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CeMap 1 > Topic 1 > Flashcards

Topic 1 Flashcards

1
Q

Money performs 2 important functions which are…

A
  1. Medium of exchange
  2. Unit of account
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2
Q

To be acceptable as a medium of exchange, money must be…

A
  1. Sufficient in quantity
  2. Generally acceptable to all parties in all transactions
  3. Divisible into small units
  4. Portable
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3
Q

Meaning of ‘inflation’

A

A sustained increase in the general level of prices of goods and services

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4
Q

Why does ‘money’ act as a store of value?

A
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5
Q

What must money retain in order to fulfil its ‘store of value’ function

A

Purchasing power / Exchange value

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6
Q

What does ‘Money’ compromise of…

A
  1. Cash
  2. Current accounts
  3. Deposit accounts
  4. Other forms of investments (liquid)
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7
Q

Meaning of financial intermediation

A

An entity that acts as the middle person between two parties in a financial transaction.

Banks and building societies are the best-known examples.

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8
Q

The purpose of mutual organisations is profit-drive - True or False?

A

False

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9
Q

List the benefits that financial institutions’ products and services offer

A
  1. Convenience

(i.e., Current accounts enable holders to make and receive payments)

  1. Means of achieving otherwise difficult objectives

(i.e., Mortgage enable people to fund the purchase of a home)

  1. Protection from risk

(i.e., Insurance protects policyholders)

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10
Q

Money is:

A
  1. A medium of exchange
  2. A unit of account
  3. A store of value
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11
Q

What are mutual organisations?

A

Organisations owned by their members OR customers

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12
Q

What is a ‘surplus party’ in an economy?

A

A party that:

  1. Has more liquid funds than they currently wish to spend.
  2. They are happy to lend out their surplus funs NOW, in order to increase the value of these funds in the future.
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13
Q

What is a ‘deficit party in an economy’?

A

A party that:

  1. Does not have sufficient liquid funds to meet their spending needs
  2. They are willing to pay money into the future to anyone who will lend them funds in the present.
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14
Q

What is the role and objective of a financial intermediary in the context of surplus and deficit parties?

A
  1. The financial intermediary BORROWS money from a SURPLUS party and LENDS IT to a DEFICIT party.
  2. They charge interest to the party with the deficit and pays some of this interest to the party with the surplus.
  3. The financial intermediary’s profit margin is the difference between the two interest rates.
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15
Q

Meaning of ‘Disintermediation’

A

When borrowers (i.e., deficit parties) and lenders (i.e., surplus parties) DIRECTLY transact with each other

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16
Q

What are four main reasons why individual and companies need the services of intermediaries?

A
  1. Geographic location
  2. Aggregation
  3. Maturity transformation
  4. Risk transformation
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17
Q

Meaning of ‘Maturity transformation’

A

Maturity transformation is the process where financial institutions borrow short-term funds (e.g., deposits) and lend or invest them in long-term assets (e.g., loans), balancing the liquidity needs of depositors with the funding needs of borrowers.

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18
Q

What is meant by ‘Risk transformation’?

A

By spreading individual depositors’ funds across a wide range of borrowers, intermediaries reduce the impact of any single borrower’s default.

This allows depositors to lend with less risk, as the bank absorbs or mitigates potential losses through diversification.

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19
Q

Apart from Risk Transformation, what is another way of mitigating risk?

A

Risk Transfer

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20
Q

What is the definition of ‘Risk Transfer’

A

Risk transfer is the process of shifting the financial burden of potential risks from an individual or entity to another party, typically through insurance, by paying a premium.

For example, individuals contribute to an insurance fund via premiums. The insurer pools these premiums, covering the losses of the few who experience adverse events, thereby minimising the financial impact on any single individual.

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21
Q

What are product sales intermediaries?

A

This is the intermediation that brings together product providers and potential customers.

Product sales intermediaries include financial advisors, insurance brokers and mortgage advisors.

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22
Q

What are ‘Retail Banks’?

A

Banks that provide payment services and savings and loans to personal
customers and smaller businesses.

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23
Q

What are ‘Wholesale Banks’

A

Banks that provide funding for other financial institutions or very large
corporate clients.

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24
Q

What is ‘Life Assurance’?

A

Insurance that provides payment, generally as a lump sum but sometimes as an income, on the death of the person covered by the policy. It is sometimes referred to as life insurance or life cover.

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25
Q

What is ‘General Insurance’?

A

Insurance designed to protect policyholders from the financial
consequences of adverse life events. Examples include home insurance,
motor insurance, travel insurance and commercial property insurance.

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26
Q

List of services offered by a financial services group:

A
  1. Retail banking
  2. Mortgage services
  3. Credit card services
  4. Wealth management services
  5. Financial asset management
  6. Investment banking
  7. Insurance services
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27
Q

What is a ‘Central Bank’?

A

A central bank acts as a banker to the government, supervises the economy and regulates the supply of money.

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28
Q

What is the name of the UK’s central bank?

A

The Bank of England (BoE)

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29
Q

What is the mission of the Bank of England?

A

To promote the good of the people in the United Kingdom by maintaining MONETARY and FINANCIAL STABILITY

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30
Q

What are the main functions of the Bank of England:

A
  1. Issuer of banknotes
  2. Banker to the Government
  3. Banker to the banks
  4. Adviser to the government
  5. Foreign Exchange Market
  6. Lender of last resort
  7. Maintaining economic stability
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31
Q

What is the ‘Liquidity’?

A

Liquidity refers to assets, like cash, that can be quickly accessed to meet liabilities without impacting their market value.

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32
Q

What is the Bank of England’s duty as the ‘Banker of the Government’

A
  1. Holds the Government’s account
  2. Provides finance to cover any deficit by making an automatic loan to the government.
  3. IF there is a surplus, the Bank may lend it out as part of its general Debt Management Policy
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33
Q

What is the Bank of England’s duty as the ‘Banker to the Banks’

A
  1. All major banks have accounts with the BoE for depositing and obtaining cash and other transaction.
  2. Influence the rates of interests by changing the rate of it charges to banks that borrow OR the rate it gives to banks that deposit
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34
Q

Does the Bank of England advise the government on monetary policy? TRUE or FALSE

A

TRUE

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35
Q

Who is responsible for setting interest rates in the UK

A

BoE’s Monetary Policy Committee (MPC)

36
Q

How many times does the MPC meet a year?

A

8 times a year

37
Q

What is the objective of the MPC?

A

Tasked with setting the base rate to achieve the government’s inflation target.

38
Q

The Financial Policy Committee does NOT sit within the Bank of England - TRUE OR FALSE?

A

FALSE

The Financial Policy Committee indeed sits within the Bank of England

39
Q

What is the role of the Financial Policy Committee?

A

It looks at the economy in broad terms to identify and address risks that affect economic stability

40
Q

Who is responsible for managing new issues of Gilt-Edged Securities?

A

HM Treasury’s Debt Management Office

41
Q

Why was the responsibility for managing new issues of gilt-edged securities transferred from the Bank of England to HM Treasury’s Debt Management Office?

A

The responsibility was transferred to prevent conflicts of interest between managing government debt and setting interest rates

42
Q

What are Gilt-edged securities?

A

Gilts are loans to the government.

43
Q

How did the Financial Services Act 2016 modify the Financial Services Act 2012?

A

The Financial Services Act 2016 merged the PRA into the Bank of England and created the Prudential Regulation Committee (PRC), enhancing the Bank’s powers.

44
Q

What rights do shareholders have in proprietary large financial institutions?

A
  1. Right to receive dividends from profits and;
  2. participate in decision-making by voting at shareholders’ meetings.
45
Q

What are ‘proprietary organisations’?

A

They are limited companies.

46
Q

What are the most common types of mutual organisations:

A
  1. Building societies
  2. Friendly societies
  3. Credit unions
  4. (some) Life assurance companies
47
Q

What do the members of a Building society comprise of?

A

Depositors and borrowers

48
Q

What do members of a life assurance company comprise of?

A

Policyholders

49
Q

Who are the members of a mutual organisation?

A

Members own a mutual organization and have a say in its operations and decisions

50
Q

What does demutualisation involve for a building society according to the Building Societies Act 1986?

A

Demutualisation involves a building society converting into a bank and changing its status to a public limited company, which requires approval from its members.

51
Q

Why did many building societies demutualise in the late 1980s and early 1990s?

A

Many building societies demutualised during this period due to the new law allowing such conversions, often motivated by the prospect of receiving windfall shares.

52
Q

What was the impact of ‘carpetbagging’ in the 1990s on building societies?

A

‘Carpetbagging’ involved opening accounts solely to receive shares from impending demutualisations, leading societies to impose restrictions on new accounts to protect long-term members.

53
Q

Have any mutual life assurance companies undergone demutualisation?

A

Yes, some mutual life assurance companies, including Aviva and Abrdn, have elected to demutualise.

54
Q

What is a credit union, and how was its membership requirement structured in the past?

A

A credit union is a mutual organization run for the benefit of its members.

Previously, members had to share a ‘common bond,’ such as working for the same employer or living in the same area.

55
Q

How has the membership requirement for credit unions changed?

A

Credit unions no longer need to prove that members share a common bond.

This change allows them to serve diverse groups, such as housing associations and employees of large companies, regardless of their geographical location.

56
Q

What are the requirements for joining a credit union?

A

To join a credit union, a person must:

  1. Meet membership requirements, and;
  2. Pay any entrance fee, and;
  3. Purchase at least one £1 share.
57
Q

What types of shares can credit unions offer, and how does membership equality work?

A

Credit unions can offer ordinary shares, which provide full membership benefits, or deferred shares, payable only in special circumstances. All members are treated equally, regardless of their shareholding size.

58
Q

What traditional role did credit unions play, and how has their role evolved?

A

Traditionally, credit unions provided savings and affordable loans in deprived communities as an alternative to ‘loan sharks.’

Recently, they have expanded to combat financial exclusion and offer a broader range of financial services and education, supported by government initiatives and legislation.

59
Q

How are credit unions governed?

A

Credit unions are governed by a board of directors elected by members at the annual general meeting (AGM).

60
Q

Who manages the day-to-day operations of a credit union?

A

Day-to-day operations are managed by employed staff.

61
Q

What regulatory body oversees credit unions, AND how are savers protected?

A

Credit unions are regulated by the FCA.

Savers are protected by the Financial Services Compensation Scheme (FSCS).

62
Q

What types of savings and loan facilities do credit unions provide?

A

Credit unions offer simple savings and loan facilities.

They may provide either a fixed interest rate on savings or a yearly dividend based on profits.

63
Q

What are the requirements for credit unions that pay interest on savings?

A

Credit unions that pay interest must have the necessary systems and controls in place

AND

Maintain a reserve of at least £50,000 or 5% of total assets, whichever is greater.

64
Q

How are loans financed in a credit union, and what are the typical interest rates?

A

Loans are financed by members’ savings.

The typical interest rate is around 1% of the reducing balance per month, with a legal MAXIMUM of 3%.

65
Q

What is a unique feature of credit unions regarding life assurance?

A

Credit unions provide life assurance that covers members’ savings and loan balances, paying off any loan balance and providing a lump sum equal to the savings held upon death, subject to limits.

66
Q

What is the main distinction between retail and wholesale transactions?

A

RETAIL transactions are smaller and serve individuals and small businesses;

While WHOLESALE transactions are larger and serve large companies, the government, and financial institutions.

67
Q

What services does retail banking provide?

A

Retail banking provides:

  1. Deposits
  2. Loans, and
  3. Payment systems.
68
Q

How is retail banking delivered?

A

Retail banking is delivered through:

  1. Branches
  2. Call centers, and
  3. Internet.
69
Q

What does wholesale banking involve?

A

Wholesale banking involves raising money through the wholesale money markets where financial institutions and large companies trade financial assets.

70
Q

Why do retail banks engage in wholesale banking?

A

To top-up their deposits as necessary, in the event that the bank does not have adequate deposits to lend.

71
Q

What is the Interbank Market:

A

The interbank market is where banks trade money and financial assets with each other, typically for short-term funding needs.

72
Q

What is ‘ring-fencing’ in the context of banking?

A

Ring-fencing is a regulatory approach that separates retail banking operations from riskier wholesale banking activities to protect retail customers’ deposits.

73
Q

What restrictions do building societies face regarding wholesale market funding?

A

Building societies can raise up to 50% of their funds from wholesale markets, with the rest coming from deposits.

Banks have no such restriction.

74
Q

What was Libor used for in the interbank market?

A

Libor was used as a reference rate for corporate lending, quoted as Libor plus a specified margin.

75
Q

How was Libor calculated?

A

Libor was calculated as an average of interest rates submitted by major banks in London, reflecting their borrowing costs and confidence in the financial system.

76
Q

What issue was discovered with Libor rates in 2012?

A

Banks were found to be falsifying Libor rates to profit from trades or appear more creditworthy.

77
Q

What recommendations were made following the Libor scandal?

A

Recommendations included basing Libor rates on actual interbank transactions, requiring banks to keep transaction records, and publishing Libor submissions.

78
Q

What did the Financial Services Act 2012 establish regarding Libor?

A

The Act made knowingly or deliberately making false or misleading statements in Libor-setting a criminal offense.

79
Q

What is Sonia, and why was it introduced?

A

Sonia (Sterling Overnight Index Average) was introduced as a replacement for Libor due to the Libor scandal.

It is based on actual overnight borrowing transactions and reflects the average interest rates paid by banks.

80
Q

Who administers Sonia, and what role does it play?

A

The Bank of England administers Sonia.

It is used to calculate interest on swap transactions and sterling floating rate notes, AND is crucial for valuing around £30 trillion of assets annually.

81
Q

What are ‘Swap transactions’?

A

A contract between 2 firms that each exchange (Swap) one type of cash flow for another.

Typically, a variable interest rate (e.g. Sonia), is swapped for a fixed interest rate.

82
Q

What are ‘floating rate notes’

A

A fixed interest security (bond) where the interest rate (the coupon) varies in with the benchmark (e.g. Sonia) used.

83
Q

How can a bank involved in wholesale banking raise money quickly
in order to finance business activities?

A

From the interbank market

84
Q

Who is responsible for administering Sonia?

A

The Bank of England

85
Q

A financial transaction that is carried out directly between an
organisation with surplus funds to lend and one that needs to
borrow is an example of:

A

Disintermediation

CeMap 1 (10 decks)

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