Term
| What are the 3 Functions of Money? |
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Definition
- Medium of Exchange
- Unit of Account
- Store of Value |
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Term
| What are the "Aspects of money"? |
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Definition
- Level: Amount available, money supply
- Variability: Changes in the level
- Denominations, Divisibility
- Practicality |
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Term
| What Aspect of Money does this represent: Using diamonds or water as money may or may not work depending on environment (water in the desert vs. next to the Colorado river) |
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Definition
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Term
| What Aspect of Money does this represent: Would you choose a seasonal item like apples? |
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Definition
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Term
| What Aspect of Money does this represent: What if you only had $100 bills? It wouldn’t work! It would need to be divided up for cheaper items |
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Definition
| Denominations, Divisibility |
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Term
| What Aspect of Money does this represent: Includes other factors that would exclude something from being used as a means of exchange |
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Definition
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Term
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Definition
| Fiat money relates to types of currency or money whose usefulness results, not from any intrinsic value or guarantee that it can be converted into gold or another currency, but instead from a government's order (fiat) that it must be accepted as a means of payment |
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Term
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Definition
Commodity money is money whose value comes from a commodity out of which it is made.
Examples of commodities that have been used as mediums of exchange include gold, silver, copper, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley etc. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or price system economies. |
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Term
| Rossel Island, Yap stones, & limited purpose money are examples of what? |
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Definition
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Term
| What are some examples of M1? |
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Definition
| M1: Currecny, checking accounts, deposits, traveler’s checks |
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Term
| What are some examples of M2? |
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Definition
| M1 and other assets that are extremely liquid, Small-denomination time deposits (<100,000), savings deposits, money market deposits and money market mutual funds |
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Term
| What are some of the problems with coins? |
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Definition
- Small coin shortage in a large economy
- Tokens lose their relation to production value, so seigniorage is no longer naturally deterred.
- Fluctuations in relative values of metals makes it difficult to promote the production of all coins |
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Term
| What were the main levels of the evolution of money? |
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Definition
1 Commodity barter
2 Commodity money
3 Metal Money
4 Govt. regulated coinage
5 Token coins
6 Commodity (gold) backed currency
7 Fiat currency |
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Term
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Definition
| Interest Rates are the cost of borrowing or price paid for the rental of funds, usually expressed as a percentage of the rental of $100 a year |
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Term
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Definition
| Yield to Maturity: the interest rate that equates the present value of cash payments received from a debt instruments with its value today |
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Term
| What is the Present Value theory? |
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Definition
| The present payment for which you are indifferent between receiving today’s payment and tomorrow’s payment. Present value is a description of inter-temporal preferences |
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Term
| What is the formula for PV? |
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Definition
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Term
| What are the different loan structures? |
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Definition
- Simple Loan
- Fixed Payment Loan (car loan)
- Coupon Bond
- Discount Bond |
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Term
| What is the formula for a Simple Loan Repaid at maturity date |
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Definition
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Term
| This is an example of what type of bond: A payment every period with a final payment of the face value of the bond |
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Definition
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Term
| What are the aspects of a Discount Bond? |
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Definition
- Bought below face value with face value paid at the date maturity
- Mathematically this is equivalent to simple loans
- US Treasury bills, US Savings Bonds, long-term zero coupon bonds |
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Term
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Definition
| A perpetual bond with no maturity date |
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Term
| What is the formula for a consul? |
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Definition
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Term
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Definition
| Coupon payment divided by price of the security is an approximation for interest rate |
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Term
| What does the rate of return stand for? |
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Definition
| Rate of Return: Payments to owner plus the change in its value, expressed as a fraction of its purchase prices |
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Term
| What are some of the Interest Rate Risks? |
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Definition
- Holding a long maturity bond is a bet that the interest rate in the future will be lower or equal to today
- The longer the period of time, the more risky this proposition is
- Shorter maturity times implies less interest rate risk |
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Term
| Name the four sources of the demands for bonds |
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Definition
- Wealth
- Expected Return (what I expect to get on an investment)
- Risk (Variability, defaulting)
- Liquidity (How easy is it for me to get in and out of an asset) |
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Term
| Regarding Expected Returns - what is the "Own return effect" |
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Definition
| It is the increases in expected return increases demand |
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Term
| Regarding the Expected Returns, what is the 'Substitute return effect' |
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Definition
| Decreases in expected returns for a substitute increases demand |
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Term
| What is the effect of an increase in risk? |
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Definition
| An increases in risk will decrease demand even if expected returns are constant |
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Term
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Definition
| Transaction costs of converting an asset to cash (Economic costs such as time are important). An increase in liquidity will increase demand |
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Term
| These are examples of what? 1. Removing ATM fees will increase the demand for debit card service 2. Increasing bank hours will increase demand for deposits at that bank |
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Definition
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Term
| How do bonds react to interest rates? |
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Definition
- Bond prices move in the opposite direction of interest rates
- As interest rates increase, bond prices decreases and demand for bond increases
- Downward sloping demand curve |
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Term
| What causes bond supply shifts? |
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Definition
- Expected Profitability, technology
- Expected Inflation
- Government Budget |
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Term
| What is the risk premium? |
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Definition
| Risk Premium: Spread between the interest rates on bonds with default risk and default-free bonds, both of the same maturity |
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Term
| This is an example of what? Investment firms which rate the probability of default |
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Definition
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Term
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Definition
| Bonds with ratings below Baa that have a high default risk, speculative-grade bonds |
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Term
| What are some of the effects of liquidity? |
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Definition
- Bonds which are liquid are more desirable.
- Large markets mean more liquidity.
- Treasury Bonds have the largest market and most liquidity. |
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Term
| How does liquidity in the market affect Municipal bonds? |
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Definition
| Municipal bonds: Low liquidity and significant default probability, but large tax benefits. |
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Term
| What are some of the problem causing factors of the Sub-prime Mortgage Crisis? |
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Definition
- Mortgaged backed securities (MBS)
- Collateralized Debt Obligations(CDOs)
- Tranche structure
- Bonds are tiered
- Paid back from least risky to most risky
- Problems with rating.
- Complexity
- Conflict of Interest |
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Term
| What is a term structure? |
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Definition
| Term structure: The relationship among interest rates on bonds with different terms to maturity. |
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Term
| This is an example of what? A plot of the yields on bonds with differing terms to maturity but the same risk, liquidity and tax considerations. |
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Definition
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Term
| What happens to Yield Curves in a recession? |
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Definition
| Yield curves will invert during a recession |
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Term
| What is the Expectations Theory? |
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Definition
| The interest rate on a long-term bond will equal an average of short-term interest rates expected over the life of the bond |
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Term
| What are the fundamentals of the Segmented Market Theory? |
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Definition
- The term structure sees markets for different-maturity as completely segmented.
- No effects from expected returns on other bonds.
- Distribution is fixed by supply and demand of individual markets. |
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Term
| What is the Liquidity Premium Theory? |
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Definition
| Term structure states that the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long term bond plus a liquidity premium that corresponds to supply and demand conditions for that bond. |
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Term
| What is the Preferred Habitat Theory? |
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Definition
Investors have a preference for bonds of one maturity over another (preferred habit). Because they prefer bonds of one maturity over another, they will be willing to buy bonds that do not have the preferred maturity only if they earn a somewhat higher expected return.
Alternative formulation of Liquidity Premium model. |
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Term
| What are the details of the Fannie Mae creation? |
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Definition
- Established in 1938 during the New Deal
- Created to provide home lending after financial markets collapsed.
- Privatized in 1968 |
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Term
| When and why was Freddie Mac created? |
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Definition
Freddie Mac (Federal Home Mortgage Corporation)
- Established in 1970
- Created to provide competition to Fannie Mae |
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Term
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Definition
- F&F buy mortgages from primary lenders.
- They repackage bundles of these mortgages and resell them as Mortgage Backed Securities (MBS).(Profits come from multiple sources:
Purchasing mortgages at a discount,Fees related to issuing MBSs) |
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Term
| What is the “implicit guarantee” of F&F? |
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Definition
| An informal understanding between investors and the government that F&F bonds will not be allowed to default. |
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Term
| What were the implications of the “implicit guarantee” for F&F? |
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Definition
- Very low risk premium
- Allows F&F to offer low mortgages. (Higher profits, Creates a duopoly)
- Allows for bond investors and credit rating agencies to ignore firm fundamentals(Allowed for very low capital holdings) |
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Term
| What are the Financial Firm Objectives? |
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Definition
- Liquidity Management
- Asset management
- Liability management
- Capital adequacy management |
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Term
| Financial institutions must have enough liquidity to: |
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Definition
- Repay liabilities (MBS)
- Purchase further assets
- Insure against risk |
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Term
| What do firms seek out with Asset Management? |
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Definition
- Financial Firm seek high return low risk assets.
- Financial Firm seek out low risk customers to sell loans.
- Purchase securities with higher returns.
- Diversify assets to manage risk.
- Maintain sufficiently liquidity. |
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Term
| What are the main aspects of Capital Management? |
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Definition
- Capital protects against failure.
- Provides returns to owners.
- Capital is required by law to operate a bank.
- Owners are concerned with return on equity
- The bank manages returns on assets. |
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Term
| What firm problems led to the current government intervention with F&F? |
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Definition
- Insufficient capital
- Risk taking in asset management
- Overexposure to other housing debt.
- Purchase of higher risk mortgages |
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Term
| What market problems lead to the current government intervention of F&F? |
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Definition
- Asset devaluation (Loss of value of homes)
- Increase of default on homes (Tight financial market, Borrowing became more expensive) |
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Term
| How did the “implicit backing” of F&F become explicit? |
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Definition
- In July, Congress provided the treasury with the ability to lend to F&F.
- The US Treasury now had the ability to buy shares in Fannie Mae and Freddie Mac |
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Term
| What did the Treasury do to bail out F&F? |
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Definition
1. Conservatorship: Significant government oversight of Fannie Mae and Freddie Mac.
2. Access to Treasury lending.
3. The Treasury will buy senior shares which have priority over existing shares.
4. The treasury will be the buyer of last resort for F&F MBSs. |
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