4.4 financial markets Flashcards
what are the five roles of financial markets
- to facilitate savings - allows people to transfer the spending power from the present to the future. can be done by storing money in savings accounts and by holding stocks and shares
- lend to individuals and businesses, allowing consumption and investment
- facilitate the exchange of goods and services by creating a payment system, central banks print money, companies offer credit card services etc.
- provide forward markets - where firms are able to buy and sell in the future at a set price. it provides stability and it exists for commodities and the foreign exchange market
- provide a market for equities, company shares. financial markets provide the ability for shares to be sold in the future, which makes assets more appealing.
identify 3 examples of financial markets
- the money market which provides short term lending and saving
- the capital market - provides longer term financing
- foreign exchange markets
- commodities markets
- derivatives markets
why are financial markets important
it supports the real economy - without financial markets businesses would find it hard to raise finance for investment and they could not run efficiently every day.
what is meant by liquidity
the ease with which an asset can be converted into cash in order to settle a liability. if something is cost free and is quick to turn an asset into cash, then it is said to be liquid.
name 2 assets that are liquid
bonds and shares
2 assets that are not liquid
houses/property
paintings
what is the purpose of a forward market for currencies
it reduces risk for business around exchange rate fluctuations. if u have a forward contract for currencies, then the firm knows in advance and can plan what their liabilities will be in the future.
what is the purpose of a forward market for other commodities
it also reduces risk for business around price fluctuations in those commodities. if your business purchases a large volume of commodities, having a futures contract guarantees supply of the commodity and guarantees price too, so that the firm can plan their liabilities and ensure they have enough liquid assets to cover their liabilities when the time comes to pay.
what is meant by narrow money
notes and coins in circulation - it makes up less than 3% of all money in circulation in the UK economy.
what is meant by broad money
narrow money plus money kept in bank accounts as deposits by households, businesses and financial institutions
what is meant by asymmetric information in financial markets and give an example
when either the buyer or the seller of financial products/services has more information than the other party - allowing one party to exploit this to their advantage. e.g. the mis-selling of pensions where the company selling it has more info than the buyer.
what is meant by market rigging in financial markets and give an example
when the market is fixed by a producer or a group of fixed producers so that they benefit. it is a form of collusion that gives some parties an unfair advantage over others in the market. an example of this was the fixing of the LIBOR rate
what is meant by a bubble and herd mentality and give an example
a bubble is when an asset rises in value, and herd mentality means that people continue into buying this rising market even after the price of the asset rises higher than the true value of the asset. this can then cause an abrupt crash as people reverse their actions and sell quickly
what is meant by negative externalities in financial markets
costs to a third party in a financial transaction who were not part of the transaction. e.g. when traders took excessive risks in the GFC and shareholders and depositors suffered 3rd party costs
what is meant by moral hazard in financial markets
when the negative effects of a decision do not fall on the person making the decision, leading to risky behaviour e.g. the idea of banks being too big to fail, and that the government will bail them out of any financial difficulties they get into. which means there is little incentive to manage risk effectively and the cost of failure is picked up by the government
