Unit 1 - Financial Institutions

Question 1

What does the Bank of England do?

Answer 1

Central bank. 
Carries out govt policy
Issues bank notes
Acts as banker to commercial banks.
Sets interest rates

Question 2

Influence of Bank of England on money markets

Answer 2

• Bank intervenes in mmarkets to influence interest rates.
• Looks to encourage development of private sector markets
• Satisfies marginal liquidity requirements of banks (through 2 week repos), ensuring overall liquidity

Question 3

What are money markets?

Answer 3

Cash deposits and short term securities (T bills and bills of exchange)

Question 4

Influence of Bank of England on currency markets

Answer 4

Govt holds gold and foreign currency (foreign reserves).

Bank sells these for £ (therefore reducing £ in market, £ rises) and vice versa

Question 5

How does Bank of England influence markets?

Answer 5

Money markets to set interest rates

Foreign reserves to influence exchange rates

Question 6

What is the Debt Management Office?

Answer 6

Responsible for issuing Treasury Bills in a weekly auction

Question 7

New issues of gilts - DMO

Answer 7

When Govt has Public Sector Net Cash Requirement, it instructs DMO to sell gilts:

• Auctions - for public offerings
• Tap stocks - to Gilt Edged Market Makers
• Syndication - issuer appoints group of banks to manage sale

Question 8

Buying gilts - DMO

Answer 8

DMO tends to buy gilts weeks/months before it matures to prevent big cash call. May buy back if a Public Sector Debt Repayment

Question 9

Regulation - DMO

Answer 9

15 GEMMS - only them allowed to buy/sell gilts from Bank/DMO

- given favourable tax treatment

Question 10

Quantitative Easing

Answer 10

Monetary policy to increase supply of money.

1) Central bank credits own account with money it creates
2) Purchases financial assets (e.g. gilts) - open market ops
3) Or changes fractional reserve system

Question 11

Stock exchange - key roles

Answer 11

1) Raise new finance for companies

2) Provide a secondary market for investors

Question 12

Stock exchange - main lenders

Answer 12

• Pension funds

- Life insurers

Question 13

Securities dealt on stock exchange

Answer 13

• Gilts/bonds/bulldogs
• OS, PS, debentures, ULS, Eurobonds
• No money markets or derivatives

Question 14

Stock exchange markets

Answer 14

Gilt edged market
UK fully listed securities
Alternative investment market (AIM)
Overseas securities

Question 15

Role of SE - provide a market

Answer 15

SEAQ - stock exchange automated quotations - market makers enter quotes into SEAQ, deals over phone

SETS - stock exchange electronic trading service - 200 FTSE stocks - firms display bid and system automatically matches orders

Question 16

Role of SE - regulate market

Answer 16

SE recognised under FSMA2000

Members - need to follow standards
Transactions - price/time/volume of trades must be reported
Companies - listing requirements

Question 17

Role of SE - settlement of trades

Answer 17

Registrar needs to be informed, share/bond cert transferred and money changes hands.

Equities - 2 days on CREST
Gilts - day after

Question 18

Role of SE - providing information

Answer 18

Stock exchange daily official list (SEDOL) shows price/volume of all transactions

Question 19

Derivative exchanges

Answer 19

Over the counter (traded directly) or through exchange - use clearing systems to prevent counterparty risk

Question 20

Investment banks

Answer 20

• Financial advice (M&As, raising capital, issuing finance/eurobonds)
• Fund management (manage unit trusts, pension funds, eurobond market)
• Money market operations (accept bills of exchange, hold T bills, issue certs of deposit)
• Act as brokers for OTC derivatives, trustees for debenture issues

Question 21

Clearing banks

Answer 21

Funds come from current accounts, savings accounts from private individuals through high street
Banks lend money through overdrafts and loans

Question 22

Clearing banks - investment markets

Answer 22

CBs have big influence on money market, bill markets, gilt markets etc
Lend to each other based on LIBOR rate

Question 23

Building societies

Answer 23

• Not as prominent in commercial money market
• Lending dominated by house-purchase mortgages
• Smaller than banks

Will invest in short dated gilts or other banks/BS with CODs

Question 24

Investment trusts

Answer 24

Companies with directors, investment managers and shareholders. Listed on SE and raise debt/equity from other investors.
Hold money in other companies/gilts/property - specialist
No change in total no of shares

Question 25

Price of share in investment trust

Answer 25

Supply/demand - usually at discount to NAV, as investment management charge and shares less marketable than actual asset (e.g. easier to buy BP shares)

Question 26

Split capital

Answer 26

If trust has a set wind up date: - Capital shares - Income shares

Question 27

Unit trust

Answer 27

Not companies - set up by a company, has mgmt company, trustees (usually clearing bank) and investors. Units bought/sold from management, not other investors. Don't raise D/E. Lots of restrictions, so invest in shares.

Question 28

Unit trust price

Answer 28

Market value of assets / no of units. Units sold at offer price which is 6% higher than bid price (mgmt buy units back at bid price and so make profit) ``` MVA = offer pricing (if UT expanding) MVA = bid pricing (if UT contracting) ```

Question 29

Open ended investment companies (OEIC)

Answer 29

Have characteristics of ITs (companies with share price) and UTs (new shares created when money invested, with price reflecting net asset value)

Question 30

Investment management companies/Fund managers

Answer 30

- Front office - buy/sell investments, asset allocation, stock selection - Back office - transaction processing, custody

Question 31

Issues with fund managers

Answer 31

- Small no of companies dominate market - Herd behaviour - Focus on short term performance - High fees - Poor action on corporate governance - Churning of portfolios to generate commission

Question 32

Self administered pension funds

Answer 32

Will buy medium/long dated investments

Question 33

Life insurers

Answer 33

Typically invests in equities and FI securities. Has lots of medium/long fixed liabs (e.g. WP gtees). Some liabs are inflation linked, e.g. WP gtees. Depends on level of free assets for solvency.

Question 34

General insurers

Answer 34

Typically invests in short/medium dated FI and MM. GI business is short term and variable (e.g. catastrophes). Some liabs index linked as payments made are value at time

Question 35

Settlement - DMO

Answer 35

CREST registry