Study Guide Questions for Exam #3

Financial Environment Analysis (Week 6)

Blackboard lectures

Financial Environment Analysis I

1. Country/Firm-specific examples of how various aspects of the financial environment affect

business strategies

a. “For example, we really created a good business in Zimbabwe during the 1990’s. But by

the early 2000’s the government was too unstable, the currency had devalued, and we

couldn’t plan or get resources. So, we walked away from the market. We also pulled out

of some cities in Russia after the ruble devalued in the 1990’s.”

b. U.S. retailers Target-ing avid Canadian shoppers

2. Various types of exposures that firms have to exchange rate fluctuations

a. Car importer expects a batch of cars to arrive from the U.K. in three months. Payment

must be made to the U.K. company in pound sterling when the cars arrive.

b. Exchange rate fluctuations have the potential to turn the importer’s expected profits from

the sales of the cars to losses.

c. For accounting purposes, an Multi-national may need to express its financial statements

in a single currency.

3. Key drivers of changes in the financial environment

a. Determined by: changes in the “real” economy, a country’s monetary policy, and

monetary policies of other countries.

4. Role of central banks in the economy

a. Monetary policy:

i. Formulated and implemented by a central bank. (ours is the Federal Reserve

Board)

ii. Through the banking system

When the U.S. dollar strengthens against other currencies, the foreign sales of U.S. exporting firms is

usually adversely affected. This is an example of operating exposure.

Financial Environment Analysis II

1. How do fractional reserve banking systems work?

a. Assume that there is one bank in the entire economy. Then assume that all transactions

are done through the banking system (consisting of a single bank, no cash transactions)

b. Total amount of currency= 100 U.S.$ (all with one person A)

c. A deposits all the cash in a bank

i. Bank’s assets: 100 $ cash

ii. Bank’s liabilities: Owes a 100$

2. What might happen if participants in the banking system were free to pursue their goals?

a. B comes to the bank to borrow money; bank loans B 100$, which B deposits in his own

account

i. Bank’s assets: $100 cash; B owes bank 100$ (loan)

ii. Bank’s liabilities: Owes a $100 (A ‘s account deposit); Owes B $100 (B’s account

deposit)

iii. “Money supply” in the system is now $200.

iv. As the bank continues making further loans, the money supply keeps increasing.

b. Money supply: defined to be a group of safe assets that households and businesses can

use to make payments or to hold as short-term investments.

https://www.qwivy.com/file/26919011/MKT-397-Final-Study-Guidedocx/

This study resource was

shared via qwivy.com

 1 / 2

2

3. What is the reserve requirement that central banks impose on the other banks in the system?

Why is this imposed?

a. Prevent banks from lending too much of what they take in as deposits

b. A specific mechanism for curbing excessive lending

c. Specify a percentage of deposits (reserves) that banks need to hold either in cash or in

account with the country’s central bank.

4. What is the reserve ratio? How does it impact the banking system?

a. Let reserve percentage (r) be 20 and intial deposit (A) be $100. Maximum possible

money supply: 500$. General formula for maximum: A/r

Suppose a bank gets a deposit of $100. If by law, the maximum amount that the bank can then give out

as a loan is $75, them the reserve ratio is 25%.

Financial Environment Analysis III

1. Fiscal versus monetary policy

a. Fiscal policy: policies relating to spending/taxing by governments (I-S) + (G- Ta + Tr) G:

government spending, Ta: taxes, Tr: transfers

b. Monetary policy: A central bank’s policies relating to the supply of money and credit,

interest and inflation rates.

2. How do central banks typically conduct monetary policy in “normal” time?

a. Primarily by influencing various decisions by participants in the banking/financial system

b. Set a target short-term interest rate

c. Open market operations to achieve targeted interest rate.

d. Major banks need to ensure that reserve requirements are satisfied on a daily basis

e. If there is a shortfall:

i. Borrow from other banks (interbank overnight lending market)

ii. Borrow from the Federal Reserve’s discount window

f. If there is a surplus:

i. Lend to other banks (interbank overnight lending market)

ii. Deposit excess reserves with the Federal Reserve

3. What are the requirements imposed on major banks by the central bank?

4. What is the Federal Funds rate?

a. Interest paid on overnight borrowing in the interbank lending market; determined by

supply/demand imbalances

5. How supply/demand imbalances affect price (in the short run)

a. Price (demanded by a supplier and paid by the purchaser) balances supply with demand

in a competitive market

b. A sudden decrease (increase) in supply, with demand remaining the same, results in the

price going up (down)

c. A sudden increase in demand, with supply remaining the same, results in the price going

up.

6. Open market operations increase or decrease the total amount of reserves in the banking system

a. Sale of certain types of securities to banks

b. Purchase of certain types of securities from banks

How does the U.S. federal Reserve Board typically conduct monetary policy in “normal” times?

A: By targeting short-term interest rates.

Financial Environment Analysis IV

1. Exercise on foreign exchange markets and transactions (see the lecture on Blackboard for

questions and problems)

a. Foreign exchange market

https://www.qwivy.com/file/26919011/MKT-397-Final-Study-Guidedocx/

This study resource was

shared via qwivy.com

Powered by qwivy(www.qwivy.org)

 2 / 2