midterm Flashcards
(67 cards)
What is the relationship between increasing money supply and inflation?
Increasing the money supply can lead to higher inflation.
When more money circulates in the economy without a corresponding increase in goods and services, prices tend to rise.
How do higher inflation rates affect interest rates?
Higher inflation often leads to higher interest rates.
Lenders demand higher interest rates to compensate for the decreased purchasing power of future repayments due to inflation.
What is the effect of a higher money supply on interest rates?
Higher money supply leads to lower interest rates.
Higher interest rates make holding money less attractive due to increased opportunity costs.
Define ‘financial system’.
The financial system is made up of markets, securities, and institutions that connect borrowers with lenders.
List the 4 social functions of the financial system.
- Production efficiency
- Consumption smoothing
- Asset/maturity transformation
- Risk sharing/Asset diversification
What is production efficiency in the context of the financial system?
The financial system helps allocate capital efficiently to increase the production of goods and services.
What does consumption smoothing refer to in financial systems?
It allows consumers to borrow money when needed and repay it later, helping them time their purchases better.
Explain asset/maturity transformation.
The financial system turns short-term assets into long-term ones, creating risks from mismatched time frames.
What is risk sharing/asset diversification?
It spreads risk across different people based on their preferences, shifting risk from older individuals to younger ones.
Why is for-profit lending important?
Lenders need to make money, ensuring they only lend to borrowers who can repay, promoting economic growth and stability.
List the three layers of responsibility in lending.
- Personal ethical code
- Enough skin in the game
- Financial regulations and auditing
What is the personal ethical code in lending?
Lenders must treat borrowers fairly and check carefully if they can pay the loan back.
Explain ‘skin in the game’ in lending.
Lenders put some of their own money into the loan, ensuring they care about the outcomes and help borrowers succeed.
What role do financial regulations and auditing play in lending?
They ensure that lending practices are honest and mitigate risks.
What is the connection between the layers of responsibility and moral hazard?
Without these rules, lenders might make bad loans, thinking someone else will pay if things go wrong.
What is the main difference between money markets and capital markets?
Money markets deal in short-term debt instruments (1 year or less), while capital markets deal in longer-term debt and equity instruments.
List 4 money market instruments.
- T-Bills
- Federal Funds
- Repos
- Commercial Paper
What are T-Bills?
Short-term government loans that mature in less than a year.
What is Federal Funds?
Overnight loans between banks to meet reserve requirements.
Define repos in the context of money market instruments.
Short-term loans where securities are sold and later repurchased.
What is Commercial Paper?
Short-term loans issued by companies to cover expenses.
List 4 capital market instruments.
- T-Notes
- T-Bonds
- Municipal Bonds
- Corporate Bonds
What are T-Notes?
Medium-term government bonds that pay interest every six months.
Define T-Bonds.
Long-term government bonds that pay interest for many years.
