Introduction to Business
M7 Assignment
Directions: Be sure to save an electronic copy of your answer before submitting it to Ashworth College for grading. Unless otherwise stated, answer in complete sentences, and be sure to use correct English, spelling and grammar. Sources must be cited in APA format. Your response should be four (4) double-spaced pages; refer to the “Assignment Format” page located on the Course Home page for specific format requirements.
Part A: Explain how the Federal Reserve Board, or the Fed, might assist the United States in the event of a recession or depression with examples. You can use the recent 2007 recession as supporting information. Discuss the tools that the Fed uses to adjust money growth. Be sure to integrate the responsibilities or functions of the Fed into your response.
Part B: Perform research on financial service institutions in your geographic area. Describe in detail the financial services that each provides, comparing interest rates, fees, and investment options. Which financial service institution do you think is best and why?
Length/Formatting Instructions
Length 4 pages, double-spaced
Font 12 point, Calibri Font, no more than 1″ margins
Program/File Type Submit in Word
Attachments Should be pasted into the Word document if possible.
Referencing system APA referencing system is necessary in assignments, especially material copied from the Internet.
For examples of correct citations, visit the following links:
http://owl.english.purdue.edu/owl/resource/560/01/
Part A: The Federal Reserve Board (Fed)
The Federal Reserve, or the Fed, has various tools that it can use to assist the country during an economic recession or depression. These tools can be broadly classified into four categories as follows:
- Open Market Operations
The Fed has the power to lower interest rates. It does this by purchasing debt securities in the market in return for new bank credit (Gorton & Metrick, 2013). Having new reserves, banks can lend to each other at a lower Federal funds rate. A decrease in interest rates spreads across the financial system, which means that banks will lend to individuals and businesses at reduced interest rates. Companies can borrow more rather than going out of business or laying off employees. The rate of job losses is suppressed when a recession occurs. If the banks decide to keep the newly injected credit for personal use, interest rates do not go lower across the financial system. The Fed can buy bonds and other assets to pump the banking system with new credit, a method referred to as Quantitative Easing (QE), to increase money in the economy (Christensen & Gillan, 2018). The Fed has used QE since 2008 to pump more money into the US economy.
- Controlling Capital Requirements
The Fed may also regulate financial institutions to ensure that they are not required to maintain capital against potential debt recovery. Historically, it was the duty of the Fed to ensure that banks maintain enough liquid reserves to remain solvent and meet redemption demands. During a recession, the Fed would lower such requirements to provide banks with increased flexibility to maintain low reserves, even though this increased the vulnerability of banks. Currently, the Fed does not mandate that banks hold a certain minimum reserve against liabilities, even though banks still hold large reserves with the Fed. The 2007-2008 financial crisis resulted in the Fed easing its regulations on minimum capital reserves (Bernanke, 2012), making it impossible for it to use this tool to assist banks during a recession.
- Discount Lending
The Fed can also loan funds to banks in need directly using a measure referred to as the discount window. This is an emergency measure of last resort for banks and other financial institutions (Berger et al., 2014). In recent years, the Fed has been discount-lending to banks at lower interest rates to favor the interests of the financial sector. The most recent discount rate, as of March 2020, was a record low of 0.25% to favor risky borrowers.
- Management of Expectations or Forward Guidance
Market expectations play an important role in guiding players in the financial sector. Doubts on whether the Fed will bail out banks or keep asset prices inflated result in pessimism among banks, investors, and companies. Fully aware of this, the Fed will ensure that the expectations of the financial sector are managed to control the behavior of banks and other financial institutions. During a recession, the Fed will seek to reassure the participants in the financial market through actions and announcements that it will cushion them from suffering losses (Gorton & Metrick, 2013).
In conclusion, the Fed reassures financial institutions that it will prevent them from suffering huge losses during a recession using the various methods or tools discussed above. Interest rates are the main link between savers, investors, economic activity, and financial institutions within an economy. Just like any other market, the financial market works under the forces of demand and supply. During an economic recession, the demand for liquidity increases while the supply of credit decreases. This increases the interest rates for loans. The Fed comes in at such a point to use various monetary policies to counteract the normal forces of demand and supply, reducing the interest rates (Gorton & Metrick, 2013). This, in turn, results in increased lending and borrowing, increasing liquidity. This explains why the interest rates in the United States drop during an economic recession.
The Fed has assisted the country during recession using the discount rate, which is the rate at which reserve banks charge commercial banks for loans; the reserve requirements, which are the amounts of deposits that commercial banks must hold in cash or on deposit at the Fed; open market operations, which refers to buying and selling of the US government securities; and through the management of financial market expectations (Bernanke, 2012). Using these methods, the Fed ensures that financial institutions, and the financial market in general, are cushioned against extreme adverse effects as a result of economic recession.
Part B: Financial Service Institutions
A financial service institution is a company that is engaged in the business of handling financial and monetary transactions such as loans, deposits, investments, and the exchange of currency (Cornett & Saunders, 2003). They encompass a wide range of business operations within the financial services industry including trust companies, banks, insurance companies, investment dealers, and brokerage firms. They can vary by scope, size, and geography. They offer various products and services to commercial and individual clients. In my area, there are various types of financial institutions including commercial banks, insurance providers, investment banks, savings and credit associations, and brokerage firms.
Commercial banks are financial institutions that accept deposits, provide checking account services, provide personal and business loans, provide mortgages, and offer basic financial products such as savings accounts and certificates of deposit to individuals and small businesses (Cornett & Saunders, 2003). The average interest rate offered by commercial banks in my locality is 0.07%, while the average bank savings rate is 0.09%. Investment banks are banks that specialize in the provision of services and products designed to facilitate business activities, including equity offerings, capital expenditure financing, and initial public offerings (IPOs). They also provide brokerage services for investors, manage mergers and acquisitions, and act as market makers for trading exchanges. Commercial and investment banks offer the most widely recognized and used financial services in the country.
Insurance companies are the most common non-bank financial service institutions. They provide insurance services to individuals and corporations and are one of the oldest financial services in the world. They protect the assets of corporations and individuals against financial risk, secured through various insurance products (Cornett & Saunders, 2003). Savings and credit associations provide financial services similar to those provided by commercial banks, but for small groups of people and individuals who register as members of the associations. They provide deposits and loans services at interest rates that are slightly more favorable than those offered by commercial banks. The average interest rate offered by savings and credit associations in my locality is 0.05%, while their average savings rate is 0.12%. savings and Credit associations are the best option for individual borrowers since they give loans at a lower interest rate. For companies, commercial banks are a better option since they can provide larger loans and better services.
References
Berger, A. N., Black, L. K., Bouwman, C. H., & Dlugosz, J. (2014). The Federal Reserve’s discount window and TAF programs: “pushing on a string?”. Available at SSRN.
Bernanke, B. S. (2012). The effects of the great recession on central bank doctrine and practice. The BE Journal of Macroeconomics, 12(3).
Christensen, J. H., & Gillan, J. M. (2018, December). Does quantitative easing affect market liquidity?. Federal Reserve Bank of San Francisco.
Cornett, M. M., & Saunders, A. (2003). Financial institutions management: A risk management approach. McGraw-Hill/Irwin.
Gorton, G., & Metrick, A. (2013). The federal reserve and panic prevention: The roles of financial regulation and lender of last resort. Journal of Economic Perspectives, 27(4), 45-64.
