Financial Markets Flashcards
(22 cards)
Functions of money
Medium of exchange
Unit of account
Store of value
Standard of deferred payment
Characteristics of money
Acceptable
Durable
Potable
Divisible
Scarce
Difficult to forge
Types of money
Narrow money
Consists of notes and coins, any balances that can be immediately used as a medium of exchange
Broad money
A measure of the money supply that includes notes,coins as well as most bank balances held by banks and other financial institutions
Financial markets
Markets that enable transfers between those that wish to deposit funds and those looking to borrow funds
Money market
The market which deals in short term finance between firms, individuals and governments
Focusing on debts which are due to be repaid in the near future
Capital market
The market which deals with the medium term and long term finance
Such as share and bond issues
Between individuals,firms and governments-focusing on debts due for repayment more than a few months ahead
Foreign exchange market
The market that deals with transactions requiring conversion from one currency into another currency
Treasury bill
A very short term form of borrowing by the government, usually repaid within three months
Bonds
A form of borrowing which gives the holder a fixed rate of interest and the money is repaid within a set period of time- bonds can be traded
Coupon-the (fixed) interest interest on a bond
Maturity date- the date of repayment for a bond
Shares
Issued by firms raising finance-these give the holder the Chance to receive dividends out of the firms profits and often allow the holder to vote in the company affairs
These are not repaid by the firm
Debt v equity
I Equity- the value of share capital issued by firms as part of their financial capital (shares in a firm) stocks and trading
More risky greater returns- more volatile market
Debt- investments in debt securities (e.g. Bonds)
Less risky so lower returns
Calculating yields on bonds
Inverse relationship between binds and interest rate rates
Yield is the interest paid as a percentage of the bonds current price in the capital market
Yield%=the coupon/the market price x 100
Commercial/retail banks
Commercial- accepts deposits from and lends money to businesses
Retail - same as commercial but for individuals
Functions:
Accepting deposits
Lending to economic agents
Providing an efficient means of payment
Objectives:
Liquidity
Profitability
Security
Conflicts between liquidity and profit as firms will lend riskier long term ventures which will be elsewhere when the bank may need it
Investment banks
A bank that does not accept customer deposits and normally provides financial services to other businesses such as arranging share or debenture issues
Assist governments with share issues of the privatisation of state owned enterprises
Also buy and sell securities in the secondary capital market, as well as buying and selling in the foreign exchange markets
Securities will be carried out to generate returns for investment banks
But also for private investors looking for someone to buy and sell on their behalf
Assets and liabilities of a commercial bank
Assets represent sources available for use often presented in order of liquidity
Most liquid to least liquid assets:
- Notes,coins and balances held at the BofE
- Money borrowed from banks to meet short term needs
- Investments- normally bonds or shares
- Advances- loans SR(overdraft) LR(mortgage)
- Tangible non current assets - physical assets (headquarters or branches)
Liabilities:
What banks owe to individuals and groups
-Share capital-sell shares to raise revenue but need to pay profits to shareholders
-reserves- profits used in the business to generate growth instead of being paid to shareholders
-long term borrowing- money borrowed from the money markets and mainly serves to provide liquidity for any shortfall in cash needs
-deposits- accounts open and maintained by banks customers
Sight deposits- (can be accessed immediately)
Time deposits- (require a period of time before they can be accessed)
Credit creation
Bank knows customers are unlikely to withdraw their full balances
They can create credit lending by lending out their customers money and making profit off of the interest
Fractional banking- the ability for a bank to hold a small amount of the their customers deposits at any time, thus allowing them to lend out money and earn Interest
However “run on the bank” - occurs when all of a banks customers withdraw their deposits and a bank may not have enough money to meet the demand
Regulation of financial system
Prudential regulation authority
Supervision of banks, building societies,credit unions,insurers and major investment firms
Wants to achieve financial stability by making sure the banks are managed properly
Financial conduct authority
Aims to protect consumers and ensure healthy competition between firms
Charging a fee to financial institutions
Can also investigaste into an industry
Financial policy committee
Identify,monitor and take action to avoid systematic risks
And to take action to make the financial system more robust
Why banks fail
If they have insufficient capital, at risk in a fall in false of their assets.
This may occur if a number of loans made by a bank fail to be repaid
Insufficient liquid assets make a bank vulnerable to a run on the bank
The BofE are a lender of last resort and provides liquidity insurance
However this leads to moral hazard
Where on firm takes on too much risk,knowing that if the risk fails, someone else will cover the costs of the failed risk
As in this instance banks will take on risks as they feel the BofE will support them if they run short of cash
Liquidity and capital ratios
Liquidity ratios :
Cash or reserve ratios
Is the requirement for banks to hold a specific amount of their deposits in the form of cash
The higher the ratio the less the bank can lend out and less able It is to create credit
Capital ratio:
A ratio of A banks equity to the amount of lending made by the bank
It’s believed that specifying a ratio will stop a bank from building up a large number of amounts lent compared to its permanent capital
A higher ratio means a bank can lend a smaller proportion compared with its capital base
Systematic risk
A risk that applies to a whole sector e.g. Banking sector
E.g. Financial crisis
Issues with regulation
Restricts economic activity - harder to lend
May divert financial services industry to output to other countries with jobs being lost
Regulation requires time and money to plan,implement and monitor
Any penalties will need to be used as to maintain the regulations credibility
Unintended consequences are likely-e.g. Development of a shadow banking sector
Regulation
PRA- supervision of financial institutions
FPC- systematic risks
FCA- charging financial institutions fees to promote healthy competition separate from government
