4.4 - The financial sector Flashcards
Bank
4.4.1 - Role of financial markets
A business that makes it profit by paying interest to those who keep money there and charging a higher rate of interest to people/businesses who borrow money from the bank
Bank assets
4.4.1 - Role of financial markets
Assets are “owned” by the bank e.g. cash, their balances with the Bank of England, loans (advances), securites (e.g. bonds) and also fixed assets such as property
Bank capital
4.4.1 - Role of financial markets
Bank capital is the value of the bank’s assets minus its liabilities (or debts)
Bank liabilities
4.4.1 - Role of financial markets
Liabilities are “owed” by the bank e.g. customers can walk into a bank or use an ATM machine to withdraw some/all of their deposits
Bank overdraft
4.4.1 - Role of financial markets
An overdraft is short-term finance, widely used by businesses of all sizes. With an overdraft the bank lets the business “owe it money” when the balance goes below zero
Bank reserves
4.4.1 - Role of financial markets
Money and liquid assets (such as securities that can be sold quickly) held by banks in order to meet cash withdrawals by customers
Banking credit
4.4.1 - Role of financial markets
An arrangement with a bank for loan, or bank lending in gerneral
Banking system
4.4.1 - Role of financial markets
The way banks work together to handle payments, make money available
Barter
4.4.1 - Role of financial markets
The practice of exchanging one good or service for another, without using money as a medium of exchange
Base money
4.4.1 - Role of financial markets
Currency (banknotes and coins) in circulation plus minimum reserves credit institutions are required/choose to hold with a country’s central bank
Base interest rate
4.4.1 - Role of financial markets
The rate of interest set by the Monetary Policy Committee of the Bank of England, being in effect the lowest rate that commercial lenders will charge interest at
Bitcoin
4.4.1 - Role of financial markets
Bitcoin is a digital currency that was launched by a secretive entrepreneur in October 2008, with the aim of being “a new electronic cash system that is fully peer-to-peer with no trusted third party”. Bitcoins are created by users (a.k.a. “miners”) who allow the Bitcoin system to use their computing power to process Bitcoin transactions. These miners are rewarded with some of the transaction fees paid by those who use Bitcoin. A few retailers, especially online, accept Bitcoin, partly because the transaction fees are lower than those of credit cards. However, Bitcoin’s value has been volatile
Bond market
4.4.1 - Role of financial markets
The market for interest-bearing securities (with either a fixed or floating rate) and with a maturity of at least one year) that companies and goverments issue to raise capital
Bond yield
4.4.1 - Role of financial markets
The yield is effectively the interest rate on a bond. The yield will vary inversely with the market price of a bond. When bond prices are rising, the yield will fall. When bond prices are falling, the yield will rise#
Broad Money
4.4.1 - Role of financial markets
A measure of the money supply. Broad money is a measure of the total amount of money held by households and companies in the economy. Broad money is made up mainly of commercial bank deposits - which are essentially IOUs from commercial banks to households and companies - and currency - mostly IOUs from the central bank
Building societies
4.4.1 - Role of financial markets
Building societies are owned by their members (i.e. customers) and not shareholders. Historically, they tended to focus on offering mortgages and savings products. Since 1986 many now offer a broad range of retail banking products. There are over 40 building societies in the UK, many of them with a regional customer bases. The 3 largest are Nationwide Building Society, Yorkshire Building Society and Coventry Building Society
Capital market
4.4.1 - Role of financial markets
Market for medium-longer term loan finance. Capital markets are the markets where securites such as shares, and bonds are issued to raise medium to long-term financing. Includes raising of finance by the government through the issue/sale of medium-term and long-term government bonds for example 10 year and 20 year bonds (loans)
Capital ratio
4.4.1 - Role of financial markets
A commercial bank’s capital ratio measures the funds it has in reserve against the riskier assets it holds that could be vulnerable in the event of a crisis. The European Union runs regular “stress tests” to check whether banks have enough of a capital buffer to weather difficult economic/financial conditions (known as disaster scenarios). Banks must maintain sifficient capital which includes money raised from selling new shares to investors and also their retained earnings (profits)
Commercial banks
4.4.1 - Role of financial markets
Commmercial banks have a licence to take the deposits of savers and make loans. They provide services to corporate and individual customers. Commercial banks make their profits by taking small, short-term, relatively liquid deposits from retail savers and transforming these into larger, longer maturity loans e.g. in the form of business loans and mortgages. Other services of commercial banks including providing debit and credit cards, private banking, money custody and guarantees, cash management and settlement e.g. through cheque accounts, as well as trade finance
Credit card
4.4.1 - Role of financial markets
A card indicating that the holder has been granted a line of credit. It enables the holder to make purchases and/or withdraw cash up to a prearranged ceiling
Credit risk
4.4.1 - Role of financial markets
This is the risk to the commerical bank of lending to borrowers who turn out to be unable to repay thier loans. Credit risk can be controlled by proper safeguards/research into the credit worthiness of borrowers. Credit risk also controlled through prudential regulation i.e. the size of reserves banks must hold back in case of bad debts
Credit unions
4.4.1 - Role of financial markets
Credit unions are small and local non-profit lending institutions. They are owned by their members and typically serving those customers who are unable to access standard retail banks products through banks or building societies. Examples of credit include London Mutual and Bristol Credit Union
Crowdfunding
4.4.1 - Role of financial markets
Crowdfunding is a form of equity finance that has grown rapidly in the USA and the UK. Crowdfunding involves the collective effort of a large number of individuals who network and pool small amounts of their capital to finance a new or existing business venture. Social causes remain the most active source of crowdfunding activity
Debt default
4.4.1 - Role of financial markets
Failure to meet a debt obligation payment, either principal or interest
Debt equity ratio
4.4.1 - Role of financial markets
The debt-equity ratio is the total liabilities of a firm divided by total shareholder equity
Debt finance
4.4.1 - Role of financial markets
Debt finance means borrowing money from an outside source with the promice of paying back the borrowed amount, plus the agree-upon interest, at a later date
Default
4.4.1 - Role of financial markets
The failure of a debtor to make agreeed payments of principal or interest on a loan, a bond or other type of borrowing
Equity
4.4.1 - Role of financial markets
Equity refers to the value of the interest of an owner or partial owner in an asset
Equity finance
4.4.1 - Role of financial markets
Equity financing means raising capital by selling shares of a business to investors
Forward market
4.4.1 - Role of financial markets
A market dealing in commoditites, currencies and securities for future (forward) delivery at prices agreed upon in advance
Financial debt
4.4.1 - Role of financial markets
Financial debt is the outstanding (unpaid) debts of banks and financial corporations - for example the level of bad debts on loans to businesses and to the housing market
Financial market
4.4.1 - Role of financial markets
A financial market is any exchchange that facilitates the trading of financial instruments, such as stocks, bonds, foreign exchange, or primary commodities such as oil and gas
Investment banks
4.4.1 - Role of financial markets
An investment bank provides a wide range of specialized services for companies and large investors. These include: Underwriting and advising on securities issues and other forms of capital raising; Advice on mergers and acquisitions and also corporate restructuring; Trade on capital markets; Research and private equity investments
Leverage
4.4.1 - Role of financial markets
Leverage is the use of borrowed funds to increase profitability. One measure of leverage is the amount of long-term debt relative to equity
Liquidity
4.4.1 - Role of financial markets
Liquidity means the ease and cost with which assets can be turned into cash and used immediately as a means of exchange
Liquidity ratio
4.4.1 - Role of financial markets
A liquidity ratio is the ratio of liquid assets held by a large bank on their balance sheet to their overall assets. Banks need to hold enough to cover expected demands from depositors. In the wake of the Global Financial Crisis (GFC) the Basel Agreement require commercial banks to keep enough liquid assets, such as cash and government bonds, to get through a 30-day market crisis
Money market
4.4.1 - Role of financial markets
This is the market for short term loan finance for businesses and households. Money is borrowed and lent normally for up to 12 months. Includes inter-bank lending i.e. the commercial banks providing liquidity for each other. The money markert also includes short term government borrowing e.g. 3-12 month Treasury Bills - to help fund the government’s budget (fiscal) deficit
Money supply
4.4.1 - Role of financial markets
The money supply is the total amount of money in circulation in a country or a group of countries in a monetary union. A distinction is made between narrow & broad money
Peer to peer lending
4.4.1 - Role of financial markets
Peer-to-peer lending happens when individual savers are able to lend directly to borrowers, often through online peer-to-peer lending platorms. Market participants include Zopa (launched 2005) and also Crowdcube (lauched 2009). Both the investor and the borrower benefits as the lender achieves higher interst rates and the borrower lower interest rates than would be on offer if either had gone through a commercial bank
Asset bubble
4.4.2 - Market failure in the financial sector
A sustained rise in the prices of assets such as housing and equities which takes their values well above long run sustainable levels
Asymmetric information
4.4.2 - Market failure in the financial sector
This type of market failure exists when one individual or party has more information than another individual or party and uses that advantage to exploit the other party. Finance is a market in information - often a potential borrower (such as a small bussiness) has better information on the likelihood that they will be able to pay a loan than the lender
Externalities
4.4.2 - Market failure in the financial sector
Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid
Financial Conduct Authority (FCA)
4.4.2 - Market failure in the financial sector
The Financial Conduct Authority (FCA) is funded entirely by the firms it regulates. THE FCA has three main objectives
1. Secure an appropriate degree of protection for consumers
2. Protect and enhance the integrity of the UK financial system
3. Promote effective competition in the interests of consumers
Financial Policy Committee (FPC)
4.4.2 - Market failure in the financial sector
The FPC’s main role in the UK is to identify, monitor, and take action to remove or reduce risks that threaten the resilience of the UK financial system as a whole. The FPC publishes a Financial Stability Report identifying key threats to the stability of the UK financial system. The FPC has the power to instruct commercial banks to change their capital reserves (buffers)
Financial crisis
4.4.2 - Market failure in the financial sector
A disturbance to financial markets, associated typically with falling asset prices and insolvency amongest debtors and intermediaries, which ramifies through the financial system, disrupting the market’s capacity to allocate capital
Illiquidity crisis
4.4.2 - Market failure in the financial sector
An agent is solvent but illiquid when its debt is not unsustainable, but it has large amounts of this debt coming to maturity (i
Insolvency crisis
4.4.2 - Market failure in the financial sector
An agent (such as business, individual or a bank) is insolvent when its debt relative to its income is so high that it will not be able to pay back its debt and the interest on it (i.e. there is an unsustainable debt). An insolvencfy crisis may require some form of debt restructuring/debt relief to lower default risk
Liquidity trap
4.4.2 - Market failure in the financial sector
A liquidity trap occurs when low interest rates and a high amount of cash balances in the economy fail to stimulate aggregate demand partly through a lack of confidence
Market rigging
4.4.2 - Market failure in the financial sector
Illegally and unfairly controlling the price or the interest rate in order to increase their joint profits or exploit customers
Moral hazard
4.4.2 - Market failure in the financial sector
Moral hazard exists in a market where an individual or organisation takes many more risks then they should because they know that they are either covered by insurance, or that the government will protect them from any damage incurred as a result of those risks
Prudential Regulation Authority (PRA)
4.4.2 - Market failure in the financial sector
The PRA is part of the Bank of England and is responsible for the prudential regulation and supervision of around 1,700 banks, building societies, credit unions, insurance and major investment firms. The PRA focuses on the solvency of specific financial amrkets such as: Insurance providers, Buy-to-let mortgage lenders, Credit unions and other specialist lenders.
Speculation
4.4.2 - Market failure in the financial sector
Speculation is the activity of buying a good or service in anticipation of a change in the price/market value e.g. currency or stock-market speculation
Sub-prime lending
4.4.2 - Market failure in the financial sector
Sub-prime lending is lending money, usually to buy a house, to people who are risky to lend to. To compensate for this risk, commercial banks charge higher interest rates
Systemic risk
4.4.2 - Market failure in the financial sector
The possibility that an event at the micro level of an individual bank/insurance company could then trigger instability or the collapse of an entire industry or economy
Central bank
4.4.3 - Role of central banks
The monetary authority and major regulatory bank in a country. Its functions including issuing and managing the country’s currency and a lender of last resort to the banks
Central bank intervention
4.4.3 - Role of central banks
When a central bank enters the foreign exchange market to buy or sell currency in order to influence exchange rates
European Central Bank (ECB)
4.4.3 - Role of central banks
The central bank for Europe’s single currency, the euro. Its main task is to maintain the euro’s purchasing power and thus price stability for member nations who use the Euro as their currency
Lender of Last Resort
4.4.3 - Role of central banks
A lender of last resort is a lender, typically a central bank, which provides financial institutions with funds when they cannot borrow from the market
Monetary policy
4.4.3 - Role of central banks
The manipulation of the supply of money (QE), interest rates and exchange rates in order to influence output, prices and employment in the economy
