4.4 The Financial Sector Flashcards
What is a financial market?
A financial market is where buyers and sellers can buy/trade a range of services or assets that are fundamentally monetary in nature.
What are the 2 main reasons for financial market to exist?
- Meet demand for services e.g saving/borrowing
- Allow speculation and financial gains
What are the 5 roles of the financial market?
Facilitate savings
- Transfer spending power into future; through saving accounts/shares
Lend to businesses and individuals
- Allows for quicker consumption and investment; easier access to funds
Facilitate exchange of goods/services
- Create payment system; e.g print money, credit card services
Provide forward markets
- Able to buy/sell in future at a set price; exists for commodities and forex
Market for equity
- Issuing shares; helps finance expansion and increase investment; people unlikely to buy if they can’t sell later on, financial market provides ability to sell shares in the future.
Why does financial market facilitate saving?
Transfer spending power into future through saving accounts/shares.
Allows banks to use this capital to lend to others.
Why does financial market lend to businesses and individuals?
Allows for quicker access to capital and funds; increased investment and consumption
How does the market facilitate exchange of goods/services?
Financial market creates payment systems e.g CB print money, banks provide credit cards,
What does it mean when the financial market provides forward markets?
Provides ability to buy/sell in future at a set price; exists for commodities and forex
How does the financial market provide a market for equity?
Provides platform for shares; ease of buying/selling stocks; important to company’s expansion; financial markets allow for ease of transactions so asset more appealing
What is a central bank?
A central bank provides financial and banking services to government and commercial banking and controls monetary policy and money supply.
How does CB act as a banker to government?
- Manages government finances
- Manages public debt
- Provide short term loans
- Hold gold reserves/ forex reserves
How does CB act as a banker to banks?
- Banks deposit their money within CB
- Lender of last resort: banks able to borrow from CB if experiencing liquidity problems
How does CB act as a regulator to banking industry?
Financial markets have high asymmetrical information
- CB regulate to protect consumers
- Required reserve ratios: banks hold a min % of money deposited to them; to avoid running into difficulties if consumers demand their money
How does asymmetric information cause market failure in financial sector?
Caused when financial institutions have more knowledge than consumers and rivals e.g;
- mortgage sellers have better information of how interest rate changes work than average consumer
- Average consumer may not realise risk involved in a contract they sign
How does externalities cause market failure in financial sector?
Costs placed on fimrs/individuals/government
e.g cost to taxpayer of bailing out banks in 2007-8
How does moral hazard cause market failure in financial sector?
Moral hazard; individuals make decisions in their own best interest knowing there are potential risks which do not affect them
e.g employees sold mortgages to ppl who can’t repay; As they sold more mortgages they receive bonuses but do not encounter negative effects which the bank do
