Unit 1 - Financial Institutions Flashcards
What does the Bank of England do?
Central bank. Carries out govt policy Issues bank notes Acts as banker to commercial banks. Sets interest rates
Influence of Bank of England on money markets
- Bank intervenes in mmarkets to influence interest rates.
- Looks to encourage development of private sector markets
- Satisfies marginal liquidity requirements of banks (through 2 week repos), ensuring overall liquidity
What are money markets?
Cash deposits and short term securities (T bills and bills of exchange)
Influence of Bank of England on currency markets
Govt holds gold and foreign currency (foreign reserves).
Bank sells these for £ (therefore reducing £ in market, £ rises) and vice versa
How does Bank of England influence markets?
Money markets to set interest rates
Foreign reserves to influence exchange rates
What is the Debt Management Office?
Responsible for issuing Treasury Bills in a weekly auction
New issues of gilts - DMO
When Govt has Public Sector Net Cash Requirement, it instructs DMO to sell gilts:
- Auctions - for public offerings
- Tap stocks - to Gilt Edged Market Makers
- Syndication - issuer appoints group of banks to manage sale
Buying gilts - DMO
DMO tends to buy gilts weeks/months before it matures to prevent big cash call. May buy back if a Public Sector Debt Repayment
Regulation - DMO
15 GEMMS - only them allowed to buy/sell gilts from Bank/DMO
- given favourable tax treatment
Quantitative Easing
Monetary policy to increase supply of money.
1) Central bank credits own account with money it creates
2) Purchases financial assets (e.g. gilts) - open market ops
3) Or changes fractional reserve system
Stock exchange - key roles
1) Raise new finance for companies
2) Provide a secondary market for investors
Stock exchange - main lenders
- Pension funds
- Life insurers
Securities dealt on stock exchange
- Gilts/bonds/bulldogs
- OS, PS, debentures, ULS, Eurobonds
- No money markets or derivatives
Stock exchange markets
Gilt edged market
UK fully listed securities
Alternative investment market (AIM)
Overseas securities
Role of SE - provide a market
SEAQ - stock exchange automated quotations - market makers enter quotes into SEAQ, deals over phone
SETS - stock exchange electronic trading service - 200 FTSE stocks - firms display bid and system automatically matches orders
Role of SE - regulate market
SE recognised under FSMA2000
Members - need to follow standards
Transactions - price/time/volume of trades must be reported
Companies - listing requirements
Role of SE - settlement of trades
Registrar needs to be informed, share/bond cert transferred and money changes hands.
Equities - 2 days on CREST
Gilts - day after
Role of SE - providing information
Stock exchange daily official list (SEDOL) shows price/volume of all transactions
Derivative exchanges
Over the counter (traded directly) or through exchange - use clearing systems to prevent counterparty risk
Investment banks
- Financial advice (M&As, raising capital, issuing finance/eurobonds)
- Fund management (manage unit trusts, pension funds, eurobond market)
- Money market operations (accept bills of exchange, hold T bills, issue certs of deposit)
- Act as brokers for OTC derivatives, trustees for debenture issues
Clearing banks
Funds come from current accounts, savings accounts from private individuals through high street
Banks lend money through overdrafts and loans
Clearing banks - investment markets
CBs have big influence on money market, bill markets, gilt markets etc
Lend to each other based on LIBOR rate
Building societies
- Not as prominent in commercial money market
- Lending dominated by house-purchase mortgages
- Smaller than banks
Will invest in short dated gilts or other banks/BS with CODs
Investment trusts
Companies with directors, investment managers and shareholders. Listed on SE and raise debt/equity from other investors.
Hold money in other companies/gilts/property - specialist
No change in total no of shares
Price of share in investment trust
Supply/demand - usually at discount to NAV, as investment management charge and shares less marketable than actual asset (e.g. easier to buy BP shares)
Split capital
If trust has a set wind up date:
- Capital shares
- Income shares
Unit trust
Not companies - set up by a company, has mgmt company, trustees (usually clearing bank) and investors. Units bought/sold from management, not other investors. Don’t raise D/E. Lots of restrictions, so invest in shares.
Unit trust price
Market value of assets / no of units. Units sold at offer price which is 6% higher than bid price (mgmt buy units back at bid price and so make profit)
MVA = offer pricing (if UT expanding) MVA = bid pricing (if UT contracting)
Open ended investment companies (OEIC)
Have characteristics of ITs (companies with share price) and UTs (new shares created when money invested, with price reflecting net asset value)
Investment management companies/Fund managers
- Front office - buy/sell investments, asset allocation, stock selection
- Back office - transaction processing, custody
Issues with fund managers
- Small no of companies dominate market
- Herd behaviour
- Focus on short term performance
- High fees
- Poor action on corporate governance
- Churning of portfolios to generate commission
Self administered pension funds
Will buy medium/long dated investments
Life insurers
Typically invests in equities and FI securities. Has lots of medium/long fixed liabs (e.g. WP gtees). Some liabs are inflation linked, e.g. WP gtees. Depends on level of free assets for solvency.
General insurers
Typically invests in short/medium dated FI and MM. GI business is short term and variable (e.g. catastrophes).
Some liabs index linked as payments made are value at time
Settlement - DMO
CREST registry
