Money & Banking

Homework # 1 - Money

Reading - Money - click here

Video - The How and Why of Buying Bitcoin - click here

Video - The Bubble Dynamics of Bitcoin - click here

Video - Why Central Banks Want to Get into Digital Currencies - click here

Homework # 2 - Banking

Reading - Banking - click here

Classwork # 2 - Banking (Answers)

1. Consider how the following events will affect the market for loanable funds and which market graph to the right shows the effect on the market.

A. More people enter the work force and incomes rise.

B. More people retire and incomes fall.

C. Foreigners save money in this economy’s banks.

D. Government borrows money to pay for the building of a new highway.

E. The economy suffers a deep recession an many people lose their jobs.

2. A firm forecasts that a $20 million investment to build a new factory will allow the company to increase its production and that sales revenue will increase by $30 million one year from now. The firm forecast estimates that annual materials and labor cost at the new factory will be $9 million.

A. What is the expected rate of return on this investment? (Hint: How should the operating cost of factory be considered?)

B. Should the company make this investment if the current interest rate is 4%?

C. Suppose the going interest rate is 6%. Should the firm undertake the investment at this rate?

C. Now suppose that the company already has the $20 million, from earlier profits, to make the investment and does not need to borrow. Should the company make this investment if the interest rate is6%?

E. Suppose the interest rate is 6%, but, because of a drop in operating costs, the new factory will only cost $8 million to run. What should the company borrow the money to make the investment?

F. What should the company do if interest rates go down to 4% and the new factory costs $8 million to run, but sales forecast predict that there is a 50% chance sales will be $26 million and a 50% chance sales will be $30 million?

3. Rank the following seven loan in order based on the interest rates you would expect each one to have (1 for the lowest and 7 for the highest). Specify the factors that you considered in your ranking.

10-year $1000 government bond.
$50 pawnshop loan (iphone as collateral).
30-year mortgage loan on a $400,000 house.
24-month car loan for $8,000.
30-day loan for $200 from a payday lender (borrower has to prove they have a job).
Credit card with a $1000 limit.
Equity credit line (based on ownership of a house) with a $25,000 limit.

4. Consider a small island country that uses shiny shells as currency – they are all the same and have equal value. The economy currently has 2000 shiny shells circulating as currency.

A. Currently, there are no banks on this island. What is the size of the M1 money supply and the M2 money supply in this economy?

B. A bank is created on the island. The islanders put all of their money in the bank and the bank fully loans out the money. Size of the money supply is the reserve requirement was 10%? What if it was 20%?

C. When the reserve requirement is 10% the economy has price stability. The economy has a money velocity of 5. Based on this, what is the GDP of the island economy measured in shiny shells?

D. What would happen to the money supply and economy if the reserve requirement was moved to 20% (assume that money velocity is still 5)?

E. Suppose a fisherman finds a coral reef full of shiny shells. The fisherman collects 100 shiny shells and brings back to the island. What effect will this have on the money supply if the reserve requirement was 10% and money velocity is 5? Based on this example, how could a commodity money (like one based on gold) be dangerous to an economy?

Homework # 3 - Banking Crisis

Reading - Banking Crisis - click here

Classwork # 3 - Banking Crisis

1. Answer the following questions using the balance sheet information for the two banks shown to the right. Both banks operate in the same economy and have a reserve requirement of 10%. The economy is suffering a financial crisis and both banks currently facing crises of confidence in which depositors are trying to take their money out of the banks. The loan amount reflects the true value of the assets after they have been “written down”.

A. Which bank is facing a liquidity problem and how should it be resolved?

B. Which bank is facing an insolvency problem and how should it be resolved?

2. Consider the bank shown with the balance sheet shown to the right. The liability side is made up of deposits and capital from investors in the bank. The asset side has outstanding loans and reserves. This bank has a 10% reserve requirement. Suppose, due to an economic downturn, the “mark to market” value of the loans falls by $5.

A. Is this bank still solvent? Why?

B. How has investor capital served as a “cushion”?

C. After the financial crisis, some people have advocated for banks to have higher “capital requirements”. What is the benefit and cost of higher capital requirements on banks?

# 3 - Banking Crisis Worksheet - click here

Homework # 4 - Investment - Stocks

Reading - Investment - Stocks - click here

Homework # 5 - Investment - Bonds

Reading - Investment - Bonds - click here

Classwork - Investing in Mutual Funds

Class Assignment - click here

Vanguard - Total Stock Market Index Fund

Vanguard - Growth and Income Fund

Vanguard - Total Bond Index Fund

Vanguard - Global Equity Fund

Vanguard - Life Strategy Fund

Vanguard - Target Retirement 2065 Fund

Homework # 6 - Review of Money & Banking (Answers)

Printable Copy of Assignment - Click Here

Class Review Power Point - Click Here

Problem # 1 - Market for Loanable Funds and Interest Rate - Using the charts to the right, state how the changes in the economy described by the statement will affect the supply or demand for loanable funds in the economy and show on the chart the way the change will affect the interest rate.

A. Increase in people’s incomes.

B. Expectation of higher business profits.

C. Higher inflation.

D. Reduction in government borrowing.

Problem # 2 - Evaluating Investment Under Uncertainty - determine the expected rate of return on the following three $1 million investments and determine the best investment. Use the formula to the right to do the calculations.

A. Investment with a 50% return of $200,000 and 50% return of $100,000.

B. Investment with a 20% return of $500,000 and 80% return of $50,000.

C. Investment with a 60% return of $300,000 and 40% return of $60,000.

Problem # 3 - Effect of Inflation on Investment - A company has an opportunity to make an investment of $1 million in a new production facility. The current interest rate is 4%. Use the following information to determine if they should make the investment.

A. The production facility is expected to generate sales of $100,000 a year and cost $50,000 a year to run. Is this a profitable investment?

B. Is this still a good investment if inflation goes up and it now costs $65,000 a year to run the production facility?

Problem # 4 - Money Supply & Economic Activity - Use the Quantity Theory of Money (M×V = P×Q) and the Deposit Expansion Multiplier (DEM = 1/ reserve requirement) to answer the following questions about an island economy that uses pearls as its form of money.

A. The economy has 2000 pearls circulating as money and a banking system that has a reserve requirement of 10%. What is the size of the money supply in the economy?

B. The only item produced and traded in the economy are fish and currently the economy is producing 100,000 fish. Given the money supply from the previous problem and a velocity of money of 10, what is the current price of fish?

C. What would be the income of a fisherman who catches 500 fish a year? Suppose this fisherman had to make a debt payment of 100 pearls, how much of their income do they have to spend on the debt?

D. What would happen to the price of fish in the economy if the economy now produced 120,000 fish and the money supply did not change?

E. What effect would this have on the income of the fisherman who catches 500 fish a year? How would the change in the price of fish affect the burden of their 100 pearl debt payment?

F. Suppose the central bank of the island economy wanted to maintain price stability for fish when the economy produced 120,000 fish. How many more pearls would they need to put into circulation as money in order to keep the price of fish the same?

G. Suppose the central bank did increase the money supply to maintain price stability in the expectation that the economy would produce 120,000 fish, but that the economy was only able to produce 110,000 fish. What would be the price of fish?

H. What effect would this have on the income of the fisherman who catches 500 fish a year? How would the change in the price of fish affect the burden of their 100 pearl debt payment?

Problem # 5 - Central Bank Policy and the Economy - A bank currently has $10 million in deposits that it can either keep on reserve or loan out. The chart to the right lists the amount of loans that it will make at different interest rates. Use the information to answer the following questions.

A. How much will the bank lend if the central bank currently sets its interest on reserves at 3%?

B. How will the bank change the amount it lends if the central bank raises the interest on reserves to 5%? How is this an effective policy in dealing with inflation?

C. How will the bank change the amount it lends if the central bank lowers the interest on reserves to 1%? How is this an effective policy in dealing with unemployment and a slow economy?

Problem # 6 - Banking Crisis - The charts below show the balance sheets for four banks following a financial crisis. The central bank needs to determine which banks to shut down, which banks to lend money to and which banks do not need help. Answer the following questions about how to handle each bank. The banks have a reserve requirement of 10%.

1. What should happen to Bank # 1? Why?

2. What should happen to Bank # 2? Why?

3. Both Bank # 1 and Bank # 2 borrowed money from Bank # 3, this is part of Bank # 3’s loans. How do those banks affect Bank # 3? What should happen to Bank # 3? Why?

4. What should happen to Bank # 4? Why?

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