LS13- Role of Financial Markets

Question 1

What are the role of financial markets?

5 points

Answer 1

• to facilitate saving
• to lend to businesses and individuals
• to provide a means by which goods and services can be bought and sold easily by providing a flat currency
• to provide forward markets in currencies and commodities
• to provide a market in which shares and bonds can be traded to facilitate raising of company finances (equities)

Question 2

To facilitate saving by businesses and individuals

Answer 2

• Offering a secure place to store money and earn interest

Question 3

Financial markets

Answer 3

• Any place where buyers and sellers meet to trade financial assets
• Can be online or in person

Question 4

Forward/futures markets

Answer 4

• When a buyer and seller can trade a financial asset at a future date, at a specified price
• Usually for trading currencies

Question 5

How forward markets provide greater certainty to firms (that trade with other firms) and/or consumers that use a different currency

Answer 5

• price of a foreign currency is agreed upon so firms can budget and make decisions
• prices are more likely to be stable for consumers
• enables firms to reduce risk/uncertainty since firms can be certain about the cost of their imports in pounds

Question 6

Why the rate of interest on saving and borrowing has to differ for commercial banking

Answer 6

• need the return paid to savers to be lower than the interest paid by borrowers in order to be profitable

Question 7

How financial markets allow for increased consumption in an economy

Answer 7

• They provide credit and transaction services

Question 8

Why companies rely on stock markets and bond markets to finance investment

Answer 8

• Providing a market for equities or issuing bonds allows companies/governments to raise large amounts of capital quickly, which is useful for expansion and R&D

Question 9

Why governments rely on bond markets to finance investment

Answer 9

• when there’s a shortfall in tax revenue, bonds can be used to fuel economic growth and development

Question 10

Credit risk for commercial banks

Answer 10

• The risk of lending to borrowers who may default on their payments
• Can be controlled by research into the creditworthiness of borrowers and by banks having sufficient capital in reserve
• Minimum capital reserves may be imposed by financial authorities
• Most banks have increased their capital reserves since the financial crisis

Question 11

Examples of barriers to entry into commercial banking

Answer 11

• Regulatory barriers/red tape e.g. banking license by the central banks
• Costs e.g. marketing, building reliable IT systems
• Brand loyalty