Financial markets

Question 1

Functions of the financial market

Answer 1

1) The flow of savings from households to entrepreneurs
2) Savings allocation
3) Offering financial management instruments

Question 2

Classification of financial markets

Answer 2

1) Money market
2) Capital market
3) Foreign exchange market
4) Derivatives market

Question 3

Types of transactions in the financial market

Answer 3

1) Hedgeing – a bet on the direction of price changes or the purchase of “insurance” for such an accident
2) Speculation and Arbitrage – Seeking Extraordinary Profits

Question 4

Spot and forward transactions

Answer 4

1) Spot transactions – are executed within 2 business days – primary instruments
2) Forward transactions – executed 30, 90, 180 days later – derivatives

Question 5

Money market

Answer 5

1) Enables the management of the liquidity of the institution
2) Short-term loans and deposits (up to 1 year)
3) Participants – banks

Question 6

Money market instruments

Answer 6

a. Short-term (up to 3 months)
Repourchase agreement (repo) –2 opposing transactions on the spot and forward markets
b. Long-term (3 months – year)
Treasury bills, certificates of deposit, commercial bills

Question 7

Capital market

Answer 7

1) Allows you to raise or allocate capital
2) Raising long-term capital
3) Stock and bond market
4) Participants:
a. Stock market: issuers (companies), individual and institutional buyers
b. Bond market: issuers (government), institutional buyers

Question 8

Foreign exchange market

Answer 8

1) Allows currency exchange to make international payments
2) Participants – commercial and investment banks, central banks, firms, investment and hedge funds act as: hedgers, arbitrators, speculators
3) Types of transactions – spot transactions, Futures and Swaps, currency options

Question 9

Derivatives market

Answer 9

1) Allows participants to hedge against price changes
2) The price of the instruments is based on the price of the underlying instrument
3) Participants – commercial and investment banks, central banks, firms, investment and hedge funds act as: hedgers, arbitrators, speculators
4) Types of transactions: Forward, Swaps, Currency Options

Question 10

Intermediaries in financial markets

Answer 10

1) Commercial and investment banks
2) Insurance and hedge funds
3) Insurance companies

Question 11

Raising capital financial markets vs banks

Answer 11

1) Financial markets can take on more risks than banks
2) Lower risk premium + no margin required = lower cost of raising capital
3) Monitoring of the company by investors

Question 12

Trends in financial markets

Answer 12

1) Increase in liquidity
2) The rise of derivatives
3) The rise of capital markets

Question 13

1) Increase in liquidity

Answer 13

• Liberalisation of financial flows
• New instruments
• New risk management methods

Question 14

2) The rise of derivatives

Answer 14

• Demand for new risk management methods

* The growing role of speculation

Question 15

3) The rise of capital markets

Answer 15

• The decreasing role of banks in capital intermediation

* The growing role of the stock and bond markets

Question 16

wHAT THE TOOLBOK FOR THE FINANCIAL MARKETS

Answer 16

Speculation
Interest rate derivatives
Foreign exchange swaps
Forward/futures currency contracts

Question 17

Speculation

Answer 17

1) Possibility of using levers
2) Possibility to make a small deposit
3) High risk – big profits

Question 18

Interest rate derivatives

Answer 18

1) Forward rate agreement (FFA) – an agreement on the settlement of the difference between the forward interest rate on the date of conclusion of the contract and the interest rate on the settlement date of the contract
2) Intrest rate swap (IRS) – an agreement for the periodic settlement of the difference between the long-term interest rate on the date of conclusion of the contract and the short-term interest rate in future periods
3) Interest rate options – an instrument that gives the POSSIBILITY of making a deposit / taking a loan at the old interest rate

Question 19

Currency Options

Answer 19

1) An instrument that gives the owner the OPPORTUNITY to buy or sell at a specified rate
2) A kind of insurance against changing the course to an unfavorable one
3) Receiving a payment in foreign currency at a certain time in the future – put option
4) Making a payment in a foreign currency at an indefinite time in the future – call option
5) This is used by commercial banks and investment management institutions abroad

Question 20

Derivatives market – problems

Answer 20

1) Misuse of derivatives
2) Improper distribution of risk in the financial market
3) Incorrect risk assessment (e.g. financial speculation on the foreign exchange market in 2007-2008)