Money and the Financial System

Question 1

What are the four purposes of money

Answer 1

Medium of exchange
Means of storing wealth
Means of evaluation
Means of establishing value of future claims and payments

Question 2

What is the role of banks in the economy

Answer 2

Facilitate moving money
Risk transformation
Maturity transformation
Expert advice
Transmission of funds
Expertise in channelling funds

Question 3

What are the three levels of money

Answer 3

Narrow money
Intermediate money
Broad money

Question 4

What is Narrow money M1

Answer 4

currency in circulation with the public and overnight deposit

Question 5

What is Intermediate money M2

Answer 5

M1 + deposits with agreed maturity up to two years + deposit redeemable up to three month’s notice

Question 6

What is Broad Money M3

Answer 6

M2+ repos+ money market funds and paper + debt securities with residual maturity up to two years

Question 7

Define MFI

Answer 7

Monetary financial institution - Deposit taking institutions including central banks, credit institutions, other deposit taking corporation and money market funds

Question 8

Explain the two types of credit institution

Answer 8

Retail banking -Branch, telephone, postal and internet banking for individual and business at published rate of interest and charges
Wholesale banking - where banks deal in large-scale deposits and loans mainly with companies and other banks and financial institutions. Interest rates and charges may be individual and negotiable

Question 9

What are a banks assets

Answer 9

Cash including reserve balances
Market loans - especially for retail banks
Bills of exchange
Reverse repos
Advances - short term loans ex: overdraft
Investments

Question 10

Define assets

Answer 10

Possession or claims held on others

Question 11

Define market loans

Answer 11

Loans made to other financial institutions

Question 12

Define bills of exchange

Answer 12

A certificate promised to repay a stated amount on a certain date (usually 3 months from issue). No interest is paid but sold at a discount and redeemed at a face value

Question 13

Define reverse repo

Answer 13

When assets are purchased under a sale and repurchase agreement, these become an asset of the purchaser

Question 14

What are liabilities of a bank

Answer 14

Sight deposits
Time deposits
Sale and repurchase agreements  
Certificates of deposits  
Capital

Question 15

Define liabilities

Answer 15

All legal claims for payment that outsiders have on an institutions

Question 16

Define sight deposit

Answer 16

Deposits that can be withdrawn on demand without penalty

Question 17

Define time deposit

Answer 17

Deposits that require notice of withdrawal or where a penalty is charged for withdrawals on demand

Question 18

Define certificate of deposit

Answer 18

Certificates issued by banks for fixed ter, interest bearing deposits. They can be resold by the owner to another party

Question 19

Define sale and repurchase agreement

Answer 19

An agreement between two financial institutions whereby one in effect borrows from another by selling its assets agreeing to buy them back at a fixed price and on a fixed date

Question 20

Define a maturity gap

Answer 20

The difference in the average maturity of loans and deposits - banks should very much consider this - banks get a benefit from the maturity gap and additional maturity.

Question 21

Define the liquidity ratio

Answer 21

The proportion of a bank’s total assets held in liquid form

Question 22

Explain profitability key idea from banks perspective

Answer 22

Interest higher on lending than deposit

Question 23

Explain liquidity from a banks perspective and the key ideas

Answer 23

Ease at which an asset can be converted to cash without loss
The more liquid an asset the less profitable
Cash is least profitable asset you can hold

Question 24

What is the role of central banks

Answer 24

Issues notes
Operates banking functions
Agent of government policy
Provides liquidity

Question 25

Define discount and repo market

Answer 25

Banks borrowing from central banks

Question 26

Define parallel money market

Answer 26

Interbank markets, Inter company Deposit markets, foreign currency market, commercial paper market

Question 27

Define secondary markets

Answer 27

Where an asset is sold before maturity to another institution or individual. Anywhere an asset is getting sold before maturity to another institution or individual not involved in the primary transaction

Question 28

Explain securitisation

Answer 28

Where future cash flows (ex: from interest rate of mortgage payments) are turned into marketable securities ex: bonds

Question 29

What is the securitisation chain

Answer 29

Lender sells assets to SPV SPV sells secured assets to bond holders Bond holder gives cash to SPV SPV gives proceeds form notes to lenders

Question 30

What does SPV stand for

Answer 30

Special purpose vehicle

Question 31

Explain the bank deposits multiplier in context of credit creation

Answer 31

Number of times greater the expansion of bank deposits is than the additional liquidity in banks that caused it: i/L (inverse of the liquidity ratio)

Question 32

Define the money multiplier in context of credit creation

Answer 32

The number of times greater the expansion of money supply is than the expansion of the monetary base that caused it

Question 33

How do liquidity ratios work in the real world

Answer 33

As you receive more deposit your liquidity ratio will change. Liquidity ratio will not be constant over time Banks may not operate a simple liquidity ratio - may not be one ratio for everything - different portfolios or commercial loans vs residential roles or credit card advances may have different views on the liquidity ratio

Question 34

What increases supply of money

Answer 34

Banks reduce liquidity ratio Non-bank private sector chooses to hold less cash - putting it back into the financial system means there's more money A public sector deficit - government spending Inflow of funds from abroad

Question 35

Define exogeneous money supply

Answer 35

money supply that does not depend on the demand for money but is set by the authorities - not dependent on interest rates

Question 36

Define endogenous money supply

Answer 36

Money supply that is determined (at least in part) by the demand for money

Question 37

Explain the transaction motive for holding money

Answer 37

Require balances of money to conduct transactions(medium of exchange)

Question 38

Explain the Precautionary motive for holding money

Answer 38

to deal with unforeseen circumstances or uncertainty over timing of receipt/payments ex; if my car breaks I have money available for unexpected events

Question 39

Explain the speculative motive for holding money

Answer 39

using money as an asset when ex: Anticipating a fall in the value of other assets categories (means storing value)

Question 40

What determines the demand for money

Answer 40

Money national income Frequency at which people are paid Financial institutions Speculation about future returns on assets

Question 41

What effect foes money supply increasing have on the key economic indicators

Answer 41

Interest rate goes down so investment increases while saving decreases Demand for foreign assets increases so exchange rate decreases This means exports increase and imports decrease Aggregate demand increases overall and GDP and Prices rise