The Financial Sector Flashcards
What Is a regulated market?
A regulated market is a medium for the exchange of goods and/or services over which a government body exerts a level of control.
What is the financial sector?
The financial sector is a category of stocks of firms that provide financial services to commercial and retail customers. It includes BANKS, INVESTMENT FUNDS, INSURANCE COMPANIES, AND REAL ESTATE.
What is financial regulation?
Financial regulation is a form of emetics tip which subjects financial institutions to certain requirements, restrictions and guidelines in order to maintain the integrity of the financial system. It is an instrument of economic policy.
What is market failure and what does it lead to?
Market failure is a situation where free markets fail to allocate resources efficiently. It leads to lack of confidence in the system, and possibly a financial crisis.
What are the two principal drivers of market failure that require regulation?
Asymmetrical information and social externalities.
What is asymmetrical information?
Asymmetric information refers to one party of the transaction having more knowledge about he product than the other. It usually occurs between buyers and sellers, where the sellers have more information than the buyer.
Distinguish between the sophisticated/professional investor and the unsophisticated/retail investor.
A professional investor is one that is deemed to have enough knowledge and experience in investment in order to weight out the risks and merits of an investment by himself, whereas the retail investor has little or no experience in investing and requires the help of a professional in order to make a good investment decision.
Define social externality.
This is a consequence of an economic activity experienced by an unrelated third party. An example of a negative social externality is the effects of pollution on the health of citizens. An effective way of dealing with these is through the creation of taxes.
What is a bank run?
A bank run is a situation when a large number of bank customers withdraw their funds at the same time, because of concerns about the bank’s solvency. As clients withdraw their funds, the probability of default increases, thereby tempting more people to withdraw their funds. A bank run is generally the result of a state of panic in the financial world.
Define the domino effect (also, contagion effect).
This is the spread of economic changes, either through a nation or internationally. The failure of one bank may cause people to panic and think that their bank, that looks similar to the one that has failed, will also fail. As a result of panic, bank customers will withdraw their funds from their bank, creating a bank run. This will lead to the failure of more banks. Hence, the financial system will collapse, as a result of the domino effect. Similarly, the fail of the financial system in one country may lead the to the fail of financial systems in other countries.
Define systemic risk. What does it lead to?
Systemic risk is the risk that the financial system collapses as a result of the domino effect. It leads to systemic instability.
What are the three objectives of financial regulation?
- To safeguard financial stability.
- To provide investor protection.
- To ensure that markets are fair, transparent and efficient.
