The financial sector practice questions (A-Level Economics)

Sample questions

All 2 free A-Level Economics questions on this topic, from the free A-Level Economics Multiple Choice Questions with Answers. Each answer is behind its own toggle; the whole paper, its PDF and the full answer key are on the exam page.

1. Question 11 mark · Financial markets: bonds
   A government bond has a nominal (face) value of 100 pounds and pays a fixed coupon of 4 pounds per year. Its market price rises to 125 pounds. The bond's yield is now:
   • A.
     4 percent
   • B.
     5 percent
   • C.
     3.2 percent
   • D.
     25 percent
   Show answerFrom the free A-Level Economics Multiple Choice Questions with Answers →
2. Question 21 mark · Financial markets: commercial banks
   A commercial bank shifts some of its assets out of cash and short-term government bills and into long-term mortgage loans. The most likely effect on the bank is:
   • A.
     higher profitability but lower liquidity
   • B.
     higher liquidity but lower profitability
   • C.
     higher liquidity and higher profitability
   • D.
     no change in liquidity, because the bank's total assets are unchanged
   Show answerFrom the free A-Level Economics Multiple Choice Questions with Answers →

Key terms

The definitions and formulas A-Level Economics expects for the financial sector, typeset as they appear on the paper.

Roles of financial markets

To facilitate saving, to lend to businesses and individuals, to allow the exchange of goods and services (payments), to provide forward markets in currencies and commodities, and to provide a market for equities.

Market failure in the financial sector

Asymmetric information (banks know less than borrowers, customers less than banks), externalities (a bank failure spreads to the rest of the economy), moral hazard (the expectation of bailouts), speculation and market bubbles, and market rigging (Libor).

Central bank functions

Implementing monetary policy, acting as banker to the government and to the banks, lender of last resort in a liquidity crisis, and regulating the banking system. In the UK the Bank of England's Monetary Policy Committee sets Bank Rate to meet the 2 percent inflation target.

Commercial bank balance sheet

Assets (cash, reserves at the central bank, government bonds, loans to customers) against liabilities (customer deposits, borrowing from other banks, bonds issued) and capital (shareholders' funds). Banks face a trade-off between liquidity, profitability and security.

Bonds and yields

A bond pays a fixed coupon; its yield is the coupon as a percentage of the current market price, so bond prices and yields move in opposite directions. When interest rates rise, existing bond prices fall.

$$\text{yield} = \frac{\text{annual coupon}}{\text{market price}} \times 100$$

Credit creation

Banks create money by lending: a loan becomes a deposit that can be lent again, limited by the reserves banks choose or are required to hold. The money multiplier is the reciprocal of the reserve ratio.

$$\text{money multiplier} = \frac{1}{\text{reserve ratio}}$$

Regulation and systemic risk

Capital ratios (equity against risk-weighted assets) and liquidity ratios (liquid assets against short-term liabilities) make banks safer at the cost of lending less. Systemic risk is the danger that one failure brings down the system, the reason banks are regulated more than other firms.

Frequently asked questions

Other A-Level Economics topics

• Nature of economics and economic methodology
• How markets work: demand, supply, elasticity
• Market failure and government intervention
• Measures of economic performance
• Aggregate demand and aggregate supply
• National income, growth and the multiplier
• Macroeconomic objectives and policies
• Business growth, market structures and the labour market
• Globalisation, trade and exchange rates
• Poverty, inequality and development

All A-Level Economics topics · A-Level Economics exam guide · All free practice exams