Parth Chheda- 1033118

Chapter 3: The financial system

1. Is there a difference between financial assets and other types of assests?

- An asset is anything of value owned by a person or a firm .A financial asset is a
financial claim, which means that if you have a financial asset, you have a claim on
someone else to pay you money. For instance, a bank checking account is a
financial asset because it represents a claim you have against the bank to pay you
an amount of money equal to the dollar value of your account.
2. What is a financial intermediary, and what are some examples of financial
intermediaries?
- A financial intermediary is an institution that borrows funds from savers and lends
them to borrowers. The most important financial intermediaries are commercial
banks. Other financial intermediaries include mutual funds, hedge funds, pension
funds, investment banks, and insurance companies.
3. What is an asset bubble, and why are asset bubbles bad for the economy?
- An asset bubble is formed when the prices of asset, such as housing, stocks or
gold, become over-inflated. Prices rise quickly over a short period of time, and are
not supported by underlying demand for the product itself.
A bubble will eventually collapse as some investors begin to doubt that the prices of
the assets will continue to rise. As investors begin to sell the assets, their prices
start to fall. Falling prices can lead to panic selling, which eventually drives prices
back to fundamental values. The collapse of the bubble can wipe out the wealth of
investors who own the assets and can harm banks and other financial institutions
that may have made loans to finance purchases of the assets
Bubbles lead to a misallocation of resources. For example, during the late 1990s, a
bubble in the price of stock for Internet companies caused a significant amount of
funds to flow to Internet companies that eventually failed. Investors could have
better used those funds for either consumption or investment in other firms
5. How does a bank run cause a bank to fail?
- When a bank closes, its assets are sold to raise the funds necessary to pay off its
depositors. If a large number of banks close, then many similar assets, such as
loans and bonds, will be sold at the same time. These sales may cause the price of
these assets to fall (or deflate), which in turn causes difficulties for other banks.
Ultimately, a banks assets provide the means for the bank to pay off depositors in
the event of withdrawals. If the value of the banks assets declines, depositors will
become more concerned about the ability of the bank to have funds on hand to
cover deposit withdrawals, which will make depositors more likely to withdraw
funds, which can lead to more bank runs, more assets being sold, and so on, in a
vicious cycle.

6,7. What determines the demand and supply for loanable funds?
- The supply of loanable funds comes from domestic households, the government,
and the foreign sector, while the demand for loanable funds comes from the
willingness of firms and households to borrow to finance investment expenditures
8. Why is the demand for money downward sloping?
- The money demand curve slopes downward because lower nominal interest rates
cause households and firms to switch from financial assets such as U.S. Treasury
bills to money
9. Why are there many different interest rates in the economy?
- There are many different rates of in the over all picture, however there is just one
maximum rate per each sector. The Federal Reserve sets the bank lending rate that
every Qualified Bank gets to borrow money at.
The Federal Government (separate from the Federal Reserve) Sets a maximum
interest rate in which banks and lending institutions can lend their money at for
each type of loan (personal, automobile, credit card, home loan ect.) Each type of
loan come with its own risk to the lender for repayment. It is the risk factor that is
the main reason for the different interest rates. Another factor in the difference in
interest rates is the inner workings of lending institutions and the competition for
acquiring customers. Some lenders have different pay scales for their employees
and executives. Thus making their own profit margins and cost of doing business
different and that justifies their reasoning to charge different interest rates.
10. How does the maturity of a bond affect its interest rate?
- If you own a 30-year bond with an interest rate of 4%, and newly issued 30-year
bonds have interest rates of 6%, then any investor you sold your bond to would be
receiving a lower-than-market interest rate for 30 years.An investor would be willing
to do this only if you offered to sell the bond at a significantly lower price. But if you
sold a oneyear bond, the buyer would be receiving a lower-than-market interest rate
for only one year and would be willing to buy the bond with a proportionally smaller
price cut