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ACCA Applied Skills · Financial Management · The nature and role of money markets

Which statement about the money market function of providing liquidity to the banking system is correct?

Banks with surplus funds lend to banks with shortages on the interbank market, usually for very short periods, which helps each bank manage daily liquidity. Interbank lending is not long-term, banks do not depend on share issues for liquidity, and central banks do intervene in money markets.

  1. ABanks with surplus funds lend them to banks with shortages on the interbank market, helping banks manage daily liquidityCorrect
  2. BBanks may only obtain liquidity by issuing new ordinary shares
  3. CInterbank lending is used only for periods exceeding five years
  4. DCentral banks are prohibited from taking part in money markets

Explanation

The interbank market allows banks with surplus funds to lend to those with shortfalls, usually for very short periods, so liquidity is smoothed. Banks do not rely only on share issues, interbank terms are short, and central banks do operate in money markets to manage liquidity and interest rates.

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