financial markets

Question 1

what is a liability

Answer 1

things which people or organisations owe

Question 2

what is an asset

Answer 2

things which people or organisations own

Question 3

what are the functions of money?

Answer 3

• medium of exchange (universally accepted)
• measure of value (allows people to compare the relative values of goods and services)
• store of wealth (inflation makes it less useful at this)
• standard of deferred payment (it is a useful method of measuring debt)

Question 4

what is narrow money

Answer 4

cash (notes and coins) along with bank deposits with the Bank of England

Question 5

what is broad money

Answer 5

cash and instant access bank and building society deposits along with less liquid assets such as some short-dated bonds

Question 6

what is the money market used for?

Answer 6

Trading of short-dated financial assets such as cash, short term loans and short dated bonds that are about to mature.
- banks and other financial institutions lend on the money market

Question 7

what are capital markets used for?

Answer 7

used by PLCs and the Government to raise finance for the long term
- Primary market is where new shares in PLCs are sold
- Second Market is for second hand shares and bonds

Question 8

what does equity mean in financial terms?

Answer 8

wealth

Question 9

when will the price of shares go up on the stock market?

Answer 9

When demand exceeds supply- usually when a firm is expected to make high profits in the near future

Question 10

what are corporate bonds?

Answer 10

debt security issued by a company and sold to individuals or financial institutions who lend long-term to the company

Question 11

what are yields?

Answer 11

the return an investor expects to receive each year over its term to maturity.

Question 12

relationship between price of bond and yield of bond

Answer 12

it is inverse.
- if yields generally rise, interest rates throughout money markets are likely to rise
- if yields on bonds fall, interest rates are likely to fall as yields on bonds set the benchmark for interest rates in money markets

Question 13

equation for bonds

Answer 13

market price = (coupon ➗yield) x100

Question 14

what are the main functions of the Bank of England

Answer 14

• To help the Government achieve macro-economic stability (they may buy and sell foreign currencies to influence the exchange rate and also use the monetary policy)
• implement monetary policy
• maintaining financial stability (lender of last resort in attempt to prevent systemic risk)
• Government’s bank (collects tax revenues and distributes these to the various Government Departments to cover Gov spending)

Question 15

what are commercial banks

Answer 15

retail and high street banks in the UK that deal with members of the public and most small and medium sized businesses

Question 16

what do commercial banks do?

Answer 16

• accept deposits from the general public
• create deposits which re lent to customers who wish to borrow

Question 17

how do banks make profit?

Answer 17

charging for services and charging borrowers a higher rate of interest than they pay savers for their deposits

Question 18

what do investment banks do?

Answer 18

don’t generally take deposits from ordinary citizens but offer a range of financial services to large businesses
- help businesses raise funds
- help businesses buy businesses

Question 19

problems of investment banks

Answer 19

suggested that retail banking activities should be done separately from the riskier investment banking activities.
Retail Banks could be short of cash due to their derivative market meaning they are at risk of a run in the bank

Question 20

what is the credit multiplier

Answer 20

a measure of the extent to which the creation of money in the banking system causes the growth in the money supply to exceed growth in the monetary base

Question 21

effect of reserve requirement on money multiplier

Answer 21

the smaller the money multiplier the bigger the money multiplier

Question 22

equation for total bank deposits

Answer 22

total bank deposits = initial deposit ➗reserve requirement

Question 23

what would be the effect of a collapse in the banking sector on the wider economy?

Answer 23

there would be a massive collapse in aggregate demand and a huge recession

Question 24

what is financial regulation?

Answer 24

imposing rules and sometimes laws which limit the freedom of banks and other financial regulations

Question 25

examples of financial regulation

Answer 25

setting reserve ratios (the amount of cash that banks must hold in reserve against deposits made by their customers), and setting capital ratios (a comparison of the available capital that a bank has on hand to its risk-weighted assets)

Question 26

what is a bank’s capital

Answer 26

money the shareholders have put in and any retained profit

Question 27

what do the monetary policy committee do?

Answer 27

responsible for implementing monetary policy to influence bank lending and consequently the money supply and AD via the transmission mechanism

Question 28

what do the financial policy committee do?

Answer 28

monitoring and reducing systemic risk.
- prevents the market failure of moral hazard (which is when banks invest more riskily due to the knowledge that the Bank of England can bail them out)

Question 29

what is systemic risk

Answer 29

the possibility that an event at one bank could trigger instability or collapse in the banking industry or economy

Question 30

why is the banking sector open to systemic risk

Answer 30

due to the interbank lending market and how closely the banks are connected

Question 31

real life examples of systemic risk

Answer 31

Credit Crunch in 2008 - Lehman’s Brother’s first collapsed which caused multiple other banks to be bailed out.

Question 32

what is the purpose of the financial conduct authority

Answer 32

• they are not a part of the Bank of England
• responsible for protecting consumers from market failure such as assymetric information between consumers and businesses

Question 33

how does asymmetric information occur in the financial markets

Answer 33

many financial products are very complicated and hard to understand - meaning when it is sold consumers do not know all the information that the firms know.

Question 33

what do insufficient liquidity make a bank vulnerable to

Answer 33

a run in the bank

Question 34

what does liquidity refer to?

Answer 34

how quickly a financial asset can be used to buy a good or service

Question 35

What’s the difference between m0 and m1

Answer 35

M1 is m0 (notes and coins) plus money held in bank accounts

Question 36

what is M2?

Answer 36

Everything in M0 including other deposits which aren’t accessible immediately but are within the next 30 days

Question 37

what is M3?

Answer 37

value of investments and assets which have significant restrictions on converting them into cash

Question 38

what is the role of financial markets?

Answer 38

• facilitate savings which can earn a return and keep money safe (they help to recycle savings into funds for investment that companies want to make)
• lend to businesses and individuals
• exchange of goods and services
• provide a market for equities

Question 39

what is the spot exchange rate?

Answer 39

the rate that you can purchase or sell currency right now

Question 40

how do banks increase the money supply in the economy?

Answer 40

by creating credit (lending money to consumers and firms which can then be injected into the economy)

Question 41

conflict with objectives of commercial banks

Answer 41

• if liquidity is high then the bank is safe and secure but is probs less profitable since it has lent out less for high returns