Question 1

The existence of banks:

Accepted Answer

Banks are able to create money through the process of fractional reserve banking, where they only need to hold a fraction of the deposits they receive as reserves and can lend out the rest. This creates more money in circulation than just the amount of currency in existence, leading to a larger money supply.

Question 2

Suppose the reserve ratio is 20%. If Holly deposits $1,000 of cash in her checking account and her bank lends $600 to Freda, the money supply:

Accepted Answer

When Holly deposits $1,000 of cash in her checking account, her bank now has an additional $1,000 in reserves. The reserve ratio is 20%, which means that the bank is required to hold $200 (20% of $1,000) in reserves and can lend out the rest. In this case, the bank lends $600 to Freda, which increases the money supply by $600. Therefore, the correct answer is D: increases by $600.

Question 3

Which of the following would be the IMMEDIATE effect if an individual made a $9,000 cash deposit in a bank?

Accepted Answer

The immediate effect of a cash deposit is an increase in bank reserves, which do not directly affect the money supply. However, if the bank lends out the deposit, it can lead to an increase in the money supply through the creation of new loans.

Question 4

Capital requirements for banks serve all of the following purposes EXCEPT:

Accepted Answer

Capital requirements are not intended to reduce deposits. Instead, they are designed to ensure that a bank has a sufficient cushion of equity capital to absorb unexpected losses, reduce the likelihood of bank failure, and enhance stability in the financial system.

Question 5

Suppose a bank does NOT hold excess reserves and the reserve ratio is 20%. If Molly deposits $1,000 of cash in her checking account and the bank lends $600 to Freda, the bank can lend an additional:

Accepted Answer

If Molly deposits $1,000 cash, the bank must hold $200 in reserves (20% reserve ratio). The bank then lends out $600 to Freda, reducing its reserves by $600 to $400. Since the reserve ratio is 20%, the bank can lend out an additional 20% of the $400 in excess reserves, which is $80. Therefore, the bank can lend an additional $80, bringing the total amount of loans to $600+$80=$680. So, the bank can lend an additional $80.

Question 6

Suppose that initially a bank has excess reserves of $800 and the reserve ratio is 20%. Then Andy deposits $1,000 of cash in his checking account and the bank lends $600 to Molly. That bank can lend an additional:

Accepted Answer

The answer of Suppose that initially a bank has excess...

Question 7

The guarantee by the FDIC to reimburse bank customers up to $250,000 per deposit in the event of bank problems is called:

Accepted Answer

The description provided matches the definition of deposit insurance, which is a guarantee by the FDIC to reimburse bank customers up to $250,000 per deposit in the event of bank problems. Fractional reserve banking refers to a banking system where only a fraction of deposits are kept on reserve, while reserve requirements and discount rates are tools used by the Federal Reserve to regulate the money supply.

Question 8

Suppose a bank has excess reserves of $50 and the reserve ratio is 20%. If Andy deposits $5,000 of cash in his checking account and the bank lends $2,500 to Molly, the money supply:

Accepted Answer

When Andy deposits $5,000, the bank's excess reserves increase to $5,050 ($50 + $5,000 x 20%). When the bank lends $2,500 to Molly, its excess reserves decrease to $2,550 ($5,050 - $2,500). The money supply is increased by the amount of the loan, which is $2,500. Therefore, the total increase in the money supply is $2,500.

Question 9

A major problem with bank runs is that they:

Accepted Answer

Bank runs can cause fear and panic among depositors of other banks, leading them to withdraw their funds as well. This can result in a domino effect that can destabilize the entire banking system.

Question 10

All of the following are examples of bank regulations designed to prevent bank runs EXCEPT:

Accepted Answer

The federal funds rate is a monetary policy tool used by the Federal Reserve to regulate the money supply, and it is not specifically targeted at preventing bank runs. Reserve requirements, deposit insurance, and capital requirements are all regulatory measures aimed at mitigating the risk of bank runs.

Question 11

Which of the following acts to protect depositors from a bank run by insuring all deposits up to $250,000?

Accepted Answer

The Federal Deposit Insurance Corporation (FDIC) is responsible for insuring all deposits at member banks up to $250,000 in the event of a bank failure or closure. This helps to protect depositors from losing their savings in the event of a bank run or other financial crisis. The Department of Justice, Federal Reserve, and Office of Management and Budget do not have a primary role in insuring bank deposits.

Question 12

Which of the following is NOT one of the main features designed to protect depositors and the economy against bank runs?

Accepted Answer

Interest rate ceilings on checkable deposits are not a feature designed to protect depositors and the economy against bank runs. Instead, they were a policy implemented in the past to control inflation and promote financial stability. However, they have been largely phased out in modern banking systems. A, B, and C are all main features designed to protect depositors and the economy against bank runs. Deposit insurance ensures that depositors will be reimbursed in the event of a bank failure, capital requirements ensure that banks have enough equity capital to absorb losses, and reserve requirements ensure that banks hold a certain amount of cash in reserve to meet deposit withdrawals.

Question 13

Suppose the reserve ratio is 20%. If Sam deposits $500 in his checking account, his bank can increase loans by:

Accepted Answer

The bank must keep 20% of the deposit as reserves, which is $100. The remaining $400 can be loaned out.

Question 14

If a bank has assets of $100 million, according to practice, its liabilities should NOT exceed:

Accepted Answer

According to the banking practice, a bank must maintain a certain proportion between its assets and liabilities, known as the Capital Adequacy Ratio (CAR). The CAR is the ratio of a bank's capital to its risk-weighted assets. In general, the minimum CAR required by regulatory authorities is 8%. Therefore, the bank's total liabilities should not exceed 92% of its assets, which is $92 million. Thus, the maximum liabilities of the bank should not exceed $93 million (i.e., 92% of $100 million).

Question 15

Banks create money when they:

Accepted Answer

Banks create money by making loans. When a bank makes a loan, it adds the loan amount to the borrower's account, creating new money in the process. This money can now be spent by the borrower, effectively increasing the money supply in the economy.

Question 16

Probably the most important feature of deposit insurance is that it:

Accepted Answer

Deposit insurance protects the economy against bank runs by providing confidence to depositors that their deposits are safe even if the bank fails. This prevents a situation where many depositors try to withdraw their money at the same time, which can cause a bank to fail and have a domino effect on other banks. It is not paid for by the federal government (it is funded by premiums paid by member banks) and it does not ensure banks will always make a profit.

Question 17

The government has almost eliminated the possibility of bank runs by instituting protective measures. All of the following are such measures EXCEPT:

Accepted Answer

Loan guarantees are not directly related to protecting against bank runs. Capital requirements force banks to hold a minimum amount of capital to cover potential losses, reserve requirements mandate that banks hold a certain amount of deposits in reserve to meet withdrawals, and deposit insurance provides insurance for customers' deposits in case of bank failure.

Question 18

A bank run occurs when:

Accepted Answer

A bank run occurs when many bank depositors are trying to withdraw their funds from the bank, typically due to fears about the bank's solvency or the safety of their deposits. This can create a self-fulfilling prophecy, as the bank may not have enough cash on hand to meet all of the withdrawal requests, causing more depositors to panic and withdraw their funds, leading to a potential collapse of the bank.

Question 19

Suppose that initially a bank has excess reserves of $800 and the reserve ratio is 30%. Then Andy deposits $1,000 of cash in his checking account and the bank lends $600 to Molly. That bank can lend an additional:

Accepted Answer

Before the deposits and lending transactions, the bank has $800 excess reserves, which means it can potentially lend up to $2,666.67 (excess reserves divided by the reserve ratio of 30%).

After Andy's deposit, the bank's reserves increase by $1,000. The bank now has $1,800 in reserves. This means the bank can lend up to $4,285.71 (reserves of $1,800 divided by the reserve ratio of 30%).

If the bank lends $600 to Molly, the bank's excess reserves will decrease to $600 ($1,800 reserves - $1,200 required reserves). This means the bank can lend up to $2,000 more ($600 Molly's loan + $1,400 new potential loans based on new reserve levels).

Therefore, the bank can lend an additional $900 ($2,000 - $1,100 already lent to Andy and Molly). So the correct answer is C) $900.

Question 20

Suppose your grandma sends you $100 for your birthday and you deposit it in your checking account. The reserve ratio is 10%. Based upon this deposit, the bank's reserves have increased by _____ and the bank's checkable deposits have increased by _____.

Accepted Answer

When you deposit $100 in your checking account, the bank's reserves increase by the full amount of the deposit, which is $100, because this is the amount they now have on hand. Additionally, the bank's checkable deposits also increase by $100, as this is the amount credited to your account.

Quiz 14: Money, Banking, and the Federal Reserve System