Due: Sept. 17, 2001

General homework policies:

You are encouraged to work together to discuss the problems and solve them. However, every paper you turn in must be created completely by you alone. You may not share written work, nor may you copy answers from any source other than your own brain.

You must list on your homework paper the name of every person you worked with. If you answer includes content from any other source, you must state the source. Failure to do so is cheating and will result in sanctions. Copying answers from someone else and listing their name on the homework is also cheating.

If there is information you need to solve a problem but the information is not stated in the problem, try to find the data somewhere. If you cannot find it, state what data you need, make a reasonable estimate of its value, and justify any assumptions you make. You will be graded not on whether your answer is correct, but whether you have done an intelligent analysis.

Only answer the questions that are asked. Do not answer questions that are not asked, and do not waste your time on peripheral discussions of minor issues. If a short answer (such as yes or no or a number) is called for, you must always explain your answer. Answers that happen to be correct but have no explanation will receive little credit. Answer that happen to be wrong but whose explanations indicate sound reasoning will receive substantial credit. Once you have explained your answer, however, extra material is neither desirable nor helpful.

Grading: Homework will not be re-graded except in cases of “manifest error.” A manifest error is one that is immediately apparent on inspection of the paper. Examples are: a numerical error in adding up the individual question scores, marking an answer wrong when it is fact right, or failing to write in a score for an individual question. Homework answers will not be re-examined subjectively to determine whether a question should have received a different number of points.

All homework must be submitted in machine-readable form, preferably in Microsoft Word, by email to smdas@andrew.cmu.edu, with a copy to shamos@cs.cmu.edu. The page count next to each problem’s point value is merely a suggestion of how long an appropriate answer might be. You are free to write more or less provided that you answer the questions.

This homework is worth a total of 150 points.

Problem 1. [50 points, 1-2 pages] How Much M1? Electronic payment systems move money that is available for payments (M1). If money is not in one of the forms included in M1, it cannot be used for payment but must first be converted into one of the M1 forms. For example, a CD (certificate of deposit) cannot be transferred to another person. It must be cashed in (converted to cash or notational money in a bank account) before it can be used for payment. During the conversion it moves to M1. (M2 does not change because M2 includes M1).

How much is the total M1 in the world? Express your answer in U.S. dollars. (This problem requires you to make justified estimates. If you find the answer somewhere (unlikely – don’t spend much time looking), it is not acceptable to copy it into your homework. You must explain why the answer is reasonable.

Problem 2. [100 points, 2-3 pages] Understanding Giro. The check has the advantage that it is negotiable, which means that it can be transferred to another person or a bank multiple times before it is presented to the drawee bank, which must pay it in fiduciary money. Checks have numerous disadvantages, however. They are tokens, which can be lost, and they require physical handling and clearing. Checks account for 80% of all payments made in the U.S. In Sweden, checks are almost unknown, and 82% of payments are made using credit transfer, or giro. The percentages are very high in most of the Europe, except France and the UK.

A check is an order to a bank to pay a specific person (the payee) and the check is given or sent directly to the payee. A giro is an order to a bank to pay money to a specific bank account, not to a person. A giro, which may or may not be in tangible form, is sent to the payor’s bank, not to the payee. The money is removed from the payor’s account and “appears” in the payee’s account. The payor’s bank will not process the giro unless there are sufficient funds in the account to cover the payment. A problem with giro is that the payee must be told somehow what the payment is for so it can associate the payment with a specific amount owed.

(a) [25 points] Give the five most important reasons you think the United States does not use giro to any significant extent. (Less than 2% of payments are made this way in the U.S.) Indicate which of these you think are good reasons and tell why.

(b) [75 points] Assume that the U.S. banks want to eliminate checks and replace them with giro payments. Using existing payment mechanisms available in the U.S. (for example, Fedwire, ACH, ATM networks, etc.), tell in detail how you would implement giro. It is essential in this problem that:

(i) Giro payments must have low cost. Therefore, the number of actual movements of money any payment orders must be small.

(ii) Giro payments must be able to be initiated from the Internet or a wireless device, including RFID devices like SpeedPass.

(iii) People who do not have computers and do not use the Internet must have some way to initiate giros.

(iv) The recipient of a giro must be able to tell who the payee is and what the payment is for.

(v) A person who sends giros must have some way (equivalent to a checkbook) of viewing a record of all such payments made.

(vi) If giro is used for retail payment, the merchant must receive immediate (within seconds) verification that the giro will be honored (so he can release the goods). Actual settlement need not be made until the next business day.

Do not deal with security or authentication issues in your answer, as we have not covered these topics yet in the course. Focus only on the flow of money. Assume all payors and payees have bank accounts in the U.S. and all payments are in U.S. dollars. You must explain how your solution satisfies all six of the listed requirements.