Financial institutions, financial markets and financial system

a) Identify which one of the following securities has the highest nominal annual return at issuance. Use the key determinants of Nominal Interest Rate to briefly explain why. [2 marks]

• 20-year bonds issued by the Australian federal government.
  • 30-year corporate bonds issued by the American technology company, Apple Inc.

b) Monetary Policy (MP) is one of the key pillars of macroeconomic policy.

i) Which monetary authority is responsible for the MP in Australia? [1 mark]

ii) Briefly explain how the monetary authority could use the MP to affect the macro economy which is overheating (Include in your answer the definition of MP, inflation target of the MP, the expected effect of any suggested change in cash rate on consumption, investment and the likely change to net export). [5 marks]

c) Australian banks are closely regulated due to the high costs of a bank failure. Banks can fail due to illiquidity. What is bank liquidity and briefly discuss how banks liquidity is regulated? (In your answer distinguish between the regulation of large and small banks and explain how banks manage their liquidity in terms of their Assets and Liabilities) [5 marks]

d) Banks can also fail due to inadequate capital. Briefly explain how banks are regulated in terms of their capital adequacy level and the rationale of this regulation. [4 marks]

e) Australia is going through its first recession in decades due to the Covid-19 pandemic. The banking sector therefore argues that the capital adequacy requirement imposed on banks should be loosened to help the recovery of the economy. Briefly explain the rational of this argument. [3 marks]