1. Financial Markets & Monetary Policy - Structure of Financial Markets Flashcards Preview

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Flashcards in 1. Financial Markets & Monetary Policy - Structure of Financial Markets Deck (33)
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1
Q

What is a financial market?

A

Any place where buyers and sellers meet to trade financial assets.

2
Q

What do financial markets do?

A

They bring together lenders and borrowers.

3
Q

Who are the lenders and borrowers in a financial market?

A

Lenders are savers and investors while borrowers are individuals, firms and government in need of cash.

4
Q

What are the functions of money?

A
  1. Accepted medium of exchange 2. Store of value3. Measure of value4. Standard of deferred payment
5
Q

What are the characteristics of money?

A
  1. Acceptable2. Durable3. Portable4. Divisible5. Limited in supply6. Difficult to forge
6
Q

What is the money supply?

A

The money supply is the total amount of money circulating in the economy.

7
Q

What are the different types of money and how are they distinguished?

A

There is M0 money - Narrow Money - The Monetary Base & M4 money - broad money - The Wider Money Supply. (There is also M1,2,3 but these are less important). The types of money are distinguished by liquidity. M1 includes only cash assets (high liquidity) as you move through to M4 more non-cash illiquid assets are included.

8
Q

What are the three different parts of the financial market?

A

The money marketThe capital marketThe currency market (foreign exchange market)

9
Q

What are money markets?

A

This is the market for the buying and selling of financial assets that have a payback date of a year or less.e.g. some bonds and interbank lending

10
Q

What are capital markets?

A

This is the market for the buying and selling of financial assets that have a payback date of more than a year.e.g. debt capital and equity capital

11
Q

What is debt capital?

A

Any financial asset that pays back an interest rate, a form of borrowing for the issuer.e.g. buying and selling gov. bonds in the l-term

12
Q

What is equity capital?

A

Equity capital is when someone has a stake in a business so receives returns through dividends rather than interest.e.g. the buying and selling of shares

13
Q

How can capital markets be further divided?

A

Capital markets are either primary or secondary markets.Primary capital markets - new issue markets, where brand new bonds may be bought.Secondary capital markets - the purchase and sale of existing bonds.

14
Q

What does the existence of the secondary capital markets do?

A

The presence of secondary capital markets makes bonds a fairly liquid form of money, it is fairly easy to convert your bond to cash by selling it on in a secondary market.

15
Q

What are currency markets?

A

This is there market for the buying and selling of the financial asset that is currency.e.g. the buying and selling of $s

16
Q

How can currency markets be subdivided?

A

Currency markets are either spot markets or future markets.Spot Markets - the buying of currency at the current ER and getting it delivered to you immediately. Future Markets - the buying of currency at the current ER but it will be delivered to you at a later date.

17
Q

Why may people choose to purchase currency in future market?

A

Businesses may use it to protect against suspected future ER falls.Speculators may use it to try and make money.

18
Q

What are bond markets and which of the three parts of the financial market do they fall into?

A

Bond markets are markets for the purchase and sale of bonds - this may be in either the money market or capital market depending on the length of the bond.

19
Q

What are bonds?

A

Bonds are essentially an ‘I owe you’ - the issuer will borrow money off someone else in exchange for a bond stating the amount they owe them.

20
Q

How do bonds work?

A

Bonds have a maturity date, when the bond reaches this date the holder can retrieve the full value of the bond. The holder is also guaranteed regular interest payments on the bond - the coupon rate.

21
Q

What is the coupon rate?

A

The coupon rate is essentially the rate of interest a holder receives on a bond. In the old days bonds would come with coupons on the end for certain amounts that could be redeemed annually, this is the equivalent of an interest rate.

22
Q

Who may issue a bond and why?

A

Bonds may be issued by the government to finance spending on infrastructure.Bonds may be issued by corporations in order to finance investments.

23
Q

Who may buy a bond and why?

A

Anybody can buy a bond, they may choose to do this if the rate of returns is better than other financial assets like loans. Also, bonds offer a very safe investment as banks and businesses rarely default on bond payments.

24
Q

What are bond yields?

A

The bond yield is the return a bond will give - this is important for investors because this allows them to compare the profitability of bonds to other assets.

25
Q

How do you calculate bond yield?

A

Bond Yield = (Coupon Rate/Market Price) x 100

26
Q

Why, considering the bond yield formula, is there an inverse relationship between the price and yield of bonds?

A

As the price of bonds rises the yield that bond offers will fall. This is because the coupon rate is fixed, if the market price rises the coupon rate is divided by a larger number, giving it a smaller yield.

27
Q

Why does it make sense that there is an inverse relationship between the price and yield of bonds?

A

If you think about it if a bond offers a maximum return, taking into account the maturity payback value and the full interest rate the yield will be that figure - what you pay for the bond. If what you pay (the price) rises, the yield falls.

28
Q

How does the inverse relationship between bond price and yield equalise bond yields to interest rate?

A

If bond yields are high compared to the interest rate returns on saving in banks demands for bonds will rise, this will drive bond prices up, this will drive bond yields down, therefore levelling bond yields and interest rates.

29
Q

At what yield will issuers generally provide bonds and may when they not do this?

A

Generally bond issuers will provide bonds with yields equal to the interest rate, they may choose to provide better bond yields if they’re desperate to borrow.

30
Q

How else may be governments/firms raise financial assets other than through bonds?

A

They may issue shares or borrow from a bank.

31
Q

How does issuing shares raise financial assets?

A

The process works largely in the same way as bonds with a subtle difference;It is a more risky investment bc they don’t have a stable interest rate, instead returns are paid as dividends so they depend on the performance of the business.

32
Q

How does borrowing from a bank raise financial assets?

A

As simple as it sounds - the borrower obtains a loan from a bank and will pay an interest rate on that loan based on the interest rate.

33
Q

What are the three key ways borrowers may raise financial assets?

A
  1. Bond Markets2. Share Markets3. Through intermediaries such as banks

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