Yr2 Financial Markets and Monetary Policy Flashcards
1
Q
PART 1
A
THE STRUCTURE OF FINANCIAL MARKETS
2
Q
What are the 4 functions of money?
A
- Medium of exchange
- Unit of account
- Store of value
- Standard of deferred payment
3
Q
What are the characteristics of money? (6)
A
- Acceptable to all
- Portable
- Durable
- Divisible
- Limited
- Difficult to forge
4
Q
What are some factors that determine how much money an individual holds?
A
- Disposable income
- Upbringing
- Interest rates
- Savings
- Spending habits
- Taxes
- Inflation rate
- Precautionary reasons
- Speculation of bond prices
- Transactions
5
Q
What is the liquidity preference theory?
A
The availability of liquid assets to a market or company
- how an individual chooses to hold their money (cash vs investment)
6
Q
What is debt?
A
Finding a financier who will lead to a sum in return for interest payments
7
Q
What is equity?
A
Having an equity financier who will invest money in return for a percentage stake in the business ownership and any profits
8
Q
How do you show loanable funds on a diagram?
A
Interest rate (y axis) and Q of loanable funds (x axis)
Savings = supply
Investment = demand for loans
9
Q
DEBT FINANCING
- Examples
- Positives
- Negatives
A
- bonds
- mortgage
- bank loan
- repayments remain constant and aren’t dependent on how the business performs
- relationship with financier ends on date of repayment
- may risk loss of personal assets
- interest payments made
- possible loss of entire business
10
Q
EQUITY FINANCING
- Examples
- Positives
- Negatives
A
- venture capitalists
- shares
- angel investors
2.
- do not have to pay back money
- investor takes all the risks
3.
- have to share profits
- loss of management control
11
Q
How do you show equilibrium in the money market?
A
X axis > quantity of money
Y axis > interest rates
Supply curve > perfectly inelastic
Demand curve > downwards sloping (consumer money)
12
Q
What are the 4 parties involved in the financial systems?
A
- Savers
- Financial markets
- Financial intermediaries
- Borrowers
13
Q
What are the 3 markets involved in the financial market and what are they?
A
- The money market
- short term finance market - The capital market
- medium/long term finance
> shares + corporate bonds - The foreign exchange
- currency market
14
Q
What are the two subsections of the capital market and what do they entail?
A
- Primary Market (new issue market)
- new issue bonds + shares - Secondary Market
- sale of existing bonds + shares
- exists for liquidity reasons
15
Q
What are the two subsections of The Foreign Exchange Market and what do they entail?
A
- Spot Market
- holidays > consumers - Forward Market
- investors predicting the value of currencies
16
Q
What is a bond?
A
An ‘IOU’ from an organisation or government to you as an investor, promising to pay you back the value of that bond at the end of a fixed period
- interest is also paid at a fixed rate
17
Q
What is an “interest” or “coupon rate” in terms of bonds?
A
Regular income from a bond
18
Q
What is the maturity date in terms of bonds?
A
When the bond promise expires and must be repaid
19
Q
What is par in terms of bonds?
A
Value of a bond at intervals over its lifespan
20
Q
What is yield in terms of bonds?
A
Advantage of purchasing the bond after the original trading date
21
Q
What are “risks” and “default” in terms of bonds?
A
If the government of a business is unable to pay you back
22
Q
Is income from a bond liable to taxation?
A
yes
23
Q
What type of relationship is there between bond value and general interest rates?
A
Inverse
24
Q
Formula for yield of a bond?
A
(Annual coupon rate / Gilt’s current market price ) x100
25
Formula for current price of a bond?
(Annual coupon rate / yield ) x100
26
What is a government bond used for?
To finance budget deficits
27
What are corporate bonds associated with and which market are they in?
High risk if they default > therefore large secondary market
28
PART 2
COMMERCIAL BANKS AND INVESTMENT BANKS
29
What is a central bank?
Government banks that set national things such as interest rates
30
What are commercial banks?
Residents banks
31
What are investment banks?
Business banks
32
What are assets and examples?
”Owned” by the bank
- cash
- Balances at the Bank of England
- loans (advances) > added payments
- fixed assets > buildings etc
33
What are liabilities and what are some examples of this?
“Owed” by the bank
- customer deposits
- money owed to bond holders
- money owed to other banks
34
PART 3
CENTRAL BANKS AND MONETARY POLICY
35
What are the two key functions of central banks and monetary policy?
1. To help the government maintain macroeconomic stability
- 2% inflation
2. Bring about financial stability in the monetary system
- acting as lender of the last resort e.g. 2008
36
What are the 4 functions of central banks?
1. Controlling the issue of notes
> how many in circulation
2. Acting as the bankers’ bank + government bank
3. Buying and selling currencies to influence the exchange rate (not all)
4. Liaising with overseas central banks and international organisations
37
MONETARY POLICY COMMITTEE
1. What is it a subsection within?
2. How often to they meet?
3. What do they determine?
4. How many members are there?
5. Name the members?
1. Bank of England
2. Once a month
3. The base rate > interest rates
4. 9
5. Governor of BofE, three deputy governors, Banks Chief Economist, external members selected by chancellor of the Exchequer.
38
What are the two types of monetary policy?
- conventional
- unconventional
39
What is conventional monetary policy?
Changes in interest rates
40
What is unconventional monetary policy and when did they start using it?
Quantiative easing + forward guidance (trying to signal future trends + business planning)
2008 onwards
41
PART 4
THE REGULATION OF THE FINANCIAL SYSTEM
42
What is moral hazard?
This exists in a market where an individual or organisation takes many more risks than they should do because they know that they are either covered by insurance, or that the government will protect them from any damage incurred as a result of those risks
43
What is asymmetric information?
This type of market failure exists when one individual or party has much more information than another individual or party, and uses that advantage to exploit the other party
44
What is market rigging / monopoly power?
This type of market failure is effectively collusion or abuse of power resulting from a concentrated market. When there is a small number of firms in the market, they may choose to work together to increase their joint profits and exploit consumers
45
What are market bubbles / herd mentality?
Exists when the price of something is driven well above what it should be, usually due to the behaviour of consumers
46
What are externalities?
Exists when a market transaction has negative consequence for a 3rd party or a transaction has a positive consequence for a 3rd party/ We can also talk about network externalities, whereby there are knock-on effects of organisations working together - you could describe this as synergy if the effects are positive, or discord if the effects are negative
47
What is the Principle-Agent problem?
This situation exists when one person is able to make decisions on behalf of another person, but the second person is unable to adequately supervise the first person. This can result in the first person acting in his/her own best interests rather than the interests of the second person
48
What is speculation?
A risky action in which a person or organisation tries to predict what will happen to the price of an asset and buys / sells accordingly in order to try and make a profit
49
What is incomplete markets?
Exists when the available level of supply is not enough to meet the needs and wants of consumers i.e. only a proportion of potential demand is met
50
What is a financial crisis?
A disturbance to financial markets, associated typically with falling asset prices and insolvency among debtors and intermediaries, which ramifies through the financial system, disrupting the markets’ capacity to allow capital
51
What are the types of financial crisis? (7)
1. Currency crisis when a fixed exchange rate regime collapses or a currency goes into a free fall
> D and S forces determine value
2. Balance of Payments (BofP) or external debt crisis
3. Sovereign debt crisis
4. Baking crisis
> 2008 (household debt crisis + snowballing effect)
5. Corporate debt crisis
> businesses defaulting on loans
6. Household debt crisis
7. Broad financial crisis that combines many elements of the above crises
52
What are some of the recent financial market failures?
1. The sub-prime mortgage crisis
2. Global financial crisis
3. Euro-zone crisis
4. The 2010 Wall Street flash crash
5. The lib or scandal
6. The Enron scandal
53
What are the 3 key regulators of the financial market?
1. Financial Policy Committee of the Bank of England
2. UK Prudential Regulation Authority (PRA)
3. Financial Conduct Authority (FCA)
54
How does the Financial Policy Committee of the Bank of England regulate the market?
Micro + macro prudential policy
- identify, monitor and take action to remove or reduce risks
- publishes reports
- power to instruct commercial banks to change their capital buffers
55
How does the UK Prudential Regulation Authority (PRA) regulate the marking?
Micro > one firm
- supervise around 1,700 banks, building societies
- particular focus on the solvency of the specific financial markets e.g. insurance, credit providers, buy to let mortgages lenders
- require specific institutions to maintain capital and liquid ratios
56
How does the Financial Conduct Authority (FCA) regulate markets?
+ what are the three key objectives
Micro and macro policy
- funded by the firms it regulated
- 3 objectives
> secure protection for consumers
> protect + enhance integrity of UK financial systems
> promote effective competition in the interests of consumers
57
What are systemic risks?
When one element of the financial markets collapses, causing a snowballing effect, meaning the whole financial system collapses
58
What is the equation for liquidity ratios?
Liquid assets / liabilities
59
What is the equation for capital ratios?
Capital / exposures
60
What are the 6 key risks to the UK financial stability?
1. High levels of unsecured consumer credit
2. Macro risks from Brexit
3. Sharp correction to share and property valuations
4. Reduce enthusiasm among foreign investors in the UK
5. UK banks are heavily exposed to the global economy
6. Geopolitical risks
61
Explain the process of capital flight risk in terms of financial instability?
1. Overseas investors become nervous about UK prospects
2. Outflow of funds causes depreciation of the sterling
3. Rise of inflationary pressure
4. Trigger high interest rates > attract investors
5. Inflation > decr real incomes + domestic demand
6. Expensive for UK gov to borrow (rising yields)
7. Slower growth then increases risk for commercial banks
62
What are the key aims of financial stability policy? (7)
1. Protect against the consequences of market failure
2. Protect the interests of consumers
3. Limit monopoly power of commercial banks
4. Protect borrowers from high IR
5. Improve access to affordable financial services
6. Information asymmetry
7. Encourage confidence
- promote investment and LR growth
- allow central bank to perform other roles
- prevent + mitigate systemic risks
