12 - Finacial Markets and Monetary Policy Flashcards
What is a financial Market?
Where buyers and sellers can trade financial assets.
Draw a diagram to show what a financial markets are broken down into. (3 categories)
Money market
Capital market
Foreign exchange market
What are money markets assets in?
Assets is highly liquid assets such as treasury bills and commercial bills.
Commercial Bills = banks short-term debt
Treasury Bills = government short-term debt
What do money markets enable and give an example?
Money market enables commercial banks to perform the most important banking function of financial markets, intermediary linking savers to borrowers.
Exp - LIBRO which is the London Interbank Offered Rate which is the rater of interest charged when banks lend to each other.
What are assets?
Things which people or organisation own.
What are liabilities?
Things which people or organisation Owe
What are commercial banks?
A commercial bank, high street banks, manages deposits, cheques and savings accounts for individuals and firms. They can make loans using the money saved with them. Everyday banking needs to consumers and small businesses.
What are commercial banks functions?
1) Accept Deposits
2) Provide Loans
3) Overdraft
4) Investment of Funds
5) Agency Functions
What is an investment bank?
Investment banks provide financial services for investors and large enterprises. It is financial advisory work, such as advising private companies on how to become a public company by floating on the stock market, or advising public companies on how to buy up another company. And also deal directly in Financial markets for their own account.
What are investment bank function?
1) Raise finance for another financial institution by selling bonds or shares to investors and to limit the risk. They do this by underwriting share issues (people buying the shares).
2) Mergers (doing paperwork, media, structure)
3) Own trading globally
What is systematic risk?
Risk of a breakdown of the entire financial system, cause by inter-linkages within the financial systems, rather than simply the failure of an individual bank.
Which out of commercial banks and investment banks suffers from systematic risk?
Investment Banks
What is a bond?
A bond is a specific type of security that is sold by firms or governments. It is a way for the firm or government to borrow money at a certain interest rate. In return for buying the bond an investor gets a certain interest rate for the duration of the bond.
Why would governement sell bonds and why do people buy them?
Government bonds are used to finance the National Debt and the government’s public sector net borrowing requirement. They are issued by the Treasury and sold on the bond market. Bonds are typically bought by pension funds, investment trusts and private individuals. Government bonds are seen as one of the safest types of investment. As governments rarely go bankrupt.
Why are Corporate bonds issued?
(Why bonds > shares)
Corporate bonds are issued to raise funding for large projects, such as to expand the firm, develop a product, move to a new premise, or takeover another firm. Bonds could be traded in a similar way to shares, and they are partially protected against variable interest rates or economic changes. However, the firm will have to pay the investors who buy the bonds interest.
What is equation for the yield with bonds?
Yield = annual coupon payment / current market price X 100
Explain this.
If the price of the bond increases what happens and why?
The yield decreases, this is because THE RETURN OF MONEY ON INVESTMENT IS FIXED AND MUST BE THE SAME.
(Bond increases in value the yield must decrease in order to pay the same, if a bond decreases the yield must increase to pay the same)
What happen if this bond in the bond market increases from £100 to £200
What happen if this bond in the bond market falls from £100 to £50
What is a coupon, in bonds?
The guaranteed fixed interest payment, usually monthly, paid by the issuer of the bond to the owner of the bond.
(This does not change whether increase or decrease in bond, and government/corporation must pay this or they will have to go bankrupt).
What is the ‘maturity date’, with bonds?
The date on which the issuer of the bond must pay to bond owner.
What are the characteristics and functions of money?
- A medium of exchange
- A mesure of value
- A store of value
- A method of payment
How is a medium of exchange a characteristic and function of money?
without money, transactions were conducted through bartering. Goods and services were traded with other goods and services, but people did not always get exactly what they wanted or needed. The goods and services exchanged were not always of the same value, which also posed a problem. Exchange could only take place if there was a double coincidence of wants, i.e. both parties have to want the good the other party offer.
Using money eliminates this problem.
How is a measure of value a characteristic and function of money?
Money provides a means to measure the relative values of different goods and services. For example, a piece of jewellery might be considered more valuable than a table because of the relative price, measured by money. Money also puts a value on labour.
How is a store of value a characteristic and function of money?
Money has to hold its value to be used for payment. It can be kept for a long time without expiring. However, the quantity of goods and services that can be bought with money fluctuates slightly with the forces of supply and demand.
How is a method of deferred payment a characteristic and function of money?
Money can allow for debts to be created. People can therefore pay for things without having money in the present, and can pay for it later. This relies on money storing its value.
What is money supply?
The money supply is the stock of currency and liquid assets in an economy. It includes cash and money held in savings accounts.
What is liquidity?
Measures the ease with which an asset can be converted into cash without loss of value. Cash is the most liquid of all assets.
What is the difference in broad money and narrow money which make up the stock of money?
Narrow money is physical currency (notes and coins), as well as deposits and liquid assets in the central bank. Highly liquid.
Broad money includes the entire money supply. Cash could be in restricted accounts, which makes it hard to calculate the money supply. It includes liquid and less liquid assets.
What is a share?
The capital of a company is divided into shares. Each share forms a unit of ownership of a company and is offered for sale so as to raise capital for the company.
Shares sold by public companies are marketable on the stock exchange. Shares sold by private companies are not marketable.
What is debt?
Debt is money which has been borrowed from a lender, which is usually a bank. There is little flexibility, and the loan is later repaid with interest.
What is equity?
Assets which people own.
Equity is a stock or security which represents interest in owning e.g. a firm, a car or a house. It is when there is no outstanding debt, such as when a loan for a car or a mortgage has been fully paid off. The owner’s equity is then the car or the house, which can be sold for cash.
What is definition for money markets
In the money market, liquid assets are traded. It is used to borrow and lend money in the short term.
What is a capital market?
The capital market is where shares and bonds are bought and sold. These can then be put to long-term productive use by firms and governments for finance. Medium-long term loan finance.
What are foreign exchange markets?
The foreign exchange market is a market where currencies are traded, mainly by international banks. It determines what the relative value of different currencies will be.
What are the role of financial markets in the wider economy?
- To facilitate saving
- To lend to businesses and individuals
- To facilitate the exchange of goods and services
- To provide forward markets in currencies and commodities.
- To provide a market for equities
How is to facilitate saving a role of the financial market?
Financial markets provide somewhere for consumers and firms to store their funds. Savings are rewarded with interest payments from the bank.
How is to lend to businesses and individuals a role of the financial market?
The transfer of funds between agents is aided by financial markets. The funds can be used for investment or consumption.
How is ‘to facilitate the exchange of goods and services’ to a role of the financial market?
The transfer of real economic resources is facilitated in a financial market. Financial markets can make it easier to exchange goods and services from the physical market, by providing a way that buyers and sellers can interact and transfer funds.
How is ‘to provide a market for equities’ a role of the financial market?
Equity markets involve the trade of shares. It is also called a stock market. Equity markets provide access to capital for firms, and allow investors to own part of a market. Returns on the investment, usually in the form of dividends, are based on future performance. A dividend is a share of the firm’s profits.
How is ‘To provide forward markets in currencies and commodities’ a role of the financial market?
The currency market is another kind of financial market. They are used to trade one currency for another currency. Currencies can have speculative attacks taken on them, which can affect the value of the exchange rate.
In commodity markets, investors trade primary products, such as wheat, gold and oil. Future contracts are a method for investing in commodities. This involves buying or selling an asset with an agreed price in the present, but a delivery and payment in the future.
A forward market is an informal financial market where these contracts for future delivery are made.
Why is there an inverse relationship between market interest rates and bond prices?
There is an inverse relationship between market interest rates and bond prices. When a bond is bought, money is lent to the issuer. The issuer agrees to pay the value of the bond back when it matures, in addition to periodic interest payments. The rate of interest is fixed when the bond is issued.
New bonds have rates close to the market interest rate. If the market interest rate falls, for example, the bond would be worth more, since it carries a higher interest rate than current market conditions. Similarly, the bond is worth less is the rate increases. This is because the bond has a lower interest rate than the current market.
How is ‘Accept Deposits’ a function of a commercial bank?
How is accepting deposits a function of a commercial bank?
Commercial banks accept deposits from the public, usually in the form of savings. Those on low incomes might save a part of their income for security, whilst firms see saving as convenient. Banks can meet the different needs of their depositors by providing different accounts. Depositors could use Demand Deposits, which allow deposits to be made or withdrawn immediately. This is useful for firms who need to make immediate payments. Alternatively, Fixed Deposits store money for a long time. They have higher rates of interest, since banks can use these deposits knowing they will not be withdrawn. Saving Deposits are done by those who withdrawn money often, but not necessarily immediately, and who are generally receiving an income. They have lower rates of interest than Fixed Deposits.
How is ‘provide loans’ a function of a commercial bank?
The main source of income for commercial banks is interest, which banks earn through providing loans. Banks create credit by using deposited funds as loans.
Some loans are secured against an asset, such as a house. This is to protect the bank’s funds if the loan is not repaid.
How do commercial banks Create Credit?
(Important)
Draw the diagram to show Contractionary Monetary Policy, higher interest rates lower inflation.
Explain this contractionary monetary policy diagram.
Draw a diagram for expansionary monetary policy
How can Expansionary Monetary Policy cause inflation but also not cause inflation?
Depends on the point on the SRAS as if it is on the inelastic point then there is no Chang rain price level so no inflation. So depends at what level of maximisation of short run aggregate supply.
What is the evaluation of expansionary Monetary Policy’s? (Effectiveness)
1) Size of output gap (graph below) AD2 to AD1 very little growth in GDP, lots of inflation. But if it is AD4 to AD3 massive growth, little demand-pull inflation, so big impact.
2. CONSUMER CONFIDENCE, people will borrow and spend, think economy will grow or get a pay rise. If they don’t have this no effect from changing interest rates.
3. Business confidence - invest more money as they believe they will make profit and there will be demand. However if they don’t have this increasing interest rate will have no effect.
4. Banks may not be willing to lend money even with low interest rates due to low confidence and unsure of financial safety. Happened during the financial security.
5. Banks may not follow with the same cut as the Bank of England for banks with their interest rates for consumers.
Cons of Contractionary Monetary Policy, reducing interest rates?
- LOWER GROWTH - lowers AD with lower C, I and X. Can lead to recession. Can lower GDP with no lowering in price level (see below).
- Higher unemployment less people needed to make products as consumption, investment and exports have been reduced.
- Impact on Indebted. People with mortgages may go homeless as they can’t pay off their debts. Buisnesses may have to let people go and bankruptcy. Bad for standard of living.
- Reduced investment, bad of short run growth AD. But also the LRAS stops productivity and competition increasing.
- Worsening ÇA deficit, Hot Money coming in. People chasing the best interest for their saving.
Explain the relationship between decrease in the interest rates, exchange rates and money supply.
How does QE cause lower interest rates?
Higher asset prices means lower yields (inverse relationship), which brings down the cost of borrowing, for capital or houses (mortgage).
