Factors that lead to worsening conditions in financial markets include
Select one:
a.
declining interest rates.
b.
anticipated increases in the price level.
c.
bank panics.
d.
only A and C of the above.
e.
only B and C of the above.
The Correct Answer and Explanation is :
The correct answer is e. only B and C of the above.
Explanation:
Financial markets are sensitive to a wide range of factors that can influence investor confidence, liquidity, and overall market stability. Among the options provided:
1. Declining interest rates (Option a):
Declining interest rates typically do not worsen conditions in financial markets. In fact, they are often viewed as stimulative to the economy and financial markets because lower interest rates make borrowing cheaper, encouraging investment and consumer spending. It also reduces the cost of debt for companies, potentially boosting profits and stock prices. Therefore, declining interest rates do not generally lead to worsening market conditions.
2. Anticipated increases in the price level (Option b):
Anticipated increases in the price level, or expected inflation, can indeed worsen market conditions. If investors expect inflation to rise, they might anticipate higher costs, lower purchasing power, and reduced profitability for companies. In reaction, they may demand higher returns on investments to compensate for the risk of inflation eroding the value of future cash flows, leading to a decrease in asset prices, particularly bonds. Moreover, central banks may raise interest rates to control inflation, which can lead to further volatility and tightening liquidity. Thus, anticipated increases in the price level (inflation expectations) can worsen financial market conditions.
3. Bank panics (Option c):
Bank panics, or banking crises, are one of the most severe factors that can disrupt financial markets. When there is a loss of confidence in the stability of banks, people rush to withdraw their deposits (bank runs), which can lead to liquidity crises and a sharp contraction in credit. This disrupts the functioning of financial markets, often leading to sharp declines in stock prices, increased volatility, and tightening of liquidity. Historical events like the Great Depression show how bank panics can significantly worsen financial market conditions. Therefore, bank panics contribute to worsening financial market conditions.
Given this analysis, the correct response is e. only B and C of the above, as both anticipated increases in the price level and bank panics are factors that can worsen market conditions.