Financial Markets

Question 1

6 Characteristics of Money

Answer 1

Acceptable
Portable
Durable
Divisible
Limited
Difficult to forge

Question 2

4 Functions of money

Answer 2

1) Medium of Exchange
2) Store of Value
3) Unit of Account
4) Standard of deferred payment

Question 3

Narrow Money

Answer 3

A measure of the value of coins in circulation and other money equivalents that are easily convertible into cash in hand.

Question 4

Broad Money

Answer 4

A measure of the total amount of money held by households and companies in an economy, eg. including assets with low liquidity.

Question 5

Liquidity

Answer 5

The ease at which an asset can be converted into cash in hand.

Question 6

Balance Sheets

Answer 6

A balance sheet refers to a statement of assets, liabilities and equity of a business or bank.

Assets - Liabilities = Equity

Question 7

Definition / Function of Financial Markets

Answer 7

To channel funds from those who have surplus funds to those with a shortage of funds.

Question 8

Money Market + Examples

Answer 8

Provides short-term finance to individuals, firms and govts. Transaction examples include - purchasing treasury bonds, interbank lending and short-term debts.

Question 9

Capital Account

Answer 9

Provides medium and long-term finance to individuals, firms and governments. Companies can raise long-term finance by issuing shares or corporate bonds but they can also borrow from banks. Divided into two further accounts

Question 10

Primary Market (Capital Account)

Answer 10

The primary market gives access to newly issued securities sold by companies and governments.

Question 11

Secondary Account (Capital Account)

Answer 11

Trade previously issued (second hand) securities.

Question 12

FOREX

Answer 12

Deals with the purchasing and selling of different currencies. Split into two further markets:

Question 13

Spot Market (FOREX)

Answer 13

The immediate purchase of a currency

Question 14

Forward Market (FOREX)

Answer 14

The exchanges of foreign currencies at a specified time in the future.

Question 15

Debt Capital

Answer 15

Capital that has been raised by taking out a loan from a bank.

Question 16

Share Capital

Answer 16

Capital that has been raised by issuing shares.

Question 17

Debt

Answer 17

Refers to an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. This can be otherwise known as deferred payment.

Question 18

Equity

Answer 18

Measured by subtracting liabilities from the value of the assets. Therefore, this can be used to determine the actual value of a person’s assets.

Question 19

Key features of Commercial Banks

Answer 19

Provide loans + overdrafts to individuals
Profit Max // Share-holder satisfaction
Accepting cash deposits
Effective means of payment
Mortages
Financial Advice

Question 20

Key Features of Investment Banks

Answer 20

Trade securities on behalf of their clients.
Advising on new share issues,
Help with mergers,
underwriting new share issues,
finance larger infrastructure projects,
managing investment portfolios.

Question 21

G-SIB

Answer 21

Global systemically important bank

Question 22

Functions of Central Banks

Answer 22

1. Monetary Policy
2. Financial Stability / Regulation
3. Govt. Policy / Lender of last resort

Question 23

Credit Creation

Answer 23

Providing a loan (asset) creates a corresponding liability for the bank in the form of a deposit in the customer’s bank account.

Banks make profit from credit creation by ensuring that the cost of borrowing exceeds the reward for saving.

Question 24

Money Multiplier

Answer 24

Where an initial deposit into a bank leads to a proportionally greater increase in the money supply. It is calculated as 1/ reserve ratio.

Question 25

Bond Yield Calculation

Answer 25

Yield = Coupon x100 Market Price

Question 26

Relationship between Bonds + Interest Rates

Answer 26

An inverse relationship between bond prices and interest rates. Most bonds pay a fixed interest rate which becomes more attractive (greater yields) as interest rates fall. As demand for bonds increases, demand-pull inflation drives up the price of bonds.

Question 27

Prudential Regulation Authority (PRA)

Answer 27

Operate under the Bank of England Regulate, supervise and promote effective competition 1,700 commercial banks and other financial institutions a microprudential regulator. They supervise financial institutions to ensure that they are effectively managing risk. They can also set capital and liquidity ratios.

Question 28

Financial Policy Committee (FPC)

Answer 28

Operating under the Bank of England, Identify, monitor and protect banks from systemic risk Macroprudential regulator. Advise the Government on managing financial markets.

Question 29

Financial Conduct Authority (FCA)

Answer 29

Funded by the firms it regulates Protection for customers Protect the integrity of the UK financial system Promote competition. Eg. Banned PPI

Question 30

Tools of Financial Regulation

Answer 30

Capital Ratios Liquidity Ratio Basel III agreement Stress Tests

Question 31

Capital Ratios

Answer 31

The amount of capital (assets - liabilities = capital) expressed as a % of total assets. This is calculated as (capital / assets) X 100. The objective of capital ratios is to prevent insolvency.

Question 32

Liquidity Ratio

Answer 32

A set amount of liquidity that a bank must possess It is calculated as current assets (short-term) / current liabilities (short-term).

Question 33

Basel III Agreement

Answer 33

Establish international standards for banking regulation In wake of the 2007-8 financial crisis. Liquidity Coverage Ratios (LCR) which suggested that all banks should possess 100% liquidity for all liabilities < 30 days. Another key feature is that banks are suggested to keep an 8% minimum capital to loans ratio.

Question 34

Stress Tests

Answer 34

Used to measure the extent to which financial institutions are vulnerable to the effects of extreme economic events.

Question 35

Consequences of Bank Failure

Answer 35

Systemic Risk Recession Bank Bailouts

Question 36

Evaluation of Banking Regulation

Answer 36

Moral Hazard Regulatory Capture Asymetric Info Enforcement Costs Shadow Banking

Question 37

Bank Run

Answer 37

When banks do not have sufficient liquid assets to meet short-term liabilities

Question 38

Insolvency

Answer 38

When banks do not have sufficient assets to meet their liabilities Assets < Liabilities