4.4- The Financial Sector Flashcards
What are the main roles of the financial market?
- To facilitate saving
- To lend to businesses and individuals
- To facilitate the exchange of goods and services
- To provide forward markets in currencies and commodities
- To provide a market for equities
How does the financial market facilitate saving?
Financial markets provide somewhere for consumers and firms to store their funds. Savings are rewarded with the interest payments from banks
How do financial markets facilitate the exchange of goods and services?
Financial markets can make it easier to exchange goods and services from the physical market by providing a way that buyers and sellers can interact and transfer funds.
How do financial markets provide a market for equity?
Financial markets allow for the trade of shares(equity market). The financial market provides access to capital for firms. Returns can be made on the investment.
What are the reasons for market failure in the financial sector?
- Assymetric information
- Externalities
- Moral hazards
- Speculation and market bubbles
- Market rigging
What is assymetric information?
Assymetric information occurs when one party to a contract knows more information than another party. For example, borrowers often know better than lenders how likely it is that they’ll be able to repay a loan
How can externalities lead to financial market failure?
There are negative externalities in financial markets. In the financial sector, mismanagement of risks is one of the causes. For example, risk taking of financial institutions led to the global financial crisis
What is a moral hazard?
A moral hazard occurs when someone is more willing to take risks because they know that someone else will have to pay the consequences. Banks might excercise a lot of risks if they know they will be bailed out by the government.
What are speculation and market bubbles?
A market bubble occurs when the price of an asset is predicted to rise significantly.This causes it to be traded more leading to an increase in demand.This leads to a rise in price. The bubble then ‘bursts’ which leads to the sale of the asset quickly. Therefore, there is a loss of confidence which can slow economic growth
What is market rigging?
This is the act of firms joining together to interfere with the market to stop it from working properly. For example, bamks could inflate or deflate interest rates to make a profit from a trade or to make it seem more financially reliable
Define central bank
The central bank manages the currency, money supply and interest rates in an economy
What are the roles of the central bank[
- Implementation of monetary policy
- Banker to the government
- Banker to the banks(lender of last resort)
- Role in the regulation of the banking industry
How does the central bank implement monetary policy
- The cenral bank influences interest rates, the supply of money and the exchange rate
- The monetary policy committee(MPC) alters interest rates to control the supply of money
- Interest rates are used to help meet the government’s target of price stability
- The central bank sets the base rate which controls the interest rates across the economy
How is the central bank a banker to the government?
The central bank provides services such as;
- Makes payments on behalf of the government
- Maintaines and operates deposit accounts of government
- Manages public debt and issues loans
- Advises the government on finance
How is the cenrtal bank a lender of last resort?
- If there is no other method to increase the supply of liquidity when it is low, the bank of England will lend money to increase the supply
- If an institutuion is close to collapsing, tha bank of England might lend to them to bail them out.
