Types of Financial Markets

Question 1

Explain the role of financial markets in the operation of modern economies

Answer 1

Financial markets create products that provide returns for those who have excess funds, making those funds available to those who need additional money for consumption or investment

Question 2

What are financial intermediaries and what do they do? (x2)

Answer 2

• They are firms that hold the accumulated funds of individuals or firms as deposits, and then make loans to other firms or individuals who can make use of them.
• They create a bridge between the savers and borrowers of the economy

Question 3

Explain the sources of savings (Household, Business, Government & Overseas)

Answer 3

• The proportion of household income that is not spent on consumer goods is saved
• Businesses can save by not distributing all of their profits to their owners. The funds that are not distributed can be supplied to financial markets until needed
• When the government budgets for a surplus, this means that it is accumulating savings
• There are foreign pools of savings supplied by individuals, firms and governments from other countries that Australia can borrow from

Question 4

Explain the reasons for borrowing for (Consumers, Entrepreneurs, The Government and Financial Institutions)

Answer 4

• Consumers borrow when their demand for goods and services exceeds their current capacity to pay for them
• Entrepreneurs and businesses managers borrow to fund the operation or expansion of their business
• The government becomes a borrower of funds when it budgets for a deficit
• Australian financial institutions can lend money to overseas borrowers (Australia borrows more from overseas countries than it lends and is a net borrower in the global financial system)

Question 5

What do primary and secondary markets do?

Answer 5

Primary markets facilitate the creation of securities, that can be sold into the economy
Secondary markets involve transactions with financial assets that have already been issued on a primary market sometime in the past

Question 6

Name and describe the main financial markets in economies across the world (x4)

Answer 6

The share or equity market - where ownership shares in companies are issued or exchanged

The debt market - where debt securities are exchanged or cash is lent and borrowed

The derivatives market - where people buy and sell financial assets that are based on the value of other financial assets

The foreign exchange market - where financial assets defined in one country’s currency are exchanged for assets defined in another country’s currency

Question 7

What is the basic function of financial intermediaries?

Answer 7

They channel the excess savings from the net savers in the economy to those who wish to borrow the funds, namely the net borrowers

Question 8

Describe 6 other financial institutions (x5)

Answer 8

Finance companies - obtain most of their funds by borrowing from the general public through the issue of debt securities or from banks like non financial businesses

Investment banks generally borrow on a short term basis from companies with surplus funds and lend these funds to other large companies and government agencies

Credit unions are non-profit, cooperative organisations whose members belong to a particular trade, industry, profession or live in a particular area

Permanent building societies accept deposits from the public and provide funds mainly for home loans as well as offering personal and business loans

Superannuation funds receive the contributions of employees and invest them in financial assets in order to provide retirement income for the contributors

Question 9

What can consumer credit do?

Answer 9

It enables individuals to tap into the future streams of income that they are likely to receive in order to fund consumption in the present

Question 10

Name all financial market products (x7)

Answer 10

• Consumer credit
• Housing loans
• Business loans
• The short term money market
• Bonds
• Financial futures and options
• The foreign exchange market

Question 11

What are housing loans?

Answer 11

Long term loans used to purchase property, requiring periodic repayments with interest

Question 12

What are business loans?

Answer 12

A form of debt that allows businesses to invest in the business operations such as new technology or expanded office space

Question 13

What is the short term money market?

Answer 13

A market that brings together people and businesses with temporary shortages or surpluses of funds. Those with surplus funds such as banks issue various forms of debt securities to those in need of funds. They have a maturity date of less than a year.

Question 14

What are bonds?

Answer 14

A written record of debt. The borrower sells a bond in return for a loan. The holder of a bond receives interest payments and the final repayment. They can be sold in primary and secondary markets

Question 15

What are financial futures and options?

Answer 15

Contracts to trade financial instruments at a later date for a certain price. They allow investors to protect themselves against adverse moments in interest rates, currency fluctuations or share prices by agreeing on a price and currency at which to buy or sell the financial product now even though they don’t have to make the transaction until a later date

Question 16

What is the foreign exchange market and what does it do?

Answer 16

The market for buying and selling of foreign currencies. It enables the movement of funds all around the world.

Question 17

How does the share market play an important role in the Australian economy?

Answer 17

The share market plays an important role in the Australian economy because businesses can sell shares in their companies to raise funds needed for growth and individuals or other businesses can gain returns on their surplus funds

Question 18

What are dividends?

Answer 18

The profit returns received by the shareholders of a business

Question 19

What are capital gains?

Answer 19

The profits made by investors who sell their shares or assets at a price above the level that they originally paid for them

Question 20

What is the main reason investors purchase shares from a company?

Answer 20

To gain a stake in any company profits and to make capital gains from increases in share prices

Question 21

How are market values indicators of a country’s economic conditions?

Answer 21

Market prices rise in accordance with new and better economic prospects for companies, rising share prices will generally suggest the economy is enjoying good conditions.

Question 22

What are the central bank’s three broad objectives? (x3)

Answer 22

• The stability of Australia’s currency
• The maintenance of full employment
• The economic prosperity of welfare of the people of Australia

Question 23

Name the functions of the RBA (x4)

Answer 23

• Conducting monetary policy on behalf of the government
• Systemic stability
• Control of note issue
• Regulation of the payments system
• Banker to the banks
• Responsibility for holding Australia’s reserves of gold and foreign currency dealings
• Banker and source of financial and economic advice to governments

Question 24

How is monetary policy defined from the RBA?

Answer 24

Reserve bank action designed to influence the cost and availability of money in the Australian economy by influencing the general level of interest rates. It is important to note that the Reserve Bank conducts monetary policy with the aim of achieving a sustained low inflation rate while encouraging economic growth

Question 25

What are ES accounts used for? (x2)

Answer 25

• ES accounts are used to allow banks to settle debts between themselves, as well as with the Reserve Bank at the end of each day’s trading
• They can also be used by banks to buy and sell government securities from the RBA

Question 26

Who is the Australian Prudential Regulation (APRA)?

Answer 26

The government body established to regulate all deposit-taking institutions, life and general insurance organisations and superannuation funds

Question 27

Who is the Australia Securities and Investments Commission (ASIC)?

Answer 27

The government body with responsibility for corporate regulation, consumer protection and the oversight of financial service products

Question 28

What is the role of the Australian Treasury?

Answer 28

They influence how governments devise budgets, collect taxes, allocate expenditure, and implement other policies such as monetary policy, labour market policy and market regulations.

Question 29

What is the All Ordinaries Index?

Answer 29

The share market index measuring changes in the overall value of companies listed on the ASX