Question

1- How is it possible that a firm can announce a record-breaking loss, yet its stock price rises when the announcement is made?

2- Explain how the Fed's uses open market operations and discount lending to affect reserves in the banking system.

Answer 1

1) Stock prices not only move on fundamental but also move on technicals. If a company reports record losses that means its fundamentals are weak; however may be markets were expecting more weakening. Also, it can be possible that markets are expecting improvement in the fundamentals from here on-wards.

2) There are three tools central banks use to influence the economy:

a) Open Market Operations : it is the activity when the bank (Fed) buys or sells securities. These are basically bought from or sold to country's commercial/retail banks. Now when the central bank buys securities, it provides cash to the other bank's reserves which helps them boost lending. On the contrary, when the central bank sells securities, it takes out cash from them and reduces their cash reserves. The central bank buys securities for expansionary monetary policy and sells for contractionary monetary policy. Quantitative easing was one such step.

b) Discount rate: It's the rate that central banks charge its members to borrow from it. Since the rate is high, banks prefer it only when they have urgent requirement and cant borrow from other banks. Normally, it is believed that if a bank is using it to borrow from the central bank, they are in trouble and cant get funds from other banks.

c) Reserve requirement