4.4 Flashcards
What is exchanged in a financial market
Financial liquid assets
What are two examples of financial markets
The stock market
The bond market
What are the five roles of financial markets
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
Explain the role of financial markets to ‘facilitate saving’
Financial markets provide somewhere for consumers and firms to store their funds. Savings are rewarded with interest payments from the bank
Explain the role of financial markets ‘to lend to businesses and individuals’
The transfer of funds between agents is aided by financial markets. The funds can be used for investment or consumption
Explain the role of financial markets ‘to facilitate the exchange of goods and services’
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.
Explain the role of financial markets to ‘provide forward markets in currencies and commodities’
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.
What is a forward market
An informal financial market where these contracts for future delivery are made
Explain the role of financial markets to ‘provide a market for equities’
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.
Is the financial market micro or macro economic
A microeconomic concept but has huge implication on the macroeconomy
When was market failure evident
The Great Recession of 2008
What are the main forms of market failure in the financial sector
Asymmetric information
Externalities
Moral hazards
Speculation and market bubbles
Market rigging
Explain the market failure asymmetric information in the financial crisis
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
What does a pecuniary externality lead to
An inefficient allocation in the market through prices rather than resources.
Example of a negative externality in a financial market
Systematic risk in financial markets.
What is a systematic risk
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.
What is liquidity
Refers to trading activity
What are liquid assets
Those which can be bought and sold easily
What is illiquidity
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
What is moral hazard
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.
How can moral hazard be applied to the financial crisis
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.
What is a market bubble
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.
What does speculation and market bubbles lead to
Results in a loss of confidence and it can lead to economic decline or a depression
What is market rigging
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.
