Financial Markets and Monetary policy Flashcards
what is a financial market
markets where buyers and sellers trade financial assets
what are intermediates
mediums for which financial transactions can take place
(banks, hedge funds)
what are the 2 types of financial markets and what goods/services are sold there
- Money Markets - assets that pay back in 1 year of less (very liquid) (interbank lending and borrowing)
- capital markets - assets with payback date >1 year
what are the 2 types of capital markets
Primary Capital markets - brand new bonds are issued through investment banks or other agency’s
Secondary capital markets - where new bonds and shares are resold
what are the two types of currency markets
Spot markets - buy currency at current exchange rate and get it delivered instantly
Futures markets - buy a currency in a given exchange rate and have it delivered in the future.
what is the point of future money markets
hedge against risk - investors can buy certain quantities at predetermined prices the have that delivered to them in the future therefore if the currency goes down in value you are protected
what are the 4 function of money
- medium of exchange (it is valuable to everyone)
- store of value (whilst inflation and deflation may affect its long run value money holds its value well)
- Measure of value
- Standard of deferred payment - allows medium for lenders and borrowers
what are the 3 characteristics of money
portable
divisible
trusted
differences between commodity money and fiat money
commodity money has intrinsic value as it is worth a certain amount of a good
fiat money relys on faith (it has no intrinsic value)
what is the money supply
the total money circulating in an economy
what are two measures of the money supply
- narrow - total amount of nots and coins and deposits in banks (liquid)
- broad - total amount of all assets with a maturity date of 5 years of less
what is near money
assets that arnt cash but can be quickly converted into cash (days/weeks)
-what is the fisher equation
-what does Q represent in the equation
- what factors do monetarists believe to be constant
- MV = PQ (total spending value = Value of what is sold)
-Q is real gdp
-V and Q therefore money supply only effects inflation
what reason do Monatarists give for V and Q being constant
-real gdp is relatively stable over time therefore Q is constant
- V will never change enough to influence prices
what is the argument that Keynesian economists use to combat the theory that v is constant
V is not fixed because of:
liquidity traps
anticipated deflation
confidence rates
why is the supply of money on a money market diagram vertical
the central bank control the supply of money
what 3 factors affect the supply of money
Reserve Requirement
Bank rate
Open market operations ( central bank buying and selling bonds)
what is a bond
A bond is a IOU, it guarantees the holder regular interest payments every year, the holder of the bond will get the value of that bond when it matures
what is the coupon rate, market price and nominal value
- coupon rate - the interest paid on the bond every year
- market price - the price at which a bond is resold at
- nominal value - how much a bond will pay back after its maturity date
how do you calculate the yield from a bond
coupon rate / market price x100
what is the money multiplier and its equation
- the amount of money a bank will add to the money supply from an initial deposit
1/reserve requirement
what is systematic risk
if an investment bank is merged with a commercial bank
- what is ring fencing
- when was the law on ring fencing passed in the uk
- investment banks seperate from commercial banks
2019
what is a banks balance sheet
record of all assets and liabilities and capital at any given point in time
what are assets on the balance sheet
anything the bank owns
what are liabilities on the balance sheet
anything the banks owes ( deposits and borrowing)
what is capital on the balance sheet
- shareholder funds and retained profit
- they are liabilities as shareholders take profit as dividends and take out funds.
what are the two types of bank failure
- liquidity crisis
- insolvency
what is a liquidity crisis
when short term assets are not enough to meet short term liabilities and there is a run on the bank
what is insolvency
when assets to no hold value therefore total assets < total liabilities
2 tools available to stop bank failure
- liquidity ratios
- reserve requirements
what are 3 consequences of bank failure
- deep financial crisis and recession
- bank bailouts ( cost to tax payer
- loss of trust in financial markets
what is the role of a central bank
- implement monetary policy
- lender of last resort
- regulate financial sysetm
why might a central bank not intervene in the case of insolvency
the central bank will only ensure individuals savings are protected by transferring them to another bank
2 points against the lender of last resort argument
- moral hazard - a risk is taken where the cost of that risk is born by a third party therefore banks may never hold sufficient liquidity
- regulatory capture - often bank of england employees used to work for commercial banks therefore commercial banks can influence for a better deal
what is financial market failure
- where financial market fail to allocate recourses at the socially optimum level of output
3 Types of financial market failures
- speculation and market bubbles
- negative externalities
- asymmetric information
what are the 3 causes of financial market failure
- excessive risk
- collusive activity
- deregulation
how does leverage deals create bubbles
leverage deals is when an investor will finance large asset purchase by borrowing therefore making end profit larger
- this large increase in demand ramps up prices above there intrinsic value therefore creates a bubble.
how does asymmetric information create a financial market failure
assymetric information leads to
- adverse selection - one party does not have full information
- moral hazard - burden of a decision shifted onto another party
this creates increased risk
4 things that the 2 regulatory bodys in the bank of england do to protect the financial system
FPC - financial policy committee
- provide emergency liquidity
- stress test
PRA - prudential regulation authority
- specify ratios (liquidity ratio)
-supervise banks on management of risk
what doe the FCA do (2 points)
financial conduct authority (government run)
- ensure legal and fair business conduct
- promote competition (deregulate)
name 4 types of financial market regulation
- reserve ratios
- maximum interest rates
- ring fencing
4 problems of financial market regulation
- moral hazard
- regulatory capture
- asymmetric information
- unintended consequences
what is the Basel recommendation for liquidity ratio and capital ratio
liquidity ration = short term assets/short term liabilities (100%) - prevents run on bank
capital ratio - capital/loans (8%) - prevents insolvency
3 evaluation points of financial market regulation
- balance needed between profitability and regulation
- equality vs efficiancy
- costs vs benifits
