Exam_questions_and_answers_Linda

1.1.Explain briefly and in general terms what is the meaning of a security and how it facilitates direct lending and borrowing? A claim on the issuer’s future income or assets It enables corporations & governments to borrow to finance their activities 1.2.Explain briefly what is a common stock, what purpose it serves and how it affects business investment decisions Represents a share of ownership in a corporation Has a claim on the earnings & assets Important investment decisions: Price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending A higher price means that it can raise a larger amount of funds, which it can use to buy production facilities & equipment 1.3.List two ways in which the quantity of money will affect the economy Inflation Business cycle Interest rates Monetary policy 1.4.Explain the differences between nominal and real GDP and the purpose for which each should be used  GDP: Market value of all final g&s produced in a country during a certain period.  Nominal GDP: Measured at current prices  Real GDP: Measured at constant/ fixed prices 1.5.List and define three commonly used measures for the aggregate price level  GDP deflator: Nominal GDP divided by real GDP  PCE deflator: Nominal personal consumption expenditures (PCE) divided by real PCE  CPI: Measured by pricing a basket of g&s bought by a typical household 2.1 Briefly explain the function of financial markets, the meaning of direct & indirect financing and the meaning of a financial intermediary  Channels funds from households, firms & government that have surplus funds by spending less than their income (lender-savers) to those that have shortage of funds because they wish to spend more than their income (borrower-spenders)  Financial markets allow funds to move from people who lack productive investment opportunities to people who have such opportunities.  Direct finance: borrowers borrow funds directly from lenders in the financial markets by selling them securities  Indirect finance: financial intermediary that stands between lender-savers and borrowerspenders and helps transfer funds from one to the other 2.2 Explain the differences between debt and equity markets, primary and secondary markets, exchanges and OTC markets, and money and capital markets  Debt instruments are offered in the debt market  Equities(stocks) are issued in the equity market  Debt instrument: contractual agreement by the borrower to pay the holder of the instruments fixed amounts at regular intervals until a specific date upon which a final payment is made.  Stocks are claimed to the share of the net income and the asset of a business  Primary market: Financial markets in which new issues of securities are sold  Secondary market: Securities which have been previously issued are resold  Exchanges: Centralised locations where buyers and sellers of securities meet to conduct trades  OTC market: 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  Money market: Financial market in which only short-term debt instruments are traded  Capital market: Financial market in which longer-term debt and equity instruments are traded 2.3 List and explain the operation of any three capital market instruments  Stocks: o Equity claims on the net income and assets of a corporation o Amount of stocks issued any given year is typically very small  Mortgages & Mortgage-Backed Securities: o Mortgages: Loans to households and firms to purchase land, housing or other real structures, in which the structure or land itself serves as collateral for the loans o Largest debt market in US o Mortgage-Backed securities: A bond-like debt instrument backed by a bundle of individual mortgages, whose interest and principle payments are collectively paid to the holders of the security  Corporate bonds: o Long-term loans issued by corporations with very strong credit ratings o Typical corporate bond sends the holder an interest payment twice a year and pays off the face value when the bond matures 2.4 Explain the functions performed by financial intermediaries and how and why these promote economic efficiency in financial market  Transaction cost: The time and money spent in carrying out financial transactions. Financial intermediaries can substantially reduce transaction costs because they have developed expertise in lowering them and because their large size allows them to take advantage of economies of scale.  Risk sharing:  Asymmetric information: adverse selection & moral hazard:  Economies of scope & conflicts of interest: