F01.V.9.1 MONEY AND BANKING – Assignment 3
Explain the principal-agent as it pertains to equity contracts. Principals are primarily the
stockholders whom own most of the equity in a firm. Agents would be the managers of the
firm who generally do not own a large portion of the firm. Because the agents generally do
not own a great of a portion of the firm the incentives may decrease to maximize
profitability to the stockholders.
Why does the free-rider problem occur in the debt market? In order for the restrictive
covenants to be effective, they must be monitored and enforced! Restrictive covenants can
reduce the risk of moral hazard. If a bondholder knows that other bondholders are
monitoring and enforcing the restrictive covenants, they can free ride. Should the other
bondholders follow suit, this will result in not enough resources to motorize and enforce
the restrictive covenants.
Your bank has the following balance sheet: Assets– Reserves $50 million, Securities $50
million, Loans $150 million. Liabilities– Checkable deposits $200 million, Bank capital
$50 million. If the required reserve ratio is 10%, what actions should the bank manager
take if there is an unexpected deposit outflow of $50 million? After the deposit outflow,
the bank will have a reserve shortfall of $15 million dollars. As a Bank manager you do
have the option to borrow from the Federal Funds market or sell off the $15 million dollars