ECS3701 ECP JUNE EXAM VERIFIED Q AND A.

ECS3701 ECP JUNE EXAM VERIFIED Q AND A, ECS3701 ECP JUNE EXAM STUDENT NUMBER: Question 1 1.1 One of the reasons why some less developed economies grow so slowly is that they do not have well-developed financial markets. Is this statement true or false? Support your answer. This statement is TRUE. The basic function of financial markets is to channel funds from savers who have an excess of funds to borrowers who have a shortage of funds. Financial markets can do this either through direct finance or through indirect finance which involves a financial intermediary. This channelling of funds helps improve the economic welfare of everyone in society because it allows funds to move from people who have no productive investment opportunities to those who have such opportunities. In this way financial markets contribute to economic efficiency. Underdeveloped financial system leads to a low state of economic development and economic growth. Difficulties faced include: - The system of property rights functions poorly, making it difficult to use these tools to help solve the adverse selection and moral hazard problems. - Poorly developed or corrupt legal system may make it extremely difficult for lenders to enforce restrictive covenants. - Banks in many transition and developing countries are owned by their governments and because of the absence of the profit motive, these state-owned banks have little incentive to allocate their capital to the most productive uses. - Many developing countries have an underdeveloped regulatory apparatus that prevents the provision of adequate information to the marketplace - Governments often use the financial systems to direct credit to themselves or to favoured sectors of the economy.