Chapter 1: An Overview of the Financial System

1. Introduction:
 The financial system is crucial for economic development. It facilitates the flow of funds,
efficient resource allocation, and supports the real economy.
 It is made up of markets, institutions, instruments, and various participants like
providers/seekers of funds, dealers, brokers, and regulators.
2. Meaning and Features of the Financial System:
 Definition: It's a system that creates a smooth, effective, and efficient linkage between
those who have excess funds (savers) and those who need funds (investors/borrowers).
 Key Features:
o Provides a connection between savers and investors.
o Facilitates the growth of financial markets over time and location.
o Allocates financial resources efficiently for productive purposes.
o Influences the speed and quality of economic development.
3. Goals of the Financial System:
 Channel Funds: To move funds from savers to investors through direct or indirect
financing.
o Direct Financing: Investors receive funds directly (e.g., through IPOs).
o Indirect Financing: Funds are channeled through financial intermediaries like
banks.
 Share Risks: To help economic actors manage risks by diversifying or transferring them
through mechanisms like insurance.
 Generate Liquidity: Enhances both market liquidity (ease of trading assets) and funding
liquidity (ability to access cash quickly).
4. Components of the Financial System:
 Financial Institutions: Regulators, intermediaries, and others that operate within the
system.
 Financial Instruments: Monetary claims like stocks, bonds, and loans used in
transactions.
 Financial Markets: Places where financial instruments are traded.
5. Functions of the Financial System:
 Clearing and Settling Payments: Facilitates exchange of goods, services, and assets
through payment methods (like credit cards, ATMs, etc.).
 Pooling Resources and Subdividing Shares: Enables large-scale projects by collecting
funds from many sources and allowing diversification.
 Transferring Resources Across Time and Space: Moves capital across different
periods, locations, and industries.
 Managing Risks: Provides ways to share risk through diversification and insurance
mechanisms.
 Providing Information: Provides price information for decision-making.
 Dealing with Incentive Problems: Aims to minimize challenges associated with
asymmetric information and agent-principal relationships.
6. Financial Assets:
  Definition: A legal contract giving its owner a claim to payments usually derived from
real assets.
 Types:
o Real Assets: Tangible or intangible items that generate goods/services over time
(e.g., land, factories).
o Financial Assets: Legal contracts that give owners a claim to payments generated
by real assets (e.g., stocks, bonds).
 Functions: Transfer funds to investors in real assets and redistribute risk.
 Properties:
o Money-ness: The ability to act as medium of exchange.
o Divisibility: The minimum size it can be traded at.
o Term of Maturity: The time until final payment.
o Convertibility: If it can be converted to other assets.
o Currency: The currency it is traded in.
o Risk/Return Predictability: How predictable the return and associated risks are.
7. Overview of Financial Markets:
 Definition: Arrangements for the buying and selling of goods and services; structures
through which funds flow.
 Functions:
o Determine prices or required return of traded securities
o Offer liquidity, so that investors can easily buy and sell securities.
o Reduce the costs associated with transactions (such as information or search
costs).
8. Classification of Financial Markets:
 Nature of Claim: Debt markets (bonds) vs. equity markets (stocks).
 Maturity of Claim: Money markets (short-term) vs. capital markets (long-term).
 Newness of Issue: Primary markets (new issues) vs. secondary markets (existing
securities).
 Cash vs. Derivative Instruments: Markets for cash instruments vs. markets for
derivatives (options, futures).
 Organizational Structure: Auction markets vs. over-the-counter markets.
 Other classifications: Spot vs. futures markets; Private vs. public markets; commodity
markets; foreign exchange markets
9. Overview of Financial Institutions:
 Function: Serve as intermediaries, channeling funds between savers and borrowers; play
a significant role in the financial marketplace.
 Role: Facilitates the flow of funds; manages risk through diversification; provides
maturity transformation; reduces transaction costs; provides information; performs
payment mechanism.
 Types:
o Depository Institutions: Primarily raise funds by offering deposits (e.g.,
commercial banks, savings & loans, credit unions).
o Non-Depository Institutions: Provide other services with the investment of
funds (e.g., insurance companies, pension funds, finance companies).
 o Investment Companies: Provide investment service and advice (e.g. investment
banks).
In a nutshell, Chapter 1 provides the foundational knowledge for understanding the entire
financial system. It establishes the key concepts, components, and functions, setting the stage for
a more detailed discussion of various topics in subsequent chapters.
Okay, let’s break down the main points of Chapter 2, which focuses
on financial institutions within the financial system:

Chapter 2: Financial Institutions in Financial System

1. Introduction:

This chapter delves into the specifics of financial institutions, exploring their
meaning, types, classifications, and their roles.

It aims to equip you with an understanding of both depository and non-

depository institutions.

It also emphasizes the significance of financial organizations for a country’s

development.

2. Financial Institutions at a Glance:

Definition: Organizations providing various financial services, controlled and

supervised by government regulations.

Function: Act as intermediaries in financial and security markets, transferring

funds from savers to those who need them. They also educate investors, and
render advice on the management of investment.

Examples: Banks, stock brokerage firms, non-banking financial institutions,

building societies, asset management firms, credit unions, and insurance
companies.

Nature: Can be either private or public entities.

Intermediation: Facilitate the process by creating assets for savers and

liabilities for borrowers which are more attractive to each.

3. The Role of Financial Institutions:

Providing Payment Mechanisms: Offer various payment methods like checks,

credit cards, debit cards, and electronic transfers.

Maturity Transformation: Convert short-term funds from savers into longer-

term loans for borrowers, thereby offering investors more choices concerning
investment maturities and the duration of debt obligations for borrowers.
Reducing Risk Through Diversification: Invest in a variety of assets, thereby
reducing the risk.

Reducing Transaction Costs: Lower the cost of writing and understanding

financial contracts, through management of experts in the area of lending.

4. Classification of Financial Institutions:

Financial institutions are generally regulated by financial laws. The most

common classifications include:

Commercial Banks

Credit Unions

Stock Brokerage Firms

Asset Management Firms

Insurance Companies

Finance Companies

Building Societies

Retailers

These institutions act as intermediaries between the capital market and debt
market. Services offered differ.

They are also categorized as deposit taking institutions and other types of
institutions.

5. Depository Institutions:

Definition: Financial institutions that raise loanable funds by selling deposits

to the public.

Major Types:

Commercial Banks

Savings and Loan Associations

Mutual Savings Banks

Microfinance Institutions (MFIs)

Credit Unions

Key Role: They provide a range of deposit and credit services.

Balance Sheet: Assets are largely loans; liabilities are mostly deposits.

Popularity: Due to offering various deposit accounts, repackaging funds into

suitable loans, and handling risk.

Commercial Banks:

They offer a range of services; like deposit, credit, investment advice,

security underwriting etc.

Generate income from loans and investments.

Functions: Process payments, issue bank notes, accept funds on term

deposits, issue bank checks, and offer performance bonds, provide loans, sell
and broker financial products.

Importance: Principle means of payment, creates money from deposits,

principal channel for monetary policy

Classifications: Chapter banking, Branch banking and Correspondent banking

Savings Banks and Savings and Loan Associations:

Specialize in extending mortgage loans.

Important in providing home financing.

Credit Unions:

Smallest depository institution; operate for a closed group of individuals.

Focus on consumer loans; offer low loan rates and high interest rates on
deposits.

6. Non-Depository Financial Institutions:

Definition: Institutions that provide other contractual services, with

investment of funds.

Types:

Insurance Companies:

Specialize in offering insurance to help mitigate against possible future risks

and losses.

Types: Life insurance, Property and casualty insurance companies.

Pension Funds:
Specialize in managing funds for retirement savings.

They create pension annuities.

Mutual Funds:

Operated by investment companies; collect shares of many investors and

invest.

Provide a wider option to their investors.

Finance Companies:

They specializes in loans to individuals and businesses.

Use funds from investors to offer loans.

Investment Banking Firms:

Underwrite and distribute new investment securities and help businesses

obtain financing.

7. Other Key Points:

Microfinance Institutions (MFIs): Aim to provide financial services to the poor,

offering small loans and accepting small savings. They are user-friendly and
usually requires group guarantees.

Mutual Saving banks: owned by their depositors and play an active role in
residential mortgage markets

Risk Management: Non-depository financial institution specialized in

managing risk through insurance or risk management tools.

Governmental Financial Institutions: Have regulatory and supervisory

functions to ensure the stability and growth of financial system.

In summary, Chapter 2 moves beyond the general view and dives into the
operational aspects of the different financial institutions, the services they
provide, and how they contribute to the overall function of the financial
system. It highlights the diverse roles these institutions play in an economy.

Alright, let’s break down the main points of Chapter 3, which focuses on
understanding interest rates in the financial system:

Chapter 3: Interest Rates in the Financial System

1. Understanding Interest Rates:

Importance: Interest rates are critical for the economy and are closely
monitored, influencing spending, saving, and investment decisions.

Measurement:

The most accurate measure of interest rates is the yield to maturity (YTM),
which equates the present value of all payments received from a debt
instrument to its current price (or value).

YTM is also known as the internal rate of return.

To compare debt instruments with different streams of payments, we must

use the concept of present value.

Alternative (but less accurate) ways to quote interest rates include current
yield and yield on a discount basis.

Types of Instruments:

Simple Loans: The lender provides funds; the borrower repays principal and
interest at maturity.

Fixed-Payment Loans: Loans repaid with the same payment amount every
period (partially principal and partially interest).

Coupon Bonds: Make fixed interest payments (coupon payments) periodically

and repay the face value at maturity.

Discount Bonds (Zero-Coupon Bonds): Bought at a discount; repay face value

at maturity.

2. Measuring Interest Rates:

Yield to Maturity (YTM):

The interest rate that equates the present value of all future payments to the
current price.

For simple loans, the interest rate equals the yield to maturity.

For fixed-payment loans, the same method of PV calculation is used, but

each payment’s present value is discounted separately.

For coupon bonds, the present values of both coupon payments and the final
repayment of face value are added.

For discount bonds, the present value equates the current price to the face
value at maturity.
Key principle: As yields on bonds rise, price fall and vice versa.

Other Measures:

Current Yield: Yearly coupon payment divided by the bond price. Useful
approximation for coupon bonds with long maturities.

Yield on a discount basis: Useful for discount bonds; equal to increase in

price divided by initial price.

3. The Distinction Between Interest Rates and Returns:

Interest Rate: The percentage payment for a debt instrument (like a bond);
what you receive if you hold it to maturity.

Return: The actual gain or loss from holding a security over a specific period;
includes both periodic payments and any price change.

The Relationship: Interest rate ≠ return, especially when securities are held
for periods other than the term to maturity.

Return = Current yield + rate of capital gain

Returns will differ from the interest rate, especially if there are sizable
fluctuations in the price of the bond that produce substantial capital gains or
losses.

A bond that has a substantial initial interest rate, its return can turn out to be
negative if interest rates rise.

4. The Behavior of Interest Rates:

Determinants of Asset Demand: Factors that influence demand for an asset,

including:

Wealth: Higher wealth increases asset demand.

Expected Return: Higher expected returns increase demand relative to

alternatives.

Risk: Higher risk reduces demand for a particular asset relative to

alternatives.

Liquidity: Higher liquidity increases asset demand.

Changes in Equilibrium Interest Rates on Bonds:

Demand Shifts:
Changes in wealth: Increased wealth shifts demand to the right and vice
versa.

Changes in expected returns: Higher expected returns on bonds increase the

demand for bonds and vice versa.

Changes in the riskiness: Increased riskiness on bonds decreases demand for

bonds and vice versa.

Changes in liquidity: Increased liquidity of bonds raises demand for bonds

and vice versa.

Supply Shifts:

Changes in expected profitability of investments: Better business

expectations increase supply of bonds and vice versa.

Changes in expected inflation: Higher expected inflation increases supply of

bonds and vice versa.

Changes in government activities: Higher government deficit increases

supply of bonds and vice versa.

5. Theory and Structure of Interest Rate:

Theories of Interest: Explaining the factors that influence interest rates

Classical Theory: Interest rate is the real phenomenon that is determined by

savings and investment.

The market clearing equilibrium where savings is equal to the investment.

Loanable Fund Theory: The interest rate is the price paid for the use of
loanable funds; it is determined by the balance of supply and demand in the
credit market.

Keynesian Liquidity Preference Theory: The rate of interest is a purely

monetary phenomenon determined by the demand and supply of money.

Structure of Interest Rates:

Risk Structure: Explains why bonds with similar terms to maturity have
different interest rates, based on the risk of default, tax status and liquidity.

Term Structure: Relates interest rates to the time remaining until maturity.

Theories of Term Structure:

Liquidity Premium Theory: Long term bonds are more risky, thus lender
require a premium to invest.

Segmented Market Theory: Lenders and borrowers like to match their assets
and liabilities maturities; so markets are segmented in terms of maturity.

Portfolio Behavior Theory: Institutional investors tend to influence the rate of

return through investment choices.

Expectation Theory: The interest rate is determined by expectations of

borrowers and lenders on future short-term interest rates.

In short, Chapter 3 explains how interest rates are measured, what can cause
them to change, and how they relate to the actual returns on bonds and
other debt instruments. It also explores different perspectives on what
determines the overall level and the structure of interest rates in financial
markets.

Okay, let’s summarize the main points from Chapter 4, which

focuses on Financial Markets in the Financial System:

Chapter 4: Financial Markets in the Financial System

1. Introduction:

This chapter explores the nature and role of financial markets, the different
instruments used within them, and how they’re organized and classified.

It emphasizes the importance of understanding how these markets function

to effectively utilize financial instruments.

2. The Nature and Role of Financial Markets:

Definition: Financial markets are where funds are transferred between those
with excess and those with a shortage.

Why Study? They are crucial for economic efficiency, growth, and the
allocation of resources.

Well-functioning markets are key for economic growth, and poor markets are
a reason for economic stagnation.

Financial markets have a direct effect on personal wealth, business/consumer

behavior, and the economy.

Functions of Financial Markets:

Channel funds from savers to spenders.

Provide liquidity for investments.

Determine the prices of traded securities.

Reduce search and information costs.

3. Structure of Financial Markets:

Direct vs. Indirect Finance:

Direct Finance: Borrowers sell securities to savers directly

Indirect Finance: Funds move through financial intermediaries

Debt and Equity Markets:

Debt Markets: Trade debt instruments (e.g., bonds, mortgages) which have
fixed amount repayment.

Equity Markets: Trade equity instruments (e.g., stocks) which represent

ownership.

Primary and Secondary Markets:

Primary Markets: Where new securities are sold by the issuer.

Secondary Markets: Where existing securities are traded among investors

Exchanges and Over-the-Counter (OTC) Markets:

Exchanges: Organized markets where trading happens at a central location

(e.g. stock exchanges).

OTC Markets: A network of dealers trading in a non-centralized manner.

Money and Capital Markets:

Money Markets: Where short-term debt instruments (maturity less than a

year) are traded.

Capital Markets: Where long-term debt and equity instruments (maturity

greater than a year) are traded.

4. Financial Market Instruments:

Financial instrument: any contract that establishes claim.

Money Market Instruments:

Treasury Bills: Short-term government debt instruments sold at a discount.

Negotiable Bank Certificates of Deposit (CDs): Debt instruments sold by
banks.

Commercial Paper: Short-term debt issued by corporations.

Bankers’ Acceptances: Bank-guaranteed drafts used in international trade.

Repurchase Agreements (Repos): Short-term loans secured by Treasury bills.

Federal (Fed) Funds: Overnight loans between banks’ deposits at the Federal
Reserve

Capital Market Instruments:

Stocks: Equity claims on the net income and assets of a corporation.

Mortgages: Loans for purchasing real estate, using the property as collateral.

Corporate Bonds: Long-term debt issued by corporations.

Government Securities: Long-term debt issued by the government.

 State and Local Government Bonds: Long-term debt issued by state

and local governments, and are also called as municipal bonds.

Consumer and Bank Commercial Loans: Loans to consumers and businesses.

Financial Derivatives:

Definition: Contracts whose value is derived from an underlying asset (like

commodities, currencies, securities, and indices)

Purpose: Used for risk management through hedging, arbitrage, and

acquiring insurance.

Types:

Forward Contracts: Agreements to buy/sell an asset at a future time and

price.

Financial Futures Contracts: Similar to forward contracts but traded on

exchanges and having standardized contract terms.

Options:

Call Options: The right to buy an asset at an exercise price within a given
period.

Put Options: The right to sell an asset at an exercise price within a given
period.
Interest-Rate Swaps: Exchange of interest payments between two parties.

6. Financial Derivatives as Hedging Instruments:

Hedging: Using derivative instruments to reduce or eliminate risk.

Long Position: Buying an asset exposes the owner to price risk.

Short Position: Selling an asset exposes the seller to price risk.

Forward Contracts: Used to hedge against interest rate changes or foreign

exchange fluctuations.

Interest rate forward contracts: Involve buying or selling a debt instrument at

a future date at an agreed price.

Foreign exchange forward contracts: Allow to fix the exchange rate for a
future transaction, by agreeing to exchange two currencies at a future date.

Futures Contracts: Are similar to forward contract but are traded on

exchanges and standardized. Futures contracts can be used to hedge
interest rate risk

Options: used for hedging using the right to buy or sell an asset at a set price
before expiration date. Options provides a chance to gain unlimited profits
while limiting potential losses to the amount of the premium.

Interest Rate Swaps: used to manage interest rate risks by converting fixed
rate liability to a variable interest rate liability and vice versa.

6. Financial Market Classifications:

Money vs. Capital Markets: Based on the maturity of securities (short-term

vs. long-term)

Over the counter market vs. Organized exchange: Based on organization of

market

Derivatives markets: Market for future, forward, options and swap contracts

In essence, Chapter 4 focuses on defining and describing the various

components and types of financial markets, emphasizing their role in
facilitating the transfer of funds and managing risk in an economy. It clarifies
how these markets are structured, which instruments are traded, and for
what purposes.

Chapter 5: The Regulation of Financial Markets and Institutions

 1. What is Regulation?

Definition: Regulation refers to rules, orders, directives, laws, or ordinances

created by the government or a competent authority to control the actions of
those within its jurisdiction.

Financial Regulation: Specifically, this is the supervision and control of

financial markets and institutions, aiming to maintain the integrity and
stability of the financial system.

It can be Implemented by government or non-governmental bodies.

2. The Importance of Financial Regulation:

Financial regulations are essential for economic growth, as they provide a

sound framework for financial transactions and stability.

Regulations ensure:

Smooth flow of cash within a country.

Institutions don’t go bankrupt due to over-outflow of funds.

Credibility of financial institutions.

Fair trial of defaulters.

Licensing only to compliant institutions.

3. Purpose of Financial Regulation:

The primary objectives of financial regulation include:

Maintain Market Confidence:

Promotes fair competition, transparency, and trust in the system.

Ensures easy entry and exit from the market, with well-defined eligibility
criteria.

Promote Financial Stability:

Aims to increase the ability of the system to withstand shocks and instability.

Addresses factors that can lead to instability, such as interest rate changes,
economic shocks, and balance sheet problems.

Protect Investors/Consumers:
Safeguards consumer interests from fraud and misinformation by ensuring
fair disclosure.

Ensures protection of depositors in cases of failure of financial institution.

Reduce Financial Crime: Aims to prevent illegal activities like insider trading,
money laundering, and market manipulations.

Regulating foreign Participation: Protecting the financial interest of a country

and its economy from foreign concern, by restricting ownership and limiting
investment.

4. Who Are the Financial Regulators?

Financial regulators are the official agencies responsible for overseeing

financial markets and institutions and they are also called as financial
authorities

Every country has a system of financial regulation, though the specific

agencies may differ from place to place.

Regulators are responsible for setting the regulatory framework for the
functioning of the financial system.

Examples of common regulators include:

Ministry of Finance of the central government

Federal Reserve Bank or central bank of the country

Securities Exchange Commissions

Insurance Regulatory Authorities

Banking Regulation Authorities

5. Forms of Financial Regulations (Types of Regulations):

Disclosure Regulations: Mandate that financial institutions provide truthful

and fair financial statements to the public on annual basis.

Regulation of Financial Institutions: Restrict financial institutions’ activities in

lending, borrowing, and funding.

Regulation of Foreign Participation: Specify the role that foreign firms can
have in domestic financial markets.

Financial Activity Regulations: Control the kind of financial activities that are
permitted in the markets (e.g. insider trading is disallowed).
 6. Arguments Over Regulations:

Arguments are based on the opinions of financial analysts, industry experts,

and economists.

In Favor of Regulations:

Ensures Safety of Public Funds: Safeguards savers and depositors.

Help the Development of Disadvantaged Sectors: Provides support and

access to financing for underserved segments of the economy.

Check Inflation: Regulates the creation of money.

Support Governments: Enables access to finance and the collection of tax

revenues.

Against Regulations:

Creates Moral Hazard: Makes institutions and depositors reckless.

Agency Capture: Creates a bias of regulators towards the regulated

industries.

Increases Costs: Raises the costs of financial services.

Gives Room for Monopolies: Restricts entry of new players and reduces
competition, hence creating monopolies and less service quality.

Leads to Market Inefficiency: Creates hindrance to mergers and acquisitions,

and thus allow inefficient firms to survive.

In essence, Chapter 5 highlights the importance of a structured and well-

regulated financial system. It details what financial regulation means, why
it’s needed, who enforces it, and the various forms that such regulation may
take. It also acknowledges the debate around the potential benefits and
drawbacks of implementing these regulations.

Chapter 6: Financial Institutions and Capital Markets in Ethiopia

1. Introduction:

This chapter discusses the application of the concepts discussed in previous

chapters to the specific context of Ethiopia, a less developed nation.

It addresses the challenges in developing countries to mobilize and channel

resources, as there are no developed financial markets.
It explains that in Africa, the flow of assistance exceeds the flow of private
capital. However, many countries in Africa are hampered by their
underdeveloped financial sector.

It stresses the Importance of having developed financial systems to channel

financial resources to the productive sectors of the economy.

2. The Formal Financial Sector in Ethiopia:

Dominance of Banks: Banks hold the dominant position, even though the
number and kind of financial institutions aren’t large.

Other Notable Institutions: Non-bank financial institutions mainly include

Insurance companies, and Microfinance Institutions.

Underdeveloped Capital Market: The capital market is not well developed.

There is no formal trading in long-term equity and debt securities.

Treasury Bill Market: The treasury bill market, where 28 and 98 day
instruments are sold, is the primary market and it is mostly dominated by
commercial banks.

Other Markets: Includes interbank money market among existing commercial

banks, a foreign exchange market and commodity market of few agricultural
products.

3. Financial Institutions in Ethiopia:

The Banking System (History and Structure):

Modern banking began in 1905.

Many organizational and policy changes occurred, especially during the

centrally planned economy.

Currently, the banking system is characterized by a central bank (NBE), a

few government-owned and privately owned commercial banks, as well as
development bank.

Despite reforms, the sector is still closed to foreign investors.

Insurance Companies:

Pre-Marxist regime, private insurance companies were in operation but were

nationalized by the government.

Currently, the EIC still remains a large state-owned firm, and alongside
private insurance companies are operating in the industry after reforms.
Microfinance Institutions (MFIs):

Established post-1996; provide financial services to rural/urban poor that

may not have access to other financial sectors.

Growing in numbers and size with considerable amounts of total capital and
assets.

4. Informal Financial Systems:

Strong Culture: Characterized by a strong informal financial sector with

money lenders, Iddir and Iqqub.

Money Lenders: Charge high-interest rates and provide a service for those
that can’t access formal channels.

Iddir: Serves as a type of life insurance, where members make regular

payments expecting future benefit (e.g. upon a death).

Iqqub: A form of rotating credit and saving association (ROSCA) where

groups of people make regular payments which are allocated to one member
at a time.

5. Summary:

The Ethiopian financial system is still developing, hindering the real economy
from obtaining its full potential.

It consists of both formal and informal institutions; formal including banks,

insurance companies, and microfinance institutions, and informal systems
encompassing money lenders, Iddir, and Iqqub.

The market In Ethiopia is undeveloped; there is no capital market for long

term securities.

There is no formal trading in long-term equity and debt securities.

There are limitations to access capital for local investors and even flow of
foreign direct investment.

Despite reforms, major challenges remain in developing a well-functioning

financial system, especially in bringing more foreign investment and
developing capital market.

In short, Chapter 6 provides a snapshot of the specific financial landscape of

Ethiopia, highlighting the major formal and informal players, and how they fit
into the country’s economic realities. It emphasizes both the challenges and
progress that have been made in developing a more robust and accessible
financial system.

Okay, here are 60 multiple-choice questions, designed to cover the

main points of the module, but without providing the answers:

Multiple Choice Questions (No Answers)

Chapter 1: Overview of the Financial System

Which of the following best describes a financial system?

a) A system for producing goods and services.

b) A network of interconnected instructions, practices, markets, transactions,

and liabilities for financial aspects of the economy.

c) A set of government policies to control the economy.

d) A collection of banks and insurance companies.

Which of the following is NOT a primary goal of a financial system?

a) To facilitate the flow of funds from savers to investors.

b) To allow economic agents to share risks.

c) To maximize government revenue.

d) To generate liquidity in the market.

Which of the following best describes indirect financing?

a) Investors provide funds directly to borrowers

b) Funds flow through financial intermediaries

c) It occurs in the primary market.

d) It includes issuance of equity.

Which of the following is a key component of a financial system?

a) Real estate markets

b) Political organizations

c) Financial institutions

d) Government agencies

Which of the following best describes a financial asset?

a) A tangible item, like land or equipment.

b) A legal contract that gives its owner a claim to payments.

c) A physical stock of money

d) An intangible item, such as goodwill.

Which property of a financial asset refers to its ability to act as a medium of

exchange?

a) Divisibility

b) Maturity

c) Money-ness

d) Convertibility

What is the typical economic function of a financial asset?

a) transfer funds from those who need funds to invest.

b) transfer funds from those who have surplus funds to invest.

c) transfer funds in such a way to redistribute unavoidable risk associated

with tangible assets.

d) Both b) and c).

Which one of the following is not an economic function of the financial

system?

a) transfer resources

b) managing risk

c) Providing information

d) Control the price of tangible assets

A financial market that trades only short-term debt instruments is known as

a:

a) Capital market

b) Equity market

c) Money market

d) Primary market
In which market are newly issued securities sold for the first time?

a) Secondary market

b) Money market

c) Capital market

d) Primary market

The debt market is a financial market in which:

a) only equity instruments are traded

b) only debt instrument are traded.

c) Both equity and debt instruments are traded

d) only stocks are traded.

What is the term used to describe financial markets where standardized

contracts are traded on organized exchanges?

A) Private markets

b) Public markets

c) Informal markets

d) Direct markets

Which of the following is NOT an example of a financial intermediary?

a) Commercial Bank

b) Insurance company

c) Stock Brokerage

d) Supermarket

Chapter 2: Financial Institutions in Financial System

Financial institutions are primarily involved in:

a) Buying and selling of goods.

b) Trading in commodity markets.

c) Providing financial services to clients.

d) Regulation of financial markets.

Which financial institution does not accept deposit?

a) Credit Union

b) Commercial bank

c) Saving and Loan Association

d) Finance company

Which of the following best describes intermediation by a financial

institution?

a) Creating assets for savers and liabilities for borrowers

b) Lending funds directly to borrowers.

c) Providing payment mechanism.

d) Managing the investment of investors.

What does maturity transformation refer to in the context of financial

institutions?

a) Reducing investment risk.

b) Converting short-term funds to long-term loans.

c) Providing a payment mechanism.

d) Managing portfolios for other market participants.

Which type of financial institution is typically owned by its members?

a) Commercial bank

b) Credit union

c) Insurance company

d) Investment company

Which of the following is not a typical function of commercial banks?

a) Selling brokerage services related to chapter trust

b) Issuance of share certificates

c) Selling insurance

d) Providing investment advice

What is the main role of investment banking firms?

a) Accepts deposit from public

b) Provides loans to businesses and individuals.

c) Provide funds to the government for their day to day financial needs.

d) Underwrite and distribute new securities and assists in raising capital.

Which of the following are the main source of funds for depository
institutions?

a) Issuing stocks

b) Accepting deposits

c) Issuing bonds

d) Borrowing from other institutions

Which of the following institutions usually specializes in mortgage lending?

a) Commercial bank

b) Credit union

c) Saving bank

d) Investment bank

What is the main difference between a credit union and a commercial bank?

a) Credit unions offer lower loan rates.

b) Credit unions are owned by their members.

c) Commercial banks offer more services.

d) Commercial banks are more tightly regulated.

Which of the following is a non-depository financial institution?

a) Commercial bank

b) Credit union

c) Microfinance institution

d) Pension fund
Which type of insurance company covers losses from injuries, accidents or
natural disasters?

a) Life insurance company

b) Annuity company

c) Health insurance company

d) Property and casualty insurance company

The main function of pension funds is to manage funds for

a) Government agencies

b) Insurance companies

c) Individuals to use during retirement

d) Business organizations

What does the term “overdraft” refer to?

a) A special deposit account that bears a high interest.

b) A credit facility that allows withdrawing funds beyond the account

balance.

c) A fixed-term loan for investment purpose.

d) An investment account in which fund is used in treasury bills

Which of the following is a primary function of depository institutions?

a) Underwriting securities

b) Accepting Deposits

c) Providing risk management services.

d) Buying stock shares.

What is the unique aspect of a special demand deposit account?

a) It is interest bearing

b) It is non-interest bearing

c) It is opened only by government entities

d) It can be opened by minors only.

In which deposit account is the transfer of funds is made via a special bank
instrument called “draft”

a) Fixed (time) deposit

b) Telegraphic transfer

c) Current Account

d) Demand Draft

Chapter 3: Interest Rates in the Financial System

The most accurate measure of interest rates is:

a) The coupon rate.

b) The current yield.

c) The yield to maturity.

d) The prime rate.

What does discounting the future refers to?

a) The process of calculating the future value of money.

b) The process of calculating the value of money received today.

c) The process of calculating the present value of future cash flow.

d) None of the above.

A discount bond:

a) pays annual coupon payment.

b) pays off face value at maturity date.

c) is bought at a price below its face value.

d) All of the above

Which of the following describes the relationship between bond prices and
interest rates?

a) They are positively correlated.

b) They are inversely correlated.

c) They are unrelated.

d) The relationship is random.

The difference between the value at the end of maturity and the original
price of a bond is referred to as

a) Yield to maturity

b) Current yield

c) Rate of return

d) Capital Gain.

If a bond’s price falls from 1000 to 900 in a year, which is not among the
reasons?

a) increase in its default risk

b) A rise in the level of interest rate.

c) A fall in its default risk.

d) A fall in risk-free rate.

Which of the following statements is not among the characteristics of a long-

term bond?

a) They have low risk

b) Their prices are more sensitive to changes in interest rates.

c) They have longer maturity.

d) They are subject to a high degree of interest-rate risk.

Which of the following is NOT a determinant of asset demand?

a) Wealth

b) Expected return

c) Transaction cost

d) Risk.

Which of the following does the loanable fund theory of interest rate depend
on?

a) Demand and Supply for loanable funds

b) The demand for money and supply of money

c) Saving and investment

d) All of the above

Which of the following best describes the relationship between the price and
YTM of a bond when the bond price is below its face value?

a) Yield to maturity will always be the same as the coupon rate.

b) Yield to maturity will always be lower than the coupon rate.

c) Yield to maturity will always be higher than the coupon rate

d) none of the above.

Chapter 4: Financial Markets in the Financial System

41. Financial markets are best described as:

a) Markets where goods and services are exchanged

b) Markets where fund transferred from those who have to those who need

c) Markets with physical location for trade

d) Markets where financial institutions meet.

42. Which of the following is a primary function of the financial market?

a) Setting government policies

b) Facilitating the flow of funds

c) Creating new products

d) All of the above.

43. Which market is used by a corporation to raise capital by issuing new

equity?

a) Secondary market

b) Money market

c) Capital market

d) Primary market

44. Which market type is characterized by a network of dealers over

telecommunication networks, who stands ready to buy and sell securities?

a) Primary market
b) Secondary market

c) Organized Exchange

d) Over-the-counter market

45. Which of the following is a debt instrument?

a) Common Stock

b) Corporate Bond

c) Preferred Stock

d) All of the above

46. Which market is generally characterized by low risk investments?

a) Capital Market

b) Commodity Market

c) Money Market

d) Stock Market

47. Which of the following is not a money market instrument?

a) Treasury bill

b) Commercial paper

c) Bankers’ acceptance

d) Corporate bond

48. Which of the following is a capital market instrument?

a) Treasury bill

b) Certificate of Deposit

c) Commercial paper

d) Mortgages

49. What does the term “underwriting” refer to in the context of primary
markets?

a) Guaranteeing a price for securities and selling to the public.

b) Trading existing securities among investors.

c) Managing funds of investors.

d) Selling securities directly to investors.

50. Which of the following financial instrument is not a derivative?

a) Treasury bond

b) Futures contract

c) Options

d) Swaps

Chapter 5: The Regulation of Financial Markets and Institutions

51. What is the primary purpose of financial regulation?

a) To increase the profits of financial institutions.

b) To maintain the integrity and stability of the financial system.

c) To hinder economic growth

d) To maximize government income.

52. What is the primary goal of a law regulating financial transactions?

a) To make financial institutions bankrupt.

b) To create new firms.

c) To ensure the flow of cash and save institutions.

d) To impose extra cost on institutions.

53. Which of the following is not the objective of financial regulation?

a) Maintain market confidence

b) Promote financial stability

c) Protect consumers

d) Increase interest rate.

54. Which of the following is a key function of financial regulators?

a) Designing new financial instruments.

b) Influencing the stock market performance.

c) Creating the regulatory framework of financial institutions.

d) Determining the interest rate of the market.

55. Which of the following is an example of a financial regulation?

a) Setting up trade barriers

b) Setting interest rates

c) Requiring banks to hold a minimum level of reserve

d) All of the above

56. A situation in which the financial institutions become less cautious

believing that the central bank will protect them refers to:

A) Agency capture

b) Moral hazard

c) Market inefficiency

d) All of the above

57. What does “insider trading” mean in the context of financial regulations?

a) Trading by small investors in the stock market.

b) Trading by individuals or firms that have privileged information.

c) Trading only in government bonds.

d) Trading with the public.

58. Which of the following can be a disadvantage of financial regulation?

a) Makes financial institutions more risk-averse

b) Protects consumers

c) Creates moral hazard

d) Prevents monopolies to emerge

59. Which is among the regulatory bodies in financial system?

a) State and Local Government

b) Federal Reserve Bank

c) Business firms

d) All of the above.

60. Which is among the arguments against regulations in the financial
sector?

a) It reduces the cost of financial services

b) It can create moral hazard.

c) It facilitates regional imbalance

d) It reduces uncertainty of market.

I hope these questions are helpful for your study! Good luck!