Financial Markets And Monetary Policy

Question 1

Characteristics of money

Answer 1

• durable (lasting)
• portable
• divisible
• hard to copy
• accepted by the population
• valuable - holds value

Question 2

Key functions of money

Answer 2

• medium of exchange
• store of value
• unit of account
• standard of deferred payment

Question 3

What is narrow money

Answer 3

The coins and notes in circulation

Question 4

What is broad money

Answer 4

A measure of the total amount of money held by households and companies in the economy

Question 5

What is the money market

Answer 5

A market for short term loan finance for businesses and households
(Includes inter-bank lending)

Question 6

What is the capital market

Answer 6

Market for medium-longer term loan finance (where securities such as shares and bonds are issued)

Question 7

What is the foreign exchange market

Answer 7

A market where currencies (foreign exchange) are traded

Question 8

What is the spot exchange rate

Answer 8

The price of a currency to be delivered now, rather than in the future

Question 9

What is the forward exchange rate

Answer 9

A fixed price given for buying a currency today to be delivered in the future

Question 10

Role of financial markets in the wider economy

Answer 10

• facilitate saving
• lend
• facilitate exchange of goods and services
• provide forward markets in currencies and commodities
• provided a market for equities

Question 11

What is debt financing

Answer 11

Borrowing money from an outside source with the promise of paying back the borrowed amount, plus the agreed-upon interest, at a later date

Question 12

Key features of bank loans

Answer 12

• loan provided over a period
• rate of interest is fixed or variable
• timing and amount of loaned are set by the lender
• usually some security required
• unsecured loans have higher interest rates (risk)

Question 13

What is a non performing loan

Answer 13

When the borrowed is unable to repay some or all of the debt

Question 14

What are Bank overdrafts

Answer 14

Short-term finance - the bank lets the business owe it money when the bank balance goes below zero

Question 15

When are Bank overdrafts useful

Answer 15

To help a business handle fluctuations in their cash flow or when the business runs into short term cash flow problems

Question 16

Advantages of debt finance

Answer 16

• less capital required to be invested by the shareholders
• debt can be a relatively cheap source of finance compared with dividends
• easy to pay interest if profits and cash flows are strong

Question 17

Disadvantages of debt finance

Answer 17

• businesses vulnerable to changes in interest rate

- businesses have less control of events if they are highly geared i.e. have a high ratio of debt to equity

Question 18

What is equity financing

Answer 18

Raising capital by selling shares of a business to investors

Question 19

Advantages of equity finance

Answer 19

• risk capital and does not offer a fixed return

- equity finance gives a business more flexibility

Question 20

Disadvantages of equity finance

Answer 20

• dilution of ownership
• requires a higher return than debt because it is risk capital
• growing expectations over time that dividends will be paid

Question 21

What are government bonds (treasuries)

Answer 21

Fixed interest securities

Question 22

What is the maturity date for a bond

Answer 22

When the bond becomes due to be repaid to whoever owns it at the date of maturity

Question 23

What is a coupon

Answer 23

Th government pays a fixed annual interest to investors

Question 24

What is the yield on bonds

Answer 24

The interest rate on a bond - it will vary inversely with the market price of a bond

Question 25

What happens to yields when bond prices are rising

Answer 25

The yield will fall

Question 26

What happens to the yield when bond prices are falling

Answer 26

Yields rise