4.4 Flashcards
What are financial markets and reasons why they exist
Financial markets- where buyers and sellers can buy and trade a range of services or assets that are fundamentally monetary in nature
Reasons financial markets exist
- To meet demand for services such as saving and borrowing
- To allow speculation and financial gains
Role of financial markets
- Facilitate savings= allows to transfer spending power from present to future eg savings, holding stocks and shares
- Lend money to firms and individuals= consumption and investment
- Facilitate the exchange of goods/services by creating payment systems to transfer funds
- Provide forward market (exists for commodities and foreign currency)- firms are able to buy and sell in the future at a set price eg farmer selling crop in LR at a guaranteed price = stability
- Market for equities- financial market provides the ability for shares to be sold in the future= makes assets more appealing
Market failure in financial sector types
- Asymmetric info
- Externalities
- Moral hazard
- Market rigging
- Speculation and market bubbles
- Housing bubbles
Market failure in financial markets explanations
- Asymmetric information where financial instuiution = more knowledge than consumer= exploitation by selling products that are not needed, may be more expensive or riskier to buy
> Also financial institutions and regulators may not know the harm of some packages= may allow firms to sell= harm consumers - Externalities- financial markets may not pay if bank collapses = costs to consumers,firms,gov
- Moral hazard- make decisions in their own best interest knowing theres potential risk. One reason= adverse risk to increase their salary eg global financial crisis= employees sold mortgages to those who cannot pay back= higher salary for them and negative effect on seller. Also financial institution may take excessive risk because central banks are a lender of last resort so they wont allow them to fail due to impact
- Market rigging-collusion to fix prices or exchange info which leads to gains for themselves eg insider trading= individualds or institutions know something about future but others dont= buy and sell to make a profit
> Individuals or institutions effect prices of commodities or assets/ exchange rates to benefit themselves eg dumping or selling currency which shift value - Speculation and market bubbles= bubble= price is predicted very high for an asset= causes it to be traded more, demadn exceeds supply and prices increase even more. But bubbles burst and prices crash = falls to original level = people panic and sell assets = decreased confidence =ecnonomic decline (herding behaviour)
> Housing market bubble- lending too much mortgages = increases demand for housing when bubble bursts due to IR for example= decreased demand = decreased prices and causes negative wealth effect = decreased AD and banks left with unpaid loans
Key roles of central bank
- Control monetary policy through IR and money supply to decrease infation and provide stability
- Banker to gov- collects payments to gov and makes payments on behalf of gov- maintaines and operates deposit account for gov and manages public debt and issues loans
> Also offer advice (timing and terms on new loans, ect) - Banker to banks- lender of last resort- prevents banks collapsing when there is no other way to borrow = protects consumers from losing their money- helps prevent run on the bank where consumers withdraw in panic because bank is failing which reduces confidence
> Banks avoid lender of last resort as it suggests they are experiencing a disaster
Role in regulation of the banking industry
Uk is regulated by PRA and FCA
PRA prudential regulation authority- promotes saftey and stability of banks, building scoieties for example ,investment firms and credit unions and ensures policy holders are protected
FCA financial conduct authority- regulate financial firms to enssure they are being honest to consumers and they seek to protect consumer interests ( they aim to increase comp)
