Solution manual for The Economics of money banking and financial markets 13th global edition by Frederic S. Mishkin All Chapters 1-26

Instructor’sResourceManual for
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The Economics of Money,
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Banking,andFinancialMarkets
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TheEconomicsof 7u 7u




7u Money,Banking,and 7u 7u




Financial Markets
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ThirteenthEdition,GlobalEdition 7u 7u 7u




Frederic S. Mishkin 7u 7u




New York, NY
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, Answers
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7u QuestionsandProblems 7u 7u




Chapter 1 7u




ANSWERS TO QUESTIONS 7u 7u




1. What is the typical relationship among interest rates on three-month Treasury bills,
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long-term Treasury bonds, and Baa corporate bonds?
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The interest rate on three-month Treasury bills fluctuates more than the other interest rates
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and is lower on average. The interest rate on Baa corporate bonds is higher on average
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than the other interest rates.
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2. What effect does high volatility of financial markets have on people's willingness to
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spend?
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The high volatility of financial markets decreases people's willingness to spend,
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primarily because it directly affects their wealth, and also because high volatility
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indicates that there are considerable fluctuations in the prices of securities over a short
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time span. It increases insecurities about the future of an economy. Refer to Figure 2 to see
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the extremelyvolatile nature of stock prices between 1950 and 2020.
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3. Explain the main difference between a bond and a common stock. 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




A bond is a debt instrument, which entitles the owner to receive periodic amounts of
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money (predetermined by the characteristics of the bond) until its maturity date. A
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common stock, however, represents a share of ownership in the institution that has issued
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the stock. In addition to its definition, it is not the same to hold bonds or stock of a given
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corporation, since regulations state that stockholders are residual claimants (i.e., the
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corporation has to pay all bondholders before paying stockholders).
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4. What is the main role of a financial intermediary? Name two financial
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intermediaries.
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A financial intermediary is a firm or institution that channels savings into investments––
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that is, it borrows funds from individuals who have saved and provides loans to those who
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need funds. Banks and mutual funds are two examples of such intermediaries.
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5. What was the main cause of the global recession in 2020?
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The recession in 2020, sometimes referred to as the COVID-19 Recession, was mainly
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caused bythe global pandemic caused bythe infectious coronavirus disease (Covid-19).
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In March 2020, the stock market fell by 25% in a single month.
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, Accordingto the World Bank’s June 2020 Global Economic Prospects, the volatility 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




induced by the coronavirus pandemic, lockdowns, and other preventive measures taken
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by global economies to contain it have led to a severe contraction in the global economy.
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6. Can you think of a reason why people in general do not lend money to one another to buy a
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house or a car? How would your answer explain the existence of banks?
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Ingeneral,peopledonotlendlargeamountsofmoneytooneanotherbecauseofseveral
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informationproblems.Inparticular,peopledo notknowaboutthecapacityof other peopleof
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repayingtheirdebts,ortheefforttheywill provideto repaytheirdebts.
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Financialintermediaries,inparticularcommercialbanks,tendtosolvetheseproblems by 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




acquiringinformationaboutpotentialborrowersandwritingandenforcingcontracts that
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encouragelenderstorepaytheirdebtand/ormaintainthevalueofthecollateral.
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7. Why are banks important to the financial system?
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Banks are one of the major financial intermediaries. They channel savings from private
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institutions or the general public to other institutions or people who need a loan. Well-
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functioning banks are veryimportant for the savings-to-loans cycle and for the housing 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




market.
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8. Can you date the latest financial crisis in the United States or in Europe? Are there
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reasons to think that these crises might have been related? Why?
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The latest financial crisis in the United States and Europe occurred in 2007–2009. At the
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beginning, it hit mostly the U.S. financial system, but it then quickly moved to Europe,
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since financial markets are highlyinterconnected. One specific wayin which these
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markets were related is that some financial intermediaries in Europe held securities
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backed by mortgages originated in the United States, and when these securities lost their a
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considerable part of their value, the balance sheet of European financial intermediaries
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was adversely affected.
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9. Has the inflation rate in the United States increased or decreased in the past few
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years? What about interest rates?
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Since 2015, inflation hasbeen around 2%, with some brief dipsin 2015 and 2020. In 2015,
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theinterest rateonthree-month Treasury billswas nearzero, and itthen roseto just over 2%
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in 2019, only to fall back near to zero in 2020.-
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10. If history repeats itself and we see a decline in the rate of money growth, what might you
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expect to happen to
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a. real output? 7u




b. the inflation rate? 7u 7u




c. interest rates? 7u




The data in Figures 3, 5, and 6 suggest that real output, the inflation rate, and interest rates
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would all fall.
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11. When interest rates decrease, how might businesses and consumers change their
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economic behavior?
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, Businesses would increase investment spending because the cost of financing this 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




spending is now lower, and consumers would be more likelyto purchase a house or a car
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because the cost of financing their purchase is lower.
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12. Is everybody worse off when interest rates rise?
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No. It is true that people who borrow to purchase a house or a car are worse off because it
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costs them moreto finance their purchase; however, savers benefit because they can earn
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higher interest rates on their savings.
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13. What is the main role of a central bank? Why are central banks, like the European
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Central Bank (ECB), important to financial analysts?
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Central banks oversee the monetarypolicyfor a specific countryor a group of nations (as in
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the case of the ECB). This is done by setting a base interest rate or by forward guidance,
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which impacts the financial and real economy. Since money affects many economic
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variables that are important to the health of an economy, financial analysts (including
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politicians and policymakers) take an interest in the conduct of monetary policy, as well as
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in the management of money and interest rates.
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14. Germany is one of the few countries that has maintained a budget surplus in the last five 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




years, and according to Reuters, the federal government made a record surplus of €13.5
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billion in 2019. How does a budget surplus arise?
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A budget surplus results from tax revenues exceeding government expenditure, which
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leads to lower government debt burdens.
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15. How would a fall in the value of the pound sterling affect British consumers?
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It makes foreign goods more expensive, so British consumers will buyfewer foreign goods
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and more domestic goods.
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16. How would an increase in the value of the pound sterling affect American
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businesses?
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It makes British goods more expensive relative to American goods. Thus, American
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businesses will find it easier to sell their goods in the United States and abroad, and the
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demand for their products will rise.
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17. How can changes in foreign exchange rates affect the profitability of financial
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institutions?
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Changes in foreign exchange rates change the value of assets held by financial institutions 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




andthusleadtogainsandlossesontheseassets.Alsochangesinforeign exchange ratesaffect
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the profitsmade bytraders in foreign exchange who work for financial institutions.
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18. AccordingtoFigure8,inwhichyearswouldyouhavechosentovisittheGrand 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u 7u




Canyon in Arizona rather than the Tower of London?
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In the mid-to-late 1970s, the late 1980s to early 1990s, and 2008 to 2015, the value of the
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dollarwaslow,makingtravelabroadrelativelymoreexpensive;thus,itwasagood time to
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vacation in the United States and see the Grand Canyon. With the rise in the dollar’s value in
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the early1980s, late 1990s, and after 2015, travel abroad became
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