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) 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. False

Suspensions can save bank from underrun as Government or central institutions can take other counter measures during these holidays, which can instill confidence in public and they may stop thinking of withdrawing their hard earned money kept with banks.

b) Even though this is liquid and acts like a bank, this system is not vulnerable to runs like banks. True

In case of MMMFs, a fall in the total value of the asset portfolio, whether from redemptions or from bad-news events that reduce assets’ market prices, immediately reduces the total value of shares so that they never over-claim the available assets. Hence, the run alike situation doesnt arise.

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. False

No, in this case also the value will not get freezed at $0.99 but will tend to go lower and the MMMF will be obliged to refund claim as per the balance only. So, sun like situation will not be forecasted.

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