| accommodative monetary policy | A policy that is aimed at increasing output and raising inflation, usually a lowering of the central bank's interest-rate target.
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| accountability | The idea that central bankers should be held responsible for their policies.
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| adverse selection | The problem of distinguishing a good risk from a bad one before making a loan or providing insurance; it is caused by asymmetric information.
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| aggregate expenditure | The total demand for the economy's production; the sum of consumption, investment, government purchases, and net exports.
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| American option | An option that can be exercised any time up to the expiration date, in contrast to a European option.
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| appreciation of a currency | The increase in the value of a country's currency relative to the value of another country's currency.
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| arbitrage | The practice of simultaneously buying and selling financial instruments to benefit from temporary price differences; eliminates a riskless profit opportunity.
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| asset | Something of value that can be owned; a financial claim or property that serves as a store of value.
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| asset-price channel | The channel of the monetary policy transmission mechanism where changes in policy affect aggregate expenditure through their impact on stock prices and the value of real estate.
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| asset-backed securities | Shares in the returns or payments arising from a specific asset or pool of assets, such as home mortgages or student loans.
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| asymmetric information | The fact that the two parties to a transaction have unequal knowledge about each other. A borrower, for example, has more information about his or her abilities and prospects than a lender.
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| at-the-money option | An option whose strike price equals the current market price for the underlying instrument.
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| automated clearinghouse (ACH) transaction | The most common form of electronic funds transfers.
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| average | See expected value.
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| balance of payments | An accounting system for tracking both the flow of goods and services and the flow of assets across international boundaries.
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| balance sheet | The list of assets and liabilities that shows an individual's or firm's financial position.
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| balance-sheet channel | The channel of the monetary policy transmission mechanism where changes in policy affect aggregate expenditure through their impact on household and firm balance sheets.
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| bank | See depository institution.
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| bank capital | Bank assets minus bank liabilities. The net worth of the bank. The value of the bank to its owners.
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| bank charter | The license authorizing the operation of a bank.
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| bank holding company | A company that owns one or more banks and possibly other nonbank subsidiaries.
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| bank-lending channel | The channel of the monetary policy transmission mechanism in which changes in policy affect aggregate expenditure through their impact on banks' willingness to make loans.
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| bank panic | The simultaneous failure of many banks during a financial crisis.
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| bank run | An event when depositors lose confidence in a bank and make withdrawals, exhausting the bank's reserves.
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| bank supervision | Government oversight of commercial banks; see also supervision.
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| Basel Accord | An agreement requiring internationally active banks to hold capital equal to or greater than a specified share (8% or as agreed by regulators) of their risk-adjusted assets.
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| basis point | One one-hundredth of a percentage point.
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| benchmark | The performance of a group of experienced investment advisors or money managers.
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| benchmark bond | A low-risk bond, usually a U.S. Treasury bond, to which the yield on a risky bond is compared to assess its risk.
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| Big Mac index | The index used to estimate whether currencies are under- or overvalued that is based on the price of the Big Mac in various countries.
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| Board of Governors of the Federal Reserve System | The seven-member board that oversees the Federal Reserve System, including participation in both monetary policy and financial regulatory decisions.
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| bond | A financial instrument that promises a series of future payments on specific dates. Also known as a fixed- income security.
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| bond market | A financial market in which debt instruments with a maturity of more than one year are traded.
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| bond principal value | The final payment made to the holder of a bond; also known as the par value and the face value.
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| Bretton Woods system | The international monetary system in place from 1945 to 1971, in which exchange rates were fixed to the U.S. dollar, and the dollar was convertible into gold at $35 per ounce.
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| brokerage firm | Financial intermediary that provides accounting and custody services, access to secondary markets, liquidity, loans, and advice.
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| British pound | The name of the currency used in the United Kingdom.
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| bubble | A persistent and expanding gap between actual asset prices and those warranted by the fundamentals; usually created by mass enthusiasm.
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| business cycles | The periodic fluctuations in aggregate economic output.
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| call option | A contract that confers the right, but not the obligation, to purchase a financial instrument at a predetermined price on or prior to an agreed upon date.
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| call reports | The detailed financial reports banks are required to file every three months. Officially known as the Consolidated Reports of Conditions and Income.
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| callable bond | A bond that the issuer has the option of repaying before the maturity date.
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| CAMELS | The system used by U.S. bank examiners to summarize their evaluation of a bank's health. The acronym stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk.
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| capital account | The part of the balance of payments accounts that measures the flow of assets among countries; also called the financial account.
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| capital account deficit/surplus | A country's capital inflows minus its capital outflows.
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| capital controls | Government-imposed barriers to investment across international boundaries; restrictions on the ability of foreigners to buy and sell domestic assets.
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| capital gain | The difference between the price that has been paid for an asset and the higher price at which it is sold; contrasts with a capital loss, where the price paid exceeds the price at which the asset is sold.
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| capital inflow controls | Government restrictions that restrict the flow of funds into a country to purchase domestic assets.
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| capital loss | The difference between the price that has been paid for an asset and the lower price at which it is sold; contrasts with capital gain.
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| capital market | See bond market and equity market.
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| capital outflow controls | Government restrictions on the flow of funds out of a country to purchase foreign assets.
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| cash items in process of collection | Checks and transfers due to a bank that have not yet been collected; a bank asset.
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| central bank | The financial institution that manages the government's finances, controls the availability of money and credit in the economy, and serves as the bank to commercial banks.
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| central bank independence | The central bank's freedom from political pressure.
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| central bank's balance sheet | The statement of the assets and liabilities of the central bank.
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| centralized counterparty (CCP) | An entity that interposes itself between the two sides of a transaction, becoming the buyer to every seller and the seller to every buyer.
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| centralized exchange | A financial market in which financial instruments are traded in a single physical location.
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| check | An instruction to the bank to take funds from one account and transfer them to another.
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| clearing corporation | The institution that acts as the counterparty to both sides of all futures market transactions, guaranteeing that the parties to the contract will meet their obligations.
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| collateral | Assets pledged to pay for a loan in the event that the borrower doesn't make the required payments.
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| commercial banks | Financial intermediaries that provide banking services to businesses and households, allowing them to deposit funds safely and borrow them when necessary.
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| commercial paper | Short-term, privately issued zero-coupon debt that is low risk and very liquid and usually has a maturity of less than 270 days.
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| commodity money | Precious metals or other items with intrinsic value that are used as money.
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| common exposure | Exposure of many financial institutions to the same risk factor.
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| common stock | Ownership shares in a firm; also called just stock and equity.
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| compound interest | The interest you get on interest as it accumulates over time.
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| consol or perpetuity | A coupon bond in which the issuer makes regular interest payments forever, never repaying the principal; a coupon bond with infinite time to maturity.
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| consumption | Spending by individuals for items like food, clothing, housing, transportation, entertainment, and education.
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| contagion | When the failure of one bank causes a run on other banks.
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| conventional (monetary) policy tools | The federal funds rate target, the rate for discount window lending, and the deposit rate.
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| counterparty | The person or institution that is on the other side of a financial contract.
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| coupon bond | A bond offering annual coupon payments at regular intervals until the maturity date, at which time the principal is repaid.
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| coupon payment | Yearly payment made to the holder of a coupon bond. Also known as a coupon payment.
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| coupon rate | Annual interest rate equal to the yearly coupon payment divided by the face value of a coupon bond.
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| credibility | The idea that everyone trusts central bankers to do what they say they are going to do.
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| credit card | A promise by a bank to lend the cardholder money in order to make purchases.
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| credit-default swap (CDS) | A credit derivative that makes a payment if a borrower defaults; allows lenders to insure themselves against the risk that a borrower will default.
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| credit easing | An unconventional monetary policy in which the central bank alters the mix of assets on its balance sheet in order to change their relative prices (interest rates) in a way that stimulates economic activity.
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| credit risk | The probability that a borrower will not repay a loan; see also default risk.
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| credit union | A nonprofit depository institution that is owned by people with a common bond, such as members of police associations, union members, university students, and employees.
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| currency | Paper money; for example, dollar bills or euro notes.
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| currency board | A fixed-exchange-rate system in which the central bank commits to holding enough foreign currency assets (often dollars) to back domestic currency liabilities at a fixed rate.
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| currency in the hands of the public | The quantity of dollar bills held by the nonbank public; part of M1.
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| currency-to-deposit ratio | The ratio of publicly held currency to demand deposits held at commercial banks.
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| current account | The part of the balance-of-payments account that measures the flow of currently produced goods and services among countries.
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| current account deficit/surplus | A country's goods and services exports minus its goods and services imports.
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| current output | The level of goods and services currently being produced in an economy.
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| current yield | A bond's yearly coupon payment divided by its current market price.
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| debit card | A card that provides instructions to the bank to transfer funds from the cardholder's account directly to a merchant's account.
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| debt | A loan obligating the borrower to make payments to the lender.
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| debt market | A financial market where bonds, loans, and mortgages are traded.
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| default | Failure to meet an obligation; in the case of a debt, the failure of the borrower to make required payments to the lender.
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| default risk | The probability that a borrower will not repay a loan; see also credit risk.
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| defined-benefit pension plan | A pension plan in which benefi ciaries receive a lifetime retirement income based on the number of years they worked at the company and their final salary.
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| defined-contribution pension plan | A pension plan in which beneficiaries make payments into an account and then receive the accumulation, plus the investment income, on retirement, at which time they must decide what to do with the funds. The options include accepting a lump sum, removing small amounts at a time, or converting the balance to a fixed monthly payment for life by purchasing an annuity.
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| deflation | A sustained fall in the general price level; the opposite of inflation.
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| demand deposits | Standard checking accounts that pay no interest; part of M1.
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| demand for dollars | Dollars demanded in the foreign exchange market as a function of the nominal exchange rate.
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| demand shock | An unexpected change in aggregate expenditure, such as a rise or fall in consumer confidence, that shifts the dynamic aggregate demand curve.
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| deposit expansion multiplier | The formula for the increase in commercial bank deposits following a one-dollar increase in reserves.
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| deposit insurance | The government guarantee that depositors will receive the full value of their accounts (up to a legal limit) should a bank fail.
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| depository institution | A financial institution that accepts deposits and makes loans.
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| deposit rate | The interest rate paid by the Federal Reserve to depository institutions on the balances they hold in their reserve accounts that exceed the amount required by the central bank.
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| depreciation | The decrease in the value of a country's currency relative to the value of another country's currency.
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| derivative | See derivative instrument.
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| derivative instrument | A financial instrument, such as a futures contract or an option, whose value and payoff are “derived from” the behavior of underlying instruments.
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| direct finance | Financing in which borrowers sell securities directly to lenders in the financial markets.
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| discount lending | Lending by the Federal Reserve, usually to commercial banks.
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| discount loans | A loan from the Federal Reserve, usually to a commercial bank.
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| discount rate | The interest rate at which the Federal Reserve makes discount loans to commercial banks.
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| disinflation | The term used to describe declines in inflation.
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| diversification | Splitting wealth among a variety of assets to reduce risk.
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| dividend-discount model | The theory that the fundamental value of a stock equals the present value of expected future dividend payments.
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| dividends | The payments made to a company's stockholders when the company makes a profit.
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| dollarization | One country's formal adoption of the currency of another country for use in all its financial transactions.
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| Dow Jones Industrial Average | The best-known index of stock market performance, it measures the average price of a single share in 30 very large and well-known American companies.
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| dual banking system | The system in the United States in which banks supervised by federal government and state government authorities coexist.
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| dynamic aggregate demand (AD) curve | The graph of the relationship between inflation and the quantity of spending on domestically produced goods and services.
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| ECB's deposit facility | Where euro-area banks with excess reserves can deposit them overnight and earn interest.
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| ECB's Main Refinancing Operations | The weekly auction of two-week repurchase agreements in which the ECB, through the National Central Banks, provides reserves to banks in exchange for securities.
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| ECB's Marginal Lending Facility | The facility through which the ECB provides overnight loans to banks; the analog to the Federal Reserve's primary credit facility.
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| economies of scale | When the average cost of producing a good or service falls as the quantity produced increases.
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| economies of scope | When the average cost of producing a good or service falls as the number of different types of goods produced increases.
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| electronic funds transfer (EFT) | Movements of funds directly from one account to another over an electronic network.
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| emergency powers | The Federal Reserve's extraordinary authority to lend to nonbanks when circumstances are deemed “unusual and exigent.”
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| e-money | Private money, as represented by a claim on the issuer, which is (1) stored on an electronic device, (2) issued on receipt of funds, and (3) accepted as a means of payment by persons other than the issuer.
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| equation of exchange | The equation stating that nominal income equals the quantity of money times the velocity of money; MV =PY.
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| equity | Ownership shares in a firm; also called stock and common stock.
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| equity market | A financial market where stocks are bought and sold.
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| euro | The name of the currency used in the countries of the European Monetary Union.
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| euro area | The countries in Europe that use the euro as their common currency.
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| eurodollars | Dollar-denominated deposits outside the U.S.
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| European Central Bank (ECB) | The central authority, located in Frankfurt, Germany, which oversees monetary policy in the common currency area.
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| European option | An option that can be exercised only on the expiration date, not before, in contrast with an American option.
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| European System of Central Banks (ESCB) | The European Central Bank plus the National Central Banks of all the countries in the European Union, including those that do not participate in the monetary union.
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| Eurosystem | The European Central Bank plus the National Central Banks of participating countries; together, they carry out the tasks of central banking in the euro area.
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| examination (of banks) | The formal process by which government specialists evaluate a bank's financial condition.
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| excess reserves | Reserves in excess of required reserves.
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| excess reserve-to-deposit ratio | The ratio of banks' excess reserves to their demand deposit liabilities.
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| exchange rate | See nominal exchange rate.
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| exchange-rate channel | The channel of the monetary policy transmission mechanism where changes in policy affect aggregate expenditure through their impact on exchange rates.
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| exchange-rate stability | One of the objectives of the central bank is to reduce exchange-rate fluctuations making it stable.
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| Executive Board of the ECB | The six-member body in Frankfurt that oversees the operation of the European Central Bank and the Eurosystem.
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| exercise price | The predetermined price at which a call or put option specifies that the underlying asset can be bought (call) or sold (put); also called the strike price.
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| expansionary output gap | When current output exceeds potential output; the gap puts upward pressure on inflation.
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| expectations hypothesis of the term structure | The proposition that long-term interest rates are the average of expected future short-term interest rates.
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| expected return | The probability-weighted sum of possible returns to an investment.
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| expected value | The probability-weighted sum of possible values of an investment; also known as the mean or average.
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| externality | Spillover impact from an activity of one party on to other parties who are not compensated (such as may occur when a firm creates pollution or systemic risk).
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| face value | See bond principal value.
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| fallen angel | A low-grade bond that was initially a highgrade bond but whose issuer fell on hard times.
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| Fannie Mae | The Federal National Mortgage Association; a government-sponsored entity that aids in the financing of home mortgages.
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| federal funds market | The market where banks lend their excess reserves to other banks; the loans are unsecured.
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| federal funds rate | The interest rate banks charge each other for overnight loans on their excess deposits at the Fed; the interest rate targeted by the FOMC.
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| Federal Open Market Committee (FOMC) | The 12 member committee that makes monetary policy decisions in the United States. Members include the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and the presidents of four Federal Reserve Banks.
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| Federal Reserve Banks | The 12 regional banks in the Federal Reserve System.
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| Federal Reserve System | The central bank responsible for monetary policy in the United States.
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| fiat money | Currency with no intrinsic value, it has value as a consequence of government decree.
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| finance company | A nondepository financial institution that raises funds directly in financial markets to provide loans to businesses and households.
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| financial holding company | A company that owns a variety of financial intermediaries.
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| financial institutions | Firms, such as banks and insurance companies, that provide access to the financial markets, both to savers who wish to purchase financial instruments directly and to borrowers who want to issue them; also known as financial intermediaries.
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| financial instrument | The written legal obligation of one party to transfer something of value (usually money) to another party at some future date, under certain conditions.
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| financial market | The part of the financial system that allows people to buy and sell financial instruments quickly and cheaply.
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| financial system | The system that allows people to engage in economic transactions. It is composed of six parts: money, financial instruments, financial markets, financial institutions, regulatory agencies, and central banks.
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| financial system stability | One objective of the central bank is to eliminate financial system volatility, ensuring that it remains stable.
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| fiscal policy | The government's tax and expenditure policies, usually formulated by elected officials.
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| fixed-payment loan | A type of loan that requires a fixed number of equal payments at regular intervals; home mortgages and car loans are examples.
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| fixed-rate payer | The party to an interest-rate swap that is making fixed payments.
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| flexible-rate payer | The party to an interest-rate swap that is making variable payments. Also called floating-rate payer.
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| flight to quality | An increase in the demand for low-risk government bonds, coupled with a decrease in the demand for virtually every risky investment.
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| float | A loan from the Federal Reserve to the commercial banking system that is the result of the workings of the check-clearing process.
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| FOMC statement | The press release that immediately follows every FOMC meeting; usually contains an announcement of the federal funds rate target, an evaluation of the current economic environment, and a statement of the risks to the economy.
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| forbearance | Willingness of regulators to allow banks with insufficient capital to continue to operate.
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| foreign exchange intervention | The purchase or sale of foreign exchange by government officials with the intention of moving the nominal exchange rate.
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| foreign exchange reserves | Assets of the central bank denominated in foreign currency.
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| foreign exchange risk | The risk arising from holding assets denominated in one currency and liabilities denominated in another.
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| forward contract | An agreement to exchange an asset for money in the future at a currently agreed upon price.
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| free rider | Someone who doesn't pay the cost but still gets the benefit of a good or service.
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| fundamental value | The present value of the expected future returns to owning an asset, which equals the asset's price in an efficient market.
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| funding liquidity | The ability to borrow money.
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| future value | The value on some future date of an investment made today.
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| futures contract | A standardized agreement specifying the delivery of an underlying asset (commodity or financial instrument) at a given future date for a currently agreedupon price.
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| gold standard | A fixed-exchange-rate regime in which the currencies of participating countries are directly convertible into gold.
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| Governing Council of the ECB | The (currently) 22- member committee that makes monetary policy in the euro area.
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| government purchases | Spending on goods and services by federal, state, and local governments.
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| government-sponsored enterprises (GSEs) | Federal credit agencies that provide loans directly for farm and home mortgages as well as guaranteeing programs that insure the loans made by private lenders.
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| gross domestic product (GDP) | The market value of final goods and services produced in the economy during a year.
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| hard peg | An exchange-rate system in which the central bank implements an institutional mechanism that ensures its ability to convert a domestic currency into the foreign currency to which it is pegged.
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| hedge funds | Private, largely unregulated, investment partnerships that bring together small groups of people who meet certain (high) wealth requirements.
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| hedger | Someone who uses financial instruments, like derivatives, to reduce risk.
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| hedging | Reducing overall risk by investing in two assets with opposing payoffs.
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| high-powered money | See monetary base.
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| holding period return | The return from purchasing and selling a bond (applies to bonds sold before or at maturity).
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| hyperinflation | Very high inflation; when prices double every two to three months.
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| idiosyncratic risk | Risk affecting a small number of people (a specific firm or industry).
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| illiquid | The inability to meet immediate payment obligations. For a bank, reserves are insufficient to honor current withdrawal requests.
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| in-the-money option | An option that would yield a profit if exercised immediately. A call option is in the money when the strike price is less than the current market price for the underlying instrument.
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| indirect finance | An institution like a bank stands between the lender and the borrower, borrowing from the lender and providing the funds to the borrower.
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| inflation | A sustained rise in the general price level; the opposite of deflation.
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| inflation-indexed bonds | A bond whose yield equals a fixed real interest rate plus realized (as opposed to expected) inflation.
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| inflation persistence | A term used to describe the phenomenon that when inflation is low one year, it tends to be low the next, and when it is high, it tends to stay high.
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| inflation rate | The measurement of inflation.
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| inflation risk | The risk that the real value of the payments from owning a bond will be different from what was expected; that the real interest rate on a bond will differ from what was expected.
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| inflation targeting | A monetary policy strategy that involves the public announcement of a numerical inflation target, together with a commitment to make price stability the central bank's primary objective to which all other objectives are subordinated.
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| information | A collection of facts. The basis for the third core principle of money and banking: Information is the basis for decisions.
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| information costs | The costs lenders must pay to screen potential borrowers to determine their creditworthiness and monitor how they use the loans.
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| insolvent | When the value of a firm's or bank's assets is less than the value of its liabilities; negative net worth.
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| insurance company | A financial intermediary that accepts premiums, which it invests in securities and real estate (its assets) in return for promising compensation to policyholders should certain events occur (its liabilities).
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| interest rate | The cost of borrowing and the reward to lending. See also yield.
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| interest-rate channel | The traditional channel of the monetary policy transmission mechanism where changes in policy affect aggregate expenditure through their impact on interest rates.
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| interest-rate risk | 1. The risk that the interest rate will change, causing the price of a bond to change with it. 2. The risk that changes in interest rates will affect a financial intermediary's net worth. It arises from a mismatch in the maturity of assets and liabilities.
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| interest-rate spread | 1. The difference between the interest rate a bank receives on its assets and the interest rate it pays to obtain liabilities. 2. Can also be used as a synonym for risk spread.
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| interest-rate stability | One of the objectives of the central bank is to reduce interest-rate fluctuations keeping it stable.
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| interest-rate swap | A contract between two counterparties specifying the exchange of interest payments on a series of future dates.
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| intermediate targets | Variables that are not directly under the central bank's control but lie somewhere between the tools policymakers do control and their objectives; the quantity of money is an example.
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| internal rate of return | The interest rate that equates the present value of an investment with its cost.
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| International Monetary Fund (IMF) | The international organization created to administer the Bretton Woods system of fixed exchange rates, provide technical assistance helping countries to design their financial and economic systems, and make loans to countries in crisis.
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| inverted yield curve | When the term structure of interest rates slopes down.
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| investment | Spending by firms for additions to the physical capital they use to produce goods and services; also includes construction of new houses.
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| investment bank | A financial intermediary that issues (underwrites) stocks and bonds for corporate customers and advises customers.
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| investment-grade bond | Bond with low default risk; Moody's rating of Baa or higher; and Standard & Poor's rating of BBB or higher.
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| investment horizon | The length of time an investor plans on holding an asset.
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| junk bond | A bond with a high risk of default. Also called a high-yield bond.
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| lagged-reserve accounting | The procedure where a bank's reserve requirement is computed based on the level of deposits several weeks earlier.
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| large certificates of deposit | Certificates of deposit that exceed $100,000 in face value. They can be bought and sold in financial markets.
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| law of one price | The principle that two identical goods should sell for the same price regardless of location.
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| lender of last resort | The ultimate source of credit to banks during a panic. A role for the central bank.
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| letter of credit | A financial guarantee provided for a fee, usually by a bank, that insures a payment by one of its customers.
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| leverage | Borrowing to finance part of an investment; increases expected return and risk.
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| liability | Something you owe.
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| life insurance | Insurance that makes payment on the death of the policyholder; see term life insurance and whole life insurance.
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| limited liability | The provision that even if a company fails completely, the maximum amount that shareholders can lose is their initial investment.
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| liquidity | A measure of the ease with which an asset can be turned into a means of payment.
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| liquidity premium theory of the term structure | The proposition that long-term interest rates equal the average of expected short-term interest rates plus a risk premium that rises with the time to maturity.
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| liquidity risk | The risk that a financial institution's liability holders will suddenly seek to cash in their claims; for a bank this is the risk that depositors will unexpectedly withdraw deposit balances.
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| loan commitment | A line of credit, similar to an individual's credit card limit, provided by a bank or other lender that gives a firm the ability to borrow whenever necessary.
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| loan loss reserves | A portion of a bank's capital that is set aside to cover potential losses from defaulted loans.
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| London Interbank Offered Rate (LIBOR) | The interest rate at which banks lend eurodollars to other banks.
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| long futures position | The position held by a buyer of a futures contract.
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| long-run aggregate supply curve (LRAS) | The quantity of output supplied in the long run at any level of inflation; the LRAS curve is vertical at potential output.
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| long-run real interest rate | The real interest rate that equates aggregate demand with potential output.
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| Lucas critique | Economist Robert Lucas's observation that changes in policymakers' behavior will change people's expectations, altering their behavior and the observed relationships among economic variables.
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| M1 | The narrowest monetary aggregate, which measures the most liquid means of payment available: currency, travelers' checks, demand deposits, and other checkable deposits.
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| M2 | The monetary aggregate most commonly used in the United States, it includes M1 plus somewhat less liquid financial instruments: small-denomination time deposits, savings deposits, money-market deposit accounts, and retail money-market mutual fund shares.
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| macro-prudential (regulation) | Aimed at limiting systemic risks in the financial system.
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| margin | 1. A minimum down payment legally required to purchase a stock. 2. A deposit placed by the buyer and seller of a futures contract with the clearing corporation.
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| marked to market | Accounting rule in which a financial instrument is repriced and funds transferred from the loser to the winner at the end of every day.
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| market capitalization | The total market value of a company; the price of a share of stock times the total number of shares outstanding.
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| market federal funds rate | The overnight interest rate at which lending between banks takes place in the market; differs from the federal funds rate target set by the FOMC.
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| markets | A virtual or physical place where goods, services, and financial instruments are purchased and sold. The basis for the fourth core principle of money and banking: markets set prices and allocate resources.
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| market liquidity | The ability to sell assets.
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| matched-sale purchase (reverse repo) | A short-term arrangement in which the Federal Reserve's Open Market Trading Desk sells a security and agrees to repurchase it in the near future.
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| maturity date | The time to the expiration of a debt instrument; the time until a bond's last promised payment is made.
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| mean | See expected value.
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| means of payment | Something that can be used to purchase goods and services; one of the functions of money.
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| micro-prudential (regulation) | Aimed at limiting the risks within intermediaries in order to reduce the probability of an individual institution's failure.
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| minimum bid rate | The minimum interest rate that banks can bid for reserves in the ECB's weekly refinancing operation; the European equivalent of the Fed's target federal funds rate; also known as the target refinancing rate.
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| monetary aggregates | Measures of the quantity of money; M1 and M2.
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| monetary base | The currency in the hands of the public plus reserves in the banking system; the central bank's liabilities.
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| monetary policy | The central bank's management of money, credit, and interest rates.
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| monetary policy framework | A structure in which central bankers clearly state their goals and the trade-offs among them.
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| monetary policy reaction curve | The relationship between the real interest rate set by the central bank and the level of inflation.
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| monetary policy transmission mechanism | The channels through which changes in the central bank balance sheet influence real economic activity.
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| money | An asset that is generally accepted as payment for goods and services or repayment of debt, acts as a unit of account, and serves as a store of value.
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| money market | A market in which debt instruments with a maturity of less than one year are traded.
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| money multiplier | The ratio between the quantity of money and the monetary base; the quantity of money (M) equals the money multiplier (m) times the monetary base. M = m × MB.
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| money-market deposit accounts | Accounts that pay interest and offer limited check-writing privileges; part of M2.
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| money-market mutual fund shares | Shares in funds that collect relatively small sums from individuals, pool them together, and invest them in short-term marketable debt issued by large corporations; retail shares are part of M2.
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| moral hazard | The risk that a borrower or someone who is insured will behave in a way that is not in the interest of the lender or insurer; it is caused by asymmetric information.
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| mortgage-backed security | A financial instrument that provides its owner with a share of the mortgage payments from a large pool of mortgages.
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| multiple deposit creation | Part of the money supply process whereby a $1 increase in the quantity of reserves works its way through the banking system, increasing the quantity of money by more than $1.
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| municipal bonds | Bonds issued by state and local governments to finance public projects; the coupon payments are exempt from federal and state income taxes.
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| mutual fund | A fund that pools the resources of a large number of small investors and invests them in portfolios of bonds, stocks, and real estate; managed by professional managers.
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| mutual fund company | Financial intermediary that pools the resources of a large number of small investors and invests them in portfolios of bonds, stocks, and real estate.
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| Nasdaq Composite Index | The value-weighted index of more than 5,000 companies traded on the over-the- counter market through the National Association of Securities Dealers Automatic Quotations service; the index is composed mainly of smaller, newer firms and in recent years has been dominated by technology and Internet companies.
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| National Central Banks (NCBs) | The central banks of the countries that belong to the European Union.
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| net exports | Exports minus imports; it represents an addition to the demand for domestically produced goods.
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| net interest income | A bank's interest income minus its interest expenses.
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| net interest margin | A bank's interest income minus its interest expenses divided by total bank assets; net interest income as a percentage of total bank assets.
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| net worth | The difference between a firm's or household's assets and liabilities.
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| nominal exchange rate | The value of one unit of a country's currency in terms of another country's currency.
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| nominal gross domestic product | The market value of final goods and services produced in the economy during a year measured at current (dollar) prices.
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| nominal interest rate | An interest rate expressed in dollar terms; the real interest rate plus expected inflation.
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| nondepository institution | A financial intermediary that does not issue deposit liabilities.
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| notional principal | The amount upon which the interest payments in an interest-rate swap are based.
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| off-balance-sheet activities | Bank activities, such as trading in derivatives and issuing loan commitments, that are neither assets nor liabilities on the bank's balance sheet.
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| open market operations | When the central bank buys or sells a security in the open market; also include central bank repurchase agreements.
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| open market purchase | The purchase of a security by the central bank.
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| open market sale | The sale of a security by the central bank.
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| open market trading desk | The group of people at the Federal Reserve Bank of New York who purchase and sell securities for the Fed's System Open Market Account.
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| operating instruments | The policy instruments that the central bank controls directly; the federal funds rate is an example.
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| operational risk | The risk a financial institution faces from computer hardware or software failure, natural disaster, terrorist attacks, and the like.
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| organized exchange | See centralized exchange.
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| out-of-the money option | An option that would not yield a profit if exercised immediately. A call option is out of the money when the strike price is more than the current market price for the underlying instrument.
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| output gap | The difference between current output and potential output.
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| overnight cash rate | The overnight interest rate on interbank loans in Europe; the European analog to the market federal funds rate.
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| over-the-counter (OTC) market | A financial market in which trades occur through networks of dealers connected together electronically.
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| overvalued currency | A country's currency when it is worth more than purchasing power parity implies.
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| par value | See bond principal value.
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| payments system | The web of arrangements that allow for the exchange of goods and services, as well as assets, among different people.
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| payoff | The amount an investor receives in return for an investment.
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| payoff method | Where the Federal Deposit Insurance Corporation sells or pays off a failed bank's depositors and then sells the failed bank's assets in an attempt to recover the amount paid out.
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| pension fund company | Financial intermediary that invests individual and company contributions into stocks, bonds, and real estate (its assets) in order to provide payments to retired workers (its liabilities).
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| perpetuity | See consol.
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| policy directive | The instructions from the FOMC to the System Open Market Account manager specifying the federal funds rate target.
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| policy duration commitment | Promise by the central bank to maintain the current policy interest rate for a period of time or until a specified condition arises.
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| portfolio | A collection or group of investments held by a person or company.
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| portfolio demand for money | The theory of the demand for money based on the use of money as a store of value; the theory that treats money as an asset analogous to a bond.
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| potential output | What the economy is capable of producing when its resources are used at normal rates; also called sustainable output.
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| precautionary demand for money | The theory of the demand for money based on the idea that people hold money to insure they have resources when faced with unexpected events.
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| present discounted value | See present value.
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| present value | The value today (in the present) of a payment that is promised to be made in the future.
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| price stability | One objective of the central bank is to keep inflation low so that prices are stable on average.
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| price-weighted average | An index based on the average price of a collection of individual stocks. Price-weighted averages give greater weight to shares with higher prices.
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| primary credit | The term used to describe short-term, usually overnight, discount loans made by the Federal Reserve to commercial banks.
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| primary discount rate | The interest rate charged by the Federal Reserve on primary credit; also known as the discount rate, it is set at a spread above the target federal funds rate.
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| primary financial market | A financial market in which a borrower obtains funds from a lender by selling newly issued securities.
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| prime-grade commercial paper | Commercial paper with a low risk of default.
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| principal | See bond principal value.
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| probability | A measure of the likelihood that an event will occur.
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| pro-cyclicality | Refers to the mutually reinforcing interaction between financial and economic activity that amplifi es economic booms and busts Note: the more general term pro-cyclical means moving in tandem with the swings of the business cycle.
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| prompt corrective action | Regulators' closing of failing banks, mandated by bank regulations.
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| property and casualty insurance | Insurance against damage from events like automobile accidents, fire, and theft.
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| purchase-and-assumption method | Where Federal Deposit Insurance Corporation finds a firm that is willing to take over a failed bank.
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| purchasing power parity (PPP) | The principle that a unit of currency will purchase the same basket of goods anywhere in the world.
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| pure discount bond | See zero-coupon bond.
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| put option | A contract that confers the right, but not the obligation, to sell a financial instrument at a predetermined price on or prior to an agreed upon date.
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| quantitative easing | Unconventional monetary policy action by the central bank to supply aggregate reserves beyond the quantity needed to lower the policy rate to zero.
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| quantity theory of money | The theory that changes in nominal income are determined by changes in the quantity of money.
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| rating | A measure of the default risk associated with a company's debt; normally a series of letters going from AAA for bonds with the lowest risk of default to D for bonds that have defaulted.
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| rating downgrade | When a bond-rating agency lowers the rating of a company, signaling that its bonds have an increased risk of default.
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| rating upgrade | When a bond-rating agency raises the rating of a company, signaling that its bonds have a reduced risk of default.
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| real business-cycle theory | The theory that prices and wages are flexible, so inflation adjusts rapidly, current output always equals potential output, and all business-cycle fluctuations arise from changes in potential output.
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| real exchange rate | The exchange rate at which one can exchange the goods and services from one country for goods and services from another country.
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| real interest rate | The interest rate measured in terms of constant (real) dollars; the nominal interest rate minus expected inflation.
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| recession | A decline in overall economic activity, as defined by the National Bureau of Economic Research.
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| recessionary output gap | When current output is below potential output; the gap puts downward pressure on inflation.
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| regulation (financial) | A set of specific rules imposed by the government that the managers of financial institutions and participants in financial markets must follow.
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| regulatory agencies | Entities responsible for making sure that the elements of the financial system operate in a safe and reliable manner.
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| reinsurance company | A very large company that provides insurance to insurance companies.
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| repurchase agreement (repo) | A short-term collateralized loan in which a security is exchanged for cash, with the agreement that the parties will reverse the transaction on a specific future date, as soon as the next day.
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| required reserve ratio | The ratio of required reserves to demand deposit liabilities.
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| required reserves | Reserves that a bank must hold to meet the requirements set by regulators. In the United States, the requirements are established by the Federal Reserve.
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| reserve requirement | Regulation obligating depository institutions to hold a certain fraction of their demand deposits as either vault cash or deposits at the central bank.
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| reserves | A bank's vault cash plus the balance in its account at the Federal Reserve.
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| residual claimant | The final person to be paid. Stockholders are residual claimants; if the company runs into financial trouble, only after all other creditors have been paid will they receive what is left, if anything.
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| return on assets (ROA) | Bank net profits after taxes divided by total bank assets; a measure of bank profitability.
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| return on equity (ROE) | Bank net profits after taxes divided by bank capital; a measure of the return to the bank's owners.
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| risk | A measure of uncertainty about the future payoff to an investment, measured over some time horizon and relative to a benchmark. The basis for the second core principle of money and banking: risk requires compensation.
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| risk-averse investor | Someone who prefers an investment with a certain return to one with the same expected return but any amount of uncertainty.
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| risk-neutral investor | Someone who is indifferent between investments with different risks but the same expected return.
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| risk premium | The expected return minus the risk-free rate of return; the payment to the buyer of an asset for taking on risk.
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| risk sharing | The ability of individuals to combine and share the financial risks that they face; one of the services provided by a financial intermediary.
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| risk spread | The yield over and above that on a low-risk bond such as a U.S. Treasury with the same time to maturity, it is a measure of the compensation investors require for the risk they are bearing. Also called a default risk premium.
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| risk structure of interest rates | The relationship among the yields of bonds with the same time to maturity but different levels of risk.
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| risk-free asset | An investment whose future value is known with certainty.
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| risk-free rate of return | The rate of return on a risk-free asset.
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| rule of 72 | The rule that allows you to find out how many years it will take for the value of an investment to double; divide 72 by the annual interest rate.
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| savings deposits | The general term used to describe interestbearing deposits that may have limited withdrawal privileges, but have no expiration date.
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| seasonal credit | Discount lending made in response to local, seasonal liquidity needs; used primarily by small agricultural banks in the Midwest to help manage the cyclical nature of farmers' loans and deposits.
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| secondary credit | Discount lending to banks that are not suffi ciently sound to qualify for primary credit.
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| secondary discount rate | The interest rate charged on secondary credit; it is usually 50 basis points above the primary discount rate.
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| secondary financial market | A financial market in which previously issued securities are bought and sold.
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| secondary reserves | Short-term U.S. Treasury securities held as bank assets.
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| securities | Financial instruments representing ownership or debt; stocks, bonds, and derivatives.
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| shadow bank | Institution with liabilities that, like bank deposits, can be withdrawn at face value with little or no notice but that are usually subject to less oversight than banks.
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| short futures position | The position held by the seller of a futures contract.
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| short-run aggregate supply curve (SRAS) | The quantity of output supplied in the short run at any level of inflation; the SRAS curve is upward-sloping with inflation.
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| sovereign risk | The risk that a foreign borrower will not repay a loan because its government prohibits it from doing so.
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| speculative attack | A crisis in which financial market participants believe the government will become unable to maintain its exchange rate at the current fixed level, so they sell the currency, forcing an immediate devaluation.
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| speculator | Someone who takes risks for the purpose of making a profit.
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| spot price | The market price paid for immediate delivery of a commodity or financial instrument.
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| spread over Treasuries | The difference between the yield on a bond and that on a U.S. Treasury with the same time to maturity; a measure of the riskiness of the bond.
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| spreading risk | Reducing overall risk by investing in assets whose payoffs are unrelated.
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| stability | Steady and lacking in variation. The basis for the fifth core principle of money and banking: Stability improves welfare.
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| stabilization policy | Monetary and fiscal policies designed to stabilize output and inflation.
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| Standard & Poor's 500 Index | A stock-market index that is based on the value of 500 of the largest firms in the U.S. economy.
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| standard deviation | Square root of the variance measure of risk; measures the dispersion of possible outcomes.
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| sterilized intervention | A foreign exchange intervention that alters the composition of the central bank's assets but leaves the size of its liabilities unchanged.
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| stock | Ownership shares in a firm; also called common stock and equity.
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| stock market | The market where the prices of common stock are determined.
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| stock-market indexes | Index numbers that provide a sense of whether the value of the stock market is going up or down.
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| store of value | Allows movement of purchasing power into the future; one of the functions of money.
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| stored-value card | A card that can be used to make purchases after money is transferred from a cardholder's account.
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| strike price | See exercise price.
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| stripped bond | A bond whose principal and coupon payments are traded separately.
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| supervision (financial) | General government oversight of financial institutions.
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| supply of dollars | The number of dollars supplied in the foreign exchange market as a function of the nominal exchange rate.
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| supply shock | An unexpected change in the costs of production, such as a rise or fall in oil prices, that shifts the short-run aggregate supply curve.
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| sustainable growth | When the economy is growing at the rate dictated by potential output.
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| swap | A financial contract obligating one party to exchange one set of payments for a second set of payments made by a counterparty.
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| swap spread | The difference between the benchmark interest rate and the swap rate, it is a measure of risk.
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| System Open Market Account (SOMA) | The official name for the securities holdings of the Federal Reserve System.
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| systematic risk | Economywide risk that affects everyone and cannot be diversified.
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| T-account | A simplified balance sheet in the form of a T that shows the changes in assets on one side and the changes in liabilities on the other.
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| target federal funds rate | The Federal Open Market Committee's target for the interest rate at which banks make overnight loans to each other; the FOMC's primary policy instrument.
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| taxable bond | A bond whose coupon payments are not exempt from income tax.
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| Taylor rule | A rule of thumb for explaining movements in the federal funds rate; the monetary policy rule developed by economist John Taylor.
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| term life insurance | Insurance that provides a payment to the policyholder's beneficiaries in the event of the insured's death at any time during the policy's term.
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| term spread | The gap between yields to maturity on a longand a short-term bond (usually free of default risk); see also yield curve.
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| term structure of interest rates | The relationship among bonds with the same risk characteristics but different maturities.
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| term to maturity | The length of time until a bond's final payment.
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| theory of efficient markets | The notion that the prices of all financial instruments, including stocks, reflect all available information.
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| time | A measurable period during which something can happen. The basis for the first core principle of money and banking: time has value.
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| time deposits | Deposits that cannot be withdrawn before a specified date. Small-denomination time deposits are part of M2.
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| time value (of an option) | The price the buyer of an option pays to the seller that is in excess of the value of the option if it were immediately exercised.
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| too-big-to-fail policy | The idea that some financial institutions are so large that government officials cannot allow them to fail because their failure will put the entire financial system at risk.
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| trading or market risk | The risk that traders who work for a bank will create losses on the bank's own account.
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| transactions costs | The costs, including time, associated with buying and selling financial instruments, as well as goods and services.
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| transactions demand for money | The demand for money based on the use of money as a means of payment, for transactions purposes.
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| transmission | mechanism of monetary policy The way changes in central bank policy influence the real economy.
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| transparency | The central bank's communication of its policy decisions and how they are made clearly to the financial markets and the public.
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| travelers' checks | Issued by travel companies, banks, and credit card companies, they are guaranteed by the issuer and usually work just like cash; part of M1.
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| Treasury Direct | The system that allows individuals to purchase U.S. Treasury securities directly from the government without the use of a broker.
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| unconventional (monetary) policy tools | Policy mechanisms (including policy duration commitments, quantitative easing and credit easing) that are usually reserved for extraordinary episodes when conventional interest rate policy is insufficient for economic stabilization.
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| underlying instrument | A financial instrument used by savers/lenders to transfer resources directly to investors/ borrowers; also known as a primitive security.
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| undervalued currency | A country's currency when it is worth less than purchasing power parity implies.
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| underwriter | A financial intermediary that sells a firm's stocks or bonds to the public, guaranteeing the price the issuer will receive.
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| underwriting | The process through which an investment bank guarantees the price of a new security to a corporation and then sells it to the public.
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| unit bank | A bank without branches.
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| unit of account | The units (like dollars) used to quote prices and other financial quantities; one of the functions of money.
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| universal bank | An institution that engages in all aspects of financial intermediation, including banking, insurance, real estate, brokerage services, and investment banking.
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| unsecured loan | A loan that is not guaranteed by collateral.
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| unsterilized intervention | A foreign exchange intervention that both alters the composition and changes the size of the central bank's balance sheet.
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| U.S. Treasury bill | A zero-coupon bond in which the U.S. government agrees to pay the bondholder a fixed dollar amount on a specific future date; has a maturity of less than one year.
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| U.S. Treasury bond | A coupon bond issued by the U.S. Treasury to finance government activities.
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| value at risk | The worst possible loss over a specific time horizon at a given probability; a measure of risk.
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| value-weighted index | An index that is based on the value of the firms, like the S&P 500. Value-weighted indexes give greater weight to larger firms.
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| variance | The probability-weighted sum of the squared deviations of the possible outcomes from their expected value.
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| vault cash | Currency that is physically held inside a bank's vaults and automated teller machines (ATMs).
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| velocity of money | The average number of times each unit of money is used per unit time.
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| venture capital firm | A financial intermediary that specializes in investing in risky new “ventures” in return for a stake in the ownership and a share of the profits.
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| vesting | When the contributions your employer has made to the pension plan on your behalf belong to you.
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| wealth | The total value of all assets; the net worth of an individual.
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| whole life insurance | A combination of term life insurance and a savings account in which a policyholder pays a fixed premium over his or her lifetime in return for a fixed benefit when the policyholder dies.
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| Wilshire 5000 | The most broadly based value-weighted stock index in use. It covers the roughly 6,500 publicly traded stocks in the United States.
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| yen | The currency used in Japan.
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| yield | The interest rate that equates the price of a bond with the present value of its payments.
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| yield curve | A plot showing the yields to maturity of different bonds of the same riskiness against the time to maturity.
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| yield on a discount basis | The return to holding a bond; differs from yield to maturity because it divides the difference between the face value and the price by the face value and because it uses a 360-day year.
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| yield to maturity | The yield bondholders receive if they hold the bond to its maturity when the final principal payment is made.
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| yuan | The currency used in China.
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| zero bound | The term for the fact that a nominal interest rate, including the monetary policy rate, cannot fall below zero.
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| zero-coupon bond | A promise to pay the face value of the bond on a specific future date, with no coupon payments.
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| zero nominal-interest-rate bound | See zero bound.
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