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A Level Economics Year 2 > MACRO - financial markets > Flashcards

MACRO - financial markets Flashcards

1
Q

what is liquidity

A

how quickly assets can be turned into cash

Cash is the most liquid of all assets whereas houses/buildings are one of the most illiquid of all assets

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2
Q

what is a financial market defined as

A

normal market where buyers and sellers come together to exchange goods/services using money as a medium of exchange.

Where buyers and sellers trade services and assets that are monetary in nature

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3
Q

what is nominal value

A

how much the bond is available for at the issue

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4
Q

how much is a coupon

A

the fixed amount of money that is paid as interest at regular times

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5
Q

what is the yield

A

the rate of return in comparison to the value of the bond (coupon / market price * 100)

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6
Q

what is the maturity

A

the date when the bond will be paid back

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7
Q

what are the functions of money

A
  1. Medium of exchanges — workers accept payment in money to use to buy products
  2. Store of value — money retains value and can be spent at a later date (inflation erodes this value)
  3. Unit of account – money acts as a measure of value, consistent value in people’s minds
  4. Standard for deferred payments — allows payment/consumption to be separate (buy now, pay later) so requires a good store of value
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8
Q

characteristics of money

A
  • Acceptable by all
  • Portable
  • In limited supply and difficult to forge
  • Durable
  • Divisible
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9
Q

where is money stored in today’s economy

A
  • Cash (coins and notes) = has no intrinsic value, but is backed by law
  • Money in current accounts = electronic money that has been deposited in banks/building societies by people
  • Near monies = assets which can be turned into money fairly quickly, eg savings accounts where additional notice needs to be given to withdraw
  • Financial assets = assets not easy to turn into cash eg bonds
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10
Q

what is the difference between narrow and broad money

A
  • Narrow money is cash and current account money, sometimes called Mo
  • Broad money is narrow money plus near monies, sometimes called M4
  • Different types of money = different measure of money supply
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11
Q

two key reasons for financial markets

A
  1. Provide genuine financial services (credit, investments and insurance) to households, firms and the government
  2. To allow participants to speculate and make money
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12
Q

types of financial markets

A
  1. THE MONEY MARKET: short term borrowing and lending, treasury bills/commercial bills, inter-bank lending (LIBOR) – banks lend surplus cash reserves to each other every day
  2. THE CAPITAL MARKET: longer term loans (financing for individuals/businesses), bonds/shares
  3. THE FOREX MARKET: trading different currencies, mostly speculative rather than for international trade purposes
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13
Q

what are some financial services

A
  • Lending/saving – to consumers, businesses or governments
  • Facilitating payments between businesses and consumers or businesses and other businesses
  • Providing forward markets (creating guaranteed prices for commodities and currencies in the future)
  • Trading assets like equities (shares)
    insurance – protecting against future financial liabilities
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14
Q

examples of financial assets

A
  • Treasury/commercial bills
  • Bonds
  • Shares
  • Pensions
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15
Q

what are treasury/commercial bills and what is involved with them

A
  • Treasury bills are issued by the government and commercial bills are issued by big companies
  • investors or financial institutions buy them at a lower price with the guarantee that they will be brought back at a higher price
  • eg/ the government issues a treasury bill for £950 that it will buy back in 90 days for £1000
  • the return is £50/£950 * 100 = 5.3%
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16
Q

what is a bond

A

bond = long term loan available to companies (corporate bonds) and the government (gilts)

the bond is issued for the money that the company or government want to raise

17
Q

how do bonds work

A

an investor will buy the bond and then start receiving fixed amounts of money (interest)

18
Q

what is the relationship between market interest rates and bonds (+ example)

A

if market interest rates rise, bonds become less attractive as investors may be better off putting their money elsewhere (the bank)

bond prices fall when market interest rates rise

EG// bond issued for £1000 with never ending maturity and coupon rate of 5% per year. Owner will receive £50/year that they own it this it the coupon. After 5 years the market interest rates go up and the bonds market price comes down to £500. The yield = coupon rate / market price X 100. Yield = 1%

19
Q

what are shares

A
  • companies selling off part of their business to specific individuals they know or the wider public on the stock exchange
  • they decide how much of their company they want to give up and how much they want for each share
  • shares (like bonds) then get bought and sold on secondary markets, but this doesn’t add any more money to the business
20
Q

what are pensions and their importance

A
  • savings account that pays an income from retirement until you die
  • individuals pay into pension funds throughout their working life and receive benefits when they stop working, probably most important investment you will make
  • pension companies have to invest peoples money so that they will be able to keep paying those people until they die
21
Q

where do businesses get finance from to find capital/labour investment

A
  • Their own savings (retained profit and good/bad points)
  • Loan from the banks increasing their debt (good/bad points)
  • Sell some equity (shares in the business) this may be privately to a specific investor or publicly on the stock exchange (floatation and good/bad points)
  • Issuing a corporate bond – investors can lend the company money and it promises to pay them a fixed amount for a fixed period of time
22
Q

what are examples of financial institutions

A
  1. Commercial/ retail banks. Aimed at individuals and businesses, pay interest out on deposits and charge interest on loans, also facilitate payments
  2. Investment banks. Trade in financial assets, typically work with other banks, not individuals, assist in mergers and floatations (when a business joins the stock exchange)
  3. Saving vehicles. Pension funds, investment houses, hedge funds
  4. Insurance companies
  5. Not one company may fulfil a number of these roles
23
Q

commercial bank function

A

Key function is to make profit for its stakeholders (different to Bank of England)

however, they also need to ensure that they are financially secure and manage their liquidity.

Sometimes these objectives may be in conflict with each other, eg a bank that aims to increase profit by taking on riskier assets like loans will find that their overall liquidity will get worse

24
Q

how do commercial banks work

A
  • Individuals and businesses deposit money at commercial banks
  • Commercial banks use that money and create additional credit (electronic money) which they can lend out to individuals and businesses these loans are sometimes called ‘advances’
  • They can only do this if they have at least some physical cash to base it on
  • As little as 1% of all money is now physical
25
Q

what is a commercial bank balance sheet

A

Balance sheet shows the value of all things a business owns (assets) and the value of all things a business owes to others (liabilities)

  • To stay secure a bank must ensure its assets are more than its liabilities
  • Some assets are liquid (turned to cash quickly) and some are illiquid (take longer to turn to cash or may lose value if they do)
26
Q

what is liquidity ratio

A

compares the more liquid assets in a bank to the short-term liabilities (current accounts and quick-access savings accounts) the higher liquidity ratio, the easier a bank can cover a ‘run on bank’

27
Q

what is the capital ratio

A

compares all of the banks assets to all of its liabilities

28
Q

how do capital/liquidity ratios impact commercial bank performance

A

A bank will want profit to be high and their share price to increase
If either of these ratios go negative then the bank faces going bust or insolvent

29
Q

what are problems created in the financial market that cause market failure

A

—> Asymmetric information – financial institutions have more knowledge than their customers
—> Moral hazard – investment bankers can take large risks with investments but are aware that they will personally bear very little of the risk. As a result, they may be inclined to act in a riskier way than is appropriate
—> Systemic risk – as the banks are inter-related and operate across multiple financial markets, there is a risk that if one of the banks fail they will all fail
—> Speculation and bubbles – speculation is rife in financial markets and this can cause market bubbles where prices go excessively high and these burst
—> Negative externalities, impacts of actions in the financial markets may negatively impact on others

30
Q

what is the key job of the bank of england

A

Central banks act as a ‘lender of last resort’ due to systematic risk, if an individual bank finds itself with a bad liquidity ratio or capital ratio, the bank may act to ensure insolvency doesn’t occur, adding to moral hazard?

31
Q

how can the financial system be regulated

A
  • Fine banks that behave inappropriately – PPI scandal, LIBOR scandal in the UK, this is controlled by Financial Conduct Authority (FCA)
  • Set maximum interest rates – aimed at payday lenders. In the UK, this is controlled by the Financial Policy Committee at the Bank of England
  • Set minimum liquidity/capital ratios – limits the risk that commercial banks can take. In the UK, this is controlled by the Prudential Regulation Authority (PRA) part of the Bank of England
  • intervene in the composition of banks, reducing the systemic risk in the system. In the UK, this is also controlled by the FCA
32
Q

what organisations help regulation of the financial system

A

the main job of the PRA, FPC and FCA is to promote stability in the financial system

stability of financial markets helps with business investment and also promotes FDI

A Level Economics Year 2 (15 decks)

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