4.4 The Financial Sector

Question 1

The Money Market

Answer 1

Short term finance for business and households
Money is borrowed and lent
Includes short term gov borrowing

Question 2

Capital market

Answer 2

Shares and bonds are issued to raise finance
Includes issuing gov bonds

Question 3

Foreign exchange market

Answer 3

Where currencies are exchanged
Gains or losses made through exchange rates

Question 4

Key roles of financial markets

Answer 4

Facilitate saving by businesses and households
Lend to borrowers and individuals
Allocate funds to productive users
Facilitate exchange of goods and services
Provide forward markets in currencies and commodities

Question 5

Characteristics of Money

Answer 5

Durability
Portable
Divisible
Hard to Counterfeit
Generally accepted by population
Valuable and holds value overtime

Question 6

Functions of Money

Answer 6

Medium of Exchange
Store of value
Unit of account- can be expressed in and understandable way that allows comparison of items
Standard of deferred payment- expressing the value of a debt

Question 7

Narrow Money

Answer 7

Measure of value coins and notes in circulation and other money equivalents that are easily convertible into cash such as short-term deposits in the banking system

Question 8

Broad Money

Answer 8

Measure of total money held by households and companies in the economy
Made up of commercial bank deposits- which are IOUs from commercial banks to households and companies

Question 9

Long term loans

Answer 9

Share capital
Retained profit
Venture capital
Mortgages
Long-term bank loans

Question 10

Medium-term loans

Answer 10

Bank loans
Leasing
Hire purchase
Gov grants

Question 11

Short-term Loans

Answer 11

Bank overdraft
Trade creditors
Short-term bank loans
Factoring

Question 12

Unsecured loans

Answer 12

Money supported by borrowers credit worthiness, rather than collateral

Question 13

Secured loans

Answer 13

Money you borrow that is secured against an asset you own

Question 14

Asymmetric information

Answer 14

Market failure exists when one party has more information than another and then uses that to exploit the other party

Question 15

Moral hazard

Answer 15

Exists where an individual or organisation takes more risks because they know that they are covered by insurance, or expect that the government will protect them from any damage incurred as a result of those risks

Question 16

Speculative bubble

Answer 16

A sharp and steep rise in asset prices such as shares, bonds, housing, commodities or crypto-currencies
The bubble is usually fuelled by high levels of speculative demand which takes prices well above fundamental values

Question 17

What causes speculative bubbles

Answer 17

Behavioural Factors- herd behaviour
Exaggerated expectations of future price rises
Period of low monetary policy

Question 18

Market Rigging

Answer 18

This market failure is collusion or abuse of the power resulting in a concentrated market
Happens when some companies in a market act together to stop a market working as it should in order to gain a competitive advantage.

Question 19

Barriers of entry into commercial banking

Answer 19

Regulatory barriers- need to be given a banking licence by the central bank
Costs of entry
Strategic advantages of larger banks

Question 20

Main function of central bank

Answer 20

Monetary policy function- interest rate, QE, exchange rate
Financial stability
Policy operation functions- lender to bank, manage liquidity of banks
Debt management - handle gov bonds

Question 21

Monetary Policy

Answer 21

Changes in interest rates, supply of money and credit and exchange rates to influence the economy

Question 22

Expansionary Monetary Policy

Answer 22

Reducing nominal and real interest rates
Steps to expand the supply of credit from the banking system via QE
Depreciation of the external value of the exchange rate

Question 23

Deflationary Monetary Policy

Answer 23

Higher Interest rates on both loans and savings
Tightening of credit supply
Appreciation of the external value of the exchange rate

Question 24

What is QE?

Answer 24

Increasing the supply of money available for banks to lend
Bank creates new money to buy gov bonds which stimulates their spending

Question 25

Reasons for QE

Answer 25

Gives central bank an extra tool of monetary policy besides changing interest rates
Without QE unemployment may rise due to fall in rGDP
QE can lead to depreciation in exchange rate which will lead to more competitive exports

Question 26

Arguments against QE

Answer 26

Really low interest rates can lead to misallocation of capital to zombie businesses
QE leads to possible increase in house prices and increased rent prices
QE has done little to increase bank lending to businesses as many commercial banks have became more risk averse
QE lowers interest rates which will worsen the return for those who hold savings