Question

Bigelow Company purchases supplies on account. What are the effects on the balance sheet equation? (Select all that apply.)

a)decrease liabilities
b)increase owners' equity
c)decrease owners' equity
d)increase assets
e)increase liabilities
f)decrease assets

Answer 1

The Fed's open market purchase increases Acme Bank's reserves by $10 million, which allows the bank to convert these additional reserves into new loans. This increases the bank's total assets without immediately changing the liabilities or equity, thus raising the bank's capacity to make new loans.

Step-by-step explanation:

Balance Sheet Changes from the Fed's Open Market Purchase

When the Federal Reserve (Fed) conducts an open market purchase, it buys securities from a bank, which increases the bank's reserves. If the Fed buys $10 million in Treasury bonds from Acme Bank, which initially has reserves of $30 million, the bond purchase will increase Acme Bank's reserves. Here is how the balance sheet changes:

• Assets: Reserves increase by $10 million because the Fed has paid this amount to Acme Bank for the bonds. After the transaction, reserves would total $40 million.
• Liabilities: There is no immediate change to liabilities from the bond transaction itself.
• Assets: Acme Bank converts the bond sale proceeds into new loans. Thus, loans would increase by $10 million, which means loans would total $60 million after the transaction.

Overall, the bank's total assets will have increased by $10 million as a result of the open market purchase, without any immediate change to liabilities or equity. Hence, this transaction increases the capacity of Acme Bank to offer new loans to its customers.