Answer these as true, false, or unceratin. a) TFU: bank holidays and suspensions

Question

Answer these as true, false, or unceratin.

a) TFU: bank holidays and suspensions of convertibility have no purpose, because if a bank undergoing a run was insolvent before, it will very likely be insolvent a few days later.

b) Money market mutual funds take in your dollars (like deposits) and invest them in short-term “safe” financial instruments to earn you interest. In essence, you buy 1 share for $1. They take your $1 and buy $1 in corporate paper, earning, say, $0.0027 for you overnight. If you then “cash out” your shares the next day, you get $1.0027. TFU: Even though this is liquid and acts like a bank, this system is not vulnerable to runs like banks.

c) Now assume there is a rule stating that MMMF’s could cash people out at $1 if (for instance) the value of the MMMF’s assets were not less than $0.99 per dollar. TFU: This makes a run on MMMF’s possible

Explanation / Answer

a)True. If a bank is insolvent, it is very likely that some depositors will lose money, hence suspension of convertibility will have no purpose.

b) False, this system is vulnerable to runs if the short term is more than 1 day, also if a large corporate default on some day which makes a large portion of your portfolio.

c) True, because whenever value of asset falls just lower than 1, people will cash their assets and invest in another money market fund.

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