OCR A Level Economics: Financial institutions, markets and borrowing (H460) – Revision Notes

These notes condense the role of the financial sector in the real economy for the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. This is Component 02 macroeconomics, and no part of it carries a separate stage label. Use the study guide for full explanations. Figures are invented: Country B and its currency unit (cu) are fictional.

Test yourself with the practice questions. See also the OCR Economics hub, the checklist and the free diagnostics.

Key definitions

Term	Meaning
Financial intermediary	Institution linking savers with borrowers
Retail bank	Serves households and small firms
Commercial bank	Lends to and takes deposits from businesses
Investment bank	Issues and trades securities, advises large clients
Pension fund	Invests contributions to pay retirement income
Insurance fund	Pools risk and pays claims from premiums
Hedge fund	Pursues high returns, often with leverage
Bond	Tradable IOU with a fixed coupon and face value
Inter-bank lending	Short-term loans between banks
Collateral (security)	Asset a lender can seize if the loan is not repaid
Real economy	Output, jobs and incomes, as opposed to financial assets

Institutions and their macro effects

Institution	Main macro channel	Main risk
Retail bank	Lending to households raises consumption	Household debt, mortgage defaults
Commercial bank	Lending to firms funds investment	Credit crunch when lending stops
Investment bank	Raises long-term capital, moves asset prices	Speculation, trading losses
Pension fund	Long-term saving into bonds and shares	Asset falls cut future pensions
Insurance fund	Pools risk so firms will take it on	Correlated events
Hedge fund	Trades that help set prices	Leverage and forced selling

Chain for any institution: action (lends, invests, trades) → change in a variable (credit, asset prices, wealth, confidence) → component of AD or AS (C, I, LRAS) → outcome (output, employment, prices).

Markets

Stock market. Firms raise equity; prices drive the wealth effect. Reminder: households hold 600m cu of shares and prices fall 15%. Wealth loss = 600 × 0.15 = 90m cu. If 5% of lost wealth is cut from spending, consumption falls 90 × 0.05 = 4.5m cu.

Bond market. Current yield = coupon ÷ price. Price and yield move in opposite directions.

Coupon 3 on face value 100
Price  96 → 3/96  = 3.125%
Price 120 → 3/120 = 2.5%

Method for a bond price after market rates change: price = coupon ÷ new yield. A bond with coupon 2 when the market yield is 2.5% is worth 2 ÷ 0.025 = 80, a fall of 20% from 100.

Foreign exchange market. A depreciation makes exports cheaper abroad and imports dearer at home; an appreciation does the opposite. Capital inflows tend to push the rate up and outflows to push it down. The effect on the trade balance depends on elasticities.

Inter-bank lending

• Banks with surplus funds lend short-term to banks with a gap after daily payments.
• It supports liquidity and gives a benchmark rate linked to the central bank’s policy rate.
• If trust breaks down, short-term funding stops and credit to the real economy falls.

Method for interest on an inter-bank loan: amount × annual rate × days ÷ 365.

80m cu for 7 days at 3.5% = 80,000,000 × 0.035 × 7/365 = 53,698.63 cu

Forms of borrowing: quick comparison

Form	Secured?	Cost	Best use	Main drawback
Mortgage	Yes, on property	Low	Buying a home	Lose home if unpaid; negative equity
Unsecured loan	No	Medium	One-off purchase	Higher rate than secured
Overdraft	No	Low for days, high for months	Short gap in cash	Easy to rely on
Credit card	No	High on unpaid balances	Short-term convenience	Compounding debt
Pay day loan	No	Very high	Emergency small sum	Rollover and debt spiral

Loan-to-value (LTV). LTV = loan ÷ property value. House 250,000 cu, loan 200,000 cu: LTV = 80%. A 25% fall in price gives a value of 187,500 cu, and equity of 187,500 − 200,000 = −12,500 cu.

Mortgage payment sensitivity. Interest-only loan of 120,000 cu. At 5.4%, monthly interest = 120,000 × 0.054 ÷ 12 = 540 cu. At 7.4% it is 740 cu, an extra 200 cu a month. This is a fall in disposable income for the household, so consumption falls.

Unsecured loan. 2,000 cu at 10% over 24 months (reducing balance) costs 92.29 cu a month. Total repaid is 2,214.96 cu, so interest is 214.96 cu.

Overdraft cost. 1,000 cu for 90 days at 20% a year: 1,000 × 0.20 × 90 ÷ 365 = 49.32 cu.

Credit card. Balance 1,500 cu at 1.8% a month: interest = 27 cu a month. Nominal annual rate = 21.6%. Effective rate = (1.018)¹² − 1 = 23.9%.

Pay day loan. Borrow 200 cu, repay 230 cu after 14 days. Cost = 30 ÷ 200 = 15%. Simple annualised = 15 × 365 ÷ 14 = 391%. Compare it with other borrowing only after annualising.

Risk, security and interest rates

• Risk premium. Higher chance of default → higher rate to compensate.
• Security. Collateral lets the lender recover part of the loan, so the rate can be lower.
• Other factors. Term, loan size, borrower history, and the base rate set by the central bank.

Method for the required rate when default probability is p, no recovery, and target return t:

(1 − p)(1 + r) = 1 + t
Example: t = 4%, p = 10%  →  1 + r = 1.04/0.90  →  r = 15.56%

With recovery share s of the loan: (1 − p)(1 + r) + p × s = 1 + t.

Ranking of typical rates, lowest to highest: government bonds, secured mortgage, unsecured loan, credit card, pay day loan.

Other worked reminders

Bank margin. A bank lends 100,000 cu at 6.5% and pays depositors 1.5%. Interest received is 6,500 cu, interest paid is 1,500 cu, margin is 5,000 cu, which covers costs, bad debts and profit.

Insurance. Claim chance 0.5%, claim size 40,000 cu. Expected claim = 200 cu. Premium 260 cu gives a 60 cu loading (30% above expected claims).

Leverage. Capital 50, assets 400. Leverage = 8. A 10% fall in assets loses 40, which is 80% of capital. The fall that wipes out capital is 50 ÷ 400 = 12.5%.

Price-earnings. Share price 60, earnings per share 4: ratio = 15. Dividend 1.5 on price 60: dividend yield = 2.5%.

Evaluating the financial sector in the real economy

For: transfers saving to investment, spreads risk, smooths consumption, funds growth, lets firms hedge.

Against: credit booms and busts, asset bubbles, contagion, household over-indebtedness, resources used in trading rather than production.

Method for a long evaluation answer: (1) define the term, (2) give two or three effects, each as a chain to AD, AS or jobs, (3) give limits or counter-arguments, (4) weigh them using the data, (5) conclude.

Judgement factors: size of leverage, quality of lending, trust between institutions, time period (long-run gains, short-run instability) and the context in the data. End with a verdict, and state what would change it.

Must-know distinctions

• Retail (households) versus commercial (businesses) versus investment (securities).
• Pension (long-term saving) versus insurance (risk pooling) versus hedge fund (high-return, leveraged).
• Coupon (fixed payment) versus yield (return at the current price).
• Secured (collateral) versus unsecured borrowing.
• Nominal rate versus effective annual rate.
• Overdraft (flexible within a limit) versus loan (fixed sum).

Quick self-test

1. A bond has a coupon of 5 and a face value of 100. Its price is 125. Find the current yield.
2. Bond prices fall. Do yields rise or fall?
3. House 300,000 cu, deposit 45,000 cu. Find the LTV.
4. Borrow 500 cu overnight between banks at 4.0% a year. What is the interest for one night to the nearest 0.01 cu?
5. Pay day loan: borrow 100 cu, repay 118 cu. State the cost over the loan period.
6. Name one reason a mortgage has a lower rate than a credit card.
7. State the effect on export prices abroad of a depreciation.
8. Capital 20, assets 160. What fall in asset values wipes out capital?
9. Give one macro risk of a hedge fund using leverage.
10. A lender wants a 6% return, default chance 5%, no recovery. Find the required rate to one decimal place.

Answers

1. 5 ÷ 125 = 4.0%.
2. Yields rise.
3. Loan 255,000; 255,000 ÷ 300,000 = 85%.
4. 500 × 0.04 ÷ 365 = 0.05 cu.
5. 18 ÷ 100 = 18%.
6. It is secured on property, so the lender can recover its loss.
7. Export prices fall abroad.
8. 20 ÷ 160 = 12.5%.
9. Forced selling can push asset prices down and pass losses to lenders.
10. 1.06 ÷ 0.95 = 1.1158, so 11.6%.

Where marks are usually lost

• Saying bond prices rise when market interest rates rise.
• Comparing pay day and bank rates without putting them on the same time basis.
• Describing what a fund does but not linking it to AD, AS or employment.
• Treating all banks as one type.
• Leaving out security when explaining why rates differ.
• Confusing coupon with yield.
• Writing percentage points as percent.
• Evaluating with a list rather than weighing which point matters most in the context.
• Forgetting the exchange rate direction: a depreciation lowers the foreign price of exports.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, Macroeconomics: the financial sector, the role of the financial sector in the real economy.