Question 1

What is a financial asset?

Accepted Answer

A financial asset is a non-physical representation of ownership that has financial value for its owner

(stocks, bonds, cash, etc.)

Question 2

What is liquidity?

Accepted Answer

How easily a financial asset can be converted into cash

(the most liquid forms of money are cash and demand deposits)

Question 3

What is rate of return?

Accepted Answer

The percentage change in the value of an investment over a given period of time

Question 4

What is risk?

Accepted Answer

The chance an investment's actual gains will be different from the expected outcome

Question 5

What is interest?

Accepted Answer

The price you pay to borrow money or the price you charge to lend money

(typically expressed as a percent)

Question 6

What is a bond?

Accepted Answer

An interest-bearing asset issued by a business or the government promising to repay borrowed money in the future

Question 7

What are securities?

Accepted Answer

Certificates or other financial assets that have monetary value and can be traded

(e.g., stocks)

Question 8

What are stocks?

Accepted Answer

Securities that represent partial ownership in some public company

Question 9

What is the difference between stocks and bonds?

Accepted Answer

Stocks: a security that represents ownership in a public corporation

Bonds: a loan from you to a corporation or government

Question 10

What are loans?

Accepted Answer

An amount of money borrowed by an individual or organization that must be repaid with interest

Question 11

What are bank deposits?

Accepted Answer

Money placed in a bank account by a customer

Question 12

What is a demand deposit account?

Accepted Answer

A bank account you can withdraw funds from at any time, without prior notice

Question 13

What does it mean that there is an inverse relationship between interest rates and the price of previously issued bonds?

Accepted Answer

When the cost of borrowing money (interest rates) rises, bond prices fall

Question 14

What is the opportunity cost of holding money?

Accepted Answer

The interest that could have been earned from holding other financial assets, such as bonds

Question 15

What is a nominal interest rate?

Accepted Answer

The rate of interest paid for a loan, unadjusted for inflation

(real interest rates have been adjusted)

Question 16

What is a real interest rate?

Accepted Answer

The rate of interest paid for a loan, adjusted for inflation

(nominal interest rates have not been adjusted)

Question 17

How do you calculate a real interest rate?

Accepted Answer

Nominal interest rate minus the actual inflation rate

(nominal = 7%, inflation = 3% -> real = 7% - 3% = 4%)

Question 18

What is money?

Accepted Answer

Any asset that is accepted as a means of payment

Question 19

What is the money supply?

Accepted Answer

The total amount of money in circulation or in existence in a country

Question 20

What are monetary aggregates?

Accepted Answer

Different ways of grouping together various types of money

(M1 and M2)

Question 21

What are M1 and M2?

Accepted Answer

Monetary aggregates that economists use to measure the money supply

M1: Coins and currency in circulation, checking accounts deposits (narrow definition of money)

M2: Everything in M1 and also other types of deposits (savings deposits)

Question 22

What is the monetary base (M0/MB)?

Accepted Answer

The total amount of money created by the central bank

(currency in circulation and bank reserves)

Question 23

What are depository institutions?

Accepted Answer

Institutions that accept deposits from individuals and businesses, such as commercial banks

Question 24

What is a balance sheet?

Accepted Answer

A financial statement that shows the assets, liabilities, and equity of an institution at a given point in time

Question 25

What is fractional reserve banking?

Accepted Answer

A system in which depository institutions keep only a fraction of their deposits in reserve and lend out the rest

(the fraction they must keep is the required reserve)

Question 26

What are required reserves?

Accepted Answer

The minimum amount of reserves that a depository institution is required to hold by law

(opposite of excess reserves)

Question 27

What are excess reserves?

Accepted Answer

The reserves that a depository institution holds above and beyond the required reserves

Question 28

What is the reserve ratio?

Accepted Answer

The portion of deposits that a bank must hold onto

(everything else can be excess reserves)

Question 29

What is the money multiplier?

Accepted Answer

The ratio of the money supply to the monetary base

The amount of money that the banking system can generate with each dollar of excess reserves that it holds

Question 30

How do you calculate the money multiplier?

Accepted Answer

If the reserve ratio is 0.2, the money multiplier = 1/0.2 = 5

Question 31

How do banks create new money?

Accepted Answer

By making loans, which creates new deposits and expands the money supply

Question 32

Why might the amount predicted by the simple money multiplier be overstated?

Accepted Answer

It does not take into account a bank's desire to hold excess reserves or the public holding more currency

(both of these limit the amount of money banks can create)

Question 33

What does the money market graph show?

Accepted Answer

The supply and demand for money

X-Axis: Quantity of money demanded

Y-Axis: Nominal interest rate

Question 34

What is the relationship between the nominal interest rate and the quantity of money demanded?

Accepted Answer

Inverse

(as the nominal interest rate increases, the quantity of money demanded decreases, and vice-versa)

Question 35

Why is the relationship between the NIR and quantity of money demanded inverse?

Accepted Answer

As NIR increases, the opportunity cost of holding money also increases since people could profit more by depositing their money in an interest bearing account

Question 36

Why is the money supply independent of NIR?

Accepted Answer

The money supply is determined by the Federal Reserve, so it has no direct relation to NIR

(this is why it's vertical on the money market graph)

Question 37

What happens in the money market when there are disequilibrium nominal interest rates?

Accepted Answer

There are surpluses and shortages in the money market

(market forces drive nominal interest rates toward equilibrium)

Question 38

What is monetary policy?

Accepted Answer

The actions by the Federal Reserve to control the money supply and achieve goals, such as price stability

(contrast with fiscal policy, which is actions by Congress)

Question 39

What are open-market operations?

Accepted Answer

When the Fed buys/sells bonds to private banks

(most important tool of monetary policy; buying = bigger MS, sell = smaller MS)

Question 40

What happens when the central bank conducts an open-market purchase?

Accepted Answer

Reserves increase, thus increasing the monetary base

Question 41

Why is the effect of an open-market purchase on the money supply greater than the effect on the monetary base?

Accepted Answer

The money multiplier effect

(open-market purchases give money to banks, increasing their reserves; the money multiplier multiplies that increase)

Question 42

What is the overnight rate (federal funds rate)?

Accepted Answer

The interest rate at which banks lend and borrow money from each other overnight

(overnight because the debt must be repaid by the next day)

Question 43

How can central banks influence the nominal interest rate in the short run?

Accepted Answer

By changing the money supply, which in turn will affect investment and consumption

Question 44

What are expansionary or contractionary monetary policies used for?

Accepted Answer

To restore full employment when the economy is in a recessionary or inflationary output gap.

Question 45

What are the lags to monetary policy caused by?

Accepted Answer

The time it takes to recognize a problem in the economy and the time it takes the economy to adjust to the policy action

Question 46

What is the discount ratio?

Accepted Answer

The interest rate the Fed charges banks to borrow money

Question 47

How would the Fed use monetary policy to deal with an inflationary gap?

Accepted Answer

The Fed would sell securities, raise the reserve ratio, and/or increase the discount ratio

Question 48

What is the loanable funds market?

Accepted Answer

A market that shows the behavior of savers (who supply loans) and borrowers (who demand loans)

(the market reaches an equilibrium when demand and supply of loans are equal)

Question 49

What is the relationship between real interest rates and quantity of loanable funds demanded?

Accepted Answer

Inverse

(higher interest rates means less people want LFs)

Question 50

What is the relationship between real interest rates and quantity of loanable funds supplied?

Accepted Answer

Positive

(loaners can make a higher profit with higher interest rates)

Question 51

What is national savings?

Accepted Answer

The amount of income (GDP) that households/businesses/govts. save

Question 52

When is there equilibrium in the loanable funds market?

Accepted Answer

When the demand for and supply of loanable funds are balanced at a specific real interest rate

Question 53

What is capital inflow?

Accepted Answer

Financial capital entering a country

Inflow of foreign funds minus outflow of domestic funds

Question 54

What is the savings-investment spending identity?

Accepted Answer

The amount of money saved in an economy is the same amount of money that will be invested into new capital

Unit 4 - Financial Sector, AP Macroeconomics Flashcards