4.4.1 - Role of financial markets

Question 1

State the five roles of financial markets

Answer 1

a) To facilitate saving
b) To lend to businesses and individuals
c) To facilitate the exchange of goods and services
d) To provide forward markets in currencies and
commodities
e) To provide a market for equities (shares and bonds)

Question 2

State the three types of financial markets i

Answer 2

• currency markets
• commodity markets
• stock market

note that financial markets are essential in order to allow fo increase consumption and investment in economies due to lending

Question 3

What do financial markets act as

Answer 3

Intermediaries between lender and borrowers
- examples include investment banks, commercial banks, pension funds)

Question 4

Outline roles c and d in depth

Answer 4

• provide a means by which goods and services can be sold easily
• reduce risk and provide greater certainty by enabling commodity and currencies to be traded in futures markets

Question 5

Define forward contract

Answer 5

contract between 2 parties to buy or sell an asset at a specified future time at a price agreed upon today

Question 6

What does fractional reserve banking involve

Answer 6

Bnaks accepting depsoits from customers and making loans to borrowers, while holding in reserve only a fraction of the bank’s deposit liabilities

Question 7

How are banks reserves held

Answer 7

As cash in the bank or as balances in the bank’s account at the central banks

Question 8

What is the reserve ratio

Answer 8

• AKA reserve requirement
• minimum amount that banks are required to hold in liquid assets and is determined by the country’s central bank

Question 9

What is the purpose of capital markets

Answer 9

• provide gov and firms with medium and long term finance (issuing bonds/shares/borrowing from banks)

Question 10

Primary capital market vs seconday capital market

Answer 10

primary: for new share and bond issues
secondary: existing securities are trade, inceasing their liqudity (selling them majes it easier to convert them into spenable cash)

Question 11

What is a forward market

Answer 11

transactions that will happen at an agreed time in the future

Question 12

Process of a forward market

Answer 12

check page 189 green box cgp

Question 13

How does financial market facilitate saving

Answer 13

• allows people to transfer their spending power from the present to the future.
• It can be done through a range of assets, such as storing money in savings account and holding stocks and shares.

Question 14

How do financial markets facilitat exchange of goods and services

Answer 14

• creating a payment system. Central banks print paper money, institutions process cheque transactions,companies offer credit card services and banks and bureau de changes buy and sell foreign currencies

Question 15

Define financial market

Answer 15

A place where buyers and seller meet to trade financial assets such as stocks, bonds, currencies, derivatives
Money market - short term highly liquid debt securities like treasury bills, commercial paper and certificates of deposits; includes financial institutions, banks, and corporations seeking short term financing or investments

Question 16

How do financial markets facilitate lending

Answer 16

• access to credit is a key requirement for economic growth & development.
• Being able to borrow money speeds up consumption by households & investment by firms.
• allows households or firms to purchase assets & pay them off over an extended period of time e.g. mortgages on home purchases

Question 17

Benefit of financial markets providing forward markets in currencies and commodities

Answer 17

They provide some price stability in commodity markets & enable investors to make a profit by speculating on future prices

Essentially risk is shared between both parties, both can lose out but they have hedged against risks and reduced uncertainty so they can better plan for future e,g investment

Question 18

How do financial markets provide a market for equities

Answer 18

• equities are shares in public companies that are listed on stock exchanges around the world. Financial markets facilitate both long term investment & speculation by providing platforms which connect buyers & sellers e.g. E-Trade

Question 19

Define financial market

Answer 19

• Financial markets are any place or system that provides buyers & sellers the means to exchange goods/services & trade financial instruments
• These include bonds, equities, international currencies, & derivatives