banks and finance

Question 1

interest rate

Answer 1

what it costs you to borrow money (when money is limited you pay more for it)

Question 2

MRT- borrowing

Answer 2

tradeoff between current and future consumption

Question 3

real interest rate

Answer 3

adjusting for inflation

Question 4

interest rate- demand

Answer 4

number of people who have access to credit markets, uncertainty of making new investments

Question 5

interest rate- supply

Answer 5

people increasing savings (old people), access to foreign capital, uncertainty over the state of the economy (great depression)

Question 6

benefits of debt

Answer 6

to make an investment today that will hopefully pay off in the future (car, education, house)

to avoid liquidating assets to make payments (selling the things you have)

Question 7

consumption smoothing

Answer 7

have a decent standard of living your whole life.

Question 8

tax smoothing

Answer 8

borrowing helps governments overcome gaps in taxes and revenues.

Question 9

discount rates

Answer 9

concern about the future or immediate gratification

Question 10

myopia reasons

Answer 10

uncertainty about the future incentives spending more money.

Question 11

discount rate formula

Answer 11

value today / value tmr

Question 12

individuals borrow at the point where…

Answer 12

MRS = MRT

discount rate = interest rate

Question 13

supply of credit

Answer 13

interest rates are determined by supply and demand

Question 14

principal agent problem

Answer 14

borrowing is another incomplete contract - you can’t make sure if they’re gonna pay back or put it to good use.

Question 15

how do we overcome p.a problem?

Answer 15

equity, collateral (these help create compatible incentives)

Question 16

equity

Answer 16

lender may require the borrower to put some of their wealth into the project

Question 17

collateral

Answer 17

the borrower has to set aside property that will be transferred to the lender if the loan isn’t repaid.

Question 18

credit rationing

Answer 18

poor people have a hard time signalling that they will pay it back.

• credit constrained: borrow on unfavorable terms.
• credit-excluded: refused.

Question 19

unsecured credit

Answer 19

like a credit card, without collateral or equity (happens when there’s a robust credit market)

Question 20

how do we solve the time inconsistency problem?

Answer 20

delegating a 3rd party to constrain yourself - limiting your future agency - legal system - credit rating agency

Question 21

financial intermediaries

Answer 21

1. banks
2. stock market
3. bond market

Question 22

bank

Answer 22

attracts deposits by paying interest - reducing transaction costs - you give money to bank and they deal with the risks

Question 23

stock market

Answer 23

represent ownership in firm

Question 24

bond market

Answer 24

its an IOU (i owe you) - you get a promise that you’ll get an interest on your funds in the future