Test 2

Question 1

asymmetric information

Answer 1

a situation in which one party knows more than another

Question 2

adverse selection

Answer 2

people that are more of a risk want loans more than people that are better risks

Question 3

moral hazard

Answer 3

when one party behaves differently because they have a loan

Question 4

how banks avoid asymmetric information

Answer 4

1) requiring collateral
2) requiring certain amounts of net worth
3) writing covenants into the loan contract

Question 5

covenant

Answer 5

part of a loan contract that makes the borrower act a certain way

Question 6

how banks earn profits

Answer 6

loans

Question 7

reserves

Answer 7

banks vault cash plus its deposits at the Fed

Question 8

excess reserves

Answer 8

banks total reserves minus its required reserves

Question 9

what banks do with excess reserves

Answer 9

1) hold them
2) lend them in the federal funds market
3) deposit them at the Fed
4) buy securities
5) make new loans with them

Question 10

fed funds rate

Answer 10

interest rate in the Fed

Question 11

discount rate

Answer 11

interest rate Fed offers loans to banks

Question 12

discount window

Answer 12

where banks request loans from Fed

Question 13

default risk (credit risk)

Answer 13

possibility a banks loan customer may not repay

Question 14

interest rate risk

Answer 14

risk that a change in interest rates will affect value of financial assets
banks diversify portfolio so that the failure of one firm or several firms will not hurt them too badly

Question 15

securitization

Answer 15

bank sells a loan which it made previously to investor

Question 16

why does the government regulate banks

Answer 16

1) to reduce the externalities caused by bank problems
2) to keep banks small
3) to prevent banker ins
4) to ensure that PMTs flow through the banking system efficiently
5) to stabilize the money supply

Question 17

contagion

Answer 17

spread of bank runs from one bank to another

Question 18

lender of last resort

Answer 18

government guarantees funds to a bank when needed

to prevent bank runs

Question 19

CAMELS

six components on which banks are evaluated

Answer 19

capital adequacy
asset quality
management
earnings
liquidity
sensitivity

Question 20

open market operations

Answer 20

tool fed uses to affect the money supply

purchases and sales of government securities in the secondary market

Question 21

fed tools for affecting the money supply

Answer 21

1) open market operations
2) changes in the discount rate
3) changes in the interest rate on banks reserve balances
4) changes in reserve requirements

Question 22

what banks managers do

Answer 22

1) assets- how much loans?
2) how much equity use to finance
3) what liabilities to use
4) liquidity- if more liquid less risk less return
5) interest rate risk- adjust for

Question 23

2 ways banks can fail

Answer 23

liquidity fail

insolvent

Question 24

liquidity fail

Answer 24

don’t have cash flow for when you need it

Question 25

insolvent

Answer 25

value of assets lower than the value of liabilites

Question 26

quantitative easing

Answer 26

open market operations but they’re announcing ahead of time what they’re going to do

Question 27

when banks fail

Answer 27

money supply goes down
credit goes down
decrease in wealth
runs

Question 28

market discipline

Answer 28

risk premium- charge you for being risky

when you get something gov’t subsidized you behave riskier than you would

Question 29

Dodd Frank

Answer 29

regulated financial institution to report derivatives

Question 30

basic effect of regulation

Answer 30

limit choices
compare benefit to cost (could end up costing more than benefit)
hidden consequences

Question 31

Central Bank

Answer 31

1) bank for gov’t
2) maintain good money
3) money control- monetary policy- tries to effect monetary policy
4) safety- lenders of last resort- if bank gets in trouble and can’t raise money they can borrow from bank reserves

Question 32

Fed

Answer 32

ran by board of governors
12 banks
serve for 14 years

Question 33

3 things Fed does to control money supply

Answer 33

1) set reserve requirement- % of reserves bank has to have at Fed
2) set discount rate- rate bank pays when borrows at Fed
3) open market operations- buying and selling securities (quantitative easing)

Question 34

special drawing rights

Answer 34

value depends on a portfolio of securities

fed balance sheet

Question 35

biggest category on fed balance sheet

Answer 35

securities

Question 36

why there are no retained earnings on Fed balance sheet

Answer 36

they give all profits back to the treasury

Question 37

how the reserve requirement affects the multiplier

Answer 37

1) rd
2) DW- discount window- you borrow from fed, int rate you have to pay them
3) OMO
4) interest paid on reserves- money bank can earn by having something deposited in acct