ECON 103 Exam 4 Review PDF

ECON 103 - Exam 4 Review Reviewed Final Exam Review Slides Final Exam Review: Money, Financial Markets, and Monetary Policy Money Not backed by a commodity: Accepted due to the government's issuance....

ECON 103 - Exam 4 Review Reviewed Final Exam Review Slides Final Exam Review: Money, Financial Markets, and Monetary Policy Money Not backed by a commodity: Accepted due to the government's issuance. Must be: Divisible Durable Widely accepted by many people Easy to determine its value Functions of Money: Medium of exchange Unit of account Store of value Liquidity: How quickly, easily, and reliably something can be converted into cash. More liquid = Easier to convert into cash. Less liquid = Harder to convert. Money Supply: M1: Currency in circulation ECON 103 - Exam 4 Review 1  Checkable deposits M2: Savings deposits Money market deposit accounts Small denomination time deposits (less than $100k) Shares in retail money market mutual funds Market for Loanable Funds: Loanable Funds: Funds available for borrowing. Real Interest Rate: The rate at which money is borrowed/lent. Supply (S): Savers providing funds. Demand (D): Borrowers seeking funds. Equilibrium (r)**: The point where supply and demand intersect. ECON 103 - Exam 4 Review 2 ECON 103 - Exam 4 Review 3  Financial Institutions: Functions: Screen and evaluate credit of potential borrowers Reduce information and transaction costs Provide standardized financial products Diversify assets to reduce risk Pool funds from many savers and lend to many borrowers Bonds: Yield: Interest payment/price of the bond. Key Terms: Maturity Date: When the bond issuer repays the principal and interest. Coupon Rate: The bond’s interest rate. Face Value: The amount repaid at maturity. Bond Price: Inversely related to interest rates. When rates rise, bond prices fall. Stocks: Ownership in a company: Entitles owners to a share of profits. Risk-Return Relationship: Riskier assets generally offer higher returns. Retirement Accounts: 401(k): Tax-advantaged employer-sponsored retirement plan. Traditional IRA: Contributions may be tax-deductible; withdrawals taxed as income. ECON 103 - Exam 4 Review 4  Roth IRA: Contributions are made with after-tax income; withdrawals are tax-free. Compounding Interest: Definition: Interest calculated on both the initial principal and accumulated interest. Effect: Investments or debts grow faster over time due to compounding. Social Security: Funded by FICA: Social Security is a government program to provide retirement income. Eligibility: Minimum age to collect is 62. Payments increase if collecting is delayed (up to age 70). Monetary Policy: FOMC (Federal Open Market Committee) sets the direction for monetary policy by targeting interest rates. Federal Funds Rate: The interest rate at which banks charge each other for overnight loans used as reserves. Federal Reserve (Fed): Functions: Provide a nationwide payments system Distribute coins and currency Regulate and supervise member banks Serve as the banker for the U.S. Treasury Board of Governors: Composed of seven members appointed by the President (14-year term). Tools of the Federal Reserve: ECON 103 - Exam 4 Review 5  1. Interest on Reserve Balances (IORB): Paid on reserves held by the Fed. 2. Discount Rate: The interest rate charged by the Fed to banks for overnight loans. 3. Open Market Operations: Buying and selling bonds to influence the money supply. 4. Reserve Requirement: The required ratio of deposits banks must hold as reserves. Expansionary vs. Contractionary Monetary Policy: Expansionary Monetary Policy: Lower interest rates. Increases the money supply. Encourages borrowing and spending. Contractionary Monetary Policy: Higher interest rates. Decreases the money supply. Discourages borrowing and spending. ECON 103 - Exam 4 Review 6 ECON 103 - Exam 4 Review 7  Federal Reserve Tools and Dynamics: Interest on Reserve Balances: Expansionary: Decrease IORB to encourage lending, increase money supply. Contractionary: Increase IORB to discourage lending, decrease money supply. Discount Rate: Expansionary: Lower the discount rate to make borrowing cheaper, increase money supply. Contractionary: Increase the discount rate to make borrowing expensive, decrease money supply. Open Market Operations: Expansionary: Buy securities, increase bank reserves, money supply. ECON 103 - Exam 4 Review 8  Contractionary: Sell securities, reduce bank reserves, money supply. Reserve Requirements: Expansionary: Lower reserve requirements, banks have more money to lend. Contractionary: Raise reserve requirements, banks have less money to lend. Key Takeaways: The Federal Reserve doesn't directly control interest rates, but it influences them through the tools above. Increasing the money supply lowers interest rates, while decreasing the money supply raises interest rates. Monetary policy aims to balance economic growth with stable prices and moderate interest rates. Practice Questions Suppose the government encourages greater participation in retirement plans. What happens to loanable funds and interest rates? Loanable funds increase; interest rates decrease If a bond has a face value of $1,000 and pays $40 per year in interest, how much is the bond worth after interest rates increase to 5%? Annual Interest Payment/Face Value = 40/1000 = 4% Bond price = Annual Interest Payment/New Market Interest Rate = 40/0.05 = 800 Bond’s value will be $800 after interest rates increase to 5% Which of the following assets will likely show the greatest increase in value over time? Blue Chip Stocks ECON 103 - Exam 4 Review 9  Which of the following tools is the Fed most likely to use to deal with a macroeconomic problem? Targeting the Federal Funds rate What is the appropriate policy for the federal reserve to use in a severe recession? Expansionary Monetary Policy According to the equation of exchange, what is the level of output if M = 1,000, V = 5, and P = 20? MxV=PxQ 1,000 x 5 = 20 x Q 5,000 = 20 x Q 5,000/20 = 250 250 If inflation is 3%, the target inflation rate is 2%, and the economy is 3% above its long-run output, what is the federal funds target rate using the Taylor Rule? Target Inflation Rate + Current Inflation Rate + 1/2(Inflation Gap) + 1/2(Output Gap) 2% + 3% + 1/2(1%) + 1/2(3%) = 7% ECON 103 - Exam 4 Review 10