and trust are essential. 4. Parties must be able to accept or reject terms. 5. Commitment and trust from both parties are necessary.
What is market equilibrium?
Market equilibrium occurs when supply and demand are balanced. Disruptions can lead to market failure, which is inefficient production, distribution, and allocation of goods and services.
What are the causes of market failure?
Market failure can be caused by negative externalities, public goods, and disproportionate market control.
How has funding for real estate loans changed?
Previously sourced from Savings and Loans (S&L), today, funding for real estate loans comes from Wall Street, allowing funds to be available nationwide, but it increases the competition for investment money.
What is the relationship between interest rates and real estate loans?
Interest rates directly impact the market price of homes and commercial properties, with changes in rates affecting loan affordability.
What role do financial institutions play in the economy?
Financial institutions act as intermediaries, turning savings into mortgages and credit, facilitating loan access.
What financial market indicators are important?
Key indicators include GDP, Consumer Price Index (CPI), nonfarm payroll report, Consumer Confidence Index, interest rates, and stock market indices like the S&P 500, Dow Jones, and NASDAQ.
What are stock market indices used for?
Stock market indices, like the S&P 500 and Dow Jones, monitor stock prices and market performance, with the S&P 500 being broad and the Dow Jones narrower.
What are bull and bear markets?
A bear market occurs when a stock market index drops 20% or more, while a bull market is a 20% rise from recent lows, often hitting record highs.
What is inflation?
Inflation is a sustained increase in the overall price level of goods and services, measured as an annual percentage increase, such as in the Consumer Price Index (CPI).
How do interest rates affect the economy?
Rising interest rates slow consumption, investment, and profits, leading to economic slowdown and falling stock prices. Conversely, lowering interest rates stimulates the economy, leading to higher growth and rising stock prices.
What is the Taylor rule?
The Taylor rule is an econometric model guiding central banks on interest rates based on deviations in inflation and GDP growth, aiming for short-term stability and long-term economic expansion.
What is the difference between intermediation and disintermediation?
Intermediation involves saving money with financial institutions, while disintermediation occurs when savers bypass institutions to invest directly in higher-yield options, potentially affecting the mortgage market.
What is the secondary mortgage market?
The secondary mortgage market is where mortgage loans are bought and sold, reducing the impact of disintermediation and ensuring a limitless supply of funds.
What is interest in the context of mortgages?
Interest is the money paid for borrowing someone else’s money, calculated as a percentage of the loan amount.
What is mortgage amortization?
Mortgage amortization is a scale that shows how much of a mortgage payment goes toward interest versus the principal. Early payments mostly cover interest, with the principal portion increasing over time.
How does principal affect mortgage payments?
Principal is the borrowed amount on which interest is paid. Over time, as the principal decreases, the interest paid also decreases, while the principal portion of payments increases.
What is included in a typical mortgage payment plan (PITI)?
A typical mortgage payment includes principal (P), interest (I), property taxes (T), homeowners insurance (I), and possibly mortgage insurance or flood insurance.
What are property taxes?
Property taxes are local taxes based on the value of a property and fund community services like schools, fire/police departments, and road maintenance. They vary by location and are often calculated based on the home’s value.
How are property taxes calculated?
Property taxes are generally calculated at a rate of $1 for every $1,000 of a home’s value. For example, a $250,000 home would have property taxes of around $250 per month or $3,000 per year.
Is homeowners insurance required by law?
No, it is not required by law in most states, but mortgage lenders typically require it as a condition of the loan.
What does homeowners insurance typically cover?
It covers property in case of fire, lightning storm, or break-in. Some policies may include coverage for flooding and earthquakes as add-ons.
What is a rider in homeowners insurance?
A rider is additional coverage for valuable items like artwork, jewelry, or musical instruments.
Do condominium owners need individual homeowners insurance?
Usually, condominium owners pay a homeowners association (HOA) fee, which covers the dwelling instead of individual insurance.
What factors influence your homeowners insurance premium?
Factors include your home’s value, location (rural/urban), proximity to fire/police, presence of attractive nuisances, and claims history.
How much can you expect to pay for homeowners insurance?
Expect to pay about $3.50 per $1,000 of your home’s value annually. For a $250,000 home, this would be around $875 per year or $73 per month.
What is the mission of the U.S. Department of the Treasury?
The mission is to maintain a strong economy, promote economic growth, strengthen national security, and manage U.S. Government finances and resources.
What activities is the U.S. Department of the Treasury responsible for?
It advises the President on financial issues, encourages economic growth, manages financial systems, produces currency, and combats national security threats.
What are the two major components of the U.S. Department of the Treasury?
The Departmental Offices, responsible for policy and management, and the operating bureaus, which carry out specific operations.
What are some basic functions of the Department of the Treasury?
Functions include managing federal finances, collecting taxes, producing coinage, managing government debt, supervising banks, and enforcing financial laws.
What is the role of the Office of Strategic Planning and Performance Improvement (OSPPI)?
The OSPPI oversees the development of the Treasury’s strategic plan and implements the performance management framework.
How does the Office of Performance Budgeting (OPB) assist the Department of the Treasury?
The OPB helps facilitate the formulation and execution of the budget for optimal performance across the Treasury’s bureaus.
When was the U.S. Mint created?
The U.S. Mint was created by Congress in 1792.
What is the primary mission of the United States Mint?
The mission is to serve the American people by manufacturing and distributing circulating coins, precious metals, and national medals while securing assets entrusted to them.
Where are the U.S. Mint’s facilities located?
Facilities are in Washington, DC; Philadelphia, PA; West Point, NY; Denver, CO; San Francisco, CA; and Fort Knox, KY.
How can you take a virtual tour of the U.S. Mint?
The U.S. Mint Virtual Tours mobile app allows users to explore 360-degree images of the Denver and Philadelphia Mints.
Can you take in-person tours at the U.S. Mint?
Yes, free in-person tours are available at the Philadelphia and Denver Mints, covering coin manufacturing and the history of the Mint.
What does the Federal Deposit Insurance Corporation (FDIC) do?
The FDIC insures deposits, examines financial institutions for safety, makes large financial institutions resolvable, and manages receiverships.
How is the FDIC funded?
The FDIC is funded by premiums paid by banks and savings associations for deposit insurance coverage, not by Congressional appropriations.
How much is the standard FDIC insurance amount?
The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.
What does FDIC insurance cover?
It covers traditional deposit accounts such as checking, savings, and money market accounts, as well as certificates of deposit (CDs).
What types of products are not covered by FDIC insurance?
FDIC insurance does not cover stocks, bonds, mutual funds, crypto assets, life insurance, annuities, municipal securities, or safe deposit boxes and their contents.
Does FDIC insurance apply to retirement accounts?
FDIC insurance applies to certain retirement accounts, such as individual retirement accounts (IRAs), if they are held in FDIC-insured institutions.
What happens when a bank fails and has FDIC insurance?
The FDIC takes action to resolve the failure by selling the bank’s deposits and loans to another institution, with customers automatically becoming customers of the new institution.
What can cause the value of your non-deposit investments to fluctuate?
The value of non-deposit investments can go up or down depending on the demand for them in the market, potentially resulting in a loss or lower-than-expected profits.
What is the role of the Securities Investors Protection Corporation (SIPC)?
The SIPC replaces missing stocks and other securities in customer accounts up to $500,000, including up to $250,000 in cash, if a member brokerage or bank brokerage subsidiary fails.
What factors should you consider when shopping for a non-deposit investment product?
Consider your investment goals, financial and tax status, risk tolerance, and time horizon for the investment portfolio.
Why should you interview multiple sales reps or broker/dealers?
To compare their experience, education, and professional background, ensuring you select one who understands your financial objectives.
Are safe deposit boxes insured by the FDIC?
No, the contents of safe deposit boxes are not insured by the FDIC, but other insurance may be available depending on the bank.
What should you consider if you’re concerned about the safety of items in a safe deposit box?
You may want to consider purchasing fire and theft insurance, often available through homeowner’s or renter’s insurance policies.
What happens if the bank holding your safe deposit box fails?
In most cases, another institution will take over the failed bank’s offices, including the safe deposit boxes. If not, the FDIC will contact you with instructions.
What is a banker’s blanket bond?
A multi-purpose insurance policy that protects a bank from losses caused by fire, flood, robbery, and other incidents, ensuring that customer funds are not lost.
How can unauthorized access to your funds be protected?
The Electronic Funds Transfer Act and other consumer protections cover unauthorized transactions, and you should contact your bank if you notice a loss.
What is the Federal Home Loan Bank System (FHLBank)?
A government-sponsored enterprise created in 1932 to support mortgage lending and community investment, consisting of 11 regional banks.
How many members do the FHLBanks serve, and who can be a member?
The FHLBanks serve approximately 6,600 members, including banks, credit unions, insurance companies, and community development financial institutions.
How do FHLBanks provide liquidity?
FHLBanks raise funds in global financial markets and lend this money to members in the form of “advances” (loans).
Are FHLBanks supervised by a government agency?
Yes, FHLBanks are regulated by the Federal Housing Finance Agency (FHFA) and are registered with the SEC.
What types of collateral do FHLBank members use?
Members primarily use residential mortgage loans, government and agency securities, and small business, small farm, and community development loans as collateral.
How do FHLBanks ensure the safety of their loans?
FHLBanks require collateralization of all advances, replace underperforming loans, and monitor credit profiles of members.
What is the capital structure of FHLBanks?
FHLBanks are self-capitalizing, and members must purchase stock in the Bank to access advances, with capital increasing based on borrowing activity.
Who governs each FHLBank?
Each FHLBank is governed by a board of directors made up of members and independent directors with expertise in various areas.
What is the role of the Federal Housing Finance Agency (FHFA)?
FHFA oversees the operations of the FHLBanks, ensuring their financial safety and soundness, as well as their compliance with housing finance missions.
How do the FHLBanks support affordable housing?
FHLBanks contribute 10% of their net income to affordable housing through the Affordable Housing Program (AHP), which provides funding for low-income households.
What are the key programs that the FHLBanks offer?
The FHLBanks offer the Affordable Housing Program (AHP), Community Investment Program (CIP), Community Investment Cash Advance (CICA), and various other community development programs.
What is the Community Investment Program (CIP)?
The CIP provides advances to members to finance housing and other economic development initiatives in low- and moderate-income neighborhoods.
How does the Affordable Housing Program (AHP) impact communities?
The AHP helps fund affordable housing for low-income individuals, improving communities by creating jobs and revitalizing neighborhoods.
What other programs do the FHLBanks support for special needs?
FHLBanks support programs focused on financial literacy, foreclosure prevention, home rehabilitation, and small business lending.
What was the purpose of the Federal Home Loan Bank Act of 1932?
The Act allowed Savings and Loan companies to offer 20-year, fixed-rate, fully amortized loans, aiding mortgage financing.
How does the FHLBank System promote community development?
FHLBanks finance affordable housing and economic development through programs like AHP, CIP, and CICA, addressing local needs and benefiting various communities.
What was money backed by in the past?
In the past, money was backed by precious metals like gold or silver.
When did Switzerland abandon the gold-backed currency?
Switzerland abandoned the gold-backed currency in 1992 when it joined the International Monetary Fund.
What replaced the gold backing of money today?
Today, money is backed by debt, not gold.
What happens if a debtor goes bankrupt in the current monetary system?
If a debtor goes bankrupt, the promise to pay becomes worthless, causing the value of money to drop.
Why are bailouts of major banks or countries necessary?
Bailouts are necessary because if a major entity goes bankrupt, it could cause a chain reaction that would collapse the entire monetary system.
What is a national bankruptcy?
A national bankruptcy occurs when a country is unable to meet its regular expenses, leading to an inability to pay its debt.
How is money created in a debt-based monetary system?
Money is created when someone signs a debt obligation, promising to pay back a loan.
What happens when a company borrows money from individuals?
No new money is created; money just changes hands between the borrower and lender.
How does a central bank create money?
Central banks can create money out of thin air by purchasing government bonds or other collateral.
What is quantitative easing?
Quantitative easing refers to central banks buying government bonds and creating new money in return.
How does the Federal Reserve create money during a crisis?
The Federal Reserve can accept collateral like subprime loans and create new money in return.
What does a debt-based monetary system require to work?
A debt-based system requires that money be continually created through new loans to ensure there is enough to pay back existing loans and interest.
What is the fundamental problem with a debt-based monetary system?
There is always a lack of money equal to the interest required for all issued loans, causing the money supply to grow indefinitely.
Why does the government have to increase national debt constantly?
The government has to increase national debt to inject new money into the system, as private individuals or companies may not take on new debt.
What happens when a government bond is due?
The money to pay back the bond is typically created by issuing a new government bond.
What is the danger of the current monetary system?
The current system is a Ponzi scheme, where debt is perpetually increased to avoid collapse.
What happens in a national bankruptcy?
The government cannot meet its payment obligations and may turn to the central bank for monetization of debt, leading to inflation.
What is hyperinflation?
Hyperinflation occurs when inflation exceeds 50% per month, causing a rapid loss of purchasing power.
How does hyperinflation end?
Hyperinflation ends with a monetary reform, where old currency is replaced with a new one.
What is the role of complementary currencies?
Complementary currencies can counterbalance the side effects of conventional money, encourage cooperation, and support more types of economic transactions.
Why is diversity in currency systems important?
A diverse monetary system promotes sustainability, much like biodiversity does for ecosystems, supporting different types of economic exchanges.
What three types of currencies should exist alongside national currencies?
- An inflation-proof global complementary currency, 2. Business-to-business currencies, 3. Community currencies.
What is the issue with current monetary agreements?
The current monetary agreements are outdated and do not serve the needs of the modern world. Reexamining and revising these agreements is necessary for a healthier monetary system.
