1. Describe how the balance sheet of the Fed is affected under each of these sce
ID: 1142672 • Letter: 1
Question
1. Describe how the balance sheet of the Fed is affected under each of these scenarios (point out changes to both assets and liabilities) and defend your answer: (a) The Fed sells S1 million dollar's worth of government bonds to banks. (b) $1 million dollar's worth of mortgage-backed securities held by the Fed expire and are paid in full by the issuers of those securities (c) S1 million dollar's worth of mortgage-backed securities held by the Fed expire and only half is paid back; the rest is defaulted on.Explanation / Answer
a) When govt sells bonds to banks then Fed has taken money from banks hence it increases its liability. Fed does this tosuck liquidity from the market.
b) Securities held by Fed expires and hence issuers will have to pay back the money to Fed. Hence there cash assets will increase by $1 million.
c) Fed. Reserve liability will increase by $0.5 million as Fed reserve will have to make provision for this defaulted amount.
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