Question

(a)     Explain THREE (3) reasons what gives money value even though they are token money.  

(b)   The following balance sheet is for a commercial bank. Assume the required reserve ratio is 4 percent.

Assets   Liabilities and Net Worth
Reserves   $100,00   Checkable Deposits   $300,000
Loans   140,000   Stock shares   200,000
Securities   60,000      
Property   200,000      

(i)     Calculate the required reserves.  
(ii)   Calculate the maximum amount that the money supply can be expanded.  
(iii)    If the reserve ratio rises to 10%, calculate the maximum amount that the money supply can be expanded.

Answer 1

a) Token money is a form of money that represents a greater value than its intrinsic value. The reasons that give money value even though they are token money are as follows:-

i) Token money derives its value from government regulation or law.

ii) Token money that gets its value entirely from its status as a means of payment.

iii) It represents a greater value than its intrinsic value.

b) (i) The bank determined the reserve ratio to be 4% and has deposits of $300,000, it is required to have $12,000 on reserve. ($300,000 x 0.04 = $12,000).

(ii) Money multiplier= 1 / Reserve Ratio = 1/ 0.04 = 25

If we have deposits of $300,000 and reserve ratio of 4%, maximum money supply = ($300,000-$12,000)*25 = $ 7,200,000.

The maximum amount that the money supply can be expanded = $7,200,000-$140,000= $7,060,000.

(iii) If reserve ratio rises to 10%, money multiplier = 1/ Reserve Ratio = 1/0.10= 10 and Reserve Requirement = $300,000*0.10= $30,000.

Maximum money supply = ($300,000-$30,000)*10 = $ 2,700,000.

The maximum amount that the money supply can be expanded = $2,700,000-$140,000= $2,560,000.