Paper 3

Question 1

Who are the Bank of England’s macro-prudential regulator and what do they do?

Answer 1

Financial Policy Committee (FPC):
- Protect against systemic risk
- Instruct PRA & FCA in tackling instability
- Advise the government on financial market shocks

Question 2

Who are the Bank of England’s micro-prudential regulator and what do they do?

Answer 2

Prudential Regulation Authority (PRA):
- Supervise risk in the form of moral hazard (banks taking excessive risk)
- Set industry standards
- Specify ratios & requirements (liquidity ratio and reserve requirements)

Question 3

Who are the Government’s macro-prudential regulator and what do they do?

Answer 3

Financial Conduct Authority (FCA):
- Supervise conduct of firms (prevent collusion of interest rates)
- Promote competition to improve consumer surp (deregulation)
- Ban mis-selling of products (PPI scandal form of market failure)
- Ban misleading adverts (Loan sharks must include interest rates)

Question 4

What are the 4 functions of money?

Answer 4

• Store of value
• Unit of account
• Medium of exchange
• Standard for deferred payment

Question 5

What does ‘standard for deferred payment’ mean?

Answer 5

Money can be used to pay back any debts arising from credit transactions

Question 6

What does ‘unit of account’ mean?

Answer 6

Money is the standard measure used to compare the value of a range of goods

Question 7

What does ‘store of wealth’ mean?

Answer 7

Money is a liquid asset which can be used to store wealth over a long period of time. HOWEVER, inflation can erode this store of wealth

Question 8

What does ‘medium of exchange’ mean?

Answer 8

Money avoids a barter economy in which consumers must find a producer who is willing to exchange for an offered good. Money eliminates the need for a double coincidence of wants

Question 9

What are the 6 characteristics of money?

Answer 9

Durable
Divisible
Portable
Acceptable / non-perishable
Scarcity
Stability in value

Question 10

What is the difference between narrow and broad money?

Answer 10

Both narrow and broad money include cash in circulation as well as central bank reserves. However, broad money also encompasses deposits such as bank deposits and sight deposits

Question 11

What are sight deposits?

Answer 11

Deposits at a bank which can be withdrawn at very short notice

Question 12

How is demand for bonds determined?

Answer 12

By the relative attractiveness of the return on bonds compared to return on saving in bank. If interest rates fall, bonds will pay a relatively better return on investment and so demand for bonds increases.

Question 13

What happens if demand for a bond increases?

Answer 13

Market price of the bond increases
This means the fixed coupon will represent a lower coupon rate of the bond and so the yield has fallen

Question 14

What is the money market?

Answer 14

Financial markets which provide short-term lending with assets maturing in less than a year (short-term bonds)

Question 15

What are capital markets?

Answer 15

Markets which provide long-term lending such that assets mature in a year or more (long-term bonds)

Question 16

What are the two components of the capital market and what do they mean?

Answer 16

Primary capital market - Issuance of new bonds in financial markets
Secondary capital market - Re-selling of bonds or other assets from the primary market

Question 17

What are FOREX markets?

Answer 17

Foreign exchange markets in which currencies are sold and purchased
(an example of hot money flows)

Question 18

What is debt capital?

Answer 18

A financial asset that pays a return based off the interest rate

Question 19

What is equity capital?

Answer 19

A financial asset that pays a return in the form of a dividend

Question 20

What are spot currency markets?

Answer 20

Buying currency at the current exchange rate to be delivered instantly

Question 21

What are future markets?

Answer 21

Buying currency at the current exchange rate to be paid in future

Question 22

Who might partake in future markets and why?

Answer 22

Importers - Buy a currency at a stronger exchange rate to prevent raw materials becoming expensive relatively
Speculators - Those trying to make profit by gambling on changes in the exchange rate

Question 23

What change in the exchange rate must be foreseen to partake in future markets?

Answer 23

A depreciation in the exchange rate

Question 24

When does inter-bank lending stop and why is this bad?

Answer 24

In a financial crisis.
This means banks struggle to maintain their liquidity ratios and this lack of liquidity can lead to a surge in withdrawals from the bank in fears of insolvency which can exaggerate the problem

Question 25

How is asymmetric information an issue in financial markets?

Answer 25

During a boom, asymmetric information can lead to speculative lending to borrowers with poor credit scores. This can lead to asset bubbles as seen in the 2008 crisis and eventually a crash