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Markets - Money markets

Worksheet 1 - Interest rates - how interesting are they?

The aim of this worksheet is to look at how the central bank intervene in the money markets to maintain the level of interest rates set by the Monetary Policy Committee.

1. Write a paragraph setting out what determines the equilibrium rate of interest in the money markets. Use the blank axes below to illustrate your answer.

Blank axes to show the equilibrium rate of interest in the money markets.

(6 Marks)

2. In the table below put a tick in the appropriate column to indicate whether the event creates a flow of money to the Bank of England or from the Bank of England.

Event	Flow TO the Bank?	Flow FROM the Bank?
The Bank of England issues notes to the commercial banks worth £400 million
ICI pays their corporation tax bill of £250 million
£100 million of Treasury Bills mature
A commercial bank agrees 'repos' with the Bank of England worth £200 million
Commercial banks buy £600 million of gilt-edged securities

(5 Marks)

3. Why is there usually a 'shortage' of liquidity each day in the money market?

(3 Marks)

4. What is a 'repo'?

(2 Marks)

5. Why do the Bank of England offer 'repos' each day?

(4 Marks)

6. Use the axes below to illustrate the possible effect on the rate of interest if the following events occurred.

a) The Bank of England don't fully relieve the shortage one day
Axes to illustrate the possible effect on the rate of interest.

b) More banknotes are issued than required
Axes to illustrate the possible effect on the rate of interest.

c) Large tax payments after the end of the tax year leave the banks very short of liquidity
Axes to illustrate the possible effect on the rate of interest.

(6 Marks)

7. Write a short paragraph to explain the relationship between gilt prices and interest rates.

(4 Marks)

Total Marks = 30