2.8 The Role of Money and Financial Markets

Question 1

What is money?

Answer 1

Anything that is acceptable as a means of payment for goods and services.

Question 2

What does money consist of?

Answer 2

• Bank notes
• Coins
• Savings accounts
• Current accounts

Question 3

What is not considered to be money, but allow money to be transferred between buyers and sellers?

Answer 3

• Debit cards
• Credit cards
• Cheques

Question 4

What is meant by medium of exchange?

Answer 4

Anything that sets the standard of value of goods and services acceptable to all parties involved in a transaction. Eg: money.

Question 5

What is a debit card?

Answer 5

Transfers money from your current account to the seller. If you do not have enough money in your account, you can’t purchase the product.

Question 6

What is a credit card?

Answer 6

This enables you to buy goods and services whether or not you have money in your account. If you cannot pay this short term loan back within 30 days you are charged interest on it.

Question 7

What is the financial sector?

Answer 7

Consists of financial organisations and their products. Also involves the flow of capital.

Question 8

What is the role of the financial sector?

Answer 8

It helps markets to function by helping consumers, firms and governments carry out economic activities.

This normally involves the lending and borrowing of money between people who don’t need to use their money now (savers) and those who need it now (borrowers).

Question 9

What are banks?

Answer 9

They are financial institutions licensed to receive deposits and make loans.

Question 10

What are three examples of commercial banks?

Answer 10

1. Barclays
2. HSBC
3. Santander

Question 11

What is the 5 roles of commercial banks?

Answer 11

• Make payments on customer’s behalf
• Issue loans to individuals/firms
• Offer safe deposit boxes
• Provide currency exchange
• Accept deposits (savings) and pay interest on them

Question 12

What is the 5 things does the Central bank do?

Answer 12

• Issue bank notes, controlling the supply of money
• Control monetary policy by setting the bank rate which determines interest rates for commercial banks
• Provides financial stability
• Manage the country’s foreign reserves
• Act as a bank for commercial banks and the government

Question 13

Who are commercial banks owned by?

Answer 13

Since they are PLCs (public limited companies) they are owned by shareholders. They are paid dividends which are a percentage share of the company’s profits every quarter year.

Question 14

Name three investment banks.

Answer 14

1. Morgan Stanley
2. Goldman Sachs
3. JP Morgan

Question 15

What do investment banks help firms with?

Answer 15

• Mergers and takeovers
• Shareholder issues
• International trade

Question 16

What are building societies?

Answer 16

They are mutual financial organisations owned by their members.

Question 17

What is the role of building societies?

Answer 17

• Provide services such as savings and mortgages
• They can only borrow limted amounts of money from the market, unlike banks

Question 18

What are insurance companies?

Answer 18

They are financial institutions that guarantee compensation for specific loss, damage, death etc in return for monthly/yearly payments.

Question 19

What can insurance companies provide?

Answer 19

• Life insurance that pays out money to surviving family, intended to replace loss of income due to death
• General insurance for non-life aspects such as property

Question 20

Why is credit provision important to consumers and producers?

Answer 20

It is important to consumers because they can buy now and pay later, increasing consumption.

Producers can use credit to borrow money to expand their company.

Question 21

Why is credit provision important to the government?

Answer 21

Governments use credit to enable them to spend before tax revenue is collected or to run a budget deficit.

Question 22

What does liquidity mean?

Answer 22

Liquidity refers to how
quickly assets can be
turned into cash.

Question 23

Why is liquidity provision
important to consumers?

Answer 23

It is important as they can borrow money now and pay later, often against an asset like a house.

Question 24

Why is liquidity provision
important to producers?

Answer 24

This means that banks are able to provide overdraft facilities (when there isn’t enough money in your account for a transaction) so firms can continue trading while waiting for their revenue.

Question 25

Why is risk management
important to consumers?

Answer 25

It allows savers to spread their risk by putting their money into a range of companies, rather than one.

Question 26

Why is risk management
important to producers?

Answer 26

This reduces the risk of not receiving payment, especially when there are delays with exporting.

Question 27

Why is risk management
important to the government?

Answer 27

This allows for vital expenditure, even when government revenue is uncertain.

Question 28

What is saving?

Answer 28

Is the part of an individual’s income which is not spent on consumption.

Question 29

What is borrowing?

Answer 29

Is receiving money (or something of value) in exchange for an obligation to pay it back in the future.

Question 30

What is investment?

Answer 30

For firms, the purchase of capital goods that are used to produce future goods and services.

It can also be an asset purchased to provide an income in the future and/or to be sold at a profit.

Question 31

How do interest rates affect the level of saving?

Answer 31

In general, higher interest rates will attract savers and vice versa. The opportunity cost of spending is the loss of interest payable on savings.

Question 32

How do interest rates affect the level of borrowing?

Answer 32

A rise in the rate of interest will increase the cost of borrowing. This rise will cause consumers (as it is more expensive to pay back) and save more. Firms will also borrow and sell less due to exports costing more.

Question 33

How do interest rates affect the level of investment for consumers?

Answer 33

The level of investment is inversely proportional to the interest rate. Consumer investment will increase if interest rates are low because there is a lower opportunity cost involved in sacrificing saving.

Question 34

How do interest rates affect the level of investment for producers?

Answer 34

Lower interest rates encourage consumer spending, so firms will need to expand and thus invest more.

However, if consumers lack confidence in the economy, the demand for products may not increase and therefore investment for expanding the firm will not be required.

Question 35

How do you calculate the effect of changes in interest rates on saving/borrowing?

Answer 35

Amount saved/borrowed × (interest rate ÷ 100)