Chapter 5= Risk and the financial sector

Question 1

difference between risk and uncertainty

Answer 1

risks can be quantified whereas uncertainty is impossible to predict. Uncertainty makes it difficult for businesses and governments to plan for the the future.

Question 2

the impact of shocks

Answer 2

fall in commodity prices
uncertainty makes businesses very reluctant to invest and FDI slows
fall in injections can be very significant
shocks always require considerable adjustment

Question 3

forward markets

Answer 3

make it possible to buy a certain quantity of goods or foreign currency at a price agreed today for delivery at a specific date. This makes it possible to insure against unexpected changes in prices or exchange rates.

Question 4

insurance

Answer 4

is the principle by which risks are shared between all those who wish to protect themselves from unforeseen outcomes

Question 5

role of the financial sector

Answer 5

• mobilising savings for lending to firms (for investment in working capital) and individuals
• facilitating the exchange of goods and services
• assessing creditor risk
• providing forward markets in currencies/commodities
• providing a market for equities

Question 6

central bank lending to other banks

Answer 6

an important central bank function is to act as a last resort this means:

• providing short term loans to even out daily fluctuations in flows of money between banks and
• lending to banks that are unable to meet all customers demands to withdraw their money.

Question 7

what is moral hazard

Answer 7

the fact that the banks can encourage them to take risks and behave irresponsibly knowing that they can borrow from their central banks.

Question 8

too big to fail means…

Answer 8

that the cost to the whole economy of a big bank failing is so great that the government cannot allow it to happen . the bank will have to be bailed out with huge loans.

Question 9

financial conduct authority

Answer 9

covers the entire financial sector, not just the banks. Its main purpose is to ensure that the financial institutions are not misled.

Question 10

the prudential regulation authority

Answer 10

is an arm of the bank of England, charged with supervision of the banks, building societies, credit unions, insurers and major investment firms.