Reference no: EM13375899

1(a). First, explain the concepts of income, wealth and money and show how each is related to the other. Next, explain the concept of the monetary base and indicate its economic significance. Do you think that, for monetary policy purposes, the Bank of Canada (Canada's central bank) should control the monetary base or bank reserves? Explain carefully.

2(b). First, briefly distinguish between a barter economy and a money-based economy, making sure to indicate the role of transaction costs in each system. Then, imagine an economy made up of the people and commodities in the Table 1 below. Each column refers to the commodity listed at the top and each row to the person listed at the left. A positive entry indicates the number of units of the commodity that someone has and is willing to sell. A negative entry indicates the number of units of the commodity that the person wants to buy. Each of these entries refers to either the quantities supplied or demanded given a price of ten dollars per unit of each commodity.  

Table 1: A hypothetical 331 economy

Potatoes   Dance Lessons  Child guidance

Elizabeth, the potato

                   farmer            +2            0                             -2

Anthony, the dance

                   instructor       -2             +2                            0

Hassan, the child

                   psychologist             0             -2                             +2

Notice that all the rows and columns add up to zero. That means we have an equilibrium price system. Each person is able to trade for what is wanted and the quantities demanded and supplied are equal at the given prices.

(i) Assume Melanie has twenty dollars. Construct a set of money-using trades that clears the market.

(ii) Construct a set of barter or indirect barter transactions that clears the market. Hint: Remember that services such as dance lessons or child guidance cannot be passed through an intermediary. Comment on your answer in each case.

2(i). If all depositors tried to convert their deposits into cash at once, they would find that there are not sufficient reserves in the system to permit all of them to do this at the same time. Why then do we not still have panicky runs on the banks? Would it be better for the Bank of Canada and the federal government to impose a 100% reserve requirement? What effect would such a reserve requirement have on the banking system's ability to create deposit money? Would it preclude any possibility of a panic?

2(ii). Explain the practice of "fractional reserves banking" and briefly show how it provides the capacity for banks to create deposit money through debt monetization (i.e., through the process of payments intermediation). Do you think that this is a "good way" to create money? Explain carefully.

3(i). First, list the names of all domestic banks in Canada. Then, distinguish between return on assets (ROA) and return on equity capital (ROE), making sure, in your answer to indicate how they are related and the significance of each.

3(ii).Given the following information on the revenues, expenses, assets and liabilities of a hypothetical Canadian bank for the year 2011, determine (a) the bank's net income after taxes; (b) the bank's return on assets (ROA); (c) the bank's return on equity (ROE); and (d) construct the bank's income statement and its balance sheet for the year, 2011; (e) lastly, calculate the relevant financial ratios associated with the C.A.M.E.L.S. rating system.

Salaries and employee benefits.....$180,000; Interest on deposits.....$270,000; Interest on loans.....$370,000; Interest income from Government of Canada bonds.....$75,000; Interest on non-deposit borrowing.....$60,000; Applicable income taxes.....$70,000; Occupancy costs.....$15,000; Provision for loan losses.....$32,000; Miscellaneous expenses.....$12,000; Interest on municipal securities.....$96,000; Service charges on deposits.....$210,000; Miscellaneous operating revenues.....$230,000; Equity capital.....$150 million; Demand deposits.....$100 million; Savings deposits.....$150 million; Time (term and notice)deposits.....$200 million; Advances from the central bank.....$12 million; Cash reserves.....$20 million; Other assets.....$50 million; Real estate loans.....$160 million; Government of Canada securities.....$25 million; Commercial and industrial loans.....$300 million; Other liabilities.....$38 million; Municipal securities.....$55 million; Loans to individuals.....$40 million.

4(a) From the end of January to the end of December 2010, the Delaney Shoes Company experienced the following changes in its assets and liabilities of interest: the company achieved a saving position of $150,000; it sold $150,000 worth of all of its holdings of Canada savings bonds and purchased $100,000 worth of another company's stocks. It paid back a short term loan of $25,000 and invested a total amount of $450,000 in the purchase of new equipment and renovations at its production facilities both in Montreal and Toronto. It decreased its bank deposits by $50,000 and obtained a long term loan of a certain amount from its bank.

(i) Using the flow-of-funds equation, determine what the company's total financial liabilities must have been during the year, 2010.

(ii) Using the TWO METHODS discussed in class, set up the company's flow-of-funds statements for 2010?

(iii) Determine if the company was a net debtor or net creditor during 2010 and calculate by how much such an amount might have been.

4(b). Consider a hypothetical banking system in which banks produce only demand deposit accounts. The currency deposit ratio (c) is 30% and the customary cash reserve ratio (r) for demand deposits is 10%. The money supply in existence is $1750 million. Using the model discussed in chapter 16 of the textbook, (i) calculate the percentage change in the equilibrium level of the money supply after the central bank decreases the monetary base by $250 million through its sale of Government of Canada treasury bills in the money market;

(ii) Calculate the amount of bank reserves held against demand deposits;

(iii) Calculate the new level of the money supply after the central bank's open market sale of the government securities;

(iv) Calculate the percentage change in the money supply if the cash reserve ratio were instead reduced to 6%. Explain your results and illustrate your answers in both cases with the appropriate diagrams.