Money and Banking: four questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
A central bank acts as a lender of last resort especially in times of financial crisis. What is the purpose of this function?
Answer: B.
The correct answer is B: to provide liquidity to the banking system.
Banks hold only a fraction of their deposits as cash, lending the rest out. That makes them profitable but leaves them vulnerable: a bank can be entirely solvent: its assets genuinely worth more than its liabilities, and still be unable to meet a sudden rush of withdrawals, because its assets are tied up in loans that cannot be called in quickly. As lender of last resort, the central bank lends to such banks so they can meet demands for cash. This stops a temporary liquidity shortage becoming a bank run, and prevents panic spreading across the system.
Why the other options are wrong:
Banks hold only a fraction of their deposits as cash, lending the rest out. That makes them profitable but leaves them vulnerable: a bank can be entirely solvent: its assets genuinely worth more than its liabilities, and still be unable to meet a sudden rush of withdrawals, because its assets are tied up in loans that cannot be called in quickly. As lender of last resort, the central bank lends to such banks so they can meet demands for cash. This stops a temporary liquidity shortage becoming a bank run, and prevents panic spreading across the system.
Why the other options are wrong:
- C, removing failing banks from the system, is the opposite of the function. The purpose is to support banks so they survive, not to close them.
- D, safeguarding the profits of the banking system, misstates the aim. The purpose is to protect depositors and financial stability, and emergency lending is typically at a penalty rate precisely so that banks do not treat it as a cheap and profitable source of funds.
- A, covering consumers' credit card debts, is not a central bank activity. It lends to financial institutions, not to individuals.
Question 2
What can a central bank increase in order to reduce consumer borrowing?
Answer: D.
The correct answer is D: the rate of interest.
Raising the interest rate makes borrowing more expensive. Loans, mortgages, overdrafts and credit card debt all cost more to service, so households take on less new debt and consumer borrowing falls. The higher rate also makes saving more rewarding, which reinforces the effect by encouraging people to save rather than spend. This is the principal instrument of monetary policy.
Why the other options are wrong:
Raising the interest rate makes borrowing more expensive. Loans, mortgages, overdrafts and credit card debt all cost more to service, so households take on less new debt and consumer borrowing falls. The higher rate also makes saving more rewarding, which reinforces the effect by encouraging people to save rather than spend. This is the principal instrument of monetary policy.
Why the other options are wrong:
- A, commercial bank deposits, is the base from which banks lend. More deposits means banks can create more credit, so this would increase borrowing rather than reduce it.
- B, government spending, is fiscal policy and is decided by the government, not the central bank. Higher spending raises aggregate demand rather than restraining borrowing.
- C, the exchange rate, affects import and export prices. A central bank can influence it, but it is not the lever for consumer borrowing, and under a floating system the rate is not set directly.
Question 3
What is not a function of a central bank?
Answer: C.
The correct answer is C: it lends to individual firms and consumers.
Lending directly to households and businesses is the work of a commercial bank, not a central bank. A central bank's customers are the government and the banking system itself; it does not take deposits from the public or offer them mortgages and overdrafts.
Why the other options are central bank functions:
Lending directly to households and businesses is the work of a commercial bank, not a central bank. A central bank's customers are the government and the banking system itself; it does not take deposits from the public or offer them mortgages and overdrafts.
Why the other options are central bank functions:
- A, lender of last resort, means providing emergency liquidity to banks that are solvent but temporarily short of cash. This prevents a liquidity problem at one bank turning into a panic across the whole system.
- B, sole issuer of notes and coins, is the central bank's monopoly over the currency. Controlling the issue is part of controlling the money supply.
- D, managing the national debt, involves issuing government bonds and handling repayment on the government's behalf.
Question 4
When will a central bank act as lender of last resort to a commercial bank?
Answer: A.
Lender of last resort means the central bank supplies cash to a commercial bank that is fundamentally sound but temporarily short of liquid funds, a liquidity crisis, where deposits are being withdrawn faster than assets can be turned into cash. It is not a rescue for unprofitable banks, a source of share capital, or a response to a bank's pricing decisions. The trigger is a shortage of CASH, not a shortage of profit.
What this practice covers
These questions are drawn from past Cambridge IGCSE papers and filtered to money and banking. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on money and banking, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Giving only two or three functions of money when four are expected.
- Confusing the characteristics of money (durable, portable) with its functions (medium of exchange).
- Confusing central banks with commercial banks.
- Saying banks make money "from fees", the main source is the interest difference.
- Forgetting that inflation undermines money's role as a store of value.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Money and Banking revision notes.