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 ofMoney,
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Banking,andFinancialMarkets
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TheEconomicsof 8i 8i




Money,Banking,and
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FinancialMarkets
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ThirteenthEdition,GlobalEdition 8i 8i 8i




Frederic S. Mishkin 8i 8i




New York,NY
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, Answers
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QuestionsandProblems
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Chapter 1 8i




ANSWERS TO QUESTIONS 8i 8i




1. What is the typical relationship among interest rates on three-month Treasury bills, long-
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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 effectdoeshigh volatilityof financialmarkets haveon people'swillingnessto
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spend?
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The high volatility of financial markets decreases people's willingness to spend, primarily
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because it directly affects their wealth, and also because high volatility indicates that there
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are considerable fluctuations in the prices of securities over a short time span. It increases
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insecurities about the future of an economy. Refer to Figure2 to see the extremelyvolatile
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natureof stock prices between 1950 and 2020.
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3. Explainthe main difference between a bond and a common stock. 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




A bond is a debt instrument, which entitles the owner to receive periodic amounts of money
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(predetermined by the characteristics of the bond) until its maturity date. A common stock,
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however, represents a share of ownership in the institution that has issued the stock. In
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addition to its definition, it is not the same to hold bonds or stock of a given corporation,
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sinceregulationsstatethat stockholders areresidual claimants (i.e., the corporation has to
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pay all bondholders before paying stockholders).
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4. What isthemain role of a financialintermediary? Nametwo 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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thatis, it borrowsfundsfrom individuals who havesavedand 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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causedbythe global pandemiccausedbytheinfectiouscoronavirus 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’sJune 2020 Global EconomicProspects, the volatility 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




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,peopledonotknowaboutthecapacityofother peopleof
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repayingtheirdebts,ortheefforttheywillprovidetorepaytheirdebts.
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Financialintermediaries,inparticularcommercialbanks,tendtosolvetheseproblems by 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




acquiringinformationaboutpotentialborrowersandwritingandenforcingcontracts that
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encouragelenderstorepaytheirdebtand/ormaintainthevalueofthecollateral.
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7. Why are banks important to thefinancial 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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functioningbanksare veryimportantfor the savings-to-loanscycle and for the housing 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




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 markets
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were related is that some financial intermediaries in Europe held securities backed by
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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 years?
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What about interest rates?
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Since 2015, inflationhas beenaround 2%, with some briefdips in 2015 and 2020. In 2015,
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theinterest rate on three-month Treasury bills was near zero, and it then rose to just over 2%
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in2019, onlyto fall back near tozeroin 2020.-
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10. If history repeats itself and we see a decline in therate of money growth, what might you
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expect to happen to
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a. real output? 8i




b. the inflation rate? 8i 8i




c. interest rates? 8i




Thedatain Figures 3, 5, and 6 suggest that real output, the inflationrate, 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 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




spendingisnow lower, and consumers would be morelikelyto 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 becauseit
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costs themmoreto financetheirpurchase;however, savers benefit because they can earn
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higher interest rates on their savings.
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13. What isthe 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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Centralbanks 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 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




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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Abudget surplusresults from tax revenuesexceedinggovernmentexpenditure, which leads
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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 makesforeign goods moreexpensive,so Britishconsumers 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 changesin foreignexchangerates 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 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




andthusleadtogainsandlossesontheseassets.Alsochangesinforeign exchangeratesaffect
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theprofitsmadebytraders in foreign exchange who work for financial institutions.
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18. AccordingtoFigure8,inwhichyearswouldyouhavechosentovisittheGrand 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i 8i




Canyon in Arizona rather than the Tower of London?
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In the mid-to-late1970s, thelate1980sto early1990s, and 2008 to 2015, the value of the
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dollarwaslow,makingtravelabroadrelativelymoreexpensive;thus,itwasagood timeto
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vacation in the United States and see the Grand Canyon. With the risein the dollar’s value in
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the early1980s, late 1990s, and after2015, travel abroadbecame
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