ECS3701 Jun/Jul 2021
EXAM QUESTION IN STUDY MATERAL
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.
(4)
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 channeling 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 following:
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 of corrupt legal systems 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 underdeveloped regulatory apparatus that prevents the provision of
adequate information to the marketplace.
Governments often use the financial system to direct credit to themselves or to favored sectors of the
economy.
1.2 If you were a private investor, would you and/or financial intermediaries benefit from risk-
sharing? Explain which party will benefit and why. (7)
Financial intermediaries are institutions that borrow funds from people (surplus units) who have saved
and in turn make loans to others (deficit units).
In terms of risk sharing, financial intermediaries can help reduce the exposure of investors to risk
through the process of risk sharing. They create and sell assets with risk characteristics that people
are comfortable with and then the financial intermediaries can use those funds to buy and sell other
assets that riskier.
Both the private investors and the financial intermediary will thus benefit from risk-sharing. The
private investor’s exposure to risk is reduced and financial intermediary can earn a profit on the
spread between the returns they earn and on risky assets and the payments they make on the assets
they have sold. This may also be referred to as an asset transformation. Risk sharing is also made
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, possible by diversification which entails investing in collection (portfolio) of assets, the returns of
which do not all move in the same direction.
1.3 In relation to interest rate:
(i) Is everybody worse off when interest rates rise? Explain your answer to highlight those that
are worse off and those that are not. (5)
Interest rate- cost of borrowing or the price paid for the rental of funds. The interest rate is
made up of several different interest rates that exist in an economy.
Not everyone is worse off when interest rates rise. Banks and investors will not be worse off
because they will make higher returns from the high interest. Consumers and businesses will
be worse off because their debt will cost more.
(ii) When interest rates decrease, explain how businesses and consumers might change their
economic behavior. (4)
When real interest rates are low there are greater incentives to borrow and fewer incentives
to lend. Therefore, businesses and consumers would be more likely to borrow more and
spend more because there’d be more disposable income. A decrease in interest rates lead to
an increase in investment spending (real fixed capital formation). Businesses and consumers
alter their investment and spending patterns, and this will lead to an increase in aggregate
demand.
2.1 Mention the 5 money market instruments and describe who issues each of the money market
instruments mentioned. (10)
Treasury bills (TB’s) which are short-term debt instruments issued by government. It is a primary
security and represents a claim on the government payable at some future date. TB’s are fully
secured and guaranteed by the government in South Africa.
Negotiable Certificate of Deposit (NCD) which is a debt instrument sold by a bank depositor that pays
annual interest of a given amount and at maturity pays back at the original purchase price. Negotiable
Certificate of Deposits (NCD’s) are sold in the secondary market.
Commercial paper is a short- term debt instrument issued by large banks and well-known
corporations. In South Africa it is described as a short-term or medium-term security (securities)
issued by corporations and other non-banking institutions to acquire working capital.
Banker’s Acceptance (BA’s) is a bank draft (a promise of payment) issued by a firm, payable at some
future date, and guaranteed for a fee by the bank that stamps it. The firm issuing the instrument is
required to deposit the required funds into its account with the bank to cover the draft.
Repurchase Agreements (Repos or RA’s) are short-term loans (normally less than two weeks) for
which TB’s serve as collateral. Most notable lenders in this case are large corporations.
This study source was downloaded by 100000853391718 from CourseHero.com on 10-03-2022 03:33:56 GMT -05:00
https://www.coursehero.com/file/127293180/ECS3701-June-July-ECP-2021-Answerspdf/
EXAM QUESTION IN STUDY MATERAL
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.
(4)
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 channeling 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 following:
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 of corrupt legal systems 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 underdeveloped regulatory apparatus that prevents the provision of
adequate information to the marketplace.
Governments often use the financial system to direct credit to themselves or to favored sectors of the
economy.
1.2 If you were a private investor, would you and/or financial intermediaries benefit from risk-
sharing? Explain which party will benefit and why. (7)
Financial intermediaries are institutions that borrow funds from people (surplus units) who have saved
and in turn make loans to others (deficit units).
In terms of risk sharing, financial intermediaries can help reduce the exposure of investors to risk
through the process of risk sharing. They create and sell assets with risk characteristics that people
are comfortable with and then the financial intermediaries can use those funds to buy and sell other
assets that riskier.
Both the private investors and the financial intermediary will thus benefit from risk-sharing. The
private investor’s exposure to risk is reduced and financial intermediary can earn a profit on the
spread between the returns they earn and on risky assets and the payments they make on the assets
they have sold. This may also be referred to as an asset transformation. Risk sharing is also made
This study source was downloaded by 100000853391718 from CourseHero.com on 10-03-2022 03:33:56 GMT -05:00
https://www.coursehero.com/file/127293180/ECS3701-June-July-ECP-2021-Answerspdf/
, possible by diversification which entails investing in collection (portfolio) of assets, the returns of
which do not all move in the same direction.
1.3 In relation to interest rate:
(i) Is everybody worse off when interest rates rise? Explain your answer to highlight those that
are worse off and those that are not. (5)
Interest rate- cost of borrowing or the price paid for the rental of funds. The interest rate is
made up of several different interest rates that exist in an economy.
Not everyone is worse off when interest rates rise. Banks and investors will not be worse off
because they will make higher returns from the high interest. Consumers and businesses will
be worse off because their debt will cost more.
(ii) When interest rates decrease, explain how businesses and consumers might change their
economic behavior. (4)
When real interest rates are low there are greater incentives to borrow and fewer incentives
to lend. Therefore, businesses and consumers would be more likely to borrow more and
spend more because there’d be more disposable income. A decrease in interest rates lead to
an increase in investment spending (real fixed capital formation). Businesses and consumers
alter their investment and spending patterns, and this will lead to an increase in aggregate
demand.
2.1 Mention the 5 money market instruments and describe who issues each of the money market
instruments mentioned. (10)
Treasury bills (TB’s) which are short-term debt instruments issued by government. It is a primary
security and represents a claim on the government payable at some future date. TB’s are fully
secured and guaranteed by the government in South Africa.
Negotiable Certificate of Deposit (NCD) which is a debt instrument sold by a bank depositor that pays
annual interest of a given amount and at maturity pays back at the original purchase price. Negotiable
Certificate of Deposits (NCD’s) are sold in the secondary market.
Commercial paper is a short- term debt instrument issued by large banks and well-known
corporations. In South Africa it is described as a short-term or medium-term security (securities)
issued by corporations and other non-banking institutions to acquire working capital.
Banker’s Acceptance (BA’s) is a bank draft (a promise of payment) issued by a firm, payable at some
future date, and guaranteed for a fee by the bank that stamps it. The firm issuing the instrument is
required to deposit the required funds into its account with the bank to cover the draft.
Repurchase Agreements (Repos or RA’s) are short-term loans (normally less than two weeks) for
which TB’s serve as collateral. Most notable lenders in this case are large corporations.
This study source was downloaded by 100000853391718 from CourseHero.com on 10-03-2022 03:33:56 GMT -05:00
https://www.coursehero.com/file/127293180/ECS3701-June-July-ECP-2021-Answerspdf/
