ECONOMICS Money Multiplication and the Federal Reserve

Directions:
Read through the Background information then answer the questions below.
Background:
Sarah Saver goes to Fancy National Bank and deposits $1,000 that she earned from her summer job. She now has a checking account with a balance of $1,000 from which she can write checks. Fancy National Bank has a 10 percent reserve requirement. The bank will put $100 in its vault and lend out the rest to people who need loans. (10% of $1000 = $100)
If you recall from the lesson, fractional reserve banking is a banking system in which only a fraction of bank deposits are actual cash-on-hand and available for withdrawal; this helps expand the economy by freeing up capital that can be loaned out to other parties.
Ernie Entrepreneur walks into Fancy National Bank wanting to borrow $900 to start his new catering business. If the bankers decide that his project is worthwhile and he meets its criteria for a loan, the bank will loan him the $900. If Ernie puts the $900 in his checking account, he can then write checks for that amount. There is now $1,900 of money available ($1,000 in Sarah’s checking account and $900 in Ernie’s account) to be spent. In other words, $900 of new money has been created.
Questions:
1. (2.5 points) If Ernie next deposits a profit of $500 from the grand opening of his business, the money supply is now this amount:
$1400
2. (2.5 points) Mark Merchant needs to borrow money for his business. The bank has $10,000 in deposits. Remembering the 10 percent reserve requirement, what is the maximum that the bank can loan Mark?
$1000
(continued on next page)
3. (5 points) Now that Mark Merchant has secured a loan for his business, how might he use that loan? Give two examples of how he could use the loan for improving his business and explain how each example will have an effect in the economy.

4. (5 points) Explain the roles and responsibilities of the Federal Reserve System. Answer in at least one complete paragraph.

5. (5 points) Compare and contrast the consequences – intended and unintended – of different monetary policy actions of the Federal Reserve Board to achieve macroeconomic goals of stable prices, low unemployment, and economic growth. What effects can occur with different Federal Reserve actions (such as increasing money supply or raising interest rates)? Answer in at least one complete paragraph.

Two products, qi and vh, emerge from a joint process. product qi has been allocated $34,300 of the total joint costs of $55,000. a total of 2,900 units of product qi are produced from the joint process. product qi can be sold at the split-off point for $11 per unit, or it can be processed further for an additional total cost of $10,900 and then sold for $13 per unit. if product qi is processed further and sold, what would be the financial advantage (disadvantage) for the company compared with sale in its unprocessed form directly after the split-off point?

Sabrina gupta, an investment advisor with a major brokerage firm, was examining wal-mart stores, inc. (wal-mart) stock and its valuation. gupta wondered whether to recommend the stock to any of her new clients or to existing clients who did not currently have wal-mart in their portfolios. her key task was to use an intrinsic value approach to price the shares and to then compare the resulting price with the price at which the stock was traded in the market. gupta wanted to use alternative valuation methods and assumptions to produce intrinsic value estimates for wal-mart stock. she was interested in seeing if the alternative methods would point to a consensus regarding the valuation of the stock and to see if the valuations suggested an investment opportunity given the current market price. methods she contemplated to use were: multi-stage growth modelprice earnings multiplemost valuation methods gupta considered required a common set of inputs: future cash flows to wal-mart investorsgrowth rate of future cash flowsdiscount factor or required rate of return by wal-mart investorsgupta gathered data to determine each of the above. gupta thought that dividends to wal-mart shareholders would adequately capture the cash flows to wal-mart shareholders; she also thought that this approach would simplify her task and she would revisit more complex valuation models if she felt the need. gupta thought that capm would provide her a relatively reliable estimate of the required rate of return. capm based required rate of return can be estimated by using a risk free rate, systematic risk of the firm and equity market risk premium. gupta thought that in a valuation exercise that involve long term cash flows, 10-year government bond yield would be an appropriate risk free rate of return estimate. she checked the 10 year note rate and found out that it was about 3.68%. gupta searched for wal-mart beta in bloomberg. bloomberg estimates betas by regressing the s& p 500 returns on the firm returns over the past two years and arrives at a “raw” beta estimate. bloomberg makes an adjustment in raw beta based on some academic research. gupta is confident that bloomberg adjustment is justified and she uses wal-mart beta estimate of 0.66 in her analysis. while gupta is aware of the importance of emrp assumption, she thinks that bloomberg’s historical estimate of 5.05% is a safe assumption. she is aware of the fact that some studies suggest a larger risk premium of approximately six per cent, while others suggest a much lower forward-looking premium of less than four per cent. she is mindful of the arbitrariness of her assumption, and she takes a note to revisit this issue if her valuations produce unreasonable estimates. anticipated dividend growth (g) is often estimated in a variety of ways. first, observed historical dividend growth can be assumed to continue in a perpetual fashion. second, future dividend growth can be estimated on the basis of recent estimates of analysts. gupta noted that the consensus annual wal-mart dividend for fiscal year 2011 was $1.21, and one respected analyst had estimated the expected constant dividend growth (in perpetuity) at approximately 3%.as the chart suggests, both earnings and dividend growth rates are declining but they seem to be higher than the “respected analyst’s” estimates. gupta decides to use several alternative perpetual growth assumptions to see the impact on price. since gupta decided to use variants of dividend discount model (ddm), she checked the anticipated earnings for 2011. analyst’s estimates suggested $4.10 earnings per share. gupta decided to use 10% growth rate from 2011 to 2012 and assumed a steady decline to 3% in 13 years (until 2024) where the perpetual growth rate of 3% resumes. she also assumed that walmart will increase its dividend payout ratio from 30% to 55% from years 2012 to 2024. you are asked to reproduce gupta’s analysis of multi-stage growth model and double check her valuation by using an earnings multiple. you have all the data you need to conduct the multi stage discounted growth model analysis, but you will need to do some research about the multiples valuation.

In march 2012, the state of california started requiring that all packaging for food and drink with the additive 4-methylimidazole (4-mi) be clearly labeled with a cancer warning. because of this, both pepsi and coke changed their formula to eliminate 4-mi as an ingredient. if pepsi and coke did not change their formula, holding all else constant, what would have happened to the demand for these goods, assuming pepsi and coke were in a competitive market? a. the demand curve for both pepsi and coke would have shifted to the right, causing the price of both products to decrease and the profits for the companies to fall. b. the demand curve for pepsi and coke would have remained unchanged, but the price of both products would have decreased and the profits for the companies would have fallen. c. the demand curve for pepsi and coke would have decreased, but the prices and profits would not have changed. d. the demand curve for only one of them would change because pepsi and coke are substitutes. e. the demand curve for pepsi and coke would have shifted to the left, causing the price of both products to decrease and the profits for both companies to fall.