Chapter 5: Environmental Influences

Question 1

Central banks may be involved with: (7)

Answer 1

1. monetary, interest rate and inflation policy
2. banking regulation
3. Implementation of government borrowing
4. Performance and integrity of financial markets
5. Intervention in currency markets
6. Printing and minting of notes and coins
7. Taxation

Question 2

Main investor classes (4)

Answer 2

1. Households
2. Financial intermediaries
3. Businesses
4. Foreign investors

Question 3

Advantages offered by financial intermediaries (4)

Answer 3

1. Pooling of investors’ resources enabling lending of large amounts
2. Diversification
3. Expertise
4. Lower costs

Question 4

Role of investment banks: (4)

Answer 4

1. advise on the price to be charged
2. handle the marketing of the issue
3. verify the quality of the information supplied
4. innovate security design and packaging

Question 5

List the main forms of government policy (5)

Answer 5

1. monetary policy
2. fiscal policy
3. national debt management policy
4. exchange rate policy
5. prices and incomes policy

Question 6

Interest rates affect: (4)

Answer 6

1. personal sector expenditure
2. business sector investment and economic growth prospects
3. corporate profitability
4. the balance of payments

Question 7

The ways in which companies avoid tax (3)

Answer 7

1. financing subsidiaries in high-tax countries mainly with debt to reduce profits
2. reducing profits in high-tax areas through excessively high transfer pricing for intra-group transactions
3. transferring profits through the use of hybrid instruments that arbitrage between tax regimes.

Question 8

Describe the main forms of government policy: (5)

Answer 8

1. Monetary policy - the control of some measure of money supply and/or the level and structure interest rates.
2. Fiscal policy - decisions on the level and structure of taxation and government spending and hence, by implication, the public sector borrowing requirement.
3. National debt management policy - the manipulation of the outstanding stock of government debt instruments held by the domestic private sector.
4. Exchange rate policy - directed towards achieving some target for the exchange rate, perhaps with the objective of influencing the country’s international trading and investment patterns.
5. Prices and incomes policy - aimed at influencing the rates of wage and price inflation.

Question 9

The success of a government’s economic policy can best be assessed in terms of the major economic objectives: (4)

Answer 9

1. unemployment
2. inflation
3. balance of payments
4. economic growth

Question 10

Monetary policy

Answer 10

the control of some measure of the money supply and/or the level and structure of interest rates.

Question 11

Fiscal policy

Answer 11

decisions on the level and structure of taxation and government expenditure and hence, by implication, the public sector borrowing requirement.

Question 12

National debt management policy

Answer 12

the manipulation of the outstanding stock of government debt instruments held by the domestic private sector, in order to influence the level and structure of interest rates or the availability of liquid reserve assets to the banking sector.

Question 13

Exchange rate policy

Answer 13

directed towards achieving some target for the exchange rate of the domestic currency in terms of foreign currencies, perhaps with the objective of influencing the country’s international trading and investment patterns.

Question 14

Non-market (direct) controls used by the Central Bank: (3)

Answer 14

1. setting minimum liquid reserve ratios
2. setting interest rate ceilings for bank deposits
3. issuing directives regarding the types of lending to be undertaken

Question 15

What is Quantitative Easing (QE): (2)

Answer 15

1. Quantitative Easing (QE) is a monetary policy used by some central banks to increase the supply of money.
2. It usually involves both a direct increase in the money supply (i.e. electronically ‘printing’ money) and a knock-on effect from the fractional reserve system, increasing money supply further.

Question 16

The Quantitative Easing process:

Answer 16

1. QE is usually implemented by a central bank by first crediting its own account with money it creates out of nothing (‘ex nihilo’).
2. It then purchases financial assets, for example government bonds, quasi-government debt, MBS and corporate bonds, from banks and other financial institutions in a process referred to as ‘open market operations’ (OMO).
3. It can also involve changing the reserve requirements for banks which, through the fractional reserve system, would increase the money supply.

Question 17

Describe Forward Guidance

Answer 17

It enables the central bank to indicate, in the absence of any unforeseen events, how the central bank believes monetary policy will change in the future - usually over the following 18 to 24 months.

Question 18

The different categories, and investors within each category, will vary in their: (3)

Answer 18

1. time horizons
2. appetite for risk
3. taxation position