Solution Manual for
Money, Banking, Financial Markets & Institutions 2nd Edition for Brandl Michael
M
Chapter 2-24
ED
CHAPTER 2: Money, Money Supply, and Interest
2-1 Section Review
1. What is the difference between money and currency? When are they the same? Why might they be
different?
C
ANS: Money is anything generally accepted in exchange for goods & services. Currency is issued by a
bank or the government, but currency is not necessarily money. They are the same when they are
O
accepted in exchange for goods and services. Currencies can stop being money if people don’t accept
them in exchange for goods and services. If a group of people stop using currency to get goods and
services but instead use bananas, then the bananas are the money.
N
2. How many prices must a barter economy have if the economy has four goods? What if it has 400
goods? Explain why having a money in the second case is beneficial.
N
ANS: 4 goods = 6 prices; 400 goods = 79,800 prices. Money allows us to specialize and reduce our search
cost. Money allows us to reduce the number of stated prices we need.
O
3. You read a news story about a country that is suffering from rapid, ongoing increases in the cost of
living. Which characteristic of money is being directly negatively impacted in that economy?
IS
a. Unit of account
b. Medium of exchange
c. Store of value
SE
d. Double coincidence of wants
ANS: C
2-2 Section Review
U
1. Bobby is confused. He states: “Since prisoners are not allowed to smoke in prisons any longer,
Radford’s examples of cigarettes in POW camps no longer applies.” How would you explain to Bobby
how Radford’s story demonstrates the concepts of the criteria of money, as well as the importance of
R
changes in the money supply?
ANS: Any asset that is able to be standardized, divisible, durable and in demand could be currency, as
long as it is a medium of exchange, is a unit of account and has store of value. Cigarettes were money.
, 2. Proponents of the Gold Standard, or using gold as money, often argue that it will keep inflation under
control. How does the experience of Europe in the sixteenth century raise doubts about that claim?
ANS: If people start to hoard gold or silver, there may not be enough money, and an economy could
slide into recession. If gold or silver increases too rapidly the economy could suffer inflation.
M
3. Ricardo and Friedman agree that if the money supply increases “too quickly” the following happens:
a. The rate of inflation decreases.
ED
b. The rate of real economic growth increases.
c. The rate of inflation increases.
d. The level of employment decreases.
ANS: C
C
2-3 Section Review
1. A critic of money economics once stated, “if you cannot measure the money supply accurately, it is
O
not worth discussing at all.” How would you refute this statement?
ANS: Due to changes in financial markets, financial innovation and changes in the way banks operate,
led to the decline in the usefulness of M2 as a monetary aggregate.
N
2. Economists are searching for a “good” measurement of the money supply. What constitutes a good
measurement of the money supply?
N
ANS: To economists, a “good” measurement of the money supply is one that conforms to economic
theories regarding inflation and the economy. For example, if the money supply (according to a
O
particular measurement) increases faster than the growth rate of the economy, then economic theory
suggests that inflation should occur. On the other hand, if the money supply (according to a particular
measurement) increases too slowly relative to the growth rate of the economy, then economic theory
IS
suggests that this will result in a recession. When the measurement of the money supply coincides with
these economic predictions, then that particular measurement has the potential to be a “good”
measurement of the money supply. During certain periods of time, both M1 and M2 have been
SE
considered to be “good” measurements of the money supply. However, there have also been periods of
time where the changes in M1 or M2 did not coincide with economic theory.
3. Which of the following is the broadest or most inclusive measurement of the money supply?
a. M1
U
b. M2
c. M3
R
d. M0
ANS: B
, 2-4 Section Review
1. Each person might have a different time preference. Explain why an older person might have a higher
or lower time preference than a young person.
ANS: An older person might have a high time preference, consumer now vs. in the future. The older
M
person will place higher value on the ability to consume now more than money in the future.
2. What is the future value of $500 in two years if the interest rate is 4%? How would you explain this to
someone who has no training in economics?
ED
ANS: 500(1.04)2 = $540.80. For someone without a background in economics, one could explain that
money invested today will grow over time. Thus, in order to have $500 in the future, today you would
only need to invest some amount that is less than $500. How much less depends on the return on your
investment (the interest rate).
C
3. If the annual interest rate is 2%, what is the quarterly interest rate?
a. 0.0204
O
b. 0.0166
c. 0.005
N
d. 0.001
ANS: C
N
O
CHAPTER 3: Bonds and Loanable Funds
IS
3-1 Section Review
1. Today, shoppers “clip coupons” before they go shopping. Explain how these modern coupons are
similar and dissimilar to the “coupons” referred to in the bond market.
SE
ANS: Today, though, most bonds are not physical printed pieces of paper with coupons that must be
clipped off and mailed to the issuer.
2. The fact that the face value of a bond does not change over the life of the bond is generally
considered a benefit to the borrower. Can you explain why?
U
ANS: If the market conditions change, say rates drop, the face value will not change.
3. The rate of interest a bond pays is called the bond’s:
R
a. face value.
b. coupon rate.
c. bond rating.
d. rating rate.
, ANS: B
3-2 Section Review
1. If you have a bond with a face value of $1,000 and a coupon rate of 2.25%, but the market interest
rate for such bonds is 2.5%, will your bond sell at par, at a premium, or at a discount? Explain why.
M
ANS: When market interest rates rise relative to coupon rates on existing bonds, the price of these
existing bonds decrease below face value. This means that this bond will be sold at a discount, since the
market price is below the face value of the bond.
ED
2. If you have a bond with a face value of $1,000 and a coupon rate of 2.5%, but the market interest
rate for such bonds is 2.25%, will your bond sell at par, at a premium, or at a discount? Explain why.
ANS: Premium because the coupon rate is less than the market rate.
C
3. If a three-year bond with a $1,000 face value has a coupon rate of 3.5%, and the current market
interest rate is 2%, what is the market price of the bond?
a. $956.75
O
b. $1,035.00
c. $1,043.30
d. $1,148.34
N
ANS: c
3-3 Section Review
N
1. You read in the financial press that market participants expect stock prices to increase dramatically in
the near future, while at the same time business confidence is increasing. Explain in words and show
graphically what will happen in the bond market if the first change is larger in magnitude than the
O
second.
ANS: Stocks and bonds are considered substitutes, the return on holding stocks are going to increase,
IS
you do not want to hold bonds. Demand for bonds will fall, relative return to bonds is declining.
Business confidence is increasing so firms are going to fund more projects. They will need to borrow
more money, or sell more bonds to raise those funds. The supply of bonds is increasing. Due to the
SE
decrease in demand for bonds is bigger than the second, we can conclude equilibrium price will fall and
equilibrium quantity will increase.
2. Stories appear in the financial press reporting two economic developments: Wealth levels in the
United States are increasing, while at the same time the relative riskiness of bonds issued by American
corporations is decreasing. Explain in words what will happen in the US bond market because of these
U
two events.
ANS: Increasing wealth levels cause an increase in the demand for bonds because households can use
R
this wealth not only to increase consumption but also save. Some portion of these new savings will find
its way into the bond market as households will purchase more bonds at every price. At the same time,
if default risk decreases, savers will buy more bonds as they are considered a relatively safer asset. So,
Money, Banking, Financial Markets & Institutions 2nd Edition for Brandl Michael
M
Chapter 2-24
ED
CHAPTER 2: Money, Money Supply, and Interest
2-1 Section Review
1. What is the difference between money and currency? When are they the same? Why might they be
different?
C
ANS: Money is anything generally accepted in exchange for goods & services. Currency is issued by a
bank or the government, but currency is not necessarily money. They are the same when they are
O
accepted in exchange for goods and services. Currencies can stop being money if people don’t accept
them in exchange for goods and services. If a group of people stop using currency to get goods and
services but instead use bananas, then the bananas are the money.
N
2. How many prices must a barter economy have if the economy has four goods? What if it has 400
goods? Explain why having a money in the second case is beneficial.
N
ANS: 4 goods = 6 prices; 400 goods = 79,800 prices. Money allows us to specialize and reduce our search
cost. Money allows us to reduce the number of stated prices we need.
O
3. You read a news story about a country that is suffering from rapid, ongoing increases in the cost of
living. Which characteristic of money is being directly negatively impacted in that economy?
IS
a. Unit of account
b. Medium of exchange
c. Store of value
SE
d. Double coincidence of wants
ANS: C
2-2 Section Review
U
1. Bobby is confused. He states: “Since prisoners are not allowed to smoke in prisons any longer,
Radford’s examples of cigarettes in POW camps no longer applies.” How would you explain to Bobby
how Radford’s story demonstrates the concepts of the criteria of money, as well as the importance of
R
changes in the money supply?
ANS: Any asset that is able to be standardized, divisible, durable and in demand could be currency, as
long as it is a medium of exchange, is a unit of account and has store of value. Cigarettes were money.
, 2. Proponents of the Gold Standard, or using gold as money, often argue that it will keep inflation under
control. How does the experience of Europe in the sixteenth century raise doubts about that claim?
ANS: If people start to hoard gold or silver, there may not be enough money, and an economy could
slide into recession. If gold or silver increases too rapidly the economy could suffer inflation.
M
3. Ricardo and Friedman agree that if the money supply increases “too quickly” the following happens:
a. The rate of inflation decreases.
ED
b. The rate of real economic growth increases.
c. The rate of inflation increases.
d. The level of employment decreases.
ANS: C
C
2-3 Section Review
1. A critic of money economics once stated, “if you cannot measure the money supply accurately, it is
O
not worth discussing at all.” How would you refute this statement?
ANS: Due to changes in financial markets, financial innovation and changes in the way banks operate,
led to the decline in the usefulness of M2 as a monetary aggregate.
N
2. Economists are searching for a “good” measurement of the money supply. What constitutes a good
measurement of the money supply?
N
ANS: To economists, a “good” measurement of the money supply is one that conforms to economic
theories regarding inflation and the economy. For example, if the money supply (according to a
O
particular measurement) increases faster than the growth rate of the economy, then economic theory
suggests that inflation should occur. On the other hand, if the money supply (according to a particular
measurement) increases too slowly relative to the growth rate of the economy, then economic theory
IS
suggests that this will result in a recession. When the measurement of the money supply coincides with
these economic predictions, then that particular measurement has the potential to be a “good”
measurement of the money supply. During certain periods of time, both M1 and M2 have been
SE
considered to be “good” measurements of the money supply. However, there have also been periods of
time where the changes in M1 or M2 did not coincide with economic theory.
3. Which of the following is the broadest or most inclusive measurement of the money supply?
a. M1
U
b. M2
c. M3
R
d. M0
ANS: B
, 2-4 Section Review
1. Each person might have a different time preference. Explain why an older person might have a higher
or lower time preference than a young person.
ANS: An older person might have a high time preference, consumer now vs. in the future. The older
M
person will place higher value on the ability to consume now more than money in the future.
2. What is the future value of $500 in two years if the interest rate is 4%? How would you explain this to
someone who has no training in economics?
ED
ANS: 500(1.04)2 = $540.80. For someone without a background in economics, one could explain that
money invested today will grow over time. Thus, in order to have $500 in the future, today you would
only need to invest some amount that is less than $500. How much less depends on the return on your
investment (the interest rate).
C
3. If the annual interest rate is 2%, what is the quarterly interest rate?
a. 0.0204
O
b. 0.0166
c. 0.005
N
d. 0.001
ANS: C
N
O
CHAPTER 3: Bonds and Loanable Funds
IS
3-1 Section Review
1. Today, shoppers “clip coupons” before they go shopping. Explain how these modern coupons are
similar and dissimilar to the “coupons” referred to in the bond market.
SE
ANS: Today, though, most bonds are not physical printed pieces of paper with coupons that must be
clipped off and mailed to the issuer.
2. The fact that the face value of a bond does not change over the life of the bond is generally
considered a benefit to the borrower. Can you explain why?
U
ANS: If the market conditions change, say rates drop, the face value will not change.
3. The rate of interest a bond pays is called the bond’s:
R
a. face value.
b. coupon rate.
c. bond rating.
d. rating rate.
, ANS: B
3-2 Section Review
1. If you have a bond with a face value of $1,000 and a coupon rate of 2.25%, but the market interest
rate for such bonds is 2.5%, will your bond sell at par, at a premium, or at a discount? Explain why.
M
ANS: When market interest rates rise relative to coupon rates on existing bonds, the price of these
existing bonds decrease below face value. This means that this bond will be sold at a discount, since the
market price is below the face value of the bond.
ED
2. If you have a bond with a face value of $1,000 and a coupon rate of 2.5%, but the market interest
rate for such bonds is 2.25%, will your bond sell at par, at a premium, or at a discount? Explain why.
ANS: Premium because the coupon rate is less than the market rate.
C
3. If a three-year bond with a $1,000 face value has a coupon rate of 3.5%, and the current market
interest rate is 2%, what is the market price of the bond?
a. $956.75
O
b. $1,035.00
c. $1,043.30
d. $1,148.34
N
ANS: c
3-3 Section Review
N
1. You read in the financial press that market participants expect stock prices to increase dramatically in
the near future, while at the same time business confidence is increasing. Explain in words and show
graphically what will happen in the bond market if the first change is larger in magnitude than the
O
second.
ANS: Stocks and bonds are considered substitutes, the return on holding stocks are going to increase,
IS
you do not want to hold bonds. Demand for bonds will fall, relative return to bonds is declining.
Business confidence is increasing so firms are going to fund more projects. They will need to borrow
more money, or sell more bonds to raise those funds. The supply of bonds is increasing. Due to the
SE
decrease in demand for bonds is bigger than the second, we can conclude equilibrium price will fall and
equilibrium quantity will increase.
2. Stories appear in the financial press reporting two economic developments: Wealth levels in the
United States are increasing, while at the same time the relative riskiness of bonds issued by American
corporations is decreasing. Explain in words what will happen in the US bond market because of these
U
two events.
ANS: Increasing wealth levels cause an increase in the demand for bonds because households can use
R
this wealth not only to increase consumption but also save. Some portion of these new savings will find
its way into the bond market as households will purchase more bonds at every price. At the same time,
if default risk decreases, savers will buy more bonds as they are considered a relatively safer asset. So,
