Theme 4 - The financial sector

Question 1

What are 5 main roles of the financial markets?

Answer 1

• Forward market contracts
• Selling of Equities
• Exchange of goods and services
• Financial lending
• Financial savings

Question 2

How to financial markets allow for parties to save?

Answer 2

Savings can include in a bank, in a pension fund or the buying of shares on the stock exchange
Savings in the banks may mean people could earn more interest on their savings

Question 3

How to financial markets allow for parties to lend?

Answer 3

Banks make profits by lending money to parties for more I.R that they give to savers. This allows for borrowing of money for consumers to buy houses (mortgages), start businesses etc and gives firms ability to expand

Question 4

How do financial markets facilitate the exchange of goods and services?

Answer 4

Makes it easier to make payments between two parties which allows for easy transactions.
Also makes it easier for the exchange of currencies

Question 5

How do financial markets facilitate forward markets?

Answer 5

Forward contracts are contracts made for the future but fixing a price for now.
This means firms can maintain costs and make profits and ensure they don’t make losses in the long run

Question 6

How do financial markets facilitate the selling of equities?

Answer 6

Equities are a share in a business. A firm can sell shares to a bank which can then sell these share to investors around the world for the business which makes it more manageable for firms

Question 7

What are the 5 types of market failure in the financial sector?

Answer 7

• Moral Hazard
• Negative externalities
• Asymmetric information
• Market rigging
• Speculation and market bubbles

Question 8

What is Moral Hazard and how could it lead to market failure?
Example in 2008…

Answer 8

Moral Hazard is when one party takes risks and other parties bear the cost of that risk. E.G. in 2008, the financial crisis caused the government to bailout banks because the financial sector is too important. This lead to bankers taking risk because they know governments bail them out

Question 9

How could negative externalities lead to failure in financial markets?

Answer 9

If bankers takes risks, this could cause third parties to lose money despite them not constituting to the risk

Question 10

How can Asymmetric information lead to failure in financial markets?

Answer 10

Bankers may know more about the risks of lending that the lender for example. This leads to risks being taken

Question 11

What is speculation and market bubbles and how can it lead to failure in the financial markets?

Answer 11

Speculation is when firms predict what is going to happen in the future. Market bubbles are huge influxes in demand of an asset which increases the prices creating a spiral. This may lead to bursts of bubbles because parties will overvalue the asset price which leads to an increase in supply and reduction in prices

Question 12

What is market rigging and how may it lead to failure in the financial market?

Answer 12

This is when a firm will speculate something and will then use this for private gains. Another example could be when a firm or individual affects the price of a commodity, asset or currency

Question 13

What are the 4 main roles of the central bank?

Answer 13

• Implementation of monetary policies
• Regulations
• Bank to commercial banks
• Bank to government

Question 14

What types of monetary policies does the central bank implement?

Answer 14

• Changing the base rate
• Changing the money supply through QE, QT and quantitative financing

Question 15

How does the central bank as a bank to the government?

Answer 15

Managing the countries national debt, selling of government bonds and lending to the govt

Question 16

How may the central bank as a bank to commercial banks?

Answer 16

The central banks constantly lend to high street banks so that the base rate can have sufficient liquidity.

Question 17

How does the central bank act as a regulator in the financial market?

Answer 17

• Bailouts
• Controlling the IR
• Control the reserves

Question 18

Explain the advantages of bailing a failing bank out?

Answer 18

• Protects savings which increases confidence
• Protects bankers jobs
• Allows transactions such as wage transfers

Question 19

Explain the disadvantages of bailing a failing bank out?

Answer 19

• Potential for moral hazard
• incentivises banks to make too many risks
• Taxpayers money is spent - this is a cost to society

Question 20

Arguments for why market rigging may be inevitable in the market?

Answer 20

• Traders are able to manipulate the value of financial products such as equities
• The best way for a trader to maximise their own profits
• Some fines may not be enough to deter traders from not engaging in market rigging
• Market rigging does take place despite regulations in the market
  Some employees have more information on current market trends

Question 21

Arguments why market rigging isn’t inevitable?

Answer 21

• Market rigging can damage brand reputation for traders
• Regulation could still be enough
• could cause consumers to lose confidence in financial markets