ECO 342 Banking & Financial Markets Study Guide Exam 1 Spring 2004

Bring: pencil

Format: 20 Multiple Choice 4 short answers Chapters 1-8

Come prepared, focus on the question and pace yourself! (1 minute per multiple choice question, 7 minutes per short answer question)

1 Introduction

¨ definitions: assets, tangible vs. intangible assets, financial assets--how are these related?

¨ categorizing financial markets: debt vs. equity, money vs. capital, cash vs. derivative, primary vs. secondary, exchange vs. OTC

¨ why have we seen increasing globalization of financial markets?

2 Financial Intermediaries and Financial Innovation

¨ what is the general role of financial intermediaries?

¨ what is the difference between assets and liabilities?

¨ how do liabilities differ with respect to the certainty about timing and amount? be prepared to give examples

¨ what is the different between direct and indirect investment? what are some of the advantages of indirect investment?

¨ what is financial innovation? why does it occur?

3 Role of Governments in Financial Markets

¨ what is the economic justification for the regulation of financial markets?

· how is regulation designed to deal with asymmetric information problems?

¨ how has financial market regulation developed from past financial crises in the United States?

4 Depository Financial Institutions

¨ How do banks’ role in maturity intermediation lead to interest rate risk?

¨ What is the tradeoff faced by depository institutions in choosing between long- and short-term investments in managing their assets and liabilities?

¨ Commercial banks

· what are assets for banks? what are liabilities?

· dual banking system: federal or state charters, only in U.S.

· McFadden Act: how did this impact the U.S. banking industry? What is the status of this regulation today?

· Great Depression legislation: regulation Q, Glass-Steagall, FDIC deposit insurance

Þ what are these regulations? what problems are associated with each regulation?

Þ what is the status of each regulation today?

· what is the capital requirement? why are assets risk adjusted in calculating the capital requirement?

¨ S&Ls, thrifts

· what are the traditional assets and liabilities of S&Ls?

· What were the origins of the S&L crisis in the 1970s?

· Deregulation--1980, 1982 how does this change asset/liability choices?

Þ why does deregulation fail to help S&Ls?

· How was S&L crisis of 1980s finally resolved? what steps were taken to strength the industry?

¨ What factors distinguish credit unions from other types of depository institutions?

5 The Federal Reserve and Money Creation

¨ Why was the Fed originally established? What is its primary function today?

¨ What is it about the structure and the financing of the Fed that makes it independent? Why is independence important?

¨ structure of the Fed

· Board --who is the current chair?

· regional banks--which is the most important?

· FOMC --how is it composed? what does it do?

¨ tools of monetary policy

· why aren’t discount loans and the reserve requirement used as monetary policy tools?

· open market operations-- how do they work?--immediate impact, longer-run impacts

Þ who decides OMO policy? who implements it?

Þ what is the target of OMO policy?

· what are repos and reverse repos? how do they differ from regular OMO?

6 Monetary Policy

¨ What are the goals of monetary policy? What kinds of tradeoffs exist among the goals?

¨ Recent Fed Monetary Policy

· recession of 1990-91--what was the Fed’s role?

· 1994--what did FOMC do to the FF rate? why?

Þ what is meant by a “soft-landing”?

· what did the Fed respond to in 1998? how did they respond?

· why did the Fed increase FF rate targets in 2000? Why did they reverse this?

· what is the current policy of FOMC towards interest rates? What is the current FF rate target?

7 Insurance Companies

¨ what is the basic function of insurance?

· why are liabilities contingent?

· how are profits determined?

¨ what types of risks are insured by different types of companies?

¨ life insurance companies

· what is the difference between term, whole, universal life, and variable life?

¨ how does claim predictability compare between types of insurance? how does this affect investment choices?

¨ what are annuities, GICs?

¨ regulation: at what level? what is regulated?

· how do life insurance companies receive favorable tax treatment?

¨ stock vs. mutual ownership: what is the difference? what are the pros and cons of each type?

8 Investment Companies

¨ what are the advantages/disadvantages of indirect investment over direct investment?

¨ mutual funds (open-end funds): sell and redeem shares; what is the NAV?

¨ closed-end funds: sell, but do not redeem shares; what is the relationship between price and NAV?

¨ unit trusts: fixed # shares, fixed termination date, no active trading, usually bond portfolios

¨ ETFs

· how are they similar/different from mutual funds? closed end funds?

· what are the advantages to ETFs? (trading, taxes, price vs. NAV)

¨ mutual fund fees: no load vs. different loads, 12b-1 fees, management fees, transaction costs;

¨ equity fund objectives: growth, income, sector, value, global/international, small/med/large cap, index

· what is the difference between passive and active portfolio management?

· why would investors accept the “average” returns of an index fund?

¨ types of funds w/ bonds, money mkt. assets, mixed assets

¨ regulation: SEC, NASD; disclosure, fees, taxation

· disclosure: about return & risk, objectives, readability

· how does taxation work?