section 4

Question 1

The characteristics and functions of money

Answer 1

a medium of exchange

measure of value

a store of value

a method of deferred payments

Question 2

why do we need money

Answer 2

to prevent double coincidence of wants

Question 3

narrow supply

Answer 3

physical currency (notes and coins)

as well as deposits and liquid assets in the central bank

Question 4

broad money

Answer 4

the entire money supply

cash could be in restricted accounts

includes liquids and less liquid assets

(hard to calculate)

Question 5

money supply

Answer 5

the stock of currency and liquid assets in an economy

it includes cash and money held in savings accounts

Question 6

money market

Answer 6

liquid assets are traded

used to borrow and lend money in the short term

Question 7

capital market

Answer 7

where equity and debt instruments are brought and sold

these can then be put to long-term productive use by firms and government

Question 8

foreign exchange market

Answer 8

where currencies are traded

mainly used by international banks

determines what the relative value of different currencies will be

Question 9

role of financial markets in the wider economies

Answer 9

Financial liquid assets are exchanged in a financial market

to facilitate saving

to lend to businesses and individuals

to facilitate the exchange of goods and services

to provide forward markets in currencies and commodities

to provide a market for equities

Question 10

examples of financial markets

Answer 10

stock market

bond market

Question 11

debt vs equity

Answer 11

debt = money that been borrowed from a lender, later repaid with interest (little flexibility)

equity = involves raising money by selling interests in the company
any contract that evidences a residual interest in the entity’s assets after deducting all of its liabilities.

Question 12

the relationship between market interests rates and bond prices

Answer 12

inverse relationship

Question 13

why is there an inverse relationship between market interest rates and bond prices

Answer 13

The inverse relationship between interest rates and bond prices stems from the concept of opportunity cost. When interest rates rise, existing bonds become less attractive because new bonds offer higher yields. This increased competition drives down the price of existing bonds to make them more competitive. Conversely, when interest rates fall, new bonds offer lower yields, making existing bonds with higher coupon rates more desirable, thus increasing their price.

Question 14

commercial bank

Answer 14

manages deposits, cheques and savings accounts for individuals and firms

they can make loans using the money saved with them

Question 15

investment banks

Answer 15

facilitate the trade of stocks, bonds, and other forms of investment

government regulation is weaker than in commercial banks

this combined with their business model gives them a higher risk tolerance

Question 16

main functions of commercial banks

Answer 16

accept deposits

provide loans
(credit cards / loans)

overdraft

investment of funds

agency functions (collect cheques and dividends, pay and accept bills, deposit interest and income tax, etc.)

Question 17

structure of a commercial banks balance sheets

Answer 17

balanced assets and liabilities

Question 18

liabilities

Answer 18

something that must be paid, it is a claim on assets

capital, deposits, borrowing, reverse funds

Question 19

asset

Answer 19

something that can be sold for value

cash, securities and bills, loans and investments

Question 20

owners equity

Answer 20

bank capital

what is left over when assets have been sold and liabilities have been paid

Question 21

use of liabilities and assets

Answer 21

liabilities are used to buy the assets

income can be earned from the assets

Question 22

what are the objectives of commerical banks

Answer 22

liquidity

profitability

security

Question 23

liquidity

Answer 23

how easy it is to turn the assets into cash

liabilities have to be payable on demand

cash and deposits are the most liquid assets within a commercial bank

Question 24

potential conflicts between commercial banks objectives

Answer 24

liquidity + profitability (cannot invest and grow cash)

security + profitability
(need to invest and grow cash but need enough cash to be able to balance liabilities)

Question 25

profitibality

Answer 25

banks need to earn profits to pay their depositors interests, wages, and general expenses needed for a banks survival, but compromises liquidity and safety

Question 26

security

Answer 26

banks face risks and uncertainties about how much cash they can get + uncertainty on whether loans will be repaid or not banks have to try and maintain safety of their assets a bank has to keep high proportions of their liabilities with itself and the central bank but this lowers profits and may lose the customers banks

Question 27

what does central bank influence

Answer 27

interest rates the supply of money/credit the exchange rate base rates currency supply regulate bank lending to ensure there is stability in the financial system banker to government lender of last resort

Question 28

what policy tools are used to control the flow of money

Answer 28

interest rates quantitive easing

Question 29

monetary policy committee (mpc)

Answer 29

alters interest rates to control the supply of money independant of the government, meet 8 times a year to discuss the interest rate

Question 30

what are the goals of interest rates

Answer 30

to keep government target of 2±1% inflation rate (through the cost and borrowing and reward of savings)

Question 31

base rate

Answer 31

defined as the interest rate set by the central banks for lending to other banks used as a benchmark for interest rates set by commercial banks

Question 32

central bank to government

Answer 32

collects payments to the government and makes payments on behalf of the government maintains and operates deposit accounts of the government manages public debt and issue loans bank also advices the government on finances (e.g. the timing and terms of new loans)

Question 33

central banker as lender of last resort

Answer 33

banker to the banks if there is no other method to increase the supply of liquidiity when it is low, the bank of england will lend to increase liquidity also if an institution is risky or close to collapsing (potential moral hazard) ^ done to protect individuals who deposit funds into banks as well as to prevent a run on the bank - but banks try and avoid due to reputational issues

Question 34

run on the bank

Answer 34

when consumers all withdraw their bank deposits at once in a panic due to believing the bank will fail (but banks do not usually have enough liquidity)

Question 35

low interest rates effect on ad

Answer 35

c = reduces opportunity cost of saving, so consumers more likely to spend also cheaper mortgages and loans increase disposable income, which will increase marginal propensity to consume i = cheaper for firms to borrow, using cheaper loans to fund research and development or other forms of investment investment also increases with consumer spending due to accelerator effect g = government debt repayments are lower, will encourage government to issue more bonds x-m = due to hot money, money would leave the country which would weaken the exchange rate so would decrease the demand for the £, which would increase price competitiveness of exports (cheaper) and increase in price of imports

Question 36

accelerator effect

Answer 36

when interest rates increase more due to increasing consumer spending

Question 37

hot money

Answer 37

money that flows from different countries in search of the highest interest rates to maximise short term profits

Question 38

quantitive easing

Answer 38

used by banks to stimulate the economy (when standard monetary policy no longer working) bank of england electronically creates more money uses the money to buy government and bank bonds banks now have more money, which will increase amount they lend and stimulate the economy also increases government bonds being bought, which increase government spending

Question 39

evaluation on quantitive easing

Answer 39

assumes banks will not just keep the extra cash maybe due to concerns on if their clients abilities to repay loans - like what occurred after the gfc and only works until a certain point, it eventually becomes futile could cause cost push inflation due to depreciation of the £ increasing costs of imports also reduces external investment in bonds and the country, as it keeps interest rates low in the long term - reduces countrys productive capacity expanded

Question 40

factors considered by the mpc when setting the bank rate

Answer 40

unemployment rate savings rate consumer spending high commodity prices exchange rate

Question 41

argument on whether banks should be regulated

Answer 41

banks when they fail have significant (+ negative) effects on the economy, so should be monitored but security and following regulation can reduce the profitability of a bank, which can limit a countries economic growth

Question 42

who regulates financial firms in the uk

Answer 42

the financial conduct authority fca (also promotes competition which is in the interests of the consumers)

Question 43

who regulates risks in bankings / ensures the financial systems stability

Answer 43

financial policy committee fpc 'clamps down' on unregulated parts and loose credits in the financial system monitors overall risks to the financial system as well as regulating individual groups

Question 44

why might banks fail

Answer 44

no regulation + risky behaviour moral hazards systemic risks liquidity ratios capital ratios