ECS3701 exam prep updated.

1 LIST THE THREE MONETARY POLICY INSTRUMENTS USED BY THE SOUTH AFRICAN RESERVE BANK. [3] -Accommodation policy (repo rate) -open market operations -reserve requirement ratio 2 DIFFERENTIATE BETWEEN A SECURITY AND A BOND. [4] - A security (also called a financial instrument) is a claim on the issuer’s future income or assets whilst a bond is a debt that promises to make payments periodically for a specific period of time. -a security earns dividends, whilst is not a liability to the institution as it may defer payments, however, bonds earn interest which is a liability and, if deferred, may attract penalties and liability will accumulate. 3 WHAT IS A FINANCIAL CRISIS? [3] - A major disruption in financial markets that is characterized by sharp declines in asset prices and the failures of many financial and non-financial firms. 4. DEFINE THE FOLLOWING TERMS: (a) Money Supply- money supply is defined as anything that is generally accepted in payment for goods or services or in the repayment of debts (b) Business Cycle- The business cycle is the fluctuation in economic activity that an economy experiences over a period of time. A business cycle is basically defined in terms of periods of expansion or recession (c) Aggregate Income- also known as GDP. It is the total value of a final goods and services produced in a country, in a given time. (d) Inflation- persistent and continuous rise in the general price level. (e) Monetary theory- The theory that relates the changes in the quantity of money to changes in economic activity. 5. SECONDARY MARKETS CAN BE ORGANIZED THROUGH THE METHODS OF EXCHANGE AND OVERTHE-COUNTER (OTC) MARKETS. DEFINE THESE TWO METHODS. -exchanges is conducted through centralised locations where buyers and sellers of securities meet to conduct trades. -OTC market is a market in which dealers at different locations have an inventory of securities ready to buy or sell ‘over-the-counter’ to anyone who comes to them and is willing to accept their prices 6. KEYNES IDENTIFIED THREE MOTIVES (FACTORS) BEHIND THE DEMAND FOR MONEY. LIST THESE THREE FACTORS, AND EXPLAIN BASED ON EACH OF THEM HOW THEY PREDICT THAT BOTH NOMINAL INTEREST RATES AND NOMINAL INCOME AFFECT DEMAND FOR MONEY [10] Transactionary motive. People engage in their daily activities like paying rent, bills, transport costs, engaging in projects and other businesses. To conduct these transactions, individuals will have to hold money, hence the transactionary motive. Under this motive, money serves the function as a medium of exchange, and therefore it’s an active balance. Demand for money for transactionary balances is relatively interest inelastic, but more income elastic.The theory argues that the higher the national income, the more transactions are done, hence more money has to be held as transactionary balances. Therefore, transactionary demand for money is a positive function of national income. Precautionary motive. Individuals also set money aside for unforeseen contingencies like unemployment and sicknesses. These are balances held by individuals for precautionary reasons, hence precautionary motive. Empirical evidence backing the theory also states that precautionary balances are positively related to national income. Money demanded for precautionary reasons is also an active balance. Speculative motive. Individuals also hold money in speculation on favourable changes in the interest rates. Money is demanded as a store of value under this motive, hence a passive balance. Interest rates, an opportunity cost for holding money are negatively related to demand for money for speculative reasons as holding money in periods of high interest rates will result in higher opportunity costs. These motives put together, explains the demand for money. Demand for money is inversely related to interest rates and positively related to national income. The following functions explains the demand for money:
=(,)−+ Where i are interest rates and Y is national income. rom the model, the conclusion was drawn that money demand is unpredictable and unstable. 7. EXPLAIN THE MEANING OF CREDIT RISK. LIST HOW BANKS CAN ATTEMPT TO MANAGE OR SOLVE THEIR CREDIT RISK [7] Credit risk is the risk of defaulting payments, this is mainly due to asymmetric information when conducting transactions. Banks can solve credit risk through any of the following ways: -screening and monitoring -long-term relationships -credit rationing -loan commitments -collateral and compensating balances