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IMC Unit 1 > Section One - Introduction to Financial Markets > Flashcards

Section One - Introduction to Financial Markets Flashcards

1
Q

What are the main functions of financial services in an economy?

A
  1. Financial intermediation,
  2. Pooling and managing risk,
  3. Payments and settlement services, and
  4. Portfolio management
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2
Q

How do intermediaries reduce information and transaction costs?

A
  1. Providing services and products that allow savers to become investors
  2. Ensuring the adequate provision of information, and
  3. Allowing borrowers to access a range of savers that can meet a variety of terms
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3
Q

What are pooled investment products

A

They allow multiple savers to invest in a wider variety of investments than they would individually, reducing overall risk

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4
Q

Explain insurance in financial markets

A

Insurance allows individuals and companies to transfer a risk exposure to an insurance company in return for a premium

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5
Q

What do derivatives allow investors to do

A

Manage their risk exposure

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6
Q

What do banks do

A

They are the main providers of payment systems that allow money to be exchanged and debts to be settled

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7
Q

Who provides settlement services?

A

Clearing houses provide settlement services to ensure buyers and sellers of securities complete a transaction

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8
Q

What are the two main services provided by the investment industry

A

Investment advice and management

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9
Q

Why have ESG factors been incorporated into investing

A

Investors are looking to mitigate risks from the factors to preserve long-term value of their investments - the most important being the environmental factor

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10
Q

What year have major economies committed to achieving net-zero carbon emissions

A

2050

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11
Q

What are the risks of environmental degredation?

A

For the planet and also for companies in terms of regulations and stranded assets (assets that have an unanticipated fall in value due to regulations/societal change)

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12
Q

What are the social and governance factors from ESG

A

They relate to how a company manages the relationsjip between its workforce and the corporate governance structures in place

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13
Q

What is a central bank

A

A financial institution involved in setting the monetary framework within whic financial organisations operate

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14
Q

How do centrral banks work

A

They typically set short-term interest ratees to meeet an inflation target, and will act as a lender of last resort to the bamking sector supplying liquidity during times of crisis

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15
Q

What is financial intermediation?

A

It involves financial institutions facilitating the transfer of funds between surplus and deficit agents

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16
Q

What is a surplus and deficit agent?

A

Surplus agents are typically households and deficit agents are those who need to borrow - primarily firms and govenments

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17
Q

Give examples of intermediaries

A

A wide variety of financial institutions act as intermediaries including deposit and investment institutions

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18
Q

What is a deposit institution? Explain and give examples

A

They accept deposits from economic agents. The deposits become liabilities of the institutions which lend funds as direct loans or investments. Deposit institutions include commercial banks and building societies

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19
Q

Explain other types of banks excluding commercial and building societies

A

The banking sector also contains universal banks, which offer financial services as well as traditioal deposit and lending facilities and also investment banks. These act as brokers, underwriters and advisers.

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20
Q

What is a savings institution?

A

They accept deposits and make loans although they usually operate under different rules to banks

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21
Q

What is an investment institution?

A

They invest the funds they raise in tradable securities such as bonds and equities. Investment institutions include insurance companies

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22
Q

What is life insurance?

A

It concerns death, illness and retirement policies

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23
Q

What is general insurance?

A

Involves the loss or damage to property, homes, vehicles, etc

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24
Q

Life insurance investment strategy

A

Tend to cover longer periods, so insurers tend to hold long-term assets

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25
Q

General insurance investment strategy

A

Usually hold shorter-term assets, reflecting their greater need for immediate cash

26
Q

Are pension funds insitutional investors?

A

Yes, they are - especially in countries with falling State Pension payments and ageing populations

27
Q

Why may a company in one country choose to list on the stock market in another country?

A

To raise capital in a market with different characteristics

28
Q

Other than listing in another country, how can companies raise capital across borders?

A

By issuing bonds in another country. This means that investment by savers and capital-raising by firms has a global dimension.

29
Q

What has the gradual removal of capital controls led to?

A

The removal of capital controls by individual nation states and the globalisation of the world economy have contributed to global capital flows

30
Q

What are the four functions of a government?

A
  1. Providing services that private firms are either unwilling or not allowed to provide
  2. Regulating firms and markets, principally to protect the customer
  3. Intervening in the distribution of income generated by private market transactions
  4. Stabilising the economy
31
Q

Explain the government role - ‘providing services that private firms are either unwilling or not allowed to provide’

A
  • This is often referred to as ‘market failure’
  • Examples include defence, law and order, and maintenance of certain infrastructure
  • Government policy may involve grants and subsidies to promote certain issues for which the market may not be satisfactorily addressing, or for which the market does not punish externalities
32
Q

Explain the government role - ‘ regulating firms and markets, principally to protect the consumer’

A
  • This includes regulation to promote competition, prevent fraud, etc
  • Governments can also regulate markets by restricting entry to them and enforcing rules to govern participants’ behaviour
  • In the UK, the FCA, PRA and FPC are regulatory bodies for financial services
33
Q

What is the PRA?

A

Prudential Regulation Authority

34
Q

What is the FPC?

A

Financial Policy Committee

35
Q

Explain the government role - ‘intervening in the distribution of income generated by private market transactions’

A
  • In order to conform to criterion of equity, e.g. minimum wage guarantee
  • Redistribution of income and wealth is a policy of most governments and is often achieved through transfer payments to households - e.g. benefits
  • Taxation is also used to achieve a better distribution of income
36
Q

Explain the government role - ‘stabilising the economy’

A
  • This is done by attempting to reduce fluctuations in income and employment, and to control movements in the general price level
  • In many economies, emphasis is placed on controlling inflation using interest rates
  • This is carried out by the MPC in the UK
37
Q

What is the BOE MPC?

A

Bank of England Monetary Policy Committee

38
Q

What is one of the main fuctions of the financial services industry

A

To provide a link between savers with funds to invest (lenders/investors) and borrowers that need funds

39
Q

Who are the main lenders in an economy?

A

Households - they generally have a surplus of income after spending

40
Q

Who are the main borrowers in an economy?

A

Typically companies and governments

41
Q

Is direct lending common

A

Direct lending between lenders and borrowers is uncommon, although the growth of peer-to-peer lending has provided some impetus to this type of lending

42
Q

How do households invest their savings

A

They invest indirectly in a range of assets through intermediaries

43
Q

What are the two kinds of asset?

A

Real and financial assets

44
Q

What are real assets?

A

Physical assets such as land, buildings and gold

45
Q

What are financial assets?

A

They are claims representing the right to some return (e.g. bank deposit or bond) or to ownership of physical assets

46
Q

Give an example of a financial asset

A

A share represents ownership in a company and gives the shareholder rights to some of that company’s assets and earnings

47
Q

What are the two categorisations of financial assets?

A

Debt claims and equity securities

48
Q

What is a debt claim?

A

They are loans made by lenders to borrowers. Lenders expect borrowers to repay the loan and to make interest payments until it is repaid

49
Q

Example of a debt claim

A

A bank deposit, which may pay a fixed or variable rate of interest over a term. A bank deposit represents a claim the lender has on the bank and is not tradable

50
Q

Are debt claims tradable?

A

Most are tradable, and one example of a tradable debt is a bond. They are issued by the government and companies and generally pay a fixed rate of interest. As such they are often referred to as fixed-income securities

51
Q

Another name for a tradable claim

A

Security

52
Q

What are equity securities?

A

Also called shares. Like bonds they are tradable securities. Shareholders have an ownership stake in the company they have invested in but the company has no obligation either to repay the money invested or to pay dividends

53
Q

How do investors who buy shares make a return

A

By selling their shares at higher prices than they bought them and possibly through dividends

54
Q

What are the advantages of indirect investment through intermediaries?

A
  1. Greater diversification
  2. Reduced transaction costs as the intermediary can trade at a lower cost that an individual saver
  3. Access to specialist expertise in financial asset being invested in
  4. Ability to invest in assets not available to individual investor, e.g. commercial property
55
Q

Examples of intermediaries

A
  • Insurance companies
  • Pension funds
  • Pooled investment vehicles
56
Q

What is an ‘open-ended’ investment vehicle?

A

When investors want to invest, the fund issues new units in exchange for cash paid by the investor. When existing investors want to withdraw, the fund repurchases their units and pays out cash

57
Q

Why is an ‘open-ended’ investment vehicle good?

A

It can grow or shrink according to demand for its units

58
Q

What is a derivative?

A

A financial contract derived from an underlying asset in such a way that price movements of the derivative and underlying asset will be highly correlated

59
Q

What are the ways derivatives can be used?

A
  1. To speculate
  2. If the underlying asset is difficult to buy or has high costs associated with investing in it. E.g. buying oil directly is expensive but purchasing a derivative contract is less costly
60
Q

How do FX transactions work for large value transactions?

A

If a fund manager wants to convert GBP into USD, the pruchase of dollars for pounds may take place directly with a dealer who will quote bid/offer prices representing the prices they buy and sell dollars in relation to pounds.

61
Q

How do FX transactions work for small value transactions?

A

The purchase will take place with a broker who will arrange for the dollars to be purchased

IMC Unit 1 (1 decks)

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