Financial Markets Flashcards
4 Functions of Money
- Medium of Exchange
- Store of Value (eg. savings and investments)
- Standard of deferred payments (Future payments)
- Unit of Account
Characteristics of money
Portability
Divisibility
Durability
Hard to counterfeit (not easy replicable)
Difference between ‘Narrow’ and ‘Broad’ Money
Narrow money is the stock of money made from cash and liquid deposits.
Broad money is the stock of money made from cash and liquid deposits, and less liquid assets.
Roles of financial markets
To lend to businesses and households
To facilitate savings by businesses and households.
To facilitates exchange of goods and service
Provide a market for equities eg. stocks and bonds
3 different ways firms can raise capital…
- Borrowing a bank loan
- Selling shares to investors
- Selling corporate bonds
Money Markets
Money markets are short term finance to firms and household. Money is borrowed and lent within 12 months from commercial banks.
Capital markets
Capital markets are medium to longer term finance, through shares and bonds for PLC’s.
- eg. sales of government bonds
Bonds & Coupons
Bonds are financial securities which are a long term form of borrowing. (gov. borrows from investors)
Coupons are the fixed annual interest, paid by the issuer to the owner of the bond.
Yield on bond
Coupon / Bond price x 100
Why is the relationship between bond prices and interest rates.
If coupon rate is higher than interest rate, investors demand for bond will increase, and so will bond price.
As more investors buy bond, yield on bond falls.
Investors than save in accounts for interest.
Investment banks
Investment banks provide services for companies and large investors.
- Advise on security issues and capital raising methods
- Trading on capital markets and equity investments.
- Trade and invest on its own account.
Commercial banks
Commercial banks help with the flow of money in the economy by providing deposit and credit eg. HSBC and Barclays - operate on profit.
Objectives of commercial bank
- Liquidity (to pay deposits)
- Profitability
- Security
Central Bank
Central banks formulate monetary policies of the economy on behalf of the government - described as ‘monetary authorities’. eg. bank of England
- Also act as a banker to the government.
Funding for Lending - Central Banks
Funding for Lending is when the B of E makes funds available for commercial banks to loan.
Forward Guidance - Central Banks
Making announcements about changes in the Interest Rates so agents can adapt accordingly.
Causes of Bank Failure
Borrowing and Lending issues
Liquidity and Capital Ratios
Moral Hazard eg. Government promises to bail out banks, leading to excessive risk taking by banks and firms leading to losses.
*Systemic Risk
Monetary Policy Committee (MPC)
MPC meet once a month to review the British economy, and vote on interest rate levels.
When setting the bank rate, they look at….
*Real Wages
*Inflation rate
*Consumer confidence
*Economic shocks
Transmission Mechanism of Monetary Policy
How changes in bank rate affects the economy…
- Change in the Bank Rate
- Impact on consumer confidence
- Impact on output, jobs and investment
- Real GDP and inflation.
However, it can take 12-24 months for the impact of IR to occur, depending on the responsiveness of the economy .
Financial Policy Committee (FPC)
Identify, monitor and protect against systemic risk, by telling commercial bank to alter capital reserves to protect against losses.
Prudential Regulation Authority (PRA)
Maintain the stability of commercial banks, through ratio requirements.
Financial Conduct Authority (FCA)
FCA Report to the treasury.
Prevent market abuse and ensure consumers and firms get fair deals from financial authorities.
Liquidity Ratio (Current Ratio)
Current Assets / Current Liabilities
Capital Ratio
Capital (Profit + Shareholder) / Advances
