Financial Markets and Monetary policy

Question 1

what is a financial market

Answer 1

markets where buyers and sellers trade financial assets

Question 2

what are intermediates

Answer 2

mediums for which financial transactions can take place
(banks, hedge funds)

Question 3

what are the 2 types of financial markets and what goods/services are sold there

Answer 3

• Money Markets - assets that pay back in 1 year of less (very liquid) (interbank lending and borrowing)
• capital markets - assets with payback date >1 year

Question 4

what are the 2 types of capital markets

Answer 4

Primary Capital markets - brand new bonds are issued through investment banks or other agency’s
Secondary capital markets - where new bonds and shares are resold

Question 5

what are the two types of currency markets

Answer 5

Spot markets - buy currency at current exchange rate and get it delivered instantly
Futures markets - buy a currency in a given exchange rate and have it delivered in the future.

Question 6

what is the point of future money markets

Answer 6

hedge against risk - investors can buy certain quantities at predetermined prices the have that delivered to them in the future therefore if the currency goes down in value you are protected

Question 7

what are the 4 function of money

Answer 7

• medium of exchange (it is valuable to everyone)
• store of value (whilst inflation and deflation may affect its long run value money holds its value well)
• Measure of value
• Standard of deferred payment - allows medium for lenders and borrowers

Question 8

what are the 3 characteristics of money

Answer 8

portable
divisible
trusted

Question 9

differences between commodity money and fiat money

Answer 9

commodity money has intrinsic value as it is worth a certain amount of a good
fiat money relys on faith (it has no intrinsic value)

Question 10

what is the money supply

Answer 10

the total money circulating in an economy

Question 11

what are two measures of the money supply

Answer 11

• narrow - total amount of nots and coins and deposits in banks (liquid)
• broad - total amount of all assets with a maturity date of 5 years of less

Question 12

what is near money

Answer 12

assets that arnt cash but can be quickly converted into cash (days/weeks)

Question 13

-what is the fisher equation
-what does Q represent in the equation
- what factors do monetarists believe to be constant

Answer 13

• MV = PQ (total spending value = Value of what is sold)
  -Q is real gdp
  -V and Q therefore money supply only effects inflation

Question 14

what reason do Monatarists give for V and Q being constant

Answer 14

• real gdp is relatively stable over time therefore Q is constant
• V will never change enough to influence prices

Question 15

what is the argument that Keynesian economists use to combat the theory that v is constant

Answer 15

V is not fixed because of:
liquidity traps
anticipated deflation
confidence rates
resisions

Question 16

why is the supply of money on a money market diagram vertical

Answer 16

the central bank control the supply of money

Question 17

what 3 factors affect the supply of money

Answer 17

Reserve Requirement
Bank rate/discount rate
Open market operations ( central bank buying and selling bonds)

Question 18

what is a bond

Answer 18

A bond is a IOU, it guarantees the holder regular interest payments every year, the holder of the bond will get the value of that bond when it matures

Question 19

what is the coupon rate, market price and nominal value

Answer 19

• coupon rate - the interest paid on the bond every year
• market price - the price at which a bond is resold at
• nominal value - how much a bond will pay back after its maturity date

Question 20

how do you calculate the yield from a bond

Answer 20

coupon rate / market price x100

Question 21

what is the money multiplier and its equation

Answer 21

• the amount of money a bank will add to the money supply from an initial deposit

1/reserve requirement

Question 22

what is systematic risk

Answer 22

risk that can have compounding effects due to the intercondectedness of financial markets

Question 23

• what is ring fencing
• when was the law on ring fencing passed in the uk

Answer 23

• investment banks seperate from commercial banks

2019

Question 24

what is a banks balance sheet

Answer 24

record of all assets and liabilities and capital at any given point in time

Question 25

what are assets on the balance sheet

Answer 25

anything the bank owns or is owed

Question 26

what are liabilities on the balance sheet

Answer 26

anything the banks owes ( deposits and borrowing)

Question 27

what is capital on the balance sheet

Answer 27

- shareholder funds and retained profit - they are liabilities as shareholders take profit as dividends and take out funds.

Question 28

types of bank failure

Answer 28

- liquidity crisis - insolvency - regulatory failure - confidence crisis

Question 29

what is a liquidity crisis

Answer 29

when short term assets are not enough to meet short term liabilities and there is a run on the bank

Question 30

what is insolvency

Answer 30

when total assets < than total liabilities therfore bank cannot reapy debt so it will fail unless it is restructured

Question 31

2 tools available to stop bank failure before they happen

Answer 31

- liquidity ratios - reserve requirements

Question 32

what are 3 consequences of bank failure

Answer 32

- deep financial crisis and recession - bank bailouts ( cost to tax payer - loss of trust in financial markets

Question 33

what is the role of a central bank

Answer 33

- implement monetary policy - lender of last resort - regulate financial sysetm

Question 34

why might a central bank not intervene in the case of insolvency

Answer 34

the central bank will only ensure individuals savings are protected by transferring them to another bank

Question 35

2 points against the lender of last resort argument

Answer 35

- moral hazard - a risk is taken where the cost of that risk is born by a third party therefore banks may never hold sufficient liquidity - regulatory capture - often bank of england employees used to work for commercial banks therefore commercial banks can influence for a better deal

Question 36

what is financial market failure

Answer 36

- where financial market fail to allocate recourses at the socially optimum level of output

Question 37

3 Types of financial market failures

Answer 37

- failure of price mechanism (speculation and market bubbles) - assymetric information (moral hazard, adverse selection) - risk - bank failure

Question 38

what are the 3 causes of financial market failure

Answer 38

- excessive risk - collusive activity - deregulation

Question 39

how does leverage deals create bubbles

Answer 39

- leverage deals is when an investor will finance large asset purchase by borrowing therefore making end profit larger - this large increase in demand ramps up prices above there intrinsic value therefore creates a bubble.

Question 40

how does asymmetric information create a financial market failure

Answer 40

assymetric information leads to - adverse selection - one party does not have full information - moral hazard - burden of a decision shifted onto another party this creates increased risk

Question 41

what do FPC and PRA do in the financial system to regulate

Answer 41

FPC - financial policy committee - provide emergency liquidity - stress test PRA - prudential regulation authority - specify ratios (liquidity ratio) -supervise banks on management of risk

Question 42

what doe the FCA do (2 points)

Answer 42

financial conduct authority (government run) - ensure legal and fair business conduct - promote competition (deregulate)

Question 43

name 3 types of financial market regulation

Answer 43

- ratios (reserve/liquidity) - regulatory bodys and thier functions - lender of last resort - ring fencing - reserve requirment - minimum and maximum interest rates

Question 44

4 problems of financial market regulation

Answer 44

-assymetric information (causing moral hazard and regulatory capture) - reduced innovation (AI/trading algorythms, online banking) - credit shortages - regulatory capture - inneficiancy

Question 45

what is the Basel recommendation for liquidity ratio and capital ratio

Answer 45

liquidity ration = short term assets/short term liabilities (100%) - prevents run on bank capital ratio - capital/loans (8%) - prevents insolvency

Question 46

3 evaluation points of financial market regulation

Answer 46

- balance needed between profitability and regulation - equality vs efficiancy - costs vs benifits