4.4

Question 1

What is exchanged in a financial market

Answer 1

Financial liquid assets

Question 2

What are two examples of financial markets

Answer 2

The stock market
The bond market

Question 3

What are the five roles of financial markets

Answer 3

To facilitate saving
To 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 4

Explain the role of financial markets to ‘facilitate saving’

Answer 4

Financial markets provide somewhere for consumers and firms to store their funds. Savings are rewarded with interest payments from the bank

Question 5

Explain the role of financial markets ‘to lend to businesses and individuals’

Answer 5

The transfer of funds between agents is aided by financial markets. The funds can be used for investment or consumption

Question 6

Explain the role of financial markets ‘to facilitate the exchange of goods and services’

Answer 6

Transfer of real economic resources is facilitated in financial market
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 7

Explain the role of financial markets to ‘provide forward markets in currencies and commodities’

Answer 7

The currency 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. 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.

Question 8

What is a forward market

Answer 8

An informal financial market where these contracts for future delivery are made

Question 9

Explain the role of financial markets to ‘provide a market for equities’

Answer 9

Equity markets involve the trade of shares. It is also called a stock market. Equit markets provide access to capital for firms, and allow investors to own part of a market. Returns on investment usually in form of dividends, are based on future performance.

Question 10

Is the financial market micro or macro economic

Answer 10

A microeconomic concept but has huge implication on the macroeconomy

Question 11

When was market failure evident

Answer 11

The Great Recession of 2008

Question 12

What are the main forms of market failure in the financial sector

Answer 12

Asymmetric information
Externalities
Moral hazards
Speculation and market bubbles
Market rigging

Question 13

Explain the market failure asymmetric information in the financial crisis

Answer 13

Before the crash asset prices were high and rising and there was a boom in economic demand.
There were risky bank loans and mortgages especially in the US where government securities were backed by subprime mortgages.
This means borrowers had poor credit histories

Question 14

What does a pecuniary externality lead to

Answer 14

An inefficient allocation in the market through prices rather than resources.

Question 15

Example of a negative externality in a financial market

Answer 15

Systematic risk in financial markets.

Question 16

What is a systematic risk

Answer 16

The risk of damage to the economy or the financial market. For example, it could be the risk of the collapse of a bank. Since this costs firms, consumers, the economy and the market.

Question 17

What is liquidity

Answer 17

Refers to trading activity

Question 18

What are liquid assets

Answer 18

Those which can be bought and sold easily

Question 19

What is illiquidity

Answer 19

Refers to assets that cannot be sold easily without a loss in value. Usually this is because there are insufficient investors willing to buy the asset

Question 20

What is moral hazard

Answer 20

A situation where there is a risk that the borrower does things that the lender would not deem desirable, because it makes the borrower less likely to repay a loan.
It usually occurs when there is some for, of insurance for the mistake. For example if a house is insured, a borrower might be less careful because they know damage caused will be paid by someone else.

Question 21

How can moral hazard be applied to the financial crisis

Answer 21

Banks might take more risks if they know the Bank of England or the government can help them if things go wrong. The financial crisis has been regarded as a moral hazard, due to the degree of risk taking.

Question 22

What is a market bubble

Answer 22

It occurs when the price of an asset is predicted to rise significantly. This causes it to be traded more, and demand exceeds supply so the price rises beyond the intrinsic value. The bubble then ‘bursts’ when the price steeply and suddenly falls to its ordinary level. This causes panic and investors try and sell their assets.

Question 23

What does speculation and market bubbles lead to

Answer 23

Results in a loss of confidence and it can lead to economic decline or a depression

Question 24

What is market rigging

Answer 24

The act of firms coming together to interfere in a market, with the intention to stop it working as it is supposed to, so the firms can gain an unfair advantage.

Question 25

What was the liber scandal and what is an example of

Answer 25

Market rigging
It was found that banks were inflating or deflating their interest rates to make a profit from trade or to make them seem more financially reliable
Loans such as mortgages student loans and other financial products use labour as a reference rate. This means manipulating the rate, as the banks were doing can negatively affect consumers and the financial market.

Question 26

What does the central bank do

Answer 26

Manages the currency, money supply and interest rates in an economy

Question 27

Examples of central banks

Answer 27

The European Central Bank (ECB)
The Bank of England
The people Bank of China

Question 28

What is the MPC in the UK

Answer 28

They alter the interest rates to control the supply of money. They are independent from the government, and the nine members meet each month to discuss what the rate of interest should be. Interest rates are used to help meet the government target of price stability, since it alters the cost of borrowing and reward for saving.

Question 29

Who controls the base rate

Answer 29

The bank, the base rate which ultimately controls interest rates across the economy

Question 30

What does the central bank do for gov

Answer 30

Provides services to the central gov
It collects payments to teh gov and makes payments on behalf of the gov.
It maintains and operates deposit accounts of the gov. The central bank also manages public debt and issues loans.

The bank can also advise the gov on finance, including the timing and terms of new loans.

Question 31

Who is the lender of last resort and what does this mean

Answer 31

The Bank of England is considered to be a lender of last resort

If there are no other methods to increase the supply of liquidity when it is low, the Bank of England will lend money to increase supply.

If an institution is risky or due to collapsing, the bank might lend to them. This is when they have no other way to borrow money.

Question 32

Why does the lender of last resort step in

Answer 32

To protect individuals who deposit funds in a bank and might otherwise lose them. It also aims to prevent a ‘run on the bank’ which is when consumers withdraw their bank deposits in a panic, because they believe the bank will fail.

Question 33

Why will banks usually avoid borrowing from the lender of last resort

Answer 33

It suggests the bank will be experiencing a financial disaster

Question 34

How can gov influence the banking industry

Answer 34

Regulate banks w regulation and guidelines. This helps to ensure the behaviour of banks is clear to institutions and individuals who conduct business with the bank.

Question 35

Why may the gov regulate the banking industry

Answer 35

Some economists argue that banks have a huge influence on the economy, if they failed it would have huge consequences. Therfore, it is important to regulate the banking industry.

Question 36

Who regulated the UK banking industry

Answer 36

PRA - Prudential Regulation Authority
FCA - Financial conduct authority

Question 37

What does the FCA do

Answer 37

Regulated financial firms to ensure they are being honest to consumers and they seek to protect consumer interests.

Also aims to promote competition which is in the interests of consumers

Question 38

What does the PRA do

Answer 38

Promotes the safety and stability of banks, building societies, investment firms and credit unions, and ensures policyholders are protected