financial markets Flashcards
what is a liability
things which people or organisations owe
what is an asset
things which people or organisations own
what are the functions of money?
- 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)
what is narrow money
cash (notes and coins) along with bank deposits with the Bank of England
what is broad money
cash and instant access bank and building society deposits along with less liquid assets such as some short-dated bonds
what is the money market used for?
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
what are capital markets used for?
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
what does equity mean in financial terms?
wealth
when will the price of shares go up on the stock market?
When demand exceeds supply- usually when a firm is expected to make high profits in the near future
what are corporate bonds?
debt security issued by a company and sold to individuals or financial institutions who lend long-term to the company
what are yields?
the return an investor expects to receive each year over its term to maturity.
relationship between price of bond and yield of bond
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
equation for bonds
market price = (coupon ➗yield) x100
what are the main functions of the Bank of England
- 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)
what are commercial banks
retail and high street banks in the UK that deal with members of the public and most small and medium sized businesses
what do commercial banks do?
- accept deposits from the general public
- create deposits which re lent to customers who wish to borrow
how do banks make profit?
charging for services and charging borrowers a higher rate of interest than they pay savers for their deposits
what do investment banks do?
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
problems of investment banks
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
what is the credit multiplier
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
effect of reserve requirement on money multiplier
the smaller the money multiplier the bigger the money multiplier
equation for total bank deposits
total bank deposits = initial deposit ➗reserve requirement
what would be the effect of a collapse in the banking sector on the wider economy?
there would be a massive collapse in aggregate demand and a huge recession
what is financial regulation?
imposing rules and sometimes laws which limit the freedom of banks and other financial regulations
examples of financial regulation
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)
what is a bank’s capital
money the shareholders have put in and any retained profit
what do the monetary policy committee do?
responsible for implementing monetary policy to influence bank lending and consequently the money supply and AD via the transmission mechanism
what do the financial policy committee do?
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)
what is systemic risk
the possibility that an event at one bank could trigger instability or collapse in the banking industry or economy
why is the banking sector open to systemic risk
due to the interbank lending market and how closely the banks are connected
real life examples of systemic risk
Credit Crunch in 2008 - Lehman’s Brother’s first collapsed which caused multiple other banks to be bailed out.
what is the purpose of the financial conduct authority
- 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
how does asymmetric information occur in the financial markets
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.
what do insufficient liquidity make a bank vulnerable to
a run in the bank
what does liquidity refer to?
how quickly a financial asset can be used to buy a good or service
What’s the difference between m0 and m1
M1 is m0 (notes and coins) plus money held in bank accounts
what is M2?
Everything in M0 including other deposits which aren’t accessible immediately but are within the next 30 days
what is M3?
value of investments and assets which have significant restrictions on converting them into cash
what is the role of financial markets?
- 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
what is the spot exchange rate?
the rate that you can purchase or sell currency right now
how do banks increase the money supply in the economy?
by creating credit (lending money to consumers and firms which can then be injected into the economy)
conflict with objectives of commercial banks
- 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
