Money and Banking Flashcards

Question

Relation between managed money and fiat money

Answer 1

Managed Money and Fiat Money are alike in that they are representative or paper money, having relatively little or no intrinsic value apart from the law or practice of the state.” (Keynes 1930, p.8)

Answer 2

* 1717 Isaac Newton (Master of the English mint) unintentionally overvalued gold, pushing silver out of circulation and putting England on a gold standard (formalized in 1816) * XIX century the age of metallic standards: gold, silver, bi-metallic * 1880-1914 Heyday of the international gold standard * 1914-1944 attempts to reestablish the Gold Standard, Gold Exchange standard, suspension of convertibility and monetary disorder * 1944 – 1971 The Bretton woods regime * 1971 End of dollar convertibility into gold

Answer 3

Co-exists with state money Belonged to the state Banks that create money - one special bank but private banks also produce. The Bank of England (oldest central bank in the world) used to be private and used to pay dividends to its shareholders and it was publicized by the labour party in the year 1946.

Answer 4

Base money = Currency + Bank reserves (state money).

Answer 5

* Bank Deposits = Current Accounts + TS Deposits * Current account deposits a.k.a. Sight deposits, Demand deposits * Held by the public and companies to settle all types of payments * Time / saving deposits (Less liquid that CAD) * Held as a saving instrument

Answer 6

* Money Supply = Currency + Bank Deposits | * Part of the money supply comes directly from the State (via the central bank), part comes from the banking system

Answer 7

Empirical counterparts of Money supply | Quantitative definition of Money

Answer 8

Includes currency, i.e. banknotes and coins, as well as balances which can immediately be converted into currency or used for cashless payments, i.e. overnight deposits.

Answer 9

comprises narrow money (M1) and, in addition, deposits with a maturity of up to two years and deposits redeemable at a period of notice of up to three months. Depending on their degree of moneyness, such deposits can be converted into components of narrow money, but in some cases there may be restrictions involved, such as the need for advance notification, delays, penalties or fees. The definition of M2 reflects the particular interest in analysing and monitoring a monetary aggregate that, in addition to currency, consists of deposits which are liquid.

Answer 10

Comprises M2 and marketable instruments issued by the MFI sector (e.g Money Market Fund shares/units). As a result of their inclusion, M3 is less affected by substitution between various liquid asset categories than narrower definitions of money, and is therefore more stable.

Answer 11

The ECB calculates the growth rates of monetary aggregates and of the components and the counterparts to monetary aggregates on the basis of adjusted flows rather than the simple comparison of end-of-period levels.

Answer 12

refer to the last day of the period (month or quarter), which can either be the last working day or the last calendar day, depending on national practice.

Answer 13

The growth rate over the n months ending in month t is calculated by dividing the index for month t by the index for month t-n.

Answer 14

Base money = Currency + Bank reserves

Answer 15

Currency = Coins + Banknotes

Answer 16

Bank Reserves = Req. Res. + Vol. Reserves

Answer 17

CBDC is potentially a new form of digital central bank money that can be distinguished from reserves or settlement balances held by commercial banks at central banks.

Answer 18

* Physically handling cash is costly; * Cash supports shady activities and reduces tax revenues (large denomination banknotes in particular); * Holding cash is risky (especially if you are hoarding it); * Cash (both banknotes and coins) is easily forged; * The cost of producing low value coins sometimes exceed their face value.

Answer 19

* Conservatism * Demographics (old people, people who live at the margins); * Seignorage (central banks make money by issuing money); * Privacy (Cash is anonymous); * Security (Cash works even if electricity is not there).

Answer 20

It is the most popular method to estimate the shadow economy among the so-called indirect macroeconomic approaches. Measures the size of the shadow economy in two stages: •1) the econometric estimation of an aggregate money demand equation, with a specific component related to cash transactions in the underground sector; •2) the computation of the value of these shadow transactions via the quantity theory of money. Quantity Theory of money MV = PY.

Answer 21

Agg. Cash = a0 +a1*(Wcash/GDP) + a2*(i dep) + a3*(GDP/POP) + a4*(TAX) Where a1 > 0, a2<0, a3>0, a4>0

Answer 22

CASHshadow = a0 + a4(*TAX)

Answer 23

In an unscheduled televised address on 8 November 2016 Prime Minister Narendra Modi gave the nation just four hours notice that 500 ($7.30; £6) and 1,000 rupee notes would no longer be legal tender. This was to crack down on corruption and illegal cash holdings aka "black money". Some 300 million Indians don't have gov issued IDs and most use cash as their man form of transaction. Indian banks had received three trillion rupees ($44.4bn) in cash in the first four days after the ban.

Answer 24

Credit enables consumers to reconcile their desired intertemporal spending path with their income path (intertemporal choice): •Borrowing makes it possible to consume in excess of present income. •Saving makes it possible to consume in excess of future income. •Nexus between finance and growth can be studied from a cyclical and/or structural perspective.

Answer 25

Credit enables companies to bridge the temporal gap between costs and revenues and to accumulate capital.

Answer 26

Credit availability influences aggregate demand, GDP and employment, often in a procyclical way.

Answer 27

•Credit impacts on aggregate supply through its influence on investment, infrastructure and innovation.

Answer 28

* Most credit operations entail the transfer of sums of money over time. * Debts are denominated in terms of money (unit of account). * Debts are paid using money (legal tender). * Money is «created» via credit operations. * Banks create bank money (deposits) by making loans to firms and households * The central bank creates money (base money) by making loans to banks

Answer 29

* Time 0 (the beginning): negotiation, contract drafting. * Time 1 (maturity or the end = fin = finance) the credit matures and paid (recall connection between credit and the means of payment function of money).

Answer 30

* Lender (creditor) = L; Borrower (Debtor) = B * Lender owns something valuable (money, financial assets, goods) that he is willing to part with between Time 0 and Time 1. * Borrower needs what L owns and is willing to pay a premium (interest + guarantees) in order to have it. * Once L and B have reached an agreement, B receives the valuables from L and signs a debt contract whereby he assumes the obligation to pay back her/his debt in accordance with mutually agreed terms.

Answer 31

The relationship between L and B as a power relation. •Asymmetric and complex power relations •Urgency, alternative sources of credit, market power exerted by L and B.

Answer 32

Elements of the contract: •Identification of lender and borrower •Description of what is being transferred •Loan duration (maturity) •Payback conditions •Periodic payments – normal case in case of long-term loans; no intermediate payment = zero coupon bond. •Interest may be forbidden as is the Middle Ages or in the case of Islamic finance) •Additional clauses (e.g. marketability, guarantees).

Answer 33

The debt contract can be marketable (e.g. government and corporate bonds) i.e. liquid or non-marketable (e.g. bank loan, consumer credit) i.e. illiquid. •Primary and secondary debt markets (financial markets) •Primary markets connect ultimate lenders and borrowers. •Secondary markets enhance liquidity. •Non-marketable debt contracts can be turned into marketable securities through securitization.

Answer 34

Marketability (Liquidity) mitigates the importance of the personal element and the need for guarantees from B to L. •Marketability (Liquidity) requires standardization, low carrying costs, wide acceptance … •Marketability (Liquidity) as an antidote to credit risk (see below). If L looses confidence in B, he can always sell the contract to some one else (possibly at a discount) as long as the debt contract is liquid enough (if at all).

Answer 35

Interest is the extra that the borrower agrees to pay to lender in return for the possibility of using lender's resources. Interest can be zero; it can also be negative!

Answer 36

* As the loan reaches maturity, B pays back his debt (principal and interest) to L or to someone else if in the meantime L sold the contract to L’ * Payback requires a unit of account to quantify the debt and a means of payment to be discharged of the obligation (Recall Keynes’s Treatise on Money).

Answer 37

* Renegotiation (extended maturity, interest reduction) * Debt forgiveness / redemption * Debt insolvency (Default partial or total)

Answer 38

•Credit risk = Lender’s risk + borrower’s risk

Answer 39

Because of information asymmetries (market failure), credit markets cannot function as anonymous price-taking markets in the neoclassical sense.

Answer 40

* Screening (ex ante) / monitoring (ex post) * Guarantees * Shorten maturity * Reduce exposure * Long-term customer relation * Credit rationing

Answer 41

Default occurs when repayment is not made on time.

Answer 42

Default may be due to feasibility constraints, if the debtor has insufficient resources to meet the terms of the contract (even if enforcement is perfect), or incentive constraints, if the creditor cannot adequately enforce the contract (limited liability plus costly state verification).

Answer 43

* Risk consolidation or transformation (law of large numbers) * Delegated monitoring and provision of liquidity services.

Answer 44

* L lends X to B at time 0 * B pays back X* to L at time 1, one year later * X* / X = (1+i) = gross interest rate in nominal terms * ( i ) = Net interest rate in nominal terms * Ex. X = 100€, X* = 105€, (1+i) = 105/100 = 1,05 * i = 0,05 = 5% This measures the Time Value of Money i.e. the value of money today (T0) measured in terms of money tomorrow (T1).

Answer 45

* Similarly, the discount rate in nominal terms 1/(1+i) indicates the of money «tomorrow» in terms of money «today». * In the example above, the discount rate is 1/(1+i) = 1/(1,05)=0,95. This means that one euro available in one year’s time is equivalent to 95 euro cents today.

Answer 46

If the rate of interest in nominal terms falls, the discount rate rises and the value of money available «tomorrow» increases relative to the value of money available «today».

Answer 47

If the rate of interest in nominal terms rises, the discount rate falls and the value of money «tomorrow» decreases relative to the value of money «today».

Answer 48

•Let us adopt L’s point of view … • •i = rEXP + πEXP + Risk + Liq •rEXP = Expected return on the loan at constant prices net of all risks (pure remuneration for waiting) •πEXP = Expected inflation risk premium as inflation erodes the purchasing power of money over time •Risk = Credit risk premium depends on the borrower’s identity, on the presence of collateral and guarantees, on time to maturity, on cyclical conditions. •Liq = Liquidity premium depends on the marketability of the debt contract, on the size of the market, on the distance between 0 and 1. Liquidity premium increases as liquidity of the credit contract declines.

Answer 49

* Default risk, liquidity premiums and different tax treatment are the main determinants of domestic rate interest rate differentials. * Changes in credit risk affect demand and supply of underlying assets (credit contracts) in opposite directions and interact with liquidity risk.

Answer 50

* P1 > P0 → inflation, (1/P) decreases over time * P1 < P0 → deflation, (1/P) increases over time * P1 = P0 → stability, (1/P) remains constant over time

Answer 51

(1+r)=(1+i)/(1+π) •Ex. i = 0,05 (5%), π = 0,02 (2%), (1+r) = 1,05/1,02 = 1,0294

Answer 52

r = i – π /(1+π)

Answer 53

•Higher than expected inflation is bad for creditors and good for debtors (including the State)

Answer 54

•Lower than expected inflation is good for creditors and bad for debtors (including the State).

Answer 55

* Coupon bonds (government bonds, corporate bonds): * Bond with maturity N (ex. N = 10 years), Face Value (ex. FV = 1.000€) and fixed coupon rate (ic = 5% annual) * B issues the bond at par and L underwrites it * At time 0, L pays 1.000 € to B * At time 1, B pays 50€ to L (Coupon = FV*ic) * At time 2, B pays 50€ to L (Coupon = FV*ic) * … * At time N, B pays 1050€ to L (FV + FV*ic)

Answer 56

* Bonds may be issued at par, below par, above par * If bond is issued below par, L pays less than FV and receives and extra return * If bond is issued above par, L pays more than FV and receives.

Answer 57

* PBOND = C / i (check !) * PBOND = C1 / (1+i) + C2 / (1+i)2 + … (Cn + FV) / (1+i)n * Both the instantaneous return and the yield to maturity vary inversely with PBOND (for a given cash flow).

Answer 58

* L lends IV (issuance value) to B at time 0 (IV < FV) * B pays back FV (face value) at time 1 * FV / IV = (1+i) zero coupon nominal rate.

Answer 59

•Instantaneous return of the bond I (inst) = C / PBOND

Answer 60

•Yield to maturity is the nominal interest rate that equates the present value of the future payments that bondholders are entitled to receive to the market price of the PBOND

Answer 61

If an investor buys the bond at time t on the secondary market (paying PBOND,t) and sells it at time t + 1 (receiveing PBOND,t+1) and receives 1 coupon the Effective return on her investment will be * R = (C/PBOND,t) + (PBOND,t+1 – PBOND, t )/ (PBOND,t) * where (PBOND,t+1 – PBOND, t )/ (PBOND,t) = g * g > 0 (capital gain) * g < 0 (capital loss) •Capital loss can be so large as to lead to R < 0 (Negative return).

Answer 62

* Typically, a rise in interest rate is associated with a fall in bond prices, resulting in capital losses on bonds whose terms to maturity are longer than the holding period. * The more distant a bond’s maturity, the greater the size of the percentage price change associated with a given interest rate change.

Answer 63

•Duration is a way of measuring the sensitivity of bond prices to changes in interest rates (Market risk) * PBOND = C1 / (1+i) + C2 / (1+i)2 + … (Cn + FV) / (1+i)n * Calculate (dPBOND/ di)(1+i/ PBOND) * Elasticity of PBOND to changes in I = Duration

Answer 64

* Treasury bill (maturity 3 months) * Treasury note (maturity 5 years) * Treasury bond (maturity 10 years) * Each security has its advantages and disadvantages both for the government and for investors. Each of them has its own FV, IV and annualised «coupon rate» * ibill = Short-term interest rate * inote = Medium-term interest rate * ibond = Long-term interest rate

Answer 65

•Term structure considers the three interest rates together and the relationship between them [ibill, inote , ibond]

Answer 66

* The yield curve: A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. * The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. * The curve is also used to predict changes in economic output and growth and in the monetary policy stance.

Answer 67

Long-term interest rates reflect market expectations about short-term interest rates in the future.

Answer 68

Risk-neutral agents will choose either bills or bonds, perfect capital markets, rational expectations, perfect substitutability between long-term security (bonds) and short-term securities (bills).

Answer 69

This theory sees markets for different-maturity bonds as completely seperate and segemented. - Bonds of different maturities are not subsitutes at all which is opposite of pure expectation theory. - Can explain why yield curves usually tend to slope upward. - Cannot explain why interest rates on bonds of different maturities tend to move together. - Cannot explain why yield curves tend to slope upwards when short-term interest rates are low.

Answer 70

•Negative interest rates in real terms occur when inflation exceeds the rate of interest in real terms r = i – π so if i < π then r < 0. •Negative interest rates in real terms often occurr in connection with financial repression (e.g. Italy in the 1970s).

Answer 71

When the government imposes specific portfolio restrictions and regulations on investors and banks.

Answer 72

* Caps or ceilings ceilings on interest rates, Government ownership or control of domestic banks and financial institutions * Creation or maintenance of a captive domestic market for government debt * Restrictions on entry to the financial industry * Directing credit to certain industries.

Answer 73

It may be preferable to lend money to another bank or a government rather than pay to keep it at the central bank. In addition some types of investment funds essentially have to buy government debt, so there is a certain amount of what has been called passive investment going on, despite the poor returns.

Money and Banking Flashcards

(97 cards)