FEEDBACK TUTORIAL LETTER

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1 FEEDBACK TUTORIAL LETTER 1 ST SEMESTER 2017 ASSIGNMENT 2 MONEY AND BANKING [MAB611S] Compiled by: Edent Tate Shipanga May

2 1.1 USEFUL INFORMATION FOR WRITING ASSIGNMENTS Below are valuable information for improving upon the quality of your next Distance Learning assignments: Be logical in your reasoning Avoid the use of I. Rather make use of We. Avoid plagiarising the work of others You are allowed to refer to other sources such as the internet but refrain from copying and pasting the answers you get from there. The idea is that you learn and are able to present your understanding of the underlying concepts. Therefore copying and pasting from various internet sources will not really help in your learning. Communicate in a simple and flowing language. Carefully paragraph your presentation. Ensure a logical flow when discussing your answers. Ensure consistency with regards to the numbering and sequencing. Always check for spellings and grammatical errors. Do extensive reading before writing your assignment The beauty of economics lies in the use of diagrams and appropriate mathematical models. Make use of these tools, whenever the need arise. Avoid duplicating your friend s work. You are however encouraged to discuss your assignment in groups. Address specifically the questions raised. Make use of Time Management principles in approaching your assignment questions. Do not introduce irrelevant materials into your discussion. Always be sure that the demands of a question are clear to you before proceeding with your discussion. The total marks awarded should guide you on how long your answer should be. More emphasis should be placed on multiple choice questions as they are not as easy as students may think. 1.2 ASSIGNMENT QUESTIONS Instructions All questions are compulsory. In deciding how much detail to provide and how much time to spend on each question, it is imperative that you use the mark allocation as a guide. Clarify all your statements, workings and assumptions. Use diagrams wherever appropriate. Diagrams must be clearly illustrated. 2

3 Semester 1: 2017 Academic Session Course Code: MAB611S Course Name: Money and Banking ASSIGNMENT 2 QUESTION 1 [30 MARKS] 1. Compare and contrast the following: a) bond and stock market a bond market is the market in which bonds or debt instruments are traded Stock market is a market in which stock or shares are traded b) primary and secondary market Primary Market: a financial market in which new issues of a security are sold to initial buyers by the corporation or government agency borrowing the funds Secondary Market: a market in which securities that have been previously issued can be resold. (securities change hands). c) capital and money market Money market: financial market in which only short-term debt instruments are traded Capital market: market in which longer-term debt and equity instruments are traded 2. Bank uses many principles of bank management to ensure banks are run efficiently and are profitable. Explain how banks manage credit risk to make sure they choose credit worthy borrowers from risky borrowers. Screening and information collection - screen out the bad credit risks from the good ones so that loans are profitable to them. Lenders must collect reliable information from prospective borrowers. Specialization in lending - lending to local firms or to firms in particular industries, such as energy. Monitoring and enforcement of restrictive covenants - By monitoring borrowers activities to make sure that borrowers are not taking on risks at their expense Long-term customer relationships - If a prospective borrower has had a checking or savings account or other loans with a bank over a long period of time, a loan officer can look at past activity on the accounts and learn quite a bit about the borrower Loan commitments - a bank s commitment - (for a specified future period of time) to provide a firm with loans up to a given amount at an interest rate that is tied to some market interest rate. 3. Explain the main reasons for the regulation of the financial system in Namibia. To increase the information available to investors: o Reduce adverse selection and moral hazard problems o Reduce insider trading To ensure the soundness of financial intermediaries: 3

4 Restrictions on entry - Only upstanding citizens with impeccable credentials and a large amount of initial funds will they be given a charter Disclosure- stringent reporting requirements for financial intermediaries Restrictions on Assets and Activities - restrictions on what financial intermediaries are allowed to do and what assets they can hold Deposit Insurance - insure people s deposits so that they do not suffer any financial loss if the financial intermediary fails. Limits on Competition Restrictions on Interest Rates QUESTION 2 [40 MARKS] 1. Using the T-accounts of the First National Bank and the Second National Bank, describe what happens when Jane Brown writes a $50 check on her account at the First National Bank to pay her friend Joe Green, who in turn deposits the check in his account at the Second National Bank. When the check clears, the T-accounts of the banks look like: First National Bank Assets ($millions) Reserves Liabilities -$50 ($millions) Deposits -$50 Second National Bank Assets Liabilities ($millions) Reserves +$5 ($millions) Deposits +$ Why has the development of overnight loan markets made it more likely that banks will hold fewer excess reserves? As a device for meeting withdrawals and satisfying reserve requirements, overnight loans are an alternative to holding excess reserves. As overnight loans become cheaper and easier to use, banks will find them less expensive than holding excess reserves, and thus reduce their holdings of excessive reserves. 3. With the aid of the graph, discus the effect of federal fund rate as a tool of monetary policy? 4

5 Equilibrium occurs at the intersection of the supply curve Rs and the demand curve Rd at point 1 and an interest rate of i*ff. 4. If the Fed sells $1 million of bonds and banks reduce their borrowings from the Fed by $1 million, predict what will happen to the money supply and motivate your answer? The Fed s sale of $1 million of bonds shrinks the monetary base by $1 million, and the reduction of borrowings from the Federal Reserve lowers the monetary base by another $1 million. The resulting $2 million decline in the monetary base leads to a decline in the money supply by a multiple. QUESTION 2 [30 MARKS] 1. Suppose the required reserve ratio were 10% of checkable deposits, and the simple deposit multiplier applied. Using negatives to represent a decrease, if the Fed bought $250 of Treasury securities from a bank, the result would be a $250 increase in reserves, a $_0_ increase in excess reserves, and a $2500 increase in checkable deposits. (Fill in the missing s and your answer should be for the entire banking system.) The simple deposit multiplier is 1/r, so that ΔD = ΔR/r = $250/0.1 =2500 [6 marks] 4. Suppose First Bank has $34 million in cheque deposits, Second Bank has $47 million in cheque deposits and the reserve requirement for cheque deposits is 10%. (a) If First Bank currently has $4 million in reserves and Second bank has $5 million in reserves, how much excess reserve does each bank have? First Bank Second Bank 10% required reserves 3.4 mills 4.7 mills Excess reserves 0.6 mills 0.3 mills [5 marks] 5

6 (b) Now suppose that a customer of First Bank writes a cheque of $1 million to a real estate broker who deposits it at Second Bank. After the cheque is cleared, how much excess reserve does each bank have? 10% required reserves after Transaction 3.3 mills 4.8 mills New excess reserves 0.7 mills 0.2 mills [5 marks] 5. Using appropriate assumptions explain how banks create money through the money creation process. Also explain the weaknesses of the money creation process. [14 marks] The assumptions that the students are supposed to state are that: the required reserve ratio is 10% or any other percentage that they would want to use in their example. the banks do not keep excess reserves. people deposit their money in the banks. They do not keep it at home. [4 marks] Students are supposed to develop an example of the deposit creation process in which they explain the relationship between deposits, the required reserves and loans and how they grow in the deposit creation process. Students can come up with any hypothetical figures of their choice. The more creative the students are the better are their chances of scoring higher marks. [6 marks] The weaknesses of the money creation process are: if depositors keep their money as cash at home the money creation process stops. if banks keep excess reserves the money creation process slows down. [4 mrks] 6

7 1.3 PERFORMANCE STATISTICS FOR ASSIGNMENT 1/2011 Total number of students who submitted Assignment 1 = 26 Total score = 1608 Average score = 61.9% Students who scored above 50% = 20 (76.9%) Borderline cases, that is, 50% = 2 (7.7%) Students who scored below 50% = 4 (17.4%) Highest score = 96 % Lowest score = 42% 1.4 EXAMINATION: The First Opportunity Examination for June 2017 (as well as the Supplementary Examination taking place in July 2017) will cover the entire content of this course as suggested by the course outline and the current study guide. These are: Money-definition, the value of money and the payment system Banking and Central Banking and financial markets The demand and supply of money Monetary and fiscal policy in the IS-LM framework Asymmetric information and the regulation of financial institutions The demand and supply of money Monetary and fiscal policy in the IS-LM framework Furthermore, you are strongly advised to study the previous Examination Question Papers for an insight into the standard of questions that may be set around the above-identified issues. Past questions are available electronically in the intranet of the NUST. In case of any difficulty in accessing them, do phone the Subject Librarian. She will assist you. Her direct phone number is

8 Also, do consider the formation of Study Groups in order to share and cross-fertilise ideas on issues related to the course. Furthermore, you should keep in close contact with the full-time and part-time students since they are benefiting a great deal from the daily face-to-face contacts with their Lecturer. Do not forget to read your Study Guide for the course from the beginning to the end. Finally, do not hesitate to contact Mr. Eden Tate Shipanga (The Lecturer for this course) should the need arise. 1.5 ACTIVITIES IN THE STUDY GUIDE The activities in the study guide are meant to provide additional intellectual challenge to you. Do attempt to go through the activities in the study guide as they will really provide you with practice questions needed for the mastery of the content for this course. 8