Topic 6 - The Impact Of Change Amd Uncertainty On Financial Products Flashcards
1
Q
CHANGE, UNCERTAINTY, RISK AND LOSS
- change and uncertainty
Define both terms (ppt)
A
Change
- the future will differ from the present
- some future trends and changes can be predicted, such as inflation rising/falling
- other changes comes about from ‘exogenous shocks’
- the 2007/08 financial crisis was one of these, as was Covid
Uncertainty
- brought about when change happens/is forecast as the future is unknown
- volatility is a source of uncertainty, ie where there are significant changes from high to low etc
- an example is exchange rates, the weather etc
- the more volatile a situation, the more unstable it is
- uncertainty cannot be measured
2
Q
CHANGE, UNCERTAINTY, RISK AND LOSS
- change and uncertainty
What is meant by ‘change’ in the context of financial services?
A
A: ‘Change’ refers to the fact that the future will be different from the present. This brings uncertainty, as people do not know what their future standard of living, financial situation, or available goods and services will be like
3
Q
Why does change create uncertainty?
A
A: The future is unknown, and people are uncertain about:
• Their future standard of living
• Goods and services they can afford
• Their financial situation when they retire
• Future government laws and social trends
• How technology will alter their lives
4
Q
Can future trends be predicted?
A
A: Some trends can be predicted, but predictions may be overestimates or underestimates. For example, inflation is expected to rise and fall over time, but its exact future rates are uncertain, making long-term financial planning difficult
5
Q
What are ‘exogenous shocks’? Give an example.
A
are unexpected events with major impacts on political, economic, and social systems.
Example: The financial crisis of 2007–08 was unforeseen by most people, leading to a severe economic recession that disrupted living standards
6
Q
How do extreme weather events or global pandemics contribute to financial uncertainty?
A
A: Such events cannot be foreseen accurately, and many people are financially unprepared for their consequences, leading to widespread economic disruption and personal financial crises
7
Q
What is volatility, and how does it contribute to uncertainty?
A
is the extent to which there are large fluctuations in a system. High volatility increases uncertainty.
Examples of volatility:
• Exchange rate fluctuations (e.g., sterling vs. euro)
• Interest rate changes
• Rapid shifts in weather temperatures
8
Q
How does volatility make predictions more difficult?
A
A: The more volatile a situation, the more unstable and unpredictable it is. Volatility enhances the uncertainty that is already present in a given financial or economic scenario
9
Q
- risk (ppt)
A
- allows you to make informed guesses and choices about the uncertainty of the future
- past data and experiences can help estimate the likelihood (risk) of something happening and prepare for it
- a harmful or damaging risk outcome is a ‘pure’ outcome and is always negative
- a good or bad outcome possibility is a ‘speculative’ outcome
10
Q
- risk
What is risk in financial terms?
A
A: Risk is the probability that something might change. It is different from uncertainty because it can be measured using probability based on past data
11
Q
How does risk differ from uncertainty?
A
A: - Risk can be measured and managed because it is based on probability.
• Uncertainty cannot be measured or predicted accurately, making it unmanageable
12
Q
What is pure risk? Provide an example.
A
A: - Pure risk is a type of risk where the only possible outcome is negative. It may involve physical injury, financial loss, or legal liability.
• Example: A family living on a floodplain risks their home being flooded, leading to financial losses from repairs and replacing damaged possessions
13
Q
What is speculative risk? Provide an example.
A
involves both potential gains and losses. It is a type of risk faced when taking a chance, similar to gambling.
• Example: Buying shares in a company. The value of shares may rise (gain) or fall (loss), affecting the investor’s financial outcome
14
Q
How can people manage pure and speculative risks?
A
A: - Pure risk can be managed by taking precautions such as buying insurance.
• Speculative risk is managed by making informed decisions, such as researching investments before purchasing shares.
15
Q
What factors make risk management difficult?
A
A: The actual outcome of a situation may be bigger or smaller than expected, making it hard to fully plan for every possibility.
Example: A bank may create a new savings account expecting high demand, only to find it unpopular and not selling well
16
Q
What are some common risks faced by financial services providers?
A
A: - Banks face the risk of borrowers defaulting on loans or interest rates rising.
• Insurance companies take on customers’ risks but also risk underestimating losses.
• Providers use mathematical models and past data to estimate and manage risks
17
Q
Can risk be completely eliminated?
A
A: No, risk can never be eliminated because all aspects of life involve some level of risk. However, risk can be reduced, minimized, managed, or transferred.
18
Q
- loss (ppt)
The impact of risk is measured as the financial loss suffered - 3 categories. Name them
A
Expected loss
Unexpected loss
Catastrophic loss
19
Q
Expected loss
A
- average amount of loss expected to face
- based on past experience and a providers knowledge of its customer
- will probably be suffered and can be controlled to some extent
20
Q
Unexpected loss
A
- the amount by which actual loss exceed expected loss
- needs investigating by the provider
21
Q
Catastrophic loss
A
- in excess of the unexpected loss
- is unlikely but conceivable and would have devastating consequences
22
Q
Examples of risk and uncertainty
A
Tightening regulation
Changing weather patterns
Religious attitudes
Ethical and environmental concerns
Terrorists attacks
Changing rates of inflation
Stock market volatility
Economic uncertainty
Attitudes to credit and debt
Institutional issues
23
Q
Why is it important to consider interest rates when examining the effects of inflation?
A
A: Because interest rates are used as a tool of monetary policy to control inflation. A rise in inflation often leads the Bank of England to raise the Bank rate to manage inflation levels
24
Q
What two key factors affect an individual’s standard of living during inflation?
A
A:
1. A change in real incomes
2. A change in real interest rates
25
What is ‘real income’?
refers to the purchasing power of income – the amount of goods and services that can be bought. If nominal income rises but inflation rises faster, real income actually falls
26
What happened in March 2014 to public sector workers regarding inflation and pay?
A: The government announced a 1% pay rise, while inflation was nearly double. This meant real incomes fell, especially for health sector workers, who viewed the rise as effectively a pay cut
27
How is a real interest rate calculated, and why does it matter?
A: Real interest rate = Nominal interest rate - Rate of inflation.
It matters because it affects the real return savers get on their savings. If inflation is higher than the interest rate, purchasing power is eroded
28
How does inflation affect savers?
A: If inflation exceeds the interest earned on savings, the real value (purchasing power) of those savings falls. E.g., 1% interest with 2% inflation = loss in real terms
29
How can borrowers benefit from rising inflation?
A: If the interest rate on a loan stays the same while inflation rises, the real value of repayments decreases, making borrowing effectively cheaper in real terms
30
How might financial services providers respond to inflation?
A: They may adjust their products to better meet customers’ changing financial needs due to inflation, such as modifying interest rates or offering inflation-linked accounts
31
- the effect of inflation on savings
What is the first impact of rising inflation on savings?
A: Rising inflation leads to a fall in people’s real incomes, which increases the cost of living and reduces their ability to save. This challenges financial service providers, who must make their savings products more attractive to compete for limited funds
32
Why have banks and building societies paid low returns on savings accounts in recent years?
A: Due to a low interest rate climate, banks can’t charge high interest rates to borrowers, so they preserve profits by paying low rates to savers
33
How have savers reacted to low interest rates on savings, and how have providers responded?
A: Savers are unhappy with low returns, prompting providers to compete by offering slightly higher rates to attract new customers
34
What are negative real interest rates?
occur when the interest rate savers receive is lower than the rate of inflation, reducing the real value of their savings.
35
What is a ‘teaser rate’ and why do providers use it?
is a short-term bonus rate on savings accounts aimed at attracting more deposits. Providers hope customers will forget to switch accounts after the bonus period ends, when the interest rate reverts to a low level
36
How do financial services providers encourage savers to deposit larger sums or stay longer?
A: They offer higher interest rates for savers willing to deposit more money or remain with the bank as existing customers
37
What are index-linked savings accounts and how do they protect savers?
A: These accounts adjust the interest rate in line with inflation, ensuring that savers don’t lose real value. Though not available at the time of writing, they could return if inflation rises
38
Why is predicting future inflation especially difficult for long-term savings like pensions?
A: Because these savings span decades, making it hard for even experts to accurately forecast inflation rates over such a long period
39
What is the role of a pension fund manager in relation to inflation?
A: The fund manager must invest contributions to ensure the fund can afford to pay the promised pension despite uncertain future inflation.
40
Why do savings account interest rates remain low despite banks’ efforts to attract customers?
A: Economic uncertainty limits how much interest banks are willing or able to offer
41
What is an annuity and how does it work in retirement?
is a financial product where a person pays a lump sum (usually from their pension fund) and receives a fixed annual income for life. It guarantees nominal income but doesn’t account for inflation unless it is index-linked
42
How does inflation affect the value of a standard annuity?
A: Inflation erodes the real value of the fixed annual income from a standard annuity, reducing the purchasing power over time
43
What is an index-linked annuity and what are its pros and cons?
adjusts income in line with inflation, maintaining purchasing power. However, it pays a much smaller income initially compared to a non-index-linked annuity
44
What determines the annuity rates available to retirees?
depend on the type of annuity, the person’s age, and current market conditions. For example, Table 6.2 (not shown) illustrates the income a 65-year-old could get with £100,000
45
Why are low interest rates on savings a problem for small savers, especially retirees?
A: Retirees often rely on interest as income. When rates are low, their income is reduced, potentially leading them to take greater financial risks to achieve higher returns
46
What risk might small savers take in response to low interest rates, and what are the consequences?
A: They might invest in higher-return schemes, but these come with a higher risk of losing their capital. This is especially dangerous for those with limited savings
47
What responsibility do banks have when advising small savers about investment products?
A: Banks must clearly inform savers of the risks involved in investment products, especially when such products might not be suitable for someone with a small portfolio
48
Why might people decide to borrow and buy assets if they expect inflation to rise?
A: People may choose to buy assets, like homes, before inflation rises to avoid future price increases. By purchasing earlier, they get the property at a lower price and also benefit from the rise in property value due to inflation. This expectation increases demand for mortgage loans
49
How does the expectation of higher inflation affect the housing market?
A: It can increase the demand for mortgage loans, as individuals want to buy property before prices increase further due to inflation
50
What is the likely response of monetary authorities to rising inflation?
A: They will likely increase interest rates to control inflation. This leads to higher mortgage rates and larger monthly repayments for borrowers
51
How do lenders help borrowers manage rising interest rates?
A: Lenders offer fixed-interest mortgages, typically lasting 2 to 5 years. These loans have a stable interest rate during the fixed term, making repayments predictable
52
What are the potential downsides of longer fixed-rate mortgage terms?
A: The longer the fixed term, the higher the interest rate tends to be. Additionally, banks may charge a fee for these mortgages
53
What happens when a fixed-rate mortgage term ends?
A: The mortgage usually reverts to a standard variable rate, which may be much higher if interest rates have risen, leading to a sharp increase in monthly repayments
54
What risk do borrowers face when their fixed-rate mortgage ends?
A: Borrowers may face a significant rise in monthly payments if interest rates have increased, increasing the risk of defaulting on their mortgage
55
Why is there also a risk to mortgage providers during inflation?
A: Providers face a greater risk of customer default due to the sharp increase in repayments after fixed-rate periods if inflation causes interest rates to rise significantly
56
What advice might providers give borrowers during uncertain inflation periods?
A: Providers might advise borrowers to save as much as possible during the fixed-rate period to prepare for higher repayments after the rate reverts to a potentially higher variable rate
57
VOLATILITY IN THE STOCK MARKET (ppt)
- changes in stock market prices help indicate the state of the economy and therefore investor expectations
- fluctuations reflect a sudden, sharp, change in demand and supply, which has resulted from investor uncertainty
58
What does volatility in the stock market indicate?
A: It signals greater uncertainty in the economy and among investors. In a volatile market, share prices rise and fall sharply, unlike a non-volatile market where price fluctuations are minimal and gradual
59
What causes volatility in the stock market?
A: Volatility is caused by sudden sharp changes in demand and supply, which in turn are driven by high uncertainty among investors
60
Why is stock market volatility a problem for investors?
A: The market value of their holdings changes constantly, making it difficult to know their true worth. This is particularly hard for small investors, who may not afford large losses and lack experience in timing the market for speculative gains
61
How can banks and building societies help customers with market volatility?
A: By designing investment products that help reduce fluctuations in asset values. However, these are usually suitable only for those willing to take more risk, as capital returns are not guaranteed
62
What is a ‘protected equity bond’ and why is it no longer available?
A: It was a product designed to return a customer’s original investment after 6 years, plus annual returns linked to the FTSE 100 index. For example, Nationwide offered one in 2012. It was discontinued due to complexity, high fees, and poor public perception
63
Why is stock market volatility a major concern for pension funds?
A: Pension funds invest over long periods to finance retirement. Sudden rises in prices increase asset values, but sudden falls can greatly reduce them, affecting retirees’ income security
64
How do pension fund managers deal with stock market volatility?
A: They use a range of investment devices, such as derivative products, to help neutralise the effect of price movements. These strategies are typically used by experts.
65
What kinds of events can drive stock market volatility?
A: A wide range of events, including key political and financial events, can cause sudden market changes
66
ECONOMIC UNCERTAINTY
What are the two specific aspects of economic uncertainty discussed in previous sections?
A:
• Rising inflation
• Stock market volatility
67
What caused the UK unemployment rate to reach 7.8% in August 2013?
A:
Low economic activity following the financial crisis.
68
What impact did Covid-19 have on the UK unemployment rate by December 2020 and January 2022?
A:
• Rose to 5.2% by Dec 2020
• Fell to 4.1% by Jan 2022 (ONS, no date)
69
What are common consumer behaviors when people fear rising unemployment?
A:
1. Increase savings in instant-access accounts
2. Pay off loans, especially mortgages
70
Why do people prioritize mortgage payments during economic crises?
A:
Losing a home is seen as the worst-case scenario
71
What did Bank of England data in Dec 2013 show about homeowner behavior?
A:
Homeowners became cautious and stopped withdrawing equity despite rising property prices, showing risk aversion due to debt and interest rate fears
72
What was the trend in mortgage arrears following the financial crisis?
A:
• Initially rose sharply
• 1.12% in arrears Q3 2014 (125,100 mortgages)
• Fell to historic lows by Q3 2021 (74,210 mortgages)
73
What actions can lenders take to avoid repossession under FCA regulations?
A:
1. Extend the term of the mortgage (e.g., from 25 to 30 years)
2. Grant a “payment holiday”
3. Allow borrower to owe more as long as some payments are made
74
What is the main advantage of forbearance to lenders?
A:
Keeps the loan as an asset on the balance sheet and avoids bad publicity from repossessions
75
What are the limitations of forbearance methods?
A:
They only delay the issue; lenders still need to prepare in case loans turn bad
76
What is Payment Protection Insurance (PPI)?
A:
Insurance meant to cover loan repayments during illness or unemployment.
Issue: Mis-sold to unsuitable customers
77
What is a “payment waiver” product?
A:
A new product used to cover loan repayments due to absence from work (e.g., illness).
Example: Offered by Scottish Police Credit Union via CUNA Mutual
78
ATTITUDES TO CREDIT AND DEBT
How did attitudes towards credit and debt change from the 1970s to the 1980s?
A: Before the 1970s, people avoided debt and mainly used mortgages to buy homes. In the 1980s, credit cards became more common, and borrowing became easier and socially acceptable. People began financing consumer goods with credit
79
Why did borrowing become more desirable in the 1980s?
A: Borrowing allowed people to buy items in instalments from future income, making goods like TVs, holidays, and mobile phones more accessible. Debt became a way to fund consumer lifestyles
80
How did the 2007–08 financial crisis impact people’s attitudes to debt?
A: The crisis revealed that many people were over-indebted. It led to higher unemployment, job loss, and defaults on credit cards and loans. Homes and assets were repossessed. This caused a shift towards “deleverage,” where people tried to pay off debt
81
What is meant by the term “deleverage”?
A: Deleverage refers to people reducing their outstanding debt after the financial crisis by repaying loans and avoiding unnecessary borrowing
82
What is the current financial climate regarding borrowing and lending?
A: People still borrow, but only if they can afford to repay. Providers are stricter and must perform affordability checks. Responsible lending is now a key focus
83
How have mortgage requirements changed since the financial crisis?
A: Applicants now need larger deposits due to lower loan-to-value (LTV) ratios. Pre-crisis, 100%+ LTV was common. Now it’s around 80%, so someone buying a £100,000 home must save a £20,000 deposit
84
What changes have been made regarding loan-to-income ratios?
A: Pre-crisis, people could borrow 6–7 times their income. Now it’s 3–4 times. For example, someone earning £25,000 could borrow £175,000 before, but now they might only get £100,000
85
How do lenders now assess mortgage affordability?
A: Lenders evaluate an applicant’s income, living costs, and ability to repay, rather than just using simple loan-to-income ratios. They also consider interest rate rises
86
What was the issue with credit card usage before the crisis?
A: Many people only paid the minimum amount each month, causing debt to build up. They also took out more cards to extend credit, leading to unsustainable debt levels
87
What actions have credit card providers taken post-crisis?
A: They’ve stopped marketing credit cards aggressively. Customers are now advised to pay more than the minimum monthly amount and limit their use to 1–2 cards
88
What role do payday lenders play in the current financial climate?
A: As credit became harder to access, people turned to payday lenders for small, short-term loans. These come with very high interest rates and fees, making repayment difficult
89
INSTITUTIONAL ISSUS
- selling the government’s banking shareholdings
What was the purpose of the UK government taking ownership of RBS and Lloyds Banking Group in 2008?
A: To rescue the struggling banks during the financial crisis. The government planned to eventually sell these shareholdings back to the private sector
90
What is the significance of the LBG share sale in May 2017?
A: It marked the completion of selling off Lloyds Banking Group to private investors, although the process took years
91
Why was the sale of RBS shares delayed beyond 2015?
A: RBS did not return to profitability until 2018 and had a low share price, so the government waited for prices to rise to recover more public funds.
92
What is the main reason the government wants to sell its RBS shares at a higher price?
A: To maximise returns and offset the government’s budget deficit
93
- breaking up bigger banks
What did the 2009 European Union’s Competition Commissioner require of RBS and Lloyds?
A: To undergo divestment – selling parts of their business to reduce size and increase competition in the UK banking sector
94
What does ‘divestment’ mean in the context of banking?
A: The disposal of certain parts of a business to reduce its size and improve competition
95
What did Ed Miliband propose in 2015 regarding large banks?
A: Banks that had become too powerful should be forced to give up branches, and a threshold market share limit should be imposed
96
What did the Competition and Markets Authority (CMA) suggest regarding branch sell-offs?
A: Banks should sell off branches by 2020 to reduce market concentration and improve competition
97
Which challenger banks were the biggest in the early 2020s, and how much did they hold in deposits?
A: Atom, Monzo, Tandem, and Starling – over £300 billion in deposits between them
98
What was Mark Carney’s argument against putting a cap on bank market share?
A: He believed it wouldn’t significantly improve competition and might lead banks to exclude lower-quality customers
99
What is a possible negative outcome of capping market share according to some bankers?
A: Banks might get rid of customers with lower credit scores, leading to financial exclusion
100
How does financial exclusion relate to banking policy?
A: Policies that reduce bank sizes could exclude vulnerable customers who rely on accessible banking services
101
- retail ring-fencing
What is the purpose of retail ring-fencing in the UK banking system?
A: Retail ring-fencing is the process of separating a bank’s retail activities (e.g., taking deposits) into a separate subsidiary from its investment banking arm. This aims to protect depositors from potential losses resulting from a bank’s trading or investment activities
102
What banking services are included within the ring-fenced entity?
A:
• Current accounts and payment services
• Savings accounts
• Secured and unsecured lending (including mortgages and credit cards)
• Trade and project finance
• Advising on/selling non-ring-fenced bank products (without exposure)
103
What legislation established the ring-fencing requirement and what are its key elements?
A: The Financial Services (Banking Reform) Act 2013 defines a ‘ring-fenced body’ and its ‘core activities’, such as:
• Accepting deposits
• Providing withdrawal and payment facilities
• Offering overdraft services
The government can expand this list if needed for financial stability. Building societies are excluded from this remit
104
What are ‘excluded activities’ that ring-fenced banks cannot engage in?
A: Investment activities as a principal (using the bank’s own capital). HM Treasury can define other excluded activities if they pose a risk to the stability of core services.
105
What role does the Prudential Regulation Authority (PRA) play in ring-fencing?
A:
• Ensures compliance with ring-fencing
• Reports annually on its effectiveness
• Can force full separation between retail and investment banking if aims are undermined (called “electrifying the fence”)
106
What are the key arguments in favor of breaking up retail and investment banking?
A:
• Reduces “too big to fail” risk
• Protects essential services (like deposits and lending)
• Easier to supervise and regulate retail banking
• Helps restore public trust in retail bank
107
What are the main arguments against separating retail and investment banking?
A:
• The 2007–08 crisis was due to interconnectivity, not size
• Retail banks would lose funding from investment arms, raising costs
• Retail banks also engaged in risky behavior (e.g., excessive lending)
• Could drive banks out of the UK (due to higher regulation and costs)
108
What were some concerns before and after the 2013 Act was implemented?
A:
• Concerns that foreign banks could take business from UK banks not subject to the rules
• Treasury review (2022): Ring-fencing may need simplifying but has had little impact on competition
109
There are 4 main institutional issues, what are they?
- selling gov banking shareholding’s
- breaking up bigger banks
- retail ring fending
- tightening regulation
110
- tightening regulation
What is the main requirement placed on financial services providers due to tightening regulation?
A: They must comply with new rules and regulations and engage with newly established bodies that oversee these regulations
111
Why is there uncertainty for providers regarding regulatory changes?
A: Because they are unsure about the exact nature of changes and their impact, such as whether new rules will affect the provision of specific products or alter procedures.
112
- changes in laws and regulations
What is the main requirement placed on financial services providers due to tightening regulation?
A: They must comply with new rules and regulations and engage with newly established bodies that oversee these regulations
113
Why is there uncertainty for providers regarding regulatory changes?
A: Because they are unsure about the exact nature of changes and their impact, such as whether new rules will affect the provision of specific products or alter procedures
114
What is the purpose of financial regulation?
A: To establish standards for how providers behave in the financial sector
115
What drives changes in financial regulation?
A: Shifting public views on what is considered acceptable practice over time
116
How might past financial practices be viewed today?
A: Practices seen as acceptable years ago may now be seen as consumer exploitation
117
What example is given to illustrate how views have changed over time?
A: In the 1960s, if customers bought unsuitable financial products, it was seen as their own fault and they were expected to have been more careful
118
What is the current duty of care expected from financial providers?
A: Providers must ensure customers understand the products being sold and that those products meet customers’ needs
119
How do changes in laws and regulations impact financial providers?
They affect how providers conduct business and increase their costs
120
What do providers need to do to comply with new regulations?
A: Understand the changes, prepare for them, retrain staff, and implement new procedures.
121
CHANGING WEATHER PATTERNS
What are some of the key indicators and consequences of climate change
A:
• Sea levels are rising.
• Polar icecaps are melting.
• Countries are facing storms, heatwaves, and floods.
• Scientists warn of continued global warming and more frequent/intense extreme weather events.
• There is uncertainty about when, where, and how intense these events will be.
122
How did climate change impact Australia in 2019–20?
A:
• Unusually high temperatures caused dry conditions.
• Major forest fires occurred, killing over 30 people.
• Homes and infrastructure were destroyed.
• Severe air pollution from smoke resulted.
• Estimated cost of wildfires: at least A$100 billion (Read and Denniss, 2020).
123
What is meant by ‘catastrophic loss’ in the context of climate events?
A:
• Losses from extreme weather events that significantly affect financial conditions.
• Dealt with through strategies like avoidance and preparation
124
What does ‘avoidance’ mean in managing catastrophic loss?
A:
• Taking steps to eliminate the financial impact of an event (e.g., relocating from flood-prone areas).
• Limited options exist.
• Environmental sustainability can help but may not fully prevent losses.
125
What is meant by ‘preparation’ in relation to catastrophic loss?
A:
• Accepts that events may happen but focuses on minimizing damage.
• Example: Disaster recovery planning, backing up IT systems in multiple locations.
• More realistic than avoidance
126
How can financial products help with climate-related events?
A:
• Help people and firms prepare for and respond to such events.
• Providers need to design suitable insurance products.
• Insurance transfers risk to another party (e.g., an insurance company).
127
How do insurance companies calculate premiums for weather-related risks?
A:
• Use actuarial data (historical, adjusted for current conditions).
• Higher probability of disaster = higher premium.
• Note: Past data isn’t always a reliable predictor of future events
128
What happens in a “good year” for insurance companies?
A:
• No major climate events occur.
• Companies receive premiums and only pay out normal compensation.
• Can make significant profits.
129
What are ‘catastrophe bonds’ and how do they work?
A:
• Issued by insurance companies to limit exposure to major disasters.
• Based on specific disasters (e.g., Typhoon Haiyan in the Philippines, 2013).
• Investors buy these bonds and earn interest if no disaster occurs.
• If the disaster happens, investors lose their capital, which goes to cover losses.
130
RELIGIOUS ATTITUDES TO FINANCIAL PRODUCTS
- Islamic finance
What are the two primary sources of Islamic finance, and what system do they give rise to?
Back:
• Sources: The Qur’an (holy book of Islam) and the Sunnah (teachings and practices of Prophet Muhammad).
• These give rise to Sharia, a system of Islamic law based on moral values and ethical considerations
131
What must a Sharia-compliant financial service provider have, and what are its restrictions?
Back:
• Must have an ethics committee to assess the ethical aspects of loans and investments.
• Forbidden from investing in or lending money for unethical purposes.
132
What is Riba and how does it impact the way Islamic banks operate?
Back:
• Riba = Prohibition of interest.
• Islamic banks cannot charge interest on loans as lending money for a return is forbidden.
• Loans must follow principles of shared risk and shared profit.
133
What is the Murabaha method used in Sharia-compliant home purchase plans?
Back:
• Instead of lending money directly, the bank buys the house and then sells it to the buyer at a profit.
• The buyer repays in installments with no penalties for late payments.
134
What is the Ijara method used in Islamic finance?
Back:
• The bank buys the property and then leases it to the customer.
• After a period of time, ownership transfers to the borrower
135
What does Gharar mean and how does it impact financial transactions?
Back:
• Gharar = Uncertainty in business transactions.
• Banks and individuals are forbidden from entering transactions with excessive risk.
• Combined with the ban on gambling, many investments are unsuitable for Islamic finance
136
What are two examples of fully Sharia-compliant banks in the UK?
Back:
• Al Rayan Bank
• Qatar Islamic Bank
137
- Christian values
How do Christian values typically influence financial services?
Back:
• Christian beliefs do not usually have as direct an impact as Islam on financial services.
• Influence is more indirect and based on ethical concerns
138
What did the Archbishop of Canterbury, Justin Welby, do in 2013 regarding payday lenders?
Back:
• Criticised high-interest rates and fees.
• Encouraged use of credit unions as an alternative.
• Church had indirectly invested in one of the payday lenders (revealed later).
• Investment was ended in 2014
139
ETHICAL AND ENVIRONMENTAL CONCERNS
- responsible lending and affordable borrowing
What triggered the rethinking of ethical approaches in financial services?
**Back:** The exposure of excessive risk-taking in the years leading up to the financial crisis made people believe providers should favor the real economy over speculative trading in financial markets.
140
What are the main aspects of the call for a more ethical banking system?
**Back:**
1. Responsible lending and affordable borrowing.
2. (Other aspects not detailed in the excerpt, but implied as part of the broader discussion.)
141
**Front:** Why is lending to someone who cannot repay considered unethical?
**Back:** It is classified as "mis-selling." Banks must assess creditworthiness to limit risk and comply with ethical lending practices.
142
What two reasons do banks have for assessing a customer's creditworthiness?
**Back:**
1. To limit their own risk.
2. To comply with ethical lending standards.
143
What responsibility do customers have in ethical lending?
**Back:** Customers must be better informed about the risks of over-indebtedness and are ultimately responsible for their own financial decisions.
144
What two assumptions underpin the FCA's approach to responsible lending?
**Back:**
1. Providers will not sell products unsuitable for a customer’s circumstances.
2. Customers are given sufficient information about the product before purchasing.
145
What is the role of the Financial Conduct Authority (FCA) in ethical lending?
The FCA asserts that while banks must lend responsibly, customers must also take responsibility for their financial decisions.
146
How is "mis-selling" defined in the context of banking?
Mis-selling occurs when a bank lends money to someone who cannot afford to repay, violating ethical lending principles.
147
- ethical and sustainable investment
What are two major concerns driving ethical and sustainable investment?
1. **Ethical issues** (e.g., opposing child labor in developing countries).
2. **Environmental sustainability** (e.g., using recyclable energy sources).
148
How can individuals promote ethical/sustainable causes if they lack direct influence over companies?
By ensuring their savings are **not invested** in unethical or unsustainable businesses.
149
What did Steve Webb (2013 Pensions Minister) argue about pension funds?
They should be **"climate resilient"** to avoid long-term risks from carbon-intensive investments.
150
What problem did the Share Action report (2013) highlight about UK pension funds?
They were **overinvested in firms using carbon-intensive fuels**, neglecting environmental risks.
151
Why did Steve Webb advocate for investing in firms shifting toward recyclables?
These firms would likely be **more valuable in the future** than those reliant on climate-damaging fuels.
152
What role did Webb suggest for pension fund trustees regarding environmental risks?
To take a **longer-term view** of environmental risks when making investment decisions.
153
What broader government initiative aligns with ethical/sustainable investment goals?
The UK government’s plan to accelerate **"green finance"** growth.
154
Define "ethical investment" in this context.
Directing funds toward businesses that align with social/environmental values (e.g., no child labor, renewable energy).
155
What is the link between carbon-intensive fuels and long-term financial risk?
Firms reliant on such fuels face **future devaluation** due to climate regulations and shifting market preferences.
156
TERRORISTS ATTACKS
What are the two main types of costs resulting from terrorist acts?
1. **Direct costs** (e.g., damage to tangible and intangible assets).
2. **Indirect costs** (e.g., economic disruption, loss of life).
157
- direct costs
What are examples of **tangible assets** affected by terrorist attacks?
Buildings, physical infrastructure (e.g., corporate offices, banks).
158
What are examples of **intangible infrastructure** impacted by terrorist attacks?
Financial networks, computer systems, customer data (e.g., account records).
159
How did the 9/11 attacks on the World Trade Center affect financial services firms?
Destroyed computer systems and data (e.g., customer accounts).
- Led to **disaster recovery plans** (e.g., data backups, secure storage).
160
What is **cyberterrorism**, and how does it target financial services?
- Deliberate hacking of computer networks to upload viruses.
- Causes data deletion, system malfunctions, and service
161
What measures can financial providers take to defend against cyberterrorism?
- Use **virus protection**, **firewalls**, and other security devices.
- Employ specialists and train staff to handle cyber threats.
162
How do terrorist attacks increase operational costs for financial providers?
- Implementing security measures (e.g., backups, cybersecurity).
- May lead to **higher fees** for customers to cover these costs.
163
What was the estimated cost of the 9/11 World Trade Center destruction by June 2002?
Between **US$33 billion and US$36 billion** (Bram et al., 2002).
164
Why are financial services particularly vulnerable to cyberterrorism?
Due to their heavy reliance on computer-based systems for transactions and data storage.
165
What broader economic effect do terrorist attacks have beyond direct costs?
They influence the **types of financial products** people buy (e.g., increased demand for insurance).
166
- indirect costs
What are the indirect costs of terrorist attacks on the economy and financial system?
A:
• They reduce confidence in the banking system and overall economy.
• Bank customers may fear depositing money or paying insurance premiums.
• Consumers may hoard cash, reduce spending, and trigger a recession.
• Investors may avoid riskier shares and bonds, leading to falling asset prices.
167
How do indirect costs of terrorism affect investment behavior?
A:
• Investors lose confidence and avoid riskier investments like shares and bonds.
• This leads to a fall in asset prices and may impact economic growth
168
- insurance policies
Why do many insurance policies exclude terrorist events?
A:
• Losses from terrorism are often excluded because:
• Probabilities are difficult to estimate.
• Potential liability is very large.
• As a result, many insurers transfer this responsibility to the state
169
How do insurance policies typically handle claims related to terrorism?
A:
• Most personal insurance policies exclude terrorism-related losses.
• Injured individuals may not be compensated.
• Travel insurance may cover medical treatment or damage abroad, but not always
170
- money laundering
What is money laundering and why is it done?
A:
• It hides the illegal origin of money from crimes like robbery, drug dealing, or tax evasion.
• Converts ‘dirty’ money into a form that appears legitimate or ‘clean’
171
How is money laundering linked to terrorism?
A:
• Terrorist activities are often financed using proceeds of crime.
• Money laundering allows these proceeds to enter the financial system undetected
172
What responsibilities do banks have in preventing money laundering?
A:
• Comply with strict laws and regulations.
• Check the origin of deposited money.
• Monitor transactions for suspicious activity.
• Report suspicions to a money laundering officer.
• Verify customer identity and understand the business relationship
173
What is the role of the FCA in money laundering regulation?
A:
• The FCA (Financial Conduct Authority) is responsible for combating financial crime, including money laundering
174
Give an example of how banks comply with money laundering regulations.
A:
• If a customer deposits a large amount of cash, bank staff must investigate the source and report suspicions to the money laundering officer
175
How do money laundering procedures affect banks and customers?
A:
• They increase provider costs.
• These costs may be passed on to customers through fees and charges
176
MC
In times of economic uncertainty:
a. Lenders make it easier for businesses and individuals to take out loans and mortgages
b. Individuals tend to move their investments into gilts or cash
c. Governments tend to spend less on welfare benefits
d. Individuals tend to move their investments into stocks and shares
B
177
Who has a duty to check the accuracy of a company’s accounts?
The compliance manager
The auditors
The board of directors
The customers
The auditors
178
Extreme weather, especially flooding, has led to an increase in:
Car insurance prices
Home insurance prices
Pet insurance prices
Life insurance prices
Home insurance
179
The term ‘ethical operations’ refers to how the systems that we have set up, and with high we live and work, can be maintained into the future
True
False
False
180
Gross domestic product (GDP) measures a country’s economic activity by reference to its:
A. Tortola output of financial service products, usually measured at their market prices
B. Totally output of goods and services, usually measures at their production costs
C. Total of imports and exports, usually measured at their market prices
D. Total output of goods and services, usually measured at their market place
D
181
Outsourcing is:
A. The process of one provider paying another to carry out certain functions that it would normally do itself
B. The practice of moving some of a company’s operational functions to overseas locations
C. Bringing some of the functions that had been moved oversees back to the UK
D. Finding financial products not provided by the bank that you have your current account with
A
182
In the event of a major failure of the financial system, the customers of the failed banks would be hit immediately.
True
False
True
183
An increase in the UK interest rates may lead to:
A. A fall in consumer spending
B. An increase in consumer spending
C. More demand for UK goods and services
D. A fall in demand for savings products
A
184
A fall in the price of oil is:
A. Good for the uk’s finances
B. Bad for the uk’s finances
C. Has no real impact on the uk’s finances
D. Never going to happen
A
185
Improving levels of financial inclusion and literacy in the UK, particularly amongst vulnerable groups, is an example of:
Corporate social responsibility
Environment ethics
Product sustainability
Exploitative
Csr
186
The relationship between sterling and interest rates mean that:
A. If interest rates rise, demand for sterling falls
B. If interest rates rise, demand will be erratic
C. If interest rates rise, demand for sterling is unaffected
D. If interest rates rise, demand for sterling rises
D
187
Once a country has joined the euro it:
A. Follows the ECB’S fiscal policy
B. No longer sets its own interest rates
C. Closes down its central banks
D. No longer sets its own financial budget
A
