Suppose the Federal Reserve sells a $3000 bond, and the reserve ratio maintained by all private banks is 20%. Assume that all loans are fully redeposited (zero “cash drains”) and that all deposits are checkable deposits. Determine the effect of the bond sale on total loans and deposits in the private banks. Explain in detail how these changes would occur. Illustrate the total result of the effects in part (1) using balance sheets for the consolidated private banks and the Federal Reserve, respectively. Discuss how the effects in part (1) would be different if: (i) the reserve ratio was 25% instead of 20%; (ii) a certain portion of loans were held as cash outside banks instead of being redeposited in the banks.
Macrohedging
Hedging or hedge accounting is a risk-mitigation technique used to protect the current financial position from potential losses. Hedging is often confused with speculating. The major difference between the two is that hedging does not involve guessing, whereas speculation is based on guessing the direction of movement of the underlying asset to book profits.
Finance Mathematics
The area of applied mathematics known as mathematical finance, also known as quantitative finance or financial mathematics is concerned with the mathematical modeling of financial markets. The application of mathematical methods to financial problems is known as financial mathematics. A financial market is a place where people can exchange low-cost financial securities and derivatives. Stocks and bonds, raw materials, and precious metals, both of which are regarded as commodities in the stock markets, are examples of securities. It uses probability, statistics, stochastic processes, and economic theory as methods.
Suppose the Federal Reserve sells a $3000 bond, and the reserve ratio maintained by all private banks is 20%. Assume that all loans are fully redeposited (zero “cash drains”) and that all deposits are checkable deposits.
- Determine the effect of the bond sale on total loans and deposits in the private banks. Explain in detail how these changes would occur.
- Illustrate the total result of the effects in part (1) using balance sheets for the consolidated private banks and the Federal Reserve, respectively.
- Discuss how the effects in part (1) would be different if: (i) the reserve ratio was 25% instead of 20%; (ii) a certain portion of loans were held as cash outside banks instead of being redeposited in the banks.
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