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ECS3701 OCT/NOV 2019 SUGGESTED SOLUTIONS
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ECS3701: OCT/NOV 2019 SUGGESTED SOLUTIONSQUESTION 1 [25 Marks]
Question 1.1: List three monetary policy instruments used by the SARB (3):
Repo Rate
Open Market Operation
Reserve requirements
Question 1.2: Differentiate between a security and a bond (4):
A security (also called a financial instrument) is a claim on the issuer’s future income or assets.
Financial instruments may be divided into two main categories: money market instruments
(e.g. Negotiable Certificate of Deposit (NCDs), Commercial Papers; Retirement Annuity
(RAs) and Bankers Acceptance (Bas)) and capital market instruments (e.g. bonds and shares).
A security earns dividends although it does not form a liability to the institutions as it may
defer payments.
A bond is a debt instrument that promises to make payments periodically for a specific period
of time. Bonds earn interest which is a liability, where there are penalties should it be deferred.
Question 1.3: What is a financial crisis? (4)
A Financial Crisis relates to major disruptions in the financial markets that are characterised
by sharp declines in asset prices and the failures of many financial and non-financial firms. A
financial crisis occurs when information flows in financial markets experience a particularly
large disruption, with the result that financial frictions increase sharply and financial markets
stop functioning. Then economic activity stops.
Question 1.4: Define (10)
(a) Money supply – this refers to the total amount of money in circulation or in existence
in a country at a particular point in time (a stock). There are several ways to define "money
supply", but standard measures usually include currency in circulation and demand deposits.
(b) Business cycle – this refers to the fluctuations in the overall level or pace of economic
activity. It can be defined as the pattern of expansion (recovery) ad contraction (recession) in
economic activity relative to its long term trend.
This study source was downloaded by 100000853391718 from CourseHero.com on 10-03-2022 05:40:14 GMT -05:00
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, (c) Aggregate income – Aggregate income is the total income of factors of production
(land, labour, capital) from producing goods and services in the economy during the
course of the year. It is best thought of as being equal to aggregate output.
(d) Inflation – this is a process which refers to a continuous/sustained and considerable
increase in the general price level whereby price increases lead to further price
increases.
(e) Monetary theory – this is the theory that relates the changes in the quantity of money
to changes in economic activity. It is based on the idea that a change in money supply
is the main driver of economic activity.
Question 1.5: Define methods of exchange and over the counter markets (4)
Exchanges refer to a place (centralised locations) specifically designed for the meeting of
buyers and sellers of securities, while, Over-the-counter-markets refer to dealers at different
locations who have an inventory of securities stand ready to buy and sell securities “over the
counter” to anyone who comes to buy (e.g. US bond market).
QUESTION 2 [25 Marks]
Question 2.1: Portfolio Theory: Three other factors determining the demand for money and the
effect of their changes on the demand for money (10)
Variable Change Money Reason
in Demand
Variable Response
Expected return relative ↑ ↑ Quantity demanded of an asset is
to other assets positively related to its expected
returns relative to alternative assets
Wealth ↑ ↑ Quantity demanded of an asset is
positively related wealth
Risk relative to other ↑ ↓ Quantity demanded of an asset is
assets negatively related to the risk of its
returns relative to alternative assets
Inflation risk ↑ ↓ Quantity demanded of an asset is
negatively related to inflation
This study source was downloaded by 100000853391718 from CourseHero.com on 10-03-2022 05:40:14 GMT -05:00
https://www.coursehero.com/file/72865509/Oct-Nov-2019-Suggested-Solution1pdf/
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