2021 Exam

Question 1

Bond Yields

Answer 1

The annual average return on a bond. Yield = coupon rate / market price. Price and yields of bonds inversely related

Question 2

Critical mass in retail payments

Answer 2

A company achieves critical mass when it has paid back initial investors and can continue running the business profitably without any additional investment required

Question 3

Best Execution

Answer 3

A legal requirement that brokers seek the most favorable options to execute their clients’ orders within the market

Question 4

A short squeeze

Answer 4

Condition that triggers rapidly rising prices in a stock or other tradable security. It occurs when lots of investors are betting on a securities price falling. Price jumps higher unexpectedly and gains momentum as a significant measure of the short sellers decide to exit their positions.

Question 4

Loophole mining

Answer 4

Where a person or business avoids the law without directly violating it. Loopholes provide ways for individuals to remove income or assets from taxable situations into ones with lower taxes or none at all.

Loopholes are most prevalent in complex business deals involving tax issues, political issues, and legal statutes.

Question 5

Law of one price

Answer 5

States the price of an identical asset or commodity will have the same price globally, regardless of location, when certain factors are considered.

Takes into account a frictionless market, where there are no transaction costs, transportation costs, or legal restrictions, the currency exchange rates are the same, and that there is no price manipulation by buyers or sellers.

Question 6

The Policy Trilemma

Answer 6

Countries can only choose 2 of the 3 policies for their economy when managing international arrangements
Fixed ER
Free Capital Mobility
Independent Monetary Policy

Question 7

The Policy Trilemma

Answer 7

Countries can only choose 2 of the 3 policies for their economy when managing international arrangements
Fixed ER
Free Capital Mobility
Independent Monetary Policy

Question 8

Restrictive covenants

Answer 8

Condition that restricts the actions of someone named in an enforceable agreement. In bond obligations, restrictive covenants limit the amount issuers can pay in dividends to investors.

Negative covenants are actions you can’t take, while positive covenants are actions you must take.

Question 9

What affects bond prices & yields

Answer 9

A bond is a type of security where the issuer owes the holder a debt. Can be used to fund projects

Real yield - nominal yield - inflation
Nominal yield (coupon rate) - total annual payments / value of bond

Monetary policy (yield curve) - short term - low IR = increase price = lower yield
Demography - long term

longer maturity date = higher yield (more risky) = lower price vice versa

Inflation - erodes the purchasing power of a bonds future cash flow. Anticipated inflation = higher IR & bond yields to make up for inflation

IR - If bond market thinks IR rate has been set too low by the Fed or BoE = inflation expectations increase = long term IR increase relative to short term rates = increasing yield over time vice versa

Risk - bonds assigned credit ratings. Lower credit ratings = less attractive to investors and price falls.

Question 10

Describe with examples order driven and quote driven markets

Answer 10

Order driven market - Trade rules match buyers & sellers - orders of buyers & sellers are displayed, detailing the price at which they are willing to buy or sell security. Buyers and sellers directly trade with each other. Price priority - highest bid and lowest ask price first. Non hidden and earliest orders first = improved liquidity

ODM - NYSE
QDM - Nasdaq
Both (Hybrid) - London Stock Exchange

A quote-driven market (OTC) as literally used to be traded over the counter- Buyers/ Sellers trade with dealers. Electronic stock exchange system in which prices are determined from bid and ask quotations made by market dealers (more liquid than order). Dealers fill orders from their own inventory or by matching them with other orders.

Question 11

How conflicts of interest make the asymmetric information problem in financial markets worse?

Answer 11

Lemons problem - how adverse selection influences financial structure. If quality cannot be assessed, buyer is willing to pay at most a price that reflects the average quality. Sellers of good quality items will not sell at the price for average quality. Buyer will decide not to buy at all because all that is left in the market is poor quality items

Debt & Equity contracts - sellers of securities may have incentives to hide information & engage in undesirable activities for stockholder.

Separation of ownership of firm - managers pursue personal benefits rather than profitability of firm.

Question 12

Tools to help solve asymmetric information problem

Answer 12

Adverse selection - collateral, gvt regulation to increase information

Moral Hazard in equity & debt contracts - financial intermediation, collateral, debt contacts (fixed periodic payment), gvt regulation to increase info

Question 13

The stages of a financial crises in emerging economies

Answer 13

Financial crises occurs when there is a large disruption to information flow in FM where financial frictions increase sharply and markets stop functioning
Can develop along 2 ways

Stage one: initial phase
Path A Credit boom and bust
Path B Fiscal Imbalances

Stage 2: Currency Crisis
Stage 3: Full-fledged financial crisis

Question 14

Twin crisis

Answer 14

Simultaneous collapse of the banking system and currency in a country

Question 15

Stages of a financial crisis in advanced economies

Answer 15

Stage one: Initiation of financial crisis
Stage 2: Banking crisis
Stage 3 :Debt deflation

Question 16

Sterilised foreign exchange interventions

Answer 16

Form of monetary action in which a central bank seeks to limit the effect of inflows and outflows of capital on the money supply. Involves the purchase or sale of financial assets by a central bank and is designed to offset the effect of foreign exchange intervention. No impact on monetary base and money supply

Show T account

As an example, consider the Federal Reserve (Fed) purchasing foreign currency, in this case the yen, with dollars that it has in its reserves. This action results in there being less yen in the overall market—it has been placed in reserves by the Fed—and more dollars, since the dollars that were in the Fed’s reserve are now in the open market.

To sterilize the effect of this transaction, the Fed can sell government bonds, which removes dollars from the open market and replaces them with a government obligation. So no impact on ER

Problems: Money spent buying foreign assets initially goes to other countries, but it soon finds its way back into the domestic economy as payment for exports. The expansion of the money supply can cause inflation, which can erode a nation’s export competitiveness just as much as currency appreciation would.

Question 17

Unsterilised foreign exchange intervention

Answer 17

Refers to how a country’s monetary authorities influence exchange rates and its money supply—domestic currency is sold to purchase foreign assets leads to a gain in international reserves, an increase in MS, depreciation of domestic currency

Question 18

The Economic Implications of Open Banking

Answer 18

Open banking - set of services supported by Application programme interface (API) in which each service provider makes clear what they are offering and asks customer for access to their data in order to provide these services.

Enhanced competition: lower prices & improved service between incumbent banks

Lowering Entry barriers: new entrants will erode the historic information advantages of banks as entrants leverage FinTech to challenge incumbents

Lower search costs for consumers: use single banking interface when seeking particular products rather than searching case by case

Consumer utility: access to a wider range of products through specialist apps

Enhanced innovation: new products

Enhanced information: to consumers could assist in budget planning

Less dependence on banks and credit cards for payments as consumers can make online credit transfers

Question 19

Challenges of open banking to consumers

Answer 19

Security & risk - security of data transfers, possibility of unauthorised data access, cyber attacks

Lack of consumers understanding of open banking or regulatory protections that are put in place to protect consumers

Consumer concerns about erosion of ‘‘relationship banking’’: increased remoteness from suppliers of financial services especially when there is a shift towards algorithms

Question 20

Challenges of open banking to banks

Answer 20

New & enhanced risks business risk: model risks, operational risk, cyber attacks

Erosion of traditional consumer interface inhibits ability to over price where competition is weak. Products likely to become commoditised - restrict margins & profitability

Greater volatility of savings balances giving rise to increased liquidity risk as consumer loyalty is lessened. Deposit takers may have to pay more to retain savings

Reputational risk associated with technology failures