The Financial Sector and Financial Markets Flashcards
What is the most basic purpose of banks and financial institutions
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.
how do banks fulfil their most basic purpose
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.
everyday forms of borrowing for individuals
personal loans
mortgages
credit cards
pay-day loans
overdrafts
personal loans
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.
mortgage
loan to buy a property
bank owns property until loan repaid.
credit cards
allow you to borrow money from a bank when purchasing goods or services.
pay-day loans
short term, small, unsecured loans, usually with high interest rates.
overdraft
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.
firms use equity and debt finance to
fund their activities.
equity finance
is raised by selling shares in a company. person buying shares providing the finance becomes shareholder and claims some ownership. shareholder entitled to dividends.
debt finance
is borrowing money that has to be paid back usually with interest. can involve borrowing from financial institutions or issuing corporate bonds.
other functions of financial institutions and markets
facilitate trade by allowing buyers to make payments quickly and easily.
they provide insurance cover to firms and individuals.
the financial sector helps economic growth
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.
the banking industry is regulated meaning
there are rules to control the behaviour of banks, and penalties for any banks that break the rules.
why do banks need regulation?
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.
financial institutions are regulated to
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.
what are the three types of financial markets
money markets
capital markets
foreign exchange markets
money markets
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.
capital markets
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.
the capital market has a
primary and secondary market.
primary capital market
is for new share and bond issues
secondary capital market
where existing securities are traded (stock exchange).
this increases their liquidity. you can sell and get cash.
a security is
a certificate with some kind of financial value which can be bought and sold.
foreign stock exchange
this is where different currencies are bought and sold. done to allow international trade and investment, or as speculation.
speculation
to make money on fluctuations in currency prices.
foreign exchange market split into
the spot market and the forward market.
spot market
this is for transactions that happen now.
forward market
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.
more on forward markets
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.
AQA only
bond are
a form of borrowing
AQA only
investors buy bonds at their face value called
the nominal value they then become bondholders.
AQA only
after bonds are issued they are traded on the
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.
AQA only
coupon is
the amount of interest paid to the bondholder for holding the bond.
AQA only
bond yield is the
annual return an investor will get form the bond.
yield = coupon over market price x 100
AQA only
when the bond matures
the current bondholder is paid the nominal value of the bond by the issuer.
