Principles of Finance 6e Chapter 4
Besley/Brigham
4-1
CHAPTER 4
ANSWERS
4-1 Financial intermediaries are business organizations that receive funds in one form and repackage
4-2 Intermediaries create a variety of financial instruments for lower costs than individuals can. Without
4-3 It would be difficult for firms to raise capital. Thus, capital investment would slow down,
4-4 a. S&Ls would be better off with a “normal” yield curve. In this situation their liabilities (deposits),
which are short-term, would have a lower cost than the returns being generated by their assets
(mortgages), which are long-term. Thus they would have a positive “spread.”
4-5 The financial intermediaries described in the text include:
(1) Commercial banks, which originally were established to service businesses, or commerce.
These types of institutions traditionally handled the checking function and loaned funds to
businesses.
4-6 The primary change that is evident from the deregulation of the financial services industry is that the
differences that previously existed among the various financial institutions are disappearing. Now
commercial banks offer mortgage loans while thrift institutions offer commercial loans. In addition,
Chapter 4 Principles of Finance 6e
4-2
4-7 Even with recent deregulation, the banking industry in the United States is very heavily regulated.
U.S. banks are prohibited from many activities that banks in other countries are not, such as owning
4-8 In a fractional reserve system, banks do not have to maintain cash equal to 100 percent of deposits.
4-9 The open market operations of the Federal Reserve are carried out by buying and selling
4-10 If the Fed increases (tightens) the reserve requirement, the money supply will decrease, everything
else equal. For example, if there were currently $100 trillion in total deposits that are subject to a 10
───────────────────────────────────────────────────────
SOLUTIONS
4-1 a. Required reserves = Deposits x Reserve requirement
($240 billion – $100 billion) = $2 trillion x Reserve requirement
money supply (deposits) Reserve requirement 0.07
4-2 Increase in deposits = $90 billion
Principles of Finance 6e Chapter 4
Besley/Brigham
4-3
Reserve requirement = 8%
Excess reserves
Maximum change in the =
money supply (deposits) Reserve requirement
$90 billion × (1 – 0.08) $82.8 billion
= = = $1,035 billion
0.08 0.08
Total deposits will increase by $1.125 trillion, which equals the $90 billion Fed increase plus
$1.035 trillion creation of additional deposits through elimination/use of excess reserves.
4-3 Increase in deposits = $120 billion
a. If the reserve requirement is 5%,
Excess reserves
Maximum change
in deposits Reserve requirement
$120 billion (1 0.05) $114 billion
= = $2,280 billion
0.05 0.05
=
−
=
Total Δ in deposits = $120 billion + $2,280 billion = $2,400 billion
b. If the reserve requirement is 10%,
Total Δ in deposits = $120 billion + $1,080 billion = $1,200 billion
c. If the reserve requirement is 50%,
billion 120$ =
500.
billion 60$
=
050.
)50.01( billion 20$1
deposits in change Maximum −
=
4-4
4-4 Decrease in deposits = $120 billion
a. If the reserve requirement is 5%,
b. If the reserve requirement is 10%,
billion 080,1$ =
100.
billion 08$1
=
010.
)10.01( billion 20$1
deposits in change Maximum −
−
−−
=
4-5 Desired decrease in money supply = $188 billion
Reserve requirement = 6%
Assuming there are no excess reserves, the amount by which required reserves must be decreased
is
Principles of Finance 6e Chapter 4
Besley/Brigham
4-5
Maximum change Change in required reserves
= Reserve requirement
in money supply
Required reserves (1 – 0.06)
$188 billion = 0.06
$188 billion (0.06)
Require reserves =
(1 – 0.06)

= $12 billion
4-6 Required reserves:
Transaction deposits = $340 million x 0.15 = $51.0 million
4-7 a. Excess reserves of $3 billion will be loaned to create additional deposits:
Maximum change in the Excess reserves
= Reserve requirement
money supply (deposits)
$3 billion
= = $20 billion
0.15
b. Excess reserves = $1.2 billion, thus $1.8 billion = $3 billion – $1.2 billion reserves will be loaned
to create additional deposits:
billion $12 =
0.15
billion $1.8
=
(deposits)supply money the in change Maximum
c. If either some or all the excess reserves are decreased because banks lend these funds, the
4-8 Total reserves = $1.63 trillion
Required reserves = $130 billion
a. The total reserves in the banking system result from transaction deposits only, because there is
no reserve requirement on nontransaction deposits. Therefore, we know the following:
Chapter 4 Principles of Finance 6e
Besley/Brigham
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-protected website for classroom use.
4-6
Required reserves = Deposits x Reserve requirement
$130 billion = Transaction deposits x 0.10
$130 billion
Transaction deposits = = $1.3 trillion
0.10
b. Total deposits = Transaction deposits + Nontransaction deposits
= $1.3 trillion + $2.0 trillion = $3.3 trillion
c. Current excess reserves = $1.5 trillion; thus, if these amounts were eliminated via lending,
the change in deposits would be:
Reserve requirement 0.10
money supply (deposits)
d.
Required reserve on = $2 trillion 0.02 = $40 billion
nontransaction deposits
4-9 Transaction deposits = $900 billion
Reserve requirement = 10%
Reserve requirement 0.08 0.08
deposits = = = =
b. The $225 billion increase in deposits represents a 25.0 percent change:
New Old
Percent increase
Deposits Deposits Deposits $225 billion
−
c. If the reserve requirement were increased to 12 percent, then the new required reserves would
be $900 billion x 0.12 = $108 billion. Therefore, the change in deposits would be
Change in $90 billion $108 billion $18 billion
= = = $150 billion
deposits 0.12 0.12
−−
−
Principles of Finance 6e Chapter 4
Besley/Brigham
4-7
4-10 Integrative Problem
a. A financial intermediary is an organization that facilitates the indirect transfer of funds from
b. The primary role of financial intermediaries is to provide a means by which the funds of surplus
units are made available to deficit units—that is, financial intermediaries help match the funds
made available by savers with the needs of borrowers. Financial intermediaries help lower the
c. Commercial banks are the traditional “department stores” of finance because they offer a
variety of products and services to a variety of customers. Even though their customers
traditionally have been businesses, commercial banks offer checking and savings instruments
and loans to both businesses and individuals. Credit unions are owned by the depositors, who
d. The banking system in the United States is characterized by a large number (thousands) of
independent banks that are relatively small in comparison to banking systems in other
Chapter 4 Principles of Finance 6e
Besley/Brigham
4-8
e. The banking systems in other countries are characterized by significantly fewer independent
banks than exist in the United States. Most other countries have fewer than 100 independent
f. The U.S. banking system has experienced significant deregulation during the past couple of
decades. Much of the deregulation has been aimed toward “evening the playing field” for U.S.
g. Ms. Delatorre should view financial intermediaries as specialists that can provide her with
ETHICAL DILEMMA
Anything For (a) Buc?
Ethical dilemma:
Mr. Charles, the CEO of the Bank of Universal City (BUC), is concerned that the company’s growth this
year will be below what is needed to achieve growth projections during the next five years. Mr. Charles
believes that Univest, the investment management division of BUC, can increase its sales so that the
entire organization can meet the projected growth for the year and keep the firm on track to meet its
future growth expectations. To help, Mr. Charles has given the VP of Univest, who is your boss, some
“leads” to contact for possible new accounts. One of the most promising leads is a religious organization
with a shady reputation—Righteous Freedom Choice (RFC). It has been rumored that RFC is involved,
either directly or indirectly, in unsavory activities, including sponsoring terrorism in other parts of the
world, and the funds it receives come from organizations involved in similar illicit activities. Although the
rumors are just that—rumors—there are indications that they might be true. A colleague of yours
provided you with much of this information, which was relayed to her by a couple of prominent
businesspersons. The validity of the information is questionable, however, because the persons who
provided the information are not on friendly terms with the head of RFC, Mr. Radcliff. Should BUC
pursue RFC as a potential customer? It appears that RFC will be moving its funds to a new investment
management firms soon. Even if the rumors prove to be correct, is there a problem with BUC managing
RFC’s money?
Principles of Finance 6e Chapter 4
Besley/Brigham
4-9
Discussion questions:
• What is the ethical dilemma?
In this case, it appears that the ethical dilemma is whether it is appropriate to do business with
• Should BUC try to attract RFC’s business?
If RFC is involved in unethical activities and BUC gets its business, other customers might take their
• What decision should BUC make?
Ask the students what they would do if they were the assistant to the vice president in charge of
Univest. Undoubtedly, students will argue for one of two decisions: (1) Try to attract RFC as a customer,
or (2) stay away from RFC. If the rumors relayed to “you” (the vice president’s assistant) by a colleague
References:
The following articles might be assigned for background material:
Nathan Vardi, “Hezbollah’s Hoard,” Forbes, August 14, 2006, p. 46-47.
Vernon Silver, “Citigroup Did Manage Arafat Funds,” The Wall Street Journal, December 31, 2004, Money
Sense 8.
Chapter 4
10
Farnaz Fassihi, “Where Did Arafat Stash the Money?,” “The Wall Street Journal Online, November 24,
2004. (http://online.wsj.com/)