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OCR Macroeconomics 2 > The Financial Sector > Flashcards

The Financial Sector Flashcards

1
Q

State the 4 functions of money

A

Medium of exchange
Store of value
Means of deferred payment
Unit of account

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2
Q

State the characteristics of money

A 
Divisibility
Acceptability 
Portability 
Stability in value
Scarcity 
Durability
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3
Q

What is the function of a bond

A

It is a way of raising revenue the person purchasing a bond is promised to pay back the amount paid and interest. It is a long term investment

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4
Q

Who purchases bonds

A

Pension schemes and Insurance companies

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5
Q

What are shares and how is their value determined

A

They allow you to own a small amount of a company. The number of shares available is decided by the IPO.
The value of a share changes depending on the firms performance & supply and demand

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6
Q

What are credit default swaps and how does their value change

A

They are a way to spread risk on an asset which could give you a return if the main asset is defaulted on.
As it becomes more likely that the loan will be repairs the CDs decease in value

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7
Q

What are options

A

They allow you to purchase a good (commodities) at an agreed price in the future

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8
Q

What are futures

A

Pre-purchasing a commodity at a price now before it is needed and is delivered in the future

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9
Q

Define liquidity

A

The ease at which you can convert an asset into cash

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10
Q

Define the Credit Creation Multiplier

A

An increase in the money supply can have a multiplied effect on the amount of credit available in an economy

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11
Q

Define Liquidity Ratio

A

Percentage of a banks deposits that are held in cash

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12
Q

How can you calculate the credit creation multiplier

A

CCM=1/liquidity ratio

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13
Q

Factors that affect the demand for money

A

Transactional-demand money to spend on goods and services
Precautionary- hold cash for emergencies (confidence can affect this)
Speculative-expect asset prices to fall so demand money now so a loss isnā€™t made

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14
Q

Define Liquidity Preference

A

The theory that people will have a preference for holding money rather than financial assets

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15
Q

How does rising incomes impact the liquidity preference and interest rates

A

They demand more goods and services, transactional demand for money increases, liquidity preference rises, interest rates rise

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16
Q

What are the implications of a rising liquidity preference & interest rate for monetary authorities

A
  • They do not want interest rates to rise overtime as consumption and investment will fall so they must increase the money supply to maintain the interest rate
  • May depend upon the elasticity of money demand. Transactional and precautionary is insensitive to changes in the interest rate
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17
Q

Explain the market for loanable funds

A

Household are motivated by the interest rate when making saving decisions. This determines the funds that are available for firms to invest

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18
Q

How is the commercial interest rate determined

A

The amount that households are willing to save = the amount firms are willing to invest

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19
Q

Does the relationship between saving & investment hold true

A

Financial markets are naturally unstable
Primary determinants of saving and investment is confidence
Investment is very volatile so will shift savings the government must manage the demand side of the economy

20
Q

Explain the quantity theory of money using the fisher equation

A

mV=pT
Money enters the economy so consumption increases as does AD the price level rises putting a pressure on wages so there is inflation

21
Q

Evaluate the usefulness of the fisher equation

A

Relies on the assumption that ā€˜vā€™ is constant and output and employment stay at the NRU without intervention

22
Q

What is a retail bank?

A

A high street bank that provides services to households and small businesses

23
Q

What is a wholesale bank

A

Their customers tend to be large companies and other banks. Wholesale banks include investment banks

24
Q

What is a building society

A

They are a form of small scale local bank. They provide long term low interest loans to buy houses

25
Q

What are pension funds

A

They provide very secure long term deposits and will take an amount of money from your salary until you retire.

26
Q

What are insurance funds

A

They allow consumers and firms to offset risk. Most people will not make a claim so only a small premium is paid

27
Q

What is a stock market

A

Shares are traded on the stock market. Share prices rise as company profits rise, investors can make more money when share prices rise or fall

28
Q

What is the bond market (fixed income market)

A

Bonds have a fixed rate of return (yield) and are inversely priced against shares. During a recession profits are low so demand for bonds rise

29
Q

What is the foreign exchange market

A

This is where currencies are sold to allow for importing and exporting to take place. Profit can be made from a spread

30
Q

What are hedge funds

A

They are investment funds & tend to be in partnerships run by a small number of investment traders. They speculate on markets and stand to make profit is the investment rises or falls

31
Q

What is a universal bank

A

A bank that operates in both retail and wholesale markets

32
Q

Define Interbank lending

A

Borrowing and lending between banks to manage short term liquidity

33
Q

What are the problems with increased universal banks

A

Retail banks are low risk but investment banking carries a much higher risk. As a result banking in the Uk has become riskier. As the market is an oligopoly they are not able to fail creating a perverse incentive for banks

34
Q

Define LIBOR

A

London Interbank Overnight Rate

35
Q

Define Repo

A

Repurchase agreement

Give asset to the central bank and promise to buy it back in x no. Of days or else they sell the assets

36
Q

State the forms of consumer borrowing

A

Mortgages
Credit cards
Overdraft
Payday loans

37
Q

What is a mortgage

A

A long term form of borrowing with a low rate of interest as it is a form of secured borrowing.

38
Q

What are credit cards and how is the interest rate determined

A

They provide a short term cash flow. The interest rate is very high as it is unsecured borrowing

39
Q

What are overdrafts and how is the interest rate determined

A

The solve cash flow problems when you spend more than is in get bank. The interest rate are high as lending is unsecured

40
Q

What are payday loans and how is the interest rate determined

A

They provide cash to consumers that have no access to bank loans or overdrafts. This is very risky for interest rates are very high (500%)

41
Q

Define securitisation

A

A method used by banks to turn debts and liabilities into liquid capital

42
Q

Explain securitisation

A
  • Retail banks lend out money for mortgages
  • Liquidity of the bank is reduced as mortgages are paid back over 25-30 years
  • Retail banks sell the mortgages to investment banks to give retail banks more liquid capital to lend out again (CCM)
  • These securities pay back 3-7% rates of return per year which is higher than elsewhere
  • There is confidence in the housing market and the value of homes is rising
  • If one person defaults on a loan the investment bank will not make a loss as they are able to sell the house while prices are rising
  • once all low risk customers had mortgage they then lent to higher risk consumers
  • Interest rates began to rise and employment began to fall so people began to default on their loans
  • Banks seized the assets and sold them driving down the price of houses whilst demand for housing fell
  • investment banks stopped receiving their payments and had to use their existing capital
  • banks stopped lending to each other and the govt bailed out banks
43
Q

Define Capital Adequacy Ratio

A

The ratio of liquid capital to current liabilities

44
Q

Explain the effects of imposing a capital adequacy ratio

A

Banks must hold more liquid capital so it people were to default or wanted to get their money banks could afford to pay.
This reduces the level of credit creation and increases the cost of production for banks.
There is negative externalities of production as society will bear the cost if the bank fails

45
Q

Criticisms of the capital adequacy ratio

A

Moral hazard was created in the industry as they knew that the government would bail them out as the banks were so large so continued to lend money. To prevent moral hazard you can break banks up into smaller denominations which would not be bailed out and would have to lend money out more responsibly

OCR Macroeconomics 2 (2 decks)

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