Solution Manual for The Economics Of Money Banking And Financial Markets 13th Global Edition Frederic Mishkin

,
, Answers
to End-of-Chapter i




QuestionsandProblems
i i i




Chapter 1 i




ANSWERS TO QUESTIONS i i




1. What is the typical relationship among interest rates on three-month Treasury bills,
i i i i i i i i i i i


long-term Treasury bonds, and Baa corporate bonds?
i i i i i i i




The interest rate on three-month Treasury bills fluctuates more than the other interest
i i i i i i i i i i i i


rates and is lower on average. The interest rate on Baa corporate bonds is higher on
i i i i i i i i i i i i i i i i


average than the other interest rates.
i i i i i i




2. What effect does high volatility of financial markets have on people's willingness to
i i i i i i i i i i i i


spend?
i




The high volatility of financial markets decreases people's willingness to spend,
i i i i i i i i i i


primarily because it directly affects their wealth, and also because high volatility
i i i i i i i i i i i i


indicates that there are considerable fluctuations in the prices of securities over a short
i i i i i i i i i i i i i i


time span. It increases insecurities about the future of an economy. Refer to Figure 2 to
i i i i i i i i i i i i i i i i


see the extremely volatile nature of stock prices between 1950 and 2020.
i i i i i i i i i i i i




3. Explain the main difference between a bond and a common stock.
i i i i i i i i i i




A bond is a debt instrument, which entitles the owner to receive periodic amounts of
i i i i i i i i i i i i i i


money (predetermined by the characteristics of the bond) until its maturity date. A
i i i i i i i i i i i i i


common stock, however, represents a share of ownership in the institution that has
i i i i i i i i i i i i i


issued the stock. In addition to its definition, it is not the same to hold bonds or stock of a
i i i i i i i i i i i i i i i i i i i i


given corporation, since regulations state that stockholders are residual claimants (i.e.,
i i i i i i i i i i i


the corporation has to pay all bondholders before paying stockholders).
i i i i i i i i i i




4. What is the main role of a financial intermediary? Name two financial
i i i i i i i i i i i


intermediaries.
i



A financial intermediary is a firm or institution that channels savings into investments–
i i i i i i i i i i i i


–that is, it borrows funds from individuals who have saved and provides loans to those
i i i i i i i i i i i i i i


who need funds. Banks and mutual funds are two examples of such intermediaries.
i i i i i i i i i i i i i




5. What was the main cause of the global recession in 2020?
i i i i i i i i i i




The recession in 2020, sometimes referred to as the COVID-19 Recession, was
i i i i i i i i i i i


mainly caused by the global pandemic caused by the infectious coronavirus disease
i i i i i i i i i i i i


(Covid-19). In March 2020, the stock market fell by 25% in a single month.
i i i i i i i i i i i i i i

, According to the World Bank’s June 2020 Global Economic Prospects, the volatility
i i i i i i i i i i i


induced by the coronavirus pandemic, lockdowns, and other preventive measures
i i i i i i i i i i


taken by global economies to contain it have led to a severe contraction in the global
i i i i i i i i i i i i i i i i


economy.
i




6. Can you think of a reason why people in general do not lend money to one another to buy
i i i i i i i i i i i i i i i i i i


a house or a car? How would your answer explain the existence of banks?
i i i i i i i i i i i i i i




In general, people do not lend large amounts of money to one another because of several
i i i i i i i i i i i i i i i


information problems. In particular, people do not know about the capacity of other people
i i i i i i i i i i i i i i


of repaying their debts, or the effort they will provide to repay their debts.
i i i i i i i i i i i i i i


Financial intermediaries, in particular commercial banks, tend to solve these problems by
i i i i i i i i i i i


acquiring information about potential borrowers and writing and enforcing contracts that
i i i i i i i i i i i


encourage lenders to repay their debt and/or maintain the value of the collateral.
i i i i i i i i i i i i i




7. Why are banks important to the financial system?
i i i i i i i



Banks are one of the major financial intermediaries. They channel savings from private
i i i i i i i i i i i i


institutions or the general public to other institutions or people who need a loan. Well-
i i i i i i i i i i i i i i i


functioning banks are very important for the savings-to-loans cycle and for the housing i i i i i i i i i i i i


market.
i




8. Can you date the latest financial crisis in the United States or in Europe? Are there
i i i i i i i i i i i i i i i


reasons to think that these crises might have been related? Why?
i i i i i i i i i i i




The latest financial crisis in the United States and Europe occurred in 2007–2009. At
i i i i i i i i i i i i i


the beginning, it hit mostly the U.S. financial system, but it then quickly moved to
i i i i i i i i i i i i i i i


Europe, since financial markets are highly interconnected. One specific way in which
i i i i i i i i i i i i


these markets were related is that some financial intermediaries in Europe held
i i i i i i i i i i i i


securities backed by mortgages originated in the United States, and when these
i i i i i i i i i i i i


securities lost their a considerable part of their value, the balance sheet of European
i i i i i i i i i i i i i i


financial intermediaries was adversely affected.
i i i i i




9. Has the inflation rate in the United States increased or decreased in the past few
i i i i i i i i i i i i i i


years? What about interest rates?
i i i i i



Since 2015, inflation has been around 2%, with some brief dips in 2015 and 2020. In
i i i i i i i i i i i i i i i


2015, the interest rate on three-month Treasury bills was near zero, and it then rose to just
i i i i i i i i i i i i i i i i i


over 2% in 2019, only to fall back near to zero in 2020.-
i i i i i i i i i i i i i




10. If history repeats itself and we see a decline in the rate of money growth, what might
i i i i i i i i i i i i i i i i


iyou expect to happen to
i i i i



a. real output? i




b. the inflation rate? i i



c. interest rates? i




The data in Figures 3, 5, and 6 suggest that real output, the inflation rate, and interest
i i i i i i i i i i i i i i i i


rates would all fall.
i i i i




11. When interest rates decrease, how might businesses and consumers change their
i i i i i i i i i i


ieconomic behavior? i