Mid Term Revision

Question1: Define the following terms:

A- Money

Answer:-Money— is defined as anything that is

generally accepted in the payment for goods & services or in the payment of debts.

B- Banks

Answer:-Banks: Banks are financial institutions

that accept deposits and make loans.

C- Financial Markets

Answer:-Financial Markets: Markets in which

funds are transferred from people who have an excess of available funds to people who have a shortage

D- Monetary Theory

Answer:-Monetary Theory: the theory that relates

the change in the quantity of money to changes in aggregate economic activity & the price level

E- Inflation

Answer:-Inflation: is the continuous increase in

the price level of goods & services in an economy.

F- Business Cycle

Answer:-Business Cycle: The upward &

downward movement of aggregate output produced in the economy.

G- Interest Rate

Answer:-Interest Rate: is the cost of borrowing

(or the return from lending.

Discuss The Following:

A- The importance of Interest Rate to the economy.

Interest Rate is the cost of borrowing or the return from lending.

I.R plays an important role on number of levels:

On a personal level, high interest rate could deter you from buying a house or a car because the cost of financing it will be high.

On the other hand, high I.R could encourage you to save because you can earn more interest income by saving.

It also affects business investment decisions:

High I.R for example, might cause a corporation to postpone building a new plant.

The main reason of inflation is a monetary phenomenon. Elaborate

Inflation is the continuous increase in the price level of goods & services in an economy.

Inflation is a monetary phenomenon , it occurs because of increasing aggregate demand as a result of increasing the quantity of money in the market, which will lead to increase in the price level.

Money Supply

Expenditures

Aggregate demand >

Aggregate Supply

Expenditure > Production

Inflation

The direction of funds from the Lender to Borrower in financial markets.

• The basic function of financial markets is to channel funds from people who have an excess of available funds to people who have a shortage.

• Financial markets can do this either through

A) Direct finance: in which borrowers borrow funds directly from lenders by selling them financial instrument

B) Indirect finance: which involves a financial intermediary who stands between the lender savers and the borrower spenders and helps transfer funds from one to the other

Differentiate between stocks & Bonds

Bonds Stocks

is a debt security that promises to make payments periodically for specified period

of time.

a stock is a security that is a claim on the earnings & assets of a corporation.

Represent borrowing Represent ownership

Stocks also called shares, equity

Holder of bond is a bondholder Holder of the stock is called stockholder

Revenue is interest Revenue received is dividends

People prefer bonds than stocks because its safer & less risky.

While companies also prefer bonds than stocks because it represents debt on the

company, not ownership as stock.

Types of stock: common stock & preferred stock

Asymmetric Information

Occurs when buyers and sellers are not equally informed about the true quality of what they buying & selling.

Adverse selection• Is the problem created by asymmetric information

before the transaction occurs .

• Adverse selection is related to information about a business before the bank makes the loan.

• All small business tend to represent themselves as high quality (that is, low risk) despite the fact that bankers know.

• In the absence of information about exactly who is good & who is bad, bankers face a problem.

Moral Hazard• Occurs after a loan is made. Moral hazard in

financial markets occurs when borrowers have incentives to engage in activities that are undesirable (immoral from the lender point of view)

• Moral hazard is a problem of asymmetric information occurring after a loan is made.

• It arises because borrowers in secrecy engage in activities that increase the probability of poor performance.