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Money Banking and Financial Markets 4th edition Stephen Cecchetti, Kermit Schoenholtz - Solutions
How has the use of credit evolved in key sectors of the economy? Plot as ratios to total credit market debt outstanding (FRED code: TCMDO) the debt of: (a) households (FRED code: HSTCMDODNS); (b) nonfinancial corporate businesses (FRED code: NCBTCMDODNS); and (c) the domestic financial sector (FRED
Financial crisis is often associated with rising, and then persistently high, unemployment rates. Plot the U.S. unemployment rate during the Great Depression until the end of the 1930s (FRED code: M0892AUSM156SNBR). Compare the U.S. experience then with unemployment rates in Spain (FRED code:
The rise of securities markets and the expansion of intermediation by nonbanks has come partly at the expense of commercial banks. Plot the ratio of bank credit (FRED code: TOTLL) to total credit market debt outstanding (FRED code: TCMDO) and comment on the trend.
Deflation raises the real burden of repaying fixed-rate debt. Japan has recently experienced a long deflation.a. Plot the percent change from a year ago of consumer prices in Japan (FRED code: JPNCPIALLQINMEI) and discuss the long-term patterns of inflation and deflation. (Turn off the recession
Explain how a bank manager uses Core Principles 1, 2 and 3 (Time Has Value, Risk Requires Compensation, and Information Is the Basis for Decisions) to select assets and issue liabilities consistent with shareholder preferences.
Based on the information provided below about banks A and B, compute for each bank its return on assets (ROA), return on equity (ROE) and leverage ratio.a. Bank A has net profit after taxes of $1.8 million and the balance sheet below:b. Bank B has net profit after taxes of $0.9 million and the
Explain why banks’ holdings of cash have increased significantly as a portion of their balance sheets in recent times.
The volume of commercial and industrial loans made by banks has declined over the past few decades, while the volume of real estate loans has risen. Explain why this trend occurred and how it contributed to banks’ difficulties during the financial crisis of 2007-2009.
Why do you think that U.S. banks are prohibited from holding equity as part of their own portfolios?
Explain how a bank uses liability management to respond to a deposit outflow. Why do banks prefer liability management to asset management?
A bank with a two-year horizon has issued a one-year certificate of deposit for $50 million at an interest rate of 2 percent. With the proceeds, the bank has purchased a two-year Treasury note that pays 4 percent interest. What risk does the bank face in entering into these transactions? What
Consider the balance sheets of Bank A and Bank B. If reserve requirements were 10 percent of transaction deposits and both banks had equal access to the interbank market and funds from the Federal Reserve, which bank do you think faces the greatest liquidity risk? Explain youranswer.
Looking again at Bank A and Bank B in Problem, based on the information available, which bank do you think is at the greatest risk of insolvency? What other information might you use to assess the risk of insolvency of these banks?
Bank Y and Bank Z both have assets of $1 billion. The return on assets for both banks is the same. Bank Y has liabilities of $800 million while Bank Z’s liabilities are $900 million. In which bank would you prefer to hold an equity stake? Explain your choice.
You are a bank manager and have been approached by a swap dealer about participating in fixed for floating interest-rate swaps. If your bank has the typical maturity structure, which side of the swap might you be interested in paying and which side would you want to receive?
If lines of credit and other off-balance sheet activities do not, by definition, appear on the bank’s balance sheet, how can they influence the level of liquidity risk to which the bank is exposed?
Duration analysis is an alternative to gap analysis for measuring interest-rate risk. The duration of an asset or liability measures how sensitive its market value is to a change in the interest rate: the more sensitive, the longer the duration. In Chapter 6, you saw that the longer the term of a
Suppose you are advising a bank on the management of its balance sheet. In light of the financial crisis of 2007-2009, what arguments might you make to convince the bank to hold additional capital?
Consider a bank with the following balance sheet. You read in the local newspaper that the bank’s return on assets (ROA) was 1 percent. What were the bank’s after-taxprofits?
Banks hold more liquid assets than do most businesses. Explain why.
Why are checking accounts not an important source of funds for commercial banks in the United States?
Suppose a bank faces a gap of -20 between its interest-sensitive assets and its interest-sensitive liabilities. What would happen to bank profits if interest rates were to fall by 1 percentage point? You should report your answer in terms of the change in profit per $100 in assets.
Are U.S. banks increasing in size? Use FRED to plot since 1984 on a quarterly basis the number of U.S. commercial banks (FRED code: USNUM) and the volume of their deposits (FRED code: DPSACBM027SBOG). Download the data and compute the average deposit size of banks in the first quarters of 1984 and
Commercial banks have become increasingly involved in real estate market. Plot the percent change from a year ago of real estate loans made by commercial banks (FRED code: REALLN) and discuss the relationship between the booms and busts in real estate lending and the expansions and recessions of
Plot since 1990 the return on equity of small banks (banks with assets of less than $1 billion; FRED code: US1ROE) and large banks (banks with assets of greater than $15 billion; FRED code: USG15ROE).How do you explain the long-run pattern?
Banks sometimes manage liquidity risk by issuing large, marketable certificates of deposits when other deposits decline. How important is this practice? Plot the share of large time deposits (FRED code: LTDACBM027SBOG) in total deposits (FRED code: DPSACBM027SBOG). Explain how this share evolved
What share of U.S. banks fail? Plot since 2000 the fraction (in percent) of bank failures (FRED code: BKFTTLA641N) relative to the number of banks (FRED code: USNUM). Comment on the timing and the proportion of failures. Were most of the failing banks large or small?
For many years you have been using your local, small-town bank. One day you hear that the bank is about to be purchased by Bank of America. From your vantage point as a retail bank customer, what are the costs and benefits of such a merger?
Why have technological advances hindered the enforcement of legal restrictions on bank branching?
Banks have been losing their advantage over other financial intermediaries in attracting customers’ funds. Why?
An industry with a large number of small firms is usually thought to be highly competitive. Is that supposition true of the banking industry? What are the costs and benefits to consumers of the current structure of the U.S. banking industry?
What was the main rationale behind the separation of commercial and investment banking activities in the Glass-Steagall Act of 1933? Why was the Act repealed?
Explain what the phrase “too-big-to-fail” means in reference to financial institutions. How did the policy responses to the financial crisis of 2007-2009 affect the “too-big-to-fail” problem?
Discuss the problems life insurance companies will face as genetic information becomes more widely available.
When the values of stocks and bonds fluctuate, they have an impact on the balance sheets of insurance companies. Why is that impact more likely to be a problem for life insurance companies than for property and casualty companies?
Compare and contrast the structures of bank holding companies, financial holding companies and universal banks.
Why did government-sponsored enterprises (GSEs) such as Freddie Mac and Fannie Mae have substantially higher leverage ratios than the average U.S. bank in the years preceding the financial crisis of 2007-2009? Explain how this made the enterprises more vulnerable to the house-price declines that
Consider two countries with the following characteristics. Country A has no restrictions on bank branching and banks in Country A are permitted to offer investment and insurance products along with traditional banking services. In Country B, there are strict limits on branch banking and on the
Statistically, teenage drivers are more likely to have an automobile accident than adult drivers. As a result, insurance companies charge higher insurance premiums for teenager drivers. Suppose one insurance company decided to charge teenagers and adults the same premium based on the average risk
Suppose you have a defined-contribution pension plan. As you go through your working life, in what order would you choose to have the following portfolio allocations: (a) 100 percent bonds and money-market instruments, (b) 100 percent stocks, (c) 50 percent bonds and 50 percent stocks?
As an employee, would you prefer to participate in a defined-benefit pension plan or a defined-contribution pension plan? Explain your answer.
In the aftermath of the financial crisis of 2007-2009, there have been calls to re-instate the separation of commercial and investment banking activities that were removed with the repeal of the Glass-Steagall Act. Do you think this is a good way to reduce systemic risk?
Suppose a well-known financial holding company agreed to be the underwriter for a new stock issue. After guaranteeing the price to the issuing company but before selling the stocks, a scandal surrounding the business practices of the holding company is revealed. How would you expect this scandal
How did the financial crisis of 2007-2009 affect the degree of concentration in the U.S. banking industry?
What are the benefits of collaboration between a large appliance retailer and a finance company?
You examine the balance sheet of an insurance company and note that its assets are made up mainly of U.S. Treasury bills and commercial paper. Is this more likely to be the balance sheet of a property and casualty insurance company or a life insurance company? Explain your answer.
One aspect of the 2007-2009 financial panic was a run on some money market mutual funds (MMMFs). Plot weekly data for 2008 on institutional MMMF deposits (FRED code: WIMFSL) and identify the timing of the run visually. Next, download the data, and report the size of the deposit outflow in the week
When did the financial crisis of 2007-2009 peak and why? Plot weekly data for 2006–2010 for the one-week LIBOR rate (FRED code: USD1WKD156N) and the effective federal funds rate (FRED code: FF). Explain the pattern.
How did competition from money market mutual funds affect traditional savings institutions that provided mortgages at fixed interest rates? Beginning in 1981, plot the ratio of retail money market mutual funds (FRED code: WRMFSL) to the sum of savings and time deposits at savings institutions
How have the market shares of banks and traditional savings institutions evolved over time? Plot the fraction (in percent) of credit market assets held by the entire domestic financial sector (TCMAHDFS) that is held by banks (FRED code: CBUSCCBTCMAHDFS). Plot a similar market share for the assets
Current technology allows large bank depositors to withdraw their funds electronically at a moment’s notice. They can do so all at the same time, without anyone’s knowledge, in what is called a silent run. When might a silent run happen, and why?
Explain why financial institutions such as pension funds and insurance companies are not as vulnerable to runs as money market mutual funds and securities dealers.
Explain the link between falling house prices and bank failures during the financial crisis of 2007-2009.
Discuss the regulations that are designed to reduce the moral hazard created by deposit insurance.
Explain how macro-prudential regulations work to limit systemic risk in the financial system.
Do you think that the central bank, as lender of last resort, should also supervise the financial industry? Why or why not?
Suppose you have two deposits totaling $280,000 with a bank that has just been declared insolvent. Would you prefer that the FDIC resolve the insolvency under the “payoff method” or the “purchase and assumption” method? Explain your choice.
One goal of the Dodd-Frank Wall Street reform is to end the “too big to fail” problem. How does it propose to do so? Why might it fail?
A government can overcome the challenge of time consistency only if it is both able and willing to make credible commitments. With this in mind, how might the U.S. laws and procedures for bankruptcy affect the “too big to fail” problem?
If banks’ fragility arises from the fact that they provide liquidity to depositors, as a bank manager, how might you reduce the fragility of your institution?
Why do you think bank managers are not always willing to pursue strategies to reduce the fragility of their institutions?
Regulators have traditionally required banks to maintain capital-asset ratios of a certain level to ensure adequate net worth based on the size and composition of the bank’s asset on its balance sheet. Why might such capital adequacy requirements not be effective?
You are a bank examiner and have concerns that the bank you are examining may have a solvency problem. On examining the bank’s assets, you notice that the loan sizes of a significant portion of a bank’s loans are increasing in relatively small increments each month. What do you think might be
Explain how a bank run can turn into a bank panic.
During the financial crisis of 2007-2009, the Federal Reserve used its emergency authority to lend to nonbank intermediaries. Explain how this extension of the lender of last resort function added to moral hazard.
Why is the banking system much more heavily regulated than other areas of the economy?
Explain why, in seeking to avoid financial crises, the government’s role as regulator of the financial system does not imply it should protect individual institutions from failure.
How might the existence of the government safety net lead to increased concentration in the banking industry?
You are the lender of last resort and an institution approaches you for a loan. You assess that the institution has $800 million in assets, mostly in long-term loans, and $600 million in liabilities. The institution is experiencing unusually high withdrawal rates on its demand deposits and is
When banks failed in the 1929-1933 period, the lack of deposit insurance meant that depositors experienced sizable losses. How big were these losses? For September 1929 through February 1933, plot the deposits in suspended banks (FRED code: M09039USM144NNBR). Download the data and sum the deposits
How frequently are the payoff and the purchase-and-assumption methods used by the FDIC? Using FRED, plot the total number of institutions receiving such assistance (FRED codes: BKTTPIA641N for purchase and assumption; and BKTTPOA641N for the payoff method). On the same graph, plot as a second line
Examine the capital ratios of large banks (FRED code: EQTA5) and small banks (FRED code: EQTA1). What can you say about the risk-taking propensity of these banks over the long run? How did the financial crisis of 2007-2009 influence the risk-taking of large banks?
How important was the lender-of-last-resort function of the Federal Reserve in the financial crisis of 2007-2009? Beginning in 2000, plot the ratio of (in percent) of borrowing from the Fed (FRED code: DISCBORR) to its asset holdings (FRED code: WRESCRT). What happened to the borrowing ratio
Shadow banks typically fund their assets by issuing liabilities of shorter maturity that are close substitutes for bank deposits. The maturity mismatch between their assets and liabilities creates rollover risk that can trigger fire sales and systemic disruption. Plot the outstanding level of one
Explain the costs of each of the following conditions, and explain who bears them. (LO1)a. Interest-rate instabilityb. Exchange-rate instabilityc. Inflationd. Unstable growth
A country in the European Monetary Union that runs very large public deficits or shows a persistently high and rising debt-to-GDP ratio violates a fiscal compact among the member countries of the union. Explain how this fiscal violation poses a challenge for the ECB in the form of moral hazard.
Transparency is a key element of the monetary policy framework.a. Explain how transparency helps eliminate the problems that are created by central bank independence.b. In what way did the financial crisis of 2007-2009 emphasize the importance of central bank transparency?c. Since 1993, the Bank of
While central bank transparency is widely accepted as a desirable, too much openness may have disadvantages. Discuss what some of these drawbacks might be.
Suppose the president of a newly independent country asks you for advice in designing the country’s new central bank. For each of the following design features, choose which one you would recommend and briefly explain your choice: a. Central bank policy decisions that are irreversible or central
A central bank should remain vague about the relative importance it places on its various objectives. That way, it has the freedom to choose which objective to follow at any point in time.” Assess this statement in light of what you know about good central bank design.
Provide arguments for why you think the financial crisis of 2007-2009 did or did not compromise the independence of the Federal Reserve.
Suppose in an election year, the economy started to slow down. At the same time, clear signs of inflationary pressures were apparent. How might the central bank with a primary goal of price stability react? How might members of the incumbent political party who are up for reelection react?
Assuming that they could, which of the following governments do you think would be more likely to pursue policies that would seriously hinder the central bank’s pursuit of low and stable inflation? Explain your choice.a. A government that is considered highly creditworthy both at home and abroad
Provide arguments for and against the proposition that a central bank should be allowed to set its own objectives.
When countries in a common currency area show persistently rising ratios of public debt to GDP, how does it affect the credibility of an inflation-targeting central bank?
The Maastricht Treaty, which established the European Central Bank, states that the governments of the countries in the European Monetary Union must not seek to influence the members of the central bank’s decision-making bodies. Why is freedom from political influence crucial to the ECB’s
Suppose the central bank in your country has price stability as its primary goal. Faced with a choice of having monetary policy decisions made by a well-qualified individual with an extremely strong dislike of inflation or a committee of equally well-qualified people with a wide-range of views,
The long list of central bank goals includes the stability of interest rates and exchange rates. You look on the central bank Web site and note that they have increased interest rates at every one of their meetings over the last year. You read the financial press and see references to how the
Suppose the government is heavily in debt. Why might it be tempting for the fiscal policymakers to sell additional bonds to the central bank in a move that it knows would be inflationary?
According to Figure New Zealand in the 1970s and 1980s combined high inflation with relatively little central bank independence. In 1989, New Zealand became the first country to adopt an inflation target. How did this policy regime shift affect inflation? Plot the inflation rate based on the
Financial stability is a goal of most central banks. Based on a graph showing the evolution of the European Central Bank’s assets (FRED code: ECBASSETS), how important was this goal for the ECB (a) Before 2007, (b) During the crisis period of 2007-2009, (c) When the euro-area crisis intensified
Interest rate stability is a common goal of central banks. When has the Federal Reserve been relatively successful at keeping interest rates stable? Compare quarterly changes since 1965 of the federal funds rate (FRED code: FEDFUNDS) with the level of inflation based on the percentage change from
To what extent has the Federal Reserve “monetized” government debt? Plot since 1970 the change from a year ago (measured in billions of dollars) in gross federal debt (FRED code: FYGFD) and the change from a year ago (measured in billions of dollars) in the federal debt held by the Federal
What are the Federal Reserve’s goals and who established them? How are Fed officials held accountable for meeting them? Explain why the Chair is most influential Fed official.
Evaluate the following statement: “The Treaty of Maastricht helped solve the time consistency problem in monetary policy but not fiscal policy.”
How did the financial crisis of 2007-2009 alter the appointment process of presidents of the regional Federal Reserve banks?
What are the goals of the ECB? How are its officials held accountable for meeting them?
Why did the sovereign debt problem of Greece – which accounts for less than 2 percent of euro-area GDP–, threaten the banking system throughout the euro area?
Go to the ECB's web site and locate the most recent introductory statement made by the president of the ECB at the press conference following a Governing Council meeting. What was the Governing Council’s policy decision? How was it justified? Is there any reference to financial stability measures?
Do you think the FOMC has an easier or a harder time agreeing on monetary policy than the Governing Council of the ECB? Why?
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