Mod 4 Flashcards
4.1 What are Financial Intermediaries?
Banks
4.1 What is the role of financial intermerdiaries?
Provide returns to savers who have excess funds by allowing borrowers who need additional money to take money for a period of time and attempt to generate a return, which is paid as interest to the bank, interest is paid to savers for leaving money in the financial intermediaries.
4.1 What is the role of Financial markets?
- Facilitate the transformation of savings into investments - this builds the stock of capital in the economy, pushing out PPC.
- Enable “deferred consumption” by holding savings for households - long-term purchases e.g. a car/house/retirement can be saved for without burying bags of gold in your backyard.
4.1 What is deferred consumption?
Consumers use portion of their income to save for larger purchases - saving now to consume larger amounts later
4.1 What is FOREX?
Foreign Exchange Market
4.1 What is the role of FOREX?
A market where you can buy and sell foreign currency
4.1 How is FOREX related to supply and demand?
The price of one currency relative to another depends on the demand and supply of each currency.
4.1 How is trading in FOREX market described?
Trading in this market is considered high-risk as it is complex, unpredictable, and subject to volatility.
4.1 What is The Debt Market?
Bonds, Consumer Credit, Housing Loans, Business Loans, and Short Term Money Market.
4.1 What are bonds?
When you buy a bond you buy an “IOU” – at the maturity of the bond you will get the full amount back. You also get small regular “coupon” payments in exchange for giving up your money for that time. They are typically issued by governments as a way of raising money.
4.1 What is Consumer Credit?
Short-term loans to consumers to fund purchases, weddings, holidays, etc. Generally high interest.
4.1 What are Housing Loans?
Long-term loans (e.g. 10 years) repaid in instalments with interest. Interest is generally low because the loan is “secured” by the house.
4.1 What are Business Loans?
Loans given to businesses, short or long term, generally with higher interest than housing loans as there is higher risk to the bank of not being repaid.
4.1 What is the Short Term Money Market?
Banks lending to each other and the RBA overnight.
4.1 What is the Derivative Market?
Making a prediction based on whether the price of something will go up or down in a futures of options contract.
4.1 What is a Futures contract?
A small brokerage fee to enter a futures contract to buy shares/the commodity tomorrow at a certain price. If the shares trade tomorrow for under the price, you will be the fool paying extra per share – but if the shares trade for over the price, you could re-sell them instantly for profit
4.1 What is an options contract?
A large upfront premium to buy a certain amount of “options”. If the share price tomorrow trades for under the price, you choose not to exercise your option. Your only loss is your premium. If it trades for over the price, you can make a profit per share like with the futures (but it is less profitable because of the large premium)
4.1 What is a share?
A share is a financial asset which represents ownership of part of a business or company
4.1 Where do share market transactions occur?
Share market transactions occur on the digital stock exchange through a registered broker. In Australia this is predominately the Australian Securities Exchange (ASX).
4.1 How do you list on the share market?
To list on the share market you must be an incorporated Publicly Listed Company.
4.1 What are primary financial markets?
Where new financial products (securities) are offered for the first time, e.g. an initial public offering.
4.1 What is a dividend?
A dividend is a distribution of earnings, often quarterly, by a company to its shareholders in the form of cash or stock reinvestment.
4.1 What are Secondary Financial Markets?
Where existing financial products (securities) are traded after their initial sale.
If shareholders sell their shares for more than they bought them for, they make “capital gains”. If the price is lower, they have make “capital losses”.
4.1 What is movement in the share market?
Much of the movement in the share market is due to speculation (buying and selling with the hope of making capital gains) .
4.1 How do share prices affect allocation of resources?
Artificially high or low share prices can lead to misallocation of scarce economic resources.
4.1 How are domestic markets and global markets linked?
Global conditions affect domestic confidence and expectations of the future.
Improved technology has led to lower costs and increased reliability for trading.
Australia is seen as a relatively attractive place for foreign investment.
4.1 What is a factor market?
Market for the factors of production (land, labour, enterprise, capital).
4.1 What is a product market?
Markets for the outputs of the production process (goods and services).
4.1 Are Financial Markets Factor or Product markets?
Product Market
4.2 What are the four Financial Regulatory Bodies?
Australian Securities and Investments Commission (ASIC)
Reserve Bank Of Australia (RBA)
Australian Treasury
Australian Prudential Regulation Authority (APRA)
4.2 What is the Australian Treasury?
The Treasury Department is a department of state. It is part of the executive government. It works to the government of the day, whatever the political persuasion of the government of the day.
4.2 What does the Australian Treasury do?
Provides advice to government on budgets, taxes, expenditure, and policy.
4.2 What is the APRA?
Oversees and writes legislation for ADIs (Authorised Deposit Taking Institutions) (e.g. Commercial/Retail Banks, CUBS) .
4.2 What does the APRA do?
When an ADI is in hot water, the APRA has special powers to intervene in order to ensure that deposit-holders receive as much of their money back as possible. The Australian Government (through APRA) has a deposit guarantee of funds up to $250k per person per ADI.
4.2 What is the ASIC?
Monitors, investigates, and intervenes in financial markets
4.2 What does the ASIC do?
Protecting consumers from scams and other unconscionable conduct.
Regulating offences such as insider trading and stopping the creation of unethical investment products.
Educating the public about all things finance.
4.2 What is the RBA?
Objectives of RBA are to
a) stability of Aust currency
b) full employment
c) economic prosperity.
4.2 What does the RBA do?
Sets Monetary Policy
Produces and Distributes Banknotes
Banker for the Australian Government
Operates Australia’s Payment System
Financial Stability
Manages Australia’s Foreign Exchange Reserves
4.3 What are money markets?
The money market refers to trading in very short-term debt investments. It involves continuous large-volume trades between institutions and traders.
4.3 What are Loanable funds?
Money available for borrowing.
4.3 Who are consumers of loanable funds?
The borrowers – they are demanding loans
4.3 Who are producers of loanable funds?
Lenders - banks and financial institutions.
4.3 What is the ‘price of money’?
Rate of interest
4.3 How can we represent market for loanable funds?
A supply and demand curve where Price us the rate of interest and the quantity is the quantity of loanable funds.
4.3 What the sectors of the economy that borrow funds?
Individuals (household sector)
Business Sector
Government Sector
4.3 When do individual consumers borrow funds?
Consumers borrow when their demand for goods and services exceeds their current capacity to pay.
4.3 When do the Business Sector
borrow funds?
Businesses borrow for R&D, to fund their start-up, to expand production, to smooth fluctuations in cash flow .
4.3 When do the Government Sector borrow funds?
Government expenditure may outpace government revenue. Governments borrow to pay for deficit spending.
4.3 What is liquidity?
The ease in which a financial asset is turned into ‘liquid’ money.
4.3 Why hold/borrow money?
Speculative, precautionary, or transaction motives.
4.3 What is a speculative motive?
This is to allow the quick purchase of assets to chase capital gain.
4.3 What is a precautionary motive?
Emergency funds for unpredictable circumstances.
4.3 What is a transaction motive?
This is the requirement to have easy access to funds to cover daily transactions or purchases.
4.3 How do interest rates affect demand for loanable funds?
As interest rates decrease, demand for money by individuals, businesses, and governments expands.
4.3 What are the 4 key sectors that lend funds?
Individuals
Businesses
Governments
International
4.3 How do individuals supply funds?
Saving deposits (actual deposit-in-the-bank-savings) are used by banks as a source of loanable funds.
4.3 How do businesses supply funds?
If they are profitable and decide to deposit their excess operating funds.
4.3 How do governments supply funds?
That are running a budget surplus can either deposit funds or pay back debt.
4.3 How does the international sector supply funds?
Given our historically low rates of saving, this is an important source of funds in Australia.
4.3 What do interest rates do to the supply of funds?
As interest rates increase, supply of loanable funds by individuals, businesses, governments, and the international sector expands due to the improved rate of return (yield).
4.3 What are factors that influence level of interest rates?
Level of Savings in the Economy
Demand for Liquid Funds
Investment Demand
Government Budget
International Interest Rates
4.3 How does Level of savings in economy influence loanable funds?
Higher savings = increased supply of loanable funds (and vice versa).
4.3 How does Demand for Liquid Funds in economy influence loanable funds?
If households want to hold money in currency (i.e. in wallet) rather than as bank deposit = decreased supply of loanable funds.
4.3 How does Investment Demand
in economy influence loanable funds?
More investment means more business borrowing for capital construction = increased demand for loanable funds.
4.3 How does Government Budget
in economy influence loanable funds?
The difference must be borrowed = increased demand for funds.
4.3 How does International Interest rates influence loanable funds?
Domestic lenders send funds overseas, to get better returns reducing domestic supply, AND domestic demand increases as domestic borrowers take advantages of relatively low domestic rates.
4.4a What is monetary policy?
Monetary policy is the actions taken by the reserve bank to manage the economy.
4.4a what is monetary policy used for?
The Reserve Bank has used an inflation target to achieve its monetary policy objectives.
4.4a What are the three monetary policy objectives?
- Stability of the currency
- Full employment
- Economic Prosperity and welfare
4.4a What is stability of the currency?
This objective is interpreted to mean low and stable inflation. Inflation is an increase in the general level of prices of the goods and services that households buy.
4.4a What is full employment?
This objective relates to the Reserve Bank promoting an environment that supports full employment. Full employment occurs when there are enough jobs for people who are available and want to work.
4.4a Economic Prosperity and welfare
This objective relates to the Reserve Bank promoting an environment that supports the economic prosperity and welfare of the Australian people. This is primarily achieved by maintaining a stable macroeconomic environment.
4.4a What is the RBA inflation target?
2-3%
4.4a What is conventional monetary policy?
In Australia, [conventional] monetary policy involves using interest rates to influence [GDP], employment and inflation in the economy. It is one of the main economic policies used to stabilise business cycles.
4.4a How do the RBA influence interest rates?
Setting the Policy Rate/ Cash rate
4.4a What is the transmission mechanism?
Describes how changes made by the Reserve Bank to its monetary policy settings flow through to economic activity and inflation.
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4.4a What is contractionary monetary policy?
Contractionary Monetary Policy = Raising interest rates slow down an overheating economy. E.g. just before the GFC the RBA raised the cash rate to over seven percentage points.
4.4a What is expansionary monetary policy?
Expansionary Monetary Policy = Lowering Interest Rates speed up a sluggish economy. E.g. during the GFC the RBA lowered the cash rate to three percentage points.
4.4a What are exchange settlement (ES) account
Banks all have a special bank account (the ES) with the RBA where they transfer money between themselves. Every payment that moves from one bank to another in Australia goes through these accounts.
4.4a Characteristics of ES Accounts
- It happens once a day, usually in the evenings.
- Banks normally end up with either a shortfall or a surplus of funds for the night / following day as a result. (Westpac surplus = NAB shortfall)
- These balance out in the short-run, often within 24 hrs.
4.4a What is the short term/overnight money market?
Interaction of supply and demand in the short-term money market results in the cash rate.
4.4a How does demand interact with short term money market
Demand for funds is low when the cash rate is high (if the cost of borrowing is high, banks will try to avoid it) - and vice versa (law of demand)
4.4a How does RBA interact with short term money market?
The RBA has the ability to increase or decrease supply of short-term funds at will. The supply of short-term funds thus does not respond to changes in price – it is perfectly inelastic.
4.4a How does RBA influence the short term money market
The RBA only needs to adjust the quantity of ES funds in the short-term money market to adjust the supply, causing a change in the cash rate.
4.4a What are Domestic Market Operations?
DMO, is where the RBA buys or sells government securities on the short term money market.
4.4a What are government securities?
Are typically long term bonds or short term treasury notes.
4.4a How does the RBA influence the economy if its booming too much in domestic market operations?
If the economy is overheating, the RBA sells securities, this reduces the money supply thus raising the cash rate, raising interest rates and slowing economic activity. (Contractionary Monetary Policy)
4.4a How does the RBA influence the economy if its growing too slowly in domestic market operations
If the economy is growing too slowly, the RBA can buy securities, thus increasing money supply and lowering the cash rate, thus leading to lower interest rates and speeding up economic activity (expansionary monetary policy)
4.4a What is the zero lower bound?
Banks need your deposits to operate their business. So to incentive households to deposit money, they must offer some benefit over you keeping that money in cash – deposit/borrowing rates must be positive a.k.a cannot go below zero.
4.4 b What is unconventional monetary policy?
Unconventional monetary policy occurs when tools other than changing a policy interest rate are used.
4.4b What are the main tools of unconventional monetary policy?
Forward Guidance
Asset Purchases
Negative Interest Rates
4.4b What is forward guidance?
Communication of the stance of monetary policy, it lets market participants know the future of the policy interest rate. Forward guidance has been helpful in reducing uncertainty about the economic and financial outlook.
4.4b What is the transmission mechanism of forward guidance?
Changing certainty and confidence leads to a different APC, changing economic growth and therefore inflation, therefore as long as the central bank is believable, their opinion on what inflation should also influence expectations of the future.
4.4b What are negative interest rates?
When interest rate on loans etc. is negative, this could be due to a bank needing money and effectively paying a customer to take out a loan with their bank.
4.4b What are asset purchases/ quantitative easing?
When a central bank conducts domestic market operations to increase the supply of money lower long-term interest rates. It is not limited to the short term money market.
4.4b Why does an economy having more money does not mean it have more wealth?
Ultimately, the wealth of an economy depends on the size and quality of it’s factors of production and how efficiently it can use those factors of production to produce goods and services, this is why we care about real GDP per capita rather than just GDP – the real ability to access goods and services to fulfill needs and wants.
4.4c How do RBA influence unemployment?
RBA lowers cash rate => interest rate falls => more spending/borrowing causes more business profits => they hire more workers in order to expand production => unemployment falls
4.4c What is Cyclical unemployment?
When unemployment increases due to a downturn on the business cycle.
4.4c What is full employment and what does it have to with the RBA?
The RBA strives to achieve full employment a goal that used to mean striving to completely eliminate unemployment. Today, many economists argue that that there will always be a “natural rate of unemployment” in the economy which exists regardless of the phase of the business cycle.
4.4c What is Seasonal Unemployment?
The nature of some jobs means that the unemployment in the economy rises and falls with the seasons.
4.4c How does Seasonal unemployment contribute to the natural rate of unemployment?
Regardless of how strongly the economy is growing, there will always be less agricultural jobs in winter than in spring.
4.4c What is Frictional Unemployment?
When people move between jobs, they are unemployed while they attend job interviews, complete paperwork.
4.4c How does Frictional unemployment contribute to the natural rate of unemployment?
Regardless of how strongly the economy is growing, there will always be people moving between jobs.
4.4c What is Structural Unemployment?
Mismatch between a worker’s skill set and the type of jobs available in the economy.
4.4c How does Structural unemployment contribute to the natural rate of unemployment?
An effective economy is dynamic and adaptive; our scarce resources (including labour) should move towards new industries as consumer preferences and needs change along with cycles of technology-driven creative destruction
4.4c Can expansionary monetary policy change the natural rate of unemployment?
Expansionary monetary policy is ineffective at lowering the natural rate of unemployment, lower interest rates don’t change the seasons or help complete job interviews.
4.4c What happens to an economy if you continue to conduct expansionary monetary policy at or below the natural rate of unemployment?
Lower cash rate = more spending = more demand in the economy, businesses are profitable and want to produce more and expand = increased demand for labour that can’t be met efficiently, therefore increased inflation.
4.4c What is the NAIRU?
Natural rate of Unemployment - NAIRU- Non accelerating inflation rate of unemployment. At or below the NAIRU, an increase in growth causes inflation.
