The financial sector Flashcards
class 9
Functions of banks (5)
- financial intermediary (make money by charging higher interest rates than they pay)
- pool savings
- spread lending risk
- payment services
- long term loans from short-term deposits (creates the risk of bank runs)
maturity transformation
using short-term deposits to make long-term loans
Explain the fractional reserve system
hold a small percentage of deposits in cash
Is there a legal reserve requirement in Canada?
No
Explain a bank run, is it frequent in Canada?
if all or most depositors try to withdraw their money, the bank doesn’t have enough cash to give everyone their money
- very infrequent in Canada
Are banks in Canada conservative
Yes, they have required capital ratios, but capital doesn’t have to be held in cash
Canadian Deposit Insurance
deposits insured for up to $100,000 in a wide range of deposits
Shadow banks
Get their funds from depositors who can withdraw their money at any time, and they use those funds to make long-term loans to investors (no deposit insurance, more freedom)
Functions of bonds (3)
- move money from savers to borrowers (mostly for investment)
- fund government debt
- spread risks and creates liquidity – lenders can sell debt easily
Risks of bonds (3)
default risk – risk of not being paid
term risk – changes in interest rates change the value of a bond
liquidity risk – bonds might be hard to sell
- government bonds are the safest bonds
Functions of the stock market (3)
- channel funds from savers to borrowers
- spread risks
- reallocate control
Bonds vs Stocks (3 characteristics)
bonds: specified future interest payments, first in line to get paid if the company goes bankrupt, no control in the company
stocks: uncertain dividends, last in line to get paid, have a vote on how the company is run
What drives the price of shares
demand – how many stocks investors will buy at each price (risk and interest rates)
supply – how many stocks investors will sell at each price
2 types of stock valuation
- fundamental analysis
- relative valuation
fundamental analysis (what is it and how do you do it)
assesses an asset’s fundamental value (forecast and value future profits)
how to assess a business’s fundamental value: 1. forecast future profits 2. discount these profits 3. add up the sum of those discounted future profits 4. divide the company’s fundamental value by the total number of shares