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business
money banking financial markets

Questions and Answers of Money Banking Financial Markets

13. What impact did Regulation Q have on the interest rates (a) earned on deposits and (b) charged on bank loans?
12. Do usury laws benefit or harm (a) well-to- do borrowers or (b) borrowers who are down on their luck?
11. Suppose the government made bank hold¬ ing companies illegal. What would you expect to happen to the number of bank failures? Why?
10. Explain the pros and cons of bank charter restrictions.
9. What is a bank holding company? Why are more than 90 percent of all banks in the United States owned by holding com¬ panies?
8. Why was the McFadden Act of 1927 en¬ acted?
7. Why are there more than 11,000 banks in the United States?
6. When was the FDIC established? Why?
5. A current proposal would increase the premium banks pay for FDIC insurance from 25 cents to 31 cents per $100 in de¬ posits. What impact, if any, would this have on (a) a national bank’s
4. Can a national bank choose not to become a member of the Federal Reserve System? Can it refuse to become a member of the FDIC?
3. Can state banks become members of the Federal Reserve System? Can they join the FDIC?
2. Who is responsible for granting charters to national banks? To state banks?
1. What does the term dual banking system mean? Why does the United States oper¬ ate under such a system?
The city council of a major city is concerned about the high interest rates local banks charge on automobile loans. The banks have argued that the high rates are necessary to cover their cost of
(a) List some of the financial innovations that resulted from banks’ attempts to circumvent banking restrictions, (b) List some of the legislative changes that blurred the distinction between
You are considering opening an account in either First National Bank or First State Bank in your local city. Briefly explain the differences between these two banks. What specific information should
20. Suzie has never written a bad check in her 30 years as a customer at Friendly Bank. The bank manager recently called Suzie to inform her that she has been given “auto¬ matic overdraft
19. Does the presence of federal deposit in¬ surance lead to moral hazard in the bank¬ ing industry? Explain.
18. Some banks do not pay interest on depos¬ its and, in fact, charge depositors a monthly maintenance fee, plus 10 cents for each check written. Does this policy contradict the analysis in this
17. Suppose a bank has market power in the deposit market. The law of supply reveals that if the bank reduces the interest rate it pays on deposits, it will attract fewer de¬ posits. What does the
16. Central Bank offers 8 different types of checking accounts and 24 different types of savings accounts. Why doesn’t Central Bank reduce its bureaucracy by offering only one type of account?
15. A bank with market power in both the de¬ posit and loan markets is experiencing losses. The bank plans to reduce the rate it pays to depositors while increasing the rate it charges on loans.(a)
14. Carefully explain why banks need not keep all deposits in reserve to cover with¬ drawals by depositors.
13. Can a solvent bank be so short on cash that it cannot accommodate withdrawals? Explain.
12. Suppose a bank has market power in the loan market. The bank can produce loans according to a total product curve, L =(1 — rr) D, where rr is the required re¬ serve ratio.(a) . Does this
11. Determine the likely impact of the follow¬ ing on an individual bank’s value mar¬ ginal product of deposits.(a). An increase in the market supply of deposits(b>. An increase in the market
10.Explain why the marginal resource cost of deposits is greater than the interest rate paid to depositors. (Assume, of course, that the bank has market power in the de¬ posit market.)
9. Bertha Bank is the sole user of deposits and issuer of loans in its market.(a) . Explain how the incentive to maxi¬ mize profits leads Bertha Bank to pay a positive interest rate on deposits,
8. Any Bank obtains deposits and issues loans in purely competitive markets where rD = 5 percent and rL = 10 percent.(a) . Use a graph to illustrate how Any Bank determines the profit-maximizing
7. Stockholders at Bank One are concerned that management is not running the bank properly. The reason for their concern is that deposits at the bank have doubled in recent years, but the amount of
6. Major Bank is the sole supplier of loans in its market area but competes in a na¬ tional market for deposits.(a) . Why might Major Bank be a monop¬ oly in the (local) loan market but a purely
5. Suppose the required reserve ratio is 15 percent. Can the marginal product of de¬ posits ever be greater than 85 percent? Explain.
4. Town Bank obtains deposits and issues loans in purely competitive markets where rD = 5 percent and rL = 10 percent. The bank manager has learned from the bank’s research department that the
3. Is it possible for a bank to have market power in the deposit market but no market power in the loan market? Justify your an¬ swer.
2. Tenth National Bank is a small bank in a large city. How do you think Tenth Na¬ tional determines the interest rate to pay depositors and to charge for loans? Ex¬ plain.
1. Why is the demand for deposits by a bank called a derived demand?
Suppose a bank has two types of depositors: A large depositor who has $10 million at the bank and many small depositors with deposits totaling $10 million. Each depositor withdraws all funds from his
If we divide both sides of the above expression by the total number of depositors (AO, we getIn other words, the average fraction of deposits withdrawn by all depositors (id) equals the total
Suppose that due to a reduction in the required reserve ratio, the marginal product of deposits increases. Illustrate the impact of this change on the interest rate paid on deposits and the quantity
Suppose the market for deposits is purely competitive. Illustrate the impact of an increase in the market supply of deposits on the profit-maximizing level of deposits at a bank that has market power
Graphically illustrate the effect on a purely competitive bank’s profit- maximizing demand for deposits if (a) the interest rate on loans increases and (b) the required reserve ratio on deposits
18. Suppose you are the president of the bank in question 17. Given the bank’s policy, what can you do to reduce or eliminate the problem of adverse selection?
17. In a recent television advertisement, a bank offered to issue a credit card to any¬ one regardless of his or her credit history. What would you expect the interest rate to be on credit card
16. In the presence of symmetric information about the ability of borrowers to repay loans, would you expect banks to charge a single interest rate to all borrowers? Why or why not?
15. Explain the difference between symmetric and asymmetric information.
14. Suppose the banks compete repeatedly over time. Determine whether (and if yes, how) they can earn profits of $5 each pe¬riod if the interest rate used in their pres¬ ent value calculations
13. Suppose the banks do not compete repeat¬ edly. What are their equilibrium profits? Why?
12. What are Bank Two’s profits if it charges an interest rate of 15 percent when Bank One charges an interest rate of (a) 8 per¬ cent and (b) 15 percent?
11. What are Bank One’s profits if it charges an interest rate of 8 percent when Bank Two charges an interest rate of (a) 8 per¬ cent and (b) 15 percent?
10. Why are there laws against collusion in banking?Answer questions 11-14 based on the fol¬ lowing profit matrix for two duopoly banks: Bank Two Interest Rate 8% 15% Bank One 8% 0,0 25,-5 15% -5,25
9. Suppose a bank with market power expe¬ riences a decrease in the marginal cost of issuing loans.(a) . Describe the factors that could lead to a decrease in the bank’s marginal cost.(b) . What
8. ‘ ‘If a bank with market power raises its interest rate above those charged by other banksr no borrowers will seek funds from that bank.” Is this statement true or false? Explain.
7. Explain why a bank may have market power.
6. Suppose the cost to a bank of issuing $100,000 in loans is $8,000.(a) . What is the bank’s average cost of is¬ suing $100,000 loans?(b) . How does one interpret this number?
5. Explain why a purely competitive bank is¬ sues a quantity of loans such that the in¬ terest rate on loans equals the marginal cost of issuing another dollar in loans.
4. Suppose the market demand for bank loans increases in a purely competitive market for loans. Using words and a dia¬ gram, explain the impact of this on(a) . The market interest rate(b) . The
3. What is the impact on the costs to a bank if an increase occurs in (a) the interest rate paid to depositors for funds, (b) the fre¬ quency with which borrowers default, and (c) the wage paid to
2. Suppose the market interest rate on bank loans is 10 percent. How many loans will a purely competitive bank issue if it charges an interest rate on loans of 10.5 percent? Explain.
1. Who demands bank loans? Who supplies them?
Banks that issue car loans require a much larger down payment on a used car than on a new one. Furthermore, interest rates on used-car loans are higher than rates on new cars. Why?
Suppose Bank One and Bank Two repeatedly face the situation presented in Table 5.1 and that the interest rate they use in their present value calculations is 40 percent, (a) What are Bank One’s
Suppose a bank with market power has a constant marginal cost of issuing loans and that marginal cost equals the average cost at each level of output; that is, marginal and average costs are equal at
Suppose the market demand for bank loans increases. Use a graph to illus¬ trate what happens to the number of loans and the profits of an individual bank that operates in a purely competitive
16. Suppose the marginal tax rate is 33 per¬ cent. Determine the effective aftertax in¬ terest rate paid by a borrower with(a) . A 12 percent mortgage(b) . A 10 percent consumer loan
15. Critically evaluate this statement: “An in¬ crease in the demand for mortgages in¬ creases the mortgage interest rate, which in turn leads to an increase in the supply of funds for mortgages.
14. Moody’s bond rating service recently low¬ ered its rating of bonds issued by several large insurance companies and pension funds, which means loans to these compa¬ nies are now more risky.
13. An article in the Wall Street Journal re¬ ported that the return on investing in stocks in 1996 is expected to be 5 percent higher than normal. Assuming investors believe this report, what would
12. Use supply and demand analysis to ex¬ plain the likely impact of a reduction in inflationary expectations on the market for(a) . ATM transactions(b) . Life insurance(c) . Mortgages(d) . Savings
11. Use supply and demand analysis to ex¬ plain the likely impact of an increase in the marginal tax rate on(a) . ATM transactions(b) . Life insurance(c) . Mortgages(d) . Savings deposits(e) .
10. Use supply and demand analysis to ex¬ plain the likely impact of a recession on the market for(a) . ATM transactions(b) . Life insurance(c) . Mortgages(d) . Savings deposits(e) . New-car
9.Show the impact on the market for per¬ sonal loans of(a) . A government law that permits bor¬ rowers to deduct interest payments on per¬ sonal loans for tax purposes(b) . An increase in the
8. Suppose the mortgage market is initially in equilibrium (label this point A in a sup¬ ply and demand diagram). Lenders expect the inflation rate to decline, whereas bor¬ rowers expect it to
7. Other things being the same, would you expect the equilibrium interest rate to be higher or lower on a small-business loan or on a large-business loan? Explain using supply and demand analysis.
6. Other things being the same, would you expect the equilibrium interest rate to be higher on a 1-year loan or on a 20-year loan? Use supply and demand analysis to explain your answer.
5. During the 1980s, federal budget deficits were financed through borrowing. Graphi¬ cally illustrate the impact of financing the budget deficit with federal borrowing on(a) . The market for
4. During the late 1970s, the interest rate on money market mutual funds increased from 10 to 15 percent. Banks and savings and loans, however, continued to pay only 5 '/4 percent interest on savings
3. Mandatory seat belt laws have reduced the number of automobile liability insurance claims. What is the impact of this result on the market price and quantity of auto¬ mobile liability insurance?
2. What is the difference between (a) an in¬ crease in demand and (b) an increase in quantity demanded? Explain and provide a diagram that illustrates the difference.
1. What is the price of a fee-based financial service? What is the price of an interest- rate-based financial service? Is it possible to convert the interest-rate-based price of a given financial
The federal government is projected to have a large deficit next year. Suppose that, instead of borrowing funds to finance the deficit, the government raised the tax rates for all individuals,
One proposal that has floated around Washington, D.C., is to enact a trans¬ action tax on financial transactions. This tax would be a fee of 1 percent or so on the value of specified financial
Graphically illustrate the impact of the following on the demand for loanable funds: (a) a reduction in inflationary expectations, (b) an increase in the profitability of business projects, and (c)
Graphically illustrate what would happen in the market for traveler’s checks if (a) due to a reduction in terrorist activity, families did more traveling; (b) a bank card was introduced that
Many banks charge a fee for wire transfer services—the transfer of funds from one financial institution to another via telephone lines or other elec¬ tronic media, including wireless
Homeowner’s insurance is a fee-based financial service. Illustrate graphically the impact of the following on the demand for homeowner’s insurance: (a) a reduction in the price of homeowner’s
14. Briefly explain why interest rates vary (1) across different types of financial instru¬ ments and (2) over time.
13. Suppose you just learned that the govern¬ ment plans to print more money to finance the federal budget deficit.(a) . How would this action affect your es¬ timate of expected inflation? Why?(b)
12. Joe issues a loan at an interest rate of 9 percent. Determine the “effective” interest rate Joe earns if(a) . Joe is in the 28 percent tax bracket and expects no inflation.(b) . Joe does not
11. Does inflation “hurt” borrowers or lend¬ ers? Explain carefully.
10. “If the expected inflation rate is 5 percent and a lender loans out money at a 4 per¬ cent interest rate, he or she will end up with a 9 percent real return on the invest¬ ment.” Is this
9. Using Table 3.1, compare the six-month commercial paper rate with the six-month U.S. Treasury bill rate. Which is usually higher? Is this always the case? Can you explain why one rate is usually
8. “If you put $100 in a bank account that draws 5 percent interest, in one year you will have $105 and in two years you will have $110.” Is this statement true or false? Explain.
7. If the interest rate is 10 percent, how much money would you have to put in the bank today to be a millionaire in 30 years?
6. (a). Determine the present value of $10,000 to be received in five years when the interest rate is (1) zero percent, (2) 5 percent, and (3) 10 percent.(b). What do you conclude about the rela¬
5. (a). Determine the present value of $10,000 when the interest rate is 5 percent and the money is to be received in (1) 1 year, (2) 5 years, and (3) 10 years.(b). What do you conclude about the
4. A coupon bond with a face value of $1,000 pays $80 at the end of each year for five years and then matures. The inter¬ est rate on similar one-year investments is 8 percent. What is the present
3. Ml was $167.9 billion in 1965 and $172.1 billion in 1966. Assuming velocity was constant during this period, how much would real output have had to grow for no inflation to have occurred? Explain.
2. The price level was 26.02 in 1960 and 26.25 in 1961. What was the inflation rate between 1960 and 1961?
1. If the price of a textbook increases by 7 percent, can you conclude that the inflation rate is 7 percent? Explain.
Your client is in the 38 percent tax bracket and thus pays $38 of every additional $100 she earns to the federal government. She has $10,000 to invest for one year and wants your advice in choosing

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