topic sheet 8

Question 1

What are the five roles of financial markets?

Answer 1

• To facilitate saving
• To facilitate exchange of goods and services
• To lend to businesses and individuals
• To provide forward markets for commodities
• To provide a market for equities.

Question 2

Identify 4 examples of financial markets?

Answer 2

FOREX markets (currency exchange)
Capital markets (shares and bonds)
Derivative markets (futures)
Money markets (treasury bills)

Question 3

Why are financial markets important?

Answer 3

• Supports the real economy.
• Firms can raise finance.
• shown in GFC

Question 4

What is liquidity?

Answer 4

-liquidity is the ease at which an asset can be transferred to cash to settle a liability- if it is cost free and easy to turn into cash it is liquid.

Question 5

What are examples of liquid assets?

Answer 5

• Bonds

- Shares

Question 6

What are examples of illiquid assets?

Answer 6

• property

- paintings

Question 7

What is the purpose of forward market for currencies?

Answer 7

-You can prevent the risk of currency exchange fluctuations as you can agree on a set price.

Question 8

What is the purpose of forward markets for other commodities?

Answer 8

-Can help to prevent against the fluctuation of volatile commodity prices.

Question 9

What is meant by M0?

Answer 9

Narrow money, notes and coins in circulation, which makes up 3% in UK economy.

Question 10

What is meant by M4?

Answer 10

-Broad money, includes M0, money held in bank accounts.

Question 11

What is meant by asymmetric information in markets?

Answer 11

-When the buyer or the seller of the financial market, has more information that the other party that they can take advantage of, this allows one party to exploit their advantage.

Question 12

What is meant by financial rigging?

Answer 12

-when the market is fixed by a producer or group of producers so they will benefit.- this is a form of collusion, eg fixing of Libor rate.

Question 13

What is meant by a bubble?

Answer 13

• This is when an asset raises in price and people continue to buy it, causing a herd behaviour.
• The price will eventually exceed the true value
• This could cause a crash and a reversal.

Question 14

What is meant by externality in financial markets?

Answer 14

-A cost to a third party of a financial who were not part of the transaction.
Eg traders taking excessive risk which causes depositors to lose savings.

Question 15

What is meant by moral hazard in financial markets?

Answer 15

When the negative effects of the person making the financial decision do not fall on the person making the decision.
Eg big banks will take greater risks if they know they will be bailed out.