Financial Markets Flashcards
What are the 6 characteristics of money?
- acceptable
- portable
- durable
- divisible
- limited
- difficult to forge
What is the way of remembering the six characteristics of money?
Do Dragons Accept People Like Dave
What are the 4 key functions of money?
- medium of exchange
- store of value
- unit of account
- standard of deferred payment
What is meant by money being a medium of exchange?
money allows goods and services to be traded without the need for a barter system
What do barter systems rely on?
a double coincidence of wants
What is meant by money being a store of value?
its value can be retrieved at a later date (means people can save now to fund spending at a later date)
What is meant by money being a unit of account?
it means that the value of something can be expressed in an understandable way, and in a way that allows the value of items to be compared
What is the way of remembering the 4 functions of money?
Some Minions Use Swords
What is meant by money being a standard of deferred payment?
this refers to the expressing of the value of a debt
What is the money supply?
the total amount of money circulating in the economy
Define narrow money
refers to any physical money, demand deposits, and other liquid assets that are easily accessible to central banks
Define broad money
a category for measuring the amount of money circulating in an economy
What is a bond?
a fixed interest loan security
Define an asset
any resources owned by a business that can be used to produce positive economic value
What is a coupon?
the amount of money that is paid periodically, such as each year, as interest on a bond
What is the yield for a bond?
the rate of return on the bond if held to maturity
What is meant by equity in a company?
the value of the assets owned by the shareholders
Define liquidity
the degree to which an asset can be converted into money without capital loss and within a short space of time
Define the liquidity ratio
the ratio of a bank’s cash and other liquid assets, to its deposits
Define the capital ratio
the amount of capital as a proportion of its total assets (loans)
Define regulatory capture
when a regulatory agency, formed to act in the public’s interest, eventually acts in ways that benefit the industry it is supposed to be regulating, rather than the public
What are capital markets?
financial markets which provide long-term borrowing and lending, usually defined as over one year
Define a commercial bank
a bank that provides services to businesses
Define a financial market
any convenient set of arrangements where buyers and sellers can buy or trade a range of services or assets that are fundamentally monetary in nature
Give 3 financial markets that investment banks engage a range of activities in
- foreign exchange market
- money market
- capital market
- derivatives market
What is shadow banking?
parts of the financial market that are either much less regulated than the norm, or are completely unregulated
What is systemic risk?
(in the context of financial markets) the danger that failure of parts of the financial system will lead to the collapse of the whole financial system
What does FPC stand for?
Financial Policy Committee
What is the Financial Policy Committee a part of?
the Bank of England
What is the role of the Financial Policy Committee?
to identify, monitor, and take action to reduce or remove systemic risk in the UK financial system
What does PRA stand for?
Prudential Regulation Authority
What is the Prudential Regulation Authority a part of?
the Bank of England
What is the Prudential Regulation Authority responsible for?
the microprudential regulation and supervision of banks, building societies, insurers and other financial institutions
What does FCA stand for?
Financial Conduct Authority
What is the Financial Conduct Authority responsible for?
macroprudential regulation and ensuring the financial industry is run with integrity
Define financial regulation
limiting the freedom of banks and other financial institutions (in order to maintain stability and integrity within the financial institution)
When does moral hazard exist?
when a firm or individual pursues profit and takes on too much risk in the knowledge that, if things go wrong, someone else will bear a significant proportion of the cost
What is meant by insolvent?
when the value of a bank’s assets falls below the level of its liabilities
What is a balance sheet?
a statement of the assets, liabilities, and capital of a business or other organisation at a particular point in time
What is the equation for equity?
assets - liabilities
How is the net worth of a business calculated?
assets - liabilities
Define a credit crunch
a sharp drop in confidence and thus a lack of credit
Define the money market
financial markets that provide short-term borrowing and lending, usually defined as up to one year
What is meant by a security?
secured loans, such as mortgage loans secured against the value of property
Which are more risky: secured loans or unsecured loans?
unsecured loans
What are the two sections of the capital market?
- primary market
- secondary market
What is the difference between the primary market and the secondary market?
- the primary market is where securities are created
- the secondary market is where the securities are traded
What is the fundamental role of the financial markets?
to ensure the smooth operation of capitalist economies
What are the two sections of the foreign exchange market?
- spot market
- forward market
What is the difference between the spot market and the forward market?
- the spot market involves the immediate exchange of foreign currencies
- the forward market involves the exchange of foreign currencies at some specified time in the future
What is the foreign exchange market?
the market in which different currencies are bought and sold
What is credit?
a form of deferred payment
What is the 2 main objectives of a commercial bank?
- to profit maximise
- to respond to shareholders
In relation to borrowing and lending, how does a commercial bank aim to profit maximise?
- borrow short term
- lend long term
What is bank failure?
where a bank cannot meet its financial obligations to creditors and/or depositors
Give 2 consequences of bank failure
- systemic risk - effects rest of the financial system
- recession - loss of jobs, income, output, etc
Give 2 ways a bank can prevent bank failure
- have enough liquidity to avoid a bank run
- have security to manage risk and avoid insolvency
- have a balanced portfolio of assets to mitigate risks that arise from a fall in one area
What is a bank run?
when many clients simultaneously withdraw their money from a bank
Why is a bank run likely to happen?
because clients have a lack of confidence in the bank’s ability to function (presently or in the near future)
How does a commercial bank make a profit?
they ensure they charge a higher rate of interest on loans than they pay on deposits
What is meant by share capital?
all the funds raised by a company in exchange for shares
How do banks create credit?
by giving loans to their customers
What are stress tests used for?
used to measure the extent to which financial institutions are vulnerable to the effects of extreme economic events
What is the purpose of stress tests?
to lower systemic risk
Give 3 ways in which a firm could raise finance
- issuing shared
- issuing corporate bonds
- borrowing from a bank
Define debt
the amount of money borrowed from one party to another
What is the main risk that arises from commercial banks borrowing short-term and lending long-term?
Liquidity risk
What is liquidity risk?
when a commercial bank may not be able to repay all of their deposits if savers decide to withdraw their funds
Give 2 ways that a commercial bank reduce liquidity risk?
- attract long-term deposits
- hold some liquid assets as capital reserves
Give 3 points that argue against financial market regulation
- moral hazard
- regulatory capture
- high administration and enforcement costs
Explain why financial market regulation may lead to greater moral hazard
- interventions such as bank bailouts may cause commercial bankers to take more risks
- as they know if the risks go bad, it is the third party (BoE, taxpayers) that have to bail the banks out
Explain why regulatory capture is likely to occur as a result of financial market regulation
- as the best regulators are usually the ones who have previously worked in the banking industry
- but they may still have close relationships to CEOs and managers still in the industry
What would it be called if the administration and enforcement costs of financial market regulation exceed to benefits?
government failure
What are the 3 functions of a central bank?
- monetary policy function
- financial stability and regulatory function
- policy operation functions
What are the two sections of the ‘policy operation function’ for a central bank?
- lender of last resort to the banking system
- banker to the government
What is another term for the bank rate?
the base rate (of interest)
