Theme 4: Financial Markets Flashcards
(23 cards)
What are the roles of financial markets?
1) Facilitate savings
2) Facilitate lending
3) Facilitate exchange
4) To produce a market for equities
5) to provide forward markets
What does it mean to facilitate saving?
To provide an opportunity for individuals and firms to save money
What does it mean to facilitate lending?
To lend money to businesses and individuals who need more cash
What does it mean to facilitate exchange?
To provide an opportunity for individuals and firms to exchange
What does it mean to provide market for equity?
To provide a market in which equity can be bought and sold
What does it mean to provide forward markets?
To provide a market in which forward contracts can be drawn up and put in place
What is equity?
When firms sell a percentage of their company to investors in the form of shares. The investors can then receive a percentage of the profits.
What are forward contracts?
A contract in which there is a Fix on the price and date of a future transaction now so that you know exactly how much you will pay.
What are the 5 types of financial market failure?
1) Asymmetric information
2) Speculation and market bubbles
3) Negative externalities
4) Moral Hazard
5) Market Rigging
What is asymmetric information?
When one party knows more/less than another in a transaction
Give 2 examples of asymmetric information in the financial sector
In the building dump to the 2008 financial crisis:
1) Bankers knew much more about their subprime mortgages than the people they were selling them to.
2) Bankers knew far more about banking than the financial regulators who were meant to be monitoring their behaviour.
What is a market bubble?
- As the price of an asset increases, demand for that asset increases.
- This increases the price of the asset further and the cycle continues until the asset become hugely overvalued.
What are negative externalities?
Costs affecting third parties outside of the price mechanism
Give an example of a negative externality in a financial market
- After the financial crisis, banks stopped lending money to people or businesses.
- Firms couldn’t borrow money, so they had to make cutbacks, which meant that millions of people became unemployed.
- There was therefore a decrease in real GDP.
- This is a negative externality because the people who lost their jobs were outside the price mechanism in the financial sector.
What is a Moral Hazard?
When someone takes more risks because somebody else is bearing the cost of that risk.
Give an example of a moral hazard
After the 2008 financial crisis, the US spent about $700 billion of taxpayers’ money in order to stop the banks from going bankrupt.
What is market rigging?
Market rigging occurs when firms unfairly try to control prices, distorting the price mechanism.
Give an example of market rigging
In 2012, Barclays was caught trying to manipulate the Libor (The global benchmark interest rate) and was fined $450 Million
In what way is the role of central banks different to the role of normal banks?
- Central banks lend money to other highstreet banks like Natwest and HSBC.
- They don’t lend to individual consumers (e.g. I can’t approach the Bank of England and ask for a loan.)
- They also don’t lend to small businesses.
What 2 things does the central bank manipulate as part of monetary policy?
As part of monetary policy, the central bank manipulates the base interest rate and the money supply.
What are the 3 roles of the central bank?
1) Lending to other banks
2) Lending to the government
3) Implementing monetary policy by manipulating the base rate and the money supply
What is one additional role of a central bank?
One additional role of central banks is to regulate the banking industry.
What is the name of the strict set of financial regulation rules imposed by the Federal Reserve in America in 2011?
The strict set of financial regulations imposed on US banks by the Federal Reserve in 2011 was called Basel III.
