financial market Flashcards
Roles of financial markets
- Facilitate saving
- Lend to businesses or individuals
- Facilitate exchange of goods and services
- Provide forward markets in currencies and commodities
- To provide market for equities
money markets vs capital markets
Money markets: short term borrowing and lending
Capital markets: long term financing- more than a year
types of market failure in the financial sector
- Asymmetric information
- Externalities
- Moral hazard
- Speculation and market bubbles
- Market rigging
market failure, what is Asymmetric information
attracting the wrong buyers due to AI
○ By having complex products like insurance or mortgages, people don’t know what they are being sold and often pay a very high price for it. with health insurance you wont get profitable customers, will only lose money
○ Financial institutions also have very little incentive to help regulators understand their business
market failure, what is Externalities
○ Costs that other firms, individuals or governments have to taken on. Cost of bailing out banks after financial crisis in 2008 is an externality
also loss of savings, jobs, income and growth
market failure, what is Moral hazard
○ When an economic agent makes a decision in self-interest. Happens in investment banking- making large ST profit which makes a huge loss to the company
market failure, what is Speculation and market bubbles
○ All trading is speculative, market bubbles are when prices of an asset are driven very high and then just collapse
○ Happens in housing bubbles, lead to unsustainable rise in house prices
happened with bitcoin
market failure, what is Market rigging
○ Where people collude to fix prices or exchange information- insider trading is an example.
heavy fines and regulation to avoid this but can still occur if punishment is weak
role of central banks
• Implementation of monetary policy
• Act as banker to the government
○ Handles accounts of government departments
• Banker to the banks- last resort, advisor to gov on bank bailouts
• Regulation of the banking industry
○ Need to be regulated otherwise the financial institutions would act to harm their customers
○ To avoid them going for short term profits that lead to collapse in future
○ Types of regulation
§ Having clear balance sheets
what affects money supply
learn interest rate graph
- reserve requirement- how much the bank must keep as a % of its deposits
- bank rate- affects inflation and lending and all
- open market operations- central bank buying/selling gov bonds in order to control amount of money supply, trying to give liquidity
what is credit creation and fractional reserve banking
1 / reserve requirement
how much extra credit it creates through depositing and lending etc
FRB- only keeping some money in the bank. will break down if everyone requires their money at once
evaluation for role of central banks
moral hazard
banks may not have sufficient liquidity
regulatory capture
why should banks and not firms have this luxury
objectives of a commercial bank
profit maximisation- by borrwing ST or lending LT with high interest rates
or taking more risks (non secured loans)
consequences of bank failure
systemic risk
recession, loss of income, jobs and output
bank bailouts- many negative externalities
how to avoid bank failure
having liquidity
security to manage risk and avoid insolvency
means you have to sacrifice profit
