4.4 The Financial sector

Question 1

Financial markets

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

• demand for services
• to allow speculation and financial gains

Question 3

role of financial market

Answer 3

• to facilitate savings
• lend to businesses and individuals
• they facilitate the excange of goods and services
• they provide forward markets
• provide a market to equities

Question 4

market failure in the financial sector - asymmetric information

Answer 4

• financial institutions often have more knowledge comapred to their customers - meaning they can sell them products that they do not need, are cheaper elsewhere or are riskier than the buyer realises.
• there can be asymmetric institutions between financial institutions and regualtors

Question 5

market failure in the financial sector - externalities

Answer 5

• There are a number of costs placed on firms, individuals and the government that the
  financial market does not pay.

Question 6

market failure in the financial sector - moral hazard

Answer 6

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

Question 7

market failure in the financial sector - speculation and market bubbles

Answer 7

• all trading in financial markets is speculative and this leads to the creation of market
  bubbles, where the price of a particular assets rises massively and then falls.
• herding behaviour
• housing market is a bubble

Question 8

herding behaviour

Answer 8

• 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.
• This leads to prices becoming excessively high and eventually enough investors decide that the price will fall, so they sell their assets and panic sets in, causing mass selling.

Question 9

market failure in the financial sector - market rigging

Answer 9

• a group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves - insider trading
• individuals or institutions affect the price of a commodity, currency or asset to benefit themselves

Question 10

role of the central bank

Answer 10

• controls monetary policy
• acts as a banker to the government
• act as the bank to other banks
• regulate financial system

Question 11

what can financial regulation include

Answer 11

• banning market rigging; preventing the sale of unsuitable products
  maximum interest rates to - prevent consumer exploitation and prevent excessively risky lending
• deposit insurance to protect consumer deposits and
  increase stability
• liquidity ratios, when banks are forced to hold a certain percentage of liquid assets.

Question 12

three key bodies of financial regualtion

Answer 12

• FPC
• PRA
• FCA

Question 13

FPC

Answer 13

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

Question 14

PRA

Answer 14

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

Question 15

FCA

Answer 15

protects consumers, promotes competition and enhances the
integrity of the system by preventing market rigging.