financial markets examples

Question 1

financial market purpose

Answer 1

so households can spend money using a credit card

Question 2

saving

Answer 2

worker paid in july putting money aside for christmas presents in november and december.
worker is 25 and wants to save money for when he is retired age 68.
firm earned £6m profit, wants to put it aside in case trading falls, so it has unexpected bills in future.

Question 3

lending

Answer 3

• household borrowing money on credit card to finance purchase of new TV
• firm borrowing money from bank to buy equipment
• large company issuing corporate bonds, borrowing from capital markets or issuing new shares to finance growth or improve balance sheet
• bank may borrow to speculate on foreign currency

Question 3

lending

Answer 3

• household borrowing money on credit card to finance purchase of new TV
• firm borrowing money from bank to buy equipment
• large company issuing corporate bonds, borrowing from capital markets or issuing new shares to finance growth or improve balance sheet
• bank may borrow to speculate on foreign currency

Question 4

exchange of goods/services

Answer 4

• central banks mint coins and print money
• retail banks offer cheque services, debit/credit cards
• visa, amex, mastercard companies offering credit card services to banks/retailers/individuals
• banks/bureau de changes buy and sell foreign currency exchanging notes, eg// transferring money from account into another bank account in different country and currency

Question 5

forward markets

Answer 5

• farmers selling crops at guaranteed price, agree to $800 a tonne for 20 tonnes for delivery in 6 months
• forward markets exist in commodities eg// wheat, cocoa, soya beans
• also in copper/nickel markets
• forex eg dollars/euros bought/sold forward too

Question 6

insurance

Answer 6

insurance against fire risks, they pay out for damage

Question 7

retail banks

Answer 7

• services like overdrafts, loans, mortgages, credit cards, forex, insurance
• building societies traditionally offer narrow range of services, taking in money from savers and lending it out again to purchase a house through a mortgage

Question 8

commercial banks

Answer 8

• provide ways for firms to receive money like from customers, and to pay for supplies and wages

Question 9

investment banks

Answer 9

• trade in foreign exchange, commodities, bonds/shares, derivatives
• derivative used widely is a forward contract to buy a commodity
• in run up to financial crisis, investment banks created range of derivative products containing risks that were little understood by key buyers

Question 10

saving vehicles

Answer 10

• assurance companies provide long term saving, getting savers to save a regular amount each month and providing a lump sum typically after 10 or 25 years

Question 11

money markets

Answer 11

• UK government borrows short term by issuing Treasury Bills that are repayable after 91 days
• bills of exchange are a form of borrowing by companies. they are promises by companies to pay for goods and services they have already received, at a fixed point in the future
• interbank market where banks lend between themselves

Question 12

capital markets

Answer 12

• main assets traded are bonds (stocks in UK) and shares (stocks in US) and the UK debt is mostly made up of bonds
• bonds make long term borrowing possible
• over past 20 years, bonds and shares have been increasingly traded outside official stock markets like the London Stock Exchange and New York Stock Exchange (wall st)

Question 13

forex markets

Answer 13

• could be spot markets where currency is traded
• or forward markets where currencies contracts are made for some time in the future like 3 months

Question 14

commodity prices

Answer 14

• London Metal Exchange or Chicago Mercantile Exchange are where commodities are traded
• a contract may specify that 10 tonnes of nickel will be available for collection in 6 months time

Question 15

derivative markets

Answer 15

• 2007-08 financial crises showed how destabilising they are
• investment bank clients were being sold derivatives that they thought were low risk when they were high risk

Question 16

insurance markets

Answer 16

• insurer may sell 20% of all house insurance policies in Jamaica. this is a big risk because Jamaica is prone to natural disasters

Question 17

balance sheet of retail/commercial banks

Answer 17

• cash and balances at the bank of england and money at call and short notice are all highly liquid assets
• commercial and treasury bills can easily be sold quickly but bank could make loss on the sale

Question 18

market failure

Answer 18

• financial crisis caused trillions of pounds of damage to real economies , financial market failure has always existed
• in the 17th and 18th century the Darien scheme in Scotland, the South Sea bubble in England and Mississippi bubble in France all = decrease in GDP of countries

Question 19

asymmetric information

Answer 19

• in case of PPI, UK banks in the 90s and 00s sold millions of insurance contracts to customers taking out a loan/mortgage/credit card but banks failed to determine if this was the appropriate insurance
• securisation in USA of mortgages. mortgages sold off to other financial companies and collection of them made then financial company could sell the rights to that income
• mortgage backed securities were major cause of financial crash

Question 20

moral hazard

Answer 20

• financial institutions taking short term risks, in investment banking, traders and senior executives can earn very large bonuses for generating profits, encouraging workers to take excessive short term risks without considering long term
• in financial crises, moral hazard used in context of institutions themselves, accused of short term risks knowing the government would bail them out

Question 21

speculation and market bubbles

Answer 21

• housing market bubbles by too much lending in the market, too much demand was created causing unsustainable increases in house prices. then large interest rate increases burst the bubble.
• falls in house prices leave negative equity as some debt owe more on their mortgage than the new lower value of the house
• UK prone to housing bubbles because too few new houses are being built and a very high proportion of households own their own houses
• in japan, housing bubble in late 80s and early 90s contributed to low GDP
• dotcom bubble = stock market valuations of new internet companies
• unsustainable rise in stock market prices in USA = wall street crash of 1929, regarded as trigger for great depression of the 30s

Question 22

market rigging

Answer 22

• insider trading, when individual/institution has knowledge about something that will happen in future
• individual may know if a companies share prices will increase or decrease so can sell at higher or lower price

Question 23

negative externalities

Answer 23

• UK gov spent £133bn nationalising UK banks/building societies working out at £2152 pp
• countries like Ireland and Greece’s taxpayers will never recoup the full cost of their governments bailing out their financial institutions