R01 Functions of financial services: free practice questions

1. Question 1 of 5

   Which of the following is one of the essential functions that financial services perform in the economy?

   Option A: Letting people insure against risks that others will take on for a priceOption B: Setting the official rate of interest for retail lendersOption C: Collecting income tax and VAT from customers on behalf of HM TreasuryOption D: Guaranteeing that every investor receives a positive return

   Show answer

   The answer is A: Letting people insure against risks that others will take on for a price

   One core function is risk transfer: individuals and firms pay others, such as insurers, to take on risks they don't want to bear. The others are functions of the Bank of England, HMRC or simply not true.

   Why the other options are wrong

   B

   The official interest rate is set by the Bank of England's Monetary Policy Committee, not by financial services firms generally.

   C

   Tax collection is the job of HMRC, not a function of the financial services industry.

   D

   Financial services let investors spread risk; they can't guarantee positive returns.

2. Question 2 of 5

   Under fractional-reserve banking, where does much of the liquidity come from when depositors need repaying?

   Option A: The Financial Services Compensation SchemeOption B: The bank's shareholders, through new share issuesOption C: Inter-bank lendingOption D: National Savings and Investments

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   The answer is C: Inter-bank lending

   Because a bank may lend out more than it holds in deposits, much of the liquidity it needs comes from borrowing from other banks. The breakdown of inter-bank lending was a key cause of the 2008/09 crisis.

   Why the other options are wrong

   A

   The FSCS compensates customers when a firm fails; it isn't a routine source of a bank's liquidity.

   B

   Issuing shares raises long-term capital; it isn't how day-to-day withdrawals are met.

   D

   NS&I is a Government savings institution that funds Government borrowing, not banks' liquidity.

3. Question 3 of 5

   Why can a building society typically offer slightly better rates than a bank?

   Option A: It is exempt from all regulation by the FCA and PRAOption B: It receives a direct subsidy from the GovernmentOption C: It is allowed to lend more than its members deposit with no reservesOption D: It has no external shareholders to pay dividends to

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   The answer is D: It has no external shareholders to pay dividends to

   As a mutual, a building society has no shareholders taking dividends, so more is available to pay interest to savers and it can charge borrowers slightly less.

   Why the other options are wrong

   A

   Building societies are regulated in the same way as banks for prudential and conduct purposes.

   B

   Building societies don't receive a Government subsidy; the advantage comes from mutual ownership.

   C

   Building societies must hold reserves; mutual status doesn't remove that requirement.

4. Question 4 of 5

   An investor wants a gilt that protects them against inflation. Which statement about index-linked gilts is correct?

   Option A: They are linked to the Consumer Prices Index and have been since they were first issuedOption B: Only the final repayment is linked to inflation; the interest is fixed in cash termsOption C: They are issued only by National Savings and InvestmentsOption D: Both the nominal value and the interest are linked to the Retail Prices Index

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   The answer is D: Both the nominal value and the interest are linked to the Retail Prices Index

   With index-linked gilts both the nominal value and the interest move with the RPI. A move to linking them to CPIH has been confirmed but isn't expected until 2030.

   Why the other options are wrong

   A

   Index-linked gilts are linked to the RPI; the switch to CPIH isn't expected until 2030.

   B

   Both the interest and the capital are index-linked, not just the final repayment.

   C

   Gilts are issued through the UK Debt Management Office, not NS&I.

5. Question 5 of 5

   Apart from physical assets, which other areas can individuals and companies insure? 1. Earnings 2. Profit potential 3. Financial transactions

   Option A: 1 and 2 onlyOption B: 1, 2 and 3Option C: 2 and 3 onlyOption D: 1 and 3 only

   Show answer

   The answer is B: 1, 2 and 3

   Protection needs extend beyond physical assets to earnings, profit potential and financial transactions. Financial transactions are usually protected with derivatives rather than insurance policies.

   Why the other options are wrong

   A

   Financial transactions can also be protected, using derivatives to offset potential losses.

   C

   Earnings can be protected, for example by life assurance or income protection.

   D

   Profit potential can be protected too, for example with key person cover.

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