The Financial Markets (Financial Markets & Regulation) Flashcards
What are the financial markets?
Markets in which financial assets, e.g. shares, bonds, currency and securities, are traded.
What are the roles of the financial markets?
- Facilitate savings (invest savings/pensions into bonds etc, keeping them safe or generate a greater return. Can also be recycled for investment by businesses and individuals)
- Facilitate exchange of goods and services
- Provide forward markets
- Provide a market for equities (allow people to buy shares).
- Lend to businesses and individuals (used to buy equities or capital investment)
What are the 3 financial markets?
- Currency Markets (foreign exchange)
- Money Markets
- Capital Markets
What is the currency market?
The Forex markets are where different currency is bought and sold.
It is the largest market, with $5.3 trillion of currency traded daily worldwide.
What is the difference between spot and forward?
Spot = deal made which involves the immediate exchange of currency.
BUT…
Forward = deal made which involves committing to a specific currency transaction at a given date.
Draw a diagram to show the Forex Market…
What are the money markets?
Markets for short-term loan finance.
It’s concerned with individuals, firms, banks and government. (Asset class maturity is 1 day to 1 year).
What assets are sold in the money markets?
- Interbank lending (which is often made overnight)
- Short-term debt obligations, i.e. commercial paper
- Short-term government bonds, i.e. treasury bills.
Why are the money markets attractive?
- Offers liquid securities, i.e. short maturity date.
- Low risk investments.
- Sold in large denominations.
- Higher return than cash in bank.
- Transactions don’t take place in one location.
- Directly matches borrowers and lenders.
Why are money markets important for banks?
They provide liquidity to fight off solvency problems.
Depositors can withdraw their money at unexpected times (bank run), so banks need cash to meet these demands. This is where the money markets and having a spread of assets from different financial markets can be useful for financial institutions (as they can liquidate and have the capital they need to battle solvency).
What are the capital markets?
Markets for medium to long term loan finance, bond and share issues.
What assets are sold in the capital markets?
- Shares
- Corporate bonds
- Long-dated government bonds, i.e. UK Gilts
What 2 markets exist within the capital market?
- Primary markets
- Secondary markets
What is the primary market?
Market where new stocks, shares and bonds are issued for the purpose of financing needs. Asset class maturity <1 year. Investors can resell into the secondary market.
What is the secondary market?
The market where existing shares and bonds are traded via stock markets i.e. London Stock Exchange.
What is the difference between treasury bills and commercial bills?
Treasury bills = short-term debt obligations issued by the government.
BUT…
Commercial bills = short-term debt obligations issued by businesses.
Why would you use the capital markets over the money market?
- PLC companies - easier for some businesses to raise large amounts of funds to finance expansion plans. These funds don’t have to be liquid as they are meeting long-term needs.
- Governments - easier for gov’t to finance budget deficits in certain fiscal years. This is done by issuing a large quantity of long-dated government bonds.
What are 2 financing approaches used by financial institutions?
- Debt capital (e.g. bonds and securities)
- Equity capital (e.g. shares)
What is debt capital?
Borrowing money from one party which must be paid back in full over time.
- Individuals = bank overdraft
- Firms = corporate bonds
- Banks = interbank lending
- Government = Bonds/Securities
The reward for party’s lending the money is interest on top of how much they’ve lended out.
What are issues with debt capital?
- Repayments required.
- Interests repayments required.
- Too much debt accumulated increases future borrowing costs.
What is equity capital?
Money that has been borrowed in return for a fraction of the company’s future profits.
What are the consequences of equity capital?
- Sacrificing ownership.
- Future profit prospects.
- No direct repayments.
Selling more equity can break up the structure of ownership in the business.
What are shares?
- Financial assets sold by companies to raise finance.
- Shareholders own part of the company.
- Shareholders recieve a fraction of company profits (dividends).
- PLC shares can be traded on the stock market.
What’s the importance of having a balanced portfolio?
It’s best to have a portfolio that has liquid assets and long-term financial assets which are more profitable. That way, if you get into solvency issues you have the liquidity to fight against it.
- Liquid = cash, assets, physical assets (e.g. gold).
- Long-term = shares, future/options, UK gilts.
