Question

1. Why are financial markets important to the health of
the economy?
2. When interest rates rise, how might businesses and
consumers change their economic behaviour?

3. How can a change in interest rates affect the profitability of financial institutions?

4. Is everybody worse off when interest rates rise?

5. What effect might a fall in stock prices have on business investment?

6. What effect might rise in stock prices have on consumers’ decisions to spend?

7. How does a decline in the value of the pound sterling affect British consumers?

8. How does an increase in the value of the pound sterling affect American businesses?

9. How can changes in foreign exchange rates affect the
profitability of financial institutions?
10. Looking at Figure 1.3, in what years would you have
chosen to visit the Grand Canyon in Arizona rather
than the Tower of London?
11. What is the basic activity of banks?
12. What are the other important financial intermediaries
in the economy besides banks?
13. Can you think of any financial innovation in the past
10 years that has affected you personally? Has it made
you better or worse off? In what way?
14. What types of risks do financial institutions face?
15. Why do managers of financial institutions care so
much about the activities of the Federal Reserve System?

Answer 1

1]

Financial markets are important to the health of the economy because :

• They channel the savings of the economy into productive uses
• They enable the discovery of fair prices of various assets such as stocks and bonds
• They provide liquidity for financial assets
• They enable businesses to raise capital at a lower cost
• They provide a system where suppliers of capital (investors) can interact with those who require capital (firms)

2]

When interest rates rise, it becomes more expensive to borrow money, as the interest expense is higher.

Thus, when interest rates rise, consumers and businesses tend to spend and invest less, as it is more expensive to borrow money for consumption or investment.