Financial Markets

Question 1

What are the characteristics of money?

Answer 1

Durability
Portability
Divisibility
Hard to counterfeit
Valuable
Must be generally accepted

Question 2

What are the functions of money?

Answer 2

Medium of exchange
Store of value
Unit of account
Standard of deferred payment

Question 3

What’s M0?

Answer 3

Notes and coins + Central bank reserves

Question 4

What’s M4?

Answer 4

Notes and coins, deposits, certificates of deposit, securities with a maturity of less than 5 years held by the non-bank private sector.

Question 5

What’s narrow money?

Answer 5

The measure of the value of coins and notes in circulation and other equivalents that are easily convertible into cash, such as short-term deposits in the banking system.

Question 6

What’s broad money?

Answer 6

A measure of the total amount of money held by households and companies in the economy. It’s made up of mainly commercial bank deposits and money.

Question 7

What are open market operations?

Answer 7

AKA QE, where the central bank, with the government’s approval, electronically prints money and pumps it into the economy through the financial markets by buying corporate and government bonds.

Question 8

What’s Fisher’s quantity theory of money?

Answer 8

MV = PT
As V and T are constant, increasing the money supply will increase the price level.

Question 9

What’s the reserve requirement?

Answer 9

Imposed in banks, it’s the % of deposits made by customers at the bank that the bank must keep hold of rather than letting it out.

Question 10

What’s the money market?

Answer 10

The market for short-term loan finance for businesses and households.

Money is borrowed and lent, normally for up to 12 months.

It includes short-term government borrowing.

Question 11

What’s the financial market?

Answer 11

The market for medium to longer term loan finance.

They’re the markets where securities such as shares and bonds are issued to raise medium to long-term financing.

It includes the raising of finance by the government through the issue/sale of medium to long term government bonds.

Question 12

What’s the foreign exchange markets?

Answer 12

Where currencies are traded. There’s no single currency market - it’s made up of thousands of trading floors.

Gains or losses are made from the movement of exchange rates - speculative activity in the currency market is often high.

Question 13

What are commercial banks?

Answer 13

They make their profits by taking small, relatively liquid deposits from retail savers and transforming these into larger, longer maturity loans.

Other services from commercial banks include providing debit and credit cards, private banking, guarantees, cash management and settlement.

Question 14

What are the five leading commercial banks?

Answer 14

Barclays
Royal Bank of Scotland
Lloyds
HSBC
Santander

Question 15

What are the services and features of a commercial bank?

Answer 15

They provide retail banking services to household and business customers.
They are licensed deposit takers - providing a range of savings accounts.
They are licensed to lend money.
They’re profit seeking
Their business model relies on receiving higher interest rates on the loans than the rate it pays out on the deposits.

Question 16

What are the types of commercial bank failures?

Answer 16

Poor management e.g, RBS takeover of AMB Ambro.
Lack of diversification
Run on the bank e.g, Northern Rock
Insufficient reserves
Economic downturn
Regulatory failure e.g, 2008 financial crisis

Question 17

What’s an investment bank?

Answer 17

They provide a wide range of services for companies and large investors including:
Advice on forms of capital raising
Advice on mergers and acquisitions and corporate restructuring
Trading on capital markets
Research and private equity investments

Question 18

What are private banks?

Answer 18

They provide wealth management services to high net worth individuals.

Question 19

What are building societies?

Answer 19

Owned by their members and not shareholders. Historically, they tended to focus on offering mortgages and saving products.

Question 20

What are credit unions?

Answer 20

Small and local non-profit lending institutions.

Question 21

What are the entry barriers to commercial banks in the UK?

Answer 21

IT systems
Payment systems
Retail deposits
Moral hazards (Large banks are “too big to fail”)
Resistance to changing accounts

Question 22

What are the commercial bank assets?

Answer 22

Cash
Balances at the BofE
Loans (advances)
Securities (e.g, bonds)
Fixed assets

Question 23

What are the commercial bank liabilities?

Answer 23

Customer deposits
Money owed to bond holders
Money owed to other banks

Question 24

What was the 2008 financial crisis?

Answer 24

A global financial shock to the global economy which started in the USA.

Question 25

What were the reasons for the financial crisis?

Answer 25

Very loose regulatory control of financial markets in the US and UK.
Regulatory capture of the credit rating agencies.
A dramatic increase in world savings due to developing countries.

Question 26

What’s the Glass-Steagall Act?

Answer 26

Passed in 1933, it aimed to separate investment and deposit banks in response to the great depression.
It aimed to reduce the risks associated with investment banking.
It created a firewall between the two types of banks.
It was repealed in 1999, which many believe led to an increase in subprime lending and therefore the 2008 financial crisis.

Question 27

What were the consequences of the credit crunch?

Answer 27

Global economy went into recession
Major fall in house prices
Bankruptcies increased
Insolvencies increased
Negative wealth effect
Rising unemployment
Fear of deflation

Question 28

What’s the Bank of England?

Answer 28

The UK’s central bank, the oldest central bank which dates bank to the 1630s.
It’s the bankers bank
The lender of last resort
It regulates the financial markets
Manages the payment system
Oversees monetary policy
Sets interest rates
Undertakes QE
Custodian of the official gold reserves

Question 29

What’s the role of the Bank of England?

Answer 29

To deliver stable prices and a stable financial system for the benefit of the economy as a whole.

Question 30

What’s financial market failure?

Answer 30

It occurs when money, equity and bond markets fail to achieve an efficient and/or equitable outcome. This can lead to economic and social costs including macro instability and loss of trust and confidence in financial institutions.

Question 31

What are examples of financial market failure?

Answer 31

Market rigging, speculative bubbles, information failures and low levels of market competition between suppliers.

Question 32

What’s the financial policy commitee?

Answer 32

It’s main role is to identify, monitor and take action to reduce risks that threaten the resilience of the UK financial system as a whole.
It publishes a financial stability report, identifying key threats to the stability of the UK financial system.
It has the power to instruct commercial banks to change their capital buffers.

Question 33

What’s the prudential regulatory authority?

Answer 33

It’s responsible for the prudential regulation and supervision of around 1700 banks, building societies, credit unions, insurers and major investment firms.
The particular focus is on the solvency of specific financial markets such as insurance providers, buy-to-let mortgage lenders, credit unions, other specialist lenders.

Question 34

What’s the financial conduct authority?

Answer 34

It’s funded entirely by the firms it regulates. It has three main objectives:
Secure an appropriate degree of protection for consumers.
Protect and enhance the integrity of the UK financial system.
Promote effective competition in the interests of consumers.

Question 35

What’s moral hazard?

Answer 35

It exists in a market structure where an individual or organisation takes more risks than they should do because they know they’e either covered by insurance, or that the government will protect them from any damage incurred as a result of those risks.

Question 36

What are examples of speculative bubbles?

Answer 36

Money Supply Bubble
Housing Bubble
Dot Com Bubble
Tulip Bubble

Question 37

What’s a systemmatic risk?

Answer 37

The possibility that an event at the micro level of an individual bank / insurance company could then trigger severe instability or collapse an entire industry or economy.

Question 38

What’s a liquidity ratio?

Answer 38

The ratio of liquid assets held by a bank on their balance sheet to their overall assets.

Question 39

What’s a capital ratio?

Answer 39

Measures the funds a bank has in its reserve against the riskier assets it holds that could be vulnerable in the event of a crisis.

Question 40

What policies were used to overcome the 2008 credit crunch?

Answer 40

Large unconventional / conventional monetary easing.
Massive fiscal stimulus.
Bailout of the private sector.

Question 41

What are the Keynesian approaches to policy response?

Answer 41

Provide strong monetary and fiscal stimulus.
Focus on labour-intensive infrastructure projects.
Bailout the private sector.
Support animal spirits.

Question 42

What are the Austrian approaches to policy response?

Answer 42

Avoid bailouts.
Fast-forward structural economic / market reforms.
Against countercyclical macro stimulus.

Question 43

What’s the world bank?

Answer 43

Provides grants and low interest loans.
Offers policy advice and technical assistance to developing countries.
Coordinates projects with governments.

Question 44

What are the key roles of the IMF?

Answer 44

Promote international monetary cooperation.
Facilitate the balanced growth of international trade.
Provides exchange stability.
Assist in setting up a multilateral system of payments.