4.1 The Structure Of Financial Markets And Financial Assets

Question 1

What are the functions of money

Answer 1

• Medium of exchange
• store of value
• unit of account
• standard of deferred payment

Question 2

What does a medium of exchange mean?

Answer 2

Bartering transactions rely on the person selling must also want to buy what you have = makes it difficult to complete transactions
money accepted as a medium exchange means no need to barter = allows for specialisation as safe knowing they can exchange for money

Question 3

What does store of value mean?

Answer 3

Money can be stored away until needed and does not deteriorate

Question 4

Why might store of value not be fully satisfied?

Answer 4

Inflation can erode the value

Question 5

What does a unit of account mean?

Answer 5

Gives products a monetary value which enables people to compare prices and values of different products

Question 6

What does standard of deferred payment mean?

Answer 6

Whereby people who don’t have money right now can buy products, knowing they can pay it back at a later date

Question 7

What are the characteristics of money?

Answer 7

• acceptable
• portable
• durable
• divisible
• limited in supply
• difficult to forge

Question 8

Why does money have to be in limited supply?

Answer 8

So it keeps it value

Question 9

What is commodity money?

Answer 9

Any money that has intrinsic value and will always have it
E.g Gold
- “gold standard”

Question 10

What is fiat money?

Answer 10

Has no intrinsic value, therefore if notes and coins become worthless from hyperinflation you cannot go trade it for something else - it has lost all value

Question 11

What is liquidity?

Answer 11

How quickly something can be turned into notes or coins

Question 12

What is the money supply?

Answer 12

The total amount or quantity of money circulating the economy at a given period of time

Question 13

What is narrow money?

Answer 13

A measure of the highly liquid forms of money, such as notes and coins + deposits in banks that can be immediately changed into cash

Question 14

What is Broad money?

Answer 14

A measure of all highly liquid forms of money = notes and coins + deposits + non cash financial assets of maturity dates of five years or less

Question 15

Function of money definition

Answer 15

A benefit generated by the use of money

Question 16

Characteristic of money definition

Answer 16

A necessary feature of money that must be present for the item to function as money

Question 17

Financial markets definition

Answer 17

Financial markets are any place where buyers and sellers meet to trade financial assets

Question 18

Who are the lenders?

Answer 18

Savers and investors

Question 19

Who are borrowers?

Answer 19

Individuals, firms and governments

Question 20

What are the three financial markets?

Answer 20

Money markets
Capital markets
Currency markets

Question 21

What are money markets?

Answer 21

The market which deals with short-term loans or finance, typically of a maturity date of a year or less

Question 22

What are capital markets?

Answer 22

The market which deals with medium to long-term loans or finance, which typically have a maturity of more than a year

Question 23

What are currency markets?

Answer 23

Lol

Question 24

What are bonds or debt capital?

Answer 24

A form of borrowing which gives the holder a fixed rate of interest and the money is repaid within a set period of time

Question 25

What are shares or equity capital?

Answer 25

These are issued by firms raising finance. These give the holder dividends out of the firms profit and often allow the holder to vote in company affairs

Question 26

What is the primary capital market

Answer 26

This deals with the issue of new securities (bonds and shares)

Question 27

What is the secondary capital market?

Answer 27

This deals with the buying and selling (trade) of securities that have already been issued

Question 28

What is the currency market?

Answer 28

The market that deals with the transaction requiring conversion from one currency into another currency

Question 29

What is the spot currency market?

Answer 29

The market for buying and selling currency at the current exchange rate

Question 30

What is the forward currency market?

Answer 30

The market where you can buy and sell currency at a given exchange rate at a specified time in the future

Question 31

What are debentures or corporate bonds?

Answer 31

Bonds issued by firms

Question 32

What are treasury bills?

Answer 32

A very short-term form of borrowing by the government (usually repaid within three months)

Question 33

Why do individuals buy bonds?

Answer 33

They may give a greater return or interest than other financial assets in the economy

Question 34

Why do people buy government bonds?

Answer 34

They have strong security and it is unlikely that governments will go bankrupt = safe place to store money and get a return

Question 35

What is the coupon

Answer 35

The fixed interest rate that is based on the nominal value of the bond that is paid annually to the bond holder

Question 36

What is the maturity of a bond mean?

Answer 36

The date the bond expires and the time the government or firm has to pay the nominal face value of the bond back to the issuer of the bond

Question 37

What are government bonds also known as?

Answer 37

Gilts

Question 38

What is the relationship between interest rates and bond market prices, and why?

Answer 38

They are inverse.
Because. if interest rates rise saving money in a bank becomes has a relative better return than holding a bond and vice versa

Question 39

What does a yield mean?

Answer 39

The percentage rate of return of a bond

Question 40

Equation to calculate yield

Answer 40

Coupon
Yield = ——————
Market price

Question 41

How much does a bonds market price rise by if the yield is high?

Answer 41

Until the coupon rate when divided by the market price is identical to the current market interest rate

Question 42

What is the role of financial markets in the wider economy?

Answer 42

• ensure finance is available in the economy for firms seeking to maximise their profits
• allows individuals to consume even if they don’t have the fund - through lending
• allows governments to gain revenue and invest into the economy through gilts