4.4 The Financial Sector

Question 1

What are financial markets

Answer 1

Any exchange that facilitates the trading of financial instruments such as stocks, bonds, foreign exchange or primary commodities such as oil and gas.

Question 2

What are the key roles of financial markets (5)

Answer 2

-to facilitate savings
-to lend to businesses and households
-to facilitate the exchange of goods and services
-to provide forward markets in currencies and commodities (e.g if oil prices are expected to rise then firms can use the forward market to buy oil for the future at the current price)
-providing a market for equities

Question 3

What are the different ways of market failure in financial markets (4)

Answer 3

-asymmetric information - complex products may mean they are too difficult to regulate
-externalities - e.g financial crash people lost their savings
-moral hazard - e.g RBS taking more risks than sensible as the gov would bail them out
-speculation and market bubbles - unsustainable increases in an asset
-market rigging - participants illegally seek to influence or control the price of an asset

Question 4

what are the key functions of the central banks (e.g Bank of England) (5 roles)

Answer 4

1. Implement monetary policy
2. manage national debt
3. regulate the banking industry
4. issue currency
5. provide funds to banks suffering from short term liquidity problems (bail the banks out)