ce What would the consolidated balance sheet of the commercial banks look like after the commercial banks fully adjusted (they are fully adjusted when they are maximizing profits again) to their sale of $50m worth of T-Bills to the Bank of Canada? (In this question, assume that the public holds any money from the resulting loans in commercial banks as bank deposits. that is, that there is no currency drain.] Consolidated Commercial Banks Assets Liabilities CB Deposits at Bank of Canada: Deposits: Bank Notes: Equity: Loans: T-Bills: *In the vault (G) What was the initial money supply (original balance sheets) and what was the money supply after full adjustment to the Bank of Canada's purchase of T-Bills (that is, the balance sheets of question (G)). (H) By how much did the money supply increase in total (include both the initial injection and the resulting expansion) and what is the money creation multiplier (using the assumption from (G))? Page 5 of 11 Suppose the Commercial Banking System has s identical banks. The initial balance sheets of each of the commercial banks can be found by dividing by the entries in the consolidated banking system presented at the start of the question (for Part (A)). Using the example of the creation of deposit money presented on pages 658-662 of the Ragan / MyEconlab text as a guide, trace through the multi-stage changes to the commercial bank balance sheets following a purchase of 20 of T-Bills from the Commercial Bank A by the Bank of Canada. The Bank of Canada pays for the T-Bills by increasing Bank A's deposits at the Bank of Canada. Assume the five banks are Bank A, Bank B, Bank C. Bank Dand Bank E and that Bank B receives the deposit in round 2: Bank Creceives the deposit at round 3, Bank D receives the deposit at round 4. There is no cash drain to the public. Follow the balance sheet changes through four rounds by creating versions of Table 26-3, 26-5, 26-6 (for each of Bank B, Bank C, and Bank D), and Table 26-7 (for four rounds). Initial Balance Sheet of Bank A (like, but not identical to Table 26-3): Bank A Assets Liabilities Deposits: 400 Reserves Deposits at Bank of Canada: 40 *Cash: 40 Loans: 400 Capital: 100 T-Bills: 20 Total Assets: 500 *In the vault Total Liabilities: 500 After sale of T-bills and loan of excess cash reserves, Round 1 (like Table 26-5) Bank A Assets Liabilities Deposits: Reserves Deposits at Bank of Canada: Vault Cash: Loans: Capital: T-Bills: Total Assets: Total Liabilities: [Note: This Table will be slightly different from Table 26-5 because the starting point was an addition to the reserves of Bank A, not a new deposit.] Round 2 at Bank B (like Table 26-6) Bank B Liabilities Deposits: Assets Reserves Deposits at Bank of Canada: Vault Cash: Loans: T-Bills: Capital: Total Assets: Total Liabilities: Round 3 at Bank C Bank C Assets Liabilities Deposits: Reserves Deposits at Bank of Canada: Vault Cash: Loans: Capital: T-Bills: Total Assets: Total Liabilities: Round 4 at Bank D Bank D Assets Liabilities Deposits: Reserves Deposits at Bank of Canada: Vault Cash: Loans: Capital: T-Bills: Total Assets: Total Liabilities: Page 7 of 11 Sequence of Loans and Deposits (like Table 26-7) Sequence of Loans and Deposits Bank New Deposits New Loans Bank A Additions to Reserves Bank B Bank Bank D Total, Rounds 2 to end I Total (Note: The Totals are not required for the answers for credit. Note also that this Table is slightly different from Table 26-7 because of the different starting point.] PART THREE 17 points (A) [6 points) Fill in the values of the Table In Column 2 labeled Present Value (Price). enter the present value column of a three-year bond with a face value of $1000 and a coupon rate of 10 percent when the interest rate is given as in Column 1. Interest Rate Present Value (Price) 0.04 0.08 0.12 The coupon rate of 0.10 implies payments of $100 in Year 1. Year 2, and Year 3. (B) [1 point] What is the relationship between the interest rate and the price of issued bonds? ) [5 points) The investment function for investment demand, I in billions of dollars, is given by i= 14 -0.21 where i interest rate and I = gross investment expenditure. Sketch the investment function with interest rates on the vertical axis and desired investment expenditure on the horizontal axis. As the interest rate changes (as in part (B)), what happens to gross investment expenditure? Page 10 of 11 B) 3 points Suppose the B of C chooses to reduce the money supply and takes actions such that M drops from 3 trillion to 2 trillion dollars. In particular, suppose the Bank of Canada decides to sell bonds to the commercial banks. How does the Bank of Canada induce the commercial banks to buy the bonds? How docs any business entice customers to buy something? If the Bank of Canada is decreasing the price of bonds to sell them to the commercial banks, what will that imply about how interest rate will move next? [See your answer to Part Three (B)]. If the reserve ratio is 0.025, what is the value of bonds that the B of C needs to sell to the commercial banks to reduce their reserves by enough to reduce the money supply by 1 trillion dollars? [1 trillion - 1000 billion) The commercial banks respond to having lower reserves by not issuing new loans when existing loans are paid off so their loans portfolios shrink. Individuals and businesses find it much more difficult to borrow money (C) 15 points) If money demand is given by i=12-2 (M) where i = the interest rate and M is the money supply, in trillions of dollars Graph the demand for money, the initial supply of money and the new supply of money. What was the initial interest rate? What is the new interest rate? Page 9 of 11 ce What would the consolidated balance sheet of the commercial banks look like after the commercial banks fully adjusted (they are fully adjusted when they are maximizing profits again) to their sale of $50m worth of T-Bills to the Bank of Canada? (In this question, assume that the public holds any money from the resulting loans in commercial banks as bank deposits. that is, that there is no currency drain.] Consolidated Commercial Banks Assets Liabilities CB Deposits at Bank of Canada: Deposits: Bank Notes: Equity: Loans: T-Bills: *In the vault (G) What was the initial money supply (original balance sheets) and what was the money supply after full adjustment to the Bank of Canada's purchase of T-Bills (that is, the balance sheets of question (G)). (H) By how much did the money supply increase in total (include both the initial injection and the resulting expansion) and what is the money creation multiplier (using the assumption from (G))? Page 5 of 11 Suppose the Commercial Banking System has s identical banks. The initial balance sheets of each of the commercial banks can be found by dividing by the entries in the consolidated banking system presented at the start of the question (for Part (A)). Using the example of the creation of deposit money presented on pages 658-662 of the Ragan / MyEconlab text as a guide, trace through the multi-stage changes to the commercial bank balance sheets following a purchase of 20 of T-Bills from the Commercial Bank A by the Bank of Canada. The Bank of Canada pays for the T-Bills by increasing Bank A's deposits at the Bank of Canada. Assume the five banks are Bank A, Bank B, Bank C. Bank Dand Bank E and that Bank B receives the deposit in round 2: Bank Creceives the deposit at round 3, Bank D receives the deposit at round 4. There is no cash drain to the public. Follow the balance sheet changes through four rounds by creating versions of Table 26-3, 26-5, 26-6 (for each of Bank B, Bank C, and Bank D), and Table 26-7 (for four rounds). Initial Balance Sheet of Bank A (like, but not identical to Table 26-3): Bank A Assets Liabilities Deposits: 400 Reserves Deposits at Bank of Canada: 40 *Cash: 40 Loans: 400 Capital: 100 T-Bills: 20 Total Assets: 500 *In the vault Total Liabilities: 500 After sale of T-bills and loan of excess cash reserves, Round 1 (like Table 26-5) Bank A Assets Liabilities Deposits: Reserves Deposits at Bank of Canada: Vault Cash: Loans: Capital: T-Bills: Total Assets: Total Liabilities: [Note: This Table will be slightly different from Table 26-5 because the starting point was an addition to the reserves of Bank A, not a new deposit.] Round 2 at Bank B (like Table 26-6) Bank B Liabilities Deposits: Assets Reserves Deposits at Bank of Canada: Vault Cash: Loans: T-Bills: Capital: Total Assets: Total Liabilities: Round 3 at Bank C Bank C Assets Liabilities Deposits: Reserves Deposits at Bank of Canada: Vault Cash: Loans: Capital: T-Bills: Total Assets: Total Liabilities: Round 4 at Bank D Bank D Assets Liabilities Deposits: Reserves Deposits at Bank of Canada: Vault Cash: Loans: Capital: T-Bills: Total Assets: Total Liabilities: Page 7 of 11 Sequence of Loans and Deposits (like Table 26-7) Sequence of Loans and Deposits Bank New Deposits New Loans Bank A Additions to Reserves Bank B Bank Bank D Total, Rounds 2 to end I Total (Note: The Totals are not required for the answers for credit. Note also that this Table is slightly different from Table 26-7 because of the different starting point.] PART THREE 17 points (A) [6 points) Fill in the values of the Table In Column 2 labeled Present Value (Price). enter the present value column of a three-year bond with a face value of $1000 and a coupon rate of 10 percent when the interest rate is given as in Column 1. Interest Rate Present Value (Price) 0.04 0.08 0.12 The coupon rate of 0.10 implies payments of $100 in Year 1. Year 2, and Year 3. (B) [1 point] What is the relationship between the interest rate and the price of issued bonds? ) [5 points) The investment function for investment demand, I in billions of dollars, is given by i= 14 -0.21 where i interest rate and I = gross investment expenditure. Sketch the investment function with interest rates on the vertical axis and desired investment expenditure on the horizontal axis. As the interest rate changes (as in part (B)), what happens to gross investment expenditure? Page 10 of 11 B) 3 points Suppose the B of C chooses to reduce the money supply and takes actions such that M drops from 3 trillion to 2 trillion dollars. In particular, suppose the Bank of Canada decides to sell bonds to the commercial banks. How does the Bank of Canada induce the commercial banks to buy the bonds? How docs any business entice customers to buy something? If the Bank of Canada is decreasing the price of bonds to sell them to the commercial banks, what will that imply about how interest rate will move next? [See your answer to Part Three (B)]. If the reserve ratio is 0.025, what is the value of bonds that the B of C needs to sell to the commercial banks to reduce their reserves by enough to reduce the money supply by 1 trillion dollars? [1 trillion - 1000 billion) The commercial banks respond to having lower reserves by not issuing new loans when existing loans are paid off so their loans portfolios shrink. Individuals and businesses find it much more difficult to borrow money (C) 15 points) If money demand is given by i=12-2 (M) where i = the interest rate and M is the money supply, in trillions of dollars Graph the demand for money, the initial supply of money and the new supply of money. What was the initial interest rate? What is the new interest rate? Page 9 of 11