Exam 1

Question 1

Representative/Fiduciary Money

Answer 1

• backed by “tangible goods”
• Receipt from gold’s smith is “as good as gold”
• prevents theft

Question 2

Fiat Money is Latin for

Answer 2

Let it Be

Question 3

Fiat Money

Answer 3

• NOT backed by tangible goods

- official (government recognizes it)

Question 4

What are 3 “MUSTs” when you have Fiat Money

Answer 4

Government has to control money supply

Eliminate/Police Counterfeiting
-secret services job

Faith and Credit

• country has to act together
• other countries accept their currecy

Question 5

What are the 3 Branches of Finance?

Answer 5

Corporate Finance
Investments
Markets/Institutions

Question 6

What are the 5 obstacles to Direct Finance?

Answer 6

Maturity

• lenders want short maturity
• borrowers want long maturity

Denomination

• borrowers want money from all 1 source
• lenders don’t want to supply all their money to 1 person (riskier)

Risk Assessment

• lenders take financial risk
• borrowers take operational risk

Information Asymmetry
-“before the fact”
adverse selection
-when sellers have information buyers do not

Moral Hazard

• “after the fact”
• 1 party could take inappropriate advantages over the other because they can

Question 7

What is Direct Finance?

Answer 7

When lenders (surplus units) and borrowers (deficit units) deal directly with one another

Question 8

What are the 3 elements of a Financial System?

Answer 8

Instruments

• securities, bonds, stocks, etc.
• financial assets used to fund “real assets”

Markets

Institutions
-intermediary between lenders and borrowers

Question 9

What is Best Efforts Underwriting?

Answer 9

When investment banks only pass capital off to clients as they successfully sell them off

*less profitable than normal

Question 10

What is the Underwriting Spread

Answer 10

Difference between what an Investment bank buys securities from the Government and sells them for to Investors

-profit of the Investment Bank

Question 11

What is the difference between Securities Brokers and Securities Dealers?

Answer 11

Securities Brokers

• are Not owners
• are “matchmakers”
• competes for customers through transaction costs

Securities Dealers
-are owners

Question 12

What is a “Run”

Answer 12

When people show up all at once to withdraw money from the bank

*happened during Great Depression

Question 13

What does FDIC stand for? When was it established?

Answer 13

Federal Depositor Insurance Corporation

Established during the Great Depression

Question 14

What does the FDIC do?

Answer 14

• identifies failing depository institutions and mergers their depositors with other depository institutions in good health
• is a deposit insurance fund for banks undergoing a “Run”
• fiscally self-sufficient

Question 15

How does an Insurance Company make money

Answer 15

Takes money(premiums) from people who buy their insurance policies and buys investments in Businesses and Governments

Question 16

What is Net Underwriting Income and how do you calculate it?

Answer 16

Insurance Company’s Net Income

(Premiums from Policy Holders - Payouts to Policy Holders) = Net Underwriting Income

Question 17

What is a mandate

Answer 17

goal/purpose of a mutual fund

Question 18

Money Markets vs Capital Markets

Answer 18

Money Markets

• short-term (1 year or less)
• safe
• liquid

Capital Markets

• longer than 1 year
• higher risk
• 3 types (stock market, bond market, mortgage market)

Question 19

Primary Markets vs Secondary Markets

Answer 19

Primary Market

• financial transaction for the first time
• first time Deficit Unit gets money “direct financial benefit”

Secondary Market
-no “direct financial benefit” to deficit unit

Question 20

Spot vs Forward vs Future

Answer 20

Spot
-price and delivery happen at the same time
Ex: buying a new garbage disposal and having it delivered next week

Forward

• agree to price in exchange for delivery later
• conditions “could” change fair value of item

Future

• longer time in between price and delivery than forward
• have to worry about fair value of item changing
• could be used for hedging or speculating

Question 21

What are 3 parts to the Federal Reserve

Answer 21

Reserve Banks (Private sector)
Board of Governors (Public sector)
Federal Open Market Committee FOMC

Question 22

What does the Board of Governors do?

Answer 22

• provides guidance to Federal Reserve Banks when they lend money to depository institutions(normal banks)
• helps the FOMC conduct monetary policy

Question 23

How many members does the Board of Governors have? How are they appointed? How long do they serve?

Answer 23

• 7 members
• appointed by President, confirmed by Senate
• 14 year long term

Question 24

What does the Federal Reserve Banks do?

Answer 24

• operating arms of Federal Reserve
• lend money to banks
• monitor banks and make sure they are following guidelines
• provide key financial services (ex: distributing the Nation’s currency)

Question 25

How are the 12 Federal Reserve Banks Structured?

Answer 25

Board of Directors

• 6 members elected from commercial banks (public)
• 3 members appointed by Board of Governors (private)

Question 26

What does the FOMC do?

Answer 26

Sets monetary policy (controls money supply and discount rates)

Question 27

How many members vote on decisions in the FOMC? Where are these members made up?

Answer 27

12 members get to vote

• all 7 members from Board of Governors
• 5 Presidents from Reserve Banks (President of Federal Reserve Bank in New York always votes)