Question

Assume P =1

2001                        2002                        2003

                  M_s                               100                           110                           105

                  Y                                 1000                        1200                        1440

A.       Calculate velocity for each year.  At what rate is velocity growing?

b. Why does Bank Capital Exist?

Answer 1

Question A.

Assumption P = 1

	2001	2002	2003
Velocity = P*Y/Ms	=(1000*1)/100 =10	=(1200*1)/110 =10.909	=(1440*1)/105 =13.71429

In 2002, velocity grew at [(10.909 - 10)/10] * 100 = 9.09%

In 2003, velocity grew at [(13.714 - 10.909)/ 10.909] * 100 = 25.712%

Velocity is growing at a multiple rate in 2002 nd 2003

Question B.

Bank capital is the residual left by the bank after subtracting fixed liabilities from the bank’s assets. It is a source of funds that the bank uses to acquire assets. It further states that any extra additional dollar retained by the bank as additional earnings are to further increase cash holding, securities, loans, or any other asset.

As a result, the leverage ration rises with bank finances of additional assets with capital.