OxfordAQA International AS and A-level Economics: Financial markets (9640) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover financial markets for OxfordAQA International AS and A-level Economics (9640), specification section 3.4.2.3. Section 3.4 is the extra International A2 content, examined from May/June 2022. All figures and institutions are invented. Before you start, read the study guide and the revision notes. Other links: course hub, printable checklist, diagnostics.

Questions

1. Prices rise by 6% a year. A household keeps 5,000 units as cash for 2 years. (a) Calculate the real value of the cash after 2 years, to 2 decimal places. [2] (b) Which function of money has been weakened? [1]

2. Distinguish between the money market and the capital market, giving one asset traded in each. [4]

3. A bond has a face value of 100, a coupon of 7 a year and a market price of 95. (a) Calculate its yield, to 2 decimal places. [2] (b) Market interest rates rise to 8%. Calculate the price at which this bond would yield 8%, and explain why the price moves in that direction. [2]

4. An importer in Country D must pay 150,000 betas in 3 months. Today 1 alpha = 3.00 betas. The 3-month forward rate is 1 alpha = 2.90 betas. (a) Explain the difference between a spot and a forward contract. [2] (b) Calculate the alpha cost of the payment if the firm uses the forward contract. [1] (c) In 3 months the spot rate is 1 alpha = 2.70 betas. Calculate the gain or loss from using the contract, compared with paying at the spot rate. [2]

5. A farm agrees to sell 80 tonnes of grain forward at 300 per tonne. (a) Calculate the revenue the farm has fixed. [1] (b) Calculate the gain or loss from the contract compared with selling at the spot price if the spot price at delivery is (i) 270 and (ii) 340. [2] (c) Explain why the farm might still choose a forward contract. [1]

6. A firm with 240,000 shares needs 600,000. Option A is a 5% bond. Option B is 60,000 new shares at 10 each. Operating profit is 90,000. (a) Calculate profit per share under each option. [3] (b) Profit falls to 20,000. Calculate the result under each option and explain which is riskier. [3]

7. (a) Distinguish between a commercial bank and an investment bank. [3] (b) Explain why a bank that does both may raise systemic risk. [2]

8. A bank has cash of 90 and loans of 810. Its deposits are 820 and its equity is 80. (a) Calculate its capital ratio, to 2 decimal places. [1] (b) 12% of deposits are withdrawn. Calculate the shortfall of cash. [2] (c) Explain why the bank may be illiquid although it is solvent, and how a central bank could help. [3]

9. The required reserve ratio is 8%. A bank receives a new deposit of 2,000. (a) Calculate the maximum credit multiplier and the maximum total deposits this supports. [2] (b) The ratio rises to 10%. Calculate the fall in maximum total deposits. [1] (c) Give one advantage and one drawback of the higher ratio. [2]

10. An index of asset prices is 100 in year 0, 140 in year 1 and 210 in year 2. In year 3 it falls by 40%. (a) Calculate the percentage rise from year 0 to year 2. [1] (b) Calculate the index in year 3 and the percentage rise needed to regain 210. [2] (c) Explain how herding behaviour and asymmetric information can help to create an asset price bubble. [5]

11. A shadow-banking lender holds assets of 800, financed by equity of 40 and short-term borrowing of 760. It has no deposit insurance. (a) Calculate its leverage and the percentage fall in asset values that would remove all its equity. [2] (b) Its failure cuts lending to firms by 90. The marginal propensity to withdraw is 0.4. Calculate the multiplier and the fall in GDP. [2] (c) Evaluate whether stricter regulation of shadow banking is the best way to reduce systemic risk. [6]

12. An insurer sells 800 policies at a premium of 140. Each policy holder has a 0.5% chance of a claim of 24,000. (a) Calculate expected claims, premium income and expected profit. [3] (b) After the policies are sold, holders take less care and the claim chance rises to 0.8%. Calculate the result and name the problem. [2]

Answers

1. (a) Real value = 5,000 / 1.06² [1] = 4,449.98 [1] (b) Store of value [1] [3] Examiner insight: Show the price factor for each year of inflation; a single division by 1.12 gives a different figure and hides the method.

2. The money market trades short-term funds and assets, with a life of up to about a year [1], for example government bills [1]. The capital market trades long-term finance [1], for example shares or bonds [1] [4] Examiner insight: Say how the two markets differ, such as the time span of what is traded; naming an example without a difference leaves the comparison unfinished.

3. (a) Yield = 7 / 95 × 100 [1] = 7.37% [1] (b) Price = 7 / 0.08 = 87.50 [1]. The price falls because buyers can now earn 8% on new bonds, so they will pay less for the older bond until its yield matches [1] [4] Examiner insight: Say the direction of the price change and the reason together; the number alone does not explain the mechanism.

4. (a) A spot contract is settled now at today’s price [1]. A forward contract fixes a price now for payment at a later date [1] (b) 150,000 / 2.90 = 51,724.14 alphas [1] (c) Unhedged cost = 150,000 / 2.70 = 55,555.56 [1]; the contract saved 3,831.42 alphas [1] [5] Examiner insight: Currency questions reward a stated direction of division; check that dividing betas by betas per alpha gives alphas.

5. (a) 80 × 300 = 24,000 [1] (b) (i) At 270, spot revenue is 21,600, so the contract gained 2,400 [1]. (ii) At 340, spot revenue is 27,200, so the contract lost 3,200 [1] (c) It gives certainty of revenue for planning, which is hedging [1] [4] Examiner insight: State gain or loss against the spot alternative, not against the contract price.

6. (a) Interest = 30,000 [1]. Bond: (90,000 − 30,000) / 240,000 = 0.25 per share [1]. Shares: 90,000 / 300,000 = 0.30 per share [1] (b) Bond: 20,000 − 30,000 = −10,000 [1]. Shares: 20,000 / 300,000 = 0.07 per share [1]. The bond is riskier because the interest must be paid whatever the profit [1] [6] Examiner insight: Use the right number of shares for each option; many wrong answers come from keeping 240,000 shares in option B.

7. (a) A commercial bank accepts deposits and lends them on to households and firms [1]. An investment bank raises capital and advises clients, and trades financial assets [1]. An investment bank deals mainly with firms, governments and investors rather than ordinary savers [1] (b) Trading losses could threaten the deposits of ordinary savers [1]. A large combined bank is connected to many others, so its failure spreads and is harder to resolve [1] [5] Examiner insight: Give a contrast, not two separate descriptions, and link part (b) to risk spreading.

8. (a) 80 / 900 = 8.89% [1] (b) Withdrawals = 0.12 × 820 = 98.4 [1]; shortfall = 98.4 − 90 = 8.4 [1] (c) Assets of 900 exceed deposits of 820, so the bank is solvent [1]. Loans are long term and cannot be called in quickly, so cash runs short (maturity mismatch) [1]. As lender of last resort, the central bank can lend against sound assets, which avoids a run or forced sales [1] [6] Examiner insight: Explain the difference between having enough assets and having enough cash; this is the point the question tests.

9. (a) Multiplier = 1 / 0.08 = 12.5 [1]; maximum deposits = 2,000 × 12.5 = 25,000 [1] (b) At 10%, 2,000 × 10 = 20,000, so the fall is 5,000 [1] (c) Advantage: banks hold more reserves against withdrawals, so they are more stable [1]. Drawback: less credit is created, so investment and growth may be lower [1] [5] Examiner insight: Pair each effect with its consequence; “banks lend less” needs a consequence for the economy.

10. (a) (210 − 100) / 100 = 110% [1] (b) 210 × 0.6 = 126 [1]; rise needed = (210 / 126) − 1 = 66.67% [1] (c) Buyers expect further price rises [1]. They copy others instead of judging value (herding) [1]. Prices rise above fundamental value [1]. Buyers cannot judge the true value or risk of the asset, so they rely on others’ actions (asymmetric information) [1]. When confidence turns, selling is also herded, so prices fall sharply and borrowers who used the asset as security may default [1] [8] Examiner insight: Link each concept to the price path; definitions of herding with no effect on prices tend to stay unrewarded.

11. (a) Leverage = 800 / 40 = 20 [1]; 40 / 800 = 5% fall [1] (b) Multiplier = 1 / 0.4 = 2.5 [1]; fall in GDP = 90 × 2.5 = 225 [1] (c) Shadow banks can spread risk because they borrow short with high leverage and no deposit insurance [1]. Capital and liquidity rules would reduce leverage and the chance of failure [1]. Regulation could stop risk being hidden from supervisors [1]. But activity may move to institutions outside the rules, and compliance costs may cut lending and growth [1]. Other tools, such as central bank liquidity and better disclosure, may work alongside regulation [1]. A judgement is needed, such as: it depends on how large and connected the shadow sector is, and on how well rules can be enforced [1] [10] Examiner insight: A conclusion that weighs size, connection and enforcement is better than listing advantages and disadvantages.

12. (a) Expected claims = 800 × 0.005 × 24,000 = 96,000 [1]; premium income = 800 × 140 = 112,000 [1]; expected profit = 16,000 [1] (b) Claims = 800 × 0.008 × 24,000 = 153,600, so there is a loss of 41,600 [1]. This is moral hazard: the insured take less care because the insurer bears the cost [1] [5] Examiner insight: Name who bears the cost when you describe moral hazard; otherwise the description is incomplete.

Where marks are usually lost

• Writing “liquid” when the answer needs “solvent”, or the reverse.
• Forgetting that bond prices and yields move in opposite directions.
• Using the wrong number of shares when comparing debt with equity.
• Dividing a foreign currency amount by the wrong exchange rate.
• Calling the forward contract a loss without comparing it with the spot rate.
• Describing a bubble without the role of expectations.
• Explaining regulation with no cost or limit.
• Giving an extended answer with no judgement.

Next steps

• Re-read the study guide and revision notes.
• See the course hub and the printable checklist.
• Take all free 10-minute diagnostics: diagnostics.
• Book a free trial class: trial.

Official syllabus

OxfordAQA International AS and A-level Economics (9640) specification, version 1.2, section 3.4.2.3, first teaching September 2020, published by OxfordAQA.