4.4 the financial sector Flashcards
(17 cards)
what are financial markets
Financial markets are where buyers and sellers can buy and trade a range of services or assets that are fundamentally monetary in nature.
why do financial markets exist
to meet the demand for services , such as saving and borrowing, from individuals, businesses and the government
and to allow speculation and financial gains.
different types of financial markets
the money market - provides short term saving and lending and the capital market which provides longer term financing
foreign exchange markets
commodity markets
derivative markets
what do retail banks provide
provide services to households, such as the payments of direct debits, saving accounts, loans and mortgages
what do commercial banks provide
provide services to businesses.
what do investment banks trade in
foreign exchange, commodities, bonds, shares, and derivatives for speculative purposes
what is a central bank
a financial institution that has direct responsibility to control the money supply and monetary policy, to manage the country’s gold and foreign currency reserves and to issue government debt.
role of financial markets
One role of the financial market is to facilitate savings, which allows people to transfer their spending power from the present to the future
they lend to businesses and individuals which allows consumption
and investment.
facilitate the exchange of goods and service s by creating a payment
system
they provide forward markets . This is where firms are able to buy and sell in the future at a set price, for example if a farmer wants to sell the crop they are growing at a guaranteed price in a month’s time.
they provide a market for equities , company’s shares
asymmetric information as a market failure in the financial markets
t financial institutions often have more
knowledge compared to their customers , both consumers and other institutions. This means they can sell them products that they do not need, are cheaper elsewhere or are
riskier than the buyer realises.
. Additionally, there can
be asymmetric information between financial institutions and regulators . The institutions have little incentive to help regulators understand their business and this causes difficulties for the regulators so may allow institutions to undertake harmful activities.
externalities as a market failure in financial markets
There are a number of costs placed on firms, individuals and the government that the
financial market does not pay . One example of this is the cost to the taxpayer of bailing out the banks after the 2007-8 financial crisis .
moral hazard as a market failure in financial markets
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.
speculation and market bubbles as market failure in financial markets
Almost 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 fallss
what is herding behaviour
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.
market rigging as a market failure in financial markets
This is where a group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves at the expense of other participants in
the market.
One example of this is insider trading, where an individual or institution has knowledge about something that will happen in the future that others do not know and so can buy or sell shares to make a profit.
Another example is where individuals or
institutions affect the price of a commodity, currency or asset to benefit themselves, for
example large trades in a currency will shift its value and this will make a difference to individuals selling or buying assets with that currency
the role the central bank
the central bank controls monetary policy through interest rates and
controlling money supply in order to keep inflation low and stable.
It acts as a banker to the government
bank to other banks . Banks deposit their money within the
central bank and this is often used to balance the accounts of banks at the end of each day, when banks owe each other money because cheques have been paid in by consumers etc.
central banks in some countries regulate the financial system
financial regulation
Regulation can include:
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;
and liquidity ratios, when banks are forced to hold a certain
percentage of liquid assets.three key
bodies for financial regulation
The FPC identifies and reduces system risk and supports government
economic policy (macroprudential)
The PRA ensures competition, ensures consumers have access to services, minimises risk should a bank fail and ensures banks take responsible action.
The FCA protects consumers, promotes competition and enhances the integrity of the system by preventing market rigging.
