Question.3043 - Financial Markets and Institutions 1) Explain Interest Rate Swaps and stock options. (10 points) 2) Explain the role that credit default swaps played in the financial crises. (5 points) 3) Explain 4 other things that led up to the financial crises and their impact on the financial markets, housing, prices and GDP. (20 points) 4) Compare and contrast the 3 different theories of money demand (15 points). 5) Given the quantitative theory of money: a) what happens to real GDP if the money supply is cut in half, velocity is stable and prices are sticky? (5 points) b) what happens to prices if the money supply doubles under the classical model assuming that velocity is stable? (5 points) 6) Compare and contrast the independence of the U.S Central Bank (Federal Reserve Bank) and the European Central Bank. Give the pros and cons of an independent central bank (10 points). 7) Explain the 4 tools of monetary policy and how they impact interest rates, financial markets, housing, and GDP (15 points). 8) Give 4 transmission mechanisms and explain how each impacts the financial markets and the overall economy (15 points)
Answer Below:
Financial xxxxxxx and xxxxxxxxxxxx Explain xxxxxxxx Rate xxxxx and xxxxx options xxxxxx Interest xxxx swaps xxxxxx speaking xxxxx Interest xxxx swaps xxxxx are xxx exchange xx one xxx of xxxx flows xxx another xx is xxxxxxxxx an xxxxxxxxx between xxx parties xxxxx one xxxxxx of xxxxxx interest xxxxxxxx is xxxxxxxxx for xxxxxxx based xx a xxxxxxxxx principal xxxxxx Most xxxxx interest xxxx swaps xxxxxxxx a xxxxx payment xxx a xxxxxxxx payment xxxxxxxx payment xxx interest xxxxxxxx which xxx linked xx an xxxxxxxx rate xxx are xxxxxxxxxxx Stock xxxxxxx Stock xxxxxxx are xxxxxxxxx that xxxxxx its xxxxxx the xxxxx but xxx the xxxxxxxxxx to xxx or xxxx stocks xx the xxxxxxxxxx security xx a xxxxxxxxx price xx or xxxxxx a xxxxx date xxxx the xxxx is xxxxxxx the xxxxxx ceases xx exist xx the xxxxx hand xxx seller xx the xxxxxx is xxxxxxxxx to xxxx or xxx the xxxxxx to xx from xxx buyer xx the xxxxxx at xxx specified xxxxx if xxx buyer xxxxxxxx so xxxxxxx the xxxx that xxxxxx default xxxxx played xx the xxxxxxxxx crises xxxxxx Credit xxxxxxx swaps xxx are xxxxxxxxxx instruments xxxxx act xxxx an xxxxxxxxx contract xxxx a xxxxx purchases x CDS xxxxxx a xxxxxxx to xxx seller xx is xx return xxxxxxxxx against x credit xxxxx like x default xx a xxxxxxx Simply xxxxxxxx the xxxxxx of xxx CDS xxxxx the xxxxxxxxx of xxxxxxx in xxxx of xxx default xx a xxxxxx the xxxx is xxx transferred xx the xxx willing xx take xx At xxx time xx financial xxxxxx the xxxxxxxx loans xxxx collectively xxxxxxx into x derivative xxxxxxx and xxxx to xxxxxxxxx In xxx year xxxxx started xxxxx bad xx that xxxx there xxxx CDS xxx just xxx traditional xxxxxxxxx debt xxx also xxx mortgage-backed xxxxxxxxxx CDOs xxx secondary xxxx When xxxxxx were xxxxxxxxxx CDS xxxx cheap xxxx things xxxx haywire xxx price xx CDS xxxx up xxx anyone xxx had xxxx these xxxxx was xxxxxxx at xxxxxx on xxxx So xxx were xxx way xxxxxxxxxx on xxxxxxxx mortgages xxxxxxxxx write xxxxx at xxxxx financial xxxxxxxxxxxx It xxx worse xx banks xxxxxxx failing xxx people xxx had xxxx CDS xx their xxxx faced xxxx larger xxxxxx So xxx most xxxxx problem xxxx CDS xx that xxx insurers xxxxxxx them xxxx them xx excessively xxx prices xxx they xxxx facing xxxxx losses xxxxxxx other xxxxxx that xxx up xx the xxxxxxxxx crises xxx their xxxxxx on xxx financial xxxxxxx housing xxxxxx and xxx points xxxxx and xxxxxxxx is xxx housing xxxxxx which xxxxxx in xxx housing xxxxxx touched xxxxx peak xxx were xxxxxxxxxx high xxxxxx were xxxx concentrating xx investing xx properties xxxxx properties xxxxx were xxxxxxxxxxxxxxx high xxxxxx In xxxxx to xxxxxxxx property xxxxxx in xxxxxxxx people xxxx loans xxxx banks xxxxx on xxxxx future xxxxxx Unfortunately xxxx the xxxxxxx bubble xxxxx in xxxxx were xxx much xxxxxx of xxx same xxxxxxxx and xxxxxxxx rsquo x values xxx stuck xxxx unsold xxxxxxxx in xxxx Prices xxxxx a xxxxx decline xxxxxxxxxx Secondly xxxxx were xxxxx which xx order xx gain xxxxxxx market xxxxx and xxxxxx operations xxxxxxxx in xxxxxxxx loans xxxxxxxx and xxxx liberal xxxx loan xxxxxxxx exercise xxxxxxxx loans xxx loans xxxxx are xxxxxxx to xxxxxxxxx at x higher xxxxxxxx rate xxx to xxxxx risky xxxxxxx These xxxxxxxx loans xxxx later xxxxxxxxxxxx sold xx financial xxxxxxxxxxxx structured xx derivative xxxxxxxx Ultimately xxxx the xxxxxxxxx were xxxxxx to xxx the xxxx the xxxxxx was xxxxxxxxxxxx seen xx the xxxxxxxxx institutions xxxxx were xxxxxxxx nothing xxx junk xxxxxx The xxxxxx rating xxxxxxxx were xxxxxxx reason xxxxxx the xxxxxxxxx crisis xxx credit xxxxxxx are xxxxxxxxx which xxxx rating xx particular xxxxx based xx the xxxxxxxxx background xxx profile xxxxx The xxxxxx ratings xxxx gave xxxxxxx to xxxxxxxxxx products xx subprime xxxxx and xxxx unable xx judge xxxx correctly xxx gave xxxx ratings xxx to xxxxx it xxx easier xx sell xxxxxxxxxxxxx in xxx market xxxxxxx have xxxxxx that xxxxxx rating xxxxxxxx and xxxxxxxxx failed xx accurately xxxxx the xxxx involved xxxx mortgage-related xxxxxxxxx products xxxx but xxx the xxxxx the xxxxxxxxxxx also xxxxxx to xxxx its xxxx by xxx adjusting xxx regulatory xxxxxxxxx to xxxxxxx problems xx newly xxxxxxxxx financial xxxxxxx Compare xxx contrast xxx different xxxxxxxx of xxxxx demand xxxxxx The xxxxxxxxx theories xx money xxxxxx are xxxxxxxxx Quantity xxxxxx of xxxxx Keynes xxxxx Liquidity xxxxxxxxxx Theory xxxxxxxx rsquo x Modern xxxxxxxx Theory xx Money xxxxxxxx theory xx money xx a xxxxxxxxx theory xxxx related xxx amount xx money xx the xxxxxxx to xxxxxxx income xx states xxx changes xx the xxxxxxxx of xxxxx tend xx affect xxx purchasing xxxxx of xxxxx inversely xxxx also xxxxx that xxxxxxxx a xxxxxx in xxx quantity xx money xxx eventually xxxxxx all xxxxxx it xxxx not xxx cannot xxxxxx all xxxxxx in xxx same xxxxxx to xxx same xxxxxx or xx the xxxx time xxxxxx Fisher xxxxxxxxx this xxxxxx with xxx following xxxxxxxx MV xx Where x is xxx quantity xx money xx money xxxxxx V xx velocity xxxxx serves xx the xxxx between xxxxx and xxxxxx P xx the xxxxx level x is xxxxxxxxx output xxxxxxxxx income xx is xxx total xxxxxx of xxxxxxxx on xxxxx goods xxx services xxxxxxxx in xxx economy xxx Keynes xxxxxxxxx preference xxxxxx rejects xxx notion xxxx velocity xx constant xxxx theory xxxxxxxxxx on xxxxx reasons xxxxxx why xxxxxx hold xxxxx a xxxxxxxxxxxx demand x precautionary xxxxxx c xxxxxxxxxxx demandLastly xxx Friedman xxxxx s xxxxxxxx theory xx money xxxxxx that xxx money xxxxxx is xxxxxxxxxx by xxx same xxxxxxx that xxxxxxxxx the xxxxxx for xxx asset xxx theory xx asset xxxxxx indicates xxxx the xxxxxx for xxxxx should xx a xxxxxxxx of xxx resources xxxxxxxxx to xxxxxxxxxxx their xxxxxx and xxx expected xxxxxxx on xxxxx assets xxxxxxxx to xxx expected xxxxxx on xxxxx Given xxx quantitative xxxxxx of xxxxx a xxxx happens xx real xxx if xxx money xxxxxx is xxx in xxxx velocity xx stable xxx prices xxx sticky xxxxxx If xxx money xxxxxx is xxx by xxxx in xxx long xxx the xxxxx levels xxxx also xxx by xxxx and xx would xxxx nil xxxxxx on xxx GDP xxxxxxx in xxx short xxx the xxxxx level xxxx fall xxxx and xx the xxxx GDP xxx sudden xxxx in xxx money xxxxxx means xxxx people xx longer xxxx as xxxx cash xx they xxxx Cash xxxxxxxx will xx accumulated xxx demand xxx everything xxxx would xxxx In xxxxx words xxxxxxxxx demand xxxxx Once xxx price xxxxx has xxxxxxx by xxxx causing xxx real xxxxx of xxx money xxxxxx to xxxxxxxx back xx its xxxxxxxx level xxx monetary xxxxxxxxx is xxxxxxxxx and xxxxxxxxx demand xxxxxxxx In xxx meantime xxxxxxx the xxxxxxx suffers x recession xxxxxx by xxxxxxxxx and xxxx unemployment x What xxxxxxx to xxxxxx if xxx money xxxxxx doubles xxxxx the xxxxxxxxx model xxxxxxxx that xxxxxxxx is xxxxxx points xxxxxxxxx to xxxxxxxx theory xx money xx the xxxxxx of xxxxx in xx economy xxxxxxx price xxxxxx also xxxxxx causing xxxxxxxxx the xxxxxxxxxx rate xx which xxx level xx prices xx rising xx an xxxxxxx Compare xxx contrast xxx independence xx the x S xxxxxxx Bank xxxxxxx Reserve xxxx and xxx European xxxxxxx Bank xxxx the xxxx and xxxx of xx independent xxxxxxx bank xxxxxx Though xxxxxxxx the xxxxxxxxxxxx of xxx Federal xxxxxxx has xxxxxxxxx the xxxxxxxx central xxxx is xxxxxxxxxx as xxx of xxx most xxxxxxxxxxx banks xxxxxxxx In xxxxxxxxxxxx the xxxxxxxx System xx Central xxxxx policymakers xxxxxxx it xxxx a xxxx degree xx independence xxxx the xxxxxxxxxxx of xxx member xxxxxx and xxx European xxxxx There xxx some xxxxxxxxxx differences xxx budgets xxx the xxxxxxxx banks xx the xxx are xxxxxxxxxxx by xxx Board xx Governors xxxxx the xxxxxxxx central xxxxx in xxxxxx are xxx ones xxx finance xxx Executive xxxxx While xxx majority xxxxxx in xxx -member xxxx goes xx the xxxxxxxxxxxx Board xx Governors xxx national xxxxxxx banks xx the xxx collectively xxxx a xxxxxxxx in xxx Governing xxxxxxx counterpart xx the xxxx made xx of xxx national xxxxxxx bank xxxxxxxxxx and xxx -member xxxxxxxxx Board xxx ECB xx less xxxxxxxx in xxx supervision xxx regulation xx financial xxxxxxxxxxxx than xxx Fed xx In xxxxx of xxxxxxxxxxxx the xxx has xxxx goal xxxxxxxxxxxx while xxx ECB xx more xxxxxxxxxxx independent xxx Fed xx free xx pursue xxxx low xxxxxxxxxxxx and xxx inflation xxxxx the xxx is xxxxxxxx to xxxxxx price xxxxxxxxx The xxx is xxxx susceptible xx political xxxxx however xxxxx any xxxxxx in xxx ECB xxxxx s xxxxxxxxx or xxxxxxxxxx would xxxxxxx a xxxxxxxxx change xx the xxxxxxxxxx Treaty xx all xxxxxxxxxxx highly xxxxxxxx whereas x change xx the xxx rsquo x organization xxx structure xxxxx be xxxxxx by x simple xxxxxxxx in xxxxxxxx Pros xx an xxxxxxxxxxx central xxxx Independent xxxxxxx bank xxx longer-run xxxxxxxxxx politicians xxx amp x Avoids xxxxxxxxx business xxxxx Less xxxxxx deficits xxxx be xxxxxxxxxxxx Cons xx an xxxxxxxxxxx central xxxx Fed xxx not xx accountable xxxxxxx coordination xx monetary xxx fiscal xxxxxx Fed xxx often xxxxxxxxx badly xxxxxxx the xxxxx of xxxxxxxx policy xxx how xxxx impact xxxxxxxx rates xxxxxxxxx markets xxxxxxx and xxx points xxx four xxxxx of xxxxxxxx policy xxx Open xxxxxx operations xxxx - xxx the xxxxxxxx and xxxx of xxxxxxxxxx in xxx open xxxxxx by x central xxxx This x key xxxx used xx the xxxxxxx Reserve xx the xxxxxxxxxxxxxx of xxxxxxxx policy xxx short-term xxxxxxxxx for xxxx market xxxxxxxxxx is xx adjust xxx supply xx reserve xxxxxxxx so xx to xxxx the xxxxxxx funds xxxx around xxx target xxxxxxxxxxx initially xxxxxxxxx inject xxxxx into xxxxxxx system xxx stimulate xxxxxx while xxxxx of xxxxxxxxxx do xxx opposite xxxxxxxx the xxxxxxx ratio x reserve xxxxxxxxxxxx are xxx age xx deposits xxxx institutions xxxx hold xx reserve xxx are xxx supposed xx lend xxxxxxxxxx the xxxxxxx ratios xxxxxxx the xxxxxx of xxxxxxxx that xxx be xxxxxxxxx by x given xxxxx of xxxxxxxx and xxxxxxx the xxxxx stock xxxxxxxxxx raising xxx cost xx credit xx the xxxxx hand xxxxxxxxxx the xxxxxxx ratio xxxxxx depositories xxxxxxxxx with xxxxxx reserves xxxxx can xxxxxx an xxxxxxxxx of xxxx credit xxx deposit xxxxxx and x decline xx interest xxxxx Changing xxx discount xxxx ndash xxxxxxx major xxxxxxxx policy xxxxxxxxxxxxxx tool xxx discount xx the xxxx charged xx commercial xxxxx and xxxxx depository xxxxxxxxxxxx on xxxxx from xxxxx central xxxx Typically xxxxxx discount xxxxx indicate xxxx more xxxxxxxxxxx monetary xxxxxxxx are xx store xxxxx a xxxxx rate xxxxx signal x less xxxxxxxxxxx move xxx use xx term xxxxxxx facility xxx ndash xxxxxxx monetary xxxxxx program xxxx by xxx Federal xxxxxxx to xxxx increase xxxxxxxxx in xxx U x credit xxxxxxx As xxx TAF xxx Fed xxxxxxxx set xxxxxxx of xxxxxxxxxxxxxxxxx short-term xxxxx to xxxxxxxxxx institutions xxxxxxxxxxxx bid xxxx a xxxxxxx bid xxx at xx overnight xxxxxxx swap xxxx relating xx the xxxxxxxx of xxx loans xxx allows xxxxxxxxx institutions xx borrow xxxxx at x rate xxxx is xxxxx the xxxxxxxx rate xxxx transmission xxxxxxxxxx and xxxxxxx how xxxx impacts xxx financial xxxxxxx and xxx overall xxxxxxx points xxx transmission xxxxxxxx are xx follows xxxxxxxx rate xxxxxxx This xx the xxxx important xxxxxxxx mechanism x reduction xx long-term xxxxxxxx rates xxxxx to xxxxxx of xxxxxxxx investment xxx consumer xxxxxxxx on xxxxxxx goods xxxx leads xx a xxxxx in xxx demand xxxxx and xxxxxxxxxx reflects xx aggregate xxxxxx and xxxxxx Asset xxxxx channel xxxxxxxxxxxx monetary xxxxxx leads xx higher xxxxxx prices xxx makes xxxxxxxxxx more xxxxxxxxxx This xxxxx to xxxxxxxx in xxxxxx and xxxxxxxxxxx and xxxxxx the xxxxxxxxx demand xxxxx Exchange xxxx channel xxxx channel xxxxx through xxxx the xxxxxxxxx demand xxx supply xxxx On xxxxxx side xxxxxxxx rate xx lowered xx monetary xxxxxxxxx which xxxxxx about x real xxxxxxxxxxxx in xxxxxxxx currency xxxxxxx thus xxxx and xxxxxxxxxxxxxxxx get xxxxxxxx On xxx supply xxxx expansion xx monetary xxxxxx increases xxxxxx of xxxxxxx and xxxx raises xxxxxxxxx Monetary xxx credit xxxxxxxxxx Basic xxxxxx is xxxx the xxxxxxxx policy xxxx have xx effect xx price xxx output xxxxxxx credit xxxxxxxxx steps xx expansionary xxxxxxxx policy xxxxxxxxx firm xxxxx s xxx worth xxx reduces xxxxxxxxx loan xxxxx This xxxxx banks xxxxxxx to xxxxxx more xxxxxx thus xxxxxxxxx a xxxx in xxxxxxxxx demandMore Articles From Finance
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