Question

3. (a) California Bank holds $375 million in deposits and maintains a reserve ratio of 5%. Show the T-account of the bank

Money Multiplier =

Final Money Supply =

(b) If First Bank has deposits = $500,000, reserves = $100,000, and loans = $400,000. Show the T-account of the bank:

If the Fed requires banks to hold 5% as reserves:
Required Reserves =

Excess Reserves =

Final Money Supply =

(c) If First Bank decides to decrease its reserves to the required amount. Show the new T-Account of the bank.

Final Money Supply =

(d) The banking system has $100 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 40%. Show the T-Account of the banks.

Final Money Supply =

5. Suppose you win the lottery. You have a choice between earning $100,000 fora year for 20 years or an immediate payment of $1,200,000. If the interest rate is 3%:

(a) Which choice would you make?

(b) For what range of interest rates should you take the immediate payment?

Answer 1

Q3 a)

T-ACCOUNT
ASSETS	LIABILITIES
$ 18.75 million	$375 million

Money multiplier = 1/r = 1/0.05 = 20

Final Money Supply = 20*Reserve amount = $375 million

b)

T-ACCOUNT
ASSETS	LIABILITIES
Loans = $400,000	Deposits = $ 500,000
Reserves = $ 100,000

Required Reserves = 0.05*500,000 = $25000

Excess Reserves = $75,000

Final Money Supply = Required Reserves*Money Multiplier = 25000*1/0.05 = $500,000

c)

NEW T-ACCOUNT
ASSETS	LIABILITIES
Loans = $475,000	Deposits = $ 500,000
Reserves = $ 25,000

d ) If reserve requirement is 40%, then it means that

0.4x = $100 billion (x= Total deposits)

x= $100 billion/0.4 = $250 billions

T-ACCOUNT
ASSETS	LIABILITIES
Required Reserves = $100 billion	Deposits = $ 250 billion

Final money Supply = 100*1/0.4 = $250 billion

Q5) a) Consider the two options:

Option 1:

Earn $100,000 for a year for 20 years.

This would give you a total amount = 100,000 + +   +...........+

= (SUM of G.P.)

= $1,532,646.05

Option 2:

Immediate payment of $1,200,000.

Value after 20 years = = $2,167,333.5

Clearly, Option 2 is a better choice.