FIN310 Class Web Page, Fall ' 23
Instructor: Maggie Foley
Jacksonville University
The Syllabus (updated 8-18)
Term project on Bank Failure
(due with final)
·
Review
of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank -
April 2023 (FYI)
·
https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf
(FYI)
Weekly SCHEDULE, LINKS, FILES and Questions
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Chapter |
Coverage,
HW, Supplements -
Required |
References
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Chapter 1-1 |
Discussion: How to pick stocks (finviz.com) How To Win The MarketWatch Stock Market Game
Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar IPO schedule: http://www.marketwatch.com/tools/ipo-calendar Part I – Review of the Financial
Market Chapter
1 Introduction |
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Special
Topic: 2023 Bank Failures
The Bank Failures, Explained ppt SVB Fallout: Wall Street
Debates Moral Hazard (video)
https://www.nytimes.com/2023/03/14/briefing/silicon-valley-bank.html By German Lopez, March 14, 2023 The collapse of Silicon Valley Bank and
others — and the government’s rescue over the weekend — left many of us again rushing
to understand the arcane details of the financial system. It can be
maddeningly complex, so I want to use today’s newsletter to explain some
of the basics. First, the latest: Bank stocks plummeted
yesterday, hitting midsize and smaller institutions in particular. Other
financial markets gyrated as well, despite U.S. policymakers’ emergency help for customers of the closed banks. “It didn’t put calm back in the
system,” said my colleague Maureen Farrell, who covers business. Why does this matter to everyday
Americans? After all, SVB is
relatively small and most of us keep no money in it. The short answer is the
potential for wider fallout. When banks collapse, other people
sometimes fear that their own banks and investments will follow. Even healthy banks don’t keep enough cash on hand
to pay out all depositors, so if too many people panic at once and pull out
their money — a classic bank run — it could lead to broader financial and economic calamity. And that is what the Biden administration and the Federal Reserve are
trying to stop: a financial crisis largely prompted by plunging confidence. How did we get to this
point? To answer that, I need to dive into more detail about Silicon
Valley Bank. As its name suggests, the bank portrayed
itself as focused on the leading edge of technology. And it served thousands
of tech firms. Yet SVB invested their
money in something much less exciting, as Paul Krugman wrote: U.S. bonds,
effectively I.O.U.s from the federal government. Because the federal government has always
paid its bills, U.S. bonds are widely considered the safest investment. SVB’s experience shows there are
moments when even these safe investments may not pay off. The details get
technical, but they’re worth unpacking to understand what went
wrong. Bonds are effectively money that the
government borrows from buyers — the public — before paying them back
later, with interest. Market conditions and the Federal Reserve, America’s central bank, help
determine that interest rate. When SVB bought bonds,
interest rates were very low. Since then, the Federal Reserve, which sets
certain influential rates, increased those to combat rising prices. Now, new
bonds can carry interest multiple times higher than those SVB bought. Imagine, then, that you want
to buy bonds today. You would want the newer bonds because they have a higher
payout. So when SVB needed to sell bonds, to raise cash that it could use for
its customers’ withdrawals, it could do so only for a discount, taking a
loss. The bank failed to follow
basic financial advice: Diversify your portfolio. “It’s not fraud,” said Joseph Gagnon, a
senior fellow at the Peterson Institute for International Economics. “But it’s an extremely risky, and
obviously risky, strategy.” In the past few weeks, venture capitalists
and other wealthy customers on social media and in private chats started
discussing concerns that SVB could no longer pay its depositors. Some began to move their money out of the
bank, and the situation spiraled quickly. “Once you start asking, ‘Are we having a bank run?,’ it’s too late,” my colleague David Enrich,
a business editor, said. A regulatory failure Financial regulations are
supposed to stop these kinds of crises. But Silicon Valley Bank’s problems were not caught
until it was too late — which many experts say was a result of insufficient
oversight. Under pressure from banks in
2018, Congress passed bipartisan legislation that Donald Trump signed into
law shielding smaller banks, like SVB, from more stringent rules. The banks
argued that they were so small that they posed little risk to the broader
financial system. SVB’s collapse and the aftermath
suggest the banks’ claims were wrong: Even smaller bank failures can threaten
the financial system as a whole, prompting some experts — but not all — to call for the federal
government to get more involved. Controlled slowdown To readers of this newsletter, the Federal
Reserve’s involvement in containing the fallout of Silicon Valley Bank’s collapse may be puzzling. The Fed, after all, has been raising
interest rates to slow the economy. An economic slowdown inherently involves
businesses, including banks, failing. The Fed’s concern is that the bank
collapses could go too far and pose bigger systemic risks beyond SVB. Think of it this way: You
can stop a runaway car by blowing out its tires, potentially causing a crash.
But it would be better if the car stopped by simply braking. Officials are
trying to get the economy to brake to a safer speed — one in which inflation isn’t so high. The economic slowdown that the Fed hopes
for would still affect everyday Americans, in both lower prices and also
potentially higher unemployment rates. But that outcome is better than an
uncontrolled bank run that topples the financial system and takes the rest of
the economy, and your 401(k), down with it. In class exercise: answer: BBBAB ABABC 1. Why did
Silicon Valley Bank collapse? A) Insufficient
customers B) Inadequate oversight C) Foreign
investments 2. How did the government
assist customers of closed banks? A) Lowering
interest rates B) Providing emergency help C) Imposing
strict regulations 3. What potential
fallout worries people when banks collapse? A) Banks lacking
in technology B) Wider financial impact C) Decreased
interest rates 4. How did
Silicon Valley Bank primarily invest its money? A) U.S. bonds B) Technology
startups C) Foreign
currencies 5. What's the
main goal of the Biden administration and the Federal Reserve? A) Encourage bank
runs B) Prevent financial calamity C) Promote high
inflation 6. Why did SVB
face challenges selling bonds for cash? A) Low buyer interest B) Favorable
market conditions C) High bond
demand 7. How did
experts describe SVB's investment strategy? A) Fraudulent B) Risky C) Innovative 8. What triggered
concerns about SVB's ability to pay depositors? A) Social media discussions B) Government
warnings C) SVB's
advertising 9. Why did
Congress pass legislation in 2018? A) Encourage
risk-taking B) Protect smaller banks C) Promote bigger
banks 10. What's the
primary concern for the Federal Reserve in this situation? A) Lowering
unemployment B) Stopping
inflation C) Avoiding uncontrolled bank runs Homework
Assignment for Special Topic – Bank Failure (due along with the first midterm
exam) Based on the papers
covered in class or from other sources you've reviewed, who should be
attributed with accountability for the bank failures observed in 2023? |
How
Silicon Valley Bank Collapsed in 36 Hours: What Went Wrong (Video, FYI) A
regulatory filing sparked a run on the bank. Then, the FDIC took control of
SVB. By
Wall Street Journal Mar 15, 2023 12:16 pm Silicon
Valley Bank collapsed in less than two days. In that time, its stock price fell
over 60% and customers tried to withdraw $42 billion. Here’s how SVB became
the second-largest U.S. bank failure ever and what it means for customers in
the future. Illustration: Alexandra Larkin
https://en.wikipedia.org/wiki/List_of_largest_bank_failures_in_the_United_States Law
School professor who served as Fed regulator talks moral hazard, implications
for inflation after SVB collapse rocks Washington and Wall Street (FYI only) BY
Christina Pazzanese Harvard Staff Writer, DATEMarch 14, 2023 https://news.harvard.edu/gazette/story/2023/03/fallout-from-bank-failures-explained/ Summary: Federal regulators have responded to the
collapse of Silicon Valley Bank and other tech-focused institutions, taking
measures to stabilize financial markets and prevent further bank failures.
Critics argue that the banks benefited from 2018 regulatory relief,
potentially incentivizing risky behavior. Daniel Tarullo, former member of
the Federal Reserve Board, highlights supervisory failure in the case of SVB
and discusses how a relaxation of regulations might have contributed to
recent problems. He acknowledges the challenge of balancing moral hazard
concerns with crisis response. Rising interest rates and inflation figures
complicate the Federal Reserve's decision-making in addressing financial
vulnerabilities. In
recent days, federal regulators have taken dramatic steps to stabilize
financial markets, protect depositors from ruin, and prevent more bank
failures following the collapse of Silicon Valley Bank and a handful of other
small, tech-focused institutions. The
measures by the U.S. Treasury, the Federal Reserve Board, and the Federal
Deposit Insurance Corporation seem to have calmed the waters — for now. But the
failures have raised questions about how banks servicing tech- and
investment-savvy clientele could plunge so quickly and precipitously. The
Justice Department, the Securities and Exchange Commission, and the Federal
Reserve have all pledged to open investigations. Critics say these banks sought and got relief
in 2018 from federal regulations designed to prevent the very conditions that
led to their failure and worry that a bailout will incentivize other banks to
act rashly and expect similar treatment in the future. To
better understand what’s going on, the Gazette spoke with Daniel Tarullo, Nomura Professor of
International Financial Regulatory Practice at Harvard Law School. From 2009
to 2017, he was a member of the Federal Reserve Board and the Federal Open
Market Committee, which sets
interest rates for commercial banks. As oversight governor for
supervision and regulation, he led the board’s financial regulatory reforms,
including implementation of the 2010 Dodd-Frank Act. The interview has been
edited for clarity and length. Q&A Daniel
Tarullo GAZETTE:
There’s been a lot of finger-pointing. Who is to blame for these bank
failures? TARULLO:
Whether this was a regulatory failure or a supervisory failure or both
remains to be answered, to some degree, but I think we can be reasonably
confident there was at least a
supervisory failure. In the case of Silicon Valley Bank, the supervisors at
the Federal Reserve Bank of San Francisco did not see the problem coming,
presumably had not looked at the liquidity situation and the potential
problem with Treasury securities that had lost value. Was that strictly
the failure of the San Francisco Fed? Or were they acting under the
guidelines they had been given by the Board of Governors in Washington? I ask
that because over the last several
years, there was a message sent to supervisors that they were not supposed to
be as strict and stringent with their banks as they had been. GAZETTE:
Was that message tied to the 2018 rollback of Dodd-Frank or a separate issue? TARULLO:
The supervision is a separate issue. Debate is swirling around how much
difference the 2018 legislation, and then the Federal Reserve’s
implementation of that legislation, in 2019, made. As best as I can
determine, there was one potential point that may have made a difference, not
in the legislation, but in the changes that the Fed itself made. But it
doesn’t appear that change was directly responsible for the problems. I do think that that set of changes
reflected a relaxation of regulation across the board by the Fed, which
probably did contribute to the problems we have seen over the past week. GAZETTE:
Are the FDIC, Treasury, and the
Federal Reserve taking appropriate steps to stabilize the banking industry? TARULLO:
We’ll see. Yesterday it didn’t look as though that was the case. Now, midday
on Tuesday, things have calmed down. In these kinds of situations, sometimes
there’s a pause and then things get worse again. Sometimes there’s a pause
and things kind of stabilize. We just don’t know where we are right now. The Fed and the FDIC and the Treasury
took, on a very ad hoc basis, a set of steps they felt they needed to take to
stop a further run on other banks — providing guarantees for uninsured
depositors, and making quite favorable terms for Fed funding available to
other banks that may have put themselves in a vulnerable position. It was an
appropriate if unfortunate response — unfortunate in its implications for
policy going forward, but appropriate in that the Biden administration and
the banking agencies did not want to take big risks with the banking system. GAZETTE:
Is the FDIC’s guarantee of deposits above its standard $250K maximum a move
that may ultimately prove a Pandora’s box, if everyone expects similar
treatment in the future? TARULLO:
In the middle of a crisis, regulators, supervisors, and the president cannot
worry too much about moral hazard. Look what happened when the government
paused over the moral hazard question with Lehman Brothers in the fall of
2008 — its failure set off the most acute phase of the financial crisis. But
once things have stabilized, the
recognition that there is a significant moral hazard out there requires a
regulatory response, and that’s what we’re going to get. What the nature
of that regulatory response is will depend on what regulators have concluded
about how widespread the problem was. But they’re going to have to face the
fact that uninsured depositors are now going to believe, ironically, that if
they have an uninsured deposit in a bank with lots of uninsured deposits,
they’re pretty likely to be bailed out. Under our current system, that’s not
the kind of incentive you want big depositors to have. One
other thing we’ve learned is that the promise that we can enforce market
discipline by resolving banks when they become bankrupt and allocating the
losses, as the law says you should — that’s just illusory. SVB was the
16th-largest insured depository institution in the country. This was not JP
Morgan, this was not Citi, this was not Bank of America. Within 48 hours, the
government concluded that it couldn’t afford to have losses allocated to
those uninsured depositors and took extraordinary steps to protect them.
People are now going to have to face the fact that the assumptions laid out
in the legislation about what the resolution process can do just don’t hold
when the heat is on. GAZETTE:
Is the failure of SVB indicative of a broader problem in the banking
industry? TARULLO:
The stress we’ve seen
has been concentrated in banks with some combination of the following
characteristics: First, their business
is heavily dependent on an industry or sector that is not performing as well
as the rest of the economy right now — tech and crypto, in particular.
Second, they hold a portfolio of Treasury securities that were not, under
current regulations, required to be marked-to-market, meaning to realize the
losses that have resulted because interest rates have gone up. Third, and
perhaps most important, they had very high proportions of deposits that were
uninsured, large amounts of money they knew was not protected by the FDIC.
Thus, when there was a whiff of a problem, depositors pulled money out as
quickly as they could. GAZETTE:
Given the role that sharply rising interest rates appears to have played in
SVB’s collapse, does that suggest the Fed’s money-tightening approach is not
working as planned? TARULLO:
The inflation figures Tuesday morning probably gave people at the Fed pause.
They came in a little higher than people had anticipated. The real question
is not whether the Fed’s policy is working — it is tightening financial
conditions, but is it tightening them so quickly that banks do not have time
to adjust? Clearly, many businesses, many financial firms, and many
individuals and households have taken hits on their portfolios of
fixed-income securities. The Fed should have been asking, as they raised
rates so rapidly, what kind of vulnerabilities might there be in banking and
other parts of the financial sector. But they probably almost exclusively
focused on inflation. GAZETTE:
Does this situation, along with Tuesday’s inflation numbers, complicate the
Fed’s path forward on inflation? TARULLO:
Absolutely. They have a Federal Open Market Committee meeting next week.
Here’s the tension: On the one hand, to the degree that there’s uneasiness
with respect to banks, any further increase would exacerbate problems with
the depreciation and value of long-dated securities that banks already hold.
On the other hand, if they don’t go forward with at least a modest rate
increase, markets again begin jumping to the conclusion that the Fed is going
to stop raising rates. Then financial conditions will begin to loosen, and as
a result, it may be harder for the Fed to achieve its inflation target. This
is going to be a very delicate decision for the Fed next week. In class
exercise – based on the above paragraph highlighted answer BAA Question 1: What characteristics are common among banks that have experienced
stress? A.
Heavy dependence on thriving industries. B. Holding Treasury securities
marked-to-market. C.
High proportions of insured deposits. Question 2: According to Tarullo, why did some banks experience stress? A. They were heavily reliant on the tech
and crypto industries. B.
They held a portfolio of uninsured deposits. C.
They were unaffected by changes in interest rates. Question 3: What was the significant factor leading to depositors withdrawing
money from stressed banks? A. Lack of FDIC protection for uninsured
deposits. B.
Fluctuations in the economy. C.
Inadequate regulations for Treasury securities. |
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Chapter 11 - 14: Commercial Banking
and Investment Banking PPT2 Commercial banking II
(Balance sheet) Content ·
Part I – SVB failure ·
Part II – Bank failure in general ·
Part III – Regulation in banking sector 1)
Summary of the paper on regulation 2)
Glass-Steagall Act 3)
Dodd Frank Act ·
Part IV – AI in banking sector · Part V – Net
interest margin ·
Part VI – Investment banking ·
FYI: VyStar Credit Union: After the outage (FYI
only) How Did Banks Start ?
(youtube)
1:
When did people first start recording their trade transactions? A.
2000 A.D. B.
8000 B.C. C.
500 B.C. Answer:
B 2:
What was the role of goldsmiths in the evolution of banking? A.
They stored goods for traders. B.
They issued the first banknotes. C.
They provided safekeeping and lending services. Answer:
C 3:
Which region became the center of the world's banking industry during the
medieval period? A.
Asia B.
Mesopotamia C.
Italy Answer:
C 4:
What ancient civilizations had evidence of credit and lending services
primarily related to seeds? A.
African civilizations B.
Mesopotamian civilizations C.
European civilizations Answer:
B 5:
What financial instruments emerged as a result of goldsmiths' expanded
services? A.
Coins B.
Promissory notes C.
Bonds Answer:
B 6:
Who established the Medici Bank, which became one of the largest and most
reputable banks in Europe? A.
Rothschild family B.
Grimaldi family C.
Medici family Answer:
C 7:
In which century did banknotes start being printed and standardized? A.
17th century B.
18th century C.
19th century Answer:
B 8:
How did banknotes contribute to the United Kingdom's Industrial Revolution? A.
Banknotes led to the decline of industries. B.
Banknotes were used as a form of art during the Revolution. C.
Banknotes played a crucial role in sustaining heightened economic activity. Answer:
C 9:
What organizations were established in 1944 to boost economies of developing
nations? A.
United Nations B.
International Monetary Fund (IMF) and World Bank C.
World Trade Organization (WTO) Answer:
B 10:
Which century saw the advent of banks as we recognize them today? A.
15th century B.
17th century C.
20th century Answer:
C Part I - Silicon Valley Bank’s Failure
SIVBQ (Silicon Valley Bank) Financials
Google finance Silicon Valley Bank (SVB) Income Statements (in thousands)
Balance Sheet
https://www.nasdaq.com/market-activity/stocks/sivbq/financials Silicon Valley Bank and how its outsized investment in
securities made it particularly vulnerable to a bank run:
Silicon Valley
Bank collapsed on 10 March 2023 after a bank run saw depositors rapidly
withdraw funds as they lost confidence in the bank’s
ability to survive. The bank’s collapse followed concerns that had been growing since
24 February 2023, when Silicon Valley Bank’s parent company,
SVB Financial Group, published its annual consolidated financial statements
for the year ended 31 December 2022. As illustrated by this week’s chart, SVB’s consolidated balance
sheet at 31 December 2022 comprised assets of $212bn, liabilities of $196bn
and equity of $16bn. Assets consisted of investment securities recorded at amortised
cost of $91bn, investment securities recorded at fair value of $26bn, loans
of $74bn, cash of $13m, and other assets of $8bn. Liabilities comprised
customer deposits of $173bn, short-term debt of $14bn, and other liabilities
of $9bn (including long-term debt of $5bn). Not shown in the chart is the breakdown of equity of $16bn,
which at 31 December 2022 primarily comprised preference stock of $4bn,
additional paid-in capital of $5bn and $9bn of retained earnings, less $2bn
in negative accumulated other comprehensive income. As disclosed on the face of the balance sheet, the fair value of SVB’s $91bn portfolio
of held-to-maturity investment securities was $15bn below its carrying value
at amortised cost, reflecting how the main fixed-asset securities in this
category – predominantly federally guaranteed
mortgage-backed securities and collateralised-mortgage obligations – had fallen in value as interest rates climbed over the
course of 2022. These unrealised losses of $15bn were not that far off the
$16bn of equity reported by SVB, suggesting the bank would struggle if it
ever had to sell these investments before they matured. SVB’s intention had been to hold onto
these investments, but circumstances changed on 9 March when depositors – concerned about
further falls in the value of SVB’s assets as
interest rates continued to rise during 2023, and an adverse reaction to a
belated capital raising exercise launched by SVB on 8 March –
withdrew $42bn in one day. This forced SVB to rapidly liquidate assets and borrow to find the cash required to
repay depositors, but by then the first major digital bank run had gained too
much momentum, with depositors attempting to withdraw a further $100bn on
Friday 10 March. With insufficient cash to repay the amounts requested by SVB’s customers, the bank was closed by regulators that
lunchtime. In class exercise 1: What caused Silicon Valley Bank to collapse in March 2023? 1. What caused Silicon Valley Bank to collapse in March 2023? A) Economic recession B)
Technological malfunction C)
Bank run and loss of confidence Answer:
C Explanation:
Many depositors withdrew their money rapidly because they lost trust in the
bank's ability to survive. This led to the bank's collapse. 2:
Why were concerns growing about Silicon Valley Bank's survival before its
collapse? A)
A sudden drop in interest rates B)
Doubts about its technology infrastructure C)
Doubts about the accuracy of financial statements Answer:
C Explanation: People
were unsure if the bank's financial statements were true, which made them
worry about the bank's future. 3:
Which components made up Silicon Valley Bank's balance sheet at the end of
2022? A)
Assets of $212bn, liabilities of $196bn, equity of $16bn B)
Assets of $196bn, liabilities of $212bn, equity of $16bn C)
Assets of $16bn, liabilities of $196bn, equity of $212bn Answer:
A Explanation:
The bank had $212bn in assets, owed $196bn to others (liabilities), and had
$16bn that belonged to the bank itself (equity). 4:
What category of investments faced significant losses on Silicon Valley
Bank's balance sheet? A)
Securities recorded at amortized cost B)
Fair value recorded securities C)
Short-term debt investments Answer:
A Explanation:
Investments that were meant to be held until maturity lost value, causing
losses for the bank. 5:
How much did depositors withdraw from Silicon Valley Bank on 9 March? A)
$15bn B)
$42bn C)
$100bn Answer:
B Explanation:
On that specific day, depositors took out a total of $42 billion from their
bank accounts. 6:
What triggered the bank's quick liquidation of assets? A)
A drop in interest rates B)
Government intervention C)
Massive withdrawals by depositors Answer:
C Explanation:
When many people took their money out of the bank, the bank had to sell its
assets quickly to get enough cash to meet the demands. 7:
What type of securities mainly contributed to the unrealized losses on SVB's
balance sheet? A)
Corporate bonds B)
Federally guaranteed mortgage-backed securities C)
International stocks Answer:
B Explanation:
Certain investments linked to mortgages lost value, causing unrealized losses
for the bank. 8:
What was the main result of the capital raising exercise SVB conducted on 8
March? A)
Increased customer deposits B)
Restoration of depositor confidence C)
Negative reaction from depositors Answer:
C Explanation:
The bank's attempt to raise capital made depositors even more concerned,
leading to a negative response. 9:
How did SVB try to address the cash shortage during the crisis? A)
Selling non-performing assets B)
Borrowing funds and selling assets C)
Seeking government aid Answer:
B Explanation:
The bank borrowed money and sold assets to acquire the cash needed to repay
depositors during the crisis. 10:
Why did regulators close Silicon Valley Bank on 10 March? A)
Involvement in illegal activities B)
Cybersecurity breach C)
Inability to meet withdrawal demands Answer:
C Explanation:
The bank lacked sufficient funds to fulfill the withdrawal requests of
depositors, prompting regulators to intervene and close the bank. What Is a Bank Failure? Definition,
Causes, Results, and Examples By JULIA KAGAN
Updated May 14, 2023 Reviewed by SOMER ANDERSON Fact checked by SUZANNE
KVILHAUG https://www.investopedia.com/terms/b/bank-failure.asp What Is a Bank Failure? A bank failure is the closing of an insolvent
bank by a federal or state regulator. The federal
government has the power to close national banks and banking commissioners
have the power to close state-chartered banks. Banks can be closed
when they are unable to meet their obligations to depositors and others. When
a bank fails, the Federal Deposit Insurance Corporation (FDIC) covers the
insured portion of a depositor's balance, including money in money market
accounts. KEY TAKEAWAYS · Bank failures occur
when the bank cannot meet its obligations to creditors and depositors. · The Federal Deposit
Insurance Corp. (FDIC) protects deposits for up to $250,000 per depositor,
per account. · In some cases, the
FDIC may fully reimburse for lost deposits of a failed bank without using
federal or state tax revenues. · Bank failures are
often difficult to predict. Understanding Bank Failures A bank fails when it
can’t meet its financial obligations to creditors and
depositors. This could occur because the bank has become insolvent or
because it no longer has enough liquid assets to fulfill its payment
obligations. The most common cause of bank failure is when
the value of the bank’s assets falls below the market
value of the bank’s liabilities, which are the bank's
obligations to creditors and depositors. This might happen because the
bank loses too much on its investments. It’s not
always possible to predict when a bank will fail. What Happens When a Bank Fails? When a bank fails, it
may try to borrow money from other solvent banks in order to pay its
depositors. If the failing bank cannot pay its depositors, a bank panic might
ensue in which depositors run on the bank in an attempt to get their money
back. This can make the situation worse for the failing bank, by shrinking
its liquid assets as depositors withdraw cash. Since the creation of the FDIC, the federal
government has insured bank deposits up to $250,000 in the U.S. When a bank fails, the FDIC takes control
and will either sell the failed bank to a more solvent bank or take over the
operation of the bank. In many cases, depositors
who have money in the failed bank will experience no change in their
experience of using the bank. They’ll still have
access to their money and should be able to use their debit cards and checks
as normal. In the event that a
failed bank is sold to another bank, account holders automatically become
customers of that bank and may receive new checks and debit cards. Examples of Bank Failures During the 2008
financial crisis, the biggest bank failure in U.S. history occurred with the
closure of Washington Mutual (WaMu), which had $307 billion in assets.
Washington Mutual struggled for several reasons, including a poor housing
market and a run on deposits. WaMu was eventually bought by JPMorgan Chase
for $1.9 billion. The second-largest bank failure in the U.S. was
the closure of Silicon Valley Bank in 2023 after a bank run in which
customers had withdrawn $42 billion within 48 hours. The bank had $209
million in assets at the time. Bank failures were
common leading up to and into the Great Depression when thousands of banks
failed. By the time the FDIC was created in 1933, American depositors had
lost a substantial amount of money due to bank failures. Without federal
deposit insurance protecting these deposits, they had no way of getting their
money back. Protections Against Bank Failures The Federal Reserve now usually requires banks
to keep a certain amount of cash reserves on hand to try to reduce the risk
of failure. The reserve amount is a portion of the deposits it holds.
Typically a bank must hold over 10% of its liabilities in cash reserves, but
this requirement was suspended in 2020 amid the COVID-19 pandemic and it has
yet to be reinstated. The FDIC may sometimes provide reimbursement
beyond its coverage limits. For example, it used funds from the Deposit
Insurance Fund to fully reimburse depositors when Silicon Valley Bank failed
in 2023. The money in the fund is furnished by quarterly fees charged to banks,
not from tax revenue. To better protect
yourself against losing money if a bank fails, consider keeping only up to
the FDIC-insured limit, or $250,000, in a bank account. If you need to
deposit more funds, you can open another account at a different bank for the
same FDIC protection. What Happens During a Bank Failure? When a bank fails, the FDIC is required to use
the least costly solution to resolve the failure. It will often sell the
bank's assets to another bank. The FDIC will
reimburse depositors for up to $250,000 per account, per institution, and in
some cases, it may fully reimburse lost funds. What Was the Biggest Bank Failure? The biggest U.S. bank
failure was the collapse of Washington Mutual (WaMu) in 2008. At the time, it
had about $307 billion in assets. The bank failure was caused by a number of
factors, including a poor housing market and a run on deposits in which
customers withdrew $16.7 billion within two weeks. When Was the Last Bank Failure? The failure of the
Silicon Valley Bank in March 2023 was among the most recent bank failures. To
find the last bank failure, check the FDIC's Failed Bank List, which includes
banks that have failed since Oct. 1, 2000. In class exercise 1: What is a bank
failure? A) A sudden shutdown due to technical
issues B) A bank's inability to fulfill
financial obligations C) A change in bank ownership Answer: B Explanation: A bank failure occurs when a bank
cannot meet its financial obligations to creditors and depositors. 2: Who has the power to close
national banks during a bank failure? A) Banking commissioners B) State regulators C) Federal government Answer: C Explanation: The federal government has the
authority to close national banks during a bank failure. 3: What does the FDIC do when a
bank fails? A) Takes over the bank's
operations B) Sells the bank's assets to
another bank C) Provides full reimbursement to
all depositors Answer: B Explanation: When a bank fails, the FDIC may
sell the bank's assets to another bank to resolve the failure. 4: What is the most common cause
of bank failure? A) Technological glitches B) Poor customer service C) Insolvency due to asset value
decline Answer: C Explanation: The value of a bank's assets
falling below its liabilities can lead to insolvency and is a common cause of
bank failure. 5: What agency covers the insured
portion of a depositor's balance when a bank fails? A) SEC B) IRS C) FDIC Answer: C Explanation: The Federal Deposit Insurance
Corporation (FDIC) covers the insured portion of a depositor's balance during
a bank failure. 6: Why might a bank experience a
run during a failure? A) To buy assets from the failing
bank B) To withdraw money before the
bank closes C) To invest in the bank's stocks Answer: B Explanation: During a bank failure,
depositors may rush to withdraw their money to avoid losing their deposits. 7: What protections did the FDIC
provide for depositors during the 2008 financial crisis? A) Full reimbursement for all
depositors B) Up to $250,000 per depositor,
per account C) Loan assistance for depositors Answer: B Explanation: The FDIC insured deposits up to
$250,000 per depositor, per account during the 2008 financial crisis. 8: What is the primary source of
funding for the FDIC's Deposit Insurance Fund? A) Federal tax revenue B) Quarterly fees charged to
banks C) Donations from individuals Answer: B Explanation: The FDIC's Deposit Insurance
Fund is primarily funded by quarterly fees charged to banks, not federal tax
revenue. 9: How can individuals better
protect themselves against losing money in a bank failure? A) Keep all funds in a single
account B) Keep up to the FDIC-insured
limit in one account C) Open multiple accounts at the
same bank Answer: B Explanation: To avoid losing money in a bank
failure, individuals can keep up to the FDIC-insured limit, which is
$250,000, in one account. 10: What happened to Silicon
Valley Bank in 2023 that led to its failure? A) A housing market crash B) A run on deposits C) Mismanagement by the board Answer: B Explanation: A bank run occurred where customers
withdrew $42 billion within 48 hours, leading to the failure of Silicon
Valley Bank in 2023. Bank Failures in Brief – Summary 2001 through 2023
There were 565 bank failures from 2001 through 2023. Please
select the year buttons below for more information.
https://www.fdic.gov/bank/historical/bank/ In class exercise 1: In which year did the highest number of bank failures occur? A) 2008 B) 2010 C) 2019 Answer:
B) 2010 2:
In which year did no bank failures occur? A)
2005 B)
2015 C)
2021 Answer:
A) 2005 3:
How many bank failures occurred in the year 2012? A)
18 B)
4 C)
51 Answer:
C) 51 4:
In which year did the second-highest number of bank failures occur? A)
2019 B)
2010 C)
2009 Answer:
C) 2009 5:
Which year had the highest total assets among the listed years? A)
2011 B)
2023 C)
2008 Answer:
B) 2023 Take away: The Factors Behind SVB's Failure ·
When people put their money in a bank,
they trust that it's safe, backed by government protection of up to $250,000.
But SVB had a lot of deposits that
weren't insured, so when the market got shaky, many depositors withdrew
their money. This was one big reason for SVB's failure. ·
Another problem was that the bank's managers used the deposited money
to make risky investments. They thought that taking bigger risks would
lead to bigger profits. However, if these investments went bad, the managers
could just close the bank and leave the depositors in trouble. It is called Moral Hazard. This term comes from
the idea that when there's a disconnect between risk-taking and the consequences
of those risks, it creates a moral dilemma where the bank's decision-makers
might be tempted to take bigger risks than they otherwise would, since they
don't have to fully bear the downside. ·
Another issue was that SVB didn't handle
the risks well, especially when interest rates were going up. This made the
situation worse and added to the bank's downfall. Part II: Banking Industry in general Topics for class discussion 1. What are the key
differences between large and small banks in terms of their operations and
impact on the economy? 2.
How do banks make money and generate profits? How the banks make the big
bucks (youtube) 3. How can you tell that banks are getting bigger
and bigger? Who need big banks? What is too big to fail (Bloomberg university) video Benefits of Local Banks vs. Big Banks
Regional banks will suffer
from regulation similar to large banks: Man Group CEO (youtube)
BY JUSTIN PRITCHARD REVIEWED BY KHADIJA KHARTIT on
May 30, 2021 When you choose a bank, it’s
critical to find the products, services, and rates that meet your needs. As you evaluate
large national banks vs. local banks and credit unions, you may wonder if the
size of an institution matters. To some degree, it does, but big banks and small
banks can offer essential services like checking and savings accounts. Here’s what to consider as you
compare banks: Convenience Choose a bank that’s easy to work
with on your terms. If you prefer to bank in-person, some institutions might
have a better presence than others in your area. Cost Fees are often lower at small
institutions, but that’s not always the case. Identify your banking needs and
compare fees for the services you need. Services Small institutions can have a
surprisingly large offering of products and services. But sometimes you need
the horsepower of a megabank.
Banking with a local institution
helps to support your local economy, and it may make your banking experience
easier. But there are always pros and cons. Let’s explore the differences
between big banks and local banks in more detail. Megabanks Have a National Reach Potential Convenience Large national banks with
household names dominate large cities, and they even reach into smaller
markets. If you value in-person banking, a bank with branches nearby might be
a decent option. They can offer one-stop shopping, allowing you to get
multiple services from the same institution. For example, you might be able
to use one login for your checking and savings accounts, credit cards, and
loans. Large banks that have a national
reach include Bank of America, Capital One, Chase Bank, Wells Fargo, and
many other large institutions. Sometimes Frustrating Big banks often have rigid systems and
processes, which makes
dealing with them difficult. If you need help from customer service, you may
be forced to call a national toll-free number, even though you know and trust
the local bankers. You may have to speak with relatively new hires or answer
multiple fraud department questions just to open an account. Contrast that
experience with a local bank, where the same person can handle everything for
you in one sitting. Costs Vary Free checking is increasingly
hard to find at megabanks. You can typically qualify for fee waivers by
keeping sufficient cash in your account or setting up direct deposit, but
genuinely free accounts are rare. You can occasionally find fee-free business
checking at national banks, while local banks charge modest fees. Local Banks Engage in the
Community Community banks and local credit
unions are an excellent option for most banking needs. Just because they’re
small doesn’t mean they can’t meet your needs. Some institutions limit their
offerings, others outsource services, and some provide everything you need
in-house. Competitive Fees and Rates Local banks are often a good bet
for free checking accounts—the account you probably need most. Some offer
standard free checking to everybody, while others waive fees if you just
agree to receive electronic statements. They also compete with attractive
rates on savings accounts and loans. Savings rates might still be higher at
online banks, but there’s nothing to prevent you from having multiple
accounts (online and local). Local Knowledge Because they’re engaged in local matters,
local banks may make transactions easier. That’s particularly true if you need to borrow money. For example, megabanks
might be unwilling to fund your local business, investment property, or
agriculture loan, but local banks are accustomed to evaluating loans in your
area. Personal Service For better or worse, local banks typically provide
more personal service than big banks. It’s not uncommon to work with the same person over time. Bank staff can even learn about
your needs and suggest bank products that may be helpful. You develop
relationships and know what to expect and who to talk to when you have
questions. At the same time, you lose the
anonymity that comes with being a big bank customer. If you live in a
particularly small town, you may prefer to keep a low profile. Offerings Vary While local banks and credit unions can
offer everything from checking accounts to merchant accounts to wealth
management, some institutions focus on basic consumer needs. If your favorite
local bank doesn’t handle business accounts and you start freelancing, you’ll
need to look elsewhere. Community Involvement Your banking needs to drive your choice of
banks, but you may feel a sense of satisfaction when working with a local
institution. Local banks and credit unions are part of the local economy, and they
often give back. You’re likely to see a local
institution’s logo at charity races and other events, signaling that they
contributed money or other resources to help make the event a reality. In class exercise 1: What is a key consideration
when choosing between large national banks and local banks? A) The color of the bank's logo B) The number of branches
nationwide C) Finding products, services,
and rates that meet your needs Answer: C Explanation: It's critical to find products,
services, and rates that meet your needs when choosing a bank. 2: What can you look for in terms
of convenience when comparing banks? A) The bank's logo design B) The presence of branches in
your area C) The bank's history and
heritage Answer: B Explanation: If you value in-person banking,
you might consider a bank with branches nearby for convenience. 3: What is a potential advantage
of using a large national bank for banking services? A) Smaller variety of services B) One-stop shopping with
multiple services under the same institution C) Exclusive access to online
banking features Answer: B Explanation: Large national banks can offer
one-stop shopping, allowing you to access multiple services from the same
institution. 4: Why might dealing with
customer service at big banks be frustrating? A) Local bankers are not
well-trained B) You can only communicate via
email C) Rigid systems and processes
that make interactions difficult Answer: C Explanation: Big banks often have rigid systems
and processes, making dealing with them difficult, even if you know and trust
local bankers. 5: What is a distinguishing
feature of local banks in terms of personal service? A) They have extensive online services B) They offer international
banking options C) They typically provide more
personal service than big banks Answer: C Explanation: Local banks usually provide more
personal service, and it's not uncommon to work with the same person over
time. 6: What type of accounts are
local banks often a good option for? A) Investment accounts B) Business checking accounts C) Free checking accounts Answer: C Explanation: Local banks are often a good bet
for free checking accounts, which are mentioned as an essential account. 7: What advantage do local banks
have in terms of local knowledge? A) They provide global financial
advice B) They have lower interest rates C) They are engaged in local
matters and understand local lending needs Answer: C Explanation: Local banks are accustomed to
evaluating loans in your area, making transactions like local business,
investment property, or agriculture loans easier. 8: Why might you lose anonymity
when dealing with a local bank? A) Because local banks require
fingerprint authentication B) Because local bank employees
are nosy C) Because you develop
relationships and bank staff can learn about your needs Answer: C Explanation: Working with local banks may
involve personal relationships and staff learning about your needs, which
contrasts with the anonymity of big banks. 9: What can local banks and
credit unions often offer in terms of competitive rates? A) Higher rates on online savings
accounts B) Lower rates on loans C) Competitive rates on savings
accounts and loans Answer: C Explanation: Local banks compete with
attractive rates on savings accounts and loans, although online banks might
still offer higher savings rates. 10: What is a benefit of working
with a local institution in terms of community involvement? A) They offer more online banking
features B) They have lower fees C) They contribute to local
events and the economy Answer: C Explanation: Local banks often give back to
the community by contributing money or resources to local events,
demonstrating their involvement in the local economy. Homework (Due with the first midterm
exam around mid September) Question 1: Too big too fail. What is your opinion on this
statement? Should we worry about banks getting bigger and bigger? Why or why
not? Question 2: What are the pro and con for big banks? How can regional
banks compete against mega banks? Question 3: What is your opinion on the application of AI in the
banking industry? Question 4: What is net interest margin? How much is the net interest
margin of BAC as of June 2023? Question 5:
List Two significant banking
regulations, along with their intended objectives. ·
For Glass Steagall Act: What is the Glass Steagall Act and how did
it come about? - GreenLine ·
For Dodd Frank Act: What is Dodd Frank? (youtube) |
Part III: Governmental Regulations on
Banking Industry A Brief History of U.S. Banking
Regulation By MATTHEW
JOHNSTON Reviewed by
MICHAEL J BOYLE on July 30, 2021 https://www.investopedia.com/articles/investing/011916/brief-history-us-banking-regulation.asp Early Attempts
at Regulation in Antebellum America From the establishment of the First Bank of the
United States in 1791 to the National Banking Act of 1863, banking regulation
in America was an experimental mix of federal and state legislation. The regulation
was motivated, on the one hand, by the need for increased centralized control
to maintain stability in finance and, by extension, the overall economy.
While on the other hand, it was motivated by the fear of too much control
being concentrated in too few hands. Despite
bringing a relative degree of financial and economic stability, the First
Bank of the United States was opposed to being unconstitutional, with many
fearing that it relegated undue powers to the federal government.
Consequently, its charter was not renewed in 1811. With the government
turning to state banks to finance the War of 1812 and the significant
over-expansion of credit that followed, it became increasingly apparent that
financial order needed to be reinstated. In 1816, the Second Bank of the
United States would receive a charter, but it too would later succumb to
political fears over the amount of control it gave the federal government and
was dissolved in 1836. Not only at
the federal level, but also at the level of state banking, obtaining an
official legislative charter was highly political. Far from being granted on
the basis of proven competence in financial matters, successful acquisition
of a charter depended more on political affiliations, and bribing the
legislature was commonplace. By the time of the dissolution of the Second
Bank, there was a growing sense of a need to escape the politically corrupt
nature of legislative chartering. A new era of “free banking” emerged with a
number of states passing laws in 1837 that abolished the requirement to
obtain an officially legislated charter to operate a bank. By 1860, a
majority of states had issued such laws. In this
environment of free banking, anyone could operate a bank on the condition,
among others, that all notes issued were back by proper security. While this
condition served to reinforce the credibility of note issuance, it did not
guarantee immediate redemption in specie (gold or silver), which would serve
to be a crucial point. The era of free banking suffered from financial
instability with several banking crises occurring, and it made for a
disorderly currency characterized by thousands of different banknotes
circulating at varying discount rates. It is this instability and disorder
that would renew the call for more regulation and central oversight in the
1860s. Increasing
Regulation from the Civil War to the New Deal The free
banking era, characterized as it was by a complete lack of federal control
and regulation, would come to an end with the National Banking Act of 1863 (and its
later revisions in 1864 and 1865), which
aimed to replace the old state banks with nationally chartered ones. The Office of the
Comptroller of the Currency (OCC) was created to issue these new bank charters as well as oversee that national banks
maintained the requirement to back all note issuance with holdings of U.S.
government securities. While the new
national banking system helped return the country to a more uniform and secure
currency that it had not experienced since the years of the First and Second
Banks, it was ultimately at the expense of an elastic currency that could
expand and contract according to commercial and industrial needs. The growing
complexity of the U.S. economy highlighted the inadequacy of an inelastic
currency, which led to frequent financial panics occurring throughout the
rest of the nineteenth century. With the
occurrence of the bank panic of 1907, it had become apparent that America’s
banking system was out of date. Further, a committee gathered in 1912 to
examine the control of the nation’s banking and financial system. It found
that the money and credit of the nation were becoming increasingly
concentrated in the hands of relatively few men. Consequently, under the
presidency of Woodrow Wilson, the Federal Reserve Act of 1913 was approved
to wrest control of the nation’s
finances from banks while at the same time creating a mechanism that would
enable a more elastic currency and greater supervision over the nation’s
banking infrastructure. Although the newly established Federal Reserve
helped to improve the nation’s payments system and created a more flexible
currency, it's a misunderstanding of the financial crisis following the 1929
stock market crash served to roil the nation in a severe economic crisis that
would come to be known as the Great Depression. The Depression would lead to even
more banking regulation instituted by President Franklin D. Roosevelt as part
of the provisions under the New Deal. The Glass-Steagall Act of 1933 created the Federal Deposit Insurance Corporation (FDIC), which implemented regulation of deposit interest
rates, and separated commercial from investment banking. The Banking Act of 1935
served to strengthen and give the Federal Reserve more centralized power. 1980s
Deregulation and Post-Crisis Re-Regulation The period
following the New Deal banking reforms up until around 1980 experienced a
relative degree of banking stability and economic expansion. Still, it has been
recognized that the regulation has also served to make American banks far
less innovative and competitive than they had previously been. The heavily
regulated commercial banks had been losing increasing market share to
less-regulated and innovative financial institutions. For this reason, a wave
of deregulation occurred throughout the last two decades of the twentieth
century. In 1980,
Congress passed the Depository
Institutions Deregulation and Monetary Control Act, which served
to deregulate financial institutions
that accept deposits while strengthening the Federal Reserve’s control over
monetary policy. Restrictions on
the opening of bank branches in different states that had been in place since
the McFadden Act of 1927 were removed under the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994. Finally, the
Gramm-Leach-Bliley
Act of 1999
repealed significant aspects of the Glass-Steagall Act as well as the Bank
Holding Act of 1956, both of which had served to sever investment banking and
insurance services from commercial banking. From 1999 onwards, a bank could now offer commercial banking,
securities, and insurance services under one roof. All of this deregulation helped to accelerate a trend
towards increasing the complexity of banking organizations as they moved to
greater consolidation and conglomeration. Financial institution mergers
increased with the total number of banking organizations consolidating to
under 8000 in 2008 from a previous peak of nearly 15,000 in the early 1980s.
While banks have gotten bigger, the conglomeration of different financial
services under one organization has also served to increase the complexity of
those services. Banks began offering
new financial products like derivatives and began packaging traditional
financial assets like mortgages together through a process of securitization. At the same time that these new financial
innovations were being praised for their ability to diversify risk, the
sub-prime mortgage crisis of 2007 that transformed into a global financial
crisis and the need for the bailout of U.S. banks that had become “too big to
fail” has caused the government to rethink the financial regulatory
framework.
In response to the crisis, the Obama administration passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in
2010,
aimed at many of the apparent weaknesses within the U.S. financial system. It
may take some time to see how these new regulations affect the nature of
banking within the U.S. The Bottom
Line In antebellum
America, numerous attempts at increased centralized control and regulation of
the banking system were tried, but fears of concentrated power and political
corruption served to undermine such attempts. Nevertheless, as the banking
system grew, the need for ever-increasing regulation and centralized control,
led to the creation of a nationalized banking system during the Civil War,
the creation of the Federal Reserve in 1913, and the New Deal reforms under
Roosevelt. While the increased regulation led to a period of financial
stability, commercial banks began losing business to more innovative
financial institutions, necessitating a call for deregulation. Once again,
the deregulated banking system evolved to exhibit even greater complexities
and precipitated the most severe economic crisis since the Great Depression.
Dodd-Frank was the response, but if history is any guide, the story is far
from over, or perhaps, the pendulum will continue to swing. Summary
based on the above article: The
evolution of banking regulation in America can be divided into distinct
phases, each driven by specific economic needs and concerns. ·
Antebellum America (1791-1860s): During this period, attempts were made to regulate
banking at both federal and state levels. The First Bank of the United States
(1791) brought some stability but was challenged as unconstitutional and not
renewed. The Second Bank of the United States (1816) faced similar opposition
and dissolved in 1836. State-level banking was highly political, often
granted based on affiliations, leading to corruption. The era ended with a
move towards "free banking" in the 1830s-1860s, which resulted in
disorderly currency and financial instability. ·
Civil War to New Deal (1860s-1930s): The National Banking Act of 1863 established a
nationalized banking system with the Office of the Comptroller of the
Currency overseeing national banks. While it provided stability, the
inelastic currency led to financial panics. The Federal Reserve Act of 1913
aimed to create an elastic currency and greater financial oversight. The
Great Depression prompted more regulation under the New Deal, including the Glass-Steagall Act (1933)
separating banking activities and the Banking Act (1935) strengthening the
Federal Reserve. ·
1980s Deregulation and Post-Crisis Re-Regulation: Banking stability and expansion followed New Deal
reforms until the late 20th century. Deregulation occurred in the 1980s,
removing barriers and allowing innovation. Acts like the Depository
Institutions Deregulation and Monetary Control Act (1980) and the Gramm-Leach-Bliley Act (1999) aimed
to increase competitiveness by permitting expanded services. Complex
financial products emerged, contributing to the subprime mortgage crisis of 2007. ·
Post-Crisis (2010s):
The 2007 financial crisis led to a reevaluation of regulation. The Dodd-Frank Wall Street Reform and
Consumer Protection Act (2010) aimed to address weaknesses in the financial
system, enhance transparency, and prevent "too big to fail"
situations. Throughout history, the
system swung between increased regulation for stability and periods of
deregulation to encourage innovation. Each phase responded to economic and
systemic challenges, shaping the trajectory of American banking and financial
systems. In class Exercise 1:
Which act aimed to replace state banks with nationally chartered ones and
established the Office of the Comptroller of the Currency (OCC)? A.
Glass-Steagall Act B.
National
Banking Act C. Dodd-Frank
Act Answer: B 2: What act,
passed in 1913, created the Federal Reserve and aimed to enable a more
flexible currency? A. Federal
Reserve Act B.
Glass-Steagall Act C. Dodd-Frank
Act Answer: A 3: Which act,
passed in response to the 2007 financial crisis, aimed to address weaknesses
in the U.S. financial system? A. Dodd-Frank
Act B.
Glass-Steagall Act C. Banking
Reform Act Answer: A 4: What act of
1999 repealed parts of the Glass-Steagall Act and allowed banks to offer
various financial services under one roof? A. Dodd-Frank
Act B.
Gramm-Leach-Bliley Act C. Depository
Institutions Deregulation Act Answer: B 5: Which act
of 1980 served to deregulate financial institutions accepting deposits and
strengthened the Federal Reserve's control over monetary policy? A.
Glass-Steagall Act B. Dodd-Frank
Act C. Depository
Institutions Deregulation and Monetary Control Act Answer: C 6: What act of
1994 removed restrictions on the opening of bank branches in different
states? A. Riegle-Neal
Interstate Banking and Branching Efficiency Act B.
Glass-Steagall Act C. Dodd-Frank
Act Answer: A 7: Which act
of 1933 established the Federal Deposit Insurance Corporation (FDIC) and separated
commercial from investment banking? A.
Glass-Steagall Act B. Dodd-Frank
Act C.
Gramm-Leach-Bliley Act Answer: A 8: Which act
of 1999 allowed banks to offer commercial banking, securities, and insurance
services under one roof? A. Dodd-Frank
Act B.
Gramm-Leach-Bliley Act C.
Glass-Steagall Act Answer: B Why Are
Banks Regulated? (FYI) January
30, 2017 By Julie L Stackhouse https://www.stlouisfed.org/on-the-economy/2017/january/why-federal-reserve-regulate-banks This
post is the first in a series titled “Supervising Our
Nation’s Financial Institutions.”
Supervising Our Nation’s Financial Institutions The
series, written by Julie Stackhouse, executive vice president and
officer-in-charge of supervision at the St. Louis Federal Reserve, is
expected to appear at least once each month throughout 2017. The
topic of financial deregulation is once again generating news stories. It
raises a foundational question: “Why is the U.S.
banking system so heavily regulated?” Banking
regulation has existed in some form since the chartering of banks and its
goals have evolved over time. Today, banking regulation serves four main
purposes. Financial Stability Instability
in the financial system can have material ripple effects into other parts of
the domestic and international financial sectors. Supervision that is focused
on financial stability (often called macro-prudential supervision) looks at
trends and analyzes the likelihood for financial contagion and the possible
impacts across firms that pose systemic risks. Protection of the Federal
Deposit Insurance Fund Since
Jan. 1, 1934, the Federal Deposit Insurance Corp. has insured the deposits
held in U.S. banks up to a defined amount (currently $250,000 per depositor
per bank). The federal government serves as a backstop to the insurance fund. In
exchange for this insurance guarantee, banks pay an insurance premium and are
also subject to safety and soundness examinations by state and/or federal
regulators. Oversight of individual financial institutions by banking
regulators is called micro-prudential supervision. While
the insurance fund protects depositors, it does not protect shareholders of
banks. When inappropriate risks are taken and prove unsuccessful, banks will
fail and be liquidated. Consumer Protection Since
the creation of the Federal Trade Commission in 1914, the federal government
has had a formal obligation to protect consumers across industries. Since
that time, numerous laws and regulations have been crafted by various
agencies to protect bank customers and promote fair and equal access to
credit. Banks
conduct financial transactions with consumers either directly (lending to
consumers and taking consumer deposits) or indirectly (through financial
technology on the front end, for example). Banking regulators enforce
consumer protection regulations by conducting comprehensive reviews of bank
lending and deposit operations and investigating consumer complaints. Competition A
competitive banking system is a healthy banking system. Banking regulators
actively monitor U.S. banking markets for competitiveness and can deny bank
mergers that would negatively affect the availability and pricing of banking
services. Although
fewer than 40 banks account for more than 70 percent of all U.S. banking
assets, as shown in the table below, there are nearly 6,000 institutions of
all sizes operating in communities across the country.
What is the Glass Steagall Act and how did it
come about? - GreenLine 401k (Youtube)
In class exercise: 1:
What caused the significant increase in stock prices by around 400% in just
four years during the 1920s? A)
Government regulations B)
Heavy borrowing from banks C)
Reduced taxes Answer:
B Explanation:
People were buying stocks using borrowed money from banks, which contributed
to the substantial increase in stock prices during the 1920s. 2:
Which event is associated with the devastating crash on October 29, 1929,
which marked the beginning of the Great Depression? A)
Black Tuesday B)
Roaring Twenties C)
The Glass-Steagall Act Answer:
A Explanation:
Black Tuesday refers to the day of the stock market crash on October 29,
1929, which played a significant role in initiating the Great Depression. 3:
What was the purpose of the Glass-Steagall Act proposed by Congress members
Glass and Steagall? A)
To encourage borrowing for stock investments B)
To separate banking activities from stock market speculation C)
To increase taxes on stock transactions Answer: B Explanation:
The Glass-Steagall Act aimed to separate banking functions from stock market
operations, limiting banks to traditional banking activities and preventing
speculation. 4: What
did the Glass-Steagall Act aim to restrict banks from engaging in? A)
Traditional banking activities B)
Stock market activities C)
Tax reduction Answer:
B Explanation:
The Glass-Steagall Act restricted banks from engaging in stock market
activities and speculation, focusing solely on traditional banking functions. 5:
When did the Glass-Steagall Act get repealed? A)
During the Roaring Twenties B)
In 1999 C)
In the 1970s Answer:
B Explanation:
The Glass-Steagall Act was repealed in 1999, long after the Great Depression,
allowing banks and Wall Street to engage in joint activities. 6:
What is the main concern associated with the alliance between banking and
speculation after the Glass-Steagall Act's repeal? A)
Increased government regulation B)
Economic volatility and risk C)
Reduced stock market activity Answer:
B Explanation: The
alliance between banking and speculation is believed to have heightened
economic volatility and risk, impacting the stability of the economy. What is Dodd Frank? (youtube)
In
class exercise 1: Who are the two individuals after whom
the Dodd-Frank Act is named? A) John Smith and Jane Doe B) Christopher J. Dodd and Barney Frank C) Michael Johnson and Sarah Thompson Answer:
B Explanation: The Dodd-Frank Act is named after U.S.
Senator Christopher J. Dodd and U.S. Representative Barney Frank, who played
key roles in its creation and passage. 2: Which government agencies were
established by the Dodd-Frank Act? A) Environmental Protection Agency and
Federal Reserve B) Financial Stability Oversight Council
and Orderly Liquidation Authority C) Department of Homeland Security and
Federal Trade Commission Answer:
B Explanation: The Dodd-Frank Act established the
Financial Stability Oversight Council and the Orderly Liquidation Authority
as new government agencies to monitor and regulate aspects of the financial
system. 3: What is the main goal of the Dodd-Frank
Act? A) To increase risk in the financial
system B) To lower risk in various parts of the
U.S. financial system C) To dismantle government agencies Answer:
B Explanation: The main purpose of the Dodd-Frank Act is
to lower risk in different areas of the U.S. financial system through
regulatory measures and oversight. 4: What is the significance of the term
"too big to fail"? A) It refers to companies that are too
small to impact the economy B) It describes companies that can be
easily managed in case of financial distress C) It denotes companies whose failure could
have severe systemic consequences Answer: C Explanation: "Too big to fail" refers to
companies that are considered so large and interconnected that their failure
could have severe and widespread consequences throughout the financial
system. Part
IV – AI in the Banking Sector A.I. will disrupt the
whole financial industry, including hedge funds: EMJ Capital's Eric Jackson
(cnbc)
Big banks are talking up generative A.I. — but the risks mean
they’re not diving in headfirst PUBLISHED MON, JUN 12 20237:48 PM EDT Ryan
Browne MacKenzie Sigalos KEY POINTS · Many terms and phrases were used by top
banking and fintech executives to describe generative AI at Money 20/20 in
Amsterdam this week, from “mind boggling” to an “explosion of innovation.” · Generative
AI, which generates content in response to user prompts, can be used to
automate complex processes in banking. · However,
the technology is still in its early days, and many banks cautioned that it
may be too risky to implement it in areas that touch consumers. AMSTERDAM, Netherlands — Major
banks and fintech companies claim to be piling into generative artificial
intelligence as the hype surrounding the buzzy technology shows no signs
of fizzling out — but there are lingering fears about potential pitfalls and
risks. At the Money 20/20 fintech conference in Amsterdam, Netherlands,
executives at large lenders and online finance firms sang the praises of generative AI, calling it an “explosion
of innovation,” and saying it will “unleash innovation in areas that we can’t
even think about.” Chalapathy Neti, head of AI at global bank messaging network
Swift, described the progress made with ChatGPT and GPT-4 as “mind-boggling.”
He added, “This is truly a transformative moment.” But in the short term, banks are scrambling to figure out the
use cases. The Netherlands’ ABN
Amro is one banking giant that’s piloting the use of generative AI in its
processes. Annerie Vreugdenhil, chief commercial officer of ABN Amro’s
personal and business banking division, revealed on a panel that it is using the technology to
automatically summarize conversations between bank staff and customers.
It’s also using it to help its
employees gather data on customers to assist with answering queries and avoid
repetitive questions. The bank is now in the process of scaling these pilots to 200
employees and is exploring a number of new pilots to start this summer. In a closed-door session on the application of AI in financial
services, meanwhile, two banking executives explained how they’re using the technology to improve their internal code and analyze
how their clients are behaving. “We are experimenting at this stage and we don’t have
necessarily anything client facing but we are using the [tech the] same as
other companies, for example, code refactoring, comms calls, the other way
around,” said Mariana Gomez de la Villa, an executive at ING Bank
specializing in strategy and innovation. Indeed, the banks
appeared unanimous in their hesitation to roll out ChatGPT-like tools to
customer-facing scenarios. Jon Ander Beracoechea Alava, advanced analytics discipline head
at Spanish bank BBVA, said that the
lender had taken a “conservative approach” to AI, adding that, at this stage,
generative AI is “still early” and “immature.” A crucial issue is that advanced AI systems require the processing
of huge volumes of data — a sensitive commodity wrapped up in all kinds of
rules and regulations. As such, Alava said that at this stage it was too “risky” to involve sensitive information from customers. Generative A.I.,
explained Generative AI is a
specific form of AI that is able to produce content from scratch. The systems
take inputs from the user and feed them into powerful algorithms fueled by
large datasets to generate new text, images and video in a way that’s more
humanlike than most AI tools already on the market. The technology was thrust into the spotlight following the
success of OpenAI’s GPT language processing technology. ChatGPT, which uses
massive language models to create human-sounding responses to questions, has
ignited an arms race among some companies over what is seen as the next
“paradigm shift” in tech. In March, Goldman Sachs’ chief information officer, Marco
Argenti, told CNBC the bank is
experimenting with generative AI tools internally to help its developers automatically
generate and test code. More recently, in May,
Goldman spun off the first startup from the bank’s internal incubator — an
AI-powered social media company for corporate use called Louisa. The push
into AI is part of a larger effort by CEO David Solomon to expedite the
bank’s digital makeover. Morgan Stanley,
meanwhile, is using it to inform its financial advisors on queries they may
have. The bank has been testing
an OpenAI-powered chatbot with 300 advisors so far, with a view to ultimately
aid its roughly 16,000 advisors in making use of Morgan Stanley’s repository
of research and data, according to Jeff McMillan, head of analytics and data
at the firm’s wealth management division. A.I. ‘co-pilot’ These are just some examples of how financial firms are using
AI, but more as a digital helper than as a core part of their services. Gudmundur Kristjansson, CEO and co-founder of Icelandic
regulatory technology firm Lucinity, showed CNBC how artificial intelligence can be used to assist with a key area in
finance: fighting crime. An AI tool the company created, called Luci, aims to help
compliance professionals with their investigations. In a live demonstration,
Kristjansson showed himself looking into a money laundering case. The AI tool
analyzed the case and described what it saw and then completed an independent
review. In this use case, the AI
acts as more of a resource — or “copilot” — to help an employee find data and
flesh out a case rather than replace the role of a person looking into
reports of suspicious activity. “Where you find money laundering is through ... interconnected
networks of people who are basically employed to do it. That’s why it’s so
hard to find it. Banks spent this year $274 billion on prevention,”
Kristjansson told CNBC in an interview. He said where Luci helps is by vastly reducing the amount of
time spent trying to work out whether something is fraud or money laundering. The whole appeal of AI to the big banks and fintechs, Money
20/20 attendees said, is the potential
reduction in the time and money it takes to complete tasks that can take
human employees days. Niklas Guske, chief operating officer at Taktile, a startup that
helps fintechs automate decision-making, acknowledged that the use of AI is challenging
in the financial sector, given the lack of publicly available data. But he stressed that it
could be a “crucial” tool to reduce the companies’ operational expenses and
improve efficiency. “In many fintech
applications, this is done through an increase in automation and reducing
manual processes, especially in onboarding and underwriting,” he told
CNBC. “This automation is truly enabled through access to more data
sources, which empower lenders to gain new insights and identify the right
customers without having to parse through dozens of PDFs for the right piece
of information.” — CNBC’s Hugh Son contributed reporting In
class exercise 1: What is "generative AI"? A) AI that generates content from user
inputs. B) AI that talks to customers. C) AI that predicts stock market trends. Answer:
A 2: Why are banks careful about using
generative AI with customers? A) Because it's too expensive. B) Because it might involve private
customer data. C) Because it's not allowed by
regulations. Answer:
B 3: How does ABN Amro use generative AI? A) To predict the weather. B) To summarize conversations between
staff and customers. C) To make coffee. Answer:
B 4: How is generative AI used as a
"co-pilot"? A) It flies planes. B) It helps employees with their work. C) It replaces human employees. Answer:
B 5: Why do banks like using AI? A) It helps them play video games. B) It saves time and money on tasks. C) It makes customers happy all the time. Answer:
B Fed
banking regulator warns A.I. could lead to illegal lending practices like
excluding minorities PUBLISHED TUE, JUL 18 202310:00 AM
EDTUPDATED TUE, JUL 18 202311:32 AM EDT Jeff Cox KEY
POINTS ·
Michael S. Barr, the Fed’s vice chair for
supervision, said AI technology has the potential to get credit to “people
who otherwise can’t access it.” ·
“While these technologies have enormous
potential, they also carry risks of violating fair lending laws and
perpetuating the very disparities that they have the potential to address,”
he added. Michael
Barr, vice chair for supervision of the board of governors of the Federal
Reserve, testifies during a House Committee on Financial Services hearing on
Oversight of Prudential Regulators, on Capitol Hill in Washington, DC, on May
16, 2023. The
Federal Reserve’s top banking regulator expressed caution Tuesday about the
impact that artificial intelligence can have on efforts to make sure
underserved communities have fair access to housing. Michael S. Barr, the Fed’s vice chair for
supervision, said AI technology has
the potential to get credit to “people who otherwise can’t access it.” However, he noted that it also can be used for nefarious means,
specifically to exclude certain communities from housing opportunities
through a process traditionally called “redlining.” “While these technologies have enormous
potential, they also carry risks of
violating fair lending laws and perpetuating the very disparities that they
have the potential to address,” Barr said in prepared remarks for the
National Fair Housing Alliance. As an
example, he said AI can be manipulated to perform “digital redlining,” which
can result in majority-minority communities being denied access to credit and
housing opportunities. “Reverse redlining,” by contrast, happens when “more
expensive or otherwise inferior products” in lending are pushed to minority
areas. Barr said work being done by the Fed and
other regulators on the Community
Reinvestment Act will be focused on making sure underserved communities have
equal access to credit. money o In
Class Exercise 1: What does Michael S. Barr say about the
impact of AI on underserved communities and housing? A. AI can only help expand credit access. B. AI can expand credit access and also be
misused to exclude communities. C. AI has no effect on fair access to
housing. Answer:
B 2: What is "digital redlining"? A. Targeting minority communities for
housing. B. Positive impact of AI on lending. C. Denying credit using AI to certain
communities. Answer:
C 3: What's the focus of the work on the
Community Reinvestment Act? A. Excluding communities from credit. B. Making sure AI is always positive. C. Ensuring equal credit access for
underserved areas. Answer:
C PART
V: What is Net Interest Margin? Investors must assess
banks' net interest margins in wake of SVB fallout, says investment director
(youtube)
Calculating Net Interest Margin
Net
Interest Margin and Retail Banking Most retail banks offer interest on
customer deposits, which generally hovers around 1% annually. If such a bank marshaled
together the deposits of five customers and used those proceeds to issue a
loan to a small business, with an annual interest rate of 5%, the 4% margin
between these two amounts is considered the net interest spread. Looking one step further, the net interest
margin calculates that ratio over the bank's entire asset base. Let's assume a bank has earning assets of
$1.2 million, $1 million in deposits with a 1% annual interest to depositors,
and loans out $900,000 at an interest of 5%. This means its investment
returns total $45,000, and its interest expenses are $10,000. Using the
aforementioned formula, the bank's net interest margin is 2.92%. With its NIM
squarely in positive territory, investors may wish to strongly consider
investing in this firm.
https://www.statista.com/statistics/1046318/net-interest-margin-wells-fargo/ Bank of America (NYSE:BAC) Net Interest
Margin (Bank Only) %
: 2.51% (As of Jun. 2023) Net Interest Margin (Bank Only) % is a measure of the
difference between the interest income generated by banks or other financial
institutions and the amount of interest paid out to their lenders (for
example, deposits), relative to the amount of their interest-earning assets.
It is usually calculated as a percentage of what the financial institution
earns on loans in a time period and other assets minus the interest paid on
borrowed funds divided by the average amount of the assets on which it earned
income in that time period (the average earning assets). GuruFocus calculates Net Interest Margin (Bank Only) % as Net Interest Income (for Banks) divided
by its average earning assets. Bank of America's annualized Net Interest Income (for Banks) for
the quarter that ended in Jun.
2023 was $56,632 Mil. Bank of
America's average earning assets for the quarter that
ended in Jun. 2023 was $2,259,327
Mil. Therefore, Bank of America's annualized Net
Interest Margin (Bank Only) % for the quarter that
ended in Jun. 2023 was 2.51%.
Part
VI – Investment Banking (FYI) Largest
full-service investment banks The following are the largest full-service
global investment banks; full-service investment banks usually provide both
advisory and financing banking services,
as well as sales, market making, and
research on a broad array of financial products, including equities, credit, rates, currency, commodities, and their derivatives. The largest
investment banks are noted with the following:[3][4] 5.
6.
8.
9.
12.
13.
14.
15.
16.
19.
https://en.wikipedia.org/wiki/List_of_investment_banks Investment Banking
Explained in 5 minutes
In class exercise (based
on the above video) 1.
What are the two main services investment banking provides? a)
Research and Trading b)
Advisory (M&A) and Financing (Underwriting) c)
Asset Management and Wealth Advisory Answer: b 2.
What does IPO stand for? a)
Initial Public Offering b)
Investment Profit Opportunity c)
International Portfolio Option Answer: a 3.
What role does an investment bank play in an IPO? a)
Buying shares from the company b)
Buying shares from investors c)
Connecting company with investors Answer: c 4.
What is "bulge bracket" in investment banking? a)
Boutique advisory firms b)
Top-tier, major investment banks c)
Independent financial consultants Answer: b 5.
What led to increased investment banking profits recently? a)
Decline in financial activities b)
Growth of boutique banks c)
Rise in mergers and acquisitions Answer: c 6.
What division handles stock trades in an investment bank? a)
Asset Management b)
Sales and Trading c)
Research Answer: b 7.
How did investment banks address junior staff burnout concerns? a)
Reduced salaries for juniors b)
Increased base salary for juniors c)
Eliminated bonuses for juniors Answer: b 8.
What regulation was enacted after the 2007 financial crisis? a)
Dodd-Frank Wall Street Reform Act b)
Investment Banking Profit Act c)
Financial Deregulation Act Answer: a 9.
What is the main revenue source for investment banks in IPOs? a)
Advisory fees b)
Stock trading profits c)
Underwriting fees Answer: c 10. What is the purpose of an Initial
Public Offering (IPO)? a) To buy shares from investors b) To sell shares to the public for the
first time c) To trade shares between investment
banks Answer:
b 11, What role does an investment bank play
in mergers and acquisitions (M&A)? a) They sell products to consumers b) They advise companies on buying or
selling businesses c) They provide legal services for
companies Answer:
b VyStar Credit Union: After the outage (FYI
only) By Mike Mendenhall | 12:00
a.m. October 7, 2022 https://www.jaxdailyrecord.com/news/2022/oct/07/vystar-credit-union-after-the-outage/ 1: What was the purpose of VyStar Credit Union's system
upgrade in the summer of 2022? A) To enhance cybersecurity B) To introduce new fees C) To improve digital banking products Answer: C Explanation: VyStar Credit Union
conducted a system upgrade in the summer of 2022 with the goal of enhancing
their digital banking products. 2: What caused VyStar's online banking outage to last more
than a month? A) Technical glitches during the upgrade B) Hacking by cybercriminals C) Extended testing period Answer: A Explanation: The online banking outage at
VyStar Credit Union lasted over a month due to technical glitches that
occurred during the system upgrade process. 3: How did VyStar respond to the challenges faced during the
online banking outage? A) They ignored the issues and focused on other matters B) They acknowledged the problems and worked to resolve them C) They blamed their customers for the issues Answer: B Explanation: VyStar Credit Union
acknowledged the challenges faced during the online banking outage and worked
to resolve the issues for their customers. 4: What effect did the online banking outage have on VyStar's
membership? A) Increased membership growth B) No change in membership numbers C) Slowdown in new memberships and increase in closed
memberships Answer: C 5: Besides Georgia, where else did VyStar Credit Union expand
its branch network in recent years? A) California B) Florida Peninsula and the Panhandle C) Midwest Answer: B 6: What other regions does VyStar Credit Union consider for
potential future expansion? A) Alaska and Hawaii B) Alabama, Tennessee, and the Carolinas C) Western Europe Answer: B 7: What is VyStar Credit Union's outlook on their partnership
with Nymbus Inc.? A) They regret their choice and are ending the partnership B) They are dissatisfied and considering other vendors C) They believe they made the right choice and plan to
continue the partnership Answer: C Explanation: VyStar Credit Union believes they made
the right choice by partnering with Nymbus Inc. and plan to continue their
partnership, despite the challenges they faced during the online banking outage. |
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|
Federal
Reserve and Monetary Policy Ppt Fed Introduction (chapters 15, 16) Ppt Fed
Monetary Policy (chapter 18) Content: · Part 1: Fed Structure · Part 2: Reserve Banks · Part 3: Monetary Policy · Part 4: Fed Funds Rate · Part 5: Interest rate and Inflation · Part 6: Open market operation · Part 7: Quantitative Easing (QE) Part I - Fed Structure The Federal Reserve System
| The Fed Explained (youtube)
For discussion: 1.
What is FOMC? How many members? How
many time does FOMC meet? What is determined at FOMC meeting? 2.
What is reserve bank? For our area,
where is the reserve bank located? 3.
What is board of governor? How many
members? Who is the chair? Summary of the video: ·
The Federal Reserve, America's
decentralized central bank, comprises three key components: the Board of
Governors, the Reserve Banks, and the Federal Open Market Committee (FOMC). ·
The Board of Governors in Washington,
consisting of seven members, oversees the entire system and manages monetary
policy and financial stability. ·
The 12 regional Reserve Banks, reflecting
diverse regional perspectives, play a vital role in their local economies and
are guided by boards with a mix of bank representatives and residents. ·
The FOMC, including select Board of
Governors members and Reserve Bank presidents, sets monetary policy, with
only some members having voting power. ·
The Federal Reserve maintains its
independence from political pressures, as Board of Governors members serve
long terms and funding comes from sources independent of the government's
budget. This independence allows the Fed to focus on the long-term health of
the U.S. economy, free from short-term political considerations. In class exercise 1. What are
the three main components of the Federal Reserve? a) Board of
Governors, Treasury Department, Federal Open Market Committee b) Reserve
Banks, Commercial Banks, Savings and Loans c) Board of
Governors, Reserve Banks, Federal Open Market Committee Answer: c Explanation: The Federal Reserve is
composed of the Board of Governors, 12 Reserve Banks, and the Federal Open
Market Committee (FOMC). 2. The Board
of Governors is responsible for: a) Managing
individual bank accounts b) Overseeing
the reserve banks c) Setting
monetary policy Answer: c Explanation: The Board of Governors plays a
key role in setting monetary policy and ensuring the stability of the
financial system. 3. What is the
primary goal of the Federal Reserve's monetary policy? a) Maximizing
government revenue b) Achieving
low and stable inflation c) Promoting
higher interest rates Answer: b Explanation: The Federal Reserve aims to
maintain low and stable inflation to support a healthy economy. 4. Which
committee makes decisions about interest rates and monetary policy? a) Board of
Governors b) Reserve
Banks c) Federal
Open Market Committee (FOMC) Answer: c Explanation: The FOMC is responsible for making
decisions related to interest rates and monetary policy. 5. The main
reason the Federal Reserve was established was to: a) Manage
government spending b) Prevent
bank failures and panics c) Control
inflation Answer: b Explanation: The Federal Reserve was
created to prevent bank failures and financial panics by providing emergency cash
reserves. 6. What is the
role of the reserve banks in the Federal Reserve System? a) Setting
fiscal policy b) Providing
financial services, contributing to monetary policy, and supervising banks c) Issuing
currency and coins Answer: b Explanation: Reserve banks have these key
responsibilities within the Federal Reserve System. 7. What is the
main goal of the Federal Reserve's monetary policy tools? a) Maximizing
government revenue b) Promoting
economic growth through high inflation c) Influencing
interest rates and the economy Answer: c Explanation: The Federal Reserve uses monetary
policy tools to control interest rates and achieve economic goals. 8. Who
appoints the members of the Board of Governors? a) The U.S.
Senate b) The
President of the United States c) The Federal
Open Market Committee Answer: b Explanation: The President appoints the members
of the Board of Governors, subject to Senate confirmation. 9. What is the
Federal Open Market Committee (FOMC) responsible for? a) Providing
financial services to banks b) Conducting
bank examinations c) Making
decisions about monetary policy Answer: c Explanation: The FOMC sets monetary policy,
including interest rates and money supply. 10. What is
one way the Federal Reserve helps banks during crises? a) Providing
free advertising b) Offering
short-term loans through the discount window c) Bailing out
troubled banks with taxpayer money Answer: b Explanation: The Federal Reserve lends
money to banks through the discount window to address liquidity issues during
crises. 11. How often
does the FOMC typically meet to discuss the economy and monetary policy? a) Once a
month b) Once a year c) Every 10
years Answer: a Explanation: The FOMC meets approximately eight
times a year to review economic conditions and set monetary policy. 12. What is
the primary goal of the Federal Reserve's involvement in monetary policy? a) Maximizing
corporate profits b) Maintaining
high unemployment c) Promoting
maximum employment and stable prices Answer: c Explanation: The Federal Reserve aims to
achieve both maximum employment and price stability through its monetary
policy actions. 13. What
entity helps maintain regional independence within the Federal Reserve
System? a) U.S.
Treasury Department b) Board of
Governors c) Reserve
Banks Answer: c Explanation: Reserve Banks contribute to regional
independence while still being part of the broader Federal Reserve System. 14. Why did
Congress create the Federal Reserve in 1913? a) To regulate
international trade b) To
establish a national currency c) To address
bank failures and financial panics Answer: c Explanation: One of the main reasons for creating
the Federal Reserve was to prevent bank failures and financial panics. 15. What is
the FOMC's primary tool for influencing short-term interest rates? a) Printing
more currency b) Setting
income tax rates c) Open market
operations Answer: c Explanation: The FOMC influences short-term
interest rates through buying or selling government securities in the open
market. 16. How many
members are there in the Board of Governors? a) 5 members b) 9 members c) 7 members Answer: c Explanation: The Board of Governors
consists of 7 members who are appointed by the President and confirmed by the
Senate. 17. What is
the FOMC's role in setting interest rates? a) It follows
the lead of foreign central banks b) It provides
investment advice to the public c) It sets the
target range for the federal funds rate Answer: c Explanation: The FOMC determines the target
range for the federal funds rate, influencing other interest rates in the
economy.
Segment 102: Structure of Federal Reserve
(video) https://www.youtube.com/watch?v=SJ-AX6PSPXw
In class exercise 1. How long is the term of office for a member of the Board of
Governors? a) 4 years b) 10 years c)
14 years Answer:
c 2.
How many Reserve Bank presidents are voting members of the FOMC at any one
time? a)
3 b)
5 c)
7 Answer: b Explanation: At any one time, five Reserve Bank presidents are voting members
of the Federal Open Market Committee (FOMC). 3.
How does each Reserve Bank reflect the diversity of the country? a)
By having a uniform structure b)
By mirroring the largest banks c)
By representing regional economies and perspectives Answer: c Explanation:
Each Reserve Bank reflects the diversity of the country by representing
regional economies and perspectives. 4.
What is the primary source of funding for the Federal Reserve? a)
Government grants b)
Interest earned on government securities and service fees c)
Donations from private corporations Answer: b Explanation: The primary sources of funding for the Federal Reserve
are interest earned on government securities and service fees. 5.
How are the Reserve Bank directors chosen? a)
Appointed by Congress b)
Elected by citizens c)
Elected by member banks and appointed by the Board of Governors Answer: c Explanation: Reserve Bank directors are elected by member banks and
appointed by the Board of Governors. 6.
How many Reserve Banks are there in the Federal Reserve System? a)
5 b)
10 c)
12 Answer: c Explanation: There are 12 Reserve Banks in the Federal Reserve System. 7.
Which entity ensures that the Federal Reserve remains independent from
political pressures? a)
Congress b)
The President c)
Long-term appointments and funding structure Answer: c Explanation: The Federal Reserve remains independent from political
pressures through long-term appointments and a funding structure that's not
tied to political budgeting. 8.
Which Reserve Bank president is always a voting member of the FOMC? a)
The president of the Federal Reserve Bank of New York b)
The president of the Federal Reserve Bank of San Francisco c)
The president of the Federal Reserve Bank of Chicago Answer: a Explanation: The president of the Federal Reserve Bank of New York is
always a voting member of the FOMC. 9.
What are the main responsibilities of the Reserve Banks? a)
Setting interest rates, collecting taxes, providing health care services b)
Conducting monetary policy, providing financial services, supervising banks c)
Regulating international trade, printing currency, enforcing immigration laws Answer: b Explanation: The main responsibilities of the Reserve Banks include
conducting monetary policy, providing financial services, and supervising
banks. 10.
Why is the diversity of the 12 regional Reserve Banks considered a strength? a)
It allows them to compete with each other b)
It ensures uniformity in decision-making c)
It helps them understand and serve different regional needs Answer: c Explanation: The diversity of the 12 regional Reserve Banks is
considered a strength because it helps them understand and serve different
regional needs. Part II: FRB – Federal Reserve Banks Federal Reserve Bank
of Atlanta https://www.atlantafed.org/ Federal Reserve Bank of Atlanta's Boardroom Video
(youtube)
2021 Commencement Keynote: Raphael Bostic President
& CEO of the Federal Reserve Bank of Atlanta (youtube,
fyi)
Federal Reserve Bank
of Atlanta – Jacksonville regional office https://www.atlantafed.org/rein/jacksonville ATLANTA FED GOES TO THE GRASSROOTS:
OBSERVING WHAT'S HAPPENING IN THE ECONOMY – Jacksonville
(video)
Part III: Monetary Policy Monetary Policy and the
Fed- EconMovies #9: Despicable Me
（YouTube）
In class exercise: 1:
What is the central goal of monetary policy? a)
To regulate inflation in the short term b)
To manipulate currency exchange rates c)
To achieve specific economic objectives by altering the money supply Answer: c Explanation:
Monetary policy aims to impact the economy's performance by adjusting the
money supply in pursuit of defined economic goals. 2:
Who has the authority to regulate the money supply and interest rates? a)
The U.S. Congress b)
The President c)
The Federal Reserve Answer: c Explanation:
The Federal Reserve is responsible for managing the money supply and
influencing interest rates to achieve economic objectives. 3:
What is the main purpose of contractionary monetary policy? a)
To stimulate economic growth b)
To control inflation c)
To encourage borrowing Answer: b Explanation:
Contractionary policy aims to reduce excessive economic growth and prevent
inflation by tightening the money supply. 4:
How does the Federal Reserve influence interest rates? a)
By directly setting fixed interest rates b)
By altering the money supply, which in turn affects interest rates c)
By providing loans to banks at specific rates Answer: b Explanation:
The Federal Reserve's manipulation of the money supply indirectly impacts
interest rates throughout the economy. 5:
What economic situation does expansionary monetary policy target? a)
High unemployment b)
Low inflation c)
High inflation Answer: a Explanation:
Expansionary policy seeks to stimulate economic activity and lower
unemployment by increasing the money supply. 6:
What term best describes the effect of lowering the money supply to control
inflation? a)
Expansionary monetary policy b)
Contractionary monetary policy c)
Stabilization policy Answer: b Explanation:
Lowering the money supply through contractionary policy helps control
inflation by reducing excessive spending. 7:
Who is responsible for leading the Federal Reserve? a)
The President of the United States b)
An appointed Chairman, such as Janet Yellen c)
The Secretary of the Treasury Answer: B Explanation:
The Federal Reserve is headed by a Chairman, like Janet Yellen, who oversees
its operations and decisions. 8:
What is the primary aim of monetary policy? a)
To eliminate unemployment b)
To maintain a balanced budget c)
To promote economic stability and growth Answer: c Explanation:
Monetary policy aims to achieve stable economic conditions and facilitate
growth by influencing money supply and interest rates. 9:
How does the Federal Reserve react to a recession? a)
By raising interest rates to curb spending b)
By lowering interest rates to encourage borrowing and spending c)
By reducing the money supply to control inflation Answer: b Explanation:
During a recession, the Federal Reserve often uses expansionary policy,
including lowering interest rates, to stimulate economic activity. 10:
How does contractionary monetary policy impact interest rates? a)
It leads to higher interest rates b)
It leads to lower interest rates c)
It has no effect on interest rates Answer: a Explanation:
Contractionary policy, aimed at controlling inflation, involves raising
interest rates to reduce borrowing and spending. 11:
How does monetary policy differ from fiscal policy? a)
Monetary policy involves changes in government spending, while fiscal policy
involves changes in the money supply. b)
Fiscal policy involves changes in government spending, while monetary policy
involves changes in the money supply and interest rates. c)
Monetary policy only impacts international trade, while fiscal policy only
affects domestic economic activity. Answer: b Explanation:
Fiscal policy involves government spending and taxation, while monetary
policy focuses on money supply and interest rates. The
Tools of Monetary Policy (video) Summary of this video and
summary of Monetary Policy ·
This video
lesson explores the tools of monetary policy used by a central bank to manage
interest rates and influence aggregate demand in an economy. ·
It introduces the money market, key components,
and three primary tools: reserve requirements, open market operations, and
the discount rate. ·
These tools allow the central bank to shape the
money supply, impact interest rates, and stimulate or curb economic activity
as needed for economic stability and growth. ·
Open market operations are a way the U.S.
Federal Reserve controls how much money is available and interest rates. ·
They do this by buying or selling government
securities. ·
Buying puts more money into the system and
lowers interest rates, while selling takes money out and raises interest
rates. ·
·
Contrationary
monetary policy (in 2023)è sell bond è reduce money supply è increase interest rate è reduce economic growth è reduce inflation ·
·
Expansionary
monetary policy (during Covid) è buy bond è increase money supply è decrease interest rate è increase economic growth è increase inflation ·
For class discussion: 1. Three approaches to conduct Monetary policy. 2. What
is easing (expansionary) monetary (policy? What is contractionary monetary
policy? 3. Draw
supply and demand curve to show the results when Fed purchases (sells)
Treasury securities. 4. Compare
fed fund rate with discount rate. Which
rate is targeted by Fed to implement monetary policy? In Class Exercise 1: What is the primary purpose of a central
bank's monetary policy tools? A) To control fiscal policy. B) To
regulate international trade. C) To manage the money supply and interest rates. Answer:
C Explanation: The primary purpose of a central bank's monetary policy
tools is to manage the money supply and interest rates in order to achieve
specific economic goals such as controlling inflation, promoting economic
growth, and maintaining financial stability. 2: Which of the following tools of monetary policy
involves changing the percentage of deposits that banks must hold as
reserves? A) Open market operations. B) Discount rate. C) Reserve requirement. Answer:
C Explanation: The reserve requirement is the tool that involves
changing the percentage of deposits that banks are required to hold as
reserves. By adjusting this requirement, the central bank can influence the
amount of money banks can lend and the overall money supply. 3: When the Federal Reserve buys government bonds in open
market operations, what effect does it have on the money supply and interest
rates? A) Increases the money supply and lowers interest rates. B) Decreases the money supply and raises interest rates. C) Increases the money supply and raises interest rates. Answer:
A Explanation: When the Federal Reserve buys government bonds in open
market operations, it injects money into the economy, which increases the
money supply. As the money supply rises, the excess liquidity leads to a
decrease in interest rates, making borrowing cheaper and encouraging
consumption and investment. 4: If the central bank wishes to reduce inflation, what
action would it most likely take? A) Selling government bonds in open market operations. B) Lowering the reserve requirement. C) Decreasing the discount rate. Answer:
A Explanation: To combat inflation, the central bank would likely sell
government bonds in open market operations. This reduces the money supply,
leading to higher interest rates and decreased borrowing, ultimately curbing
inflationary pressures. 5: What happens when the central bank raises the discount
rate? A) Banks are more likely to borrow from the central bank. B) Banks are more likely to lend to each other. C) Banks are less likely to borrow from the central bank. Answer:
C Explanation: When the central bank raises the discount rate, it
becomes more expensive for banks to borrow from the central bank. This encourages
banks to seek alternative sources of funds and reduces their borrowing from
the central bank. 6: In the context of monetary policy, what is the purpose
of increasing the reserve requirement? A) To stimulate economic growth. B) To decrease the money supply. C) To lower interest rates. Answer:
B Explanation: Increasing the reserve requirement means banks must hold
a larger portion of their deposits as reserves, reducing the amount of money
they can lend out. This decrease in lending capacity leads to a reduction in
the money supply. 7: When the central bank engages in an expansionary
monetary policy, what is its likely goal? A) To decrease unemployment. B) To reduce inflation. C) To stimulate economic activity and growth. Answer:
C Explanation: An expansionary monetary policy aims to stimulate
economic activity and growth. This is typically done by increasing the money
supply, lowering interest rates, and encouraging borrowing and spending. 8: What is the main reason for a central bank to use contractionary
monetary policy? A) To encourage borrowing and investment. B) To reduce unemployment. C) To control inflation. Answer:
C Explanation: Contractionary monetary policy is used to control
inflation by reducing the money supply, increasing interest rates, and
limiting borrowing and spending. 9: Which tool of monetary policy is most commonly used by
central banks to manage the money supply? A) Changing the exchange rate. B) Changing the fiscal policy. C) Open market operations. Answer:
C Explanation: Open market operations are the most commonly used tool of
monetary policy, where central banks buy or sell government bonds to adjust
the money supply and interest rates. 10: When the central bank increases the discount rate,
what is its likely impact on borrowing and spending? A) Borrowing and spending increase. B) Borrowing and spending decrease. C) Borrowing increases, but spending remains unchanged. Answer:
B Explanation: Increasing the discount rate makes borrowing more
expensive for banks, which can lead to reduced borrowing and spending by
businesses and households. 11: If a central bank wants to stimulate economic growth
during a recession, which tool of monetary policy is most suitable? A) Increasing the discount rate. B) Selling government bonds. C) Lowering the reserve requirement. Answer:
C Explanation: Lowering the reserve requirement encourages banks to lend
more money, which increases the money supply and promotes borrowing and
spending, thus stimulating economic growth. 12: During a period of high inflation, what action could a
central bank take to address the situation? A) Decrease the reserve requirement. B) Sell government bonds. C) Lower the discount rate. Answer:
B Explanation: When the Federal Reserve sells government bonds in open market
operations, it takes money out of the economy, which decreases the money
supply. As the money supply declines, it leads to a increase in interest
rates, making borrowing more expensive and discouraging consumption and
investment. Homework (due with the first midterm exam) 1.
What was the reason behind the Federal Reserve's decision to increase
interest rates, and what measures did it employ to attain this objective? Do
you support it? Why or why not? 2.
The next FOMC meeting will be held on September 19-20, 2023. Will Fed
raise rates in September? Why or why not? 3.
Explain the Federal Funds rate and its significance in the economy.
Also, what is the current value of the Federal Funds rate as determined by
the Fed? 4. Define quantitative easing (QE) and provide comprehensive details about it. |
Part IV: Fed Funds Rate
Release
date: July 1, 2023 https://fred.stlouisfed.org/graph/?g=pbTc What is the Fed Fund rate (youtube) In class exercise 1: What is the federal funds rate? a) The
interest rate at which banks lend money to customers b) The
interest rate at which the Federal Reserve lends money to banks c) The
interest rate at which banks lend money to each other Answer: c Explanation: The
federal funds rate is the interest rate at which banks lend money to each
other overnight. This lending activity occurs between banks to address
short-term reserve needs. 2: Why
do banks need to maintain reserves? a) To
invest in long-term projects b) To
meet the legal requirements set by the Federal Reserve c) To
lend money to individuals and businesses Answer: b Explanation: Banks
are required to keep a portion of their deposits as reserves. These reserves
serve several purposes, including meeting legal requirements set by the
Federal Reserve, facilitating transactions with other banks, and providing
funds to customers. 3: What
purpose does the federal funds rate serve? a) It
directly controls consumer loan interest rates. b) It
influences credit conditions and the broader economy. c) It
determines the profit margins of individual banks. Answer: b Explanation: The
federal funds rate is significant because the Federal Reserve uses it to
influence credit conditions and, by extension, the overall economy. The
Federal Reserve can impact this rate through open market operations. 4: Why
did banks borrow reserves from each other before 2008? a) To
invest in high-risk ventures b) To
keep their reserve holdings relatively low c) To
address shortfalls in meeting Federal Reserve requirements Answer: c Explanation:
Before 2008, banks borrowed reserves from each other to ensure they could
meet the legal reserve requirements set by the Federal Reserve, especially
when their own reserves fell below the mandated levels. 5: How
can changes in the federal funds rate affect the economy? a) By
directly controlling government spending b) By influencing
credit conditions and borrowing costs c) By
determining stock market prices Answer: b Explanation:
Changes in the federal funds rate can impact credit conditions, affecting
borrowing costs for individuals and businesses, which, in turn, can influence
spending and investment. Part V: How does raising interest
rates control inflation? (youtube)
In class exercise 1, Why do central banks raise interest rates? a) To stimulate economic growth b) To control inflation c) To
encourage borrowing Answer: b Explanation:
Central banks raise interest rates as a measure to control inflation. When
inflation is seen as too high, raising interest rates slows down borrowing and
spending, which helps reduce demand and, in turn, lower the rate of price
increase in the economy. 2. How
does a rise in interest rates affect borrowers? a)
Borrowing becomes cheaper b)
Borrowing becomes more expensive c)
Borrowing remains unchanged Answer: b Explanation: A rise
in interest rates makes borrowing more expensive, as individuals and
businesses need to pay higher interest on their loans. This can lead to
reduced borrowing and spending in the economy. 3. How
do higher interest rates impact savings? a)
Savings earn higher interest b)
Savings earn lower interest c)
Savings remain unaffected Answer: a Explanation: Higher
interest rates lead to higher returns on savings accounts, making it more
rewarding for individuals to save money and earn interest on their deposits. 4. Why
might a rise in interest rates lead to lower consumer spending? a)
Borrowing becomes cheaper b)
Interest earned on savings increases c)
Borrowing becomes more expensive Answer: c Explanation: A rise
in interest rates increases the cost of borrowing, which can discourage
consumers from taking out loans for purchases. This, in turn, leads to lower
consumer spending. 5. How
does a central bank influence commercial banks' interest rates? a) By
providing direct loans to individuals b) By
setting a benchmark interest rate c) By
regulating stock market transactions Answer: b Explanation:
Central banks set a benchmark interest rate that influences the rates at
which commercial banks lend money to businesses and individuals. Changes in
this benchmark rate impact borrowing costs across the economy. 6. Why
might fixed-rate mortgage holders be less directly affected by rising
interest rates? a)
Fixed-rate mortgages have variable interest rates b)
Fixed-rate mortgages have lower interest rates c)
Fixed-rate mortgages have consistent interest rates Answer: c Explanation: Fixed-rate
mortgage holders are less directly affected by rising interest rates because their
interest rates remain consistent over the duration of the mortgage.
Variable-rate mortgage holders, on the other hand, see changes based on
prevailing interest rates. 7. What
is the potential impact of rising interest rates on businesses? a)
Businesses will find it easier to borrow for investments b)
Borrowing costs for businesses will increase c)
Businesses will experience reduced competition Answer: b Explanation: Rising
interest rates increase the cost of borrowing for businesses, making it more expensive
to finance investments and operations. This can lead to reduced economic
activity and business expansion. 8. How
do central banks use interest rates to curb inflation? a) By
increasing the money supply b) By
reducing government spending c) By
making borrowing more expensive Answer: c Explanation:
Central banks raise interest rates to make borrowing more expensive. This
reduces consumer spending and investment, helping to slow down the economy
and control inflation. 9. What
is the potential consequence of central banks raising interest rates too
quickly? a)
Lower unemployment rates b)
Economic growth and stability c)
Pushing the economy into a recession Answer: c Explanation:
Raising interest rates too quickly can lead to decreased borrowing and spending,
potentially causing a slowdown in economic growth and even a recession due to
reduced consumer demand and business activity. 10. Why
is it challenging for central banks to predict the full effects of interest
rate changes? a) Economic
data is always accurate b) The
economy is highly unpredictable c)
Interest rates have minimal impact on the economy Answer: b Explanation: The
economy is complex and influenced by various factors. Central banks find it
challenging to predict how interest rate changes will unfold and impact
different sectors over time. 11. How
does a rise in interest rates impact stock prices? a)
Stock prices rise due to increased investor confidence b)
Stock prices remain unchanged c)
Stock prices may fall due to reduced consumer spending Answer: c Explanation: A rise
in interest rates can lead to reduced consumer spending and decreased
economic activity, which can negatively affect corporate earnings and, in
turn, lead to Part VI: Open Market Operation How Do Open Market
Operations Affect the U.S. Money Supply? By
KESAVAN BALASUBRAMANIAM Updated April 08, 2022, Reviewed by MICHAEL J BOYLE,
Fact checked by MARCUS REEVES https://www.investopedia.com/ask/answers/06/openmarketoperations.asp The U.S. Federal Reserve
conducts open market operations by buying or selling bonds and other
securities to control the money supply. With these transactions, the Fed can
expand or contract the amount of money in the banking system and drive
short-term interest rates lower or higher depending on the objectives of its
monetary policy. KEY
TAKEAWAYS · The
Federal Reserve buys and sells government securities to control the money supply
and interest rates. This activity is called open market operations. · The
Federal Open Market Committee (FOMC) sets monetary policy in the United
States, and the Fed's New York trading desk uses open market operations to
achieve that policy's objectives. · To
increase the money supply, the Fed will purchase bonds from banks, which
injects money into the banking system. · To
decrease the money supply, the Fed will sell bonds to banks, removing capital
from the banking system. · Open
market operations have played a key part in navigating recent economic
downtowns including the 2008 Global Financial Crisis and the COVID-19
recession. The Importance of Open
Market Operations Open
market operations are one of three key tools the Federal Reserve uses to
achieve its policy objectives. The objective of open market operations is to
change the reserve balances of U.S. banks and cause reactionary changes to
prevailing interest rates. The Fed
can increase the U.S. money supply by buying securities. Using newly created
money, the Fed can go to the market, inject this capital into U.S. banks, and
apply downward pressure on market interest rates as lenders now have more
money to distribute as credit. The Fed can also decrease the U.S. money
supply by doing the opposite. By selling securities it is holding on its
balance sheet, the Fed can extract capital from bank reserves and decrease
the amount of funds banks have available to lend. Open
market operations are important as it attempts to guide the direction of the
economy. When the Fed is buying securities and increasing the money supply,
the Fed is attempting to stimulate economic growth. This typically has a
ripple effect of increased inflationary pressure, higher economic growth,
higher employment, and generally greater economic prosperity for citizens and
companies. Open
market operations also signal when the Fed believes inflationary pressure has
gotten too high and the economy needs to contract. By selling securities, the
Fed attempts to raise rates, slow economic growth, and stem inflation.
Unfortunately, contractionary economic periods like this also traditionally
cause increases in unemployment. It also makes obtaining credit more
expensive for companies and citizens. The
Role of the Federal Open Market Committee The
Federal Open Market Committee (FOMC) sets monetary policy in the United
States with a dual mandate of achieving full employment and controlling
inflation. The committee holds eight regularly scheduled meetings each year,
though emergency sessions may be called. During
these meetings, the FOMC determines whether to increase or decrease the money
supply in the economy. This decision is driven by the FOMC's long-term goals
of price stability, sustainable economic growth, and prevailing market conditions.
The New York Fed's trading desk then conducts its market operations with the
aim of achieving that policy, buying or selling securities in open market
operations. Expanding
the Money Supply to Fuel Economic Growth During
a recession or economic downturn, the Fed will seek to expand the supply of
money in the economy with a goal of lowering the federal funds rate—the rate
at which banks lend to each other overnight. To do
this, the Fed trading desk will purchase bonds from banks and other financial
institutions and deposit payment into the accounts of the buyers. This
increases the amount of money that banks and financial institutions have on
hand, and banks can use these funds to provide loans. Contracting
the Money Supply to Stabilize Prices The Fed
will undertake the opposite process when the economy is overheating and
inflation is reaching the limit of its comfort zone. When the Fed sells bonds
to the banks, it takes money out of the financial system, reducing the money
supply. Example
of Monetary Contraction By the
end of 2021, the Federal Reserve was faced with rapidly escalating inflation
and a booming economy. To try and preserve price stability, The Fed announced
it would begin tapering its purchase of Treasury securities. Starting December
2021, the Fed began buying $10 billion less Treasury securities each month
and $5 billion of agency mortgage-backed securities each month. This
will cause interest rates to rise, discouraging individuals and businesses
from borrowing. In theory, consumers will spend, consumer, borrow, and invest
less. It will also become more expensive for companies to expand. The impact
of both outcomes is to slow inflation and economic growth, though the
downside risk is an increase in unemployment. In class exercise 5. What
are open market operations conducted by the Federal Reserve? A)
Direct lending to consumers B)
Buying and selling securities C)
Foreign currency exchange Answer:
B Explanation:
Open market operations involve the Federal Reserve buying and selling securities,
such as bonds, to influence the money supply and interest rates. 6. Which
committee sets monetary policy in the United States and oversees open market
operations? A)
Federal Trade Commission (FTC) B)
Federal Open Market Committee (FOMC) C)
Securities and Exchange Commission (SEC) Answer:
B Explanation:
The FOMC sets monetary policy and is responsible for overseeing open market
operations to achieve policy objectives. 7. How
does the Federal Reserve increase the money supply through open market operations? A) By
selling securities to banks B) By
reducing bank reserves C) By
buying securities from banks Answer:
C Explanation:
The Fed buys securities from banks, injecting money into the banking system
and increasing the money supply. 8. What
is the goal of the Federal Reserve when it sells securities in open market
operations? A) To
increase the money supply B) To
decrease interest rates C) To
reduce inflation Answer:
C Explanation:
Selling securities reduces the money supply, which helps control inflation
and prevent it from rising too high. 9. What
is the primary objective of the Federal Reserve when it buys securities
through open market operations? A) To
stimulate economic growth B) To
increase inflation C) To
reduce unemployment Answer:
A Explanation:
Buying securities to expand the money supply aims to stimulate economic
growth, leading to higher employment and inflation. 10. Why
does the Federal Reserve sell securities when the economy is overheating? A) To
increase the money supply B) To
decrease interest rates C) To
reduce inflationary pressures Answer:
C Explanation:
Selling securities helps reduce the money supply and control inflation during
economic overheating. Segment 406: Open Market
Operations (youtube)
In class exercise 1. What
is the primary tool the Federal Reserve uses for implementing its monetary
policy decisions? A)
Fiscal stimulus B)
Currency manipulation C) Open
market operations Answer:
C Explanation:
The Federal Reserve primarily uses open market operations to implement its
monetary policy decisions. 2. What
is the main goal of open market operations conducted by the Federal Reserve? A) To
control inflation directly B) To influence
long-term interest rates C) To
affect the federal funds rate Answer:
C Explanation:
Open market operations aim to influence the federal funds rate, a short-term
interest rate, by buying or selling securities. 3. When
the Federal Reserve buys securities in open market operations, what happens
to the federal funds rate? A) It
rises B) It
remains unchanged C) It
falls Answer:
C Explanation:
Buying securities injects more money into banks, increasing their lending
capacity and pushing down the federal funds rate. 4. How
does a decrease in the federal funds rate influence borrowing and spending? A) It
encourages consumers and businesses to borrow and spend more B) It
discourages borrowing and spending C) It
has no impact on borrowing and spending Answer:
A Explanation:
Lower interest rates make borrowing cheaper, which tends to stimulate
borrowing and spending by consumers and businesses. 5. What
is the potential downside of using open market operations to lower interest
rates? A)
Increased inflation B)
Reduced economic growth C)
Depreciation of the currency Answer:
A Explanation:
Lower interest rates can stimulate borrowing and spending, potentially
leading to increased inflation. 6. When
the Federal Reserve sells securities in open market operations, what effect
does it have on the federal funds rate? A) It
rises B) It
remains unchanged C) It
falls Answer:
A Explanation:
Selling securities reduces banks' reserves, leading to reduced lending
capacity and higher interest rates. 7. What
does the Federal Open Market Committee (FOMC) do every six weeks? A) Sets
the federal budget B) Sets
the target federal funds rate C)
Determines currency exchange rates Answer:
B Explanation:
The FOMC sets the target federal funds rate, which guides open market operations
to achieve desired monetary policy outcomes. 8. Does
the Federal Reserve influence the supply and demand of reserve balances
through open market operations? A) By
directly adjusting the federal funds rate B) By
buying and selling securities C) By
changing tax rates Answer:
B Explanation:
The Federal Reserve buys and sells securities to influence the supply of
reserve balances and, consequently, the federal funds rate. Special Topic: Quantitative easing (QE)
Quantitative Easing (QE)
and How the Fed Responds to Financial Crises
Summary ·
The Federal Reserve's use of quantitative
easing (QE) as a tool to stimulate economic growth during crises, such as the
2008 financial crisis and the COVID-19 pandemic. ·
QE involves the central bank purchasing
assets like long-term Treasury bonds and mortgage-backed securities to keep
interest rates low and promote lending. ·
Concerns about the potential consequences
of QE: hyperinflation, increased debt levels, and the unequal distribution of
benefits. In
class exercise: 1. What is the primary goal of
quantitative easing (QE)? A) Reducing inflation B) Boosting economic growth C) Controlling interest rates Answer:
B Explanation: QE aims to stimulate economic growth by
maintaining liquidity in the financial system, encouraging lending, and
keeping interest rates low. 2. How does the Federal Reserve typically
use open market operations to influence interest rates? A) By buying long-term government bonds B) By selling short-term government bonds C) By purchasing corporate stocks Answer:
B Explanation: The Fed typically influences short-term
interest rates by buying or selling short-term government bonds. 3. During a financial crisis, when might
the Federal Reserve resort to quantitative easing (QE)? A) To raise interest rates B) To lower interest rates C) To stabilize currency exchange rates Answer:
B Explanation: QE is often used during crises to lower
interest rates and stimulate lending and economic activity. 4. What is one potential concern
associated with quantitative easing (QE)? A) Deflationary pressures B) Hyperinflation C) Reduced unemployment Answer:
B Explanation:
Critics worry that QE could lead to excessive
money supply growth and hyperinflation, although this outcome is debated
among economists. 5. How does quantitative easing (QE)
differ from the Fed's typical open market operations? A) QE involves buying longer-term assets,
while open market operations involve short-term assets. B) QE only affects the stock market, while
open market operations affect bond markets. C) QE is used to reduce the money supply,
while open market operations aim to increase it. Answer:
A Explanation: QE focuses on longer-term assets, such as
bonds, whereas open market operations deal with short-term assets like
Treasury bills. 6. What is the primary objective of the
Federal Open Market Committee (FOMC)? A) Managing inflation B) Achieving full employment and
controlling inflation C) Regulating commercial banks Answer:
B Explanation: The FOMC's dual mandate is to pursue full
employment and stable prices (controlling inflation). 7. How does the Federal Reserve primarily
influence short-term interest rates? A) Through quantitative easing (QE) B) By adjusting the federal funds rate C) Through open market operations Answer:
B Explanation: The Fed mainly influences short-term
interest rates by changing the federal funds rate. 8. What is the primary impact of
quantitative easing (QE) on stock prices? A) It tends to lower stock prices. B) It has no effect on stock prices. C) It often raises stock prices. Answer:
C Explanation: QE can stimulate economic growth, leading
to higher stock prices. 9. Which asset does the Federal Reserve
primarily purchase during quantitative easing (QE) programs? A)
Corporate bonds B)
Long-term government bonds C)
Short-term government bonds Answer:
B Explanation: The Fed often buys longer-term government
bonds during QE. 10. What is one potential downside of
quantitative easing (QE) related to debt levels? A) Lowering debt burdens B) Reducing government deficits C) Encouraging higher debt levels Answer:
C Explanation: QE can make borrowing cheaper, potentially
encouraging individuals and businesses to take on more debt.
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We have a Fed visit planned for October 17th, from 1:30 PM to 2:30 PM,
at 800 Water Street, Jacksonville. The dress code is business casual; please avoid jeans and sneakers. |
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First midterm exam Study Guide (the file is here) |
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Chapter 1 – Introduction of
Financial Market and Institution
ppt
Contents: ·
What is Money? ·
Bitcoin and Crypocurrency ·
Asset Based Security (MBS, Student
Loan based Security) ·
FDIC, SEC, and FINDRA ·
HFT – High Frequency Trading ·
Flash Crash ·
Spoofing ·
AI + HFT 1.
What are
the six parts of the financial markets
What is Money? : To pay for purchases and
store wealth (fiat money, fiat currency). What about crytocurrency?
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High-Frequency Trading (HFT) By JAMES CHEN, Updated August
25, 2021, Reviewed by MICHAEL J BOYLE, Fact checked by KATRINA MUNICHIELLO https://www.investopedia.com/terms/h/high-frequency-trading.asp What Is High-Frequency Trading (HFT)? High-frequency trading, also
known as HFT, is a method of trading that uses powerful computer programs to
transact a large number of orders in fractions of a second. It uses complex
algorithms to analyze multiple markets and execute orders based on market
conditions. Typically, the traders with the fastest execution speeds are more
profitable than traders with slower execution speeds. In addition to the high speed of orders, HFT is also characterized by high turnover rates and order-to-trade ratios.
Some of the best-known HFT firms include Tower Research, Citadel LLC, and
Virtu Financial. KEY TAKEAWAYS ·
HFT is complex algorithmic
trading in which large numbers of orders are executed within seconds. ·
It adds liquidity to the
markets and eliminates small bid-ask spreads. ·
HFT is criticized for
allowing large companies to gain an upper hand in trading. ·
Another complaint is that
the liquidity produced by this type of trading is momentary—it
disappears within seconds, making it impossible for traders to take advantage
of it. Understanding High-Frequency
Trading (HFT) HFT became popular when
exchanges started to offer incentives for companies to add liquidity to the
market. For instance,
the New York Stock Exchange (NYSE) has a group of liquidity providers called
Supplemental Liquidity Providers (SLPs) that attempts to add competition and
liquidity for existing quotes on the exchange. The SLP was introduced following the collapse of Lehman
Brothers in 2008, when liquidity was a major concern for investors. As an
incentive to companies, the NYSE pays a fee or rebate for providing said
liquidity. With millions of transactions per day, this results in a large
amount of profits. Benefits of High-Frequency
Trading (HFT) HFT has improved market
liquidity and removed bid-ask spreads that previously would have been too
small. This was
tested by adding fees on HFT, which led bid-ask spreads to increase. One
study assessed how Canadian bid-ask spreads changed when the government
introduced fees on HFT. It found that market-wide bid-ask spreads increased
by 13% and the retail spreads increased by 9%. Critiques of High-Frequency
Trading (HFT) HFT is controversial and has
been met with some harsh criticism. It has replaced a number of
broker-dealers and uses mathematical models and algorithms to make decisions,
taking human decision and interaction out of the equation. Decisions happen in
milliseconds, and this could result in big market moves without reason. As an
example, on May 6, 2010, the Dow Jones Industrial Average (DJIA) suffered its
largest intraday point drop ever, declining 1,000 points and dropping 10% in
just 20 minutes before rising again. A government investigation blamed a
massive order that triggered a sell-off for the crash.
Flash
crash From Wikipedia, the free encyclopedia A flash crash is
a very rapid, deep, and volatile fall in security prices
occurring within an extremely short time period. A
flash crash frequently stems from trades executed
by black-box trading,
combined with high-frequency trading, whose speed
and interconnectedness can result in the loss and recovery of billions of
dollars in a matter of minutes and seconds. Occurrences The Flash Crash This
type of event occurred on May 6, 2010. A
$4.1 billion trade on the New York Stock Exchange (NYSE) resulted
in a loss to the Dow Jones Industrial Average of
over 1,000 points and then a rise to approximately previous value, all
over about fifteen minutes. The mechanism causing the event has been heavily
researched and is in dispute. On April 21, 2015, the U.S. Department of
Justice laid "22 criminal counts, including fraud and market
manipulation" against Navinder Singh Sarao, a
trader. Among the charges included was the use of spoofing algorithms. 2017 Ethereum Flash Crash On June
22, 2017, the price of Ethereum, the
second-largest digital cryptocurrency,
dropped from more than $300 to as low as $0.10 in minutes at GDAX exchange.
Suspected for market manipulation or an account takeover at first, later
investigation by GDAX claimed no indication of wrongdoing. The crash was
triggered by a multimillion-dollar selling order which brought the price
down, from $317.81 to $224.48, and caused the following flood of 800 stop-loss and margin
funding liquidation orders, crashing the market. British pound flash crash On
October 7, 2016, there was a flash crash in the value of sterling, which
dropped more than 6% in two minutes against the US dollar. It was the pound's
lowest level against the dollar since May 1985. The pound recovered much of
its value in the next few minutes, but ended down on the day's trading, most
likely due to market concerns about the impact of a "hard Brexit"—a
more complete break with the European Union following
Britain's 'Leave' referendum vote in June. It
was initially speculated that the flash crash may have been due to a fat-finger
trader error or an algorithm reacting
to negative news articles about the British
Government's European policy. In
class Exercise 1,What is a flash crash in the financial
markets? A. A gradual decline in security prices B. A rapid and volatile fall in security prices C. A surge in stock prices Answer: B Explanation: A flash crash refers
to a sudden and rapid decline in security prices. 2. What can contribute to a flash crash? A. Slower trading algorithms B. Black-box trading combined with high-frequency
trading C. Manual trading only Answer: B Explanation: Flash crashes often
result from the combination of black-box trading and high-frequency trading. 2. When did the Flash Crash of 2010 occur? A. June 22, 2017 B. October 7, 2016 C. May 6, 2010 Answer: C 3. How much was the loss to the Dow Jones Industrial
Average during the Flash Crash of 2010? A. Approximately 1,000 points B. $4.1 billion C. $0.10 Answer: A Explanation: The Dow Jones
Industrial Average lost approximately 1,000 points during the Flash Crash of
2010. 4. What charges were brought against Navinder Singh
Sarao related to the Flash Crash of 2010? A. No charges were filed B. 22 criminal counts, including fraud and market
manipulation C. Charges of high-frequency trading Answer: B Explanation: Navinder Singh Sarao
faced 22 criminal counts, including fraud and market manipulation, in
connection with the Flash Crash of 2010. 5. What cryptocurrency was involved in the 2017
Ethereum Flash Crash? A. Bitcoin B. Ethereum C. Litecoin Answer: B Explanation: The 2017 Ethereum
Flash Crash involved the cryptocurrency Ethereum. 6. What triggered the 2017 Ethereum Flash Crash? A. A sudden surge in buying orders B. A multimillion-dollar selling order C. A technical glitch in the exchange Answer: B Explanation: The 2017 Ethereum
Flash Crash was triggered by a multimillion-dollar selling order. 7. What was the lowest level of the British pound
against the US dollar during the British pound flash crash? A. Its highest level since 1985 B. A 6% drop in two minutes C. A complete recovery Answer: B Explanation: The British pound experienced
a 6% drop in two minutes during the flash crash. 8. What was initially
speculated as the cause of the British pound flash crash? A. A manual trading error B. A trader error or
algorithm reaction C. A sudden interest rate
hike Answer:
B Explanation:
The initial speculation for the cause of the British pound flash crash was a
trader error or algorithm reaction. 9. Which term describes
trading programs that execute rapid and high-frequency trades using
mathematical algorithms? A. Black-box trading B. Traditional trading C. Human-based trading Answer:
A Explanation:
Trading programs that execute rapid and high-frequency trades using
mathematical algorithms are often referred to as black-box trading. 10. In which exchange did
the 2017 Ethereum Flash Crash occur? A. New York Stock Exchange
(NYSE) B. GDAX exchange C. London Stock Exchange
(LSE) Answer:
B Explanation:
The 2017 Ethereum Flash Crash occurred on the GDAX exchange. 11. What are the typical
timeframes involved in a flash crash? A. Hours and days B. Seconds and milliseconds C. Weeks and months Answer:
B Explanation:
Flash crashes typically occur within seconds and milliseconds. 12. How much did the price
of Ethereum drop during the 2017 Ethereum Flash Crash? A. It remained unchanged B. From $300 to $0.10 C. It increased
significantly Answer:
B Explanation:
The price of Ethereum dropped from over $300 to as low as $0.10 during the
2017 Ethereum Flash Crash. 13. What is spoofing in the
context of high-frequency trading? A. A form of trading without
algorithms B. Manipulating the market
by making fake purchase offers C. A technique for buying
and selling at market price Answer:
B FLASH CRASH!
Dow Jones drops 560 points in 4 Minutes! May 6th 2010 (video)
Flash
Crash 2010 - VPRO documentary – 2011 (video, optional)
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Chapter 2 What is Money Content: ·
M0, M1, M2, M3 ·
Money Supply and Inflation ·
Money velocity ·
Fractional Banking System ·
Money multiplier and reserve ratio Part I What is
Money? ·
There is no single "correct" measure
of the money supply: instead, there are several
measures, classified along a spectrum or continuum between narrow and broad monetary
aggregates. •
Narrow measures include only the most liquid assets, the ones most easily used
to spend (currency, checkable deposits). •
Broader measures add less liquid types of assets (certificates of deposit, etc.)
•
M0: In some countries, such as the United Kingdom, M0 includes bank
reserves, so M0 is referred to as the monetary base, or narrow money. •
MB: is referred to as the monetary base or total currency. This is the base from which other
forms of money (like checking deposits, listed below) are created and is
traditionally the most liquid measure of the money supply. •
M1: Bank
reserves are not included in M1. (M1
and Components @ Fed St. Louise website)
•
M2: Represents M1 and "close substitutes" for M1. M2 is
a broader classification of money than M1. M2 is a key economic indicator
used to forecast inflation. (M2 and components @
Fed St. Louise website) •
M3: M2 plus large and long-term deposits. Since 2006, M3 is no
longer published by the US central bank. However, there are still
estimates produced by various private institutions. (M3 and components at
Fed St. Louise website) In class exercise: 1.
What does M0 represent in the money supply? a) Total currency b) Checking deposits c) Savings deposits Answer:
a Explanation: M0 includes all
the physical currency in circulation and in bank vaults. 2.
Which component is included in M2 but not in M1? a) Savings deposits b) Notes and coins in
circulation c) Demand deposits Answer:
a Explanation: M1 includes
demand deposits, while M2 adds savings deposits and close substitutes. 3.
What is the key purpose of M2 in economic forecasting? a) Projecting GDP growth b) Predicting interest rates c) Forecasting inflation Answer:
c Explanation: M2 is a broader
classification used to predict changes in the overall price level
(inflation). 4.
Which measure includes large and long-term deposits that M2 does not? a) M0 b) M1 c) M3 Answer:
c Explanation: M3 includes M2
components plus large, long-term deposits. 5.
What is the primary component of M0? a) Savings deposits b) Notes and coins in
circulation c) Traveler's checks Answer:
b Explanation: M0 primarily
consists of physical currency in circulation. 6.
Which measure is known as the monetary base? a) M1 b) MB c) M2 Answer:
b Explanation: The monetary
base (MB) is the total currency, including bank reserves. 7.
What does M1 represent in the money supply? a) Narrow money b) Broad money c) Long-term investments Answer:
a Explanation: M1 is a narrow
measure, including highly liquid assets. 8.
What happened to the publication of M3 by the US central bank after 2006? a) It became more detailed. b) It was discontinued. c) It included fewer
components. Answer:
b Explanation: M3 was no
longer published by the US central bank after 2006. 9.
Which measure includes large time deposits and institutional money market
funds? a) M2 b) M1 c) M3 Answer:
c Explanation: M3 includes M2
components and larger assets. 10.
What is the primary focus of M1 in the money supply? a) Including large deposits b) Representing broad money c) Capturing the most liquid
assets Answer:
c Explanation: M1 focuses on
highly liquid assets. Let’s watch this money supply video: In
class exercise 1. What
is the role of the Central Bank in a country's monetary system? a) Print physical currency b) Regulate the stock market c) Provide loans to individuals Answer:
a Explanation: The Central Bank is
responsible for issuing and regulating the physical currency in circulation. 2.
Which term is used for securities that are easily tradable and can be bought
and sold in large quantities? a) Liquid securities b) Rare assets c) Illiquid investments Answer:
a Explanation: Liquid securities are easily tradable
assets that can be quickly converted into cash. 3. What
is the most basic form of money in an economy? a) M1 b) M2 c) Base Money (M0) Answer:
c Explanation: Base Money (M0) represents
the physical currency issued by the Central Bank. 4. In
the context of money supply, what does M1 include? a) Physical currency and checking account
deposits b) Savings accounts and stocks c) Government securities and bonds Answer:
a Explanation: M1 consists of physical
currency and easily accessible checking account deposits. 5. What
is the primary purpose of a Central Bank purchasing securities in the open
market? a) To regulate the stock market b) To increase the money supply c) To fund government spending Answer:
b Explanation: Central Banks purchase
securities to inject money into the economy, increasing the money supply. 6. What
happens to the money supply when the Central Bank prints more physical
currency? a) It decreases b) It remains unchanged c) It increases Answer: c Explanation: Printing more physical
currency adds to the money supply. 7. What
component of the money supply includes savings accounts and time deposits? a) M0 b) M1 c) M2 Answer:
c Explanation: M2 encompasses M1 and adds
savings accounts and time deposits. 8. What
is the primary difference between M1 and M2? a) M2 includes physical currency; M1 does
not. b) M2 adds assets that can be easily
converted to cash. c) M1 includes long-term investments. Answer:
b Explanation: M2 includes M1 plus assets
that can be quickly converted into cash. 9.
Which measure of money supply is the most comprehensive but may not be
reported by central banks? a) M1 b) M2 c) M3 Answer:
c Explanation: M3 is a broader measure of
money supply, but it may not be reported by all central banks. |
Draw Me The Economy: Money Supply (video)
For discussion:
In
class exercise 1. What
is the term for the creation of money by banks through accounting entries
when granting loans? a) Currency printing b) Money multiplication c) Fractional reserve banking Answer:
c Explanation: Fractional reserve banking is
the practice where banks create money by lending out a fraction of their
deposits. 2. What
economic effect does an increase in the money supply have, resulting from
banks granting more loans? a) Inflation b) Deflation c) Stagnation Answer:
a Explanation: An increase in the money
supply from more loans often leads to inflation, where prices rise due to
excess money in circulation. 3. In a
deflationary economy, what tends to happen to consumers' buying behavior? a) They increase non-essential purchases. b) They put off non-essential purchases. c) They buy at regular rates. Answer:
b Explanation: In deflation, consumers often
delay non-essential purchases because they expect prices to decrease further. 4. In an
economy with high inflation, what typically happens to consumers' purchasing power? a) It increases. b) It remains unchanged. c) It decreases. Answer: c Explanation: High inflation erodes the
purchasing power of money, causing it to decrease over time. 5. What
is the target inflation rate considered ideal for a stable economy by most
economists? a) 0-1% b) 2-4% c) 5-7% Answer:
b Explanation: Most economists consider a
target inflation rate of 2-4% as ideal for maintaining economic stability. 6. What
economic situation arises when there is too little money in circulation,
causing prices to fall? a) Stagflation b) Inflation c) Deflation Answer:
c . Explanation: Deflation occurs when prices
fall due to a shortage of money in circulation, leading to economic
challenges. Inflation
continues to rise, but ‘the year-over-year numbers are pretty meaningless at
this point,’ says economist—what actually matters Published Wed, Sep 13 2023 9:23 AM EDT https://www.cnbc.com/2023/09/13/inflation-rises-in-august-why-its-not-as-bad-as-it-looks.html Summary: •
Inflation is at 3.7%, higher than usual. •
The Fed is trying to slow down inflation •
Inflation is rising again, but it may not be
as bad as it sounds. Here’s what’s happening: Driven
by surging energy prices, the closely watched year-over-year inflation rate
climbed from 3.2% to 3.7% in August, according to the Labor Bureau’s latest consumer index report. That’s
still well above the Federal Reserve’s target rate of 2%, so it remains a concern. However, the year-over-year rate should be
taken with a grain of salt, as it no longer reflects the dramatic drop from
peak prices in summer 2022. This has created a distortion known as “base effects” where monthly price increases in 2023 seem more
significant than they actually are, even though they’re
growing at nearly half the rate we saw in 2022. “The
year-over-year numbers are pretty meaningless at this point,”
says Daniel Altman, chief economist at Instawork, an online
staffing platform. “What matters is the current path
of prices.” Inflation has slowed by other measures To better gauge where inflation is headed,
the Federal Reserve says it’s closely monitoring core inflation, a measure of
inflation that excludes volatile food and energy prices, which can
fluctuate wildly in a given month. When
you look at this measure, inflation is trending in the right direction. In August, core
inflation rose
by 0.3% after increasing by 0.2%
the previous two months. That’s less than half the
monthly rate we were seeing in early 2022. The sweet spot is about 0.2%, says Sarah
House, economist at Wells Fargo. Wells Fargo expects overall inflation to
continue cooling, with a forecast of 2.2%
inflation in 2024, says House. “We’re starting to
see progress on on inflation,” she says. “But there’s still quite a bit of
distance before we reach the overall target of 2%.” What
this means for you To reduce
inflation, the Fed has discouraged spending by making it more expensive to
borrow money. This
has been done through a series of interest rate hikes, which have risen from
near-zero in March 2022 to its current range of 5.25% to 5.5% — the highest it’s been in 22
years. This
means increased credit card and loan costs for consumers. These costs have started to add up, too: •
The average interest rate for credit cards is now over 20% — an all-time high, Bankrate reports. •
Interest rates for new auto loans now average 7.4%,
the highest they’ve been in over 15 years, per
Edmunds. •
The average student loan interest rate for undergrads has risen from 4.99%
during the 2022-2023 school year to 5.5% for the 2023-2024
school year, according to the U.S. Department of Education. The good news is that the Fed is unlikely
to announce another interest rate hike when it meets Sept. 19-20, based on
Wednesday’s data. The likelihood of any increase
dropped to 5% as of Wednesday morning, according to the CME FedWatch Tool, which
measures rate hike probabilities. That’s largely
because the economy has finally shown
signs of cooling, as unemployment has increased, job gains have declined and
wage growth has slowed. And with core inflation decelerating in recent months, there’s “little justification for another hike,”
says Altman. “Just keeping rates at this level is
still applying the brakes to the economy.” In
class exercise 1. What
is the current inflation rate in August 2023? a) 2% b) 3.2% c) 3.7% Answer:
c 2. What
is the Federal Reserve's target inflation rate? a) 5% b) 3% c) 2% Answer:
c 3. Why
is the year-over-year inflation rate considered less meaningful now? a) It no longer reflects the dramatic drop
in prices. b) It shows prices are rising too quickly. c) It indicates a stable economy. Answer:
a Explanation: The year-over-year rate is
distorted by past price drops and may not reflect current trends. 4. What
does "base effects" refer to in the context of inflation? a) The core factors driving inflation. b) The impact of energy prices on
inflation. c) Distortions caused by past price
changes. Answer:
c Explanation: "Base effects"
refer to distortions caused by past price changes. 5. What
measure of inflation excludes volatile food and energy prices? a) Core inflation b) Year-over-year inflation c) Peak inflation Answer:
a Explanation: Core inflation excludes
volatile food and energy prices to provide a more stable measure. 6. How
did core inflation change in August? a) It decreased by 0.2%. b) It increased by 0.3%. c) It remained unchanged. Answer:
b 7.
What is the current range of the Federal Reserve's interest rates? a) 0% to 1% b) 3% to 4% c) 5.25% to 5.5% Answer:
c 8. What
impact do interest rate hikes have on borrowing money? a) They make borrowing cheaper. b) They make borrowing more expensive. c) They have no effect on borrowing. Answer:
b Explanation: Interest rate hikes increase
the cost of borrowing money. 9. What
is the average interest rate for credit cards now? a) 10% b) 15% c) Over 20% Answer:
c 10.
What is the average interest rate for new auto loans currently? a) 5% b) 7.4% c) 10% Answer:
b 11. How
has the average student loan interest rate for undergrads changed from
2022-2023 to 2023-2024? a) It decreased. b) It remained the same. c) It increased. Answer:
c Explanation: The average student loan
interest rate for undergrads increased from 4.99% to 5.5%. 12. Why
is the Fed less likely to announce another rate hike? a) The economy is heating up. b) The economy is cooling down. c) It wants to encourage more borrowing. Answer:
b Explanation: The Fed is less likely to
announce another rate hike because the economy is showing signs of cooling. 13.
What is the overall target for inflation according to the article? a) 1% b) 2% c) 3% Answer:
b 14. What
is the primary tool the Fed has used to combat inflation? a) Reducing taxes b) Raising interest rates c) Increasing government spending Answer:
b Explanation: The primary tool the Fed has used to combat inflation is raising interest rates to discourage spending. |
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· From https://tradingeconomics.com/united-states/money-supply-m2
In class exercise
1. What is the change in Money Supply
M2 from Aug 2023 to Sep 2023?
a) Increase of $0.40 Billion
b) Increase of $0.50 Billion
c) Decrease of $0.40 Billion
Answer: a
2. What is the change in Foreign
Exchange Reserves from Aug 2023 to Sep 2023?
a) Increase of $665.00 Million
b) Decrease of $665.00 Million
c) Increase of $665.40 Million
Answer: b
3. What is the change in Central Bank
Balance Sheet from Sep 2023 to Oct 2023?
a) Increase of $200.26 Million
b) Increase of $2.19 Billion
c) Decrease of $2.19 Billion
Answer: b
https://tradingeconomics.com/united-states/money-supply-m0
https://tradingeconomics.com/united-states/money-supply-m1
https://tradingeconomics.com/united-states/money-supply-m2
From https://www.federalreserve.gov/releases/h6/current/default.htm
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Part II Money Supply,
Money Velocity, and Inflation In class
exercise 1. What does the velocity of
money measure? a)
How quickly we spend our money. b)
The total amount of money we have. c)
How many foreign goods we buy. Answer: a 2. What does a higher
velocity of money mean? a)
We are saving more. b)
Money is being spent faster in the economy. c)
We have less money. Answer: b https://fred.stlouisfed.org/series/M2V
What Is the Velocity of Money? The velocity of
money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to
another. It also refers to how much a
unit of currency is used in a given period of time. Simply put, it's the
rate at which consumers and businesses in an economy collectively spend
money. The velocity of money is usually measured as a ratio of gross
domestic product (GDP) to a country's M1 or M2 money supply. Velocity of Money = GDP ÷
Money Supply What Does Velocity of Money Measure? The velocity of money
estimates the movement of money in an economy—in other words,
the number of times the average dollar
changes hands over a single year. A high velocity of money indicates a bustling economy with
strong economic activity, while a low velocity indicates a general reluctance
to spend money. How Do You
Calculate the Velocity of Money? The velocity of money is calculated by dividing a
country's gross domestic product by the total supply of money. This
calculation can use either the M1 money supply, which includes physical
currency, checkable deposits, and certain other figures, or the M2 supply,
which also includes savings deposits and money market funds. Why Is the
Velocity of Money So Low? The velocity of money in the United States fell
sharply during the first and second quarters of 2020, as calculated by the
St. Louis Federal Reserve Bank. While there is no definitive explanation, the
fall is likely due to the diminished activity incurred during the COVID-19
pandemic, as well as an increase in consumer savings due to economic
uncertainty. https://www.investopedia.com/terms/v/velocity.asp In class exercise Questions 1: How do you find
the velocity of money? A)
Multiply GDP by Money Supply B)
Divide GDP by Money Supply C)
Subtract Money Supply from GDP Answer: B Questions 2: What does it
mean if the velocity of money is low? A)
People are spending a lot B)
People are hesitant to spend money C)
Prices are increasing rapidly Answer: B Explanation:
A low velocity suggests that people are not eager to spend their money. Question 3: Which money
category includes savings accounts and money market funds? A)
M1 B)
M2 C)
M3 Answer: B 4. Why did the velocity of
money drop in 2020, according to the St. Louis Federal Reserve? A)
More economic activity B)
Less savings C)
COVID-19 pandemic and more savings Answer: C Explanation:
The velocity fell because of less economic activity during the pandemic and
more people saving money. 5. What does a high velocity
of money mean for an economy? A)
The economy is slowing down B)
The economy is very active C)
Prices are going down a lot Answer: B Explanation:
A high velocity suggests that people are spending a lot in the economy. 6. What's the reason for calculating the
velocity of money? A)
To see how much money people are saving B)
To understand economic growth C)
To know about stock market performance Answer: B Explanation:
It helps us know how quickly the economy is growing and how much people are
spending. 7. What happens when the velocity of money is
too high? A)
The economy gets very slow B)
Prices go up a lot C)
People save more money Answer: B Explanation:
If the velocity is too high, it can lead to prices rising rapidly. |
The Velocity of Money Explained in One Minute (youtube)
In
class exercise 1.
What does the velocity of money
measure? A)
The amount of money in circulation B)
The rate at which currency changes hands C)
The value of a dollar Answer: B Explanation:
The velocity of money measures how quickly a unit of currency is used in
transactions. It's about how fast money moves from one person to another. 2. What is the role of
commercial banks in the issue of inflation? A)
They increase the velocity of money B)
They decrease the velocity of money C)
They have no impact on the velocity of money Answer: B Explanation:
Commercial banks slow down the use of money by holding onto a lot of it,
which means money changes hands less often. 3. How does giving money
directly to individuals affect inflation? A)
It decreases inflation B)
It has no effect on inflation C)
It increases inflation Answer: C Explanation:
When people get money directly, they're more likely to spend it. More
spending can make prices go up, which is inflation. 4. What happens to the velocity of money if banks start
lending more to people? A)
It decreases B)
It stays the same C)
It increases Answer: C Explanation:
If banks lend more, people have more money to spend, and it moves through the
economy faster. So, the velocity of money goes up. 5. What is the primary factor determining
whether inflation occurs when money is created? A)
The amount of money created B)
The velocity of money C)
The type of goods and services bought Answer: B Explanation:
The speed at which money moves around (velocity) is a big factor in deciding
if prices go up (inflation) when new money is made. 6. Why does the video
suggest that inflation doesn't simply appear when more money is pumped into
the system? A)
Because money always leads to inflation B)
Because the velocity of money matters too C)
Because central banks control inflation Answer: B Explanation:
It's not just about how much money there is; it's also about how quickly it's
used. The speed matters. 7. Which term describes
money that banks hold in excess of what they're required to keep on hand? A)
Excess currency B)
Extra money C)
Excess reserves Answer: C Explanation:
Excess reserves are the extra money banks have above what they need to keep
safe. Money Velocity
Is At An All-Time Low. Why Does It Matter? Forbes
Finance Council, Ivan IllanForbes Councils Member Forbes
Finance CouncilCOUNCIL POST| Membership (Fee-Based), Apr 25, 2022,07:00am
EDT There
are many economic measurements that could be referenced when formulating a forecast.
You’re probably familiar with economic data like unemployment figures, Fed
funds rate and the inflation rate. Those are important but don’t necessarily
tell the whole story on the state of the economy, much less the direction to
which things may be headed. In my and my team’s own research, as part of our
investment committee decision-making discussions, we often like to seek out
more obscure data. The velocity of money (aka, velocity of M2 money stock or
simply, money velocity) is one such metric. Money velocity (MV) isn’t a
complicated concept. The Federal Reserve might describe it as the turnover
rate of a dollar through the U.S. economy. A higher MV figure means a dollar
is cycling through domestic transactions for goods and services more frequently.
Conversely, a lower figure would mean the exact opposite, which could
indicate a slowing economic backdrop. Referencing
data on MV from the Federal Reserve Bank of St. Louis, you can see something
noteworthy. In the most recent quarter
(Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123.
Essentially, this means that one USD cycled through the U.S. economy in Q4
2021 about 1.123 times. During the Great Financial Crisis (GFC), MV went from
a high of 1.989 at the GFC’s start in Q3 2007 to a low of 1.712 by end of the
crisis in Q1 2009. Now surprisingly, MV is 34.4% lower than where it was at
coming out of the GFC. This seems troubling. It’s possible that a
declining MV could have been directly attributed to record low interest rates,
which resulted from record high growth of money supply.
After all, the formula for MV is
simple: GDP/money supply. Therefore, a huge increase in the denominator
naturally results in a lower figure without the same corresponding increase
in GDP. If not cycling through
transactions, where did all that newly minted money go? Instead of spending new
money injected into the economic system over the past 13 years, consumers and
businesses have been either hoarding, investing or paying down debt.
Household savings rates spiked during the past couple of years, which
resulted in cash hoarding in checking and savings accounts. Since
the GFC, and because of record low interest rates, investors allocated monies
toward various asset classes, primarily corporate stock shares and real
estate. Households took some of that new money and paid down debt, while
corporations took advantage of the low rates and issued record amounts of new
debt. U.S. corporations are now sitting atop the highest corporate debt
mountain in U.S. history. In
class exercise 1.
What is the velocity of money (MV) a
measure of? A)
The speed of dollar bills B)
The turnover rate of a dollar through the economy C)
The value of a dollar bill Answer: B Explanation:
MV measures how quickly a dollar moves through the economy, being spent on
goods and services. 2. How does a higher MV
figure suggest? A)
It indicates a slowing economy B)
It means the economy is growing rapidly C)
It has no impact on the economy Answer: B Explanation:
A higher MV figure suggests that dollars are changing hands frequently,
indicating a more active economy. 3. What does a lower MV
figure imply? A)
Economic stability B)
A stagnant economy C)
A rapidly growing economy Answer: B Explanation:
A lower MV figure means that dollars are not circulating as much, which can
suggest economic stagnation. 4.
What does MV stand for? A)
Money Value B)
Monetary Velocity C)
Money Volume Answer: B Explanation:
MV stands for Monetary Velocity, representing the speed at which money moves
through the economy. 5. How is MV calculated? A)
By counting the number of dollar bills in circulation B)
By dividing GDP by money supply C)
By adding up the value of all goods and services in an economy Answer: B Explanation: Velocity
of Money = GDP ÷ Money Supply 6. What was the MV figure in
Q4 2021, according to the article? A)
1.989 B)
1.123 C)
1.712 Answer: B Explanation:
In Q4 2021, the MV figure was 1.123, meaning a dollar cycled through the U.S.
economy about 1.123 times during that period. 7. How does the current MV
compare to the period after the Great Financial Crisis (GFC)? A)
It is significantly higher B)
It is about the same C)
It is significantly lower Answer: C Explanation:
The current MV is 34.4% lower than it was after the GFC. 8. What might have
contributed to the decline in MV? A)
High GDP growth B)
Low interest rates and increased money supply C)
Reduced government spending Answer: B Explanation:
Low interest rates and a surge in money supply could lead to a lower MV
because money may not be spent as quickly. 9. How have consumers and
businesses used newly injected money into the economy in recent years? A)
They have spent it on goods and services B)
They have hoarded it, invested it, or paid down debt C)
They have donated it to charity Answer: B Explanation:
Instead of spending the new money, consumers and businesses have saved it,
invested it, or used it to reduce their debts. 10. What happened to
household savings rates in recent years? A)
They remained constant B)
They decreased C)
They spiked Answer: C |
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Part III What is Fractional Reserve Banking System? Money creation in a fractional reserve system |
Financial sector | AP Macroeconomics | Khan Academy
https://www.youtube.com/watch?v=gd8B-zrMSYk In Class Exercise 1. What is the result of
multiplying the initial amount by (1 / Reserve requirement)? a)
The number of banks involved b)
The maximum effect on M1 money supply c)
The number of IOUs created Answer: b Explanation:
Multiplying the initial amount by (1 / Reserve requirement) gives you the maximum
effect on M1 money supply. 2. What is the maximum
effect on M1 money supply when the reserve requirement is 20%? a)
2 times the initial amount b)
5 times the initial amount c)
10 times the initial amount Answer: b Explanation:
When the reserve requirement is 20%, the maximum effect on M1 money supply is
5 times the initial amount. 3. What happens to the money
supply when banks minimize their reserves? a)
It decreases b)
It increases c)
It remains unchanged Answer: b Explanation:
When banks minimize their reserves, it increases the money supply through
lending. Fractional Reserve
Banking By JULIA KAGAN
Updated August 10, 2022, Reviewed by SOMER ANDERSON What Is Fractional Reserve
Banking? Fractional reserve banking is a system in which only a fraction of bank deposits are
backed by actual cash on hand and available for withdrawal. This is done to
theoretically expand the economy by freeing capital for lending. Today,
most economies' financial systems use fractional reserve banking. KEY TAKEAWAYS ·
Fractional reserve
banking describes a system whereby banks can loan out a certain amount of the
deposits that they have on their balance sheets. ·
Banks are required
to keep on hand a certain amount of the cash that depositors give them, but
banks are not required to keep the entire amount on hand. ·
Often, banks are
required to keep some portion of deposits on hand, which is known as the
bank's reserves. ·
Some banks are
exempt from holding reserves, but all banks are paid a rate of interest on
reserves. Understanding Fractional Reserve Banking Banks are required to keep on hand and available for withdrawal
a certain amount of the cash that depositors give them. If someone deposits
$100, the bank can't lend out the entire amount. Nor are banks required to
keep the entire amount on hand. Many
central banks have historically required banks under their purview to keep
10% of the deposit, referred to as reserves. This requirement is set in the
U.S. by the Federal Reserve and is one of the central bank's tools to
implement monetary policy. Increasing the reserve requirement takes money out
of the economy while decreasing the reserve requirement puts money into the
economy. Historically, the required reserve ratio on non-transaction
accounts (such as CDs) is zero, while the requirement on transaction deposits
(e.g., checking accounts) is 10 percent. Following recent efforts to stimulate
economic growth, however, the Fed has reduced the reserve requirements to
zero for transaction accounts as well. Fractional Reserve Requirements Depository institutions must report their transaction accounts,
time and savings deposits, vault cash, and other reservable obligations to
the Fed either weekly or quarterly. Some banks are exempt from holding
reserves, but all banks are paid a
rate of interest on reserves called the "interest rate on reserves"
(IOR) or the "interest rate on excess reserves" (IOER). This rate
acts as an incentive for banks to keep excess reserves. Reserve requirements for banks under the Federal Reserve Act
were set at 13%, 10%, and 7% (depending on what kind of bank) in 1917. In the
1950s and '60s, the Fed had set the reserve ratio as high as 17.5% for
certain banks, and it remained between 8% to 10% throughout much of the 1970s
through the 2010s. During this period, banks with less than $16.3 million in assets
were not required to hold reserves. Banks with assets of less than $124.2
million but more than $16.3 million had to have 3% reserves, and those banks
with more than $124.2 million in assets had a 10% reserve requirement. Beginning March 26,
2020, the 10% and 3% required reserve ratios against net transaction deposits
was reduced to 0 percent for all banks, essentially removing the reserve
requirements altogether. Prior to the introduction of the Fed in the early 20th century,
the National Bank Act of 1863 imposed 25% reserve requirements for U.S. banks
under its charge. Fractional Reserve
Multiplier Effect "Fractional
reserve" refers to the fraction of deposits held in reserves. For
example, if a bank has $500 million in assets, it must hold $50 million, or
10%, in reserve. Analysts reference an equation referred to as the multiplier
equation when estimating the impact of the reserve requirement on the economy
as a whole. The equation provides an
estimate for the amount of money created with the fractional reserve system
and is calculated by multiplying the initial deposit by one divided by the
reserve requirement. Using the example above, the calculation is $500
million multiplied by one divided by 10%, or $5 billion. This is not how money
is actually created but only a way to represent the possible impact of the
fractional reserve system on the money supply. As such, while is useful for
economics professors, it is generally regarded as an oversimplification by
policymakers. What Are the Pros of
Fractional Reserve Banking? Fractional reserve
banking permits banks to use funds (i.e., the bulk of deposits) that would be
otherwise unused and idle to generate returns in the form of interest rates
on new loans—and to make more money available to grow the economy. It is thus
able to better allocate capital to where it is most needed. What Are the Cons of Fractional
Reserve Banking? Fractional reserve banking could catch a
bank short of funds on hand in the self-perpetuating panic of a bank run.
This occurs when too many depositors demand their cash at the same time, but
the bank only has, say 10% of deposits in liquid cash available. Many U.S.
banks were forced to shut down during the Great Depression because too many
customers attempted to withdraw assets at the same time. Nevertheless,
fractional reserve banking is an accepted business practice that is in use at
banks worldwide. Where Did Fractional Reserve Banking Originate? Nobody knows for sure when fractional reserve banking
originated, but it is certainly not a modern innovation. Goldsmiths during the
Middle Ages were thought to issue demand receipts for gold on hand that
exceeded the amount of physical gold they had under custody, knowing that on
any given day only a small fraction of that gold would be demanded. In 1668, Sweden's Riksbank introduced the first instance of
modern fractional reserve banking. In Class
Exercise 1. What is the basic idea of
fractional reserve banking? a)
Banks keep all the money. b)
Banks only keep some money and lend the rest. c)
Banks don't use money. Answer: b Explanation:
Fractional reserve banking means banks don't keep all the money; they lend
some of it out. 2. Why do banks not keep all the
deposited money? a)
They don't like to keep money. b)
To lend out money and make more. c)
They want to save money for later. Answer: b Explanation:
Banks lend out some of the deposited money to earn interest and help the
economy. 3. What is the usual amount banks
must keep in reserve? a)
100% of deposits. b)
50% of deposits. c)
10% of deposits. Answer: c Explanation:
Banks often keep 10% of deposits in reserve, not all of it. 4. Why might central banks reduce
reserve requirements? a)
To slow down the economy. b)
To make banks keep more money. c)
To boost the economy by lending more money. Answer: c Explanation:
Lowering reserve requirements encourages banks to lend more, helping the
economy grow. 5. What is the Fractional Reserve
Multiplier Effect? a)
Counting the number of banks in a country. b)
Estimating how reserve rules affect the money supply. c)
Making copies of money. Answer: b Explanation:
It's a way to figure out how reserve rules impact the total money available. 6. What's one advantage of
fractional reserve banking? a)
Banks always have enough money. b)
It helps banks earn money and support the economy. c)
Banks can't lend money. Answer: b Explanation:
Fractional reserve banking lets banks make profits and lend money to help the
economy grow. 7. What's one downside of
fractional reserve banking? a)
Banks don't make any money. b)
Banks can run out of cash during a crisis. c)
Banks don't lend any money. Answer: b Explanation:
In a crisis, if too many people want their money at once, banks may not have
enough cash on hand. 8. Which bank introduced modern
fractional reserve banking? a)
Riksbank in Sweden. b)
A bank in the USA. c)
A bank in England. Answer: a Explanation:
The modern version of fractional reserve banking began with Riksbank in
Sweden. Example:
You deposited $1,000 in a local bank
Summary: First Cycle: ·
Initial Deposit: A
customer puts $1,000 in the bank. ·
Bank Keeps Some: The
bank keeps $100 as a reserve (like saving for later). ·
Money to Lend: The
bank has $900 to lend to others. ·
Lend It Out: The
bank lends all $900 to people who need loans. ·
Reserved Money: The
bank still has $100 saved in reserve. ·
Customer's View: The
customer thinks they still have $1,000 in their account, even though $900 was
lent out. Second Cycle: ·
Money Returns: The
$900 that was lent out comes to the second bank. ·
Reserve Again: The
bank sets aside $90 (10% of $900) as a reserve. ·
More to Lend: After
the reserve, the bank has $810 to lend. ·
Lend It Again: The
bank lends all $810 to others. ·
Reserved Funds: The
bank still has $90 saved in reserve. ·
Customer's Belief:
The two customers still thinks they have $1,000+ $900=$1,900, even though
$1,710 was lent out. Third Cycle: ·
Money Returns Again:
The $810 from the last cycle comes to the third bank. ·
Reserve Once More:
The bank sets aside $81 (10% of $810) as a reserve. ·
Money to Lend Again:
After the reserve, the bank has $729 to lend. ·
Lend It Again: The
bank lends all $729 to others. ·
Money Saved: The
bank still has $81 saved as a reserve. ·
Customer's Belief
Continues: The three customers still believes they have $1,000+
$900+$810=$2,710, even though $2,439 has been lent out in the first three
cycles. This cycle keeps going,
with the bank lending out most of the money while customers believe they
still have the full amount in their accounts. The bank saves a fraction (10%)
as a reserve and uses the rest for lending. This way, banks can lend money to
help the economy grow while ensuring they have some money set aside for
safety.
Excel Template (FYI) – Fractional reserve banking Homework of
chapter 2 (due with second midterm) 1.
Write down the definition of M0, M1, M2 and M3; Which one is used as
a measure of money supply in this country? How much is it by the end of July
2020? 2. From Fed St. Louis website,
find the most recent charts of M1 money stock and M2 money stock. a.
http://research.stlouisfed.org/fred2/categories/24 b.
Compare the two charts and discuss the differences between the two
charts. 3.
What is fractional banking system? 4.
Imagine that you deposited $100,000 in Bank A. Reserve
ratio is 0.1. Imagine that the
fractional banking system is fully functioning. After five cycles, what is
the amount that has been deposited and what is the total amount that has been
lent out? 5.
What is Money velocity? Briefly explain the relationship between
money velocity and inflation? 6.
Briefly explain how changes in money supply and velocity affect
inflation? 7.
What is the relationship between reserve ratio and money multiplier? 8. (optional for extra credit)
Refer to the video, and write a summary: Weaknesses of fractional reserve
lending (khan academy) 9. (optional for extra credit) “United States - Velocity of M1 Money Stock was 1.44600 Ratio in April of 2023, according to the United States Federal Reserve. Historically, United States - Velocity of M1 Money Stock reached a record high of 10.70300 in October of 2007 and a record low of 1.19500 in July of 2021.” --- https://tradingeconomics.com/united-states/velocity-of-m1-ratio-q-sa-fed-data.html#:~:text=United%20States%20%2D%20Velocity%20of%20M1%20Money%20Stock%20was%201.44600%20Ratio,1.19500%20in%20July%20of%202021. · What does the information about how fast money is used, its historical ups and downs, and its effects on economic policies tell us about the economy? |
Money Multiplier and
Reserve Ratio
https://www.economicshelp.org/blog/67/money/money-multiplier-and-reserve-ratio-in-us/
The
Money Multiplier refers to
how an initial deposit can lead to a bigger final increase in the total money
supply. For example, if the commercial banks gain deposits of £1
million and this leads to a final money supply of £10 million. The money
multiplier is 10. The money multiplier is a
key element of the fractional banking system.
The
Reserve Ratio The reserve ratio is the % of
deposits that banks keep in liquid reserves. For example 10% or 20% Formula for money multiplier
In theory, we can predict the size of the money multiplier by
knowing the reserve ratio.
Example of money multiplier
Note: This
example stops at stage 10. In theory, the process can continue for a long
time until deposits are fractionally very small.
Using the Reserve ratio to influence monetary policy
In theory, if a Central
Bank demands a higher reserve ratio – it should have
the effect of acting like deflationary monetary policy. A higher reserve ratio
should reduce bank lending and therefore reduce the money supply. Money Multiplier in the real
world
In a simple theory of the money multiplier, it is assumed that
if the bank lends $90 – all of this will return. However, in the real world, there are
many reasons why the actual money multiplier is significantly smaller than
the theoretically possible money multiplier.
Therefore, due to these factors, the reserve ratio and money
multiplier are theoretical. Loan first multiplier
The money multiplier model suggests banks wait for deposit and
then lend out a fraction. However, in
the real world, banks may take it upon themselves to issue a loan, and then
seek out reserves from other financial institutions/Central Bank or private
individuals. For example, in the credit
bubble of 2000-2007, many banks were lending mortgages by borrowing on
short-term money markets. They were lending money
that wasn’t related to saving deposit accounts. Money multiplier and
quantitative easing
In 2009-12 Central Banks pursued quantitative easing. This
involves increasing the monetary base. – Buying bonds off banks gave them
greater cash reserves. In theory, this increase in the money multiplier
should increase the overall money supply by a large amount due to the money
multiplier
However, in practice, this didn’t occur. The money supply
didn’t increase because banks were not keen to lend any extra money. Also,
banks were trying to improve their reserves following the credit crunch and
their previous over-extension of loans. In
class exercise 1. What
is the Money Multiplier's main function? a) To increase interest rates. b) To decrease the money supply. c) To show how much an initial deposit can
boost the total money supply. Answer:
c Explanation: The Money Multiplier helps us
understand how a little bit of money can make a lot more money in the
economy. 2. If a
bank gets deposits of $1,000 and the Money Multiplier is 5, how much money
can it create? a) $1,000 b) $5,000 c) $10,000 Answer:
b Explanation: With a Money Multiplier of 5,
the bank can turn every $1 into $5 by lending it out to others. 3.
What does the Reserve Ratio tell us? a) How much money people save in their
bank accounts. b) The percentage of deposits banks must
keep safe. c) How much money a bank can lend to customers. Answer:
b Explanation: The Reserve Ratio tells us
how much money a bank has to keep safe and cannot lend out. 4. If
the Reserve Ratio is 20%, what's the Money Multiplier? a) 1/0.2 = 5 b) 0.2 c) 0.05 Answer:
a Explanation: When the Reserve Ratio is
20%, the Money Multiplier is 5, meaning every $1 in the bank can become $5 in
the economy. 5.
Why might the real Money Multiplier be smaller than the theoretical one? a) Because banks always lend out every
penny. b) Because people keep some money in cash
and save some. c) Because banks want to lend as much as
possible. Answer:
b Explanation: In reality, people save
money, which means not all of it gets lent out, reducing the Money
Multiplier. 6. How
does a higher reserve ratio affect the Money Multiplier? a) It makes the Money Multiplier bigger. b) It doesn't change the Money Multiplier. c) It makes the Money Multiplier smaller. Answer:
c Explanation: A higher reserve ratio means
banks can't lend as much, so the Money Multiplier becomes smaller. 7. What
does a higher reserve ratio mean for banks? a) They can lend more money. b) They must keep more money in reserve
and can't lend as much. c) They can lower interest rates. Answer:
b Explanation: A higher reserve ratio means banks
have to keep more money safe, so they can't lend as much. 8. What
happens to the Money Multiplier if people save more and spend less? a) It gets smaller. b) It stays the same. c) It gets bigger. Answer:
a Explanation: When people save more and
spend less, banks can't lend as much, which makes the Money Multiplier
smaller. 9. What
role did banks play during the credit bubble of 2000-2007? a) They only lent money from savings
deposit accounts. b) They lent money borrowed from
short-term money markets. c) They didn't lend any money. Answer:
b Explanation: During the credit bubble,
banks borrowed money from short-term markets to make loans, not just from
people's savings. 10. How
does the real world differ from the money multiplier model? a) In the real world, banks always lend
every deposit they get. b) In the real world, banks may not lend
all deposits, and various factors can affect the Money Multiplier. c) In the real world, banks never keep
reserves. Answer:
b Explanation: Real-world factors like people's
spending habits and banks' decisions can make the Money Multiplier different
from what the model suggests
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Chapter 3 Financial
Instruments, Financial Markets, and Financial Institutions Part I: Examples and characteristics of financial instruments What
Is a Financial Instrument? Video
https://www.investopedia.com/terms/f/financialinstrument.asp Financial
instruments are assets that can be traded, or they can also be seen as
packages of capital that may be traded. Most types of
financial instruments provide efficient flow and transfer of capital all
throughout the world's investors. These assets can be cash, a contractual
right to deliver or receive cash or another type of financial instrument, or
evidence of one's ownership of an entity. KEY TAKEAWAYS
Understanding Financial
Instruments Financial
instruments can be real or virtual documents representing a legal agreement
involving any kind of monetary value. Equity-based financial instruments
represent ownership of an asset. Debt-based financial instruments represent a
loan made by an investor to the owner of the asset. Foreign exchange instruments
comprise a third, unique type of financial instrument. Different
subcategories of each instrument type exist, such as preferred share equity
and common share equity. International Accounting
Standards (IAS) defines financial
instruments as "any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another
entity." Types
of Financial Instruments Financial
instruments may be divided into two types: cash instruments and derivative
instruments. Cash Instruments The
values of cash instruments are directly influenced and determined by the
markets. These can be securities that are easily
transferable. Cash instruments may also be
deposits and loans agreed upon by borrowers and lenders. Derivative Instruments The value and characteristics of
derivative instruments are based on the vehicle’s underlying components, such
as assets, interest rates, or indices. An equity options contract, for
example, is a derivative because it derives its value from the underlying
stock. The option gives the right, but not the obligation, to buy or sell the
stock at a specified price and by a certain date. As the price of the stock
rises and falls, so too does the value of the option although not necessarily
by the same percentage. There can be over-the-counter
(OTC) derivatives or exchange-traded derivatives. OTC is a market or process
whereby securities–that are not listed on formal exchanges–are priced and
traded. Types of Asset Classes of
Financial Instruments Financial instruments may also be
divided according to an asset class, which depends on whether they are
debt-based or equity-based. Debt-Based Financial Instruments Short-term debt-based financial
instruments last for one year or less. Securities of this kind come in the
form of T-bills and commercial paper. Cash of this kind can be deposits and
certificates of deposit (CDs). Exchange-traded derivatives under
short-term, debt-based financial instruments can be short-term interest rate
futures. OTC derivatives are forward rate agreements. Long-term debt-based financial
instruments last for more than a year. Under securities, these are bonds.
Cash equivalents are loans. Exchange-traded derivatives are bond futures and
options on bond futures. OTC derivatives are interest rate swaps, interest
rate caps and floors, interest rate options, and exotic derivatives. Equity-Based Financial
Instruments Securities under equity-based
financial instruments are stocks. Exchange-traded derivatives in this
category include stock options and equity futures. The OTC derivatives are
stock options and exotic derivatives. In class exercise 1. What are financial
instruments? a) Virtual documents b) Real
assets c)
Assets that can be traded Answer:
c 2. What is the main purpose of financial
instruments? a) To
represent ownership of a car b) To
transfer capital among investors c) To
represent virtual agreements Answer: b Explanation:
Financial instruments help transfer capital among investors. 3. How are equity-based financial
instruments defined? a) As ownership
of an asset b) As
loans from investors c) As
virtual agreements Answer: a Explanation:
Equity-based financial instruments represent ownership of an asset. 4. What do debt-based financial instruments
represent? a) A
loan from a borrower b) A virtual
currency c) A
legal agreement involving monetary value Answer: a Explanation:
Debt-based financial instruments represent a loan made by an investor to the
owner of the asset. 5. What is a derivative financial
instrument? a) An
instrument that derives its value from underlying components b) An
instrument only found in foreign markets c) An
instrument that represents ownership of a company Answer: a Explanation:
Derivative financial instruments derive their value from underlying
components like assets, interest rates, or indices. 6. What is an example of a cash
instrument? a) A
certificate of deposit b) A
stock option c) A
bond Answer: a Explanation:
Cash instruments include deposits, loans, and securities that are easily
transferable, such as certificates of deposit (CDs). 7. What is the key characteristic of
derivative instruments? a)
Their value is determined by markets. b) They
always involve physical assets. c) They
represent ownership of companies. Answer: a Explanation:
Derivative instruments derive their value from underlying components and are
influenced by market conditions. 8. What are short-term debt-based
financial instruments? a)
Securities with a maturity of one year or less b)
Long-term loans c)
Stocks Answer: a Explanation:
Short-term debt-based financial instruments have a maturity of one year or
less, such as T-bills and commercial paper. 9. What is the primary function of
over-the-counter (OTC) derivatives? a) They
are virtual documents. b) They
are traded on formal exchanges. c) They
are priced and traded outside of formal exchanges. Answer: c Explanation:
OTC derivatives are traded outside of formal exchanges. 10. What does a bond represent among
financial instruments? a)
Ownership of an asset b) A virtual
contract c) A
loan that lasts for more than a year Answer: c Explanation:
Bonds are long-term debt-based financial instruments. 11. How are foreign exchange instruments
different from other financial instruments? a) They
are always virtual agreements. b) They
are influenced by stock markets. c) They
involve currency exchange. Answer: c Explanation:
Foreign exchange instruments involve the exchange of currencies, making them
unique among financial instruments. Getting
to Know the Money Market By BARCLAY PALMER Updated June
08, 2021 https://www.investopedia.com/articles/04/071304.asp The major attributes that draw an
investor to short-term money market instruments are superior safety and
liquidity. Money market instruments
have maturities that range from one day to one year, although they are most
often three months or less.
Because these investments are associated with massive and actively traded
secondary markets, you can almost always sell them prior to maturity, albeit
at the price of forgoing the interest you would have gained by holding them
until maturity. Types of Money Market Instruments A large number of financial
instruments have been created for the purposes of short-term lending and
borrowing. Many of these money market instruments are quite specialized, and
they are typically traded only by those with intimate knowledge of the money
market, such as banks and large financial institutions. Some
examples of these specialized instruments are federal funds, the discount
window, negotiable certificates of deposit (NCDs), eurodollar time deposits,
repurchase agreements, government-sponsored enterprise securities, shares in
money market instruments, futures contracts, futures options, and swaps. Aside from these specialized
instruments on the money market are the investment vehicles with which
individual investors will be more familiar, such as short-term investment pools (STIPs) and money market mutual funds,
Treasury bills, short-term municipal securities, commercial paper, and
bankers' acceptances. Here we take a closer look at STIPs, money market
mutual funds, and Treasury bills. Short-Term Investment Pools and
Money Market Mutual Funds Short-term
investment pools (STIPs) include money market mutual funds, local government
investment pools, and short-term investment funds of bank trust departments.
All STIPs are sold as shares in very
large pools of money market instruments, which may include any or all of the
money market instruments mentioned above. In other words, STIPs are a convenient means of
cumulating various money market products into one product, just as an
equity or fixed income mutual fund brings together a variety of stocks,
bonds, and so forth. STIPs
make specialized money market instruments accessible to individual investors
without requiring intimate knowledge of the various instruments contained
within the pool. STIPs also alleviate the large minimum investment amounts
required to purchase most money market instruments, which generally equal or
exceed $100,000. Money
market accounts are safe, low-risk investments. They're generally a good
place to put your money, especially if you need immediate access to it while you
collect interest. Institutions offer higher interest
rates because they use the funds in money market accounts to invest in
short-term assets with short-term maturities, as noted above. How does the Money Market work? (video)
In class exercise based on the above video 1. Why do people like money market
accounts? a) They
make you rich. b) You
can get your money quickly. c) They
invest in stocks. Answer: b Explanation:
People like money market accounts because you can access your money quickly. 2. What does a money market account mainly
invest in? a)
Long-term debt. b) Real
estate. c)
Short-term debt. Answer: c Explanation:
Money market accounts mostly invest in short-term debt. 3. Are money market accounts risky? a) No,
they are low-risk. b) Yes,
they are high-risk. c) Risk
depends on the day. Answer: a Explanation:
Money market accounts are not very risky. 4. How do money market accounts and
savings accounts differ? a)
Money market accounts pay higher interest. b)
Savings accounts are less safe. c)
Money market accounts have extra fees. Answer: c Explanation:
Money market accounts have fees, which is different from savings accounts. 5. What are the two main types of money
market funds? a)
Happy and sad funds. b)
Taxable and non-taxable funds. c) Big
and small funds. Answer: b Explanation:
The two main types of money market funds are taxable and non-taxable. 6. Can interest rates in money market
funds change? a) No,
they stay the same. b) Yes,
they can go up or down. c)
Interest rates don't matter. Answer: b Explanation:
Interest rates in money market funds can change. 7. What's the main goal of a money market
fund? a) To
make you rich quickly. b) To
keep your cash safe from inflation. c) To
limit losses and offer a bit of interest. Answer: c Explanation: The main goal of a money
market fund is to limit losses while providing a little interest. Part II: Order types
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|
COMPANY NAME |
SYMBOL |
EXCHANGE |
PRICE |
SHARES |
IPO DATE |
|
Nasdaq |
$10.00 |
6,000,000 |
10/6/2023 |
||
|
Nasdaq |
$10.00 |
10,000,000 |
10/6/2023 |
||
|
Nasdaq |
$4.00 |
2,500,000 |
10/5/2023 |
||
|
Nasdaq |
$23.00 |
2,500,000 |
9/29/2023 |
||
|
Nasdaq |
$4.00 |
1,700,000 |
9/29/2023 |
||
|
Nasdaq |
$5.00 |
2,000,000 |
9/28/2023 |
||
|
Nasdaq |
$7.00 |
1,143,000 |
9/27/2023 |
Ho Homework ( DUE with the second midterm exam)
1)
What are the differences
between market order and limit order?
2)
What is short selling
stock? How to short sell a stock?
3)
Check three stocks listed
above in the IPO table.
·
Follow these stocks and
report their performances one month after the IPO.
·
Summarize your
findings.
4)
What are the major
differences between NYSE and NASDAQ?
5)
What are the major
differences among Dasdaq 100, S&P 500 and the Dow?
6)
What is money market?
7)
Watch Robinhood to allow users
to buy into IPOs
Would you like to invest in IPOs through Robinhood? Why or why not?
Part IV: NASDAQ
vs. NYSE
What is the difference between NYSE and NASDAQ? (video)
Summary:
NYSE
vs. Nasdaq: What's Different?
·
Leading Stock Exchanges:
NYSE:
The New York Stock Exchange
Nasdaq:
National Association of Securities Dealers Automated Quotations
·
How They Trade:
NYSE:
People on the trading floor shout and use hand signals to buy and sell
stocks.
Nasdaq:
It's like online shopping; people trade stocks through a computer system.
·
Who Can List:
NYSE:
Companies need to have a lot of shares and shareholders.
Nasdaq:
Companies need a good number of shares and a minimum price for their shares.
·
Company Size:
NYSE:
Companies on NYSE need to be pretty big, with shares worth at least $4 each.
Nasdaq:
They have some rules, but they don't mention how big a company needs to be.
·
Dealing with Dealers:
Nasdaq:
Companies listing here need at least three dealers to help with their stocks.
·
Cost to List:
NYSE:
It can be expensive, up to $250,000 to list your company here.
Nasdaq:
Costs between $50,000 to $75,000 to list a company.
In class exercise
1: What is the NYSE?
A)
A type of car
B)
A place to trade stocks
C)
A famous restaurant
Answer: b
Explanation:
The NYSE is where people trade stocks, like buying and selling shares in
companies.
2: How do people trade on
the Nasdaq?
A)
Through a computer system
B)
By shouting and using hand signals
C)
By sending letters
Answer: a
Explanation:
Nasdaq is a stock exchange where people use computers to trade stocks, like
shopping online.
3: What does a company need
to have to list on the NYSE?
A)
A small number of shares
B)
Expensive office space
C)
A lot of shares and shareholders
Answer: c
Explanation:
To be on the NYSE, a company must have many shares and many people who own
those shares.
4: What's the cost to list a
company on the Nasdaq?
A)
$1,000
B)
$50,000 to $75,000
C)
It's free
Answer: b
Explanation:
Listing a company on Nasdaq can cost between $50,000 and $75,000.
5: How do people trade on
the NYSE?
A)
Using a magic wand
B)
By sending emails
C)
By comparing bid and ask prices
Answer: c
Explanation:
On the NYSE, people trade stocks by looking at the prices buyers are willing
to pay (bid) and sellers are asking (ask).
NYSE vs NASDAQ - who has more "mega cap" listings? (video)
In class exercise
1. What is the primary focus of the
Nasdaq?
a)
Energy companies
b)
Technology stocks
c)
Retail companies
Answer: b
2. How many stocks does the Nasdaq
Composite Index track?
a) 100
stocks
b) 500
stocks
c)
About 4,000 stocks
Answer: c
3. What is the primary purpose of a stock
market index?
a) To
trade stocks
b) To
calculate stock prices
c) To
provide information about a group of stocks
Answer: c
4. Why is the S&P 500 widely used?
a)
Because it's a technology index
b)
Because it represents 500 large companies
c)
Because it's calculated differently
Answer: b
5. Which index represents
30 large public U.S. companies?
a)
Nasdaq 100
b)
S&P 500
c) The
Dow
Answer: c
6. How is the Dow's calculation different
from the S&P 500?
a) It
only considers stock prices.
b) It
is based on the product of stock price and shares.
c) It
includes technology stocks.
Answer: a
7. What type of companies are included in
the Nasdaq?
a) U.S.
technology companies
b) U.S.
energy companies
c) U.S.
retail companies
Answer: a
8. How many large companies does the
Nasdaq 100 consist of?
a) 30
companies
b) 100
companies
c) 500
companies
Answer: b
9. What criteria are used to select stocks
for the S&P 500?
a) Type
and age of the company
b)
Stock price and shares
c)
Size, type, age, and more
Answer: c
10. What does the Nasdaq Composite Index
measure?
a) The
change in all stocks on the Nasdaq
b) The
performance of 100 technology stocks
c) The
change in stock prices on the NYSE
Answer: a
11. What is the primary difference between
the Nasdaq and the NYSE?
a) The
Nasdaq focuses on technology stocks, while the NYSE focuses on energy stocks.
b) The
Nasdaq is a stock exchange and an index, while the NYSE is only a stock exchange.
c) The
Nasdaq is based in Europe, while the NYSE is based in the U.S.
Answer: b
Dec 10, 2018 6:47 AM -05:00, Ben
Lobel, Markets Writer
https://www.dailyfx.com/nas-100/NASDAQ-vs-NYSE.html
NASDAQ and the New York Stock
Exchange (NYSE) are the two largest stock exchanges in the world, providing a
platform for trading securities. But while they share similarities in their
considerable size and purpose, they are very different markets.
Understanding the differences
between Nasdaq and NYSE can shed light on how stock market trading works.
NYSE and NASDAQ are the biggest
stock exchanges in the world
WHAT ARE THE DIFFERENCES BETWEEN
NASDAQ AND NYSE?
The main difference between
Nasdaq and NYSE is their markets. Nasdaq
is a dealer’s market, with participants trading through a dealer rather than
directly with each other, while NYSE is an auction market, which enables
individuals to transact between each other on an auction basis.
Other differences include the
location of the transactions, how traffic is controlled, and the types of
companies listed – all of which are explored in more depth in the sections
below.
The formats that Nasdaq and NYSE
take – dealer’s market and auction market respectively – represent a
fundamental difference between the way they operate. An auction market, as run by NYSE, is a system based on buyers and
sellers entering competitive bids at the same time. The price at which a stock
is traded reflects the highest price that a buyer is willing to pay, and the
lowest price a seller is willing to accept. Matching bids and offers are then
paired together with the orders executed by the ‘specialist’ (see ‘Traffic
Control’ below).
However,
a dealer’s market, as run by Nasdaq, is a type of market where multiple
dealers post prices at which they will buy or sell a specific stock. In a
dealer’s market, a dealer is designated as a market maker – a member firm or
market participant such as a brokerage company or bank – that actively buys
and sells stocks on behalf of traders. Market makers can enable the process
of matching up buyers and sellers to be a lot quicker, maintaining liquidity
and ensuring an efficient trading process.
Location of Transactions
While both institutions are based
in New York City, the location of transactions for trading on Nasdaq and on
the NYSE are very different. NYSE
retains a physical trading floor, although many of the transactions occur at
its data center in Mawah, New Jersey.
However, as an electronic
exchange, Nasdaq does not have a physical trading floor and operates through
direct trading between investors and the market makers. While Nasdaq trading originally took place over a computer bulletin
board system, now automated trading systems offer the benefit of daily
trading volumes and full reports on trades.
Traffic Control
Traffic controllers, in essence,
connect buyers and sellers, but their role differs between Nasdaq and NYSE.
At each exchange, they are responsible for dealing with traffic problems and
ensuring their markets run effectively. However, Nasdaq’s traffic controller, known as the ‘market maker’, actively
buys and sells stocks on behalf of traders, while the NYSE’s traffic
controller, known as the ‘specialist’, facilitates the market for buyers and
sellers through setting opening prices for stocks, accepting limit orders,
and moderating interest for particular stocks.
The two roles are, on paper,
different in that Nasdaq’s market maker effectively creates a market, while
NYSE’s specialist simply facilitates it. However, both roles have the same
goal of enabling a smooth and orderly market for clients.
It is worth noting that
approximately 40% of the volume traded
on the Nasdaq is done through an electronic communications network (ECN),
which is an automatic system for directly matching buyers and sellers. On the
NYSE, only 7% of the volume is done via an ECN, but that could change with
evolution towards a hybrid system of humans and machines.
Types of Companies Listed
When it comes to the listings on
Nasdaq and NYSE, the NYSE trades
stocks for around 2,800 companies, while Nasdaq has more than 3,300 listings.
The NASDAQ-100 features 100 of
the largest publicly-traded businesses, based on market capitalization, but Nasdaq’s wider exchange features many
small and micro-capitalization stocks also.
Listing Requirements
Listing requirements differ
between Nasdaq and NYSE. Nasdaq listing
requirements mean that companies must have at least 1,250,000 shares
available for the public to trade, while companies listing on NYSE must have
issued a minimum of 1,100,000 to at least 400 shareholders. Other differences
include fees; for companies looking to list on the NYSE the entry fee goes up
to $500,000, while for Nasdaq, the entry fee ranges from $50,000 to $75,000,
with a yearly fee of around $27,000.
Additionally,
there is a minimum share price of $4 for NYSE-listed companies and the market
value of the company’s public shares must be at least $40 million. For a
listing on Nasdaq, companies must have a minimum of three dealers for its
stocks.
Perception of Stocks
The general perception of the
stocks on Nasdaq and NYSE is that the more volatile trades are to be found on
Nasdaq. This is because long-established,
stable companies are more often found on the NYSE, with examples ranging
from Coca Cola to Citigroup, IBM and Walmart. The Nasdaq, on the other hand, has more of a reputation for listing
fast-growth tech businesses with potentially more scope for dramatic price
movement. Stocks to be found on Nasdaq include Facebook, Apple, Google
and Amazon.
Private vs Public
The ownership structure of each
exchange used to be different to how it is today. Formerly, Nasdaq was listed
as a publicly-traded corporation, while the NYSE was private. However, in
March 2006, the NYSE went public, making its shares available to traders on
an exchange. Traders can bet on Nasdaq and NYSE through the Nasdaq and NYSE
platforms respectively.
HOW TRADERS CAN USE THE
DIFFERENCES BETWEEN NASDAQ AND NYSE TO THEIR ADVANTAGE
In summary, when choosing which
stock markets to go for as a trader, you might consider the following:
- Volatility: If
you’re looking for stocks with the potential for rapid price movements,
you may find more opportunities on Nasdaq. On the other hand, NYSE
offers shares that are generally more established and stable.
- Nature of trading: If you want to trade through floor brokers, you will have that option with NYSE, while Nasdaq offers electronic trading. Products offered by both can be traded via third-parties, ECNs, and derivatives.
Indices
·
NASDAQ
indices include the NASDAQ Composite, NASDAQ-100, and NASDAQ Biotechnology.
· Indices on the NYSE include the Dow Jones Industrial Average and NYSE Composite.
·
Other indices, like the S&P 500 and Russell 1000, include stocks listed on both
exchanges.
https://www.diffen.com/difference/NASDAQ_vs_NYSE
Experience Wall Street Stock Trading In The 1980s
(optional)
Robinhood will give retail
investors access to IPO shares (youtube
as well) https://www.cnbc.com/2021/05/20/robinhood-will-give-retail-investors-access-to-ipo-shares-a-longstanding-wall-street-dominion.html
PUBLISHED
THU, MAY 20 2021 11:44 AM EDTUPDATED THU, MAY 20 20211:34 PM EDT Maggie
Fitzgerald
Robinhood said it is
giving retail investors access to IPO shares. Retail traders typically don’t
have a vehicle to buy into newly listed companies until those shares begin
trading on an exchange. Robinhood will
not be an underwriter for companies
hitting the public markets but the stock trading company will get an
allocation of shares by partnering with investment banks.
It is unclear if
Robinhood clients will be able to invest in Robinhood’s pending market debut.
IPO
shares have historically been set aside for Wall Street’s institutional
investors or high-net worth individuals. Retail traders typically don’t have
a vehicle to buy into newly listed companies until those shares begin trading
on an exchange, which is often after the share price has surged.
“We’re starting to roll out IPO Access, a new product that will give you the
opportunity to buy shares of companies at their IPO price, before trading on
public exchanges. With IPO Access, you can now participate in upcoming IPOs
with no account minimums,” Robinhood said in a blog post Thursday.
Robinhood will not be
an underwriter for companies hitting the public markets but will get an
allocation of shares by partnering with investment banks. This move is
Robinhood’s latest to antagonize Wall Street. IPO stock pops on the first day averaged 36% in 2020, according
to Dealogic, demonstrating individual investor thirst for some of these
popular names that is not priced into IPO pricing. These are gains the little
guy is missing out on.
The traditional IPO
process has been criticized in recent years as being broken, with investment
banks allotting the shares to big clients who reap the instant first-day
gains. Going public by way of direct listing has combated some of these
criticisms.
Using
IPO Access, Robinhood clients will be able to request to buy shares at their
initial listing price range. When the final price is set, clients will be able to go through with
the purchase, change or cancel.
“We currently anticipate that up to 1.0% of
the shares of Class A common stock offered hereby will, at our request, be
offered to retail investors through Robinhood Financial, LLC, as a selling
group member, via its online brokerage platform,” Figs said in its S1 filing
document.
“This is the first
initial public offering to be included on the Robinhood platform and there
may be risks associated with the use of the Robinhood platform that we cannot
foresee, including risks related to the technology and operation of the
platform, and the publicity and the use of social media by users of the
platform that we cannot control,” the company added.
The IPO date isn’t
set, but companies typically go public one to months after their S1
prospectus is filed with the SEC.
It is unclear if
Robinhood clients will be able to invest in Robinhood’s pending IPO. The
stock trading app is expected to go public in the first half of 2021 and has
filed confidentially with the SEC.
IPO Access will be
rolled out to all clients over the next few weeks.
Robinhood’s
IPO product comes on the heels of record levels of new, younger traders
entering the stock market during the pandemic.
That surge has continued into 2021, marked by frenzied trading around
so-called meme stocks like GameStop.
Online finance
start-up SoFi made a move similar to Robinhood’s in March; however, Sofi will
be an underwriter for its offered IPOs.
https://robinhood.com/us/en/support/articles/ipo-access/
For discussion:
·
What advantage to
buy pre-IPO shares?
·
What risks are
associated with it?
In Class Exercise
1: What
is Robinhood giving retail investors access to?
a) Bonds
b) IPO shares
c) Real estate
Answer:
b
Explanation: Robinhood is providing retail
investors with access to IPO (Initial Public Offering) shares, allowing them
to buy shares of companies at their IPO price.
2: Why
have IPO shares historically been limited to Wall Street's institutional
investors?
a) Because retail investors aren't
interested in IPOs
b) Because retail investors prefer trading
on exchanges
c) Because IPO shares were typically
reserved for institutional investors and high-net-worth individuals.
Answer:
c
Explanation: IPO shares have traditionally
been set aside for institutional investors and wealthy individuals, making it
difficult for retail traders to access them.
3: How
does Robinhood plan to provide access to IPO shares?
a) By becoming an underwriter for IPOs
b) By partnering with investment banks to
get an allocation of shares
c) By purchasing IPO shares on the open
market
Answer:
b
Explanation: Robinhood will collaborate
with investment banks to receive an allocation of IPO shares, allowing them
to offer these shares to their clients.
4: What
is the goal of Robinhood's IPO Access product?
a) To provide access to IPO shares at
their initial listing price
b) To allow investors to trade shares on
public exchanges
c) To facilitate after-market trading of
IPO shares
Answer:
a
Explanation: The aim of Robinhood's IPO
Access is to enable investors to purchase shares of companies at the IPO
price before they start trading on public exchanges.
5: What
is a potential advantage of buying pre-IPO shares?
a) Guaranteed profits
b) Access to shares at a lower price than
the post-IPO market
c) Higher liquidity
Answer:
b
Explanation: Buying pre-IPO shares allows
investors to purchase shares at the IPO price, which is often lower than the
price at which they start trading on public exchanges.
6: Why
has the traditional IPO process been criticized in recent years?
a) Due to a lack of interest from retail
investors
b) Because it favors small investors
c) Because investment banks allocate shares
to big clients, leading to instant first-day gains.
Answer:
c
Explanation: The traditional IPO process
has faced criticism for favoring big clients of investment banks, who often
benefit from immediate price gains on the first day of trading.
7: What
role do market makers play on the NYSE American?
a) They regulate the stock market
b) They provide financial advice to
investors
c) They buy and sell specific securities
to ensure liquidity and an orderly marketplace.
Answer:
c
Explanation: Market makers on the NYSE
American are responsible for buying and selling specific securities to
maintain liquidity and orderliness in the market.
8: What
term was the AMEX known as before it became the American Stock Exchange?
a) NASDAQ
b) New York Stock Exchange (NYSE)
c) New York Curb Exchange
Answer:
c
Explanation: Before becoming the American
Stock Exchange (AMEX), it was known as the New York Curb Exchange.
9: What
was the reputation of the AMEX in terms of the types of companies it listed?
a) It listed only blue-chip companies
b) It listed companies that couldn't meet
NYSE's strict requirements.
c) It specialized in technology companies
Answer:
b
Explanation: The AMEX gained a reputation
for listing companies that couldn't meet the stringent requirements of the
New York Stock Exchange (NYSE).
10:
What is the primary purpose of an exchange-traded fund (ETF)?
a) To provide direct ownership of a
specific stock
b) To track an index or a basket of assets
c) To facilitate short-term trading of
stocks
Answer:
b
Explanation: ETFs are designed to track
the performance of an index or a group of assets, providing investors with
diversified exposure.
11: Why
did many companies postpone their IPO plans in 2022?
a) Due to regulatory issues
b) Because they preferred direct listings
c) Because of factors like inflation,
rising interest rates, and geopolitical events.
Answer:
c
Explanation: Many companies delayed their
IPOs in 2022 due to concerns related to inflation, rising interest rates, and
geopolitical events affecting market stability.
12: Why
did some IPOs face challenges in 2022?
a) Because the market was booming
b) Because investors were eager to buy IPO
shares
c) Because they struggled to meet the
valuation expectations, given changing market conditions.
Answer:
c
The Fed Jax Tour – 10/17/2023, 1:30 – 2:30 pm, 800, water
street, business casual
Second Midterm Exam 10/19/2023 In class
Chapter 5 Diversification – Part
I - S&P500 Index
Contents:
· S&P500 Index
· QQQ
· Mutual Fund vs. ETF (small cap growth vs. small
cap value vs. large growth vs. large value)
· Behavior Finance
Investing in the S&P 500 (video)
In
class Exercise
A.
100 stocks
B.
200 stocks
C.
5,00 stocks
Answer: C.
2. What percentage of the US
market capitalization does the S&P 500 cover?
A.
80%
B.
50%
C.
30%
Answer: A.
Explanation:
The S&P 500 covers roughly 80% of the US market capitalization.
3.
Jared Kizer's analysis of the S&P
500's performance from March 2009 through October 2018 used a statistical
method called:
A.
Hypothesis testing
B.
Bootstrapping
C.
Regression analysis
Answer:
B
Explanation:
Jared Kizer's analysis used bootstrapping to examine the S&P 500's
performance during that time period.
4. What was the main finding
of Jared Kizer's analysis of the S&P 500's performance?
A.
The S&P 500's recent performance was highly unlikely.
B.
The S&P 500's performance is likely to repeat in the future.
C.
The S&P 500's performance is entirely predictable.
Answer: A.
Explanation:
The main finding was that the S&P 500's performance was highly unlikely.
5. How many stocks are there
in the S&P 500 index?
A.
50
B.
500
C.
1,000
Answer: B.
Explanation:
The S&P 500 consists of 500 US stocks.
6. What is one of the key
reasons why the S&P 500's future performance is deemed unlikely to match
its recent performance?
A.
Its low cost
B.
Its past performance
C.
It being a committee-based index
Answer: C.
Explanation:
The fact that the S&P 500 is a committee-based index is mentioned as a
reason for its future performance being unlikely to match its recent
performance.
:
Current valuations are the best predictor of future returns in the stock
market.
7. The video suggests that
global diversification can provide benefits, even when the US stocks have:
A.
The lowest volatility
B.
The highest returns
C.
The most diversified portfolio
Answer: A.
Explanation: The video highlights that global
diversification can provide benefits, even when US stocks have the lowest
volatility.
Stock returns
from 2013-2023 - Apple and S&P 500
Stock returns
from 2013-2023 - QQQ and S&P 500
https://aiolux.com/contrasts/side-by-side?scroll=quick_comparison&symbol_arr=qqq%2CSPY&time_span=10y
In class exercise:
1: What is the main takeaway from the comparison between AAPL and
SPY's volatility?
A) AAPL has higher volatility,
indicating it's riskier compared to SPY.
B) AAPL has lower volatility, making it a safer
investment.
C) Volatility doesn't affect investment decisions.
Answer:
a
Explanation: AAPL's price experiences larger
fluctuations, signifying higher risk compared to SPY.
2: How would you describe the concept of
volatility in the stock market?
A) Volatility represents the speed at which stock
prices change.
B) Volatility indicates a stock's profitability.
C) Volatility is a measure of the size and
frequency of price fluctuations.
Answer:
c
Explanation: Volatility measures how much and how
often a stock's price changes, reflecting its risk.
3:
Based on the volatility data, which investment might be preferred by risk-averse
investors?
A) AAPL, as it offers higher returns due to
increased volatility.
B) SPY, as it has lower volatility, indicating
lower risk.
C) Neither, as risk-averse investors avoid the
stock market.
Answer:
b
Explanation: Risk-averse investors typically
prefer investments with lower volatility because they are less likely to
experience significant price fluctuations.
4: In the context of stock market volatility,
which investment would likely be preferred by long-term investors?
A) AAPL, due to its higher volatility and profit
potential.
B) SPY, as it offers lower volatility and reduced
short-term risk.
C) Long-term investors don't consider volatility
in their decisions.
Answer:
b
Explanation: Long-term investors typically prefer
investments with lower volatility, like SPY, to reduce the short-term risk
associated with price fluctuations.
https://portfolioslab.com/tools/stock-comparison/AAPL/SPY
In class exercise
1: What does the Sharpe Ratio measure in the
context of investments?
A) The
speed at which investment values change.
B)
Total return of an investment without considering risk.
C)
Risk-adjusted return, considering investment's volatility.
Answer: c
Explanation:
The Sharpe Ratio assesses an investment's return in relation to its risk or
volatility.
2: If two investments have identical
Sharpe Ratios, what does that imply?
A) It
suggests both investments provide similar risk-adjusted returns.
B) Both
investments have the same returns.
C) One
investment is riskier than the other.
Answer: a
Explanation:
When two investments have the same Sharpe Ratio, it indicates that both offer
similar risk-adjusted returns relative to their volatility.
3: Using the Sharpe Ratio, which
investment would be more favorable for an investor focused on minimizing
risk?
A)
AAPL, with a Sharpe Ratio of 0.91.
B) SPY,
with a Sharpe Ratio of 1.21.
C) The
Sharpe Ratio does not help in assessing risk.
Answer: b
Explanation:
A higher Sharpe Ratio suggests better risk-adjusted returns, making SPY more
favorable for risk-averse investors.
4: What is the formula for calculating the
Sharpe Ratio?
A)
(Return - Risk-Free Rate) / Standard Deviation
B)
(Return - Investment Cost) / Total Assets
C)
Return / Market Capitalization
Answer: a
Explanation:
The Sharpe Ratio is
calculated as the excess return of an investment over the risk-free rate
divided by its standard deviation, which measures volatility.
Regress
Apple’s Return on S&P500’s
Apple and
S&P500’s Stand Deviation Comparison
Questions for class discussion:
· Which one is better, the S&P500 or
Apple? In the past? About the future?
· Which one is riskier and which one’s
return is higher?
· Are you tempted to invest in APPLE or
SP500?
· How to find the next Apple?
· How much is the weight of Apple in
S&P500? For example, you have a total of $1,000 to invest in SP500, how
much you have invested in apple?
· How are the weights in the following
table calculated?
S&P
500 Companies by Weight
The S&P 500 component weights are listed from largest to
smallest. Data for each company in the list is updated after each trading
day. The S&P 500 index consists of most but not all of the largest
companies in the United States. The S&P market cap is 70 to 80% of the
total US stock market capitalization. It is a commonly used benchmark
for stock portfolio performance in America and abroad. Beating the performance of the S&P with less risk is the goal
of nearly every portfolio manager, hedge fund and private investor.
S&P 500 ETF Components
This list shows the holdings of
the SPDR S&P 500 ETF Trust (SPY).
|
# |
Company |
Symbol |
Portfolio% |
Price |
|
|
1 |
7.14% |
|
|||
|
2 |
6.78% |
|
|||
|
3 |
3.22% |
|
|||
|
4 |
2.88% |
|
|||
|
5 |
2.26% |
|
|||
|
6 |
1.95% |
|
|||
|
7 |
1.94% |
|
|||
|
8 |
1.85% |
|
|||
|
9 |
1.72% |
|
|||
|
10 |
1.37% |
|
|||
|
11 |
1.34% |
|
|||
|
12 |
1.25% |
|
|||
|
13 |
1.17% |
|
|||
|
14 |
1.05% |
|
|||
|
15 |
1.02% |
|
|||
|
16 |
1.01% |
|
|||
|
17 |
0.97% |
|
|||
|
18 |
0.90% |
|
|||
|
19 |
0.83% |
|
|||
|
20 |
0.81% |
|
https://www.slickcharts.com/sp500
Game:
Which stock is not among the top 20 stocks in the S&P 500 as of October
21, 2023?
For class discussion:
·
Based on the above information, what is your
conclusion?
·
When you invest in S&P500, how is the fund allocated?
|
Ticker |
Company
Name |
6/30/2019 |
12/31/2018 |
12/31/2017 |
12/31/2016 |
12/31/2015 |
12/31/2014 |
|
MSFT |
Microsoft
Corp. |
4.20% |
3.73% |
2.89% |
2.51% |
2.48% |
2.10% |
|
AAPL |
Apple
Inc. |
3.54% |
3.38% |
3.81% |
3.21% |
3.28% |
3.55% |
|
AMZN |
Amazon.com
Inc. |
3.20% |
2.93% |
2.05% |
1.54% |
1.45% |
0.65% |
|
FB |
Facebook
Inc. |
1.90% |
1.50% |
1.85% |
1.40% |
1.33% |
0.72% |
|
BRK.B |
Berkshire
Hathaway Inc |
1.69% |
1.89% |
1.67% |
1.61% |
1.38% |
1.51% |
|
JNJ |
Johnson
& Johnson |
1.51% |
1.65% |
1.65% |
1.63% |
1.59% |
1.61% |
|
GOOG |
Alphabet
Inc. Class C |
1.36% |
1.52% |
1.39% |
1.19% |
1.26% |
0.85% |
|
GOOGL |
Alphabet
Inc. Class A |
1.33% |
1.49% |
1.38% |
1.22% |
1.27% |
0.84% |
|
XOM |
Exxon
Mobil Corp. |
1.33% |
1.37% |
1.55% |
1.94% |
1.81% |
2.16% |
|
JPM |
JPMorgan
Chase & Co. |
1.48% |
1.54% |
1.63% |
1.60% |
1.36% |
1.29% |
|
V |
Visa
Inc. |
1.23% |
1.10% |
0.91% |
0.76% |
0.84% |
0.56% |
|
PG |
Procter
& Gamble Co |
1.13% |
1.09% |
1.03% |
1.17% |
1.21% |
1.36% |
|
BAC |
Bank
of America Corp. |
1.05% |
1.07% |
1.26% |
1.16% |
0.98% |
1.04% |
|
VZ |
Verizon
Communications Inc |
0.97% |
1.11% |
0.95% |
1.13% |
1.05% |
1.07% |
|
INTC |
Intel
Corp. |
0.88% |
1.02% |
0.95% |
0.89% |
0.91% |
0.95% |
|
CSCO |
Cisco
Systems Inc |
0.96% |
0.93% |
0.83% |
0.79% |
0.77% |
0.78% |
|
UNH |
UnitedHealth
Group Inc |
0.95% |
1.14% |
0.94% |
0.79% |
0.63% |
0.53% |
|
PFE |
Pfizer
Inc. |
0.98% |
1.20% |
0.95% |
1.02% |
1.11% |
1.08% |
|
CVX |
Chevron
Corp. |
0.97% |
0.99% |
1.04% |
1.15% |
0.95% |
1.17% |
|
T |
AT&T
Inc. |
1.00% |
0.99% |
1.05% |
1.36% |
1.18% |
0.96% |
|
HD |
Home
Depot Inc |
0.94% |
0.92% |
0.97% |
0.85% |
0.94% |
0.76% |
|
MRK |
Merck
& Co Inc |
0.88% |
0.95% |
0.67% |
0.84% |
0.82% |
0.89% |
|
MA |
Mastercard
Inc. |
0.97% |
0.82% |
0.62% |
0.51% |
0.54% |
0.45% |
|
BA |
Boeing
Co. |
0.78% |
0.81% |
0.72% |
0.46% |
0.51% |
0.48% |
|
WFC |
Wells
Fargo & Co |
0.78% |
0.93% |
1.18% |
1.29% |
1.41% |
1.43% |
http://siblisresearch.com/data/weights-sp-500-companies/
Best stocks by one-year performance
|
Ticker |
Company |
Performance
(Year) |
|
NVDA |
NVIDIA
Corp |
256.23% |
|
META |
Meta
Platforms Inc |
138.16% |
|
FICO |
Fair,
Isaac Corp. |
123.51% |
|
LRCX |
Lam
Research Corp. |
103.75% |
|
AVGO |
Broadcom
Inc |
103.63% |
|
GE |
General
Electric Co. |
102.86% |
|
ADBE |
Adobe
Inc |
92.02% |
|
AMAT |
Applied
Materials Inc. |
90.20% |
|
PHM |
PulteGroup
Inc |
88.70% |
Source: Finviz. Data
is current as of Oct. 18, 2023 and is intended for
informational purposes only.
Worst stocks by year-to-date performance in
year 2022
|
Stock Name |
Symbol |
Losses in 2022 |
|
Generac |
(GNRC) |
-71.56% |
|
Match |
(MTCH) |
-68.78% |
|
Align Techology |
(ALGN) |
-67.87% |
|
Tesla |
(TSLA) |
-67.80% |
|
Catalent |
(CTLT) |
-64.84% |
|
Facebook |
(META) |
-64.43% |
|
PayPal |
(PYPL) |
-62.79% |
|
Carnival |
(CCL) |
-60.80% |
|
VF |
(VFC) |
-60.65% |
|
Warner Bros Discovery |
(WBD) |
-60.33% |
|
Stanley Black & Decker |
(SWK) |
-59.08% |
|
Zebra Technologies |
(ZBRA) |
-56.69% |
|
Caesars Entertainment |
(CZR) |
-55.50% |
|
Advanced Micro Devices |
(AMD) |
-55.37% |
|
CarMax |
(KMX) |
-53.17% |
|
Western Digital |
(WDC) |
-52.02% |
|
Expedia |
(EXPE) |
-51.68% |
|
Seagate Technology |
(STX) |
-51.44% |
|
Netflix |
(NFLX) |
-51.31% |
|
EPAM Systems |
(EPAM) |
-51.11% |
|
NVIDIA |
(NVDA) |
-50.94% |
|
Amazon |
(AMZN) |
-49.75% |
|
West Pharmaceutial Services |
(WST) |
-49.41% |
|
Airbnb |
(ABNB) |
-48.27% |
|
Salesforce |
(CRM) |
-48.01% |
https://www.statmuse.com/money/ask/worst+performing+stocks+in+the+s%26p+500+in+2022
HW chapter 5 -1 (Due
with the second mid-term exam)
1. Calculate the monthly
stock return and risk of Apple and SP500 in the past five years. And draw a conclusion
regarding the tradeoff between risk and return (optional for extra credits)
Steps:
From finance.yahoo.com, collect stock prices
of the above firms, in the past five years
Steps:
· Goto finance.yahoo.com, search for the
companies (Apple and S&P500, respectively)
· Click on “Historical prices” in the left
column on the top and choose monthly stock prices.
· Change the starting date and ending date to
“Oct 19th, 2018” and “Oct 19th, 2023”, respectively.
· Download it to Excel
· Delete all inputs, except “adj close” –
this is the closing price adjusted for dividend.
Evaluate the performance of each stock:
· Calculate the monthly stock returns.
· Calculate the average return
· Calculate standard deviation as a proxy for
risk
Please
use the following excel file as reference.
FYI Excel (or template) (From Oct 2018 – Sept 2023)
2.
Calculate the most
recent weight of Apple in SP500. Also calculate the weight of GOOGLE,
Amazon, Netflix.
Hint: please use 35.802 trillion (35,802,000,000,000) as of October 19,
2023
for SP500 market cap. The website for this information is here:
https://www.slickcharts.com/sp500/marketcap
(Hint collect stock price, total shares outstanding. Market value = stock
price * shares outstanding.
Market value of each stock / 35.802 trillion =
weight of the stock in S&P500 index)
What Is
the Weighting of the S&P 500? --- Understanding the Sectors and Market Caps
in the Index
BY TIM LEMKE
REVIEWED
BY DORETHA CLEMON on June 18, 2021
https://www.thebalance.com/what-is-the-sector-weighting-of-the-s-and-p-500-4579847
If
you’ve ever dipped so much as a toe into investing, you’ve probably heard
about the Standard & Poor’s 500 Index.
The S&P 500 is the most
common index used to track the performance of the U.S. stock market.
It is based on the stock prices of 500
of the largest companies that trade on the New York Stock Exchange or the
NASDAQ.
The
S&P 500 is often hailed as a representation of the entire U.S. stock
market and American business as a whole, but that is not entirely accurate.
While it does give you exposure to a broad swath of the economy, it is heavily weighted toward specific market
capitalizations, sectors, and industries, which is important to know if you
are seeking to build a diversified equity portfolio.
S&P 500 Market
Capitalizations
By
design, the S&P 500 includes only
large companies. Only the biggest companies with massive market
capitalizations ($9.8 billion or more) are included-think of large firms
such as Apple, Microsoft, Amazon.com, Facebook, and Alphabet, the parent
company of Google. One could argue that the S&P 500 is 100% weighted
toward large-cap firms, though many of the biggest firms would technically be
considered mega-cap.
It's
important for investors to know that while investing in the S&P 500 can
give great returns, they may be missing out on returns from
medium-sized and small companies. Those who are looking for exposure to
smaller firms should consider investments that track the S&P 400, consisting of the top mid-cap companies, or the Russell
2000, which features mostly smaller companies.
Those
who are looking for exposure to smaller firms should consider investments
that track the S&P 400, consisting of the top mid-cap companies, or the
Russell 2000, which features mostly smaller companies.
S&P
500 Sector and Industry Weighting
Any
attempt to diversify your stock portfolio should include some attempt at
diversification according to sector and industry. In fact, some investment
strategies suggest a perfect balance of sectors, because any sector can be
the best-performing group in any given year.
In
recent years, certain sectors and industries have performed better than
others, and that is now reflected in the makeup of the S&P 500. It also
means that many sectors won't be as represented in the index.
As
of December 22, 2020, the breakdown of sectors in the S&P 500
was as follows, according to State Street Advisors (the creator of the SPDR
S&P 500 ETF Trust, an exchange-traded fund that seeks to track the
performance of the S&P 500):
Information technology:
27.60%
Health care: 13.44%
Consumer discretionary:
12.70%
Communication services:
10.79%
Financials: 10.34%
Industrials:
8.47%
Consumer
staples: 6.55%
Utilities:
2.73%
Materials:
2.64%
Real
estate: 2.41%
Energy:
2.33%
As
you can see, the S&P is
heavily weighted toward tech, health care, and consumer discretionary stocks.
Meanwhile, there aren't as many
utilities, real estate companies, or firms involved in producing and selling
raw materials.
This weighting has changed
greatly over the years. Look back 25 years, and you’ll likely see far fewer
tech companies and more emphasis on consumer discretionary and communications
companies. Go back 50 years, and the mix will look even more different.
Why
It Matters
The weighting of the S&P
500 should be important to you, because the index is not always a
representation of the types of companies performing the best in any given
year. For example, while consumer discretionary
may have been the top-performing sector in 2015, it ranked third in 2017 and
seventh in 2019. The communications services sector was last in performance
in 2017 but had ranked second just one year earlier. The financials sector
was dead last in 2007 and 2008, in the midst of the financial crisis, but it
claimed the top spot in 2012 and performed third-best in 2019.4
Predicting which sectors
will perform best in any given year is very difficult, which is why
diversification is key.
How To Supplement the
S&P 500
Investing
in the S&P 500 through a low-cost index fund can provide a very strong
base for most stock portfolios. But to get broad diversification among market
caps and sectors, it may help to expand your reach.
Fortunately, there are
mutual funds and exchange-traded funds (ETFs) that provide exposure to
whatever you may be seeking. An investor who is looking to boost their
portfolio by purchasing small-cap stocks can buy shares of an index fund
designed to mirror the Russell 2000. If you want to invest more in financial
stocks, you can access funds comprising a wide range of banks and financial
services firms.
There are also mutual funds
and ETFs that offer broad exposure to the entire stock market, including all
market caps and sectors. Vanguard’s Total Stock Market ETF and the S&P
Total Stock Market ETF from iShares are two popular examples.
In
class Exercise
1.
What is the primary focus of the S&P 500?
a. Representing the entire U.S. stock market
b. Tracking small-cap companies
c. Focusing on international stocks
Answer:
a
2.
How are companies selected for the S&P 500?
a. Random selection
b. Based on their location
c. Companies with huge market capitalizations
Answer:
c.
Explanation: Only companies with massive market
capitalizations ($9.8 billion or more) are included in the S&P 500.
3.
What's the main drawback of investing in the S&P 500 for those seeking
exposure to smaller firms?
a. Higher fees
b. Lower returns
c. Missing out on returns from medium-sized and
small companies
Answer:
c.
Explanation: Investing in the S&P 500 may mean
missing out on returns from medium-sized and small companies.
4.
Why is sector and industry diversification important in a stock portfolio?
a. It reduces taxes
b. It ensures higher returns
c. Any sector can be the best-performing group in
any given year
Answer:
c.
5.
How has the sector weighting in the S&P 500 changed over the years?
a. It hasn't changed at all
b. It has changed significantly
c. It has become more diversified
Answer:
b.
Explanation: The weighting has changed
significantly over the years.
6.
Why should the weighting of the S&P 500 matter to investors?
c. The index may not always represent the
best-performing companies.
a. It helps them choose individual stocks
b. It indicates the best-performing sector
Answer:
a.
7.
What is the benefit of investing in the S&P 500 through a low-cost index
fund?
a. Guaranteed high returns
b. Diversification among market caps and sectors
c. Tax advantages
Answer:
b
8.
How can investors seeking small-cap exposure achieve it?
a. Purchase shares of an index fund mirroring the
Russell 2000
b. Invest in an S&P 500 ETF
c. Invest in an international fund
Answer:
a.
9.
How does diversification help investors?
a. It guarantees high returns
b. It eliminates all investment risks
c. It reduces risk by spreading investments across
different assets
Answer:
c.
10.
Which ETF provides broad exposure to the entire stock market, including all
market caps and sectors?
a. S&P Total Stock Market ETF
b. Russell 2000 ETF
c. Vanguard's Total Stock Market ETF
Answer:
a. .
How to Calculate
the Weights of Stocks
The weights of your stocks can play a big role
in your investment strategy. Here's how to calculate them.
Calculating the weights of stocks you own can be
useful to your investment strategy. For example, if your investment goal is to
allocate no more than 15% of your portfolio to any single stock, determining
the weights of the stocks in your portfolio can tell you whether or not you
need to make any changes. Here's how to calculate the weights of stocks, what
this information means to you, and an example of how you can use this.
Calculating the
weights of stocks
Basically, to determine the weights of each of your stocks,
you'll need two pieces of information. First, you'll need the cash values of
each of the individual stocks you want to find the weight of.
You'll also need your total portfolio value. If
you want to determine the weights of your stock portfolio, simply add up the
cash value of all of your stock positions. If you want to calculate the
weights of your stocks as a portion of your entire portfolio, take your
entire account's value – including stocks, bonds, cash, and any other
investments.
The calculation is simple enough. Simply divide
each of your stock position's cash value by your total portfolio value, and
then multiply by 100 to convert to a percentage.
What the weights
tell you
These weights tell you how dependent your portfolio's
performance is on each of your individual stocks. For example, your
portfolio's day-to-day fluctuations will depend much more on a stock that
makes up 20% of the total than one that only makes up 5%.
So, when your
heavily weighted stocks do well, your portfolio can go up quickly. For
example, if a stock with a 20% weight in a $50,000 portfolio doubles, it
would mean a $10,000 gain. On the other hand, if a stock only makes up 2% of
your portfolio, your gain would only be $1,000, even though the stock itself
was a home run.
Conversely,
heavily weighted stocks can drag your portfolio down during tough times,
while lower-weighted stocks will have a smaller effect.
Examining your
portfolio: An example
Let's say that you own the following stock investments: $2,000
of Microsoft, $3,000 of Wal-Mart, $2,500 of Wells
Fargo, and $4,000 of Johnson & Johnson. A quick
calculation shows that your total portfolio value is $11,500, and using the
formula mentioned earlier, you can calculate the weights of each of your four
stocks:
|
Stock |
Cash Value |
Weight |
|
Microsoft |
$2,000 |
17.4% |
|
Wal-Mart |
$3,000 |
26.1% |
|
Wells Fargo |
$2,500 |
21.7% |
|
Johnson & Johnson |
$4,000 |
34.8% |
In this example, Johnson & Johnson carries
twice the weight of Microsoft; therefore, a big move in J&J will have double
the effect on your overall portfolio than the same move in Microsoft would.
In class
exercise
1. Why is calculating
the weights of stocks in your portfolio important?
a. It guarantees high returns.
b. It helps you identify potential investment opportunities.
c. It can guide your investment strategy.
Answer: c.
2. What information do you
need to calculate the weights of stocks in your portfolio?
a. The stock market's daily performance.
b. The cash values of individual stocks and your total portfolio
value.
c. The latest financial news.
Answer: b.
3. How do your portfolio's
day-to-day fluctuations relate to the weights of your stocks?
a. Stocks with higher weights have a more significant impact
on your portfolio's fluctuations.
b. Fluctuations are independent of stock weights.
c. Lower-weighted stocks contribute more to fluctuations.
Answer: b.
4. What effect does a stock
with a 20% weight have on a portfolio compared to a stock with a 2% weight?
a. They have the same effect on the portfolio.
b. The 20% stock has a more substantial impact on the
portfolio's performance.
c. The 2% stock has a more substantial impact.
Answer: b.
5. Let's say you own
$5,000 of Apple and $15,000 of Google. If your entire portfolio is worth
$50,000, what is the weight of your Apple investment?
a. 10%
b. 20%
c. 30%
Answer: a.
6. If a stock makes up
40% of your portfolio, what does this indicate about its impact on your
portfolio's performance?
a. It has a negligible impact.
b. It has a moderate impact.
c. It has a significant impact.
Answer: c.
7. Why might lower-weighted
stocks in your portfolio have a smaller effect on its fluctuations?
a. They are more volatile.
b. Their performance is unrelated to the overall market.
c. They represent a smaller portion of your portfolio.
Answer: c.
What Apple’s Stock Split
Means for You
· By STEVEN RUSSOLILLO
WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has now split its stock
four times throughout its history. It previously conducted 2-for-1 splits on
three separate occasions: February 2005, June 2000 and June 1987. According
to some back-of-the-envelop math by S&P’s Howard Silverblatt,
if Apple never split its stock, you’d have eight shares for each original one
prior to the most recent split. So Friday’s $645.57 closing level would
translate to $5164.56 unadjusted for splits.
No Here are five things you need to know
about Apple’s stock split.
WHO DOES THE STOCK SPLIT IMPACT? Investors who
owned Apple shares as of June 2 qualify for the stock split, meaning they get
six additional shares for every share held. So if an investor held one Apple
share, that person would now hold a total of seven shares. Apple also
previously paid a dividend of $3.29, which now translates into a new
quarterly dividend of $0.47 per share.
WHY IS APPLE DOING THIS?
The iPhone and iPad maker says it is trying to attract a
wider audience. “We’re taking this action to make Apple stock more accessible
to a larger number of investors,” Apple CEO Tim Cook said in
April. But the comment also marked an about-face from two years earlier. At
Apple’s shareholder meeting in February 2012, Mr. Cook said he didn’t see the
point of splitting his company’s stock, noting such a move does “nothing” for
shareholders.
WILL APPLE GET ADDED TO THE DOW? It’s unclear
at the moment, although a smaller stock price certainly makes Apple a more
attractive candidate to get added to blue-chip Dow. Apple, the bigge,
your screens aren’t lying to you. Shares of Apple Inc. now trade under $100,
a development that hasn’t happened in years.
Apple’s unorthodox 7-for-1 stock split,
announced at the end of April, has finally arrived. The stock started trading
on a split-adjusted basis Monday morning, and recently rose 1% to $93.14.
In a stock split, a company increases the
number of shares outstanding while lowering the price accordingly. Splits
don’t change anything fundamentally about a company or its valuation, but
they tend to make a company’s stock more attractive to mom-and-pop investors.
Apple shares rallied 23% from late April, when the company announced the
split in conjunction with a strong quarterly report, through Friday.
A poll conducted by our colleagues
at MarketWatch found 50% of respondents said they would buy Apple
shares after the split. Some 31% said they already owned the stock and 19%
said they wouldn’t buy it. The survey received more than 20,000 responses.
st U.S. company by market capitalization,
has never been part of the historic 30-stock index, a factor that many
observers attributed to its high stock price. The Dow is a price-weighted
measure, meaning the bigger the stock price, the larger the sway for a
particular component. That is different from indexes such as the S&P 500,
which are weighted by market caps (each company’s stock price multiplied by
shares outstanding).
WILL APPLE KEEP RALLYING? Since the financial
crisis, companies that have split their stocks have struggled in the short
term and outperformed the broad market over a longer time horizon. Since
2010, 57 companies in the S&P 500 have split their shares. Those stocks
have averaged a 0.2% gain the day they started trading on a split-adjusted
basis, according to New York research firm Strategas Research
Partners. A month later, they have risen just 0.5%. But longer term, the
average gains are more pronounced. Since 2010, these stocks have averaged a
5.4% increase three months after a split and a 28% surge one year
later, Strategas says.
WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has
now split its stock four times throughout its history. It previously
conducted 2-for-1 splits on three separate occasions: February 2005, June
2000 and June 1987. According to some back-of-the-envelop math by S&P’s
Howard Silverblatt, if Apple never split its stock, you’d have eight
shares for each original one prior to the most recent split. So Friday’s
$645.57 closing level would translate to $5164.56 unadjusted for splits.
In class exercise
1. What is the primary reason Apple is conducting a stock split?
a) To attract a wider audience of
investors
b) To increase its market capitalization
c) To boost its dividend payments
Answer:
a
Explanation: Apple's CEO Tim Cook
mentioned that the stock split is aimed at making Apple stock more accessible
to a larger number of investors.
2. In a
7-for-1 stock split, how many additional shares do investors receive for each
share they already hold?
a) 2
b) 6
c) 7
Answer:
c
Explanation: In a 7-for-1 stock split,
investors receive seven additional shares for each share they already hold.
3. Why
did Apple's CEO, Tim Cook, express hesitancy about stock splits in the past?
a) He believed stock splits are beneficial
for shareholders.
b) He thought stock splits did "nothing"
for shareholders.
c) He wanted to lower the stock price.
Answer:
b
Explanation: In 2012, Tim Cook stated that
he didn't see the point of splitting the company's stock, as he believed it
did "nothing" for shareholders.
4. How
have stocks that split their shares performed in the short term (one day and
one month) since 2010, on average?
a) Negative returns both in one day and
one month
b) Positive returns both in one day and
one month
c) Positive returns in one day but
negative returns in one month
Answer:
a
Explanation: On average, stocks that split
their shares have experienced negative returns in both one day and one month.
5. What
type of stock index is the Dow Jones Industrial Average (the Dow)?
a) A market capitalization-weighted index
b) A price-weighted index
c) A sector-weighted index
Answer:
b
Explanation: The Dow is a price-weighted
index, where higher stock prices carry more influence.
6. How
did Apple's stock price change immediately after the stock split
announcement?
a) It increased by 23%
b) It remained unchanged
c) It decreased by 7%
Answer:
a
Explanation: Apple's stock price rallied
23% after the stock split announcement.
7. What
is the new quarterly dividend per share after the stock split for investors who
held Apple shares as of June 2?
a) $3.29
b) $0.47
c) $0.12
Answer:
b
Explanation: The $3.29 dividend per share
translates into a new quarterly dividend of $0.47 per share.
8.
How many times has Apple conducted
2-for-1 stock splits in its history?
a) One time
b) Two times
c) Three times
Answer:
c
Explanation: Apple has conducted 2-for-1
stock splits on three separate occasions in its history.
9.
Which index is commonly weighted by market capitalization?
a) The Dow Jones Industrial Average
b) The S&P 500
c) The NASDAQ Composite
Answer:
b
Explanation: The S&P 500 is commonly
weighted by market capitalization.
10.
What was the closing price of Apple stock on a
split-adjusted basis following the most recent stock split?
a) $645.57
b) $5164.56
c) $93.14
Answer:
c
Explanation: After the 7-for-1 stock
split, Apple's stock traded at $93.14 on a split-adjusted basis.
11.
How many additional shares do investors receive for every share held in a
7-for-1 stock split?
a) 1
b) 6
c) 7
Answer:
c
Explanation: In a 7-for-1 stock split,
investors receive seven additional shares for each share held.
13.
What was the closing price of Apple's stock on Friday before the split?
a) $645.57
b) $5164.56
c) $93.14
Answer:
a
Explanation: The closing price of Apple's
stock on Friday before the split was $645.57.
Chapter 5 Part II – Mutual
Funds and ETF
Want
to improve your personal finances? Start by taking this quiz to get an idea of
your investment risk tolerance – one of the fundamental issues to consider
when planning your investment strategy, either alone or in
consultation with a financial services professional.
Investment Risk Tolerance Test (FYI)
Discussion: Based on your risk tolerant score, which of the follow
shall you choose? Why?
Example: Optimally
diversified portfolio
1.
3. 
Summary on
investment options vs. Risk
Tolerance
· Small-Cap Growth: Small growth investments
often carry higher risk due to their potential for significant price
volatility. These stocks represent smaller, fast-growing companies with less
established track records. Example: Avis
Budget Group Inc. ETF at https://www.morningstar.com/small-growth-etfs
· Large-Cap Growth: Large growth investments
also carry a notable risk, as they are typically shares of larger,
established companies that are expected to grow at an above-average rate.
However, their size and maturity can make them less volatile than small
growth stocks. Example: Apple Inc. ETF
at https://www.morningstar.com/large-growth-etfs
· Small-Cap Value: Small value investments typically have a moderate level of
risk. These stocks represent smaller companies that are undervalued relative
to their fundamental financial metrics. While there is potential for growth,
they may be subject to market fluctuations.
Example: AutoNation, ETF at https://www.morningstar.com/small-value-etfs
· Large-Cap Value: Large value investments often
have a lower risk level. They are shares of well-established, larger
companies that are considered undervalued by market standards. These
investments tend to be less volatile than their growth counterparts. Example: GE, ETF at https://www.morningstar.com/large-value-etfs
· Money Market: Money market investments are among the lowest-risk options.
They typically include short-term, highly liquid, and low-risk securities
like Treasury bills and certificates of deposit (CDs). While they provide safety
and stability, they offer lower returns compared to stocks or bonds.
For class discussion:
1. What is a Value Stock - Value Investing (youtube)
In class exercise
·
What
is the primary goal of value investing?
A. Identifying undervalued
stocks for long-term growth
B. Achieving rapid
short-term gains
C. Speculating on high-risk
assets
Answer:
A.
Explanation: The primary
goal of value investing is to find and invest in undervalued stocks with the
expectation of long-term growth as the market recognizes their true value.
2.
Which
financial concept is associated with the idea that a sum of money received in
the future is worth less than the same amount received today?
A. Inflation
B. Opportunity cost
C. Time value of money
Answer:
C.
Explanation: The time value
of money concept suggests that the value of money decreases over time due to
factors like inflation and the opportunity cost of not having that money
available for investment.
3.
When
comparing companies using the price-to-earnings (P/E) ratio, a lower P/E
ratio typically suggests:
A. A more expensive stock
B. A higher growth potential
C. An attractive investment
opportunity
Answer:
C.
Explanation: A lower P/E ratio
indicates that a company's stock may be undervalued, making it a potential
value investment, as it offers a better value opportunity relative to its
earnings.
4.
What
is the main advantage of investing in value stocks?
A. Higher potential returns
B. Lower risk
C. Guaranteed profits
Answer:
B
Explanation: The primary
advantage of investing in value stocks is that they are perceived to carry
less risk because they are believed to be undervalued, and their prices have
room to grow over time.
5.
According
to Warren Buffett, in the short run, the stock market is like a:
A. Voting machine
B. Slot machine
C. Weighing machine
Answer:
A.
Explanation: Warren
Buffett's quote suggests that in the short run, the stock market reflects the
opinions and emotions of investors (a voting machine), but in the long run,
it reflects the fundamental value of companies (a weighing machine).
6.
What
is a value trap in the context of investing?
A. An undervalued stock with
high growth potential
B. A stock that appears
undervalued but deserves a lower price
C. A stock trading at its
intrinsic value
Answer:
B.
Explanation: A value trap is
a stock that may seem undervalued but, in reality, deserves its lower price
due to fundamental weaknesses, such as poor financial health or unfavorable
prospects.
2. Small Cap Stocks vs Large Cap Stocks - Which are Better
Investments
In class exercise
1.
What
is the general range of market caps for mid-cap companies?
A. $1 billion to $10 billion
B. $5 billion to $30 billion
C. $50 billion to $100
billion
Answer:
B.
Explanation: Mid-cap
companies typically have market caps ranging from $5 billion to $30.
2.
What
conclusion can be drawn from the historical performance of small-cap
companies?
A. Small-cap companies
consistently outperform other categories.
B. Small-cap companies are
too risky to consider.
C. Small-cap companies offer
higher potential returns but come with higher risk.
Answer:
C.
Explanation: Small-cap
companies have the potential for higher returns but also come with higher
risk.
3.
What
is a key factor when considering investments in small-cap companies?
A. Extensive research
B. Diversification
C. Investing in large-cap
companies
Answer:
B.
Explanation: Doing thorough
research is crucial when considering investments in small-cap companies.
4.
How
to build a well-diversified portfolio?
A. Invest exclusively in
small-cap companies.
B. Stick to large-cap
companies for stability.
C. Consider diversifying
with large-cap companies but explore small-cap opportunities for growth.
Answer:
C.
Explanation: A
well-diversified portfolio may include both large-cap companies for stability
and small-cap companies for growth opportunities.
5.
What
financial principle explains the potential of small-cap stocks?
A. Risk-return trade-off
B. Efficient market
hypothesis
C. Random walk theory
Answer:
A.
Explanation: The concept of
higher risk and higher potential return associated with small-cap stocks,
illustrating the risk-return trade-off.
6.
How
is the risk level of small-cap stocks compared to large-cap stocks?
A. Small-cap stocks are less
risky.
B. Small-cap stocks are
equally risky.
C. Small-cap stocks are
riskier.
Answer:
C.
Explanation: Small-cap
stocks are riskier compared to large-cap stocks.
7.
What
is the main takeaway from the video regarding investing in small-cap stocks?
A. Small-cap stocks provide substantial
growth opportunities with added risk.
B. Small-cap stocks
guarantee high returns.
C. Small-cap stocks are
suitable for conservative investors.
Answer:
A.
Explanation: The video's
main takeaway is that small-cap stocks offer significant growth opportunities
but come with added risk, making them suitable for investors seeking higher
potential returns.
8. How Diversification Works (youtube)
In class exercise
1: What is the main idea behind the saying
"Don't put all your eggs in one basket" in investing?
A) It
encourages diversification to reduce risk.
B) It
suggests investing in only one company.
C) It
emphasizes the need to focus on a single investment for higher returns.
Answer: A
Explanation:
The saying "Don't put all your eggs in one basket" advises against
concentrating all your investments in a single position and encourages
diversification to reduce the risk of losing everything if that one
investment falters.
2: What is an example of an idiosyncratic
risk?
A) A
global economic downturn affecting multiple companies.
B) A
company-specific event, like a management mistake or a natural disaster.
C)
Market volatility impacting all stocks equally.
Answer: B
Explanation:
Idiosyncratic risks are specific to a particular company or event, such as a
management error or a natural disaster affecting one company, rather than
affecting the broader market or multiple companies.
3: In terms of diversification, what does
"correlation" refer to?
A) The
similarity in stock prices for different companies in your portfolio.
B) The
number of stocks in a portfolio.
C) The
total value of assets in your investment portfolio.
Answer: A
Explanation:
In the context of diversification, correlation refers to how closely the
stock prices of different companies in your portfolio move together. Lower
correlation indicates that they move somewhat independently.
4: Which investment theory suggests that
investing in uncorrelated assets increases the return per unit of risk taken?
A)
Behavioral Finance Theory.
B)
Efficient Market Hypothesis (EMH).
C)
Modern Portfolio Theory (MPT).
Answer: C
Explanation:
Modern Portfolio Theory suggests that investing in uncorrelated assets (diversification)
increases the return per unit of risk taken, making your portfolio more
risk-efficient.
5: According to the Law of Diminishing
Marginal Benefit, what happens as you add more stocks to your portfolio?
A) The
benefit of diversification increases.
B) The
benefit of diversification decreases.
C) The
benefit of diversification remains constant.
Answer: B
Explanation:
According to the Law of Diminishing Marginal Benefit, as you add more stocks
to your portfolio, the reduction in portfolio volatility (the benefit of
diversification) decreases.
6: Why do active investors often prefer
not to hold too many positions in their portfolios?
A) To
avoid diversification entirely.
B) To
reduce their portfolio risk.
C) To
focus on stocks they understand and can actively manage.
Answer: C
Explanation:
Active investors may prefer not to hold too many positions to allow for
focused analysis and active management of stocks they understand, rather than
diluting their efforts.
7: What type of risk is reduced by
diversification?
A)
Market risk.
B)
Currency risk.
C)
Idiosyncratic risk.
Answer: C
Explanation:
Diversification reduces idiosyncratic risk, which is the risk specific to
individual companies, as it spreads your investments across different
positions.
8: How can you increase diversification in
your portfolio without having to buy a large number of individual stocks?
A) By
actively managing each stock in your portfolio.
B) By
holding cash equivalents only.
C) By
investing in ETFs or mutual funds.
Answer: C
Explanation:
Investing in ETFs or mutual funds allows you to achieve diversification
without having to buy a large number of individual stocks. These funds hold a
diversified portfolio of assets.
Mutual fund vs.
ETF
What is ETF? (Video)
IN CLASS
EXERCISE
1. What is an ETF?
A) An investment vehicle designed to track the price movement of
a specific basket of assets.
B) A type of bond.
C) A savings account at a bank.
Answer: A
Explanation:
An ETF (Exchange-Traded Fund) is an investment vehicle that aims to replicate
the price movements of a specific basket of assets.
2. How are ETFs traded?
A)
Only in foreign stock exchanges.
B)
In a manner similar to individual stocks.
C)
Exclusively through mutual funds.
Answer: B
Explanation:
ETFs are traded on US stock exchanges and can be bought and sold just like
individual stocks.
3. Why might an investor choose to buy shares
of a gold ETF like GLD rather than physical gold?
A)
Physical gold is more affordable.
B)
Physical gold is easier to store.
C)
ETFs provide a cost-effective and less cumbersome way to invest in gold.
Answer: C
Explanation:
ETFs offer a cost-effective and less cumbersome way to invest in assets like
gold compared to purchasing physical gold.
4. How can you invest in the Dow Jones
Industrial Average without buying all 30 companies in the index?
A)
By purchasing a collection of mutual funds.
B)
By directly acquiring shares of all 30 companies.
C)
By buying shares of an ETF that tracks the Dow Jones.
Answer: C
Explanation:
You can invest in the Dow Jones Industrial Average by buying shares of an ETF
that tracks this index, such as DIA.
Mutual Funds vs. ETFs - Which Is Right for You? (Video)
IN CLASS EXERCISE
1: What is a key difference
between mutual funds and ETFs?
A)
Mutual funds are actively managed,
while ETFs are passively managed.
B)
Mutual funds are ideal for self-directed investors.
C)
ETFs set their share price once a day.
Answer: A
Explanation:
This is a crucial distinction; mutual funds are actively managed by fund
managers, while ETFs are passively managed, often tracking specific indices.
2: Which investment option is suitable for
investors who prefer professional management and a less hands-on approach?
A)
ETFs
B)
Stocks
C)
Mutual funds
Answer: C
Explanation:
Mutual funds are actively managed by professionals, making them ideal for
investors who don't want to actively manage their investments.
3: How frequently do ETFs
trade on stock exchanges?
A)
Once a month
B)
Continuously throughout the day
C)
Once a year
Answer: B
Explanation:
ETFs trade like individual stocks, allowing investors to buy and sell them
continuously during market hours.
4:
What is the primary benefit of ETFs
for self-directed investors?
A)
Lower fees
B)
Professional management
C)
Limited control
Answer: A
Explanation:
ETFs often have lower expense ratios compared to actively managed mutual
funds, making them cost-effective for self-directed investors.
5: How can you buy mutual
funds and ETFs?
A)
Only through a broker
B)
Only through a financial advisor
C)
Through a broker, financial advisor, or directly from the fund company
Answer: C
Explanation:
Both mutual funds and ETFs can be purchased through various channels,
including brokers, financial advisors, and directly from the fund company.
6: Which option is commonly
used in 401k retirement plans?
A)
Stocks
B)
ETFs
C)
Mutual funds
Answer: C
Explanation:
Mutual funds are frequently used in 401k retirement plans due to their
professional management and diversified portfolios.
For discussion:
What one of the above funds is
the most favorite one to you? Why?
HW chapter 5 -2 (Due with the second mid-term exam)
1.
Work on this test and report your score. Make a
self-evaluation about yourself in terms of your risk tolerance level. Based on
your risk level, set up a investment strategy! Please provide a rationale.
The website to take the test is the following: https://jufinance.com/risk_tolerance.html
2.
Compare ETF with mutual fund
3. Compare QQQ with SPY?
ETF Battles: QQQ vs. SPY
(youtube)
Summary: QQQ vs. SPY - A Comparative
Analysis
1. Cost: SPY is significantly cheaper than QQQ, with annual expenses less than half
of QQQ.
·
SPY: 0.09% annual expenses
·
QQQ: 0.20% annual expenses
2. Bid-Ask Spreads: Both ETFs have
minimal bid-ask spreads, reducing trading costs.
·
SPY: Narrow bid-ask spreads around 0.01%
·
QQQ: Similar narrow bid-ask spreads
3. Dividends: SPY offers a higher
dividend yield due to diversified exposure to dividend-paying sectors.
·
SPY: 12-month trailing yield of 1.90%
·
QQQ: 12-month trailing yield of 0.77%
4. Diversification: SPY wins in
diversification with broader exposure to various sectors.
·
SPY: 500 stocks across 11 industry groups
·
QQQ: Heavily concentrated in technology (over 63%)
5. Performance (Short-term): QQQ outperforms
SPY in the short term.
·
QQQ: Gained approximately 20% over the past year
·
SPY: Gained around 7% over the same period
6. Performance (Long-term): SPY emerges as
the long-term winner.
·
QQQ outperforms SPY over 1, 10, and 15 years due to tech sector
concentration.
·
SPY outperforms QQQ over 20 years, with a significant lead.
7. Conclusion:
·
SPY is the overall winner, offering lower costs, better
diversification, a higher dividend yield, and superior long-term performance.
In class exercise
1. Why is SPY considered the winner in the "cost"
category?
a) It charges a higher annual expense
ratio than QQQ.
b) It charges a lower annual
expense ratio than QQQ.
c) Both SPY and QQQ have the same expense
ratio.
Answer:
b
Explanation: SPY is considered the winner
in the "cost" category because it has a lower annual expense ratio
compared to QQQ.
2.
Which stock exchange is QQQ listed on?
a) Nasdaq stock exchange
b) New York Stock Exchange
c) London Stock Exchange
Answer:
a
Explanation: QQQ is listed on the Nasdaq
stock exchange.
3. How
does QQQ's diversification compare to SPY's diversification?
a) QQQ is more diversified as it holds 500
stocks.
b) QQQ is less diversified as it holds
only 100 stocks.
c) QQQ and SPY have the same level of
diversification.
Answer:
b
Explanation: QQQ is less diversified than
SPY, as it holds a smaller number of stocks (100) compared to SPY's 500
stocks.
4. Why
does SPY have a higher dividend yield compared to QQQ?
a) SPY invests primarily in technology
companies.
b) SPY charges a higher annual expense
ratio.
c) SPY invests in dividend-rich sectors
like real estate and utilities.
Answer:
c
Explanation: SPY has a higher dividend
yield because it invests in sectors like real estate and utilities that
typically offer higher dividends.
5. What
is the primary reason for SPY's long-term performance advantage over QQQ?
a) SPY has a higher expense ratio.
b) SPY is a Nasdaq-listed ETF.
c) SPY's diversified exposure to various
industry groups.
Answer:
c
Explanation: The main reason for SPY's
long-term performance advantage is its diversified exposure to different
industry groups, whereas QQQ is heavily concentrated in tech.
6.
Which ETF is declared the overall winner in the video?
a) QQQ
b) SPY
c) Both QQQ and SPY are equally winners.
Answer:
b
Explanation: SPY is declared the overall
winner in the text's analysis due to its lower costs, superior
diversification, higher dividend yield, and better long-term performance.
ETF Battles: QQQ Vs. SPY,
Who Wins?
https://seekingalpha.com/instablog/18416022-etfguide/5418872-etf-battles-qqq-vs-spy-who-wins
Mar. 10, 2020
7:38 PM ETInvesco QQQ ETF (QQQ), SPY
This is an
excerpt from the video titled, ETF Battles: QQQ vs. SPY with Ron DeLegge at
ETF guide.
During normal
markets, daily trading volume for QQQ averages around 75 million shares
while SPY averages 173 million shares.
During the
latest market correction, daily volume skyrocketed to record levels with QQQ
topping 149,247,100 shares traded in a single session while SPY booked
385,764,000 shares. (Both trading volume peaks occurred on Feb. 28, 2020)
Cost
The first
category for comparing QQQ vs. SPY is cost. Who wins? SPY charges annual
expenses of just 0.09% compared to 0.20% for QQQ. Put another way, QQQ is
more than double the cost of SPY! While SPY isn't necessarily the cheapest
S&P 500 ETF, compared to QQQ it's a bargain. Bid ask spreads are another
element of an ETF costs. And ETFs with tight bid ask spreads reduce the
frictional trading costs associated with buying and selling funds. In this
regard, QQQ and SPY are evenly matched with both funds having very narrow
bid ask spreads that hover around 0.01%.
Dividends
First, both
funds distribute dividends from their equity holdings every quarter. SPY
has a 12-month trailing yield of 1.90% while QQQ is at 0.77%. Clearly,
SPY wins but there's more behind the reason why. SPY, unlike QQQ, contains
significant exposure to key dividend paying industry sectors like financials,
real estate, and utilities. On the other hand, QQQ is overweight technology
(63.91% of its portfolio is committed to this sector at the time of
publication) and the tech sector is a historically low dividend yielding
industry group. SPY beats QQQ by having a higher dividend. Also the fact
that SPY obtains its dividends across a far more diversified base of 11
industry groups compared to the technology heavy QQQ makes it a winner.
Diversification
Almost 65%
of QQQ's sector exposure is to technology companies, which isn't very
diversified at all and if you blindfolded me and asked me to guess what type
of ETF that QQQ is, I would immediately describe it as an industry sector
fund. In contrast, SPY beats QQQ on diversification because not only does
it have more stocks - 500 - but the stocks it owns are scattered across 11
different industry groups which include technology along with a whole
bunch of other important industry sectors like healthcare, materials, and
industrials.
Performance
Excluding
dividends, QQQ has gained around 20% over the past year while SPY has
gained around 7%. So QQQ wins the short-term performance race.
What about longer time frames? QQQ outperformed SPY over the past 10 and 15
year period too. But if we go back 20 years, SPY wins because it gained
around 197% not including dividends while QQQ gained just 101%. At the end of
the day, QQQ's lights out performance during the past 1, 10, and 15 years is
largely due to its concentrated portfolio in technology. SPY's less
concentrated exposure to tech during this time frame resulted in a lower
return. Nevertheless, over 20 years SPY did manage to outperform QQQ by a not so small 96%. This is a
split decision with QQQ winning the shorter term performance race while SPY
wins the longer-term race.
Final Winner
of ETF Battles
Who wins the
ETF battle between QQQ vs. SPY? The final winner of today's hard fought
battle between QQQ and SPY is...the SPDR S&P 500 ETF (SPY). It's got
lower cost, better diversification, a higher dividend yield, and better
long-term performance.
In class
exercise
1. In the "cost"
category, which ETF is declared the winner?
a)
QQQ
b)
SPY
c)
Both QQQ and SPY have the same cost
Answer: b
Explanation:
SPY is declared the winner in the "cost" category because it has a
lower annual expense ratio compared to QQQ.
2:
What is the significance of bid-ask
spreads in ETF costs?
a)
Bid-ask spreads have no impact on ETF costs.
b)
Wider bid-ask spreads are preferable for traders.
c)
Narrow bid-ask spreads reduce trading costs when buying and selling ETFs.
Answer: c
Explanation:
Narrow bid-ask spreads are beneficial because they reduce the costs
associated with trading ETFs.
3.
How do the dividend yields of SPY and
QQQ compare?
a)
SPY has a higher dividend yield.
b)
QQQ has a higher dividend yield.
c)
Both SPY and QQQ have the same dividend yield.
Answer: a
Explanation:
SPY has a higher dividend yield compared to QQQ.
4. Why does SPY have a higher
dividend yield than QQQ?
a)
SPY has more stocks in its portfolio.
b)
QQQ is diversified across various industry groups.
c)
SPY contains dividend-rich industry sectors.
Answer: c
Explanation:
SPY's higher dividend yield is due to its exposure to dividend-paying sectors
like financials, real estate, and utilities.
5. How does QQQ's
diversification compare to SPY's diversification?
a)
QQQ is more diversified.
b)
QQQ is less diversified.
c)
QQQ and SPY have the same level of diversification.
Answer: b
Explanation:
QQQ is less diversified because it has a higher concentration in the
technology sector.
6. What is the reason behind
QQQ's strong short-term performance?
a)
QQQ has a lower expense ratio.
b)
QQQ has a higher level of diversification.
c)
QQQ has a concentrated portfolio in technology.
Answer: c
Explanation:
QQQ's strong short-term performance is attributed to its concentrated
exposure to the technology sector.
7. Who is declared the
winner in the "long-term performance" category?
a)
SPY
b)
QQQ
c)
Both SPY and QQQ have the same long-term performance.
Answer: a
Explanation:
SPY is declared the winner in the "long-term performance" category
due to its better performance over 20 years.
8.
Why does SPY win the long-term
performance category?
a)
SPY has lower expenses.
b)
SPY's concentrated exposure to technology.
c)
SPY's diversified exposure to various industry groups.
Answer: c
Explanation:
SPY's diversified exposure to multiple industry groups contributes to its
long-term performance.
Here are the 7 biggest investing mistakes you want
to avoid, according to financial experts
Here are the common mistakes
that the average investor makes with their money.
Updated Thu, Apr 7 2022,
Elizabeth Gravier
https://www.cnbc.com/select/biggest-investing-mistakes/
It’s no secret that the
pandemic brought a wave of new investors eager to give a shot at playing the
market.
In fact, a Charles Schwab
study found that 15% of all current U.S.
stock market investors got their start in 2020 — giving rise to what Schwab
calls the “Investor Generation.”
The pandemic prompted the perfect timing to begin investing:
stocks became cheaper to buy as the market dipped, savings account interest
rates got slashed in half and many young consumers were stranded at home with
nothing much else to do.
Plus, now that many brokerage firms now offer accounts with no
minimums and zero-commission trading, just about anyone can start investing,
even with a small amount of money.
To help guide this new
generation of investors, as well as their more experienced counterparts,
Select spoke with a handful of certified financial planners about what to
watch out for.
Here are the seven biggest investing
mistakes they say are the most common.
·
Constantly watching the markets
·
Chasing the trends
·
Following bad advice from social media
·
Not giving your investments time to grow
·
Investing money you’ll soon need
·
Having unclear investing goals
·
Delaying investing altogether
Mistake 1: Constantly watching the markets
Of all the mistakes we heard,
this one came up the most.
“I have told many clients to
turn off their TVs and stop watching the daily market news,” Danielle Harrison,
a Missouri-based CFP at Harrison Financial Planning, tells Select.
While it’s normal (and
generally advised) to keep an eye on what’s happening in the overall economy, it’s easy to get swept up in the
excitement or doom and gloom of it all. The markets are constantly moving and
trying to follow along in real-time can lead you to continuously checking or
changing your investments when you’re better off leaving them alone for the
long haul.
“You’re likely to perform worse
than if you just stuck with your original strategy in the first place,” says
Douglas Boneparth, a New York City-based CFP, president of Bone Fide Wealth
and co-author of The Millennial Money Fix. Viewing negative performance
without context can lead to rash decision making, while positive performance
can instill overconfidence, explains Joe Lum, a California-based CFP and
wealth advisor at Intersect Capital.
Lum agrees that it’s best for investors to avoid tracking their
performance (both good and bad) too frequently. While it’s easier than ever
to get instant information on your portfolio’s progress, it doesn’t mean it’s
necessary.
“If we were running a
marathon, it wouldn’t make sense to track our mileage in quarter-mile
increments,” Lum says. “The same can be said about long-term investing,
particularly in retirement accounts which traditionally have the longest time
horizon.”
Before investing, Boneparth suggests asking yourself, “Can I
hold these positions for a long period of time?”
“Investing should be boring,”
Harrison says. Her advice? Look at your investments on a quarterly basis,
which should be more than enough for most investors.
Mistake 2: Chasing the trends
Whether it be participating in
a frenzy over GameStop stock, which we all saw back in January, or investing
in the newest cryptocurrency, chasing the trends is a common mistake
investors make.
Lauryn Williams, a Texas-based
CFP and founder of Worth Winning, says she
sees investors follow the next hot stock not knowing why they are choosing a
particular investment other than the fact that “someone else says it is
awesome.”
“A lot investors make the
mistake of chasing trends or what’s cool because of FOMO,” Boneparth adds. He
recommends always doing your due diligence before putting your money in the
market. Or, as another option for a more hands-off approach, invest passively in the markets through
index funds and watch your portfolio grow over time. By using your brokerage account to buy diversified mutual and index
funds, you take on less risk than when you buy an individual company’s stock.
The best free stock trading
platforms
Select reviewed over 12 online
brokers that offer zero-commission trading and narrowed down the top six platforms for all sorts of
investors: TD Ameritrade; Ally
Invest; E*TRADE; Vanguard; Charles Schwab; and Fidelity.
These six offer the widest range of investment options,
user-friendly technology, quality customer support and educational resources.
You can read more about our methodology on selecting the best $0 commission
trading platforms below.
Mistake 3: Following bad advice from social media
“I cringe at the
misinformation out there surrounding investing and finances in general,
especially on social media,” Harrison says.
The overall guidance from experts
is simple: Don’t take investment
advice from those who don’t know your personal financial situation. For
example, you may feel pressured by someone on social media to start investing
in a certain company, but they aren’t clued in to what other investment
options you may have. You may be better off putting that money in your
employer-sponsored retirement account, especially if your company matches
contributions up to a certain percentage of your salary.
Make sure to do your own research
when investing and read up on the person giving financial advice on TikTok or
another social-media platform. Whether
you are just starting out or you’re a more seasoned investor, a good place to
begin is with FINRA’s free e-learning program for investors.
Mistake 4: Not giving your investments time to grow
When it comes to investing,
time is important. Ideally, you should hold investments for as long as you
can to maximize your returns. “Investing is something you do with the
expectation of reasonable returns over a long-term period,” Harrison says.
A big mistake Williams sees is investors bailing out on an
investment because they did not double their money in a certain period of
time, which is usually days or weeks.
“If you need your money to grow urgently, you probably don’t
have proper savings,” she says. “Quick growth comes with a lot of risk.” More about this
in Mistake No. 5 below.
Mistake 5: Investing money you’ll soon need
People jumping into the markets before building themselves a
strong financial foundation is the biggest mistake Boneparth sees
investors make.
Prior to investing, you should feel in control of how you spend
your money. A big part of that is building a cash reserve so you don’t need
to rely on your investments when you run into an emergency or want to make a
certain purchase.
“The stock market can be volatile, and you’d hate to lose the
money you were saving for something like a down payment on a home you were
wanting to purchase,” Harrison says.
A good way to know if you’re
ready to invest is understanding if you have a healthy amount of cash in a
savings account set aside for all your near-term goals. Harrison suggests
that money needed within a relatively short time period, such as within three
years, should not be invested in stocks.
Mistake 6: Having unclear investing goals
Once you have a separate
savings net set aside that you can fall back on, make sure you have clear
goals as you go into investing.
Harrison warns that investing
to make more money is rarely the goal. Instead, people should see money as a
tool for meeting their other goals. Making investing all about returns is a
common mistake she sees.
“You don’t have to chase high
returns that also correlate with higher risk, if you can adequately meet your
goals with less risky investments,” Harrison says.
Many investors use the S&P
500 as a benchmark for their investment performance, but Lum points out that
this index is often not a fair comparison against individuals’ actual
portfolios.
“While the S&P 500 serves
as an easy proxy for how ‘the market is doing,’ it is important to remember
that the design of your portfolio and performance should be aligned to meet
your goals — not an index that doesn’t know your financial situation, goals
or time horizon,” Lum says.
Mistake 7: Delaying investing altogether
Lastly, choosing to never invest at all is a costly mistake.
Keeping all your cash in a bank account means that money loses its purchasing
power due to the rising rate of inflation.
“Some people are so scared of
investing that they never even begin and lose out on the amazing compounding
effect that can happen over the long term,” Harrison says.
In class exercise
1.
Which of the following is the most common investing mistake as per the financial
experts in the article?
a) Chasing trends
b) Delaying investing
c) Watching the markets constantly
Answer:
c
Explanation: Constantly watching the
markets is the most common investing mistake mentioned by the experts.
2. What
does Danielle Harrison advise investors to do regarding watching the markets?
a) Review investments on a quarterly basis
b) Check the markets daily
c) Avoid watching the markets completely
Answer:
a
Explanation: Danielle Harrison suggests
that investors should review their investments on a quarterly basis, rather
than watching the markets daily.
3. What is the potential consequence of constantly tracking your investment
performance, according to Joe Lum?
a) Improved decision-making
b) Overconfidence in investments
c) Reduced risk
Answer:
b
Explanation: Joe Lum explains that
constantly tracking investment performance can lead to overconfidence, which
may not be beneficial.
4.
Which mistake involves investing without understanding why a particular
investment was chosen?
a) Constantly watching the markets
b) Chasing the trends
c) Delaying investing
Answer:
b
Explanation: Chasing the trends is the
mistake where investors may follow investments without a clear understanding
of why they're chosen.
5. What
is the downside of following investment advice from social media, according
to the article?
a) Social media advice is highly reliable
b) Social media advice is personalized to
your situation
c) Social media advice may lack context
Answer:
c
Explanation: The article warns that social
media advice may lack context and may not consider an individual's specific
financial situation.
6. What
should be the primary goal when going into investing, according to the
financial experts?
a) Meeting other financial goals
b) Chasing high returns
c) Doubling your money quickly
Answer:
a
Explanation: The experts advise that the
primary goal of investing should be to meet other financial goals, not just
chasing high returns.
7. What
is the downside of delaying investing altogether?
a) It leads to a loss of compounding
returns
b) It ensures the safety of your money
c) It helps beat inflation
Answer:
a
Explanation: Delaying investing may result
in missing out on the compounding effect that can happen over the long term, leading
to a loss of potential returns.
How A Ponzi Scheme Works (youtube)
Summary:
·
Ponzi schemes are illegal and deceptive
activities that cause harm to unsuspecting investors.
·
They depend on a continuous flow of new
investors to pay earlier ones, leading to financial losses for most people
involved.
In
Class Exercise
1. What
is the primary characteristic of a Ponzi scheme?
a) Consistent and legitimate profits
b) Amazing returns that beat the market
c) A pyramid structure of paying earlier
investors with funds from newer investors
Answer:
c
Explanation: The primary characteristic of
a Ponzi scheme is that it operates by using funds from new investors to pay
returns to earlier investors, creating a pyramid-like structure.
2. How
could new investors be attracted to a Ponzi scheme?
a) By investing in the stock market and
generating consistent profits
b) By promising amazing returns that
surpass all other investors in the market
c) By providing financial education and
investment advice
Answer:
b
Explanation: Ponzi schemes typically
attract new investors by promising unusually high and consistent returns on
their investments.
3.
What happens when a Ponzi scheme can no longer attract enough new money to
pay earlier investors?
a) The scheme collapses as earlier
investors cannot be paid
b) The scheme continues to operate with
profits from investments
c) The scheme adapts by finding
alternative sources of income
Answer:
a)
Explanation: When a Ponzi scheme can't
bring in enough new investors' money to pay earlier investors, it collapses
as it can't fulfill its promises.
Part III: Behavior
Finance
Behavior
Finance Introduction PPT
Behavioral Finance |
Investor Irrationality (youtube)
Anchoring https://www.youtube.com/watch?v=eqTLPtPMKLs
•
Test yourself
first:
A stock
price jumps to $40 from $20 but it suddenly dropped back to $20. Shall you
buy the stock or not?
•
The
concept of anchoring draws on the tendency to attach or "anchor"
our thoughts to a reference point - even though it may have no logical
relevance to the decision at hand.
•
Avoiding Anchoring
–
Be
especially careful about which figures you use to evaluate a stock's
potential.
–
Don't
base decisions on benchmarks
–
Evaluate
each company from a variety of perspectives to derive the truest picture of
the investment landscape.
Mental Accounting https://www.youtube.com/watch?v=1cQUlmdQdOs
•
Test
yourself
–
Shall
you payoff your credit card debt or start saving for a vocation?
–
How do you
spend your tax refund?
•
Mental
Accounting refers to the tendency for people to separate their money into
separate accounts based on a variety of subjective criteria, like the source
of the money and intent for each account.
Example: People
have a special "money jar" set aside for a vacation while still
carrying credit card debt.
Confirmation Bias https://www.youtube.com/watch?v=yxDDrEA497E
•
Confirmation
bias: First impression can be hard to shake
–
people
selectively filter information that supports their opinion
–
People
ignore the rest opinions.
–
In
investing, people look for information that supports original idea
•
Generate
faulty decision making because of the bias
Example: investor finds all sorts of green flags about the
investment (such as growing cash flow or a low debt/equity ratio), while
glossing over financially disastrous red flags, such as loss of critical
customers or dwindling markets.
Gambler’s fallacy https://www.youtube.com/watch?v=f_MUjkr0yu4
–
An
individual erroneously believes that the onset of a certain random event is
less likely to happen following an event or a series of events.
Example:
Consider a series of 20 coin flips that have all landed with the
"heads". A person might predict that the next coin flip is more
likely to land with the "tails“.
Slot machines: Every losing pull will
bring them that much closer to the jackpot. But that is wrong. All pulls are
independent.
•
Example:
–
You
liquidate a position after it has gone up in several days.
–
You hold
on to a stock that has fallen in several days because you view further
declines as "improbable".
•
Avoiding
Gambler's Fallacy
–
Investors
should base decisions on fundamental
or technical
analysis before determining what will happen.
It is irrational to buy a stock because you believe it is
likely to reverse.
Herding https://www.youtube.com/watch?v=L8aRm82r8l8
–
Example:
Dotcom herd
–
The
tendency for individuals to mimic the actions of a larger group.
•
Social
pressure of conformity is one of the causes.
–
This is
because most people are very sociable and have a natural desire to be
accepted by a group
•
The
second reason is the common rationale that a large group could not be wrong.
–
This is
especially prevalent when an individual has very little experience.
–
Overconfidence https://www.youtube.com/watch?v=E0X3xxV8upI
•
Confidence
implies realistically trusting in one's abilities
•
Overconfidence
implies an overly optimistic assessment of one's knowledge or control over a
situation.
Disposition
effect (prospect theory) https://www.youtube.com/watch?v=sM91d5I36Po
–
which is
the tendency for investors to hold on to losing stocks for too long and sell
winning stocks too soon.
»
The most
logical course of action would be to hold on to winning stocks to further
gains and to sell losing stocks to prevent escalating losses.
»
investors
are willing to assume a higher level of risk in order to avoid the negative
utility of a prospective loss.
»
Unfortunately,
many of the losing stocks never recover, and the losses incurred continued to
mount .
Avoiding the Disposition Effect
•
When you have a choice of thinking of one large gain or a
number of smaller gains (such as finding $100 versus finding a $50 bill from
two places), thinking of the latter can maximize the amount of positive
utility.
•
When you have a choice of thinking of one large loss or a
number of smaller losses (losing $100 versus losing $50 twice), think of one
large loss would create less negative utility.
•
When you can think of one large gain with a smaller loss
or a situation where you net the two to create a smaller gain ($100 and -$55,
versus +$45), you would receive more positive utility from the smaller gain.
•
When you can think of one large loss with a smaller gain
or a smaller loss (-$100 and +$55, versus -$45), try to separate losses from
gains.
12 Cognitive Biases Explained - How to Think Better and
More Logically Removing Bias (video, FYI)
0:18 Anchoring Bias 1:22 Availability Bias 2:22 Bandwagon Effect 3:09 Choice Supportive Bias 3:50 Confirmation Bias 4:30 Ostrich Bias 5:20 Outcome Bias 6:12 Overconfidence 6:52 Placebo Effect 7:44 Survivorship Bias 8:32 Selective Perception 9:08 Blindspot Bias
Homework: (due with the second mid-term
exam)
· Explain with
examples of the following concepts: gambler’ fallacy, mental accounting,
disposition effect
In
class exercise
1.
What is anchoring in decision making?
A. A tendency to rely on reference points,
even if they are irrelevant.
B. Choosing the most popular option.
C. Trusting your gut feeling.
Answer:
A
Explanation: Anchoring is the tendency to
attach your thoughts to a reference point, even if that reference point has
no logical relevance to the decision at hand.
2. How
can you avoid anchoring in investment decisions?
A. Use any figures to evaluate a stock's
potential.
B. Base decisions solely on benchmarks.
C. Evaluate a company from various
perspectives to get a more accurate picture.
Answer:
C
Explanation: To avoid anchoring, you
should evaluate a company from a variety of perspectives to derive the truest
picture of the investment landscape.
3. What
is mental accounting in personal finance?
A. Separating money into different
accounts based on subjective criteria.
B. Keeping all your money in one account.
C. Spending money impulsively.
Answer:
A
Explanation: Mental accounting is the
practice of separating your money into different accounts based on subjective
criteria, like the source of the money and its intended use.
4.
How can you avoid mental accounting pitfalls?
A. Keep all your money in a single
account.
B. Have a budget, and to watch your
spending more closely
C. Spend money impulsively without a plan.
Answer:
B
Explanation: To
prevent mental accounting errors, it's essential to establish a budget and
closely monitor your expenses. Additionally, having a strategy for managing
unexpected income can prevent squandering it on unnecessary purchases. separate your money into multiple accounts
for different purposes.
5.
What is confirmation bias?
A. A tendency to seek information that
supports your beliefs and ignore opposing views.
B. A neutral assessment of all available
information.
C. A complete disregard for any
information.
Answer:
A
Explanation: Confirmation bias is the
tendency to selectively filter information that supports your existing
beliefs while ignoring opposing views.
6.
How can confirmation bias impact decision making in investing?
A. It leads to unbiased decision making.
B. It generates faulty decision making by
focusing on information that supports existing beliefs.
C. It encourages diversification of
investments.
Answer:
B
Explanation: Confirmation bias can lead to
faulty decision making by focusing on information that supports existing
beliefs, potentially ignoring critical information.
7. What
is the gambler's fallacy?
A. Believing that random events are
independent of each other.
B. Always making bets based on intuition.
C. Believing that future events are
influenced by past events.
Answer:
C
Explanation: The gambler's fallacy is the
belief that future random events are influenced by past events, which is not
necessarily true.
8. How
can you avoid falling for the gambler's fallacy in investing?
A. Make investment decisions based on
intuition.
B. Rely on fundamental or technical
analysis before making decisions.
C. Always believe that past performance
predicts future outcomes.
Answer:
B
Explanation: To avoid the gambler's
fallacy, investors should base their decisions on fundamental or technical
analysis rather than relying on intuition or past performance.
9. What
is herding in the context of decision making?
A. The tendency to make independent
decisions.
B. The tendency to mimic the actions of a
larger group.
C. The avoidance of social pressure.
Answer:
B
Explanation: Herding refers to the
tendency to mimic the actions of a larger group, often due to social pressure
or a belief that a large group cannot be wrong.
10. Why
do individuals often engage in herding behavior?
A. Due to a desire to conform and be
accepted by a group.
B. Because they are naturally independent
thinkers.
C. Because they believe that following a
large group is always profitable.
Answer:
A
Explanation: Individuals often engage in
herding behavior due to a desire to conform and be accepted by a group.
11.
What is overconfidence in decision making?
A. Realistically trusting in one's
abilities.
B. Having an overly optimistic assessment
of one's knowledge or control over a situation.
C. Having no confidence at all.
Answer:
B
Explanation: Overconfidence refers to
having an overly optimistic assessment of one's knowledge or control over a
situation.
12.
What is the disposition effect in investing?
A. The tendency to hold on to losing stocks and sell winning stocks.
B. The tendency to sell winning stocks and
buy losing stocks.
C. A balanced approach to buying and
selling stocks.
Answer:
A
Explanation: The disposition effect is the
tendency to hold on to winning stocks for too long and sell losing stocks too
soon.
13. How
can you avoid the disposition effect in decision making?
A. Focus on one large gain and ignore
smaller gains.
B. Think of losses as one large loss to
minimize negative feelings.
C. To
steer clear of the disposition effect, one effective approach is to establish
investment goals that are in harmony with your financial objectives.
Answer:
C
Chapter 9
Options
Contents:
v Option in general
v Call option
v Put Option
v Impact of Interest rate on Option Pricing
Options Trading For
Beginners - The Basics (youtube)
Brief
Summary:
·
Options trading involves speculating on
the price of an asset through contracts, allowing traders to profit without
owning the asset.
These contracts include an exercise price and a premium.
·
Option buyers have the right but not the
obligation to honor the contract, while option sellers have an obligation.
·
Call options give the right to buy, and
put options give the right to sell.
·
Premiums are determined by intrinsic
value, time value, and implied volatility.
·
Risk management is crucial, as options
trading involves leverage, and traders shouldn't risk more than 2% of their
capital.
In class exercise
1. What is the primary
purpose of options trading?
a)
To guarantee profit
b)
To speculate on the price of an asset
c)
To own the underlying asset
Answer: b
Explanation:
Options trading allows investors to speculate on the price of an asset
without owning it, which is the primary purpose.
2. In options trading, what
is a "call option"?
a)
The right to buy a security at a predetermined price
b)
The right to sell a security at a predetermined price
c)
The right to own the underlying asset
Answer: a
Explanation:
A call option gives the buyer the right to buy a security at a predetermined
price.
3. What kind of option would
a bearish investor use to speculate?
a)
Call option
b)
Bullish option
c)
Put option
Answer: c
Explanation:
A bearish investor would use a put option, which allows them to sell the
security at a predetermined price.
4. What factors determine
the premium of options?
a)
Market capitalization and trading volume
b)
Intrinsic value, time value, and implied volatility
c)
Current and historical stock prices
Answer: b
Explanation:
The premium of options is derived from these factors.
5. Why is risk management
crucial in options trading?
a)
To guarantee profit
b)
To minimize the impact of leverage
c)
To eliminate all risks
Answer: b
Explanation:
Risk management helps control the magnifying effect of potential losses due
to leverage in options trading.
6. In options trading, what
is the "strike price" also known as?
a)
Exercise price
b)
Premium price
c)
Current market price
Answer: a
Explanation:
The strike price is the same as the exercise price in options trading.
7. What do you call options
with a strike price above the current market price?
a)
In-the-money options
b)
Out-of-the-money options
c)
At-the-money options
Answer: b
Explanation:
Options with a strike price above the current market price are considered
out-of-the-money.
8. Which term refers to the
agreed-upon price at which the option buyer can sell the shares?
a)
Premium price
b)
Implied volatility
c)
Strike price
Answer: c
Explanation:
The strike price is the agreed-upon price for selling shares in a put option.
9. What is the suggested
risk management strategy for options traders?
a)
Risk more than 2% of capital in one trade
b)
Use large exposures to maximize gains
c)
Don't risk more than 2% of capital in one trade
Answer: c
Explanation:
The recommended risk
management strategy for options traders is not to risk more than 2% of
capital in a single trade.
The five basic components of option pricing include
the following:
1. Underlying
Asset Price – The price of the underlying stock or index the option
is written on.
2. Asset
Volatility – Amount of uncertainty associated with the asset's
expected return. In general, the higher the volatility, the more expensive
the option will be. For example, if an asset's value is $100 today, and next
month the price is estimated to be either $125 or $75, then the amount of
uncertainty here is very high. Because of this, the option price will be high
as well. After all, the more volatile the security, the greater chance that
it will deliver large returns for the option holder. This uncertainty of
return is one of the main drivers of option prices.
3. Time
to Expiration – The amount of time left before the option expires.
The price of an option decreases as it approaches its expiration date. Why is
this? Well, as the expiration date approaches, the chances of the option
gaining in value become lower and lower because the underlying security has
less time in which to make a major up or down move.
4. Risk-Free
Rate – For a variety of reasons that are beyond the scope of this
report, the rate of return that may be earned without bearing any risk also
comes into play when pricing options. Normally this is assumed to be the rate
of interest earned by U.S. Treasury Bills.
5. Option
Strike Price – This is the price at which the option can be
exercised.
https://www.nasdaq.com/articles/the-5-factors-that-determine-options-prices-2019-11-08
Part II: Call option
In class
exercise
1. How many
shares does an options contract typically represent?
a) 10 shares
b) 50 shares
c)
100 shares
Answer: c
Explanation:
Options contracts typically represent 100 shares.
2. In the video, what is the
significance of an options contract expiring sooner?
a)
It makes the contract more expensive.
b)
It makes the contract cheaper.
c)
It doesn't affect the contract price.
Answer: b
Explanation:
Options contracts with shorter durations are generally cheaper.
3. What is the main risk
associated with options trading?
a)
Risk of losing the entire investment
b)
No risk involved
c)
Guaranteed profits
Answer: a
Explanation:
The video emphasizes that there is a risk of losing the entire investment
with options trading.
4. Which scenario results in
a worthless options contract?
a)
Stock price below the strike price for a call option
b)
Stock price above the strike price for a call option
c)
Stock price at the strike price for a call option
Answer: a
Explanation:
If the stock price is below the strike price for a call option, the contract
is worthless.
5. How can you make a profit
with a call option?
a)
When the stock price is below the strike price
b)
When the stock price is above the strike price
c)
When the stock price is exactly at the strike price
Answer: b
Explanation:
You make a profit with a call option when the stock price is above the strike
price.
6. What are options
contracts for?
a)
1 share
b)
10 shares
c)
100 shares
Answer: c
Explanation:
Options contracts typically represent 100 shares.
7. How does the duration of
an options contract affect its price?
a)
Longer duration makes the contract cheaper
b)
Longer duration makes the contract more expensive
c)
Duration has no effect on the contract price
Answer: b
Explanation:
Options contracts with longer durations are typically more expensive.
8. What is the main way to make
a profit with call options?
a)
When the stock price goes up
b)
When the stock price goes down
c)
When the stock price stays the same
Answer: a
Explanation:
Call options are profitable when the stock price rises.
9. How is the price of an
options contract determined?
a)
It is fixed by the platform
b)
It is based on the number of shares in the contract
c)
It depends on the strike price and other factors
Answer: c
Explanation:
The price of an options contract is influenced by factors like the strike
price.
10. What is one way to
realize a profit with a call option without buying the actual stock?
a)
Exercise the option and buy the stock
b)
Sell the options contract itself
c)
Wait for the contract to expire
Answer: b
Explanation:
You can profit by selling the options contract without purchasing the stock.
Call options: Learn the basics of buying and selling
By James
Royal, 11/1/2021
https://www.bankrate.com/investing/what-are-call-options-learn-basics-buying-selling
Call options are a type of option that increases
in value when a stock rises. They’re the best-known kind of option,
and they allow the owner to lock in a price to buy a specific stock by a
specific date. Call options are appealing because they can appreciate quickly
on a small move up in the stock price. So that makes them a favorite with
traders who are looking for a big gain.
What is a call option?
A call option gives you the right, but not the
requirement, to purchase a stock at a specific price (known as the strike
price) by a specific date, at the option’s expiration. For this
right, the call buyer will pay an amount of money called a premium, which the
call seller will receive. Unlike stocks, which can live in perpetuity, an
option will cease to exist after expiration, ending up either worthless or
with some value.
The following components comprise the major traits
of an option:
Strike price: The price at which you can buy the underlying
stock
Premium: The price of the option, for either buyer or
seller
Expiration: When the option expires and is settled
One option is
called a contract, and each contract represents 100 shares of the underlying
stock. Exchanges
quote options prices in terms of the per-share price, not the total price you
must pay to own the contract. For example, an option may be quoted at $0.75
on the exchange. So to purchase one contract it will cost (100 shares * 1
contract * $0.75), or $75.
How a call option works
Call options
are “in the money” when the stock
price is above the strike price at expiration. The call owner can exercise
the option, putting up cash to buy the stock at the strike price. Or the
owner can simply sell the option at its fair market value to another buyer
before it expires.
A call owner profits when the premium paid is less
than the difference between the stock price and the strike price. For example,
imagine a trader bought a call for $0.50 with a strike price of $20, and the
stock is $23 at expiration. The option is worth $3 (the $23 stock price minus
the $20 strike price) and the trader has made a profit of $2.50 ($3 minus the
cost of $0.50).
If the stock
price is below the strike price at expiration, then the call is “out of the
money” and expires worthless. The call seller keeps any premium received for
the option.
Why buy a call option?
The biggest advantage of buying a call option is
that it magnifies the gains in a stock’s price. For a
relatively small upfront cost, you can enjoy a stock’s gains above the strike
price until the option expires. So if you’re buying a call, you usually
expect the stock to rise before expiration.
Call options vs. put options
The other
major kind of option is called a put
option, and its value increases as the stock price goes down. So traders
can wager on a stock’s decline by buying put options. In this sense, puts act
like the opposite of call options, though they have many similar risks and
rewards:
Like buying a
call option, buying a put option
allows you the opportunity to earn back many times your investment.
Like buying a
call option, the risk of buying a put option is that you could lose all your
investment if the put expires worthless.
Like selling a
call option, selling a put option earns a premium, but then the seller takes
on all the risks if the stock moves in an unfavorable direction.
Unlike selling
a call option, selling a put option exposes you to capped losses (since a
stock cannot fall below $0). Still, you could lose many times more money than
the premium received.
In class exercise
1. In the scenario where a call option is "in
the money" at expiration, what can the call owner do?
a) Choose to
exercise the option
b) Only sell
the option
c) Request a
refund
Answer: a
Explanation: A
call owner can exercise the option by buying the stock at the strike price.
2. What happens if the stock price is below the
strike price at the call option's expiration?
a) The option
is "in the money"
b) The call is
worthless
c) The premium
is refunded
Answer: b
Explanation:
If the stock price is below the strike price, the call option expires
worthless.
3. Why is buying a call option appealing for
traders?
a) It
guarantees a profit
b) It
magnifies gains
c) It reduces
the cost of the stock
Answer: b
Explanation:
Buying a call option allows traders to profit from a stock's price increase
with a relatively small upfront cost.
4. How much does it cost to purchase one options
contract for a call option quoted at $0.75 per share on the exchange?
a) $7.50
b) $0.75
c) $75
Answer: c
Explanation:
To purchase one options contract, you would pay (100 shares * 1 contract *
$0.75 per share), which equals $75.
5. What happens to a call option when the stock
price is above the strike price at expiration?
a) It is
"in the money"
b) It expires
worthless
c) The premium
is refunded
Answer: a
Explanation: A
call option is "in the money" when the stock price is above the
strike price at expiration.
6. What is the profit for the trader who
bought a call option for $0.50 with a strike price of $20, and the stock is
$23 at expiration?
a) $2.50
b) $0.50
c) $3
Answer: a
Explanation: The
profit is calculated as the difference between the stock price ($23) and the
strike price ($20), which is $3, minus the cost of the option ($0.50),
resulting in a profit of $2.50.
7. What is the primary risk of buying a put
option?
a) Losing all
your investment if the put expires worthless
b) Maximizing
your gains
c) Locking in
stock prices
Answer: a
Explanation:
Buying a put option carries the risk of losing the entire investment if the
put expires worthless.
8. How do call options differ from put options?
a) Call
options gain value as stock prices go down
b) Call
options increase in value as stock prices rise
c) Call
options have a capped loss potential
Answer: b
Explanation:
Call options gain value when stock prices increase, while put options gain
value when stock prices decrease.
9. What is the main advantage of selling a put
option?
a) Earning a
premium
b) Exercising
the option
c) Locking in
stock prices
Answer: a
Explanation:
Selling a put option allows the seller to earn a premium.
10. In the context of selling put options, why are
the potential losses capped?
a) Because the
premium received is fixed
b) Because the
seller cannot lose more than the premium
c) Because the
stock price can never go below $0
Answer: b
Explanation:
The potential losses for selling a put option are capped because the seller
cannot lose more than the premium received.
11. Why do options contracts with shorter
durations tend to be cheaper?
a) Shorter
durations guarantee profits
b) Shorter
durations involve less risk
c) Shorter
durations have less time for the stock to move
Answer: c
Explanation:
Options contracts with shorter durations are cheaper because there is less
time for the stock to make significant movements.
Basic
Options Calculator (FYI) - Powered by IVolatility.com
·
https://www.optionseducation.org/toolsoptionquotes/optionscalculator (great tool to calculate
option prices)
· https://www.cboe.com/education/tools/options-calculator/ (CBOE option calculator)
Call and Put price of AAPL on Google
Finance
Call and Put price of AAPL on Nasdaq
https://finance.yahoo.com/quote/AAPL/options?date=1705622400
https://finance.yahoo.com/quote/AAPL240119C00050000?p=AAPL240119C00050000
In class exercise
1. What is the strike price of the Apple
call option mentioned in the above information?
a)
$117.95
b)
$50.00
c)
$128.35
Answer: b
2. What is the current bid price for this Apple call option?
a)
$118.70
b)
$125.60
c)
$128.35
Answer: b
3. What is the current Ask price for this
Apple call option?
a)
$117.95
b)
$118.70
c)
$128.35
Answer: c
4. What is the Open Interest for this
Apple call option?
a) 6
b)
17.55k
c) N/A
Answer: b
5. The "Day's Range" for this
call option indicates:
a) The highest
and lowest prices it traded at today
b) The
price range it can be exercised at
c) The
highest and lowest historical prices for Apple stock
Answer: a
6. If today is November 3, 2023, how many
days are left until the expiration date of this call option?
a) 75
days
b) 77
days
c) 443
days
Answer: a
Explanation:
The expiration date is January 19, 2024, which is 75 days away from November
3, 2023.
7. What is the "Volume" for this
Apple call option?
a) 6
b) 50
c)
117.95
Answer: a
8. The Bid price of $125.60 indicates:
a) The
price a buyer is willing to pay to purchase the option
b) The
price a seller is willing to accept to sell the option
c) The
current market price of Apple stock
Answer: b
9. If the Apple stock price is currently below
the strike price of the call option, the option is considered:
a)
"In the money"
b)
"At the money"
c)
"Out of the money"
Answer: c
10. If an investor holds this Apple call
option with a strike price of $50.00 and the current Apple stock price is $55.00,
what is the intrinsic value of the option?
a)
$5.00
b)
$117.95
c)
$50.00
Answer: a
Explanation:
The intrinsic value of the option when the stock price is $55.00 and the
strike price is $50.00 is $5.00 ($55.00 - $50.00).
11) What does "open interest" in
options trading represent?
a) The
total number of options contracts that have been bought and sold on a
specific day.
b) The
number of options contracts that are still open or not yet exercised, closed,
or expired.
c) The
total number of options available for trading on a specific exchange.
Answer: b
Explanation:
Open interest refers to the number of options contracts that are still
outstanding and have not been exercised, closed, or expired. It reflects the
total number of open positions in the market.
12) What
does "volume" in options trading represent?
a) The
total number of options available for trading on an exchange.
b) The
total number of options contracts that expire on a given date.
c) The
number of options contracts that have changed hands (bought or sold) during a
specific trading day.
Answer: c)
Explanation:
Volume represents the total number of options contracts that have been bought
or sold during a particular trading day. It indicates the level of trading
activity.
13) How is open interest different from volume
in options trading?
a) Open
interest reflects the trading activity during a specific day, while volume
represents the total outstanding contracts.
b) Open
interest represents the number of contracts available for trading, while volume
represents the total positions held by traders.
c) Open
interest is the number of outstanding contracts, while volume measures the
trading activity during a specific day.
Answer: c
Explanation:
Open interest is the total number of options contracts that are still open or
not yet exercised, closed, or expired. Volume, on the other hand, measures
the trading activity during a specific trading day, indicating the number of
contracts that changed hands. Open interest provides information about the
total number of positions held in the market, while volume reflects the day's
trading activity.
o Home
Work
1. What is
call option?
2. What is put
option?
3. Who benefits
from falling stock prices, call option holders or put option holders, and who
benefits from rising stock prices? Explain why.
4. (optional for extra credit) Between call option holders and put option
holders, who will benefit from the rising of interest rate? Who is going to
benefit from the falling of interest rate? Please refer to https://www.investopedia.com/articles/active-trading/051415/how-why-interest-rates-affect-options.asp#:~:text=With%20an%20increase%20in%20interest,negatively%20by%20increasing%20interest%20rates.
Part II: What Is a
Put Option?
Put Options Explained:
Options Trading For Beginners (youtube)
In class exercise:
1. What is the primary
purpose of a put option?
A.
To sell a stock at a predetermined price
B.
To buy a stock at a predetermined price
C.
To profit from a stock's rising price
Answer: A.
Explanation:
A put option gives the holder the right to sell a stock at a specified price,
which is the primary purpose of a put option.
2. How does one profit from
a put option?
A.
By selling the option for a higher premium
B.
By buying the stock and selling it at a higher Strike price
C.
By buying the stock and selling it at a lower Strike price
Answer: B.
Explanation:
Profits are made when the stock's
market price falls, allowing the holder to buy the stock at a lower price and
sell it at the higher strike price.
3. If the stock's price
remains above the strike price, what happens to the put option?
A.
It becomes more valuable
B.
It becomes worthless
C.
The premium increases
Answer: B.
Explanation:
If the stock's price stays above the strike price, there's no incentive to
sell it at a lower price, so the put option becomes worthless.
4. What happens to the value
of a put option with more time until expiration?
A.
It becomes more valuable
B.
It becomes less valuable
C.
Its value remains the same
Answer: A.
Explanation:
Put options with more time until expiration are more valuable because there's
a longer time for the stock's price to potentially fall below the strike
price.
5. Which offer is better in
terms of time to expiration?
A.
Offer to sell within one week
B.
Offer to see within two weeks
C.
Offer to sell within one month
Answer: C
Explanation:
Offer number three, with a longer time frame of one month, is better because
it provides more time for the stock's price to potentially fall.
6. Which strike price is
more valuable in the example?
A.
$35
B.
$40
C.
$45
Answer: C.
Explanation:
In the example, a higher strike price is more valuable because it allows the
holder to sell the stock for a higher price if needed.
7. How many shares are
typically included in one options contract?
A.
10 shares
B.
100 shares
C.
1,000 shares
Answer: B.
Explanation:
Options contracts are typically based on 100-share increments.
8. If you want to buy 10 put
options, how much would it cost you if each option costs $45?
A.
$4.50
B.
$450
C.
$4,500
Answer: B.
Explanation:
To calculate the cost, you multiply the cost of one option by the number of
options (10 x $45 = $450).
9. What is the primary risk
associated with buying a put option?
A.
Losing the entire investment
B.
Missing out on potential gains
C.
Increased taxes
Answer: A.
Explanation:
The risk with buying a put option is that if the stock's price doesn't fall
below the strike price, you lose the premium paid.
10. What is the main
advantage of using a put option for hedging?
A.
It guarantees profits
B.
It allows for unlimited gains
C.
It protects against potential losses
Answer: C
Explanation:
Hedging with put options helps protect investments from potential losses in a
declining market.
11. Which feature of a put
option affects its price and value the most?
A.
The expiration period
B.
The strike price
C.
The number of shares in a contract
Answer: A.
Explanation:
The expiration period has a significant impact on a put option's price and
value, with longer periods generally making the option more expensive.
12. How is the price of a put
option determined in the options market?
A.
It is set by the buyer.
B.
It is set by the exchange.
C.
It is determined by market supply and demand.
Answer: C.
Explanation:
The price of an option is determined by market forces, primarily supply and demand.
13. What is the primary
objective when buying a put option?
A.
To maximize the premium paid
B.
To profit from a stock's price increase
C.
To protect against a stock's price decline
Explanation: The main objective
of buying a put option is to protect against potential losses from a stock's
price decline.**
A put option (or “put”) is a contract giving the
option buyer the right, but not the obligation, to sell—or sell short—a
specified amount of an underlying security at a predetermined price within a
specified time frame. This predetermined price at which the
buyer of the put option can sell the underlying security is called the strike
price.
Put options
are traded on various underlying assets, including stocks, currencies, bonds,
commodities, futures, and indexes. A put option can be contrasted with a call
option, which gives the holder the right to buy the underlying security at a
specified price, either on or before the expiration date of the option contract.
KEY TAKEAWAYS
· Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.
· Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies.
· Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility.
· Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.
· Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.
https://www.investopedia.com/terms/p/putoption.asp
Part
IV: An Example of Factors Affecting Option Prices
How and Why Interest Rates Affect Options
(FYI only)
By
SHOBHIT SETH Updated June 08, 2022, Reviewed by CHARLES POTTERS
Fact
checked by KIRSTEN ROHRS SCHMITT
Interest
rate changes impact the overall economy, stock market, bond market, and other
financial markets and can influence macroeconomic factors. A change in
interest rates also impacts option valuation, which is a complex task with multiple
factors, including the price of the underlying asset, exercise or strike
price, time to expiry, risk-free rate of return (interest rate), volatility,
and dividend yield. Barring the exercise price, all other factors are unknown
variables that can change until the time of an option's expiry.
Which
Interest Rate for Pricing Options?
It is
important to understand the right maturity interest rates to be used in
pricing options. Most option valuation models like Black-Scholes use
annualized interest rates.
It is
important to note that changes in interest rates are infrequent and in small
magnitudes (usually in increments of 0.25%, or 25 basis points only). Other
factors used in determining the option price (like the underlying asset
price, time to expiry, volatility, and dividend yield) change more frequently
and in larger magnitudes, which have a comparatively larger impact on option
prices than changes in interest rates.
KEY
TAKEAWAYS
·
Changes in interest rate directly affect
option pricing, whose calculation is made up of numerous complex factors.
·
For standard option pricing models like
Black-Scholes, the risk-free annualized Treasury interest rate is used.
·
When
interest rates increase, call options benefit while put option prices are
impacted negatively.
Interest Advantage in Call Options
Purchasing
100 shares of a stock trading at $100 will require $10,000, which, assuming a
trader borrows money for trading, will lead to interest payments on this capital.
Purchasing the call option at $12 in a lot of 100 contracts will cost only
$1,200. Yet the profit potential will remain the same as that with a long
stock position.
Effectively,
the differential of $8,800 will result in savings of outgoing interest
payment on this loaned amount. Alternatively, the saved capital of $8,800 can
be kept in an interest-bearing account and will result in interest income—a 5% interest will generate $440 in one year.
Thus,
an increase in interest rates will lead to either saving in outgoing interest
on the loaned amount or an increase in the receipt of interest income on the
savings account. Both will be positive for this call position + savings.
Effectively, a call option’s price increases to reflect this benefit from increased
interest rates.
Interest Disadvantage in Put Options
Theoretically,
shorting a stock with an aim to benefit from a price decline will bring in
cash to the short seller. Buying a put has a similar benefit from price
declines, but comes at a cost as the put option premium is to be paid. This
case has two different scenarios: cash received by shorting a stock can earn
interest for the trader, while cash spent in buying puts is interest payable
(assuming the trader is borrowing money to buy puts).
With an increase in interest rates,
shorting stock becomes more profitable than buying puts, as the former
generates income and the latter does the opposite. Thus, put option prices are impacted negatively by increasing interest rates.
The Rho Greek
Rho is a standard Greek that measures the
impact of a change in interest rates on an option price. It indicates the
amount by which the option price will change for every 1% change in interest
rates. Assume that a call option is currently
priced at $5 and has a rho value of 0.25. If the interest rates increase by
1%, then the call option price will increase by $0.25 (to $5.25) or by the
amount of its rho value. Similarly, the put option price will decrease by the
amount of its rho value.
Since
interest rate changes don’t happen that frequently,
and usually are in increments of 0.25%, rho is not considered a primary Greek
in that it does not have a major impact on option prices compared to other
factors (or Greeks like delta, gamma, vega, or theta).
How a Change in Interest Rates Affects
Call and Put Option Prices?
Taking
the example of a European-style in-the-money (ITM) call option on underlying
trading at $100, with an exercise price of $100, one year to expiry, a
volatility of 25%, and an interest rate of 5%, the call price using
Black-Scholes model comes to $12.3092 and call rho value comes to 0.5035. The
price of a put option with similar parameters comes to $7.4828 and put rho
value is -0.4482 (Case 1).
Rho
Calculation using Black-Scholes Model
Source:
Chicago Board Options Exchange (CBOE)
Now,
let’s increase the interest rate from 5% to 6%,
keeping other parameters the same.
Rho
Calculation using Black-Scholes Model
The
call price has increased to $12.7977 (a change of $0.4885) and put price has
gone down to $7.0610 (change of $-0.4218). The call price and put price has changed
by almost the same amount as the earlier computed call rho (0.5035) and put
rho (-0.4482) values computed earlier. (The fractional difference is due to
BS model calculation methodology, and is negligible.)
In
reality, interest rates usually change only in increments of 0.25%. To take a
realistic example, let’s change the interest rate
from 5% to 5.25% only. The other numbers are the same as in Case 1.
Rho
Calculation using Black-Scholes Model
The
call price has increased to $12.4309 and put price reduced to $7.3753 (a
small change of $0.1217 for call price and of -$0.1075 for put price).
As can be
observed, the changes in both call and put option prices are negligible after
a 0.25% interest rate change.
It is
possible that interest rates may change four times (4 * 0.25% = 1% increase)
in one year, i.e. until the expiry time. Still, the impact of such interest
rate changes may be negligible (only around $0.5 on an ITM call option price
of $12 and ITM put option price of $7). Over the course of the year, other
factors can vary with much higher magnitudes and can significantly impact the
option prices.
Similar
computations for out-of-the-money (OTM) and ITM options yield similar results
with only fractional changes observed in option prices after interest rate
changes.
Arbitrage
Opportunities
Is it
possible to benefit from arbitrage on expected rate changes? Usually, markets
are considered to be efficient and the prices of options contracts are
already assumed to be inclusive of any such expected changes.
Also, a change in interest rates usually
has an inverse impact on stock prices, which has a much larger impact on
option prices. Overall, due to the small proportional change in option price
due to interest rate changes, arbitrage benefits are difficult to capitalize
upon.
The
Bottom Line
Option pricing is a complex process and
continues to evolve, despite popular models like Black-Scholes being used for
decades. Multiple factors impact option valuation, which can lead to very
high variations in option prices over the short term. Call option and put option premiums are impacted inversely as interest
rates change. However, the impact on option prices is fractional; option
pricing is more sensitive to changes in other input parameters, such as
underlying price, volatility, time to expiry, and dividend yield.
In class exercise
1.
Which of the following factors does NOT influence option valuation?
A. strike price
B. Interest rate
C. Market volume
Answer:
C.
Explanation: Market volume is not a factor
influencing option valuation in the article.
2. Which
type of interest rate is typically used in standard option pricing models
like Black-Scholes?
A. Daily interest rate
B. Annualized interest rate
C. Variable interest rate
Answer:
B.
Explanation: Option pricing models like
Black-Scholes typically use annualized interest rates.
3. How
do interest rate changes typically occur in reality?
A. In increments of 1%
B. In increments of 0.25%
C. In increments of 5%
Answer:
B.
Explanation: In reality, interest rates
typically change in increments of 0.25%.
4. What
is the effect of increasing interest rates on call options?
A. It has no effect
B. Call options benefit
C. Call option prices decrease
Answer:
B.
Explanation: Increasing interest rates
lead to cost savings for call options, resulting in benefits.
5. How
does an increase in interest rates affect put option prices?
A. It has no effect
B. Put option prices increase
C. Put option prices decrease
Answer:
C.
Explanation: Increasing interest rates
have a negative impact on put option prices.
6. What
does the Rho Greek measure in options pricing?
A. Stock price fluctuations
B. Impact of interest rate changes
C. Time to option expiration
Answer:
B.
Explanation: Rho measures the impact of
changes in interest rates on option prices.
7. For
every 1% change in interest rates, how much will a call option's price change
if it has a rho value of 0.25?
A. It won't change
B. It will increase by $0.25
C. It will decrease by $0.25
Answer:
B.
Explanation: A call option's price will
increase by the amount of its rho value for a 1% change in interest rates.
8. What
is the primary effect of changes in interest rates on stock prices?
A. Stock prices increase
B. Stock prices remain the same
C. Stock prices decrease
Answer:
C.
Explanation: Changes in interest rates
often have an inverse impact on stock prices, causing them to decrease.
9.
Which type of options have a similar impact as shorting stock when interest
rates increase?
A. Put options
B. Call options
C. None
Answer:
A
Explanation: Put options have a similar
impact to shorting stock when interest rates increase, but at a cost.
Final
Exam
· In class 11/18, from 10am-5pm
· Also available 16-17, from
11am-5pm, contact instructor
· Term project due
Final exam Study Guide (Word
File here, more detailed
Part 1: What is S&P500 index (SPY)?
Investing in the S&P 500 (video)
Part 2: S&P 500 Companies by Weight
Based
on this article: What Is the Weighting
of the S&P 500? --- Understanding the Sectors and Market Caps in the
Index
https://www.thebalance.com/what-is-the-sector-weighting-of-the-s-and-p-500-4579847
Part 3:
Diversification
1. What is a Value Stock -
Value Investing (youtube)
2. Small Cap Stocks vs Large
Cap Stocks - Which are Better Investments
https://www.youtube.com/watch?v=ijcsImmqSZU
3. How
Diversification Works (youtube)
4.
What is ETF?
What is ETF? (Video)
5. Mutual Funds vs. ETFs - Which Is
Right for You? (Video)
6. ETF Battles: QQQ vs. SPY
(youtube)
7. How A Ponzi Scheme Works (youtube)
Part IV: Behavior Finance
1.
Behavioral Finance |
Investor Irrationality (youtube)
2.
Anchoring https://www.youtube.com/watch?v=eqTLPtPMKLs
3.
Mental
Accounting https://www.youtube.com/watch?v=1cQUlmdQdOs
4.
Confirmation
Bias https://www.youtube.com/watch?v=yxDDrEA497E
5.
Gambler’s
fallacy https://www.youtube.com/watch?v=f_MUjkr0yu4
6.
Herding https://www.youtube.com/watch?v=L8aRm82r8l8
7.
Overconfidence https://www.youtube.com/watch?v=E0X3xxV8upI
8.
Disposition effect
(prospect theory) https://www.youtube.com/watch?v=sM91d5I36Po
Part V: Call and Put Options
Call Options Explained: Options Trading For Beginners (youtube)
Put Options Explained:
Options Trading For Beginners (youtube)
Short Answer
Questions (total 10 points)
Sample question 1:
You
purchased a call option for a stock with a strike price of $50. The
current stock price is $55, and you paid a premium of $3 for the call option.
Calculate the profit for the call option.
Answer:
Profit
= (Stock Price - Strike Price) - Premium Paid
Given
the information:
Profit
= ($55 - $50) - $3 = $2
Sample question 2:
You
purchased a put option for a stock with a strike price of $50. The
current stock price is $45, and you paid a premium of $3 for the put
option. Calculate the profit for the put option.
Answer:
Profit
= (Strike Price - Stock Price) - Premium Paid
Given
the information:
Profit
= ($50 - $45) - $3 = $2
Wishing you a joyful Holiday break and looking forward to seeing you in the sPRING!
