10) the financial sector

Question 1

What are commercial banks?

Answer 1

financial institution used by everyday people ie deposits, loans, mortgages
Eg HSBC, Lloyds

Question 2

What are investment banks?

Answer 2

Investment banks- provides large amounts of long term fixed capital mostly for established firms. They take a share in the borrower firm to exercise some amount of influence to maximise their return eg JPMorgan chase, Goldman Sachs

Question 3

What are pension funds?

Answer 3

Pension funds- pooled contributions from pension plans set up by employers, unions or other organisations to provide retirement benefits. Largest investment blocks in the country and make their money through investing their contributions into stocks
Eg aviva, Prudential

Question 4

What are hedge funds?

Answer 4

Hedge funds- alternative investment available only to sophisticated investors, institutions and individuals with significant assets. Use tactic called leverage, which is where they invest borrowed money which could pay-out a massive return or end up with a huge loss. Less regulated and most risky

Question 5

What is the money market?

Answer 5

-Money markets- market for short term loan finance for businesses and households, lent up to a period of 12 months max. Also includes interbank lending ie one bank lending to another to help liquidity (cash flow). Also includes short term government loans to fund the government budget deficit

Question 6

What is the stock market?

Answer 6

-Stock market- capital market where ownership of different companies are sold as shares, and people gamble their money in the hope that the company does well and the value of their share increases. Vital for free market as it provides companies with access to capital in return for a loss of small amounts of ownership

Question 7

what is the bond market?

Answer 7

-The bond market- financial market where participants can issue debt ie they will pay out some money and then the money is paid back over several years with interest (long term investment) also used by governments

Question 8

What is the FOREX market?

Answer 8

FOREX- foreign exchange market, also the biggest financial market where currencies are bought and sold. About $2000 billion a day is traded.

Question 9

What 4 roles do banks play in an economy?

Answer 9

• Banks are critical to the operation of a developed economy.
  • They facilitate transactions enabling Consumption
  • They provide funds to Businesses enabling investment.
  • They enable savings.
  • They play a key part in business and consumer confidence.

Question 10

What impact do fund groups have on the economy?

Answer 10

• key in economic performance because they help to finance major public and private projects, as well as infrastructure too, which increases the standard of living of areas as well as providing increased investment and consumption, in addition to employment
• they are also necessary for government borrowing too ie bonds
• however if funds are badly managed or take too many bad risks they can shock business and consumer confidence in the future, which can reduce long term components of AD

Question 11

What are the 5 types of borrowing??

Answer 11

• mortgages
• unsecured loans
• overdrafts
• credit cards
• pay day lending

Question 12

What are mortgages/secured loans?

Answer 12

-long term secured loans for about 20 years, used for the purchase of property and normally require a deposit of 10%. Property used as security ie if they can’t pay they lose the property

Question 13

What are unsecured loans?

Answer 13

more short term loans eg for buying a car. Unsecured means you get the loan without having to provide the bank with security (don’t lose the car if you cant pay it back) but the bank can reject the loan if its deemed too risky

Question 14

What are overdrafts?

Answer 14

Overdrafts
-Very short-term loans eg for one day. The bank allows account holders to spend an agreed amount over the amount they have in their account, helps businesses to alleviate cash flow problems but businesses have to pay whereas consumers do not.

Question 15

What are credit cards?

Answer 15

Credit cards
- form of borrowing where the user pays at the end of the month and not when they purchase something. The credit card company pays for the good straight away and then the consumer pays later.

Question 16

what are payday lending schemes??

Answer 16

-Exceedingly high interest rates are charged on these loans for people who are in desperate need of quick cash. They are often unethical as they do not often provide clear guidelines of their usage and can quickly become dangerous

Question 17

What is interbank lending and why is it important?

Answer 17

• The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for one week or less, the majority being overnight. Such loans are made at the interbank rate (also called the overnight rate if the term of the loan is overnight).
  This performs an important roles: often commercial banks are short of money and so are forced to borrow money on the money markets. These are typically short term loans and can be interbank or direct to the Central Bank.

Question 18

Why do rates of interest vary across the money market?

Answer 18

Banks try to balance risk v security.
Riskier loans (e.g. unsecured loans) will often attract a much higher interest rate than secured loans (e.g. mortgages). This is because there is more risk of the bank losing money so they want a higher return to compensate.
In most circumstances the overnight rate is the lowest available interest rate, and as such, it is only available to the most creditworthy institutions and therefore there is less risk of default.

Question 19

What markets, instruments and institutions make up the financial sector?

Answer 19

• The financial sector comprises all financial markets, instruments and institutions.
  Markets: e.g. the money market, stock market, bond market, forex
  Instruments: Interest rates, QE, Exchange Rates
  Institutions: Banks (Commercial, retail, investment); Pension Funds; Hedge Funds etc

Question 20

What 3 services do the financial sector provide and explain them?

Answer 20

• Credit provision- credit fuels economic activity by allowing businesses to invest beyond their cash in hand, households to purchase homes without saving the entire amount in advance, and governments to smooth out their spending by mitigating the cyclical pattern of tax revenue and invest in infrastructure.
• Liquidity provision- businesses and households need security against unexpected needs for cash, with banks being the main provider of this by offering demand deposits which can be withdrawn at any time (current account) or credit. Banks and their affiliates are at the core of the financial market by providing lending to each other as well as funding important projects or security
• Risk management- finance allows businesses and households to pool their risks from exposure to the financial market and commodity price risks. Much of this is provided by banks through derivative transactions.

Question 21

What are the 3 problems with the financial sector?

Answer 21

• speculation
• caution
• corruption

Question 22

What is speculation and why is it bad?

Answer 22

• the stock market is now more used a gambling mechanism whereby people risk money on shares they expect to increase in value rather than for businesses to source finance
• the market has become far too obsessed with short term return and investors gamble with little to no knowledge of the business

Question 23

What is caution and why is it bad?

Answer 23

• due to the recession, banks have become much less inclined to lend to smaller businesses as they have much more chance of failing
• there is much more regulation in place to stop. banks using money because of the risks involved

Question 24

What is corruption and why is it bad?

Answer 24

Corruption- banks in 2014 including RBS and HSBC were fined for rigging FOREX markets through their own influence for their own gain, instead of serving businesses, governments and share holders. Best example was the PPI scandal where financial services mis sold PPI and it was too expensive.