midterm - unit 3: money

Question 1

modern money backing

Answer 1

-the USD is backed by the full faith and credit of the United States government
-congress says that the federal reserve banks must hold collateral value in notes that the federal reserve bank puts into circulation

Question 2

Dollars: Real vs Banking

Answer 2

Dollars in the real economy:
<->Banks <->
HH <-> Firms

Dollars in the banking system:
<->Banks<->
Fed <-> Treasury

Question 3

Monetarism: supply shock

Answer 3

1. following a positive and permanent shock to AS, the economy experiences downward pressure

Question 4

Monetarism: Money supply

Answer 4

-as long as the velocity of money does not increase in a systematic fashion,
1. to avoid deflation the money supply must rise alongside RGDP
2. to induce inflation, money supply must rise faster than RGDP

Question 5

Exchange vs over the counter

Answer 5

-an exchange is a central platform that allows trading
-over the counter markets are networks of bilateral trading relationships centered around one or multiple dealers

Question 6

There are two exchange rate archetypes

Answer 6

1. Free floating:
   -the exchange rate is entirely market determined without any sort if government intervention
2. Fixed:
   -the exchange rate is entirely fixed (with some respect to some other commodity)

Question 7

International monetary history

Answer 7

-Gold standard
-Gold exchange standard
-Reserve currency

Question 8

US monetary timeline

Answer 8

1. commodity —> commodity backed fiat
2. commodity backed fiat
3. dirty float/ pure fiat

Question 9

Appreciation

Answer 9

-if a currency appreciates, locally produced goods become more expensive abroad
-whereas foreign produced goods become cheaper locally
-causes a positive shock to demand, a negative shock to supply, or both

Question 10

Depreciation

Answer 10

-if a currency depreciates, locally produced goods become cheaper abroad
-whereas foreign produced goods become more expensive locally
-to boost local aggregate demand, a country might be tempted to depreciate, or devalue, its currency
-causes a negative shock to demand, a positive shock to supply, or both

Question 11

Trade based models

Answer 11

-exchange rates fluctuate so as to equilibriate asset goods prices
-the law of one price
-purchasing power parity

Question 12

asset based model

Answer 12

-exchange rates fluctuate so as to equilibriate asset returns
-uncovered interest rate parity
-covered interest rate parity

Question 13

Bank vs NBFI ex

Answer 13

banks:
-a financial institution with Fed account and deposit insurance
-commercial banks
-savings and loan institutions
-credit unions

nbfis:
- a financial institution without a Fed account and deposit insurance
-collective investment vehicles
-pension funds
-insurance companies

Question 14

CBDC

Answer 14

-a central bank digital currency is any electric currency issued by a country’s central bank
-wholesale CBDC: held in and used by banks to settle interbank debts
-retail CBDC: held and used by households and firms

Question 15

benefits of retail CBDC

Answer 15

within a country:
-increase access to the underbanked
-lower interchange fees for merchants
-higher interest rates on demand deposit accounts
cross border:
-improve cost border payments

Question 16

Intrinsic value of bitcoin

Answer 16

real:
-bitcoin does not have any real intrinsic value because it never pays any sort of real dividends
nominal:
-bitcoin does not have any nominal intrinsic value because it never pays any sort of nominal dividends

Question 17

Considering the two definitions listed below, discuss whether Floyd Mayweather’s boxing skills (at his peak) constituted an asset and whether they constituted money
Asset: an asset is any possession that has value
Money: An asset is said to be money if it jointly serves as a store of value, medium of exchange, unit of account, and standard of deferred payment in the same economy

Answer 17

-considering the definitions his skills at his peak were an asset
-they were valuable in the world of boxing (record and earnings)
-even though his skills were valuable and generated money, they don’t fit all the criteria as listed in the definitions
-his skills are not universally recognized as a medium or exchange or deferred payment

Question 18

What is the nominal value of a dollar bill? In your answer, be sure to state explicitly if and why it is zero or greater than zero.

Answer 18

-the nominal market value of a dollar bill is greater than zero because it has a face value of one dollar
- this means that in an economy it can be exchanged for goods and services that are worth one dollar.
-It’s value can fluctuate based on inflation and other factors that impact it’s purchasing power over time

Question 19

The US dollar is involved in 9 out of 10 foreign exchange transactions. Why would a trader buy US dollars first if they really wanted to buy another currency. For example, why would a trader holding Japanese Yen trade them for US dollars first and then use those US dollars to buy Swiss francs rather than just use their Yen to buy Swiss francs directly?

Answer 19

-The US dollar is mainly used in exchange transactions for several reasons
-first the US dollar is considered to be a global reserve currency, which means that it is widely accepted and many banks have it around the world
-when a trader wants to buy another currency like the Swiss franc, they would go through the US for a couple of reasons
1.) the US dollar is very liquid which means that there are alot of buyers and sellers of USD, so trades in it are faster and easier
2.) the depth of the US dollar market ensures that traders can usually get the amount of USD they need without being largely impacted by exchange rates
3.) the transaction costs may be lower

Question 20

Describe how the gold standard limits a central banks ability to create fiat money

Answer 20

-the gold standard is a system where a country’s currency is directly pegged to gold at a fixed price
-under the gold standard, central banks can only issue as much money as they have in gold reserves
-this limits their ability to create fiat money because they have to balance the amount of currency that is in circulation and the amount of gold in reserve
-if they print more money than they have in gold it can lead to inflation or run on the gold reserves which would destabilize the economy

Question 21

When looking at the price of cookies at the grocery store, which function of money is being fulfilled?

a. store of value
b. medium of exchange
c. unit of account
d. standard of deferred payment

Answer 21

c. unit of account

Question 22

When using dollars to purchase cookies at the grocery store, which function of money is being fulfilled?

a. store of value
b. medium of exchange
c. unit of account
d. standard of deferred payment

Answer 22

b. medium of exchange

Question 23

Which of the following types of dollars is both physical and accessible to households for purposes of purchasing goods and services?

a. currency in circulation
b. vault cash
c. demand deposits
d. reserves

Answer 23

a. currency in circulation

Question 24

The nominal market value of a financial asset such as a stock or bond

a. is given by the price at which it can be sold in financial markets
b. given by the cash flow they generate for their owners
c. is zero unless the owner is able to exchange it for a good or service
d. is zero unless the own derives happiness from owning the financial asset

Answer 24

a. is given by the price at which it can be sold in financial markets

Question 25

The nominal intrinsic value of a concert ticket

a. lies in the enjoyment of the owner in attending the concert
b. is given by the highest price at which it can be sold
c. is zero unless the owner is able to exchange it for some other good or service
d. is zero because the ticket does not generate any cash flow for their owner

Answer 25

d. is zero because the ticket does not generate any cash flow for their owner

Question 26

the real intrinsic value of a laptop

a. lies in the owners ability to manage their work or private life with it
b. is given by the highest price at which it can be sold
c. is zero because the laptop does not generate any cash flow for their owner
d. is zero unless the owner is able to exchange it for some good or service

Answer 26

a. lies in the owners ability to manage their work or private life with it

Question 27

The real market value of bitcoin

a. is given by the amount of goods or services that can be bought with it
b. is zero because bitcoin does not generate any cash flows for their owner
c. is zero unless the owner derives real happiness from owning it

Answer 27

a. is given by the amount of goods or services that can be bought with it

Question 28

Which of the following is true

a. deposits create loans
b. loans create deposits

Answer 28

b. loans create deposits

Question 29

A financial bubble occurs when an assets market value exceeds the intrinsic value. According to this definition, are dollar bills a financial bubble? in your answer be sure to explicitly reference the intrinsic value and the market value of a dollar bill

Answer 29

-based on the definition the dollar bill is not a bubble
-the intrinsic value of the dollar bill is low, but the market value of the dollar bill bases itself on how it is used in the economy
-people use the dollar bill as a method of exchange so it gets frequent use and is trusted
-the dollar bill is also backed by the government and they are in charge of distribution
-even though inflation contributes to the change in purchasing power that the dollar bill has, it does not have the qualifications to be considered in a financial bubble

Question 30

Early FX models viewed exchange rates as being primarily driven by international trade. More recently, macroeconomics have started viewing the FX market like any other. Describe why someone might wish to buy foreign currency such as GBP from the point of view of international finance

Answer 30

-There are many reasons which someone would wish to buy foreign currency through the lens of international finance
-the first reason is diversification of an investment portfolio, having foreign currency can help make the impact of changes in currency less impactful
-another reason is for trade, if a company in a country wants to buy a good from another they would need to convert their currency
-traveling is another reason for buying foreign currency, tourists visiting other countries need to exchange their own money for the currency of where they are visiting so they can purchase things when in the different country

Question 31

Unlike non-bank institutions (NBFI’s), banks have the power to create money, namely because their IOU’s are widely accepted as a means of payment. Name and describe the legal difference between bank IOU’s and NBFI IOU’s that renders the former, but not the latter, an accepted means of payment

Answer 31

-The legal difference between a bank IOU and an NBFI IOU revolves around the concept of deposits
-banks are allowed to take deposits that people make because they show as a liability on their balance sheet.
-these deposits are basically considered an IOU from the bank to whoever deposited the money, banks can do this because they are subject to legal rules which make sure that the money deposited is safe
-because of these rules there is alot of trust in banks which means that from a bank, an IOU is a working form of payment.
-NBFI’s on the other hand don’t have the same rules, and even though there may be some money protection it is not as trusted as if it came from a bank