Financial Sector Flashcards
Define financial market
Any exchange that facilitates the trading of financial instruments such as bonds, foreign exchange or commodities such as oil and gas.
5 roles of the financial markets
- Facilitate savings by households and businesses
- Lend to businesses and individuals
- Facilitate the final exchange of goods and services
- Provide forward markets in currencies and commodities
- Provide a market for equities
Savings
Lending
Exchange
Forward markets
Equity
Main types of financial markets
- Money market - short term loan finance (money loans from financial institutions)
- Capital market (stocks, shares, bonds/ government bonds) long terms
- Foreign exchange market (FOREX) (trading foreign currencies - foreign exchange)
Formula of yield
Y = interest/price
Types of Forwards markets
- Currency forward market (locks in exchange rate of a currency by “hedging”
- Commodity forward market (locks in a price for, usually a raw material to be exchanged between buyers and sellers)
How a financial market connects lenders and borrowers
Lenders (savers and investors) -> lend their money to financial markets -> which borrowers (individuals, firms, government) would borrow form them.
Lenders will receive their return from intermediaries (commercial banks, pension funds, mutual funds) or (investment banks, hedge funds).
Intermediaries will set an interest rate, which borrowers will pay, for the return for the lenders.
Characteristic of money
Durability
Portability
Divisibility
Acceptability
Hard to counterfeit
Valuable
Medium of exchange
Unit of account
Store of value
Deferred payment
Types of money in the money supply
Broad money (measure of total money held by households and companies in the economy)
Narrow money (measure of the value coins and notes in circulation and other money equivalents that are easily convertible into cash such as short-term savings deposits in the banking system)
Main functions of a commercial bank
Provide retail banking services to households and businesses
Deposit-takers proving savings account
Lend money and create money
Relies charging a higher interest rate on loans than the rate of paid on deposits
Profit-seeking businesses
“Spread” on their assets and liabilities is used to pay operating expenses of a bank and make profit
How do commercial banks make profit
- Interest-rate spreads
- Service fees
- Brokerage percentage
Functions of a investment bank
- Provides specialised services for companies and large investors
- Underwriting and advising on security issues
- Advise on mergers, acquisitions and corporate restructuring
- Trading on capital market
Corporate research and private equity investments - Trades and invests on its own account
How do banks fail?
- “Run” on the banks - bank faces liquidity crisis (savings lent out, not enough liquidity to give savers their funds) from depositors confidence drops, withdrawal money
- Credit crunch - banks fear of not paid back
- High loses from bad debts - loan default rate may rise in recession as borrowers struggle to make loan repayments. Credit rate falls and share price falls
Definition Financial market failure
When a market fails to allocate scarce resources in an efficient and/or equitable way leading to a loss of economic and social welfare.
Types of market failure
- Externalities from financial instability (caused by banks, bailed by government using taxpayer money)
- Monopoly power in financial markets (ability of business to set price above a level that would exist in a highly competitive market)
- Market rigging (company in market act to stop market from working as it should to give themselves an unfair advantage and gain)
- Speculative bubbles and irrational behaviour (when market price is driven above what it should be due to herding behaviours of consumers/ investors in financial markets)
- Moral hazard and attitudes to risking taking (state bailouts of failing banks, bank taking most of the risk knowing government will bail them)
- Asymmetric information and complexity (insider information in stock markets, bank knows less than a debtor)
