5. The Financial Sector Flashcards
What are the key roles of the financial sector?
- Facilitate saving
- Lend to businesses and households
- Facilitate the exchange of goods and services
- Provide forward markets in currencies and commodities
What is a forward market?
A forward market is an over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery
What is a financial market?
Financial markets refer broadly to any marketplace where the trading of securities occurs, including the stock market, bond market, and forex market.
What is exchanged on financial markets?
Liquid financial assets
Why is a stable financial sector required to promote economic development?
Because without a financial sector, households and firms cannot generate sufficient savings to make the macroeconomy stable.
What does the Harrod-Domar model state?
The Harrod-Domar model states that investment, saving, and technological change are required in an economy for it to see economic growth - the rate of growth increases as the savings ratio increases.
How do you calculate the rate of growth according to the Harrod-Domar model?
Savings Ratio / Capital Output Ratio
(Capital Output Ratio - the amount of capital needed to produce one unit of output)
What is microfinance?
The borrowing of small amounts of money from lenders to finance enterprise. Small loans usually for ‘unbankable’ people to promote financial independence and security.
Do microfinance loans have high or low repayment rates?
High
How does the financial sector promote economic development?
- Facilitates savings
- Enables management of the economy e.g. fiscal policy
- Financial markets allow firms to raise capital
- Facilitates borrowing = investment
- Enables government borrowing
What is a foreign currency gap?
When a country’s expenditures in foreign currency, such as payments for imports or servicing foreign debt, exceed its foreign currency earnings from exports or other sources, such as foreign investment or remittances.
What is capital flight?
Capital flight is the uncertain and rapid movement of large sums of money out of a country.
“the outflow of resident capital which is motivated by economic and political uncertainty.”
What is debt relief?
The partial or total forgiveness of debt
What are the 4 functions of money?
- Medium of exchange
- Unit of account (measure of value)
- Store of value
- Method of deferred payment
What are the required characteristics of money?
Money must be:
- Durable
- Divisible
- Portable
- Uniform
- Limited in supply
- Acceptable
Define the money supply
The stock of currency and liquid assets in an economy
What is narrow money?
Physical currency (M0), deposits and liquid assets (M1)
What is broad money?
Less liquid assets e.g retail deposits (M2), securities and commodities (M3)
What is a liquidity trap?
a period of very low interest rates and a high amount of cash balances held by households and businesses which fails to stimulate aggregate demand.
What is the Quantity Theory of Money?
The theory states that the general price level of goods and services is directly proportional to the money supply.
What is Fisher’s Equation of Exchange?
MV=PY
Where M= Money Supply, V= Velocity of Money, P= Price Level and Y= National Output
What is the Velocity of Money?
The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another.
Simply put, it’s the rate at which consumers and businesses in an economy collectively spend money.
Which variables are assumed to be constant in Fisher’s Equation of Exchange?
V - as the frequency that workers are paid does not change quickly or often
Y - as Y is independent of the money supply
If V and Y are constants what does Fisher’s Equation of Exchange show?
MV=PY
V and Y are constant
If M (money supply) increases, P (price level) will increase.
Which organisations regulate the UK financial sector?
- Financial Conduct Authority (FCA)
- Bank of England through:
- Prudential Regulation Authority (PRA)
- Financial Policy Committee (FPC)
What does the FCA do?
The FCA regulates financial firms to ensure they are being honest to consumers and they seek to protect consumer interests
What does the PRA do?
The PRA promotes the safety and stability of banks, building societies, investment firms, and credit unions, and ensures policyholders are protected
What does the FPC do?
The FPC regulates risk in banking and ensures that the financial system is stable
What is moral hazard?
A situation where one party is able to take risks because it does not have to bear the full consequences of those risks. In financial markets, moral hazard occurs when investors or market participants are able to take on excessive risk because they believe that they will be bailed out if those risks lead to losses.
What are systematic risks?
Systematic risks refer to the risks inherent to the entire market
How can investors manage systematic risk?
Investors can manage systematic risk by ensuring that their portfolios include a variety of asset classes, such as fixed income, cash, and real estate, each of which will react differently to an event that affects the overall market.
What is a liquidity ratio?
Liquidity ratios are metrics used to determine a debtor’s ability to pay off current debts without raising external capital. Liquidity ratios measure a company’s ability to pay debt obligations and its margin of safety
What is a capital ratio?
A capital ratio is a comparison between the equity capital and risk-weighted assets of a bank used to determine a bank’s financial strength.
What are the functions of a central bank?
- Manage the currency
- Manage the money supply
- Manage interest rates
- Lender of last resort
- Lender to the government
- Regulate the financial sector
What are the 2 Bretton Woods institutions?
The World Bank and the IMF
What does the World Bank do?
The World Bank reduces poverty by lending money to the governments of its poorer members to improve their economies and to improve the standard of living of their people
What does the IMF do?
The IMF monitors the international monetary system to identify risks and recommend policies for growth and financial stability. It also promotes free, global trade and exchange rate stability, as well as lending to countries.
What is external debt to a nation?
The amount of money owed to foreign lenders
