BUS 353

1. BUS 353 Part IV: Money and Markets

2. A. The Economy and the Business Cycle • The Economy – The interaction of people producing, buying, and selling goods and services • The Business Cycle • Boom – the peak of the business cycle, with high capacity utilization and low unemployment • Recession (Contraction) – a shrinking economy, indicated by rising unemployment and falling output

3. A. The Economy and the Business Cycle • Recovery – the economy is stable following a contraction, unemployment is stable to falling slightly • Expansion – a growing economy, indicated by increasing employment and output (Gross Domestic Product, or GDP) • Investing and the Business Cycle • It is nearly impossible to pick exact market tops and bottoms • The best protection against the business cycle is a diversified portfolio • The best environment for investors is slow, steady growth

4. B. Tracking the Business Cycle With Government Data • Jobs Data – Monthly payroll information released on the first Friday of every month – includes the number of jobs created, unemployment rate, wages, hours worked per week, and weekly unemployment claims (http://www.bls.gov/ces/) • Inflation Measures – High inflation curbs economic growth and erodes the value of fixed income investments (http://www.bls.gov/bls/inflation.htm) • Core – excludes food and energy • Measures include CPI, PPI, etc.

5. B. Tracking the Business Cycle With Government Data • Sales – Measure economic strength through consumer spending (http://www.census.gov/epcd/econ/www/indijun.htm) • Gross Domestic Product (GDP) – A measure of economic growth (economic output) – generally, 3% or more annually is regarded as robust economic growth (http://www.bea.gov/)

6. C. The Federal Reserve • Created as the United States Central Bank, similar to those in other countries (Bank of England in the U.K., European Central Bank for the Eurozone, Bank of Japan, etc.) (http://www.federalreserve.gov/) • Sets interest rates • Issues currency • Manages the overall level of money in the economy • Oversees the national banking system

7. C. The Federal Reserve • The Federal Reserve’s primary tool in economic regulation is setting short term interest rates • Fed Funds Rate – the interest rate banks charge each other for overnight loans • Discount Rate – the amount that the Federal Reserve charges member banks for overnight loans (extended so that banks can meet required cash reserves) (http://www.federalreserve.gov/releases/h15/data.htm)

8. C. The Federal Reserve • The Fed raises interest rates to slow the economy, and lowers interest rates to spur economic growth • Specific roles of the Federal Reserve • Policymaker – buys and sells government securities to control the amount of money in circulation • Banker – maintains bank accounts for the U.S. government and government agencies

9. C. The Federal Reserve • Lender – makes loans to banks • Regulator – interprets laws governing banks, monitors compliance with banking rules • Controller – replaces worn and damaged currency • Guardian – watches over gold stored by foreign governments as a reserve for currency exchange • Administrator – national check clearinghouse • Policies are set by the Federal Reserve Chairman and by meetings of the Open Market Committee (http://www.federalreserve.gov/aboutthefed/default.htm)

10. D. The Money Supply • Money Supply Policies • Increasing the money supply increases liquidity, providing more money for loans and fueling economic expansion but increasing inflation risk • Decreasing the money supply decreases liquidity, increasing interest rates, slowing economic growth, and damping inflation

11. D. The Money Supply • The money supply is increased when the New York Fed purchases government securities from banks and brokerage houses, using money that hasn’t existed before • The new money increases that firm’s reserves • The resulting money can then be re-lent • Example – 10% reserve • Decreasing the money supply decreases liquidity, increasing interest rates, slowing economic growth, and damping inflation • The money supply is decreased when the New York Fed sells government securities, reducing the amount of money in circulation • The contraction spreads through resulting bank transactions

12. D. The Money Supply • Money Supply Gauges • M1 = Funds readily available for spending – cash and checking accounts • M2 = M1 plus all private deposits • M3 = M2 plus short term financial assets (http://www.federalreserve.gov/releases/h6/Current/)

13. E. The Banking System • Types of Banks • Commercial Banks – accept deposits and provide loans to businesses and individuals • Savings Banks – generally provide mortgage loans and obtain deposits from individuals • Credit Unions – pool depositors’ money to make loans to other members • Investment Banks – underwrite stock and bond offerings, advise on mergers and acquisitions; subject to only minimal regulation

14. E. The Banking System • Types of Deposits • Transaction deposits – deposits against which checks can be written (checking accounts) • Demand deposits – accounts from which money can be withdrawn at any time (savings accounts) • Time deposits – provide interest payments for a fixed term (certificates of deposit)

15. F. The Banking System • Government Regulation • Federal Reserve – regulates how much cash (reserves) banks must maintain, and serves as the primary regulator for federally chartered banks • Office of the Federal Comptroller of the Currency -- charters, regulates, and supervises the activities of national banks, international branches of U.S. banks, and U.S. branches of non-U.S. banks – oversees lending and investments by banks

16. F. The Banking System • Federal Deposit Insurance Corporation – insures bank deposits to $250,000 per individual per bank • State Banking Regulators – regulate lending and investment practices of state chartered banks

17. G. Calculating Rates of Return • Basic Formula: Gain or Loss = (Sale Price + Dividends) – Purchase Price (Gain or Loss) + Dividends Percentage = ------------------------------------ Return Initial Cost

18. G. Calculating Rates of Return Future Value 1/n Compound = ------------------ -1 Annual Return Present Value Where n = number of years (term) Gain or loss must include dividend or interest payments (or interest on borrowed funds) plus capital gains (or capital losses)