T4.4: Financial Sector

Question 1

What is a bank?

Answer 1

A business that makes its profit by paying interest to those who keep money there and charging a higher rate of interest to people/businesses who borrow money from the bank.

Question 2

What are bank assets?

Answer 2

Assets are ‘owned’ by the bank e.g. cash, their balances with the Bank of England, loans (advances), securities (e.g. bonds) and physical assets such as property.

Question 3

What is bank capital?

Answer 3

Bank capital is the value of the bank’s assets minus its liabilities (or debts).

Question 4

What are bank liabilities?

Answer 4

Liabilities are ‘owed’ by the bank e.g. customers can walk into a bank or use an ATM machine to withdraw some/all of their deposits.

Question 5

What is a bank overdraft?

Answer 5

With an overdraft, the bank lets the business ‘owe it money’ when the balance goes below zero.

Question 6

What are bank reserves?

Answer 6

Money and liquid assets (such as securities that can be sold quickly) held by banks in order to meet cash withdrawals by customers.

Question 7

What is banking credit?

Answer 7

An arrangement with a bank for a loan, or bank lending in general.

Question 8

What is the banking system?

Answer 8

The way banks work together to handle payments, make money available.

Question 9

What is barter?

Answer 9

The practice of exchanging one good or service for another, without using money as a medium of exchange.

Question 10

What is base money?

Answer 10

Currency (banknotes and coins) in circulation plus minimum reserves credit institutions are required/choose to hold with a country’s central bank.

Question 11

What is the base interest rate?

Answer 11

The interest rate set by the monetary Policy committee of the Bank of England, being in effect the lowest rate that commercial lenders will charge interest at.

Question 12

What is Bitcoin?

Answer 12

Bitcoin is a digital currency that was launched by a secretive entrepreneur in October 2008, with the aim of being ‘a new electronic cash system that is fully peer-to-peer with no trusted third party’.

Question 13

What is the bond market?

Answer 13

The market for interest-bearing securities (with either a fixed or a floating rate) and with a maturity of at least one year that companies and governments issue to raise capital.

Question 14

What is bond yield?

Answer 14

The yield is effectively the interest rate on a bond. The yield will vary inversely with the market price of a bond.

Question 15

What is broad money?

Answer 15

A measure of the money supply. Broad money is a measure of the total amount of money held by households and companies in the economy.

Question 16

What are building societies?

Answer 16

Building societies are owned by their members (i.e. customers) and not for profit. They offer a broad range of retail banking products.

Question 17

What is the capital market?

Answer 17

Market for medium-longer term loan finance. Capital markets are where securities are sold to raise medium to long-term financing.

Question 18

What is the capital ratio?

Answer 18

A commercial bank’s capital ratio measures the funds it has in reserve against the riskier assets it holds that could be vulnerable in the event of a crisis.

Question 19

What are commercial banks?

Answer 19

Commercial banks have a licence to take the deposits of savers and make loans.

Question 20

What is credit risk?

Answer 20

This is the risk to the commercial bank of lending to borrowers who turn out to be unable to repay their loans.

Question 21

What are credit unions?

Answer 21

Credit unions are small and local non-profit lending institutions owned by their members.

Question 22

What is crowdfunding?

Answer 22

Crowdfunding is a form of equity finance that involves the collective effort of a large number of individuals who pool small amounts of their capital to finance a new or existing business venture.

Question 23

What is debt default?

Answer 23

Failure to meet a debt obligation payment, either principal or interest.

Question 24

What is the debt equity ratio?

Answer 24

The debt-equity ratio is the total liabilities of a firm divided by total shareholder equity.

Question 25

What is debt finance?

Answer 25

Debt finance means borrowing money from an outside source with the promise of paying back the borrowed amount, plus the agreed-upon interest at a later date.

Question 26

What is default?

Answer 26

The failure of a debtor to make agreed payments of principal or interest on a loan, a bond or other type of borrowing.

Question 27

What is equity?

Answer 27

Equity refers to the value of the interest of an owner or partial owner in an asset.

Question 28

What is equity finance?

Answer 28

Equity financing means raising capital by selling shares of a business to investors.

Question 29

What is the forward market?

Answer 29

A market dealing in commodities, currencies and securities for future (forward) delivery at prices agreed upon in advance.

Question 30

What is financial debt?

Answer 30

Financial debt is the outstanding (unpaid) debts of banks and financial corporations.

Question 31

What is a financial market?

Answer 31

A financial market is any exchange that facilitates the trading of financial instruments, such as stocks, bonds, foreign exchange, or primary commodities.

Question 32

What are investment banks?

Answer 32

An investment bank provides a wide range of specialized services for companies and large investors.

Question 33

What is leverage?

Answer 33

Leverage is the use of borrowed funds to increase profitability.

Question 34

What is liquidity?

Answer 34

Liquidity means the ease and cost with which assets can be turned into cash and used immediately as a means of exchange.

Question 35

What is a liquidity ratio?

Answer 35

A liquidity ratio is the ratio of liquid assets held by a bank on their balance sheet to their overall assets. Banks need to hold enough to cover expected demands from depositors.

In the wake of the Global Financial Crisis (GFC), the Basel Agreement requires commercial banks to keep enough liquid assets, such as cash and government bonds, to get through a 30-day market crisis.

Question 36

What is the money market?

Answer 36

The money market is the market for short-term loan finance for businesses and households, where money is borrowed and lent normally for up to 12 months.

It includes inter-bank lending and short-term government borrowing, such as 3-12 month Treasury Bills.

Question 37

What is the money supply?

Answer 37

The money supply is the total amount of money in circulation in a country or group of countries in a monetary union, with a distinction made between narrow and broad money.

Question 38

What is peer-to-peer lending?

Answer 38

Peer-to-peer lending happens when individual savers lend directly to borrowers, often through online platforms, benefiting both parties with higher interest rates for lenders and lower rates for borrowers.

Examples include Zopa, Crowdcube, Funding Circle, Rate Setter, and Thincats.

Question 39

What is an asset bubble?

Answer 39

An asset bubble is a sustained rise in the prices of assets such as housing and equities, taking their values well above long-run sustainable levels.

Question 40

What are externalities?

Answer 40

Externalities are third-party effects arising from the production and consumption of goods and services for which no appropriate compensation is paid.

Question 41

What is the Financial Conduct Authority (FCA)?

Answer 41

The FCA is funded entirely by the firms it regulates and has three main objectives: (i) Secure an appropriate degree of protection for consumers; (ii) Protect and enhance the integrity of the UK financial system; (iii) Promote effective competition in the interests of consumers.

Question 42

What is the role of the Financial Policy Committee (FPC)?

Answer 42

The FPC’s main role is to identify, monitor, and take action to remove or reduce risks threatening the resilience of the UK financial system.

The FPC publishes a Financial Stability Report identifying key threats to stability and can instruct banks to change their capital reserves.

Question 43

What is a financial crisis?

Answer 43

A financial crisis is a disturbance to financial markets, typically associated with falling asset prices and insolvency among debtors, disrupting the market’s capacity to allocate capital.

Question 44

What is an illiquidity crisis?

Answer 44

An illiquidity crisis occurs when an agent is solvent but unable to meet short-term debt obligations, potentially leading to insolvency.

Question 45

What is an insolvency crisis?

Answer 45

An insolvency crisis occurs when an agent’s debt relative to its income is so high that it cannot pay back its debt, requiring debt restructuring or relief.

Question 46

What is a liquidity trap?

Answer 46

A liquidity trap occurs when low interest rates and high cash balances fail to stimulate aggregate demand due to a lack of confidence.

Question 47

What is market rigging?

Answer 47

Market rigging is the illegal and unfair control of price or interest rates to increase joint profits or exploit consumers.

Question 48

What is moral hazard?

Answer 48

Moral hazard exists when an individual or organization takes excessive risks because they are covered by insurance or government protection.

Question 49

What is the Prudential Regulation Authority (PRA)?

Answer 49

The PRA is part of the Bank of England responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers, and major investment firms.

Question 50

What is speculation?

Answer 50

Speculation is the activity of buying a good or service in anticipation of a change in price or market value.

Question 51

What is sub-prime lending?

Answer 51

Sub-prime lending is lending money, usually for purchasing a house, to individuals considered risky borrowers, often at higher interest rates.

Question 52

What is systemic risk?

Answer 52

Systemic risk is the possibility that an event at the micro level of an individual bank or insurance company could trigger instability or collapse of an entire industry or economy.

Question 53

What is the role of a central bank?

Answer 53

A central bank is the monetary authority and major regulatory bank in a country, responsible for issuing currency and acting as a lender of last resort.

Question 54

What is central bank intervention?

Answer 54

Central bank intervention refers to a central bank entering the foreign exchange market to buy or sell currency to influence exchange rates.

Question 55

What is the European Central Bank (ECB)?

Answer 55

The ECB is the central bank for the euro, tasked with maintaining the euro’s purchasing power and price stability for member nations.

Question 56

What is a lender of last resort?

Answer 56

A lender of last resort is typically a central bank that provides funds to financial institutions when they cannot borrow from the market.

Question 57

What is monetary policy?

Answer 57

Monetary policy involves the manipulation of the supply of money, interest rates, and exchange rates to influence output, prices, and employment in the economy.