Financial markets and monetary policy: Practice Questions

Which of the following is a function of the Financial Policy Committee (FPC) within the Bank of England's regulatory framework?

A 10-year UK government bond has a nominal coupon of \(\text{\pounds}5\) and a current market price of \(\text{\pounds}125\). What is the current yield on this bond?

The Financial Policy Committee (FPC) identifies a significant rise in the house price-to-earnings ratio and a rapid growth in mortgage debt. To maintain financial stability, which macroprudential tool is the FPC most likely to recommend?

A government bond has a nominal face value of \(\text{\pounds}1,000\) and a fixed annual coupon payment of \(\text{\pounds}40\). If the market price of this bond falls to \(\text{\pounds}800\), what is the new current yield on the bond?

In the monetary policy transmission mechanism, if the central bank reduces the Bank Rate, why might the impact on Aggregate Demand (AD) be limited if commercial banks are experiencing a liquidity trap?

A government bond has a nominal value of \(\text{\pounds}1,000\) and a fixed coupon of \(\text{\pounds}50\). If the current market price of the bond falls to \(\text{\pounds}800\), calculate the current yield of the bond.

Explain the inverse relationship between market interest rates and bond prices, specifically describing what happens to the market price of an existing government bond if the central bank raises the base interest rate.

Identify and briefly explain one reason why a commercial bank might face a liquidity crisis despite being technically solvent (having positive net equity).

A 5-year government bond is issued with a nominal value of \(\text{\pounds}1,000\) and an annual coupon of \(\text{\pounds}40\).

a) Calculate the initial yield on this bond at the time of issue. (1 mark)
b) Two years later, the market interest rate for similar assets rises to \(6\%\). Explain why the market price of this bond will change and calculate its new approximate market price, assuming the yield must align with the new market rate. (2 marks)
c) Discuss how an increase in the Bank Rate by the Monetary Policy Committee (MPC) might lead to the change in bond prices described in part (b). (2 marks)

In the UK, the Bank of England operates as the central bank with specific responsibilities for maintaining financial stability and conducting monetary policy.

a) Distinguish between the primary objectives of the Monetary Policy Committee (MPC) and the Financial Policy Committee (FPC). (2 marks)
b) Explain the concept of moral hazard in the context of the central bank's role as a lender of last resort. (2 marks)
c) Evaluate the likely impact on a commercial bank's profitability and stability if the Prudential Regulation Authority (PRA) requires it to significantly increase its liquidity ratio. (3 marks)