4.12.1 - The Structure of Financial Markets and Financial Assets

Question 1

What are assets?

Answer 1

Things which people or organisations own.

Question 2

What are liabilities?

Answer 2

Things which people or organisations owe.

Question 3

What does money function as?

Answer 3

A medium of exchange or means of payment
A store of value or wealth
A measure of value
A standard of deferred payment

Question 4

What are the three main forms of money?

Answer 4

• Commodity
• Representative
• Token

Question 5

What is commodity money?

Answer 5

Commodities that functioned as money had an intrinsic value of their own, as they yielded utility and/or services to their owners.

i.e. rice, wheat, beads etc.

Question 6

What is representative money?

Answer 6

Gold and silver was deposited with goldsmiths for safekeeping, and the goldsmiths would issue notes that could be exchanged for silver/gold on demand.

This is representative money.

Question 7

What are the characteristics for money to possess?

Answer 7

• Relative scarcity
• Uniformity
• Durability
• Portability
• Divisibility

Question 8

What is token money?

Answer 8

Money that holds no intrinsic value of its own.

Takes two main forms: cash and bank deposits.

Question 9

What does money being the primary unit of value allow people to do?

Answer 9

More accurately compare the prices of goods even when there is no intention of spending money.

Question 10

What is the money supply?

Answer 10

The stock of financial assets which function as money.

Question 11

When did people begin paying attention to the money supply in the economy?

Answer 11

In the 1970s when monetarism became the prevailing economic view.

Question 12

What is narrow money?

Answer 12

The part of the stock of money made up of cash and liquid bank and building society deposits.

Question 13

What is broad money?

Answer 13

The part of the stock of money made up of cash, other liquid assets such as bank and building society deposits, but also some illiquid assets.

The measure of broad money used by the BoE is called M4.

Essentially, money in any form of cash or other assets that are easily liquidified.

Question 14

What is liquidity?

Answer 14

Measures the ease with which an asset can be converted to cash without a loss of value.

Cash is the most liquid of all assets.

Question 15

What is Goodhart’s Law?

Answer 15

As soon as the government tries to control the money supply, other financial assets, previously regarded as ‘near money’ outside the current system of control will take on the function of money.

Question 16

What are shares?

Answer 16

Undated financial assets, sold initially by a company to raise financial capital. Shares sold by public companies or PLCs are marketable on a stock exchange, but shares sold by private companies are not marketable. Unlike a loan, a share signifies that the holder owns part of the enterprise.

Question 17

What are bonds?

Answer 17

Financial securities sold by companies or by governments which are a form of long-term borrowing. Bonds usually have a maturity date on which they are redeemed, with the borrower usually making a fixed interest payment each year until the bond matures.

Question 18

What is equity?

Answer 18

The assets which people own.

Question 19

What is debt?

Answer 19

People’s financial liabilities or money they owe.

Question 20

What is a wealth portfolio?

Answer 20

The different wealth assets that an individual owns and holds at a particular point in time.

Question 21

What is a portfolio balance decision?

Answer 21

Makes the distinction between physical and financial assets, and arranges financial assets according to liquidity and profitability.

Question 22

What are financial markets?

Answer 22

Markets in which financial assets or securities are traded.

Question 23

What is a money market?

Answer 23

Markets that buy and sell assets that have short term maturities (day or a year) that can be converted to cash easily.

Question 24

What is a capital market?

Answer 24

Where securities such as shares and bonds are issued to raise medium to longterm financing. Where shares and bonds are then traded on the second hand market e.g. the LSE.

Question 24

What is a foreign exchange market?

Answer 24

Global, decentralised markets for the trading of currencies.

Question 25

What do money markets allow banks to do?

Answer 25

Arrange their assets in terms of their liquidity or profitability.

This enables commercial banks to be a financial intermediary linking savers to borrowers.

Question 26

What is the LIBOR?

Answer 26

London Interbank Offered Rate.

A rate of interest charged when banks lend to one another, usually for very short periods of time.

Question 27

What is the main function of the money market?

Answer 27

To supply both private-sector commercial firms and the government with a source of short-term finance.

Question 28

What are treasury bills?

Answer 28

Short-dated government loans.

Question 29

What are corporate bonds?

Answer 29

Debt security issued by a company and sold as new issues to people who lend long-term to the company.

Question 30

What are government bonds?

Answer 30

Debt security, known as gilt-edged securities or gilts, issued by a government and sold as new issues to people who lend long-term to the government.

Question 31

What are the main securities traded on the capital markets?

Answer 31

Shares, corporate bonds and government bonds.

Question 32

What is the relationship between bond prices and yield?

Answer 32

As the price of bonds rise, yield falls.

Suppose the price of a bond is £100, the yield on the bond is 5%. If the price of the bond rises to £200 on the LSE, the yield on the bond falls to 2.5%

Question 32

What is a coupon?

Answer 32

The guaranteed fixed annual interest payment, often divided into two 6-month interest payments, paid by the issuer of a bond to the owner of the bond.

Question 33

What is a maturity date?

Answer 33

The date on which the issuer of a dated security, such as a gilt-edged security or a Treasury bill, pays the face value of the security to the security’s owner.

Question 34

What are capital markets made up of?

Answer 34

New-issues market (primary market)
Second-hand market (secondary market)

Question 35

How can companies borrow long-term?

Answer 35

By selling corporate bonds.

Question 36

Where are new issues of shares generally sold?

Answer 36

In the primary market, usually arranged by an investment bank.

Question 37

What is the principal function of the LSE?

Answer 37

Increase the liquidity of second-hand securities, making it easier for buyers to manage their investments and sell securities when required.