Week 2

Question 1

Free market economics

Answer 1

Where prices for goods and services are freely set by supply and demand without the influence of government policy or rules.

Question 2

Complete regulation

Answer 2

All prices and trade are set by the government.

Question 3

Which is more desirable? A completely free market or complete regulation?

Answer 3

Neither extreme is desirable to achieve efficient flow of funds.

Question 4

What does Australia’s balance of regulation in a free market do? (2)

Answer 4

Protects consumers and taxpayers from excessive risk taking and provides and equitable outcome for all stakeholders.

Question 5

What does over-regulation do?

Answer 5

It inhibits the efficient flow of funds

Question 6

How does over-regulation inhibit flow of funds?

Answer 6

It does not leave banks free to compete because of interest rate ceilings imposed on their deposit taking and loan products.

Question 7

Does under regulation also inhibit flow of funds?

If so, how?

Answer 7

Yes.

Without sufficient rules/parameters to operate by the financial market can experience wide scale fraud.

Question 8

3 monetary authorities who regulate Australia’s financial system are

Answer 8

1. RBA.
2. APRA.
3. ASIC.

Question 9

What is the RBA responsible for?

Answer 9

Monetary policy, the payments system and the stability of the financial system.

Question 10

Why is the RBA important in finance?

Answer 10

It plays a prime role in determining the cost of debt capital in the economy.

Question 11

3 things the RBA does

Answer 11

1. Acting as the government’s banker.
2. Issuing Australian currency notes.
3. Overseeing the payments system.

Question 12

What is monetary policy?

Answer 12

Control over the supply of money.

Question 13

Expansionary money policy

Answer 13

Increasing money supply.

Question 14

Contractionary money policy

Answer 14

Decreasing money supply.

Question 15

What is official cost rate?

Answer 15

The benchmark interest rate of the economy.

Question 16

How do banks respond when the RBA increases the cash rate?

WHY?

Answer 16

Banks will likely increase their interest rates on their products (loans and deposits).
The cost of an important source of bank funding has increased so they will pass on this expense to customers.

Question 17

How do banks respond when the RBA decreases the cash rate?

WHY?

Answer 17

Banks will likely decrease their interest rates on their products (loans and deposits).
The cost of an important source of bank funding has decreased so they will pass on this saving to customers in attempts to gain market share.

Question 18

What does an increased cash rate do to cost of debt in the economy?
Why?

Answer 18

Increases cost of debt in the economy because loans become more expensive.

Question 19

What does an decreased cash rate do to cost of debt in the economy?
Why?

Answer 19

Decreases cost of debt in the economy because loans become cheaper.

Question 20

What happens when cost of debt increases?

Or decreases?

Answer 20

People borrow less, lower consumption and investment, contracts supply of money, dampens economic growth.
People borrow more, greater consumption & investment, expanding supply of money, stimulating economic activity/growth.

Question 21

How does the RBA affect economic activity?

Answer 21

By influencing the overall cost of debt in the economy.

Question 22

When the economy weakens and cost of debt is high what can the RBA do?

Answer 22

The RBA can enact expansionary money policy by lowering the cash rate (e.g. By 25 basis points), thus lowering the cost of debt and stimulating consumption and investment (with lower interest rates).

Question 23

When the economy overheats and cost of debt is low what can the RBA do?

Answer 23

The RBA can enact contractionary monetary policy by increasing the cash rate, which increases cost of debt, dampening consumption and investment.

Question 24

What is the RBA’s official cash rate today?

Answer 24

7%.

Question 25

How does the RBA measure economic performance?

Answer 25

Inflation.

Question 26

What is inflation?

Answer 26

A change in the general levels of goods and services in the economy.

Question 27

If demand for g/s increases, what happens to inflation?

Answer 27

It increases (shown by increase in prices).

Question 28

Decreased demand for g/s means inflation .....

Answer 28

Decreases.

Question 29

Can inflation be both good and bad?

Answer 29

Yes.

Question 30

Increased inflation also means consumption and investment are .... Decreased inflation means consumption and investment are ....

Answer 30

Growing. | Declining.

Question 31

Why is too much inflation undesirable?

Answer 31

Because it indicates the economy is overheating - incomes and prices of g/s are growing at an unsustainable rate.

Question 32

Why is too little inflation undesirable?

Answer 32

It indicates the economy is weakening - income is flat or declining, resulting in poorer demand of g/s, and thus poorer wage growth and higher unemployment.

Question 33

If you earn 3% on an investment, but inflation is 3% what might this mean?

Answer 33

You are not actually able to buy more and you have not actually earned anything.

Question 34

What is the inflation risk?

Answer 34

The potential erosion of purchasing power gained from income and investment.

Question 35

How is the inflation risk compensated?

Answer 35

By the inflation risk premium.

Question 36

Rate of return =

Answer 36

Nominal rate - inflation rate.

Question 37

What is the Australian payment system?

Answer 37

A set of arrangements that enables consumers, businesses and other parties to enter into and settle financial transactions.

Question 38

What does the Australian payment system include?

Answer 38

EFTPOS, debit cards, PayPal and other forms of cash payment.

Question 39

3 roles regarding payments

Answer 39

1. Promotes the efficiency and stability of the Australian currency (AUD) and the payments system. 2. It provides the facilities for the settlement of transactions. 3. It acts as the banker to the Australian government.

Question 40

Electronic banking

Answer 40

The execution of banking services, using electronic devices.

Question 41

Advantages of electronic banking:

Answer 41

- low/no fees. - speed/efficiency, convenience. - greater accessibility and functionality. - a way of supplementing face-to-face banking.

Question 42

Disadvantages of electronic banking

Answer 42

- security, privacy and trust concerns. - unreliability of internet and infrastructure. - simple preference for face-to-face banking. - self-perceived inability of consumers to handle electronic banking.

Question 43

What is APRA responsible for?

Answer 43

The prudential supervision of: - banks and other ADIs (Authorised Deposit-taking institutions), controls their risk taking. - insurance companies. - superannuation companies.

Question 44

What do ADIs do?

Answer 44

ADIs serve as the main intermediary through which the flow of funds and payment system occurs in the economy, particularly between the general public and the private sector.

Question 45

Why is it important that ADIs do not take excessive risks? (3)

Answer 45

- to maintain investors confidence. - to prevent bank failures from spreading to other banks; limit contagion and risk of disrupting whole economy. - protect the stability of the financial system.

Question 46

Capital Adequacy

Answer 46

A portion (capital adequacy ratio) of a banks capital that they cannot lend out as assets that has to be kept as liquid capital in reserve to buffer and protect against loan losses.

Question 47

ADIs must adhere to an ____ CAR

Answer 47

8%

Question 48

For example, if a business has $100 capital and there is 8% CAR how much in $ must that business set aside?

Answer 48

$80

Question 49

If more capital has to be left in reserve (if CAR), holding all else constant, what affect does this have on remaining capital?

Answer 49

There will be less capital available to be invested in productive, interest-earning assets and total revenue from assets also goes down.

Question 50

So a higher CAR increases .....

Answer 50

Effective cost of capital.

Question 51

3 things ASIC is responsible for

Answer 51

1. Regulating financial markets (e.g. ASX). 2. Consumer protection in superannuation, insurance, deposit-taking and credit. 3. Regulating the raising of equity capital by an IPO (initial public offering).

Question 52

How does the ASIC influence the cost of an IPO? (2)

Answer 52

Directly through the number and extent of regulations that listing companies need to comply with. More extensive regulation = greater IPO cost.

Question 53

How would such a high transaction cost of capital affect the flow the funds?

Answer 53

Higher costs would discourage it.

Question 54

3 ASIC priorities

Answer 54

1. Assist and protect retail investors and consumers in the financial economy. 2. Facilitate international capital flows and international enforcement. 3. Build confidence in the integrity of Australia's capital markets.