Macro M7 - Financial markets

Question 1

What is the main role of commercial banks?

Answer 1

To be the intermediary between borrowers and savers

Question 2

How do commercial banks make their profits?

Answer 2

By taking small, short-term relatively liquid deposits from savers and transforming these into larger, longer maturity loans

Question 3

What services are provided by investment banks?

Answer 3

Underwriting, M&A advice, Trading on capital markets, Private equity investments

Question 4

What do private banks do?

Answer 4

Provide wealth management services to high net worth individuals

Question 5

What are building societies?

Answer 5

Owned by their members, they offer mortgages and savings products. Many also offer a broad range of retail banking products.

Question 6

What are credit unions?

Answer 6

Small and local non-profit lending institutions. Owned by their members and are for people who cannot access banks or building societies

Question 7

What is bank capital?

Answer 7

The value of the bank’s assets minus its liabilities

Question 8

What are bank reserves?

Answer 8

Money and liquid assets held by banks in order to meet withdrawals from customers

Question 9

Examples of a bank’s assets

Answer 9

Cash, balances at BofE, Loans (e.g. advances), securities (e.g. bonds), fixed assets (e.g. land)

Question 10

Examples of a bank’s liabilities

Answer 10

Customer deposits, money owed to bond holders, money owed to other banks

Question 11

What is a bank’s balance sheet?

Answer 11

A financial statement which reports a banks assets and liabilities

Question 12

What are stable deposits?

Answer 12

Deposits that cannot be withdrawn quickly. Banks usually offer higher interest rates for them. They help banks control their ‘liquidity risk’

Question 13

What is liquidity risk?

Answer 13

The risk that savers will want to withdraw their deposits and the bank is unable to pay

Question 14

What is credit risk?

Answer 14

The risk of a bank lending to borrowers who turn out to be unable to repay their loans (default on their loans)

Question 15

What are the three functions of money?

Answer 15

Medium of exchange, store of value, unit of value

Question 16

What is fiat money?

Answer 16

Assets used to make transactions with no intrinsic value – the current way of exchanging goods and services

Question 17

What is near money?

Answer 17

Assets which can be converted into cash without delays (Liquid)

Question 18

What is non-money?

Answer 18

Assets which do not function as a medium of exchange due to encashment delays (Illiquid)

Question 19

What is narrow money?

Answer 19

The narrowest measure of money. Only includes the most liquid assets
(Cash + Reserves)

Question 20

What is broad money?

Answer 20

The largest measure of money within the economy. It includes narrow money as well as the least liquid assets

Question 21

What is a bond?

Answer 21

A financial instrument which can be issued and sold to raise finance. Beholders receive periodic payments linked to the overall value of the bond until it matures.

Question 22

What is a bond yield?

Answer 22

The annual coupon payment expressed as a percentage of the market price of the bond

Question 23

What is a coupon payment?

Answer 23

A periodic payment that the bondholder receives during the time between when the bond is issued and when it matures

Question 24

What are guilts?

Answer 24

Bonds issued by the government

Question 25

How to calculate the yield of a bond?

Answer 25

(Coupon / Market price) X 100

Question 26

What does an increase in the base rate do to the exchange rate?

Answer 26

Increases the value of the pound

Question 27

What did economist Minsky believe?

Answer 27

That stability was destabilising. Banks get complacent and start taking bigger risks in the pursuit of profit

Question 28

If a bank makes a new loan to a customer, what will happen to the bank’s liabilities, assets and money supply?

Answer 28

They will all increase

Question 29

What is quantitative easing?

Answer 29

When the Bank of England buys bonds on the secondary market. This increases demand and therefore increases price.

Question 30

What is austerity and what is needed when it is implemented?

Answer 30

Contractionary fiscal policy. Therefore lots of expansionary monetary policy is needed.

Question 31

On a commercial bank’s balance sheet, total assets should be equal to what?

Answer 31

Total liabilities + capital

Question 32

What are four traditional investment bank activities?

Answer 32

Underwriting share issues
Proprietary trading
Fund managing
M&A advice

Question 33

What is moral hazard? (Asymmetric information)

Answer 33

When the behaviour of individuals change after a contract is agreed and enforced (E.g. People are more likely to be carefree after they have insurance on something)

Question 34

What is adverse selection? (Asymmetric information)

Answer 34

Private information means that only those who benefit will enter into a contract (E.g. only those who need insurance will get it)

Question 35

What are the forms of market failure within the financial sector?

Answer 35

• Speculation
• Asset price bubbles
• Market rigging
• Externalities
• Moral hazard
• Asymmetric information

Question 36

What are speculative bubbles?

Answer 36

When asset prices become inflated and overvalued, when they burst it causes large economic problems. Banks can cause speculative bubbles due to their herding behaviour

Question 37

What is market rigging?

Answer 37

When individuals and companies work together for a mutual benefit to stop a market operating as it should do