Money, Banking, and International Finance
However, they are persuaded to invest in a longer-term security if they receive a higher
interest rate, the term premium. Preferred habitat theory does the best in explaining the yield
curve.
- When a yield curve has a negative slope, the investors are pessimistic about the future, and
the economy usually enters a recession a year later.
Answers to Chapter 10 Questions.........................................................
- Liabilities are demand deposits, savings accounts, small and large-denomination time
deposits, borrowings, discount loans, and federal funds (if the bank borrowed funds). Assets
include vault cash, deposits at other banks, deposits at the Federal Reserve, loans, and
bank’s physical assets like its buildings and computers. Capital reflects a bank’s net worth.
- A bank’s net worth equals bank’s total assets minus total liabilities. Investors want a positive
net worth because the stockholders receive assets if the bank is liquidated.
- Liquidity risk is the risk that depositors show up at the bank and withdraw too much at one
time. Consequently, the banks must use good management to meet depositors' withdrawals.
- Something severe happens to a bank that causes total liabilities to exceed total assets.
- Banks use credit risk analysis, collateral, credit rationing, and restrictive covenants to reduce
adverse selection. Furthermore, banks could foster a long-term relationship with their
customers.
- Housing bubble popped, causing housing prices to plummet. If a bank forecloses on a home
that is losing value, then too many foreclosures cause total liabilities to exceed total assets.
- Banks split their assets and liabilities into long term and short term. Then banks scrutinize
the short-term assets and liabilities because if the interest changes, subsequently, it
immediately impacts these assets and liabilities. Banks can develop strategies, whether a
bank manager believes interest rates will rise or fall.
- Floating rate debt is loans with a variable interest rate. If the interest rate increases, then
borrowers must pay more interest on their payments.
- Securitization is the bundling of illiquid assets like mortgages into a fund. Then this fund
allows investors to invest in it. A fund offers different tranches with different credit ratings
and rates of return.
- This is really a tough question. If banks retained their rigid lending standards and the credit-
rating agencies accurately rated the CDOs and ABS, then the housing bubble would still
