MGMT E-2000 Fall, 2012 Problem Set 1

| September 3, 2016

MGMT E-2000

Fall, 2012

Problem Set 1

(Due Tuesday, Sept. 25)

(100 pts.)

1. (10 pts.)

Explain the distinction between direct and indirect finance.

2. (10 pts.)

Discuss the reasons for the decline we have witnessed over the past 30 years in the number of U.S. banks.

3. (30 pts.)

Suppose the total amount of reserves in the economy is $5 billion, and the public does not directly hold any cash. Also, suppose all banks hold excess reserves equal to 4% of deposits and the required reserve ratio is 5%.

a. (5 pts.)

Calculate the money multiplier.

b. (5 pts.)

What is the total money supply (or money stock)?

c. (10 pts.)

Bank of America (BOA) has $300 million in deposits and $10 million in net worth. Draw a balance sheet for BOA.

Now suppose that all banks in the economy decide to reduce excess reserves to just 1%.

d. (5 pts.)

Explain in general why banks might want to keep some excess reserves. Also explain why banks want to keep excess reserves as low as possible.

e. (5 pts.)

Calculate the new equilibrium money stock.

4. (25 pts.)

Assume the public in Sylvania holds $4 billion in cash. All commercial banks are required to hold 20% of their checking deposits as reserves. All banks in Sylvania are identical, and have the following identical balance sheets:



Reserves $ 50M

Checking Deposits ?

Loans $ 300M


Assume that this balance sheet is complete, i.e., lists all assets and capital of these banks, and that the only liability of the banks is checking deposits.

a. (5 pts.)

Find the dollar amount of checking deposits each of these banks has on its balance sheet.

Show your work.

b. (5 pts.)

What percentage of checking deposits is each of these banks holding as excess reserves?

Show your work.

c. (15 pts.)

If the total money stock (supply) is $1B, find the total amount of reserves held by banks in the economy.

5. (25 pts.)

Bank A is the only bank in the country of Sunny-weather. The total amount of cash held by the public in Sunny-weather is $4,000.

Initially, Bank A’s balance sheet is below. (There are no other holdings of assets or liabilities than those listed):



Reserves $2,500

Checking Deposits $6,000

Loans $5,500

Bank Capital


Total ?

Total ?

a. (5 pts.)

Complete Bank A’s balance sheet.

b. (5 pts.)

Compute money supply in Sunny-weather.

c. (5 pts.)

How much is the reserve required ratio in Sunny-weather if Bank A holds only required reserves? Show and explain your work.

d. (5 pts.)

Assume instead that the reserve required ratio is 10%. What dollar amount does Bank A have to hold as required reserves? Is Bank A holding excess reserves? How much?

e. (5 pts.)

Continue to assume that the reserve required ratio is 10%. Compute the money multiplier in the country of Sunny-weather.

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