Financial Markets Flashcards
6 Characteristics of Money
Acceptable
Portable
Durable
Divisible
Limited
Difficult to forge
4 Functions of money
1) Medium of Exchange
2) Store of Value
3) Unit of Account
4) Standard of deferred payment
Narrow Money
A measure of the value of coins in circulation and other money equivalents that are easily convertible into cash in hand.
Broad Money
A measure of the total amount of money held by households and companies in an economy, eg. including assets with low liquidity.
Liquidity
The ease at which an asset can be converted into cash in hand.
Balance Sheets
A balance sheet refers to a statement of assets, liabilities and equity of a business or bank.
Assets - Liabilities = Equity
Definition / Function of Financial Markets
To channel funds from those who have surplus funds to those with a shortage of funds.
Money Market + Examples
Provides short-term finance to individuals, firms and govts. Transaction examples include - purchasing treasury bonds, interbank lending and short-term debts.
Capital Account
Provides medium and long-term finance to individuals, firms and governments. Companies can raise long-term finance by issuing shares or corporate bonds but they can also borrow from banks. Divided into two further accounts
Primary Market (Capital Account)
The primary market gives access to newly issued securities sold by companies and governments.
Secondary Account (Capital Account)
Trade previously issued (second hand) securities.
FOREX
Deals with the purchasing and selling of different currencies. Split into two further markets:
Spot Market (FOREX)
The immediate purchase of a currency
Forward Market (FOREX)
The exchanges of foreign currencies at a specified time in the future.
Debt Capital
Capital that has been raised by taking out a loan from a bank.
Share Capital
Capital that has been raised by issuing shares.
Debt
Refers to an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. This can be otherwise known as deferred payment.
Equity
Measured by subtracting liabilities from the value of the assets. Therefore, this can be used to determine the actual value of a person’s assets.
Key features of Commercial Banks
Provide loans + overdrafts to individuals
Profit Max // Share-holder satisfaction
Accepting cash deposits
Effective means of payment
Mortages
Financial Advice
Key Features of Investment Banks
Trade securities on behalf of their clients.
Advising on new share issues,
Help with mergers,
underwriting new share issues,
finance larger infrastructure projects,
managing investment portfolios.
G-SIB
Global systemically important bank
Functions of Central Banks
- Monetary Policy
- Financial Stability / Regulation
- Govt. Policy / Lender of last resort
Credit Creation
Providing a loan (asset) creates a corresponding liability for the bank in the form of a deposit in the customer’s bank account.
Banks make profit from credit creation by ensuring that the cost of borrowing exceeds the reward for saving.
Money Multiplier
Where an initial deposit into a bank leads to a proportionally greater increase in the money supply. It is calculated as 1/ reserve ratio.
Bond Yield Calculation
Yield = Coupon x100
Market Price
Relationship between Bonds + Interest Rates
An inverse relationship between bond prices and interest rates.
Most bonds pay a fixed interest rate which becomes more attractive (greater yields) as interest rates fall.
As demand for bonds increases, demand-pull inflation drives up the price of bonds.
Prudential Regulation Authority (PRA)
Operate under the Bank of England
Regulate, supervise and promote effective competition
1,700 commercial banks and other financial institutions
a microprudential regulator.
They supervise financial institutions to ensure that they are effectively managing risk.
They can also set capital and liquidity ratios.
Financial Policy Committee (FPC)
Operating under the Bank of England,
Identify, monitor and protect banks from systemic risk Macroprudential regulator.
Advise the Government on managing financial markets.
Financial Conduct Authority (FCA)
Funded by the firms it regulates
Protection for customers
Protect the integrity of the UK financial system
Promote competition.
Eg. Banned PPI
Tools of Financial Regulation
Capital Ratios
Liquidity Ratio
Basel III agreement
Stress Tests
Capital Ratios
The amount of capital (assets - liabilities = capital) expressed as a % of total assets. This is calculated as (capital / assets) X 100. The objective of capital ratios is to prevent insolvency.
Liquidity Ratio
A set amount of liquidity that a bank must possess
It is calculated as current assets (short-term) / current liabilities (short-term).
Basel III Agreement
Establish international standards for banking regulation In wake of the 2007-8 financial crisis.
Liquidity Coverage Ratios (LCR) which suggested that all banks should possess 100% liquidity for all liabilities < 30 days.
Another key feature is that banks are suggested to keep an 8% minimum capital to loans ratio.
Stress Tests
Used to measure the extent to which financial institutions are vulnerable to the effects of extreme economic events.
Consequences of Bank Failure
Systemic Risk
Recession
Bank Bailouts
Evaluation of Banking Regulation
Moral Hazard
Regulatory Capture
Asymetric Info
Enforcement Costs
Shadow Banking
Bank Run
When banks do not have sufficient liquid assets to meet short-term liabilities
Insolvency
When banks do not have sufficient assets to meet their liabilities
Assets < Liabilities
