Financial markets

Question 1

Functions of money

Answer 1

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

Question 2

Money supply

Answer 2

• Notes and coins
  > Notes and coins in circulation outside the BoE
• M0
  > Notes and coins plus central bank reserves
• M2
  > Notes and coins in circulation + All retail bank and building society deposits
• M4
  > M0 + retail and wholesale deposits in banks and building societies + certificates of deposits

Question 3

Characteristics of money

Answer 3

• Durable
• Portable
• Divisible
• Scarcity
• Acceptability
• Uniformity hard to counterfeit

Question 4

Narrow money

Answer 4

• The narrow money definition of the money supply is a measure of the value of the coins and notes in circulation and other money equivalents that are easily convertible into cash such as short term deposits in the banking system

Question 5

Broad money

Answer 5

• Broad money is a measure of the total amount of money held by households and companies in the economy
• Broad money is made up of mainly commercial bank deposits - which are essentially IOU’s from commercial banks to households and companies

Question 6

Factors affecting the supply of money

Answer 6

• Open market operation
  . The is the same as QEasing. The central bank buys government bonds effectively creating money
• The reserve requirements imposed on banks
  > This is the % of deposits made by customers at the bank of England that the bank must keep hold off rather than lending it out
• The base rate set by the BoE
  > The rate of interest will influences how many households and businesses are willing and able to borrow

Question 7

Factors affecting the demand for money

Answer 7

• The rate of interest on loans
• Income
  > The number and value of monetary transactions that we expect to carry out
  > Changes in GDP
• The extent to which we also want to hold other financial assets,such as bonds, property, savings - the speculative motive for holding the money
• The number of financial instruments available
• The extent to which we might have to pay out large unexpected payments
• The rate of anticipated inflation

Question 8

The importance of current yield for government borrowing

Answer 8

• There are millions of bonds available to buy in the open secondary
• Investors can always buy almost unlimited amounts
• The bonds they buy will always pay the current yield
• If the government wants to borrow more money by issuing more government bonds then it must at least match the current yield available from existing bonds
• Therefore the bond market tells the government what interest rate it can borrow at
• Central banks set the base rate but the bond market sets the rate at which governments can borrow

Question 9

The role of the the financial market

Answer 9

• Financial markets play a facilitating role in the markets economy acting as the oil in the engine to keep the parts moving
  > Savings
  > Lending
  > Transaction services - electronic and cheque Characteristics payments
  > Facilitating the raising of capital - through debt or equity
  > Insurance
  > Pricing risks - “wisdom of the crowd”