MACRO - financial markets Flashcards
what is liquidity
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
what is a financial market defined as
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
what is nominal value
how much the bond is available for at the issue
how much is a coupon
the fixed amount of money that is paid as interest at regular times
what is the yield
the rate of return in comparison to the value of the bond (coupon / market price * 100)
what is the maturity
the date when the bond will be paid back
what are the functions of money
- Medium of exchanges — workers accept payment in money to use to buy products
- Store of value — money retains value and can be spent at a later date (inflation erodes this value)
- Unit of account – money acts as a measure of value, consistent value in people’s minds
- Standard for deferred payments — allows payment/consumption to be separate (buy now, pay later) so requires a good store of value
characteristics of money
- Acceptable by all
- Portable
- In limited supply and difficult to forge
- Durable
- Divisible
where is money stored in today’s economy
- 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
what is the difference between narrow and broad money
- 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
two key reasons for financial markets
- Provide genuine financial services (credit, investments and insurance) to households, firms and the government
- To allow participants to speculate and make money
types of financial markets
- 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
- THE CAPITAL MARKET: longer term loans (financing for individuals/businesses), bonds/shares
- THE FOREX MARKET: trading different currencies, mostly speculative rather than for international trade purposes
what are some financial services
- 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
examples of financial assets
- Treasury/commercial bills
- Bonds
- Shares
- Pensions
what are treasury/commercial bills and what is involved with them
- 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%
what is a bond
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
how do bonds work
an investor will buy the bond and then start receiving fixed amounts of money (interest)
what is the relationship between market interest rates and bonds (+ example)
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%
what are shares
- 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
what are pensions and their importance
- 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
where do businesses get finance from to find capital/labour investment
- 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
what are examples of financial institutions
- Commercial/ retail banks. Aimed at individuals and businesses, pay interest out on deposits and charge interest on loans, also facilitate payments
- 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)
- Saving vehicles. Pension funds, investment houses, hedge funds
- Insurance companies
- Not one company may fulfil a number of these roles
commercial bank function
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
how do commercial banks work
- 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
