4.1 The structure of financial markets and financial assets

Question 1

What are the 4 Characteristics of Money?

Answer 1

A medium of exchange
A measure of value (unit of account)
A store of value
A method of deferred payment

Question 2

Money is a medium of exchange….

Answer 2

-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.

Question 3

A measure of value (unit of account)…

Answer 3

-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.

-Money also puts a value on labour.

Question 4

A store of value…

Answer 4

-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.

Question 5

A method of deferred payment…

Answer 5

-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.

Question 6

What is the Money Supply?

Answer 6

-the stock of currency and liquid assets in an economy.
- It includes cash and money held in savings accounts.

Question 7

Narrow Money

Answer 7

-physical currency (notes and coins), as well as deposits and liquid
assets in the central bank

Question 8

Broad Money

Answer 8

-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.

Question 9

What is the Money Market?

Answer 9

• It is used to borrow and lend money in the short term.
  -Liquid assets are traded.

Question 10

What is the Capital Market?

Answer 10

-where equity and debt instruments are bought and sold.
-These can then be put to long-term productive use by firms and governments.

Question 11

What is the Foreign Exchange Market?

Answer 11

-a market where currencies are traded, mainly by international banks.
- It determines what the relative value of different currencies will
be.

Question 12

What is the role of financial markets in the wider economy

Answer 12

-facilitate savings
-lend to businesses and individuals
-facilitate the exchange of goods and services
-provide forward markets in currencies and commodities
-provide a market for equities

Question 13

What does it mean by to facilitate savings?

Answer 13

-Financial markets provide somewhere for consumers and firms to store their funds.

-Savings are rewarded with interest payments from the bank.

Question 14

What does it mean like to lend to businesses and individuals

Answer 14

-The transfer of funds between agents is aided by financial markets.

-The funds can be
used for investment or consumption.

Question 15

What does it mean to facilitate the exchange of goods and services?

Answer 15

-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.

Question 16

What does it mean to provide forward markets in currencies and commodities?

Answer 16

-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.

-A forward market is an informal financial market where these contracts for future delivery are made.

Question 17

What does it mean to provide a market for equities?

Answer 17

-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.

Question 18

What is debt?

Answer 18

-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.

Question 19

What is equity?

Answer 19

-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.

Question 20

Why is there is an inverse relationship between market interest rates
and bond prices?

Answer 20

-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.

Question 21

Why is there an inverse relationship between market interest rates and bond prices (2)?

Answer 21

-Firms can raise finance by issuing shares, issuing corporate bonds and borrowing from a bank.

-Raising finance through shares is relatively cheap for firms. Although
firms are legally obliged to pay their shareholders dividends- they only pay dividends when there are distributable profits and it is voted for by shareholders.

-Borrowing could involve paying back loans with high interest rates, which could be
expensive- might be unaffordable for new, smaller firms. However, it is flexible and the funds can be increased or decreased by borrowing more or paying back the loan.

-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.

Question 22

In relation to government bonds, what is the term coupon?

Answer 22

-it is an interest payment to the bondholder between the date of issue and the date of maturity.

Question 23

What is the maturity?

Answer 23

• Maturity is the period of time for which the financial asset is outstanding.

-When it finishes and has been repaid, it has matured.