CHAPTER 20 – MONEY, FINANCIAL INSTITUTIONS, AND THE
FEDERAL RESERVE
After you have read and studied this chapter, you should be able to:
1. Explain what money is and what makes money useful.
2. Describe how the Federal Reserve controls the money supply.
3. Trace the history of banking and the Federal Reserve System.
4. Classify the various institutions in the American banking system.
5. Briefly trace the causes of the banking crisis of 2009-2010 and explain how the government protects your funds during such crises.
6. Describe how technology helps make banking more efficient.
7. Evaluate the role and importance of international banking the World Bank and the International Monetary Fund.
Listed below are important terms found in the chapter. Choose the correct term for the definition and write it in the space provided.
Banker’s acceptance |
Federal Deposit Insurance Corporation (FDIC) |
Open-market operations |
Barter |
International Monetary Fund (IMF) |
Pension funds |
Certificate of deposit (CD) |
Letter of credit |
Reserve requirement |
Commercial bank |
M-1 |
Savings and Loan Association (S&L) |
Credit unions |
M-2 |
Savings Association Insurance Fund (SAIF) |
Debit card |
M-3 |
Smart card |
Demand deposit |
Money |
Time deposit |
Discount rate |
Money supply |
World Bank |
Electronic funds transfer (EFT) system |
Nonbanks |
|
2. M-2 plus big money deposits like institutional money market funds make up the ___________ money supply.
3. The ____________________is a percentage of commercial banks’ checking and savings accounts that must be physically kept in the bank.
4. The technical name for a savings account is a _______________________, for which the bank can require prior notice before the owner withdraws money.
5. A _____________________is a promise that the bank will pay some specified amount at a particular time.
6. ____________________is anything that people generally accept as payment for goods and services.
7. The interest rate the Fed charges for loans to member banks is the __________________.
8. Financial organizations known as __________________ accept no deposits, but offer many of the services provided by regular banks include pension funds, insurance companies, commercial finance companies, consumer finance companies and brokerage houses.
9. A time deposit (savings) account called a ________________earns interest to be delivered at the end of the certificate’s maturity date.
10. A computerized system known as _____________________electronically performs financial transactions such as making purchases, paying bills, and receiving paychecks.
11. The part of the FDIC that insures holders of accounts in savings and loan associations is called the __________________.
12. An electronic funds transfer tool known as a __________________ serves the same function as checks, in that it withdraws funds from a checking account.
13. The activity called ______________ is the direct trade goods and services for other goods and services.
14. A financial institution called a ____________________ accepts both savings and checking deposits and provides home mortgage loans.
15. The ________________is the amount of money the Federal Reserve Bank makes available for people to buy goods and services.
16. A _________________is a promise by a bank to pay the seller a given amount if certain conditions are met.
17. _______________________ are amounts of money put aside by corporations, nonprofit organizations, or unions to cover part of the financial needs of members when they retire.
18. A profit-seeking organization that receives deposits from individuals and corporations in the form of checking and savings accounts and then uses some of these funds to make loans is called a _____________________.
19. The __________________________is an independent agency of the U.S. government that insures bank deposits.
20. The buying and selling of U.S. government bonds by the Fed is called____________ and has the goal of regulating the money supply.
21. The ________ includes everything in M-1 plus money that may take a little more time to obtain, such as savings accounts, money market accounts, mutual funds, and certificates of deposit.
22. The technical name for a checking account is a(n) ____________________, from which money can be withdrawn anytime on demand by the depositor.
23. The ______________________assists the smooth flow of money among nations.
24. The __________________, also known as the International Bank for Reconstruction and Development, is primarily responsible for financing economic development.
25. Money that can be accessed quickly and easily, such as currency, checks, traveler’s checks, is called the ______________ money supply.
26. A ____________________is an electronic funds transfer tool that is a combination credit card, debit card, phone card, driver’s license card and more.
1. What is a “barter exchange”?
2. Describe five characteristics of a "useful" form of money.
a. _______________________________________________________________________
b. _______________________________________________________________________
c. _______________________________________________________________________
d. _______________________________________________________________________
e. _______________________________________________________________________
3. What is e-cash and how can you use it?
4. What are M-1, M-2 and M-3, and what is the difference between them?
Which is the most commonly used definition?
5. What would happen if the Fed were to make too much money available in the economy?
6. What would happen if the Fed took money out of the economy?
7. Why does the money supply need to be controlled?
8. What does a “falling dollar” mean?
What does a rising dollar mean?
What does this mean for the prices of European goods?
9. What makes our dollar “weak” or “strong”?
11. What organization is in charge of monetary policy?
12. What are the five major parts of the Federal Reserve System?
a. _________________________________________________
b. _________________________________________________
c. _________________________________________________
d. ________________________________________________
e. ________________________________________________
13. What is the primary function of the board of governors?
14. Describe the Federal Open Market Committee.
15. What are some activities of the Federal Reserve?
a. __________________________________________________________
b. __________________________________________________________
c. __________________________________________________________
d. __________________________________________________________
e. __________________________________________________________
f. __________________________________________________________
g. __________________________________________________________
16. The three basic tools the Fed uses to manage the money supply are:
a. ___________________________________________________
b. ___________________________________________________
c. ___________________________________________________
17. Which of the three tools the Fed uses to manage the money supply is:
a. most commonly used: ______________________________________
b. most powerful: ____________________________________________
18. Describe what happens in the economy when the Fed increases the reserve requirement.
What is the result of a decrease in the reserve requirement?
19. When using open market operations, what actions does the Fed take when it wants to:
a. decrease the money supply: _______________________________________________
________________________________________________________________________
b. increase the money supply: _______________________________________________
________________________________________________________________________
20. Why is the Fed often called the banker’s bank?
21. An increase in the discount rate by the Fed: _____________________________________
____________________________________________________________________________
A decrease in the discount rate by the Fed: ______________________________________
____________________________________________________________________________
22. What is the federal funds rate?
23. Why do banks encourage forms of payment when customers are making purchases outside of their local area?
24. Why were colonists forced to use barter for goods?
25. Why did Massachusetts begin issuing its own paper money?
Why did this continental currency become worthless?
26. Land banks were established to _________________________________________________.
27. Describe the evolution of the “central bank.”
28. Describe the state of banking by the time of the Civil War.
29. The Federal Reserve System was designed to___________________________________.
30. What led to the bank failures of the 1930’s?
31. What actions did congress take in 1933 and 1935 to strengthen the banking system?
Learning Goal 4
32. Identify four types of banking institutions.
a. _____________________________________________________
b. _____________________________________________________
c. _____________________________________________________
d. ____________________________________________________
33. What kinds of institutions are included in a list of nonbanks?
34. What are two types of customers for commercial banks?
a. ___________________________________________________
b. ___________________________________________________
35. How does a commercial bank make a profit?
36. Describe the characteristics of a certificate of deposit (CD) including how interest rates are determined.
37. Identify the services offered by commercial banks in addition to checking (demand deposits) and savings accounts (time deposits):
a. ____________________________ g. ____________________________
b. ____________________________ h. ____________________________
c. ____________________________ i. ____________________________
d. ____________________________ j. ___________________________
e. ____________________________ k. ____________________________
f. ____________________________ l. ____________________________
38. What services are being offered through ATMs?
39. What is another name for savings and loans institutions, and why are they known as such?
40. Why did so many S&Ls fail between 1979 and 1983?
41. In the 1980s The federal government stepped in to strengthen S&Ls by permitting them to:
a. ________________________________________________________________
b. ________________________________________________________________
c. ________________________________________________________________
d. ________________________________________________________________
42. What services do credit unions offer their members?
43. What has been the result of competition between nonbanks and banks?
44. What financial services are offered by:
a. Life insurance companies ________________________________________________________
_______________________________________________________________________________
_______________________________________________________________________________
c. Brokerage firms ________________________________________________________________
_______________________________________________________________________________
d. Commercial and consumer finance companies______________________________________
________________________________________________________________________
45. Why do some people believe the Fed was responsible for the recent banking crisis?
46. Describe mortgage backed loans and how they contributed to the crisis.
47. How did the Fed contribute to the problems created by mortgage backed loans when home values began to decline?
48. In the end, the blame for the banking crisis can be placed on:
a. ________________________________________________________________________________
b. ________________________________________________________________________________
c. ________________________________________________________________________________
d. ________________________________________________________________________________
e. ________________________________________________________________________________
49. List the three major sources of financial protection
a. _____________________________________________________________________________
b. _____________________________________________________________________________
c. _____________________________________________________________________________
50. In the case of a bank failure the FDIC : ______________________________________________
________________________________________________________________________________
________________________________________________________________________________
51. Why were the FDIC and the FSLIC created?
52. How was SAIF formed?
53. What does the NCUA provide for?
54. One solution banks have used to reduce the cost of processing checks is to:
_____________________________________________________________________________
The most efficient way to transfer funds is: _______________________________________
55. The benefit of electronic funds transfer is that: ______________________________________
_______________________________________________________________________________
56. What are “Go-Tags”?
57. How is a debit card different from a credit card?
What is a drawback of a debit card compared to credit cards?
58. What are payroll debit cards and how do they work?
59. How are smart cards different from other cards?
60. What is:
a. direct deposit? ______________________________________________________________
____________________________________________________________________________
b. direct payment? _____________________________________________________________
_____________________________________________________________________
61. What banking services are available to customers through online banking?
62. Benefits online banks can offer to customers include: _____________________________
_______________________________________________________________________________
63. How have customers responded to Internet banks? Why?
64. In banking the future seems to be__________________________________________
_________________________________________________________________________
Learning Goal 7
65. What three services are offered to banks to help businesses conduct business overseas?
66. What could be the international impact of the Federal Reserve System changing interest rates?
67. The net result of international banking and finance has been: ____________________________
__________________________________________________________________________________
__________________________________________________________________________________
__________________________________________________________________________________
68. The World Bank is primarily responsible for: __________________________________________
69. The World Bank now lends most of its money to _______________________________________
__________________________________________________________________________________
70. What criticisms have been aimed at the World Bank?
71. What is required by the International Monetary fund?
a. _______________________________________________________________
b. _______________________________________________________________
c. _______________________________________________________________
72. What is the IMF designed to oversee? What is the goal of the IMF?
Learning Goals 1,2
1. Using what you have learned in this chapter as well as in other chapters about economics, answer this question: What is the importance of the stability of the value of money, and controlling the money supply in the international marketplace today?
2 Sun-2-Shade is a company that makes self-darkening windshields for the automotive industry. Sun-2-Shade has made it big! The company has done so well here in the U.S. that management is seriously considering expanding into overseas markets. It is your job to research the idea, and you want to begin by helping other top managers understand some of the considerations of "going global.” Within the context of the "value" of money compared to other currencies, what are some of the issues you will want to bring up to your managers?
3. The Fed uses three major tools to control the money supply
Reserve requirement
Open market operations
Discount rate
a. Complete the following chart illustrating how each tool is used, and its effect on the money supply and the economy:
EFFECT ON EFFECT ON
TOOL ACTION MONEY SUPPLY ECONOMY
Reserve Increase reserve ________________ _______________
requirement requirement
Decrease reserve ________________ _______________
requirement
Open market Buy government ________________ _______________
Operations securities
Sell government ________________ _______________
securities
Discount rate Increase discount ________________ _______________
rate
Decrease discount ________________ _______________
rate
b. Identify whether the Federal Reserve would increase or decrease the money supply in the following situations, and what the effect would be .
1. High unemployment ___________________________________________
2. High rates of inflation ___________________________________________
4. When the Fed regulates the money supply using one of the three tools just mentioned, what happens to interest rates overall?
Learning Goal 3
5. The American banking system has a long history. List the major events that led up to the establishment of the Federal Reserve System, and subsequent events that have affected the American banking system.
a. ___________________________________________________________________________
b. ___________________________________________________________________________
c. ___________________________________________________________________________
d. ___________________________________________________________________________
e. ___________________________________________________________________________
f. ___________________________________________________________________________
g. __________________________________________________________________________
h. ___________________________________________________________________________
i. ___________________________________________________________________________
j. __________________________________________________________________________
k. __________________________________________________________________________
l. __________________________________________________________________________
Learning Goal 4
6. The American banking system consists of three types of organizations:
Commercial banks
Savings and loans
Credit unions
Match each of the following descriptions to the correct type of institution:
a. ____________ Offers interest-bearing checking accounts called share draft accounts at relatively high rates.
b. ____________ Also known as thrift institutions.
c. ____________ Offer a wide variety of services, to depositors and borrowers, including ATMs, credit cards, short and long term loans, financial counseling, automatic payment of telephone bills, safe deposit boxes, tax deferred individual retirement accounts, overdraft checking account privileges.
d. ____________ Since the 1980s have been able to offer higher interest rates, allocate up to 10% of their funds to commercial loans, and offer adjustable rate mortgages.
e. ____________ Since they are member owned and non-profit, they are exempt from federal income taxes.
7. How are credit unions different from commercial banks and S&Ls?
8. Describe how nonbanks are becoming an important financial force, and how they compete with traditional banking institutions.
Learning Goal 5
9. Do some research on the housing and banking crisis in your geographic area. How have the decline in housing prices and the resulting banking crisis affected your area? Have housing prices declined in the same proportion as the national decline? What actions have banks in your area undertaken to get your business to try to stay afloat? Have any banks closed in your area as a result of the crisis? (Hint: a quick way to determine what housing prices have done in your area is simply to do a google search, using your city name along with “housing prices”. You can also search to get more information about the banking crisis by googling banking crisis, timeline, or any other descriptor that you find interesting.)
10. What is the difference between FDIC, SAIF, and NCUA? Why were the FDIC, and the predecessor to SAIF, (known as the FSLIC) created?
11. In your opinion, with today’s economic conditions, and the competitive banking industry, is it still important to have organizations such as the FDIC, SAIF and the NCUA?
12. Compare what you have learned in earlier chapters about the trends in businesses to become more efficient and competitive to the trends in the U.S. banking industry.
13. In previous chapters, we have discussed the global nature of the marketplace, and the need for U.S. businesses to become and stay more competitive. How does what we have learned in those chapters about U.S. business, relate to international banking, and the U.S. banking industry?
Learning Goal 1
1. Today many people have found that bartering
a. can be done online.
b. has been eliminated by the ease of cash transactions.
c. become more difficult because it’s hard to find people with whom to barter.
d. has become obsolete in most countries.
2. Which of the following would not be included in a list of characteristics of money?
a. Portability
b. Divisibility
c. Stability
d. Usability
Learning Goal 2
3. In referring to the money supply, which of the following is money that can be accessed quickly and easily , and includes coins and paper money as well as checks?
a. M-1
b. M-2
c. M-3
d. money supply
4. The term _____________is used to describe the situation of “too much money chasing too few goods.”
5. When the price of a European coffee maker becomes less expensive to buy here in the
United States, you could say that we are experiencing a
a. falling dollar.
b. inflated dollar.
c. rising dollar.
d. stable dollar.
6. When the Fed increases the reserve requirement,
a. interest rates will go down.
b. banks will have more money to lend.
c. inflation could go up.
d. banks have less money to lend.
7. The discount rate is:
a. the amount of money member banks must keep on hand at the Fed.
b. the interest rate Fed charges for loans to member banks .
c. the rate the Fed charges for selling bonds.
d. the interest rate banks charge other banks.
8. Maria Reta-Martinez read a news article that the Fed is buying back government bonds that people are willing to sell. Maria determined that the Fed
a. is trying to slow down the economy by reducing the money supply.
b. is trying to raise interest rates to keep the economy from growing too quickly
c. is trying to combat inflation by taking money out of circulation.
d. is increasing the money supply in an attempt to stimulate the economy.
Learning Goal 3
9. The bank failures of 1907 and the resulting cash shortage problems led to the creation of
a. the Federal Reserve System.
b. the gold standard.
c. monetary policy.
d. the money supply.
10. After the stock market crash of 1929, and the resulting bank failures of that time, Congress passed legislation creating:
a. laws which prevented banks from failing.
b. the Federal Reserve System.
c. federal deposit insurance.
d. nonbanks.
Learning Goal 4
11. The technical name for a savings account is a:
a. demand deposit.
b. time deposit.
c. certificate of deposit.
d. deposit insurance.
12. Which of the following organizations would be considered a nonbank institution?
13. Which of the following services would not be offered to customers by commercial banks?
b. inexpensive brokerage services
c. pension funds
d. traveler’s checks
14. Competition between banks and nonbanks, such as insurance companies and pension funds, has
a. decreased with the deregulation of the banking industry.
b. not changed in 50 years, since the creation of the Federal Reserve System.
c. increased significantly as nonbanks offer many of the services provided by regular banks.
d. stabilized with the economic crisis of 2008-2010.
Learning Goal 5
15. The Federal Deposit Insurance Corporation insures accounts up to:
a. $10,000.
b. $50,000.
c. $100,000.
d. $500,000.
16. Funds in savings and loan institutions are protected by:
a. Federal Deposit Insurance Corporation (FDIC).
b. National Credit Union Association (NCUA).
c. Federal Savings and Loan Insurance Corporation (FSLIC).
d. Savings Association Insurance Fund (SAIF).
Learning Goal 6
17. Smart cards
a. are a new credit card offered by nonbanks.
b. combine the functions of credit cards, debit cards, phone cards and other types of cards.
c. are a form of direct deposit.
d. allow employers to make direct payments to your creditors.
18. Internet Banking:
a. are few in number and not expected to grow.
b. allows customers to do all financial transactions from home.
c. have higher expenses because they have to hire administrators of the online systems and software designers.
d. will most likely continue in organizations that offer traditional banking facilities as well as online services.
Learning Goal 7
19. A ________________ is a way of conducting business overseas which promises that a bank will pay some specified amount at a particular time, with no conditions imposed.
a. guarantee a certain exchange rate
b. offer letters of credit
c. bankers acceptance
d. money exchange
20. The organization which is responsible for financing economic development is the:
a. Federal Reserve Bank.
b. International Monetary Fund.
c. World Bank.
d. Bank of the Americas.
21. The World Bank:
Learning Goal 1
1. _____ The banking system is becoming simpler as the flow of money from one country to another becomes freer.
2. _____ Bartering is still used by buyers and sellers, online as well as face to face in some developing nations.
3. _____ In order to make money more difficult to counterfeit, the U.S. has changed the look of some of the denominations of its paper currency.
Learning Goal 2
4. _____ If there is too much money in the economy, prices will go up because people will bid up the prices of goods and services, causing inflation.
5. _____ There are 15 Federal Reserve Banks.
6. _____ An increase in the reserve requirement would encourage businesses to borrow money and thus stimulate the economy.
7. _____ The most powerful tool used by the Fed to control the money supplyis open market operations.
Learning Goal 3
8. _____ Continental currency, the first paper money printed in the United States, became very valuable over the years as the first form of money used in the U.S.
9. _____ The Federal Reserve system was created after the stock market crash of 1929 to help control the run on banks.
Learning Goal 4
10. _____ Commercial banks have two types of customers – borrowers and lenders.
11. _____ A certificate of deposit has a maturity date, and that is when interest is paid.
12. ____ Commercial banks are offering a wider variety of services, such as brokerage services, financial counseling, automatic payment of bills, and IRAs.
13. ____ Nonbanks are becoming more competitive with other financial organizations and are offering many of the same services
Learning Goal 5
14. ____ The only type of institution in which funds are protected by the U.S. government is a commercial bank.
15. ____ The SAIF is part of the FDIC and was originally known as the FSLIC.
Learning Goal 6
16. ____ Bankers are encouraging transactions that utilize an electronic funds transfer system, as EFT reduces costs.
17. ____ Debit cards are the same as smart cards and offer the same functions.
18. ____ Direct deposit is a preauthorized electronic payment into a merchant’s account.
Learning Goal 7
19. ____ The result of international banking has been to link the economies of the world into one interrelated system with no regulatory control.
20. ____ The International Monetary Fund has the responsibility of assisting the smooth flow of money among nations.
1. Credit unions |
10. Electronic Funds Transfer |
19. Federal Deposit Insurance |
2. M-3 |
11. Savings Association |
20. Open-market operations |
3. Reserve requirement |
12. Debit card |
21. M-2 |
4. Time deposit |
13. Barter |
22. Demand deposit |
5. Banker’s acceptance |
14. Savings and Loan Association |
23. International Monetary |
6. Money |
15. Money supply |
24. World Bank |
7. Discount rate |
16. Letter of credit |
25. M-1 |
8. Nonbanks |
17. Pension funds |
26. Smart card |
9. Certificates of deposit (CD) |
18. Commercial bank |
|
1. A barter exchange is an service where you can put goods and services into the system and get trade credits for other goods and services you need. It makes it easier to barter because you don’t have to find people to barter with, as the exchange does that for you.
2. Five characteristics of a “useful” form of money are:
a. Portability – money needs to be easy to carry around
b. Divisibility – different sized coins are made to represent different values
c. Stability – the value of money is more stable (unlike the value, or prices, of bartered goods)
d. Durability – Coins last for a long time
e. Uniqueness - money must be hard to counterfeit or copy, so it must be elaborately designed
3. Electronic, or e-cash is the latest form of money. You can e-mail e-cash to anyone using websites, and make online bill payments.
4. These terms stand for different definitions of the money supply. M-1 includes coins and paper bills, money that is available by writing checks and money that is held in traveler's checks or money that is easily available to pay for goods and services. M-2 includes all of that, but adds in money held in savings accounts and other forms of savings that is not as readily available. M-2 is M-2 plus big deposits like intuitional money-market funds.
M-2 is the most commonly used definition of money.
5. If the Fed made too much money available, prices would go up, assuming that the same amount of goods and services were available. People would bid up prices to get what they want, causing inflation. This could be called “too much money chasing too few goods.”
6. If money were taken out of the economy prices would go down because there would be an oversupply of goods and services compared to the money available to buy them.
7. The money supply needs to be controlled because this allows us to manage the prices of goods and services. Also, controlling the money supply affects employment and economic growth or decline.
8. A falling dollar means that the amount of goods and services you can buy with a dollar goes down.
A rising dollar means that the amount of goods and services you can buy with a dollar goes up.
The prices you pay for a European good would be lower if the American dollar was strong relative to the euro. When the euro gains strength and rises in value against the dollar, the cost of European goods goes up.
9. What makes a dollar weak or strong (falling or rising dollar) is the position of the U.S. economy relative to other economies.
10. When the economy is strong, the demand for dollars is high, and the value of the dollar rises.
When the economy is weak, the demand for dollars declines, and the value of the dollar falls.
So, the value of a dollar depends upon a strong economy.
11. The Federal Reserve System (the Fed) is in charge of monetary policy.
12. The Federal Reserve System consists of
a. The board of governors
b. The Federal Open Market Operations
c. 12 Federal Reserve Banks
d. Three advisory councils
e. The member banks of the system
13. The primary function of the board of governors is to set monetary policy. The board of governors also administers and supervises the 12 Federal Reserve System banks.
14. The Federal Open Market Committee has 12 voting members and is the policy-making body. The committee is made up of the seven members of the Board of Governors plus the president of the New York Reserve Bank. Four others rotate in from the other Reserve Banks. The advisory councils offer suggestions to the board and the FOMC. The councils represent the various banking districts, consumers, and member institutions, including banks, savings and loans, and credit unions.
15. The Federal Reserve
a. buys and sells foreign currencies.
b. regulates various types of credit.
c. supervises banks.
d. collects data on the money supply and other economic activity.
g. buys and sells government securities.
16. The three tools the Fed uses to manage the money supply are:
a. reserve requirements
b. open-market operations
c. the discount rate
17. a. The most commonly used tool to manage the money supply is open market operations.
b. The most powerful tool the Fed uses is the reserve requirement.
18. When the Fed increases the reserve requirement banks have less money to loan, and money becomes scarce. In the long run, this tends to reduce inflation. It is so powerful because of the amount of money affected when the reserve is changed.
A decrease in the reserve requirement increases the funds available to banks for loans, so banks make more loans, and money becomes more readily available. An increase in the money supply stimulates the economy to achieve higher growth rates but can also create inflationary pressures.
19. a. To decrease the money supply, the federal government sells U.S. government securities to the public. The money it gets as payment is taken out of circulation, decreasing the money supply.
b. If the Fed wants to increase the money supply, it buys government securities from individuals, corporations, or organizations that are willing to sell.
20. One reason the Fed is called the banker’s bank is that member banks can borrow money from the Fed and then pass it on to their customers as loans. The discount rate is the interest rate that the Fed charges for loans to member banks.
21. An increase in the discount rate by the Fed discourages banks from borrowing and consequently reduces the number of available loans, resulting in a decrease in the money supply.
A decrease in the discount rate encourages member bank borrowing and increases the funds available for loans, which increases the money supply.
22. The federal funds rate is the rate that banks charge each other.
23. When you write a check from out of state, the process becomes much more long and involved than writing a check to a local retailer. It is a complex and costly process, so banks encourage the use of credit cards, debit cards and other forms of electronic transfers.
The History of Banking and the Need for the Fed
24. Strict laws in Europe limited the number of coins that could be brought to the New World by colonists, and besides, there were no banks in the colonies. So, colonists were forced to barter for goods.
25. Massachusetts issued its own paper money in 1690 because the demand for money was so great.
This money was called continental currency, and it became worthless after a few years because people didn’t trust its value.
26. Land banks were established to lend money to farmers.
27. In 1791, Alexander Hamilton persuaded Congress to form a central bank, a bank where banks could keep their funds and borrow funds if needed. It was the first version of a federal bank, but closed in 1811. It was replaced in 1816 because state chartered banks couldn’t support the War of 1812. The Central Bank was closed again in 1836.
28. By the time of the Civil War, banking was a mess. Different banks issued different currencies. During the war, coins were hoarded because they were worth more as gold and silver than as coins. The problems with the banking system continued after the Civil War and climaxed in 1907 when people got so nervous about the safety of banks that they withdrew their funds, creating a “run on the banks.” People began to distrust the banking system in general.
29. The Federal Reserve System was designed to prevent a repeat of the 1907 banking panic.
30. The stock market crash of 1929 led to bank failures in the early 1930s. The stock market began tumbling, and people ran to the bank to get their money out. In spite of the Federal Reserve, banks ran out of money, and states were forced to close banks.
31. In 1933 and 1935 Congress passed legislation to strengthen the banking system, to further protect us from bank failures. The most important move was to establish federal deposit insurance.
Learning Goal 4
32. a. Commercial banks
b. Savings and loan associations
c. Credit unions
d. non-banks
33. Institutions included in a list of nonbanks are:
a. Pension funds
b. Insurance companies
c. Commercial finance companies
d. Consumer finance companies
e. Brokerage firms
34. Two types of customers for commercial banks are
a. Depositors
b. Borrowers
35. A commercial bank uses customer deposits as inputs, on which it pays interest, and invests that money in interest-bearing loans to other customers. Commercial banks make a profit if the revenue generated by loans exceeds the interest paid to depositors plus all other operating expenses.
36. Certificates of deposit deliver interest at the end of the maturity date. The depositor aggress not to withdraw any of the funds until then. They are available for periods of three months up to many years; the longer the CD is to be held, the higher the interest. Interest rates depend on economic conditions and the prime rate at the time of the deposit.
37. Services offered by commercial banks in addition to checking accounts (demand deposits) and savings accounts (time deposits) include:
38. ATMs can dispense maps and directions, phone cards, and postage stamps. They can sell tickets to movies, concerts, sporting events and more. They can show movie trailers, news tickers, and video ads. Some can take orders for flowers and DVDs, and download music and games.
39. S&L’s are often known as thrift institutions since their original purpose was to promote consumer thrift, or saving, and home ownership.
40. Between 1979 and 1983 many savings and loan institutions failed for a variety of reasons. The biggest reason may be the fact that capital gains taxes were raised, making investments in real estate less attractive. Investors walked away from their real estate loans, and left S&Ls with property that was worth less than the money the S&L had loaned to the investors. When the property was sold, the S&Ls lost money.
41. In the 1980s the government stepped in to strengthen S&Ls by permitting them to:
a. offer higher interest rates
b. allocate up to 10 percent of their funds to commercial loans
c. offer mortgage loans with adjustable interest rates.
d. offer banking services such as financial counseling to small businesses, and credit cards.
42. Credit unions offer their members the full variety of banking services: interest-bearing checking accounts at relatively high rates, short-term loans at relatively low rates, financial counseling, life insurance and a limited number of home mortgage loans.
43. The diversity of financial serves and investment alternatives offered by nonbanks has led banks to expand the services that they offer. As competition between banks and nonbanks has increased, the dividing line between them has become less apparent. In fact, banks today are merging with brokerage firms to offer full-service financial assistance.
44. a. Life insurance companies provide financial protection for their policyholders. They invest the funds they receive from policy holders in corporate and government bonds. Recently more insurance companies have begun to provide long-term financing for real estate development companies.
b. Pension funds are amounts of money put aside by organizations to cover part of the financial needs of members when they retire. A member may begin to collect a monthly draw on the fund upon reaching a certain age. To generate additional income, pension funds invest in low return, but safe corporate stocks or in other conservative investments.
c. Brokerage firms have traditionally offered services related to investments in various stock exchanges. They have now made inroads into regular banks’ domain by offering high-yield combination savings and checking accounts. In addition firms offer checking privileges on accounts. Investors can also get loans from their broker using their securities as collateral.
d. Commercial and consumer finance companies offer short-term loans to businesses or individuals who either cannot meet other credit requirements or who have exceeded their credit limit and need more funds. These finance companies’ interest rates are higher than those of regular banks.
45. Some people believe the Federal Reserve is responsible because it kept the cost of borrowing so low that people borrowed more than they could pay. Congress wanted more affordable housing and prodded banks to lend to people with minimal assets
46. Organizations pressured banks to make risky loans. Banks learned they could avoid much of the risk by dividing their portfolios of mortgages up and selling the “mortgage backed loans” to other banks all over the world. The securities seemed safe because they were backed by the homes that were mortgaged, and seemed to be guaranteed by Fannie Mae and Freddie Mac.
Banks sold many of these securities hoping to make money, and were accused of pushing loans onto naïve customers.
47. The Fed failed in their duties by failing to issue sufficient warnings. When home values began to decline, people began defaulting on their loans and the properties were turned back over to the banks. Since the banks owned the mortgages on the homes, bank profits dropped dramatically, which led to the banking crisis of 2008-2010 and the need for the government to help out the banks.
48. In the end, the blame for the banking crisis can be placed on:
a. The Federal Reserve System
b. Congress for promoting questionable loans
c. Banks for making risky loans and selling mortgage backed securities as safe investments
d. government regulatory agencies for not doing their job
e. people who took out loans they couldn’t repay
49. a. Federal Deposit Insurance Corporation (FDIC)
b. Savings Association Insurance Fund (SAIF)
c. National Credit Union Administration (NCUA)
50. If a bank were to fail, the FDIC would arrange to have its accounts transferred to another bank or pay off depositors up to a certain amount.
51. The FDIC and the FSLIC were started during the 1930s. Many banks and thrifts failed during those years, and people were losing confidence in them. The FDIC and FSLIC were designed to create more confidence in banking institutions.
52. The government placed the FSLIC under the FDIC, in order to get more control over the banking system. When they did that, they gave it a new name, the Savings Association Insurance Fund, or SAIF
53. The NCUA provides up to $100,000 coverage per individual depositor per institution. The coverage includes all accounts, and additional protection can be obtained by holding accounts jointly or in trust.
54. One solution banks have used to reduce the cost of processing checks is to issue credit cards. However credit cards also have costs.
The most efficient way to transfer funds is the electronic exchange of money, rather than the physical exchange of money.
55. The benefit of EFT is that funds can be transferred more quickly and more economically than with paper checks.
56. “Go Tags” are pea-shaped chips with a radio transmitter inside that can stick to a cell phone or ID badge to make payments fast and easy. They are faster than a credit card.
57. A debit card serves the same function as a check, in that it withdraws money directly from a checking account. Debit cards look like credit cards but they function differently. The difference is that you can spend no more than is in your checking account. When a sale is recorded, an electronic signal is sent to the bank, and funds are automatically transferred from your account to the retailer’s account. A record of the transaction appears immediately.
The drawback for debit cards is that they don’t offer the same protection in the case of a stolen card. You are liable for everything.
58. Payroll debit cards are a way that some firms pay their workers, and are an alternative for those who don’t qualify for a credit or debit card. Employees can access funds in their accounts immediately after they are posted, withdraw them from an ATM, pay bills online or transfer funds to another cardholder.
The system is cheaper for companies than issuing checks.
59. Smart cards are a combination of credit cards, debit cards, phone cards, and more. The magnetic strip found on other cards is replaced on a smart card with a microprocessor. The card can then store information, including a bank balance. Each merchant can use the information to check the card’s validity and spending limits, and the transaction can debit the amount on the card. Some smart cards are used to allow entrance into buildings and secure areas, such as university dorms, to buy items, and serve as ATM cards. Parents can use smart cards to monitor children’s transactions.
60. a. Direct deposit credit made directly to a checking or savings account.
b. A direct payment is a preauthorized electronic payment. A customer signs a form when he or she wants automatic payment to a certain company, and the designated company is authorized to collect funds for the amount of the bill from the customer’s account.
61. Online banking services include transferring funds, paying your bills, and checking on account balances. You can apply for a car loan or mortgage online and get a response immediately. You can also buy and sell stocks online.
62. Benefits online banks can offer include better interest rates and lower fees because they do not have the cost of physical overhead traditional banks have.
63. Many consumers are pleased with the savings and convenience, but not all consumers are happy with the service they receive from Internet banks. Many are nervous about the security of banking online. People fear putting their financial information into cyberspace where others may see it. Also, consumers often want to talk to a knowledgeable person when they have banking problems.
64. In banking the future seems to be with traditional banks that offer both online services and brick and mortar facilities.
Learning Goal 7
Leaders in International Banking
65. Banks help businesses conduct business overseas by providing:
66. If the Federal Reserve decides to lower interest rates, foreign investors can withdraw their money from the United States and put it in countries with higher rates.
The opposite is also true, so that when the Fed raises interest rates, money could come into the U.S. just as quickly.
67. The net result of international banking and finance has been to link the economies of the world into one interrelated system with no regulatory control. American firms must compete for funds with firms all over the world. Global markets mean that banks don’t necessarily keep their money in their own countries. They make investments where they can get the maximum return.
68. The World Bank is primarily responsible for financing economic development.
69. The World Bank now lends most of its money to less-developed nations to improve productivity and help to raise standards of living and quality of life.
70. Environmentalists charge that the World Bank finances projects that damage the ecosystem. Human rights activists argue that the bank supports countries that restrict religious freedoms and tolerate sweatshops. AIDS activists complain that the bank does not do enough to get low-cost drugs to developing nations.
71. The International Monetary fund was established to assist the smooth flow of money among nations. It requires:
a. members to allow their currency to be exchanged for foreign currencies freely
b. members to keep the IMF informed about changes in monetary policy
c. nations to modify those policies on the advice of the IMF to accommodate the needs of the entire membership.
72. The IMF is an overseer of member countries’ monetary and exchange rate policies. The IMF’s goal is to maintain a global monetary system that works best for all nations and enhances world trade.
Learning Goals 1,2
1. The stability of the value of money in the global marketplace is important because if the value of money is not stable, other countries will not accept that money in trade. In other words, if the marketplace believes your money will not be valuable to use, the market will not accept your money as payment for what you want to buy.
The money supply needs to be controlled in order to control prices, and in part, the American economy. If there is too much money in the economy, prices of goods and services will increase, because demand will be greater than supply. If there is less money, people will not be spending at the same rate, demand correspondingly goes down, and prices will go down. That could result in an oversupply of goods and services, and possibly a recession. What makes a dollar weak or strong is the position of the U.S. economy relative to other economies. When the economy is strong, people want to buy dollars and the value of the dollar rises. The value of the dollar depends on a strong economy.
2. Some of the "money" issues Sun-2-Shade will need to research relate to how strong the American dollar is compared to the currency of the countries in which Sun-2-Shade is interested. If our dollar is weak, or falling, in comparison to the euro, the British pound, the Japanese yen, or others, Sun-2-Shade could be very affordable for their target market. If the American dollar is strong, or rising, the price of Sun-2-Shade’s product could be too high for some.
Further, we would want to know what the forecast might be for the future of the U.S. economy. Is our economy expected to be strong? What are the forecasts for recession, inflation, income growth, both here, and in our target countries?
3. a. Tool Action Effect on Effect on
Money supply Economy
Reserve Increase Decrease Slows down
Requirement Decrease Increase Stimulated
Open market Buy securities Increase Stimulated
operations Sell securities Decrease Slows down
Discount rate Increase Decrease Slows down
Decrease Increase Stimulated
b. 1. In a situation of high unemployment, the Federal Reserve may increase the money supply, which would have the effect of reducing interest rates. This would be a tool to stimulate the economy and encourage businesses to borrow, which could create jobs.
2. With high rates of inflation, the Fed may choose to decrease the money supply. This would have the effect of raising interest rates, which may cool the economy and fight inflation.
4. When the Fed takes action to increase the money supply, (either by decreasing the reserve rate, decreasing the discount rate or buying government bonds) interest rates will go down. Think of interest as the price of money. When the supply goes up, the price will generally go down. Correspondingly, if interest rates have declined, demand for goods and services could go up, the economy begins to grow, and inflation may begin to heat up. The opposite effect occurs when the Fed reduces the money supply. Interest rates will rise, which will slow demand for goods and services, which slows economic growth. Inflation will also then slow down, as supply begins to be equal to or exceed demand, and prices will stabilize.
Learning Goal 3
5. a. Paper money established in 1690.
b. Land banks established to lend money to farmers.
c. Central bank established in 1781.
d. Central bank closed in 1811.
e. Second central bank established 1816
f. Division between state banks and central bank.
g. Central bank closed in 1836.
h. Civil War - banks issuing their own currency.
i. Cash shortage problems in 1907; banks began to fail.
j. Federal Reserve System established in 1907 to lend money to banks.
k. Stock market crash of 1929 and subsequent bank failures in 1930s.
l. Legislation passed to strengthen banking system, establishing federal deposit insurance in 1933 and 1935.
Learning Goal 4
6. a. Credit unions
b. Savings and loan
c. Commercial banks
d. Savings and loan
e. Credit union
7. Credit unions offer services similar to banks and S&Ls, but differ in their ownership structure. Credit unions are financial cooperatives, owned by members, while banks and savings and loans are often publicly held corporations. Credit unions are also not for profit institutions, while banks and credit unions are profit-making organizations.
8. Nonbanks are financial institutions that accept no deposits but offer many of the services offered by regular banks. Nonbanks include life insurance companies, pension funds, brokerage firms, commercial finance companies, and corporate financial services. The diversity of financial services and investment alternatives offered by nonbanks has caused banks to expand the services they offer. For example, life insurance companies invest the funds they receive from policyholders in corporate and government bonds. In recent years, more insurance companies have begun to provide long-term financing for real estate development projects. In fact, banks today are merging with brokerage firms to offer full service financial assistance. Pension funds typically invest in corporate stocks and bonds, and government securities. Some large pension funds lend money directly to corporations. Brokerage houses have made serious inroads into regular banks’ domain by offering high-yield combination savings and checking accounts. In addition, investors can get loans from their broker.
Learning Goal 5
9. The answers to this will vary of course depending upon where you live. Housing prices in the St. Louis area for example did not decline as dramatically as those nationally.
10. The FDIC is a government agency that protects bank deposits of up to $100,000. In the case of a bank failure, the FDIC would arrange to have your accounts at that bank transferred to another bank, or pay you off up to $100,000. The FDIC covers about 13,000 institutions, which are mostly commercial banks. SAIF insures the accounts of depositors in thrift institutions, or savings and loans. It is part of the FDIC. SAIF was originally called the Federal Savings and Loan Insurance Corporation. NCUA is the agency that protects depositors in credit unions.
Both the FDIC and the FSLIC were established to protect the deposits of customers, and to create more confidence in the banking industry at a time when many institutions were failing. This was during the Great Depression, and hundreds of banks were failing. To get more control over the banking system, the government placed the FSLIC under the FDIC and gave it the name of The Savings Association Insurance Fund, SAIF.
11. Answers will vary. Economic conditions to consider would be the American economy - are we coming out of the recession? Will we experience a period of inflation? Other factors to consider are the current mortgage and banking crisis and the competitive factors in the banking industry. With nonbanks performing significantly more banking functions, how are banks competing? How does this affect the banks’ profitability? If banks are struggling to stay in business, then insurance on our funds remains an important security.
12. Trends in the banking industry have paralleled changes we have seen in other industries. We have studied how companies have begun putting the customer first, and have streamlined their operations to better satisfy customer’s needs at lower costs. Banks have begun to look at customer needs, and have made “one-stop shopping” available for all a customer’s financial needs. One company can provide you with credit cards, mortgages, all kinds of insurance, and brokerage services. As the competition increases, costs will go down, benefiting consumers.
Banks have applied updated technology to their services, offering services like debit cards, payroll debit cards, smart cards, direct deposit and direct payment features.
Further, the Internet has made online banking available, in the same way that the Internet has made the purchase of all kinds of products available from Internet stores. The online banking industry has suffered from customer service problems, just like online stores have done, and so, like other retail businesses, we will likely have a combination of online and brick and mortar financial institutions.
Learning Goal 7
13. The U.S. banking system is directly tied to the success of banking and businesses throughout the world. American firms must compete for funds with firms all over the world. If a firm in another country is more efficient than one here in the United States, the more efficient firm will have better access to international funds. Therefore, U.S. businesses must compete not only in the marketplace, but in the financial arena as well.
Further, today's money markets form a global system, and international bankers will not be nationalistic in their dealings. They will send money to those countries where they can get the best return on their money with an acceptable risk. When the Federal Reserve System makes a move to lower interest rates in the U.S., foreign investors may withdraw their money from the U.S. and put it in countries with higher rates. To be an effective player in the international marketplace and financial worlds, the U.S. must stay financially secure and businesses must stay competitive in world markets.
MULTIPLE CHOICE TRUE-FALSE
1. a 12. a 1. F 11. T
2. d 13. c 2. T 12. T
3. a 14. c 3. T 13. T
4. b 15. c 4. T 14. F
5. c 16. d 5. F 15. T
6. d 17. b 6. F 16. T
7. b 18. d 7. T 17. F
8. d 19. c 8. F 18. F
9. a 20. c 9. F 19. T
10. c 21. a 10. F 20. T
11. b
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