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Macro Economics > 4.2.4 Financial Markets And Monetary Policy > Flashcards

4.2.4 Financial Markets And Monetary Policy Flashcards

1
Q

Characteristics and functions of money

A
  • medium of exchange
  • measure of value
  • store of value
  • method of deferred payment
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2
Q

Money market

A

Liquid assets traded in short term

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3
Q

Capital market

A

Equity and debt instruments are traded. These can then be put into long term use by firms and governments

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4
Q

Foreign exchange market

A

Where currencies are traded mainly international banks

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5
Q

Broad money

A

Includes cash but also more illiquid forms of money such as bank deposits, treasury bills, gilts

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6
Q

Narrow money

A

Cash and short term deposits which can easily be turned into money

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7
Q

Role of financial markets

A
  • to facilitate saving
  • to lend to businesses and individuals
  • to facilitate exchange of goods
  • to provide forward markets in currencies and commodities
  • to provide a market for equities
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8
Q

Debt

A

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

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9
Q

Equity

A

A stock or security which represents interest in owning something e.g. a firm

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10
Q

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

A

Bonds have fixed interest rates. This means if the real interest rates drop the bond would be worth more since it carries higher interest than current market conditions. The opposite happens if interest rates rise

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11
Q

Coupon rate

A

The yield paid by a fixed income security

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12
Q

Maturity

A

The period of time for which the financial asset is outstanding

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13
Q

Yield

A

The % of the face value which paid each year

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14
Q

How do you calculate the yield

A

Coupon rate/ face value

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15
Q

Commercial bank

A

Manages deposits, cheques and savings accounts for individuals and firms

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16
Q

Investment bank

A

Facilitate the trade of stocks, bonds and other firms of investment. Government regulation is weaker and this combined with their business model gives them a higher risk tolerance

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17
Q

Functions of a commercial bank

A
  • accept deposits
  • provide loans
  • overdraft
  • investment of funds
  • agency functions
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18
Q

Liability

A

Something which must be paid and I’d a claim on assets. They are made up of share capital, deposits, borrowing and reserve funds

19
Q

Examples of assets

A 
Cash
Securities
Bills
Loans
Investments
20
Q

Objectives of a commercial bank

A
  • liquidity
  • profability
  • security
21
Q

Why do banks aim to be liquid but not too liquid?

A

So that they can quickly give people their money if they need to but holding too much liquid assets means lower profability

22
Q

Why do banks aim to be profitable but not too profitable?

A

They need profit to pay their depositors. However if they aim to be too profitable they might not be liquid so safety of the bank is jeopardised

23
Q

Why do banks aim to be secure but not too secure?

A

They must be secure to prevent uncertainty but if they are too secure they wont gain profits

24
Q

Functions of a central bank

A

Implementation of monetary policy
Banker to the government
Banker to banks

25
Q

What are the monetary policy instruments

A

Interest rates
Quantitative easing
Funding for lending
Forward guidance

26
Q

What is funding for lending

A

The government introduced a ‘funding for lending scheme’ in the uk due to worsening conditions in the euro area and banks facing higher costs. This meant costs of production were lowered for banks so they could lend money out

27
Q

What is forward guidance

A

Used by central bank to detail what the future monetary policy will be to reduce uncertainty

28
Q

Factors to consider when setting the base rate

A

Unemployment rate
Savings rate
Commodity prices
Exchange rate

29
Q

What should happen to interest rates if unemployment is growing

A

Interest rates should be dropped to encourage spending since spending will be low

30
Q

What should happen to interest rates if the saving rate is high

A

Interest rates should drop to incentivise spending

31
Q

What should happen to interest rates if oil prices suddenly rise?

A

They should rise because high oil prices will lead to cost push inflation and high interest rates combat this

32
Q

What should happen to interest rates if the exchange rate depreciates

A

Should increase interest rates because there’s a net increase in exports

33
Q

How does a reduction in exchange rate affect macro objectives?

A

Reduction in XR- weaker pound- cheaper exports- more expensive imports- exports rise- imports fall. Assuming imports and exports are price elastic, the current account deficit would increase. Cost push inflation occurs cos of expensive imports.

34
Q

Why do governments use regulations and guidelines for banks

A

To ensure the behaviour of banks is clear to individuals and firms in business with the bank. If they failed it would be a catastrophe

35
Q

Who regulates UK banking?

A

Prudential Regulation Authority (PRA)
Financial Conduct Authority (FCA)
Financial Policy Committee (FPC)

36
Q

What do the PRA do?

A

Promote safety and stability of banks, building societies, investment firms and credit unions whilst ensuring policy holders are protected

37
Q

What do the FCA do?

A

Checks firms are being honest to customers and aim to promote competition which benefits customers

38
Q

What do the FPC do?

A

Regulate risk in banking and ensure the financial system is stable. It clamps down on unregulated parts and loose credit

39
Q

What are reasons for a bank failing?

A

Moral hazard
Systemic risk
Liquidity and capital ratios

40
Q

What is moral hazard and how do banks do it

A

Because banks know the central bank will help them if they fail, they are deliberately risky

41
Q

What is a systemic risk

A

The risk of damage of the economy or financial market. It is effectively a negative externality

42
Q

Liquidity ratio

A

A measure of how able a company is to pay off short term obligations. The higher the ratio the greater the safety margin of the bank

43
Q

Capital ratio

A

A comparison between the equity, capital and risk weighted assets of a bank. A bank’s financial strength is determined using this

44
Q

Summary of global financial crisis (2008-2009)

A

Asset prices were high and rising.
There were risky bank loans and mortgages where gov securities were packed with subprime mortgages.
This meant borrowers had poor credit history and after US housing market crashed, several homeowners defaulted in there mortgages. Banks lost huge funds and were reliant on the government

Macro Economics (6 decks)

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