Question

Please limit your answer to a maximum of one short paragraph per question

1. What is an Asset Bubble?

2. Why are financial markets important for economic growth?

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

4. Explain the difference between fiscal policy and monetary policy.

5. Explain the difference between bonds and stocks?

Answer 1

1. Assets bubble :- When the price of an asset become over inflated in very short span of time, without the support of real demand for the asset, is called assets bubble .When the investors are continuously bid up the price of the assets beyond the actual, real or sustainable value of the assets then assets bubbling come into existence. It is an economic cycle featured by rapid escalation of assets price, which ultimately at the end crates massive price reduction and then deflection starts occurring.

2. Why are financial markets important for economic growth ?

Financial markets are the key elements for the growth of economy. It encourages savings of household and mobilized such accumulated savings to the most productive investment proposal .Basically it creates a bridge between surplus units and deficit units .It mobilized accumulated savings from the surplus units to the productive deficit units. Without financial markets (money market and capital market) such transfer of funds and capital formation can't be made.

3. What effect might a rise in stock prices have on consumers decision to spend :-

When the stock price will be high then consumers wealth also will be high. Because of this, when stock price will get increased then consumers will be interested to increase their spending on stock. Consumers of stock are always thinking that if they will spend more when the price of stock is high, then in future such price trend will be upwards sloping and their wealth will be maximized.

4. Difference between monetary and fiscal policy :

a) Monetary policy involves in changing the interest rate and money supply in the economy and Fiscal policy involves changing government spending and tax rate.

b) Monetary policy is mostly independent from the political process but in fiscal policy there is a strong involvement of political affairs and government  tries to change in the tax rate.

c) Monetary policy set by the Central Bank and fiscal policy set by the government.

d) Side effects of monetary policy found on exchange rate and housing market and side effects of fiscal policy found on government budget and borrowings.

e) Inflation is the specific target of monetary policy but fiscal policy doesn't have any specific target.

5) Difference between bonds and stock:

a) Bonds are borrowed fund securities and stock are ownership securities.

b) Bondholders are the creditors or the loaner of the company and stock holders are the owners of the company.

c) Generally bond holders don't have any voting rights but stock holders have the voting rights.

d) For bonds company has to pay interest but for stock company may pay dividend if earned profit.

e) Interest on outstanding bonds are the expenses of the company but dividend on outstanding stock is the appropriation of profit.

f) At the time of liquidation, bond holders will be paid before and stock holders will be paid at last.

g) From the investors point of view bonds are less risky securities and stocks are much risks securities.