Essay Plans Flashcards
SEM 1 What affects bond prices and yields
IR
Price: If IR ^ = existing bonds less attractive compared to newly issued bonds as they will offer lower rates of Interest and coupon payments will be smaller = investors demand a discount on lower coupon bonds = price falls
Yield: Yield increases to incentivise people to buy bonds
Inflation
Price: If inflation ^ = IR^ = harder to borrow = d for bonds falls so price falls. Inflation also erodes purchasing power of interest = demand higher yields to offset loss in real value
Yield: inflation erodes purchasing power of interest = demand higher yields to offset loss in real value
Maturity
Price: If maturity ^ = price falls as long term bonds are more sensitive to change in IR as their cash flows are spread over a longer period and inflation so price fluctuates
Yield: bonds with longer maturity have higher yield to maturity to compensate for increased risk
Credit quality
Price: If Credit Quality ^ = price increases because there is lower risk of default
Yield: investors demand lower yields as their returns are safer. High credit quality bonds also have narrow credit spread indicating lower risk premiums so lower yield needed
SEM 1 How will bond prices and yield adjust after pandemic
Yields increase: capital and businesses expand = increased demand for capital = increased consumer spending. Increased borrowing costs = investors demand higher yields to maintain attractive returns
Bond prices fall = existing bonds with lower yields becomes less attractive
Inflation ^ due to rising demand = investors demand higher bond yields to compensate for erosion of purchasing power
Shift in investor sentiment from safe - haven assets to more risky = p falls y increases
L3 Economic implications of open banking
Open banking - set of services supported by application programme interface (API) where each provider makes clear what they are offering. Consumer permission required before an Authorised Third Parties (ATP) accesses bank data. Providers accessing customer’s account are able to view the patterns and history of their transactions and advise the customer of changes that might be beneficial. This will involve the third party creating apps so that a customer can view all account options together
1 Enhanced competition: lower prices & improved service between incumbent banks in retail finance sector due to new entrants e.g. fintech companies
2 Lower entry barriers: new entrants erodes historic information advantages of banks as entrants leverage fintech to challenge incumbent banks. Also access to consumer data through a third party means new entrants don’t need to establish own customer base before producing new products.
3 Lower search costs for consumers: can use an API when searching for products rather than searching case by case. Eliminates the need for consumers to log in to multiple platforms or visit different physical branches, reducing the time and effort required to track and manage their finances.
4 Less dependence: on banks & credit cards as consumers can make online credit transfers more quickly. As a result of increased competitiveness consumers have more options to choose from.
Challenges to traditional banks of open banking
1 New enhanced business risk: operational risks e.g. cyber attacks. Dependence on 3rd parties for support
2 Erosion of traditional consumer interface inhibits ability to over price some aspects of business where competition is weak
3 Loss of customer relationship: harder to maintain customer loyalty. Especially member owned banks.
4 Disintermediation: remove banks from part of the process eroding revenue streams (lending & payments), loss of business revenues
5 AI erodes historic advantages and pressure to innovate = expensive
Challenges of open banking to consumers
1 Security risks: Cyber attacks = sensitive financial information shared
2 Erosion of relationship banking
3 Lack of understanding of open banking
L3 How P2P lending transforms financial intermediation landscape
P2P lending - provide online technology creating a marketplace where investors lend to potential borrowers & provide credit through P2P agreements
Borrower:
Direct borrowing & lending: individuals can directly borrow from a pool of investors. Reduces dependence on banks and wider range of investors and borrowers.
Increase access to credit: technology uses data to assess credit worthiness. Borrowers with limited credit history can access loans
Cost efficient: eliminates several layers of intermediaries. Reduces costs such as brick and mortar branches. More competitive IR for borrowers
Lenders:
Cost efficient: earn higher IR by lending directly to borrowers due to lower operational costs
Innovation: leverage of technology utilises online platforms & data to coordinate loans. Faster transactions. Also reduces risk of default as lenders have more knowledge
Diversification: lenders can allocate funds across various loans spreading risks across multiple borrowers
Risks and issues of P2P lending
Success of platforms depends on numbers of borrowers and lenders
Platforms following lending club model documentation will be a constant challenge as the investors, not platform make final decisions whether to lend
Default & credit risk: borrowing to small businesses comes with higher risk of default. Makes it crucial to assess credit worthiness of borrowers
If borrowers default, lenders aren’t covered by deposit guarantee schemes.
No protection if firm providing P2P lending goes bankrupt (Trust buddy 2015)
L4 Factors that affect ER in LR
Domestic IR:
Higher IR attract foreign investors seeking higher returns = capital inflows increase = higher d for currency = appreciation
Foreign IR:
Foreign currency becomes more attractive to investors = capital outflows . More expensive for foreign producers = p of imports increase for domestic goods = increase inflation = depreciation
Trade barriers:
Make imported goods expensive = d for foreign goods fall = improved trade balance = upward pressure on ER
Can lead to retaliation = foreign country impose trade barriers = uncertainty & reduced investor confidence = capital outflows = ER falls
Productivity:
Increased competitiveness = more efficient production at lower costs = lower prices = increased d = exports = appreciation
Higher capital flows + investment as productivity attractive to investors = increase d for currency = increased ER
Explain how the central bank must intervene under fixed ER where undervalued currency is pegged to foreign currency
Financial Crisis in Advanced Economies
S1 Initiation stage
Credit boom & bust: mismanagement of financial innovation leads to asset price boom and bust
Asset price boom & bust: busts causes decline in value of financial assets
Increased uncertainty: caused by failure of institutions. Reduced information during recession = financial frictions rise & reduced lending
S2 Banking Crisis
Deterioration in balance sheets & tougher business conditions leads to insolvency as firms net worth becomes negative
Asymetric information - fear for deposits safety as don’t know quality of banks loan portfolios. Panic withdrawals = bank failure
Massive asset sell off to quickly raise funds = price declines = insolvency
Fewer banks operating = limited info about creditworthiness of borrowers & spenders = adverse selection and moral hazard problems
S3 Debt deflation
Unanticipated decline in price level leads to further deterioration in firms net worth due to increased burden of indebtedness
As debt contracts have fixed IR and long maturity. Fixed repayments mean decline in price level raises firms liabilities.
Financial Crises in Emerging Economies
S1 Initial phase
Path A: Credit boom & bust : banks play more important role in emerging market economies as securities are well developed. Liberalisation opens economy to capital flows = financial globalisation = vulnerable to shocks. Lack of expertise in monitoring of tax & borrowers leads to lending boom. Liberalisation = Principle agent problem = supervisors may not act in public interests
Path B: Gvts in need of funds force banks to buy gvt debt. Investors lose confidence in gvts repayment ability = debt loses value = banks net worth decreases. As a result of increased IR = high risk firms most willing to pay rates (adverse selection). Uncertainty linked to unstable political system makes it harder to screen & monitor credit
S2 Currency crisis
Deterioration of bank balance sheets triggers currency crisis. Gvt cannot raise IR to defend currency (would lead to insolvency). Speculators expect devaluation so sell currency. Gvt budget deficit = investor suspicion about repayment ability. Investors sell currency = speculative attack
S3 Fully fledged financial crisis
Currency mismatch arises. Banks likely to fail - individuals less likely to pay debts + debt in foreign currency increases. Adverse selection = moral hazard and reduced lending = lower investment
Twin crisis: Financial crisis + Currency crisis
