4.4 Financial Sector Flashcards
What is a financial market
A place or system that provides buyers and sellers the means to trade goods and services and financial instruments (i.e - bonds, equities, international currencies)
State the 5 roles of Financial Markets
1) Facilitate saving
2) Lend to businesses and individuals
3) Facilitate the exchange of goods/services
4) Provide forward markets in currencies and commodities
5) Provide a market for equities
Explain the 5 roles of financial markets
Facilitate saving: storing money for future use is essential for households & firms. It also provides money that financial institutions can lend i.e.1 person’s savings is
another person’s borrowing
Lending: access to credit is key for EG + ED. Being able to borrow money speeds up consumption by households & investment by firms.It also allows households or firms to purchase assets &
pay them over an extended period of time e.g.mortgages on home purchases
Exchange goods & services: each purchase of goods/services
requires the movement of money between at least two parties. Financial markets provide
multiple ways for this exchange to happen including phone apps (GooglePay),debitcards,
creditcards & bank transfers
Forward markets in currencies & commodities: They provide some price stability in commodity markets & enable
investors to make a profit by speculating on future prices
5. They provide a market for equities: equities are shares in public companies that are listed
on stock exchanges Financial markets facilitate both longterm
investment & speculation by providing platforms which connect buyers & sellers e.g.ETrade
What is equity
When firms raise finance by selling shares
What are the 5 types of market failure
- asymetric information - sellers often have an information advantage (2008, financial institutions bundled lots of mortgages and sold them to investors, they had more info about the risks. Mortgage sellers understand the implications of IR repayments better than consumers)
- externalities: +- externalities exist in financial markets (When investors speculate on property prices, a negative consumption externality occurs as young buyers end up paying more (or are forced out of the market) due to the higher prices caused by speculation (AirBnB effect))
- moral hazard: an incentive to increase its exposure to risk because it does not bear the full costs of that risk. (Banks seem to be considered ‘too big to fail’ & governments bear the consequences of their risky behaviour)
- speculation and market bubbles: The higher the money supply in an economy, the greater the
speculation & potential for market bubbles
Significant amounts of quantitative easing since 2008 have increased the money supply & created potential bubbles in different markets - market rigging: some banks and individual bankers have been involved in rigging IRs to profit maximise, this is fraudulent and can be whistleblowed
Central Banks
the monetary authority and major regulatory bank in a country
They are responsible for monetary policy and maintaining financial stability
Main roles of central banks
- setting interest rates
- regulating banks
- maintaining financial stability (act as a lender of last resort)
- issuing currency (can include managing the floating exchange rate)
- conducting research
Base interest rate and consumer habits
expansionary measure - lowering IR: more spending, more borrowing, less saving
contractionary measure - raising IR: more saving, less spending, less borrowing
Central bank, banker to banks (lender of the last resort)
During times of financial distress;
emergency lending: in times of crisis to prevent their collapse and limit risk
discount window: short-term loans as higher IR, TIB the CB also needs to survive
collateral requirements: a condition for lending, mitigates risk of default
reputation: lender of last resort as they can provide support in time of need
Central bank as banker to the govt
they issue govt bonds
they can manage the govt’s debt by buying/selling bonds to stabilise prices
providing advice to make informed decisions about fiscal policy
Central bank as
Financial conduct authority (FCA)
- regulates any institutions that deal with borrowing/lending and insurance
- they protect consumers to make sure they are being treated fairly
- they regularly monitor financial markets to identify risks and emerging issues
Prudential regulation authority (PRA)
- regulates any institutions that deal with borrowing/lending and insurance
- they establish standards and requirements which ensure liquidity, risk management, governance… to ensure that the financial firms maintain appropriate levels of financial resources to withstand shocks.
