4.4 financial sector

Question 1

what are the five roles of the financial sector?

Answer 1

1) facilitate savings , 2) lend to businesses and individuals which allows investment and consumption 3) facilitate the exchange of goods and services
4) they provide forward markets 5) they provide a market for equities

Question 2

what is the aim of saving?

Answer 2

transfer their spending power from the present to the future

Question 3

how does the financial market facilitate saving?

Answer 3

It can be done through a range of assets, such as storing money in savings account and holding stocks and shares.

Question 4

why is it important for the financial sector to lend to business and individuals?

Answer 4

firms will borrow in order to invest whereas consumers will borrow to fund consumption

Question 5

what is the cost of borrowing?

Answer 5

the interest rate

Question 6

how does the interest rate affect borrowing?

Answer 6

an increase in the interest encourages saving and discourages investment

Question 7

under what condition will firms borrow?

Answer 7

they will borrow if the rate of return on the investment is greater than the rate of interest

Question 8

how do the financial markets facilitate the exchange of goods and services?

Answer 8

they create a payment system which allows transactions, they print money , offer credit and banking

Question 9

what is the forward market

Answer 9

This is where firms are able to buy and sell

in the future at a set price`

Question 10

why are the forward markets important?

Answer 10

they remove volatility and can minimize the risks of transactions by hedging their costs

Question 11

how does the finance markets facilitate the market for equitys?

Answer 11

Financial markets provide the ability for shares to be sold on in the future, making the asset more
appealing.

Question 12

why might a company issue shares?

Answer 12

to finance expansion of the company

Question 13

what are reasons for market failure in the finance market?

Answer 13

Asymmetric information, Externalities, Moral hazard, Speculation and market bubbles, Market rigging

Question 14

how does asymmetric information cause market failure?

Answer 14

this causes market failure as the financial institutions have more information then the buyers. as a result they can sell them products they don’t need, goods they can get cheaper elsewhere or are riskier then the buyer believes. there is also asymmetry between the regulators and the institutions , the institutions have no incentive to help regulators understand their business therefore the regulators may unknowingly allow harmful activity

Question 15

what is an example of asymmetric information causing market failure?

Answer 15

The Global Financial Crisis was partially caused by banks selling packages of prime and subprime mortgages, but advertising them as all prime mortgages.

Question 16

how does externality’s cause market failure in the financial sector?

Answer 16

there are a number of costs that are payed by firms the taxpayer and the government but not by the financial market. one example being the banks being bailed out after the financial crisis of 2008. there are also the long term cost to the economy after due to its effect on demand and growth

Question 17

how does moral hazard cause market failure ?

Answer 17

this occurs when individuals make decisions that are in their best interest even if they are risky. employees may do this as it could lead to a higher salary and if it fails they are not held accountable. it can also be done by financial institutions as they know the central bank will bail them out due to the massive impact to the economy if they collapse

Question 18

what is an example of moral hazard causing market failure?

Answer 18

The Global Financial Crisis was caused by moral hazard, when employees sold mortgages to those who would not be unable to pay them back. By selling more mortgages, they would see higher salaries and bonuses but would not see the negative effects if the
loan was not repaid

Question 19

how does speculation and bubbles cause market failure?

Answer 19

a market bubble is when the price of assets increase excessively high and then fall. they occur from the herding behavior of investors. they also occur in the housing market if there is too many mortgages given out and high demand for housing. when the bubble bursts there is a fall in demand for houses and a negative wealth effect, reducing AD, and banks are left with loans that will not be repaid in full

Question 20

what are examples of bubbles?

Answer 20

the dot com bubble in the 1990s and the

Wall Street Crash in 1929. housing market collapse of 2007

Question 21

how does market rigging cause market failure?

Answer 21

individuals or institutions affect the price of a commodity, currency or asset to benefit themselves, for
example large trades in a currency will shift its value and this will make a difference to individuals selling or buying assets with that currency.

Question 22

what is market rigging?

Answer 22

This is where a group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves at the expense of other participants in the market.

Question 23

what is inside trading?

Answer 23

where an individual or institution has knowledge about something that will happen in the future that others do not know and so can buy or sell shares to make a profit.

Question 24

what is an example of market rigging?

Answer 24

In the Libor scandal of 2008, financial institutions were accused of fixing the London Interbank Lending Rate (LIBOR), one of the most important rates in the world.