1. Explain the basic functions and the characteristics of financial market 2. Wh
ID: 2506006 • Letter: 1
Question
1. Explain the basic functions and the characteristics of financial market
2. What are the three functions of money?
3. What is the future value of a $100 deposit earning interest at 7% for the next two years?
4. Explain the effect on the future value when interest rate increases (or decreases)
5. Distinguish the difference between real and nominal interest rates.
6. What factors will shift the demand of bonds?
7. What factors will shift the supply of bonds?
8. What items are reported as assets for a bank? What items are reported as liabilities for a bank?
9. If a bank has $400,000 of checkable deposits, a required reserve ratio of 20%, and it holds $160,000 in reserves, then the maximum deposit outflow it can sustain is?
10. Explain the following terms:
a. Adverse selection
b. Moral hazard
11. What are off-balance-sheet activities of a bank?
12. What is the contagion effect?
13. Explain why banks engage in financial engineering?
14. What the functions of Federal Reserve?
15. Explain why the Federal Reserve is independent?
Explanation / Answer
1Ans)Function of Financial
A market is a place where supply for a particular good is able to meet demand for it. In the case of financial markets, the good in question is money.
In capital markets, supply agents are those with "positive savings capacity", i.e. mainly households (surprising as that may seem!), and businesses, although the latter generally prefer to reinvest profits or distribute dividends to shareholders. The demand side comes from governments, the modern welfare state having substantial cash requirements, or other companies. Such agents are said to have "financing requirements".
2Ans)
Three functions of money are:
1. Medium of exchange: Money can be used for buying and selling goods and services. If there were no money, goods would have to be exchanged through the process of barter (goods would be traded for other goods in transactions arranged on the basis of mutual need). For example: If I raise chickens and want to buy cows, I would have to find a person who is willing to sell his cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of the double coincidence of wants.
2. Unit of account: Money is the common standard for measuring relative worth of goods and service.
3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be spent to buy goods and services). Money
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