LOS a: Distinguish between the concept of liquidity as “appetite for risk” as contrasted with the more traditional view that liquidity is the creation of the central bank.

Q1. When funds are withdrawn from the shadow banking system, which consists of hedge funds, structured investments, REITs, etc…, this is a sign that:

A)   investors are more risk averse, and it would lead to a lowering of liquidity.

B)   investors are less risk averse, and it would lead to a lowering of liquidity.

C)   investors are less risk averse, and it would lead to an increase in liquidity.

Q2. John Connery and Bill Munro are discussing the credit markets and how risk aversion can affect liquidity. Connery says that if the risk aversion of savers decreases, then liquidity in an economy decreases, and he says the risk aversion of investors is not a factor with respect to liquidity in an economy. Munro says that if the risk aversion of investors decreases, then liquidity in an economy decreases, and he says the risk aversion of savers is not a factor with respect to liquidity in an economy. With respect to these statements:

A)   Connery is correct and Munro is wrong.

B)   Connery and Munro are both wrong.

C)   Connery is wrong and Munro is correct.

Q3. With respect to the traditional view of liquidity being determined by the central bank, what is the role of the risk aversion of savers and investors?

A)   The risk aversion of savers is important, but the risk aversion of investors is not.

B)   The risk aversion of investors is important, but the risk aversion of savers is not.

C)   Neither the risk aversion of savers nor the risk aversion of investors is important.

LOS a: Distinguish between the concept of liquidity as “appetite for risk” as contrasted with the more traditional view that liquidity is the creation of the central bank. fficeffice" />

Q1. When funds are withdrawn from the shadow banking system, which consists of hedge funds, structured investments, REITs, etc…, this is a sign that:

A)   investors are more risk averse, and it would lead to a lowering of liquidity.

B)   investors are less risk averse, and it would lead to a lowering of liquidity.

C)   investors are less risk averse, and it would lead to an increase in liquidity.

Correct answer is A)

In the shadow banking system, investors will withdraw liquidity in times of crisis. When investor risk aversion has increased in the ffice:smarttags" />U.S., investors have sold shadow bank assets and refused to fund the shadow banks. When investor risk aversion increases, funds are withdrawn from the shadow banking system and liquidity decreases.

Q2. John Connery and Bill Munro are discussing the credit markets and how risk aversion can affect liquidity. Connery says that if the risk aversion of savers decreases, then liquidity in an economy decreases, and he says the risk aversion of investors is not a factor with respect to liquidity in an economy. Munro says that if the risk aversion of investors decreases, then liquidity in an economy decreases, and he says the risk aversion of savers is not a factor with respect to liquidity in an economy. With respect to these statements:

A)   Connery is correct and Munro is wrong.

B)   Connery and Munro are both wrong.

C)   Connery is wrong and Munro is correct.

Correct answer is B)

If either savers or investors do not want to exchange funds due to increased risk aversion, then the liquidity in an economy decreases.

Q3. With respect to the traditional view of liquidity being determined by the central bank, what is the role of the risk aversion of savers and investors?

A)   The risk aversion of savers is important, but the risk aversion of investors is not.

B)   The risk aversion of investors is important, but the risk aversion of savers is not.

C)   Neither the risk aversion of savers nor the risk aversion of investors is important.

Correct answer is C)

Liquidity has been traditionally measured by economists in terms of monetary aggregates (e.g.,M1, M2, etc). In this view, the available liquidity in an economy is determined by the central bank, which controls the supply of money. The central bank extends liquidity to commercial banks that create additional liquidity when they make loans. The preferences of savers and investors are not considered in this view.

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