Download Unit 4 Test Review Savings, Investment and the Financial System 1

Unit 4 Test Review
Savings, Investment and the Financial System
1. What is a financial intermediary? Explain how each of the following fulfills that role:
a. Mutual fund
b. Bank
c. Pension fund
d. Life insurance company
2. What is a financial asset? Explain how each of the following fulfills that role:
a. Loan
b. Bond
c. Stock
d. Checkable Bank Deposit
What three main functions do they have?
3. What is liquidity? What does the term “liquid asset” mean?
4. If you choose to purchase a stock, you are likely to receive a(n) (higher, lower, equivalent) return in exchange for
a(n) (higher, lower, equivalent) risk.
If you choose to purchase a bond, you are likely to receive a(n) (higher, lower, equivalent) return in exchange for
a(n) (higher, lower, equivalent) risk.
5. What is the Savings-Investment Spending Identity?
6. Define the term budget balance. What is the difference between a budget surplus and a budget deficit? Budget
Balance = ______________________ + _________________________.
7. Define the term national savings. National Savings = ______________________ + ________________________.
8. Define the term private savings. Private Savings = _______________________ + _________________________.
9. Define the term capital inflow. Capital Inflow = ________________________ + ___________________________.
10. In a closed economy (S = I), suppose that GDP is $20 trillion. Consumption is $10 trillion and government
spending is $5 trillion. Taxes are $1.5 trillion. What is the value of each of the following:
a. Government budget balance
b. National savings
c. Private savings
d. Investment spending
Now assume it is an open economy (S=I), where exports are $1trillion and imports are $3 trillion. How much is
the net capital inflow?
Money Measurement
11. What is included in the M1 definition of money? What is included in M2? M3?
12. Indicate whether each of the following is part of M1, M2, M3, or neither:
a. $95 on your campus meal card
b. $0.55 in the change cup in your car
c. $1,663 in your savings account
d. $459 in your checking account
e. $27.50 check from your friend
f. $150,000 in a time deposit
g. 50 shares of stock worth $2,000
h. A $1,000 line of credit on your Amazon credit card
13. What are the three main functions/roles of money? Indicate the correct role for each scenario:
a. Using money to purchase a new MP3 player
b. Buying the latest Blue-Ray disc movie with a $20 bill
c. Keeping part of your wealth in a savings account
d. Discovering money in your coat that you placed there last winter
e. Putting a price on a meal
f. Buying a ticket to a rodeo
14. Explain the monetary equation of exchange (MV=PQ). Given this equation, graph the results of expansionary
monetary policy.
15. What is the federal funds rate? What determines the federal funds rate? Who participates in the federal funds
market?
Demand for Money and the Money Market
16. What is the opportunity cost for holding money?
17. What does the Money Demand curve represent and why is it downward sloping?
18. What circumstances will cause a shift in the demand for money? Which of these circumstances will cause a
proportional increase in the quantity of money demanded?
19. Draw a graph depicting the money market.
a. Label the point equilibrium. What does this point on the graph represent?
b. If the current interest rate was above equilibrium, what would eventually happen to interest rates?
c. If the current interest rate was below equilibrium, what would eventually happen to interest rates?
Banking and Money Creation
20. Why is there a money multiplier and what is its formula? Why in reality is it smaller than in theory?
21. Suppose the reserve requirement is 15% and you deposit a $5,000 bonus you just received in your checking
account.
How much of the deposit is the bank required to keep in reserves?
How much can the bank loan out?
What is the possible maximum expansion in the money supply?
22. What will happen to the money supply under the following circumstances in a checkable-deposit-only system?
What is the multiplier in each scenario? (Assume the banking system does NOT hold excess reserves.)
a. The required reserve is 25% and a depositor withdraws $700 from his checking account.
b. The required reserve is 5% and a depositor withdraws $700 from his checking account.
c. The required reserve ratio is 20% and a customer deposits $750 to her checking account.
d. The required reserve ratio is 10% and a customer deposits $600 to her checking account.
23. A commercial bank holds $700,000 in demand deposits and $10,000 in reserves. If the required reserve ratio is
10%, what is the maximum amount by which this bank may increase its loans? What is the maximum amount by
which the banking system may increase loans as a result?
24. What is the difference between the money supply and the monetary base? Which is a component of both?
(Draw the venn diagram to help!)
25. When the required reserve ratio is lowered, the potential for money creation (increases/decreases). When the
required reserve ratio is raised, the potential for money creation (increases/decreases).
26. Where can a bank choose to store its reserves?
The Federal Reserve and Monetary Policy
27. What are the functions of the Fed? In what ways is it the “banker’s bank”?
28. What are the tools of the Federal Reserve? Which tool does the Fed utilize most often?
29. Explain how the Federal Reserve uses open market operations to increase/decrease the monetary base.
30. Why is the discount rate higher than the set by the Fed purposely higher than the federal funds rate?
31. Complete this chart depicting the impact of Fed open market operations:
Operation
Bank Reserves Money Supply Interest Rates
Buying Bonds
Selling Bonds
32. Complete this chart depicting Federal Reserve monetary policy options:
Response to Type of
Reserve
Discount Rate
Open Market
Impact on Aggregate
Monetary Policy Requirements
Operations
Supply & Demand
High Inflation
Recession
33. Complete this chart depicting economic impacts of monetary policy:
Type of Monetary Policy Interest Rates
Private (Business)
GDP
Employment
Investment
Contractionary
Expansionary
The Market for Loanable Funds
34. What is the real interest rate? How is it related to the nominal interest rate?
35. What is the rate of return? How is it utilized in project evaluation?
36. What circumstances will cause a shift in the demand for loanable funds?
37. What circumstances will cause a shift in the supply of loanable funds?
38. Illustrate and explain:
a. The Fisher effect
b. Crowding Out
39. Complete this chart depicting the Loanable Funds Market:
LF Market response to
Shift in supply ↑or ↓ in
or demand
supply or demand
Government budget deficit
Government budget surplus
Increase in private savings
Decrease in private savings
Interest rates
Total amount
borrowed
40. Using the table below.
Possible Investment Projects
Project
Rate of Return on Investment
Cost of Investment
F
20%
$500
G
18
300
H
16
1,000
I
14
200
J
12
2,000
K
10
1,500
L
8
1,200
M
6
800
a. Assume the market interest rate is 15%.What is the last project undertaken? What is the amount of planned
investment spending?
b. Assume the market interest rate is 11%. What is the last project undertaken? What is the amount of planned
investment spending?