Money and Banking Discussion Questions

Money and Banking Discussion Questions
Order 5908324
Money and Banking Discussion Questions
Question 2
a) new; expand deposits and loans
b) 50; 950
c) increase; 20; $20 000
d) withdrawal; contract deposits and loans
e) below; $19 000
Question 4
a) If the Regal Bank is currently at its target reserve ratio, then the target ratio is given by
the ratio of actual reserves to actual deposits. This is $200/$4000 = 0.05, or 5 percent.
b) The value of the owners’ investment in the bank is the capital shown on the liability
side of the balance sheet. This is what the firm is worth if it were to be sold. It is $400.
c) See the balance sheet below. After the new deposit of $100, the Regal Bank has $4100
of deposits and capital of $400. The new cash goes into reserves, which now total $300.
Loans are unchanged at $4200. The new reserve ratio (before there are any new loans
made) is $300/$4100 = 0.073 or 7.3 percent.
Assets Liabilities
Reserves $300 Deposits $4100
Loans $4200 Capital $400
d) If instead there is a withdrawal of $100, the new balance sheet is as shown below. The
bank “pays” for the withdrawal out of reserves, and also reduces liabilities by the amount
of the withdrawal. The new reserve ratio is 100/3900 = 2.6 percent.
Assets Liabilities
Reserves $100 Deposits $3900
Loans $4200 Capital $400
© 2005 Pearson Education Canada Inc.
Question 6
a) The table is shown below. For a withdrawal, the process is the same as for a new
deposit, except in reverse. Commercial banks “finance” withdrawals from their reserves,
but then must reduce deposits to restore the target reserve ratio. They reduce deposits by
reducing their outstanding stock of loans (that is, by “calling in” some of their existing
loans).
Round ∆Deposits ∆Reserves ∆Loans
First –$5000 –$400 –$4600
Second –$4600 –$368 –$4232
Third –$4232 –$338.56 –$3893.44
Money and Banking Discussion Questions
b) The eventual total change in deposits is –$5000 × (1/.08) = –5000 × (12.5) = –$62 500.
The total change in reserves is 8 percent of the change in deposits, or (.08) × (–$62 500)
= –5000 (which is exactly equal to the withdrawal of $5000). The eventual total change
in loans is –$57 500.
Question 8
This is a good question for students to see the different roles of bank reserves and the
public’s cash drain in affecting the extent of money creation stemming from a new
deposit. In this question, let ∆X be the injection of cash into the Canadian banking system
($40 000). Ultimately, this new cash will be held either as reserves by the banks, R, or as
cash by the public, C. That is,
∆C ∆R = ∆X.
If deposits are given by D, the change in reserves is given by ∆R = v∆D, where v is the
reserve requirement. The change in the public’s cash holding is ∆C = c∆D, where c is the
cash drain. Substituting into the above equation we get,
c∆D v∆D = ∆X
∆D = ∆X/(v c)
∆R = [v/(v c)] × ∆X
a) For v = 0.10 and c = 0, we have ∆D = $400 000 and ∆R = $40 000.
b) For v = 0.10 and c = 0.05, we have ∆D = $266 667 and ∆R = $26 667.
c) For v = 0.10 .05 and c = 0.05, we have ∆D = $200 000 and ∆R = $30 000
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