The Financial Sector and Financial Markets

Question 1

What is the most basic purpose of banks and financial institutions

Answer 1

is to make money available to those who want to spend more than their income

using the savings of those who don’t currently want to spend.

Question 2

how do banks fulfil their most basic purpose

Answer 2

by helping people and firms to save. (bank accounts pension funds bonds)

provide loans to businesses and individuals.

allow equities and bonds to be issued and traded on capital markets.

Question 3

everyday forms of borrowing for individuals

Answer 3

personal loans

mortgages

credit cards

pay-day loans

overdrafts

Question 4

personal loans

Answer 4

loans to individuals paid back over small number of years.

can be secured or unsecured

secured where bank can force sale of asset to recover the loans cost.

unsecured loans have higher rate of interest as they are riskier.

Question 5

mortgage

Answer 5

loan to buy a property

bank owns property until loan repaid.

Question 6

credit cards

Answer 6

allow you to borrow money from a bank when purchasing goods or services.

Question 7

pay-day loans

Answer 7

short term, small, unsecured loans, usually with high interest rates.

Question 8

overdraft

Answer 8

loans made to firms individuals that occur when funds in their account falls bellow 0. fee might need to be paid and interest may need to be paid on money borrowed.

Question 9

firms use equity and debt finance to

Answer 9

fund their activities.

Question 10

equity finance

Answer 10

is raised by selling shares in a company. person buying shares providing the finance becomes shareholder and claims some ownership. shareholder entitled to dividends.

Question 11

debt finance

Answer 11

is borrowing money that has to be paid back usually with interest. can involve borrowing from financial institutions or issuing corporate bonds.

Question 12

other functions of financial institutions and markets

Answer 12

facilitate trade by allowing buyers to make payments quickly and easily.

they provide insurance cover to firms and individuals.

Question 13

the financial sector helps economic growth

Answer 13

effective and efficient financial institutions and financial markets enable economic growth.

because economic growth is driven by the spending of individuals and firms, much of which relies on credit.

Question 14

the banking industry is regulated meaning

Answer 14

there are rules to control the behaviour of banks, and penalties for any banks that break the rules.

Question 15

why do banks need regulation?

Answer 15

the banking industry can have an impact beyond those with bank savings. it can potentially destabilise a country’s whole economy.

greater profitability in banking is also often associated with taking greater risks. therefore there is an incentive for banks to take financial risks in the hope of making a profit.

huge economic importance + incentive to take risks = regulation.

Question 16

financial institutions are regulated to

Answer 16

reduce impacts financial market failure

protect consumers by policing individuals and firms to ensure act fairly and legally.

ensure integrity and stability of financial institutions and services they provide.

maintain confidence in financial sector and avoid sudden panics.

Question 17

what are the three types of financial markets

Answer 17

money markets

capital markets

foreign exchange markets

Question 18

money markets

Answer 18

provide short term finance to banks, companies, gov, individuals.

short term debt maturity of up to about a year.
can be as little as 24 hours.

Question 19

capital markets

Answer 19

provide medium and long term finance.

gov firms can raise finance by issuing bonds. firms can raise finance by issuing shares or by borrowing from banks.

Question 20

the capital market has a

Answer 20

primary and secondary market.

Question 21

primary capital market

Answer 21

is for new share and bond issues

Question 22

secondary capital market

Answer 22

where existing securities are traded (stock exchange).

this increases their liquidity. you can sell and get cash.

Question 23

a security is

Answer 23

a certificate with some kind of financial value which can be bought and sold.

Question 24

foreign stock exchange

Answer 24

this is where different currencies are bought and sold. done to allow international trade and investment, or as speculation.

Question 25

speculation

Answer 25

to make money on fluctuations in currency prices.

Question 26

foreign exchange market split into

Answer 26

the spot market and the forward market.

Question 27

spot market

Answer 27

this is for transactions that happen now.

Question 28

forward market

Answer 28

is for transactions that will happen at an agreed time in the future.

prices are agreed on the day of the deal, but delivery happens later.

Question 29

more on forward markets

Answer 29

contracts called futures are made at a price agreed today but for delivery later.

futures are useful for firms who export and import goods. they lock in an agreed exchange rate between their currencies, this allows both firms to be more confident about their future plans.

either firms could loose out if exchange rates changes. but the risk sharing encourages more trade.

forward markets also exist for commodities.

Question 30

AQA only

bond are

Answer 30

a form of borrowing

Question 31

AQA only

investors buy bonds at their face value called

Answer 31

the nominal value they then become bondholders.

Question 32

AQA only

after bonds are issued they are traded on the

Answer 32

secondary capital market. investors can buy them or sell them at any price. this bond price fluctuates depending on supply and demand of the bond.

coupons are paid to the current bondholder.

Question 33

AQA only

coupon is

Answer 33

the amount of interest paid to the bondholder for holding the bond.

Question 34

AQA only

bond yield is the

Answer 34

annual return an investor will get form the bond.

yield = coupon over market price x 100

Question 35

AQA only

when the bond matures

Answer 35

the current bondholder is paid the nominal value of the bond by the issuer.