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Money & Banking Final Exam

Lesson 10 Interest Rate Determination/Real Interest Rates

- Determining Quantity Demane !or "sset #relation $/-%
- &ealt'( total resour)es o*ne +y ini,iual- in)luing assets #$%
- Ex.e)te Return( returne o,er next .erio relati,e to ot'ers #$%
- Risk( egree o! un)ertainty relati,e to ot'ers #-%
- Li/uiity( ease o! turning asset into )as' ,s ot'ers #$%
- Basi) Bon 0u..ly an Deman
- Lo*er .ri)es #'ig'er interest rates%- /uantity emane is 'ig'er #-%- /uantity su..lie is
lo*er #$%
- Deman In!luen)es
- Ex.e)te Interest Rate Fe 1oli)y- negati,e relations'i.
- Ex.e)te In!lation Rate- negati,e relations'i.
- Ex.e)te Return on ot'er assets- negati,e relations'i.
- Risk #negati,e%
- Li/uiity- .ositi,e relations'i.
- &ealt'- .ositi,e
- 0u..ly In!luen)es
- 2o,ernment e!i)its in)rease e!i)its- in)rease su..ly
- "lternati,e )ost o! !inan)ing
- Ex.e)te 1ro!ita+ility .ositi,e relations'i.
- Ex.e)te In!lation .ositi,e relations'i.
- Exam.le( In)rease in ex.e)te in!lation( eman in*ar- su..ly out*ar- .ri)es o*n-
interest rates go u.
- &'y o e!i)its enlarge uring re)essions +e)ause o! .u+li) *orks .rograms
- I! all t'ings are e/ual- an in)rease in treasury e+t outstaning *oul make +on .ri)es !all an
interest rates *oul rise +e)ause su..ly in)reases- +uget e!i)its in)rease in re)essions- .ri,ate )reit
emans ease- in,estors !a,or risk !ree se)urities #treasuries%
- I! e!i)it *as 0- treasury *oul still 'a,e to issue ne* e+t to reeem maturing e+t
- 3y.es o! +is( 4om.etiti,e- 5on)om.etiti,e- Foreign International Monetary "ut'ority
#non)om.etiti,e%- 0ystem 6.en Market "))ount #roll o,er +i%
Lesson 11 Risk an 3erm 0tru)ture o! Interest Rates
- &'y on7t sto)k an +on .ri)es mo,e in o..osite ire)tions all t'e time8
- De!ault Risk *'en issuer o! +on is una+le or un*illing to make interest .ayments
- Risk 1remium s.rea +et*een interest rates on +ons */ e!ault risk an interest rates on 3-+ons
- 3reasury Bills
- 0'ort-term se)urities maturing in one year or less
- Bills sol 9 is)ount !rom !a)e ,alue
- &'en it matures- in,estors re)ei,e !a)e ,alue
- 1ri)e : Fa)e ;alue # 1 #is)ount < time in ays/=>0%%
- 3reasury 5otes & Bons interest .ai semi-annually
- 5otes interest +earing se)urities- !ixe maturity +et*een 1 an 10 years
- Bons maturity in ex)ess o! 10 years
- 3reasury In!lation 1rote)te 0e)urities #3I10%
- interest rate is !ixe t'roug'out t'e term o! se)urity
- .rin)i.al amount o! se)urity is a?uste !or in!lation
- 03RI10 0e.arate 3raing o! Registere Interest an 1rin)i.al 0e)urities
- in,estors 'ol an trae ini,iual interest an .rin)i.al )om.onents o! 3reasury notes an
+ons as se.arate se)urities
- .o.ular i! you *ant to re)ei,e a kno*n .ayment on a s.e)i!i) !uture ate
- In,estor only re)ei,es .ayment at maturity
- Fig't to Quality risk .remium is t'e )'ange in .ri)e o! +on i! t'ere *as an in)rease in e!ault risk
on )or.orate +ons +e)ause eman !or )or.orate +on *oul go o*n- an treasury +ons *oul go
- I! tax rates are ex.e)te to go u.- eman !or muni)i.al +ons *oul go u. an treasury +on
eman *oul go o*n- .ri)e o! muni)i.al +on goes u.- treasury goes o*n
- 3'e @iel 4ur,e .lot o! yiel on +ons *it' i!!ering terms to maturity +ut t'e same risk- li/uiity
an tax )onsierationsA
- B.*ar-0lo.ing long term rates are a+o,e s'ort term rates
- Flat long term : s'ort term rates
- In,erte long term rates are +elo* s'ort term rates
- 3'eory o! 3erm 0tru)ture o! Interest Rates
- Interest rates on notes an +ons o! i!!erent maturities mo,e toget'er o,er time
- 0'ort term interest rates are lo*- yiel )ur,e is likely to u.*ar slo.e- in,erse is also true
- @iel )ur,e almost al*ays slo.es u.*ar
- @iel 4ur,e 3'eories
- Ex.e)tations #mo,ing toget'er an lo* s'ort term C u.*ar slo.e%
- Interest rate on long term +on *ill e/ual a,erage o! ex.e)te s'ort term interest rates
o,er t'e li!e o! t'e +on
- Buyers o! +ons on7t .re!er one maturity o,er anot'er- t'ey )are a+out ex.e)te return
- Im.lie For*ar Rate(
- Eg( = yr yiel is =D- E-yr yiel is =AFGD- *'at is im.lie !* 1-year rate in
year E8
Et' yr !* rate : #E<=AFGD%-#=<=D% : ED
- Ex.lains *'y term stru)ture o! interest rates )'anges at i!!erent times
- 0egmente Markets #@iel )ur,e al*ays slo.es u.*ars%
- Bons o! i!!erent maturities aren7t su+stitutes- interest rate !or ea)' +on *it'
i!!erent maturity is etermine +y su..ly an eman o! t'at +on
- In,estors .re!er +ons o! one maturity o,er t'e ot'er +ase o! t'eir nees- exam.le- i!
in,estors 'a,e s'ort 'oling .erios- t'en t'ey .re!er s'ort maturity +ons *it' less
interest-rate risk- *'i)' is *'y yiel )ur,e slo.es u.*ars
- Li/uiity 1remium 3'eory #.ro,es all =%
- Interest rate on long term +on *ill e/ual a,erage o! s'ort term interest rates o,er t'e
+ons li!e .lus a li/uiity .remium t'at )orres.ons to t'e su..ly an eman o! t'at
.arti)ular +on
- Bons o! i!!erent maturities are su+stitutes +ut not .er!e)t
Lesson 1F Feeral Reser,e 0ystem- 3rans.aren)y an Ine.enen)e
- Fe uties in E main areas( )onu)ting monetary .oli)y- su.er,ising an regulating +anking
institutions- maintaining sta+ility o! !inan)ial system an )ontaining systemi) risk t'at may arise-
.ro,iing !inan)ial ser,i)es to +anks- us go,ernment an !oreign o!!i)ial institutions
- Boar o! go,ernors #H% )ontrol t'e system- an t'e +oar o! go,ernors as *ell as !e reser,e +ank
.resients )om.rise t'e Feeral 6.en Market 4ommittee *'i)' etermines monetary .oli)y
- Reser,e Re/uirements set +y +oar o! go,ernors- a,ise +y F6M4
- 6.en Market 6.erations ire)te +y F6M4
- Dis)ount rate re,ie*e an etermine +y +oar o! go,ernors- a,ise +y F6M4- !eeral
reser,e +anks esta+lis' it
- Boar o! 2o,ernors 'as = +ankers an = +usiness leaers ele)te +y mem+er +anks- an t'en =
.u+li) interest ire)tors a..ointe +y +oar o! go,ernors
- Feeral Reser,e Banks Fun)tions(
1A 4lear 4'e)ks
FA Issue ne* )urren)y/*it'ra* amage )urren)y
=A Make is)ount loans to +anks *it'in istri)t
EA E,aluate mergers/ex.ansions o! +anking a)ti,ity/Liaisons +et*een +anks an Fe 0ystem
GA Examine +ank 'oling )o7s an state-)'artere +anks
>A 4olle)t ata on lo)al +usiness )onition
HA Resear)' to.i)s relate to )onu)t o! monetary .oli)y
- Fe Reser,e Bank o! 5@
- exe)utes monetary .oli)y
- agent o! B0 treasury an )onu)ts B0 go, !inan)ing o.erations
- exe)utes inter,ention on !oreign market
- )ustoy/ser,i)es to !oreign )entral +anks
- .resient ser,es as ,i)e )'air o! F6M4
- Boar o! 2o,ernors
- "..ointe +y .resient- )on!irme +y senate
- 1E year non rene*a+le term- staggere to limit one .resients in!luen)e
- 1resient sele)ts )'airman !or !our-year rene*a+le term
- ;ote on )onu)t o! 6.en Market 6.eration
- 0et reser,e re/uirements
- 4ontrol is)ount rate/set margin re/uirements
- 0u.er,ises a)ti,ity o! !oreign +anks in B0
- Fes goal is to +e trans.arent +ut t'ey aren7t al*ays
- 3'ey 'a,e ine.enent re,enue
- 4ongress )ontrols stru)ture
- 1resient 'as in!luen)e on t'e !e +e)ause t'e .resient nominates )'airman an senate a..ro,es
- &'en ele)tions a..roa)'- !e takes a)tion as usual +ut t'ey o it in moeration- t'en a!ter t'ey o
*'at t'ey nee to o *it'out moeration
- Bet*een late I0s early 00s- !e starts to release statements an make t'ings more .u+li)
- +ene!its( le,els t'e .laying !iel
- makes !e more a))ounta+le
- reu)es .oli)y lags + )utting re)ognition lags
- im.ro,es transmission o! .oli)y ,ia t'e ex.e)tations t'eory o! yiel )ur,e
- reu)es li/uiity an term .remiums in yiel )ur,e
- 3oo mu)' trans.aren)y )omes at risks- too mu)' in!ormation )oul in,ol,e riskier traes *'i)'
*oul make e)onomy more ,ulnera+le to sur.rises
- Jee.ing t'e Fe as a se.arate entity ensures t'at .oliti)al .ressure oesn7t +ias monetary .oli)y- an
you )an7t !inan)e t'e treasury- +e)ause t'en you7re ?ust monetariKing !eeral e+t
Lesson 1= Money 0u..ly 1ro)ess
- "gents( Fe Reser,e 0ystem- Banks- De.ositors & Borro*ers
- Fe a!!e)ts +ank reser,es ,ia se)urities
- Monetary Base : Reser,es $ 4urren)y #'ig' .o*er money%
- *e see a!ter !inan)ial )risis- reser,es an )urren)y goes u.- mainly reser,es
- Fe selling se)urities reu)es +anking reser,es
- 6.en Market 6.erations( an o.en market .ur)'ase in)reases ,olume o! +ank reser,es- sales e)rease
+ank reser,es
- I! .eo.le eman more )urren)y it reu)es +ank reser,es- +ut not monetary +ase- +e)ause money ?ust
mo,es into )urren)y !rom reser,es
- Borro*ing !rom is)ount *ino*- in)reases +ank reser,es- .aying +a)k reu)es reser,es
- 6t'er !a)tors a!!e)ting reser,es an monetary +ase( !loat- treasury e.osits at t'e !e- inter,entions in
!oreign ex)'ange market- reem.tion !rom !es .ort!olio
- Ex)ess reser,es re.resent a )us'ion against un)ertainty +anks on7t make interest o!! o! it
- Money 0u..ly an De.osit gro*t' is etermine +y !e a)tions an market ynami)s
- Multi.le De.osit )reation )'ange in e.osits : )'ange in reser,es/reser,e ratio
- De.osit Multi.lier oesn7t *ork in real *orl +e)ause o! lagge reser,e a))ounting- *'i)' reners
is)onne)t +et*een e.osit gro*t' an re/uire reser,es as *ell as !e !uns rate targeting- i! eman
!or ex)ess reser,es in)reases +e)ause t'ere7s eman in !e !uns market- t'e !uns rate rises t'en t'e
!e nees to a reser,es to get t'e !uns rate +a)k on target
- 6.en Market 6.erations F6M4 sets target FB5@ exe)utes
- Reser,e Re/uirements Boar o! 2o,ernors
- Dis)ount Rate Dire)tors .etition to Boar o! go,ernors
Lesson 1E 3raitional 3ools o! t'e Fe
- 2oals o! Monetary 1oli)y( Maximum 0ustaina+le 2ro*t' & Em.loyment- 1ri)e 0ta+ility- Moerate
Long term Interest rates
- Maximum 0ustaina+le 2ro*t' Rate( Real 2D1 : 1otential
- 0ustaina+le Em.loyment( 0omet'ing *it' .'illi.s )ur,e
- 1ri)e 0ta+ility( )ore 41I an 14E
- 3ools o! t'e Fe
1A 6.en Market 6.erations aime to a!!e)t +ank reser,e +alan)es
- 3o a reser,es( +uy se)urities or engage in tem. re.ur)'ase agreements #R1%
- 3o train reser,es( sell se)urities or engage in re,erse R1 #RR1%
- Buy an sell se)urities t'roug' .rimary ealers
- Buying se)urities e)reases !e !uns rate +) o! in)rease o! +ank reser,es #su..ly%
- Dynami)( !unamentally )'anging t'e !uns rate target( .oli)y e)ision
- De!ensi,e( o!!set )'anges in t'e autonomous !a)tors #+uying selling se)urities or
engaging in R1 or RR1%- *it' intent o! )'anging !uns rate
FA Reser,e Re/uirements
- In)rease in reser,e ratio( eman )ur,e s'i!ts out C !uns rate goes u.
- Deman !or Reser,es : Ex)ess Deman $ Re/uire Reser,es
- 0u..ly o! Reser,es : Balan)es at Fe $ ;ault 4as'
- 3reasury e.osits 9 Fe rain reser,es
- 5o longer regare as e!!e)ti,e .oli)y tool
=A Dis)ount &ino* Loans
- &'en +anks +orro*- reser,es in)rease
- rate !ollo*s !e !uns rate- slig'tly a+o,e it- )ounte as a .enalty rate
- !e t'oug't t'at t'is *oul remo,e +a stigma o! +orro*ing !rom t'e !e
- Lo*ering t'e is)ount rate 'as no e!!e)t i! it7s still a+o,e !e !uns rate
Lesson 1G 4reit 4risis
- Lyman Minsky 0ta+ility Brees Insta+ility
- Fe .oli)y *as too easy !or too long
- Lo* rate a?usta+le mortgages .ro,ie to +oost 'ome sales
- &'o *as to +lame8
- Fe !or kee.ing rates !or too lo* !or too long
- Regulators in)luing t'e !e s'oul 'a,e +een .roa)ti,e
- 0e)uritiKation o! mortgages- s'i!ting t'e risk !rom leners to +roa s.e)trum o! in,estors
- Rating "gen)ies
- Risky Mortgage Instruments an little is)i.line +y Mortgage Brokers
- 5ai,e .u+li)
- Ina+ility to o! issuers to roll o,er )ommer)ial .a.er !or)e +orro*ers to s'o* u. at oorste.s o!
- Banks attem.te to in)rease Manage Lia+ilities ue to in)rease !uning re/uirementsA 3'is is Large
3ime De.osits- 3erm Fe Funs an Euroollar/Li+or Borro*ing
- Biing !or Manage Lia+ilities )ause raise in Li+or rate- *'i)' in)rease )ost o! +orro*ing *'i)'
in)rease mortgage ratesA
Lesson 1> 4risis Relate Li/uiity 1ro,isions
- Fe trie to reu)e s.rea so +anks *oul +orro* !rom t'em an take .ressure o!! +iing & li+or
rate *oul go o*n- in7t *ork
- 3'ey reu)e s.rea again an extene terms o! loans- still in7t *ork
- 3erm "u)tion Fa)ility -