Role Of Financial Markets

Question 1

What is the main goal of a Financial Market?

Answer 1

The main goal of a financial market is to match buyers and sellers to efficiently allocate financial capital to its most productive uses helping to increase economic growth.

Buyers and sellers come together to trade financial assets, such as stocks, bonds, currencies, and derivatives.

Question 2

Key roles of a financial market?

Answer 2

• To facilitate saving by businesses/households - secure place to store
money and earn interest

• To lend to businesses/consumers

• To allocate funds to productive uses; allocate capital to where the
rate of return relative to risk is highest

• To facilitate the final exchange of goods/services (e.g contactless
payment)

• To provide forward markets to allow economic agents to insure
against price instability and hedge against possible risks

• To provide a market for equities, allowing business to raise new
capital

• To provide information about the prices of financial assets

Question 3

There is an _______ relationship between market interest rates and bond prices.

Answer 3

inverse

A bond is a loan, repaid when the bond matures; it pays annual interest (the coupon); bonds can be traded after issue

Example: Tutor2u issues a £1,000 bond with £80 annual interest to investors to be repaid in 2028 the date of maturity

• Yield = £80 interest/market value of bond = 8%

• Interest is paid annually on a set date such as June 1st to bond holders and interest is fixed at £80 per year

• Bonds are traded in the market so the price can and does change

• This changes the implied % yield on a bond e.g if the price rose to £2,000, then the yield falls to £80/£2000 = 4%; if the price fell to £500 then the yield rises to

Question 4

What is Equity?

Answer 4

Equity represents ownership in a company
- entitles shareholders to a
proportional share of profits and voting rights.

• Equity does not need to be repaid and carries higher risk, but
potentially higher returns through dividends and capital gains.

Question 5

What is Debt?

Answer 5

Debt involves borrowing money that must be repaid with interest over a
specified period.

• Debt holders do not have ownership rights but have a priority claim on assets in case of bankruptcy, making it a lower-risk investment with fixed returns.

Question 6

What is a Commercial Bank?

Answer 6

Provide traditional banking services such as accepting deposits, making loans, and offering checking and savings accounts.

They focus on providing financing to consumers and small businesses.

Extra information:
• Banks are licensed deposit-takers providing a range of savings accounts

• They are licensed to lend money and create money via new bank loans, overdrafts and mortgages

• Charges a higher interest rate on loans (or other assets) than the rate it pays out on deposits (or other liabilities) to pay the operating expenses of a bank and helps them to make a profit

• Commercial banks are heavily regulated by governments,

Question 7

What is an Investment Bank?

Answer 7

Specialise in underwriting securities, M&A advisory, trading, research, and asset management.

Extra information:
• Operate in capital markets.

• They focus on providing financial services to corporations, institutional investors and high-net-worth individuals.

• They are subject to some regulations, often less stringent than commercial banks, often with a focus on securities and financial market operations.

• They are typically investment firms with no physical branches and a focus on providing advice and services