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Finanacial Marlets Flashcards

1
Q

What is a financial market

A

Where buyers and sellers can trade financial assets

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2
Q

What is the money market

A

IOUs that are less than 1 year
Eg. Bonds, interbank lending

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3
Q

What is the capital market

A

IOUS greater than 1 year
Eg.bonds(debt) and shares(equity)

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4
Q

What are the functions of money

A

Medium of exchange
Store of value
Measure of value
Standard of deferred payout

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5
Q

What are the characteristics of money

A

Acceptable
Portable
Durable
Divisible
Limited in supply
Difficult to forge

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6
Q

What are the types of money

A

Notes and coins
Deposits
Near money(non cash assets easily converted)

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7
Q

What is the money supply

A

The money supply is the total amount of money available in an economy at a given time.
Ranges from M0(narrow)-M4(broad)
Where each section increases the liquidity of non cash financial liquid assets where M4 includes bonds less than 5 years

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8
Q

Why are bonds issued

A

So that firms and the government can raise finance

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9
Q

What is the role of commercial banks

A

Accept savings
Lend
Act as financial intermediaries
Allow payments from one agent to another
Advice

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10
Q

What is the role of investment banks

A

Prop trading- investing excess capital
Market making-second hand markets for bonds/shares
Mergers and acquisitions-advice
New issues-underwriting,publish

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11
Q

What is the danger of most banks having a commercial and investment side to them

A

Increases systemic risk as failures of the risky investment side can bring down commercial side and bring down the whole financial system due to banks interconnectedness

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12
Q

What is systemic risk

A

It usually happens when the failure of a single institution or a group of institutions causes a ripple effect, potentially leading to widespread instability or collapse of the financial system.

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13
Q

What is on a commercial banks balance sheet

A

Record of all assets,liabilities and capital(shareholders equity) at any given point in time(snapshot)

The balance sheet must balance where assets=liabilities+capital

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14
Q

Where on a balance sheet is it recorded if a risky loan is not repayed

A

The capital section will take the hit on the firm of reduced retained profit

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15
Q

What are the reasons a commercial banks could fail

A

Not enough liquid short term assets to meet short term liabilities-liquidity crisis(bank run)

Not enough capital to offset losses in asset values(liquidity>assets)- insolvency

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16
Q

Insolvency meaning

A

A bank owes more than they own
(Liabilities>assets)

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17
Q

Run on the banks meaning

A

A run on the banks happens when a large number of customers rush to withdraw their money from a bank at the same time because they believe the bank might fail or become insolvent.

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18
Q

What are the tools to prevent bank failure

A

Cash ratio-forcing banks to hold enough cash to pay CL
Liquidity ratio-forcing banks to hold enough CA to meet CL
Leverage ratio:make sure banks hold enough capital to offset any losses in long them investments and advances
Capital ratio:holding enough capital to cover advances
Reserve requirement:a certain percentage of deposits must be held at BofE to meet CL

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19
Q

What are commercial banks objectives

A

Profit maximisation-borrow short term and lend long term
Or take more risk(non secured loans)

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20
Q

Consequences of bank failure

A

Systemic risk
Recession: lost incomes, jobs and output
Bank bailouts-UK taxpayer bare brunt of cost of failure

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21
Q

What do banks need to do to reduce chance of bank failure

A

Need for liquidity to avoid bank run
Manage risk and avoid insolvency
This means sacrificing some profit

A balanced portfolio of assets is key to stop this occurring

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22
Q

What is the role of the central bank

A

Implement monetary policy
Act as a banker to the government-bonds
Act as a banker to the banks(liquidity assurance to stop systemic risk)
Regulate the financial system

23
Q

Benefits of the central bank being the lender of last resort

A

• It prevents panic and collapse in the financial system.
• Helps restore confidence when banks can’t borrow money from other sources.
• Aims to contain systemic risk and stop issues from spreading across the entire financial market.

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Problems with banks being g
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Problems with banks being the lender of last resort
Moral hazard- central bank will bail out a bank if risks go wrong, therefore encouraging greater risk Regulatory capture Why should banks gain this luxury when other firms don’t?
27
What is financial market failure
Where free financial markets fail to allocate financial resources at the socially optimum level
28
What are the two types of financial market failure
Excessive risk leading to overall collapse of the financial system(overproduction of financial assets Collusion and fixing of interest rates/exchange rates and monopoly pricing
29
What are the consequences of excessive risk
Systemic risk-loss of confidence and faith in banks Recession,lost incomes, jobs and output,financial crisis Bank bailouts-negative externalities ok tax payer
30
What is a leveraged deal
Borrowing to amplify the outcome of a deal
31
Problems with deregulating financial markets in mid to late 1900s
Removing capital/liquidity ratio Scrapping reserve requirement Using commercial bank funds for IB activities This increases the level of risk banks were able to take increasing likelihood of bank failure, systemic risk
32
What are the separate causes of financial market failure
Speculation and market bubbles-ER Asymmetric info-moral hazard and adverse selection Negative externalities-ER Market rigging- collusion
33
Why are speculation and market bubbles a financial market failure
People buy asset and sell at higher prices to make profit What is prices fall and the deal is leveraged? Excessively high estimates of future price increases can create an asset bubble Eventually demand falls, price falls leaving the asset worthless creating huge debts Bank either won’t get paid on loans given out it won’t be able to pay back own loans leading to bank failure
34
Why is asymmetric info a cause of financial market failure
Where most likely buyers are those the seller would prefer not to sell to due to imperfect info: Excessive risk then taken:eg insurance Premium based on who it believes will buy For safe buyers premium is too high For risky buyers the premium is good value Therefore only sell to risky customers risking losses and collapse
35
Why are negative externalities a cause of financial market failure
Cost to the tax payer of bailouts(due to bank being ‘too big to fail’ Loss of savings Loss of jobs, income and growth
36
Why is market rigging a cause of financial market failure
Traders/bankers/intermediaries collude to manipulate markets to make huge profits Eg rigging forex markets Will still occur is punishment and enforcement of regulation is weak
37
When is regulation rational
Where public interest is being harmed
38
Financial policy committee(BofE)
Macroprudential regulators: Identify, monitor and protect against systemic risk Instruct PRA and FCA in tackling financial stability issues Advise gov on shocks and bailouts
39
Prudential regulation authority(PRA)
Microprudential regulators: Maintain stability of banks Supervise management of risk Setting industry standard for conduct and management with enforcement Specify ratios/recquirements
40
Financial conduct authority(FCA) Treasury employed
Microprudential regulator Protect consumers and increase confidence in financial institutions/ products by: Supervising conduct of firms/markets to ensure legal activity Promote competition Banning products against customer interest - mis selling Banning or changing misleading adverts for financial products-loan sharks
41
What is the cash ratio
Cash assets/CL Aims to prevent liquidity crisis Basel recommendation-none
42
What is the liquidity ratio
CA/CL Aims to prevent liquidity crisis Basel recommendation 100% in 2019
43
What is the reserve requirement
The fraction of deposits that must be held at the BofE Prevent liquidity crisis Basel recommendation-none (10% USA)
44
What is the capital ratio
Capital/specified loans Aims to prevent insolvency and systemic risk Basel recommendation-8% minimum Specified loans reduced effectiveness
45
What is the leverage ratio
Capital/loans+long term investments Aims to prevent insolvency and systemic risk Basel recommendation-3% minimum More conclusive than capital ratio
46
What are the problems with financial market regulation(eval)
Moral hazard-cost of bad decisions payed by taxes Regulatory capture Asymmetric info- hard to regulate effectively Info failure-regulators 1 step behind Unintended consequences: Eg. Deregulation increases systemic risk Banks may leave commercial side Max interest leads to excess demand and bad borrowers Administrative and enforcement costs high
47
Evaluation of financial market regulation(conclusion)
Balance is needed to protect consumers and protect against systemic risk but also need to maintain bank profitability Regulation should promote equity without damaging efficiency Costs vs benefits and gov failure?
48
Pros and cons of fractional reserve banking
It increases the money supply through what’s called the money multiplier effect. • It allows banks to stimulate economic activity by lending more. • But it also means banks don’t have all your money on hand, which can lead to problems if everyone wants their money back at once (a bank run)
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50
Types of financial market regulation
Ban market rigging Prevent sale of unsuitable products Max interest rates Deposit insurance(75k) Keep commercial and IB separate Deregulation Limits on bank lending Liquidity assurance and other ratios
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Economics (9 decks)

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