Theme 4.4 - The financial sector

Question 1

4.4.1 - What is the role of the financial market?

Answer 1

Six key roles of financial market:

• to facilitate saving buy businesses and households: offer a secure place to store money and earn interest
• to lend to businesses and individuals
• to allocate funds to productive uses
• to facilitate the final exchnage of goods and services
• to provide forward markets in currencies and commodities
• to provide a market for equities

Question 2

4.4.2 - Where was market failure evident in the financial sector through asymmetric information ?

Answer 2

Evident during the Great Recession of 2008
- risky bank loans and mortgages = borrowers with poor credit histories = defaulted mortgages in 2007 = loss of huge funds and need of bailout

Question 3

4.4.2 - Where was market failure evident in the financial sector through externalities?

Answer 3

• Externalities - collapse of banks risked - akin to a negative externality

Question 4

4.4.2 - Where was market failure evident in the financial sector through moral hazard?

Answer 4

• Moral Hazard - risk of borrower doing something undesirable to lender was high in financial crisis

Question 5

4.4.2 - Where was market failure evident in the financial sector through speculation and market bubbles?

Answer 5

• Speculation and market bubbles - occurs when price of an asset is predicted to rise causing more trade and demand to increase - when price fall causes panic and selling of assets - loss of confidence

Question 6

4.4.2 - Where was market failure evident in the financial sector through market rigging?

Answer 6

• Market rigging - act of firms coming together to interfere in a market with the intention of stopping it working as it should eg Libor Scandal