Chapter 5 - Environmental Influences

Question 1

Main interests of the central bank

Answer 1

• Monetary, interest rate and inflation policy
• Banking regulation
• Implementation of government borrowing
• Performance and integrity of financial markets
• Intervention in currency markets
• Printing and minting of notes and coins
• Taxation

Question 2

Main economic variable controlled by the money supply

Answer 2

Inflation

Question 3

Open market operations (OMOs)

Answer 3

Central bank buying and selling of bills

Question 4

Non-market controls used by central banks

Answer 4

• Setting minimum liquid reserve ratios
• Setting interest rate ceilings for bank deposits
• Issuing directives regarding the types of lending to be undertaken

Question 5

Quantitative easing

Answer 5

Monetary policy used to increase the supply of money

Usually involves both a direct increase in money supply (by purchasing financial assets from banks and other financial institutions) and a knock-on effect from the fractional reserve system (e.g. changes to the reserve requirements for banks)

Question 6

Fractional reserve system

Answer 6

Refers to funds being received by banks and loaned on to other customers

Bank reserves are only a fraction of the quantity of deposits in the banks

Question 7

Forward guidance

Answer 7

Guidance by central bank on how it believes monetary policy will change in the future

Question 8

Main investor classes

Answer 8

• Private individuals (“households”)
• Managers of short-term and long-term mass savings products (“financial intermediaries”)
• Corporates
• Foreign investors

Question 9

Investor classes mainly differ in respect to

Answer 9

• Time horizons
• Appetite for risk
• Taxation position

Question 10

Households

Answer 10

Diversification is a key consideration (leads to the need for financial intermediaries)

• Small amounts available to invest
• Much of wealth tied in house

Question 11

Financial intermediaries: Broad definition

Answer 11

Channels resources between lenders and borrowers

Question 12

Financial intermediaries: Advantages and disadvantages

Answer 12

Advantages:

• Pooling of resources from small investors enables lending to large borrowers
• Diversification from lending to many borrowers allows acceptance of loans which individuals might deem too risky
• Expertise from large volumes of business

Disadvantages:

• Additional layer of cost
• Products offered might need meet requirements of investors
• Products might be inflexible
• Loss of control over investment choice

Question 13

Businesses

Answer 13

Typically need to raise money to finance investment in real assets

Objectives in issuing securities:

• Get best possible price
• Market at lowest possible cost
• Issuing securities that best meet their requirements

Question 14

Investment banking firms

Answer 14

• Advise issuing firms on prices to charge
• Handle marketing of securities
• Protect own reputation by checking and certifying quality of information offered
• Innovate security design and packaging to stimulate demand

Question 15

Governments

Answer 15

Are not major investors.

Typically borrow to finance expenditure (By exploiting they creditworthiness)

Question 16

Main types of securities issued by governments (2)

Answer 16

• Treasury bills

- Government bonds

Question 17

Sources of finance for governments (other than borrowing)

Answer 17

Taxation

Also:

• Sale of public assets
• Profits from nationalised industries
• Printing of money

Question 18

Main forms of government policy

Answer 18

• Monetary Policy
• Fiscal Policy
• National debt management policy
• Exchange rate policy
• Price and incomes policy

Question 19

Monetary policy

Answer 19

The control of some measures of the money supply and/or the level and structure of interest rates

Question 20

Fiscal policy

Answer 20

Decisions on the level and structure o taxation and government expenditure

Question 21

National deb management policy

Answer 21

The manipulation of the outstanding stock of government debt instruments held by the domestic private sector

Question 22

Exchange rate policy

Answer 22

Directed towards achieving some target for the exchange rate of the domestic currency in terms of foreign currencies

Question 23

Prices and incomes policy

Answer 23

Aimed at influencing the rates of wage and price inflation

Question 24

Other forms of government policy: Taxation

Answer 24

Policy regarding overall level and distribution of taxes

Question 25

Other forms of government policy: Labour policy

Answer 25

Sets the background for the flexibility of labour and the bargaining power of organised labour

Question 26

Major economic policy objectives

Answer 26

- Unemployment (low) - Inflation (low and stable) - Balance of payments (at a level that does not constrain the achievement of other objectives) - Economic growth (high and stable)

Question 27

Effects of interest rates on the domestic economy (Personal sector)

Answer 27

- Increase in mortgage repayments => lower disposable income and personal sector expenditure - Higher rates on credit might also encourage higher levels of saving

Question 28

Effects of interest rates on the domestic economy (Business sector)

Answer 28

- Likely detrimental since capital investment and economic growth prospects will be reduced - Higher levels of interest payments on outstanding debt will reduce corporate profitability

Question 29

Effects of interest rates on the balance of payments

Answer 29

An increase in domestic interest rates is likely to attract an inflow of foreign investment funds and may also encourage the repatriation of domestic funds held overseas