1 markWhat is the primary role of financial markets in an economy?
To provide goods and services to consumers
To facilitate the exchange of money for goods
To channel funds from savers to borrowers
To regulate government spending
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1 markHow do financial markets help allocate resources in an economy?
By imposing price controls on goods and services
By promoting economic inequality
By directing funds to their most productive uses
By restricting trade between countries
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1 markWhich of the following is a form of market failure that can occur in financial markets?
Perfect competition among financial institutions
Inadequate consumer protection regulations
Efficient allocation of capital
Self-regulation by financial firms
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1 markWhich of the following best describes moral hazard in the financial sector?
It involves ethical dilemmas faced by financial professionals
It refers to the increased risk-taking by financial institutions due to government bailouts
It concerns the willingness of individuals to save and invest
It is the practice of self-regulation by financial firms
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1 markWhy is moral hazard a concern in the context of insurance and asymmetric information?
Moral hazard occurs when insurers refuse to pay claims
It can lead to policyholders taking on excessive risks because they are insured
It refers to the unfair distribution of insurance coverage
Asymmetric information has no connection to moral hazard
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1 markWhat does a central bank typically do to influence the economy?
Regulates the stock market
Manages fiscal policy
Controls the money supply
Oversees international trade agreements
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1 markWhy is a "lender of last resort" important in the field of central banking and financial stability?
To promote price stability through interest rate changes
To ensure a stable and functioning banking system during crises
To provide subsidised housing loans to citizens
To control the national defense budget
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In May 2020, the UK government introduced a loan scheme to help small businesses survive the downturn in the economy. Small businesses could borrow up to £50,000 at an interest rate of 2.5% for up to 6 years from a bank. The government guaranteed 100% of the loans, to enable banks to issue them quickly, and only minimal checks were made on borrowers.
(Source: adapted from https://www.ft.com)
Which one of the following would be a risk if ‘only minimal checks were made on borrowers’ in this loan scheme?
Asymmetric information
Crowding out
Market rigging
Speculation
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5 marksWith reference to Extract A, explain the role of forward markets in currencies
Extract A
UK companies use forward currency market
The Norfolk-based picture frame maker Nielsen Bainbridge recently made forward contracts in the foreign exchange market to reduce the impact of currency fluctuations. The pound’s post-Brexit referendum depreciation has been a test of nerve for Nielsen Bainbridge and many other importers. At present, the company’s suppliers are located in Europe or China. “Currency therefore has a big impact on our business and the margins we can obtain,” says Ms Burdett, the Finance Director. Forward contracts enable institutions, businesses, and individuals to lock in an exchange rate over a certain period of time, regardless of how the rate moves during that time. Ms. Burdett buys currency as soon as Nielsen Bainbridge confirms a large order as a way to fix costs. One-third of UK business managers are considering shifting from EU to UK suppliers.
(Source: adapted from https://www.ft.com)
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4 marksWith reference to the information below, explain one role of financial markets
In May 2020, the UK government introduced a loan scheme to help small businesses survive the downturn in the economy. Small businesses could borrow up to £50000 at an interest rate of 2.5% for up to 6 years from a bank. The government guaranteed 100% of the loans to enable banks to issue them quickly, and only minimal checks were made on borrowers.
(Source: adapted from https://www.ft.com)
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Using the data provided in Extract D, explain one role of financial markets
Extract D
UK house prices may fall up to 20%
Turmoil on the UK financial markets has prompted analysts to predict that house prices could fall dramatically, and many lenders in the mortgage sector are withdrawing deals. People coming to the end of their fixed-rate mortgages are seeing rises from 2% to over 5.5%, with increases in the cost of borrowing of over £5200 a year by 2024 for the average mortgage in the UK. Many people think UK house prices will never fall, but analysts say the fall could be between 10% and 20%.
One mortgage lender said that a lack of housing supply will not keep house prices up when mortgage interest rates are somewhere between 5% and 7%. He claimed that ‘the decade-long property bubble is about to burst […] It’s a buyer’s market now’. The greatest impact will be seen in the southeast of England.
(Source: adapted from https://www.theguardian.com)
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15 marksDiscuss whether providing substantial government financial support to banks is the best policy response during a financial crisis
The UK economy since the financial crisis Figure 1: Pound sterling to US$ exchange rate, 2016-17
Extract A
UK companies use forward currency market
The Norfolk-based picture frame maker Nielsen Bainbridge recently made forward contracts in the foreign exchange market to reduce the impact of currency fluctuations. The pound’s post-Brexit referendum depreciation has been a test of nerve for Nielsen Bainbridge and many other importers. At present, the company’s suppliers are located in Europe or China. “Currency therefore has a big impact on our business and the margins we can obtain,” says Ms. Burdett, the Finance Director. Forward contracts enable institutions, businesses, and individuals to lock in an exchange rate over a certain period of time, regardless of how the rate moves during that time. Ms. Burdett buys currency as soon as Nielsen Bainbridge confirms a large order as a way to fix costs. One-third of UK business managers are considering shifting from EU to UK suppliers.
(Source: adapted from https://www.ft.com/content/d50ce580-3968-11e7-ac89-b01cc67cfeec)
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