The Business of Banking

Question 1

bank

Answer 1

profit-maximising firm that creates money in the form of bank deposits in the process of supplying credit

Question 2

money

Answer 2

medium of exchange consisting of bank notes and bank deposits, accepted as payment because others can use it for the same purpose

Question 3

central bank

Answer 3

creates a kind of money called legal tender and lends to banks at its chosen policy interest rate

Question 4

wealth

Answer 4

all that is owned and owed by an individual

Question 5

income

Answer 5

maximum amount that you could consume and leave wealth unchanged

Question 6

depreciation

Answer 6

loss in value of a form of wealth either through (1) use or (2) passage of time

Question 7

net income

Answer 7

gross income - depreciation

Question 8

balance sheet

Answer 8

tool to measure wealth, both sides are always equal (assets, liabilities and net worth)

Question 9

asset

Answer 9

anything of value that is owned

Question 10

liability

Answer 10

anything of value that is owed

Question 11

net worth

Answer 11

assets - liabilities

Question 12

base money

Answer 12

cash (liability of central bank)

Question 13

bank money

Answer 13

bank deposits created by commercial banks when they extend credit to firms/households (liability of commercial banks)

Question 14

maturity transformation

Answer 14

borrowing money short-term and lending it long-term, essential but exposes to (liquidity and default) risk

Question 15

mortgage

Answer 15

loan contracted by households/businesses to purchase a property without paying everything at once

Question 16

liquidity risk

Answer 16

risk that an asset cannot be exchanged for cash before a financial loss

Question 17

default risk

Answer 17

risk that a loan will not be repaid

Question 18

interest rate

Answer 18

price of borrowing base money

Question 19

policy interest rate

Answer 19

set by central bank, applies to banks that borrow base money from each other and from central bank

Question 20

government bond

Answer 20

financial instrument issued by governments promising to pay flows of money at specific intervals

Question 21

yield

Answer 21

implied rate of return the buyer gets on their money when they buy a bond at its market price

Question 22

bank’s operational costs

Answer 22

administration costs of making loans

Question 23

bank’s interest costs

Answer 23

banks must pay interest on their liabilities, e.g. deposits

Question 24

bank’s revenue

Answer 24

interest on and repayment of loans it has extended to customers

Question 25

bank’s expected return

Answer 25

return on the loans it provides, taking into account default risk

Question 26

insolvent

Answer 26

entity is this if value of assets < value of liabilities

Question 27

bank bailout

Answer 27

government buys an equity stake in a bank or something else to prevent it from failing

Question 28

financial accelerator

Answer 28

mechanism through which ability to borrow increases when the value of collateral pledged goes up

Question 29

collateralised debt obligation (CDO)

Answer 29

structured financial instrument - a bond or note backed by fixed income assets (collapse in value of them contributed to ‘08)
→ derivative based on MBS’s

Question 30

mortgage-based security (MBS)

Answer 30

financial asset that uses mortgages as collateral

Question 31

subprime mortgage (!!!)

Answer 31

residential mortgage issued to high-risk borrower e.g. with history of bankruptcy