Topic 1 Flashcards
Money performs 2 important functions which are…
- Medium of exchange
- Unit of account
To be acceptable as a medium of exchange, money must be…
- Sufficient in quantity
- Generally acceptable to all parties in all transactions
- Divisible into small units
- Portable
Meaning of ‘inflation’
A sustained increase in the general level of prices of goods and services
Why does ‘money’ act as a store of value?
What must money retain in order to fulfil its ‘store of value’ function
Purchasing power / Exchange value
What does ‘Money’ compromise of…
- Cash
- Current accounts
- Deposit accounts
- Other forms of investments (liquid)
Meaning of financial intermediation
An entity that acts as the middle person between two parties in a financial transaction.
Banks and building societies are the best-known examples.
The purpose of mutual organisations is profit-drive - True or False?
False
List the benefits that financial institutions’ products and services offer
- Convenience
(i.e., Current accounts enable holders to make and receive payments)
- Means of achieving otherwise difficult objectives
(i.e., Mortgage enable people to fund the purchase of a home)
- Protection from risk
(i.e., Insurance protects policyholders)
Money is:
- A medium of exchange
- A unit of account
- A store of value
What are mutual organisations?
Organisations owned by their members OR customers
What is a ‘surplus party’ in an economy?
A party that:
- Has more liquid funds than they currently wish to spend.
- They are happy to lend out their surplus funs NOW, in order to increase the value of these funds in the future.
What is a ‘deficit party in an economy’?
A party that:
- Does not have sufficient liquid funds to meet their spending needs
- They are willing to pay money into the future to anyone who will lend them funds in the present.
What is the role and objective of a financial intermediary in the context of surplus and deficit parties?
- The financial intermediary BORROWS money from a SURPLUS party and LENDS IT to a DEFICIT party.
- They charge interest to the party with the deficit and pays some of this interest to the party with the surplus.
- The financial intermediary’s profit margin is the difference between the two interest rates.
Meaning of ‘Disintermediation’
When borrowers (i.e., deficit parties) and lenders (i.e., surplus parties) DIRECTLY transact with each other
What are four main reasons why individual and companies need the services of intermediaries?
- Geographic location
- Aggregation
- Maturity transformation
- Risk transformation
Meaning of ‘Maturity transformation’
Maturity transformation is the process where financial institutions borrow short-term funds (e.g., deposits) and lend or invest them in long-term assets (e.g., loans), balancing the liquidity needs of depositors with the funding needs of borrowers.
What is meant by ‘Risk transformation’?
By spreading individual depositors’ funds across a wide range of borrowers, intermediaries reduce the impact of any single borrower’s default.
This allows depositors to lend with less risk, as the bank absorbs or mitigates potential losses through diversification.
Apart from Risk Transformation, what is another way of mitigating risk?
Risk Transfer
What is the definition of ‘Risk Transfer’
Risk transfer is the process of shifting the financial burden of potential risks from an individual or entity to another party, typically through insurance, by paying a premium.
For example, individuals contribute to an insurance fund via premiums. The insurer pools these premiums, covering the losses of the few who experience adverse events, thereby minimising the financial impact on any single individual.
What are product sales intermediaries?
This is the intermediation that brings together product providers and potential customers.
Product sales intermediaries include financial advisors, insurance brokers and mortgage advisors.
What are ‘Retail Banks’?
Banks that provide payment services and savings and loans to personal
customers and smaller businesses.
What are ‘Wholesale Banks’
Banks that provide funding for other financial institutions or very large
corporate clients.
What is ‘Life Assurance’?
Insurance that provides payment, generally as a lump sum but sometimes as an income, on the death of the person covered by the policy. It is sometimes referred to as life insurance or life cover.