Question

1.If bank depositors begin to withdraw more currency from banks,

a. The monetary base is unchanged

b. Bank reserves increase

c. The monetary base decreases

d. Bank reserves are unchanged

2.Covenants such as those to discourage undesirable behaviour of borrowers and those which require borrowers to maintain and insure their collateral are intended to help solve the

a. Adverse selection in equity contracts.

b. Moral hazard in debt contracts.

c. Adverse selection in debt contracts.

d. Moral hazard in equity contracts

3.The Bank of Canada will engage in a sale and repurchase agreement when it wants to ________ reserves ________ in the banking system.

a. increase; permanently

b. decrease; temporarily

c. increase; temporarily

d. decrease; permanently

Answer 1

1. If bank depositors begin to withdraw more currency from banks “The monetary base decreases”

When the depositors withdraw the money from bank, the demand deposits falls and reserve ratio also falls. This will reduce the monetary base. The monetary base in a country is the total amount of bank notes and coins. This includes: the total currency circulating in the public, plus the currency that is physically held in the vaults of commercial banks, plus the commercial banks' reserves held in the central bank.

2. Covenants such as those to discourage undesirable behaviour of borrowers and those which require borrowers to maintain and insure their collateral are intended to help solve the “moral hazard in Debt contracts”

Debt covenants are agreements between a company and a creditor stating limits that the company may not breach in case of use of funds or assets management. This help to solve the moral hazard which may happen if borrowers takes undue risk with the money borrowed.

3. The Bank of Canada will engage in a sale and repurchase agreement when it wants to “increase” reserves “Temporarily” in the banking system.

Repo agreements are used to affect the reserves for shorter duration period of time as repo agreements are lend for shorter time. Repo rate is the rate at which the central bank lend loans to the commercial banks on collaterilized basis.