Financial Sector

Question 1

what is a financial market

Answer 1

where buyers and sellers can buy and trade a range of services or assets that are fundamentally monetary in nature

Question 2

why do financial markets exist

Answer 2

1. meet demand for services
2. allow speculation and financial games

Question 3

what are the types of financial markets

Answer 3

1. money - short term saving and lending
2. capital - longer term financing
3. foreign exchange
4. commodity
5. derivative
6. insurance

Question 4

what are the types of financial institutions and what to they do

Answer 4

1. retail banks - services to households
2. commercial banks - services to businesses
3. investment banks - trade in foreign exchange, commodities, bonds, shares and derivatives for speculation purposes as well as giving advice to firms on how to raise finance and on mergers
4. saving vehicles
5. central bank - responsible for controlling the money supply, monetary policy, manage the country’s gold and foreign currency reserves and to issue government debt

Question 5

what are the 5 roles of the financial market

Answer 5

1. facilitate savings
2. lend to businesses and individuals
3. facilitate the exchange of goods and services
4. provide forward markets
5. market for equities

Question 6

what are forward markets

Answer 6

firms are able to buy and sell in the future at a set price. exists for commodities and in foreign exchange and helps to provide stability

Question 7

what is a market for equities

Answer 7

issuing shares is an important way for companies to finance expansion but people would be unlikely to buy shares if they were unable to sell them on in the future. financial markets provide the ability for shares to be sold in the future, making the asset more appealing

Question 8

what is asymmetric information and the issues it causes

Answer 8

• financial istitutions often hvae more knowledge compared to their customers
• they can sell them products that they do not need, are cheaper elsewhere or are riskier than the buyers realise
• can be asymmetric information between financial institutions and regulators - institutions have little incentive to help regulators understand their business

Question 9

what are the issues with externalities of financial markets

Answer 9

costs are placed on firms, individuals and the government that the financial market does not pay

Question 10

what are the moral hazard issues of financial markets

Answer 10

• make decisions in their own best interests knowing there are potential risks
• individual workers take adverse risk in order to increase their salary
• the central bank is the lender of the last resort and so will not allow them to fail because of the impact it would have an economy

Question 11

what are the issues with speculation and market bubbles from financial markets

Answer 11

• creation of market bubbles, where the price of a particular assets rises massively and then falls
• they tend to occur because investors see the price of an asset is rising and so decide to purchase this asset as they believe the price will continue to rise and will profit them in the future
• leads to prices becoming excessively high and eventually enough investors decide that the price will fall, sp they sell their assets and panic sets in, causing mass selling
• known as herding behaviour

Question 12

what are the issues with market rigging in financial markets

Answer 12

• group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves
• insider trading = individual or institution has knowledge about something that will happen in the future that others do not know so can buy or sell shares to make profit
• individuals or institutions affect the price of a commodity, currency or asser to benefit themselves

Question 13

what are the 4 roles of the central bank

Answer 13

1. controls monetary policy
2. banker to the government
3. bank to other banks
4. regulate the financial system

Question 14

what does being a bank to other banks involve for the central bank

Answer 14

• deposit their money within the central bank and this is often used to balance the accounts of banks
• they are a lender of last resort
• if a bank experiences liquidity problems, they can turn to the central bank to sell their illiquid assets or to take a loan in the short term

Question 15

what does regulating the financial system involve for the central bank

Answer 15

prevent financial institutions from undertaking activities which harm consumers or engage in risky activities which would lead to collapse or systemic collapse

Question 16

what does banker to the government involve for the central bank

Answer 16

hold the government’s bank account and lend to them, holding government debt, as well as holding gold and foreign exchange reserves

Question 17

what are the three key bodies for financial regulation

Answer 17

1. FPC
2. PRA
3. FCA

Question 18

what does the FPC do

Answer 18

identifies are reduces system risk and supports government economic policy (macroprudential)

Question 19

what does the PRA do

Answer 19

• ensures competition
• ensures consumers have access to services
• minimises risk should a bank fail and ensures banks take responsible action
  (microprudential)

Question 20

what does the FCA do

Answer 20

• protects consumers
• promotes competition
• enhances the integrity of the system by preventing market rigging

Question 21

what are examples of financial regualtion

Answer 21

• preventing the sale of unsuitable products
• maximum interest rates to prevent consumer exploitation
• prevent excessively risky lending
• deposit insurance to protect consumer deposits and increase stability
• increase liquidity rations - when banks are forces to hold a certain percentage of liquid assets