Financial markets

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define money
a medium of exchange or a means of payment & a store of value or a store of wealth. (measure of value and as a standard deferred payment, unit in which the prices of goods are quoted and which accounts are kept.
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What is narrow money?
money which restricts the measure of money to cash and bank and building society deposits(current account deposits), reflects the medium-of-exchange function of money, functioning as a means of payment
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what is the financial market
a market in financial assets or securities. can be classified as short-dated financial assets(money markets) & markets for long-dated & undated financial assets(capital markets). foreign exchange markets and markets for commodity futures & insurance
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what is a capital market
provide a means for lenders and borrowers to satisfy their long-term financial needs
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what is a money market
provide a means for lenders and borrowers to satisfy their short-term financial needs
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what is the role of the financial market in the wider economy
economies would not be able to function. The supply of liquidity necessary to finance economic transactions would dry up. FInancial markets act as intermediaries which channel funds from those who have surplus to those who have a shortage of funds.
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cont.
Foreign exchange markets: become v difficult, if not impossible, for international trade and tourism to take place
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what is the difference between debt and equity
debt is what people owe, equity is what they own. e.g. consider a company which needs to raise money to finance it's expansion. if it borrows, the company is increasing it's debt EXPAND
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what are bonds
when companies borrow, they sell a form of company debt know as corporate bongs. Gov. bonds are a form of gov. debt. In the UK these are called gilts.
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why is there an inverse relationship between market I/R and bond prices
EG! Consider a £100 gov bond which pays the bond holder a guaranteed £5 a year in interest. If the bond price remains at £100, the bond holder earns a 5% annual year payment. If I/R inc to 10%, the second hand price of the £100 bond must fall on the
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continued!!!
stock exchange to £50 to convert the £5 guaranteed annual interest payment into a yield of 10%. Inverse relationship between the bond's price & I/R rate the bond earns if it sold in the second- hand on the stock exchange.
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what is the difference between commercial and investment banks
commerical banks(high-street banks) are commercially run financial institutions that deal with ordinary members of the general public and businesses. Although they are both profit-making organisations and commercially run institutions, investment
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banks(e.g. US-owned Goldman Sachs) are mainly involved in helping companies, other financial institutions, other organisations(e.g. gov. and it's agencies) to raise finance by selling shares or bonds to investors and to hedge against risks.
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what is the main function of a commercial bank
acting as an intermediary between households and firms, is to accept deposits from the general public that can be transferred by cheque, by debit card, to create deposits which are lent to customers who wish to borrow from their banks. & Foreign exch
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why do retail banks have to have a ratio of cash and other liquid assets
maintain customer's confidence in the bank, while generating profits for the bank. Prudent banking involves a trade off between liquidity and profitablility
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How do banks balance the risk of the security of their assets?
Non-secured loans are risky because if a customer defaults on the loan, the bank cannot recover any money. Because of this risk of non-payment of unsecured loans, banks charge higher I/R and hence make more profit than with secured loans (mortgages)
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What would be the problem if the bank kept all it's assets in the most liquid form of cash?
It would not really be a bank, but a safe-deposit institution. The banks profits would come largely from the fees it charged customers for guarding their valuables. The banks cash would be completely liquid but not profitable
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How do banks make profit?
INTEREST RATES: greedy banks may be tempted to create far too many profitable advances- banks possess influencing cash to meet customers' possible cash withdrawals. These banks would be operating on too low a ratio of cash and other liquid assets to
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cont.
the advances they have created. IF a run-in on the bank occurred, banks would crash
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Example: 2008 !
Northern Rock & US bank Lehmann Brothers sought profit through providing sub-prime mortgage loans to high-risk customers. These loans turned into bad debts when customers defaulted. Bad debt lead the bank to go out business/NR nationalised by gov.
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how do banks create credit and bank deposits??????
bank deposits created by commercial banks are the largest part of the money supply. E.g.
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what are the main function of a central bank
BofE: help the gov. maintain macroeconomic stability and to bring financial stability in the monetary system, controlling the note issue, acting as the banker's bank, gov. bank, buying and selling currencies to influence e/r. liasing w oversea CentBs
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how can macroeconomic stability be reached?
the BofE's remit is to deliver price stability and subject to that, support the gov's economic objectives such as growth and unemployment
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how can financial stability be achieved
through the central bank acting as a lender of last resort to the banking system and by the central bank's monitoring and regulation of the financial system. The lender-of-last-resort function can be defined as the readiness of the central bank to
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cont.
extend loans to bank that are solvent but have Short-term liquidity problems
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Describe how the BofE implements monetary policy
For over 30 years, control of inflation is a key objective. The gov. sets the inflation rate target, which since 2003 has been 2% CPI inflation, and instructs the BofE to operate monetary policy.
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In the 2008 recession, what happened to these macroeconomic objectives?
negative economic growth and growing une led to a situation which controlling inflation and the main policy objective was temporarily sacrificed(OC)with monetary policy being used to increase AD and bring about recovery. BofE main objective is price
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cont.
price stability, it must also support the gov.'s economic policy objectives such as growth and unemployment
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what is the bank rate?
the interest rate set by the Bank of England which the Bank uses as a benchmark for setting the I/R that it charges when lending to commercial banks or other financial institutions
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What happened in 1997 to do with the BofE?
The Treasury abandoned its hands-on-role in implementing monetary policy in 1997, when the gov. made the BofE operationally independent. The BofE now sets the Bank Rate independently of the gov.
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What is the role of the MPC(monetary policy committee)
in 1997, the MPC was created. if the Bank wished to pursue an expansionary monetary policy to boost spending in the economy, usually when the CPI inflation rate is below 2%, the MPC will cut bank rate. If The Bank wishes to pursue contractionary op
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what factors are considered by the MPC when setting the Bank Rate?
the une rate, level of saving, changes in retail sales, external shocks, consumer/business confidence, state of the housing market & market for mortgages, movement in the pound's exchange rate
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What are the simple effects in the exchange rate on the economy?
a fall in the ex/r makes exports more competitive in the world markets but imports less price competitive in the UK market. the BOP on current account improves and AD increases
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What are the longer term effects on ex/r changes?
whether there was significant une in the economy before ex/r fell on the slope of the SRAS curve of the initial point of the macroeconomic equilibrium. If the increase in PL is deemed to high by the MPC, the Bank Rate may raise to reduce AD
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describe the monetary policy transmission
diagram
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How does the BofE influence the growth of the money supply
for many decades, the BofE has been operating accommodating monetary policy, which which it allows the money supply to increase or decrease so that the stock of money in the economy equals the amount of money people wish to hold at current market i/r
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cont.
Base rates: 0.5% from 2009 to 2016, other monetary policy instruments have been introduced to influence the growth of the money supply E.g. QE
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When has QE been used & why
2009-2012 used primarily to increase the money supply directly- also affects LT I/R and therefore the demand for loans. When QE started in 2009, the BofE hoped that it would revive consumer and business spending and increase economic growth
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How does QE work?
Buying Gilts: sellers of assets have more money to spend. If they buy assets(shares, corporate bonds), push up prices of assets, making the people who own them(directly/through pension funds) better off so they may spend more.
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cont.
higher asset prices means lower yields, reducing the cost of borrowing for businesses and households, boosting spending. Banks will hold more reserves, may boost their lending to consumers and businesses. Borrowing increases, so does spending.
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how is the financial system regulated in the UK??????
financial regulation involves limiting the freedom of banks and other financial institutions, and the people they employ, to behave as they otherwise might wish to do. Financial regulation by the FPC at the BofE by the PRA and by the FCA, not in BofE
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What is the FPC responsible for?
Macroprudential regulation: concerned with identifying, monitoring and acting to remove risks that affect the stability of the financial system as a whole
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What is the PRA responsible for?
Microprudential regulation: focuses on ensuring the stability of individual banks and other financial institutions. It involves identifying, monitoring and managing risks that relate to individual firms
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why do bank failures occur?
as banks are financial institutions which "borrow short but lend long". much of the assets that commercial banks possess results from the creation of deposit liabilities which consumers can instantly withdraw. Bank's assets are usually long term
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cont.
(e.g. 25 year mortgages granted to finance house purchase). Banks can fall victim to rouge bank workers who steal huge amounts of money from the banks that employ them.
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WHy might banks fail?
insufficient liquidity makes a bank vulnerable to a run on the bank and insufficient capital exposes the bank to the risk of a fall in it's assets
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What is a liquidity ratio?
ratio of cash and other liquid assets owned by the bank to its deposit liabilities. Liquidity is the measure of the ease and ability with which assets can be coverted to cash. to remain viable, banks must have enough liquid assets for withdrawals
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what is a captial ratio?
amount of capital on a bank's balance sheet as a proportion of loans. If banks do not have sufficient capital, they are at risk if the value of their assets fall.
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what is a captial ratio?
amount of capital on a bank's balance sheet as a proportion of loans. If banks do not have sufficient capital, they are at risk if the value of their assets fall.
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what is moral hazard?
exists where a bank pursues profit and takes on too much risk in the knowledge that if something goes wrong, someone else will bear a significant portion of the cost. investing in high risk assets can lead to high profits, but unless there is possibi
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cont.
possibility that financial institutions will be allowed to fail, there is an incentive for risky behaviour with high rewards.
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link moral hazard to the 2007/8 recession
banks are tempted to take too much risks in pursuing large profits. They do this as they believe that the Bank of England, in it's role as lender of last resort, and the gov, throughout its bailouts will not allow banks to fail.
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What is the difference between systemic risk and a one-off shock?
one-off shock effects 1 bank without rippling into the rest of the banking system. systemic risk affects the entire banking system & other financial institutions. Can effect the whole economy bc of role banking and finance is big.
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What is narrow money?

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money which restricts the measure of money to cash and bank and building society deposits(current account deposits), reflects the medium-of-exchange function of money, functioning as a means of payment

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what is the financial market

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what is a capital market

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what is a money market

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