SUNGU – ECO 301 HOMEWORK ASSIGNMENT #2

QUESTION

SUNGU – ECO 301HOMEWORK ASSIGNMENT #2DATE ASSIGNED: 11/3/2015Solve all fifteen questions. Each question is worth 0.33 credit points for a total of 5% ofyour course credit. I want to see your work – in detail. (I would like to see equations andgraphs. The more the better! For essay/explanation questions, a proper essay consisting ofat least a paragraph is needed.) There will be no partial credit for incomplete answers.The deadline for this homework assignment is the very last day of classes. However, youare very strongly advised to take a look – at the very least – before the midterm. GoodLuck!!1) Bank Y and Bank Z both have assets of $1 billion. The return on assets for bothbanks is the same. Bank Y has liabilities of $800 million while Bank Z’sliabilities are $900 million. In which bank would you prefer to hold an equitystake? Explain your choice.2) Suppose a bank faces a gap of -20 between its sensitive assets and liabilities.What would happen to bank profits if interest rates were to fall by 1 percentagepoint? You should report your answer in terms of the change in profits per $100in assets.3) Suppose you have two deposits totaling $280,000 with a bank that has just beendeclared insolvent. Would you prefer that the FDIC resolve the insolvency underthe ‘payoff method’ or the ‘purchase and assumption’ method? Explain yourchoice.4) How do you think financial regulators should address the ‘too-big-to-fail’ issueassociated with large, systematically important financial institutions?5) Suppose the president of a newly independent country asks you for advice indesigning the country’s new central bank. For each of the following designfeatures, choose which one you would recommend and briefly explain yourchoice.a) Central bank policy decisions that are irreversible or central bank policydecisions that can be overturned by the democratically elected government.b) The central bank has to submit a proposal for funding to the government eachyear or the central bank finances itself from the earnings on its assets andturns the balance over to the government.c) The central bank policymakers are appointed for periods of four years tocoincide with the electoral cycle for the government or the central bankers areappointed for 14-year terms.6) Suppose you examine the central bank’s balance sheet and observe that since theprevious day, reserves had fallen by $100 million. In addition, on the asset side ofthings, securities had fallen by $100 million.a) What activity might the central bank have carried out earlier in the day to leadto these changes in the balance sheet?b) Do you think the central bank was aiming to increase, decrease, or maintainthe size of the money supply by carrying out the changes described above?c) Do you think the size of the banking system’s balance sheet would be affectedby these changes to the central bank’s balance sheet?7) Suppose you observe a rise of $100 million in reserves on the liability side of thecentral bank’s balance sheet with all other liabilities remaining unchanged. On theasset side, the entries under ‘securities’ and ‘loans’ remained unchanged. Whatmight have accounted for the change in reserves and how would this action bereflected on the balance sheet?8) In which of the following cases will the size and content of the central bank’sbalance sheet change? Draw the relevant T-account and show the change.a) The Federal Reserve conducts an open market purchase of $100 million UStreasury securities.b) A commercial bank borrows $100 million from the Federal Reserve.c) The amount of cash in the vaults of commercial banks falls by $100 milliondue to withdrawals by the public.9) Suppose, one morning, the Open Market Trading Desk drastically underestimatesthe demand for reserves when deciding the quantity of reserves to supply to themarket. Use the graph of the Market for Bank Reserves to show why the marketfederal funds rate will not exceed the discount rate regardless of how large the gapbetween estimated and actual reserve demand.10) [MISHKIN 9th Edition, Ch. 14/#13] If a bank sells $10 million of bonds to theFED to pay back $10 million on the discount loans it owes, what will be the effecton the level of checkable deposits? (Assume a required reserve ratio of 10%, noexcess reserves and no change in currency holdings by the public.)11) [MISHKIN 9th Edition, Ch. 14/#10] If reserves in the banking system increase by$1 billion as a result of discount loans of $1 billion and checkable depositsincrease by $9 billion, why isn’t the banking system in equilibrium? What willcontinue to happen in the banking system until equilibrium is reached? Show theT-account for the banking system in equilibrium. (Assume a required reserve ratioof 10%, no excess reserves and no change in currency holdings by the public.)12) [MISHKIN 9th Edition, Ch. 14/#8] If the FED buys $1 million of bonds from theFirst National Bank, but an additional 10% of any deposit is held as excessreserves, what is the total increase in checkable deposits? (Assume a requiredreserve ratio of 10%, no initial excess reserves and no change in currencyholdings by the public.)13) [MISHKIN 9th Edition, Ch. 15/#8] If there is a switch from deposits intocurrency, what happens to the federal funds rate? Use the supply and demandanalysis of the market for reserves to explain your answer.14) [MISHKIN 9th Edition, Ch. 15/#10]The benefits of using FED discountoperations to prevent bank panics are straightforward. What are the costs?15) [MISHKIN 9th Edition, Ch. 16/#4] If the FED has an interest rate target, why willan increase in demand for reserves lead to a rise in the money supply?

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