Financial Markets

Question 1

Functions of financial institutions

Answer 1

1. To Facilitate Saving: These institutions ensure the security of deposited funds and often pay interest to encourage saving. institutions can allocate these funds to support loans and investments
2. To Lend to Businesses and Individuals: act as intermediaries between savers and borrowers. They collect deposits from individuals and then lend this money to businesses and individuals in need of capital
3. To Facilitate the Exchange of Goods and Services: Financial institutions provide a wide range of payment and transaction services that facilitate the exchange of goods and services in the economy. e.g. credit card services
4. To Provide Forward Markets in Currencies and Commodities: These contracts allow businesses and investors to hedge against currency exchange rate fluctuations and commodity price volatility. Reducing uncertainty
5. To Provide a Market for Equities: allowing individuals and institutions to buy and sell shares of publicly traded companies. Stock exchanges and brokerage firms facilitate these transactions. potentially benefit from capital gains and dividends

Question 2

Market failure: moral hazard

Answer 2

1. Moral hazard: when investor are protected from the consequences of their actions, they may engage in riskier behavior than they would otherwise. E.g. banks were bailed out in he financial crisis

Question 3

Market failure: asymmetric information

Answer 3

Asymmetric information: one party knows more in a transaction. E.g. subprime mortgages - he bankers knew more

Question 4

Market failure: speculation and market bubbles

Answer 4

Speculation and market bubbles: speculated that housing prices would rise so kept on giving out sub prime mortgages. Eventually this created a housing bubble. The bubble then burst as people realised that housing was overvalued and sold them

Question 5

Market failure: negative externalities

Answer 5

Negative externalities: costs which effect third parties outside the price mechanism. Banks didn’t have money after the financial crisis. Couldnt lend to business, people losing their jobs. Less money being spent in the economy - decrease in AD

Question 6

Market failure: market rigging

Answer 6

Market rigging: Libor is used as a global interest rate.
Barclay give gave inaccurate libor rates. Barclay profi at the expense of others.

Question 7

Role of central banks:

Answer 7

• implementation of monetary policy
• banker to the government: often hold the governments bank account
• banker to the banks: banks deposit their money within the central bank, often used to balance the accounts of banks. The CB can lend them money to prevent them from collapsing
• regulating the banking industry: preventing financial institutions from undertaking activities which cause harm to customers

Question 8

Three key bodies for financial regulation

Answer 8

• FPC: supports government economic policy
• PRA: ensures competition
• FCA: protects consumers, promotes competition, prevents market rigging

Question 9

Financial market

Answer 9

• where buyers and sellers can trade financial assets
• lenders & borrowers need financial markets