Week 10 - Financial Markets

Question 1

Purpose of money

Answer 1

1) medium of exchange
2) store of value
3) unit of account
4) standard of deffered payment

Question 2

What are the properties money should have?

Answer 2

1) acceptable to most people
2) of a standardised quality
3) durable
4) valuable relative to its weight
5) divisable

Question 3

What is the problem with commodity money

Answer 3

Can be debased by the metal being made less pure and the overall money supply if fixed by the supply of the metal

Question 4

What is fiat money?

Answer 4

authorised by a central bank or gov and doesn’t have to be exchanged by a central bank for a commodity. It offers much more flexibility but depends on the belief in the integrity of the gov

Question 5

What is credit?

Answer 5

loans, advances and bills provided to the private non-bank sector by financial intermediates.

Question 6

What is financial intermediation?

Answer 6

facilitate money transactions and specialise in particular function to make them more efficient

Question 7

What are commercial banks?

Answer 7

Businesses where bank accepts money from savers and lends out this borrowed money. The core business is to connect surplus financial units and deficit financial units. Also invest deposits in financial securities.

Question 8

What are investment banks

Answer 8

Only have a trading book and structure business financing transactions such as a corporate share issues.

Question 9

What is leverage?

Answer 9

refers to the use of financial debt. Commercial banks are leveraged as banks use other’s money to make more money

Question 10

Formula for spread

Answer 10

interest rate received - paid

Question 11

How does money creation work?

Answer 11

banks keep reserves and lend out the money that is not kept as reserves and leverage the money. deposit some, keep a percentage and lend out the rest, next institution keeps some and lends the rest and so on.

Question 12

What are the 3 functions of a bank?

Answer 12

1) act as private businesses to connect savers and borrowers to earn profit
2) systemic functions of providing an efficient allocation of funds across present and future and leverage existing money
3) increase financial liquidity

Question 13

Formula for shareholders’ equity

Answer 13

equity = assets - liabilities

Question 14

What is the reserve ratio?

Answer 14

ration of reserves to deposits

Question 15

Define excess reserves

Answer 15

reserves above normal ration, banks try to minimise reserve (as they can earn no money and depreciate)

Question 16

Formula for simple deposit multiplier

Answer 16

SDM = 1/RR

Question 17

Why is the simple deposit multiplier the maximum that can be created

Answer 17

banks may hold excess reserves and people don’t deposit all their money.

Question 18

3 main roles of the RBA

Answer 18

1) maintain the financial integrity and stability of Australia
2) implement monetary policy
3) intervene (as needed) in foreign exchange markets

Question 19

What is the new quantity theory of money?

Answer 19

Fischer argued only V was constanct in change in P = change in M + change in V - change in Y. If M growth faster than economic growth, there will be inflation V is actually not constant

Question 20

What are the technical goals of the RBA?

Answer 20

• low stable inflation
• sufficient financial system liquidity
• calibrated exchange rate
• overall financial system intergrity

Question 21

What effects the demand for money

Answer 21

• Real GDP can shift the curve as higher incomes mean higher demand
• inflation can also shift it as it mean you need more nominal cash to make a purchase

Question 22

What is seignorage?

Answer 22

Difference between the value of money and cost of producing and distributing it

Question 23

Who benefits most from contractionary monetary policy?

Answer 23

savers can benefit more and increase their spending, borrowers face higher interest repayments, low income earners are often ‘marginal’ borrowers and may be at a higher risk of loan defaults.

Question 24

What is quantative easing?

Answer 24

A central bank prints money and uses this money to but assets off firms and bank balances sheets. Generally, the prices paid by the CB were well above the market price to ensure financial institutions don’t become insolvent.

Question 25

What is the fundementals based approach to banking crisis

Answer 25

a financial crisis is a period of adjustment to shift in real economic forces as reflected in financial system adjustments.

Question 26

What is the financial panic/speculative excesses to banking crisis

Answer 26

speaks of normal financial system leverage and functioning morphing into speculation leading to price bubbles, overvaluation and ultimate collapse.

Question 27

What is the impact of the RBA buying gov bonds?

Answer 27

increase in money supply, higher cash rate.

Question 28

What happened with quantative easing in the GFC

Answer 28

Since there was a 0 interest rate, monetary policy was ineffective. Central banks printed money to purchases assets from more than they were worth. The aim was to maintain liquidity, prevent deflation and inject liquidity.