SOLUTION MANUAL for Money, Banking, Financial
Markets & Institutions 2nd Edition
by Brandl Michael, All Chapters 1 - 24
,TABLE OF CONTENTS
Part I: MONEY AND ITS PRICES.
1. Introduction and Overview.
2. Money, Money Supply and Interest.
3. Bonds, Loanable Funds & Interest Rates.
4. Interest Rates in More Detail.
Part II: MONEY AND OVERALL ECONOMY.
5. Financial Markets through Time.
6. Aggregate Supply & Aggregate Demand.
7. Banks and Money.
Part III: CENTRAL BANKS.
8. Central Banks.
9. Monetary Policy Tools.
10. The Money Supply Process.
11. Monetary Policy & Debates.
Part IV: THE BANKING SYSTEM.
12. Bank Management.
13. Bank Risk Management & Performance.
14. Banking Regulation.
Part V: FINANCIAL MARKETS.
15. Money Markets.
16. Bond Markets.
17. Stock Market & Efficiency.
18. Mortgage Market.
Part VI: GLOBAL FINANCIAL MARKETS.
19. FX.
20. Global Financial Architecture.
Part VII: FINANCIAL INSTITUTIONS.
21. Thrifts and Finance Companies.
22. Insurance and Pensions.
23. Mutual Funds.
24. Investment Banks and Private Equity.
, 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?
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 accepted in exchange for
goods and services. Currencies can stop being money if people don’t acceptthem 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.
2. How many prices must a barter economy have if the economy has four goods? What if it has 400goods?
Explain why having a money in the second case is beneficial.
ANS: 4 goods = 6 prices; 400 goods = 79,800 prices. Money allows us to specialize and reduce our searchcost.
Money allows us to reduce the number of stated prices we need.
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?
a. Unit of account
b. Medium of exchange
c. Store of value
d. Double coincidence of wants
ANS: C
2-2 Section Review
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 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.
3. Ricardo and Friedman agree that if the money supply increases “too quickly” the following happens:
a. The rate of inflation decreases.
b. The rate of real economic growth increases.
c. The rate of inflation increases.
d. The level of employment decreases.
ANS: C
2-3 Section Review
1. A critic of money economics once stated, “if you cannot measure the money supply accurately, it isnot 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.
2. Economists are searching for a “good” measurement of the money supply. What constitutes a goodmeasurement
of the money supply?
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 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 suggests that this will result in a recession. When the
measurement of the money supply coincides withthese 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
considered to be “good” measurements of the money supply. However, there have also been periods oftime 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
b. M2
c. M3
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 higheror lower
time preference than a young person.
ANS: An older person might have a high time preference, consumer now vs. in the future. The olderperson 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 tosomeone
who has no training in economics?
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).
3. If the annual interest rate is 2%, what is the quarterly interest rate?a.
0.0204
b. 0.0166
c. 0.005
d. 0.001
ANS: C
CHAPTER 3: Bonds and Loanable Funds
3-1 Section Review
1. Today, shoppers “clip coupons” before they go shopping. Explain how these modern coupons aresimilar and
dissimilar to the “coupons” referred to in the bond market.
ANS: Today, though, most bonds are not physical printed pieces of paper with coupons that must beclipped 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 generallyconsidered a
benefit to the borrower. Can you explain why?
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:
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 interestrate for such
bonds is 2.5%, will your bond sell at par, at a premium, or at a discount? Explain why.
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 themarket price is below the
face value of the bond.
2. If you have a bond with a face value of $1,000 and a coupon rate of 2.5%, but the market interestrate 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.
3. If a three-year bond with a $1,000 face value has a coupon rate of 3.5%, and the current marketinterest rate
is 2%, what is the market price of the bond?
a. $956.75
b. $1,035.00
c. $1,043.30
d. $1,148.34
ANS: c
3-3 Section Review
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 second.
ANS: Stocks and bonds are considered substitutes, the return on holding stocks are going to increase, 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 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 Americancorporations is decreasing.
Explain in words what will happen in the US bond market because of thesetwo events.
ANS: Increasing wealth levels cause an increase in the demand for bonds because households can use
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,
, as the default risk of bonds decreases, the demand for bonds increases. So, because of these two events (increased
wealth and decreased riskiness), the overall demand for bonds increases.
3. If the market price for bonds is higher than the equilibrium price, what is the result, and what willchange to
bring about equilibrium as price falls, ceteris paribus?
a. Shortage; quantity demanded will increase and quantity supplied will decrease.
b. Surplus; quantity demanded will increase and quantity supplied will decrease.
c. Surplus; quantity demanded will decrease and quantity supplied will increase.
d. $ Shortage; quantity demanded will decrease and quantity supplied will increase. ANS: c
3-4 Section Review
1. During the Reagan Administration in the 1980s, the US government ran large government budget deficits,
which many argued would slow down the US economy. Using the loanable funds framework, explain in words
and graphically why this argument was being made.
ANS: Please refer to Fig. 3-12: The demand for loanable funds must increase, therefore increasing interest rates,
which as stated, will cause borrowing to slow down.
2. During the Reagan Administration in the 1980s, while the US government was running large government budget
deficits, the rest of the world was also bringing large amounts of their savings to the United States. Using the loanable
funds framework, explain in words and graphically why this may have contributed to the economic expansion of the
1980s.
ANS: Rest of the World If interest rates in the United States increase relative to interest rates in the restof the world,
borrowers from the rest of the world who are borrowing in the United States may choose instead to borrow at
home. Thus as US interest rates increase, we see a decrease in the quantity of loanable funds demanded.
3. Assume the loanable funds market is in equilibrium. An increase in the demand for loanable funds will result in a
equilibrium interest rate as the quantity of loanable funds demanded
and the quantity of loanable funds supplied as the market moves to a new
equilibrium.
a. higher; increases; decreases
b. lower; decreases; decreases
c. higher; increases; increases
d. lower; increase; increases
ANS: c
3-5 Section Review
1. Explain why changes in the demand for bonds change the supply of loanable funds.
ANS: Understand how the bond market and the loanable funds market work in the same way and give us the same
result. This occurs because the bond market is a subsector of the loanable funds market. Changes that impact the
bond market also impact the overall loanable funds market. Keep in mind, however, that things can impact the
loanable funds market that do not impact the bond market.
Markets & Institutions 2nd Edition
by Brandl Michael, All Chapters 1 - 24
,TABLE OF CONTENTS
Part I: MONEY AND ITS PRICES.
1. Introduction and Overview.
2. Money, Money Supply and Interest.
3. Bonds, Loanable Funds & Interest Rates.
4. Interest Rates in More Detail.
Part II: MONEY AND OVERALL ECONOMY.
5. Financial Markets through Time.
6. Aggregate Supply & Aggregate Demand.
7. Banks and Money.
Part III: CENTRAL BANKS.
8. Central Banks.
9. Monetary Policy Tools.
10. The Money Supply Process.
11. Monetary Policy & Debates.
Part IV: THE BANKING SYSTEM.
12. Bank Management.
13. Bank Risk Management & Performance.
14. Banking Regulation.
Part V: FINANCIAL MARKETS.
15. Money Markets.
16. Bond Markets.
17. Stock Market & Efficiency.
18. Mortgage Market.
Part VI: GLOBAL FINANCIAL MARKETS.
19. FX.
20. Global Financial Architecture.
Part VII: FINANCIAL INSTITUTIONS.
21. Thrifts and Finance Companies.
22. Insurance and Pensions.
23. Mutual Funds.
24. Investment Banks and Private Equity.
, 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?
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 accepted in exchange for
goods and services. Currencies can stop being money if people don’t acceptthem 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.
2. How many prices must a barter economy have if the economy has four goods? What if it has 400goods?
Explain why having a money in the second case is beneficial.
ANS: 4 goods = 6 prices; 400 goods = 79,800 prices. Money allows us to specialize and reduce our searchcost.
Money allows us to reduce the number of stated prices we need.
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?
a. Unit of account
b. Medium of exchange
c. Store of value
d. Double coincidence of wants
ANS: C
2-2 Section Review
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 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.
3. Ricardo and Friedman agree that if the money supply increases “too quickly” the following happens:
a. The rate of inflation decreases.
b. The rate of real economic growth increases.
c. The rate of inflation increases.
d. The level of employment decreases.
ANS: C
2-3 Section Review
1. A critic of money economics once stated, “if you cannot measure the money supply accurately, it isnot 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.
2. Economists are searching for a “good” measurement of the money supply. What constitutes a goodmeasurement
of the money supply?
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 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 suggests that this will result in a recession. When the
measurement of the money supply coincides withthese 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
considered to be “good” measurements of the money supply. However, there have also been periods oftime 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
b. M2
c. M3
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 higheror lower
time preference than a young person.
ANS: An older person might have a high time preference, consumer now vs. in the future. The olderperson 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 tosomeone
who has no training in economics?
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).
3. If the annual interest rate is 2%, what is the quarterly interest rate?a.
0.0204
b. 0.0166
c. 0.005
d. 0.001
ANS: C
CHAPTER 3: Bonds and Loanable Funds
3-1 Section Review
1. Today, shoppers “clip coupons” before they go shopping. Explain how these modern coupons aresimilar and
dissimilar to the “coupons” referred to in the bond market.
ANS: Today, though, most bonds are not physical printed pieces of paper with coupons that must beclipped 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 generallyconsidered a
benefit to the borrower. Can you explain why?
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:
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 interestrate for such
bonds is 2.5%, will your bond sell at par, at a premium, or at a discount? Explain why.
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 themarket price is below the
face value of the bond.
2. If you have a bond with a face value of $1,000 and a coupon rate of 2.5%, but the market interestrate 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.
3. If a three-year bond with a $1,000 face value has a coupon rate of 3.5%, and the current marketinterest rate
is 2%, what is the market price of the bond?
a. $956.75
b. $1,035.00
c. $1,043.30
d. $1,148.34
ANS: c
3-3 Section Review
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 second.
ANS: Stocks and bonds are considered substitutes, the return on holding stocks are going to increase, 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 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 Americancorporations is decreasing.
Explain in words what will happen in the US bond market because of thesetwo events.
ANS: Increasing wealth levels cause an increase in the demand for bonds because households can use
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,
, as the default risk of bonds decreases, the demand for bonds increases. So, because of these two events (increased
wealth and decreased riskiness), the overall demand for bonds increases.
3. If the market price for bonds is higher than the equilibrium price, what is the result, and what willchange to
bring about equilibrium as price falls, ceteris paribus?
a. Shortage; quantity demanded will increase and quantity supplied will decrease.
b. Surplus; quantity demanded will increase and quantity supplied will decrease.
c. Surplus; quantity demanded will decrease and quantity supplied will increase.
d. $ Shortage; quantity demanded will decrease and quantity supplied will increase. ANS: c
3-4 Section Review
1. During the Reagan Administration in the 1980s, the US government ran large government budget deficits,
which many argued would slow down the US economy. Using the loanable funds framework, explain in words
and graphically why this argument was being made.
ANS: Please refer to Fig. 3-12: The demand for loanable funds must increase, therefore increasing interest rates,
which as stated, will cause borrowing to slow down.
2. During the Reagan Administration in the 1980s, while the US government was running large government budget
deficits, the rest of the world was also bringing large amounts of their savings to the United States. Using the loanable
funds framework, explain in words and graphically why this may have contributed to the economic expansion of the
1980s.
ANS: Rest of the World If interest rates in the United States increase relative to interest rates in the restof the world,
borrowers from the rest of the world who are borrowing in the United States may choose instead to borrow at
home. Thus as US interest rates increase, we see a decrease in the quantity of loanable funds demanded.
3. Assume the loanable funds market is in equilibrium. An increase in the demand for loanable funds will result in a
equilibrium interest rate as the quantity of loanable funds demanded
and the quantity of loanable funds supplied as the market moves to a new
equilibrium.
a. higher; increases; decreases
b. lower; decreases; decreases
c. higher; increases; increases
d. lower; increase; increases
ANS: c
3-5 Section Review
1. Explain why changes in the demand for bonds change the supply of loanable funds.
ANS: Understand how the bond market and the loanable funds market work in the same way and give us the same
result. This occurs because the bond market is a subsector of the loanable funds market. Changes that impact the
bond market also impact the overall loanable funds market. Keep in mind, however, that things can impact the
loanable funds market that do not impact the bond market.
