Role Of Financial Markets Flashcards
(12 cards)
What are the 5 roles of a bank?
- To facilitate saving
- To lend to businesses and individuals
- To provide forwards markets in currencies and commodities
- To facilitate exchange of goods and services
- To provide market for equities
Market Failure in Financial Sector
Asymmetric information, externalities, moral hazard, speculation and market bubbles, market rigging
Role Of Central Banks
Implement Monetary Policy, Banker to government, lender of last resort and regulate banking industry
How do Banks facilitate saving?
Allow for individuals and firms to save their money in a bank deposit and potentially earn interest
How do Banks lend to firms and individuals?
They use the savings to lend to firms and individuals
How do Banks provide forward markers for currencies and commodities?
Offering forward contracts that allow parties to lock in future prices, reducing price volatility and risk.
How do Banks provide a market for equities?
Financial institutions often serve as intermediaries in the equity market, allowing individuals and institutions to buy and sell shares of publicly traded companies
How do Banks facilitate exchange of goods and services?
Provide a way for buyers and sellers to interact and transfer funds
Externalities within financial markets
Excessive and Risky Lending can cause a Bank to become insolvent, causing firms to lose savings which can force firms to make employees redundant (harming a third party)
Moral Hazard within financial markets
Financial institutions are aware that if they were to go bust, they would be bailed out out. This can encourage risky behaviour at the expense of the savings of firms and individuals
Speculation and Market Bubbles within financial markets
Displacement stage – excitement grows about a new product / emerging technology
Prices boom as demand surges + limited (inelastic) supply causing market prices to spike higher
Euphoria as more investors look to take advantage (Robert Shiller calls this “irrational exuberance”)
Profit taking stage – some investors sell as they realise prices are out of line with fundamentals
Panic – the herd mentality switches to desperate selling and prices fall fast inflicting big losses
Financial traders may get over confident and act irrationally, causing harm the bank’s profitability (Dot.Com Bubble, Housing Market Bubbles)
Market Rigging within financial markets
Collusion, insider trading, pump and dump tactics to gain an unfair advantage through market manipulation
