BA1 Chapter 3

Question 1

What are the different financial markets?

Answer 1

Capital Markets - Stock market for shares and bonds
Money markets - Short-term debt financing and investment
Commodity markets - oil, metals etc
Derivatives markets - instruments for the management of financial risk
Insurance markets - facilitate the redistribution of various risks
Foreign exchange markets - trading forex

Question 2

What are the roles of intermediaries?

Answer 2

Risk Reduction
Aggregation
Maturity transformation
Financial intermediation

Question 3

How do businesses deal with cash flow problems in the short, medium and long term?

Answer 3

Short term- Overdraft
Medium term- Loans leasing
Long term- equity and loans

Question 4

How do governments deal with cash flow problems in the short medium and long term?

Answer 4

Short term- Central bank credit facility
Medium term- Loans and bonds
Long term- Loans and bonds

Question 5

What are some of the considerations when assessing financial products?

Answer 5

Yield/Cost 
Risk
Time periods 
The amounts involved
Liquidity 
Transaction costs

Question 6

What is the difference between capital and money markets?

Answer 6

Capital markets are usually for more than a year and include bonds and mortgages

Money markets are less than a year and include CDs and bills of exchange

Question 7

Name the characteristics of ordinary shares (equity)

Answer 7

Return: Potentially very high
Risk: Potentially very high
Timescales: long term
Liquidity: Good for quoted companies

Question 8

Name the characteristics of bonds

Answer 8

Return: Low
Risk: Low
Timescales: Vary from short term to long term
Liquidity: Good if quoted companies

Question 9

Name the characteristics of Certificates of deposit (CD)

Answer 9

Return: Very low
Risk: Very safe
Timescales: 3 to 6 months
Liquidity: Can be sold on the money market

Question 10

Name the characteristics of Credit agreements

Answer 10

Return: Usually very high interest
Risk: The credit card company faces the risk
Timescales: Usually short-term
Liquidity: Debt cannot be sold by lender but debt may be repaid earlier usually

Question 11

Name the characteristics of Mortgages

Answer 11

Return: Usually relatively low
Risk: Usually low
Timescales: Long-term
Liquidity: Can be sold by lender in form of CDO. The borrower may repay loan early with possible penalties

Question 12

Name the characteristics of bills of exchange

Answer 12

Return: The difference between the discounted amount of which it is sold/bought and the full face value
Risk: Level of risk varies
Timescales: Short term
Liquidity: Can be resold on the money market

Question 13

How do you calculate yield on equity?

Answer 13

Dividend yield= (dividend per share/share price) * 100

Question 14

How do you calculate the running yield on a bond?

Answer 14

Running yield= (annual interest/market value) * 100

Question 15

Explain the term structure for interest rates

Answer 15

Lenders normally demand higher interest rates on loans as the term to maturity increases

Question 16

What is the difference between the real and nominal interest rates?

Answer 16

Nominal interest rate is the simple % interest per annum

The real interest rate is the return after inflation has been taken out

Question 17

What are the two types of financial intermediaries?

Answer 17

Deposit-taking institutions (DTIs) such as banks and building societies

Non-deposit-taking institutions (NDTIs) such as insurance companies, pension funds and investment trusts

Question 18

Break down the types of banks

Answer 18

Investment banks

Commercial banks

• Retail banking
• wholesale banking

Question 19

What is a cash ratio?

Answer 19

10% of deposited cash will be withdrawn, leaving the rest for loans and investments

Question 20

Formula for change in total deposits

Answer 20

Change in total deposits = (1/cash ratio) * the initial cash deposit

Question 21

What is the role of Central banks?

Answer 21

Banker to other banks

Banker to the government

• Bank accounts for government departments
• Operates monetary policy
• Raising/redeeming funds and managing the national debt
• Manages the reserves of foreign currency

Supervises banking system

• Manages liquidity
• Lender of last resort

Question 22

What are characteristics of a money markets

Answer 22

Treasury bills, commercial bills, CDs and short term debt

Used by banks, companies, local authorities and the Government via discount houses

Question 23

What are characteristics of the stock markets

Answer 23

Full equity market
-Primary and secondary markets in ordinary shares, preference shares and debentures

Alternative investment market (AIM)
-For shares in smaller companies

Government bonds

• Fixed certain price
• Main buyers are pension funds and life assurance companies