Financial Institutions and Markets

Full Answer Section

. Features Differentiating Organized Exchanges from the Over-the-Counter (OTC) Market (2 Marks):

• Organized Exchange:

  • Centralized marketplace with established rules and regulations.  
  • Securities are listed and meet specific listing criteria.  
  • Trading is conducted through brokers and a matching system that ensures fair and orderly execution of orders.  
  • Examples: NYSE, NASDAQ.  

• Over-the-Counter (OTC) Market:

  • Decentralized network of dealers connected electronically.  
  • Securities are not formally listed and may not meet strict listing requirements.  
  • Negotiation directly between dealers or through electronic communication networks (ECNs).  
  • May offer greater flexibility for trading less liquid securities.
  • Examples: Pink Sheets, OTC Bulletin Board.  

3. Lien in Mortgage Lending (1 Mark):

• A lien is a legal claim against a property that serves as security for a debt.  
• In mortgage lending, the lender holds a lien against the borrower's property (the house) until the mortgage is fully repaid.  
• If the borrower defaults on the loan, the lender can foreclose on the property and sell it to recoup the remaining loan balance.  

4. Country with Weak Currency (3 Marks):

• The statement that a country is always worse off with a weak currency is uncertain. It depends on the specific economic context.

Negative Impacts of a Weak Currency:

- **Imports become more expensive:** Reduced purchasing power for imported goods and services, leading to higher prices for consumers and businesses that rely on imports.
- **Inflation:** Increased import costs can fuel inflation, as businesses pass on higher costs to consumers.
- **Reduced exports:** Weak currency may make exports cheaper and more competitive, but may not offset import costs.
- **Capital flight:** Investors might be less likely to invest in a country with a weak currency, leading to capital outflow.

Potential Benefits of a Weak Currency:

- **Increased exports:** Can make exports cheaper and more attractive to foreign buyers, boosting export-oriented industries.
- **Tourism:** A weak currency can make a country more affordable for tourists, potentially boosting tourism revenue.

Overall, the impact of a weak currency is complex. It depends on the country's economic structure, the degree of its reliance on imports and exports, and the effectiveness of government policies in response to currency fluctuations.

5. Large Balance of Payments and Inflation (2 Marks):

• A balance of payments (BOP) is a record of a country's economic transactions with the rest of the world. It has two main components:  

  • Current account: Tracks the flow of goods and services (imports and exports).  
  • Capital account: Tracks the flow of financial investments (foreign investments in a country and domestic investments abroad).

• A large current account deficit, where imports significantly exceed exports, can contribute to inflation in several ways:

  • Increased demand for imported goods: Pushed by a weak local currency and domestic spending, higher import demand can put upward pressure on prices.  
  • Reduced domestic production: If imports become cheaper than domestically produced goods, some domestic production capacity may shrink, leading to potential shortages and price hikes.
  • Depreciation of the currency: To address a persistent deficit, a country's central bank might devalue its currency to make exports more competitive. This can further increase import costs and fuel inflation.  

However, a large current account surplus (exports significantly exceed imports) is not always inflationary. If the surplus is primarily driven by increased savings or foreign investment, it might not lead to excessive demand pressures within the economy.

In conclusion, the relationship between a large balance of payments and inflation is nuanced and depends on the specific components of the balance of payments.

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