Financial Markets

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  • Created on: 08-06-18 09:20
Financial market
A place where individuals can trade financial assets.
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Lenders
Individuals who sell financial assets (e.g. savers, investors etc).
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Borrowers
Individuals who buy financial assets (e.g. consumers, firms, government etc).
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Bond market
A financial market where government or corporate bonds are sold.
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Stock market
A financial market where shares for businesses are sold.
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Intermediaries
Organisations which act as financial marketplaces (e.g. commercial banks, investment banks etc).
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Commercial bank
An organisation which allows savers to deposit money which can be lent to borrowers.
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Investment bank
An organisation which purchases large quantities of shares and equity which are sold to investors.
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Hedge fund
An organisation which borrows money from and invests on behalf of lenders to generate high returns (tend to be more risky, but more regulated).
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Money market
A financial market where assets are traded which have a maturity of (must be paid back by) a year or less.
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Capital market
A financial market where assets are traded which have a maturity of (must be paid back by)
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Debt capital
Financial assets which must be paid back with an interest rate levy (debt).
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Equity capital
Financial assets which generate a return for the lender (e.g. shares).
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Primary capital market
New financial assets are issued.
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Secondary capital market
Existing financial assets are traded.
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Currency market
A financial market where currencies are traded.
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Spot currency market
Currency is sold at the current exchange rate and is delivered instantly.
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Futures currency market
Currency is sold at the current exchange rate but is delivered in the future (useful for importers concerned of a depreciation).
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Money supply
The amount of money in circulation in an economy.
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Functions of money
Medium of exchange, Store of value, Measure of value (unit of account), Standard of deferred payment
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Characteristics of money
Durable, Acceptable as medium of exchange, Divisible into smaller amounts, Portable, Scarce, Difficult to forge
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Narrow money (M0)
A measure of money supply which only takes into account the most liquid assets (e.g. cash/coins, and deposits in bank accounts).
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Broad money (M4)
A measure of money supply which takes into account less liquid assets as well as liquid assets, such as bonds with high maturity.
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Fisher equation
MV=PQ (Money Supply x Velocity of Circulation = General Price Level x Output GDP)
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Velocity of circulation
The frequency of transactions in an economy.
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Interest rate
The reward for saving or cost of borrowing. Acts as a way for banks to make profit.
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Reserve ratio/requirement
A % of capital that banks must keep reserved by law.
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Bank rate
The cost of commercial banks borrowing from a central bank.
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How are interest rates set in the short run?
Increase in the money supply (shift right of MS) leads to a fall in interest rate (IR) as the scarcity of money available to banks is reduced.
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How does a change in reserve ratio requirement affect interest rates?
Decrease in reserve ratio requirement increases the amount of money banks can lend out, so money supply increases, leading to a reduction in interest rates.
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How does a change in the bank rate affect interest rates?
Decrease in the bank rate reduces the cost of borrowing to commercial banks, leading to increase in the amount of money they borrow. This leads to increase in money supply and thus reduction in interest rates.
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How can the central bank engaging in open market operations affect the interest rate?
Central bank can purchase bonds. If a return is made, this increases the amount of money available for lending to commercial banks, resulting in a reduction in the bank rate (see bank rate card).
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Bond
A type of financial asset which guarantees repayment + interest. It is popular because it is a low-risk and usually high return asset.
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Coupon
A fixed rate of interest over the duration of the bond.
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Maturity
Time when a bond is paid back.
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Nominal value of a bond
The true value of a bond (differs from market price). E.g. a carrot might cost 50p at one store, and 30p at another. Different price, but the product is still the same carrot.
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Bond yield
The true rate of return on a bond.
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Bond yield formula
Coupon / Market Price x100
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How do banks create credit? (fractional reserve banking)
Savers save their money in banks. Part of this deposit is used by the bank to lend to borrowers. Borrowers use this to fund economic activities which generates income. Part of this income is then paid back to the bank which can be used for lending.
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Money multiplier formula
1 / Reserve Ratio
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Credit created formula
Money Multiplier x Original Deposit
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Functions of commercial banks
Deposits from savers, lend to borrowers, act as a financial intermediary, give advice, provide a framework for payments to occur
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Functions of investment banks
Prop trading, create new markets, give advice to mergers/acquisitions, issue new bonds/shares
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Bank run
When a bank has insufficient liquid assets to meet short term liabilities resulting in savers rushing to retrieve their money from the bank).
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Insolvency
When a bank has insufficient capital to offset losses in asset value. Liabilities > Assets
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Role of central bank in the financial system
Implement monetary policy, act as a banker to government and commercial banks, regulate financial system
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Other cards in this set

Card 2

Front

Lenders

Back

Individuals who sell financial assets (e.g. savers, investors etc).

Card 3

Front

Borrowers

Back

Preview of the front of card 3

Card 4

Front

Bond market

Back

Preview of the front of card 4

Card 5

Front

Stock market

Back

Preview of the front of card 5
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